Month: April 2008

Not Concerned About Reinsurance Group of America

Not Concerned About Reinsurance Group of America

Posted on by David Merkel

So Reinsurance Group of America missed estimates. Big deal; they’ve had good-to-excellent earnings for the last ten quarters; they have a bad quarter now and then when the “law of small numbers” catches up with them. Look at 2Q05 and 4Q01 for examples. The law of small numbers means that every now and then, you get a random gaggle of deaths with high face amounts, and the quarter is bad. This is often a good buying opportunity, because Wall Street, which only understands that the earnings missed, without understanding the underlying model, assumes that the miss will persist into the future. That has not been true of RGA.

I have met the CEO and CFO of RGA, and I think they know what they are doing, more than all of the other companies that do life reinsurance. They are the quality name in the space, including their more complex European competitors.

The stock price is currently way above my lower rebalance point, but I would be a buyer on weakness if I did not have a position. This is one of those stocks that you tuck away for 5-7 years, and you find that it doubles. The current oligopolistic nature of life reinsurance may shorten that timespan.

Full disclosure: long RGA

Ten Things To Be Concerned About

Ten Things To Be Concerned About

Posted on by David Merkel

1)? Picking up on some comments from last night’s post, why I am I not concerned about counterparty exposure?? Because Wall Street has always been very good at cutting off overleveraged clients in the past.? LTCM was an exception there, and only because Wall Street gave in to their request for secrecy.? Wall Street grabs collateral first, and then lets the client argue to get it back.? The investment banks require a significant margin, and when there is significant concern about getting paid, the lines get pulled.

The real worry here is that the investment banks don’t have good enough risk controls for each other.? Note that Bear’s crisis started when other banks stopped extending credit to Bear, and the fear fed on itself.

I liken the investment banks to long-tail commercial casualty insurers.? No one knows whether the reserves are right.? No one can.? Confidence is a necessary part of the game, which is made easier at lower levels of leverage.? But high leverage and opaqueness are a recipe for disaster when volatility rises.

2) Should you worry about Fed policy?? Yes.? The Fed is steering away from the Scylla of a compromised financial sector, and into the Charybdis of inflation.? As I will point out later, that is already having impacts on the rest of the world.? As for now, there are a few ill-informed writers who say that a negative TIPS yield on the short end is a reason not to buy TIPS.? That might be correct if inflation mean-reverts.? Given the short-term resource scarcity building in our world, I don’t think that is likely.

3) Should you worry about the US Government budget deficit?? A little — oh, and worry about the real deficit, one that puts the wars and other emergency appropriations on-budget, and takes out the excess cash flow from Social Security.? In a macro sense, for the nation as a whole, the impact isn’t that great… but it sends a message to foreign creditors who wonder what the value of the dollars will be when they get paid back.? When they see the Fed running an aggressive monetary policy in the face of rising inflation and a weak dollar, it makes their heads spin, as they contemplate the hard choices the weak dollar forces on them.

4) Could the falling dollar cause a crisis in China?? Maybe.? China is levered to US growth, which is slowing, and their export competitiveness versus the US declines as the dollar declines.? And what will they do with all of those dollar reserves?? Beats me.? After a certain point, additional reserves are useless — it is akin to lending more to an entity that you know is insolvent.? My guess is that the yuan will get revalued after the Olympics, and then the real slowdown will hit China.

5)? What of foreign food riots; are they a worry?? (More, and more.)? A little.? They are a canary in the coal mine.? They point to the short-term scarcity of total resources in our world, which only becomes obvious as a large part of the world tries to develop.? But, one practical thing that it implies is that energy and food prices will remain high for some time.? We are one global market at present, and energy and food prices are interlinked through the energy and fertilizer costs of farmers, and through stupid ideas like corn-based ethanol.

6) What of flat crude oil? production?? Yes, worry.? As I have said before, the government oil companies of OPEC countries control most of the supply, but they don’t always manage their resources as well as a capitalistic oil company.? Mexico, Venezuela, and Russia have declining production, to name a few.? The Saudis may not want to produce more, because they don’t know what to do with all the US dollar reserves that they have today.? Or maybe they can’t…

7) Worry about falling housing prices?? Yes.? The problems in the housing market stem from overbuilding.? There are too many houses chasing too few solvent borrowers.? This will eventually affect prime mortgages, because declines of 15-20% in housing prices mean that many prime loans would be underwater in a sale.? Remember, an underwater loan becomes a default after a negative life event — unemployment, death, disability, divorce, and uninsured disaster.

Before all of this is done, one of the major mortgage insurers should fail.? We aren’t there yet.

8 ) What of falling residential real estate prices in foreign countries? Yes, worry.? For Europe, it could lead to the end of the Euro, as countries needing looser monetary policies get tempted to abandon the Euro.? If the Euro’s existence becomes questioned, it will be a systemic risk to the world.

9) What of credit card delinquencies?? Yes, worry.? It shows that total financial stress on the consumer is high, particularly when added to the problems in mortgage and home equity loans.

10) Should you worry about bank solvency?? A little.? All of these previously described stresses have some bearing on the ability of the banking system to make good on their obligations.? Be aware that the FDIC was designed to handle sporadic losses, not systemic crises.? The odds of these problems affecting the depositary financials is still low, but the protective measures will not be capable of dealing with the worst case scenario, should it arise.

Perhaps I have more to worry about.? As I close up here, I haven’t mentioned the PBGC, Medicare, and a variety of other problems.? But, I have to call it a night, and symmetry with last night’s piece is worth a little to me.

Ten Things Not To Worry About

Ten Things Not To Worry About

Posted on by David Merkel

There are many that cover the markets that try to get you to worry about things that aren’t real problems.? Here’s a sampling for the evening:

1) Changes in accounting standards, or ineffective/opaque accounting standards.? Take Goldman Sachs and level 3 assets as an example.? The accounting standard is fine, so long as you understand it.? In general, the higher the level of level 3 assets, the more opaque the valuation of assets is, and a valuation haircut gets assigned to the stock.? This is proper, because it happens to all companies with high or cloudy accrual figures.? It makes it hard to estimate free cash flow.

Should we move from US GAAP to IFRS, it should not affect the valuations of stocks on average, though it will make it a little harder to do financial analysis.? What does not change is free cash flow, which is not subject to accounting rules.? The money that can be withdrawn from a business without harming its current prospects (free cash flow) is the key metric for understanding business value.

2) Counterparty risk.? In derivatives, for every loser, there is a winner.? So long as the appropriate margin levels are maintained at the main brokerages, and the main brokers don’t experience conditions that dramatically change their credit quality, counterparty risk is not a problem.? (Or maybe, I should say, worry about the brokers, not the other counterparties.)

3)? Investors moving to cash.? Money rarely leaves the market.? When funds raise cash (and here), others buy their shares at a discount.? Typically, they are stronger holders than those that sold.? I wouldn’t be too bullish over stories of investors moving to cash, but I certainly would not be bearish.

4)? Rating agency downgrades, unless they trigger a debt covenant.? For the most part, market spreads and yields are set independently of debt ratings.? Sophisticated investors dominate the market, not the rating agencies.? As an example, suppose the US were downgraded to Aa1/AA+/AA+.? After a week, I doubt yields would change much at all, because the fundamental view of the US would not be changed by a change in its rating.

5) High credit spreads.? Those are a reason to be optimistic, because it means pain has been taken already.? Spreads can’t get higher than a certain level, or companies start delevering, because it is profitable to do so.? So when you see spreads near record highs, that is a buying signal, at least for the debt.

6) Retailers in trouble.? Some retailers are always in trouble during hard economic times.? It’s a tough business model, so expect some defaults; it is normal and healthy for the economy as a whole.

7) Collapse of a large portion of the auction rate securities market. ? Most borrowers will refinance.? In the interim, speculators are driving down the rates that get paid.

8) Downgrades of the major financial guarantors.? The market has priced it in, and perhaps we just run off MBIA and Ambac.

9) Tranche warfare in CDOs.? Read your prospectus with care, but when the seniors grab hold of a deal after and event of default, that is a step toward normalizing the market, though the mezzanine holders may ineffectively object as they end up getting nothing.

10) The ABX indexes, etc.? I’ve written about this before, but the various synthetic indexes — ABX, CMBX, LCDX, etc., are very hard to arbitrage against the cash market bonds that they represent.? The indexes should not be used for pricing as a result.? Whenever the synthetic market gets too much bigger than the cash market, it becomes a bettors market, and becomes incapable of delivering pricing signals to the underlying cash markets.

There are enough real things to worry about.? Perhaps I will write about those tomorrow.

Second Quarter 2008 Portfolio Changes

Second Quarter 2008 Portfolio Changes

Posted on by David Merkel

For this quarter, I sold two my two placeholder assets, the Industrial and Technology SPDRs, and Arkansas Best, which had richened enough for me to trade out of it.

I had two rebalancing buys, Charlotte Russe and Avnet.? On Charlotte Russe, the rebalancing buy occurred because I tendered all my stock @ $18 in the Dutch Tender, and 45% of it got bought.? On Avnet, things aren’t as bad as the market thought on 4/15, in my opinion.? I had one rebalancing sell, Helmerich and Payne.? Just taking some off the table for risk reduction purposes.

Here is my final comparison file that was based off of data at the close of business on Monday.? To comply with the Bloomberg data license, all numeric fields remaining are ones that I calculated.? The columns of the file rank the 290 stocks on the following metrics (lower better unless noted):

  • 52-week RSI
  • Trailing P/E
  • P/Book (2)
  • P/Sales (2)
  • P/2008E
  • P/2009E
  • Dividend Yield (higher better)
  • Net Operating Accruals (2)
  • Implied Volatility
  • Neglect (higher better)

The grand rank sums up the ranks giving double weights to P/B, P/S, and NOA.? My current stocks are highlighted in yellow, except for the two middle ones, which are in orange.? Candidates for sale come from the lower half (high grand ranks), candidates to buy from the upper half.

Here were my purchases (P/2008E):

  • International Rectifier — 9.5x
  • Group 1 Automotive — 7.1x
  • OfficeMax — 9.3x
  • Universal American Financial — 5.8x

Cheap names all (and could get cheaper?).? If you asked me what my concerns might be over this group of names, I would say that credit quality is adequate but not stellar.? I would also confess a little doubt on Universal American.? It looks cheap, and lines of business they are in are stable lines.? They lost money on mezzanine subprime mortgage ABS.? I looked at the writedowns, and they seem adequate.? If you send the security vintages 2006-2007 to zero, this stock is still cheap, in my opinion.?? What I can’t evaluate is whether they could have operational problems in their senior health insurance business.? It’s a good business, if managed properly.

As for International Rectifier and Group 1, I have owned them before.? With IRF, I like industrial technology — stuff that is harder to obsolete.? On Group 1, I looked at all of the small cap auto retailers, and picked this one.? I liked its business mix, and what seemed to be a clean balance sheet, with few immediate needs for liquidity.? The group as a whole has been smashed, and is discounting very unfavorable conditions.? I don’t think things are that bad, and besides, a lot of the revenues come from repairs and sales of used cars.

With OfficeMax, I think prospects are less cyclical than the market seems to believe.? Office supplies get purchased during bad economic times as well, and the current price already discounts? a lot of pain.

Well, those are my purchases.? Let’s see how they fare over the coming years.

Full disclosure: long HP CHIC AVT GPI UAM OMX IRF

Five Notes: What Can the Fed Do?

Five Notes: What Can the Fed Do?

Posted on by David Merkel

1) There have been a number of recent articles questioning/explaining what the Fed can do in this present environment. Here are some examples:

My own view is that the Fed has used up a lot of firepower on the asset side, but still has a lot to work with. That said, the Fed should be careful not to complicate its balance sheet with a lot of off-balance-sheet agreements. Policy flexibility for a central bank is a real plus, so complicated agreements that make formerly liquid assets illiquid are to be avoided, particularly in a crisis.

Regarding Fed funds, it looks like they will cut 25 basis points on 4/30, but make noises that they are getting close to being done. Perhaps 1.75% will be the low for the cycle.

2) I already miss Alea. Before jck went on hiatus, he commented that the TAF was not effective at lowering rates, and that the TSLF was a success, though by success, he means that it’s not in hot demand. Tony Crescenzi speaks similarly. Perhaps the existence of the PDCF reduces the need.

3) Perhaps Lehman is an example of that, moving buyout loans off of their books, and getting financing for the AAA portion from the PDCF. Given the imitative culture of Wall Street, I would expect to see this repeated by other investment banks.

4) Volcker-mania. In one sense, it’s weird to see him speaking out now, given that he was silent for Greenspan, save for a little at the end. I agree with almost all of what he has been saying; it reads like my writings over the past five years. For a sampling of opinion:

Greenspan ate sour grapes, and Bernanke’s teeth have been set on edge. Bernanke inherited Greenspan’s ignored problems. At this point he and the Fed are puzzled — seeing rising inflation, but fearing what higher rates could do to the banking system. With a similar view that the Fed has few good options, consult Tim Duy.

5)? Finally, if we turn off the microphones, and shut down the cameras, will Alan Greenspan cease to exist?? His defensiveness toward his record undermines his record.? Better he should stop talking publicly, particularly if he follish enough to suggest that the housing market will bottom in 2008.

The US Dollar and the Five Stages of Grieving, Revisited

The US Dollar and the Five Stages of Grieving, Revisited

Posted on by David Merkel

I recently received an e-mail from a reader regarding the post, The Problem with Hoarding, or, Don?t Play a Game with Someone Who Can Change the Rules. Here it is:

Why pick the year 2020 for a max? I like the previous post about the US Dollar and the 5 stages of grieving

That previous post was the one that first got me hooked on Aleph. Google found it for me when I was searching for some answers on what the heck was going on in the world.

Let me clarify. By 2020, I don’t think the US Dollar will be the world’s reserve currency. It may happen sooner than that. As for the five stages of grieving, that applies to the intermediate-term, and maybe the short-term. It certainly sounds like the G-7 is entering the stage of bargaining. If they decide to do a currency intervention, I hope they remember The Four Rules of Currency Intervention. It would save them money, whatever money is nowadays.

We are getting close to an inflection point here.? The pips are beginning to squeak.? Be ready for an intervention; and be prepared for it not to work, unless they follow the four rules.

Problems with Tax Reform

Problems with Tax Reform

Posted on by David Merkel

As I sit here, my taxes are done, all except for one K-1 that is very late, to put it mildly.? My taxes are complex, but my rule is that I do my own taxes.? If I can’t figure out the code, then I am probably doing something that I don’t understand the full economics behind it, and I should avoid it as a result.? Besides, it keeps me up with trends in the tax code that I might not truly grasp.? Surprises this year included the form for HSAs, and a credit? for promoting domestic production.? I also learned some of the intricacies in accounting for the sale of S corporation stock.? Not fun, but I learned something, and that is good.

It does motivate me to write a piece on tax reform, though.? I don’t fit neatly on the political spectrum: I’m a libertarian on economics, and a conservative on social policy (though conservative really isn’t the right word). Tax reform means different things to different people; let’s consider what it means to conservatives and liberals.

What does tax reform mean to conservatives?

  • Eliminate the estate tax
  • Eliminate the double taxation of dividends
  • Eliminate the marriage penalty (actually should be a goal of liberals, and not conservatives, but hey…)
  • Flatten the tax rate structure
  • Preferentially tax income classes that aid in capital formation
  • More taxation at the state level, less at the federal level
  • Carve out exceptions for political allies that support your broad agenda

What does tax reform mean to liberals?

  • Roll back the Bush tax cuts
  • Keep the estate tax
  • Increase the progressivity of tax rates
  • More taxation at the federal level, less at the state level
  • Preferentially tax wage income at lower rates
  • Carve out exceptions for political allies that support your broad agenda

To me, both of them miss a dimension of the problem.? The main problem is how we define income, not the rate at which we tax income.? Both liberals and conservatives support areas in the tax code that allow for deferral of taxation.? To me, that is a core problem in the tax code.? Taxation should be roughly proportionate to the good that a taxpayer is deriving from society.? As a proxy for that, it should be proportional to his increase in net worth, whether the increase in net worth is liquid or not.

I will use Warren Buffett as my example.? Because he rarely sells stock, his taxes are deferred both personally, and at Berkshire Hathaway.? His net worth keeps going up, and the Treasury doesn’t get a piece of it.? Then he has the nerve to show up on Capitol Hill in favor of the estate tax, a tax of which his estate will pay little, because he has given most of it away.

My view is that people should be taxed like traders, on the increase in their net worth, at the same rate, regardless of where the income comes from.? Taxes would be paid on a mark-to-market basis.? There would be no more tax deferral IRAs or 401(k)s, and even pension earnings would get taxed inside DB plans.? Life insurance and annuities would lose their tax breaks.? Even charitable endowments would be taxed.? Private equity would get taxed off of “phantom income” at a 15% compounded rate, i.e., a private equity fund with $100 million in equity would have to pay taxes on $15 million of phantom income, at the fund if 15% distributions are not made to shareholders.? Truing up would occur at the dissolution of the fund.

Another key component here would be that there would be no separate tax accounting basis — the IRS would use GAAP.? What you report, is what you get taxed on, with the exception that firms that are heavily indebted to avoid paying taxes would get taxed on phantom income, the same as private equity.? Also, all like-kind exchanges would be taxed.? Even real estate would follow the property assessor, and income taxation would occur on the increase.

Then eliminate all deductions, conservative and liberal ones, and you have a tax code that can operate at a low rate because the entire increase of wealth in the economy is being taxed, without exceptions.? Oh, and since the income has been taxed all of the way up, the estate tax is no longer needed.? It was needed when wealthy people could shelter their increasing net worth from taxation.

Objections to this Outlandish Proposal

  • Would you really allow investment losses to reduce someone’s income to zero, or below?? Yes, though there would have to be some safeguards against people who disguise their hobbies to be businesses.
  • This will kill investment; the economy won’t grow without tax deferral!? Nonsense.? Most tax deferral incentives don’t change the amount of investment, but just the forms that the investments go into.
  • Without tax deferral, people won’t buy life insurance, annuities, and corporations won’t provide pensions.? To some degree, yes, but after the shock wears off people will invest for maximum advantage again, and with an eye toward what is best, not what is tax-favored.? With my proposal, I don’t care if people have pensions or savings.? It’s all the same.? Life insurance and annuities will be bought for risk reduction reasons, not tax reasons.
  • This will kill private equity!? It won’t.? It may shrink it a little, but there are many advantage to private equity aside from deferral of taxation.
  • But phantom income will require illiquid investments to retain liquidity for taxes, or require equity holders to fund taxes.? Guilty as? charged.? It changes the business model to that degree.
  • This discriminates against the poor in favor of the rich.? No, it discriminates against the clever rich, who shield the increase in their net worth from taxation.? Taxes delayed often become taxes avoided in entire.? Poor people should pay some taxes.? They benefit from society a little, and taxes would give them greater interest in voting.
  • If there’s no deduction/credit for JKL, then JKL will disappear.? Good, or, maybe I should say, yes, there will be a decrease, but if it is valuable, it will find its own level.
  • This proposal is incomplete!? You haven’t considered a lot of other areas.? No doubt; there would be a lot to do here, should it ever see the light of day.? Let John McCain be a real straight-talking maverick, and adopt a proposal like this.? He could be a real conservative, while offending all of the “conservatives.”

I harbor no illusions here.? We have the tax code that we deserve.? Don’t blame the IRS.? Don’t blame the President or Congress.? Blame those who elected them, and those who failed to vote.? The politicians offer us favors from our own money, and we thank them for it, by re-electing them.? I know that my views of tax reform will never be enacted because it steps on too many feet.? Can you imagine how many accountants, attorneys and actuaries would be unemployed by this?? If they fought hard against TRA ’86, just imagine how they would fight against this.? The politicians like fostering the illusion that they create our prosperity, when in reality, they take a share of it.? A proposal like this, that makes taxation more immediate, and more transparent, would make people more concerned about where their taxes go, because they would feel it more acutely.

And then, after all of this, we should move election day to April 15th.? Let the voters feel acutely what the politicians have decided for raising revenue, and they will render a better verdict.

The Problem with Hoarding, or, Don’t Play a Game with Someone Who Can Change the Rules

The Problem with Hoarding, or, Don’t Play a Game with Someone Who Can Change the Rules

Posted on by David Merkel

US Dollar reserves continue to build up in the Middle East, China, and other parts of the world as well.? Good for them.? Isn’t it great that they have all of those foreign currency reserves to draw on?

Well, maybe. The question becomes who they sell the dollar assets to, and at what price.? When many nations hold an excess of dollar claims, more than they need for trade purposes, the desire to have more dollar claims declines.? Thus the dollar falls in value versus other currencies.? Eventually the day will come where US goods are irresistible, but we aren’t there yet.

And, we are putting out more dollar claims.? Witness the trade deficit and the record US government budget deficit (and that’s with Social Security on-budget, and the wars and other “emergencies” off-budget.? Let the rest of the world fund our spending by lending to us in depreciating dollars.

Well, that creates inflation in the US, with import price rises feeding that.? It feeds inflation in the countries that insist on keeping their currencies artificially cheap versus the dollar to subsidize their exporters.? It fees recession, or at least economic slowing. in nations that allow their currencies to rise to restrain inflation.

So, back to my title.? Hoarding US dollar reserves brings no advantage after a certain point, particularly when many are doing it.? There is nothing scarce about dollar claims.? Take the rest of the title: would you play a game with someone who can change the rules against you? Lending to the US in US Dollar terms is exactly that.? The US mouths a strong dollar policy while pursuing a weak dollar policy.? Who in the US government cares about the budget or trade deficits at present, enough to do something about them?? No one significant.? Both parties are spending like there is no tomorrow, out of a sense of financial crisis.

What will impose discipline on the system?? A falling US Dollar, and a lack of willingness for foreigners to accept payment in US Dollars.? Or, massive foreign demand to buy US companies, not debt.? Or, nations that stop subsidizing their exporters, because the inflation becomes too great, and allow their currencies to appreciate.? Maybe we see this in a few years, but certainly by 2020.

Nerds and Barbarians

Nerds and Barbarians

Posted on by David Merkel

There have been a lot of bits and bytes spilled recently over whether hedge funds like volatility or not. Here’s a sampling:

Here’s the truth, the answer isn’t a simple yes or no.? Hedge funds are limited partnerships that do a wide variety of things in the markets.? Some aim for easily modeled consistent gains through arbitrage.? Others aim for maximum advantage, no matter what.? I call the first group the “nerds” and the second group the “barbarians.”? Neither of these terms are meant to be insulting — I consider myself to be a nerdy barbarian.

Nerds are yield-seekers.? They are attempting to achieve high smooth yields well in excess of the nominal risk-free rate on a constant basis.? They tend to get funded by fund-of-funds who attempt to diversify nerds, and maybe a barbarian or two, who have clients looking for smooth yields in excess of their hurdle rates.

When volatility rises, nerds get hurt.? In the same way that junk bond investors get hurt in volatile times, so do hedge fund nerds.? Almost all simple arbitrages rely on calm markets, where there is enough liquidity to finance every project imaginable, and a few that aren’t imaginable.? Volatility alerts investors to the concept that maybe there will not be enough cash flow to complete the transaction at a positive net present value.

Barbarians are another matter.? They swing for the fences, and are looking for maximum advantage.? They look to earn the returns from big bets that could be right or wrong.? They like increased volatility, because it enables them to take positions when they are despised or enraptured.? They play for the mean reversion, something that the nerds can’t do.

To make matters more complex, some hedge fund groups blend the two attitudes.? Good idea, if you can maintain your competitive advantages.

To close this, there is no simple answer to whether hedge funds like volatility or not.? Some benefit,? some get hurt. In my opinion, because of hedge fund-of-funds, which like nerds, volatility tends to hurt hedge funds in aggregate, but not by much.

With credit spreads wide, and disarray among the nerds, it is probably time to favor high yield investing and nerds in hedge funds.??? Don’t jump in with both feet though, I would only allocate 50% of a full position at present.? There is a lot more volatility to be worked out of the system.

The Global View — Six Themes

The Global View — Six Themes

Posted on by David Merkel

Though I write mainly about US economic and investment issues, I try to be think globally as I consider macroeconomics. I think that many economists are hobbled because they think about the US economy in a closed framework, neglecting the effects that the rest of the world has on the US. Prior to the end of the cold war, that was a useful shortcut, but now many aspects of the US economy depend on global, and less on local factors. (Some articles cited here will be dated, but are still relevant in my mind.)

This article is meant to take you through six themes affecting the global economy. Here goes:

China

I’ve been writing about neomercantilism and China now for almost five years. The negative effects are now obvious. Inflation has been rising in China, because too much credit is chasing too few goods. That inflation is funneling into US goods prices as well. China exports too much, and imports too little, which forces them to import US credit. This is getting tired, and the Chinese and Middle Eastern savings gluts need a new place to invest, or better, new goods to buy. Absent these adjustments, in order to cool the economy, the PBOC keeps raising reserve requirements again and again. Better they should revalue the yuan up 20%, or they will continue to import inflation from the US.

China has its growing pains amid this. Pollution is rampant, and standards for product safety are low. Beyond that, China now competes with the US and Europe for economic alliances in Africa. Given past bad blood there, the Chinese may at many points be better received, that is, until they abuse their welcome.

Currencies

The main question here is the demise of “Bretton Woods II” where the rest of the world uses the US Dollar as the main reserve currency, while the US continues to debase the dollar through the issuance of more dollar claims. You can read about it in any of the following articles:

Now, Ken Fisher told us not to worry about the declining dollar, but the euro-yen exchange rate. It’s too early to say, but that exchange rate is flat, while the S&P 500 is off 7% or so. Perhaps the overall carry trade is weakening, but not with the euro as a currency to purchase, yet.

Finally, not only is the weak dollar good for exports, but for tourism as well. Now maybe they buy some of our slack houses as well…. please?

Inflation, Especially Food Prices

All the buzz is over rice, which has risen fivefold in six years. You can read about it here:

Now, that inflation is feeding back to the US, but slowly.? You would think that this would be a great time to eliminate US farm subsidies, but no, they are too effective at buying votes insuring economic stability in the Midwest.

Now, in the face of these inflationary pressures, the ECB is not mimicking the Fed.? They see the inflationary pressures, and aren’t loosening, at least not much.? Australia is even tightening.

Recession Fears in the Developed World

Now there are similar stresses in housing in some places of Europe, as compared to the US.? Consider Spain (and here), and the UK.? Low-ish interest rates can lead to overbuilding anywhere, if the regulators look the other way.? Japan may not have housing worries, but their growth is slowing, and they worry about the next recessionary leg of a what is proving to be a long recessionary era (since 1990).

Energy

It doesn’t matter how you slice it, Chavez has mismanaged the Venezuelan economy, and particularly the oil industry.? Now he is trying to do the same thing to cement.? Venezuelans are experiencing shortages and high inflation, as Chavez directs resources that he has stolen nationalized to his cronies and his foreign interests that he funds in order to make life difficult for US foreign policy in Latin America (not that I am a great fan of US policy there — I only recognize the conflict).

The Middle East has lots of new oil fields to tap at the right price, yes?? Well, I’m not so sure.? It is interesting to see the UAE develop a nuclear program.? Perhaps they are looking to a day when oil will not be so plentiful?? Then again, maybe we will have a big energy find in Greenland (an island that may once again be green, now that temperatures are rising to levels last seen in the middle ages).

Emerging Markets

Coming back to the beginning of the article, emerging markets (like China), are going through an adjustment period.? Since these two articles were written, emerging market equities have fallen significantly.? They may fall further; many of those nations are geared to global growth, and when it slows, it slows even more for them.? Many of them are absorbing US inflation as well, and need to raise their exchange rates.? That will hurt exports in the short run, but will aid in bringing economic stability.

Theme: Overlay by Kaira.