China and other concepts.

Dear,
Last week I had a very interesting conversation with a good friend, investment bank analyst in Hong Kong.

We discussed about two press comments, apparently not related, but with interesting implications with each other.

Two weeks ago, former Treasury Secretary of the US, Henry Paulson, warned that U.S. Government Faces 'Debt Bomb' that could be far more painful than the financial crisis in 2008 and 2009, and even more difficult to contain. 
http://english.capital.gr/dj/news.asp?details=1710189

Last week, rating agency Standard & Poor's warned that China is at Highest Risk of Downturn on Overinvestment.
http://www.bloomberg.com/news/2013-01-31/china-at-highest-risk-of-downturn-on-overinvestment-s-p-says.html

Those two warnings are just the symptom of a serious illness of our economic model in the last decade; the world has grown with China producing low value products that US consumers paid with debt. 
http://www.usdebtclock.org/

For years the construction has worked very well and as a consequence we lived the amazing growth of the years previous to 2008 Financial Crisis, but now the US Debt bubble is close to burst.

What those two comments reflect is that US can simply not pay their huge debt and China (main holder of a very important part of the US debt) faces a huge production overcapacity (plus a real estate bubble, and lack of solvency in their financial system, amongst many other problems).

What’s the long term value of your investments in manufacturing capacity, which will not generate future cash-flows, because your clients simply don’t have the money to pay the merchandise you produce?

While markets are happy to accept that some way you will pay your debt, no problem.

But when trust disappears, interest rates rise and then, problem.

What we see above is a huge waste of Capital, that when it becomes visible will generate huge financial tensions, which as Mr. Paulson pointed out, will be much worse than the 2008 Financial Crisis.

In my opinion making visible this problem will drive a deep transformation of the Financial System, from a model based in volume to a model based in efficient Capital Management (including very detailed Capital Allocation).

In a world of much more limited growth, Capital becomes a very scarce resource and managing efficiently the main priority.

On the other hand, the capacity of the US for financing its debt is supported by the position of the US Dollar as global trade currency. But if we look at the consequences of the breakdown of the Bretton Woods agreements in the 1970s, maybe we’ll understand that this privilege of the US economy can eventually disappear.

But we’ll talk about it another day.

Looking forward to read your comments.

K. Regards.
Ferran.