It is the one substance that man needs to survive. Without it, life as we know it cannot continue. Despite this, supplies of clean, drinkable water are diminishing rapidly due to the global population boom and industrialisation.
As its flow continues to dry up, the price of water will increase rapidly. In the wake of this crisis, financial institutions have begun to create new funds so that investors can benefit from investing in this rare commodity.
On paper, the potential opportunity for profit looks immense.
Glaciers are melting, rivers are drying up and over usage has reduced rivers that were previously raging torrents to trickles. The glass is now absolutely half full and its price will rise.
But there is an obvious question that needs to be asked. Will water management be left to the private sector or is it more likely that the entire industry globally, will become heavily regulated and the various water companies run as state monopoli?
In a worst case scenario, Water will become a national security issue. There will be countries that are haves and others that are have nots.
Imagine a situation such as we saw last winter with Russia and the Ukraine. Ukraine had not paid its bill and so Russia cut off the gas supply. The collateral damage meant that other countries were also affected, particularly Bulgaria. Now imagine that happening with water.
This is not a matter for mere corporations. This is the stuff of reapolitik. This is the business of governments not banks. There is also a moral issue and the notion that it is ok to financially benefit from the scarcity of a substance that is the very stuff of life itself.
Before I begin to overindulge in my new found piety though; I cannot see how water utility corporations will be allowed to continue as private sector entities, particularly if water has long term supply issues. If the point of investing in water funds is to benefit from long term shortages, then surely at the very point when these funds are about to make their greatest profit, they will be nationalised.
Sunday 28 June 2009
Wednesday 24 June 2009
The Crisis: Labour Destroys The UK Pension System
With UK income taxes now as high as 60% for higher earners, Alistair Darling has twisted the knife further by increasing tax relief on pension contributions to the point where it almost seems pointless to have one.
New Zealand has a system which is the envy of the world. Decent tax benefits and flexibility for private pensions. But if your private annuity exceeds a minimum threshold, then your state pension (which like it's British equivalent is tiny) is taxed at 100%. This frees up money for those in need, resulting in a sustainable pension system.
Below is an article from the Daily Mail of 24th June.
Pensions crisis: 96% of final salary schemes are doomed... OAPs worst off in Britain... and state funds withering on the vine
By Olinka Koster
The extent of the pensions crisis was laid bare yesterday by a 'triple whammy' of worrying reports.
Almost all blue-chip companies now admit their final salary schemes are 'unsustainable', according to a major survey.
At the same time, two separate studies said that Britain's state pension was the worst in the Western world.
Pensions crisis
Concerns for the future: A 'triple whammy' of reports have laid bare the scale of the pensions crisis
The reports confirm that private sector workers face a bleak future, with the state handout withering on the vine and dozens of generous company schemes on the verge of being wound up.
However, most gold-plated public sector schemes - funded by the taxpayer - remain untouched.
Almost 90 per cent of state employees receive final salary pensions, compared with just 16 per cent in the private sector.
Opposition parties and campaign groups said last night that the three studies provided yet more evidence of the growing crisis in pension provision.
Liberal Democrat work and pensions spokesman Lord Oakeshott said: 'Gordon Brown has been in charge of our pensions for the past 12 years.
'He should be ashamed of these shocking statistics, showing Britain's miserable means-tested state pension right at the bottom of the world pension league.'
Prior to 1997, Britain's state pension pot was in relatively good health. But in one of his first acts as chancellor, Mr Brown scrapped the tax relief on dividends paid into pension funds, costing them around £100billion.
It triggered the shutdown of final salary schemes covering hundreds of thousands of workers.
Yesterday's 'triple whammy' of bad news comprised:
* A survey of 1,000 blue-chip companies by Pricewaterhouse Coopers, which found that 96 per cent believe their final salary schemes are unsustainable.
* A study by the influential Organisation for Economic Cooperation and Development (OECD), placing Britain at the bottom of a 'pensions' league table for those yet to retire.
* Research by the UK-based Office for National Statistics, which confirmed just how little the state pension is now worth.
The House of Lords also released a report yesterday criticising Chancellor Alistair Darling's Budget for removing a series of tax breaks on pension contributions.
Tory pensions spokesman Theresa May said: 'This is yet more bad news for cash-strapped pensioners who are the innocent victims of this recession.'
Some 16 per cent of the firms which responded to the PWC survey had already closed their final salary schemes to current members.
Lords anger
A further 55 companies said they intended to freeze their schemes for existing members within the next five years.
Meanwhile, the report from the OECD showed that younger British workers will get far less generous state payouts than their counterparts in France, Germany and Spain.
Those entering the labour market today can expect to receive a state pension worth just four times their average annual earnings of £31,500 over the course of their retirement.
In contrast, Germans will receive more than seven times their average salary, while the French will get more than nine times their annual pay.
The figures from the ONS, which measured how state pensions reflect previous salaries, revealed that Britain has the least generous arrangement of any OECD country. The basic state pension is just £95.25 per week for an individual and £152.30 for a couple.
Michelle Mitchell of Age Concern said: 'It's a national disgrace that more than two million UK pensioners are trapped in poverty.
'With British pensioners receiving one of the lowest state pensions in Europe, the Government must go further to improve the situation for the country's poorest older people.'
The latest round of dismal news comes as unemployment reached its highest level since the end of 1996 - just before Labour came to power.
Many workers are suffering from pay freezes, leaving little spare cash to save for their retirement.
Pensions minister Angela Eagle said last night: 'It's absolute nonsense to suggest this Government is not committed to pensioners.
'Measures such as pension credit and winter fuel payments mean that even the poorest pensioners in the UK are still better off than the poorest pensioners in other countries.'
New Zealand has a system which is the envy of the world. Decent tax benefits and flexibility for private pensions. But if your private annuity exceeds a minimum threshold, then your state pension (which like it's British equivalent is tiny) is taxed at 100%. This frees up money for those in need, resulting in a sustainable pension system.
Below is an article from the Daily Mail of 24th June.
Pensions crisis: 96% of final salary schemes are doomed... OAPs worst off in Britain... and state funds withering on the vine
By Olinka Koster
The extent of the pensions crisis was laid bare yesterday by a 'triple whammy' of worrying reports.
Almost all blue-chip companies now admit their final salary schemes are 'unsustainable', according to a major survey.
At the same time, two separate studies said that Britain's state pension was the worst in the Western world.
Pensions crisis
Concerns for the future: A 'triple whammy' of reports have laid bare the scale of the pensions crisis
The reports confirm that private sector workers face a bleak future, with the state handout withering on the vine and dozens of generous company schemes on the verge of being wound up.
However, most gold-plated public sector schemes - funded by the taxpayer - remain untouched.
Almost 90 per cent of state employees receive final salary pensions, compared with just 16 per cent in the private sector.
Opposition parties and campaign groups said last night that the three studies provided yet more evidence of the growing crisis in pension provision.
Liberal Democrat work and pensions spokesman Lord Oakeshott said: 'Gordon Brown has been in charge of our pensions for the past 12 years.
'He should be ashamed of these shocking statistics, showing Britain's miserable means-tested state pension right at the bottom of the world pension league.'
Prior to 1997, Britain's state pension pot was in relatively good health. But in one of his first acts as chancellor, Mr Brown scrapped the tax relief on dividends paid into pension funds, costing them around £100billion.
It triggered the shutdown of final salary schemes covering hundreds of thousands of workers.
Yesterday's 'triple whammy' of bad news comprised:
* A survey of 1,000 blue-chip companies by Pricewaterhouse Coopers, which found that 96 per cent believe their final salary schemes are unsustainable.
* A study by the influential Organisation for Economic Cooperation and Development (OECD), placing Britain at the bottom of a 'pensions' league table for those yet to retire.
* Research by the UK-based Office for National Statistics, which confirmed just how little the state pension is now worth.
The House of Lords also released a report yesterday criticising Chancellor Alistair Darling's Budget for removing a series of tax breaks on pension contributions.
Tory pensions spokesman Theresa May said: 'This is yet more bad news for cash-strapped pensioners who are the innocent victims of this recession.'
Some 16 per cent of the firms which responded to the PWC survey had already closed their final salary schemes to current members.
Lords anger
A further 55 companies said they intended to freeze their schemes for existing members within the next five years.
Meanwhile, the report from the OECD showed that younger British workers will get far less generous state payouts than their counterparts in France, Germany and Spain.
Those entering the labour market today can expect to receive a state pension worth just four times their average annual earnings of £31,500 over the course of their retirement.
In contrast, Germans will receive more than seven times their average salary, while the French will get more than nine times their annual pay.
The figures from the ONS, which measured how state pensions reflect previous salaries, revealed that Britain has the least generous arrangement of any OECD country. The basic state pension is just £95.25 per week for an individual and £152.30 for a couple.
Michelle Mitchell of Age Concern said: 'It's a national disgrace that more than two million UK pensioners are trapped in poverty.
'With British pensioners receiving one of the lowest state pensions in Europe, the Government must go further to improve the situation for the country's poorest older people.'
The latest round of dismal news comes as unemployment reached its highest level since the end of 1996 - just before Labour came to power.
Many workers are suffering from pay freezes, leaving little spare cash to save for their retirement.
Pensions minister Angela Eagle said last night: 'It's absolute nonsense to suggest this Government is not committed to pensioners.
'Measures such as pension credit and winter fuel payments mean that even the poorest pensioners in the UK are still better off than the poorest pensioners in other countries.'
Tuesday 23 June 2009
Investment: A Time To Buy By Gareth Milliams
Our savings plans made a very handsome profit from September onward by dollar cost averaging in emerging markets. We sold out in May and switched to a US$ money fund. New monthly premiums have been redirected to oil and resources funds. These funds we believe will offer major discounts in the next few weeks as the market corrects. Long term, the extra units that these funds buy will convert to profit as the market recovers.
Risk is relative to the amount invested. Investing a monthly premium in order to buy discounted units makes absolute sense. But it only makes sense if capital sums are protected. Monthly savings invested for long periods become capital.
The best environment for a monthly investment is high volatility which is counter to the best environment for a lump sum. Capital needs smoothed growth. That was why we sold out to cash in May and started a new phase of monthly contributions into the aforementioned commodity funds.
Last night the equity markets in Europe and the US lost over 2.5% and this morning, the Nikkei is down almost 3%. Who knows whether this is a minor correction in a new bull market or whether the bull was (as many of us suspect) a bear in disguise?
These questions will be answered in the fullness of time. I'm just glad that my clients money is safe and out of it.
Risk is relative to the amount invested. Investing a monthly premium in order to buy discounted units makes absolute sense. But it only makes sense if capital sums are protected. Monthly savings invested for long periods become capital.
The best environment for a monthly investment is high volatility which is counter to the best environment for a lump sum. Capital needs smoothed growth. That was why we sold out to cash in May and started a new phase of monthly contributions into the aforementioned commodity funds.
Last night the equity markets in Europe and the US lost over 2.5% and this morning, the Nikkei is down almost 3%. Who knows whether this is a minor correction in a new bull market or whether the bull was (as many of us suspect) a bear in disguise?
These questions will be answered in the fullness of time. I'm just glad that my clients money is safe and out of it.
Sunday 21 June 2009
Geoeconomics: A New Cold War? By Gareth Milliams
One of the reasons why the West won the Cold War against the tyranny of Soviet communism, was not necessarily because of the superiority of our political system nor was it just due to the might of the NATO military machine. The roots of the victory extend even beyond President Reagan asking Gorbachev to tear down German walls.
After Stalin's death, and after Nikita Khrushchev became leader of the Soviet Union; Khrushchev criticised Stalin, denouncing him and his "cult of personality" in a secret speech to the Politburo in 1956. He then started making overtures for "peaceful coexistence" with the West.
Mao felt that Khrushchev was betraying Communism and was attacking him personally, because he too had built up a cult of personality as Stalin had. Then Khrushchev backed out of an agreement to give China the information they needed to build their own atomic bomb.
The tensions between the Soviet Union and China would reach their peak in 1968-69, when they had a series of armed engagements along their borders, especially in the north east and and north west.
These hostilities and Russia's growing support of the North Vietnamese led to the 1972 rapprochement between China and the US (ping pong diplomacy) and ultimately to the invasion of Vietnam by China in 1979.
The West was fortunate. If there ever had been a sustained and united Soviet/China Axis, the world may have been a very different place. Just their combined diplomatic influence alone would have been immense.
Fast forward to 2009:
The global financial crisis has forced Russia and China to reevaluate their relationship. Whilst their economies structurally, have little in common (Russia looks to a higher oil price, whereas China is a net consumer), both of these nations are heavily dependent upon the US dollar as the worlds reserve currency for trade.
The dabasing of the US dollar is a major problem for all emerging nations, particularly for those who hedge their own currencies with US$ treasuries. Many in the developing world believe that the time has come for a balanced basket of currencies to be adopted as the world's reserve currency.
Back on April 1, before the G20 meeting I wrote the following:
"I think it likely that the dollars position as the worlds reserve currency will be under threat over the next few days. Whilst I do not expect the dollar doubters to prevail, it makes sense that Russia and China use its underperformance as leverage in their negotiations".
On June 16th at the BRIC conference, the AP reported the following: "The dollar gave back some of its day-ago gains after Russian officials called for the creation of new reserve currencies in addition to the dollar and said the country may invest part of its currency holdings in bonds issued by Brazil, China and India".
It goes on to say, Chinese officials have also pushed for expanding emerging economies' representation in the IMF's "Special Drawing Rights" basket, currently made up of the euro, yen, pound and dollar. SDR's have served, in limited use, as a reserve asset since 1969.
Referring back to the April 1 article in this blog, I wrote, "I think that the basket of currencies proposal as an alternative to the US dollar is a 'stalking horse' for the eventual launch of the Renminbi on the world markets".
In my opinion, China is not particularly interested in greater representation for "expanding emerging economies" in the IMF's SDR basket at all. Like all nation states, it puts self interest above all else.
Since the economic downturn, the US has weakened economically and China is resurgent. I think it only logical and even inevitable that the Renminbi and the Rouble eventually be included in the SDR basket.
Before this happens, expect even wider use of both currencies via bilateral currency swaps between China, Russia and its trading partners.
Inclusion of these two great nations within a global reserve basket could be a great geopolitical stabiliser. Trade is the greatest bringer of peace and harmony. War and political tension is its enemy. Having membership of a reserve currency brings obligation and responsibility. It behooves both of these superpowers to achieve a new entente cordiale.
Rather than being something to fear, maybe the political demise of the US dollar for a more inclusive global reserve has implications beyond just trade.
After Stalin's death, and after Nikita Khrushchev became leader of the Soviet Union; Khrushchev criticised Stalin, denouncing him and his "cult of personality" in a secret speech to the Politburo in 1956. He then started making overtures for "peaceful coexistence" with the West.
Mao felt that Khrushchev was betraying Communism and was attacking him personally, because he too had built up a cult of personality as Stalin had. Then Khrushchev backed out of an agreement to give China the information they needed to build their own atomic bomb.
The tensions between the Soviet Union and China would reach their peak in 1968-69, when they had a series of armed engagements along their borders, especially in the north east and and north west.
These hostilities and Russia's growing support of the North Vietnamese led to the 1972 rapprochement between China and the US (ping pong diplomacy) and ultimately to the invasion of Vietnam by China in 1979.
The West was fortunate. If there ever had been a sustained and united Soviet/China Axis, the world may have been a very different place. Just their combined diplomatic influence alone would have been immense.
Fast forward to 2009:
The global financial crisis has forced Russia and China to reevaluate their relationship. Whilst their economies structurally, have little in common (Russia looks to a higher oil price, whereas China is a net consumer), both of these nations are heavily dependent upon the US dollar as the worlds reserve currency for trade.
The dabasing of the US dollar is a major problem for all emerging nations, particularly for those who hedge their own currencies with US$ treasuries. Many in the developing world believe that the time has come for a balanced basket of currencies to be adopted as the world's reserve currency.
Back on April 1, before the G20 meeting I wrote the following:
"I think it likely that the dollars position as the worlds reserve currency will be under threat over the next few days. Whilst I do not expect the dollar doubters to prevail, it makes sense that Russia and China use its underperformance as leverage in their negotiations".
On June 16th at the BRIC conference, the AP reported the following: "The dollar gave back some of its day-ago gains after Russian officials called for the creation of new reserve currencies in addition to the dollar and said the country may invest part of its currency holdings in bonds issued by Brazil, China and India".
It goes on to say, Chinese officials have also pushed for expanding emerging economies' representation in the IMF's "Special Drawing Rights" basket, currently made up of the euro, yen, pound and dollar. SDR's have served, in limited use, as a reserve asset since 1969.
Referring back to the April 1 article in this blog, I wrote, "I think that the basket of currencies proposal as an alternative to the US dollar is a 'stalking horse' for the eventual launch of the Renminbi on the world markets".
In my opinion, China is not particularly interested in greater representation for "expanding emerging economies" in the IMF's SDR basket at all. Like all nation states, it puts self interest above all else.
Since the economic downturn, the US has weakened economically and China is resurgent. I think it only logical and even inevitable that the Renminbi and the Rouble eventually be included in the SDR basket.
Before this happens, expect even wider use of both currencies via bilateral currency swaps between China, Russia and its trading partners.
Inclusion of these two great nations within a global reserve basket could be a great geopolitical stabiliser. Trade is the greatest bringer of peace and harmony. War and political tension is its enemy. Having membership of a reserve currency brings obligation and responsibility. It behooves both of these superpowers to achieve a new entente cordiale.
Rather than being something to fear, maybe the political demise of the US dollar for a more inclusive global reserve has implications beyond just trade.
The Crisis: Is This The Death Of The Dollar? By Edmund Conway Of The Daily Telegraph
After two smugglers were stopped last week with what at first appeared to be $134bn in US state bonds, the tension and paranoia surrounding the fate of the dollar hit a new high.
Published: 7:32PM BST 20 Jun 2009
Border guards in Chiasso see plenty of smugglers and plenty of false-bottomed suitcases, but no one in the town, which straddles the Italian-Swiss frontier, had ever seen anything like this. Trussed up in front of the police in the train station were two Japanese men, and beside them a suitcase with a booty unlike any other. Concealed at the bottom of the bag were some rather incredible sheets of paper. The documents were apparently dollar-denominated US government bonds with a face value of a staggering $134bn (£81bn).
How on earth did these two men, who at first refused to identify themselves, come to be there, trying to ride the train into Switzerland carrying bonds worth more than the gross domestic product of Singapore? If the bonds were genuine, the pair would have been America's fourth-biggest creditor, ahead of the UK and just behind Russia. No sooner had the story leaked out from the Italian lakes region last week than it sparked a panoply of conspiracy tales. But one resounded more than any other: that the men were agents of the Japanese finance ministry, in the country for the G8 meeting, making a surreptitious journey into Switzerland to sell off one small chunk of the massive mountain of US bonds stacked up in the Japanese Treasury vaults.
In the event, late last week American officials confirmed that the notes were forgeries. The men, it appeared, were nothing more than ambitious scamsters. But many remain unconvinced. And whether fake or otherwise, the story underlines one important point about the world economy at the moment: that the tension and paranoia surrounding the fate of the US dollar has hit a new high. It went to the heart of the big question: will the central bankers in Japan, China and elsewhere continue to support the greenback even in the wake of the worst financial crisis in modern history, or will they abandon it as America's economic hegemony dissipates?
Dollar obituaries are nothing new. The currency has been presumed dead more times than Shane Macgowan. But like the lead singer of The Pogues, the greenback has somehow withstood repeated knocks and scrapes over the years and lived on, battered, bruised and a couple of teeth the lighter, to fight another day. In the 1970s and 1980s there were plenty predicting its demise, although at that point the main challenger was the Japanese yen. And in the years preceding this crisis, economists and investors including Peter Schiff and George Soros were lining up to declare the dollar's demise as the world's reserve currency. In the late 1990s, the creation of the euro gave dollar sceptics another stick to beat the currency with, and no doubt the European currency has claimed some of the prominence in its first decade.
Now, following the collapse of the global financial system, those warnings have become louder still, and ever more difficult to dismiss – because this time around there are threatening noises coming from those who actually have the power to do something about it. First came a paper from Zhou Xiaochuan, the governor of the People's Bank of China (PBoC), a couple of months ago, positing the idea of introducing the special drawing right (SDR) – a kind of internal currency at the International Monetary Fund (IMF) – as an international reserve currency. These calls were then repeated, with more force, by the Russian president, Dmitry Medvedev, who last week declared that the world needed new reserve currencies in addition to the dollar.
And this time around, the dollar is most certainly suffering. Since 2002 its trade-weighted strength – calculated against a basket of other currencies – has fallen by more than a quarter, from 112 to 81 points. In the same period, the proportion of dollars held by reserve managers in leading central banks has also taken a dive. According to figures from the IMF, confirmed holdings of dollars in government vaults, from Beijing and Tokyo to London and Paris, fell from 71pc of reserves to 64.5pc between 2002 and 2008.
However, detecting what is really happening in the world of foreign exchange reserves is notoriously closer to an art than a science. For instance, figures from April seemed to suggest a fall in China's holdings of US Treasuries – something 'dollapocalypticists' pounced on at the time. But according to Brad Setser of the Council on Foreign Relations, the country was merely rejigging its Treasury portfolio rather than liquidating parts of it. In such an opaque world it is little wonder the conspiracy theories over those two Japanese smugglers show little sign of dissipating.
Nonetheless, for US Treasury Secretary Tim Geithner, who has inherited his predecessors' role as dollar wallah-in-chief, the currency's travails have made it all the more difficult for him to repeat the mantra that he "believes in a strong dollar" while keeping a straight face. Indeed, when he tried to insist at a university lecture in Beijing earlier this month that "Chinese financial assets are very safe," it drew floods of laughter from the audience.
He wasn't playing for laughs, but the irony of the situation is plain to see. If there were a textbook list of actions one could take to weaken a currency, the US (alongside most other developed nations) would be following it to the letter. It has cut interest rates to a whisker above zero; it has engaged in quantitative easing, pumping cash directly into the economy; it has committed to spending trillions of dollars on a fiscal stimulus package designed to pull the country out of recession; it has pledged tacitly to support its stricken banks so that no major institution is allowed to collapse. In any normal circumstances, actions like these would hammer a currency.
According to Stephen Jen of BlueGold Capital Management: "People are having second thoughts not simply because they don't like the dollar, but they are having second thoughts about whether US assets are obviously the strongest assets to own."
Like everything else, the currency's fate depends on how well the US authorities manage the crisis. The US is balanced on a knife-edge between possible Japan-style deflation as the weight of all its debts bear down on it and potential inflation as the force of all its powerful stimulus measures take root. No one knows for sure which way it will fall, but neither would be particularly good for the currency, and by extension for those who hold much in the way of dollar assets.
And China and all other major central banks which have trillions of dollars in their vaults, face something of a dilemma. Any fall in the greenback will cause the value of their investments to slide. Even if they wanted to exit, there seems no easy way of doing so without provoking some serious self-harm. Indeed, according to Olivier Accominotti, a PhD economist at Paris's Sciences Po university, the situation is not unlike that faced by France in the 1920s, as it sought to reduce its massive sterling reserves. The Bank of France found itself in a "sterling trap" in which it "could not continue selling pounds without precipitating a sterling collapse and a huge exchange loss for itself".
Neil Mellor, of Bank of New York Mellon, said: "We've got a situation where Geithner is smiling and has no choice but to stress the credibility and stability of the US financial and economic system, while the creditors [such as the Chinese] smile back and say they believe him, while at the same time giving hand signals to their reserve managers to get rid of these things."
Rather like the brinksmanship on display throughout the Cold War, it is a dilemma which applies itself to game theory. Both sides know that the dollar is set to weaken, but both could be set to suffer if they both allowed it to collapse at the same time. "If you are the Chinese it is in your interest to play the game – you've got a lot of dollars at stake – but in the long run you surely want to reduce your holdings and diversify them at the margins," says Mellor.
Still, with every passing week, the conjunction of different warning signals for the US currency seems to evolve and intensify. Recently, the alarm bell ringing most loudly has been the increase in yields on US Treasuries – a sign, some fear, of acute nervousness among institutional investors about the sheer scale of the cash the Obama administration is planning to borrow in coming years. The Federal Reserve's meeting next week is likely to be watched attentively by everyone with a stake in the game, as the central bank indicates whether it is planning to plough more dollars of newly-created cash into the economy.
But while the debate fixates on the greenback, the issues at heart here go far deeper. The dollar's fate is intertwined with that of the global economy. America is on the brink of losing its economic superpower status, which it will have to share with China at least, if not others, in the coming years. Holding such a position confers important responsibilities, none of which is more symbolic than providing the world's reserve currency – the currency against which all major commodities are denominated, and the de facto international unit of exchange in trade and finance.
It was a position enjoyed by UK sterling during the first waves of globalisation in the Victorian era and the final decades of the British Empire. Eventually, around the time of the Second World War, the dollar inherited the mantle. At first this was something enshrined in the Bretton Woods agreement of 1944, which fixed world currencies to the dollar, but although that system broke down in the 1960s and 1970s, it has remained the de facto currency of choice.
In a globalised world, with trade being carried out between hundreds of different nations by thousands of different companies, having an international standard makes sense: it enables traders to exchange goods more quickly and efficiently than they would have done otherwise. It may be invisible to us, but the vast majority of foreign exchange transactions – particularly those between smaller nations – involve the dollar. Exchange your sterling for Thai baht and you're actually swapping pounds for dollars for baht, whatever the exchange booth says. Even the much-vaunted exchange arrangements by the Brazilian and Chinese are designed not to disrupt these foundations, but merely to smooth things over for importers and exporters.
But a by-product of the dollar's dominance has been the skewing of the world's monetary system. By dint of having this blessed position, the US has been able to finance ever-larger current account and fiscal deficits, with both the government and the public borrowing from overseas, at cheap rates of interest. It has been able to sell US Treasuries at interest rates that other countries can only dream of because of this position as reserve currency. It has had a captive consumer – both because its government bonds are something of a safe haven and because those wishing to peg their currencies against the dollar and enhance their trade flows have little choice but to buy US Treasuries.
And this mutated international monetary system that has evolved since the 1960s is largely responsible for the crisis into which the world has tipped. Because it was able to borrow off other countries at such low rates without enduring the market punishment – in other words higher interest rates – America was able to build up massive current account deficits which poured a record amount of debt throughout its economy, which manifested itself in the financial crisis.
Indeed, as Mervyn King said in a speech earlier this year: "At the heart of the crisis was the problem identified but not solved at Bretton Woods – the need to impose symmetric obligations on countries that run persistent current account surpluses and not just on countries that run deficits. From that failure stemmed a chain of events, no one of which alone appeared to threaten stability, but which taken together led to the worst financial crisis any of us can recall."
When the PBoC's Zhou referred to the SDRs he was not merely questioning the dollar's pre-eminence. He was indicating something far more radical – that China supports plans for a new Bretton Woods-style agreement to manage the flows of cash around the world. At that seminal conference in 1944, John Maynard Keynes's original idea, which was watered down by Harry Dexter White of the US Treasury, was for an international reserve currency, Bancor, fixed against a basket of 30 currencies, and that countries would be penalised if their current accounts swung too far into surplus or deficit. It is an idea which is now being dusted off from history books by officials in finance ministries around the world, including in China.
Such a radical shake-up would cause earthquakes in the currency markets, a prospect which perhaps makes it unlikely. So in the absence of such a deal, how is the dollar's role likely to evolve in the coming years? The short answer is that no one should expect it to lose its reserve currency status any time soon. It took around half a century for Britain to cede this position to the US, even after being overtaken in true economic might.
One possibility is that the SDR may be used increasingly as a means of denominating assets in accounts, but this is something which would take place gradually, over a course of some years. But even if that is a bridge towards a multi-polar world, in which other currencies vie with the dollar for influence, it will take some time – perhaps 30 years or more, according to Stephen Jen. "People should look at history," he said, referring to sterling's pre-eminence in the first part of the 20th century. "There's a real incumbency advantage."
Jim O'Neill, chief economist at Goldman Sachs, sees the next few years as something of a "vacuum period".
"The BRIC countries [Brazil, Russia, India and China] are becoming so much more important, while the G7, including the US declines, which raises issues about the degree of dominance of the dollar. The problem is that the currencies of the BRICS are the ones that matter, but they won't let you export or use their currencies.
"Until we see another five years' of evidence over whether China is a more consumer-driven economy, becoming bigger and bigger, and whether the euro can have a successful second decade, the dollar looks set to remain dominant."
China has made some hints about loosening its hold over the yuan in recent months, but these are only early manoeuvres. A second step would be to allow the yuan to become a part of the SDR – whose own value is determined by those of a basket of currencies including the dollar, pound and euro. As Jen adds, there are certain prerequisites any contender to the crown of world reserve currency needs in its pocket.
"We have to ask this question: is Russia going to provide asset market that will be as liquid, reliable property rights, the rule of law, currency convertibility and so on? Will we see the same from the likes of China? Their task is very daunting."
Referring to the forged Treasury bonds picked up on the Japanese smugglers on the Swiss border, he adds: "There is a message here: we haven't heard much about anyone counterfeiting roubles. That is probably telling you something."
Published: 7:32PM BST 20 Jun 2009
Border guards in Chiasso see plenty of smugglers and plenty of false-bottomed suitcases, but no one in the town, which straddles the Italian-Swiss frontier, had ever seen anything like this. Trussed up in front of the police in the train station were two Japanese men, and beside them a suitcase with a booty unlike any other. Concealed at the bottom of the bag were some rather incredible sheets of paper. The documents were apparently dollar-denominated US government bonds with a face value of a staggering $134bn (£81bn).
How on earth did these two men, who at first refused to identify themselves, come to be there, trying to ride the train into Switzerland carrying bonds worth more than the gross domestic product of Singapore? If the bonds were genuine, the pair would have been America's fourth-biggest creditor, ahead of the UK and just behind Russia. No sooner had the story leaked out from the Italian lakes region last week than it sparked a panoply of conspiracy tales. But one resounded more than any other: that the men were agents of the Japanese finance ministry, in the country for the G8 meeting, making a surreptitious journey into Switzerland to sell off one small chunk of the massive mountain of US bonds stacked up in the Japanese Treasury vaults.
In the event, late last week American officials confirmed that the notes were forgeries. The men, it appeared, were nothing more than ambitious scamsters. But many remain unconvinced. And whether fake or otherwise, the story underlines one important point about the world economy at the moment: that the tension and paranoia surrounding the fate of the US dollar has hit a new high. It went to the heart of the big question: will the central bankers in Japan, China and elsewhere continue to support the greenback even in the wake of the worst financial crisis in modern history, or will they abandon it as America's economic hegemony dissipates?
Dollar obituaries are nothing new. The currency has been presumed dead more times than Shane Macgowan. But like the lead singer of The Pogues, the greenback has somehow withstood repeated knocks and scrapes over the years and lived on, battered, bruised and a couple of teeth the lighter, to fight another day. In the 1970s and 1980s there were plenty predicting its demise, although at that point the main challenger was the Japanese yen. And in the years preceding this crisis, economists and investors including Peter Schiff and George Soros were lining up to declare the dollar's demise as the world's reserve currency. In the late 1990s, the creation of the euro gave dollar sceptics another stick to beat the currency with, and no doubt the European currency has claimed some of the prominence in its first decade.
Now, following the collapse of the global financial system, those warnings have become louder still, and ever more difficult to dismiss – because this time around there are threatening noises coming from those who actually have the power to do something about it. First came a paper from Zhou Xiaochuan, the governor of the People's Bank of China (PBoC), a couple of months ago, positing the idea of introducing the special drawing right (SDR) – a kind of internal currency at the International Monetary Fund (IMF) – as an international reserve currency. These calls were then repeated, with more force, by the Russian president, Dmitry Medvedev, who last week declared that the world needed new reserve currencies in addition to the dollar.
And this time around, the dollar is most certainly suffering. Since 2002 its trade-weighted strength – calculated against a basket of other currencies – has fallen by more than a quarter, from 112 to 81 points. In the same period, the proportion of dollars held by reserve managers in leading central banks has also taken a dive. According to figures from the IMF, confirmed holdings of dollars in government vaults, from Beijing and Tokyo to London and Paris, fell from 71pc of reserves to 64.5pc between 2002 and 2008.
However, detecting what is really happening in the world of foreign exchange reserves is notoriously closer to an art than a science. For instance, figures from April seemed to suggest a fall in China's holdings of US Treasuries – something 'dollapocalypticists' pounced on at the time. But according to Brad Setser of the Council on Foreign Relations, the country was merely rejigging its Treasury portfolio rather than liquidating parts of it. In such an opaque world it is little wonder the conspiracy theories over those two Japanese smugglers show little sign of dissipating.
Nonetheless, for US Treasury Secretary Tim Geithner, who has inherited his predecessors' role as dollar wallah-in-chief, the currency's travails have made it all the more difficult for him to repeat the mantra that he "believes in a strong dollar" while keeping a straight face. Indeed, when he tried to insist at a university lecture in Beijing earlier this month that "Chinese financial assets are very safe," it drew floods of laughter from the audience.
He wasn't playing for laughs, but the irony of the situation is plain to see. If there were a textbook list of actions one could take to weaken a currency, the US (alongside most other developed nations) would be following it to the letter. It has cut interest rates to a whisker above zero; it has engaged in quantitative easing, pumping cash directly into the economy; it has committed to spending trillions of dollars on a fiscal stimulus package designed to pull the country out of recession; it has pledged tacitly to support its stricken banks so that no major institution is allowed to collapse. In any normal circumstances, actions like these would hammer a currency.
According to Stephen Jen of BlueGold Capital Management: "People are having second thoughts not simply because they don't like the dollar, but they are having second thoughts about whether US assets are obviously the strongest assets to own."
Like everything else, the currency's fate depends on how well the US authorities manage the crisis. The US is balanced on a knife-edge between possible Japan-style deflation as the weight of all its debts bear down on it and potential inflation as the force of all its powerful stimulus measures take root. No one knows for sure which way it will fall, but neither would be particularly good for the currency, and by extension for those who hold much in the way of dollar assets.
And China and all other major central banks which have trillions of dollars in their vaults, face something of a dilemma. Any fall in the greenback will cause the value of their investments to slide. Even if they wanted to exit, there seems no easy way of doing so without provoking some serious self-harm. Indeed, according to Olivier Accominotti, a PhD economist at Paris's Sciences Po university, the situation is not unlike that faced by France in the 1920s, as it sought to reduce its massive sterling reserves. The Bank of France found itself in a "sterling trap" in which it "could not continue selling pounds without precipitating a sterling collapse and a huge exchange loss for itself".
Neil Mellor, of Bank of New York Mellon, said: "We've got a situation where Geithner is smiling and has no choice but to stress the credibility and stability of the US financial and economic system, while the creditors [such as the Chinese] smile back and say they believe him, while at the same time giving hand signals to their reserve managers to get rid of these things."
Rather like the brinksmanship on display throughout the Cold War, it is a dilemma which applies itself to game theory. Both sides know that the dollar is set to weaken, but both could be set to suffer if they both allowed it to collapse at the same time. "If you are the Chinese it is in your interest to play the game – you've got a lot of dollars at stake – but in the long run you surely want to reduce your holdings and diversify them at the margins," says Mellor.
Still, with every passing week, the conjunction of different warning signals for the US currency seems to evolve and intensify. Recently, the alarm bell ringing most loudly has been the increase in yields on US Treasuries – a sign, some fear, of acute nervousness among institutional investors about the sheer scale of the cash the Obama administration is planning to borrow in coming years. The Federal Reserve's meeting next week is likely to be watched attentively by everyone with a stake in the game, as the central bank indicates whether it is planning to plough more dollars of newly-created cash into the economy.
But while the debate fixates on the greenback, the issues at heart here go far deeper. The dollar's fate is intertwined with that of the global economy. America is on the brink of losing its economic superpower status, which it will have to share with China at least, if not others, in the coming years. Holding such a position confers important responsibilities, none of which is more symbolic than providing the world's reserve currency – the currency against which all major commodities are denominated, and the de facto international unit of exchange in trade and finance.
It was a position enjoyed by UK sterling during the first waves of globalisation in the Victorian era and the final decades of the British Empire. Eventually, around the time of the Second World War, the dollar inherited the mantle. At first this was something enshrined in the Bretton Woods agreement of 1944, which fixed world currencies to the dollar, but although that system broke down in the 1960s and 1970s, it has remained the de facto currency of choice.
In a globalised world, with trade being carried out between hundreds of different nations by thousands of different companies, having an international standard makes sense: it enables traders to exchange goods more quickly and efficiently than they would have done otherwise. It may be invisible to us, but the vast majority of foreign exchange transactions – particularly those between smaller nations – involve the dollar. Exchange your sterling for Thai baht and you're actually swapping pounds for dollars for baht, whatever the exchange booth says. Even the much-vaunted exchange arrangements by the Brazilian and Chinese are designed not to disrupt these foundations, but merely to smooth things over for importers and exporters.
But a by-product of the dollar's dominance has been the skewing of the world's monetary system. By dint of having this blessed position, the US has been able to finance ever-larger current account and fiscal deficits, with both the government and the public borrowing from overseas, at cheap rates of interest. It has been able to sell US Treasuries at interest rates that other countries can only dream of because of this position as reserve currency. It has had a captive consumer – both because its government bonds are something of a safe haven and because those wishing to peg their currencies against the dollar and enhance their trade flows have little choice but to buy US Treasuries.
And this mutated international monetary system that has evolved since the 1960s is largely responsible for the crisis into which the world has tipped. Because it was able to borrow off other countries at such low rates without enduring the market punishment – in other words higher interest rates – America was able to build up massive current account deficits which poured a record amount of debt throughout its economy, which manifested itself in the financial crisis.
Indeed, as Mervyn King said in a speech earlier this year: "At the heart of the crisis was the problem identified but not solved at Bretton Woods – the need to impose symmetric obligations on countries that run persistent current account surpluses and not just on countries that run deficits. From that failure stemmed a chain of events, no one of which alone appeared to threaten stability, but which taken together led to the worst financial crisis any of us can recall."
When the PBoC's Zhou referred to the SDRs he was not merely questioning the dollar's pre-eminence. He was indicating something far more radical – that China supports plans for a new Bretton Woods-style agreement to manage the flows of cash around the world. At that seminal conference in 1944, John Maynard Keynes's original idea, which was watered down by Harry Dexter White of the US Treasury, was for an international reserve currency, Bancor, fixed against a basket of 30 currencies, and that countries would be penalised if their current accounts swung too far into surplus or deficit. It is an idea which is now being dusted off from history books by officials in finance ministries around the world, including in China.
Such a radical shake-up would cause earthquakes in the currency markets, a prospect which perhaps makes it unlikely. So in the absence of such a deal, how is the dollar's role likely to evolve in the coming years? The short answer is that no one should expect it to lose its reserve currency status any time soon. It took around half a century for Britain to cede this position to the US, even after being overtaken in true economic might.
One possibility is that the SDR may be used increasingly as a means of denominating assets in accounts, but this is something which would take place gradually, over a course of some years. But even if that is a bridge towards a multi-polar world, in which other currencies vie with the dollar for influence, it will take some time – perhaps 30 years or more, according to Stephen Jen. "People should look at history," he said, referring to sterling's pre-eminence in the first part of the 20th century. "There's a real incumbency advantage."
Jim O'Neill, chief economist at Goldman Sachs, sees the next few years as something of a "vacuum period".
"The BRIC countries [Brazil, Russia, India and China] are becoming so much more important, while the G7, including the US declines, which raises issues about the degree of dominance of the dollar. The problem is that the currencies of the BRICS are the ones that matter, but they won't let you export or use their currencies.
"Until we see another five years' of evidence over whether China is a more consumer-driven economy, becoming bigger and bigger, and whether the euro can have a successful second decade, the dollar looks set to remain dominant."
China has made some hints about loosening its hold over the yuan in recent months, but these are only early manoeuvres. A second step would be to allow the yuan to become a part of the SDR – whose own value is determined by those of a basket of currencies including the dollar, pound and euro. As Jen adds, there are certain prerequisites any contender to the crown of world reserve currency needs in its pocket.
"We have to ask this question: is Russia going to provide asset market that will be as liquid, reliable property rights, the rule of law, currency convertibility and so on? Will we see the same from the likes of China? Their task is very daunting."
Referring to the forged Treasury bonds picked up on the Japanese smugglers on the Swiss border, he adds: "There is a message here: we haven't heard much about anyone counterfeiting roubles. That is probably telling you something."
Thursday 18 June 2009
Investment: Our New Corporate Website Is Launched!
With personal blogs from our leading financial advisers and an online valuation system available in Japanese, Chinese and English; we believe that the new Pinnacle Wealth Management website is both cutting edge and informative. For those of you who invest with us, we hope that you like it.
Thursday 11 June 2009
The Crisis: A New Acronym By Gareth Milliams
You've heard of the BRIC (Brazil, Russia, India, China) nations. The worlds leading emerging market nations. Now we have a new one, for those EU nations that have not fared so well through the downturn. They are the PIGS.
P = Portugal
I = Ireland
G = Greece
S = Spain.
P = Portugal
I = Ireland
G = Greece
S = Spain.
Monday 8 June 2009
The Crisis: Michael Lewis Talks To Fareed Zakaria
"...one of the things that's odd about the current situation is that the people who created the problem are so powerful in deciding what the solution to the problem is going to be. There is a great tradition on Wall Street of making a fortune, creating a mess, and then making a fortune cleaning it up. But to do it on this scale is breathtaking to me".
Brilliant stuff!
Sunday 7 June 2009
Investment: The Return Of The Saving Plan By Gareth Milliams
They were much derided, particularly by those who held large lump sum portfolios; but monthly savings plans are making a comeback and for good reasons.
The global equity markets are volatile and will stay that way for a long time to come. This is the perfect environment for savings plans. Their main benefit is that they allow the investor to take advantage of that volatility (no matter how negative).
For example:
An investor buys 300 units at a dollar each. At the end of the first month the price stays the same. In month two, the price drops 50% to 50 cents but returns back to $1.00 at the end of the third. Obviously the price stays at $300.
The savings plan scenario with a $100pm contribution over 3 months works as follows:
Month One: 100 units @ $1.00
Month Two: 200 units @ 50 cents
Month Three: 100 units @ $1.00
The total is 400 units with a value of $400.
By contributing monthly, an investment which ultimately stayed at parity as a lump sum, made a 33% profit. The profit was made by buying the lows at discount. Buying into a 50% drop, became a 100% gain ($1.00-50 cents-$1.00) for that contribution when the units were back at $1.
Too often, I see a portfolio which has had some success, be debased because the capital was not managed correctly. There sometimes appears to be a fear of switching profitable funds to cash in order to protect the capital.
I do not have that fear. My first job is always to preserve capital. I will sell units in funds that I consider under pressure, if the capital value of the investment is under threat. But I may also buy into those same funds (or an alternative) with the next monthly contribution in order to start a new profit dynamic.
Managed correctly, monthly savings plans are incredibly powerful investment tools. Every investment programme should have one as part of its long term strategy. It is the most efficient method of taking advantage and profiting from volatility and negative market movements.
The global equity markets are volatile and will stay that way for a long time to come. This is the perfect environment for savings plans. Their main benefit is that they allow the investor to take advantage of that volatility (no matter how negative).
For example:
An investor buys 300 units at a dollar each. At the end of the first month the price stays the same. In month two, the price drops 50% to 50 cents but returns back to $1.00 at the end of the third. Obviously the price stays at $300.
The savings plan scenario with a $100pm contribution over 3 months works as follows:
Month One: 100 units @ $1.00
Month Two: 200 units @ 50 cents
Month Three: 100 units @ $1.00
The total is 400 units with a value of $400.
By contributing monthly, an investment which ultimately stayed at parity as a lump sum, made a 33% profit. The profit was made by buying the lows at discount. Buying into a 50% drop, became a 100% gain ($1.00-50 cents-$1.00) for that contribution when the units were back at $1.
Below is a chart which explains unit purchasing at discount with dollar cost averaging very succinctly. Please click to enlarge.
However, the reason why dollar cost averaging models never outperform lump sum is that there is a point when the capital value of the investment just becomes too big. This is where most savings plans lose momentum. A ten percent loss on a $50,000 investment cannot be easily averaged by a $1,000 pm premium. Therefore, to manage a monthly savings plan is to manage two investments, the capital amount and the monthly contribution.
However, the reason why dollar cost averaging models never outperform lump sum is that there is a point when the capital value of the investment just becomes too big. This is where most savings plans lose momentum. A ten percent loss on a $50,000 investment cannot be easily averaged by a $1,000 pm premium. Therefore, to manage a monthly savings plan is to manage two investments, the capital amount and the monthly contribution.
Too often, I see a portfolio which has had some success, be debased because the capital was not managed correctly. There sometimes appears to be a fear of switching profitable funds to cash in order to protect the capital.
I do not have that fear. My first job is always to preserve capital. I will sell units in funds that I consider under pressure, if the capital value of the investment is under threat. But I may also buy into those same funds (or an alternative) with the next monthly contribution in order to start a new profit dynamic.
Managed correctly, monthly savings plans are incredibly powerful investment tools. Every investment programme should have one as part of its long term strategy. It is the most efficient method of taking advantage and profiting from volatility and negative market movements.
Currencies: Jim Rogers Talks Of A Future Currency Crisis
Jim Rogers talked to CNBC and discussed the possibility of America losing its status as the worlds only reserve currency. This came to the fore again when Timothy Geitner made his visit this week to America's No1 creditor, China.
Luo Ping, a director general at the China Banking Regulatory Commission said, “Except for US treasuries, what can you hold? US treasuries are the safe haven. For everyone, including China, it is the only option. We hate you guys. Once you start issuing $1 trillion to $2 trillion [of bonds] we know the dollar is going to depreciate, so we hate you guys, but there is nothing much we can do.”
Russia Today reported the following comments by President Medvedev on 6th June:
Whilst I believe even more that the Renminbi will take a larger role as a reserve currency, I also believe that I may have been wrong regarding the possibility of a global basket of currencies. If the political will exists, then even that which seems impossible can be made possible.
Luo Ping, a director general at the China Banking Regulatory Commission said, “Except for US treasuries, what can you hold? US treasuries are the safe haven. For everyone, including China, it is the only option. We hate you guys. Once you start issuing $1 trillion to $2 trillion [of bonds] we know the dollar is going to depreciate, so we hate you guys, but there is nothing much we can do.”
Russia Today reported the following comments by President Medvedev on 6th June:
“No national currency can be appointed to the world's reserve. The role of the Russian Federation is to make the Rouble a more attractive, convenient, and reliable method of transaction for all those who are ready to use it.”
Deputy Prime Minister Igor Sechin dealt the greenback another blow at the forum on Friday. He said oil prices should not be tied to the dollar.
Russia is not alone in welcoming the winds of change – China and Brazil have echoed the idea of abandoning the greenback. Yet any nation with huge dollar holdings also fears the dollar’s collapse.
On April 6th, I wrote in The Constant Broker:
Whilst I believe even more that the Renminbi will take a larger role as a reserve currency, I also believe that I may have been wrong regarding the possibility of a global basket of currencies. If the political will exists, then even that which seems impossible can be made possible.
Friday 5 June 2009
The Crisis: Anatomy of a Collapse (click to enlarge)
A hat tip to Barry Ritholtz at The Big Picture and Jess Bachman at Wallstats for this brilliantly conceived schematic of where we were, are now and heading toward in this financial crisis.
Casey's Charts: John Paulson, The Worlds Best Hedge Fund Manager Agrees With Gareth On Strategy
If John Paulson ever wants a job in Kamiyacho working for Pinnacle, it's his...
The privately owned hedge fund sponsor Paulson & Co. added over $3.7 billion in new gold positions during the first quarter of 2009, increasing its total investment to $4.3 billion. About 46% of the equity portfolio is now allocated towards gold and gold stocks.
Not familiar with Paulson & Company, or founder John Paulson? You should be, and here’s why:
• Paulson’s bet on the subprime mortgage debacle earned $3.7 billion in 2007.
• The company made an estimated £606 million profit selling short British bank stocks in September 2008.
• John Paulson ranked #2 on Alpha’s Highest-Earning Hedge Fund Managers of 2008.
• Two of Paulson & Co.’s funds ranked #1 and #4 on Barron’s Top 100 Hedge Funds 2009 list.
 | June 04, 2009 |
The privately owned hedge fund sponsor Paulson & Co. added over $3.7 billion in new gold positions during the first quarter of 2009, increasing its total investment to $4.3 billion. About 46% of the equity portfolio is now allocated towards gold and gold stocks.
Not familiar with Paulson & Company, or founder John Paulson? You should be, and here’s why:
• Paulson’s bet on the subprime mortgage debacle earned $3.7 billion in 2007.
• The company made an estimated £606 million profit selling short British bank stocks in September 2008.
• John Paulson ranked #2 on Alpha’s Highest-Earning Hedge Fund Managers of 2008.
• Two of Paulson & Co.’s funds ranked #1 and #4 on Barron’s Top 100 Hedge Funds 2009 list.
Thursday 4 June 2009
The Markets: Gold Rally Reflects Only Weak US Dollar
Interesting conversation on CNBC. The most important quote from Charlie Morris of HSBC is that "long term volatility of the market is still through the roof".
Wednesday 3 June 2009
Geoeconomics:The Trillion Dollar Question: China Or America? Who Is Going To Come Out Of The Economic Crisis Stronger? By Niall Ferguson
Two years ago, economist Moritz Schularick and I coined the word "Chimerica" to describe what we saw as the key relationship in the then-booming global economy: China plus America. Cheap Chinese labour was making US corporations highly profitable. Spendthrift American consumers, in turn, were keeping Chinese corporations busy with export orders. And the Chinese monetary authorities were converting export surpluses into dollar denominated reserves with the aim of preventing their own currency from appreciating. The unintended consequence was a multi-billion dollar credit line to the United States, financing America's deficit at rock-bottom rates.It was those low long-term rates – combined with monetary policy errors by the Fed, excessive bank leverage and reckless financial engineering – that inflated the American property bubble, the bursting of which triggered this crisis.
To simplify the story, think of an unhappy marriage in which one partner does all the saving, while the other does all the spending. (We all know at least one couple like that.) But then the partner with the retail therapy habit maxes out on his/her credit cards. At the same time, the parsimonious partner finds her/his job under threat. What previously was a stable relationship is suddenly on the rocks.
In February, the People's Daily acknowledged the "global importance and influence" of Chimerica, but warned of an impending "period of chillness". Could this be one of those great turning points in history, when the balance of power tilts decisively away from an established power and towards a rising challenger? It is possible. Financial crises often accelerate the gradual shifting of the geopolitical tectonic plates; they are to history what earthquakes are to geology.
It was inflation that undermined the foundations of Habsburg power and opened the way for the Dutch Republic. It was the disastrous Mississippi Bubble of 1718-19 that fatally weakened ancien régime France, while Britain survived the contemporaneous South Sea Bubble with its fiscal system intact. For most of the nineteenth century, financial crises in the United States had only marginal effects on the City of London. By 1907, however, a Wall Street crash could send a shockwave across the entire British Empire, a harbinger of a new era of American power.
Something similar may be happening as a consequence of the American financial crisis that began nearly two years ago. The flapping of a butterfly's wings may trigger a hurricane in the Home Counties; in much the same way, a crisis in the market for subprime mortgages could signal the waning of US hegemony and the advent of a Chinese century. Just visit the nearest bookshop if you don't believe me. There, alongside Fareed Zakaria's prophetic The Post-American World, you'll soon find Martin Jacques's darkly visionary When China Rules the World.
Just consider the impact of this crisis on the United States and China. According to the International Monetary Fund, the US economy will contract by 2.8 per cent this year – while China's is forecast to grow by more than 6 per cent.
The US stimulus package – worth $787 billion – has had rather a muted impact. The economy will do better in the current quarter than in the last one. But house prices are still falling at close to 20 per cent year on year. The rate of foreclosures per month is still rising. And a crisis in commercial real estate could blow a new hole in the balance sheets of US banks.
Moreover, no amount of stimulus can swiftly reduce the debt burden weighing down America's over-leveraged consumers. According to Bank Credit Analyst research, for household debt to return to a more sustainable level, real consumer spending would need to grow at no more than 1.3 per cent a year between now and 2013. If that calculation is correct, the Obama administration will have to junk its predictions of 3 per cent growth next year and 4 per cent the year after that.
China's stimulus is worth less in dollar terms – $585 billion – but Beijing is clearly getting more bangs for its bucks. In April, fixed investment surged by nearly
34 per cent. Net imports of iron ore leapt by a third, and imports of oil by just under 14 per cent. It's a measure of China's new economic influence that commodity traders attribute much of the recent upward pressure on oil, copper and other raw material prices to Chinese purchases. Indeed, China's growing presence in commodity markets in sub-Saharan Africa and South America – not just as a buyer, but also as an investor – has an almost imperial character to it.
Of course, China has not been wholly unscathed by the astonishing collapse of exports that struck Asian economies in late 2008 and early 2009. Many more Chinese than American workers have lost their jobs since this crisis began. Yet I do not believe (as some Sino-pessimists do) that the regime in Beijing faces a serious threat of social unrest. Like other rising powers in past centuries, China is imbued with a remarkable sense of patriotism that is not just a product of Communist Party propaganda. People are proud of their country's economic miracle over the past 30 years. After two wretched centuries, they believe China is on the way back. People whose grandparents survived the Great Leap Forward and whose parents endured the Cultural Revolution can surely cope with a decline in the growth rate from 11 to 6 per cent.
In short, it may be time to start believing the projections made by Jim O'Neill and his colleagues at Goldman Sachs, who predicted just a few years ago that China's gross domestic product could equal that of the United States by 2027. Three years ago, China did not have a single bank among the world's top 20, measured by market capitalisation. Today the top three are all Chinese. In 2006, the United States had seven of the top 20 banks, including the top two; today it has three, and the biggest, JP Morgan Chase, is rated fifth.
Even before its economy becomes the world's biggest, China can play a much more assertive role in its relations with the United States. The spouse with the money generally wins the argument, after all. Especially when the argument is about the other spouse's debts.
And what debts! The US federal government's deficit this year will be $1.84 trillion – roughly half of total expenditure and nearly 13 per cent of GDP. Not since the Second World War has the gap between income and spending been so huge. Moreover, the Congressional Budget Office anticipates that total debt will nearly double in the decade ahead. With the lion's share (around 70 per cent) of their $2 trillion of international reserves held in the form of US bonds, the Chinese are understandably alarmed by this tsunami of red ink. Last week's financial market action – which saw both bonds and the dollar drop sharply – will have caused palpitations in Beijing.
To be sure, China is still piling up those dollar-denominated bonds. In March alone, China's holdings of US Treasuries rose $23.7 billion. But Deutsche Bank recently predicted that Chinese reserves will rise by only $100 billion this year, compared with $418 billion last year. You don't need a Nobel prize in economics to know that $100 billion won't finance much of a $1.84 trillion deficit.
We know pretty much what Treasury Secretary Timothy Geithner is hearing in Beijing this week because the Chinese have been grumbling about American profligacy for months. "We have lent a huge amount of money to the United States," Wen declared in March. "Of course we are concerned about the safety of our assets. To be honest, I am a little bit worried." Soon after that, on the eve of the G20 Summit in London, the Chinese central bank governor Zhou Xiaochun proposed that the US dollar might eventually be replaced as the world's main reserve currency.
"The United States is making policy decisions purely according to domestic considerations and is giving little thought to the outside world," complained Zhang Ming, an economist at the Chinese Academy of Social Sciences, in April. "This being so, the Chinese government should prepare its defences. We can keep buying US debt but we have to attach some conditions."
The big question is: what conditions? For Mr Geithner knows the truth of the old adage: when you owe the bank a small amount, the bank has the power. But when you owe the bank a huge amount, it's the other way round. Luo Ping, a director-general at the China Banking Regulatory Commission, put it nicely in an interview back in February: "Except for US Treasuries, what can you hold? US Treasuries are the safe haven. For everyone, including China, it is the only option. We hate you guys. Once you start issuing $1 trillion to $2 trillion [of bonds] we know the dollar is going to depreciate, so we hate you guys, but there is nothing much we can do."
"We hate you guys?" Now that really does have the ring of marital breakdown. Let's hope Mr Geithner is good at ducking crockery. Like divorces, major shifts in the balance of power are seldom amicable.
Niall Ferguson's 'The Ascent of Money: A Financial History of the World' is published in paperback by Penguin this week
(From The Daily Telegraph)
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