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Paul Gambles
Co-founder of MBMG Group

 

Update February 27, 2016

The dangers of being right for the wrong reasons: Part 1

There are so many factors that could affect the global economy in 2016, analysts could actually be right for the wrong reasons – and that could be disastrous.
In a recent article A time for analysis not panic,1 I mentioned that, for once, I wouldn’t be making any forecasts for 2016 because the next eleven months or so are just too unpredictable.
It seems that I am going against the grain of either a large consensus or just a very loud one. First it was the Royal Bank of Scotland, which warned investors of a ‘cataclysmic year’, then it was Société Générale strategist Albert Edwards. The man renowned as the City of London’s most vocal bear suggested that we were heading for a global crisis as severe as 2008/2009.
Albert may well be right but, even to me (the supposed ‘Bear of Bangkok’), the RBS tone runs the risk of sounding a little too hysterical. Like myself, Albert has consistently explained the dangers of experimental policies in a debt-deflation environment for several years. Since the redoubtable Bob Janjuah’s departure, RBS don’t seem to have been quite so clear in their message. The sudden appearance of a Cassandra on every street corner (in London’s Square Mile at least) coming somewhat out of the blue and without context seems all too much like doomsday prepping; especially if it still begs the question as to why this narrative has suddenly come to a head. Is it because there’s a genuine feeling that 2016 will be the year financial crisis returns? Or is it merely because analysts looked at all the red lines and down arrows on the weekly charts when they were prompted for their New Year’s predictions?
Either way, there is some sound reasoning as to why financial crisis is coming. I’m just not convinced it will happen this year or that it needs to be such a uniformly destructive event from every individual viewpoint as some seem to suggest.
That said, there are some very, very significant issues to address.
Eurozone
The Eurozone is a major flashpoint. The European Central Bank has embarked on a three-pronged attack of quantitative easing (QE), a negative interest rate policy (NIRP) and public sector austerity. Let’s call it the ECBQENIRPPSA – or, more accurately, a recipe for disaster. Quite why the ECB feels the way forward is to replicate Japan’s economic model from 1990 onwards is beyond me. The Land of the Rising Sun has been caught in a debt-deflation cycle ever since. However, the ECB appears to think the Eurozone is some kind of economic exception and will avoid this fate. It isn’t and it won’t. Debt deflation is structural. It’s the point in the cycle when debt (which is the biggest single driver of both economic activity and asset prices) reaches a point reminiscent of Monty Python’s Mr. Creosote and just can’t expand any further without exploding.
With debt-deflation, company profits are squeezed, thus salaries remain low and the disposable income to pay off debt remains limited. Stagnation can pervade for a very, very long period of time. Hence Japan’s debt-to-GDP ratio has hardly reduced, despite the economic suffering there in the last 10-15 years.
Private debt
Whilst the IMF, Eurostat and other providers of economic indicators continue to obsessively publish figures on government debt, private debt remains the critical factor. True, there has been significant deleverage since 2009 when private debt rates were at around 98% of GDP. Yet, Q3 2015 data shows the ratio at around 79.5%2 - still a considerable amount and far too high a base on which to build a sustainable rally. Governments have misguidedly try to fill this gap, which has papered over the cracks rather than fix the foundations. And as the cracks become ever wider, governments globally are taking increasingly desperate measures to apply more wall paper. The BoJ’s decision to herald negative interest rates was just the continuation of this attempt to cover up the deeper problems and shouldn’t have come as a shock to anyone. Governments globally will adopt ever more radical measures which are ultimately doomed to fail in a way that will seem quite catastrophic but will give some semblance of restoring stability before that happens.
And that, in essence, is why 2016 is impossible to predict. As my IDEA Economics colleague Prof. Steve Keen recently put it, “The scary stuff isn’t there on the same scale. It’s the depressing stuff that is. That’s the situation Japan’s been in, with having built up too much private debt, too much bank debt.”3
So the cracks will get ever wider but governments seem determined to keep doing everything that they can to hide them from view. Until they reach the point that they can’t do this anymore. Some commentators suggest that this will happen when the Central Banks have run out of tools. But that’s not quite right in my view. I’d say that a wallpaper brush and some paste aren’t the right tools in the first place to deal with shaky foundations. As Steve Keen says, Central Banks will continue until they have “exhausted the capacity to use the wrong tools but the right ones are still sitting there and they’re ignoring them.”4

Footnotes:
1 http://www.mbmg-investment.com/in-the-media/inthemedia/75
2 World Bank Data
3 https://www.youtube.com/watch?v=7OSHu80IXi0& feature=youtu.be&t=3m45s
4 https://www.youtube.com/watch?v=7OSHu80IXi0& feature=youtu.be&t=3m45s

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 February 20, 2016

New Year Wishes – Part Two

In the second part of my New Year wishes, I ask for debt jubilees, ending austerity and getting China’s economic statistics to a realistic level.
Yes to a debt jubilee

Having diagnosed the debt problem, we should implement the cure; ultimately the most viable solution to the debt problem. I’d like to see governments and central banks – in the US but also in Japan, the UK and the Eurozone – pay out money to reduce private debt, and also quasi-private debt such as that owed by the governments of the Eurozone periphery. Some may think this is an act of bailing out people who only have themselves to blame, prohibitively expensive and utopian. I have two answers to these accusations: government and central banks.
To begin with, in many countries government policy to reduce regulation, to make lending more accessible, is what got debt to such high levels in the first place. Of course, no-one has forced people to borrow and consume but permitting repeated repackaging of debt (such as sub-primes in the US) or 50-year mortgages with inadequately regulated savings banks (as in Spain1) certainly encourages it. For some people this was their only way to buy a property. Given the sharp rise in prices in several countries – an 80% rise between January 2000 and January 2006 in the US; in Spain a huge cumulated growth of 232% between 1997 and 2007 - that has applied to an increasing number of people.
As for the argument of cost, the Fed’s version of Quantitative Easing – a vain attempt at stimulating the economy through buying up bonds – created liabilities of around USD 4.5 trillion off its balance sheet. If that had been converted into real money and shared equally between all US mortgage-holders, it would have resulted in a cheque for just over USD 55,800 arriving in each letterbox.
Calling such a move utopian doesn’t hold any water either. Debt jubilees have been tried and tested – from the first civilizations in Mesopotamia to, most recently, a year ago in Croatia where around 60,000 of its poorest, most indebted citizens had their liabilities wiped out by banks, telecoms and utilities operators. The overall cost of the Croatian example was estimated at just over USD 30.4 million, or 5 weeks’ bombing of Syria, according to the UK government’s costings.2
And the great thing is that everyone benefits – my colleague at IDEA Economics, Michael Hudson, has probably done more than anyone to prove that a functional economy, with a more equal share of the pie not only benefits the weakest in society but also produces greater wealth for the richest.
No to austerity
Along with that, European countries have to stop their austerity programmes. This is not even an option if we are to see signs of sustainable economic growth. Right now governments are cutting back on health services (for example, 13.6% spending cuts in Spain between 2009 and 2013), legal services (an 8% cut to the UK Ministry of Justice’s 2015/16 budget) and ministries (150,000 jobs cut since 2008 in France alone).
All this has taken place under the mistaken belief that government budgets should be run like company accounts. As my IDEA Economics colleague, Prof. Steve Keen, has explained,3 public debt is a sign of the state of the economy – not a cause. Trying to reduce the public debt removes spending capacity from private pockets and results in another unnecessary slump. The apologists of austerity continue to sow the seeds of the next great depression, financial crisis and global conflict.
As public services are reduced the population becomes poorer and public sector workers’ salaries are cut or they are made redundant; thus consumption is hit and the economy shrinks. The most sustainable way a government can cover its costs is through taxation – but taxation which targets surplus and idle capital and income – the only objections to steeply progressive forms of taxation are misguided ideology.
At a presentation called “WTF??”4 with Steve Keen and Richard Duncan, I cross-examined (in their absence of course) those individuals with the greatest apparent responsibility for causing the Global Financial Crisis. It would be too simplistic to pin all the blame on any one man but when primary responsibility attaching to Ronald Reagan’s advisor, Art Laffer was exposed,5 it’s fair to say that had he been anywhere in the vicinity of Sukhumvit that night lynching mobs and pitchforks would have gone some way to implementing street justice.
Putting this on a global scale shows the inequality cutting government services creates. Oxfam have just released a report which suggests that, in 2010, 388 people owned as much wealth as the poorest half of the world. The report estimates that number is now at just 62 people.
Can we handle the truth?
My final wish would be for government statisticians in Peking to take a truth pill, only partly because of the possibility that they might actually choke on it!
Official statistics had China’s year-on-year GDP growth at 6.8% for Q4 of last year; December exports fell by 1.4% compared with a year earlier – far less than expected; household and corporate debt are apparently at 38% and 125% respectively. Frankly, I’ve read Dan Brown novels which are more believable.
These figures may indicate a slowdown compared with recent years but they’re still quite good considering the intervention the Chinese government has undertaken in recent months.6 In fact the figures are just too good to be true.
Many economists consider the real GDP rate to be significantly lower than the government says – and this may have been the case for some time. If this is indeed the reality, consumption could also be well lower than published. Added to slower GDP growth caused by China’s attempts to move from an economy dominated by exports would represent a double blow to GDP.
And then there’s the debt. To start with, I’m convinced Chinese corporate debt is much higher than the official figure of 125% of GDP7 – I have it at between 140%-175% of GDP.8 A lot of this is in state enterprises, which presumably has a high proportion of non-performing loans within the banking system - of course we don’t know exactly what proportion. Added to that there is the large – and largely unquantifiable – shadow banking system which exists in China.
What we need from China is transparent data, so that we can trust what we see and act accordingly to avoid, where possible, another global financial crisis.
Leaving winter?
Taking all of these measures would provide a sustainable long-term structure for the global economy to grow. There will always be good times and bad times – or seasons as Kondratieff labelled them9 - but not as extreme as we saw in 2008 and could well experience in the not-too-distant future.

Footnotes:
1 Spain: The Bell is tolling but is anyone listening? MBMG Investment Advisory Update, August 2015, http://www.mbmg-investment.com/in-the-media/inthemedia/57
2 Estimated by UK Government at USD 291 million/year, http://uk.reuters.com/article/uk-britain-osborne-syria-idUKKBN0TK4PH20151201
3 https://www.youtube.com/watch?v=Au2N07eHa-Q
4 http://www.austchamthailand.com/event-775828 & https://www.youtube.com/watch?v=5wEZ6M-veMs http://www.bccthai.com/BCCT/asp/EventDetail.asp?EventID=2253
5 Ibid
6 http://www.mbmg-investment.com/in-the-media/inthemedia/59
7 McKinsey Global Institute analysis
8 MBMG IA estimate, taking into consideration shadow banking and GDP overstatement.
9 https://northcoastinvestmentresearch.files.wordpress .com/2009/01/kondratieff-cycle.jpg


Update February 13, 2016

New Year Wishes – Part One

The only function of economic forecasting is to make astrology look respectable
- Ezra Solomon, 1984

If we’re to completely believe the media, every 31st December, as the bells chime 12 times, the sparkling wine flows and the Spanish try to gobble 12 grapes in as many seconds, a line is drawn under the old year and a blank page awaits in the new one, just one second later.
That blank page could pave the way for anything: a healthier lifestyle, a plan to save more and spend less or – as people in the finance world tend to do – make predictions for the New Year, indicating possession of some special insight as to how the economy and markets will behave.
It’s fair to say that, once you have a few years’ financial advisory under your belt, you can make an educated guess at what could happen in the coming year. Experience and analytical skills can give us a reasonable idea of the prevailing winds but it’s quite a leap to suggest a 12-month timeframe. That’s why I avoid stock-picking: so many factors and rumours can affect an individual share price that it’s impossible to predict its trajectory at a given time.
This year is different, however. Not only is it impossible to predict the exact timing of events, as I wrote recently,1 I don’t even think it’s possible to forecast what those events are.
So, rather than wildly predict the next 12 months, I’ve decided to note down what I would like to see happen. I doubt some of my suggestions will take place by the time the bells welcome in 2017 but, if we’re to avoid an economic crisis which could make 2008 look like a mere tremor, the quicker they become reality, the better.
Fed rates
First on my list is for the US Federal Reserve to stop its failed attempts to try to create economic growth via the financial repression of Zero Interest Rate Policy. “Didn’t they already do that in December?” you might ask. Well sort of – but not really. The Fed Monetary Committee’s decision to increase the rate which banks generally use as a benchmark for their own lending rates, was the first in eight years. Yet, amidst all the speeches, commentary and other brouhaha, the new rate is just 0.5%. To put that into perspective, the average pre-crisis rate between January 2006 and January 2008 was 4.58%.
According to the US Federal Reserve, the aim of this policy is to stimulate the economy by improving banks’ balance sheets and therefore their capacity to lend. Consequently, so the theory goes:
The Fed can help spur business spending on capital goods – which also helps the economy’s long-term performance – and can help spur household expenditures on homes or consumer durables like automobiles. For example, home sales are generally higher when mortgage rates are 5 percent than when they are 10 percent.2
In other words, if a central bank encourages commercial banks to reduce lending rates, companies and individuals will borrow more money and spend it. That will increase consumption, allowing the economy to function ‘normally’ again.
That sounds reasonable – until you factor in the reason that the 2008 crisis happened in the first place is that private debt in the US was through the roof (see chart).
All this makes the Fed’s policy sound like that forlorn hope of gambling addicts that one final bet will clear all of their debts.
On announcing the raise, Fed chair Janet Yellen said that the move “[…] recognises the considerable progress that has been made toward restoring jobs, raising incomes and easing the economic hardship of millions of Americans.”3
The figures used to justify this manipulation are hardly jaw-dropping: quarter-on-quarter consumption growth has averaged just 0.5% since interest rates were set to minimum in December 2008; unemployment has fallen to 5%, which is still slightly above the Q1 2007 (i.e. pre-crisis pre-emergency-interest-rate) figure of 4.5% and only 0.3% lower than when the Fed last kick-started an interest-rate-raising cycle in 2004; and inflation remains below the Fed’s target of 2%.
It seems to me that the Fed made its move because it was feeling the heat after hinting for almost a year that it would raise the base rate. The quarter-percent increase appears to be a half measure to appease the masses – more or less paying lip-service to outsiders – buying it time to see what effect the raise will have on the economy.
What it should really do is focus on eradicating the private debt burden that, even at zero interest rates, creates an inordinate drag on consumption.
Otherwise, a large part of corporate and household incomes are destined to be directed towards servicing debt payment over buying goods and services. This leads to a reduction in business volumes, putting downward pressure on hiring and salaries, sparking a vicious deflationary spiral of still lower business revenues and further downward pressure on hiring and salaries ad nauseam.4

Footnotes:
1 http://www.mbmg-investment.com/in-the-media/inthemedia/75
2 https://www.stlouisfed.org/publications/inside-the-vault/spring-2011/low-interest-rates-have-benefits-and-costs
3 http://www.ft.com/intl/cms/s/0/46a9001a-a424-11e5-8218-6b8ff73aae15.html#axzz3x0GN1DFs
4 http://www.ideaeconomics.org/basics/


Update February 6, 2016

A developing story – Funny business in the Year of the Monkey

China is in the midst of structural transformation from a manufacturing-driven economy to a consumption-led one; from a state-directed command economy structure to being market driven. It’s also gradually working towards a more liberalized or more convertible currency. But can its economy continue to grow?
Economic uncertainty
Economic uncertainty and a likelihood of further ‘surprise’ currency depreciation has dramatically increased outflows which hit USD170bn, or equivalent to 5% of its foreign reserves in December 2015 alone.
The RMB remained too tightly pegged to the USD for too long. This has created some major structural imbalances which will need to be unwound. These structural shifts are occurring during a time of dangerously high corporate debt; a continuing slowdown in economic growth; collapse in several commodity prices (somewhat artificially buoyed up by China in the first place); a corruption crackdown; and eye-opening interferences in the capital markets which overall has led to sporadic, dramatic losses for the investing public: many people have rushed into stock margin-loans.
Worrying signs
Depending on which figures you believe, corporate debt accounts for between 140%-175% of GDP – even the lowest estimate is one of the highest in the world. A lot of which is at the state enterprise level: a contributory factor to the unknown but presumed high level of non-performing loans (NPL) within the banking system.
Inter-bank (HIBOR) lending rates recently spiked up to around 70%, comparable to countries in the months preluding a full-blown financial crisis. They then fell sharply, highlighting the sheer volatility and uncertainty attached to China. It’s not clear exactly which banks were lending to each other at these rates: rates which tend, at various times to be manipulated to the low side by huge injections of state liquidity and can cause subsequent spikes if withdrawn again. Such unknowns only amplify the lack of transparency and lead to damaging mal-investment and speculation.
In addition to this, export growth has been slowing in USD but grew more than 2% in Renminbi terms according to the country’s latest data. Also, labour costs have been creeping up, reducing job demand. This confirms my long-held suspicions that excess capacity (caused by excessive investment in fixed asset formation following the onset of the GFC) has resulted in highly marginal and sometimes negative manufacturing profit margins.
GDP is another hotly-debated subject. Many economists consider the published growth rate to be higher (perhaps significantly) than the reality and may have been for some time. If this is true, hiring rural immigrants may not be enough for manufacturers to improve results. This is strangely relevant because rural consumption expenditure levels are significantly lower than their urban equivalent: once workers move from the countryside to the cities there’s often a sudden jump in their consumption, thus an increase in overall GDP growth. A lower rate of consumption, coupled with a slower GDP growth caused by China’s attempts to move from its moribund export model (global trade is now back to levels preceding the great China boom of the noughties), would further diminish economic growth.
What now?
The Chinese authorities are still likely to continue monetary easing through 2016 to maintain growth. This will pile further pressure on the RMB to continue to weaken further – but the consensus isn’t particularly helpful with many economists seeing the currency weakening by 5-20% in 2016. To what extent the Chinese will be prepared to support the Renminbi given the alarming draw-down on its foreign reserves in 2H 2015 is also an unknown. Still, any rapid draw down in foreign reserves would further exacerbate outflows.
That doesn’t mean that the policy tools available can’t give the impression of a fully functioning economy and capital market in China for the remainder of this year and possibly even longer. The only structural fix for China that I envisage involves the genuine write-off of unpayable debts, the bankruptcy of rotten businesses (state, publicly and privately owned), the unwinding of government manipulation of capital markets and a huge amount of economic and financial pain, before China can build a solid base for the next stage of its economic resurgence.
SocGen’s Albert Edwards is predicting that Chinese equity markets will fall by 75%. That could easily be right but is more likely to be understating or overstating how bad things need to get before they can structurally get better.
I feel that the range in possible currency and market performance is really too wide to be able to refute or confirm whether China would be a terrible/bad/OK/good/amazing place to invest this year.
Going forward
For the short term, any exposure to China should be considered as speculative. I firmly believe that in the medium term, China’s economy and markets will face exceptional difficulties and potential losses and thus should be seen as dangerous. For the longer term, it could be one of the more attractive high risk opportunities available. Therefore the key to investing in China is really how well that matches your own expectations and outlook.
My best guess looking ahead is that the Renminbi is set to weaken further and that this will damage confidence, pushing down along with it Chinese share prices, as well as currencies of neighbouring economies, with far reaching ripple effects for all capital markets. Although, if investors believe that a weaker currency is the panacea for all Chinese woes, this could just as easily lead to an equity rally, in which case the recently launched currency hedged China ETFs would perform strongly.
But if not, I wouldn’t be surprised to see the Shanghai stock market (SSEC) drop significantly below 3000 points in 2016.

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]

The dangers of being right for the wrong reasons: Part 1

New Year Wishes – Part Two

New Year Wishes – Part One

A developing story – Funny business in the Year of the Monkey