Developments in the past month still leave many of us puzzling over what exactly transpired and where we are headed. With an already heavy workload – I’ve moved into the private equity space looking at things from agriculture to energy and ships, I struggled to start a few threads here but couldn’t finish them as the scenes keep changing. So finally I decided to just write a “theoretical” piece, hopefully to garner a debate here.
To sum up my current sentiment, I am less surprised at the market correction in the past two days than the speed at which markets started crashing a month back. So in other words, I think I got some of my earlier conspiracy theories right – I think.
When one tries to piece together a jigsaw puzzle, a common mistake upfront is to assume there is only one puzzle out there. I think there are several puzzles running concurrently, some intermeshed with each other.
1. The challenge on the USD hegemony. Are monetary policies politically driven? Yes, they are. How come? Because we are in a big turning point in financial history again. The hegemony of the USD is being challenged by the Chinese and the US knows that they have exposed themselves to this challenge by adopting serial QE in the past five years. As the time is running out – timeline here being imposed by the end 2015 deadline for the IMF SDR (Special Drawing Rights) review where China is likely to push for the CNY inclusion, the US felt it’s time to get its act together.
But why now in the middle of 2013? Because Ben Bernanke‘s term is ending next January. And it’s a good chance for the US to use his departure to also signal the end of QE and normalize things. Bernanke’s successor will be named in September by Obama. I think it’s still a very big toss-up who will get the job but most agree that it has to be someone quite different or in fact quite (philosophically) the opposite of Bernanke – in short, a hawk. Since the serial QE ran over a course of 5 years, the unwinding may also need to take 5 years which is about the same length of the Fed chairmanship.
2. Reversing the Plaza Accord on Japan. The US needs an ally. Or one can be politically incorrect to call it a “fall guy” – someone there to cushion the QE tapering for the world and therefore the US. Japan is a willing (because of Abe) and suitable (because of Fukushima’s permanent damage to Japan’s current account position due to the energy imports to replace the loss of nuclear energy) candidate. The Plaza Accord signed in September 1985 led a 50% devaluation of the USD against the JPY and DEM (Deutsche mark, spelling it out here in the interest of our younger audience) only to create such a big asset bubble that the eventual bursting in the late 1980s became a point of no return for Japan. Europe got out of it, thanks to the EMU/ euro enterprise. The US was protected by the cheap USD. After nearly 3 decades, the Nikkei is still some 65% below its 1989 peak. It might actually do Japan some good to see the JPY devalue itself back to the pre-Plaza Accord level by stepping really hard on the QE accelerator.
3. China’s counter strategy – to tighten ahead of the Fed. China also needs to sort out its house. No government wants to rush to burst its own asset bubble. But if the US has a time constraint, so does China as after all, their timeline is the same one – the IMF SDR basket review at end 2015. If China acts after the Fed started tapering, the Chinese markets might not be able to take the double whammy. You can be sure that the liquidity squeeze in the last two weeks won’t be the last squeeze. A Chinese saying goes as such – you need to give a guy the chance to catch his breath even if you’re hanging him.
4. Imminent collapse of London financial centre. After the Libor fiasco, the EU is making a case to migrate Libor setting to Paris on the premise that the critical mass of Libor users no longer reside in London. Well… should we call the rate Pibor from now on – that’s a different contest in the future. Will losing Libor undermines London as a financial centre – yes, if you look back at history – London’s rise as the global financial centre was due to the birth of Libor which was something the US needed at that time to bring back the missing dollars that could not go through the open route. Ok, let’s be straight forward here – one theory was that the US wanted the dollars trapped in Russia to come back. Thereafter, London continues to act as the conduit for all global/ cross border financial transactions – becoming the dominance of global FX trading.
Now, think of China. It is not in China’s favour that London is losing it since London has helped to hold back the US dominance, especially that of US banks. More importantly, China needs a platform to launch the final phase of the CNY globalisation – clearly London is a friendlier party than New York. So it is no wonder that London and China have quite quickly signed the CNY swap line recently. And France is saying it also wants one. The significance of putting the CNY swap line out into the G7 market space is a big one because the UK jurisdiction – i.e. the BOE – will make sure the offshore CNY is given the same treatment as all other foreign currencies trading in its marketplace i.e. no special quotas, limits etc that PBOC can dictate. And of course, it also means the whole world now can access the CNY from London. By the way, take note that the BOE has changed a new governor from an autocrat to a market-friendly/ ex Goldman Sachs technocrat.
Now these are four theories above. I never really like being seen as a conspiracy theorist in the financial world – it always seems like such a lame excuse for saying “I dunno”. But we all agree that we are in the cusp of a major turning point in the global markets – call it normalisation for comfort. So let’s open up to conspiracy theorists and their theories. Let’s ask them (please not me :)) these questions:
– Where should we put our money, assuming we have been net savers and not net borrowers? If you’re the latter, then start paying up now. At this point, I was trying desperately to gather facts to show that the rich countries/ rich corporates/ rich individuals have leveraged up a lot more than their poor counterparts during this QE bonanza. So in a way, the tapering can be seen as an equalizer.
– How should Asian central banks respond – to hike or cut rates? Cut – hope to invite fresh inflow. Hike – hope to stem outflow. If you cannot decide, you do nothing – that’s the most likely scenario in the next 6-12 months.