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     holycow
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Username: holycow
Post Number: 370
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| | Tuesday, November 16, 2004 - 02:49 pm: |  
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Asia-Pacific: The Casino
Andy Xie (from the Bahamas)
Long commodities and short dollar remain the dominant trades among most money managers that I have met this week in the US. The large US current-account deficit and a major revaluation by China are the underpinnings for this trade. Because most money managers are on the same side, the only scenario for most to make money would be a major revaluation by China that would fundamentally re-price assets that allow the current positions to be taken off profitably. Otherwise, the long-commodities and short-dollar trades would be zero-sum games.
I believe that China would not revalue its currency for the foreseeable future. Any move toward flexibility would have to wait for the Chinese economy to land and for the speculative enthusiasm surrounding China to cool. And any move toward currency flexibility would not be a significant appreciation and would be balanced in upward or downward bias.
Instead of a major revaluation, I expect the Chinese economy will cool sharply in the coming year due to (1) supply overwhelming demand in property and other major sectors and (2) a sharp slowdown in exports on rising Fed funds rate. The cooler Chinese economy would reduce commodity demand and bring down commodity prices sharply.
The flawed logic for Chinese revaluation
The dream that, when one wakes up some day, Chinese currency will be up by 25% is driving financial speculation in the world today. The theory is that China could raise the currency value to deal with inflation and make commodities more affordable to continue high growth, which would support even higher commodity prices. Chinese revaluation would allow China to take over from the US to drive global growth, which would justify a lower dollar.
The above view is one-sided and ignores the adverse impact on China from revaluing its currency. First, speculation makes the outcome unpredictable. If the revaluation is big enough, overseas Chinese who have parked a massive amount of money in Chinese banking system to speculate in the Chinese currency would withdraw the money to take profit. That would depress domestic money supply and pop the property bubble. If the currency appreciates a little, it would incite more speculation and attract more inflow, which would inflate the property bubble and cause a bigger crash afterwards.
Second, China is experiencing a massive investment bubble, especially in its property sector. Currency appreciation after experiencing a bubble would cause the economy to remain depressed for many years, as Japan saw in the 1990s. It is not logical to appreciate a currency substantially after a bubble.
Third, Chinese revaluation would cause the expectation for commodity prices to rise further, which would make growth even more expensive for China. Hence, the outcome for Chinese commodity users would be the opposite to the current expectation. Financial speculators have run up commodity prices to tax China for growth. Chinese revaluation would only increase their appetite to tax China.
...causes another round of carry trades
What is occurring, in my view, is that there is too much money chasing returns in a world of low interest rates. Even though the Fed has raised interest rate four times, the level is still low and below inflation. The liquidity sloshing around in the hedge-fund community is still massive. What is occurring in financial markets is another round of carry trades (see 'Last Frenzy', October 4, 2004).
The current round of carry trades began in mid-September, when China did not raise interest rate as some feared (see 'Last Frenzy', October 4, 2004). It began with a big rebound in the H-share in mid-September, which prompted most money managers to believe that China would appreciate the currency to deal with inflation and keep interest rates low to sustain demand growth.
Commodity prices followed the H-share index. Copper and oil rallied sharply. The copper fell apart first when China raised margin requirements for copper futures in Shanghai. China's rate hike on October 28 has cooled the oil market.
Short dollar appears to be the last phase of this round of carry trades. Many of the money managers I have met in the past two weeks were convinced that China was selling dollars in preparation of an imminent change in the exchange-rate regime, even though such rumors came before and were proven to be unfounded.
...driven by Greenspan's liquidity
The global economy has experienced a massive liquidity bubble, as the tech burst, '9-11' and the Iraqi War caused central banks around the world to keep interest rates at historical lows and for unprecedented long periods. The liquidity bubble has turned into demand mainly through speculation in asset markets, mainly property. The resulting high asset prices have turned into a consumption boom in OECD economies through the wealth effect from higher property prices and an investment boom in China funded by rapid exports to the OECD economies and capital inflow.
The strong demand growth has led to the high commodity prices and the expectation of Chinese revaluation. The current round of carry trades is a derivative of the strong global demand from the property bubble. As the property bubble begins to deflate, though slowly, the case for the carry trades would weaken overtime.
...on random China rumors
Every other week, it seems, markets move on the prospect credibility for the rumor is usually from someone who claims to have heard from some senior government official. Even though such rumors came and went so many times before, it still works. The reason for the recurring potency of China rumors is because the markets have nothing else to trade on.
China is big and opaque. Everyone can have a strong view on China and it cannot be proven either wrong or right. The best line to explain away the inconsistencies of a view is that Chinese data are not reliable and the real data would support the view.
The most popular misconception about China is that its top leaders are in control of everything. Hence, if you can understand what Chinese leaders want, you can predict what Chinese economy will be. The role of market is lost in this sort of thinking. If market forces are so useless in China, why is China trying to become a market economy?
China has so many government officials. Everyone has an impressive title and has an opinion on everything. When an issue becomes hot, all sorts of people in the government come out to express their views, even on something as serious as the exchange rate. The market interprets what one government official says as reflecting the government position. This is a misunderstanding of how China works. Very few people in the government have real power over important decisions.
China's opaqueness and the abundant supply of official views have created ample ammunition for speculation. As long as liquidity is still ample among hedge funds, there will always be speculation around China. Indeed, China and hedge funds are perfectly made for each other.
...and creating a sharks-eat-sharks world
The level of speculation in financial markets is so high, that I believe it is frightening away other investors. When a market makes a major move, it is hard to tell if the fundamentals have changed or if it is just hedge funds. The uncertainty about the market prices has made most long-term investors unwilling to trade. Hence, hedge funds become more and more dominant in financial markets, increasing the odds that market moves are zero-sum games.
Most of the market moves in 2004 have been zero-sum games. This has led to a new game in the financial markets: hedge funds try to front-run other hedge funds. For example, one could guess what sort of rumor would come out of China and take a position before it comes out. Alternatively, one could take a position and then start a China rumor.
The world is truly a giant casino today.
HC
"... if you've got a chart, I have an opinion!"
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holycow
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Username: holycow
Post Number: 415
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| | Monday, November 29, 2004 - 05:09 pm: |
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the HONEST Chinese speak...
"Honestly speaking, the more speculation (about a yuan revaluation) there is in society, the more unlikely it is that the necessary measures can be undertaken," he said at the Association of Southeast Asian Nations (ASEAN) summit in Laos.
"You must consider the impact on China's economy and society and also consider the impact on the region and the world," Wen said.
Last week, deputy governor Li warned that external pressure on China to abandon the peg would only be counter-productive.
"Under heavy speculation we cannot move (towards greater flexibility) and under heavy external pressure we cannot," Li told the Financial Times.
"The best environment for us to gradually move towards a more flexible exchange rate is when people don't talk about it."
HC
"... if you've got a chart, I have an opinion!"
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holycow
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Username: holycow
Post Number: 448
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| | Thursday, December 02, 2004 - 06:21 pm: |
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Asia/Pacific: Asia Can Defend Itself
Andy Xie (Hong Kong)
Asia is at a crossroads. If the region remains passive in its exchange rate policies, many of its economies could be trapped in deflation, low growth, and strong currencies for years to come, in my view.
The rapid ascent of the Korean won could not have come at a worse time. Korea’s domestic demand is stagnant. The high household debt remains a strong headwind against any consumption recovery. The small and medium enterprise (SME) sector is also weighed down by a heavy debt burden and soft sales, which limits any capital spending recovery. Korea’s exports are decelerating due to a weak DRAM price and China’s import slowdown. If the won continues to appreciate, as many market participants expect, Korea will see a recession next year, in my view.
The US economy is accelerating again and growing at about 4.5%. Europe and Japan are practically stagnant. The middle-income economies like Korea’s are growing slowly, if at all. Most emerging economies are also decelerating. The global economic cycle is decelerating despite a stronger US economy. The US is the strongest large economy in the world now, but it wants to push down the dollar.
Many in the US argue that it should devalue to decrease its current account deficit. I doubt that it would be effective. Currency adjustment works for a small economy relative to the world. The US is one-fourth of the global economy. It is difficult to imagine that changing the dollar value alone would eliminate its US$600 billion current account deficit. Hence, as the US merrily pushes down the dollar, the world could be headed for a financial crisis.
The US encouraged overconsumption through tax cuts and super low interest rates to avoid a recession after the tech bubble burst. This is the primary reason why the US current account deficit is so big. Of course, the rest of the world is also responsible. As Americans continued to binge, everyone else was happy to sell into the booming US demand and even fund the US binge with their surplus dollars.
The right solution to the US deficit, in my view, should primarily be in the form of higher US interest rates and taxes to discourage consumption and boost savings in America. But all informed people in the US would say that this is not possible: Americans would not accept a downturn, and, hence, the US government should push down the dollar to solve the problem.
Would a weak dollar solve the US deficit problem? It works in theory by making imports more expensive to Americans, which encourages production for import substitution, and exports cheaper to foreigners, which boosts production for exports. However, the US needs to build factories to realize such benefits from a cheaper dollar. With a low savings rate, it would need to borrow more from other countries to build such factories, which would increase the US current account deficit in the short term.
The danger for Asia is that it could push the region into the trap of deflation, low growth, and strong currencies. Asian economies are heavy in manufacturing. Strong currencies would cause de-industrialization, which boosts capital surpluses and makes strong currencies even stronger.
The world has been in an unstable equilibrium with the US borrowing and consuming, and Asia producing and lending. As the global economy slips out of this unstable equilibrium into something else, the future has multiple equilibria. If Asia remains passive when the US is pushing, it could be trapped into an equilibrium in which Asian economies would be characterized by low growth, deflation, and current account surpluses to fund the re-industrialization of the US.
Asian countries could take a few steps to safeguard their interests and prevent the US from dictating an outcome for the region:
First, Asian countries should shorten the duration of their dollar reserves. Asian central banks have been purchasing US treasuries when they buy dollars from hot money or trade surpluses. This action has artificially kept the US bond yield low, which has boosted the US housing market and consumption through mortgage refinancing. If Asian central banks keep their dollar reverses in the money market, the dollars would go back to the Fed, as it targets short-term interest rates. Hence, the interventions by Asian central banks to neutralize the hot money would be neutral to the US money supply.
As the Asian central banks sell US treasuries, the result would be to boost the US bond yield and decrease US consumption. The rising bond yield would force the Fed to raise interest rates more and quicker, as it should in light of the excessively accommodative monetary environment relative to the US economic growth rate. These two effects from Asia’s selling treasuries could stabilize the currency market.
Second, Asian central banks should prepare for and, if need be, implement monetization of government debt. This willingness to dilute the currency value is a powerful weapon to dissuade the hot money from pushing up Asian currencies.
Hot money can profit from pushing up Asian currencies under two conditions. First, Asian banks intervene in the market, which allows the hot money to build up massive positions. Second, when the central banks retreat, the hot money can push up the currencies quickly to cause panic among Asian businesses. When Asian businesses buy Asian currencies aggressively out of fear for their survival in the global market under constantly appreciating currencies, this is the moment that the hot money players could sell their holdings at sizable profits.
If Asian central banks show their willingness to dilute the value of their currencies, they would send a powerful signal to their domestic businesses that they should not panic despite the recent appreciation in their currencies. When the probability of such panic is low, the hot money is likely to leave.
Third, Asian economies should organize to negotiate with the US collectively on how to correct the global imbalance. Korea is in a unique position to coordinate such an effort. The US should increase interest rates and taxes to decrease the imbalance, while Asia should change its habit of always promoting investment and exports. When Asia sits down with the US collectively, it needs to propose policy changes that would boost Asian consumption, in my view.
Changing the region’s policy of high property prices is the key to correcting its bias towards savings and investment, in my view. A developing country needs to invest to develop. It requires high savings rates. Keeping property prices artificially high is the most effective means of increasing the savings rate, as it increases the propensity to save among working people in order to keep a roof over their heads. Japan, the Asian Tiger economies, and now China have all gone down that path.
Japan and the four Tiger economies have already passed the phase of rapid capital accumulation. They should decrease the ratio of property prices to income and make it closer to that in the US or Europe, which would increase consumption preferences closer to levels in the US or Europe. The irony is that bringing down property prices relative to income is bad for consumption in the short term. But, without this fundamental change, Asian consumption will always be elusive, in my view; when people have to pay so much for property, they tend to consume less.
Asian cooperation depends on Japan’s willingness to work with other Asian economies to confront the US. Most market observers would find such a proposition laughable. Japan has shown its willingness to comply with every US wish in the past few years. Asian economies have registered low in Japan’s policy considerations. However, yen appreciation may well push Japan back into deflation. Shouldn’t Japan be scared of such a prospect?
Many in the market argue that the yen could appreciate more because deflation has made it cheaper against the dollar in real terms. However, deflation happened in Japan for a reason. It was a form of adjustment. Using deflation to justify a stronger yen is to deny the need for an adjustment in Japan in the past. In my view, significant yen appreciation would almost certainly push Japan back into deflation.
It is in the overwhelming interest of the region to stand its ground. The only sustainable economic equilibrium is a cooperative one, in my view. I believe the world needs to dissuade the US from using hot money to push the global economy in its direction only.
HC
"... if you've got a chart, I have an opinion!"
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holycow
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Username: holycow
Post Number: 449
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| | Thursday, December 02, 2004 - 06:47 pm: |
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Note: the previous article is dated 29/11/04... considering I am thinking of "cutting down" my posts, I think I am doing extremely well! 
Nov 23, 2004
Asia/Pacific: Asia Should Sell Treasuries Now
Latin America: Dollar Pain, Latin Gain?
Asia/Pacific: Asia Should Sell Treasuries Now
Andy Xie (Hong Kong)
I believe Asian central banks should sell their holdings of the US treasuries now. A weakening currency should lead to higher bond yields. However, because Asian central banks hold significant amounts of US treasuries, US yields have not reflected US dollar policy. This lack of pain is encouraging the US to pursue its devaluation policy. If Asian central banks dumped their treasury holdings for short-term paper, the US government would have to balance between a weaker dollar and higher bond yields.
The US has been binging beyond its means since 1999. In 1999 and 2000, the new economy hype sucked the rest of the world into buying US tech assets. Asian portfolio investors now hold worthless NASDAQ stocks and European MNCs own many US tech companies that have heavy debts but weakening revenues.
After the tech burst, Mr. Greenspan cut interest rates aggressively, causing US treasury yields to fall to around 4% from 6%. The bond market rally sucked in foreign buyers, who supported US consumption and the dollar.
As treasury yields have bottomed out, the US now wants to devalue the dollar (which would be to the cost of foreigners who hold trillions of dollars of US financial assets) to create jobs to sustain its consumption. I see the weak dollar policy as simply another way to get foreigners to subsidize US spending.
Asiacan fight back. The US uses its superpower status and the advantage of the dollar as the currency for trade pricing and central bank reserves to get foreigners to fund its outsized spending habit. Without a market signal, this US ‘shopping addiction’ won’t stop.
Asian central banks have been buying US treasuries to recycle the dollars that hedge funds take to Asia. This trade depresses US bond yields, which gave US consumers an excuse to continue their shopping spree through mortgage refinancing and the US government an excuse to run a large fiscal deficit. Now the bond yield has bottomed and the mortgage refinancing game is dead. The US is switching to a weak dollar policy. The Asian central banks do not appear to be reacting to this policy as normal investors would, which is sending the wrong signals to the US government, in my view.
If Asian central banks sell these treasuries now and keep the dollars only in cash form, it would cause the US bond yield to rise, possibly by 150 bps, in my view. That higher bond yield would stop the merry-go-round among the Fed, the hedge funds, the Asian central banks and the US consumer. With higher bond yields bringing down US consumption, the global imbalance would heal. Alternatively, the US government could raise taxes to cut the fiscal deficit, which would stabilize the dollar and the treasury yield at the same time. That would be a happy outcome for the world, I believe.
Most Asian economies have short-term interest rates lower than or at 2%. This strategy would not be financially costly. Japan, in particular, could keep the dollars that it buys locked up. With a zero short-term interest rate, Japan could do this indefinitely. It would effectively neutralize the hedge fund flows into Asia and force US bond yields to reflect fundamentals.
Higher US rates are the end-game in any case. The weak-dollar policy will not solve the US deficit problem, in my view. It would, were the dollar cheap enough for the US to start a factory-building boom. Last year, US imports were US$1,257 trillion, versus US$725 billion of exports. The deficit was US$532 billion. The US would need a great many new factories to fill this gap. The dollar index against major currencies dropped by 15% last year. However, the US deficit in the first nine months of this year was up by 19.2% (perhaps one could cite the J-curve as an explanation, although I doubt it). There is little evidence to suggest that dollar weakness will mean more factories in the US.
I believe the weak-dollar policy may work only if it triggers higher inflation in the US, forcing the Fed to raise interest rates higher and more quickly, as it did in the early 1980s, which would cause a recession in the US and decrease the US trade deficit through less domestic spending. Such a recession is necessary, in my opinion. The US should have seen a recession following the tech burst. However, it shied from this, and has since been juggling to sustain demand growth. When this juggling act falters, a recession will occur anyway.
So why take the round-about way, since the solution is higher US interest rates in the end anyway? If Asian central banks sold treasuries now, it would bring the issue to a head. If the US does not want higher treasury yields, it can cut the budget deficit, which would lead to a lower trade deficit, stabilizing the dollar. this is because them Yankies have a prez who is persuading a monetary policy that is cocked-eye to the nth degree... kinda modified version of Reagonomic - high deficit, high inflation and high interest! Just wait for the meltdown, won't be too long!
Asiais at a crossroads. Asian governments must be strategic in dealing with the ebbs and flows in the currency markets. The hedge fund industry has become so big that short-term flows in the currency market are large and sentiment-driven. If Asian governments are swayed simply by the large flows, they risk making major mistakes as regards their economic futures.
The critical objective for Asian economies is to avoid the fate that befell Japan in the late 1980s. China and South Korea have experienced massive debt growth since the Asian financial crisis. China’s domestic credit has risen to 150% of GDP this year from 100% in 1997, mainly on business borrowings. Korea has shifted its debt to households from businesses – i.e., its debt problem that caused the crisis in 1998 has been redistributed, not solved. If their currencies appreciate substantially, these two economies could fall into the Japan-style trap of low growth, low interest rates, low inflation and a strong currency.
How China deals with the renminbi peg is the key to how the world unfolds. Many people want China to do what Japan did in the 1980s – create a large bubble to support the global economy while the US rests. ‘Currency flexibility’ is just code for drawing China down the path of mega revaluation. The Japanese yen doubled within two years after the Plaza Accord in 1985. As soon as China buckles under pressure, it could suffer the same fate, in my view.
If China goes down this slippery path of appreciating its currency under pressure, its scope for economic development will shrink sharply over time. Chinese goods suffer widespread discrimination, despite the WTO system, because Europe, Japan and the US do not recognize China as a market economy, which gives them ample room to keep out Chinese goods. Chinese goods sell because they are so cheap that businesses in these economies go to the trouble of bringing in Chinese goods for big profits. If the Chinese currency appreciates by as much as many people want, Chinese goods will cease to be irresistible and China’s exports could suffer greatly due to discrimination.
However, if Europe, Japan and the US recognize China as a market economy, China could consider some flexibility on the currency. Were China to fail to receive anything in return for currency appreciation, the market would likely view it as vulnerable to pressure – and keep pushing. That would take it down the path that Japan traveled in the 1980s.
I think the right path for China is to increase interest rates to slow down investment, which would decrease speculation. Contrary to the popular view that higher interest rates would attract more money, when China shows determination to land the economy, hot money will leave, in my view. With speculation cooling down, China could undertake currency reforms at its own pace. The renminbi’s value would be determined by the true balance between demand and supply, rather than by speculation or political pressure.
HC
"... if you've got a chart, I have an opinion!"
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