All over the planet, paper is still what they are buying.
Even though the Bank of Japan took its first, tiny baby step towards normalizing interest rates (when it doubled its overnight lending rate from 0.25% to 0.5%) the yen fell on the news, because the BOJ had showed, once again, that it was ready to keep supplying the financial trade with all the low-cost credit it wanted, and that nothing much would change.
Of course, speculators could still borrow yen, trade the currency for, say, New Zealand dollars, buy NZ bonds and make a cool 5% gain. Leveraging their capital 20 times, they could double their money in a year. The hedge fund manager who put $10 million into this ‘yen carry trade’ could borrow $200 million worth of yen, invest the proceeds in New Zealand bonds, make a net profit of about $10 million (after paying interest on the yen loans), then take 20% off the top for himself, giving him compensation of $2 million on this trade alone.
The carry trade keeps everyone happy. The Japanese are happy because they believe their low lending rates help keep their economic expansion going. GDP growth in Japan is running at 4.8% – not bad at all. And Japanese stocks are trading at a 15-year high (although that is not saying much, since they crashed 18 years ago and still have a long way to go before they get back to where they were in 1989). The hedge fund investors are happy because they’ve made an 80% gain. And all other investors are happy because the Japanese are helping to pump the great flood of liquidity that is making them rich…or at least, making them look rich.
All over the world, the tide of easy money is pushing up asset prices. Democracy and capitalism are supposed to be the big victors of the post-Cold War period, but the hottest markets are neither democratic nor really capitalistic. China is soaring, of course. But so is the nation that kicked out U.S. troops 35 years ago so it could enjoy its own miserable system of misgovernment – Vietnam.
The Financial Times reports: “After watching the formal stock market’s main index soar by 249 [percent] over the last 13 months, Vietnam’s emerging middle class is in the throes of stock market mania and students, civil servants and state enterprise managers with cash to spare are all rushing to buy shares and dreaming of windfall profits.
“The recent bull-run on the formal exchange, with 107 listed companies, has been propelled partly by foreign investors, eager for exposure to one of Asia’s fastest-growing economies.”
Why is the Vietnamese stock market manic? Part of the answer is that Vietnam is privatizing and embracing elements of the western, capitalistic system. But the more important part of the answer is that there is a lot of money around and it will go anywhere where the going is good.
The Financial Times continues: “‘It’s a frenzy,’ says Jonathan Pincus, the U.N.’s chief economist in Hanoi. ‘All the chatter in Hanoi is about people investing in the market. I don’t know if anyone knows what these companies are worth, but they are buying the paper.’
“Until recently, Vietnamese tended to put what savings they had into more traditional assets such as gold or real estate. But in the past year the number of trading accounts in the Vietnamese stock market has almost quadrupled from 32,000 to about 120,000.”
Who knows how to say ‘bubble’ in Vietnamese? The callow Vietnamese traders probably haven’t learned yet. Perhaps they have no word for ‘crash’ yet either?
We don’t know, but we will bet that the Vietnamese lexicon will be enriched by these two words just at the moment that Vietnamese investors are impoverished by millions of disappearing dollars’ worth of paper assets. Then, the Vietnamese who were once buying gold and real estate will probably start buying gold and real estate again.
But that is all in the future. And if you believe the cover story in this week’s Economist, the future may be in the past. “The End of the Crash Era,” is the headline; the picture above shows dinosaurs with coins on their bodies. You may no longer need gold coins, says the article, because the things they were supposed to protect you against are things of the past. In this new era, no crashes means no need for crash protection. No need for crash protection means no need for gold.
But wait, what’s this? The price of gold shot up $23 yesterday to $684. This is telling us something. What?
Gold is what you buy when you worry that the paper is not necessarily as valuable as other investors think. What you get at the top of a credit expansion is a lot of financial assets – paper assets – bid up to prices that they don’t deserve.
Just look at the Vietnamese market. A company that makes copper cable just went public at a market capitalization of $140 million. The company makes only $1.1 million in profit, giving a P/E ratio well over 100. Making copper cable is not exactly a high-tech high growth business. So, we can just imagine that investors are getting carried away and that the paper they are buying is not worth as much as they believe.
Of course, what happens next is just what you’d expect. The price of the paper goes down. Gold, which tends to hold an intrinsic value no matter what, will be a relatively better place for an investor’s money.
Every era has its endangered species, but we doubt that gold is today’s dinosaur. We would guess that it is the credit expansion that faces extinction, not gold. And when it does, people will look to gold for safety.
Markets and Money