Jun 11, 2012
This is the $41 trillion dollar question now isn’t it? China cut their benchmark lending rate for the first time in 4 years on Thursday and now everyone is asking whether that will be the trend which will begin to stabilize the world economy. In Barron’s latest heavy-hitter roundtable Bill Gross of PIMCO (AMEX:BOND) pointed out that policy makers in the U.S. are at the end of their policy rope. With nominal interest rates zero-bound in the West and Japan they are now down to bond purchasing to push rates negative further punishing savers but it is not working.
Housing and employment numbers in the U.S. are just bouncing along a bottom which is evidence that nothing has been fixed, just postponed by all of the stimulus and bailouts. Creating nominal GDP growth and transferring wealth from the productive to the non-productive classes of a society is not staving off a depression. And yet, that is the underlying assumption of many a respected asset manager.
As the situation in Europe pushes towards its crisis point, which looks for all the world like it will come to a head again at the end of this month, the question is can the emerging markets begin a loosening cycle to kick start the process of helping the U.S. and Europe grow out of their funk? For both the U.S. and Japan the crisis is giving them the opportunity to sell debt into a voracious market. Anyone long the ProShares UltraShort 20+ Year Treasury ETF (AMEX:TBT) has known an unprecedented amount of pain; having lost 26% from the March peak.
China has made a number of moves which signal their growing more comfortable with the Yuan floating in international trade: the wider daily trading range, the open trading between it and both the Aussie and the Yen, raising the limits of foreign holdings of Yuan in offshore funds. So, it would seem that at this point China’s willing to allow the Yuan to depreciate to boost trade.
Hence the rate cut.
That relationship, long-term, is bearish for the U.S. Dollar and should be bullish for the Yen. Even given the 7.2% rally in the CurrencyShares Japanese Yen ETF (AMEX:FXY) since March, that only erased half of the loss from the beginning of 2012. There is plenty of room for the Yen to strengthen versus the Dollar if The Fed is forced to act to keep the European Banks solvent.
They have the room, in terms of monetary policy, to make these moves. In many ways they have to do so. Around the Pacific Rim these economies are now addicted to growth. In both China (AMEX:FXI) and Vietnam they have the problem of continuing to grow or risk sincere civil unrest. In many ways Thailand has a similar problem what with political tensions rising and stability being maintained by their ailing 84 year old king. Nominal GDP growth has slowed across ASEAN and like the West the largest ASEAN economies have little to no room to stimulate via monetary policy.
Singapore’s rates are zero bound and inflation is a steady 5% thanks to high energy prices and a 3% depreciation versus the dollar. Mayalsia’s rates are at 3%, with low CPI inflation but growth is slowing to 4.2% in 2012. Both countries sport, however, very tight labor markets and Malaysia, in particular, has moved steadily away from an export-driven economy, though they have now substituted for one whose growth is dependent on domestic construction, i.e. a potential for malinvestment in real estate.
China, Vietnam and Indonesia have been fighting inflation as well as property bubbles, which, ironically, put them in a good position from a monetary policyperspective. Vietnam has just cut rates for the fourth time in 3 months on strengthening banking liquidity and falling energy prices. Growth for the 2nd quarter may be unspectacular but it will likely soar if commodity prices stabilize. China’s benchmark rate is 6.31% now, Vietnam’s is 11%. India and Russia both sport rates above 8% but both are dealing with very strong currency devaluations, and in Russia’s case, falling oil prices.
For Asia to save the West in 2012 is a dicey call to make. If this was 2014 or 2015 after another two years’ worth of building up regional trade along with the needed infrastructure completed it would be far easier. In the short term the iShares MSCI Malaysia Index ETF (AMEX:EWM) looks like good value in the case of either a European implosion or a coordinated central bank printing event.
In the former with its low P/E and very low exposure to Europe provide a cushion that should make it attractive once the dust in Europe settles. In the latter equity markets will take off and the fund with it. A similar argument can be made for the Market Vectors Vietnam Index ETF (AMEX:VNM). Capital will seek a place to gestate during a global slowdown; buying distressed, but high quality assets. Both of them have a low lower downside risk than the S&P 500 and offer better potential returns if the Fed moves to continue supporting the U.S. equity markets like it has been since 2009.
Now that Spain has bailed out its banks, pending German approval of using the ESM for the funds, the same process that played out in Greece is beginning in Spain. It will not solve any of Spain’s problems, but it will calm the markets for a few weeks at most.
Germany has been the beneficiary of the Euro’s structure for the past 15 years with a kind of internal mercantilism that has sent a tremendous amount of wealth towards Germany at the expense of the rest of the E.U. For the Germans to continue to persist on this course and castigate the PIIGS knowing full well that the original Masstricht treaty was a Faustian bargain for these countries is the height of arrogance and the ultimate cause of this situation.
It looks like most of the world is not in a position to suffer the Germans’ greed because the costs are too high. China will lower rates to maintain some semblance of growth, but that growth will not go to Germany and Europe preferentially, it will go to Asia as a whole, from Russia to India to Japan. While China may have the ability to nearly single-handedly bailout the world economy again like it did after Lehman Bros. fell, it looks like this time the potential future costs are too high.