tirsdag den 7. oktober 2008

The Road Less Traveled. We Don’t Want to Get There.

It is my pleasure to welcome my first guest on my blog, my good friend, Mr. Yoshi Fujioka, Fujioka Investment has written an extremely well formulated piece about the long term issues and where we are in the cycle of investment. Yoshi been trading in all major centres, he is an independent trader in Singapore, and a true Gentleman, please enjoy:

The Road Less Traveled. We Don’t Want to Get There by Yoshi Fujioka

"The sound of a bell echoes the impermanence of all things. The color of a flower reveals the truth that the prosperous must decline. The proud do not endure like a dream on a spring night; the mighty fall at last, they are as dust before the wind." The opening of The Tale of the Heike

I came across a press freedom index by Reporters without Borders, which prompted me to look at America’s economic standing relative to its social/political evolution as I believe an economy cannot continue to prosper when its society and political representation are languishing and a constructive capitalism can only be developed through freely available access to accurate information (government data, corporate earnings reports and a proper universal accounting system) and minimum corruption.

I have compiled my civilization index, which consists of Press Freedom of Index (PFI: Reporters without Borders), Corruption Perception Index (CPI: Transparency International) and a percentage ranking of the global GDP (nominal):
(Click on chart to get bigger format)

CPI: Corruption Perception Index (Transparency International)
PFI: Press Freedom Index (Reporters without Borders)
GDP (nominal): International Monetary Fund

The economic and social deterioration in the US and Europe, where I spent 22 years of my life, dampened my weekend spirit and my natural reaction was cursing in silence, “Is this the products of Bush’s neo-conservatism?” Their Laissez Faire turned out to be opposition to its people’s interventions/participation and weakening the national credibility. I was taught taxation was designed to redistribute resources from the wealthy and businesses to people, but it is now from the people to the selected businesses.

I have no doubts that capitalism had defeated socialism, but I’m not sure if democracy has prevailed over autocratic governments. The autocratic countries are funding the democratic countries and the financial power is shifting from the large democracies to China, Russia and Arab nations. The market should always be aware of the deteriorating credibility of USD as the only reserve currency, which is monetizing the commodities belonging to other nations. USD is the currency of a debtor nation prone to a shock if the creditor nations decide to monetize their own natural resources via a monetary union like Gulf Monetary Union (which will no longer require the USD peg).

The last depression took 23 years and WW II to recover and it is unreasonable to expect a quick resolution to the current crisis. We’ve just dealt with the banking balance sheet clean-up. There are still European banking crisis, a new earning report season, $62 trillion credit derivatives market and the deleveraging of the US consumption (72% of the US GDP growth).

The US is running $800 billion current account deficit (over 7% of its GDP), which in turn comes back to finance further debts. When the deficit declines, the credit will become less available at a higher cost and hit assets negatively. The easy monetary policies have created asset bubbles leading to current pains and the Fed may be about to ease its policies further when the government is injecting $700 billion and yet needs to deleverage the economy to minimize the further shock (the US GDP/credit expansion is 1:5 for the last 7 years). But the major central banks have been increasing their money supply at a rate of more than 10%. Deleveraging the economy was exactly what the US didn’t do before 1929 and as Michael Milken himself said, "30:1 leverage is not a business, it has never been a business and it will never be a business."

Deflation vs. Inflation

Japanese deflation: The market is looking at the Japanese model to answer the future course of the general price level: asset deflation and lower consumption, which caused a deflation. I am feeling uneasy about this answer since I cannot overlook the differences in the external debt ratio, saving rate and trade surplus vs. trade deficit. The Japanese budget deficit was financed internally (95% plus) and the largest portion of the JGB went to the public financial institutions like the postal saving & insurance systems, public pension funds and the BOJ. Therefore, the increased issuance did not cause supply-demand inbalance in the market and the overall trade current account was at a huge surplus.

Chinese Purchase of Treasuries: China’s industrial production has 49% share in its GDP while the US GDP consists of 20% manufacturing and 70% consumption, 18% in UK and 27% in Japan. This is my answer to the decoupling believers. The US, Japanese and European recessions will have a material impacts. The Chinese economy is also highly leveraged at alarming inefficiency and overcapacity while they rely heavily on bank loans. The 08 Chinese GDP is expected to slow to 10% from 12% in 07 and Steven Roach is forecasting that the GDP could contract to 8% if their exports decline further.

The primary driver of the Chinese policies is the continuation of the communist party rule and everything else comes second and third. So they will do everything to keep its 1.3 billion people employed as many as possible. Otherwise, what’s the point of having a communist party if they can’t give its people jobs? This was the reason the government allowed the banks to lend recklessly to build more factories leading to the overcapacity, continuing debt servicing costs with employees who cannot be easily laid off in the global recession. China will use its reserve to stimulate its economy. So after the less trade surplus and more fiscal spending, China would be less willing financier for the US and will demand higher returns on their capital.
Will Emerging Nations Continue to Invest in the West? It has been said these countries have no other investment choice. What the market should ask is when this assumption will change. The autocratic nations will have to open their markets to each other as they have to seek natural resources and commodities. Also, a recent study by the Pew Hispanic Center on the12 million illegal immigrants in the US made me wonder if the world want the US as much as before: the illegal entry from Mexico is down -25% and down -50% from the Central America.

The End Results of these Crises:

1. Further fiscal packages to deal with the $62 trillion credit derivatives market and home ownership.
2. Much more regulations.
3. The majority of the hedge funds disappearing as the banks deleverage themselves since the hedge fund industry’s return will be a fraction of what it was. The recent USD strength is a short term result of their position closing and redemption.
4. Downgrading of the US Treasuries and eventual rise in yields, minimum to 5% 10y UST in 09 (I expect the majority of the government bonds to remain where they are until January 09).
5. Resumption of USD depreciation and some kind of FX control.
6. Loss of confidence in the Swiss banking system. As seen in the Icelandic banks ballooned their balance sheet to 900% of the GDP (the krona has slumped 14% vs. euro and the inflation at 14%) The Swiss banking system is outside the EMU & EU and too big for the country alone to deal with. If the real damage surfaces, the Swiss Franc will depreciate against every major currencies.
7. JPY appreciates to 85/USD
8. S&P will resume its downtrend to 800
9. Stagflation

Well, I end my note here by quoting Andrew Jackson’s words when he closed a bank:"Gentlemen, I have had men watching you for a long time and I am convinced that you have used the funds of the bank to speculate in the breadstuffs of the country. When you won, you divided the profits amongst you, and when you lost, you charged it to the bank. You tell me that if I take the deposits from the bank and annul its charter, I shall ruin ten thousand families. That may be true, gentlemen, but that is your sin! Should I let you go on, you will ruin fifty thousand families, and that would be my sin! You are a den of vipers and thieves." - Andrew Jackson, 7th US President


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