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Paul Gambles
Co-founder of MBMG Group


Update September 26, 2015

Fed Interest Rate: no rise, no decision, no surprise

The manager’s indecision is final
– Duncan McKenzie about Leeds United manager Jimmy Armfield, 1975

So after all the will they? won’t they? hype, the Federal Reserve has decided not to raise its 0.25% base rate.
Shortly before Fed chair Janet Yellen made the announcement, I was asked what the Fed could do that would shock me. I answered that three things would surprise me: that it would be decisive, show leadership and communicate clearly. There were no surprises at all. As a contact on Twitter, Brad Moseley, put it as the announcement was being made, “If you suffer from insomnia, record Yellen now & play back tonight. Sleep is guaranteed.”
In December 2008, in an attempt to help the economy recover from the global financial crisis, the Fed lowered its base interest rate – the rate at which it lends to banks – from 1% to 0.25%. It has remained there ever since, with the objective of making borrowing for businesses and individuals cheaper and thus stimulating consumption.
Ever get the feeling you’ve been cheated? - Joe Lydon (a.k.a. Johnny Rotten)
The Fed’s base rate has been touted to finally rise at least since March of this year – and several times thereafter.1 Consequently, what should have been a normal scheduled FOMC meeting was turned into a circus by the Fed’s complete loss of control of its message during the previous months (just like the taper tantrum episode2 a couple of years ago).
Early this year it seemed like they would raise some interest rates3 - but none of the rates which matter, in terms of increasing private borrowing/bank funding costs this year.
Then, in March, the Fed started to hint that a real increase was in the offing. This led some commentators to suggest it would come in June; though by May, Janet Yellen had ruled that out but said it would be sometime this year.4
Faking it
At that time it was clear to me that the Fed had talked itself into such a corner over raising rates that, if it didn’t want to lose credibility with the markets, it’d have to do something, even if it didn’t want to. Thus, it looked like the central bank would fake it. They could do that by pushing up a dummy rate like the IOER rate – the interest rate at which the Fed pays banks for depositing excess reserves; or through a base-rate increase undermined by other means, such as continued expansion of the Fed’s balance sheet and/or flattening the yield curve on treasury bonds. The latter tactic is where the Fed offers lower rates on long-term T-bonds, thus reducing the gap between the yields on short-term and long-term, making any change to the base rate less effective.
Then, in late June, came the Chinese stock market meltdown,5 which gave Mrs Yellen et al. the perfect excuse not to raise rates at all – fake or otherwise.
So, over this time the Fed had managed to confuse everyone with comments on patience6, considerable time7, data dependent8 etc. Fundamentally, the Fed had two basic choices - hike or stick. By the 17th September FOMC meeting, they’d managed to get themselves into such a pickle that, whichever one they chose, half the world would freak out.
We are being cheated
The Fed ultimately decided to stick. Not that it matters: whatever choice the Fed made would have been for the wrong reasons anyway. The world is in a major debt deflation, largely created – or at least encouraged by – the Fed, which seems to have been oblivious of this until they got smacked in the face by China’s inability to continue sweeping its problems under the carpet.9
Commentators are seeing this non-decision as throwing China a lifeline at America’s expense.10 But that’s not right either. Using emergency measures as normal policy for 7 years has created massive distortions in developed economies.11 Using extreme stimulus non-stop for so long in China has created the biggest and most widespread bubbles the global economy has ever seen.12
Yellen’s announcement just enables these distortions and bubbles to continue a while longer without being pricked. There’s a creeping sense of unease among markets that the party can’t go on forever.13 The reason that last night was so important was that markets were worried that the Fed would ‘take away the punchbowl’, the distortions would unwind and the People’s Bank of China would be unable to prevent the bubbles bursting.14 It seems to me that the markets were also hoping for some silver bullet that would mean that all the future problems would somehow magically disappear. Last night just resulted in neither any fulfilment of hopes nor any realization of fears. All that has just been put on hold for longer.
You don’t know what you’re doing!
So it seems that we’re no further forwards - we’re still in an environment where policy is all about avoiding having to face the reality. The risk is that the unwinding of distortions will lead to the bursting of global asset bubbles and an extreme crash and depression. Again, all that has been delayed a while longer.
In essence, we’ve all been cheated, not just by last night, not just since Yellen took over the reins, but by the whole Greenspan-Bernanke-Yellen unholy trinity and probably since the Fed was created in 1913. Welcome to Bubbleville!

1 See various articles:,, http://money.cnn .com/2015/06/17/news/economy/federal-reserve-interest-rate-janet-yellen/
14 idem

Please Note: While every effort has been made to ensure that the information contained herein is correct, MBMG Group cannot be held responsible for any errors that may occur. The views of the contributors may not necessarily reflect the house view of MBMG Group. Views and opinions expressed herein may change with market conditions and should not be used in isolation.

MBMG Group is an advisory firm that assists expatriates and locals within the South East Asia Region with services ranging from Investment Advisory, Personal Advisory, Tax Advisory, Corporate Advisory, Insurance Services, Accounting & Auditing Services, Legal Services, Estate Planning and Property Solutions. For more information: Tel: +66 2665 2536; e-mail: [email protected]; Linkedin: MBMG Group; Twitter: @MBMGIntl; Facebook: /MBMGGroup

Update September 20, 2015

China is playing the markets, but what’s it all about?

It seems that all the financial news over the last couple of months has been about China. The dramatic crash brought international focus on the world’s second largest economy:1 yet as the media vans pack up and head off, the problems haven’t gone away and the government seems to be up to some funny tricks.

Chart 1 - Source: Financial Times.

Wise economists have warned us that if America sneezes, we would catch pneumonia. – Peter Thorneycroft, president of United Kingdom Board of Trade, 1954
There are a couple of revisions I’d like to make to the above quote. Firstly, there’s the implication that there are plenty of wise economists; then the point that nowadays it’s China’s expulsion of air that creates health concerns.
Given that only around 13 of the 36,000 registered economists foresaw the Global Financial Crisis2 – the actual event itself, not the timing – the number of wise economists strikes me as quite low.

Chart 2 - Source: Agnus Maddison, Rijksuniversitonieit Grngen.

Regarding China; whilst it has been documented for over ten years that it is a major world economic player,3 many commentators seem to have suddenly woken up to the reality that it is in a highly precarious position.4 This is something that I have been concerned about for several years; however, I fear we don’t yet know the half of it.
History shows that economic miracles eventually run out of steam – mid-1960s Germany and 1990-2008 Japan are cases in point.
In fact, Japan is still in the depths of a 25-year plus debt deflation;5 however, as many countries experienced a downturn post GFC in 2008, I thought taking the chart further would be labouring the point. Poor trade results, economic results, property and stock market bubbles and astronomical levels of corporate debt are bringing China closer to the Japanese model.6

Chart 3 - Source: Agnus Maddison, Rijksuniversiteit Groningen.

It’s not just the size of China’s economy that makes it a leading player and concern – the country is a major exporter and importer to several nations.7 Consequently, June and July’s prolonged crash provoked dramatic headlines, accompanied by pictures of people looking forlornly at a giant digital screen showing share prices heading south.8 The government took measures to control the negative effects of the crash; cutting interest rates, halting scheduled IPOs and allowing speculators to use their houses as collateral for marginal loans.9
Then, in late July, trade figures reports revealed an 8.3% year-on-year drop in exports and an 8.1% year-on-year descent in imports.10 This seemed to prompt the PBOC to abandon its strong yuan policy and in mid-August, the currency was devalued three times in as many days, as the central bank looked to rebalance the economy through cheaper exports and lower foreign currency debt repayments.11
Dollar Dump
Unsurprisingly, these measures grabbed the headlines, as it quickly became clear to what length the PBOC would go to maintain control of the economy. However, it is curious that there has been little mention of another big move. China’s central bank has been actively dumping US dollars from its balance sheet for the best part of a year.
At first glance, this isn’t at all apparent. China is a major investor in US Treasury Bonds, for example, and the PBOC appears to have been gradually selling them off in 2014; yet 2015 figures show it soon bought them all back again (see chart 4).12

Chart 4 - Source: US Treasury.

However, this conflicts with other information: the amount of foreign currency the PBOC holds in reserve has plummeted in the last year or so. Since June 2014, the Chinese central bank has shed 11% – some USD 435 billion – of its foreign reserves from its balance sheet, including a 3% sell off in August 2015 alone.13
Here’s where the detective work comes in. It has been suggested for some months that China likes to use Euroclear, a Brussels-based securities trader,14 in order to provide more anonymity for its transactions. If this were the case, some of China’s T-bond trading would show up on Belgium’s list of holdings.
Funnily enough, if we compare the rate at which the PBOC has been shedding its foreign reserves with the amount of both Chinese and Belgian-held T-bonds, there is a striking correlation (see chart 5)15.

Chart 5 - Sources: POBC, US Treasury.

Sales now on!
So why would China go on such a selling spree? Especially as selling foreign reserves would run counter to the programme of weakening the RMB to boost exports.16 Although admittedly it does appear that the PBOC may have used considerable sums of foreign exchange reserves to boost the RMB when they felt that it had declined too far against the USD.17 Either way, the central bank still has plenty left in its war chest. It currently holds more foreign reserves than any other country in the world – some three times more than second-placed Japan.18
Whilst the PBOC’s Chief Economist Ma Jun has stated that further intervention in currency markets would only happen in exceptional circumstances,19 I find it hard to believe that China’s addiction to attempting market control has been cured. Its moves, such as multiple interest-rate cuts and the whopping 1% cut in banks’ reserve requirement ratio (RRR)20, often smack of desperation. If it has the power and will to do this, why would it stop?
Still, my curiosity is not completely satisfied. I can understand the use of foreign reserves to stabilise currency but why was it done via Belgium? Normally China does transactions from home and through UK-based offshore banks.21 It seems to me that the PBOC is hiding something; and not very subtly either. It could be that China has learned from Japan’s strait jacket of being such a large investor in US T-bonds that it couldn’t sell any substantial part of its holding without damaging the value of the remainder. China wouldn’t want to get caught out like that.
If so, it would make sense to hide behind as much privacy as possible. Or maybe, just maybe, we’re entering a phase of the China debt crisis that’s so severe that China is being forced to liquidate the sovereign equivalent of the family silver. If things are that bad, it’s a real worry and it’s definitely something that Chinese policymakers would want to keep as quiet as possible.

3 Eswar Prasad, China’s Growth and Integration into the World Economy, IMF 2004
4 MBMG IA Research Note China’s Turning Japanese
5 Steve Keene’s 2015 Economic Outlook,
6 China flatters to deceive, MBMG IA Update, June 2015
7 idem
10 Wall Street Journal
12 US Treasury
13 People’s Bank of China
15 PBOC and US Treasury
17 idem
18 IMF figures

Update September 12, 2015

Stock market crash emphasizes need to reassess approach… unless you already had it right!

After the crash, the Dow Jones Industrial Average (DJIA) has recovered. So everything is ok, right? Well, not quite.
Monday 24th August apparently saw the most volatile session ever in the almost 120 years of the DJIA (in terms of the successive point swings).1 The next day was the biggest reversal since 2009, as the markets’ putative rally turned sharply and headed south.2
For every point swing on the US and other global indices there seems to have been thousands of words of commentary published; yet the overall effect of this seems to do little to help clarify the situation. The cacophony of the commentaries simply added to the noise of the markets.
Having said that, this shouldn’t come as too much of a surprise: it seems that many people didn’t expect it or understand what was happening; and everyone miscommunicates to some extent when under pressure.
There are some interesting examples:
Chief investment strategist at Janney Montgomery Scott, Mark Luschini’s description was unfathomable. He said a negative close “would be a set up to grind sideways to work out this process, if this rally and enthusiasm can’t last I think it’s an indicator (of that consternation).”3
Kevin Mahn, chief investment officer at Hennion and Walsh came up with the equally unhelpful comment, “I think obviously the market sold off far more than it should have.”4 Maybe someone should tell the market just how much it should sell off.
My favourite, though, was chief investment officer at Tower Bridge Advisors, James Meyer’s comment on the morning rally: some of the things “bothering markets yesterday were China and collapsing commodity prices and both of those have given us some relief and when I look at China I don’t look at the Shanghai market. I look at the Hong Kong market.”5 I suspect that many Hong Kong citizens and quite a few geography teachers might be perplexed by that view!

Chart 1 - Index: 50 days before final reading = 100 - Source: NYSE

There have been a raft of equally unhelpful but much more reassuring sounding comments about how such corrections are all part and parcel of the long-term process of making money from capital markets and nothing to be unduly concerned about or out of the ordinary.
Amongst all the edicts investors should heed, one stands out above all others: it’s time in the market that builds returns, not timing the market.6 As USA Today’s Matt Krantz put it, “[…] a five-year period should be enough time for a long-term investor to be made whole even in a bad market.”7
Whilst I don’t believe that it’s possible to consistently, accurately forecast market short-term direction, I do feel that economic conditions can impact markets – especially in extremis. I’ve been saying for some time that the conditions we face nowadays are in fact in extremis. Prof Steve Keen, my colleague at IDEA Economics, also alluded to this in the Is America Turning Japanese part of his 2015 Outlook.8 The view that markets always bounce back within five years is both misleading and dangerous.
Despite the Fed and BEA’s declarations that the US economy is back on its feet9 there have been clear signs of debt deflation in the US – as well as in other economies around the world. Thus, these conditions shouldn’t really surprise anyone; yet it they have. Many, for that matter.10
Of course, I wasn’t the only one expecting this: Richard Champion of Canaccord and RMG’s Stewart Richardson suggest several reasons why there is so much world market volatility right now.11 Some of the commentary out there certainly falls into the category of stating the bleeding obvious (even if it wasn’t apparently obvious before the crisis). For those who have been caught out, lessons in catching falling knives may be of more use than after-the-event writing, such as Liz Ann Sonders’s piece for Schwab12.
Tempting as it may be to dismiss those who didn’t see the current malaise coming, this retrospective advice is of little help now. What we do need to know, though, is where we stand and where we may be going. Here’s my view:
I’m no trader and to me long-term positioning is key. The collapse in the markets isn’t a sudden blending flash, so much as an inevitable outcome of impending debt deflation. I expect to see policy responses to try to avert this; though this may merely delay and make the eventual debt deflationary scenario even worse.
If this happens, it would mean that medium-term equity investing (5 years or so) would contain the inherent risk that markets will be very significantly lower in 5 years than they are today – even after this correction. Also, any strategy that fails to acknowledge this would be taking huge risks. As Chart 1 shows, the pattern of Dow Jones Industrial Average values in the days leading to the crises of 1929 and 1987 look frighteningly similar – corrections occurred just weeks before a more sustained drop hit. Thus, seeing a relatively small correction as an opportunity to buy totally misses the point that we are approaching the precipice. Having said that, such a correction is significant enough to warrant an overall re-appraisal of relative asset values.
The right approach
The last time that stocks were great value was when the S&P touched the memorable 666-point in 2009 – since then as the S&P has rallied 200%, I’ve been more alarmed about the risks building up at ever-higher valuations and have advised how to take risk off the table.
A good way is to use long/short managers; another is absolute return; and a further method is volatility-constrained investments – the unconstrained index is down by over 10% since the end of July, whereas the minimum volatility version of the index is much less effected (see chart 2).

Chart 2 - Source: MSCI

Risk, not return
The way forward is to take a defined, focused investing approach, designed around realistic appraisals of risk, married to the investor’s risk profile. That’s easier said than done but it is absolutely the right method.
The overriding danger is that, because the markets are experiencing what could well be a slight correction, it is all too tempting in times like this to take a heuristic approach13 – i.e. the assumption that what goes down must eventually come back up.
Rather than make such a perilous assumption, it is wise to understand that, at any time, we can control risk but we can only influence return. Consequently, focusing on return is always wrong, whatever the scenario.

4 idem
5 idem
9, NMw6g5O
11 searchable/August_2015/Articles/The_Return_of_ Volatility%20_Market_Update.pdf & http://www.rmginvestment .com/investment-bulletins_detail_249_A-Brutal-Week-in-Markets—What-Next

Update September 4, 2015

Spain: The bell is tolling on austerity but is anyone listening?

In summer no less than around 9 million people1 tend to visit Spain for a holiday. With its hot climate, beaches, culture and excellent food, it’s no surprise that it is so popular. However, whilst tourists take in the sun and sangría, daily life for the local people is as hard as it’s been for decades.
Rising from the ashes of an oppressive dictatorship, Spain became an example of how an EU member could develop. From joining the EEC in 1986, until the global financial crisis hit, Spain’s per capita GDP consistently gained on the EU average (see chart 1).

Chart 1 - Source: OECD.

The problem was that, along with the huge investment in infrastructure (by 2011 the country had 69% greater motorway density than in 1996, for example2) came a massive increase in construction: 15 million new buildings and 4.2 million new homes appeared between 2002 and 2011 – representing a 20% increase. What’s more, 15% of those 4.2 million homes were built in 2005-2006 alone.3 With that came a significant rise in house prices and household debt (see charts 2 & 3), as banks offered mortgages of up to 50 years for 100% of the market price.4

Chart 2 - Source: Eurostat

Chart 3 - Source: OECD

Then, the height of the Spanish bubble came as the US housing market was about to burst, leading to the global financial crisis (GFC).
By 2006, the ECB’s base interest rate (EURIBOR) was more than double that of just three years previously.5 As some 94% of mortgages in Spain are based on variable interest rates,6 monthly repayments quickly became much higher at a time when employment figures nosedived (see chart 4).

Chart 4 - Source: Eurostat

The bubble burst meant that Spanish banks were excessively exposed to toxic property assets - between 2007 and 2013, loan defaults of property developers and construction firms jumped from 0.6% of the total bank lending in these sectors to over 25%. Across all sectors, the non-performing loan ratio went from 0.7% of lending to 13.6% over the same period – that figure doesn’t even include the toxic loans placed in the bad bank SAREB.7
Loan defaults on houses led to foreclosures, which numbered over 270,000 between Q4 2011 and Q1 20158. When the government intervened in July 2012,9 around half the loans in the Spanish banking system were given out by the regional, unlisted and poorly-regulated savings banks (cajas).10
The national government was also adversely affected by the burst: its public debt rose by 133% between 2006 and 2012 – and is still rising today.11 Some of this was down to money used to bail out the banking system. However, the main reason was that government spending had increased significantly between 2000 and 2009.12 This expenditure had been largely covered by revenues from property-related taxation;13 once the bubble burst and people stopped buying houses, government revenues took a hit (see chart 5).

Chart 5 - Source: IMF World Economic Outlook, April 2015

So with a high level of public debt, rising unemployment and a worrying number of foreclosures; what did the government do? Concentrate on its own debt, of course. It announced austerity measures in May 2010 worth 1.5% of GDP and further measures of the next six months’ worth an estimated 5% of GDP in total. These measures included a 2% rise in VAT.14
Unsurprisingly, this policy has done nothing to boost economic activity. GDP has barely recovered, house prices are still low and consumer prices fell by 0.6%, on average, in the first half of 2015.15 Employment statistics have been reduced to ‘good news’ announcements: such as the recent publication of statistics showing 295,600 more people in work in Q2 2015. What was not mentioned in this announcement was that around half of these jobs were in the service sector (i.e. tourism during its peak period) and whether the positions were temporary or permanent.16
Despite the sharp upturn in public debt, the percentage of Spanish public debt to GDP was at under 47% when austerity was announced. By comparison, Greece was at 106% and Germany at 54%. By the end of 2014 Spain’s debt had reached 78%; but then GDP fell by 1% on average between 2009 and 2014,17 so the debt figure is not as dramatic as at first glance.
Also, the recent past has shown that the way to increase government revenue is to encourage a growing economy, not a shrinking one. After all, a government’s budget is not a giant version of an individual’s bank account.
As Prof. Steve Keen, my colleague at IDEA Economics, pointed out in his 2015 Outlook paper,18 if a government runs at a surplus, it means that it’s getting more tax from the private sector. Thus, the private sector is earning less – and therefore likely running up debts – in order to keep the government in surplus. Proof of this in Spain is that private consumption is falling: Q1 year-on-year consumption has dropped by 2.6% between 2006 and 2015.
So it looks like Spain is heading for the debt deflation that has hampered Japan for the last 25 years.19 As with Greece, it is in the Eurozone, so is straight-jacketed regarding monetary policy.
It’s time for austerity to stop before it’s too late: the government of Catalonia, Spain’s richest region, has declared its next elections in late September as a plebiscite on whether it remains part of the kingdom.20 Otherwise before the national government acts, the bell could already have tolled.
Paul Gambles has completed CFA level 1 and is licensed by the SEC as both a Securities Fundamental Investment Analyst and an Investment Planner.

2 Infrastructure in the EU: Developments and Impact on Growth, European Commission, Occasional Papers 203, December 2014
3 Instituto Nacional de Estadística
5 European Central Bank
7 William Chislett, Spain’s Banking Crisis: a light in the tunnel, Real Instituto El Cano, 2014.
8 _132166.html
9 eu_ms/spain/index_en.htm
10 Willim Chislett, Spain’s Banking Crisis: a light in the tunnel, Real Instituto El Cano, 2014
11 Eurostat
12 IMF World Economic Outlook, April 2015
13 Juan Carlos Hidalgo, Looking at Austerity in Spain, Cato Institute,
14 Spain’s Economic Crisis: A Timeline, Daily Telegraph, 8th June 2012
15 INE, Spanish National Institute of Statistics
17 Eurostat
18 Steve Keen’s Economic Outlook 2015, http://www.
19 ibid

Please Note: While every effort has been made to ensure that the information contained herein is correct, MBMG Group cannot be held responsible for any errors that may occur. The views of the contributors may not necessarily reflect the house view of MBMG Group. Views and opinions expressed herein may change with market conditions and should not be used in isolation.
MBMG Group is an advisory firm that assists expatriates and locals within the South East Asia Region with services ranging from Investment Advisory, Personal Advisory, Tax Advisory, Corporate Advisory, Insurance Services, Accounting & Auditing Services, Legal Services, Estate Planning and Property Solutions. For more information: Tel: +66 2665 2536; e-mail: [email protected]; Linkedin: MBMG Group; Twitter: @MBMGIntl; Facebook: /MBMGGroup


HEADLINES [click on headline to view story]

Fed Interest Rate: no rise, no decision, no surprise

China is playing the markets, but what’s it all about?

Stock market crash emphasizes need to reassess approach… unless you already had it right!

Spain: The bell is tolling on austerity but is anyone listening?