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The US Economy. Growth Strong but Not Fast. Trade Expressions. PDF Print E-mail
Written by Burnham Banks   
Friday, 31 July 2015 03:34

The US economy remains the most important and vibrant in the world. China is fast catching up but for market depth and liquidity, for corporate governance and clear and well defined regulations, the US is the prime market for fixed income and equities.


Trade Expression:


1. Long term buy US equities.

2. Long term overweight USD.

3. Underweight exporters.

4. Medium term buy US non agency RMBS.

5. Medium term buy US high yield via loans and bonds.

6. Medium term buy US 30 year long bond.

7. Medium term short US 2 year bond.

8. Medium term cautious US investment grade.

9. Short term cautious US equities.




1. Long term growth is stable. US continues to enjoy a technological advantage over the rest of the world, especially developing markets.

2. Long term growth rate has been chronically over-estimated. This creates mis-estimation of cyclical highs and lows.

3. US is intentionally becoming less reliant on outsourcing of manufacturing as well as importing oil. The result is a more self-reliant economy. 4. Outsourcing manufacturing implies importing finished product.

5. The US trade balance is likely to move towards balance over the long term.

6. The housing recovery remains on track although it is a mature recovery. Affordability and house hold balance sheet recovery will support the stability of this recovery.

7. Healthier tax receipts and reduction of military footprint is reducing the budget deficit.



1. The Fed wants to raise interest rates for a host of reasons.

2. The delay is because it cannot raise interest rates, not because it doesn’t want to.

3. The rate hike trajectory will be very gentle.

4. The Fed is not independent, it considers the debt service costs of the US treasury in its calculations.



1. The Fed balance sheet is acutely inflated. At some stage the balance sheet will need to be shrunk.

2. Equity market valuations are being supported by low interest rates, access to credit, share buy backs and ample liquidity.

3. Earnings growth is not accelerating. Bloomberg estimates historical PE at 18.4, current PE at 17.8 and next year PE at 16. This implies earnings growth of 3.6% in 2015 and 11% in 2016.

4. Domestic politics. The US election will take place Nov 2016. At this early stage in the process many unexpected things can happen.

5. Geopolitics 1. A strong USD can destabilize the dollar bloc economies. It can disrupt non-dollar bloc economies as well as currency hedging costs enter the calculus for sovereign funding. The net currency hedged yield for owning a long dated BRL or IDR bond may be less attractive than owning a US treasury for example.

6. Geopolitics 2: A more self-reliant US has implications for its strategic and economic allies. Witness what self-reliance in energy has done for the political stability has done for the Middle East as American strategic assets are gradually tapered from the region.



Rationale for trade expressions:


1. Long term buy US equities.

- I like US equities for all the reasons under Economy. The economy is robust but growing moderately.

- I are cautious for reasons Risk 1, Risk 2 and Risk 3.

- Absolute valuations are not cheap. Valuations relative to treasuries are cheap. Therefore valuations are very dependent on rates. The ultra-long duration nature of equities may lead to underperformance in a rising rate environment.


2. Long term overweight USD.

- Economy 3 and Economy 4 above point to slowing imports and thus a lower supply of USD. This supports not only the USD level but will likely raise the actual cost of funding in USD internationally.

- The safe haven status of USD makes it attractive as other regions are relatively weaker or more risky than the US.


3. Underweight exporters.

- For the simple reasons that we expect a strong USD and greater trade protectionism in the world.


4. Medium term buy US non agency RMBS.

- Economy 5. Housing data has on balance been strong. We advocate the more direct and targeted exposure to US housing which is via the non-agency RMBS market than the more volatile house builders where company management introduces idiosyncratic risk.


5. Medium term buy US high yield via loans and bonds.

- A slow but positive and durable growth environment is ideal for high yield corporate debt.

- There are two trade expressions here: loans which carry little duration and will be very useful in the early stages of the rate hike cycle and bonds which carry more duration.

6. Medium term buy US 30 year long bond.

- Economy 6, Policy 3 and Policy 4 support investing in the long end of the US curve.

- Economy 6, the US budget. The congressional budget office estimates that the total and primary budget deficits will improve from now but trough in 2018.

- Policy 3 and 4. The US federal reserve and indeed most central banks have in recent times shown themselves to be not independent of their government’s funding needs. They have either monetized debt by buying treasury bonds or they have suppressed debt service costs by keeping rates lower longer than they needed to. That the US treasury began issuing 2 year FRNs in Jan 2014 only creates a direct alignment between low short term interest rates and the debt service of the US treasury.

- The consensus view on the US 30 year bond is that it will fall (yield will rise). However, given the safe haven nature of the bond (investors buy it in crises) and the fact that the US treasury market has priced in the rate hike cycle, we advocate having a small position in a balanced portfolio as a form of portfolio catastrophe insurance.


7. Medium term short US 2 year bond.

- Rate hikes will most impact the front end of the curve.

- Yield difference between 2 year and 30 year US treasuries. The curve is likely to flatten as the current economic cycle matures towards the next recession.

- If one expects the 30 year to outperform we must by inference expect the 2 year to underperform.


8. Medium term cautious US investment grade.

- I am cautious about the 2 to 7 year sector of the USD term structure. Investment grade corporates issue mainly in this sector of duration which we seek to avoid. The credit spread is insufficient in our view to surmount the duration in a rising rate environment.

- Investment grade issuers are likely acquirers in the current M&A environment so there is significant event risk.


9. Short term cautious US equities.

- Absolute valuations are unattractive. Relative valuations, however, are better. This, however, makes US equities sensitive to the coming rate hike.

- I think that the market may be underestimating the immediate and short term effect of a rate hike which may introduce volatility in the market.



Last Updated on Friday, 31 July 2015 03:46
Who Will Own The Robots? We Have More Than We Need, Its Just Unequally Distributed. Post Scarcity? PDF Print E-mail
Written by Burnham Banks   
Friday, 31 July 2015 03:23

Who owns all the stuff?

In a knowledge economy labor’s share of income keeps diminishing while capital’s share keeps increasing as businesses are able to accumulate intellectual property whereas individuals have limitations. In the limit who owns the businesses?

The march of technology will see many jobs made redundant by automation. If robots replace humans then in the limit who owns the robots?

Unlike other factors of production knowledge is not consumable. Producing more of a product does not exhaust knowledge. Knowledge defies scarcity. When knowledge becomes responsible for an increasing proportion of value in the production of goods and services, who should own knowledge?

When factors of production are not unbalanced the question of who owns what factors of production do not arise. When factors of production are highly unbalanced some factors will see returns diminished relative to others. Owners of that factor are at a disadvantage and owners of other factors are at an advantage. Is there a concept of discrimination between factors of production and is there a concept of fairness?

One or all?

Deflation and interest rates.

Human ingenuity should over the long term reduce our reliance on labour and resources. The relative marginal product of both should fall as should the marginal income to both. Does this imply factor price deflation and wage deflation? Does it also imply general price deflation?

A firm has productive assets and cash which it funds with equity and debt. Productive assets include labour and technology, both have a cost as well as a return. A firm cannot own labour but rents it from individuals. A firm can either rent or own technology. The cost of owning an asset is the cost of financing it, which is the cost of equity and debt. The cost of renting an asset is its price or in the case of labor, wages. The price or wage a firm is willing to pay is the marginal revenue product of labor. If the productivity of labour is low, wages will be depressed. If final good prices are depressed, so too will wages be depressed. The corporate balance sheet likes product inflation, falling interest rates and falling wages. Falling wages and rising product inflation implies lower share of labour in output. This incentive would not be so if labour could be owned instead of rented for then its labor cost would be its cost of capital. Businesses also favor inflation the more highly levered they are as it erodes the real value of the debt.

A household derives income from income yielding assets, labour and interest on cash. Its assets consist of investment assets, the capitalized value of its labour and cash. Its liabilities include mortgages, car loans, student loans and short term debt such as overdrafts and credit card debt. Households like rising asset prices and falling interest rates. To the extent that inflation correlates with asset prices, wages and employment households like inflation. Highly levered households also prefer inflation. Younger households prefer inflation as they have a longer period of employment ahead of them and more debt and less savings; they also prefer lower interest rates and a steeper yield curve. Older households prefer deflation as they have less debt and a shorter period of employment before them’ they prefer higher interest rates and a flatter yield curve.


House prices are driven by demand and supply. For a fixed supply house prices rise where employment prospects are strong and mortgages are available and cheap. House prices are also correlated with long duration bond prices as they are themselves ultra-long duration assets priced on the basis of capitalized rental income.

In space constrained cities and countries house prices tend to rise faster than wages and affordability. Employment prospects rise only to drive greater population density which drives up house prices. The value of housing accrues not just to the occupier or owner but to the society as a whole which benefits from the clustering of skilled labour and network effects. Individuals who own multiple houses see rising wealth. Households who own a single house face no real wealth effect from rising or falling house prices as replacement costs rise and fall in step. Ownership of more than one house exposes the owner to the wealth effects of the variation in house prices. Since houses in cities and houses are a scarce resource which benefits not just the owner or occupier but society as a whole what are the economic implications when individuals or entities own multiple houses?

Inequality and ownership. Scarcity and abundance.

Businesses or corporate entities have earned an increasing share of output and income at the expense of labor. There are several factors why this might be so. One of those factors is that the economy continues to evolve towards a greater reliance on knowledge and technology. A human being can only acquire and retain a limited amount of knowledge and skill whereas a corporate entity can accumulate the ownership of intellectual property and either capitalize on it or charge a rent for its use. If the return on intellectual capital is fixed but its marginal contribution to output rises relative to all other outputs, especially labour, then labour’s share of profits will fall. Automation is a practical example of where capital and technology replace labour. In the limit labour may become largely redundant.

If labour is unnecessary in production yet the economy is able to produce all the goods and services demanded by people, how would goods and services be allocated to people? This is the post scarcity environment envisaged in some utopias. One practical question is, what things abundant without bound and be produced at no cost and what things cannot? Given sufficiently advanced technology all material things are abundant practically without bound. What might be subject to scarcity? People? People could theoretically be produced without bound. Space? With sufficiently powerful terra forming there is an abundance of planets which could be colonized. This may sound absurd but we are discussing possibilities and thus sufficiently advanced technology would surmount the most apparently intractable problems. Even space is abundant. How about location? Location is an abstract concept and could remain scarce no matter what technologies we develop.

Location is given relevance by certain qualities. Where these qualities are material they can be replicated without bound and location becomes replicable. What non material qualities could define location uniquely that it could not be replicated without bound? Proximity to and relationships with individuals in a given location would be hard to replicate. This begs the question if individuality was replicable and takes us far from our initial musings.

Time. Technology might be able to extend human lifespans without limit, however, time cannot be created. Time expended on one activity cannot be expended on some other activity. Time is therefore not abundant. Time, however, is relative and it is relative to the lifespan of the observer. A sufficiently long lifespan can lower the opportunity cost of time monotonically. In an arbitrary time frame, say in a fixed number of minutes, scarcity remains relevant. Time spent doing one thing cannot simultaneously be spent doing something else. Time remains scarce although there may be some theoretically possible practically improbable technologies which might compress time or the perception of time.


In an infinitely abundant world what is the concept of want and need? What gives the individual satisfaction? Maslow’s hierarchy presents as an ordinal stack of tranches beginning with physiological need followed by material security followed by social belonging, esteem and finally self-actualization. Maslow’s hierarchy envisages increasing sophistication, self-awareness and morality. It does not envisage what happens or can happen beyond self-actuation, or alongside it. Post scarcity may actually confound some of the expectations of this hierarchy.

Hardship and competition improve the breed. Without want there is nothing to animate natural selection and so there is nothing to distinguish negative from positive mutation. Without a mechanism to sort away negative mutation will it imply more diversity? If technology can preserve the weak, it might well imply more diversity.

Will society maintain or shed its brutality? Is the human soul predisposed to competition? How will it react when there is nothing to compete over? Will it create an abstract or an irrelevant competition? If so predisposed, is this predisposition a survival mechanism?

Back to more practical concerns:

We suspect that there are currently more resources in the world than the world needs, that poverty is not a problem of scarcity but of distribution, that inequality is unnecessary and an unnecessarily high price of progress. We don’t know why but we suspect this is the state of the world. If so, the current problems faced by humanity are an indictment of our system of economics. We have settled on capitalism and the price mechanism as mathematically and rationally, the best available allocation system. A better distribution exists but no better distribution mechanism exists and the best mechanism has resulted in the current distribution. To accept it is to be defeatist.

Certainly for the rich there is no incentive to change the current state. One doesn’t have to be very rich to fall to inertia. The conspiracy theorist might hypothesize that it is not mere inertia but an active policy of maintaining the status quo through the influence of politics and academia. Certainly even the not so well off might baulk at instigating or supporting change when they consider their fortune and the prospect of having to share what they have with those who have not. Change will only come if a sufficient proportion of the population are impoverished or come to feel that their chances of advancement are sufficiently low. When global growth is sufficient that all constituents have an increasing standard of living the risk of change is low. If, however, global growth slows, then a critical mass of malcontents may arise to drive change.

The world economy has witnessed robust growth up until 2008. Some of this growth has been borrowed from the future by being credit financed. This is an intertemporal transfer of growth. It requires that future growth is sufficient to more than compensate for that transfer. Since the crisis of 2008 growth has rebounded but slowly. A large quantity of debt has been transferred from private balance sheets to public mutualized balance sheets. They have not been defaulted upon or written down. To do so would be to accelerate the reversal of that intertemporal transfer. To hoard it away from the spotlight is to prolong the reversal of that intertemporal transfer. Repayment is immutable but can be redistributed over time.

Can current and future growth compensate for the growing inequality that capitalism naturally perpetuates?

Last Updated on Friday, 31 July 2015 03:26
Greek Bailout Solution. Unlikely To Work. And a Proposed Solution. PDF Print E-mail
Written by Burnham Banks   
Tuesday, 14 July 2015 09:20

14 July:


It’s not over. The deal agreed by the Eurogroup with Greece will need the creditor parliaments and the Greek parliament to vote and approve before the governors of ESM can approve it. The Greeks will likely approve it although Tsipras 149 votes will likely not all be yes, it is expected some 30 will vote against, the 106 pro Euro opposition will be sufficient to carry the motion. As for the creditors, only Finland looks risky. Under normal circumstances an ESM bailout requires unanimity but the ECB can and in the event of dissent will likely decide that the action is a threat to the stability of the union and force the vote into a special motion requiring an 85% majority. The potential dissenters will unlikely get beyond 3% of the vote. And so the Greek bailout will likely be ratified.

The ESM’s response to the proposal is not unequivocal and there are potential uncertainties in the language which suggest that there could be further negotiations.

While in the short term the deal will likely be approved by the Greek parliament the fact that the deal Tsipras has achieved is worse than the June 26 creditor proposal and indeed worse than any deal in the negotiations thus far poses a risk to his leadership. The deal involves no debt write down, no end to austerity, a restart to asset sales and this time under the strict supervision of the Troika and the continued monitoring of progress by the creditors, something that was deemed humiliating and demeaning. Syriza is itself a coalition and the integrity of this coalition must certainly come under pressure given the quality of the bailout deal. One can reasonably expect a shakeup in the Greek parliament and possibly new elections.

Even assuming that all parties were agreeable it is difficult to see how Greece would comply with the budget targets. It is one thing to agree to something but another to have a plan to achieve it. So far both creditor and debtor have focused on targets without devising the means to achieving them. Few countries have achieved what the Greeks are aiming for, not even their largest creditor Germany.

The probability that Greece gets into a financially distressed situation at some stage in the not too distant future, under this plan, is quite high.



15 July:


Having had time to sleep on this I'm beginning to have doubts that the Greek parliament will pass it. Tsipras began with an anti-austerity platform and coalition party. He's now ended up with a tighter austerity program than he bargained for at the start of negotiations. Parts of Syriza will vote against the creditor plan. He is counting on the opposition to support this pretty draconian plan. Now the opposition may have been for austerity when they thought it might work but the capital controls have taken the Greek economy off the cliff, not near it, off it. ELA is frozen, thankfully not retracted, and with TARGET2 off limits the Greek economy is essentially is containment. I am simply not sure anymore if the opposition New Democracy will support what is an unworkable creditor plan.


The plan itself is incomplete, which under these dire conditions is actually a source of hope. As it stands, without a write down, the plan is unworkable and seems to have been put together either by amateurs or creditors seeking Chapter 7 instead of Chapter 11. Trying to raise cash by selling assets is a great idea on paper but is impractical. Once the seller is identified as a motivated seller, the bids will tumble to fire sale levels that no credible creditor would agree to if they believed they had claim to such assets and their proceeds of sale. If the sale program was sufficiently determined, the proceeds will fall well short of the 50 billion EUR envisaged. If the sale was attempted at reasonable prices, the fact that the assets for sale are earmarked for sale would mean that the deals will not get done and it is likely that there will be recriminations over the speed of the asset sales and the motivation of the debtors or the creditors.


A credible plan would see the following principles:


1. As close as possible to a commercially viable deal that an arms length investor would fund.

2. A long term solution as long as the longest maturing debt that will be issued as part of the restructuring.


My plan would include:


1. Debt restructuring:

* Issue of senior secured bonds with first claim to a proportion of tax revenues and a sinking fund under control of creditors.

* Issue of senior unsecured bonds with zero coupons for first 10 years and coupons stepping up thereafter.

* Issue of mezzanine GDP linked bonds.

* Legacy bonds to be written down by X% with immediate effect and the recovery value financed by the new bonds above. X could be substantial, circa 30%-50%.

2. Pension reform.

*  No new defined benefit pensions to be issued. All defined contribution schemes to be frozen (not cancelled) at this point (that is, any indexation to stop.)

*  Introduction of defined contribution pensions. Employers pay 15%, employees pay 15%. Assets held in an independent safe custody vehicle beyond the reach of government or state.

* Phased withdrawals of state pensions. Private annuity options.

* Medical insurance part funded from this pool.

3. Social security.

* Unemployment benefits and other social welfare benefits separately funded by payroll taxes.

* Medical insurance part funded from this pool.

4. Taxation.

* VAT proposed in current creditor plan.

* Corporate taxes to be cut when possible. Ideally 1% cut each year in primary surplus till 20%.

* Tax holiday for specific industries - tech, biotech, industries likely to bring investment.

* Social security tax for employers cut from 28% to 10% to compensate for 15% contribution to employee pension fund.

* Social security tax for employers replaced by compulsory pension contribution. This is a simple reclassification.

* Personal allowance of 5,000 EUR.

* 2% cut to all marginal income tax rates.

5. Investment.

* Infrastructure investment funded by private participation in infrastructure bonds and equity.

6. Anti-corruption.

* Anti-corruption campaign. This to address tax collection and tax liability as well as general rule of law.


7. Financial system recapitalization.

*  The banking system will have to be recapitalized. That much is clear. The recapitalization will have to come from first from the government and then from private sources. The banks will issue equity underwritten by the government and simultaneously issue tier 1 capital and mezzanine debt.

The government's biggest expenses are on pensions, medical insurance and social security. By moving from defined benefit to defined contribution, the burden of pensions is shifted to the people, as it should. Medical insurance is split between being funded by the pension pool (individual responsibility) and the social security pool (collective responsibility). These measures will lessen the collective burden and improve the state finances allowing for a reduction in marginal tax rates.


If the creditors are unhappy with the debt write-down and the issue of further debt and the latitude for Greece to run smaller surpluses or indeed small deficits in an interim adjustment period, then they should just eject Greece from the euro.




Last Updated on Wednesday, 15 July 2015 00:33
China. Opportunities and Lost Opportunities. Prospects for China Equity Markets. PDF Print E-mail
Written by Burnham Banks   
Friday, 31 July 2015 02:35

I have been optimistic about the development of China as it matures into a middle aged, consumption led, economy governed by rule of law and subject to market forces.

What I liked most about China was what I regarded as a genuine desire for reform, to govern by rule of law, to allow markets to be policed by demand and supply, to modernize corporate enterprise law. I saw evidence of all these things in the form of the elevation of the constitution in last November’s Fourth Plenum and again earlier this year when official would be required to swear allegiance to the constitution and not just the Party. I continue to see the anti-corruption efforts carried out with determination. The efforts to include the RMB in the SDR will also open up the country’s capital account more and allow the currency to find a market clearing level.

I recognized that the economy was slowing from 7.5% to 7.0% this year and that even with the slowdown, the Chinese economy would create more incremental nominal output than the ME economy growing at 3%. At that rate, corporate profits would come under pressure. Among the HK H shares, PE multiples were 8 times in 2014 and expected to be stagnant at 8X in 2015 improving to 7.3X in 2016 implying a tepid 9.6% earnings growth. In the Shanghai A shares, PE multiples were 18.8 times in 2014 and expected to be 15.3X in 2015 and 13.5X in 2016 implying earnings growth of 22% in 2015 and slowing to 13% in 2016. These are aggregates of course and hide a wide range of numbers.

The main driver of equity markets was going to be liquidity and a PBOC put. Fundamentals while unexciting were sufficiently robust to hold the market in line while central bank efforts to drive the real economy would also drive down interest rates and cost of debt boosting valuations. Our view therefore relied on the general economy being on the weak side, growing at between 6.5% to 7.0%, to do two things, one, generate sufficient nominal output growth to sustain the employment and investment, and two, be sufficiently weak to keep the PBOC in expansionary mode.

The PBOC is currently operating a number of market friendly policies. One, it is in rate cutting mode. It has cut the deposit and lending benchmark rates 3 times this year and the banks’ required reserve ratio (RRR) twice from 20% to 18.5%. With rates at 4.85% and an acutely high RRR, the PBOC has a lot more room to cut rates. Two, cutting rates is a blunt instrument as market rates may not react. The PBOC is actively operating open market operations, basically repo operations, to bring down market rates of interest to lower debt service across the board. Pledged Supplementary Lending, Medium Term Lending Facility, et al, are all expansionary open market operations designed to improve liquidity and lower borrowing costs. Third, the PBOC is encouraging a wide ranging rebalancing of where credit is deployed in China. Currently, corporates and local governments are over leveraged whereas small and medium enterprises are starved of credit and consumer credit while growing is yet small. The government’s local government debt swap, essentially refinancing local governments’ high debt service off balance sheet liabilities to lower cost, more transparent, on balance sheet municipal bonds is not only lowering the debt burden for local governments but is improving credit quality for creditors the large extent of whom are the country’s commercial banks. The municipal paper also serves as capital efficient eligible collateral for the PBOC’s repo operations.

The above led me to the opinion that China equities were a good investment. The question is, why did the market fall so much and what is the current prognosis?

Why did the market fall so much? When the tech bubble burst in 2000, Nasdaq fell 75% over the space of 3 years. The S&P, however, was not immune and lost 45% in the same time frame. There is a tech bubble in China. The ChiNext market has fallen some 42% since June; in the same time the Shanghai Composite has fallen 32%. ChiNext PE ratios were at 130 while the Shanghai Composite traded at 26X. Retail investors and margin investors which include corporate investors led to a bubble in some sectors which are now bursting. Margin calls are causing leveraged positions to be unwound.

What do I think of what the Chinese government are doing to support the market? In the face of collapsing markets, governments around the world and throughout history have always sought to intervene. The Americans did in during the Great Depression, they and every major economy did it again in 2008. Ireland bankrupted itself saving its banks. The question is, will it work? The answer, today in China as before in America and Europe and Japan, is no. The market must find its level. All bailouts do is delay the process of finding that level. Even the current state of the American and European markets is one where the overhang from 2008 has not been fully worked out. In the short term, market intervention can arrest a falling market. China of all countries has the financial firepower to support markets.

Do I think that the Chinese market intervention represents a setback to the reform efforts? Given that the intervention in markets is no more intrusive than the actions of the Fed or the BoE or the ECB in 2008, I think not. I think the Chinese government will continue with market and political reform. The reform will just have to be adjusted around any bailouts of the equity or bond markets. Just like anywhere else. China’s reform efforts are not based on altruism or a change of philosophy. The Communist Party sees the reform, the change to rule of law as opposed to rule by Party, as a strategy to avert an existential threat to the Party in the face of a maturing populace. It will not stop now.

What is the current prognosis? Have I changed how I think of the Chinese equity markets?

Yes. I think that fundamentals are poorer than I thought and that part of the reason is the sharp fall in equity markets. When I examined the level of leverage in the equity market I saw that retail margin trading participation was manageable, circa 8.8%, in relation to the total market capitalization. What I have no transparency on is the magnitude of leverage exposure by corporates. A common means for smaller companies to raise debt is to provide their equity as collateral. This type of activity was prevalent in the 1980s and 1990s in South East Asia. Now if the proceeds of these loans is used to invest in operating assets then while the capital structure of the business may be questioned the operational model is not. If, however, companies invest proceeds in the stock market then clearly there is a serious issue with business models. Companies in South East Asia prior and up to the Asian crisis in 1997 were engaged in these investment practices. While not all companies did this, it introduced a feedback loop which greatly increased volatility in earnings, balance sheets and equity market pricing.

I do not see much more downside. I think that the Chinese government will not countenance lower prices as it would destabilize the real economy. Also, if our suspicions about where some companies have been deploying their capital, in financial assets rather than in operational assets, then the government will have to address the issue and put a floor under equity markets.

I do not see much upside. When the PBOC expanded policy in 2014 it was its intention to boost the real economy and lower borrowing costs specifically for local governments and small and medium sized enterprises. It was not its intention to inflate the equity market. In fact the PBOC recognized that the rising equity market was at some level when valuations outran fundamentals an undesirable side effect of its expansionary policy. Unfortunately, its attempts at deflating the equity market, and there were several attempts, were not sufficiently determined and a bubble inflated. The government will not allow another bubble to inflate and will therefore likely introduce cooling measures if equities should rise sharply or substantially from current levels. The behavior of the currency makes a good example of how the market can be subdued by sufficiently determined policy. The A share market is still only semi-open and thus can be supported or indeed suppressed by policy.

Last Updated on Friday, 31 July 2015 02:38
Greece. Temporary Separation Tabled. Sovereign Capital Structures and Bankruptcy. PDF Print E-mail
Written by Burnham Banks   
Monday, 13 July 2015 01:25

On June 26, had Greece agreed to these terms a deal would have been done. Instead Tsipras calls a referendum and seeks a No vote from his people. Before the vote, Tsipras goes back to the Eurogroup to accept the terms. Merkel says that they have to wait for the referendum since Tsipras would, in the spirit of democracy, have to respect the Greek people's decision. The people give Tsipras his No vote. He comes back to the table effectively accepting the creditor terms (in the June 26 proposal) confounding the No vote he had obtained at home.

This behaviour gives a clue to what it must have been to negotiate with Tsipras and Varoufakis in the preceding 6 months. Varoufakis probably resigned when he discovered Tsipras was going to accept the creditor terms after the No vote.

The behaviour also explains why Germany may be sceptical about the representations of the Greek government. If the Greeks agree to the bailout terms, there is no guarantee that they will comply with the very terms they have agreed. A logical strategy is to ask Greece to leave the Euro, provide Greece with some level of support, but require Greece earn its way back into the currency union.

On a slightly separate note, I think the Greek experience has shown that the world needs a better sovereign bankruptcy process and a better definition and design of sovereign capital structure. I would like to see the emergence of a sovereign covered bond market with claim on sovereign assets as well as a sovereign ABS market where default would result in the assignment of portions of tax receipts to creditors or tranched ABS where cash flows are prioritized over tranches in a waterfall structure and additional cash flows are used to capitalize sinking funds under the negative control of creditors.

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