European Crisis - No Way Out

PM Lee, at the recent G20 summit in Cannes, urged European leaders to adopt policies conducive to growth as a long-term solution to the sovereign debt crisis there.  My guess is that he was being polite and needed to say something encouraging after Singapore had been invited as an observer.

The fact of the matter is that there is no way out of the Eurozone debt crisis.  This has been a problem 40-years or more in the making.  Furthermore, based on traditional economics, the fact of Europe's aging population argues against any possibility of economic growth as a viable option for dealing with the debt problem.  When we add to this the fact of energy dependence and racial issues there, the lack of a realistic solution becomes crystal clear.

Now the only question is when the thing will blow up global stock markets, which appear to have been successful in pretending that the problem has a solution, thus far.  It has often been said that the stock market is for kids, and that the real adults play in the bond market.  I guess that must be true given the divergence in these 2 key markets.

A Good Summary of the Troubles in the US

I came across the follow passage from this month's edition of The Dines Letter, published by the legendary investor James Dines.  It provides summary of the challenges facing the US in the coming years, and is the basis for much of my investment think:

A richly-endowed America drained the bulk of its inherited reserves of
crude oil long ago, along with many of its other resources, well ahead of the
rest of the world. Now, with its work force priced uncompetitively higher than
hungrier labor in world markets, it is basically out of business and in
forebodingly deepening trouble. Why is that not more widely evident? By
historic accident the United States owns the world’s "reserve currency" such
that it can print as much money as it chooses, which we described clearly in
our Goldbug! book.

America can still use its great intellectual resources to create games and
social websites, much as a comparably hollowed-out England became the
world’s balladeers (exemplified by Beatle mania) after World War II. But
every action has consequences, and the racket of just printing money and
borrowing has never ended well. America scurries about to spend its wealth
on wars – justified or not – and nobody inquires as to where those dollars
wind up. Worse, to crown the spending, America additionally borrows over
$40 for every $100 it spends, a clearly unsustainable folly.

Unlike George Friedman's more optimistic analysis of the prospects for the country in the next decade, Mr. Dines is decidedly less enthusiastic about his country's future.

In the same article, he also predicts that we will soon see the end of free markets as nations scramble for the remaining resources of the world.  This line of thinking is similar to those of historian Harold James, who sees a general move towards state-directed capitalism, the type commonly practised in this part of the world.

Current Investment Strategy

Disclaimer: By law, I am not qualified to give investment advice, so the following does not pretend to be such. Read at your own risk.

Someone left a comment on one of the blog posts here and asked what my investment strategy would be, so here's an outline of my current investment thinking.

Long-term Fundamentals

The longer term issues that underpin my investment thinking are:

• Peak oil
• Resource scarcity
• Sovereign debt problems in US, EU, Japan
• Instability in the Middle East
• Possible instability in China
• Collapse of the USD-based global currency system
• Possible global depression

Because of these issues, I tend to think that the Warren Buffett style of investing will no longer work. Notice that his track record has been rather poor in the past decade: Wells Fargo needed a US Federal government bailout. Citibank's liabilities far exceed its assets if they were marked to market.

Where possible, I will put my money in things which will appreciate in value should any of the aforementioned issues come to the fore. Given a more expansive idea of what constitutes investments for me, even buying additional bags of rice for storage (during sales) can be an investment in an environment where food prices are going up steadily.

Short-term Challenges

The biggest short-term issue is US Federal Reserve policy, namely whether or not it will continue to 'print money' and debase the USD against everything else. Overnight US markets have been very quiet, reflecting a wait-and-see attitude. If there is any hint of tightening, I think a lot of markets will come off. Hopefully things become clearer once the Fed policy signals become known.

The forces of debt deflation continue to be met with global central bank efforts to re-inflate the system, thus causing a lot of cross-currents which make investing a challenge for many people.

Some Other Thoughts

These are some other things that colour my investment thinking:

• Real estate in Singapore is currently priced as if nothing bad will ever happen to the global economy or our own.
• Singaporeans are over-leveraged due to expensive housing.
• CPFIS policies need to be updated. They still reflect a pre-2000 view of the investment universe. Unless they are revised to reflect the new reality, there will be a retirement funding crisis down the road.
• Unless you have more than S$1 million to invest, you are very, very likely to get poor investment advice from the professionals. Most of the financial advisors who are in the 'retail market' serving poorer customers (I am such a customer) are, in my view, not equipped to handle the complexity that we are now experiencing. As such, I think expending effort to take control of your own investments is the way to go.

Current Portfolio

Some of the things I currently hold:

• Gold and silver
• Mining shares

I am looking to get into positions in energy once the uncertainty over US Fed policy has abated to some extent.

Finally, the most important 'asset class' for the future - trusted friends and family. This may be the most undervalued 'asset class' in Singapore right now.

Pardon the lack of fluency and organisation in this piece. :-)

Stocks - Time for Caution

In the week after the Sendai earthquake in Japan, there was a report in ST on 19 March wherein some market analysts were saying that the correction in the stock market presented a good 'buy on weakness' type of opportunity.  While some of the arguments were interesting, they appear to me to have seriously underestimated the risks from the unfolding events in the Middle East/North Africa as well as the ongoing sovereign debt crisis in Europe.

Furthermore, looking at the Singapore market action itself, there appears to be a mood of caution amongst the speculators, while the markets in the US shows hints of distribution.  The US markets, still leaders in terms of being able to influence global investor sentiments, show more signs of nearing a top than rather than good entry points for long-term holdings.  The only thing, some would argue, that is keeping the market from dropping is the billions of dollars funneled into the market by the US Fed via its QE2 programme.

As such, I would hesitate to say that now is the time for long-term investors to accumulate stocks.  This is a trading market.

Inflation - We Must Protect Ourselves

 Based on the feedback that I see on both the REACH and CPF Facebook pages, many Singaporeans are still whining about inadequate government action with respect to dealing with the inflation problem.  For those who are still labouring under the delusion that the government will be able to help them with this bread-and-butter issue, I offer up the latest piece of evidence that such hopes are woefully misplaced:
 
Upgrading key to tackling inflation

In this CNA news report, MND Minister Mah Bow Tan was quoted as saying:

Oil prices are shooting up and food prices are going up, so how do we lower the price of food when we have to pay more to import food? The only way is to upgrade our skills and increase our pay.

A major reason for rising oil and food prices is simply the non-stop money printing engaged by all the major central banks around the world, including those of China and India besides those of the Western powers and Japan.  Skills upgrading doesn't solve the problem at all.  This is very simple monetary theory.

When I see such a lack of understanding of basic economics from a Cabinet minister, I tell myself that I need to deal with the problem on my own, and not expect the government to be able to help me.

And no, I'm not going to get started on how current policies make the 'upgrade your skills so that you can increase your pay' logic flawed and misleading.  That's for another day.

Earth to Bernanke

With many Americans concerned about the rising costs of food and other necessities, Bernanke's latest speech at the National Press Club indicated that he doesn't think inflation is a serious problem in the US. I wonder if he lives on another planet.

In any event, his stance on inflation produced an immediate reaction in the commodities market, as we can see from the 5-min gold futures chart below:

As mentioned previously, I was too risk-averse to make long bets on commodities at this stage, and Bernanke proved me wrong. The rough rice futures contract moved higher again and it was a mistake on my part not to have taken a position.

Thoughts on the Property Cooling Measures

Following the announcement of the latest measures to cool the speculative bubble in the real estate market here, much of the debate continues to centre around the role played by speculators, immigration and foreigners. What I have not seen discussed in detail is the role played by the negative real interest rate environment.

From an Austrian School perspective, negative real interest rates tend to foster bubbles through mal-investments. In my view, Singapore's current monetary policy has to some extent been held hostage (due to export competitiveness considerations) by the US Federal Reserve's zero-interest rate policy as well as the People's Bank of China's USD-peg policy. This has resulted in a negative interest rate environment that is 'conducive' for the growth of speculative bubbles.

If the latest measures by the Ministry of National Development are effective in cooling real estate demand, the continued existence of negative real interest rates could well see hot money moving into the local stock market or other asset classes.

James Kunstler's 2011 Forecasts

Well-known peak oil author James Kunstler has written a very long article on his blog detailing what he thinks could happen to the global situation in 2011. While I don't agree with some of the stuff he has written, his piece is nonetheless a very thought-provoking one.

In the article, the issue of the break-down of globalisation and even advanced industrial activities were considered, these being a corollary of the breakdown in both the global financial system and a short-fall in the output of oil. While such a prediction may not come to pass any time soon, I believe that the scenario is worth contemplating, especially with regard to how it would impact Singapore's economic survival. Personally, I find thinking about such a scenario allows one to appreciate the fragility of our country and to pierce through what I believe is a false sense of security arising from our national wealth.

Be that as it may, I also feel that the article provides some useful inputs as to the type of issues that we have to be prepared for in terms of dealing with unfavourable future outcomes.

World Bank Chief Talks About Gold Standard

The financial media has been set abuzz over the weekend because of comments by the World Bank chief Robert Zoellick regarding the include of gold into a future international monetary system. Calling for a more cooperative system which will include the major currencies of the world, he added the following statement, as reported by the Financial Times:

"The system should also consider employing gold as an international reference point of market expectations about inflation, deflation and future currency values."

Whether or not this is another one of those 'trial balloons' that senior people like the float before a major policy change I don't know, obviously.

But it is worthwhile considering what impact the inclusion of gold into a future monetary system will have on Singapore. This is particularly so given the low percentage of our foreign reserves that is being stored in gold. Based on IMF data, as reported by Wikipedia, Singapore only has 127.4 tonnes of gold reserves, which is a miserable 2.3% of our total reserves.

In a future system that values gold more than the current one, will Singapore suddenly become poorer relative to other countries that have more gold? How will that affect our CPF savings? Does the government have more gold than what it has reported to the IMF, like China previously? I have not figured it out yet, but like I said, it's something to think about.

US Federal Reserve QE2 looks set to fail

Since the US Federal Reserve announced its US$900 billion 'QE2' programme of buying US Treasury debt and other mortgage-backed securities, stocks, bonds and commodities have moved violently in response. Looking at the intra-day actions on Wednesday and Thursday (US time), the market seems to be signalling failure of the new policy. Here's why.

Whatever the ostensible reasons for 'QE2', one important reason for the Fed's actions is to prop up the US stock market, using the 'reflation trade' to try to create enough wealth effect to stimulate household consumption, and thus get the US economy moving again. This is typical Keynesian thinking.

However, when we look at the market movements in the latter part of the week, we find that while US stocks have moved up, commodity prices have increased to an even greater degree. Since commodity prices influence cost-of-living, it means that the weak wealth effect has been more than negated by pipeline inflation. Thus, the market appears to me to be saying that the Fed's leveraging up of its balance sheet ultimately is a lot of 'noise' but no real impact is achieved. This is exactly what economists of the Austrian School have predicted together with some of the more savvy market participants.

For us here in Singapore, what this means is that we have to discount most of the 'good news' that the mainstream media is feeding us about the effectiveness of the Fed's latest policy move in helping the US economy to recover. The risk of a 'double dip' is still out there, probably in 2011.

Korea Considers Capital Controls

In a move that appears to bolster my belief that the boom in the emerging market economies and stock markets are due more to the US Federal Reserve's quantitative easing rather than improvements in the global macroeconomic fundamentals, South Korea is reportedly considering measures to curb capital inflows, as reported by the Chinese edition of FT.

韩国透露了实施一系列新的资本管制措施以应对投资流动激增的可能性。

这意味着亚洲第四大经济体可能采取与巴西、泰国和印尼相似的防御性政策。

The full article can be found here.

And as a further sign that the underlying structural problems in Europe has not been addressed, let alone resolved, budget talks in Portugal aimed at implementing austerity measures to satisfy the bond market have made little headway so far.

Now that the US Fed is expected to announce a new round of quantitative easing, we need to watch to see what impact that policy will have on stock markets. We live in very interesting times indeed.

Multiple reserve currency system

The Straits Times reported several days ago that Prof. Barry Eichengreen of U.C. Berkeley in a speech in Singapore said that countries should not worry about the move towards a multiple reserve currency system:

THE move towards a multiple reserve currency system is inevitable and instead of fearing it, world economies should welcome it, a prominent American economist said yesterday.

This is because such an arrangement, which will include the United States dollar, the euro and the Chinese yuan, provides more stability than the single currency system now, said Professor Barry Eichengreen.

As far as I can remember, the world has never had a multiple fiat reserve currency system before, so one has to wonder how Prof. Eichengreen came to the conclusion that such a system would be more stable. If 1 central bank can destabilise a single currency system, how does giving more central banks the ability to destabilise a multiple currency system make it more stable?

Besides this, the analyses of the current USD reserve currency system by various economists have shown that the reserve currency country, in this case the US, under such a system has to run persistent trade deficits. If the analysis can be extended to a multiple-currency system, it will also imply that both the EU and China has to be ready to accept trade deficits. While I am not certain about the EU’s position, it would seem almost as certain as finding an ice cube in hell that China would countenance running a trade deficit. Premier Wen Jiabao’s statement that a 20% appreciation in the RMB could risk creating social unrest in China clearly showed that China is not ready to give up its export-led economic model.

On the other side of the issue, the US may also not be ready to give up the seigniorage privileges that come with being the sole reserve currency. Being able to buy oil and other precious items with printed coloured paper is an enormous advantage to the US, which also helps to support its global empire.

With Brazil withdrawing from the G20 process as a sign that countries appear determined to continue with the ongoing currency war, the current geopolitical reality is not exactly supportive of Prof. Eichengreen’s vision of a stable, multi-currency global financial architecture. The risk of a chaotic end to the current USD reserve currency system will remain as long as the Federal Reserve continues to debase the USD and countries are not willing to come to an agreement on how to deal with the global structural imbalances between the developed countries and the emerging ones.

Here in Singapore, the MAS has continued with its policy of allowing for a gradual appreciation of the SGD on a trade-weighted basis. This has the effect of ameliorating the negative effects of global monetary debasement. That said, if the rate of appreciation of the SGD is lower than the rate of monetary debasement of the currencies that form the basket against which it is measured, we will likely continue to see inflation in hard assets and resources. That would most certainly mean higher food and energy prices for us.

Currency wars

Mexico is the latest country to complain of a strong exchange rate by selling US$600 billion worth of USD options, following loud protests from Brazil. Amongst the developed countries, the EU, Japan, South Korea and Switzerland have all either tried to talk their currencies down or intervened in the FX market to try to weaken their currencies. The reason for such sentiments is plain - everyone wants to export their way out of recession and into economic growth, and with China's exchange rate pegged to the USD, the fear of losing even more market share to China is driving many countries to try to devalue their currencies.

Since balance of payments must always balance on a global basis, it is impossible for everyone to achieve a balance of trade surplus without someone willing to run a deficit. That someone used to be the United States, but since the start of the global financial crisis, Americans have either been unable or unwilling to continue to play this role.

We live in a strange world indeed. In the papers, we read about an economic recovery, but then we also notice that countries are all complaining about strong currencies. 1 side of this story is not true. Which side would you believe?

Looking at things as they are now, if the global economic situation deteriorates further, currency wars could escalated into full-fledged trade wars between nations. One possible trigger could be the US-China row over the RMB exchange rate issue. That may trigger the start of a new wave of protectionism. Sounds a little like what happened in the 1930s, doesn't it?

Current Global Economic Conditions

Despite the strong performance of the Singapore economy so far this year, it is prudent to take note that the outlook for the global economy in the next 6-12 months is quite negative.

In the US, despite the NBER's proclamation that the recession was over in the middle of 2009, the reality appears to be that it is still in the midst of a severe economic contraction, to the extent that some US econ bloggers have called it a 'depression'. Consider the following statement put out by the folks at The Automatic Earth:

"77pc of Americans are now living paycheck to paycheck, in 2007 this figure was 43pc. That's 239 Million people one lost check away from ruin"

At present, there are about 43 million Americans who are on food stamps, and the level of desperation was aptly described by WalMart CEO Bill Simon, as reported by the Wall Street Journal:

"And you need not go further than one of our stores on midnight at the end of the month. And it’s real interesting to watch, about 11 p.m., customers start to come in and shop, fill their grocery basket with basic items, baby formula, milk, bread, eggs,and continue to shop and mill about the store until midnight, when electronic — government electronic benefits cards get activated and then the checkout starts and occurs. And our sales for those first few hours on the first of the month are substantially and significantly higher"

Over in Europe, Ireland is now acknowledged as the first country to officially go into a 'double dip', while the German economy has also slowed and the Greek situation is nowhere near resolved.

In Asia, the Japanese are upset with the Chinese buying their bonds, which they feel is a backdoor way of forcing the Bank of Japan to intervene in the FX market to weaken the Yen, so as to divert US Congressional attention away from the Chinese themselves, who are refusing to let the RMB rise. That said, China itself is not in any particularly strong state. In an effort to stave off protectionist measures by the US, Premier Wen Jiabao has stated on Bloomberg that a 20% RMB revaluation would cause social upheaval. Given the amount of excess manufacturing capacity in China and the razor-thin margins of the exporters there, I personally take Mr. Wen's statement as an appeal from a position of weakness rather than strength.

On top of all these, there appears to be a currency war going on globally, as the central banks of all the major economies are trying to avoid a strengthening of their own currencies against the USD, while the US Federal Reserve's intention to weaken the USD is being taken seriously by the markets, as evidenced by the strong performance of gold and silver.

Given the above, I believe it may be prudent to take steps to guard against the systematic currency devaluations that are taking place now. For my fellow Singaporeans, I have this to say: Go easy on the property speculation, there are risks just around the corner. I will write more regarding this in future.