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Paul Gambles
Co-founder of MBMG Group

 

Update August 27, 2016

Could Paul Pogba crash the Equity Markets?

The last 12 months has thrown up a cornucopia of opportunities for global value investors. Gold, US Treasuries, minimum volatility/high dividend equities and US Dollar strength have all yielded not only handsome rewards but also diversification that has hedged equity Beta – the measure of volatility – in a way that has generated attractive risk-adjusted returns.

However, these have now performed so strongly that the time seems to have come to either sell or pare all of these and frustratingly there don’t seem to be any equally strong candidates to replace them.

The two equally dangerous consensus views seem to be that:

i. Asset prices may be unjustifiably expensive, yet while policy conditions remain supportive and arguably become even more so, a rising tide will continue to lift all asset boats.

ii. Old assumptions no longer apply and under this new paradigm, asset values are somehow justifiable after all.

The former may well seem to be true for a while, until suddenly and devastatingly it quite clearly isn’t. But what about the second argument? Whilst cyclically adjusted P/E ratios (CAPE) indicate that markets are so overvalued that they are susceptible to falls of 50% or more, that may take decades to recover. Eminent commentators such as Carmignac’s Didier Saint-Georges talk of equity investing as ‘dancing on a volcano’1; yet the ardour of equity cheerleaders continues unabated. However, MBMG’s recent research has unearthed another, slightly unusual, indicator that might just help convince them that this bull run could be in its final stages.

In the world of football, Juventus recently sold star midfielder Paul Pogba to Manchester United for a record fee of €110 million (US$122 million).2 Given the economic situation of the real world, football can often seem like it’s on a different planet. Having said that, be it coincidental or not, there’s a raft of historic precedent that footballers’ valuations run wild at the same time that stock markets set themselves up for a major fall that dates back to the earliest days of transfer fees (see chart 1):

Chart 1 - Sources: The Independent, The Newcastle Book of Days, The Leaguers: The Making of Professional Football in England, British Newspaper Archive, BBC News, Reuters, Transfermarkt.com

The 1932 transfer of Bernabe Ferreyra between Buenos Aires-based teams Tigre and River Plate3 marked the peak of an overvalued market and in an echo of the 25 years that the Dow Jones took to recover,4 from its 1929 peak, wasn’t surpassed (in inflation adjusted terms) until the 1954 transfer of Juan Alberto Schiaffino from Uruguayan club Pearol to Italy’s AC Milan for 52 million Lire.5

More recently, the mid-1970’s oil crisis was followed by a new transfer record in 1976 when Paolo Rossi moved between Italian clubs Juventus and Vicenza for 2.6 billion Lire.6 Again this was followed by a crash in transfer values reminiscent of that in equity markets, until the phenomenon that was Diego Maradona came along in the mid-1980s and broke the record twice within just three years7 (see chart 2).

Chart 2 - Sources: BBC, Transfermarkt.com

That’s astonishing enough but especially so considering that the reason for his second move (from FC Barcelona to Napoli) was largely down to the Argentine’s involvement in a brawl in the Spanish Cup Final – under extreme provocation from Athletic Bilbao players; and his organisation of an all-night team tour of Parisian nightclubs following a friendly match.8

The turn of the millennium saw a pattern reminiscent of 70 years earlier, when a sharp rise in equity markets9 was paralleled by a sharp rise in transfer prices. The March 2000 peak in US indices was mirrored by a new record transfer fee of 150 billion Lire when Zinedine Zidane moved from Juventus to Real Madrid.10

However, football markets took longer to recover than equity markets and the world record wasn’t broken in nominal terms until Kak made the same move 8 years later, in early June 2009.11 The record in real terms was broken later that month, when Cristiano Ronaldo also joined Madrid from Manchester United later that year.12

The Global Financial Crisis had ensured that this remained the inflation-adjusted high watermark (although Gareth Bale’s move to Madrid in 2013 saw a new nominal high13). However, Pogba moving for US$122 million could be a sign of a contagion from the asset bubble in equities to transfer values once again (see chart 3).

Chart 3 - Sources: Juventus FC & BBC.

As it has done since the turn of the last century, this might be a sign that the bubble in valuations for both is once again about to burst.

Footnotes:

1 https://www.carmignac.co.uk/node/4345/

2 http://www.bbc.com/sport/football/37016170

3 World Soccer Magazine

4 http://www.macrotrends.net/1319/dow-jones-100-year-historical-chart

5 http://www.bbc.co.uk/sport/football/23903470

6 idem

7 idem

8 Jimmy Burns, Maradona: The Hand of God, A&C Black 2011

9 http://www.macrotrends.net/1319/dow-jones-100-year-historical-chart

10 Juventus FC

11 Transfermarkt

12 idem

13 BBC


Update August 20, 2016

Debt, Inequality and Credit Stagnation Part 2

In the second part of my article on Prof. Steve Keen and his Dataconsult Breakfast talk in Bangkok in late July, I look at his thoughts on private debt and its effect on economies.

Having established that private debt is actually the real economic disease affecting us, the below chart reveals that it doesn’t take in-depth analysis or a PhD in economics to see that, while Eurozone countries are pushed by the ECB to reduce government debt, the real problem is in fact private debt (see chart 1).

It’s the private debt that counts

Chart 1 - Source: BIS.

Private debt was the major contributory factor to the GFC1 – in no small way because of bubbles in house prices (see chart 2). As Prof. Steve Keen points out, when the private debt-to-GDP ratio is high, credit dominates other economic factors: a comparison of US credit and employment highlights this (see chart 3).

Chart 2 - Sources: ECB & St Louis Federal Reserve.

Chart 3 - Source: Prof. Steve Keen.

Also, Steve demonstrated in his talk how house price changes are driven by the acceleration in mortgage debt (see chart 4).

Chart 4 - Compiled by Prof. Steve Keen

Possible solution

With this evidence in front of us, it would seem logical that governments and central banks of the most effected economies would do their upmost to reduce the amount of private debt, for example through a modern debt jubilee, as another IDEA Economics colleague, Michael Hudson, has demonstrated.2 This is something which Michael shows has happened regularly in the past.3 The overall effect of a modern jubilee would be to make economic conditions much more favourable for individuals and businesses alike (see graphic).

All this may seem like a highly costly way of rebooting the economy; yet the sums spent by central banks in an attempt at stimulation are so astronomical that they’re difficult to even contemplate. In its weekly editorial of 25th July, BOOM Finance & Economics puts the figures at US$3.5 trillion by the Fed on its QE policy, the ECB’s  Expanded Asset Purchase Programme has cost US$1 trillion so far, the Bank of England has put down US$500 billion on its Asset Purchase Facility and the Bank of Japan’s stimulus package is at US$3.4 trillion so far. To give these numbers some kind of perspective, Croatia launched a programme to wipe out the debt of up to 60,000 of its poorest citizens at a cost of a maximum of just US$317,000.4

As the BOOM editorial rightly points out, all this  stimulus is costing trillions, while – according to povety.com – some 7.6 million people in the world die from hunger every year.

Even if the central banks’ policies weren’t so expensive, they are completely misplaced. The general principle behind them is to kick-start economies by giving businesses and individuals easier access to debt – the very thing that put us in this mess in the first place. Meanwhile, austerity measures aim to reduce government debt; which means fewer public services, less spending on education, health and infrastructure – services which help improve people’s capacity to earn, thus increasing consumption, helping business, bringing more tax income and so on.

In fact, if governments actually bring in more money than they spend, it’s bad news for the economy. That’s because to achieve surplus, government taxes on the private sector exceed the subsidies paid to it by the government, so the private sector has to run a deficit with the government. But that means shrinking the private sector – the opposite of governments’ good economic management objective, unless the private sector somehow produces not only enough money to finance the government surplus, but also enough to allow the economy to grow at the same time.5 That’s some ask.

It’s taken a while but even the IMF has finally recognised this, urging G20 governments to increase their spending on infrastructure to boost growth.6 In its recent annual report, the central bankers’ central bank, the BIS, has also now admitted that there is an “urgent need to re-balance policy” and central banks’ “inability to get to grips with hugely damaging booms and busts” and the “debt fueled growth model.”7

That’s all very well but it’s now time – in fact it’s been time for about eight years – for central banks to stop mistreating the symptoms and deal with the actual disease. Steve’s analysis of BIS debt data shows that there are several countries which should be red-flagged for dangerously high levels of private debt: including Australia, Canada, Korea and Malaysia. If these countries, the US, the Eurozone and the UK don’t dramatically reduce private levels quickly, Steve believes another important financial crisis will hit them. If he’s right – as he was about 2008 – then China may not be in a position to soften the blow this time around.8

 The Effects of a Modern Jubilee

1. Reduction in people’s debt levels;

2. Cash injection for non-debtors;

3. Alteration in the distribution of bank assets, with debt instruments declining and value and cash assets rising;

4. Fall in bank income, as debt is an income-earner for banks, whereas cash reserves are not;

5. Fall in income flows to asset-backed securities (ABSs) as a large part of the debt would be paid off; and

6. Individuals and corporations owning ABSs would have more cash to spend, instead of being reliant on income from ABSs.

Source: http://www.ideaeconomics.org/a-modern-jubilee/   

Footnotes:

1 http://www.ideaeconomics.org/blog/2015/1/13/steve-keens-2015-outlook

2 http://www.ideaeconomics.org/a-modern-jubilee/

3 http://michael-hudson.com/wp-content/uploads/2010/03/HudsonLostTradition.pdf

4 https://www.washingtonpost.com/news/worldviews/wp/2015/01/31/croatia-just-canceled-the-debts-of-its-poorest-citizens/

5 Steve Keen’s Economic Outlook 2015 IDEA Economics http://www.ideaeconomics.org/

6 https://www.theguardian.com/business/2016/jul/23/imf-calls-for-more-government-spending-as-rate-cuts-lose-their-impact?CMP=Share_iOSApp_Other  

7 BIS 86th Annual Report via http://boomfinanceande conomics.com/

8 http://blogs.ft.com/the-exchange/2015/08/19/12621/


Update August 13, 2016

Debt, Inequality and Credit Stagnation Part 1

The last week of July saw the visit to Bangkok by the inspirational economist Steve Keen, who is about to publish his latest book Can we avoid another financial crisis? which surveys the prospects for 42 countries around the world (including Thailand, Singapore, Indonesia, Malaysia and Hong Kong).

As well as being Professor of Economics and Head of the School of Economics, Politics and History at Kingston University London, Steve is chief economist of IDEAeconomics,1 a body dedicated to reforming economics, where I am an advisory board member. Steve’s previous book Debunking Economics2 explained the many logical and empirical flaws in mainstream (and Marxian) economics without using mathematics and has been translated into Chinese, French and Spanish.

Given events over the past decade, you may not think the words inspirational and economist sit comfortably together. In fact, Steve himself may well agree. That’s because he’s a prominent critic of the conventional neoliberal3 form of economics which has dominated governments, central banks, universities and the media over the past fifty years or more.

As banks, debt and money play an integral role in Steve’s dynamic approach to economics, he was one of just six registered economists in the world to anticipate the 2007-2008 global financial crisis (GFC).4 “Mainstream economists failed to anticipate the crisis, not because it was an unpredictable Black Swan,” Steve explains, “but because false pre-determined beliefs meant they ignored the cause of the crisis: banks lending too much money to finance speculation rather than investment.”5

Neoliberalism dominates

Neoliberalism has played two decisive roles in the modern global economy. Firstly, it played an important part in creating the GFC through its ideology of lowering financial services regulations. For example, neoliberal thinking in the US brought about the 1999 Gramm-Leach-Bliley Act6 (or Financial Services Modernization Act7 as it was tragically nicknamed). This Act of folly removed the prevention of a financial institution from acting as any combination of an investment bank, a commercial bank, and an insurance company. It’s no coincidence that the restrictions were initially put in place as a reaction to the Wall Street Crash and is aftermath by the 1933 Glass-Steagall Act.8 A year later, the Commodity Futures Modernization Act allowed banks more freedom in the derivatives market and enabled them to become more aggressive in the home loan market.9

The second contribution neoliberal economics has made is to exacerbate the problems of the GFC, without reducing the threat of a new crisis. Neoliberals dominate the world’s major central banks – including the Federal Reserve, Bank of Japan, Bank of England and the European Central Bank. Their obsession with reducing government spending has led them to embark on a policy of fiscal austerity, combined with quantitative easing and zero/negative interest rates as tools.

The net result of all of this is… pretty much nothing. Except the small matters of trillions of US dollars off central bank balance sheets,10 huge cuts in public services11 and widespread public anger at governments.12 And yet economies have hardly been boosted by all this tumult. As a case in point, eight years after the GFC hit, the Eurozone’s four largest economies have low GDP, pitiful consumption, little or no improvement in the number of people employed and scary unemployment levels (see charts).

Failing Eurozone

Source: IMF

Why have central banks failed?

In his talk at the Dataconsult Breakfast in Bangkok, Steve explained that the current tools being used – quantitative easing (QE) and negative interest rates on bank reserves – are useless.

To start with, QE isn’t money printing: it in fact puts money into private bank reserve accounts held at the central bank, not into people’s bank accounts. QE has served to inflate already leverage-inflated asset prices and doesn’t even enable private lending anyway, as even the Bank of England has admitted in its now famous paper which contradicted its own recent policies.13
The policy of negative base interest rates is counter-productive as well. They don’t cause negative rates on personal bank accounts but instead give banks negative income assets, leading the banks to increase rates on private loans.

All this results in maintaining the symptoms of overvalued assets, instead of addressing the cause of the problem – the massive amounts of private debt.
I’ll take a closer look at private debt in Part 2.

Footnotes:
1 http://www.ideaeconomics.org/
2 Zed Books; Revised, Expanded ed. edition (September 1, 2011)
3 http://www.investopedia.com/terms/n/neoliberalism.asp
4 http://intheblack.com/articles/2015/07/07/6-economists-who-predicted-the-global-financial-crisis-and-why-we-should-listen-to-them-from-now-on
5 http://www.forbes.com/sites/stevekeen/#190e25b26e6b
6 https://www.law.cornell.edu/uscode/text/15/chapter-94/subchapter-I
7 http://www.investopedia.com/terms/f/financial-services-act-of-1999.asp
8 http://www.investopedia.com/terms/g/glass_steagall_act.asp
9 http://www.nytimes.com/2008/09/28/magazine/28wwln-reconsider.html?_r=1
10 http://www.telegraph.co.uk/finance/economics/11362087/ECBs-quantitative-easing-programme-launched-by-Mario-Draghi.html &
 http://www.zerohedge.com/news/2015-08-19/after-6-years-qe-and-45-trillion-balance-sheet-st-louis-fed-admits-qe-was-mistake
11 http://www.bbc.com/news/10162176
12 http://www.channel4.com/news/europes-anti-austerity-movements-from-podemos-to-the-snp
13 http://www.bankofengland.co.uk/publications/
Documents/quarterlybulletin/2014/qb14q1prerelease moneycreation.pdf


Update August 6, 2016

Howzat? Is the UK out? Part Two

Following on from my look at the effects of the UK’s referendum result on currency markets, it’s now worth checking out equity markets, the UK and global economies.

In terms of equity markets, it seems fair to assume that the FTSE has, as expected – if not even more quickly – shrugged off the impact of the UK exit vote, despite hysteria about American banks relocating to Paris1 (I’ll believe that when I see it), Virgins feeling safer on the continent2 and Mark Carney3 doing his best impersonation of the character Private Frazer from ‘Dad’s Army’, whose catchphrase was “We’re doomed!” (and by the way the new big screen version is good family infotainment on the topic of the UK’s relationship with Europe4).

In the fullness of time I expect the FTSE to ultimately fall further from here but not initially by any more than it would have done had the UK remaindered. In terms of the UK property market, the widening of discounts in properly structured property investment trusts is exactly as I’d anticipated and has more to do with the overvaluation of the UK property market. The referendum has let some air out of this bubble which is ultimately beneficial. The suspension of open-ended property funds is an inevitable occurrence for this kind of inanely, almost criminally, mis-structured investment product which really should have been banned following the debacle of 2008 for this asset underclass.5 It speaks more to the marketing capabilities of big asset managers and the huge blind spots that too many advisors and investors have developed in the desperate search for yield at any cost. This accident was waiting to happen. That it happened now may be able to point to the  Breferendum as a proximate catalyst, rather than cause, but in so doing it has spared the greater pain that would have come from delaying this.

Much has been made about the political complications surrounding Scotland and Northern Ireland. I can see absolutely no economic significance in either of these situations that won’t, in all probability, be overtaken by much more significant economic events. In fact, that also applies to the UK as a whole. One of the more thoughtful analyses of the result announced in the early hours of June 24th was by Irish Economist David McWilliams6 who was at pains to point out that this isn’t a ‘Sarajevo moment’. However, his article concludes that “It will only become a monumental historical event if, like the Bourbons, the EU – and by extension the Irish elite – choose to ignore this warning. They can’t be that remote, can they?”

Anyone familiar with David or his work might suspect that he’s firmly convinced that they are indeed that remote and therefore this will become a monumental historic event.

In which case, the real importance of the Referendum result will be if genuine democracy is allowed to return to Europe and the EU is broken up. One of the main challenges to this may well be the anointing of Theresa May as the UK’s next PM. Ironically for a clergyman’s daughter, Ms. May is a protégée   of the Bullingdon Boys. She is also an (albeit new) Oxford alumnus. More alarming is perhaps the way that the Parliamentary Tory Party so quickly adopted Ms. May, a deeply committed remainderer, as the overwhelmingly popular candidate. The expectations should be for a very ambivalent approach to pursuing exit designed to promote delays, confusion and ultimately a change in the direction of travel away from the exit door.

The key issue is whether this strategy is able to succeed in not only preventing the UK’s exit but moreover deterring the vast majority of long-term EU member nations whose constituents favour a referendum and an exit. I wouldn’t be surprised if the May Government is able to prevaricate so long that Article 50 is never invoked. I would, however, be surprised if populist anti-EU sentiment across the continent fails to materialize in a way that leads to the break-up of the EU. The June referendum’s main significance is that it opened this door.

Prior to the Referendum, I produced this comparison based on the results of research from Pew (see chart 1):7

Chart 1

However, the very tiny amounts of contagion resistance are from EU citizens – not the political classes. Yanis Varoufakis has already discovered just how difficult the EU’s self-preserving political machinery can be at preventing the right thing actually coming to pass8. Therefore, the period during which electorates and governments battle over the ‘failed construct’9 that makes up the EU, could in and of itself be sufficiently destabilizing to provoke the EuroZone’s Minsky Moment.10

If the break-up of the whole EU doesn’t happen, the separation of the twenty-something supposedly single but increasingly non-fungible federal currencies will certainly do so. Again this is something that I laid out in advance of the Referendum11 and it seems that the markets are now also taking this seriously judging by the price action of the European banking sector and Deutsche Bank in particular (see chart 2), as well as the sudden rush of negative news flow12.

Deutsche Bank Share Price 2016

Chart 2 - Source: Marketwatch.com

The pain wouldn’t end there if this Minsky Moment led to the demolition of China’s economic house of cards13 and the consequential purging of the global debt system would endure for a number of years. But finally then we’d be able to ultimately burst the credit bubbles of the last 30-40 years, which are currently destroying the financial prospects of the large majority of the 7 billion people whose present and future is otherwise blighted.

The UK’s exit may have been brought about for the wrong reasons but it’s the first step towards a painful but necessary global economic healing.

Footnotes:

1 https://next.ft.com/content/a3a92744-3a52-11e6-9a05-82a9b15a8ee7

https://next.ft.com/content/e0a5af3a-3ddd-11e6-8716-a4a71e8140b0

http://www.independent.co.uk/news/business/news/uk-banks-move-brexit-eu-referendum-paris-amsterdam-passporting-single-market-eea-sapin-hollande-a7110651.html

2http://money.cnn.com/2016/06/28/news/companies/richard-branson-virgin-jobs-brexit/

3 http://www.thisismoney.co.uk/money/comment/article-3676038/MAGGIE-PAGANO-Important-Government-moves-quell-sense-panic-led-deep-rifts-UK-continent-Brexit.html

4 https://www.youtube.com/watch?v=HaxkLVtRY1U

5 http://www.ft.com/cms/s/0/5c1be46c-4456-11e6-b22f-79eb4891c97d.html

6 http://www.independent.ie/opinion/columnists/david-mcwilliams/calm-down-the-brexit-referendum-result-is-not-a-21stcentury-sarajevo-34842130.html

7 http://www.pewglobal.org/2016/06/07/euroskepticism-beyond-brexit/

8 And the Weak Suffer What They Must?: Europe’s Crisis and America’s Economic Future by Yanis Varoufakis, Nation Books, 1568585047

9 https://twitter.com/CapitalJon/status/746588316288458753

10 http://www.investopedia.com/terms/m/minskymoment.asp

11 http://www.cnbc.com/2016/06/20/brexit-would-expose-germanys-vulnerable-underbellybut-its-the-best-outcome.html

12 http://www.cnbc.com/2016/07/06/european-bank-stocks-tumble-again-amid-brexit-fears.html

13 http://www.zerohedge.com/news/2014-03-19/chinas-minsky-moment-here-morgan-stanley-finds

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]

Could Paul Pogba crash the Equity Markets?

Debt, Inequality and Credit Stagnation Part 2

Debt, Inequality and Credit Stagnation Part 1

Howzat? Is the UK out? Part Two