Fear is everywhere. Let’s look at the fears. The Yen carry trade seems to be the big fear on a global basis. Subprime mortgage failures are an additional fear in the U.S.
We do agree that subprime mortgage problems will lead to the failure of several poorly run sub prime mortgage lenders, and should lead to criminal charges for many of the mortgage brokers who sold fraudulent loans to the mortgage companies. It may even follow that some the founders of these poorly managed, irresponsible and unwise lenders should return their ill-gotten stock profits that they received before their companies blew up.
This is a problem in a sector of the U.S. economy. It is a serious problem for that sector. It is however, not a serious problem for the world economy.
Sure the subprime problem could move to alt-A mortgages (mortgages that are a step above subprime). It might also cause some selling of the U.S. dollar. This would be good for the price of gold.
The second fear, and the one that we see as more powerful, is that the Yen carry trade will implode, and all of the participants will cease borrowing in Yen at very low interest rates, and then buying assets elsewhere to get higher yields. If they cease, the yen will skyrocket in value causing hundreds of billions of dollars to exit global bond markets and thus drying up capital worldwide.
The extrapolated fear is that this will create a lack of world wide liquidity, and an implosion of bond, stock and commodity markets in many countries.
WORLD STOCK BOND AND COMMODITY MARKETS ARE HAVING A NORMAL AND TEMPORARY CORRECTION
Although world stock, bond and commodity markets will have periodic corrections, there are three reasons why the yen carry trade will not collapse overnight.
Reason #1-Japan finds the carry trade useful and wants it to continue. The great majority of participants in the carry trade on a global basis are Japanese households who buy Japanese investment trusts to increase their income. This is because Japanese interest rates are miniscule and to increase income Japanese households buy such trusts. According to the Nikkei Weekly, at the end of 2006, Japanese households held over 23 trillion yen or about 200 billion U.S. dollars of these trusts a rise of about 46% in 2006.
That is a lot of money for Japanese savers. Clearly, it would be political suicide for the government of Japan to allow them to be wiped out. Thus, any unwinding of the Japanese investment trust, carry trade will take a very long time. We do not believe that it will begin in earnest until interest rates in Japan rise to a level where Japanese investors can get a much higher return than the 1/2% per year return currently available in Japan.
Reason #2-It is very difficult to collapse the world economy with the growth of money supply that is being seen worldwide. For example, over the last 12 months the growth rates of some of the world’s monetary aggregates that we put in our last letter (which we got from our friend Larry Jeddeloh) were: Russia M2 +48%, UK M4 +13%, Euro zone M3 +10.6 %, China M2 +15.9 %, Australia M3 +13%, Korea M3 +10.6%. These are just a few of the fast money supply creation rates world wide. The U.S., Canada and many other countries also have strong growth rates of their monetary aggregates.
Reason #3-World central banks will supply even more liquidity to avoid a politically unpalatable meltdown. For over 40 years, in times of financial crisis, world central banks (and especially the U.S. central bank) have added liquidity to defuse problems and increase confidence in the global financial system. This behavior has historically had the effect of minimizing the impact of crises and maximizing the opportunity for those who have the liquidity to buy when assets are cheap.
It is not only central bankers that will work hard to defuse problems, and avert meltdowns in the markets. Today, Christopher Dodd, the Chairman of the U.S. Senate Banking Committee is floating trial balloons around Congress about the U.S. Government spending billions to bail out troubled subprime borrowers.
FOR THE ABOVE THREE REASONS, WE DO NOT THINK THE WORLD CAN HAVE A MAJOR MELT DOWN AT THIS TIME. WE SEE THE CURRENT DECLINE IN WORLD BOND, STOCK AND COMMODITY MARKETS AS A NORMAL CORRECTION
Let us assume people see the problem that has been created by the U.S. triple deficits, and the U.S.’s unwillingness to confront off balance sheet liabilities like social security and Medicare. People come to realize that gold is a haven of safety and they sell U.S. dollars and buy gold. We believe that over time this will happen, yet the gold market is too small to contain much of the ocean of liquidity. IF GOLD WERE TO TRIPLE IN PRICE, people will still have a lot of excess liquidity, which will go into stocks and bonds globally. People have historically looked for safety and growth. Gold provides some safety as it is the last ‘real’ money in our opinion. Investors will also use some of their liquidity to seek growth and, several countries are exhibiting fast economic growth. These countries will also attract a lot of capital looking for good returns.
DESPITE THE FEAR, FAST GROWTH CAN BE FOUND IN MANY PLACES
Just as an example, let’s take two of today’s headlines:
• Japan Economy Reports Best Annual Growth in 3 years—-Financial Times 3/13/07 (Japan grew GDP by 5.5% in the fourth quarter of 2006)
• Fueled By Oil Money, Russian Economy Soars—Wall Street Journal 3/13/07–Russian GDP grows for the 7th straight year.
Even though we favor other countries with higher growth rates and more political stability, these are examples of how headlines about fast economic growth dominate the press everyday.
Best wishes to you all.