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"Macro" Musings


giofranchi

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Mr. Charles Gave and Mr. Louis Gave on "The Emerging Market Panic"

 

Panics do not destroy capital; they merely reveal the extent to which it has been previously destroyed by its betrayal in hopelessly unproductive works.

--John Mills

 

As everyone knows, the US dollar is still the world’s reserve currency. If/when the Fed maintains negative real rates for an inordinately long period of time, fewer and fewer people choose to save in US dollar and the currency heads lower. However, the dollar does not go down forever. When the exchange rate becomes between one or two standard deviations undervalued on a purchasing parity basis, it stops falling, if only because foreigners start loading up on US assets (Brazilians buying condos in Miami, Russians in New York city, etc.). Still, as long as real rates in the US are negative, the Fed, for all intents and purposes, is signaling that it does not want the dollar to rise and so it duly remains undervalued—an undervaluation which amounts to a “false price.” Combine this “false price for the currency” with the “false price in the cost of capital,” and the odds of a considerable misallocation of capital go through the roof.

 

 

Gio

Daily+1.27.14.pdf

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http://www.bis.org/review/r090916b.pdf?frames=0

 

I thought it might be useful to read some of Stanley Fisher's speeches. Here is on from 2009 about how to deal with the next crisis. He advocates:

 

1. More power to the central banks as it is important to have all information and tools in one place;

2. take over and wind up over time insolvent banks to prevent Lehman's type problems (change);

3. greater international cooperation through FSB (same but not done);

4. Banks should have risk officer reporting directly to board (change and I bet the Fed informally appoints these officers);

5. Anticipate crises, expect differences and take action before the crisis (change);

6. More focus on financial stability instead of setting inflation targets (no change);

7. Use QE to avoid deflation (no change).

 

Lots of other substantial changes. As the head of Israel's central bank his was the first to drop rates when the last crisis hit, he used QE, including QE to build larger foreign reserves which he favours, and he was the first to increase rates as the crisis abated. An earlier speech about the 1997 Asian crisis favours flexible exchange rates over pegs, bigger reserves, favours allowing devaluation to speed adjustment and raising interest rates ie take the pain now to adjust faster. It looks to me that the EMs are following this advice. Should create opportunities to invest in EMs with weakening currencies as these policies will result in more pain but faster adjustment than 1997. For instance Sberbank (Russia) or Hanjaya Mandala Sampoerna tbk PT (Indonesia) are getting cheaper in USD.

 

 

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I wanted to compare the prospects of Washington vs BC so I arbitrarily compared some of the CFAR reports for vancouver WA vs. Vancouver BC. The interesting difference was that the in US the interest rate on borrowings was only 0.5% for most and about 3% for some while in BC the lowest rate was 1.7% to as high as 7%. We waste a lot of money on interest by comparison in BC. Both had significant investment income. In WA investment income had plummeted since 2007. In BC you wondered why they didn't pay off the high interest rate obligations. BC also had way more fat.

 

Does anyone know how the cities in Washington State borrow at 0.5% for infrastructure like water?

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In the case of interesting dynamics, I recall asking a Columbian friend living in the US a few years ago why they changed their mind about not moving back home.  The response was that it was now too expensive living in Columbia because the expats were driving up the prices with their Euros.  I guess that situation may change or at least have a non-inflationary force.  The ebb and flow of the macro world is surely complex.

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Wages, rents, and the velocity of money—how quickly it changes hands—are “going to be rising significantly over the course of the next several quarters,” Rosenberg says. He adds that his stance will then seem less “ludicrous” than it does now.

 

http://www.businessweek.com/articles/2014-02-20/inflation-ahead-economist-david-rosenberg-says?campaign_id=yhoo

 

 

 

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2. take over and wind up over time insolvent banks to prevent Lehman's type problems (change);

5. Anticipate crises, expect differences and take action before the crisis (change);

6. More focus on financial stability instead of setting inflation targets (no change);

7. Use QE to avoid deflation (no change).

 

5. sounds good, but what would it look like? The Federal Reserve is going to push Lehman Brothers into conservatorship in March 2008, zeroing out the influential figures and institutions who own the stock? And then subsequently use monetary actions to forestall an expectations collapse as a result of a major financial institution collapsing? If the Fed is going to "manage" institutions prior to systematic instability, then the Fed is going to have to push against the market. Otherwise, the market would take care of such institutions by doing things that look a lot like systematic instability.

 

You have to sympathize with the Fed. Stabilize the system and then face the music when you impair a powerful institution, or impair the institution and then face the music when you try to stabilize the system?

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2. take over and wind up over time insolvent banks to prevent Lehman's type problems (change);

5. Anticipate crises, expect differences and take action before the crisis (change);

6. More focus on financial stability instead of setting inflation targets (no change);

7. Use QE to avoid deflation (no change).

 

5. sounds good, but what would it look like? The Federal Reserve is going to push Lehman Brothers into conservatorship in March 2008, zeroing out the influential figures and institutions who own the stock? And then subsequently use monetary actions to forestall an expectations collapse as a result of a major financial institution collapsing? If the Fed is going to "manage" institutions prior to systematic instability, then the Fed is going to have to push against the market. Otherwise, the market would take care of such institutions by doing things that look a lot like systematic instability.

 

You have to sympathize with the Fed. Stabilize the system and then face the music when you impair a powerful institution, or impair the institution and then face the music when you try to stabilize the system?

 

Perhaps it will look like the Soviet system where a party member shared in decision making. Note the generals were the ones who were shot for failures, never the party member. The life of the bank CEOs just got more dangerous. Also remember that the party member was also responsible to set up the machine gun brigades which shot soldiers who retreat.

 

Such a system may be intended to allow even more debt and leverage, but this time more targeted by central control. It might be possible for more growth to emerge by targeted lending to certain industries to overcome entrenched vested interests which sometimes stifle progress. Portland cement is one such example. Unfortunately what usually happens is the reverse, for example, central command has created the medical cartel.

 

My own preference is like Jim Grant's who wants the Fed to return to its original mandate so that it only intervenes to lend in crises and only when good collateral is provided. This overcomes the borrow short lend long problem while avoiding the current moral hazard of rewarding recklessness. Fisher's solution overcomes the same problem in a different way. During war Fisher's solution is warranted but risking the good general bad general problem while Grant's solution is favoured upon the return to peacetime when any idiot can run banks with little harm except to their stock holders. We all should pray for a return to peacetime as there are a lot of central planners in charge of banks any of which might cause us to suffer grievous losses or even to lose the war.

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