Bo Peng

The Lurking China Money Deal

Interesting perspective. Chinamerica is a perfect union of convenience for now. They supply the perfect dope for each other in a classic co-dependency. China's addition is growth in manufacturing through export. US' is reflation through consumption and credit. Both sides surely realize it's not a sustainable marriage. Yet, just to survive the day, or so they think, they must keep feeding each other the dope.

If this co-dependency is not rehabilitated willingly, it'd get ugly: US will default, either technically or through a combination of USD devaluation and inflation. China will get burned badly and become increasingly suspicious and indignant. USD will not be able to maintain the reserve currency status.

Today's official onset of monetization of debt is an ominous turn of event. It's the last resort, a desperate measure. The US gov is dead set to continue the addiction. For how much longer can they monetize debt before the world find an alternative reserve currency, or at least a basket of them, or perhaps gold + leverage?

Buy gold and TIPS.

Is a Case of Quant Trading Sabotage About to Destroy Goldman Sachs?

"Co-located", with what? Must be the exchange order execution servers. Otherwise network latency alone could easily put you beyond the microsecond timescale.

In other words, GS prog trading orders don't go through the internet to reach the exchanges, but rather just one ethernet router away.

The physical proximity has to be a critical factor to achieving such extreme low-latency.

Is this legal? Does it raise any questions of unfair access or anti-competitive behavior? I don't know. But these could be interesting questions.

Is a Case of Quant Trading Sabotage About to Destroy Goldman Sachs?

Could the reason for GS stopping or at least scaling down their program trading be that they were concerned of potential legal inquiries if/when the secret of their system gets out?

My best guess is it's a massive front-running scheme, which doesn't have to be illegal if done with publicly available data.

The Lurking China Money Deal

What'd happen if all deficit countries start monetizing their own debt at the same time? No impact to fx (as zeroth-order approximation) among the deficit currencies. Surplus countries are screwed. So they'll start monetizing their own debt, too, just to keep their currencies low (in sync with deficit ones). This is what Japanese just did. I think Chinese may do it soon. Whereas monetization of debt used to be the third rail, it'll be standard practice before you know it.

Everybody's happy. Problem solved.

Then it becomes a race to the cliff -- see who can monetize more debt.

China's Economy Isn't in the Same Boat as the 'Developed' World

I'd appreciate if everybody could please try not to turn this into a discussion about political philosophy. I'm not saying it's not a fascinating, worthy topic; it's just that this is not the proper platform.

And, please, no nationalist or xenophobic rants.

Thank you.

The Lurking China Money Deal

beenburnedtwice, in theory, yes, the Chinamerica co-dependency could be broken without severe withdrawal reaction.

Americans need to save more, break out of the entitlement culture, and do more real work -- like make some shit, more than just hi-tech. A society with 60% middle class hiring people to mow the lawn and vacuum the floor is simply not sustainable without systematic, sustained exploitation of the rest of the world. But the rest of the world is waking up, smarting up, and catching up. We started with slaves. We're still living on slaves, only the plantation owners are now "middle class", labor unions, and big corporations (and that slavery is soft, indirect, and more subtle). But the world is beginning to run out of slaves.

Chinese need to continue transforming their economic structure, expand the service sector and become more innovation-driven.

In short, they need to become a little more like each other. But it takes time -- years, maybe decades. In China, I at least see the political will to continue transforming, easing out of the addiction. In US, I really doubt we have the will to do the necessary. We just want to prolong the high. Life without slaves and entitlements is like, so, third-worldly. As if.

Co-dependency per se is not a bad thing. It prevents us from hurting ourselves by screwing the other. But this particular one is just not healthy, not sustainable.

VIX Nearing 20: Who Cares?

"In terms of volatility, we are right at the VIX’s lifetime moving average, which means investors are pricing in an average amount of risk and uncertainty – in historical terms – at the moment."

From the fundamental point of view, do you believe the current risk in the economic/financial system is right about the historical average over the past 20 years?

We're right in the middle of a bubble.

Annihilate the Perverse Effect of CDS on Bondholders

viewfromnyc, I think you misunderstood what I was saying. I was not saying CDS seller should share the bond recovery. That would change the nature of the product. I was saying CDS seller takes on credit risk of the issuer while the buyer transfers out of the credit risk, therefore in bankruptcy court the bondholder's representation should reflect her real credit risk exposure after accounting for the hedge.

In normal times, bondholders of course would like to get coupon payments. In distressed situation, however, yield goes to 30% and bondholder is faced with the choice of taking the capital loss by selling on the secondary market or taking the significant default risk by holding on to the paper. In good'ol times, these are the only two choices. So she's very incentivized to help saving the company. Now she just buys CDS and, all of a sudden, bankruptcy becomes at worst a non-event, roughly equivalent to if the company spring back to health and bond goes back to par or if the company drags on in despair.

DIP financing used to be an important life saver for companies in Chapter 11. Shareholders used to aligned with the company. Now with hedging, people can have zero exposure, yet still retain their voting rights. This is absurd. Hedging is perfectly fine. It's the bankruptcy court and shareholder meetings that have fallen behind times and produced the absurdity.

U.S. Dollar Can and Will Drop

Excellent analysis, Stephen. The race to the cliff -- competitive QE -- is just waiting for the sound of next shoe dropping.

In a way it's unfair to US. UK and Japan started it way earlier. But once Fed did it, now the moral inhibition against QE has disappeared. Instead of being the last resort, the world will consider QE the first choice when the next crisis trigger event hits, if only to protect their self-interest. A classic example of Prisoner's Dilemma.

Five Ways This Bubble May End

Ricard, I think I've answered your question of "bank fails then what" question before. I see that you're not convinced. ;>

Bank fails. Deposit is saved. Commercial banking part remains public if possible. Investment banking part is taken over by gov and then sold to private partners ASAP. We go back to the old Wall Street model that had worked quite well for about two centuries. Counterparty risk chain reaction is unlikely as demonstrated by the non-event of Lehman CDS settlement.

My point is, too big to fail means it's too big, therefore needs to be broken down. Instead, the gov (not just US gov) is making them even bigger.

China's First Step Towards Bilateral Currency Swaps

Over the time horizon of 10-20 years, I think the end of USD as the sole reserve currency is almost a certainty. Rather than putting up a futile fight or staying in denial, US could instead try to prepare for and take advantage of it. For example, a devalued USD can have many positive effects on US economy -- jobs, export. But it's something we're not used to, thus appears scary. It takes a change in mentality to adapt to it.

Can We Go Back to the Old Wall Street?

Ricard,
There's very little cost if we
1. separate commercial banks from investment banks
2. let investment banks fail -- and fail they will
3. nationalize investment banks
4. set up RTC for investment banks
5. auction off investment banks to private partners more or less right away
6. auction off RTC assets in a few years (hold some to maturity)

U.S. Dollar Can and Will Drop

I'd like to add one point: as a commenter pointed out, USD devaluing is not all negative. It could stimulate jobs and export. But such a transition would require a fundamental transformation of global finance and trade, as well as the economic structure in the US. Abrupt changes would be disruptive and even destructive. After Fed's QE, the chance of abrupt USD devaluation some time within the next year or so has increased dramatically.

China's Economy Isn't in the Same Boat as the 'Developed' World

Ricard, you raised a good point. Unfortunately, I have no anecdotal evidence to say either way on it, not to mention data, which I doubt anybody has. I guess we'll have to wait and see.

Billy Gee, I tried to stay away from anything that might be used to stoke protectionist sentiment but I have to make an exception for you because your comment on Chinese government bureaucrats involved in "import stifling" goes beyond ignorance. One important factor in chronic trade imbalance between US and China is the fact that US government prohibits export of many hi-tech products to China. This is xenophobia thinly veiled behind phony ideology arguments that have been outdated since 30 years ago. National security can be a valid concern. But it needs balance and scrutiny. The list of prohibited export to China was arbitrarily drawn up by politicians two decades ago with no public debate. It has denied many American businesses tremendous opportunities and caused a lot of distrust and suspicion towards US among certain segments of Chinese society. This is stupidity beyond comprehension as far as I'm concerned.

China's Economy Isn't in the Same Boat as the 'Developed' World

Socialism cannot compete! :
>>Then a) you admit China isn't a "developed" country? And b) why would I invest in an undeveloped country right now?

Whoever told you China is even close to a developed country was pulling your legs. ;> Parts of the few modern urban centers look are fantastic, even authentic in many ways. And the improvement in overall living standard as well as the general sense of satisfaction/content over the past 20-30 years -- and yes, even the political scene -- is nothing short of astonishing. But no, it'd take more than a generation to transform a country of 1.3B people from an almost complete lack of industrial foundation into a "developed" country, no matter how you define "developed".

As paultaut answered above, this (plus my basic stability view) makes China a potential outperformer in investment. Even today, 1.5 years into the subprime crisis and full half year into the global crisis, only the R in BRIC looks somewhat shaky. BIC is still burning strong.