Apple, Google and the Tax Holidays on Offer in Ireland

Much has been written in the past two weeks about apparent anomalies in the tax regime in Ireland and the ability of two of the biggest corporations in the world – namely Apple and Google, to exploit these anomalies to their advantage, i.e. to avoid paying taxes to the tune of Billions of dollars, to any tax authority, anywhere, for many years. Neither company has broken any law, rather, both have jumped on the incredibly generous tax laws which operate in Ireland, a country that enables large multinationals to register their entities in Ireland while not having to be tax resident there, nor indeed tax resident anywhere.

There have been many vocal objections within Europe in recent years to Ireland’s lowly corporation tax rate of 12.5% which is significantly lower than the EU norm. However, despite the protestations, Ireland managed to convince the Troika during the bailout talks 2.5 years ago that Ireland had to retain this tax rate to ensure the sustainability of existing business operations from multinationals in the country, a sector that currently provides upwards of 150,000 jobs in a county with a population of around 4 million people. The fear was that if this tax rate was increased significantly, it would trigger an exit of multinational firms from the economy, and further depress an already stuttering economy, thus exacerbating the country’s already dire debt problems.

However, the Apple and Google story really has nothing to do with Ireland’s corporation tax rate. Even if the corporation tax rate were 35% (as in the US), this would not have made much difference to the actual tax take Ireland would have netted from either company, as Apple and Google only pay nominal tax in Ireland, reported as being just 0.05% and 0.14% respectively of total income channeled through their Irish entities. The tax anomalies that exist in Ireland permit a company to register there, but if the entity is managed from outside the Irish jurisdiction, it can be deemed to not be tax resident in Ireland, thus the corporation does not have to pay tax to the Irish State for the operations of these companies. In the case of Apple, three of the Group’s main revenue generating companies are registered in Ireland, but are tax resident in Bermuda, where there is no tax. Using this arrangement, Apple managed to restrict its overall tax liability across the globe in 2011, to just 1.9% of the Group’s income. Apple is a US conglomerate with its Headquarters in Silicon Valley, and given the corporation tax rate for American registered companies is 35%, it is easy to see why certain people in charge of the legislature in the US might get quite exercised on this issue.

Similarly, in the UK, the House of Commons were informed two weeks ago, that Google Ireland paid tax of just €70 Million on sales of €47 Billion between 2005 and 2011. Google’s sales in the UK were channelled through its Irish company and Google essentially paid no tax in the UK on UK sales. Google availed of the same tax loophole as Apple, whereby it funneled revenues from non-Irish operations through Irish subsidiaries which although registered in Ireland, were not deemed tax resident in Ireland. The funds then made their way to a Bermuda registered Google company, to avail of the 0% tax rate on offer there. The House of Commons committee subsequently branded Google ‘devious’.

So who is to blame for the tens of Billions of dollars in lost tax revenue? It is hard to blame the companies themselves directly, as ultimately the function of corporate companies is to maximise the wealth of their shareholders. There is an argument that both Apple and Google come up short in terms of displaying corporate moral responsibility, whereby they have deliberately avoided paying their fair share in tax contributions back to the economies that contributed most to their success. However most corporations will generally operate within the legal parameters set for them, and if the legal parameters come up short, and this provides an opportunity, then most companies will take such an opportunity if it helps it to preserve and grow its wealth for shareholders.

The Irish Government has been at pains over the past week to state Ireland is not a tax haven and that the government does not do deals with companies on the tax liability a company must pay. However the fact is that Ireland deliberately operates an accommodative policy surrounding legal registration and tax residency and this accommodation is used by scores of multinationals to avoid paying tax in other jurisdictions. This has nothing to do with the low corporation tax regime already operating in Ireland. Apple and Google between them provide about 6.000 jobs in Ireland and these jobs are obviously deemed more important to the country than the very significant tax revenue the country could earn from both companies, and indeed from other multinationals, were these companies forced to pay corporation tax on all earnings channeled through all their Irish registered entities.

The European Union could introduce a rule that all companies registered in the European Union are automatically liable for tax at the tax rate applicable in the jurisdiction in which the company is registered, closing off the Irish loophole that permits a company to be registered as a legal entity in one country, while being resident for tax purposes in a separate jurisdiction. Of course the EU, US and other major governments could also determine that, for tax purposes, IP has to be registered in the country of origin of the IP, as opposed to being registered in some remote island and thereby by proxy, this would force large multinational companies like Apple and Google to radically rethink their policy in relation to corporate responsibility and tax and their overall economic contribution to all society.

Bob - May 27th 2013

Jamie Dimon's Two Fingers to Governance

What is going on at JP Morgan Chase?

Despite the multiple scandals that has plagued the broader Banking sector in recent years and the more recent 'London Whale' trading scandal, where JP Morgan blew billions of dollars of investors money, JP Morgan Bank has spectacularly demonstrated its inability and reluctance to embrace strong leadership and transparency by voting down a proposal to separate the key corporate roles of Chairman and CEO. As to why this proposal needed to go to a vote by shareholders in the first place, says a lot about Jamie Dimon's own personal agenda within the Bank and his rather alarming indifference to best practices in governance. What is he afraid of? What has he got to hide? Why does he not want to be accountable to anyone within the Organisation?

Even undergraduate students that study business studies and corporate governance will know the critical importance for the separation of the CEO and Chairman roles in an organisation. The Board's job is to oversee the performance of management and to hold management to account. How can the Board carry out this function if the Chairman of the Board happens to also be the Head of Management (CEO). Given the Chairman sets the agenda for Board meetings and is the most powerful and influential person on the Board, how can the Board function in any meaningful or effective manner, if the Chairman also happens to be Management's chief representative and defender on the Board.

The fact a publicly listed Bank the size of JP Morgan Chase is even allowed to retain a CEO and Chairman as the same person does not say much for the regulatory authorities in the US. In many countries this would be a breach of governance practice and the Bank would be expected to provide an explanation in its Annual Report for the breach, and to provide details on what it is doing to rectify the transgression. Many of the failings of international banks during the financial crisis had to do with core governance failures and the failure of Boards to rein in management, when risks in the sector began to escalate.

JP Morgan Chase may well argue that it outperformed and outlasted most of its competitors during the Banking crisis, but that does not give Mr Dimon a license to be answerable to nobody and to both manage and govern the bank as he sees fit. If he is truly proud of the job he has done, he would be open to transparency and accountability, and welcome a non-executive Chairperson to evaluate his performance and to report back independently to the Bank's shareholders. Ultimately one has to ask what is the role of the non-executive Directors on the Board of the Bank and if these Directors believe it enhances their corporate reputations to sit on such a dysfunctional Board structure. How effective can the Remuneration Committee be if a member wishes to question the remuneration package afforded to Jamie Dimon? Dare they strike it down? They can hardly revert to the Chair for guidance, or support.

The number one requirement in good corporate governance practice is the separation of the CEO and Chair roles. Any organisation that fails this simple test is a long-term recipe for disaster and should be seen as a significant risk for would-be investors. JP Morgan Chase is an Institution where strong ego wins out over strong governance. Step clear!

Bob - May 22 2013

Market Watch: Canadian Dollar

Is it time for the Canadian Dollar to make a significant correction against its Australian counterpart?

The Canadian dollar is traditionally one of the more difficult currencies to predict in terms of medium to longer term movement, given direction is principally dictated by a number of factors outside the confines of the Canadian economy and the monetary policy moves of the Bank of Canada, namely 1) the general trend in global commodity prices and 2) close affiliation and thus link to the performance of the US economy and the US dollar.

It is thus a risky currency to trade, although over the past 12 months it has generally traded within a fairly confined range against the US dollar, while trading a little stronger against the Euro for all of 2013. The Canadian dollar has not had anything like the same inflated gains achieved by the Aussie and New Zealand dollars since the turnaround in global financial markets, but this is thanks to the much more accommodative interest policy adopted by the Bank of Canada, as against that adopted by the Central Banks in Australia and New Zealand. Interest rates in Canada have remained at 1.00% while the higher rates on offer in the Aussie dollar (3% + up until recently) meant that any speculative holding trade involving commodity currencies has generally gone on the Aussie dollar. The recent sharp fall in metal prices and the reduction in overnight rates (to 2.75%) announced by the Reserve Bank of Australia last week has triggered some dilution in this holding trade, and the loonie is now up 5% against the Aussie in the past month. However, the pair are due a further correction given the Aussie is still trading almost 30% higher against the loonie than when the pair last traded at a fully corrected price back in early 2009. Of course the problem with being bearish on the AUD/CAD pair is the punitive overnight cost of the interest rate differential (2.75% Vs 1.00%), but the signs do indicate this pair should make a significant move downwards, certainly down to 95 and possibly down to 90, through the course of this year.

But, and this is an important but, the Canadian dollar will only make significant gains against the Aussie on the back of a move downwards in AUD/USD, and thus a good hedge to take on in tandem with a sell of AUD/CAD, is to sell USD/CAD. While not the perfect hedge, it will significantly reduce the risk of holding AUD/CAD in the medium term, while the interest rate differential in selling USD/CAD is in the traders favour (0.25% Vs 1.00%). This strategy is for an initial 3 months.

Ted - May 15 2013

Austerity and ECB Policy

Last Thursday the ECB announced a 25 basis points reduction in its overnight rate bringing interest rates to 0.50%, the lowest level they have reached in the Euro era. An accommodative policy has been adopted by the Federal Reserve, ECB, Bank of England since the Financial crisis in 2007-2008, but all the evidence suggests this policy has failed miserably to stimulate many of the major economies in the developed world, with contraction again the dominant force in Europe and Japan, while the US experiences a moderate recovery. The Euro area economy contracted at an annualised rate of 0.6% in the final quarter of 2012, while Japan contracted at a rate of 0.4%. The UK economy grew by a slight 0.6% annualised rate in the first quarter of 2013, while the US economy expanded by a more impressive 2.5% in the same quarter.

Little to none of the cheap money being fed into the bank chain from the top of the hierarchy by the Central Banks is making its way into the real economy - i.e. by way of retail bank support and lending to small businesses and end consumers. If the people that are the lifeblood of the economy are starved of cash and disposable income, then the real economy is missing the basic stimulus it needs to grow and the Central Banks need to reassess its policy, or, more importantly, reassess how the institutional banks are interpreting their policy. Owing to flagrant indifference of the banking sector to the Central Bank's policy intentions, any trickle of funding that does currently make its way from the banks to the real economy usually brings with it a vastly inflated interest rate tag, just to reinforce the fact that accommodative monetary policy is not accommodative where it is needed. None of this money is available at an affordable price where it is needed most.

But if the cheap money being ushered out by the Central Banks is not going into the real economy, where is it going?

Answer: Into risk assets such as commodities, bonds, even equities. How? The institutional banks are borrowing cheap money from the Central Banks, such as the Fed, ECB and Bank of Japan, and rather than making this money available for end borrowers (the original intention of the Central Banks), the Institutional banks are diverting the cheap funds from the Central Banks into their own investment channels, to speculate on higher risk investments in the hope of a more profitable and quick return. For the most part this tactic has worked over the last 3 years with largely exaggerated price increases achieved in commodities and equities, while sovereign bonds in many defunct European countries are now achieving close to record yields for investors. The added political lobbying by bank interests of influential governments within the European Union has helped to safeguard bond investments, as the EU currently prohibits sovereign debt write-downs and the burning of major bondholders exposed to Europe's burgeoning sovereign and banking debt. Any country that might consider straying from this policy is threatened with expulsion from the Euro.

For the institutional banks it is a no-brainer. Why lend money to the man on the street or to someone starting up in business, with the risk that entails, when the option exists to direct this money into a 6% yielding bond, a speculative fund investing in oil futures (up 50% since 2009), or gold (still up 113% in the past 4.5 years despite a recent sell-off) or equities (The Dow is up a massive 130% in the same period). A 5-year term loan given to a small business might yield 18% over 5 years and is not without risk, while a mortgage given to an end consumer might yield 40% after 20 years. The differential gap in terms of potential yield between investment risk and lending risk is something of a moral dilemma for institutional banks, but not one they lose any sleep about, and when push comes to shove it is lending to the real economy that is losing out to speculative investment. Of course what this means is that with cheap and free money barging its way into riskier assets, these assets have grown at a rate which is completely out of synch with growth in the underlying economies and thus the aforementioned assets are completely overpriced in real economic price terms and the run-up in prices is unsustainable, and many of these assets are soon headed for a serious downward correction, if not crash landing, in the not too distant future. Oddly enough, given the impact of political bullying and potential ECB intervention, sovereign bonds within the Euro area may be at the lower end of this risk investment scale.

So what does this mean? Central Banks are accelerating a policy of providing cheap money to banks so these banks may use this money to invest in risk instruments rather than lend this money to the real economy. The net result for many of the underlying economies is economic contraction as government austerity measures intensify and fuel costs continue to inflate, thanks largely to the speculative investment which the Central Banks are inadvertently helping to fuel. Cash-starved businesses in developed economies are being run aground and unemployment in Europe is now at a Euro era high at 12.1%. Japan's Central Bank is currently undertaking desperate measures to try to discredit it own currency with the result that the currency has fallen 28% against the dollar in the past 8 months, while the Nikkei has soared 63% since the middle of November. The price moves in Japan are totally at odds with the economy's lack of economic growth and its underlying fundamentals and the price moves appear more fictional than real. It just does not seem plausible that such moves can occur and be representative of the economic facts. But of course they are not representative of the real economy, rather they are representative of the repatriation of cheap funds originating from the speculative children (banks) of accommodative Central Bank policy, as their fund managers race trigger-happy across the globe, in an avaricious chase for big profits from risky assets.

Why are institutional banks allowed to borrow money for half nothing from the ECB, Bank of England, Bank of Japan and the Fed, when this cheap money is not finding its way into the real economy and is not being used to help the economies of the Euro, UK, Japan and United States? The reason is simply because, despite the near-collapse of the banking sector in Europe just a frighteningly short time ago, the ECB and other major Central Banks have failed miserably to impose the proper regulatory procedures required to keep the money distribution policies of banks under control. It is incredulous that the ECB itself has not imposed stricter rules and monitoring procedures, for tracking cheap funds being poured into the banking sector, given the strict rules it has imposed on the Governments of the Euro area, forcing an era of severe and heretofore unseen levels of austerity, for most of the citizens of the Euro area. Is it that the ECB, and Central Banks generally, are run by bankers whose modus operandi is for the benefit and growth of banks, moreover the real economy and its citizens?

Bob - 7th May 2013

The Dollar, Bernanke and the Golden Goose - Are they Coming Home to Roost?

It is interesting to note the top three headlines on CNBC business news this evening:

‘Why are Investors so Worried about a Stronger US Dollar’

‘Fed will Keep Rates near Zero through 2010’ says Bill Gross

and

‘Rates to Remain Low’ says Ben Bernanke

Why is it that such mundane speak is making headlines all of a sudden (apologies to our other Bob on the floor)? Well it’s like this: last Friday the dollar had its only significant one-day rally in 6 months and early on Monday the unthinkable happened, i.e. the dollar sustained a rally into a second day, something that has been rather unheard of since last March. This has put the frighteners on many institutional investors, most of whom have made large profits on the back of a weak dollar, and basically on nothing else. If your reason for financial living begins to be questioned or it is beginning to wear thin, you look to your usual suspects - financial leaders like Ben Bernanke and Bill Gross to reaffirm your (albeit fundamentally flawed) strategy and have them undermine the counter view. This is exactly what has happened today although in Gross’ case he was merely putting his own spin on what Bernanke himself had just said. Why rein in the wisdom and direction of a herd when the good shepherd is on your side?

And why the sudden need to pull the rug from under the dollar? The reason is simple – Friday’s jobs report reveals that in November the US shed the lowest number of jobs it has lost in any month since the recession started 2 years ago. The marginal 11k loss caught most analysts by surprise, with even the most conservative data watchers having predicted a job loss of at least 100k. To compound matters, the number of jobs lost in October was revised downwards by a further 80K, thus the jobs report across the 2 months was far less negative than nearly everyone had anticipated.

So why is such positive news proving worrisome for US investors? Why is 'not so bad' news bad for stocks and commodities (Gold fell almost $50 an ounce last Friday). Surely in a year where there has been zero to cheer about down on Main Street some little bit of respite in the labor market would be taken positively by markets, markets that are meant to represent these same economic facts and prospects? The problem of course is that financial markets do not represent economic facts, not currently in any event. There is a massive disconnect between main street and Wall Street, something that has only widened dramatically this year, despite major assurances from Messrs Bernanke and Company following the financial market collapse last year. In just six 'primarily recessionary' months Ben Bernanke and his cohorts have managed to fuel an asset bubble in stocks and commodities which in normal boom times would take 8-10 years to build. By bending over backwards and sideways, and somersaulting over the Chinese and other US debt holders, Bernanke has pumped enough ‘money for nothing’ into the system to trigger a 60% plus rally in US stocks between March and November and to infuse sufficient panic about the US ‘well being’ that investors have flooded into all forms of anti-US wellbeing financial instruments like gold, oil, every other dollar denominated commodity known to mankind and every single currency that is not a US dollar or a US dollar proxy (such as the Yuan). The resultant depletion of the value of US denominated assets relative to other currencies is quite staggering in the context of it only taking 6 months to get there. Loose fiscal policy from the US Administration and almost limitless free money from the Fed has enabled unrepentant investment banks and other greed-driven financial institutions to say thanks by creating an enormous bubble in financial markets, the likes of which has never been seen before.


The much publicized recovery we hear about every day on CNBC and Bloomberg is another one of those recoveries that is unfortunately divorced from economic reality (we love Maria Bartiroma but pretty please they need to change those other records). Hedge fund managers are falling over themselves (many on the airwaves) to try and justify their reckless trades and investments and thus the lauding of them folk Bernanke and Gross, who always seem to serve the interests of financial markets in those high gloss towers over the economic coalface down on Main Street (well, at least Bill has a colourful reason, albeit a selfish one, but our Ben was supposed to have read the black and white pictures in those 1930s annuals). If Ben or anyone looks at the latest Commitment of Traders Report on gold, we find that there is currently almost $28 billion of speculative long positions on gold (all managed funds) against only $860 million of short positions. This means a staggering 97% of speculative trades are betting that gold is going to continue to rise in value against 3% that believe it will fall – it hit $1226 an ounce last week. Such biased positions are not sustainable in the long run. They never are. Gold is very close in bias terms to where oil was in July last year before it crashed. Other notable extremes exist for many other related instruments including silver, the Aussie dollar and the Swiss franc. Trichet used to warn of such investment extremes before but even he has gone to pasture on this one, although he is the most consistent vocal on the needs for a stronger dollar, whatever that means. Tim Geithner's vocal interventions for a stronger dollar are laughable efforts and usually tend to lead to the dollar being sold off more sharply. US policy on the dollar is kinder garden stuff and when we hear officials advocate a strong dollar it usually can be translated as meaning 'a weak dollar please, but not so weak today as it might be please - (tomorrow).'

In a market where we have instruments with anything from a 2:1 to a 30:1 bias against the US dollar, it does not require sound economic reasons for market players to buy the dollar to initiate market chaos and to force a meltdown of asset prices. It simply requires a reality check on the part of those over-zealous investors (currently the majority) and to see an inevitable move on their part to the exit stalls. When a huge Stadium becomes overcrowded panic can set in more readily and a stampede could ensue, without warning. Bernanke and the world’s governing body (Central Bankers) have once again failed to patrol this particular Stadium and their general ignorance to events and their total inability to learn any lesson from what happened just 12 months ago means that the next fatal episode will lie at the door of their layer of command. They are the upper hierarchy of the global banking system, and they will be responsible for the next bubble-bust and financial crash, soon to be visited upon us, barring a miracle. Let us just hope this particular goose does not turn out to be a Bernanke roast that ends up on our table this Christmas.

We may need Bill Gross to give up the day job and work them airwaves again to keep Ben's goose at bay (mind you, it must be tough to have to manage the world's largest bond fund during a time of great economic distress, yet have all the time in the world to talk on TV). Way to go, Bill.

Bob B - Dec 7, 2009

Has the RBA lost the plot?

The Reserve Bank of Australia's decision to raise interest rates earlier this month led to a massive 8% rally in the Australian dollar against the US dollar over the past two weeks. The Australian dollar has now rallied over 50% since early March, a rally so sharp that it raises very serious questions about the currency's credibility as a reliable asset form. The currency has now seen a combined 100% swing in its valuation (50% each way) against the US dollar over the last 15 months. The Australian economy has weathered the recent recession better than all developed economies, experiencing only a temporary negative dip in GDP. How then does this explain the massive volatility in the country's currency? One thing is does demonstrate to us is that the value of the Australian dollar has very little or nothing to do with the actual performance of the Australian economy and its trade volumes, but more to do with the speculative greed driven by the 'money for nothing' monetary policy of the US Federal Reserve (and the Bank of Japan before it). The loose monetary policy of the US is seeing speculators (many of them major US investment banks) use the dollar as a funding currency to essentially sell the dollar in favour of any liquid asset that is not the US dollar. So while hundreds of thousands of American citizens find themselves being made redundant every month, hundreds of billions of the free money being given to US banks by the Fed, supposedly to stimulate the US economy, is instead being used to speculate against the US dollar and in effect bet against a credible recovery in the US, thereby triggering a rather rapid acceleration in the depletion of the wealth of the US population. The ridiculous price surges being witnessed in commodities and many currencies has absolutely zero to do with the economic principles of demand and supply and everything to do with highly leveraged risk and the unchecked and unregulated transactions of large hedge funds and investment banks.

Many Central Banks continue to misread financial markets, primarily because they have not got a clue how they are operated, let alone regulated. The Reserve Bank of Australia takes the biscuit in terms of universal ignorance and shocking misjudgment. We should not be too surprised though as the RBA is the only central bank in the developed world in recent years that intervened to try to prop up its currency at a time when it was grossly overvalued. That episode might go some way to explaining why Governor Stevens chose to hike interest rates at a time when deflation is more of a concern across the globe than inflation. The RBA have a strong Aussie dollar policy and they are prepared to risk the long-run sustainability of the Australian economy in exchange for attracting short-term funds. The US economy has suffered hugely over the past 2 years of recession and the Fed's ongoing accommodative policy of low interest rates is reflective of an economy in protracted turmoil. The most recent current account report out of the US shows the US current account deficit running at 3% of GDP over the past 12 months. The corresponding report for Australia, where the RBA has just risen interest rates, shows a deficit of 3.9%. The disconnects between the Australian dollar, interest rate policy and harsh economic reality are stark and the RBA's continual misreading of the economic world portrays Governor Stevens as a type of Alice in Wonderland type character.

Let's hope his fable does not have a sorry ending, for the citizens of Oz and all its companies that need to export to the outside world.

Bob - Oct 20

The Elastic Band that is the Dollar

The dollar has fallen dramatically in recent months and it took a leg lower in the past week when increased liquidity after the summer holidays saw investors put their money into higher yielding currencies and metals. Despite the usual garb being published daily about the 'dollar being finished' and US debt spiraling out of control, there are some dangerous extremes developing in financial markets again and all the evidence points to financial markets once more being divorced from economic reality. A sharp reversal is inevitable, with the strength and severity of the reversal likely to be determined by the length of time it takes for markets to meaningfully 'correct' or pull back from these extreme levels. The longer it takes, then the more taut the elastic becomes and the more severe the reversal.

Let us look at the key events that lead me to this conclusion.

1) Gold prices.
Gold has risen sharply in the past 2 weeks, to over $1,000 an ounce for the first time since early 2008. Closer examination shows that this increase is not owing to any physical demand for the commodity but by speculative demand from money managers. Open interest hedge fund positions in gold at present, sees over 98% of hedge fund monies being net long on gold. This is an extraordinary extreme no matter how one looks at it and history tells us biased positions do not last forever and the greater the bias the greater the potential for a fall or collapse. Astute money managers should right now be reducing their exposure to gold for this reason, if for nothing else. Gold has the potential to retreat back to $800 or even less within no time, if some event triggers a sale. Central banks could deliberately bring about this collapse in the gold price, if they chose to do so, and there are several reasons why it might be in their economic interests to do so. Gold is traditionally used as a hedge against inflation but currently the globe has a deflationary problem and present and future US market rates do not hint at any looming inflationary issue for the world's largest economy. Gold prices are completely out of sync with interest rate expectations, which indicates gold prices are greatly inflated at current levels. Be warned!

2) Commodity Currencies.
The economic exaggeration currently reflected in equity prices is also evident in the price of commodity currencies. The Australian and New Zealand dollars are up over 40% against their US counterpart since March. The Canadian dollar is up over 20%. The global recovery story is only in its infancy and currency moves of the order of 40% are nonsensical, particularly for the Aussie and New Zealand dollars which represent economies with pretty dire current account deficits. This currency appreciation is based entirely on market speculation. 90% of non-commercial open interest in the Aussie dollar on September 1st was made up of speculative long positions. This represents an unsustainable extreme. It also demonstrates that Central banks have yet to grasp how speculative financial markets are free to derail competitive currency exchange. Central Banks have learned nothing from the recent market collapse and they continue to watch in silence as leveraged speculation in currencies leadings to a pronounced instability in exchange rate markets. The Australian and New Zealand dollars are due for sizeable corrections sooner or later, with both currencies currently punching well above their real exchange rate values.

3) Japanese Yen
What has been striking about the past 2 months in particular has been the replacement of the Japanese yen as the world's favourite funding currency (i.e. by speculative risk merchants) by the US dollar. What this means is that carry trades (speculative bets on higher yielding currencies) are now carried out using the US dollar (the dollar has a paltry 0-0.25% yield rate). 3 month libor rates currently have the dollar cheaper than the yen as a funding currency for the first time in many years. Carry trades, while attractive in some ways, are also very destructive to international trade competition as a large volume of speculative bets involving the same funding currency has the effect of depreciating the value of that funding currency, sometimes quite considerably. We also know that market scares lead to unwinding events that can result in a very sharp appreciation in the funding currency. We have seen this over many years with the yen and for now the dollar is the favoured vehicle for carry trades. At present almost 80% of open interest in the Japanese yen is net long, a quite remarkable position given we have had almost 6 months of unbroken growth in stock markets and sustained investment in riskier assets. It is safe to assume that the the bulk of the biased positioning in the yen right now is against the US dollar and any eventual return to impartial positioning, will result in a sharp reversal and a significant rise in USD/JPY. It is almost certain that interest rates will rise in the US before Japan and will rise much more quickly, something that will spark major capital flows from yen to dollars. The market will figure this one out eventuality, sooner rather than later, so look out for a sharp rise in USD/JPY before the end of this year.

PPP
What most speculative traders and daily analysts tend to ignore is purchasing power parity. It is almost incredulous that over a period of a few months an Australian can buy 40% more with their money than a US citizen can in US dollar terms. The prior Aussie rally to over 95 US cents can be discounted as that was driven exclusively by an asset bubble that burst last year. The differential standard of living in both the Australian and US jurisdictions has hardly changed in the past 6 months, yet the exchange rate markets that Central Banks have criminally refused to regulate now sees Australian citizens being able to buy 40% more than US citizens thanks to the unchecked greed of hedge fund managers. Of course we know that this is a false exchange rate, but at the same time it presents a fantastic opportunity for Australians to buy up US dollar denominated assets at a huge discount. Much the same can be said for Japanese and European (non-UK) investors. Because of the weak dollar exchange rate, it is an excellent time for Asian Banks to buy US Treasurys. European bonds are grossly over-priced for the Japanese and Chinese because of an inflated euro (which is over 20-25% overvalued) and the safer option in the longer run is to stick to buying US bills (forget what the doomsday merchants claim for the US, because we have learned in the past 2 years that the US is where it matters and that any negative contagion from there is global). Capital flows will eventually flow back into the US because of the gross imbalance in PPP and it will happen in a very significant way, once evidence of sustained economic recovery in the US is firmly established. The euro is currently benefiting in an environment that sees zero to minimal capital investment in the non-speculative 'real' economy,' but it will find itself out of favour when capital flows begin to pick up in earnest, quite simply because it is way too expensive to invest in the Eurozone. Even in good times, Eurozone economic growth is always a laggard behind the US and Asia.

Bob B - Sep 15, 2009