... the day of reckoning draws closer....Red China is about to pull the plug on the US.
Until recently, it appeared that Bear Stearns (NYSE: BSC) had one investor still happy with putting money into the investment bank. That would be China's CITIC Securities. The capital would have given the firm a relationship with a large U.S. financial company. It has some real strategic value.
Over the weekend, CITIC sent a message that was the equivalent of saying "goodbye and good luck" According to Reuters, CITIC stated, "We cannot guarantee reaching a final agreement in the future."
While the news should not surprise anyone, it may just be the tip of the iceberg for U.S. banks and brokerages. Overseas financial institutions have been willing to put money into U.S. firms to get joint ventures in place. Sovereign funds have sent out checks to troubled Wall Street operations because they feel that when the U.S. economy turns, the equity they have purchased will rise in value.
The debacle at Bear Stearns may change much of that. The perception of the risk of putting money into U.S. financial companies may have doubled.
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....as if we needed another one. This time it is food....
WHAT HAS the food crisis got to do with Northern Rock? Quite a lot, actually. The rocketing price of wheat, soya beans, sugar, coffee etc is all part of the credit crisis which has caused panic in financial markets and encouraged investors to take their money out of risky mortgage bonds and shaky equities and put it into commodities as "stores of value". Put another way, the Western banks are exporting their debts to the third world.
The phenomenal increases in food prices are only in part a consequence of climate change and population. Most of the recent rises have been the result of speculation and the collapse in the value of the dollar. This is being tacitly encouraged by the central banks, such as the US Federal Reserve, who are trying to ignite another asset bubble to replace the real estate and dotcom bubbles which have burst in spectacular fashion. It's the third bubble and it's hitting the third world hard.
Desperate for quick returns, trillions of dollars are being taken out of private equity and financial derivatives and ploughed into food and raw materials. The financial websites call it the "commodities super-cycle". It ranges from precious metals at one end, to corn, cocoa and cattle at the other - speculators are even placing their bets on water prices.
The collapse in the price of the dollar means that most international commodities are more expensive for poor people. The dollar's decline is a result of the low interest rate policy of the Federal Reserve. When rates are set below the rate of inflation, investors have to keep moving their massive funds from sector to sector in search of higher returns
It seems that you can speculate on just about everything - even graves. Recently, China has been afflicted by get-rich-quick graveyard scams. Firms offered investors the opportunity to buy up lots of graves in the hope that prices would increase.
However, the grave yard bubble may be about to burst. The authorities have decided to clamp down on the cemetery speculators. Nevertheless, the grim reaper remains unperturbed. He marches on as he always did....
(BBC News) Inch for inch in China, it often costs more to be buried in a piece of land, than it does to actually live on it. So, inevitably, China has its own get-rich-quick-with-a-grave scheme.
Wang Peng is among those who have lost their life savings The idea is this - you buy up loads of empty plots, their value increases, and then you sell them off at a profit. Companies have released promotional videos promising investors a quick return on their money.
One video shows a beautiful cemetery, lined with temples. All you have to do - the company promises - is buy some empty graves, wait a while, sell them off. And make a safe and easy profit. A solid-looking deputy mayor sitting behind an equally solid looking desk is shown in one video - reassuring ordinary people that buying up stacks of graves is a good idea. But for many investors it has all gone wrong.
At his apartment in Beijing, Wang Peng searches for the certificates he has locked in a cupboard - he does not want his four-year-old granddaughter to find them and scribble on them. The certificates show that he bought 24 empty plots in a cemetery called Spiritual Spring.
These pieces of paper are all that Mr Wang has to show for his family's entire life savings - more than £10,000. But the company has never delivered. And the certificates are worthless.
"I will never forgive them," he says, "because they cheated me badly". "They made me lose all my life-savings. I am having such a difficult time right now. Why should I forgive them? "They should return our money. You can't treat us ordinary people this way."
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In the run-up to this week's FOMC meeting, several commentators have suggested that the Fed may be delaying a necessary cut in interest rates. The story goes something like this; recent data tells us that economy is slowing rapidly, whilst inflationary pressure is subsiding, and if the Fed doesn't do something soon, then the economy will slip into a nasty recession by the end of the year.
The problem at the story is that it's only half true. Certainly, the economy is slowing, but inflationary pressures remain rather strong. Just take a look at gas prices if you own any doubt about that. The consumer still keeps on consuming, as the chart above suggests. There is a slight post-holiday dip consumption,but by March everything is back to normal. Certainly, the housing market is looking into the abyss, but the stock market is doing fine, so the overall effect on wealth is redistributive, rather than a growth reducing.
However, if you think about a little further, you will realise that it is consumer spending that is the problem, not inflation. There is a nasty story behind that retail sales chart. It is a story of declining personal savings. Low interest rates have discouraged savings, and encouraged consumption, which in turn has been fuelled by an accumulation of private-sector debt. The counterpart of this declining savings rate is found in the US current account. The federal government has also done its part to accumulate a large stock of debt. For several years, the government has run large fiscal deficits, financed by treasury bills, largely bought by foreigners.
Private and public sector balance sheets need to recover, which is just a fancy way of saying that people need to save more and the government should reduce spending. The only thing that will make people save more is a higher return on their savings. This is why the Fed needs to raise rates, and at a minimum, keep them at the current level for the foreseeable future.
What would happen if the Fed decided to cut rates prematurely as some would suggest? Simply, the consumer would keep on doing what she has done the last five or six years. She would keep on borrowing, keep on spending, and keep on building up debt. The US current account will continue to be high. In the short term, foreign central banks will keep financing that deficit, until one day they will have had enough, and suddenly start selling dollars. At this point, the current account will adjust very rapidly indeed, and the US economy could sink into a calamitous recession.
Currently, the economy is slowing, but that is a good thing. It is better to have a gradual slowdown in growth, coupled with an orderly repair of private balance sheets, rather an a disorderly financial crisis. Let's hope that the Fed ignores these shortsighted calls for a cut in interest rates.
Just how unbalanced is trade between the US and China?
Back in 1985, bilateral US-Chinese trade was in balance. The US exported to China about as much as China exported to the US. Since then, however, the US has sucked up Chinese imports. Last year, the US imported almost $290 billion of goods, but exported just $55 billion.
Last year, the US ran up a $818 billion trade deficit. Around a third of that deficit was due to trade with China. Overall, the bilateral US-China trade deficit is running at about 2 percent of GDP a year.
So how do the Chinese manage to out-trade the US? China tightly pegs its currency's value to that of the dollar at an an extremely low rate. This low rate means that Chinese goods are very price competitive and this encourages a large bilateral surplus with the United States. This policy, in effect, offers a massive subsidy to exports. However, the Chinese need to purchase huge amounts of US assets by printing local currency. In 2006 alone, the Chinese central bank purchased around $200 billion in U.S. Treasury Bills and other securities. Currently, the Chinese are sitting on $1.2 trillion of foreign exchange reserves.
However, the Chinese can't keep on subsidizing exports in this manner. It is bad for poor Chinese workers, who are effectively subsidizing rich US consumers. It is bad for the US economy, which is building up huge liabilities with China.
The solution is simple enough. China must let the Yuan appreciate. American exports with China can begin to recover, while Chinese workers can begin to see real increases in their standard of living. However, the Chinese government seem addicted to this "export-at-all-costs" development strategy.
Check out this great post by Brad Setser. He examines what he calls three "dated perceptions of China", namely:
1. Crappy banks - Chinese state owned banks are filled with non-performing loans,
2. Externally balanced trade - China runs a surplus with the US but a deficit with the rest of the world, so its trade is in rough balance and finally that
3. A technologically deficient economy - China just assembles imported components with little value-added.
Not so, says Brad. Time to correct those outdated ideas about China.
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Japan is holding a mountain of US dollars. The Finance Minstry in Tokyo reported that Japan's foreign exchange reserves rose to an all-time high of 908.96 billion dollars at the end of March from the previous record of 905.05 billion dollars in February. Japan's large foreign exchange reserves are the result of years of currency intervention by the government to keep the yen down against the dollar and help exporters stay competitive. In other words, the Japanese have kept the Yen artiificially low so that they could flood US markets with cheap goods.
However, the Japanese are not the only ones playing this game. Japan’s foreign exchange reserves are the second largest in the world, after China, whose holdings reached 1.07 trillion dollars at the end of 2006.
There are two possible interpretations of U.S. Treasury Secretary Henry Paulson's recent comments about the US economy. Neither of them are reassuring. Either Paulson is crapping himself with fear but trying to hide it or he is just plain complacent.
The world is drowning in personal debt. This story from Bloombergs illustrates just how serious the situation has become:
"Deng Yijun, a cargo freight agency manager in Shanghai, faced a dilemma last December. “I needed a car, but I didn't want to use up my savings as the stock market was booming,'' she says. “So I used credit cards.''
Deng, 32, was eyeing a Ford Focus that cost about 200,000 yuan ($25,815), roughly equal to her savings. Maxing out three cards, she put 140,000 yuan on plastic and gained 56 days of interest-free credit. She paid the rest herself. Most of her remaining cash went into stocks, including Sichuan Swellfun Co. - a distiller whose share price more than tripled in the past year.
Deng says she was able to buy the car for three times her annual salary and purchase stocks after card issuers Bank of Shanghai, China Merchants Bank Co. and China Construction Bank Corp. gave her credit over the phone."
Think for a moment about the implied risks; Deng's personal net worth; and lending standards in Chinese banks.
Deng starts with sufficient savings to buy this car and be debt free. However, she avoids the safe option and entangles herself in high levels of personal debt in order to maintain her over-inflated and risky investments. She would be well advised to sell her shares and pay down her debt. However, those rising stock prices are just too tempting; greed wins over financial prudence.
So she goes into debt, and she isn't thinking small. The debt to income ratio implied by this transaction is on the high side. After some arithmetic, it is clear that Deng has credit card debt equivalent to 2.1 times annual income.
The interest payments will take up a large chunk of Deng’s disposable income, because interest rates on credit cards are always extortionate. Therefore, she has to be anticipating that the return on her equity portfolio is higher than the interest payments on her credit cards.
Furthermore, Deng’s personal balance sheet looks decidedly risky. On the asset side, she has a car, which is always a depreciating asset, along with some overvalued Chinese equity. It would only take an unfortunate collusion in the rush hour and a substantial correction in the stock market, and poor Deng would be seriously upside down. In other words, she would be all liabilities and no assets.
In sum, there is a high probability that Deng will default on this debt. If there are enough Deng's out there in China, then the banks that own that credit card debt have some serious issues to resolve.
But what about the banks that allowed Deng to open herself up to these massive risks? They allowed Deng to accumulate such an enormous debt simply by talking to her on the phone. At the risk of understatement, lending standards do seem to be a little lax in China at the moment.
Unfortunately, Deng is a worldwide phenomenon. The names might change, and the transactions might be different, but across the planet, ordinary people are being encouraged to take on huge amounts of debt that they can barely service. For the most part, this debt is financing over-priced real estate. However, it is also financing unsustainable levels of consumption.
Unfortunately, this spend fest can not continue indefinitely. The easy way out of this mess would be for central banks to hike interest rates. It will be painful, and too late to save Deng, but at least it would discourage other people from being buried in debt.
However, central banks are always cowards. They will wait, and wait until it is too late. It will not be a hike in interest rates that will stem the flood of toxic debt; it will be a rise in defaults. Suddenly, commercial banks will remember that there is such a thing as credit risk, they will stop financing the Dengs of this world. There will be no more Ford Fiestas financed with credit cards; consumption will crash and the world will fall into a recession.
Central bank governor Zhou Xiaochuan said in an interview published Tuesday that China would stop stockpiling foreign exchange reserves. "Many people say that foreign exchange reserves in China are (already) large enough,'' Zhou told the Emerging Markets magazine. We do not intend to go further and accumulate reserves," he said.
Despite earlier interest rate hikes, China's economy just keeps on growing. Last year, it expanded 10.7 percent. This extraordinary economic growth has fueled a remarkable property bubble.
The red kingdom has perhaps the strangest property bubble in history. In principle, a bubble should be impossible; the state owns all the land. Moreover, there is no effective legislation guaranteeing private property. Instead, there is a leasing bubble. The state issues leases, normally lasting for 70 years, and which gives the owner the exclusive rate to use the property. However, the leases are transferable and this creates the basis of the Chinese bubble.
The leasing system has been one of the cornerstones of the Chinese economic miracle. Since all land is state owned, the Chinese government can determine land usage without any annoying planning regulations. Therefore, when a new foreign investor needs a factory, the bulldozers move the locals out and up goes the shiny new building. A few little envelopes here and there and things can move real quick.
But what happens when the leases expire? Now that is a tricky question. No one really knows for sure. It is not as if there is a functioning legal system that can defend property rights.
Despite these legal difficulties, investors have bought up these leases with scant regard for the future. Prices have shot up, partly fueled by easy credit. Now, the central bank is trying to calm things down. However, it is going to take more than one marginal hike to calm the crazy Chinese non-property bubble.
When will Congress start to get serious about trade policy with China? Today, the Chinese authorities reported their trade surplus for the first two months was $39.6 billion, more than triple the same period last year. Exports gained 52 percent in February, the biggest jump since 1995. Imports climbed 13 percent.
The Chinese central bank have kept the Yuan low, and made their exports very cheap. This policy helps industrialise and strengthen China and facilitiatse its expansionist aspirations. However, it is also exploitative. Chinese wages are kept artificially low. In effect, poorly paid chinese workers subsidize the unwarranted and slovenly lifestyles of flabby Americans.
The under-valued exchange rate pumps cheap goods in to the US and destroys our manufacturing base. This policy has led to China accumulating foreign-currency reserves amounting to a record $1 trillion, a fifth of the world's total. The stock of reserves is now so big that it has become useless. Any attempt to reduce their holdings of US dollars would destabilise foreign exchange markets, leading to a run on the dollar and a sudden and uncontrollable appreciation of the Yuan.
Nevertheless, the Chinese keep talking up a change. China's central bank Governor Zhou Xiaochuan today pledged to accelerate the drive to a market-led financial system. He also pledged to loosen controls on interest rates and begin to bail out loss-making state banks. Fu Ziying, assistant minister of commerce also promised to cut some import tariffs and export rebates. Apparently, these measures are supposed to pave the way for a more flexible yuan, and fend off calls in Congress for trade sanctions.
The message from these numbers to Congress is clear; give the US manufacturers some protection.
Hey! You've won a ride back to the top
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