Central banks make policy errors and learn little if anything and will Ireland call in the IMF?

After suggesting that we might see a short-term rally in the US dollar even I did not expect the immediate enthusiasm it showed for it! Indeed it showed a sharp rally against the Pound, Euro and Yen with the charts going virtually vertical for a while. So against the pound we are now longer flirting with $1.62 we are at $1.60 , the Euro has dropped from just under $1.40 to $1.38 and the Yen fell from the 80.63 I reported yesterday to 81.72 as I type this. So the dollar index which attempts to allow for trade flows has risen to 77.55 which compares with 77.27 yesterday when I was talking about the beginning of the rally. However there is one clear cautionary note about this, such sharp rallies are often signs of a rally in what remains a bear market. But they can go further than you expect before resuming the downward trend.

The Bank of Japan and her policy error

The country most relieved by this turn of events must be Japan which has been struggling against a strong Yen for virtually all of this year. The Bank of Japan intervened in a fruitless attempt to stop the rally at 83 Yen to the US dollar back on the 15th of September. So for once its losses from this are reducing. Sadly it did not take the advice I offered on the 25th of August.

So in my view the best thing for the Bank of Japan to do is nothing. It is a humbling thought that even such a strong organisation is subject to the whims of the markets but it is also true.The Bank of England was forced to accept this long ago. Added to this is a theory that I have developed which goes as follows, talk of official exchange rate intervention seems to encourage markets to take the proposed intervention on and I think that we saw some of this yesterday.

In essence I believe that we have seen another policy error from a central bank. They are really wracking them up in the credit crunch era. Yet this does not seem to dissuade them from intervening in ever more areas. So I have a question for readers of this blog, is there another area where there does not appear to be any criteria of failure like there is for a central banker?

At the moment the Bank of Japan is engaging in a policy of promising some more Quantitative Easing but not actually doing it. The US $62 billion it promised has not occurred whilst the Bank of Japan promises to use it in ever more innovative ways. In this instance I am using the central bank definition of innovative which often actually means unwise. Buying real estate or shares even indirectly is not a role for a central bank unless there is a specific reason for it.

Japan’s Equity Market appears to be a beneficiary of the Fed.’s move

This breathed a sigh of relief this morning as it saw the US dollar surge against the Yen and the rally was added to by hopes that some of the new bank capitalisation rules will not apply to purely domestic lenders. These two factors combined to push the Nikkei 225 equity index up by 136 points to 9830. As the Dow Jones had fallen by some 60 points to 11,346 the spread between the two indices has now reduced to 1516 points from its recent peak of 2000. So here is an interesting and unexpected impact from Ben Bernanke’s QE2, it has so far resulted in more of a boost for Japan’s equities than it has for those of the US, which represents his “bazooka” at least partially missing the target for now.

 Some thoughts on Precious Metals: Gold and Silver

I reported yesterday about the recent statement by the head of the World Bank Mr. Zoellick about gold. He has returned to the subject this morning in a speech denying ( as I suspected) that he was calling for a return to a gold standard however he did add to his calls for a Bretton Woods 3. The full speech is available on the World Bank website.

The key currencies will be the dollar, the euro, the pound, the yen and over time the renminbi as it internationalizes and moves towards an open capital account. It’s also the case though that gold is now being used, being viewed, as an alternative monetary asset. This is not the same as a gold standard. Gold has become a reference point because holders of money see weak or uncertain growth prospects in all currencies other than the renminbi, and the renminbi is not free for exchange. So in relative terms, gold is appealing to people who ask: “where should I put my money”. It’s a hedge on uncertainty.

There are two main messages here in my view. The first is the implicit downgrading of the US dollar as a reserve currency and the second is the acknowledgement of the increasing importance of gold in these times.

Market Impact

The various interpretations of Mr. Zoellick’s speech led to quite a whipsaw action for the gold price yesterday. After rushing to a peak price of US $1423 per ounce it then plummeted to $1383 but has now rebounded again to $1408. This gives me a wry smile at the use of the word “uncertainty” in Mr. Zoellick’s speech as this is exactly what he created for the gold price! I did suggest to a “gold bug” yesterday that it might be good manners to write a thank you letter to Mr. Zoellick for the money he had made him.

One precious metal which has been charging forwards with much less media impact has been silver and I do not know if Mr. Zoellick was indirectly hinting at this when he used the phrase search for a “silver bullet” in his speech this morning. It too suffered from whipsaw price action yesterday and today where it has fallen 6%( in response to the main exchange requiring more margin to trade)  but at just under US $27 per ounce it is up 56% on a year on year basis.


There is an interesting piece of perspective I have spotted in the Financial Times. If you take the rally in the gold price in 1980 and look for an equivalent level now of the peak then it would be US $2344 if you adjust for the US dollar and inflation. So there you have it either it is peaking or to quote Bachman Turner Overdrive and the gold bug I was talking to yesterday “You aint seen nothing yet.”

Just to put Silver in perspective too it peaked at around US $50 in the middle of the Hunt Brothers debacle.

The Euro zone’s problems continue to worsen


We saw a Treasury Bill issue by Greece yesterday. If we look at the bare numbers it paid a yield of 4.82% to borrow 300 million Euros over 6 months which is up on the 4.54% it paid for equivalent borrowing last month. If we consider this as a toe in the water what does it tell us?

Firstly it tells us what problems she has. After all many of those who might invest in such an instrument can borrow from the European Central Bank at 1% and then receive 4.82% for a nice profit. In normal times investment banks would pile in for the “free money” to a chorus of “bonuses all round”. But these are not normal times. For domestic investors there is the problem of inflation affecting the real yield and for foreign investors there is the fear of default.

It was not so long ago that Greece could borrow at this rate for ten years. A year ago today she could in fact.

Ireland is the new Greece

Unfortunately the situation here is one of policy error followed by policy error. The Irish authorities seemed mired in petty politics and cronyism and seem unable to raise their game or to realise the seriousness of their nation’s position. Europe has from time to time tried to help in the form of the European Central Bank stepping in to support her debt market but her two main recent innovations have back-fired. The idea of private-sector bondholders sharing in the pain has led to an exit of them from Ireland.

Perhaps worst of all errors has been the so-called shock and awe weapon or EFSF. It was apparent to me from the beginning that it was not well designed or conceived as I wrote on the 10th of May pointing out that the likeliest recipients were also contributors and wondering how that would ever work, “Portugal 11.6 billion Euros, Greece 10.4 billion Euros and Ireland 7.2 billion Euros” were the numbers I quoted. Then on the 25th of June I pointed out that it was in fact 20% smaller than expected and that it might be issuing bonds at a difficult time and that at best it would be slow and unwieldy. Now just to put the icing on the cake uncertainty has arisen as to what rate it might lend at. Accordingly my view is that Ireland should bypass this failure and go directly to the IMF.

All of these factors have led to the Irish government bond market having ever higher yields. Her shortest dated bond which matures in November next year closed last night at a yield of 4.56% compared with the 4.18% of the day before. So she has even lost control in the shorter maturities which in theoretical terms should be easier to control as I explained for Greece above. However longer-term yields went to nearly 8% yesterday.

I have two reflections on this. A comment on here pointed out that in the recent CEBS stress-tests for Europe’s banks the so-called worst case scenario was for a yield of 6.75% on Irish ten-year government bonds. The other is that on the 16th of April I wrote on this blog about Greece writing for international help and her equivalent yield was 7.4%. Ireland does not have to issue any bonds for a while so she is in a relatively stronger position to resist calling for help but I increasing ask myself the question to what end?


17 thoughts on “Central banks make policy errors and learn little if anything and will Ireland call in the IMF?

  1. Hi Shaun,

    speaking of Greece, Reuters reports that the expected revision for the 2010 deficit will show it to be in the order of 9.3% instead of the projected 7.8% in the government’s budget.

    The reasons given are lower revenues and a revised deficit of 15.5% for 2009 (this is supposed to come out by mid-November when things get settled with Eurostat).


    • Hi John
      Thanks for the update. I had been concentrating on Ireland as she is under even more pressure today with rumours that she is talking to the IMF.Personally I hope she has been for a while as it would have been negligent in my view not to have done……Actually as I written before I feel the IMF should have been called in some time ago.

      As I have written in my many articles on Greece I am worried about her economic growth prospects for the rest of this year and the next. I think it is likely to be worse than the offficial forecasts. These will feed into the fiscal numbers which as this article suggests are already less good than promised or forecast. As I discussed at the beginning of the EU/IMF support operation this was a probable outcome that should have been factored in at the beginning. By this I mean a vicious circle where economic growth declines fed by cutbacks which then means more cutbacks are needed.

  2. King is now admitting that the BoE and MPC have dismally failed to exercise their remit in controlling UK inflation, (which is of course the MPC’s only authorised task according to its official remit), and that inflation will now rise significantly before it eventually goes below 1 % per annum. He does not actually state what he believes it may rise to. Evidently they and he are so inept that they seriously believe once it has risen to a frightening level it will just “happen” that it will fall back to 1 % again without any control or stimulus from the BoE!! I would suggest that is naive to say the least.

    Of course the astute amongst us already knew that UK inflation was intentionally out of control, and the fact that he is now actually admitting it indicates that it could get quite messy! See http://www.ft.com/cms/s/0/e6a628a8-ecbf-11df-88eb-00144feab49a.

  3. Ireland and Portugal will bite the dust within a fortnight. Lets just hope that it does’nt drag down Espana with them. Its really sad for Ireland, who really did bite the bullet early on.

  4. Great blog as usual. Did you hear John Bruton, ex PM of Ireland on the radio this morning. Said that Ireland would be able to pay its debts as it had a great workforce, export-led economy, narrow tax base easy to expand bla bla bla. He seemed very confident that Irelan would grow its way out of this mess. I cannot decide whether he believes this tosh or is just putting on a brave face.

  5. If you did not learn from past history, you will repeat it! When you put more money in circulation, the value of money decreases! That is the fact that we have all the trouble in the world! So no people or nations will buy U.S. Treasary Bonds or Currency Notes! Instead they buy Australian and Canadian Treasary Bonds and Notes!

  6. Hi Shaun.. it was Kyle Bass 10/13 discussing the implications of debt for the US. He also says Ireland, Greece, and a few others are a certainty to default. Kyle Bass is without doubt the smartest economist on this side of the pond, bar none. A must see for economy nuts.

  7. Hi Shaun

    The EFSF appears to be a partnership agreement between 16 sovereign states to provide one or other of its members with credit if they reach a point of financial insolvency. The pooled sovereignty is used to obtain AAA rating to borrow from international investors who wont lend to the insolvent partner? The bigger partners guarantee the borrowings of the AAA issuer. The loan terms are delegated to the ECB / Commission, who seeks terms to compensate the guarantors? Is that right? Maximum funds are 440bn euros? So, the compensation would be an arrangement fee and a loan margin on top of the funding costs of the multinational issuer all of which is deducted from the principal loan? Terms are all delegated to a working group?

    • In essence yes but what has not been tested is if the markets will let those countries who do not have a AAA rating borrow at AAA rates. For example it is possible that they could query Spain’s element of the scheme. The guarantee is for each national share…

      There is a lot which remains unsure about the scheme but plainly neither Portugal and Ireland can contribute.However it also has a 20% margin to help the AAA status so we have by my maths aronund 420 times 0.8 as its maximum firepower or some 336 billion.

      This also affects the promised aid from the IMF because this was offered on a two/thirds versus one/thirds ratio and around 52 billion Euros is taken away from the IMF promise compared to the numbers claimed on May tenth/eleventh.

      Much is still unclear however. Personally I think the new interest rates quoted cannot be right as I remember the calculation coming to around 5.2/5.3% so I find it hard to see it hitting 8% now.

    • Interesting that he cites Japan as an example of someone who will restructure as Martin Wolf came up with a solution:

      Get the Bank of Japan to employ an Argentine central banker to cause some inflation. Their current bonds would devalue where they than can buy them back and reduce their debt.

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