Crises Take Longer Coming Than You Think, and Happen Much Faster Than You Thought

Thu, Jul 17, 2014 - 2:39pm

Kenya has become the most recent poster child for the massive hunt for yield.

In his recent interview with with Financial Sense Newshour (click here for audio), EconoMonitor's Satyajit Das tells the story:

"[T]he Kenyan bond...was $2 billion, for 2 years, and had a coupon of 6.875%, which is obviously very attractive. And the funniest thing was the road show. The President of Kenya couldn't go because he has warrants for his arrest for crimes against humanity and couldn't go to Europe because he'd get arrested. The central bank governor couldn't go because he is fighting charges of graft and corruption. The only person who could go was the finance minister but halfway through the roadshow he had to go back to announce that the budget deficit had blown out to $4 billion, and also to basically manage a crisis because the Al-Shabab militants based across the border in Somalia had attacked some coastal villages killing about 50 people for watching the soccer World Cup and tourism had collapsed. But the most amazing thing about that whole episode is that the investors did not bat an eyelid and the issue was massively oversubscribed."

Like many of our guests, Das believes this is just another example of how distorted the risk-reward relationship has become in certain areas of the globe as central banks around the world pump liquidity into the financial system and simultaneously keep rates at very low levels.

Many have cited the Bank of Japan's multi-decade attempt to fight deflation in response to the bursting of their own massive stock bubble as an example that is now being followed.

If that's the case, Das points out, this game of low rates and ever-expanding central bank balance sheets can go on for much longer than you think. Here he says:

"We all know this game will end and we all know that we are going to have to pay for it. But the crucial thing is this game is going to continue for a very very long period of time because the fire power they [central banks] have is just astonishing. To give you one measure, the Japanese central bank's balance sheet is almost 50% the size of the Japanese economy. Now if you look at the European Central Bank or the Fed, they are nowhere near that. They are less than half that. So the game can go on a long long time. But the problem with the game is, this is a game of confidence. All investors are looking at each other and they all know when the music stops they have to be sitting down. The problem is that they don't know when the music stops and the problem is not whether the music stops or doesn't, it's when the first person makes a run for their seat that the whole thing will start. And that is almost impossible to time. Rudiger Dornbusch who's a professor at MIT once said crises always take longer to arrive than you think and then happen much quicker than they ought to."

Although investing in Kenyan bonds may not be the wisest option, as many know, betting on a crisis doesn't always work out either. As Keynes himself once famously stated, "Markets can remain irrational longer than you can remain solvent."

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