2008 Review in Pictures and 2009 Forecast - Eric Janszen

[GRG55]

Re: 2008 Review in Pictures and 2009 Forecast - Eric Janszen

Yes, excellent stuff as usual.

I too would like know more of your thoughts on currency issues.

As regards the Renminbi and the Yen, it occurs to me that the Chinese and Japanese economies will very likely be far harder hit than the US economy. Yes, they have their best and brightest as their government officials, but I suspect a large part of their "wealth" is in fact due to false book entries.

Remember, it takes two to create a bad debt - in this case a debtor who is a bad credit risk (in this case America) and a lender with poor credit control (China and Japan).

So, did the credit bubble originate in America or in Asia? The US silliness has been at least partly exposed, but the Asian stupidity has yet to be widely acknowledged. If you have messed up you will lose face sooner or later...

The data, such that it is, seems not to support your contention. So far it would appear that Japan and China have avoided the worst of the excesses that have plagued European banks, communities in Norway north of the Arctic Circle, and the outback of Australia. China and Japan holdings seem concentrated less in CDOs and more in holdings of Treasuries and US agencies, the latter which now has explicit US government backing. The losses they have seen, especially Japan, are related to the currency risk of holding US$ denominated instruments, not due to risk of outright default.

Many others also suspect that much of the "wealth" in Asia is "false book entries"...but I haven't seen anyone actually back that up with any facts.

And at the end of the day whether China has $2 T, $2 B, or just $2.00 of actual reserves, it would seem it is still a hell of a lot more solvent than the United States of America or the United Kingdom at this moment in history.

[metalman]

Re: 2008 Review in Pictures and 2009 Forecast - Eric Janszen

The data, such that it is, seems not to support your contention. So far it would appear that Japan and China have avoided the worst of the excesses that have plagued European banks, communities in Norway north of the Arctic Circle, and the outback of Australia. China and Japan holdings seem concentrated less in CDOs and more in holdings of Treasuries and US agencies, the latter which now has explicit US government backing. The losses they have seen, especially Japan, are related to the currency risk of holding US$ denominated instruments, not due to risk of outright default.

Many others also suspect that much of the "wealth" in Asia is "false book entries"...but I haven't seen anyone actually back that up with any facts.

And at the end of the day whether China has $2 T, $2 B, or just $2.00 of actual reserves, it would seem it is still a hell of a lot more solvent than the United States of America or the United Kingdom at this moment in history.

origins of the asian dollar accumulation? itulip search function says...

Politics of Foreign Debt - Part I: Why the government had to bail out the GSEs

To make a long story short, the practice of keeping foreign holdings of US agency and treasury debt on Fed account started under Arthur Burns in the early 1970s as a way for the US to regain control of its currency that the US was losing to the euro dollar market.

Banking expert Martin Mayer, author of The Bankers: The Next Generation The New Worlds Money Credit Banking Electronic Age and a dozen other books on banking and frequent writer for Barron’s Magazine, Institutional Investor, and others explains:Exporters to America who keep the dollars and use them for American purchases and investments create what economists call an autonomous flow of funds back to the United States, financing the American trade deficit with an American investment surplus.

This produces the argument most closely associated with the new Federal Reserve chairman, Ben Bernanke (though Alan Greenspan believed it, too), that our trade deficit is caused by a surplus of savings that can't be profitably invested in the home countries of our trading partners. Financing for our trade deficit comes before — and actually causes — the deficit itself.

If instead of investing their dollars in the United States, foreign exporters want to take the proceeds of their sales in their own currency, their central banks will in effect sell them that currency for their dollars. Back in the late 1960's, when Great Society deficits and the Vietnam War prompted the first serious sell-off of dollars (and forced the United States to abandon the gold standard because too many holders of dollars, led by President Charles de Gaulle of France, wanted gold), those central banks lent those dollars into the new Eurodollar market, where they traded somewhat separately from domestic dollars.

This created a nightmarish prospect of the United States losing control of its own currency, and in 1971 the Fed chairman, Arthur Burns, negotiated a deal with the European and Japanese central banks. The deal was that they would return to America the dollars they acquired in their own economies, and the Fed would invest the money on their behalf, in absolutely safe government securities, without charge and at the best rates.

Today, the Fed continues as custodian of the "foreign official holdings" of such government obligations. During the Clinton administration, the Fed agreed to invest in federally guaranteed housing securities for those foreign central banks that wanted a better yield on their dollar reserves than they would get from government bonds, and now half a trillion dollars* of the total official holdings are invested in agency paper.

Foreign official holdings of government paper is a miner's canary number. It tells you if there is big trouble ahead. The most common worry is that the number will shrink suddenly, with foreign governments dumping their dollar holdings, driving down the dollar's value and driving up American interest rates, but that's not a real danger. If the price of our government securities dived, the foreign central banks would have to bear the loss. This would be a budget item for their governments, whose leaders would not like it at all.

- Federal Reserve System: The Mark of the Bust, Martin Mayer, June 14, 2006

* Half a trillion two years ago, almost a trillion today.

[GRG55]

Re: 2008 Review in Pictures and 2009 Forecast - Eric Janszen

origins of the asian dollar accumulation? itulip search function says...

I have a not yet completely thought out view that the USA also wanted to take large amounts of current claims [US Dollars in the hands of foreign governments] and convert them into deferred claims [T-bonds in the hands of foreign governments].

The risk of allowing foreign interests to hold current claims in the form of actual US Dollars is the temptation to convert those Dollars into ownership of the means of production in the United States [e.g. China buying Unocal, or Dubai's DP Ports buying P&O with its USA port operations businesses]. As long as it is in the form of T-bonds the claim, and that risk, is put off into the future, and additionally, that option can never be exercised by T-bond holders without their first finding a willing buyer who will allow them to convert their T-bonds into Dollar currency with which to make the purchase [Notwithstanding that at maturity the US Government will presumably always honor the redemption and pay in US Dollars, perhaps "unwillingly", if the foreign holder declines to "re-invest" the proceeds in a new Treasury issue].

The purchase of Agencies is interesting because technically they did not represent any future claim against the US economy [other than to the degree that mortgage debtors ability to pay is related to their employment in the US economy] but instead were a claim against a so-called "asset". The change to an explicit US government backing for agencies altered that situation more dramatically than perhaps the financially illiterate in Congress truly appreciated.

[j4f2h0]

Re: 2008 Review in Pictures and 2009 Forecast - Eric Janszen

Is EJ's assertion that oil will go nowhere this year based on an assumption of peace? It seems to me with very large budding conflicts in Pakistan v India, Israel v Palestine, and our war with the Afgans ramping up, that it is possible for the supply chain to be damage to the point that supply drops further than demand creating a price spike?
I obviously dont know much but this seems very logical and plausible, any thoughts from the community?

[GRG55]

Re: 2008 Review in Pictures and 2009 Forecast - Eric Janszen

Is EJ's assertion that oil will go nowhere this year based on an assumption of peace? It seems to me with very large budding conflicts in Pakistan v India, Israel v Palestine, and our war with the Afgans ramping up, that it is possible for the supply chain to be damage to the point that supply drops further than demand creating a price spike?
I obviously dont know much but this seems very logical and plausible, any thoughts from the community?

Oil may "go nowhere" in US Dollar terms in 2009, just as gold went nowhere in US Dollar terms in 2008.

However, depending on how the US Dollar performs in the currency markets in 2009, oil may go up considerably in terms of other currencies, just as gold in 2008 went up considerably in terms of Euros, and spectacularly in terms of Canadian/Aussie/Kiwi Dollars and the British Pound [something that both Mega and hayekvindicated said they took advantage of].

Regarding the prospects of "peace" in 2009, I am doubtful. But let's remember that in times of elevated conflict and global uncertainty, there is always a rush to the senior [reserve] currency...over the past 70+ years that's been the US Dollar. Since there appears no obvious alternative today [other than the minority who prefer gold] it would not be surprising if the present, increasingly hostile, global political climate maintains a bid under the greenback. For at least a little while longer...:p

btw: This is not a trivial effect. While we go on about an oil price "crash", let us have a quick peek at two situations. In January 2008, near-month Brent crude oil was selling for about US $90 per barrel and the UK Pound exchange was about US $2.00. A domestic purchaser of North Sea Brent [like a refinery in Aberdeen] would have paid about GBP 45 for a barrel back then. Brent is currently selling for about $46.00 per barrel and the UK Pound exchange is US $1.452, meaning that same Aberdeen refiner is buying a barrel of domestic crude in its local currency for about GBP 32, a reduction of "only" 29%. Now compare that to its US competitor refiner, bidding for Brent, who has seen an input cost reduction of 49% over that same time period.

Edit added: Supply chain interruptions can have a rapid and dramatic influence over crude oil prices, but the effects are never long lasting. Even such drama as the 1979 Iranian Revolution and Iraq's 1990 invasion of Kuwait did not have long-lasting, durable influence over oil prices. It is the larger, slower macro trends that are important...political nationalism that reduces exploration and reserves development in country after country across the world; large scale shifts in populous regions from bicycles to scooters to automobiles; major increases in global air travel, that sort of thing.

[jk]

Re: 2008 Review in Pictures and 2009 Forecast - Eric Janszen

the paradox i see is that the u.s. dollar will be strong as long as the u.s. economy sucks, provided that the rest of the world is in the same bad shape. the demise of the dollar will result from any recovery here, or the rise of a strong regional economy elsewhere in the world - presumably in asia.

edit:
the old "conundrum" was that the fed lowering short rates didn't bring down long rates. now that the fed is at the zero bound, and long rates are down to a "2" handle, the new conundrum will be that the dollar stays firm, frustrating short dollar and commodity reflation plays, and frustrating hopes for an export led rebound.

domestic stimulus will be funded by the issuance of ever more treasuries, but - as long as the economy sucks - rates will stay low and the dollar firm. this leads to a paradoxical conclusion: the only hope for the dollar is that stimulus doesn't work.

if stimulus does work and the u.s. domestic economy perks up, risk aversion will diminish and investors flee low-yielding treasuries. velocity will rise as sharply as it has dropped, and the mass of money "frozen" in treasury holdings will liquify.

we are experiencing a "sudden stop" in the economy- many commentators have noted the rapidity of recent recessionary trends. the scenario described above is a "sudden start," unlocking implicit but long-standing inflationary forces. i.e. "poom."

am i making sense here? comments welcome.

[GRG55]

Re: 2008 Review in Pictures and 2009 Forecast - Eric Janszen

the paradox i see is that the u.s. dollar will be strong as long as the u.s. economy sucks, provided that the rest of the world is in the same bad shape. the demise of the dollar will result from any recovery here, or the rise of a strong regional economy elsewhere in the world - presumably in asia.

edit:
the old "conundrum" was that the fed lowering short rates didn't bring down long rates. now that the fed is at the zero bound, and long rates are down to a "2" handle, the new conundrum will be that the dollar stays firm, frustrating short dollar and commodity reflation plays, and frustrating hopes for an export led rebound.

domestic stimulus will be funded by the issuance of ever more treasuries, but - as long as the economy sucks - rates will stay low and the dollar firm. this leads to a paradoxical conclusion: the only hope for the dollar is that stimulus doesn't work.

if stimulus does work and the u.s. domestic economy perks up, risk aversion will diminish and investors flee low-yielding treasuries. velocity will rise as sharply as it has dropped, and the mass of money "frozen" in treasury holdings will liquify.

we are experiencing a "sudden stop" in the economy- many commentators have noted the rapidity of recent recessionary trends. the scenario described above is a "sudden start," unlocking implicit but long-standing inflationary forces. i.e. "poom."

am i making sense here? comments welcome.

I thought that the "old conundrum" [as expressed by Greenspan in early 2005] was one of persistently low T-bond yields, despite the Fed's repeated increase of the funds rate? [as the Fed was coming under more frequent criticism for the increasingly obvious credit-fueled housing boom/bubble]

Otherwise, I am in broad agreement with the scenario. However, temporary euphoria around the anticipated success of the government's latest stimulus announcement may result in one or more "false starts" to reapplication of the risk trade in earnest, resulting in a rocky, perhaps volatile 2009 [for all markets] such that the "sudden start" may still be an extended affair.

[rchdenton]

Re: 2008 Review in Pictures and 2009 Forecast - Eric Janszen

So, for the record, I do not place any blame at all on the likes of China or Japan. The core responsibility for the systematic failures lay at the feet of the regulators in the United States and those failures were, and remain, theirs.

Sorry Chris, the US merchant banks and others in the US just took (unscrupulous and sometimes criminal) advantage of dumb overseas lenders.

You actually reinforce my point that the finger of blame has only thus far been acknowledged in the debtor, not as yet in the equally culpable creditor.

Look at it this way, when the bank lends me money it asks for colleratal. No collateral, no lending. I have learned that if the bank don't like the look of the deal I'm trying to put together then I should seriously question why the hell I think it's so good.

You cannot have a dodgy debt without a failure on the part of the creditor. As yet the creditor nations have not acknowledged this. There is always a loss of face to do so.

[rchdenton]

Re: 2008 Review in Pictures and 2009 Forecast - Eric Janszen

origins of the asian dollar accumulation? itulip search function says...

Thanks metalman, you obviously understand where I'm coming from. Good to get to reread that.

The situation here in New Zealand is a little different and I think we are now a cycle ahead of the US.

Our currency floats freely. Our reserve bank is transparent. Our current account is in balance, we produce and sell the same value of goods and services as we buy from overseas. So the production/consumption economy is in balance with the rest of the world.

What is entirely messed up is our investment balance. Due to financial and monetary mismanagement in the 70s and 80s (very similar to the current US situation) we have a massive imbalance with foreign investors. Quite simply we messed up big time and had to sell half the country to Japan. The other half has massive debts to Japan. So far the Japanese continue to lend us the money to pay the interest on our debts provided we pay them a stiff rate.

As I see it we are where the US will be in 20 years time, except the US will still be very much bigger and in the northern hemisphere.

My above summary is a gross oversimplification but not entirely unfounded.

[rchdenton]

Re: 2008 Review in Pictures and 2009 Forecast - Eric Janszen

the paradox i see is that the u.s. dollar will be strong as long as the u.s. economy sucks, provided that the rest of the world is in the same bad shape. the demise of the dollar will result from any recovery here, or the rise of a strong regional economy elsewhere in the world - presumably in asia.

Thank you jk. Yes, that is exactly what I would like to make sense of.

I think you are on the right track there. Care to be more expansive?

[jk]

Re: 2008 Review in Pictures and 2009 Forecast - Eric Janszen

I thought that the "old conundrum" [as expressed by Greenspan in early 2005] was one of persistently low T-bond yields, despite the Fed's repeated increase of the funds rate? [as the Fed was coming under more frequent criticism for the increasingly obvious credit-fueled housing boom/bubble.

you're right. i got mixed up.

[The Outback Oracle]

Re: 2008 Review in Pictures and 2009 Forecast - Eric Janszen

rchdenton...I thought your CAD was something like 6-8% of GDP? Slightly worse even than ours here in OZ. In OZ we have sold a lot more than half the country off! (and we have the $640B debt as well)

[The Outback Oracle]

Re: 2008 Review in Pictures and 2009 Forecast - Eric Janszen

http://www.rbnz.govt.nz/keygraphs/Fig6.html

I don't know how to add a link in here but this is a graph of NZ CAD's showing a current CAD of 8% of GDP

[rchdenton]

Re: 2008 Review in Pictures and 2009 Forecast - Eric Janszen

http://www.rbnz.govt.nz/keygraphs/Fig6.html

I don't know how to add a link in here but this is a graph of NZ CAD's showing a current CAD of 8% of GDP

CAD.bmp

You are quite correct, but it is the investment imbalance that causes it.

[rchdenton]

Re: 2008 Review in Pictures and 2009 Forecast - Eric Janszen

Presumably we have got to the point where we have to pay off principal and interest or sell some more of NZ.

I still don't understand why the Japanese keep lending us more dosh to pay the interest. Is the idea of capitalising interest a banker's way of gaining ownership? Keep lending until you've got them by the balls?