The Way of the Samurais and Sovereign Wealth Funds
The global economy and her capital markets are certainly fascinating to follow at the moment if also a bit worrisome as we stand on the brink of what might very well be a nasty recession in key parts of the global system. One of the undercurrents of the whole global economic edifice which I, among others, have been tracking is the underlying state of global liquidity conditions and more specifically the point about a disconnect in global liquidity conditions. Now, this disconnect as I see it is materialising itself in many forms but two forms in particular have caught my attention. The first would be how sovereign wealth funds and derivatives thereof are now acting of lenders of last resort to distressed financial institutions in need to shore up balance sheets on the back of the subprime devastation. Moreover of course, and as Brad Setser would be at pains to point out those official inflows are also busy financing the external US deficit and thus keeping the US economy afloat in a time of many risks ahead. I agree with Brad on this but I find it hard to see how currency re-alignments would make all the imbalances go away with one big swoop in the sense that capital above and always goes for yield especially if that yield cannot be found in the domestic market. But that I guess is an ongoing discussion between Brad and me. In any case the following is a very much to the point ...
Consequently, I think it is more than fair to view the rise of sovereign wealth funds as by product of a set of policy decisions that continue to impede global balance of payments adjustment. That would be true no matter whether the resulting pools of foreign assets are invested in safe bonds or potentially risky banks. It would be true no mater whether the funds are managed commercially or invested strategically. And I worry a bit that the debate over sovereign funds has displaced the debate over global adjustment. Yet absent adjustment – adjustment that no doubt would be facilitated by a US energy policy that helped reduce oil demand – the US will necessarily be selling large quantities of itself to emerging market governments for a long time. That is a fundamental characteristic of the current global system. The US is running a far larger deficit than private creditors want to finance in good times. And, well, in bad times, it isn’t really clear that private creditors want to finance any US deficit at all …
Now, as I also point out in my recent post on Citigroup's eye-boggling Q4 write-down* tied to the subprime crisis this whole discourse is very sexy at the moment not to say very relevant since it is really interesting to see the way capital markets are working and essentially changing at the moment. Political quibbles about selling your soul to foreign interests seem to have steadily cruised into the sunlight at this point even if they might re-appear swiftly again once the dust settles. That sovereign wealth funds are the talk of the town at the moment can be seen from the recent front page of the Economist's print edition. As per usual this means a leader and a briefing and as always they are both a good read.
However and apart from the rise of the SWFs I have also been eyeing another symptom of a disconnect in global liquidity conditions and thus how companies increasingly are turning to Japanese savings in order to raise capital. The subsequent issuance of the so-called samurai bonds can be ascribed to three factors basically. the abundance of capital in Japan, the relatively favorable lending conditions compared to the interbank rate in Europe and the US and lastly (and perhaps most importantly) the low yield environment in Japan and the increasing decline in home bias amongst Japanese investors. Bloomberg recently summed up the trend as the issuance of samurai bonds tripled in 2007 compared to 2006. And now we see how the trend seems set to linger as Morgan Stanley also decides to tap the liquidity of Japanese savings/funds ...
Morgan Stanley raised 50.2 billion yen ($470 million) from the first Japanese currency-denominated bond sale by a U.S. securities firm in more than six months, according to a Ministry of Finance filing.
Morgan Stanley's $2 billion of 5.625 percent bonds maturing in 2012 trade at 188 basis points more than U.S. Treasuries, unchanged from yesterday and down from a six-month high of 199 basis points on Nov. 21, according to Zions Bancorporation prices. Morgan Stanley, Deutsche Bank AG and Barclays Plc are among banks that have increased sales of samurai bonds after losses On U.S. subprime mortgages roiled global credit markets since July, making it difficult for companies to sell debt in dollars.
As always I have a point and this point cuts across what I have been talking about with respect to global liquidity in general and most importantly in an attempt to differentiate the rather tedious idea of excess liquidity and how this said liquidity should be mopped up. Clearly, this is part of the story (irrational exuberance and all) but it is not the whole story and as Einstein said; Everything should be made as simple as possible, but not simpler which is another way of saying that we should never allow ourselves to make things simpler than the complexity of the situation allows. In this way, I want to stress that the imbalances in the global economy and in essence the whole global edifice is more structural than many people think and this is not merely about American and Anglo-Saxon exuberance even if I think that many a red ear is forming in the (sin) City and on Wall Street. There is a flip side to all this which is what we are now seeing and in essence what we need to ask is the simple yet important question as to what really drives capital flows between countries. If you ask me I think demographics are important and as we move forward I intend to show why.
Meanwhile, of course I won't even for a minute let my glance stray away from Brad Setser and his work as well as the more immediate extent to which the global slowdown turns into a great nastiness of a recession.
* Merril Lynch is the latest to join the pillory