China

Excellent article in today's Torygraph by our old friend Ambrose Evans-Pritchard on the China theme - http://www.telegraph.co.uk/finance/comment/ambroseevans_pritchard/10431582/Chinas-Communists-want-unattainable-goal-of-affluence-without-freedom.html - executive summary: it's all going to end in tears. Only surprise is he doesn't somehow conclude it's all the fault of the Euro.

Asian Financial Crisis, take 2 - A sense of deja vu

In the early 90s interest rates in the West were slashed - particularly in the US where rates fell to 3% in 1992 from as high as 8-9% in the late 80s. This was partly in repsonse to a housing bubble bursting and also in resonse to the Savings and Loan crisis in which many US Savings and Loan companies (basically a building society) went bust.

This dramatic drop in rates led to Asian borrowers overborrowing in what now appeared to be "cheap" US dollars. When US interest rates started to rise, and the currency went up with them, many of theses borrowers found themselves unable to pay the interest on their now expensive US dollar borrowings. Some of these borrowers were sovereigns, some major financials, some major corporates. The result was a spike in defaluts and ultimately the Asian Financial Crisis in the late 90s.

Fast forward 15 years or so and everywhere I look I see Asian borrowers issuing US$ denominated debt. My inbox is full of new issue offerings from a bewilbering array of names, many of which I've never heard of before. Lots are unrated, and trade on implicit support from governments (especially China, Singapore and Malaysia), los are property developers of one form or another. None of them are worth touching with a bargepole.

In the private sector, household debt levels have jumped in Singapore, Malaysia, Thailand and China in particular - again often fuelling property speculation

When US rates go up, and liquidity flows out of Asia back to the States, a lot of these companies and individuals will find themselves high and dry. And so many are property developers that a small fall in property values and demand could cause a snowball effect of failing developers and defaulted debt. They are all on the same side of the trade, and have no obvious protection. It may not be exactly the same as the US RMBS and sub-prime debacle, but it could easily end up the same way - a lot of borrowers, borrowing money they can't really afford, but they can manage as long as property prices keep going up. When that circle stops, and the developers are left with unsold inventory or forced to sell at a loss, then the game will be up.

It could be 2 years, 5 years, 10 years or tomorrow - it's a confidence game and who knows when the emperors new clothes will be pointed out for all to see - but it will come. Asia seems destined to repeat the mistakes of the past, only this time on a much bigger scale and with much bigger global ramifications.

China

Headline in the FT - China manufacturing data surges to strongest reading in 18 months.

And now supposedly Chinamis storming ahead. Really? The ever growing number of ships parked off the East Coast here in Singapore tells me otherwise.

Official China data isn't worth the paper it's printed on. They're trying to pretend all is well when it patently isn't.

I believe the Chinese economy is a huge Ponzi scheme relying on sucker westerners pouring in capital at the bottom. Once the west stops pouring the cash in as it finds cheaper places to make its cheap plastic rubbish (SE Asia, Africa, Bangladesh etc) the Chinese economy is going to be in real trouble. 

Turning Japanese

With depressing predictability, Europe seems to be turning Japanese - see the link to an excellent article by the less-hysterical-than-usual Ambrose Evans-Pritchard. The reasons have been clear for along time for anyone with half a brain and half a memory. Like Japan, the Europeans have failed to properly clean up their banks balance sheets, instead hoping that time and inflation will gradually reduce the problems currently hidden away by the simple trick of hopelessly optimistic marking to market of many loan assets - creating the dreaded zombie banks that act as a buffer to credit and capital allocation rather than a conduit Like Japan, they have an ageing population. Like Japan, they have an overvalued currency. Like Japan, they have made minimal structural changes to an economic model that is clearly broken - in particular very inflexible labour markets. Like Japan, inflation is turning into deflation, and already has done in several eurozone countries. Like Japan, the central bank has made some noise but actually done very little.

Europe can still fix these problems relatively easily, but seems to lack the political will to do so. The French are making things worse by taxing everyone and everything, and then changing their minds whenever unions or farmers protest, the Italians are doing little except squabble, the Greeks seem to be trying to wriggle out of their commitments to the Troika, the Spanish and Portuguese are making the right noises but it's far from clear that even half of what they say will be put into practice. And of course the Germans are steaming ahead serenely, seemingly unconcerned by the fate of all around them. To be fair to Germany, it is only their frugality over the years and consequent economic strength now that is holding the eurozone together, but I'm afraid they will have to accept and ECB rate cut to help out their weaker neighbours and weaken the Euro or they risk tipping the whole thing over the edge into a new depression.

Strangely, the Euro itself is not in danger at present. As long as the politicians want it, it will survive. A fact that seems lost to most non-eurozone commentators. If one of the euro-sceptic parties gets into power somewhere though, then all bets are off. Marine Le Pen with her Front National in France looks the most likely at the moment, but none of them can be written off entirely.

In the meantime, prepare for more talk from the ECB, but only put money on a recovery once they've actually acted.

More can kicking....

So apparently the crisis is over. The Republicans caved in and now a budget a raise of the debt ceiling limit will ne signed by Obama later today. 

Rejoice, rejoice. 

Except the crisis isn't over. All they've done is put it off till January and February, when the new authorities expire. So we shall reconvene on this with a hangover in early January. And in the meantime the uncertainty persists, leaving a small economic hangover in it's wake as firms delay investments and spending. 

Meanwhile, in civilisation, the UK is doing quite nicely. I still like my long £ versus €.

Once more unto the breach

And so it looks like they really might breach the deadline and fail to get either a budget or a debt ceiling increase in place in time to avert a "technical" default.

This raises 2 questions in my mind.

Firstly how long does the default have to last to stop being "technical" and become actual, so to speak

Secondly, what happens if no one really cards? Both political sides are playing brinkmanship on the grounds that a default is so apocalyptic that it can never be allowed to happen, much like the

mutually assured destruction of the Cold War era. But with only 24 hours to go equity markets are broadly flat, bonds haven't sold off except for a few short dated bills which have eased a bit, and most of the world seems remarkably sanguine. Does this mean no one, except the Chinese government, really cares? And if so, then the supposed pressure on the politicians surely is less than expected, meaning it could drag on quite a while.

To be honest I'm not sure what this all means for markets or the US economy, though it surely can't be good news, but I'm starting to think a default, technical or otherwise, may not be anywhere near as bad as everyone fears. 

US default. THE END IS NIGH. Or not.

Personally, I really can't see a way that the 2 sides can agree to either the budget or the debt ceiling, but no doubt at some point they will. In the meantime there is the very real possibility that the US will default on some securities. Because treasuries apparently don't contain cross-default wording (most bond issuers have what is termed cross-default clauses. This basically means that if they default on one bond, they default on all - a strong incentive to not miss any coupon payments or maturities. The US government apparently doesn't have this. Maybe investors should insist on it in the future?) there will then be some defaulted US government bonds, and some non-defaulted - until they mature or a coupon is due anyway.

This will clearly cause havoc - especially in the repo market, where few banks or clearers have systems that are designed to allow differentiation between defaulted and non-defaulted US securities. As a result i imagine many will simply refuse to take any treasuries as collateral. Clearly very bad news, and many are saying this is another Lehman moment which will tip the world back into financial chaos.

I'm afraid I don't agree. The Lehman problem was in large part caused by its sudden and unexpected nature. No-one had planned for Lehman to actually disappear over that weekend. I had a bbq with a friend who worked for Lehman that weekend and we were laughing about him working for BofA, Merrill or Barclays on Monday, but none of us thought the company would disappear.

The difference this time is everyone can see it coming, and has had weeks, or even months if they had their eyes open, to get themselves sorted out. Yes there will be ructions, but most players will by now have contingency plans in place, and probably already in full swing. Other collateral than treasuries will be pledged in repo, investors are already shying away from short-dates treasuries. For the most part it will be a huge inconvenience, not a disaster.

I hope I'm right.

Snatching defeat from the jaws of victory

Unbelievable as it may seem, US politicians seem determined to derail the nascent and weak recovery in the US. The two sides of the political spectrum are so far apart that I can't see how they will resolve the budget and debt ceiling issues before tonight and the 17th respectively. Republicans believe that because they control one of the US legislative chambers they have a mandate to effectively try to repeal Obamacare. Democrats believe that because they have the other chamber and the presidency they have a mandate to tell the Republicans to get stuffed. 

To the non-American world, it is quite astounding that it could come to this. How can a budget system allow one side to tie defunding of already passed legislation to a budget? How can a constitution allow that to happen?

Anyway, leaving the lunacy of the American political system aside, a shutdown of government and potentially a technical default on treasuries loom. While the default may be purely technical, it will cause havoc in the repo market, and knock on to other markets very quickly. It will ultimately get resolved of course, but in the meantime it can't help the US economy, and that is still 25% of the global economy.

Stocks to fall, $ to fall, bonds to rise (except defaulted treasuries of course).....  everywhere.

Hold your nerve

The Fed is not going to raise rates. Nor is the Bank of England, or the ECB, or the BoJ or anyone that matters.

The back-up in long term rates is already having an impact on US house sales, and e same will happen  everywhere else. They'll scale back, but then hold at close to 0% for quite a while as the markets get used again to the "old normal" - ie no QE distorting long term interest rates.

And we're back

From a few weeks in Europe. It wasn't all sun, food, rosé and warm but not humid weather. I actually did do a spot of observing along the way, and here is the result....

France - most of southern France is for sale, except no-one is buying, because the semi-communist M Hollande's new tax regime has scared them off. Capital gains tax through the roof, exemptions withdrawn, and wealth taxes being increased.The place is a mess. The only holiday makers appear to be Belgians and Dutch who seem to still be loaded. There were a few Germans too, but relatively few French compared to previous years. Lots of horror stories of people with houses they can't sell or rent, boats that have been for sale for well over a year, in many cases over 2 years, restaurants you normally can't get into for love or money that this year you could just walk up to without a booking and sit down, and generally a pretty depressed feel to the place.

And the restaurants thigh lighted one of France's continuing problems. Total labour inflexibility. The ones with customers were woefully understaffed because under French law you can't just hire someone for a summer season and then fire the, when you don't need them. So instead of hiring, restaurant owners operate with skeleton staff, as does everyone else. Labour inflexibility and tax rates will keep France at the bottom of the European league tables for years to come.

UK - admittedly I was in the London bubble, but that is a place that has a buzz. Streets are full, people are shopping, eating out, having fun and enjoying the summer. There was no feel at all of a recession or even a slowdown.

In short, buy GBP vs sell EUR.

And back to Asia - as many ships as ever parked up out there. Singapore city is a bubble like London, but outside of Singapore I think the slowdown is continuing, Not looking to go long Asia at any time soon.

A Credit Crunch with Chinese Characteristics

Great article today in the FT by Simon Rabinovitch in Beijing on the recent spike in short term RMB interest rates. No doubt man will fail to spot the significance of this, but for those with short memories, a spike in USD short rates is what killed Lehman. Why? Because banks borrow short and lend long, running a maturity mismatch between assets and liabilities. For Chinese banks right now any loan they haves de at less than 8% (and that's likely to be most of them) is losing them money.

This is unlikely to end well. 

I've said all along that governments splurging cash they don't have to alleviate the credit crunch will only put off the day of reckoning, not avoid it altogether. And when it arrives, the bigger the splurge the bigger, the headache.

(Before anyone says these are the Chinese banks not the government, they are majority government owned and went on a huge lending spree from 09-11 under government orders, mostly to local government special purpose vehicles with no assets to their name to finance questionable infrastructure projects. When the collapse comes it'll be as fast as you can spell Ponzi).

UK

Car sales are up, inflation is low, employment seems to be holding up, growth is grinding higher, Mervyn King has successfully kept sterling down, trade and exports seem to be growing, the labour market is the most flexible in Europe, and many Europeans are running to the UK from rising taxes at home. Cautious optimism is warranted.

China. I hate to say I told you so, but....

From Bloomberg.  "China’s trade, inflation and lending data for May all trailed estimates, signaling weaker global and domestic demand that will test the nation’s leaders’ resolve to forgo short-term stimulus for slower, more-sustainable growth.

Industrial production rose a less-than-forecast 9.2 percent from a year earlier and factory-gate prices fell for a 15th month, National Bureau of Statistics data showed today in Beijing. Export gains were at a 10-month low and imports dropped after a crackdown on fake trade invoices while fixed-asset investment growth slowed and new yuan loans declined."

Why would you believe anything unless it comes from a truly independent statistical organisation, and especially when the numbers come from a one party state whose government has explicitly stated that they aim to maintain power for all eternity.

Conspiracy theory. BOE, MPC, ECB, QE, £, € and other acronyms

In the corridor outside the Bank of England Monetary Policy Committee meeting room. 

Mervyn: right guys, before we go in and the recorder gets switched on I'd like to have a quick word. The economy is still clearly a mess, though maybe slightly less of a mess than it was. It's certainly not ready for any tightening - it'd kill the bond markets and  the currency would rally if anyone thought we were going to do anything rash, but we're already pretty much maxed out on bond buying and cutting rates when no one is lending anyway is just pushing on a piece of string. The only help we can really provide is to keep the currency weak, but we're not allowed to say that out loud and unfortunately the yanks and the japs have had the same idea - and both have more firepower than us. Fortunately Europe's still refusing to play the QE game, and they're our biggest trade partner, so we can certainly target them. So here's the plan. 

I'm going to propose we do more QE and claim its to support the recovery. You and you (points at random at two of the others), you vote with me. Everyone else votes against. Then we appear to still have an easing bias, the currency stays down against the Euro and everyone wins without us actually having to do anything. 

Everyone except the Europeans obviously (cue evil laughter from all). 

Ok. Everyone clear? In we go then. 

China slowdown

Today's numbers show an unexpected trade deficit of $1.6bn for Indonesia, and the HSBC PMI for India is showing a contraction. Ships are queued up off Singapore, and the A$ (traded by many as a proxy for China because of Australia's huge exports of raw materials) is falling as the central bank is forced to cut rates to prop up the economy.

Yet somehow China is still supposed to be serenely cruising along at 7.5+% growth for now and all eternity.

Hmmmmmm....  Something is rotten in the State of Denmark.....  Or whatever the quote is.

KEEP CALM AND STAY LONG BONDS

Much is being made of recent sell-offs in government bond markets across the world. With the exception of Japan, which is a disaster waiting to happen as i have mentioned before, I would suggest there is no reason to panic.

It seems the fear started with comments from the Fed, firstly via Bernanke and then from the Fed minutes suggesting that it may be time to start planning to scale back the $85bn a  month in bond purchases currently being undertaken. Not end the purchases, but scale back. It would appear many market participants had assumed this was never going to happen. How could they be so stupid? It has to happen at some point, and when it does it is a GOOD sign, as it means the Fed finally judges that the US economy is able to stand on its own feet without the need for constant support. I think however, that the markets reactions over the past 10 days or so show that we are nowhere near that point. The Fed will not want to come out and comment or act on the current gyrations if it can avoid it, and will presumably hope to simply let the current wobble in sentiment fade away, but if necessary they will either talk or act to calm markets and restore order. They need a significant drop in unemployment before there is any move to end QE, and that doesn't look likely to happen in a hurry.

The spillover into other markets looks even stranger. The US is the only economy with enough internal demand and trade to stand alone and stop QE. The UK can't without recovery in Europe, and the Europe haven't even started true QE yet, let alone be close to stopping it.

And for anyone who thinks China and Asia are going to lead a recovery, here is a photo from this morning of the ships in the holding pattern off Singapore's East Coast (not sure how well a panorama photo will work on a blog - hopefully you can click it to see more detail). Lots of ships is a bad sign. These are ships that have unloaded a cargo but have not taken anything new on and are simply waiting for a job. Many of these ships  have been here for weeks waiting for somewhere to go. Trade is stagnant.

Rates are going nowhere for a long time. Stay long. If you can, get longer.

China, and a statistical rant

Makes a change from Japan, though I'm not sure this is going to be much more cheery. 

HSBC's purchasing manager index for China came in sub 50 and somehow people are surprised. I have no idea why. All anyone has to do is look at the number of ships sitting in Asian ports waiting for a cargo to see world trade is on it's knees. 

The problem with all these bank and academic economists is they all sit in offices staring at flashing numbers on screens which are almost always backward looking - last months retail sales, inflation, export and import volumes etc ( also these numbers are released by government departments which often have a very obvious reason to make them flattering, making the numbers questionable at best). 

They should look out of the window once in a while and trust the evidence of their eyes. 

Japan yet again

Today's FT main article makes scary reading. According to the BoJs own calculations a 100bp rise in long term government bond yields would lead to mark to market losses of 20% of capital for regional banks and 10% of capital for major banks. Those are huge numbers, and JGB yields have already backed up 30-40bp since QE35 (or whatever the number is - I've lost count) started. 

Losses like that would totally hobble the financial system and create a huge credit crunch as banks simply stop lending to preserve capital. 

But as I pointed out earlier, JGBs have to be a sell. If the BoJ is set on creating inflation of 2% within 2 years then why would you hold on to a bond paying less than 1%?

And all the time the population continues to age and shrink, and there is no sign of a move to let immigrants in to at least try to arrest the demographic collapse.

Damned if they do, damned if they don't....

I hope I'm wrong but I just can't see how this ends well. 

Japan again....

Seems I'm not alone in my Japan views - from today's FT online -

Kyle Bass bets on full-blown Japan crisis

He makes the argument with much more technical detail than I did but the gist is the same - Sell JGBs - the demographics and the numbers are against them. 

Japan

Abenomics - the ultimate death or glory shot. If it comes off they might just squeak enough growth out of the economy to get their debt under control. Might. If not, then they're totally screwed, with a debt load that is totally unserviceable. Having said that of course, that's the way they're going anyway so this is just going to speed the journey up if that is indeed where they end up.

I have a huge fear the end is going to be messy. The current growth is certainly great news, but I think it's a flash in the pan caused by the sudden devaluation of the Yen. They're starting from too weak a debt position to be able to overcome the problems of structural inertia, terrible demographics and innate Japanese conservatism.

One thought for the investors out there, whichever way it goes, JGBs are a huge sell. 

Success = inflation = rising rates = sell JGBs. 

Failure = bankruptcy and/or hyperinflation = sell JGBs.

Light at the end of the tunnel?

Could there be light at the end of the tunnel? There are commentators talking it up (no one dates mention green shoots yet but it can't be far off) but I'm still suspicious of this burst of optimism, even if it is only cautious optimism at the moment. My imperfect indicators tell me world trade is not on fire - the ships have never been more plentiful off the coast here and that's a bad sign - a parked ship is a ship with nowhere to go and nothing to deliver. I do think e are getting close to the bottom in the UK and US where aggressive early moves to crystallise bad debts and get them off the books are finally bearing fruit, but Europe is still a mess, India is in trouble and Asia, with the exception of debt fuelled Japan, is at best ticking over.

Which brings me neatly to Japan....