Macro Man's mediations on (but not limited to) things macro - particularly FX - always deserve a read and careful consideration. His attention was caught by Fed Chairman Bernanke's lightweight waffling at the New York Economic Club last night. I concur with his amusement at the inversion of the Chairman's focus. But the sentence that caught my attention most was the following, contained as it was in MM's captured excerpt:
When financial stresses were most pronounced, a flight to the deepest and most liquid capital markets resulted in a marked increase in the dollar. More recently, as financial market functioning has improved and global economic activity has stabilized, these safe haven flows have abated, and the dollar has accordingly retraced its gains.The question that caused my eyes to blink repeatedly in disbelief and head to uncontrollably nod from side-to-side was: Does The Fed Chairman actual believe this revisionist manure about what occurred? This seemingly unusual take on events (unusual for a Fed Chairman, not a freshly-minted academicwith no market experience) is clearly derived from the same School of Thought as the one spawning the Savings Glut hypothesis for America's large imbalances, and has as much probability of being correct (hint: not much).
So lets be clear about this once and for all. The rally in the dollar, along with the reversal of all trades across the markets from outperformance in highly-shorted securities to the correlation within the entire anti-dollar complex had virtually nothing to do with dollar primacy resulting from premeditated aversion to risk and almost everything to do with systemic deleveraging and consequential reversal of open positions, full-stop. Whether this was driven by pre-emptive attempts to reduce leverage in anticipation of, or reaction to changes in quantities and pricing-spreads of available credit, realized investment losses, and/or in response to firm or provisional demands by end-investors to their speculative agents for their money back, or all of the above and similar flavours of the same is, for all intents, irrelevant. To imagine otherwise (in light of the evidence of price movements across the panpoly trades) is disingenuous at best and ludicrous absurd puerile [please insert derogatory adjective of choice here] drivel at worst, and we should wonder aloud, who actually wrote this script for the Chairman, and admonish him (or less likely, her) accordingly.
The Savings Glut Hypothesis! By gosh, we've heard so little of the good old Savings Glut for so long. Cassandra, you are a most venerable lady. Perhaps you could share some of your old memories of the Trojan War? The Savings Glut! Why, I haven't heard anyone talking about that since the Great Moderation.
ReplyDeleteOh, right. I forgot. Our economy is being planned by the leading theorist of the Great Moderation. Perhaps I'm just stuck in some sort of a hasheesh-induced time warp.
BTW, Chairman B's fallacy is a fine illustration of the reaming one subjects oneself to, when one tries to reason about political economy using arbitrarily mulched indexes such as "the dollar."
"The dollar" - ie, the number - is a mathematical abortion, because it is an attempt to produce a unitless price, or "value." The dollar-euro rate is a real price - both numerator and denominator are units. The DXY is not a real price, but a mathematical fallacy.
Of course there is a formula for computing the DXY from a set of real prices. Of course everyone knows this. What you can't do, however, is reason about causality in terms of a vat of blended numbers like this.
Fallacies have consequences. One of them is the one you describe, Cass. In a liquidity (maturity transformation) crisis, fundamental long-term interest rates rise sharply; the price of future dollars, in present dollars, plummets; financial securities represent a stream of future dollars; their prices plummet.
(Note that this spike in long rates is not visible in the Treasury market, which is normally how people measure interest rates, because the MT crisis did not affect these (genuinely) risk-free securities. It sure affected everything else, though!)
Why did the crisis affect the dollar/euro and related rates, in just the way Chairman B describes? Because many people held foreign-currency securities for the purpose of earning dollar returns - at least, more than held dollar securities for the purpose of earning foreign-currency returns.
Thus, a side effect of the rush of cash out of the future and into the present is the rush of cash out of the euro (and other currencies in the DXY basket) and into "the dollar." This flow corresponds to the shift in supply and demand, which changes the exchange rate.
It is indeed serious cause for concern that Chairman B does not appear to understand this process at all. Then again, it's hardly news!
BTW, although I obviously sympathize with the Paul-Grayson attack on the Fed, I am seriously concerned that if it is gelded by transparency another huge wave of the financial crisis will hit.
The only thing that saved this crazy system last year was the Fed's ability and willingness to buy arbitrary securities in a basically opaque and lawless manner. This was always going to be a one-shot deal - by the very nature of Washington.
And its end appears to approach. The lion will have its balls cut off - sooner or later. What then? Who will print the dollars?
Chère Cassandra, you are a modern day Lao Tseu. bien cordialement, Marc-Antoine de Fourchambault
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