Impact of China's rise on the world economy.

Impact of China's rise on world economy
1) huge increase in global current account imbalances
2) global decline in nominal and real yields on all forms of debt
3) increase in equity risk premium (gap between earning yield on equities over bonds)
4) increase in global returns on physical capital

1 and 2 can be explained by the global saving glut, loose monetary policies, but a massive increase in global labour supply and extreme risk aversion of creditors from emerging economies explains 3 and 4.

We have seen that the accumulation of net overseas assets are entirely accounted for by public sector acquisitions and channeled principally into reserves.

The global balance of trade and economic power has been tilted by the resurgence of the Chinese economy, and this will have a large impact on global trade and growth in the future. China has already started acquiring raw materials directly by buying into companies with large reserves and will continue to do so in a larger way to secure its vast needs for growth.

We will continue to see the expansion of their growth and there will be opportunities for investors who manage to identify targets that are aligned with the Chinese interests for raw marerials.

Eric Tan,
London

Dr. Friedman VS. Dr. Keynes

This is not a boxing match within the scientific arena nor is it an episode from the popular British science fiction television series.

The Federal Reserve seemed to think that prescribing massive injections of liquidity to avert the kind of banking crisis that caused the Great Depression of the early 1930s (Friedman-style) and coupled with another course of running of massive fiscal deficits in excess of 12 percent of gross domestic product this year, and the issuance therefore of vast quantities of freshly minted bonds (Keynesian-style) will give the economy a double dosage of drugs to pull the patient out of E.R.

But there is a clear contradiction between these two approaches and the central bank is trying to have it both ways.
Question is : can we be a monetarist and a Keynesian simultaneously?

The aim of the monetarist policy is to keep interest rates down, to keep liquidity high, the effect of the Keynesian policy is to drive interest rates up.
However, both of them have the same objective of trying to stimulate demand:
A) Monetary easing increase the money supply and flows to a liquidity constrained economy and reduces the cost of borrowing, leading also to restoration of credit.
B) Fiscal stimulus from the government replaces the components of our economy that are falling sharply such as consumption, investment, construction, capital spending, inventories, exports etc. when economy is suffering not just from a lack of liquidity but also problems of solvency and a lack of credit.

Real concern is that lenders may start to grow dubious about the financial solvency of governments and that would lead to a fresh push for the interest rates to head north as we have observed in government bond yields this week. After all, $1.75 trillion is an awful lot of freshly minted treasuries to land on the bond market at a time of recession, and we don’t quite know who is going to buy them. It's certainly not going to be the Chinese. Maybe only the Fed can buy these freshly minted treasuries, and there is going to be, in the weeks and months ahead, a very painful tug-of-war between our monetary policy and our fiscal policy as the markets realize just what a vast quantity of bonds are going to have to be absorbed by the financial system this year. That will tend to drive the price of the bonds down, and drive up interest rates, which will also have an effect on mortgage rates, which is precisely what the central banks have been trying to avert.

Bottom-line: lock in your 2.5% mortgage rates for the next 10 years!

Eric Tan, London

Shift in Chinese Economics

With a sharp slowdown in global growth projected by the International Monetary Fund (IMF) for 2009 and 2010, the chinese economy is undergoing a fundamental shift in design. No longer is it expecting the export driven growth to support its economy, but evidence is showing that China is now looking inwards to drive the country's huge capacity that was once known as "the world's factory floor".

The world's most populous country is leveraging its internal demand to propel it's economy. Indicators showing year on year increases in domestically bound cargo is driving corporates to make a rush to capture the spending power of inland consumers in sectors. Retail sales number have held up and property transactions are surging across the country. China's plan to implement a healthcare reform of $125bn will raise disposable income and reduce need for high saving levels.

If China suceeds in unlocking their domestic demand and coupled with a Rmb4tn fiscal stimulus, it is increasing positive that they have seen the worst of the financial crisis.

Eric Tan, London

Can spending hold up?

Overview of the the current state of the US economy

The American economy is contracting at its steepest pace in 50 years, the government reported on Wednesday, but an unanticipated rise in consumer spending since January suggested to many economists that the worst of the recession might have passed

Output fell at a 6.1 percent annual rate in the January-through-March quarter after falling at a rate of 6.3 percent in last year’s fourth quar
Analysts are expecting that as tax breaks and government stimulus spending kick in, the decline in the gross domestic product could be cut in half by summer by federal spending and on various small windfalls for consumers

The looming question remains the severity of job losses. More than five million jobs have disappeared since the recession began in December 2007. As their wages disappear, households spend less, and business, in response, reduces the output of goods and services, cutting more jobs in the process.

Eric Tan

Thoughts on being "cautiously optimistic" on the economy.

Key question to ask: Can an inventory-driven recovery in output, alongside aggressively expansionary monetary and fiscal policy, generate enough optimism among consumers, producers, and lenders to make the recovery sustainable for more than a few months?

any thoughts ?

PPIP: A Stampede on Thin Ice. Markets for the week ending 27-Mar

The S&P 500 Index rose more than 6% this week as hope mounted that the worst might be over for the banking system and a turn of the broader global economy is on the way.

As US released more details of its Public Private Investment Plan (PPIP), the US stock market surged 7% overnight but fears on the viability of the plan and likelihood of participation from banks were the main concerns.

My take on the new release is that the US is taking on a "do-everything-it-takes" attitude to rescue the economy and that should set the right tone for investors and stabilise the markets but ultimately it is not the pricing of the legacy assets and loans that will turn around the lack of confidence, but the greater transparency that is attached to this move that will allow the big banks to raise sufficient capital from private markets (in the range of hundreds of billions more) that will call an end to the crisis.

A couple of issues need also to be addressed to stop the economy from spiralling down further:

a) Distressed home sales: Without a clear sign of the bottom of falling house prices, risk appetite will not return. Hence, finance for viable borrowers with sound leverage need to be earmarked to help establish a floor for home valuations

b) Deleveraging of consumer : UK household savings rate jumped from 1.7% in the third quarter of 08 to 4.8% in the fourth quarter. Although rebuilding and repairs of the household balance sheet will bring balance back to the debt-fueled decades of 90's and early 2000's, the governments also need to ensure consumer credit is freed up to improve liquidty for the people. This is not to fuel another debt spending spree, but to inject consumption back into the economy and pull it out of a longer than expected recession.

Final words, Stabilisation is still not equal to Recovery.

Eric Tan, London

How is Gold a play on quantitative easing and debasing of currencies ?

Gold in itself is a relatively smaller market, and say if the market starts to have doubts that Obama will not be able to halve the US deficit by the end of his first term, investors may start to shift their reserves into gold. So let's expand this exponetially to say China or the Middle Eastern states start to do the same with their reserves, we will certainly see new levels of gold prices.

Hence a bet on gold is essentially a bet against all paper currencies and against all central banks, and that seems to be a bet put on by several hedge funds including Paulson's now.

If the Fed is forced to debase the USD because of increasing prospects of deflation or inflation, UBS's forecast of $2500 per ounce gold prices, may not look impossible..

Eric Tan, London