Things have been a little erratic lately here in US, but not really headline-worthy.
The economy continues to grow, sort of, houses continue to sell and stock
and bond prices fluctuate but can't seem to follow through in either direction.
We are not, in short, engulfed in any kind of crisis.
But out in the world, especially in once-hot emerging markets like Brazil
and China, the story is very different. As Prudent Bear's Doug Noland explains
in his
most recent Credit Bubble Bulletin:
Meanwhile, the "developing" market Bubble continues to unwind. As leverage
comes out of the commodities, currency "carry trades" and developing stocks
and bonds. And as capital flight becomes a more serious issue, the marketplace
must ponder the consequences not only of what a faltering Bubble means
for scores of markets and economies, there is as well the issue of developing
central banks having to sell from their trove of Treasuries and bunds and
such to finance a surge in outflows ("hot" and otherwise). There's even
this new dynamic where Treasury yields rise on days of global currency
and equity market tumult. It's been awhile...
I suspect that the global jump in yields (and CDS and risk premiums) has
more to do with de-leveraging than it does with tapering worries. This
dynamic has caught many by surprise. The speculators anticipated cleverly
exiting their leveraged MBS and other trades based on their expectations
for Fed policy. Now, there's a tremendous amount of unanticipated market
uncertainty.
Japanese policymakers have really mucked things up. The Nikkei sank 6.5%
Thursday and was down 1.5% for the week. Perhaps it's a little early to
pronounce the BOJ's "shock and awe" monetary experiment a failure. The
yen rallied 3.5% this week against the dollar. Against the Philippine peso
it was up 4.5%, versus the South Korean won 4.1%, the Indian ruppee 4.3%,
the Malaysian ringgit 4.0%, the Indonesian rupiah 3.2%, the Argentine peso
3.9% and the Brazilian real 4.2%. Indonesia raised rates to support its
weak currency. The yen "carry trade" (sell yen and use proceeds to buy
higher-yielding instruments globally) is doling out painful losses - forcing
the unwind of leveraged trades across many markets. I wouldn't be surprised
if the yen short is the largest short position in modern history. The yen
bears are now running for cover - causing all kinds of havoc in the currencies
and securities markets.
"Emerging" Asian markets are in the middle of an unfolding financial storm.
Friday's 2.1% gain cut the Philippine equities loss for the week to 9.2%.
Even with Friday's 4.4% recovery, the Thailand stock exchange ended the
week down 3.4%. South Korea's Kospi dropped another 1.8%.
Latin America is as well caught in troubling dynamics. Brazil's currency
(real) traded to a four-year low against the dollar this week - despite
currency interventions and the removal of taxes on financial flows and
currency derivatives. Brazilian equities were hit for 4.4% this week, increasing
y-t-d losses to 19.1%. Mexican stocks dropped 2.4%, boosting y-t-d losses
to 10.2%.
The Shanghai composite dropped 2.2% in a holiday-shortened week. China
pegs its currency to the U.S. dollar, so we can't look to the performance
of the renminbi for much of an indication of flows or mounting financial
market stress.
I have posited that China is in the midst of an historic Credit Bubble.
I have over the years tried to explain how interrelated their Bubble is
to ours. Our mismanagement of the world's reserve currency led to 20 years
of huge Current Account Deficits. A significant portion of the Trillions
of associated IOU's have made it onto the balance sheet of the People's
Bank of China, especially over recent years. And no Credit system and economy
has gone to greater excess during the post-2008 global reflation. It was
the "fledgling" Credit Bubble spurred to "terminal phase" excess.
If the "developing" economy Bubble has passed an important inflection point,
then China is vulnerable. If "hot money" is leaving EM [emerging markets]
then China should be susceptible. And, let there be no doubt, when China
finally succumbs global economic prospects really dim - and prospects for
some fellow EM economies turn downright dismal. Recall how the tightening
of subprime finance gravitated to "Alt-A" and then worked its way to the "conventional" core.
And when housing in general began to falter the bottom fell out of subprime.
This week provided a bevy of notable China-related headlines: From the
Financial Times: "China Debt Auction Failure Raises Liquidity Fears;" "Fresh
Data Highlight China's Sluggish Growth." From Bloomberg: "China Debt Sale
Fails for First Time in 23 Months on Cash Crunch;" "China Local Debt Audit
'Credit Negative,' Moody's Says;" "China's Leaders Face Test of Growth
Resolve After May Slowdown;" "China Export Growth Plummets Amid Fake-Shipment
Crackdown." From Reuters: "Fitch Warns on Risks from Shadow Banking in
China;" "China Estimates Fake Trade Invoicing at $75 billion in Jan-April;" "China
State Auditor Warns Over Local Government Debt Levels."
The price of Chinese sovereign Credit default swap (CDS) "insurance" jumped
from 92 to 113 in three sessions, before dropping back down to 98 on Friday.
Chinese interbank lending rates have recently spiked higher - and there
were even reports of several borrowers forced to pay up for increasingly
scarce liquidity. There were debt auctions that did not go smoothly. The
currency forwards market is showing some atypical downward pressure on
the renminbi.
Many believe this newfound tightness in Chinese money markets can be easily
resolved by liquidity injections from the People's Bank of China. And perhaps
Chinese monetary and economic managers still have things under control.
If so, the same clearly cannot be said for many of their fellow "developing" policymakers.
Capital flight is always extremely difficult to manage. I worry that the
world has never faced the possibility for such destabilizing flows and
speculative de-leveraging. To be sure, global markets have never been as
dependent upon the power of central bankers. And in my mental tallies of
risk and complacency, I never envisaged they could so elevate in tandem.
So can the US stay placid when the rest of the world turns chaotic? Highly
doubtful. There's a market phenomenon in which one investment play blows up
and forces those on the wrong side of the trade to dump their liquid assets
to raise cash. Which causes the high-quality assets to fall as much or more
than the junk. As Noland notes, the world's premier liquid asset is the Treasury
bond.
If the developing world's need to raise cash is a factor in the recent spike
in US interest rates, this implies a feedback loop in which rising US rates
further destabilize emerging markets, forcing the sale of more Treasuries,
and so on. Can the Fed stop this? Not unless it wants to buy up not just the
newly-issued Treasuries as it does now, but the trillions of dollars of bonds
that might be dumped once things really get going.
It's important to understand that we're here because for years the developed
world in general and the US in particular have been exporting their problems
to the developing world via monetary policy. We fund our overspending by creating
a bunch of new dollars, many of which flow beyond our borders looking for
higher yields. They land in, say, Brazil, pushing up both local asset prices
and the exchange rate of the real. So individual Brazilians see their cost
of living rise while Brazilian exporters are priced out of global markets.
This is the currency war that Brazil's government has been complaining about.
Then the hot money flows back out, causing a different set of problems for
a country that has spent the past decade trying to adjust to excessive capital
inflows. The result: some seriously fragile banks and over-leveraged companies
and investors, any of which could trigger a nationwide crisis.
The same general process is at work in other major emerging markets, with
each in its own way now posing a threat to the global financial system --
at the pinnacle of which sit the S&P 500 and the Treasury market, looking
an awful lot like Southern California real estate circa 2007.
