Let us look at the population in the USA. It stands at around 305 million. 25% are under 18 and that leaves 229 million. 12.5% are over 65 and can be considered as retired. The number is now reduced to 190 million. Assume 10% of the population are mental, have a disability which prevents them from working, are in prison or unemployable for one reason or another. That leaves a total of 160 million adults.
The stimulus package is 800 billion which divided by 160 million is equivalent to giving each working adult $5,000. The average salary for an American is $45,000 . The stimulus package includes infrastructure projects and subsidies to State Governments .About $500 billion will go direct to the people. Assume the unemployment rate goes up by7.5%. Out of 160 million, that is 12 million workers and multiplied that by the average salary of $45,000, the amount comes to $540 billion that is lost because of unemployment. Thus the stimulus package is more or less roughly equal to the loss of income for those who lost their jobs.
But the key problem is that many Americans borrow to spend. The average American with a credit file is responsible for $16,635 in debt, excluding mortgages, according to Experian. (Source: U.S. News and World Report, "The End of Credit Card Consumerism," August 2008).Total U.S. consumer debt (which includes credit card debt and non-credit-card debt but not mortgage debt) reached $2.55 trillion at the end of 2007, up from $2.42 trillion at the end of 2006. (Source: Federal Reserve).Divide by 160 million working Americans, that means each working adult has an average of $16,000 consumer debt EXCLUDING HOUSE MORTAGES!
Now that the borrowing has dried up, spending will drop even with the stimulus package.The latter is just enough to counter balance the loss of income of the increased number of unemployed.There is nothing to replace the spending that dries up because of the credit crunch.
There is only one way to stop the pain and that is allowing consumer debt to start again. My friend who just returned from America was amazed to see TV commercials asking consumers to buy now and pay back two years later.Perhaps the only way is to allow easy credit and resume the borrowings of the past decades.
But now foreign countries are becoming wary of the US dollar. US Treasury bonds will be avoided once everyone sees that debt is going to balloon to even more unimaginable proportions. There are two ways to sustain debt. One is to borrow and the other is to print more money. As the former becomes more difficult, printing money becomes the only solution and the result is a colossal drop in the value of the US dollar versus gold and other more stable currencies.
If Obama risks his political capital on the stimulus package, he will definitely ends up as a one term President. The solution is very painful. Banks must fail and be taken over by corporate raiders to start anew. Bankruptcies will purge all those companies that are not competitive or in the wrong industry (eg pampering people on luxuries ). People have to downsize their homes, their cars and their life styles. People have to be so frightened that they stop borrowing to spend. US companies must start to become competitive again and Americans will have to join the rest of the world in slogging it out just to make ends meet. Thrift becomes a household word and good old fashion work and save atttitude becomes fashionable again.
Thursday, February 12, 2009
Monday, January 12, 2009
You cannot be a virgin twice
12 January 2009
Governments the world over are hoping for a return to the good old days. But those days are gone, vanish and kaput especially for the USA. The great bull run funded by easy and almost free money is over. Remember the dot com crisis where profits does not matter and all it takes is an internet idea and voila, your company is worth millions. The dot com balloon vanished faster than it came. Profits does matter and this is fundamental investment logic. You pay to buy shares in a company for its future stream of profits. If there is no profit or only the possibility of profit, then you are throwing away your money investing in a dream.
Likewise good old economics will say that debt matters. You cannot keep borrowing forever and ever. For three decades or more, the USA have been a borrower nation. The Government borrowed, the consumers borrowed, the hedge funds companies borrowed and so forth. It seems that borrowing has become a permanent way of life and some new rule of economics have been invented. So the new paradigm in investment is simple. You cannot borrow ALL the time. You can borrow to invest, to create new services or products but you cannot borrow to spend ....not all the time. So with borrowing grounded to a sudden halt, the borrowers are made to face reality which is they can only spend what they earn. Having known the horrors of excessive liquidity , the financial institutions have learned that money must be lent prudently. The banks in particular the investment banks have lost their virginity in an orgy of unbridled debt and mind boggling leveraging.
Now liquidity is tied to financial engineering. The latter is the twin sister of debt. Without huge debt and excessive leveraging, financial engineering would not be able to make the spectacular profits it made in the past decade. The good old days of thirty year old making a million in salary and bonuses by simple trading and leveraging are over. Now it is back to basic which means money is earned through either the making of a product or the provision of a service. Financial engineering neither makes a physical product or a necessary service. To be blunt, it is gambling in a more sophisticated way. Now that casino has gone bankrupt. The virgin has become a whore and there is no going back.
Obama is asking the Americans to go back to old fashioned ways of earning money. Building roads, repairing infrastructure, designing alternative energy solutions and so forth. But the Americans have long relied on immigrants to do its heavy work like road building and other construction work. Alternative energy requires graduates in Science and Engineering and a high degree of post graduates students are foreigners. He is asking Anericans to forget about baseball and Hollywood and go back to boring subjects like Science and Engineering. Goodness who wants to be an engineer when there is the dream of earning instant millions by becoming a Hollywood star. The American Idol is popular because it is the Amercian dream. Nobody wants to go back to do backbreaking work or mind breaking research unless they are forced to. That means lost of retrenchments, lay offs, foreclosures until reality sinks in. That reality is we have to work and work hard for our money.
Throwing trillions at the economy won't work if mindsets are not changed. You can go from being an investment banker to a researcher in alternative energy unless you go back to college and pick up some technical qualifications. You will have to wait for five years or more before enrollment for engineering and Science courses pick up when the students realised that having a good technical degree will help them get a job. And enrollment cannot just increased like that. You need more professors, more laboratories and being a lecturer has to become a hip profession. So we should not wait or hope for the American consumer to spend again, like they did in the good old days.
But all is not doom and gloom. USA represents only 20% of the world economy. There is still that 80% out there that does not have the same approach to life. Chinese students are studying hard and millions graduates emerge from engineering colleges in China and India. Yes there will be slow down and retrenchments in China and emerging markets. They have to live without their top customer, the US consumer. In time, they will adjust and a new market will emerge. This new market will cater to the needs of consumer in emerging markets rather than in developed countries. Take tourism as an example. Chinese tourists may prefer to tour the cheaper Asian countries than visit Europe or USA. Asian non Chinese tourists may prefer to visit China rather than expensive Europe. The booming Asian market in tourism does not depend on Americans or Europeans.This is the new economy that will emerge from the Western originated debt crisis.
Asians will design, manufacture and sell to Asians. A new market will developed. No longer will entrepreneurs look to the West for new ideas and needs but they will start top design products that meet Asian needs.For example, today modems are designed for developed countries where telephone lines are short and easily available. In many parts of Asia there is a shortage of telephone lines and so wireless technology has come to the rescue. Phone and internet communications can be instantly provided by installing a wirelesss terminal that communicates with a base station thirty kilometres away. Satellite receivers are ridiculously cheap. Newspaper in developing countries will receive their newspaper via such satellite receivers. All it need is a low cost electronic display or what is now called e-paper. Today it is expensive but what if the manufacturer is making it by the billions? A low cost satellite receiver with e-paper can deliver news cheaply to billions of people from Peru, Nigeria , Nepal, India to China. These will be products designed by Asians for Asians and China, Taiwan and Korea will lead the way. Japan is too enamoured with Western markets to pay attention .
Now e-paper with high resolution similar to printed paper may be years away. But consumers in Asia are more concerned about cost than high resolution. A low cost but much cheaper e-paper may not have a market in USA and Europe but readily accepted by Asian customers who prefer low resolution news to no news at all. Today researchers are only targetting at the Western markets but the new market will provide the global growth. It is when emerging markets start trading, selling and servicing to one another. This is a huge potential market but can only be understood if you live in an emerging economy. I once asked a lecturer from Temasek Polytechnic to ask his students to design a low cost vacuum pump. He could not get Singapore students to do the project for to a Singaporean, $10 is low cost already. He got three students from India, China and Myanmar to design a $2 vacuum pump. This will be a market understood only by those who earn less than a $1,000 a month. To UK engineer earning $7,000 will not understand why a $100 product must be made to sell at $3.
Years ago, the former Prime Minister of Malaysia exhorts his countrymen to look east. Now is the time to starting looking Eastward for investments, for product design, for new markets and new services. The money is already in the East with China, Japan, Taiwan and Singapore hacing billions in their reserves. When these reserves are put to serve the needs of Asians , Africans and Latin Americans, a new global market will be created. Look east, the west has lost its virginity already.
Governments the world over are hoping for a return to the good old days. But those days are gone, vanish and kaput especially for the USA. The great bull run funded by easy and almost free money is over. Remember the dot com crisis where profits does not matter and all it takes is an internet idea and voila, your company is worth millions. The dot com balloon vanished faster than it came. Profits does matter and this is fundamental investment logic. You pay to buy shares in a company for its future stream of profits. If there is no profit or only the possibility of profit, then you are throwing away your money investing in a dream.
Likewise good old economics will say that debt matters. You cannot keep borrowing forever and ever. For three decades or more, the USA have been a borrower nation. The Government borrowed, the consumers borrowed, the hedge funds companies borrowed and so forth. It seems that borrowing has become a permanent way of life and some new rule of economics have been invented. So the new paradigm in investment is simple. You cannot borrow ALL the time. You can borrow to invest, to create new services or products but you cannot borrow to spend ....not all the time. So with borrowing grounded to a sudden halt, the borrowers are made to face reality which is they can only spend what they earn. Having known the horrors of excessive liquidity , the financial institutions have learned that money must be lent prudently. The banks in particular the investment banks have lost their virginity in an orgy of unbridled debt and mind boggling leveraging.
Now liquidity is tied to financial engineering. The latter is the twin sister of debt. Without huge debt and excessive leveraging, financial engineering would not be able to make the spectacular profits it made in the past decade. The good old days of thirty year old making a million in salary and bonuses by simple trading and leveraging are over. Now it is back to basic which means money is earned through either the making of a product or the provision of a service. Financial engineering neither makes a physical product or a necessary service. To be blunt, it is gambling in a more sophisticated way. Now that casino has gone bankrupt. The virgin has become a whore and there is no going back.
Obama is asking the Americans to go back to old fashioned ways of earning money. Building roads, repairing infrastructure, designing alternative energy solutions and so forth. But the Americans have long relied on immigrants to do its heavy work like road building and other construction work. Alternative energy requires graduates in Science and Engineering and a high degree of post graduates students are foreigners. He is asking Anericans to forget about baseball and Hollywood and go back to boring subjects like Science and Engineering. Goodness who wants to be an engineer when there is the dream of earning instant millions by becoming a Hollywood star. The American Idol is popular because it is the Amercian dream. Nobody wants to go back to do backbreaking work or mind breaking research unless they are forced to. That means lost of retrenchments, lay offs, foreclosures until reality sinks in. That reality is we have to work and work hard for our money.
Throwing trillions at the economy won't work if mindsets are not changed. You can go from being an investment banker to a researcher in alternative energy unless you go back to college and pick up some technical qualifications. You will have to wait for five years or more before enrollment for engineering and Science courses pick up when the students realised that having a good technical degree will help them get a job. And enrollment cannot just increased like that. You need more professors, more laboratories and being a lecturer has to become a hip profession. So we should not wait or hope for the American consumer to spend again, like they did in the good old days.
But all is not doom and gloom. USA represents only 20% of the world economy. There is still that 80% out there that does not have the same approach to life. Chinese students are studying hard and millions graduates emerge from engineering colleges in China and India. Yes there will be slow down and retrenchments in China and emerging markets. They have to live without their top customer, the US consumer. In time, they will adjust and a new market will emerge. This new market will cater to the needs of consumer in emerging markets rather than in developed countries. Take tourism as an example. Chinese tourists may prefer to tour the cheaper Asian countries than visit Europe or USA. Asian non Chinese tourists may prefer to visit China rather than expensive Europe. The booming Asian market in tourism does not depend on Americans or Europeans.This is the new economy that will emerge from the Western originated debt crisis.
Asians will design, manufacture and sell to Asians. A new market will developed. No longer will entrepreneurs look to the West for new ideas and needs but they will start top design products that meet Asian needs.For example, today modems are designed for developed countries where telephone lines are short and easily available. In many parts of Asia there is a shortage of telephone lines and so wireless technology has come to the rescue. Phone and internet communications can be instantly provided by installing a wirelesss terminal that communicates with a base station thirty kilometres away. Satellite receivers are ridiculously cheap. Newspaper in developing countries will receive their newspaper via such satellite receivers. All it need is a low cost electronic display or what is now called e-paper. Today it is expensive but what if the manufacturer is making it by the billions? A low cost satellite receiver with e-paper can deliver news cheaply to billions of people from Peru, Nigeria , Nepal, India to China. These will be products designed by Asians for Asians and China, Taiwan and Korea will lead the way. Japan is too enamoured with Western markets to pay attention .
Now e-paper with high resolution similar to printed paper may be years away. But consumers in Asia are more concerned about cost than high resolution. A low cost but much cheaper e-paper may not have a market in USA and Europe but readily accepted by Asian customers who prefer low resolution news to no news at all. Today researchers are only targetting at the Western markets but the new market will provide the global growth. It is when emerging markets start trading, selling and servicing to one another. This is a huge potential market but can only be understood if you live in an emerging economy. I once asked a lecturer from Temasek Polytechnic to ask his students to design a low cost vacuum pump. He could not get Singapore students to do the project for to a Singaporean, $10 is low cost already. He got three students from India, China and Myanmar to design a $2 vacuum pump. This will be a market understood only by those who earn less than a $1,000 a month. To UK engineer earning $7,000 will not understand why a $100 product must be made to sell at $3.
Years ago, the former Prime Minister of Malaysia exhorts his countrymen to look east. Now is the time to starting looking Eastward for investments, for product design, for new markets and new services. The money is already in the East with China, Japan, Taiwan and Singapore hacing billions in their reserves. When these reserves are put to serve the needs of Asians , Africans and Latin Americans, a new global market will be created. Look east, the west has lost its virginity already.
Sunday, November 2, 2008
Making sense of the strong US dollar
It makes no sense. US markets are down, housing prices have halved, large well known and supposedly well capitalised banks have to be rescued, US total deficit exceeded the US$10 trillion mark which the Singapore Straits Times wrote is qual to a debt of more than half a million per family in the USA and yet the US dollar is high? To make sense of this currency movement, let us take the currency as the equivalent of shares in a company. If a company is doing well, its shares will go up because each share is supposedly equal to a portion of the value or assets of the company. We should table all the assets in the USA, add up all the shares in all the US companies, add up all the properties and land cost, add up all the gold the Federal reserves have and divide them by the total amount of US dollars in the world. This in essence is what each US dollar should be worth
The constant Federal and Trade deficits for the past decades implies that
the US is spending more , much more than it is earning. Thus the US dollar should have a lower value compared to other currencies such as the Euro which cumulatively have a positive budget deficit . So why is the US dollar strengthening? I believed it has more to do with liquidity than with the actual fundamentals. US banks are not lending money which means there is a shortage of US dollars. And when there is a shortage, the price of that commodity goes up. In this case, that commodity is the US dollars. Secondly US investors and fund managers are liquidating overseas stocks and commodities and converting them into US dollars. There is therefore a demand for the US dollars needed to pay the investors who have sold their overseas stocks and commodities. If a fund manager sold $1 million Singapore dollar worth of Singapore shares, he will want to sell that $1 million dollar of Singapore dollars to buy US dollars and bring that US dollar back into the USA.
This will eventually create a humongous pool of US dollars in the USA but this pool is counterbalance by the fact that banks are not willing to lend . Think what happens when the lending starts again? For each dollar in its account, a bank can lend out $10 dollars. Where will these trillions of dollars find a home? I believed many US investors will be fed up with their own stock market and property investment which will mean they will look overseas to park their surplus dollars. I forsee a huge boom for overseas shares and properties once the economic picture clears and it can be seen that Asia and some emerging countries like Poland are relatively unscathed by the financial turmoil.
When I hear the news report on CNN and CNBC, I often hear commentators comment on the GLOBAL Financial Crisis. Yet Asia is definitely not in the same position as USA and Europe and even with Europe some countries fare better than others. Poland for example is booming even now. Once the picture settles and we know that Asia and some countries are not that badly affected., investors will chase after assets in these countries. I predict that shares in these countries will be selling for PE ratios far in excess of 20. Property and gold prices will soar as investors seek safety in assets that does not depreciate. Gold prices can be expected to exceed US$1,000 per ounce.
What is happening is not so much an appreciation of assets but a depreciation in paper money especially the US dollar. With so much money chasing after limited assets, these assets have to increase in price.The paper money in banks all over the world is like a crouching tiger, waiting for the coast to be safe and clear, before it pounce. Asian stocks, Asian properties, Asian anything will soon be the flavour of the month. There will be a huge plethora of unit trusts touting all sorts of Asian investment opportunities. Investment is controlled by two emotions: fear and greed. Today it is fear that predominates and so the tiger waits. But a time will come when greed will prevail and the tiger pounces.
This is a time to reap a massive harvest for those with the courage to be contrarians.
The constant Federal and Trade deficits for the past decades implies that
the US is spending more , much more than it is earning. Thus the US dollar should have a lower value compared to other currencies such as the Euro which cumulatively have a positive budget deficit . So why is the US dollar strengthening? I believed it has more to do with liquidity than with the actual fundamentals. US banks are not lending money which means there is a shortage of US dollars. And when there is a shortage, the price of that commodity goes up. In this case, that commodity is the US dollars. Secondly US investors and fund managers are liquidating overseas stocks and commodities and converting them into US dollars. There is therefore a demand for the US dollars needed to pay the investors who have sold their overseas stocks and commodities. If a fund manager sold $1 million Singapore dollar worth of Singapore shares, he will want to sell that $1 million dollar of Singapore dollars to buy US dollars and bring that US dollar back into the USA.
This will eventually create a humongous pool of US dollars in the USA but this pool is counterbalance by the fact that banks are not willing to lend . Think what happens when the lending starts again? For each dollar in its account, a bank can lend out $10 dollars. Where will these trillions of dollars find a home? I believed many US investors will be fed up with their own stock market and property investment which will mean they will look overseas to park their surplus dollars. I forsee a huge boom for overseas shares and properties once the economic picture clears and it can be seen that Asia and some emerging countries like Poland are relatively unscathed by the financial turmoil.
When I hear the news report on CNN and CNBC, I often hear commentators comment on the GLOBAL Financial Crisis. Yet Asia is definitely not in the same position as USA and Europe and even with Europe some countries fare better than others. Poland for example is booming even now. Once the picture settles and we know that Asia and some countries are not that badly affected., investors will chase after assets in these countries. I predict that shares in these countries will be selling for PE ratios far in excess of 20. Property and gold prices will soar as investors seek safety in assets that does not depreciate. Gold prices can be expected to exceed US$1,000 per ounce.
What is happening is not so much an appreciation of assets but a depreciation in paper money especially the US dollar. With so much money chasing after limited assets, these assets have to increase in price.The paper money in banks all over the world is like a crouching tiger, waiting for the coast to be safe and clear, before it pounce. Asian stocks, Asian properties, Asian anything will soon be the flavour of the month. There will be a huge plethora of unit trusts touting all sorts of Asian investment opportunities. Investment is controlled by two emotions: fear and greed. Today it is fear that predominates and so the tiger waits. But a time will come when greed will prevail and the tiger pounces.
This is a time to reap a massive harvest for those with the courage to be contrarians.
Friday, October 10, 2008
The Mother Black Swan
Months ago I wrote about the possibility of a Black Swan event for the financial industry. A Black Swan is an unlikely event but with severe repercussions and impact. The melt down of the financial industry constitutes such a Black Swan event. The severity of the credit crisis caught everyone by surprise. It seems no one knows how BIG the sub prime problem is . When the Federeal Reserve bailed out Fannie Mae and Freddie Mac, who are severely impacted by the mortgages they backed, everyone thought the crisis is more or less stabilised.
Then Bear Stern started wobbling and was bailed out by the Federal Reserve Board . Then Lehman Brothers was allowed to go bankrupt but AIG started to have serious financial issues and was given $80 billion loans. A more serious look revealed that the credit market was in a kind of seizure and $700 billion was approved by Congress to solve the mess. Central banks got together to lower interest rates and more liquidity was pumped into the market .But stock markets kept on falling, falling, falling.
When investment banks are leveraged thirty times and commercial banks leveraged ten times, there is an absolutely humongous amount of debt that needs to be cleared and eliminated. The Carry Trade has started to unwind as Japanese banks have obviously recalled loans in yen. This is why the yen have strengthened while the high yielding currencies like the Aussie and Kiwis have fallen. The Aussie Dollar fall resembles that of a bungee jump as it was steep beyond belief. There is no fundamental reason to such a steep fall in the Aussie, a country rich in resources , stable government and a highly educated population. It is obvious that many investors have borrowed yen and bought Aussie and now they have to sell the Aussie to redeem the Yen denominated loans. Hence Yen goes up and Aussie goes the other way.
Investors have also borrowed yen to buy shares and this has triggered selling all over the world. No one in his right mind would sell shares at such low prices. They did not want to but HAVE to because they have to return their loans whichever currencies the loans are in. Now assuming the total value of shares worldwide is worth $21Y trillions. Only $Y trillion is bought with cold hard cash .The remaining $20Y trillion is bought with loans, loans which now the banks are asking back. Investors borrowed to buy hedge funds which are extremely highly leveraged themselves. So we have this leveraging upon leveraging. Investors who are leveraged are buying investment products which are highly leverage. The deleveraging process has still some more weeks to go before their positions are unwind .
Central banks seem to see the problem as a credit problem and think that by providing more money at lower interest rates, confidence would be restored . What the Central Banks should do is to follow what Hong Kong did many years ago. The Hong Kong Government went in and buy the shares to prop up the market. Perhaps in time they will recognise this but buying shares seems to be political suicide especially with the Presidential elections around the corner. Shares will continue to fall until the loans have all been redeemed and then the rebound will begin. US and European shares will fall until overseas buyers see value and start buying them up. The first rebound will be Asian shares as they are fundamentally sound and do not have the debt and leveraging issues faced by USA and Europe.
But the Mother of all Black Swan has yet to come. This is the real biggie, the knock-out punch that will floor all but those who have hedge in gold. This is when confidence in the US dollar evaporates. When overseas customers stop buying US Treasuries, or US bonds or even US shares. The Federal deficit needs $2 billion a day. Without this infusion of funds from overseas, the only solution would be to print dollars. The result is extremely high inflation in USA and for a period of time, markets will be even more volatile than what we have seen.
There will be a scramble to find a currency to replace the US dollar. The IMF and World Bank will be expanded to include Asia and will be more reflective of the actual financial strength of each country. Perhaps even majority vote in these two world institutions may move to Asian and Middle East countries for after all they are the ones with the money. He who has the money calls the tune.It will be an irony that now IMF and the World Bank will be assisting developed countries who were previously the ones who provided them with the funds. Now an Asian pied piper calls the tune and it would be interesting to see a Chinese or a Japanese lecturing the Prime Minister of Germany or UK on how to manage his country. The only solution to such a massive crisis is to let the ones with the money decide on how they are to lend to the one who needs the money. The current situation is that the ones in debt are the one who decides how their debts are going to be repaid. China, Japan and Middle East countries are not going to provide loans to IMF or World Bank when they have no control over these institutions.
There will not be a collapse. The world is too sophisticated for that to happen. Central bankers and economist will gather together to find a solution. But it will not be just Western bankers and economists but Asians and Middle Eastern bankers and economists who has to come up with a solution that is palatable to their own citizens as well. A price must be paid for the folly of the past. Just as IMF insisted on strong medicine for the countries in which it provided loans, the same strong medicine has to be given out, this time to Western countries; higher tax, lower Government spending , no agricultural subsidies for farmers and so forth.
China , Japan and Asia will have to find new markets for their products. The emergence of countries like Brazil, Russia , Poland and others plus China's potentially huge domestic markets will take up the slack from the US. After all the US contributes only 20% to the global economy and this can be taken up by the emerging countries. Japanese consumers have not been spending but will be encouraged to do so when their Yen becomes so strong that going overseas and buying overseas products become very cheap. Will Japanese consumer take over from the American consumer? Not totally but together with Chinese, Brazilian, Russian and Korean consumers , they will take up the slack that the American consumers have left behind.
A reverse brain drain will occur when top talents and professionals now flow West to East , increasing the competitiveness of Asian companies. The West becomes a less important market .Already we see this in China where there are products catering solely to the Chinese market.Likewise we will see products tailored to Japanese taste which means smaller products to taken up less space and more functionality as well. The lack of funds by Western countries will lead to Asia becoming more dorminant in Africa and even Latin America.
In time to come , Latin America will become the next Asian tigers. America will be too pre-occupied and too poor to interfere with its southern neighbours. It would be interesting when educated Latinos and Mexicans start returning home from USA to their home countries and start new companies. Many Chinese and Indians have done the same in the past decade. It will be a different world but still a rich world where knowledge will continue to grow and new products , new services will sprout.
Friday, September 12, 2008
The long term value of gold
13 September 2008
How do we make sense of the sudden strengthening of the US dollar and the drop in commodities and in particular gold prices? This article tries to give some logic as to how the long term price of gold is being derived. We will first look at the growth in money supply. How much money is being created out of thin air year after year? I am still amazed that some friends still think that Governments cannot create "fiat" money and that any money created have to be backed by gold. This was abandoned since the early 1970s and Central Banks have the power ot create money at will. So let us look at what some journalists say about this money suppy growth.
This was reported in the Economic Times on 12 Septembr 2008:
BEIJING: China's broad measure of money supply rose 16 per cent year-on-year at the end of August, level with the government's annual target, the central bank said on Friday. Here is an excerpt from the Press Release of the European Central Bank on 27 Feb 2008:The annual rate of growth of M3 stood at 11.5% in January 2008, compared with 11.6% in December 2007.
China has pegged its currency to the US dollar which means that as the US expands its money supply, China has to follow suit. The increase in China's money suppy gives us an indication of the US money supply as well as described in the article below:
Financial Senses University wrote on 28 Feb 2008:
In a story published in July, 2006 by the China Daily newspaper titled “Money supply growth unlikely to slow” we were told that, "the ballooning forex reserve is a major factor behind the dynamic growth of the money supply," by Li Yongsen, an economist at Renmin University of China. "The central bank has to release new money to mop up the excess US dollars in the marketplace and enforce a floating band for the renminbi, which is driving up money supply growth," he said. So we ask again. How can there be negligible money supply growth in the US and 2-3% inflation, when China, a country with a pegged currency to the $US, is experiencing money supply growth in the mid-teens and 6.5% inflation in December?The answer should be obvious.That is what the continued rise in the $US prices for precious metals and commodities is telling us."
FXStreet.com wrote on 31 July 2008:
SINGAPORE (Thomson Financial) - Singapore's broad money supply, or M3, rose 7.9 percent to S$325.08 billion ($239 billion) in June from a year ago, data from the Monetary Authority of Singapore showed on Thursday.
M2 edged up to S$315.70 billion from S$293.61 billion a year earlier.
Prices are dependent on two things. Supply and demand and the value of money. We have often think of prices only in terms of supply and demand. If demand exceeds supply, then the prices will go up. What we have often not looked at is the value of money. There is $X amount of money in the world available to buy $Y amount of assets whether it is gold, stocks, properties or bonds. Over time , on an average basis Y must equal to X. Of course there are different asset classes within Y which may move in the opposite directions but over the long run, when we look at prices over one or two decades, then Y generally follows X. Let us take gold as an example. There is the supply and demand issues. On the demand side gold is bought mainly as jewelry with some industrial uses but mainly it is kept by Central Banks and investors as a store of value. Due to its limited supply, gold tends to hold its value better.
As more and more money is being created, then the price of gold goes up , not because there is a great demand but because there is simply too much money chasing after too little gold. Now gold is not an interest bearing investment and so when stocks and properties are going up, few would want to hold gold. Still over ten to twenty years, gold will show its ability as a store of value. Let's look at how gold retain its value over the past ten and twenty years
In September 1998, gold was selling at US$300 per ounce. today it has dropped to US$763. That is an annual increase of 9.78%. However based on money supply growth ,here is what gold prices should be:
1.If it follows a 16% increase ( see quote on China),: US$1,323.
2. If it follows a 11.5% increase (EU) :US$890
3.If it follows a 20% increase ( my guess for USA): US$1,857
Based on money supply growth rates, gold should be valued from US$890 to US$1857.
Let us go back twenty years to 1988. Gold is priced at US$485. Based on today's price of US$763, that is an annual increase of a miserly 2.29%. Assume different average growth rates in the money supply will show that gold is indeed undervalued:
1. 5% growth in money supply, gold should be US$1,286
2. 7.5% growth in money supply, gold should be US$2,060
3. 10% growth in money supply, gold should be US$3,262.
The recent drop in the price of gold is due to a recent contraction in the money supply and other factors described below.
The Telegraph on 19 August 2008 wrote:
"The US money supply has experienced the sharpest contraction in modern history, heightening the risk of a Wall Street crunch and a severe economic slowdown in coming months.Data compiled by Lombard Street Research shows that the M3 ''broad money" aggregates fell by almost $50bn (£26.8bn) in July, the biggest one-month fall since modern records began in 1959. "
This $50billion is a drop in the bucket compared to the amount of funds available world wide for investments. The drop in commodities and equities is most probably caused by hedge funds liquidating their positions probably due to the credit crunch, the sudden contraction in money supply and a herd mindset. The hedge funds managers that want to bet on commodities going up may not be able to borrow to leverage their positions. The sudden contraction in money supply reduces the ability of fund managers to increase their leverage which means if a large investor shorts or sell, the other investors are less able to balance them out.
Wall Street Journal on 9 September 2008 wrote:
“Hedge funds have delivered their portfolios and become defensive, and are now sitting on a lot of cash,” says Mary Ann Bartels, chief U.S. market analyst at Merrill Lyncht Journal Macro-oriented hedge funds, those that invest across a number of sectors and asset classes, were hit particularly hard in August, a result of weakness in widely-held technology shares and resource stocks.
The $155 billion in cash is equivalent to about 8% of hedge fund assets, according to Ms. Bartels, a bullish signal, for hedge-fund managers do not tend to stay in cash for long. With seasonal factors soon turning in favor of stocks (the last three months of the year are generally among the strongest for equities), investors aren’t likely to remain on the sidelines for long. “They’re going to want to participate to boost their numbers,” Ms. Bartels says.
The Wall Street Journal Market Watch on 29 August 2008 wrote:
"Three unidentified U.S. banks held 86,398 short positions, or bets that gold prices will fall, in the COMEX gold market as of Aug. 5 -- 10 times more short positions than a month earlier, a government report showed.The report by the Commodity Futures Trading Commission, which regulates U.S. futures markets, also showed short positions held by three U.S. banks in silver futures had increased more than four times during the same period." The data in the bank participation report is so clear and compelling that it is hard to conclude anything but manipulation," said Theodore Butler, a precious metals analyst, in a note.
The sudden jump in short positions coincided with a slide in silver and gold prices, which fell $12.30 an ounce in July and another $89.20 in August, their biggest monthly loss since at least 1984, according to Factset. Silver has slumped more than $4 an ounce in August, also the biggest since 1984. As for the banks involved in the recent short selling of gold, they are only market makers, taking orders from large money players, such as hedge funds, said Jeffery Christian, founder of commodities research firm CPM Group. "What you have here is the footprints of hedge funds exiting the commodities markets en masse," said Kitco's Nadler.
Bullion Vault on 14 August 2008 wrote:
IN THE WEEK ENDING the 25th of July, a decrease of €578 million in "gold and gold receivables" – reported by the European Central Bank – reflected the sale by two Eurosystem central banks roughly equal to the sale of just over 30 tonnes of gold, notes Julian Phillips of the Gold Forecaster.
The above articles seem to indicate that the drop in gold prices are caused by hedge funds exiting their positions and Central Banks selling of part of their gold reserves coupled with a contraction in money supply. But these are short term events and eventually $X and $Y has to come to some form of equilibrium. THE PRICE OF GOLD WILL BE DETERMINED BY ITS ABILITY TO HOLD ITS VALUE AGAINST PAPER CURRENCIES.
If the US dollar reverts to his previous exchange rate at the beginning of the year, gold will rise to US$806 based on this devaluation of the US dollar alone. However if the money supply growth over the decade is factor in, gold could easily exceed the US$1,000 mark. With the current Federal Deficit in the US , the poor performance of its economy, the large household debts, the depreciation of the US dollar is inevitable.
How do we make sense of the sudden strengthening of the US dollar and the drop in commodities and in particular gold prices? This article tries to give some logic as to how the long term price of gold is being derived. We will first look at the growth in money supply. How much money is being created out of thin air year after year? I am still amazed that some friends still think that Governments cannot create "fiat" money and that any money created have to be backed by gold. This was abandoned since the early 1970s and Central Banks have the power ot create money at will. So let us look at what some journalists say about this money suppy growth.
This was reported in the Economic Times on 12 Septembr 2008:
BEIJING: China's broad measure of money supply rose 16 per cent year-on-year at the end of August, level with the government's annual target, the central bank said on Friday. Here is an excerpt from the Press Release of the European Central Bank on 27 Feb 2008:The annual rate of growth of M3 stood at 11.5% in January 2008, compared with 11.6% in December 2007.
China has pegged its currency to the US dollar which means that as the US expands its money supply, China has to follow suit. The increase in China's money suppy gives us an indication of the US money supply as well as described in the article below:
Financial Senses University wrote on 28 Feb 2008:
In a story published in July, 2006 by the China Daily newspaper titled “Money supply growth unlikely to slow” we were told that, "the ballooning forex reserve is a major factor behind the dynamic growth of the money supply," by Li Yongsen, an economist at Renmin University of China. "The central bank has to release new money to mop up the excess US dollars in the marketplace and enforce a floating band for the renminbi, which is driving up money supply growth," he said. So we ask again. How can there be negligible money supply growth in the US and 2-3% inflation, when China, a country with a pegged currency to the $US, is experiencing money supply growth in the mid-teens and 6.5% inflation in December?The answer should be obvious.That is what the continued rise in the $US prices for precious metals and commodities is telling us."
FXStreet.com wrote on 31 July 2008:
SINGAPORE (Thomson Financial) - Singapore's broad money supply, or M3, rose 7.9 percent to S$325.08 billion ($239 billion) in June from a year ago, data from the Monetary Authority of Singapore showed on Thursday.
M2 edged up to S$315.70 billion from S$293.61 billion a year earlier.
Prices are dependent on two things. Supply and demand and the value of money. We have often think of prices only in terms of supply and demand. If demand exceeds supply, then the prices will go up. What we have often not looked at is the value of money. There is $X amount of money in the world available to buy $Y amount of assets whether it is gold, stocks, properties or bonds. Over time , on an average basis Y must equal to X. Of course there are different asset classes within Y which may move in the opposite directions but over the long run, when we look at prices over one or two decades, then Y generally follows X. Let us take gold as an example. There is the supply and demand issues. On the demand side gold is bought mainly as jewelry with some industrial uses but mainly it is kept by Central Banks and investors as a store of value. Due to its limited supply, gold tends to hold its value better.
As more and more money is being created, then the price of gold goes up , not because there is a great demand but because there is simply too much money chasing after too little gold. Now gold is not an interest bearing investment and so when stocks and properties are going up, few would want to hold gold. Still over ten to twenty years, gold will show its ability as a store of value. Let's look at how gold retain its value over the past ten and twenty years
In September 1998, gold was selling at US$300 per ounce. today it has dropped to US$763. That is an annual increase of 9.78%. However based on money supply growth ,here is what gold prices should be:
1.If it follows a 16% increase ( see quote on China),: US$1,323.
2. If it follows a 11.5% increase (EU) :US$890
3.If it follows a 20% increase ( my guess for USA): US$1,857
Based on money supply growth rates, gold should be valued from US$890 to US$1857.
Let us go back twenty years to 1988. Gold is priced at US$485. Based on today's price of US$763, that is an annual increase of a miserly 2.29%. Assume different average growth rates in the money supply will show that gold is indeed undervalued:
1. 5% growth in money supply, gold should be US$1,286
2. 7.5% growth in money supply, gold should be US$2,060
3. 10% growth in money supply, gold should be US$3,262.
The recent drop in the price of gold is due to a recent contraction in the money supply and other factors described below.
The Telegraph on 19 August 2008 wrote:
"The US money supply has experienced the sharpest contraction in modern history, heightening the risk of a Wall Street crunch and a severe economic slowdown in coming months.Data compiled by Lombard Street Research shows that the M3 ''broad money" aggregates fell by almost $50bn (£26.8bn) in July, the biggest one-month fall since modern records began in 1959. "
This $50billion is a drop in the bucket compared to the amount of funds available world wide for investments. The drop in commodities and equities is most probably caused by hedge funds liquidating their positions probably due to the credit crunch, the sudden contraction in money supply and a herd mindset. The hedge funds managers that want to bet on commodities going up may not be able to borrow to leverage their positions. The sudden contraction in money supply reduces the ability of fund managers to increase their leverage which means if a large investor shorts or sell, the other investors are less able to balance them out.
Wall Street Journal on 9 September 2008 wrote:
“Hedge funds have delivered their portfolios and become defensive, and are now sitting on a lot of cash,” says Mary Ann Bartels, chief U.S. market analyst at Merrill Lyncht Journal Macro-oriented hedge funds, those that invest across a number of sectors and asset classes, were hit particularly hard in August, a result of weakness in widely-held technology shares and resource stocks.
The $155 billion in cash is equivalent to about 8% of hedge fund assets, according to Ms. Bartels, a bullish signal, for hedge-fund managers do not tend to stay in cash for long. With seasonal factors soon turning in favor of stocks (the last three months of the year are generally among the strongest for equities), investors aren’t likely to remain on the sidelines for long. “They’re going to want to participate to boost their numbers,” Ms. Bartels says.
The Wall Street Journal Market Watch on 29 August 2008 wrote:
"Three unidentified U.S. banks held 86,398 short positions, or bets that gold prices will fall, in the COMEX gold market as of Aug. 5 -- 10 times more short positions than a month earlier, a government report showed.The report by the Commodity Futures Trading Commission, which regulates U.S. futures markets, also showed short positions held by three U.S. banks in silver futures had increased more than four times during the same period." The data in the bank participation report is so clear and compelling that it is hard to conclude anything but manipulation," said Theodore Butler, a precious metals analyst, in a note.
The sudden jump in short positions coincided with a slide in silver and gold prices, which fell $12.30 an ounce in July and another $89.20 in August, their biggest monthly loss since at least 1984, according to Factset. Silver has slumped more than $4 an ounce in August, also the biggest since 1984. As for the banks involved in the recent short selling of gold, they are only market makers, taking orders from large money players, such as hedge funds, said Jeffery Christian, founder of commodities research firm CPM Group. "What you have here is the footprints of hedge funds exiting the commodities markets en masse," said Kitco's Nadler.
Bullion Vault on 14 August 2008 wrote:
IN THE WEEK ENDING the 25th of July, a decrease of €578 million in "gold and gold receivables" – reported by the European Central Bank – reflected the sale by two Eurosystem central banks roughly equal to the sale of just over 30 tonnes of gold, notes Julian Phillips of the Gold Forecaster.
The above articles seem to indicate that the drop in gold prices are caused by hedge funds exiting their positions and Central Banks selling of part of their gold reserves coupled with a contraction in money supply. But these are short term events and eventually $X and $Y has to come to some form of equilibrium. THE PRICE OF GOLD WILL BE DETERMINED BY ITS ABILITY TO HOLD ITS VALUE AGAINST PAPER CURRENCIES.
If the US dollar reverts to his previous exchange rate at the beginning of the year, gold will rise to US$806 based on this devaluation of the US dollar alone. However if the money supply growth over the decade is factor in, gold could easily exceed the US$1,000 mark. With the current Federal Deficit in the US , the poor performance of its economy, the large household debts, the depreciation of the US dollar is inevitable.
Thursday, July 24, 2008
Gold has reached its fair value
Gold is a store of money and so is paper money. The one exception is that gold has a limited supply while money can be created at will. Many people still think that money is somehow pegged to gold and that Government must have some gold to back up their currency. No the gold peg was removed decades ago and money can now be created almost at will. The key to the possibility of gold reaching US$2000 per ounce is dependent on how much money has been created.
On March 23, 2006, the US Government stopped publishing the M3 money supply data. A reason for doing so is that it wants to hide the amount of money it is creating . The rate at which this M3 money supply increases annually could raneg from a low of 6% to a high of 9%. This means the value of money will decrease. Using the rule of 72, this means the value of the US dollar will drop by half in 12 years using a 6% increase in money supply or just 8 years if we use the higher 9% figure. Thus when gold hits the US$2000 level, it is not that gold prices have risen but that dollar has devalued.
The well known US trade deficit has hit the US$800 billion level which means they buy more than what they exported. We do not know how this trade deficit is computed and whether services are excluded or not. A printer may be made by Hewlett Packard in China and exported back to the USA creating a deficit . But profits made by Hewlett Packard worldwide will be used to pay for the cost of its staff in the US and so this sort of offset the trade deficit. Assuming that somehow three quarters of the trade deficit somehow returns to the US, it leaves an annual deficit of US$200 billion.
But this is part of the overall debt. The Federal , State and Cities in the USA has substantial debts as well. The Federal Debt at at 25 July 2008 is US$9,528 billion dollars. At a 4% interest rate, it has to pay $240 billion just in interest alone each year! This Federal Debt is growing at the rate of $1 million a minute. Scary though it sounds, the pciture can get worse.According to the Institute of Truth in Accounting, the true federal debt is $55,146 billion of off balnce sheet items are included such as Social Security and Medicare. These are "promises" that have to be fulfil in the coming years!
All the increase in money supply goes to fund these debts. When someone incurs a debt, it also mean the other party has money to spend. When the US Government incurs a debt, its employees would be paid and hence have money to spend. When the US Government spends on buying military hardware, defence contractors make a pile and this money goes to its employees and shareholders. So as the US Government goes on a borrowing spree, everyone is happy and the party continues. The question is when will this party end?
Amazingly even more debt is created by the past housing boom fueled by easy credit .These housing mortages are the no questions asked, 100% loans called subprime mortgages. The two institutions that provide mortgage guarantees , Freddie Mac and Fannie Mae, have provided $4.8 trillion worth of mortage guarantees. They owned half the housing mortgage which puts the total US housing mortgage at $10 trillion. The loans benefited housing contractors, real estate agents, interior decorators, furniture and appliance suppliers and a whole gamut of businesses that benefitted from a housing boom! Now all these money spent and earned have to be repaid, somehow.
US Government may step in to bail out Freddie Mac and Fannie Mae but where does it gets the funds from? It is already in deficit which means it either prints more money, borrow more or do both. The end result is the same, an increase in money supply which will cause the US dollar to devalue over time and increases the price of gold! The price of gold in US dollars is meaningless and perhaps more meaningful to compare it with say a house.
In 1970, a terrace house in Singapore can be bought for S$70,000 and gold prices was US$35 per ounce . Based on an exchange rate of $1.8, the terrace house would cost 1,111 ounces of gold. Today the same terrace house cost $1.2 million and gold is at US$930 an ounce with an exchange rate of 1.36. The cost of the same house in gold is 945 ounces. Thus we see that based on gold prices, the cost of the house has indeed dropped rather than increase! Based on this analogy, we see that gold at US$930 per ounce has reached its fair value based on current exchange rate and property prices in Singapore.
Thursday, June 26, 2008
What on earth is CDS?
Many people are anxious whether the sub prime mortgage issue is over. Have all the banks written off their bad debts due to the sub prime mortgages. But the question is partially irrelevant because that is not the only issue facing the financial markets. Credit Default Swaps or CDS is a massive US$62 trillion dollar market.
Subprime is about MBS or mortgage backed securities but how much CDS based on MBS has been issued? More curious is who are holding these MBS? In the following weeks, we may hear more about CDS and CDS may be as familiar a term as subprime. So hold on tight, the financial tsunami is on its way
Credit Default Swaps is like an insurance policy, used by debt owners to hedge, or insure, against a default on a debt. There is no assets or collateral involved and hence it can be speculative.Warren Buffett once described derivatives bought speculatively as "financial weapons of mass destruction." In his Berkshire Hathaway annual report to shareholders he said, "Unless derivatives contracts are collateralized or guaranteed, their ultimate value depends on the creditworthiness of the counterparties. In the meantime, though, before a contract is settled, the counterparties record profits and losses -- often huge in amount -- in their current earnings statements without so much as a penny changing hands.
The CDS market is said to be more than $45 trillion in mid-2007, according to the International Swaps and Derivatives Association and is far larger than the size of the U.S. stock market (which is valued at about $22 trillion and falling) , the $7.1 trillion mortgage market and the $4.4 trillion U.S. treasuries market according to Harvey Miller, senior partner at Weil, Gotshal & Manges. The effect of CDS's collapse would be even lower liquidity and signals the end of low interest rates. The higher interest rate would have serious impact on an already declining US economy.
CDS is an unregulated market and is used by banks to cover losses when companies fail to repay their loans. If CDS are priced low, then the bank can afford to lend relatively "risk free" at lower interest rates. Without CDS or higher priced CDS, banks would need a higher interest rate to cover the potential loss on a loan. With a slowing economy, risk to loans will increase and with problems from past CDS issued, banks may be very reluctant to lend with collaterals.Subprime is about MBS or mortgage backed securities but how much CDS based on MBS has been issued? More curious is who are holding these MBS? In the following weeks, we may hear more about CDS and CDS may be as familiar a term as subprime. So hold on tight, the financial tsunami is on its way
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