'...little is ever really new in the world of finance. The public has a euphoric desire to forget...'
-John Kenneth Galbraith, The 1929 Parallel, Atlantic Journal
Forty years ago, just prior to a performance at Amsterdam's renowned Concertgebouw, a group of radical young musicians began making noises with their nutcrackers and bicycle horns. Their "nutcracker action" denounced the orchestra as a status symbol of the ruling elite, claiming that it was guilty of "maintaining an undemocratic artistic environment." Persuaded by the immediate dangers of deflation, I feel much the same antagonism towards most investment matters today, especially the Asian business model and the investment community's bullishness regarding China.
From the phenomenon that was Japan in the 1970s/80s to the aforementioned Asian Tiger movement in the 1990s to our present obsession with China's economic might and its future prospects, Asia has won the hearts and minds of the financial world's most demanding investors. Witness Fidelity's legendary British fund manager Anthony Bolton's explanation for his decision to come out of retirement and launch a new career at the helm of a China fund, "...only a remarkable opportunity could have tempted me...this may be the biggest economic and investment story of our generation..."
In the spirit of the nutcracker revolutionaries, I would like to warn you that I think the Asian business development model is flawed. I think our elites have it wrong. It is my contention that China produces GDP growth without per capita wealth creation. It is analogous to a cocktail party without the cocktails; what is the point?
Furthermore, I fear that should China suffer an economic reversal, it might have especially ominous implications for Japan. I am concerned about the lopsided nature of Japan's finances, with its domestic liabilities (pension and insurance schemes) being supported by the country's substantial overseas dollar hoard. To my mind this trillion dollar reserve of foreign exchange has parallels with America's sub-prime debt. This may be contentious but I believe that both assets are dubious and dangerous in nature. For the Japanese and other sovereign Asian currency reserves are only of use so long as they are not deployed domestically; just like Napoleon's bayonet. Let me explain.
Japan is effectively short its own currency and, to aggravate matters further, so is the international hedge fund community. Think about it, do you know of any wealthy acquaintance that has yen- denominated cash deposits? Dollars, euros, pounds, Swiss francs, even Singapore dollars, yes, but no one holds the currency of the world's second largest economy. This arrangement is not viable in the longer term. To quote Galbraith once more, "The enemy of the conventional wisdom is not ideas but the march of events." Sure, the yen is not cheap on a purchasing power parity basis and its domestic exporters struggle to remain competitive with a yen-denominated cost base. But an unforeseen event, such as a slump in Chinese economic growth, has the potential for torschlusspanik in the currency markets, which could in turn precipitate a much higher value of the yen.
