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In God We Trust But Not The Dollar - Rs - Issue II - 26Sep07


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In God We Trust But Not The Dollar - Rs - Issue II - 26Sep07

  1. 1. 2007 alternative investments in the world’s fastest growing markets In God We Trust, But Not The Dollar Roman Scott Managing Director Calamander Group Economic Spokesman British Chamber of Commerce Singapore Issue II 26 September 2007 Calamander Capital Economic Outlook, Q3 2007
  2. 2. 26 September 2007 In God We Trust, but Not the Dollar R eaders will be happy to hear that the ongoing CDO or US sub-prime debt crisis is not to be the exclusive focus of this quarter’s musings. The purpose of this column is strategic, and the focus what I believe to be medium to long-term fundamental economic trends that will broadly shape risk and returns. Readers can wallow in current market news all day on Bloomberg and CNBC, and wallowing they have been as the last two months crisis has unfolded. That said, given that it now does appear that the CDO crisis is beginning to have an impact on the broader economy and the medium term, I will indulge in a few impolite words on the affair. For all the foolish chatter by young analysts about an ‘unprecedented’ meltdown, this was re-run of a regular occurrence in the banking industry: that of a cycle of extremely poor credit decisions by professional lenders, in this case matched by extremely poor investment decisions by professional investors. Common in the emerging markets, that this happened in the world’s richest and most developed economy in the era of sophisticated Basle II credit risk standards speaks volumes about the triumph of hubris in American ‘sell or die’ business practices. Many professionals appear to have forgotten, or simply didn’t know, that these events happen somewhere in the world as regularly as a really decent British summer (once in five years?). Indeed, they are regular enough to keep some people in almost permanent employment cleaning them up, myself included. Of course twenty years of doing that is enough to drive anyone insane, which is why I now write columns for ‘The Orient’ and continue to keep company with dodgy bankers from badly run banks that we tried either to shut down or have them taken over during their credit collapse ten years ago. It was called the “Asian Financial Crisis’ and at the time I recall it was the US and the US driven IMF that were the most vocal in calling for the prosecution of those responsible, and correctly so. I look forward to seeing the US pursue the same policy on their home soil ten years later. There is one difference this time around. In the good old days of the traditional bank crises, i.e. reckless lending to those with no ability, or intention, to ever pay back, the bank suffered the consequences. Now that we have the fabulous invention of a structured market with a cool name to pass on such stupidity to even more foolish investors, it becomes a market crisis instead. After all, why blow up a bank and your grandma’s deposits when you can blow up your grandma’s pension fund instead? The only flaw in the supposed advantage of derivatives like CDO’s to spread risk far and wide to a broader market is that the appetite for such risks, and those with the balance sheets to buy it, appear to have been, well, more banks. Surprise! Of course, most of the world’s major hedge fund joined in, but as we all know most hedge funds don’t really know anything about anything. The surprise was that the very large, sophisticated, banks with top quality credit risk management one would have expected never to have written these risks themselves were only to happy to buy such poor quality risk written by lenders with no standards. As usual, Wall Street got paid handsomely for the privilege for selling garbage dressed up- tech stocks yesterday, CDO’s today. Even worse, nobody ends up know quite who actually owns this junk-it may well be your grandma-or who the end risk is. Call me old fashioned, but at least in the old model the bankers vaguely knew who they were lending to, the sort of risks they were taking, and even, dare I say it, the quality of Economic Outlook Q2, 2008 Page 2
  3. 3. 26 September 2007 the people and the neighborhoods they lived in. For all the ink spilled on the case I have only seen one banker, Deutsche Bank’s CEO Ackermann, call it what it really is, gross negligence by the management of those banks or investors involved. This is a case of lending that targeted the naïve and the vulnerable, sold by the incompetent or fraudulent, repackaged by the unscrupulous, and bought by the foolish. The ratings agencies went along for the ride and the regulators appeared asleep at the wheel. “Nough” said, as they say in British sub-prime land. We will be exploring further the economic impact of the crisis on Asian economies in detail at the next BCOC Economic Briefing Breakfast on October 25th with Manu Baskaran, chief economist from the Centennial Group. But in summary, I see no reason for undue pessimism on the broad economy outside the US. The US has been slowing for at least four quarters. While problems in the housing sector appear to be amplifying this trend and hurting the American consumer, the damage to the 13 trillion dollar US economy is containable. Corporate balance sheets, profits and debt levels remain in good shape. Too much is made of the level of export dependency of Asia on the US, and some pain over the next six months will not derail the largest, consumer based Asian countries- China, India, Indonesia. Medium term, I maintain my long held bullish view on both Asia broadly and the ASEAN economies (see last issue of ‘The Orient’), as well as Asian currencies. Other than some tech exporters, and employees of the wrong banks, I do not believe you should be unduly worried. Given my focus on long term fundamental trends with the background of the sorry tale of US sub prime, this seems an appropriate time to revisit my favourite worry, the greenback. Regular followers of the “breakfast’ series will recall my long held nervousness about the US dollar, and recommendations from late 2002 onwards to short the USD and hold assets in Euros, CHF or Asian units. I have not voluntarily held a US dollar, other than as a short, for over four years. However, as the chart shows (chart 1), consistent dollar bears have often been in the wrong, particularly versus the Yen. From March 2002, Yen did strengthen through to March 2005 with the recovery in the Japanese economy, but then turned negative again. Within a year the Dollar was back to 120 Yen and has range traded ever since until recent events. The Yen remains the most undervalued major currency. The Euro has followed the script better, although again from March 2005 it gave back some of its gains and only reverted to strength against the dollar from May last year. It took until this month to break past its December 2004 peak of 0.733 USD/EUR. Economic Outlook Q2, 2008 Page 3
  4. 4. 26 September 2007 The core of the bear argument has always been an economic fundamentalist view that goes like this: US debt levels are unsustainably high and continuing to grow at an alarming rate; this debt has to be externally financed demanding high relative yields, US interest rates and the level of the dollar are supported by dollar demand via external financing, principally by Asian nations retaining dollars in trade and purchasing dollar debt; and that in doing so these nations maintain lower yields and weaker currencies than their economic fundamentals would otherwise suggest. At the time of our first ‘dollar worries’ chart on this in late 2002, US debt levels were 600 billion dollars (remember that in the mid nineties the US had almost no debt). That level has now surpassed 900 billion and is approaching a trillion. A decade ago Asian nations held one third of global reserves. Now they hold two thirds, mostly in dollars. The core of the argument for the dollars bears such as myself has always been that such a cozy arrangement eventually would have to slow and revert to norm, and that with the purchase of dollars on this magnitude even a slowdown of buying would depress the currency in the process. For dollar bulls, their argument has been that if Asian and other nations continue to believe in the perpetual cycle of US economic strength and dollar dominance, the attractiveness of US assets, and the exporting advantages of maintaining relatively weaker currencies; then there is no reason at all why the party should ever end. Asia will continue to export to the US consumer, and simply recycle the dollars back by building dollar reserves and buying US debt. For a long while it seemed as if Dollar bulls were right and a sort of perpetual motion had been buildtup with the understanding of all parties that this was the game. Capital saving countries, read Economic Outlook Q2, 2008 Page 4
  5. 5. 26 September 2007 Asia, have continued until recently to buy and hold US dollars at an unprecedented rate. But all parties eventually come to an end. I believe that that we may be finally seeing the beginning of the end-a long awaited, slow decline of an aged warhorse, just as sterling gracefully declined a generation ago. Of course, the dollar has some uses, which I am sure will continue. I do admit that a wad of dollars has no equivalent for bell boys, and visas-on-arrival in Asian airports. For buying oil, and weapons, dollars remain the cash of choice, as I hear it is for the drug trade and other interesting segments of the cash economy. But even that may change over time. If the greenback remains on my short list (excuse the pun), what then is our currency of choice? Of course, if you are a speculator, going long the Asian units undervalued on a purchasing power parity basis makes sense- particularly the Yen, the Ringgit, and the Won. But as economic fundamentalists we do not believe in currency speculation, despite the modern trend to call it an asset class (an idea I dislike as much as credit derivatives). What an investor in real assets needs is a currency that provides all of the upside potential of the Asian economic growth story, with stability and smart management against extreme volatility. The ideal would be a balanced currency basket of a weighted proportion of the best of those currencies, continually managed and adjusted relative to macro economic movements. There is such a basket. Even better, it is managed by some very bright folks who charge nothing for the service. It is called the Singapore dollar, and it remains our investment holding currency of choice. A picture speaks a thousand words… Economic Outlook Q2, 2008 Page 5
  6. 6. 26 September 2007 Global Disclaimer This research note and/or opinion paper, article, or analysis has been released by Calamander Capital (Singapore) Pte Ltd., or its parent company or affiliates, to professional investors, clients, and business members of the British Chamber of Commerce for information only, and its accuracy/completeness is not guaranteed. All opinions may change without notice. The opinions expressed, unless stated otherwise, are not investment recommendations, or an offer or solicitation to buy/sell any funds, investments or other services of the Calamander Group, Calamander Capital, or its affiliates. Calamander Capital does not accept any liability arising from the use of this communication. Copyright © 2008 Calamander Capital. All rights reserved. Intended for recipient only and not for further distribution without the consent of Calamander Capital Pte Ltd For further details, please contact calamander capital (singapore) pte ltd (co. reg. no. 200723396M) MAS exempted fund manager 85 a/b circular road, singapore 049437 tel. +65 6723 8129 fax. +65 6491 1227 Economic Outlook Q2, 2008 Page 6
  7. 7. 26 September 2007 alternative investments in the world’s fastest growing markets singapore property fund II sri lanka private equity fund meridian emerging market art fund the wine growth fund asia emerging banking fund calamander capital (singapore) private limited 85 a/b circular road calamander capital management limited (cayman) singapore 049347 calamander group (singapore) private limited tel. +65 6723 8129 meridian art partners, llc fax. +65 6491 1227 Economic Outlook Q2, 2008 Page 7