Posted 08 January 2007 - 08:51 AM
January 1 2007
WINSTON Churchill's tribute to the RAF pilots who dissed the Luftwaffe in the Battle of Britain could be an apt metaphor for the liquidity tsunami that has swept the global financial markets. Never have so many junk assets owed so much to the epic money pump of so few central bankers, who have now managed to reprice risk down to zero.
Sure, don't worry be happy is the theme song of the zeitgeist and I am happy enough to surf on the junk asset wave because it is downright fatal to be Scrooge McDuck when it is time to run with the bulls on the stock exchange. But financial markets invariably ambush the bold (gold?) and the beautiful, the leveraged princes of high beta risk. Bitter experience and history has taught me that nothing lasts forever, we both know risk appetites can change, that it's hard to hold a candle in the cold December Dubai rain. The slasher Hollywood movies of my youth had it right. Somewhere out there in sunny suburban Xanadu, in the never never land of risk, the goblins are out there, waiting, waiting for their prey, watching the hoofbeats of the herd as it sprints to its doom. Murphy's Law, alas, works all too predictably on Wall Street.
I am no Cassandra, quite the contrary, in fact. But, sadly, Cassandras can sometimes hit the bull's eye, as I did when I kept pleading to my friends that the GCC financial markets were the mother of all asset bubbles in the summer of 2005. Strange, conventional wisdom today was downright capital markets heresy a mere sixteen months ago. Had investors heeded my warnings and cut exposure to GCC shares last summer, billions of dollars of would not have vanished into money heaven and the lives of thousands of investors in the Gulf would not have been ruined. In the money game, the Cassandra syndrome defines the art of survival. No guts, no glory, you bet, but all guts, no brains just ensures poor Jack get gutted.
The best and the brightest in world finance are all optimists for 2007. And why not? The VIX (greed — fear gauge) is at a decade low at 11. Goldilocks is alive and kicking. The entire world has gone ballistic for risk, Chinese banks at 5 times book value, condo deals in Damascus and Karachi, Third World debt risk spreads the narrowest in history, 150 per cent returns in Ho Chi Minh, Egyptian stocks triple the valuation of the SP500 or the Footsie. Fine and dandy as long as the music plays on but what if the music stops. What then?
Every boom contains the genesis of its own bust. When Alice in Wonderland rules the roost in the financial markets, when real estate speculation resembles a mad hatters ball, when aberrant behavior (risk repriced to zero) becomes gospel truth in our monetary Mount Olympus, I must flash an SOS. Every easy money boom in world finance — Wall Street in the 1920's, Japan in the 1980's, Southeast Asian in the 1990's, the GCC since 2002 exhibit eerily similar phenomena. Rapid expansion of credit, go go bankers (yes, Sir no sir, three bags full sir, London Bridge is falling down, my fair punter, Yes Sir I can boggie!), the irrational pricing of risk (95 per cent financing on spec real estate, 120 brokers on DFM to trade 30 shares, of which 5 actually trade) and extravagant, unreal projects full of hot air ($50 billion cities in the Sinai desert? Why not brand new resorts on the moon?) Bubbles spawn bubble gum financiers, a specie I know all too well as a money manager in Dubai who gets pitched deals high on the Loony Tunes index every day. Financial markets are all about the calculus of risk in business cycles and neither Lord Keynes not the monetarists predicted the Great Depression. But the classical economists of the Austrian School did.
Inflation in our times is not the CPI but the exponential rise in credit, monetary aggregates and asset prices. When the Greenspan Fed responded to the Silicon Valley tech bust and 9/11 with its epic monetary ease, it spawned the biggest credit bubble since the 1920's on Wall Street. The result? Rapid fixed investment growth, soaring stock markets, property bubbles fueled by cheap debt, irrational pricing of risk, leveraged daisy chains of offshore capital, financial markets morphed into Vegas/Monaco casinos. This was the identical zeitgeist in New York 1929, Tokyo 1989, Seoul Asean 1996, Latin America 1994, and GCC 2005. It was a yalla, hooplay hefla, hype and hip hip hooray credit opera until the fat lady stopped singing.
What could derail the global business cycle in 2007? The household borrowing binge and property bubble have now ended. Like TMT in the 1990's, trillions of the dollars invested in speculative real estate all over the world is now at grave risk as America slips into the quicksand of a housing recession. The surge in commodities prices have less to do with China than the Fed and the 45 per cent devaluation of the dollar against the euro since 2002. Amazingly, central banks in the GCC want to buy euros now? Now? When the euro has risen 45 per cent against the dollar in the last four years?. Still, better late then never. My recommended anti-dollar money hedges? Norwegian kroners, Russky roubles, Aussie/Sing dollars. Even our maid saves in Aussie dollars!
If all is honky dory, why are the CEO's who run corporate America so reluctant to boost capex? Because they know that credit booms built on leverage and property speculation are destined to end in liquidity shocks and recession. The contagion in US housing will, mark my words, mean Black Death for asset markets all over the world. Property was Joe and June America's mega — ATM and the housing crash means recession as capex cannot pass the baton alone. That will spell doom for the commodities boom.
The yen carry trades, the trillion dollar hot money hedge fund carnival, China's white hot GDP growth, Russian and Arab petro-dollars, the parabolic rise in the CRB commodities index, the $800 billion American trade deficit are all symptoms of the brave new world of international finance. The Fed cannot ease, as Wall Street no naively expects, amid such monetary madness. The ECB and the Bank of Japan have abandoned easy money. Watch the T-bond yield hit 5 per cent, gold and oil fall below $600 and $55, the CRB index plunge to 250. The bull is old, tired and vulnerable. There is a debt pyramid in the financial markets that makes credit contraction and a liquidity shock inevitable. Sometime next year, American housing will cause the global ATM machine to spew leprosy, not cash. Stock markets will crash. The next big EM blowup will be intercontinental. Remember the old Simon and Garfunkel song? Hello, darkness, my old friend...
Observer
The future is 90% present and 10% vision.