JBTC

So I asked this question a while back. With the establishment already acknowledging the risk (head of OECD speaking on Bloomberg), what could /should/will the regulators and governments do? The level 1 thinking is the negative rates are leading to a bank crisis. The level 2 thinking may be 1) how much of this is reflected, when leading European bank stocks are at a 30-year low? 2) Could ECB etc do something to soften the crisis? The longs need to ask the question, and the shorts need to think even harder about this.

I agree. So China's manufacturing competitiveness has eroded somewhat compared to its past. But it remains mostly competitive to both the DM countries (lower cost) and EM countries (unparalleled scale, supply chain, infrastructure, worker quality). I suspect even taking out the benefit of lower commodities/oil, China will continue to run surplus.

Well that's sort of my point: when no-one wants to hold cash, and passes it on to the next person as fast as possible, you get a rise in the money velocity and, all else equal, inflation. Which is what the central banks think they want. You're assuming the cash has to be parked somewhere. That's exactly what the central banks are trying to stop. They want it to go round and round. First of all, is it happening? As rates have come down, has money velocity gone up? I want to know. Second, if it is and somehow causing inflation, that's great news isn't it? Because we can finally get rid of negative rates. Back to normal - whew! I actually don't completely discount the possibility of seeing inflation. Maybe that's the ultimate contrarian trade. Call me biased but I don't quite like the negative rates death spiral seemingly unfolding before us...

ni-co, My understanding is much of Chinese debt is internal, meaning that it is borrowed from domestic savers, not from foreigners. A lot was also dollar based - borrow at 1% in the US, lend at >>1% in China, minimal fx risk because of the peg = nice carry. Chinese GDP is over USD10tn, and some people peg Chinese debt as much as 3x GDP, or USD30tn. Whatever your "a lot" is, it's likely small when measured in China's scale. Yes, but not necessarily small when compared to: 1. Chinese borrowers' ability to repay in dollars 2. Chinese capital and current account flows 3. Chinese bank equity. These are the things that matter when it comes to whether China will have to devalue (which I believe they will). Bottom line: all EM's are having moderately serious issues with $ debt. Exactly. The inflowing dollars were converted into yuan (in the end the PBoC bought those dollars with newly printed yuan and invested them into US treasuries held as reserves). The capital, in form of newly printed yuan, found its way – through the regular and the shadow banking system (multiplier effect!) – into the Chinese economy. A lot of yuan denominated loans are directly or indirectly dependent on those capital flows. Now the flows are in reverse-gear and the multiplier effect works in the other direction, tightening credit conditions. Even worse, by trying to stabilize the yuan against the dollar (selling USD and buying yuan), China is actually tightening domestic money supply as well, thereby making the problem worse. I don't want to go into details, other than saying for most China watchers, foreign debt is not China's Achilles heel. See the quote below and a full article on this subject. "Another concern is that the weaker RMB will increase China’s external debt burden, a key ingredient in both the Latin American debt crisis in the 1980s and the Asian financial crisis in the 1990s. In our view, there are far fewer risks associated with China’s current external debt than those crisis-ravaged countries." http://www.barrons.com/articles/does-chinas-external-debt-pose-a-major-risk-1444726980 I however do not disagree China may have to devalue. This is off topic but perhaps important to many. The current account is no problem. China continues to run huge surplus in current account, especially in goods. Basically the rest of world has stopped making things and can only buy from China. This is partly due to misguided industrial policies of many DM countries where manufacturing is regarded as outdated. But this is reality today. In services, there is a deficit, as China has to buy Hollywood films and the millions of tourists are spending overseas. But all in, FX piles up everyday due to China's manufacturing competitiveness. The risk is in capital account. China has run up major asset bubbles, mostly in housing. It tried to ignite a bubble in stocks last year, but it was not as successful. Increasingly Chinese companies are finding it difficult to make money at home. All of this is compelling money to leave China. Companies are buying up overseas businesses and commercial properties. The individuals have pushed up property prices from Vancouver to Sydney. Here, money leaks out everyday. So it seems to me both factors need to be taken into consideration when thinking about Rmb. Based on what has occurred in Europe, Japan, etc, I am tempted to think a cheapening Rmb is helpful to the Chinese government. However, this will benefit mostly companies that export, rather than consumers who buy imported goods. That is a problem, because Chinese government's stated goal is to re-balance, meaning to move to a consumer based economy. By cheapening Rmb, consumers' buying power is weakened. So nothing is too obvious. In the end, I feel the government will probably give up on its goal to rebalance (which is a LT benefit) and try to protect the exporters.

What do you mean? Both Apple and Google are examples of companies which create wonderful products. Banks instead are very useful, I agree. But I would not define their products nor services wonderful. Therefore, I don’t see how a comparison between something that’s ‘necessary’ and something that’s ‘wonderful’ might make much sense… Cheers, Gio Sorry we weren't discussing the investment merits between banks and Apple etc. I was trying to say that human society progressed despite not having smart phones in the past 1000 years. But without banks the human progress would not have happened. Now with the onset of negative rates, looks like we may need to go back to our caves :-(

1. Handelsbanken's AR suggests corporates are starting to pull deposits. 2. There are lots of options - bonds, stocks, real estate, gold etc. 3. Yes. One of the small Swiss banks already has I believe. 4. Yes - or raising borrowing costs which I believe has happened in Switzerland. Agreed re banks vs. Apple and Google! I don't think NIRP stops banks from functioning per se - but I do think it makes life very hard for them and crucially I think it has all sorts of unintended consequences. Perhaps most importantly it makes it abundantly clear that easy money hasn't created "escape velocity". Other assets are not replacements for cash. You can buy stocks from me, but then I am stuck with the cash. I can buy a house, then the seller is stuck with cash. The cash has to be somewhere. If not in the bank, where? I suppose the central banks wanted to get people to use cash to buy stocks etc. But now with negative rates, stocks have crashed. So apparently there are not enough people willing to take their cash to buy stocks. -0.1% is no good, but -30% is worse. So some banks have started to charge more. I frankly always thought they could. If the negative rate environment applies to all banks, of course they can charge whatever they want, as long as they don't over charge relative to competitors. Regarding easy money, I am not going to justify it. But the key question is - what could the central banks have done better and what could they do now? If they are doing the best they can (not saying they are, I just don't know much about these things), we just need to move on. Steve Eisman, of Big Short fame, wrote a piece in NYT last week saying that the big banks are not the issue today. The issue is income inequality, which has caused the poor to borrow to finance their lifestyle. He may be right or wrong. If he is right, I don't know the solution to that. These are big issues. I wish I could understand them better, but I imagine neither Buffett nor Watsa has a solution or invests based on these imponderables. But I digress...

ni-co, My understanding is much of Chinese debt is internal, meaning that it is borrowed from domestic savers, not from foreigners. A lot was also dollar based - borrow at 1% in the US, lend at >>1% in China, minimal fx risk because of the peg = nice carry. Chinese GDP is over USD10tn, and some people peg Chinese debt as much as 3x GDP, or USD30tn. Whatever your "a lot" is, it's likely small when measured in China's scale.

petec is trying to think through the negative rates. I was hoping to hear more thoughts on this. 1. Some of you are familiar with Sweden. They have had negative rates for a bit and just made the rates even more negative. Does anyone know what the Swedish banks are seeing? Is there a run on the banks? 2. What fundamental difference is there between zero and small negative rates, in terms of customer behavior and choice? I can imagine people arguing 10 years ago that if rates fall to zero, money would pour out of the banks. It hasn't happened, has it? For the poor, maybe it's easy to move their $1,000 out of their bank and put it under the mattress. But realistically for the vast majority of the rich and the middle class, what are options are we really talking about? 3. I recall seeing a notification from IBKR that they will start charging negative rates to customers. Could banks do that at some point? 4. To the extent that negative rates for customers are simply impossible, could the banks start charging for checks and all sort of transactions to make up for the loss in NIM? I of course haven't got the answers to the questions. But we own businesses which hire people (hopefully capable) to deal with all sorts of difficulties. Is the negative rates the thing that will finally end the banks and hence the civilization? I am quite sure without banks our life will be more miserable than without Apple and Google combined. I can understand DB and other European banks are under pressure due to a number of headwinds. But I would be much more worried if indeed the negative rates by itself will stop banks from functioning.

ni-co, My understanding is much of Chinese debt is internal, meaning that it is borrowed from domestic savers, not from foreigners.

ni-co, great post. A couple of questions: 1) So is this potential crisis being triggered mostly by negative interest rates, or are there other factors that have caused the kick-the-can-down-the-road approach by the Europeans to no longer work? 2) Assuming ECB knows what you know, is there anything they can do to forestall the crisis? Is there a way for us to tell if ECB sees what you see? I suppose they do talk to the banks they regulate. Thanks for your insights.

This may be a profound thought. 1) Surely the battle to beat the market involves both the investors and the 500 stocks selected by employees of S&P. Most of the discussion has been about how the investors LOST the battle, while it could be that at least in the past decade, the few guys at S&P did a great job by removing losers and adding winners. They surely have picked APPL, GOOG, FB, AMZN, etc out of their own initiative. 2) By the same token, perhaps those guys at S&P in the decade prior made horrible mistakes by including stocks such as Enron. The value guys outperformed because they were able to commit less such errors. 3) S&P 500 clearly has the benefit of diversification. In the past decade our world increasingly moved to a knowledge based economy which is more prone to winner-take-all. Value investors generally fail to embrace the infamous FANG, partly because they own only 20-30 stocks, which does not allow them to cast a wide net in order to catch the very few winners. But S&P can try to be inclusive. Maybe in the future a concentrated portfolio will have its limitation.

Belatedly those "best" stocks are heeding the call. SBUX -7%, NKE -5%, FB -6%, HD -4% Is this capitulation or the start of a more serious leg down?

US new housing construction remains at a very low level historically despite the recovery in the past few years. The negative sentiment is either housing has gone up a lot (prices yes) or the younger generation no longer lives in houses and they rent apartments in the city. If you look at the US economy sector by sector, I am hard pressed to find one that has better potential than housing. Some of the good vehicles are NVR certainly (barely sold off), MHK (down some), HHC (fell like oil stocks given it has assets in Houston), JHX (very high quality IMHO), and BRK which also has sizable housing exposure.

Was told to buy USD/CNH in IB. Never tried though. Negative carry, rates can change quite a bit due to Chinese central bank attempting to squeeze speculators from time to time.

Curious - are they cheap? If there are only a handful of good companies in the emerging markets while hundreds of billion dollars are chasing them, the math doesn't seem too encouraging.

How do you short cnh? I have been looking for an asymmetric way to do this. Outright; USD-CNH spot trade. Not asymmetric at all. I'm OK with a linear return profile here (for now). Not sure what asymmetric ways there are to express a negative view on China or CNH, to be honest.. Maybe one could buy put options on things that trade inversely with Chinese sentiment and Chinese consumer purchasing power. I.e. stuff like LVMH / Salvatore Ferragamo. Or buy put options on commodity & commodity-linked names like Glencore. Welcome your views. I periodically expressed a negative China trade by shorting YINN (a China ETF), but that's not asymmetric. Sorry, in what brokerage account could you do the USD-CNH trade? Thanks.

Not a lot...

http://www.wsj.com/articles/manhattan-townhouse-hikes-price-to-lucky-28-888-million-1452007145

For one, the Chinese property craze is sustained by the Chinese in China watching China Central Television. 60 minutes is irrelevant. Also, in China, people don't trust anything intangible - they don't even trust things that are tangible - there are fake goods everywhere. Real estate is as real as it gets there.

I hate to say this about the V/MA haters. Investing is not about possibility - it's about plausibility, it's about the odds of your claim panning out. Also remember extraordinary claims require extraordinary proof. Given it has taken decades for V/MA to dominate (in spite of the non-stop attacks from merchants, governments, tech players, etc), given the network effects, given the secular growth trends, given their strong executions, claims that V/MA can be eliminated or weakened with ease surely require extraordinary evidence. But I haven't seen such evidence. Moreover, some who make bold claims do not seem to have the most basic knowledge about the interchange systems. To me the more pressing questions about V/MA are 1) what growth can they sustain given the high penetration in developed markets? Note that they are mostly shut out of China. 2) given they are no longer bank owned, can banks force pricing concession over time, hence eroding their margins? 3) what happens to their margins if Apply Pay etc becomes the norm in 10 years? Just a few examples. Given they are at 30x, even marginal reduction in growth rates and margins will impact the investment.

Sorry I can't help you. :) V/MA post such fat margins and growth that attracts a lot of skeptical minds. Some think the tech startups will win. Some say the tech stalwarts. Some say the banks. The fact that they can't quite agree gives clues about the strength of their ideas. Payment systems are not just technology. As I said before technology is a small part of it. It's only natural that banks were the central part of the payment system that is V/MA today. Merchants, while having benefited enormously from V/MA, grew unsatisfied, because merchants make anemic margins. Walmart led an alliance to try to come up with its own system, which failed to fly. So far all the victories merchants have had against V/MA come from the courts, not the marketplace. It's highly unlikely a bank such as JPM can take on V/MA. Unless all the banks in the world try to come together and start over again, given V/MA are no longer bank owned. Even in Canada and Australia where banks are highly consolidated, V/MA rule. The tech companies should not try to kill V/MA. They should try to sell to V/MA and cooperate, as Apple has done.

One more announcement of the death of the credit card model... http://www.forbes.com/sites/bruceupbin/2013/02/15/tokenization-and-the-collapse-of-the-credit-card-payment-model/

Seems to me the fascination with technology may be overdone. V/MA rule the world not because of the technology they use. It's the same thing over the past few decades. It's the marketing and alliance building so powerful that both millions of merchants and billions of consumers have agreed to adopt. V/MA own no technology. In a similar way Western Union has dominated money transfer. It has nothing to do with technology. WU is about marketing and compliance. That said the outlook and moat WU has is not comparable to what V/MA have.

Anyone invested in IEP and any thoughts on why or why not?

In the video Russo said that his strategy of investing in global consumer companies expanding in emerging markets worked for 20 years until the recent couple of years. Does anyone have any thoughts on whether the recent slowdown in EM is temporary or secular? In the past decade when China was growing, it seems all EM countries were growing with it. With China slowing and commodities not doing well, most of them (except perhaps India) have faltered as well. On one hand, the EM per capita consumption is low for most consumer products. On the other, most EM countries have failed to move beyond middle income and become truly successful. Clearly Mr. Russo is assuming the long-run growth of EM consumers.