Groundhog Day

Each morning I rise and shine thinking, hoping, and wishing that the world be better place than the one I left behind the night before. Gosh knows I try to be a better in what ways I can. But why oh why do nation states in general (and to get to the point for this is an economics-related blog of sorts) and the various finance ministries & central banks in particular have such difficulty making it "a better place" and doing the right things for world as a whole?

I am not here to bash "free trade", the benefits of trade, or the imperative of each minister or chief banker to regard the interests of the polity from whence he came above the interests of the world in general. But each day, we seem to diverge further from, rather than converge towards, any medium-term sustainable global equilibrium. And each morning as I scan the headlines and review the figures in detail, I am both both saddened and worried anew. Yes cliched as it is, like Bill Murray in "Groundhog Day".

Just once might I get up and hear: "The head of the BoJ admitted that Japanese interest rates are too low (and have been for too long) and thus effective immediately will be normalizing rates. "He said further that such normalisation will occur "at once", and there will be quote "No pussy-footing around". When questioned about the impact of the move upon the stability of financial markets, he said: "Speculators who have borrowed YEN at near zero to finance investment activities in other parts of the world when economic activity and inflation are so obviously very buoyant must be smoking crack or be severely mentally challenged if they didn't factor in the risk of eventual normalisation of YEN rates into their speculative equations. From Japan's point of view, they deserve whatever financial fate befalls them, not to mention that the Darwinian shakeout will make the world financial markets more efficient in the future.

Or how about: "PBoC Chief Zhou today announced the full scale float of the RMB, effective immediately. In teh same breath, he warned speculators that Chinese Banks have lots of bad debt, Chinese rates while low, are not expected to rise anytime soon, and that inflation is actually much higher than officially admitted, but that the float of the RMB will help the market enforce some much needed discipline..."

And then of course, we would all like to hear: "US lawmakers, feeling the deficit is really rather too large, said today they believe the USA needs to raise Federal revenues, and thus taxes, at least until revenue and expenditure correlate more closely. Speaking for the unanimous bi-partisan coalition, Sen Chaffee said they'll be effecting it by raising marginal inome tax rates by 10% on the dollar in the highest brackets as well as implementing a windfall resource tax, and a hefty nationwide Carbon Tax to both raise revenue and promote efficiency).

One day of course, I would be profoundly gladdened to hear "The entire Bush administration has resigned effective immediately". "New elections will be called for next week..."

Or, in keeping with the main topic of this board, Japanese equities, I would see a better world if: "Masayoshi Son, alledged charismatic and enigmatic founder of the Softbank internet empire was led away by officials from the Tokyo Prosecutors office Financial Crimes Squad as they investigate wrong-doings within the Softbank group of companies. Reporters were told Mr Son admitted to the various counts of fraud and was deeply deeply apologetic to those who as a result of his notoriety and schemes came to believe that wealth could be created in ways other than through the alignment of great prescience and good hard honest work, and of course time...".

I can dream, can't I?

Abe & Omi

I know this is irrelevant in comparison to the weighty subjects often tackled here but has anyone noticed how cute the names of new Japanese Primo and MoFo Chief (Abe & Omi) sound when ennunciated together?

In both German & Dutch the sweet nicknames for Grandama & Grandpa are "Oma" & "Opa". Along the south Indian coast, the same is Ajja & Ajji. Father & Mother in Hebrew are of "Abba" & "Ema". "Abe" and "Omi" just has such a cute and ring to it, that one might mistake them for a an absent-minded elderly couple puttering about their business meaning no one any harm. And heavens knows that that such an image might be important in the battle to defend what are indefensible interest rate and weak yen policies. one could imagine that every little bit will help...

Amaranth: Was It The Market?

That Amaranth had a losing position is [now] a USD $6billion undeniable fact. But the nagging question that I have about this trade-gone-bad is: (a) did the position itself sink Amaranth", (b) did the market sink Amaranth or (c) did some more nefarious interplay of causes sink Amaranth?

The common perception is that it was (a) "the position", which means the size of its bet, and the severe wrongness of the bet was responsible. This ascribes the disaster essentially to bad luck and poor risk-management and oversight. An elephant skating on thin ice, so to speak, that broke. To the young (after all, he IS rather green) Mr Hunter's defense, he didn't expect such a large move in such a compressed period. And he had been blessed with remarkable luck and prescience before so he (and his boss) might be foregiven for a lapse whereby they extrapolated Mr Hunter's (and by extension Amaranth's) luck into skill.

But I have been around the block a few times, and things are rarely what they seem. I am not ruling it out, but "the market" is rarely as big an anonymous as lore and certainly financial hacks purport. "The market" is, after all, the sum of participants, and though the mythology of capitalism would be furthered by widepsread belief that prices are set in pure competition by thousands of small anonymous ineffectual hedgers and speculators, reality very often differs. For the inconvenient truth (to borrow Mr Gore's pleasant turn of phrase) IS that some players are huge and alone can set or at least [temporarily] have great impact upon the marginal price. And all-too-often, large investors DO collude thus acting in concert. Yes it's prohibited, but when has that ever stopped anyone from trying to squeeze a profit? And it is none-too-easy for authorities to prove it in fact. And there are other feedback mechanisms such CTA trend-following strategies that have the same de facto collusive effect, even if the particpants never speak.

Where I am going with this? Metalgesellschaft's oil plunge, Sumitomo-Hamanaka's "little" copper problem, as well as Codelco's Juan-Pablo Davila's copper cock-up were all examples where feedback mechanisms whether overtly revealed, parsed from price-action, or driven by plausible rumour, innuendo, or margin calls, are rather different from the over-sized wrong-footed bet where the market random goes against. In all these, and potentially Amaranth's case, the market is hunting. They smell blood, and may not know why or what is precisely causing the move but as it moves, "they" (the market-as-hunter-killer) increase positions and press, thereby shaking the proverbial tree to see what falls. In Amaranth's case, there was information available to the market as it was common knowledge to the Energy cognoscenti that they'd bought MotherRock's book. And LTCM's [rightly} resident paranoic Lawrence Hillenbrand will tell you that unles you're Exxon that is the beginning of the end...

To my suspicious mind, this is getting warmer to the truth. And it somewhat shifts the "blame" from "stupidly unlucky" to "unluckily stupid", since getting caught out as such reveals hubris, overconfidence, and a feeling that one is smarter than "the market". All cardinal market sins and Bad! Bad! Bad!

But there is third possibility that is understandably NOT discussed in the mainstream media, but surprisingly is not discussed in the trade press either. And this is the possibility that their clumsy and quasi-public long Natty position was the subject of predatory trading by those with material non-public information about the Fund and it's positions. You see, Securities firms and Mega-Banks are required to have what are called Chinese walls, ostensibly to reflect the scale and impermeability of the Great Wall of China. But this is a rather poor analogy. "Shoji Partition" might be better. Or perhaps, "A Blood-brain barrier", or even "Placenta-like Separations". These are more accurate because information can and does flow to "those who require it" in the firm, i.e. risk-management personnel, Executive Committee members, CEO, CEO staff. Irrespective of what these firms might advertise, whe information flows, nothing is secure - certainly not as secure as one with an oversized-Natty position and already high-leverage would require to feel safe and secure (at least where I sit).

Roger Lowenstein's account, When Genius Failed reconstructed the scenario pretty well. Essentially, if you're very leveraged, once someone sees your positions, you're a target. Hillenbrand was seemingly the only one who really understood this risk. He made sure they used multiple Prime Brokers, swapped positions between leverage providers to insure no one saw the full extent of their leverage or their positions. If one cannot be certain as to whether one has an offsetting position at another shop, the risk-reward equation for "gunning" is greatly reduced. After LTCM started to take a hit, and needed either new capital or bigger lines, anyone who might supply the credit that was needed also needed to see "the position". All the Positions. He fought it, but there was recourse, and that was the precise point at which Hillenbrand knew they were dead.

LTCM accused many of the people of trading against them once they saw their positions, Goldman Sachs being singled out, in particular. But AIG, Citigroup, Berkshire, all had seen the enitre book. But everyone had lines with LTCM, so even for those who didn't see the whole book, and even they didn't know whether there was a hedge on the other side, they knew what THEIR risk was, or rather what as a lender to LTCM, they would soon be owning as principal in the event LTCM missed their call, or violated the fine print. As a creditor, a firm knew precisely what to sell and its childish to think they didn't take measures to protect themselves directly by "hedging" their risk (i.e. selling some or all of the position out directly in anticipation) or that opportunists managing the various trading desks didn't understand "the wink & the nod" that this client was now "shark bait", or that the sales manager on the bond desk couldn't resist helping another large client who would still be a client AFTER the mess was mopped up, make a little money.

But there was another incident a couple of years ago called "Eifuku" (amusingly pronounced "I F*ck You"), in which a Japanese hedge fund priming with Goldman Sachs took on entirely too-much leverage, and ploughed it into rather stupid concentrated positions. And in the span of a few short days, "the market" moved against them, and lo and behold, Goldman "owned" the position. The proprietor screamed "foul play", and sent a letter to his investors that all his positions mysteriously moved against him at the same time, causing margin call after consecutive margin call until POP!! Rumours circulated later that they had been "gunned" by Goldman. And Admittedly, this is suspect since it would make very bad business sense to risk a franchise for a little trading profit. But the world is small. And there ARE other plausible, though unproven, possibilities. For example, the head of a large London hedge fund might have worked at Goldman, and still had private friends there, and might have even been a big client of theirs. Perhaps Mr "Eifuku" had an oversized ego and inflated opinion of himself, was a Cowboy, and a potential liability to the white-shoes. Coveted position information thus passed could have seen such a client and fund trade against the position. Given the leverage, it would only take a couple days to torpedo it. Goldman would then "own the inventory" and would presumably sell the offsetting position to the client hedge fund locking in a lovely profit, and solving the problem of a loose cannon. Not to mention that the now-enriched client, with boosted returns, would gather more assets, thus completing a virtuous circle. "Boat drinks!!" Of course all the foregoing is pure and unsubstantiated conjecture, and by way of disclosure, is meant to entertain a plausible alternative explanation for very real events.

Which brings us to what really happened to Amaranth. We know they had a big energy position that was compromised from the get-go because others bid for it, so they knew marfin calls were being made. We know that they had reasonably high leverage across the fund (and I don't care what anyone says or what comparisons they make to LTCM, it WAS high). We know Citadel is very active in the energy markets and has boatloads of capital, and probably "saw" the MotherRock position. Having missed it, and seen the market tail south, did THEY "gun" it? Did their Prime Brokers "see" the position and decide it was scarily big and thus sell some Natty to hedge their credit risk, thus creating larger margin calls? Did the IB prop desks (through their Prime's) "get wind" of the position, see the margin calls, and give it a friendly "push"? Did the CTA Trend followers acclerate the trend through their "informationless" feedback loop? Maybe all? Maybe none. But be assured that there is an objective reality out there and the NYMEX Natty "time and sales" audit trail that flows back to the ultimate traders will reveal a story. How nefarious that story ultimately is will have to wait for a determined investigative pit-bull. I wonder to what extent "plausible deniability" is being manufactured as you read this?

Never Feel Sorry For A Man With His Own Plane

One of the top headlines in Bloomberg news this morning was the revelation in an Austrian Magazine that an Austrian speculator had been forced to sell amongst other things a van Gogh in order to repay the Austrian Bank whose money he was reputed to have lost in the markets. The article closed by saying that the centerpiece was, (of all places), now adorning the walls of Steve Wynn's Las Vegas palace, and that it's former owner was too distraught to cast eyes upon it ever again.

In addition to the irony that the famous canvas finds itself yet again, in a gambling establishment, it must be pointed out that that it is but another in a long list of speculators and famous works sold under duress. Alan Bond, Ryoei Saito who's story is detailed by Cassandra here, along with many others whose involuntary art dispositions and subsequent legal humiliation were far worse than what's at stake here.

Perhaps the point of the Bloomberg article was to mock the feelings the van Gogh's former owner, though with Mr Bloomberg himself being a collector, such an accusation might be out of line. Or perhaps the implied sympathies were genuine. After all, the wealthy do have feelings too. But the implicit plea for sorrow made me think of that film with Anthony Hopkins, Alec Baldwin, (and Bart The Bear, for whihc he won a special Academy Award) called "The Edge", in which Hopkins plays a fabulously wealthy older man with a stunning young wife who as it happens is having an affair with his confidante, the young Mr Baldwin. They are all away in somewhere in Alaska for Hopkins character's birthday celebration where they (sans wife) take a little sea plane voyage to do some fly fishing or such.

Baldwin's character, emboldened 'cause he's sleeping with his rich old Friend's beautiful young wife starts taunting Hopkins asking how difficult and challenging it must be "to be rich". "You never who your friends are", "You never know if someone is sincere or just wants something for from you....". "Yeah it must be rough...". Hopkins is silent. Expressionless. He hears what Baldwin is saying, clearly contemplating it carefully as they cross beautiful virgin Alaska wilderness. Then, in with the utmost of non-chalance, Hopkins responds: "Yes, well you should NEVER feel sorry for a man who owns his own Jet Plane...". Which seems rather fitting in the circumstances in case one was in danger of shedding too many sympathetic tears.

Get Rich Funds vs. Stay Rich Funds

Are you a "Get Rich Fund" or a "Stay Rich Fund"?!??, I recall him asking. "You're a "Stay Rich Fund", which is all very nice and I am sure you're a nice girl, but, I only invest in "Get Rich Funds. Perhaps, you should talk to Izzy...since he's sweet on "Stay Rich Funds...." . Yup, that was a "potential investor meeting" following the LTCM debacle in late 1998. It followed a meeting in which the short, cigar-chomping Jewish allocator screamed "Dammit, Leverage is POISON!!". That of course followed the guy who said: "...only 20% pa and Sharpe of 2x?!?? You'll be lucky to raise a two dimes...I saw three guys this morning doing 35% with Sharpe's of 12..."

Such were the dark days in 1998 following LTCM's mere hiccup in comparison to the heaving technicolour yawn of the Amaranth Fund's demise. What will be the fallout for the street, hedge funds and hedgefund investors?

At $9bn, everyone who could, seemingly did have a piece of Nick Mouanis' Amaranth. Every Fund of Fund, family office, and large pension fund will have got stung. Many, will make public pronouncements, because they have to, though others -particularly in Switzerland - will be either more discreet or too embarassed to admit association. And surely the Japanese were there. Maybe that's why Mouanis let it happen: in response to the pathetically selfish neo-mercantilism of Japanese monetary policy? OK, probably not. And surely some of the Petro-dollars got "recycled" from Russian & Middle-Eastern owners to CTA's and the investment banks shorting Natty (who must have been the big winners), in their pursuit of putting the wounded holder of "The Ill-Fated Long Position", out of their margin-call misery.

LTCM was a capital dislocation event. It widened spreads of all variety across all credit-sensitive markets. And they stayed divergent or distended for a reasonably long period because LTCM was pari-passu with every prop-desk and Wall Street firm inventory position (and they had eaten their fill and weren't taking any more). The heightened perceived risk caused capital to pull in its horns, making it difficult for anyone to raise equity let alone think about dramatically increasing leveraged exposure to risk. Eventually it dissipated as the Fed ill-fatedly open the spigots in fear for the Y2K bug-a-boo. And the pain of investor losses faded.

But make no mistakes: the demise of Amaranth IS a capital dislocation event. Fortunately for the markets, their leveraged exposure was concentrated in Energy, and zero-sum. And though its zero sum, this is a dramatic destruction of equity, is not entirely offset since the short-Natty "winners" are not necessarily levered Spec Funds, per se. But more imtportantly, like in 1998 there will be ripples, and these ripples will cause risk-reduction, meaning position reduction in anticipation of year-end redemptions. Risk-spreads will widen, even though this was not a credit event. Christmas in Greenwich will not be as gluttonous as it might otherwise have been.

For the real economy, global imbalances (and the median US stock), Amaranth and its fallout is probably good news (for the moment). That there was excess speculation by all manner of Macro, Strategi, and Trend-Following investor in energy (and other commodities) as well as their stocks is obvious. Kicking the shit out of Natty validates the reality that there is plenty of supply (for the moment). Copper & Nickel are probably next. Maybe the whole real-asset complex. The net result will improve sentiment across the board by taking the heat off rising goods & service prices, the Fed, and especially the US's massive trade and current a/c deficits. PCE will take that much longer to roll over, and Nouriel Roubini's bold recession call, may prove to a quarter or two too-premature.

In the meantime, for hedge fund principals, and marketers alike, it is worth rehearsing your investor explanation for why you are no longer (and never really have been) a go-go "Get Rich Fund", but in fact are (and always have been) a conservative "Stay Rich Fund", irrespective of your momentum-humping pursuits, and envelope-pushing leverage. Just hope and pray that they do not demand to "look under the hood"...

[Bad] Hedge Fund Poetry Corner

So, Farewell
Then Amaranth
Fund L.P.

The Myth
of Your Floral
Permanence -
Now Shattered.

Seekers of
"the Secrets
Between Price
& Value", You
Might've Been.

But, Torpedoed
by "Natty"
while
Shooting The Moon!"
Will Be
Your Epithet

Some Will Call
You "Vermin",
While
"Fraud" May Roll
From The Lips
of Others.

But Markets
Will Remember You
Simply As:
September's
"Cannon Fodder".

(with apologies to EJ Thribb)

That Joint IMF Statement (in full).

All work and no play makes Hank, Sadakazu & Zhou dull boys. All work and no play makes Hank, Sadakazu & Zhou dull boys. All work and no play makes Hank, Sadakazu & Zhou dull boys. All work and no play makes Hank, Sadakazu & Zhou dull boys. All work and no play makes Hank, Sadakazu & Zhou dull boys. All work and no play makes Hank, Sadakazu & Zhou dull boys. All work and no play makes Hank, Sadakazu & Zhou dull boys. All work and no play makes Hank, Sadakazu & Zhou dull boys. All work and no play makes Hank, Sadakazu & Zhou dull boys. All work and no play makes Hank, Sadakazu & Zhou dull boys. All work and no play makes Hank, Sadakazu & Zhou dull boys.

All
work
and
no
play
makes
Hank
Sadakazu
& Zhou
dull
boys.

.syob llud uohz & uzakadaS, knaH yalp on dna krow llA .syob llud uohz & uzakadaS, knaH yalp on dna krow llA .syob llud uohz & uzakadaS, knaH yalp on dna krow llA .syob llud uohz & uzakadaS, knaH yalp on dna krow llA .syob llud uohz & uzakadaS, knaH yalp on dna krow llA .syob llud uohz & uzakadaS, knaH yalp on dna krow llA .syob llud uohz & uzakadaS, knaH yalp on dna krow llA .syob llud uohz & uzakadaS, knaH yalp on dna krow llA .syob llud uohz & uzakadaS, knaH yalp on dna krow llA .syob llud uohz & uzakadaS, knaH yalp on dna krow llA .syob llud uohz & uzakadaS, knaH yalp on dna krow llA .syob llud uohz & uzakadaS, knaH yalp on dna krow llA .syob llud uohz & uzakadaS, knaH yalp on dna krow llA .syob llud uohz & uzakadaS, knaH yalp on dna krow llA .syob llud uohz & uzakadaS, knaH yalp on dna krow llA

A L L W O R K A N D N O P L A Y M A K E S H A N K , S A D A K A Z U A N D Z H O U D U L L B O Y S . A L L W O R K A N D N O P L A Y M A K E S H A N K , S A D A K A Z U A N D Z H O U D U L L B O Y S. A L L W O R K A N D N O P L A Y M A K E S H A N K , S A D A K A Z U A N D Z H O U D U L L B O Y S. A L L W O R K A N D N O P L A Y M A K E S H A N K , S A D A K A Z U A N D Z H O U D U L L B O Y S

All work and no play makes Hank, Sadakazu & Zhou dull boys.
All work and no play makes Hank, Sadakazu & Zhou dull boys.
All work and no play makes Hank, Sadakazu & Zhou dull boys.
All work and no play makes Hank, Sadakazu & Zhou dull boys.
All work and no play makes Hank, Sadakazu & Zhou dull boys.
All work and no play makes Hank, Sadakazu & Zhou dull boys.
All work and no play makes Hank, Sadakazu & Zhou dull boys.
All work and no play makes Hank, Sadakazu & Zhou dull boys.
All work and no play makes Hank, Sadakazu & Zhou dull boys.

Errrr. That's it, now if you would please be on your way and go sell the Yen again!

GeithnerSpeaks: On Balance He's Balanced

That Geithner speech in full:

"Markets are not perfect & fail. People too are fallible. Flights-to-quality are scary. The big are getting bigger - huge in fact. Leverage & agency probs may amplify bad market outcomes to the detriment of the system. But balance should be sought and cost/benefit weighed wisely before trying to "save" the system. The large equity of Levered Specs can help transfer risk away from core to periphery. Free-riding on systemic health may be an issue. Central Banker's can regulate & spank. Cascades can happen. CBs can catch them, saving the day, but that may create moral hazard. Errr that's all"

There is a lot of hand-wringing about hedge funds, leverage, and speculation. Probably too much. Geithner said in essence that leverage & modern markets should be monitored as accidents can happen, but on balance its more-than-alright, and quite manageable, though we shouldn't be complacent. I wonder if much of the concern is not at the obscenely outsized spoils that result from their bets, rather then the speculations themselves.

Let it be said that I morally disapprove of highly leveraged betting as a force of habit like I disapprove of smoking. But I doubt the necessity and the wisdom of drawing too-strict a line (for ice-cream, too, is dangerous) to restrict its undertaking, except where damage to the public can be established. And while there are potentially systemic stability issues, there is a great deal of rather sophisticated private equity (bank & nroker equity capital) and their strong self-interest (and domestic and international regulatory regimes) to temper the stupidity and greed all along the way, that insulates "the public", between speculators private losses and such systemic disaster requiring public intervention.

If private nitwits - whether individually or however organized - desire to make big leverged gambles (with their equity), where the collateralised financing arises from others (be they banks, or brokers who as it happens also have plenty of equity), and where margining is in most casea is daily and sacrosanct (particularly where granted leverage is knife-edge), and where said providers of leverage are themselves self-interested, the problem is more likely to be an issue of hoe large will the "self-inflicted wounds" be rather than consituting a serious and unmanageable systemic problem for it is likely that "solutions" don't create issues as meaningful as the problem.

Recall there was no public money lost or directly risked in the LTCM aftermath. The equity holders of the fund lost everything, and where the collateral, ex-post, was insufficient, their leverage providers got stung too. Full-stop. And this was as it should have been, and numerous lessons being learned by all concerned: e.g. How much leverage is too much; Take great care leveraging illiquid OTC positions; Never never never under any circumstances let anyone see your positions; Be careful of pari-passu risk; Be firm in demanding to know a leveraged speculator's entire exposure if granting them "extreme" leverage"; Be sure to warn investors 10-ways to Tuesday they can lose EVERYTHING and things can and indeed might go horribly horribly wrong.

There IS an agent-principal dilemma (as Geithner highlighted numerous times), generally speaking in the financial & investment management industries. But its endemic with few exceptions - from Fidelity Mgmt (yes Vanguard too!) to hedge funds, insurance co's, and prop traders at banks. Buffet to his credit, despite Berkshire's AAA rating, refuses to allow Berkshire & GenRe to participate in the low-margin swaps biz, in order to avoid Herstatt-like cross-default issues. This epitomizes the distinction between "the get-rich & richer specs" and the "Stay Rich" investors. This is the real issue at stake, and it cannot be legislated or directivized out of existince - not in a hugely complex world where regulatory arbitrage is rife.

Higher capital adequacy standards, demands for more regulatory transparency, higher tax rates on leverage-enhanced trading & investment profits, tigher controls on widow, orphan, & general public participation in leveraged funds all can contribute to a greater systemic margin of safety and contribute to official policy that makes a positive policy statement about the utility to society of excessive "greed". But as one goes further down to the path of prohibitions, and overly-wieldy regulation, it's a slippery slope where if one ventures, one must begin to examine the public utility of lotteries, casinos, bungee-jumping, sports cars, trans-fat snacks, sugared-drinks, unprotected sex, or for that matter any form of risk-taking behaviour.

The TSE says: Me Too !!

That stock & commodity exchanges have proved fabulous post-floatation investments is undeniable (excepting the NYSE where "members" & Goldman judiciously sucked out the juice a-priori). But NASDAQ, CME, CBOT, ISE, Deutsche Borse, LSE all have spun profits for the prescient and the lucky. In typical Japanese style, somewhat after the apparent peak of boom in values, the venerable Tokyo Stock Exchange is readying its own transformation into a publicly-traded entity slated for 2009, a date that reflects delays resulting from recent trading mishaps for which management has been excoriated.

But I must admit to being less than enthusiastic about the wisdom of the central exchange marketplace within a capitalist, market-driven economy as a for-profit endeavor. As I look at these words, they appear oxymoronic and even silly on the page, but my concerns are real for a number of practical reasons. For the exchange while it has many constituents - the companies who list there, the brokers that facilitate trade there, the institutional investors who transact there, the public who trades there, and public who uses the values derived therefrom for micro-level allocative decisions throught the economy - has IMHO a single pivotal role: to most efficiently assist in the allocation of resources.

My first objection begins with the question: What is the role of "the exchange" in a capitalist system? Is the objective to maximise profits for the "owners" per se or is it to grease the proverbial wheels of the economy by facilitating maximally efficient price discovery, thus allocation of scarce resources that in the case of a stock market, brings together those seeking capital with those supplying it? In my opinion, it is clearly the latter.

Proponents of publicly-listed, joint-stock company exchanges will self-servingly argue that not-for-profits underinvested, and have insufficient resources to "compete". But exchanges are natural monopolies, or could be or in my opinion should be granted such status, provided the benefits accrue to all constituents. Investing in technology takes capital, but it is not deterministic that because an exchange has excess capital or free cash-flow, it will invest, nor is it the case that because it doesn't have a war-chest, it won't. The NYSE has always had lots of money, and has recently raised turnover fees - not because of a paucity of investment, but for the sake of offering the shareholders an adequate return on the high prices they paid for their shares during the transfer of ownership from men's club to profit-seeking enterprise.

Second in the laundry list are the natural conflicts of interest. Now, we all know that exchanges were, previously, "members clubs", and were run as such so the bar is not set very high in regards to a for-profit company doing more than remunerating Dick Grasso and enriching Spear Leeds. Since they were run in the interests of the members, they maintained high guild-like barriers to entry preserving oligopoly-like profits for the members. In the NYSE's case, specialists were outrageously granted exclusive license (for which they didn't even competitively bid for) to steal money (which they did) from those transacting. In NASDAQs & LSE's case, they fought tooth and nail to preserve a system that prevented their customers from getting the best price in order to preserve their members' profits. In both cases all the other constituents lost.

Tokyo, on the other hand historically maintained a much fairer and more neutral market-structure system. While it is indeed run as members club, there is more impartiality and fairness in the structure. Even in the by-gone days of floor trading, the TSE eschewed specialists for a "Satori" whose job - like that a public servant - was to manage the order-flow and independantly match buyers and sellers, not to scalp them when it suited (like Spear Leeds). The same held true for the "maerklers" in Germany, whose role was the same. In both cases there was no principal vs. agent conflict, no privileged information, and club membership benefits were limited to the oligopoly rents it provided members to their granting a point of access to trade. Technology soon supplanted the floor, and now everything is fairly and impartially handled by computers, as they are in Continental Europe. Only the Anglo-Saxons stand out resisting the virtues of technology in order to preserve the benefits for the boys club.

The third issue is "costs". But this is not so simple as the difference fees it costs to transact. NASDAQ may historically have been cheap to transact upon from a commission point of view, but if the implicit cost of spread and impact was taken into account, it might look very expensive. France might have been cheap to transact from a commission point of view, and very transparent, but the monoply extracted high costs for settlement. The NYSE may appear cheap to trade and efficient to settle, but the cost in terms of what the specialists manage to extract from their privileged monoplies is high indeed. So what do we know? The fact is that the infrastructure costs money to develop and maintain. Surveillance and administration costs money. And constituents are will pay, one way or the other. We also know that concentration of liquidity is "good" and "fragmentation", while increasing competition, (a good sobering wake-up call for NYSE), also increases trading costs and decreases allocative efficiency. This should not be seen as an indictment of not-for-profit exchanges, but rather an strong reprimand for "crony capitalism" as evidenced by the NYSE. The bottom line here is that what is good for the shareholders (higer costs & fees) is patently bad for all the other constituents as the higher fees deter turnover, liquidty, and thus decrese the efficiency with which resources are allocated. Can one imagine a bigger conflict of interest??!?

The Tokyo Stock Exchange is not immune from such accusations, but they are different. The Tokyo Stock Exchange (complicit with Japanese Finannce Ministry Officials) has historically given petty advanatge to Japapnese Brokers. Historically they did not permit the "baikai" or the order book to electronically leave Japan, and limited the dissemintation of this information to special Japanese-owned machines, or from the floor. They were also very slow to permit electronic connectivity from abroad - again to rpeserve the oligopoly rents for members, particularly Japanese ones. But ever inventive, people found a way. Proprietary traders at a member brokerage in NY were reputed to have trained a video camera on the baikai machine to watch which they could access. Morgan Stanley, in the early days of connectivity allowed their customers to send through the orders electronically to their desk, where a Japan-domiciled clerk had the job quite literally of "pressing the button" to on-send the orders to the floor, thus meeting the letter of the law.

Further conflicts arise in for-profit organization. The TSE historically served to protect small investors by vetting the companies that listed there, as did the NYSE. Fly-by-nights were prohibited by minimum requirements for audit compliance, sales, earnings, operating history length, etc. This prevented the speculative issues from listing, thus protecting the public from scams, and their own greed. Today in the US (like in the 1920's) we are seeing listing of shells with no businesses who hope to acquire business or companies in the future. Or on smaller exchanges, MOTHERS, JASDAQ, etc. there are companies with little operating history, and very small floats, that are easily manipulated by speculators, hedge funds, and institutional investors such as Fidelity & Jardine. There is no good reason in a world awash with capital and savings why these securities should be be granted equal shelf-space and and best should carry serious warnings regarding lack of operating history, excess valuations, high volatility and the lack of liquid markets, particularly during times of stress.

Finally, there is what one might call freebie revenue. Financial data has become enormously valauble to participants wishing to review history in order to make better investment decisions. This includes current & historical time quote & sales data, volumes, short-interest, failed trades, specialists trades (for which by the way, there is NO transparency at all), etc. The exchange extracts huge tribute for these records, in many cases making availability prohibitively expensive for all but the most well-heeled participants. In a sense it's both exclusionary and anti-democratic. But the true conflict arises insofar as the high prices they demand for real-time access and data deters turnover, and thus liquidity, and so injures the interests of all other constituents, thus creating an inherent tension between the exchange "owners" and all of the other constituents.

It's ironic that a listed corporate for-profit exchange at the center of financial capitalist financial markets creates such inherent conflicts of interest, leading yo what is probably a sub-optimal allocation of economy-wide resources. The answer to the question of the best structure, as the NYSE has clearly shown, is not the Gentlemen's Member Club. And for-profit creates inherent conflicts. Even a "mutual association" is a poor choice given the diffuse and varying interests of constituents. I would offer that that only a true not-for-profit public service organization would maximize utility for all constituent while at the same contributing economy-wide benefits.

Euro Makes New High v. Yen - And So...

Bloomberg news reported today Aug 28th 2006 that the Euro posted an all-time high vs. the Japanese Yen, ostensibly because investors believe that European rates will be heading higher, faster, than Yen rates. In a related news item, Brad Setser over at RGE Global punctured the myth floating around US policy circles (particularly conservative ones) that Europeans are not pulling their weight and need to expand their domestic demand as well as their imports. The two points are undoubtedly related, and highlight the dilemma or perhaps crisis effecting the international monetary system, and sheds light on the direction where potential finger pointing might be in order.



Setser highlighted that Euro-area demand (and imports) have been rising smartly. But sadly, from a US perspective that is, Europe's goods imports have primarily increased with Asian exporters, hence their new vigour and demand take-up has done more to increase Asian surpluses than they have done to make a dent in US deficits. Such is the luck 'o the draw in a free-market. This is partly the result of the goods and services the US has to offer, in addition to the impact of a Japanese Yen that’s de facto shadowing the RMB, an RMB that’s more explicitly pegged to the dollar, and a dollar that’s been depreciating against the Euro, and it's entire trade-weighted basket, creating a daisy chain resulting in Euro appreciation vis-à-vis the RMB and Yen, for no good reason(s), and undoubtedly some rather bad ones, since the Euro area is in rough balance, while the neo-mercantilists of the Pacific ride roughshod over the spirit of the international monetary system.

The new high of the Euro vs. Yen (as pictured above is significant, if for no other reason than it is wrong. It is wrong in regards to the spirit of the international monetary system, for it neutralizes the market mechanism of "relative price" for which the system depends to nudge the balance of payment accounts in a direction more convergent with long-term sustainability. And with nothing to police the system, the lack of market signal and pressure allows cynical free-riding, or worse, potentially lethal parasites. This in no way pejoratively judges the necessity or determination of China and its people, still a poor country, to develop rapidly. However, undermining the systemic mechanism of adjustment carries with it great cost and moral hazard - something that seems to be viewed somewhat cynically in Beijing, if actions imbue more meaning than words (which I believe they do). At the very least, everyone must recognize that continuation of the status quo, without meaningful appreciation of the RMB vs. USD and Euro runs the very real risk of seeing the world retreat down the rat-hole(s) of beggar-thy-neighborism, protectionism, or, in the extreme US repudiation or default. In the intereim, it opens the system up to the possibility of real speculative attack that would find the authorities defending the wrong side of the trench in the war. The resulting costs and economic dislocations from such systemic turmoil are immense, and one need only look at Argentina for a view of what unresolved bad policy can produce in teh realm of mayhem & chaos.

But this post was NOT primarily about China, but about the focus of Cassandra’s Love-Hate relationship: Japan. For Japan, the above picture is the Euro/Yen, and there can be no excuse. The Japanese are first-world, and one of the richest nations on earth. Their focus upon, and domination of, world markets in may key areas is without comparison, providing rents which sustain a rich quality of life and advantageous position. And this is a position that has been made possible by a world monetary order dependant upon cooperation and respect for the rules of the game. Yet the domination of markets more than sufficient to sustain them appears not to be enough to satisfy them. And so they illicitly beggar jobs from the USA and Europe by currency exchange rate manipulation using direct intervention and unparalleled reserve accumulation of dollars. Even against China, they refuse to allow the hollowing on anything but THEIR terms, hollowing that the USA and Europe have been granting de facto to the developing world for two and a half decades. This is as it must be. IF Japan insists on using whatever means necessary to trash its currency in order to gain pecuniary economic and parochial advantage for its corporations and its citizens, the Japan must be prepared to pay the ultimate price: systemic breakdown, eventual collapse or severe devaluation of the central currency (the USD); potential seizure of Japanese assets abroad. None of these things should be viewed joyfully, or wished for. But, if one is playing a game with rules, and one persistently breaks the rules, one should be prepared for the consequences, whatever they may be. For the level-headed eastern-establishment trilateral-types in the US may, in the future, be unable to prevent the more aggressive emotions erupting from the rust-belt of formerly triumphal America, intent on finding a whipping-boy and flogging him.

Flash! Crossholdings Unwound

In a research report dated 21st of August, 2006, K. Nishiyama of Nomura Securities says: The final figure makes it clear to us companies have finished unwinding their cross-shareholdings. The final figure is the approximately 11% of oustanding market cap (excluding listed subsidiaries/affiliates and the holdings of life & non-life insurance companies) that has held steady at this level (again) as it has for the past calendar years. This is from a peak in 1990 of 50% of outstanding market capitalization (including insurance co's holdings) and 33% which is the amount sympahtetic to the current constant 11%. It took more than a decade and a half, but it's finally done!

So can investors rest easier now? Or even better, can they look forward to the time when managers try to please them, above their affections to other constituents (i.e. management themselves!), as well as non-executive employees, suppliers, customers, and government ministry officialdom? That is an interesting question, for one must remember that there is much overlap here. For while the companies may have shed their holdings, one would be premature to say these holdings have found themselves homes in the hands of stable (or for that matter unstable market-oriented investors. This is because "Government" has not finished intermediating the "great unwinding". Through the DIC (Deposit Insurance Corporation, the BoJ and its affiliates, and Daiko Henjo pension giveback share acquisitions programs, the Government (and thus the people) own quadruple-digit billions of yen worth of shares.

Why should we care about this technical distinction? Investors should care for several reasons. First, these shares are in purgatory. An institutional half-way house, so to speak. Some must be unwound within the next several years. Second, the State of Japan was nearly downgraded by Moody's not long ago, and they've continued to run > 6% per annum fiscal deficits. So although they may not want to sell the proverbial family silver, their accumulated Debt-to-GDP ratio may cause them to sell against their wishes. And remember: these are no small lines of stock, but a vast amount of shares in virtually every enterprise in Japan. Mind you, this is not a prognostication that Japanese shares will be going lower any time soon (though I do not preclude this from happening), but rather to take such "All Clear!!" proclaimations with a touch of skepticism.

The Enigma of Martin Armstrong

Some memories fade, but are not forgotten. The same holds true for certain personalities, particularly the bizarrre and eccentric. One such notorious individual is Martin Armstrong a.k.a. Princeton Economics a.k.a. self-professed expert in the history of money and things gold, and of course, true to my theme of things Japanese. He was accused of Ponzi fraud and the purveyor of the notoriously unvaluable "Cresvale Bonds" that besotted Japanese corporate investors and populated their portfolios, much to their eventual chagrin. Coincidentally, in a bout of synchronicity, I was wondering only a few weeks ago what's become of him and was preparing a post, so it is timely indeed that after languishing for six and a half years in a Manhattan jail cell, he finally pleaded guilty to charges fo Fraud on Thursday, August 17th 2006.

In a nutshell, Martin Armstrong was a confidence trickster, if not a fraudster for which he was accused. Martin Armstrong was also a bad trader. A very very bad and inept trader. And Martin Armstrong committed fraud to cover up his bad trades. And then he committed more trades to cover up his fraud. Most in Nikkei and Gold. Despite the laughable ineptitude with which he implemented his "strategies", by most accounts he was smooth, suave and authoritative, in a way that encouraged people to entrust to him their money. Which he duly lost. Many many hundred of millions of US doillars. Perhaps billions. The official court dockets (available on-line) from his 1999 indictment in the Manhattan district of US Federal Court read like a Shakespearean comedy. The more he traded, the more he lost. So much and so bad were his trades that his colleagues, and brokers mercilessly joked about it behind his back. He was so consistently wrong-footed in his bets that he would have done far better flipping a coin to decide whether or not to be long or short. Or use the infamous "8-Ball" method. Or consult Nancy Reagan's financial astrologer, or ask the advice of Paul Wolfowitz. Anything but use his own judgement.

Though his company, Princeton Economics, had head offices in the US, he traded from Tokyo in an office overlooking the gardens of the Imperial Palace. For Japan has a special place in his scheme. You see, the Japanese too, in undertaking their own form of speculation known as Zaitech, had lost billions in late 80's and early 90's on dubiously-thought-out wrong-footed speculation and investment. Like Martin Armstrong, and other agent-trader victims shell-shocked by large lossess, they were too ashamed and emabrassed to tell their shareholders that they had punted wrongly, or in UK football vernacular, scored an "own-goal". Not willing to "come clean, they found themselves with a serious problem and yearned for a clever and tidy solution that would absolve them of the thing they feared most, which was NOT the losing of the money itself, but accepting responsibility, a dilemma not unlike that faced by I. Lewis "Scooter" Libby.

Enter Martin Armstrong and the almost forgotten Cresvale Securities. He too had a problem since his golden-tongued investment plans, proved rather less robust than hoped [and promised] and resulted in large trading losses for his clients. It seems that he was able to continue his scheme and make payments to the clients who redeemed by using the proceeds from new investors. This, however was proving more difficult as losses mounted, and so he need new clients. Big clients. Well-heeled clients who wouldn't be asking for their money back any time soon. Like money from a dead persons trust. A better yet, a dead-pet trust. Or even better: a Japanese corporate client that themselves had a dirty big secret to hide.

And so they found each other: the companies, like an inveterate gambler, desperate for an investment saviour who would, over time, regain their previous losses, rescuing them from humiliation and shame they most dreaded (not to mention a demotion to the Corporate Travel Office, or Janitorial Services Dept.) and Armstrong, now with a fresh load of clients, and more importantly, their cash. In between them stood Cresvale Japan, the securities firm who brought them together, gave legitamacy to both their pursuits, and took nice fees out of the middle in the process, and in so doing torpedoed themselves out of existence.

The scheme worked something like this: Japanese Corporate 'Y' perhaps lost $100,000,000 speculating through a subsidiary, selling Nikkei Put Options or buying boatloads of overvalued shares after consulting with Madame Inoue's Buddhist toad. They were able to hide this for a while by playing "pass the parcel". perhaps between offshore subsidiaries with different year-ends. Thus their consolidated accounts still showed these losses as assets at their full value on their balance sheets. So Armstrong/Cresvale prposed they swap $50,000,000 of new money for a "repair bond" with a maturity value equal to the full $150,000,000 ($100mm of losses + $50mm of new money) and then let Magic Martin do his thing. If things went right, they would make their money back and everyone wins. If something goes wrong, well they can blame the investment losses on Armstrong, call it fraud, and take write-offs, without having to take responsibility in the first instance. (note: this is sketch of the essence, not the actual details).

This is all interesting, but what really fascinated about this story is that in the mid-90s, certain un-named American value investors had eyed a number of Japanese companies that they believed "cheap" because they seemed to have large amounts of cash & marketable securities on their balance sheets, relative to their now-diminished market capitalizations. In some cases it was in excess of their entire market capitalization. Many reasons were put forth explaining the phenomena such as: "empire building"; "saving for a rainy day"; "deflation"; "management conservativeness"; "investor pessimism"; "adverse taxes upon large distributions"; "legal inability to conduct share buy-backs" etc. All seemed somewhat plausible. Conspicuous by its absence, except as speculated by the most hardened, battle weary cynical gaijin observers was: "because it doesn't exist".

But clearly some people HAD to know about their losses. For other foreign banks were in the repair bond business. And many of the companies themselves were household names. Maybe their businesses were not as fraudulent as Armstrong's, but nonetheless their audited accounts and actions were meant to deceive shareholders by masking losses and allowing them be amortized over many years.

Annd since we are writing it, we all now know that things didn't go according to planned. When the Armstrong fraud broke, many of the guilty Japanese Corporates had to come clean. Sort of. They said they were victims of fraud (and some truly were unsuspecting purchasers of Cresvale Bonds), but the "repair Bond" concept and angle was often lost on most observers. Yakult Honsha (TSE#2267) was said to have $1bn of losses, as well as engineering firm Chudenko (#1941); specialty chemcial maker Gun-Ei Co. (#4229) pharma co's. Kissei (#4547), and Towa Pharm (#4553), machine-tool giant Amada Corp (#6113), pneumatic specialist SMC (#6273), eletronic parts mfgr Alps Electric (#6770) advertising agency Asatsu (#9747), office furniture maker Itoki Crebio (#7972) and more than 50 other firms were deemed to be "stung". Yakult's losses were so big that they couldn't blame Armstrong, but many other co.s did, and were "absolved" of culpability for their original sins.

The epilogue was that Armstrong, accused of Fraud, sat in jail for contempt of court, not brought forth to trial for failure to turnover evidence and in particular, tell authorities the whereabouts of $15mm of gold and silver coins and bronze statues he'd squirreled away. It was the longest such languishment for contempt in United States history. All the while, he's claimed that he was innocent of the fraud. I make no judgement here, but it seems likely from the court documents and testimony that he did commit fraud in the form of the ponzi that used new proceeds to pay old losses. His brokers, Republic Bank, (now the behemoth HSBC) coughed up nearly USD$600mm for their part of not alerting autorities to the potential wrong-doing, whichh court documents alledge, they were well aware. But most of the losses were not "embezzlement" or "theft", per se, as the newspapers and Japanese Corporates would have readers believe, but out-and-out ineptitude and shitty trading, for which is no crime, excepting one's sensibilities of the good, the bad, the random and the ugly.

His guilty plea may reflect that Armostrong the man met Armstrong the fraudster. Or it may reflect Armstrong's understanding that having spent six years in jail, an admission of guilt might allow him to squeeze a few years of freedom in his (no pun intended) "Golden Years".

For investors, the only the protection they can afford themselves is doing appropriate due diligence and being highly skeptical of anything that purports to be "too good to be true", or turn base metals or paper into errrrr gold.

PM Tanigaki? Rat's Chance in Hell

Back from holiday and rested, I see in a headline that all is now clear: Chief MoFo Tanigaki's pseudo-vicious fight with the BoJ was a prelude to his now not-so-secret desire to succeed PM Junichiro ("Elvis") Koizumi as Japan's next PM, Bloomberg reported. His platform? Consumption tax increases coupled with lukewarm anti-nationalist foreign policy. It is the true Keidanren platform making him far and away the favorite of Corporatist and Mercantilist interests in Japan who would like to see a weaker yen and a "kindler, gentler Japan" to the billions of emerging Asian consumers. The only problem is that these are inherently unpopular policies with "the people". No matter that the Emperor's own reservations have been leaked to the press about PMs making official visits to the Shrine where amongst others, the spirits of Class-A war criminals are errr remembered and revered. No matter than neo-mercantilism is set to torpedo the post-WWII monetary system. Tanigaki is well behind Abe in polls, who leads with between 40% & 50% of voter sentiments. But at least we can now understand why Keidanren's Man With a Plan has been such a persistent and vocal critic of ending BoJs Free Money policy.

Testosterone & Markets

How does one disentangle youthful exhuberance from recklessness or separate age's wisdom from over-conservatism? These are particularly interesting questions from the point of view of investment and speculation, and I believe, become particularly germane following a period where volatility and diminuation have been absent from price action for a longer-than-normal duration.

I have no categorical answers, but I have some anecdotes to share beginning high atop the petit Luberon in Vaucluse some years ago. After a lovely picnic amidst the herbs & cicadas, our group descended towards Oppede down a path that turned into a large and steep field of loose scree. My friend and I had done this walk dozens of times, though we were with a group of young people who were on the mountain for the first time. Descending thorugh a field scree, with the right pitch can be as exhilarating as skiing, pulled by gravity, softened by deep but hard loose stones. We picked up the pace, and within the limits of safety, began surfing through the stones. The others made their way, too, surfing at their own pace, or excusing themselves from what must be sais, was a risky undertaking to begin with. A few moments later, one of the younger and most exhuberant members of the group, brimming with testosterone and enthusiam, came bounding past us, taking dangerously giant steps. Mid-stride, I look over at my experienced friend and we shook our heads in disbelief and exchanged looks that said "That lad is insane and it will end in tears". But a few minutes later, we saw him splayed across the rocks, with bright-red blood oozing from a large and nasty gash atop his head. Bad luck? Possibly. Overconfidence & testosterone? Probably.

I drive a motorcycle myself which might be considered a risky endeavor (at least by the actuaries). But I am neither reckless, nor unnecessarily aggressive. I take advantage of the benefits that the motorcycle offers to bypass traffic jams, always looking for the unexpected: the car that is signalling left. but turns right; the motorist exiting from a blind drive, etc. This caution is driven by fear that comes with experience and wisdom. It results from a rapid mental cost vs. benefit analysis which says the advanatge of early arrival, or satisfication at having beaten the traffic is insufficient to the cost of death or incapacitation. It is that simple. Yet, every day, I am surrounded by other motorcyclists - mostly young men their late teens and twenties - who arrive on the "wrong side" of the cost vs. benefit calculation. They weave recklessly through cars and fellow motorcyclists, pass cars at high-speed around blind corners, tempt fate of on-coming traffic with cavalier non-chalance, and overtake around cars that have stopped to let someone pass. I realize that I could be accused of being overly conservative, of the kind that comes with age and family. But few of my aged peers die or or paralyzed needlessly or painfully. This fate is reserved for the reckless and young. Interestingly, they are not without skill as riders. Most are better than I, with many driving from young ages and participating in motocross. No. Their achilles heel lies in their inability to visualize potential risks; to imagine mechanical failure; to anticipate that others might be fallible. In short, they are onverconfident, probably driven by raging levels of testosterone.

Which brings me to markets, speculators, and hedge funds. For one cannot but see the parallels between youthful enthusiam and confidence - often a prerequisite for outsized returns (without respect to risk). But it is also a primary contributor to crash & burn syndrome. Age does (or at least should) breed a brand of conservatism that teaches one to respect markets, but to value the power of independent thought. To look forward, rather than backward. To approach risk laterally, and from many dimensions. To question the paradigm of "what is working", and look to those that are not for potential ideas. I am certain that there are smart and capable young investors, wise beyond their years, and every bit as capable as older peers. But they are rare. Youth, by definition, is prefaced by single-mindedness, that is a boon during a bull-market, but a potentially fatal flaw when risk rises, paradigms shift, and the ground upon which one stands rapidly turns to quicksand. Take a moment to reflect upon the benefits of age and wisdom.....

My Sadakazu Tanigaki Scrapbook

Japan's MoFo's were at it again today, issuing warnings that deflation might not have been whipped yet, and that the BoJ should refrain from raising rates from their current Zero level despite the lowest unemployment rate in the OECD, rising asset prices, a 7% of GDP fiscal gap, as well as robust capex and rising housing starts, and, yes, eight consecutive months of positive inflation numbers. All which reminds me of Monty Python's "Dead Parrot" sketch. Given Mr Tanigaki's variant perception, I thought it would be a good time to break out my Tanigaki Scrapbook.

Here is Mr Tanigaki one of his partners in crime, Mr Kuroda, looking very cheerful indeed at a recent ADB meeting. Notice the smiles and the confidence. It is interesting to note that in pitched battles between the Finance Ministry (or the Treasury, Exchequer etc.) and the Central Bank, in any country (except where the Chief Banker is a toad), the Finance Minister almost always resembles the cuddly toy, while the Central Banker is always cariacatured as Darth Vader. This is because the Finance minster typically tells "the people" that they can "have their cake and eat it too".

Here, we see Japan's Finance Minister Sadakazu Tanigaki, shaking hands with his Chinese counterpart Jin Renqing in the Chinese port city of Tianjin. Tanigaki was in China to attend a meeting of Asian and European financial leaders. Notice how tightly Mr Tanigaki is holding Renqing's hand. It was reported by those present that following the photo-opp, Tanigaki refused to let go, and security had to be called to pry their hands apart. Though it was hushed by reporters, he was reputed to have lost his typical decorum revealing the honne behind his tatamae by screaming: "We will follow the RMB where-ever it goes, we will NEVER revalue without you, whatever the cost, to the ends of the earth and the end of time.....we will not let it go...."
Apparently, my sources tell me, PBoC Chief Zhou Xiaochuan was observing Mr Tanigaki's rather uncharacteristic outburst, and was seen here grinning broadly at the mad-hatter-like behaviour of the Minister, reputed to have said: "Hasta la vista, baby!"


Here is Mr Tanigaki displaying faux-concern for the impoverishment of the "Mr & Mrs Sato" that might result if the Bank of Japan raises interest rates to where they should be given that Japan has the lowest unemployment rate in the OECD, is running a 7% of GDP fiscal gap, experiencing a boom in asset prices, with commercial rising rents, eight consecutive months of rising consumer prices, and robust housing starts. Observers are asking why, with all the problems in the world, and reform issues on his plate at home, Mr Tanigaki has made it a personal crusade to undermine the Weberian bureaucrats steering the BoJ. Answer: One might think it was to hide the immense incompetence within his own ministry and his inability and unwillingness to do anything about the huge and persistent fiscal gaps. But the real reason might be, that higher rates, though prudent and necessary, might ruin the MoF's grand Macchiavellian plan to trash the Yen to insure Japan's currency remains competitive with its Asian neighbors.

Ah yes, "Plan B". Mr Tanigaki is shown here with his vision of the future: A Yen that has been debased so thoroughly by persistent 7% of GDP fiscal gaps, and through years of ZIRP and quanititative easing, that the only thing the YEN will be good for is framing and hanging on one's sitting room wall. Observe the Elvis-like hair-do on the pictured figure on the note.


But Tanigaki is wily and always prepared. Here, he is seen executing "Plan C": Pray Pray Pray that the BoJ will continue to neglect it's fiduciary responsibilities. No matter that China remains vastly poor by comparison. No matter that the USA has [perhap unwittingly] donated many jobs and much wealth to the cause of Chinese development. No matter that Japan, though vastly rich is unwilling to give a competitive inch to China or its Asian neighbors, putting the vast burden of global adjustment squarely upon the Americans and the Europeans. No wonder the Chinese detest the Japanese. But can it last? He is praying it can and will.

Finally we see Mr Snow giving advice to Mr Tanigaki on post-governmental careers. Mr Snow tried the less oblique route to international financial reconciliation, but was undermined (like Mr O'Neill before him) by an American Congress pandering for votes and a political system dominated by special interest campaign contributions, an administration that spells Economics with a "K", and by the helpful assistance of "friends" such as Mr Tanigaki, Mr Renqing.

Tanigaki: "Elvis Lives!! - ZIRP Forever?"

Bloomberg reported today that Japanese core prices rose 0.6% YoY in May, their 8th consecutive monthly rise, while the unemployment rate fell to 4%, the lowest in eight years, and certainly the lowest amongst their largest OECD peers. Housing starts, too, increased robustly. That is EIGHT years and FOUR percent. But this should come as no surprise. For the government continue runnning a fiscal gap equivalent to nearly 7% of GDP, while the BOJ still has their discount interest rate at about ZERO. But "Why" do they persist with what is arguably a most reckless fiscal and monetary policy ?

Because they are cynically selfish and not "team players" in the international sense. Because they are intent on winning and holding market share in classic mercantilist tradition, through policies that overtly manipulate the exchange rate. They rightly (though selfishly) believe it is better to subsidise employment than unemployment, though any economist (most certainly Keynes & Triffin when they sculpted the Bretton Woods system from the ashes of WWII) would tell you that this is a classic example of a fallacy of composition whereby what is "good for a part" is not necessarily "good for the whole" [system]. They are are beggaring jobs, employment, and thus wealth over and above what they have rightfully earned from others.

So what will Tanigaki and Koizumi heir-to-be, Abe, do to spin this one? Well it seems PM Junichiro Koizumi is taking it very seriously indeed. So seriously that he's making a special trip to the USA. To see the Treasury Secretary & the President? No stupid! To commune with the spirit of Elvis at Graceland! This of course makes eminent sense for both Tanigaki and Elvis are shrouded in mystical denials and each harbour a "big lie". For Elvis, rumours abound that the "King Lives". But we all know that's horse-shit. Tanigaki's big lie is "Deflation still haunts Japan and so Japan can tolerate neither a stronger Yen, higher interest rates, nor lower government expenditure. This too is complete total utter rubbish. He knows. I know it. And most economists with an ounce of objective reality know it too. But in the eyes of the international community, especially voodoo soulmates in Washington, this can be defended, if implausibly, and so allow Japan to continue keeps rates absurdley low and fiscal gaps absurdly high, in comprison the reality on the ground, and thus ugli-fy the Yen, to maintain competitive parity with the Asian big-three of China, Korea & Taiwan.

So what happens now? The BoJ is worried. Or rather concerned. In a distinctly Japanese sort of way. Gov. Fukui remarks daily upon the future repurcussions of current policy blunders, but these are limited to Japan (fears of over-investment etc.), and not "the global commons". And the pressure to NOT go against the grain, and disturb the harmony of the nation by neutralizing Japan's self-serving parasitic policies is strong. But the pressure will continue to mount on Tanigaki, for HIS denial is looking more ridiculuous. So, he will marginally relent and "allow" the BoJ to raise rates, albeit too little, and too slowly to make any difference except quell criticism (whichh they detest). Such half-hearted moves will be yet another indication of their measured parochial cynicism at the expense of the rest of the world - something that has come to be expected from our Japanese allies. Indeed, with friends like this, who requires enemies?

Mr Fukui Ups the Ante

Poor Toshihiko Fukui. Fresh from losing the ZIRP tug-o'-war for the hearts and minds of Japanese people with Chief MoFo Tanigaki, he found himself under intense scrutiny for his investment in MAC, the investment fund of now-disgraced pseudo-activist and admitted insider-trader Yoshiaki Murakami. No doubt this was egged on by the MoF & Tanigaki, and while people like former intervention hot-hand Eisuke Sakikibara said there was no malice involved, he admitted it was rather careless and dumb of Mr Fukui. Clumsy indeed, but if Mr Fukui desired to enrich himself, just imagine how much he could peddle his material non-public information to someone like Mr Tudor, Mr Kovner or Mr Moore. No! He is an honest, loyal, if a bit naive, public servant.

And Mr Fukui has done Japan Inc. well. For he has steered a true course in comparison to that Mr Hayami, and achieved the objectives set out by the boffins. But now he has a problem. He has become distinctly uncomfortable with the policy and its longer-term impacts, both upon Japan and the US and he wants, shall we say, tack. Unfortuntely , Mr Tanigaki is minding the mainsheet, and in so doing is doing his best to prevent any change of direction.

And so today, Mr Fukui seems to have had enough and in upping the ante in teh BoJs battle with the MoF, has declared, according to Bloomberg news, that there should be no delay in implementing the change in policy. It doesn't get any more explicit than that. Now, I wonder if the MoF will produce some incriminating photos of Mr Fukui or send some tattooed types to loiter around the foyer of the BoJs fine edifice.

Central Banks Behind the Curve??!?

Debate is raging: how bad is inflation? Is the the Fed "behind the curve"? Are inflationary expectations picking up? Perhaps, some ask, inflation is only a problem amongst Aspen ski homes, tins of Beluga caviar, and Harvard tuition??!?

Another fracture in arguments supported by inflation apologists (IMHO akin to Creationists and evidence tallied by Darwin and, for that matter, all science) was hammered by a private auctioneer in the form of Gustav Klimt's portrait of Adele Bloch-Bauer, that sold to a museum affiliated with the Lauder family for a staggering sum of USD$135,000,000 dollars.

The apologists may argue that this was a "special picture", and was "unique". But aren't they all? The point is that each new record is an important tell-tale that says: Money is increasing in quantity faster (and accujmulating in more concentrated fashion) than the general increase in GDP. Today it's a Klimt. Tomorrow it will be your haircut, and your bag of crisps, and the quart of milk.

Tokyo Momentum Update

While the Average stock in Japan is down about 16.5% CYTD, and the indices have shed nearer to 20%, little has changed insofar as investor preferences, at least as they relate to momentum. One-month, three-month, six-month twelve-month, and all flavours of formation period in-between, have maintined their "spread" out-performance between the best-performing and worst-performing deciles of stocks.

This is curious if only because there has not only been enormous liquidation and margin-puking going on, but mperhaps more importantly, other major world bourses, most notably the USA have seen their 3,6,12 & 36 mo momentum spreads get absolutely crucified by a magnitude of 25% - numbers not seen November 2002 and January 2001. As a result Calamos ( doyens of uber-momentum), and heirs apparent to Navellier (TOP20 Fund -25.4% peak to trough)has seen his formerly $20bn long-only fund pummeled 20% since mid May.

Why has the relative performance of winners and losers been so dramatically altered in the USA, but not in Japan? My guess is that inflation and its associated interest rate rises that people fear, are structurally perceived as posing greater earnings threat to the US market. This is exemplified by heightened conditional co-variances of "risky" stocks (i.e. stocks whose earnings have higher r-squared to changes in aggregate demand and aggreagte US earnings), that will (presumably) manifest itself from continued hikes in US rates. Most sensitive to this are primarily effect sectors most buoyed by the "liquidity trade" (materials, mining, cyclicals, housing, etc.) coupled with secondary effects of general deleveraging by hedge funds, which means, "selling what they own". This has caused BOTH accelerated sector rotation coincidental to intra-sector convergence - both which are anti-momentum effects.

Japan, by contrast, has been caught in the jetwash. This has seemingly caused marginal exposures across the board to be reduced, which has not caused excess sector rotation nor the intra-sector convergence that so defines anti-momentum (excepting the shortest of reversion horizons). Where does it go from here? The momentum effects in Japan appear to result from the attention certain stocks receive from large foreign admirers, be they hedge funds, activists, or large long-only shops. And I believe that these allocations are somewhat stickier than the marginal flows driving some fo the US style shifts, and so I see no immediate reversal. Until, of course, if and when, Japanese stocks return to ignominimy. As for the immediate direction, the selling has been overdone and today the 14th of June with many fine securities having shed 30% to 40% from values seen just a few months before, I strongly suspect a significant and profitable near bounce is on the cards.

June 9th Market Musings

There is much that fascinates me today. Newsflow on Murakami continues strong, with most writers wielding late, but probably deserved, tar & feathers. The market bounced in sympathy with an "outside reversal" afternoon bounce in the US markets, and an oversold technical condition after a classic "margin puke" in Japan. And finally, the largest-ever MBO in Japan was announced with Nomura Principal Finance teaming with management to take the Skylark Co. (TSE Code#8180) private at a price of YEV2500/shr.

Today's news on Murakami alledges that in addition to being a child-raper, a North-Korean spy, being responsible for global warming, and being covert operative for Al-Zarqawi, he back-stabbed, two-timed Livedoor's Horie but dumping shares in NBS, after he urged [and convinced, we are supposed to believe] Horie to buy them at higher and higher prices. We are meant feel sorry for Horie, and despise Murakami's lack of honor. But I feel like I am watching the Japanese equivalent of Jerry Spinger, and really feel no sympathy for either of them.

Following on this, the Asahi Shimbun reports on research by Kazunori Suzuki, professor at Chuo University's Graduate School of International Accounting, that suggests Murakami's activist style of investing actually destroys both companies and shareholder value. He's analysed the juicy and apparently undervalued companies in which Murakami's fund made investments and found that while their ensuing stock market performance was better than average, their ensuing business performance was pathetically worse than average on many important measures. The researchers suggest that this might be due to the distraction and low morale caused by the raiders' unwanted interest in the company, and therefore questions whether the activist has the company's long-term interests at heart. The skeptic (being me) would respond that the share price performance was aresult fo the raider/activists own buying upon the relatively illiquid markets of the smaller companies that caught his eye, and the true story will need to be seen only after MAC and other activists dispose of their holdings, or the researchers try to disentangle the subsequent share price performance due to "improved management and shareholder focus" from the insanely large market impact of incentivized fund managers jamming up the prices of these securities to collect ludicrously large performance fees. Furthermore, the skeptic might rightfully suggest that the companies in MACs portfolio suck. They are sh*t that sticks to your shoe, and they are cheap for a reason. OK, they were too cheap, but that is quickly resolved once one buys them up, and then what? You've gota large position in a sh*tty, illiquid company. It was no surprise that the companies that appeared "the cheapest" in the mid nineties all has "Martin Armstrong Repair Bonds" in the "marketable securities" line on their balance sheet, where REAL marketable securities should have been.

Finally, there is Skylark - Japan's largest MBO to-date. Rumour has it that the sale was the resulot of a typically Japanese family feud (similar to the Canadian McCain's), and the exit via a sale to Nomura and management was a mutually acceptable option. But THE PRICE for a pedestrian chain sushi-conveyors, buffets and dressed up noodle wagons?!?!? Granted, MBOs are "new" to Japan, and sometimes you have to learn by doing - even if the lessons are harsh. There is no lesson on the perils of "paying too much" than paying too much. And while I admire the engineering prowess, manufacturing organization, and long-term committment of Japanese corporations, I would also point out that Zaitech was invenyed in Japan, and there is good reason was THIS concept was never successfully exported!