After a day which was dominated by the return of the Bank of Japan to currency intervention we can now look at the effects a day later. The exchange rate versus the US dollar has been fairly stable since the initial surge and is now at 85.39 but the rate has improved again versus the Euro to 111.06. The Bank of Japan has intervened more than once and we wait to see what response the currency markets have as these are early days in the engagement. One fascinating rumour did go round the markets at lunchtime yesterday that the Chinese central bank had intervened the other way, this really would put the cat among the pigeons but remains a rumour.
This intervention does have possibly unintended side effects. For example Japan will be buying US dollars and will presumably want to get some interest on them and the largest US dollar market for this would be US Treasury Bonds and Bills (government debt) and such purchases would presumably be at the shorter maturities. Also if we look at Japan and make the assumption that the intervention will succeed it suddenly makes investing in Japanese Government Bonds look less attractive because foreign investors in a countries bonds are usually looking for currency appreciation as well as coupons or interest. At the moment the BoJ is explicitly trying to create a loss for them. Now overseas purchases of Japanese Government Bonds are only 5% of the market which is comparatively much lower than in the UK or US for example, and I have assumed the intervention succeeds which is not my personal view, but it may have an effect in a country which is refinancing an enormous percentage of its national debt this year.
So far Japan has bought around ten billion dollars in its currency intervention. In my view this will only be the start as currency markets know that Japan is intervening on her own and is not getting any help from other world central banks. In fact she is getting criticism with the Chairman of the US House of Representatives Ways and Means Committee calling it a “predatory exchange rate policy”. Ouch. But Naoto Kan the Prime Minister seems determined and talked of more “resolute action”. So this saga has a way to go I feel.
The Swiss Franc
Talking of currency intervention reminds me of the Yen’s “currency twin” the Swiss Franc. This is suffering from the aftereffects of the failed intervention efforts of the Swiss National Bank(SNB) from earlier this year. At the moment there is no great activity with the exchange rate at around 1.30 to the Euro although one has to remember that this level has two consequences. The announced losses of 7.5 billion Euros for the SNB’s currency intervention will be much higher at this level and Swiss exporters are suffering.
Just to prove that there is no shortage of silly ideas the Swiss trade unions have suggested that either the SNB intervenes again or that it creates a two tier Swiss Franc. So the choice is a policy which has failed so far or the creation of a fantasy currency which will create even more losses for the SNB. Suddenly the foreign exchange job being advertised on the SNB website seems to be possibly a poisoned chalice! At least you get paid in Swiss Francs……..Also on this subject Union Bank of Switzerland are predicting that Switzerland will raise interest rates today and they are well-connected so this may have some credence. For a country with a strong currency whose rally must have had an anti-inflationary effect,the effects of which are mostly yet to come, this would be very unwise in my view.
We are seeing the credit crunch response move into a new phase as we are seeing the creditor nations make their responses. One view on this is that they are simply trying to stop the appreciation of their currencies. However even this has the possible side effect of attempting to create something similar to what was called “competitive currency devaluations” in the 1930. Also there may be something deeper in the Japanese intervention as if it should turn out to be unsterilised it will boost the money supply and will therefore be inflationary. Now in her current disinflationary environment that may not be all bad as she has struggled for some time with this problem. I will be watching this development which may turn out to be as significant as the intervention itself. For now in Japan a monetary boost may help but even here as I have argued before care is needed as such efforts can rapidly go wrong. One example of this is that I already see suggestions that such a policy would be good for other countries too which is much more dangerous, and ignores the premise that we need to make sure that Japan is actually following such a policy which only time will tell us.
Greece and the prospect of default
I mentioned earlier this week that the Greek Finance Minister George Papaconstantinou is on a roadshow in Europe to persuade investors to buy Greek government bonds, or in some cases more of them. To aid his case he has suggested.
“Restructuring is not going to happen. There are much broader implications for the euro zone should Greece have to restructure its debt,”
Actually I agree with his second sentence but cannot agree with the first. He then goes on to say.
If Greece restructures, why on earth would people invest in other peripheral economies? It would be a fundamental break to the unity of the euro zone.”
Again I agree with his second sentence and this makes me wonder if this is the real reason for his speech and tour, a type of veiled threat to the politicians of the euro zone and hence have a large vested interest in Greece not defaulting. This would perhaps be more logical than the stated reason for the tour. Even though the tour has been accompanied by a lot of hot air and rhetoric if we look at the evidence we get a different view.
Yesterday Greek government bond yields rose. Her ten-year yield is now 11.7% and her three-year is now 11.72%. In some ways the three-year yield is the most damning for Mr.Papaconstantinou as this is the around the timescale at which Greece will have to return to financial markets and the price and yield still mean that she would immediately be on a path to insolvency. The recent treasury bill issue did not go that well either. On Monday I suggested that there would be some arm-twisting to get a good result. However there was some evidence of arm-twisting as local banks were the main buyers but the yield on the 6 month bills was 4.82% which is higher than that at the last issue on July 13th when the yield was 4.65%.Back in January she could issue such bills for an interest rate of 1.38%.
In a way the last figure is very revealing as since January the stronger euro zone countries have been able to raise short-term money at ever cheaper rate whereas Greece is on a very different path. And this path involves the euro zone and IMF effectively taking get of her bond issuance needs for a while if not her bill needs, as well as the “shock and awe” package of May. It remains my view that it would be better if Greece restructured her debt now to try and get her financial position on a more sustainable path.
The position of Ireland and Portugal in terms of government bond yields took a knock yesterday too with ten-year yields rising to 5.98% and 5.84% respectively. They will not welcome Mr.Papaconstantinou’s comments if they contribute to further falls in their bonds. They are in danger of funding themselves at a more expensive rate than the one they are charging Greece for the help they are providing her.
The European Central Bank has produced a working paper which looks at Greece’s situation with regards to her balance of payments which have been a problem for some time and indeed from well before she joined the Euro. After my usual cautionary note about the accuracy of balance of payments figures which questions to my mind the reliance on mathematical modelling of this type we get.
In sum, despite the fact that the ongoing financial and economic crisis seems to have speeded up adjustment of current account imbalances in Greece, as it has forced the correction of some underlying domestic imbalances, bold and co-ordinated policy measures are needed to restore the economy’s external equilibrium.
Now re-read the last bit again and remind yourself that it is the ECB who has published this paper. Not quite the view of the euro zones politicians is it?
Mervyn King and his speech to the Trades Union Congress
This speech got quite a bit of airtime in the UK media and some of it was due to this in Mervyn’s speech.
Before the crisis, steady growth with low inflation and high employment was in our grasp. We let it slip – we, that is, in the financial sector and as policy-makers – not your members nor the many businesses and organisations around the country which employ them.
So some humility for once and a speech tailored to the audience. In some ways this is refreshing but then he moved onto more debatable and contentious ground and if you notice an implicit slap on the back for himself which is not quite so humble.
Thankfully, the costs of the crisis have been smaller than those of the Great Depression. But only because we learnt from that experience
Such talk is dangerous to my mind as we are a long way from knowing what the costs of this crisis will be and accordingly we do not yet know if we have followed the right path. Then we get an even more disturbing statement and the emphasis is mine.
So the Bank of England has taken extraordinary measures – described as “quantitative easing” – to boost the supply of money in order to support a recovery in the economy and keep inflation on track to meet our target
I was not aware that it was on track and am even more unclear as to how being more than 1% over target in each month this year leaves us on track. He appears to have temporarily forgotten the letters he has had to write to the Chancellor of the Exchequer to explain the divergence. Perhaps of course he has a different target to the one that is published and if so he should tell us what it is.