The rocky upwards ride of Bitcoin continues

One of the features of 2017 has been the extraordinary price volatility exhibited by Bitcoin. This has of course come at a time when many have been mulling exactly the reverse in equity markets although of course the current rhetoric over and from North Korea may well change that. For some perspective let us look back to the 29th of December.

“When I signed off before Christmas I ended with this.

The average price of Bitcoin across all exchanges is 910.16 USD

As you can take the boy out of the city but it is much harder to take the city out of the boy I had noted that it had been further on the move this week and now I note this.

Bid: $972.27 Ask: $972.28

So there has been a push higher and of course we are reminded of two things. The first is simply a factor of the way that we count in base ten meaning that the threshold of US $1000 is on the near horizon and the second is the Bitcoin surge of a bit more than a couple of years ago.”

Back then I pointed out two things. Firstly the chart pattern was of a “bowl” formation so that the price would need to keep rushing higher or it would end up like one of those cartoon characters who run over the edge of a cliff and briefly levitate before the inevitable happens. The next was that it was approaching the price of gold in individual units although later we looked at the fact that as an aggregate it was a long way away as there is much more gold.

What was driving things?

There were various influences. One generic was fear of what plans central banks have for fiat countries in an era of low and indeed negative interest-rates. Partly linked with this was the specific issue of demonetisation in India where some bank notes were withdrawn. Added to this was the continuing demand from wealthy Chinese to move some of their money abroad and the efforts of the authorities to block this so at times Bitcoin gets used.

The surge

Here is Fortune to bring us up to date.

Bitcoin was worth less than $590 a year ago. Then early Tuesday, the cryptocurrency surged to yet another all-time high above $3,500, as investors likely pulled their funds from the new Bitcoin spinoff, Bitcoin Cash or “Bcash,” to invest it in Bitcoin.

Bitcoin pulled back slightly by mid-day, trading at $3,430.

CNBC returned to the comparison with the price of gold although to be fair they did offer some perspective.

That’s nearly three times the price of gold, which settled at $1,262.60 an ounce, up nearly 10 percent for 2017…….That said, the gold market is worth trillions while bitcoin’s market capitalization is only about $57 billion…..Lee pointed out that the overall size of the gold market at about $7.5 trillion dwarfs that of bitcoin.

It didn’t take long from approaching the price of gold to nearly triple it did it? Bloomberg has decided to give us a comparison which will upset central bankers everywhere.

It has increased more than threefold this year, compared with a doubling in the value of Vertex Pharmaceuticals, the best performer in the S&P 500 Index.

At least they didn’t point out that it has gone up (much) more than house prices as there is only so much a central banker can take in one go! Still they were not finished with comparisons.

Here’s some other stuff you could buy for the price of one bitcoin, including but not limited to 100 22-pound boxes of Hass avocados.

 Actually that don’t impress me much to coin a phrase as a PC user who is not especially keen on living solely on avocados and facing the consequences of setting up a stall to sell them all. But we get the idea.

Splitting the atom

The cryptocurrencies have a problem around growth and change and here is the FT Alphaville view on the fork at the opening of this month.

In the next 24 hours, the trust in the bitcoin system is going to be even more severely tested than usual. The community of miners, nodes and developers is initiating a so-called hard fork which hopes to expand the network’s processing capacity, allowing it to scale more effectively. In the process bitcoin will be split in half, and two new systems will emerge.

The hope is that faith will be channelled into the newly evolved, expanded and improved chain, while the old chain will be abandoned. But anyone and everyone who has a bitcoin will via the process suddenly be endowed with two assets instead of one, with a free option to support one and render the other useless. If the effective split makes people feel twice as enriched, it’s worth asking, why they shouldn’t feel inclined to keep hold of both of them? And that too will be an option.

It would appear that investors have sold the new Bitcoin cash to buy more of the existing Bitcoin. It would be amusing if they are rejecting change wouldn’t it? On a more serious note is this how money will be created in the future? We only have a very short time frame to consider but as we stand there has been both money and wealth creation here. Perhaps the central banks are in charge after all……

The only way is up baby

Business Insider seems rather keen.

Arthur Hayes, CEO of BitMEX, a bitcoin derivative exchange, thinks SegWit marks an important milestone for bitcoin’s future.

“At long last, the solution touted to solve bitcoin’s scaling problems, Segwit, is activated,” Hayes said.

“With Segwit implemented, I believe $5,000 Bitcoin is within striking distance,” he concluded.

Comment

Let us look at the functions of money and start with a unit of account. Many people will know of Bitcoin but how many will account in it? Not much I would suggest. The price surge will mean that so far it has performed really rather well as a store of value and indeed quite an accumulator of it but we also need to note that along the way there have been sharp drops. There has been progress in it being a medium of exchange as more places accept it but it is still a very long way away from anything like universal acceptance.

However in continues to survive and in more than a few ways thrive. Fears of central banks blocking bank accounts continue to feed its growth. Frankly the rumours that Euro area bank deposits could be frozen in a banking collapse would have been cunning if started by a Bitcoin fan. There are loads of risks just like there are in any new venture but also care is needed as this from Gadfly of Bloomberg indicates.

There are also fears that big traders are having an undue influence on the price of Bitcoin, with one blogger flagging the actions of “Spoofy” — a nickname for traders who apparently place million-dollar orders without actually executing them. Bitcoin is essentially unregulated, so risks are abundant.

I love the idea that regulation has pretty much fixed risk, what could go wrong? But even more importantly many ordinary or dare I say it regulated markets are being spoofed these days and if the reports that reach me are any guide the regulators seem to have both a tin ear and a blind eye. Along that road we may well find a reality where for some Bitcoin looks rather like a safe haven although these days we need to add the caveat whatever that is?

Also finance regularly provides us with curiousities. Today’s comes from the land of the rising sun as we note that it is clearly in the firing line from North Korea and yet the Yen has strengthened through 110 versus the US Dollar.

Central banks face an inflation inspired policy exit dilemma

Later today the ECB ( European Central Bank) will announce it latest policy decisions on interest-rates and extraordinary monetary policy such as QE ( Quantitative Easing) asset purchases. I am not expecting any grand announcement of change as this came last time if you recall.

As regards non-standard monetary policy measures, we will continue to make purchases under the asset purchase programme (APP) at the current monthly pace of €80 billion until the end of March 2017. From April 2017, our net asset purchases are intended to continue at a monthly pace of €60 billion until the end of December 2017, or beyond, if necessary, and in any case until the Governing Council sees a sustained adjustment in the path of inflation consistent with its inflation aim.

Ever since then they have been keen to tell us this is not a taper and the formal minutes showed quite a bit of debate on the matter.

either to continue purchases at the current monthly pace of €80 billion for an additional six months, or to extend the programme by nine months to the end of December 2017 at a monthly pace of €60 billion. In both cases, purchases would be made alongside the forthcoming reinvestments starting in March 2017.

I think they made the right choice to reduce the size of the monthly purchases but do not see why they guaranteed it to the end of the year apart from them being afraid of markets getting withdrawal symptoms.

What are these policies supposed to do?

Back in 2015 the ECB issued a working paper on how it thought QE worked.

First, via the direct pass-through channel, the non-standard measures are expected to ease borrowing conditions in the private non-financial sector by easing banks’ refinancing conditions, thereby encouraging borrowing and expenditure for investment and consumption.

Actually this is a generic explanation of the claimed benefits of extraordinary policies and applies in some ways more directly to the TLTROs (Targeted longer-term refinancing operations) . As ever it is the “precious” which is considered to be the main beneficiary.

this encourages banks to increase their supply of loans that can be securitised, which tends to lower bank lending rates.

Of course this can have plenty of effects and let us remind ourselves that house prices in Portugal are rising at an annual rate of 7.6% which is the “highest price increase ever observed” as I analysed on Monday. Let us then move on by noting that officially this will be recorded as a “wealth effect” and will benefit the mortgage books of the troubled Portuguese banking sector whereas for first-time buyers and those looking to move up the property ladder it is inflation. Although the Euro area measure of inflation ignores this entirely.

In December 2016, the annual rate of change was 0.9% (0.5% in the previous month)

We note that even so it is rising and move on.

Next we have this effect.

Second, via the portfolio rebalancing channel, yields on a broad range of assets are lowered. Asset purchases by the central bank result in an increase in the liquidity holdings of the sellers of these assets. If the liquidity received is not considered a perfect substitute for the assets sold, the asset swap can lead to a rebalancing of portfolios towards other assets.

This is how the 0.1% and indeed the 0.01% benefit as they of course by definition have plenty of assets overall. It is also part of the road where 8 people have as much wealth as the bottom half of the world’s population.

There is supposed to be a third announcement effect but it is hard not to have a wry smile at the claims made for Forward Guidance when you read this.

It has been found to be muted in the United Kingdom, moderate in the euro area and highly uncertain in the United States,

Inflation Target

Here we have the definition of it.

The primary objective of the ECB’s monetary policy is to maintain price stability…….The ECB has defined price stability as a year-on-year increase in the Harmonised Index of Consumer Prices (HICP) for the euro area of below 2%.

There is clear abuse of language here as the Euro area his in fact had price stability with inflation ~0% in recent times but the ECB does not want this. Back in the day a past ECB President ( Trichet) gave us a rather precise definition of 1.97% in his valedictory speech.

Where are we now?

Yesterday there was something of a change.

Euro area annual inflation was 1.1% in December 2016, up from 0.6% in November. In December 2015 the rate was 0.2%.

So the broad sweep of higher inflation in December around Europe continued as we saw quite a jump. Some of that may unwind but 2017 is likely to see a higher and higher theme as we note transport for fuel rising at an annual rate of 6% and vegetables at 5.2% so exactly the wrong sort of inflation for consumers and workers. There is only one country now with disinflation which is Ireland but more than a few clustering around 2% including Germany at 1.7%. It makes you think if we move to today’s house price update how statisticians in Ireland can report disinflation with house prices rising at an annual rate of 7.1%. Also we seem set to see a phase of more general inflation worries from Germany which has house price inflation of 6.2%.

Exit strategies

Back in December 2009 my old tutor at the LSE Willem Buiter wrote this.

The large-scale ex-ante and ex-post quasi-fiscal subsidies handed out by the Fed and to a lesser extent by the other leading central banks, and the sheer magnitude of the redistribution of wealth and income among private agents that the central banks have engaged in could (and in my view should) cause a political storm.

He was not aware then of the scale of what he calls fiscal subsidies which have been handed out by the Bank of England, Bank of Japan and the ECB since amongst others. But here is his crucial conclusion.

Delay in the dropping of the veil is therefore likely.

The prediction that they will delay exiting from monetary policies such as QE is spot on in my view and is where we are now. We have seen a PR campaign for example by Bank of England Governor Mark Carney as he sings along to Shaggy on distributional issues concerning wealth and also income.

She saw the marks on my shoulder (It wasn’t me)
Heard the words that I told her (It wasn’t me)
Heard the scream get louder (It wasn’t me)

However I disagree with Willem completely here.

There are few if any technical problems involved in reversing the unconventional monetary policies – quantitative easing, credit easing and enhanced credit support – implemented by central banks around the world as short-term nominal interest rates became constrained by the zero lower bound.

I was never entirely convinced by this line of argument but of course to be fair to Willem the situation now concerning QE is completely different in terms of scale.  Many bond purchases look to be permanent and the UK for example has bought Gilts which mature in the 2060s.

Comment

If we look at the overall picture we see that 2017 poses quite a few issues for central banks as they approach the stage which the brightest always feared. If you come off it will the economy go “cold turkey” or merely have some withdrawal systems? What if the future they have borrowed from emerges and is worse than otherwise? We learn a little from what the US Federal Reserve has done but maybe not as much as we might think for two reasons. Firstly whilst it stopped new QE purchases it continues to reinvest maturing purchases from the past. Secondly in terms of the international picture it did so whilst so many others were on the “More.More,More” road as it got a type of first mover advantage.

The Bank of England is in a particularly bad place as it applied more when in fact there were arguments for less ( likely higher inflation) followed by the Bank of Japan which is buying assets so quickly. Accordingly I wait to see if we get any hints of future moves from the ECB today.

Oh and do you note that the official rationale for QE type policies never seems to involve confessing you would like a lower value for your currency?

Me on TipTV Finance

 

http://tiptv.co.uk/inflamed-inflation-not-yes-man-economics/

Banks rather than the real economy remain the main priority of central banks

The credit crunch era has seen a whole litany of policies to help and aid the banking and financial sector. The most obvious was all the bailouts which took place across the world. A sub-plot to this was the way that such large losses could be made without it apparently being anybody’s fault! This was particularly odd as of course these individuals were so highly paid due to claimed skills and talent. Or to put it another way we went from privatisation of profits to socialisation of losses.

Central banks then joined in by slashing official interest-rates and then by indulging in QE (Quantitative Easing) policies to reduce bond yields and mortgage rates as well. Along the way we got specific schemes to aid ( Special Liquidity Scheme in the UK) the banks and then later to subsidise lending ( Funding for Lending Scheme). These were often described as help for smaller business but of course mostly found their way into the mortgage market which was a double gain for the banks and financial institutions. Not only did they get cheap funding but the consequent lower mortgage rates boosted their asset book via higher house prices. As Hot Chocolate reminded us for the banks and economic policy.

Everyone’s a winner, baby, that’s no lie (yes, no lie)
You never fail to satisfy (satisfy)

Let’s do it again.

Negative Interest-Rates

These present several problems for the banking industry. There is quite an irony here as of course they are results of efforts to save and then boost the banking industry. It has mostly been forgotten but an early sign of fears of trouble came in the UK when the Bank of England cut its Bank Rate to 0.5%. The Cheltenham and Gloucester 4 year tracker mortgage at 0.52% below that focused minds. As the Ivory Tower occupants adjusted to higher oxygen levels at ground level they also had to adjust to the arthritic natures of the Information Technology systems of the UK banks which had remained in the era of where we had VHS and cassette tapes and so on. Ooops! Could they cope with this? I believe that this was the main reason the Bank of England did not cut Bank Rate below 0.5% back then and leading some ( Mark Carney) for instance to think of it as a lower bound.

There was a work around which others have repeated since where the negative interest-rate was bypassed via reducing the capital owed each year to compensate. Actually for those wondering I have seen this used elsewhere too making me wonder about IT there. Then we note the other potential problems which where would depositors simply leave as they received negative interest-rates? Also what would happen if borrowers could borrow at negative interest-rates would borrowing go to plagiarise myself from yesterday “To Infinity! And Beyond!” Even worse what would be the impact of the fact that when banks deposit at the central bank as they do in size they would have to pay for the privilege? A survey from the ECB this week had 81% of banks replying to say that negative interest-rates hurt their profits. As we mull whether 19% did not reply we know that the central banks will respond to this especially in a Euro area promising more of the same.

Draghi: We continue to expect rates to remain at present or lower levels for extended period of time; well past horizon of asset purchases

Oh and if you were wondering if banks were being hurt by this well we got an official denial of it and you know what that means!

Draghi: In the first full year of negative interest rates profitability of banks has gone up

Just to add to the problems there are further troubles for banks which either operate in or own businesses for the longer term as Mario Draghi admitted yesterday.

It’s pretty evident that pension funds and insurance companies and other actors are significantly affected by the low level of interest rates.

Actually he summed up the full state of play quite well here.

I think they are being affected by low rates, although one should keep in mind that they also realised substantial capital gains on the bonds that we are buying, because some of them are amongst the main sellers, the main counterparties in our asset purchase programme.

So Jam yesterday which is still around today but tomorrow looks somewhat jam free which of course will disappoint the White Queen for starters.

Bank of Japan

Today’s news is brought to us from Bloomberg.

The yen dropped the most in seven weeks after people familiar with the matter said that the Bank of Japan may consider helping financial institutions to lend by offering a negative rate on some loans.

There is a lot to cover here so let me start with the fact that over the “lost decade” period the Bank of Japan has had policy after policy to boost loans and if any of them had worked the “lost decade” would be over. How do you say “disintermediation” in Japanese? Also those who follow the currency will have noticed the plummet today to 110.5 to the US Dollar although of course we know to take care with knee-jerk reactions as the Euro taught is less than 24 hours ago.

Returning to the subject at hand this is intriguing as Japan’s baby step into negative interest-rates went to quite a lot of trouble to avoid affecting the banks. But seemingly we have seen yet another misfire over there. Thus another plan is mooted to help them. It seems to be ploughing a rather similar furrow to the ECB move in this area from the 11th of March.

Banks will pay the MRO rate at the time of bidding, so right now it’s zero. And they may even get a reduction on that rate which increases with the amount of loans they grant. So the maximum reduction will bring the rate on the TLTRO II to the level of the deposit facility rate at the time of bidding.

I guess many of you have the feeling that banks will invariably find that they qualify to borrow at -0.4%. Would it be impolite to wonder if the Italian banks might get there first? I note that the VOX website on the 15th of April so a month later caught up with my view on the likely impact.

This column argues that this ‘cash for loans’ scheme, which might cost up to €24 billion, is unlikely to affect the real economy greatly. This is because banks can easily window dress their loans to qualify.

There is a fair amount of circularity here. You see in Japan each deal for the banks to boost the economy has apparently worked but then turned out to be window dressing. So as to the ECB and the Bank of Japan the answer to who is trolling who seems to be both of them.

Comment

The relationship between central banks and the banking sector is a symbiotic one and one which for today’s musical theme could be in purple as they sing to each other.

I would die 4 u
I would die 4 u

It has been a Sign O’ The Times that the banks have taken the Cream whilst the real economy is left wondering where all the money went. That continues and yesterday luchtime I opened my view on the Riksbank on Share Radio with some lyrics which had deeper meanings as the bad news arrived. RIP Prince.

Dearly beloved
We are gathered here today
2 get through this thing called life

Meanwhile

Transparency on our finances and behaviour is in the UK apparently only for plebs like us. From Naked Capitalism.

George Osborne has agreed to make MPs exempt from anti-money laundering checks under pressure from moaning Tory backbenchers……..Tory MP Charles Walker claimed MPs and their families were being treated like “African despots”……. MPs appear on automatic watch lists of “Politically Exposed Persons” (PEP), used by banks to prevent money being funnelled into criminal gangs or hidden in offshore tax havens.

Er they used to appear.

Will central banks forever cry “To Infinity! And Beyond!”

Some days pieces of news just leap off the screen at you and this morning has seen a strong example of that. One event has encapsulated many of the themes of this website already so let us crack on as I temporarily hand you over to the Riksbank of Sweden.

Riksbank to purchase government bonds for a further SEK (Swedish Kronor) 45 billion and repo rate held unchanged at -0.50 per cent.

This is a bit like one of those Russian dolls so let us open them up one by one. Firstly for newer readers the Riksbank has been operating in an icy Nordic world of negative interest-rates for over a year now and its deposit rate is the lowest of all at -1.25%.  It was relatively late to the policy of QE (Quantitative Easing ) starting it in February last year but has since expanded and expanded the effort from the original 10 billion Kronor toe in the water. Indeed there is a new front being opened today.

The purchases cover both nominal and real government bonds, corresponding to SEK 30 and SEK 15 billion, respectively.

I like the idea of inflation linked bonds being called “real” and the others? There is an additional risk here if you think about it as an exchange between the treasury and an “independent” central bank. Or if they are one and the same well what are they playing at? I will answer that later. But we are left with the thought that the Riksbank may have been running out of conventional or nominal bonds to buy.

As to the pace of purchases context is not easy. As you can see it is much faster than the plan from this time last year but also represents a slowing on the first half of 2016 so take your pick.

The Swedish economy

Students of economics are no doubt taught these days by those living in Ivory Towers that monetary easing is a response to economic difficulties so let us check that out.

Sweden’s GDP increased 1.3 percent in the fourth quarter of 2015, seasonally adjusted and compared to the third quarter of 2015. GDP increased 4.5 percent, working-day adjusted and compared to the fourth quarter of 2014.

Even the most casual observer will have to admit that this is an odd and indeed bizarre type of economic difficulty as the Swedish economy looks both turbo and super-charged. As to fears of the economy slowing, well the Riksbank raised its economic growth forecast for 2016 this morning to 3.7%. Now I do not know about you but there was a time when economic growth of 8% in only two years would have a central bank applying the brakes and raising interest-rates.

The excuse is low inflation and in particular it being below the 2%. Readers of this website will be aware that I think the trend has changed illustrated by the new theme for the price of crude oil. Some of this was evident in the latest Swedish inflation numbers.

The inflation rate was 0.8 percent in March, up from 0.4 percent in February. The Swedish Consumer Price Index (CPI) increased by 0.5 percent from February to March 2016.

Indeed if you exclude mortgage rates which have been driven lower by the Riksbank then the picture changes again.

The inflation rate according to CPIF was 1.5 percent in March 2016. CPIF increased by 0.5 percent from February to March 2016.

For those of you wondering where all the money has gone well you do not have to look too far for it.

 (House)Prices increased by almost 12 percent on an annual basis during the first quarter 2016, compared to the same period last year.

So the list of casualties in the QE wars has both first time buyers and those looking to trade up the property market in Sweden on it.

Oh and the list of winners starts with asset owners again a feature regularly denied by central bankers.

Meanwhile GDP per head may not be all you think it might be. From Sweden Statistics.

In the next few years the population in Sweden is expected to increase by about 1.5 percent per year.

Currency Wars

Todays policy action is explicitly described as such by the Riksbank.

With continued expansionary monetary policy abroad, there is a risk that the krona will appreciate earlier and faster than in the forecast…..The continued asset purchases will reduce the risk of the krona appreciating faster than in the forecast and of a break in the upturn in inflation.

Oh and just in case this does not work.

The Riksbank is also prepared to intervene on the foreign exchange market if the krona appreciates so quickly as to threaten the upturn in inflation.

Some of you may be wondering how did that work out for the Swiss National Bank ( and indeed the Bank of Japan)? Well according to market observers it opened fire itself last night.

as per usual the SNB busy buying EUR selling CHF ahead of the ECB tomorrow

The link and indeed casual factor here is the Euro. You may note that something which is regularly badged by supporters as an example of stability is clearly not for the surrounding nations. Some of this is caused by the monetary policy response to the lack of economic stability and growth within the Euro area to which other nations respond. Only a couple of weeks ago even Hungary joined the negative interest-rates club albeit only -0.05%. Mind you it always starts like that.

Of course another part of the Nordic region will be closely following events as the Nationalbanken which is presumably meeting right now in Copenhagen Denmark mulls how to respond to all of this. When you are pegged to the Euro you have no choice at all. After all with it expecting economic growth of 1.3% in 2016 it is in danger of being a “lenny lightweight” when it meets the Riksbank at international meetings.

An Inconvenient Truth

All this effort to weaken a currency and yet? Well Twitter does have its uses and takes up the story.

Robert Bergqvist Riksbank delivers more QE (SEK+45bn) but SEK is strengthening!

Katie Martin: Riksbank boosts QE to cool the krona. Krona jumps.

So the Riksbank joins the Swiss National Bank, ECB and Bank of Japan is seeing that monetary easing leads to a stronger rather than a weaker currency. Also the half-life of the  initial easing response has shortened dramatically to a few second now if that.

Oh and this sums it up although we are left wishing that his parents had called him Rick.

European Central Bank

The Euro and the monetary policy of the ECB are the main drivers of the events above. Muse sing about a “supermassive black hole” and the Euro has been like that for the interest-rates and currencies of its neighbours. Today Mario Draghi is on deck and we are left wondering whether he has been subject to some early morning economic policy trolling from the Riksbank!

Personally I think that the Riksbank was catching up from the last ECB move and whilst mice do upset elephants I am only expecting some minor policy changes if at all today. Along the lines of a definition change or two around for example the “assets” of Italian banks and similar.

Comment

By the time you read this many of you will know the ECB decision and if it sticks to rhetoric and Open Mouth Operations it will be mimicking the Bank of Japan.

BoJ Officials Are Said To Share Rising Concern About Yen’s Gain… (@livesquawk)

But we see that negative interest-rates and QE are a clear example of junkie culture where the central banking addict needs ever higher doses with ever more side-effects or unintended consequences. For a while now the main game has been trying to devalue or depreciate your currency which can also be called exporting deflation. Of course it is not going well as we see exactly the reverse often happening. Time for some Outkast.

I’m sorry Ms. Jackson (oh)
I am for real
Never meant to make your daughter cry
I apologize a trillion times.

In these inflated times a trillion seems a bit undercooked but as to how long this will last the duo do have an opinion.

Forever, forever, ever, forever, ever?

How many central banks will turn into hedge funds?

One of the under appreciated consequences of all the monetary easing and intervention that has gone on in the world since the credit crunch is the impact on central banks themselves. What I mean is that they find themselves holding ever larger sums of assets which in many cases they are compounding by often holding ever riskier ones. They are taking advantage of the fact that they are backed by national treasuries – although being backed by 19 national treasuries as the European Central Bank or ECB  has a different perspective in my opinion  – allowing the view that this is somehow risk-free to proliferate. Well it may not be risk-free for the taxpayers who find themselves backing all this!

The Bank of England

So far it has mostly confined itself to what we might call bog standard QE where it purchases UK Gilts. However it has been lengthening the maturity of its £375 billion of holdings in an Operation Twist style and now for example has some £989 million of our 2068 Gilt. Too Infinity! And Beyond! Indeed…

The main risk to taxpayers is in fact even less understood operations like the house price boosting Funding for Lending Scheme. Some £69 billion of cheap loans to banks have been issue here and should house price ever fall there are risks.

Foreign Exchange Reserves

These seem to be safe but the QE era has led to changes here because you see conventional theory has central banks investing in shorter dated bonds. Some of you will be spotting the problem already! This is how the Financial Times puts it.

European and Japanese (interest) rate cuts are putting pressure on many central banks’ returns — a source of income used to cover running costs and to provide finance ministries with profits on which they have come to rely.

In other words investing at negative yields carries a guaranteed loss if you hold to maturity which is awkward to say the least when you come to explain your stewardship to auditors and indeed taxpayers. The ECB in particular is hoist by its own petard here as I recall it arguing that value on maturity was the way of valuing Greek bonds back in the day and of course that is still convenient there. But not elsewhere. We have just excluded the Euro and the Yen which of course are major markets (even now some 20% and 4% of reserve assets respectively) and logical ones to put some of your reserves. So what are they doing? From the FT.

central bank reserve managers are making or “seriously considering” buying bundles of loans repackaged as asset-backed securities or switching out of currencies affected by negative rates.

There are issues here as we move from theoretically at least safe government bonds to what are less safe assets. There are in fact two issues which the FT does not point out so let me point them out.

The good news for central banks is that a consequence of their own actions is that they have made a profit. Of course they will not put it like that! No doubt the press communiques will concentrate on skilled management and their own abilities. But the QE era has driven the prices of the bonds they hold as foreign exchange reserves higher and hence bingo. Even the own-goal by former UK Chancellor Gordon Brown when he sold gold at what is now cruelly called Brown’s Bottom will look a little better as the replacement strategy of buying bonds does well.

The catch is for future investment as what do you do now with bond prices so high? Indeed these “independent” central bankers will be under pressure from politicians who have no doubt got used to spending the profits created for national treasuries to carry on regardless as the film put it. But where do they go now to do this? The FT gives us a nod and a wink.

But central banks have shed some of their conservatism in recent years, with monetary policies such as quantitative easing forcing them to sell bonds and buy riskier instruments such as equities.

Revealing language there via “forcing them”. Really? Many central banks are not allowed to buy equities for this purpose and so they will be buying longer-dated bonds and dipping into riskier ones. I will discuss the equity buyers in a moment but here is an idea of scale for you.

Total managed reserves were $10.9tn at the end of last year, according to the International Monetary Fund.

Even in these times of ever larger numbers that is quite a lot. By the way how do the numbers keep getting larger when we are supposed to be in deflation? Anyway the UK government has net US $ 38.4 billion which the Bank of England manages. Tucked away here is the issue that gross reserves are around US $97 billion larger as we mull we have liabilities too and the phrase what could go wrong? The bit we do know is that if it should it will not be anybody’s fault.

Riskier bonds

Moving onto a slightly different field which is QE then the ECB gave us an example of this in yesterday’s update.

Asset-backed securities cumulatively purchased and settled as at 15/04/2016 €19,220 mln……..Covered bonds cumulatively purchased and settled as at 15/04/2016 €169,255 mln.

The ABS securities are the riskiest and as an aside you may wonder Mario Draghi made such a big deal of them as in the scheme of things purchases have been relatively small. The US Federal Reserve has been a big buyer in this area and as it still hold some US $1.76 trillion does not seem to have been keen on realising the value stored there.

Equities and property

Here we find what I labelled the “currency twins” back in the day as there were many similarities between the Swiss Franc and the Japanese Yen. The carry trade pushed their currencies lower originally but reversing it post credit crunch saw them shoot higher which the respective central banks resisted. Here are the consequences.

Swiss National Bank

This has the equivalent of some US $600 billion to invest as a result of its past interventions and promises to take on all-comers. Of that some 18% was invested in equities at the end of 2015 and that is why I refer from time to time to it being affected by movements in the share price of Apple for example.

The equity portfolios in the foreign currency investments were comprised of shares from mid-cap and large-cap companies (excluding banks) in advanced economies and, to a lesser extent, shares of small-cap companies. The SNB does not engage in equity selection; it only invests passively.

I wonder what Swiss watchmakers think of their central bank using their money to invest in the creator and manufacturer of the Apple watch? But as we observe this I note that of course we do have what might be considered purist hedge fund behaviour here which is punting, excuse me invested in Apple shares. The equity component had also risen from 15% to 18%.

Bank of Japan

The Bank of Japan also has large foreign exchange reserves amounting to some US $1.26 trillion. All that intervention had to go somewhere or to put it another way we see why the Bank of Japan was reluctant to intervene again as the Yen surged a week or so ago.  The Ministry of Finance is not keen on breaking this down but we do know that in its QQE (Quantiative and Qualitative Easing) policy the Bank of Japan is a keen equity and indeed property investor. From its latest Minutes.

Second, it would purchase ETFs and J-REITs so that their amounts outstanding would increase at annual paces of about 3 trillion yen and about 90 billion yen, respectively.

The Exchnage Traded Funds or ETFs are equity purchases and the J-REITs are property ones. So far just under 7.6 trillion Yen and 300 billion Yen have been purchased respectively. Indeed there are issues building here as regards market stability and structure. From Bloomberg.

the BOJ has accumulated an ETF stash that accounted for 52 percent of the entire market at the end of September, figures from Tokyo’s stock exchange show.

Comment

There is much to consider here as we see more and more central banks make the journey to what a Martian observer might have trouble distinguishing from a hedge fund. The elephant in the room is making investments which can make losses. Also here is a conceptual question for you. Is something a profit if it results from your subsequent purchases? The Bank of Japan which is both a template and the extreme case should be mulling this today in response to this.

JAPAN’S 30-YEAR YIELD FALLS TO RECORD 0.335% (h/t @moved_average )

In this situation it may already be beyond the point of no return which poses its own questions as it chomps on Japanese financial assets “like a powered up Pac-Man” as The Kaiser Chiefs put it.

Most other central banks have only taken relative baby steps on this road but we see that in yet another “surprise” even their foreign exchange reserve management is being affected. As I note that the ECB is the central bank mostly likely to dip into equities next let me leave you with a question. How is it that people who are badged as so intelligent and skilled seem to be so regularly surprised by the consequences of their own actions?!

For a minute there, I lost myself, I lost myself
Phew, for a minute there, I lost myself, I lost myself

For a minute there, I lost myself, I lost myself
Phew, for a minute there, I lost myself, I lost myself (Radiohead Karma Police)

 

 

The rise and fall of the economic central planners

Yesterday was a day which was not a good one for Bank of England Governor Mark Carney. Even the usually supine and tame press corps have spotted that Forward Guidance has been a dismal failure especially for those who remortgaged on the hints and promises of higher mortgage rates only to find that they have fallen. In fact the situation was so bad we got an official denial that it had failed. Also the man who told us that monetary policy was not “maxxed out” ended up going down a familiar road with hints of lower interest-rates and more QE (Quantitative Easing). That does not go well with his mantra of higher interest-rate soon! Indeed this was the theme of the Open Mouth Operations as inflation and interest-rates were to be “higher…….or lower”.

Japan

We can take this theme wider as the attempts at central planning abroad are not going so well either. If we look at the Far East and Japan the policy of the Bank of Japan which is only a week old is already looking to be in dissarray. What I mean by this is that the mechanisms by which it is supposed to work are via a lower exchange-rate and via wealth effects from a higher stock market. If you boil Abenomics down to its basics then you have these two.

If we start with the value of the Yen then the main transmission mechanism is via the US Dollar exchange rate because it is the reserve currency in which most commodities are priced. But it is now at 116.9 which is stronger than it was before Governor Kuroda announced the move to an interest-rate of -0.1%. Yes the Yen shot lower as an initial response but since it has regained the ground and some. If we move to the Nikkei 225 equity index we see a similar theme where it shot higher on the announcement but since has come back to where it started and is now at 16,819 for the weekend.

The other mechanism that economic theory would suggest to be at play involves lower interest-rates stimulating the economy. We certainly have lower interest-rates although there are exceptions to the official -0.1% and bond yields too are now ultra-low with the ten-year JGB (Japanese Government Bond) falling as low as 0.01% this morning. But if lower interest-rates provided much of a stimulus in Japan we would not have the concept of the “lost decade(s)” would we?

The Euro

The situation described above has echoes for Mario Draghi and the ECB (European Central Bank). They have cut interest-rates to -0.3% promised further cuts to around -0.5% and are spending 60 billion Euros a month on QE bond purchases. Yet the Euro has gone boing like Zebedee in The Magic Roundabout and is now around 1.12 to the US Dollar. It has also risen to 1.30 versus the UK Pound £. Bloomberg sums it up thus.

The European Central Bank’s own calculation of the single currency’s effective exchange rate against a trade-weighted basket of 38 other currencies stood at 119.9056 on Thursday. That means that the real-world value of the euro has risen faster than the more commonly tracked exchange rate against the dollar.

Trade-weighted, the euro is at the highest level since Jan. 2, 2015,

The rally in 2016 so far has been approximately equivalent to a 0.6% increase in the ECB interest-rate. So we see that in the currency wars which are the major mover and shaker these days the central planners are seeing that their tanks are in retreat. Awkward. Although the ECB is in a better position than Japan because it is seeing some growth it must be wondering if that will now fade a bit.

US Federal Reserve

This is in disarray too right now. I do not particularly mean the response to the 0.25% interest-rate rise which has its own issues. I mean the Forward Guidance that we would get “3-5” more rises of that size in 2016. That has now disappeared with Federal Reserve members suggesting that financial markets have done much of their work for them. In the complicated world in which we live the US Dollar has fallen leading to partly cause the consequences discussed above and the US economy appears to have slowed.

Not good for our “masters of the universe” and the nearest to a world central bank we have.

Are bond yields signaling a recession?

In old-fashioned terms bond yields where they currently are would be signalling more of a depression than a recession. But of course the situation has been distorted by the trillions of bond purchases in the various QE programmes. However if we look at the yield curve we are seeing a reinforcement of this view. From Reuters.

The U.S. two-year/10-year yield curve, the difference between two-year and 10-year borrowing costs, this week fell to 110 basis points, the flattest in eight years…….A flattening yield curve has in the past been a reasonably accurate portent of slowing growth and an inverted curve, when the long-dated yield falls below the short-dated yield, an even more accurate guide to looming recession.

This has worked as a signal reliably in the past although the danger is of course that bond markets are now so distorted and manipulated that it may have changed. One thing we can say is that it is a failure for Forward Guidance that people are discussing it as confidence and psychology matter.

The Baltic Dry Index

This has been falling for a while now. It became fashionable for the economic commentariat to dismiss it hence the phrase Baltic Dry Index Twitter came to be. However rather awkwardly for them it continued to fall.

I know that a move of a particular percentage should have the same impact everywhere but it is at least more symbolic when you see a change from 3 to 2 as the big figure.

Harpex Shipping Index

There are challenges to the methodology of the BDI so let us also take a look at the Harpex which is based on rates for container ships. It hit a high of 646 last summer and since then it too has been falling and seems to have stabilised in 2016 around 364. As you can see it too is signalling in the words of Taylor Swift “trouble,trouble,trouble”.

Comment

There are plenty of signals right now that are flashing yellow alert about economic developments. We will have to see how they unfold but there very existence is a challenge to the central planners who bestride the globe proclaiming success as they overlook the moral hazards and junkie culture their polices and actions have encouraged. Eight years into the credit crunch they are in danger of repeating the lost decade from Japan.

Meanwhile the usually sensible and intelligent Gillian Tett has joined the control freak squad in the Financial Times today and returned us to the subject of banning cash so that negative interest-rates would be more effective.

For better or worse, the nature of money is changing. And who knows? If this revolution helps curtail tax evasion and terrorist finance — and makes our lives more convenient along the way, too — it might turn out to be one of the better developments to have emerged from the finance industry in recent years.

There is a good reply pointing out that terrorists use cars and mobile phones so should we ban them too? But underlying this is the fact that the central planners feel they need “More,More,More”

RIP Maurice White

it has been a bad year for music with one of the founders of Earth Wind & Fire dying overnight. Let me leave you with the opening verse of my favourite song of theirs.

Do you remember the
21st night of September?
Love was changing the minds of pretenders
While chasing the clouds away

 

 

How much can a central bank lose before bankruptcy looms?

One of the features of the “new normal” of the credit crunch era is that central banks bestride the economic and financial stages like colossi as they dispense both cash and claimed wisdom. Many are in thrall to our central banking overlords but not here as it was only yesterday I discussed their inconsistencies and fudges when setting interest-rates. This morning has brought news of yet another set back for the theory that central banks are omnipotent and it has come from the often sleepy small country of Switzerland. Indeed Swiss citizens are likely to get something of a shock when they read the news and discover what has been done in their name and with their money.

The Swiss National Bank (SNB)

The latest release from the SNB is not for those of a nervous disposition especially if you happen to be a Swiss taxpayer.

The Swiss National Bank (SNB) is reporting a loss of CHF 50.1 billion for the first half of 2015.

If we convert into UK Pound’s then this is £33.3 billion. So how did this happen?

On 15 January 2015, the SNB decided to discontinue the minimum exchange rate of CHF 1.20 per euro with immediate effect. The subsequent appreciation of the Swiss franc led to exchange rate-related losses on all investment currencies. For the first half of 2015, these amounted to a total of CHF 52.2 billion.

Thus we see that it was not only private investors, currency and spread trading companies (some went bust back then) and hedge funds which were hit as a modern version of King Canute finally submitted to the tide. Added to this were problems with bond markets which if you recall have followed the surge of early 2015 with declines since and remember due to the size of its foreign currency intervention and reserves the SNB is a large holder of Euro area bonds.

A loss of CHF 3.9 billion was recorded on interest-bearing paper and instruments.

The SNB must think that it never rains but it pours as it note that it has been a bad 2015 so far for something which it is famous for holding which is of course gold.

A valuation loss of CHF 3.2 billion was recorded on gold holdings.

So far we have too many losses so let me factor in something which is immediately obvious when you think about it. The SNB makes a profit out of its negative interest-rate of -0.75%.

The profit on Swiss franc positions totalled CHF 571 million. It was essentially made up of CHF 530 million of negative interest charged on sight deposit account balances since 22 January 2015,

Also the SNB received some interest payments on its various bond holdings.

Interest income provided a positive contribution, at CHF 3.5 billion,

Thrown into the mix is something that does not get the publicity it deserves outside of on here anyway as the SNB is an equity market punter, excuse me investor. Like the Bank of Japan which owns nearly 7 trillion Yen of equities the SNB has spread its wings into this area. As the early part of 2015 was good for equities the SNB can breathe a small sigh of relief and publish this.

By contrast, equity securities and instruments benefited from the favourable stock market environment and contributed CHF 4.1 billion to the net result……. as did dividend income, at CHF 1.2 billion.

What about Apple?

Some wry entertainment has been found in this development described by Bloomberg on the 6th of May.

Switzerland’s central bank owned 8.9 million shares in the iPhone maker on March 31, according to a regulatory filing made to the U.S. Securities and Exchange Commission. That’s up from 5.6 million shares at the end of 2014, a 60 percent increase, according to Bloomberg calculations.

We do not know the exact state of play here but we do know as Apple’s share price peaked at around 132 and was 122.35 at last night’s close that it is no longer solely a one way trade. Should it not work out then I imagine that the Swiss watchmaking industry will be particularly underwhelmed by their central bank investing in the maker of the Apple Watch.

Balance Sheet Alert

As of the 30th of June the SNB owned some 529.5 billion Swiss Francs of foreign currency assets and some 36.4 billion Swiss Francs of gold. If we look at the investment percentages then we see  it held some 90 billion Swiss Francs worth of equities with the vast majority of the rest in other countries government bonds.

This is an awkward consequence of the foreign currency intervention undertaken by the SNB and if you have heard people describe central banks as hedge funds these days well here is the prima facie case of it.

Is the SNB bust?

The answer to this is not yet as the capital has shrunk for obvious reasons as we note a fall in capital from 86.3 billion Swiss Francs to 34.3 billion. If it was a listed company then we might be heading to the panic zone but of course it is not. Swiss taxpayers may be getting nervous at this point because they via the Swiss Treasury back the SNB. Also as pointed out a few years back by Willem Buiter central banks do have access to a large source of funds.

As long as central banks don’t have significant foreign exchange-denominated liabilities or index-linked liabilities, it will always be possible for the central bank to ensure its solvency though monetary issuance (seigniorage).

A sort of printing response or in modern language press control and the letter P.

Also it is not that central banks cannot go bust as we review one obvious past problem and one less obvious one.

Two recent examples are the Reserve Bank of Zimbabwe (the current inflation rate in Zimbabwe is over 100,000 percent year-on-year) and the National Bank of Tajikistan.

I have written before about issues concerning the structure of the ECB (European Central Bank) partly because it is backed by 19 different treasuries which may copy their attitude to the Greek crisis and have divergent views. However the Swiss taxpayer may null the fact that 40.02 of their central bank is owned by private shareholders. I know nothing about Theo Siegert of Dusseldorf but according to the 2014 Annual Report he owns some 6.5%.

What about Switzerland?

There is an explicit issue for the shareholders in the SNB.

Last year, the SNB paid dividends to shareholders of 2 billion francs after posting 38.3 billion francs in profit but warned such hefty payouts might not continue.

We have the second half of 2015 to come but the outlook for a dividend this year is none to bright as we stand. Also there is the issue of currency strength finally being a drag on the economy. The BBC has looked at its impact on border towns.

The consequences for borders towns like Kreuzlingen were immediate. While Swiss prices have been somewhat higher than those in Germany for some years, with the franc now so high many products cost twice as much or more in Switzerland.

So why shop in Kreuzlingen when ten minutes walk away the bustling German town of Konstanz awaits?

Also Swiss cheese manufacturers are being affected.

“In May our foreign sales figures, especially for traditional cheeses, really slumped”, says Mr Hausammann. “We had a 14% reduction over the same month last year.”

Comment

This week has seen more than a few examples of central banking problems. It was  the Bank of Russia on Wednesday with the value of the Rouble and consequent inflation and yesterday it was the US Federal Reserve and the Riksbank with doppelgänger like views on economic policy. Now we see that there are costs to the “unlimited intervention” policy of the SNB which of course turned out to be very large rather than unlimited. Perhaps the Swiss taxpayer will end up  being very grateful for that!

Meanwhile back in the UK another central bank seems to have hit some choppy water. From Reuters.

New Bank of England rate-setter Gertjan Vlieghe should reassure parliament that his ongoing financial link to one of the world’s biggest hedge funds does not pose a conflict of interest, a senior MP said on Thursday.

What could go wrong?