Mrs. Watanabe Gets a Margin Call


Annnnd we’re back. This week begins with very different levels of manufacturing activity in China and Australia. One is bullish. The other not so much. One confirms the basic idea that the world is slowing down, growing less fast, writing down bad credits, and saving for a rainy day. The other doesn’t exactly contradict that idea.

But we’d like to begin this week of reckoning with a simple observation: the rigging of short-term interest rates can prompt ordinary people to take extraordinary risks.

We hesitate to say bad risks because each act of risk taking is an individual thing. But what they have in common is that access to cheap money effectively lowers personal inhibitions to risk in the same way that a shot of tequila increases your chance of doing something stupid in a bar.

Take the Mrs. Watanabes of Japan. Its term that refers to retail investors in Japan who play the foreign currency markets with lots of leverage seeking lots of yield. The hunt for yield is prompted by an anti-deflationary monetary policy in Japan that has left short-term and bank interest rates appalling low, and often negative in real terms (below the rate of inflation).

That’s right. If your cash is getting hammered in a savings around and if it’s relatively inexpensive to borrow, why not gear up and speculate on something like, say, Australia’s commodity currency? The Financial Times is reporting that Japan’s regulators are cracking down on the amount of leverage forex speculators can use. The aim is to reduce “excessive speculation” by “inexperienced traders.”

The new rules limits borrowing by traders to fifty times whatever collateral they can post. Next year, it will be dialed back to twenty-five times collateral. The new rules, the FT claims, have accounted for a move up in the Yen as retail investors close out positions to comply. Just what they will do with their underperforming cash instead (buy stocks) is unclear.

What’s perfectly clear is that an inflationist monetary policy of cheap rates turns ordinary people into speculators. It’s a practical response. As cheap money distorts asset values and punishes those on a fixed income, you have to take greater risks just to find a decent yield for your money. By preventing retail investors from doing something to earn a return on their money, the regulator are just compounding the original mistake of forcing people to speculate in the first place.

But since we’re talking about speculating, and since we’re assuming that most people in Australia are not going to do so in the forex markets, what about stocks? Is that a reasonable way to speculate? Well, it certainly could be, if you’re able to find a stock tied to an asset that’s being revalued/de-risked/or in demand.

Diggers and Drillers editor Dr. Alex Cowie will be looking for a lot of those shares this week at the Diggers and Dealers conference in Kalgoorlie. At first we were concerned about the tremendous confusion that might result on Alex’s name badge. But the stock Doc has been jet setting his way from one mining project to another in the last three months. So we agreed that the possibility of confusion was worth whatever new stories he might come across in Kalgoorlie. He’ll be filing reports with DR all week. And D&D readers, as usual, will be treated to a comprehensive round up of the week’s events in Alex’s subscriber-only e-mail update on Friday.

But really if you read about India’s purchase of nearly $1 billion worth of coal tenements in Queensland, you’ll know what we’re talking about. Speculating on resource stocks can pay. It can also drive you nuts and lose you a fortune. But it can pay.

The deal in question is between Indian coal giant Adani and Linc Energy (ASX:LNC). Linc will be a familiar name to long-time Australian Small Cap Investigator readers. Your truly tipped it several years ago as a play on the unconventional gas-to-liquids industry that might develop from Queensland’s stranded coal fields (coal deposits too small or low in quality to qualify as a mine, but too rich in energy to be ignored altogether).

Linc’s business plan was always complicated, gasifying the coal underground in a barely commercial process, and then turning the gas into a liquid fuel in a proven process that’s been around for a long time and has been used by the Germany in World War Two and South Africa during apartheid.

But the basic value proposition hinged on the coal in Linc’s tenements being valuable. And despite the changing regulatory and political environment, the coal in the ground was coal in the ground. The deal still requires approval by Australia’s Foreign Investment Review Board. If it goes through, it will be India’s largest deal in Australia yet, and probably not its last.

For the record, ASI editor Kris Sayce sold out of the Linc position in February of this year. When he sold, the stock was up 122% from the original share price. Kris managed to bank gains on the stock, even though the business itself has yet to generate cash-flow in the way your editor described in the original story. That’s the world of speculation, where you take your gains when you have them.

Will there be more on offer this year, though? Kris and Alex think so, obviously. And they are paid to do nothing but look for such opportunities every day. So we hope the find some. Of concern, though, is the report today from China’s Federation of Logistics and Planning that manufacturing activity fell in July.

Mind you the survey showed that China’s manufacturing is still expanding, but barely so. The big question is whether this slowdown is evidence that the government’s crackdown on housing and real estate speculation is slowing the whole economy down and leading to slower demand for Aussie resources. And if it’s working, has it just started or is it already over?

We won’t bore you by reciting our theory again about how a bursting Chinese property bubble could do serious damage to Aussie resource investors. But it IS our story and we’re sticking to it. And the relatively encouraging Aussie manufacturing data released today (which also show expansion) doesn’t change our mind.

Finally, how about that Alan Greenspan? He is the gift that just keeps on giving. No longer speaking in any official capacity as the leader of banking cartel, the former Fed chairman now says things in public which seem contradictory to his policy objectives as Fed chief. It’s as if Greenspan is now saying all the things he secretly thought, or simply thinking thoughts that were unthinkable when he worked as the lead shill for the Fed.

The Maestro did point out that while the Fed can control short-term interest rates (as the Bank of Japan and the RBA can generally do as well), it can’t control long-term interest rates. Speaking to Bloomberg, Greenspan said, “There is no doubt that the federal funds rate can be fixed at what the Fed wants it to be but which the government has no control over is long-term interest rates and long-term interest rates are what make the economy move.”

This is relevant for Australians, too. As we’ve said, we reckon that what banks charge for mortgage loans here in Australia will be less and less a function of the cash-rate (the RBA’s price of money) and more and more a function of the global cost of capital (where Aussie banks borrow in the wholesale funds market in Europe and America.)

To the extent that Aussie banks can attract more deposits through higher bank interest on savings accounts, it’s possible that more funding needs can be sourced by a growing deposit base. But without crunching the raw data, we’d suggest the rate of expansion in the Aussie economy would be a lot lower if it has to be sourced from available savings. Slower, but a lot healthier.

It might not be all peaches and cream for America, though. Greenspan says that, “If this budget problem eventually merges to the point where it begins to become very toxic, it will be reflected in rising long-term interest rates, rising mortgage rates, lower housing. At the moment there is no sign of that because the financial system is broke and you cannot have inflation if the financial system is not working.”

Come again? Do what now?

We think the Maestro means that as long as investors keep dumping savings into the U.S. bond market, rates will stay low and the massive expansion of the Fed’s balance sheet will not result in any runaway inflation in the U.S. We will have “deflation” (lower credit growth and bank lending and falling asset prices) as long as banks remain undercapitalised and continue to carry hundreds of billions of dollars (if not trillions) of bad loans and dodgy collateral.

What happens when the financial system starts working again? We’ll tackle that one tomorrow. Until then…

Dan Denning
for The Daily Reckoning Australia

Dan Denning
Dan Denning examines the geopolitical and economic events that can affect your investments domestically. He raises the questions you need to answer, in order to survive financially in these turbulent times.


  1. The AU market is following Dan’s commentary today, there is a massive hot money run on. Running the AUD-USD against the various likely suspects and indexes confirms it. Following Dan, hot money is risk money which in turn has been ZIRP and balance sheet extension washed money that they don’t want assets or cash landing in the US economy anyway because it will cause either inflation or a marked to market deflation. So go west young man (beyond the US border) and by state guaranteed assets (Biker) or commodity plays.

    Anyone looked at wheat … $4 bushel to nearly $7 bushel in the blink of an eye. Viterra privately raised $400m at 5.95% due 2020. Maybe Aussie banks should turn their portfolio over!

    All the above might speak of the QEII ….. love the name

  2. A good read, Ross. The Greeks really are stuffed, I thought as I read that homes had dropped by 45% in some instances. Now a half-completed holiday home in Mykonos should be a steal, mused I:

    “July 28 – Bloomberg (Sharon Smyth): “Greek island homes, long coveted by millionaires and Hollywood stars such as Tom Hanks, are being marked down by as much as 45% as the country’s debt crisis destroys demand for holiday getaways. A half-built villa on Mykonos, an island in the Aegean Sea known for its all-night beach parties, is being offered by brokers… for 2 million euros ($2.6 million) after the price was reduced by 500,000 euros.” :)

  3. Well Im no FX trader but i thought the aud/usd might be rejected at 90 to 91 Ross.. at about the price average of late 09 early 10 consolidation. Have to see from here how she goes since thats where we’re at. But then a QE11 will trump much of that I’m guessing.
    Do you think we’ll see a QE11 any time Ross?
    Would it possibly mean Keene will be hung out to dry for longer?
    Any thoughts on DXY?. Its falling into support now at low 80s. Things actually seem ready for a reversal when I think about it, ie DXY bounce, AUD off cliff :)

  4. Interesting news from The Diggers and Drillers Conference here in WA:

    WA’s population is predicted to grow by 120,000 in 2011 – 2012, but we already have 25,000 families on our public housing waiting list in 2010.

    I think Keen will be hanging around, desiccated, for a couple more years, Lachlan. Hope you’re taking advantage of that 21.25% after-tax FHSAS program!

  5. Lachlan, Doug Noland thinks it is politically inevitable and he has better connections than I. I wasn’t making a statement on the level of the AUD-USD per se, just the latest surge that reflects the hot money. It is more USD against all risk currencies. NZD has broken out too, even against the AUD. That has been trading choppily for weeks, back and forth in a band, a real tussle. I won’t buy Kiwis until it gets back over 1.3 in a burst again.Unless the AU banks go bust at that level the RBA has to knock it back down or blow up the 4 pillar balance sheets.

  6. Hi BP. If things can stay the same for a few more years yet I’ll be very happy. I’m saving and not ready for an implosion yet to be honest. And I dont think dropping a money bomb on the US economy would do them the world of good either (neither does QE11 necessarily imply that either as far as I know…maybe just more $ for the shadow boys).
    Keene dessicated for a couple more years..wouldn’t suprise me either even though I’ve said otherwise in earlier posts. But as I say also that markets can often be propped longer than many would think. I am prepared for the worst but realistically if this plays out nobody is going to like it much no matter how prepared they think they are. Further down the track still..people will get it all back together and great new opportunites to come.

  7. If that is so Biker why are prices in Perth falling?

  8. Thanks Ross. Your insights always a bonus here on DR…(even if I dont totally understand all of it, but getting there) ;)

  9. Hmm that hot money just keeps a comin. Sometimes they pop before they drop ya know. We shall see.

  10. “If that is so Biker why are prices in Perth falling?”

    Got me baffled, Steven. Apparently it has dropped 2.5%!

    Another 52.9% to go, to match the sharemarket crash… Shares are still down 33%… . Funny how Keen never called that… . ;)

    I figure you are right though. Property is going to crash… and soon.
    Get out your chequebook… and a bottle of Bodega… half-price homes in Sydney, next weekend!~ :)

  11. “If things can stay the same for a few more years yet I’ll be very happy.”

    I figure that’s probably what we can expect, Lachlan. It appears that Aussies are banking their surpluses these days. Both our kids are, too.

    We expect a wages blowout here, as industry and mining compete for workers.
    The mining tax situation probably knocked confidence about, big-time.
    No sign of austerity here, yet, though… . :)

  12. “half-price homes in Sydney, next weekend”

    Woow thats news to me, I didn’t know it was possible that house prices could half in the matter of 1 week

    Stop making yourself look like an idiot you fool!

  13. ” I didn’t know it was possible that house prices could half in the matter of 1 week”

    Well, just a few weeks back, you singled out a Perth beach suburb, Scarborough, as a loser, Steven. I responded with a link showing that Scarborough had _risen_ over 19% in the last year. ;)

    “Stop making yourself look like an idiot you fool!”

    Love it. You’re angry. You lose. :)

  14. “Anyone looked at wheat … $4 bushel to nearly $7 bushel” – At least partially related to drought in Russia possibly?

  15. True enough Ned, Ukrainian farmers are said to be holding onto what they have on farm.

    Teaching our guys a lesson. Tell them nothing, don’t answer surveys or just plain lie in them, don’t sell forward while still accepting all the production risk because you are buying a false de-risking paradigm and limiting your upside, and ultimately you will always get a better price by riding the volatility than you do when the markets manage you into your corner and only deliver more certainty for the traders and buyers.

    Inventories were at an historical high just 3 months ago globally.

  16. Evening Ned.
    Drought threatening WA wheat crop also is reported today. Maybe impetus for prices also?
    As for the east, I”ll be snooping around the D.Downs later this year (and adjacent regions). Would expect to see decent wheat crops finishing as I would for my own native seed targets. Rememeber our floods recently. Me heart is full a hope :)

  17. “Greenspan says that, “If this budget problem eventually merges to the point where it begins to become very toxic, it will be reflected in rising long-term interest rates, rising mortgage rates, lower housing. At the moment there is no sign of that because the financial system is broke and you cannot have inflation if the financial system is not working.””

    Wonder what Big Al meant – You can’t have inflation [in the price of leveraged assets?] if the financial system is not working maybe? – Because there certainly seem to be plently of historical examples of getting inflation in goods and services when the financial system is not working.

    And I assume ‘broke’ should be ‘broken’.

    Yes Ross, the Eastern Europeans have had a couple of decades of quite brutal lessons to help them get their heads back around how ‘free markets’ work; what’s going to inflate and why; and how to best play the game to their advantage I guess. Ukrainians – A classic case of You aren’t being paranoid if they really ARE out to get you perhaps? :)

    G’day Lachlan – We’ve got family on the Downs – Used to work grain and pigs – The family got a bit big for the farm to support them all though. But they still live on it. With most of them having jobs off the farm I gather.

  18. Maybe Al means that the financial system cant produce steady, lower rates of inflation we’re used to since the private sector (not so much big end town) in USA cannot produce increasing taxable revenue. And for various reasons eg overleveraged, increasing tax burdens etc. The only type of inflation you could produce in this declining GDP state is the nasty kind …otherwise we allow deleveraging, deflation to do take its course.
    Good to see they kept the farm Ned. I reckon that productive land will will always be worth a lot with so many new mouths to feed..even if farmers are hard up. Not paid enough for their food. I’m surrounded by people on high non-farm incomes who pour all their dough into farmland and farming enterprises. One of my brothers has several farms he has accumulated. Some people love the farm life despite the struggle with cash flow.

  19. Crumbs that westerly’s gotta a go on here Ned. Im goin back to bed..cold. Same wind should be hitting your pad too ;)

  20. The Farm – asset rich – dirt poor – the banker at the gate – but life!

    More on the QEII narrative being peddled and of course the source is the force (The Fed).

    So Treasury prices are down for the first time in ages & risk money hits the table and it buys risk currencies, commodities and risk equities (commodity players and banks with sovereign guarantees). The Euro is up too so we get a double jump off the cross. They say building approvals were down and it knocked the AUD but if I was trading it I would be buying into that dip because we don’t matter much at all, just a fish in the big sea of hot money flows that hit our shores.

  21. Ross I still think a pop’n’drop is possible but like you not bothering to bet on anything specific. Seems anything happens, anytime these days. Its crazy.
    QE11 I’ve always thought will come but I think at present they’re suggesting QE and ramping a little just to get the last few suckers in at a local top. For the present time I dont see a good trade anywhere…my usual haunts are acting very unpredictably. Love all the daily dramas but so keeping up with the reading.


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