Business Times Singapore Investment
Roundtable
Currency wars in the Year of the Snake - Will investors be bitten in 2013?
William R. Thomson
Posted Feb 14, 2013
PANELLISTS
Eisuke Sakakibara: Former vice-finance minister for international affairs of Japan
Kenneth Courtis: Former vice-chairman, Goldman Sachs (Asia) and co-founder of Themes Investment Management
Robert Lloyd-George: Chairman, Lloyd-George Investment Management, Hong Kong
Ernest Kepper: President, Asia Strategic Investment Associates, Japan
William Thomson: Chairman of Private Capital, Hong Kong; director of FinaVestment, London
MODERATOR: Anthony Rowley: Tokyo correspondent for The Business Times
THE Year of the Snake will bring “unexpected change and instability” say those who believe it is possible to divine such things and we do indeed appear to be entering uncharted waters as a sea of liquidity created by central banks plays havoc with currencies.
Some asset prices – those of equities and commodities especially – are at new heights. Bond markets are submerged. The Business Times roundtable group of international financial and economic experts look into 2013 and told us they foresee challenge and opportunity.
Rowley: A sanguine view suggests that this should be a year of continuing, if unexciting recovery in advanced economies. A safe year in short. But I don’t get the sense that everyone here is on board with that idea. Kenneth?
Courtis: The fundamental force driving markets is the coordinated and desperate action of the world’s central banks to offset powerful depressive forces released with the popping of the Bush Bubble and the contagion which resulted for the world financial system. Despite five years of an unprecedented global effort to dominate the crisis, global economic growth, employment, and world trade remain substantially below peak 2007 levels.
Financial systems and economies in OECD (Organisation for Economic Co-operation and Development) countries remain fragile, despite repeated claims of bankers and policy officials to the contrary.
With governments virtually everywhere in the developed world imposing austerity (in order to) reduce overall debt levels, the reality is that leverage has continued to increase in just about every OECD economy since the onset of the crisis. It seems that the greater the austerity, the greater has been the increase in debt levels! This equation has just become more powerful with the government in Tokyo committing to a surge in new deficit spending to dramatically increasing the levels of liquidity being injected into the system.
At the same time, the US (Fed) remains committed to increasing liquidity again this year, and the ECB (European Central Bank) and the Bank of England are on standby to do “whatever it takes”. We will continue to have a highly powerful, sustained effort by central banks to force investors to take on more and more risk.
Rowley: What does that mean for the global economy?
Courtis: With world trade flat and the weak economies of the developed world leading exporters everywhere into pressuring governments to generate more competitive currencies, we have entered into a period of competitive devaluations.
The latest to engage this futile, beggar thy neighbour policy, is Japan. Already since its peak last July, the yen is off 19 per cent versus the US dollar, and 32 per cent versus the euro.
Exports from much of the rest of Asia are now set to feel the pain of this devaluation of the yen.
We will reach a point where pressure will emerge for Europe to offset the pressures of what Japan is now doing. The US set in 2009 a target to double exports by 2015. It is hard to see that happening in a world of slow growth and aggressive competitive devaluations without the US dollar also at some point falling. So what this means is that we will see an increasingly volatile global foreign exchange market.
Rowley: You mean “currency wars”.
Kepper: Currency wars have begun and they are very serious, difficult to predict, and cannot be easily reversed. Excessive money printing is the cause.
Thomson: Much as was the case in the 1930s, everybody wants to export their way out of their problems and nobody wants a strong currency, certainly not the US dollar, the euro or the yen. It really is “beggar your neighbour” time. The Japanese are the latest to join the weak currency party.
Rowley: Professor Sakakibara – “Mr Yen” I should say – Prime Minister Shinzo Abe’s government denies that it is targeting the yen exchange rate but inflation targeting is having the same effect isn’t it?
Sakakibara: We can expect monetary policy to continue to be eased (in Japan) and a 2 per cent inflation target that is very difficult or almost impossible to achieve implies that easing will continue, and could even intensify, for a prolonged period of time. I think the yen will probably go beyond 92 or 93 to the US dollar.
I don’t think it will go beyond 100. It will probably turn around towards 85 again. We cannot continue targeting depreciation of the currency. It has already incited talk about currency wars. Monetary easing is going to continue but it will have limits in pushing currencies down.
Rowley: Which brings us to the question of where exchange rates in general will go in 2013.
Kepper: The US dollar will weaken significantly in 2013 as it is abandoned as the required currency to buy oil and as the world’s leading reserve currency.
The “petrodollar” – which was created when Opec (Organization of the Petroleum Exporting Countries) announced they would only accept US dollars in payment for oil in the 1970s – was a move of key importance as it created a demand for US dollars by requiring countries to acquire US dollars before purchasing oil and therefore allowed the US to live beyond its means by printing unlimited amounts of money at virtually no cost, to borrow excessive amounts of money at excessively low rates, and build up enormous trade and budget deficits with few adverse effects.
What it did was essentially create a 40-year secular bull market for US dollars. This is how America obtained cheap credit by issuing treasury bonds as nations who were competing to sell goods to the US began to accumulate vast stores of surplus US dollars which were lent back to the US, creating America’s unprecedented 30-year secular bull market in US bonds.
The US dollar is about to lose its importance as a reserve currency as China, Russia, India, Brazil, Venezuela, Argentina, South Africa, Malaysia, Indonesia, South Korea, and Columbia are all doing direct deals and swaps in currencies other than the US dollar.
Sakakibara: The US economy seems to be doing well so some appreciation of the US dollar against the euro and the yen may continue. The euro crisis seems to have settled down but there are a lot of problems there still.
Courtis: I see increasingly unstable currency markets ahead. The outlier in this will be the yen, which with the peak of a four-decade bull market in mid-2012, has now begun a long journey lower, a journey hastened by the country’s aggressive devaluation. I see the yen reaching 120 to the USD, if not in the Year of the Snake, then in 2014.
Kepper: The best currencies to invest in for 2013 come from Asia, South America, Australia – but not the US.
Lloyd-George: I believe the yen will fall to 100 to the US dollar and this will have a substantially positive effect on Japanese exports and the Tokyo stock market. The euro will probably not go higher than 135 and the real question in this game of competitive devaluation is who can reflate most effectively in expanding their money supply and supporting financial assets. Inflation cannot be indefinitely postponed when we consider that the monetary base in the USA may be expanding at almost 40 per cent annually at present. I would anticipate that by the end of 2013, we will see substantially higher inflation starting in some of the developing countries and eventually reaching the US and Europe.
The yuan will probably break the six yuan to the US dollar mark this year and could go higher. The rapid pace of yuan internationalisation is impressive – yuan trade settlement in Hong Kong was up 30 per cent last year.
Thomson: Yes, the Chinese are being quite expansive in increasing the use of the yuan abroad but doing it in an unconventional manner, especially through bilateral currency deals with other Asian and developing countries. They are using such swaps creatively to get around sanctions to countries such as Iran. But they are going much further using London as a centre for yuan trading. Internationalisation is well underway but their next steps and the timetable are unclear. They are being very pragmatic.
Rowley: Not exactly plain sailing in currency markets. What about bond markets. Do things look any better there?
Courtis: In the absence of inflation in most of the world economy, these policies have led predictably to a vast rally in bonds to the point where yields today no longer reflect the underlying risks in the economy. In the high yield market, spreads to top quality paper are compressed to levels never seen before. The investment implication is that 2013, unlike the last two to three years, is not going to be a stellar year for bond markets.
Indeed, debt markets are now so highly priced that any accident to the world economy, such as a spike in commodity prices, a renewed period of concern about Europe – which I think is not far away – will lead to a sell off in these markets. At the same time, any hint that growth will be even a little stronger, will also put downward pressure on bond prices.
Kepper: If you want to invest in bonds in 2013 – don’t. Bond prices cannot go higher and the interest rate cannot go lower. Inflation in America is probably 10 per cent and unemployment in the range of 25 per cent. It is hard to accept US statistics anymore. The statistics given out by the US government are no longer realistic as the Fed maintains that money printing does not cause inflation.
Prices of commodities will continue to rise in spite of economic deterioration due to lack of supply. As bond prices implode, interest rates will rise leading to severe inflation – and as foreigners stop buying US bonds, the demand for the US dollar will drop.
Thomson: Deficits are being reduced at a glacial rate but government debts can never be reduced even if the rate of growth of overall indebtedness declines. The other question is whether central banks will be able to reduce their swollen balance sheets by selling some of their debt back onto the market. That also seems a long way off.
Right now, if central banks reduced their buying programmes of government debt, the bond market would collapse and interest rates spike higher and renew the recession.
The US may attempt some gradual normalisation of its QE programme later this year or more likely in 2014 or even 2015. It will be a very challenging task and, at present, I would be sceptical of it succeeding.
Lloyd-George: I expect that by the end of 2013, 10-year bond yields in Europe and in the United States will have risen back to their historical norms of between 3 and 4 per cent. Japan will also experience a bond market bust, with yields rising to 2 per cent to 3 per cent. Even if the worst does not come to pass and yields remain low in the Global Sovereign Bond Markets, bonds are an unattractive bet with a very poor risk/reward ratio.
Rowley: What about equities – better news there?
Courtis: I see 2013 as the year of equities, just as 2012 was the year of bonds. We have already seen a strong leg-up of equity markets in the past few weeks, and with intermittent corrections, I see that trend continuing during the months ahead. With bond markets at bubble peaks, the private sector in much of the world set to remain very cautious about new investments, and households struggling on all fronts, the vast and still increasing liquidity pouring out from central banks is set to move more and more into other asset markets, in particular equities and real estate.
Markets are on the whole relatively cheap, particularly markets in Europe, China, Brazil, Russia, Japan, and much of South-east Asia. Companies have, on the whole, the wherewithal to maintain or indeed to increase dividends and to engage in significant share buybacks.
Lloyd-George: The year 2013 has started surprisingly strong and we expect at least 15 per cent appreciation this year, on the back of global liquidity. The announcement that the Basel Three Rules were being relaxed for banks to allow them to include a wider range for assets in their reserves is extremely positive and will stimulate economic growth in the eurozone, the US, and Japan.
Emerging markets will be the biggest beneficiaries of this liquidity and lending boom. Mining stocks could also benefit as they are now quite depressed, particularly gold shares, although we do not expect the bullion price to do anything very exciting this year.
This could be a year of steady progress with the debt crisis postponed into 2014. We expect that Japan will recover strongly with the depreciated yen, that the Chinese stock market will also rebound by 20 per cent to 30 per cent, and that the Asean area, after some political wobbles due to elections in Malaysia and elsewhere, will finish the year with strong growth.
As always, the contrarian investor will have the best returns as we have seen from the examples of depressed European bonds and shares, base metal mining companies, and in the agricultural sector, which we continue to believe will be a very attractive area for investments.
Thomson: Equity markets have performed very credibly in the past few months to the point where the bargains have largely gone. They are indeed being driven as much by liquidity and the search for yield as by fundamentals. The problem, of course, is government policies of financial repression and intervention in bond markets that is leading to absurdly low yields and driving cash into equities.
For the time being, I believe that cash will continue to seek quality. Any significant move into speculative issues would be a bright warning sign to beware. Japanese equities may have an even more significant rally on the back of looser monetary policy. The market for smaller companies there offers some value and is due for a revaluation but it is one for specialists. Other Asian markets are also being driven by liquidity.
Rowley: Given the risks you have all pointed to, how can investors make their portfolios crash resistant in the Year of the Snake?
Kepper: There is no such thing as a crash-resistant portfolio that doesn’t have gold in it and most investors aren’t holding enough gold. It’s all of a sudden a different financial world – with different rules for making money than at any point in history. The only sure investment in these times is in a non-dollar, non-euro currency. The debt debacle and the lack of any sort of credible financial consolidation plan will affect everything from interest rates to the US credit rating.
I expect precious metal prices to rise significantly over the next decade due to QE and other money printing programmes. I expect a lot of conversion out of paper money into hard assets, including gold, gold companies, and silver. I recommend physical bullion and gold and silver coins. Gold will go through US$2,000/oz next year and upwards to US$3,000 and US$5,000 by 2015.
Rowley: Thank you all, and a happy new Year of the Snake to everyone.
BT’s roundtable group of international financial and economic experts look into 2013 and told us they foresee challenge and opportunity.
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William R. Thomson
email: wrthomson@private-capital.com.hk
William Thomson is Chairman of Private Capital Ltd. in Hong Kong and an adviser to Axiom Funds and Finavestment Ltd. in London.
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