Monthly Archives: December 2010
Lunch With the Treasury Secretary.
When I wake up at 4:30 am each morning to check the overnight markets and review the opening salvo of incoming emails, I often have trouble focusing in my groggy state. So I had to blink twice when the first message in my inbox politely inquired if I had time to meet the Secretary of the Treasury in Palo Alto for lunch that day, apologizing for the short notice.
Tim Geithner was in San Francisco for a day to meet with a small group of venture capitalists and other business leaders. I can’t say who else was invited. Suffice it to say that I was the only one without an NYSE or NASDAQ listing.
When I greeted lithe, athletic, but diminutive Treasury Secretary, I could see the six secret service agents in the room visibly tense up. At 6’4” I towered over him, but he shook my hand firmly. I knew he was an avid surfer, and asked if he had stowed his board on Air Force One so he could shoot “Steamer Lane” in nearby Santa Cruz after the meeting. He laughed, confessing that he rode the waves in a less than adequate fashion.
Geithner succinctly laid out the administration’s position on a wide range of financial and economic issues. The economy is now healing, has been growing for 20 months, but conditions were still very tough, especially if you were in construction, real estate, or small banks. Private sector investment grew of 20% in H1, but then slowed down to 10% in H2. Exports are strong.
The economy is undergoing some difficult, but necessary changes. The crisis was caused by excessive debt levels, the adjustment of which is now mostly behind us. The savings rate has soared from below 0% before the crisis to 4%-6% today. The debt burden is falling. Still, further measures are required.
Geithner thrilled his audience by proposing a permanent investment tax credit for domestic R & D. On top of that, he wants to add a one year tax credit for capital investment. It was music to the ears of those present, who were primarily engaged in the business of starting new companies. He would also eliminate tax preferences that encouraged companies to build plants overseas. At the very least, the playing field should be level.
Stepped up spending on infrastructure is a big priority, which has suffered from decades of neglect and under investment. The US is not a country with unlimited resources, and this is where the taxpayer gets the highest return on money spent.
He also highlighted the urgency to extend tax cuts for the bottom 98% of the working population. The country entered the crisis with an unsustainable fiscal situation, and this would help address that.
Geithner says that the US would not engage in a debasement of its currency. It is very important that our counterparties believe that we will fulfill our long term obligations. The US benefits from the dollar being used as a reserve currency, and there will be no non dollar reserve currency in our lifetimes.
The Dodd-Frank bill was an essential reform, as a huge financial industry had grown up outside the existing rules. Banks needed bigger shock absorbers.
Governments do a very bad job at picking industries to protect, which only supports the weak at the expense of consumers.
Geithner said that by any measure, the Chinese Yuan was undervalued, and that was unfair to all of the country’s trading partners. Although this was enabling China to reap short term benefits, long term it meant that the US was setting its monetary policy. A flexible exchange rate would give China economic independence and soften the impact of imported inflation. When asked what exchange rate he would be happy with, he would only say “HIGHER”.
The 49 year old Geithner has devoted much of his life to public service. He spent his childhood abroad while his father was a micro finance administrator for the
Ford Foundation, growing up in Zimbabwe, Indonesia, and India, and finally graduating from high school in Bangkok. He did his undergrad at Dartmouth, and obtained a master’s in Asian studies at Johns Hopkins, where he gained fluency in Chinese and Japanese. I first met Tim myself two decades ago, when he was a low level Treasury attaché at the Tokyo embassy who spoke the local language
flawlessly. After that, his rise was meteoric, from Undersecretary of the Treasury for International Affairs, to President of the New York Fed, to his current gig.
Geithner put on quite the performance. No matter what the question, he was able to caste it in the context of its historical background, the lead up over the past two decades, the current policy response, and parallels with other major and minor countries. We jumped from the Japanese stagnation, to the Swedish banking crisis in the early nineties, to Indonesia’s explosion of hyperinflation in the sixties, to the
Mexican debt crisis, all within a minute. His canned answers to standard question rolled effortlessly off his tongue, while original problems delivered an intensity of thought one rarely sees.
Before he left, I pulled out all the cash in my wallet and pointed out to Geithner that while I had bills signed by previous Treasury Secretaries Larry Summers, Paul O’Neil, and Robert Rubin, I lacked one with his illegible scrawl. Did he have any which he could exchange with me? He sheepishly admitted that while such bills existed, they we being held back from circulation until the Treasury’s existing stockpile of Hank Paulson bills ran out, in order to deliver taxpayers good value for money. I would only see his bills once the economy recovers and the growth of M1 starts to accelerate. That is truly an answer one would expect from the 75th Treasury Secretary.
Apple’s next stop: $1,000.
When I took a young, cocky, long haired, Levis wearing Steve Jobs around to meet Morgan Stanley’s institutional investors to pitch an Apple share offering 28 years ago, I vowed never to buy anything from the man. He was such a great salesman, and possessed such a messianic devotion to his product, the risk of getting legged over had to be great.
This proved a good strategy for the next 18 years, when the company nearly went under three times, and the stock repeatedly plunged from its initial listing price of $22 down to $4. Disastrous products like the Apple Newton came and went, and then poor Steve got fired.
Living in the San Francisco Bay Area, I was also creeped out by the fanatical cult following that Steve enjoys. Criticize an Apple product here, and you risk getting attacked, ostracized, deleted from address books, and chopped off Christmas card lists. There was also no end of abuse from my IPod and Imac addicted kids.
I have to confess now that my prior prejudices caused me to miss the boat on Apple for the last decade, when the stock soared from $4 to $275, eventually topping Microsoft (MSFT) with a nearly $300 billion market capitalization. To see the company bring out a ground breaking, high end $499-$829 product like the IPad and sell 2 million units in a short two months during appalling economic conditions is nothing less than amazing. The recent stock performance has also been miraculous, bouncing back from a flash crash low of $195 to challenge its old high in a matter of weeks.
Forecasts for the global smart phone market are ratcheting up by the day on the back of surging demand from emerging markets. Sales could reach 250 million units annually by 2012, of which 17% currently is sold by Apple. The company has become a monster cash flow generator, spewing out $12 billion over the last 12 months. It sits on a cash mountain of $23 billion, or $45/share. Apple now has the envious problem in that sales of several of its products are going hyperbolic at the same time.
Some analysts have Apple’s earnings skyrocketing from the current $12/share to $30 over the next two years, which at the current 22 multiple would take the share price up to $675. If the company’s multiple expands to its pre crash average of 35 X, that would take the stock to a positively nose bleeding $1,073, giving it a 400% return over the next two years.
I’m not saying that you should rush out and load up on stock today. But it might be worth taking a stake on the next wave of fear that strikes the market.
To prove that I am not the world’s worst Apple analyst, let me tell you about Ron Wayne, who owned 10% of Apple (AAPL) and you sold it for $800 in 1976. What would that stake be worth today? Try $22 billion.
That is the harsh reality that Ron Wayne, 76, faces every morning when he wakes up, one of the three original founders of the consumer electronics giant. Ron first met Steve Jobs when he was a spritely 21 year old marketing guy at Atari, the inventor of the hugely successful “Pong” video arcade game. Ron dumped his shares when he became convinced that Steve Jobs’ reckless spending was going to drive the nascent start up into the ground, and he wanted to protect his assets in a future bankruptcy.
Co-founders Jobs and Steve Wozniak kept their original 45% ownership. Today Job’s 0.5% ownership is worth $1.5 billion, while the Woz’s share remains undisclosed.
Ron designed the company’s original logo and wrote the manual for the Apple 1 computer, which boasted all of 8,000 bytes of RAM (which is 0.008 megabytes to you non-techies). Today, Ron is living off of a meager monthly social security check in remote Pahrump, Nevada, about as far out in the middle of nowhere you can get, where he can occasionally be seen playing the penny slots.
What a Long and Windy Road It’s Been
Quote of the Day
“If You’ve lived long enough on Wall Street, you know that we shoot out wounded and eat our young,” said Brad Hintz, an analyst with Sandford Bernstein.
Enjoy the Dollar Rally While it Lasts.
Any trader will tell you the trend is your friend, and the overwhelming direction for the US dollar for the last 220 years has been down.
Our first Treasury Secretary, Alexander Hamilton, found himself constantly embroiled in sex scandals. Take a ten dollar bill out of your wallet and you’re looking at a world class horndog, a swordsman of the first order. When he wasn’t fighting scandalous accusations in the press and the courts, he spent much of his six years in office orchestrating a rescue of our new currency, the US dollar.
Winning the Revolutionary War bankrupted the young United States, draining it of resources and leaving it with huge debts. Hamilton settled many of these by giving creditors notes exchangeable for then worthless Indian land west of the Appalachians. As soon as the ink was dry on these promissory notes, they traded in the secondary market for as low as 25% of face value, beginning a centuries long government tradition of stiffing its lenders, a practice that continues to this day. My unfortunate ancestors took him up on his offer, the end result being that I am now writing this letter to you from California—and am part Indian.
It all ended in tears for Hamilton, who, misjudging former Vice President Aaron Burr’s intentions in a New Jersey duel, ended up with a bullet in his back that severed his spinal cord. Cheney, eat your heart out.
Since Bloomberg machines weren’t around in 1790, we have to rely on alternative valuation measures for the dollar then, like purchasing power parity, and the value of goods priced in gold. A chart of this data shows an undeniable permanent downtrend, which greatly accelerates after 1933 when FDR banned private ownership of gold and devalued the dollar.
Today, going short the currency of the world’s largest borrower, running the greatest trade and current account deficits in history, with a diminishing long term growth rate is a no brainer. But once it became every hedge fund trader’s free lunch, and positions became so lopsided against the buck, a reversal was inevitable.
We seem to be solidly in one of those periodic corrections, which began six month ago, and could continue for months or years.
The euro has its own particular problems, with the cost of a generous social safety net sending EC budget deficits careening. Use this strength in the greenback to scale into core long positions in the currencies of countries that are major commodity exporters, boast rising trade and current account surpluses, and possess small consuming populations. I’m talking about the Canadian dollar (FXC), the
Australian dollar (FXA), and the New Zealand dollar (BNZ), all of which will eventually hit parity with the greenback. Think of these as emerging markets where they speak English, best played through the local currencies.
For a sleeper, buy the Chinese Yuan ETF (CYB) for your back book. A major revaluation by the Middle Kingdom is just a matter of time.
I’m sure that if Alexander Hamilton were alive today, he would counsel our modern Treasury Secretary, Tim Geithner, to talk the dollar up, but to do everything he could to undermine the buck behind the scenes, thus over time depreciating our national debt down to nothing through a stealth devaluation.
Given Geithner’s performance so far, I’d say he studied his history well. Hamilton must be smiling from the grave.
The Collapse of the Yen: When is This Party Getting Started?
“Oh, how I despise the yen, let me count the ways.” I’m sure Shakespeare would have come up with a line of iambic pentameter similar to this if he were a foreign exchange trader. I firmly believe that a short position in the yen should be at the core of any hedged portfolio for the next decade, but so far every time I have dipped my toe in the water, it has gotten chewed off by a piranha.
To remind you why you hate the Japanese currency, I’ll refresh your memory with this short list:
* With the world’s weakest major economy, Japan is certain to be the last country to raise interest rates.
* This is inciting big hedge funds to borrow yen and sell it to finance longs in every other corner of the financial markets.
* Japan has the world’s worst demographic outlook that assures its problems will only get worse. They’re not making Japanese any more.
* The sovereign debt crisis in Europe is prompting investors to scan the horizon for the next troubled country. With gross debt approaching 200% of GDP, or 100% when you net out inter agency crossholdings, Japan is at the top of the list.
* The Japanese long bond market, with a yield of 0.1.2%, is a disaster waiting to happen.
* You have two willing co-conspirators in this trade, the Ministry of Finance and the Bank of Japan, who will move Mount Fuji if they must to get the yen down and bail out the country’s beleaguered exporters. When the big turn inevitably comes, we’re going to ¥100, then ¥120, then ¥150.
That works out to a price of $40 for the (YCS), which last traded at $16.35. But it might take a few years to get there. The Japanese government has some on my side with this trade, not that this is any great comfort. Four intervention attempts have so been able to weaken the Japanese currency only for a few nanoseconds.
If you think this is extreme, let me remind you that when I first went to Japan in the early seventies, the yen was trading at ¥305, and had just been revalued from the Peace Treaty Dodge line rate of ¥360. To me the ¥83 I see on my screen today is unbelievable. That would then give you a neat 15 year double top.
It’s All Over For the Yen
The Chinese Yuan is just begging for a home run.
Any doubts that it is a huge screaming buy should have been dispelled when news came out that China had displaced Germany as the world’s largest exporter. The Middle Kingdom shipped $1.2 trillion in goods in 2009, compared to only $1.1 trillion for Deutschland. The US has not held the top spot since 2003.
China’s surging exports of electrical machinery, power generation equipment, clothes, and steel were a major contributor. German exports were mired down by lackluster economic recovery in the EC, which has also been a major factor behind the weak euro. Sales of luxury Mercedes and BMW cars, machinery, and chemicals have cratered.
Two back to back interest rate rises for the Yuan, and a snugging of bank reserve requirements by the People’s Bank of China, have stiffened the backbone of the Yuan even further. That is the price of allowing the Federal Reserve to set China’s monetary policy via a fixed Yuan exchange rate. Is it possible that Obama’s stimulus program is reviving China’s economy more than our own?
The last really big currency realignment was a series of devaluations that took the Yuan down from a high of 1.50 to the dollar in 1980. By the mid nineties it had depreciated by 84%. The goal was to make exports more competitive. The Chinese succeeded beyond their wildest dreams. There is absolutely no way that the fixed rate regime can continue.
There are only two possible outcomes. An artificially low Yuan has to eventually cause the country’s inflation rate to explode. Or a global economic recovery causes Chinese exports to balloon to politically intolerable levels. Either case forces a major revaluation.
Of course timing is everything. It’s tough to know how many sticks it takes to break a camel’s back. Talk to senior officials at the People’s Bank of China, and they’ll tell you they still need a weak currency to develop their impoverished economy. Per capita income is still at only $5,000, a tenth of that of the US. But that is up a lot from $100 in 1978. Talk to senior US Treasury officials, and they’ll tell you they are amazed that the Chinese peg has lasted this long. How many exports will it take to break it? $1.5 trillion, $2 trillion, $2.5 trillion? It’s anyone’s guess.
One thing is certain. A free floating Yuan would be at least 50% higher than it is today, and possibly 100%. In fact, the desire to prevent foreign hedge funds from making a killing in the market is a not a small element in Beijing’s thinking. The Chinese Central bank governor, Zhou Xiaochuan, says he won’t entertain a revaluation for the foreseeable future. The Americans say they need it tomorrow.
To me, that means about six months.
Buy the Yuan ETF, the (CYB). Just think of it as an ETF with an attached lottery ticket. If the Chinese continue to stonewall, you will get the token 2.2% annual revaluation the swaps have been discounting. Since the chance of the Chinese devaluing is nil, that beats the hell out of the zero interest rates you now get with T- bills. If they cave, then you could be in for a home run.
The Chinese Yuan is Looking for a Home Run
Where The Economist “Big Mac” Index Finds Currency Value.
My former employer, The Economist, once the ever tolerant editor of my flabby, disjointed, and juvenile prose (Thanks Peter and Marjorie), has released its “Big Mac” index of international currency valuations (click here).
Although initially launched as a joke three decades ago, I have followed it religiously and found it an amazingly accurate predictor of future economic success. The index counts the cost of McDonald’s (MCD) premium sandwich around the world, ranging from $7.20 in Norway to $1.78 in Argentina, and comes up with a measure of currency under and over valuation.
What are its conclusions today? The Swiss franc, the Brazilian real, and the Euro are overvalued, while the Hong Kong dollar, the Chinese Yuan, and the Thai Baht are cheap. I couldn’t agree more with many of these conclusions. It’s as if the august weekly publication was tapping The Diary of the Mad Hedge Fund Trader for ideas. I am no longer the frequent consumer of Big Macs that I once was, as my metabolism has slowed to such an extent that in eating one, you might as well tape it to my ass. Better to use it as an economic forecasting tool, than a speedy lunch.
The Big Mac in Yen is Definitely Not a Buy
Quote of the Day
“At some point in 2011, knuckles are going to be turning white, and we’ll see whatever rabbits Ben Bernanke is going to have to pull out of his hat” ,said David Rosenberg of Gluskin, Sheff in Associates