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The Smartest Man in Global Capital Markets on the Fed, China, and What's Next for World Markets

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In our latest interview with TSMIGCM, we take a tour around the world and review the impact of QE.

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Severe and Unrelenting Policy Backlash From Abroad Regarding the Impacts of QE

Mexico has not been the only country challenging the US Fed on its policies. From Brazil to China, and from Russia to Germany, this was fast becoming a well-rehearsed chorus of angst. This has happened in an environment that can best be described as a "Buy America" one. Many smart money managers and foreign companies have increasingly been advocating the purchase of US assets of all kinds. When traveling the world, this can be heard everywhere; it is the trend today.

The idea that the US FED is the cause of everyone's problems has become quite the rallying cry. Take Brazil as an example. They have advocated capital controls more times than I can count to protect their currency from rallying against the dollar and infringing on exports. But the Fed has barely made a left turn in the road, and the Brazilian reais has collapsed to an exchange rate of 2.27 reais per US dollar. The problem with Brazil is that it is an emerging market, and not an emerging superpower. It has a poor and marginally competent government; labor costs have skyrocketed, as have commercial real estate prices -- that is, when it can be found in the Faria Lima district of Sao Paolo, it is way too expensive; labor unions have vast power; the state immerses itself in every aspect of production; and the country is vastly overregulated. I have met dozens of emerging market debt and equity investors and IB clients during these past weeks, and for the most part, they were negative on Brazil. A country that should by all accounts be growing at a 6-7% annualized GDP is growing below 1%. So, the Fed will migrate away from QE; the US dollar will strengthen. Then who will the Brazilians blame? As can be seen by recent social unrest, they have finally gotten it right -- themselves!!

Summation of Part I

To sum all this up, I recently had a lunch with a hedge fund manager I have great respect for. You would all know the name, but I can't reveal it. I outlined my view that the "liquidity unwind" would create 1994-like distortions in credit and fixed income markets. Upon finishing, I was told that my guest was in complete agreement with me but for one thing. What I was missing, so he said, was that there would be "no exit strategy." The Fed, he suggested, viewed QE as binary; it would go on for a very long time precisely out of fear of another 1994 at a time when EMEA banks were still weak, Japan was dancing on the periphery of irrelevance, China was slowing down, and most importantly, the central banks had no more arrows left in their respective quivers. "Forever," I was told.

Give Bernanke and the Fed credit; they see and know all of this. They very meticulously -- almost forensically -- orchestrated a "correction" that amounted to 5% in equities, 5-10% in select US Credit Products, and 15%+ in emerging markets-related asset classes and currencies. This was necessary! Central bankers have maintained for years that they should not manipulate and manage asset prices. Today, that is exactly what they are doing. There has been no coherent US fiscal policy to assist the Fed in its quest to salvage US growth and reflate. History will prove this true.

Part II - GEOGRAPHIES (Select Thoughts on Countries of Interest)

Japan

QE will fail in Japan. Unlike the US, which has awesomely flexible labor markets, lots of transparency, reasonable immigration policies, and few subsidy-related distortions in its economy, Japan is subject to many rigidities that do not set the preconditions for QE to succeed. Virtually no one of consequence in Washington, DC, thinks that the Japanese will succeed. But as I have said before, there are a couple positive signs.
  • Major exporters likely to benefit from a collapsing yen appear to voice a fiduciary responsibility to increase overseas direct investments with the profits windfall they will get.
  • The companies most reliant on domestic sales are also advocating cross-border acquisitions, and there are some signs that consumers are modifying their savings and spending patterns. Regrettably, in the absence of substantive deregulation and structural reform, Japan is not capable of having a sustained QE equate to anything but trading opportunities.

The country recognizes that the current demographic trend does create a sense of urgency regarding the exporting of business models to other jurisdictions and increasing foreign direct investments (FDI) across the globe, preferably where demographic trends best offset what's happening at home. As an example, Japanese multi-national companies have been very reticent to increase FDI in India for many years. India is an integral part of the US-China containment strategy, and it has been an imperative of US policy wonks to encourage Japanese FDI in that country. Having recently spent a full week there, it is clear that this is now happening. Japanese policy banks -- like the Japan Bank for International Cooperation and the Development Bank of Japan -- are providing almost $8 billion in guaranteed loans to help construct the Mumbai-Delhi Corridor Project, all in an effort to illicit more FDI. Japanese Prime Minister Shinzo Abe has targeted another $45 billion in Japanese FDI for India in this year alone.

So corporate Japan is on the move, as it should be. The real bottleneck to QE will be the consumer and the country's inertia in terms of agricultural reform, immigration policy changes, and other issues. These things will hold Japan back. The likely result will be an over-reliance on the things they are comfortable with; thus, there will arguably be much more FDI in global emerging markets. The target list for this investment includes Vietnam, Thailand, Indonesia, The Philippines, Myanmar, India, Brazil, Mexico, Poland/The Czech Republic, Germany, and the US.
No positions in stocks mentioned.
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