Bernanke’s high stakes poker game at the G-20
By Peter Navarro The opinions expressed are his own.
Ben Bernanke is about to play the biggest poker hand in global monetary policy history: The Federal Reserve chairman is trying to force China to fold on its fixed dollar-yuan currency peg. This is high-stakes poker.
Although Bernanke will not be sitting at the table to play his quantitative easing card when all the members of the G-20, including China, meet this week in South Korea. Every G-20 country is suffering from an already grossly under-valued yuan pegged to a dollar now falling rapidly under the weight of Bernanke’s QE2. In fact, breaking the highly corrosive dollar-yuan peg is the most important step the G-20 can take for both robust global economic recovery and financial market stability.
Regrettably, China continues to believe — mistakenly — that the costs of a stronger yuan in terms of reduced export-led growth outweigh three major benefits: increased purchasing power to spur domestic-driven growth, significantly lower costs for raw materials and energy, and a dramatic reduction in speculative hot flows rapidly pushing up inflation.
Of course, the biggest victim of the peg is the U.S which can never eliminate its huge trade deficit with China through currency adjustments. The resultant chronic trade imbalance shaves almost 1% from America’s annual GDP growth rate and costs almost 1 million jobs a year.
Europe, with the notable exception of Germany, suffers a similar problem because of a euro overvalued relative to the yuan. Moreover, as the dollar-yuan pair declines under the weight of QE2, the risk of recession in Europe rises. For its part, Germany largely avoids the peg’s damage through robust exports to China. In addition, Germany’s higher savings rate coupled with vaunted cost efficiencies have allowed it to gain at the expense of other more free-spending countries of the euro zone. Politically, this spells trouble because Germany’s separation from the euro zone pack makes it the one country most likely to align with China.
In sharp contrast, Japan has been brought to its knees by China’s fixed peg. Every time the U.S. dollar declines in value and pulls the yuan down with it, Japan (as well as fellow G-20 members South Korea and India) lose more jobs and growth to China. As a further injury, China has aggressively pushed up the yen up through massive interventions in the Japanese market.
Michael Lewis’ Big Short an unsettling experience
Henry Paulson didn’t see it coming. Nor did Timothy Geithner foresee the meltdown of the financial markets. According to Standard & Poor’s President Deven Sharma, testifying before Congress in the fall of 2008: “Virtually no one – be they homeowners, financial institutions, ratings agencies, regulators, or investors – anticipated what is occurring.”
Why? Perhaps “it took a certain kind of person to see the ugly facts and react to them – to discern, in the profile of the beautiful young lady, the face of an old witch,” says Michael Lewis, author of numerous best-sellers including 1980s Wall Street memoir Liar’s Poker and now The Big Short: Inside the Doomsday Machine (W.W. Norton, $27.95).
Lewis’ new volume is an entertaining and very edifying look at several such insightful people — the tiny handful of investors “for whom the trade became an obsession.” These were unusual, “almost by definition odd” folks, soon to make big money on the cataclysm: There is Steve Eisman, the former Oppenheimer analyst who regularly demonstrated a prodigious “talent for offending people,” notably in a tendency to trash subprime originators as early as 1997.
Next up is Michael Burry, a compulsive, “one-eyed money manager,” a man profoundly uncomfortable around other people who could only work alone in his office with the door closed and the shades drawn. Poring over obscure corporate documents, Burry saw the insanity in the financial markets and in 2005 began prodding big Wall Street firms to offer credit default swaps, or financial insurance policies, against the failure of mortgage-backed derivatives. Finally, there’s the “weirdly like-minded” threesome who made up the money-management outfit they called Cornwall Capital Management. They were “sweet-natured, disorganized, inquisitive” –”the kind of guys who might turn up at their fifteenth high school reunions with surprising facial hair and a complicated life story.”
This band-of-outsiders conceit is familiar — reminiscent of everything from Huckleberry Finn to The Dirty Dozen – and if The Big Short were no more than a collection of such profiles, it would satisfy many readers. But Lewis’ volume has lots more to offer thanks to its clear explication of exotic derivatives and meltdown events.
Much of this may be familiar to regular readers of the financial press, and may remind some of Wall Street Journal writer Gregory Zuckerman’s much lauded account of hedge-fund trader John Paulson’s $15 billion coup, The Greatest Trade Ever. But even these readers are likely to admire the lucidity of Lewis’ book. Here, for example, is how Lewis explains the two financial instruments at the heart of the mess. The subprime mortgage-bond-backed collateralized debt obligation, or CDO, was “so opaque and complex that it would remain forever misunderstood by investors and rating agencies.”
It was a bunch of mortgage bonds, often rated triple-B, used to construct an entirely new tower of bonds, which ratings firms like Moody’s and Standard & Poor’s were persuaded to rate triple-A. The CDO, which hid huge risks via obfuscation, “was a machine that turned lead into gold” for Wall Street, writes Lewis. The credit default swap, meanwhile, was effectively an insurance policy with semiannual premium payments – but also an asymmetric bet. As in roulette, “the most you could lose were the chips you put on the table; but if your number came up you made thirty, forty, even fifty times your money.”
Anyone know how to get in touch with Cornwall Capital? I’m really impressed by their methods and I’m looking into establishing my own derivative based hedgefund.
“Dollar demise”: Inexorable but not sudden
– Neal Kimberley is an FX market analyst for Reuters. The opinions expressed are his own –
LONDON (Reuters) – An article in Britain’s Independent newspaper on Tuesday rightly attracted a lot of market attention with its provocative heading “The demise of the dollar.” While subsequent and almost co-ordinated denials from numerous capitals have taken the steam out of the story, the dollar’s role is again under scrutiny.
While the geopolitical realities of the Middle East would arguably rule out the re-pricing of oil in non-dollar currencies at this time, that may change in the future.
Alarmist conclusions that the dollar is on a swift road to ruin are wide of the mark. The road will be long and at its end the dollar will not be ruined, but it will be less important.
The dollar remains, however, on the back foot as the story resonated with a market that was already looking for an excuse to unload the greenback. Sovereign reserve managers, working for future generations, will have taken note. These stories add to the uncertainty of holding vast sums of dollars in trust.
It has long been the fate of reserve currencies to depreciate and be displaced. Global reserve currency status has always encouraged the beneficiary nation or empire to live beyond its means, safe in the knowledge that the rest of the world must hold its currency to pay for goods and commodities. The Roman dinar, the Spanish reale and most recently the British pound are all examples of currencies that have gradually lost their reserve status in this manner.
The key point is that the process is gradual. Displacement occurs in baby steps, small incremental developments which eventually create an unstoppable momentum. When the European Community first posited the idea of the single currency, the markets (particularly in London) sneered. Yet the euro was born and has prospered.
The demise of the dollar has been gradual. It has been on a downward slope since the early 1970′s. We are now witnessing the final descent and this will be rapid. Watch for the proposed “One World Currency” to begin circulation around 2012.
No U.S. bounce from China’s safety net
– Christopher Swann is a Reuters columnist. The views expressed are his own –
Offer a U.S. Treasury secretary visiting Beijing one wish, and he will certainly opt for a revalued Chinese currency. Offer a second, and the probable choice would be a strengthened social safety net.
Timothy Geithner followed bipartisan tradition when he recently called on the Chinese to strengthen their social benefits. Indeed, it has become an article of faith that a solid welfare state will allow the Chinese to curb their abnormally high savings rate — which is at the heart of the global economic imbalance.
Luckily for Geithner, this consolation prize appears within reach. China’s spending on welfare rose 27 percent last year.
Particular excitement has surrounded China’s plan to provide near-universal healthcare by 2011. Free from the need to stockpile for a medical emergency, the Chinese people will be more able to splurge on consumer goods, it is thought.
Jim O’Neill, Goldman Sachs’ chief global economist and the doyen of China enthusiasts, argues that this is perhaps the most important public policy in the world at the moment.
Yet while welfare reform is almost certainly good for the Chinese, it may do precious little for the United States. Hopes for China on this front are based on half truths.
Mr. Swann, this is one of the most incisive analyses I’ve read with nearly a quarter of a century living in Asia, 4 in mainland China and 4 in Macau (while it still belonged to Portugal).
When I lived in Tianjin 1985-86 and Beijing 1986-88, the commorn street intelligence held that a typical worker saved around 40% of his or her income, partly because there wasn’t all that much to buy and partly of the then-extant cradle-to-grave system that provided for practically everything. While I’m certainly no expert on anything at all to do with economics, that seemed to be borne out by Chinese I knew, including the family of a lady from Beijing I married. Her Mother save 35-40% of her salary, while her Father usually hit the 50% range (but, then, his salary was considerably higher than hers). Other friends, colleagues, and students (I taught in universities) told me comparable stories. I even got into the act myself after marrying, knowing that we would be going to the U.S. for further studies for my wife, and in about 19 months, earning the equivalent of $400/month, I saved about $2750. But even I had few expenses, though I didn’t get *quite* everything a Chinese citizen did.
So, I’m a bit puzzled by the percentage saved as cited in your article. True, what I read was in the popular press, and my direct experiences with Chinese were (1.) only anecdotal, and (2.) univerfied — I never asked anyone to show me their bank book or to see the stash under the bed or whatever.
I returned to mainland China for nearly a year 1999-2000, and even that late my boss and his wife, both of whom worked, after about seven years of marriage (and having a daughter along the way) saved enough money to buy multiple household high-end goods (television, refrigerator, sound system, etc.), a late-model used car, and a late-model used motorcycle — AND an apartment measuring about 750 dquare feet. And their families both were dirt-poor, so it wasn’t the daddies forking over a chunk.
Anyway, I thoroughly enjoyed the article and learned some things from it — thanks!
Clarity important for Europe stress tests
– Leo Apotheker, co-CEO and member of the executive board of German software maker SAP AG, is a guest columnist. The views expressed are his own. —
The U.S. government’s recent bank stress tests were all about clarity. With hard data and clear facts, they shone a bright light on the shadowy uncertainties of complex financial transactions.
The question now is: Will this sort of clarity be a part of doing business in the financial industry?
Bank regulators in the European Union should look at the U.S. example and make results of their upcoming stress tests of European banks transparent to the public.
Currently, they intend to inform only the EU finance ministers and executive agencies.
U.S. Treasury Secretary Timothy Geithner hit it on the head when he said last week, “There is a reassurance in clarity.”
I think many would agree that reassurance is vital to the return of confidence in the financial system.
Central bankers in Europe are significant political actors who derive much of their independence from providing the regulatory and monetary infrastructure that allows banks to thrive. Given their political heft, it is not surprising that across Europe, central bankers are not embracing stress tests, especially pan-European stress tests. Engaging in transparent stress tests and publishing results will inevitably lead to political contestations that will have the potential for embroiling central banks in political tussles. So when European central bankers either believe that bank stress tests are useless or that they do not need to be performed at an individual bank level, they are engaging in a politically defensive move.
This is understandable if one believes that the external environment will correct enough to provide an exogenous boost, but highly risky for three reasons. First, the absence of stress tests at the individual bank, country, and regional levels may make it very hard to spot co-varying risks across banks and the region. Should there be any additional shocks, exogenous or otherwise, the banking sector will indeed become the subject of political competition and the central banks will not be spared involvement.
Second, it may be very difficult for distressed European banks to raise significant additional capital after this period because of a persistent lack of confidence in some European banks. These two preceding scenarios are not particularly far-fetched given the less than ideal conditions across Europe for high margins on deposit-taking activities.
Finally, a lack of interest in stress tests and in coordinating stress tests across Europe, provides the banking lobbies, who have proven themselves very adept at maneuvering within short political calendars, with an opportunity to reassert themselves. This could create the latitude for an additional variety of poorly regulated practices. And we know where that has led us.
Summers’ compensation intensifies reform doubt
The weekend revelation National Economic Council chief Lawrence Summers received almost $5.2 million in salary and other compensation last year from hedge fund DE Shaw and Co, and hundreds of thousands more in speaking fees from other banks, has dealt another blow to the administration’s fast-waning credibility on financial reform.
Summers and protege Treasury Secretary Timothy Geithner have already attracted criticism for a strategy many commentators believe is unduly favorable to Wall Street.
For all the talk of beefed up supervision and stringent capital requirements in future, financial assistance to the banking system has come with few conditions. Anxious not to offend powerful Wall Street interests, Treasury staff have consistently pushed back against attempts to impose compensation restrictions or other penalties on recipients of public funds.
It all stands in marked contrast to the tough line being taken with General Motors and Chrysler. Bank chiefs were invited to discuss the industry’s future at the White House; GM CEO Richard Wagoner was summarily dismissed.
Wall Street’s special treatment is justified by citing the industry’s pivotal credit-creating role. But there is a widespread suspicion financial interests have captured the government agencies, legislators and senior officials meant to regulate them. It is the type of rent-seeking behavior common in emerging markets and associated in the past with militant industrial unions and President Dwight Eisenhower’s military-industrial complex.
In a thoughtful article in the latest edition of The Atlantic magazine, former IMF chief economist Simon Johnson argues U.S. policy has been controlled for the past two decades by a “financial oligarchy” which exercises influence through campaign contributions and the regular exchange of top personnel between Wall Street firms and the White House, Treasury and other institutions meant to regulate them. It promotes an identity of views between the regulators and the regulated.
The disclosure of Summers’ earnings simply fuels that impression, and the administration’s decision to publish the disclosure forms on a Friday afternoon shows awareness of the embarrassing appearance of business as usual for an administration that came to power promising “change we can believe in.”
Maizie, you are correct. What the Fed does is a responsibility the U.S. Constitution requires the congress to fulfill. That power was given away in 1913. The Congress is good about giving away their powers; War Powers Act, FISA, Patriot Act, Homeland Security Act….
The fact of the matter is Executive Branch administrations are all beholding to some large corporate interests. This particular administration appears to be in the pocket of Wall Street and High Finance. Summers, Geitner and Emmanuel should all be replaced. They are to closely tied to Wall Street.
A private entity of powerful bankers and bureaucrats controls the money with no government oversight. The definition of a Fascist State is a form of government generally, though not always, headed by a dictator who serves the interests of large industries. I think the U.S. banking system qualifies as a large industry.
World stuck with the dollar, more’s the pity
– James Saft is a Reuters columnist. The opinions expressed are his own –
The dollar is, and will remain, the U.S.’s currency and its own and everyone else’s problem.
The idea of creating a global currency, as espoused by China earlier this week, is interesting, has a certain amount of merit and is simply not going to happen any time soon.
U.S. desire for free access to the cookie jar that being the world’s reserve currency represents will be too strong, especially given its need to finance huge amounts of debt reasonably cheaply. As well practicalities are fearsome, even if consensus was more or less there.
Chinese central bank head Zhou Xiaochuan on Monday called for the creation of a new “super-sovereign” global reserve currency, advocating building on an International Monetary Fund instrument called Special Drawing Rights.
Zhou echoed a call by Russia last week, when it indicated it would raise the issue at the upcoming Group of 20 meeting in London on April 2, saying the idea had support from emerging market economies including Brazil, India, South Korea and South Africa.
There is no doubt that the current system breeds instability, but it enjoys the great advantage of entrenchment and sticking with it allows the U.S., and others, to avoid making hard choices and paying true market prices for their economic decisions.
The biggest problem with a world currency and a mega-strong IMF is who will be in charge after all, whom will the IMF be responding to? Without democratic supervision, IMF may turn into the worst type of Frankensteinian monster ever created. And let us keep in mind that IMF is actually ruled by the US.
By linking the currency the Chinese have linked the US and Chinese economy. What better than to have no currency risks with your major customer. If the US devalues then its currency will also devalue vs the rest of the world giving it competitive advantage.
When the Fed pumps money into the economy, it is in effect pumping money into the combined Chinese US economy. Guess where all the money will end up. In low cost/ high return China ofcourse.
So you have inflation in China and deflation in USA. If the Chinese dont give in on exchange rate and they just tighten then there could be a hard landing in China. Thats after a hard landing happens in other developing economies and US enters another recession. Hopefully sense will prevail before then.