On the last leg of his four-nation tour in Asia, U.S. President Barack Obama revived the issue of a still-pending free-trade agreement signed in 2007 with South Korea (KORUS FTA), but an auto trade imbalance will continue to be a major obstacle to Congressional approval.

At a news conference in Seoul, President Obama and Korean President Lee Myung-bak, both showed willingness to renegotiate elements of the deal and to have both countries ratify it as soon as possible.

“I am a strong believer that both countries can benefit from expanding our trade ties,” President Obama said. “I have told President Lee and his team that I am committed to seeing the two countries work together to move this agreement forward.”

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That could be easier said than done, especially for Capitol Hill democrats that rely on support from labor unions.

“Before we move forward with the U.S.-Korea Free Trade Agreement, I feel it necessary to remind my colleagues in Congress that the draft agreement allows Korean discriminatory treatment of imported U.S. automobiles to perpetuate,” said U.S. Rep. John Dingell, D-MI today (Friday).

Certain Korean cars are among the bestsellers here, he said, while U.S. automakers have “grave difficulties accessing the market.”

Those difficulties can be attributed to an 8% duty on U.S. auto exports to Korea as well as taxes on engine displacement, both of which would be removed under the trade agreement.

Despite this, officials in both Washington and Detroit say the deal doesn’t address certain non-tariff barriers, which are preventing more American cars from entering Korea, a report in The Korea Herald says.

Kim Do-hoon, an economist at the Korea Institute for Industrial Economics and Trade (KIET) argues the deal addresses all U.S. concerns, including Seoul’s safety and environmental standards as well as the removal of the duty on autos.

The opposition to the deal stems from Korea’s domestic auto tax laws on larger cars, which are typically American, Kim says. Korea’s auto registration tax and special consumption tax are on the rise as a measure to contain the growing demand for bigger cars by Korean consumers.

“Our auto taxation system is of a domestic issue and not deliberately aimed at being a non-tariff barrier, so it could be that this is acting as a misunderstanding,” Kim said. “This is a domestic issue, a policy-related measure aimed at encouraging consumption of smaller cars to reflect our national challenges, whether it be environmental or traffic-related. I don’t think the U.S. should mistake our local taxation regulations as an intentional means by the Korean government to prevent American automakers from making business here.”

When it comes to autos, there’s a huge trade imbalance between the United States and Korea. In 2008, U.S. auto exports of 7,000 to Korea represented just 1% of Korean imports.

However, many analysts believe this imbalance is being dictated by the market not trade barriers.

“The Korean government has opened up the domestic car market to the fullest satisfaction of the U.S. in the FTA,” KIET’s Kim said. “There is no more to open up in this sector, so I think it is only fair to say that the auto issue is more of a subject of political rhetoric for the Obama administration aimed at catering to the sensitive labor group.”

It is not clear whether further negotiation on autos is an option.

“If automobiles are a problem, we are in a position to discuss them again,” President Lee said yesterday (Thursday) during a joint news conference with President Obama.

However, one official from the Korean president’s office speaking to The Herald on the condition of the anonymity says a deal is a deal.

“If we rewrite the document, that is a renegotiation. It is the government’s policy that the agreement not be changed.”

Korean Trade Minister Kim Jong-hoon appeared to clarify the Korean president’s remarks, saying “it just means if they say there are problems, we are willing to listen. But I believe most of the problems [the United States] prepare and bring to us, if they do, will be those that can be addressed by simple explanations,” he added.

News and Related Story Links:

• Wikipedia:
  South Korea President Lee Myung-bak
• The New York Times:
  South Korea Trade Pact is Revived by Obama
• The Korea Herald:
  Seoul Rules Out U.S. FTA Revision
• Los Angeles Times:
  A “Grand Bargain” for North Korea

Concerned with accelerating inflows of so-called “hot money,” more emerging market nations are considering new capital controls to keep their currencies from appreciating and prevent asset bubbles from becoming a problem.

Loose monetary policy in the United States and Europe has flooded fast-growing Asian economies where Western investors are seeking higher yields. India, Taiwan, South Korea, Hong Kong, and Indonesia are among the regions investigating options to combat the rapid inflows of foreign capital that are driving up stock prices, and threatening their export sectors by forcing their currencies to appreciate.

“With interest rates exceptionally low and with abundant liquidity around the world, Hong Kong faces the potential risk next year that asset prices may go up sharply and become increasingly disconnected from economic fundamentals,” the Hong Kong Monetary Authority said on its Web site.

Hong Kong attracted a record $73 billion (HK$567.5 billion) in foreign inflows between Oct. 1, 2008 and Nov. 13, 2009, according to the Hong Kong Monetary Authority (HKMA). That has driven a 57% surge in Hong Kong stock prices and a near-30% in property values.

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Foreign investors have plowed more than $15.5 billion (732.5 billion rupees) into India’s stock market this year, helping push it 75% higher. The rupee has surged about 4.7% against the dollar as a result and further increases could stymie the nation’s exports.

Meanwhile about $15.5 billion (NT$500 billion) in foreign funds has poured into Taiwan dollar accounts – five times more than what the nation’s central bank considers acceptable.

Some emerging market nations have already taken action. Brazil last month imposed a 2% tax on foreign investment in the country’s stocks and bonds, hoping to halt the appreciation of its currency, the real.

Additionally, Brazil’s Finance Ministry said Tuesday that it will soon start taxing the issuance of depositary receipts in international markets, in a bid to prevent companies from selling shares abroad instead of locally. The Bovespa Index has surged 136% this year in dollar terms.

China, too, has taken measures to alleviate the pressure hot money has put on its currency. In October, the central government – for the first time in 17 months – allowed mutual fund companies to resume purchases of foreign assets through its Qualified Domestic Institutional Investors (QDII) program.

E Fund Management Co. Ltd., China’s fifth-largest mutual fund company, and the smaller China Merchants Fund Management Co. Ltd. both obtained investment quotas from the State Administration of Foreign Exchange (SAFE). SAFE approved $1 billion in investment for E Fund and $500 million for China Merchants. That means both funds are now free to invest in offshore markets such as stocks and bonds.

And on Friday, SAFE issued another $1 billion quota to Bosera Fund Management Co. under the QDII program.

While the quotas aren’t particularly large they provide an outlet for hot money inflows as well as the government’s massive trade imbalance.

China’s foreign exchange reserves rose by $141 billion in the third quarter to $2.27 trillion in September. Combined with the trail of hot money that has followed the economy’s recovery, China’s forex holdings are pressuring the yuan to rise.

Analysts say that measures like the ones taken by Brazil and China are just the beginning.

“I think this is going to be one of the big trends in Asia… There is a very strong risk that other countries start to jump on the bandwagon and try these things out,” Richard Kelly, a senior economist at TD Securities Inc., told The Globe and Mail .

News and Related Links:

• The Globe and Mail:
  Emerging economies hit brakes on ‘hot money’

• Money Morning:
  Tax on Foreign Investment Won’t Dent Brazil’s Currency

• Money Morning:
  China Encouraging Overseas Investment to Take the Pressure Off of Its Currency

The Organization for Economic Cooperation and Development (OECD) more than doubled its 2010 forecast for developed nations, saying that strong growth in Asia – particularly China – would help pull the “more feeble” West out of its financial malaise.

After predicting in June that the combined economy of its 30 member nations would grow 0.7% in 2010, the OECD raised its forecast for developed economies to grow 1.9% next year and 2.5% in 2011. Economic output will contract by 3.5% this year, the Paris-based organization said today.

“We now have the numbers that support a recovery in motion,” Jorgen Elmeskov, the OECD’s acting chief economist, told Bloomberg News. “It’s still a slow recovery because of considerable headwinds from the need to adjust the balance sheets of households, enterprises and financial sectors.”

The OECD cautioned that the recovery is still fragile in developed nations, while pointing to China as the main catalyst for a global rebound.

“The upturn in the major non-OECD economies, especially in Asia and particularly China, is now a well-established source of strength for the more feeble OECD recovery,” said the OECD, whose only two Asian members are Japan and South Korea.

U.S. gross domestic product (GDP) should expand by 2.5% in 2010 and eurozone growth will accelerate to 0.9%, the group said. In June, the OECD had projected 0.9% growth for the United States and flat growth for the eurozone. The OECD said Japan should expect GDP growth of 1.8% in 2010 instead of 0.7%.

That compares to 10.2% GDP growth in China.

The OECD also released its first 2011 forecasts, suggesting 2.8% growth for the United States, 1.7% growth for the eurozone, 2% growth for Japan, and 9.3% growth for China.

“Outside of the OECD, things are more buoyant, especially in Asia,” Elmeskov told Bloomberg. “The non-OECD countries weren’t affected by asset-price meltdowns as much and up to the downturn ran sensible economic policies.”

These growth rates are far from guaranteed, however, as unemployment and growing debt presents a serious threat. The OECD said unemployment in its 30-nation bloc would increase by 21 million by the end of 2010, compared to 2007. Gross debt among developed countries may exceed their total GDP by 2011. Debt currently equates to 90% of the nations’ total GDP.

Because the recovery is inherently weak, the U.S. Federal Reserve and other policymakers should keep monetary policy loose. The group’s projects assume that the Fed and European Central Bank (ECB) will keep their interest rates unchanged for most of next year.

The Fed has set its benchmark Federal Funds Rate to a record-low range of 0%-0.25% and the ECB’s rate stands at a record-low 1%. Policymakers should maintain these rates despite the risks that asset bubbles will form, Elmeskov said.

“We are talking about a risk here, not something that is happening,” Elmeskov said. “One can say that given where we are there’s little alternative to very low rates but we need to be aware that they could imply the risk of bubbles forming.”

News and Related Links:

• OECD:
  OECD Economic Outlook No. 86, November 2009
• OECD:
  Recovery still too timid to halt rising unemployment, says OECD Economic Outlook
• Bloomberg News:
  OECD Doubles 2010 Growth Forecast, Recovery to Widen
• Reuters:
  Asia helps feeble West in global recovery -OECD

In a warning that focuses on the need to contain the soaring federal deficit, U.S. President Barack Obama yesterday (Wednesday) said that a continued accumulation of government debt could be enough to blunt the recovery and then drop the U.S. economy into a “double-dip” recession.

It was President Obama’s most-severe warning yet about the dangers of growing budget deficits at a time when the U.S. unemployment rate is at 10.2% and climbing. The comments were made to Fox News during an interview granted in Beijing during the president’s nine-day trip through Asia.

“I think it is important, though, to recognize if we keep on adding to the debt, even in the midst of this recovery, that at some point, people could lose confidence in the U.S. economy in a way that could actually lead to a double-dip recession,” President Obama told Fox News interviewer Major Garrett.

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A “double-dip” recession occurs when an economy emerges from one downturn, only to sputter, stall and quickly drop back into another recession.

Challenge Facing Obama

The Obama administration faces the unenviable task of somehow transforming the nascent U.S. economic rebound into a full-blown and lasting economic recovery, while at the same time finding a way to engineer a long-term and lasting reduction in the nation’s massive budget deficits, analysts say.

The budget deficit – and the damage the debt is inflicting on the U.S. dollar – is almost certain to be a topic of conversation when President Obama meets with China’s government leaders. President Obama was in Beijing as part of an Asian tour that was scheduled to address global economic challenges.

In a candid interview, President Obama said his administration is trying to balance the need to rev up the economy – without adding to the budget shortfalls created as the nation’s leaders try to “prime the pump” after one of the worst financial crises in history. The president said that he’s still considering additional tax incentives for businesses as a way of reversign the surging jobless rate.

“There may be some tax provisions that can encourage businesses to hire sooner rather than sitting on the sidelines. So we’re taking a look at those,” President Obama told Fox News.

Money Morning Sees Little “Double-Dip” Risk

In a news-analysis story published earlier this month, Money Morning Contributing Writer Jon Markman said that a new research report concluded that the odds of a double-dip recession occurring right now are very low. That means that a drop back into recessionary conditions looks less and less likely even as unemployment creeps higher and has crossed the 10% threshold for the first time in a quarter century.

Deutsche Bank AG (NYSE: DB) economists – who conducted the research – reviewed U.S. economic history all the way back to the 1850s, and found that double-dip recessions are exceedingly rare: There have only been three episodes in which the economy has fallen back into recession within a year of a previous recession ending. And that’s out of 33 recessions that have taken place since 1854.

Indeed, when these double-dip downturns do occur, they happen under circumstances quite different from today’s situation, Markman wrote.

Two of the three double-dips happened in the years prior to World War II – in 1913, and again in 1920. The more relevant example was the double-dip recession of the early 1980s, which was driven by the fight against double-digit inflation rates.

U.S. President Jimmy Carter imposed credit controls in March 1980, which resulted in a sharp but short-lived recession before the economy expanded again for 12 months. Then U.S. Federal Reserve Chairman Paul A. Volcker hiked short-term interest rates to 20% in the summer of 1981, as he pushed the economy back into recession while dealing a death blow to inflation.

With deflation just as likely as inflation at the moment, a repeat of the 1980s just isn’t in the cards, as the Fed is set to keep rates at very low levels until the end of 2010, Markman said.

In the leadoff story to its ongoing “Outlook 2010” economic-forecasting series which debuted this week, Money Morning concluded that the U.S. economy would dodge the double-dip downturn that has been the focus of so much fear since the Bush and Obama administrations launched their financial counterattacks on the worst financial crisis since the Great Depression.

However, Money Morning also found that economic forecasters are reluctant to predict a sharp economic rebound for 2010. In fact, as opposed to a classic “V-shaped” economic recovery that would accelerate as the year goes on, many economists are predicting that the rate of growth will slow as the New Year unfolds.

[ Editor's Note : To read Money Morning 's “Outlook 2010” story on the U.S. economy, please click here. The story is accessible free of charge.]

News and Related Story Links :

• Reuters:
  Obama: Too much debt could fuel double-dip recession
• FoxNews:
  Obama Calls Israeli Settlement Building in East Jerusalem ‘Dangerous’
• NPR:
  Obama Warns Of ‘Double-Dip Recession’; Says Afghan Decision Is Weeks Away
• Investopedia:
  Double-Dip Recession
• Money Morning “Outlook 2010” Annual Economic Forecasting Series (U.S. Economy Part I of II):
  U.S. Economy Will Dodge a Double-Dip Downturn, But Won’t Escape Unemployment Woes During 2010 Jobless Recovery
• Money Morning Week Ahead Column:
  Investors Needn’t Fear a Double-Dip Recession
• Wikipedia:
  Paul A. Volcker
• WhiteHouse.gov:
  Jimmy Carter

Having gone “all in” on a U.S. economic recovery with his $44 billion acquisition of Burlington Northern Santa Fe Corp. (NYSE: BNI), Warren Buffett showed a less aggressive stance in Berkshire Hathaway Inc.’s (NYSE: BRK.A, BRK.B) Nov. 16 filing with the Securities and Exchange Commission (SEC).

Buffett trimmed Berkshire’s holdings in riskier businesses that have uncertain futures, such as newspapers, healthcare companies, and credit ratings agencies in favor of more stable long-term picks such as Wal-Mart Stores Inc. (NYSE: WMT) and ExxonMobil Corp. (NYSE: XOM).

The 13-F filing showed that as of Sept. 30 Berkshire had increased its Wal-Mart holdings by almost 90% over the summer, adding 18 million shares worth nearly $1 billion.

Berkshire also jettisoned 7 million shares of ConocoPhillips (NYSE: COP), while revealing a new $95 million stake in ExxonMobil. In a separate filing released Monday Berkshire revealed it had 854,490 shares of Exxon on its books at the end of the second quarter – something that was not included in the company’s original second-quarter SEC filing. Berkshire held 1.3 million shares as of Sept. 30.

The company’s most recent SEC report – which noted that some “confidential information has been omitted” – showed Berkshire increased its stake in Wells Fargo & Co. (NYSE: WFC) by 3.6% to 313.36 million shares.

The company also added a new stake of 3.4 million shares of Nestle SA (OTC ADR: NSRGY) and 3.625 million shares of Republic Services (NYSE: RSG).

Berkshire eliminated its stakes in Eaton Corp. (NYSE: ETN) and WABCO Holdings Inc. (NYSE: WBC).

The moves show Berkshire taking a conservative approach to its $44 billion acquisition of Burlington Northern, which included $10 billion worth of debt. Buffett referred to the acquisition as “an all-in wager on the economic future of the United States,” which is still struggling to emerge from its worst economic downturn in 70 years.

News and Related Story Links:

• Securities and Exchange Commission
  Berkshire Hathaway Inc. 13-F Filing: Sept. 30 2009

• Money Morning:
  Buy, Sell or Hold: Buffett’s Berkshire Hathaway Inc. Has Been Masterfully Managed and Will Continue to Benefit Investors

• Money Morning:
  Buffett Bets on Bright U.S. Economic Future With Burlington Acquisition

• Money Morning:
  Berkshire’s Back, So What’s Warren Buffett Buying Now?

Hershey Co. (NYSE: HSY) and Italian-based confectioner Ferrero SpA are considering a possible bid for U.K. candy giant Cadbury PLC (NYSE ADR: CBRY), raising the potential for a costly bidding war. But should a battle take place, U.S. food giant Kraft Foods Inc. (NYSE: KFT) is still the odds-on favorite.

Hershey, the maker of Reese’s Peanut Butter Cups, said in a statement it’s “reviewing its options,” leaving open the door to an offer but not saying one would be forthcoming. Ferrero, the Italian maker of Tic Tacs and Nutella spread, said it was in “preliminary stages of evaluating its options in respect to Cadbury,” according to Reuters.

Neither company hinted that they were working together on a joint bid, one that most analysts doubt could top the hostile $16.2 billion cash-and-share offer from Kraft. After media reports by Reuters, the two were asked by the U.K. Takeover Panel to clarify their intentions.

Cadbury, which has repeatedly rejected Kraft’s bid as inadequate, saw its shares rise to their highest levels in almost a month yesterday (Wednesday), gaining 9.5 pence, or 1.2%, to 797.5 pence ($13.39) at 4:35 p.m. in London trading. Kraft’s offer is currently valued at about 726 pence ($12.20) a share.

Most analysts remain skeptical Hershey and Ferrero can outbid Kraft due to structural difficulties.

“There are many barriers to Hershey and Ferrero launching a formal offer. The degrees of freedom on financing aren’t high for either.” Martin Deboo, an analyst at Investec in London, told Bloomberg News.

Hershey is controlled by a charitable trust, and is much smaller than Cadbury, analysts noted. Ferrero is privately owned and has limited experience with acquisitions.

Complicating the deal for Hershey, which already carries a heavy debt load, are trust provisions that dictate a bid would need to be funded with debt rather than equity.

“The only way Hershey could finance a bid is if the trust decided to move to a single-class share structure, relinquishing its control and making it easier…to sell new stock,” Pablo Zuanic, an analyst at JPMorgan Chase & Co. (NYSE: JPM) in London, told Bloomberg. “We see that as unlikely.”

“The Hershey Trust needs to ensure that it can meet its charitable purposes and protect its long-term income … It will probably act conservatively and won’t want to see Hershey overpay and take on a lot of leverage for an acquisition,” a lawyer at a London law firm told Reuters, speaking anonymously.

For Hershey, which gets about 85% of its $5.1 billion in annual sales from the slow-growing U.S. confectionery market, a deal with Cadbury could give the company access to faster-growing gum and candy markets.

For Ferrero, whose sales are concentrated in Germany, Italy and France, a Cadbury merger would offer entry to the chocolate-loving British market.

The deal may also hinge on economies of scale, gaining all three companies more leverage in the cocoa market, where prices have climbed for four straight years, and are up 18% this year.

“Together, Cadbury, Ferrero and Hershey would gain good control of the cocoa market, which is the rationale of such a potential deal,” Arnaud-Cyprien Nana Mvogo, a merger-arbitrage analyst at Aurel BGC in Paris, wrote in a note to investors obtained by The Wall Street Journal.

On November 9, Kraft formally offered to buy Cadbury in a hostile takeover. But by reiterating, and refusing to raise, its original offer of Sept. 7, it may have opened the door to competing bids. Cadbury rejected both offers as “derisory.”

“Our offer is fair and attractive. And we remain confident we’re the best, most logical partner,” Kraft spokesman Michael Mitchell said Tuesday, according to a report in The Journal.

But Cadbury refuses to budge.

“We have always said that we would give proper consideration to any serious offer that delivers full value for the company,” a Cadbury spokesman said Wednesday. “Unless and until we find ourselves in that situation we have nothing to comment upon.”

In the end, no matter who wins the battle, Cadbury is likely to command a higher price.

“This will change Kraft’s psychology on the bid, and somewhat improves the probability of a higher bid from them,” Deboo said.

News & Related Story Links:

• Reuters:
  Ferrero, Hershey mull Cadbury move; Kraft seen ahead
• Bloomberg News:
  Hershey, Ferrero Mull Options on Kraft Target Cadbury
• Money Morning :
  Kraft Launches Hostile Bid for Cadbury
• The Wall Street Journal:
  Hopes Rise for Cadbury Bidding War
• Money Morning:
  Kraft’s Bid for Cadbury Not Sweet Enough

In spite of the Obama administration’s latest effort to boost the U.S. housing market by extending the first-time homebuyer credit, numbers reported yesterday (Tuesday) by the nation’s biggest home-improvement retailer, The Home Depot Inc. (NYSE: HD), indicate it could still be some time before the industry can claw its way out of the basement.

Home Depot reported sales of $16.36 billion for the fiscal quarter ended Nov. 1, down almost 8% from $17.78 billion in the comparable period last fiscal year. That resulted in an 8.9% drop in net income, which fell to $689 million, or 41 cents a share – down from the year-ago figures of $756 million, or 45 cents a share. Same-store sales were down 6.9% corporate-wide, and 7.1% in the United States.

Investors took little solace Atlanta-based Home Depot’s third-quarter report, sending the company’s shares down 66 cents, or 2.39%, to close at $26.99.

Home Depot’s lackluster earnings negatively impacted shares of rival Lowe’s Companies Inc. (NYSE: LOW) as well. Lowe’s stock sank 26 cents, or 1.2%, to close at $21.48 a share.

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While the per-share earnings were quite a bit better than the pre-report analyst estimates of 36 cents a share – and considerably stronger in relative terms than the numbers reported Monday by Lowe’s – the numbers don’t necessarily reflect an improvement in housing demand or the home-repair market.

Instead, industry observers said Home Depot managed to partially offset lackluster sales with decisive cost-cutting measures, including freezing executive salaries, eliminating jobs, tightening inventory controls and even reducing energy use in stores. The company has also scaled back expansion plans, closed several “concept” stores and stepped up customer-service efforts in a bid to increase customer loyalty and repeat business.

Home Depot projected fourth-quarter earnings of 12 cents a share, down 25% from the 16 cents a share forecast by analysts surveyed by Thomson Reuters. It also predicted an adjusted full-year profit of just $1.55 a share, down 13% from last year.

“There is still a great deal of pressure in the housing and home-improvement markets,” said Home Depot Chairman and Chief Executive Frank Blake.

Blake said that “some positive signs of stabilization” were emerging, but data from the National Association of Home Builders’ (NAHB) monthly survey painted a somewhat bleaker picture.

The NAHB’s Sentiment Index, which had risen to 19 in September, fell to 18 in October and to 17 this month – though November’s number was actually reported as “holding steady” after the original October reading was revised downward to 17. On the plus side, the survey was taken before the government’s homebuyer credit was extended, and that may have negatively impacted the reading.

Going forward, neither the numbers nor the news bode particularly well for a recovery in the housing market or Home Depot.

“Both Lowes and Home Depot will hit positive same-store sales comps in the second or third quarter of next year,” senior Piper Jaffray retail analyst Mitchell Kaiser told CNBC. “But given housing prices still down, they’re going to inch towards down. It’s the bigger ticket items that are under pressure.”

News & Related Story Links:

• MarketWatch:
  U.S. Nov. home builders’ index flat at 17
• CNBC:
  My Ratings on Lowe’s & Home Depot: Analyst
• National Association of Home Builders:
  Builder Confidence Unchanged in November
• The Home Depot Inc.:
  The Home Depot Announces Third Quarter Results; Updates Fiscal Year 2009 Guidance
  

In a signal of confidence for the future of mergers-and-acquisitions (M&A), Lazard Ltd. (NYSE: LAZ) appointed Kenneth Jacobs as its chairman and chief executive officer following the unexpected death of famed dealmaker Bruce Wasserstein.

Jacobs, a 21-year company veteran, was most recently CEO of Lazard North America and has a history of leading M&A advisory teams.

“Jacobs is clearly qualified for the position because he has run the North American operations of the company,” Dick Bove, vice president and equity research analyst at Rochdale Securities LLC told Bloomberg Television. “It should be positive for Lazard.”

The worst financial crisis since the 1930s has resulted in a dramatic slowdown for the M&A market in 2009, taking huge chunks of revenue from the income statements of companies that depend on deals.

For Lazard, the downturn was evident: Third quarter revenue at its M&A and strategic advisory business – once its No. 1 source of sales – fell to $124.6 million from $230.8 million in the same period last year, a drop of 46%. That drop was easily offset by growth in its restructuring business, where revenue rose to $119.1 million from $23.9 million a year ago, a gain of 397%.

When the Lazard’s board set out to find a replacement for Wasserstein, it could have appointed a new chief executive to take the company in a different direction – such as shifting more resources to its asset management business.

Instead, the company chose Jacobs, who has led Lazard teams on a number of high-profile deals. Most recently, he advised GlaxoSmithKline PLC (NYSE ADR: GSK) on its purchase of Stiefel Laboratories  Inc. and the Rohm Family Trusts, which played a part in the sale of Rohm and Haas to The Dow Chemical Co. (NYSE: DOW).

Lazard, which got 62% of its third-quarter revenue from its financial advisory business, is optimistic on the long-term future of M&A.

“The economy is beginning to stabilize and CEO confidence is returning,” then-interim CEO Steven J. Golub said last month. “We are still planning for a gradual increase in traditional M&A activity, reaching the prior period highs in about four years.”

M&A activity so far this month has reached a total value of $236.1 billion, up 44% from $163.7 billion in all of October, Financial News Online reported, citing data from Dealogic. Still, the total of $2 trillion in M&A deals so far this year are far behind 2008’s pace. (Deal values had reached $2 trillion in July of that year.)

Analysts at Deutsche Bank AG (NYSE: DB) said in October the market is ripe for a significant rebound in M&A over the next 12 months as newly capitalized companies look for acquisitions to spur growth in difficult markets. A prime example of this was when Hewlett-Packard (NYSE: HPQ) last week said it would acquire 3Com Corp. (Nasdaq: COMS), giving H-P a shot in the arm in the networking business as well as a presence in China.

Jacobs has seen his share of turbulent times at the company, including 2005 when Wasserstein took the company public against the wishes of Michel David-Weill, a descendant of the firm’s founders.

“Jacobs has always been there for Lazard through all the upheavals the firm has had during the last ten years,” William Cohan, author of Lazard history “The Last Tycoons” told Reuters. “He has always been the guy behind the scenes holding the firm together.”

News and Related Story Links:

• Wikipedia:
  Bruce Wasserstein 
• Bloomberg News:
  Lazard Names Jacobs to Replace Wasserstein as CEO
• Financial News Online:
  News Analysis: The Return Of Bumper M&A
• Money Morning:
  Hewlett Packard-3Com Deal Shows Urgency for Growth in Competitive Tech Sector

The U.S. Federal Reserve may take an unorthodox approach to raising interest rates by paying interest on bank reserves rather than relying on traditional open market remedies, as it exits from its long-term fiscal stimulus programs, Reuters reported today (Tuesday).

Paying interest on reserves is mostly untested and would represent an unexpected twist in the Fed’s response to the financial meltdown.

“In the old days … the Fed controlled the federal funds rate with open market operations,” Antulio Bomfim, a former Fed economist now with Macroeconomic Advisors LLC in Washington told Reuters. “Now, at least in this period when reserves are over-abundant, the way the Fed hopes to raise the federal funds rate will be primarily by raising the interest rate it pays on reserves.”

Usually, when the central bank wants to set a target for the federal funds rate it buys or sells Treasury securities on the open market, influencing interest rates by deploying or withdrawing capital.

By paying interest on reserves, the Fed makes it attractive for banks to keep their money at the central bank as long as interest rates in private markets are lower.

By doing that, the Fed can put a floor under the lending rate that banks charge each other for overnight loans, which is the central bank’s traditional choice for influencing the economy. Open market operations to raise interest rates would be relegated to a supporting role in the initial stages of tightening.

In order to spark an economy mired in deep recession, the Fed flooded the financial system with liquidity in December by cutting its interest rate to near zero – a move that more than doubled its balance sheet.

More recently, the Fed has promised to keep rates “exceptionally low” for “an extended period,” to nurture the fragile recovery. Now, with some economists warning that extraordinary economic stimulus could spark inflation, officials have begun to consider how best to eventually remove the support.

In order to impose its will on borrowing costs, the Fed is likely also to use a combination of open market operations to drain reserves from the banking system, including reverse repurchase agreements. In those operations, the Fed sells Treasury securities for a short term, similar to the certificates of deposit consumers buy at banks.

The central bank got the power to pay interest on bank reserves in October 2008, when Congress passed emergency legislation to deal with the financial crisis.

San Francisco Federal Reserve Bank President Janet Yellen has said she thinks interest on reserves will be sufficient by itself to tighten financial conditions.

“The fact that they introduced interest on reserves tells you that they think that system gives them better control,” said Charles Lieberman, a former head of monetary policy analysis at the New York Fed now with Advisors Capital Management.

No Plan B

In another sign the Fed is wary of inflation, San Francisco Federal Reserve Bank President Janet Yellen said Tuesday that the central bank is keeping a close eye on the economy for signs of growth, acknowledging that record low interest rates and loose monetary policy cannot be maintained for too long.

“We all understand very well that we cannot have an accommodative policy for too long. That once these conditions no longer prevail, it is a core responsibility of the Federal Reserve to preserve price stability,” she said after a speech in Hong Kong, according to Reuters.

Last week in a speech in Phoenix, Yellen questioned the strength and durability of the U.S. economy, which expanded in the third quarter for the first time in more than a year.

“Unemployment could stay high for several years to come,” said Yellen. “High unemployment, weak job growth and paltry wage increases are a recipe for sluggish consumer spending growth and a tepid recovery.”

But Yellen, a voting member on the Fed’s policy-setting body, said that there is already enough stimulus in the financial system to bring the economy back to growth and there are no plans for further credit easing.

“We are not going to push them (the emergency actions to increase liquidity in the banking system) further,” she said. “There is no plan B.”

Former Bank of England deputy governor John Gieve, who also sat on the panel in Hong Kong, added, “There was never a plan B, so it’s good plan A worked.”

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Stimulus measures in Japan helped the world’s second-largest economy grow at its fastest pace in more than two years, but it’s unlikely policymakers will reduce spending despite the nation’s rapidly growing debt.

Gross domestic product (GDP) in Japan grew at 4.8% annual rate in the third quarter, surpassing all the forecasts of 20 economists polled by Bloomberg News. That follows a revised gain of 2.7% in the three months ended June 30, according to Japan’s Cabinet Office. Japan’s economy grew 1.2% on a quarterly basis.

“The turnaround in public investment has definitely contributed to the rebound in GDP, so if they do start to cut it’ll weigh on growth,” Hiromichi Shirakawa, chief Japan economist at Credit Suisse Group AG (NYSE ADR: CS), told Bloomberg.

Stimulus measures around the world helped Japan’s exports grow 6.4%, but as global economies withdraw stimulus measures, growth in Japan is expected to slow. Programs like the United States’ “Cash for Clunkers” ended in August and China’s cut on sales taxes for small cars is scheduled to stop after 2009 ends.

Without these props in place, auto sales could fall 10%, taking 0.16% off economic growth, The Wall Street Journal reported, citing estimates from the Japan Research Institute.

In a troubling sign for unemployment and its overall economy, Japan’s inventories are on the rise again, accounting for 0.4% of third-quarter growth. Should overseas demand falter, Japan – which already has one-third of its factories idle – this newfound economic growth could slow.

Japan’s unemployment rate is currently at a near-record 5.3%.

“Manufacturers are saddled with massive overcapacity so you can’t expect a strong recovery for quite some time. That’s a given,” Hiroshi Shiraishi, an economist at BNP Paribas SA in Tokyo told Bloomberg. “That means this initial bounce-back in the economy won’t really accelerate.”

Despite an expected slowdown in growth, most economists say overseas demand will prevent a double-dip recession in Japan, Reuters reported.

The Shift in Stimulus

Newly elected Japanese Prime Minister Yukio Hatoyama’sDemocratic Party of Japan (DPJ) blocked the outgoing Liberal Democratic Party’s (LDP) additional $32.4 billion (2.9 trillion yen) in stimulus, and may hold the funds until next year amid declining tax revenue.

Unlike the LDP, which spent stimulus largely on infrastructure, Prime Minister Hatoyama and his fellow DPJ policymakers plan to use the money for social welfare spending, such as subsidized child care and lower tuition fees at schools.

While the stimulus measures are expected to help domestic demand, Japan will still be faced with reducing its record deficit, which accounts for 170% of its $5 trillion GDP. Estimates say the figure will balloon to between 200% and 250% sometime next year.

“The problem is that you can’t expand fiscal spending forever because we’ve got this fiscal deficit to worry about,” Credit Suisse’s Shirakawa told Bloomberg. “They’re concerned about the economy on the one hand, on the other they’re concerned about the deficit.”

To combat declining tax revenue and its rising deficit, Japan could issue at least $550 billion (50 trillion yen) in bonds, Finance Minister Hirohisa Fujii suggested.

“There’s no mistaking the budget deficit stems from the past year’s global recession. Now is the time to be bold and issue more deficit bonds,” Fujii told reporters at the National Press Club last month. “Those who may call this pork-barrel spending — that’s a total lie.”

Ten-year yields fell to their the lowest level in almost four weeks as shares on the Japan’s Topix slipped on concern companies will sell more equities to raise funds.

“The GDP report paints a positive picture of the Japanese economy, but the shape of the economy going forward is still unclear,” Makoto Yamashita, chief Japan interest-rate strategist at Deutsche Securities Inc. in Tokyo told Bloomberg. “We’ll see some rapid adjustments in the bond market today following last week’s gains.”

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• The New York Times:
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• Bloomberg News:
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