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Wednesday, January 30, 2013

Stocks and Capital Flight – Old and New

 

In my time I’ve watched a bunch of countries go south. In the 80’s it was all of South America. Poland, Yugoslavia and South Africa also hit the skids during those years.

 

There was an observable pattern as events unfolded. The early stages of a crisis were always marked with capital outflow by the financial elite in the country.  The wealthy families bought real estate properties outside of the country; they increased their ownership of foreign (mostly US) financial assets. They used whatever local currency they had (or could borrow) to buy hard assets in the country. In this case, hard assets meant  companies (or farms) that produced stuff that could be exported, and thus be a source of hard currency earnings. Two minor examples:

 

- In Ecuador there was an explosion of shrimp farming. The expenses of production were all in Sucres (the local currency). The shrimp were sent to the US and sold for dollars. (This was a great business – ecological disaster however.)

 

In South Africa, it got so bad that people ended up buying luxury boats with their SA Rands, and just sailing away. A lot of the boats ended in the Caribbean. Many were sold for cash dollars.

 

 

I bring this old stuff up because I see definitive evidence (on a daily basis), that this is happening in China today. You name the City outside of China; I’ll show you the real estate transactions where it is Chinese money that is doing the buying.

 

 

Another observable phenomenon back then was in the local stock markets. When the local currency was rapidly devaluing, the only safe-haven trade was to move money into stocks. The stocks in favor during these times of crisis were the shares of companies that were exporters (source of hard currency). In Brazil it was the steel companies, in Argentina/Chile it was the food exporters, in Mexico the money went to the oil exporters.

 

We are witnessing precisely the same thing happening today in Japan. Japanese stocks are going up lock step with the falling Yen. So far, Japanese stocks have outperformed the currency devaluation. That is true for the citizens of Japan. It has is also been true for most  foreign investors.

 

eurusd

 

usdjpy

 

 

China, today, is much different than Argentina was in the 80’s. But the level of capital flight by the wealthy from China should not go unnoticed. There is a big red flag being waved.

 

Japan is certainly no Mexico, who devalued its currency again and again. But the stock markets of the two countries, then and now, are also raising those Red Flags.

 

I’m always wary of looking at the past and using history as a guide for what will happen in the future. To the extent that the past is a guide, then we may be in for a rough spell, one that is not “homegrown”.

 

By my read of history, the “tipping point” occurs at about the time when the local stock market returns fall below the currency depreciation. When that balance is broken, chaos usually follows. In the case of Japan, this could come as a result of a sudden down correction in the Nikkei, coupled with another big move down in the Yen versus the Euro and the dollar.

 

As far as China is concerned, I think the cracks are already there. The growth in domestic debt is fueling the capital outflow. The “off balance sheet” financing for the capital outflow is coming from the sale of Wealth Management Products. This powder keg now totals $2 Trillion, and it’s growing fast. I think these investments are not unlike a ponzi scheme.

 

ponzi graffiti

Comments

  1. Are there any realtors working in Hawaii, Singapore or Malaysia (or maybe even Oz) who would care to comment on sales to Japanese clients over the last couple of years?

    • Egad! I guess I should just give up writing. Either I can’t write, or you can’t read.

      I never said anything about Japanese capital flight. I never said Japanese citizens were buying RE. I certainly never said anything about Hawaii.

      I did say that Chinese citizens were buy RE all over the globe. I stand by that.

      Do me a favor, re-read this. If you still are confused, then I have to give this up. I don’t think I could have been much clearer. But, obviously, you were confused.
      bk

      • The writing in this post is perfectly clear. I recall maybe one past item about Fx markets that left me confused, but that was more a result of my limitations and not your writing; I’m dense about currency operations and physics.

        Don’t you go anywhere.

      • Perhaps the point was to inquire if wealthy Japanese are doing the same as the Chinese, but in a place they traditionally invest, Hawaii. Their currency is expected to decline more quickly in the coming year. It seems to be a rational association. Or do you have to declare something to be so in your blog entry first before a person can ask a question about it?

  2. Roberto Hernandez says:

    “…in Mexico the money went to the oil exporters.”

    It was, and still is, impossible to buy stock in a Mexican oil exporter, because there is only one such company, the government-owned Pemex, whose stock is not listed.

    Mr. Krasting, how you dare to write like that, is beyond me. You owe us readers.

    • Did I say the stock of PEMEX? I did not.

      Before and during the crisis there was a big effort to move the deck chairs on the Titanic. I was involved with this effort.

      Mexico had ~100B of debt (incredible how small this seems today). There were many individual creditors. Some of the big debtors were PEMEX, CEMEX, CFE (electric), FEMSA, TAMSA. The biggest was direct debt of the Republic of Mexico, there was also Banco Central guaranteed debt.

      The thinking (later proved wrong) was that some of these would end up being money good, others might not. The concern was the straight Republic debt. That certainly was headed for a restructuring. So a big swap market developed where “titles” were swapped. These were done with ratio swaps. To get out of a lesser credit, you had to swap for more of a “better” credit.

      Because of the $ receipts, PEMEX was considered a “better” credit and traded to a premium versus other Mexican debt. FEMSA also traded to a premium. It was in this way that the money flow moved in the direction of PEMEX.

      So no, PEMEX was not a common stock type of play. An example of a common stock that folks would try to hide in would be Tubos de Aceros. It provided pipe domestically for the oil industry, it also had a big export business.

      I would note that none of these defensive tactics worked very well in the short term. However, some monster companies emerged. FEMSA, most notably.

      • While I have no idea why Mr. Hernandez is so ticked off, reread your column, this time from the prospective of a reader, not the all-knowing author.

        “The stocks in favor during these times of crisis WERE THE SHARES OF COMPANIES that were exporters (source of hard currency). In Brazil it was the steel companies, in Argentina/Chile it was the food exporters, in Mexico the money went to the oil exporters.”

        Boy, it’s super hard to see how someone would assume you meant shares of the oil company in Mexico! : /

        Feel free to explain how the company that makes pipe for use in Mexico is an “oil exporter”.

        I guess along with the millions earned on wall street comes a boatload of arrogance and disdain for the mere peasantry.

        No reply necessary, I won’t be back to read anything here.

  3. Roberto Hernandez says:

    “Japan is certainly no Mexico, who devalued its currency again and again. But the stock markets of the two countries, then and now, are also raising those Red Flags.”

    Even if the Mexican Bolsa is currently overbought, with record P/E and FV/EBITDA multiples, there are no signs of capital flight. If you have facts about this issue, please inform, instead of delivering gratituous statements.

    You owe us readers some respect.

  4. Jezzz BK Seems those turkey buzzards are after you.Great info as usual.

  5. So how is your day going today Bruce?

  6. Bruce, I’ve heard 1 out of 10 houses in Calif. were purchased by Chinese. They also seem to be buying hotels in my area(Pasadena), I know at least 2.

    • One of the reasons for that is the effect of the one-child policy that has left China with a shortage of females (I’ll skip the horrifying explanation of how/why.) Parents of Chinese young men buy houses here so the sons can move here to find wives.

  7. Bruce,

    Your analysis is spot-on, except there are some additional reasons for the capital flight from China. My son recently returned from a long study abroad in China. It was his opinion that the Communist party members who have accumulated a lot of money from various activities are the ones trying to get their money out. He says there is an implicit agreement between the people and the Communist Party that as long as there is good economic growth and the people are seeing the benefits, they are willing to put up with the Communist Party. When the good times end, the Communist Party members know that their “party” will also end. I think they see a slowdown ahead in the next few years and know the good times and their special privileges are going to end. So it is not necessarily a capital flight because of a weakening currency, but a view ahead of weakening privileges for the elite.

    • Yikes! Another who is confusing what I (tried) to say.

      -China has capital flight, but does not have a weak currency.

      -Japan has a weak currency (of late) and the stock market is rising.

      Two completely different things. Both of them are signs of trouble. Both are repeats of history.

      With that said, I will throw the lap-top into the Hudson, and then crash into a nearby bridge abutment at high speed….

      • “I will throw the lap-top into the Hudson, and then crash into a nearby bridge abutment at high speed”
        No, please don’t!
        Think of the consequences: You could irreversibly damage the bridge abutment, contaminate the Hudson and deprive humanity of an excellent financial blogger!

        My uneducated guess about the chinese shopping spree is money laundering. Do you think that could be an explanation?

      • say it ain’t so! who would keep the buzzards warm if you were gone

      • Bruce,

        Sorry about that. I know you didn’t say China had a weak currency. You drew parallels to previous instances that involved weakening currencies and you didn’t really explicitly state your opinion regarding why capital was leaving China. I thought the additional anectodal evidence would be interesting for you and your readers.

        Cheers.

        • Oops – I guess you did state your reason: “The growth in domestic debt is fueling the capital outflow.” Well, in either case there are some other political forces at play.

  8. Are there any FX textbooks (or any books for that matter) that teach/explain the fundamentals of FX? Does anyone have a reading list they’d like to share?

  9. While leftwing media are harping on Phil Mickelson, the big capital flight (and brain drain) that is impacting the USA is the flight from high tax / big government union states like CA, IL, and “NE” (Bruce Krasting’s extended New England states), and its only a matter of time before VA and MD join the list

    Not even the government pensioners are willing to pay the exorbitant usury needed to keep the government union pension system afloat. Why should the average US taxpayer, making $65K per year according to the IRS records, struggle and sacrifice for some arrogant prick DMV worker or P&Z “officer” who gets six figures in retirement after not really working 20 years?

    That is the big capital flight that impacts US (and G7) investors — fleeing the monster that

    Who cares what faustian bargain the Chinese people did (or did not) make with the Chinese communist party? At the end of the day, we face a better chance of being hit by lightning than being hit by al-qaeda. But every single one of us will fall victim to the criminal cabals (both parties) running Washington DC.

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  19. These Wealth Management Products, which offer 10% or more in a 3% market, can only be described as Ponzi schemes. Understated inflation with, at the same time, low interest rates (sound familiar?), drive these products which can only be sustained by new investors seeking higher yields. Such funds seem to be a way for banks to evade reserve ratios, which I believe are now at over 20% in an effort to contain inflation.
    What I don’t understand in your article is how these WMPs in China could be encouraging capital flight because I understand them to be typically lending money into pools which roll over local debt, or investing in domestic construction bonds financing infrastructure projects or even financing building projects in China, such as the famous empty cities. In other words, are you saying the funds are not trapped locally and are these funds actually investing overseas speculating in real estate or other foreign assets? If so, the problem there would be that there is no individual ownership of anything, just ‘ownership’ of pooled assets in a Ponzi scheme, whereas capital flight usually is the result of informed individuals exporting money which they believe to be in jeopardy and the assets purchased with this money to be personally owned by them.
    In the case of China, it would be the party bosses and wealthy industrialists somehow able to evade export controls on currency and capital.
    It would also be interesting to see a chart of the USD/renminbi/EURO and the Chinese stock market. The Chinese market has fallen some 60% since the peak in 2007, and now rests not much above the level of 2008 after the collapse.

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  21. Could all this capital flight represent more of a vote against the$US given the large dollar holdings and the foreign transactions are presumably denominated in dollars and not yuan. I don’t know the mechanism/process but i believe China government controls/routes these flows of funds somehow. It’d be another mechanism to reduce the glut of dollar foreign reserves. Comments?

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