ECB Intervenes in Bond Markets, More to Follow

Following the global market route, a reportedly reluctant ECB has started intervening in Europe's bond markets.

From Bloomberg,

European Central Bank President Jean- Claude Trichet may be forced to step up his fight against the sovereign debt crisis after a resumption of bond purchases yesterday failed to halt a rout in Italy and Spain.

Over opposition from Germany’s Bundesbank, Trichet yesterday sent the ECB back into bond markets as yields on Italian and Spanish yields soared, threatening the ability of the euro region’s third- and fourth-largest economies to borrow. As the sell-off continued, traders said the ECB purchased only Irish and Portuguese securities, suggesting the central bank is reluctant to put up the funds needed to tame a crisis it says governments are responsible for fixing.

“The ECB is being dragged unwillingly back to the table, having tried originally to palm off responsibility for restructuring the euro zone to governments,” said Peter Dixon, an economist at Commerzbank AG in London. “If the ECB is serious about playing its part in holding the euro zone together, then it’s going to have to spend a considerable sum.”

The ECB, which ceased buying bonds four months ago, was forced back into action after governments failed to convince investors that a package of new measures agreed to last month will prevent the crisis from spreading. The ECB may be hesitant to intervene in Italian and Spanish markets, which according to Bloomberg data have a combined 2.2 trillion euros ($3.1 trillion) worth of outstanding bonds, for fear of starting an engagement it can’t get out of.

As expected, once the distress on the marketplace becomes pronounced, global central banks will set aside political squabbling to give way for more inflationism. [All these meant to save the cartelized global banking system]

Yet if this episode of bloodbath continues, expect the ECB to expand its purchases to include Italian and Spanish bonds. That’s the ECB’s version of QE (asset purchases from money printing) now at work.

So you have 3 major central banks intervening in the financial marketplace over the past 48 hours, the Swiss, Japan (yesterday’s record 4 trillion yen or US $50.6 billion at the forex market) and now the ECB.

Global central bankers appear to be synchronizing their efforts at an escalating scale. Expect even more.

Hot: BSP’s Amando Tetangco says Philippines Open to Currency Intervention

Given the recent fad of currency interventions initiated by the SNB and the BoJ, the Philippine central bank, the Bangko Sentral ng Pilipinas (BSP) has threatened to join the bandwagon

From Bloomberg,

The Philippines is prepared to impose controls to cap volatility in the peso after its currency rose to a three-year high this week, central bank Governor Amando Tetangco said in an e-mail late yesterday. The bank “will not go against the fundamental currency trend but will not hesitate to use tools, including imposing prudential limits on certain transactions of banks,” he said.

Gadzooks. This guy speaks as if he has been bestowed with supernatural powers to control the marketplace, like the fabled King Canute who commanded the sea waves to halt.

The Philippines has already been engaged in subtle currency interventions, but because of the political correctness, which are meant to advance the remittance and export based interest groups, the BSP honcho has announced his willingness to do much further actions at the risks of unintended consequences

These people are hardly accountable for their actions, and would boldly take any measures at our expense.

Well, if competitive devaluation becomes widespread or the predominant measure worldwide, then expect inflation to accelerate.

Global hyperinflation could turn into a real risk.

Japan Intervenes to Curb Rising Yen

From one currency intervention to another, yesterday the Swiss Franc, today the Japanese Yen (the BoJ finally made good their earlier broadcasted plan)

From Bloomberg

Japan intervened in the foreign- exchange market to sell yen, Finance Minister Yoshihiko Noda told reporters today in Tokyo.

The nation acted alone, and was in touch with other countries, Noda said. The Bank of Japan separately said in a statement that it will end its policy meeting today, one day early. Noda said that he hopes the central bank will take appropriate action.

All these money being printed will flow somewhere.

Bottom line: Paper money, as Voltaire said, will eventually return to its intrinsic value: ZERO

Hot: Swiss National Bank Intervenes to Halt a Surging Franc

My skepticism about the Swiss franc has been validated. You simply just can’t trust central bankers. Not even the Swiss variety.

The Swiss National Bank (SNB) surprised the currency market as it intervened by ‘injecting liquidity’ in an attempt to forestall the upsurge of the franc.

The SNB apparently went ahead of the Japanese who are mulling to do the same.

From the Marketwatch (bold emphasis mine)

The Swiss National Bank on Wednesday moved to halt the rise of the Swiss franc, saying the strength of the currency was "threatening the development of the economy and increasing the downside risks to price stability in Switzerland." The euro EURCHF +2.08% jumped 1.8% versus the Swiss currency to trade at 1.1061 francs, while the U.S. dollar USDCHF +1.80% jumped 1.4% to 77.61 centimes. Calling the franc "massively overvalued at present," the SNB said it would move its target for three-month Libor as close to zero as possible, narrowing the taret range to 0% to 0.25% from 0% to 0.75%.

The SNB said it will simultaneously "very significantly increase" the supply of liquidity to the Swiss franc money market over the next few days, and that it aims to expand banks' sight deposits at the SNB from around 30 billion Swiss francs to 80 billion Swiss francs. In a statement the central bank said it is "keeping a close watch on developments on the foreign exchange market and will take further measures against the strength of the Swiss franc if necessary."

Under such environment gold prices continue to streak at fresh record levels, which as of this writing has been drifting around the 1,665-1,670 range

from Kitco.com

I would suspect that part of this intervention, aside from publicly wishing for a weaker franc, is to flood the system with money to mitigate the losses being endured by European equity markets.

My guess is that the US will be next pretty soon.

Japan Considers More Currency Intervention

In this world of paper money system, policymakers seem to have a single designated solution to every economic problem: policies that leads to the destruction of their currencies via the printing press.

From Reuters, (bold emphasis mine)

Japanese Finance Minister Yoshihiko Noda said he was closely communicating with the Bank of Japan and other countries on how to address the yen's recent rise.

Sources familiar with the BOJ's thinking also said the central bank will consider easing monetary policy this week as the yen is trading near a record high against the dollar. "Investors' main concern is the possibility of intervention and the yen's moves, so while the market may weaken, hit by concerns about the U.S. economy, losses could be limited to around what the market gained yesterday as investors may be cautious about selling," said Kazuhiro Takahashi, general manager at Daiwa Securities.

These people have not learned from the March 18^th intervention which hardly stopped the Yen from rising.

It’s also another sign why major economies, as Japan, would continue to flush the world with money from thin air which may lead to market asymmetries and higher commodity prices.

Did the Joint Currency Intervention for a Weaker Yen Succeed?

Japan’s triple whammy calamity, last March, pushed the yen to the stratosphere. This prompted global finance ministers to jointly intervene in the currency markets to stem its rise.

This from UK’s Guardian.co.uk last March, (highlights mine)

Finance ministers and central bankers from the world's developed nations decided late on Thursday night to send a firm message to financial markets that they would not stand by and watch the yen continue to strengthen

The Bank of Japan began selling yen overnight to depress its value. Other central banks are expected to follow suit as their markets open through today, in a rare concerted move.

The intervention signified as war against speculators: central banks versus speculators.

Over a month since the intervention, the New York Federal disclosed yesterday its participation in the joint action:

The U.S. monetary authorities intervened in the foreign exchange markets on one occasion during the first quarter, on March 18, buying $1 billion against Japanese yen, the Federal Reserve Bank of New York said today in its quarterly report to the U.S. Congress.

During the three months that ended March 31, the dollar depreciated 5.5 percent against the euro but appreciated 2.5 percent against the Japanese yen. In this period, the dollar’s trade-weighted exchange value depreciated 3.7 percent as measured by the Federal Reserve Board’s major currencies index.

The coordinated G-7 intervention was carried out by the foreign exchange trading desk at the New York Fed, operating in conjunction with Japanese monetary authorities, the European Central Bank (ECB) and the monetary authorities of, Canada and the United Kingdom. The intervention amount was split evenly between the Federal Reserve System Open Market Account and the U.S. Treasury’s Exchange Stabilization Fund (ESF).

The blue arrow marks the date when the US government (US Federal Reserve and the Treasury) intervened along with central banks of other nations in a grand scale of collaboration against speculators.

Over the short term, the intervention proved to be a success; the yen weakened.

Today, the yen is seen back at the level where the global governments intervened. In short, billions of dollars of taxpayers money went down the drain.

Bottom line:

Interventions did have immediate effects (which resonates with today’s war against commodities). However, eventually the effects wear out.

Yet who bears the losses from such interventions? Obviously taxpayers!

The battle was won by the central banks in March, but they appear to be losing the war.

Questions and Answers on Philippine Monetary and Fiscal Issues

The following is my to answer some of the questions that my colleagues have posted on facebook group which they say is required for their research.

Role of Central Bank and Currency Interventions

With reference to the record $66.2 billion Gross International Reserves (GIR) the Philippines has tallied for the first quarter of 2011, this can be broken down into Foreign Investments, Gold, Special Drawing Rights (SDRs), foreign exchange and Reserve position in the fund.

Breakdown of Gross International Reserves (Bangko Sentral ng Pilipinas)

Reserve assets can further be broken down into securities mostly in foreign bonds and notes and secondly in foreign currency cash and deposits.

Reserve asset breakdown Bangko Sentral ng Pilipinas

The role of the BSP, like all other central banks, is to manage exchange rate fluctuation and or the state of balance of payments.

They do this by either indirect foreign currency intervention (tweaking money supply) or indirect foreign currency intervention (buy or sell foreign currencies with local currency) [Steven M. Suravonic, International Finance Theory and Policy]

And in managing capital inflows they can be sterilized or non-sterilized. Non sterilized intervention can result to inflation.

Jang-Yung Lee explains [IMF 1997 Sterilizing Capital Inflows]

Capital inflows result in a buildup of foreign exchange reserves. As these reserves are used to buy domestic currency, the domestic monetary base expands without a corresponding increase in production: too much money begins to chase too few goods and services.

To ease the threat of currency appreciation or inflation, central banks often attempt what is known as the "sterilization" of capital flows. In a successful sterilization operation, the domestic component of the monetary base (bank reserves plus currency) is reduced to offset the reserve inflow, at least temporarily. In theory, this can be achieved in several ways, such as by encouraging private investment overseas, or allowing foreigners to borrow from the local market. The classical form of sterilization, however, has been through the use of open market operations, that is, selling Treasury bills and other instruments to reduce the domestic component of the monetary base. The problem is that, in practice, such sterilization can be difficult to execute and sometimes even self-defeating, as an apparently successful operation may raise domestic interest rates and stimulate even greater capital inflows. Unfortunately, many developing countries also lack the tools available to run a classical sterilization policy, or find it simply too costly to do so. This is often the case wherever the financial system is not fully liberalized.

The Philippines has undertaken both measures with questionable results.

From the ADB Institute,

As described earlier, the BSP has engaged in both sterilized and unsterilized intervention. A simple correlation analysis indicates that intervention, as measured by the percentage of international reserves, has limited impact on the exchange rate’s level, percentage change, and volatility (Table 11 [ PDF 53.5KB | 1 page ]).¹⁰ The results indicate that intervention had a modicum of success in reducing exchange rate volatility in the Philippines between 1993 and 1996. Meanwhile, intervention prevented a rise in the exchange rate (measured in US$/peso) after the crisis, particularly during the period 2003–2007. In many instances the results are counter-intuitive, i.e. the correlation coefficient is positive, similar to the result of the impulse response function that was presented in Section III (Figure 4 [ PDF 42.8KB | 1 page ]). ADB Institute, Evaluation of Policy Responses, March 5, 2008

External Debt (Fiscal and Monetary Issues)

The question of debt has also been raised.

External debt as defined by the BSP covers all short-term and medium-term obligations of the BSP, commercial banks, public and private sectors payable to non-residents.

One must be reminded that external debt which covers by the national government is a fiscal issue whose repayment is allocated by the Philippine Congress. The 2011 php 1.645 trillion budget allocates 23% to debt servicing (dateline Philippines, President Aquino’s Budget message—Office of the President’s Official Gazette)

The BSP’s role according to Manila Bulletin/Cuervo Far East is to set “internal annual debt ceiling to monitor foreign borrowings, either from commercial sources or from official development assistance funds or donor aids.”

External Objectives and the Role of Forex Currency Reserves

Now domestic monetary policy is about domestic political and economic issues, and is hardly about coordinating inflation with external sources.

External issues are assumed by currencies that play the role of foreign currency reserves, where the conflict of interest between domestic and international objectives engenders what is known as the Triffin Dilemma.

IMF During the 1997 Asian Crisis and the Philippine Debt Moratorium in 1970-80s

During the Asian crisis the left has blamed liberalization, pegged currency and high interest rates (Walden Bello) when the problem has been a global rotational issue of bubble cycles.

Paper money has never been about sound money. It has been about political objectives.

As to whether the restricting Peso ‘inflation’ would hurt the US dollar hegemony, US dollar’s hegemony depends largely on the sustainment of its inflationist policies. If the US recklessly pursues a dollar debasement as their main policy thrust, countries will either jointly devalue (race to the bottom or competitive devaluation) or abandon the US dollar as a foreign currency reserve.

Finally, with regards to the role played by the IMF during the Philippines during the Philippine debt moratorium

Country-data com provides some clue: (bold emphasis mine)

On October 17, 1983, it was announced that the Philippines was unable to meet debt-service obligations on its foreign-currency debt of US$24.4 billion and was asking for a ninety-day moratorium on its payments. Subsequent requests were made for moratorium extensions. The action was the climax of an increasingly difficult balance of payments situation. Philippine development during the decade of the 1970s had been facilitated by extensive borrowing on the international capital market. Between 1973 and 1982, the country's indebtedness increased an average of 27 percent per year. Although government-to-government loans and loans from multilateral institutions such as the World Bank and Asian Development Bank were granted at lower-than-market rates of interest, the debt-service charges on those and commercial loans continued to mount. In 1982 payments were US$3.5 billion, approximately the level of foreign borrowing that year and greater than the country's total debt in 1970. The next year, 1983, interest payments exceeded the net inflow of capital by about US$1.85 billion. In combination with the downturn in the world economy, increasing interest rates, a domestic financial scandal that occurred when a businessman fled the country with debts estimated at P700 million, escalating unrest at the excesses of the Marcos regime, and the political crisis that followed the Aquino assassination, the debt burden became unsustainable (see table 16, Appendix).

The Philippines had turned to the IMF previously in 1962 and 1970 when it had run into balance of payments difficulties. It did so again in late 1982. An agreement was reached in February 1983 for an emergency loan, followed by other loans from the World Bank and transnational commercial banks. Negotiations began again almost immediately after the moratorium declaration between Philippine monetary officials and the IMF. The situation became complicated when it came to light that the Philippines had understated its debt by some US$7 billion to US$8 billion, overstated its foreign-exchange reserves by approximately US$1 billion, and contravened its February 1983 agreement with the IMF by allowing a rapid increase in the money supply. A new standby arrangement was finally reached with the IMF in December 1984, more than a year after the declaration of the moratorium. In the meantime, additional external funds became nearly impossible to obtain.

In each of these arrangements with the IMF, the Philippines agreed to certain conditions to obtain additional funding, generally including devaluation of the peso, liberalization of import restraints, and tightening of domestic credit (limiting the growth of the money supply and raising interest rates). The adjustment measures demanded by the IMF in the December 1984 agreement were harsh, and the economy reacted severely. Because of its financial straits, however, the government saw no option but to comply. Balance of payments targets were met for the following year, and the current account turned positive in FY (fiscal year--see Glossary) 1986, the first time in more than a decade. But there was a cost; interest rates rose to as high as 40 percent, and real GNP declined 11 percent over 1984 and 1985. The dire economic situation contributed to Aquino's victory in the February 1986 presidential election.

Hope this helps,

Benson

Market’s Addiction To Inflationism As Seen In The Currency Markets

Exchange-rate policies produce the usual spiral of interventionism: the de facto consequences tend to diverge from the original intentions, prompting further rounds of doomed interventions. This interventionist escalation is not only limited to an incessant repetition of the same failed policies, but the errors committed in one policy area also affect other parts of the economy. Thus, it is only a matter of time until errors of monetary policy lead to fiscal fiascos, and exchange-rate interventions lead to trade conflicts.- Dr. Antony P. Mueller

The markets loudly cheered on Japan’s aggressive engagement of her version of quantitative easing. Even more ecstatically to the joint intervention by the G-7 on the currency market to weaken the Japanese Yen.

As I earlier pointed out, there is little relevance between Japan’s money printing and the containment of the radiation risk[1], as well as, the weakening of the Yen which may, on the contrary, even harm the recovery process, as a weak currency would increase the prices of imports which Japan sorely needs for her public works[2].

Yet this is exactly what I have been driving about since time immemorial, the global financial markets addiction to inflationism.

It’s not clear how effective such interventions work. The last time Japan intervened massively in the currency markets in 2004 (£150 billion[3]) as shown in the above chart[4] the result was an apparent failure.

To add, this week’s market meltdown, despite manifesting some signs of 2008 or across the board selloff, lacked the traditional safehaven features: the US dollar (USD) hardly rallied (red circle below the YEN) while the rally in US treasuries (UST) had likewise been unimpressive!

Meanwhile the Euro (XEU) substantially firmed while the Yen (XJY) soared by 3.3% on Wednesday March 16^th! But the Yen gave up much of its gains on Friday following the G-7 announcement.

Reports say that the repatriation trade has been exaggerated.

According to the Finance Asia[5],

Japanese insurers are well-hedged at about 70% and have huge holdings in government bonds, which they could easily sell if they needed yen. And the industry is reinsured by the government anyway, so there is no shortage of yen in the insurance market.

The repatriation trade is, at best, premature, but the rumour of its existence was enough eventually to tip the market into a forced sell-off yesterday as dollar/yen sank below 80.

Mrs Watanabe, the archetypal Japanese housewife, typically holds a long position in US dollars. By Tuesday, those positions reached an all-time peak and, with dollar/yen parked close to 80, foreign speculators anticipating repatriation flows started to sell in the early hours of yesterday morning as trading moved from New York to Tokyo and liquidity was exceptionally low.

It is unclear if these reports are accurate and dependable, but it would seem that the steep overnight climb of the Yen has been unwarranted.

And thus, the markets natural response has been to sell down the Yen down which apparently has been exacerbated by the G-7 intervention.

Furthermore, critical credit markets hardly budged.

US Cash indices and 3M Libor OIS spread for both the US and the Euro, had seen little signs of anxiety in the face of the meltdown.

All these simply evince of a knee jerk fear premium.

In addition, the European Financial Stability Facility [EFSF] has been reinvigorated which may have given some legs to the Euro. According to the Danske Bank research team[6],

The negative events seem to have overshadowed the positive news that EU leaders agreed on new terms for the EFSF. The lending capacity of the existing facilities has been increased to EUR500bn and the EFSF has been allowed to purchase bonds in the primary market. This could prove a substantial help for Portugal. In addition, the interest rate has been lowered for Greece and the maturity extended after Greece agreed to sell state owned assets worth EUR50bn. The moves by the EU leaders were ahead of market expectations and are positive for peripheral spreads and therefore for the banking sector.

The actions of the Euro have basically been fulfilling what we have been saying throughout 2010[7].

Bottom line:

The current environment has clearly departed from the 2008 episode.

Moreover, like Pavlov’s dogs, financial markets have been elated by inflationism, which only means that current market trends can continue if governments continued to inflate.

---

[1] See Japan’s Disaster Recovery Program: Wishing Away Real Problems With A Tsunami of Money, March 15, 2011

[2] See Currency Intervention: Japan And The G-7 Aims To Boost Stock Markets, March 18, 2011

[3] Businss TimesOnline.co.uk Japan ends its £150bn currency intervention as economy firms, March 24, 2004

[4] Shedlock Mish Currency Intervention Madness, Japan Intervenes to Weaken the Yen, September 15, 2010

[5] Finance Asia, Mrs Watanabe, not repatriation, driving yen volatility, March 18, 2011

[6] Danske Bank, Weekly Credit Update, March 18, 2011

[7] See Ireland’s Woes Won’t Stop The Global Inflation Shindig, November 22, 2010; See Buy The Peso And The Phisix On Prospects Of A Euro Rally, June 14, 2010

Japan’s Currency Intervention, More Inflationism Ahead

``The whole world would then be able to inflate together, and therefore not suffer the inconvenience of inflationary countries losing either gold or income to sound-money countries. All the countries could inflate in a centrally-coordinated fashion, and we could suffer manipulation and nflation by a world government-banking elite without check or hindrance. At the end of the road would be a horrendous world-wide hyper-inflation, with no way of escaping into sounder or less inflated currencies.” Murray N. Rothbard on the Keynesian ideal “Bancor”

How the heck would you expect financial markets to falter with all the new stuff being worked out by major global central banks?

Let us put it this way, Japan has declared a war on her rising currency the Yen[1], which has been erroneously blamed by her government for their domestic economic malaise, by intervening in the currency markets.

This means that the Bank of Japan would have print money to sell yen in order to buy US dollars. And they have commenced on this operation just as China have begun to slow their purchases of US securities[2] —perhaps to accommodate for an appreciation of China’s yuan.

And as we have repeatedly predicted, economic ideology, path dependency and the prevailing low interest rates will prompt governments of major economies to use their respective printing presses to the hilt, in the assumption that money printing has little impact on the economy or the markets.

Policymakers are shown as exceedingly short-term oriented or with little regards to the possible consequences from their present actions.

And their academic and mainstream apologists have provided intellectual support, in the belief that by intervening in the currency market, or by the destroying their currency, they will the save the world. This is a delusion. Never has it been the case where prosperity had been attained by the destruction of one’s currency.

This is no more than a redistribution scheme by the Japanese government aimed at bolstering her exporters (17% of the Japanese economy as of 2007[3]) at the expense of the rest of the domestic economy in order to revive the old model where the US functioned as the world’s major consumption growth engine.

This interventionism could likewise be aimed at maintaining the low interest regime in the US in order to support the US banking system.

Or possibly, this could even signify as a clandestine three cornered coordinated operation with China, as China appreciates her currency by reducing purchases of US assets. Meanwhile, Japan takes over China’s role as the major accumulator of US securities, given the existing fragility of the US banking system.

Implications of the Japanese Yen Interventionism

Japan intervened in the currency markets in 2004. However the conditions of the past would be dissimilar today. Back then, the US was inflating a housing bubble, today, inflationism has been aimed at shoring up the local banking system.

Another, one possible reason Japan had not engaged in rampant inflationism during Japan’s lost decade could due to her cultural idiosyncrasy and a declining population, where Japan had wanted to maintain the value of Yen’s purchasing power. And this has been misconstrued as deflation[4].

Yet we see two problems with Japan’s interventionism.

First, the culture of savings of the Japanese will be jeopardized as the Yen is depreciated against real goods and services, rather than against the US dollar.

This isn’t likely to translate into new investments nor will this approach succeed to reinvigorate the economy. Instead, it could prompt for more capital outflows into commodity and peripheral markets.

Second, since the US has been inflating by keeping the US Federal Reserve’s balance sheet bloated, this means that Bank of Japan would not only have to print money but extensively print money WAY AHEAD of the US given the conservative position of the Bank of Japan’s balance sheet (BoJ) [see left window figure 2].

Figure 2: Competitive Devaluation And Record Gold Prices (chart courtesy of Danske Bank and Stockcharts.com)

Competitive Devaluation And Record Gold Prices

So in effect, we now have a three way competitive devaluation among the currencies of major economies, or a race to the bottom which includes the US dollar, the British Pound, and the Japanese Yen.

Thus, almost instinctively the gold market has responded to such development by exploding to new nominal record highs in US dollar terms (right chart-top window).

Priced in the Yen, Gold has likewise polevaulted as the BoJ made official her government’s interventionism in the currency market.

Slowly but surely rising gold prices continue to reflect on the growing cracks in the fiat paper money standard. Eventually the paper money system crumble like experiments in the past.

So as major economies devalue their currencies, we are likely to witness a monumental shift in the search for alternative “store of value” in the commodity markets and in the asset markets of the peripheral “emerging” economies as the ASEAN.

Figure 3: The Previous BoJ Interventionism and the Nikkei 225 (chart courtesy of Danske Bank and yahoo finance)

Japan’s previous interventionism failed to accomplish its goals (see figure 3), it took other factors to fire up a rally in the US Dollar-Japan Yen pair such as the American Jobs Creation Act Of 2004[5] which included a limited period of tax reduced incentives for multinationals who were enticed to repatriate overseas earnings, and others.

So whether this signifies as a standalone operation or a covert three way joint action among China, Japan and the US, the likelihood of the success of BoJ’s actions will likely be limited—unless Japan will aggressively take on more risk by exposing its system to the risk of hyperinflation.

In the past, such interventionism had coincided with the rising Nikkei (right window). With the degree of interventionism likely to be stronger than 2004, we should expect much of these easy money to flow into various assets.

So global bubble cycles are likely to get amplified.

Again all these add up to fly in the face of deflation exponents.

---

[1] Japan Times, Government acts to drive down yen, September 15, 2010

[2] Wall Street Journal Blog, Don’t Worry About China, Japan Will Finance U.S. Debt, September 15, 2010

[3] Google public data, Exports as % of the Economy, World Development Indicators

[4] See Japan’s Lost Decade Wasn’t Due To Deflation But Stagnation From Massive Interventionism, July 6, 2010

[5] Investopedia.com American Jobs Creation Act Of 2004

Mercantilism: Misunderstanding Trade And The Distrust Of Foreigners

One of goal is to expose on false doctrines peddled by mainstream media.

Here is another example of the fixation of the currency "magic wand" solution to global ills.

In a recent article by the Economist, the woes of Japan's diminishing share of world trade has unfairly been pinned to its firming currency.

From the Economist, ``Its 10% slice this year will equal that achieved by Japan at its peak in 1986, but Japan’s share has since fallen back to less than 5%. Its exporters were badly hurt by the sharp rise in the yen—by more than 100% against the dollar between 1985 and 1988—and many moved their factories abroad, some of them to China. The combined export-market share of the four Asian tigers (Hong Kong, Singapore, South Korea and Taiwan) also peaked at 10% before slipping back."

While it may be true that Japan's share of world exports have fallen, blaming the strong yen is far from accurate. There may have been some companies or industries that may be affected, but this can't be applied in the general or macro sense.

What this implies is that the article has engaged in selective perception of its presentation of facts or has engaged in fact twisting in of support of a preconceived bias, i.e. inflationism via anti-market bias currency interventions.


As you will note from the chart above by Google's public data, exports as % of GDP has been rising for the world.

This means that for most of the world's major economies, exports have been improving. This includes the BRIC's or particularly China or even the 'burdened' strong yen of Japan.

Yet, to give a better perspective, the world's GDP has been in an uptrend going into the 2008 crisis, with most of the world's economies reflecting such improvement.

In other words, the impression that China has been stealing export market share, by manipulating her currency, at the expense of Japan who 'suffers' from a strong currency is far from the reality.

Instead, what has been happening is that as globalization gets entrenched, the pie of world output has been increasing with an increasing share of contributions from more nations nations participating in global trade, particularly, from emerging markets as China.

In short, the major fallacy of the mercantilist view is the perspective that trade is a zero sum game. It isn't. In fact globalization has generally benefited the world.

And currencies, the favorite snake oil nostrum, have hardly been the determinant of the share of exports or competitiveness or economic growth. [see previous discussion: Big Mac Index: The Fallacy of Blessed And Burdened Currencies]

In fairness to the Economist, they mentioned other factors that may have helped China's expanding exports amidst a falling share of her major trading partners during the recent recession.

``Lower incomes encouraged consumers to trade down to cheaper goods, and the elimination of global textile quotas in January 2009 allowed China to increase its slice of that market."

Nevertheless, article's underlying theme seems slanted towards 'Sino phobia' -which unnecessarily portrays her as arbitrarily benefiting from the recession.

Again the Economist, ``Strong growth in China’s spending and imports is unlikely to dampen protectionist pressures, however. China’s rising share of world exports will command much more attention. Foreign demands to revalue the yuan will intensify. A new year looks sure to entrench old resentments".

Well perhaps it is more than just a misperception of the role of trade but from an anti-foreign bias endemic in the public's mind.

According to Professor Bryan Caplan, ``The root error behind 18th-century mercantilism was an unreasonable distrust of foreigners. Otherwise, why would people focus on money draining out of “the nation” but not “the region,” “the city,” “the village,” or “the family”? Anyone who consistently equated money with wealth would fear all outflows of precious metals. In practice, human beings then and now commit the balance of trade fallacy only when other countries enter the picture. No one loses sleep about the trade balance between California and Nevada, or me and iTunes. The fallacy is not treating all purchases as a cost but treating foreign purchases as a cost." (emphasis added)

Bottomline: Mercantilist solution deals with symptoms and not the cause. This means that policymakers who follow mainstream prescriptions is likely to suffer from the law of unintended consequences.

Philippine Peso: Interesting Times Indeed

``There are more borrowers who vote than creditors who vote. This is why democratic politics always favors long-term price inflation.” Gary North, Pushing On A String

We noted how the Peso’s performance has been a riddle, as discussed in Philippine Phisix at 2,500: Monetary Forces Sows Seeds Of Bubble

Figure 5: Danske Emerging Market Briefer: Peso Underperformance

The Philippine Peso has been underperforming its peers both in the Emerging Markets and its neighbors see figure 5 and 6.

Figure 6: Bloomberg: Bloomberg-JP Morgan Asia Dollar Index. AP Dollar Index

The Bloomberg-JP Morgan Asia Dollar Index which tracks 10 of the most actively traded currencies in Asia shows that since March of this year, Asian currencies have mostly been up while the Peso has lagged severely.

Recently, an email supposedly from an anonymous official from the World Bank reportedly said that the Philippine government has been manipulating the Peso to keep it below Php 52 to a US dollar-were it should be.

Of course the allegation was not only spurious and politically slanted, but it had little economic or expertise tacked on the assertion which supposedly emanated from a financial expert.

But if there has been any manipulation, it would be to bring the Peso down, this by expanding government liabilities by virtue of deficit spending.

While the Phisix has seen some improvements in foreign inflows over the past weeks, this hasn’t been extrapolated to the attendant firmness in the Philippine Peso. Yet last week’s carnage accounted for a modest net outflow, so this could add to the onus on the Peso.

Ideology of Policymakers Likely Tilted Towards Interventionism

The incentives aren’t for the Bangko Sentral ng Pilipinas [BSP] to appreciate the Peso; the market fundamentally determines the Peso’s strength.

Instead, it is the mainstream ideology based on a consumption modeled economy which gives the authorities the predisposition to depreciate the currency by intervention.

For instance, increased concerns over a material slowdown of remittance growth which may even post negative (-4%), according to the IMF [Manila Standard], risks weighing on the Philippine economic growth to negative (-1%).

So the BSP, in order to keep the economy from seeking its true levels, will increase the purchasing power of foreign based OFWs at the expense of the residents through higher prices. That’s because mainstream economists fixates on OFW remittances which constitutes only about 11-12% of the GDP and has been assumed to carry the onus of consumption expenditures.

Up to this point, I have yet to see a research which provides estimates on the share of OFW spending (direct and indirect or including the so-called multiplier) to total consumption. All the rest have merely been suppositions (and exaggerations in my view).

The fact that economic growth has materially slowed in the face of still positively growing OFW remittances suggests that manufacturing and agriculture could be a larger weight than the OFW remittances but which the mainstream economists and policymakers tend to ignore.

Deficit Spending For Elections, Mano a Mano

Moreover, pre-election spending by frontloading expenditures to spruce up economic figures going into the election could be another possible angle.

The Philippine Government says it is deeply committed to preserving its fiscal discipline, but expects deficit spending target up to 3.2% of the GDP (Philstar.com). Heck, it is election time and many vested interests are positioning for 2010, so it would be natural to expect an overshoot.

DBS along with ING estimates deficits to hit 4.5% of the GDP (GMAnews.tv). No question here about Philippine deficits. But from this premise they predict bearishness on the Peso.

Hello.

Currencies are basically valued by pairs. If the primary concern for the Philippines has been its fiscal deficits, then relative to the US dollar this should be minor.

The US fiscal deficit is expected to reach 13% of GDP see figure 7!

Figure 7: Heritage Foundation: Exploding US Deficits

Think of it, 13% versus 4.5%, that’s a yawning gap in favor of the Peso!

Ok, the US will be borrowing from its own currency, that’s their privilege. And that’s the added risk premium for the Philippines. But the margin has extremely been one sided. Moreover, the key issue would be sources of funding and not just deficits.

Will the US economy rebound strongly enough to generate revenues to pay for these debts? Will there be enough local and foreign savers to finance these humongous public liabilities? Will official sources to continue to fund US government spending sprees? Or will the US monetize its debts?

Remember it isn’t just new issuance but present rollover financing for maturing debts that needs to be taken into account!

The recent activities in bond market hasn’t been optimistic for foreign buying activities of US treasuries, according to the Wall Street Journal, ``The closely watched figure, excluding transactions that don't occur on an open market, recorded net purchases of $11.2 billion in long-term U.S. securities, after purchases of $55.4 billion in March, according to the monthly Treasury International Capital report, known as TIC.” That’s nearly an 80% drop in foreign buying!

Yet this week, the US treasury will hold another record offering to the tune of $104 billion (CNBC.com). So record upon record issuance will test the limits of the global pool of capital. Losing the ability to raise financing will likely prompt for debt monetization or the US will be faced with the risk of a default.

Moreover, deficits are expected to be still relatively larger than the Philippines even in 2010.

Notwithstanding, the unraveling of the next wave of mortgage resets, other credit woes (credit card, auto loans, Commercial Mortgages, leveraged debts) and deficits from states that would necessitate for Federal bailouts are likely to generate pressures for additional deficit financing.

Hey guys, when looking at the Peso, the US dollar isn’t neutral or fixed. It’s like a tale of the tape of a boxing match, mano a mano.

The Last Barrier Standing

Ok there hasn’t been concrete evidence in terms of declining US dollar reserves (which continues to modestly expand in May) or admission from the BSP of any market intervention. So here we are merely making wishy washy conjectures. Maybe we could try to see the outstanding gold holdings.

But as far as BSP intervention is concerned, there seems to be a stronger incentive for such actions on concerns over the sagging consumer spending from declining remittances of OFWs and from election spending that could weigh down on the Peso. That’s the bearish case.

But the last word on the US dollar from Doug Noland in his latest Credit Bubble Bulletin ``Our foreign Creditors may be content to recycle dollar flows back into Treasuries, but they are thus far in no mood to return to financing our business or household sectors. This may prove a major factor contributing to an altered flow of finance throughout the U.S. economy. It can also be read as a warning that the crucial process of dollar recycling rests increasingly on market perceptions of the soundness of one single market – U.S. Treasuries.” (bold highlight mine)

Remarkably, only a single barrier stands between success and doom. You may call it credibility, but I call it FAITH.

Interesting times indeed.