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Speculation and Bubbles Continue to Rise Around Globe

Tuesday, 05 October 2010 08:33 AM Current | Bio | Archive

The Bank of Japan (BoJ) has finally cut its overnight call-rate target to a range of 0.0 percent (zero) to 0.1 percent from just 0.10 percent.

So the zero interest-rate policy (ZIRP) is finally in place in Japan, the second- or third-biggest economy in the world, depending on how you calculate it. The BoJ also set up, as a temporary measure of course, a 35 trillion yen ($420 billion) pool of funds to buy or accept as collateral assets such as government bonds, commercial paper and asset-backed securities.

In fact, we could say the BoJ now announced the effective implementation of formal QE by expanding the money supply (QP) with a commitment to continue until an inflation objective has been met (QE).

Understandingly, markets seem a little skeptical, remembering the last time QE was pursued in Japan, it succeeded in turning bad deflation into good deflation. So, we know what can be expected if no miracle occurs. I don’t think this time will be different.

Besides this, the Organisation for Economic Co-Operation and Development (OECD) said the average annual inflation rate in its area stayed steady at 1.6 percent in August and excluding food and energy, the annual inflation rate held also steady at 1.2 percent year on year.

Deflation continued in Japan for the 19th consecutive month, with consumer prices falling by 0.9 percent in the year to August. Annual inflation was 1.1 percent in the United States (down from 1.2 percent), 1.0 percent in Germany (down from 1.2 percent) and 1.6 percent in the eurozone, down from 1.7 percent in July.

So far, we could say no inflation in the near term in the OECD area.

Widespread steady high unemployment is certainly a factor that keeps real inflation and inflation expectations at low levels, for now at least. In emerging economies, we see exactly the opposite.

Coming to Europe for a moment, the eurozone's economic growth reportedly slowed sharply in September, with contractions in Spain and Ireland.

Official data also showed retail sales in the eurozone fell 0.4 percent in August, its biggest fall since April, more than expected (down 0.2 percent) and a sign that consumer demand is unlikely to boost growth in the third quarter.

The final eurozone composite output index, a measure of private-sector activity based on a monthly survey of some 4,500 firms, dropped to 54.1 in September from 56.2 in August. (A reading above 50 still indicates growth.)

Also, and this could be more worrisome, Moody's has placed Ireland's Aa2 rating on review for possible downgrade.

“Ireland's ability to preserve government financial strength faces increased uncertainty as a result of three main drivers, which together would further increase its debt and aggravate its debt affordability,” Moody’s states.

These key drivers are:

• Crystallization of additional bank contingent liabilities.

• Increased uncertainty regarding the economic outlook.

• Elevated borrowing costs.

Taking these three factors into account, Ireland is on a trajectory toward lower debt affordability during the next three to five years, Moody’s said.

So, if all this wasn’t enough … Brazil imposed fresh controls on inflows of foreign capital by increasing the existing Brazilian financial-transactions (IOF) tax to 4 percent from 2 percent.

The measure is to avoid further excessive appreciation of the Brazilian real but will not apply to money entering the country to invest in equities or as foreign direct investment (FDI.)

Conclusion: this higher levy won’t curtail the fact that many speculators will continue taking advantage of the “carry trade” that simply results from the spread between interest paid on Brazilian short-term government debt, of about 10.75 percent a year, and the cost of borrowing overseas in the U.S., Europe, Japan, etc., where money is available for speculation at about half a percentage point per year, because the speculators do so through transactions in derivative instruments that do not entail bringing foreign currency into Brazil.

Yes, long-term investors shouldn’t even think about it because here we are in “speculation and bubble territory!”

But, for the moment at least, for the speculators it has worked extremely well.

Nevertheless, I would also take notice of what the Brazilian Finance Minister Guido Mantega said: “We’re in the midst of an international currency war … This threatens us because it takes away our competitiveness … The advanced countries are seeking to devalue their currencies.”

By the way, Chinese Premier Wen Jiabao noted: “We must work together to ... keep exchange rates of major reserve currencies relatively stable.”

A number of European officials may remember ECB President Jean-Claude Trichet’s argument in favor of a return to the Bretton Woods system just two years ago. (The Bretton Woods system of monetary management established the rules for commercial and financial relations among the world's major industrial states in the mid 20th century.)

In the other camp lies the U.S. and others who, and I use here the words of former Treasury Secretary John Snow, continue to believe that “the history of efforts to impose nonmarket valuations of currencies is at best nonrewarding.”

In between, we find the likes of Japan and South Korea that would probably prefer not to intervene but find themselves forced to do so by the battle raging around them.

It seems likely that calls for some kind of currency accord will rise in volume in the days ahead, with the latest coming from Charles Dallara, Managing Director of the Institute of International Finance (IIF,) who called for urgent action by a core group of the world’s major economies to broker agreements on critical macroeconomic and exchange-rate issues.

“Sustaining growth and restoring confidence will require not only astute domestic policymaking, but an unprecedented level of multilateral coordination,” he said. “It will also require action that transcends purely domestic short-term concerns.”

However, with the U.S. and China (and arguably Europe and Japan) holding to almost exactly the same positions they had before the November 2004 G-20 meeting in Berlin, it seems reasonable, at least to me, to suppose that the outcome will be, unfortunately, the same as six years ago, which means in clear English nothing whatsoever.

So, for the investor, all this ultimately comes down to try to understand a little bit of the choices the big players could take. One the one hand the U.S. is free to choose to follow a policy toward the dollar that the former Japanese Vice Minister Eisuke Sakakibara, who is also known as “Mr. Yen,” once memorably characterized as “benign neglect.”

On the other hand, China and others are free to continue to buy dollars and euros and Japanese yen and Korean won, etc., denominated assets with the proceeds of their intervention operations.

At some point, one side or the other must, inevitably, become tired of following their chosen policy route. Given China’s clearly expressed concerns about dollar-denominated assets I think we can suspect, and contrary what many think, that it will be them rather than the U.S. that will relent.

However, as there is no way whatsoever of knowing at what point this will happen, investors are faced with the difficult choice of what to hold as a safe haven in the interim.

As I have said before, little wonder then that the Australian dollar continues to look attractive to me despite the fact that the Reserve Bank of Australia (RBA) has held its key cash rate at 4.5 percent for the fifth consecutive month.

With so many central-bank fingers poised above the “on” button of the printing presses, and with no one notably keen to see their currency appreciate against that of their competitors, I’m still convinced gold will grind higher, including the unavoidable dips, which should be buying opportunities for long-term investors, on its further way up, until “they” finally will give up on using the money printer and go back to good housekeeping.

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The Bank of Japan (BoJ) has finally cut its overnight call-rate target to a range of 0.0 percent (zero) to 0.1 percent from just 0.10 percent. So the zero interest-rate policy (ZIRP) is finally in place in Japan, the second- or third-biggest economy in the world, depending...
Tuesday, 05 October 2010 08:33 AM
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