1. Deflation inan age offiatcurrencyRussell Napier

2. Conclusions To reach record lows (1921, 1932, 1949, 1982) equities will have to more than 60%. Deflation produces record-low valuations but deflation remains unlikely. Central banks strain to produce inflation but developments in EM suggest a deflation shock now likely Capital exodus from China disrupts the creation of inflation In the search for yield cash is trash so time to own cash2008 CLSA Asia-Pacific Markets (CLSA).IMPORTANT: The content of this report is subject to CLSAs Legal and Regulatory Notices as set out at www.clsa.com/disclaimer.html, a hard copy of which maybe obtained on request from CLSA Publications or CLSA Compliance Group, 18/F, One Pacific Place, 88 Queensway, Hong Kong, telephone (852) 2600 8888. Page 2

3. US CAPE 1881-2012Cyclically adjusted price-earnings ratio (PE10 or CAPE)50 (x)4540353025201510 5 0 1881 1891 1901 1911 1921 1931 1941 1951 1961 1971 1981 1991 2001 2011Source: Robert Shiller2008 CLSA Asia-Pacific Markets (CLSA).IMPORTANT: The content of this report is subject to CLSAs Legal and Regulatory Notices as set out at www.clsa.com/disclaimer.html, a hard copy of which maybe obtained on request from CLSA Publications or CLSA Compliance Group, 18/F, One Pacific Place, 88 Queensway, Hong Kong, telephone (852) 2600 8888. Page 3

4. Where the bear market ends It will end with a deflationary shock and very low CAPEs and S&P500 around an index level of 450 While the US is a long way from this combination the situation in Europe is very differentPrevious lows for the cyclically adjusted PE and targets for real S&P Cyclically Adjusted PE S&P Target1921 5.2X 3001932 5.8X 3401949 9.1X 5281982 6.6X 3862008 CLSA Asia-Pacific Markets (CLSA).IMPORTANT: The content of this report is subject to CLSAs Legal and Regulatory Notices as set out at www.clsa.com/disclaimer.html, a hard copy of which maybe obtained on request from CLSA Publications or CLSA Compliance Group, 18/F, One Pacific Place, 88 Queensway, Hong Kong, telephone (852) 2600 8888. Page 4

5. Current CAPEs US 21.3X China 18.0X Asia ex Japan 19.3X Europe 13.1X UK 12.5X World 18.2X Germany 16.0X Japan 21.3X Italy 7.8X Greece 1.8X Spain 8.5X Ireland 6.0X India 24.0X Portugal 9.2X2008 CLSA Asia-Pacific Markets (CLSA).IMPORTANT: The content of this report is subject to CLSAs Legal and Regulatory Notices as set out at www.clsa.com/disclaimer.html, a hard copy of which maybe obtained on request from CLSA Publications or CLSA Compliance Group, 18/F, One Pacific Place, 88 Queensway, Hong Kong, telephone (852) 2600 8888. Page 5

6. Long bear markets are normalDow Jones Industrial Index, 1900-1921120 (DJI)110100 90 80 70 60 50 40 1900 1902 1904 1906 1908 1910 1912 1914 1916 1918 19202008 CLSA Asia-Pacific Markets (CLSA).IMPORTANT: The content of this report is subject to CLSAs Legal and Regulatory Notices as set out at www.clsa.com/disclaimer.html, a hard copy of which maybe obtained on request from CLSA Publications or CLSA Compliance Group, 18/F, One Pacific Place, 88 Queensway, Hong Kong, telephone (852) 2600 8888. Page 6

7. Long bear markets are normalDow Jones Industrial Index, 1936-1950250 (DJI)230210190170150130110 90 1936 1938 1940 1942 1944 1946 1948 19502008 CLSA Asia-Pacific Markets (CLSA).IMPORTANT: The content of this report is subject to CLSAs Legal and Regulatory Notices as set out at www.clsa.com/disclaimer.html, a hard copy of which maybe obtained on request from CLSA Publications or CLSA Compliance Group, 18/F, One Pacific Place, 88 Queensway, Hong Kong, telephone (852) 2600 8888. Page 7

8. Long bear markets are normalDow Jones Industrial Index, 1964-19821,100 (DJI)1,000 900 800 700 600 500 1964 1966 1968 1970 1972 1974 1976 1978 1980 19822008 CLSA Asia-Pacific Markets (CLSA).IMPORTANT: The content of this report is subject to CLSAs Legal and Regulatory Notices as set out at www.clsa.com/disclaimer.html, a hard copy of which maybe obtained on request from CLSA Publications or CLSA Compliance Group, 18/F, One Pacific Place, 88 Queensway, Hong Kong, telephone (852) 2600 8888. Page 8

9. Deflation drives low valuations History shows how deflation is one of the few times when bonds outperform equities. In periods when deflation has been probable, equities yield more than bonds. Deflation kills equity, as assets decline faster than liabilities. Deflation kills equity if cashflow declines, forcing debt defaults by corporations and individuals. All the great bear-market bottoms coincide with the death of deflation.2008 CLSA Asia-Pacific Markets (CLSA).IMPORTANT: The content of this report is subject to CLSAs Legal and Regulatory Notices as set out at www.clsa.com/disclaimer.html, a hard copy of which maybe obtained on request from CLSA Publications or CLSA Compliance Group, 18/F, One Pacific Place, 88 Queensway, Hong Kong, telephone (852) 2600 8888. Page 9

10. Rally ends with 4% inflationUS inflation and Dow Jones Industrial Average, 1966-197814 1,050 1,00012 95010 900 850 8 800 6 750 4 700 650 2 CPI (LHS) Dow Jones Industrials - Price Index 600 0 550 66 67 68 69 70 71 72 73 74 75 76 77 78Source: Datastream2008 CLSA Asia-Pacific Markets (CLSA).IMPORTANT: The content of this report is subject to CLSAs Legal and Regulatory Notices as set out at www.clsa.com/disclaimer.html, a hard copy of which maybe obtained on request from CLSA Publications or CLSA Compliance Group, 18/F, One Pacific Place, 88 Queensway, Hong Kong, telephone (852) 2600 8888. Page 10

11. Beware inflation near 4%US inflation and Dow Jones Industrial Average, 1985-19885.0 2,800 CPI (LHS) Dow Jones Industrials - Price Index 2,6004.5 2,4004.0 2,2003.5 2,0003.0 1,8002.5 1,6002.0 1,4001.5 1,2001.0 1,000 1985 1986 1987 1988Source: Datastream2008 CLSA Asia-Pacific Markets (CLSA).IMPORTANT: The content of this report is subject to CLSAs Legal and Regulatory Notices as set out at www.clsa.com/disclaimer.html, a hard copy of which maybe obtained on request from CLSA Publications or CLSA Compliance Group, 18/F, One Pacific Place, 88 Queensway, Hong Kong, telephone (852) 2600 8888. Page 11

12. Beware inflation near 4%US inflation and Dow Jones Industrial Average, 1989-2003 (000)4.0 12.0 11.53.5 11.0 10.53.0 10.02.5 9.5 9.02.0 8.5 8.01.5 CPI F(LHS) Dow Jones Industrials - Price Index 7.51.0 7.0 1998 1999 2000 2001 2002 2003Source: Datastream2008 CLSA Asia-Pacific Markets (CLSA).IMPORTANT: The content of this report is subject to CLSAs Legal and Regulatory Notices as set out at www.clsa.com/disclaimer.html, a hard copy of which maybe obtained on request from CLSA Publications or CLSA Compliance Group, 18/F, One Pacific Place, 88 Queensway, Hong Kong, telephone (852) 2600 8888. Page 12

13. Beware inflation near 4%US inflation and Dow Jones Industrial Average, 2002-20096 (000) 15 CPI (LHS) Dow Jones Industrials - Price Index 145 134 123 112 101 90 8 (1) 7 2002 2003 2004 2005 2006 2007 2008 2009Source: Datastream Source: DATASTREAM2008 CLSA Asia-Pacific Markets (CLSA).IMPORTANT: The content of this report is subject to CLSAs Legal and Regulatory Notices as set out at www.clsa.com/disclaimer.html, a hard copy of which maybe obtained on request from CLSA Publications or CLSA Compliance Group, 18/F, One Pacific Place, 88 Queensway, Hong Kong, telephone (852) 2600 8888. Page 13

14. Beware inflation near 4% 6 (%) 1,600 1Y % change of CPI - ALL URBAN: ALL ITEMS : United States S&P 500 COMPOSITE (RHS) 5 1,400 4 3 1,200 2 1 1,000 0 800(1)(2) 600 2008 2009 2010 2011 2012Source: Thomson Reuters Datastream2008 CLSA Asia-Pacific Markets (CLSA).IMPORTANT: The content of this report is subject to CLSAs Legal and Regulatory Notices as set out at www.clsa.com/disclaimer.html, a hard copy of which maybe obtained on request from CLSA Publications or CLSA Compliance Group, 18/F, One Pacific Place, 88 Queensway, Hong Kong, telephone (852) 2600 8888. Page 14

15. The S&P at 450 The CAPE and Q ratio lows of 1921, 1932, 1949 and 1982 suggest the S&P will bottom at around 450 A loss of faith in US Treasuries and the dollar by foreigners will drive the final leg of the bear market. Treasury market structurally growing when babyboom- medicare and social security entitlement begins. Demand for Treasuries falls as emerging world goes for consumption-driven growth and surpluses shrink. Funding western governments squeezes private sector activity2008 CLSA Asia-Pacific Markets (CLSA).IMPORTANT: The content of this report is subject to CLSAs Legal and Regulatory Notices as set out at www.clsa.com/disclaimer.html, a hard copy of which maybe obtained on request from CLSA Publications or CLSA Compliance Group, 18/F, One Pacific Place, 88 Queensway, Hong Kong, telephone (852) 2600 8888. Page 15

16. The predicted roll over is underwayPercentage of Treasury market owned by foreign central banksSource: Thomson Reuters Datastream2008 CLSA Asia-Pacific Markets (CLSA).IMPORTANT: The content of this report is subject to CLSAs Legal and Regulatory Notices as set out at www.clsa.com/disclaimer.html, a hard copy of which maybe obtained on request from CLSA Publications or CLSA Compliance Group, 18/F, One Pacific Place, 88 Queensway, Hong Kong, telephone (852) 2600 8888. Page 16

17. Why the EM money cycle mattersLargest economies contribution to money-supply growth(%) Local-currency terms US$ termsUSA 15 10Eurozone 6 10Japan 1 25UK 5 (1)China 45 40Russia 3 1Brazil 7 4India 6 2Mexico 3 2Korea 1 0Indonesia 0 0Turkey 2 0Australia 3 3Canada 3 2Switzerland 1 1Saudi Arabia 1 1Source: Datastream, CLSA Asia-Pacific Markets2008 CLSA Asia-Pacific Markets (CLSA).IMPORTANT: The content of this report is subject to CLSAs Legal and Regulatory Notices as set out at www.clsa.com/disclaimer.html, a hard copy of which maybe obtained on request from CLSA Publications or CLSA Compliance Group, 18/F, One Pacific Place, 88 Queensway, Hong Kong, telephone (852) 2600 8888. Page 17

18. Chinas 1Q-3Q12 BOP went to a deficitChina current- and capital-account surplus 450 (US$bn) 400 China current-account balance 350 China capital & financial account balance 300 250 200 150 100 50 0 (50) Jun 98 Jun 03 Jun 97 Jun 99 Jun 00 Jun 01 Jun 02 Jun 04 Jun 05 Jun 06 Jun 07 Jun 08 Jun 09 Jun 10 Jun 11Source: Datastream2008 CLSA Asia-Pacific Markets (CLSA).IMPORTANT: The content of this report is subject to CLSAs Legal and Regulatory Notices as set out at www.clsa.com/disclaimer.html, a hard copy of which maybe obtained on request from CLSA Publications or CLSA Compliance Group, 18/F, One Pacific Place, 88 Queensway, Hong Kong, telephone (852) 2600 8888. Page 18

19. Low Chinese reserve growthChina reserve growth60 (%)5040302010 0 01 04 98 99 00 02 03 05 06 07 08 09 10 11 12 02 05 97 98 99 00 01 03 04 06 07 08 09 10 11 Aug Aug Aug Aug Aug Aug Aug Aug Aug Aug Aug Aug Aug Feb Feb Feb Feb Aug Feb Feb Feb Aug Feb Feb Feb Feb Feb Feb Feb FebSource: Datastream2008 CLSA Asia-Pacific Markets (CLSA).IMPORTANT: The content of this report is subject to CLSAs Legal and Regulatory Notices as set out at www.clsa.com/disclaimer.html, a hard copy of which maybe obtained on request from CLSA Publications or CLSA Compliance Group, 18/F, One Pacific Place, 88 Queensway, Hong Kong, telephone (852) 2600 8888. Page 19

20. EMs reserve growth created money and inflationGrowth in foreign reserves among largest EM holders (2007-latest)China 112%Russia 7%Taiwan 45%Brazil 109%South Korea 30%Hong Kong 94%India 7%Singapore 50%Algeria 73%Thailand 101%Mexico 84%Iran 62%Indonesia 86%Poland 55%Philippines 129%Source: Datastream2008 CLSA Asia-Pacific Markets (CLSA).IMPORTANT: The content of this report is subject to CLSAs Legal and Regulatory Notices as set out at www.clsa.com/disclaimer.html, a hard copy of which maybe obtained on request from CLSA Publications or CLSA Compliance Group, 18/F, One Pacific Place, 88 Queensway, Hong Kong, telephone (852) 2600 8888. Page 20

21. Capital leaves as returns declineReturn on capital employed for the listed sector(%) 2007 2012USA 13.5 13.6Europe 13.1 11.7Brazil 15.6 10.7China 15.6 10.5India 11.6 9.6Russia 15.8 15.9Source: CLSA Asia-Pacific Markets2008 CLSA Asia-Pacific Markets (CLSA).IMPORTANT: The content of this report is subject to CLSAs Legal and Regulatory Notices as set out at www.clsa.com/disclaimer.html, a hard copy of which maybe obtained on request from CLSA Publications or CLSA Compliance Group, 18/F, One Pacific Place, 88 Queensway, Hong Kong, telephone (852) 2600 8888. Page 21

22. Borrowing offshore boosted capital inflowGross external debt(US$bn) 2007 LatestBrazil 193 306China 389 695India 173 346Russia 464 545Source: IMF, OECD, BIS2008 CLSA Asia-Pacific Markets (CLSA).IMPORTANT: The content of this report is subject to CLSAs Legal and Regulatory Notices as set out at www.clsa.com/disclaimer.html, a hard copy of which maybe obtained on request from CLSA Publications or CLSA Compliance Group, 18/F, One Pacific Place, 88 Queensway, Hong Kong, telephone (852) 2600 8888. Page 22

23. Japan the land of 0%Japan M4 growth 6 (% YoY) 5 4 3 2 1 0(1)(2)(3)(4) 12 98 99 00 01 02 02 03 04 04 05 06 07 08 09 10 11 97 98 99 00 01 03 05 06 07 08 09 10 11 Sep Sep Mar Mar Mar Mar Mar Mar Mar Mar Mar Mar Mar Mar Mar Mar Mar Sep Sep Sep Sep Sep Sep Sep Sep Sep Sep Sep Sep SepSource: Datastream2008 CLSA Asia-Pacific Markets (CLSA).IMPORTANT: The content of this report is subject to CLSAs Legal and Regulatory Notices as set out at www.clsa.com/disclaimer.html, a hard copy of which maybe obtained on request from CLSA Publications or CLSA Compliance Group, 18/F, One Pacific Place, 88 Queensway, Hong Kong, telephone (852) 2600 8888. Page 23

24. Euroland 3.0% and will fallEurozone M3 growthSource: Datastream2008 CLSA Asia-Pacific Markets (CLSA).IMPORTANT: The content of this report is subject to CLSAs Legal and Regulatory Notices as set out at www.clsa.com/disclaimer.html, a hard copy of which maybe obtained on request from CLSA Publications or CLSA Compliance Group, 18/F, One Pacific Place, 88 Queensway, Hong Kong, telephone (852) 2600 8888. Page 24

25. Money is inflation - UK QE failsUK M4 growth 20 (% YoY) 15 10 5 0 (5)(10) 03 12 98 98 99 00 01 02 04 05 06 07 07 08 09 10 11 97 99 00 01 02 03 04 05 06 08 09 10 11 Sep Sep Mar Mar Mar Mar Mar Mar Mar Mar Mar Mar Mar Mar Mar Mar Mar Sep Sep Sep Sep Sep Sep Sep Sep Sep Sep Sep Sep SepSource: Datastream2008 CLSA Asia-Pacific Markets (CLSA).IMPORTANT: The content of this report is subject to CLSAs Legal and Regulatory Notices as set out at www.clsa.com/disclaimer.html, a hard copy of which maybe obtained on request from CLSA Publications or CLSA Compliance Group, 18/F, One Pacific Place, 88 Queensway, Hong Kong, telephone (852) 2600 8888. Page 25

26. Money is inflation- China at low end2008 CLSA Asia-Pacific Markets (CLSA).IMPORTANT: The content of this report is subject to CLSAs Legal and Regulatory Notices as set out at www.clsa.com/disclaimer.html, a hard copy of which maybe obtained on request from CLSA Publications or CLSA Compliance Group, 18/F, One Pacific Place, 88 Queensway, Hong Kong, telephone (852) 2600 8888. Page 26

27. Why Euroland money growth will slowLoan growth to Euro-area residents excluding governments14 (%)1210 8 6 4 2 0(2) 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 00 11 98 99 01 02 03 04 05 06 07 08 09 10 12 Sep Sep Sep Sep Sep Sep Sep Sep Sep Sep Sep Sep Sep Sep Sep Mar Mar Mar Mar Mar Mar Mar Mar Mar Mar Mar Mar Mar Mar MarSource: Datastream2008 CLSA Asia-Pacific Markets (CLSA).IMPORTANT: The content of this report is subject to CLSAs Legal and Regulatory Notices as set out at www.clsa.com/disclaimer.html, a hard copy of which maybe obtained on request from CLSA Publications or CLSA Compliance Group, 18/F, One Pacific Place, 88 Queensway, Hong Kong, telephone (852) 2600 8888. Page 27

28. Solutions for the over indebted stateFederal debt as % of GDP, 1792-2021 140 (%) 120 100 80 60 40 20 0 1792 1799 1806 1813 1820 1827 1834 1841 1848 1855 1862 1869 1876 1883 1890 1897 1904 1911 1918 1925 1932 1939 1946 1953 1960 1967 1974 1981 1988 1995 2002 2009 2016 2021Source: OMB and Historical Statistics of the United States of America2008 CLSA Asia-Pacific Markets (CLSA).IMPORTANT: The content of this report is subject to CLSAs Legal and Regulatory Notices as set out at www.clsa.com/disclaimer.html, a hard copy of which maybe obtained on request from CLSA Publications or CLSA Compliance Group, 18/F, One Pacific Place, 88 Queensway, Hong Kong, telephone (852) 2600 8888. Page 28

29. Conclusions US Treasuries could repeat their 83% price decline of 1946-81. The supply/demand imbalance for Treasuries can be met with higher rates or higher savings and deflation. Deflation is bad for equities but also for government bonds in the Euro area Deflation has been good for government bonds in areas which print their own money but this will end Cash provides optionality and foreign cash real optionality2008 CLSA Asia-Pacific Markets (CLSA).IMPORTANT: The content of this report is subject to CLSAs Legal and Regulatory Notices as set out at www.clsa.com/disclaimer.html, a hard copy of which maybe obtained on request from CLSA Publications or CLSA Compliance Group, 18/F, One Pacific Place, 88 Queensway, Hong Kong, telephone (852) 2600 8888. Page 29

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