Monday February 28, 2005 - 11:22:33 GMT
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Black Swan Capital - www.blackswantrading.com
It seesm ripe for comdols. But...
“The word ‘risk’ derives from the early Italian risicare, which means ‘to dare.’ In this sense, risk is a choice rather than a fate. The actions we dare to take, which depend on how free we are to make choices, are what the story of risk is all about.”
Peter Bernstein, Against the Gods: The remarkable story of risk
Liquidity is sloshing around the globe. China’s going to open its capital account. Inflation is in check. Japan is recovering. It’s reflation time again! So buy commodities and commodity currencies—and sell dollars. That’s what it looks like this morning.
This excerpt is from an excellent article written in October 1997 by Eric Uhlfelder for Mutual Funds magazine, Lock and Load: Gambling with Asia’s Tigers:
“The collapse of the Thai baht was the culmination of a series of financial troubles that were hidden behind the country's 8-plus percent perennial growth rate. However, the Thai economy had been sluggish for some time, as evidenced by three consecutive years of major losses on the Bangkok Stock Exchange. Finance and real estate sectors were in real trouble. Years of booming exports and attractive interest rates flooded the economy with capital which was often poorly utilized. With all this money around, speculators drove up stock prices, industry overbuilt capacity and developers glutted a once soaring property market. Banks made ill-advised loans, and regulators were no where to be seen. Extravagant government infrastructure projects and public corruption further soaked up capital.”
Does any of the above sound a bit like China today? Artificially low interest rates, coupled with inadequate capital markets to properly allocate finance capital, and extreme hot money speculation were all part and parcel to the last Asian financial crisis. Hmmm…!
From the Economist magazine dated today March 26th:
“…the neglect of the equity market has a high price. China has private savings of at least 12 trillion yuan ($1.4 trillion) sitting unproductively in banks. The country also has thousands of entrepreneurial firms crying out for funds.”
Well, these entrepreneurs aren’t just sitting on their hands. They are looking elsewhere for capital to fund projects—many of which are marginal at best, especially considering they will have to pay real market rates from real financial institutions.
An excerpt from Stratfor.com:
“The People's Bank of China released a report Feb. 24 detailing a significant rise in foreign borrowing by Chinese firms. Total foreign debt rose 18.1 percent in 2004, from $193.6 billion to $228.6 billion. The increase in short-term debt -- traditionally, debt with a one-year maturity -- was nearly double that, at 35.1 percent, going from $77 billion to $104 billion. The Chinese said they were not concerned by the figures, given the sizeable cushion the country's $609.9 billion in currency reserves offers. They are lying.
“With major state sectors slowing down, China's exporters, who account for one-third of China's $1.65 trillion gross domestic product (GDP), seem to aspire to become the new thorn in the government's side. Only China's exporters, whose sales bring in large amounts of hard currency, can gain access to foreign financing -- which implicates them in the rapid debt accumulation in 2004.”
Because the Chinese government is doing its utmost to ration credit in sectors it deems to have too much capacity and lacking any clear capital market alternative, Chinese exporters are forced to tap international lenders to borrow. This means their debt level will continue to soar as profit margins in China continue to fall. These firms are “removing themselves from Bejing’s protective umbrella,” says Stratfor. It means these key firms are extremely exposed should global interest rates rise.
It all comes back to Mr. Greenspan and whether he is serious about soaking up some of the liquidity he created: “Our measure of ‘global liquidity’ consists of the sum of America’s monetary base (notes and coins plus banks’ reserves held at the Federal Reserve) and foreign-exchange reserves held by central banks around the world. In both 2003 and 2004 this rose at annual rates of more than 20%. In no other two-year period since 1975 has liquidity increased by so much,” according to the Economist.
One more tidbit, this is also from the Economist: Based on an inflationary index developed by economist Ian Morris, at HSBC, which includes housing prices, instead of ‘rent” as now used in the calculation of the consumer price index, “The Economist calculates that broad inflation is now 5.5%, the highest since 1982.” Yikes!
Do we remember what was happening in 1982? A very big man named Paul Volcker, then head of the Fed, solidified his reputation as central banker extraordinaire because he made the tough choice between recession and inflation by ratcheting up interest rates. Mr. Greenspan is a very smart man. He is also a man who values his reputation. I don’t think he likes being called either “Easy Al” or “the Bubble Master.”
So, for now, the trend is your friend. It appears the path of least resistance for the dollar is down. But I think it’s important to keep in mind that if Mr. Greenspan acts even a bit more decisively than he has. And if the market decides long rates are too low and are losing support from global central banks, the dynamics for commodities and every other asset market could change very quickly—and for the worst.
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