Ambrose Evans-Pritchard has been a staunch critic of the European Union (EU) since its inception. His most recent article regarding Italy's former PM Silvio Berlusconi of the Forza Italia Party examines the high levels of mistrust among states like Italy and France towards the ECB.
J
Berlusconi plans Paris-Rome axis to humble European Central Bank
Ambrose Evans-Pritchard
16/04/2008
Silvio Berlusconi's return to power in Italy is a nightmare come true for the European Central Bank, opening the way for a Rome-Paris axis with the political muscle to force a change in monetary policy.
Read more by Ambrose Evans Pritchard
Silvio Berlusconi does not share the EU-loyalities of the outgoing government. The billionaire politician has pledged an alliance with France's Nicolas Sarkozy aimed at humbling the bank and asserting the primacy of elected leaders over interest rates and the currency. "A very strong euro is hurting Italy's economy. I will discuss intervening with the ECB with Sarkozy," he said.
The threat brought a sharp retort yesterday from the ECB's German governor and chief economist Jurgen Stark. "I would recommend to political leaders in Europe, newly elected and re-elected, to read the European law on the ECB," he said. Mr Berlusconi - who is setting up a temporary office in Naples to tackle the city's long-running rubbish crisis - inherits an economy trapped in near slump conditions.
The country has lost 40pc in unit labour cost competitiveness against Germany since 1995, largely due to anaemic productivity gains and an inflationary wage-bargaining culture. Yet it cannot use the old method of devaluation to claw back parity. The International Monetary Fund forecasts growth of just 0.3pc in both 2008 and 2009, levels that are certain to cause a renewed rise in the country's national debt. Italian car sales plunged 18.8pc in March, and the Alpine lender Credito Valtellinese has just become the first European bank in living memory to miss a redemption on a callable bond - raising concerns of deeper troubles brewing in Italy's financial system.
Mr Sarkozy has repeatedly attacked the ECB's tight money policies, blaming it for causing the euro to surge 27pc in two years to a record $1.59 against the dollar. He says the ECB risks bankrupting Airbus and driving much of Europe's industry off-shore. Until now he has lacked the allies needed to impose his will.
"Politics is everything in EMU, and the re-election of Berlusconi represents a big shift in the political balance of power," said Bernard Connolly, global strategist at Banque AIG. "Spain will probably join France and Italy before too long, so you will have three of the big four eurozone countries in the same camp. They can set 'broad guidelines' for the ECB. It is a total misperception that the ECB should not be subject to political influence."
Article 111 of the Nice Treaty gives politicians power to set a fixed exchange rate for the euro (by unanimous vote), or to shape the exchange rate (by qualified majority vote). This power gives EU ministers an indirect means to force the ECB to cut interest rates. The treaty article has never been invoked but it hovers in EU affairs like Banquo's Ghost.
Mr Berlusconi does not share the EU-loyalities of the outgoing government. Ex-premier Romano Prodi was once the president of the European Commission, the public face of the euro. His finance minster Tommaso Padoa-Schioppa was a founder of Europe's monetary union.
The last time Mr Berlusconi was in power, two ministers from his coalition partner 'La Lega Nord' called for a return to the lira to escape the constraints of the euro system. While he did not endorse the comments, he appeared to relish their effect on his enemies in Brussels and Frankfurt.
Wednesday, April 16, 2008
Nouriel Roubini and the US dollar
Nouriel Roubini, on point as always highlighting the inadequcies of the G7 attempts to talk up the US as the ECB faces growing concerns that intervention may be the only hope the Forex market has to return to some sense of normalcy.
What that is in today's markets is anybody's guess.
J
G7 Stance on the US Dollar: Talk is Cheap
Nouriel Roubini Apr 14, 2008
The French Finance Minister Lagarde compared the G7 statement on the US dollar to the 1985 Plaza Accord to weaken the US dollar; but the forex market pretty much ignored the statement pushing the dollar further down. The statement certainly signals that the G7 are getting closer to the point where the dollar weakness bothers both the US and Europe and where coordinated forex intervention may be considered; but as the saying goes “talk is cheap”. Verbal intervention – of the sort used even by Trichet in the last few weeks and used by the G7 in their weekend statement – almost never works (as the Japanese learned a few years ago). Also sterilized fx intervention usually does not work – unless such intervention goes with the wind rather than against the wind, is seriously coordinated and aggressive and signals future changes in actual monetary policies (i.e. unsterilized intervention).
What works in affecting exchange rates is unsterilized intervention – or equivalently – changes in relative monetary policies, i.e. changes in policy rates.
Currency movements are driven – apart from market noise and momentum – by economic fundamentals. Several fundamentals are driving the dollar south relative to euro and other floating currencies.
Lets discuss these fundamentals and their implications…
First, the still large and structural US current account deficits that – however shrinking – is still huge is bearish for the dollar.
Second, relative interest rate differentials; and with the Fed still expected to cut rates while ECB and BoJ are so far on hold this is dollar bearish.
Third, relative growth differentials; and with the US entering a recession while Europe and Japan slowing but at a more moderate rate this is also bearish for the US dollar.
Fourth, the relative riskiness of US assets relative to European and Japanese assets; and with the US financial crisis still in full swing, toxic assets still partly hidden (who is holding them and how much?) and the risks of further writedowns still large this is another bearish factor for the dollar.
Fifth, with China and other effective members of BW2 still effectively heavily managing their currencies relative to the US dollar (or still into outright pegs as in the Gulf states) downward fundamental pressures on the dollar are reflected in the dollar rate relative to the floaters rather than against the Asian and BW2 currencies.
So, all these five fundamental factors imply a weaker dollar ahead relative to the euro and most of the other floaters. So would verbal intervention work to stem the fall of the dollar? Of course not. So, would coordinated sterilized intervention work? Maybe for a few days but not much more.
Would unsterilized intervention or reduction in policy rates in Europe work to stop the ascent of the euro? Yes but an ECB worried about inflation has not yet reached the point of easing Eurozone rates to stem the rise of the euro. So Trichet may express his concerns about a strong Euro – and a euro close to 1.60 relative to the dollar implies pain not only for exports of the PIGS (Portugal, Italy, Greece, Spain) but increasingly also for those of France and of the Germany (the export superpower); but unless he is willing to ease rates the fall of the dollar relative to the Euro may continue for a while.
So, what could stop a disorderly fall of the dollar and a disorderly rise of the euro and the yen? At some point the rise of euro and yen is going to weaken enough economic growth in the Eurozone and in Japan that two things will happen: the growth slowdown in Europe (with outright recession in some European economies) and Japan (with the risk of Japan tipping into another recession) will tip growth rate differentials that are now bearish for the dollar into being bearish for euro and yen. Second, such a growth slowdown in Europe and Japan will lead to expectation if policy rate easing by ECB and BoJ that will also tip interest rate differentials against euro and yen.
Certainly with the euro now closer to 1.60 than 1.50 the euro is overvalued in real terms: European traded goods are much more expensive than American goods (or as European observers put it to me: “for European tourists goods are now cheaper in New York than in Bangkok!”). I.e. on a PPP basis the euro has already overshot upward its fundamental value. But market dynamics, herding and momentum can drive the euro above 1.60 (and possibly the yen back towards 90). But the more this short-run overshooting occurs the weaker the Eurozone and Japanese economies will get and the more likely the probability of ECB and even BoJ cutting rates. Thus, if euro and yen were to overshoot in the short run market forces (relative expected growth and interest rate differentials) will put a floor to how weak the dollar can get and how strong the euro and yen can get.
So, with BW2 central banks still aggressively managing their currencies values relative to the US dollar and the currencies of the floaters being controlled by endogenous changes in relative economic fundamentals a total disorderly crash of the US dollar is unlikely. And given a severe US recession and a global recoupling of growth these limits to further sharp weakness of the US dollar may imply that global imbalances may remain large for the foreseeable future even if the dollar weakness does – at the margin – help the narrowing of the US current account deficit.
In conclusion, Mr. Trichet if you are really worried about the rise of the euro there is something very simple you can do to stem that rise: cut European policy rates! All the rest – including coordinated sterilized intervention – may end up being cheap talk.
What that is in today's markets is anybody's guess.
J
G7 Stance on the US Dollar: Talk is Cheap
Nouriel Roubini Apr 14, 2008
The French Finance Minister Lagarde compared the G7 statement on the US dollar to the 1985 Plaza Accord to weaken the US dollar; but the forex market pretty much ignored the statement pushing the dollar further down. The statement certainly signals that the G7 are getting closer to the point where the dollar weakness bothers both the US and Europe and where coordinated forex intervention may be considered; but as the saying goes “talk is cheap”. Verbal intervention – of the sort used even by Trichet in the last few weeks and used by the G7 in their weekend statement – almost never works (as the Japanese learned a few years ago). Also sterilized fx intervention usually does not work – unless such intervention goes with the wind rather than against the wind, is seriously coordinated and aggressive and signals future changes in actual monetary policies (i.e. unsterilized intervention).
What works in affecting exchange rates is unsterilized intervention – or equivalently – changes in relative monetary policies, i.e. changes in policy rates.
Currency movements are driven – apart from market noise and momentum – by economic fundamentals. Several fundamentals are driving the dollar south relative to euro and other floating currencies.
Lets discuss these fundamentals and their implications…
First, the still large and structural US current account deficits that – however shrinking – is still huge is bearish for the dollar.
Second, relative interest rate differentials; and with the Fed still expected to cut rates while ECB and BoJ are so far on hold this is dollar bearish.
Third, relative growth differentials; and with the US entering a recession while Europe and Japan slowing but at a more moderate rate this is also bearish for the US dollar.
Fourth, the relative riskiness of US assets relative to European and Japanese assets; and with the US financial crisis still in full swing, toxic assets still partly hidden (who is holding them and how much?) and the risks of further writedowns still large this is another bearish factor for the dollar.
Fifth, with China and other effective members of BW2 still effectively heavily managing their currencies relative to the US dollar (or still into outright pegs as in the Gulf states) downward fundamental pressures on the dollar are reflected in the dollar rate relative to the floaters rather than against the Asian and BW2 currencies.
So, all these five fundamental factors imply a weaker dollar ahead relative to the euro and most of the other floaters. So would verbal intervention work to stem the fall of the dollar? Of course not. So, would coordinated sterilized intervention work? Maybe for a few days but not much more.
Would unsterilized intervention or reduction in policy rates in Europe work to stop the ascent of the euro? Yes but an ECB worried about inflation has not yet reached the point of easing Eurozone rates to stem the rise of the euro. So Trichet may express his concerns about a strong Euro – and a euro close to 1.60 relative to the dollar implies pain not only for exports of the PIGS (Portugal, Italy, Greece, Spain) but increasingly also for those of France and of the Germany (the export superpower); but unless he is willing to ease rates the fall of the dollar relative to the Euro may continue for a while.
So, what could stop a disorderly fall of the dollar and a disorderly rise of the euro and the yen? At some point the rise of euro and yen is going to weaken enough economic growth in the Eurozone and in Japan that two things will happen: the growth slowdown in Europe (with outright recession in some European economies) and Japan (with the risk of Japan tipping into another recession) will tip growth rate differentials that are now bearish for the dollar into being bearish for euro and yen. Second, such a growth slowdown in Europe and Japan will lead to expectation if policy rate easing by ECB and BoJ that will also tip interest rate differentials against euro and yen.
Certainly with the euro now closer to 1.60 than 1.50 the euro is overvalued in real terms: European traded goods are much more expensive than American goods (or as European observers put it to me: “for European tourists goods are now cheaper in New York than in Bangkok!”). I.e. on a PPP basis the euro has already overshot upward its fundamental value. But market dynamics, herding and momentum can drive the euro above 1.60 (and possibly the yen back towards 90). But the more this short-run overshooting occurs the weaker the Eurozone and Japanese economies will get and the more likely the probability of ECB and even BoJ cutting rates. Thus, if euro and yen were to overshoot in the short run market forces (relative expected growth and interest rate differentials) will put a floor to how weak the dollar can get and how strong the euro and yen can get.
So, with BW2 central banks still aggressively managing their currencies values relative to the US dollar and the currencies of the floaters being controlled by endogenous changes in relative economic fundamentals a total disorderly crash of the US dollar is unlikely. And given a severe US recession and a global recoupling of growth these limits to further sharp weakness of the US dollar may imply that global imbalances may remain large for the foreseeable future even if the dollar weakness does – at the margin – help the narrowing of the US current account deficit.
In conclusion, Mr. Trichet if you are really worried about the rise of the euro there is something very simple you can do to stem that rise: cut European policy rates! All the rest – including coordinated sterilized intervention – may end up being cheap talk.
Tuesday, April 15, 2008
The Guns of August
I have started reading Barbara Tuchman's The Guns of August and 100 pages in I have nothing but good things to say about it. I recommend this book to anyone wishing to understand the foundations of WW1, which as the author builds sowed the seeds of WW2.
My favourite exerpt so far: (page 26)
Character is fate the greeks believed. 100 years of German philosoply went into the making of this decision in which the seeds of self-destruction lay embedded, waiting for its hour to begin the great war.
The voice was Schlieffen's plan for encirclement of the enemy, but the hand was the hand of Fichte who saw the German people chosen by providence, of Hegel who saw them leading the world to a glorious destiny of compulsory Kultur, of Nietzsche who told them that Supermen were above ordinary controls and the German people who called their temporal ruler the "all-highest".
What made the Schlieffen plan was not Calusewitz but the body of acumulated egoism which suckled the German people and created a nation fed on the dessperate delusion of the will that deems itself absolute.
J
My favourite exerpt so far: (page 26)
Character is fate the greeks believed. 100 years of German philosoply went into the making of this decision in which the seeds of self-destruction lay embedded, waiting for its hour to begin the great war.
The voice was Schlieffen's plan for encirclement of the enemy, but the hand was the hand of Fichte who saw the German people chosen by providence, of Hegel who saw them leading the world to a glorious destiny of compulsory Kultur, of Nietzsche who told them that Supermen were above ordinary controls and the German people who called their temporal ruler the "all-highest".
What made the Schlieffen plan was not Calusewitz but the body of acumulated egoism which suckled the German people and created a nation fed on the dessperate delusion of the will that deems itself absolute.
J
Monday, April 14, 2008
In-efficient market hypothesis?
This highly entertaining article courtesy of Johh Mauldin's weekly newsletter takes a no-nonsense look at the current debacle that is the credit crisis. I especially like the references to Efficient Market Hypothesis.
Enjoy,
J
Five Delectable Examples of "Stein's Law"
by H. "Woody" Brock
Enjoy,
J
Five Delectable Examples of "Stein's Law"
by H. "Woody" Brock
The most basic statement of Stein's Law says: "If something cannot go on forever, it will stop". More specifically, the late Herb Stein stressed that, when a trend cannot go on, it always stops--even when nothing is done about it. This yardstick of common sense is particularly apposite today, as we see in the following five examples of trends whose time has come and gone.
1. Mean Reversion in US Wealth Growth: A March 7 front page headline of the Financial Times proclaimed, "Fed Data Alarms Markets - Wealth of US Households Contracts". We have written about "mean reversion in national wealth growth" for the past five years, and explained why it would soon have to occur. In this regard, one of the most fundamental of all theorems in economics tells us that national wealth must (and empirically does) grow over the long run at the rate of GDP growth.
Well, wealth reversion has now arrived, and will be with us for far longer than most anyone expects. First, wealth has already contracted by $500 billion in 2007. Second, wealth contraction will continue to occur until mid-2009 when house prices reach their trough. And third, wealth growth will probably be sluggish up to and beyond 2020, running at about 3%. One reason why is that most baby boomers have their money in their houses--not in traditional defined benefit pension plans. Accordingly, the only way they will be able to retire in the style they expect is to sell their houses to one another. Next joke.
How remarkably this new 2.5% wealth growth regime of 2007-2020 will differ from the previous regime of 1981-2006! During that period, US net worth soared from $10 trillion to $57 trillion--an arithmetic average growth rate of 18% and a compound annual growth rate of 7.2%. For readers who doubt what we are arguing, note that the average growth of wealth across the two regimes being analyzed compounds at exactly 5.5%. This is precisely the long-run growth of nominal GDP. And all the Golden Rule Theorems in Growth Theory require that wealth growth and GDP growth converge to the same growth rate in the long-run.
This will fundamentally change both American politics and daily life. In particular, it will be the final nail in the coffin of hopes of early retirement for most baby-boomers. In short, "wealth reversion" is finally coming home to roost. What cannot go on does not go on.
2. Financial Services: The growth, profitability and excessive pay in this sector were always too good to be true, and now much of this excess may be over. Between (i) the deleveraging of bank balance sheets, (ii) the loss of confidence in exotic "financial products" by the investing public, and (iii) the need for banks to repay the Fed (or whomever) for existing and prospective bailouts, tepid growth and reduced profitability lie ahead for this sector during the next 5 years. For an analogy, look back on the growth and profitability of the telecom sector between the years 1991-2007, and in particular on the breakpoint of the late 1990s. What could not go on in telecom ceased to go on, and so shall it be in "finance".
3. The 2002-2009 US Housing Bubble and Burst: Many people suspected that the housing boom was indeed a bubble. There is no longer any doubt that it was, and for the following ex post reason: For house prices to have fallen as much as they have--and to do so with no interest rate shock--is proof positive that a pure bubble was in play. It was a speculative bubble fueled by excess credit creation and lax lending standards. What could not go on did not go on.
4. Excess Leverage: Commentaries about and explanations of today's credit market implosion continue to roll in from luminaries everywhere. Martin Feldstein of Harvard (allegedly the most important macroeconomist in the world) concludes that blame lies with the failure of Fed regulators to properly supervise the banks within their purview. Others blame the incompetence of those charged with "risk assessment" for dramatically underestimating risk. They claim that the solution to today's troubles lies in instituting much more effective risk management procedures.
Still others call for greater market transparency, truth in lending, and incentives to guarantee more of both. Finally, there are repeated complaints about the extent of greed on Wall Street. Yes, we have all become shockingly greedy!
Yet almost no one singles out the distinctive role of excess leverage not only as the principal culprit, but perhaps the only variable than can and should be regulated by government--as it once was. Indeed, in his lengthy and much discussed March 17 Op-Ed piece in the Financial Times, former Fed Chairman Alan Greenspan never once cited the role of leverage in wreaking today's havoc. This oversight is as irresponsible as it was unbelievable, but it epitomizes the deficient analyses of consensus pundits.
Chapters II-IV of our February 2008 PROFILE report explained how excessive leverage has exacerbated today's crisis, and why leverage is the principal "control variable" that must be managed in the future. More specifically,
- The Fed has no direct control over institutions that now make over 70% of all loans. As Chairman Bernanke has stressed in recent months, the Fed's powers are thus limited in dealing with the kind of crisis now at hand.
- The risks that allegedly should be "properly assessed" are largely endogenous in nature. The joint probability distribution characterizing such risk is often non-knowable. Think Heisenberg Uncertainty Principle! Because of this non-knowability, glib assertions that recent happenings are "four sigma events" are wholly invalid. For to state that an event is four-sigma implies knowledge of an underlying probability distribution that in fact does not exist and thus cannot be assessed!
- Human nature never changes, and hoping that people will become less greedy and optimally transparent is unrealistic.
- Leverage, however, is controllable. Moreover, since it exponentially amplifies endogenous risk, and in doing so creates "perfect storms" like that of today, the regulation of leverage can accomplish a very great deal, at least in circumstances when such measures are called for.
To sum up, those writing about today's morass seem as ignorant of the reality that excess leverage is largely responsible for what has happened as they are that much reduced leverage is the appropriate remedy for the future. Perhaps this oversight is no accident. After all, those who now run our major financial institutions increasingly owe their own fabled fortunes to the utilization of leverage subsidized by the public. Moreover, those financial economists who are handsomely paid to report today's developments happen almost exclusively to be employees of the very same institutions that have created, peddled and profited from toxic CDOs and SIVs.
In short, are we not forced to ask whether the foxes are finally guarding the chicken coop? If they are not, you would never know it. This author is frankly appalled by the failure of those who should know better to single out and stress the all-important role of excess leverage in creating today's crisis. Leverage will end up hurting millions of innocent bystanders far more than any other factor will have done. Hyman Minsky: Where are you when we need you most? And where for that matter are Wisdom and Common Sense?
This is a deep observation that constitutes a paradox within the very foundations of modern financial theory: The irrationally high levels of leverage justified by the Efficient Market Theory via its dramatic underestimation of risk becomes the source of Economic Inefficiency in the precise and revolutionary sense first proposed by Kenneth Arrow in 1953: a misallocation of risk itself. [Recall the reason why the EMT necessarily underestimates risk: It implies zero endogenous risk.]Yet just as Stein's Law predicts, this trend too has had its day. Stay tuned for that large-scale deleveraging of Wall Street and indeed of the consumer that is just commencing.
5. Modern Financial Theory: Modern financial theory as applied ranks with string theory in physics as one of the greatest intellectual frauds of our time. Whereas the vacuous pretensions of string theory have finally been exposed (we now know that the theory never generated a single falsifiable prediction), those of "financial engineering" are just beginning to be exposed both in the press and in lawsuits alike.
What is remarkable to us is how this masquerade has continued for as long as it has both at a practical and at a theoretical level.
- At a practical level, it finally dawned on succored investors that you cannot transform a sow's ear into a golden purse. That is, in an era of 3.5% risk-free yields, investors should never have expected that securities yielding 6% could have been "AAA" in the first place. They have now learned that such a risk/return transformation is indeed impossible, notwithstanding claims to the contrary by modern alchemists of finance.
Investors have also been discovering the vacuity of the longstanding claim that "the market correctly prices every security"--arguably the central tenet of the Efficient Market Theory. When the Chairman of the Federal Reserve Board stands up at lunch in New York and asks a packed audience, "Could someone please tell me what this stuff (mortgage-backed securities) is worth?"--then you know the game is over.
The same holds true for the growing realization of the complete inadequacy of today's models of risk assessment. Indeed, this is one of the main points made by Alan Greenspan in his March 17 column. [Greenspan as always is allergic to good theory, so his analysis falls back upon "data analysis problems". But he is on the right track in admitting the sorry state of today's models.]
- At a theoretical level, are those professors of finance and CFA curriculum officials who have peddled efficient market dogma for decades aware of what is really happening? Do they understand that they are witnessing the collapse-in-disgrace of the fundamental theoretical conceit that has landed us in today's quagmire, namely: "Armed with portfolio theory, options pricing theory, Arbitrage Pricing Theory, reams of data, and banks of computers, we the Wizards of Wall Street can now optimally assess, price, slice, dice, and manage risk. Government happily is no longer needed to save us from ourselves in times of irrational exuberance."
In Chapter II of our February 2008 report, we discussed what went wrong in the evolution of financial economics. In particular, we retraced the way in which Kenneth Arrow's original 1953 conception of the Economics of Uncertainty was bastardized by the Chicago School a quarter of a century later. Whereas Arrow's theory assumed that agents had diverse opinions about the future and were thus regularly wrong in their forecasts--wrong, not irrational--the Chicago School imposed the dogma of Rational Expectation: Agents all know and agree upon the true probability distribution of future news, and are thus never wrong. Moreover, they are assumed to know how to price all such news perfectly, with the result that markets are blithely assumed to price all assets correctly. Assumed, not demonstrated. Yes, assumed, not demonstrated.
- This was the origin of the theory of Economics Without Mistakes (our phrase) that lies at the heart of what has gone wrong in global markets. In particular, this was the origin of a family of theories predicting that financial market risk is very small, is fully assessable, is fully priceable, and thus is fully manageable. And this in turn was what intellectually justified today's extremely dangerous levels of leverage. [An agent of a given risk tolerance will be "excessively leveraged" if his models significantly underestimate the true risks at hand. In the real world, some 80% of total risk is endogenous, not exogenous. Yet in Efficient Market Theory models, there can be no endogenous risk at all.
- Having discussed all this in past commentaries, we conclude on a somewhat lighter vein with a proposal for improved pedagogy in financial theory in the future. In doing so, we express our own version of Stein's Law: Teachings that are absurd are eventually recognized to be absurd, and will cease to be taught to tomorrow's young
Sunday, April 13, 2008
Paul Volcker blasts Fed's printing press ramp-up.
Thanks to www.beearly.com for this article from the Globe and Mail. Former Fed Chairman Paul Volker has strong words for the current Fed regime.
J
THE BUY SIDE: POLITICS
AVNER MANDELMAN
APRIL 12, 2008
A few days ago an unusual event took place: Paul Volcker, the mythical U.S. Federal Reserve Board chairman from the Reagan years, criticized the policy of the current Fed chairman, Ben Bernanke, in a speech to the Economic Club of New York. Just so you grasp how extraordinary this was, you should first understand that normally a past Fed chairman scrupulously avoids saying anything at all about current Fed policy - for the simple reason that the current Fed chairman's words are one of his most important tools: They can sway markets.
This ability does not fade entirely when a Fed chairman leaves. So when a past Fed chairman speaks, his words can clash with those of the present one and make that one's job difficult. Out of professional courtesy, past Fed chairmen therefore keep quiet; Mr. Volcker especially - the man who hiked interest rates to 20 per cent to kill inflation, at the cost of a deep recession. But last week Mr. Volcker spoke his mind bluntly. He said, in effect, that the current Fed is not doing its job.
This would have been unusual enough. But Mr. Volcker went further. Not only is the Fed not doing its job, he said, but it is doing the wrong job: It is defending the economy and the market, instead of defending the dollar. And just to stick the knife in, Mr. Volcker added that this bad job now will make the real job - defending the greenback - much harder later. It'll cause even greater economic suffering.
In plain words, Mr. Volcker implied that the current Fed is not only incompetent, but that its actions are dangerous. There is no record of Mr. Bernanke's reaction, nor that of anyone else inside the Fed. But there was plenty of buzz in the market because what Mr. Volcker said amounted to a rousing call to raise interest rates. Yes, raise rates, and do it now.
Can you imagine what this would do to the market? I sure can, which brings me to the gap between physical economic reality as we witness it every day in our physical investigations, and the surreal market chatter we see and hear on TV. This gap has never been wider - but it will inevitably close as markets catch up to reality - as just forecast by former president Ronald Reagan's Fed chairman.
Let me cite three items, then go back to Mr. Volcker. First, commercial real estate. You surely have read about the residential real estate problems - subprime loans syndicated and resold, causing the implosion of several U.S. financial institutions. The writeoffs and damage here total close to a trillion dollars, said the IMF recently. That's about one-seventh of the U.S. gross domestic product, or more than three years of growth. But what of commercial real estate? I heard recently from some savvy private real estate investors that although commercial real estate fell by 20%, it should fall by a further 20 to 30 per cent before it provides a reasonable rate of return. So whatever economic damage was done to the economy by residential real estate speculation may eventually be equalled by commercial real estate. Say another 10th or seventh of GDP erased, or another two-three years of growth gone.
Second, there's also the war in Iraq. Some U.S. economists recently estimated it has cost about two trillion dollars to date - another two-sevenths of U.S. GDP. That's five more years of GDP growth gone.
And third, we haven't even begun to tally the private equity blowups that are surely coming. Taken all together, the economic damage spells a very bad and long recession. How to fix it? No problem, say the actions of Mr. Bernanke's Fed. Let's print the missing money - and it doesn't matter if it causes inflation and tanks the dollar. Because that's not our job.
Up to now Mr. Volcker kept quiet, but no more. In his speech he just said, in effect, that the recession is not the Fed's problem. It's the government's. The Fed's job is to defend the currency and fight inflation - exactly the opposite of what this Fed is doing. The solution? Raise interest rates, Mr. Volcker practically said, no matter the consequences now, because if you don't, you'll have to raise them even more later, with even more awful consequences.
Will rates indeed rise? I have no doubt they must. Not now, perhaps, but at the end of this year or the beginning of 2009, with a new president in the White House. The stock market, which usually looks six to nine months ahead, already understands this and may soon react. In fact, when Mr. Volcker's words sink in, the markets are likely to sink as this bear market rally ends. For surely you understand we are still in a bear market - and only in the beginning of it? Yes, we are experiencing a rally, and like most bear rallies, it is sharp and spiky. But when bear rallies end, they leave a lot of spiked bulls behind - and this rally should be no different. When it is over -in the next few weeks, methinks - the waterfall could continue, as the market begins to digest the inevitability of higher inflation and higher interest rates ahead.
Against all protocol, Mr. Volcker just went out on a limb and warned you of this. I urge you to heed his words.
J
THE BUY SIDE: POLITICS
AVNER MANDELMAN
APRIL 12, 2008
A few days ago an unusual event took place: Paul Volcker, the mythical U.S. Federal Reserve Board chairman from the Reagan years, criticized the policy of the current Fed chairman, Ben Bernanke, in a speech to the Economic Club of New York. Just so you grasp how extraordinary this was, you should first understand that normally a past Fed chairman scrupulously avoids saying anything at all about current Fed policy - for the simple reason that the current Fed chairman's words are one of his most important tools: They can sway markets.
This ability does not fade entirely when a Fed chairman leaves. So when a past Fed chairman speaks, his words can clash with those of the present one and make that one's job difficult. Out of professional courtesy, past Fed chairmen therefore keep quiet; Mr. Volcker especially - the man who hiked interest rates to 20 per cent to kill inflation, at the cost of a deep recession. But last week Mr. Volcker spoke his mind bluntly. He said, in effect, that the current Fed is not doing its job.
This would have been unusual enough. But Mr. Volcker went further. Not only is the Fed not doing its job, he said, but it is doing the wrong job: It is defending the economy and the market, instead of defending the dollar. And just to stick the knife in, Mr. Volcker added that this bad job now will make the real job - defending the greenback - much harder later. It'll cause even greater economic suffering.
In plain words, Mr. Volcker implied that the current Fed is not only incompetent, but that its actions are dangerous. There is no record of Mr. Bernanke's reaction, nor that of anyone else inside the Fed. But there was plenty of buzz in the market because what Mr. Volcker said amounted to a rousing call to raise interest rates. Yes, raise rates, and do it now.
Can you imagine what this would do to the market? I sure can, which brings me to the gap between physical economic reality as we witness it every day in our physical investigations, and the surreal market chatter we see and hear on TV. This gap has never been wider - but it will inevitably close as markets catch up to reality - as just forecast by former president Ronald Reagan's Fed chairman.
Let me cite three items, then go back to Mr. Volcker. First, commercial real estate. You surely have read about the residential real estate problems - subprime loans syndicated and resold, causing the implosion of several U.S. financial institutions. The writeoffs and damage here total close to a trillion dollars, said the IMF recently. That's about one-seventh of the U.S. gross domestic product, or more than three years of growth. But what of commercial real estate? I heard recently from some savvy private real estate investors that although commercial real estate fell by 20%, it should fall by a further 20 to 30 per cent before it provides a reasonable rate of return. So whatever economic damage was done to the economy by residential real estate speculation may eventually be equalled by commercial real estate. Say another 10th or seventh of GDP erased, or another two-three years of growth gone.
Second, there's also the war in Iraq. Some U.S. economists recently estimated it has cost about two trillion dollars to date - another two-sevenths of U.S. GDP. That's five more years of GDP growth gone.
And third, we haven't even begun to tally the private equity blowups that are surely coming. Taken all together, the economic damage spells a very bad and long recession. How to fix it? No problem, say the actions of Mr. Bernanke's Fed. Let's print the missing money - and it doesn't matter if it causes inflation and tanks the dollar. Because that's not our job.
Up to now Mr. Volcker kept quiet, but no more. In his speech he just said, in effect, that the recession is not the Fed's problem. It's the government's. The Fed's job is to defend the currency and fight inflation - exactly the opposite of what this Fed is doing. The solution? Raise interest rates, Mr. Volcker practically said, no matter the consequences now, because if you don't, you'll have to raise them even more later, with even more awful consequences.
Will rates indeed rise? I have no doubt they must. Not now, perhaps, but at the end of this year or the beginning of 2009, with a new president in the White House. The stock market, which usually looks six to nine months ahead, already understands this and may soon react. In fact, when Mr. Volcker's words sink in, the markets are likely to sink as this bear market rally ends. For surely you understand we are still in a bear market - and only in the beginning of it? Yes, we are experiencing a rally, and like most bear rallies, it is sharp and spiky. But when bear rallies end, they leave a lot of spiked bulls behind - and this rally should be no different. When it is over -in the next few weeks, methinks - the waterfall could continue, as the market begins to digest the inevitability of higher inflation and higher interest rates ahead.
Against all protocol, Mr. Volcker just went out on a limb and warned you of this. I urge you to heed his words.
Friday, April 11, 2008
Yuan continues rise against the dollar
This aritcle on the Yuan's steady appreciation against the US dollar appeared in yesterday's IHT. Domestic inflation in China is rising steadily, while the it's central bank is being pressured to allow further appreciation. The rising Yuan's effect on the US dollar coulpled with the ECB's recent decision to freeze interest rates portends further weakness for the US dollar.
Dollar falls below 7 yuan for first time since 1993
By Lu JianxinReuters
Thursday, April 10, 2008
SHANGHAI: The dollar weakened and slipped below 7.00 yuan on Thursday for the first time in over a decade, underlining China's growing economic strength and its increasing use of the currency as a policy tool.
The central bank, which tightly controls the foreign exchange market, paved the way for the rise by fixing the yuan's daily mid-point, or reference rate, at a fresh high of 6.9920 before trade began. The yuan opened at 6.9920 against the dollar compared to 7.0017 at Wednesday's close. It was the first trade above 7.00 since China devalued the yuan to 8.7 from 5.8 at the start of 1994, creating a modern foreign exchange market.
"China is now under both international and domestic pressure for the yuan to appreciate at a fast pace," said Liu Dongliang, currency analyst at China Merchants Bank in Shenzhen. The Chinese central bank tightly controls the market through regulations and indirect intervention, and has limited the pace of yuan appreciation to support growth in China's exports.
But since July 2005, when the yuan was revalued and its peg to the dollar scrapped, its rise against the dollar has gained pace each year, from 2.6 percent in 2005 to 3.4 percent in 2006 and 6.9 percent in 2007. So far this year, it is up 4.5 percent. The acceleration is partly due to the weakness of the dollar in global markets, and to diplomatic pressure by China's major trading partners for faster appreciation to cut the huge Chinese trade surplus.
Last November, the central bank declared for the first time that it would use the exchange rate actively to fight inflation, which hit an 11-year high of 8.7 percent in February this year. That suggests China is gradually shifting toward managing its currency in the same way as developed economies, allowing big swings to cool the economy when it overheats and to stimulate it during slowdowns, analysts said.
"There now appears to be a clear understanding among the top leadership that sticking to a devalued currency is not good for the Chinese economy, including inflation," said a dealer at a top Chinese state-owned bank in Beijing. He declined to be named because he was not authorized to speak publicly to media.
Yuan appreciation has become especially important to restrain inflation since the start of this year as the central bank has partially loosened domestic monetary policy, flooding the money market with funds to ease financing problems at small companies.
Some foreign investment banks speculate that to prevent inflows into China of funds betting on continuous yuan appreciation, authorities may resort to another large, immediate revaluation of the currency.
But Chinese leaders have publicly ruled out such a step, and the onshore foreign exchange market believes it is highly unlikely because of the instability it could cause.
Instead, dealers said yuan appreciation will slow in the second half of this year as inflation eases and the central bank guards the economy against a slowdown in U.S. and global growth. While the strong yuan helps Chinese firms such as airlines and oil importers to reduce their overseas procurement costs, it is already hurting lower-end exporters such as clothing makers.
Reflecting expectations for yuan appreciation to slow later in 2008, one-year appreciation against the dollar implied by offshore forwards has dropped in recent weeks, to 11.2 percent on Thursday from a record 13.8 percent in mid-March.
Onshore dealers generally have predicted the yuan will appreciate 8.5 to 10 percent for all of this year. The yuan's strength is gradually making it an attractive store of value around the region. Yuan bank accounts in Hong Kong are expanding rapidly, and Chinese businessmen and tourists informally exchange the yuan around southeast Asia.
But for the yuan to become a major traded currency on the scale of the dollar or euro, China will need to remove capital controls and allow much greater market volatility- steps which remain many years away, analysts said.
Dollar falls below 7 yuan for first time since 1993
By Lu JianxinReuters
Thursday, April 10, 2008
SHANGHAI: The dollar weakened and slipped below 7.00 yuan on Thursday for the first time in over a decade, underlining China's growing economic strength and its increasing use of the currency as a policy tool.
The central bank, which tightly controls the foreign exchange market, paved the way for the rise by fixing the yuan's daily mid-point, or reference rate, at a fresh high of 6.9920 before trade began. The yuan opened at 6.9920 against the dollar compared to 7.0017 at Wednesday's close. It was the first trade above 7.00 since China devalued the yuan to 8.7 from 5.8 at the start of 1994, creating a modern foreign exchange market.
"China is now under both international and domestic pressure for the yuan to appreciate at a fast pace," said Liu Dongliang, currency analyst at China Merchants Bank in Shenzhen. The Chinese central bank tightly controls the market through regulations and indirect intervention, and has limited the pace of yuan appreciation to support growth in China's exports.
But since July 2005, when the yuan was revalued and its peg to the dollar scrapped, its rise against the dollar has gained pace each year, from 2.6 percent in 2005 to 3.4 percent in 2006 and 6.9 percent in 2007. So far this year, it is up 4.5 percent. The acceleration is partly due to the weakness of the dollar in global markets, and to diplomatic pressure by China's major trading partners for faster appreciation to cut the huge Chinese trade surplus.
Last November, the central bank declared for the first time that it would use the exchange rate actively to fight inflation, which hit an 11-year high of 8.7 percent in February this year. That suggests China is gradually shifting toward managing its currency in the same way as developed economies, allowing big swings to cool the economy when it overheats and to stimulate it during slowdowns, analysts said.
"There now appears to be a clear understanding among the top leadership that sticking to a devalued currency is not good for the Chinese economy, including inflation," said a dealer at a top Chinese state-owned bank in Beijing. He declined to be named because he was not authorized to speak publicly to media.
Yuan appreciation has become especially important to restrain inflation since the start of this year as the central bank has partially loosened domestic monetary policy, flooding the money market with funds to ease financing problems at small companies.
Some foreign investment banks speculate that to prevent inflows into China of funds betting on continuous yuan appreciation, authorities may resort to another large, immediate revaluation of the currency.
But Chinese leaders have publicly ruled out such a step, and the onshore foreign exchange market believes it is highly unlikely because of the instability it could cause.
Instead, dealers said yuan appreciation will slow in the second half of this year as inflation eases and the central bank guards the economy against a slowdown in U.S. and global growth. While the strong yuan helps Chinese firms such as airlines and oil importers to reduce their overseas procurement costs, it is already hurting lower-end exporters such as clothing makers.
Reflecting expectations for yuan appreciation to slow later in 2008, one-year appreciation against the dollar implied by offshore forwards has dropped in recent weeks, to 11.2 percent on Thursday from a record 13.8 percent in mid-March.
Onshore dealers generally have predicted the yuan will appreciate 8.5 to 10 percent for all of this year. The yuan's strength is gradually making it an attractive store of value around the region. Yuan bank accounts in Hong Kong are expanding rapidly, and Chinese businessmen and tourists informally exchange the yuan around southeast Asia.
But for the yuan to become a major traded currency on the scale of the dollar or euro, China will need to remove capital controls and allow much greater market volatility- steps which remain many years away, analysts said.
Thursday, April 10, 2008
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