For the week, the S&P500 gained 0.9% (up 5.5% y-t-d), and the Dow increased 0.5% (up 6.1%). The broader market remained exceptionally strong. The S&P 400 Mid-Caps gained another 1.0% (up 12.8%), and the small cap Russell 2000 jumped 1.3% (up 12.4%). The Banks came under heavy selling pressure, sinking 4.5% (up 5.9%). The Broker/Dealers slipped 0.4% (down 7.6%). The Morgan Stanley Cyclicals gained 0.7% (up 11.7%), and the Transports rose 1.4% (up 14.5%). The Morgan Stanley Consumer index increased 0.9% (up 7.7%), and the Utilities added 0.3% (up 2.6%). The Nasdaq100 jumped 3.5% (up 12.8%), and the Morgan Stanley High Tech index rose 3.3% (up 5.7%). The Semiconductors gained 2.0% (down 0.8%). The InteractiveWeek Internet index jumped 3.5% (up 22.8%). The Biotechs added 0.3%, increasing 2010 gains to 24.9%. Although bullion jumped another $22, the HUI gold index added only 0.3% (up 21.6%).
One-month Treasury bill rates ended the week at 13 bps and three-month bills closed at 14 bps. Two-year government yields increased 2.5 bps to 0.35%. Five-year T-note yields rose 6 bps to 1.14%. Ten-year yields jumped 16 bps to 2.57%. Long bond yields surged 23 bps to 3.97%. Benchmark Fannie MBS yields were 13 bps higher to 3.38%. The spread between 10-year Treasury yields and benchmark MBS yields narrowed 3 bps to 81 bps. Agency 10-yr debt spreads narrowed 2 to 18 bps. The implied yield on December 2010 eurodollar futures increased 2.5 bps to 0.35%. The 10-year dollar swap spread declined 3.5 to 7.0. The 30-year swap spread declined 2.75 to negative 38.5. Corporate bond spreads were mixed. An index of investment grade bond risk increased 2 to 99 bps. An index of junk bond risk declined 2 to 511 bps.
Debt issuance slowed this week. Investment grade issuers included JPMorgan Chase $4.0bn, Raytheon $2.0bn, Reliance $1.5bn, American Honda $450 million, Mutual of Omaha $300 million, University of Notre Dame $160 million, and Post Apartment Homes $150 million.
Junk issuers included XM Satellite $700 million, Regency Energy $600 million, Manitowoc $600 million, and Clearwater Paper $375 million.
Converts issues included Ciena $320 million.
The list of international dollar debt sales included ING Bank $2.0bn, Finland $2.0bn, Dubai Electric & Water $2.0bn, Petroleos Mexicanos $1.0bn, JSC Severstal $1.0bn, Export-Import Bank of Korea $1.0bn, Provincia de Buenos Aires $800 million, Sino-Forest $600 million, Provincia de Cordoba $596 million, Bangkok Bank $1.2bn, Ahaikmunai $450 million, and Central China Real Estate $300 million.
U.K. 10-year gilt yields jumped 8 bps to 2.94%, and German bund yields surged 12 bps to 2.37%. Greek 10-year bond yields sank 88 bps to a 4-month low 8.89%, and 10-year Portuguese yields dropped 50 bps to 5.72%. Ireland yields fell 35 bps to 6.12%. The German DAX equities index jumped 3.2% (up 9.0% y-t-d) to the highest level since August 2008. Japanese 10-year "JGB" yields added a basis point to 0.875%. The Nikkei 225 dropped 1.9% (down 9.9%). Emerging equity markets were mostly higher. For the week, Brazil's Bovespa equities index rose 1.4% (up 4.7%), and Mexico's Bolsa added 0.8% (up 8.2%). South Korea's Kospi increased 0.3% to a 2010 high (up 13.0%). India’s Sensex equities index slipped 0.6% (up 15.2%). China’s Shanghai Exchange surged 8.5% (down 9.3%). Brazil’s benchmark dollar bond yields rose 12 bps to 3.72%, and Mexico's benchmark bond yields jumped 21 bps to 3.80%.
Freddie Mac 30-year fixed mortgage rates dropped 8 bps last week to 4.19% - and were down 19 bps in three weeks and 73 bps year-over-year. Fifteen-year fixed rates sank 10 bps to 3.62% (down 75bps y-o-y). One-year ARMs increased 3 bps to 3.43% (down 117bps y-o-y). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed jumbo rates down 3 bps to 5.23% (down 77bps y-o-y).
Federal Reserve Credit jumped $8.6bn to $2.293 TN. Fed Credit was up $73.2bn y-t-d (4.2% annualized) and $186.5bn, or 8.9%, from a year ago. Elsewhere, Fed Foreign Holdings of Treasury, Agency Debt this past week (ended 10/13) surged another $15.9bn (18-wk gain of $191bn) to a record $3.267 TN. "Custody holdings" have increased $311.8bn y-t-d (13.4% annualized), with a one-year rise of $402.4bn, or 14.1%.
M2 (narrow) "money" supply jumped $19.6bn to $8.752 TN. Narrow "money" has increased $219bn y-t-d, or 3.3% annualized. Over the past year, M2 grew 3.3%. For the week, Currency increased $1.9bn, and Demand & Checkable Deposits jumped $8.2bn. Savings Deposits rose $17.1bn, while Small Denominated Deposits declined $6.7bn. Retail Money Fund assets slipped $0.9bn.
Total Money Market Fund assets (from Invest Co Inst) declined $5.8bn to $2.799 TN. Year-do-date, money fund assets have dropped $495bn, with a one-year decline of $605bn, or 17.8%.
Total Commercial Paper outstanding increased $5.1bn to $1.128 TN. CP has declined $42.5bn, or 4.6% annualized, year-to-date, and was down $199bn from a year ago.
Global central bank "international reserve assets" (excluding gold) - as tallied by Bloomberg’s Alex Tanzi – were up $1.532 TN y-o-y, or 20.7%, to a record $8.932 TN.
Global Credit Market Watch:
October 12 – Bloomberg (Matthew Brown and Anchalee Worrachate): “Greek borrowing costs declined in a sale of bills today after the International Monetary Fund said it may give the nation more time to repay loans and China disclosed plans to buy bonds. Greece issued 1.17 billion euros ($1.62 billion) of six-month Treasury bills today at a yield of 4.54%...”
October 12 – Bloomberg (John Glover and Karen Eeuwens): “The $316 billion of junk-rated corporate debt that needs refinancing in Europe through 2014 is a ‘wall of maturities’ that dwarfs the historic capacity of the market, Moody’s… said. Speculative-grade issuers in Europe, the Middle East and Africa have $502 billion of bonds and loans outstanding, Moody’s said… ‘The wall of maturities does raise questions,’ said Chetan Modi, an analyst at Moody’s… ‘How is the market going to get this increased capacity and what does that mean for pricing and for other conditions?’”
October 11 – Bloomberg (Caroline Hyde): “Lenders to speculative-grade companies in Europe are charging the lowest interest rates since before credit markets seized up in a sign they don’t expect the region’s fiscal crisis to infect corporate debt. Investors demand an average yield of 7.62% to hold junk-rated European debt, the lowest since July 2007…”
October 12 – Bloomberg (Emre Peker and Tim Catts): “Leveraged loan sales are approaching a three-year high, enabling companies to slash borrowing costs… Speculative-grade firms raised $260.1 billion in loans this year, more than double the amount in the same period of 2009…"
October 14 – Bloomberg (Chris Fournier): “Yields on Canadian corporate debt are at the lowest levels in at least two decades as international investors purchase record amounts of the nation’s bonds and as the government plans to balance its books by 2015.”
October 14 – Bloomberg (Zainab Fattah): “Some Dubai office buildings are so ill-conceived and poorly located that they will never be occupied, while others may command no more than the cost of maintenance, according to CB Richard Ellis Group…”
Global Government Finance Bubble Watch:
October 15 – Bloomberg (Garfield Reynolds and Wes Goodman): “The Federal Reserve and Japanese investors are poised to pass China and become America’s largest creditors following efforts from U.S. policy makers and the Bank of Japan to stimulate growth. The… U.S. central bank’s Treasury holdings have risen to a record $821.2 billion, approaching China’s $846.7 billion. The figure for Japan is $821 billion, the most ever.”
October 11 – Bloomberg (Shelley Smith): “At a time when governments around the world are facing growing debt, China’s bonds are becoming almost as safe as U.S. Treasuries in the market for insuring against defaults. Five-year credit-default swaps contracts on the nation’s bonds fell 29% in the past month, the biggest drop among more than 80 nations, and ended last week at 56 bps… Default swaps for the U.S. were little changed at 46.”
October 13 – Bloomberg (Abigail Moses and Shannon D. Harrington): “Credit-default swaps on bonds sold by Brazil, Russia, India and China are closing in on those tied to the world’s largest economies, which are piling on debt in an attempt to stoke growth. The average cost of contracts protecting debt of the so-called BRICs dropped to 41.4 bps more than the price of swaps on the Group of Seven countries and last week reached the lowest on record.”
Currency Watch:
October 11 – Bloomberg (Simon Kennedy and Sandrine Rastello): “Leaders of the world economy failed to narrow differences over currencies as they turned to the International Monetary Fund to calm frictions that are already sparking protectionism. Exchange rates dominated the IMF’s annual meeting in Washington on concern that officials are relying on cheaper currencies to aid growth, risking retaliatory devaluations and trade barriers. China was accused of undervaluing the yuan, while low interest rates in the U.S. and other rich nations were blamed for flooding emerging markets with capital. Finance ministers and central bankers pledged to improve cooperation, yet did little to show how they would alter their ways beyond agreeing to let the IMF study the matter.”
October 11 – Bloomberg (Ye Xie and Lilian Karunungan): “China is moving to add more emerging-market currencies to its foreign-exchange reserves, a strategy central banks around the world are following to diversify their $8.7 trillion in holdings. ‘We can diversify more the foreign reserves, to consider not only smaller countries, but some emerging-market economies,’ central bank Governor Zhou Xiaochuan said… With increased assets, ‘you can shift some to riskier, but higher-return investment instruments,’ said Zhou.”
October 14 – Bloomberg (Lukanyo Mnyanda): “Currency traders may supplant so- called bond vigilantes credited with enforcing government fiscal discipline in past decades as more nations ease their monetary policies through asset purchases, M&G Investments said. ‘If the authorities are actually or are merely threatening to print money, then economic agents should act vigilantly and avoid this new money by exchanging it for other currencies or assets,’ M&G money manager Richard Woolnough wrote… ‘If the bond vigilantes are dead, who will take their place? The sequel to the bond vigilantes could well be the currency vigilantes.’”
The dollar index declined 0.4% (down 1.1% y-t-d). For the week on the upside, the Taiwanese dollar increased 0.9%, the Singapore dollar 0.9%, the South Korean won 0.8%, the Australian dollar 0.6%, the Swedish krona 0.6%, the Japanese yen 0.6%, the Swiss franc 0.5%, the Norwegian krone 0.3%, the Danish krone 0.3%, the euro 0.3%, the Canadian dollar 0.2% and the British pound 0.2%. For the week on the downside, the Mexican dollar declined 0.2%.
Commodities Watch:
October 14 – Bloomberg (Tony C. Dreibus): “Commodities extended a rally to the highest in two years on speculation the declining U.S. dollar will boost investments in metals, energies and agriculture futures.”
October 15 – Bloomberg (Luzi Ann Javier): “Cotton futures jumped to a record for the second consecutive day… on speculation that China, the biggest user, may boost imports to meet demand from domestic textile makers. Cotton is…set for a 10% gain this week.”
October 12 – Bloomberg (Luzi Ann Javier): “The rice harvest in the U.S., the world’s fourth-largest exporter last year, may be at least 10% smaller than estimated, missing a forecast record output and pushing prices 30% higher, a producers’ group said.”
October 15 – Bloomberg: “Rubber’s rally to a record today in China may be extended after prices broke a key resistance level and demand rises amid tight supply, according to technical analysis by Yongan Futures Co.”
October 15 – Bloomberg (Phoebe Sedgman): “New Zealand wool prices continued a three-month surge amid renewed demand from China and India… The benchmark price jumped 10% from September… Prices have surged 42% since July’s auction…”
The volatile CRB index added 0.3% (up 4.5% y-t-d). The Goldman Sachs Commodities Index (GSCI) slipped 0.3% (up 7.2% y-t-d). Spot Gold gained another 1.6% to $1,369 (up 24.8% y-t-d). Silver jumped 5.1% to $24.285 (up 44% y-t-d). November Crude declined $1.27 to $81.39 (up 3% y-t-d). November Gasoline declined 2.1% (up 3% y-t-d), and November Natural Gas dropped 3.3% (down 37% y-t-d). December Copper rose 1.7% (up 15% y-t-d). December Wheat declined 2.0% (up 30% y-t-d), while December Corn surged 6.6% (up 36% y-t-d).
China Watch:
October 15 – Bloomberg: “China’s property prices rose and transactions jumped in September from the previous month, underscoring the need for further government curbs to discourage speculation and prevent asset bubbles in the fastest-growing major economy. Prices in 70 cities climbed 0.5% from August and the value of property sales soared 56%... Prices rebounded for the first time since May on a monthly basis after staying unchanged in the previous two months and declining in June.”
October 13 – Bloomberg: “China, the world’s biggest exporter, posted a $16.9 billion trade surplus for September, capping the largest quarterly excess since the financial crisis in 2008… Exports rose 25.1% from a year earlier and imports climbed 24.1%... The third-quarter trade gap was $65.6 billion, the most since a $114 billion surplus in the final three months of 2008.”
October 13 – Bloomberg: “China’s foreign-exchange reserves, the world’s largest, surged by a record to $2.65 trillion at the end of September… Currency holdings rose about $194 billion in the third quarter…"
October 11 – Bloomberg (Ye Xie and Mark Deen): “China countered mounting pressure from major trading partners for a stronger yuan as central bank Governor Zhou Xiaochuan highlighted a domestic unemployment rate he estimated at more than 9%. A ‘very fast’ appreciation probably wouldn’t bring balance to the world economy, Zhou said… China’s central bank is balancing inflation, growth, fiscal policy, the international balance of payments and the ‘sensitive issue’ of unemployment, he said.”
October 14 – Bloomberg (Shelley Smith): “China’s plans to lay twice as much high-speed track as the rest of the world combined is turning 2010 into a record year for yuan bond sales. The rail ministry will issue 20 billion yuan ($3 billion) in 10- and 15-year notes today, pushing non-sovereign sales to 312 billion yuan this year, up from 307 billion yuan in the same period of 2009… Government restrictions on bank loans to cool inflation in an economy growing four times faster than the U.S. are increasing the funds banks have available to buy bonds… China is spending about $300 billion to build a high-speed network of at least 18,000 kilometers (11,185 miles) by 2020. By contrast, President Barack Obama’s $50 billion program to repair ‘crumbling’ U.S. transport networks awaits Congressional approval.”
October 15 – Bloomberg (Wendy Leung): “Chinese shoppers visited Hong Kong in record numbers last week to splurge on $130,000 watches, vintage wine and diamonds, boosting sales for Sotheby’s and retailers including Omega retailer Hengdeli Holdings Ltd. Merchants’ sales gained as much as 30% from a year ago during China’s Golden Week holiday, according to the Hong Kong Retail Management Association.”
October 11 – Bloomberg (Hwee Ann Tan): “Daimler AG’s Mercedes-Benz said unit sales in mainland China rose 114% in September to more than 13,940 units…”
Japan Watch:
October 11 – Financial times (Mure Dickie, Lindsay Whipp and Christian Oliver): “Japan has called on South Korea and China to ‘act responsibly’ on exchange rate policy amid growing fears of currency war that could undermine global growth. Naoto Kan, the Japanese prime minister… said efforts by individual nations to depress the level of their currencies had no place in G20 cooperation. ‘We’d like South Korea and China to act responsibly within common rules,’ Mr Kan said…”
India Watch:
October 15 – Bloomberg (Unni Krishnan): “India’s inflation unexpectedly accelerated, increasing pressure on the central bank to extend the most aggressive monetary policy tightening in Asia. The benchmark wholesale-price index rose 8.62% in September from a year earlier…”
October 12 – Bloomberg (Kartik Goyal): “India’s industrial production growth slowed to a 15-month low in August… Factory, utilities and mines output rose 5.6% from a year earlier after a revised 15.2% increase in July…”
Asia Bubble Watch:
October 15 – Bloomberg (Jonathan Burgos): “The Asia-Pacific has overtaken North America as the world’s biggest derivatives market amid increasing demand for futures and options contracts in the region’s fast-growing economies. Derivatives contracts traded in Asia-Pacific accounted for 38% of the global total in the six months to June… That compares with 33 percent in North America, it said.”
October 14 – Bloomberg (Patricia Lui): “Singapore will seek faster currency appreciation to curb accelerating inflation even as growth in the local economy slows, the central bank said… The Monetary Authority of Singapore will steepen and widen the band in which the republic’s dollar trades against a weighted basket of currencies… The currency climbed to the strongest level versus its U.S. counterpart since 1981 after the surprise announcement…”
October 11 – Financial times: “Thailand is introducing a tax on foreign holdings of bonds, the latest in a string of attempts by emerging economies to curb destabilising capital inflows amid fears of a global currency war. The Thai cabinet on Tuesday imposed a 15% withholding tax on capital gains and interest payments for government and state-owned company bonds, a clear signal that it would take tough measures to curb inflows of ‘hot money’."
Latin America Watch:
October 12 – Bloomberg (Jens Erik Gould): “Mexico’s industrial production rose 8.1% in August from a year earlier, the national statistics institute said."
Unbalanced Global Economy Watch:
October 12 – Bloomberg (David Wilson): “Spending on aging populations worldwide will be an increasing source of strain on government finances during the first half of this century, according to S&P… Forty-nine countries were examined in the study, which concluded that spending will rise to an average of 22% of GDP -- the broadest gauge of economic output -- from 14.2% in the next 40 years.”
October 12 – Bloomberg (Jennifer Ryan): “U.K. inflation exceeded the government’s 3% limit for a seventh month in September as higher clothing and food costs kept up price pressures in the economy.”
October 14 – Bloomberg (Rainer Buergin): “The German economy, Europe’s largest, will expand more than twice the pace previously projected this year as consumers step up spending, the country’s leading institutes said… Gross domestic product will rise 3.5% in 2010 and 2% in 2011…”
October 12 – Bloomberg (Toby Alder): “Sweden’s inflation rate rose in September as consumer demand picked up in the largest Nordic economy… Headline inflation accelerated to 1.4% from 0.9% in August…”
U.S. Bubble Economy Watch:
October 14 – Bloomberg (Mark Drajem): “China’s trade surplus with the U.S. jumped to $28 billion in August, reaching a record for the first time since the financial crisis began two years ago.”
October 14 – Bloomberg (Dan Levy): “More than 100,000 U.S. homes were seized by lenders in September, a record number… Lenders took over 102,134 properties last month, RealtyTrac Inc. said… One out of every 371 households received a notice. Sales of properties in the foreclosure process accounted for almost a third of all U.S. transactions in the month…”
Real Estate Watch:
October 12 – Bloomberg (David M. Levitt): “Commercial property investors are focusing on the best buildings in major U.S. markets, driving up prices in six cities as the rest of the country hovers near the post-crash bottom, according to the MIT Center for Real Estate. …prices for ‘trophy’ commercial properties are up 19% since bottoming in New York, Washington, San Francisco, Boston, Los Angeles and Chicago. The Moody’s/REAL Commercial Property Price Index tracking the entire U.S. has gained 1% from a seven-year low in October 2009.”
Central Bank Watch:
October 13 – Bloomberg (Scott Lanman and Craig Torres): “Federal Reserve policy makers may want Americans to expect inflation to accelerate in the future so they spend more of their money now. Central bankers, seeking ways to boost flagging growth after lowering interest rates almost to zero and buying $1.7 trillion of securities, are weighing strategies for raising inflation expectations as well as expanding the balance sheet by purchasing Treasuries, according to minutes of the Fed’s Sept. 21 meeting… Some Fed officials are concerned that expectations of lower inflation will become self-fulfilling… Chairman Ben S. Bernanke said in 2003 that Japan could beat deflation by using a ‘publicly announced, gradually rising price-level target.’ ‘The Fed is on the verge of actively targeting a higher inflation rate,’ said Dan Greenhaus, chief economic strategist at Miller Tabak…”
October 12 – Bloomberg (Scott Lanman and Joshua Zumbrun): “Federal Reserve policy makers last month were prepared to ease monetary policy ‘before long’ and focused on purchases of Treasury securities and boosting inflation expectations as ways to add stimulus. Policy makers ‘wanted to consider further the most effective framework for calibrating and communicating any additional steps to provide such stimulus,’ the Fed said…. The Fed also said for the first time that it was considering targeting a path for the level of nominal gross domestic product as a way to increase price expectations.”
October 14 – Bloomberg (Steve Matthews and Joshua Zumbrun): “Richmond Federal Reserve Bank President Jeffrey Lacker said a Fed policy devoted primarily to reducing unemployment risks damaging the central bank’s credibility in containing inflation. ‘With inflation reasonably close to any plausible definition of price stability, and all expectations measures pointing in the right direction, making unemployment a policy imperative poses clear risks to the credibility of our long run inflation goals,’ Lacker said…”
October 12 – Bloomberg (Fergal O’Brien and Jana Randow): “European Central Bank President Jean-Claude Trichet said he favors ‘early warning’ systems and quicker sanctions to prevent governments from implementing policies that could lead to soaring budget deficits. ‘It is essential to establish sound procedures to enhance and enforce fiscal surveillance in the euro area,’ Trichet said… ‘We need shorter deadlines under excessive deficit procedures so that corrective policy action is taken in good time. We need quasi-automaticity in the application of sanctions.’”
Fiscal Watch:
October 15 – Bloomberg (Vincent Del Giudice): “The U.S. government posted its second straight annual budget deficit in excess of $1 trillion as lingering unemployment constrained tax revenue. The shortfall totaled $1.294 trillion in the fiscal year ended Sept. 30, second only to the $1.416 trillion deficit in 2009… Federal spending fell 1.8 percent in fiscal 2010 to $3.456 trillion as expenditures tied to the financial crisis, such as TARP, were wound down. Fiscal 2010 tax receipts and other revenue increased by 2.7 percent to $2.162 trillion after declines in each of the two previous fiscal years…”
Speculator Watch:
October 12 – Bloomberg (Katherine Burton): “Eric Mandelblatt expects to have raised at least $500 million when his Soroban Capital Partners LLC begins trading stocks next month… At least two other managers, Mark Carhart and Pierre-Henri Flamand, are slated to open in coming months with half a billion dollars or more each… Helping all three traders pull in at least 10 times more than most hedge-fund startups this year may be one line on their resumes: Goldman Sachs Group Inc.”
Inflationary Biases and the U.S. Policy Dilemma:
Martin Wolf penned an interesting piece in Wednesday’s Financial Times titled “Why America is going to win the global currency battle.” The title was provocative, with the world now keenly focused on Global Competitive Monetization and so-called “currency wars.” If things somehow go right, perhaps there will be some relative winners. There will be no real winners. We Americans will lose.
Chairman Bernanke today made his case for additional Fed purchases/monetization of Treasury debt. Unemployment is much too high and inflation is too low. As such, it is stated with great conviction that the Fed has a clear policy mandate to stimulate job growth and combat heightened deflation risks. Dr. Bernanke has spent an acclaimed academic career studying the forces behind the Great Depression. Present-day structural impairment – financial and economic - will continue to provide a most fertile backdrop in which to experiment with his (“inflationism”) theories. While our Fed chief is cheered on by participants throughout the global risk markets, many international policymakers must be watching in a state of disbelief.
I would like to focus on a particular line of reasoning in Mr. Wolf’s analysis: “To put it crudely, the US wants to inflate the rest of the world, while the latter is trying to deflate the US. The US must win, since it has infinite ammunition: there is no limit to the dollars the Federal Reserve can create. What needs to be discussed is the terms of the world’s surrender: the needed changes in nominal exchange rates and domestic policies around the world… China wants to impose a deflationary adjustment on the US, just as Germany is doing to Greece. This is not going to happen. Nor would it be in China’s interest if it did. As a creditor, it would enjoy an increase in the real value of its claims on the US. But US deflation would threaten a world slump.”
First of all, it would be more accurate to say that the U.S. wants to CONTINUE inflating the rest of the world. Some years ago, unconstrained finance and U.S. Credit Bubble Dynamics were unleashed upon the world. Much of the globe succumbed to a massive inflation of Credit, asset prices, speculative excess, malinvestment, and intractable financial and economic imbalances. Going all the way back to the eighties, U.S. “twin deficits” played an instrumental role in fomenting Japan’s inflationary Bubble. The Japanese were repeatedly “encouraged” to loosen Credit and stimulate domestic consumption as a means of rectifying U.S. trade imbalances. The consequences were calamitous for Japan, while the U.S. was allowed to inflate its way out of immediate trouble.
China surely doesn’t “want to impose a deflationary adjustment on the U.S.” Nor do I believe it is a case of Germany imposing deflation on Greece. The markets – too long accommodative of Greek borrowing profligacy – finally said “enough is enough.” German policymakers were complicit for failing both to ensure adequate controls or to impose discipline much earlier. The belated market reaction was, as they tend to be, abrupt and quite harsh.
But let’s get back to the Chinese. As always, domestic concerns are their overriding focus. They have acute social and economic issues that will dictate policy. And significantly complicating the situation, they now have their own raging Credit Bubble to contend with. The Chinese economy faces severe Bubble-related distortions and imbalances. Inflationary pressures continue to gain momentum, a situation compounded by weak dollar-induced commodities inflation and huge “hot money” inflows. Credit and asset inflation will prove exceedingly difficult for China’s policymakers to manage. It is clear from public comments that they are increasingly troubled by the direction of U.S. fiscal and monetary management. Even so, their focus remains inward. They in no way want to repeat the Japanese experience.
Dr. Bernanke faces some major dilemmas when it comes to his goal of reflating the U.S. economy. Foremost, the U.S. economic structure remains precariously impaired. Not even massive fiscal deficits can reignite home prices inflation and boom-time consumption levels. Those are facets of the burst Bubble, and they will remain largely immune to inflationary forces. And that’s the problematic nature of “Bubble Economies.” In this case, a multi-decade period of Credit excess inflated prices and distorted spending patterns throughout the entire economy (incomes, consumption, asset prices, corporate cash flows, government receipts and expenditures, goods imports, outbound financial flows, etc.).
Our system became a Credit glutton – and the amount of new Credit necessary to sustain the system’s maladjusted structure is in the process of inciting dangerous inflationary distortions around the world. In the past, I’ve written about the “Core to Periphery” inflationary bias. There is today a deeply imbedded propensity (“Monetary Process”) for liquidity originating within the U.S. Credit system to flow out to other venues perceived to offer better returns or provide better “stores of value.” The Treasury and Federal Reserve (the “Core”) can create Credit/purchasing power and marketplace liquidity, but the more they inflate (non-productive Credit) the greater the propensity for the flows to flee the dollar (in route to the inflating “Periphery”).
The U.S. cannot win the “currency war.” In reality, central bankers in China, Japan, Brazil, South Korea and elsewhere aren’t even battling against us. They have, instead, been waging war on the market. If foreign central bankers had not intervened and accumulated massive dollar holdings (international reserves up an incredible $1.5 TN in 12 months!) – in the process providing a “backstop bid” for both our currency and the Treasury market – it would be an altogether different market environment today.
There will be no answer for global imbalances found by the U.S. “inflating the rest of the world.” The problem with inflationism is that one year of inflationary measures leads only to the next year of greater inflation. The amount of outbound financial flows and inflationary pressures emanating out of our system have already become unmanageable.
The most recent bout of dollar weakness has incited robust inflationary biases. The Asian region – most notably China and India – is already overheated. Throughout the “developing economies, ” Credit systems are operating in excess. Most commodities have been under intense upward price pressure. This inflationary bias is especially pronounced for the commodities in demand from the booming “Periphery” economies (i.e. copper, sugar, wheat, corn, rice, cotton, rubber, etc.) And as dollar confidence falters, precious metals prices skyrocket. And, in an over-liquefied, speculative financial world, these dynamics feed on themselves.
Back in the early-nineties through the initiation of the post-tech Bubble reflation, our policymakers enjoyed a backdrop conducive to extraordinary policy effectiveness and flexibility. A prominent global “Periphery to Core” financial flow dynamic – otherwise know as “King dollar” – ensured an inflationary bias largely contained within U.S. asset markets. We would run enormous deficits and egregiously loose monetary policy. Yet the resulting Current Account Deficits and speculative flows would be too easily recycled right back into our securities markets. We could have our cake and eat it too.
“Periphery” Credit systems and economies were at the time so prone to boom and bust dynamics, only the Greenspan Fed could ensure global market participants (especially the leveraged speculators) buoyant securities markets with ample liquidity and robust inflationary biases. There was essentially no amount of U.S. Credit inflation that could not be easily recycled through global currency markets right back to our debt markets.
“King dollar” and Greenspan’s penchant for tinkering with the markets created the most powerful monetary control mechanism the world has ever witnessed. He could flick a switch – 25 bps – and inflate the bond and stock markets, leveraged speculation, home prices, equity extraction, and GDP. Most regrettably, the post-tech Bubble reflationary war against so-called “deflation risks” provided the final death knell for the “Periphery to Core” dynamic. The reign of King dollar was over, although it was not until the bursting of the historic mortgage finance Bubble that inflationary biases vacated U.S. asset markets for much better opportunities elsewhere. Immediately, monetary policymaking lost much of its previous effectiveness. In the face of policy impotence, the U.S. was left with a terribly impaired economic structure and an addiction to cheap foreign Credit.
To simplify things, the problem today is twofold. First, to sustain the maladjusted U.S. economic structure requires ongoing massive stimulus, yet the U.S. monetary mechanism has lost much of its effectiveness in stimulating domestic output (consumption and investment). Second, inflationary biases have shifted decisively to non-dollar overseas securities markets, Credit systems, economies, and commodities markets – and these inflationary biases have, of late, gained significant momentum.
It is a myth that there can be some global resolution to today’s imbalances. Policymakers around the world can continue to accommodate our Credit excesses. This would only ensure greater Monetary Disorder, heightened inflationary distortions, a more problematic buildup of U.S. debt, and more acute global systemic vulnerabilities. We are not getting our house in order, and blaming others deflects from the real issues.
One of these days, Mr. Market might just turn on our debt markets. There is now talk of “currency vigilantes,” yet global risk markets these days absolutely feast on dollar weakness. After all, when the private market turns away from our currency, global central banks stand tall as the ever-reliable, insatiable “backstop bid.” Dollar weakness bolsters inflationary flows to our bonds and all the “Un-dollars” (gold, silver, emerging economies, commodities, equities, and global risk assets, more generally).
So – in spite of the strengthening “Core to Periphery” inflationary flows bias - dollar weakness has thus far ensured the recycling of excess dollars right back into our Treasury market (guaranteeing at least one powerful U.S. Bubble dynamic). And our politicians have become comfortable blasting the buyers of our debt as “currency manipulators” and the whole dollar-support mechanism as some “beggar thy neighbor” “currency war.” Well, I often ponder how the marketplace will function that seemingly inevitable day when the markets have to start going it on there own – without the comfort of an ever-towering “backstop.” Not easy to envision a winner anywhere in sight.
