Month: July 2014

Röpke on Inflation Targeting

Alan Greenspan has come out recently, again denying any central bank responsibility for the last crisis. David Stockman has responded in typical fashion.

This is a controversial topic: Martin Armstrong, whom I greatly admire for his historical insights, has attacked Stockman harshly, agreeing with Greenspan. Armstrong’s conclusion is data driven, i.e. he has no theory, which comes with the usual epistemological problems that Mises pointed out in his masterpiece “Theory and History“. As an Austrian, I clearly side with David Stockman’s analysis.

As discussed in this post, I am currently reading Wilhelm Röpke’s book “Crisis and Cycles”. I always find it interesting to read pre WWII economics books. Economists at that time seemed to care about  real world problems, they were less of specialists (“Fachidioten”) and trained in classical economics and philosophy rather than math-modelling. In the book, Röpke intensively discusses the role a central bank’s mandate plays in creating bubbles.

Röpke stresses that the Fed’s pre-crisis (i.e. pre 1929) objective of “price-level stabilization” was ill-suited in regulating the volume of credit. Similar to today, where the same thing is called “inflation targeting”, central banks thought there is no problem as long as consumer prices show no market rise – in other words: we have been here before.

Röpke’s two main objections, familiar to every Austrian:

  1. Indices used measuring the price-level are arbitrarily constructed and have serious data issues – they cannot be precise in any scientific sense
  2. Prices in a dynamic economy are not stable. A stable economic system is not one where everything stands still but a system in which there is a continually moving economic equilibrium – stable prices are not even desirable

He even goes so far as to proclaim (p.150): “Better no credit control at all than one based on this treacherous and dangerous criterion” and advocates replacing the idea of “stable money” with the objective of “neutral money” defined as “money which exerts no influence on the structure of production and prices,” basically a constant money supply.

We seem to have learned nothing from the past – so much for progress in the social sciences! Worse, one can argue that has gotten worse as the current objective is not only maintaining a stable price level growth but also to boost employment by boosting the volume of credit. I wonder whether stock market participants in the “roaring twenties” also were talking about the equivalent of the “central bank put”. So far, I have found no indication – but I will keep looking.

P.S. The excellent spontaneous finance blog also has a new post on this topic.



Emerging Markets slowdown and investor complacency

Unilever, the big consumer products company, has just released its first half figures: surprisingly growth in emerging markets (EM), where it makes most (57%) of its sales, came in below expectations. Growth has been around 6.6% which is below the inflation rate in most of these countries, i.e. there has been no “real” growth in sales. Consumer goods companies ales usually are good proxies of gdp growth with the added benefit that they are more reliable and more readily available than gdp estimates proper.

After a bad start into 2014, emerging markets assets (currencies, bonds and shares) have made a strong comeback recently. Whereas at the beginning of the year there was a lot of talk about the end of the BRICS story and Turkey facing huge political problems, there is none of it right now. As famous Hungarian-born speculator Andre Kostolany always used to say: “it is not the news that make the prices, but the prices make the news!”

As a long time investor in Emerging markets who started to invest in EM at the beginning of the millennium  I was caught by surprise by the recent move. After all, most markets did not touch what I would consider fair value (on the currency and interest rate side) although market technicals looked terrible. In the past, even during the booming 2003-2008 period, there was regular overshooting on the downside whenever a correction was due. I eagerly was awaiting to put my cash hoard into profitable use by mid 2014 – to no avail.

Ok, surprising market moves are a regular feature, I am used to that. But the following chart, taken from the FT, shocked me:


The sovereign debt issuance of emerging market governments (China excluded, mind you) has reached record proportions. Regardless of whether you agree with me or not on general market prospects, we certainly can agree that the EM-outlook has already looked better. Lending record amounts under these circumstances can only be judged as mindless yield-hunting…

Wilhelm Röpke on Business Cycles

I am currently reading Wilhelm Röpke’s excellent book “Crisis and Cycles” published in 1937. Röpke, a personal friend of Ludwig von Mises, was a German economics professor and an adherent of the Austrian school. As an advisor to Ludwig Erhard he was instrumental in the making of the German “Wirtschaftswunder” (which Mises never tired to point out was no wonder at all, but simply the expected outcome of sensible economic policies). Sadly, those people have almost been forgotten in Germany (and Austria), instead we are told that we owe our prosperity to the infamous “Sozialpartnerschaft” – a bad joke.

The book doesn’t provide new theoretical insights to those who are familiar with Austrian Business Cycle Theory, but is an application (by an outstanding economist) of the theory to world events. It is in this sense a “practical” book. There many interesting tidbits and I will certainly post about some of them in the future. But the most interesting piece of information for now is (surprise, surprise) statistical: it is from page 54 where the author discusses the shrinkage of production (this would nowadays be proxied by GDP) that occurred in various countries between end of 1928 to June 1932. The figures are taken from the third League of Nation’s (today’s UN) World Economic Survey and read as follows (Production in 1928 indexed to 100): Germany: 60.7; Great Britain: 89.4; USA: 53.2 (!); Sweden: 76.9 and France: 73.2.

Yes, you read correctly: the US, the most powerful economy at that time and source of innovation, was hit the most by the great depression – and by a big margin! After sobering up, I realized that this is consistent with the Austrian theory (although I have been studying this theory for the better part of the last ten years I had to let the numbers sink in, nevertheless), where the causes for the bust and its size are to be sought in the preceding boom. It is certainly the case that the “Roaring Twenties” where mostly an US phenomenon – European countries still licking wounds after WWI.

“So where does that leave us now?” you might ask.

America at that time was also the largest creditor nation on earth (before WWI it had been Britain), in fact the boom was to a large extent financed by capital inflows from a devastated Europe (and subsequently, partially lent out to “Emerging markets”). It was one reason why the Fed hesitated to raise interest rates despite the boom, for a higher US rate would have made it even more difficult for an allied Britain to finance its current account.

Now, ask yourself: who is the largest creditor nation nowadays? Who has so much “money” that despite breakneck growth at home there is still spare change to buy resources in Africa and condos in Manhattan, Hong Kong and Vancouver?

It is China that is the most vulnerable to higher rates and to a global slowdown….

Macro Man on Fed-Speak

Two funny posts:

Macro Man translates Yanet Yellen’s recent congressional testimony for us.

Bill Bonner’s review of Hillary Clinton’s autobiography – entertaining!

Reading these two articles one invariably gets the impression that world “leaders” either do not get it, or that they try to deceive us intentionally. While most people fall into the latter camp (think conspiracy theorists), I really believe that they have no clue what’s going on – at least, this is my experience working with government at different levels. People usually find that hard to believe: they observe that in sports or at work, generally speaking, the best get promoted and assume that is true for government as well. Yes, there is also a lot of politics at, say, Microsoft and at Harvard (“peer review”) but it is usually within acceptable bounds. Those companies that adapt unsound management practices and that are not protected by a state monopoly usually fail. Not immediately of course, but they do fail in the end.

This is different in bureaucracies which live in an artificial environment: there are no profitability targets and no angry costumers. It is also difficult to assign responsibility to someone specifically. It it Obama’s bad leadership, or those stubborn republicans that prevent the implementation of sensible measures? In a democracy, we are told, “we govern ourselves” and as a consequences it is not so easy to point to those responsible. People influencing the decisions, i.e. bureaucrats behind the curtain, usually are not known to the public. In short: the ideal breeding ground for demagogues who profit from disorder and who have no hesitation in pointing the finger at suspects without real evidence: “When it becomes serious, you have to lie“.

Competence in problem solving, in other words, is the least required character trait – therefore we should not expect to see it. Instead, we get empty suits whose only goal (and skill) is to conceal their real intentions as much as possible.

China’s capital account not so closed after all…

Interesting article on Bloomberg: it appears that the main Chinese Banks have helped individuals to transfer money out of China. It says that this  program/product has been officially approved since 2011, although never publicly announced. What did the Chinese residents do with the money? Answer: they bought  real estate in HK and around the world supporting my thesis that the Chinese credit expansion been the main driver behind higher asset prices globally (of course, this expansion would not be possible without low Fed rates).

What is striking is the naivety of the Bloomberg reporter: she interprets this program as a sign that Chinese authorities are “experimenting” how a freely convertible yuan would look like. How enlightened those Chinese rulers are!

I have another interpretation: the program was legal, but not announced, in order to enable party cronies to transfer money out of the country without arising suspicion internationally about the Chinese growth miracle (who needs to invest in foreign lands if growth back home is so great?) and not to anger the “unwashed masses” in China. The article is silent about whether the banks offered this product to every costumer, or just to the initiated. This would be interesting information.

One piece of evidence, two opinions. What do you think?



Elevators in China: Is a Chinese slowdown priced in?

Given that the Chinese slowdown and the prevalent problems in its banking sector has already been discussed for quite some time in the mainstream media, it is natural to assume that the market has already “discounted” a big chunk of the bad news coming out of China. Little surprise that investors are hunting for opportunities among Chinese stocks. The reasoning seems to be: if it has been in the news for quite some time, it must be in the price already.

Trying to back out implied expectations from prices of Chinese stocks or rates is fraught with problems: accounting, governance and regulatory issues influence the price of financial assets certainly in a larger way than in Europe and the US. Indeed, playing China via developed market companies that have significant exposure to China’s growth, has been the most profitable way for investors to participate in the Chinese growth miracle.

Finnish elevator maker Kone OYI (KNEBV:FH) certainly fits into this category: it is well-managed, well-financed and the stock price has returned 500 percent since May 2005 when shares cost 6 euros. The chart below shows the performance over the past five years. Mind you, this impressive growth has been achieved without leverage.



The growth in the share price is mirrored in the fundamentals as Kone has profited directly from China’s skyscraper-craze. The table below breaks down the evolution of sales per region: as expected, sales in Europe and the US have grown merely in line with inflation, whereas sales in Asia-Pacific (read: China) have grown through the roof, + 34 percent p.a. This is extraordinary growth.


The stock has rerated correspondingly: whereas the EV/sales multiple for Kone stood at 1,62 (up from 1,42 at the market’s 2007 top) it stood around 2,39 at the end of 2013 (see table below). Looking at the aggregate multiple doesn’t tell us the whole story, however, since 60 percent of Kone’s sales are generated in the stagnating European and US market for which we can assume that the market is not willing to pay extraordinary multiples.


In order to assess the market’s perception of the Chinese growth story I have tried to back out the multiple that the market is assigning to Kone’s Asian business. For this, I have used the EV/Sales Multiple (1,42) that the market put on Kone’s business at the end of 2007, i.e. before the great depression and when the Asian Business accounted for 15% of net sales. Multiplying the sales in the past 5 Years by this multiple I arrive at the market’s valuation for EMEA and US business (EV EMEA+US). This I deduct from the Kone’s EV to arrive at the valuation for the Asian stand-alone business, which, divided by sales, gives me the Asia (China) multiple.

As can be seen, the market’s current multiple of 3,92 for the Asian business ranks second highest over the past five years – a period that has been market by tremendous growth. I was only surpassed by 2011 exuberance, in the days when China seemed invincible. To make a long story short: the market is far from pricing in anything like a slowdown. China has the potential to nastily surprise the market. Stay tuned!

Why the chinese Yuan is overvalued

The excellent Epsilon Theory blog has an interesting essay on how the rules of the game are changing in China: essentially it slowly dawns on Chinese leaders that the successful growth model of the past decades, where a stable or even steadily increasing currency has been one of the main pillars, is not sustainable in a world in which its main trading partners are trying to keep the status-quo (“stability”) by means of credit expansion and beggar-thy-neighbour policies. To sum it up: Fed QE has probably done most harm in China.  Unexpected, eh? The Chart below neatly illustrates how things have changed.


The blue line shows the CNY/USD exchange rate which has been slowly appreciating over the past ten years. The first big appreciation period (2004-2008) was accompanied by healthy gdp growth (green) and relative outperformance of Chinese stocks relative to their US counterparts (red). The Chinese authorities, like everyone else, were surprised by the financial crisis: growth slowed down markedly and they decided to briefly suspended their CNY appreciation so as not to weaken domestic importers unnecessarily. Eventually markets calmed down due to central bank intervention in the West (and heavy credit growth in china) and the bureaucrats continued their steady appreciation policy as if nothing has changed. But things have changed: as the chart shows, growth has come down markedly and Chinese shares have lost substantial ground compared to their us counterparts…have Chinese leaders finally realized that the game has changed? Is this what their recent, timid devaluation efforts are about?

As readers of this blog know I think that China is the biggest credit bubble in recorded history. Whether they realize the game has changed or not: ultimately they will have to devalue the CNY – with worldwide repercussions, compared to which the 1997 Asian crisis will look like child’s play…