By Bill Dahmer
China is very effective at using organizations like the WTO and IMF to its own advantage against the west, while effectively keeping foreign competition out of China with tariff and non-tariff barriers to trade as well as with bureaucratic measures. I know lots of foreign companies make stuff in China, but very few actually make any money in China. The Chinese have simply not allowed that to happen. It is almost a political-trade policy crafted after studying Japan's export-driven trade policy combined with France's masterful manipulation of EU political institutions for its own narrow, national self-interest. You have to admire China Inc. on some level that they are able to out-compete us using the western institutions that we created like the WTO, IMF and even the UN.
My wife and I are going out to HK & Shanghai at the end of this year. We will visit friends in HK (and golf in Macau) with a side-trip to Shanghai. I have some friends in Shanghai, but have never been there. One of my friends wants to introduce me to some fund managers in China as well as some country managers at such places as Cargill, Coca-Cola, P&G, etc. in Shanghai that he knows quite well. Plus I will have the chance to talk to some bankers in HK while we are there. So I am really looking forward to the trip.
We were in Dubai in the spring of 2008 and it did not pass the smell test. It was all debt-driven hype with artificial islands, castles built on sand and apartments in the sky sold to speculators. And worse the place not only did not have any fresh water, but relied on desalination, and burning natural gas 24/7, 365-days a year to keep those houses and apartments air-conditioned and to run all the elevators. About as sustainable in the long-run as Los Vegas, which has been called by National Geographic that largest waste of fresh water in the world. So when the financial crisis came along in H2'08 I was not surprised that the property sector in Dubai was one of the first dominoes to fall.
China, and Shanghai in particular, are also suffering from what many feel is a property bubble. As many as 60-percent of the apartments being bought are for speculative purposes and not by end users. So I guess I also want to get out to Shanghai to see for myself what is real and what is hype. It seems like every one's Plan A (and Plan B) is investment in China and/or growth in China supporting growth everywhere else. That is a lot of eggs to put in one basket. Governments and central banks around the world as well as industry must be praying that at least some of the growth in China is built on strong fundamentals, and is not just driven by mercantile trade policies like central bank currency manipulation to remain export competitive to create jobs (at whatever long-term cost) to absorb an ever-expanding workforce to protect social stability in China.
To put it in perspective, five percent growth in China, compared to 10-percent plus per year, would feel like a recession. But how sustainable is 10-percent growth year after year? We are already seeing a dangerous game of global protectionism forming vis a vie currency markets as many exporting nations intervene to try to devalue their own currencies as a matter of economic survival. It is no wonder that precious metals, commodities and physical assets are going up in price as governments spend money they do not have and central banks try to devalue their way out of the deflationary trap they have created for themselves.
However, China and the value of the yuan is the fuse in the currency wars, which is really protectionism and subsidizing exports by any other name. It may not be the Smoot-Hawley Tariff Act all over again, but History rhymes. A lot will depend on G20 solidarity at their upcoming meeting in S. Korea in November, but I fear national self-interest will prevail over collective action for the greater good. We shall see, but my feeling is that in the OECD there is simply too much debt and not enough economic activity to service it in a low, slow, no growth environment.
Plus we are seeing a generational transfer of wealth on a monumental scale from debtor to creditor nations as well as from importers to exporters that will leave many aging populations in the west much poorer than we have become accustomed to, or what we expect. This in turn could lead to short-term populist fixes instead of painful, long-term reforms.
I suspect we will see something like a return to the stagflation conditions of the 1970s in the OECD. I see higher levels of taxation (relative to income growth); more regulation; lower, slower growth in the real economy; a strain on public services as governments (at all levels) struggle to service their debts (and unfunded future liabilities); but, on the other hand, high basic input (PPI) and commodity prices (CRB) due to population and economic growth elsewhere (in places like Asia for example); while workers' wages stagnate due to a lack of pricing power and an excess of capacity in many sectors. The illusion of economic growth based on falling interest rates, rising asset prices and expanding consumer credit will help us about as much as they have helped Japan for the past 15-years. Not.
If governments and central banks try to monetize their debts to pay for public services then this will just touch off another round of high inflation similar to what we did see in the mid-70s to mid-80s. Given that we are collectively more heavily-indebted now than then this would likely be very unsustainable. And as usual the political, social and economic risks will be very asymmetrical as there will be some winners and many losers from the re-balancing of global growth. Its hard to thrive when others are struggling to survive (at least if you have a conscience).
I am pretty sure we will see another financial crisis in the near future. After mid-term elections in the US in November the Fed will most likely embark on QE2, while elsewhere there is a liquidity crisis brewing as banks will struggle to roll-over their funding needs at anything but free money from the central bank's discount window using assets of dubious value, while they face more bad loans and write-offs. Those that can borrow do not need it. Those that need to borrow are not credit worthy any more. This is not going to persuade banks to start lending to the real economy again, so long as the economic picture remains so unclear.
Not that there is much demand in any case. We have shrunk our loan book because we simply cannot put money to work productively at the moment. The loan book has shrunk by two-thirds since the start of the crisis and may be reduced further. Plus we can fund ourselves in rubles at below the rate of inflation, so it makes little sense to run currency risk by borrowing in US dollars or euros. However, anecdotally, some friends have complained that banks are being very schizophrenic in their lending, and walking away from solid projects based on the flimsiest of excuses. There is simply no certainty, so no one wants to stick their neck out. Well, except in places like Shanghai (or Cyprus) where investing really means gambling.
2010 has been a challenging year. Harder than 2009 in many respects. I expect a difficult 2011 as well. We had thought we had survived the the crisis in 2008, but looking forward we see many challenges in the next few years. And a lot of that uncertainly stems not from market failure, but the failure of government interference in the market, as so many market prices are so manipulated that no one knows what anything is worth anymore. What is a 'risk free' long-term treasury worth in US dollars when the Fed is trying to lower the yield by buying bonds, and China is manipulating the exchange rate between US dollars, the euro and the renminbi? No one really knows. Ditto for standard metrics like debt to equity ratios when banks do not have to report all their assets and all their liabilities on their balance sheet at fair market values, and accounting profits come from all sorts of tricks like treating loan loss provisions carried forward as a reduced tax liability asset. What is allowed by law does not make it a genuine profit or a real asset.
So in any case, we hope to live to play another day. There are no guarantees in the current environment though. Another reason I am anxious to get out to Asia to see what is going on. On one hand it is a source professional insights, but also personal exposure to future growth markets should anything happen to my job here in Cyprus. Cyprus is not exactly the center of the investment universe, so I like to get out and increase my visibility from time to time. As they say, out of sight, out of mind."
My wife and I are going out to HK & Shanghai at the end of this year. We will visit friends in HK (and golf in Macau) with a side-trip to Shanghai. I have some friends in Shanghai, but have never been there. One of my friends wants to introduce me to some fund managers in China as well as some country managers at such places as Cargill, Coca-Cola, P&G, etc. in Shanghai that he knows quite well. Plus I will have the chance to talk to some bankers in HK while we are there. So I am really looking forward to the trip.
We were in Dubai in the spring of 2008 and it did not pass the smell test. It was all debt-driven hype with artificial islands, castles built on sand and apartments in the sky sold to speculators. And worse the place not only did not have any fresh water, but relied on desalination, and burning natural gas 24/7, 365-days a year to keep those houses and apartments air-conditioned and to run all the elevators. About as sustainable in the long-run as Los Vegas, which has been called by National Geographic that largest waste of fresh water in the world. So when the financial crisis came along in H2'08 I was not surprised that the property sector in Dubai was one of the first dominoes to fall.
China, and Shanghai in particular, are also suffering from what many feel is a property bubble. As many as 60-percent of the apartments being bought are for speculative purposes and not by end users. So I guess I also want to get out to Shanghai to see for myself what is real and what is hype. It seems like every one's Plan A (and Plan B) is investment in China and/or growth in China supporting growth everywhere else. That is a lot of eggs to put in one basket. Governments and central banks around the world as well as industry must be praying that at least some of the growth in China is built on strong fundamentals, and is not just driven by mercantile trade policies like central bank currency manipulation to remain export competitive to create jobs (at whatever long-term cost) to absorb an ever-expanding workforce to protect social stability in China.
To put it in perspective, five percent growth in China, compared to 10-percent plus per year, would feel like a recession. But how sustainable is 10-percent growth year after year? We are already seeing a dangerous game of global protectionism forming vis a vie currency markets as many exporting nations intervene to try to devalue their own currencies as a matter of economic survival. It is no wonder that precious metals, commodities and physical assets are going up in price as governments spend money they do not have and central banks try to devalue their way out of the deflationary trap they have created for themselves.
However, China and the value of the yuan is the fuse in the currency wars, which is really protectionism and subsidizing exports by any other name. It may not be the Smoot-Hawley Tariff Act all over again, but History rhymes. A lot will depend on G20 solidarity at their upcoming meeting in S. Korea in November, but I fear national self-interest will prevail over collective action for the greater good. We shall see, but my feeling is that in the OECD there is simply too much debt and not enough economic activity to service it in a low, slow, no growth environment.
Plus we are seeing a generational transfer of wealth on a monumental scale from debtor to creditor nations as well as from importers to exporters that will leave many aging populations in the west much poorer than we have become accustomed to, or what we expect. This in turn could lead to short-term populist fixes instead of painful, long-term reforms.
I suspect we will see something like a return to the stagflation conditions of the 1970s in the OECD. I see higher levels of taxation (relative to income growth); more regulation; lower, slower growth in the real economy; a strain on public services as governments (at all levels) struggle to service their debts (and unfunded future liabilities); but, on the other hand, high basic input (PPI) and commodity prices (CRB) due to population and economic growth elsewhere (in places like Asia for example); while workers' wages stagnate due to a lack of pricing power and an excess of capacity in many sectors. The illusion of economic growth based on falling interest rates, rising asset prices and expanding consumer credit will help us about as much as they have helped Japan for the past 15-years. Not.
If governments and central banks try to monetize their debts to pay for public services then this will just touch off another round of high inflation similar to what we did see in the mid-70s to mid-80s. Given that we are collectively more heavily-indebted now than then this would likely be very unsustainable. And as usual the political, social and economic risks will be very asymmetrical as there will be some winners and many losers from the re-balancing of global growth. Its hard to thrive when others are struggling to survive (at least if you have a conscience).
I am pretty sure we will see another financial crisis in the near future. After mid-term elections in the US in November the Fed will most likely embark on QE2, while elsewhere there is a liquidity crisis brewing as banks will struggle to roll-over their funding needs at anything but free money from the central bank's discount window using assets of dubious value, while they face more bad loans and write-offs. Those that can borrow do not need it. Those that need to borrow are not credit worthy any more. This is not going to persuade banks to start lending to the real economy again, so long as the economic picture remains so unclear.
Not that there is much demand in any case. We have shrunk our loan book because we simply cannot put money to work productively at the moment. The loan book has shrunk by two-thirds since the start of the crisis and may be reduced further. Plus we can fund ourselves in rubles at below the rate of inflation, so it makes little sense to run currency risk by borrowing in US dollars or euros. However, anecdotally, some friends have complained that banks are being very schizophrenic in their lending, and walking away from solid projects based on the flimsiest of excuses. There is simply no certainty, so no one wants to stick their neck out. Well, except in places like Shanghai (or Cyprus) where investing really means gambling.
2010 has been a challenging year. Harder than 2009 in many respects. I expect a difficult 2011 as well. We had thought we had survived the the crisis in 2008, but looking forward we see many challenges in the next few years. And a lot of that uncertainly stems not from market failure, but the failure of government interference in the market, as so many market prices are so manipulated that no one knows what anything is worth anymore. What is a 'risk free' long-term treasury worth in US dollars when the Fed is trying to lower the yield by buying bonds, and China is manipulating the exchange rate between US dollars, the euro and the renminbi? No one really knows. Ditto for standard metrics like debt to equity ratios when banks do not have to report all their assets and all their liabilities on their balance sheet at fair market values, and accounting profits come from all sorts of tricks like treating loan loss provisions carried forward as a reduced tax liability asset. What is allowed by law does not make it a genuine profit or a real asset.
So in any case, we hope to live to play another day. There are no guarantees in the current environment though. Another reason I am anxious to get out to Asia to see what is going on. On one hand it is a source professional insights, but also personal exposure to future growth markets should anything happen to my job here in Cyprus. Cyprus is not exactly the center of the investment universe, so I like to get out and increase my visibility from time to time. As they say, out of sight, out of mind."
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