449 days and counting
Cockroaches, Sylvester Stallone, and the Beijing Olympics...
WE JUST GOT a crucial clue as to the development of today's massive bull market in global financial assets.
The bull market will continue.
For how much longer? That's the question on everyone's lips and ear lobes. And today, we have a precise, mathematically sound, conceptually irrefutable answer. More or less.
That is how much time you have left to make your fortune in the great global M&A boom, where every asset is for sale, and every company's a buyer.
How do we come to that number? Well, on August 8 next year, the summer 2008 Olympics will begin in Beijing. Anxious to show itself off to the world, China's government will do anything it can to avert a destabilizing financial panic before then.
We're not saying that Beijing will succeed. Like everyone else participating in today's worldwide equity land grab, China's officials are well out of their reckoning.
Still, an important step has been taken this week to keep the boom going for at least another 449 days.
"China will let its banks buy shares overseas for the first time, diverting some of the country's 35 trillion yuan ($5.49 trillion) in savings from the local sharemarket, where trading has surged sevenfold," reports Zhao Yidi at Bloomberg.
You can call this deregulation, free-market capitalism, manipulation, desperation, whatever you like. Here at the Old Hat Factory in Melbourne, it reminds us of brain surgery.
Specifically, we are reminded of the brain surgery performed on Bob Woodruff, the correspondent for US network ABC News who was injured in an IED attack while riding with a US military patrol in Iraq.
We saw several stories on how Woodruff's life was saved. To prevent his brain from swelling up against the confines of his skull – and causing irreversible or even fatal damage – military doctors removed a pizza slice-shaped chunk of his skull.
His brain, says Woodruff's wife, then swelled up to the size of a rugby ball on the outside of his head. But the surgery saved his life. Later, after the swelling went down, cosmetic surgeons were able to reconstruct the missing piece of skull and reshape Woodruff's head. If you saw him today, you would hardly notice the man had a large piece of his skull removed.
And what does this have to do with China?
China sits on tremendous foreign currency reserves and banking assets – the result of savings rates in the 20% range. Every time China sells a new pair of extra large sweat pants to America, the dollars come back to China. China has to do something with those dollars, but the influx of money risks adding to China's already firm inflationary outlook.
What to do? The process of "sterilizing" the inflationary effect of these imported dollars – bought by exporting goods to the US – is a little Byzantine. We won't explain the whole thing here. Only what it means.
Extra foreign currency reserves have become a kind of swelling on the brain of the Chinese financial system. They are causing massive inflation in local share markets. The central bank has tried and failed to relieve this swelling by raising short-term interest rates – as well as the lending reserve requirement – at local banks. It just hasn't worked.
The animal spirits are unleashed in China. And if they do not find new pastures to roam and assets to consume, they will soon turn on each other, devouring local gains in a massive sell off.
In liquidity terms, China's forex and banking reserves are now free to find a home on other equity markets. First stop will be Hong Kong. But where next? America? Australia? London?
Worldwide, total government currency reserves now stand around $5 trillion. Last year there was $4 trillion in M&A deals. Already this year we've seen $2 trillion in deals. Central banks are largely powerless to stop these cross-border capital flows with monetary policy. In fact, they are contributing to the phenomenon.
"To the extent that you have central banks intervening to keep the value of their currency at a competitive level by accumulating dollar reserves at a rapid pace, that is going to boost liquidity and be one of the factors contributing to M&A activity," says Nick Bennenbroek of Wells Fargo Bank in New York.
Says Steve Barrow, currency strategist at Bear Stearns, agrees:
"We believe the liquidity that results from the currency system fuels the strength in asset prices, the strength in global growth and the strength in M&A activity."
But when does strength lead to instability? When is too much growth no longer a good thing? And did Sylvester Stallone really need to take human growth hormone to make us believe that Rocky Balboa was still a champion?
In China, if the bubble is not successfully transplanted to new soil, it would have grievous consequences for the whole world, China first.
"The central bank is increasingly concerned about asset bubbles," says Jun Ma, an economist at Deutsche Bank. "The social implications could be huge if there is a major correction. Most of the new investors in China are poor, low- income people and they will be hit the most."
Those who have the most to lose are usually the last into a mania. We saw this in the US subprime market. Are we now seeing it as Chinese farmers send their hard-earned savings to speculate on US stocks?
And just who can survive a global financial meltdown anyway? In looking for the business answer, we turn to the natural world and our friend the roach. Each night we see a few here and there in our redoubt at Charnwood Oaks. Roaches exist everywhere on the planet except at the poles, where it is too cold for even their hardy souls.
They have survived and thrived on the planet for over 300 million years, adapting to all conditions. Not much kills a roach. Radiation won't work. Blunt force will. And so too, strangely, will dehydration.
In studying our adversary we learn that many roach-killing products effectively block up a roach's pores so it slowly dehydrates. This sounds cruel, but it appears to be effective.
The hard facts of biology, however, are bad news for anyone trying to dodge the roaches lurking behind today's financial mania.
At least for the next 449 days, there is still plenty of liquidity to go around.