But as
There are some good signs out there for sure, but let's not get carried away.
Saturday, July 18, 2009
The media needs to calm down
Since the past few days, a lot of good news has been thrown on the financial papers. The Yen is coming back strong against the US Dollar breaking the 94 mark at Friday close. This is good comeback from a 3 month low reached just over a week ago. Manufactiuring news from the US and China is positive. The Indian markets were rallying a few days ago boosted by Realty and Metals. Singapore reported 20.4% GDP growth (annualized) from April to June. Japanese central bank also said that the worst of the recession is over. And of course, who can forget the blockbustre results by GS and a strong JPM performance. This prompted several media channels to paint a bright and rosy picture misquoting econmists such as Dr. Roubini et. al. This further triggered market rallies in the US. You just needed to see the markets section on any internet newspaper over the last few days and you would see green.
But as points out, what these media channels are hiding are Dr. Roubini's views that this recession is a U shaped one instead of V-shaped recessions we've seen in the past. So the recovery would be slow and challenging. Over 75% of US corporate results disclosed have beaten the analyst forecasts but it should be realized that these are boosted by inventory liquidation and reduced labour cost. The question we should be asking is that, is this rally sustainable? The Citi and BOA results yesterday should calm the media frenzy a little. Both posted quarterly profits but if it weren't for one-off gains (Citi divesting Smith Barney and BOA selling its stake in China Construction Bank), these behemoths would have been in the red.
There are some good signs out there for sure, but let's not get carried away.
But as
There are some good signs out there for sure, but let's not get carried away.
Thursday, July 2, 2009
The "deflation or inflation" argument
One might get confused by reading the newspaper these days. Some analysts claim that the US is heading for a deflation whereas there are others who still believe that the plethora of money printed would lead us to inflation. John Lee discusses this debate in an article on marketoracle.co.uk. He argues that it is unlikely the US will go through a deflationary phase like the one experienced by Japan in the 90s.
The deflationists cite the examples of the Great Depression of the 1930s and the Japanese lost decade of the 90s in support of their argument. They claim that the real estate and equity market bubbles were fueled by debt and an implosion of leverage caused more than a 50% devaluation in both these asset markets.
In the Japanese case, the crisis took its roots in the 80s where easy credit and excessive borrowing fueled real estate and stock market bubbles that burst at the turn of the decade. The Nikkei fell by over 70% and commercial real estate prices in major cities plummeted over 80% from their peaks. These created non-performing loans worth $2-3 trillion, a sum greater than Japan's GDP.
The mortgage market in Japan was steady througout the turmoil owing to the willingness of banks to defer payments. As a result the default rates were very low. The budget deficit went into the double figures only after 1997. Since Japan enjoys current account surplus and does not have a significant proportion of foreign borrowing, the yen was safe from attacks by debt and/or stock redemption.
As the interest rates were virtually zero, Japan had to resort to Quantitative Easing (Purchasing public and private assets by printing money). But this was only tried 11years after the bubble burst.
The US situation is a total contrast to the Japanese one in the early 1990s because the US is already running a double-digit budget deficit (at 12%). As mentioned above, Japan's budget deficit only reached double digits as a percentage of GDP in the 7th year of the crisis. Japan was one of the larget creditors in the world whereas the US is one of the l;argest debtors with $12 trillion owed to international lenders. The US is also in a current account deficit importing $670 billion more than in its exports in 2008. China alone holds $800 billion of US Treasury and if it wants to sell there will not be many buyers. This means that the Fed will have to buy all those by printing money. Actually, the Fed has already signalled its intent to purchase all sorts of US Treasuries.
This means that as long we have a paper money system, and a trigger happy Fed, we would be hard pressed to experience inflation. In only 2008 and 1009, the Fed has bought $2 trillion in toxic AIG notes and has committed to buy an additional $1.7 trillion of MBS and US Treasuries. It took Japan 10 years to get into quantitative easing and the US is looking at printing $4trillion by the end of 2009. So it is clear that the US will not take a similar trajectory to the 90's Japan but the concern is that it might take a path similar to that of Argentina in 2002. Hyperinflation!!
The problem that policy makers should be concerned about should be about minimizing the devaluation of the USD. Argentina's peso has still not recovered from the inflation phase. The per capita foreign debt on a US citizen is $186,717 and a meagre 7% saving rate is not sufficient. Even at 10% saving rate, it would take 10 years for the US to pay off the existing loan needless to say that every quarter sees more loan piled on. This could easily make the politicians to print more money but that would be devastating for the dollar. So what needs to be done is to cut back budget deficits and increase interest rates as soon as deflation worries fade away.
The deflationists cite the examples of the Great Depression of the 1930s and the Japanese lost decade of the 90s in support of their argument. They claim that the real estate and equity market bubbles were fueled by debt and an implosion of leverage caused more than a 50% devaluation in both these asset markets.
In the Japanese case, the crisis took its roots in the 80s where easy credit and excessive borrowing fueled real estate and stock market bubbles that burst at the turn of the decade. The Nikkei fell by over 70% and commercial real estate prices in major cities plummeted over 80% from their peaks. These created non-performing loans worth $2-3 trillion, a sum greater than Japan's GDP.
The mortgage market in Japan was steady througout the turmoil owing to the willingness of banks to defer payments. As a result the default rates were very low. The budget deficit went into the double figures only after 1997. Since Japan enjoys current account surplus and does not have a significant proportion of foreign borrowing, the yen was safe from attacks by debt and/or stock redemption.
As the interest rates were virtually zero, Japan had to resort to Quantitative Easing (Purchasing public and private assets by printing money). But this was only tried 11years after the bubble burst.
The US situation is a total contrast to the Japanese one in the early 1990s because the US is already running a double-digit budget deficit (at 12%). As mentioned above, Japan's budget deficit only reached double digits as a percentage of GDP in the 7th year of the crisis. Japan was one of the larget creditors in the world whereas the US is one of the l;argest debtors with $12 trillion owed to international lenders. The US is also in a current account deficit importing $670 billion more than in its exports in 2008. China alone holds $800 billion of US Treasury and if it wants to sell there will not be many buyers. This means that the Fed will have to buy all those by printing money. Actually, the Fed has already signalled its intent to purchase all sorts of US Treasuries.
This means that as long we have a paper money system, and a trigger happy Fed, we would be hard pressed to experience inflation. In only 2008 and 1009, the Fed has bought $2 trillion in toxic AIG notes and has committed to buy an additional $1.7 trillion of MBS and US Treasuries. It took Japan 10 years to get into quantitative easing and the US is looking at printing $4trillion by the end of 2009. So it is clear that the US will not take a similar trajectory to the 90's Japan but the concern is that it might take a path similar to that of Argentina in 2002. Hyperinflation!!
The problem that policy makers should be concerned about should be about minimizing the devaluation of the USD. Argentina's peso has still not recovered from the inflation phase. The per capita foreign debt on a US citizen is $186,717 and a meagre 7% saving rate is not sufficient. Even at 10% saving rate, it would take 10 years for the US to pay off the existing loan needless to say that every quarter sees more loan piled on. This could easily make the politicians to print more money but that would be devastating for the dollar. So what needs to be done is to cut back budget deficits and increase interest rates as soon as deflation worries fade away.
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