Despite reading and agreeing with much of the GaveKal book as reported last week, we remain what they call "perma-bears" on the US economy and the USD. The reversal of the slide in the USD of recent months, and the strong performance of the US stock markets makes us bears feel like hibernating, a temptation we must, however, resist in the light of long-term trends. Remember, the whole debate is whether low profits but high cash inflows into China (and not just China) will continue to facilitate the high profits but high dollar outflows of the USA.
Here is a sobering figure: remember when the US current account deficit was significantly less than the trade deficit because of higher returns of US investments overseas than returns to foreign investments in the USA? Now the two deficits are about the same at $ 750 billion, but of which net interest costs have reached $200 billion per year and are rising sharply. The net position of foreign ownership of US assets has now reached $2.5 trillion. Euroland and other English-speaking countries take the total to $ 4.3 trillion net, owned first by Japan at $ 1.5 trillion and then mainly emerging markets. Quite a reversal of historical trends.
GaveKal are absolutely right about China manufacturing at low margins. China expert, Simon Hunt, provides hard data: losses in the manufacturing sector of China are running at about $ 25 billion per year, also growing sharply, compared with a current account surplus of $129 billion (of which $101 billion trade).
Neither situation looks sustainable, but apparently the US authorities act as if they wish and expect the status quo to continue indefinitely. Theirs is a do-nothing policy. China is, however, more than likely to act. Hunt identifies a major shift in Chinese economic policy now underway: from "growth at any price" (including easy lending, over-investment, building boom and loss-making manufacturing) to "value-creation", with added value for the all the population, including those outside the coastal boom cities. The losses of Chinese industry result from over-investment, and therefore excess capacity, made for political rather than commercial reasons. This can be corrected only be shifting from capital expenditure to domestic consumption. A reduction in capex will be achieved by banks being ordered to lend on a commercial basis. Consumption is obviously expanding, but only among the new rich in the big cities. Hunt suggests that the fear of medical expenses still make most Chinese heavy savers; more social security would change this mindset.
We must avoid thinking that the imbalance is only about China. On one side, it is a "one-consumer" story, but the supply side has many other participants: Japan, oil-producers and many emerging economies. Yet, somehow, it is China which will serve as the model many others will follow. The shift in Chinese policy will mean rising prices for manufactured goods, but lower prices for commodities, especially those associated with construction. Overall, we suppose that inflation will still remain low, and that the Fed will not dare raise the overnight rate so far as to invert the yield curve. The dollar remains vulnerable to the Chinese and other Asia policies, as well as to a weakening of the prop of higher interest rates than for the euro and other currencies.
The continued recovery of the Japanese economy has rekindled interest among our clients for Japanese convertible bonds.
Holders of Argentine bonds who declined to convert have paid a high price; surely Argentina will bail them out as some point, but is enjoying "making them suffer" in the meantime. The Province of Buenos Aires has a swap deal on offer very similar to that of the Federal debt a year ago. The deadline is 16th December. We recommend holders accept.
Emerging markets are nearly all doing very well, which explains the continued tightening of spreads and the repayment of IMF debt in advance by Brazil. Whether they obtain satisfaction on agricultural products in the Hong Kong negotiations seems unlikely. It is odd to see the US preaching more in favour of trade liberalism than the EU. Can the Bush Misadministration really have had a change of heart? Not the case for France, unfortunately.
Recommended average maturity for bonds in each currency
Barbell in EUR. Move to a neutral 5 year in USD.
|As of 07.12.05||2010||2012||Floaters & 2015||2012|
|As of 09.11.05||Floaters||2012||Floaters & 2015||2012|
|Dr. Roy Damary|