Managing Managing Money Money Sensibly Sensibly 5 June 2006 WHY THE US CURRENT ACCOUNT COULD BEGIN TO COUNT! ! Adrian Clayton " Nothing bores me more than the monotony of an asset manager or, even worse, an economist beating the same old weathered drum! The strategy is of course simple but insidiously evil, by sticking to a uniform message, they will inevitably be proven right after the passage of enough time and then promptly hail themselves as the hero. Today I will also be beating an old drum, but, fortunately, it is a fresh topic for me and hopefully the content will deviate ever so slightly from the painfully uniform stuff we all read so often. The US current account is expanding like a bloated, pregnant heifer. Having reached $668.1bn by the end of 2004 and accounting for 5.7% of US gross domestic product, the debt surged ahead again in 2005 to a whopping 6.4% of GDP ($804.9bn). Such a debt, which is largely a function of imports exceeding exports, requires financing to the tune of $2.21bn per day and investors into the US, mainly via their bond market, have funded the debt. Put differently, foreigners have played the banker to the US consumer. It is interesting how large the foreign ownership of US Federal Debt is. According to IRS data sourced by ABC News, it has reached a level of 53%. Compared to foreign ownership of US corporate assets, estimated to be only 1%, the debt ownership issue is meaningful. Low corporate ownership is, however, not hugely surprising as it is well known that the Yanks are cautious about foreigners owning strategic assets. This was clearly illustrated with Dubai Ports World’s attempted take-over of six US ports earlier this year and the highly contentious and blocked acquisition by the China state owned enterprise, CNOOC, of Unocal Corp. Anyway, returning to my central theme about the deficit and why it is now becoming so important. For ages the asset management industry has been singing the praises of an emerging Asia, particularly SE Asia and the powerhouse China. Not so coincidentally, Japan has risen from an extended slumber and economic growth is finally beginning to demonstrate a more sustained trend. Simultaneously, the financial industry mutters perpetually about a savings glut in Asia and the wave of capital that is flowing across the bows of the G7 nations and funding the abovementioned deficits. So Asia has, together with the likes of Germany, been funding the spending habits of the Americans. However, are we potentially at the beginning of a tidal shift in global capital flows and what are the potential implications thereof? Managing Money Sensibly 5 June 2006 This question is well worth asking as Asian countries are beginning to ‘create’ their own consumer. Until recently their major role in the global economy has been to replicate goods at dirt cheap rates and export these to the West. Cash receipts from this enterprising business model would then flow back to the west to keep the consumer fire burning – they would thus be fulfilling the role of cheap manufacturer and supplier of product and then funder of expenditure. This was doable because home consumption has been infantile and factory capacity was huge. What is changing of course is that the Asian consumer is beginning to make his presence known and internal consumption is showing traction. Whilst I am not implying that this will have an overnight affect on the world, it is worth noting that it could have some material long-term implications as it effectively could remove liquidity from the global macroeconomic backdrop and the ‘glut of savings’ could dissipate. This would have serious implications for the US dollar but also US consumption. Of even more importance is that such a scenario would have a global contagious affect on interest rate positions and bond curves – these would need to head higher. Naturally global property markets and equity prices would be affected too and emerging markets would experience a severe lashing. The emerging world would be dented as these markets have enjoyed huge capital flows in the past three years and have also bit awash with hot money. This subtle shift is worth noting as it is currently being accompanied by interest rates moving higher on a global scale. There could thus be two vectors driving a reduction in money supply globally. Whilst I am in no way attempting to prognosticate an Armageddon scenario, it is worth taking note of changing drivers, particularly when these were the very same factors which created the goldilocks investment landscape of the past twenty years. Enjoy your week. Alphen Asset Management ADRIAN CLAYTON NEELS VAN SCHAIK SHAUN LE ROUX MARK SEYMOUR THEO VAN DER LINGEN MARK CLIFF If you have any queries regarding the above commentary please contact Mark Cliff on 021 799 8069 or 083 700 3600 or firstname.lastname@example.org PLEASE NOTE: While every effort has been made to ensure that the information contained herein is correct, Alphen Asset Management cannot be held responsible for any errors that may occur. The views of the contributors may not necessarily reflect the house view of Alphen Asset Management. Views and opinions expressed herein may change with market conditions and should not be used in isolation.