Jack Worthington's Social & Investment Commentaries

RE: Greece & China

Posted in Investment & Social Commentaries by Jack Worthington on July 8, 2015

Publishing client note…

RE: Greece & China

XXXX – IMO, these two current crises are important, uncommon catalyst events that are likely to have a significant impact on the near to 10+ year global economic outlook…and obviously commodity prices including oil.

Greece:

  • If populist anti-austerity forces prevail in some significant way…if successful in bending the global financial community to their demands…contagion into other emerging markets is likely…a mindset is changed as the stigmas related to default and capital controls are weakened…an irrational, populist “revolutionary” mindset takes over; i.e. the torch and pitchfork crowd gains their voice…”hell no, we won’t pay”. In fact, the Latin Americans have been one of the loudest cheering squads for the Greek “No” vote.
  • Free global mobility of investment capital is not an immutable law of economics…the general absence of capital controls is a relatively recent development in economic history which gained significant momentum in Reagan years. Positive:  Foreign direct investment in the forms of capital and portfolio flows from developed to developing world over the past 30 years, allocated somewhat efficiently, has driven a remarkable improvement in developing world living standards (people moved from the rice paddy to a desk job and car ownership) and general economic prosperity globally.  Negative: A lack of capital controls in a developing economy has significant risks…asset bubbles are created on the way in as large amounts of capital are invested in small markets…and those asset bubbles can be popped spectacularly and sometimes overnight, when spooked foreign securities investors bolt for the door…leaving carnage in their wake.  With the past few econ crises since the 1990’s, capital controls, especially in developing world, are gaining acceptance again and will find their way back into the global economy in some form…guaranteed…it’s coming…just a matter of when, not if.  This is a meaningful and high impact sentiment tide change in recent economic history.  A trivial example of how things used to be…long forgotten: apparently, in the 1960’s Brits were not allowed to take more than £50 out of the country for their vacations.
  • Practical implications: 1) When implemented, capital controls (in various forms) and, or a perceived increase in developing economy investment risk, will reduce the amount of FDI going into developing economies…whose economic growth (and demand for commodities) will slow…yes, they are shooting themselves in the foot…oil, iron ore, copper, etc… down.  2) World equity markets headed into a down cycle.  Equities are technically valued as the net present value of future growth opportunities “NPVGO”; i.e. when future growth opportunities are reduced, the stock price is automatically reduced.  Many of the world’s largest companies have transitioned into truly global organisations, selling products to customers, and investing in production capacity, globally.  When their NPVGO is reduced, their stock price is automatically going down.
  • This scenario is likely to gain steam in the near term. I’ve lived through so many crises over my career (as an expat local in the foreign meltdown economy) that the definition of “near term” could mean anything from beginning today, up to roughly 3 years at outside.  I’ve seen these things explode quickly (Asia) and fester as money slowly drains out (France).  Social unrest in these “back to the rice paddy” scenarios can be explosive and violent…been there, seen that.  At some point, it’s possible that general emerging market disease contagion returns again; i.e. how the localised Mexican Peso crisis of 1994 quickly spread to global EM’s including China.  This Greek crisis has that potential.

China:

  • The stock market collapse in China is a unique situation. We can’t look at it in the same way as we do a US or European stock market collapse.  In China, 85% of market participants are unsophisticated, individual, ordinary folk gamblers who move in herd lockstep.  Panic sets in…unsophisticated gamblers sell everything…greed returns…unsophisticated gamblers buy everything.  Boom-bust built into the system.  In contrast, the US market is driven by a very large number of highly sophisticated and informed professional investors, managing a very broad range of investment strategies.  Less boom-bust built into the system…outside of program trading / fat fingers, etc…!  Let’s keep it there for a minute and not complicate the discussion!
  • One of China’s top strategic national priorities is to make the RMB a global reserve currency. To do this, the capital account must be opened to at least the level of the US, where FDI flows rather freely in and out…and a very wide range of investment products and opportunities are available to park your RMB…both within and outside China.  This, in combination with fundamental demand for RMB for global trading purposes, is what will underpin the RMB as an important world reserve currency.  China does not have these fundamentals in place, but is somewhat aggressively trying to move into that direction…but fearful of the negative effects brought by a lack of capital controls.
  • When/if the RMB becomes a competitive world reserve currency, demand for RMB will be at the primary expense of US$. The US$ is now sitting on top of the hill (maximum, and hugely significant benefits currently accruing to US citizens)…when/if RMB ascends, US$ will move to some place further down the hill (significant standard of living benefits transferred from individual American citizens to Chinese citizens).
  • IMO, the Chinese will not allow the Greek contagion mentioned above to impede progress on one of its key national priority interests…to improve the standard of living for ordinary Chinese citizens by gaining reserve currency benefits. IMO, I believe the Chinese will buck the trend on capital controls, and continue if not accelerate financial market liberalisation.  The Chinese need to continue their efforts to attract sophisticated, professional, foreign market participants to help exert guiding influence in their equity markets…reducing the local “gambler” effect.
  • IMO, to have a grasp on the world’s economic and geopolitical future, it’s important to know what the ruling powers of China plan for their own future and place in the world. Fortunately, Xi Jinping gives us that outline in his book “The Governance of China”, available in English, and written for our benefit.  Repetitive and not well-translated…it’s still very helpful.  A good roadmap, written by the leader of the long-term power structure guiding the world’s #1/#2 economy…and rising.
  • IMO, the Chinese gov’t needs to allow the market bloodbath to take place, and animal spirits to re-enter at their natural pace, with minimal gov’t intervention. Their gamblers will be back in full force soon enough if the gov’t doesn’t spook them w/ overly interventionist policies.

Summary:

De-risk short term, with a long-term China bet.

JW

NY, NY

8 Jul 2015

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