Thought Bubbles from the Deep

[qldfrog]

interesting entry by wysiwyg
https://www.aussiestockforums.com/forums/showthread.php?t=13317&page=3
I suppose the debate/definition of services can go there if anyone wants to add their views

 

[DeepState]

Incredible reach, Sinner.

What about Freegold (which is none of the above)?

I am officially exposed to the concept....

If one has looked deeply into it, surely one has read of and understood the Triffin dilemma and its implications. Did you know Mr Triffin later helped form the European Monetary System?

He saw it coming in 1959. Smart guy!

Dismantled is a strange way to put it, I would say the US strategically defaulted on obligations to prevent the incessant draining of Treasury gold by US trade creditors and raise the local price of oil in hopes of making local fields more viable. I challenge different interpretations! (can also see the Yamani quote in Flow Addendum link at the bottom of this post).

Would you prefer collapsed? I figure it was a slow motion pulling apart of the original premise that went for some time. Perhaps you can anchor that date from the end of the Gold Pool. Maybe you could argue that the growth in USD claims in the international market grew too large and the process outlined by Triffin could be seen to pre-empt the end of the system. Triffin's framework outlined why the liquid dollar claim system was inherently more unstable than the Gold standard in pure form [abomination]. The predictable outcome was that the US could not constrain itself when it had such a monetary advantage. Too much of a good thing and policy errors.

On oil, it was not without precedent that import restrictions were applied. The Nixon Shock was accompanied with an import surcharge. If the US wanted to improve the local competitiveness of oil producers, it didn't have to depreciate. It had other tools. Some, like limiting exports of oil, were subsequently used. A depreciation, though, would have this effect.

A strategic default? When you cannot make good your pledges, it's not really a choice when the debt is called. The system was decaying and the financial situation was getting worse rapidly before suspension of convertibility. It was technically bankrupt (foreign claims exceeded official gold for the US) in about 1968. The gold run, precipitated by accelerating international circulation of US money, made the situation untenable. The gig was up when the current account turned negative even as FDI and foreign donations continued. The decay part of Triffin's dilemma bit. It is true that they could have drained gold to zero and pulled the plug before that. So it is strategic in the sense that they got to pick a date. That would be the rough equivalent of some South American country making a strategic choice to abandon a USD peg when it basically runs out of reserves. They don't generally run this stuff to zero. They don't fight losing battles to the very end when the gig is up. Perhaps a strategic withdrawal.

An examination of the Balance of Payments historical data reveals that the world did not collapse largely because the European and Gulf blocs of Central Banks (marginal net creditors) allowed the US to export inflation via building up huge piles of bonds. The BoJ also joined in around this time and has never really stopped. Objectively, this is structural support for the USD to stop an otherwise large shockwave from disrupting the economy.

Leading up to the Nixon Shock (1971) and through to the end of the Smithsonian Agreement (1973), the balance sheets of the foreign Central Banks became stuffed full of US monetary assets. It was not supposed to be that way. It was shoved onto balance sheet. When convertibility ended, free float did not emerge. It was Dollar Standard. There continued to be sustained US liquidity internationalisation, accelerating under a erroneous combination of Phillips Curve doctrine and Full Employment policy (not balanced with an inflation target) at the time.

There are always two sides to a ledger. Were the foreign CBs supporting the USD and allowing the export of US inflation? Or were they protecting their own exporters by keeping their currencies cheap relative to an overvalued USD. Heading into the Nixon Shock, inflation in Japan, France, UK and Germany exceeded that of the US. So it is an odd, but technically plausible, claim to imply that the foreign nations were prepared to absorb excess US inflation and thus bought bonds. I think another explanation is that they had to absorb bonds because the new exchange rates were still misaligned with the USD being overvalued despite being depreciated post the closure of the gold window. If the Smithsonian Agreement had worked, and monetary growth in the US were better contained (it was not pulled in), this accumulation of bonds would not have occurred. It is evident that the foreign powers weren't doing this for fun because the collapse of the Smithsonian Agreement saw a dramatic reduction in the rate of reserve accumulation.

And so it was for ~30y until 1999 when the Euro was officially launched. Lucky for the USD, just as the European CB bloc was winding down structural support of the USD, the Chinese stepped up to the plate and were acting as the marginal structural support until the GFC.

EZ countries continued to acquire Treasury assets after the Euro was launched. In substantial volume. It might be argued that the EZ never wound down structural support. They continued to be a meaningful proportion of Treasury owners, buying more and more, at an increasing rate. However, an acceleration of debt issuance was absorbed by Chinese reserve buying, along with other Asia post Currency Crisis Official Reserve build. After all, the White House was presided over by George W with a strong appetite for deficit spending. Of course, it could be argued that China and Asia produced a savings glut which forced the US into excess deficit spending and over-investment. Can't please everyone I guess.

When you say "what matters for money...", if you are referring to "easy money" then I'd 100% agree with the above. Easy (credit) money is one of the greatest human inventions of all time! It would be utterly foolish (and likely impossible) of us to regress back to a hard money system.

But the use of easy money as the global reserve asset leads to Triffins dilemma. Hmm...if only there was a monetary system that was created on a basis of understanding this principle

You're a genius, Sinner. What do you make of the Banco alternative?

Acknowledging that that the flow of monetised metal (for the purpose of reserve asset) does in fact matter goes a long way in understanding historical events as far back in time as Roman invasion of Arabia over the flow of spices causing a drain on Empire gold in 24AD, European (mostly British) invasion of China over the flow of silk and tea causing a drain on Empire silver in the 17th and 18th Century causing the First Opium War, the "Nixon Shock" in the early 1970s, the launch of the Euro and many others

Totally amazed yet again.

 

[sinner]

You're a genius, Sinner. What do you make of the Banco alternative?

haha no genius here, just an avid reader of FOFOA.

Just wanted to answer this one quickly, will try and post a longer reply to the rest tomorrow.

From the "Freegold Foundations" post I linked above

So often in commentaries of this sort that propose a “solution”, the author is strangely obsessed with the notion of replacing the dollar (as a reserve currency unit) with simply another institutional emission of similar ilk (such as currencies of other nations, SDRs, bancors and whatnot). Their avoidance of any meaningful discussion of the most obvious remedy is almost pathological in the extreme. To be sure, we don’t need to invent any manner of universal reserve currency to fill the role of a unit of account because that role is already served in a fully functional capacity for any given country by its own monetary unit.

What IS desperately needed, however, is a universally respected reserve asset capable of filling our current void with a reliable presence that serves as a store of value. And far from needing to be conjured or created by complex international committees, that asset is already in existence and held in goodly store by central bankers and prudent individuals around the world ”” it’s known as gold. From amid the ruins of a chaotic financial crisis that was brought about by its own complexity, a degree of sanity will prevail, and gold as a freely floating asset will arise in stature as THE important element of global monetary reserves. The floating aspect is the vital evolutionary improvement over all previous structural monetary failures which tried to use a gold standard at a fixed price (i.e., unit of account) perversely joined to the very elastic money supply of any given country’s banking system.

Totally amazed yet again.

Can't recommend FOFOA enough, his posts are long but worth it (IMHO).

 

[DeepState]

Thought for the moment: When people talk about the option value of cash, how are you supposed to figure out what that value is? This type of assessment is needed so you can determine whether it is better just to invest in something else that you think might make you money.

Trigger for thought: Recent El Erian article in FT.

 

[sinner]

Thought for the moment: When people talk about the option value of cash, how are you supposed to figure out what that value is? This type of assessment is needed so you can determine whether it is better just to invest in something else that you think might make you money.

Trigger for thought: Recent El Erian article in FT.

If using cash for "option value" (assumed to mean hedging equity volatility) then I would consider it as merely another form of insurance, because after all the return profile will be different depending on the market regime, just like with options.

In bull markets, holding puts or cash will underperform although cash is better than puts as you're not paying volatility premium.

In range markets, holding puts or cash will outperform, but whether puts or cash is better depending largely on the hedging regime implemented.

In bear markets, holding puts or cash will outperform although puts is better than cash as you harvest the volatility premium.

The determinant of the value is largely driven by demand and we can infer from proxies of demand. e.g. the "option value" (again assuming this to mean hedge) of options is well proxied by VIX and the "option value" of cash is well proxied by the inverse of the relative change in price for a broad range of riskier assets.

 

[DeepState]

participation.... If you drill into this number, the implications are really much worse. The decline in this number has been driven by the exodus of 16-55 cohort from the workforce, and would look worse if it wasn't for the >55 cohort rejoining the workforce in droves as their retirement plans went out the window (thanks to low 401k returns and negative real returns on savings thanks to ZIRP/QE).

The standard thinking on this goes that the decline was driven partly by demographics and partly because the younger generation chose to go to college for a while. This is not rebounding to baseline levels that would be anticipated allowing for the demographics argument (despite your comments likely being true as well). As a result, many in the Fed believe that there is more slack in the labour market than appears the case from the unemployment figures alone. Wage rises, for example, remain low when the unemployment rate is not too far off what would be regarded as full employment levels.

Then I came across this today. The WSJ refers to a recent paper in Proceedings of the National Academy of Sciences of the USA (www.pnas.org). It was co-authored by Deaton, a winner of the Nobel for Economics this year.

It finds that mortality for middle aged whites is, increasing, breaking a very long trend of declining mortality. Reasons include suicide, alcohol abuse, chronic liver disease...offsetting declining lung cancer prevalence. The increase in the rate of mortality for the middle aged from drug and alcohol overdoses jumped past diabetes, liver disease, suicide and lung cancer since 2000. It is incredible.

Although focused mostly on those with high school level educations in middle age, the pattern is also visible across other education and age demographics. Hispanics and Blacks continue to see mortality levels declining. Hence, the rise in mortality is very stark. Period of this observation is 1999-2013, compared with prior data. No other rich country is showing such stats.

It appears that economic stress may be having very significant impacts on the white population (hollowing out of the middle class would hit this demographic most, I guess).

It does not look directly related to the GFC in the sense that these patterns appear to break from trend in the early 2000s. Still.

Notice how the participation rate for Whites drifts lower whilst it is flat to up for Blacks and Hispanics in recent years.



At first pass, this looks like a pointer to the real cost of inequality.

 

[sinner]

Thought for the moment: When people talk about the option value of cash, how are you supposed to figure out what that value is? This type of assessment is needed so you can determine whether it is better just to invest in something else that you think might make you money.

Trigger for thought: Recent El Erian article in FT.

I also remember Warren Buffett says something about cash being a call option with no strike, no expiration, etc and the premium is calculated as the return on cash minus the return he could get from other assets.

 

[DeepState]

I also remember Warren Buffett says something about cash being a call option with no strike, no expiration, etc and the premium is calculated as the return on cash minus the return he could get from other assets.

I should have been clearer, but this was what I was ultimately referring to.

That premium will be known after the event. It is higher for people with excellent investment skills. Yet the option value is also higher for those with greater investment skill. What's the trade-off?

I can definitely see the value in the case of illiquid investment and in other situations where good ideas to deploy cash are sporadic and substantive when they come.

I suppose the concept is easy to understand if you think of the world as having a departure point of cash. Yet Buffett thinks the departure point is pretty much fully invested in stock (at least for his wife's endowment).

:dunno:

 

[DeepState]

Some thoughts.

30 Sept 2015 [XAO Banter Thread]

Yes. I am long biased. Equity positions have been a maximum of 75% of target exposure over the last year as valuations in the US looked rich. Positions in Australia were cut by 2/3rds in July and by half in Europe/UK at about the same time. Currency exposure to the USD buffered the pain, as have bond positions. Still, there is pain.

Have recently rebuilt the international equity positions to full weight and remixed currency exposures (less USD and more EUR and JPY..thankfully).

Where are the balls of steel buyers??? 15%+ Peak to trough. Big statements when markets are up. Silence now.

US PAYROLLS

Early this morning the US non-farm payrolls figure for October was released. It was a strong figure and the expectations for US Fed tightening moved higher. Along with this, we have seen the USD strengthen vs major currencies, gold weaken (more than by the USD general appreciation would imply), long bond yields in developed markets climb and CDS spreads decline. A good day.


RISK AVERSION UNWIND

This announcement follows on from a retracement of significant fears in the market that dragged indices down heavily in late August following adverse economic developments in China. Most notably, these were the Flash Manufacturing PMI, devaluation of the Yuan and wild correction on the equity markets that were not well contained despite a range of ad hoc policy measures and arrests. Trade data that came out later in the month were not helpful either. On top of this, Brazil was not doing well. Concern was significant for an EM risk event. Economic and financial risks were downside skewed. Somewhere in there was increasing concern for the implications of a low oil price for the financial worthiness of related firms and reduced economic activity in the US as a result of lowered exploration and development activity.

Since then, equity markets and other indicators have been much more positive and the fear spike has been materially unwound. If I were to summarise, it was another fear of China collapse that did not (yet) eventuate.


AUSTRALIAN MONETARY POLICY

I am interested in the outlook for Australian policy rates in the next six months or so, for various reasons.

The RBA has had monetary settings at a record low of 2% for official cash. It has been ratcheted down as a result of adjustments from non-mining investment and much lower than expected commodity prices. Also, despite business conditions improving a long way since 2013 and now at pre-crisis levels, investment activity remains constrained (outside of mining). A key question is whether rates are expected to decline further.

The RBA expectations for GDP are a return to potential growth levels in FY 2017 and pretty healthy in FY 2016. Inflation is slightly on the low side of the target band and, when the oil impact washes through and tradeables inflation comes though following the depreciation of the AUD, inflation is pretty much in the zone. Unemployment is expected to decline in a year or so. Though employment growth will be there, an increase in the participation rate is expected as market conditions improve. I imagine a measure of re-training might be required and workforce re-tooling is necessary when an economy goes through this magnitude of change.

This is taking place during the year where the peak effect of declining mining investment is taking place. Also, there was a slight downgrade of 2015 GDP expectations because of delays in bringing on energy exports that are soon to boost our current account. A delay in timing, not volume.

On an expectations basis, this is not the sort of thing which requires an interest rate cut. These assumptions were also built on an assumption of static exchange rates which have declined since the forecasts were cut. The AUD has weakened since and USD strengthening is expected at the lift-off event. Lift-off expectations are now looking much more likely in the next six months. Hence, these estimates are now slightly bearish cases. On top of that, commodity prices are now seen to have upside risk skews.

More on the bull case are expectations of further monetary easing from Japan (although Kuroda said that all was good in the last 24 hours and Abe claims that Japan is escaping deflation). If this occurs, it would be a strong boost to our exports. It would be a positive stimulus to Japan's domestic economy (which consumes Australian energy and raw materials) and the impact of monetary policy flows throughout Asia, stimulating theirs. It will also impact interest rates in the US (Japan is stepping in to buy US Treasuries as China becomes a net seller). Japan, rest of Asia and the US are our largest export destinations.

China cut the RRR twice since the risk spike commenced in earnest and has cut policy rates. It has plenty of room to keep stimulating but is must be acknowledged that the reserve drain is worrisome. For some reason that still mystifies me, they defy the hurdles that would befuddle any other major economy in the way in which all this hangs together. Ultimately, the Yuan is expensive and will be devalued unless there is a major reversal (as opposed to stasis) in the opening of the capital account...freezing money from leaving the country. If they take the initiative, it will be positively regarded. If it is reactive, it will be seen as a sign of weakness. Direct and contagion effects are evident.

In recent comments and observations from Yellen, EM risks have receded a long way. This aligns with what the market is now pricing elsewhere and what Dep Gov Lowe is now thinking.

The case for a cut in rates exists because the slow wages growth indicates that there may be more slack in the economy that could do with a boost if inflation expectations do not come through. In other words, they have underwritten inflation. More slack can emerge if slowing housing price growth, low real wages growth, heightened unemployment, slowing residential construction growth... leads to an increase in the savings rate. The recent round of variable mortgage rates is unhelpful in this regard, unless you are a stock holder. If this dynamic takes hold, kiss non-mining business investment good-bye.

But let's think about this for a second. Is Australia is deep trouble? Not compared to Japan or Europe. What about the US? No, not really. Yet Australian real rates are zero. About the same as Europe and Japan. That's how much stimulus is currently going on. When seen this way, the US has got to lift the monetary pedal. The whole question is the pace. Each time the US lifts rates, it basically implies that Australia has eased from an international markets perspective if at least some of this is taken via exchange rates.

Anyhow, I am a little surprised that there is presently no talk at all of a potential rise in Aust rates in the later part of 2016. What seems to be factored is a flat line in monetary policy for any mid or upside scenario and a healthy chance of another cut if inflation were to drop to maybe 1.5% and for this to be seem to be a problem. The chances of that are currently assessed at less than 15% over the next 12 months but pricing is higher than 40%. Hmmmm.

 

[Trembling Hand]

AUSTRALIAN MONETARY POLICY

I am interested in the outlook for Australian policy rates in the next six months or so, for various reasons.

The RBA has had monetary settings at a record low of 2% for official cash. It has been ratcheted down as a result of adjustments from non-mining investment and much lower than expected commodity prices. Also, despite business conditions improving a long way since 2013 and now at pre-crisis levels, investment activity remains constrained (outside of mining). A key question is whether rates are expected to decline further.

I would be surprised if investment activity doesn't continue to disappoint for a long time compare to our economy of 5-10-20 years ago. There is little left of the capital intensive manufacturing industries after AUD being stronger for longer. Whats left is niche operations which are not big spenders and the dreaded services which don't require much spending to employ another 100 dudes at desks with a cheap Dell compared to 100 dudes on a production line.

 

[qldfrog]

the dreaded services which don't require much spending to employ another 100 dudes at desks with a cheap Dell compared to 100 dudes on a production line.

But Joke aside I agree with you;
Qld focused:

I have the feeling qld is getting a bit better than it was a year ago job wise, but salaries/rates are down.
This is anecdotal, and i also observe the rate of carpark filling at train stations etc; more traffic;
I also believe we are at the end of a local tradies boom (due to RE boom/renovation;
as i see it, white collars jobs showing sign of life, tradies going down, manufacturing & mining anihilated.

Currency wise, I tend to believe the US will not raise rates next month, nor in next year and may even try to push lower:they might get inventive early next year with another QE style;

i have a substancial interest in USD and am wondering if I should start moving these into other currencies after what has been a good ride for this financial year.
On the other end, a rise next month would be quite nice unless it triggers this feared EM collapse!!!

I also believe that even with a very weak economy in Oz, at some stage the export of LNG added to the coal/IO will bring enough currency to start pushing the AUD higher
Weak local economy but some export might have some effect this way.What do you think? in that context, the RBA might lower its rate mid 2016?
Crazy thoughts?

 

[Trembling Hand]

Currency wise, I tend to believe the US will not raise rates next month, nor in next year and may even try to push lower:they might get inventive early next year with another QE style;

i have a substancial interest in USD and am wondering if I should start moving these into other currencies after what has been a good ride for this financial year.
On the other end, a rise next month would be quite nice unless it triggers this feared EM collapse!!!

I also believe that even with a very weak economy in Oz, at some stage the export of LNG added to the coal/IO will bring enough currency to start pushing the AUD higher
Weak local economy but some export might have some effect this way.What do you think? in that context, the RBA might lower its rate mid 2016?
Crazy thoughts?

Yeah I think your idea of more US QE rather than a hike soon is deep in the contrarian corner.

 

[sinner]

Yeah I think your idea of more US QE rather than a hike soon is deep in the contrarian corner.

One single tiny rate hike of half of half of half a percent? Maybe.

Nascent trend of slowly raising rates? Actually not possible without significant increases in GDP or commensurate decreases in the Fed balance sheet. I put the probability of balance sheet reduction near 0 ergo also consider rate trend extremely unlikely without strong GDP numbers.

While we are on the topic, can someone explain to me the difference between QE and Federal deficit spending unbacked by fresh Treasury issuance? No? Didn't think so. Their impact on the monetary base is identical!

Maybe no more "QE" but the monetary base will suffer another debasement/expansion in volume, just the same as if Yellen took up QE, one way or another. Every dollar demanded by the ongoing deflation in credit will be matched by a shiny new dollar of base money.

One would also note that of the two camps, the "deep contrarian corner" has done a better job of forecasting the direction of rates than has the "deep conformist corner" since the GFC.



Enjoy the credit deflation while it lasts, my , because most will be shocked by what's coming after that.

 

[Valued]

I think the possibility of a fed rate hike is even higher than the market thinks it is right now. Unless the China data is bad (and it's not out yet), in my opinion it's practically guaranteed they would raise rates. Something bad needs to happen at this point for them not to do it.

 

[qldfrog]

I think the possibility of a fed rate hike is even higher than the market thinks it is right now. Unless the China data is bad (and it's not out yet), in my opinion it's practically guaranteed they would raise rates. Something bad needs to happen at this point for them not to do it.

sure +.25 in december to then walk back in march after whatever pretext..can the US afford to raise without drama, not sure

 

[Valued]

sure +.25 in december to then walk back in march after whatever pretext..can the US afford to raise without drama, not sure

The strength of the US economy is being underestimated by a lot of people. The strength of its inflation is being underestimated significantly too, at least by retail traders.

The only potential weakness in raising interest rates is the housing market and employment could be a little better, but the strong job growth numbers have eased that concern. US unemployment is higher than the 5% that is being reported. However, they are doing very well compared to everyone else.

 

[sinner]

The strength of its inflation is being underestimated significantly too, at least by retail traders.

Which measure of inflation are you looking at that tells you that? How are you measuring the inflation estimation of retail traders anyway?



BPP (http://bpp.mit.edu/usa/. in the above chart in orange) seems to track CPI pretty closely, and although the free data is delayed now I doubt the spread between BPP and CPI has widened beyond the spread between PCE and CPI...

 

[odds-on]

Enjoy the credit deflation while it lasts, my , because most will be shocked by what's coming after that.

Deflationary spiral? Hyperinflation?

Great posts Sinner.

 

[sinner]

Deflationary spiral? Hyperinflation?

Great posts Sinner.

Famous quote from FOA

http://fofoa.blogspot.com.au/2011/04/deflation-or-hyperinflation.html

"My friend, debt is the very essence of fiat. As debt defaults, fiat is destroyed. This is where all these deflationists get their direction. Not seeing that hyperinflation is the process of saving debt at all costs, even buying it outright for cash. Deflation is impossible in today's dollar terms because policy will allow the printing of cash, if necessary, to cover every last bit of debt and dumping it on your front lawn! (smile) Worthless dollars, of course, but no deflation in dollar terms!"

 

[Valued]

Which measure of inflation are you looking at that tells you that? How are you measuring the inflation estimation of retail traders anyway?

View attachment 64962

BPP (http://bpp.mit.edu/usa/. in the above chart in orange) seems to track CPI pretty closely, and although the free data is delayed now I doubt the spread between BPP and CPI has widened beyond the spread between PCE and CPI...
View attachment 64960

The core inflation rate and/or the trimmed mean inflation rate. They are 1.9% and 1.7% respectively. Most people would be focusing on the inflation rates reported in the media or in the overall inflation rate which was recorded as 0% in September.