Tuesday 8 April 2014

All the eggs in one basket

My new year has begun and I am feeling modestly smug about my decision to stay out of the market. I have a couple of worries. Will I be able to make money this year or will I just avoid losing it as the market tumbles? Could this be another year when I think things are going to turn out badly only to be second guessed by the market? Is my belief in GVC with its massive yield fully justified or should I worry that the market does not see it as a bargain? Should I be taking advantage of gold's faltering bounce back from its dip?



Good questions with no clear answers. As ever I will just have to go on worrying  and then act as my mood dictates.

And then there is my growing understanding of the Dollar Trap. The more I read the more fearful I feel. See below for the next ghastly episode. It really is a story by Edgar Allen Poe. Evil stalks the financial corridors and disaster lurks behind every creaking door.



All those eggs in one basket


All that money accumulated by emerging markets as their balance of payments surpluses continue has ended up, mostly, in one place: US Treasury bonds. And there it sits, trapped. Its sheer volume means that China, and the other bond holders are in a bind. They cannot reduce their holdings. If they sell, or even curb the rate at which they buy prices will start to fall. And with that their reserves would begin to fall in value which means very nasty hole would appear on the asset sides of balance sheets across the world.

In the 1920s/30s something similar happened in France. Its holdings of UK Sterling bonds were great and as the French attempted to break away. Its sales of bonds gave a spur to an already weakening Pound. Its Sterling holdings fell in value, and the French central bank became technically insolvent.

A trap if ever there was one. China is increasingly aware of the problem but sees no way out.

Can the US continue to go on borrowing forever. In theory yes. The debt can roll from one generation to the next and given that the interest rates that it  pays are so low the US is in a strong position. Additionally all the time that Dollar FX rates remain high repayments are also manageable.

In addition the US has a big plus which is helping it to handle what otherwise looks like an intractable problem. It holds external assets and these assets are much higher yielding than the treasuries which it continues to sell. Therefore, as it pays out interest, it earns interest and dividends at a very satisfactory rate which go a long way to offsetting its costs.

The opposite is true of the US creditors. Their unflagging desire to buy US bonds ensure that prices stay high, yields remain low.

All those eggs in one basket are good for the weaver but disastrous for the chicken farmer. Paradoxically it keeps the show on the road for far longer than it deserves. The crash, if it does happen will be much worse because the imbalances just keep growing. Another banking crisis and we really will be in the soup.

I have a passion for mixed metaphors which I have now indulged to the full..

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