31 March 2011

It has been a busy month at VF, many new offices, 51 new hires, time of significant expansion of both our capabilities and reach... and while regimes collapsed, technically from economic point of view not that much has changed from our comments last time (yes we are still long commodities and short USD, long EM and short the DW)... but here is our latest market commentary for your kind consideration. 

Where is the benefit for China from USD2tr of reserves if you will never manage to spend it?

Portugal has almost made a full circle, going back to "Stage 1: Traditional Society" of the Rostow model.


We wake up to the news that Timothy Geithner "seeks uniform exchange rate policy in G20 meeting in Nanjing".  This is no surprise to us, as we have predicted long time ago that the only controlled way out of this “stalemate” is to fix the exchange rates (US demand), simultaneously swapping the value of Chinese debt into some “world currency” (Chinese demand).  This is of course the easiest solution, similar to that of standard divorce settlement where both parties lose a bit, but everyone is freed from their bad past.  This solution would of course be wrong, away from the market forces and would certainly lead to another currency crisis down the line… but maybe in 10 years time.. so not under our command (who remembers the great reigns Alan Greenspan?).  Exchange rates cannot be fixed, as countries develop at different growth rates.  I am sure that both Chinese and US are aware of this (I am also sure that US learning from the problems of Greece, Portugal and Ireland will also never denominate their debt in foreign currency – as this would be almost treason).

To understand best how the market forces will work in the future, lets just analyze the current problems.  

Is China really benefitting that much from sponsoring American deficit and consumption addiction?  Where is the benefit for China from USD2trn of reserves if you will never manage to spend it?  Is this really beneficial to anyone but the US Government?   There is this slang saying that if someone owns you 1,000 dollars “you hold them by their balls” (vide credit card business), but if someone owns you 1,000,000 dollars “they hold you by your balls”, ie I jump you jump philosophy (vide the banking sector crisis, and all the loan defaults / postponements there).   How is China hoping to make use of these USD2trn, as even a gradual shift to commodities, real assets, potentially already highly overavalued equity (assuming lack of regulatory vetos), Africa; all would already lead to the significant devaluation of US dollar and of course the real value of the debt from the foreigners perspective.  

The real problem is not even allocation of capital to new ventures (just call Vision Finance we will help), but the withdrawal of capital from the US debt system, which just to maintain its stability needs to be regularly refinanced, and refinanced, and refinanced – fed like a hungry parasite.   One way or the other, in this highly complex chess game China has to accept the loss of most of these USD2trn, and seek either high recovery value (what they do), or maximum destabilization of the US economy so that following this devaluation of USD it is still not able to pick it self up (basically hoping for maximum lag in recovery of production in US - what will directly benefit Chinese production).  

However realistically, as soon as USD depreciates 50%, the Americans will need to learn how to recycle their TVs and furniture much better (and they should), they will learn how to drive 10 year old cars, and use less fuel (and they should), but in the long-run you will not stop the US from coming back.  US is a highly efficient free market economy which has great capacity to change – from profit to bankruptcy, from unemployment to billionaires, and ironically, in the times of Facebook and free internet, this capacity of US to change has never been greater (as long as people are really not en mass addicted to alco, drugs and PS3 – vide new generation in UK where 25% long term unemployment amongst the university graduates... the lost generation).  

Somehow I feel that today the asset class of "entrepreneurship", albeit very global, is still predominantly in American ownership (see Facebook or a have a trip to the movies to see Inception, The Adjustment Bureau, Black Swan) – though I must say that I was impressed by the discovery by the Chinese scientists of the gay gene:


(ignoring the taboo nature of this topic, assuming that this is true, it is quiet a discovery I would say).


So what are the next steps:

First for China (and other SE Asian countries):

- Continue the “status quo”, as frankly what choice do they have? Yes try to negotiate some deal, but accept that unless Americans make a major error (possible but unlikely) no deal will happen, HOWEVER…

- to watch out for local issues, as to me there is little doubt that FB revolution will spread from ME to China (be real; how long do you think people will accept living without even the right to move from one city to another, working for 1 usd a day,  on a forced one child policy and with huge global food inflation?). Yes like Jim Rogers I want to teach my kids Mandarin too, but its not about tomorrow… and its not as much about China as it is about global network of Chinatowns (yet migration and the sheer numbers + hard working culture of Chinese people).

- to stimulate demand for goods locally and in Africa / ME / Asia / S America, as at one point, when the USD and EUR drop 50% - 80% these markets will disappear quickly creating demand vacuum

- to gradually shift away from USD bonds, into home, Africa, even real assets in America / Europe and other “bankrupt territories”.  How difficult is it to spend 2tr USD?  Capitalization of NYSE alone is approaching USD20 trillion.  If needed – go to Europe!  Pay the premium when needed, and above all be quick in this process.


For US (and other consumers):

- prepare for the inevitable, with that being a depreciation of the currency.  Try to make it as gradual as possible, giving the time for the economy to adjust.

- enforce policies that aim at technology, recycling, of course natural resources, as the power of US will be decided on how it lifts itself up from this currency shock.  Will there be social order, will there be chronic unsolvable long term unemployment, lost generation like in Europe, breakdown of social structure, loss of US power abroad?  Loss of US “image” abroad?

- restrict ability of foreign debt holders to switch this debt into real assets (learn from mistakes of the 1980s when Japanese companies basically started to take over US companies).

- maybe even impose import taxes, but not as punishment for exchange rate, but in return for piracy losses.

- watch out for major policy mistakes... like that of fixing its debt to some global currency unit - learn the lessons of Greece, Portugal, Ireland, Spain – who in effect became victims of almost China like policies of Germany (for details see the link.  http://www.financewithvision.com/research/market-commentary/4-february-2011 ).

Finally, the last VF word to both China and US:  be happy from what you got… life goes on despite your chess games, and think about the real issue like that of Global Warming, as this is the single biggest factor that will end both of your economies (and ironically the risks here are much bigger to USA than to China… as the breakdown of the North Atlantic Current will turn half of the USA into the ice zone in few years – and that’s also certain and a question of just time).


Any development economist will know what the Rostow’s Growth Model is.  If not, thank you to globalization and to Wikipedia, as now you do


In essence, it is the model that outlines the growth patterns for the economies.  It is an old model and very basic,  but its main controversy is about the fact that in the early stages of economic growth it is often better for the economy to be under “good” dictatorship regimes than under messy democracy  (China vs India being a good example, economic success of Chile under Pinochet the other).

Now, fast forward 50 years to the original model, to 2011 and the events from the parliament in Portugal last week, where in some ways Portugal has almost made a full circle, going back to Stage 1: Traditional Society of the Rostow model.  One man wants to make positive changes by adapting the austerity budget (perhaps late), but the opposition, no doubt seeking opportunism and also fear of his success, refuse him to do this, blocking him, in effect totally crippling the country, bringing it on its knees, default perhaps (hey it’s not their fault?!).  This is exactly what good dictatorship in the Rostow’s model aims to avoid, and if we extrapolate this further, we will once again come up with some frightening conclusions:

a)      there is no global or even national politics… just politics of self interest, short-term self interest 

b)      perhaps to save the planet from ourselves in the long-term, yes global warming again… we need to realize that in some ways we are still a very Traditional Society, in need of the good and understanding long-term leadership… or The Adjustment Bureau.

Yes I am sure you got it.. there is a duration mismatch in politics...  a mismatch which might have not been present back in 1787, but more than ever, it is clearly visible in 2011 ( I wonder what does Alan Greenspan think of this?).