Category Archives: CBs

DXY and exports

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2008-06-03 Dollar Index vs US Exports

Dollar Index vs US Exports

Right – seems to me the dollar will fall until it’s at a level where the trade gap goes to about zero. So even though exports are way up and the trade gap down, there could be a lot more to go.

A nation can only run a trade deficit to the extent non-residents (governments and private sector agents) desire to net accumulate its financial assets (or buy its domestic assets such as real estate).

Seems to me Paulson, Bush, and Bernanke have successfully kept the world’s CBs, monetary authorities, and portfolio managers from actively accumulating USD financial assets.

Doesn’t seem like jawboning is going to alter foreign ‘savings desires’ apart from short term trading responses.


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Reuters: Paulson on Mideast USD pegs

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Maybe the weak USD is causing him to have second thoughts on preventing CBs and monetary authorities from accumulating USDs to keep their currencies low and support their exporters?

Ending dollar peg won’t solve Gulf inflation: Paulson

by David Lawder

(Reuters) U.S. Treasury Secretary Henry Paulson said on Saturday the dollar peg for currencies in the Middle East had served those countries well and any changes to the peg would be a sovereign matter.

Paulson, on a visit to Saudi Arabia, Qatar and the United Arab Emirates, also told a news conference the current level of oil prices were a burden on economies and consumers around the world.

Asked about the dollar peg, Paulson said:

“That is a sovereign decision … The dollar peg, I think, has served this country (Saudi Arabia) and this region well.”

Paulson earlier met Saudi Finance Minister Ibrahim al-Assaf to discuss a range of issues including the oil market, the U.S. and Saudi economies and issues related to foreign exchange.


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Wed am recap

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Mainstream economics says:

Get inflation right and that ‘automatically’ optimizes long-term growth and employment.

Adding to demand with a negative supply shock turns a ‘relative value story’ into an ‘inflation story.’

The ECB is following mainstream theory, while the Fed is not.

why?

The Fed sees looming systemic, deflationary tail risk at the door. At least up to now.

The panic of 1907 and the early 1930s deflationary collapse (both previous examples given by the Fed) were gold standard events.

With a gold standard (and/or other fixed rate regimes) there are direct supply side constraints on the reserve currency. Interest rates are market determined, and during a credit crunch rates spike higher ‘automatically.’ Even the treasury must fund itself and faces the same supply side constraints, thereby limiting fiscal responses. This continues in today’s fixed fx currencies.

With floating fx/non-convertible currency there are inherent no direct supply side constraints on bank lending, deposit creation, and credit in general. Any constraints are on the demand side, including financial capital where constraints are also on the demand side. The CB necessarily directly sets rates, not market forces, and government spending is not constrained by taxing, borrowing, etc., hence fiscal packages are subject only to political choice.

Today’s risks are much the same as previous financial crisis type risks like 1987 and 1998, where the government and its agencies have the open option of ‘writing the check’ as desired, with inflation the price to pay, not government solvency as with fixed fx regimes.

Just like the 1970s, the Saudis are acting the swing producer and setting price and letting quantity they pump adjust. This is also necessarily the case when one is single supplier at the margin with excess capacity. The alternative of pumping flat out and hitting bids in the spot market is not a functional option for any monopolist. Only price setting is.

Russia is also a monopoly supplier at the margin and probably is also acting as a swing producer. So crude prices go to where the higher of the two set them.

Mainstream theory has not yet publicly addressed this kind of negative supply shock.

One option is to match the domestic inflation rates to the price hikes to try to avoid declining real terms of trade.

This is both politically impossible, and it can quickly lead to accelerating inflation.

We have two choices, neither particularly attractive:

  1. Watch our real terms of trade continue to collapse as crude prices are continuously hiked.
  2. Try to inflate to moderate the drop in real terms of trade.

Ironically, we will chose the later as we did in the 1970s because inflation is not a function of interest rates in the direction CBs subscribe to.

Increasing nominal rates increases inflation via the cost and demand channels.

Costs of holding inventory and investment rise with rate hikes.

Governments are net payers of interest to the non-government sectors; so, rate hikes also increase government spending on interest to support incomes in the non-government sectors.

Good luck to us!

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Re: Fannie & Freddie

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(an email exchange)

>
>   On Mon, Apr 21, 2008 at 9:55 AM, Russell wrote:
>
>   Fannie and Freddie now back 82% of all mortgages in the U.S.,
>   up from only 46% in the second quarter of 2007. If they need
>   a bailout – could be a trillion dollars –

Funds are already advanced to the homeowners which supports demand.

A ‘bailout’ would only be an accounting entry between the government’s account and the agency’s account – no effect on aggregate demand.

>   the USA may lose its AAA credit rating.

Like Japan did. Just another sign of incompetance by the ratings agency if it happens.

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FT: Detail of BOE plan

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Looks functionally the same as direct lending to the banks vs their mortgage-backed securities.

Don’t know why they are taking this indirect route. Maybe because the Fed is also doing a security lending facility vs direct lending, and the BOE doesn’t want to show them up by doing it right as a gesture of solidarity.

Like everyone in Spain talking with a lisp when pronouncing the ‘s’ sound because the king did way back.

Gets stranger by the day.

Treasury and Bank to publish mortgage remedy

by Chris Giles

The government and Bank of England’s plan to unblock mortgage markets will be published today, but its broad outline began to emerge shortly after Mervyn King, Bank governor, met the heads of the main British banks a month ago.

Unlike other European countries, which wanted to change accounting rules to increase the value of mortgage-backed securities on banks’ books, the British authorities have aimed to acquire these assets at a price higher than the current market values but lower than the price that reflects the fundamental risk of default.

Because they reckon a gap between the two prices exists, the intention is to ease the liquidity strains on banks without the taxpayer adopting much extra risk or buying assets that are fundamentally under water.

With Treasury approval, the Bank of England is to swap mortgage-backed securities for government paper for a year, with an understanding that these year-long swaps will be extended for a further two years.

The programme will act as a new Bank of England facility by which banks will be given short-dated and highly liquid Treasury bills with maturities of one year or less. The Bank will accept mortgage-backed securities and other asset-backed securities in exchange. So arrangements will not be counted as new government debt by public sector books.

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Answer to the USD question

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Ed says:

Warren,

Isn’t it also true that the US export boom is less a result of the weaker dollar, so much as it is the cause? Foreigners using the trade surplus dollars they were previously content to save, are now spending them, and the shopping list is sizable. In this sense, all the dollars we have been exporting for years are coming home to roost, and that explains a good chunk of the inflation we are seeing.

Ed

I agree the cause is foreigners switching as a sector from wanting to accumulate USD to not wanting to accumulate them, and therefore spending them.

However, I see the market forces working as follows:

The first desire is ‘not to save’ which drives the USD down either until the $ is somehow low enough where they want to save it again, which doesn’t make sense to me, or until the USD is low enough for them to spend them here, which makes a bit more sense to me.

And the other force is the decreased desire to export to us which is evidenced by higher import prices.

Last, this is all inflationary, and inflation is the other channel for getting rid of a trade gap.

For an extreme example, if there is sufficient inflation for the minimum wage to go to $60 billion per hour, the real trade gap is suddenly down to only an hour of labor, though still nominally at 60 billion.

The combination of rising net exports, falling imports, and inflation are all working together right now to digest the sudden shift from CBs and monetary authorities away from buying USD financial assets.

Fiscal adjustment checks start going out in a couple of weeks.

Rest of govt. spending going up as well.

GDP should muddle through and inflation continue to accelerate.

It may dawn on the Fed that the weak dollar is hurting the financial sector as the consumer is being squeezed by food/energy prices and therefore having trouble making loan payments. That’s the price of sticky wages, at least this time around.

Foreign CBs have no option regarding world currency stability but to try to put pressure on the Fed to stop cutting.

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FT: US credit rating under threat

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Seems no end to the stupidity that continues to spew out from all kinds of places.

You’d think the ratings agencies would have learned their lesson with Japan – downgraded below Botswana and still funded JGB’s at under 1% for years until the BOJ raised rates.

And last I saw ten year US credit default was around ten basis points?

I had a discussion with S&P years ago. Seem to remember a name ‘David’?

He seemed to sort of grasp that operationally governments with their own (non convertible) currencies and floating fx policies aren’t revenue constrained, but obviously didn’t quite get it when they downgraded Japan.

The eurozone is another issue, where they have downgraded national governments and that does mean something regarding risk, just like the US States, but with no legal safety net by the Federal authorities like the US. Fortunately the eurozone banking system hasn’t been tested, yet.

Simple trade: sell US credit default, buy Germany, for example.

US credit rating under threat

by Aline van Duyn

The US government’s need to provide financial backing to the state-sponsored mortgage financiers that dominate the US housing market could pose a risk to the country’s triple-A credit rating, Standard & Poor’s, the credit rating agency, said on Monday.

In the event of a deep and prolonged US recession, S&P said the potential costs of propping up government-sponsored enterprises (GSEs) like Fannie Mae and Freddie Mac, which have implicit government backing, could cost the US government up to 10 per cent of GDP.

The costs of supporting broker-dealers like Bear Stearns in a dire economic situation would be much lower, at below 3 per cent of GDP, S&P said.

“The size of GSEs, coupled with their current level of common equity, could create a material fiscal burden to the government that would lead to downward pressure on its rating,” the S&P report said.

The S&P comments come amid increased pressure for better regulation of the mortgage financiers, especially as their role in the US housing market is likely to increase as they are used to provide support for struggling homeowners.

Policymakers are pushing for Fannie Mae, Freddie Mac and the lesser-known Federal Home Loan Banks to pump liquidity into the US mortgage market and this has prompted regulators to call for stronger oversight of such institutions.

Fannie Mae, Freddie Mac and the Federal Home Loan Banks have become the backbone of the troubled US mortgage market as purely private sources of finance have all but dried up or are offered only at punitive terms.

In the second half of 2007, about 90 per cent of new mortgage funding was provided by GSEs. They have about $6,300bn of public debt and mortgage securities outstanding, more than the $5,100bn of outstanding US government debt.

Fannie Mae and Freddie Mac have no formal state guarantees but investors believe the US government would step in if the system got into trouble. This allows the agencies to raise funds at very low rates against a triple-A credit rating, in spite of high levels of leverage.

The capital surplus ratio for GSEs was recently reduced to 20 per cent from 30 per cent, allowing them to operate on a more leveraged basis.

In January, Moody’s Investors Service, another credit rating agency, said the US could risk its triple-A rating within a decade unless soaring healthcare costs and social security spending was curbed.

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Re: Comments on G7 Statement on FX

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(an email)

>
>   On Sun, Apr 13, 2008 at 11:41 PM, Craig wrote:
>
>   Ok. So then it seems to me that it’d be a big change
>   for foreigners to panic on USD assets. Not saying it
>   couldn’t happen, but it’d need a big catalyst. In the
>   mean time, I suppose foreigners will peck away,
>   the dollar will do what it does and purchasing power
>   parity will provide some elastic limits on downside.
>
>   True?
>
>   Craig
>
>

Ironically, the ‘fundamentals’ of the $ are pretty good – purchasing power parity is good, the govt deficit is relatively small, and the relatively difficulty of getting $US credit helps as well.

But the technicals remain extremely negative (we’ve cut off the traditional buyers) CBs, monetary authorities, and chunks of our own pension funds.

So it’s not so much as concern about ‘foreigners’ in general, but specifically CBs and monetary authorities no longer accumulating perhaps $50 billion a month, and no one else stepping in to replace them, so instead the $ goes to a level where the trade gap goes away.

And that level of the $ can be anywhere, as while the correction process is ‘using’ the level of the $ to get the trade gap to 0, the trade gap is not that strong/precise a function of the level of the dollar.

It’s an example of a ‘cold turkey’ adjustment (the sudden cut off of all the $ accumulators at once) with no prior thought to the subsequent adjustment process, apart from the limited understanding that it would somehow drive exports, and the mistaken notion that exports are a ‘good thing.’

I do think the rest of the G7 thinks the ‘answer’ for the G7 is to convince the Fed to stop cutting rates.

As I mentioned a while back, the Fed has become an international ‘outlaw’ seemingly prodding the world to follow it in an international race to the bottom regarding inflation. It started the game ‘who inflates the most wins’ with their ‘beggar they neighbor’/mercantilist weak/$ policy to ‘steal’ (or maybe in the way the Fed sees it ‘reclaim’) world agg demand and support US gdp with US exports at the expense of foreign gdp.

Now it seems this policy is backfiring. The weak $ has seemingly raised food/energy prices for the US consumer, weakening the financial sector as less income is available for debt service as well as other consumption, and while exports have helped it’s only been enough to muddle through. And US inflation is sprinting ahead as well.

So the Fed rate cuts have not been seen to have helped the financial sector, the consumer, nor the US economy in general.

The Fed is being seen as destabilizing the world’s economy, weakening the US financial sector, depressing US consumer demand, depressing foreign domestic demand, and driving US to dangerous levels.

Once again it seems it’s being demonstrated that weakening your currency and inflating your way out of debt is not a road to prosperity.

And world markets are pricing in further US rate cuts.

Good morning!

Warren

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Money (USD)

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My take on the USD:

It was at a level based on foreigners wanting to accumulate $70 billion per month which also = the US trade gap (accounting identity).

Most of that desire to accumulate came from foreign CBs trying to support their exporters, oil producers accumulating USD financial assets, and foreign portfolios allocating some percentage of assets to USD assets.

Paulson cut off the CBs calling the currency manipulators and outlaws.

Bush cut off the oil producers by being perceived to be conducting a holy war.

Bernanke scared off the portfolio managers with what looks to them like an ‘inflate your way out of debt’ policy.

And US pension funds are diversifying out of USD into passive commodities and foreign securities.  Looks to me like the desire to accumulate USD overseas is falling towards zero rapidly.

This means they sell us less and buy more of our goods, services, and our real assets.

Volumes’ of non oil imports are falling and of oil imports are flat.

The dollar has gotten low enough for the trade gap to fall from over $70 billion to under $60 billion per month (February was an aberration IMHO).

The dollar will ‘adjust’ until it corresponds with a trade gap that = desired foreign accumulation of USD financial assets.

I see no reason to think the trade gap should not go to zero.

The USD probably has not traded down enough to reflect the zero desire to accumulate USD abroad.

The ECB has serious ideological issues regarding buying of USD.  Not the least of which they don’t want to give the impression that the USD is ‘backing’ the euro, which would be the appearance if they collected USD reserves.

The ECB has an inflation problem, and they believe the strong euro has kept it from being much worse.

The policy ‘shift’ might be the process of ending of US rate cuts at the next meeting by cutting less than expected.

This might first mean only a 25 basis point cut when the market prices in 50 basis points, followed by no cut when markets price in 25 basis points, for example.

This would firm the USD and soften the commodities near term, as after the last 75 basis point cut when markets were pricing 100 basis points.

But this does not change the foreign desires to accumulate USD as direct intervention by the ECB would, for example.

So the adjustment process that gets us to a zero trade gap will continue.

And it will continue to drive up headline CPI with core not far behind.

And US GDP will muddle through in the 0% to +2% range with weak private sector consumption being supported by exports, US government consumption, and moderate investment.

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Dow Jones: No mof intervention

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The MOF would have bought USD long ago if Paulson hadn’t gone around branding any CB a ‘currency manipulator’ and an international outlaw.

The USD is in freefall and is now the major source of inflation.

And maybe the Fed as seen the connection?

MOF Frets Over Yen, But No Hint Of Intervention

by Takeshi Takeuchi

(Dow Jones) Japanese currency authorities expressed alarm about the dollar’s fall close to the Y100-mark for the first time since 1995 but didn’t offer any clues about whether or when they might take any countermeasures.

Finance Minister Fukushiro Nukaga and his vice minister on currency affairs, Naoyuki Shinohara, separately voiced caution after the dollar fell to Y100.19 in the mid-day Tokyo session.

Nukaga said it is “a shared perception among the G7 (Group of Seven industrialized countries) that excessive exchange rate moves are undesirable,” while Shinohara also noted “excessive foreign exchange moves are undesirable.”

The two point men for Japan’s currency policy also said they will “continue closely watching foreign exchange markets,” a code phrase that shows their displeasure about current dollar/yen moves.

Neither of them, however, commented on whether they are considering taking countermeasures against the dollar’s rapid fall against the yen.

But Shinohara repeated the word “excessive” a few times in exchanges with reporters, suggesting the ministry’s level of caution has been at least raised in response to the imminent possibility of the dollar’s break below the Y100-mark.

In the past, finance ministry officials usually stepped up their currency rhetoric in stages before intervening. Their remarks on yen strength often changed from “rapid” to “a bit sharp” to “brutal,” while they also threatened “appropriate action” as an advance warning before intervening.

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