Enzio's Clock

Background

1. Putting recent events into the context of The Economic Clock™

By now everyone has accepted what we have suggested for months, namely that the global Economic Time has been worsening. It has morphed from an excess supply of money into an excess demand for money, and of late, the many derivatives of the sub prime crises have transformed the excess demand for goods into an excess supply of goods.

Thus, The Economic Clock™ suggests that globally we are standing in front of an

• excess demand for money (EDM), and an
• excess supply of goods (ESG)
  

Subscribers know that asset markets cannot move if there is an EDM. That is because an EDM means that there is no "spare cash". Asset markets are driven by spare cash: only after people have paid for all of their overheads can they invest with the residual, and that is what this "excess supply of money" is all about. Besides, if there is an ESG, how can margins or turnover improve at all?

2. Three things that may be a little different this time

We have been around too long to fall for this naive/inexperienced "this time it's different" Wunschdenken (wishful thinking"). Indeed, have just put the current crises into the context of the timeless Economic Clock and see that, broadly speaking, the pattern is holding true. All of which means that when the US market dives this October, all markets will crash - short term. However, we believe that certain markets will rebound faster than others, and this spells an opportunity for those following The Economic Clock™.

This time around, there are three subtle differences which investors who want to make money must be aware of.

First, the excess demand for money is not entirely Central Bank-driven. Yes, it is true that -

• The European Central Bank (ECB) is keeping a tight leash on its monetary aggregates,
  
• The Bank of Japan (BoJ) keeps bludgeoning its monetary aggregagtes, and
  
• The US Fed finally is allowing the monetary aggregates to expand timorously.

However, on top of this supply phenomenon has loomed another one: banks themselves don't want to lend! And this, according to Germany's excellent Frankfurter Allgemeine Zeitung (FAZ) of 11th September, suggests that the markets may be driving the Central Banks - and not the (usual) other way around! Were the ECB to raise rates, as she wishes to, and were the Fed to cut rates, as presumeably she will do on 18th September, the dollar would crash even more - with calamatous consequences in financial markets. For one thing, a dollar crash would drive up imported inflation and thus long bond yields - putting another spear into the backs of the American middle class burdened with rising mortgage rates and falling house prices. Step in "cost-push" inflation via higher import as well as commodity prices.

Thus, the FAZ is labelling the current crisis as one that boils down to a power struggle: who is in charge? The Central Banks - or the markets? And for "now, the winner is: the markets! They are driving the Central Banks.

Here is what has been happening because banks are gun-shy to lend:

• The ECB recently pumped another Euro 75 bn into the financial system for three months in order to cap the rise in interbank rates, and
• The Fed has made one month money available through its discoun window to those banks in need.

Thus, we see that even if the ECB wants to be seen as a disciplined inflation hawk, markets are forcing her to increase liquidity - because banks don't want to lend. Hence, for instance, UK overnight interbank lending rates have rocked to 6.75%, courtesy - inter alia - because North Rock PLC is turning into gravel. Even the Fed, had she had her own way, probably would have gone for one more rate hike - just to ensure that no further (cost-push) inflation rears its ugly head during and shortly after the US Presdential election campaign. But, markets won't allow such Central Bank prudence.

Thus, "the difference" this time is that markets are forcing the hands of G-2 Central Banks. This means that the Fed will cut rates initiallly, but once the markets have backed off, the Fed will stop cutting - and that the ECB will tighten even more, once markets back off again.

The second difference is that the financial landscape has evolved: China and India are at the dawn of their first industrial revolutions. Crucially, as Toynbee (Change and Habit, 1966) puts it, communication is the "annihalation of distance". With the internet, these two governments are under enormous pressure to "deliver" - to create jobs and thus prosperity. If they don't, they will be toppled.

One vital implication is that you must look beyond China's and India's exports to America as their "only" growth engine. Ever since I began my broking career in 1986 I never bought this simple story: in order to export, you must import the necessary inputs that the exporting country cannot provide. Thus, the "net effect" of exports, the visible trade deficit, generally has equated to under 6% of GDP. But, the far bigger fish to track is private consumption: in any economy, this accounts for two thirds of GDP. And with the governments especially of China and India being forced to create jobs and thus growth, private consumption increasingly will dwarf exports as a key growth engine. All of which makes us structural optimists on China and India.

This does not mean that their economies are immune to America's. Rather, it means that global investors have a greater choice of where to put their money, once the G-2 Central Banks aresume/ are allowed to create an excess supply of money. This means that investors have greater portfolio choices now.

Weak dollar. The third difference is that normally the dollar climbs during times of turbulence: people want a safe haven to ride out the storm. But this time, the US is the economic storm. So, people will sell dollars and buy more stable Euros. Meanwhile, another quirk to this crisis: the yen has to strengthen because people will unwind their carry trades (CTs). Previously, they borrowed cheap yen in order to buy high-yielding assets. This means that the dollar is relinquishing its "safe haven" role, courtesy of Countrywide Financial "Corpse" morphing into Northern "Gravel" PLC.

3. How to make money off this

Chindia. First, keep loading up on China, H Shares and on Hong Kong, as well as on India. They all have out-performed the G-3 markets handsomely, and will continue to do so for the political reasons just mentioned. We include Hong Kong because we are the water skier at the back of the Chinese speed boat.

Commodites. Secondly, if you believe in China's and India's growth mandates, then buy well-run commodity producers.

G-3. Thirdly short the US markets, along with those in Europe especially Japan's. With Mr. Abe's resignation on 12th September, expect the LDP's big knives to clash with those of the Upper House rulers, the DPJ.

Investment banks. Fourthly, short the investment banks, who already are shaking. In their understandable quest for profits, you have read of "big" names that are encountering financial difficultes. If you share our view that the subprime mess has to worsen, then it is probable that these investment banks will encounter even greater difficulties, too. That, with a worsening global Economic Time, means that their deal flow and thus profits skid, too.

Sell the dollar.Finally, go long the Euro and the yen. As the mush in the US economy deepens courtesy of America's sub-prime messes, her Economic Time is going to worsen faster than in Europe. Do the Fed will have to cut interest rates faster than she initially may have wanted to. The implication has to be a weaker dollar, particularly against the Euro. But the dollar also must weaken against the yen: if it is true that the size of the global carry trade is huge, then people will be forced to sell many assets they financed by borrowing cheap yen, and then they must rep-pay their yen loans, so up goes the yen.