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March 2011 Investment Journal 

 Just when markets were getting used to the idea of increased risks from the Middle East, Mother Nature took center stage in March with the devastating Japanese earthquake and tsunami. Stock markets reacted with swift declines, and equally swift recoveries, ending up flat for the month, as were bonds. Gold was up 1.6%, with oil and silver leading the charge in the commodity area.
While the full extent of the damage in Japan is still being gauged, it is clear that nuclear power and uranium moved rapidly out of favor with investors, and the general public, perhaps for a long time. Alternative energy sources were quickly re-appraised, and rebuilding estimates multiplied. A Japanese official stated that "years", not "months" would be required, and that sobering assessment should overlay any investment repercussions from this immense and historic tragedy.
Geopolitical events continued to evolve, especially in Syria and Yemen, as the pushback against the entrenched order gained more momentum. In a hotly debated military move, the U.S. stated that it would not take the lead in Libya, instead supporting a NATO led force to enforce a no-fly zone over Libya. Many market pundits opined how this would further tighten the oil market, since a prolonged resolution of the conflict and less global leadership from the U.S. would make for a riskier world.
In the U.S., budget negotiations were ongoing. Continuing pending resolutions are only a temporary solution, and the longer it takes to agree, the more uncomfortable the markets may become. The Fed met this month and once again tried to downplay the significance of recent increases for food and fuel, while restating their intention to keep interest rates low for the foreseeable future.
The big event this month occurred in Germany, where voters in its most conservative state of Baden-Wurttemberg threw out the center right CDU party after almost 60 years of continuous majority rule. The Green Party won big with its No Nuclear platform, and Chancellor Merkel's party could not placate enough unhappy voters by ramping up its anti-Euro bailout position. Federal elections in this key country are two years off, so it is hard to see how Merkel's position will soften. If anything, the volume should go up on her call for strict limits on further assistance to distressed European debtors.
Portugal, for instance, was the latest country to step into the Eurozone emergency ward, as its government collapsed amid deteriorating finances. Portuguese bond yields have reached new Euro-era highs, and are by most accounts unsustainable. A caretaker government awaits elections this summer, where the Portuguese electorate are primed and ready to vote against any further cutbacks. Spain is circling the neighborhood around the ward, and Italy is on the avenue headed that way. Needless to say, the debt drama of the developed world is going to add a few more European acts this year.
The big theme around debt de-leveraging is how global imbalances persist, posing extreme challenges for central banks. In Europe, one country may be struggling (Portugal), while another is reviving (Germany), yet both are governed by the European Central Bank (ECB), who cannot both simultaneously raise and lower interest rates to account for these differences, especially since they are bound by charter to solely manage an inflation target (not domestic growth and employment as in the U.S.).
These unworkable options are being slowly guided towards a more independent collective effort.  Unnoticed by most this month, Lorenzo Bini Smaghi, a senior ECB executive board member, proposed moving towards an independent global central bank, which would more effectively be able to rectify these imbalances. In a March 4 speech made to the Bank of International Settlements (BIS) in Paris, he stated:
"...the crisis we've been living through the last three years is the result of imbalances accumulated both at the macro and micro level, mainly in advanced economies. Surveillance of these imbalances was clearly insufficient. Any prescription to improve the resilience of our economies must thus include a strengthening of surveillance."
The entire speech is here: Lorenzo Smaghi Speech. The really remarkable proposal is his call for central banks to discard the assumptions and inconsistencies that underlie their forecasting models in the face of a more globalized, less U.S.-centric world. As Smaghi puts it: "The solution to this problem, at least for monetary policy, is to set a rule or establish an independent central bank which is aware of such an inconsistency and has a sufficiently long horizon to avoid it".  The ECB now has joined the U.S. Federal Reserve in emphasizing the need for "globality" (recall Bernanke's speech to the ECB in Frankfurt we reviewed last November in which he called for more "global coordination"). It is likely this idea will gain traction in the over-indebted nations as the "path to payoff" becomes increasingly insurmountable, and currencies jostle to gain an advantage in resuscitating moribund economies filled with aging workers and infrastructure.
There's never a dull moment around here, and we look forward to updating you again at month end. Thanks as always for reading our Journal.

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