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.