Mr Bernanke, if you don’t mind, would you tell me whether or not you do your own shopping at the Grocery store?
Senator Ron Paul
Macro Overview
Ron Paul Goes To Town On Bernanke
After my last few commentaries, right on cue… here’s Ron Paul on the debasement of fiat currencies right in the face of Ben Bernanke during today’s testimony before the Committee on Financial Services. This does not come as a surprise to anyone, Ron Paul has long been a thorn in Bernanke’s side. Perhaps the only surprising thing was that Barney Frank (a Democrat) praised him. See this article in Forbes.
For the record I don’t agree with everything Ron Paul says and I’m not a Gold bug. But I do find many things Ron Paul says interesting, if not entertaining.
I’m going to keep this short and sweet – here is Sen Ron Paul (running for President!) ploughing into Ben Bernanke. My favorite bit is when he asks Bernanke if he does his own shopping – heh heh!
Market Overview
LTRO #2 Results Fails To Excite The Market
Was the half a Trillion Euro take up on LTRO #2 a good thing or a bad thing for the economy. I’ll be honest, I don’t know. Nobody knows. We’ve all been bamboozled by so many creative measures and screwed up by so many coercive political tactics that I’m not even sure what reality is any more. I think we’ll just call it “policy fatigue”… I’ve had enough – haven’t you?
While all this was going on a little something caught my eye. Did you see the Greek CDS levels? In fact just the steepness of the CDS 2s-10s is not at … wait for it… -21,000 basis points.
Chart of the Day –Greece2 yr CDS and 2s-10s CDS steepness.
The Fed is embarking on something new and, I think, highly questionable.
Which is: to enforce the symptoms of prosperity, rather than sound money.
Jim Grant [emphasis mine]
Macro Overview
The New Interest Rate
Forget Central Bank Base Rates, they are rendered impotent in a balance sheet recession, Oil prices are the new economic accelerant and right now Mr. Oil seems hell-bent on tightening and decelerating economic activity.
In a piece last week, I casually commented on oil… perhaps too casually.
I read yesterday somewhere that “Oil was the new interest rates”… rates are irrelevant now and oil plays a bigger part in dictating economic activity. I don’t know why but it was an interesting comment and I thought I should share it with you. Any of you that peek at Google Trends will know that “gas prices” is one of the fastest growing searches at the moment.
Ironically, by trying to boost consumption with monetary easing, the Fed must be careful that it does not stifle consumption by boosting the cost of energy.
Now Oil is a big red flashing beacon on everyone’s radar. Indeed, the FT today frets: Oil price rise sparks profit concerns in Asia. Ahhh… you see? The Chinese weren’t so crazy to stockpile oil in the midst of a slow down when the price was $50-$70 – nearly half what it is now.
Bloomberg quoted a Tom Keene interview with legendary bear David Rosenberg in an article which came out on Friday:
The price of oil rose above $109 for the first time in nine months today and is in the midst of its longest streak of advances in more than two years. Rosenberg said that for each additional penny at the gas pump, $1.5 billion is strained out of household cash flow.
“By May we’re going to be talking about gasoline prices breaking a new high, between $4 and $5,” he said.
The Strait of Hormuz is only half the story, dear reader, the reality is we are in a brave new world where ALL the major central banks are simultaneously debasing their currencies. All business need a form of money to live, it is to the economy what blood is to the human body.
But, by definition a money-form must not only be an exchange medium but a store of wealth and capital… it must be something for which the supply can be understood, even predicted. This is why investors (and China) seek oil… and gold. All the major paper promises (aka fiat currencies) are wearing thin – so much so that even the Swiss Franc is beginning to rise again.
Here is what I wrote in a piece last summer and the attached video of a Bloomberg interview with the legendary Jim Grant:
I leave you, once again, with something I put in my piece (The Feral Reserve), Jim Grant’s wonderfully eloquent quote in this Bloomberg interview, after 11min 30 seconds:
“… the clarifying insight into Quantitative Easing came in the form of a letter to the editor of the financial times about a year ago. The writer says:
‘Ah! Finally I think I get it. I get what Quantitative Easing means. I understand now… what I no longer understand is the meaning of the word money.’
That is the definitive insight into what the enterprise of QE is all about…. Debasement.”
I’m not going to comment on the markets really today. I’m only going to show a Chart of the Day – Brent Crude Oil (of course). This is not so much a rise in popularity of the metal per se, it is a representation of the lack of faith in paper promises.
Some of you will note, that comment above was exactly the same as yesterday’s – it’s just I substituted the word “Gold” for “Oil”.
Chart of the Day
Brent Crude Priced In Dollars (Source: Bloomberg)
Events
Macro Events:
Update:
Nothing Significant
Alerts:
Germany CPI
Japan Industrial Production
South Korea Industrial Production
Corporate Events:
Results:
Nothing Significant
Dividends:
Nothing Significant
Reading, Links:
For article on the history of monetary debasement read:
Oh I’ve chosen my words carefully, Persian, perhaps you should have done the same…
THIS IS SPARTA!
King Leonidas – in the Film 300
Macro Overview
The New Old Currencies Of Choice
When Sen Ron Paul quizzed Ben Bernanke about the monetary properties of Gold as a currency, Bernanke flatly refused to accept that Gold was a currency – see my comment last summer. In his mind, the only reason we talk about Gold as money today was tradition. Bernanke was wrong, Gold is a form of money, it always has been, in fact I’d go as far to say that almost everything is a form of money, but Gold has particularly good attributes.
A few days ago, I wrote a piece called The Emerging Gold Standard which made references to how Iran was trying to circumnavigate trade sanctions by settling oil trades in Gold. The article also referenced my piece on The Marco Polo Connection, where I speculated that China’s interest in “bailing out” Italy was largely gold related (China has a huge desire for the yellow metal and Italy has the largest Gold-to-GDP ratio).
Today we hear rumors of the EU having Greece by the Golden Balls in the latest bailout deal – see Zerohedge piece on this. It appears as scavenging eyes sniff at the carcass of another failing state they no longer salivate over paper promises. They want something tangible… “give me oil …or gold” they hiss through snarling canines. The World of Finance welcomes new old currencies.
Spartans Will Be Slaves
Well 2.5 millenia is a long time in the scheme of politics I suppose. There was a time when Greek leaders refused to let their people be slaves. Today things are different; their Gold is seized, their Government is subordinate to higher authorities, their economic prosperity is deemed expendable by leaders in other countries. To add insult to injury, sticking with ZeroHedge – they run an article with the title: The Colonization Begins: Germany May Send 160 Tax Collectors To Greece.
Welcome to the Currency Wars of the 21st century. When a nation feels aggrieved it no longer sends soldiers to burn rape and pillage the region, it sends tax collectors and demands Gold in return. So I suppose 2.5 millenia is a long time in the scheme of politics – things can change in that time.
Finally, a really cool video on ZeroHedge explaining Greece’s debt enslavement to Europe with reference to the LTRO “cash for trash” scheme. Something which I wrote about in my comment: LTRO = Lying To Restore Order. You have to watch this vid…
Market Overview
Gold
I’m not going to comment on the markets really today. I’m only going to show a Chart of the Day – GOLD (of course). In my view this is not so much a euphoric rise in popularity of the metal per se, it is a representation of the lack of faith in paper promises.
Fitch considers that the proposal to reduce Greece’s public debt burden via a debt exchange with private creditors will, if completed, constitute a rating default, and result in the country’s IDR being lowered to ‘Restricted Default’ (‘RD’) upon completion. The ratings of GGBs affected by the exchange, including those not tendered but restructured under CACs, which are expected to be imposed retrospectively on bonds issued under Greek law, will also be lowered to ‘D’ (‘default’) at this time.
Shortly after completion of the exchange with the issue of new securities, Greece’s sovereign rating will be moved out of the ‘RD’ category and re-rated at a level consistent with the agency’s assessment of its post-default structure and credit profile.
Fitch regards the imposition of retrospective CACs as a material adverse change in the terms and conditions of GGBs in the context of an imminent debt exchange and confirms its assessment that the exchange will be distressed and de facto coercive on private holders of Greek bonds. Nonetheless, the primary credit event is the exchange itself and Fitch will rate Greece and its securities accordingly.
The BoE were split today on their decision to leave QE unchanged. Can you believe it? We’ve stopped talking about base rates … I can’t remember the time we did. The only thing we talk about is monetization of debt, printing paper promises up the wazoo. Nobody pauses to question the validity of the underlying promise. Except perhaps the holder of Gold – who took the hard currency to a new 3 month high of $1780 today.
The game is getting tighter for the Brits. Only a few months ago we were lamenting the CPI at over 5%! But we’re already talking about increasing the current rate of asset purchases. It’s a currency war out there… bring out the heavy artillery.
Default Semantics – It’s All Greek To Me
I’ll try to keep my comments on Greece brief. To be honest I have Greece-writing-fatigue. The politicians have bought themselves some more time. But it appears that the Feds are inflating everything… even the cost of time!
Already the doubts are creeping in and we have not even got to the implementation + riots on the streets stage yet. The Independent writes in an article today:
That pessimistic view was reinforced by a confidential document on Greece, compiled by European and IMF analysts, that was leaked on Monday night. The secret report showed that Greece’s debt burden could easily still stagnate at an unsustainable 160 per cent of GDP at the end of the decade if the economy does not return to growth quickly.
Analysts also expressed doubts over whether the Greek government would be capable of delivering the austerity measures that have been demanded by Greece’s European creditors in exchange for the new bailout funds.
The article also details the leakage of a secret Troika report which showed that the bailout may not even make a dent in the Greek debt to GDP ratio. You can’t make this up.
Already the mob is reforming, they are restless, they may have little power individually right now and some of them may have “riot-fatigue” … but they also have numbers on their side.
Fitch is the latest agency to shut the door on Greeceafter the horse had bolted and long galloped gaily over the horizon. As Forbes implied in their article, it’s not really enough to save them from default – it’s like giving a bankrupt man a new limit on his credit card… it means you can live a little longer, but it doesn’t help, it only hurts.
I’ve stopped using ISDA terminology as it no longer has any meaning. So I think Fitch downgraded Greece to official rating “stick-a –fork-in-me-I’m-done”. After stopping time to ponder whether a 70% gun-to-the-head haircut on the NPV of a bond constitutes a default… errmmm… let me think about that for a minute… one day we’re gonna look back on all this and laugh… but first let us join hands and weep.
The Greek 5 yr CDS (if indeed it makes any sense anymore to call it Credit “Default” Security) is back trading above 10,000 bps … if indeed that number even makes any sense anymore…I don’t know anymore.
Here is an interesting question though; if you were a hedge fund with a shed load of CDS protection on Greece would you have considered buying the distressed bonds off the banks (perhaps in concert) in order to have enough sway among the bond holder committee to put a spanner in the CAC-enforced bond swap and force a CDS default trigger? I guess we’re about to find out. Something tells me this is all going to get very litigious.
Market Overview
What’s Happening To The Consumption Revival?
I dunno about you but if consumption was on the up and up I’d kinda expect a better day from WMT and DELL. Both stocks seem to be having difficulty putting out optimistic vibes about consumption patterns.
Chinese Flash Manufacturing disappointed too, but this is not a number I give huge credence to. We’ll see later on when inflation numbers are published how things are fairing. If inflation is too high then this is a worrying sign for the Central Bank as it will have little room to stimulate consumption in China. If inflation is too low it may be a sign of a genuine slowdown taking course.
Tomorrow look out, more consumption plays reporting including Gap and Target.
Land Of The Rising Dollar
I say this because factors which determine the backdrop for Japanese stocks originate largely from outside the country.
Japan’s growth comes from its export engine. It’s main trade partners being the US and China. So the Japanese economy is highly dependent on consumption patterns outside its borders and across its seas.
The Yen is falling, but for no other reason than it has simply lost its luster as a safe haven currency. The fact that we have been talking about the Yen as a safe haven currency speaks volumes in itself. Chart of the Day today is the Yen-Dollar.
Chart of the Day
Yen/Dollar (Source: Bloomberg)
Events
Macro Events:
Update:
China HSBC Flash Manufacturing 49.7
Alerts:
Mexico GDP – I don’t know why but I’m actually really anticipating this number… perhaps it’s the fact that Mexico has been growing so rapidly (even faster than Chinaover the last couple of years) … and the fact it’s so close to America.
Taiwan– Industrial Production
US Jobs
Corporate Events:
Results:
AIG [AIG], Commerzbank [CBK GR], Credit Agricole [ACA FP], Deutsche Tel [DTE GR], The Gap, Honeywell [HON], [GPS], Target [TGT],
Margaret Thatcher – British Prime Minister (1975 – 1990)
Macro Overview
The Iron Lady Of Europe
Angela Merkel has resisted all comparisons with Britain’s Iron Lady of the 1980’s, Margaret Thatcher. For one thing, she stands for something different ideologically speaking – Merkel is staunchly pro-European integration. Thatcher, by comparison, made her opinions quite clear on the matter, as you see above!
But there are striking similarities between these two political female powerhouses. Perhaps it is something that comes with being a woman who has fought tooth and nail through the ranks to the pinnacle of European politics. Merkel, like Thatcher, sticks to her guns. She sometimes initially appears quite methodic and patient at the negotiating table but when she makes her demands, she normally gets what she wants. You don’t have to agree with the policies of either Thatcher or Merkel to have a degree of admiration for their aggressive ability to get what they want done and get it done with authority.
There is plenty of talk about “union” and “helping” or even “bailing out” other European nations, but let’s make no mistake this is nationalistic politics at its most ferocious. Merkel’s obligation is, first and foremost, to the German electorate – not the Greeks or the Portuguese or the French or the “Union”. Her actions so far have not dissuaded me from this in any way. And judging her on this alone, she is indeed an exceptional politician.
Domestically, Merkel has quenched the anti-Europe swell while overseas she has pressed for treaty change while venting about the inflationary consequences of ECB participation – a shrewd tactic to shield intentions and lever into political negotiations. While holding the Greeks et al over an austerity barrel, she has France right where she wants it – begging at the end of a very short dog-lead. She has Britain right were she wants it – exiled, insulated and in splendid isolation. And the rest of Europe potentially chastised to an iron-fist treaty of curiously Germanic design.
What is perhaps more poignant about The Iron Lady of Europe is what she does not do. When there is political sensitivity in Europe, she remains practically silent, allowing other political voices to vent the heat before taking a line which is true and unequivocally assertive. Which reminds me of one of Thatcher’s quotes:
Being powerful is like being a lady. If you have to tell people you are, you aren’t.
Market Overview
Gold Rising On European Doubts
Seems strange doesn’t it? We have “momentous” news out of Europe on the latest Greek bailout and Gold hits a new high? Something does not add up in Europe… I imagine it’s the Mathematics!
Wait… so all this turmoil in the markets, hundreds of billions of Euros thrown over The Med and we still cannot draw a line under the problem? Hmpft! You know the score, dear reader; like a NINJA (No Income, No Job or Assets) with a huge mortgage, Greece is insolvent, she doesn’t need a loan… she needs a fresh start.
Europe will not move forward while the Greek people are beholden (or even feel they are beholden) to German politicians, no matter how deftly the European Elite try pull the puppet strings of the “Greek Government” and the Wool over the ordinary Greek person’s eyes. In fact I should not really call them the Greek Government I should call them “The Unelected Representatives In The Eurozone of Greek Descent” – because that’s what they are.
Europe will not move forward while private investors feel cheated either by indirect subordination by the ECB or CDS trigger-gaming by the politicians.
Europe will move backwards if growth in the Eurozone stalls further and Europe will move backwards faster than you can say “what’s that horrific sucking sound?” if investors begin to doubt the credibility of the ECB.
Chart of the Day shows Gold and Greek CDS Steepness – which hit a new low (or a new INVERTED steepness) as the 2 year spiked.
Chart of the Day
Gold (Source: Bloomberg)
Greek CDS Steepness (Source: Bloomberg)
Events
Macro Events:
Update:
Eurozone Consumer Confidence in line (-20.2) … not really very good.
The gold standard has one tremendous virtue: the quantity of the money supply, under the gold standard, is independent of the policies of governments and political parties. This is its advantage. It is a form of protection against spendthrift governments.
Ludwig von Mises
Macro Overview
The Old Gold Standard – Learning From The Romans
The first thing I’d like to point you towards is this article in Reuters. Let me quote the first two sentences from the article:
India has reportedly agreed to pay Tehran in gold for the oil it buys, in a move aimed at protecting Delhi from US-sanctions targeting countries who trade with Iran. China, another buyer of Iranian oil, may follow Delhi’s lead.
The report, by the Israeli-based news website DEBKAfile, states that Iran and India are negotiating backup alternatives with China and Russia, should the US and EU find a way to block the gold payment mechanism.
All too often conversations about Gold standards escalate quickly into political arguments about Nixon, Bretton Woods and the long term history of Gold currency standards. Modern Monetary Theorists and Gold bugs face off against each other, implying: either you have a gold standard or you do not.
But the reality is not so simple. If that is the case, why do fiat currency governments still hoard massive banks of gold? Surely, there must be some sort of weight to this collateral. In fact, even during the so-called gold standard era of the mid 20th century, only part of the currency base was ever covered by gold. We’d have to go back to Roman times to find currencies which were 100% backed by gold (because they physically were pieces of gold!)
While I understand the concern of many gold-bugs: fiat debasement is truly a massive economic phenomenon (if not a worrying concern) of our era. The Bretton-Woods style gold-standard is not necessarily a panacea. History rarely repeats, but it often rhymes.
There are those who point to how the Roman Empirewas built on a Gold standard and a Gold Currency (The Denarius). The Empire’s downfall coincided nicely with the debasement of the Denarius from a gold standard. But what is often missed is the fact that, once the reputation of the currency was lost, attempts made to re-standardize to gold completely failed the economy. As I wrote in my piece: The Perils of Currency Debasement: Learning From The Romans.
The Denarius was a gold and silver coin which was introduced a couple of centuries before Christ and was the roman currency and the empire’s equivalent of a global reserve currency. However, in the centuries after Christ, starting around the second century AD, it was systematically debased to pay for roman fiscal mismanagement and the unsustainable obligations of a far-reaching superpower. In fact one can pin-point the beginning of the decline of The Roman Empire to the decade starting, coincidentally, with the commencement of the debasement of the Denarius. Romans simply kept shaving precious metals out of the coin and replacing the incorruptible silver and gold with a more “faith-based” system of ubiquitous scrap metal + “golden promises” toward a “strong Denarius policy” (heard that one before?). Saving a very brief flirtation by Diocletian to bring back a heavier gold and silver standard, this practice continued until it tarnished the luster of loyalty; The Roman Empire had no faith, no purchasing power, no wealth and, eventually, no purpose.
As I alluded to, people often look at gold currency in the wrong context; just because the roman system, and successful monetary systems thereafter, were based off a Gold Standard does not mean that this should necessarily be the currency-base of choice in a modern world. Currency debasement may be more of a symptom of a failing faith-based economy than a cause. Indeed, an interesting observation is that the debasement of the currency not only marked the peak of The Roman Empire, but also that, once momentum against the roman currency was entrenched, attempts by Diocletian to revert back to a gold standard were a complete failure – if anything further fueling the inflationary fire.
The New Gold Standard
As I alluded to in one of my comments (quoting Jim O’Neill of Goldman Sachs); Economies like India, China, Russia and Brazil are set to contribute much more to global economic growth over the next ten years than the whole of Europe and America put together. In fact China could achieve this all by itself.
During this period we are likely to see the two largest economies (Europe and the US) print the heck out of their respective fiat currencies in a sort of competitive debasement race. This is especially true with Super Mario at the helm of the ECB – who appears to be much more accommodative to creatively accommodative monetary policies – see LTRO comment. This in turn motivates the US to keep pace with its own currency debasing policies (currency rates are just a relative value game, after all). This currency rate helps the central banker to import just the right amount of inflation where its own reflationary tools have little traction (ZIRP/zero bound of interest rates).
This is why it is extremely interesting to see the emerging growth superpowers looking to diversify away from traditional fiat settlement currencies. As wrote in a group email today:
I think the “gold standard” is often considered a black and white issue, whereas the reality is normally something a little more opaque. Perhaps we are already moving towards a sort of gold standard – not in the Bretton Woods sense but in the sense that governments will look to gold as an exchange mechanism/collateral for large deals?
Interesting the intimacy of dialogue between Italy and China last year when it was reported that China may be stepping in to help Italy with debt purchases. Given the respect and hunger the Chinese have for gold and the fact that Italy has the largest Gold-to-GDP ratio of any large economy, it would not surprise me if this came up in conversation
Gold to GDP Ratios
.
The Italy/China discussions were highlighted in my comment a while ago: The Marco Polo Connection. Today we hear, not only Ron Paul but front-runner Newt Gingrich making some pretty assertive comments on the concept of getting “back to hard money”.
But it may be worth considering the emergence of a new gold standard of the 21st century. One where economic juggernauts vie for superior gold reserves as a measure of their fiscal prowess and fundamental proof of their creditworthiness in a World where the true value of fiat currencies is hard to predict or quantify. After all… history rarely repeats, but it often rhymes.
Market Overview
Global Slowdown and Mild Weather Weigh Heavily On Hard Commodities
Hardly surprising that hard commodities and fossil fuels are down given the outlook for global growth and the relatively mild weather we’ve had acrossEurope. But there is another side to this argument as described above: the debasement of the denominators. Perhaps it is time to start looking at commodities like Coal and Nat Gas to buy. Chart of the Day shows Central Appalachian Coal Futures… through all the good news out in the past month or so the price is still down over 20% from where it was just 6 months ago.
Chart of the Day
Central Appalachian Coal Futures (Source: Bloomberg)
Events
Macro Events:
Update:
Nothing Significant
Alerts:
Australia Inflation
Germany IFO Business Survey
Singapore Inflation
US FOMC
Corporate Events:
Results:
Boeing [BA], Citrix Systems [CTXS], ConocoPhilips [COP], Motorola [MSI],
The spending idiocy of the World is gonna catch up with itself and that’s where we are today.
Kyle Bass – Hedge Fund Manager
Macro Overview
Much of what I needed to say on the Eurozone has been said and I’ll update you if things change… if you’d like a quick refresher here are some links to the most popular key articles on the Eurozone:
I’m taking a few days off writing extensive opinionated material and will choose instead to provide you with a few choice excerpts/videos/links which I think have shaped my views this year and will shape my forecasts into next year.
Betting on Chinese Growth is not a Risk-Free Trade
In my last “Investment Opportunities From and Asian Perspective” I was typically optimistic about Asian economies. As we have seen, a lot can change in 6 months and it’s time for me to update my views. Firstly, the growth trend in Asia is not going to suddenly stop any time soon, but it is increasingly important to understand the risks with investing in Asia, in particular China. With current political, societal and inflation dynamics, 5% growth in Europe would be euphoric, 5% growth in China would be a disaster. It is therefore worth my while dedicating a comment to highlighting some of the risks I see as front and centre.
Not long ago I told a cautionary tale which referred to some of the economic risks China faces going forward.
Breakneck Growth in China hides a lot of cracks beneath the surface. I’m not just talking about NPLs it’s the entire nature in which capital is allocated in a business society used to persistently high growth and relatively low inflation.
This has been touched upon by Peking University Professor, Michael Pettis, in particular in a couple of pieces:
To quote a couple of sentences from the second piece:
In all previous cases of countries following similar growth models, the dangerous combination of repressed pricing signals, distorted investment incentives, and excessive reliance on accelerating investment to generate growth has always eventually pushed growth past the point where it is sustainable, leading always to capital misallocation and waste. At this point – which China may have reached a decade ago – debt begins to rise unsustainably.
Deteriorating Economic Backdrop Will Expose China’s Underbelly of Corruption
Credit risk, fraud, scandal and default have been on the up in China for a long time, but recently it’s been hitting the limelight. Have no doubt, in the long term I am extremely positive about Asia’s long term prospects – nowhere more so than China. But what is deeply concerning about these developments, though, is that not only is the frequency of accounting fraud and business scandal events increasing, so too are the magnitudes.
A couple of weeks ago I saw this commentator try to put a light-hearted sunmary on things following PUDA Coal’s press release:
PUDA, which has already been the subject of a summer long stock halt, a delisting, and a sham buyout offer, revealed that its CEO had resigned, and, by the way, forged documents which he had given to the SEC.
But investors whose stock is down 96% YTD may be forgiven for having a sense-of-humor-failure. Then there’s the Silvercorp saga - which I won’t bore you with. But it’s worth noting that the reason Chinese stocks were falling while other markets were rallying at the end of September was due to Khuzami’s barbed comments on companies not operating out of the US. A thinly veiled threat on how the World’s largest regulator would be coming after less-than-righteous Chinese companies.
But this being China, nothing is straightforward. Deloitte says handing over audit documents might violate China’s state secrets laws and therefore it shouldn’t have to comply. This is not as crazy as it sounds. A close reading of the firm’s resignation letter suggests local bank branches—almost certainly of large, state-owned banks—may have falsified routine documents verifying cash balances.
Experienced auditors report that this is an increasingly common problem in China, stemming from unduly close relationships between branch officials and companies. It also, not incidentally, hints at weak internal controls within listed financial institutions that were theoretically reformed in the 1990s from their old pattern of political interference and lax controls.
You cannot make this up. We’ve always maintained that one must adopt a patient attitude to investing in China, but there’s patience and then there’s prudent risk management.
Last month we found out that Sino-Forest turned out to be more like “Sino-Tree”… and soon to be “Sino-Twig” and “Sino-Dust”. This week, the latest in an increasingly long line of high-profile Chinese business scandals hit the tapes: Chaoda’s Fraud Scandal. See this pdf file (courtesy of “Anonymous Analytics” via ZeroHedge) I urge you to read this, or just skim through the “History of Deceit” section starting page 6. I mean honestly, this record makes The Sopranos look like The Brady Bunch.
Chaoda’s shocker exposes a serious point: this fraudulence is not limited to small-to-medium Chinese spivs doing back-door listings on North American stock exchanges – it has perforated throughout in Asia. Read between the lines of Muddy Waters’ Carson Block’s comments, when he says:
… Hong Kong has had a more thorough pre-IPO process, but the question is: how many problems have slipped through the cracks in Hong Kong.
When this level of fraud (especially accounting fraud) exists, it is impossible to quantify the risk of NPLs on the financial sector and, in fact, all business within China. Perhaps more disturbing from a macro level; complacent investors (perhaps even Chinese officials) may think that, by maintaining high growth these mal-investments will iron themselves out. History has show that this is not so, there comes a point at which malpractices need to be reconciled – literally.
One thing I’m conscious of: as China approaches what some people call a “growth recession” (basically a level at which inflation becomes appreciable compared to real growth – see comment I made last month) then fat tail credit risks, like Fraud, embezzlement, gross mis-management, financial events, sudden default rate spikes etc, will become an appreciable drag on investment performance, and it will take some investment funds out entirely.
It is not easy to get good access to default rates in China but the FT reports that yields on loans to developers are hitting 20%+, suggesting that “developers are losing access to funding”. My guess default rates will rise exponentially over the next 2 years – if they are not doing so already.
Never-the-less, we hear many reassurances that non-performing loans (NPLs) in China are “contained”, but where have we heard that before and how on earth is it possible to quantify a risk which, as Pettis correctly asserts, by it’s very nature we cannot see? The NPLs we are currently able to observe in China are but the tip of a rather imposing iceberg.
Some of my friends in closer dialogue with Greater China businesses think that magnitude of bank losses due to NPLs may be greater than book equity of the banking sector as a baseline case. Don’t ask what the worst case scenario is, it’s too horrific to put into print.
But, as I’ve commented on before in a Market Nightshift comment, this potential liability rather puts to bed the absurd notion that China would prioritize bailing out European sovereign states 5,000 miles away – without demanding something extremely valuable in return (hint #1: China Wants Golds, hint #2 Italy has largest Gold to GDP reserves of any large economy).
National Gold Reserves to GDP - China is a minnow that wants to be a shark.
All societies are corrupt to some degree, but, as with most rapidly developing economies, in China it is widely accepted that corruption runs right through the core of business and politics, in particular local government officials. Only this month China launched a surveillance program to stop corrupt government officials transferring funds and fleeing the country. Indeed TIME Magazine published an unbelievable article this summer claiming that Public Officials Stole $120 Billion and Fled the Country – that’s probably more than it would take to bail out Italy in one fell swoop today!
One need only look at the interplay between land sales and the real estate Business to understand just how rife corruption is in the business sector. This corruption has gotten so apparent that, even in a strictly controlled society like China, there have been unrestrained protests against the injustice. I choose my words carefully, it’s not that corruption has necessarily gotten worse in the last few years, it is just more apparent. The blatantly corrupt practices of “fat-cat” family executives and government officials is painful, even for a non-communist states, to bear. But in a country with ideological virtues beset in egalitarianism it is all the more difficult to swallow, ever more so when rising inflation and subsiding growth contribute to a “growth recession”. The Chinese Communist Party, of all people, should know about that.
While everybody I meet seems to agree that “it’s just the Asian way” of doing business, indeed with all rapidly growing Emerging Markets, few have taken time to address all the potential consequences should the exposing action of the growth recession dynamic we witness in China continue at its current rate. Indeed few Asian investors have needed to consider this paradigm shift… yet. China is a long term growth story, but over the next couple of years, the unceremonious unveiling of China’s corrupt underbelly is not going to be sublime chapter in China’s amazing growth story. The question is: are you prepared for it?
Soft Landing or Hard Landing? That is the Question
It is interesting to note that debate has shifted from: “will China experience economic deterioration” to “OK what kind of deterioration will we get”. Last week, in their comment “Here Comes The “China Hard Landing”, ZeroHedge cited a BoA’s presentation and their strategist, David Cui who is rated #1 China Strategist according to the Institutional Investor All-China Survey. Here is an excerpt:
Fitch’s head of sovereign rating Andrew Colquhoun commented that in the near term, the biggest risk to China’s sovereign rating is the banking sector.
BofAML’s David Cui was ahead of the curve on this one:
He believes that there is still a large downside risk in China.
David believes that there is a good probability of a hard landing, he highlights timing associated with this could be past 2013 with the new administration.
A great WSJ article a couple of weeks ago inferred that actually China may have understated the size of its economy and growth – especially in the service sector. While that may be encouraging to some, to an investor, that is now historic data, long embedded into market valuations. In fact, it brings new fears of potential “reverse feedback contagion” (from Asia to The West) and potential understatement of inflation effects, should the growth recession persist. But, even if you assume that official Chinese numbers are not themselves severely corrupted, (that’s a big “IF” – ironically, WikiLeaks revealed that even China’s contender for the leadership Li Keqiang thinks that the official Chinese numbers are manufactured) then we are on a new growth trajectory in China and it’s not going to be all one-way traffic – like it has been over the decade preceding the financial crisis. Indeed PIMCO’s catch- phrase “New Normal” may be more appropriate in China than anywhere else.
ZeroHedge also think that sub 7% growth in China would constitute a “hard landing” and the day after this report was published, Bloomberg published a rather more disturbing poll that [emphasis mine]:
Fifty-nine percent of respondents said China’s gross domestic product, which rose 9.5 percent last quarter, will gain less than 5 percent annually by 2016.
Of course, these are just the opinions of a couple of bearish analysts, one needs tangible information: the commodity most associated with all economic activity (but especially in China) is copper. You need copper to construct anything with pipes or electrical wires in it. China is by far the largest consumer of copper in the World, sucking up anything from 20% to 40% of the World’s supply – depending on the mood. That is because China has been the growth engine of the World of late and, as we all know, copper is the barometer of the infrastructure and real estate industry: booming copper prices means booming construction means booming economy. Here is a chart of copper today:
Make a note of the volume trend. Down 25% YTD this is pretty much the worst performing asset I have seen this year. If politicians in Europe and America were not grabbing all the headlines this year, trust me, we’d be crapping ourselves about this.
So, these are not immediate concerns and even if it does happen; 5-7% growth is still 5-7% real growth, and, if things do slow down as fast as these analysts think, 2013 – 2016 is still quite a long way away. But bear in mind, the markets don’t look back, they look forward and there is going to be an increasing divergence between the fortunes of the various asset classes and risks in Asia. Just because the Chinese economy is likely to hum along does not mean that your Chinese investments will. If you are still tuned into the investment risks of yester-year in China-centric markets, mark my words: you’regoingDOWN.
As investors in Asia, it is imperative to differentiate the characteristics of the accessible markets. Firstly, take this comparison: insiders in the US account for 8% of shareholding concentration. Insiders in “liquid Asia” (ex Japan) account for almost 50% of concentration. This has been a proven hunting ground for financial fee-grabbers in services ranging from asset management, private banking, hedge funds, private equity and stock brokers to the High Net Worth Individuals (HNWIs). But there is a flip side to this; it means that there is a huge agency problem bias towards enhancing shareholder value, at times at the expense of creditors. Forget the stock market, to judge the business risk towards investing in China it pays to be attentive to the structural issues underpinning the credit markets in China. Bloomberg headlines offer a few clues as simultaneous reports are published; first that emerging market bond markets have seized up with companies “selling the fewest bonds in 2 ½ years” and then that China sovereign bond risk is at the highest since the violent throes of the last crisis because… “[e]ventually in China, the burden in the banking sector will have to be reflected in the sovereign balance sheet.”
The reality is this, debt and fraud go hand in hand and fraud in Asia, even in the Greater China region, is paradoxically prevalent while extremely hard to detect. Over many years of buoyant business activity and economic optimism, it has been (at times systematically) hidden by the twin veil of an exorbitant growth trajectory and stable funding costs/inflation dynamic. This financial utopia is near an end. I have long been an optimist in China and I still am, but this view should not come as a surprise, dear reader – remember in a comment 18 months ago, I wrote:
Inflation, Inflation Everywhere – but not where we want it
Every headline you read in Asia points to a highly inflationary environment. If we take Bloomberg today for example:
“Increasingly the choice facing the government is between inflation or bad loans,” said Shih, author of the book “Finance and Factions in China,” who teaches political science at the university in Evanston, Illinois. “The only mechanism for controlling inflation in China is credit restriction, but if they use that, this show is over — a gigantic wave of bad loans will appear on banks’ balance sheets.”
This is caused by many things but one of the primary factors is the importation of American Monetary Policy. This happens naturally with a Global Reserve Currency as dominant as the Greenback. But it is exacerbated by the existence of currency pegs, as the Federal Reserve seeks to inflate the heck out of the Global Reserve Currency’s Monetary Base.
At some point China will have to address the NPL versus Inflation dilemma. At some point China will have to address the Growth versus Inflation trade-off I spoke about on 29th December 2009:
First, let’s recognize that there is a trade-off between economic growth (measured by real GDP) and Inflation. Sounds like a silly thing to say because, effectively: RealGDP = GDP – Inflation. So you could argue that RealGDP is irrespective of inflation because it is a measurement of economic growth with inflation already accounted for. That’s great if you define reality by what you read in text books but you and I both know, that this is absurd in practice. An economy with nominal GDP growing at 4.5% and 1.5% inflation is much more stable than an economy with nominal GDP growth growing at 15% and 12% inflation, despite the fact that they both have the same 3% REALGDP growth.
In China, a place where social instability is Public Enemy Number 1 and inflationary canary-in-the-mine is the protagonist of such toxicity, they know this trade-off all too well. As I’ve often remarked, high growth is the high tide which hides the “jagged rocks” of social and economic instability. China is an organism which not only desires such break-neck growth speed, it needsit as the socio-economic bio-plasma upon which the blood-flow of trade and economically harmonious activity is dependent on. What is the magic number? Well, it would seem that +8% real GDP growth is the number that China feels is a safe distance beyond which it can manage social and economic shocks of instability (in particular the inflation / growth trade-off). It’s quite clear to me that, while many economies would be thrilled with, say, +6% real GDP growth, this is sailing way too close to the inflationary wind, as far as China is concerned.
Wake Up to Reality
The good news is, in a slow down the inflationary risk should subside concurrently. That said, it has never been more important to understand the credit risks one is accumulating in Asia. Due to the globalization of financial contagion, one may even be at risk if one does not invest in Asia, but there is no doubt in my mind, if you invest directly in Emerging Asian or China-centric loans or are dependent on Chinese governance in any way; your business risk as it pertains to credit risk, counterparty risk, fat-tail event (headline/fraud/scandal/systemic) risk has never been higher… and it looks like it is only going one way.
Wake up and smell the coffee before it is too late. Reacting to this risk as it occurs is what some funds said about holding sub-prime CDOs. Times are changing in Asia – China will continue to grow at a rapid pace, but this decade will be nothing like the last for investors, especially investors directly taking credit risk in China-centric Asia.
If we would increase the figures, and I don’t really understand how anyone in Brussels at the Commission can have such a silly idea…the result could be that other member states…lose their AAA rating,
Wolfgang Schaeuble – German Finance Minister
Macro Overview
Mr Schaeuble’s remarks against bolstering the EFSF put a dampener on the mood today, the eve of the Great German EFSF Vote. If this vote does not pass we are back to the drawing board in Europe (and probably down another 10-15% on global equities). But, firstly, I think it will pass and Germans will vote for it. Secondly, I think the market misinterpreted this. Schaeble may be German, but he’s a politician too. This was a bargaining stance, not a veto of the plan. Put another way, there are ways that Spain and Italy could make concessions to ensure that AAA-rating is maintained at core member states and (more crucially) the EFSF. You just have to give what you can.
In Spain’s case, they have little to give so, like Ireland and Portugal, they must give up a degree of sovereign power to states like Germany and France.
In the case of Italy, well they have assets which they can swap with other states which would not bolster not only the funding but also the credit rating of other EU financial entities. What assets are these? Well they may be the very same assets China was courting the other day (see comment), the asset that everyone with anything to spend (especially China) craves dearly… (hint).
The reality is this; there are absolutely viable solutions to the European debt crisis. The problem is; they are political solutions. Big decisions need to be made by politicians who hold considerable amounts of power – unfortunately, they have rather gotten used to holding this power. If they have not understood the wishes of their electorate by now, then they will never understand.
Market Overview
Not going to comment on the markets because it’s all froth. Big determinant will be this German vote – could help Europe to fuel another global rally if things start looking up inEurope.
I’m going to show some good news instead of the normal drivel. Ireland’s CDS spreads actually seem to be getting better – see Chart of the Day.
Chart of the Day
Irish CDS Levels (Source: Bloomberg)
Gold Reserves to GDP Ratio - China's lust for Italy's Assets?
Small recessions are probably the price we pay for avoiding big recessions
– Andrew Smithers
Macro Overview
Looking out over the fields and woodland from my dining room window I notice that, at exactly the same time every night, flocks of rooks fly west to roost in the woods – just before sunset. It’s become a routine, fly east into the sun in the morning to feed, fly west into the sun to rest. I can see them fighting and jostling in mid air as they approach the woods – presumably for the best roosts. We are all volatile animals and, just like the rooks, our lives run on the cyclicality of the World without us realizing. Attempts to smooth the business cycle over the last two decades have resulted only in more volatility and more violent cyclicality. We take for granted the cyclicality of the sun, the moon, the days, the seasons and, of course, the greatest cycle of all: the cycle of life. You see, we need volatility, we need cyclicality, we’re born into it, it’s hardwired into our brain, fate and physics, it’s what keeps us on our toes, it’s what makes the World go round – literally! Smithers (who says anyone who thinks stocks are undervalued are “stupid”) may be right; it may be that we need small recessions to prevent us from having big recessions. The price of stability is instability.
National Bank of Switzerland beware: “I fought the Market and… the Market won!” said Japan’s Ministry of Finance as they beat a hasty retreat by announcing a package to bail companies exposed to FX losses out (effectively waving the white flag on direct currency manipulation) only hours after Moody’s downgraded the country’s debt. The market is, by definition, too strong for prolonged manipulative forces – if it is not, they by definition it is not a market. Well, if Japan cannot control its currency what chance do the Swiss have? If people regard the Swiss Franc as a safe asset, they’ll treat it like Gold – negative yields will not deter them.
No let up for the European Banks – especially the investment banks. It’s a bloodbath on job-shedding.
Yesterday I drew attention to the fact that stock market was not really up because the “FDIC’s list of problem banks is shrinking”. Today ZeroHedge ridicule that headline too, turns out 39 banks were probably absorbed by mergers and of the 23 remaining banks, it’s likely that 22 dropped off the list because they had failed!
Bloomberg’s theme for the week seems to be “turning Japanese” – keep up guys, Turning Japanese was last week’s news!
I suppose we should mention the BoAML rumours that JPM will step in to take them over. I find the rumour of the rumour more interesting than the rumour itself. The thought that the market even entertains this issue says something about the fluidity of ideas in the US financial system. But to the heart of the issue. Firstly an internal memo says that these rumours are “baseless and don’t even make practical sense”. This may not reassure investors, as nobody believes the CEOs of financial institutions even know what’s going on in their own companies, never mind what their opinions are about capital requirements. But when the biggest bear on the US financial sector in living memory defends the bank’s position it’s worth taking heed if only because she knows more about it that we all do and has a reputation to defend. The stock had huge rally today adding $6.5 bil to its market cap but it is still not very far off it’s lows.
Market Overview
A reflux of reflexivity is back, highlighting the inverse relationship between shares and the economy. Markets were trading up from the open at the beginning of the week because the data is week. Today strong durable goods orders mean that the market obviously dipped a bit in the middle of the day (less probability of QE), but the lure of Ben’s potential arsenal display at Jackson Hole had them rallying again into the close.
As I said, the week is all about the crescendo building up to Jackson Hole. You might as well forget about any other information. When Friday morning comes on the East coast of America, you may want to consider the following:
Which markets should you be watching?
Don’t get mesmerized by the stock market – this alone will not help you determine what the true market response is. Keep a close eye on the dollar, Commodities (especially Gold) and the bond markets. If the dollar drops and stocks and commodities rise then I think it’s safe to say the market is pricing in QE3 imminently. If stocks drop and bond yields rise (especially at the short end) then I think it’s safe to say the market is staring into the abyss.
What would be a bullish/bearish Bernanke statement for stocks/commodities/your asset of choice?
I think Bernanke has a tough job. I doubt he will “announce” any concrete, decisive action – there is too much political pressure against this and I’m not sure Jackson Hole is the correct pulpit for this. As Rosenbergsays, Jackson Hole is supposed to be a forum for central bankers and think tanks to deliberate the long term objectives of the global economy. The Fed has already hijacked this arena for its own pseudo FOMC policy announcements. But QE3 action would be going too far, I believe. Rather, Bernanke will likely explain his actions thus far and then lay on the table potential options for QE3. In the process (hopefully) reassuring the market that these options are plentiful and “shovel ready”.
What would be considered bullish/bearish price action?
Well plenty of theories here. In my opinion the most bullish scenario for equities and commodities is if the Bernanke basically says nothing and stocks drop to test the lows before building a sustainable rally. Then we know the market is pricing in economic conditions fully. But if we get very strong hints of QE3 and there is a knee-jerk rally, be careful – the market may call Ben’s bluff and decide to test the lows just to see if his bazookas are loaded (as Smithers warns about)! The worst case scenario is if Bernanke mentions “the limitations of Central Bank policy” (see Pilly Fed, Plosser’s comments in my piece on 18th August) and the markets trade down through the lows within a few days (or hours!).
Chart of the Day
So many to choose from… here is mine for today…
Portuguese 5 year CDS (Source: Bloomberg)
Events
Macro Events:
Update:
German IFO Consumer Confidence below expectations across the board.
US Durable Goods orders came out better than expected.
Alerts:
US GDP – expected to be confirmed at +1.1% for second quarter
US Initial Jobless Claims – needs to be below 400k to add optimism.
US University of Michigan Confidence– it’s at historic lows already we really can’t afford another drop – needs to be above 55.
