Markets for Thee, Not for Me

Daniel Gross has a piece up at Slate (link) which would qualify as an April Fool’s special if we didn’t have good reason to believe that these guys really mean what they say.

That is: we are told that the real culprit in the current financial uproar is not lunatic lending, bubble economics, greed, panic, narcissism, what-have-you. No: it is the mark-to-market accounting rule that requires the bankers to mark their securities (down) to current market prices.

As Gross points out, mark-to-market is always a tricky business, a costly-tradeoff at best (except when you are dealing with stuff regularly traded on exchanges, like hog bellies or shares of stock). But this isn’t quite the argument the fussbudgets are making. They are not saying that mark-to-market is impossible, so much as that the “known” prices don’t represent “real” values.

Ha! Well, a couple of points. First, recall that this is the argument of every debtor in extremis—if only my creditors will be patient, if only I can have a little more time, if only if only yadda yadda.

“Hey! Three wishes!” as the lobster says on his way into the pot. “Four! Five! How many wishes you want?” The debtor always believes that something will turn up. Funny thing is, sometimes he is right. The skill of a good investor is to be able to sort out the signals from the noise, to know a good deal when they see one, and not to be distracted by the monentary trampling of the herd.

The reason all this is so comical is in this case is the source: the current round of bleating emits from the very highest of high priests of hairy-chested free market orthodoxy: Steve Forbes, and Paul Craig Roberts and others of their ilk—the guy who have never in their life seen a market price they didn’t like until now when it is their ankle that gets the bite.

Note: I don’t mean to criticize Gross here, who is clearly in on the joke, although I do think he lets them off rather easy: there are some situations where sneering mockery is the only suitable response.

Brad and Daniel's Excellent Adventure

Brad Setzer and Daniel Gross follow the money, and it takes them a long way from home. First, Setzer (link):

In 2007:

China’s government added $430b to its foreign exchange reserves.

Russia’s government added $150b to its foreign exchange reserves.

China’s state banks likely – this is the only point here where there is some real doubt – added around $150b to their foreign portfolio, or would have, had China not made it harder to borrow from abroad and thus forced them to pay down some of their external debt. The state banks' dollar purchases reduced the central bank’s need to intervene in the market (apparently the exchange rate risk remains with the government). The central bank basically told the state banks to hold more of their required reserves in dollars.

Brazil’s government added a bit over $90b to its reserves. Brazil’s Treasury holdings are up close to $70b for through November, in another kind of reverse bailout.

India's government added a bit under $90b to its reserves, almost none of which seems to have been invested in US Treasuries.

The China Investment Corporation likely had about $17b to invest abroad – as the majority of the funds it raised in 2007 were used to buy the central banks’ stake in the state banks and to recapitalize China Development Bank. It will get something like $105b early in 2008. Maybe $45b to $50b of that is already committed to the recapitalize the domestic banking system, leaving up to $60b more to invest abroad. But the CIC is still the smallest official investor among the BRICs.

Sum it up and the BRICs added just a bit under $800b ($760b) to their formal foreign exchange reserves (the total would top $800b if I counted China, Russia and India’s valuation gains) even without counting the Chinese banks. Counting the state banks and the CIC, the total is more like $900b. I was conservative back in July.

Goldman started dreaming of the BRICs well before energy traders started dreaming about $100 a barrel oil. The Gulf can hardly be left out of the discussion today.

The Saudi Monetary Agency’s foreign assets likely increased by $75b in 2007 -- they were up over $60b through November (Table 8a, in Saudi riyal). Saudi pension funds added another $5b.

The Gulf's other central banks likely added close to $50b to their reserves – though we are still waiting for data from the Emirates for the second half of the year.

The big existing Gulf investment funds – the Abu Dhabi Investment Authority (which, incidentally is likely to be bit smaller than the $875b to $1 trillion total that is commonly cited; see Mohsin Khan’s statements in the FT), the Kuwait Investment Authority, the Qatar Investment Authority and the confusing jumble of Dubai investment funds (some belonging to Dubai, run by Sheik Mohamed, and some belong to Sheik Mohamed, ruler of Dubai) – likely added around $100b to their assets. The $100b total doesn’t count any additional funds that they borrowed to finance some of their more aggressive strategies, or the capital gains on their existing holdings. $100b is what the funds got from their countries surplus oil revenues and the interest on their existing holdings.

Meanwhile, Daniel Gross finds trouble at the other end of the pipe—the filthy rich aren’t spending their money here, either (link):

The latest investment trends similarly lead me to think you may not be acting in the national interest. America's private-equity firms are plowing cash into India, China, and Latin America, and private bankers are urging clients to drop the home bias. (Don't think condos in Palm Beach and ski chalets in Aspen; think beachfront property in Thailand and ski resorts in the Alps.) A Spectrem Group survey of people with more than $500,000 to invest found that 31 percent are putting more capital to work internationally than in the past. "The rich are investing a larger share of their capital overseas," says Richistan author Robert Frank.

Just when the economy has started to take on water—and we don't know if we've just sprung a leak or we've hit an iceberg—you are racing for the lifeboats. Please, don't abandon us. Ski at Sugarbush instead of Gstaad. Invest in P.F. Chang's China Bistro instead of China. It might not be as rewarding, financially or psychologically. But your country needs you now, more than ever. And after all we've done for you, it's the least you can do.

Update: Thank heavens for those overseas markets (link)!

Update II: Guess it goes both ways (link).

The Future Lies Ahead...

Daniel Gross chortles over the March 12 Forbes which says (link):

"Has the Bull Market Just Started?

Gross treats the question as rhetorical, but here is the answer: maybe. Not by my lights, I am the ultimate pessimist, having lived through nine of the last four recessions. But that's the point. You never know. You just never know.

Prediction is hard, said Mark Twain, especially if it is about the future.

Must Read: Hedge Funds

Or maybe not a must read; maybe you already. Anyway, Daniel Gross sums up the evidence that we're heading for a hedge fund meltdown.

I have a perverse view of these things because I hang out with bankruptcy lawyers. My take is that these guys think a meltdown is indeed coming. Their problem is that they can't seem to get a handle on how to get a piece of it: they seem to fear that Skadden Arps will occupy every profitable position in every case.

Or most of them. A lawyer from deep in the boondocks says: "There'll be enough for everybody, don't worry. Enough for everybody."