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Strategies & Market Trends : Currencies and the Global Capital Markets

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To: paul ross who wrote (126)	5/16/1998 8:24:00 AM
From: Henry Volquardsen	Read Replies (1) of 3536

Paul, I'm glad you posted again. Your comments touched on a lot of important points and I was hoping you didn't interpret my disdain for Mr Birch's style of analysis as including you. Also it's not my thread, I just started it. The question about what point the interest payments on the debt become to large to sustain is a very interesting question. Conventional wisdom has been, I believe, that the threshold was 60% of GNP. However we have a number of countries that are currently prospering with ratios well in excess of 100%, Italy and Belgium to name two. The problem is that such high ratios leave no room for maneuver. Neither of these countries would have been able to survive to this point, however, if it had not been for the subsidy of the EU. Italy in fact will be the biggest beneficiary of the Euro because the lower interest rates are giving them explosive growth and lower expense on the current debt stock and allowing them to make progress on cutting the debt. But up until now they have been restricted from spending this windfall by the need to qualify for entrance. The big question will be whether, once in the Euro, the politicians will be able to keep their hands of the surplus long enough to bring the debt out of the danger zone. So the question of what level of debt is sustainable can be impacted by external events and the growth potential of the economy. I said I believed that conventional wisdom had the threshold at 60%. All major economies are at or above that level including the US. Why isn't putting an intolerable strain on the economy? I believe that the productivity explosion caused by recent technological progress of the last few years plus the growth potential from a number of economies that have recently embraced free markets has raised the threshold temporarily. If not for these factors I believe the debt would already be a major problem for Europe and would be crimping the US. The impact of these factors will not last forever so it will be very important to use the current strong economic environment to get the debt well below 60%. It was not that long ago that we had a deficit in 9 figures while we had a primary surplus. As far as the dollars sold by the Bank of Japan, they would have no direct impact on money supply. They held those dollars in Treasury securities and would sell those, most likely to the Fed, to use for intervention. The Fed would sell those Treasuries back into the open market. The Japanese banks that bought those dollars would indeed hold those dollars in interest bearing investments. In fact the funding of their dollar investments has been a major problem for Japanese banks and this helped them. But as far as the Yahoo article's contention that it caused problems for the Fed. I disagree. I was trading through that period and there were no problems. I have heard a lot of talk about the 'yen carry' trade causing flows into dollar bonds. This is nothing new and a trade of this sort in various directions is always in the market. For the past two years much of the market has been funding lire bonds with deutschmarks, essentially the same trade. The point about the yen carry trade is that it is not large enough to swamp the bond markets. If it were we would be looking at rates significantly lower than they are right now. Also the fear that when this trade reverses it will cause a collapse in the bond markets is wrong and just plain ignorant of market dynamics. The truth is that the bond trades largely on its own fundamentals. If the yen carry trade were to suddenly reverse it would cause near term weakness in the bond. But all this would do is find many buyers at rates not much higher than we are now. The point to remember is that the financial markets are much more complex and structurally sound then many people realize. It would take much more than the reversal of one particular trade strategy to cause a collapse. You also mention gold leasing. I am very familiar with this market professionally. There is a lot of misinformation about where this gold has gone. I have heard many theories that this has funded huge short speculation in gold and a rise in gold prices will cause a short squeeze that will wipe out these speculators and the central banks will not get their gold back. The truth is the gold leasing is a very credit sensitive business. Most central banks will lend only to the most credit worthy institutions. These institutions in turn have been lending the gold largely to hedgers not speculators. In many cases these loans are collateralized or otherwise credit enhanced. The hedgers are working mines with solid production. So if gold prices rise these gold leases will be repaid with future production. Henry

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