After writing yesterday’s article I sat down and thought of the implications of the recent moves in currency markets. If we review them in the round we have seen the following in recent times.
1. An announcement by China that she will end the peg for the Yuan and allow it to revalue (in effect rise) to help with its trade surpluses. However so far it has only revalued by around 2% against the US dollar from 6.83 to 6.71.
2.Just over a week ago the Bank of Japan began currency intervention to weaken the level of the Yen. It had fallen below 83 Yen to the US dollar and was putting price pressure on Japan’s exporters. However Japan was and still is a country with export surpluses.
3. The United States and her Treasury Secretary Timothy Geithner have been very critical of other countries exchange rate policies. He has been particularly critical of China but much less so of Japan’s recent moves. However if we look at the trade-weighted performance of the US dollar we see this.From 2005 to July 2008 we saw a fall from 92.3 to 72.1 so quite a substantial devaluation followed by some ebbs and flows. But if we look at the last 6 months or so we see the following, a peak on the 8th June 2010 of 88.4 but a current value of 79.9 as I type, making for a devaluation of 9.6% in just over 3 months. The most recent drop has been associated with the statement by the FOMC that I wrote about yesterday.
Plainly these factors do clash. We have already seen friction between China and Japan as China wonders how a country with substantial trade surpluses is allowed to devalue whilst it is under pressure to revalue its currency. Now we are seeing friction between China and the United States as Prime minister Wen responds to Mr.Geithner’s criticisms that the Yuan needs to revalue by at least 20%. According to Bloomberg he said.
“We cannot imagine how many Chinese factories will go bankrupt, how many Chinese workers will lose their jobs, and how many migrant workers will return to the countryside”
So if we look at the currencies quoted earlier we see the following, China has kept a low level of the Yuan since mid-2008 to boost her economy, by one means or another the United States seems to be devaluing her currency and Japan is intervening to reduce hers in spite of her trade surpluses. Some might call this madness as many of these moves are inconsistent but I am more afraid of the echoes of the 1930s when we went through an era of “competitive devaluations”. I hope that it does not lead to more friction as this can have implications for matters such as trade talks.
The Export Fallacy
Why do countries want to devalue their currency? They are hoping to improve their export performance and balance of trade. Individually there may be gains but for the world as a whole this is a zero-sum game and for every winner there is a loser. Of the main currencies it looks like the Euro is currently the loser. It finds itself being intervened against by the Bank of Japan over the last week raising its value from 106 Yen to 113 Yen at the peak so far. But it has also been falling against the US dollar and is now at nearly 1.34 versus it whereas not so long ago in early June we were discussing dips below 1.20. According to the ECB the effective or trade weighted index has risen to 103.84 from its low of 99.86 in early June but remember these numbers are flattered by the fact that until a week again it was falling against the Yen often at a rapid rate.
Looking at the current situation where clashing views on currencies led to disputes not only makes me afraid of a competitive devaluation nightmare it also has another worry, protectionism. Perhaps this is best evidenced by the US Congresses plans to pass a law to get China to revalue the Yuan.
Also I worry about the competence of our leaders. If we stretch our minds back to the summer we can recall European leaders railing against the falls in the Euro with their talk of a “wolf pack”. Yet as the peripheral euro zone members suffer for a lack of economic competitiveness logically the fall in the Euro could be seen as the market operating to help this. So now the leaders have what they want but I can only see this making the situation for the peripheral nations worse. Now exchange rates do not have immediate impacts on an economy and the link is not as automatic as is often assumed but it is plain which is more likely to help over time and yet it is the reverse of what Europe’s politicians wanted. Clueless.
Portugal struggles with its bond issue
Media reports are often misleading on this subject as for example demand was reported to be strong for the two issues made by Portugal. However those more interested in facts rather than spin will have spotted that of a planned issue of 1 billion Euros Portugal in fact only issued some 750 million Euros which sits oddly with the media reports of strong demand.
Looking at the figures further Portugal had to pay 6.24 % to borrow €300 million in 10-year bonds, and 4.69 % to borrow €450m in four-year bonds. The yields compared with rates of 5.31 % for the 10-year bonds at the last auction in August and 3.62 % for four-year bonds at the previous offering in July. The yield on the ten-year was the highest for Portugal since the launch of the euro in 1999. In itself the impact is not enormous as compared with the previous issue the ten-year bond will cost Portuguese taxpayers some 2.79 million Euros a year extra and the four-year will cost some 4.8 million Euros extra per year. But over time the cumulative effect of a dripping tap can build up and be severe. So like Ireland we find that Portugal can still issue debt but at a high cost and this cost weakens both of them as we go forwards.
The UK Monetary Policy Committee
Recently the Monetary Policy Committee has been attempting a re-run of a good-cop bad-cop scenario of a 1970s or 1980s detective series. This makes me think of John Thaw in The Sweeney for the bad cop but please feel free to have whatever image you prefer! Last week we had David Miles as the good cop who apparently is so worried about inflation, then we got Adam Posen who with his talk of possible “heavy-duty credit-easing” was more bad cop on inflation. Yesterday we got another good cop Spencer Dale whose priority is according to his speech.
ask me my three main priorities for monetary policy and I will tell you: inflation, inflation, inflation
followed by a critique of past policy.
The evils of inflation are well known. The high and volatile rates of inflation of the 1970s and 80s stunted our economic performance. Companies and households were unable to budget and plan efficiently. Resources were misallocated. Long-term contracts were avoided. The value of hard-earned savings was eroded.
Unfortunately for those who think we may be getting someone concerned about the more recent rise in inflation we get.
there are significant risks to both sides of the inflation outlook
Those who are interested on the statistics on Mr.Dale’s tenure of the MPC you get the following.He has attended some 26 meetings and of these some twenty months have been over the target and only 6 below. Also during his tenure in some 16 of the months the rate of inflation has exceeded its target by more than 1% which is the benchmark for the Governor having to write an explanatory letter to the Chancellor.There have been no such downside occurrences. Remember he has been on the MPC at a time of great economic problems and falls in output which one would normally associate with lower rather than higher inflation a point which he made in his speech, I was not there to tell if there was an ironic twist on this.
One could look at this another way. It takes say 18 months or so for changes in interest rates to take effect. So if we ignore the first 18 months of his tenure on the MPC and look at the subsequent months you see the following every single month has been more than 1% over the inflation target. This contrasts substantially with “inflation, inflation, inflation” being a priority. Also echoing Tony Blair may not be entirely wise in itself as it immediately makes many think of an era where many facts were spun.
The MPC Minutes
For a few months now the MPC has been split 8 to 1 where the 8 vote for no change in what is a very expansionary current policy whilst Andrew Sentance votes for a small rise in interest rates. So we have been getting a bit of groundhog day. However the latest minutes showed a small change of nuance.
“For some of those members, the probability that further action would become necessary to stimulate the economy and keep inflation on track to hit the target in the medium term had increased.”
In itself I see this as a change of nuance but this news came out as our markets were responding as well to the new statement from the FOMC so it is difficult to split what turned out to be an extraordinary move in UK government debt prices into components.
The UK gilt or government bond market surges
This surged yesterday in a move which was very strong and unusual. There is a ten-year gilt and it rallied by 1.3 points or to put it another way the yield fell by 0.15% to 2.97%. If we look to our longest dated gilt which runs to 2060 it rallied by 2.89 to 100.05. So a powerful one-day move which index-linked gilts followed and indeed exceeded as our longest-dated version of this which runs to 2055 rallied by 4.3 to 130.48 or a move of 3.4%.
To my mind this opens up a dichotomy. Conventional gilts were to my mind trying to front-run potential moves by central banks whereas inflation linked bonds were rallying because of the implied implications for inflation too. Now put the impact of inflation on conventional bonds. After the rally our inflation and our prospective inflation is higher than the yield on our ten-year bonds.
Energy Policy and wind farms
I am often asked about the topic of energy supply with particular variants being peak oil and will we run out? Having seen the news that the world’s largest wind farm has opened off Kent I would like to open a discussion on this. I know that there are amongst my readers some with expert knowledge in this area and I would like their thoughts on this. I understand that wind farms are expensive so the implications of this on energy prices might be one strand. But my conceptual problem with wind farms is what do we do if the wind does not blow? For example the cold snap in February of this year was a period of still air as well as I understand it.