As the so-called peripheral European Union countries struggle with debt crises and the US embarks on another round of stimulus spending, governments – including those in Asia – are taking the wrong response to their economic woes.
So argued Jim Walker, founder of research house Asianomics and former CLSA chief economist, in a speech at AsianInvestor’s Southeast Asia Institutional Investment Forum last week. He made some bold comments, including that the euro is “finished”, China’s problems are worse than Europe’s, and Chinese consumers are reining in spending, not increasing it.
His advice as a result: sell the euro to parity with the dollar; buy 10-year US Treasuries and gold; sell China consumer plays; and sell Australian banks and the Australian dollar.
Walker kicks off by arguing that the euro can’t be saved as things stand, because the problems are far too serious in places such as Ireland, Greece, Portugal and Spain.
In the next five to 10 years – not five to 10 months or quarters – all those countries will be asked to deflate their way back to some form of competitive equilibrium, says Walker. “This is politically impossible. Not a single currency in the world has withstood that kind of pressure," he adds, with one exception: Hong Kong during and after the financial crisis.
Many countries devalued their currencies in that crisis, but Hong Kong was left “high and dry”, pegged to the dollar. In 2003, nearly six years after the Asian crisis began, Hong Kong was still suffering as a result; there were stories mooting ‘the end of Hong Kong’, says Walker. “That’s how hard deflation is.”
Moreover, Hong Kong not being a democracy helped the SAR government to maintain the peg. “You watch the Europeans try,” warns Walker. In addition, the global economy at the time that Hong Kong was recovering was in relatively good shape, so Hong Kong was deflating against a great back-drop.
Ireland, Greece, Portugal, Spain and probably a few others will be deflating into a much worse back-drop. “So in five to 10 years – two to three election cycles – there’s no chance that all these countries will still be in the euro,” says Walker.
“When we look at the difficulties of the US dollar and quantitative easing, you should remember that the euro is 10 times worse,” he adds. “You should be making sure you sell it.”
Walker then turns to the issue of stimulus spending and the reported recovery of the consumer and manufacturing sectors in China and the US.
Given the level of capital that has been injected into these countries’ economies in the past two years, he says, their purchasing manager index (PMI) readings are very low, at around 55. They should be at 65-70, which would indicate a broad-based economic recovery, says Walker. (A reading above 50 indicates that the manufacturing sector is expanding, and the higher the number, the broader – not the stronger – the expansion is.)
In 2009, China added 40% of its 2008 GDP in terms of money supply, and this year it has added 30% of its 2009 GDP in money supply, notes Walker. “There’s no miracle in China; it's called inflation,” he says. “And when monetary stimulus there turns into inflation – as it quite clearly is now – and has to be reversed, expect that PMI and other measures to fall very quickly.”
At present the most expensive stocks in China by far are consumer-related stocks, says Walker, because everyone believes the Chinese consumer is on the march. “He is on the march,” he adds, “but marching backwards", as inflation is hitting him in the pocket.
Walker goes on to argue that the more stimulus there is from the US and elsewhere, the less emerging markets have a chance of emerging, as they are the ones hardest hit by high commodity prices.
The reason government spending is “so pernicious and dangerous”, he adds, is that there’s no difference between public and private debt, because taxpayers fund government spending. “Hence, as governments build debt, people save more,” says Walker. “So governments in the US and Europe have over the past three years forced people into a debt deflation, a deleveraging cycle that will continue for the next five to 10 years. All past crises have shown this to be the case.”
But it is China that has the biggest problems globally, he argues. Its problems are worse than Europe’s because of how the world's most populous country has responded to the crisis.
China was in bad shape before the crisis began, says Walker. It is a very unbalanced, export-orientated economy, unusually for such a big country, but also very investment-orientated because it’s been suppressing interest rates for so long.
And now it is the top country worldwide in terms of money supply and has been growing its money supply sharply over the last two years and pouring it into property and infrastructure development, which is not really needed, he says – particularly the infrastructure.
Now the Chinese government is trying to cool the property market, but the only way to do that is by raising the price of capital, not by “fiddling around with prices here and there, reserve requirements etcetera”, says Walker.
This stimulus would also have a negative effect on the country’s currency. “If the renminbi were a free-floating currency it would be in freefall, not rising,” he says. “China can’t print as much money as it has and expect the RMB to be rising.”
A slowdown in China could also have negative effects on the Australian economy, which is why he recommends selling Australian banks and the Aussie dollar, he told AsianInvestor after the presentation.
Walker argues that such a slowdown could undermine the prices of commodities supplied by Australia, at which point substantial Chinese money flows into Australia that support property prices may disappear, leading to bad debts for Australian banks.
Meanwhile, he is fairly positive on Japan, arguing that the yen looks quite strong relative to what’s been going on in the rest of the world. Why? There’s now no interest rate differential between Japan and the rest of the world. “And it is probably the one major central bank that has run a sound money policy,” he says.
“That’s why the currency keeps going up, which is beneficial for Japan," he adds. "Japan doesn’t need growth, it’s a declining society; it needs to protect what it’s got.”