F&F Mix Results: Narrowing F&F Spreads But Defaults from F&F Credit Default Swaps

``In traditional finance, borrowers borrow and lenders lend. The only firms exposed to, say, home mortgages, are the banks that issue them. Thanks to derivatives, a firm with exposure can pass it off, and a firm with no exposure can assume it. Markets thus have less information about where risk lies. This results in periodic market shocks. Put differently, derivatives, which allow individual firms to manage risk, may accentuate risk for the group. Markets were stunned to discover that Long-Term Capital owned outsized portions of obscure derivatives. They dealt with that shock in typical fashion: they panicked.” - Roger Lowenstein, Long-Term Capital: It’s a Short-Term Memory

 

With the US government’s recent action to preserve the global monetary system, we find that aside from the undefined cost to taxpayers, the US treasury has now assumed the responsibility for the $5.3 trillion of mortgage securities aside from its outstanding $5.3 trillion of treasury securities as of March 2008.

 

So far, the US Treasury’s action has partially eased the yield spread of the F&F papers from its risk-free counterparts as shown in Figure 4.

Figure 4: Danske Bank: Before and After Spread of F&F vis-à-vis Fed Rate and 10 year Treasury

 

 

Even as the Federal rates had been lowered rates by 325 basis points as shown in the left panel in figure 4, the F&F rates have not equally responded. However, after the action taken by the US Treasury, the F&F rates dropped steeply as displayed in the right panel.

 

By lowering of the mortgage rates, the US government hopes to ease the burdens of homeowners smacked by a perfect storm of lack of access to credit, falling asset prices (real estate and stocks), rising unemployment, slowing economy and still high but fast declining energy/ fuel prices. 

 

And by narrowing the spreads from US treasuries, the US government hopes to provide cushion to the fast deteriorating financial and economic conditions by allowing investors access to cheap money which could feed into the mortgage market and buy F&F papers and thus restoring liquidity and confidence, aside from the credit ratings of the F&F papers.

 

But this doesn’t take away the fundamental problem of having too many houses for sale at prices buyers can’t seem to afford.

 

Moreover, the spreading of the mortgage woes to the level above the subprime market seems to be the next wave of credit concerns. The Alt-A mortgages covering about 3 million US household borrowers totaling some $1 trillion in mortgage papers with about $400 billion issued during the height of the boom in 2006 where an estimated 70% of borrowers were said to have exaggerated income (Bloomberg).

 

Aside the recent actions by the US government appear to have triggered a “credit event” in the CDS market of the F&F papers. A Credit Default Swap (CDS) is a credit derivative functioning as an insurance contract that pays if a company or “counterparty” defaults on its liabilities.

 

However unlike an insurance contract, the CDS market is many times more than size of the actual bonds referenced. The unregulated CDS market is estimated to be at around $62 trillion. The problem of which is if an outsized default occurs a contagion of non-collection from losses may lead to a systemic loss.

 

The recent “conservatorship” of F&F by the US Treasury has triggered defaults on some CDS contracts referencing to the F&F securities. The contracts affected were estimated at $250-$500 billion which should to result to some $10 to $25 billion in additional losses (Financial Times).

 

And perhaps some of these losses had been accounted for the recent volatility in the global markets.

Fannie & Freddie’s Conservatorship’s Possible Implications To Asia

``The US doesn’t just need US government money to support the US housing market: It needs money from foreign governments as well. And no one more than China. China’s central bank borrows RMB from the state banks (whether by selling sterilization bills or by hiking the reserve requirement) and then uses those funds to buy large quantities of Agencies. The flow of Chinese savings into the US housing market is entirely a government flow.”-Brad Setser, Council of Foreign Relations. So true … 

It’s nothing new from what we have been saying all along or from what we have been saying earlier.

The problem of the US deleveraging isn’t likely the same problem of Asia. Although much of the world’s tightened financial and economic linkages has unduly put to a strain on Asia’s financial markets. Aside from the slowdown in most of the OECD economies, which has likewise added to some pressures on the economic front.

Asia’s exposure to toxic papers remains modest as shown in figure 5.

Figure 5: IMF: Asia’s Exposure To Toxic Papers and External Debt

Next to the low exposure of Asian banks (as measured in % of equity) to toxic papers, the structure of external debt has been mostly long term except for Hong Kong, Singapore and Taiwan, which means financing woes have not been much of a significant concern.

 

Although we recently featured Korea as one of the apparent victims of the Fannie and Freddie’s where a foreign broker claimed the return of a currency crisis and a potential meltdown of Asia in Sequel To Asian Financial Crisis?, Costly Bailouts and Bernanke Buys Time, Figure 6 seem to dispel such concern.

Figure 6 IMF: Credit and Money Growth in Indonesia (left) and South Korea (right)

 

In short, much of the credit crunch in the OECD economies could have translated to a meaningful slowdown of liquidity growth in Asia, but this isn’t happening yet.

 

Broad money growth remains robust in South Korea (red) as shown in the right pane amidst a negative real interest rate (blue). In fact, money supply gained 13.2% last July (eastday.com). Yes, following the F&F takeover, Korea’s Kospi recovered by 5.24% while the won bounced from the streak of losses up 1.6%.

 

Meanwhile despite the 10% plunge in Indonesia’s JKSE index last week which had been linked to a sharp downturn in commodity prices. Credit growth seems to remain robust (left pane) courtesy of the IMF.

 

Funny how many of experts dug deep into the investing public’s psyche peddling the myth of how high “inflation” have caused the recent market rout. In terms of Indonesia, now that falling oil and commodity prices should equate to lower “inflation”, the rally in its market which should have happened seemed to have vanished altogether opposite the justifications by mainstream analysts.

 

Considering the dearth or selectivity of global liquidity much of the risk dynamics becomes more of micro than macro.

 

In the same way, these experts created the impression that the cutting of interest rates by the Bernanke’s Federal Reserves would lead to a rally global markets late 2007. It never happened.

 

In the same plane, local experts bruited about how remittances drove the Peso stronger. Where remittances remain at record levels, yet Peso has gone bust.

 

True, we can’t be wildly bullish on Asia because of the prevailing climate of uncertainty across the pond, but we should view this slack as an opportunity to accumulate than as an opportunity to run!

 

We believe that most of the selling that had accrued in Asia had been due to the ongoing deleveraging process (which includes unwinding of pair trades of the US dollar-commodity, momentum driven, aside from covert government support on the US dollar) which has importantly been the key link to most of the infirmities in Asian markets as shown in Figure 7.

Figure 7: US Global Investors: Declining Trend of Foreign Outflows

 

It is funny too how analysts screaming for us to run for the hills would use different data time frame references to prove or support their views. This cognitive bias is called “framing”.

 

Last August, we pointed out in Phisix: Knocking At The Exit Gates of the Bear Market! that 80% of the money which came into Asia in 2007 had been redeemed. Last week’s panic stricken analyst alluded to the size of foreign inflows from 2001 as a measure to portray a potential stampede amidst the gloomy outlook.

 

Well good enough, a chart provided by US Global Investors gives us a balance perspective. It reveals of almost the same pattern as we had been seeing in the Phisix: declining trend of foreign outflows!

 

According to US Global Investors, ``Net foreign selling in the emerging Asian markets since mid-2007 has exceeded more than half of the investment inflows seen in the 2003-2007 bull market. Capitulation among investors in the region might signal a rebound in stocks ahead.” (highlight mine)

 

Moreover, the recent actuation from the US government appears to give some light to Asian equities. This from the New York Times,

 

``But the takeover of the companies also reinforced concerns about troubles of the American economy and highlighted its significant reliance on foreign investors, particularly in Asia.”

 

If US policy actions had indeed been directed at Asia as caviled by some, then it is a blatant admission of dependence on Asian capital for the survival of the US dollar standard system.

 

Moreover, it also shows how much political capital Asia has generated enough exert influence on US policymaking to favorably act on its interests as in the case of F&F.

 

With the writing on the wall, how could one be bearish on Asia unless for short sighted reasons?

 

Finally I’d like to share this quote from Director of Research Robert J. Horrocks, PhD of Matthews International Capital (emphasis mine),

 

``The recent moves by the Treasury may help the process by which Asia reflates relative to the U.S., and this environment may be helpful for Asian financial stocks. They have been seen for too long as carrying the same kinds of credit risks as the Western banks, and Asian financial stocks suffered as their counterparts in the U.S. fell. Moves to reduce risk in the U.S. and global financial systems seem likely to favor Asian banks, which have clean balance sheets and strong underlying economies. Reducing risk in the U.S. debt market may also take pressure off regional currencies as investors worried that much of the official foreign exchange reserves were held in Fannie and Freddie debt.”

 

Now with the “inflation” scare and the “Fannie and Freddie” woes off the hook, would Asia find its legs and commence on a gradual recovery?

 

We’ll soon find out.

LHC Particle Collider/Black Hole Machine: Doomsday Deferred or Fears Unwarranted?

Mission Accomplished. Large Hadron Collider (LHC) successfully launched.

From BBC,

``Three decades after it was conceived, the world's most powerful physics experiment has sent the first beam around its 27km-long tunnel.

 

``Engineers cheered as the proton particles completed their first circuit of the underground ring which houses the Large Hadron Collider (LHC)...

``On Wednesday, they sent a proton beam around the full circumference of the LHC tunnel.

 

``Technicians had to be on the lookout for potential problems: "There are on the order of 2,000 magnetic circuits in the machine. This means there are 2,000 power supplies which generate the current which flows in the coils of the magnets," Steve Myers, head of the accelerator and beam department, told BBC News.

 

``If there was a fault with any of these, he said, it would have stopped the beam. They were also wary of obstacles in the beam pipe which could prevent the protons from completing their first circuit."

Has the fears been exaggerated? Or has doomsday simply been deferred?

The LHC controversy seems to me like a page taken out of the debate over "Global Warming".

Will Tomorrow Be Doomsday? “Black Hole” Machine Switches On

For our apocalyptist pundits, here is another good fodder; we should probably SELL because…

it is the END of the world!

 

But I guess it would be too late for that because the supposed date for the “end of the world” is said to happen tomorrow, Wednesday September 10^th!

 

How?

 

Because of this…

From Popsci.com: Large Hadron Collider: A machine that would “give birth to microscopic black holes”

 

A brief description from Newsky.com

 

``The Large Hadron Collider (LHC) is 12 stories high and cost £5b. It is buried more than 300ft under the Alpine foothills in a 17mile tunnel along the Swiss-French border.

 

``When the giant machine gets going, the LHC will blast protons - one of the building blocks of atoms - at a velocity just shy of the speed of light, generating temperatures of more than a trillion degrees centigrade.

 

``Each proton beam will pack as much energy as a Eurostar train travelling at 150 kilometres per hour.

 

``In layman's terms, the LHC will take protons and smash them together at high speeds.

 

``The resulting collisions will hopefully replicate conditions found in the moments following the Big Bang - or the beginning of the universe - and scientists will study the fallout.”

 

The Hadron Collider is scheduled to be switched on tomorrow.

 

Critics say that such experiment runs the risks of creating unwieldy “black hole” that might devour earth!

 

This from the BBC, ``But there are a small but significant group of naysayers who worry that the LHC is not 100% safe. Opponents say it is possible the collider could produce micro black holes and dangerous "strangelets", and that catastrophic effects from these cannot be ruled out.”

 

Some people think the risks are serious enough to bring it to court.

 

This from the Guardian

 

``If you think it's unlikely that we will all be sucked into a giant black hole that will swallow the world, as German chemistry professor Otto Rössler of the University of Tübingen posits, and so carry on with your life as normal, only to find out that it's true, you'll be a bit miffed, won't you?

 

``If, on the other hand, you disagree with theoretical physicist Prof Sir Chris Llewellyn Smith of the UK Atomic Energy Agency, who argues that fears of possible global self-ingestion have been exaggerated, and decide to live the next two days as if they were your last, and then nothing whatsoever happens, you'd feel a bit of a fool too.

 

``Rössler apparently thinks it "quite plausible" that the "mini black holes" the Cern atom-smasher creates "will survive and grow exponentially and eat the planet from the inside". So convinced is he that he has lodged an EU court lawsuit alleging that the project violates the right to life guaranteed under the European Convention of Human Rights.”

 

However most experts say that we shouldn’t be alarmed and that the experiment will run smoothly and that many information about universe could be uncovered to benefit us. Again from the BBC, `` However, the consensus of physicists is that the collider is perfectly harmless. Micro black holes would vanish almost instantaneously.”

 

We just pray that things will turn out fine as the consensus expects. Otherwise, doomsayers would be proven right for the wrong reasons-we should have sold early to enjoy our last days as running for the hills won’t do any good.

The Tragedy of Political Mascotism

``It is our moral and rationally selfish obligation to help others understand that freedom is not free.  And one of the biggest costs of freedom is an end to government handouts.”-Robert Ringer

 

Political mascotism is when incumbent political leaders use the underprivileged to dramatize or “put a face” on the predicaments of the society and to represent the “deprived” sectors supposedly meant to benefit from their proposed political programs.  This showcase of symbolism has been a conventional feature for almost every incumbent President of the Philippines during their SONA (State of the Nation Address).

 

Unfortunately for Mang Pandoy (Felipe Natanio), who served as the model of “courage and dedication to improve life” for the 1992 SONA of former President Fidel V. Ramos, passed away last week in the same destitute and disadvantaged conditions prior to his ascension as a political icon. RIP Mr. “Mang Pandoy” Natanio.

 

While media seemed quick to pounce on the opportunity to imply of the personality based “failure of leadership” attributes, what appeared to have been lost in the tragic Mang Pandoy experience is the most important lesson of all: the failure of government intervention through the patron-client based political economy.

 

We learned that following FVR’s SONA in 1992, Mang Pandoy was accorded with a television show “Ang Pandayan ni Mang Pandoy” (inquirer.net)which he co-hosted in a government owned TV station. Unfortunately, because of the lack of continued appreciation from the public, the show lasted for only 3 years. Although at the same time he was also appointed with a short-lived job at the House of Congress which likewise came to a close as his “popularity” faded.

 

But there had been other opportunities which he reportedly have also wasted; he was said to have been given livelihood projects which included a hog raising package, aside from scholarship grants for his children-from which none of his children availed to its fullest because of “lack of allowance and daily fare.”

 

UP professor Randy David quoted by the Inquirer.net poignantly encapsulates Mang Pandoy’s hapless living conditions (highlight mine), ``He had ended up expecting the government to help him all the time. But help was not always there.”

 

So instead of a role model for social and economic upliftment as the former President had envisioned for Mang Pandoy, he turned out to be a paradigm of unintended consequences for government welfare programs.

 

Apparently Mang Pandoy and his family’s utter reliance on government support have cost them numerous opportunities to progress. Applied on a multiplier scale, this is what I decry as the “dependency culture”, where absolute dependence on welfare programs or from gratuity of politicos translates to bigger government spending which takes a toll on the productivity aspects of the society. 

 

And lost productivity means higher costs of doing business which extrapolates to higher hurdle rates or lesser investment opportunities needed to boost the capital stock of the economy. Yet, without investments we can’t get the Mang Pandoys of the society out of poverty.

 

Remember, governments are essentially consumers of capital.  That’s the reason why they tax and use the coercive arm of its institutions to enforce collections. And when governments spend more via intervention in order to provide the Mang Pandoys their share of the economic pie, it also means that someone else would have to fund these activities. Funds, which should have been efficiently allocated to productive sectors and thus expand the labor pool and incomes, ends up subsidizing non-productive jobs or activities.

 

As the illustrious Ludwig von Mises of the Austrian School of Economics wrote in Socialism, ``All almsgiving inevitably tends to pauperize the recipient” aptly describes on the conditions of the Mang Pandoys of our society.

 

Yet lamentably our Mang Pandoys elect for the illusion of perpetual government sustenance instead of living on the ideals of having “courage and dedication to improve life”-the slogan ironically contrived by the former President Fidel Ramos for our Mang Pandoys. Noble sounding political slogans almost always end up as empty rhetoric.

 

Paradoxically too, the Mang Pandoys are the very constituents from where most of our politicians derive their innate strength for expanded political power. By pandering on the masses and to media by catering to the abstractionisms of “guiltism, envyism, villainism, covetism, and angerism” to quote self development author Robert Ringer, by encouraging more economic and financial dependence and by peddling the charade of simplified cure all solutions or elixirs to the society’s complex problems so they can arrogate for themselves more control over our lives and expand access to financing to whimsically bankroll programs for political or personal reasons.

 

In the words of conservative economist Thomas Sowell, ``Politics is largely the process of taking credit and putting the blame on others-- regardless of what the facts may be. Politicians get away with this to the extent that we gullibly accept their words and look to them as political messiahs.”

 

And while corruption has been a popular political issue, it has hardly been dealt by the media and our experts as a symptom to a systemic disease but one of personality based disorders which seem to always recur, if not deeply rooted in the bureaucratic culture. Hardly anyone tells you that the systemic corruption is an offshoot to BIG government. You reduce chances of corruption by minimizing their political power and by slashing wasteful and nonproductive discretionary spending.

Yet day in and day out we hear politicians offer themselves as the solutions to our problems. At the end of the day, we all end up as losers with the Mang Pandoy’s enduring most of the brunt. Headline stuff indeed. Unfortunately we never seem to learn.

Sequel To Asian Financial Crisis?, Costly Bailouts and Bernanke Buys Time

``So the lesson we can take away from all this is to respect what the market tells us, listen to it and ignore the nonsense in the news. More recent incongruous market action should be respected because it may be indicating something important.”-George Kleinman, Commodity Trends, What I Learned This Year Trading Commodities

 

Since I read voluminous reports, articles and research papers daily, I get the privilege of having to access a diversity of opinions and insights of which ranges from the extreme ends of optimism and pessimism. Thus, I realized that my personal biases have been frequently challenged or tempered by the influences of contrasting outlooks. Instead of having extreme convictions which are usually swayed by emotions my views have been redirected to the moderation.

 

Over the years we have pointed on the perils of systemic overleveraging via the US housing bubble and how it poses as a challenge to the global market and the economies. Now that it has become a reality and whose dynamics has been providing us with a suspense thriller, I have been arguing today that the “US is not the Philippines and vice versa” such that while there are transmission linkages that could impact the local economy via trade, labor and financing, there are domestic factors to reckon with that could help cushion on the negative effects from the present systemic deleveraging seen in developed economies.

 

Besides, if I had to take the view of the extreme pessimist, I would have to move to the countryside, stockpile upon years of food (aside from raising them by ourselves) and medicine, accumulate precious metals, and load up on ammunition, energize our homes with solar panels and erect my “mini” fortress in anticipation of the holocaust. Think medieval times applied to present circumstances. That is what the extremes see. Great Depression, a world at war, grand anarchy, massive famine and hunger, breakdown of the financial and monetary system and the society’s division of labor and etc.-arising out of the sudden arrival of “peak oil” or from the ravages of a global economic depression.

 

However, I learned from the Austrian School of Economics that people are rational beings which when confronted with even similar circumstances react distinctly as we discussed last week in Global Recession: Reading From Individual Actions Than From The Collective. Because of such divergence in the actions of individuals there is the tendency that the perceived outcome could be different from what many analysts expect.

 

If it were as simple for people to react in a “common” manner, as seen via the lens of “omniscient” experts, perhaps in the model of the “Gaussian curve”, then our problems would be easily solved. Governments through these experts can simply legislate away on how we should act. But the reality is that we are not robots, our rationalities cannot legislated, and governments only react to circumstances brought upon by the compounded actions of the marketplace. Why do you think we have this “deleveraging” problem in the first place?

 

Not wanting to stop the boom which the US authorities fostered (negative real rates, current account deficits, Fannie and Freddie Mac’s privileged status-which impelled them to take upon greater risk in their portfolios and prompted for a model from which was assimilated by private label mortgages, former Federal Reserve Chair Greenspan’s promotion of ARM, tight regulation in the banking system which led to creation of the “shadow banking system”, etc.) in the first place, now the same authorities have been applying cushion to the impact of an unwinding market dynamic emanating from a grand malinvestment edifice. Yet, if circumstances have been as predictable and politicians react accordingly, we wouldn’t be in these shoes today.

 

Sequel To Asian Financial Crisis? Not So Fast!

 

Even from the Philippine perspective we see the same unpredictability. Because of the interconnectedness brought upon by globalization trends, we have been saying that perhaps the Philippine economy will probably experience slower growth because of the adverse development abroad which are likely to negatively impact our “external linkages”. None of this has happened yet. Export growth trends (up 8.3% in June) and (remittances up 30% in June) have remained vigorous. Maybe it will be a matter of lagged effects.

 

It has been the same with our bullishness of the Peso relative to the US dollar. Where fundamentals favor many ex-US dollar currencies, especially relative to Asia, the sheer vigor in the momentum of the US dollar’s ACROSS THE BOARD advances have spawned many “rationalizations” from “high inflation” to “relative economic growth” to “shrinking liquidity due to current account improvement” and now to Fannie and Freddie Mac inspired risk of a currency crisis. Much of them I believe as unfounded.

 

Look at the following horrid news items:

 

This from the Bloomberg (emphasis mine),

 

Asia Currencies to Fall 12% on Capital Flight, ABN Amro Says

 

``There is more downside to Asian currencies from a reflow of capital out of Asia,'' Irene Cheung, a Singapore-based strategist at ABN Amro Bank, said in a phone interview. ``The decline could accelerate in the next two months because banks in the U.S. and Europe are pulling out. They are short of cash and need to recapitalize toward year-end.''….

 

``As much as $1 trillion flowed into Asia since 2001, of which two-fifths went to China, slightly more than a third to Korea and the rest went mostly to India and Taiwan, according to ABN's estimate.

 

Or this Korea’s Chosun.com (highlight mine)

 

``The main reason behind Monday’s panic was the September crisis rumor, which refused to go away despite government efforts to calm jitters.Stoking them was a scenario where W8 trillion (US$1=W1,118) worth of foreign investment in bonds maturing in September would exit the Korean market at once, further undermining the won and leading to a string of bankruptcies in financial institutions.”

 

Or this from UK Timesonline.co.uk

``Heavy investment by the Korean Government in Fannie, Freddie and other US-related agency bonds has left a potentially huge liquidity problem - perhaps $50 billion (£27.4 billion) - in the foreign reserve portfolio. Some believe that Seoul might have no ammunition left to prevent a significant flight from the won. Fruitless currency intervention by South Korea - increasingly desperate-looking verbal and financial measures to fight the market trend - cost about $20 billion in July alone.”

 

I don’t know why the seeming emphasis on the South Korean won’s 3.3% decline (see figure 1) when the Australian dollar and the New Zealand dollar even took heavier blows, down 5.08% and 4.46% respectively. Although I suspect that the latter two can be easily attributed to sharp decline in commodity prices.

Figure 1: yahoo.com: The Skyrocketing US dollar-Korean Won

 

Except for the Chinese remimbi (down .04%) and the Japanese yen (up 1.14%), based on Bloomberg’s data, ALL Asian currencies took it to the chin with the biggest casualties including the once mighty Singapore Dollar (down 1.43%). The Peso was down nearly 2% to 46.82 to a US dollar. Such dramatic cascading actions in the currency markets have led to creepy claims of market disaster.

 

Patching up all these we understand that stuffed with outsized holdings of US Fannie and Freddie Mac papers have basically rendered South Korea’s central bank as illiquid. Faced with maturing bonds in the face of a central bank liquidity crunch aggravated by current account deficit and portfolio liquidations from the deleveraging US and European institutions translates to a currency run. Thus, the currency crisis of South Korea and the rest of Asia!

 

Run for your lives…Its Asian crisis all over again! Or is it?

 

Of course we understand too that the global credit crunch has adversely impacted many companies that rely on global trade like Daewoo Shipping, some of whose international customers have withdrawn due to the lack of access to credit, aside from the anticipation of slowing business due to economic growth deceleration. And state owned Korean institutions, the Korea Development Bank and Korea Asset Management Corp, which controls 50.4% (Bloomberg, Hat Tip Craig McCarty) have reportedly been selling their stake in the company, possibly reinforcing the view of the state’s liquidity predicament.

 

But wait, what seems grossly inconsistent is that if South Korea’s central banks are truly in liquidity crunch, the same institutions cited above have played separate roles in NEGOTIATING TO ACQUIRE stakes at the beleaguered US financial institutions of the LEHMAN Brothers and Merrill Lynch!

 

So what could also be seen as selling by state owned Korean financial institutions of Daewoo shipping could also be interpreted not as raising liquidity for financing obligations but as an arbitrage, buying US assets! If the latter view is correct then, where’s the currency crisis?

 

Horror Stories Deserve A Second Look

 

Of course we can’t deny that with heightened incidences of liquidations from hedge funds on every asset class would “hurt” somewhat ex-US currencies due to a gush of outflows.

 

But to assume that MOST of the money which had flowed into Asia WILL EQUALLY stampede out seems one dimensional if not downrightridiculous or absurd. Such assumption ignores the fact that Asia has also been a source of liquidity growth and not just in the US.

 

Proof?  This from India’s Daily News Analysis (emphasis mine), ``Wealth is growing at much faster rates among the rest of the world.Households in Asia, the Pacific Rim excluding Japan and Latin America saw the greatest growth, with wealth rising 14%. That growth was fuelled by manufacturing in Asia and commodities in Latin America and the Middle East, as well as more currency and political stability.”

 

Besides, such analysis ignores that the fact that Asia has been impacted by trade and financial linkages and have NOT been the source of the financial disaster. In short there is a stark difference between structural and cyclical factors.

 

Another proof?

 

While, many OECD economies have been undergoing the paroxysm of deleveraging which essentially raises the cost of capital aside from the paucity of access to capital seen via contracting bank lending, figure 2 shows how the Philippine Banking system continues to experience robust growth!

Figure 2: ATR Kim Eng: Philippine Banking System Continues to Expand!

 

This from ATR Kim Eng (Hat Tip: Ton Garriz), ``The growth in outstanding loans of commercial banks accelerated to 18.1% Y/Y in June from 15.8% in May. The trend is consistent with the numbers reported separately by banks in their Q2 financial results. Credit expansion was driven by wholesale and retail trade (+38.5%), electricity, gas and water (+43.8%), and transportation, storage and communications (+57%). The growth in loans to the manufacturing sector grew at a slower pace of 7% although an improvement from 5.2% in the previous month. Manufacturing accounts for the 22% of total loans, the largest among categories. Auto loans also reversed course, growing 15.3% in June from a 6.9% contraction in the previous month.”

 

So aside from growth seen in the general industry we are seeing also credit growth in the consumer segment as seen in Auto Loans. This also suggests that sales of cars despite “high” oil prices can be expected to remain firm.

 

Additional information from the Inquirer.net,

 

``Consumer-related loans, which made up of about 8.0 percent of total bank lending, climbed 22 percent in June against a revised 19.9 percent in May, the central bank data showed. Consumption loan growth came mostly from credit card receivables which grew 27.3 percent in June, the central bank said.”

 

So the credit contraction or a liquidity crunch hasn’t infringed (yet. Though I don’t expect it to impact us materially) on the premises of the Philippine economy. Also all these suggest that the Philippine economy remains vibrant.

 

And the financial markets except the Peso have been bearing us out.

 

While Korean bonds have fallen (rising yields) reflecting the anxiety of deficit-global deleveraging process, Philippine bonds continue to rallymarkedly (falling yields).

 

This implies two possible developments, one, “lower” expectations of future consumer price inflation and two, diminished symptoms of “liquidity” crunch or contagion from the world’s develeraging process.

 

As we have written in many times during the past, market internals of the Phisix have shown decreasing depth of foreign selling. This has recently supported the Phisix’s “divergence” from most of the global markets, see figure 3.

Figure 3: PSE: Once Again, Diminishing Foreign outflows

 

As you can see, the foreign selling since the credit crunch unraveled last year has been the dominant theme in the Phisix. But once again the scale of selling activities (exhibited by the red arrow) seems to be diminishing and NOT increasing in contrast to the gloom and doom citations by freaked out analysts!

 

And yes, while the markets may not agree with me yet on the Peso which I believe reflects mainly a function of the unwinding short US dollar Carry trade, the deleveraging process, government intervention and momentum, this perhaps could last longer than my expectations.

 

Besides as we pointed in our July 20 issue Philippine Peso: Technical Pattern, BSP Actions and Diminished Inflation Points To A Rally, previous patterns have shown the Peso to correct by 45-50% before resuming its upward path which means the Peso could go over 47 before appreciating.

 

And if falling Asian currencies have been associated with the illiquidity from Asian central bank portfolio holdings of Fannie and Freddie Mac securities then the latest proposed emergency actions by the US Treasury (which is set to be announced before Asian markets open on Monday) suggest that “implicit guarantees will become explicit” as the US nationalizes the two behemoth widely owned mortgage institutions.

 

This from Bloomberg, ``The Treasury plans to put Fannie and Freddie into a so- called conservatorship and pump capital into the companies, House Financial Services Committee Chairman Barney Frank said in an interview yesterday. The government would make periodic capital injections by buying convertible preferred shares or warrants, according to a person briefed on the plan. Paulson is seeking to end a crisis of confidence in the companies sparked by concern the companies didn't have enough capital to weather the biggest housing slump since the Great Depression.”

 

US Dollar Weighed By Heavy Cost of Bailout, Bernanke Buying Time

 

It’s simply amazing how we can be bullish the US dollar when the US government will be throwing so much money to salvage its financial system from a complete meltdown at a heavy cost to its taxpayers.

 

Don A. Rich in Mises.org wrote about the estimated full cost to taxpayers in rescuing Fannie and Freddie Mac alone, ``the real cost of the bailouts will easily exceed $1.3 trillion. In fact, the real cost is likely to range between $1.3 trillion to $1.6 trillion, and is not unlikely to reach $2.5 trillion.”

 

In perspective, US $1.3 trillion is almost equivalent to 10% of the US GDP! That’s for the GSEs alone, how about the others (FDIC and the rising bank foreclosures)?

 

Furthermore, just look at these comments from the news wires:

 

The Bloomberg quotes PIMCOs top honcho and bond market wizard Bill Gross (highlight mine),

 

``Unchecked, it can turn a campfire into a forest fire, a mild asset bear market into a destructive financial tsunami,'' Gross said. ``If we are to prevent a continuing asset and debt liquidation of near historic proportions, we will require policies that open up the balance sheet of the U.S. Treasury.''

 

Former Federal Reserve Chairman Paul Volker says of the same thing (Bloomberg)

 

``This bright new system, this practice in the United States, this practice in the United Kingdom and elsewhere, has broken down,'' Volcker said today at a banking conference in Calgary. ``Growth in the economy in this decade will be the slowest of any decade since the Great Depression, right in the middle of all this financial innovation.''

 

No, the US dollar’s rally can’t be about economic growth or earlier recovery relative to its peers. The remaining pillar that keeps the US economy afloat has been exports, if the actions in the international financial markets are any indications, as seen in collapsing commodity prices and falling equity values in the BRIC zone (except India!), these suggest that US exports will likewise founder perhaps ushering its economy to a full blown recession perhaps from here going forward.

 

It can’t be about compression of liquidity out of the improvement in the US current account deficits too, if US exports fall in tandem with imports then the deficit standings will remain the same. Besides, the strength of the US exports implies the strength of the global economy; meaning in order for the US economy to keep from falling into a recession it needs a stronger global economy. So relativity-wise, the US can’t outgrow the world economy, especially against emerging markets which has supplied most of its financing requirements.

 

Yet any supposed improvement in the current account deficits will likely be offset by a sharp widening of fiscal deficits where government spending can’t be curbed at the same rate as the slowdown in tax revenues. And these deficits entail the need for foreign capital to plug or fill such yawning gap.

 

It can’t be about the rush to secure US dollars to pay off debt as deflation proponents argue. The liquidity crunch has been mainly a US and partly a Europe phenomenon. Besides, liquidity hasn’t been a monopoly of the US dollar and its financial system.

Figure 4: PIMCO: World Real Policy Rates Remain Negative!

 

Figure 4 from Pimco demonstrates that the world remains essentially “accommodative”.

 

My interpretation is that by keeping the US Fed policy rates down, Chairman Bernanke aims to transmit its inflationary policies via dollar links and currency pegs to Emerging Economies in order for latter to recover earlier-if not to remain vibrant-in order to buoy (via exports) and finance (plug deficits) the US economy, aside from inflating away the relative values of foreign owned US financial liabilities. (Korea’s plan to buy into Lehman and or Merrill Lynch exhibits such patterns).

 

You see the probable strategy employed by the global central banks led by Chairman Bernanke’s US Federal reserve seems to be to buy enough time for the world to recover and eventually write off all the losses in the affected financial sectors (once enough capital has been raised and when markets stabilize) similar to what the US Federal Reserve did in the early 1980s when every major American bank was technically bankrupt.

 

This apropos excerpt from one of our favorite analyst John Maudlin (underscore mine),

 

``They had made massive loans all over Latin America because the loans were so profitable. And everyone knows that governments pay their loans. Where was the risk? This stuff was rated AAA. Except that the borrowers decided they could not afford to make the payments and defaulted on the loans. Argentina, Brazil and all the rest put the US banking system in jeopardy of grinding to a halt. The amount of the loans exceeded the required capitalization of the US banks.

 

``Not all that different from today, expect the problem is defaulting US homeowners. So what did they do then? The Fed allowed the banks to carry the Latin American loans at face value rather than at market value. Over the course of the next six years, the banks increased their capital ratios by a combination of earnings and selling stock. Then when they were adequately capitalized, one by one they wrote off their Latin American loans, beginning with Citibank in 1986.”

 

Conclusion

 

The important thing to differentiate from our standpoint to that of horror stories is that the world is much integrated, more sophisticated and collaborative or more flexible as to diffuse these shocks to perhaps minimize stress levels. That’s why I try to always keep my mind open than simply fall for emotionally stirred hypes.

 

Applied to the investing world, such scenario translates to the same theme: gradual accumulation of EM and Asian assets and/or currencies as the opportunities arise, because the world likely to grow or recover in support of the US economy and not the other way around.