The reader/investor who sent the link to this Bloomberg story provided the comments below. Not he does not resort to capital letters casually:
THIS IS HARD TO BELIEVE. THOSE CB’S DON’T HAVE UNLIMITED $’S,
SO IF TRUE, THEY WILL BE BORROWING THEM FROM THE FED VIA AN EXTENSION OF FED SWAP LINES,
THE FOMC HAS APPROVED LINES OF $620 BILLION AS LAST REPORTED
THIS IS FUNCTIONALLY UNSECURED LENDING TO THESE CB’S.
REPAYMENT CAN ONLY COME FROM SELLING THEIR OWN CURRENCIES FOR THE NEEDED $’S
(OR BY SOMEHOW NET EXPORTING TO THE US OR SELLING ASSETS TO THE US WHICH ARE HARD TO IMAGINE)
SOMEHOW THIS HIGH RISK, UNSECURED, ‘BACK DOOR’ LENDING HAS REMAINED UNDER ALL RADAR SCREENS.
AND, IF TRUE, WE WILL SOON SEE THE TOTAL $US FUNDING NEED IN THE EUROZONE.
So one consequence is a continued strong dollar (despite the rally in the euro due to relief over the coordinated rescue announcement yesterday), which will hurt the export sector, the one area of good cheer in recent economic news. Surprisingly, however. Dollar borrowing rates improved in Europe but remain at elevated leavls.
From Bloomberg:
The Federal Reserve led an unprecedented push by central banks to flood the financial system with dollars, backing up government efforts to restore confidence and helping to drive down money-market rates.
The ECB, the Bank of England and the Swiss central bank will auction unlimited dollar funds with maturities of seven days, 28 days and 84 days at a fixed interest rate, the Washington-based Fed said today. All of the previous dollar swap arrangements between the Fed and other central banks were capped.
“By providing unlimited dollar funds they are acting on the back of the G-7 plan to ensure the system is fully liquidized,” said Lena Komileva, an economist at Tullett Prebon Plc in London. “We’re going to see even more liquidity provided and more aggressive rate cuts are coming.”
Leaders of the world economy have redoubled efforts to unfreeze credit markets and avert the worst global recession in thirty years after last week’s 20 percent slide in the MSCI World Index. Policy makers from the Group of Seven nations pledged at the weekend to take “all necessary steps” to stem a market panic and European governments are today announcing plans to avert a banking collapse across the region.
The cost of borrowing in dollars for three months today fell to 4.75 percent from 4.82 percent, the highest this year. The rate for euros over the same timeframe declined to 5.32 percent from 5.38 percent…..
“Taken together, the latest moves increase the chances that we will begin to see some relaxation of the intense funding stresses,” Dominic Wilson and other economists at Goldman Sachs Group Inc. wrote in a note today. “This is because bank solvency risk should decline as the government offers protection.”
As well as slashing interest rates in concert last week, global central banks are expanding their toolkits to push down money-market rates. The Fed on Oct. 7 said it will create a special fund to buy U.S. commercial paper and the ECB last week said it would offer financial firms unlimited euro funds. The Bank of England is scheduled to revamp its own money-market operations later this week.
Update 9:30 AM A later Bloomberg story show further improvement in money market rates but we will have to wait to see if interbank lending starts to go out to longer tenor than overnight:
Money-market rates in Europe fell after policy makers offered banks unlimited dollar funding and European governments pledged to take “all necessary steps” to shore up confidence among lenders.
The euro interbank offered rate, or Euribor, for one-week loans dropped 26 basis points to 4.37 percent today, the biggest decline this year, according to the European Banking Federation. The London interbank offered rate, or Libor, for three-month dollar loans dropped 7 basis points to 4.75 percent, the largest drop since March 17, the British Bankers’ Association said.
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Yves, Two questions please:
(1) Why is there a need for US$ in Europe? More precisely: /who/ needs US$ in an economy where trade and local loans are in Euros?
(2) If the supply of $ is being increased, why did you write that “one consequence is a continued strong dollar”? Increasing the supply normally drops the price, ceteris paribus, n’est pas??
Merci d’avance.
jwalker
Feels like a global consolidation to me. Foreign companies and banks, backed by their central banks, are buying up stakes in US companies at no risk to themselves. Meanwhile America is tightening its dollar grip on the world and coordinating the effort with the ECB.
Matt Dubuque
First there was a worldwide shortage of Treasuries.
Then there was a worldwide shortage of dollars.
This is not consistent with a run on Treasuries.
This is not consistent with a run on the dollar.
Just the opposite.
Matt Dubuque
mdubuque@yahoo.comP
It looks lie a sop to the bagholders of US mortgage debt. They can recoup by ramping the US stockmarket and taking profits.
there is a need for $ in Europe
because Americans sold tons of debt / structured products (CDOs) etc… to (stupid) European Banks, who thought they would always be able to raise USD short term through FX swap agreements.
but they are cornered because the FX swap market is dead and involves counterparty / delivery risk, and because their collateral is NOT eligible in CBs…
if these European banks go bust, and/or eat the losses on those USD assets, they wont need any USD anymore…
Americans sold never to be repaid loans to the world to finance their consumption. It worked once, and in huge size, but it wont work twice.
Yves, I enjoy reading you site and I have learned a lot in these last few weeks. I had one question. What are the best indicators to forecast the potential for hyperinflation?
-Ty
I JUST LOVE READING TEXT WRITTEN IN ALL UPPERCASE STOP IT FEELS LIKE READING A TELEGRAM STOP BTW I REALLY LIKE THIS BLOG STOP
One reader in another post linked an article in WSJ according to which European banks are big borrowers in USD commercial paper. If they can’t roll over they have to liquidate their positions or borrow elsewhere, hence this new ‘facility’.
Although I like this blog, and especially the discussions here, I’m getting more confused now. It sounds like the FED is just so powerful, with unlimited supply of dollars. Why do you people worry about a meltdown in the last few days?
Is there any downside for FED to do this?
Did BLOOMBERG Pull this story?! I googled a sentense from the article and two hits, you and Bloomberg, yet when I go to Bloomberg, the story is changed.
Trends can continue past sustainability – but eventually they can’t continue. And that can happen suddenly. As some point everyone will realize that dollars are just pieces of paper, and the dollar will re-adjust, and in my view, dramatically.
The worldwide shortage of dollars is indicative of a huge unwinding of dollar denominated assets and debt. Think of it as stage one in a process of obtaining liquid investments – cash. This is temporarily boosting the dollar.
The big unknown is how long the foreign holdings will remain in dollars. It will be a wait-and-see whether the US economy handles the credit crisis better than others. If US country risk remains higher than other centers – stage two of the unwind begins and dollars are coverted to other currencies or gold and commodities.
Let’s see if we can break down what is happening.
Here is the equation for velocity of money:
Velocity = GDP or economic activity
————————
Money supply
Let’s take a look at what happens when the US economy tanks, ie GDP sinks, then velocity goes down. Let’s say credit collapses, cutting the money supply, then velocity starts going up, or to keep economic activity at the same level velocity goes up. We are seeing the demand for dollars because of credit collapse in an attempt to keeep economic activity from tanking.
If the Fed and treasury try to up the money supply in an attempt to keep velocity from running out of control (high velocity means running with a paycheck to buy essentials before the price goes up), then eventually the total value of that money decreases in terms of a reference, say gold.
The need for money is being seen in the current drop of gold price (liquidation to find dollars), and rise in the dollar. As the effects of the fed and treasury work through, the results will be the devaluation of the dollar, until a rise in economic activity can compensate.
The end result is severe monetary inflation, even though the current dynamics are for deflation.
Someone described it as the incredible ebb tide before the tsunami. The dollars beach is dry, but soon they will all come back and cover the buildings.
What are the best indicators to forecast the potential for hyperinflation?
There’s no need to worry about hyper-inflation short term. Just small increases in long interest rates will set off another chain reaction of deleveraging, deflation and institutional failure.
What happens to the remnants of the residential and commercial real estate markets when prime mortgage rates go up to, say, 8.5%? And at a time when real incomes are falling and lending standards are being torqued down?
Like the man said last night, sell this pop.
printfaster,
Absolutely spot on. Your tsunami metaphor sums it up nicely.
if you have the staying power play the long term play: short the hell out of the dollar and load with euro. why? the US economy is on steroids:
– 6.5% GDP shortage feeds 2.5% GDP growth. in the EU area both are equal;
– huge indebtness;
– no savings;
– expensive confrontational and inflationary military policy;
EU interest rates will be higher no matter what, bar collapse of the USD but then your short USD/long EUR play would be quite in the money.
on the other hand, there are much more powerful short term trends and the returns from what some would call ‘noise’ could be bigger.
either way stay the course and dont repeat Buffet’s 2005 currency mistake: by high, sell low. he betrayed his own rule to invest for the long run.
Anonymous @ 9:18
I’d agree, with caveat that the foreign investment is ‘no-risk’ because they are fundamentally so over leveraged their is nothing for them to risk.
The only think propping the Euro up is the CBs’ inability to print them.
Seems like the ‘solution’ to our latest troubles is to turn the crank even faster. Which might work for a while.
But only for a while.
I posted this twice yesterday and no one seems to get it:
Foreign Exchange Swap Lines
The Federal Open Market Committee (FOMC) has authorized a $330 billion expansion of its temporary reciprocal currency arrangements (swap lines). This increased capacity will be available to provide funding for U.S. dollar liquidity operations by the other central banks. The FOMC has authorized increases in all of the temporary swap facilities with other central banks. These larger facilities will now support the provision of U.S. dollar liquidity in amounts of up to $30 billion by the Bank of Canada, $80 billion by the Bank of England, $120 billion by the Bank of Japan, $15 billion by Danmarks Nationalbank, $240 billion by the ECB, $15 billion by the Norges Bank, $30 billion by the Reserve Bank of Australia, $30 billion by the Sveriges Riksbank, and $60 billion by the Swiss National Bank. As a result of these actions, the total size of outstanding swap lines is $620 billion.
I think I need a new blog to go to.
More like a bathtub than a tsunami. We’re pouring in more money, but the drain is still open. Someone has to take the losses from the CDS mess, and the central banks are still trying to save all the players. But the money is simply gone, it doesn’t exist and can’t be monetized. They’re trying to spread out the losses, but there still have to be losses.
Yves,
You might want link/comment the latest post by Setser on this subject.
Anyone factored in the potential split up of the Euro into their equations?
The european scene has been a total shamble the last few weeks. The huge political strains are only going to get much much worse over the next few months as the severe recessions start to bite in the weaker countries.
What happens when Italy or Spain buckle under the strain?
It is becoming quite clear why Japan allowed all that bad debt to stay on the books. And this was BEFORE the wholesale abuse of Credit Default Swaps.
My question is whether the world governments are going to stand behind the CDS that come with the banks they recapitalize. If so they simply can’t let the market discovery mechanism work and mark to model will rule the day.
Japan could survive because the bad loans weren’t protected by swaps. Not the case this time. Either the government has to “simulate” an income stream for bad loans or let the swaps pay off. Am I missing something here?
Donna
Your observation that it looks like a bathtub draining is exactly what is seen when a tsunami precedes with recession.
In the case of the dollar, there is a large, pent up supply of dollars and dollar monetized debt. Dollars that have been hidden in various banks around the world. Not so much hidden as sequestered.
If the value of the dollar recedes to a critical level, that supply of dollars/monetized-debt will be released. It will all come back from offshore.
Until then of course, feel free to sun yourself on the newly expanded beach.
A billion here, a trillion there. It just doesn’t look like real money anymore. Perhaps this has something to do with our economy based on number-crunching machines? Well soon enough the financial system will collapse unto itself in a computational black hole.
anon 12;50 PM,
Yep, cracking the Eurozone might be part of what in some circles is still called ‘inter-imperialist rivalry’ — or, we could say a struggle by the U.S. to perpetuate dollar hegemony even as one consequence would be another hit to same nation’s export sector.
Or heck, it may be so simple as an attempt to ressurect the stock market Keynesianism of the 1995-2000 period.
More like a bathtub than a tsunami. We’re pouring in more money, but the drain is still open.
The cycle of a stopped up flushing toilet is far closer to the truth.
Everyone’s stale nostrums, worn-out cliches and false historical analogies are failing. The scene changes like a kaleidoscope daily. That’s the neat part of truly revolutionary times. What was too radical to consider last week is already overcome by events next week.
Now, when this week’s Ancient Regime rescue plan peters out in a week or a month, what next?
This is not a mass failure of financial systems. It’s a mass failure of financiers.
Soro’s sock puppet Obama promises “real change”, unlike Goldman Sachs dominated Bush/McCain. And what’s his latest bold change? A pathetic copy from FDR’s playbook: Bank holiday – foreclosure holiday.
Obama’s a #2 alright. But he’s not FDR II. He’s Gorbachev II.
Once this phase passes, you can be sure the Fed will sterilize its past interventions.
Matt
Dont look for answers anywhere. People only have ideas but no concrete definite answers of what the future holds. Everyone of the above posts is purely hypothetical guesswork.
What a freakish occurence:
The US acting as a creditor, as opposed to a debtor.
Who knows, maybe we can make similar loans to Asia, South America and Africa…and eventually we’ll get a pristine 1:1 asset to liability balance sheet.
Good Times!
BTW:
This is an interesting take from Peter Wadkins of Thomson on today’s price action in the Euro. I don’t believe he was writing it with the subject matter of this post in his mind. Nevertheless, he seems to notice the same….just with a different perspective:
“Euro Still Baulks On Rallies New York,
October 13th. Technical analysis purists insist that price action is the most
relevant regardless of what fundamental news comes out to “bend the charts”.
Today”s action, to put it into the inimitable words of Lewis Carroll gets
“Curiouser and curiouser”. EUR/JPY took off like a rocket, hit 138.84, slammed
into a brick wall and plunged back to 138.25. As a consequence EUR/USD soared to
1.3603 and dropped back to 1.3560, and USD/JPY hit 102.16 and has eased to
102.00. Of all three the USD/JPY move is the most logical, it”s still bid
heading into what should be a buoyant Asian open.
The Euro”s behaviour seems to have a darker side to it – there were heavy
real money sales that knocked the pair down from 1.3625 to 1.3488 this morning;
there were even larger flows went through in Friday”s US session, and there
seems to be an “interested seller” around 1.3600. The litmus test will be if
Japanese stocks lift off can EUR/JPY follow, and does it drive EUR/USD higher if
not we”ll all be heading down the rabbit hole together again.”
Alas, poor Yorick! I knew him, Horatio: a fellow
of infinite jest, of most excellent fancy: he hath
borne me on his back a thousand times; and now, how
abhorred in my imagination it is!
> Someone, somewhere should look at this nice story:
Is the Prime Rate a Scam?
http://www.interfluidity.com/posts/1160447599.shtml
Now look at the graph above. The average spread between the Federal Funds Rate and the Prime Rate from August 1955 through August 1989 was 1.33%. From 1991 onward, that spread has been nearly constant at 3%. In the earlier period, the Prime Rate spread was what one would expect it to be, a variable, market-determined quantity reflecting the availability of capital and perceptions of risk even among "creditworthy" borrowers. Now it is a fixed quantity, more than double its average prior to 1989. At around the same time, sophisticated borrowers switched to an entirely different benchmark, leaving consumers and small businesses to pay the higher spread.
All this mess was triggered by the fail of LEH which drove to us dollar rallying wildly against all major currencies to cover short term funding needs. All financial assets went down, treasuries and gold more or less kept their values. In the medium and long term dollar will resume its down trend. After 10 years global imbalances are still there, now you have to deal with both a financial crisis and global recession and there is nothing one can do to avoid.
Where is the Fed getting all of these dollars “to flood the market”? Is the Treasury simply printing in over drive? Am I missing something or is pretty much EVERY solution that has been proposed over the last few weeks HIGHLY INFLATIONARY? Are we about to experience hyperinflation like we have NEVER seen?
There was a long ago television film which offers a good metaphor for this dollar push. [Inaccurate but substantive summary] Two groups were trapped in the backcountry fighting over two suitcases of $100 bill they had found, but bad weather they weren’t ready for rolled in. The guy holding one suitcase, clutched it to his heart through the worst night, and froze to death. The other group burned the bills to keep a fire going; they walked out the next day, back to reality.
The Fed is burning the money. That may or may not be the best worst choice, but let’s be clear about what they are doing.
So, if I can convert to a foreign currency, which would it be? I have the following options: HK Dollar, CAD Dollar, Euro, GBP, and JAP Yen. Thoughts???
The real power of the FED is its ability to “monetize all debts public and private”. It would seem this is a global authority. And of course this is ultimately a global consolidation of money and banking that is far from over.