The Love Trapezoid

The Love Trapezoid
David R. Kotok
January 10, 2012

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If you can take your eyes off the primary election coverage, watch Geithner. The US is engaged in a love trapezoid. The four corners are Beijing, Teheran, Tokyo, and Washington. Treasury Secretary Geithner is the Obama Administration’s front person. Track the news for the names of the other agents.

This is a very serious time. The pieces are linked. Some bullets as you watch the news flow.

1. The US faces the pressure of follow-through on Iran sanctions. Iran is an exporter of oil to Asia. Japan is dependent on imported oil. China is not self-sufficient. One part of this trapezoidal geometry is about oil.

2. Iran is feeling the heat from sanctions. The US wants to tighten them. It cannot do so without help from Asian “friends.”

3. China and Japan are each buyers of US Treasury securities. They each help finance the American fiscal deficit and the ongoing current-account deficits. They each want to diversify their reserves. They are not sellers, but they are reluctant additional buyers. This is truer for China than for Japan, but it is true in both cases.

4. China is glacially proceeding toward world reserve-currency status. It gradually allows its currency to strengthen against the dollar. It follows a policy that is fully rational for the Beijing oligarchs. It shrugs off political threats from Washington politicians (Schumer, Graham) who love to bash China while talking to their American constituents. China understands our political processes and our weaknesses. However, China also understands “realpolitik” and uses it. They learned US use of realpolitik from Nixon and Kissinger. Expect them to smile publicly but put some very intense private heat on Geithner.

5. Japan faces enormous economic pressure and sees the yen strength as now threatening. In order to weaken the yen, it must acquire other currency holdings in large quantity. (See the Cumberland website, www.cumber.com, for G4 central bank charts, and flip to those on the Bank of Japan. You will be able to observe how Japan expanded its balance sheet several years ago and subsequently contracted it. We expect them to expand it in 2012 as they seek to arrest yen strength.)

6. Japan is negotiating with China so that it may acquire reserve debt instruments denominated in Chinese currency. Beijing likes this because it is a step toward achieving world reserve-currency status. Geithner now worries, because the trend points toward a gradual and long-term weakening of the US position, as the world’s second (China) and third (Japan) largest economies maneuver their global positions.

7. Our Asian friends know that the US election cycle creates maximum vulnerability for the United States. That also makes circumstances more dangerous and raises risk profiles. Europe is of no help to us, given its internal crises.

We recall that a three-legged stool is a stable form. A four-legged stool is less stable. A four-legged stool with a trapezoidal top is least stable. Especially when one of the legs is Iran.

Watch Geithner in Asia and the news flow. Read between the lines, since the public statements will all be scripted and self-serving. Risk is high. Also, stay overweight energy. We are.

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David R. Kotok, Chairman and Chief Investment Officer