Greece is within a few weeks of running out of money to pay its debts. Default looms, and it could cause financial disruption in Europe and around the world. Yet the Greek government and the Euro bloc are at loggerheads in an Alphonse-and-Gaston routine where true compromise is as commonplace as hen's teeth. Sounds like Congress. Meanwhile, the rest of us wait for Godot.
Luck, however, is part of life, and both Greece and the EU are very lucky. In its current state of economic extremis (and Greece is suffering the equivalent of the U.S. Great Depression of the 1930s), Greece would want to depreciate its currency. If it could do so, depreciation would make its export businesses more competitive and bring in tourism. But Greece, being part of the Euro bloc, has no control over its currency. The European Central Bank calls the shots for the Euro.
Serendipity would have it that the ECB decided recently to engage in quantitative easing (i.e., the buying of Euro-denominated bonds in the open market) as a way to stimulate the EU's stagnant economy. Quantitative easing is one way of printing money, and the Euro has fallen by about 25% as a consequence. A 25% price move is an elephantine move in the currency markets, and changes all kinds of economic relationships. European exports just got gussied up in a big way, and European tourism is now a bargain compared to a year ago.
Greece doesn't export a lot outside of Europe, but it is one heck of a tourist destination. If given some time, Greece's tourist business will probably pick up. Some of Greece's exports might be shifted to non-Euro bloc nations. Greece might have a shot at recovery.
Much of the problem is that neither the EU nor the Greek government trust each other. Definitive resolution is impossible without trust. The result has been a steady kicking of the can down the road every time Greece and the EU have to negotiate. This time, however, if they kick the can down the road (which is one possible outcome of the current impasse), the consequence may be positive. If Greece has a couple of years to turn itself around using the low Euro, it may have a shot at recovering enough to satisfy the EU's debt collectors. But will the EU and Greece muddle through one more set of negotiations? If everyone were rational, they might pull it off. But then again, if everyone were rational, they wouldn't be in the mess they are now in.
Showing posts with label currency markets. Show all posts
Showing posts with label currency markets. Show all posts
Thursday, April 2, 2015
Friday, January 16, 2015
Did Someone Blow Up the Swiss Currency Peg?
Much to the surprise of numerous market players, the Swiss National Bank yesterday (Jan. 15, 2015) dropped its commitment to peg the Swiss franc at 1.20 to the Euro. The Swiss franc suddenly rose some 20% in value, a price shift that clobbered anyone betting the peg would hold. Losses have been sudden and very sharp. A major foreign exchange broker, FXCM, has received an emergency $300 million bailout loan from Leucadia National. Another forex broker, Alpari UK, has entered insolvency proceedings. A new Zealand broker, Excel Markets, has been knocked out of business.
The Swiss National Bank's reasons for abandoning the peg aren't very clear. But the abrupt demise of the peg is reminiscent of the UK's withdrawal of the British pound from the European Exchange Rate Mechanism in 1992, after a large hedge fund shorted over 10 billion pounds on September 16, 1992. The Bank of England was trying to fight market forces that dictated a lower valuation for the pound, and in the end couldn't win that fight.
A news story reports that in December 2014, there was a very large capital inflow into the Swiss franc, with some 34 billion francs being bought up. See http://www.cnbc.com/id/102343957. This is about 10 times the monthly average. One can wonder whether this flood of capital was the result of a calculated move by one or a few big market players. While there has for some months been a flight to safety resulting from the EU's economic slowdown (and the likely de facto devaluation in the near future of the Euro via ECB quantitative easing), Vladimir Putin's banditry in Ukraine, and the never-ending turmoil in the Middle East, December's inflow is so abruptly large than one cannot exclude the possibility that it was a move made by a few powerful players. And if it was, they would have profited handsomely from the Swiss franc's recent price rise.
The Swiss National Bank's reasons for abandoning the peg aren't very clear. But the abrupt demise of the peg is reminiscent of the UK's withdrawal of the British pound from the European Exchange Rate Mechanism in 1992, after a large hedge fund shorted over 10 billion pounds on September 16, 1992. The Bank of England was trying to fight market forces that dictated a lower valuation for the pound, and in the end couldn't win that fight.
A news story reports that in December 2014, there was a very large capital inflow into the Swiss franc, with some 34 billion francs being bought up. See http://www.cnbc.com/id/102343957. This is about 10 times the monthly average. One can wonder whether this flood of capital was the result of a calculated move by one or a few big market players. While there has for some months been a flight to safety resulting from the EU's economic slowdown (and the likely de facto devaluation in the near future of the Euro via ECB quantitative easing), Vladimir Putin's banditry in Ukraine, and the never-ending turmoil in the Middle East, December's inflow is so abruptly large than one cannot exclude the possibility that it was a move made by a few powerful players. And if it was, they would have profited handsomely from the Swiss franc's recent price rise.
Tuesday, May 3, 2011
Is the Federal Reserve Following Germany's Example?
Germany is Europe's economic engine. Its recent recession wasn't Great, like America's. Its unemployment levels didn't rise as sharply as America's. It has a trade surplus and a strong manufacturing sector at the core of its economy. Considering that West Germany had to absorb moribund formerly Communist East Germany during the past 20 years, one has to wonder how the Germans did it.
Part of the answer is they concentrate on producing high value added goods, taking advantage of their technological know how. The vaunted German machine tool industry makes highly specialized equipment, and constantly seeks to improve, which makes them hard to compete against.
But a crucial part of Germany's success is that wages have been held down. German workers are paid less than French workers (although both nations are well above the EU average). And, surprise! The French economy is weaker. German unions have gone along with wage restraint, in order to promote employment. German workers accepted limited income growth for the sake of fostering national competitiveness in export markets. The American image of Germany is a swirl of Mercedes, BMW, Audi and Porsche logos. The truth is more modest--a nation whose GDP per capita, disposable income per capita and other measures of economic well-being are lower than America's.
The U.S. Federal Reserve is, by all appearances, on a quiet, not for attribution mission to devalue the dollar. Although paying lip service to the sanctity of the Almighty Greenback, the Fed has relentlessly pushed down the dollar's value with a two and a half years and counting zero interest rate policy. Even now, as inflation is rising and central banks in many other nations are raising their rates, the Fed continues to believe that a free dollar is the best dollar (but free only for the financial institutions eligible to borrow at the ultra low rates available in the fed funds market; credit card borrowers can look in the mail for yet another interest rate or fee hike). The free dollar is, on the international currency markets, a falling dollar. That, in turn, raises the costs of imported goods. With the world economy now tightly integrated--some "American" cars have more foreign content than some Hondas and Toyotas--a falling dollar means higher costs for American consumers. This is most evident in the oil markets, where the rising price of gasoline and other petroleum products is the leading factor in pushing up prices. But price pressures are gradually spreading across the spectrum of consumer goods, and the Fed may have to narrow the definition of core inflation if it's going to keep prices down. As prices rise, real wages fall.
By weakening the dollar and, in effect, lowering American wages, the Fed makes America more competitive in the world economy. U.S. exports have been gradually rising, boosting employment (although at 8.8% of the labor force without jobs, we're still a long way from full employment). The price of "recovery" in this manner will be Germany's compromise: more jobs but constrained wages. And American consumers will have to become more like German consumers--tighter with the nickels, making do with last year's model, darning socks, mixing liquid soap with water to make it last longer, and, ugh, saving. Saturday afternoon at the mall will be replaced by Saturday afternoon in the kitchen home canning tomatoes grown in the back yard. The Model T in grandpa's barn will have to be fixed up and put back on the road. But it was and can still be a great car.
The Fed now prescribes America's economic policy. Congress and the Administration manage only to offset each other in a bipolar tango between partisan confrontation and distasteful compromise. Fiscal policy is virtually nonexistent. Only the limited tools available to the central bank are being put to use. And we will have to live with the consequences, because there are no other options.
Part of the answer is they concentrate on producing high value added goods, taking advantage of their technological know how. The vaunted German machine tool industry makes highly specialized equipment, and constantly seeks to improve, which makes them hard to compete against.
But a crucial part of Germany's success is that wages have been held down. German workers are paid less than French workers (although both nations are well above the EU average). And, surprise! The French economy is weaker. German unions have gone along with wage restraint, in order to promote employment. German workers accepted limited income growth for the sake of fostering national competitiveness in export markets. The American image of Germany is a swirl of Mercedes, BMW, Audi and Porsche logos. The truth is more modest--a nation whose GDP per capita, disposable income per capita and other measures of economic well-being are lower than America's.
The U.S. Federal Reserve is, by all appearances, on a quiet, not for attribution mission to devalue the dollar. Although paying lip service to the sanctity of the Almighty Greenback, the Fed has relentlessly pushed down the dollar's value with a two and a half years and counting zero interest rate policy. Even now, as inflation is rising and central banks in many other nations are raising their rates, the Fed continues to believe that a free dollar is the best dollar (but free only for the financial institutions eligible to borrow at the ultra low rates available in the fed funds market; credit card borrowers can look in the mail for yet another interest rate or fee hike). The free dollar is, on the international currency markets, a falling dollar. That, in turn, raises the costs of imported goods. With the world economy now tightly integrated--some "American" cars have more foreign content than some Hondas and Toyotas--a falling dollar means higher costs for American consumers. This is most evident in the oil markets, where the rising price of gasoline and other petroleum products is the leading factor in pushing up prices. But price pressures are gradually spreading across the spectrum of consumer goods, and the Fed may have to narrow the definition of core inflation if it's going to keep prices down. As prices rise, real wages fall.
By weakening the dollar and, in effect, lowering American wages, the Fed makes America more competitive in the world economy. U.S. exports have been gradually rising, boosting employment (although at 8.8% of the labor force without jobs, we're still a long way from full employment). The price of "recovery" in this manner will be Germany's compromise: more jobs but constrained wages. And American consumers will have to become more like German consumers--tighter with the nickels, making do with last year's model, darning socks, mixing liquid soap with water to make it last longer, and, ugh, saving. Saturday afternoon at the mall will be replaced by Saturday afternoon in the kitchen home canning tomatoes grown in the back yard. The Model T in grandpa's barn will have to be fixed up and put back on the road. But it was and can still be a great car.
The Fed now prescribes America's economic policy. Congress and the Administration manage only to offset each other in a bipolar tango between partisan confrontation and distasteful compromise. Fiscal policy is virtually nonexistent. Only the limited tools available to the central bank are being put to use. And we will have to live with the consequences, because there are no other options.
Monday, February 14, 2011
Currency Market Ripoffs
News services report that banks have allegedly been ripping off customers in the foreign exchange markets. Major banks buying or selling foreign currencies for institutional investors have supposedly been cheery picking their day's transactions after the market closes, keeping the good trades for themselves, and sticking their customers with the lousy trades. Unlike the stock markets, there isn't a consolidated tape in the currency markets that reports transactions publicly, and customers are at a disadvantage in trying to figure out whether they've gotten fair prices. The banks have a free hand to turn lead into gold by keeping the golden trades for themselves and dumping the lead into customer accounts.
It's easy to be a winner in the financial markets if you have the benefit of hindsight and can help yourself to a do-over. It's even easier when you're transacting in an unregulated market that's largely opaque to your customers. The currency markets are unregulated, and only the naive and poorly read would be surprised by the recent allegations. After all, similar ripoffs occurred in the opaque mortgage-backed securities and derivatives markets, crucial parts of an unregulated shadow banking system whose collapse in 2007-08 continues to haunt our economy today. A recurring story of Wall Street is that insiders will rig the market against the public whenever they can. The news reports about currency trading ripoffs is just another iteration of that story.
That institutional customers, including some well-known money managers, were victimized brings to mind a lesson of the Bernie Madoff scandal: even the well-heeled and sophisticated are vulnerable. No one is safe when transparency and accountability are in short supply. Moreover, pension funds and other investment vehicles holding money for the benefit of middle class workers and investors are among the victims. This isn't just a problem for residents of Palm Beach.
Greater regulation of the currency markets, even simple measures like better recordkeeping of transactions and more timely confirmation of trades with customers, would enhance accountability. However, today's political climate precludes greater regulatory protections, even if pension funds and other repositories of middle-class assets are at risk. Some victims have filed lawsuits--the State of Virginia even intervened in one--and perhaps they'll recover their losses after a long slog through the courts. Otherwise, caveat emptor remains the word of the day.
It's easy to be a winner in the financial markets if you have the benefit of hindsight and can help yourself to a do-over. It's even easier when you're transacting in an unregulated market that's largely opaque to your customers. The currency markets are unregulated, and only the naive and poorly read would be surprised by the recent allegations. After all, similar ripoffs occurred in the opaque mortgage-backed securities and derivatives markets, crucial parts of an unregulated shadow banking system whose collapse in 2007-08 continues to haunt our economy today. A recurring story of Wall Street is that insiders will rig the market against the public whenever they can. The news reports about currency trading ripoffs is just another iteration of that story.
That institutional customers, including some well-known money managers, were victimized brings to mind a lesson of the Bernie Madoff scandal: even the well-heeled and sophisticated are vulnerable. No one is safe when transparency and accountability are in short supply. Moreover, pension funds and other investment vehicles holding money for the benefit of middle class workers and investors are among the victims. This isn't just a problem for residents of Palm Beach.
Greater regulation of the currency markets, even simple measures like better recordkeeping of transactions and more timely confirmation of trades with customers, would enhance accountability. However, today's political climate precludes greater regulatory protections, even if pension funds and other repositories of middle-class assets are at risk. Some victims have filed lawsuits--the State of Virginia even intervened in one--and perhaps they'll recover their losses after a long slog through the courts. Otherwise, caveat emptor remains the word of the day.
Tuesday, September 14, 2010
Japan's Yen Intervention: A Trade Skirmish?
The Japanese central bank has unilaterally stepped into the currency markets and bought U.S. dollars in an effort to lower the value of the yen and push up the dollar. It appears to have increased the dollar by about 1%. In economic terms, this intervention is similar to a 1% across-the-board tariff on all U.S. goods imported into Japan. Conversely, it creates a 1% price cut on all Japanese goods imported into the U.S.
While American consumers wouldn't mind a 1% price cut, this intervention could export some of Japan's unemployment to the U.S. American workers making products that compete with now cheaper Japanese goods may face a greater risk of layoffs and reduced income.
The Japanese government apparently had hoped for international support for its intervention. It got none. Everyone's hurting and no one wants to take someone else's unemployment.
There was no public reaction from the U.S. government to the Japanese intervention. A 1% shift in currency valuations is small from a medium to long term perspective, and could easily shift back within a few days from now in today's volatile currency markets. The U.S Treasury has its hands full squabbling with the Chinese about the valuation of the yuan, and probably doesn't want to fight on two fronts simultaneously.
The yen is rising because it's becoming more valuable. One reason is that the Chinese government has been buying yen denominated assets in order to diversify away from the dollar. The Chinese are killing two birds because this diversification is also likely to weaken the dollar. Because the Chinese yuan is still essentially tied to the dollar, when the dollar sinks, so does the yuan. The Chinese tack allows them to maintain approximate parity with the dollar while gaining a trade advantage over the Japanese.
By intervening, the Japanese central bank is in effect riposting with a two birds with one stone tactic of its own. Pushing the dollar up also pushes up the yuan against the yen, thereby recovering some of the trade advantage the Chinese have gotten lately.
Next week, the Federal Reserve will meet again and perhaps give more guidance on the extent of the quantitative easing (read, printing of money) it has in mind for the foreseeable future. The more the Fed quantitatively eases, the lower the dollar will fall in the currency markets. The Japanese may perceive this as aimed at them, even though it isn't. They might respond with more intervention.
With economies around the world slowing and governments too leveraged for much more stimulus spending, currency manipulations are a deceptively cheap and easy way to improve a nation's prospects. The problem is that one nation's gains come at the expense of other nations. When they all start to maneuver their currencies around, they wittingly or unwittingly form a circular firing squad aiming inward. Things weren't pretty when that happened in the 1930s and they wouldn't be pretty if it happened again.
While American consumers wouldn't mind a 1% price cut, this intervention could export some of Japan's unemployment to the U.S. American workers making products that compete with now cheaper Japanese goods may face a greater risk of layoffs and reduced income.
The Japanese government apparently had hoped for international support for its intervention. It got none. Everyone's hurting and no one wants to take someone else's unemployment.
There was no public reaction from the U.S. government to the Japanese intervention. A 1% shift in currency valuations is small from a medium to long term perspective, and could easily shift back within a few days from now in today's volatile currency markets. The U.S Treasury has its hands full squabbling with the Chinese about the valuation of the yuan, and probably doesn't want to fight on two fronts simultaneously.
The yen is rising because it's becoming more valuable. One reason is that the Chinese government has been buying yen denominated assets in order to diversify away from the dollar. The Chinese are killing two birds because this diversification is also likely to weaken the dollar. Because the Chinese yuan is still essentially tied to the dollar, when the dollar sinks, so does the yuan. The Chinese tack allows them to maintain approximate parity with the dollar while gaining a trade advantage over the Japanese.
By intervening, the Japanese central bank is in effect riposting with a two birds with one stone tactic of its own. Pushing the dollar up also pushes up the yuan against the yen, thereby recovering some of the trade advantage the Chinese have gotten lately.
Next week, the Federal Reserve will meet again and perhaps give more guidance on the extent of the quantitative easing (read, printing of money) it has in mind for the foreseeable future. The more the Fed quantitatively eases, the lower the dollar will fall in the currency markets. The Japanese may perceive this as aimed at them, even though it isn't. They might respond with more intervention.
With economies around the world slowing and governments too leveraged for much more stimulus spending, currency manipulations are a deceptively cheap and easy way to improve a nation's prospects. The problem is that one nation's gains come at the expense of other nations. When they all start to maneuver their currencies around, they wittingly or unwittingly form a circular firing squad aiming inward. Things weren't pretty when that happened in the 1930s and they wouldn't be pretty if it happened again.
Thursday, July 1, 2010
How the Chinese Yuan Re-valuation Will Affect the U.S. Real Estate Market
The re-valuation of the yuan recently announced by the Chinese government has implications for the balance of trade, capital flows into China, and political relations between the U.S. and the People's Republic. What seems to have gone unnoticed is the consequence of this re-valuation for the U.S. real estate market.
As the dollar falls in relation to the yuan, it will make less and less sense for the Chinese to lend to America. They would need interest rates that covered not only lending costs and risks, but also currency risk in an environment where the yuan will almost surely rise. Current low U.S. mortgage rates, a boon to buyers who are financially qualified, are like cold pizza to lenders. And the Federal Reserve appears dead set on keeping interest rates low, lower and even lower. During much of the past decade or so, the Chinese were big buyers of American mortgage-backed investments. The mortgage crisis cooled their jets big time. Even though the secondary market for mortgages today consists almost entirely of U.S. government guaranteed investments, currency risks will make the flow of funds from China less unpredictable. It's true that Europe and the Euro don't, at the moment, provide China with attractive alternatives to the dollar. But China is working on boosting domestic demand and building an internally focused economy. Over time, it will demand fewer dollars and Euros, and provide less real estate financing in the States.
The excess inventory from foreclosures, short sales and the like will be a drag on the real estate market for years. The shrinkage of foreign credit due to the falling dollar will add to the stagnation. We'd better hope the falling dollar gives U.S. exports one helluva jump start, because it will probably tighten up an already parsimonious mortgage market.
As the dollar falls in relation to the yuan, it will make less and less sense for the Chinese to lend to America. They would need interest rates that covered not only lending costs and risks, but also currency risk in an environment where the yuan will almost surely rise. Current low U.S. mortgage rates, a boon to buyers who are financially qualified, are like cold pizza to lenders. And the Federal Reserve appears dead set on keeping interest rates low, lower and even lower. During much of the past decade or so, the Chinese were big buyers of American mortgage-backed investments. The mortgage crisis cooled their jets big time. Even though the secondary market for mortgages today consists almost entirely of U.S. government guaranteed investments, currency risks will make the flow of funds from China less unpredictable. It's true that Europe and the Euro don't, at the moment, provide China with attractive alternatives to the dollar. But China is working on boosting domestic demand and building an internally focused economy. Over time, it will demand fewer dollars and Euros, and provide less real estate financing in the States.
The excess inventory from foreclosures, short sales and the like will be a drag on the real estate market for years. The shrinkage of foreign credit due to the falling dollar will add to the stagnation. We'd better hope the falling dollar gives U.S. exports one helluva jump start, because it will probably tighten up an already parsimonious mortgage market.
Tuesday, March 9, 2010
Bernie Does Europe
The following is entirely fictional.
The man stood out clearly among the other visitors at the Butner, NC medium security facility. He was trim, and scanned the room with dark eyes. His precisely cut blue suit, narrowed at the waist, the scaloppine soles of his pointed loafers, and his muted silk shirt offset by a mauve tie, would have photographed well east of the English Channel. His face was locked into a faint, bemused smile. It was a well-practiced expression, one perhaps used to mask his thoughts and emotions.
He had no trouble spotting the inmate he came to meet. The latter, an older man who was short and lumpy, would have been obvious even if he hadn't been so often photographed by the press. The visitor waved.
"Mr. Madoff."
"Yes. It's nice to meet you, Mr., uh . . ."
"John Talent," said the visitor, with the accent of someone who'd grown up with light breakfasts, not large ones.
"Yes, Mr. Talent." Bernie suspected that the visitor's registry, where Mr. Talent would have signed in, would not be terribly revealing to the press should they get their hands on it.
"I have the package you requested. Five pounds of shrimp cocktail and a quart of cocktail sauce."
"Wonderful, wonderful. You have no idea how hard it is to get a decent appetizer around here."
"I can imagine, sir," said the visitor, with well-exaggerated sympathy.
"Well, Mr. Talent. What was it you wanted to talk about?"
"I seek insight about your . . . former method of business. That is to say, your financial success."
"My . . . well, I suppose I was successful for a while."
"Yes, yes. How did you succeed in persuading people to give you money, and then keep it there?"
Bernie paused for a moment, seemingly in thought. "It comes down to telling them what they want to hear. Investing consists of putting your money down on a promise. The key is to make the best promise."
"That is interesting in abstract," said Talent quickly. "Let us consider, however, the possibility that the interests raising money are, shall we say, in some difficulty and their difficulties are not entirely unknown."
"Well, let me think. Uhmmm . . . can you tell me what interests you're talking about?"
"Perhaps we can say they are European. More I cannot reveal," replied Talent, his smile tighter than ever.
"Well," said Bernie, through a mouthful of shrimp. "They would have to improve the promises. That is, increase the promised earnings or profits on the investment, and make it appear that they have a very good chance of paying the returns. Look for ways to enhance your revenue, while cutting costs. At least, promise to do those things. By the way, this is excellent shrimp."
"I am pleased that you are enjoying it. Now, let us hypothesize that a . . . bailout, I think the English word is . . . will probably be necessary. That would require a third party--someone to provide the bailout for the interests I represent, so that we appear stronger. How should we deal with the third party?"
"What kind of bailout do you mean: funds, a guarantee of debt, or something else?"
"Any and all of them. Everything is under discussion. The important thing is to inspire confidence among the creditors."
"The creditors," muttered Bernie. "So you are trying to raise money to pay off old debts falling due?"
"Ahhh . . . perhaps I have said too much. But this is true. We must raise money to pay old debts. And there is not so much time."
"And you need a bailout to give the creditors confidence about your ability to repay new debt?"
"Precisely. We have been searching for a bailout, a new source of funds or at least a guarantee."
"How is that search going?" asked Bernie, plunking three pieces of shrimp at once into the cocktail sauce.
"Not very well. The European parties we approached speak in generalities. They don't want to say yes, but they don't want to say no."
"Why won't they say yes?"
"Because they believe we will use the money for consumption, not for investment. So it will not generate new revenues. It is, how you say, like the Ponzi arrangement."
Bernie chewed in silence for a moment. "I see. Then, why won't they say no?"
"Because they have invested in us already. If they say no and we fail, they will be harmed."
"So it is against their interests to say yes, and against their interests to say no."
"Precisely."
Bernie took a deep breath, and then another mouthful of shrimp. "Then you need to find another sugar daddy."
"Pardon?"
"Another benefactor. A new player to give you a bailout. Perhaps someone some distance away, who is not as involved in the situation. You have been talking to Europeans?"
"Yes. Interested parties in Europe."
"Maybe you should hop over the pond."
"Are you speaking of America?"
"That might be the next place to try."
"How could we persuade America to help European interests?"
"Think of something you could offer America."
The visitor stroked his chin, and then spoke. "We have been the victims of speculation in the derivatives market. It is very aggressive and damaging. Perhaps we could offer ourselves as an example of why your government should increase the regulation of derivatives. Your president might be interested, because he wants to add more regulation of derivatives but is having political problems with those people, the lobbyists. The international situation would give him . . . how you say it, political leverage . . . to change the laws. The lack of regulation is increasing international instability. This way, the profit making devices used by your big bankers . . . you call them Wall Street, I believe . . . will now be used against them."
Bernie smiled wryly. "I guess it's fair to say that sometimes, American financiers do go too far, and then the law catches up with them."
"So, if we give your government an international incident they can use to their advantage, perhaps they would have some sympathy for our situation."
"Maybe. Everything would have to be done very subtly. Nothing can be explicit, because the American government has many problems within the country to deal with, and the American people expect their government to take care of problems at home first."
"I understand perfectly. We will be very discreet."
"Good luck, then. And don't hesitate to come back for more advice."
"You have been very helpful, Mr. Madoff. Next time, I will bring ten pounds of shrimp."
The man stood out clearly among the other visitors at the Butner, NC medium security facility. He was trim, and scanned the room with dark eyes. His precisely cut blue suit, narrowed at the waist, the scaloppine soles of his pointed loafers, and his muted silk shirt offset by a mauve tie, would have photographed well east of the English Channel. His face was locked into a faint, bemused smile. It was a well-practiced expression, one perhaps used to mask his thoughts and emotions.
He had no trouble spotting the inmate he came to meet. The latter, an older man who was short and lumpy, would have been obvious even if he hadn't been so often photographed by the press. The visitor waved.
"Mr. Madoff."
"Yes. It's nice to meet you, Mr., uh . . ."
"John Talent," said the visitor, with the accent of someone who'd grown up with light breakfasts, not large ones.
"Yes, Mr. Talent." Bernie suspected that the visitor's registry, where Mr. Talent would have signed in, would not be terribly revealing to the press should they get their hands on it.
"I have the package you requested. Five pounds of shrimp cocktail and a quart of cocktail sauce."
"Wonderful, wonderful. You have no idea how hard it is to get a decent appetizer around here."
"I can imagine, sir," said the visitor, with well-exaggerated sympathy.
"Well, Mr. Talent. What was it you wanted to talk about?"
"I seek insight about your . . . former method of business. That is to say, your financial success."
"My . . . well, I suppose I was successful for a while."
"Yes, yes. How did you succeed in persuading people to give you money, and then keep it there?"
Bernie paused for a moment, seemingly in thought. "It comes down to telling them what they want to hear. Investing consists of putting your money down on a promise. The key is to make the best promise."
"That is interesting in abstract," said Talent quickly. "Let us consider, however, the possibility that the interests raising money are, shall we say, in some difficulty and their difficulties are not entirely unknown."
"Well, let me think. Uhmmm . . . can you tell me what interests you're talking about?"
"Perhaps we can say they are European. More I cannot reveal," replied Talent, his smile tighter than ever.
"Well," said Bernie, through a mouthful of shrimp. "They would have to improve the promises. That is, increase the promised earnings or profits on the investment, and make it appear that they have a very good chance of paying the returns. Look for ways to enhance your revenue, while cutting costs. At least, promise to do those things. By the way, this is excellent shrimp."
"I am pleased that you are enjoying it. Now, let us hypothesize that a . . . bailout, I think the English word is . . . will probably be necessary. That would require a third party--someone to provide the bailout for the interests I represent, so that we appear stronger. How should we deal with the third party?"
"What kind of bailout do you mean: funds, a guarantee of debt, or something else?"
"Any and all of them. Everything is under discussion. The important thing is to inspire confidence among the creditors."
"The creditors," muttered Bernie. "So you are trying to raise money to pay off old debts falling due?"
"Ahhh . . . perhaps I have said too much. But this is true. We must raise money to pay old debts. And there is not so much time."
"And you need a bailout to give the creditors confidence about your ability to repay new debt?"
"Precisely. We have been searching for a bailout, a new source of funds or at least a guarantee."
"How is that search going?" asked Bernie, plunking three pieces of shrimp at once into the cocktail sauce.
"Not very well. The European parties we approached speak in generalities. They don't want to say yes, but they don't want to say no."
"Why won't they say yes?"
"Because they believe we will use the money for consumption, not for investment. So it will not generate new revenues. It is, how you say, like the Ponzi arrangement."
Bernie chewed in silence for a moment. "I see. Then, why won't they say no?"
"Because they have invested in us already. If they say no and we fail, they will be harmed."
"So it is against their interests to say yes, and against their interests to say no."
"Precisely."
Bernie took a deep breath, and then another mouthful of shrimp. "Then you need to find another sugar daddy."
"Pardon?"
"Another benefactor. A new player to give you a bailout. Perhaps someone some distance away, who is not as involved in the situation. You have been talking to Europeans?"
"Yes. Interested parties in Europe."
"Maybe you should hop over the pond."
"Are you speaking of America?"
"That might be the next place to try."
"How could we persuade America to help European interests?"
"Think of something you could offer America."
The visitor stroked his chin, and then spoke. "We have been the victims of speculation in the derivatives market. It is very aggressive and damaging. Perhaps we could offer ourselves as an example of why your government should increase the regulation of derivatives. Your president might be interested, because he wants to add more regulation of derivatives but is having political problems with those people, the lobbyists. The international situation would give him . . . how you say it, political leverage . . . to change the laws. The lack of regulation is increasing international instability. This way, the profit making devices used by your big bankers . . . you call them Wall Street, I believe . . . will now be used against them."
Bernie smiled wryly. "I guess it's fair to say that sometimes, American financiers do go too far, and then the law catches up with them."
"So, if we give your government an international incident they can use to their advantage, perhaps they would have some sympathy for our situation."
"Maybe. Everything would have to be done very subtly. Nothing can be explicit, because the American government has many problems within the country to deal with, and the American people expect their government to take care of problems at home first."
"I understand perfectly. We will be very discreet."
"Good luck, then. And don't hesitate to come back for more advice."
"You have been very helpful, Mr. Madoff. Next time, I will bring ten pounds of shrimp."
Sunday, March 7, 2010
Currencies: the Latest Bubble to Burst. Is Municipal Debt Next?
In the leverage-fueled, easy money world of the turn of the 21st Century, life is just one asset bubble after another. The bubbles du jour are the Euro and the pound sterling. The Euro bloc and the U.K. seem to have achieved faux prosperity with gads of borrowed money, some of it carefully tucked away in quiet, little (or perhaps not so little) derivatives transactions.
But the problem with debt is that creditors expect to be repaid. As creditors sought to have their way, the Euro and pound lost value. This down trend may have been exacerbated by trading in credit default swaps, the hydra of the financial markets. Thus, derivatives seemingly not only heightened the bubble, they also may have intensified the pop. Government officials in EU nations now talk openly about restricting the use of credit default swaps for sovereign debt. The financial engineers of the derivatives markets will likely sprout two or more new contracts for the credit default swap if it is cut off from the sovereign debt markets. Europe will have to search long and hard for a champion to truly kill this beast.
Municipalities in the U.S. also availed themselves of the easy credit offered by not terribly transparent derivatives. Many now find themselves locked into long term contracts that are expensive to maintain and expensive to terminate. Their only consolation is that the Wall Street bankers who sold them these puppies are back to earning big bonuses, thanks to the American taxpayer. Municipal bankruptcies are rare, but perhaps will be less so in the near future. If local governments must choose between police and fire protection, good educations for children, and decent roads, on the one hand, or continuing to enrich multi-millionaire investment bankers on the other, it's not hard to imagine that the sanctity of contract will take a fall. The Bankruptcy Code is intended to give debtors a fresh start, and a goodly number of municipal officials are likely to proceed on the premise that all politics are local.
They may take inspiration from the Chinese government. A news story today on Bloomberg.com (http://www.bloomberg.com/apps/news?pid=20601087&sid=ay..a15ZCHJU&pos=3) reported that China's national government will repudiate Chinese municipal guarantees of debt incurred by financing vehicles local governments set up to circumvent municipal borrowing restrictions, and prohibit such guarantees in the future. Kinda of reminds one of the SIVs and other special purpose vehicles banks set up for mortgage-backed investments to circumvent capital and financial reporting requirements. This Chinese version of the problem doesn't, at first glance, seem likely to precipitate a currency crisis, since the unguaranteed loans appear to be held mostly by Chinese banks. Beijing's purpose is probably to cut back the vast quantities of credit in China that may send inflation spiraling upward. But the notion that governments need not kowtow to banks could acquire increased currency (pun intended) from the Chinese example. While the federal government, almost incapable of achieving even modest reform of the financial regulatory structure, is clenched tightly within the grip of Wall Street's lobbying machine, the populism sweeping the nation could find new expression in municipal bankruptcies, where local government officials could claim heroic status for themselves (and re-election) by telling the big banks to stick it.
But the problem with debt is that creditors expect to be repaid. As creditors sought to have their way, the Euro and pound lost value. This down trend may have been exacerbated by trading in credit default swaps, the hydra of the financial markets. Thus, derivatives seemingly not only heightened the bubble, they also may have intensified the pop. Government officials in EU nations now talk openly about restricting the use of credit default swaps for sovereign debt. The financial engineers of the derivatives markets will likely sprout two or more new contracts for the credit default swap if it is cut off from the sovereign debt markets. Europe will have to search long and hard for a champion to truly kill this beast.
Municipalities in the U.S. also availed themselves of the easy credit offered by not terribly transparent derivatives. Many now find themselves locked into long term contracts that are expensive to maintain and expensive to terminate. Their only consolation is that the Wall Street bankers who sold them these puppies are back to earning big bonuses, thanks to the American taxpayer. Municipal bankruptcies are rare, but perhaps will be less so in the near future. If local governments must choose between police and fire protection, good educations for children, and decent roads, on the one hand, or continuing to enrich multi-millionaire investment bankers on the other, it's not hard to imagine that the sanctity of contract will take a fall. The Bankruptcy Code is intended to give debtors a fresh start, and a goodly number of municipal officials are likely to proceed on the premise that all politics are local.
They may take inspiration from the Chinese government. A news story today on Bloomberg.com (http://www.bloomberg.com/apps/news?pid=20601087&sid=ay..a15ZCHJU&pos=3) reported that China's national government will repudiate Chinese municipal guarantees of debt incurred by financing vehicles local governments set up to circumvent municipal borrowing restrictions, and prohibit such guarantees in the future. Kinda of reminds one of the SIVs and other special purpose vehicles banks set up for mortgage-backed investments to circumvent capital and financial reporting requirements. This Chinese version of the problem doesn't, at first glance, seem likely to precipitate a currency crisis, since the unguaranteed loans appear to be held mostly by Chinese banks. Beijing's purpose is probably to cut back the vast quantities of credit in China that may send inflation spiraling upward. But the notion that governments need not kowtow to banks could acquire increased currency (pun intended) from the Chinese example. While the federal government, almost incapable of achieving even modest reform of the financial regulatory structure, is clenched tightly within the grip of Wall Street's lobbying machine, the populism sweeping the nation could find new expression in municipal bankruptcies, where local government officials could claim heroic status for themselves (and re-election) by telling the big banks to stick it.
Tuesday, February 23, 2010
Greece, the Euro and the Currency Quandary
The following is entirely fictional.
Dour winter winds chilled the yard at the Butner, NC medium security facility. Inmates tried to exercise under the muddy gray overcast, their unprotected fingertips aching from lack of warmth. Jorge stepped around the weightlifting area and approached the older man seated on a bench.
“Hey, Bernie.”
“Hello, Jorge.”
“Bernie, I was wondering if I could get your advice on something.”
“Sure. What’s on your mind?”
“I got a chicken tamale for you, made the way you like. I figured it would help you think.”
“Oh, thanks so much, Jorge. My brain is firing up already.”
“Bernie, I got a prob . . . Well, my sister in Bogota has a problem.”
“What’s that?”
“She has some money, some U.S. dollars. And she’s trying to figure out what to do with them.”
“You mean, what to spend them on?”
“No. Like what to put them in.”
“You mean what to invest in--stocks and bonds?”
“No, I . . . she don’t like stocks and bonds because, you know, the big guys in New York, they got control over those markets. No one else knows what the stocks and bonds are really worth.”
“I understand that point. Uh, how much money does she have? I mean, depending on how much she has, you might be able to find special investments.”
“Bernie. . . Can you keep a secret?”
“Sure, Jorge. I’m very good at keeping things secret.”
“Okay, she has about ten million.”
“Ten million dollars? Holy cow. How did she get that much?”
Jorge paused and glanced around before speaking. “She . . . ah . . . found it on the sidewalk.”
Bernie smiled ever so slightly. “I guess that can happen. Investing such a large amount can be complicated. I mean . . . well, let me ask, is it in a bank account now?”
“No. Cash. Cash only. That’s the only way I do bus . . . , well, it was cash when she found it.”
“Investing that much cash would be complicated.”
“I . . . she can get it . . . how, you say, washed?”
“Laundered?”
“Yeah, that’s it. Laundered. You don’t have to worry about that Bernie. I can . . . she can take care of that. The problem is what to wash it into. That’s the hard part. I was thinking . . . I mean, for her. I was thinking for her that maybe we put them in Euros. The dollar isn’t so strong any more. And the Euro has gone up a lot. But then I hear that there’s a problem with Greece or some place, like they got too much debt or a lousy government budget, so the Euro is going down. What’s going on there, Bernie?”
“As I understand it, Greece and some other European countries borrowed a lot of money, and they’re having trouble paying it back. These debt problems make their economies grow slower. Because people think Europe's economy is weakening, its currency, the Euro, is worth less.”
“The TV was saying something like Greece or someone was hiding some of their problems. You know anything about that?”
“I gather that Greece and other European countries did these fancy deals called derivatives, which disguised some of their debt so they didn’t look so financially weak.”
Jorge frowned fiercely. “I don’t like that sneaky s___. A dude who pulls sneaky s___ on me is trying to f___ me. I don’t do no sneaky s___. When a guy tries to f___ me, I f___ him back. And, you know, I f___ him to his face, ‘cause I don’t f___ around.”
With well-practiced diffidence, Bernie glanced at Jorge, seeing eyes that could pierce steel. “I’ll bet you don’t, Jorge.”
“You can take my word on that, Bernie. I mean, you know that lying bastard that put me in this place, you know, he testify against me in court, saying I’m a narco trafficker, and the judge throw in me jail? When I get out . . . “ Jorge drew a finger across his throat.
Bernie practiced his diffidence some more. “I hope we get some warmer weather soon.”
Jorge threw back his bulky head and laughed thickly. “I like you, Bernie. You stay cool. Okay, so what we doing to do? I mean what do you think my sister should do? No Euros, ‘cause I don’t like that sneaky s___. How ‘bout the Japanese yen?”
“The yen has done pretty well overall, because Japan is basically a wealthy country and has a strong manufacturing sector that exports successfully. But the Japanese government is constantly trying to push the yen down because a weak currency helps their manufacturers export.”
Jorge thought about this for a moment. “You mean they f___ their own money?”
“Well, I don’t think they look at it that way. But you’re not far off the mark.”
“S___. Then, what’s a good thing to put the money into? I mean, I don’t want gold, ‘cause then I . . . my sister has to protect it, ‘cause there’s a lot of bad people that might try to steal it, and you know, someone might start shooting, and then s___ really starts to happen. “
“I agree, Jorge. Gold isn’t an optimal investment.”
“Then, what should I . . . my sister do?”
Bernie thought for a moment, and sighed. “Sometimes, Jorge, there aren’t any great investments. The markets fluctuate, and in a down cycle, you may just have to try to hang in there until things get better. Maybe it wouldn’t be a bad idea if . . . uh, your sister just held onto the dollars.”
Jorge frowned at the walls that would mark the limits of his freedom for years to come, and remained silent while a nearby sparrow chirped. Then, the edges of his lips lifted to betray his amusement. “So, is that how you pulled off that, what you call it . . . a party scheme?”
Bernie paused, and then said, “you mean a Ponzi scheme?”
“Yeah, that’s it. Ponzi scheme. That’s how you did it, right?”
“What do you mean?”
“You say the markets sometimes go down; not always up.”
“That’s correct.”
“So when you promised people whatever, ten or twelve percent steady, all the time, no bad times, they want believe it ‘cause otherwise they gotta deal with the market going up and down, and they don't like that. And then they give you their money.”
Bernie brooded before saying, “That about sums it up. I made it easy for them to give me their money and they made it easy for me to get it. We all took the easy way out. Legally, I’m the bad guy. But it’s easier to kill sheep than lions.”
Jorge took a deep breath, and said, “I ain’t no sheep. I had to work hard . . . I mean my sister had to look hard on the sidewalk for this money. We ain’t gonna put it where people pull sneaky s___ or these other people they f___ their own money. Maybe we just have to, like you say, hold the dollars for now.”
“I think that’s the right attitude, Jorge. Playing games with debt and currencies aren’t odds on winners. People who don’t look for the easy way out have better chances in the long run. You can take that from me.”
Wednesday, October 21, 2009
The Cart-Horse Problem of the Currency Debate
The blogosphere and op ed pages are filling up with calls to arms over the recent decline of the dollar. Predictions of the imminent collapse of American civilization abound. Gold sales boom.
Although the value of the dollar is very important, it is the result, not the cause, of our economic problems. A currency becomes strong when the nation issuing it is economically strong. A currency weakens when the issuing nation's economy weakens. The strong currencies today--the Japanese yen and the Chinese yuan--got that way because Japan and China became manufacturing powerhouses. Both nations try like heck to keep their currencies weak in order to bolster exports. Over the long course of time, they have failed. Their currencies have inexorably strengthened as their economies have strengthened. The Japanese yen has tripled its value in the last 30 years. The Chinese yuan probably would be considerably higher than its current value, as well, if it were freely tradeable--the Chinese government does not allow full convertibility of the yuan in order to constrain the outflow of capital from China.
Conversely, the dollar has fallen as the U.S. has shifted from being a manufacturing powerhouse to a binge consumer living off the equity of its real estate. The American way of life in recent years was possible only because foreigners were willing to buy dollar-denominated debt, in effect lending us the money for $5 lattes, $3,000 wide-screen TVs, luxury nameplates on all three cars in the driveway, and a house twice as large as the one we grew up in. When things fell apart, the entire nation became like a person with 22 credit cards and $230,000 of consumer debt, looking for a bailout.
A weakening nation cannot, through government intervention, preserve or increase the value of its currency. Calls to the Treasury or the Fed to intervene in currency markets or raise interest rates in order to support the dollar are misguided. The last major economic power to try something like that--Great Britain in September 1992--was blown up by a wolf pack of hedge funds that shorted the pound in the direction it would have eventually gone anyway. It's doubtful that any collection of hedge funds, however large and well-leveraged, could blow up the dollar. But the other major economic powers of the world can. And, gradually, they are, with talk of repricing oil in a basket of other currencies and gradual reallocation of central bank bond portfolios away from the dollar.
There is a way to save the dollar. That would be to institute government policies to bolster the manufacturing capabilities of the U.S. economy. America has a long and illustrious history as a manufacturing powerhouse, and does not inevitably have a dark future in that regard. It also does not have to rely on exports to support a manufacturing sector, since the American consumer, although currently down in the dumps, will probably rise from the ashes if given half a chance (i.e., a full-time job) and a little more reasonably priced credit. But the Federal Reserve, with its all for the banks and none for anyone else distortion of the Robin Hood tale, offers only sermons but not solutions. And the Obama administration's stimulus package has been unfocused and diffuse. A nation cannot spend or consume its way to economic health. It must be able to make things that other people will pay good money for. This should be the goal of government economic policy.
Although the value of the dollar is very important, it is the result, not the cause, of our economic problems. A currency becomes strong when the nation issuing it is economically strong. A currency weakens when the issuing nation's economy weakens. The strong currencies today--the Japanese yen and the Chinese yuan--got that way because Japan and China became manufacturing powerhouses. Both nations try like heck to keep their currencies weak in order to bolster exports. Over the long course of time, they have failed. Their currencies have inexorably strengthened as their economies have strengthened. The Japanese yen has tripled its value in the last 30 years. The Chinese yuan probably would be considerably higher than its current value, as well, if it were freely tradeable--the Chinese government does not allow full convertibility of the yuan in order to constrain the outflow of capital from China.
Conversely, the dollar has fallen as the U.S. has shifted from being a manufacturing powerhouse to a binge consumer living off the equity of its real estate. The American way of life in recent years was possible only because foreigners were willing to buy dollar-denominated debt, in effect lending us the money for $5 lattes, $3,000 wide-screen TVs, luxury nameplates on all three cars in the driveway, and a house twice as large as the one we grew up in. When things fell apart, the entire nation became like a person with 22 credit cards and $230,000 of consumer debt, looking for a bailout.
A weakening nation cannot, through government intervention, preserve or increase the value of its currency. Calls to the Treasury or the Fed to intervene in currency markets or raise interest rates in order to support the dollar are misguided. The last major economic power to try something like that--Great Britain in September 1992--was blown up by a wolf pack of hedge funds that shorted the pound in the direction it would have eventually gone anyway. It's doubtful that any collection of hedge funds, however large and well-leveraged, could blow up the dollar. But the other major economic powers of the world can. And, gradually, they are, with talk of repricing oil in a basket of other currencies and gradual reallocation of central bank bond portfolios away from the dollar.
There is a way to save the dollar. That would be to institute government policies to bolster the manufacturing capabilities of the U.S. economy. America has a long and illustrious history as a manufacturing powerhouse, and does not inevitably have a dark future in that regard. It also does not have to rely on exports to support a manufacturing sector, since the American consumer, although currently down in the dumps, will probably rise from the ashes if given half a chance (i.e., a full-time job) and a little more reasonably priced credit. But the Federal Reserve, with its all for the banks and none for anyone else distortion of the Robin Hood tale, offers only sermons but not solutions. And the Obama administration's stimulus package has been unfocused and diffuse. A nation cannot spend or consume its way to economic health. It must be able to make things that other people will pay good money for. This should be the goal of government economic policy.
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