5th February 2012: Currency Wars and The Yield Curve Lending Trap
Currency Wars: James Rickards
Quote of the Day:
… we need to produce things as opposed to paper…
Bill Gross
Macro Overview
QE’s Yield Curve Lending Trap
- Interesting article by Bill Gross this month where he talks about the limitations (even negative consequences) of QE on the very thing it was designed to nurture: credit extension. Put simply, the zero bound of Fed reserve rates and the twisting of borrowing costs across the entire yield curve may act as a disincentive towards credit extension. The reason being: they (the lenders) have the same downside risk (100%) and yet are simply not going to make as much money (relative to their own risk-free borrowing rates) from a lower-rate loan! Makes sense when you put it like that really, doesn’t it? Here is an excerpt.
But modern capitalism is dependent as well on maturity extension in credit markets. No venture, aside from one financed with 100% owners’ capital, could survive on credit or loans that matured or were callable overnight. Buildings, utilities and homes require 20- and 30-year loan commitments to smooth and justify their returns. Because this is so, lenders require a yield premium, expressed as a positively sloped yield curve, to make the extended loan. A flat yield curve, in contrast, is a disincentive for lenders to lend unless there is sufficient downside room for yields to fall and provide bond market capital gains. This nominal or even real interest rate “margin” is why prior cyclical periods of curve flatness or even inversion have been successfully followed by economic expansions. Intermediate and long rates – even though flat and equal to a short-term policy rate – have had room to fall, and credit therefore has not been trapped by “price.”
- We have often thought of the limitations of the zero bound in terms of the “Japanese Experience” – see my comment: Turning Japanese and Richard Koo’s Balance Sheet Recession. But Gross’s observations offer a new perspective on what is, effectively, the same problem. In a secular downturn, you cannot force lenders to lend and you cannot force businesses to borrow.
- I look at Keynesian fiscal stimulus a bit like the shock absorbers on a car, when the economy hits a pothole the road the Keynesian suspension kicks in the smooth the ride out a little bit. But in a secular dip, when the road itself is undulating, there is nothing the shock absorbers can do, the car must follow the road upwards as well as downwards.
limitations to Keynesian "shock-absorbers"
Market Overview
Currency Wars
- So the Dow Jones hit a new high… the highest level since pre-Lehman, in fact. It took us a while to get there, but we did it. The S&P still has some way to go but, who knows, we could be there before summer?! Hey, I don’t know anything and I’m not about to make predictions on the S&P.
- What I do know is central banks, globally, are each completely attuned towards the pursuit of highly accommodative policy. That’s right, in the past the ECB and Chinese Central Banks have been seemingly dancing to their own beat; choosing to focus heavily on price stability with much emphasis on asset prices.
- But as the Euro-crisis has unfolded and with a new, seemingly more print-happy President at the helm, the ECB has changed its tune. China, with a property market slowdown and a resolute focus on its own leadership change and 12th 5-year plan, has also let it be known that there is a stimulus bazooka there to be used.
- So, I think, for the first time in living memory, all major central banks have their arsenal stocked, their bazookas loaded and are taking aim… at the purchasing power of their own currencies! But fiat currency calibration is a relative value game, which of course means they are, in effect, taking aim at each other. Enjoy your election year!
- For the sake of antagonism, Chart of the Day is a long term chart of the Rmb. I’ve also included as usual, for the beginning of the week, the Sovereign Debt Calendars.
Chart of the Day
Renminbi (Source: Bloomberg)
Auctions 5th Feb - Daily (click to enlarge)
Auctions 5th Feb - Weekly (click to enlarge)
Events
Macro Events:
Update:
- US ISM Non-Manufacturing was 56.8 – fantastic number if I’m being honest (we’ve only had one ISM number higher than that in the last 5 years).
Alerts:
- Taiwanese CPI
Corporate Events:
Results:
- Japan Tobacco [2914 JT], Loews [L], NTT [9432 JT], Suzuki [7269 JT], Yum! Brands [YUM]
Dividends:
- Nothing Significant
Reading, Links:
Bloomberg Article on James Rickards Book: Currency Wars.
