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“Its only when the tide goes out, that you learn who’s been swimming naked”

Economic growth
By Paul Hodges on 24-Jun-2013

Financial markets fell around the world last week, as the $10tn tide of central bank liquidity began to retreat.  This highlighted very clearly how central banks’ misguided policies have caused markets to lose their role of price discovery.  Asian investors are only now realising that China may have hit its Minsky Moment.  The blog headlined this risk a year ago. 

A Minsky Moment is named after Hyman Minsky, who warned that a long period of stability leads to major instability, as investors become complacent about risk.  This occurred in September 2008 on the subprime issue, as Pimco and the blog both warned at the time.  Now central banks have created the same problem again.

China is the first example of this, as investors realise they have overpaid for assets during the bubble, and are rushing for the exits.  But sadly, China is not along in being in this position – although its new leadership is unique in understanding what is happening. This is why, as the blog warned 2 weeks ago, the world will become a ‘scary’ place.

There are in fact now four areas of major global stress, in addition to China:

  • The US economy appears very treacherous.  On the surface, it seems to be in recovery mode, with housing seeing modest improvement.  But dig deeper into the data, and the picture becomes much more speculative.  And the major rise in interest rates now underway will be a heavy blow for potential new homeowners.
  • Western Europe has been very complacent since last year’s European Central Bank promise to ‘do whatever it takes’ to safeguard the banking system.  As the BIS (the central bankers’ bank) warns today, since then we have only seen more rhetoric, not action.  There is still no banking union, whilst economic and political union – essential for monetary union – are not even on the agenda
  • Japan has placed its bets on Abenomics.  This relies on lenders being prepared to lend at today’s low interest rates, whilst the government does its best to ensure they lose money by increasing the inflation rate and devaluing the currency
  • Oil markets have soared due to the liquidity programmes.  Free money is always attractive to speculators and traders.  But record high prices are not normally seen when supply is increasing rapidly, demand is flat, and stocks are at high/record levels

Each of these situations clearly pose a serious threat to the global economy.  Yet policymakers, with the exception of China, have fallen into the trap of believing their own propaganda.  They are as complacent as investors about the risks.

By the time they wake up, the rush for the exits may well already be in full flood.  As the great investor Warren Buffett wisely noted a decade ago, “Its only when the tide goes out, that you learn who’s been swimming naked”.  

Latest benchmark price movements since January and ICIS pricing comments are below:
Naphtha Europe, down 12%. “Traders managed to sell only one cargo on the open market platform this week, compared with ten cargoes last week”
PTA China, down 10%. “The market outlook is bearish because of abundant supply and weakening demand”
Benzene NWE, down 10%. “Many players argue that improved availability and exchange rate dynamics could help pull the market down”
Brent crude oil, down 7%
HDPE USA export, up 9%. ”Talk from Asia of less imports available from Iran”
S&P 500 stock market index, up 9%
US$: yen, up 11%