## Tuesday, March 20, 2007

### Word of the Day

empyrean \em-py-REE-uhn; -PEER-ee-\, noun:
1. The highest heaven, in ancient belief usually thought to be a realm of pure fire or light.
3. The heavens; the sky.

1. Of or pertaining to the empyrean of ancient belief.

Dictionary.com

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My former colleagues used to tease me about the words that I use. I was always able to fend off the label of being an utter nerd in that I didn't know about 1/3 of dictionary.com's word of the day. So....here it is in tribute to a market top! It may reach empyrean levels!

Gary K is still concerned about volume, but he's seeing some leadership, so he is looking for higher close and better volume.

joey said...

Leisa, on Bill's blog, you said you had a yen/USD trade on. I assume you've seen news akin to the following (being an extract from Chuck Butler's article in today's Daily Reckoning):

Now onto, Japan. The Bank of Japan (BOJ) Governor Fukui was at it again last night. And by "it" I mean simply dissing the yen, to keep it weak. Last night, Fukui said that interest rates in Japan would stay low. Talk about giving the green light to carry trade enthusiasts! He basically told these carry trade people to go ahead and short yen, because the borrowing costs aren't going higher, and that he would do his best to keep the currency weak, to allow them even more profits.

Geez Louise… Where did this guy come from? Oh… And now the Big Boys from Goldman are telling investors to sell yen versus the dollar, and that the unwinding of carry trade was overdone. Now they may be correct, but I find it very interesting that they didn't come out with that little ditty until Fukui gave the "green light"!

Leisa said...

Hi Joey:

I have some shares of FXY. Yes, I saw all of that "stuff". Japan greatly needs the yen to stay low because they export so much. Mizhou Bank announced awful numbers (25% reduction in income) due to increasing loan defaults. It's worth remember that Japan's tenuous recovery was due to their own asset bubble which burst--the results of which you still see them coping with.

It will be interesting to see how China elects to diversify its trade surplus.

joey said...

what will China do?

here is a wonderful piece from yesterday's Strateguc Investment:

***Stratfor on Hot Chinese Money

Global Market Brief: China's Impending Big Splash

The vice chairman of China's National People's Congress, Cheng Siwei, said March 8 that the Chinese government needs to put some of its mammoth $1 trillion (as of Jan. 1) in currency reserves to better use. Cheng said he broadly agrees with International Monetary Fund assessments that China needs to keep "only" about$650 billion as reserves, and should apply the remaining amount to more efficient purposes. While Cheng is not ultimately the decision-maker for the reserves, his statements are just the latest in a series of leaks that point to an imminent change in the way Beijing manages its currency reserves. Whatever decision Beijing makes, it will shake the world.

Stratfor normally does not engage in blind speculation. But when a cash-rich government indicates it is about to toss $350 billion or so in spare change at something -- without giving hint as to what that something might be -- speculation really is the only option. The core issue is simply one of scale. That amount represents the single-largest pool of cash that any government has thrown at anything, ever. Adjusted for inflation, the United States' largest effort, the Marshall Plan, comes in at just over$100 billion.

In essence, China is about to throw a very large rock into the pond without telling anyone where specifically to expect the splash. There are, however, several possible scenarios as to where that splash might occur and what its impact could be.

Investment Fund

From a financial point of view, Chinese investment money is used extraordinarily inefficiently. Money is thrown regularly at suboptimal domestic projects, irrespective of profitability, in order to further social goals such as full employment on the premise that it is better to have workers at work doing nothing of value than to have them unemployed and considering long marches.

By using foreign exchange reserves to launch a major investment fund, China could generate income with Chinese cash, without delving into the politics and pain of reform. At the same time, it could secure a hefty nest egg as a hedge against future crises. Therefore, many Chinese have floated the idea of setting up an investment project modeled after the Government of Singapore Investment Corp. (GIC). The GIC manages the bulk of Singapore's foreign exchange, mostly in a mix of stocks and bonds, and is broadly considered one of the world's most responsible and successful investment agencies.

Any Chinese GIC, however, likely would have a far less conservative profile that would impact far more heavily on global markets.

The GIC does not invest within Singapore, largely because Singapore views its currency reserves as an emergency fund. (If the country is in a state of emergency, then it would be preferable for investments to be held in other parts of the world.) Since China would only be investing about one-third of its reserves in this new project, it still has a cushion of about $650 billion. China, therefore, could afford both structurally and ideologically to go a bit wild with its investments, compared to Singapore, and invest at home as well. That suggests that China would invest far more heavily in more speculative stocks and bonds, and likely far more in property than the 10% of total portfolio that GIC limits itself to. At issue is market depth. Most big investment funds are very careful not to invest in any particular asset to such a degree that their presence impacts pricing. With$350 billion to play with, affecting market values is going to be a constant concern -- and if the way China has so far managed its domestic markets is any indication, the impact will be large and volatile.

Just as important, the GIC is so respected and successful because it is extraordinarily well run by a group of apolitical technocrats in a country where corruption is nearly nonexistent. China, in comparison, sports reserves of corruption and political malfeasance that are legendary. Taken together with the far larger amounts of cash, the relative suddenness with which the Chinese would enter the market, and far more aggressive investment guidance, the potential for stimulating investment bubbles on a global scale could be massive.

Infrastructure and Influence

Either independent of or tied to a Chinese government investment fund (as any of these options could be) is the possibility of putting a few hundred billion behind China's efforts to secure its foreign policy and strategic goals.

With such a broad category, this figure could have a seemingly unlimited impact. A few billion here or there could construct nearly any infrastructure needed to ensure that critical commodities become permanently linked to the Chinese economy -- chrome from Congo, platinum from South Africa, natural gas from Turkmenistan, oil from Equatorial Guinea. What technologies Chinese companies currently lack – deep-water or sea ice drilling, for example -- could simply be purchased with a generous pile of cash.

Such funding also would allow China to purchase friends by the dozen. Total foreign direct investment in sub-Saharan Africa in 2006, for example, was only $38 billion. China is looking at a figure that is eight times that amount. Entities that normally fund development efforts -- the World Bank comes to mind -- would find such competition crushing. China often offers cash with minimal strings attached, as values such as transparency and anti-corruption do not rank high within the country, much less in its foreign economic relations. Unlike the GIC route that would seek to improve returns, going for developing-world infrastructure and influence primarily would be a political goal, with profit a distant concern. As such, the economic impact of such an approach actually could dwarf the economic impact of the GIC model. It is one thing to surge out money in order to seek money via suavely selected investments; it is quite another to surge out money in order to achieve noneconomic goals regardless of profitability. Price explosions and bubbles would be highly likely in any industries related to infrastructure, such as steel, cement, and shipping. Manipulation of Global Currency Movements Right now, China's currency reserves are heavily skewed toward the U.S. dollar, with some 60% held in U.S. government bonds and U.S. dollars. Many have raised the possibility that China will shift some of this exposure to the euro. Messing with this proportion would dramatically impact Chinese economic orientation. Right now, the United States is China's top export destination. Keeping the bulk of Chinese currency reserves in U.S. dollars is not only a consequence of that, but also helps reinforce it. So long as China is dumping its reserves into dollars, U.S. interest rates will remain relatively low, thus encouraging U.S. consumers to spend -- and often to spend on Chinese goods. Also, even with U.S. rates low, U.S. government bonds still pay out more than their European counterparts. This is a very sweet deal for the Chinese: It keeps them lashed to the world's largest market and gives the Americans a vested interest in Chinese political stability. Yet this does not mean China is ideologically committed to keeping its reserves in the dollar. A large-scale shift to the euro, for example, would certainly impact trade flows and threaten that all-important China-U.S. link, but it would have one very interesting side effect: It would dramatically strengthen the euro at the dollar's expense. Since the Chinese yuan remains de facto pegged to the dollar, the yuan would plunge, as well, thus spurring both American and Chinese exports to the rest of the world. Washington might not be thrilled with a weaker dollar, but the export boom that would result could be directly credited to China, something that could soothe bilateral relations somewhat. The only limiting factor for China in this scenario is how fast it could physically divest itself of its U.S. bonds without triggering an immediate devaluation of its remaining assets. Again, for a country in which profitability is rarely key, the answer likely is on a shorter time horizon than one might think. Internal Rationalization Another possible model also comes from Singapore: Temasek, a state holding company that manages assets the world over -- companies, not stocks or bonds -- and takes an active role in corporate management. The hands-on, politicized nature of Temasek has raised hackles in many states -- Temasek's involvement in Thai telecoms contributed to the 2006 overthrow of the government of former Thai Prime Minister Thaksin Shinawatra -- and also makes it a likely candidate for a Chinese copy. It really fits perfectly into the Chinese management style. Under technocratic control, such a holding company would, in theory, bundle China's best and brightest state-owned enterprises into a sort of flagship holding. Then, using the currency reserves as a lever, it would steadily bring more firms into the holding. That does not mean they would be brought in willingly. The Chinese government has been attempting to force Chinese firms to use capital more efficiently -- largely by attempting to limit their access to money. This has not worked particularly well for two reasons. First, local Chinese leaders own many of these dud firms and use their connections to secure financing, which they then skim for their own purposes. This is as much a center-periphery political turf fight as it is an economic rationality battle. Second, China is so awash in cash that it is difficult to seriously constrict capital availability. Following the Temasek model would allow the government to knock off these local leaders a few at a time, only picking fights that the center would be sure of winning, rather than adjusting the system en masse and risking an economic (and political) meltdown. It also would provide a pool of capital that could be lent out to these star firms -- many of which are small and medium enterprises that have provided the bulk of new jobs in China of late -- that is free of the problems that plague the state banks. In essence, this system could create a new state bank that operated according to Western standards. Such an effort likely would be piecemeal, painful, and slow, but it would not risk any fundamental crashes by tinkering with the financial system. Neither would it address the issue of a nonfunctional banking sector, though it would attack the corruption issue directly at its source in a very real way. It also would have the welcome side effect of consolidating President Hu Jintao's government's political control, hardly an inconsequential impact. Regardless of what China does with its currency reserves, it is going to have a massive impact -- likely far more than what we have addressed here. The implications would not be limited to euro-dollar exchange rates or Chinese-U.S. export surges. Moving a fair amount of cash out of government securities into, well, anything else, will lead to increased yields for those government securities. That will increase their attractiveness to other investors at the expense of other assets, which could contribute to lower property and/or stock values. Such a spread change would be even more pronounced in whatever assets the Chinese decide to chase as their involvement reduces yields. Finally, China needs "only" between$600-700 billion in currency reserves to maintain economic stability. Since the beginning of 2003, China has added about $200 billion annually to its reserves. The$350-odd billion the country is about to spend is not the end-all, be-all -- it is just the beginning.