Relevant and even prescient commentary on news, politics and the economy.

Kash is En Fuego Today

Go. Read.

  1. US Bank Exposure to Greece, part 3. The FT lets someone from Nomura argue that Kash’s declaration of U.S. bank exposure to Greek default in Part 2 (referenced here, but just go to Kash’s link for the gist) was overstated.

    Nomura and The FT lose the argument, badly.

  2. Disasters for an economy — either real or financial — are not always disasters for the economy’s currency.”* Good to think of in combination with this piece from Barry Ritholtz.

*I may write up more using this when I can do some charts and graphs. It is starting to appear as if no one other than Dr. Black understands The Whole of The Euro Story.

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It’s lonely at the top: now it’s up to the Bank of Japan to hold the yen down

Wow, FX space is totally rattled this week: the yen hit 76.25 against the dollar at the end of the day on March 16 and has since rebounded to current levels 80.90 (1:50pm in NY on 3/18). What happened over this time span? Mass speculation on yen appreciation due to earthquake-related repatriation, followed by technical levels being hit that drove the yen up against the dollar, and a collapse of the dollar against the yen (spike downward in the chart below). And then yesterday the G7 central banks (the Bank of Japan, Bank of England, European Central Bank, the Federal Reserve, and the Bank of Canada) agreed to coordinate a weak-yen effort. Today the yen is off 2.7% against the dollar.

Note: In the chart above, a decline in the USD/YEN is an appreciation of the Japanese yen and a depreciation of the US dollar. The chart above illustrates the daily fluctuation of USD/Yen since the Tōhoku earthquake on March 11.

The coordinated depreciation of the yen against its major trading partners is ‘concerted’, and such an effort has not occurred since September 2000 when the G7 bid up the euro. The yen effort is very different, as I’ll explain below. Furthermore, ongoing weakness in the yen against the rest of the G7 currencies depends on further actions by the Bank of Japan into next week and beyond.

Some thoughts:

* In 2000 the wedge between the eurodollar spot and its PPP estimate of fair value diverged throughout the year. The spot rate became increasingly undervalued, hitting a wide in October 2000 (according to Bloomberg estimates of PPP). This seems to be a traditional initial condition for intervention. In contrast, though, the USD/YEN spot is seriously overvalued according to a similar measure of PPP fair value. I should note that currency fair value is a contentious topic. (more after the jump)

* The NY Fed makes available balances through 1999 only, so I am unable to ascertain the impact on the Fed balance sheet of the coordinated efforts from the 1987 Louvre Accord nor the 1985 Plaza Accord . I digress. In the 2000 effort, the euro bottomed in 9/21 at 0.8460 in dollars during the day, reaching an intra-day high of 0.8992 on 9/22. The closing impact of the G7 coordination was roughly a 2.7% appreciation of the euro against the USD. Efforts, however, were quickly retraced (see chart below).

* We are already there in yen space: the yen is down 2.7% in just one 24-hour session. It’s likely that this effort lasts throughout next week, since (1) a retrenchment of the dollar would challenge global central bank credibility, and (2) the statement is more explicit in its mention of “readiness to provide any needed cooperation”.

* In 2000 the Fed purchased roughly 10% of its stock of euro holdings, or $1.3 bn worth of euros (see second table below). Using 2000 as a guide, this would imply that the Fed purchases roughly $2.3bn this time around. However, given the size of the ‘model’ trading flows and technical barriers, this time’s flows are likely to be bigger. We’ll see in coming months when the Fed releases its FX holdings update.

* There is a limit to the Fed’s buying of yen, since the Fed is selling yen assets. The Fed and the Treasury (the Fed manages two accounts of FX holdings, the SOMA and ESF account for the Treasury) hold $23 bn in yen-denominated assets (see second table below) – that’s an absolute upper bound on purchases, although FX swaps do allow some room for maneuvering (although I find it very unlikely that the Fed would print currency for this effort). In 2000, the Fed purchased roughly $1.3 bn euro – that number should be at least doubled this time around, given that FX markets are bigger now. In comparison, Wall Street estimates that the BoJ bought $12bn-$40bn..

If there’s going to be succes, it depends on the Bank of Japan’s flows, not those of the other central banks.

My take is that given the size of today’s move, the 2000 effort was not nearly as concerted as has been demonstrated thus far. Next week will be interesting. The goal, I guess, is to get the currency back into a range that will not be prone to technical bounces. I think that the BoJ’s going all in.

Rebecca Wilder

Chart and Table Appendix:

Eurodollar in 2000

FX holdings in 2000

FX holdings in 2010

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Foreign exchange surpluses

Global trade in the slogans of politics and media means outsourcing at the moment, and currency disputes, but a global economy has implications many Americans have not experienced in any large and macro way, and suggests there are other implications to consider:

Here are some key paragraphs from an article by Michael Hudson (Hat tip reader rayllove):

China already is seeking to buy mineral, fuel and agricultural resources abroad to supply the inputs that it needs for its own growth. But these efforts still leave substantial foreign exchange surpluses. Most countries have used these surpluses to buy up key sectors of foreign economies. This is what Britain, the United States and France have done for more than a century.”

“When the US economy runs payments surpluses with foreign countries, it insists that they pay for their foreign debts and ongoing trade deficits by opening up their markets and “restore balance” by selling their key public infrastructure, industries, mineral rights and commanding heights to US investors. But the US Government has blocked foreign countries from doing the same with the United States. This asymmetry has been a major factor causing the inequality between high US private-sector returns and low foreign official returns on their dollar holdings.”

“The refusal of the US Government to behave symmetrically by not letting China buy key US companies with the dollar inflows that enter China to buy its own companies, above all its financial and banking sector, is largely responsible for the asymmetrical situation noted above, in which US investors earn 20% in China, but China earns only 1% in the US.

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Inflation in China is not necessarily a bad thing

Yesterday, the release of key economic indicators in China produced headlines like this: China Targets Inflation as Economy Runs Hot. The table below lists the full release, including the consensus expectations (Bloomberg’s survey) for each statistic. (Here is the link for the actual data release.)

As you can see, the survey undershot the actual results across many of the releases, including that for GDP and inflation (CPI). The surge in the CPI, 1.9% y/y in December versus 1.4% y/y expected, attracted a lot of attention. According to the Economist, Helen Qiao and Yu Song at Goldman Sachs points out that prices may be on an (increasingly) upward trajectory:

The recent rise in inflation was caused mainly by higher food prices as a result of severe winter weather in northern China. In many cities, fresh-vegetable prices have more than doubled in the past two months. But Helen Qiao and Yu Song at Goldman Sachs argue that it is not just food prices that risk pushing up inflation: the economy is starting to exceed its speed limit. If, as China bears contend, the economy had massive overcapacity, there would be little to worry about: excess supply would hold down prices. But bottlenecks are already appearing. Some provinces report electricity shortages, and stocks of coal are low. The labour market is also tightening, forcing firms to pay higher wages.

The final sentence is very important – a tight labor market will lead to higher wages (the data on wages is 4 months old, so I will not plot it out). This suggests, completely by inference on my part, that prices pressures will be the wage-price spiral type – this can quickly get out of hand.

To be sure, the inflation surge was driven primarily by food prices, up 5.3% over the year; but with retail sales growing at a rate of 17.5% over the year and broad money growing at a 27.7% pace in 2009, prices hikes are bound to spread. We already saw inflation pressures building in the trade balance. Now I get to my chosen post-point: why is inflation in China necessarily a bad thing?

The inflation pop sparked a lot of market angst yesterday. Of course, this is just a single data point; but if inflation does build, and the government insists on maintaining its tight peg against the $US, then inflation will do what US consumers and Asian savers have not: reverse trade flows.

Specifically, and holding all else equal, sizable inflation in China would drive up the value of its real-exchange rate (REER), where the REER is the nominal exchange rate adjusted for relative prices in China versus its trading partners – faced by the Chinese.

As illustrated in the chart above, the REER has been on a downward trajectory throughout 2008, but remains elevated compared to its 2006 levels. The real exchange rate is the single-most important factor in determining trade flows. An inflation-driven growth in the real value of the Chinese yuan (REER) would effectively, and eventually, drop China’s export share with key trading partners.

Rebecca Wilder

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Are exporters in Asia real-ly losing their competitive edges?

by Rebecca

Central banks across Asia are concerned and actively engaged in some kind of currency manipulation – direct intervention, quasi-capital controls, and/or public speech (I will refer to this later, but RGE published a great article to the fact) – as investors flock to global capital markets seeking the “risk-on” trade. Central banks are attempting to stem the sometimes sharp currency appreciation, however, real exchange rates remain competitive.

Over the last three months, the $USD has dropped 3.6% against the Singapore dollar, 4% against the Malaysian ringgit, 6.1% against Indonesian rupiah, 1.9% against the Thai baht, 3.6% against Indian Rupee, 6.8% against the Korean won, and 1.8% against the Taiwan dollar.

The chart illustrates the trend in key Asian (not including China, whose exchange rate is explicitly pegged at 6.83 since July 2008) nominal exchange rates (measured in local currency units per $USD) – appreciating , which has Asian export industries worried. Central banks are intervening (in some cases through direct $USD purchase), where further intervention is a near certainty as many of these countries see export growth as the impetus to recovery. As such, and according to RGE last week, Asian central bankers are faced with a dilemma:

Despite a flood of portfolio investments into many of the region’s asset markets since early 2009, Asia still needs foreign capital to stimulate investment and finance its current accounts. Therefore, facing a sluggish export recovery and a pegged Chinese renminbi, most countries have opted to contain currency appreciation via verbal and actual interventions to avoid losing competitiveness. Intervention in the foreign exchange market has led to record reserve growth of over US$70 billion in Q3 alone in emerging Asia ex-China. Although most Asian countries are expected to keep intervening amid some currency appreciation, several countries may impose restrictions on foreign currency transactions. Given buoyant equity markets, attractive carry trades and the U.S. dollar weakness, policy measures will not contain the impact of capital inflows on Asian currencies, meaning that some appreciation from the least trade-dependent countries is to be expected. Taiwan is the country where capital controls or new restrictions are most likely to be implemented.

True, Asian nominal exchange rates are appreciating (sharply in some cases); but what one needs to consider is the real effective exchange rate. Actually, real effective exchange rates (taking also into account relative prices) remain rather competitive. In fact, only Indonesia and South Korea are experiencing any substantial real appreciation, and South Korea’s coming off of a very low base.

The chart above illustrates the real exchange rate: the nominal exchange rate defined in units of home currency per unit of foreign currency * (foreign price level)/(home price level). A movement up indicates a real appreciation of the local currency against the country’s trading partners.

Real exchange rates in Malaysia, Thailand, Taiwan, and India fell in the latest monthly data point; and furthermore, some are seeing the downward trend intact. Indonesian policymakers are worried – the sharp appreciation of its currency is growing the real exchange rate quickly.

It’s a complicated policy world out there – a hodgepodge of monetary stimulus, capital controls, and fiscal deficits. Something’s gotta give; and my bet’s that it will not be the currency. Direct intervention and further capital controls are on the way in Asia in spite of the need for foreign-sponsored domestic investment.

Rebecca Wilder

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Big week for currency intervention measures

by Rebecca

Policymakers across Latin America are announcing measures to stem currency appreciation against the $US. Since March 2009, the $US depreciated 25% against the Colombian peso, 28% against the Brazilian real, 14% against the Mexican peso, 12% against the Peruvian nuevo sol, and 11% against the Chilean peso.

Much of the $US’s lost value is due to a renewed risk appetite as the “flight to (US) quality” unwinds somewhat. Even so, emerging market policymakers are worried; and governments across the region are stepping up to halt the appreciation either directly (Peru) or with quasi-capital controls (Brazil).

The Brazilian government announced a 2% tax on foreign capital flows into the domestic fixed income and equity markets. And to Brazil’s northwest, the Colombian central bank on Friday announced plans for direct intervention in the foreign exchange market to the tune of 3 trillion pesos (only after lesser and indirect measures announced the previous week proved only transiently effective). And Peru’s central bank has been purchasing $US on a regular basis since September 2009.

As the chart above illustrates, the Banco Central de Reserva del Perú has been very successful in stemming the appreciation. Colombia’s initial efforts (like halting the repatriation of foreign dollar holdings) were successful but only to a point – the peso fell almost 4% against the $US; but since then, the peso has settled to around 1917 Peso/$US. Brazil’s efforts, however, did little to break the trend of the real: the $US appreciated roughly 2% in the wake of the capital tax announcement, but the BRL (the real) gained back every bit of value that it lost in about 2.5 days. As one of my colleagues said, “you can’t submerge a beach ball”.

I suspect that Colombia’s direct intervention announced on Friday will successfully drive down the value of the peso, as the foreign capital inflows are primarily from $US-denominated government bond issues (little equity flows). It’s kind of interesting that the government is concerned about the appreciation of the peso but issuing debt denominated in $US…….

Brazil’s capital markets are too big and too enticing to foreigners right now (see charts below) – more direct measures are needed to stop the BRL’s appreciation. We will see if the Banco Central do Brasil goes there – Asia’s certainly doing it!

Text added: The charts illustrate the EXTERNAL bond and equity issuance by country as a share of total issuance in Latin America from the IMF Global Financial Stability Report.

Rebecca Wilder

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