Archive for the ‘Currencies’ Category

What if China crashes?

Sunday, May 9th, 2010

Regarding the current drama in Europe, if the European authorities does nothing (or stoically refuse any thought on moral hazards), the world will get a GFC II, in which Australia may not be so lucky this time round. Our guess is that when push comes to shove, the Europeans will eventually print money and kick the can further down the road. After all, with the nightmare of the Panic of 2008 still fresh in their minds, they will not repeat the ‘mistake’ of acting too slowly. The outcome will be more moral hazards and monetary inflation, which is something we and our children will pay down the road.

Meanwhile, as the global financial markets are fixated over the current sovereign debt crisis in Europe, contrarian investors (especially Australian investors) should look at another part of the world for any potential mishaps- China. Starting from January this year, the Chinese government had been tightening the supply of credit. Measures include turning off the credit tap to increasing bank reserves requirements. Recently, unlike 2008, the Chinese government seemed to be getting really serious about cracking down on property speculation, even to the extent that it is giving the impression that it wants the property bubble to burst (see Is China’s Stock Market Crashing?).

As we wrote in Marc Faber: Beware of investing in Australia (as it follows the Chinese business cycle), with all these tightening measures, China will slow down this year. The question is, will the Chinese government accidentally over-tighten cause a crash instead? Remember, its objective is a soft-landing (which they managed to pull off in the 1990s under ex-premier Zhu Rongji). But will they end up going too far, resulting in a hard-landing?

Only time will tell.

But if it happened, you can sure that Australia will have a very ride. As we warned our readers a few months ago in Hazard ahead for Australia- interim crash in China,

Therefore, investors should understand this basic principle: because of the leverage that Australia is exposed to China, any slowdown in China will have a leveraged effect on Australia.

The first effect of an economic slow-down in China will be a fall in base metal prices. Already, there are some signs that base metal prices are cooling off. For example, copper prices are approaching the lows made in January this year. If China crashes, we can expect base metal prices to crash too.

Next, given that the Australian dollar (AUD) is seen as a commodity currency, it will fall. This is to be expected as Australia’s terms of trade and business cycle is closely tied to Chinese demand for commodities, which in turn is tied to the business cycle in the Chinese economy. A crashing Chinese economy will be likely to test the AUD as it was tested in 2008. Mining companies in general will not do well in such an environment. In fact, speculators like Jim Chanos will be shorting the Australian mining stocks (see How is Jim Chanos going to short China? (Australia: take note)).

Then, with the deteriorating terms of trade (due to falling Chinese demand), the Australian economy will slow down. With that, there will be speculations (and hope) that the Reserve Bank of Australia (RBA) will be cutting interest rates.

If China’s coming slowdown is just a soft-landing, then the story may end here. But if it’s a hard-landing, then there will be more complications. In that case, Australia is very likely to have a hard landing too. This is where we are getting nervous. The critical thing to watch out for is Australia’s unemployment rate. As we wrote in RBA committing logical errors regarding Australian household finance,

Given Australia?s high household debt (see Aussie household debt not as bad as it seems?), prime debt can easily turn sub-prime when unemployment rises. As unemployment rises, it will eventually reach a critical mass of prime debts turning sub-prime.

Given that Australia’s highly leveraged banking system is heavily concentrated on mortgages (Black Swans lurking around Australia?s banking system), there will be a tipping point in the unemployment rate that will trigger a banking crisis. That in turn may trigger a currency crisis (see Will there be an AUD currency crisis?).

How to buy and invest in physical gold and silver bullion
If there is an AUD currency crisis, the RBA will be in a quandary. Should it cut interest rates further to support the domestic economy (and condemns the AUD)? Or should it raise interest rates to defend the AUD (and condemn the domestic economy)? This was what Iceland faced in 2008- high inflation, collapsing currency and rising unemployment. The Icelandic central bank had to raise interest rates to defend its currency. Remember, a collapsing AUD implies that the price of oil imports in AUD will sky-rocket (limited to the extent that oil prices are falling due to reduced Chinese demand). As you can read in Five potential emergencies- energy crisis, this will be extremely disruptive to the Australian economy.

Of course, the scenario that we painted is extreme. But after having read and understood Nassim Nicholas Taleb’s The Black Swan, we learnt not to say “never.” Hopefully, the outcome will not be that bad. But for those who want to be prepared, we highly recommend How to buy and invest in physical gold and silver bullion.

Bad luck for investors- confluence of two headwinds

Thursday, May 6th, 2010

For those of you who are active traders/investors, you can surely sense that the feel of fear is coming back to the financial markets. The more prominent narrative for this fear is Greece (plus Portugal, plus Spain). It was just less a month ago that the financial markets were shrugging off the possibility of a Greek default (see Is the Greek debt crisis over?). Back then, investors were ?satisfied? with just a ?40-45 billion ?bailout? package. Now, according to the narrative of the media, even a ?100+ package is not enough to ?satisfy? investors. Not only that, the contagion is now spreading to Portugal and even Spain. So, does it mean that in less than a month, the financial markets suddenly see the light that Greece cannot pay its debts?

That goes to show that the financial market is very often illogical and irrational. When you look at the big picture, it should be clear that this is a deep-rooted problem that cannot be solved with a meeting. As we wrote in All quiet on the Greek front?,

But make no mistake, this story is like a trench warfare that will play out over a period of years (see Currency crisis: first countries in the line of fire- PIIGS). It will engulf more than Greece- vulnerable  countries include Portugal, Italy, Ireland and Spain.

The financial markets, being irrational as it is, will alternate between fear and optimism. We wouldn?t be surprised if this current bout of fear turn back to optimism after another high-level meeting/announcement will appear to ?solve? the problem. Then perhaps some time later, another bout of panic will return. In a way, this is like ?trench warfare? in which neither side is able to gain ground permanently, as they grind each other down. In the same way, the forces of deflation and inflation will battle each other, as money printing (which is the only way out of this crisis) will grind down the value of paper money (euro).

For Australia, there is another headwind- the coming slowdown of China. Marc Faber even go as far as saying that China is likely to crash in 9 to 12 months. Since the global economy is already battling the crisis in Europe, a crash in China will be another serious blow.

This is just bad luck for those who are holding long positions! So, what if China crash? Keep in tune!

Marc Faber: Beware of investing in Australia (as it follows the Chinese business cycle)

Monday, April 26th, 2010

Currently, economists in major institution in Australia are still forecasting growth in the Chinese economy. Even the Reserve Bank of Australia (RBA) are pencilling in further boost of the Australian economy because they expect continuing growth of Chinese demand for Australia’s commodities. With such rosy forecasts, the mainstream pundits believe that Australia’s economy will continue to power ahead, which will result in further “skills shortages,” inflation, and for the property spruikers, further growth in property prices. This is the reason why the RBA had the guts to raise interest rates.

But as contrarian investors, this should be the time for you to be more careful. As we warned our readers a few months ago in Hazard ahead for Australia- interim crash in China,

Therefore, investors should understand this basic principle: because of the leverage that Australia is exposed to China, any slowdown in China will have a leveraged effect on Australia.

In other words, the ups and downs of the Australian economy follow the business cycle of China. And yes, the business cycle still exists in China. As we wrote in Will the China boom go in a straight line?,

Put it simply, we do not believe that the rise of China will take on the path of a straight line. Instead, there will be ups and downs, booms and bust and progress and setbacks. Anytime when the path does not look like a straight line upwards and take a temporary dive, the market will flip to the other extreme of this story and project extreme pessimism into the indefinite future. In other words, the market always looks at one side of the boom and completely ignores the flip side.

Contrarian investors like Marc Faber believes that the Chinese economy will “slow down regardless” any time from now on. Whether this slowdown will be a nice soft-landing or a gut-wrenching crash is another matter. This will have implications on the Australian economy, currency, stocks and property market. Make no mistake, this is what he said in an interview:

Mind you, there are massive excess productive capacities in the Chinese economy. As we wrote in Is China going to dump their excess metal stockpiles?, there are eye-witnesses’ reports of ghost cities, vacant office blocks and apartments in China. It had been reported that China’s excess capacity for steel and cement production is around the current capacity of United States, Japan and India combined. All these points to a massive mis-allocation of resources in China, which according to the Austrian School of economic thought, a pre-cursor to a bust (see our free report, What causes economic booms and busts?).

That’s why, as we wrote in Chinese government cornered by inflation, bubbles & rich-poor gap, the Chinese government will have to rein in their runaway economy sooner or later (e.g. through administrative means, revaluation of the yuan). The longer they delay, the bigger the inevitable bust will be.

A voluntary reining in of the runaway economy will definitely result in a smaller bust today (the alternative will be an involuntary and bigger bust tomorrow). That’s where the problem lies- the Chinese government lacks credibility in its will to cool down the economy. Within the circles of the Chinese property speculators, there’s an assumption that the Chinese government lack the guts to induce deflation in property prices (which will have negative effects on the rest of the economy). The reason is because once the deflation forces take hold, it will be very difficult to reverse. The same applies to the Australian government. The assumption is that at the end of the day, the government (whether it’s the Chinese or the Australian government) will indulge in moral hazards (e.g. bail out, print money, etc).

But dear readers, make absolutely no mistake about this: even if the government succeeds in avoiding a big bust today at all costs, this very success will result in more severe unintended side-effects and Black Swans. In Australia’s case, it will be a currency crisis (see Will there be an AUD currency crisis?) and/or social breakdown (because a policy of inflation is inherently unfair and widen the rich-poor gap). In China’s case, it will be complete social collapse, which is not uncommon for those who are familiar with China’s long history. Over thousands of years, China endured endless repeated cycles of corruption, dynastic collapse, followed by renewal through the birth of a new dynasty.

Hence, we will not be able to offer our readers the exact time-frame and predictions of what will happen next. No one can. But this is what you can do: be flexible and watch out for the signs and prepare the drills to be activated. So, bear this in mind: the moment the financial markets believe that the Chinese government’s talk about cooling its economy will be real concrete action, things will happen very fast.

Will there be an AUD currency crisis?

Tuesday, April 20th, 2010

A few weeks ago, in Black Swans lurking around Australia?s banking system, we expressed our nervousness about Australia?s banking system:

We must confess, we are getting more and more nervous about the potential for a Black Swan hitting the Australian economy. Particularly, we are looking at a vulnerability in the banking system.

As we wrote in that article, the solvency of Australia?s highly leveraged banking system is concentrated too much on mortgages. It is bad enough for the entire banking system to be so highly leveraged. It is even worse for the leverage to be concentrated on a particular type of loan- mortgages.

In other words, any one of the Big 4 banks are too big to fail because if one fails, it is likely that the others will follow. That implies that the Australian government will have to act quickly to nationalise the entire banking system in such an event.

Will that be the end of the story?

No, our fear is that the biggest casualty in this story will be the Australian dollar.

Firstly, Australia?s gross foreign debt (at December 2009) is AU$1.2 trillion. Correspondingly, the net foreign debt is AU$648 billion. It is highly unlikely that foreigners will continue to lend money to an already highly indebted Australia with a broken banking system. In fact, it is likely that the great Aussie carry trade will reverse, causing a rapid depreciation of the AUD. Should the implosion of the Australian banking system cause a panic, we can easily see the Australian dollar crash.

Secondly, nationalisation of the entire banking system will be prohibitively expensive for the Australian government. The asset column of Commonwealth Bank?s balance sheet alone is around 60% of Australia?s GDP. In the context of a banking crisis, the Australian government will have to guarantee bank deposits. As we wrote in Australian government?s contingent liability to exceed AU$1 trillion, that is a contingent liability of over AU$1 trillion. That means Australia?s relatively small budget deficit can easily balloon to dangerous levels very quickly.

In short, we can?t see how the Australian dollar will retain value in a banking crisis. An AUD currency crisis may not happen, but as we get more and more nervous, we find it more and more imperative to be prepared. As we wrote in Protecting yourself against currency crisis,

Personally, we feel that the best way to protect yourself from a currency crisis is to leave the country before TSHTF. If not, stock up some physical cash (both foreign and local), physical gold and silver (see our book, How to buy and invest in physical gold and silver) and supplies- these will tide you over while the sh*t is hitting the fan. For the longer term, you may want to move some of your savings overseas- you may not be able to use them in the midst of the crisis, but when it is all over, the local currency may no longer exist (e.g. you may have to convert the old currency to a new one at unfavourable rates).

Is the Greek debt crisis over?

Sunday, April 18th, 2010

When you read the latest statement on monetary policy decision of the Reserve Bank of Australia (RBA), you will find that they believe that the Greek sovereign debt crisis is contained for the moment:

The concerns regarding some sovereigns appear to have been contained at this stage.

The language is reminiscent of the start of the sub-prime mortgage problems. Currently, it seems that the global financial markets are shrugging off the possibility of a Greek government debt default, which has a wider implication on the Euro as a currency, which in turn has a wider implication on the global financial markets (see All quiet on the Greek front?).

But dear readers, do not be fooled by this apparent calm. Sure, the concerns looked ?contained? but the problems are still simmering. To let appreciate this situation, look at the following facts:

  1. Greece has to pay 4% more for their debt than Germany, the most credit-worthy nation. That?s roughly twice the margin from January 2010, at the height of the financial market jitters.
  2. The most recent attempt by the Greek government to raise money was very undersubscribed.
  3. Greece needs around ?50 billion in 2010, of which around ?25 billion is needed by June.
  4. After 2010, the Greek government needs to refinance its debt at 7-12% of its GDP.
  5. Greece budget deficit currently sits at 12% of GDP and must be financed as well.
  6. Greek government debt is forecasted to be over 150% of GDP by 2014.
  7. The current ?bailout? package by the EU and IMF is around ?40-45 billion, which is short of what the Greeks need at ?50-75 billion.
  8. The ?bailout? package requires:
    1. ? that Greece must exhaust its ability to borrow from the financial markets first before accessing the package.
    2. ? unanimous agreement among EU members.
    3. ? the debt will be provided at market rates, rather than on concessionary terms (although under new proposals full market rates will not be used).
    4. ? full participation of the IMF, which means the IMF will have a say in the (usually stringent) conditions for the loan.
    5. ? meet Germany?s condition that the EU framework for future bailouts be changed.

As you can see, the Greek problem is going to be more like a trench warfare than a blitzkrieg. It will probably take years, taking down lots of casualties on the way.

Mind you, Greece is not the only country. There are other countries like Portugal, Ireland, Italy, Spain and UK who are going to face the same problem over the next few years. The question is, while the trench warfare is going on in the Greek front for the next couple of (or few) years, can the global financial markets remain orderly when one or more of the Portuguese, Irish, Italian, Spanish and British fronts are opened simultaneously?

Fingers crossed.

Watch April 15 2010: simmering tensions between US and China

Tuesday, March 23rd, 2010

April 15, 2010 is a day worth watching. It will be the day when the US Treasury will issue a report, designating whether China is a “currency manipulator” or not. While the repercussions of China being labelled a “currency manipulator” are worrying, this issue is hardly new. In fact, as we wrote in US shooting own foot with tariff on Chinese goods three years ago,

At present [April 2007], the US Congress is simmering in antagonism against China for her trade surplus against the US. They see China as a convenient scapegoat for America?s economic woes, accusing her of misconducts that includes currency ?manipulation,? unfair trade practices and so on.

For the past three years, both sides seem to be going round in circles regarding the Chinese currency peg issue. It seemed that China was repeatedly on the verge of officially being accused of currency manipulation, only for that charge to be withdrawn from the final assessment. Based on statistical probability, the chances for that charge to be issued again are slim. But as our long-time readers know us, we are no fans of using statistical probabilities to ‘predict.’

One thing is clear: the pressure for officially labelling China as a “currency manipulator” is much strong today than three years ago. Firstly, President Obama is more inclined towards that than former President Bush. Secondly, the US economy today is at a more advanced stage of deflation (i.e. unemployment, fall asset values, economic stagnation) than three years ago. Thirdly, mid-term elections are coming and consequently, there are a lot of domestic pressures for Obama to get tough on China.

In the face of further economic stagnation, the US is sliding downward towards mob rule. With a clear understanding of Irving Fisher’s debt deflation theory of the Great Depression, we can easily understand that for an economy heavily addicted to debt, all it takes for the economy to slow down is a slowdown in credit growth. As we wrote in Australia?s credit growth is still falling,

Marc Faber once said that for an economy that is addicted to debt, all it needs to tip it into a recession is for credit growth to slow down- no contraction of credit is required. Also, as Professor Steve Keen explained, at this stage of the debt cycle, the aggregate spending in the economy is made up of income plus change in debt. In the absence of income growth, a slowdown in credit growth implies declining aggregate spending by the private sector.

Currently, the US is in the midst of a generational shift in culture/mindset from borrowing to saving. That is, in economic terms, the US private sector is de-leveraging. The symptoms of de-leveraging will be asset price deflation, economic stagnation, rising unemployment and so on, which will be counteracted by increase in government debt and spending (which itself is limited by market’s confidence in government debt).

In lay-person’s terms, the US is suffering because they are on cold turkey from debt. In contrast, the Chinese are postponing their pain by going further into debt (i.e. policy of inflation and force-feeding of credit into the economy). This result in an illusion that America is suffering while China is ‘prospering’ (which is worsened by Chinese government’s propensity to doctor the figures to look good in order to save ‘face’).

But the mob wants to find a scapegoat to blame for their woes. It so happens that the most convenient scapegoat is China (specifically, China’s policy of artificially holding its currency down) because at this point of the cycle, China is looking very good. It is perceived that this policy worsen America’s unemployment rate. By implication, it is perceived that with China’s official unemployment rate much lower, China is ‘prospering’ at America’s expense.

The problem is that if China is to acquiesce to America’s demands today, it will not solve the America’s problem tomorrow. In fact, the immediate effect will be to worsen America’s (and China’s as well) economic woes. Price inflation will rise and market based interest rates will go up, worsening America’s debt deflation problem. The reason is because the Chinese currency control had been in place for too long and that resulted in long-term structural changes to both the US and China’s economies. Removing the control immediately means that both economies will have no time to adjust, compounding the current level of pain for both sides.

For China, if the words of its Vice Commerce Minister Zhong Shan are accurate, the profit margins of many Chinese exporters were less than 2%. By appreciating the yuan, many Chinese exporters will go under, which by implication will have serious impacts on unemployment in China, and by extension, on social stability.

SEO Secrets e-bookBut as we wrote before in Chinese government cornered by inflation, bubbles & rich-poor gap, China has their own inflation problem that will eventually threaten social stability. They are already taking tentative steps to rein in inflation (see Is China going to allow its banks to fail in the upcoming (potentially gigantic) wave of bad debts?). Letting their yuan appreciate is very likely part of their overall plan to re-balance their economy. It will happen eventually. But the problem is, the Chinese wants to do it gradually. But the US politicians, on the other hand, want China to do it quickly in order to appease their electorates. Already, we have American economists like Paul Krugman (who is of the same ideology as Ben Bernanke with regards to money printing to solve economic problems) writing inflammatory articles and egging for a economic fight with China.

So, April 15, 2010 will be an interesting date to watch. If China gets labelled as a “currency manipulator,” then trade tensions jump up a level. If left unchecked, that will result in trade war. If trade war is left unchecked, the gloves will come off and there will be more unsportsmanlike actions from both sides (i.e. covert dirty war). If dirty war goes unchecked, there is a risk of shooting war. We are not saying all these things will happen- our point is that there will be a time and sequence for things to happen.

Hedging against currency crisis with electronic gold

Thursday, March 18th, 2010

Back in January this year, we talked about protecting yourself against currency crisis in Protecting yourself against currency crisis. The basic idea of that article is that the time to prepare for such an eventuality is before TSHTF. Once it happens, it is too late.

For our Australian readers, this seems to be less of a worry because there is still an air of optimism (relatively) among the population. But for our American readers, the nagging feeling of fear and brooding seems to be permeating among the masses. As the author of this book, The Ultimate Suburban Survivalist Guide: The Smartest Money Moves to Prepare for Any Crisis, wrote in the introduction,

Do you have a pervasive sense of anxiety, as if our modern world is on thin ice? Do you have an uneasy feeling that Wall Street seems to be collapsing under the weight of bad debts and bad decisions- and dragging your job along with it? Or, maybe you feel our society is coming apart at the seams, and that our civilization could actually break down and collapse.

You are not alone. A lot of people are worried. In fact, there is a growing movement of people who are preparing for the end of the world as we know it (TEOTWAWKI).

That book is written in an American context. If you are an American reader, please let us know how true or accurate this is in the comments below.

Now, for this article, we will stick to the original point (currency crisis) and not venture to the theme of TEOTWAWKI (survival skills/gears, self-sufficiency, guns, supplies stockpiles, etc). We hazard a guess that the TEOTWAWKI theme is of more interest to our American readers than to our Australian readers. But if enough readers express their interests in TEOTWAWKI, we may do more research and write more about it. If not, let’s stick to the topic. (By the way, contrarians like Marc Faber are alluding to the TEOTWAWKI theme).

Okay, back to currency crisis. There are two components to hedging yourself against currency crisis:

  1. Diversify your assets overseas.
  2. Prepare a cache of physical monetary assets (e.g. physical cash and physical gold/silver).

For the second component, our book How to buy and invest in physical gold and silver bullion would cover it very well. But for this article, we will look at the first component.

One of the ideas (and note, they are ideas- nothing in this blog should be taken as financial advice) that is floating around in our mind is electronic gold. We first touched on this idea two years ago in What is the future of silver?,

Today, we have a very powerful technology that can solve the convenience and sub-divisibility problem (see Properties of good money) associated with [using] gold [as] money- computers. All we need is a trusted central repository of gold (perhaps today?s central bank can change its institutional role for this purpose) and let computer systems keep track of ownership and transfer flow of gold money. In other words, the gold is physically kept in a secure central location while the finer sub-divisions and change of ownership of gold money is recorded as bookkeeping entries on computers. No physical movement of gold is necessary.

This passage was written to refute some of the views that gold can never ever function as money again because it will be physically inconvenient (or beyond imagination) to carry minuscule amount of physical gold as money to buy small items (e.g. bread).

Well, two things against this argument:

  1. In Zimbabwe, people were already used flakes of gold to buy bread (see the video at Rural Zimbabweans are desperately panning for gold powder to ward off starvation).
  2. The same problem of inconvenience existed two hundred years ago and that’s why mankind invented the use of warehouse receipts for gold as a proxy for money (the history of money is written in more detail in our book, How to buy and invest in physical gold and silver bullion). Warehouse receipts for gold are the precursor to the paper money we have today.

In this current age of information technology, this problem can be easily solved with electronic gold. In fact, there are quite a few electronic gold solutions currently implemented today. One of them is GoldMoney.com (which we disclose that we have an affiliate interest with them).

One very important thing to remember: the whole point of owning gold is to own an asset that is nobody’s liability (if you want to understanding the reasoning behind it, please read How to buy and invest in physical gold and silver bullion). That will eliminate most gold ETFs, gold futures, gold CFDs, etc because they are basically financial assets disguised as ‘gold’ as they exist as a liability in someone else’s balance sheet. As for other types of gold that you do not take physical possession for yourself (e.g. kept in vault storage on your behalf), you have to look at them on a case-by-case basis to ensure that

  1. You own the legal title to the gold (i.e. your gold is really yours and not belong to the liability column of someone else’s balance sheet), and
  2. Trust that they are able to physically deliver your gold to you on demand.

So, if you trust GoldMoney.com, then they fulfil these two criteria. But do not let us tell you who to trust or not to trust- seek advice, do research and decide for yourself.

When we first heard of GoldMoney.com, we imagine a world whereby gold becomes money and payments can be made back and forth electronically as conveniently as PayPal. If you have a full-holding account in GoldMoney.com, you can certainly do that with their patented technology. We don’t see why it can’t be done.

But we talked to those guys and found out something interesting. Apparently, most of their clients do not use GoldMoney.com as electronic gold money (as we imagined in our fantasy). In reality, most of them link their full-holding GoldMoney.com account with their bank accounts all over the world. Why would someone do that? Here is what we think (bear in mind, this is just our opinion)…

Remember, back in Protecting yourself against currency crisis, we wrote

Personally, we feel that the best way to protect you from a currency crisis is to leave the country before TSHTF.

If you believe that all paper fiat currencies will eventually depreciate significantly against gold, then it makes sense to hold gold. Let’s say you have a cache of physical gold and you decide to leave the country? That means you have to lug your physical gold to that country where there’s always a danger of loss in transit from bandits, thieves, corrupt officials, ship-wrecks, air-crash, etc. Or maybe the custom officers in both the source and destination country may not look in favour of anyone bringing in physical gold. Whatever the reason, you may not feel comfortable having so much valuables in your physical possession while you’re on transit to another country. For a big fat filthy rich person, it is physically too demanding to lug around his large stash of gold.

GoldMoney. The best way to buy gold & silver So, here come the folks at GoldMoney.com. Since you have already set up links between your full-holding GoldMoney.com account and the various overseas bank accounts all over the world, you do not have to worry about hauling physical gold around. (Of course, having some physical gold coins in your pocket will always be useful for things like paying for a space on a leaky boat to travel to that country- jokes aside, we mean it is not wise to completely do away with having some physical gold in your physical possession).

So, the next time you visit a foreign country, you may want to open a bank account over there!

Meanwhile, please vote on the poll below:

All quiet on the Greek front?

Sunday, March 14th, 2010

It’s less than a couple of months ago, financial markets around the world were panicking over Greek government debt default. Speculators like George Soros were probably short-selling Greek government bonds, which in itself will result in rising interest rates for the Greek government. That in turn would increase its debt servicing burden, which would make it even more likely for the Greek government to default. This is like the positive feedback loop that we talked about in Thinking tool: going beyond causes & effects with systems thinking. Those speculators holding Credit Default Swaps (CDS) will have a perverse hope of seeing a Greek Government default.

Today, it seems that this story is a non-issue for the market. Has the story ended?

We afraid this is just the beginning. The Greeks had merely just announced on an austerity plan and some of its people are taking to the streets in protest. As you can read from European politicians hammered from both sides, there will be many parts to this story. Much of the ugly political and legal sausage making process will be happening behind closed doors, which means you wouldn’t get to read them in the media. That will lull many into a false sense of calm.

But make no mistake, this story is like a trench warfare that will play out over a period of years (see Currency crisis: first countries in the line of fire- PIIGS). It will engulf more than Greece- vulnerable? countries include Portugal, Italy, Ireland and Spain. While the Euro may stage a counter-rally here and then, it is most likely to be in a secular down-trend.

As Marc Faber said, the Greek austerity measures will cripple the Greek economy:

Austerity measures may end up making the Greek economy weaker, which means tax receipts will be reduced. That in turn may even make it harder for the Greek government to service its debt. When that happens, you will see speculators moving in again, resulting in another panic quite some time later. This is what we will call the Part 1, Act 2 of the story.

In the meantime, even if the speculators’ hands are tied from touching Greece (by government regulations), they may be setting their sights at countries like Spain or Portugal. That’ll be Part 2, Act 1 of the story.

Is China allowed to use its US$2.4 trillion reserve to spend its way out of any potential crisis?

Thursday, February 11th, 2010

Everyone knows that China has US$2.4 trillion of reserves. This has led to many (including some analysts from big financial institution) to believe that such gigantic reserves are akin to ‘cash’ that China can spend its way out of any potential crisis.

Actually, this is one big misconception that this article will address.

The US$2.4 trillion of reserves is only half the picture. Looking at that alone is analogous to looking at the asset column of a company’s balance alone. What’s also important is the liability side of the picture. When you put the two together, then you will get a better idea of how much of the ‘cash’ (i.e. the reserves) that the Chinese government can really spend.

First, we will look at the liability side of China’s ‘balance sheet.’ According to this report from Pivot Capital Management,

… the size of the Government?s debt is vastly understated. Not included in the public debt figures are the liabilities of the local governments, which the Ministry of Finance estimated at $680bn as of the end of 2008. In addition to that, a large part of the loans extended this year (estimated at $350bn) went to finance public infrastructure projects guaranteed by local governments. Furthermore, when the Chinese government bailed out its banking system in 2003, it set up Asset Management Companies that issued bonds to the banks at par for the non-performing loans that were transferred to them. These bonds, worth about $260bn, are explicitly guaranteed by the Ministry of Finance and the Central Bank and sit on the balance sheets of the big four banks. The Chinese government also explicitly guarantees $400bn worth of debt of the three ?policy banks?. In total, these off-balance sheet liabilities are equal to $1.7tn, which would bring China?s public debt to GDP ratio up to 62%, a level that is comparable to the Western European average.

These debt guarantees within the off-balance sheet liabilities are what we call “contingent liabilities.” Australia’s bank deposit and wholesale funding guarantee are examples of contingent liabilities of the Australian government (see Australian government?s contingent liability to exceed AU$1 trillion).

These off-balance sheet liabilities are not the only liabilities. The Chinese currency in circulation is also a liability. Remember what we wrote in How does China ?save?? Story of the circuitous journey of a US$? In that article, we explained how a US dollar travelled from America (in the hands of an American consumer) to China, and then exchanged as RMB and then travelled back to the US as Treasury bond purchases. The crucial intermediate step to examine in this circuitous journey is when the US dollar is exchanged for RMB. As we all know, the RMB is pegged to the US dollar at a specified ratio. Currently, the ratio is at 1:6.833. To simplify matters, let us round up the number to 1:7. What happens (in a very highly simplified form) is that for every US dollar that gets presented to the PBOC, approximately 7 RMB will be issued.

One way to look at it is that the RMB in circulation are ‘backed’ by US dollars in the form of currency reserves. That was exactly the same situation that America faced in the 1920s. Back then, under the gold standard, the US dollar was pegged against gold in the ratio of approximately 1:20. In reality, not every US dollar was backed by gold. In other words, the US dollar was partially backed by gold in the same way your ‘cash’ at bank was partially backed by physical currency and your bank’s deposit on the central bank. That is, there was a theoretical possibility that there could be a run on the Federal Reserve’s gold if every citizen decided to redeem all their currencies for gold at once. In the same way, China’s RMB in circulation are partially ‘backed’ by their US currency reserve. According to the chart provided by Pivot Capital’s report, only a little over 20% of China’s total currency (plus gross external debt) are ‘backed’ by their US dollar reserves, which isn’t spectacular compared to other emerging economies. In fact, South Africa is the winner in this aspect because their reserve coverage ratio is almost 160% i.e. it has $16 of reserves for every $10 of currency.

Of course, in reality, it is unlikely that there’s going to be a run on China’s US dollar reserves. But according to Pivot Capital, since 2007, there are approximately US$500 billion of “hot money” in China that can easily leave the country at a moment’s notice. That US$500 billion is money that China cannot spend and must be ready to meet the ‘redemption’ demand of the “hot money.”

So, in reality, the picture of China’s currency reserves is not as rosy as it seems.

Protecting yourself against currency crisis

Friday, January 29th, 2010

Today, we will continue from the final question asked at Next phase of GFC is when governments go bust,

When governments go bust, we will have currency crisis. How do you protect yourself against this?

First, let us begin with understanding what a currency crisis is. From the Wikipedia,

A currency crisis, which is also called a balance-of-payments crisis, occurs when the value of a currency changes quickly, undermining its ability to serve as a medium of exchange or a store of value…? Governments often take on the role of fending off such attacks by satisfying the excess demand for a given currency using the country’s own currency reserves or its foreign reserves (usually in euros, US dollars or UK pounds).

Basically, a currency crisis occurs when there is a problem in a country’s balance of payments (see Understanding the Balance of Payments). The currency will depreciate very rapidly and as a consequence, cannot be used as money and cannot function a store of value effectively. This usually manifests itself as sky-rocketing price inflation, which undermines everyone’s standard of living. When Hugo Chavez recently announced the planned devaluation of the Venezuelan currency (that’s not technically a currency crisis, but this is just an example to show you its effects), people rushed out to buy consumer goods in anticipation of price inflation.

From this, you can see that obviously, the key to protecting yourself from a currency crisis is to diversify your savings away from the affected currency (e.g. foreign currency, gold, silver, etc). Does it mean that all we have to do to hedge ourselves is to go to our local bank branch, open a foreign currency account and then transfer some of our savings to that account?

Unfortunately, that’s true only in a perfect world. In reality, when there’s a currency crisis, there’s a high chance that a banking crisis will come along with it. For example, in Argentina’s currency crisis (1999-2002), the government froze bank accounts in an attempt to prevent a run on the banks. In some cases, governments may even impose capital controls (especially in pegged currencies), which basically means your money will be stuck.

In such an environment, Black Swans abound, which means the financial system may be dysfunctional. That means your foreign currency stored in your local bank’s foreign currency account can be, for all intent and purposes, useless. In today’s modern economies, since exchange of physical cash forms a tiny percentage of commercial transactions, a dysfunctional financial system will affect most commercial transactions in the economy, which in turn implies that the economy will be paralysed. Even if the financial system is working, price inflation will make life miserable for most people.

In such a bleak environment, we can imagine people resorting to barter, physical cash (both foreign and local) and even physical silver and gold. Hopefully, local governments and communities will take the initiative and come up with complementary currencies so that the economy can still function (otherwise, everyone will be reduced to primitive bartering). In Argentina, a spectrum of complementary currencies had emerged, in such a large scale that some of them are even called “quasi-currencies.”

Personally, we feel that the best way to protect yourself from a currency crisis is to leave the country before TSHTF. If not, stock up some physical cash (both foreign and local), physical gold and silver (see our book, How to buy and invest in physical gold and silver) and supplies- these will tide you over while the sh*t is hitting the fan. For the longer term, you may want to move some of your savings overseas- you may not be able to use them in the midst of the crisis, but when it is all over, the local currency may no longer exist (e.g. you may have to convert the old currency to a new one at unfavourable rates).

Note: All these are NOT personal advice- they’re just ideas for you to consider.