Sea Change, the Wealth of the World is Rotating
Sea Change, the Wealth of the World is Rotating
Be careful what you wish for, powder kegs and the matches have been lit, the Yen
Time to load up on Commodities, Gold and crude, the train is leaving the station!!!
Sea Change, the Wealth of the World is Rotating
This is one of the most shocking charts (courtesy of the NY times) I can ever recall seeing, it is one that spells eventual doom for one group of Global Sovereign market participants, and boom for another! This is the shifting sand's of Globalization and wealth. This is as they say in business the "bottom line." This is a major shift of Wealth from the developed economies of the world to the emerging world. The developed countries of the world are in position for a real catastrophe, and the emerging markets are emerging at a far greater rate then previously believed. Interest spreads between the two are at historic lows and now we can see why, they have MONEY in the bank, if a hiccup comes in the global economy they are prepared to service their creditors. Their debts are at historical lows, and their savings at historic highs. The developed nations conversely are extremely vulnerable to a liquidity crisis, as they are in the opposite position of debts at historic highs and savings and investment at historic lows. It is clear why the G8 is creating liquidity as quickly as possible; debt is very, very deflationary.
Now lets look below at the balance sheet of the top emerging nations courtesy of the financial times, that as a percentage of GDP, debt is half the levels of the developed world, where onbalance sheet obligations run from 60 to 150% of GDP. These figures do not include future pension obligations and in the case of the United States does not include off balance sheet borrowing of the Surpluses from the Social Security trust funds. In 1992 these emerging group ran a cumulative deficit of 547 billion dollars, but by 2005 ran a surplus of $248 billion, in 2006 and 2007 these surpluses only grew. A good example is Nigeria, which is a turbulent nation, but it has virtually wiped out its foreign debt obligations. And as you can see the other emerging economies have retired mountains of foreign debt obligations as well. Considerably reducing their potential of economic instability from external borrowing. And they have Trillions of dollars, and yen and Euros of savings in the bank.
Who hold the CARDS? aka the creditors of the western world? China, Russia, India, The Middle East, Venezuela, Iran, etc. These countries are willing suppliers of goods, raw materials and services, but I don't see one of them as actual friends of the West. In fact, one could argue, that its payback time and the emperor (ie, Europe and America) has no clothes. As a example of the power shift look no further than Russia as it stares down western Europe with regularity. If these high saving, budget surplus emerging powerhouse nations ever quit or reduce their appetite for the developed country credit offerings or currencies, you can expect quite a plunge in bonds and considerably higher interest rates.
The credit requirements of the developed world just to keep up the outstanding obligations and current spending is astronomical. The external debt payments of the industrialized world to these emerging markets have more than doubled in the last three years. And at the rate the developed world are debasing their currencies, their credit offerings are bombs. It is one of the principle reasons asset markets are skyrocketing, a good portion the new money the emerging world are receiving is not going into these fixed income assets, they are now going into assets to protect themselves from the global money printing machines. And those same assets can just reprice as the currencies they are priced in debase.
When looking at the average growth rate in the developed world and then looking at the credit and money growth in those same countries we can also see that the developed world is creating almost 4 dollars of new credit obligations for every dollar of GDP growth. Borrow four to make one? Is not a recipe for sustainable growth!! Every dollar of debt must be paid for with future earnings. Those deficits and credit obligations are calls on future earnings. The anemic growth has to service growing mountains of debt in the developed world, and the roaring growth in the emerging markets services ever dwindling obligations! The seeds of growth are savings, they have it, and the developed world doesn't.
These are the seeds of Protectionism in the west. Politicians and their citizens in the west will recoil sooner or later as they become poorer and poorer, and their suppliers become wealthier and wealthier. The politicians in Washington keep encouraging reckless behavior such as Mortgage equity withdrawals and increased borrowing by consumers to just keep the party going. It is a recipe for reelection now and disaster later. A game of kick the can down the road.
The developed world is also not prepared to meet the challenge of Globalization in a number of other areas as well; the US has dumbed down their schools courtesy of the public schools and teachers unions who refuse to measure themselves against their global competitors. The United States has had a negative savings rate for the last two years, and so has none of the seed corn of capital formation. Go to www.youtube.com and watch man on the street interviews, on subjects ranging from Global warming, terrorism, geography, the constitution, and almost any subject you can imagine, the ignorance of the US population is frightening, just as the politicians wanted, so as to better manipulate the population.
But you better be careful what you wish for, as you might get it good and hard. The laws of unintended consequences are kicking in as because of the lack of savings, education and training the US is totally unprepared to meet the challenges of Globalization. Of course, France, Italy, Germany and much of central Europe fall into many of these categories as well, but at least their populations save money. But the man on the street is not informed, and mislead by a liberal media. Politicians can just pin the tail on the donkey of the foreign devils, not their lack of practical solutions to the problems, they prefer political ones implemented to pay back their campaign contributors, to the detriment of the constituents.
For as long as I can remember since starting my career in 1983 the Developed world has long wanted the emerging world to reform and open up their economies and join the global trading system. Now they have, and the picture isn't pretty for the developed world. As they have done just the opposite, larding up on the social programs, dumbing down their electorates, raising taxes and regulations in a relentless manner. Destroying incentives to work, and fostering a "dependence on government mentality". Conversely, people in the emerging world of the "former satellites of the USSR in Eastern Europe", China, Russia, India are doing just the opposite and are developing very self reliant and very entrepreneurial segments in their economies. These people know first hand that the government is a poor provider of economic security, and for the most part don't want to go back to the way things were in those former "workers paradises". LOL. Don't get me wrong, there are plenty of problems in the emerging world, but they are constantly being reduced, while the problems are just increasing in the Developed world as politicians resist reform, deregulation and tell their constituents they can fix the problem by passing a law against whatever is concerning or bothering them that day.
The Graham Schumer tariff bill a prime example of the belief you can change reality with a few words on paper, the bill proposes 30% tariffs on Chinese goods if they don't revalue their currencies by 30%, what a laugh, this would be a 30% direct tax on everyone who shops at Wal-Mart or many of the other superstores. Those consumers would instantly lose 30% purchasing power of their dollars, and be very much worse off as the substitutes for these products would be of far less quality and higher price. Their lives would be far worse. The manufacturing base went off shore for one reason, and one reason only. The federal governments in Washington DC and Europe who regulated, taxed and mandated their way to the unprofitability of these domestic ventures. They can't compete Globally with the rules as they are today! The politician's say that's OK; we will just pass a law against these rugged competitors. Do you believe this will really stop the problems of coping with the realities of globalization?
The US and Central Europe have some of the highest Corporate tax rates in the world. Now having destroyed domestic manufacturers, the Congress and the European Commission has set its sites on Multi-nationals. Senator James Webb the new senator from Virginia speaking on Fox news Sunday explicitly set his sites on these companies and plans to raid the profits from their overseas operations. Why does Intel build plants in Viet Nam? Soon Intel will move their global headquarters out of the US before these idiots are through. As we look for the reasons of industrial decline in the developed world look no further then the fools on Capital hill, in Brussels, in Berlin, in Paris, in Madrid, and in Rome.
The emerging world is sitting on trillions of dollars of reserves, and as sure as savings are the seed corn of capital formation and wealth, new local capital investment opportunities are emerging at a breakneck pace. Homes, offices, Factories, roads, infrastructure, cars, and power generation are just a few of the items needing to be built. Many analysts believe the Commodity bull market over because of the auto and housing slumps in the United States, NO WAY. Just because 300 million people in the United States reduce their expenditures on housing and cars, this isn't a good case for a commodity bear market as 3 billion new entrants onto the world stage are quite willing to step in to cover the weakening demand for materials in the developed world.
And who will be the drivers of these new opportunities, it is the new crop of graduates these emerging economies are churning out in astounding numbers. The Internet has democratized education and the wealth that has been created in the emerging economies is driving the creation of a tsunami of college-educated workforces. Take a look at this chart from a recent report by Steven Roach of Morgan Stanley.
China, Asia and India are turning towards their hungry and hopeful new graduates to lift their populations out of poverty, 10's if not 100's of millions of people are emerging on an annual basis. These emerging economies have emerged and the rate which the wealth of the world is being transferred to them, soon they may be our masters.
Be Careful What You Wish For-
Powder Kegs and the Matches Have Been Lit!! (aka the "YEN")
With markets on their highs worldwide, Politicians memories in Europe and America have become very short. Just Last May a waterfall in equity and bond prices caused the Central Banks and Sovereign Financial authorities to see the horror of falling asset prices in an Asset dependent world. The Central Banks tried to tighten money and credit conditions and quickly realized the systemic threat to the Global financial systems of their actions. They immediately went to work and the result was an average growth worldwide in money and credit expansion of 14 to18% in 2006, depending on whose report you read.
The results of their actions can be seen today in every asset class, every stock index, every private equity deal, and commercial and residential real estate market in the world (except the residential housing market in the US which went through a tulip like mania, and got far far ahead of itself), these assets have exploded in price to the upside. The recent private equity battle over Sam Zells equity office properties is a good example of the liquidity available as the Return on Equity of the final deal was only 4.5%, talk about priced for perfection, this is a disaster waiting to happen for the funders of this deal. Unless, they have the financials authorities at their back inflating away the value of the base currencies, which they do!!!
Recent reports indicate that in general pension funding levels have recovered the ability to meet their future liabilities on the back of this asset price growth. This health is the direct result of an increase in financial asset values from $113 trillion dollars in 2003 to $140 trillion dollars in 2006. A 23% increase in just three years. A projected value of 200 trillion dollars by 2010 paints a rosy picture. Pension liabilities and any debt based liabilities for that matter will be paid back in devalued currencies. This sure shores up the old balance sheets...
Now a new threat to these asset values is rapidly emerging from the newly elected left leaning government in the United States and the always-left leaning European Union. They have long bemoaned the Chinese Yuan's peg to the dollar, and the unfair advantage Chinese exporters have over domestic suppliers of manufactured goods. Not to mention their natural advantage of low labor costs and high savings rates. Now these know nothing politicians that live in the past glory of their economies and are ignorant of global finance are attacking the Japanese yen and that is a very two-edged sword.
One of the little reported causes of the liquidity crunch that lead to the May thru July Global asset blood bath was the withdrawal of a huge portion on the quantitative easing by the Central Bank of Japan. During the February through end of may time frame the bank of Japan withdrew trillions of Yen from their banking system, and therefore from March 18 through May 15th 2006 the yen skyrocketed from 83.9 to 92.2 against the dollar or about 10% when they withdrew the liquidity. Less of anything means higher prices; it is the law of supply and demand.
Notice the date the yen hit its high? It is almost the to the day the top in the asset prices in Bonds, stocks, commodities, etc. The liquidation of assets was the result of forced liquidation of carry trades. These trades were becoming very painful as the 10% gain in currency was wiping out the gains on the speculative buy side of the equation. People who play with leverage have to have stop losses, or be wiped out in these episodes. And of course they liquidate their most liquid investments first, ipso facto exchange traded stocks, bonds and commodities.
The worlds asset prices have now recovered, and guess what? The Yen as we speak is back at 82.6 against the dollar. This is no or coincidence or accident. It is the nature of the underpinnings of Trillions and trillions of dollars of the aforementioned Global financial asset values. It is the footprints of the YEN carry trade.
The Yen carry trade is where global asset managers borrow in Yen at .25 of 1 % and then buy higher yielding assets Worldwide that yield much more, anywhere from 4 to 5 % in Sovereign bond markets, to more risky high yield emerging markets, corporate debt issues, stocks, real estate. (Here's an example; they can borrow Yen for 5 percent of face value in the futures market or from a Japanese bank, in other words they sell yen or yen futures, put up 5% margin for say $100,000 of yen, and pay the market .25% interest and then spend the 100,000 dollars on another investment that yields considerably more (junk bonds, stocks, or any high yield bet, etc.) or buy a futures contract that pays 7.5% on the Aussie dollar. They make the spread). As long as the yen is flat to down they are quite successful investments, and offer huge leverage opportunities to enhance returns. But a rally in the yen quickly turns these investments upside down and forces liquidation of the speculative end of the carry trade, i.e. Stocks, bonds, real estate, etc.
Thus when the Yen rallied because of the previously mentioned tightening by the Bank of Japan last spring it convulsed the Worldwide asset markets this borrowed money was used to purchase. Losing 10% in currency terms means, if you make less than 10% on the buy side then you lose!!! It was a major reason the global stock, bond and asset markets tumbled and the markets dived lower. They had to take their bets off the table and stop their losses before they were killed....
Heading into the G8 meeting this weekend politicians in Washington and the Central European Union are attacking the low value of the Yen as TOO LOW and a competitive advantage for the Japanese and a disadvantage for the welfare states. But keep in mind the Japanese economy is only just beginning to recover from 15 long years of stagnation, low growth, and deflation. It is finally beginning to grow, but is weak and prone to set backs. And Japans westernized/developed economy is not a high growth, low wage, low benefit affair like China, India and the emerging world. Japan is a low growth story, they need to preserve what economic activity they have and build on it, they are not booming at the expense of the US and European economies. So lets see the US and European Politicians are saying; raise the yen, go from barely positive to negative economic growth and lets bring down the carry trade and asset values worldwide. What FOOLS and IMBECILES! The only voice of reason has been that of US treasury secretary Hank Paulson who says correctly the value of the currency reflect the economic fundamentals of Japan, a deflationary slow growth story.
This is nothing but political ignorance and populist grandstanding at its worst, Targeted to the most ignorant of their populations and the press. But a rally in the Yen of even 5 to 10 % will send their domestic stock, bond, and asset markets skidding lower destroying the wealth recaptured since the reflation of 2003 began. The little fraction of trade and business they lose to Japanese competitiveness due to Yen weakness will be dwarfed by the Tsunami of lost wealth caused by the drop in asset values. Now keep in mind that the yen carry trade is responsible for some of the appreciation of assets worldwide, but many more of those assets are financed through domestic and international stock or bond issuance, securitized debt, and old-fashioned borrowing of one sort or another. Those creditors will be crushed by the loss of value of the assets they loaned against. Ditto the holders of the assets. It will hit the balance sheets of the borrowers and lenders in Europe and the United States SIMULTANEOUSLY. Debacles happen at the margin, only a small percentage of players need to forced to the sidelines like we saw last May through July to cause a large downswing. All the debt issuance worldwide is basically collateralized by the inflated asset values, if the asset values decline below the amount that is owed then the loans and bonds that they are in what is called negative equity. This is the kiss of death for the lender.
The danger of attacking ones emerging market creditors is evident in the first segment of this newsletter. But to attack Japan on this subject is to invite disaster sooner than later. A spastic appreciation of the yen due to political ho ha, truly could cause a collapse of the financial systems of their own asset based economies... A domino effect that brings down asset values and the global financial systems they underpin. And for no reason, but to grab a few headlines to mislead their most ignorant citizens, and to pander to their trade union cronies. These are the financial and political leaders of the West, ignorance at the highest levels of our leadership. Talk about pooping where one eats...
Time to Load up on Commodities, Gold and Crude the Train is Leaving the Station
The next leg of the commodity bull market caused by global money and credit creation is poised to begin and the charts tell the story. Just as asset prices in the world have zoomed higher since the second quarter 2006 meltdown, commodities are now poised to recover as well; commercials are loaded up on the long side. Copper has retraced a Fibonacci 62% of its previous move, as has crude oil. Gold has gone through a mammoth period of consolidation in both terms of time and price. And the emerging economies have never slowed down; their growing appetite for commodities is set to continue apace. The grain markets are poised for huge moves with global grain supplies in relation to demand at record lows. Ditto for industrial metals, they too are still in short, short supply. And with liquidity at record levels the capital investment climate in the world is set to accelerate. I could go through all the charts but I won't, lets just look at one, the point and figure chart of gold;
A nice double bottom similar to the one we saw in stocks late last summer, in fact it looks like a mirror image of those bottoms. It projects Gold back through the old highs of May at $730, with an initial price objective of $790. This gold chart is evident in every currency in the world. The crude market is ready to rumble, inventories are lower and declining, while production in Mexico is collapsing falling over 500,000 barrels a day in 2006 and projected to decline the same amount in 2007. Add to this the nationalization of Venezuela's oil fields (a recipe for declining production) and continued problems in the middle east and Nigeria, the continued economic booms in the emerging economies and good growth in the developed world and it says; Its time to reenter the commodity markets in a big way, the next leg up is set to begin....
In conclusion, the world is changing, our leaders are not up to the tasks of managing globalization and preparing us to meet its challenges, as rather than practical solutions they are devising political ones. It is a looming disaster for the developed world as our politicians live in the past. But until they do hit the law of unintended consequences in a big way the global money and credit creation will fuel a party for the time being. You need to learn to have investments which can flow to any part of the planet in a heartbeat and make money in all market conditions, up down and sideways. In other words learn about alternative investments and how they can diversify your traditional stock, bond and real estate holdings. If you enjoyed this edition of Tedbits check out our archives at www.TraderView.com subscriptions are free, or send it to a friend, and if you wish to learn more about alternative investments and how to create your own custom made multi approach hedge fund to diversify your portfolios give me a call or drop me an email. Don't miss the next Tedbits and the beginning of the "Fingers of Instability" series.