Sunday, August 31, 2008

Global Recession: Reading From Individual Actions Than From The Collective

``Here’s the truth: voters naively think (or hope) that one man has the right answers in the right plan. It's not possible. Presidential policies are way too simple in a world way too complex to be prescriptive with any certainty in their consequences. Stuff happens. I believe the only thing a single man can do before an audience is this: get their attention; move them to action. Influence. Change their psychology. Make them positive, make them hopeful, inspired, make them motivated. Make them act. We don't have to agree with the words of history's greatest orators, but we can't deny they moved people. Mostly for the better (Cicero (before senate in Rome), Jesus (Sermon on the Mount), Patrick Henry (liberty or death), Lincoln (Gettysburg + Inaugural Address), FDR (fear speech) Churchill, Kennedy (Ask not and Moonshot), MLK (I have a dream), Reagan, even—Al Gore created an entire movement, with a slide-deck). Make no mistake: history is littered with corrupted power, jingoistic rhetoric, misguided promises and words wielded with malicious intent from galvanizing speakers (Hitler, Stalin, Castro, Chavez) who took a broken people and raised their spirits and moved them to action--and to atrocities--in the completely wrong direction.”-Josh Wolfe, Words Matter
Recession has been the de rigueur word in the web sphere. The more the clarion the call for a global recession, the more public’s attention seems to have been drawn to this. The debate has apparently shifted from one of the probability of occurrence to one of severity and duration of the “established” event.

While it is true that what seem to ail the world today have been imbalances that have been fostered throughout the years, it isn’t clear how these “malinvestments” should result to cataclysm on a global scale.

The worst part is that the penance from the sins of one clique is seen as similar penitential discipline to the others whom have not committed the same iniquities. Thus, because of connectivity or “recoupling” we are told, we ought to prepare for Armageddon.

We learned from the Austrian school that because people are rational and thinking individuals guided by reasons to our every action, the diversity of the individual’s marginal utility or our “values” may generate different responses to even similar circumstances that we are faced with. Seen from the real world perspective, where circumstances are distinct for everybody, the responses from individuals are even more complex and disaggregated than can be comprehended by “articulate self-righteous” aggregate looking Keynesian assimilating experts.

As Jim Fedako of the recently
wrote, ``the concept of the individual must never be lost amid the ideal of the collective — the belief that the members of the collective (the nation in this instance) are faceless automatons dedicated to serving the whole.”

Such divergences can be seen even from governments themselves.

Many have argued that deteriorating conditions in the external trade and financial linkages would lead to central banks’ conventional response of cutting policy interest rates. During the last crisis, European central bankers followed the steps of the US Federal Reserves; faced with a recession in 2001 the US Fed slashed policy rates to 1% while the European Central Bank cut similar rates to 2%. Recently, as the US Fed cut an aggregate 325 basis points on the advent of the credit crisis, the Europeans refused to follow. And many have been puzzled by the ECB’s persistent recalcitrance.

In June, Wolfgang Munchao (at the
Financial Times) sees this in the light of evolving geo-political economic dynamics (highlight mine),

``This suggests that in terms of global monetary policy, we are in the middle of a shift from a unipolar to a bipolar world. In the past, the Fed’s policy alone used to determine the global monetary policy stance – via the dollar, the global anchor currency. Through long periods of loose monetary policies, including lengthy episodes of negative real interest rates, the Fed contributed directly to the rise in global inflation. I am not referring to the recent commodity price increases but to the trend rise in inflation we have been observing for some time.

``European inflation has also risen as part of this global trend. If the ECB follows the course Mr Trichet appears to have set out, there is now a real possibility that the eurozone, and perhaps some other regions in the world as well, could decouple from this US-led trend. This is what I mean by policy decoupling.”

While the ECB might belatedly respond to the lowering of interest rates considering rapidity of declines in economic conditions, this isn’t at all certain. The
Bloomberg quotes European Central Bank council member Axel Weber as saying in an interview in that ``there's no scope for interest-rate cuts and the bank may even need to raise borrowing costs again once the economy emerges from its slump.”

All this goes to show that the decoupling recoupling debate is nothing but abstractionism that won’t attain absoluteness simply because nations interact with each other and at same time retain distinctiveness in terms of domestic activities. In the same manner arguments which leads to a global meltdown based on such premises should also be seen with skepticism.

Look at how the world has defied such conviction, e.g. one year into the US-Euro credit crisis impelled global economic slowdown, Germany’s exports continue to account for positive growth whereas the country’s economic slowdown has been due to slowing domestic demand (
Wall Street Journal). In other words, Germany’s present weakness has been in the account not because of external linkages but from domestic strains allegedly from “high consumer prices” and not the externally presumed cause-and-effect factors.

Or look at Japan’s recent exports see figure 1.

Figure 1: Danske Bank: Asia leads Japan’s exports

The conventional analyses have focused on deteriorating export markets of US and Europe as one of the reasons for marking down Japan. But just recently China has emerged as Japan’s top export destination (IHT). The Dankse chart shows how the growth clip of Asian exports (blue) have remained resilient (or rangebound) in spite of the sharp volatilities in the US (red) and the European market (apple green).

Of course, we don’t deny that present developments may lead to the belated reactions in both Japan and Germany relative to external links as the downshift from global economic growth spreads, but the lesson is clear: If governments-organizations controlled by a few individuals-can’t get their act to be as predictable for the gloom-and-doom advocates, how much more when we deal with markets.

Stock Markets As Indicators Of Recession

``The media loves a recession, because it means no slow news days for a while. Every utterance from the Fed is a headline, weekly columns write themselves (just pick two recession cliches from your cliche file and rub ‘em together), and "man in the street" interviews will always yield some nice emotional sound bites.”- John Carlton, How to Survive Excessive Recession Hand Wringing

Financial markets function as forward discounting mechanisms and could thereby serve as leading indicator for impending recessions.

According to renowned Wharton economist Jeremy Siegel in Stocks for the Long Run, since 1948, 10 recessions in the US were preceded by a stock market decline with a lead time of 0 to 13 months or an average of 5.7 months. (It should be noted that ten stock market declines of greater than 10% in the DJIA were not followed by a recession)-[source].

Figure 2: Economagic: S & P 500 and US Recessions

Figure 2 from Economagic validates the view of Mr. Siegel that the stock markets have historically accounted for as strong lead indicators of previous economic storms. The recessions of 1970, 1974, 1981, 1991 and the latest bust all shows of falling stock markets values (based on the S & P 500 closing prices) prior to the formal recession (shaded areas).

Moreover, since official declarations are backdated-for instance the National Bureau of Economic Research (NBER), a private non-profit organization that officially reckons of the US business cycle, in 2001 declared the US entered into a recession in March but was broadcasted only in November 2001 (BBC)-the markets have already reflected upon the gist of the downside adjustments.

The S&P 500 accounted for nearly ¾ of the losses of the entire cycle in terms of scale (peak-trough) and had been at more than 50% of the duration of the time cycle of the bear market, when the pronouncement of a recession was made.

The point is, by the time of the official recession was recognized by the NBER, the likelihood is that the markets have already reflected the meat of the losses or is in the last inning of the bear market.

Of course, we’d like to point out that ALL recessions are different in terms of underlying causes, operating conditions and effects or impacts to markets or the economy such that we can’t interpret wholly past conditions as reflective of the future. Doing so would render one guilty of simplistic thinking.

Derivatives and structured finance or the so-called "shadow banking system", technology enabled real time capital flows, "Mrs Watanabe" and the US$ 3 trillion+ per day currency trades, South-South trading, 37 years of off-Brettonwoods “gold” standard, global transmission effects by currency pegs and dollar links, globalization of trade, labor and finance, emergence of sovereign wealth funds, massive growth of current account imbalances, emerging market vendor financing of current account deficit developed economies (or nondemocratic countries financing democratic nations), offshoring/outsourcing, WIKInomics, telecommutations, hybrid electric cars, climate change, nanotechnology, biotechnololgy and etc....account for only SOME of the variables that were NOT SEEN or were NOT AS SIGNIFICANT in the PAST as it is today that will continue to revolutionize or sizably impact present conditions going forward-in terms of economic, social, cultural, financial, political, environmental and scientific spectrums.

What we can do is to simply look at these circumstances and integrate past lessons into examining the potential distributive outcomes. Assuming a replay of past conditions under the present landscape signifies as haphazard analysis or thinking at best.

Recession: The Denmark and New Zealand Experience

From the recent global slowdown we can take glimpse of how some equity markets have responded to official recessions.

So far among developing economies only Denmark (EU Business) and New Zealand (BBC) have been official casualties to the economic downdraft or has encountered an economic growth recession in a technical sense (two quarters of negative economic growth), see figure 3.

Of course, Japan, UK and some economies under the Eurozone have been widely anticipated to fall into the daisy chain category of economic recessions in the coming quarters. Such expectations have allegedly resulted to a swift change of tide as seen in the furious rally of the US dollar index.

Figure 3: Denmark’s KFX Index (left) and New Zealand’s NZ50 (right)

Although Denmark officially acknowledged a recession last July (blue arrow)-having covered two quarters from October 2007 to June 2008 (see vertical blue lines)-we can note that from the peak-trough, the KFX has lost 23% and is now down about 18% from its former highs.

What seems to be noteworthy is that the labor market seems to be tight in spite of the recession. According to Steen Bocian chief economist of Dankse Bank (highlight mine), ``For now then, low unemployment is tempering the bleakest portents for the Danish economy. However, it is important to remember that the economy has just emerged from a long period of strong economic growth which has exerted immense pressure on the labour market. Labour shortages are therefore still a big concern for many businesses, making them reluctant to let people they worked hard to recruit go, even if order books are beginning to dry up.

``So, it is probably only a matter of time before we see a rise in unemployment. Nevertheless, there is a lot of evidence to suggest that such a move may be slow in coming and unlikely to result in especially high joblessness. Anyway, rising unemployment is not necessarily a bad thing for the Danish economy in the current climate. It may sound strange to say that the economy could benefit from having more people out of work, and of course this could not stand as an end in itself. But there is no doubt that pressure on the labour market remains intense, and unemployment is well below the structural level . i.e. one compatible with stable wage and price formation in the slightly longer term.”

It is indeed peculiar to hear an economist say that “high unemployment will be good for an economy” which is frequently blamed on “inflation” when monetary policies should be more of the culprit but nonetheless the low of levels of unemployment should extrapolate to a floor to the downside momentum of the Danish economy.

The chart itself seems to croon of the same tune; the KFX appears to be exhibiting signs of a bullish “double bottom”! So the likelihood is that Denmark’s travails could be short term in nature.

On the other hand, New Zealand which also was officially declared to be in a technical recession early August (blue arrow), covering the first semester of the year (blue vertical lines), has seen its major benchmark down on a peak to trough basis of nearly 30% to presently 22% following its recent rebound.

While it would be too early to conclude if New Zealand is in the path to a confirmed inflection point, what can be noted is that based on the technical picture the NZ50 appears to be attempting for a breakout from its bear phase of the stock market cycle. The seeming “breach” from the downside channel of the NZ50, once confirmed, should demarcate such transition.

Some Asian Bellwethers Attempt To Form A Bottom

The New Zealand’s primary benchmark the NZ50 is one of the 7 Asian bourses which seem to be working towards a formative “bottom” cycle as seen in Figure4.

Figure 4: Asian Bourses Attempting To Bottom

Aside from the Phisix and Vietnam where we previously discussed in The Philippine Peso And The Phisix: With A Little Help From Our Neighbors, and New Zealand; India’s BSE (upper left window) seems to mimic the NZ50’s motion, while the Taiwan’s Taiex (upper right window), Australia’s All Ordinaries (lower left window) and Thailand’s SET (lower right window) seem to be in a tight consolidation-typical characteristics of market bottoms; albeit this is too premature to conclude since it would need to manifest more prolonged period of rangebound movement or gradual ascension).

Nevertheless as a matter of market timing and the seasonality of trends, September usually has been a critical period for the global stock market as shown in Figure 5, although as reminder, seasonal trends aren’t infallible indicators.

Figure 5: September’s Seasonal Weakness

The US Dow Jones Industrials have tended to be weakest during September which if seasonal trends should persist, increases the odds of volatility this month considering the already frail economic environment.

And this is where it gets interesting; if Asian equity markets manage to withstand the turbulence abroad, then the chances for the “bottoming” process are likely to get enhanced going into the yearend. This implies that if the present “divergences” will be sustained from the expected infirmities in the US markets, then Asian markets could probably see a much amplified rally by the end of the year to highlight the establishment of the bottom cycle.

And going back to the current recessions of New Zealand and Denmark, the intensity and durations of such adjustments also matters. The recession’s longevity would likely be determined by the cyclicality or secularity of the present market trends relative to the domestic economic cycle. This suggests that if, for instance, Denmark’s recession had been based on economic growth ‘overheating’ than from systemic excessive overleveraging to deleveraging adjustments, then the present recession could be ‘short and shallow’ instead of an extended one. Hence the market actions should equally reflect such momentary shortcomings than a brutish bear.

Conclusion and Recommendation

Recessions are the official affirmations of the public’s expectation of statistical negative economic growth. Where the stock market signifies as a strong leading indicator, a declaration of official recession could be construed similar to the reverse analogy of “buy on rumor, sell on news”…or simply “sell the rumor, buy the news”.

So far among developed economies, only Denmark and New Zealand has entered its fold while some others have been expected to follow.

In addition, the durability and duration of a recession depends on the degree of structural or external influences on the economic and the market cycle. Read from the stock market’s perspective, in most instances, the official declaration of a recession usually marks of the last leg of the bear market cycle especially if the market’s deterioration was earlier prompted by cyclical forces. Structural led bear markets tend to extend losses overtime and in terms of depth.

Recession will probably be a problem for some Asian economies as Japan. However, interpreted from the stock market’s action, many Asian markets have been currently attempting to form a bottom which probably means that the contagion impact from the US credit crunch could be peaking unless proven otherwise. Going into the usually volatile month of September, such critical “bottom-forming” exercise could be confirmed or debunked.

If Asian markets manage to hold its standings or its present gains into September, then based on seasonal factors there is a good chance for the markets to rally going into the yearend. A rally that fortifies the technical picture seen above compounded with broader participation could formally establish the region’s transition towards the market’s “bottom” cycle and an upcoming recovery.

In the same plane, any weaknesses seen in the market this month could be seen as an opportunity to accumulate.

At the end of the day, stock markets are likely to be driven by monetary growth and credit creation, technological advances, economic and productivity growth.

Philippine Peso-US Dollar Dynamics: Forced Liqudation, Momentum and Big Brother

``In sum, the world is approaching a turning point after nearly a decade of growth without serious emerging market crises. It has benefited enormously from the specialisation of parts of the developed world, primarily the US, in the output of non-traded goods and the specialisation of emerging markets in traded goods. The US, with its strong institutions and impeccable credit, was thought to be in a good position to handle this specialisation, though the financial crisis shows that even it has its limits. As the US reduces its current account deficit, a transition in specialisation will have to take place. In the medium term, this will create opportunities in emerging markets, while also increasing risks.-Raghuram Rajan professor of finance at the Graduate School of Business, University of Chicago, is a former chief economist of the International Monetary Fund, Emerging markets must shift their focus inwards

The Philippine Peso dropped .6% over the week to Php 45.92 against the US dollar, this despite the Bangko Sentral ng Pilipinas’ recent move to raise its policy rates by 25 basis points (
Bloomberg). So much for the argument of interest rate rate differentials.

Dollar bulls earlier claimed that the reason why the Philippine Peso has been recently clobbered was due to “rising consumer price inflation”. Now that signs of “food price” driven “inflation” has been moderating as we expounded in
Philippine Peso Wilts Under The Unwinding Short US Dollar Carry Trade!, the argument has shifted towards a “weakening economy”.

US-Philippines Economic Growth Differential Mirage

While true enough the Philippines accounted for a sharp deceleration in terms of economic growth,
4.6% in the 2nd quarter (compared to 8.3% over the same period last year) at the time when consumer goods inflation reached 12.2% last July (to our guess the peak of the present cycle), US economic growth which surprisingly accelerated to 3.3% over the same period is still far below the present Philippine growth rates.

Yet what appears to have driven US economic growth in the 2nd quarter has been mostly “improved demand for exports” which according to, “added 3.1% to GDP, compared to just 0.8% in the advanced reading.”

Yet looking forward, gains from such progress look questionable,

Figure 6: Northern Trust: Deteriorating Corporate Profits

According to Northern Trust’s Asha Banglore, ``However, corporate profits from the rest of the world on a quarter-to-quarter basis have now dropped for two quarters in a row. Moreover, the recent rally of the dollar casts doubts about the ability of corporate profits from the rest of the world to help trim the decline in overall corporate profits.”

Why? From a theoretical standpoint a faltering global economy isn’t likely to give a lift to the already moderating export growth clip which should equally translate to declining corporate profits from exports going forward, as shown in figure 6.

This soft environment essentially translates to an adverse feedback loop that could drag US economic growth lower over the coming quarters.

On the other hand, the Philippine growth had been likewise boosted by ironically a resurgence of “exports” in the face of supposed deterioration of trade linkages, aside from remittances and the outperformance in agriculture. This from the, ``Only the agriculture, fisheries and forestry (AFF) sector posted a faster growth at 4.9 percent from 4.2 percent. The faster rise in the AFF sector was due to higher demand for domestically produced food because of the country’s growing population and the rising cost of imported food.”

Why our emphasis on the agriculture? Because from the “inflation” standpoint, food accounts for the biggest chunk or nearly half of the Filipinos’ headache when reckoning in terms of the expenditure basket. And the growing output from agriculture related industries will likely mitigate statistical inflation aside from redirecting wealth to the countryside.

So what has weighed on the Philippine economy aside from “inflation”? The answer from the industrial viewpoint is in services (
communications and transport) and industry particularly mining. While it is easy to blame “inflation”, it is unclear what has prompted such a slowdown and if these had been merely hiccups.

Overall, even based from the recent significant deceleration in Philippine growth, the US economy isn’t likely to outgrow the Philippines enough to justify the Peso’s weakness in terms of growth differentials. This also shows that monetary policy isn’t likely to favor the US too, because stronger economic growth allows more leeway for the local central bank to raise interest rates enough to widen the interest rate spread between the Peso and the US dollar.

US Dollar As Safehaven? Not In The Context of Iraqi Bonds or China’s Anxieties Over Fannie and Freddie

And again we simply can’t buy the hokum that the US dollar should function as “safehaven” in today’s global financial crisis; especially not when the source or origin or epicenter of today’s stresses –a diffusion of the deeply rooted US credit crisis emanating from an insolvent financial industry-is from the US.

Take a look at this news account…

From the
Financial Times, ``Bank of China has cut its portfolio of securities issued or guaranteed by troubled US mortgage financiers Fannie Mae and Freddie Mac by a quarter since the end of June.

``The sale by China’s fourth largest commercial bank, which reduced its holdings of so-called agency debt by $4.6bn, is a sign of nervousness among foreign buyers of Fannie and Freddie’s bonds and guaranteed securities.”

Does China’s queasiness over the fate of its
$376 billion holdings of Fannie and Freddie Mac securities signify US assets or the US dollar as a safehaven status?

…or how about this…Iraq bonds are now considered as “safer” than some US banks!

From the
Bloomberg (emphasis mine),

``Iraq's bonds are delivering the biggest returns in emerging markets as oil export revenue bolsters government finances and violence declines.

``The country's $2.7 billion of 5.8 percent bonds due 2028 gained 45 percent since August 2007, according to Merrill Lynch & Co. indexes. Investors demand 4.84 percentage points more in yield to own the debt instead of Treasuries, down from 7.26 percentage points a year ago. The spread is narrower than for notes of Ohio banks National City Corp. and KeyCorp, suggesting Baghdad may be safer for bond investors than Cleveland…

``Iraq provides some insulation from the market,'' Brown said. ``The risks are so idiosyncratic that it trades on its own drivers.''

The “Iraq is safer than Ohio bonds” doesn’t seem to support the US dollar as “safehaven” status, does it? Or maybe there has been a sudden epiphany for global investors to reckon Iraq bonds as the alternative “safehaven” asset? Moreover, I thought I heard someone utter “decoupling is a myth” argument?

In Taleb’s Black Swan rule, a single contradictory observation is enough to demolish a long held, deeply entrenched and popular espoused generalization.

Portfolio Outflows As Evidence

If there is anything that supports the case of a strong US dollar is that today’s forcible liquidations-in efforts to monetize liquid assets and shore up capital for the wobbly US financial industry-seems to be one of the main reasons behind the weakness of the Peso see figure 7.

Figure 7 DBS bank: Net foreign Selling in Philippines

The underperformance of the Philippine Peso and the Phisix relative to its Indonesian counterparts (JKSE and the Rupiah) can be partially explained by portfolio outflows for the Philippines and inflows in Indonesia.

But this isn’t just based on relative dimensions but seen from even across the region see figure 8.

Figure 8: EPFR Global: Asia ex-Japan least favored among EM regions; clear preference for commodities exporting regions

EPFR Global says that fund flows have favored commodity exporters. But generally, reckoned from a year-to-date basis, international portfolio funds have been net sellers of Emerging Markets, except for EMEA or Europe Middle East and Africa (green line).

And again this seems to be the invisible knot that ties the so called “recoupling” theory. Beleaguered companies or institutions embroiled in the credit crunch sell their most liquid assets to raise capital. Since many of these have accumulated significant overseas assets especially based on former favorite themes, thus the selling activities seem to be global and synchronic in nature.

Albeit, the outperformance of Middle East and Africa also seems to be buttressed by the rotation of portfolio flows. And we can’t discount momentum; liquidity constrains could have also introduced the sell EM Asia and buy Middle East Africa arbitrage. Yet as a puzzle the EMEA’s markets seem to be immune from the inflation story even when “inflation” seems to be relatively higher than Asia.

As an aside, Saudi’s Stock Exchange (Tadawul) is set to open its doors to foreigners (
Economist). Will the sagging Tadawul index get the much needed shot in the arm from foreign investors? Perhaps. If today’s preferential flows to the Middle East and Africa will continue. If foreign investors will remain blinded by market momentum even as the inflation story has been much more entrenched in the region.

Big Brother Is All Over

But again such appears to be just part of the major movers, the other, we suspect comes from the unwinding of the paired trades possibly triggered by government intervention as previously argued in
Philippine Peso Wilts Under The Unwinding Short US Dollar Carry Trade!

Recently the Bloomberg quoted on Japan’s Nikkei English News which reported of a long planned coordinated exercise by the officials of the US, Japan and Europe to support the US dollar.

From the
Bloomberg, ``Finance officials from the U.S., Japan and Europe in mid-March drew up plans to strengthen the U.S. dollar following troubles at Bear Stearns Cos., Nikkei English News reported, citing unnamed sources.

``The intervention designed by the U.S. Treasury Department, Japan's
Finance Ministry and the European Central Bank called for the central banks to purchase dollars and sell euros and yen, with Japan providing the yen needed for the currency swap if the greenback's value dropped significantly, the news service said.”

So present activities may have reflected government’s strong arm tactics.

Aside, chatters of market manipulation hasn’t been restricted to the US dollar, but to gold markets as well.

Some has speculated that governments through several banks have tried to suppress oil prices to shape conditions of an improving economic environment as the Presidential election nears.

According to the
Moming Zhou of CBS,

``Recent heat from Congress and regulators, along with public speculation, over whether commodity prices are being manipulated has also reached gold pits, where the debate was stirred by a surge in bets last month that gold prices would fall…

``Three unidentified U.S. banks held 86,398 short positions, or bets that gold prices will fall, in the COMEX gold market as of Aug. 5 -- 10 times more short positions than a month earlier, a government report showed.

``The report by the Commodity Futures Trading Commission, which regulates U.S. futures markets, also showed short positions held by three U.S. banks in silver futures had increased more than four times during the same period…

``Mendelsohn said he believes the government has tried to make the U.S. economy, oil, and markets appear in better shape and also to temporarily curb the immediate effects of the slumping housing market, of bad home loans and of the credit crisis.

With US government hands evidently seen in almost every corner of the financial sphere working feverishly to avoid what seems to be for them the menace of a catastrophic “deflationary” crash, it isn’t farfetched to also intervene for political purposes.


So, for us, issues germane to 1) statistical inflation, 2) economic growth differential, 3) interest rate differentials, 3) higher risk aversion landscape or lastly 4) US dollar as safehaven seem to be unconvincing fundamental reasons behind the recent US dollar’s rebound.

We are more convinced of the dynamics of 1) momentum 2) global capital raising activities partly via forcible liquidations by the developed world financial industry and most importantly 3) the tweaking of government hands of the financial markets for political and financial reasons.

However, continued US government support for the financial industry (Fannie and Freddie, growing bank closures) plus clamors for expanding Federal rescue to other industries like the
Detroit automakers, aside from vastly expanding fiscal deficits combined with baby boomers claims on unfunded liabilities are likely to weigh on US balance sheets and is expected to reflect on the US dollar.

Thursday, August 28, 2008

Philippine Stock Exchange Plans to Extend Trading Hours On A New Trading Platform by June 2009

According to the PSE, ``The board of directors approved the extension of trading hours in the afternoon from 2 pm up to 4 pm. The extended trading hours will coincide with the launching of the new trading system which is tentatively scheduled to go live on or before June 30,2009. Further all trading participants will be mandated to conduct afternoon sessions via off-floor trading.”

The PSE attempted to lengthen trading sessions to cover afternoons during early 2002, but was forced to scrap or do away with the experiment following the low reception which sparked broker complaints. Of course, the doldrums had everything to do with the unraveling bear market then.

However, with the market cycle turning higher, combined with the new trading platform acquired from the NYSE-Euronext (potential to expand into derivative trading-yes!-think of it the next time a bear market reemerges we can hedge!), we could be looking forward to better days.

Wednesday, August 27, 2008

Finance 101: Securitization

The Securitization process as defined by the IMF Finance (highlight mine),

“In its most basic form, the process involves two steps (see chart). In step one, a company with loans or other income-producing assets—the originator—identifies the assets it wants to remove from its balance sheet and pools them into what is called the reference portfolio. It then sells this asset pool to an issuer, such as a special purpose vehicle (SPV)—an entity set up, usually by a financial institution, specifically to purchase the assets and realize their off-balance-sheet treatment for legal and accounting purposes. In step two, the issuer finances the acquisition of the pooled assets by issuing tradable, interest-bearing securities that are sold to capital market investors. The investors receive fixed or floating rate payments from a trustee account funded by the cash flows generated by the reference portfolio. In most cases, the originator services the loans in the portfolio, collects payments from the original borrowers, and passes them on—less a servicing fee—directly to the SPV or the trustee. In essence, securitization represents an alternative and diversified source of finance based on the transfer of credit risk (and possibly also interest rate and currency risk) from issuers to investors.”

In a more recent refinement, the reference portfolio is divided into several slices, called tranches, each of which has a different level of risk associated with it and is sold separately. Both investment return (principal and interest repayment) and losses are allocated among the various tranches according to their seniority. The least risky tranche, for example, has first call on the income generated by the underlying assets, while the riskiest has last claim on that income. The conventional securitization structure assumes a three-tier security design—junior, mezzanine, and senior tranches. This structure concentrates expected portfolio losses in the junior, or first loss position, which is usually the smallest of the tranches but the one that bears most of the credit exposure and receives the highest return. There is little expectation of portfolio losses in senior tranches, which, because investors often finance their purchase by borrowing, are very sensitive to changes in underlying asset quality. It was this sensitivity that was the initial source of the problems in the subprime mortgage market last year. When repayment issues surfaced in the riskiest tranches, lack of confidence spread to holders of more senior tranches—causing panic among investors and a flight into safer assets, resulting in a fire sale of securitized debt. Securitization was initially used to finance simple, selfliquidating assets such as mortgages. But any type of asset with a stable cash flow can in principle be structured into a reference portfolio that supports securitized debt. Securities can be backed not only by mortgages but by corporate and sovereign loans, consumer credit, project finance, lease/trade receivables, and individualized lending agreements. The generic name for such instruments is asset-backed securities (ABS), although securitization transactions backed by mortgage loans (residential or commercial) are called mortgage- backed securities. A variant is the collateralized debt obligation, which uses the same structuring technology as an ABS but includes a wider and more diverse range of assets.”

Read the entire
article here

Defunct Olympic Games

From the Economist ``THE Beijing Olympics may be over, but the long run-up to the London Olympics has begun. In 2012 baseball and softball will be dropped as Olympic events. Played by only a handful of countries, they join a long list of discontinued Olympic events. The 100m freestyle swim for sailors survived just one Olympics after being limited to sailors from the host country. If some other events are dropped—farewell to rhythmic gymnastics or synchronised swimming?—there might be space to bring back more unusual sports. Perhaps it is time again for live pigeon-shooting (in Trafalgar Square) or an old favourite, the tug-of-war.”

Tuesday, August 26, 2008

36 Facts from the 2008 Beijing Olympics

Chris Chase via Yahoo sports gives us 36 interesting facts from the 2008 Beijing Games…

To quote Mr. Chase’s entire article…

In honor of the 36 gold medals won by the United States at the 2008 Summer Olympics, Fourth-Place Medal presents 36 interesting facts about the overall medal count:

1) China won the most gold medals at the Beijing Games with 51. They become the first country to crack the 50-gold mark since the Soviet Union in 1988. The most golds ever won in a single Olympics is 83 (United States, 1984).

2) It's the first time since 1936 that a country other than the United States or the Soviet Union has led the medal count.

As a side note: if we include in the tally the medal count of the former Soviet Union countries as representative of the old USSR-they would have still dominated the top spot for overall medal counts (but not for gold)…

Courtesy of

Now Back to the facts…

3) China won more golds in Beijing (51) than they did total medals in Atlanta (50).

4) 'Project 119' was a Chinese initiative designed toward winning golds in the medal-rich sports of swimming, track, rowing, kayaking and sailing. Reports are already crediting Project 119 with China's dominance in the gold medal count, but Chinese athletes won just four golds in those sports. Their total was instead augmented by even better performances in Chinese-dominated events like diving, gymnastics and table tennis.

5) The United States won the same amount of golds (36) that they did in Athens, continuing a remarkable consistency that the nation has exhibited over the past half-century. American Olympic gold totals since 1952: 40, 32, 34, 36, 45, 33, 34, 83, 36, 37, 44, 38, 36 and 36. (The outlier of 83 was from the boycotted 1984 Los Angeles Olympics.)

6) The overall medal count was won by the United States for the fourth consecutive Olympics. The U.S. earned 110 medals, compared to China's 100.

7) Per capita, China won one gold medal for every 25 million people in the country. The United States' per capita rate was one gold for every 8.5 million. The tiny island nation of Jamaica, which won a staggering six golds in Beijing, had a per capita rate of one gold for every 450,000 residents. Had China won at that rate, the country would have earned 2,889 golds.

8) Greece won 16 medals as the host country in 2004. Four years later, the founders of the Olympics managed just four -- their lowest total since 1992.

9) African countries won a total of 40 medals, the highest total in history for the continent.
10) Six countries won their first ever Olympic medals: Afghanistan, Bahrain, Mauritius, Sudan, Tajikistan and Togo.

11) Great Britain won 47 medals, the most in their history and a 17-medal increase from Athens. Expect an even higher total in 2012, when the Games will be held in London for the first time in 68 years. The last time Great Britain competed in a Summer Olympics on its home turf, they earned a disappointing three golds.

12) India has 17% of the world's population. They won 0.31% of Olympic medals.

13) China: 19.8% of population, 10.4% of medals.

14) United States: 4.6% of population, 11.5% medals.

15) Jamaica: 0.041% of population, 1.15% medals.

16) Iceland was the least populous country to win an Olympic medal.

17) Pakistan was the most populous country not to win an Olympic medal (164 million residents, sixth-largest nation in the world).

18) Michael Phelps would have finished tied for 9th in the gold medal count, ahead of countries including France, Netherlands, Spain, Canada, Argentina, Switzerland, Brazil and Mexico.

19) The rest of the world won seven golds in men's swimming events. Phelps, of course, won eight.

20) The United States won the most golds (7) and most total medals in the track competition (23), despite having what was widely considered a disappointing meet

21) More proof that boxing is dead in the United States: the country earned just one medal (a bronze) in the 12 boxing events. Even after three straight disappointing boxing performances at the Summer Games, the U.S. has still won the most Olympic boxing medals (109) in history.

22) China won 8 out of 12 possible medals in table tennis and 7 of 8 possible golds in diving.

23) Great Britain won 7 of 10 golds in track cycling and won 12 medals overall. The rest of the world earned 18 medals in the sport.

24) National gold-medal sweeps: Basketball (USA), Beach Volleyball (USA), Rhythmic Gymnastics (RUS), Synchronized Swimming (RUS), Table Tennis (CHN) and Trampoline (CHN).

25) Sweden had the best medal tally (4 silver, 1 bronze) without winning a gold.

26) Armenia won 6 bronze medals, but no gold or silver ones.

27) Speaking of former Soviet states, members of the former Soviet Union won a total of 173 medals in Beijing.

28) In 1992, Cuba finished 5th in the gold medal count. In 2008, the nation finished 28th.

29) From 1980 to 2008, Jamaica won three Olympic golds. In a span of six days in Beijing, Usain Bolt won three.

30) Sweden was a fixture in the top-three of the overall medal count for the early part of the 20th century. In Beijing, the Scandinavian country finished 38th and was shut-out in golds for just the second time in history.

31) Panama and Mongolia won the first gold medals in their respective histories.

32) China won 27 gold medals in judged sports.

33) The United States won 4 gold medals in judged sports.

34) China's "real" medal tally was 24/17/14/55.

35) The "real" medal tally for the United States: 32/31/27/80.

36) In all, 958 medals were handed out to athletes from 87 countries, the most medals and medal receipients in Olympic history.

Sunday, August 24, 2008

Will King Dollar Reign Amidst Global Deflation?

``Panics do not destroy capital; they merely reveal the extent to which it has been previously destroyed by its betrayal into hopelessly unproductive works”.- John Stuart Mill (1806-1873) British philosopher, political economist, civil servant and Member of Parliament, was an influential liberal thinker of the 19th century.

Deflation proponents have been confidently increasing their pitch of a global depression or “severe and prolonged” recession cheering about the US dollar’s recent gains as signs of such manifestation.

Since the US credit system has turned disorderly and dysfunctional, it is true that an alternative major flux for global “liquidity” stems from the US current account deficit. And an improving US current account deficit suggests of a further drain of liquidity AWAY from the global financial system, thus amplifying risk towards the financial markets.

Deflation proponents emphatically argue that the strength of the US dollar stems from (factually) the US dollar’s role as the de facto world currency reserve and secondarily from its sophisticated, deep and advanced state of the markets that are likely to attract “limited” capital flows away from the hinges and back to the center or the origin. Hence a global meltdown extrapolates to KING dollar reasserting its hegemonic role in the international monetary sphere.

Global Liquidity Story Isn’t Exclusively A US Dollar Issue

The US dollar’s role as the nonpareil currency reserve of the world is yet incontrovertible, meaning the US still maintains its lead position among the other currencies as the elected currency benchmark (or reserves) for central banks.

BUT its leadership isn’t at all the monopoly it once used to be. And this is the important difference: the Euro has incrementally been expanding a material foothold in the share of the composition of the currency reserve market especially in the context of developing countries or emerging markets.

From the IMF’s September 2007 survey (emphasis mine),

``Data reported to the IMF by industrial and developing (nonindustrial) countries, compiled on an aggregate basis in the IMF's Currency Composition of Official Foreign Exchange Reserves (COFER) database, reveal that more developing countries than industrial countries have switched holdings into euros. Nonindustrial countries hold some 30 percent of their reserve assets in euros and 60 percent in dollars (as of December 2006), compared with 19 percent and 70 percent, respectively, six years earlier.

``Industrial countries' use of the euro has risen to 21 percent from 17 percent in December 2000, while their dollar holdings have remained fairly steady at 72 percent compared with nearly 73 percent six years earlier. Their remaining holdings are in such currencies as the Japanese yen and the pound sterling.”

Figure 1: Brad Setser: Central Banks Still Buying Dollars

Figure 1 from our favorite fund flow analyst Brad Setser of the Council of Foreign Relations shows how the composition of global currency reserves have been growing over the past decade.

So even as currency reserves of global central banks have steadily grown in absolute terms, which also translates to growth in other major currencies aside from the US dollar, the Euro seems to have outpaced the growth in the US dollar. Hence, the growing share of the Euro relative to the US dollar in the universe of currency reserves.

Why is this important? Because if the premise for a severe recession comes from financial links in terms of a liquidity crunch (aside from the trade linkage), then from the angle of asymmetries in the current account distribution-the Euro zone against the emerging markets-also matters.

If hypothetically 65% of global currency reserves are in the US dollars, and 25% comes from the Euro then the trade imbalances also project liquidity flows not only from the US (although it signifies the main channel) but also from the secondary reserve currency in the Euro and also (but insignificantly) in others. Hence the Euro is also a contributor to global liquidity!

In other words, global liquidity flows from the premise of the trade-current account is not solely a US perspective and can’t be the only basis to reckon for liquidity flows, see figure 2.

Figure China Trade Balance

Figure 2 from illustrates China’s growing surplus from its trade balance with the world despite the present economic growth slowdown, which implies a shift of the weight of its trade from the US to the Eurozone. Thus, these surpluses have “partially” contributed to the amazing $1.81 trillion surge in their forex reserves last July in spite of the sagging global economy.

And this shouldn’t be seen in the context of China alone as much as it should apply to other emerging countries such as the oil exporting nations most especially the Gulf Cooperation Council (GCC).

While it may be true that the Eurozone may now be feeling the pinch of a US led dramatic growth economic slowdown as we pointed out in our recent weekday post Global Recession watch: Japan and Euroland Economic Growth Turns Negative!, this will also translate to a second round leash effect on the US, which means it isn’t clear whether the US current account deficit would improve at all (since both exports and imports are likely to deteriorate in the face of a slowing global economy!).

One thing seems clear is that regardless of the state of the US current account, the case for the taxpayer funded government intervention to ameliorate the woes from the deleveraging plagued stricken Wall Street plus the spillover effects on the Main street are likely to more than offset any improvements in the current account, which means more financing needs by the US public-by either of the following options borrowing abroad, selling assets or printing money-and private sector.

The point is improving current account imbalances should reflect both sides of the ledger and doesn’t automatically translate to a complete or outright drain of liquidity as deflation proponents suggest.

Strength of US Dollar Depends On The Reliability Of US Markets?

Yet if the argument will directed to the premise that the inherent advantage of the US markets due to its depth, sophistication and advance conditions signify as main reasons why the perceived “trust” as a safehaven status, this quote from the Bank of the International Settlements over the fate of the Euro as an alternative foreign currency reserves should serve as an eye opener (highlight mine) `` The euro comes closest to challenging the dollar in its role as a store of value. As a unit of account and medium of exchange, the dollar’s role is not as secure as it once was, but the dollar is still preeminent.”

So what defines a store of value for the BIS?

Again the BIS ``In the strictest sense, this will be a currency whose value is reliable in terms of future purchasing power. This in turn is linked to the maintenance of sustainable macroeconomic policies. Moreover, the store of value function can also depend on the anchoring role of a currency to the extent that the central bank tries to align the currency composition of its country’s assets and liabilities. More generally, the store of value function of an international currency is linked to the breadth and depth of financial markets, in particular to the availability of investments which meet wealth holders’ risk-return objectives.”

So if the Euro’s best chance to compete with the US dollar is seen in the role of a store of value, it implies that the Euro’s “breadth and depth of the financial markets” appears to have nearly assimilated the US markets in order for the BIS to issue such qualifying statement.

Besides, in today’s functioning monetary platform in the fiat “paper” money standard whose system is backed by nothing but promises based on “Full Faith and Credit” of governments then the US dollar as the alleged beneficiary via the “safehaven” asset status from a global meltdown overlooks where the epicenter or source of today’s crisis emanates from.

This comment from Yu Yongding, a former adviser to China's central bank on the cataclysmic repercussions for the global financial system on a failure of U.S. mortgage finance companies Fannie Mae and Freddie Mac as quoted by Bloomberg (HT: Craig McCarty)

``If the U.S. government allows Fannie and Freddie to fail and international investors are not compensated adequately, the consequences will be catastrophic, if it is not the end of the world, it is the end of the current international financial system.''

If we go by Mr. Yongding’s statement; the end of the current international financial system is tantamount to the end of the US dollar as the global currency reserve!

So how does one consider the US dollar as today’s “safehaven” when it has been a major source (US housing bust, subprime, Fannie and Freddie Mac) for most of the troubles scourging the financial markets today?

True, global central banks continue to accumulate US dollars have been responsible for their policy decisions, but this is done to maintain the status quo or because of the Nash Equilibrium-( - a game of two or more players wherein “each player is assumed to know the equilibrium strategies of the other players, and no player has anything to gain by changing only his or her own strategy (i.e., by changing unilaterally). If each player has chosen a strategy and no player can benefit by changing his or her strategy while the other players keep theirs unchanged, then the current set of strategy choices and the corresponding payoffs constitute a Nash equilibrium.”)

- or its military doctrine equivalent of the Mutually Assured Destruction (MAD) scenario where once such an event unfolds could prove to be devastating to all involved (once deeply exposed trading partners of the US suddenly decide to quit the game)! So for example, if China decides to quit from the US dollar accumulating game, hell would probably break lose (via a US dollar crisis or hyperinflation on a global scale)!

So it isn’t clear that global central banks will continue supporting the US economy or its financial markets, which will likely to be reflected in the state of the US dollar, if economic or political conditions degenerate further.

Besides, US officials seem very much aware of these conditions, hence quickly signed into a new law to provide for a temporary fix to the ailing GSEs; aside from previous bridge liquidity “alphabet soup” of Fed-US treasury programs, widening the scope of collateral acceptance and direct stimulus to the public.

Another, the seeming “resiliency” of the US economy in the face of a housing and financial sector meltdown has been predicated on mainly its “net” exports and global central bank financing. Thus we read into US Federal Reserve Chair Ben Bernanke’s current policy actions as an indirect stimulus meant for global economies especially for countries tied to the US dollar via currency pegs as previously discussed Global Financial Markets: US Sneezes, World Catches Cold!. The US seems banking on “inflating” on global growth to sustain its economy and keep it out from the clutches of recession.

Thus inflation as a US monetary policy is being transmitted globally and the world has been reciprocating.


This from Joachim Fels of Morgan Stanley (emphasis mine),

``In most countries – even in many that have raised interest rates this year – the policy stance is fairly easy. Real short-term interest rates (nominal policy rates minus current CPI inflation) are currently negative in no less than 20 of the 36 countries in our coverage universe. Among others, these include the US, Japan, Canada, Switzerland, Russia, Ukraine, the Czech Republic, Korea, Taiwan, Singapore, Indonesia, the Philippines, Malaysia and Peru. With policy easy to start with, there is thus little scope to cut rates aggressively. By contrast, there are only a few countries that have relatively high real short rates and thus tight monetary polices. Apart from Australia and New Zealand (where real short rates stand at 2.75% and 4%, respectively), these include Brazil and Turkey, where real rates stand at 6.6% and 4.65%, respectively.

``Global real policy rate still negative. Aggregating across all countries in our coverage universe, the weighted global monetary policy rate currently stands at 4.5% in nominal terms. However, current global (weighted) inflation is running at 5.3%, so the global real rate is -0.8%, the lowest in this decade. Thus, global monetary conditions remain very expansionary, limiting the room for a major global monetary easing.

So if global monetary environment remains expansionary how can deflation proponents argue that the world will be engulfed with a meltdown from deflationary forces? The US and the UK, Spain, Ireland, Australia and those suffering a structural “housing bust” does not translate to the same predicament all over the world, especially not in the Philippines.

Besides what is to “deflate” in the Philippines or most of Asia?

Figure 3: BIS: Loan/deposit Ratio of banking systems in Asia and the Pacific

Except for Australia and Korea whose loans are above deposit reserves, loans in most of Asia have not been “leveraged” as shown by the BIS and are below reserves of deposits. In other words, the Asian banking system has more deposits than extended loans.

Yes, a global economic slowdown is in the cards-some will experience recession, some won’t-but definitely not from the garden variety type as seen in the deflation paragon.

Deleveraging Is Not A One Way Street; Short Sales And Market Efficiency

Then there’s the other argument where the whole world will be enveloped by the feedback loop of de-leveraging.

Against the common impression deleveraging isn’t a one way-street though, see figure 4, especially when we deal with advanced or sophisticated markets because of the available facilities to bet on EITHER DIRECTIONS.

Figure 4: US-dollar Index-commodity Pair trade

The chart in figure 4 shows how gold (candlestick main window) /oil (lower pane) and the US dollar index (black line behind main window) have had a strong inverse correlation, as demarcated by the blue vertical lines (as US dollar troughs when oil/gold peaks and vice versa). The Dow Jones AIG Grain (lowest pane) seems to have moved ahead of its major commodity bellwether.

The tight correlation suggests of the proliferation of “paired” trades, which means participants who shorted/longed the US dollar also bought/sold oil and gold. Such is why the violent action in one market could have reflected an equally volatile action in the another-but in an opposite direction!

It also means that since every transaction is accounted for by an entity, anyone (represented by an individual or by a company) who is “forced to liquidate or delever” on their market position has to closeout (by taking the opposite position-of either a buy or sell-on the original position taken!). If an entity took up a “short sell” position then one closes by “buying”, and in the same manner if the same entity takes up a “long” position then the consummation of the trade translates to a “sell”.

Thus deleveraging doesn’t automatically mean selling, it can also mean buying!


Figure 5: US SEC’s Short Sale curb=Magnified Upside For US Financials!

The US SEC imposed a curb on “naked” (selling without actual possession of borrowed shares) short selling on 19 financial companies last July 16th. And as we demonstrated above, the huge short position taken by the public was forced to unravel, see figure 5 (see blue arrows). This led to a strong simultaneous upside rebound for the beleaguered Dow US financials (main window), the Broker Dealers (pane below the main window) and Banking indices (lowest pane). Yet this doesn’t account for derivatives.

Maybe one factor why the US equity markets have not entirely collapsed in the face of a prospective or ongoing recession, prompted by the meltdown in the housing and financial domain, is because of the public’s liberal access to “short” the market. To quote’s Robert Murphy ``But the basic principle is simple enough: just as a speculator who wants to go long can borrow money to buy stocks, so too a speculator who wants to go short can borrow stocks to "buy money." Short selling is no more mysterious than buying stocks on margin.” Hence, the short selling facilities could have minimized the volatility on the downside by allowing for greater pricing efficiency through expanded liquidity.

Well of course since this isn’t back by any evidence, this is just a guess on my part.

But for the world markets especially in dealing with the deleveraging issue, it could be a different story. Deleveraging means global investors have to sell equity holdings as “short facilities” have not been as deep and widely used as those in the US.

For instance, the Philippines now allows for “borrow and lending”, though I have not read the entire regulation, based on my principal’s opinion, the rules seem quite stringent and rigid as to discourage any actual application because of the costs of compliance. If costs exceeds the benefit who will avail of the trade?

Put differently what good is a facility if it is stifled by suffocating regulations or if it can’t be used?

Finally the penchant of deflation proponents is to compare present occurrence to that of the Great Depression,

This quote from Professor Barry Eichengreen of the University of California, Berkeley in the Financial Times should account for a good retort,

``And since other currencies were linked to the dollar by the fixed exchange rates of the gold standard, US deflation caused foreign deflation. As US demand weakened, other countries saw their currencies become over­valued. They were forced to raise interest rates in the teeth of a deflationary crisis. By raising interest rates, foreign countries transmitted deflation back to the US. Only when they delinked from the dollar and allowed their currencies to depreciate did deflation subside.

``The difference now is that the Fed knows this history. Indeed Ben Bernanke, the Fed chairman, wrote the book on the subject. Seeing the analogy, his Fed has responded to the subprime crisis with aggressive lender-of-last-resort operations. If anything, it may have been too impressed by the analogy. Its mistake was to cut interest rates so dramatically at the same time that it extended its credit facilities. It would have been better to lend freely at a penalty rate. Higher interest rates would have made its emergency credit more costly and led to better-targeted lending and less inflation.

``The Fed’s response has forced other central banks that manage their exchange rates against the dollar, mainly in Asia, to import inflation rather than deflation. Their currencies have become undervalued rather than overvalued. As their real interest rates have fallen, these countries are now exporting inflation back to the US. Where global deflation led to the collapse of commodity prices in the 1930s – devastating those countries dependent on exporting commodities – our current inflation is having the opposite effect. This time, primary producers are the biggest beneficiaries.”

In short, the gold standard of then and today’s paper currency standard aside from the transmission effects of the currency pegs supported by mercantilist policies have been important nuances.

One important thing which was not marked by this observation was that the Great Depression was significantly exacerbated by “Protectionism”.

Summary and Recommendations

A global recession may happen but it isn’t likely to be a depression or alternatively said “severe and prolonged”. Not for most of Asia, especially the Philippines. A global recession may occur because OECD or major developed economies seem to be undergoing recession but is not likely the case for most of the EM economies.

The argument for a US current account improvement as effectively draining the global liquidity picture seems incomplete. The Euro is also a secondary contributor. Although a slowing Eurozone could also mean further test on global liquidity conditions.

Likewise, the second round effect from a global economic slowdown is likely to put a stress on US exports clouding the certainty of the improving path of the US current account balance.

What is clear is that the taxpayer funding of the financial sector and of the main street will offset any improvement in the current account which means more financing requirements through external borrowing, selling of assets to foreigners or monetization.

The argument that the US dollar represents as “safehaven” under a global deflation is unclear if not questionable. First, global deflation seems unlikely; the world’s monetary climate seems still expansionary. Besides most of Asia has less to deflate compared to the overleveraged West. Asia’s “contagion” problems will likely fall on liquidity and not solvency issues.

Second, since the US dollar is the source of the present stress, the argument of its “safehaven” status has been in a test since 2002. Such tests isn’t likely to end soon and may get worst.

Third, the recent rebound by the US dollar and the accompanying fierce selloff in the commodities could be as a result of pair trade deleveraging, aside from a reflection of a global economic growth slowdown. Deleveraging does not equate to outright selling since it can also mean buying especially under markets that are advanced, sophisticated and deep.

Fourth, we don’t buy the argument that the US dollar or the Euro or of any paper currencies as representing any insurance from currency debasement policies by global governments. Inflationary policies assure the loss of purchasing power of paper currencies.

Although the US dollar may rally against the Euro, this may signify an interim or cyclical move instead of a complete turnaround similar to 2005. The US dollar has been in a bear market since 2002 and is likely to remain under pressure given the massive fundamental imbalances it is faced with.

Meanwhile, gold has been on a losing streak. Gold and precious metals represent as our insurance against government’s inflationary actions. The precious metal sector could depart from the performances of its industrial siblings based on the question of health of global economies.

We understand gold to be in a long term bullmarket especially from the fundamental perspective where global governments will work to use their inflationary powers to reduce the impact of any financial or economic dislocation for mostly political ends.

Figure 6: US Global Investors: Gold’s Seasonal Performance

We understand too that added to gold’s present infirmities from delevariging issues is that gold is in a seasonal weakness (see figure 6) and could most likely pick up over the next few months once the deleveraging issues fade.