Currency Wars

[Dr Mordrid]

Bloomberg....

Bernanke Bludgeons China With Inflation as Currency War Intensifies....

We’re in the throes of Currency War III, and Ben Bernanke has won the first offensive by flooding China with inflation.

If this sounds like a geeky online game, recall how Chinese prices surged after the Federal Reserve unleashed its quantitative easing in 2009 and 2010, one of many moves James Rickards parses in his somber book, “Currency Wars.”

“It was the perfect currency-war weapon and the Fed knew it,” he says, describing how the Fed’s expanding money supply forced China to print more yuan to maintain its peg to the dollar. “China was now importing inflation from the United States through the exchange-rate peg after previously having exported its deflation to the United States.”

Enough was enough, as President Barack Obama has now summed up the U.S. view that the yuan remains undervalued.

Rickards, whose CV includes stints at Citibank Inc. and Long-Term Capital Management LP, has written one of the scariest books I’ve read this year. Though I was tempted at first to dismiss him as alarmist, his intelligent reasoning soon convinced me that we have more to fear than fear itself.

Part history, part primer and analysis, the text covers topics ranging from the “misuse of economics” to complexity theory. The pieces, although disparate, fit together snugly, as in one of those mystery jigsaw puzzles that come with clues in lieu of cover art. The picture that emerges is dark yet comprehensive and satisfying.
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[UtwigMU]

Things are getting messier year by year. I also think rating agencies (who are only approved by US Government) had a part in downgrading some of PIIGS ratings so as to undermine Euro. Usually currency/trade wars lead to real wars.

Next 5-10 years will surely be interesting.

As in supposedly Chinese curse "May you live in interesting times."

[Umfriend]

Things are getting messier year by year. I also think rating agencies (who are only approved by US Government) had a part in downgrading some of PIIGS ratings so as to undermine Euro.

BS. The rating agencies are approved and regulated by the EU as well (google ECAI, somewhat similar to NRSRO. One of them downgraded the US as well.

It's funny, sometimes they are late and they get blamed, sometimes they are on the spot and they get blamed again. I find the scrutiny they are under ridicoulous given that these are all private companies. EU is proposing a ban on distressed sovereign nations. Another politicians' folly who dreams of a political reality that will not be achieved due to economic reality.

[VJ]

The problem with the rating agencies is that there are no consequences if they get it wrong. Lehman Brothers had one of the highest ratings up to 2 months before they went down. As a result of that, they may be a bit more cautious, and rather err on the other side. But this can cause a down spiral that is impossible to get out of: a country's rating goes down, it has to pay more for loans, can't manage, so it's rating goes down again... (basically: because you can't pay, you will have to pay more) Another example of them getting things wrong without consequences: just recently, one agency incorrectly lowered the rating for France - this was corrected again the next day, but a lot of damage can be done in one day. If this would have happened to a less stable country for instance...

IMO, they should only update the ratings that change the interest at fixed times (e.g. 2 times per year), but with intermediate warnings so that the country can take measurements (and these measurements are given enough time to show their effect. Now, a warning is issued, markets immediately respond, and the country does not have time to act.
Alternatively, they could cancel or freeze the rating, not dissimilar to how a stockmarket closes if all stocks go down too much (or if things are going wrong), to allow the markets to stabilize first.

So we need things like the rating agencies, but I think the whole way the system works should be modified somewhat... Just my 2c...

[dZeus]

The problem with the rating agencies is that there are no consequences if they get it wrong. Lehman Brothers had one of the highest ratings up to 2 months before they went down. As a result of that, they may be a bit more cautious, and rather err on the other side. But this can cause a down spiral that is impossible to get out of: a country's rating goes down, it has to pay more for loans, can't manage, so it's rating goes down again... (basically: because you can't pay, you will have to pay more) Another example of them getting things wrong without consequences: just recently, one agency incorrectly lowered the rating for France - this was incorrected again the next day, but a lot of damage can be done in one day. If this would have happened to a less stable country for instance...

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I don't like credit rating agencies business model (getting paid by the people who issue the debt), as it creates an atmosphere where they're easily corrupted (as the rating of securitized sub-prime mortgage debt shows). But downgrading countries can definitely not be blamed on these rating agencies. Rating agencies usually change their rating long after the credit market and CDS market already has priced in the new rating. In other words: they're behind in their decisions. Of course some of these markets are easily distorted by the act of buying up debt by central banks.

The main issue is that the stock market reacts violently to 'after the fact' realizations on changes of creditworthiness by these rating agencies (so much for the efficient markets hypothesis). If holders of bonds would be forced to mark to market, the potential write-off of the price of bonds would be far more gradual in time and not cause these big shocks. On the other hand, holder of bonds that keep them till maturity are not affected by the trading price as long as there is no risk of solvency of the issuer.

PS. I rely on Umfriend to correct any non-sense in above post

[Umfriend]

Of course rating agencies (like any risk-assessor) err. Everyone does. I just don't believe the service they provide would be improved by political influence. Hell yeah, Greece would have vowed to repay all in time 2-years ago and if the EU could, they would have forced a AAA-rating on all EU countries.

Make no mistake, by the time Greece went below investment grade, it was clear that they would face problems making payments when due. Even here, the rating agencies were late and Greece and the EU were (and still are) very slow in taking measures alleviating the credit risk of the PIIGS. I believe the complaint that the downgrades worsen the crisis is insincere, what worsens the crisis is the inertia of the debtors.

Normally, rating agencies do issue "warnings", that is they put a rating on "watch". The only thing it takes for a country to not be downgraded is take adequate action timely. A no-go.

I don't see why a private company issuing opinions should be forced to change assesments at fixed intervals nor do I see how that is in the interest of the creditors. As they are publishing their opinions, I would even argue that it would be a odds with freedom of speech. It would just increase uncertainty (and potentially larger downgrades as they comprise a period of 6-months as opposed to as, if and when appropriate). Any bad new might increase volatility as creditors are basically on their own in making their assesment.

Countries simply should not take that much of debt to finance spending. Easy as that.

The comparison with a cease-of-trading in stocks I do not buy (a cease for 5 or 10 minutes as opposed to months).

[Umfriend]

I don't like credit rating agencies business model (getting paid by the people who issue the debt), as it creates an atmosphere where they're easily corrupted (as the rating of securitized sub-prime mortgage debt shows). But downgrading countries can definitely not be blamed on these rating agencies. Rating agencies usually change their rating long after the credit market and CDS market already has priced in the new rating. In other words: they're behind in their decisions. Of course some of these markets are easily distorted by the act of buying up debt by central banks.

The main issue is that the stock market reacts violently to 'after the fact' realizations on changes of creditworthiness by these rating agencies (so much for the efficient markets hypothesis). If holders of bonds would be forced to mark to market, the potential write-off of the price of bonds would be far more gradual in time and not cause these big shocks. On the other hand, holder of bonds that keep them till maturity are not affected by the trading price as long as there is no risk of solvency of the issuer.

PS. I rely on Umfriend to correct any non-sense in above post

Not much wrong with your post. I think stating that credit and CDS markets already price in expected new ratings is contradictionary to stating that there are violent reactions on ratings though.

There certainly is an effect of down (or upgrades) on prices but most is indeed already reflected in prices (see e.g. the recent rise in interest rates on Italian debt).

Although a case could be made for marking-to-market (I am a proponent of that but only for rather marketable assets and excluding hedges pursuant to a sound policy so by far not as extreme as IFRS), a case for valuing at historic cost ("amortised cost") for hold-to-maturity assets (this is a policy choice, not a property of the asset!) can be made as well. However, even at amortised cost, loan loss provisions must be made which should cover for the risk of insolvency.

[Umfriend]

On the business model: issuer-pays model certainly has its issues. "Easily corrupted" is quite a stretch I think but yeah, it has issues.

All rating agencies started out as subscriber-paid services. A number of the smaller rating agencies still are. As a result, ratings were not public information and the number of subscribers was low. So the issuer-pays model does cause a lot of information to become public at no cost to the public. I submit that this is a large benefit to society, paid for by the issuers.

If you don't trust them, simply pay one of the others for the ratings.

[Brian Ellis]

I'm totally opposed to ratings agencies. They cause their own prophecies to be fulfilled and, in doing so, no doubt profit from insider trading.

Almost inevitably, they emit downgrading on European government bonds on a Friday afternoon after trading has ceased in Europe but continues in the US, just after a massive sell-off of the country's bonds. This is a selling short operation, as there is important rebuying after the announcement when the price is lower and the yield is higher, especially if the maturity is long term. Typically, this can increase anyone's holdings by up to 10%. Easy money! I suspect S&P's French fiasco was similar and no accident or mistake.

Self-fulfilling prophecies because many investors and, worse, analysts believe them and react to their pronouncements. The trouble is that these guys prefer to listen to the agencies, rather than do their own analyses. Recently, Moody's downgraded all three of the local banks on the pretext that they are exposed to the Greek 'haircut'. This was probably justified with Laiki Marfin Bank which invested heavily in Greece. It may have been partially justified with the Bank of Cyprus which claimed assets and liquidities covering the value of Greek investments. It was not justified with the Hellenic Bank which claims that their total exposure to Greek debts is less than 5% of their total. In fact, they divested their Greek holdings several months ago at a loss, long before Moody's became delirious.

They are evil.

[Umfriend]

Uhm, those are stark accusations. Any source/evidence? I would point to par. 2.1 of Moody's Code of Conduct (no trading in securities by employees where there is a conflict of interest).

Re. Hellenic Bank, that one was downgraded because of the downgrade of Cyprus itself as a result of which government support for the bank, if needed, became less likely or more limited. Same for Bank of Cyprus. Both one notch.

Only Marfin was downgraded 3 notches and that was indeed also due to the Greek exposure, at about 91% of Tier 1 capital. With a 50% write-down, they will fall short of the minimum Tier-1 requirements significantly and with present market conditions it'll be quite a challenge to recover from that.

In short, your factual claims are wrong.

Moreover, had there been no rating agencies, it'd be virtually impossible to discover this information as a potential investor/depositor. At least now, the public can gauge the risks. Without it'd have been a black box and probably NO investor would consider investing any funds in these banks anymore. Rating Agencies typically get more information from Issuers than they are willing to provide to the public. I maintain that the rating agencies, with all their flaws and errors, provide a valuable service to the financial industry and the public.

[Evildead666]

Since when has a "code of conduct" stopped anyone from doing the exact opposite ?

At the moment, countries have been hit by the huge debt and loans that they were allowed to accrue over the past few years before 2008.

2008 happened, and the banks all started wanting their money back from the bad loans. Unfortunately, this was not possible.

[VJ]

Normally, rating agencies do issue "warnings", that is they put a rating on "watch". The only thing it takes for a country to not be downgraded is take adequate action timely. A no-go.

True, but the markets respond to these warnings. IMO, the warnings should only be issued to the country. Then the country can take appropriate action without the markets pre-emptively responding.

It would just increase uncertainty (and potentially larger downgrades as they comprise a period of 6-months as opposed to as, if and when appropriate). Any bad new might increase volatility as creditors are basically on their own in making their assesment.

Maybe, but it is a bit odd knowing that an agency can issue a warning, and then the rating *might* change any time between the next week or the next 6 months... or not at all. There should be some fixed time before it changes...

Countries simply should not take that much of debt to finance spending. Easy as that.

True... but we are now in the different situation where that much debt is present.

The comparison with a cease-of-trading in stocks I do not buy (a cease for 5 or 10 minutes as opposed to months).

I believe the stock market in Moskou closed for a week, a few years ago.

Uhm, those are stark accusations. Any source/evidence? I would point to par. 2.1 of Moody's Code of Conduct (no trading in securities by employees where there is a conflict of interest).

Yes, but you would have a hard time convincing me that everybody is strictly following that code of conduct. Of course what they do is illegal, but there is lots of money involved. I do believe that if it happens it is due to individuals rather than "company policy", but individuals can cause a lot of damage (e.g. Barings bank).

[Umfriend]

Since when has a "code of conduct" stopped anyone from doing the exact opposite ?

Good point. Just like a lack of any evidence has never stopped people from making accusations.

At the moment, countries have been hit by the huge debt and loans that they were allowed to accrue over the past few years before 2008.

2008 happened, and the banks all started wanting their money back from the bad loans. Unfortunately, this was not possible.

Not so sure, I think it is more that banks and other parties became unwilling to extend further financing.

[Umfriend]

True, but the markets respond to these warnings. IMO, the warnings should only be issued to the country. Then the country can take appropriate action without the markets pre-emptively responding.

Why? There is no contract between the countries and the rating agencies. They are not a public institution. How much reliance would you have on a rating agencies' opinion if you know that they warn debtors but not creditors?

Maybe, but it is a bit odd knowing that an agency can issue a warning, and then the rating *might* change any time between the next week or the next 6 months... or not at all. There should be some fixed time before it changes...

Again, why? I think it is valuable information that a rating agency is going to asses recent developments and which direction they expect the assesment to take. In any case, these are private companies and I do not see why they should comply with politicians' folly.

True... but we are now in the different situation where that much debt is present.

So countries took on to much debt and therefore the rating agencies should change behaviour? That's like telling a bank they should be more lax towards a debtor because they can't meet their obligations.

I believe the stock market in Moskou closed for a week, a few years ago.

Any source? Way shorter than semi-annual. Moreover, why not then enforce a cease-trading on government bonds in certain circumstances as opposed to require something from the rating agencies? See what'll that do: option to cease trading at the whim of the debtor.

Yes, but you would have a hard time convincing me that everybody is strictly following that code of conduct. Of course what they do is illegal, but there is lots of money involved. I do believe that if it happens it is due to individuals rather than "company policy", but individuals can cause a lot of damage (e.g. Barings bank).

Fraud occures all the time everywhere. But I see no substance to the accusation made by Brian. As a side note, Greece has consistently underreported its debt. Had any private party done so they'd have been indicted.

I don't mind parties taken to account for their mistakes. I do mind parties being accused without substance and I do mind parties being accused of wrongdoing when their behaviour has been rather consistent and the underlying cause lies elsewhere (and the parties making the accusations are the causing parties).

[Brian Ellis]

Re. Hellenic Bank, that one was downgraded because of the downgrade of Cyprus itself as a result of which government support for the bank, if needed, became less likely or more limited. Same for Bank of Cyprus. Both one notch.

It is quite unlikely that Hellenic would ever need government support, as they are at almost no risk from dodgy investments, except local mortgages most of which are covered by positive collateral. Even the recent ones were limited to 80% (I think) of valuers' assessments or purchase price, whichever was lower. Older ones benefit from enormous increases in property values (e.g., my own house is now worth between 3 to 3.5 times what I paid for it outright in 1997, even with the very depressed property market). The biggest risk is from property developers that have vast quantities of unsold/unfinished houses and apartments. A number of these have already gone bust and more are likely as they cannot keep up interest payments. However, the banks are rarely foreclosing on smaller developers which are not limited companies because of a complete mess on title deeds.

Yes, Cyprus was downgraded, two notches, by one of the agencies, ostensibly because of the explosion in July that castrated the country with power shortages. In reality, it was because of poor economic administration with inadequate "austerity measures", yet they knew full well that a round of tougher measures was on the point of being anoounced and a third one is now in the pipeline. Even more important, they knew that important fossil fuel finds were being announced (US-based Noble Energy yesterday said its Cyprus gas prospect, where exploratory drilling is now underway, holds estimated gross resources of 3 to 9 trillion cubic feet (tcf) of gas.). This will be confirmed with more accurate numbers in about a month when the drilling reaches the bottom, where they estimate there will probably be some billions of barrels of oil. Maybe more short-selling on the quasi-certainty of hydrocarbons being exploitable.

Also, Cyprus has negotiated a short-term loan from Russia of several billion euros (don't remember the exact figure) at only 2.5%, ostensibly as security against investors wanting cash for bonds that mature early next year, rather than an exchange to more recent bonds which I think are offered at 98% of par with 4.75% yield and 10 year maturity. Our problem is more immediate cash flow than a negative balance sheet. The austerity measures are designed to address this problem, if the Ministry of Finance are to be believed (????)