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谢国忠

谢国忠博客:只说出心中真相

 
 
 

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麻省理工学院经济学博士

个性介绍: 1960年出生于上海,1983年毕业于上海同济大学路桥系,1987年获麻省理工学院土木工程学硕士,1990年获麻省理工学院经济学博士。同年加入世界银行,担任经济分析员。在世行的五年时间,谢国忠所参与的项目涉及拉美、南亚及东亚地区,并负责处理该银行于印尼的工商业发展项目,以及其他亚太地区国家的电讯及电力发展项目。1995年,加入新加坡的Macquarie Bank,担任企业财务部的联席董事。1997年加入摩根士丹利,任亚太区经济学家,2006年9月辞去该职务。

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still selling bonds   

2008-07-08 23:15:19|  分类: 言论 |  标签: |举报 |字号 订阅

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Still selling bonds



In early June, global financial markets gyrated down on central banks'tough language on inflation. The BoE said it would even accept a dropin living standard for containing inflation. The Fed said that the riskof a serious economic downturn was small and it would shift itspriority to inflation fighting. At one point, ECB sounded like a ragingbull for hiking interest rate. Even the Bank of Japan mentioned therisk of inflation. At one point, market priced in four rate hikes bythe Fed by mid-2009. As a result, dollar firmed, oil price stabilized,and yield curve flattened around the world. If the inflation fightingis real, it bodes well for bonds. But, I think otherwise.



Whilerates will rise, maybe earlier than mid-2009 that I expected before,they won't be aggressive. If the Fed and ECB raise rates in the summer,it is intended to give substance to their talk but won't herald rapidrate increase ahead. Market is probably jumping ahead of itself. Thebottom line is that rising rates would trigger a deep recession andcentral banks, while desiring lower inflation, are not yet ready toaccept a deep downturn in exchange. The tough talk is mainly aimed atpushing down oil price, which would ease inflationary pressure anddecrease the need for raising interest rates.



Indeed,the central banks are already backing off in a confused fashion. TheECB now says that it may raise interest rate once. The Fed continuedits language on the balance of risk between growth and inflation. Itsaid that the growth was at less risk and inflation at more risk, i.e.,it could be in a position to raise rates. It is still not saying thatit would raise rates to contain inflation even if growth is at risk.The language confusion just indicates the central banks wish thatinflation would go away without rate hikes that would bring down growthalso. They are in denial. It is a stagflationary world. Inflationfighting is meaningful only if central banks accept and trigger a deepdownturn.



This jawboning strategy that promises apainless way to ease inflation is failing. Market sees through the talkand understands that central banks still put growth ahead of inflation.They won't hike rates as fast as inflation rates are picking up, i.e.,monetary policies around the world would remain loose and boostinflation. Inflation in the global economy would head up, not down. Onthe other hand, the bursting of the credit-cum-property bubble isweighing down economic growth. Surging oil price allocates too muchmoney to a few who can't spend it all and, hence, is bad for growthtoo. The IMF now expects global growth to slow by one percentage pointin 2008 to 3.7% and inflation rate up by over one percentage point to5.5%. Inflation rate is significantly above growth rate. The gap wouldwiden in 2009. It seems that the world consensus as well as the realityis moving towards stagflation.



Let me do some chestpounding here. In late 2006, I predicted stagflation for the US and theglobal economy in 2008. At the time, not a single soul I met agreedwith me. I believed that the mild recession after the tech burst in2000 was due to the rise of a global property bubble and wroterepeatedly on the subject then. But, I struggled with the likelyending. I played with the deflationary ending for a while. The bubblecould burst on its own when speculators suffer acrophobia. Thecollapsing asset prices would depress demand, exposing overcapacity andtriggering deflation.



As the global asset bubble wenton and on, I questioned this scenario and realized that the deflationending wouldn't happen. The reason is the unlimited risk appetite inthe global financial system. Most speculators play with other people'smoney ('OPM'). They are paid a cut on the speculative gains but don'tshare the speculative losses. This incentive system permeates theglobal financial system, especially with the rise of hedge funds,private equity firms, and the proprietary trading at investment banks.Hence, as long as central banks keep monetary policies loose, theresulting monetary growth would flow into some asset classes. As thecredit-cum-property bubble bursts, the money was likely to go intocommodities. A commodity bubble is far more inflationary and lessgrowth friendly than a property bubble. A property bubble boosts growththrough wealth effect. Hence, its inflationary impact is via its growthimpact. A commodity bubble boosts production cost, which depressesgrowth, and boosts inflation at the same time.



Thecommodity bubble will end only when central banks decrease moneysupply. That will take a long time. Central banks have been playingSanta Claus for twenty years as inflation declined on globalization andthe collapsing energy demand in Russia and Eastern Europe, which gavethem a license to print money without immediate inflationaryconsequences. This is why central bankers like Greenspan were sopopular. In an inflation-prone environment, effective central bankersshould be tough taskmasters like the Fed Chairman Paul Volker (1979-97)or the President of the Deutsche Bundesbank Hans Tietmeyer (1993-99).Human nature doesn't change overnight. The current generation ofcentral bankers couldn't transform into Volkers or Tietmeyers. Theyenjoy the limelight too much and love to be loved. My stagflation callwas based on two factors-the love seeking central bankers and the OPMwielding speculators.



A prediction is meaningful onlywhen one sees irrational factors that block efficient markets.Inefficient factors ultimately come from the irrational side of humannature or some institutional flaws. I am not always right. On oil, forexample, I underestimated the interplay between supply tightness,demand strength due to subsidies in emerging economies, and the powerof speculative capital. The bubble has lasted much longer than Iexpected. When the Fed cut interest rate last summer, I understood itssignificance for oil and other commodities and called for a massivebull run for oil due to the Fed's turnabout on its policy.



Basedon my understanding of today's central bankers, I believe that theinflation crackdown is more noise than substance. They still believethat, through clever posturing, they can scare away oil speculatorsand, hence, support their loose monetary policies to simulate growth.Their clever posturing, however, is running into the brick wall of OMPwielding speculators who have no downside, only upside in calling thecentral bankers bluff and pushing oil price ever higher.



Thegame between central bankers and speculators would end when inflationis high enough that public opinions put inflation fighting ahead ofgrowth stimulating. Today's central bankers are like politicians andswayed by public opinions. As the pain from asset deflation stilldominates public opinions in the US and other developed economies,today's central bankers don't have the guts to go against popularopinions and do the right thing for the future. They are like theircounterparts in the 1970s and won't act preventively. The world,unfortunately, is likely to repeat the stagflationary cycle of the1970s.



Stagflation should be the most importantconsideration for investors in 2008 and 09. Of course, one shouldcarefully consider where the prices are and how much they have pricedin stagflation. The biggest mis-pricing I see is in the bond market.Despite a gut-wrenching bear market this year, bond prices are stillgrossly overvalued. This is the biggest risk to central banks withlarge foreign exchange reserves (e.g., China, Japan, Russia, and SaudiArabia). What can they do to dodge the bullet of a collapsing bondmarket?



The yield on the 10Y US treasury has risen30bps points to 4.12% in a month. This is a massive bear market in thebond land. The current level, however, is still far from sufficient inreflecting future inflation. The US's inflation is likely to be between5-5.5% in 2008 from 4.1% in 2007, considering that the inflation in thepast twelve months was 7.2%. The 10Y TIPS or inflation protected bondsyields 1.63%. The difference, 2.49%, is the market inflationexpectation for the next ten years. The bonds are vulnerable to bothchanging inflation expectation and rising real interest rate.



Somesurveys show that American consumers expect inflation to average above3.5% over the next five years. This is actually not too far off fromthe post World War II average. Is the financial market or consumerright? Normally, financial investors should be more reliable thanconsumers. The former are armed with research capacity and investmentexperience. However, the investor base for the US treasuries is aspecial one. Central banks around the world are the main buyers oftreasuries. They are reluctant buyers. Their funds come from tradesurpluses and capital inflow. Both are driven by the US monetarypolicy. When the Fed has an expansionary monetary policy, central banksaround the world are flooded with dollar inflow and, to preventcurrency appreciation, are forced into accumulating foreign exchangereserves. For liquidity and security they usually buy the UStreasuries. This angle suggests that the treasury pricing may not berational and may not reflect fundamentals.



Thelong-term average real interest rate for US treasuries is about 2.5%.The current level of 1.6% is probably too low. Maybe the flight toquality is a factor. As other asset classes tumble, the safest assetclass-TIPS becomes overvalued. But, as the financial crisis works itsway through, probably, by the end of 2009, the TIPS's pricing couldalso normalize.



The inflation priced into thetreasuries is also too low, even thought the expectation has risen from2.2% in January to 2.5% now. The Fed is prone to stimulating. It hasthe triple mandates of keeping inflation down, supporting employment,and maintaining financial stability. The compromise that it must makemeans that it will overshoot its inflation target of 2% by asignificant margin. The historical average of 3.5% is a good indicationfor the future. The US economy is likely to suffer a decade of lowgrowth due to (1) the retirement of the baby boomers, (2) theskyrocketing healthcare cost, and (3) rising competition for naturalresources. The Fed would be under enormous pressure to stimulate theeconomy. The chances are that the US inflation over the next decadewould be above the historical average and the dollar would remain inthe bear market for the foreseeable future.



Theinvoluntary investor base for government bonds is the main cause forthe pricing distortion. When the market comes to its senses, the yieldon the 10Y US treasuries may need to rise by 2-2.5 percentage points.The re-pricing of the US treasuries would have similar though smallerimpact on government bonds in other countries like Japan, Euro-zone, orthe UK. The central banks around the world are holding a dangerousasset. As they are the market, they cannot all escape without causingthe price to crush. They are collectively trapped. Hence, the firstmover would gain.



The oil exporters like Saudi Arabiaare flooded with money. The OPEC countries make $4 billion everydayfrom oil exports. They can afford to hold the US treasuries despite thedownside risk. The loss may not be so big for them. China can't affordto behave like them. China's foreign exchange reserves come mostly fromlabor-intensive export industries like electronics, garments, shoes,furniture, etc. Every dollar is earned from the sweat of the workerswho make $100 or so per month. China's large foreign exchange reservesreflect the number of workers in China, not good fortune or high valueadded. Hence, China can't afford to waste a penny of its $1.7 trillionforeign exchange reserves. China's central bank should decrease theduration of its portfolio as much as possible to avoid capital lossesfrom potential treasury re-pricing.



When central banksget out of treasuries, what could they buy? As their funds are vast,the only alternative is stock market. Global stock markets have beendeclining and will probably decline more. They are trading at 2.3 timesbook value at present, neither expensive nor cheap. By the way, theonly reliable measure for market value in the long run is the price tobook value ratio. As the world economy is still on the way down andinterest rates on the way up, stock markets are in rough territory.But, the current level is supportable over time. If central banks buyover the next twelve months, they may suffer some losses in the shortterm but should make money in the longer term. Further, given theirsizes, they cannot buy when markets are buoyant; their buying wouldpush up markets so much that they end up overpaying and losing money inthe long run.



Stocks may not perform well duringstagflation. As rising interest rates and slowing economies depressearnings and increase the holding cost. But, the value of stocks willnot get inflated away like bonds. Companies have assets and debts. Theassets are value preserving, while debts are likely to decline in realvalue with inflation. The diminished profit outlook during stagflationdepresses market valuation. But, as soon as the stagflation isovercome, stocks will perform well to recover the lost ground duringdeflation. To a large extent, the bull market in the 1980s was due toits undervaluation during the stagflationary 1970s.



Ifcentral banks do decide to switch into stocks from bonds, the bestapproach is probably to buy indexes via index funds or proxies. Overthe long term, index funds outperform over 90% of the actively managedfunds. This is because the later incur too much transaction costswithout adding enough value in stock picking. Central banks aregovernment institutions and would struggle to build up stock pickingcapability. However, central banks probably know macro trends betterthan an average investment house. It is possible to extend this skillto pick sector indices.



Holding bonds is probably theworst investment position today. Private investors have fled bondsalready. Central banks are supporting bond markets. It's time for themto leave. China should run for the exit first.


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