Marc Faber is in a bullish mindset, particularly on gold. In a wide-ranging interview with CNBC TV-18 in India, Faber talked about where he sees markets headed and why he thinks gold will never drop below $1,000 an ounce.

Private sector contracting while public sector expanding

This is the frame that Marc Faber puts on recent events post 2008 panic, namely that we are likely to see an era of increased government intervention. This is an echo of comments Bill Gross has been making for some time. We are seeing this stimulus on both the fiscal and monetary sides through fiscal stimulus programmes and quantitative easing worldwide.

The economy has not responded robustly given the size of stimulus, Faber says. Asset markets, on the other hand have. This sets up a clear dichotomy between ordinary citizens and those who benefit most from asset price appreciation on Wall Street and elsewhere in the financial sector. Moreover, the spill-over of asset price appreciation into commodity prices further constrains purchasing power for ordinary citizens.

Less certain about carry trade

Faber is less certain about the U.S. dollar carry trade. He sees a dollar overhang due to the enormous U.S. current account deficit and $7.7 trillion in U.S. dollar reserves as more the issue. Many are looking to sell these dollars and hedge their exposure in precious metals and other currencies.

Treasury bearish

The one area where Faber is bearish is U.S. treasuries. He says:

There is a risk that at some stage in 2010, the government bond markets (would) weaken considerably because I don’t understand why anyone who would now buy a 10-year US treasury at a yield of less than 3.5%. It’s a losing proposition. I also don’t understand why anyone could buy a 30-year US treasury at a yield of 4.4%. So I think that eventually yields will go up and this could disturb the stock market.

Not as bullish on equities

Given the huge uptick in share prices globally, Faber believes there is now limited upside going forward.  He says the risk/reward in equity markets at present is not favourable. Moreover, profit margins are cyclically high due to cost-cutting. Faber anticipates weakness in profits in 2010, causing earnings to disappoint and precipitating a correction.

Bullish on commodities and precious metals

His logic is as follows: cash is now trash with zero interest rates. So holding cash means underperforming.  Bonds present an unfavourable risk/reward.  Therefore, commodities and precious metals look attractive. One must also have equities exposure.

Interestingly, he makes a fairly explicit statement in favour of peak oil from about 1:40 in the second video below. The world is adding less in oil reserves than it consumes. That necessarily means a tighter supply/demand dynamic, especially given the demand in emerging economies for oil.

He uses a technical argument to make his money quote (in bold):

I believe that whereas in the past the USD 1000 per ounce level was kind of a resistance level, now it becomes a support level. I don’t think that you’ll see gold below a USD 1000 per ounce probably ever again.

So I’m actually quite positive. Maybe gold at this level is a better buy than it was at USD 300 per ounce in 2001.

Much, much more below.

(videos embedded below)

Marc Faber Interview: Part 1 (6:19)

Marc Faber Interview: Part 2 (5:42)

Sources

Gold will never fall below $1,000 an ounce: Faber – Live Mint

Gold won’t fall below $1000/oz level ever again: Marc Faber – Money Control

Related posts:

• Marc Faber says avoid financials and buy gold
• Marc Faber: I advise every American to hold his gold outside of the United States
• Marc Faber makes bullish comments on Bloomberg
• Marc Faber: “Monetary policy in the United States will stay expansionary”
• Marc Faber: “I am 100% sure that the U.S. will go into hyperinflation”

On the eve of U.S. President Barack Obama’s visit to China, a major Chinese official has criticized U.S. monetary policy in unusually harsh language. Liu Mingkang, China Banking Regulatory Commission chairman said the zero interest rate policy of the U.S. Federal Reserve posed a “new systemic risk.”

Liu, using language reminiscent of warnings by NYU economist Nouriel Roubini and speaking at a financial forum in China’s capital Beijing, said:

This situation has already encouraged a huge dollar carry trade and had a massive impact on global asset prices… It is boosting speculative investment in stock and property markets and will pose new, insurmountable risks to the global recovery and, particularly, to the recovery in emerging markets.

In my view, this is pure political posturing by the Chinese in order to defuse any U.S. criticisms of Beijing’s currency peg. Call it a pre-emptive strike. The U.S. has seen the unemployment rate rise to 10.2% and the trade deficit rise quite dramatically as well. Many are blaming the Chinese and their currency peg to the U.S. dollar.

When Barack Obama visits China this week, the Chinese expect him to focus on the yuan dollar peg. His administration will find it increasingly difficult to hold protectionist pressures at bay given the yuan’s firm peg to the U.S. dollar even while the dollar has plummeted.  To prevent the U.S. from successfully painting the Chinese peg as the sole major risk to the global economic recovery, the Chinese must therefore point to the destabilizing effects from measures taken by the U.S. to reflate its domestic economy.

The Chinese have shown success thus far. Last week, Tim Geithner penned an Op-Ed in the Wall Street Journal along with the Finance Ministers of Indonesia and Singapore which pointed a critical finger at China by asking for “market-oriented exchange rates.” Yet when the APEC (Asian Pacific Economic Cooperation) summit in Singapore ended that same language was cut from the final commiunique.

On the other hand, there has been little change in the prospects of a revaluation of the yuan peg.

Reuters reports:

Chinese Vice Commerce Minister Chen Jian on Sunday played down talk of a shift in the central bank’s currency policy as well as mounting expectations of a rise in the yuan’s exchange rate.

Speculation that China might let the yuan resume its climb after a 16-month pause swirled after a change last Wednesday in the long-standing wording used by the People’s Bank of China to describe its currency stance.

In its third quarter monetary policy report, the central bank failed to refer to keeping the yuan "basically stable at a reasonable and balanced level" when discussing the outlook for the exchange rate.

Asked whether the PBOC was heralding a return to the gradual appreciation of the yuan against the dollar seen from July 2005-July 2008, Chen told Reuters: "I don’t think the central bank meant to say that."

And all indications suggest that we are now returning to the same unbalanced pre-crisis growth model – but with the global economy in a considerably more fragile state. In this climate, the issues of the yuan currency peg and low interest rates in the U.S. will continue to be front and center for some time to come.

Related posts:

• Chinese to start settling trade in Yuan
• China issues bonds to “promote the RMB in neighbouring countries”
• US angling to get Chinese to revalue renminbi
• China slams U.S. profligacy
• Is China avoiding using US dollars?

Hong Kong’s leader Donald Tsang has come out with a scathing criticism of U.S. monetary policy, comparing it to Japan’s which he believes contributed to 1997’s Asian crisis. This is the most direct and strident criticism of the U.S. Federal reserve’s monetary policy from a major international politician yet.

Bloomberg reports:

The Federal Reserve’s policy of keeping interest rates near zero is fueling a wave of speculative capital that may cause the next global crisis, Hong Kong’s leader said.

“I’m scared and leaders should look out,” said Donald Tsang, chief executive of the city, said in Singapore today. “America is doing exactly what Japan did last time,” he said, adding that Japan’s zero interest rate policy contributed to the 1997 Asian financial crisis and U.S. mortgage meltdown…

“We have a U.S. dollar carry trade at the moment,” Tsang, 65, said in a speech where leaders of the Asia Pacific Economic Cooperation forum are gathering for a weekend summit. The carry trade is where investors borrow cheaply in one currency and use the funds to invest in other currencies.

“Where is the money going — it’s where the problem’s going to be: Asia,” Tsang said. “You can see asset prices going up, not only in Korea, in Taiwan, in Singapore and in Hong Kong, going up to levels that are incompatible or inconsistent with the economic fundamentals.”

Tsang’s criticisms are sure to draw attention as it comes during the APEC summit in Singapore, which is a cross-Pacific economic and political group now being used to show Asian-U.S. cooperation and harmony. Tsang has an especially painful memory of the Asian Crisis as he was Hong Kong’s financial secretary at the time and was forced with the central bank to spend $15 billion to defend Hong Kong’s currency peg as speculative capital fled Asian markets en masse. Depression ensued across wide swathes of Asia, leaving a psychological scar that reverberates today.

As for the comparisons of America to Japan, I find them very well placed.  Yesterday I posted an article in which Marshall Auerback and Fox’s Brian Sullivan discussed parallels between the two. Nouriel Roubini fears that a U.S. dollar carry trade is building which is being used to help inflate assets outside of the U.S. in a global financial bubble.

This is certainly what the Japanese had done in the 1990s. Last August, before the Lehman collapse and panic I wrote that Japan was an enabler of the tech bubble of the late nineties:

the Bank of Japan did not realize the limitations of monetary policy. It could provide easy money, but it could not control where that money ended up. So, ultimately it ended up in the carry trade and helped supply the fuel for the tech bubble.

Was the BOJ responsible for the Tech Bubble? That’s a question that cannot be answered. But, what is true is that the Japanese government and monetary authorities were very instrumental both in the late 1990s and earlier this decade in providing free money to global investors via the carry trade.

Tsang is saying that Japan’s easy money policy also infected Asian markets, helping to inflate an unsustainable bubble which led to collapse and depression. In a macabre repeat of economic history, he sees the same re-occurring now as the U.S. tries desperately to ward off deflation.

Source

Fed May Cause Next Crisis, Hong Kong’s Tsang Suggests – Bloomberg

Related posts:

• Japan’s easy money policy was the trigger for the tech wreck
• Is the U.S. dollar carry trade replacing the one in Japanese yen?
• Depression in Japan
• Asia is de-coupling
• Big Mac Index: Europe overvalued, Asia undervalued

Nouriel Roubini seems to think so. In remarks quoted via Bloomberg, he called the enormous increase in asset prices “the mother of all carry trades.”

Investors worldwide are borrowing dollars to buy assets including equities and commodities, fueling “huge” bubbles that may spark another financial crisis, said New York University professor Nouriel Roubini.

“We have the mother of all carry trades,” Roubini, who predicted the banking crisis that spurred more than $1.6 trillion of asset writedowns and credit losses at financial companies worldwide since 2007, said via satellite to a conference in Cape Town, South Africa. “Everybody’s playing the same game and this game is becoming dangerous.”

If you recall, this is the same trade the world’s punters were putting on via the Japanese yen when the Japanese were pumping out huge amounts of liquidity earlier in this decade.  The yen’s real effective exchange rate only hit post Plaza Accord trade-weighted lows in 2007 when the carry trade was all the rage and just when all hell was breaking loose in subprime.

Reuters said then:

The yen’s real trade-weighted value slipped in October as the Federal Reserve’s interest rate cuts gave a boost to global stock markets and prompted investors to sell the Japanese currency in carry trades.

Bank of Japan data on Friday showed its index of the yen’s real effective exchange rate fell 1.9 percent in October to 96.7 JPYEEXR=J.

The retreat in the BOJ’s REER index took it closer to a 22-year low of 92.8 hit in both June and July, when the currency was sliding as carry trades flourished.

That was the weakest since the September 1985 Plaza Accord in which the five biggest industrialised countries agreed to depreciate the dollar against the German mark and the yen via intervention, aiming to correct the giant U.S. trade deficit at the time.

For the year the yen’s real value has lost 3.6 percent despite periodic bouts of strength as the credit market crunch this year and worries about the U.S. economy prompted market players to unwind risky carry trades.

The yen has suffered in the past few years from carry trades in which investors use the low-yielding Japanese currency as a cheap source of funds to buy higher-yielding currencies or rising assets, such as stocks or commodities.

My view has been that the Japanese yen carry trade was a major contributor to asset bubbles globally as the Bank of Japan’s excess liquidity found its way to other asset markets via the carry trade.  Last August, in my post “Japan’s easy money policy was the trigger for the tech wreck” I also pointed to the yen carry trade as a major factor in the Internet bubble. And I certainly see it as a major factor in this decade’s housing bubbles.

Now the U.S. dollar is the carry trade currency of choice, with zero percent interest rates funding asset purchases globally. This play is certainly pumping up all manner of asset prices. But as with the yen carry trade before it, I do not see this ending well.

Roubini takes a similar tack:

The risk is that we are planting the seeds of the next financial crisis,” said Roubini, chairman of New York-based research and advisory service Roubini Global Economics. “This asset bubble is totally inconsistent with a weaker recovery of economic and financial fundamentals.

Source

Roubini Says Carry Trades Fueling ‘Huge’ Asset Bubble – Bloomberg

Related posts:

• China slams U.S. for inflating global asset prices via carry trade
• U.S. Bailout: the mother of all carry trades?
• Hong Kong: “America is doing exactly what Japan did last time”
• Japan’s easy money policy was the trigger for the tech wreck
• Chart of the day: Aussie – Yen cross

One other reason to sell the dollar is interest rates.  Why not borrow in dollars where interest rates are low and invest elsewhere where yields are high?  This is what is known as the carry trade.

In the past decade, the Japanese yen and the Swiss franc were favorites for the carry trade because of their low yields.  But now, the U.S. dollar presents the same opportunity due to the likelihood that rates will stay low for a long time to come.

The video below explains.

See also Is the Dollar Set to Become the New Yen? from Market Beat.

Related posts:

• Is the U.S. dollar carry trade replacing the one in Japanese yen?
• U.S. Bailout: the mother of all carry trades?
• Chart of the day: Aussie – Yen cross
• The carry trade unwinds and it’s not pretty
• Reverse carry trade borrowing is deadly

In economic circles, there has been a lot of buzz about Quantitative Easing of late.  Basically, the U.S. Federal Reserve has lowered interest rates to near zero percent and the fear is that these cuts will not have enough effect on the willingness to lend in order to reflate the U.S. economy.  Therefore, the Fed has decided to take more draconian measures, one of which is Quantitative Easing, flooding the economy with money.

This experiment is not without risks.  There is the potential for very high inflation down the line if the Fed is successful.   But, does the Fed have a choice?  It seems that it is looking at deflation or depression on the one hand or stagflation on the other.  Take your choice.

But before you take sides, first let me go back a few years in history to describe exactly just what quantitative easing, a policy first really practiced in earnest in Japan, really is.  Wikipedia has an excellent definition.

Quantitative easing was a tool of monetary policy that the Bank of Japan used to fight deflation in the early 2000s.

The BOJ had been maintaining short-term interest rates at close to their minimum attainable zero values since 1999. More recently, the BOJ has also been flooding commercial banks with excess liquidity to promote private lending, leaving commercial banks with large stocks of excess reserves, and therefore little risk of a liquidity shortage.

The BOJ accomplished this by buying much more government bonds than would be required to set the interest rate to zero. It also bought asset-backed securities, equities and extended the terms of its commercial paper purchasing operation.

In essence, the Bank of Japan found that despite lowering short-term interest rates to zero it could not get its zombie banking sector to lend. Credit, the life blood of our fractional reserve banking system, was just not increasing. Therefore, the Bank of Japan began buying Japanese government bonds (JGBs) with money that it created out of thin air — that is they bought existing assets with money that did not previously exist. Central Banks can do this because they control the electronic printing presses. Now, the likes of Murray Rothbard, an Austrian School economist calls this counterfeiting. However, regardless of how you see this, this is how our monetary system works.

But this is also the definition of inflation. See my post, “What is inflation” for a primer on why inflation is not consumer price inflation, but rather an increase in the supply of money.  And while the Japanese economy did not get higher consumer price inflation as a result of the massive quantitative easing, this money did create the carry trade as people borrowed in Yen and invested abroad.  The Japanese central bank was then very much a factor in creating the global bubble we just experienced.

Printing money is effective because it has the effect of putting more high-powered money into circulation. The aim is to increase bank reserves enough so as to increase lending that results from those reserves.

And Fed Chairman Ben Bernanke knows this. He is a student of the Great Depression and deflation, a well-regarded economic historian. Bernanke earned the moniker “Helicopter Ben” a few years back as a result of some comments he made in 2002 at the National Economists Club regarding quantitative easing to avoid deflation before he became the Fed Chairman. Here is what he said as quoted on the Federal Reserve’s website:

As I have mentioned, some observers have concluded that when the central bank’s policy rate falls to zero–its practical minimum–monetary policy loses its ability to further stimulate aggregate demand and the economy. At a broad conceptual level, and in my view in practice as well, this conclusion is clearly mistaken. Indeed, under a fiat (that is, paper) money system, a government (in practice, the central bank in cooperation with other agencies) should always be able to generate increased nominal spending and inflation, even when the short-term nominal interest rate is at zero.

The conclusion that deflation is always reversible under a fiat money system follows from basic economic reasoning. A little parable may prove useful: Today an ounce of gold sells for $300, more or less. Now suppose that a modern alchemist solves his subject’s oldest problem by finding a way to produce unlimited amounts of new gold at essentially no cost. Moreover, his invention is widely publicized and scientifically verified, and he announces his intention to begin massive production of gold within days. What would happen to the price of gold? Presumably, the potentially unlimited supply of cheap gold would cause the market price of gold to plummet. Indeed, if the market for gold is to any degree efficient, the price of gold would collapse immediately after the announcement of the invention, before the alchemist had produced and marketed a single ounce of yellow metal.

What has this got to do with monetary policy? Like gold, U.S. dollars have value only to the extent that they are strictly limited in supply. But the U.S. government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at essentially no cost. By increasing the number of U.S. dollars in circulation, or even by credibly threatening to do so, the U.S. government can also reduce the value of a dollar in terms of goods and services, which is equivalent to raising the prices in dollars of those goods and services. We conclude that, under a paper-money system, a determined government can always generate higher spending and hence positive inflation.

Of course, the U.S. government is not going to print money and distribute it willy-nilly (although as we will see later, there are practical policies that approximate this behavior).8 Normally, money is injected into the economy through asset purchases by the Federal Reserve. To stimulate aggregate spending when short-term interest rates have reached zero, the Fed must expand the scale of its asset purchases or, possibly, expand the menu of assets that it buys. Alternatively, the Fed could find other ways of injecting money into the system–for example, by making low-interest-rate loans to banks or cooperating with the fiscal authorities. Each method of adding money to the economy has advantages and drawbacks, both technical and economic. One important concern in practice is that calibrating the economic effects of nonstandard means of injecting money may be difficult, given our relative lack of experience with such policies. Thus, as I have stressed already, prevention of deflation remains preferable to having to cure it. If we do fall into deflation, however, we can take comfort that the logic of the printing press example must assert itself, and sufficient injections of money will ultimately always reverse a deflation.

Translation: it is always preferable to a central bank to print money or create some reasonable facsimile of printing to prevent deflation before its onset than to try and deal with deflation once it has set in.

I strongly suggest you read Bernanke’s remarks in their entirety. The most important statement he made was about the electronic printing press and its effectiveness in combating deflation. If we are to take him at his word, Bernanke will print money — lots of it — to avoid deflation. The key, of course, is high-powered money. Rebecca Wilder said this quite well on a recent post of hers:

What is the difference between money and high powered money? Money is a function of two things

1. The monetary base, which equals bank reserves plus currency in circulation
2. The money multiplier, or how quickly the base switches hands in a fractional reserve banking system (for a discussion of money creation, see this wiki article).

The Fed is raising the monetary base through its QE policy and increasing its balance sheet (credit extended to the banking system) from $884 billion on August 28 to $2.1 trillion on November 28. The Fed simply creates new monetary base (reserves) out of thin air; hence, the printing money connotation.

This experiment is not working, though. Before the present day, conventional wisdom was that in Japan in the 1990s and in the U.S. in the 1930s, policymakers waited too long to begin any quantitative easing. Deflation had already set in and QE was pretty much a bust, as a result. However, we are beginning to see that it was not only the delay in policy, but the natural course of deleveraging which caused credit and the money multiplier to contract.

I mentioned this in April in my post “Finding a bottom,” which I quote her in its entirety because it is germane to why credit will contract:

As the writedowns at global financial institutions near $300 billion in capital lost as a result of the sub-prime crisis, the question as to when we reach a bottom is ever more urgent. Market history tells us that the severity of the bust after an economic upswing is usually related to the size of the original upswing. This mortgage and credit bubble being the mother of all bubbles requires a sustained and robust deleveraging to set things right. Therefore, the real economy in which we all live and breath should feel some very significant impacts for some time to come. My hope is this process will find a bottom late next year.

De-leveraging
We are now in the midst of a financial crisis after a large speculative bubble. As such, the real economy effects will tend to be larger than during a garden-variety recession. The problem is the deleveraging feedback loop that needs to work its way through the system. The Federal Reserve, The Bank of England and the European Central Bank are doing everything they can to make sure this process occurs without a systemic failure in the global financial system like what was suffered during the Great Depression.

De-leveraging begins when the speculatively financed investments go bust and writedowns occur. Normally, banks can handle these writedowns without having to de-leverage because they are well-capitalized. However, when banks writeoff unexpectedly large amounts of capital, this reduces their capital base and makes the bank look more leveraged and risky as a financial institution. $300 billion is a large amount. When the financial sector writes off $300 billion in equity capital in the span of one year, some institutions start to look pretty risky. In a fractional reserve banking system (in which only part of deposits are held in reserves), banks risk ruin if depositors lose trust in their stability. Therefore, it is important for institutions to re-capitalize after large writedowns.

Re-capitalising can occur in one of three ways: the banks can increase their equity capital through paid-in capital, they can increase their equity base through profits or they can de-leverage. To date, banks have been forced to issue additional equity capital (often from sovereign wealth funds) in order to maintain strong balance sheets. However, the Federal Reserve has done all it can (and more — indeed, too much more) by lowering interest rates to banks in order to increase the spread between money lent and money borrowed, which will increase bank profits. This too will help banks — albeit slowly as the banks can only profit from these spreads over time.

Nevertheless, banks will not be able to strengthen their balance sheets quickly enough through those two methods without significant deleveraging. They will need to sell assets and reduce future credit availability in order to gain the rock solid balance sheets that customers, counter-parties, and consumers will require in a more cautious economic environment.

The Feedback Loop
How much deleveraging will need to occur? That brings us back to market history, which tells us that deleveraging will be extensive given the size of the speculative run-up earlier this decade. Moreover, the feedback loop with the real economy suggests that many more writedowns are to come. As investments have soured and credit availability becomes scarce, individuals and companies have started to feel the pinch in the real economy. Layoffs have begun in earnest. As a result, consumers have cut back. This will cause more financial distress in other lending sectors of the economy. Top on the list are Alt-A Mortgages, some Prime Mortgages (especially zero percent, zero down and adjustable rate varieties), Construction and Development loans, Corporate Real Estate loans, Credit Cards, Auto Loans and High Yield Corporates. From here, the feedback loop will begin again with losses, writeoffs, and credit tightening in the new distressed sectors as well as in the previously distressed sub-prime market. The feedback loop continues with more deleveraging, layoffs, consumers tightening their belt, and reduced corporate profitability.

At some point, this whole feedback loop will end a we will find a bottom. The hope is that we can do this with a minimum of damage to the real economy, a minimum of personal financial distress and as quickly as possible. When we reach the bottom is anybody’s guess, but expect this deleveraging process to play out at least for the entirety of 2008 and through well into 2009. Let’s hope that we find a bottom then.

When we do find a bottom we should know whether Bernanke has been successful. If he fails, prices fall, the real value of debt rises and depression ensues. If Bernanke succeeds, however, the outcome is less clear. Rebecca Wilder paints a good picture of what is at stake here.

Will the Fed’s QE strategy lead to inflation? In the short-term, no. The money multiplier is falling because the economy is in a nasty recession alongside a serious credit crisis. In this environment, the surge of high powered money will not cause prices to rise.Prices normally drop in a recession (deflation) because the demand for money (the ability to purchase goods and services) falls with rising unemployment and declining income (slackening demand for goods and services). But the 2008 recession is accompanied (or partially caused) by a credit crisis that induces banks to hoard the new base as excess reserves; this adds to the deflationary pressures. If deflation were to become embedded into consumer and firm expectations, then the macroeconomy could be facing a severe problem. So for now, and until the economy emerges from its recession, QE will not lead to inflation.

But what happens when the economy rebounds? Inflation becomes a serious risk if the Fed does not extract the high powered money. If the Fed gets it wrong, or its timing is off, then the money supply will rise quickly as banks start to lend more freely, and inflation results.

In the US’ case, I see the Fed getting it wrong as a serious risk to price stability (rising inflation). American consumers are not savers and love to spend; and although some suggest that the American saving behavior has changed, the evidence is far from concrete. Unless saving rises permanently – the economy transitions to a world where consumption is less than 70% of GDP – consumers will be more than happy to swoop up the new bank lending and spend that new easy money.

Quite frankly, I am not sure the Fed can get us out of this one.  Money multipliers are plummeting and credit is just not increasing.  Meanwhile, the real economy is falling off a cliff, meaning more loans will sour.  How does the Fed believe it can increase lending in that environment?  I’m sorry — deleveraging will continue apace.

But, what if I am wrong?  What if the Fed can reflate the economy? Well, then we have to worry very seriously about the huge amounts of money sloshing around the system.  If things get back in gear, inflation is going to be a very big problem.  We can only hope this is a problem the Fed can handle.  But, for most of us, this is the problem which we would rather have.

Sources
Quantitative easing – Wikipedia
All of the buzzwords in one post: quantitative easing, inflation and printing money – News N Economics
Remarks by Governor Ben S. Bernanke Before the National Economists Club, Washington, D.C.
November 21, 2002: Deflation: Making Sure “It” Doesn’t Happen Here – Federal Reserve Board

Related posts:

• Is quantitative easing really inflationary?
• Connecting Fed cuts with credit writedowns and quantitative easing
• Is Japan next on the road to quantitative easing?
• Nouriel Roubini: Will massive stimulus ward off stag-deflation?
• Don’t underestimate the power of printing money

Last night an article by Niels Jensen of Absolute Return Partners caught my eye. In it, he made a very strong case for worrying about European bank exposure to emerging markets and its potential for creating systemic risk. I would like to share some highlights from this well-written piece and add a few thoughts of my own.

I have talked quite a bit about this problem in my blog in the past. Below are a few related articles. I am generally of the view that the crisis in the U.S. and Western Europe has been addressed sufficiently to provide a slow recovery. However, I am quite concerned of collateral damage from elsewhere bringing things to a head and precipitating a systemic problem. European bank lending to over-indebted emerging markets is tops on my list of worries.

Niels Jensen puts it quite well.

In the US, bank lending is already responding to Fed’s tactics. Total commercial and consumer bank lending has grown by an annualised rate of almost 50% in the last month and a half. Quite impressive in an economy which is supposedly in recession.

So far so good. The problem is, however, that the near meltdown has unleashed an asteroid storm of problems. Take Iceland. As most investors know by now, Iceland is in very serious trouble. According to at least one estimate, European banks stand to lose about $75 billion on Iceland – not exactly pocket change. And that is on a population the size of Coventry! Earlier this week, the Central Bank of Iceland raised the policy rate from 12% to 18%. Inflation is now running at about 16% and will undoubtedly peak at much higher levels. According to Danske Bank, expect it to hit 75% before things get better. That is ugly.

The canary in the coalmine

I have an increasingly uneasy feeling that Iceland is the canary in the coalmine. Hungary is struggling. So are Pakistan, Ukraine, Belarus, Romania and Argentina. Cristina Fernández de Kirchner, the President of Argentina, took everyone by surprise last week when she announced that the country’s private pension funds (about $26 billion) would be transferred into the state pension system. The official line is that she is aiming to protect the country’s pension funds from the global turmoil. Who is she kidding?

Now, the Federal Reserve Bank has decided to provide emergency loans to Mexico, Brazil, Singapore and South Korea. Not that long ago, it was Singapore (amongst others) which provided emergency funding to the ailing U.S. banking sector. If countries such as South Korea and Singapore require help from the outside, the state of affairs in other and less developed nations could be much worse than generally perceived.

This is the problem. There are any number of countries that are in jeopardy of imploding from a slowing economy, high debt and macro imbalances. The list extends from Asia to Eastern Europe to Latin America and beyond.

“So what?” you say. Well, not so fast. In a globalized economy, the interdependence of nations is a lot more than you might think. In fact, European banks have a lot of exposure to Emerging markets, having lent ridiculous sums over the past decade. Think of this as a 1980s Latin American debt problem writ-large.

European banks at risk
Worldwide cross-border lending now stands at $37 trillion with about $4.7 trillion going towards Eastern Europe, Latin America and emerging Asia. Cross-border lending by European and UK banks to emerging market countries accounts for 21% and 24% of respective GDPs compared to 4% for U.S. banks and 5% for Japanese banks (see chart 4). Europe has about $3.5 trillion of debt outstanding to emerging market countries whereas the U.S. has only about $500 billion on the line.

The country most exposed to emerging markets is Austria with total emerging market loans accounting for no less than 85% of the country’s GDP – most of it to Eastern Europe. Austrian banks have been aggressively pursuing opportunities in Eastern Europe for years. They have in fact been so aggressive that their total lending to the region (approximately $300 billion) exceeds the amount lent by Germany to Eastern Europe. Even more worryingly, Austrian banks are the largest holders of debt on Hungary and Ukraine – two of the most fragile economies on the old Soviet bloc. As an aside, when the global banking system collapsed in May 1931 in the midst of the Great Depression, it was a run on the Austrian banks which acted as a catalyst.

Italy is possibly in an even more dire condition. According to a recent article in The Daily Telegraph3, Italy’s public debt is now the third largest in the world, behind the U.S. and Japan. And, at 107% of GDP, it is almost twice the limit set by the Maastricht Treaty (so much for treaties!). Italy is also a big lender to Eastern Europe. Unicredit alone has about $130 billion of debt outstanding to Eastern European countries. Italy’s predicament is well recognised by fixed income investors. 10-year Italian government bonds now yield 1.08% more than their German sister bonds. The market is telling us that something rather unpleasant could happen to Italy. It is even possible that Italy could be forced to pull out of the euro, unless they can turn the ship around fairly quickly.

Meanwhile, UK banks are primarily exposed to emerging Asia and Latin America. Only Poland stands out in Eastern Europe as a major recipient of loans from UK banks and Poland is perhaps not up to its neck in problems the way Hungary and Ukraine are right now, but the situation is deteriorating there as well. Sweden is mostly exposed to the Baltic countries. The three Baltic countries owe a total of $123 billion, $83 billion of which originate from Sweden. Knowing that Latvian banks in particular have been rather innovative with the structure of their mortgage products (such as Yen based loans), would you sleep well if you were the credit officer of one of the major Swedish banks?

Spain is the Latin juggernaut

Spain is another worry. Contrary to popular belief, the U.S. is not the largest lender to Latin America – Spain is. Just under $1 trillion of cross-border debt is outstanding across Latin America. Only 17% of that comes from U.S. banks. Spanish banks, on the other hand, have more than 30% of the debt on their books. Let’s hope for Spain’s sake that Ms. Kirchner is telling the truth when she claims that the nationalisation of the private pension funds was done to protect them from the evils of this world. Somehow I doubt it.

The sharp rise in the value of the U.S. dollar and the Yen is not helping emerging market economies either. We do not know exactly what proportion of the $4.7 trillion of loans to emerging market countries are denominated in U.S. dollars and Yen respectively, but we suspect that it is a significant share. As long as the world is deleveraging, you should expect both currencies to continue to appreciate in value, as most carry trades have been based on either U.S. dollars or Yen. Meanwhile, some countries are putting up a brave fight (e.g. Hungary and Romania). However, as we learned in 1992, a wounded currency is like a bleeding torso in shark infested waters. You can rest assured that speculators will finish off the job. No central bank can win that battle.

One might argue that a devaluation of the Hungarian currency or a collapse of the Pakistani economy won’t really affect your portfolio, but that misses the point. It is the risk to an already wounded banking industry you have to worry about. And, as I have pointed out above, European banks are much more exposed to emerging market countries than their U.S. competitors.

And this is a big problem because European banks are undercapitalized. You might remember an article I wrote in June referencing a Citigroup study that said that European banks had a $400 billion capital shortfall. This shortfall has not disappeared. Arguably, it is much worse despite the many government bailouts in the intervening months because the losses have been much greater than anticipated.

If European banks were to suffer large losses in the emerging markets, we could have another panic on our hands, and this time no amount of government intervention would be able to forestall the inevitable bank runs and deleveraging. I recommend you read Niels’ piece. We need to sound the alarm on European banks because these institutions are in desperate need of more capital. If we wait until crisis hits to tackle this looming threat, it may be too late.

Source
When the Chickens Come Home to Roost – Niels Jensen

Related posts:

• A shift to Eastern Europe and emerging markets too
• Currency crisis is gathering storm
• Ten eastern European countries now looking to IMF for bailouts
• Quote of the day: Austrian banks
• Switzerland threatened with bankruptcy

By now, you are familiar with the carry trade, where one borrows in one’s own currency in order to invest in higher yielding foreign assets, often times with significant leverage. The Japanese were famous for making this trade in Australian Dollars, U.S. Dollars, you name it.

What a lot of people don’t realize that everyone and his brother was doing the reverse carry trade as well. This is a trade where one borrows abroad in a currency where interest rate are low and then invests that money at home.

Both trades can make one a lot of money, especially using leverage. And indeed, for quite some time, many have made a killing simply by performing this trade. However, both trades carry some risks. The normal carry trade carries currency risk — i.e. the currency in which you invest your funds falls more than you collect in excess returns before you can repatriate your funds. The reverse carry trade is a problem if your credit comes due and you are unable to rollover this foreign currency debt — i.e. you essentially default because no one will lend to you in the foreign currency.

Of the two trades I find the reverse currency trade much riskier than the carry trade. Let me give you a few examples why.

First, there’s Iceland. This small country of 300,0000 turned itself into a financial services powerhouse, leading to unsustainable spending growth. In order to get there, its banks needed to g abroad to increase their asset base. However, along the way, these companies started to do the reverse carry trade. When Iceland, the country, and its banks ran into difficulties, no one wanted to lend to the Icelandic banks. As a result, result, Kaupthing became the first European issuer to default on Japanese Yen denominated bonds.

Kaupthing Bank hf today became the first European borrower to default in Japan’s samurai bond market after the state-controlled bank missed its last chance to make a 450 million yen ($4.8 million) coupon payment.

Two investors in the Reykjavik-based bank’s 50 billion yen in 1.8 percent notes, who declined to be identified, said they hadn’t received funds that were originally due on Oct. 20. Kaupthing had a one-week grace period to make its payment, according to the terms of the sale prospectus.

Yields on the bonds have risen as high as 45,000 basis points over the one-year yen swap rate to nearly 451 percent as investors hurried to unload the securities in recent days.

A basis point is 0.01 percentage point.
-Bloomberg

Then, there are the stories behind the Fed’s need to extend swap lines to every Tom, Dick, and Harry central bank around the world. You were probably wondering where all the money Alan Greenspan printed went. Well, some of it went to our own mortgage bubble in the good ol’ U.S. of A. But, some of it also went to foreign banks that proceeded to finance their own speculative binges abroad. Houston, we have a problem — these banks can’t roll over their dollar-denominated. The credit markets have come unstuck and everyone is in a panic. What to do?

Enter the Fed. Basically, the Fed is acting as a global lender of last resort by offering virtually unlimited dollars to the ECB, the Swiss central bank, the BoE, the South Korean central bank, as well as the Mexican and Brazilian central banks. Needles to say, this is not good for the U.S. dollar’s value over the long-term. But, who else is going to step in here?

All of these central banks need the money for their domestic financial institutions. So rather than leave these banks at the mercy of the global credit markets, Ben Bernanke and company have stepped in and given the money to the local central banks who then help these companies by loaning them the dollars to roll over their debt or by helping them get out of dollars and into their own currency. Again, swapping out of dollars means less demand for the Greenback and a lower U.S. Dollar.

Finally, there’s this little story I caught at Bloomberg today.

Imre Apostagi says the hospital upgrade he’s overseeing has stalled because his employer in Budapest can’t get a foreign-currency loan.

The company borrows in foreign currencies to avoid domestic interest rates as much as double those linked to dollars, euros and Swiss francs. Now banks are curtailing the loans as investors pull money out of eastern Europe’s developing markets and local currencies plunge.

“There’s no money out there,” said Apostagi, a project manager who asked that the medical-equipment seller he works for not be identified to avoid alarming international backers. “We won’t collapse, but everything’s slowing to a crawl. The whole world is scared and everyone’s going a bit mad.”

Foreign-denominated loans helped fuel eastern European economies including Poland, Romania and Ukraine, funding home purchases and entrepreneurship after the region emerged from communism. The elimination of such lending is magnifying the global credit crunch and threatening to stall the expansion of some of Europe’s fastest-growing economies.

“What has been a factor of strength in recent years has now become a social weakness,” said Tom Fallon, emerging-markets head in Paris at La Francaise des Placements, which manages $11 billion.
-Bloomberg

It makes you want to cry — this is a hospital for Pete’s sake. And they are getting caught up in this global currency and credit crisis. But, that’s the carry trade for you.

From where I am sitting, a lot of the recent turmoil in emerging markets is a direct result of the reverse currency trade — borrowing at low rates in foreign currency in order to invest at home. Argentina, Brazil and half of Asia blew up less than 10 years ago for just these reasons.

When will they learn? Do people have that short a memory.

Related posts
Currency crisis is gathering storm
The carry trade unwinds and it’s not pretty
Currency crisis is gathering storm
A shift to Eastern Europe and emerging markets too
Asia is next
Japan’s easy money policy was the trigger for the tech wreck

Sources
Iceland Kaupthing Defaults on Samurai Bonds as Yields Hit 450% – Bloomberg
`Panic’ Strikes East Europe Borrowers as Banks Cut Franc Loans – Bloomberg

Related posts:

• Is the U.S. dollar carry trade replacing the one in Japanese yen?
• U.S. Bailout: the mother of all carry trades?
• Swiss Franc at Dollar parity?
• The carry trade unwinds and it’s not pretty
• Chart of the day: Aussie – Yen cross

Just as Japan is starting to unwind its carry trade, a new one might be forming in the form of 1% base rates in the United States. The carry trade was very popular amongst Japanese retail investors, especially using leverage (see article – hat tip Yves Smith). But, this trade unwound in a vicious way these past few months (see links here and here).

Now, a new carry trade is forming to take its place (at least for the moment). I am NOT bullish on the dollar, but if you can get 18% on Krona investments versus a measly 1% in USD, you might be tempted. Such are the consequences of easy money.

Nevertheless, I digress because this post is about Japan and its carry trade. Below is an article that gives you a feel for what that trade is all about and why its coming undone. Mrs. Watanabe might be advised to stick with domestic savings no matter what the yield.

Mrs Watanabe is crude shorthand for Japan’s $15,000bn pool of savings, the deepest in the world and worth more than the annual economic output of the US. These vast resources are somewhat apocryphally marshalled by Japanese women, who have traditionally held a firm grip on family finances.In fact, Mrs Watanabe is very crude shorthand indeed: she is just as likely to be Mr Watanabe, the manager of a Japanese life assurance company portfolio, or Mr Smith, an American hedge fund manager, borrowing in yen to buy South African rand, U.S. mortgage-backed securities or tea futures. Whoever, she is, she borrowed cheaply in yen, courtesy of Japan’s rock-bottom interest rates – which have been stuck between zero and 0.5 per cent since 1999 – and put the money in higher-yielding assets abroad.

The important thing to know about Mrs Watanabe is that, temporarily at least, she has all but stopped flapping her wings. In the past days, as spectacular moves in global currencies reveal, the carry trade has been violently unwound. With last week’s panic retreat from risk assets of almost every description came a dramatic rise in the yen, partially reversed in the past two days on rumours of a Japanese interest rate cut. Even so, the yen was trading on Wednesday at about Y97 to the dollar, the other “safe haven” currency, against a remarkably steady Y110-Y120 in recent years.

No, if you have your calculator handy, you probably already realized that 97 yen is only 80% of 120 yen. If Mrs. Watanabe was investing in U.S. treasurys, she’s not so happy right about now. And, if it as Australian or New Zealand Dollars, less so. But the interest spreads are pretty intoxicating. Where else is one to put one’s money – Japanese stocks hit a 26-year low recently.

These gyrations do nothing to solve the underlying problem, which is that Asia has an excess of savers and the U.S. and Europe an excess of spenders. Unless that is solved, the world seems condemned to repeat the swings of recent years, as capital is arbitraged between countries where money is cheap to those where it is expensive.Until recently, one of Mrs Watanabe’s favourite wheezes was to take her Japanese yen and put them in Australian dollars, earning her a roughly six-point interest rate gain. This week, she – and those who travel with her – will not have missed the fact that Iceland just raised its interest rate to 18 per cent. That is a 17.5 point differential with Japan, and counting. Krona, anyone?

Related Posts
Currency crisis is gathering storm
Chart of the day: Aussie – Yen cross
Chart of the day: Japanese Yen
Japan’s easy money policy was the trigger for the tech wreck

Related articles
Mrs Watanabe and the sudden rise of the yen

Source
Beware the unwinding of the yen carry trade – FT

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• Quote of the day: Nationalized banking predators
• Reverse carry trade borrowing is deadly
• Wassup 2008
• US GDP shrinks 0.3% in Q3
• Chart of the day: Aussie – Yen cross

Of the major currencies, the Japanese Yen has been the strongest in the last few months, while the Australian Dollar has been the weakest. These two currencies have also been the most conspicuous in the Japanese carry trade. That trade is now coming unstuck, precipitating changes of epic proportions.

For those of you who don’t know what the carry trade is, it is essentially a debt/asset position whereby one borrows money at low interest rates and invests that money in higher yielding assets (often with significant leverage). In Japan, after the stock market imploded and interest rates were cut to near zero, the carry trade took on monumental proportions amongst retail investors. See Yves Smith’s tale about this phenomenon from last year.

With an enormous gap between Australian interest rates and Japanese interest rates, buying Australian Dollars and selling Japanese was a particularly good trade for a very long time. However, those days are well and truly over.

The chart below should give one pause as to whether the trade was ever really worth it in the first place. The violent move out of the carry trade has left many with enormous losses.

In the end, it demonstrates the unintended consequences of easy money policies.

Related posts:

• The carry trade unwinds and it’s not pretty
• Japan’s easy money policy was the trigger for the tech wreck
• US Dollar rising dramatically
• U.S. Bailout: the mother of all carry trades?
• Is the U.S. dollar carry trade replacing the one in Japanese yen?

Although off its highs for the day, the Japanese Yen is still looking very strong against every major currency. Earlier, it pushed as high as 92 yen to the dollar. Jim Rogers was on Bloomberg saying it was headed much higher.

Below is the last month’s chart for the Yen against the U.S. Dollar, the British Pound, the Euro, and the Australian Dollar.

Source
Currency Charts – Forex Street

Related articles
Yen Rises to 13-Year High Versus Dollar as Carry Trade Unwinds – Bloomberg

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• Chart of the day: US Dollar
• Chart of the day: Aussie – Yen cross
• Is the U.S. dollar carry trade replacing the one in Japanese yen?
• US Dollar rising dramatically
• The dollar is rising against floating currencies

Something dramatic is happening in the currency markets. I commented on this in my post “U.S. Dollar rising dramatically.” These currency moves are related to international dollar debt, the carry trade unwind and expected interest rate cuts due to slow growth.

Charts might help show the magnitude of the moves we are seeing. Below are charts of the U.S. Dollar against the Euro, the British Pound, The Canadian Dollar, the Swiss Franc and the Japanese Yen. The Dollar is rising against all these currencies except the Yen, where the Yen is rising even more dramatically.

Note: Most U.S. dollar currency cross rates are expressed in Dollars per foreign exchange currency. However, following market conventions, the Pound and Euro cross rates are expressed in FX currency to the dollar. This makes these graphs appear to show a falling dollar.

U.S. Dollar – Japanese Yen

Euro – U.S. Dollar

British Pound – U.S. Dollar

U.S. Dollar – Swiss Franc

U.S. Dollar – Canadian Dollar

Source
Currency Charts – Forex Street

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• U.S. Dollar: Cliff Diving Again
• US Dollar rising dramatically
• U.S. Dollar: Cliff Diving
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The U.S. Dollar is rising once again. As the realization kicks in that the U.S. will not be alone in its economic struggles, currency traders are making major bets that interest rates will fall outside of the U.S. across the board. The British Pound, the Euro and the Canadian Dollar have all been losers. The Japanese Yen is holding up rather well.

The U.S. has led the charge in cutting interest rates, but as the global economy slows other countries are expected to cut interest rates a lot more. Interest rates are much higher in Australia, New Zealand, the UK and the Eurozone, giving these economies more room to cut. As a result, currencies in those areas are falling.

In September, I speculated that currency moves would cause damage to hedge funds taking large currency bets. We are now seeing damage to speculators. The Australian and New Zealand Dollars have already fallen precipitously versus the U.S. Dollar, leading the Hong Kong-based financial trader Citic Pacific to take $2 billion in rogue trading losses. Now, we can see monumental moves in the Pound, the Euro and the Canadian Dollar (see red circles in chart above). More fallout is likely.

The only currency that is holding its own is the Japanese Yen. Marshall Auerback believes the U.S. Dollar and the Japanese Yen are both going higher for different reasons.

The Dollar is rising in part due to an unwind of dollar-denominated debt that international financial institutions are unable to refinance in this credit environment. This is one reason that the Fed has loaned unlimited funds in U.S. Dollars to the Swiss Central Bank and the European Central Bank.

The Yen seems to be rising because of the unwind of the “carry trade” as Japanese retail investors realize that interest rate convergence is happening and they can no longer invest abroad safely at high rates of interest.

Whatever the reasons for the recent moves, they are dramatic and someone somewhere is nursing some very big losses.

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The dollar rally spells trouble for some investors
Japan’s easy money policy was the trigger for the tech wreck

Related articles
Currency Bets Gone Bad Hit Companies in Developing Economies – Naked Capitalism
Citic Pacific Under Investigation After Currency Loss – Bloomberg

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• Chart of the day: US Dollar
• Chart of the day: Aussie – Yen cross
• The carry trade unwinds and it’s not pretty
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• Is the U.S. dollar carry trade replacing the one in Japanese yen?

Yesterday, I made the case for us to be less concerned about the U.S. and even Western Europe, but to be very concerned about a slowdown in Asia. The reasons for this are simple: most analysts now understand the extent of problems in the U.S. and Western Europe.

This, is part of the reason I am more optimistic about financial markets in Europe and the U.S. I am even bullish on some sectors of those economies despite the slowdown. However, less is known outside of the U.S. and Western Europe. Expectations are too high and disappointment is likely.

Today, I want to continue the theme of looking outside Europe and North America, but this time I want to focus on Eastern Europe and Emerging Markets. And to get right to the point, these areas will see a very marked slowdown, leading to very hard landings in some cases.

We have seen what can happen in a small country like Iceland when the macroeconomic data show an economy out of control. Iceland was the first small country to melt down because it had the biggest imbalance with its gaping 14.6% current account deficit. The results are especially dire for these small nations because they do not have the world’s reserve currency like the United States does. And, thus, they are more likely to feel the full force of a loss of confidence.

But, unfortunately Iceland is not an isolated case. In Eastern Europe, it’s all about overvalued currencies and poor macroeconomics. For instance, Estonia has a massive 11.8% current account deficit, Latvia’s is 13.8% and Lithuania’s is 14.0%. In Slovakia, it is 5.6%, Slovenia 6.6%, Hungary 5.9%, Poland 4.9%, and in the Czech Republic 2.8%. All across Eastern Europe there is a massive capital account surplus (hot money from abroad) to match this current account deficit. Western European Banks have been speculating in Eastern Europe and are sure to get burnt when things start to unravel there.

In July, I noted the problem in the Baltics in particular:

The Baltics are looking a lot like Argentina was before it collapsed at the beginning of the decade: fixed exchange rate, large current account deficit, significant foreign bank lending, overheating economy turning to bust.

This combination is a toxic mix that will certainly end in the disaster it did for Argentina. I have a vivid memory of being in Buenos Aires when workers were rioting in the streets, knocking over cars and setting them on fire. Foreign banks were littered with Graffiti, including the word “ratas,” scrawled across them. Many banks were shut down and closed and too many bank I could see had armed guards with submachine guns out front to protect them. I can’t say this same disastrous scenario awaits the Baltics, but things could get pretty dicey there in any event.
-Are the Baltics the new Argentina?

For other countries, it s not as much the current account as it is falling commodity prices. All across Latin America, commodity prices are important — in Chile, Peru, Argentina, Brazil, Venezuela and Mexico to name the biggest economies in the region.

As you can see from the graph above, commodity prices are falling across the board as the global economy heads into a recession. This has had different but equally staggering effects on various parts of the globe.

• In Western Europe and the U.S., deleveraging is going to slow credit growth and reign in consumer spending, leading to recession across the board.
• In South Africa, Australia, New Zealand and Canada, a combination of lower commodity prices and tighter credit will cause housing bubbles to burst and lead to deep recessions.
• In Africa, Latin America, Russia and the Middle East, commodity deflation is going to kill the commodity-dependent economies.
• In Eastern Europe, excessive current-account deficits due to hot money is going to lead to capital flight and depression as we have seen in Iceland. The most overexposed here are the Baltics. As Sweden is a major lender there, it is no wonder they are putting a massive $200 billion prop under their financial services sector.
• In Asia, slowing demand worldwide will not be offset by increased domestic demand. We have already seen Singapore enter recession, South Korea bail out its banking sector China begin to experience a stock market and housing bubble unwind, and Japan suffer recession. Growth there will be much slower than expected.

Make no bones about it, we are headed for a major global recession and no economy will be spared. This is one major reason governments are cushioning the blow with stimulus packages. As for the emerging markets and Eastern Europe in particular, the headlines below in related posts from today and yesterday should make clear that there is a crisis of confidence in those regions. Anyone investing there should beware, lest they find another Iceland on their hands.

Related articles
Emerging-Market Banks Suffer in `Iceland Look-Alike Contest’ – Bloomberg
Baltic Governments May Run Wider Budget Deficits in 2009 – Bloomberg
Sweden Pledges SK1.5 Trillion to Guarantee Lending – Bloomberg
Swedbank Credit Rating Cut at Moody’s on Debt Reliance, Baltics – Bloomberg
Hungary Cuts 2008 Growth Forecast on Credit Crisis – Bloomberg
Ukraine, IMF May Sign $15 Billion Loan By Next Week – Bloomberg
Argentine Bonds, Stocks Plunge on Pension Takeover Speculation – Bloomberg
Russia May Need to Cut 2009 Spending Amid Falling Oil Prices – Bloomberg
Brazil’s Real Weakens as Global Investors Unwind Carry Trades – Bloomberg
Credit Crisis Fools Latin America’s Leaders: Alexandre Marinis – Bloomberg
Mexico’s Peso Falls for Third Day on U.S. Recession Concern – Bloomberg

Source
Trade, exchange rates, budget balances and interest rates – The Economist
Commodity Futures – Bloomberg

Related posts:

• A bearish view on Eastern Europe
• UBS does not see the need for panic over Eastern Europe
• The emerging markets crisis
• Bloomberg talks Eastern Europe as Latvia downgraded
• Emerging Markets will be tested by inflation

There are some great ideas out there about what the U.S. bailout is all about. Earlier, I mentioned my belief that it had everything to do with marking to market. Just a while ago, I caught a post that has a very intriguing angle on the plan: it’s the mother of all carry trades (hat tip Brad DeLong).

For those of you who don’t know what a carry trade is, it is a term used when investors borrow money where it is cheap and then invests that money at a higher rate. The quintessential example of the carry trade was the Japanese carry trade. Japanese investors (and many foreigners) borrowed money in Japan at near zero percent and invested the money abroad at much higher interest rates, often with significant leverage.

Could Hank Paulson be looking to do a carry trade?

There might be a gem in the Treasury’s plan to buy $700 billion of dubious mortgage-related assets.

Call it the biggest carry trade in history. It might just put as much as $60 billion a year in the government’s coffers.

All of the discussion of risk has focused on whether the government eventually could sell the assets it buys from financial institutions for more than they cost. In other words, whether the government — and therefore taxpayers — would incur a loss or a gain.

“I am very uneasy with the proposal to spend a trillion dollars to buy illiquid assets, toxic securities from large financial institutions, and have the taxpayers pay for that,” Representative Spencer Bachus, the top Republican on the House Financial Services Committee, said on Sept. 23.

The government will get the $700 billion by selling a range of Treasury securities to the public with yields of 3 percent to 4 percent. With investors around the world clamoring to buy risk-free Treasuries, the market should be able to absorb the jump in supply without a significant increase in yields.

Contrast that with likely yields on the troubled assets for which there currently is no market. No one can be sure how big a haircut there will be on the assets Treasury buys, though if it’s 50 percent or more, their yields should be 10 percent or higher.

That is, the government will be borrowing at 3 percent to 4 percent to buy assets yielding 10 percent or even 12 percent. Conservatively, that spread on an investment of $700 billion should generate income of $40 billion to $60 billion annually.

This is an interesting twist to the bailout speculation. And while these toxic assets are not ideal vehicles for a carry trade since they can blow up, the interest rate differential would help to reduce the cost of the bailout.

Click the link below for the full article.

Source
Bailout May Be Granddaddy of All Carry Trades: John M. Berry – Bloomberg

Related posts:

• Japan’s easy money policy was the trigger for the tech wreck
• Chart of the day: Aussie – Yen cross
• Is the U.S. dollar carry trade replacing the one in Japanese yen?
• The Dollar Carry Trade
• The carry trade unwinds and it’s not pretty

It was about 4 weeks ago now that I said I thought the dollar rally was not a fundamental move, but a monster bear market rally which will end up hurting dollar shorts. Back then, the Euro was trading for 1.5164 dollars. Today, the Euro will only get you 1.426 dollars. That’s a move of 9 big figures in 4 short weeks on the Euro-Dollar cross. Some hedge funds are getting slaughtered as we speak, guaranteed. Will we soon see announcements that some hedge funds have collapsed? I think so.

We have already seen a major collapse at one hedge fund due to the dollar move. Ospraie Fund is closing after a 38% loss on the year. But, the magnitude of this dollar move is truly enormous. Gold is down from over $1000/oz. to $800. Silver is down. Oil is down to nearly $100 a barrel. And all the major currencies are taking a beating including the Swiss Franc, the Euro, Sterling, the Loonie, and the Australian Dollar. The U.S. Dollar is rising against everything and that is bound to mean some major losses at funds that were betting against the dollar. The Yen and the Canadian Dollar seem to be the only things holding their own amongst the major currencies — and the Yen is rising only because of the unwind of Yen carry trades.

I would be pleasantly surprised if we did not get another few major announcement regarding hedge fund losses in the near-term. The U.S. Dollar should be a weak currency given the structural imbalances in the global economy, foremost amongst them the gaping current account deficit in the United States. However, for now, the dollar is rising and that will mean pain for those adventurers who were making a one-way bet on dollar
weakness.

Is the market telling us something? Is Europe weaker than North America? Or is this just the product of intervention?

Related posts
Hedge Funds: the bell tolls for Ospraie
Quote of the day: 10 Aug 2008 – trickier than LTCM
The dollar is rising against floating currencies
The Big Mac Index

Charts source
exchange-rates.org

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• US Dollar rising dramatically
• Hedge Funds
• The Dollar
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Most Americans would have you believe that the U.S. Federal Reserve was entirely responsible for the monetary conditions which created the mother of all stock market bubbles after the LTCM bailout. Yes, the Fed was complicit in the extraordinary rise of technology in the late 1990s. However, it was the Bank of Japan and its Zero Interest-Rate Policy which may have been the real locomotive for the tech boom.

A friend of mine recently told me the story of his mother-in-law, an ordinary Japanese woman, living in Japan, whose friendly broker used to call her every couple of months when Japanese interest rates were near zero, asking her if she wanted to invest in some foreign fixed income assets his brokerage was peddling that offered much higher yields. Invariably she said yes, and she, along with millions of other Japanese, became part of what is infamously known as the carry trade.

This all began in 1998-1999 when the Japanese realized that deflation was spoiling their ability to pull out of a deep economic depression that had lasted eight long years. Basically, the Bank of Japan cut interest rates to near zero in order to stimulate spending. But, in the global economy, ordinary Japanese citizens like my friend’s mother-in-law didn’t even need to to look for better places to put their money. Their inventive brokers created higher interest products specifically for them that allowed them to sell yen, buy foreign currencies like U.S. dollars and invest in U.S. treasurys or GSE paper.

Basically, the Bank of Japan did not realize the limitations of monetary policy. It could provide easy money, but it could not control where that money ended up. So, ultimately it ended up in the carry trade and helped supply the fuel for the tech bubble.

Was the BOJ responsible for the Tech Bubble? That’s a question that cannot be answered. But, what is true is that the Japanese government and monetary authorities were very instrumental both in the late 1990s and earlier this decade in providing free money to global investors via the carry trade.

My friend says his mother-in-law doesn’t get those calls anymore becuase the carry trade has moved on. If anything, the carry trade has moved on to the United States as the U.S. now has the lowest interest rates in the G7. This new round of easy money may have spawned the oil bubble we have recently witnessed and its hard to say where the money will find its way next.

Ben Bernanke and Alan Greenspan assured the global investing community that they would not repeat Japan’s mistake after Japan’s own bubble because they would ease immediately instead of waiting for defaltion to kick in. Make no mistake, Greenspan and Bernanke have held to their promises as interest rates in the U.S. have been below the rate of inflation for much of this decade.

Howver, what is clear is that easy money is never the right monetary remedy for weak economic growth. Easy money only leads to increasing risk appetites of the investing public and new bubbles somewhere in the global investment world.

The parallels between Japan’s bubble and the one in the U.S. are growing clearer by the day.

Related posts:

• Hong Kong: “America is doing exactly what Japan did last time”
• Chart of the day: Aussie – Yen cross
• Is the U.S. dollar carry trade replacing the one in Japanese yen?
• U.S. Bailout: the mother of all carry trades?
• The carry trade unwinds and it’s not pretty