In a research piece dated today, Richard Koo, Nomura's Macro observer commented on recent market concern over BoJs pussy-whipping by the MoF. To sum up his observations, he said the BoJ, while between a rock and a hard place" should have just done the deed whether the market was expecting or not. He also observed that the carry trade is errr out of hand, saying that it is sooo over the top that even Croation home buyers are funding at nearZIRP in YEN, and that people, important people, and very important people (e.g. Angela Merkel) are rather concerned by the fact that while the RmB is appreciating albeit slowly, the YEN, Germany's main competitor has been, and continues to move, in the opposite direction. Finally, he notes that the BoJ should purely and simply intervene in the FX and buy Japanese Yen for US Dollars, thankyouverymuch.
I say, "Bravo!", Mr Koo. A BGO (blinding glimpse of the obvious) as former RJR Chairman F. Ross Johnson was renown for saying. But nonetheless someone had to say it. OK so they won't be able to move a vast amount of trillion dollar baby, but they could effect a reasonable correction by nudging the soggy unit towards the general direction of fair value vs. the USD, and even perhaps the Euro. This would allow the BoJ to "resonate" with the pathetic domestic whinging and whining regarding blah blah deflation weakness not yet deflation blah blah, while satisfying the rest of the OECD that Japan really is not intent on fostering a parasitic set of international monetary policies. Mr Omi, you're next....
Tuesday, January 30, 2007
Sunday, January 28, 2007
It's Official: Women are mere "Birth-Giving Machines"
In a rather remarkable gaffe, Shinzo Abe's Health Minister, Hakuo Yanagisawa, spoke his mind with brutal honesty in describing Japanese women as birth-giving machines, according to the BBC. Of course with a fertility rate in Japan of 1.26, the lowest in the world, such an assertion is met with some skepticism at best, and with derision by the more pedantic. Yanagisawa is no newbie to the trenches having served numerous governments internationally and within the sennior ranks of the finance ministry. His remarks come at a rather uncomfortable time for PM Abe whose approval ratings are flagging rather dramtically for someone who has done ummm errrr nothing at all. Did I hear someone suggest Tourette's Syndrome??? 
And in an another remarkable gaffe revealing yet more stunning high-level honesty behind the facade of tatamae by another old warhorse in the Abe Cabinet, Finance Minister Koji Omi was reported to have been overheard comparing the the BoJ and it's MOF-induced persistent policy of ZIRP & nearZIRP as the world's most munificent "Liquidity Giving Machine" and that continuation of this policy will work to serve TeamJapan's parochial interests by insuring that the YEN remains [paraphrasing again] "even more pathetic and disagreeable to investors than the US Dollar....". His spokesman officially denied the remarks, wink wink nod nod....
Friday, January 19, 2007
Central Bank Policy Tools Revisited
Any parent will tell you: There simply are some things that children must learn by experience. I recall my first university "Money & Banking" course, taught by a most-jolly Nigerian graduate student lecturer, with a big belly laugh, a keen sense of irony, and an enamoration with his own sense of humor similar to that of my Zen Buddhism professor. Ahhh, those were the days! But the point that I mean to make is that one can teach conceptually about Moral Suasion, Jawboning, Open Market Operations or The Discount Rate, but similar learning a foreign language, one doesn't truly learn it, nor truly appreciate the nuances until one has a large wrong-way position in relation so some Central Bank action or another.
Given the "Hear No Evil, See No Evil, Speak No Evil" stance of virtually all of the world's Central Banks, I thought it might be useful to review the tools within the arsenal of the modern day Central Banker, such that every reader is familiar in the event authorities do an about-face and decide that policy action is superior to the collection of honoriam, and beaucoup free rounds of Golf.
1. Jawboning.
"Jawboning" is the attempt to change market expectations without actually doing anything. Talk is cheap, so the old saw goes, and this is true from the point of view of political capital. It is "talking the talk", or "sowing the seeds". The opportunities for FOMC members to use this both varied and numerous. Lectures, speeches, Congressional testimony, trade conferences, press interviews, all provide opportunities for the Governors to express views that will attempt to nudge the market in the desired direction.
Sometimes these attempts have unintended consequences. Greenspan's now-famous Irrational Exhuberance is case in point. Bernanke's "Helicopter" reference in a private speech is another piece of chewing inexorably stuck to the Chairman's shoe. The trend has clearly been for greater transparency, and less cryptic-ness, which as the story goes, is believed to reduce volatility and increase economic efficiency by reducing uncertainty in planning, capital budgeting and variance in financing costs. Inflation targetting is the ultimate expression of this mechanistic view.
However, I am of the opinion that it is more complex, and thus requires more nuance. Speculation and economic activity are intricately linked, through reflexive feedback mechanisms. Economic conditions can and do change dramatically in response to war, natural disaster, political upheaval, etc. Apprising the market accordingly of adjusting expectations and conditions can be useful, even if they upset the prevailing paradigm. The market may believe that the Central Bank will tolerate higher inflation, and so they will express this belief in as many ways and as vigorously as possible until the CB indicates that it will not tolerate what the market thinks it might. This might cause a small derailment as the market adjusts, but this is most certainly superior to allowing a gross misallocation of resources and then causing a much more damaging train wreck later. So the quicker Mr Bernanke manages to slip a quip in one of his speeches about how gobsmacked he is by the rising cost of education , healthcare, housing, hotels, and all manner of goods and services, the quicker he might be able to disassociate himself from "The Helicopter".
In Japan, of course, despite the independence of the BoJ, things are NOT what they seem. For in Japan the most important thing to remember is that no one within the power structure of TeamJapan act inconoclastically for very long before being jettisoned. This is essential to remember when considering BoJ independence. For if the Prime Minister's office and the MoF are deeply opposed to that which is important to the BoJ, there is no question who will win...
2.. Moral Suasion.
Ahhh yes. There was a time when Commercial Banks respected Central Bankers. They understood that these Weberian-style bureaucrats were making a sacrifice in electing public service over the private sector. And the Central Bank could make life difficult for both commerical and merchant banks, if it chose to. Today. it would seem, that even the management of an American IB or commerical bank cannot rein in the traders and risk-takers within the organization, so how can a central bank hope to influence the activities and undertakings of institutions beneath its oversight? Not to mention that IBs and univeral banks - whether chartered in America or elsewhere - are now global, in scope and domicile. And there is no universal regulator except perhaps the BIS by extension of the broadest of capital adequacy agreements.
In Japan, by contrast, few could conceive of not heeding the gameplan of TeamJapan for the sake of parochial gain. This goes for the Corporate level and the level of the individual. If the BoJ say "Don't unload stocks into a falling market", supply will evaporate. If MoF says "Buy Stocks to support the market", they will find a way with discretionary funds and proprietary accounts, to make it so. If they say: "Don't repatriate profits so as place undue upwards pressure upon the YEN", Japanese non-financial corporations will find non-YEN investments, whether real or financial, in order to park their funds. Such is the power of Moral Suason in a society with unimaginably deep web of obligations. Make the mistake of taking personal initiative to sell stocks when MoF says "Dont Sell", and one may find oneself in old age drinking alone within a cardboard box in Shinjuku Station, or reassigned to the Corporate Travel Office instead of receiving the seniority promotion earned from years of Service.
Back in the US, the threats are reversed. IF you rock the boat and bite the hand that feeds you, the Public Servant will find that no IB of Commercial Bank will hire him and pay him millions like Gerald Corrigan or Wayne Angell. Such is the present day power of moral suasion. Witness how a sober-minded (but outspoken) Secretary O'Neill in the Treasury was hounded for making waves about fiscal policy. And even a relatively uncontroversial Fisher at the FRB Dallas took stinging heat for appearing too concerned about the threats of inflation.
3. Open Market Operations
This is day-to-day management of "classical money" rollicking through in the system. Repos, reverse repos, coupon passes add or drain reserves accordingly, in pursuit of policy objectives. But it seems to me that in this era of zeros, the Fed would to be monstrously persistent in its presence and have a medium-sized army traders to make an impact. Since it seems that Fed (confirmed again by Mishkin's speech today) is to help assure a one-way ticket for asset prices (and for the record, that direction is NEITHER down nor sideways), one would be forgiven for seeing this a rather pathetically ineffective tool in the age of explosive derivative growth (or did I mean growth in explosive derivatives?!!?), globalization and free flow of capital.
In Japan such operations were characterized by so called Quantitative Easing which flooded the banks with so liquidity that one could actually quite literally get paid (though admittedly small) to borrow YEN. Now how daft is that? But did it work?? Oh how it worked! Greenwich and Chelsea home prices galloped as a result, as did virtually all global assets EXCEPT Japanese ones. Japanese asset prices stayed on their back for another four years despite free money in near-infinite supply that was taken up by anyone and everyone NOT Japanese for any and every purpose EXCEPT investment in Japan. Japanese asset prices only lifted off after the Chinese capital investment boom was full-throttle open AND asset prices in the rest of the world had appreciated beyond comfort zones. And what does the Bank of Japan have to show for it? About a trillion dollars of US Treasury Bonds which they haven't quite figured out how to dispose of just yet.
4. Adjusting Reserve Requirements of Member Banks
"There was a time....when I was a boy....." Did your father ever start an impossible boring story that way? Irrespective, there was a time when this was contemplated in much the same way people experimented with LSD, or worse PCP or Quaaludes. Few swim in those waters anymore just as no one countenances altering reserve requirements which is probably viewed in the same light as "running over yourself with your own car". What would this do, if anything? Certainly drive banks offshore and capital away and hobble domestically chartered banks at the expense of non-US banks. But since most banks are multi-jurisdictional these days, and standards are set in Basel anyway, what would it really accomplish? Oh yes, there is one little additional thing about the regional FRB Governors being elected by the very same bankers who would be f*cked by the change in the reserve requirement. "Biting the hand that feeds you" is the first thing to comes to mind....
5. Modulating Margin
Yes there is a thing called "Reg-T" that says: "You can only borrow a maximum 50% against the collateral of your listed shares. But real specs use futures and options. Here you can get 20x or 50x implied gearing. Margin is soooo passe except for domestic day-trading saps. Hedgies of course use heavy offshore gearing to get around Reg-T in any event. And most other instruments are levered up to what volatility and market will ultimately bear. Swaps and all manner of complex options like "one-touch look-back compound calls" could have effective gearing that would have made Marshall Molotov look like a wussy. And you don't even need to be a professional to get leverage like that! My local bank (in a full-page advertisement in today's newspaper) is offering 100% interest-only mortgages on amounts up to USD$1million. My math may be rusty, but that sounds to me about as close to infinite gearing as one can get. "Reg-T"? Ha!!
6. Market Supervision
They could and should use this more. Name and shame etc. Banks and brokers are guilty. I think real supervision would be a fun job if one worked on some kind of a reverse incentive basis - i.e. payment of a percentage of the reduction in grey and nefarious activity. Moreover, a movement by overseers to a "spirit" of the law interpretation vs. letter of the law owuld help furtehr. Yes, you are guilty unless you write the overlord and get written approval that the bogus tax-loss leases can be used to offset real income.
7. Covert Market Intervention
I've written before about "The BoJ's Hot Hand". And the Kong Kong Monetary Authority in 1998 boldly stood up and like JP Morgan after the crash in 1929, bought pretty much all they could equalling perhaps 10% of the Hang Seng in the HKMAs case. THAT was at 7000, whereas the Hang Seng is roughly 3x that now at >20,000. And anyone who can remember (When I was a boy....) will recall Japanese PKO (Price Keeping Operations) that kept participants on their toes, though few knew who (MoF, or BoJ) really was giving the orders, or for that matter, why.
In the US, Canadian investment house Sprott has written at length about the alledged "The Plunge Protection Team" and their secret operations. And though plausible in theory, I have serious doubts for the US is the land of "deep throat". A place where the Vice-President likely ordered the outing of a CIA Agents because her husband voted "Blue State". There is about a ZERO chance of something as big as a PPT being kept secret. The Market sunk the bank of England; the Thai Bhat, Nick Leeson's solo plunge-protection team; Amaranth, LTCM. We are talking about people like "Brownie" and FEMA and the same government that couldn't evacuate their own colon, let alone keep a massive multi-billion market intervention and support scheme a secret. Maybe one day American's - like the Japanese before them - will find a need and reason to intervene, but I don't see it yet.
8. Overt Market Intervention
This is "Loud and Proud" entry into the market. And it's typically done for efffect. It shows a seriousness. of intent. When I was first cutting my teeth, the mere rumour: "The Fed is checking prices...." was enough to make one dump everything and go double the other way. And there was "The BuBa is checking prices too" whereby the formerly-bold speculators would be seen scattering in all directions yelling "Run Away Run Away Run Away....". Then there was the canny Mr. Yen, Eisuke Sakakibara who waited patienty like Lao Tzu for his moment, Japan having been savaged by Rubin's policy of "Dancing upon their heads didn't work...let's try telling the market we don't care where dollar-Yen goes...". Like Dr Seuss's Grinch, he waited until all the little Who's in Whoville were sleeping and drunk and body-slammed the Yen so hard it triggered every stop and cleared every chart point causing every system not only to close out sort dollars, but strong mindless impulse to go long dollars in one single well-timed and well-planned raid effectively ending the strong-yen siege. THAT was a tool. THAT was resolve. THAT shoved short dollar-yen positions so far up the specs rears, no one dared go the other way for years, except for a day trade.
BUT the market today is more like a pack of hyenas, and even if a Central Bank is like a Lion - King Of The Beasts - hyenas are not easily deterred. They will harass a lion, sometimes chase him/her off, for there is safety in numbers Which is why this tool must be used sparingly and with great gravitas. For as the BoE learned there are limits - even to a central bank - of defending a wrong-sided position.
8. Capital Controls.
Central Banker can, and do, restrict capital flows into and out of their respective countries, with mixed success, and not without cost. That's fine where a small country is evolving, but rather more problemmatical once it's already open and in the big leagues of convertibility. Just the alliteration of the words makes me wince, and think of Malaysia's Matahir and his repsonse to 1998. These are Heavy! Heavy! Heavy! though remains a possibility. Theyh can stem an outflow, but is a bit like killing a mouse with a guillotine. Effectively, capital controls, for countries with already-convertible currencies, are akin to changing the rules, mid-game. At the wrong place and wrong time, it can have crushing consequences, for once the outflow starts, one way of insuring that no further capital will return is to slap them on. Capital controls, in any event, deal with the symptom and not the problem, much like treating cancer with pain-killers: it may stop the hurt, but it willdo nothing to cure the underlying disease.
10. Short-term Interest Rates - The Discount Rate & Fed Funds Rate
This is The Hammer. This is, at the end of the day, what the market in advanced-stage capitalism best understands: the Price of Money, for it the price at which member banks borrow from the Federal Reserve, and by extension for most of the time sets scene for the region the Fed would like to see the market-determined Fed Funds Rate, or US Interbank rate. It becomes a sort of benchmark rate and feeds through to the rest of the economy and financial system.
When it is low, and longer-frame rates are higher, this creates an opportunity to manufacture liquidity and profits, though not without risk that the yield curve could bite them in a variety of nasty ways. But when its inverted, financial institutions can of course borrow long and lend short (usually deemed rather risky) but typically only make spread profits by assuming credit risk. Famed Shakespearean John Gielgud speaking on behalf of Smith Barney used to term this "Making money the old fashioned
way", something eschewed in a modernity where money and financial profits can so erffortlessly be conjured by the carry trade. Banking, it would seem, is too much effort and too hard an undertaking. Indeed, modern bankers eschew the classical risk of potentially not being re-paid, and prefer to be the equivalent of third-party administrators, leaving the real risk to be socialized and concentrated where and as it may.
But everyone must understand that the Central Banker can only erally control the short rate, and through the short rate and its path of depandancies, so the bond rate is impacted. In the days when the Bond Market was considered "el vigilante muy feroz", a steep yield curve where short rates were substanitially below long rates was rightfully understood by anyone and everyone as at once expansionary, and likely inflationary. Raise the short rate, the long rate stabilizes or dips. Lower the short rate and watch the long rate rise. And it was effective. Traders and portfolio managers watched payrolls, and hourly earnings like a hawk to make sure they were snookered by monetary or economic movements, and with present value of their fixed-income slice diminished.
That was, of course, until the neo-mercantilists decided to accumulate US reserves in such vast quantities that it didn't matter where the short rate was, or how large the budget deficit ballooned. Japanese and Chinese official buyers were "bid" for bonds. So sure of their future appetite, they sold T-Bond put options to everyone with impunity. The result of course was not disimilar to an extended general strike by law enforcement officials whereby criminals - both petty and dangerous - now understood the meaning and set off on a crime wave like the world had never seen, safe from consequence for all officials who might or could do anything were "gone fishin". And some had joined forces with the crooks, and were looting at every chance. Such was the impact of destroying the integrity and vigilance of the Bond Market.
The discount rate remains a viable tool. But it is likely that given the loss of credibility, and the implied puts beneath ecojomic activity (which are essentially political in nautre) the application of monetary strangulation required for the desired throttling of credit creation, speculation, and growth in economic activity (if those be the goals) is IMHO far greater today than what might have been required in days of old. That's during "good times". However, the flip side is that with so leverage out there, and everything correlated to the continued growth and expansion of credit, it might only take "a waaafer thin mint" or a another straw upon the proverbial camel to trigger a revulsion that in the absence of Mishkin-like response -would be larger than anything seen since the 30s.
11. The Helicopter
The final tool in the Central Bankers' arsenal, a relatively modern banking invention is the Helicopter. Historically a tool of marine rescuers, or an accompanying weapon of ground warfare, the Helicopter is believed by markets to represent the financial equivalent of "manna from heavan" in the event markets were ever to falter. Proponents would ostensibly send out [many] helicopters laden with packs and stack of Green Bills adorned with dead presidents (and some jars of peanut butter & cans of spam). Okies (presumably red-staters would then feel that they had resources and fortitude to run (actually fill up their RV and drive) to the local Home Depot or Walmart and continue their twoo-decade-long leveraged consumption binge, thereby saving the grand American economic experiment from the dustbin of history.
Given the "Hear No Evil, See No Evil, Speak No Evil" stance of virtually all of the world's Central Banks, I thought it might be useful to review the tools within the arsenal of the modern day Central Banker, such that every reader is familiar in the event authorities do an about-face and decide that policy action is superior to the collection of honoriam, and beaucoup free rounds of Golf.
1. Jawboning.
"Jawboning" is the attempt to change market expectations without actually doing anything. Talk is cheap, so the old saw goes, and this is true from the point of view of political capital. It is "talking the talk", or "sowing the seeds". The opportunities for FOMC members to use this both varied and numerous. Lectures, speeches, Congressional testimony, trade conferences, press interviews, all provide opportunities for the Governors to express views that will attempt to nudge the market in the desired direction.
Sometimes these attempts have unintended consequences. Greenspan's now-famous Irrational Exhuberance is case in point. Bernanke's "Helicopter" reference in a private speech is another piece of chewing inexorably stuck to the Chairman's shoe. The trend has clearly been for greater transparency, and less cryptic-ness, which as the story goes, is believed to reduce volatility and increase economic efficiency by reducing uncertainty in planning, capital budgeting and variance in financing costs. Inflation targetting is the ultimate expression of this mechanistic view.
However, I am of the opinion that it is more complex, and thus requires more nuance. Speculation and economic activity are intricately linked, through reflexive feedback mechanisms. Economic conditions can and do change dramatically in response to war, natural disaster, political upheaval, etc. Apprising the market accordingly of adjusting expectations and conditions can be useful, even if they upset the prevailing paradigm. The market may believe that the Central Bank will tolerate higher inflation, and so they will express this belief in as many ways and as vigorously as possible until the CB indicates that it will not tolerate what the market thinks it might. This might cause a small derailment as the market adjusts, but this is most certainly superior to allowing a gross misallocation of resources and then causing a much more damaging train wreck later. So the quicker Mr Bernanke manages to slip a quip in one of his speeches about how gobsmacked he is by the rising cost of education , healthcare, housing, hotels, and all manner of goods and services, the quicker he might be able to disassociate himself from "The Helicopter".
In Japan, of course, despite the independence of the BoJ, things are NOT what they seem. For in Japan the most important thing to remember is that no one within the power structure of TeamJapan act inconoclastically for very long before being jettisoned. This is essential to remember when considering BoJ independence. For if the Prime Minister's office and the MoF are deeply opposed to that which is important to the BoJ, there is no question who will win...
2.. Moral Suasion.
Ahhh yes. There was a time when Commercial Banks respected Central Bankers. They understood that these Weberian-style bureaucrats were making a sacrifice in electing public service over the private sector. And the Central Bank could make life difficult for both commerical and merchant banks, if it chose to. Today. it would seem, that even the management of an American IB or commerical bank cannot rein in the traders and risk-takers within the organization, so how can a central bank hope to influence the activities and undertakings of institutions beneath its oversight? Not to mention that IBs and univeral banks - whether chartered in America or elsewhere - are now global, in scope and domicile. And there is no universal regulator except perhaps the BIS by extension of the broadest of capital adequacy agreements.
In Japan, by contrast, few could conceive of not heeding the gameplan of TeamJapan for the sake of parochial gain. This goes for the Corporate level and the level of the individual. If the BoJ say "Don't unload stocks into a falling market", supply will evaporate. If MoF says "Buy Stocks to support the market", they will find a way with discretionary funds and proprietary accounts, to make it so. If they say: "Don't repatriate profits so as place undue upwards pressure upon the YEN", Japanese non-financial corporations will find non-YEN investments, whether real or financial, in order to park their funds. Such is the power of Moral Suason in a society with unimaginably deep web of obligations. Make the mistake of taking personal initiative to sell stocks when MoF says "Dont Sell", and one may find oneself in old age drinking alone within a cardboard box in Shinjuku Station, or reassigned to the Corporate Travel Office instead of receiving the seniority promotion earned from years of Service.
Back in the US, the threats are reversed. IF you rock the boat and bite the hand that feeds you, the Public Servant will find that no IB of Commercial Bank will hire him and pay him millions like Gerald Corrigan or Wayne Angell. Such is the present day power of moral suasion. Witness how a sober-minded (but outspoken) Secretary O'Neill in the Treasury was hounded for making waves about fiscal policy. And even a relatively uncontroversial Fisher at the FRB Dallas took stinging heat for appearing too concerned about the threats of inflation.
3. Open Market Operations
This is day-to-day management of "classical money" rollicking through in the system. Repos, reverse repos, coupon passes add or drain reserves accordingly, in pursuit of policy objectives. But it seems to me that in this era of zeros, the Fed would to be monstrously persistent in its presence and have a medium-sized army traders to make an impact. Since it seems that Fed (confirmed again by Mishkin's speech today) is to help assure a one-way ticket for asset prices (and for the record, that direction is NEITHER down nor sideways), one would be forgiven for seeing this a rather pathetically ineffective tool in the age of explosive derivative growth (or did I mean growth in explosive derivatives?!!?), globalization and free flow of capital.
In Japan such operations were characterized by so called Quantitative Easing which flooded the banks with so liquidity that one could actually quite literally get paid (though admittedly small) to borrow YEN. Now how daft is that? But did it work?? Oh how it worked! Greenwich and Chelsea home prices galloped as a result, as did virtually all global assets EXCEPT Japanese ones. Japanese asset prices stayed on their back for another four years despite free money in near-infinite supply that was taken up by anyone and everyone NOT Japanese for any and every purpose EXCEPT investment in Japan. Japanese asset prices only lifted off after the Chinese capital investment boom was full-throttle open AND asset prices in the rest of the world had appreciated beyond comfort zones. And what does the Bank of Japan have to show for it? About a trillion dollars of US Treasury Bonds which they haven't quite figured out how to dispose of just yet.
4. Adjusting Reserve Requirements of Member Banks
"There was a time....when I was a boy....." Did your father ever start an impossible boring story that way? Irrespective, there was a time when this was contemplated in much the same way people experimented with LSD, or worse PCP or Quaaludes. Few swim in those waters anymore just as no one countenances altering reserve requirements which is probably viewed in the same light as "running over yourself with your own car". What would this do, if anything? Certainly drive banks offshore and capital away and hobble domestically chartered banks at the expense of non-US banks. But since most banks are multi-jurisdictional these days, and standards are set in Basel anyway, what would it really accomplish? Oh yes, there is one little additional thing about the regional FRB Governors being elected by the very same bankers who would be f*cked by the change in the reserve requirement. "Biting the hand that feeds you" is the first thing to comes to mind....
5. Modulating Margin
Yes there is a thing called "Reg-T" that says: "You can only borrow a maximum 50% against the collateral of your listed shares. But real specs use futures and options. Here you can get 20x or 50x implied gearing. Margin is soooo passe except for domestic day-trading saps. Hedgies of course use heavy offshore gearing to get around Reg-T in any event. And most other instruments are levered up to what volatility and market will ultimately bear. Swaps and all manner of complex options like "one-touch look-back compound calls" could have effective gearing that would have made Marshall Molotov look like a wussy. And you don't even need to be a professional to get leverage like that! My local bank (in a full-page advertisement in today's newspaper) is offering 100% interest-only mortgages on amounts up to USD$1million. My math may be rusty, but that sounds to me about as close to infinite gearing as one can get. "Reg-T"? Ha!!
6. Market Supervision
They could and should use this more. Name and shame etc. Banks and brokers are guilty. I think real supervision would be a fun job if one worked on some kind of a reverse incentive basis - i.e. payment of a percentage of the reduction in grey and nefarious activity. Moreover, a movement by overseers to a "spirit" of the law interpretation vs. letter of the law owuld help furtehr. Yes, you are guilty unless you write the overlord and get written approval that the bogus tax-loss leases can be used to offset real income.
7. Covert Market Intervention
I've written before about "The BoJ's Hot Hand". And the Kong Kong Monetary Authority in 1998 boldly stood up and like JP Morgan after the crash in 1929, bought pretty much all they could equalling perhaps 10% of the Hang Seng in the HKMAs case. THAT was at 7000, whereas the Hang Seng is roughly 3x that now at >20,000. And anyone who can remember (When I was a boy....) will recall Japanese PKO (Price Keeping Operations) that kept participants on their toes, though few knew who (MoF, or BoJ) really was giving the orders, or for that matter, why.
In the US, Canadian investment house Sprott has written at length about the alledged "The Plunge Protection Team" and their secret operations. And though plausible in theory, I have serious doubts for the US is the land of "deep throat". A place where the Vice-President likely ordered the outing of a CIA Agents because her husband voted "Blue State". There is about a ZERO chance of something as big as a PPT being kept secret. The Market sunk the bank of England; the Thai Bhat, Nick Leeson's solo plunge-protection team; Amaranth, LTCM. We are talking about people like "Brownie" and FEMA and the same government that couldn't evacuate their own colon, let alone keep a massive multi-billion market intervention and support scheme a secret. Maybe one day American's - like the Japanese before them - will find a need and reason to intervene, but I don't see it yet.
8. Overt Market Intervention
This is "Loud and Proud" entry into the market. And it's typically done for efffect. It shows a seriousness. of intent. When I was first cutting my teeth, the mere rumour: "The Fed is checking prices...." was enough to make one dump everything and go double the other way. And there was "The BuBa is checking prices too" whereby the formerly-bold speculators would be seen scattering in all directions yelling "Run Away Run Away Run Away....". Then there was the canny Mr. Yen, Eisuke Sakakibara who waited patienty like Lao Tzu for his moment, Japan having been savaged by Rubin's policy of "Dancing upon their heads didn't work...let's try telling the market we don't care where dollar-Yen goes...". Like Dr Seuss's Grinch, he waited until all the little Who's in Whoville were sleeping and drunk and body-slammed the Yen so hard it triggered every stop and cleared every chart point causing every system not only to close out sort dollars, but strong mindless impulse to go long dollars in one single well-timed and well-planned raid effectively ending the strong-yen siege. THAT was a tool. THAT was resolve. THAT shoved short dollar-yen positions so far up the specs rears, no one dared go the other way for years, except for a day trade.
BUT the market today is more like a pack of hyenas, and even if a Central Bank is like a Lion - King Of The Beasts - hyenas are not easily deterred. They will harass a lion, sometimes chase him/her off, for there is safety in numbers Which is why this tool must be used sparingly and with great gravitas. For as the BoE learned there are limits - even to a central bank - of defending a wrong-sided position.
8. Capital Controls.
Central Banker can, and do, restrict capital flows into and out of their respective countries, with mixed success, and not without cost. That's fine where a small country is evolving, but rather more problemmatical once it's already open and in the big leagues of convertibility. Just the alliteration of the words makes me wince, and think of Malaysia's Matahir and his repsonse to 1998. These are Heavy! Heavy! Heavy! though remains a possibility. Theyh can stem an outflow, but is a bit like killing a mouse with a guillotine. Effectively, capital controls, for countries with already-convertible currencies, are akin to changing the rules, mid-game. At the wrong place and wrong time, it can have crushing consequences, for once the outflow starts, one way of insuring that no further capital will return is to slap them on. Capital controls, in any event, deal with the symptom and not the problem, much like treating cancer with pain-killers: it may stop the hurt, but it willdo nothing to cure the underlying disease.
10. Short-term Interest Rates - The Discount Rate & Fed Funds Rate
This is The Hammer. This is, at the end of the day, what the market in advanced-stage capitalism best understands: the Price of Money, for it the price at which member banks borrow from the Federal Reserve, and by extension for most of the time sets scene for the region the Fed would like to see the market-determined Fed Funds Rate, or US Interbank rate. It becomes a sort of benchmark rate and feeds through to the rest of the economy and financial system.
When it is low, and longer-frame rates are higher, this creates an opportunity to manufacture liquidity and profits, though not without risk that the yield curve could bite them in a variety of nasty ways. But when its inverted, financial institutions can of course borrow long and lend short (usually deemed rather risky) but typically only make spread profits by assuming credit risk. Famed Shakespearean John Gielgud speaking on behalf of Smith Barney used to term this "Making money the old fashioned
way", something eschewed in a modernity where money and financial profits can so erffortlessly be conjured by the carry trade. Banking, it would seem, is too much effort and too hard an undertaking. Indeed, modern bankers eschew the classical risk of potentially not being re-paid, and prefer to be the equivalent of third-party administrators, leaving the real risk to be socialized and concentrated where and as it may.
But everyone must understand that the Central Banker can only erally control the short rate, and through the short rate and its path of depandancies, so the bond rate is impacted. In the days when the Bond Market was considered "el vigilante muy feroz", a steep yield curve where short rates were substanitially below long rates was rightfully understood by anyone and everyone as at once expansionary, and likely inflationary. Raise the short rate, the long rate stabilizes or dips. Lower the short rate and watch the long rate rise. And it was effective. Traders and portfolio managers watched payrolls, and hourly earnings like a hawk to make sure they were snookered by monetary or economic movements, and with present value of their fixed-income slice diminished.
That was, of course, until the neo-mercantilists decided to accumulate US reserves in such vast quantities that it didn't matter where the short rate was, or how large the budget deficit ballooned. Japanese and Chinese official buyers were "bid" for bonds. So sure of their future appetite, they sold T-Bond put options to everyone with impunity. The result of course was not disimilar to an extended general strike by law enforcement officials whereby criminals - both petty and dangerous - now understood the meaning and set off on a crime wave like the world had never seen, safe from consequence for all officials who might or could do anything were "gone fishin". And some had joined forces with the crooks, and were looting at every chance. Such was the impact of destroying the integrity and vigilance of the Bond Market.
The discount rate remains a viable tool. But it is likely that given the loss of credibility, and the implied puts beneath ecojomic activity (which are essentially political in nautre) the application of monetary strangulation required for the desired throttling of credit creation, speculation, and growth in economic activity (if those be the goals) is IMHO far greater today than what might have been required in days of old. That's during "good times". However, the flip side is that with so leverage out there, and everything correlated to the continued growth and expansion of credit, it might only take "a waaafer thin mint" or a another straw upon the proverbial camel to trigger a revulsion that in the absence of Mishkin-like response -would be larger than anything seen since the 30s.
11. The Helicopter
The final tool in the Central Bankers' arsenal, a relatively modern banking invention is the Helicopter. Historically a tool of marine rescuers, or an accompanying weapon of ground warfare, the Helicopter is believed by markets to represent the financial equivalent of "manna from heavan" in the event markets were ever to falter. Proponents would ostensibly send out [many] helicopters laden with packs and stack of Green Bills adorned with dead presidents (and some jars of peanut butter & cans of spam). Okies (presumably red-staters would then feel that they had resources and fortitude to run (actually fill up their RV and drive) to the local Home Depot or Walmart and continue their twoo-decade-long leveraged consumption binge, thereby saving the grand American economic experiment from the dustbin of history.
Thursday, January 18, 2007
That BoJ Rate Policy Statement In Full
1. We the Board Members setting monetary policy for the Bank of Japan elect 6-to-3 to leave the discount rate unchanged.
2. We reached this decision independently, based wholly upon the domestic economic data, and not upon whether free money (technical term= nearZIRP) is contributing to a negative real global rate of interest and global runaway asset-price inflation, or as a result of threats made by the LDP that BoJ Board Members voting in favor of a rate increase would find their children, and their children's children forever "unmarriable" within polite circles.
3. Board Members who cast dissenting votes are kindly asked to go to the mail room and retrieve a cardboard box and clean their desks out, and to leave the BoJ ID Badges and Luncheon Vouchers at the main security Desk.
4. All Gaijin desiring "free YEN", please queue at the first door on the left of the main foyer, and please have your suitcases or other form of portage ready.
5. Errrr. That's all.
(asset markets may now resume their ascent)
2. We reached this decision independently, based wholly upon the domestic economic data, and not upon whether free money (technical term= nearZIRP) is contributing to a negative real global rate of interest and global runaway asset-price inflation, or as a result of threats made by the LDP that BoJ Board Members voting in favor of a rate increase would find their children, and their children's children forever "unmarriable" within polite circles.
3. Board Members who cast dissenting votes are kindly asked to go to the mail room and retrieve a cardboard box and clean their desks out, and to leave the BoJ ID Badges and Luncheon Vouchers at the main security Desk.
4. All Gaijin desiring "free YEN", please queue at the first door on the left of the main foyer, and please have your suitcases or other form of portage ready.
5. Errrr. That's all.
(asset markets may now resume their ascent)
BoJ Policy Freeze; Abe Says: What? Don't Look At Me!
So the BoJ hemmed and hawed yet again before finally deciding to do nothing, yet again. PM Abe guiltily was on the horn immediately following the decision and said:
Understandably, the YEN weaken to historical lows vs. the Euro, and multi-year lows against the USD dollar.
(Errrrr, did the CIA have anything to do with the JFK's assasination?!?!)
"I didn't interfere....I had nothign to do with it....it was completely independent ....really! .....really! ..... really! .... awww come on guys don't you believe me?....what do you think there is some conspiracy to keep the YEN weak for the sake of TeamJapan, what are you insane? You journalists probably think the the CIA killed Kennedy too, huh?...."before being yanked off stage by his personal secretary. In hilariously scripted fashion, three members of the policy-making comittee dissented on the decision to DO NOTHING, ostensibly because leaving rates at nearZIRP yet again is careless, reckless, anti-social, not to mention fricking insane.
Understandably, the YEN weaken to historical lows vs. the Euro, and multi-year lows against the USD dollar.
(Errrrr, did the CIA have anything to do with the JFK's assasination?!?!)
Friday, January 12, 2007
Barbary Apes & the Art of Central Banking
Anyone who's visited the UK lately can see that London is bubbling and frothing. House prices are, once again, vaulting upwards, restaurants and airports are jammed, and all manner of high-end product or service retailer are replacing the tired bookie on the high street. Even the ubiquitious corner shops are being remodeled replete with a zillion watts of halogen, uncluttered aisles more akin to Waitrose than Londi's. Vertical tower cranes adorn the London skyline as new skyscrapers dwarf the once-dominant Centrepoint Tower, whilst rents are increasing smartly too, according to CB Richard Ellis's latest report. Housing affordability? Ha! It'd so unaffordable that few Brits outside hedgies and merchant bankers own (or even live) with the Congestion Zone. So the Bank of England has raised rates, and rightfully so. Granted, London can be deemed pseudo-idiosyncratic since it does prey upon the rest of EC by generously allowing tax refugees to live there without paying Inland Revenue. And Hedge Funds are popping up and multiplying like mushrooms in a cow pasture after a spring rain due to the lack of the SEC, and a subtler, more level-headed approach to fighting terrorism. Most major metropli share the feel-good of London. New York is the same. As is Tokyo, Moscow, Rio, Khartoum, as are Dubai, Mexico City, and Caracas. In fact the whole world - save Zimbabwe, Mogadishu, North Korea, Dresden, and yes, Detroit - is booming and building. The ECB has been raising rates, though they remain comparatively and historically low. And despite jawboning by the Trichet, higher VAT in Germany, and higher energy prices, European real estate is rising, unemployment is falling, speculative building continues apace, and estate agents and stock brokers are more ubiquitious than engineers or machinists. Liquidity is growing. And it it growing significantly. Assets of all types are being sold by old long-standing owners to new owners, and used as collateral in this transfer of ownership. It leaves the old owners with paper, while the new owners put up a bit of equity and borrow the rest, often collateralized by the assets themselves, the newly collateralized and rated paper that then is used as equity, near-equity or faux-equity for creation of further credit. But while there IS indeed real growth in eastern europe, and encouraging recovery in old europe, this boom, it would seem to me, is decidely financial. And this has been rewarding for owners of assets, and doubly so for owners that are geared. But make no mistake: the feel-good is the result of leverage and debt. And the source of such funds and the ease with which one can borrow them - i.e. the grease - is I suspect still coming from "liquidity" created by loose fiscal policies (deficit spending) of what's been 3% of GDP in the EU, 4%+ or so in the US (taking into account SS and other OBS obligations), and 4 or 5% in Japan, on top of still-easy money in the EU, very cheap money from Switzerland, and still almost free money from Japanese ZIRP, now, (called nearZIRP in my lingo). Asian savings, and GCC petrodollars further enable it. And with still-easy money, and the dollars from US nearZIRP of 02-to-05 still sloshing about unspent by the neo-mercantilst trade financiers excepting US TBills, Bonds & MBS, and the deficits continuing to add many zeros to the cumulative figures, speculators have, to say the very least, been emboldened.
So emboldened have they become, that everyone has become a spec. Whether individual home buyers in America using floating, IO mortgage product, or formerly staid folk that traded on connections and information (like Carlyle), professional specs are now seizing everything in site, whether alone or through consortia. TPG, KKR, CINVen, GS, and a hundred others all borrowing to buy assets. And Morgan Stanley, manager of the largest levered real estate fund no longer is content or satified by buying buildings. It's appetite has gotten so big, and apparent bullishness on assets so whetted, it's taken to feasting upon entire listed REITs, swallowing them whole with some equity and a lot of debt. Where is all this money emabring upon leveraged asset acquisition pecadilloes coming from??!? Is the market THAT ineffficient, that it's got the prevailing price so so wrong? Are the debt-to-equity ratios of companies that ineffciently underleveraged? Or is there something more nefarious going on? Have smart people simply figured out how to manufacture paper money at low cost in order to buy very real assets and things? Probably, the answer is "No", "No", "Yes", and emphatic "Yes". And the culprits are a combination of globalization, open-capital flow, large differentials in interest rates, and a purgatory-like stasis that is preventing adjustment in the relative value of currencies. If in fact it is so, is this bad? And If so, what is to be done?
"Why?" is still the nagging question I ask myself this question every day. And that "Why?" implies, "Why are not participants afraid of the effects of policy shifts, recession, uncertainty in their risk equations determining the pricing of risk?? Is it that one has magically found the keys to the printing press, and they are raking it in and converting it assets as quickly as possible, OR is it perhaps that the world is so awash with liquidity that delegated agent portfolio managers have it, and must use it or lose it, even if valuations are not attractive, cap rates on real estate are low, or the risk vs. reward of changes inimical to the realization of profits for investors at the end of the trade, poor. In either case asset values are rising, and price signals in both the real and financial economies are being distorted. There is no silver lining in this round of leveraged private equity as there was when Oliver Stone's Wall St. Villain shook up the sleepy New England family manufacturing firm to ostensibly make them more competitive and efficient. These buyouts are not about running the companies better, or realizing value for shareholders, whatever the rhetoric. It is about borrowing to take something private with other people's money, stripping it, and flipping it back out sans assets and with pathetic capital structures, having pried loose untoward management fees, success fees, incentive fees, directors fees, refinancing fees, handshakes, parachutes, and all manner of other freebies, goodies, consultancies, etc. before selling it back out to the public market saps. The early deals have been home-runs for investors and structurers alike, but one must wonder now with a deal-or-two-a-day being done, what the outcome of these will be. Either way, the signals and competitive incentives for the market and the immediatre future prospects for the workers and communities where these enterprises dwell is rather grim. For as leverage goes up, so all accounting conservatism goes to proverbial pot: R&D & ad spending are slashed. All but the most urgent & necessary capital expenditure is torpedoed. Working capital pared to the bone. Anything that can be levered, factored or securitized is so encumbered. Employees are laid off. Benefits and wages cut. Extra-responsiblities heaped upon non-eexecutive, non-buy-out affiliated salaried employes that are fortunate enough NOT to be fired. Good for capital. Bad for labour. Good for competitor firms, for the new owners will be in the midst of a Sherman-style march that will see the enterprise, in all likelihood marginalized and handicapped for years to come, as their competitors and nearest-neighbors invest, whistle-dixie and take "the long view".
But hey, this is capitalism, and a free market. Why should we care? And if we should care, what should we do? I think we should care because the result is inequality and further imbalance enroute to economic serfdom and marginalisation of anyone NOT already a large owner of assets or king of Wall Street. Like it or not, this will have economic, political, sociological and psychological consequences that will floor a generation, for skill-sets and compeititve market positions, once yielded, are most difficult to recapture. I am not talking central planning. I am a fan of the market, and think capitalism the lesser of evils. But I think that perverse incentives to accumulate that are granted to a limited few at the expense of the many is simply wrong, ethically speaking, for will have political manifestations, make no mistake. And when the hordes become meaningfully disenfranchised, and no longer believe the rules of the game are fair, then all manner of turn-the-world-upside-down becomes possible.
More immediately, what's to be done? The prime enablers are globalization and free movement of capital, coincidental to dramatically different national interest rates, combined with the neutering of market signals by surplus nations systematically and persistenly accumulating debtor nation reserves. The first allows "the carry trade". The second enables large imbalances - trade deficits - to persist without immediate or tangible consequence. Both of these spawn perverse outcomes and dangerous consequences to national economies and the international monetary system alike.
Now, some will say hard money is the answer. And here, I must admit to being philosophically sympathetic. BUT practically speaking, politically speaking, this is extreme, and at once difficult, at least as far as true hard money solutions go. And I will further admit to secretly having sympathy with Vickrey & discisples who mourn the social costs of lost output, as well as those who highlight the stickiness of prices on the downside, and therefore argue that cautionary erring on the side of looseness is better than erring on the side of being too scrooge like. In this sense, I am no radical. BUT I do believe that there is great moral hazard in income inequality, and in selectively giving the keys to the press to some, with a put option, and that this will cause rgeat distortion like housing bubbles, and wholesale raping of enterprises for short-term parochial gain at the expense of enlightened social policy, a balanced economy and longer-term competitiveness. This is unconscionable in a world that itself is, day-by-day becoming more competitive, and is something communities all across America and Europe will come to regret when the look back should they persiist in substituting leverage and consumption for investment, balance, a long-term view. All, which to say, in the most long-winded way that I believe, we must end the carry trade, and adopt fiscal, energy and macro policies that encourage longer-term competitiveness, balance, and fortitude and equality.
For the carry trade is the lifeblood of the Spec. There is no problem with investors from one nation desiring to invest, in another. There IS a problem with investors in one nation conjuring up financial liquidity to parasitically profit off of another while at the same time preventing it from confronting the financial issues and problems that are most pressing, like trade and current account deficits. I believe of course that our trading partners are NOT helping, and are disingenuous. ZIRP is a sham, and even if Japan experiences further disinflation or deflation (mild as it would be), they SHOULD, since they are running persistent surpluses, are demographically stagnant, undergoing dramatic producitivity increases, and situated adjacent to the largest deflationary force the world has ever seen. But leaving the cynical self-interest of MITI, MoF and BoJ, the USA can take matters into its own hands, for its own self-interest, and should NOT passively let itself be exploited for the narrow interests of transnationals, banks & finance houses benefitting most directly from the one-direction of trade and continuation of status quo and the great sucking sound that it is producing in the domestic economy.
So what specifically should do we do, since open capital flows are a cornerstone of globalisation and the international monetary system? Like many things that go awry incrementally, policy correction to fix the problem need not be intractable or even difficult. A simple statement that the speculative leveraged carry trade will not be tolerated any longer will go a long way. For this situation of the Central Bank and hordes of mischievious and clever speculators reminds me of one of my favorite anecdotes from when I visited Gibraltar some years ago. Aside from being strategically important at the mouth of the Med, and the foot of Europe, it is the home of a large troupe of barabry apes. They run wild around the place, live in caves up the side of the rock (the one now notorious by Prudential), and frequently descend upon the populated town to steal pies from the windows of old ladies, and picnic boxes from small children. Ocassionally they run amok and can truly cause chaos and mayhem, during full moons for example.
But fortunately there is a solution to help civil man and beast live side-by-side. You see, the first thing that the leader of the British garrison does when there is a leadership change in Gibraltar's British squadies, is meet with the apes, mano-a-ape-o. As the story goes, they manage to round up a great number of them into a cave, with the new British Commander. The Officer rolls up his starched sleeves. Stares the alpha Barbary male down, and proceeds to wrestle the alpha male ape down to the ground, and beat the pulp out of him thus establishing dominance. Once the Commander is ensconced atop the Barbary Ape hierarchy, he is the law, so that whenever the apes run amok, the garrison leader need only show up and tell them to "shove off" for them to run off with their tails between their legs, without screaming fuss, a fight, or tossing of bottles. Understand, that it is not out of sadistic pleasure that this is done, just as a Central Banker should take no pride in generating volatility, uncertainty, and occasional liquidation in financial markets. But, it must be understood that it IS for the greater good, else the mischievious little buggers will run amok with no apparent recourse....