Simply put

The "price" of oil rises, the dollar falls. Any net difference for a dollar-based investor? Obviously, not much if any. But does the illusion distort other behaviour?

Apply that basic rule of thumb, now, to stock prices, and to an extent US Treasury bond prices, which is what these posts from the excellent FT Alphaville explains.

Bernanke’s genie released

The Bernanke put — aka that almost magical and metaphysical QE2 effect — appears to be having an impact on equity options skew already.

Simply explained: skew is what happens when the price of calls does not equal the price of puts exactly. That is to say when out out-of-the-money calls cost more or less than the equivalent puts.

So essentially, skew happens when the market is willing to pay more for protection on one particular direction in the underlying than the other.

Now here’s the interesting thing. Before Ben Bernanke’s Jackson Hole speech the skew in the S&P 500 had reached very high levels, with downside protection trading very expensive.

But as a second round of quantitative easing became increasingly expected by the market, that skew began to ease significantly.

This dynamic can be observed most directly by looking at the option market’s implied volatility skew, which measures the difference between the cost of puts and calls. As illustrated below, this declined significantly following the Fed’s hint at additional QE on September 21. Why buy downside protection when the Fed has done it for you?

Which is all well and good.

But there is another point that Curnutt makes, which is that the Fed may be unwittingly displacing all that volatility elsewhere:

…it looks like there’s a divergence between currency and equity volatility. The Fed may be compressing equity volatility but it’s incentivising currency volatility in its place.

He measures this divergence by looking at the correlation between the Vix index — which is derived from the implied volatility of the S&P 500 index — and the implied volatility of the UUP dollar index ETF [see the chart in the post].

All of which makes Curnutt conclude (our emphasis):

All in all, we are left thinking that there may be a derivatives market analogue to the “law of conservation of energy”. Perhaps it reads: “volatility cannot be created or destroyed, it can only change form”.

Which has to make you ask: will the granting of the market’s wish for liquidity actually lead to a much more sinister implication elsewhere?

Unwinding the US Treasury trade

there really is something perverse about the country undertaking the biggest bout of unconventional monetary policy ending up with the steepest curve.

Flattening yield curves are theoretically meant to stimulate the economy by lowering borrowing costs. (For those wondering, steep yield curves also have some benefits — like building banks’ balance sheets back up — more on which later).

this is from Bank of America Merrill Lynch:

The highlight of the Fed’s Treasury purchase program announced yesterday is the concentration of Treasury purchases in the 5y to 10y sector. This purchase program creates a negative supply of Treasuries to the private sector in 2011.

This will be most acutely felt in the belly of the curve, which is the preferred habitat of foreign institutions. The belly of the curve is also attractive because of favourable carry and roll down due to Fed hikes that are priced into the curve from 2013 onwards.

On the other hand, demand for the long end of the curve comes mostly from pension fund flows, which tends to be sporadic. This argues for a steep 5s-30s curve in the US.

In addition, the Fed is engaged in fighting disinflation and some pickup in inflation can be welcomed by the Fed … In this scenario, the long end will reflect an addition inflation risk premium, further steepening the US curve.

So $2,500bn worth of QEasing in the States has bought the Fed a steepening yield curve. Meanwhile, such a steep yield curve works to boost bank profits by upping the amount of money they can make borrowing short and lending long.

This was also one of the reasons why some commentators believed the Fed should actually be moving to flatten the curve. Suppressing the curve, it was thought, could decrease the attractiveness of the so-called US Treasury ‘curve trade’ and force banks to actually lend to the economy.

Flattening the yield curve to make banks lend to something other than the US Treasury is predicated on there actually being some private sector demand for loans (something which is still totally unclear), of course. But it might put a stop to some of the criticism currently being lobbed at the US central bank for its QE2 policy.

The below for example, is Reuters columnist Felix Salmon’s take on a 4,000-word piece by Shahien Nasiripour about winners and losers in the Fed’s monetary policy:

It’s truly outrageous that banks are lending more money to the U.S. government than they are to all commercial and industrial borrowers combined; well done to Nasiripour for connecting these dots and for providing a much-needed dose of outrage at the way in which

Bernanke’s monetary policy simply isn’t helping the broad mass of the U.S. population

.

Wall Street mocks unemployed Main Street

Following on from the last two posts, Equal opportunity destroyer and Bernanke: Rising stockmarket = economic growth are a couple of data points on the day:

US weekly jobless claims rise more than expected

U.S. initial jobless claims rose more than expected for the the week ended Oct. 30, matching the levels reached at the end of 2009.

And,

Jobless claims rise, but equities, metals shrug off losses

Commodities futures traders and brokers managed to shrug off a less-than-stellar jobless claims report on Wednesday morning, and both stock index futures and precious metals futures were looking bubbly.

For the week ending October 30, the advance seasonally adjusted unemployment claims figure rose 20,000 to 457,000, up from the previous week's revised figure of 437,000. That breaks a recent positive trend in the job market, where unemployment claims appeared to be falling - but with the Federal Reserve set to inject $600 billion into circulation by buying Treasury bonds, markets didn't appear to be bothered.

Jobless Claims up, Productivity Caps Inflation

New U.S. claims for jobless aid rose last week and a strong rebound in productivity in the third quarter showed employers wringing more output from current workers rather than hiring.

"The big picture is that firms are trying to squeeze every ounce out of the workers they have and this is one reason they feel no need to hire," said Cary Leahey, an economist at Decision Economics in New York.

Jobless Claims Cut Through the Noise

Lack of jobs is retarding consumer spending, helping to jeep housing the doldrums and creating great skepticism about the supposed recovery and the stock market.

The economy is in very weak shape; housing inventory equals eleven years of sales at their current pace and nine million mortgages are in default or in the process of foreclosure, about 28 years worth of inventory at the current pace of sales; the coming austerity in Europe and budget pull backs in the US guarantee a recession by mid year next year; corporate profits are going to hit a wall in 2011.

Traders, of course, are following a new mantra on Wall Street:

If economic data is bad, go long, the market will go up because Bernanke will keep the printing presses on. If economic data is strong, go long, the market will go up because corporate profits will be great in 2011.

Fed sparks world stocks buying binge

"What you achieve with quantitative easing is that you signal to investors not to buy U.S. government securities, take the money elsewhere, which in turn will weaken the dollar and spur economic growth," said Axel Merk, president and portfolio manager at Merk Investments in Palo Alto, California.

"The Fed in my view is trying to debase the dollar because printing all that money is not going to spur growth on its own. The risk is that the money doesn't stick and it doesn't go to where it's supposed to go," said Merk, who runs the company's $500 million currency mutual fund.

See, The Fed’s Big Gamble

QE2 or Titanic?

Or both ?

The Titanic, of course, was dubbed "the safest ship ever built".

She was touted as the safest ship ever built, so safe that she carried only 20 lifeboats - enough to provide accommodation for only half her 2,200 passengers and crew. This discrepancy rested on the belief that since the ship's construction made her "unsinkable," her lifeboats were necessary only to rescue survivors of other sinking ships. Additionally, lifeboats took up valuable deck space.

The QE2 is also a bit of a legend, dubbed "the greatest ship the world has ever known". She is now a drydocked hotel-in-waiting, intended to service the Palm Jumeirah in Dubai in another display of the Encore of Excess. She is owned by Nakheel, the Dubai company. Remember Nakheel?

Both ships serve as sort of a metaphor for the Monitization of Debt policy of the US Federal Reserve Board, which is expected to be revealed real soon like. Some folk are referring to it as a sort of Corruption of the Currency.

When Guambat thinks about it, he thinks of those glorious times back some fifty plus years ago in middle school days when he got a goody-two-shoes job in the Principal's office, which quarantined him from the boring class room. The job: running the mimeograph machine, cranking away while getting high and giddy on the addictive smell of the copier chemicals.

Guambat reckons Mr. Bernanke shares a similar addiction. Having run off 1.5 Thrillion dollars just a year ago, he's cranking up to run off another half to one more Thrillion more.

The Joys and Horrors Of QE2 (commentary by Dan Dorfman)

In football, they call it a Hail Mary Pass -- a last-minute act of desperation in which a quarterback throws a very long forward pass which has only a minimal chance of success.

That's essentially how economist Madeline Schnapp of West Coast liquidity tracker TrimTabs Research, partially owned by Goldman Sachs, views the widely expected second round of quantitative easing, or, as it's called, QE2.

What excites so many people is that QE2 is supposed to be a significant economic booster. In brief, the Federal Reserve prints money, which is used to buy long-term debt from banks that gives them more capital to lend and lower interest rates. In turn, that injection of this liquidity supposedly will goose the economy, stimulating more job creations, more housing sales and higher wages and salaries.

The QE2 program -- estimated at between $500 billion $1 trillion -- is expected to be announced November 3 at the Fed's Federal Open Market Committee meeting.

The first such easing, QE1, an estimated $1.5 trillion, took place in March of last year. As you can tell by the ongoing sluggishness of the economy, it has hardly been a bell-ringer.

Fed Policy Generates Sharp Divisions

Proponents say buying hundreds of billions of dollars more in Treasury bonds will provide only modest support for the economy. Foes warn that it could backfire by pushing up commodity prices, sowing seeds of unwelcome inflation in the future, or by undermining confidence in the Fed's ability to manage—and eventually reduce—its holdings.

Opponents stretch across the ideological spectrum, from John Taylor, a Stanford University economist and former Bush Treasury official, to Joseph Stiglitz, the Columbia University Nobel laureate and former Clinton White House official. Mr. Taylor has said the effort, known as quantitative easing, or QE, won't work, and that the government instead should avoid raising taxes and stop imposing new regulations. Mr. Stiglitz has said QE won't work and that the economy needs a big dose of spending increases and tax cuts.

Economists don't even agree on what another round of quantitative easing would do. Bank of America Merrill Lynch expects it should help push the 10-year Treasury yield to around 2% late this year from 2.63% today. Mizuho Securities says the effect of any new asset purchases "will be limited."

In a Dow Jones Newswires survey of firms that trade directly with the Fed, economists from Nomura Securities International Inc. said another round of QE would maintain "consumer confidence on track to keep the recovery ongoing." UBS said it would help only "modestly." Deutsche Bank said purchases could hurt the economy if they push the dollar down too far.

In its first bond-buying program, which ended in the spring, the Fed bought $1.75 trillion of mortgage-backed securities and Treasurys. The move, during severe stress in financial markets, is credited with helping to pull the economy out of its downward spiral. If the Fed could cut short-term interest rates, its traditional tool, it would. But short-term rates are near zero so it is seeking an alternative strategy.

QE2 risks currency wars and the end of dollar hegemony

The Fed's "QE2" risks accelerating the demise of the dollar-based currency system, perhaps leading to an unstable tripod with the euro and yuan, or a hybrid gold standard, or a multi-metal "bancor" along lines proposed by John Maynard Keynes in the 1940s.

China's commerce ministry fired an irate broadside against Washington on Monday. "The continued and drastic US dollar depreciation recently has led countries including Japan, South Korea, and Thailand to intervene in the currency market, intensifying a 'currency war'. In the mid-term, the US dollar will continue to weaken and gaming between major currencies will escalate," it said.

Pious words from G20 summit of finance ministers last month calling for the world to "refrain" from pursuing trade advantage through devaluation seem most honoured in the breach.

"It is becoming harder to mop up the liquidity flowing into these countries," said Neil Mellor, of the Bank of New York Mellon. "We fully expect more central banks to impose capital controls over the next couple of months. That is the world we live in," he said. Globalisation is unravelling before our eyes.

Each case is different. For the 40-odd countries pegged to the dollar or closely linked by a "dirty float", the Fed's lax policy is causing havoc. They are importing a monetary policy that is far too loose for the needs of fast-growing economies. What was intended to be an anchor of stability has become a danger.

Hong Kong's dollar peg, dating back to the 1960s, makes it almost impossible to check a wild credit boom. House prices have risen 50pc since January 2009, despite draconian curbs on mortgages. Barclays Capital said Hong Kong may switch to a yuan peg within two years.

As this anti-dollar revolt gathers momentum worldwide, the US risks losing its "exorbitant privilege" of currency hegemony – to use the term of Charles de Gaulle.

The innocent bystanders caught in the crossfire of Fed policy are poor countries such as India, where primary goods make up 60pc of the price index and food inflation is now running at 14pc. It is hard to gauge the impact of a falling dollar on commodities, but the pattern in mid-2008 was that it led to oil, metal, and grain price rises with multiple leverage. The core victims were the poorest food-importing countries in Africa and South Asia. Tell them that QE2 brings good news.

It may be instructive to read up on the debate whether, or to what extent, global protectionist measures causes or potentiated the Great Depression.

Ya feelin' lucky, punk?

John Hussman, PhD, is a good read, from time to time. His writing style is often dry and since he constrains his view of the economy to the big picture, he's not so frenetically following the many distractions of the day that a market trader might, so new themes and ideas develop slowing in his weekly diary. But, from time to time, he is well worth the read.

And this time, it is not only helpful, but he's actually got some life in his prose. Here are a few extracts.

The Recklessness of Quantitative Easing

In the movie Dirty Harry, Clint Eastwood growls his famous line "I know what you're thinking. 'Did he fire six shots, or only five?' Well, to tell you the truth, in all this excitement I kind of lost track myself... You've gotta ask yourself one question. Do I feel lucky? Well, do ya punk?"

Over the past two years, the Fed has emptied what has largely turned out to be a chamber of blanks. Its remaining credibility lies in the belief by the public that Bernanke still has a live round left to fire. Once the Fed engages in QE, a failure of appreciable improvement in U.S. employment and economic activity would result in a substantial loss of public confidence. The Fed would be wise to save whatever ammunition it has left for a crisis point when the U.S. public is in dire need of confidence.

An additional fruit of careless, non-economic thinking on behalf of the Fed is the idea of announcing an increase in the Fed's informal inflation target, in order to reduce expectations regarding real interest rates. The theory here - undoubtedly fished out of a Cracker Jack box - is that lower real interest rates will result in greater eagerness to spend cash balances.

Unfortunately, this belief is simply not supported by historical evidence. If the Fed should know anything, it should know that reductions in nominal interest rates result in a lowering of monetary velocity, while reductions in real interest rates result in a lowering of the velocity of commodities (commonly known as "hoarding").

A second round of QE presumably has two operating targets. One is to directly lower long-term interest rates, possibly driving real interest rates to negative levels in hopes of stimulating loan demand and discouraging saving. The other is to directly increase the supply of lendable reserves in the banking system. The hope is that these changes will advance the ultimate objective of increasing U.S. output and employment.

To assess whether QE is likely to achieve its intended objectives, it would be helpful for the Fed's governors to remember the first rule of constrained optimization - relaxing a constraint only improves an outcome if the constraint is binding. This policy will be ineffective because it will relax constraints that are not binding in the first place.

On the demand side, it is apparent that the U.S. is presently in something of a liquidity trap. Interest rates are already low enough that variations in their level are not the primary drivers of loan demand.

Businesses and consumers now see their debt burdens as too high in relation to their prospective income. The result is a continuing effort to deleverage, in order to improve their long-term financial stability. This is rational behavior. Does the Fed actually believe that the act of reducing interest rates from already low levels, or driving real interest rates to negative levels, will provoke consumers and businesses from acting in their best interests to improve their balance sheets?

On the supply side, the objective of quantitative easing is to increase the amount of lendable reserves in the banking system. Again, however, this is not a constraint that is binding. The liquidity to make new loans is already present.

Despite the probable lack of measureable benefits, further QE poses significant risks. It has already triggered a steep decline in the exchange value of the U.S. dollar, and threatens a destabilization of international economic activity, a loss of confidence, and the creation of a "boom-bust" cycle threatening to choke off any economic recovery that does emerge.

The Fed might like to believe that a cheaper dollar will improve trade by increasing U.S. exports and reducing imports. However, over the past two decades, and particularly in recent years, U.S. imports have been much more elastic in response to fluctuations in the U.S. dollar than exports have been. This suggests that provoking further dollar depreciation is likely to have negative effects on the global economy, owing to a shift away from imports, but with few positive effects for U.S. economic activity. Indeed, a further depreciation would unnecessarily create a negative wealth effect for U.S. consumers facing higher prices for imported goods and services. Any improvement in the trade deficit would be largely offset by downward pressure on U.S. consumption.

As a side note, some observers have suggested that QE represents nothing more than "printing money." While this might be accurate if the Fed never reverses the transactions, the most useful way to think about QE, in my view, is as an attempt to directly lower interest rates by purchasing Treasury securities. This interest rate effect - not any major inflationary outcome - is the cause of the dollar depreciation we are observing here. There is little doubt that the effect of large continuing fiscal deficits is long-run inflationary, but as I've noted repeatedly over the years, there is little correlation between inflation and temporary - even large - variations in the monetary base. Inflation is ultimately a fiscal phenomenon born of unproductive spending, regardless of how that spending is financed.

once the Fed has quadrupled or quintupled the U.S. monetary base from its level of three years ago, how will it reverse its position? Japan was able to successfully reverse its program of QE several years ago without much impact on yields, but unlike the U.S., it had the luxury of an extremely high savings rate. With nearly 95% of its debt held domestically, Japan had no need to resort to foreign capital. In contrast, over half of the U.S. national debt is held by other countries. Without a deep pool of domestic savings, and with no repurchase agreements in place, the Federal Reserve will eventually have to entice domestic and foreign investors to buy the Treasury securities back, pressuring interest rates higher, and virtually ensuring a capital loss.

Better policy options are available on the fiscal menu. Historically, international credit crises have invariably been followed by multi-year periods of deleveraging, but measures can be taken to smooth the adjustment. The key is to focus on the economic constraints that are binding. Presently, these relate to high private debt burdens, uncertainty about income, weak aggregate demand, and the reluctance by U.S. businesses to launch new projects.

Appropriate fiscal responses include extending unemployment benefits, ensuring multi-year predictability of tax policy, expanding productive forms of spending such as public infrastructure, supporting public research activity through mechanisms such as the National Institute of Health, increasing administrative efforts to restructure debt through writedowns and debt-equity swaps, abandoning policies that protect reckless lenders from taking losses, and expanding incentives and tax credits for private capital investment, research and development.

Throwing a trillion U.S. dollars against the wall to see what sticks is not sound monetary policy. By pursuing a policy that relaxes constraints that are not even binding, depresses the U.S. dollar, threatens to destabilize international economic activity, encourages a "boom-bust" cycle, provokes commodity hoarding, and pops off the Fed's last round of ammunition absent an immediate crisis, the Fed threatens to damage not only the U.S. economy, but its own credibility.

The prospects of a US$ Banana Republic??

Paul Keating has made his inimitable mark on Australian politics, first as Treasurer and later as Prime Minister. He was the self-proclaimed "Placido Domingo of Australian politics". He certainly was (and mostly remains) a man of words.

In 1983, as Treasurer, he did away with the fixed exchange rate mechanism of the Aussie Dollar, allowing it to float. It floated like a rock. Interest rates jumped up to 20%.

As one admiringly critical website explained,

In spite of the lower value of the dollar, many areas of the manufacturing sector were not competitive with more technologically advanced industries in Asia, especially South Korea and Taiwan. Imports continued to rise. By 1986 foreign debt was higher than anticipated.

Treasurer Keating warned that if Australia did not "get manufacturing going again and keep moderate wage outcomes and a sensible economic policy, it would end up being a third-rate economy . . . a banana republic."

His "banana republic" remark, made off the cuff in a radio interview if Guambat's memory doesn't fail (most unlikely), had the same salutary effect as Alan Greenspan's "irrational exuberance" quip.

But it was Keating's banana republic quote that came to mind whilst Guambat was perusing the most recent soothing words from David Stockman, who once advised The Other Great Communicator -- the American one.

Commentary: Trillion-dollar deficits don’t matter

According to CBO’s August update, the two-year, cumulative red ink under current law (FY 2011-2012) will total $1.7 trillion. But that doesn’t count the upcoming lame duck session’s predictable one-more-stimulus bacchanalia.

Juiced up by their election rout, the tax-side Keynesians in the GOP are certain to ram through a two-year extension of the Bush tax cuts for one and all.

In return, the hapless White House will insist this one-half trillion dollar gift to the “still haves” be matched with several hundred billion more in presently unscheduled funding for emergency unemployment benefits and other safety net programs for the “no-longer-haves.”

In combination, these measures — along with more realistic economic assumptions — mean that the FY2011-2012 deficit will be $700 billion higher than current projections, pushing the two-year total to at least $2.5 trillion. Read Minyanville’s “What a Republican Victory Means for Equity Markets.”

These considerations make one thing virtually certain: After the new Congress sinks into rancorous partisan stalemate and does absolutely nothing about this fiscal hemorrhage, the Treasury will be selling at least the $100 billion per month of new government paper for so long as the New York Federal Reserve is open to buy. Stated differently, national policy now amounts to monetizing 100% of the federal deficit.

In the olden times — say three years ago — the idea of 100% debt monetization would have been roundly denounced as banana republic finance. No more. Earlier this week, William Dudley, who occupies the Goldman Sachs permanent seat on the Fed’s Open Market Committee, helpfully clarified that the new-age Fed should be judged by what’s in its heart, not what’s on its balance sheet. He said:

“I am mindful of concerns… that [the Fed’s actions] could be interpreted as a policy of monetizing the federal debt. However, I regard this view to be fundamentally mistaken. It misses the point of what would be motivating the Federal Reserve.”

They may devoutly believe in their hearts (if hopefully not in their minds) that it’s economic milk and honey that they’re bringing to America, but in fact what they’re dispensing is digital greenbacks.

At the moment, the five-year note yields barely 1.0%, and the maturities below that quickly descend toward zero — with the 2-year at 35 basis points and 90-day bills at 12 basis points. Those maturities account for in excess of 90% of the $9 trillion in Treasury debt presently held by the public. So, in the world of ZIRP, the public debt is now essentially non-interest bearing.

Moreover, with a stroke of the “repo” key it can also be turned into cash — that is, legal tender — in a millisecond.

But what emergency motivates today’s greenback experiment?

It would appear to be two self-evidently foolish objectives.

The first is the claim by the Fed’s money printer’s caucus that QE2 in the magnitude being contemplated might lower the 10-year benchmark rate by 50 basis points.

Stunning.

We have a nation drowning in 19 million empty housing units owing to the Fed-engineered housing bubble, households still buried in $13 trillion of debt from the same cause, and idle business capacity on a scale not seen since the 1930s — and we’re supposed to believe that taking down the current all-time low interest rate by another 50 basis points will make a difference?

Worse still, [the other] salutary effect of this dubious proposition, according to chief apothecary Brian Sack, is that risk asset values are likely to be elevated to levels “higher than they would otherwise” reach — thereby encouraging consumers to go back to their former spending ways -- owing to the illusion of higher net worth, as conjured by the Fed.

These are pretty pathetic reasons for issuing massive quantities of digital greenbacks.

Like all other experiments in printing-press finance, its main impact will be to give a destructively erroneous signal to fiscal policymakers on both ends of Pennsylvania Avenue: Namely, that chronic trillion-dollar deficits don’t matter because the Fed is financing them for free.

Yen worthless, US$ falls, global stock markets celebrate

“This is close to a currency war”

GLOBAL MARKETS-Stocks surge, dollar falls on world stimulus hope

World stocks surged and the U.S. dollar fell broadly on Tuesday after the Bank of Japan unexpectedly cut interest rates, fueling speculation that other governments will take additional actions to reinvigorate the global economic recovery.

The BOJ's measures -- cutting its overnight rate target to virtually zero and pledging to buy 5 trillion yen ($60 billion) worth of assets -- pushed the Nikkei average .N225 to close 1.5 percent higher.

Governments' ultra loose monetary policies may debase the value of currencies and are leading to continued demand for gold and the rise of other commodities.

BOJ May Have Fired First Shot in New Round of Global Action

The renewed push for easier monetary policy comes as the International Monetary Fund warns growth in advanced economies is falling short of its forecasts ahead of its annual meetings in Washington this week. The dilemma for policy makers is that their actions may do little to revive growth and end up roiling currency markets.

“The Bank of Japan is at the head of the pack,” said Stewart Robertson, an economist at Aviva Investors in London, which manages about $370 billion in assets. “It looks like a lot of others will follow. Whether it’s right or not is another matter.”

“The bottom line for the U.S. is a growth trajectory so slow you’d nearly call it stalled,” Paul McCulley, a portfolio investor at Pacific Investment Management Co., wrote on the company’s website this week.

The revival of quantitative easing is a reversal from earlier this year, when central banks were halting stimulus or debating how to tighten policy. What’s changed is the loss of momentum in industrial economies.

“At the present time, the growth threat is more of a danger than inflation,” said Graeme Leach, chief economist at the Institute of Directors, a London-based business lobby group. “Yes, inflation is above target now. But a double-dip recession would raise the specter of deflation.”

The question for those central banks leaning toward buying more assets is whether doing so will actually bolster expansion, said Charles Dumas, director of international research at Lombard Street Research Ltd., a London-based consultancy.

“Is quantitative easing going to cause people to spend more? I don’t think so,” he said. “It does add value in reducing the risk of a downward spiral in markets.”

Another risk is that the use of unconventional monetary policy is viewed as an effort to weaken currencies to boost exports, rising competitive devaluations and protectionist responses, said Eric Chaney, chief economist at AXA Group in Paris. Japan, Switzerland and Brazil are among the countries that have already intervened in markets to restrain their exchange rates.

“This is close to a currency war,” said Chaney, a former official at the French France Ministry. “It’s not through exchange-rate manipulation, but through monetary policies.”

If you have it, the BoJ will buy it

If you live in Japan and thought about selling stuff in the closet on EBAY, hawk it to the BoJ instead. Gold is not in a bubble, money printing is.

A ticking, aging time-bomb in JGBs

Last time Japan went scouting for JGB investors, it had a plentiful resource in its own population base — all of whom were aging but were also looking for a risk-less investment until retirement day.

This time round, though, the aged Japanese pensioner is unlikely to be as enthusiastic a purchaser of JGBs simply because in many circumstances retirement day has already dawned. In fact, they’re likely to start cashing those JGBs in.

Japan’s dependency ratio is now approaching 100. This is significant. The dependency ratio is the percentage of retired people supported by working people.

Very soon Japan will have more retired people than working people, and the savings rate will fall further. This is not only an issue for the productive capital of economy, it means Japan will be in less of a position to use domestic savings to fund their burgeoning deficit. Gross debt to GDP is 200%.

BoJ says: ‘Bye, bye bank note rule’

Mrs Watanabe should be scared!

Guambat conducted an experiment wherein he laid out a piece of string in a line and tried to push it from one end. He reckons the various national currency and debt policies competing around the world will have a similar result, but worse: it will end in knots.


FURTHER READING:

The Specter of Protectionism: World Faces New Wave of Currency Wars

Euro down the drain, caught in a Greece trap

Moody's Lowers Greece Ratings On Nation's Continued Woes

Moody's Investors Service lowered its ratings on Greece, and warned further downgrades were possible, as the ratings agency noted significant risk that debt may only stabilize at a higher and more costly level than previously estimated.

Following the news, the euro dropped to an 11-month low, as fresh worries over Greece's fiscal position led investors to flee riskier assets for the safety of the dollar.

Greece activates aid plan

Greece on Friday triggered an emergency aid plan to draw cash from other countries that use the euro and the International Monetary Fund and ease a debt crisis that has weighed on the shared currency.

The package has enough money to keep Greece from defaulting on its massive debts any time soon. But Greece faces years of painful cutbacks, and its long-term finances -- as well as whether its troubles will infect other indebted EU members and further harm the euro currency -- are still being questioned.

Read more: http://www.miamiherald.com/2010/04/24/1595578/greece-activates-aid-plan.html#ixzz0m05wls4S

Euro Recovers From Lows On Greek Aid Request

The euro rebounded sharply off a one-year low Friday after Greece formally asked for a financial aid package and euro- zone lynchpin Germany said it was prepared to help.

But with uncertainties still enveloping the aid process for Greece and debt issues casting a shadow over other euro-zone countries, the common currency is likely to come under renewed pressure. Structural issues--such as low-growth prospects and profligate spending--could lead to further declines in the euro.

Greek workers strike, warn of social explosion

Nurses, teachers, tax officials and dockers stopped work during the 24-hour strike, which paralyzed public services, while EU and IMF officials met in Athens for talks that could lead to a financial bailout for Greece.

"People are asking for blood," said ALCO pollster Costas Panagopoulos. "They need someone to be punished for what is happening. They want the government to put all those who did not pay their taxes in prison."

Greek sailors to strike over market liberalisation

Greek seamen on Thursday called a strike next week after the government said it would lift restrictions on foreign cruise ships in a first step towards liberalising the country's labour market.

In the confluence of fundamentals and technicals

Barry Ritholtz provides a price chart of the US dollar, with MACD technicals indicating an uptrend from a oversold position. His conclusion is that the chart "suggests a dollar rally is in the offing".

Right on cue, the real world chimes in:

Iraq says Iranians cross into disputed oilfield

Iran Forces Occupy Iraqi Oil Well, Border Guard Says (Update1)

MORE TO THE IRAN/IRAQ STORY:

Stratfor has been reporting that the incursion story is VERY muddied and hard to substantiate in detail. It appears more aimed by Iran to stir the pot than to add any territory. They report the US steadfastly does not want any part of this event at the moment.


AND IT AIN'T OVER YET...:


Iran 'withdraws' from disputed well

Iranian troops have withdrawn partially from a disputed oil well in the border region with Iraq, the Iraqi government has said.

Ali al-Dabbagh, a government spokesman, said that a group of Iranian troops who had allegedly seized control of the well last week had pulled back in the early hours of Sunday morning.

"The Iranian flag has been lowered," Dabbagh told Al Jazeera. "The Iranian troops have pulled back 50 metres, but they have not gone back to where they were before."

Iraq considers the well to be part of its al-Fauqa oil field.

Iran's armed forces, however, issued a statement on Saturday saying that, in Tehran's view, there had been no incursion into Iraq as the oil well was within Iranian borders.

"Our forces are on our own soil and, based on the known international borders, this well belongs to Iran," the statement said.

Submerging markets

Some of the emerging market darlings are submerging, but the love may linger anyway.

Mexico's debt is downgraded to just above 'junk'

Standard & Poor's lowered its rating on Mexico's foreign-currency debt to BBB from BBB-plus, after a cut of the same magnitude by Fitch Ratings on Nov. 23.

If Mexico were to fall to a BB rating, its debt would be considered non-investment-grade, or junk. That would wipe out the progress the country made regaining investment-grade status early in this decade.

Mexico has raised taxes this year to boost revenue, but the measures haven't gone far enough given declining oil production, S&P said.

But stock and currency investors continue to give Mexico the benefit of the doubt in the short run. Some investors may well wonder why the country deserves a lower debt rating than Greece, given the latter's far more desperate budget situation.

S&P's projection that Mexico's budget deficit will average 3% of gross domestic product through 2011 looks modest compared with Greece's deficit, which is expected to be near 13% of GDP this year. S&P still rates Greece A-minus, waiting to see what steps the government will take to rein in spending.

Meanwhile, back in the USSA:

US needs plan to tame debt soon, experts say

The U.S. government must craft a plan next year to get its ballooning debt under control or face possible panic in financial markets, a bipartisan panel of budget experts said in a report on Monday.

Though the government should hold off on immediate tax hikes and spending cuts to avoid harming the fragile economic recovery, it will need to make such painful changes by 2012 in order to keep debt at a manageable 60 percent of GDP by 2018, according to the Peterson-Pew Commission on Budget Reform.

The national debt has more than doubled since 2001, thanks to the worst recession since the 1930s, several rounds of tax cuts and wars in Iraq and Afghanistan.

A looming wave of retirements over the coming decade is expected to make the situation worse.

The national debt currently accounts for 53 percent of GDP, up from 41 percent a year ago. That's likely to rise to 85 percent of GDP by 2018 and 200 percent of GDP by 2038 unless dramatic changes are made, the commission said.

Quick: what's the currency of Dubai?

Dirham.

As in:

Nakheel PJSC, the Dubai World property developer, posted a first-half loss of 13.4 billion dirhams, according to a document obtained by Bloomberg News.

Debt restructuring by Dubai state-run companies may almost double to $46.7 billion as more of the emirate’s businesses need help making payments, Morgan Stanley said.

Nakheel PJSC’s $3.52 billion of Islamic bonds due Dec. 14 dropped more than 10 percent yesterday to 46.5 cents on the dollar, according to Citigroup Inc. Bonds sold by DIFC Investments and Dubai Holdings Commercial sank as low as 44.5 cents on the dollar after Moody’s Investors Service cut the credit ratings of six state-run companies. A jump in the cost of DP World’s credit-default swaps implied a 33 percent risk that the port operator will renege on debt.

OK, so you didn't quite get that currency quick enough. Here's an easier one:

What's the currency of Greece?


No, not drachma. It's the Euro, as in:

Fitch yesterday downgraded Greece’s credit rating one step to BBB+, the third-lowest on its investment-grade scale, and said the outlook for the rating is negative.

Moody’s also said that its top debt ratings on the U.S. and the U.K. may “test the Aaa boundaries.”

(From the same Bloomberg article as above.)

Some broader perspective here: Testing the AAA boundaries

OK, another one. What's the currency of Spain?

Again, the Euro, as in S&P revises Spain’s outlook to negative [UPDATE]:

Not to be outdone by its rivals at Fitch, who on Tuesday downgraded the sovereign rating of the Hellenic Republic of Greece, Standard & Poor’s on Wednesday revised its outlook on the Kingdom of Spain to negative from stable.

[Quoting from S&P report:]

The change in the outlook stems from our expectation of significantly lower GDP growth and persistently high fiscal deficits relative to peers over the medium term, in the absence of more aggressive fiscal consolidation efforts and a stronger policy focus on enhancing medium-term growth prospects.

Which, begins to sound a bit like Japan: Japan GDP revised heavily downward

Japan’s growth between July and September was revised down heavily on Wednesday, suggesting the country’s recovery is more fragile than previously thought.

Growth on the previous quarter was revised down from 1.2 per cent to 0.3 per cent. At an annualised rate the revision was from 4.8 per cent to 1.3 per cent.

A recovery in business investment reported in the first release proved an illusion.

While the revision undermined the idea that Japanese businesses have regained confidence and are preparing to expand output, private consumption was a bright spot, with growth revised up from 0.7 per cent to 0.9 per cent quarter on quarter.

[But:] “Consumer spending will probably start to decelerate in coming quarters,” said Seiji Adachi, a senior economist at Deutsche Securities in Tokyo. “People won’t keep purchasing durable goods just because the government has extended incentives.”

And Mexico: Fitch downgrades Mexico

And Russia: Russia downgrade first of many?

Meanwhile, the currency of the US (known for the last few years as the "doo doo"), may possibly be staging a bottoming, but only compared to the rest of the world's harder hit currencies:

Greenback Breakout?

The horrifyingly most non-event in currency news today

North Korea revalues currency, destroying personal savings

Chaos reportedly erupted in North Korea on Tuesday after the government of Kim Jong Il revalued the country's currency, sharply restricting the amount of old bills that could be traded for new and wiping out personal savings.

The revaluation and exchange limits triggered panic and anger, particularly among market traders with substantial hoards of old North Korean won -- much of which has apparently become worthless, according to news agency reports from South Korea and China and from groups with contacts in North Korea.

The currency move appeared to be part of a continuing government crackdown on private markets, which have become an essential part of the food-supply system in the chronically hungry North.

etc.

And so the world's most worthless currency becomes more worthless. It's not like the US currency has lost favor, is it?

Renewed Appetite for Risk Drives Dollar to 15-Month Low

Yen Could Extend Rally after Post Dubai Stabilization

Don't get carried away with carry trading

FT Alphaville carries a warning about those looking for easy pickin's in the carry trade patch.

The warning: if you look only at the nominal value of rate differentials without the implied volatility behind the differential you are ignoring the risk part of the trade, to you're peril.

Whatever the incentives from the rate differentials, implied volatilities remain high enough to discourage carry trades. In both cases, the incentives are not only well below the peak, they are well below the average.

In other words, it’s only when volatility diminishes that we will really begin to see the instigation of the “mother of all carry trades“. Be warned.

The Third-World way of asset allocation

David Malpass posits some interesting comments about the relation between a weak currency, particularly in this case the US dollar, and the prosperity of a nation in a WSJ column today.

Malpass was formerly the Chief Global Economist for Bear Stearns, who has done stints in both Reagan's and Bush I's administrations. In short, he's someone with much greater knowledge and experience in these matters than Guambat by lightyears.

Says he,

The Weak-Dollar Threat to Prosperity.

On the surface, the weak dollar may not look so bad, especially for Wall Street. Gold, oil, the euro and equities are all rising as much as the dollar declines. They stay even in value terms and create lots of trading volume. And high unemployment keeps the Fed on hold, so anyone with extra dollars or the connections to borrow dollars wins by buying nondollar assets.

Investors have been playing this weak-dollar trade for years, diverting more and more dollars into commodities, foreign currencies and foreign stock markets. This is the Third-World way of asset allocation.

Corporations play this game for bigger stakes, borrowing billions in dollars to expand their foreign businesses. As the pound slid in the 1950s and '60s and the British Empire crumbled, the corporations that prospered were the ones that borrowed pounds aggressively in order to expand abroad.

If stocks double but the dollar loses half its value, who beyond Wall Street are the winners and losers? There's been a clear demonstration this decade. The S&P nearly doubled from 2003 through 2007. Those who borrowed to buy won big-time. Rich people got richer, seeing their equity bottom line double. At the same time, the dollar's value was cut nearly in half versus the euro and other stable measures. Capital fled, undercutting job growth. Rent, gasoline and food prices rose more than wages.

Equity gains provide cold comfort when currencies crash.

A better approach would start with President Barack Obama rejecting the Bush administration's weak-dollar policy.

Guambat was intrigued by the analysis, mainly because Guambat is easily impressed, but more so because it had escaped Guambat's attention that Bush even had a weak dollar policy. All Guambat recalled was Hank Paulson's insistence on a strong dollar policy.

But, then, sure enough, right back there in the start of that 2003 through 2007 period Malpass mentioned, there is Bruce Bartlett in the National Review warning of just such a calamity:

Bush and the Buck, December 8, 2003

One of the reasons why presidential administrations fail is that they often fall victim to the law of unintended consequences.

Unfortunately, the Bush administration is in danger of making the same mistake with respect to the dollar. Having become obsessed with the trade deficit, it is looking for other ways to reduce imports and raise exports. One way of doing this is to reduce the value of the dollar on foreign exchange markets. A lower dollar makes imports more expensive and exports cheaper in terms of foreign currencies.

The problem is that this process is not taking place on its own, nor is it cost-free. The Treasury Department has been signaling for some time that it would not be displeased if the dollar fell. This sort of "benign neglect" can be as effective as direct action in foreign currency markets, such as having the Treasury sell dollars. When currency traders know that we won't defend our currency, they take advantage of it by selling dollars against other currencies. That is a key reason why the dollar has fallen sharply against the euro and is now at a record low.

Another effect of this weak-dollar policy became evident in recent days when the OPEC oil cartel indicated that it might raise prices to compensate for the falling dollar.

Although the signs are nascent, they indicate that inflation is starting to show its ugly head again, the result of an extremely easy Fed policy over the last three years. Sensitive commodity prices like gold are up, the dollar is down, and OPEC is again complaining about lost purchasing power. It's like déjà vu all over again.

All interesting, but Guambat's hind leg is furiously scratching his head trying to remember any rampant inflation since 2003. Apart from stocks and real estate and commodities, there was no particular inflation, leastwise, of the sort the CPI measures.

Was there something else, then, that led to the rich getting richer and wages not keeping pace with goods, as Malpass pointed out? Is a weak dollar the cause or coincidence of that condition, or nothing more than a furhpy?

Maybe; just maybe. This is what Malpass had to say (also in the National Review) back at the start of that period, 2003, when things just started going out of control according to his current write.

Tax-Cut Scorecard, It’s not all Bush asked for, but it will add materially to economic growth, May 23, 2003

President Bush met with House and Senate leaders on Monday and urged them to finish the tax cut this week. Final negotiations took place Wednesday with Vice President Cheney. The tax-cut bill should be signed into law by the president around Memorial Day.

So how does it stack up? The final bill is not all that Bush asked for, but it will add materially to economic growth and equity values.

Important growth provisions include the acceleration of the already-scheduled income-tax cuts, a cut in the long-term capital gains tax rate to 15 percent, a cut in the dividend tax rate to 15 percent, and an expansion of the expensing of business-equipment purchases.

Unlike the president's original proposal, the final deal reduces dividend taxes to 15 percent rather than zero percent and does not include the "deemed dividend" concept or basis step-up. As a result, it won't be as beneficial to share values or the U.S. corporate capital structure as the president's original proposal.

A rough estimate is that the tax cut will add at least $600 billion (or 5%) to U.S. equity market capitalization.

Guambat notes the DJIA peaked in November 2007 at just over 14,000 from a low in March 2003 (coincidentally anticipating the tax cuts in May mentioned by Malpass?) of just under 7500. A bit more than a mere 5% addition to the equity market capitalization, shall we say? Either that estimate was made by someone purposefully low-balling for political purposes, or incompetent.

Malpass, today, blames it all on a weak dollar policy. The Third World way of asset allocation, he says.

Guambat sort of suspects it is all the result of a First World way of asset allocation, by way of wealth distribution through taxation of ordinary incomes while alleviating taxation of gains from capital assets. Asset allocation is one thing, but the prosperity of a nation is another.


FOLLOW-UP: Reading some of the past blog comments about Malpass, Guambat noticed that he has regularly been pilloried for his views, such as this from Barry Ritholtz a few years back, as well as this : "I really don't like to single out any one firm or strategist for excessive criticism -- hey, we're all wrong on quite a regular basis. But, goddamn, if Bear Stearn's David Malpass hasn't been on the wrong side of more than a few major issues facing the economy over the past few years."