Randomly Noted

In my travels around Asia the past couple of weeks, I’ve been meeting with various banks and investors to learn more about the FX market in connection with our big initiative there. Stopped in to see a decent sized U.S. hedge fund and was fascinated by the investment strategy.

Among other tings, these folks invest in convertible bonds issued in local currencies in home countries. They end up with three factors that can affect returns: credit exposure, changes in interest rates and changes in currency values. The manager relayed an interesting anecdote that explained the benefit of such a strategy: the bond and underlying stock hadn’t moved much in price but the currency had to the point it allowed him to convert the bonds into stock and then sell the stock, convert the currency to dollars and make a handsome return. In other words, currency fluctuations in transactions like this can help take an out-of-the-money convertible and all of a sudden bring it in the money.

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Here’s another anecdote supportive of the truism that everything is relative:

Larry Summers, the outgoing director of the Obama administration’s National Economic Council, earlier this week was making the case that while far from ideal, the U.S. economy was making progress.

“You’ve got to like our hand” in the U.S. as compared with the struggles in much of Europe and in Japan, Summers said Monday evening at The Wall Street Journal’s CEO Council meeting in Washington.

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In the U.S., the Federal Reserve’s plan to buy up to $600 billion of government bonds in an effort to stimulate the economy met with mixed reviews. In some parts of Asia, like Hong Kong, the reaction isn’t mixed – it’s not liked at all.

Donald Tsang Yam-kuen, the chief executive of Hong Kong, was quoted in the South China Morning Post as being very critical of the plan. The Fed purchases are designed to lower interest rates in the U.S. And that is intended to make money less expensive to borrow, which gives people more money to spend. But what worries the HK chief executive is that investors looking for higher returns will turn to Asian markets and inflate stock, bond and property markets. “This has increased the risk of asset bubbles,” he was quoted as saying.

It is a dangerous balance. On one hand, the U.S. does need to do something to jump start one of the most important economies in the world and to the world. But if an asset bubble were to occur in Asia and a repeat of the financial crisis of 1997-1998 followed, that would do nothing to help the U.S. and global economic situation.

For the U.S. Treasury Secretary, there are probably no fun days and less fun days. Maybe history will look more kindly, but it’s tough sledding right now.

Today was likely one of those less-fun days for Treasury Secretary Timothy Geithner. He had to appear before angry committees of the Senate and House of Representatives and tell them why retaliatory measures against China for controlling its currency are not the way to go.

Today must have been as much fun for Geithner as heading to Capitol Hill to defend the big bank bailouts. Actually today was probably less fun. Because there are defenses of bank and AIG bailouts, however unpopular they have become from a rear view mirror view.

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The recent Bank for International Settlements FX market survey unvelied a number of trends. One that didn’t get much coverage was some of the reordering of the top ten trading centers around the world. Not huge shifts but interesting nonetheless. For example, Switzerland – home of two of the largest FX trading banks in UBS and Credit Suisse dropped from the third largest trading center in 2007 to the 5th largest in 2010. Moving ahead and up a spot each was Japan (now 3rd) and Singapore (now 4th). The answer for the shift could be connected to the credit crisis of 2008 – Asia was touched but in a way much less then Europe and the U.S. Asian economies suffered through the recession but not as much as elsewhere.  And big banks were particularly hit hard through the crisis.

Another interesting tidbit – when you look at the top four trading centers in each of the three regions, you know that Europe will certainly be the largest, which it is with around 47% of the marketshare. But second place is Asia (20%) and the Americas are third (19.7%). The gap between numbers one and four in Asia is 4.4 percentage points. But it is 17.6 percentage points in the Americas. The U.S. is the second biggest player but it drops significantly after that – Canada comes in number two in the region with a 1.2% market share. Mexico and Brazil each have an 0.3% share.

A mutiny in Australian politics is not unheard of, but certainly this one has caught many people by surprise.
Kevin Rudd was increasingly unpopular as prime minister in voter opinion polls for a number of reasons—his rollback of a pledge on a carbon emissions scheme and a plan to levy a new tax on profits in the mining sector–but to remove him so close to an election, with one expected within a matter of months, is a high-stakes gamble.

The anecdotal feedback among voters so far is that the manner in which the centre-left Labor party leadership has ousted Rudd, and installed Julia Gillard as the country’s first female prime minister, was all a bit unpleasant.

The move came swiftly, and most probably in response to internal party polling that would have shown Rudd–who came to power on a wave of optimism and popularity in late 2007–would struggle to win a federal election against his Liberal party counterpart, Tony Abbott. The government was in danger of becoming the first since before World War II not to secure a second term.

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If China’s liberalized currency policy truly leads to better balance in the global economy, it will be helped by another unexpected Chinese phenomenon.

That’s the nascent labor activism in China.

Admittedly, there’s a lot of extrapolation that has to go on in order to contemplate a virtuous circle between a strong Chinese yuan, reducing the price of needed imports and fighting inflation at home, and a newly muscular labor movement winning higher wages and benefits broadly across a gigantic nation.

First, you have to stipulate that Saturday’s announcement by the Chinese government that it would return to the managed exchange rate policy in force before the credit crisis will result in a significant and steady appreciation of the yuan.

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We can’t really call them capital controls, or even quasi-capital controls. Can we call them capital curbs? Capital management?
Perhaps we can call them Claytons controls, after the nonalcoholic drink that was popular in the 1970s and 1980s for its slogan: “The drink you have, when you’re not having a drink.”

Asian nations aren’t calling their recent actions “capital controls,” and the measures being taken certainly aren’t draconian; so far this year it’s mostly been rhetoric from authorities, about watching hot money flows, while there have been modest steps in Taiwan, South Korea and Indonesia to make it a bit harder for people to move money around.

But it is clear that authorities are growing more anxious about how fast money can come in–and out–of their countries.

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The problem for financial markets when it comes to North Korea is knowing when things have gone from bad to nuclear.

All too often we have witnessed an episode of barb-throwing between the North and South, accompanied by any number of threatening or retaliatory measures: Withdrawal of aid, testing of missiles, testing of nuclear weapons, border skirmishes and such.

Over the decades that Pyongyang and Seoul have remained in limbo from a war that never officially ended, one feels we’ve seen it all.

That makes this week’s events sound a bit like the boy who called wolf.

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The bailout package for Greece has not stemmed the bleeding in global markets, but for Asia the declines in currencies and stocks may soon lure investors back in.

What we are seeing is Asia and the U.S. catching a cold from Europe, as violence grows in Greece over the planned austerity measures and as ratings agencies sound warnings on the fiscal health of others in the region, including Spain and Portugal.

Just as an example, Hong Kong’s share market has fallen three days in a row, losing 3.7% over that period, while the Taiwan dollar Wednesday fell to its lowest level against the greenback since April 9. Thursday, the Nikkei is down more than 3.0% and South Korea’s Kospi has shed 2.3%, with the Korean won around six-week lows against the U.S. dollar.

The declines in Asia, which have included a widening in credit default swaps in an otherwise encouraging environment for the region’s companies and debt, come as investors react to the latest woes in the euro-zone.

The contagion though for now is peripheral; it’s just the end result of a fading global mood for risk. Strip that away, and what do you find?

Asian banks have minimal exposure to European debt–certainly that from Greece, Spain and Portugal. It seems prudence continues to win the day. Asian banks and their economies came through the recent U.S.-induced financial crisis in relatively good shape precisely because they had steered clear of subordinated debt products and repackaged debt generally.

Asian governments have also–some more so than others–worked to overcome the frailties in their banking and financial systems that were exposed so violently when the Asian financial crisis hit more than a decade ago. That’s left systems in much stronger shape, and central banks much better armed with foreign exchange reserves.

The region’s economies have also been faster and more convincing in their recovery over the past six to 12 months. Many challenges remain, none the least from how and when to exit the large spending measures put in place during the crisis, and how and when to tighten monetary policy (as inflation starts to rise), but if there’s one place that offers any sort of sanctuary right now, it would be Asia.

The region needs Europe and the U.S. to keep buying its products, but intra-regional trade has taken up some of the slack, particularly from China.

Sounder economic fundamentals and a stronger banking system mean Asian markets may soon appear more attractive to investors in currencies and stocks (and also the better Asian credits), even if the Greek wobbles continue. It would take a lot more than what we’re currently seeing to suggest we’re heading anew for some sort of global banking or debt crisis.
That may mean the declines start to slow over the coming week as value appears.