Archive for October, 2007

China considers leaking money to overseas stock

Thursday, October 4th, 2007

Today, we caught hold of this article in the news media: China may look to buy shares in BHP, Rio Tinto:

Chinese authorities are looking to loosen outward investment restrictions to reduce pressure on inflation, asset prices and the pegged yuan.

Recall that in our earlier article, Why is China printing so much money?, China has to print money in order to maintain the value of its currency (the RMB) against foreign currencies within a band. This ballooning of money supply is causing the current priceĀ  inflation problems in China (see Cause of inflation: Shanghai bubble case study). The Chinese authorities are thinking of this new scheme in an attempt to control domestic price inflation. Below is a highly simplified example of how it works on the level of an individual:

  1. Let’s say you are a local Chinese investor with excess RMB to invest in. Let’s say you decide to invest in Australian stocks.
  2. With your excess RMB, you buy US dollars from the Chinese central bank.
  3. Given that the Chinese central bank is awashed with excess US dollars (see Awash with cash?what to do with it?, it exchanges your RMB for US dollars.
  4. With the US dollars that you had just acquired, you buy up Australian dollars.
  5. With these Australian dollars, you buy Australian stocks (e.g. BHP, Rio Tinto).

So, as you can see, this results in less RMB circulating in the Chinese economy, which reduces price inflation pressures. Isn’t this a good idea?

Well, there is a risk with this that can end up in disaster. Indeed, as the article said,

Yu Yongding, an economist who stepped down from the central bank’s monetary policy committee last year, recently warned Chinese officials that they could court disaster by opening outward investment channels before introducing a more flexible currency regime.

“Capital controls are China’s last line of defence and cannot be eased until China’s financial reforms are complete,” he said.

“Growth is cyclical and a sudden change in China’s situation could prompt massive capital flight. If there are no restrictions to ease the blow at that point, the effects on China’s economy will be disastrous.”

Why is it possible that this may result in disaster? Stay tuned!

Increase in Australian M3 in August

Wednesday, October 3rd, 2007

In Degradation of Australia?s fiat paper money, we showed you the graph of the debasement of the Australian currency from July 1959 to July 2007. The M3 figure for August 2007 had been released- an increase from $874.6 bn to $897.0 bn. This means that within the space of 12 months, the money supply in Australia had increased by 18%!

P.S. See the comments on a clarification of the percentage figure.

Drugged up stock market

Tuesday, October 2nd, 2007

Ever since Ben Bernanke cut interest rates, the US stock market had been surging, even hitting another record high.

Dear readers, don’t you see something amiss is going on? It had been said that the stock market is an early indicator of the health of the economy. It is very much like the radar of an aeroplane, telling the pilot what dangers are ahead. In fact, the stock market is such a sensitive indicator that its alarms of economic slowdowns often turns out unfounded. Thus, if the stock market is a functional indicator, it should react badly to bad news and react well to good news.

But this is no longer true today. Back in October last year, we already notice this curious phenomena. In Divergent sentiment, we wrote:

So, the stock market is wrong, not because the stock prices rise due to economic growth. They rise due to monetary inflation (printing of money).

There are already plenty of chatters about a looming recession in the financial markets. There has been a steady influx of bad economic news (e.g. sub-prime fall out, deflating house prices, dysfunctional credit market, etc) since we wrote that article. GDP growth in the US is in a downtrend. These are NOT good economic news. Yet, apart from the brief corrections in February and August this year, the stock prices are still climbing upwards relentlessly.

Don’t you find it strange?

Somehow, we have come to the point whereby bad news becomes good news to the stock market. In the minds of the stock market, bad news is good news because a deteriorating economy will induce the Fed to flood the financial system with even more cheap money.

“Hey, why worry? The Fed is shouting as much drinks as we all want [which is infinite by the way]!” the market seems to be saying.

To us, this clearly describes an addict. A drug addict will feel a rush of exuberance when consuming drugs even though they are destroying his/her body. The more drugs one consume, the more one needs them as the addiction imprisons with a stronger and tighter hold. The economy (and by extension, the stock market) is addicted to cheaper and cheaper money. It is such cheap money that got it into trouble in the first place. And now, the Fed is making it clear that they will supply even more drugs… oops, we mean cheap money!

For those who are wise, look at what the US dollar (see What can we expect in a US dollar decline? and One potential trouble-maker to watch out for in 2007) and gold is doing.

Faint drumbeats of war

Monday, October 1st, 2007

Back in January this year, we expressed our concern for a possible Israeli strike on Iran. Recently, we have been noticing an increase in the media’s news speculation on a US plan to strike Iran. For example, we just saw ‘US plan to bomb Iran’ in the Sydney Morning Herald (SMH).:

Australia, Britain and Israel have “expressed interest” in a US campaign to launch “surgical” bombing raids on Iran targeting the Revolutionary Guard facilities, one of the US’s leading investigative reporters, Seymour Hersh, reports.

The Israelis may have a reason poke their nose into Iran, but we wonder what business does Australia have in bombing Iran? In any case, politics aside, a bombing campaign against Iran is an example of a Black Swan event?one that is highly improbable but has colossal impact. When that happens, oil and gold will surge, the jumpy stock market will tank and the dysfunctional credit market will get worse.

Given the advanced military technologies of the US and Israel, we guess they will be immediately effective in stopping (or at least temporarily delaying) the Iranians from acquiring nuclear weapons. But we doubt they can control the effects of what comes after?once the genie is out of the bottle, it is very hard to put it back. Much will depend on how the Iranians react. If they meekly back down with their tails between their legs, then this will just be another skirmish. But if they decide to unleash the full extent of their fury, then the outcome will be unpredictable.

Anyway, since geopolitics is outside our area expertise, we cannot say much. But as investors, it may be useful to top up our cache of gold, just in case.