Safe haven bubble pops


The safe haven slaughter goes on. You might read elsewhere that what is transpiring in emerging markets is a “flight to safety” but that is patently wrong. Flights to safety are earmarked by rises in US Treasuries, the US dollar, the yen and falling gold. Right now we have the opposite.

What we are seeing in global financial markets is the same old stampede from one investment thesis to another. Ably supported by the high priests of moral hazard: central banks.

Describe it as “the trend is your friend”, “it’s all fine until it’s not”, or “reflexivity”.  It’s all the same thing. Markets are not rational. They chase a theme to the very brink of absurdity and then unwind it. We’ve seen it time and time again in the Latin American and Asian debt crises, in the dot com bubble, in the US sub-prime bubble and now the unwind of the post-GFC “safe haven bubble”.

The passing thesis is post-GFC Asian growth pre-eminence and capital preservation. The new theme is the return of US growth and going long developed economy risk.

Last night was a better night for bonds with the US catching a bid on tomorrow’s Fed meeting. Whether the Fed will back off is now academic. The taper rhetoric will remain and the QE unwind is now the trade de jour.

The FT has more on the implications:

When China unleashed the largest stimulus package in its history in response to the 2008 crisis and slowing export markets in the west, it came at a price. Today China is grappling with a bill that some economists say has driven total debt to gross domestic product past 200 per cent.

While China offers the most extreme example of using debt to fund growth, it is a pattern that has been repeated across Asia. Without exports, central banks turned on the taps, leading to a jump in household and corporate borrowing.

Now, as the US Federal Reserve considers a reversal of its ultra-loose monetary policy, the region faces a new challenge: coping with life after debt. And as investors gauge the impact of that transition, the ghosts of the 1997-98 Asian financial crisis have been reawakened.

“All this QE money has lead to a massive credit inflation bubble in Asia,” said Kevin Lai, chief regional economist at Daiwa Securities. “The crime has been committed, we just have to deal with the aftermath. During that process there will be a lot of damage . . . It’s like a margin call. Households will need to sell their assets. There will be a lot of wealth destruction.”

…“We’re going into a period of stagnation in growth over the next couple of years,” said Fred Neumann, chief Asia economist at HSBC. “It was a sweet spot and that’s now coming to an end. Asian economies had an easy ride because they bought themselves growth through leverage. They should have used that time to carry out structural reforms. Instead they’ve used the cheap money and enjoyed the high growth rates. That opportunity has now gone.”

The falling growth rates across Asia also serve as evidence of a deterioration in productivity. Credit intensity – a measure of how much debt is needed to create a single unit of economic growth – has risen sharply almost everywhere. In Hong Kong, it has almost tripled since 2007, while in Singapore it has jumped more than fourfold.

“A lot of this new credit is going into housing and property across the region. That area is not the most productive, it doesn’t bring new value into the system,” says Jimmy Koh, head of economic-treasury research at United Overseas Bank in Singapore.

Sound familiar, anyone?

So, how far does it run and what are the implications? First, it’s BRIC bashing. There is slowing growth in China and its shadow banking crunch will ensure no strong rebound, Brazil is struggling with recession, India is in a current account crisis as the rupee collapses and Russian growth is slowing. Closer to home Thailand is in recession, Singaporean growth is poor, Indonesia is slowing fast and also facing a stock market crash and currency pressures on its weakening  current account.

The AFR has more via Saul Eslake:

Still, economists argue there is little chance these countries are headed for a full-blown crisis, like the one that slammed Asia in 1997-98. GaveKal’s Kroeber argues although the situation will almost certainly get worse in emerging Asian markets in the next few months, “panic is not indicated”.

He argues “throughout the region – even in India where policy has been comatose or in Thailand where credit growth was ­overdone – economic fundamentals are decent and national balance sheets are reasonably strong”.

As a result, he says, investors should be deciding what thresholds should be reached before the sell-off becomes a buying opportunity. In particular, he argues investors should be looking to buy emerging Asian bonds when their real yields climb to around 3 per cent to 3.5 per cent. (At present, Korea, Malaysia and Indonesia are closest, with real 10-year yields in the 2 per cent to 2.5 per cent range).

“Across the region, yields have further to rise before foreign capital is likely to stream back in and provide support to both bond and equity markets. Once they do rise, economic fundamentals become key. Here India stands out as the big loser. It is caught in stagflation with decelerating growth and stubborn inflation; the high oil price guarantees its current account deficit (biggest in the region at 5 per cent of GDP) will remain perilously wide; and an ineffectual and exhausted government will continue its zombie-walk toward elections next spring.”

In contrast, Korea, Malaysia and the Philippines all run solid current account surpluses. And Taiwan, Korea and Malaysia are also big exporters, which will likely benefit if US demand picks up next year.

I don’t think so. The yield spikes there will also ensure lackluster growth continues. There is also the likelihood of some further fiscal consolidation after the September debt ceiling debate. Europe is also likely to take a hit as peripheral bond yields jump. Stock markets in the periphery are getting hit pretty hard.

Asia is in better shape than 1997. But there are still problems. The debt this time is in households rather than crony corporates and if the outflow of capital is strong enough, housing busts will pull down some countries in the region. That will still result in very painful current account corrections.

However, that is not the base case at this stage. Once this initial bout of hysteria passes, I expect the taper to taper itself as developed market growth disappoints and captial flight should pull up before emerging market outflows are calamitous. But you never can tell with these things. It only takes one big leveraged player to set off the panic.

For Australia it’s simply more evidence that the mining boom is done with all of the implications of terms of trade weakness, falling investment and fiscal instability that that entails. If it all happens at a measured pace then our banks won’t be hit with the same rising costs of funds weighing on their Asian counterparts. A greater risk may be that the local securitisation market becomes uneconomic meaning non-bank lending stalls. The May/June period showed stress but has since improved with CBA delivering a a jumbo last week and BOQ issuing two weeks ago. It’s been a  few months since we’ve seen a minor player which might be interesting now.

The dollar is providing some comfort, falling heavily against the euro and pound. But it is also up against most of our commodity exporting competitors in Brazil, Indonesia and South Africa, as well as the US dollar. If the overall shift continues you would expect it to continue to fall.

Hopefully the great volatility machine that is global markets will calm before the damage is too great.

Houses and Holes
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  1. Is any of this surprising?

    This is exactly what happens when central banks try to ‘support demand’ by firing up the private banking debt machine with super low interest rates.

    A super charged torrent of money sloushing through all those economies who were persuaded by ‘economic theory’ that modern economies should dismantle almost completely internal water supplies, sea walls, dykes, and other possible protections from fast moving external capital flows.

    Here are a few stories of some locals who have been damaged by the obessions of our own RBA with modern theories on the free flow of capital.

    The irony of course is that when the penny finally drops and the value of a domestic saving culture is understood – few will remember what it is.

    • “On the bottom tax rate of 20.5 per cent, including Medicare, a term deposit needs to pay 3.8 per cent just to break even according to Mitchell Watson, research manager at Canstar. On the top marginal rate it would have to pay 4.67 per cent, which is just short of the best rate on a five-year term deposit.”

      Read more:

      The inflation rate faced by people at that level is a damned sight higher than the RBA’s 2%! Non tradable has been running at 4.5% which is about where these people sit. So even at the bottom MARGINAL tax rate you’d need over 5.7% just to earn ZERO!

    • “The irony of course is that when the penny finally drops and the value of a domestic saving culture is understood – few will remember what it is.”


      However modern ‘economic theory’ doesn’t need savings anyway!


      • Trouble is, if one wants to save and get a decent return, then someone else needs to borrow…and we have a bit too much of that on the private side already, and the politics of Government borrowing is a bit murky too.

        As a lender, I am more worried about whether or not I will get my money back frankly.

  2. “…Even ignoring the potential for growth, which is non-existent with a term deposit…” Capitalising interest must be growth of sorts, surely? But growth comes in two forms – nominal and real, and the beneficiaries of real growth might be those that have term deposits or unapplied debt when/if deflation finally arrives 🙂

  3. Dammit I gotta save my posts! My cynicism must be getting a bit too heavy to float through the blogosphere!

  4. migtronixMEMBER

    The trend is your friend, but re AUD/BRL/INR with friends like these who needs enemies? All those Indian who refused to heed the becking call of their CB to stop buying Gold and instead invest in Indian Government debt are all very happy ignoring that advice. Note to CB’s, your population isn’t as stupid as you are.

  5. ‘“A lot of this new credit is going into housing and property across the region. That area is not the most productive, it doesn’t bring new value into the system,”’

    Ha ha yes that sounds very familiar.

    • “A lot of this new credit is going into housing and property across the region. That area is not the most productive, it doesn’t bring new value into the system”

      Actually that statement is not really correct. Housing adds value to people’s lives. If you have a productive balanced economy then improved housing should be a RESULT of that economy.
      Unfortunately for us housing IS the whole economy….worse flipping established houses is MOST of the economy!

    • Ah, computers…

      Try dumping into an open, blank word process doc before you “submit”.

      That, and copying before sending are one of my habits before posting long responses….

      Ticks me off, too, when it just fails and you lose your work….!

  6. I’ll have another go!
    Good piece!
    We’re lucky here that we have all these smart economists who can tell all these stupid Asians how to really run an economy. The stupid Chinese with their stupid government could really benefit from a course in Australian economics!

    Any! Nah! We’ll be right! All we gotta do is get the RBA to keep lowering interest rates and for the governments to run massive deficits. That way we’ll get consumption going and all those retail shops really flying! With that the coffee shops and restaurants will keep booming. All the Westfields will be really humming.
    TRhen we can employ more public servants to create more rules, regulations and thought control legislation. The new regulations will require supervision and enforcement which will require more public servants. Of course this also results in private sector employment as the private sector employs people to ensure conformity with the new regulations. This all then creates a positive feed-back loop into the coffee shops and restaurants!
    With all this new prosperity we can then all go and buy new SUV’s to keep all those shiny new car dealerships spit and polished!
    Automatically from all this we get BOOM! BOOM! BOOM! in Sydney/Melbourne/Canberra Real Estate. Bloody bewdy! That’s how life’s meant to be for us Aussies. We deserve it!

    Lucky nobody here knows about Current Account Deficits and their implications so we can ignore that! We are running out of mines to sell to cover the CAD but look at all the rural land we still have to sell! Our farmers are getting too bloody old anyway!

    In a spirit of good-will we can bring Wayne Duck back out of retirement to advise all these stupid Asians how they can run their economies like ours. In a spirit of bi-partisanship we’ll team him up with Andrew Robb. Wow! What a team!

    So no worries mate! It’s no wonder the world loves us.

    • flawse, you make it sound like Australians will get out of bed one morning saying, “What’s the army doing on the streets?… Flat broke?… Massive debts?… Who?…. (a puzzled look)Yeah?”

      As they then step into their 5th Audi, not having fully paid off the first one, on the way to a coffee shop to buy one cappuccio on credit card.

  7. Markets are not rational. They chase a theme to the very brink of absurdity and then unwind it.


    The efficient market hypothesis was one of the more dangerous economic theologies to propagate in recent times.

  8. I read many of these articles and conclude that the entire world has forgotten whatever high school math they once learned.

    The NULL of the first derivative occurs at the maximum rate of change of the underlying measured quantity.

    Hot money is a higher order derivative product, so there is no mathematical basis for expecting Hot money to flow in synch with changes in fundamental policy. The direction and magnitude of hot money flows depend on acceleration and on the rate of change in acceleration. It’s high time that at least our economists understood these math basics.

  9. I’m not sure I see any “safe-haven” going pop. Maybe a bit of a fizz. Most certainly an increase in volatility.

    Volatility has to be the new norm.

  10. Cherie Byrne, who is 62 and retired, relies on the interest on her term deposits and two mortgage loans to solicitors. ”I dread every rate cut. I do feel boxed-in because I’m eating into my capital every year,” Cherie says.

    well boo F**king hoo… 62 and retired because your friends in their 50s feel a bit tired..

    well Cherie… thanks to you and your boomer friends my generation will be working probably until about 75 or until I drop, whichever comes first.

    • If the Fed will in fact taper, it can be only because circumstances are forcing it’s hand. What those are I am certain we won’t know until after it becomes apparent. I suspect that it is a major deterioration in demand for Treasuries, worldwide. Therefore masking that demand loss with the “tapering” meme becomes a figleaf for a much larger issue- confidence in the US financial system. Rising rates in the US are quite disturbing and emphatically end the means by which the Fed has pumped the US financial system. We could be witnessing the beginnings of not so much a bubble bursting but more collapsing in on itself. Shambolic retreat might describe it best?

  11. A greater risk may be that the local securitisation market becomes uneconomic meaning non-bank lending stalls.


    this extended period of low rates ..and prospectively lower rates will give added life to this market …and with it opportunities for smaller lenders.

    disappointing to see the same bearish themes continuing on what is still a good forum.