Friday, February 02, 2007

Five Things Hoarding USD Reserves Is NOT Responsible For (And Twelve Things For Which It Is)

One trillion USD of YEN-financed carry trades of one sort or another, says PI Econs Tim Lee!! One might then take a bold at guess at all the manner of leveraged speculative trades financed by Swiss Franc carry. Add a trillion USDs on the books of the PBoC, the same for TeamJapan, and another one-half to one-trillion USDs across , Russia, GCC and the ROW. Then, close your eyes and take a deep breath when contemplating what that Ivy education will cost in 2014 for your MoonUnit or Dweezil when she/he reaches the age of consent.

The more sanguine say "Worry not!" for they are but the benign products of globalization. But I cannot help but feel that these rough pencil-on-the-back-of-envelope numbers represent many-a-distortion-in-the-making here on Planet Earth. Of course, not all absurdities of modernity in this brave new millennia result from the cavalierly selfish to the wantonly stupid policies and actions of both leveraged implementers and official enablers. For example:


(1) Scooter Libby's aboutface & newfound desire to take down Karl Rove.
(2) John Bolton's Stalin-wannabee moustache
(3) The fog and appalling food at Heathrow Airport
(4) Marc Faber's ponytail
(5) Absurd rules concerning "liquids & gels" in carry-on luggage


(1) Absurdly low USD interest rates relative to experienced inflation and asset price inflation leading to negative savings rates
(2) Unustainable US fiscal, trade and current account deficits
(3) The death of offical CB ability to modulate liquidity growth with free-flow of capital & hugely varying interest rates
(4) Rapid & persistent liquidity growth relative to GDP Growth;
(5) Greatly exaggerated and excessive USA PCE in relation to USA GDP
(6) Low to negative real interest rates & resultant US gross over-investment in oversized, shitbox housing
(7) Environmental destruction and/or global extinction of numerous fish & wildlife species
(8) De facto concession by USA of manufacturing & its web of dependancies to nations with policy horizons longer than a nano-second.
(9) Worse-Than-Non-Existant Energy Policy in the USA
(10) Continued mindless suburban sprawl in the USA
(11) Persistent and pervasive global asset-price inflation & destruction of risk premia encouraging all manner of leveraged overinvestment.
(12) Donald Trump


Avinash Goldfish said...

I guess you ordered them in increasing honor dubiosity, right?

tmcgee said...

your comments are always over-the-top, and enjoyable.

Cassandra said...

Thank you TMC....but surely you exaggerate: Have you ever seen Marc Faber's ponytail?? And the Honus Wagner card really did change hands at $1,500,000!

Anonymous said...

Back in the late '80s and early '90s when I used to attend Chicago Japan-American Society meetings, the several times they had an economist or financial type speaking I'd get up and opine that the only way the trade deficit with Japan could continue was if the Japanese continually loaned us back an equal amount, and asked whether they agreed with this and how long they thought we could continue piling up debt at $100 billion a year.

Though back then I was of the opinion that even the measly $100 billion deficits were unsustainable, and that someday the dollar would plummet and there'd be a great reckoning, today I'm in a Dr. Strangelove "How I learned to stop worrying and love the trade deficit" mode. As fantastic as the trade deficit and savings rate curves are, I just can't see any way things will change, unless China comes apart at the seams, or the US House and Senate go mad and pass Smoot-Hawley II.

We seem to have entered a financial "Twilight Zone".

Cassandra, from your vantage point in the financial industry, can you conceive of anything that will stop the Chinese and Japanese from continuing to ZIRP us into financial hyperspace?

I always liken the Asian mercantilism to the telecom bubble years vendor financing frauds of Nortel and Lucent management, done on a Brobdingnagian scale, with no outside agency ever to call them to account.


Anonymous said...

In fact I can imagine one scenario which brings the current lunacy to an end -- a sequence of events like:

1. Housing inventory glut combines with after-effects of lax lending to send home prices back to year-2000 levels, wiping out most of American home equity and the myth that real estate always goes up (still have vivid memory of young Japanese couple telling me back circa 1998 they were thinking of buying a condo, but had decided to wait, 'cuz they were sure it'd be cheaper in a few years -- shocking words to an old Japan hand like me).

2. Realizing they can't retire on cashed-out home equity, boomers start saving again. Younger people also start saving. Overshoot of savings rate mean-reversion to above 8% takes an additional 5-6% from GDP on top of housing collapse effect.

3. With no one wanting to borrow even at zero interest, money supply expansion mechanisms of fractional reserve banking cease to function. Simultaneously, intense recession in consumer demand causes imports from Asia to decline dramatically, shrinking the trade surpluses the Asians had been lending back to us.

4. Forced to buy long-term bonds and implement ZIRP at all durations like Japan in order to counter money supply shrinkage (due to failure of fractional-reserve banking multiplier mechanism), Fed ends up destroying pension funds and retirees dependent on interest income. Savers realize they need to save even more.

5. Political repercussions of collapsing trade lead to collapse of Chinese government. China reverts to chaos. US House and Senate pass Smoot-Hawley II. Global trade collapses .


"Cassandra" said...

I think that there are numerous scenarios – like the one you paint – that could derail it. It just that they are all, while not improbably, less probably than forecasting out the continuation of the status quo. But as much as I detest the leveraged carry-traders and the anti-social parasitism that they represent, they probably have the correct trade on to profit from the status quo, for the time being, and that things will drift in their favor – along with the rest of the liquidity-correlated assets until something breaks. When that “something” breaks, there will be no exit from the trade, and the thing that breaks is likely to go Snap!, rather gently unwind. So the carry traders protect their ass with OTM calls on YEN and accept he lumps if and when they come. It’s a binary world out there.

I do believe – unlike the Gavekal thesis – that liquidity IS a problem, and that while they are correct in that it is NOT the Fed that is creating it, (the Fed, the BoJ the SNB and all official accumulators and private specs) are enabling it. Inflation is already here, and will only accelerate (cost push both wages and inputs) as economies are already overheating, overbuilding, employing capital sub-marginally and very speculatively for poor purpose that supports the distortions of the status quo (luxury slope-side condos, golf resorts, seaside resorts and time shares etc.). PIMCO (perhaps it was McCulley ) painted what IMHO is the correct policy for the moment (i.e. not relying upon change in Japanese or Chinese policy and not intentionally contractionary), i.e. intended to kill the cycle), but the one that would have the greatest sustainability provided the US policy straitjacket of the environment forced by mercantilists. IF the US is as dynamic and flexible as the US has been historically (my caveat), then he proposed (what I call a tit-for-tat) a policy mix of near ZIRP accompanied by very tight fiscal policy (probably consisting of not just a balanced budget, but perhaps even a surplus, derived from income tax hikes, ground-rent on commercial property, energy taxes, some of which would be re-distributed to ease dislocations and hasten the weaning off oil to greener energy economy-wide. This has the benefit of supporting nominal house prices, at current nominal levels and hopefully avoiding a housing bust. The Europeans would be encouraged to do the same within the Euro-bloc and then Presto!, there is no more inter-OECD leveraged interest rate arb that feeds liquidity.

Now the flows may continue between OECD and developing world, but such flow of savings and investment is, at the least, no longer flowing uphill, but in the direction of places actually in need of capital and investment. Traditional energy and other inputs prices would also be tempered as the demand side slacks, but hopefully not implodes.

It won’t be pretty. It will likely be recessionary, but it will incinerate the worst of speculative excess and associated moral hazard, and restore an integrity to finance and markets for things must be more balanced to maintain sovereignty, flexibility, the integrity of the markets as allocative tools which are the centerpiece of capitalism. Take that away, which accum of USD reserves has done, and we embark down the road towards a form of Randish cronyistic plutocracy cleaving the people away from sustainable equality and away from higher-value-added employment, politics, and a sense of public interest that considers sustainablility of policy results something desirable. I;ve been accused of being a financial Calvinist (no insult to me) as I think a a Calvinistic work ethic is nothing to be ashamed of. I think it is simply a sober-minded precursor to insuring perception and reality are converging rather than diverging, and this is essential to competing in a world where others are trying even harder and want it even more. But to be certain, what I am suggesting is not pain for pain for pain sake i.e. for the sake of generating unemployment to benefit capital, but a policy readjustment that has positive benefit for longer-run and generational balance since we seem to be beyond the point of diminishing marginal returns from a dollar of debt-induced growth – something that buggers future generations for diminishing current advantage.

In short, I think US housing (along with other assets) will bottom here so long as liquidity and employment remain robustly carried as they are at the moment (the status quo) which I sadly do believe. I look at other anglo-saxon places that, by all expectation should have crashed or corrected, but are resuming rises due to liquidity and asset inflation. In the nearer future, real returns on real estate may be negative, but nominal returns will be positive. The real loser: the long-dated bondholder…..which goes back to the people of the Japan, China, GCC and other large paper USD holders who’ve lent long and fixed. The real correction will come when the bond market’s inner child is released, and we see the return of conflictual industrial action, and the misery index of coincidental to stagflation bears its likeness…