The world stock and metals markets got a correction earlier this week. We knew a correction was coming because the markets had a big run
without much of a pullback. On Tuesday, we recommended selling the Vanguard Emerging Market Fund (NYSE: VWO) as we thought the pull-back in emerging markets was going to last longer. There were reports of slower GDP growth data from China and Brazil, and talk of a more ob-structive government in India’s most populous state, Uttar Pradesh. How-ever, the emerging markets are proving to be resilient, and today we are re-recommending that investors buy VWO. We see long-term outperformance for the emerging markets, and we see more sharp correction that investors should use as buying opportunities
How About a Tour de QE?
Our excursion into the world of monetary debasement starts with a close-up view of four regions of the world where rapidly-expanding central bank balance sheets have taken over. Then, as a special attacktion, we will also visit a number of countries who are lowering interest rates and reserve requirements for their banks.
By the end of the trip you will have seen a variety of methods to stimulate an economy. Some methods of economic stimulation will use a central bank’s balance sheet and ability to create money for the banking system by purchases of bonds, stocks, or other instruments. Others you observe on our tour may not even bother with the asset purchases — they will simply print the money.
Let’s kick off this tour with a look at the major developed economies’ most recent history with QE.
- Six Central Banks Work Together — U.S. Dollar Swap Lines
On Nov 30, 2011, six of the largest central banks — the U.S. Federal Reserve, the Bank of Canada, the Bank of England, the European Central Bank (ECB), the Bank of Japan, and the Swiss National Bank — agreed to “coordinated actions to enhance their capacity to provide liquidity support to the global financial system”.
A key element to this coordination was the U.S. Federal Reserve’s announcement that it agreed to offer unlim-ited U.S. dollar swaps with other central banks. These bilateral currency swap arrangements allow other
central banks to borrow dollars from the Fed until February 1, 2013 in unlimited amounts and re-lend them to their respective domestic regulated banks that have needed access to dollar funding. This was critical as many of the traditional dollar-funding markets had dried up, especially for European banks. Central banks taking advantage of these lines can now provide their domestic banks much-needed liquidity in case of cash shortages.
With this announcement, dollars were now available for the swapping with the full faith and credit of the U.S. government behind them. Within four weeks, almost 100 billion dollars had been swapped for other central banks’ currencies. Most of the Fed’s swaps were with the ECB. The ECB re-lent these dollars to banks that did not have enough capital to repay their depositors and creditors, and made irresponsible investments. In essence, the U.S. Federal Reserve is creating new dollar liquidity to help bail out sick banks overseas. The Fed is saying, “How much do you need? We will lend it to you against the collateral that you swap with us, and you can keep it until February 1, 2013 — or longer, because we can always extend the maturities.”
Even though the dollar swap lines were available, the banks needed more help. On December 21, 2011, the ECB launched the first of two tranches of low cost three-year loans to banks in an operation called the Long Term Refinancing Operation (LTRO). 523 banks snatched up about 490 billion Euros (about 650 billion USD) in loans. December’s LTRO program was deemed a success, and so just last week, a second tranche of LTRO loans was made available. 800 banks took part in LTRO II, to the tune of about 530 billion Euros (745 billion USD). The two LTRO programs together created 1.4 trillion U.S. dollars’ worth of additional liquidity for the European banking system. Banks were able to substitute their lower-quality sovereign debt bonds for good quality ECB cash at a low interest rate. The lower-quality bonds were on banks’ balance sheets at values far above the market price, so they couldn’t realistically use these bonds to generate liquidity. After LTROs I & II, banks have usable liquidity with which to earn interest and pay bills.
In our view this program is a form of Quantitative Easing since some of these loans to the ECB will not be re-paid. They will essentially be converted to gifts. The banks, supposedly, will repay these loans when the losses on their bad debts and sovereign bond portfolios magically evaporate, and their balance sheets return to health. We say they are gifts because here at Guild, we consider the repayment of these loans to be improbable. Why? Because the banks in the nations that are the biggest borrowers are still being pushed by domestic political forces to continue to make bad loans and to buy sovereign bonds in insolvent European states. Most of these states will continue to need bailouts because their politicians have no idea how to act responsibly and still be reelected. In our opinion, they will do very little to mend their misguided ways. The loans that are not repaid will be forgiven. Therefore, these gifts equal money printing, or QE.
- British QE — Why Bother with Subtlety?
The Bank of England announced in February that it will extend its program of QE begun in March 2009. It agreed to take its bond purchases up to a total of 325 billion Pounds or about 500 billion USD.
- Japanese QE — Not Trying to Hide it, Either
The Bank of Japan has admitted to over 800 billion USD in QE over the past few years, and they added 130 bil-lion USD to their QE in February 2012.
The above regions are actively engaged in QE programs. But it’s not just here, as we have said before; it’s QE Everywhere, or “QE-E”. Even in conservative Switzerland, as well as in Scandinavia, governments have also been forced to print money to keep their currencies from appreciating too rapidly versus their trading partners.
The scale of monetary debasement we see on this tour is staggering. Here at Guild Investment Management all we can say is: Wow! This has been the biggest money printing and liquidity expansion exercise in world histo-ry, and we are still on the first leg of the journey. Along with a few other commentators, we have been commu-nicating to the world that the only option that most politicians will entertain is “QE to Infinity”. This is because other more disciplined and conservative courses of action imperil politicians’ re-election prospects. We have been explaining this reality for several years and with each passing month, the footprints of the QE-E monster are increasingly common sightings.
One way to measure liquidity creation is central bank balance sheets. If they get bigger, liquidity is growing.
Note the charts of central bank balance sheets below.
ECB Balance Sheet: 3.1 Trillion Euros
U.S. Federal Reserve Balance Sheet: 2.9 Trillion Dolla
Bank of England Balance Sheet: 315 Billion Pounds
Bank of Japan Balance Sheet: 144 Trillion Yen
We are seeing the footprints in other parts of the world as well. Easy money is not just a developed-market phenomenon.
Tour de Lower Rates
Over the past six months, since inflation peaked in the developing world last summer, interest rates are being lowered by many nations simultaneously. Beginning in about October 2011, emerging market central banks began lowering interest rates and cutting bank reserve requirements. More nations have been joining the party as time has passed.
Monetary policy has been eased in two ways in the developing markets:
- Rather than cut interest rates, some governments have lowered the banking reserve requirements (the amount of cash that a bank must hold in reserve to balance out the risks of their loan book). Lower reserve require-ments lower the cost for a bank to lend, and allow more leverage on the bank’s balance sheet. Lower lending costs to the bank usually translates to lower interest rates for the bank’s customers. It becomes cheaper for busi-nesses and consumers to borrow money. Some governments also use edicts to require banks to lend in greater quantity or at lower prices. This often happens in countries where banks are fully or partially government-con-trolled. India and China are examples.
- Central banks lower interest rates to attract more borrowers. Lower interest rates are an important form of liquidity creation. They perform their function by accelerating the amount of leverage in the banking system as more companies and individuals borrow and re-deposit part of their borrowings into banks. These new deposits are then re-lent. This process has technical names, but think of it as an increase in liquidity in the system. This liquidity finds its way into stocks, consumer and capital goods, and other purchases — and it ends up increasing the economic growth rate of the nation.
As we write this Commentary, many countries’ central banks are lowering their interest rates. Below are charts of several central bank policy rates that began falling in recent months.
Bank of Indonesia Began Cutting Rates in September 2011
Bank of Thailand Cut Rates in October 2011
Brazilian Central Bank Has Cut Rates 4 Times Since Last August
Chilean Central Bank Cut Rates In January 2011
Philippine Central Bank Began Cutting in December 2011
Russian Central Bank Cut Rates in December 201
China Has Cut Bank Reserve Requirements Twice in Recent Months
Reserve Bank of India is Also Cutting Bank Reserve Requirements
These interest rate cuts are outside the four QE regions we saw on our Tour de QE. China, India, Brazil, Thailand, Russia, the Philippines, Malaysia, Chile, and others are easing their monetary policy.
What Conclusions do we Draw from These Tours?
Our Tour de QE, alongside our Tour de Lower Rates leave us with a clear message: liquidity is being created. All of this simultaneous synchronized liquidity will find its way into stocks, commodities, fixed assets, bonds,
consumer goods, and capital goods.
Also Spotted on Our Tour — Governments Buying Stocks
When nations engage in QE and in lowering interest rates at the same time, it is usually to increase confidence in their banking systems and economies. Some of those who are at the controls of the financial levers have thrown yet another stimulating influence into the mix.
They have used government money from pension funds or from other government sources to buy stocks.
While it may not be QE if the purchases are not being made by the central bank, it still provides liquidity very rapidly to the economy and creates immediate demand for stocks. It is clear that the recent market rallies have been accelerated in this manner. We anticipate that this type of direct intervention will continue and acceler-ate in the future. Governments around the world want to support stock markets, but not all of them do it so transparently. Today, China’s national pension funds are buying Chinese stocks. In some European countries, government-controlled pension agencies, or other governmental entities, are purchasing European stocks.
When adding QE-E, many countries’ lowering interest rates, reduced bank reserve requirements, and outright stock purchases by governments, the result is a powerful liquidity brew. We could call it coordinated interven-tion because that’s exactly what it is. Policy makers know (as do we) that it is easier to force an already rising
market higher than it is to reverse a declining market. In our view this is their overall strategy.
Chinese Shanghai Composite Index — 1 Year Chart
What is Going On? And What are We Doing?
What we have is a bald attempt to force stock markets higher and it is having the side effect of taking gold and oil prices higher as well. Longer term, we expect it to send the dollar lower and better-managed
currencies higher. Our strategy is to own stocks during these liquidity-driven rallies. When the rallies have run their course and banking problems resurface, we plan to sell stocks and add to our gold holdings. Gold has been a fixture in our portfolios as an insurance policy and as an investment vehicle. To us, it is a foregone certainty that another banking crisis will arise because the European, U.S., and Japanese banking problems have been pa-pered over — but are far from solved. When new waves of liquidity are unleashed in future years, we will once again buy stocks to participate in the liquidity bubble. Then, when the banking system once again shows signs of frailty, we plan to reduce our exposure to stocks and add to our gold holdings, repeating the process as often
Remember When a Billion was a Big Number?
The bailouts and stimulus programs are getting bigger and bigger. Each time there is a crisis, each time addi-tional liquidity is required, the amounts of QE created to placate the markets will grow. The declines in the val-ue of currencies engaging in the liquidity creation will also grow. Volatility will also grow for gold, currencies, stocks, etc. Our strategy of actively managing exposure to rallying markets, in our opinion offers the best hope for investor survival during the coming volatility and turmoil in financial markets. We plan to use it ourselves and we believe that it provides the best option to survive and prosper in the difficult months and years ahead.
We want to own stocks in the short-term, but this doesn’t mean we don’t have a long-term view. The markets are becoming increasingly volatile and difficult. Investors need a good manager with a good long-term view in order to make any money. It won’t be easy, and most investors will likely lose money; have their assets inflated away, or lose them completely. A few will tread water, and only a select few who have experience and do their work will get rich. In which category do you wish to be?
Why are the Rich Trying to Leave China?
Numerous publications have pointed out that many wealthy Chinese are leaving the country. Why is this and will it continue?
We contacted some of our Chinese friends and here is what we found out. This section is a combination of writ-ten interviews, and discussions with individuals, including some strong critics who have lived in China.
- Successful Chinese people generally recount their desire that their children be educated outside of China. They preferred the U.S., Canada, Australia, or the UK, where their children could learn English, as they consid-ered English to be the world language, and a necessity for success.
- They also recount their concerns that Chinese education is too structured and does not train people to think in independent and creative ways. One contact recounts how his brother got a scholarship to a large technical university in the U.S. After one year, he had arranged to transfer to MIT. He said that he knew at least as much or more than his fellow students in the sophomore class at MIT about math and physics on a textbook level but he was well behind them in how to problem solve and think creatively. He was also behind them in knowing how to integrate new insights and ideas into his math and physics training.
- Businesspeople recount that the Chinese government has an immense number of regulations. In order to succeed, it is common to skirt the regulations. In other words, many businesspeople operate in the grey area and sometimes do illegal things to succeed. This makes them frightened. They fear that at a later date their behavior will expose them to prosecution. This fear of future prosecution drives many to leave China.
- Achieving success is paramount in Chinese culture and this stimulates the desire to do whatever it takes to succeed. We have often heard the phrase that suggests if you aren’t doing everything to get ahead, you aren’t trying hard enough. This can lead to cheating in school and in business, and even engaging in fraud. The U.S. newspapers have been filled with cases of U.S.-listed Chinese companies which have been attacked for alleged fraudulent behavior. Many Chinese companies are under investigation or involved in court prosecutions for fraud and misrepresentation to stockholders. For decades Chinese companies and entrepreneurs have been accused of pirating brand name goods. However, in the case of U.S.-listed Chinese companies, several have come under the scrutiny of the SEC and the FBI for stock fraud. Below is a chart of a fund that tracks U.S.-listed Chinese companies. The fund’s underperformance reflects investor skepticism about U.S.-listed Chinese companies.
Powershares Golden Dragon Halter USX China Portfolio — 1 Year Chart
- Pollution, crowding, and food safety are often referred to by expatriates as things that caused them to want to leave China. Almost all of our contacts say they miss China. They are proud of their traditional culture, the Chinese language, and customs that have persisted for millennia, but they do not like the current effects that rapid growth have had on the quality of life, food supply, air and water pollution.
- Most say that housing is expensive and apartments are small and cramped in China’s big cities. Even the well-off live in smallish homes. Expatriates explain that they get a lot more for their money in a medium-sized city abroad, although New York, Los Angeles, Sydney, London, Toronto and other major cities are also expensive.
- The concept of immigrating is widespread, and nothing new for Chinese. A survey conducted in Novem-ber 2011 by the Bank of China (a government-owned bank) and Hurun Report analyzed trends among China’s wealthy. The wealthy includes about 950,000 families with assets of 1.6 million USD or more. These people gave the reasons listed above for their desire to emigrate and they cited U.S., Canada, Singapore, and Europe as their preferred destinations.
China is aware of these trends and many high-ranking officials have discussed this issue in the Chinese media. The current five-year-plan, which began in 2010, focused more on improving public services and solving
environmental problems. Verbal dissent and statements of dissatisfaction are more common in China these days. Is this because of growing discontent or because of more freedom to speak your mind? We think that both are contributing reasons for the change.
China Must Change to Attain World Economic Leadership
China must open its currency regime, upgrade its banking system , develop a bond market, and take other actions that we have mentioned in the past to become a world economic leader and the world reserve currency.
Additionally, Chinese business ethics must improve if China is to attain world business leadership. Nevertheless, China still continues to move toward becoming a great economic power. China must adopt a more ethical and moral business climate, and create less of a “buyer beware” environment if sustainable and respected world leadership is to be their eventual reality.
Inflation Continues to Outpace Wages
According to data recently released by the U.S. Department of Labor, American workers are having a hard time keeping up with the rising costs of living. In the twelve months ended January 31, 2012, average
hourly compensation actually fell by about 1.2 percent. Meanwhile, the U.S. Consumer Price Index (CPI) rose about 2.9 percent over the same 12 months.
Incomes not keeping up with prices is nothing new. This week CNN Money cites a census study from Sentier Research showing that U.S. median household income is down 8.7 percent since January 2000. When you consider that CPI is up almost 35 percent since January 2000, and the underlying prices of basic essentials have risen over 70 percent (as measured by our Guild Basic Needs IndexTM) since January 2000, you really see the squeeze-play that has been put on the average Americans’ pocketbook. The bottom line is that the American standard of living (and the average American’s ability to save) is being caught in a vise between rising prices and stagnant wages.
Inflation keeps on keeping on…even though incomes have stagnated.
We bring the issue of rising cost of living to the attention of our readers, not to depress, but to educate. We want our readers to realize that there are strategies and investments that can help protect their standard of living. The purchasing power of the dollar has been in a near-constant state of decline for decades. Proactive, targeted, and disciplined investing can help you stay ahead of the even-more-rapid declines in purchasing power that are in our future. Stay tuned to our commentaries for more on how to protect your portfolio. See you next week.
Please click the graphic below
5—116,530 shares of Golar LNG (NYSE: GLNG) was purchased between December 2nd, 2011 and January 11th, 2012 between a price range of $43.5017-$46.1647, there was one sale of 15,000 shares on January 11th, 2012 at $44.1006.
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