asian tigers alive and roaring december 2003 l.
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Asian Tigers - Alive and Roaring December 2003. Ade Odunsi. Part 1 Global Backdrop . Global Backdrop. Like it or not, Asia is deeply entangled in the US’s massive external imbalance Willingness of Asia to extend cheap credit to the US government and consumer

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global backdrop
Global Backdrop
  • Like it or not, Asia is deeply entangled in the US’s massive external imbalance
  • Willingness of Asia to extend cheap credit to the US government and consumer
  • Asian saving has helped fund tax cuts and credit growth in the US
  • A post-bubble US recession has largely been avoided
  • This has supported US consumption of Asian manufactured goods
  • The “mother of all vendor financing deals” (David Bowers, Merrill Lynch Research)
  • Imbalances however are reaching worrisome levels
asian resurrection
Asian Resurrection
  • Asia is only 11% of the world economy but is growing 2.5x as fast
  • Over the 2001-2003 period China represents only 4% of Global GDP but contributed 17.5% to Global GDP growth!
if you scratch my back
If You Scratch My Back...
  • Asian trade deficit with US excluding Japan $179bn (of which China $114bn!)
  • Current Account = Capital Account
  • Asia purchased $161bn of US securities over the past 4 quarters (30% of CA deficit)
a quick word on china
A Quick Word on China
  • US Bilateral trade surplus has jumped by 50% over the last 3 years (>$100bn)
  • 50% of exports to US are foreign companies - FDI
  • Imports from China are not direct substitutes for US goods
  • China has emerged as the leading manufacturer of labour-intensive goods
  • China runs a trade deficit with the rest of the world
  • The shift in manufacturing jobs abroad has been happening since the 1950’s
  • The money comes straight back - China owns >$120bn of Treasuries
the elephant in the corner
The Elephant in the Corner
  • CA deficit reaches $520bn - never bet against the US consumer!
us dependence on foreign capital
US Dependence on Foreign Capital
  • “Foreign capital” increasingly means Asian capital
  • Asia bought $23bn of US assets in September alone
hot money dominates
“Hot Money” Dominates
  • The upturn in the US stock market this year has not convinced foreigners to make long-term investments in the US
  • At the peak of the bubble, US equity inflows from overseas reached $200bn
it s a little known fact
It’s a Little Known Fact...

The rally in the US Equity market is domestically driven!

TIC = US Treasury International Capital System

  • Significant funding of the CA deficit is by foreign Central Banks (>$1 trillion)
  • Bank of Japan is the largest buyer of Treasury securities (> $130bn this year)
  • Net foreign buying of corporate bonds has outstripped Treasury securities over the last 12 months - the search for yield
  • A worrying development: foreign net purchases of US financial assets dropped from $62bn in August to $16bn in September
pent up demand not in us
Pent-up Demand Not in US
  • There are three common conditions to a lasting pickup in private demand
  • Rising confidence and low real interest rates are met in each of the G3
  • Private financial surpluses in Japan are 5% of GDP; 3% in the Eurozone (2003); -1% in the US
reality check
Reality Check
  • This financing arrangement between Asia and the US has benefited both
  • Asia needs US demand just as much as US needs Asian capital
  • Talk of protectionist policies by the US are largely political
  • The ‘basic’ problem with the deficit is that it is HUGE
  • Low yields on US assets make the deficit increasingly difficult to finance
  • How does the US recovery sustain itself?
  • The problem ‘officially’ recognised at the G7 meeting in September 2003 - this likely marks the beginning of the end of this dynamic
what is our view
What Is Our View?

Rising local activity will enable Asia to grow out of its CA surplus

  • ‘Competitive reflation’ has boosted Asian economies
    • Aggressive FX intervention by Asian Central Banks to limit currency appreciation and maintain competitiveness (also limited ability to sterilise)
    • Lower interest rates
    • Massive growth in Asian FX reserves (Treasuries: $15bn/month on average)
  • But rising employment and utilization rates pushing up inflation
  • Business is booming and Asian consumers have a large pool of savings
  • Strong economic outlook will be the catalyst for acceptance of currency appreciation in Asia
  • THE END GAME: redistribution of growth from the US to Asia. Asian consumers will be the main drivers of demand
the flip side
The Flip Side
  • Slower US growth (…but Q3 GDP growth 8.2%)
  • Higher returns in Asia attract capital from US securities markets
  • US interest rates adjust higher resulting in lower demand
  • Fed committed to keeping short-term interest rates low
  • The US dollar must devalue to maintain balance
  • Imbalances correct gradually
deja vu
Deja Vu
  • The Plaza Accord (1986)
  • Trade weighted USD index peaked in Feb ‘01 and has fallen 23%
  • EURUSD FX rate has fallen 42%
what else could happen
What Else Could Happen?
  • Massive US recession?
    • Fed to keep interest rates ultra-low for an extended period
  • Competitive reflation in Asia results in a major inflation shock, impacting real rather than nominal exchange rates
  • A combination of all 3 factors
  • In everyone’s interest to engineer a slooowwww adjustment
the fx virtual market
The FX ‘Virtual’ Market
  • Huge (For comparison, US Treasuries $400bn/day)
  • Liquid
  • Sophisticated
  • Highly automated
  • Fast
  • Unregulated (!?*)
  • 24 hour global market

Source: BIS Central Bank Survey 2001

fx as an asset class
FX as an Asset Class
  • Massive increase in interest in FX as an asset class i.e. currency speculation
  • Driving component of many investment bank’s recent profitability
  • FX is not cyclical - consistently profitable!

1) Trending markets - US dollar in a long-term structural decline

2) Quest for alpha

3) A search for ‘alternative’, non-correlated assets

4) A little known fact - FX is a less risky asset

  • What are chances of the FX rate going to zero?
  • CB’s tend to intervene if volatility gets too high
but fx is a zero sum game right
But FX is a Zero-Sum Game, Right?
  • Another little known fact - not every participant in the FX market is a profit maximizer!
  • Central Banks For example:- Bank of England ‘defending’ the pound in 1992- Bank of Japan sales of Yen for US dollars this year have exceeded $130bn Yen has still strengthened by over 12%!
  • International corporations
  • Private individuals
  • Professional currency managers make up less than 1% of daily turnover SIGNIFICANT PROFIT POTENTIAL!
show me the money
Show Me the Money
  • Buy Asian equities
    • India
    • Thailand
    • Taiwan
show me the money24
Show Me the Money
  • Chinese Renminbi (CNY) is a pegged currency (8.2771 CNY per USD)
  • Active ‘off-shore’ forward market (non-deliverable market)

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