Category Archives: Balance of Payments

S&P revises its outlook for T-bonds from stable to negative

April 19, 2011 By in Balance of Payments, government debt trap, Strategy Tags: , , , , , , , , , , , Leave a comment

The S&P announcement

Yesterday the rating agency issued a new “unsolicited” opinion (meaning it wasn’t hired by the US to do so) on US government debt.  While retaining its current AAA rating for Treasuries, S&P has revised down its outlook for the country’s long-terms obligations from stable to negative.

What does this mean?

“Negative” means S&P thinks there’s at least a one in three chance of a credit downgrade within the next two years.

S&P’s reasoning?

The factors S&P considers most important are:

–deterioration of the US fiscal position over the past decade

–damage done by the financial crisis and ensuing recession

–inability of Washington to agree over the past two years on a plan to address these issues

–the “significant risk” that nothing will be done before the election in November 2012.

Although S&P (like everyone else) regards unfunded entitlement programs Social Security and Medicare/Medicaid as the main sources of budgetary woes, it points out that the country may also have to cough up another $685 billion to recapitalize Fannie Mae and Freddie Mac.  S&P observes, as well, that much of the US sovereign debt is concentrated in the hands of a small number of foreign governments, raising the possibility that one or more might change their minds.

be careful what you wish for

It wasn’t that long ago that Congress was lambasting the rating agencies for not being proactive enough in downgrading the exotic credit instruments spewed out by Wall Street.  Their collapse weakened the national finances and made the deficit a “today” issue rather than one that could be safely be put off.

I wonder how Washington likes proactivity now?

And the S&P raters whose integrity was questioned by Congress wouldn’t be human if they didn’t take a kind of satisfaction in calling attention to the fact that the UK–and even France (?!?)–are further along the path to fiscal responsibility than the US.

what happens next?

A lot depends.  I don’t think there’s much anyone can say for sure.

For one thing, not everyone agrees that the S&P analysis is correct.  For example, a comment popped into my inbox at about 6pm on Monday from Jim Paulsen, the chief economist for Wells Capital, arguing that the deficit is primarily cyclical.

It seems to me, though, that the S&P announcement puts additional pressure on elected officials to cooperate with one another.  That pressure would increase if, say, Moodys, were to follow the S&P lead and say something similar.  The debate on raising the federal debt ceiling will give an almost immediate indication of whether the Democrats and Republicans can work together.

No matter what, my guess is that the S&P announcement will turn out to be a significant turning point for US government finances.  Despite the dollar being the world’s reserve currency, I think the days of Washington just willy-nilly issuing news bonds are coming to an end–sort of like maxing out an almost infinite credit line.

Also, if past form holds true (and I think it will), domestic borrowers–not foreigners–would be the first to desert the Treasury market in large numbers.  This means that worry about Treasuries will express itself initially, and primarily, through higher interest rates, not a weaker currency.  Only if the situation becomes really ugly will the dollar come under significant pressure.

From an overall economic perspective, I find the “hidden” loss of wealth through currency depreciation to have worse negative effects than adjustment through higher interest rates and a slower economy.  From a stock market point of view, however, it’s much easier to devise a money-making strategy in a weak currency environment than in a high interest rate one.

Stay tuned.



G-7 intervention to stop the yen’s rise: will it work?

March 18, 2011 By in Balance of Payments, comparative advantage, currency effects, Current Market Thoughts, J-curve, Japanese development, Purchasing power parity (PPP) Tags: , , , , , , , , , Leave a comment

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Please take my survey.  Thanks to everyone who has done so already.  If you haven’t yet, I’d appreciate it if you’d do so.  It’s brief, anonymous and will help me focus future posts.

PSI reader survey.

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Will G-7 intervention work?

Yesterday, the G-7 group of major industrial countries announced plans for coordinated intervention in the foreign exchange markets in order to halt the rise of the yen against the currencies of other developed nations.  In the wake of last week’s earthquake and tsunamis, the yen had risen by about 5% against the dollar.  Will the G-7 be successful?

The short answer is “…most likely, no.”

How so?

The main reason is that the major international commercial banks, who are the main forces in the global currency markets, are far larger and have greater financial resources than national governments do.  That might not have been true twenty-five or thirty years ago, but it is today.  Even the G-7 nations acting together don’t have the financial firepower to oppose a concerted move by the banks.  In the past, it hasn’t helped either that governments have typically tried to defend currency values that were politically attractive but economically unsound.

Japan the most skillful government player

I’ve been watching the currency markets as a global investor for over twenty-five years.  Over that time, the country that, to my mind, has the best record in influencing the direction of its currency is the Japan.  Understanding it can’t oppose the banks directly, it has waited until a wave of speculation has almost exhausted itself and then applied enough pressure to send the yen in the opposite direction.

Japan’s present stance is a curious one, though.  The current administration in Tokyo, the Democratic Party of Japan, came into office with the intention of reversing the long-standing (and very outdated) policy of the Liberal Democratic Party of always aiming to weaken the yen in order to help the prospects of export-oriented industries.  Nevertheless, when the original DPJ finance minister tried to enforce the new policy, he was replaced with someone more willing to cater to the Keidanren.  The new minister immediately began selling the yen in what I saw as simply a wasteful attempt to establish his pro-industry bona fides.  That was Naoto Kan, who is now the prime minister.  Who knows what he’ll do now.

A second curious aspect of the situation today is that there’s no good reason for the yen to be a strong currency.  The country’s workforce is shrinking.  The government is ineffective and heavily in debt.  The budget is in deficit.  And the country hasn’t shown any real growth in over twenty years.  Japan’s most “positive” feature  vs. the euro or the dollar is that it’s a known quantity and has less near-term potential for negative economic developments than the EU or the US.

Why has the yen been rising, then?  After the Kobe earthquake in 1995, Japan repatriated large amounts of money invested abroad.  Insurance companies needed funds to pay claims.  Parties–individual or corporate–who had no third-party insurance needed money to rebuild.  this activity drove the yen up by about 20% against the dollar in the months following the earthquake.  It’s probably too soon for this to be happening again.  The yen probably started to rise early this week as speculators began to bet the same thing would happen again.

Interestingly, the yen gave back almost all its gains as soon as the G-7 announced its plans and Tokyo was seen selling the yen aggressively in the currency markets.  To me, this suggests that the big players in the market haven’t decided what to do yet.  In the end, though, it will be the banks, not the G-7, that decide whether the yen strengthens or not.

investment implications

What’s the significance of a rise in the yen for investors?

An appreciating currency has two effects:

–it slows economic growth in local currency terms, and

–it reorients what economic energy there is–away from export-oriented industries, and toward domestic-oriented firms and importers.

If you were investing in Japan and thought the yen would rise, you would overweight domestic firms and underweight exporters and other companies with large foreign-currency exposure.  But the most sensible thing for most people to do, as I suggested a couple of days ago, is just to stay away.  (I own two social networking stocks in Japan, DeNA and its smaller competitor, Gree.  For now, I’m keeping them both.  These are youth-culture special situation stocks that are growing very fast, so I think they’ll be relatively unaffected by problems in the overall economy.  But I wouldn’t advise anyone to follow my lead.)

China’s trans-Colombian railroad proposal: good for Latin America

February 16, 2011 By in Balance of Payments, China, economics, emerging markets, Strategy Tags: , , , , , , , 1 Comment

Railroad Tycoon

Sid Meier’s Railroad Tycoon has always been one of my favorite video games.  I wasn’t particularly good at it (it took too much time), but the idea was to build a corporate railroad empire in the US during some period in history.  In addition to laying your own track and building your own depots and stations, you could also own the raw materials providers that depended on rail transport, as well as the processing plants that turned these inputs into finished goods.  You could also buy out your competitors’ empires by astute stock market dealing.

Sino-Colombian projects

Someone high up in the Beijing government must also be a Sid Meier fan.  The president of Colombia, Juan Manuel Santos, in an interview with the Financial Times, says that his country is in advanced talks with China about constructing a 130-mile rail line running through Colombia connecting the Atlantic and Pacific coasts.  Combined with a new port to be built on the Atlantic side, the project would serve as an alternative to the Panama Canal.

Talks are farther along than this on another Sino-Colombian project, which would expand the Pacific port of Buenaventura and build another 450 or so miles of track that would speed the flow of Colombian coal to the Pacific, and to China in particular.

what’s at stake

What does Colombia gain from such deals?  …in the first instance, modern infrastructure and access to the Pacific Basin to market its natural resources (most of its existing rail capacity reaches toward the Atlantic), without much spending of its own (Colombia’s idea is to use build-operate-transfer concessions, in which China will make the capital outlays in return for the right to operate the ports and rail lines for a specified period of time).

And China?  …goodwill; access to Colombian coal; the possibility of extending the rail network into Venezuela, where it is developing extensive oilfields; a way to get around the potential bottleneck caused by restrictive work practices at the Los Angeles area ports.

more

Is there more?  Yes.

Much as a generation ago foreign firms used the UK as a jumping off point for the rest of the EU, Colombia may play the same role for China in the Americas.  One could see a reverse flow to the natural resources traffic that would be headed to Asia–components shipped from China to Colombia for final assembly, to be sent from there to the rest of Latin America–and potentially to the Us and Canada as well.

For its part, Colombia is worried about catching the “Dutch disease,” meaning the economic distortions that excessive reliance on natural resources creates.  With about half its citizens living below the poverty line and per capita GDP not much higher than China’s, Colombia would welcome the economic oomph that being China’s entrepôt to the Americans would bring.

where the US stands

Politically, the US may consider stronger China-Colombia ties to be a blow to its prestige.  On the other hand, Washington is one of the biggest catalysts behind China’s moves.  I don’t mean the AFL-CIO’s success since 2006 in blocking a bilateral trade deal with Colombia (which would result mostly in Colombia dropping its taxes on goods exported from the US–go figure that one out!), however.

Just as it did with Japan a quarter-century ago, Washington is vetoing any direct investment from China on “national security” grounds, effectively preventing Beijing from spending its huge dollar holdings on anything other than more Treasury bonds.  China is also interpreting (correctly, in my opinion) the unwillingness of Washington to tackle the three largest sources of government spending–the military, Medicare and Social Security–as evidence the US has no real commitment to preserving the purchasing power of the dollar.  So Beijing shouldn’t have a particularly high investment hurdle to beat–just not losing money would be enough–in considering projects like those in Colombia.

what should an investor do?

From an investment point of view, I don’t think there’s any need to rush out today and buy Colombian stocks (I don’t even know in practical terms how open the market, soon to merge with Chile’s and Peru’s bourses, is to foreigners).  But that country seems to  me to be the clear long-term winner from these developments.  It may well also be that one or more of the Chinese port companies, which I think are attractive on their present merits, will end up with a significant Colombian exposure.

Washington and technology transfer

February 8, 2011 By in Balance of Payments, Dividends, economics, employment, Uncategorized Tags: , , , , , , Leave a comment

an important distinction

In an increasingly globalized world, it’s crucial for investors to keep a basic distinction in mind. It’s the difference between who owns a business and where the money-making activities are located.

for Wall Street

For a stock market investor, the more important issue is whether the company whose stock he holds is making profit gains, not whether the factory whose sales produce these increases is in the US or China.  In fact–something I think Wall Street. with its fixation on domestic economic statistics, is only beginning to grasp–half the revenues, and likely a larger share of profits and profit growth, of the S&P 500 come from outside the US.

In the longer run, of course, there will be negative consequences for the stock market in the US if unemployment remains at 9%.  Why?  This is a social problem that Washington will try to “fix”.  The Fed is already attempting to do so, with the further monetary easing dubbed QE II.  Not that any US citizen needs to be reminded, but Washington also “helped” the country by bringing us from budget surplus to deficit during the past decade, committing us to wars in Iraq and Afghanistan and creating the Fannie Mae and Freddie Mac messes.  It’s also kept corporate taxes high enough that most multinationals don’t repatriate their foreign cash, making that money unavailable for reinvestment in the US or payment of dividends to shareholders.

for Main Street

For a political policymaker, on the other hand, especially with 9%+ of the workforce unemployed, I would have thought that having new jobs located in the US is far more important than trying to make sure the employer is a domestic company.  After all, the fact that all the BMW X3s in the world are made in the US (I found this out in a Super Bowl commercial) is good for domestic employment, even if the company is incorporated in Germany.  Look, too, at the strong growth of the social networking business in the US, due in good part to investments from DST Global (Russia), Tencent (China), and DeNA and Gree (Japan).  The jobs being created are in the United States, even though the backers are abroad.

That’s not the view form the Potomac, however.

the Obama speech

Yesterday, President Obama made a speech on encouraging economic growth to the US Chamber of Commerce (full text from the Huffington Post). \ As a statement of purpose, the address could easily have been taken from an economics textbook from the 1960s.  Unfortunately for government policy, the world has changed radically since then.

What was the speech missing?  Well, it did allude to the fact that high tax rates were hurting the balance of payments by stopping the flow back home of profits earned abroad by US companies.  And it did mention trying to encourage exports.

But it assumed that an export-oriented economic strategy still makes sense.  Logistics issues aside, it ignored the fact that in today’s world, companies entering a big new foreign market may want their production base closer to their customers. Host countries definitely want that, too, to get the maximum benefit of technology transfer. Tax benefits may also come into play.

It also skipped over the fact that creating advanced manufacturing jobs in the US does nothing for the huge number of structurally unemployed, which is the pressing political/social issue of the day.  And it assumed that the US has a lot to teach the rest of the world, but has nothing to learn in return.  In other words, the idea the the US could benefit from technology transfer appears never to have entered Mr. Obama’s mind.

...a big deal?

Is this a big deal?  Right now, no.  The only real evidence of “protectionist” tendencies in Washington that I can see is last year’s congressional action to up the visa fees that Indian IT outsourcing companies have to pay to bring workers into the US.  Yes, the US will lose tax revenues, domestic IT costs will rise and the Indian firms’ (few) US workers will lose the chance to acquire skills they might use to launch competitor companies.  This is very small potatoes compared with congressional action during the 1980s.  One might also argue that such actions are no longer possible since the Democrats lost of control of the House.

On the other hand, the chances seem slim that Washington will do something constructive on the jobs front using a severely outdated picture of the way economies work.  It certainly won’t make it easy for foreign companies to set up shop here, so that US workers can be trained in new skills.

While this is not a stock market worry for today or tomorrow, someday this closed-mind attitude may catch up with us.  So it’s something to keep in the back of your mind.

 

the size of “gray” income in mainland China: the Wang Xiaolu study

November 22, 2010 By in Asian economic development, Balance of Payments, China, currency effects, Current Market Thoughts, economics, emerging markets, Hong Kong Tags: , , , , , , , Leave a comment

I mentioned in my post from yesterday that in looking over the Li & Fung corporate website, I came across mention in Li & Fung’s 3Q10 China Trade Quarterly of a study by a prominent Chinese economist, Dr. Wang Xiaolu, on the size of the underground, or “gray,” economy in China.  Dr. Wang’s estimate of the gray economy in China in 2008 is RMB 5.4 trillion, or about US$ 815 billion at today’s exchange rate.  That would amount to around 30% of aggregate disposable personal income in the Middle Kingdom–an immense percentage.

The study itself, sponsored by Credit Suisse and a followup to a less extensive earlier analysis using 2005 data, can be found on Scribd.

Dr. Wang’s conclusions

Based on 2008 data:

1.  official average per capita income of the top 10% of wage earners in China =  Rmb 43614 (US$6580)   actual income = Rmb 139,000 (US$20,950).

official income of next 10% = Rmb 26500 (US$3990)     actual income = Rmb 54900 (US$8275).

2.  Two-thirds of the gray income is in the hands of the top 10% of the population.

3.  Official figures substantially underestimate income inequality in China, which is in fact even worse than in the US.  On Dr. Wang’s numbers,

–51.9% of disposable income is in the hands of the top 10% of Chinese earners  vs.  47.2% in the US

–7.8% of income is in the hands of the bottom 40% of Chinese earners  vs.  9.6% in the US.

what is “gray” income?

Gray income is money received in exchange for goods and services that is not reported to the government and on which no tax is paid.  Dr. Wang clearly seems to me to be a reformer who wants to call attention to systematic abuse of power by high-ranking officials.  His examples of gray money all seem to revolve around this issue.

His examples include the semi-legal, like:

–excessive bonuses or perquisites for high officers of government-owned enterprises, or

–excessive wedding gifts to the children of politically powerful parents.

They also include the illegal, such as:

–bribes paid to public officials

–excessive costs in public construction

–government officials profiting from land sales they control

–stock manipulation.

Dr. Wang’s methodology

his reasoning

Dr. Wang points out that official statistics on income are derived from interviews from a random sample of Chinese citizens.  Participation in the surveys is voluntary, however .  Dr. Wang maintains that:

1) all citizens questioned under report their income, and

2) many high-income people contacted decline to participate.

Together, these factors create a systematic downward bias to the official numbers.

an illustration

Dr. Wang illustrates that the official figures cannot be correct by pointing out that one can use them to conclude that Chinese citizens saved, in the aggregate, Rmb 3.5 trillion in 2008.  But data from other sources that show the increase in personal bank savings, private property purchases, and private buying of bonds and stock IPOs–in other words, that act as a proxy for the actual amount of money citizens saved during the year–total to over Rmb 11 trillion!

how Dr. Wang proceeded

In general outline,

–Dr. Wang trained a cadre of interviewers and developed a questionnaire intended to develop detailed information about expenditures on necessities like food and, in a more subtle way than the government’s survey, inquire about income.

–He created a list of potential interviewees from the friends and acquaintances of his interviewers, and selected  a subset of about 5000 of these to be actually interviewed.

–Post interview, the questioners graded the survey questionnaire based on their judgment as to the completeness and truthfulness of the answers, rejecting a bit less than 20% of the questionnaires on these grounds.

–He used the data collected from the remaining 4000+ to generate an Engel coefficient for China, that is, a relationship between expenditure on food and total income.  He then applied this coefficient to the government survey data, on the assumption that the information revealed by interviewees about expenditure on food is relatively correct.

is this scientifically correct?

No.  The biggest issue is that here’s no reason to believe that the friends and acquaintances of Dr. Wang’s interviewers are representative of wage earners in China as a whole.

Also, interviewees in the US tend to be less truthful in person-to-person interviews than in internet or mail (in the old days) surveys.  I don’t know what evidence there is in China.  I also don’t know what evidence there is that the cadre of interviewers is good at telling whether an interviewee is  being honest or not.

is this the best information we can hope for?

Probably yes.

investment implications

Even if Dr. Wang’s results are only directionally correct, they imply that disposable income in China is a quantum leap higher than official figures suggest.

If he’s right that the extra income in concentrated among the wealthiest Chinese citizens, then the market for luxury goods there may be much bigger than is commonly believed.  This would be good news for the Macau casinos and for luxury goods producers around the world–including local brands that may develop.

Severe income inequalities are a potentially politically destabilizing social issue.  This is Dr. Wang’s greatest concern, I think.  As Credit Suisse points out in its report that contains Dr. Wang’s findings, Beijing seems to concur.  It has encouraged/allowed large wage increases for factory workers in eastern China.  And it appears to be signaling it wants workers’ unions to take a greater role in ensuring that workers get a greater share of enterprise profits.

This may also be a big reason the Chinese government is opposed to a one-time large appreciation of the renminbi.  Doing so would simply validate the current, potentially dangerous, income inequalities.  Better, say, to encourage a doubling of workers’ wages over the next five years and allow the resulting demand for foreign goods push up the Chinese currency than to let “hot money” portfolio inflows do the job all at once.

a closing note

Credit Suisse points out that Greater China (the mainland, Hong Kong and Taiwan) already accounts for 28% of Swatch’s sales and 20% of Richemont’s.  Booming watch sales seems to be more evidence for the sharp male skewing of Chinese luxury consumption that Bain points out in its latest annual luxury goods survey (see my posts on Bain).

Credit Suisse’s favorite among the Macau casinos is the Galaxy Entertainment Group (0027:HK), on the idea, prevalent in Hong Kong, that the mass market is the best place to be.  That may well be true, although I’m still a bit skeptical.  But Galaxy appears to me to be the weakest of the casinos, however.  CS also thinks that the stocks of property developers stand to benefit as the world begins to appreciate how much income China has.  Myself, although I really like property stocks, I’d prefer something in financial services.

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