A Cross Eyed Market : Looking London Talking Tokyo



There is a normal correlation between the various financial (listed) markets, which is mathematically/ statistically measurable. Sometimes these correlations break down when different parts of the larger markets see different things. These break-downs are usually temporary, as the market resolves these contradictions and settles down in favor of one view or the other.

Declaimer: This article written was originally in March 2013, and some of the data points may be outdated.

For example, the big thing happening just now in world markets is actually coming from the currency markets. That is the sudden acceleration of money printing by most of the big Central Banks; they may have different reasons for what they are doing, but the overall effect of their combined actions is a massive infusion of monetary liquidity.

Let us go into this phenomenon in some detail. Japan first, because they seem to be at Ground Zero. The last time Japan had 2% inflation (the new BoJ target) in 1994, JGBs were quoting at yields of 6-8%. That was in a situation where Japan still had a Current Account Surplus and Savings Rates running in the low 20s. Today’s Japan has a Current Account Deficit, Chinese/ Korean competition for its exports, and a negative Savings Rate….in short, its Savings Deficit (Fiscal Deficit + CAD – Savings Rate), the amount it must seek from foreigners is a number (% of GDP) approaching the same level as Greece.

Currency markets can see this and have beaten down the Yen some 15%. Abe-economics, the so-called “economic theory” of Shinzo Abe, the new Prime Minister, may find a tombstone next to Hitler-o-politics (a.k.a. Nazism), which tried to improve the world by killing all it found unsuitable. This ‘genetic improvement’ ended up as ‘ethnic cleansing’, a baton that was picked up by many others in subsequent years.

I will not speculate on the exact details of how this will end, but I am reminded of the drunkard who seeks forgiveness for his gambling debts on the grounds that his daughter ‘looks cute’…you see them often at a Delhi traffic signal. What finally happens to them?

At the other end of the Eurasian land mass, the Pound Sterling is doing similar things for not very different reasons. Across the Channel, the Swiss Franc is being determinedly held down for exactly the opposite reasons. The Euro is following Japan down the same abyss, sliding helplessly into a destiny that it cannot change until it changes its own constitution.

In short, the Dollar stands alone, with the Chinese Yuan hanging onto its coattails. This “comeback combination’ is the new Gold, attracting a huge shift in Purchasing Power, which will shake the world in a manner bigger than the 2008 Housing Crisis did. While currency markets can see the contours of the iceberg, the bridge of the Titanic is dancing at the party…

The equity markets are busy ‘seeking yield’, sick of the negative real interest rates in the bond markets. All this new cash infusion is going to end in inflationary ‘growth’, which should see it all getting captured as higher corporate profits, that is the theory. So while currencies will adjust against each other, setting off competitive ‘currency wars’, which will hopefully settle down without a succeeding ‘trade war’, the equity markets will mistakenly assume that all this money will be captured by higher demand, leading to higher profits. That will happen because a deleveraged household sector will resume consumption, but a sluggish job market will hold wages down. Fair enough, but it also assumes that commodities particularly Gold, have exhausted themselves. Oil is going to be driven down by the massive innovations around the corner, especially from shale oil and solar. Other commodities will be held down by the lower energy cost of producing the virgin stuff, or of recycling industries coming back with lower energy costs…..there is some logic to all this. All bubbles start on a real truth and then run ahead of themselves. When inflationary expectations change suddenly, interest rates will spike upward, destroying Govt Balance Sheets and blowing out bond markets. This will hurt an unlikely place: the household savings that have built up in the last 5 years, which are parked in T-bills.

Your grandmother (mine is dead) was having fun in 2008, buying Lehman Brothers stock out of ‘equity withdrawals’ from the zero-interest mortgages that she got from Countrywide Financial. Your Christmas gifts came from the same place, remember? What did she do after that?

At 67, she is the last of the Baby Boomers, managing to hold onto half a job at the retail store where nobody buys anymore…she put her meager savings into (guess what?) T-bills. And since she will need the money over the next 20 years, she chose to buy shorter 3-year tenures.

And who should be at the other end of the deal, but Mr. Bernanke? He sold her 3-year maturities and bought up to 10-to-30-year maturity. Now he needs to keep (long-term) Interest rates low, so corporates (and Govt) can issue bonds with long maturities. Building themselves up for a proper blowout when inflationary expectations change as all this new (Q)e-money starts to move around.

Like a game of Monopoly, when the Bank runs out of money, it issues new cash, starting all the players out again on a new game of chance. The winners of the older game (before the Bank went bust) feel cheated, but they go on with the game, hoping to keep their winning streak. The only thing left at the end of the game is the feeling of being cheated; just a feeling, after all….there are no winners at the end of this, just a merry-go-round that keeps you on a treadmill with a sense of purpose.

The 80-year-old Japanese grandfather spent his time learning TQM, doing all those energetic exercises to prove his corporate loyalty, and building better cars, but lived in a small hole-in-the-wall in Tokyo. He saved all his money to buy a bunk-in-the-wall, only to see it all go down 82% after 1989. He continued to work hard, built even better cars, and put his now-chastened money into Japan Post. This time, his stock of savings did not depreciate….until 2013. At 97 years old, he must be wondering whether it was really good to be Japanese. We (Indians) think so, because we live in similar conditions, without even building that kind of car…

The Americans, however, had a lot of sex. The bankers at least, can’t complain. First, they bought all those Japanese cars, handing over pieces of paper that turned out to be worthless. Then they got the Fed to issue a new e-paper, from which they got to keep their bonuses. This was inflation-protected even as their eventful sex lives gave them a reason to live.

This time too, Wall Street gets to enjoy itself, protected from the inflationary pressures the Fed has set off. Energy costs are (structurally) deflating, even as fear-driven “safe haven” flows from Europe and now Japan seeks US Treasuries. So while the CAD does a structural turnaround, there is no problem in funding the Savings Deficit. Would you rather worry about a blowout in the Japanese bond markets, Spanish bonds, Italian bonds, European bonds, British bonds….jeez, when will they get around to worrying about US bonds?!!!

But for those who look at US equities and decide that therefore, the same can be said for Japanese (equities), or the European and British varieties, please note that God is American. Yes, maybe it IS the end of the commodity cycle, especially those that take energy to produce/ recycle.

Notice that I haven’t come round to India yet, which now needs to be despatched with the limited space available to me. In a country with high structural inflation (coming from food and energy prices), high unemployment, falling savings and investment, and high Fiscal and Current Account Deficits, how do you have high stock markets and low currency depreciation? So are we, like Mr. Rakesh Jhunjhunwala says, in a structural bull market or is it just a manic-depressive Mr. Market that is trying to figure out whom to believe, the US Dollar or the S & P? Do we hear what the currency markets are telling us, or do we ape the American (equity) story, happy without a reason…?!!!

So what now, my friend? Que sera sera, whatever will be, will be…



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