Force Six Gale Warning from the Financial Markets

By Nicholas Asheshov

A Force Six gale is, according to the Admiralty definition, when “the wind will blow umbrellas inside out.”

In Europe, Japan and the United States the shares and bonds  of many of the world’s best-known banks have crashed.  Some, like Deutschebank and Credit Suisse, have had huge losses.  The sanctity of European bank bonds is being questioned along with the European and world economy, even the future of the EU itself.    Scores of banks in the United States and Japan,  including great names like Goldman Sachs, JP Morgan, Mitsui and HSBC, have had weak profits.  Italian banks are having to be rescued  yet again.   Portugal’s venerable Espirito Santo is bankrupt, its bondholders palmed off with dud never-never notes.   Bond and stock markets, partly controlled by computer algorithms, in Tokio, New York, London, Paris and Frankfurt are  roller coasters bordering on 2008-style panic.

The confusion is understandable.  Interest rates may be going up this side of the Equator, including Peru, but in the rest of the world they are going down.   Worse, they are not just getting lower but have  turned negative.

No one knows what this means.  But everyone, starting with Wall St., London, Frankfurt and Tokio, knows it means trouble.  Mario Draghi, the  fine Italian chairman of the ECB, admitted this week that the markets are clearly “concerned” about the “slowing prospects” for the world economy.

In  Japan, Germany, Switzerland, Sweden,  clients today  pay their banks to hold their deposits.  Investors are having to pay an extra point to buy bonds.  This means they are paying to lose money.  They seek safety and expect  deflation in the coming years, which means their bonds will increase in value.

It is not much different in the United States, Canada and Australia.   You lend someone money and it is you, not them paying the interest. Yes, that’s it. Not even  economists, who will believe anything,  can explain what this mirror world might mean.  What we can grasp  is  that it means trouble.

It is part of a world where oil, at $30, heading for $20/bbl,  is  being produced in maniacal surplus at  huge losses.  Steel and aluminum, two other industrial basics, are the same.  Forty of the world’s 46 aluminum plants are in China. The disproportion is the same in steel.

The world shipping industry, a barometer,  is in a state of virtual collapse.  This does not mean the world economy has stopped. There are still plenty of loaded ships criss-crossing the oceans, including in and out of Callao.  But shipping companies, not just the Chinese, have been building many too many new ships.   The Maersk Line, of Copenhagen, the world’s greatest,  has 27 huge container carriers coming into service, each one longer than the height of the Empire State Building.

The key part of this is too much money.  This tsunami of computer cash, produced by the world’s central banks, including  in Lima, is what  has produced too many oil wells,  too many mines, too many factories.  Even more difficult to grasp is  there is too much food in an often-hungry world. The prices of wheat, soya, rice, maize are down.  In the same vein the new money has not produced enough new jobs.

A banker friend in the City looks at the banking meltdown in Europe and recalls the Carthaginian general defeated by Rome looking at his devastated country, saying according to Tacitus, ‘They have created a desert and call it peace.’   OTT perhaps, but what else can negative rates mean?   Peru, in this, is in the same boat as much of Europe.

The trilliions of new dollars, yen and euros have produced, most damaging, trillions in debts, many of which cannot and will not be paid.  This is the kernel, the sand in the oil of today’s distressed financial markets.  The true value of assets, from London houses to bank bonds, factories, mines and agricultural land moves in a shadowy world where no one knows  the value any more, even of currencies.

It is the same in Peru.  The Central Bank and the financial system has, like Mexico, Brazil, Colombia and Chile, large reserves.  But it also has billions in  big debts.  In an economy shuffling along at one or two percent, not including mining, the thousands of millions borrowed by Peruvian companies will not be easy to repay.  In practical terms, this means Peruvian voters will have to choose between going kaput! like Brazil, or electing over the coming few months an experienced new government.

Lima’s four big banks have declared record profits.  It is  not just private universities that prosper  in the otherwise sclerotic economy.

The Banco de Credito’s profits for 2015 soared by 45%.  It is unlikely that many or any of the bank’s clients did as well.  The other banks were less impressive.

The Continental, run by its managing partner BBVA, Madrid, increased a couple of  points only.  More of a worry, nine out of every 10 soles in the Continental’s  profits came  from dollar exchange: the Continental is today  a big money exchange.  Scotiabank and Interbank also had substantial profits.  For Interbank, more than half of these came from buying and selling dollars.  Like the Continental, it has become, for the shareholders,  a money exchange house.  For the banking system as a whole, fully two out of every five soles in profit came from charging its clients for changing dollars.  This is not a good sign.

Europe Banking WhoopsEver since the 2008 collapse of the US and European financial systems, it has been the central banks that have kept the world economy going.  Today’s financial roulette means that this will not continue.  All over the world, with the possible exception of China, governments, not the central banks,  have done nothing to repair the damage.  This applies, absolutely, to Peru as well.  The United States government —like most of Europe, Russia Canada and Japan— has been the problem, not the solution.  With an inoperative government and tax system, the world’s biggest economy has a poor transport and public services system and non-functional health and education.  If this sounds familiar, it is  what the newspapers, economists and many politicians have been saying in Lima for years.  The lack of infrastructure investment in the name  of  austerity, as in England, or because of political inefficiency, as in the United States and Peru, is one big reason, the IMF itself says, for anaemic economic activity, despite the quantitave easing.

What the Lima banks and the slow economy are saying is that Peru no longer has spare reserves to spend on keeping the US dollar and other imports cheap.  It seems as though the Central Bank, which has spent an impressive $25 bn of the country’s reserves trying to stop a devaluation, is beginning to look at what is happening elsewhere in the world instead of keeping the Sol massively overvalued.  A director of one of the commercial banks says, “They miscalculated.  They thought the drop in copper was just tempporary.”  Big mistake.

The BCR may perhaps  be throwing  in the towel.  It has in the past few weeks been speeding up its Sol devaluation.  At the present rate the US dollar would be costing S/.4.20 by next Christmas.  This is getting towards what it would cost today if there was a free exchange market.


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