Wednesday, October 27, 2010
Hiatus
There is so much to write about at the moment but unfortunately this Blog will be in hiatus for a week or two as Pharos has had shoulder surgery.
Sunday, October 24, 2010
G20 - Papering over the cracks, still blaming surplus countries
There was so much in the G20 meeting over the weekend but we think comments and the communiqué still tell us the “west” for want of a better term doesn’t get it. Originally US Treasury Secretary Geithner wanted to try to reign in current account imbalances but the Chinese apparently kicked this to the curb.
You have to question whether policy makers in the advanced economies really get it. The "IT" we mean is the type of Economic Imperialism they have practicing with regard to emerging economies and particularly China over the past 20 years.
The GFC is often blamed on the global surpluses of cash flowing from the trade surpluses of China and other nations as if the other side of global trade, current account deficits, were the responsibility of the sellers. Advanced industrial economies went to Asia and more latterly and largely, China, because they had massive underpaid, by Western standards, workforces who could produce stuff for the consumers of the advanced economies cheaply. In a sense the logic that underlies this thinking relies on the Keynesian postulation of Say’s law that is “supply creates its own demand”.
But western policy makers, especially in the US, cheer led the consumerism and inflation moderation that China and other Asian nations bought to the global economy and western companies reaped massive margins and profits from these new producers. Certainly China benefitted and has turned itself into the 2nd biggest economy in the world but continuing to blame surplus countries seems to point to a papering over the cracks rather than a recognition of culpability.
This makes BOE Governor King's speech last week all the more prescient. http://spotlight-onmarketsandeconomics.blogspot.com/2010/10/mervyn-king-is-worried-about-imbalances.html
The G20 addressed the risk from global protectionism directly in the communique saying:
"given the high interdependence among our countries in the global economic and financial system, uncoordinated responses will lead to worse outcomes for everyone. Our cooperation is essential."
And so say all of us! That's code we think for no beggar thy neighbour trade or currency policies. But high minded rhetoric may be difficult to hold in the current dire economic landscape particulalry given short termism of electorates and the
Will the Finance Ministers of the G20 who met, along with their Central Bankers actually be able to deliver co-operation if the political going gets tough or, as we may see in the US on Melbourne Cup day, the dynamics and makeup on Capitol Hill change after the mid-term elections. We hope so
Wednesday, October 20, 2010
Mervyn King is worried about imbalances, currencies and trade wars
BOE Governor King gave a very important speech on Tuesday both in its own right and in the context of what is happening and being said in regard to currency markets and global imbalances between the surplus and deficit countries.
Obviously also his comments on the challenges ahead for the UK should be seen in the context of the Governments spending cuts and austerity measures. But rather than focus on the UK specific stuff we will look at the rich vein on the global challenges ahead.
On the need to export.
"To achieve a rebalancing we need to sell more to, and buy less from, economies overseas. To close the gap between exports and imports, more than half a million jobs will 4probably need to be created in businesses producing to sell overseas – compensating for fewer employment opportunities serving UK consumers or the public sector.Such an adjustment is unlikely to be smooth. Unless the fall in domestic spending coincides with the necessary increase in net exports, the path for the economy will be bumpy."
On trying to generate growth in the UK but particularly globally
"The biggest risk to an orderly rebalancing of our economy comes from abroad. Efforts to restore world demand are impeded by the scale of the imbalances in trade, which are beginning to grow again. If the UK and other low-savings countries are to rebalance their economies, demand for their products must increase overseas. Lower domestic demand in the deficit countries must be accompanied by strong growth in domestic demand in the surplus countries if the world economy is not to slow. That will require a change in the strategy of those countries that have built their own policies around export-led growth."
Further on the dichotomy of needs between surplus and deficit countries
"All countries accept that global rebalancing is necessary. But there is a clear difference between the path of adjustment desired by the surplus countries, which are faced with the need for a longer-term structural shift away from reliance on exports, and the path of adjustment preferred by the deficit countries, which are under greater near-term pressure to reduce the burden of debt in both private and public sectors."
On the paradox of the global disagreement and currency wars
"Such conflicts are, however, symptoms of a deeper disagreement on the appropriate time path of real adjustment. Since surpluses and deficits must add to zero for the world as a whole, differences between these desired ex ante adjustment paths are reconciled ex post by changes in the level of world output. And the risk is that unless agreement on a common path of adjustment is reached, conflicting policies will result in an undesirably low level of world output, with all countries worse off as a result."
On the international monetary system
"The international monetary system today has become distorted. The major surplus and deficit countries are pursuing economic strategies that are in direct conflict. And there are some innocent victims. Those emerging market economies which have adopted floating currencies are now suffering from the attempts of other countries to hold down their exchange rates, and are experiencing uncomfortable rates of capital inflows and currency appreciation. So there is more to this issue than a bilateral conflict between China and the United States.
On the breakdown of international conviviality between policy makers.
" At the G7 meeting in October 2008, I was part of the group of ministers and central bank governors who threw away the prepared communiqué, and replaced it by a bold short statement of our determination to work together. That spirit, so strong then, has ebbed away. Current exchange rate tensions illustrate the resistance to the relative price6changes that are necessary for a successful rebalancing."
On Smoot Hawley – Trade wars 2010
"The need to act in the collective interest has yet to be recognised, and, unless it is, it will be only a matter of time before one or more countries resort to trade protectionism as the only domestic instrument to support a necessary rebalancing. That could, as it did in the 1930s, lead to a disastrous collapse in activity around the world. Every country would suffer ruinous consequences – including our own. But, to borrow a phrase, in order to be tough on protectionism, we need also to be tough on the causes of protectionism.
On what needs to be done?
Principal 1
"focus discussion on the underlying disagreement about the right speed of adjustment to the real pattern of spending. Without agreement on this, policies will inevitably conflict. Once broad agreement is reached, it should be easier to agree on the instruments of policy."
Principal 2
"in terms of policy instruments, put on the table many potential policy measures – not just the single issue of exchange rates. That should include, in addition to exchange rates, rules of the game for controlling capital inflows, plans to raise saving in the deficit countries, structural reforms to boost demand in the surplus countries, and even the role and governance of the international financial institutions.
What is needed now is a "grand bargain" among the major players in the world economy. A bargain that recognises the benefits of compromise on the real path of economic adjustment in order to avoid the damaging consequences of a move towards protectionism. Exchange rates will have to be part of such a bargain, but they logically follow a higher level agreement on rebalancing and sustaining a high level of world demand."
How long will the hangover be?
"The next decade will not be nice. History suggests that after a financial crisis the hangover lasts for a while. So the next decade is likely to be a sober decade – a decade of savings, orderly budgets, and equitable rebalancing. Our prospects remain closely linked to developments in the rest of the world. But we can influence the outcome, with monetary policy still a potent weapon to ensure that the amount of money in the economy is growing neither too slowly, as in the recent past, nor too quickly so as to reignite inflation. With that, and the inspiration provided by the Black Country's example of how to adapt to economic change, I am sure of one thing. A sober decade may not be fun but it is necessary for our economic health."
Let's hope Mervyn has a lot of freinds in the Central Bank and Political scene. He's right and needs to be listened too.
http://www.bankofengland.co.uk/publications/speeches/2010/speech454.pdf
Obviously also his comments on the challenges ahead for the UK should be seen in the context of the Governments spending cuts and austerity measures. But rather than focus on the UK specific stuff we will look at the rich vein on the global challenges ahead.
On the need to export.
"To achieve a rebalancing we need to sell more to, and buy less from, economies overseas. To close the gap between exports and imports, more than half a million jobs will 4probably need to be created in businesses producing to sell overseas – compensating for fewer employment opportunities serving UK consumers or the public sector.Such an adjustment is unlikely to be smooth. Unless the fall in domestic spending coincides with the necessary increase in net exports, the path for the economy will be bumpy."
On trying to generate growth in the UK but particularly globally
"The biggest risk to an orderly rebalancing of our economy comes from abroad. Efforts to restore world demand are impeded by the scale of the imbalances in trade, which are beginning to grow again. If the UK and other low-savings countries are to rebalance their economies, demand for their products must increase overseas. Lower domestic demand in the deficit countries must be accompanied by strong growth in domestic demand in the surplus countries if the world economy is not to slow. That will require a change in the strategy of those countries that have built their own policies around export-led growth."
Further on the dichotomy of needs between surplus and deficit countries
"All countries accept that global rebalancing is necessary. But there is a clear difference between the path of adjustment desired by the surplus countries, which are faced with the need for a longer-term structural shift away from reliance on exports, and the path of adjustment preferred by the deficit countries, which are under greater near-term pressure to reduce the burden of debt in both private and public sectors."
On the paradox of the global disagreement and currency wars
"Such conflicts are, however, symptoms of a deeper disagreement on the appropriate time path of real adjustment. Since surpluses and deficits must add to zero for the world as a whole, differences between these desired ex ante adjustment paths are reconciled ex post by changes in the level of world output. And the risk is that unless agreement on a common path of adjustment is reached, conflicting policies will result in an undesirably low level of world output, with all countries worse off as a result."
On the international monetary system
"The international monetary system today has become distorted. The major surplus and deficit countries are pursuing economic strategies that are in direct conflict. And there are some innocent victims. Those emerging market economies which have adopted floating currencies are now suffering from the attempts of other countries to hold down their exchange rates, and are experiencing uncomfortable rates of capital inflows and currency appreciation. So there is more to this issue than a bilateral conflict between China and the United States.
On the breakdown of international conviviality between policy makers.
" At the G7 meeting in October 2008, I was part of the group of ministers and central bank governors who threw away the prepared communiqué, and replaced it by a bold short statement of our determination to work together. That spirit, so strong then, has ebbed away. Current exchange rate tensions illustrate the resistance to the relative price6changes that are necessary for a successful rebalancing."
On Smoot Hawley – Trade wars 2010
"The need to act in the collective interest has yet to be recognised, and, unless it is, it will be only a matter of time before one or more countries resort to trade protectionism as the only domestic instrument to support a necessary rebalancing. That could, as it did in the 1930s, lead to a disastrous collapse in activity around the world. Every country would suffer ruinous consequences – including our own. But, to borrow a phrase, in order to be tough on protectionism, we need also to be tough on the causes of protectionism.
On what needs to be done?
Principal 1
"focus discussion on the underlying disagreement about the right speed of adjustment to the real pattern of spending. Without agreement on this, policies will inevitably conflict. Once broad agreement is reached, it should be easier to agree on the instruments of policy."
Principal 2
"in terms of policy instruments, put on the table many potential policy measures – not just the single issue of exchange rates. That should include, in addition to exchange rates, rules of the game for controlling capital inflows, plans to raise saving in the deficit countries, structural reforms to boost demand in the surplus countries, and even the role and governance of the international financial institutions.
What is needed now is a "grand bargain" among the major players in the world economy. A bargain that recognises the benefits of compromise on the real path of economic adjustment in order to avoid the damaging consequences of a move towards protectionism. Exchange rates will have to be part of such a bargain, but they logically follow a higher level agreement on rebalancing and sustaining a high level of world demand."
How long will the hangover be?
"The next decade will not be nice. History suggests that after a financial crisis the hangover lasts for a while. So the next decade is likely to be a sober decade – a decade of savings, orderly budgets, and equitable rebalancing. Our prospects remain closely linked to developments in the rest of the world. But we can influence the outcome, with monetary policy still a potent weapon to ensure that the amount of money in the economy is growing neither too slowly, as in the recent past, nor too quickly so as to reignite inflation. With that, and the inspiration provided by the Black Country's example of how to adapt to economic change, I am sure of one thing. A sober decade may not be fun but it is necessary for our economic health."
Let's hope Mervyn has a lot of freinds in the Central Bank and Political scene. He's right and needs to be listened too.
http://www.bankofengland.co.uk/publications/speeches/2010/speech454.pdf
Tuesday, October 19, 2010
RBA Minutes - next move up but timing a "matter of judgement"
The minutes to this month’s meeting were very instructive in their intellectual obfuscation. We don’t mean this in the sense that they are intentionally meaning to deceive or conceal the true meaning but rather that there seems to be something in the minutes for both the rate hikers and rate leavers like us.
For the hikers the fact that the minutes said the outcome of the pro and con arguments for a move this month were “finely balanced” and that the Board can’t wait forever to “see whether risks materialised” tells us that the November meeting is definitely live. This is particularly given that the concerns occupying the mind of the Board and the Bank are those related to factor utilisation of which last month’s 55,800 rise in employment and unemployment rate of 5.1% suggest some tightness.
Please don’t think we have changed camps but we are no good to you or ourselves if we blindly ignore the messages.
But equally strong in the minutes was the message that given their concerns about the medium term outlook for the Australian economy and given their expectation that the next move in rates is up then the fact they held fire speaks through a megaphone.
With regard to the strength to the labour market outlined above they tempered it a little with a comment that Bill Mitchell from Newcastle University would have been proud of. That is, that "business surveys suggest that most firms were not experiencing significant difficulties finding labour." Mitchell continues to argue, and ABS data supports, so this one quote sort of supports that there is a vast swathe of under-employment in Australia at the moment which rings true in this context. Which does mitigate the bearish tone earlier, or at least buys the Board time.
Equally to the extent that the AUD/USD rallied after the minutes were released we’d suggest that the rate bears take note of the explicit comment about the impact of the rising dollar on activity within the economy. We always think in MCI terms even if it is not explicit and we believe so does the RBA otherwise why would they use the AUD to act as an automatic stabiliser so often and why would other nations be now seeking to devalue their way out of their economic malaise. It’s because monetary conditions are not just interest rates, the currency plays a role. To this end the RBA said “the rise in the exchange rate would, if it continued, effectively be tightening financial conditions at the margin.” At close to USD 1 there is at least one if not 2 tightenings in that level of the exchange rate since the last SoMP.
The RBA also mentioned our concerns about households and credit and wondered, as did we all, at the anecdotal evidence on retailing which seems at odds from the last GDP figures. All in all the RBA still expects rates to move higher but its a matter of judgement when.
With consumers where we think they are we hope they wait till 2011.
For the hikers the fact that the minutes said the outcome of the pro and con arguments for a move this month were “finely balanced” and that the Board can’t wait forever to “see whether risks materialised” tells us that the November meeting is definitely live. This is particularly given that the concerns occupying the mind of the Board and the Bank are those related to factor utilisation of which last month’s 55,800 rise in employment and unemployment rate of 5.1% suggest some tightness.
Please don’t think we have changed camps but we are no good to you or ourselves if we blindly ignore the messages.
But equally strong in the minutes was the message that given their concerns about the medium term outlook for the Australian economy and given their expectation that the next move in rates is up then the fact they held fire speaks through a megaphone.
With regard to the strength to the labour market outlined above they tempered it a little with a comment that Bill Mitchell from Newcastle University would have been proud of. That is, that "business surveys suggest that most firms were not experiencing significant difficulties finding labour." Mitchell continues to argue, and ABS data supports, so this one quote sort of supports that there is a vast swathe of under-employment in Australia at the moment which rings true in this context. Which does mitigate the bearish tone earlier, or at least buys the Board time.
Equally to the extent that the AUD/USD rallied after the minutes were released we’d suggest that the rate bears take note of the explicit comment about the impact of the rising dollar on activity within the economy. We always think in MCI terms even if it is not explicit and we believe so does the RBA otherwise why would they use the AUD to act as an automatic stabiliser so often and why would other nations be now seeking to devalue their way out of their economic malaise. It’s because monetary conditions are not just interest rates, the currency plays a role. To this end the RBA said “the rise in the exchange rate would, if it continued, effectively be tightening financial conditions at the margin.” At close to USD 1 there is at least one if not 2 tightenings in that level of the exchange rate since the last SoMP.
The RBA also mentioned our concerns about households and credit and wondered, as did we all, at the anecdotal evidence on retailing which seems at odds from the last GDP figures. All in all the RBA still expects rates to move higher but its a matter of judgement when.
With consumers where we think they are we hope they wait till 2011.
BBH - Economic growth may not return
We just picked up this article by Marc Chandler of Brown Brothers Harriman on "Seeking Alpha" . We don't agree with all his premises but we do agree that there is a lot of wood to chop before the global economy gets back on track and before the imbalances that exist are worked through.
With Scottish ancestors we've never really bought into the idea that having too much saving, or what is now called "surplus capital" was a bad thing. Economically we get it but the reason it is a problem is that the world is beset with what Hyman Minsky would call "money manager capitalism". It is the flow of this money from one jurisdiction to another and across markets which is so distorting the usual signals one gets from underlying growth. When markets are driven not by the supply and demand for goods but the supply and demand for money then we get an unstable economy. Chandler says:
Chandler, whose views we have always respected, has an interesting take on the current situation and the history of it and even though we think he is letting policy makers off far too lightly in the above quote given we believe they are actively looking to beggar thy neigh its worth a look.
Lets say we agree with the conclusion if not all the content
http://seekingalpha.com/article/230247-the-broken-cash-register-why-economic-prosperity-might-not-return
With Scottish ancestors we've never really bought into the idea that having too much saving, or what is now called "surplus capital" was a bad thing. Economically we get it but the reason it is a problem is that the world is beset with what Hyman Minsky would call "money manager capitalism". It is the flow of this money from one jurisdiction to another and across markets which is so distorting the usual signals one gets from underlying growth. When markets are driven not by the supply and demand for goods but the supply and demand for money then we get an unstable economy. Chandler says:
"Surplus capital lies at the heart of the so-called currency wars. Currency devaluations are not so much about beggar-thy-neighbor moves in order to boost exports. They are more about trying to minimize or neutralize capital flows which are pouring into a dozen or so emerging markets which can hardly absorb their own savings, let alone a chunk of the savings from the US, Europe and Japan...These large capital inflows could fuel a bubble in local asset prices, distort pricing signals, complicate policy, and pose a serious risk when the flows go into reverse"Minsky is, as ever, prescient.
Chandler, whose views we have always respected, has an interesting take on the current situation and the history of it and even though we think he is letting policy makers off far too lightly in the above quote given we believe they are actively looking to beggar thy neigh its worth a look.
Lets say we agree with the conclusion if not all the content
http://seekingalpha.com/article/230247-the-broken-cash-register-why-economic-prosperity-might-not-return
US Economy - can QE2 work?
Markets seem to be undertaking a form of "hyperbolic discounting" in their reaction to the moves by the Fed to the next stage of Quantitative easing. We really have a jaundice view of this and feel that equities are way ahead of themselves on this front because we just can't see the outcome that will satisfy the expectation.
The Economist magazine has an article titled "it's all up to the Fed - The Fed will try to force the economy into orbit with more bond purchases" which highlights what markets seem to be expecting in its title. The article looks at the challenge ahead for the Fed and the US economy. It's worth a read if you get the time but the intro is our favourite bit:
"ROCKET science may be out of fashion on Wall Street, but it still has a following at the Federal Reserve. All year long officials there have looked for signs that the economy has reached “escape velocity”: growth that is strong enough to bring down unemployment once the propellants of government stimulus and inventory replenishment are spent....Such signs remain maddeningly elusive." Our Bolding
http://www.economist.com/node/17258945?story_id=17258945&fsrc=scn/tw/te/rss/pe
To our mind the point of quantitative easing is to get money sloshing around the economy and get a little bit of inflation working through the economy. In this way, so the theory goes, people’s, or should we say consumers, behaviours will be returned to their thriftless ways of spending not saving what they earn and have. It’s the role that mortgage equity redraw played in the recovery from the post September 2001 lows and the early decade economic weakness. Indeed we remember Chairman Greenspan in a speech in 2002 or maybe 2003 lauding the fact that US home owners had buttressed the economy from the worst of the possible economic decline by using mortgage equity redraw as a tool for consumption. Gary Shilling, the doyen of US Economists, has often shown that were it not for Mortgage Equity Redraw the US growth rate for 2001 and the subsequent 3 years would have been negative. That is people used their homes (fixed asset) as a line of credit to finance in what large part appears to have consumption (recurrent expenditure).
To our mind the point of quantitative easing is to get money sloshing around the economy and get a little bit of inflation working through the economy. In this way, so the theory goes, people’s, or should we say consumers, behaviours will be returned to their thriftless ways of spending not saving what they earn and have. It’s the role that mortgage equity redraw played in the recovery from the post September 2001 lows and the early decade economic weakness. Indeed we remember Chairman Greenspan in a speech in 2002 or maybe 2003 lauding the fact that US home owners had buttressed the economy from the worst of the possible economic decline by using mortgage equity redraw as a tool for consumption. Gary Shilling, the doyen of US Economists, has often shown that were it not for Mortgage Equity Redraw the US growth rate for 2001 and the subsequent 3 years would have been negative. That is people used their homes (fixed asset) as a line of credit to finance in what large part appears to have consumption (recurrent expenditure).
Now we know where that has got them now and as stretched as the analogy might be with quantitative easing that’s what the Fed and policy makers seem aimed at trying to do. They want to get a bit of inflation into the system to get people spending again. But we know that the net equity position of many US households has been eroded and we know that with almost 10% unemployment and another 7 or 8% underemployment getting consumers spending in such a manner so as to give the recovery self sustaining momentum will be difficult. Which brings us back to our sceptical position on the impact of QE and its efficacy.
One of the things in finance that irks us is just this point – we are about to see another theory rolled out and tested in real time on the world’s biggest economy with no surety of its efficacy and the only live experiment in Japan having shown that it has limited benefit. Thankfully drug companies can not unleash cures on us like this. So as David Blanchflower said overnight QE does not work quickly (perhaps at all) and we are going to need to see a very large program of buying.
No wonder currencies are being pursued as the easy fix.
Monday, October 18, 2010
Vale Benoit Mandlebrot
The world is a lesser place for the passing of Benoit Mandlebrot over the weekend. Mandelbrot is known as the father of fractal geometry but he was much more than that. To us he was one of the most important writers on the fallacy of the EMH and other tenuous financial theories.
His writing, with Richard L. Hudson, "THE (MIS)BEHAVIOUR OF MARKETS - A Fractal View of Financial Turbulence" was a wonderful and revolutionary retake on conventional wisdom. He was often criticised because his theories on finance helped explain and not predict market movements. The simply niavete and arrogance of such assertions always left us baffled. Only slaves to a non-existant perfect world of rational optimisors and efficient frontiers could even think to make such criticism.
In revealing modern fiancial and portfolio theory to be a sham which violated the scientific oath of "do no harm mandelbrot wrote:
His writing, with Richard L. Hudson, "THE (MIS)BEHAVIOUR OF MARKETS - A Fractal View of Financial Turbulence" was a wonderful and revolutionary retake on conventional wisdom. He was often criticised because his theories on finance helped explain and not predict market movements. The simply niavete and arrogance of such assertions always left us baffled. Only slaves to a non-existant perfect world of rational optimisors and efficient frontiers could even think to make such criticism.
In revealing modern fiancial and portfolio theory to be a sham which violated the scientific oath of "do no harm mandelbrot wrote:
"whether guide or master, modern portfolio theory bases everything on the conventional market assumptions that prices vary mildly, independantly, and smoothly from one moment to the next. Iif those assumptions are wrong, everything falls apart. rather than a carefully tuned profit engine, your portfolio may actually be a dangerous, careering rattletrap."The Independant this morning has the following paragraph in its small article on Mandelbrots death
"Scientific and mathematical geniuses are distinguished by a particular elegance of mind. Fiendish complexity becomes something the non-specialist can comprehend. Rarer still is the scientist whose mental elegance creates, or reveals, something of physical beauty...
Benoit Mandelbrot, whose death has just been announced, was a mathematician who made it his life's work to find beautiful shapes in nature and decode their secrets. In minute ways, he saw perfect order in apparent chaos, and enabled others to see it, too. He devised, and developed the study of, fractals – seemingly random shapes that conformed to patterns when broken down into one repeating form.
His fractals were invariably things of beauty – seen in phenomena as different as snowflakes and cauliflowers. But his methods also had practical applications that included generating graphics and producing actual works of art. He turned his mind also to economics, declaring the global financial system too complex to function properly. How right he turned out to be. If yesterday belonged to the economists, perhaps tomorrow will be the mathematician's world."Indeed it may. Like Hyman Minsky before him perhaps Mandelbrot will find his theories to find most traction after his passing. But we'll leave the final word to Mandelbrot from the aforementioned book.
"I am a persistent man. once I decide something, i hold to it with extraordinary tenacity. i pushed and pushed to develop my ideas of scaling, power laws, fractality, and mulitfractality. i pushed and pushed to get out into the scholarly world with my message of wild chance, fat tails, long term dependance, concentration, and discontinuity. Now I am pushing and pushing again, to get these ideas out into a broader marketplace where they may finally do some concrete good for the world."Benoit Mandelbrot 24/11/1924 - 14/10/2010 R.I.P
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