Financial Education: 3. Learning to read the Tea Leaves

[pywong]

With the mass of information being churned out daily and the fact that most of us are busy chasing the good life, it is hard to make sense of the world.

One of the way is to develop a simplified picture of the world. That is what the Rat Race series is all about.

By itself, it is not enough. We live in a world driven by money and what happens in the financial system have a big impact on our lives. There is a lot of information and "news" available. The volume is so much that we eventually drown in it. Most people give up at this stage and decide that it is simpler to put their nose to the grinding stone and work hard. Welcome to the Rat Race.

Another way for us is to learn how to read the Tea Leaves - to understand what is going on and to try and "predict" or anticipate the future. Often times it is obvious - when you see a steamroller headed down your way, you get out of the way.

Sometimes the storm signals are not so obvious. Then we need to build up the little pieces of information to develop a composite picture. We can see it in the thread - Financial Crisis Coming. http://www.usj.com.my/bulletin/uploa...ad.php?t=22392

Here is another way: Reading analysis by people smarter than us. Check out here: http://www.sitkapacific.com/files/Si...007_review.pdf

A few takes here:
1. The US economy is in recession. We can assume that it will affect us in Malaysia.

Key question to ask: Is the Govt doing anything about it?

Nothing much. Badawi is more concerned with saving his own skin.

2. The stock market will drop. If we are in the market, does it make sense to get out? The do-nothing option is still available if we have enough spare cash and we are not concerned with losing it.

3. The US bond is headed up. Since it is based on USD which is expected to crash, it is not going to do us much good investing in it.

4. The place to be in is precious metals, gold mining shares and essential commodities.

[pywong]

In learning to read the tea leaves, it is useful to understand what is inflation.

Many believe that inflation is caused by rising prices. Not true. Rising prices is a symptom of inflation.

Another misconception is that it is due to shortage of materials. Again, not correct.

If driven solely by a supply-and-demand imbalance, rising prices have absolutely nothing to do with inflation. If gasoline prices rise because supplies decrease relative to demand, this isn’t inflation. It is simply the free markets at work addressing a supply imbalance. Rising prices simultaneously retard existing demand and entice new supplies to market, leading to a new equilibrium level between consumption and production.

All throughout history, inflation has exclusively been rising prices directly driven by growth in money supplies. If you have relatively more money competing to buy relatively fewer goods and services, the only possible outcome is higher prices. And although the meaning of words gradually changes over centuries, if you look in any dictionary, encyclopedia, or economic textbook today you’ll find that inflation is monetary.

American Heritage says inflation is “a persistent increase in the level of consumer prices or a persistent decline in the purchasing power of money, caused by an increase in available currency and credit beyond the proportion of available goods and services”.

The problem is rising money supplies often coincide with supply imbalances in specific commodities, so usually both inflation and simple economics are co-drivers.

For example, global oil demand is growing as China, India, and the rest of the developing world drive more cars and transport more goods. But supply growth can’t keep pace, as big new oilfields are exceedingly rare. So much of oil’s bull is fundamental, it has nothing at all to do with inflation. But at the same time, oil priced in euros has risen slightly less than half as much as it has in dollars. So about half of the oil bull seen by Americans is largely driven by dollar inflation. And that applies to us in Malaysia as well.

Be aware that varying large fractions of the rising prices are purely fundamental. Global demand is straining global supplies. Rice is a great example of this today. But the remaining fractions of price increases we are seeing are the result of true monetary inflation. This is a direct result of the US Fed printing huge volumes of money (annual growth rate of 20%) to bail out the banks and mortgage companies. Anyone holding USD or money tied to USD pays a price in a decrease in purchasing power.

As you watch the US Fed and the Eurobanks lending money to all and sundry to prevent a collapse of the banks, remember that is inflationary and your ringgit is shrinking accordingly.

You can follow the links here for more discussions on this subject:

http://www.usj.com.my/bulletin/uploa...ad.php?t=22719
http://www.usj.com.my/bulletin/uploa...ad.php?t=22662

[pywong]

As explained here: http://www.usj.com.my/bulletin/uploa...ad.php?t=22474 page 3,
inflation allows the Ruling Class to pay less in wages and pensions.

[pywong]

An important element on reading the tea leaves is watching the financial institutions. There are 3 groups that we can monitor easily:
1. Banks
2. Mortgage Lenders
3. Builders

Let's start with the banks and list out which ones are suffering from write-downs and distress. This is not to say that they are in danger of collapse. But if their losses are in the billions, it bears watching, especially since the US Fed and the Securities and Exchange Commission seem to collude with bigger banks to swallow smaller banks.

There's more to this than what is reported in the news. It is necessary to read a wide range of analysis to understand the background and to remember that greed is the over-riding motive in all financial matters.

List of banks in distress or have suffered write-downs.

• Barclays PLC - $6.4B? (0) May 15, 2008
• Credit Agricole SA-$13.8B (0) May 15, 2008
• Societe Generale SA- $13.7 /$8.5B (0) on May 14, 2008
• Morgan Stanley - $16.1B (0) May 14, 2008
• Lehman Brothers - $7.2B (1) May 14, 2008
• Goldman Sachs - $5.4B (2) May 14, 2008
• RBS - $3.6B/$24 B (2) May 14, 2008
• HSBC Bank PLC - $5.3B (0) May 14, 2008
• Citigroup - $67.1B/$36B (5) May 8, 2008
• Merrill Lynch - $32.2B (1) May 8, 2008
• Washington Mutual - $1.6B (2) May 7, 2008
• Fifth Third Bancorp - $155M (0) May 2, 2008
• WestLB AG - $3.14B (0) May 1, 2008

• HBOS PLC - $2.5B (0) on April 30, 2008
• Bank of America - $4.4B (3) April 30, 2008
• Deutsche Bank - $11.3B (1) April 29, 2008
• National City - $200M (0) April 21, 2008
• JP Morgan Chase - $9.9B (2) April 17, 2008
• US Bancorp - $1.2B (0) April 16, 2008
• Wells Fargo - $2.9B (1) April 16, 2008
• Wachovia - $6.8B/$10.5B (4) April 14, 2008
• SunTrust - $718.7M-$1.5 B (1) April 13, 2008
• Mitsubishi Financial Group - $510M (0) April 12, 2008
• Mizuho MFG - $5.4B (0) April 10, 2008
• Bank of NY Mellon - $118M (0) April 9, 2008
• Sovereign Bancorp - $1.580B (0) April 8, 2008
• Bayern LB - $6.7B (0) April 3, 2008
• UBS - $38.0B/$26.5B (2) April 1, 2008

• IKB - $12.91B (0) March 20, 2008
• Bank of Montreal (BMO) - $639M (0) March 19, 2008
• DZ BANK AG - $2.1B (0) March 7, 2008
• HSBC - $26.5B (0) March 5, 2008

• ABN AMRO Group - $2.4B (1) February 28, 2008
• Royal Bank of Canada - $544M (0) February 20, 2008
• Canadian Imperial Bank of Commerce - $3.2B (0) February 20, 2008
• Credit Suisse - $5.95B (0) February 19, 2008
• Natixis - $1.8B (1) February 18, 2008
• Commerzbank - $855M (1) February 15, 2008

One thing we observe is that the number of banks getting into trouble is increasing month by month and the value of loss is also increasing - Apri USD 85 Billion, up to mid-May USD 200 billion. That is a monthly rate of USD 400 billion for May, which is almost 5 times that for Apr. The trend is very scary. If this continues, the chances of a financial collapse is very high.

Next, we will look at mortgage lenders.

[pywong]

The list of banks above with the numbers can be interpreted as follows:

Banks suffering write-downs (reduction in capital) are:
................No............Capital Reduction, USD B.... Raise Capital, USD B
Feb 08: ......6.............14.75......................... .........0
Mar 08: ......4.............42.15......................... .........0
Apr 08: .....15.............92.23......................... .......35.5
15 May 08: 13...........175.70............................... .68.5

In the first half of May alone, the write-downs has exceeded the total for Feb to Apr 08. Similarly for the need to raise capital. The trend is not good as it is accelerating. If this continues, the banks will collapse before the end of the year, especially when we consider Tier 3 (very high risk) assets which will be discussed in another posting.

See the attached file for a graphical presentation.

[pywong]

Watch this carefully. Either it is a ploy to siphon money out because of the fear of Anwar's takeover of the govt by Sept 16, or it is some dumb management over-paying for foreign acquisitions in the face of a financial crisis. Time will tell. If you have savings in Maybank, think hard.

Asian Wall Street Journal

Malaysia's Maybank Loses Luster
String of Purchases Raises Eyebrows Due to Premiums
By ELFFIE CHEW
May 19, 2008

KUALA LUMPUR, Malaysia -- It has been a tough year for Malayan
Banking. Its shares have sharply underperformed the broader market. It
has lost its position as the country's most valuable bank stock. Its
recent acquisitions and stake moves have raised eyebrows. To top it
off, many observers don't see its fortunes turning around anytime
soon.

......

[pywong]

A corollary of "Do not get into debt" is to save more. In saving more, it is important that we keep our savings in a stable form of "money", not paper money.

Observe what happens if China were to use increase the exchange rate of the RMB and encourage the Chinese to consume more.

The Answer for China’s Inflation Peter D. Schiff 18 May 2008

Letting the yuan (RMB) rise might be an answer for China, but it spells trouble for the US


• A stronger currency, commensurate with China's increased economic strength, would both tamp down inflation and allow Chinese consumers to buy more goods and services.
• By allowing their currency to appreciate, Chinese monetary authorities would no longer need to buy and remove as many dollars from the open market, producing an immediate reduction in the demand for US Treasuries, mortgage-backed securities and other US dollar-denominated debt.
• The result in America would be a simultaneous increase in both consumer prices and interest rates. Such developments would only compound the problems already rippling through the US economy.

http://asiasentinel.com/index.php?op...1206&Itemid=32

If China were to adopt the above policy, chances are the US economy will crash, along with the value of the USD. Our RM will follow accordingly. To protect ourselves, we should convert our cash to gold or silver.

[kpc]

If China were to allow the RMB to strengthen, wouldn't it make US exports cheaper and consumption in US more expensive?
The effect of this would reduce the large US trade deficits.

This would solve more problems for USA in the longer term.

[Joe Gomez]

If China were to allow the RMB to strengthen, wouldn't it make US exports cheaper and consumption in US more expensive?
The effect of this would reduce the large US trade deficits.

This would solve more problems for USA in the longer term.

If China were to do that, wouldnt she ( China ) be impacted in exactly the opposite manner ? Wouldnt she want to avoid that ?
Just curious .......

[pywong]

If China were to allow the RMB to strengthen, wouldn't it make US exports cheaper and consumption in US more expensive?
The effect of this would reduce the large US trade deficits.

This would solve more problems for USA in the longer term.

In theory, yes. But if a person is already bankrupt and in such a deep hole (trust me, it is a very, very deep hole. Debt = 5 x GDP) he can't even pay the interest, let alone the capital. I am afraid it is too late.

US has only a few choices:
1. Sovereign default
2. Debase the USD to zero
3. Nationalise all the privately held gold in US.
4. Go to war.
Maybe a few others I have not thought of yet.

[DarkNite]

I am afraid it is too late.

US has only a few choices:
1. Sovereign default
2. Debase the USD to zero
3. Nationalise all the privately held gold in US.
4. Go to war.
Maybe a few others I have not thought of yet.

What means Sovereign default?
What's the repercussion?
I also understand that China do invest a lot in US.
Would that means their investment also goes up in smoke?
Or they get to own USA?

[pywong]

What means Sovereign default?
What's the repercussion?
I also understand that China do invest a lot in US.
Would that means their investment also goes up in smoke?
Or they get to own USA?

Please read this article:
http://www.bankofengland.co.uk/publi...fs_paper01.pdf

Definition on page 8 & 9.

China investments in US: No easy answers. If a big bully owes you money and refuse to pay, what are you going to do?

What you want to be concerned with is what happens to your assets, not China's assets. China's problems would be the least of your problems in such a crisis.

[DarkNite]

Please read this article:
http://www.bankofengland.co.uk/publi...fs_paper01.pdf

Definition on page 8 & 9.

China investments in US: No easy answers. If a big bully owes you money and refuse to pay, what are you going to do?

What you want to be concerned with is what happens to your assets, not China's assets. China's problems would be the least of your problems in such a crisis.

Thanks for the link.
Been following your articles.
On China's problem being the least of my problem,
my apologies, on the contrary, it does affect my 'rice bowl'.
My boss company and several of his friends have
investment in China and planning to increase operations there.
And most of the goods and services are for US.
Before we did not monitor the exchange rate USD:RMB as closely as now.
It puts him and his friends in a dilemma.
We are trying to minimized the impact of this fallout as much as possible.

[kpc]

There are opinions that China and Japan will not allow the USD to depreciate too much or too quickly.
These central banks will keep on buying US dollars to prop it up.

B'cos if the USD falls over the cliff, who is going to consume all the manufacturing output of these two manufacturing giants?

So pywong,

could your predictions be too fatalistic at the moment?

[pywong]

There are opinions that China and Japan will not allow the USD to depreciate too much or too quickly.
These central banks will keep on buying US dollars to prop it up.

B'cos if the USD falls over the cliff, who is going to consume all the manufacturing output of these two manufacturing giants?

So pywong,

could your predictions be too fatalistic at the moment?

kpc, there are two ways to approach it.

1. You can put your faith in the Central Banks of China, Japan and the US. So their policies dictate the fate of your cash.

2. You can get out of the way by parking your cash in precious metals, doesn't really matter which - gold, silver, platinum. All 3 if you want to play safe.

Say, you are right and the US survives. From past trends, it is guaranteed that the USD has to devalue further. Her economy and total deficit cannot sustain the current value of the USD. Therefore, your RM depreciates accordingly.

Say, you are wrong and the USD crashes. What happens to your RM?

Either way, isn't it safer to park your cash in gold?

Concerning your point about China and Japan not wanting to let the USD crash because they have too much invested in the USD. It is worthwhile to remember that China and Japan is merely one factor in the equation. There are other more important considerations.

The US Fed is frantically trying to save her crony banks and printing money like crazy to do so. The Fed is accepting very poor quality and dodgy assets from the banks in exchange for the USD. Bear in mind, the Fed has only USD 860 billion and the figure is dropping fast. At the rate the Fed is going, by the end of the year, the Fed will be holding junk assets and zero cash.

2nd point: The Fed and the US Treasury is fighting a "war" to suppress gold price. It is estimated that the US have less than 4000 tonnes left. Historically, a nation that has no gold and no foreign reserves will be declared bankrupt because other nations will not accept her currency. Last month someone was selling a lot of gold so much so that the price dropped by more than USD 150/oz to USD 850/oz. That gold cannot be replaced because annual production shortfall is 1000 tonnes.

Gold is now shooting back. It has exceeded USD 900/oz this morning. China, India, Russia and the Arabs are rotating their USD into gold. By the end of the year, gold should reach between USD 1150 to USD 1600/oz.

3rd point: US deficit is now > USD 9 trillion. That is a 9 with 12 zeros. You stack USD 100 dollar note side by side, you can build a bridge from KL to Johannesburg. Actual debt of the US Govt is of the order of USD 50 to 60 trillion, taking into account her social security obligations. She can't pay the interest, let alone the capital.

4th point: The US is fighting 2 wars - Afghanistan and Iraq. Historically, no power in the world has ever managed to subdue Afghanistan. I don't think the Afghans intend to let the Americans create a precedent.

BTW, you need to read the Rat Race series to see another angle to this.

Irag is bleeding the US. She is in a quagmire but too frightened to admit it.

5th point: There is USD 700 trillion of financial derivatives floating around, most of it created by the US banks. All it needs is a spark and the whole thing will blow up. Last August's shock was just a prelude. The list of bank write-downs and capital raising is a very strong indication of financial stress. Wait till you see the number of mortgage institutions going bust. It is spooky.

Whether Obama, Clinton or John McCain comes in will not make a whit of a difference. Ron Paul, maybe. Even then there will be tremendous pain. Are the Americans willing to go through that after enjoying the fruits of empire for more than 60 years. (It is just like the NEP for the UMNOPutras.)

Historically, govts in such a position ends up bankrupt.

Coming back to my point, what China does, is not really going to make much difference to the US. China herself is in a bubble that could crash if her policies are not managed properly.

Regarding your question about who is going to consume Japan and China's production, that is their problem, not ours. For a start, they could raise their exchange rate and consume it internally.

For me, I prefer to hide in a cave and meditate.