Tag Archives: debt

Setting of the Rising Sun

Japan’s economic crisis has been slowly trudging down a dead end road since their economy collapsed in the early 90’s. Their insistence on maintaining public programs as status quo has been financed by selling government debt to domestic corporations and private citizens. This has cannibalized both private citizen and corporate savings. This tacit deal has allowed Japan to artificially keep interest rates low based on their captive pool of treasury purchasers. This process of spending more than the government is collecting on an annual basis, combined with sales of treasuries to finance the difference has left them ill prepared to handle this disaster at a time of global economic uncertainty.

While some economists are taking the stance that Japan’s rebuilding is just what they need to get their economy back on the right track, I think it’s quite possible that their economy may be too far gone to save. Furthermore, the scale of their disaster will place a huge burden on developed nations who will be called upon to assist them in the process. Many of these nations, including the United States, have no room for error in their own economic policies. The end result could be a localized natural disaster that triggers a global recession.

Professor Ken Rogoff of Harvard School of Public Policy Research wrote a book in 2009 describing the historical relationship between banking crises and sovereign default. His research states that the average historical tipping point is approximately 4.2 times debt to revenue. Once a country is spending 4.2 times more than it is collecting, default is on its way. John Hayman and Lawrence McDonald, cite individually, that Japan’s expenses outpace revenues by more than 20 times annually. Their debt to GDP ratio, their total assets and earnings minus total debts and liabilities, is around 200%. The third largest economy in the world spends 20 times more per year than it earns and owes twice as much as it’s worth. One note of caution, the United States ranks third in the debt to revenue ratio, behind Japan and Ireland and we owe as much as we’re worth. We will be double negative in 2011 if we don’t change substantially.

Debt will surely rise even further as Japan borrows to rebuild. Standard and Poor’s downgraded Japan’s credit rating to AA in January, prior to the disaster. Japan will have to move to the open market to finance their reconstruction. Their domestic lenders will be busy financing their own rebuilding processes. This will force Japan to pay open market rates for most of their new debt. Open market rates will be AT LEAST 100 basis points and most likely, closer to 200 basis points higher.  The interest payments would total more than 25% of the country’s revenue. Japanese credit default swaps will sky rocket.

The strain of rebuilding Japan will affect us whether we lend financial assistance or not (which we will). The demand of replacing 30% of Japan’s energy source will show up in the price of fossil fuels. Japan currently consumes 5.2% of the world’s oil supply. Replacement of lost energy will add another 1.3 million barrels per day plus the added oil necessary for the reconstruction. Their added demands equal Italy’s total consumption. Add this to the global uncertainty of North African fuel supplies and the added fuel that goes into fighting a third global conflict and we have questionable supplies coupled with increasing demand.

Rising oil prices couldn’t come at a worse time for our economy, which had been gaining some traction. GaveKal research published a chart in which rapidly rising oil prices are overlaid with economies growing more than 2% above their leading indicators, which we are. This has happened 5 times in the last 70 years. Four of the five led directly to recession. The fifth was in 2005 and was ameliorated by the credit and housing booms, which may have delayed the recession until 2007. Rising fuel costs act as a tax on the economy.  The latest housing numbers, the worst ever, blame much of it on high gas prices. Furthermore, while the unemployment rate is stabilizing, the length of time people are unemployed is at an all time high of 37 weeks. Finally, the stock market has returned to its upper 10%, in normalized valuations. Japan’s natural disaster could very well mean this is the zenith of our economic recovery.

This blog is published by Andy Waldock. Andy Waldock is a trader, analyst, broker and asset manager. Therefore, Andy Waldock may have positions for himself, his family, or, his clients in any market discussed. The blog is meant for educational purposes and to develop a dialogue among those with an interest in the commodity markets. The commodity markets employ a high degree of leverage and may not be suitable for all investors. There is substantial risk of loss in investing in futures.

The Politics of Cocoa

The Ivory Coast is caught in the middle of a major struggle. They are the world’s largest cocoa producer and are believed to have some of the largest untapped oil fields in the world. The country should be laying the groundwork and creating the infrastructure to capitalize on their natural resources and developing as a nation. Instead, their nation is on the unsafe to travel list by the CIA and they are on the brink of declaring marshal law.

Laurent Gbagbo has ruled the former French colony for the last ten years. He has been accused of siphoning money from the country into his personal offshore coffers and silencing any political rivals quickly and ruthlessly. During his reign, he has sold approximately two billion worth of dollar denominated bonds on the world market. He has also actively solicited Russian investment in oil and mineral deposits. Russia’s number one private oil company, LUKoil has an estimated stake of nearly $800 million in oil drilling and development rights and plans with the Ivory Coast.

The first open election in years has ousted Gbagbo and installed Alassane Ouattara as the President elect. The election results are supported by the United Nations and he is a former deputy managing director at the International Monetary Fund. However, Gbagbo has refused to acknowledge the results and still controls the military and the purse strings. Therefore, he has simply refused to make payments on the bonds they’ve issued to the global market unless he is recognized as the county’s leader and is using the military to enforce his rule.

Gbagbo has placed himself in the middle of an international trade dispute between two superpowers. His deal with LUKoil will most likely be renegotiated if Ouattara assumes leadership. LUKoil is using the Ivory Coast investment to lobby against domestic Russian production taxes. LUKoil has to show some production capability in these lands to maintain their leverage against Medvedev and the state run Rosneft. Therefore, it is in their best interest to covertly supply Gbagbo with any means necessary to fuel his standoff. This contingent is also supported by China. They are citing the recent election issues as the climax of 20 years of failed importation of western democracy, while also shoring up their own future natural resource acquisitions.

The United Nations recognizes Ouattara as the rightful leader. Western countries, members of the United Nations and hedge funds hold the vast majority of the outstanding debt. Furthermore, the Ivory Coast supplies one third of the world’s cocoa. In 2010, that cocoa was worth approximately $3.9 billion at exchange prices. London trader Anthony Ward who made the largest exchange purchase in history last July, now owns nearly $100 million of that warehoused cocoa. Ivory Coast cocoa is also traded actively in New York and its supply must be guaranteed in order to trade futures on either exchange.

The Ivory Coast is preparing for military action and the U.N. just sent 2,000 troops. Some are reporting that Gbagbo is simply stalling for time to fortify his defenses. Others are questioning whom he is preparing to defend himself against. Will the Ivorian people rise up in a unified democratic voice or, will there be direct foreign involvement and if so, on whose side? Will western forces step in to defend their financial interests and install democracy in the name of the people or, will Gbagbo hit for the cycle by guaranteeing the exchanges, the bondholders and LUKoil in return for not starting another global conflict?

My father never liked trading the cocoa market. He told me once when I was a kid that he didn’t like the idea of something happening halfway around the world and not knowing about it until it was too late. Trading used to be about gaining access to information. Now, it’s about interpretation.

This blog is published by Andy Waldock. Andy Waldock is a trader, analyst, broker and asset manager. Therefore, Andy Waldock may have positions for himself, his family, or, his clients in any market discussed. The blog is meant for educational purposes and to develop a dialogue among those with an interest in the commodity markets. The commodity markets employ a high degree of leverage and may not be suitable for all investors. There is substantial risk of loss in investing in futures.