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Generational Dynamics Web Log for 19-May-05
South Korea signals that it might stop purchasing US Treasury bonds

Web Log - May, 2005

South Korea signals that it might stop purchasing US Treasury bonds

Meanwhile, Financial Times speculates about "a larger market meltdown."

In an interview with the Financial Times yesterday, Park Seung, the governor of the Bank of [South] Korea said, “I believe that we now have sufficient reserves to secure our sovereign credibility, so I do not anticipate increasing the amount of foreign reserves further."

This follows by one day the report that Norway is selling off half of its US Treasury Bond holdings.

By using the phrase "foreign reserves," Park did not mention the US Treasury bond specifically, but that is evidently what he meant, as South Korea has been one of the largest purchasers of these bonds in the past. He added, “We now need to take more consideration of profitability, and I think we're at a stage where we need to manage our reserves in a more useful way.”

When South Korea made a similar remark in February, it caused a sharp reaction in the bond market, as the price of 10-year Treasury bonds fell sharply.

However, yesterday's announcement produced no such result. In fact, bond prices actually rose yesterday.

Why is that? Because hedge fund investors have been moving away from risky corporate bonds to safer US Treasuries, ever since S&P changed its rating last week on GM and Ford, giving their debt "junk bond" status, as we discussed a week ago. Thus, hedge funds investors are taking the place of central banks in purchasing Treasury bonds, and keeping their prices up.

(Incidentally, when bond prices go up, the interest rates they pay go down. 10-year Treasury bonds closed yesterday at 4.098%, the lowest it's been in a while, which means that home mortgage rates will be down again.)

Things are changing rapidly on the world economic scene, as the use of hedge funds has been increasing exponentially in the last few months and the last year. These funds are largely unregulated, and permit highly leveraged investments with varying amounts of risk.

During the 1930s Great Depression, officials blamed the stock market crash on the common 1920s practice of purchasing stocks on "margin" or credit. So 1930s politicians passed regulations and created the Securities and Exchange Commission (SEC) and other agencies to guarantee that credit would be strictly regulated, and that no 1920s-type stock market bubble would every occur again.

Well the SEC and the FED obviously completely failed to prevent the 1990s stock market bubble, and they've also failed to regulate credit, given that America's level of public debt is the highest in history.

But now we see that hedge funds are the vehicle that have replaced "margin" sales as a form of unregulated credit purchases. The increasingly rapid rise in the use of these unregulated credit vehicles indicates that they're creating exactly the same kind of instability and risk that margin credit did in the 1920s.

I'm not the only one that this has occurred to. In a speech yesterday, Sir Andrew Large, the Deputy Governor of the Bank of England warned that the rapidly expanding market of credit derivatives is "tricky and opaque," and that they threaten the stability of financial markets.

“Credit risk transfer has introduced new holders of credit risk, such as hedge funds and insurance companies, at a time when market depth is untested,” he said. “The growth of derivative instruments ... (has) added to the risk of instability arising through leverage, volatility and opacity.” He called for increased regulation.

All of this extreme volatility is causing analysts more and more to consider the possibility of a complete market meltdown, according to an article in yesterday's Financial Times.

“Two weeks ago, we might have said that the chances of a market meltdown were 1 per cent, but now we might put it nearer 10 per cent,” said an analyst at a large American bank. “The issue is being talked about.”

The article lists two scenarios that might lead to such a meltdown:

Another corporate shock, like the one that hit GM and Ford last week, that might trigger broader investor panic about bonds.

Evidence that investors are pulling their money out of hedge funds.

“If we were to see significant hedge fund redemptions and further unwinding of credit exposure as a result, it would ... turn a weak market that is suffering from poor liquidity into a meltdown,” the article quotes a major investment banker as saying.

Meanwhile, investors are gorging themselves on stocks on a massive buying spree. The Wall Street stock markets rose by 1% yesterday, and at midday today (Thursday), Asian stock markets in Japan and South Korea are incredibly more than 2% higher.

Many people consider this to be good news, but unfortunately it's not. It doesn't mean that the stock market is going to continue to rise, any more than a November heat wave in New York City means that winter isn't coming. As we're predicted since 2002, the stock market is going to fall to the Dow 3000-4000 range with 100% certainty, and a stock market rise now simply means that the stock market has just that much farther to fall, whether the fall occurs next week, next month, or next year. (19-May-05) Permanent Link
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Generational Dynamics Web Log for 19-May-05 South Korea signals that it might stop purchasing US Treasury bonds

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Generational Dynamics Web Log for 19-May-05
South Korea signals that it might stop purchasing US Treasury bonds