Monday, September 22, 2008

Money Moving to 'Safety in Asia'?

It seems that Alastair Darling is declaring no tax rises in the UK, despite the deterioration of the government financial position. Other comments by Gordon Brown have been supportive that this will be the UK government position. Of course, what this means is that the government will continue to borrow, and borrow ever more heavily. Estimates of borrowing for all kinds of figures are floating around, but most of the have been far to conservative (but nevertheless alarming enough - I would reference this but am having troubles accessing some websites). Those that are predicting massive increases in borrowing are not accounting for the scale of the coming contraction.

So it seems that the irresponsibility goes on; the lack of any grasp of the severity of the situation continues. As I keep saying, the only way out of the crisis is structural reform (see solutions to the left), but the government answer is to continue to bury its head in the sand of debt. To mix my metaphors slightly, it seems that the solution is move ourselves ever deeper into the quagmire, and this can only delay the possibility of recovery. Furthermore, this is a very loud signal the UK's creditors, and will at the very least hasten the drying up of lines of credit, and speed the decline of the £GB. Both of these will naturally feed off the other, as they are both effects are based in lack of confidence, and one will reinforce the other. The day of default moves nearer.

I have also just seen some news over the shifts in the stock markets. It seems that London and European markets have been dropping, whilst the Asian markets were rising.

It is far too early to tell, and I do not normally bother commenting on short term fluctuations in markets (as you really need to be 'within' the markets to see the thinking behind the short term movements). However, in the context of what has been happening, could this be a process of money moving from West to East. In the current climate, this would be a reasonable reaction. If, as I expect the $US, £GB and Euro (to a lesser extent) are about to take a further battering, then we have to ask whether the markets are moving ahead of the declines (but will also precipitate the decline they are fleeing from). The Western currencies will almost certainly devalue against the emerging economy currencies overall (ignoring the China currency problem) so this could be strategic manoeuvring. Clearly, those who move their money early, will stand to gain. The nature of the downward slide in currencies may be bumpy along the way (sentiment being one of the drivers), but the slide will certainly happen. Is the market thinking this way (markets do not, of course, have their own intentionality, so I hope you will forgive the metonymy)?

This would appear logical, but there is some illogic in the activity. Whilst I do not believe (and I do not know enough about these countries to be certain) that they will be hit as hard as the UK and US, Australia and New Zealand are also going to suffer in the crisis. Bearing this in mind, it is curious that their markets also gained, though this could be positive sentiment on the back of other Asian gains.

It is, of course, too early to tell, but it would certainly be a natural thing to move money into Asia at this stage in the crisis. Of course, if this happens on any scale, then a bubble in Asian stock markets is the next logical outcome.

However, I am moving into speculation here which is not the general aim of this blog. I think we need to sit back during this period, and let the markets absorb the final details of the bailout in the US before we can see how quickly sentiment will turn back to the negative. I am guessing that markets are on a knife edge of irrational optimism, or complete despair, and they might move any direction in the short term. However, short to medium term the only direction of Western markets (US and UK in particular) is down......

If that happens will money be safe in the East? I think that the Eastern markets will also follow the West down at some point, but how much by is a less clear issue, and the falls would need to be considered in the light of the currency movements. Whatever the case, I would speculate that the Eastern markets do present a better prospect overall due to the currency movements, but present risks as well (as I have discussed in previous posts). As I have also emphasised previously, in this kind of turmoil, there is no safe place for money. Too much hangs on sentiment, and that is not a very safe thing on which to risk money.

Note Added 23 September: With regards to the above post, a small apology. I am not sure that it is as clear as it should be - perhaps a little too rushed on this occasion, and also it is a little too speculative. However, I will leave it as it is, as one of the underlying principles of the blog is to leave each post untouched except for dated notes and additions. It does, however, raise an interesting question. What will the market do to try to save the value of their money before the currency devaluations?

The inevitablility of devaluations are becoming evident to the market; the $US will devalue, as will other Western currencies (the £GB in particular). This is no secret, as a recent Telegraph article points out:
'But as investors scrambled to make sense of last week’s events, already one conclusion was all but irrefutable – the US dollar will have to take another major fall'
With regards to the £GB, some may be taking comfort in the headline strengthening agains the $US, but this is only temporary, as the £GB is going to be found to be weaker even than the $US. Also, as I have pointed out before, it is not the measure of the Western currencies against each other that should be watched, but how they measure against the currencies of the emerging markets. The same Telegraph article says this of the £GB:
'Ironically, despite the pound’s comparative strength against the dollar – having risen from just above $1.75 in the past few weeks – it remains extremely weak against other world currencies, due to investors’ fears about the UK’s own home-grown problems.'
In a crude analagoy, measuring the sick against the sick is not the best way to understand the health of a person. Just because both are suffering from an acute fever, but one person's temperature is higher than the other, does not make the less sick person healthy.

What of the Euro? The Euro economy is such a mixed bag of basket cases (e.g. Italy) and stronger economies (e.g. Germany), that it is difficult to see how this currency will move long term, except that it will also fall against the emerging market currencies. How far is a difficult question. In the short term, it might strengthen, as the market clings on to the lifeboat of past certainties.

Returning to the original post, what happens if money starts to move out of the West into the East (and emerging markets). Whilst the early movers into these markets will retain their wealth, the movement of money out of the Western economies will precipitate currency falls. At the same time, the movement of money into the emerging markets will destroy wealth within the emerging markets, because the assets purchased with a falling currency will leave someone holding devalued currency. As such, as the money moves out, the currencies will drop ever faster....but will still manage to inflate asset prices in the emerging economies.

This means that the more that money is transferred to the emerging markets, the more that the investors will be buying into overinflated assets with ever greater sums of devaluing currency. As such, as the underlying value of the assets will not justify the prices, the value of the transferred money will in any case be destroyed in the future. The only winners will be those that buy into the assets early. They will lock in the value, even if the asset bubble bursts at a later point. However, even these assets will be at some risk because as the debt money-go-round collapses, the exporting countries will see exports fall, and therefore will suffer their own pain. As I suggested in the original post, the upside is that some of this pain will be ameliorated by having assets in a stronger currency.

All of this is to ignore the political and other risks in the emerging economies, which makes all such investments risky (e.g. what happens if the damage in the West does tip China into recession? See post on China).

As you will note, as I have mentioned in previous posts, in the current turmoil there is no safe haven, excepting possibly gold, and I have already warned one reader to make sure to look closely at the history of gold prices before jumping into that market (I have not followed gold prices such that I have a sense of where the price can or will go in the current circumstances).

The bottom line in all of this is that the correction is ongoing, and there is no real way to stop the 'wealth' destruction that was always inevitable. Only the most astute, and fastest moving in the West will manage to hold onto the current vale of their assets.

Note 2: It seems that Paulson is now pressuring other countries to follow him on his course of bailouts and that the US stockmarket suffered from falls today. The wildcard at this stage of the crisis was always going to be the question of how governments would react. Instead of addressing the underlying problems, they are trying to 'magic' them away. Such actions can only delay and, as I have pointed out many times, worsen the crisis. As such, it seems that the wildcard of government action has proven to be action to exacerbate the crisis. With such action, the situation can only go downhill.

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