from MacroScope:
India’s central bank battles alone in inflation struggle
What more does India's central bank have to do? Last week data showed March inflation rising to almost 9 percent on an annual basis. More importantly, core inflation is above 7 percent for the first time in 3 years meaning demand-side pressures are rising fast. And that's despite the Reserve Bank of India raising interest rates eight times since last March.
The inflation data comes just after a quarterly HSBC report based on purchasing managers indexes showed that inflation in India seemed impervious to monetary policy tightening.
The truth, is the inflation-fighting central bank has little backup from the government which remains stubbornly in spending mode. Its foot-dragging on reform and foreign investment contributes towards keeping food price inflation high. This year's fiscal deficit target is 4.8 percent of GDP and even this is seen as optimistic.
"What India really needs is to have domestic demand slowing down quite rapidly but the government is not prepared to risk that,"says Claire Dissaux, investment strategist at Millenium Global in London.
The RBI has repeatedly said it shouldn't have to do all the heavy lifting. But lack of support from the government means the central bank will have to put up rates another 100 bps this year, analysts reckon.
Of course India is not alone in this bind though it is the most extreme example of lax fiscal policy being counterbalanced by tight monetary policy. Brazilian interest rates are among the highest in the developing world at 11.75 percent and that is down to loose fiscal policy, a lot of it "quasi-fiscal spending" via the state development bank BNDES, research house Capital Economics says.
Brazil's central bank suggested recently that fiscal tightening of one percent of GDP would have the same impact as 125 bps of interest rate hikes.
Central banks face crisis of confidence
Central banks around the world are facing the worst crisis of confidence since the 1930s, as investors, households and firms question their commitment and ability to deliver price stability.
Whether it is inflation or deflation, outsiders question whether the major central banks will be able to regulate prices in the next few years.
TOO HOT …. Bank of England Chief Economist Spencer Dale last week lashed out at what he branded “dangerous talk” the Bank had gone soft on inflation and was choosing to ignore price increases persistently above the target.
Dale admitted “One of the most worrying comments I have heard in recent months came at a lunch of senior businessmen I attended. One of the diners suggested that the UK was returning to its old ways of “depreciating the exchange rate and inflating its way out of trouble.” Soon after, a City circular asked “is the MPC turning a blind eye to inflation.” This is dangerous talk. The evils of inflation are well known.”
He insisted the monetary policy committee (MPC) had only three main priorities — inflation, inflation, inflation — and was committed to meeting the target.
But the rest of the speech was a familiar justification of why inflation has been above target for 41 of the last 50 months (one off shocks to the price level, mothballed spare capacity, exchange rate depreciation and stronger retailers’ margins) and why the Bank had been right to refuse to respond and keep policy very stimulative.
In the end it was an unconvincing narrative that is unlikely to satisfy the Bank’s critics, or a public increasingly angry prices are rising while wages are not.
The Knightian dog ate my recovery
Remember when business and economic leaders droned on about “100-year storms,” 2008′s get-out-of-jail free card for people who missed the housing bubble?
This was the whole idea that there was no way that people could be held accountable for the crisis because the notion of there being a problem with continual double-digit house price growth and sky-high leverage was just so darned unlikely.
Well, it looks like we have the 2010 version of how the dog ate their homework again and this time it is called “Knightian uncertainty.”
Over to European Central Bank chief Jean-Claude Trichet, who in a weekend speech at the Federal Reserve’s economic conference in Jackson Hole, Wyoming more or less said there is a biggish chance that he and his peers have no idea what is going on or what will happen next.
“Today, central bankers have to take decisions in an environment marked by a degree of uncertainty in the economic and financial sphere that seems to me largely unprecedented. … The acceleration of major advances in science and technology (not only information technology), the ensuing structural transformations of our economies, the ever-growing complexity of global finance and the overall process of globalisation are itself creating a multidimensional acceleration of change,” Trichet said.
“These phenomena contribute not only to a wider degree of uncertainty in underlying probability distributions, including fat tails. They also entail a much more significant element of Knightian uncertainty — that is, the type of uncertainty in which there is no underlying probability distribution.”
So, what is this Knightian uncertainty and why is it causing the price of our shares and houses to go down? Named after University of Chicago economist Frank Knight, it is the idea that there is a distinction between risks, which you can assign probabilities to, and uncertainties, which you just can’t fathom.
Excellent article pointing out the uncertainty facing us and the admission that economists don’t have a clue. I wonder why they haven’t looked at our new economy as a “reset”. That is, if you look at the numbers, DOW, volumes, and corporate revenues, we have gone back to the economy of the 80′s. Corporations are making profits because they have downsized their work force and volumes are low but profitable. Our consumerism is back to the 80′s. There are other indications as well and other forces of our own making at work, but suffice it to say that we will be at this “reset” level for a while and economists and industrialists need to start dealing with it.
from MacroScope:
Central banks should hedge: Gary Smith
Gary Smith, head of central banks, supranational institutions and sovereign wealth funds at BNP Paribas Investment Partners, has written a special guest blog for Macroscope in which he argues that central banks should consider ways to hedge their FX reserves against the crisis.
"After the 2008 crisis, a mathematical approach to measure the adequate level of foreign exchange reserves – import cover or an equation relating to short-term debt – no longer has much credibility. In the absence of sensible guidelines on adequacy of reserves there is now a general desire to have plenty of reserves.
What is lacking from the reserves debate, however, is whether National Wealth Managers in general (and central bank reserves managers in particular) should invest in assets that might increase in value during a crisis.
The traditional approach of investing in short dated, high grade government bonds is based on the desire to be in safe and liquid assets, which is logical enough. However during a crisis, it is not the stable value of the assets in which reserves are invested which is of interest to the currency speculators, but the pace at which reserves are being spent to defend the value of the domestic currency. Foreign exchange reserve managers do not invest in assets which might appreciate during a crisis for two probable reasons, firstly these investments would be based on the use of derivatives, and secondly such a strategy, as with any insurance policy, would require the payment of premiums. But perhaps using a small proportion of the many monthly increases in the value of foreign exchange reserves to help insure against the intense pain that can be created during a crisis might make some sense?
This chart shows the monthly change in Asian foreign exchange reserves in each month during a 15 year period 1995-2010. In most months (73%) foreign exchange reserves increased, usually by a small increment. What is also clear is that although months in which reserves fall are considerably less frequent, a fat-tail decline can be debilitating for the NWMs, and indeed for the nation.
Imagine the power of being able to announce during a currency crisis that foreign exchange reserves had received a positive impulse from the successful crisis management strategy of owning call options on gold, or put options on the S&P500. When all the news is bleak, the desire to announce any type of good news is immense. Why doesn’t this prompt a more detailed exploration of strategies that might have a positive pay-off during a crisis? My many conversations with NWMs around the world suggest that the principal reason is that local politicians are unlikely to fully understand, and hence sanction such a strategy (a strategy that would not be without costs, i.e. in the 73% of months of rising reserves, some of the upside would have to be used in order to pay for the insurance protection). For many, the use of derivatives is associated with speculative attempts to capture asset price appreciation, rather than insurance against the downside."
A rising tide of capital controls
(James Saft is a Reuters columnist. The opinions expressed are his own)
Easy money in the United States, a falling dollar and growing flows of funds seeking better returns in emerging markets are touching off a new round of capital controls in hot emerging markets, a trend that could accelerate and will at the very least increase market volatility.
It shouldn’t be a surprise, really; loose money in the developed world is helping to spur investment into emerging markets, driving currencies up and making local exports less competitive for countries which, unlike China, aren’t hitching a free ride as the dollar declines.
Inflation may be a threat for many of these, but with the global economy still struggling, it certainly won’t feel that way to policy makers.
Russia on Wednesday joined the list of countries eyeing new measures to stem currency speculation and appreciation. Moscow was careful to say it would not impose actual capital controls, which seek to regulate flows of funds into or out of an economy, but the measures they are considering would have exactly that effect, making it tougher or more expensive for money borrowed abroad to be brought into Russia.
Kazakhstan, which has been intervening actively to slow the ascent of its tenge currency, has introduced legislation allowing capital controls, but so far has not used them.
Indonesia said this week it will consider curbs on foreign holdings of short-term official debt, sending its rupiah into a brief swoon until central banker Hartadi Sarwono damped things down by saying currency moves based on such flows were so far manageable.
The more critical question is: when will the asset bubble in emerging markets burst? Will the world go into double-dip recession if the bubble burst?The moment the Greenback appreciates, and shows signs of sustained appreciation, the money will flow out of emerging markets, causing havoc for many small countries.
A rally that is both rational and crazy
(James Saft is a Reuters columnist. The opinions expressed are his own)
Stocks and other risky assets are rallying around the world this week because the Group of 20 nations said on the weekend they would keep the economic stimulus flowing, a state of events which illustrates where we are and what a very strange place it is.
The G20, the only group of big hitters that matters because it is the only group which includes the Chinese, met in Scotland over the weekend and, as is the way of these things, did very little with immediate consequences for anybody.
In the communique they issued, the Group of 20 finance ministers, after congratulating themselves on the recovery, more or less admitted that the measures we once thought of as heroic are in the process of becoming commonplace.
“However, the recovery is uneven and remains dependent on policy support, and high unemployment is a major concern,” the statement said. “To restore the global economy and financial system to health, we agreed to maintain support for the recovery until it is assured.”
Let me put that in human terms for you:
“We’ve spent untold trillions saving the economy, but, er, we’ve really only saved the financial system and that only to the extent that we keep on saving it. Jobs, well, not so much. We therefore pledge to continue doing this thing that may or may not be working until we are sure that it is.”
Property taxes, utility bills (you call them rates I think) haven’t changed and the towns and cities haven’t noticed that the bubble burst. In fact the property taxes and utility bills still creep upward due to their own COLA logic. This does not help the consumer who is supposed to be stimulating the economy through big consumer spending. None of this local taxation does anything to stimulate economic activity. It just sucks up income on more or less unproductive efforts. All town projects are really on hold. But it must be nice to work for the local schools or town hall. Talks with my dear old Dad remind me that this is what the Depression was like. You were well off if you worked for the Town or State government – but those days almost sound humane because town or state employees didn’t have contractual cost of living adjustments.
All the towns and cities may be doing is waiting until the dollar has inflated to levels where the assessments seem like they match and make sense again. Our houses won’t be more valuable, they will only sound like they are. But nothing much is selling so I can’t understand how that will ever work. Since the property in towns and cities has dropped appreciably in price and still aren’t selling, how can it ever get back, even with inflation, to the levels before the prices collapsed? There is some increase in the employment here but the wages haven’t risen. A very few more people can now pay their bills but those bills are getting larger. They have invisibly risen dramatically actually, because they are being based on assessments made at the peak of the bubble. But in visible terms they are still also rising.
It’s a little like living in an expanding universe and actually feeling the phenomenon.
from The Great Debate UK:
Is a bubble burbling in financial markets?
-Jane Foley is research director at Forex.com. The opinions expressed are her own.-
The discrediting of the efficient markets theory in the aftermath of the financial crisis appears to have been accompanied with growing support for the view that rather than efficient in nature, financial markets are predisposed towards the formation of bubbles.
A bubble can simply be defined as an occurrence that begins when the price of an asset has been driven significantly above it "fair" value. According to the efficient markets theory this would not happen.
If bubbles are a natural outcome of financial market activity it is relevant to ask whether the very loose fiscal and monetary policies of many central banks and governments are presently sowing the seeds of the next bubble.
Even though the real economies of the U.S., UK, Eurozone and Japan continue to be defined by expectations of rising unemployment and falling real wages, access to cheap money has already helped restore the profitability of many investment banks.
In turn, this has fed risk appetite which is evident in the rally in stocks since the spring, increased demand for "risky" currencies and a recovery in commodities prices. Brent oil has rallied by 128 percent from its 2009 low. The ability of oil to rally despite the existence of oil supplies well above the seasonal average suggests there is already speculative element in this market which could be in danger of driving prices above their fair value.
This week’s meetings of the Federal Reserve, the Bank of England and the European Central Bank have focussed attention not so much on rates, but on the extraordinary policy decisions taken by these central banks in the wake of the financial crisis and whether conditions are ripening in favour of a gradual withdrawal of some of these policies.
Jane, since you assert that the demand for crude was flat while the price was rising, a plausible explanation would be that the whole production curve has been elevated to compensate the loss in US$ value. I think that conditions for spotting a bubble formation stages should be investigated in correlation with the level of affordability for the end consumer. The housing bubble was predicted 2 years in advance, based on this kind of approach.
However, in repeated statements, Middle East suppliers were not shy spelling out that their comfort zone prices were between US$75 and US$80 when the barrel was hovering around US$60. In very short time, prices on the market have been elevated to a plateau of US$80, with no apparent changes in observable factors concurring in price formation. Therefore, what is the mechanism of translating a statement of desire into effective pricing in a market deemed free?
Position fatigue prompting short-term dollar rethink
– Neal Kimberley is an FX market analyst for Reuters. The opinions expressed are his own –
Dollar bears have been disappointed by the G20.
Talk of re-balancing remained just talk; the bears can discern nothing substantial. Some risk is being taken off and dollars bought back selectively. While the dollar’s general downtrend is intact, there are risks of a temporary reversal, with some seeing the euro temporarily back to $1.4500/50.
Traders can contrast G20 with the Plaza Accord in 1985 which was driven by U.S. Treasury Secretary James Baker’s persistence. But he only had to convince four peers. G20 is and will be a different story. Dealing with the G20 must be like herding cats.
Disappointment over G20 has come at an inauspicious moment. Extensive short dollar foreign exchange positions have been underpinned by the unparalleled provision of dollar liquidity by the world’s central banks.
The market has used that dollar liquidity to fund purchases of other currencies and assets. Currency speculators raised their bets against the dollar in the latest week to the most since March, 2008, data from the Commodity Futures Trading Commission on Friday showed.
But the market is realising that the major central banks are contemplating the initial steps in their exit strategies, which would naturally reverse the dollar-funded carry trade.
I second that Anubis ! Add the air that was destroyed in the process too. See also for gold holdings, mind the double counting:
http://en.wikipedia.org/wiki/Official_go ld_reserves
The irony is that the largest producers own very little of their own gold.
Getting ready for the dollar’s fall
It just won’t go away, this needling worry about the U.S. dollar losing its coveted top-dog status.
No matter that there are plenty of reasonable arguments to support the dollar as the world reserve currency — namely there’s just no alternative — for perhaps decades to come.
Yet, in a world where once-rock-solid assumptions quickly turn to dust, investors should keep an eye on the dollar since changing perceptions are chipping away at its cherished status as currency to the world.
Much of the debate so far this year has centered on creating an alternative to the U.S. dollar, championed by China and Russia as a way to wean the world off its dependence on the U.S. as well as buffer individual nations against the missteps of those in developed world. Most recognize creating a new currency will take years and the chances of an existing currency, like the yuan, usurping the dollar anytime soon are remote.
But that doesn’t mean big money isn’t starting to prepare for world in which the buck isn’t the currency of choice.
Curtis Mewbourne, a portfolio manager at PIMCO, has suggested that investors diversify away from the dollar and to move into other currencies, especially those in emerging markets.
“And while we have not yet reached the point where a new global reserve currency will arise, we are clearly seeing a loss of status for the U.S. dollar as a store of value even in the absence of a single viable alternative,” he wrote in an article published on PIMCO’s website.
I keep reading articles like this which still seem to use the same old tired arguments concerning dollar status. This is very disappointing. A possible look at the real prevailing strategies used by China and other creditor nations easily reveals that the dollar has many enemies:
* According to a MarketWatch article, China has pulled all her gold bullion holdings from London and is moving them to a new high Security location near the airport in Hong Kong. This may be China’s own attempt to start her own bullion market in the Far East. This action also clearly restricts and damages the London Bullion Market’s gold leasing capabilities. The Gulf States have also done the same.
*China kicked off issuing her own Treasuries on Sept 28 of this year. These bonds are a direct competitor to US Treasuries.
*The Chinese govt is now discreetly buying gold from her own gold mines after suddenly becoming the largest producer of gold in the world.
*The Chinese people can now buy as much gold and silver as they like — all 1.3 billion of them. This is being heavily promoted by the Chinese govt.
*The Chinese govt is slowly buying gold on th markets. Every time the uS govt dumps dollars onto the gold markets, China just buys gold safely in the dips with her dollars. Therefore, the US has lost control of the gold price and has therefore lost control over dollar value. The Chinese are now in control of the greenback.
* China appears to be returning to a partial gold standard. If China controls the gold markets as well as backs her Yuan with gold, the strength and stability of the Yuan will be untouchable and unassailable when compared to other world fiat currencies.
*China’s own sovereign wealth fund — China Investment Corporation(CIC) — has spread its investments out rapidly and very effectively, investing around the world mainly in extractive commodity industries. The CIC has alot of weight to throw around — $300 billion — and, amongst others, has been investing heavily in the oil and precious metals markets. Effectively, China’s CIC fund is dumping dollars for gold and other more worthy hard asset investments now.
*It appears that other world central banks have also begun buying gold now, as a hedge against the China gold plays.
*Recently, in an UK Independent article called “The Demise of the Dollar”, the countries of China, Russia, France and the Gulf states all openly announced that they would be dumping the petro-dollar for the euro. Iran will also be doing the same.
In terms of economics and the markets — particularly pertaining to the adverse affects on the dollar — these are certainly not trivial economic events.
If the author would bother to actually research what’s really going on with the dollar, she could perhaps put 2+2 together and form a believable opinion. I’m not saying that all this will happen quickly, all I’m saying is that the dollar is well on its fading way, and will probably end up, after some years, as merely a regional currency amongst equals as opposed to being the top dog currency.
Get ready for the “Great Immoderation”
– James Saft is a Reuters columnist. The opinions expressed are his own –
The recession will soon be dead, laid to rest alongside the idea of the “Great Moderation”, a set of hopeful assumptions that underpins expectations about economic growth and asset valuations.
This, when investors, bankers and executives ultimately realise it will cause them to pull in their horns, take less risks and be less willing to pay high prices for assets.
Economists, observing that since the 1980s recessions have been mild and short and expansions long and robust, developed the theory that better economic management, namely cutting rates in the aftermath of bubbles, globalisation and, get this, improvements in financial markets, had led to a sort of best-of-all-possible-worlds “Great Moderation”, in which economic volatility fell and with it the risk premia required for holding financial assets.
This little theory has, needless to say, come somewhat unstuck during the current downturn which has been great but far from moderate.
This raises the uncomfortable possibility that the last 25 years of good times were just a bit of luck, or even worse, an artificially engineered consumption binge with central banks and governments playing a role similar to what Chicago tavern keepers used to do — opening up early so last night’s patrons can have a quick nip to take the edge off on the way into work.
It’s a debate which is far from academic and its outcome will influence much more than the actions of central bankers and regulators.
Well James, I am glad that this is simply a ‘recession’ and that it appears to be coming to an end. It is nice to know that the bank stress tests were such a success despite the fact that the test was ‘rigged’ from the start. Read Dr Martin Weiss on this. It is also interesting that banks are so strong that they do not have to mark derivatives etc mark to market but can value them at what they like. I wonder why the market value is not correct? Oh it is a simple thing called insolvency.
Well I am off to fantasy island now James to pump this market and spend my money. No doubt I will meet you there James, along with the CNBC crew and a whole pile of other economists etc. Great days are coming-NOT!
