Currency wars threaten Lehman-style crisis

Inside the new European Central Bank headquarters in Frankfurt, central bankers are increasing the chances of another Lehman-style crisis

By Liam Halligan

1:07PM GMT 14 Mar 2015

The euro plunged towards parity with a surging dollar this week

The euro plunged towards parity with a surging dollar this week 
Global currency markets made front-page headlines last week as the euro plunged towards parity with a surging dollar and the pound similarly soared against the single currency.
But why is the dollar so buoyant and the euro spiralling downward? And should you lock in the strong pound by buying your summer holiday money now?
You may, quite reasonably, think that economic fundamentals, such as GDP growth and cross-border trade flows, still drive exchange rates.
Unfortunately, though, you’d be wrong. For we live in the age of “extraordinary monetary measures” and “central bank diktat”.
That may sound like a remote, jargon-laced statement, the musings of a nerdy economist. I’d say, in response, that the recent actions of Western central bankers are provoking not only heightened market volatility, but also increasing international conflict and the looming prospect of another Lehman-style systemic lurch. The dangers, sadly, are very real.
Currency dealers, and the ubiquitous computerised trading robots, are influenced far less these days by growth or inflation forecasts than by the market’s view on the origin of the next splurge of quantitative easing.

That judgment is driven, in turn, by the coded missives of central bankers like the US Federal Reserve’s Janet Yellen, Mark Carney at the Bank of England and, particularly in recent months, Mario Draghi at the European Central Bank (ECB).

Why did the euro fall to almost $1.05 last week, a 12-year low, having dropped some 12pc against the greenback since the start of the year? Why, when each pound bought you just €1.19 last March, can holidaymakers now expect €1.40 for every pound exchanged?

The main reason is the ECB’s long-awaited programme of virtual money-printing, which launched last Monday. Under euro-QE, the eurozone will be flooded with at least €1,100bn (£825bn) of newly created money over the next year and a half, as the Frankfurt-based central bank buys government and corporate bonds at the rate of around €60bn a month.

Like some kind of economic horse-whisperer, Draghi then commented that the eurozone economy is “now pointing in the right direction”, apparently raising the prospect of even-faster ECB money-creation, so depreciating the euro even more. As such, at the time of writing, the single currency has dropped over 6pc in six days, a pace of decline seen only once since the euro was launched in 1999 – and that was just after the 2008 Lehman Brothers collapse.

The other major cause of the single currency’s recent fall is that the Fed – having already indulged in its own vast money-printing programme, which saw America’s central bank expand its balance sheet threefold as a percentage of annual GDP over five years – could soon be weaning itself off the monetary steroids.

As such, for the first time in almost a decade, US interest rates may be about to go up. Expectations are rising, ahead of a key policymaking meeting this week, that the Fed will drop its pledge to be “patient”, pointing to a rate rise perhaps as early as June. Such a prospect, of course, pushes up the dollar.

So, as a result of ECB money-printing and US central bank musing, the dollar has lately soared against the euro. After months of speculation that Fed QE is finally over and rates will soon increase, America’s currency has rocketed 25pc against a trade-weighted range of currencies since May, with the dollar index now at its highest level since 2003.

The reality, of course, is that the Fed’s successive doses of QE since late 2008 have been designed to keep the lid on the dollar, deliberately reining in the greenback in a bid to boost US competitiveness and limit the value of the vast debts America now owes its foreign creditors – not least China.
The eurozone, meanwhile, having initially had to bow to German objections, has so far implemented QE more covertly, expanding its balance sheet slower than the US – and the UK for that matter. As such, the ECB has used complex transactions beyond the gaze of voters in member states where central bank profligacy is frowned upon and money-printing has previously gone badly wrong – sparking inflation, political extremism and worse.

The perpetually moribund eurozone economy of recent years, though, to say nothing of a currency union that stumbles from crisis to systemic crisis, means euro-QE is now, apparently, OK. In other words, the eurozone can finally get its own back on the US and Britain by attempting to print its way to a cheaper currency, winning back some competitiveness. That’s the theory, anyway.

What we’re seeing, then, is the West’s very own version of “currency wars”. For almost half a decade, the big emerging markets have complained bitterly – and often publicly–- about mass money-printing by the world’s “leading economies”. The likes of Brazil and China have highlighted, rightly, that Western QE has lowered the relative value of their carefully accumulated dollar and sterling reserves (and debts) against local, emergent currencies such as the yuan and the real.

Now, with eurozone leaders engaging in fully blown QE, and rejoicing at the euro’s fall against the dollar, currency wars are taking place not just between the developed world and the emerging markets but between the developed nations themselves. Japan, of course, is also part of this intra-G7 currency conflict, having lately launched an astonishingly extreme QE programme designed to pump up the Bank of Japan’s balance sheet from just over 20pc to no less than 75pc of annual output within three years.

As such, the world’s leading economies have reduced themselves to blatantly competing less on the quality of what they produce, than on the speed with which they can depreciate their currencies against one another. The lessons of history are that such situations are prone to escalate into rancour and, ultimately, conflict. That’s the unfortunate truth.

We are, then, a very long way from normal. Consider that the ECB is launching its QE programme at a time when real interest rates are already negative. As such, historically ultra-loose monetary policy is now being made even looser. Myopic politicians like QE – because, by rigging sovereign bond markets, it allows them to keep borrowing and spending. Mismanaged banks also like QE – because it means they sell their burnt-out, under-performing investments to the state and pretend they’re solvent, which avoids the discomfort of going bust.

Meanwhile, respectable people are increasingly alarmed, raising concerns about “extraordinary measures” that some of us have been voicing for years.

The head of the Dutch central bank, having not previously complained publicly, last week admitted that euro-QE, by propping up spendthrift governments, would shield the likes of France and Italy from “market discipline”, postponing vital reforms. A senior Goldman Sachs banker added that negative interest rates are “freaking him out”.

And no wonder. For the longer profligate eurozone governments are able to ramp up borrowing, the more likely monetary union is dramatically to implode. And the further share prices are pumped up by QE and other monetary mutations, the more vulnerable global stock markets are to crash.

For now, as the euro weakens, the pound looks strong. While that’s bad news for UK exporters, it does make your holiday pounds go further. Consider, though, that while sterling is soaring now, we’re facing in May the most uncertain general election for decades. A minority Labour government, propped up by an increasingly Left-wing Scottish National Party – a distinct possibility, even if the Tories win the most votes and even the most seats – could see sterling plunge.

In the end, you see, whatever the actions of politicised central bankers, the fundamentals win.

The Truth Behind Central Banks' Machinations

By Shah Gilani, Capital Wave Strategist, Money Morning

March 6, 2015

Central bankers aren't stalwart free-market shepherds, although that's how they cloak themselves.

The truth is they're more like wolves… communist wolves in sheep's clothing. Today I'm going to show you what their game really is.

Then I'm going to show you how we'll fight back…

The Central Bankers' Real Game

Central banks aren't free-market enthusiasts.

Sure, they may profess doing "God's work," saving free markets from the excesses to which they're prone. But that's utter rubbish – or worse.

Central banks are run by central bankers. Central bankers are bankers, and bankers are wolves, not shepherds.

It's just not true that central banks are public-spirited entities shepherding the public from predatory packs of profiteering pimps and panderers. In fact, they are the ultimate example of wolves guarding the proverbial henhouse. Here's why.

Every central bank has a mandate. It is to serve and protect banks and bankers who leverage themselves and lend in excess in order to reap greater profits – and too often need bailing out before they collapse.

Central banks don't lend to companies or people. They only lend to banks. That's what they exist to do. What's amazing is how central banks are able to lend to banks. They have their governments' green light to simply print money and give it to their bank "constituents."

Sure, sometimes it looks like there are government forces controlling central banks, but the fact that the U.S. Congress still cannot audit the Federal Reserve (despite a strong desire to do so on the part of many leading legislators) – shows how that's all part of the grand facade for the sake of fooling the public.

Central banks can print money and give it to banks because they have a standing deal with the governments that are supposed to somehow control them.

Here's the Deal

Governments – meaning the people in power, who want to stay in power – don't want to tax their citizens to pay for the all the stuff they give them to buy their loyalty and votes. And they don't have to, because central banks print the money governments need.

Of course, it's not the government's fault if there's too much money printed and it leads to inflation. That's the fault of central banks printing too much money. Bad bankers!

Of course, it's not the government's fault if there's not enough money printed and there's deflation. That's the fault of central banks not printing enough money. Bad bankers!

Here's a look right through that wool that's been pulled over the public's eyes.

An Alternative to Being Led Astray

Japan’s Accounting Problem
Adair Turner
MAR 16, 2015

Japan sidewalk yawning man

TOKYO – Over the next few years, it will become obvious that the Bank of Japan (BOJ) has monetized several trillion dollars of government debt. The orthodox fear is that printing money to fund current and past fiscal deficits inevitably leads to dangerous inflation. The result in Japan probably will be a small up-tick in inflation and growth. And the financial markets' most likely reaction will be a simple yawn.
Japanese government debt now stands at more than 230% of GDP, and at about 140% even after deducting holdings by various government-related entities, such as the social-security fund. This debt mountain is the inevitable result of the large fiscal deficits that Japan has run since 1990. And it is debt that will never be “repaid" in the normal sense of the word.
Figures provided by the International Monetary Fund illustrate why. For Japan to pay down its net debt even to 80% of GDP by 2030, it would have to turn a 6%-of-GDP primary budget deficit (before interest payments on existing debt) in 2014 into a 5.6%-of-GDP surplus by 2020, and maintain that surplus throughout the 2020s.
If this was attempted, Japan would be condemned to sustained deflation and recession. Even a modest step in that direction – the sales-tax increase of April 2014, for example – produced a severe setback to economic recovery.
Instead of being repaid, the government's debt is being bought by the BOJ, whose purchases of ¥80 trillion per year now exceed the government's new debt issues of about ¥50 trillion. Total debt, net of BOJ holdings, is therefore falling slowly. Indeed, if current trends persist, the debt held neither by the BOJ nor other government-related entities could be down to 65% of GDP by 2017. And because the government owns the BOJ, which returns the interest it receives on government bonds to the government, it is only the declining net figure that represents a real liability for future Japanese taxpayers.
The stated aim of the BOJ's giant quantitative easing operation is to raise asset prices, reduce interest rates, weaken the yen's exchange rate, and thus stimulate business investment and exports. These indirect transmission mechanisms are certainly having some positive impact on inflation and growth: private credit has turned positive since QE was launched. But the bigger economic stimulus derives from the government's continued large fiscal deficits, effectively funded with BOJ-created money.
That reality is not yet openly admitted. The official doctrine is that the BOJ eventually will sell back all of the government bonds that it has acquired. But it need not do so. Indeed, the BOJ could maintain its current level of government-debt holdings indefinitely, making new purchases as existing bonds mature. And if the money created – in the form of commercial bank reserves at the BOJ – ever threatened to support excessive credit growth and inflation, the BOJ could offset that danger by imposing reserve requirements on the banks.
The Japanese authorities are thus doing what former US Federal Reserve Board Chairman Ben Bernanke proposed in 2003 – using monetized fiscal deficits to put spending power directly into the hands of companies and households. The BOJ rejected Bernanke's advice at the time, insisting instead that all deficits must be financed with bonds; now, however, the BOJ is effectively monetizing past and current deficits alike. If it had done so earlier, Japan would have experienced less deflation and slightly higher growth, and would now have smaller public debts. But better late than never.
The Japanese authorities could make their monetization explicit by replacing some of the interest-bearing debt held by the BOJ with a perpetual non-interest-bearing bond. But, regardless of whether they do so, the economic reality will become increasingly obvious over the next 2-3 years, and financial and political commentary will increasingly focus on the government's consolidated debt burden, net of central bank holdings.
As that process plays out, there is a small risk that financial markets will be spooked by orthodox fears that monetization implies excessive inflation, and that large increases in government bond yields and dramatic yen depreciation will result. But the more probable market reaction will be a collective shrug of the shoulders, accepting permanent monetization as the only possible safe way to alleviate an otherwise intractable debt burden.
Japan will end up having monetized, post facto, the large public deficits that it ran after the end of 1980s credit boom, and which usefully offset the impact of sustained private deleveraging in the 1990s and 2000s. Doing so earlier would have been better; but, even without such radicalism Japan's “lost decades" were not quite as disastrous as is commonly assumed.
Japan was already one the world's richest countries in 1990, and its per capita income has continued to grow, albeit slowly. Its unemployment rate, now 3.6%, has been consistently below European levels. And its “public debt burden" will turn out to be an illusion.
It is the eurozone, not Japan, that should worry us. Tight constraints on fiscal deficits and an absolute prohibition on monetization by the European Central Bank have prevented an effective response to the post-2008 debt overhang, driving the eurozone unemployment rate to 11.2%. The potential social and political consequences of lost decades of slow growth and high unemployment would be far more serious in Europe, with its diverse national identities and imperfectly integrated ethnic and religious minorities, than in culturally and ethnically homogeneous Japan.
While Europe is playing with social and political fire, Japan simply needs to tweak its accounting entries. A shrug of the shoulders is well justified.

Behind the Tantrums of QE Withdrawal Lies a Very Grave Deflationary Threat

By: Rajveer Rawlin

Monday, March 16, 2015

Last week most risk assets sold of on the prospects of QE withdrawal following strong job numbers out of the U.S. Here's how things shaped up:

  The S & P 500 was down well over 1%

  Gold was down close to 1%

  Oil was down close to 10%

  Copper was up about 2.5%

  Emerging markets were down close to 3%

  The clear winner was the dollar which surged nearly 2%

If markets were really bothered about inflation, gold and oil would be going through the roof instead they have absolutely collapsed over the past year:

SPDR Gold Shares (GLD)
United States Oil ETF (USO)

In addition the flight to quality trade that surfaced during the recession of 2008 into the dollar seems to have emerged with a vengeance:

PowerShares DB US Dollar Bullish ETF (UUP)

While one may want to brush aside the emergence of deflation which has already started to surface in recent PPI and CPI numbers, let's not forget what it did to Japan since the early 90's.

Despite the all out war to contain deflation in Japan interest rates are still negative and the stock market which has rallied off late is still down over 50% from the highs it set in 1989.