Posts filed under “Think Tank”

Andy Xie: Here We Go Again

Former Morgan Stanley Analyst Andy Xie explains why China is a potential bubble:


Asset bubbles come and go. Each begins with a story: Japan as No. 1, the East Asian miracle, dotcom mania, how financial innovations eliminate risk – just to mention the latest four. Each begins with a plausibly bullish story, which is then magnified by the financial markets, creating the inevitable bubble.

Back in the 1980s, Japan produced world-conquering, seemingly invincible companies like Sony and Toyota. Their competitive gains justified the re-rating of Japan’s asset prices. The issue was by how much? This is where imagination ran riot. Next came the East Asian miracle – a story of gross domestic product. The “Asian Tiger” economies generated high GDP growth rates even while the US economy was depressed. Financial markets caught on to that, extrapolated the trend ad infinitum, and re-priced their assets accordingly.

At the end of the 1990s, the dotcom phenomenon conjured up the possibility of making unlimited amounts of money in a new economy. Financial markets ignored the role of competition in limiting profitability, while irrational exuberance led to overinvestment and the collapse of profitability. More recently, financial innovations were peddled with a tale of decreased risk through financial engineering, and that lower risks would lead to the re-rating of risk assets like property or stock. It turned out that this, too, was just a story. Decreasing risk was a mathematical illusion. As more and more people believed the story, prices of risky assets moved higher, which validated the expectation of lower risk – for the time being.

The current bubble is unique. It began with a horror story: paper money will evaporate in value and, hence, you should buy something — anything — with it. At a recent lecture I gave in Hangzhou, one wealthy member of the audience said: “Property may be 100% overvalued. But I will still get half when it comes down. Paper money will be worth zero.” The allure of this latest tale is that the economy doesn’t matter. If the world is in recession, so what? If stock and property markets collapse, so what? We just run away from paper money, right? Better to borrow to buy assets. This is where bank lending policies come into play. But the more willing the banks are to lend, the hotter the asset markets become.

Chinese mainland banks experienced a banking crisis a decade ago. They lent with abandon for land speculation in the early 1990s, which led to rampant inflation and triggered monetary tightening. Land prices began to fall in the mid-1990s, and they sank further in the Asian Financial Crisis of 1997 due to falling exports. Forty percent of all bank loans were non-performing.

To rescue the banks, the government stripped out their bad assets, mandated wide lending margins to enable them to earn their way back, and floated them in Hong Kong for recapitalization. These helpful measures were accompanied by a lending boom after 2004. Now they are ranked first, second and third worldwide in terms of market capitalization.
However, for banks, good fortune doesn’t usually last. A lending boom is inevitably followed by a crisis. This has yet to play out on the Chinese mainland.

Right now, banks are force-feeding the economy with liquidity. The purpose of the so-called “quantitative easing” was to generate domestic demand while exports slumped, but the liquidity has flowed into property and stock markets instead (and has partly become government fiscal revenue).

The inflation-fear bubble will burst in due course. Paper money loses value over time at the rate of the difference between inflation and interest rates, so if the inflation rate is 6% and the bank deposit rate is 2%, paper money loses 4% per annum, or 0.33% per month. Stocks and properties in China may be 100% overvalued, with only two decades of relatively high inflation justifying their prices. However, persistently high inflation leads to currency devaluation, which triggers capital flight and, eventually, an asset market collapse. This story simply won’t hold together for long.

A case in point is the US Savings and Loans crisis of the late 1980s and early 1990s. The US Federal Reserve kept monetary policy loose to help the banking system. The dollar went into a prolonged bear market. During the descent, Asian economies that pegged their currencies to the dollar could increase money supply and lending without worrying about devaluation, but the money couldn’t leave home due to the dollar’s poor outlook, so it went into asset markets.

When the dollar began to rebound in 1996, Asian economies came under tightening pressure that burst their asset bubbles.

The collapsing asset prices triggered capital outflows that reinforced asset deflation. Asset deflation destroyed their banking systems. In short, the US banking crisis created the environment for a credit boom in Asia. When US banks recovered, Asian banks collapsed.

Is China heading down the same path? There are many anecdotes to support the comparison. Property prices in Southeast Asia became higher than those in the US, but “experts” and government officials had stories to explain it, even though their per capita income was one-tenth that of the US. Their banks also commanded huge market capitalizations, as financial markets extended their growth ad infinitum. The same thing is happening in China today.

When something seems too good to be true, it is. World trade — the engine of global growth — has collapsed. Employment is still contracting throughout the world. There are no realistic scenarios for the global economy to regain high and sustainable growth.

China is an export-driven economy. Bank lending can support the economy for a short time, however, stocks are as expensive as during the heydays of the last bubble. Like all previous bubbles, this one, too, will burst.


Here We Go Again
Andy Xie
China International Business, October 10, 2009

Category: Think Tank

Another day, another $ drop

Another day, another 14 month low in the $ index and record high in gold. This comes even after the Oct German ZEW investor confidence figure in their economy was almost 3 points less than expected and unexpectedly fell from Sept, below forecasted inflation data in France and the UK and a comment from an…Read More

Category: MacroNotes

On the Cusp of a Fascinating Earnings Season

Good Evening: The major U.S. stock market averages rose for a sixth straight day today, and the S&P 500 set a new closing high for 2009 in the process. I will first breeze through today’s events before examining what I think could be a fascinating earnings season. Since there are important similarities and differences between…Read More

Category: Markets, Think Tank

Quarterly Review and Outlook – Q3 2009

I look forward at the beginning of every quarter to receiving the Quarterly Outlook from Hoisington Investment Management. They have been prominent proponents of the view that deflation is the problem, stemming from a variety of factors, and write about their views in a very clear and concise manner. This quarter’s letter is no exception, where they once again delve into the history books to bring up fresh and relevant lessons for today. This is a must read piece.

Hoisington Investment Management Company ( is a registered investment advisor specializing in fixed income portfolios for large institutional clients. Located in Austin, Texas, the firm has over $4-billion under management, composed of corporate and public funds, foundations, endowments, Taft-Hartley funds, and insurance companies. And now let’s jump right in to the essay.

John Mauldin, Editor
Outside the Box

Ponzi Finance

The Federal Reserve reported that as of June 30, 2009 total U.S. debt was $52.8 trillion. Total U.S. debt includes government, corporate and consumer debt. Importantly, however, it does not include a few trillion in “off balance sheet” financing, contingent unfunded pension plans for corporate and state and local governments, or unfunded liabilities of the U.S. government for such items as Medicare, Social Security and other programs. Currently GDP stands at $14.2 trillion, so there is approximately $3.73 in debt for every dollar of output in the United States, a level unprecedented in our history (Chart 1). Normally, debt levels as a percent of GDP would be uninteresting and immaterial; however, the current level of debt is unique in two ways. First, the asset side of the balance sheet purchased by the debt is falling in price. Second, the money that was borrowed to purchase those assets was often fraudulently expended. Neither the borrower nor the lender really expected the debt to be serviced. Rather, each party expected the asset price to rise extinguishing the debt.


This type of financial arrangement was correctly analyzed by the famous American economist Hyman Minsky in his paper, “Financial Instability Hypothesis”, in which he described three phases of debt financing. The first is “hedge finance”, where the lender expects a return on both principal and interest. The second is “speculative finance” where the lender expects to get interest on the loan but perhaps not the principal. The third case, where the lender expects neither the principal nor interest to be returned, is referred to as “ponzi finance”. This was typified in the last business cycle by loans issued without documentation, no down payment home loans, extremely low cap rates on commercial real estate, and the high leverage borrowing ratio of private equity funds. Even ponzi finance works as long as asset prices are rising. But once the bubble is pricked, the debtor is left with declining asset values that preclude the rollover of their obligations.

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Category: Think Tank

2nd quietest volume day of the year

While the market has come off its intraday highs, it didn’t take much as volume is running at the slowest pace since Jan 2nd, the Friday after New Years Day. With earnings reports upon us in earnest beginning tomorrow, the stock market becomes a different place in that it more discriminates between those that deliver…Read More

Category: MacroNotes

Oh, Those Financials!

Oh, financials, financials, financials. Here we go again. JPMorgan Chase reports quarterly profits on Wednesday; Citi announces a quarterly loss on Thursday, Bank of America delivers its results (no one knows if loss or profit) on Friday. The parade will continue right through Halloween.

Cumberland does not use single stocks in its US equity account management. So while we are keenly focused on these reports, we’ll review some of the applicable ETFs instead.

Since March 9 the big bank ETF that tracks the KBW Bank Index has delivered a total return of 145%. The three banks reporting this week constitute 25% of the weight of the exchange-traded fund (ETF) that mirrors that index. Its symbol is KBE. These big banks are deemed “too big to fail” and have benefitted greatly by obtaining the federal government’s direct support and guarantees. That subsidy will be revealed in their positive surprises to earnings reports

Contrast KBE with KRE. It is the exchange-traded fund composed of regional banks that have not been deemed “too big to fail” by the Washington-based troika of Treasury, Fed, and White House/Congress. Many regional banks are small enough to be resolved by the FDIC, and many suffer from a greater concentration of deteriorating commercial loans than their larger brethren. Their status is reflected in the performance of their stocks. KRE has had a total return of only 49% since March 9. It has actually lagged the performance of the S&P 500 index, represented by the “Spider.” SPY has had a total return since March 9 of 59%.

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Category: Think Tank

Self sustaining or not? That is the question.

In a harbinger of what’s to come in terms of Q3 growth, Singapore is the first nation of significance to report Q3 GDP and it was better than expected. Its GDP grew 14.9% q/o/q annualized, .4% higher than forecasts. Q3 Earnings reports beginning in earnest this week will translate for us what the statistical global…Read More

Category: MacroNotes

Killing the Goose

Killing the Goose
October 9, 2009
By John Mauldin

Killing the Goose
What Were We Thinking?
Let’s Play Turn It Around
Detroit, the Red Sox and the Yankees, and Traveling Too Much

Peggy Noonan, maybe the most gifted essayist of our time, wrote a few weeks ago about the vague concern that many of us have that the monster looming up ahead of us has the potential (my interpretation) for not just plucking a few feathers from the goose that lays the golden egg (the US free-market economy), or stealing a few more of the valuable eggs, but of actually killing the goose. Today we look at the possibility that the fiscal path of the enormous US government deficits we are on could indeed kill the goose, or harm it so badly it will make the lost decades that Japan has suffered seem like a stroll in the park.

And while I do not think we will get to that point (though I can’t deny the possibility), for reasons I will go into, there is the very real prospect that the upheavals created by not dealing proactively with the problems (or denying they exist) will be as bad as or worse than the credit crisis we have gone through. This is not going to be something that happens overnight, and the seeming return to normalcy that so many predict has the rather alarming aspect of creating a sense of complacency that will only serve to “kick the can” down the road.

This week we look at the problem, and then muse upon what the more likely scenarios are that may play out. This is a longer version of a speech I gave this morning to the New Orleans Conference, where I also offered a path out of the problems. This letter will be a little more controversial than normal, but I hope it makes us all think about the very serious plight we have put ourselves in.

Let’s review a few paragraphs I wrote last month: “I have seven kids. As our family grew, we limited the choices our kids could make; but as they grew into teenagers, they were given more leeway. Not all of their choices were good. How many times did Dad say, ‘What were you thinking?’ and get a mute reply or a mumbled ‘I don’t know.’

“Yet how else do you teach them that bad choices have bad consequences? You can lecture, you can be a role model; but in the end you have to let them make their own choices. And a lot of them make a lot of bad choices. After having raised six, with one more teenage son at home, I have come to the conclusion that you just breathe a sigh of relief if they grow up and have avoided fatal, life-altering choices. I am lucky. So far. Knock on a lot of wood.

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Category: Think Tank

The American Enterprise Institute in Washington hosted this discussion on the steps taken by the government to stabilize the financial markets. In the first session, AEI resident scholar Vincent R. Reinhart presented his findings gleaned from a series of conversations with market participants. Angel Ubide of Tudor Investment Corporation; Greg Ip, the U.S. economics editor…Read More

Category: Bailouts, Regulation, Think Tank

TIPS, what they sayin?

With the persistent weakness in the US$, a 4% rally this week in the CRB index, much better than expected job’s data from Australia and Canada, a rate hike from the RBA, and a weak 30 yr US bond auction, inflation expectations in the 5 year TIPS has risen 11 bps on the week to…Read More

Category: MacroNotes