I have rarely been accused of this crime in recent times. During my regular Sunday morning conversation with a friend in the industry, he said that I was sounding more optimistic than he would have expected. Optimism on financial markets and I make strange bedfellows. He might be right to hint that I am overlooking something.
Certainly, the pessimism does not have to come from Europe. Recent announcements should actually support the notion that the missing element of a fiscal union (some call it fiscal unification to emphasize the process rather than the outcome) in the European Monetary Union is being put into place, if clumsily. The proposal to fund Greece—should it fail to raise money from the market—through International Monetary Fund (IMF) assistance supplemented by European Union member countries is a smart one. Greece cannot escape serious budget reforms, either way. Serious budget reforms include improvement in governance and labour productivity. Decline in living standards must be tolerated at least for a while. Spain and Portugal have lower public debt to gross domestic product ratios (gross debt ratio). Their problems should be more manageable. The real one is Italy and we do not know when that would blow up.
The other big worry out there is Japan. Its gross debt ratio is expected to hit 250% by 2014, according to IMF, and its net debt ratio would be “only” 140%. Its population is greying. Consequently, incomes would fall, as would savings. Pension funds would be depleted. Japanese pension fund—a big buyer of Japan government bonds (JGB)—has applied for credit lines to meet its obligations to retirees since it does not want to risk a rise in the interest rate on JGBs by selling them. The question is, who would buy the new government debt issued by Japan since it is not blessed with a growing economy and rising tax revenues. An imploding North Korea might send some needed immigrants into Japan. That would support economic activity. It is a moot point whether the Japanese are keen on it. The solvency of Japan is in doubt. Here too, the question is one of timing its arrival. So far, the Japanese government bond market shows no sign of stress.
The more immediate issue is the possibility of the US naming China a currency manipulator when the US treasury releases its much-awaited report on 15 April on exchange rate practices around the world. It is one of those unilateral reports that the US government produces, offering judgement on practices around the world. Wonder whether the US would have been labelled an interest rate and currency manipulator with its penchant for interest rate cuts for all declines in asset prices.
Congress is baying for blood. Nobel laureates pitch in and the heat is on. But my friend believes that saner heads would prevail and that the US would open negotiations with China on a timetable for exchange rate adjustments. After all, it makes no sense for the US to prepare for its strategic and economic dialogue with China in May by calling China names in April. I agree with him on that.
The other issue is the story of bubbles and problem loans in China. This was briefly discussed in last week’s Bare Talk. China’s property bubble must be one of the most widely identified bubbles in the world. Bubbles grow bigger and dangerous when everyone believes that prices are rational. China’s local government debt indigestion is a headache for its banks, but the government should be able to see this one through, given current growth momentum. Yes, China may not be able to handle the fallout of another loan binge in the coming years. By then, economic growth might be too weak to wash away all sins of command capitalism. All the more reason for them to set financial prices freer sooner rather than later. The good news is that they appear readier than before to make their moves.
The failure of US treasury debt auctions last week is an important development. The yield on the US 10-year treasury bond climbed to 3.85% by the end of the week. It is not a reflection of any innate US economic strength. It reflects poor demand. Whether the lack of demand is temporary or permanent remains to be worked out. If the latter, we have to call Houston. We have a problem. Alan Greenspan thinks so.
This would force the Federal Reserve to abandon talk of exiting from quantitative easing and the dollar would resume its dive. That would kick off the next phase of global paper money debasement. Here too, a rush to judgement should be resisted. We have to wait for the release of the US employment report on the day after the All Fools’ Day.
In conclusion, Bare Talk thinks that there is still time to pull the bid on risky assets. Like many of its judgements, this one can be wrong too. It could be picking pennies in front of the roadroller.
V. Anantha Nageswaran is chief investment officer for an international wealth manager. These are his personal views. Your comments are welcome at firstname.lastname@example.org