Cureent market environment

Karl Marx would be pleased…well, maybe not. In any event, the world’s Central Banks are tired of the weak Dollar, and are separately taking matters into their own hands. [Before I continue, I should probably acknowledge the inherent dangers of lumping every Central Bank together under one umbrella. Still, given the current market environment, and the fact that all Central Banks are acting uni-directionally, it seems like a fair categorization].
As I was saying, Central Banks – especially in the developing world – are extremely unhappy with the Dollar’s continued decline, and with the opposing strength in their respective currencies. Over the last year, these Central Banks have waded into the forex markets, one after another, in a non-concerted effort to stem the gains in their currencies. As the Dollar’s decline has gained new momentum, so have they redoubled and intensified their efforts.
In the last couple weeks alone, at least a dozen (and these are only the ones on my radar screen) have issued threats and/or taken action aimed directly at the “speculators,” which are blamed for the across-the-board rise in emerging market currencies and asset prices. Their concerns are twofold: that currency appreciation could choke off economic recovery, and that speculative investment is driving the creation of new asset price bubbles.
While their goals are largely the same, their tactics differ. Some are testing the old approach of simply buying Dollars on the spot market. Thailand, Israel, South Korea, Philipines, and Russia, for example, are now intervening heavily on a regular basis. “Experts estimate that some of the largest emerging economies may have spent as much as $150 billion on currency intervention over the past two months, judging from the growth of their international reserves, according to data from Brown Brothers Harriman.”
Other Central Banks have resorted to policy-making measures; Taiwan and Brazil are perhaps the best examples here. The former has essentially banned foreigners from opening new time deposits in the country, while the latter has just imposed a 1.5% tax on investment in Brazilian ADR shares to match the 2% tax on new FDI. In addition, sources claim that other measures are being considered, including “an overseas sovereign bonds issue denominated in Brazilian reals and a change in rules that would allow foreign equities investors to deposit guarantees overseas.”
South Korea and Sri Lanka have been even more creative in restraining their currencies. Sri Lanka is now making it easier for its citizens to take money out of the country, while South Korea is now placing limits on the hedging activities of exporters, who “have sold large amounts of dollars in the forward market to hedge foreign orders, putting upward pressure on the won.”
Still other Banks are still in the “rhetorical” stage of intervention, whereby they simply convey to investors that they are monitoring forex markets for “instability” and “irregularities.” Such code-words are designed to signal that rapid currency appreciation will not be accepted idly. “People see the central bank looking closely at the dollar and think maybe it’s a good time to unwind some of their positions,” explained one analyst in response to “rhetorical intervention” by the Bank of Chile.
Unfortunately for these Central Banks, their efforts are ultimately unlikely to be successful. They can probably succeed in slowing, or even temporarily halting the rise in their respective currencies, but won’t be able to achieve a permanent cessation. That’s because the forces they are fighting against are simply too large ($3 Trillion per day of forex turnover) and too determined (Russian and Brazilian interest rates are both above 8%, compared to 0% in the US) to be stopped. “It’s [intervention] not working, and it’s a good thing that it’s not working. Emerging-market currencies are appreciating and they’re going to keep on appreciating against currencies from the old world. [Central Banks] has to adapt to that,” declared one trader. Still, you can’t blame them for trying.

Posted by Adam Kritzer in Uncategorized 1 Comment »
November 23rd 2009
“Strong Dollar” Policy is a Joke
US economic officials have been busy of late, propagating the “Strong Dollar” farce to anyone who will listen. “I believe deeply that it’s very important for the U.S. and the economic health of the U.S. that we maintain a strong dollar,” said Treasury Secretary Timothy Geithner at last week’s APEC summit in Singapore. Added Ben Bernanke, Chairman of the Federal Reserve, “We are attentive to the implications of changes in the value of the dollar and…will help ensure that the dollar is strong and a source of global financial.”
The markets hardly reacted to Geithner’s assertions, probably because he has parroted this same promise on several occasions since assuming office last January. Investors can be excused for their jadedness, since similar promises were repeatedly made during the Bush administration, during which time the Dollar registered some of its steepest declines in memory.
Still, you’ve got to give Geithner an A for effort, since he has seemingly taken advantage of nearly every opportunity to pontificate about the Strong Dollar policy. ” ‘The dollar isn’t strengthening in the real world, but I told him [Geithner] I value his stance. The fact that I value his stance means that I believe things will develop that way, and that I believe the U.S. is making efforts to make that happen,’ ” said new Japanese Finance Minister Hirohisa Fuji. By his own admission, Fuji’s remarks were somewhat perfunctory, and it’s obvious to him the Dollar will continue depreciating
Bernanke, meanwhile, has more credibility on this issue, especially since the Fed so rarely discusses forex in public domain, which is why the Dollar initially spiked after he spoke. However, investors quickly registered the contradiction inherent in his remarks, which contained repeated promises about keeping rates low. Not to mention that the wording he used was almost identical to a speech from 2008. It’s no wonder, then, that the Dollar actually finished down on the day.
So if the markets aren’t taking this talk about a Strong Dollar seriously and Bernanke/Geithner know they aren’t being taken seriously, what’s the point of these vain pronouncements? [After all, it's not even clear that a strong Dollar is in the best interest of the US, which has benefited economically from a narrowing of the trade deficit]. A few explanations have been suggested.
The first is that the rhetoric is intended to re-assure foreign investors and creditors that their assets/loans in the US will be safe from massive devaluation. While foreign Central Banks continue to purchase US Treasury Securities, their have been increasing grumblings that loaning to the US government is a losing proposition. Second, a weak Dollar is inherently inflationary, since it makes imports more expensive. The reverse correlation between oil (and other commodities) and the Dollar means that a weak Dollar could feed back into higher prices double time. Towards that end, Bernanke was actually speaking earnestly about the Fed’s intentions to monitor forex markets, as they bear on inflation.
Finally, while US policymakers seem resigned to the Dollar’s continued decline, they need to make sure that it remains “orderly” (this characterization has cropped up repeatedly in political circles, of late). “We believe Chairman Bernanke’s comments reflect a desire to prevent a disorderly decline in the currency, rather than halt its depreciation altogether.” There is an obvious recognition that a complete collapse in the value of the Dollar would be terrible for everyone, of which Bernanke no doubt also undersds.
Still, the markets are keenly aware that the US (i.e. the Fed) is not prepared to put its money where its mouth is. The reason for the current bout of Dollar weakness is almost entirely connected to the Fed’s easy monetary policy (and its quantitative easing program) and the never-ending US budget deficit. If the US was seriously committed to a strong Dollar, then the Fed could simply tighten monetary policy. (The federal government could make more of an effort to balance its budget going forward, but this is currently less of a concern to forex markets).
Alas, the Fed is nowhere near ready to hike rates, nor is it willing to contemplate unwinding its quantitative easing program. Most analysts expect interest rates to remain at the current record lows well into next year. Futures contracts expiring in June 2010 are pricing in a Federal Funds Rate of only .42% at that time. Most telling is that Bernanke, himself, has declared rates will remain low for an “extended period.” In hindsight, using the same speech to talk up the Dollar probably wasn’tthe best idea.

Posted by Adam Kritzer in Uncategorized No Comments »
November 21st 2009
Everyone Thinks the Yuan is Undervalued….Except for China
Subtle title, right? I couldn’t resist, considering that literally all economists and government officials (outside of China, of course) have sounded off on the Chinese Yuan in the last month. Recent additions to this list include President Obama, Chiefs of the IMF and World Bank, President of the Asian Development Bank, US Commerce Secretary Locke and Treasury Secretary Geithner, Nobel Laureate Paul Krugman, ECB Chief Jeane-Claude Trichet, Harvard University Professor Martin Feldstein, Japan’s finance minister…not to mention the thousands of others that didn’t make international news for their denunciation of China’s currency policy.
This rhetoric has also been accompanied by several important developments, including a Presidential visit to China, several meeting of the G20, a summit in Singapore, a slight change in the wording of China’s forex strategy, the release of economic data that suggest China’s economy is strengthening, etc. At the same time, their remains an obstinate insistence from every corner of the CCP that despite this pressure, there are no imminent plans to further revalue. Investors are erring on the side of appreciation, however, and futures prices reflect a 3.5% rise in the value of the RMB over the next 12 months.
This disconnect is indicative of the fact that there is both a political and an economic side to this issue. When examined exclusively from either side, it looks like pretty cut-and-dried, since economics suggests that a revaluation is both necessary and desirable, but the misalignment of political interests suggests that it won’t be carried out any time soon.
More specifically, a chorus of economists (backed by hard data) is arguing that the RMB is one of the foremost causes of the widening imbalances. After a brief hiccup, China’s trade surplus is once again expanding, and is on pace to reach $300 Bill ion in 2009, more than half of which can be attributed to the US. Meanwhile, while GDP is projected at 10.5%, the rest of the world is still sputtering along. “China is ’stealing’ jobs from developing countries and hindering a global recovery by keeping the yuan low, Nobel laureate Paul Krugman says. ‘China’s bad behavior is posing a growing threat to the rest of the world economy.’ ”
Economists also argue that a revaluation would also be in China’s own best interest. Foreign capital is now pouring into China at a record pace – largely in anticipation of an imminent appreciation in the Yuan – such that asset prices have almost doubled over the last year. “Risks of asset-price bubbles and misallocation of resources amidst abundant liquidity need to be addressed,” said the Chief Economist from the World Bank. Echoed the head of the IMF: “An undervalued currency encourages companies to invest in ways that may not be viable once the currency rises. ‘If you have wrong prices, you make wrong decisions, especially concerning investment in the long run.’ ”
Foreign politicians, especially those from the US, have been hammering these points home. President Obama made the RMB a key issue during his visit to China this week. Senator Chris Dodd chimed in with his two cents, that “You can’t give your competitor, your adversary in this case, a 40 percent advantage in global economies.” As analysts pointed out, the US, unfortunately, doesn’t have any leverage on this issue, as it is basically dependent on China to fund its budget deficits through Treasury Purchases. Thus, Chinese Prime Minister Hu JinTao couldn’t even be bothered as to so much mention the RMB when summarized the meeting with Obama for reporters.
Other Chinese Ministers rebuffed reporters in separate sessions who even dared to bring up the RMB: “Any policy changes by China, including on the exchange rate, will be based on its assessment of its own interests, not on external pressure.” Meanwhile, “Chinese officials refused to sanction a statement at the Asia Pacific Economic Co-operation summit in Singapore that would have pressed it to adopt ‘market-oriented’ exchange rates for the yuan.” In fact, they have begun to push back against criticism, by arguing that a weak Yuan has actually been economically beneficial. “China keeping a basically stable exchange-rate policy is, in reality, good for the global economic recovery,” argued the Minister of Commerce .
This political/economic dichotomy is also evident within China. The Central Bank recently changed some of the language which governs its forex policy; going forward, the Yuan will apparently be tied to a basket of currencies, with its value also influenced by trends in capital flows. However, “The central bank’s position is getting a determined push-back from manufacturers and exporters –especially along China’s wealthy coast –who stand to reap significant gains in the short term.” Given that the decision to lift the RMB will ultimately be made in the political arena, it’s understandable that the latter group has such a strong bearing on the process.
As I indicated above, investors are cautiously optimistic that the government will eventually relent to its critics and allow the currency to resume its steady upward path. Futures prices have risen steadily since September, when they reflected a flat RMB over the next twelve months. According to one analyst, ” Officials may, starting in the second half of 2010, allow it to recoup the drop of about 10 percent on a trade-weighted basis it’s had since March.” Goldman Sachs, long respected for its economic forecasts, remains one of the lone naysayers, arguing that the Yuan isn’t going anywhere until at least 2011.
Personally, my money is an appreciation in the near-term, as soon as the first quarter of 2010. Chinese leaders are stubborn, but they aren’t stupid. It won’t be pressure from the US that will shake them from their moorings – but a further inflation of property and stock market bubbles and concerns over the economy’s unhealthy dependence on exports for growth.