Gekko

National Review, Dec 31, 1997 by John Dizard

The Clinton Presidential Library will be the first of its kind with an adult books and films section.

A friend and reader called the other day from Alabama to ask what she should do with a large sum of cash that had just come her way --large, that is, in relation to her respectable but modest means. Once she mentioned "cash" and "money-market fund," a little shiver went through me. A lot of people will wish they had more of both in six months' or a year's time. Keep it there, at least for now, I counseled. For myself and my friends in the professional community, there are a lot of opportunities thrown up by the Asian events. But if you're not able or inclined to go short on one side of an investment position, just stay liquid for the moment. Opportunity costs from missed bull runs will be much less depressing than cash losses from the corrections coming our way.

And one of those corrections, I believe, is going to be in the bond market, including the Treasury-bond market. You have no doubt read a lot in, say, USA Today, or heard a lot on CNBC, about how we're going to a 1 per cent inflation rate and how that must translate into higher bond prices.

Or maybe not. Remember who the customers for the T-bonds have been -- leveraged traders and foreign buyers. Both groups have pressures on them that we tend to disregard. The leveraged buyers -- that is to say the hedge-fund people and securities dealers -- have bought bonds on credit. When short-term rates are at best 10 or 20 basis points less than the rates on the longer-term bonds they are holding, they have very little cushion against which to work. That makes them jumpier than a White House lawyer trying to kick Prozac. They can't make enough on their "carry," or interest margin, to offset any capital losses.

The other set of buyers, across one body of water or another, are conscious (as you are not) of the currency risk of holding Treasury bonds. Your broker (sorry -- "financial consultant") may talk about Treasuries' being "risk free," but the crib sheet he's reading from doesn't apply to Mrs. Watanabe or her broker. They're spooked by bear-market rallies in the yen. And if they are financial institutions in some countries across the Pacific, they're likely to bring at least some assets back home to pay some past-due bills before the power gets shut off.

Foreigners have been doing us a favor in recent years. Collectively, Americans have been selling their bonds to the Mrs. Watanabes of the world and putting the cash into our stock market. The narrowly defined government deficit may be going down, but at the same time we need more cash going in to our markets to sustain them. So our dependence on foreigners' willingness to buy our paper is great --and the withdrawal symptoms when they have to cash out will give us a sense of what recovering crack addicts go through.

I see that the Korean elite read the last Gekko, slapped its collective forehead, and followed at least some of my advice. They're going to sell off some of the insolvent Korean banks to foreign commercial banks which can spend their vacations translating their credit handbooks into Korean. Even so -- and with the IMF in the picture -- the smart money says the Koreans' mountain of short-term loans will have to be partly rescheduled into longer-term paper and partly defaulted on. That's life.

The Korean people, who are pretty Spartan by nature, think that their problems are due to a crooked elite who borrowed a bunch of dollars and spent them on champagne, Mercedeses, cocaine, and hookers. No, folks, that's the Russian elite. The Korean elite (which does have its ethical challenges) went out and spent the money building semiconductor plants and auto factories on the theory that the products could just be shoved down foreigners' throats. To finance this capital-spending orgy, they put it all on the international-finance equivalent of their Visa cards. They were wrong, but they're not decadent.

Companies such as Samsung, which decided to bull its way into the semiconductor market, have a problem now that they can't buy new equipment. Micron Technologies of Boise can probably cut unit costs faster -- thanks to technological improvements it can still afford -- than Samsung can benefit from devaluation.

As a group the Koreans lack the charm of Parisian boulevardiers and subtlety in their investment judgment. But they don't lack brains, determination, or courage. Of all the Asian countries, they're in the worst shape and are the most likely to make a big comeback.

By the way, I took some heat at the beginning of the year when I suggested it was time to sell short the Canadian ten-year government bond against the equivalent U.S. Treasury. At the time that appeared in Gekko, the Canadian bond was about 200 basis points more expensive than the ten-year. At this writing it's around 8 bp more expensive. I thought it would cross over to a positive spread by the end of the year, but that's close enough for government work. As the Canadian dollar sinks, if we don't get to a positive spread by the end of the year, we will in the first quarter of next year.