Tags: Japan | China | India | banks

All That Shines Is Not Gold (in Asia)

By    |   Wednesday, 24 July 2013 07:57 AM

I had a very interesting conversation on the flight back from Europe that made me want to focus on Asia this week. I was chatting with a lawyer of Malaysian decent who was trained in London and is now working in Hong Kong. I asked her about the state of businesses in Hong Kong. She had a fascinating comment about how a Western tourist was always catered to before a Chinese tourist was in shops in Hong Kong for the longest time.

However, in the past three years, the roles have reversed. She sees Chinese customers being waited on hand over foot, while western tourists are treated second best. It goes to show you the power of the rising Chinese.

I want to focus on the three Asian stars and briefly check under the hood to see what's cranking.

China seems to be rumbling along. It's latest print of 7.5 percent gross domestic product growth reminds me of the Goldilocks story — not too hot, not too cold, just right! Of course there are the "China is heading for a crash" campers who claim victory when China's growth is not in the double digits.

I honestly believe China is now exhibiting the traits of an economy in transition. It is moving away from being a factory to the world to a mature and stable economy, with robust internal consumption.

Much of the changes are deliberate and managed. For example, we have seen how China has now started liberalizing the interest rates charged on loans market. It is trying to deregulate it and make it market driven. Next will be deposits. Baby steps, but all part of the big plan to float the yuan and then make it a possible replacement as the reserve currency to the world in the next five to 10 years.

India is a wounded tiger. It has been slapped down and beaten upon as far as its currency markets. I would have to concede that much of that is self-inflicted. Years of stagnation and rampant corruption has to take a toll. It has come at the worst possible moment, with the country having huge current account deficits.

With elections in 2014, this sorry state of affairs in India will continue and the stock markets will be at the mercy of the Federal Reserve tapering story since a lot of the momentum on Dalal Street (India's Wall Street) is driven by foreign fund inflows and outflows. I would wait until after the elections to determine if further investment in India is warranted.

Japan is a fascinating story now. Prime Minister Shinzo Abe seems to do no wrong these days. Not only did he win the crucial vote in the Upper House this past weekend, but also he won with a large majority. So it seems that he has free rein to run Japan for now.

But what I found under the headlines makes me cringe. With the huge stimulus that the Bank of Japan has undertaken, I am noticing a real problematic trend that could be disastrous to Japan, Europe and the whole world. As we see significant cash being pumped into the Japanese markets, we see tremendous pressure to generate yield. Japanese bond yields are low to negative, so where does the public invest?

On the other side, we have Europe where the European Central Bank is trying hard to shrink its balance sheet and is, thus, withdrawing money from circulation. So businesses are desperate for cash. In this contrasting world, we are seeing a rapid emergence of "samurai" Bonds — European banks are issuing Japanese yen-based bonds with high yields.

These bonds are secured by questionable or weak assets. While the issuers of the bonds are reasonable names in the market, the lenders are more of the regional bank types that have no experience in such bond management.

If there is a failure of any bond issuances or even a significant rising of risk, we will see several regional banks in Japan collapse causing a bank run in Japan. I will watch this development more closely and if this gets uncontrollable, I will short the smaller regional Japanese banks.

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I want to focus on the three Asian stars and briefly check under the hood to see what's cranking.
Wednesday, 24 July 2013 07:57 AM
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