Tavakoli Structured Finance LLC

The Financial Report

By Janet Tavakoli

China’s New Silk Road and USD Reserve Currency Status

In October of 2013, with China poised to overtake the U.S. as the largest economy in the word, Ai Boajun, vice mayor of Shanghai and member of the Standing Committee of the Communist Party of China Shanghai Committee, told the Chicago Council on Global Affairs he wants a stronger renminbi with free convertibility and cross border trading in local currency.

The reserve currency status of the dollar weakens when international trade in alternate currencies eliminates the dollar as the middleman. Moreover, foreign ownership of U.S. debt is a clear and present danger.

China has two small operations in London and Frankfurt to process trading cash flows directly between euros and yuan. But that may grow. China is building a New Silk Road, a rail line from Zhengzhou via Kazakhstan, Russia, Belarus, and Poland to Hamburg. The 18-day trip cuts in half the time it takes to transport goods by ship. China exported consumer goods in exchange for high tech goods from Germany amounting to over $189 billion of bilateral trade in 2012.

Last month Russia announced it would trade hydrocarbons in rubles and the local currencies of its trading partners including China and Europe. In September 2005, Putin and then German Chancellor Gerhard Schröder signed an agreement to build a $4.7 billion pipeline to connect Vyborg, Russia and Greifswald, Germany. Schröder left office in November 2005, and within three weeks announced he was joining the board of Nord Stream AG, the pipeline joint venture majority owned by Gazprom. In 2006, Rothschild Group hired Schröder as an international business advisor.

Can we ask for China’s cooperation to preserve the reserve currency status of the dollar? In 2009, President Obama chided China for its fiscal policy. But Chinese national interest was the driving force, not pronouncements from Washington. Here are some possible reasons why. The following section is my commentary published in the FT in 2009:

The China syndrome: it’s our fault they don’t trust us

The Financial Times – February 5, 2009
By Janet Tavakoli

When Washington passed out hundreds of billions in bail-out funds in September 2008, it said it could worry about the cause of the meltdown later. This allowed lack of trust in the US financial system to fester.

More recently, the Obama administration turned up the rhetoric against China, saying it believed the country was “manipulating” its currency. The president also wants to see a Chinese stimulus package.

The US needs China to hold the US Treasury and agency debt it owns and to keep buying new US debt. So if Washington wants to ease tensions and keep its borrowing options open, it should look to Wall Street.

Did Washington think it could allow US investment banks to carpet bomb Asia with financial mini-bombs and escape the fallout?

In Hong Kong alone, $2bn of Lehman’s principal-destroying mini-bonds were sold. Most US investment banks joined in the insanity. Investors – including officers at nosebleed-high levels in Japan, Macao, Hong Kong, Singapore, and mainland China – have been burned as their triple-A investments were wiped out.

George Soros in his recent Financial Times article was correct that credit derivatives created issues, but he missed the most glaring problem.

US investment banks were not the victims of bear raids; they were fundamentally unsound. Investment banks and hedge funds turned financial risk into financial crack with leverage. The risky overrated debt had no upside and lots of downside. Leverage in the form of massive borrowing and credit derivatives made the fall swift, painful and often fatal for equity investors in investment banks and hedge funds.

Pundits trying to inflate their own bubbles of self-credit put the blame on unsound models. But such fools for randomness are a distraction from the key issue: malfeasance.

Financiers and structured finance professionals were aware of the negative potential of risky loans. Yet they took it even further. The risky tranches – those that any investment banker worth their salt knew were write-offs – were used to create other packages that their buddies “managed” in one fund, while shorting in their hedge funds.

The problem was not the models’ failure to capture probability outliers but the industry’s failure to rein in the liars.

Sophisticated investors with structured finance expertise (bond insurers, bank portfolios, large pension funds) became willing victims by failing to perform basic due diligence.

But there were genuine victims: naive homeowners who were misled into risky mortgage loans and retail investors who were missold risky mislabelled products.

The biggest victim has been the global financial system, and we are all suffering the effects of mischief that remains unchecked. There is no innocent explanation for many of the securitised bonds made and sold by investment banks. They were a conduit for shifting losses.

There were no black swans or swans of any colour involved. Like Black Bart, the 19th-century Californian stage coach robber, Wall Street bankers made off with the loot without firing a shot. They were enabled by Washington overseers and financial regulators who – when not beneficiaries of the good times – behaved like ostriches.

Meanwhile, news of the fact that no one in the US has been brought to justice has not escaped notice. It is possible that Chinese banks are being less co-operative with the US because Wall Street scammed them.

There is hope, but the only way out of this is a return to sound financial principles, which will include cleaning up our mess.

At the Davos conference, Jamie Dimon, JPMorgan chief executive, sounded like Warren Buffett or Charlie Munger (or Janet Tavakoli) when he remarked: “Some really stupid things were done by American banks and American investment banks. To policymakers, I say: Where were they?”

Dimon Mines Irony

In 2012 the financial community had reason to recall Dimon’s words during the 2012 London Whale debacle wherein more than $6 billion in credit derivatives losses wiped out years of gains in JPMorgan’s London-based chief investment office. Dimon denied JPMorgan withheld information from regulators.

But it seems the bank had inadequate risk controls and told the truth too slowly. The SEC said top managers failed to update the board’s audit committee about the gravity of the situation before filing the first quarter 2012 report; JPMorgan later restated first quarter 2012 earnings. The SEC fined JPMorgan $920 million, and JPMorgan Chase admitted it violated securities laws.   Investigations are ongoing.

A lot of bad actors from the financial crisis got away scot free, and the ongoing financial scandals are a symptom of our lax policies. The U.S. didn’t have the moral high ground when President Obama criticized China in 2009, and the U.S. doesn’t have the moral high ground now.

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