FX CONCEPTS FX CONCEPTS

GLOBAL MACRO RESEARCH GLOBAL MACRO RESEARCH

CURRENCIES INTEREST RATES EQUITIES COMMODITIES
To contact FX CONCEPTS New York: 1 (212) 554-6830; London: +44 20 7213 9600; Singapore: (65) 67352898; research@fx-concepts.com


MARKET INSIGHT REPORT
Crumbling Countries, Soaring Markets
By John R. Taylor, Jr.
Chief Investment Officer
_____________________________________________________________________________
There seems to be a serious disconnect between the major financial markets of the
world and the crumbling global governance structure. We are past the point that we can
say these problems involve peripheral countries with minor international presence that
will be settled soon. Markets are supposed to be forward discounting machines, but by
our measure they are failing because the risks of curtailed future cash flows must be
higher than they were last year yet the markets are up. How can they promise less future
cash for current investments when so many possible problems could intervene? The
future risks are not a bunch of black swans, as we can see their rough outline. With
some analysis we should be able to identify the underlying causes and processes
involved in their development, with the goal of valuing their impact. Although analysis
has been done on the direct financial impact of these events, we feel the many
interrelated societal and psychological issues need to be tackled. The geopolitical issues
will impact the markets this year and next, but even more important they are an
indication that the world is starting a process of dramatic change that will alter many
aspects of our daily lives. In this short piece, our goal is to get us thinking about what
characteristics underlie these issues. The best place to start is with the short hegemonic
dominance of the United States beginning in 1989. The overwhelming military and social
position of the US and the American belief in its exceptionalism were not compatible.
The American myth that all men are basically good and rational and will do well if they
are free has driven its international relationships for hundreds of years. The US was a
hegemon with a soft touch because of its belief in the goodness of man. This is a bad
combination. I believe Sigmund Freuds analysis that men are violent creatures
basically desirous of killing each other, and civilization must control that beast. The
history of the 20th century backs Freud not the US (even though the US used Freuds
concepts better than anyone else). The adaptation of Freuds ideas was the basis for
government intervention in social welfare. Consumerism soothes the violent beast. If
we accept that consumerism and social harmony (or lack of killing) are tightly correlated,
the US succeeded as a hegemon by supporting economic growth for a while. This was
not enough as not all people see consumption as a goal. US dominance failed as
economic growth faltered and the US refused to accept that not all of us are rational
economic men. The US myth proposes democracy where violence rules. This does not
work and the US is ridiculed almost everywhere. It is being forced out of the hegemonic
role. Local powers, unhindered by the US myth Russia, the EU, China, and far less
acceptable ones like ISIS fill the vacuum. The fractious border zones will prove crisis
prone, but the Middle East and Islamic world without any locally legitimate power will
prove Freud correct as violence has the upper hand. The new global governance
structure is a balance of power far more complex, and tenuous, than the one during the
Cold War, and history says that all balances prove unstable and prone to conflict.
Furthermore, the US probably wont accept a lesser position in a world that ignores its
myth. Russias move into the Ukraine illustrates the inadequacy of the USs hegemonic
vision Obama wonders why Putin is irrational. The Chinese attack on the US Pacific
order is perhaps unavoidable and acceptable, but the mess in the Arab world is not.
Projecting violence, the lowest common denominator is not difficult, but projecting order
is almost impossible the US experience in Iraq and Afghanistan are the most recent
examples. The US has failed as a hegemon and the global backwash with its violence
will be with us for years. Are the markets priced for it?
FX CONCEPTS FX CONCEPTS
GLOBAL MACRO RESEARCH GLOBAL MACRO RESEARCH
CURRENCIES INTEREST RATES EQUITIES COMMODITIES
To contact FX CONCEPTS New York: 1 (212) 554-6830; London: +44 20 7213 9600; Singapore: (65) 67352898; research@fx-concepts.com


CURRENCY - Asia Long-Term View

Softly, Softly
By John R. Taylor, Jr.
_____________________________________________________________________________
The Chinese authorities have proven themselves
very adept at just nudging the tiller a bit to port and
then a bit to starboard keeping the financial state
right on course. We are not talking about the GDP
numbers, the housing statistics, or any of the more
manageable economic statistics, but the truly rowdy
and often uncontrollable ones the currency and
equity markets. We are not saying the Chinese
authorities do not have their hand in these markets
as they obviously do just like the US and every
other country does but that they have been able
to make these markets so attractive they are
attracting investors at just the right pace to satisfy
the needs of the broader economy and the government itself. Chinese markets have
changed a great deal since the beginning of 2014 and this does not seem to get a lot of
press. First, the renminbi market has begun to act like a real Asian market with the
government watching carefully but with the outside users of the market having some
power to move prices in the direction they deem appropriate. Looking at the way the
USD/CNY trades, it would be very hard to differentiate its movements from those of the
USD/JPY if they were unpriced and unlabeled. The gentle movements serve to build up
confidence in the market, which expands the markets depth and allows it to be used for
more financial transactions, becoming a parking place for excess funds and investments.
In Chinas case both the renminbi and the Hong Kong dollar have benefitted from
the sanctions against the Russians and the fears of others as the Mid-East
situation deteriorates and the US dollar is seen as too dangerous by some
investors and banks. The correlation between the currency and the equity market has
gone from effectively zero to the positive 30% to 60% range, which makes it comparable
to many EM relationships. When the equity market moves up, the currencies do as well
because offshore money is being attracted into the country. Control of this process, as
the Chinese authorities have shown, lessens the risks for all involved and help China
economically and politically as it competes in the world marketplace.

How long can they do this? Will they be able to weather an equity reversal or a sell off in
emerging market bonds? The cycles seem to imply they will not be immune from the
global pricing issues around them. The cycles on both the currency and the equity
market look as though they will peak in the last week of October or very early November
and this coincides with the picture we have for the dollar markets as well. The Shanghai
Composite has a chance that after a pullback for a month or so it rallies into the first
quarter, which should be a far better performance than Europe if it occurs but the US
also shows that as a possibility. The renminbi looks as though it will strengthen to
the 6.0900 level against the dollar but will not make a new high before it turns
back down in November. The test for the Chinese government will be if they can keep
the currency well enough bid that foreign investors continue to park money with the
currency. The equity market should reach 2400 at a minimum and 2520 at a maximum
in November before it turns down again.