Global markets freaked out on Tuesday primarily due to the following events:
- U.S. Treasury Secretary Geithner’s speech on Monday pledging “The United States and no country around the world can devalue its way to prosperity.”
- Within hours after Geithner’s statement, China made a surprise interest rate hike—its first since 2007–raised fears that Chinese growth will slow with global implications.
- The unravelling of the “foreclosure-gate” could mean banking crisis 2.0
Geithner’s comments, uncertainty over the Chinese economy and worries about the U.S. mortgage market led a flight by investors into U.S. Treasuries, which sent the dollar surging 1.7 per cent against a basket of six major currencies on Tuesday, while shifting capital away from equities, gold and other commodities, including crude oil.
Some analysts believe that the timing of Geithner comment and China’s interest rate shift–in the context of the G20 meeting days away–may suggest a currency accord. However, from all indications, China and Geithner appear to be acting under totally separate agendas however “coordinated” they might seem.
China Primary Directive – Growth
The 25-basis-point increase in China’s one-year lending rate announced by the central bank on Tuesday is aimed to rein in inflation and asset prices. Nonetheless, contrary to the fear of slow China growth crimping global economic recovery, the move suggests Beijing’s confident about the economic recovery, while the scale indicates its primary directive is to sustain growth.
In fact, due to its huge population, China most likely will need to keep growth at 8% range to create jobs, or the Communist Party could risk another “civil revolution” similar to the one Mao waged some 60 years ago.
8.5% – Slowest Growth in a Decade for China
In its October 2010 East Asia and Pacific Economic Update, World Bank noted
“China’s growth prospects over the coming decade continue to look bright, but rebalancing the economy by altering the pattern of growth and investment is becoming increasingly critical to ensure sustainability.”
The bank forecasts China’s real GDP to grow 9.5 per cent in 2010 and slow to 8.5 per cent in 2011.
Currency War Still On
In the process of sustaining growth, propping up the yuan is a side-effect, which just so happened to quell global criticism of China’s currency policy. But Beijing is not going to let yuan appreciate as much as Geithner (and the rest of the world) would like. So other countries–including the U.S.—either have to live with that, or the currency war will still be on even after the G20.
Strong Dollar Talk – No Substance
On the other hand, Geithner’s strong dollar talk is more symbolic than substance since Fed’s QE1, the coming QE2, not to mention the ever growing national debt, basically have sealed the fate of the US dollar.
A rapidly sinking dollar, which hit a 10-month low against major currencies last Friday, posts various risks including hyperinflation and even bank runs. This most likely prompted Geithner to break his 8-month silence on dollar.
Meanwhile, the foreclosure-gate mess could cost banks massive sums in losses and lawsuits, i.e., another banking crisis. The scandal spiraled into a major crisis in recent weeks after evidence surfaced that some foreclosures were based on flawed paperwork, i.e., “robo-signing.”
Bank of America, Ally’s GMAC Mortgage unit, JPMorgan Chase and Goldman Sachs suspended foreclosures to review paperwork. Attorneys general in all 50 states as well as the FBI are currently investigating whether mortgage lenders violated state laws. Moreover, Bloomberg reported that the New York Fed had joined with PIMCO and BlackRock in an attempt to force BofA to buy back $47 billion in mortgage bonds.
Up to $120 Billion in Loss
While most analysts agree that the biggest threat is likely the related law suits, but estimates vary. Banking analyst Dick Bove estimated that under the best-case scenario, banks losses will top $80 billion, over the next three to five years, while Stifel Nicolaus put the total loss figure at $47 billion, with $9.5 billion specifically to Bank of America, and JPMorgan Securities said to be in the range of $55 billion (more likely scenario) to 120 billion (the worst case scenario).
So far, most seem to see this crisis stay contained as banks now are better capitalised and less leveraged than before the financial crisis. Regardless of a total loss of $47 billion or $120 billion, one thing is certain–this will drag on for several years whenever there are mass law suits involved, which will likely sap earnings as well as stock prices in the foreseeable future.
Although a few analysts including Bove think bank stocks are oversold, and thus present good investment opportunity, I will err on the side of caution due to the high degree of uncertainty involved as Jim Rogers said,
“Nobody knows what book value at BofA is, including BofA.”
Dian L. Chu, Oct. 0, 2010