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Thursday, June 19, 2003

Money To Burn

Too much money, that's Andy Xie's explanation of where we are. I suspect he may be right, understanding why there may be too much money is another matter altogether.

You are holding cash and the interest rate is zero. The bank in which you keep your money pays dividends equal to 5% of the stock value. Then your friendly private banker calls you up and confidently explains that you would be better off if you owned the bank�s stock than if you continued to deposit your cash with the bank. Aha, you saw through this one! The bank�s stock price could fall but your deposits are protected, first, by the bank�s capital, i.e., shareholders, and, second, if the stock price falls to zero, by the government that regulates the bank.

We saw the same situation in the Tokyo property market. The rental yield rose above the mortgage interest rate in the 1990s. For some reason, the property value always seems to drop a bit more than the pickup in the yield for owning the property. This also happened in the Hong Kong property market. The property market was more sophisticated in Hong Kong than in Tokyo and had the affordability index to show why property was worth buying. Waves and waves of bottom-fishers braved the market. They now have no cash. However, they are proud owners of high-yield assets but at much-reduced capital values.

Asset markets have been cash guzzlers in East Asia for years. The cash goes to maintaining growth in value-subtracting GDP. Hong Kong property provides the best illustration of this point, in my view. Buyers effectively subsidize an industry that faces declining prices. Their past savings subsidize the property industry, which in turn keeps up GDP. Without the massive destruction of savings, the Hong Kong economy would have shown a much greater decline.

The stock market is a less obvious example. It can attract money through volatility. Even though most markets in Asia have been merely fluctuating for the past ten years, they have raised money to fund one industry after another. Investors have poured money into a series of growth industries. However, the high profitability of a growth industry generally proves to be ephemeral, I believe. As capacity expands, most ex-growth industries are plagued by excess capacity and low profitability.Too much money is at the root of the problem. It causes speculative spasms in asset markets and excessive capacity formation in production. The two conspire to generate high GDP growth and value destruction. Economic growth generates high profitability in an industry, only to be destroyed by easy capital for capacity formation.

The Asian experience is spreading. The world has too much money, I believe. Money with zero maturity (MZM) has grown at 12% a year in the US since the NASDAQ peaked in March 2000, 62% faster than the average for the preceding ten years. Much of the surplus liquidity in the global monetary system will be destroyed, in my view, either through (1) deflation bubbles or (2) stagflation. The world currently seems to be on the first path. The world�s asset markets are behaving increasingly like their Asian counterparts. Stock markets experience periodic speculative spikes up with little change in fundamentals. People give more and more of their savings to governments to spend. Rising fiscal deficits coincide with falling interest rates.

The relationship between markets and the economy has fundamentally changed in the current environment. Falling interest rates provide the justification for pouring more savings into low-profit activities, which keeps up GDP. Giving money to the government to spend is the ultimate expression of supporting low value-adding GDP. In a normal environment, rising profitability attracts more capital.
Source: Morgan Stanley Global Economic Forum
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