Simon Smelt

Lessons from Central Europe

Textbook example. Excellent, thanks. Lesson is to just get the big decisions right.

Book Review: The House of Dimon, by Patricia Crisafulli

A change from the "criminally insane bankers rape middle America" line.
So, let's see. James Dimon, according to Crisafulli, is the guy who has had key roles at AmeEx, Citbank, and now JP Morgan, and is:
- a great leader
- good with numbers
- risk averse
- pursues a culture of honesty and transparency
- tackles problems early.
So, what went wrong?

If Dimon has even half the qualities attributed to him, then there are five possible reasons why he (and the other Wall St tycoons) failed so drastically:
(a) the crisis was unforseeable
(b) it's all a plot
(c) bounded rationality: he got distracted by all the CEO hoop-la, trusted Greenspan et al, and took his eyes off the core issues
(d) competitive pressures left no alternative but to dance to the music
(e) moral hazard: we're heading over the cliff but the government wants us to keep pumping this garbage and will rescue us; meantime let's make $$$.

We know (a) isn't true and I don't believe (b). Personally, I suspect a mixture of (c), (d), and (e).

Can China Do Without the U.S. Dollar?

If you were right and there is no possible alternative to the U.S. $, then America should stop worrrying and just keep borrowing until the economy comes right. 'Cos nobody has any choice but to accept the US.
But back in the real world, the main actors balance and re-assess their risks all the time. The US has extracted probably near the max from reserve currency status and is now clearly having to adapt its policies to keep its creditors content. Meantime, China is demonstrating that it is exploring many alternatives to the US $ both as store of value and means of exchange. The main protection for the U.S. is that China's elite does very well out of current export arrangements and would be threatened by any big shifts. So, U.S. survival depends on the present regime in Beijing. A more radical regime might decide to enrich its own people (China's phenomenal growth has offered only crumbs to most households) and boost domestic demand rather than export capacity or take the loss on its U.S. savings in order to achieve world domination through collapsing the U.S. economy. Meantime, what were the options of the U.S. government again? Punish China by withholding all those shiny new $$ that China so needs??

On Jul 02 12:24 PM Mad Hedge Fund Trader wrote:

> Not in a million years. Make that ten years. Will people pleeease
> stop incessantly talking about the possibility of China dropping
> the dollar as a reserve currency? What else are they going to use?
> Monopoly money? Taiwanese dollars? Collectable postage stamps? At
> nearly $2 trillion, the Middle Kingdom’s reserves are so enormous
> that no other currency in the world could accommodate the switch,
> and no other security offers the necessary depth and liquidity but
> Treasury bills. Chinese attempts to buy anything in size causes its
> price to immediately skyrocket, such as we saw in the relatively
> Lilliputian commodity markets last year. And really, how like is
> it that China embarks on policies that quickly halve the earnings
> of the country’s exporters, as well as its 30 year hoard of accumulated
> savings? The demise of the dollar has been predicted more often than
> the ditching of Microsoft’s Windows as the global PC operating system,
> and is just as likely. Hate the greenback as much as you like, but
> there just isn’t any other alternative. I have been hearing these
> arguments ever since the US went off the gold standard in 1973. First
> there was a perennial Arab threat to price crude in a basket of currencies.
> Gee, they never seem to complain when the buck is going up. Then
> there was the speculated emergence of the “Yen Block”, in the eighties,
> back when Japan was dominating international trade and the yen was
> bumping up against ¥80 to the dollar. Remember the book “Japan as
> Number One? Ha! Double Ha! Then we got all that European whining
> after the launch of the euro when the weak dollar was everyone’s
> one way trade. Let’s face it, Europeans hate using someone else’s
> currency as the primary reserve instrument. Before the dollar, sterling
> was in widespread use and was equally despised. So rather than waste
> time discussing this issue anymore, let’s talk about something more
> important, like which of those two flies over there will jump off
> the wall first.

Efficient Markets vs. Innovation: No Such Thing as a Free Lunch

Nice argumentation but it overlooks:
(i) The possibility of genuine innovation in financial markets that adds value just like innovation in other markets - to put it another way, markets may be efficient and at the production possibility frontier, but that frontier moves overtime.
(ii) In a complex world, different players have different and changing interests, so there are a galaxy of constantly changing possibilities for e.g. doing pairs of offsets, such as CDS on a bilateral basis.
Your car seller example is odd. The car yard makes its money from margin on sales, not speculating on the inherent value of what it sells. A perfect market would equilibriate prices between yards, but then a perfect market (perfectly informed buyers and sellers, zero price of info) could do away with the need for intermediation. Thus, the presence of intemediaries in financial markets shows they are not perfect, but does not prevent them being efficient within given information costs and market complexities.

What Increased U.S. Savings Means for China

A nice piece of analysis.

Stocks as well as flows are relevant. As China's trade surpluses fall, her accumulated overseas savings will be repatriated, providing an ongoing investment boost to the economy. That investment may be so low quality that it amounts to state sponsored consumption but it can still boost the domestic economy, for a while. One of the negatives is downward pressure on the US $. To put it another way, China's accumulated savings give her some room for manoeuvre.

Southern Europe Banking: The East as a Dry Run for What's to Come

At least Latvia has devaluation as a tool. Spain, Greece and the other Eurozone members don't. So, are you suggesting that Spain needs to reduce its wage costs by 20% relative to Germany? Hard to imagine any government pursuing that path for long.

Multiple Regulatory Agencies

Your own analysis is sophisticated, but let down by citing Peter Levin's "fantastic post". As a sociologist, he doesn't seem to grasp that: (i) money by its nature is fungible, (ii) that financial markets have always been inter-linked and about risk (but also about liquidity), (iii) the critical development with loans was not the integration of previously separate silos but the analysing away of the need for information about the borrower - leading to new forms of scaleability. The history of crashes is in large part about unanticipated linkages and/or weaknesses of new technology. The present crash conforms with this.

JPMorgan Global PMI Report: May Manufacturing Improves Again

Nice coverage, thank you. In terms of a conventional economic cycle, we have reached or are reaching the bottom of the V around the globe. What this doesn't tell us is:
(i) the impact of all the debt that governments are building up to achieve this;
(ii) how much more junk from the financial sector yet has to surface.
V, W or L shaped recovery? Still not clear.

Why Is Oil Creeping Back Up?

Separate out the long term factors from the short term factors to get a clear picture on oil.
Long term maybe there's economic recovery and demand increases, driving oil prices up. Short term, storing excess inventory - including in tankers parked offshore - is expensive, too expensive to wait for the green shoots to blossom.
So, it's a market squeeze with the costs of storage offset by (i) gains in trades against those who've been shorting against the current price AND (ii) by taking future short positions for the time when all that inventory has to be released.

Risking Deflation in the Eurozone

Sure, the prospects for GDP growth, particularly exports, and for further bank risk look grim. But aren't there some countervailing factors in terms of inflation risk? Thus:
a) In "saver" economies, notably Germany, the household sector has some cushion to fall back on (unlike the U.S.), so consumption may prove quite robust
b) The collapse in industry investment, along with the shift toward a more domestically oriented economy, may produce local bottlenecks. The output gap relates to past demand patterns, not future ones.
c) Particularly in the weaker Southern economies, extra supply of debt will tend to drive up interest rates. Asset prices will tend to fall but higher debt servicing costs is an upward price pressure.
d) Ongoing weakness in the banking sector, along with any monetization of debt, may weaken confidence in the government. If some struggling Eurozone governments massively resort to the printing press, there could be contagion.

Germany: Seeing Is Believing, But Stabilizing Is Not Recovering

Great material, thank you.The figures from Germany make it all the more puzzling that the ECB hasn't moved more strongly to lower interest rates in the Eurozone. Or, do you think they are driven by concerns over various European governments' potential monetization of debt?

Is the U.S. Dollar Headed for a Mighty Crash? Part II

Overall, international trade is decreasing - the OECD forecasts by c15% on an annualised basis. Trade transactions used to be mainly in U.S. $ but are decreasingly so, e.g. China's bilateral deals and some move to Euros by the Arab Gulf states. International financial transactions are additionally dwindling as over-stretched banks return to their national base and to basics.

So, the U.S. has a declining share of a declining market for a currency to enable international trade or financial transactions.

In terms of the U.S. $ as a store of wealth and financial asset, China and others are clearly nervous and seeking to diversify. With every government on the planet expanding its debt issuance, there will be plenty of opportunity to diversify away from the U.S. $.

So, declining international demand and expanding supply of U.S $ government assets (bills or bonds). Therefore, price adjustment downward.

Japan's GDP Enters Free Fall, Posting 15.2% YoY Drop in Q1

Great summary, thank you.
Hard to know which are leading and which are lagging indicators amidst such a huge shock.
The resilience of household consumption may well be based on the famously high Japanese savings rate - they have margin. It means that Japan is moving rapidly away from export dependency.
However, as the effects of industry cut-backs work their way through the economy, households may suffer more.

China's Growth Is No Miracle

OK, for the sake of argument, let's accept that China's government - through the banks, SOEs and provincial powers - is making poor quality investment decisions with its stimulus package. But, with high savings, there is no Chinese debt position to exacerbate. And, as the spend is additional to normal, it is not necessarily removing funds from better internal use. It's just money not well spent. What will probably happen is less investment by China in the U.S. as the trade gap shrinks. So, the loser from the poor quality Chinese stimulus package is the U.S.

The danger for China is inflation: lots of spend without increasing productive capacity will lead to inflation somewhere in the system. Higher unemployment should keep down wages - unless the government develops a social welfare system. That would raise reserve wages and thus push up low skill wages, spoiling the whole game for China's elite. Otherwise, inflationary pressures may be expressed in rising asset prices (again).

Extending Medicare: Medical and National Suicide

To cut through the various claims about the terrors of British or Canadian healthcare and keen-ness for a universal system:
1) International studies show the U.S. to spend an above average % of GDP on healthcare and get below average results for an advanced country. By contrast, France gets value for her Euro - a good place to be sick provided you speak French.
2) Extending the benefits of Medicare just builds on a crappy and broke system which the U.S. already cannot afford.
3) Phoney balloney claims to save trillions illustrate that the U.S. health care industry and politicians have no intention of tackling the deep seated problems.

All governments are struggling with managing health care costs but some do better than others. The Israeli approach of universal compulsory contributions (rising with income) to one of a small number of competing insurers and with government top ups seems to me a sensible one.