Showing posts with label Bretton Woods. Show all posts
Showing posts with label Bretton Woods. Show all posts

Tuesday, April 01, 2014

David Stockman: Financialization is a Product of Monetary Central Planning

I have written a lot about how the evolution towards “financialization”—where the finance industry has practically grown in such a huge size to eclipse traditional economic sectors as the industry and agriculture—has been due to the US dollar standard and how this has reconfigured today’s global financial and economic structure. As examples see here, here here and here. 

I have also noted that financialization has been an unintended consequence from Triffin Dilemma also brought about by the US dollar standard. 

Former politician and current iconoclast David Stockman eloquently explains how the tampering of the incumbent monetary system, or specifically the conversion from Bretton Woods 'fixed exchange standard' to the US dollar standard operating mostly on ‘floating exchange rate’ has sired “financialization” that has benefited mostly Wall Street.(from David Stockman’s Contra Corner) [bold mine, italics original]
Under the fixed exchange rate regime of Bretton Woods—ironically, designed mostly by J.M. Keynes himself with help from Comrade Harry Dexter White—there was no $4 trillion daily currency futures and options market; no interest rate swap monster with $500 trillion outstanding and counting; no gamblers den called the SPX futures pit and all its variants, imitators, derivatives and mutations; no ETF casino for the plodders or multi-trillion market in “bespoke” (OTC) derivatives for the fast money insiders. Indeed, prior to Friedman’s victory for floating central bank money at Camp David in August 1971 there were not even any cash settled equity options at all.

The world of fixed exchange rates between national monies ultimately anchored by the solemn obligation of the US government to redeem dollars for gold at $35 per ounce was happily Bloomberg-free for reasons that are obvious—albeit long forgotten. Importers and exporters did not need currency hedges because the exchange rates never changed. Interest rate swaps did not exist because the Fed did not micro-manage the yield curve. Consequently, there were no central bank generated inefficiencies and anomalies for dealers to arbitrage. Stated differently, interest rate swaps are “sold” not bought, and no dealers were selling.

There were also natural two-way markets in equities and bonds because the (peacetime) Fed did not peg money market rates or interpose puts, props and bailouts under the price of capital securities. This means that returns to carry trades and high-churn speculation were vastly lower than under the current regime of monetary central planning. Financial gamblers could not buy cheap S&P puts to hedge long positions in mo-mo trades, for example, meaning that free market profits from speculative trading (i.e. hedge funds) would have been meager. Indeed, the profit from “trading the dips” is a gift of the Fed because the underlying chart pattern—mild periodic undulations rising from the lower left to the upper right–is an artifice of central bank bubble finance.

And, in fact, so are all the other distincitive features of the modern equity gambling halls—index baskets, cash-settled options, ETFs, OTCs, HFTs. None of these arose from the free market; they were enabled by central bank promotion of one-way markets—that is, the Greenspan/Bernanke/Yellen “put”. The latter, in turn, is a product of the hoary doctrine called “wealth effects” which would have been laughed out of court by officials like William McChesney Martin who operated in the old world of sound money.

In short, Wall Street’s triumphalist doctrine—claiming that massive financialization of the economy is a product of market innovation and technological advance—is dead wrong. We need “bloombergs” not owing to the good fortune of high speed computers and Blythe Master’s knack for financial engineering; we are stuck with them owing to the bad fortune that Nixon and then the rest of the world adopted Milton Friedman’s flawed recipe for monetary central planning.
In short, the US dollar standard has spawned one colossal global bubble finance.

I recommend that the article be read in the entirety: via the link here
 
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Another beneficiary of the financialization, of course, has been the government. Such has been accommodated through exploding global debt markets as shown in the chart above

And as pointed out earlier
"the real reason why governments promote the quasi permanent inflationary boom is to have access to money (via credit markets and taxes) to support their pet projects. And proof of this is that global debt, according to the Bank of International Settlements have ballooned to $100 trillion or a $30 trillion or a 42% increase from 2007 to 2013 due mostly to government spending. Such colossal diversion of resources is why the world is now faced with a clear and present danger of a Black Swan economic and financial phenomenon." 
In other words, financialization functions as a key instrument to rechannel or divert economic resources from society to political agents and their cronies backed by guarantees from central banks. And bubble blowing is just one of the major consequences. 

Yet what is unsustainable will eventually stop.

Thursday, February 06, 2014

Inflation is a process: 1960-80 Edition

One observation I recently received concerned about how US Federal Reserve policies allegedly produced an “immediate inflation” in the 1970s (via stagflation) while today’s massive over $4 trillion of balance sheet expansion as of December 2013 hasn’t produced the same effect.

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graphics via the CNN

Well inflation don’t just appear, like a genie, from nowhere. Inflation is a process.

This applies as well to during the 1960s to 1980s

From Wikipedia: (bold mine)
In 1944, the Bretton Woods system fixed exchange rates based on the U.S. dollar, which was redeemable for gold by the U.S. government at the price of $35 per ounce. Thus, the United States was committed to backing every dollar overseas with gold. Other currencies were fixed to the dollar, and the dollar was pegged to gold.

For the first years after World War II, the Bretton Woods system worked well. With the Marshall Plan Japan and Europe were rebuilding from the war, and foreigners wanted dollars to spend on American goods – cars, steel, machinery, etc. Because the U.S. owned over half the world's official gold reserves – 574 million ounces at the end of World War II – the system appeared secure.

However, from 1950 to 1969, as Germany and Japan recovered, the US share of the world's economic output dropped significantly, from 35 percent to 27 percent. Furthermore, a negative balance of payments, growing public debt incurred by the Vietnam War and Great Society programs, and monetary inflation by the Federal Reserve caused the dollar to become increasingly overvalued in the 1960s. The drain on US gold reserves culminated with the London Gold Pool collapse in March 1968.

By 1971, America's gold stock had fallen to $10 billion, half its 1960 level. Foreign banks held many more dollars than the U.S. held gold, leaving the U.S. vulnerable to a run on its gold.

By 1971, the money supply had increased by 10%. In May 1971, West Germany was the first to leave the Bretton Woods system, unwilling to devalue the Deutsche Mark in order to prop up the dollar. In the following three months, this move strengthened its economy. Simultaneously, the dollar dropped 7.5% against the Deutsche Mark. Other nations began to demand redemption of their dollars for gold. Switzerland redeemed $50 million in July. France acquired $191 million in gold. On August 5, 1971, the United States Congress released a report recommending devaluation of the dollar, in an effort to protect the dollar against "foreign price-gougers". On August 9, 1971, as the dollar dropped in value against European currencies, Switzerland left the Bretton Woods system. The pressure began to intensify on the United States to leave Bretton Woods.

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The above chart from economagic reveals that price inflation didn’t just “appear”. 

The US government had already indulged in monetary inflation as far back in the advent of the 1960s (as seen via M2 blue line). Meanwhile price inflation (CPI red line) began its upward trek only 5 years after. (both are measured via % change from a year ago).

When the Bretton Woods era came to a close, US M2 soared in two occasions. This  led to accompanying spikes in CPI which resulted to ‘stagflationary’ recessions.

Former Fed Chair Paul Volcker was widely credited for wringing out inflation by massively raising interest rates. Although Dr. Marc Faber already noted that the supply side glut from the early inflation has began to impact prices and that Mr. Volcker’s action may have complimented on this adjustment phase. The US economy had 3 agonizing recessions in the late 1970s to the early 1980s following the monetary experiment from the Nixon Shock before the imbalances brought about by previous monetary inflation had been reversed.

The point is inflation is a process which undergoes different stages

As the late Austrian economist Percy Greaves Jr. explained in simple layman terms
The first stage of inflation is when housewives say: "Prices are going up. I think I had better put off buying whatever I can. I need a new vacuum cleaner, but with prices going up, I'll wait until they come down." During this stage, prices do not rise as fast as the quantity of money is being increased. This period in the great German inflation lasted nine years, from the outbreak of war in 1914 until the summer of 1923.

During the second period of inflation, housewives say: "I shall need a vacuum cleaner next year. Prices are going up. I had better get it now before prices go any higher." During this stage, prices rise at a faster rate than the quantity of money is being increased. In Germany this period lasted a couple of months.

If the inflation is not stopped, the third stage follows. In this third stage, housewives say: "I don't like flowers. They bother me. They are a nuisance. But I would rather have even this pot of flowers than hold on to this money a moment longer." People then exchange their money for anything they can get. This period may last from 24 hours to 48 hours.
From the US ‘stagflationary’ experience, market developments combined with policy actions prevented the third stage (crack-up) boom from transpiring. But the policy tradeoff had been to induce harrowing periods of recessions.

Some notes:

-The foundation of the stagflation era of 1970s went as far back to the inflationary policies by the Fed during the early 1960s. The sustained inflationist policies eventually led to consumer price inflation.

-US inflationist policies largely due to the Vietnam war and US welfare (New Society) programs put an end to the Bretton Woods Standards.

-Recessions are necessary to reverse previous monetary abuse. The Bust serve as necessary medicine and therapy for the inflationary boom ailment.

There are also other factors that influence price inflation. For one, productivity growth from globalization helped reduced the impact of US Federal Reserve policies in the post Volcker era. This has been wrongly construed as the Great Moderation.

The massive explosion in the growth of the asset markets supported by debt that have also been instrumental in shifting the nature of the impact of inflation since a lot of monetary inflation today have been absorbed by asset markets (trillion dollar derivatives, bond markets, currency markets, etc...).

Bottom line: Just because statistical consumer price inflation seem subdued today, doesn’t mean there won’t be price inflation tomorrow or sometime in the future.

As one would note from the experience of the 1970s when price inflation emerges, it comes rather quickly

And in my view, the highly volatile financial markets today are symptoms such transition, but in a different light: asset inflation boom morphing into asset bust.

The next question is how will central bankers and the government react? Will their response lead to a crack-up boom (ruination of a currency via hyperinflation) or deflationary depression? I call this the von Mises Moment

Monday, August 12, 2013

Will the Triffin Dilemma Haunt the Global Financial Markets?

As measured by the Dow Jones Industrials US equity benchmark suffered their first loss in 7 weeks. Are these signs of fatigue or are these signs of an overheating or climaxing bubble? 

My impression is should US markets begin to wilt in earnest, then current downdraft in Asian markets are likely to intensify.

The US reportedly posted a substantial 22% reduction in the deficits of her trade balance owing to record exports and to a shrinking oil import bill according to the Wall Street Journal[1]

Shrinking US trade deficits can signify a symptom of unsustainable imbalances from the current monetary order, the US dollar standard.

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The US dollar remains the largest international foreign exchange reserve with over 60% share (right window[2]).

International currency reserves are over $10 trillion with the US Dollar also having the biggest share (left window). Perhaps a big segment of the undisclosed reserve currency may also be in US dollars.

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Over 50% (right window) of the $12 trillion (left window[3]) of international debt securities has been denominated in US dollars.

The point of this exercise is to demonstrate of the world’s continuing dependence on the US dollar as medium of exchange and as reserve currency.

Yet the US dollar standard seems to operate on the principle of the Triffin Dilemma, formulated by the late Belgian American economist Robert Triffin.

The eponymous theory by Mr Triffin elucidates of the economic conflict emanating from a world reserve currency particularly on meeting short term-domestic interests as against long term international objectives[4]

Under the Triffin dilemma, the issuing reserve currency makes it easy for a nation to consume more goods and services via an overvalued currency.

The same overvalued currency easily allows for financing of either budget deficits and or trade deficits, aside from having more latitude in “determining multilateral approaches to either diplomacy or military action”[5].

In short, a reserve currency provides the issuer the privilege of an interim “free lunch” or to quote the French economist Jacques Rueff “deficit without tears”[6]
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One of the other side effects of the Triffin dilemma has been the intense deepening of the financialization of the US economy[7]

Instead of producing goods, the US economy evolved towards shuffling of financial papers partly required by foreigners to recycle their dollar holdings. As one would note, the gist of expansion of financialization came as the US dollar became unhinged from the Bretton Wood System in August 1971.

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Of course the other side effect of the Triffin dilemma has been the growing frequency of global bubble cycles as evidenced by the greater incidences of global banking crises since the Nixon Shock of 1971

Aside from the massive accumulation of reserve currency by foreigners that would eventually undermine the reserve currency status, a dynamic which the world seems headed for, an equally detrimental factor to a reserve currency status is the proportional devaluation that would shrink these deficits.

Mr. Triffin actually articulated the problems of the Bretton Woods System where the failed system seemed to have validated his thesis. 

In a testimony before the US congress in November 1960, Mr Triffin argued that “If the United States stopped running balance of payments deficits, the international community would lose its largest source of additions to reserves. The resulting shortage of liquidity could pull the world economy into a contractionary spiral, leading to instability.[8]

Given the deep reliance by global markets and global economy on the US dollar system, improving US trade deficits are likely to extrapolate to reduced liquidity in the ex-US global system. Such dynamic will only provide more muscle or ammunition for bond vigilantes, and equally, would mean a tightening of a system deeply dependent on the largesse of US dollar steroids from US authorities.

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In the recent past, a reduction in the deficits of US trade balance coincided with strains in the global ex-US equity markets as measured by the MSCI[9] (lower pane)

Diminishing trade deficits here functioned as symptoms to dot.com bubble bust and to the 2008 Lehman bankruptcy. When financial markets collapsed as consequence to a bubble, international trade grinded to a near halt. This led to a substantial reduction of US trade deficits. Thus the narrowing trade balance coincided with recessions.

The causal flow may or could be reversed today; perhaps reduced liquidity from US exports of her currency the dollar may incite instability in the global financial markets.

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The effect of shrinking liquidity on the global system will likewise affect US corporations. With 34% of the revenues of US S&P 500 companies coming from non-US sales[10], the adverse effect is that shrinking global liquidity will eventually land on US shores.

And it’s not just trade deficits that has contracted, US budget deficits have also dwindled to 4.2% of the GDP from 7.7% a year ago[11]. So this could be a one-two punch against the global markets and economy. And should the FED taper, such will exacerbate on the effects of the Triffin Paradox.

Will the European Central Bank, the Bank of Japan, the Bank of England and the People’s Bank of China fill in the vacuum from improving US twin deficits?

Or will Triffin’s ghost haunt the global financial markets?

Interesting times indeed.


[1] Wall Street Journal Oil Boom Helps to Shrink U.S. Trade Deficit by 22% August 6, 2013

[2] The European Central Bank THE INTERNATIONAL ROLE OF THE EURO July 2013 p.19

[3] The European Central Bank, op cit., p23

[4] Wikipedia.org Triffin dilemma


[6] Jacques Rueff, The Monetary Sin of the West, Mises.org

[7] Wikipedia.org Financialization

[8] IMF.org The Dollar Glut Money Matters: An IMF Exhibit—The Importance of Global Cooperation System in Crisis (1959-1991)


[10] Businessinsider.com CHART: The S&P 500 Is Not The US Economy, May 10, 2013

[11] National Forex Calculated Risk; US Deficit is Shrinking August 10, 2013

Monday, April 15, 2013

Tanking Gold and Commodities Prices and the Theology of Deflation

One of the bizarre and outrageously foolish or patently absurd commentary I have read has been to allude to the current commodity selloffs to what I call as the theology of deflation, particularly the cultish belief that money printing does not create inflation. 

Yet if we go by such logic, then hyperinflation should have never existed.

Doug Noland of the Credit Bubble Bulletin debunks such ridiculousness:
With global central bankers “printing” desperately, the collapse in gold stocks and sinking commodities prices were not supposed to happen. Is it evidence of imminent deflation? How could that be, with the Fed and Bank of Japan combining for about $170bn of monthly “money printing.” Are they not doing enough? How is deflation possible with China’s “total social financing” expanding an incredible $1 Trillion during the first quarter? How is deflation a serious risk in the face of ultra-loose financial conditions in the U.S. and basically near-free “money” available round the globe?

Well, deflation is not really the issue. Instead, so-called “deflation” can be viewed as the typical consequence of bursting asset and Credit Bubbles. And going all the way back to the early nineties, the Fed has misunderstood and misdiagnosed the problem. It is a popular pastime to criticize the Germans for their inflation fixation. Well, history will identify a much more dangerous fixation on deflation that spread from the U.S. to much of the world.

I see sinking commodities prices as one more data point supporting the view of failed central bank policy doctrine. For one, it confirms that unprecedented monetary stimulus is largely bypassing real economies on its way to Bubbling global securities markets. I also see faltering commodities markets as confirmation of my “crowded trade” thesis. For too many years (going back to the 90’s) the Fed and global central bank policies have incentivized leveraged speculation. This has fostered a massive inflation in this global pool of speculative finance that has ensured too much market-based liquidity (“money”) has been chasing a limited amount of risk assets. Speculative excess today encompasses all markets, including gold and the commodities. Over recent months, these Bubbles have become increasingly unwieldy and unstable. Commodities are the first to crack.
In the theology of deflation espoused by monetary cranks, financial markets and the economy operates like spatial black holes, they are supposedly sucked into a ‘liquidity trap’ premised on the ‘dearth of aggregate demand’ and on interventionists creed of "pushing on a string" or of the failure of monetary policies to induce spending. Thus the need for government intervention to inflate the system (inflationism) to encourge spending.

Further money cranks tells us there has been no link between inflation and deflation.  Or that there are hardly any relationship of how falling markets could have been a result of prior inflation. 

Bubbles are essentially nonexistent for them. Inflationism has been seen as operating in a vacuum with barely any adverse consequences because these represent the immaculate acts of hallowed governments. Whereas deflation has been projected as “market failure”.

Yet we see plummeting commodity prices, contradictory to such obtuse view, as representing many factors. 

Global financial markets (stocks and bonds) have been seen as having implicit government support (e.g. the Bernanke Put or Bernanke doctrine), thus the safe haven status may have temporarily gravitated towards government backed papers rather than commodities.


Yet this doesn’t entail that endless money printing will not or never generate price inflation. Again such logic anchored on free lunch, simply wishes away the laws of economics.

Second, falling commodity prices doesn’t mean the absence of price inflation but rather monetary inflation has been manifested via price inflation in assets or asset bubbles so far. 

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The “don’t fight the central banks” mantra has led the marketplace to go for yield hunting by materially racking up credit growth.


Both markets suggests that government policies has heavily influenced market actions to chase yields by absorbing or accruing more unsustainable debt.

China’s massive money growth backed by financial expansion have masked the marked deterioration in her economy.  This perhaps supports the essence of the broad based gold led commodity panic.

And as Mr. Noland points out, cracking commodity prices may be portentous of the periphery to the core symptom of a coming crisis.

Falling commodity prices will initially hurt the emerging markets and could likely spread through the world. 

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Commodity exports plays a substantial role in emerging economies (IMF)

This means that global growth will be jeopardized thereby increasing the risks of bubble busts from the periphery (emerging markets and frontier markets)

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Emerging markets are supposed to comprise nearly 50% of global growth this year. (chart from the Daily Bell)

I also earlier pointed out that Indonesia's boom has been popularly attributed to commodity exports, even when latest developments suggests more of a property bubble. The Financial Times warns of an ASEAN bubble and notes of an unwieldy boom in Indonesia's luxury real estate projects.
Ciputra Development, which builds luxury condominiums, said that while prices in central Jakarta, the capital, had been growing at a rapid clip – about 30-40 per cent a year – a new trend had emerged.
If woes from Indonesia's commodity exports will spread through the property sector, then the Indonesian economy will become highly vulnerable. This makes the region including the Philippines susceptible too.

Boom will segue into a bust.
 

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Yet the recourse to eternal money printing will one day set another path. (chart from Zero hedge).

Inflationism comes in stages. Thus every stage commands a different outcome.  We are still operating on bubble cycles from which the current gold-commodity pressures signify as the typical the denial stage from inflation risks provoked by Fed policies.

As the great Ludwig von Mises predicted. (bold mine)
This first stage of the inflationary process may last for many years. While it lasts, the prices of many goods and services are not yet adjusted to the altered money relation. There are still people in the country who have not yet become aware of the fact that they are confronted with a price revolution which will finally result in a considerable rise of all prices, although the extent of this rise will not be the same in the various commodities and services.

These people still believe that prices one day will drop. Waiting for this day, they restrict their purchases and concomitantly increase their cash holdings. As long as such ideas are still held by public opinion, it is not yet too late for the government to abandon its inflationary policy.

But then, finally, the masses wake up. They become suddenly aware of the fact that inflation is a deliberate policy and will go on endlessly. A breakdown occurs. The crack-up boom appears. Everybody is anxious to swap his money against "real" goods, no matter whether he needs them or not, no matter how much money he has to pay for them.
In short we are in a stage where people have yet to become aware of a price revolution ahead even when policies have been directed towards them.

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We have seen such setting before.

Gold prices surged from $35 in 1971, which began during the Nixon Shock or after the closing of gold window based on the Bretton Woods gold exchange standard, to about $190 in 1975 or 4.4x the 1971 level. Following the peak, gold prices plunged by about 45% to around $105 in 1976. (chart from chartrus.com)

The returns from Gold’s recent boom from $ 300 to $ 1,900 has been about 5.3x before today’s dive. So there may be some parallel.

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Then, the interim collapse has served as springboard for gold’s resurgence. Gold prices evenutally hit $850 in the early 80s. (chart from chartrus.com)

Of course, the stagflation days of 1970-80s has vastly been different than today.

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Debt levels of advanced economies has already surpassed the World War II highs. (from US Global Investors) This is why advanced economies has resorted to derring-do or bravado policies of unprecedented inflationism from central banks.

Most of which has been meant to finance fiscal deficits, increasing the likelihood of the risks of price inflation and debt default over time. Such has been the typical outcome based on EIGHT centuries of crises according to non-Austrian Harvard economist Carmen Reinhart (along with Harvard contemporary Kenneth Rogoff).

Monetary cranks essentially tells us that “this time is different”. They believe that they are immune from the rules of nature. They denigrate history.

Moreover there has been a global pandemic of bubbles, which simply means that the path dependency for governments policies will be directed towards sustaining them.

Authorities will resort to bailouts, rescues and further inflationism in fear of  bubble busts in order to maintain the status quo.

This will not be limited to advanced economies but will apply to emerging markets including the Philippines as well.

Another difference is that, then, US monetary policies had been severely tightened which caused a spike in interest rates and two recessions. US Federal Reserve’s Paul Volcker had been credited to have stopped the inflationary side of stagflation or the “disinflationary scenario”, according to the Wikipedia.org

Today, there has been a rabid fear of recessions

Globalization too, from the opening of China, India and many emerging markets, led to increased productivity which essentially offset inflation levels. A 2005 study from the Federal Reserve of Kansas City notes that
Rogoff also credits the “increased level of competition—in both product and labor markets—that has resulted from the interplay of increased globalization, deregulation, and a decreased role for governments in many countries” as contributing to the reduction in global inflation.
Today with almost every economy indulging in bubble policies and therefore serially blowing bubbles, capital consumption leads to decreased productivity, heightening the risks of price inflation.

The Royal Bank of Scotland recently pointed out that Asia’s credit bubble has been accompanied by decreasing labor productivity. When the public’s activities having been directed towards financial market speculation than production, then evidently labor productivity has to decline.

Of course, direct confiscation of people’s savings via the banking system ala Cyprus will also become a key factor for the prospective search for monetary refuge.

Third, in the world of financial globalization, speculative bubbles translates to immensely intertwined markets, such that volatility in global markets, particularly in JGBs may have prompted for massive reallocation or a shift in incentives towards government backed securities.

This Reuters article gives us a clue:
"The scale of the decline has been absolutely breathtaking. We tried to rally and that just didn't get anywhere ... there hasn't been any downside support, it's like a knife through butter," Societe Generale analyst Robin Bhar said.
The pace of the sell-off appeared tied to volatility in the price of Japanese government bonds, which has forced certain holders to sell other assets to meet the risk modeling of their investment portfolios.
Fourth is that such selloffs has deliberately been engineered by Wall Street most possibly to project support on Fed policies for more inflationism. Wall Street, thus peddles the inflation bogeyman to spur political authorities to maintain or deepen inflationism which benefits them most

In my edited response to a friend on the recent record levels of US markets, I explain the redistribution of Fed Policies to Wall Street to the latter's benefits

Given the relative impact (Cantillon Effects) from the Fed’s money printing, those who get the money first, particularly Wall Street, e.g. primary dealers and bondholders who sell bonds to the FED via QE, the 2008 bailout money (TARP), proceeds from the Fed’s Interest Rate on Excess Reserves and etc, may have used such to speculate on the stock markets and the credit markets (e.g. junk bonds, revival of CDOs) rather than to lend to main street. Thus the parallel universe: economic growth has been tepid, but financial market booms.

There has also been the interlocking relationship between bond and stock markets as I earlier pointed out here

Since December the politically connected Goldman Sachs has called for the selling of gold which has been followed by a coterie of Wall Street allies

From the Star Online:
Several renowned global financial institutions such as Credit Suisse Group AG, Goldman Sachs Group Inc, Nomura Holdings Inc, Deutsche Bank AG, UBS Ag, and Socit Gnrale SA (SocGen) have already turned bearish on gold in recent weeks, and cut their gold-price forecast for 2013 and 2014.
So current selloff cannot be dismissed as having been a purely market dynamic and not having been influenced by a grand design to promote further inflationism.

Lastly, as I noted during the start of the year, gold’s 12 year consecutive rise has been ripe for profit taking.
Although, so far, with the exception of gold, no trend has moved in a straight line, so it would be natural for gold to undergo a year of negative returns.
Expect this selloff in gold-commodity sphere to increase risks towards a transition to a global crisis, and for central banks to engage in more aggressive inflationism. 

Such transition will eventually bring about the risks of stagflation.

Tuesday, August 16, 2011

The US Dollar Standard on its 40th Year

Known as the Nixon shock, the US dollar-Gold convertibility was closed in August 15, 1971, that’s 40 years ago.

How this came about, Cato’s Dan Griswold explains, (bold highlights mine)

In a surprise televised speech on Sunday evening, August 15, 1971, the president announced that he would immediately impose wage and price controls, slap a 10 percent duty on imports, and suspend the international convertibility of the U.S. dollar into gold. All were to be temporary measures, of course, to promote jobs, dampen inflation, and combat “international money speculators” betting against the dollar. (You can read the entire speech here.)...

The centerpiece of the Nixon Shock was its controls on prices. In a market economy, freely fluctuating prices are the nervous system that coordinates supply and demand. Yet in one of the more chilling statements delivered by a U.S. president, Nixon told the nation that evening,

“I am today ordering a freeze on all prices and wages throughout the United States for a period of 90 days.

The price controls did tame inflation temporarily, but it came roaring back within three years to double-digit levels and persisted through the 1970s because of loose monetary policy. A tight lid on a boiling tea pot can only contain the steam for a time before it explodes.

The controls continued on gasoline, causing artificial shortages (as price controls usually do) symbolized by gas lines during the 1970s. Only when President Reagan finally lifted the controls on oil and gasoline in 1981 did the specter of short supplies finally disappear. (The 10 percent import surcharge did prove to be temporary, lasting only until the end of 1971.)

Closing the gold window was arguably inevitable given the lack of monetary discipline by the U.S. central bank. By 1976, the dollar and other major currencies were floating freely, which has turned out to work rather well, as Milton Friedman predicted it would. It also turned out that pressure on the dollar to depreciate was not driven by speculators after all but by the surplus of dollars that had been created to finance the Vietnam War and the Great Society.

The lessons:

One lesson of the Nixon shock is that if politicians are granted “emergency powers” they will tend to abuse them in situations that were never envisioned when the powers were originally granted. A second lesson is that “temporary” measures have a habit of becoming permanent. The big lesson is that the power of politicians over the economy should be limited. Any request for temporary emergency powers should be greeted with the deepest skepticism.

Of course there is another more important lesson: 40 years ago TODAY, ONE US dollar is now only worth 18 cents of buying power.

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From the BLS

82 cents of every dollar accounts for how much worth of resources that has been surreptitiously and illicitly transferred from her citizenry to the US government and their cronies. This represents 40 years of mass deprivation, deception and delusion.

And to consider, the CPI inflation may have even been grossly underestimated as the method to compute this has changed over the years or as argued by John Williams of the Shadow Statistics via substitution, hedonic regression and etc… here

Henry Ford was right when he said

It is well enough that people of the nation do not understand our banking and monetary system, for if they did, I believe there would be a revolution before tomorrow morning.

It’s been 40 years of infamy.

Friday, July 22, 2011

Capital Flows, Financial Liberalization and Bubble Cycles

Professor Arnold Kling excerpted the latest edition from the classic Charles Kindleberger book, “Manias, Panics, and Crashes

One of the themes of this book is that the bubbles in real estate and stocks in Japan in the second half of the 1980s, the similar bubbles...in the nearby Asian countries in the mid-1990s, and the bubble in U.S. stock prices in the second half of the 1990s were systematically related. The implosion of the bubble in Japan led to an increase in the flow of money from Japan; some of this money went to Thailand and Malaysia and Indonesia and some went to the United States....When the bubbles in the countries in Southeast Asia implode, there was another surge in the flow of money to the United States...

The increase in the flow of money to a country from abroad almost always led to increases in the prices of securities traded in that country as the domestic sellers of the securities to foreigners used a very high proportion of their receipts from these sales to buy other securities from domestic residents...It's as if the cash from the sale of securities to foreigners was the proverbial 'hot potato' that was rapidly passed from one group of investors to others, at ever-increasing prices.

Harvard economists Carmen Reinhart and Kenneth Rogoff places the culpability of the global banking crises on financial liberalization

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They write

Periods of high international capital mobility have repeatedly produced international banking crises, not only famously as they did in the 1990s, but historically.

There are vast dissimilarities between political economic conditions of today and the yesteryears to simplistically impute the causal relationship of capital mobility and banking crises.

For instance, the pre-20th century had mostly operated from precious metal based monetary system and had largely been without central banks compared to the 20th century. Also today’s era can be characterized as having assimilated the Bismarckian welfare structured state than the pre-20th century, which implies of a starkly different operating political system.

The economic environment had also been different. The pre-20th century hallmarked the transition of the agricultural epoch to the industrial age. The 20th century was the culmination of the industrial era which currently has been transitioning to the information age. There are so many many many more variables to consider.

For me, correlations like this should be meticulously scrutinized rather than just taken as “given”.

Although I won’t deny that liberalization could have been one of the many factors which may have contributed to historical episodes of banking crisis, perhaps this has not been the principal one.

However going back to the chart, one can note of the huge concentration in the incidences of banking crises (green circle) during the post-Bretton Woods; the de facto US dollar standard system of today. This comes after the Nixon Shock, a monumental event eponymous to President Nixon’s closing of gold convertibility in 1971.

The degree of concentration of banking crisis has been unprecedented when compared the cumulative interspersed banking crises of 1800-1970.

This lends credence to the “hot potato” dynamic as narrated by Robert Aliber co-author of the Charles Kindleberger’s classic.

As I have been saying here, the gamut of modern day or contemporary global bubble cycles represent as mainly the consequences of the central banking induced business cycles, the welfare state and the intensifying frictions or strains from the Triffin Dilemma that continues to plague the global fiat money system founded on the US dollar.

This “deficit without tears” paper money system which has privileged the US for the past 40 years has been unsustainable and won’t likely last (unless there would be drastic reforms on the political system).

The trend of gold prices has been showing the way.

Monday, June 14, 2010

Buy The Peso And The Phisix On Prospects Of A Euro Rally

``The euro will survive, the shorties won't. A sound analysis of the fundamentals clearly shows that the euro's external position does not warrant its demise. The eurozone has no current account deficit and no net external debt and the global competitive position of many euro countries is strong. Even more so: the highly indebted "Club Med" countries along with Ireland have implemented the measures to get clean. This by itself is a global rarity.”-Antony P. Mueller, Euro Shorties Take Care


Coming from oversold levels, I believe that the Euro is ripe for a major bounce. And this should have a tremendous impact on global asset classes.


First of all let me point out that that I’m no fan of the Euro or for that matter any paper currency, including the Chinese Yuan or Philippine Peso. Like the fate of all previous paper currencies throughout man’s existence, they are all destined to meet their eventual doom.


That’s because the Fiat currency system functions as principal instruments of governments, through central banks, to advance on political goals of the political leadership which are mostly incompatible or clash with the universal economic laws.


As Friedrich Hayek wrote[1], (italics his)


What we should have learned is that monetary policy is much more likely to be a cause than a cure of depressions, because it is much easier, by giving in to the clamour for cheap money, to cause those misdirections of production that make a later reaction inevitable, than to assist the economy in extricating itself from the consequences of overdeveloping in particular directions. The past instability of the market economy is the consequence of the exclusion of the most important regulator of the market mechanism, money, from itself being regulated by the market process.


Hence most of the collapse of politically mangled currencies had been due to war or hyperinflation[2].


Reasons Why Euro Isn’t Going To Collapse, For Now


Having said so, this brings us to the next point; the allegations of the imminence of the death of the Euro, which in my view, seem highly exaggerated and representative of extreme pessimism.


Yes the Euro is bound to meet its inevitable demise, along with the US dollar and the others, somewhere down the road, but I don’t see it unravelling soon-not this year, or the next.


The fundamental reason is that interest rates globally remain at very low levels, from which allows governments to conduct inflationist rescue packages such as the recent nearly $1 trillion bailout of the Euro[3].


And low interest rates are emblematic of mitigated effects of inflation, for the time being.


Moreover, as we have earlier discussed, today’s globalization trends have NOT been restricted to trade, investment and financial, and labor flows, but such trend also incorporates monetary policies and government collaborative actions[4]. An example would be the recently reactivated currency swap arrangements and multilateral loans extended as part of the Euro rescue deal.


The point is, for as long as governments have the leeway to cross finance or accommodate each other, any talk of currency dissolution seems like wishful thinking.


In other words, what will immobilize governments from the present collaborative stance will be the series of dramatic interest rate responses to an accelerating rate of increases in inflation.


Under this scenario, the debt burdens of the financial system of those economies that are highly leveraged would be amplified and this effectively reduces the space for policy collaboration among governments and significantly lessens the accommodation for domestic government financing.


And it is under such juncture, where governments fighting their own domestic demons would forcibly either resort to the reglementary strictures of fiscal discipline (default or restructuring, a.k.a. partial default) or to hyperinflate. And the death knell or the survival of any currency will be determined by the accompanying critical policies made, when faced under such circumstances. Yes, we have long called this the Mises Moment.


International Uniformity Of Inflation


Yet if you read the many expert opinions, the above risks are simply ignored for the simple reasons of having too much blind faith on the efficaciousness of printing money, with less consideration of the unintended consequences from such actions, and too much reliance on short-term goals.


Figure 1: Danske Bank/BCA Research: ECB Quantitative Easing


For instance, one can find the excessive fixation to deflation by the mainstream as a pretext to advancing the cause of turning stones into bread by inflationism.

This from BCA Research[5],


``In our opinion, deflation is a much greater threat, especially if the central bank moves too slowly to limit contagion within the region. We sympathize with the concern that monetary policy in the euro area is set for the region as a whole and efforts to set interest rates to support the weakest members will over-stimulate the Germany economy. Unfortunately, relatively low trade-openness in the weaker nations means that currency depreciation will provide disproportionate support to the stronger regional members. As a result, the only way to stimulate the Med-4 successfully is to quantitative ease and ramp up asset purchases.”


Never mind the reality that the Eurozone isn’t being plagued by consumer price deflation in spite of the enormous debt problems because inflation has remained positive and has been climbing.


In May of 2010, according to news reports, Eurozone posted a positive 1.5% inflation rate[6]. While it is true that the Eurozone did experience a short bout of slight or marginal CPI deflation in June to October 2009, inflation has been more of the dominant story in this crisis.


Moreover, the deflation scare mongering is a matter of “data mining” or using selective statistics to rationalize a bias, such as in the right window of Figure 1.


The general idea is; since the European Central Bank’s (ECB) balance sheet have shown to be less engaged in activist policymaking via quantitative easing, the recommendation, hence, is to match the degree of aggressiveness employed by the US and UK.


This has been a fallacy predicated on having “uniform” inflationism, similar to the one exposed by Henry Hazlitt anent the Bretton Woods standard.


Mr. Hazlitt, who accurately predicted the collapse of Bretton Wood, warned[7], (all bold highlights mine)


``A provision for uniform inflation in all major countries would increase the temptation to inflate in each country by removing some immediate penalties. When the currency of a single country begins to sag because of inflationary policies, two embarrassing results follow. One is the immediate loss of gold, unless the Government prohibits its export (which makes the currency sag more); the other is the humiliation of seeing the country's currency quoted at a discount in other nations. A uniform inflation in the world's most important countries would avoid both of these embarrassments.”


And today’s near similar, coordinated and or convergent monetary policy actions seen in most nations and the policy collaboration among governments which have marked the current globalized environment seem to illustrate the same stance in the imposition of inflation on a “uniform” scale.


In addition, the metric commonly used to mount such a scare tactic has been monetary aggregates, which appears to have departed from the actions in the financial markets[8]. Plainly put, where statistics say deflation, real world prices say inflation.


Legendary investor Jim Rogers has a better refutation to this. In an interview, when asked about the effectiveness of monetary aggregates in measuring the risks of inflation or deflation, Mr Rogers replied[9], ``Is M3 something you buy in a shop? M3 can lead to changes in the price structure, but M3 is not price inflation or deflation.”


So it’s all a matter of choice, choose to live in the real world and see inflation or elect to live in a make-believe world which says deflation.


One mustn’t forget that the European integration had been longstanding pet project for European bureaucrats for over 50 years.


Whether the EU’s existence has been meant to achieve the following political goals:


-“Roman Empire” socialist democratic construct of modern Europe, instead of a liberal “Christian Europe”, as asserted by GaveKal’s Charles Gave[10] or


-in Stratfor’s Papic and Zeihan[11] view designed at projecting regional power in the geopolitical sphere where national power has been on a decline and or to reduce the odds of the repeated slant for warfare given the Eurozone’s geographical structures;


...it is important to stress that the European political ideology has been skewed to sustain the EU system at almost all conceivable costs.


Proof?


This from Bloomberg[12],


``European Union President Herman Van Rompuy said the 750 billion-euro ($905 billion) rescue package would be expanded if it doesn’t quell the debt crisis, becoming the first EU leader to float the idea of a larger fund.


``“Currently there isn’t even the hint of a request to put this rescue plan into practice,” Van Rompuy told Belgium’s Trends magazine. “And if the plan were to prove insufficient, my answer is simple: in this case, we’ll do more.”


And so the alleged barriers of the ECB’s purported independence from political influences is being gradually eroded or unravelled as a farce.


Betting On ‘This Time Is NOT Different’


THE weekly purchases by the ECB of financial assets meant to buoy the banking system appear to have slowed (figure 1 left window) as global financial markets appear to have calmed (see figure 2).


Figure 2: Danske Bank: Improving Sentiment


Aside from credit default swaps of the crisis affected PIIGS (right window), signs are showing of a marked broad based improvement in the money market metrics as exhibited by the LIBOR OIS [spread between the LIBOR and overnight swap rates-an indicator of banking health[13]] and FRA/OIS [the spread between future interbank rates and overnight indexed swaps] seen in the right window from Danske Bank Research[14]


The implication is, since there will likely be reduced anxieties over credit risk, we could probably see a resumption of recovery in the credit markets, considering the scope of actions being conducted by the monetary authorities in the EU area and elsewhere (Japan?), combined with continued fiscal spending by many global governments, aside from the steep yield curve which is likely to generate sundry borrow short-lend/invest long “carry” arbitrages.


None of these is meant to suggest that any impending recovery would be sound.


But we have always bear in mind that under a Fiat money standard, the reality is that boom-bust (Austrian Business) cycles have been repeatedly fuelled by the manipulation of interest rates which engenders malinvestments and distorts the production structure of the economy which subsequently leads to volatility from an ensuing market clearing process. And this cycle is further buttressed by moral hazard issues from government intervention even seen by neo-Keynesian Hyman Minsky.


Yet all these money printing and interest rate manipulations are likely to incentivize people to spend, speculate or search for added returns.


And I don’t think this cycle is going to be different. The only difference is likely to be the OBJECT or character of the bubble but not the dynamic that fuels the bubble.


Figure 3: stockcharts.com: Euro led meltdown


Yet when people or experts speak about “this time is different”, mostly represented as “new paradigm” during the electric atmosphere at the peak of a boom, or “death” of an asset in the depression phase, they usually signify as sentiment based or “comfort of the crowd” analysis.


In short, they can serve as manifestations of a major forthcoming inflection point.


So when we read about predictions of the ‘demise’ of the Euro over the next 5 years by a significant number[15] or 48% or 12 out of the 25 economists surveyed (!!), our contrarian reflexes suggests that a turning point for the Euro could be just around the corner.


To reminisce, last year they said that it could have been the death[16] of the US dollar[17], which apparently did NOT take place. On the contrary, the US dollar became one of today’s safehaven!


The lesson is once mainstream begins to sing in chorus on issues with questionable grounds, we tend to take the opposite stand.


Buy The Philippine Peso, Asian Currencies and The Phisix


In Figure 3 the falling Euro (XEU) began only to impact global markets by mid-April, via a convergence, where global stocks (DJW), commodities (CCI), emerging sovereign bonds (JEMDX) synchronically fell (blue vertical line and downward arrow in red).


Earlier, the falling Euro wasn’t much of a factor, as global markets had been indifferent (except commodities).


Yet the kernel of the apprehension seen in the financial markets came about when the Greece bailout was announced which apparently was construed as inadequate.


Now the tide seems to be turning (see blue vertical line guided by the green upside arrow).


It’s been the same dynamic with Asian currencies (see Figure 4).



Figure 4: Bloomberg-JP Morgan Asian Dollar Index[18]: Euro Convergence


The Euro’s decline hasn’t been a factor at the onset of 2010, where Asian currencies rose strongly against the US dollar, especially after the first round appearance of the Greece debt crisis episode last February.


However, the tremors following the “insufficient” Greece bailout turned nasty as Asian currencies fell concomitant with global financial markets.


But this trend appears to be likewise bottoming in conjunction with market activities in the commodities, bonds and stock markets.


Since the negative sentiment over credit risks appear to be abating, the current oversold Euro conditions, technical (chart) considerations, the massive pessimism over the Euro and the apparent bottoming of several asset classes, we are likely to see a significant rebound in Asian currencies as market sentiment improves.


For me, these factors should accrue to a strong buy on ex-US dollar currencies including the Philippine PESO, which last stood at 46.64 based on Friday’s close and other Asian currencies.


Naturally a rallying Peso should add to more levity in the Phisix.


Why? (see figure 5)

Figure 5: Philippine Peso and Net Foreign Trade


A rising Peso has mostly been accompanied by surges in foreign trade activities. This has been evident as the Peso reached its zenith (44.23) at the end of April to early May (see blue oval).


Lately as the Peso fell, it’s been mostly Net foreign outflows. This has been true for most of May until the second week of June, where in 6 weeks, only 2 accounted for inflows.


And as the Peso’s fall is likely to reverse, we could the same phenomenon take place.


Importantly, since foreign funds are likely to deal with Phisix issues, or the 30 component issues that comprise the Phisix benchmark, the prospective re-entry of foreign funds could translate to a big jump on the Phisix.


Although I’m not sure of the precise timing of the Euro reversal play, my suspicion is that it could happen over the coming weeks. But if I am lucky enough, it could even happen by next week.


There is another point I’d like to emphasize, if the relative valuation of a monetary unit is based ``on the relationship between the quantity of, and demand for, money[19]” then the lack of “inflationism” by the ECB relative to the US Federal Reserve and the Bank of England (go back to figure 1) should translate to the ‘quantity’ factor in favour of the Euro.


This leaves us with the demand for money, which is currently being driven by the mostly dour sentiment on the Euro. Therefore, the lack of demand has so far offset the quantity factor advantage. But this is likely to change once the turbulence over European credit markets breezes over.


Bottom line: There is likely to be a tremendous “leash effect” on global financial markets on a Euro rally vis-a-vis the US dollar. And if I am right, the Euro appears to be at an inflection phase of this market cycle.



[1] Hayek, Friedrich August, Denationalisation Of Money p.102

[2] Dollardaze.org, Demonetized Currencies

[3] See $1 Trillion Monster Bailout For The Euro!

[4] See Why The Philippine Phisix Will Climb The Global Wall Of Worries

[5] BCA Research, ECB: Hesitation Is Lethal

[6] Associated Press, Eurozone official inflation edges up to 1.6% in May, May 31,2010

[7] Hazlitt, Henry From Bretton Woods To World Inflation, A Study Of Causes And Consequences p.40

[8] See M3 Not A Valid Measure Of Money

[9] Hera Research, Interview: Jim Rogers on Currencies and Inflation, goldseek.com, June 3, 2010

[10] See Was The Greece Bailout, A Bailout of The Euro System?

[11] See Inflationism And The Bailout Of Greece

[12] Bloomberg, EU to Expand Rescue If Package Fails, Van Rompuy Says, June 10, 2010

[13] Wikipedia,org LIBOR OIS Spread

[14] Danske Bank, Weekly Focus Another week in the shadow of the debt crisis

[15] Conway, Edmund, Euro 'will be dead in five years' Telegraph.co.uk, June 5, 2010

[16] Conway, Edmund Is this the death of the dollar? Telegraph.co.uk, June 20, 2009

[17] Fisk, Robert, The demise of the dollar, independent.co.uk, October 6, 2009

[18] Bloomberg Bloomberg-JP Morgan Asian Dollar Index (ADXY)

[19] Mises, Ludwig von Stabilization Of The Monetary Unit, On The Manipulation of Money And Credit, p.25