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The markets have begun to swoon and one of the canaries was two Thai tycoons.This pair of Thai tycoons, neither of them well-known internationally, has made a total of $27 billion in acquisitions in the past year, more than all Thai companies spent abroad in the preceding three years.
That’s the kind of statistic common in today’s global deal mania, fueled by the glut of funny money. It raises a dreaded question: what happens when the music stops, and when global leverage stops being so available?
We’re about to see….
The Thai billionaires – 74-year-old Dhanin Chearavanont and Charoen Sirivadhanabhakdi, 69 – were both well-established in the Thai business community, but nevertheless their combined $27 billion of acquisitions represented a risky gamble.
One bought a wholesaler on 50 times earnings, while the other bought the flagship Singapore brewer Fraser and Neave for $11 billion, quadrupling his holding company’s debt-to-earnings ratio.
The Trouble is Thailand has been here before – and well within living memory. It was an orgy of leveraged and overpriced acquisitions that led to the Thai banking and monetary crisis of 1997 that sparked an Asia-wide crisis and led to the Thai stock market losing nine tenths of its value.
In today’s markets, the aggressive Thai acquirers seem likely to be the first victims of any credit squeeze that might occur.
After Fed Chairman Ben Bernanke’s recent news conference, it certainly looks like the squeeze is beginning.
And last Friday, an auction of short-term domestic Chinese T-bills was only two-thirds subscribed. It turns out that the interbank rate in China is currently around 8%, way above the 3.9% the government was paying for its T-bills and way above Chinese inflation, which at least on official figures is running just over 2%. Tight money in China will inevitably affect the rest of us at some point.
Bernanke and his British and Japanese counterparts (but not necessarily European Central Bank head Mario Draghi) will fight bitterly against a credit crunch, but they will have little or no effect.
Contrary to a recent revisionist theory, Bernanke was already printing money like a madman in 2007-08 when the housing bubble burst, and he proved completely unable to avert a crunch. Walter Bagehot in 1873 said that the solution to a credit crunch was to lend unlimited amounts of money, but at very high interest rates.
In 2008, that solution was never tried – instead Bernanke dropped interest rates to zero – and it won’t be this time, either.
Credit crunches hit because lenders have lost confidence in the value of the collateral against which they have lent. In those circumstances, misguided “mal-investment” has occurred, as Austrian-school economists call it, and that investment needs to be liquidated.
The market has become imbalanced, with more demand for funds than supply. To ensure that ordinary profitable commerce goes on, interest rates need to rise. That reduces the demand for funds (as borrowers put off projects that are no longer viable, and cease speculative investments) and increases the supply (as banks and other lenders decide that higher interest rates make it more attractive to save than to spend.)
If this happens, a recession occurs, to be sure, but there is no financial crisis and no prolonged period of underemployment such as we have seen since 2008.
What to Expect
The good news is that interest rates are already beginning to rise; the 20-year Treasury bond yield has risen from about 1.5% to around 2.4% yesterday. That won’t be a smooth rise, any more than the stock market fell smoothly in 2000 and 2007, after it had peaked.
However, at some point long-term interest rates will revert to their normal level, 2.5% to 3% above the rate of inflation – or about 5% today. That will cause a credit crunch, which Bernanke and his international colleagues will attempt to fight, but they won’t succeed, because by fighting it they will merely worsen the funds imbalance and reduce the availability of funding for trade and sound projects.
It’s difficult to guess the timing of this downturn, because so much depends on unpredictable market psychology. At one extreme, if China’s money tightness causes ripples in the world economy and U.S. Treasury bond rates rise sharply, panic could come quite quickly.
However, with central banks continuing to ease and markets generally continuing positive, my “best guess” is that interest rates will have to rise quite a lot further before a credit crisis ensues, and that certainly no break is likely while 10-year treasury yields remain below 3%, which was their level during much of 2009-2011. 2014, not 2013, looks to be the year of the great crash.
What Are the Buys?
As investors, we should look for impregnable balance sheets and businesses which are not too dependent on the whims of the super-rich. Emerson Electric (NYSE:EMR) is a good internationally diversified example of such a business – indeed Emerson is so recession proof that it has increased its dividend every year since 1957.
We should also look for countries like Singapore, Chile and Colombia which are well-run and underleveraged, and avoid countries like Brazil, India, Russia and Thailand which have in the past shown a tendency to get in trouble. Country funds like the iShares MSCI Singapore Fund (NYSE:EWS) are a good haven.
EMR and EWS will suffer too in a recession and economic downturn, but they will not succumb to the credit crunch and will still be healthy when the market bounces back.
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