International | Nov 24 2011
GaveKal offered the following observations this week: European banks are essentially the world's most global banks-providing, for example, more US$ loans to the rest of the world than US banks do. Indeed, the EMU played a lead role in the growth in the global funding market from 2000-2007-when?total global cross-border claims on average grew by +5% of global GDP every six months, rising as high as US$22.5 trillion before the bust in 2008.
Of course, now that European banks are aggressively deleveraging as the EMU crisis deepens, one question is: which global markets will experience the largest "sucking sound" as loans are pulled. Given the recent underperformance of Asia, it seems investors are worried about the region's dependence of foreign liquidity. And Europe's banks play a lead role in Asia's external funding market: some 21% of foreign claims on Asia ex-Japan are from European banks (excluding UK banks), compared to 16% from US banks. While there is no real risk of a widespread balance of payment risk in Asia (the balance sheets here are very healthy and the Fed Swap lines should also ease any short-term pressures), a contraction in European funding will at minimum raise the cost of capital in the region, and at worst lead to a painful reenactment of the 2008 "Dollar Squeeze." One simplistic way to identify early signs of stress is to look at the foreign reserve positions of Asian central banks. If we start to see a drain of FX reserves, then that implies a dearth of US$ and a potential liquidity squeeze. So how are we doing?
* The newly industrializing nations: The East Asian NIEs saw drains on their reserves in September. Taiwan's reserves have basically been flat since April, and saw an -US$11bn reduction in September. Singapore's were flat in the July to August then fell by -US$15bn. Korea's reserves fell by -$8.8bn in September after a period of flatness….. However, all three of these countries saw an increase in FX reserves in October, when investors inflows were accelerating. Their total reserve levels are very close to their historical peaks.
* The new rising Tigers: The more worrisome drops in reserves have come in Malaysia, Indonesia and Thailand-Indonesia's reserves dropped by -8.1% in September and failed to rebuild in October. This is not a good trend.
* China and India: China, meanwhile, saw a -US$60bn decline in reserves in September. That may sound like a lot but it just 1.8% of the total $3.2 trillion in reserves. Still, the pace of growth in China reserves has been slowing. India, meanwhile, has failed to take a hit on its reserves, despite a sharp sell-off in the Rupee.
So looking solely at reserves, there is a bit of a deterioration but we are not yet seeing any major red flags. To a certain extent, this probably reflects the fact that global leverage in the system is lower than its was pre-GFC. For obvious reasons, global banks were relatively conservative in the immediate post-Lehman environment and this showed in the cross-border loan volume. However, in the past year, we have seen momentum gathering pace again, with cross-border claims rising by more than US$1.4trn in 1H11 after a US$1.3trn jump (equivalent to 5% of global GDP) in 2H10. And Asia is clearly one of the regions that have absorbed a good portion of the rebounding global funding market. Thus, if we are now moving to an environment where EMU bank deleveraging is accelerating (and we think we are), then it makes sense for Asian markets to suffer. At the very least, the cost of capital will likely be rising in Asia, even if regional central banks cut their policy rates: cheap foreign credit will simply be less available.
The above expressed views are GaveKal's, not FNArena's (see our disclaimer). All copyright GaveKal.
GaveKal is a financial services firm that offers institutional investors and high net worth individuals fund management, independent research on global macro-economic trends and events, and independent advisory work on China and its impact on the global economy.
For more information, visit www.gavekal.com
