US Dollar – Positioning and Sentiment
Between the summer of 2014 and its recent peak in March this year, the US dollar index was a one-way street – a blow-off like move that mainly mirrored the equally relentless decline in the euro, which has been suffering from the ECB’s misguided ministrations. The euro has the by far largest weighting in the dollar index (nearly 58%). In the meantime, euro area money supply growth has begun to significantly exceed US domestic money supply growth (year-on-year growth in money TMS: euro area 12.4%, US dollar 7.5%) and interest rate differentials have turned in the dollar’s favor as well, so the revival of the dollar does make some sense from a fundamental perspective – only the size of the move has been a surprise. Recently the dollar has gone through its biggest correction since the rally began. Below we will take a look at a wide range of relevant positioning and sentiment data to illustrate where things now stand.
Image via Istock
An Accelerating Trend
While the euro itself has recovered a bit from its worst levels in recent sessions, euro basis swaps have fallen deeper into negative territory. In order to bring the current move into perspective, we show a long term chart below that includes the epic nosedive of 2011. We are not quite sure what the move means this time around, since there is no obvious crisis situation – not yet, anyway.
A negative FX basis usually indicates some sort of concern over the banking system’s creditworthiness and has historically been associated with euro area banks experiencing problems in obtaining dollar funding. This time, the move in basis swaps is happening “quietly”, as there are no reports in the media indicating that anything might be amiss. Still, something is apparently amiss:
Not Quite Right in the Head?
The belief that the market economy requires “steering” by altruistic central bankers, who make decisions influencing the entire economy based on their personal epiphanies, has rarely been more pronounced than today. Most probably it has actually never been stronger. It is both highly amusing and disconcerting that so many economists who would probably almost to a man agree that it would be a very bad idea if the government were to e.g. take over the computer industry and begin designing PCs and smart phones by committee, think that government bureaucrats should determine the height of interest rates and the size of the money supply.
Photo credit: Michael Probst
The Fed has Provided the Bulk of Money Supply Growth since 2008
We have discussed the topic of money supply growth extensively in these pages over time. Below is a brief recap of how the system works in the US. Note that although fractional reserve banking and central bank-directed and backstopped banking cartels are in place all over the world, there are several “technical” differences between them. So the workings of the US system cannot be transposed 1:1 to e.g. Japan’s system or the euro system.
There are two possibilities of growing the fiat money supply: In “normal” times, commercial banks will extend loans which are partially “backed” by fractional reserves. These loans create new deposit money, which once again can serve as the basis of further credit creation, which again creates new deposit money, and so forth. It can be shown mathematically that based on a hypothetical fractional reserve requirement of 10%, extant deposit money in the system can be grown 10-fold (for a detailed discussion of the “money multiplier”, see here).
A Relentless Downturn
When Chinese investors discovered that Bitcoin might offer an avenue for circumventing China’s exchange controls, the digital currency soared to an incredible $1,250 per unit (on some, but not all Bitcoin exchanges – prices tend to vary a bit between the different exchanges). This was of course not only due to the perception that exchange controls could be evaded with Bitcoin; the Chinese are well known for their love of gambling after all. As real interest rates were in negative territory for long stretches of time in recent years, China’s citizens have sought out all sorts of investments to preserve the purchasing power of their savings – Bitcoin was just one more option, but China’s authorities ultimately cut this option off.
Image credit: fmh
Game of Chicken Continues, EU Ratchets Up Pressure on Greece
After the ECB has made Greek debt no longer eligible for repos (note that this mainly concerns government bonds however, bank bonds that have been “guaranteed” by the government will however no longer be eligible after February 28 2015 either – these amount to a quite large € 25 billion), fears of an intensifying bank run in Greece are growing. At the end of December, Greek banks owed about € 56 billion to the euro system. This is estimated to have jumped to about € 70 billion since then.
These debts to the system have grown concurrently with a sharp decline in deposit liabilities since November last year, when it dawned on people that there might be an election. Unfortunately more up-to-date data aren’t available as of yet, but we will try to post them as soon as the Bank of Greece makes them available. However, there exist estimates regarding the extent of the decline in deposits since the end of December as well – very likely an additional € 15 billion has fled from the Greek banking system since then.
Central Bank Madness is Contagious
Lately central banks around the world are busy slashing interest rates (if they still have any to slash), or printing money more or less outright if they have bumped into the much-dreaded zero-bound. In fact, the newest fad is to cut interest rates even if there aren’t any left to cut. The minus sign on the keyboard has turned out to be useful after all!
Not only are the Keynesian dunderheads running the SNB at it (there is absolutely no reason to elevate them to quasi-sainthood just because they kicked an untenable peg out from under the euro), but lately also Denmark’s central bank. Note here that Denmark is home to one of the biggest household and mortgage debtbergs on the planet, relative to economic output. We somehow doubt that the credit bubble will be kept in check by slashing interest rates to minus 75 basis points.
The Danish situation – Denmark’s household debt to GDP ratio and the central bank’s crazy negative benchmark interest rate. Note how two tiny baby-step rate increases were enough to send the credit bubble into wobble mode – click to enlartge.
No More Dancing Naked in the Streets …
When the BoJ’s board last voted in favor of enlarging its “QQE” (qualitative and quantitative easing) program even further, from already enormous amounts to nothing short of gigantic amounts, the board’s vote was 5:4 in favor, with outgoing board member Ryuzo Miyao considered to have cast the “swing vote”.
As Chris Woods of CLSA remarked at the time, in a society like Japan’s with its strong focus on consensus, “they might as well have been dancing naked in the streets”. Indeed, something like this has never happened before, although some resistance to Kuroda’s plans already reared its head previously. At most though there would be one or two members voting against further inflationary measures, but never nearly half of the board.
As Reuters reports, this problem is about to be dealt with this year. The newest nominee to the BoJ’s board is Yutaka Harada, reportedly a “committed reflation supporter”. That should actually read “inflation supporter”, because “reflation” is really just a euphemism for “inflation”. While he replaces another inflationist, the government will soon have the oipportunity to tilt the balance on the board more permanently toward loose monetary policy with the next appointment, as one of those who voted against further easing will leave the board in June. At this point one can probably be fairly certain that no suspected “hawk” stands a chance of being nominated by Shinzo Abe’s government anytime soon.
Inflation proponents Koichi Hamada (the Tuntex Professor Emeritus of Economics at Yale University), left and Yutaka Harada, right (as an aside, another well-known Yale-educated inflationist is former Argentine central bank governor and serial money printer Mercedes Marco Del Pont)
Photo credit: tokyofoundation.org
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