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  • Global macro says US might win in the end after all ...


    Wednesday 7 September 2011

    "Imperfection is beauty, madness is genius and it's better to be absolutely ridiculous than absolutely boring."

    Marilyn Monroe

    Commentary & Analysis

    Global macro says U.S. might win in the end after all ...

    There is little doubt the doom and gloom crowd has the upper hand when it comes to sentiment about the U.S. economy and its future in the world. I know many want their doom and gloom beliefs validated, and therefore it’s burning-at-the-stake time for one to be the least bit optimistic about the future of the U.S. at a time like this. But let me give it a try and see if makes any sense to you.

    I am not going to deny there is a host, a virtual plethora, of reasons why it looks ugly for the U.S. But, this game of winning and losing among competing nations is a

    For you to accept my argument, you must ultimately agree with the following two premises:


    coupling lives because consumer demand still flows primarily from the center [industrialized nations’ demand] out to the periphery [emerging and developing nations].

    2. In times of falling global growth, current account surplus nations take the negative brunt of the adjustments.

    If you accept those two premises, you can see right out of the gate why the U.S. is in a position of relative gain in a world which may be poised for slower growth and possibly outright deflation. The U.S. is by far the largest single consumer market and is the world’s largest current account deficit nation.

    Already I suspect many are thinking: "What a nut!" Understandably so, given what you have seen that passes as global analysis, since you’re conditioned to believe current account surpluses are the ticket to safety and prosperity. In fact, what triggered this missive was a story I read yesterday by some analyst, I forget where, who said large fx reserves are "doing what they are supposed to protecting the BRIC nations." The writer evidently disagrees with my two initial premises.

    And I am not saying that it is a bad thing to be in surplus; but I am saying given the distribution of imbalances across the global spectrum at this point in time, when the U.S. is still the global buyer of last resort, China is keeping growth alive only through massive internal malinvestment, and the eurozone has the mother of all imbalances from which to extricate itself, surplus nations will find themselves in Wiley Coyote, out-over-the-cliff zone, as the world will be forced into rebalancing by various means. On a relative scale, the U.S. wins, even if it isn’t exactly pretty for anyone.

    Here’s why the U.S. wins, and I will keep it as simple at possible, lest you fall asleep…

    1. The world is extremely leveraged as it faces yet another "peer into the abyss" moment. Much of the ongoing private deleveraging since the credit crunch has been replaced by public leveraging called "fiscal stimulus and monetary ease." Debt on top of debt is not a recipe for real growth. If it was, Zimbabwe would be an economic model we all emulate. Despite howls to the contrary, from many who believe in the debt on top of debt growth policies, the market will win this one. And in the process the massive wall of liquidity from this stimulus, that pumped up the BRIC nations, will decline. Investment, not consumer demand in these nations, will take a hit. And with it, so will GDP growth. This will trigger a self-feeding run to safer ground which includes deeper capital markets. Despite the downgrade in the US credit rating, US capital markets still play the role of hiding place for large pools of capital and will continue to do so until an alternative appears.

    2. Declining global demand is already leading us down the path of currency war (the implicit name for trade protection). Switzerland’s latest move is just another skirmish in the ongoing battle to protect local exports. China can ill afford to let its currency ramp up in this environment where exports have already been impaired.

    As politicians everywhere run out of stalling tactics and stimulus money, yet local jobs haven’t returned, the cry to "bring jobs home" will grow louder. I believe the currency war will morph more directly into explicit trade barriers. The US wins big-time in a trade war, and those dependent on the US demand lose big time. Why? US companies have a deep market here at home, something other countries don’t have to the same degree. More jobs would actually be created if local industries are protected by barriers (not necessarily good for long-term competitiveness, but we are speaking intermediate-term realities here). The so-called "dangerous" US current account deficit would fall, as US citizens by fewer goods from those surplus nations outside the US. A falling US current account would also mean the US would become less dependent on international capital flows, but the flipside is as US demand is taken out of the world economy, surplus nations would become increasingly dependent on those investment flows to keep growth alive. But it won’t happen because more investment in the BRICs only means more excess capacity that won’t be taken in world markets, and local demand is still too low on a relative basis to keep GDP growth strong. Thus, the investment flow would reverse quickly back to the center, a la the US.

    Needless to say, this is only a very brief overview. But I think you can at least see there is an alternative story to US doom and gloom. It’s why I can’t personally buy into the rationale that says the US is going to hell in a hand basket but the rest of the world will be just fine.

    As always, time will tell which story rises to the top.

    Note: Even the elites are thinking deeply about the restoration of America; time to think of America first and rebuild at home so we can be stronger in the future. This I think dovetails on the idea the US can win the global macro game in the current environment, especially with the many challenges facing China in its inevitable transition to a more consumer-driven economy. It makes strategic and geo-political sense to me. Here is an example I think of that type of thinking by one the elite policy makers—Richard Hass, President, Council on Foreign Relations, in a piece titled, "Bringing Our Foreign Policy Home." Isn’t interesting that when Pat Buchanan or Ron Paul call for the same they are treated like pariah and called the most dreaded word in the elite vocabulary—"Isolationists." Ahhh ... run! Lock up the women and children ...

    Jack Crooks

    Black Swan Capital

    Editor of Currency Currents Professional

    Currency Currents Blog

    1. Decoupling of the emerging market world is still a fantasy;

    relative game. In the world of global macro analysis, one country’s negative adjustment process can be another’s positive gain. That is the essence of the argument.


    Sep 07 1:20 PM | Link | Comment!
  • Attractive valuations? Does that mean Keynes-ja vu all over again?
    Commentary & Analysis

    Attractive valuations: does that mean Keynes-ja vu all over again?

    Hey – you can’t argue against the fact that stocks and commodities are more attractive buys right now than they were two weeks ago, based entirely on relative value.

    Would I rather buy copper at $3.90 per pound instead of $4.50 a pound? Yes.

    Would I rather buy Bank of America at a 30% discount to where it was trading 10 days ago? Yes.

    But the more pertinent question might be: right now do I want to buy copper or Bank of America ... at all? Not really; at least not yet. I think there are some major risks to the global financial system that easily trump these newfound “attractive” valuations.

    Forget free-market fundamentals. What matters most to the capital markets now is whether the governments of the U.S. and Western Europe have the will and the wherewithal to save the global financial system from disaster yet again.

    Those two sentences were from a Bloomberg article. And they point to two very important ideas that will impact valuations one way or the other:

    1. The global financial system faces disaster. This implies that it’s not just one nation or region undergoing economic headwinds; this implies that the major growth-producing regions of the world are facing financial problems that are set to wreak havoc on growth ... together. Call it systemic; it evokes contagion fears – it appears time to start heeding the warnings.

    2. The global financial system faces disaster ... AGAIN. The difference here is being that commentators, economists, investors, and policymakers have, only a few years ago, already witnessed a major financial crisis that rocked financial markets. That time, in 2008, the market collapse seemed to sneak up on everyone; this time many are at least aware that there are forces that could wreak havoc on markets.

    In other words: 1) major risks are lingering but 2) investors and policymakers might behave differently towards Financial Crisis: Round 2 because they’ve seen it before. In the former scenario, current attractive valuations are, well, not that attractive. In the latter scenario, investors may be inclined to jump on current valuations with the expectations that a complete collapse a la 2008 will be thwarted.

    Those are two scenarios I am operating under as I try to best navigate the latest price action. Unfortunately, I am skeptical that investors and policymakers have learned enough from the first round of crisis to avoid a second round.

    From Reuters:

    Business from China and India is robust enough for shippers such as Paragon Shipping, Box Ships Inc. and Seanergy Maritime Holdings not to be losing sleep over financial crises in the United States and Europe, executives said.

    This may prove my point. Investors, and even the esteemed policymakers and executives around the globe, may determine that major developing markets can compensate for the growth disappointment that the US and Europe are almost certain to deliver.

    Gee, that sounds familiar. Yogi?

    It’s like déjà vu all over again.

    Last time we were told that emerging markets could compensate for lost demand as the US consumers’ hands were tied up in deleveraging. Turns out it was global money pumping and liquidity that compensated for lost demand. It’s like Keynes-ja vu all over again.

    Except this time might it be India and China alone that compensate for a mediocre West? After the 2008 financial crisis China saw its GDP growth slump into the 6% range. And that was back when China wasn’t facing near as many problems as they are now – e.g. their growth model is further stressed, inflation is a major issue and Chinese officials may have little influence to alter their economy’s trajectory.

    India didn’t escape from the 2008 financial crisis unscathed, either. And now they are battling their own headwinds as well as those that come with slower global commerce.

    We were told that South Africa and Brazil were among the emerging markets that had little, if any, exposure to the financial systems of the West. Neither of those economies fared well when the global financial system froze up. And I don’t expect they’re capable of taking up the slack if major economies continue to slow.

    Are investors building their houses out of BRICS?

    Together, or individually, Brazil, India, China and South Africa will not be saviors in the event the global financial system hits a brick wall, despite rumors (again) to the contrary.

    But what about Russia, the only one of the BRICS I left off the wall?

    I’ve been reading a few stories lately touting the “attractive” Russia investment story – some believe it is much more attractive than any of its fellow BRICS. Maybe! Maybe, but Russia isn’t going to pull anyone out of the fire if we revisit the credit crunch. Russia has commodities and commodities get creamed in a credit crunch. Period!

    We will share the good, bad, and ugly of Russia and its economy next week when in the August edition of Global Investor. Stay tuned.

    In the meantime, we’ll watch how the valuations argument shapes up. If investors come rush to snatch up seeming bargains on shares and commodities, I don’t think it will last. But it will set the stage to rack up some profits on a new leg down. Back to the Bloomberg excerpt:

    Forget free-market fundamentals. What matters most to the capital markets now is whether the governments of the U.S. and Western Europe have the will and the wherewithal to save the global financial system from disaster yet again.

    Ultimately, I think investors will be disappointed in the near-term by governments’ inaction. But the policymaking saviors will certainly (eventually) arrive in some way with measures to stem the market collapse. At that point we’re faced with what I talked about on Wednesday – does the Federal Reserve have the tools (the money, really) to restore investor confidence?


    Aug 12 10:48 AM | Link | Comment!
  • The Fed: their toolbox is bigger than yours.
    Commentary & Analysis

    The Fed: their toolbox is bigger than yours.

    Perhaps the only words from the FOMC announcement yesterday which would not have led to a relief rally would have been:

    We’re hiking rates by 50 basis points. Sorry.

    Your esteemed leaders,

    The FOMC

    P.S. The US economy is toast.

    I say this for two reasons: first, I think the markets were due for a breather; second, I think expectations were set in line with what was eventually delivered; third, I think the Fed carefully and effectively acknowledged – via low-rate pledge and rhetoric – the struggling US economy.

    Most commentators were not yet expecting Bernanke & Co. would unleash a brand new bond-buying initiative (i.e. QE3). Most did believe the Fed would continue with its “low rates for an extended period” language – they did. Most were ready to buy at much more attractive “valuations”.

    But perhaps the current (and future) difference-maker was the timeline ... envisioning slow growth until 2013. This 2-year forecast adds a bit more seriousness to the situation. And while the low-rate pledge is supportive at this moment, I think it will need to be augmented by some other form of easing measures in order to keep investor sentiment from eroding.

    In other words, look for this rally to peter out in a matter of days. A 1250 target on the S&P 500 seems like a reasonable topping point ... as long as 1200 and 1230 don’t get in the way:

    Currency Currents

    If it means anything to you, Goldman Sachs seems to agree. They now expect QE3 is more likely than not.

    We now see a greater-than-even chance that the FOMC will resume quantitative easing later this year or in early 2012. We have changed our call because today's statement suggests that the committee's reaction function to incoming economic news is more dovish than we had previously thought. Although Fed officials still expect a gradual decline in the unemployment rate, they made a conditional commitment to keep the funds rate unchanged "at least through mid-2013" and implied that they would employ additional policy tools in case their economic forecast deteriorated further. This would probably mean more QE if their forecast converged to our own modal view of a flat-to-higher unemployment rate through the end of 2012, let alone our downside risk case of a renewed recession.

    GS agrees with me; or I with them. And that’s all fine and dandy. But I ask again, as we have done many times in the pages of Currency Currents: will QE3 matter?

    Consensus seems to agree that QE1 and QE2 failed to support the real economy but succeeded tremendously in supporting the financial economy and financial markets. I think the consensus also agrees that a QE3 won’t do anything to support the real economy this time around either.

    And to me that represents a legitimate headwind to QE3’s potential effectiveness in propping up the financial markets this time around (i.e. investors realize this time that the economy is going to get worse) ... as it did in rounds past.

    What might impact this expectation for an all-around QE3 failure is the composition of QE3.

    Both QE1 and QE2 consisted of large scale asset purchases (primarily government bonds). Yesterday’s FOMC statement suggested the Fed has multiple tools at its disposal. Of course, the credibility and effectiveness of these “tools” are immediately suspect ... since the Fed hasn’t already pulled them from the toolbox. But the surprise factor might just be enough to bolster investor sentiment.

    You know how the saying goes:

    “Don’t’ fight the Fed” because their toolbox is bigger than yours.

    Gold Futures and US Dollar Index Futures, daily: low rates until 2013?

    Currency Currents

    Aug 10 11:29 AM | Link | Comment!
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