March 11, 2013 6:39 pm

High vaultage
Central banks have become crucial but controversial participants in currency markets
A foreign currency exchange sign hangs above a shop in Hong Kon©AFP

Traders of Japan’s currency became unusually fond of the Tokyo night air last year. Long after their colleagues had gone home, the traders left the grand investment houses that dominate the skyline of the Marunouchi financial district and strolled north for a block or two.

Once they reached the Beaux-Arts style Bank of Japan building, they would count the taxis parked outside. A lot of cabs meant the officials were working late. This, the traders speculated, meant they were planning an intervention in the currency market.

To aid Japan’s exporters, the central bank has loaded up on foreign currency in recent years to lower the yen’s value against the dollar. Although these interventions are not known in advance, the BoJ declares its foreign exchange purchases soon after making them.

What happens next with the money, however, is shrouded in secrecy. Little is known about what the reserve managers at the BoJ, and their counterparts in central banks around the world, buy.


Central banks

Trying to fathom what secretive central banks do with their huge forex reservesJapan, the second-largest reserves holder, had $1.28tn at the end of last year – has long been a headache for traders and investors.

But the influence of central banks has now grown to critical levels. Currency wars and global monetary easing have filled the vaults of the world’s central banks with record amounts of reserves.

Since 2006, those have doubled, making central banks crucial participants in markets. Yet there is little accountability or transparency over their holdings.

With fears of currency wars on the rise and no end to monetary easing, the reserves could swell even further.

The $4tn-a-day forex market is the largest in the world but covert activities by central bank reserve managers have the clout to move it.

“They pose a lot of distortions in the market,” says one hedge fund investor who asked not to be named. “As an investor I can find out what Pimco is doing in the bond markets. But we’re made to feel we can’t ask what central banks are doing and there’s something uncomfortable about that. I’m afraid that this may lead to more volatility in the global economy in the years ahead.”

Many acknowledge the immediate effect that currency interventions have on financial markets. The G20 group of nations said in February that “excessive volatility” of financial flows and disorderly movements in exchange rates had “adverse implications for economic and financial stability”. Yet there is far less focus on the longer term impact of the surge in foreign exchange reserves.

The International Monetary Fund estimates that central banks held $10.8tn in assets at the end of September, more than four times as much as global hedge funds. China alone holds $3.32tn – the largest reserves of any central bank. 

After Japan come Saudi Arabia and Russia. In fifth place is the Swiss National Bank, which has amassed reserves worth $468bn, mostly in the past year as it has sought to cap the Swiss franc’s gains against the euro after its currency became a haven for investors fleeing the eurozone crisis. With the threat of more currency wars looming, other central banks could follow the SNB’s lead.

Central banks’ newly found riches are pushing them towards adventurous diversification into more unusual currencies. Unknown to many, they often use third parties, such as BlackRock and other private-sector companies, to manage their assets and conduct transactions. The SNB last year outfoxed markets by buying euros through a prime brokerage service at Rabobank.

“‘Safety, liquidity, return’ has long been the traditional mantra of central bank reserve managers,” says Terrence Keeley, global head of BlackRock’s Official Institutions Group. “But today that’s an oxymoron. Not even the safest assets are that safe.”

Reserve managers have traditionally held low-yielding assets that can be sold easily if a central bank suddenly needs to counter moves in the currency, which can dent export trade, stymie inward investment and spark banking crises.

Both US Treasuries and eurozone government debt allow ready access to dollars and euros and are the two most popular reserve currencies. But their allure is fading. While the Federal Reserve still holds close to a record $3.25tn-worth of Treasuries on behalf of foreign central banks, the figure represents a shrinking proportion of such banks’ portfolios. In 2000, the dollar made up 71 per cent of reserves. Today it accounts for just 62 per cent. The euro’s sheen has, understandably, faded; the currency’s share of reserves has fallen from 28 per cent in 2009 to 24 per cent today.

With interest rates at or close to zero, reserve managers have been feeling the pinch. Central bankers have never been driven primarily by rates of return. But there are costs associated with maintaining a large reserves stockpile – and yields of just 0.14 per cent on one-year US Treasuries do not cover them.

The problems of the advanced economies have pushed reserve managers to search for higher-yielding assets, often denominated in more exotic currencies. That means fresh reservesgained through interventions or trade – are increasingly likely to be diversified out of dollars and euros.


John Normand, head of forex strategy at JPMorgan, estimates that 50 per cent of central banks now have exposure to emerging currencies, up from 25 per cent two years ago. “The eurozone crisis has made central banks more sensitive to the quality of what they buy,” he says. “This year is when the reserve story could start to get more interestingeven if the eurozone crisis has abated, we may still see more flows into alternative currencies.”

Switzerland is a case in point. Last summer the SNB was a key mover of the global forex market. It was known to be buying tens of billions of euros each month, hoping to keep the franc weak to protect its exporters in the face of inflows from spooked overseas investors at the height of the eurozone crisis in May. But the Swiss, wary of getting stuck with huge amounts of euros, decided to exchange them.

Rumours abounded among forex investors that the SNB was buying Swedish krona and the Australian dollar. The currencies became widely sought after by other investors seeking to follow or even front-run the central bank.

Bankers said there had been days when the SNB was the biggest single buyer of Australian debt. Figures released by the SNB later in the year confirmed the rumours; the proportion of “othercurrencies on its balance sheet – the Australian dollar, Swedish krona, Danish krone, Singapore dollar and Korean wonrose.

. . .

This level of transparency from a central bank is rare. Many monetary authorities in Asia and the Middle East refuse to declare the currency composition of their reserves even to the IMF, which compiles data on the holdings. And it is reserve managers in these regions that have seen their portfolios expand the most in recent years.

Clues to the behaviour of these central banks can, however, to some degree be gleaned from disclosures of the SNB, and others, such as the Bank of Israel, that are less opaque. Like any other investors, central bankers can succumb to herd-like behaviour. Anecdotal and empirical evidence indicates Switzerland’s appetite for currency diversification is matched elsewhere. Of those that do declare the currency composition of their reserves to the IMF, the proportion of assets invested in currencies other than the dollar, yen, euro or pound rose from less than 2 per cent in 2006 to nearly 6 per cent last year.

With their relatively high interest rates and cherished triple A sovereign debt rating, interest in the past two years has focused chiefly on the Canadian dollar and the Australian dollar; so much so that the IMF is considering switching both out of the “other category and listing them as reserve currencies in their own right. Analysts point to a rise in foreign ownership of these nations’ debt as evidence that central banks are buying in force. The portion of foreign-owned Canadian government debt rose from 12 per cent in 2007 to 28 per cent today, according to Nomura, while the bank calculates foreign ownership of Australian government debt rose from 58 per cent to 72 per cent.

Many central banks trade in foreign exchange, and other markets, themselves. But traders say such banks increasingly rely on third parties to cover their tracks, as Switzerland’s use of Rabobank demonstrates. Other banks are looking at using automated systems, or algorithms, to drip-feed purchases through the market.

Given the size of central banks’ portfolios, other investors are concerned by what they view as the banks’ secrecy. Central banks are becoming both players and referees,” says one investor. “They don’t have to report to regulators and when there’s a crisis yes, they can control it. But they also distort markets. They have way too manyofficialreserves.”

. . .

A report from Standard & Poor’s, the rating agency, last year argued that the SNB’s hefty purchases of euros had played a large role in reducing the spread between peripheral and core government bond yields in Europe, which global investors used as a barometer of the eurozone crisis. The SNB said the rating agency had overestimated the size of its footprint in the market. Some central banks have been keen to demonstrate awareness of the dangers of wading into new and smaller bond and currency markets; the SNB said recently that it was in constant discussion with other central banks about how to diversify its reserves without causing price distortions.

However, others do not make these courtesy calls. And some have become fed up with what they feel is other investors’ scaremongering.

Those managing central banks’ assets play down fears that the banks’ rapid accumulation of reserves could be a destabilising force. David Smart of Franklin Templeton says investors are unlikely to gain more transparency. He believes markets’ ability to weather changes in reserve managers’ behaviour in recent years suggests there is little cause for concern.

Diversification has been going on for a few years now and we haven’t encountered any big problems,” he says. Central banks don’t hold a particular advantage over other investors. They’re very conscious of how much they can do in these markets without distorting them.”

Back in Tokyo, yen traders no longer need to count cabs. Investors have relieved the BoJ of its need to intervene. Selling the yen has been one of the most popular trades this year among hedge funds amid expectations that a new BoJ governor will take unorthodox measures to fight deflation. Yet unlike Switzerland, Japan has pulled back from earlier suggestions it might buy foreign currency. The move, which would further build up reserves, is viewed by other central banks as potentially destabilising to global markets. For now, Japan is keeping its powder dry.

Copyright The Financial Times Limited 2013.

Sputtering global economy belies stockmarket boom
Asia's economic recovery is losing momentum and Europe's slump is proving deeper than expected, raising concerns that soaring stock markets globally have jumped ahead of economic reality.
By Ambrose Evans-Pritchard, International business editor
8:53PM GMT 11 Mar 2013
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Asia's economic recovery is losing momentum and Europe's slump is proving deeper than expected, raising concerns that soaring stock markets globally have jumped ahead of economic reality.
China's industrial output rose 0.6pc in January and 0.8pc in February, the slowest pace since early last year. Photo: AP

Japan's closely-watched index for machinery orders fell 13pc in January, nearing levels last seen after the Lehman Brothers crisis. "It is a shockingly poor number and illustrates the divergence between the improvement in sentiment in financial markets and what is actually happening on the ground," said Julian Jessop from Capital Economics.

China's industrial output rose 0.6pc in January and 0.8pc in February, the slowest pace since early last year. Retail sales growth dropped to 12.3pc, the weakest since early 2004. "The goal of consumer-led growth remains a pipe dream for now," said the group's China economist, Qinwei Wang. "The economic rebound may already be stalling."

The US economy is holding up, as cheap shale gas drives a manufacturing revival, but Charles Dumas from Lombard Street Research said America still has to navigate the most drastic fiscal squeeze since the Second World War. "We think tightening will be 2.5pc of GDP this year and that will hit profits," he said. "We expect a 10-20pc correction in the S&P 500."

While the US unemployment rate dropped to 7.7pc in February – the lowest since 2008 – this was entirely due to a fall in the "participation rate" to a fresh low of 63.5pc, as people dropped off the rolls. Jobs figures are a lagging indicator in any case. Commodities can be a better gauge and they are flashing amber, refusing to confirm that a fresh cycle of global expansion is fully under way.

The Baltic Dry Index, measuring freight rates for bulk goods, is at 2009 lows and the CRB commodities index has been slipping since September. Copper futures have fallen 10pc over the past month and "Dr Copper" is famously prescient.

Officials at key central banks and the International Monetary Fund doubt the world economy has reached "escape velocity", worried over the debt overhang and chronic lack of demand.

Albert Edwards from Societe Generale said: "Financial markets can ignore weak data for a long time so long as it is not catastrophic but reality catches up with them eventually." He said the latest phase of Wall Street's blow-off has been driven by companies raising debt to buy back their own stocks despite poor earnings, as they did during the Greenspan boom.

"It feels eerily similar to the prior mid-2007 peak. Buying shares when they are expensive in the wake of a huge rally seems designed to destroy value," he said.

Europe remains the world's economic black hole. Data on Monday showed a 1.2pc decline in French industrial output in January, weaker than expected. French real M1 money aggregates have fallen at an annual rate of 7pc over the past six months, pointing to a sharp downturn.

European Central Bank chief Mario Draghi says small firms still face a credit crunch across large parts of the currency bloc and warned that "hard" economic facts had yet to validate "soft" surveys.

The bank is sticking to its tight money stance for now, though "doves" pushed for a rate cut last week. Former board member Lorenzo Bini-Smaghi said the ECB may have to cut rates unless there is evidence of real recovery soon. "Growth is not picking up," he told Bloomberg.

China still has scope for fiscal stimulus if need be but Beijing has hit the "Phillips Curve" constraint, discovering that the trade-off between growth and inflation is becoming much harder to manage.

Fitch Ratings says total credit has jumped from $9 trillion to $23 trillion over four years, adding as much as the entire US banking system. This is yielding ever less growth. Stimulus is leaking into property and rising prices instead.

Xianfang Ren from IHS said: "The government's policy challenge this year is to strike a balance between containing the asset bubble and pushing the economy out of the growth malaise."

Sceptics say the global market boom has been driven by a wash of liquidity from the US, UK, Japanese and Swiss central banks, abetted by China's shadow banking system, with the Draghi pledge to save Italy and Spain icing the cake.

This has ignited asset prices as intended. Whether this method of stimulus will trickle down to the real economy or merely inflate a fresh credit bubble with all its attendant dangers is the great unanswered question.

March 11, 2013 6:31 pm
The shock news that made gold price soar
Central banks boosted the bullion market by limiting their sales of the metal
Behind the scenes at the IMF’s round of annual meetings, 15 central banks had signed up to a five-year commitment to sell no more than 400 tonnes of gold a year between them.

Central banks have spooked markets before. In the 1990s it was goldnot foreign exchange traders who had the most to fear from the actions of the world’s monetary guardians.

As confidence grew that the problem of inflation had been solved, central banks began to question the wisdom of holding gold, long regarded as a hedge against price pressures.

Increasingly viewed as a cumbersome asset that was expensive to store and yielded no fixed return, central banks, which at the time owned a quarter of gold above ground, began to sell, with some using the proceeds to invest in government debt.

The US Federal Reserve, the world’s biggest gold holder, was always unlikely to divest of its bullion. But others across Europe were soon following the lead set by the National Bank of Belgium in 1992. In the late 1990s, the Bank of England and the Swiss National Bank, then big holders of bullion, announced planned sales. The gold price plunged.

Statements by central banks, including the Banque de France, one of the biggest holders of bullion, failed to pare the losses.

Concerned, the World Gold Council, a producer-funded trade body, stepped up its efforts to remind central bankers of the motives for holding gold, notably as a long-term store of value.

Then at meetings on the fringes of the Bank for International Settlements in Basel, central bankers that remained attached to gold voiced fears that the behaviour of their peers was destabilising the market. Those intent on selling considered action necessary to stabilise the price. Cue Mr Duisenberg. In the days following his announcement, the gold price soared.

More than a decade on, central banks remain tied to commitments on gold sales. In recent years, monetary authorities have become net buyers of bullion.

Copyright The Financial Times Limited 2013.

Networked Development

Hans Vestberg

11 March 2013

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STOCKHOLMThe challenges that the world faces in the twenty-first century are systemic and global in nature. There will be no easy answers to any of them, but one thing is clear: we need transformative solutions that are scalable. Incremental measures will only distract us from the scope of the challenges that we confront.
One of the best examples of scale is the mobile telecommunications industry. There are now 6.4 billion mobile phone subscriptions, with the number expected to increase to 9.3 billion by 2017 or 2018. Ericsson estimates that by 2018, 85% of the world’s population will have access to mobile-broadband coverage via 3G networks, and 50% will have 4G. In this context, the near ubiquity of mobile networks has created a new paradigm for sustainable development, putting technological advances at the forefront of policymaking.
Technology is enabling us to share, collaborate, and exchange knowledge in entirely new ways, creating a dynamic shift in mindset. A new society what we call the Networked Society – is emerging. And in the Networked Society, we have an obligation to ensure that we exploit mobile and broadband technologies not just for collaboration and entertainment, but also for sustainable development.
Connectivity is a basic enabler of economic growth and improved quality of life, and there is a strong business case for investing in broadband to optimize the delivery of essential services in education, health care, safety, and security, and to redefine urban landscapes through intelligent electricity grids and more efficient transportation.
In 2000, when the United Nations Millennium Development Goals (MDGs) were established, broadband was in its infancy, and most of these benefits had not even been imagined. Today, as world leaders consider the post-2015 development agenda, we cannot overlook the importance of including broadband as a key part of the infrastructure needed to achieve future goals.
The economic benefits of broadband are immense. A 10% increase in broadband penetration can add a full percentage point to sustainable GDP growth, and doubling broadband speed increases GDP by 0.3% on average. Moreover, mobile commerce expected to reach $800 billion worldwide by 2016 – has enormous potential to improve social and financial inclusion.
Likewise, cloud computing is already starting to revolutionize the way content is delivered and accessed both by teachers and students. An example of this is the cloud-based solution for schools developed by Ericsson in the Connect To Learn program. By addressing the challenges of access and quality of education, Connect To Learn – a collaborative effort between Ericsson, Columbia University’s Earth Institute, and Millennium Promiseidentifies strategies to integrate teachers’ professional development with twenty-first-century tools and practices in classrooms.
As for health care, half could be delivered remotely and more efficiently. Evidence of this can be seen in the Millennium Villages Project, where mobile communications have had a particularly significant impact on health care: improved response times to emergencies, reduced isolation, and better training and equipment for health-care workers.
Building on this success, the One Million Community Health Workers campaign was recently launched to expand community health-worker programs in Sub-Saharan Africa by the end of 2015. With the use of the latest communications technology and diagnostic testing materials, the health workers will be able to link the rural poor to the broader system of doctors, nurses, hospitals, and clinics.
These transformations are the result of both scale and innovation. But they have been set in motion without concentrated government efforts. If these examples were deliberately and specifically considered by the 110 countries that have national broadband plans (and those that still do not), we would be much more likely to achieve the positive transformations that we all want.
This shift in awareness among policymakers will be crucial not just for socio-economic improvement, but also for creating a low-carbon economy, which will require moving from the energy-intensive physical infrastructure of the last century to the connected, information-based infrastructure of the twenty-first century. We need a new paradigm that enables us to decouple GDP growth from CO2 emissions, thereby ensuring further poverty reduction without causing greater environmental damage.
The potential is there, but too often government talks to government and industry talks to industry. Public-private partnerships are essential to solving these shared challenges. Development agencies, NGOs, and the private sector should work more effectively together to create scalable and maintainable solutions.
Two forums are making great strides. One is the Broadband Commission, which advocates for broadband as a key infrastructure of the twenty-first century. The other is the UN’s Sustainable Development Solutions Network (SDSN), which seeks to leverage the private sector’s wealth of resources – its innovative capacity, research and development, management skills, and know-how – to turn policy ideas into reality.
Already, industries that have traditionally operated independently – from energy to utilities to transportation – are moving quickly toward cross-sector collaboration, radically altering the business environment, and creating opportunities for new low-carbon business models to thrive.
With concentrated public-private efforts, and proactive governments like those of Sweden, Australia, and India, to name a few, the Networked Society will produce transformative solutions that lift billions of people out of poverty and help us to sustain our planet. We may not be able to imagine what the future holds, but we know that the Networked Society will shape its possibilities.
Hans Vestberg is CEO of Ericsson.