>>>>> Barring a recession, we will witness the Death of the Death of Inflation.<<<<<<<<
The Black King
by Sean Corrigan
November 28, 2000
Sean Corrigan is publisher of The Capital Letter available from Capital Insight, www.capitalinsight.co.uk
Forget the FOMC and thinly-veiled promises of where the next 25bps is coming from on the Funds rate, the Fed has already embarked upon an easing. Since the week of the 26th October, when the Dollar had finally looked like topping out, driven from its DXY highs by a sharp reversal in UST prices, the Fed has been quietly expanding its balance sheet. Picking up a billion or two quietly in outright Treasury purchases and swelling repos by two thirds or nearly $8 billion, less a few diminishing factors, it has added a net $8.7 billion to the sum.
While that may not sound much, it does mean that anything between $80 - $100 billion of new bank credit has been given a base by this enlargement of the tip of the lowest of the inverted pyramids which comprise the monetary system. Occurring over 4 short weeks, this represents an annualized increase of 20% and is both the fastest gain and the highest end-total since late April-early May.
In addition, the ECB is still grinding its weekly way higher with its reserve provision, as it has since its inception, and seems to be foolishly sterilizing its interventions. The BOJ has positively exploded to mid-November with its forty day injection of Y15 trillion. The last week's development of the Yen and the JGB market both, against a backdrop of official concern for plunging equities and banking stock weakness, can only suggest yet another slug of high-powered money will hit the numbers in the near future.
Forget CPI and its equivalents. The Central Banks have - as ever – gone back to protecting their cartel, the banking sector which they were all instituted to underwrite with government mandates and taxpayer's money, from the consequences of its own follies.
To encapsulate those follies, let us look at one simple set of data. As the BIS Quarterly Review on International Banking and Financial Developments summarizes, net issuance of debt securities in Q3 was $259 billion, with US Dollars accounting for twice that in the Euro – a reversion to the pre-EMU pattern after a year of Euro predominance. Banking activity had also been expanding through the year across the BIS area, in particular in the syndicated loan market where Mar-Sept saw an enormous $654 billion of deals, nearly $4.5 billion per business day, largely reflecting Canal Boom borrowing for Telecoms and late cycle M&A activity. One quarter of all such borrowing this year has been for Telecoms, one quarter of that has been provided by US banks, with another 20% being sourced from the UK and Germany.
How much of that is still good debt? How much of that is parked in special-purpose funding vehicles away from regulatory scrutiny and mark-to-market discipline? How much has been repackaged into CLO's and sold on to unsuspecting mutual funds? Who knows, but the erosion of collateral values has brought the monetary cavalry riding to the rescue once again, as it has roughly every six months in the last five years of the Bubble.
The Fed's participation this time is an especially interesting escalation, since the Fed is still the only central bank which can gamble on strengthening its currency by providing reserves, rather than undermining it that way. It is still a gamble, though, and one which the Plunge Protection Team only rarely undertakes so openly. Matters are indeed serious.
Europe still fails badly on this count, of course, as the balance of payments figures once again illustrate. Year-to-date, Europe has suffered a portfolio outflow of EUR127.6 billion. However, this aggregate disguises the somewhat remarkable fact that Europe bought a net EUR243 billion in foreign equity in these nine months, of which up to EUR38 billion admittedly might represent a counterpart to stock-financed direct investment flows. Against that remaining balance of over EUR200 billion, the banking sector raised EUR155 billion abroad, EUR143.5 billion of that at short-term, while other money market instruments to the tune of EUR37.3 billion were sold to foreign holders.
Europe has effectively run a EUR200 billion margin trade this year – this most horrifyingly expensive of all years – the bulk of it has been financed through the monetary sector and the ECB has underwritten the trade in its weekly refinancing tenders. It is the combination of the two – not the first alone and not any uncritical Keynesian rubbish about growth differentials or official interest rate disparities - which has combined to send the Euro into its death spiral.
So why does this not apply to the Fed, when it starts printing money? Can Alan Greenspan alone make the difference in perception? Can Larry Summers bully the rest of the world into holding onto surplus dollars whatever the circumstances?
Here we must remember the old adage that if you owe the bank a hundred dollars, that's your problem, while if you owe it a million, it's the bank's.
In 1989, the BIS estimates that it captured most extant foreign official exchange reserves in its $403 billion total of global official sector USD holdings. At end-1999, it thinks that the $993 billion it can easily identify understates the true sum of around $1.4 trillion in Uncle Sam's costless IOUs, out of a $1.7 trillion worldwide pot.
In other words, a trillion dollars more of everyone else's reserves are now dependent on Greenspan's whim than at the peak of the last US cycle. It would not do to be too mechanistic, especially as some central banks sequester such holdings in reserve valuation accounts and since multpliers vary from country to country and from period to period, but after adding back in the Fed's own $600 billion balance sheet, the two TRILLION US Dollars sitting in central banks around the globe could be the foundation of something of the order of $20-30 trillion in banking sector assets - a whole year's reported national product for Planet Earth.
Imagine what would happen if those holdings were to lose 10-15% of their value as private sector holders lost faith in the worth of the substantial pile of the credit notes they have lodged with American consumers. We feel sure this is the bogeyman whose frightening visage the US Treasury describes for the rest of G7 at bedtime. The Euro, it seems, was launched too late to stand a chance of competing with the Almighty Dollar, a mere garage Dot.com against a monetary Cisco Systems.
The US Dollar - on the BOE index – last week nosed above its Summer peak and is threatening to make new 14-year highs. It has already staged a Fibonacci retracement of the 1985-1995 decline mapped out on the ebb from the highwater mark of Reaganomics.
If it were to sustain this move, any decent technician, blindfolded and led to an unmarked chart, would start from the behavioral shift in mid-1995 at 88.60, work via a high-volume area centrally-placed in the post-Asian crisis range at 108.80 (where the H2'2000 move also began) and project all the way up to 129.00 – almost another 10% from here.
To many, that would be unthinkable. To most it would be highly damaging. It is not what most would forecast using conventional 'wisdom'. However, it could be rationalized.
Imagine that, like some Sci-Fi conflict being fought out in the stupefying silence of the interstellar void, the world is noiselessly engaged on another struggle for supremacy between a potential debt deflation cycle, set in train as a vast raft of assets and the shaky enterprises behind them goes sour, and another wave of 'financial stability' activism from the BIS institutions.
To switch metaphors, in that battle, the Dollar plays the role of the Black King on the chessboard. It may be the weakest piece, but its survival is the paramount concern of all those around it, whether they will it or not. The Queen – Gold – has long since been sacrificed for position. It may be that to avoid a 'defeat' (in truth a painful transition to what may be a more stable system, though a vastly different political order) the Euro Bishops, the Sterling Knights and the Yen Rooks – not to mention the lesser currency pawns – will also be offered up in turn.
One of the reasons the USD has continually confounded its critics is that there is simply no consensus as to where to hide from its influence. All paper currencies are vulnerable, most equity markets are still historically rich, many societies have become overburdened with debt. The system has no anchor but the USD itself and the corruption of money per se means that 'managed' currencies are nothing but a euphemism for competitive devaluation by stealth, that the free riders end up driving the bus.
Against such a backdrop, it might require a series of major blunders on the part of the US authorities, or a series of misfortunes restricted to the American economy alone, to begin a fracture in the linchpin. It would need the bravery to accept an appreciation of one's own exchange rate elsewhere to see the trend reversed. Do you think the British would not respond to a US-led slowdown by clamouring for monetary relaxation in the UK, that the Europeans would not switch to even more stimulus, that the Swiss would not go with the 'counter-cyclical' tide?
Stay with major government bonds for now while the initial manoeuvres unfold and the troops are marshalled. If equities give way on a big scale, the need to bail out banks will reward you immensely. But, if lesser credits begin to stabilize and equity breaks the Bears' hearts once more, be quick to shift. Your cheapest equity call is a put on bonds, financed out of your gains to date. Remember that resources are already scarce and wages and rents are rising along with fuel. Consumers' psychology is shifting and if they are spared pain, they will spend the newly-minted cash quickly. Barring a recession, we will witness the Death of the Death of Inflation.
If central banks win once more, this time they are likely to deliver up the worth of fixed income assets to an inflationary aftermath whose flames will make the bond crash of 1999 look tame.
prudentbear.com |
