Kyle Bass, addressing Chicago Booth's Initiative on Global Markets last week, clarified his thesis on Japan in great detail, but it was the Q&A that has roused great concern. "The AIG of the world is back - I have 27 year old kids selling me one-year jump risk on Japan for less than 1bp - $5bn at a time... and it is happening in size." As he explains, the regulatory capital hit for the bank is zero (hence as great a return on capital as one can imagine) and "if the bell tolls at the end of the year, the 27-year-old kid gets a bonus... and if he blows the bank to smithereens, ugh, he got a paycheck all year." Critically, the bank that he bought the 'cheap options' from recently called to ask if he would close the position - "that happened to me before," he warns, "in 2007 right before mortgages cracked." His single best investment idea for the next ten years is, "Sell JPY, Buy Gold, and go to sleep," as he warns of the current situation in markets, "we are right back there! The brevity of financial memory is about two years."
Given China’s rapid rise in all aspects of national power, as well as its reluctance to release specific details about many important aspects of its military spending, its annual budget announcement rightly attracts worldwide attention. Last week, China revealed its projected 2013 official defense budget: 720.2 billion yuan (roughly $US114 billion), a figure that continues a trend of nominal double-digit spending since 1989 (the lone exception: 2010). Although China’s limited transparency about specific defense budget line items matters, it shouldn’t distract observers from seeing the bigger picture concerning China’s military development: The People’s Liberation Army (PLA) increasingly has the resources, capabilities, and confidence to attempt to assert China’s interests on its contested periphery, particularly in the Near Seas (Yellow, East, and South China Seas). This development has the potential to seriously challenge the interests of the U.S., its allies, and other partners in the region, as well as access to and security of a vital portion of the global commons—waters and airspace that all nations rely on for prosperity, yet which none own. That’s why the PLA’s development matters so much to a Washington located halfway around the world.
Since the second half of 2012, financial markets have recovered strongly worldwide. But this financial market buoyancy is at odds with political events and real economic indicators. In short, we are witnessing a rapid decoupling between financial markets and inclusive social and economic well-being. As a result, the income of the global elite is growing both rapidly and independently of what is happening in terms of overall output and employment growth. Demand for luxury goods is booming, alongside weak demand for goods and services consumed by lower-income groups. All of this is happening in the midst of extremely expansionary monetary policies and near-zero interest rates, except in the countries facing immediate crisis. Structural concentration of incomes at the top is combining with easy money and a chase for yield, driving equity prices upward. And yet, despite widespread concern and anxiety about poverty, unemployment, inequality, and extreme concentration of incomes and wealth, no alternative growth model has emerged.
The UK government appears to be contemplating changing the BOE's mandate so it can be freer tolerate greater near-term price pressures. The Tory-led government is commented to fiscal consolidation--austerity--the same kind of policies many want to see the US adopt, and needs greater monetary stimulus to avoid a deeper contraction in the UK economy.
First it was gas prices, then it was food prices, and now it is the turn of basic utilities to see costs surge by double digits. Dow Jones reports that "Japanese utilities, forced to idle their nuclear power plants over the past two years and facing higher fuel costs due to a weak yen, are now looking to push through double-digit rate hikes for their commercial customers." This means less disposable income, less corporate profits, less monetary velocity, less growth and ultimately less "inflation" in other things such as the much desired stock market, which was supposed to be the wealth effect offset to all staples price increases. At least on paper. Of course we explained on various occasions, most recently here, why in Japan a US-style of wealth effect price substitution would never work. Surely nobody could possibly see this coming - "The action comes at a bad time for some Japanese companies that were hoping the fall in the yen and much-trumpeted efforts by the government to turn round the economy would help improve their prospects." Ah hope - the only strategy left.
While FX Reserves may not exactly be freely spendable ready cash, they are often used a proxy for a nation that is 'wealthy'. It seems, however, from the following chart that in fact the FX reserves of the world shows a different picture than Americans might like to consider. The highest level of reserves are split between currency manipulators and resource-rich nations. China and Japan top the table, according to Bloomberg, and Saudi Arabia and Russia are rising fast up the league tables of FX horders. Just as notable is that China's FX reserves have swelled to $3.31 trillion at the end of 2012 from $286.4 billion a decade ago, representing a pace of $829 million per day. The problem is that recently China has hardly had the same appetite for the USD it exhibited in prior years. With the world apparently devaluing against a more stoic inflation-anxious China, it would seem Japan's 'horde' will dwindle fast if they ever do anything but jawbone.
When we first reported on China's "hogwash" yesterday, the number of floating pigs in Shanghai's water supplying Huangpu River was a "modest" 1200. It has since tripled to 3300. From SCMP: "The agriculture and environmental protection departments in Shanghai's Songjiang district have pulled more than 3,300 dead pigs out of the Huangpu River, which flows through the municipality, in the past week." What is worse is that at least one pig-related virus has been found in a water sample: "Porcine circovirus, a common hog disease that is not known to be infectious to humans, was found in a sample taken from the water, Shanghai's animal disease control department was quoted as saying by eastday.com a major Shanghai news portal." The good news is that tests by the Shanghai Animal Disease Prevention and Control Centre on five sets of internal organs taken from the dead pigs has ruled out five other diseases including foot-and-mouth, hog cholera and blue-ear. Of course, this is China, whose disclosure record is second only to Japan, where as a reminder the government said the radiation level was under control days after the Fukushima explosion, even as the reality was far grimmer.
Just like yesterday, it will be up to the US session to provide the perfectly expected, VIXterminating, volumeless ramp as the rest of the world just did not have it in i to take the S&P to all time highs in overnight trading. To summarize: currency talkfare out of Asia, hope springs eternal out of Europe despite the usual spate of ugly numbers, PIIGS bond auctions backstopped by the ECB and always "that much better" than the expected, a UK economy that is just imploding to provide an alibi for more open-ended QE and a crushed pound, and with the US due to make everything better by sending the SP to its all time high (just 9 points away) on the one week anniversary of the record high DJIA, as the NY Fed clobbers the VIX to a 10 handle or lower on even more ugly, unadjusted economic data.
Because having legal authority to buy corporate bonds, ETFs and REITs, in addition to everything else the Fed now buys, is apparently not enough to crush, mangle and suicide its currency, the BOJ is now considering adding yet another "asset" to its cocktail of eligible securities for purchase: those which Buffett once declared weapons of mass financial destruction - derivatives.
Worse Than Ever?
With their crackpot monetary ideas, central banks have been robbing Peter to pay Paul without knowing which one was which. And a problem here is this thing behavioral psychologists call self-attribution bias. It describes how when good things happen to people they think it’s because of something they did, but when bad things happen to them they think it’s because of something someone else did.... When we look around we can’t help feeling something similar is happening. The 99% blame the 1%; the 1% blame the 47%. In the aftermath of the Eurozone’s own credit bubbles, the Germans blame the Greeks. The Greeks round on the foreigners. The Catalans blame the Castilians. And as 25% of the Italian electorate vote for a professional comedian whose party slogan “vaff a” means roughly “f**k off ”, the Germans are repatriating their gold from New York and Paris. Meanwhile in China, that centrally planned mother of all credit inflations, popular anger is being directed at Japan, and this is before its own credit bubble chapter has fully played out. (The rising risk of war is something we are increasingly worried about…) Of course, everyone blames the bankers (“those to whom the system brings windfalls… become ‘profiteers’ who are the object of the hatred”).
In the upcoming week the key focus on the data side will be the US February retail sales figures on Wednesday, which should provide clearer evidence on how the tax increases that took place on January 1 have affected the consumer. In Europe, industrial production and inflation data will be the releases to watch. On the policy side, the focus will be on the BoJ appointments in an otherwise relatively quiet week for G7 central banks. Italy’s newly elected lawmakers convene for the first time on Friday 15 March and the expectation remains that President Napolitano will formally invite Mr Bersani to try and form a new government. He may also opt for a technocrat government. Although clearly preferred by markets, winning political backing may prove challenging.
A few observations about growth and policy backdrop that is shaping the investment climate. It is a large overview that may be helpful to start the week.
Whether it is a reflection of the inflated price of regular edibles thanks to Abe's Yen devaluation escapades, or simply more evidence of the greater fool theory playing out among a mesmerized world, the latest gourmet eating experience in Japan highlights the human ability to follow a herd in spite of all common sense. As CBS reports in this somewhat remarkably not The Onion clip, the highest delicacy among Japanese diners is now - dirt. Of course, no-one would be expected to eat, chew, gnaw on any old garden variety, umm, garden; this is potting soil that is boiled, grilled, steamed, and pureed and then dribbled on creme brulee, rolled over mashed potatoes, and drizzled over arugula. Is it any wonder that consumer confidence in Japan is soaring, despite their currency's dismal demise and soaring prices for energy; as even the ever-calm-and-polite host of this clip is 'surprised' at the taste (hint: not in a good way). Of course, there is nothing new in this world as geophagy (eating dirt) is a traditional cultural activity in Africa for pregnant and lactating women. So perhaps, this is Japan's subliminal message to their people to start procreating a little more - as that demographic cliff is getting very close.
Chinese Foreign Minister Yang Jiechi said Saturday that "Japan needs to face up to reality, and take real steps to correct its mistakes... so as to prevent a further escalation," with regard the demand that Japan reverse its nationalization of the small islet chain of the Senkakus. In some of the strongest rhetoric yet, The Japan Times reports that the Chinese minister said Japan's 'single-handed' actions so far have "caused great damage to China-Japan relations and undermined stability in the region," and urged Tokyo to "make concrete efforts" to prevent fraught bilateral ties from spiraling out of control. As the reigns of control in China continue to be handed over (with Yang expected to become state Councillor for foreign affairs), we suspect the situation is far from resolved - especially with Shinzo Abe fighting a war on another front (that China is likely not pleased with either).