US currency crisis
Over the past year since March 2009, the Federal Reserve not so quietly
engaged in a major printing effort (of 1.75 Trillion dollars), while
concealing the fact that this monetization was required to keep
US economy afloat.
They use the term of “quantitative easing” to mask the truth for the general
public. Quantitative easing is printing money out of thin air. They also
directed the printing presses toward bailing out very sick US mortgage
market (mostly MBS), although there was also explicit monetization of
Explicit monetization of US treasuries by the Fed is almost equivalent to
default. However, US credit rating agencies continue to rate US sovereign
debt as AAA (surprise!)
It appears China, the largest holder of US sovereign debt, is finally
starting to “get it”. If China is serious about De-pegging from US
dollar, as pressured by US authorities, then we may see US
dollar plunge. For now Chinese currency is pegged to US dollar,
thus, Chinese buying is determined by the peg. Read more in this article in FT.
By Gerard Lyons
Published: April 27 2010 15:50 | Last updated: April 27 2010 15:50
There is a ticking time bomb under the dollar. When it explodes depends not just on the US economy
but also on policy actions in Beijing and Washington. Over the last year the Chinese have undermined
the dollar by the back-door, questioning it as a store of value and medium-of-exchange.
Although the Chinese are not advocating the renminbi as the alternative to the dollar this may be only
a matter of time. One needs to focus on what the Chinese do, as well as listen to what they say. A key
development is China’s encouragement of international use of the renminbi, although they prefer to call it invoicing.
This may be from a low starting point but one Chinese saying may be worth bearing in mind: “A march
of 10,000 miles begins with one small step”. Early signs are promising.
China is encouraging exporters to invoice in the renminbi and is setting up systems to allow trade
payments in renminbi. This make sense. China’s trade is soaring. New trade corridors may soon
require new means of payment. When the Chinese and Brazilian Presidents met last
year they agreed to use their own currencies to settle more of their bilateral trade, rather than
invoicing in dollars. Although viewed as symbolic, it is a sign of things to come.
This picture is from the Chicago tribune
US national debt is a disaster in the making. Currently the demand for treasuries
is being artificially propped by US credit rating agencies that downgrade European
countries but keep their mouth shut about the fiscal position of the United States and
the States in the United States, such as California, which are much worse off than
Greece (in the EU).
Essentially, the two choices for the Fed are not pretty –
hyperinflate or face a devastating deflationary collapse due
to mega-Ponzi derivative fiasco. The Fed chose hyperinflation.
“Any serious attempt to withdraw the stimulus at
this point will trigger a deflationary depression and
a continuation of the current policies will put us
firmly on the road to hyperinflation”
Here’s what the Deutsche team, led by Jim Reid, say:
Although we’re positive in the near-term, looking at the world today it’s clear that the current macro environment will be
difficult to sustain. The markets will need evidence in 2010 that there is an observable path back to fiscal discipline for those
countries that have been most aggressive in responding to the fall-out from this crisis. If not we continue to run the risk of
Sovereign land mines disturbing the benign corporate landscape.
Indeed if 2010 is a difficult year it’s highly unlikely that the catalyst comes from within the equity or corporate credit markets.
This means the macro environment will decide 2010, and in reality investors in Sovereign debt around the world will probably
decide the fate of risk assets. In late 08/09 the authorities had little to lose in aggressively attempting to stave off a
Depressionary cycle. So far they deserve extremely high marks. However 2010 could be a transitional year between heavy
intervention and the paying of the bills. A return to positive global growth should help but we would expect more volatility in
2010 than in H2 2009.
Back to Sovereign risk, history is littered with examples of inflation, devaluations and Sovereign defaults after financial crisis.
One might wonder why this time should be any different. Sustainability is the key word. As soon as markets doubt the
sustainability of a country’s deficit then we have a problem. This is why it’s important that in 2010 the authorities provide a
credible path for future fiscal discipline, even this path involves many years of adjustments. One of the largest challenges will
be funding the still large global government issuance in a world with less QE. QE limited the discussion on the impact of
crowding out in 2009. Will we be as fortunate in 2010?
Deutsche Bank has the following scenarios:
Scenario 1 — This scenario is the most optimistic and is one where the authorities have as good a year as they did in 2009.
They likely keep stimulus extremely high in the system without there being any noticeable consequences of their actions (e.g.
rates at the short and long-end stay low). Under this scenario we would expect equities to be significantly higher, credit
spreads be much tighter but with bond yields only edging slightly higher as the authorities are seen to have firm control of
inflation expectations and may even be continuing to buy bonds.
Scenario 2 – This scenario is the most likely and suggests that we start to see gradual easing off the gas from the authorities
but only as it’s proved that there is some momentum in the underlying economy. Under this scenario risk assets have a good
year but returns are checked to some degree by rising bond yields and less stimulus being injected into markets. A satisfactory
year for risk, especially equities, but a mildly negative one for fixed income. Credit investors will likely have to rely on spreads
(and higher beta credit) to get positive total returns.
Scenario 3 – This is the second most likely scenario overall in 2010 but one that potentially becomes more likely as the year
progresses. Here we are likely to see sharply higher bond yields start to disrupt the positive momentum in markets. These
higher yields could be either due to Government supply starting to overwhelm demand (especially as the impact of QE, and
similar schemes, wane), or because of inflation fears. It seems unlikely that actual inflation will be a concern in 2010 but it’s
quite possible for expectations to become unanchored. We would also have to include the potential for a Sovereign crisis
somewhere in the Developed world within this scenario. We would note that the higher yields in this scenario are not based on
positive growth momentum but by inflation/Sovereign risk. Such a scenario is incorporated in Scenario 2.
Scenario 4 — This is the nightmare scenario of Deflation or in less extreme terms perhaps a double-dip. Given that much of the
world is currently still in negative YoY inflation territory it is difficult to completely rule out even if we do live in a fiat currency
system and even if inflation is expected to return to positive territory in early 2010. For deflation to be sustained we would
probably need an exogenous event to hamper the authorities ability to continue to successfully fight this credit crisis. Such
events could be a fresh banking crisis arising, a political backlash encouraging immediate increases in 2 December 2009 Macro
Credit and Equity Page 4 Deutsche Bank AG/London economic regulation or withdrawal of stimulus, or possibly a Government
bond/currency sell-off that forces the authorities to aggressively reign in stimulus for fear of a sovereign crisis. A Sovereign
crisis outside the Developed world could also encourage this scenario as there would be a flight to quality into Developed
market bond market in spite of the fact that these markets have their own large fiscal issues. Bond yields would eventually rally
strongly but risk assets would experience a very poor year. As time progresses this scenario becomes less likely as the system
gradually repairs itself and the authorities are allowed more time to inflate the global economy. As we discuss in scenario 3, the
more likely risk scenario is inflation, especially as time progresses.
We have tried to simplify and narrow down the scenarios as much as possible to allow for easy explanation but the reality is
that there are many other permutations for the year ahead. For example and as discussed above, within the worst case
scenario we would have to include a slightly less severe outcome where growth fails to show any momentum after the stimulus
starts to fade (a double dip perhaps?). If the authorities are unwilling or unable to stimulate further then we could have a weak
economy even if we don’t see outright deflation. This would likely be negative for equities/credit but the outcome would be
unlikely to be as negative as the -30% outcome.
The other big problem in differentiating between the two negative scenarios is with regards to Sovereign risk. If we have
Sovereign risk within the EM complex (e.g. Dubai) then Western bond yields could rally strongly on a flight to quality basis. So
an element of this risk is priced into Scenario 4. However we are in a fairly unusual point in history where there is also an
increasing risk of a Sovereign crisis occurring in the Developed world at some point. The fiscal deficits arising from this crisis
have to be addressed at some point. If the market eventually sees no credible medium-term way of certain Western countries
balancing their budgets and repaying their debts then we may see a large rise in Government yields. This in itself could be
enough to raise funding costs to levels that encourage a vicious circle.
Figure 1 and Figure 2 help us understand why we are entering into unknown territory in terms of Developed market debt. These
charts simply show the Debt to GDP ratio of the US and the UK. The Government part of the deficit is starting to rise sharply in
both regions and although it looks within the range of historic observations we have to remember that Governments have
implicitly and explicitly backed the debt of other parts of the economy. This makes Government liabilities potentially much
larger. The hope is that growth rebounds strongly enough for the Debt/GDP ratio to fall naturally over time. Such a scenario
would also require yields to stay low to facilitate such an adjustment. All we can say is that there are risks that the deficits of
such indebted countries at some point appear unsustainable to the market. This is when far more difficult decisions than those
made in 2009 would have to be made.
Investors should favor government bonds in countries with strong fiscal positions, such as Germany, this year, and prepare for a
tougher year in the U.S. and the U.K. in particular, where interest rates will rise as governments and central banks start to
withdraw their huge stimulus efforts, according to Bill Gross, co-chief investment officer at bond fund giant Pimco.
Bill Gross, January 2010 Pimco investment outlook.
Distressed as I am about the state of American democracy, a rational money manager cannot afford to get mad or “just get even” when it comes to investing clients’ money. Still, like pilots politely advertise at the end of most flights, “We know you have a choice of airlines and we thank you for flying ‘United’.” Global investment managers likewise have a choice of sovereign credits and risk assets where stable inflation and fiscal conservatism are available. If 2008 was the year of financial crisis and 2009 the year of healing via monetary and fiscal stimulus packages, then 2010 appears likely to be the year of “exit strategies,” during which investors should consider economic fundamentals and asset markets that will soon be priced in a world less dominated by the government sector. If, in 2009, PIMCO recommended shaking hands with the government, we now ponder “which” government, and caution that the days of carefree check writing leading to debt issuance without limit or interest rate consequences may be numbered for all countries.
The crisis didn’t start last year, it was building up for some time.
The real reason was not the housing bubble. Yes, housing prices soared due to
Greenspan’s ultra easy monetary policy in the early 2000-s,
but, in fact, in gold terms they are quite average historically, as of late 2009/early 2010.
The real problem was falling US standard of living, and that has been happening for some time,
as seen on these charts below. The falling standard of living is a direct consequence of
the falling currency.
This old missive from Bill Fleckenstein is worth putting on this blog. The Fed is currently jawboning the dollar, saying how they will drain the excess liquidity. All at the same time while unprecedented quantitative easing is taking place and the interest rates are kept at zero. Those who believe record low treasury yields guarantee little or no inflation need to look further at the history of United States during World War II, when government debt and inflation skyrocketed, while long term interest rates were very low. As a result, treasury investors lost money.
7 small steps to crisis
- Step 1. Nobody notices or pays attention that the dollar is falling.
- Step 2. Folks wake up, but they either don’t care or rationalize dollar weakness as a good thing.
- Step 3. The central banks now know they have a problem, but the bankers think the market will obey them. It will, for a while.
- Step 4. The dollar now tests everyone’s resolve by resuming its decline. The currency markets will not respond to jawboning by finance ministers.
- Step 5. In this step, the finance ministers are forced to take action. (Think about it. Even if they’d stated that they wanted the dollar to go up, nothing either explicit or implied indicates they’ll do anything about what’s happening. That will come next.) When they do take action, the market will do what they want — but only for a while.
- Step 6. The ministers take some additional action, but it won’t be enough, and the currency markets won’t do what the ministers want.
- Step 7. Finally, we’ll have a full-blown crisis, and that will be the end game.
The United States is effectively bankrupt, with total obligations exceeding the GDP of the World.
Widely cited for it’s AAA sovereign rating, 12 Trillion national debt is only part of the iceberg.
The bottom, invisible part is much bigger, according to U.S. Department of Treasury.
The table below illustrates matters as they were at the end of 2008.
There is no way these obligations can be paid without a major money printing,
major tax hike, a default on Social Security and Medicare, or a combination
of these. The AAA sovereign rating for USA that U.S. credit rating agencies
assign to this country is as much of a lie as their AAA subprime mortgage
debt ratings were. This big lie is still propagated, even as a major 1.725 Trillion printing
effort by U.S. Federal Reserve is currently in process.
By Andrew Torchia – Analysis
LONDON (Reuters) – The U.S. dollar may come under renewed pressure
from emerging market currencies and the euro after a meeting of the world’s top
finance officials failed to take concrete action on rebalancing global money flows.
Finance ministers and central bank governors of the Group of 20 major countries,
meeting in Scotland at the weekend, launched a “framework” in which they will
discuss how to reduce trade and savings imbalances between nations.
But their communique talked only in general terms about rebalancing economies,
and implied they might not agree on specific policies for individual countries to
adopt before the end of next year at the earliest.
The result may be a continuation of heavy fund flows into emerging markets,
boosting currencies there. And central banks intervening to slow currency
appreciation may keep investing much of the money they obtain in the euro,
pushing up that currency too.
“We’re probably looking at fresh dollar weakness in the short term” in the
wake of the G20 meeting, said Kenneth Broux, senior markets economist at Lloyds TSB.
Robin Griffiths, technical strategist at Cazenove Capital:
“The dollar trade-weighted is clearly in a downtrend, it does have days when it rallies,
but it’s basically persisting downwards and each potential support level breaks”
“With US interest rates expected to stay near zero for some time, the greenback has
now taken over from the yen’s 20-year reign as the main carry-trade currency”
“What that tells you is that many people wanting to invest anywhere go and borrow some
dollars to do it with. Because they’re institutionalized in the opinion that — by the time
we pay this thing back it will be worth less”
“That’s extremely unhealthy and if this trend goes much further, like taking out the low
of one-year ago … we’ll have a fully fledged dollar crisis and that will knock on across all