Posts filed under “Currency”
The press and the market continues to speculate about the negative impact of an exit of Greece from the Euro (expectations seems to be over 50%) and both the financial consequences of such an exit on the EZ (indeed everyone else) and, in particular, on the adverse contagion issues in respect of the other PIIGS and core EZ countries, for that matter. Yes it is true that the Greek party Syriza (comprising leftist anti bail out elements) came a surprising second in the last elections and, until recently, has lead in the polls. However, the most recent polls suggest that the Greeks may well be rethinking. New Democracy (23.1%) is narrowly back in the lead (with indications that its support is increasing), followed by Syriza and then Pasok some 10 points behind. If the next elections (due on 17th June) reflect recent polls, a coalition comprising New Democracy and Pasok will be able to form a working majority in Parliament, something which I believe the market has not picked up on as yet
Early days, but I for one believe that the trend away from Syriza will continue. Greeks, by an overwhelming majority (between 75% to 80%) want to remain in the Euro, as they realise that the reintroduction of the Drachma will result in an effective devaluation of at least 50%, by all accounts. The resultant hardship (the need to close the current account deficit to zero immediately) will make the current austerity plans seems like a mild dose of influenza, compared with the pneumonia that will follow an Euro exit. Yes the EZ will be negatively impacted, but the Greeks will make up their minds, based on the likely impact on themselves. This suggests to me that voters will swing away from Syriza and to New Democracy, in particular.
Whilst the Greeks want to remain in the Euro, they do not want to abide by the austerity measures, which their previous administration agreed to. Yes the austerity measures are tough, very likely too tough, but Greece needs to sort out the fiscal mess which it created for itself. The EU suggests that the Geeks will be offered some “sweeteners” if they chose to remain in the Euro, including some kind of growth measures (whatever they are) and possibly a watering down some aspects of the austerity measures. Will this be enough to persuade the Greek voters from following the nonsensical path proposed by the head of the Syriza, Mr Tsipras. Personally, I am beginning to believe that it may. Am I convinced - certainly not, but as days go by, I would not be surprised if the polls indicate that support for Syriza ebbs away and New Democracy’s lead increases.
If I’m right, markets should begin to recover. Personally, I just wish that Greece goes away. The gloom and doom scenario guys are overstating the impact of a Greek exit in my humble view. Yes, there will be huge losses for the EZ, but certainly not of the order of E1tr suggested by Mr Dallara of the IIF – do you think he has a vested interest – of course he does, as he acts for the small group of remaining private sector bondholders who will lose everything if Greece exit’s the Euro. He has every interest in exaggerating the size of the potential losses, in an attempt to get the EZ to offer more assistance to the EZ. Estimates of losses for the EZ (including banks etc) from a Geek exit, range from E150bn (too low in my opinion) to Mr Dallara’s E1tr (ludicrously high) – big numbers in any event. However, a Greek exit will force the ECB to act. Citi estimates that the ECB will have to provide some E800bn in liquidity to mitigate a run on EZ banks in the event of a Greek exit. In addition, the ECB will lower interest rates, buy Spanish and Italian bonds (quite possibly other country bonds) in size and introduce QE, etc, etc, something which is necessary. Draghi will have the perfect excuse to act. As a result, after the initial shock, I for one believe that the EZ will finally have begun to take the action necessary to start to resolve the crisis – there would be no alternative. Consequently, I really hope that Greek voters follow Syriza, but I fear that they wont.
Trying to predict anything involving the Greeks is virtually mission impossible. However, I am beginning to wonder whether the current excitement/panic is way overdone. I have closed all my shorts and remain hugely cashed up, but may well nibble away a bit more in coming weeks. However, it is impossible, in my humble view, to come up with an informed view at present and, as a result, extreme caution is the name of the game. There will be time.
The Yen’s Looming Day of Reckoning
By Andy Xie
Japan looks set to depress the value of the yen to boost trade – how China must brace itself for the impact
Japan is on an unsustainable path of a strong yen and deflation. The unprofitability of Japan’s major exporters and emerging trade deficits suggest that the end of this path is in sight. The transition from a strong to weak yen will likely be abrupt, involving a sudden and big devaluation of 30 to 40 percent. It will be a big shock to Japan’s neighbors and its distant competitors like Germany. The yen’s devaluation in 1996 was a main factor in triggering the Asian Financial Crisis. Japan’s neighbors must have a strong banking system to withstand a bigger devaluation of the yen.
Japan’s nominal GDP contracted 8 percent in the four years to the third quarter of 2011, and six percentage points of that was due to deflation. Without increased government expenditure, the contraction will be one percentage point more. Japan has not seen this kind of sustained deflation since the 1930s.
Without government deficits, Japan’s economy will decline much more. Central government bonds and borrowings plus its guaranteed debts rose by 116.3 trillion yen during the period, equivalent to one-fourth of the level of the nominal GDP in the third quarter of 2011. If Japan had adopted balanced budgets, its economy would have contracted two to three times more. This will lead to a debt crisis in its private sector.
A strong yen, deflation and rising government debt form a short-term equilibrium that lasts as long as the market believes it is sustainable. The yen has seen a relentless upward trend since it depegged from the dollar in 1971, up to 83.4 from 360 again to the dollar. When wages and asset prices rise, a strong currency can be justified. When wages and asset prices fall, a strong currency is suicide. Japan’s nominal GDP peaked in 1997 and its nominal wages did too. Its property prices have declined every year since. The Nikkei rose in only four out of the last fifteen years and is still close to a three-decade low.
Japanese policymakers, businesses, academics, currency traders and the average Mrs. Watanabe all believe in a strong yen. This belief is wrong but self-fulfilling. It has lasted so long because the Japanese government adopts policies to offset the destabilizing effects of deflation due to a strong yen. Hence, Japan’s national debt has marched upwards along with the value of yen. It is expected to top yen 1,000 trillion in 2012, 215 percent of GDP, 7.8 million yen (or roughly US$ 94,000) per person, and about half of net household wealth per capita.
The sustainability of Japan’s deflationary path depends on the market’s confidence in Japan’s debt market. As Japanese institutions and households hold almost all of the government’s debts, their faith in the government’s creditworthiness is the mojo for Japan’s seemingly harmless deflationary spiral.
A Vast Bubble
In a normal market, greater supply leads to lower prices. The opposite occurs in a bubble; faith in price stability or appreciation exaggerates demand. Japan has the highest level of government debt and the lowest bond yield. The later is necessary for the former. Even though the yield on 10-year Japanese Government Bonds (JGB) is only 1 percent, the interest expense is expected to top 22.3 trillion yen in the fiscal year that begins next month. This is one-quarter of the general account budget. If the bond yield rises to 2 percent, the interest expense would surpass the total expected tax revenue of 42.3 trillion yen.
In addition to its fiscal vulnerability to a rising interest rate, Japan’s budget deficit is still too high. The government budgeted 44 trillion yen in net additional borrowing in the next fiscal year, nearly half of its expenditures. It needs to double its tax revenue to balance the budget. But, as the economy is deflating with declining private consumption, a major tax increase would cause the economy to go down more, shrinking the tax base and requiring even bigger tax increases to balance the budget. Even though the government plans to achieve a primary fiscal surplus, i.e., revenue above non-interest expense, by fiscal 2020 to 2021, it is difficult to see how.
The justification for the low JGB yield is deflation. The real interest rate (the nominal rate plus deflation) is comparable to that in other countries. This rationale requires deflation to persist. But, deflation shrinks the nominal GDP or tax base. How could the government pay back its escalating debt by taxing a shrinking economy? It can only sustain its debt by borrowing more. This fits the definition of a particular type of Ponzi scheme.
The JGB bubble explains the seeming lack of pain in Japanese society. A strong yen and deflation haven’t led to an employment crisis because the government deficit is pumping up aggregate demand. As long as wages decline in line with prices, one doesn’t feel the pain. Japan’s household debt is only half of GDP, about half of the level in the United States. Deflation doesn’t cause much balance sheet trouble.
The Strong Yen Bubble
Yen bulls usually point at Japan’s trade and current account surplus as supporting factors. A trade surplus can reflect a country’s competitiveness or lack of it. Current account surplus is savings minus investment. When investment declines, the trade surplus is boosted. When a country cuts investment, it signals declining competitiveness. Hence, the current account surplus shouldn’t be viewed as a supporting factor for strong currency.
Hi there, Japanese January core machinery sales rose by +3.4%, much higher than the +1.6% forecast and a turnaround from the decline by -7.1% in December. Overseas orders rose by +20.1% MoM, much higher than the +5.6% in December. A lower Yen will help further; The Chinese PBoC lowered its daily fix for the Yuan…Read More
From Variant Perception, whose new blog is here. Source: Variant Perception
The Fed’s EXPLICIT Goal Is to Devalue the Dollar by 33% … and NEGATIVE Yield Bonds Are Coming The Federal Reserve’s explicit goal is to devalue the dollar by 33%. As Forbes’ Charles Kadlec notes: The Federal Reserve Open Market Committee (FOMC) has made it official: After its latest two day meeting, it announced its…Read More
Another step in the global trade war/currency crisis and U.S. dollar devaluation that we’ve been forecasting for the past decade. This Japan/China accord is the Asian trading bloc predictably coming together in the incipient global trade war. But the incipient global equity Supercycle Bear Market will be accompanied with a rising“safe-haven” status U.S. dollar –…Read More
G4 Central Balance Sheets /European Contagion
December 17, 2011
David R. Kotok
“A picture is worth one thousand words.” We present 13 pictures to describe the title subject, on our website, www.cumber.com.
Scroll to the two chart stacks. In the first, we reflect changes in the balance sheets of the G4 central banks. The G4 central banks are the Bank of England (BOE), the Bank of Japan (BOJ), the Federal Reserve (FED), and the European Central Bank (ECB). Other central banks are important; however, the G4 comprises the four central banks managing the currency blocks of nearly 85% of the capital markets that trade in the world. Other large capital markets are linked to one of them. Therefore, China’s central bank is not shown, because China manages its currency exchange rate via a peg to the others.
If you capture the G4 transactional changes, you get most of the financial impacts of the world. Paging though the G4, one sees the following information leap from the charts. The central bank balance sheets of the BOE, BOJ, and ECB have all recently increased in size. That of the FED has not. In fact, the FED’s balance sheet is actually slightly smaller than it was a few weeks ago.
Why is two weeks so important? Two weeks have elapsed since the central banks announced a coordinated activity on November 30th. Notice how those balance sheets have expanded; note also where they have expanded. We have color-coded the various compositions of both assets and liabilities of each balance sheet. The recent growth in total assets of the four central banks is clear.
The one central bank balance sheet that did not grow is that of the United States’ central bank, the Federal Reserve. Notice what happened in the last few weeks when the others expanded and the FED did not. The US dollar actually started to strengthen against other currencies, particularly the euro. As we have been writing and stating for some time, there is a relationship between the foreign exchange markets and changes in the exchange rates among and between the currencies, and the actions of the central banks involved with those currencies. We see the reaction in the foreign exchange market almost at once. A central bank takes an action, makes a statement, initiates a policy – whatever the case may be – and the foreign exchange markets readjust the ratios among and between the currencies. That is apparent in the past two weeks, and it is apparent in an examination of those four central bank balance sheets.
Cumberland has stacked the four central bank balance sheets so they can be flipped easily by any interested party. We will update them regularly. The other stack of charts shows the “good” countries and the “bad” countries in the Eurozone. And it shows the spreads of interest rates between the good countries and the benchmark German 10-year sovereign debt instrument, known as the “bund”, and the spreads between the bad countries and the bund. Notice how the spreads peaked in almost every case a few days prior to the November 30th announcement of the change in central bank policies. We speculate that someone somewhere got wind the policy change was coming and may have made themselves a lot of money on that trade.
More after the jump
Time.com – As the Crisis Refuses to Calm, Scenarios of Euro Collapse Appear French researcher Emmanuel Todd argues that though the implosion of the euro would produce a period of economic pain, panic, and instability, he says that shock wouldn’t last as long as some predict (18, maybe 24 months), before companies and governments picked…Read More
Bank lending in China slowed to Yuan562.2bn, as compared with Yuan587bn in October. In addition, M2 rose by just +12.7%, the slowest since May 2001 (source Bloomberg). There is no doubt that the Chinese authorities will ease further, though I remain sceptical as to whether it will be enough, given the structure and serious imbalances…Read More