Running away from a charging bear, you don’t have to be faster than the bear; just faster than the slowest person running from the bear. Or so runs the age-old aphorism.
US politicians, particularly those at present in government, have taken this idiom to heart in more ways than one. Treasury Secretary Henry Paulson is busy telling everyone who will listen that the US will rebound faster than other economies forming the Group of Seven of leading industrialized nations; an observation that I am not personally in disagreement with as my recent articles on Europe (see Utterly pointless Europe, Asia Times Online, August 16, 2008) and Japan (see Asian economies meet gravity, Asia Times Online, August 22, 2008) have highlighted.
US data on Thursday showed better-than-expected second-quarter growth, although much of this was due to a one-off tax rebate that provided consumers with the illusion of having a bit more money in their pockets. True to form, Americans may have decided to use the rebate to buy the latest Blu-ray DVD player rather than top up their retirement pensions; then again, the depth of the hole in the latter was probably too much for most of them to even bother addressing.
In any event, Asian makers of electronics benefited from the American government’s largesse. Alongside though, data from Europe pertaining to both growth and inflation has remained steadily weak. In turn, this has led to a broad underperformance of financial markets in Europe relative to other areas. American manufacturers in specific areas such as capital goods have also used the decline in the US dollar to compete with their European counterparts.
However, markets look at the future even as they consider recent data. It is here that the case for US equities fails. The consumer is completely strapped out, and without the ability to secure credit from banks – which are constrained both by access to financing and capital losses – there is little chance that any upturn in demand will follow.
While it is right to assume that US exporters would perform better over the near-term, their overall position in the economy isn’t big enough to really matter for the direction of financial markets. Meanwhile, the contribution of European exporters to their economy will only rise because of demographic factors – Europeans being too old to buy anything but dentures – and it is here that a rebounding America and cheaper Asia are killing them off.
Stimulus – lying or testing?
A report by an American investment bank’s Hong Kong office on August 19 alluded to the possibility of a Chinese stimulus; the release of the report immediately caused a jump in Chinese stock markets on August 20 with the Shanghai Composite rising 7.6% on the day, from 2,344 to 2,523. A few days hence, as of the 28th, the market closed at 2,350, with the analyst having to declare in a press conference that the report was based on his own research and not on any leaks from the government.
Outright, we can discount the idea that any report about specific policy actions in China could be based on independent research; the opacity of the government and conflicting policy objectives of different power groups (for example the central bank and the commerce ministry) make that trajectory impossible. On the contrary, the report would be more useful to investors if it were based on a government leak. Two possibilities exist for this situation; firstly that a government official sent out a trial balloon, and secondly that a game of bluff was underway.
It is no secret that Chinese authorities are deeply embarrassed by the poor performance of their stock market this year, with the decline of 54% (51% in US dollar terms) outstripping the losses of even minnow economies like Vietnam (41% down), Pakistan (36% down) and the Philippines (25% down), despite the greater-than-10% growth all year. Even accounting for the fact that the decline follows years of strong performance, the correction has clearly gone well beyond anything that was expected at the beginning of the year when the government sought to cool the economy.
As I wrote a while ago (see India 1, China 0, Asia Times Online, Mar 3, 2007), Chinese policymakers have shown a penchant for poor decisions, backtracking and general confusion. This is thanks to the stunning absence of leadership from President Hu Jintao, whose reform credentials are non-existent in a period of economic performance that demanded the greatest such initiatives from him. Given this absence, it seems all too likely that vested interests take center stage and provide greater confusion for investors.
The recently concluded successful Beijing Olympics may also have diverted attention from important matters – indeed, in the middle of the “ugly girl” scandal for the opening ceremony, it was revealed that the decision came in a senior government level meeting, perhaps even at the Politburo. Irrespective of what you think of the scandal itself – I am personally disgusted by it – it boggles the mind that senior government functionaries in a US$2.5 trillion economy had the time to sit around talking about the ideal girl on stage. Perhaps the agenda item for the next Politburo meeting includes a discussion on the ideal cut of the swimsuits for female athletes in the 2012 Olympics.
Thus it is that the combination of policy confusion and lack of responsibility send conflicting signals to investors, which will dent confidence and provide the basis for an economic slowdown far sharper than intended by the government. Meanwhile, junior functionaries appear to be making statements that help to push the markets in one direction or the other, to buttress their own specific agenda items.
Private sector fibs
Not to be left behind in the battle of the lies, the private sector has also jumped into the fray. First up are the two US mortgage agencies, Fannie Mae and Freddie Mac (see And now for Fannie and Freddie, Asia Times Online, July 12, 2008) who have been at great pain to convince investors that they would survive to the next year with their current hoard of capital and cash.
Considering this in greater detail, doesn’t it really bother anyone that the entities that are supposed to be permanent fixtures of the US economy are even talking about mundane existential worries over the relatively short-term? There is a fierce ongoing debate between the likes of former Federal Reserve chairman Alan Greenspan, who would like these agencies dismembered – a course of action I also favor – and others in the US government who would like to see the status quo maintained.
To demonstrate their viability, the agencies have continued to raise debt, with the $3 billion raised this week, mainly from Asian and Russian central banks, being shown as proof of their continued access to capital markets. It is not the least ironic that the only investors to help the US agencies are the very governments that seek accommodation in other matters of US policy?
Temasek Holdings, an investment arm of the Singapore government, this week found itself in the position of actually having to express confidence in John Thain, the head of Merrill Lynch. This follows a disastrous multi-billion dollar investment in Merrill by Singaporeans. With the most recent capital raising done by Merrill denting market confidence in Thain – he had promised barely a few weeks ago that there was no need for Merrill to raise additional capital – it then become important for Temasek to issue the statement.
The statement is Exhibit A in the attempt by Asian central banks and government-backed investors to justify to their stakeholders the merits of their strategy in propping up the US financial system. As I have written before on the subject, investing in the US financial system remains the easiest way to lose money, even in the present market when opportunities to lose money lurk at every turn.
Then there is Lehman Brothers. While I wouldn’t presume to have done any extensive analysis of the company, it appears to me from looking at variables such as share prices, funding costs and news flow that the investment bank is in deep trouble; perhaps even of the existential kind.
Taking a leaf from the practices of other investment banks facing such as quandary, Lehman this week quickly unveiled a potential saviour in the form of Korea Development Bank (KDB), a government-owned bank in South Korea that is itself in the midst of a privatization that will see it becoming a more-focused investment bank in the country. The primary reason for such an expression of interest appears to be that KDB’s current head used to work for Lehman.
The difficulty here though is to figure out which of the two parties stands to benefit from a statement that for all intent and purposes appears quite distant from reality. While it is tempting to think that Lehman has more to gain – time given by new capital that can be used to take more losses and cut employees – KDB also benefits in more subtle ways, in its battle to determine the terms of privatization.
KDB has been a monolithic financial institution in Korea for a long time, a mini-system within the financial system, with a wide-ranging mandate that gave it unprecedented access to cheap funds, long-term assets and excellent career paths for its employees. With privatization, many of these advantages would be dented.
Announcing an interest to buy a bank such as Lehman would present the government with a quandary because of a government lack of familiarity with risky investments (especially seeing how poorly other such sovereign investments from Asia have done); but it also spins KDB away from the government orbit. In effect, the leadership of KDB is staring down government officials, demanding to know if they would support the idea of KDB becoming a global financial institution or would they get scared of the potential cost of failure to the taxpayers.
As games of bluff go, this one really does take the cake.