Roberta Gudmund sent a message to the members of Future of Democracy.

Subject: Drugged Elephant(s) in the Room: How to Address Off Balance Sheets Hiding Leverage?

Dear Friends

The 158-year old Lehman Brothers' collapse on September 15, 2008, was the largest bankruptcy in US history. That event is etched on the financial world's collective memory because it unleashed the most devastating financial crisis in generations, causing panic in capital markets, accelerating The Great Unwind, and bringing about a virtual freeze in global trade, The Great Reset. This led to trillion dollar rescue packages from Washington and other capitals.

It has taken a year of painstaking research and a 2,200-page report in nine volumes by a Chicago-based lawyer, Anton Valukas, to lift the lid on the management failures, destructive internal culture and reckless risk-taking that confined Lehman to history. The bankruptcy examiner's massive report on the collapse of Lehman Brothers has found "credible evidence" that top executives, including the Chief Executive, approved misleading statements and used accounting gimmicks as drugs to hide the truth from investors and the public. Worse, the report raises serious questions about the behaviour of auditors and regulators, who are supposed to protect the public. Specifically, the report's revelations include:

The Whistle-Blower

Inside Lehman Brothers Holdings Inc, some executives were very concerned about the firm's Enron-like accounting practices as the company headed to the brink in September 2008. In May 2008, Matthew Lee, a former Lehman senior vice president wrote a letter to senior management warning that the company may have been masking the true risks on its balance sheet. His warnings, revealed in the bankruptcy report, show that Lehman's auditors knew of potential accounting irregularities and allegedly failed to raise the issue with Lehman's board. At the time Mr Lee voiced his concerns in May 2008, Lehman was under siege from investors who questioned whether the securities firm was accurately valuing its risky assets. "We are also dealing with a whistle-blower letter, that is on its face pretty ugly and will take us a significant amount of time to get through," William Schlich, a former lead partner on Ernst & Young's Lehman team, wrote in a June 5, 2008, email to a colleague, which is included in the examiner's report.

Repo 105 and The Drug of Balance Sheet Manipulations

In a June 12, 2008, interview with Ernst & Young, the whistle-blower Matthew Lee raised the issue that Lehman was moving as much as USD 50 billion off its balance sheet, using a practice the firm called "Repo 105," the report says. The accounting device was used by Lehman to temporarily park assets off its books at the end of a quarter to make it look as if the firm had less debt, the report concludes, something investors and credit raters would tend to look favourably on. Lehman "had way more leverage than people thought; it was just out of sight," Mr Lee told the examiner in July 2009, according to the report. Herbert "Bart" McDade, the man known inside the bank as its "balance sheet tsar", described the "Repo 105" instruments in an email as "another drug we're on". Another executive ordered traders to "wean themselves off" Repo 105 as if it was a drug.

"The examiner has investigated Lehman's use of Repo 105 transactions and has concluded that the balance sheet manipulation was intentional, for deceptive appearances, had a material impact on Lehman's net leverage ratio and, because Lehman did not disclose the accounting treatment of these transactions, rendered Lehman's [financial statements] deceptive and misleading," the report says. The device was so rare that Lehman could not find a US law firm to give a legal opinion on it, using instead UK-based Linklaters, says the report.


In a meeting the day after they interviewed Mr Lee, Ernst & Young auditors failed to mention his allegations about Repo 105 to Lehman's board "even though the Chairman of the Audit Committee had clearly stated that he wanted every allegation made by Lee -- whether in Lee's May 16 letter or during the course of the investigation -- to be investigated," the report states. The examiner's report doesn't just raise questions as to the liability of Ernst & Young, Lehman's auditor; it raises questions about the entire foundation of public reporting. What precise purpose does it serve to have a supposedly independent auditor -- paid for by the company -- sign off on accounts? After Enron's collapse led to the annihilation of its auditor Arthur Andersen, the industry was meant to have been transformed. Aren't accountants subject to the same searching scrutiny as ratings agencies, regulators and the banks themselves? From Enron to Lehman and from Satyam to Parmalat, it is clear that the major accountants lack either the skill or the determination to ferret out fraud.

Crux of Deteriorating Risk Management

The crux of the report, based on the review of 34 million pages of documents out of the 350 billion pages obtained by Mr Valukas, is its portrayal of Lehman's insatiable risk appetite and its alleged efforts to cover up the extent of its financial crisis. At the end of 2006, senior officials at Lehman decided to increase the ceiling on the firm's risk limits, or how much Lehman stood to lose from its trading and investment activities, Mr Valukas recounts. Madelyn Antoncic, then Lehman's chief risk officer, resisted an increase in the limit from USD 2.3bn to USD 3.3bn but was overruled, according to the probe. By the end of 2007, it was USD 4bn. The report provides a scathing picture of just how weak Lehman's risk-management practices ultimately became -- and how they contributed to Lehman's implosion.

Stress Tests

Lehman Brothers, like its peers, was required to stress-test its trading positions and investments. Despite the risks posed by Lehman's dramatic ramping up of its illiquid investment portfolio, the firm's own stress tests excluded illiquid assets. Specifically, the firm excluded its principal investments in real estate, its private equity investments and its leveraged loans backing buyout deals. For example, a USD 2.3bn bridge loan for the buyout of Archstone-Smith Real Estate Investment Trust in May 2007 was never included in its risk usage calculation, although that single transaction would have put Lehman over its already enlarged risk limit, the examiner notes.


Lehman's practices meant that the firm did not have a true picture of just how vulnerable it was to volatility in capital markets and, more importantly, in the markets for the illiquid assets in which it had invested. The issue was all the more crucial to Lehman because the firm, with only USD 25bn in capital, had far less of a balance sheet buffer than its much stronger competitors.


The bankruptcy examiner's nine volumes report could have far-reaching implications for former Lehman Brothers' executives, including its former chief, Dick Fuld, and its auditors Ernst & Young. The bank that comes out of the report is an organisation prepared to take short cuts and huge risks to boost earnings, where control and accounting procedures were found to be sorely lacking. It also sheds a damning light on the inner workings of some parts of Wall Street that may be hell-bent on maximising profits and hiding losses plus true leverage using off balance sheet techniques. Contagion risks and counterparty failure have been the main hallmarks of The Great Unwind and The Great Reset thus far. In the light of the Lehman report, the question is whether there is a better way to ensure volatile investment banking and proprietary trading functions do not dominate the future stability of the commercial banking and financial intermediation environment that is so critical to real economic activity across the world. Could transparent leverage rules outlawing the use of obscure off-balance-sheet structures achieve this?

The world outside of policy making is still waiting for a fundamental reassessment of banks’ business models with sophisticated off balance sheet activities that hide true leverage. What banks are actually doing inside and how they may play acrobatics with rules to compete with each other has become utterly opaque and non-transparent to the investors, amongst other stakeholders. Wouldn't a single new rule barring off-balance-sheet techniques prevent a future "Lehman Brothers" to use accounting manoeuvres to make itself look financially stronger than it actually is? This is the “drugged elephant in the room” syndrome on which some policy makers have not yet had the time or inclination to focus.

The post mortem report emphasises not only the need for transparent and comparable accounting rules, for improvements in corporate governance, but it also supports the imposition of a transparent group leverage ratio to provide a binding capital constraint -- that Basel risk-weighted rules have been unable to achieve -- and suggests the need for the elimination of non-transparent off balance sheet activities to hide true leverage. These reforms are essential to deal with contagion and counterparty risk that are so integral to the ‘too big to fail’ drugged elephant(s) in the room.


We welcome your thoughts, observations and views. To reflect further on this, please respond within Twitter, Linked and Facebook's ATCA Open and related Socratic dialogue platform of HQR.

All the best

DK Matai

Chairman and Founder:;, ATCA, The Philanthropia, HQR, @G140

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Dear ATCA Colleagues

We are grateful to:  Dr Harald Malmgren presently touring the Far
East having flown from Seoul, South Korea, to Tokyo, Japan, and based
in Washington DC, USA, for "Falling Dollar: Good news or Bad news?";
and Bill Emmott, based in London and Somerset, England, for "The
Falling Dollar is unequivocally Good News"

for their response to the ATCA think piece, "The Weakening US Dollar
and the changing China & Japan Positions" and the more recent
update, "Sterling trading at 14 year record of nearly 2 Dollars."

Dr Harald Malmgren is an internationally recognised expert on world
trade and investment flows who has worked for four US Presidents. His
extensive personal global network among governments, central banks,
financial institutions, and corporations provides a highly informed
basis for his assessments of global markets. At Yale University, he was
a Scholar of the House and Research Assistant to Nobel Laureate Thomas
Schelling, graduating BA summa cum laude in 1957. At Oxford University,
he studied under Nobel Laureate Sir John Hicks, and wrote several
widely referenced scholarly articles while earning a DPhil in Economics
in 1961. His theoretical works on information theory and business
organization have continued to be cited by academics over the last 45
years. After Oxford, he began his academic career in the Galen Stone
Chair in Mathematical Economics at Cornell University.

Dr Malmgren commenced his career in government service under President
John F Kennedy, working with the Pentagon in revamping the Defence
Department's military and procurement strategies. When President Lyndon
B Johnson took office, Dr Malmgren was asked to join the newly
organised office of the US Trade Representative in the President's
staff, where he had broad negotiating responsibility as the first
Assistant US Trade Representative. He left government service in 1969,
to direct research at the Overseas Development Council, and to act as
trade adviser to the US Senate Finance Committee. At that time, he
authored International Economic Peacekeeping, which many trade experts
believe provided the blueprint for global trade liberalisation in the
Tokyo Round of the 1970s and the Uruguay Round of the 1980s. In 1971-72
he also served as principal adviser to the OECD Wise Men's Group on
opening world markets, under the chairmanship of Jean Rey, and he
served as a senior adviser to President Richard M Nixon on foreign
economic policies. President Nixon then appointed him to be the
principal Deputy US Trade Representative, with the rank of Ambassador.
In this role he served Presidents Nixon and Ford as the American
government's chief trade negotiator in dealing with all nations. While
in USTR, he became known in Congress as the father of "fast track"
trade negotiating authority, which he first introduced into the
historically innovative Trade Act of 1974. He was the first official of
any government to call for global negotiations on liberalisation of
financial services, and he was the first US official to call for the
establishment of an Asian-Pacific Economic Cooperation arrangement,
known in more recent years as APEC.

In 1975 Malmgren left government service, and was appointed Woodrow
Wilson Fellow at the Smithsonian Institution. From the late 1970s he
managed an international consulting business, providing advice to many
corporations, banks, investment banks, and asset management
institutions, as well as to Finance Ministers and Prime Ministers of
many governments on financial markets, trade, and currencies. He has
also been an adviser to subsequent US Presidents, as well as to a
number of prominent American politicians of both parties. Over the
years, he has continued writing many publications both in economic
theory and in public policy and markets. He is Chief Executive of
Malmgren Global and also currently the Chairman of the Cordell Hull
Institute in Washington, a private, not-for-profit "think tank" which
he co-founded with Lawrence Eagleburger, former Secretary of State. He

Dear DK and Colleagues

Re: Falling Dollar: Good news or Bad news?

The recent weakening of the dollar has been declared "good news" by
distinguished commentators within ATCA such as Bill Emmott and without.
While a weaker dollar might be good news for the US, it could be very
bad news for the rest of the world!

When the dollar falls, the flipside is that the valuations of other
currencies rise. A dollar decline would improve the competitiveness of
American exports in world markets while cutting the competitiveness of
exports of other nations. The US economy is primarily driven by
domestic consumption - but most of the other major economies around the
world, and almost all emerging market countries, are dependent on
external demand to maintain growth. The core economies of the Eurozone
have tepid, and in some cases, even negative domestic consumption. More
than a third of China's GDP is derived from exports. Although India has
strong domestic consumption, economic growth in the rest of the world's
emerging markets is primarily driven by foreign demand for their

By itself, this might not be so troublesome. But the US economy is the
primary engine propelling global economic growth. Now, as a result of
the slumping US housing market and other domestic factors, the US
economy is slowing down, and in the next year it can be expected to
slow even more. Already, it is evident that this US slowdown is
resulting in slowing global economic growth. In 2007 we can expect a
much slower pace of global demand, and therefore slower growth in all
of the export-dependent economies of the world.

During the last few years of robust American economic growth the
supposedly buoyant economies in Continental Europe have only managed to
eke out an economic growth rate about half that of the US. This is
because the core economies of the Eurozone have not been politically
able to address structural reforms, and have remained dependent on
external demand. Now, as the US slows from an average rate of growth of
GDP of 3.5 or 4.0 percent per year to a much slower 2.0 percent per
year - or even less - world economic growth will fall back. It is
incorrect to evaluate European export prospects in terms of exports to
the US. European exports to the whole world are likely to suffer as
global growth slips. In a context of slowing global growth, the
Eurozone is likely to fall back to stagnation, or possibly even

Some economic analysts argue that the US economy is not the only engine
of global growth. They argue that China has become the "other engine."
But the momentum of China's economy is highly sensitive to export
demand. This is not simply a matter of exports to the US; it is a
matter of dependence on worldwide demand for Chinese exports. The
Chinese government and most Chinese business leaders have not yet
considered the damage that might be wrought by a global slowdown, but
there can be little doubt that the pace of growth in China will suffer
shocks from weakened external demand. The Chinese economy cannot remain
an independent engine of growth if the US economy slows - and now, the
US economy is slowing.

As global economic growth slows, the growth of world trade will also
decelerate. If the dollar becomes markedly weaker, it is helpful to the
US economy, because US exporters can steal market share in competition
in a weakening world marketplace. But the US gain will be at the
expense of other nations like Germany, France, Italy, South Korea, and
Japan. Small wonder then that European finance ministers are already
grumbling about excessive strengthening of the Euro. They are fearful
that the Euro's continued rise will bring to a halt the recent
improvements in the economies of Continental Europe, and return the
bigger economies of the Eurozone to higher unemployment and stagnation.
If the dollar is to fall much further, the Euro correspondingly will
have to rise much more - to the breaking point, so far as Europe's
hopes for continued recovery are concerned.

In a context of global slowdown, central banks and private investors
alike will have to rethink where to park their financial assets during
times of economic trouble. There will likely be what financial analysts
call a "flight to quality." The safest parking place in times of
trouble is the US dollar. It is still the primary currency dominating
trade and investment transactions worldwide. It is the largest, most
liquid financial market in the world - easy to enter, easy to adjust
from one type of asset to another, easy to sell when you want to sell -
and US dollar assets are one of the most legally protected types of
assets available in the global marketplace.

Is there any alternative market or group of markets big enough to
absorb a massive flight from the dollar? The gold market is far too
small. Sterling and the Eurozone financial markets are simply not big
enough and especially not liquid enough to absorb a massive shift from
dollars - and European governments anyway would simply not allow the
Euro to rise sharply as a result of a big swing to the Eurozone. Some
speculative capital has sought refuge in commodities, or in real estate
and other assets. But all of the alternatives are less liquid than
remaining in dollar-denominated assets. In times of potential world
economic trouble, the safest parking place for capital is the biggest,
most liquid market, which is the dollar-based market.

In the context of slowing global growth, and potential recession in
some countries, there will eventually tend to be a return of foreign
capital to US Treasuries, or to US dollar-denominated debt instruments
like corporate bonds, mortgage-backed securities, and the explosively
growing array of other securitized assets and financial derivatives. A
dollar decline combined with global slump will bring about a rebound in
demand for the dollar eventually.

In the meantime, the Federal Reserve has essentially lost control of US
market rates of interest. The Fed can set short-term rates, but
long-term rates have already fallen below the Fed's target rate,
signalling that investors in the US and throughout the world believe
that an economic slowdown is under way and that the Fed will have to
yield next year and begin cutting US interest rates. The flow of
capital into the US debt market is growing, and this is driving down
long-term interest rates in the US, and reducing the spread between
interest rates on private debt and on US government debt

As for other major central banks, they are beginning to feel this
economic downdraft, as longer-term interest rates in their markets are
falling to, or even below, their short-term targets. The European
Central Bank (ECB) is still talking publicly about the need to be
"vigilant" about inflationary pressures, but its members are well aware
that a continued rise in ECB rates next year would plunge European
economies into recession, in a context of flagging global economic

Many press and media commentators have expressed alarm that the
governments of China, Japan, the OPEC countries, and other major
holders of US Treasuries in their reserves might panic and sell of
their dollar holdings as the dollar declines. They repeatedly argue
that present "global imbalances" are unsustainable, and that a global
currency meltdown lies ahead, perhaps triggered by the dollar's

Would central banks really sell of dollar holdings and rush to assets
denominated in Euros or other currencies? Consider China: The currency
reserves of the Chinese government now include dollar-denominated
assets totalling nearly one trillion US dollars. Some Chinese
authorities recently suggested that Chinese reserves need to be
"diversified." A common interpretation in the press has been that this
means selling off the dollar, but so far that has not happened. A
massive sell off of Chinese holdings of dollars would not only weaken
the dollar, it would cut the value of their remaining dollar holdings.
The Chinese government has too large a stake in dollar assets to allow
an unwanted reduction in the value of their reserves.

Chinese monetary authorities have actually been diversifying the
composition of their dollar-denominated holdings, but not by selling of
dollar assets. Instead, they have gradually been reducing the share of
US Government Treasuries held and increasing the share of other
dollar-denominated debt instruments. For example, there has been a huge
increase in Chinese official demand for higher-yielding US private,
mortgage-backed securities. From the Chinese point of view, this is an
appropriate risk management practice, to seek assets with a higher
return to offset potential moderate dollar weakening.

Stepping back from the technicalities of Chinese management of the
composition of their national reserves, it is evident that Chinese
government policy has strongly resisted significant strengthening of
the value of their own currency. US and European financial authorities
have pounded the Chinese government about the need for a significant
appreciation of the Yuan, but the Chinese have defiantly refused to
comply. They have allowed a very small adjustment, and made vague
promises about additional, gradual adjustments in the future,
essentially ignoring foreign pressures.

This stubborn resistance to appreciation of the Chinese Yuan is
primarily motivated by domestic politics in China. The Chinese national
leadership is finding itself in a predicament. The leadership wants to
maintain its political power over the nation, but it is rapidly losing
its grip on an economy which is increasingly managed locally, by local
governments and local businesses which are unresponsive to Beijing's
demands. The Chinese economy is evolving into wild-west capitalism,
functioning under the Golden Rule: Those who have the gold make the
rules. Disparities in incomes and disparities between the rich coastal
provinces and the interior are growing dramatically. Local governments,
operating in corrupt relationships with local businesses, are
increasingly exploiting local populations and confiscating their land.
Incidents of public violence at the local level now occur throughout
China at a rate of several a day - though the scope and intensity of
this violence is little reported in world press and media.

In this volatile Chinese political situation, currency policy is
decided by the Standing Committee of the Politburo of the Communist
Party, not by the central bank or the ministry of finance. The
Politburo leadership knows that a weak currency helps to keep
unemployment from exploding. A stronger Yuan would severely hurt inland
farmers and rural business and banks, generating far more violence and
a river of people flowing from the interior to the coastal cities in
search of jobs. For the Politburo, a major change in the relationship
of the Yuan to the US dollar could mean the collapse of the central
government leadership. I have often said about China that it is a
country with one flag but many governments. A severe shock generated by
a big currency swing could potentially threaten the survival of the
current Communist leadership, and even bring about a China with more
than one flag. This is too big a risk for the current members of the
Politburo. In essence, the political leadership does not want the
dollar to decline significantly. Selling off US Treasuries or the
dollar is inconceivable in this volatile political context.

What about Japan's vast holdings of US Treasuries? The Japanese
government has not intervened in currency markets for a very long time.
The current weakness of the Yen is not the result of currency
intervention, but rather the result of the low domestic interest rate
policy of the Bank of Japan and the government. For example,
speculative investors throughout the world continue to borrow funds in
Japan at absurdly low interest rates and then sell the Yen proceeds in
order to buy other currencies to be used for investment in assets in
many other markets. Japanese households increasingly seek to invest in
foreign-denominated assets which provide much higher yields than the
miniscule interest on Japanese savings accounts or Japanese government

Japan's domestic interest rate policy thus results in a weak currency.
If world financial market forces brought about a modest increase in the
value of the Yen, the Japanese government would not resist. But the
Japanese central bank and government are not about to jack up domestic
interest rates sharply in response to pressures from General Motors for
a stronger Yen - Japan's newly emerging economic recovery is far too
delicate to sustain a big increase in domestic borrowing costs.
Japanese authorities are preoccupied with keeping a tentative, modest
economic recovery alive, especially now before next July's Upper House
elections. A big interest rate hike is politically out of the question.
I expect Japanese interest rates to rise, but only very, very
gradually, over years, not months.

Some central banks, like those in the Arab OPEC countries, assert a
dislike of dollars, but if we look closely, the vast surpluses
generated by rising oil revenues tend to be managed by professional
money managers in various financial centers around the world, and they
in turn place a dominant share of these surpluses into
dollar-denominated assets. They, too, see no alternative. The OPEC
producers will also not panic and sell off all their dollar holdings.

Some analysts say the answer to all this confusion and the dangers of
continued "global imbalances" must lie in an official realignment of
currencies. This has been talked about for years, but the major
governments around the world want no part of it. Politicians in Europe
and Asia do not want to be seen to be responsible for allowing a big
rise in the value of their currencies, especially since it would
cripple their economies. An official realignment is not politically
possible, especially now, in the context of a global economic slowdown.

For the US, as I have said, a moderately falling dollar could be
beneficial for US exporters. Even more beneficial has been the strong
flow of domestic and international capital into the US public and
private debt market, because this is bringing long-term interest rates
down in the US economy. Mortgage rates are consequently falling,
gradually putting in place a shock-absorber under the US housing
market. But it must be recognized that the housing slump is not over.
Only recently, former Federal Reserve Chairman Greenspan pronounced the
housing downturn to have hit bottom. No one directly involved in the
housing market agrees. Most builders foresee many more months of
weakening demand and falling valuations of homes, before the bottom is
found. About one-third of all new jobs created in the US are directly
or indirectly generated by home construction, so we can expect
continued downward pressures on the US economy. Households will
gradually feel growing pain as the values of their homes appear to
fall. Employment figures will look increasingly weak. Household
consumption will become increasingly cautious. The most likely result
of all these forces, together with falling US interest rates, will be a
slowdown, but not a recession. However, we cannot rule out an American
recession. It is too early to tell where the bottom lies.

For the rest of the world, the 2007-08 outlook is gloomy. A continued
weakening of the dollar in this context is good news for the US, but
bad news for everyone else.

Harald Malmgren

-----Original Message-----

From: Intelligence Unit

Sent: 01 December 2006 11:58

To: ''

Subject: ATCA: Sterling trading at 14 year record of nearly 2 Dollars;
Emmott -- The Falling Dollar is unequivocally Good News; The Weakening
US Dollar and the changing China & Japan Positions

Dear ATCA Colleagues

[Please note that the views presented by individual contributors are
not necessarily representative of the views of ATCA, which is neutral.
ATCA conducts collective Socratic dialogue on global opportunities and

Re: Sterling trading at 14 year record of nearly 2 Dollars

The British Pound (GBP) remained close to its highest level against the
US Dollar since Sterling left the Exchange Rate Mechanism (ERM) in
1992, despite positive economic news from the United States. Sterling
strengthened to USD 1.9670 moving towards USD 2.0 by end-of-December
according to Forex forecasters as fears over the US economy persisted
in the face of better-than-expected growth figures in the US.

The dollar has been struggling since late last week over fears that the
Federal Reserve will cut interest rates in a bid to boost the ailing
economy. The strong pound is good news for Britons heading to New York
for their Christmas shopping with tourists getting as much as 1.93 US
dollars for every pound at high street exchanges. It also benefits
firms importing goods from overseas as they get more for their money,
although it is bad news for British businesses reliant on exports as it
makes their goods more expensive to buy.

The dollar managed to recover slightly against the euro, however, as
European officials warned about the Euro's recent surge. The euro
softened from its 20-month peak of 1.3218 US dollars to 1.3170 US
dollars after French Prime Minister Dominique de Villepin said the
Euro's rise was weighing on competitiveness. French finance minister
Thierry Breton also warned that strong movements in currencies are
never good.

It came as the US Commerce Department said US gross domestic product
increased at a 2.2% annual rate in the third quarter - well above the
1.6% initially expected. The figures bolstered views that the US
Federal Reserve can hold off a cut in interest rates which could
undermine the dollar further. It fell sharply yesterday as a spate of
disappointing US economic news added further weight to the view
interest rates will be cut.

-----Original Message-----

From: Intelligence Unit

Sent: 29 November 2006 12:21

To: ''

Subject: Response: Bill Emmott -- The Falling Dollar is unequivocally
Good News; ATCA: The Weakening US Dollar and the changing China &
Japan Positions

Dear ATCA Colleagues

[Please note that the views presented by individual contributors are
not necessarily representative of the views of ATCA, which is neutral.
ATCA conducts collective Socratic dialogue on global opportunities and

We are grateful to Bill Emmott, based in London and Somerset, England,
for his response, "The Falling Dollar is unequivocally Good News" to
the ATCA think piece, "The Weakening US Dollar and the changing China
& Japan Positions."

Bill Emmott was the Editor-in-Chief of The Economist, the world's
leading weekly magazine on current affairs and business, from 1993
until March 31st 2006. He is now an independent writer, speaker and
consultant. After studying politics, philosophy and economics at
Magdalen College, Oxford, he moved to Nuffield College to do
postgraduate research into the French Communist party's spell in
government in 1944-47. Bill has written four books on Japan -- The Sun
Also Sets: the limits to Japan's economic power, Japan's Global Reach:
the influence, strategies and weaknesses of Japan's multinational
corporations, both of which were best-sellers, and Kanryo no Taizai
(The bureaucrats' deadly sins), published only in Japanese. Most
recently, he wrote a book version of an extended essay, published in
The Economist in October 2005 and called "The Sun also Rises" to echo
his 1989 book. This longer, book version was published in Japanese
translation under that same title (Hiwa Mata Noboru) by Soshisha in
January 2006. In February 2003 he published a book about the global
issues of our times called "20:21 Vision - 20th century lessons for the
21st century". Bill writes a column on international affairs for a
Japanese monthly magazine, Ushio. He is currently working on a new
book, about the rivalry between Japan, China and India.

Bill Emmott is a member of the executive committee of the Trilateral
Commission, a member of the BBC World Service Governors' Consultative
Committee, a director of Development Consultants International, a
Dublin-based company, a member of the Swiss Re Chairman's Advisory
Panel, a director of the UK-Japan 21st Century Group, and co-chairman
(with The Hon Roy MacLaren) of the Canada-Europe Roundtable for
Business. He was a director of The Economist Group from 1993 until
2006. He has honorary degrees from Warwick and City Universities, and
is an honorary fellow of Magdalen College, Oxford. He writes:

Dear DK and Colleagues

Re: The Falling Dollar is unequivocally Good News

The fall of the dollar is unequivocally good news, both for America and
for the rest of the world. Everyone has known for years that America's
economic path could not continue in the same direction for ever:
economic growth financed by ever-increasing borrowing from abroad and
by a reduction in households' saving rate, that has boosted
consumption, was not in itself either bad or wrong, but it was simply
unsustainable. We cannot know in advance whether this drop in the
dollar truly signals an end to that (long) phase of development or not,
but if it does it would be healthy. These huge capital imbalances are
best thought of through the metaphor of avalanche risk at a ski resort:
resorts need snow just as economies need capital, but if too much
accumulates then there is a risk of a sudden adjustment, as in an
avalanche. It is better if the adjustment can be managed more steadily.

Can it be? Like Alan Greenspan, I would place some faith in the
flexibility of the American economy. Falling house prices will hurt
those who have borrowed excessively on the collateral of homes and will
depress consumption more widely. The falling dollar will begin (slowly)
to compensate for that by helping American exporters. Monetary policy
is likely either to be left unchanged or to be loosened as growth
slows, so that may act as some support too. There is some fear of
inflation, but if America's economy really does slow substantially or
even go into recession, then the resulting drop in demand for oil and
gas in the world's largest energy consumer is, other things equal,
likely to bring about a further fall in energy prices worldwide,
somewhat easing the inflationary pressure. Of course, other things may
not be equal: supply disruptions caused by terrorism or other conflict
could intervene. But although such factors are unpredictable, at least
I would say that the likelihood of American military attacks on Iran,
which have been the subject of some speculation, must now be extremely
low. If all the aforementioned speculation proves correct, then we
could reasonably expect America's flexibility in the allocation of
resources to produce what might be called a "fast in, fast out"

Some people worry that the dollar's collapse could be so rapid as to
force the Fed to raise interest rates sharply, worsening the recession;
or so rapid as to produce a big jump in bond yields, raising the cost
of corporate borrowing and worsening the recession in that manner. One
cannot rule such an outcome out altogether, but I take some comfort
from the fact that overseas dollar holdings, in the form of US Treasury
bonds, have been so concentrated in the hands of central banks in
China, Japan and the Gulf. Such authorities are less likely to rush
headlong for the exit doors than are private investors. In both
political and financial terms, they know that a dollar collapse would
not be in their interest. If anyone can manage this adjustment in a
steady, careful way, it would be them.

Best wishes

Bill Emmott

Dear ATCA Colleagues

[Please note that the views presented by individual contributors are
not necessarily representative of the views of ATCA, which is neutral.
ATCA conducts collective Socratic dialogue on global opportunities and

Re: The Weakening US Dollar and the changing China & Japan Positions

The US Dollar (USD) extended its declines on Tuesday, sending the Euro
above USD 1.32 for the first time since March 2005, as US data
supported expectations the US central bank -- The Federal Reserve --
may cut interest rates early next year. The USD fell to a new 20-month
low against the Euro on Tuesday, as a spate of disappointing US
economic data further dimmed the prospect of higher interest rates in
the world's largest economy. A long-term factor behind the weakening
Dollar is the widening US current account deficit and many market
watchers say that the Dollar is just beginning to catch up with the
fact that the United States is deep in debt, a significant chunk of
which is held by China and Japan. Both the Asian powers are beginning
to review their entrenched positions in regard to the value of their
own currencies and the mix of their foreign reserves and holdings.

China's foreign reserves are thought to have exceeded USD 1 trillion
after officially hitting USD 987.9 billion by late September. To keep
its own exports cheap, China has been artificially controlling the
value of the Yuan, which is significantly undervalued in terms of real
market rates. The country's central bank on Monday bumped up the Yuan's
official level to 7.8402, and the currency traded at a record high
versus the US Dollar. Still, daily movements are limited at 0.3 percent
above or below the official level -- a trading system set up in July
2005. China's central bank, the People's Bank of China, refused to
comment Tuesday on rumours that Beijing is shifting its foreign reserve
holdings away from US Treasuries. Speaking in Beijing Friday, the
bank's Vice Governor, Wu Xiaoling, allegedly noted the risks arising
from the US Dollar's decline for East Asian holders, triggering further
Dollar selling.

Earlier this month, the US Treasury Department said foreigners sold
more Treasuries than they bought in September for the first time in
three-and-a-half years. However, the selling was led by Japan, the
largest holder of US Treasuries. Japan's holdings fell in September to
USD 639.2 billion from USD 644.3 billion in August. China, the
second-largest holder of US Treasuries, boosted its stake to USD 342.1
billion in September from USD 339.1 billion the prior month.

A US government report showed October orders for long-lasting goods and
equipment fell 8.3 percent, the biggest decline since July 2000, ie,
more than six years. The median home price saw its largest
year-over-year decrease ever, and consumer confidence fell to its
lowest reading since August. The reports -- which suggest to investors
that the slowing US economy may not be able to withstand a rate hike --
were enough to overshadow comments from US Federal Reserve Chairman Ben
Bernanke that inflation is 'uncomfortably high.' Higher interest rates,
a weapon against inflation, tend to strengthen a currency by making
investments in that denomination more attractive and vice-versa.

Since the US Dollar began to weaken last Wednesday, the Euro has
strengthened by more than 2 percent, taking its gains for the year to
around 11 percent. Another report on Tuesday showed sales of existing
US homes rose in October for the first time since February. That caused
the Dollar to pare its losses, although traders cautioned against
reading too much into the one-month move. A weakening Dollar can be a
double-edged sword for the US economy; it decreases Americans'
purchasing power, but it makes US goods cheaper for foreigners, and
therefore more competitive in the global market.

Former Federal Reserve Chairman Alan Greenspan, speaking at an investor
conference Tuesday, said concerns over the US Dollar were unnecessary
if the US economy stays flexible. He added that forecasts about the
Dollar's direction are about as reliable as a coin toss: "Everyone has
an opinion on which way the Dollar will go ... and half of them will be

We look forward to your further thoughts, observations and views. Thank


Best wishes

For and on behalf of DK Matai

Chairman, Asymmetric Threats Contingency Alliance (ATCA)