It has been widely noted this week, including here and also again here, that Bill Gross is on record as describing US current monetary policy as having all of the characteristics of a Ponzi scheme. At the same time Gross also proposes that Chairman Bernanke has really no other options than to implement such a scheme, as he has run out of all other viable policy weapons.
But what about the argument that he could/should do nothing and wean the US economy off a diet of endless asset purchases? In essence the flaw in this argument is that he may not have the option of curtailing QE and, in an ironic sense, this would go a step further in exonerating the Fed Chairman.
Looked at from the perspective of the US government's finances, although the unintended consequences of QE are highly undesirable - e.g. a weaker US dollar, friction with other global trading partners, creation of asset bubbles in emerging markets, booming commodity prices etc. - the US economy is most likely now addicted to QE in the same way that happens in any Ponzi scheme.
There's an old saying that a "rolling loan gathers no loss" and if government's simply roll forward expiring debt with new debt in moderation this does not pose systemic risk. However when the magnitude of the expiring debt is so colossal, and where there is clear evidence that, were it not for the stated aim of the Fed that it is effectively backstopping the Treasury market, non US government buyers (e.g. PIMCO, pension funds, PBOC, BOJ etc) may not participate (at least not at current historically low coupon rates).
There is much talk about the Fed's exit strategy but if the Ponzi scheme is as voracious as it appears to be, due to the over-commitments of US federal debt obligations, it looks as though the Fed is trapped. Not only will it be the lender of last resort it may ultimately become the only lender. Unless the Fed continues to reassure other market players such as other sovereign buyers, banks and pension funds, that they - and this includes PIMCO as well - can turn over their inventory quickly to the Fed if the market becomes illiquid, the absence of bids will create that very same illiquidity and systemic risk.
For many private investors, and this may well include PIMCO, it is not their intention to hold a 10 year bond to maturity. Rather they wish to avail themselves of easy exit possibilities from an accommodating central banker running a public buyback program. This "easy exit" is especially true should interest rates be rising and the value of the bond is declining. Usually it is only very long term asset managers such as pension funds that are committed to such buy and hold strategies - with all of the interest rate risk and duration difficulties that comes along with such an extended holding horizon.
More typically for many private investors their typical holding period may be weeks/months where they are looking to unload the bonds at higher prices each time the Fed steps in with more QE.
If the Fed terminates QE just how easy will it be to keep the Ponzi scheme afloat?
In a nutshell, this is why Chairman Bernanke is "boxed in" and why not only Mr. Gross is turning bearish on US bonds but also so are other major holders such as the People's Bank of China.
Friday, 29 October 2010
Wednesday, 27 October 2010
It's now respectable to call it a Ponzi scheme
Whether one calls it Quantitative Easing (QE), or one uses any other of the multitude of acronyms that have been floated since TARP, the simplest nomenclature for the financial mechanics which constitute US monetary policy is to call it what it really is - a Ponzi scheme. Reduced to its simplest the US Treasury issues bonds at which the principal buyer (or implicit guarantor that indefinitely large quantities of the bonds will always be accepted as collateral) is the Federal Reserve.
Over several years, but especially the two most recent, a number of market commentators, not within the mainstream of "reputable finance", have been gutsy enough to characterize the manner in which the public sector balance sheet has been expanded to prop up asset prices as a Ponzi scheme. But most have been marginalized or considered to be part of the loony blogosphere and dismissed by their more "respectable" and politically correct peers.
In his current commentary Bill Gross from PIMCO has finally uttered the words which give a new respectability and gravitas to this characterization. Here is the relevant section from his current commentary .
The only real question is why is it only now that Mr. Gross is willing to publicly acknowledge something which he must surely have known and thought about dozens of times over a very long period? Surely it couldn't be as simple as the fact that in the same letter he predicts that the 30 year bull market in Treasuries is now over. For Mr Gorss to reach this conclusion one is left wondering just how consequential it is for capital markets that he has realized that, even with PIMCO's vast buying power, a monetary policy predicated on QE, like all Ponzi schemes, eventually requires an incommensurately large flow of money from investors to keep the scheme going.
For a graphic image of just how unsustainable this self-reflexivity eventually becomes there is the archetype known as Ouroboros which is a voracious creature that ends up devouring its own tail.
Over several years, but especially the two most recent, a number of market commentators, not within the mainstream of "reputable finance", have been gutsy enough to characterize the manner in which the public sector balance sheet has been expanded to prop up asset prices as a Ponzi scheme. But most have been marginalized or considered to be part of the loony blogosphere and dismissed by their more "respectable" and politically correct peers.
In his current commentary Bill Gross from PIMCO has finally uttered the words which give a new respectability and gravitas to this characterization. Here is the relevant section from his current commentary .
It seems that the Fed has taken Charles Ponzi one step further. Instead of simply paying for maturing debt with receipts from financial sector creditors – banks, insurance companies, surplus reserve nations and investment managers, to name the most significant – the Fed has joined the party itself. Rather than orchestrating the game from on high, it has jumped into the pond with the other swimmers. One and one-half trillion in checks were written in 2009, and trillions more lie ahead. The Fed, in effect, is telling the markets not to worry about our fiscal deficits, it will be the buyer of first and perhaps last resort. There is no need – as with Charles Ponzi – to find an increasing amount of future gullibles, they will just write the check themselves. I ask you: Has there ever been a Ponzi scheme so brazen? There has not. This one is so unique that it requires a new name. I call it a Sammy scheme, in honor of Uncle Sam and the politicians (as well as its citizens) who have brought us to this critical moment in time. It is not a Bernanke scheme, because this is his only alternative and he shares no responsibility for its origin. It is a Sammy scheme – you and I, and the politicians that we elect every two years – deserve all the blame.
The only real question is why is it only now that Mr. Gross is willing to publicly acknowledge something which he must surely have known and thought about dozens of times over a very long period? Surely it couldn't be as simple as the fact that in the same letter he predicts that the 30 year bull market in Treasuries is now over. For Mr Gorss to reach this conclusion one is left wondering just how consequential it is for capital markets that he has realized that, even with PIMCO's vast buying power, a monetary policy predicated on QE, like all Ponzi schemes, eventually requires an incommensurately large flow of money from investors to keep the scheme going.
For a graphic image of just how unsustainable this self-reflexivity eventually becomes there is the archetype known as Ouroboros which is a voracious creature that ends up devouring its own tail.
Friday, 22 October 2010
More than usual FX is driving markets
Several commentators (including myself) have recently pointed out that much more than usual asset markets are being driven by price developments in the foreign exchange markets. And in trading yesterday across several FX pairs and watching the associated movements in equities, gold, oil and other commodities the broad theme was exemplified par excellence
Here are some "Big Picture" themes for a "dress down" Friday column.
1. There is an inherent bias in US monetary policy to weaken the US dollar, despite all protestations to the contrary.
2. The Chinese know this and, as George Soros has recently commented, they have sufficient reserves and enough skin in the game that they can effectively "manage" (manipulate) the FX markets to achieve their longer term goals of diversification so that they are less reliant on dollar denominated assets and at the same time secure their stake in resources/commodities to continue to grow their economy at 10% per annum.
3. The world is awash in dollar liquidity which helps to explain why US equities and bonds have marched relentlessly higher despite, especially in the case of Treasuries, the real inflation adjusted returns and expected future returns seem absurdly "underpriced" and defy explanations from "traditional finance theory".
4. Many major funds are massively short US dollars from the use of all kinds of derivatives which are tied into correlation strategies involving everything from commodity plays to yield curve arbitrage and ETF rotation plays.
5. It would not take too much evidence of a short term US dollar rally to lead to some sudden and large scale shifts in asset allocation
6. Continuing with the theme from earlier this week in this column, many global equity indices are stalling at key fibonacci levels
7. Systematic (i.e. overall market) risk is under-priced
8. Exactly how global policy makers would deal with another bout of systemic risk remains a mystery of staggering proportions.
The intraday moves on the S&P 500 are becoming more erratic which is indicative of a lot of short sellers trying to pick an intermediate term top and to a large extent the "traps" are being set in the FX market where, even if the S&P 500 shows remarkable resilience, the astute inter-market traders can reap their rewards from coordinated plays with strategic FX pairs.
1200 is still the upside target but the 1155 value registered earlier this week also represents an Achilles heel which may need to be tested again before the April highs are challenged.
To end for today ... it is vital for those large funds that are aligned with the Chinese currency management goals, and are counting on a weak dollar to sustain further gains in the S&P 500, that the ambushes based on selling the euro, aussie and sterling do not turn into a rout.
Here are some "Big Picture" themes for a "dress down" Friday column.
1. There is an inherent bias in US monetary policy to weaken the US dollar, despite all protestations to the contrary.
2. The Chinese know this and, as George Soros has recently commented, they have sufficient reserves and enough skin in the game that they can effectively "manage" (manipulate) the FX markets to achieve their longer term goals of diversification so that they are less reliant on dollar denominated assets and at the same time secure their stake in resources/commodities to continue to grow their economy at 10% per annum.
3. The world is awash in dollar liquidity which helps to explain why US equities and bonds have marched relentlessly higher despite, especially in the case of Treasuries, the real inflation adjusted returns and expected future returns seem absurdly "underpriced" and defy explanations from "traditional finance theory".
4. Many major funds are massively short US dollars from the use of all kinds of derivatives which are tied into correlation strategies involving everything from commodity plays to yield curve arbitrage and ETF rotation plays.
5. It would not take too much evidence of a short term US dollar rally to lead to some sudden and large scale shifts in asset allocation
6. Continuing with the theme from earlier this week in this column, many global equity indices are stalling at key fibonacci levels
7. Systematic (i.e. overall market) risk is under-priced
8. Exactly how global policy makers would deal with another bout of systemic risk remains a mystery of staggering proportions.
The intraday moves on the S&P 500 are becoming more erratic which is indicative of a lot of short sellers trying to pick an intermediate term top and to a large extent the "traps" are being set in the FX market where, even if the S&P 500 shows remarkable resilience, the astute inter-market traders can reap their rewards from coordinated plays with strategic FX pairs.
1200 is still the upside target but the 1155 value registered earlier this week also represents an Achilles heel which may need to be tested again before the April highs are challenged.
To end for today ... it is vital for those large funds that are aligned with the Chinese currency management goals, and are counting on a weak dollar to sustain further gains in the S&P 500, that the ambushes based on selling the euro, aussie and sterling do not turn into a rout.
Thursday, 21 October 2010
Selling England By The Pound
Residents of the world’s largest onshore tax haven, or as it has been amusingly described by Ambrose Evans Pritchard, a rainy version of the Cayman Islands in the North Atlantic, are getting set for belt tightening as the government is chopping away at entitlement programs and getting rid of 500,000 public sector workers in the coming three years or so.
But the borrowing continues with record public deficits - in September alone the UK required more than £15bn to plug the gap between revenues and expenditures.
However, it is heartening to hear the political leaders talking about how "we’re all in this together", but as I commented on Twitter yesterday, there are quite a lot of MP’s that will have to clean up their own tax avoidance (evasion) shenanigans before that slogan becomes too laughable.
Anyway enough of politics and let’s take the higher ground - and in this case it looks almost certainly higher ground for $EURGBP as targets above 0.90 are now alive and well. On the contrary it is lower ground for $GBPUSD with imminent targets in the $1.5640 region. But as FX traders can attest sterling sometimes takes the long way home, and whipsaw behavior is to be expected as the whiz kids in the towers at Canary Wharf engage in their passion for "bouncy castles".
Continuing with the theme of both fibonacci retracements and Great Britain as it is sometimes referred to (especially by George W Bush as I recall), the chart for EWU shows that the MSCI UK index also faces a challenge to remain above the 62% retracement level. It has been turned back already three times so far in 2010.
One of the more novel ways that the UK government may try to dig out from its mountain of debt is by selling off "bits" from the public sector in a 2010 version of Margaret Thatcher’s privatization. Going even further back into modern UK history, and with reminiscences of Edward Heath, three day weeks and power cuts, if the government does decide to "privatize" some bridges and other bits of infrastructure, serious thought should be given to a re-issue of the classic 1973 Genesis album Selling England by the Pound.
But the borrowing continues with record public deficits - in September alone the UK required more than £15bn to plug the gap between revenues and expenditures.
However, it is heartening to hear the political leaders talking about how "we’re all in this together", but as I commented on Twitter yesterday, there are quite a lot of MP’s that will have to clean up their own tax avoidance (evasion) shenanigans before that slogan becomes too laughable.
Anyway enough of politics and let’s take the higher ground - and in this case it looks almost certainly higher ground for $EURGBP as targets above 0.90 are now alive and well. On the contrary it is lower ground for $GBPUSD with imminent targets in the $1.5640 region. But as FX traders can attest sterling sometimes takes the long way home, and whipsaw behavior is to be expected as the whiz kids in the towers at Canary Wharf engage in their passion for "bouncy castles".
Continuing with the theme of both fibonacci retracements and Great Britain as it is sometimes referred to (especially by George W Bush as I recall), the chart for EWU shows that the MSCI UK index also faces a challenge to remain above the 62% retracement level. It has been turned back already three times so far in 2010.
One of the more novel ways that the UK government may try to dig out from its mountain of debt is by selling off "bits" from the public sector in a 2010 version of Margaret Thatcher’s privatization. Going even further back into modern UK history, and with reminiscences of Edward Heath, three day weeks and power cuts, if the government does decide to "privatize" some bridges and other bits of infrastructure, serious thought should be given to a re-issue of the classic 1973 Genesis album Selling England by the Pound.
Monday, 11 October 2010
Currency war - for China a smoke and mirrors job
The following brief citation which I came across at the naked capitalism website, expresses the unusual power which China has in the world of FX as alluded to here.
Furthermore it also helps to explain why, for the US to condone Japanese currency management (or at least not to criticize it), the Chinese government can afford to take the high ground and a tough stance in the negotiation, instigated by the US Treasury secretary, about increased voting rights for BRIC nations in the IMF as discussed here
Congratulations to the writer of the above paragraph as it captures elegantly the essence of the back and forth on the "currency war" issue.
Furthermore it also helps to explain why, for the US to condone Japanese currency management (or at least not to criticize it), the Chinese government can afford to take the high ground and a tough stance in the negotiation, instigated by the US Treasury secretary, about increased voting rights for BRIC nations in the IMF as discussed here
"Japanese intervention...means that Chinese authorities managed to get Japan to acquire their Dollar reserves for them. Instead of buying Dollars, China buys Yen, which in turn induce Japan to buy Dollars. This maintains the artificial capital flows to the US while allowing China to escape accusations of being a “currency manipulator.”
Congratulations to the writer of the above paragraph as it captures elegantly the essence of the back and forth on the "currency war" issue.
Saturday, 9 October 2010
What currency war?
The following comes from the Nasdaq website as the IMF meeting in Washington appears to be failing to agree on a resolution to address the accusations that there is a currency war
China's official Xinhua News Agency on Saturday sought to turn the table on the U.S., accusing it of being the currency manipulator and of threatening the global economic recovery. The Xinhua article, citing officials at government think tanks, pointed to the dollar's 12% fall against the euro since June and recent strength of Brazilian real, the Japanese yen, the Korean won and other currencies and the possibility of Federal Reserve Board quantitative easing measures as evidence that the U.S. purposely weakens its currency indirectly. "The U.S. not only manipulates the dollar's exchange rates, it also manipulates other countries' exchange rates," Xinhua quoted Cao Honghui, a division chief at the Chinese Academy of Social Sciences, as saying. Chinese scholars have made such accusations before whenever China's currency manipulator status is being discussed in the U.S., but this fresh accusation comes as the yuan valuation issue is at the center of attention during the IMF/World Bank meetings in Washington.
The systemic view from eight miles high
ZIRP, QE and competitive devaluations all manifestations of late stage Ponzi capitalism (that’s capitalism with a public backstop, of course)
Is Mr Geithner really in a position to make such demands on China?
The following "initiative" from Mr. Geithner follows on from a theme articulated earlier in the week in which the older and supposedly richer (in fact, the most indebted) economies are prepared to grant more power to the newer and less affluent (in fact, surplus economies with huge currency reserves and savings) economies in the G20 with respect to IMF voting rights.
Surely there is great irony in the fact that Mr. Geithner has so little leverage to exert over the PBOC and central banks of the G20 "tigers", that the reverse situation of China and the other BRIC's considering how many votes should be allotted to the US, UK, France, Spain etc, would be a much more plausible scenario.
Moreover, there is further irony in the fact that the PBOC are doing the US a massive favor at present by unloading their US dollars in exchange for yen, euros and Aussie and Canadian dollars, which has the affect of enabling the US to have the most successful stance in competitive devaluations, with the side benefit for China that the exports from Germany, Japan, Canada etc will be relatively less competitive in world markets than the yuan based manufacturing which is tied to a depreciating US dollar.
From the viewpoint of IMF realpolitik it really feels as though the tail (Mr. Geithner) is trying to wag the dog (PBOC).
WASHINGTON (MarketWatch) -- The United States has linked a faster rise in China's currency to a deal that would give the Asian country more sway at the International Monetary Fund. In a speech to the IMF's governing council on Saturday, Treasury Secretary Timothy Geithner said any agreement to give emerging market economies more voting power at the IMF "needs to be accompanied with more progress by countries, particularly the surplus countries, towards more market-oriented exchange rate policies and policies that will reduce reliance on exports and strengthen domestic demand." The top Chinese representative at the IMF talks, Zhou Xiaochuan, the head of China's central bank, has already rejected any link between the two issues. The U.S. has been seeking new levers to force China to let its currency rise.
Surely there is great irony in the fact that Mr. Geithner has so little leverage to exert over the PBOC and central banks of the G20 "tigers", that the reverse situation of China and the other BRIC's considering how many votes should be allotted to the US, UK, France, Spain etc, would be a much more plausible scenario.
Moreover, there is further irony in the fact that the PBOC are doing the US a massive favor at present by unloading their US dollars in exchange for yen, euros and Aussie and Canadian dollars, which has the affect of enabling the US to have the most successful stance in competitive devaluations, with the side benefit for China that the exports from Germany, Japan, Canada etc will be relatively less competitive in world markets than the yuan based manufacturing which is tied to a depreciating US dollar.
From the viewpoint of IMF realpolitik it really feels as though the tail (Mr. Geithner) is trying to wag the dog (PBOC).
China controls the world currency markets says George Soros
George Soros, interviewed on the BBC Radio 4 program Today (October 9) can be heard in the clip referenced below making the rather striking assertion that the "Chinese effectively control the entire world's currency system".
Here is the audio clip and the assertion comes around 1:40 into the interview segment.
Notice how the interviewer completely fails to grasp the true significance of what Soros is alleging and moves on with the interview in a one-dimensional and prosaic manner to talk about re-valuation of the yuan against the dollar.
If Soros is right, and there is mounting evidence that he is, for example as I have discussed in this article , which can also be found here, the consequences for those running global asset allocation strategies and believing in the notion that markets, especially in FX, are price discovery mechanisms, should really be quite disruptive.
Here is the audio clip and the assertion comes around 1:40 into the interview segment.
Notice how the interviewer completely fails to grasp the true significance of what Soros is alleging and moves on with the interview in a one-dimensional and prosaic manner to talk about re-valuation of the yuan against the dollar.
If Soros is right, and there is mounting evidence that he is, for example as I have discussed in this article , which can also be found here, the consequences for those running global asset allocation strategies and believing in the notion that markets, especially in FX, are price discovery mechanisms, should really be quite disruptive.
Saturday, 2 October 2010
The twists and turns of Chinese currency management
The following news item from Reuters on Saturday (October 2nd) shows some remarkable cunning in an era when accusations are being hurled around about currency manipulation and especially the Chinese version of it, which is multi-faceted, and includes, to the annoyance of the Japanese central bank, the enthusiasm that the PBOC has for buying the yen whenever the BOJ tries to make it cheaper. The current visit by the Chinese Premier to Greece is now providing an opportunity for further magnanimity which could result in a stronger euro, which may not be exactly what Monsieur Trichet has in mind.
The last quote is particularly revealing as it achieves at least three objectives for the world's second largest economy:
1. It is a recognition by the Chinese authorities that in a fragile and totally inter-connected financial system, a serious crisis for the basket case EZ economies would be especially harmful to China which has vast holdings of euros and the government bonds of the Eurozone constituent states.
2. The support of China for the sovereign credits of Greece, and quite likely the other PIIGS economies will help to further bolster the euro against the yuan. This can only be good for Chinese exporters.
3. Furthermore it could have the affect of diverting attention away from the current antagonism between Washington and Beijing over the artificially low rate of exchange between the US currency and the yuan. Ironically by supporting the Eurozone financial system, and indirectly the euro, it will become harder for the ECB and the Federal Reserve to condemn the Chinese actions, which can only be considered as making a positive contribution from the perspective of helping to avert systemic anxieties.
In the post-2008 meltdown era, the trend towards a more altruistic form of "capitalism", some would even say outright socialization of the global financial system, China appears to be taking a leadership role in recognizing its dependency on the continued solvency of its less dynamic trading partners by rewarding them with pledges of further financial support. In so doing the Chinese authorities will continue to find even more reasons to continue its policy of "currency management". Perversely policy makers in the US and Eurozone may not appreciate such altruism.
(Reuters) - China offered on Saturday to buy Greek government bonds when the country returns to markets, in a show of support for the country whose debt burden pushed the euro zone into crisis and required an international bailout.
Premier Wen Jiabao made the offer at the start of a two-day visit to Greece, his first stop on a tour of Europe, and also said he wanted to boost shipping and trade ties with Athens, underscoring Beijing's use of economic strength to win friends.
"With its foreign exchange reserve, China has already bought and is holding Greek bonds and will keep a positive stance in participating and buying bonds that Greece will issue," Wen said, speaking through an interpreter.
"China will undertake a great effort to support euro zone countries and Greece to overcome the crisis."
The last quote is particularly revealing as it achieves at least three objectives for the world's second largest economy:
1. It is a recognition by the Chinese authorities that in a fragile and totally inter-connected financial system, a serious crisis for the basket case EZ economies would be especially harmful to China which has vast holdings of euros and the government bonds of the Eurozone constituent states.
2. The support of China for the sovereign credits of Greece, and quite likely the other PIIGS economies will help to further bolster the euro against the yuan. This can only be good for Chinese exporters.
3. Furthermore it could have the affect of diverting attention away from the current antagonism between Washington and Beijing over the artificially low rate of exchange between the US currency and the yuan. Ironically by supporting the Eurozone financial system, and indirectly the euro, it will become harder for the ECB and the Federal Reserve to condemn the Chinese actions, which can only be considered as making a positive contribution from the perspective of helping to avert systemic anxieties.
In the post-2008 meltdown era, the trend towards a more altruistic form of "capitalism", some would even say outright socialization of the global financial system, China appears to be taking a leadership role in recognizing its dependency on the continued solvency of its less dynamic trading partners by rewarding them with pledges of further financial support. In so doing the Chinese authorities will continue to find even more reasons to continue its policy of "currency management". Perversely policy makers in the US and Eurozone may not appreciate such altruism.
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