Macro
Micro-Regulation of the banks may aid Andrew Xie’s Mild Stagflation (let us hope)
Apologies for the late arrival of this comment – I attended the AsiaHedge Hedge Fund Awards last night. Consequently, I have a bit of a champagne-induced headache today. Great to see my friends at Evenstar ( http://www.evenstarcapital.com/ ) winning The Best Event-Driven Fund of the Year, congratulations!
Right, back to business: you may recall yesterday I laid into the Chinese real estate market. But no argument on this would be complete without bringing the infamous Andy Xie into the fold. At times I think he’s courageous and quite brilliant, other times listening to him is as painful as scraping my fingernails down a blackboard – for this reason alone, he is irresistible. His comments on the Chinese economy and asset bubbles: on Bloomberg TV: Andy Xie. Notice how insistent he is on communicating just how important property is to the Chinese economy.
Continuing my Andy Xie theme, I’d just like to highlight an article from him which I read recently. He rambles a bit at the end, but this is Xie at his antagonistic best – I found it quite a captivating read. But some of his points are well founded: his reference to “mild stagflation” of low growth and inflation around 4% to 5% is pretty much in line with what I suggested in response to Mauldin’s piece on the 20th October – here is an excerpt.
In Mauldin’s latest piece he (shockingly) parts from the “Muddle Through” theory that he has held for many years on the grounds that the deficits are basically too big to ignore. I think this may be premature, there is a way out for the US economy: to stoke a fairly high rate of inflation and keep it consistently high for a number of years (without off-shooting into hyperinflation). No, this will not be pretty, and may be the backdrop for multiple recessions over the next decade, but it’s still within the bounds of “Muddle Through”, with real GDP growth averaging 1-2% over the long term.
Now, don’t misunderstand me, the Mild Stagflation theory is an optimistic forecast – it’s just about the best we could hope for, given the deficits and tax-burden Mauldin continuously alludes to, for example here. The caveat is that, in order for inflation to do the dirty work of what is effectively a soft default on Dollar-denominated assets (yes, that includes US government bonds), inflation will have to persist. As Xie eloquently points out, “the pain lingers”.
But his central point, I think, is that inflation is what the Central Banks are striving for. Not the benign, warm and fluffy inflation we’ve been accustomed to, but a higher, more abrasive, more painful level is required. Its tough medicine to swallow, but we’d better hope we get it. I hope Xie’s point, that: “the dirty little secret is that it [monetary policy] works by inflating asset prices” is not lost on readers by his abrasive style of writing. I would have perhaps phrased this differently so let me try to give my interpretation of what Xie meant:
Under the circumstances, inflated asset prices are an inevitable consequence of monetary policy as it stands, given the blatant inefficiencies of what I have called the “transition mechanism” for monetary policy (i.e. the banking sector – specifically the regulation thereof.
This is a point I’ve been repeating, just yesterday, referring to Mervin King’s eye-catching comments, I commented on the new-found ability of banks to regain their profitability and said “something will happen regarding regulation of the banks: watch this space”. On that note, I’d like to link-in today’s piece from one of the most respected economic minds in the World: Mohammed El-Erian. See the most important point he makes in this comment? Let me enlighten you with some selected excerpts, for effect:
There is another stage of de-risking in banks’ future. This second stage will be driven by the regulatory authorities, rather than the markets. Ironically, the success of some banks in restoring huge profitability will make this phase come earlier and be more consequential for banks.
There is a sixth issue, which is much more controversial. Should regulatory authorities reverse the multi-year trend toward combining commercial and investment banking activities in single institutions? At the heart of this issue is whether to restrict the ability of banks to use government-guaranteed deposits to fund investment banking activities.
Mervyn King, the governor of the Bank of England, is pushing for such a reversal. In doing so, he is reacting to the view that, to use his colorful language adapted from Churchill, “Never in the field of financial endeavor has so much money been owed by so few to so many. And, one might add, so far with little real reform.”
Regardless of what happens on this sixth issue, it is clear that the banking system will soon be taking an important step towards the “utility” end of the institutional spectrum – a likelihood that is yet to be internalized, both in market valuations and in consensus expectations regarding the medium-term prospects for growth in the U.S. and U.K., in particular.
Need I say more?
Macro Data to Watch:
- Bank Holiday in Hong Kong on Monday – don’t expect a comment!
- Taiwanese Industrial Production
- Taiwanese Export Orders
- Singapore CPI
- UK GDP out today – I reckon anything positive is good news here.
- Spanish jobs numbers out today – can unemployment get any higher for the poor Spanish!?
- South Korean GDP comes out on Monday remember.
Markets
I can’t keep bullying the Dollar indefinitely – I almost feel sorry for it. I know I’ve been a Dollar bear for the best part of a year now but we are oversold by almost every technical, at some point we must get a Dollar rally. I get scared when I get things right – it’s just not supposed to happen that way!
Global Stocks to Watch:
- Earnings:
- China Construction Bank
- Hynix
- KDDI
- Honeywell
- Schlumberger
- Microsoft
- B Sky B
- On a broad note, keep an eye on the bank stocks as earnings continue to spill out and the rhetoric on banking pay and regulation continues from all quarters.
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