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    Gavekal Research

    GaveKal Daily - Can Capitalism Work Without a Cost of Capital?

    It is obvious that central banks operate with four policy gauges:

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    GaveKal Daily - The "PIG" Test of the Euro Project

    The European debate continues to rage—including here at GaveKal. Readers of yesterday’s Five Corners page on the weekend’s European Council summit may have noticed that Anatole was unimpressed by the event, which he saw as stronger in rhetoric than action. “What the leaders did was deliver more speeches about their commitment to defend the European financial system,” he wrote. “They then agreed to meet again in another three months’ time to...

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    The Russian Hedge

    The recent events in Japan and the Middle East have considerably changed the situation on world energy markets—in particular for natural gas. First, a sharp decline in gas exports from North African countries needs to be compensated by deliveries of piped gas into Europe by other suppliers; second, the crisis in Japan has led China, Germany and others to re-examine their nuclear strategy, and consider other sources of energy—and here natural gas...

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    The Keynesian Divisor

    If government spending goes up, and if this increase is financed by debt, it is reasonable to believe, as Ricardo did (or Milton Friedman with his constant income hypothesis) that the existing growth rate is borrowed from the future. In other words, it is an illusory growth since government debt is nothing but a deferred tax .

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    Speeches Instead of Safety Nets

    After a tragic plane crash, all the leaders of the European Union are wafted up to Heaven and find themselves in a long queue, snaking off into the distance with no end in sight. After a few minutes, the presidents and prime ministers lose patience and start to grumble, shouting to an attendant angel: “Don’t you know who we are? We are the leadership of the European Union. We demand immediate entry to the VIP lounge.” The angel mumbles something...

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    Running with the Bulls in a World of Extreme Risk

    In the dozens of meetings we have had recently with clients in Europe and the US two messages have come through loud and clear. The first is that we at GaveKal are now worried about the short-term prospects for the world economy and financial markets. The second is that almost all the investors we meet have gone through the opposite transition. After asking repeatedly over the last two years: “is it time to sell this rally?”, we now find almost...

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    The Fragmentation of the PIGS

    One of the interesting similarities between the Eurozone crisis and the subprime crisis is how the contagion risks were initially downplayed. In 2007, Ben Bernanke tried to calm rising fears in the US housing market by estimating that subprime-related losses would hardly surpass a very manageable US$100 billion. Three years later, Jean-Claude Trichet argued that the Greek crisis was not a major issue for the Eurozone since Greece accounted for...

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    GaveKal Daily - Should Investors Buy on Dips?

    As investors think through the crucial question of whether to buy on dips amid the current turmoil, there are not too many comforts or certainties on which to cling. The price of oil is worryingly high and Middle East tensions remain heightened. And while most of the global media coverage from Japan has tended towards the hysteric, there is still a lack of clarity on the radiation threat in Japan and what a potential global “no-nuke” backlash...

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    GaveKal Daily - PIGS Do Well on a Risk-Off Day

    The future of Europe’s monetary union is one that the GaveKal team has debated vociferously (see EMU Debt Crisis, Part III), so it is no surprise that last weekend’s EMU deal was also received with various degrees of emotion. Indeed, our house views are in many ways a microcosm of the broader debate on the Euro. There are those who think this experiment will eventually fail, and good riddance when it does (Charles and Louis); those who think the...

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    Why Diverging EU-US Rates Policy is Dangerous

    There have been plenty of occasions in the past when US and European monetary policy has differed enormously without causing any trouble, so how could the small divergences of monetary policy described on the previous page have had such enormous financial impact? There seem to have been two broad reasons—US currency weakness and German inflation. As shown in the chart below, each of the financial shocks identified (yellow shading) coincided with...

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    Past Clashes in EU-US Monetary Policy

    As Shakespeare said, “when sorrows come, they come not single spies, but in battalions”. Just as the world economy has finally recovered from the 2008 disaster, financial markets are suddenly confronted with three potentially catastrophic and unpredictable risks. The two horrors understandably dominating the headlines are the earthquake in Japan and Libya’s descent into civil war. Both these events, in addition to their human toll, threaten...

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    GaveKal Daily - The Conflicting World of Central Banks

    “There is amongst central bankers a solid unity of purpose to continue to anchor solidly inflation expectations”, Mr. Trichet said yesterday while chairing the Global Economic Meeting in Basel, attended by representatives of most major central banks. But despite these grand proclamations about supposed central bank “unity in purpose”, not everyone is on the same page.

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    GaveKal Daily - Introducing our 2Q Quarterly Strategy Chart Book: A Structural Turning Point for Markets?

    We would first like to offer our readers an apology: it appears that not all clients received the email notification about the publishing of our most recent Quarterly Strategy Chart Book last Friday, due to technical problem with our server. For anyone who missed it, the 2Q Quarterly is available on our website here (at 74 pages, this is a pretty hefty edition so it may take a few minutes to download).

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    QSCB - 2Q11 - A Structural Turning Point for Markets?

    We would first like to offer our readers an apology: not only are we publishing our Quarterly Strategy Chart Book just 24 hours after the publication of our China Economic Quarterly (with can't miss articles on alternative energy, insurance, RMB deregulation, Mongolia, and the property slowdown), but this quarterly is long as well: a full 74 pages!

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    GaveKal Daily - That Didn't Take Long!

    Print Version:

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    A European Tour d’Horizon

    Print Version:

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    GaveKal Daily - Europe's Pass the Parcel Game

    The major trigger for last fall’s blow-out in European spreads was Germany’s rumblings about the need for ‘hair-cuts’ in some cases and Germany’s obvious discomfort at footing the bill to keep the Euro show on the road. In turn, this led to fears that the EMU crisis would spread from the smaller countries to Spain, widely seen as ‘too big to bail’. Still, after much hand-wringing and back-room deals, Germany’s apparent willingness to pay up to...

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    Why Ireland Can Drive a Hard Bargain with the EU

    Friday’s Irish election is the next big challenge for the Euro-zone’s financial stability. There has been very little market comment about the probability that Ireland’s new government will renegotiate the terms of the EU/IMF bailout, even though the Fine Gael-Labour Opposition, who are almost certain to form the next government, have promised to do just that. But if we look at what investors have been doing, as opposed to what they are saying,...

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    A New Mandate For OECD Central Banks?

    Perhaps the most lasting effect of the financial crisis may be on the reputations of central banks. After the resignations of Axel Weber from the ECB and Kevin Warsh from the Fed, came last week’s humiliating gyrations about interest rate policy by the BoE (see Mervyn King’s Capitulation)—which in turn were followed immediately by an attack on the Monetary Policy Committee by one of its own members and an almost unanimous outcry from the British...

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    GaveKal Daily - Global Rebalancing, Inflation and the Value of the RMB

    One crucial issue regarding the lasting power of the current economic recovery is whether growth is on a sustainable trajectory, or being gained through the same ‘old tricks’ that often prove illusory over time. In most of the previous recoveries in the past couple of decades, salvation came through an expansion in the US current account deficit—i.e., the US consumer leveraged up and went on a shopping spree. As we argued in our Quarterly...

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    GaveKal Daily - A New Horizon for Developed Market Tightening?

    We have seen how the world has reacted to increased tightening in the emerging markets—EM has underperformed the developed markets in the past few months. The next question is how will markets react to a faster pace of tightening in the developed markets, which increasingly appears to be on the agenda. Yesterday we had the Bank of England indicate that rate hikes are imminent (see Mervyn King’s Capitulation), and the Riksbank produced its fifth...

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    Mervin King's Capitulation

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    GaveKal Daily - The EMU's Ides of March?

    January saw decidedly improving investor sentiment in Europe, with narrowing PIIGS spreads and a strengthening Euro. However, over the past two weeks, this trend has stalled, with spreads now widening again and the Euro trading lower. This could be related to the impending deadline for the final stability plan. March looms, and in March the EU is expected to reveal details of its final back-stop—whether and when there will be any haircuts,...

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    GaveKal Daily - Shedding Some Light on Turkey's Unorthodox Monetary Policy

    Understanding the real intentions of monetary policymakers has become an even tougher task than usual in these post-crisis times. One example of this can be found in Turkey, where a number of recent monetary actions appear quite contradictory. Despite booming economic growth and worrying global inflationary pressures on food and energy, the Central Bank of the Republic of Turkey (CBRT) has cut its policy rates twice since December. At the same...

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    Gavekal Research

    GaveKal Daily - The Questions Central Bankers Have to Be Debating

    The surprise resignations of Axel Weber from the ECB and Kevin Warsh from the FOMC do leave the outside observer thinking that debates within the halls of these powerful institutions must be rather spirited. As they should following two years of unprecedented activism, even the most unbiased and dispassionate of observers (which we rarely claim to be!) are left with the following quandaries:

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    Gavekal Research

    Is a Greek Sovereign Default Unavoidable?

    As colorfully expressed last year in an essay by Michael Lewis (see Beware of Greeks Bearing Bonds), the idea that Greece can pull off an aggressive fiscal consolidation and economic reform often faces amused rebuttal. Based on the valuation of Greek bonds, the market currently believes that reversing the Greek debt trap will prove to be an impossible mission. Even the already substantial reforms on which Greece has embarked under the thumb of...

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    GaveKal Daily - Strong News and Stronger Markets

    With snow hitting the Super Bowl in Dallas, there is little doubt that we are in the midst of a severe winter. And of course, in winter, bears hibernate. Which is just as well, for bears have little to munch on right now: economic activity is bouncing back strongly, jobs are being created (albeit at a slow pace), global trade is soaring, the great majority of companies are reporting better than expected sales, and US profit margins are making...

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    The Franco-German Compromise

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    The ECB Hikes Rates Without Making Headlines

    Whether Fed and the ECB move together, or apart, matters greatly to forex rates. Bernanke and Trichet both responded to the global crisis by flooding their banking systems with excess reserves, thus driving overnight interbank rates down near their respective ‘floor rates,’ the rate paid by central banks for deposits of excess reserves. With the floor rate set at 0.25% in both systems, the short rate spread thus became negligible. However, one...

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    Gavekal Research

    A Dovish Fed, a Dovish ECB and a Dovish BoE

    Despite the demands for tighter monetary policy now emanating from an unholy alliance of the Chinese Politburo, the Tea Party, the Bundesbank and the Wall Street Journal, last week the Fed and the ECB made clear that early rate hikes are not on their agenda (though Will argues on page five that the ECB may be tighter than it appears). And the Bank of England is likely to send the same message after Thursday’s meeting of the MPC. So why are the...

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    Gavekal Research

    The Hi-Octane Promise of Russia's Market

    The quicker than expected revival of East European growth (see A Four-Pillar Strategy to Investing in Europe) is good news for European companies, who sell much more to emerging EMEA than to China or even to Asia as a whole. And within the emerging EMEA, Russia’s consumer market is the main draw. Even one of Russia’s most protected industries—automobiles—still offers massive potential:

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    GaveKal Daily - A Ricardian Debate on the Back of the UK's Poor GDP Numbers

    Of the many debates currently animating our internal meetings, the most passionate must be the one between Charles and Anatole on whether increases, or cutbacks, in government spending are harmful or helpful for economic recovery.

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    Gavekal Research

    The Rebound in European Velocity

    As the year begins, European financial markets have already rallied much more than most imagined possible. Interestingly, this is occurring while no new concrete decision has been taken by EU leaders on the crisis front. So is the rally a classic case of short covering?

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    Inflation is China’s Problem, Not the Fed’s

    If there is a contrary indicator even more reliable than a cover-story in The Economist or Time Magazine, it is the mood at the World Economic Forum, which begins this Wednesday in Davos. Last year the “spirit of Davos” was focused mainly on whether the global economic recovery would be sustainable, whether central banks and governments would tighten their monetary and fiscal policies prematurely, and whether the euro would be blown up by street...

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    The Asset Allocation Quandary of 2011

    For almost every pension fund, the single most important decision is the relative weighting of equities versus fixed income. The next challenge concerns rebalancing decisions: should one automatically rebalance to keep weights (say 50/50) on an even keel or should one tactically redeploy capital based on the freshest macro and investment environment?

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    Les Aristocrates a La Lanterne

    As the readers have probably realized by now, Marx has always been one of our heroes for a simple reason: there is no wrong idea about economic systems, political systems, human nature, or the future which he did not embrace with gusto. Finding someone else who has been so consistently wrong would be quite a challenge. But, like a broken clock, even Marx got to be right once when he wrote that “the economic infrastructure determines the...

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    GaveKal Daily - Europe's Improving Outlook

    As we explained in our latest ad hoc (see A Four-Pillar Strategy To Investing In Europe), 2010 was a paradoxical year for Europe. The region's economic recovery surprised most observers by its strength (especially in Germany), and the financial stabilization of Eastern Europe was confirmed in spite of apocalyptical predictions by many pundits (Krugman, Rogoff, etc.). But these two encouraging developments have been almost entirely eclipsed...

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    A Four-Pillar Strategy to Investing in Europe

    More than a year after investors had to come to terms with the fact that ‘Greece’ was not just the name of a musical with John Travolta, and after a significant redefinition of the Euro-area institutional framework, a large divergence of opinion still exists within the financial community on the level, and nature, of the remaining European risk. Even in our little firm, we find it hard to come to a consensus—not only on the near-term outlook,...

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    GaveKal Daily - Will the German Recovery Spill Over to the South?

    The best place to get into a bubble is at ground floor, and then leave on the 8th floor before it reaches the 10th. Of course identifying a bubble at incubation is very difficult because at this stage, it does not feel bubbly and wild, but rather sensible, sober and conservative. Which brings us to Germany….

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    The Coming German Housing Boom

    In the decade between the Asian Crisis and the US sub-prime bust, real estate in almost every Western country roared ahead. Every country except Germany where the residential real estate market scarcely budged.

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    GaveKal Daily - Still More Questions Than Answers in Europe

    One of the best TV shows ever produced has to be the British series "Yes Minister," where, in one episode, career bureaucrat Sir Humphrey tells Minister Jim Hacker that 'you can never be certain that something will happen until the government denies it'. With that in mind, Angela Merkel's promise yesterday that Germany will do 'whatever it takes' to save the Euro sounds somewhat hollow. For example, will...

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    Gilts vs OATS

    In the next few years the world will see a fascinating controlled experiment in economic policy. The US and Britain, two economies with very similar structural problems and cyclical positions have started to pursue diametrically opposite fiscal policies. Britain, from this month onwards, has begun the fastest and most ambitious fiscal consolidation ever attempted by a G7 country; meanwhile political gridlock in Washington has more or less...

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    An Easy Fed and a Strong Dollar

    Whatever central bankers may think about the rights and wrongs of Charles’s arguments about the natural rate of interest (and many official economists, especially in Europe and Japan, certainly share Charles’s concerns), the reality is that the Fed is not going to start raising interest rates in the first half of 2011. This can be almost guaranteed following last week’s disappointing non-farm payroll figures. Such is the political importance of...

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    Is EMU Rebalancing Possible?

    As 2010 unfolded, the viability of the European monetary union project became the main ‘x-factor’ for global financial markets. And as the new year starts, we see little reason why 2011 should prove any different. Indeed, the genie is now out of the bottle and the world realizes that the Euro is a political project with significant economic costs. Worse yet for European policymakers, these economic costs are now rapidly mutating into political...

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    GaveKal Daily - Is the Euro Low Enough to Save the PIGS?

    We have focused on strong US economic data this week, but of course the US is not the only large economy emitting signs of a solid recovery. German factory orders released yesterday remind us that Northern Europe is in solid shape, with the northern EMU members' trade competitiveness boosted by the Euro's weakening against most currencies. The Euro's real effective exchange rate-calculated by taking into account the weight of each...

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    GaveKal Daily - The Riksbank Pushes On Despite Trouble to the South

    This document is part of our old archive. It was published on 2010-12-16.You can download it here: GKDailyReport101216.pdf

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    More Europe or Less Europe?

    This document is part of our old archive. It was published on 2010-12-14.You can download it here: GKFiveCorners101214.pdf

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    The UK in 2011

    This document is part of our old archive. It was published on 2010-12-14.You can download it here: GKFiveCorners1012141.pdf

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    Latvia's Rerating--A Hope for the PIGS

    This document is part of our old archive. It was published on 2010-12-13.You can download it here: GKFiveCorners1012131.pdf

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    Gavekal Research

    GaveKal Daily - Tough Road Ahead for the UK

    This document is part of our old archive. It was published on 2010-12-10.You can download it here: GKDailyReport101210.pdf

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