Neomercantilism and Sloppy Central Bankers
When I wrote for RealMoney, one of my continuing themes was that the Federal Reserve was less relevant because neomercantilistic nations like China (and perhaps OPEC nations) had reasons for promoting exports to the US that were less than economic. As such they would buy US fixed income in order to facilitate their exports. What could be sweeter? You send goods; we send promises, denominated in our own currency.
With that, I want to point to a short post from Marginal Revolution. Like me, he takes the “modified Austrian” view that the bubble was caused not only by the Fed, but also by the neomercantilists, both of which I fingered in my “Blame Game” series. Buying longer dollar-denominated debt stimulated mortgage rates more than the Fed could, because under normal conditions the Fed can only affect the short end of the yield curve.
PS — What a long day, to NYC and back. I appeared on Fox Business News show “Happy Hour.” They said I did very well. If I get video I will post it here. As I have said before, time on live television goes fast. The four minutes seemed like the blink of an eye. At the end, Liz asked me for a third stock, and I blanked out, so I said Assurant, a company that I love, but don’t currently own. I will own it in the future. I meant to say Pepsico, but it just didn’t come to mind.
I also had dinner with my friend Cody Willard after the show. Though our rhetoric is different, we basically agree that the actions of the government in the bailout offer much possibility/potential for favoritism. Also, that it is easy to start a bailout, and hard to end one.
Let the government chew on this: Pepsico issued $3.3 billion of corporate debt yesterday. For a company with recession-proof products and a Aa2/A+/AA- balance sheet, for them to pay 4%+ over Treasuries is astounding. Liquidity? What liquidity? If financing needs are outside the A-1/P-1/F1 CP box, there is no help. Not that there should be help, but the corporate bond market is a truer indicator of our stress than the money markets, which still aren’t in great shape.
Full disclosure: long NUE PRE PEP
October 22nd, 20087:52 am at
David,
Another weird credit market anecdote: Tom Graff reports on Realmoney that 30 year swaps yesterday traded at a 0.5 bps spread. This is obviously nuts, and due to unwinding of positions by leveraged players. If you have the opportunity, probably a great opportunity to pay fixed, and hedge with long Treasuries.
For Halloween this year, somebody ought to dress up as the credit market, it’s much scarier than any fictional vampire or ghost LOL.
Steve
October 22nd, 200810:08 am at
David,
why Assurant? would not your prefer Ace at a cheaper M/B valuation, better profitability and low CAT exposure? P&C looks cheap in general though
October 22nd, 200810:37 am at
Steve, I commented over at AI on that same phenomenon, they may as well buy long Treasury zeroes to gain duration at those rates.
PlanMaestro, I’ve always liked Assurant — they are very well run and diversified. ACE — I tend to worry about what I don’t know there. Are reserves set properly — much longer-tail in nature. I would rather own PRE, it is more conservative — they don’t discount their reserves, and disciplined about risk taking. True book value is near $90.
October 22nd, 200810:49 am at
David,
I commented on a paper here
that empirically assess the importance of neomercantilism versus sloppy central bankers.
October 22nd, 200811:40 am at
David, they are both important, and it is hard to untangle the two effects. We don’t have enough data.
October 22nd, 200811:54 am at
Thanks Steve, liked very much the shorter tail part and no CAT exposure. Will take a look at it.
Given your expertise in P&C, would it be possible a summary of your perspective in the sector?
The companies I know were badly burned at the beginning of the decade and learned their lessons (no CDOs, shorter tail, well reserved) but is difficult to do a comparison of valuations.
October 22nd, 20084:58 pm at
Sheesh! I’m not a fixed income guy, but when someone tells me that pepsi’s issue is at T+400, I want to buy.
Mr. Merkel:
You mentioned the neomercantilists recycling their dollars back into U.S. assets to control their currencies. The U.S. current account deficit is likely to contract at a time when the Treasury is issuing in record amounts. Given that the Treasury is largely financed externally by dollars that boomerang back from surplus countries, and that a contracting CA deficit is likely to diminish the number of dollars available to boomerang, does that mean that the bailouts are likely to be monetized?
In other words, with a contracting CA deficit, the neomercantilists will have to reinvest a smaller surplus to control their currencies. The increasingly large treasury issues seem to depend on large external financing, which seems unlikely to come in as strongly as when the CA deficit was huge.
Am I missing something big here?
October 23rd, 20081:45 pm at
Matt,
The flip side of a declining CA deficit is lower US consumption and a rising savings rate. To at least some extent (and possibly at the cost of higher rates), these savings will end up funding the treasury issuance.
October 23rd, 20086:28 pm at
There should be a lot of opportunities here for cash-rich companies that aren’t dependent on external financing. I spoke with the CEO of one such (small) company last week, and he mentioned that he was looking to take advantage of the opportunity to buy assets from eager sellers.