From Caijing Magazine (by Andy Xie October 28, 2009)
Every party ends sooner or later, and I see two scenarios for the next bust. First, every trader is borrowing dollars to buy something else. Most traders on Wall Street are Americans, British or Australians. They know the United States well. The Fed is keeping interest rates at zero, and the U.S. government is supporting a weak dollar to boost U.S. exports. You don't need to be a genius to know that the U.S. government is helping you borrow dollars for speculating in something else.
But these traders don't know much about other countries, particularly emerging economies. They go there once or twice a year, chaperoned by U.S. investment banks eager to sell something. They want to think everything other than the U.S. dollar will appreciate; Wall Street banks tell them so. Since there are so many of these traders, their predictions are self-fulfilling in the short-term. For example, since the Australian dollar has appreciated by 35 percent from the bottom, they now feel very smart while sitting on massive paper profits.
When a trade like this one becomes too crowded, a small shock is enough to trigger a hurricane. There must be massive leverage in many positions, but one just never knows where. When something happens, all these traders will run like mad for the exit, and that could lead to another crisis.
Surging oil prices could be another party crasher. This could trigger a surge in inflation expectation and crash the bond market. The resulting high bond yields might force central banks to raise interest rates to cool inflation fear. Another major downturn in asset prices would reignite fear over the balance sheets of major global financial institutions, resulting in more chaos.
Oil is a perfect ingredient for a bubble: Oil supplies cannot respond to a price surge quickly. It takes a long time to expand production capacity, and oil demand cannot decrease quickly due to lifestyle stickiness and production modes. Low-price sensitivities on both demand and supply sides make it an ideal product for bubble-making. When liquidity is cheap and easily obtained, oil speculators can pop up anywhere.
Oil speculators are no longer restricted to secretive hedge funds. Average Joes can buy exchange traded funds (ETFs) that let them own oil or anything else. Why not? Central banks have made clear their intentions to keep money supplies as high as possible, debasing the value of paper money to help debtors. It seems no good deed is unpunished in this world. If you speculate big, governments will offer a bailout when your bets go wrong and cut interest rates and guarantee your debts, allowing bigger bets. People who live within their means and save some for a rainy day see dreams shattered. Central banks can't wait to break their nest eggs.
It is better to be a speculator in this world. The powers that be are with you. Maybe everyone should be a hedge fund; ETFs give you this opportunity. As the masses are incentivized to avoid paper money while buying hard assets, the price of oil could surge to triple-digit territory again.
A word of caution for all would-be speculators: You'll want to run for your life as soon as the bond market takes a big fall. And the case for a double dip in 2010 is already strong. Inventory restocking and fiscal stimuli are behind the current economic recovery, and when these run out of steam next year, the odds are quite low that western consumers will take over. High unemployment rates will keep incomes too weak to support spending. And consumers are unlikely to borrow and spend again.
Comments:
The coming dollar rally is about market psychology more than any other factor, in my view. With nearly every economist, government official and perhaps 90% of investors bearish on the dollar, and the Fed pursuing its ultra low interest rate strategy the trend must soon reverse.
As Andy Xie points out, there must be huge leverage in many trading positions. Apparently, few have learned the lessons of Lehman's and the October 2008 correction. Too much leverage is never good. Leverage is the two edged sword that cuts both ways, it amplifies profits on the way up, and hammers borrowers with massive losses on the way down.
His second point regarding the price of crude oil is critical. Crude prices rising are highly inflationary since the price of energy quickly is capitalized into the cost of goods produced. Inflationary pressures could quickly derail any recovery and promote a fear trade movement back to the dollar and treasuries.
If a fear trade does materialize, the dollar rises, as it is still the global reserve currency, and stocks and commodities crash.
This is the scenario that remains constantly on my mind.
Every party ends sooner or later, and I see two scenarios for the next bust. First, every trader is borrowing dollars to buy something else. Most traders on Wall Street are Americans, British or Australians. They know the United States well. The Fed is keeping interest rates at zero, and the U.S. government is supporting a weak dollar to boost U.S. exports. You don't need to be a genius to know that the U.S. government is helping you borrow dollars for speculating in something else.
But these traders don't know much about other countries, particularly emerging economies. They go there once or twice a year, chaperoned by U.S. investment banks eager to sell something. They want to think everything other than the U.S. dollar will appreciate; Wall Street banks tell them so. Since there are so many of these traders, their predictions are self-fulfilling in the short-term. For example, since the Australian dollar has appreciated by 35 percent from the bottom, they now feel very smart while sitting on massive paper profits.
When a trade like this one becomes too crowded, a small shock is enough to trigger a hurricane. There must be massive leverage in many positions, but one just never knows where. When something happens, all these traders will run like mad for the exit, and that could lead to another crisis.
Surging oil prices could be another party crasher. This could trigger a surge in inflation expectation and crash the bond market. The resulting high bond yields might force central banks to raise interest rates to cool inflation fear. Another major downturn in asset prices would reignite fear over the balance sheets of major global financial institutions, resulting in more chaos.
Oil is a perfect ingredient for a bubble: Oil supplies cannot respond to a price surge quickly. It takes a long time to expand production capacity, and oil demand cannot decrease quickly due to lifestyle stickiness and production modes. Low-price sensitivities on both demand and supply sides make it an ideal product for bubble-making. When liquidity is cheap and easily obtained, oil speculators can pop up anywhere.
Oil speculators are no longer restricted to secretive hedge funds. Average Joes can buy exchange traded funds (ETFs) that let them own oil or anything else. Why not? Central banks have made clear their intentions to keep money supplies as high as possible, debasing the value of paper money to help debtors. It seems no good deed is unpunished in this world. If you speculate big, governments will offer a bailout when your bets go wrong and cut interest rates and guarantee your debts, allowing bigger bets. People who live within their means and save some for a rainy day see dreams shattered. Central banks can't wait to break their nest eggs.
It is better to be a speculator in this world. The powers that be are with you. Maybe everyone should be a hedge fund; ETFs give you this opportunity. As the masses are incentivized to avoid paper money while buying hard assets, the price of oil could surge to triple-digit territory again.
A word of caution for all would-be speculators: You'll want to run for your life as soon as the bond market takes a big fall. And the case for a double dip in 2010 is already strong. Inventory restocking and fiscal stimuli are behind the current economic recovery, and when these run out of steam next year, the odds are quite low that western consumers will take over. High unemployment rates will keep incomes too weak to support spending. And consumers are unlikely to borrow and spend again.
Comments:
The coming dollar rally is about market psychology more than any other factor, in my view. With nearly every economist, government official and perhaps 90% of investors bearish on the dollar, and the Fed pursuing its ultra low interest rate strategy the trend must soon reverse.
As Andy Xie points out, there must be huge leverage in many trading positions. Apparently, few have learned the lessons of Lehman's and the October 2008 correction. Too much leverage is never good. Leverage is the two edged sword that cuts both ways, it amplifies profits on the way up, and hammers borrowers with massive losses on the way down.
His second point regarding the price of crude oil is critical. Crude prices rising are highly inflationary since the price of energy quickly is capitalized into the cost of goods produced. Inflationary pressures could quickly derail any recovery and promote a fear trade movement back to the dollar and treasuries.
If a fear trade does materialize, the dollar rises, as it is still the global reserve currency, and stocks and commodities crash.
This is the scenario that remains constantly on my mind.
Comments
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