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.

About the author
David Llewellyn-Smith is Chief Strategist at the MB Fund and MB Super. David is the founding publisher and editor of MacroBusiness and was the founding publisher and global economy editor of The Diplomat, the Asia Pacific’s leading geo-politics and economics portal. He is also a former gold trader and economic commentator at The Sydney Morning Herald, The Age, the ABC and Business Spectator. He is the co-author of The Great Crash of 2008 with Ross Garnaut and was the editor of the second Garnaut Climate Change Review.