The China Vortex

This is pretty self-explanatory.

Investors who bought notes due February 2018 on March 17, just after the Fed helped arrange the bailout of Bear Stearns Cos., have lost 6.2 percent, according to Bloomberg data.

The 10-year note, at 4.25 percent, yields no more than the inflation rate, leaving investors with real returns near zero. Consumer prices have exceeded 10-year yields by an average of 36 basis points since December, Bloomberg data show. In 1980, inflation reached a 33-year high of 14.8 percent and yields averaged 11.4 percent.

`Out of the Bottle’

Yields on 10-year notes had dropped to an almost five-year low of 3.28 percent on March 17, after the Fed cut the discount rate at an emergency weekend meeting and backed JPMorgan Chase & Co.’s deal to buy Bear Stearns Cos. Rates on three-month bills plunged to 0.39 percent, the lowest since the 1950s, the same day as investors sought the safety of the shortest maturity government debt.

Consumer prices advanced 4.2 percent in May from a year earlier, the Labor Department said June 13. The rate was above the median forecast of 3.9 percent in a Bloomberg survey of economists, and the highest since January.
Economists at New York-based Morgan Stanley say inflation will reach 5 percent to 5.5 percent this summer, the highest since 1991.

“The global inflation genie is out of the bottle,’’ Morgan Stanley analysts led by Joachim Fels, co-head of global economics, said in a June 11 report. Even if the pace moderates in coming months, “we are likely to see higher average inflation rates,’’ they said. Inflation averaged 3.1 percent during the past two decades.
`Unsustainable Levels’

Inflation is also eliminating the rewards of owning U.S. stocks. Standard & Poor’s 500 Index shares yield 0.2 percentage point more in profits than the interest on 10-year notes, the smallest advantage since 2004, data compiled by Bloomberg show. The last time corporate earnings returned less than bonds, the index posted its biggest monthly decline in five years.

“What did you say? You wanted us to buy more US assets?”

Oh, and I forgot to mention, this is in straight dollar terms only. You need to also figure in how much the US dollar is going to depreciate against other currencies in the coming ten years.

“Ouch!”

I wonder how the Chinese government is going to explain this to Chinese citizens, since it is their official responsibility to protect Chinese investments and assets? And that the situation, particularly re inflation, is going to get much worse before it gets better?

And it really doesn’t matter who becomes US president either, at least with regard to this set of issues.

Not even a US president can do anything about this.

JP Morgan Chase has just purchased Bear Stearns at $2 a share, an investment bank which was valued at $150 a year last year. Equity and capital markets are poised for a volatile week. The US Fed is set to make another rate cut, a desperation move, on Tuesday. This is likely to push the US dollar into free-fall, and set the stage for inflation in the US and later worldwide. More and more companies and individuals will choose to distance themselves from the US dollar.

Some time ago, I talked about why globalization, at least in its current form, would fail. Globalization has been oversold, especially in the US, where it was seen as leading to some growing kumbaya world where everyone just got along. That is not happening, and will not happen.

There is a strange resemblance between the way globalization was sold and the way real-estate was sold up until last year in the US. Up until 2007, Americans were told that real-estate prices would never go down, they only leveled off in bad times. When the bad times passed, then real-estate prices would climb again. Globalization was sold the same way.

It didn’t matter if American factories were relocated to China because Americans would find something else to do which would add greater value-added. Guess what? Americans haven’t found where that new value-added is, which in turn is leading to higher unemployment, and a generally angry population. We will see how their anger is channeled when the November elections come up.

In the meantime, Chinese government policy, through its VAT policy, encourages local governments to set up factories which waste energy to make products with very little value-added which Americans have bought on credit. Calling this real growth is just a fantasy, to use polite language.

This is why inflation is already flowing through the Chinese economy, first with food prices, and is now working its way through the system. It is likely that the situation will become much worse, and will soon hit the Shanghai and Shenzhen bourses.

The _real_ globalization where value is _really_ created is about enabling people to work productively in different regions with little or no damage to the environment, and enabling them to use their skills in a productive manner without having to travel great distances which previously took a lot of time. But that is not simple to explain, is it?

The business valuation models for these new productivity tools do not yet exist. Ironically, the valuation models for hocus-pocus subprime-mortgages did exist. It’s just that they got turned upside-down in a short time.

So what have all the risk consultants been measuring lately? I’d say that they’ve been out to lunch. That’s why, in these times, the Chinese approach to measuring risk makes more sense.