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Category Archives: Currency

Charts: Foreign Holding of USD Down in 2022

Source : Goldmoney

The Upside-down World of Currency

Alasdair Macleod wrote . . . . . . . . .

The gap between fiat currency values and that of legal money, which is gold, has widened so that dollars retain only 2% of their pre-1970s value, and for sterling it is as little as 1%. Yet it is commonly averred that currency is money, and gold is irrelevant.

As the product of statist propaganda, this is incorrect. Originally established in Roman law, legally gold is still money and the states’ debauched currencies are not — only a form of credit. As I demonstrate in this article, the major western central banks will be forced to embark on a new round of currency debasement, likely to put an end to the matter.

Central to my thesis is that commercial bank credit will contract sharply in response to rising interest rates and bond yields. This retrenchment is already ending the everything bubble in financial asset values, is beginning to undermine GDP, and given record levels of balance sheet leverage makes a major banking crisis virtually impossible to avoid. Central banks which are already in a parlous state of their own will be tasked with underwriting the entire credit system.

In discharging their responsibilities to the status quo, central banks will end up destroying their own currencies.

So, why do we persist in pricing everything in failing currencies, when that will almost certainly change? When the difference between legal money and declining currencies is finally realised, the public will discard currencies entirely reverting to legal money. That time is being brought forward rapidly by current events.

Why do we impart value to currency and not money?

A question that is not satisfactorily answered today is why is it that an unbacked fiat currency has value as a medium of exchange. Some say that it reflects faith in and the credit standing of the issuer. Others say that by requiring a nation’s subjects to pay taxes and to account for them guarantees its demand. But these replies ignore the consequences of its massive expansion while the state pretends it to be real money. Sometimes, the consequences can seem benign and at others catastrophic. As explanations for the public’s tolerance of repeated failures of currencies, these answers are insufficient.

Let us do a thought experiment to highlight the depth of the problem. We know that over millennia, metallic metals, particularly gold, silver, and copper came to be used as media of exchange. And we also know that the use of their value was broadened through credit in the form of banknotes and bank deposits. The relationships between legal money, that is gold, silver, or copper and credit in its various forms were defined in Roman law in the sixth century. And we also know that this system of money and credit with the value of credit tied to that of money, despite some ups and downs, has served humanity well ever since.

Now let us assume that in the absence of metallic money, in the dawn of economic time a ruler instructed his subjects to use a new currency which he and only he will issue for the public’s use. This would surely be seen as a benefit to everyone, compared with the pre-existing condition of barter. But the question in our minds must be about the durability of the ruler’s new currency. With no precedent, how is the currency to be valued in the context of the ratios between goods and services bought and sold? And how certain can one be about tomorrow’s value in that context? And what happens if the king loses his power, or dies?

Clearly, without a reference to something else, the king’s new currency is a highly risky proposition and sooner or later will simply fail. And even when a new currency has been introduced and linked to an existing form of money, if the tie is then cut the currency will struggle to survive. Without going into the good reasons why this is so, the empirical evidence confirms it. Chinese merchants no longer use Kubla Khan’s paper made out of mulberry leaves, and German citizens no longer use the paper marks of the early 1920s. But they still refer to metallic money.

Yet today, we impart values to paper currencies issued by our governments in defiance of these outcomes. An explanation was provided by the great Austrian economist, Ludwig von Mises in his regression theorem. He reasonably argued that we refer the value of a medium of exchange today to its value to us yesterday. In other words, we know as producers what we will receive today for our product, based on our experience in the immediate past, and in the same way we refer to our currency values as consumers. Similarly, at a previous time, we referred our experience of currency values to our prior experience. In other words, the credibility and value of currencies are based on a regression into the past.

Mises’s regression theory was broadly confirmed by an earlier writer, Jean-Baptiste Say, who in his Treatise on Political Economy observed:

“Custom, therefore, and not the mandate of authority, designates the specific product that shall pass exclusively as money, whether crown pieces or any other commodity whatever.”

Custom is why we still think of currencies as money, even though for the last fifty-one years their link with money was abandoned. The day after President Nixon cut the umbilical cord between gold and the dollar, we all continued using dollars and all the other currencies as if nothing had happened. But this was the last step in a long process of freeing the paper dollar from being backed by gold. The habit of the public in valuing currency by regression had served the US Government well and has continued to do so.

The role of a medium of exchange

Being backed by no more than government fiat, to properly understand the role that currencies have assumed for themselves, we need to make some comments about why a medium of exchange is needed and its characteristics. The basis was laid out by Jean-Baptiste Say, who described the division of labour and the role of a medium of exchange.

Say observed that human productivity depended on specialisation, with producers obtaining their broader consumption through the medium of exchange. The role of money (and associated credit) is to act as a commodity valued on the basis of its use in exchange. Therefore, money is simply the right, or title, to acquire some consumer satisfaction from someone else. Following on from Say’s law, when any economic quantity is exchanged for any other economic quantity, each is termed the value of the other. But when one of the quantities is money, the other quantities are given a price. Price, therefore, is always value expressed in money. For this reason, money has no price, which is confined entirely to the goods and services in an exchange.

So long as currency and associated forms of credit are firmly attached to money such that there are minimal differences between their values, there should be no price for them either, other than a value difference arising from counterparty risk. A further distinction between money and currencies can arise if their users suspect that the link might break down. It was the breakdown in this relationship between gold and the dollar that led to the failure of the Bretton Woods agreement in 1971.

Therefore, in all logic it is legal money that has no price. But does that mean that when its value differs from that of money, does currency have a price? Not necessarily. So long as currency operates as a medium of exchange, it has a value and not a price. We can say that a dollar is valued at 0.0005682 ounces of gold, or gold is valued at 1760 dollars. As a legacy of the dollar’s regression from the days when it was on a gold standard, we still attribute no price to the dollar, but now we attribute a price to gold. To do so is technically incorrect.

Perhaps an argument for this state of affairs is that gold is subject to Gresham’s law, being hoarded rather than spent. It is the medium of exchange of last resort so rarely circulates. Nevertheless, fiat currencies have consistently lost value relative to legal money, which is gold, so much so that the dollar has lost 98% since the suspension of Bretton Woods, and sterling has lost 99%. Over fifty-one years, the process has been so gradual that users of unanchored currencies as their media of exchange have failed to notice it.

This gradual loss of purchasing power relative to gold can continue indefinitely, so long as the conditions that have permitted it to happen remain without causing undue alarm. Furthermore, for lack of a replacement it is highly inconvenient for currency users to consider that their currency might be valueless. They will hang on to the myth of its use value until its debasement can no longer be ignored.

What is the purpose of interest rates?

Despite the accumulating evidence that central bank management of interest rates fails to achieve their desired outcomes, monetary policy committees persist in using interest rates as their primary means of economic intervention. It was the central bankers’ economic guru himself who pointed out that interest rates correlated with the general level of prices and not the rate of price inflation. And Keynes even named it Gibson’s paradox after Arthur Gibson, who wrote about it in Banker’s Magazine in 1923 (it had actually been noted by Thomas Tooke a century before). But because he couldn’t understand why these correlations were the opposite of what he expected, Keynes ignored it and so have his epigonic central bankers ever since.

As was often the case, Keynes was looking through the wrong end of the telescope. The reason interest rates rose and fell with the general price level was that price levels were not driven by interest rates, but interest rates reacted to changes in the general level of prices. Interest rates reflect the loss of purchasing power for money when the quantity of credit increases. With their interests firmly attached to time preference, savers required compensation for the debasement of credit, while borrowers — mainly businesses in production — needed to bid up for credit to pay for higher input costs. Essentially, interest rates changed as a lagging indicator, not a leading one as Keynes and his acolytes to this day still assume.

In a nutshell, that is why Gibson’s paradox is not a paradox but a natural consequence of fluctuations in credit and the foreign exchanges and the public’s valuation of it relative to goods. And the way to smooth out the cyclical consequences for prices is to stop discouraging savers from saving and make them personally responsible for their future security. As demonstrated today by Japan’s relatively low CPI inflation rate, a savings driven economy sees credit stimulation fuelling savings rather than consumption, providing capital for manufacturing improvements instead of raising consumer prices. Keynes’s savings paradox — another fatal error — actually points towards the opposite of economic and price stability.

It is over interest rate management that central banks prove their worthlessness. Even if they had a Damascene conversion, bureaucrats in a government department can never impose decisions that can only be efficiently determined by market forces. It is the same fault exhibited in communist regimes, where the state tries to manage the supply of goods— and we know, unless we have forgotten, the futility of state direction of production. It is exactly the same with monetary policy. Just as the conditions that led the communists to build an iron curtain to prevent their reluctant subjects escaping from authoritarianism, there should be no monetary policy.

Instead, when things don’t go their way, like the communists, bureaucrats double down on their misguided policies suppressing the evidence of their failures. It is something of a miracle that the economic consequences have not been worse. It is testament to the robustness of human action that when officialdom places mountainous hurdles in its path ordinary folk manage to find a way to get on with their lives despite the intervention.

Eventually, the piper must be paid. Misguided interest rate policies led to their suppression to the zero bound, and for the euro, Japanese yen, and Swiss franc, even unnaturally negative deposit rates. Predictably, the distortions of these policies together with central bank credit inflation through quantitative easing are leading to pay-back time.

Rapidly rising commodity, producer and consumer prices, the consequences of these policy mistakes, are in turn leading to higher time preference discounts. Finally, markets have wrested currency and credit valuations out of central banks’ control, as it slowly dawns on market participants that the whole interest rate game has been an economic fallacy. Foreign creditors are no longer prepared to sit there and accept deposit rates and bond yields which do not compensate them for loss of purchasing power. Time preference is now mauling central bankers and their cherished delusions. They have lost their suppressive control over markets and now we must all face the consequences. Like the fate of the Berlin Wall that had kept Germany’s Ossies penned in, monetary policy control is being demolished.

With purchasing powers for the major currencies now sinking at a more rapid rate than current levels of interest rate and bond yield compensation, the underlying trend for interest rates is now rising and has further to go. Official forecasts that inflation at the CPU level will return to the targeted 2% in a year or two are pie in the sky.

While Nero-like, central bankers fiddle commercial banks are being burned. A consequence of zero and negative rates has been that commercial bank balance sheet leverage increased stratospherically to compensate for suppressed lending margins. Commercial bankers now have an overriding imperative to claw back their credit expansion in the knowledge that in a rising interest rate environment, their unfettered involvement in non-banking financial activities comes at a cost. Losses on financial collateral are mounting, and the provision of liquidity into mainline non-financial sectors faces losses as well. And when you have a balance sheet leverage ratio of assets to equity of over twenty times (as is the case for the large Japanese and Eurozone banks), balance sheet equity is almost certain to be wiped out.

The imperative for action is immediate. Any banker who does not act with the utmost urgency faces the prospect of being overwhelmed by the new interest rate trend. The chart below shows that the broadest measure of US money supply, which is substantially the counterparty of bank credit is already contracting, having declined by $236bn since March.

Contracting bank credit forces up interest rates due to lower credit supply. This is a trend that cannot be bucked, a factor that has little directly to do with prices. By way of confirmation of the new trend, the following quotation is extracted from the Fed’s monthly Senior Loan Officers’ Opinion Survey for October:

“Over the third quarter, significant net shares of banks reported having tightened standards on C&I [commercial and industrial] loans to firms of all sizes. Banks also reported having tightened most queried terms on C&I loans to firms of all sizes over the third quarter. Tightening was most widely reported for premiums charged on riskier loans, costs of credit lines, and spreads of loan rates over the cost of funds. In addition, significant net shares of banks reported having tightened loan covenants to large and middle-market firms, while moderate net shares of banks reported having tightened covenants to small firms. Similarly, a moderate net share of foreign banks reported having tightened standards for C&I loans.

“Major net shares of banks that reported having tightened standards or terms cited a less favourable or more uncertain economic outlook, a reduced tolerance for risk, and the worsening of industry-specific problems as important reasons for doing so. Significant net shares of banks also cited decreased liquidity in the secondary market for C&I loans and less aggressive competition from other banks or nonbank lenders as important reasons for tightening lending standards and terms.”

Similarly, credit is being withdrawn from financial activities. The following chart reflects collapsing credit levels being provided to speculators.

In the same way that the withdrawal of bank credit undermines nominal GDP (because nearly all GDP transactions are settled in bank credit) the withdrawal of bank credit also undermines financial asset values. And just as it is a mistake to think that a contraction of GDP is driven by a decline in economic activity rather than the availability of bank credit, it is a mistake to ignore the role of bank credit in driving financial market valuations.

The statistics are yet to reflect credit contraction in the Eurozone and Japan, which are the most highly leveraged of the major banking systems. This may be partly due to the rapidity with which credit conditions are deteriorating. And we should note that the advanced socialisation of credit in these two regions probably makes senior managements more beholden to their banking authorities, and less entrepreneurial in their big-picture awareness than their American counterparts. Furthermore, the principal reason for continued monetary expansion reflects both the euro-system and the Bank of Japan’s continuing balance sheet expansion, which feed directly into the commercial banking network bolstering their balance sheets. It is likely to be state-demanded credit which overwhelms the Eurozone and Japan’s statistics, masking deteriorating changes in credit supply for commercial demand.

The ECB and BOJ’s monetary policies have been to compromise their respective currencies by their continuing credit expansion, which is why their currencies have lost significant ground against the dollar while US interest rates have been rising. Adding to the tension, the US’s Fed has been jawing up its attack on price inflation, but the recent fall in the dollar on the foreign exchanges strongly suggests a pivot in this policy is in sight.

The dilemma facing central banks is one their own making. Having suppressed interest rates to the zero bound and below, the reversal of this trend is now out of their control. Commercial banks will surely react in the face of this new interest rate trend and seek to contract their balance sheets as rapidly as possible. Students of Austrian business cycle theory will not be surprised at the suddenness of this development. But all GDP transactions, with very limited minor cash exceptions at the retail end of gross output are settled in bank credit. Inevitably the withdrawal of credit will cause nominal GDP to contract significantly, a collapse made more severe in real terms when the decline in a currency’s purchasing power is taken into consideration.

The choice now facing bureaucratic officialdom is simple: does it prioritise rescuing financial markets and the non-financial economy from deflation, or does it ignore the economic consequences of protecting the currency instead? The ECB, BOJ and the Bank of England have decided their duty lies with supporting the economy and financial markets. Perhaps driven in part by central banking consensus, the Fed now appears to be choosing to protect the US economy and its financial markets as well.

The principal policy in the new pivot will be the same: suppress interest rates below their time preference. It is the policy mistake that the bureaucrats always make, and they will double down on their earlier failures. The extent to which they suppress interest rates will be reflected in the loss of purchasing power of their currencies, not in terms of their values against each other, but in their values with respect to energy, commodities, raw materials, foodstuffs, and precious metals. In other words, a new round of higher producer and consumer prices and therefore irresistible pressure for yet higher interest rates will emerge.

The collapse of the everything bubble

The flip side of interest rate trends is the value imparted to assets, both financial and non-financial. It is no accident that the biggest and most widespread global bull market in history has coincided with interest rate suppression to zero and even lower over the last four decades. Equally, a trend of rising interest rates will have the opposite effect.

Unlike bull markets, bear markets are often sudden and shocking, especially where undue speculation has been previously involved. There is no better example than that of the cryptocurrency phenomenon, which has already seen bitcoin fall from a high of $68,000 to $16,000 in twelve months. And in recent days, the collapse of one of the largest crypto-exchanges, FTX, has exposed both hubris and alleged fraud, handmaidens to extreme public speculation, on an unimaginable scale. For any student of the madness of crowds, it would be surprising if the phenomenon of cryptocurrencies actually survives.

Driving this volte-face into bear markets is the decline in bond values. On 20 March 2020, when the Fed reduced its fund rate to zero, the 30-year US Treasury bond yielded 1.18%. Earlier this week the yield stood at 4.06%. That’s a fall in price of over 50%. And time preference suggests that short-term rates, for example over one year, should currently discount a loss of currency’s purchasing power at double current rates, or even more.

For the planners who meddle with interest rates, increases in rates and bond yields on that scale are unimaginable. Monetary policy committees, being government agencies, will think primarily about the effect on government finances. In their nightmares they can envisage tax revenues collapsing, welfare commitments soaring, and borrowing costs mounting. The increased deficit, additional to current shortfalls, would require central banks to accelerate quantitative easing without limitation. To the policy planners, the reasons to bring interest rates both lower and back firmly under control are compelling.

Furthermore, officials believe that a rising stock market is necessary to maintain economic confidence. That also requires the enforcement of a new declining interest rate trend. The argument in favour of a new round of interest rate suppression becomes undeniable. But the effect on fiat currencies will accelerate their loss of purchasing power, undermining confidence in them and leading to yet higher interest rates in the future.

Either way, officialdom loses. And the public will pay the price for meekly going along with these errors.

Managing counterparty risk

Any recovery in financial asset values, such as that currently in play, is bound to be little more than a rally in an ongoing bear market. We must not forget that commercial bankers have to reduce their balance sheets ruthlessly if they are to protect their shareholders. Consequently, as over-leveraged international banks are at a heightened risk of failing in the new interest rate environment, their counterparties face systemic risks increasing sharply. To reduce exposure to these risks, all bankers are duty bound to their shareholders to shrink their obligations to other banks, which means that the estimated $600 trillion of notional over the counter (OTC) derivatives and on the back of it the additional $50 trillion regulated futures exchange derivatives will enter their own secular bear markets. OTC and regulated derivatives are the children of falling interest rates, and with a new trend of rising interest rates their parentage is bound to be tested.

We can now see a further reason why central banks will wish to suppress interest rates and support financial markets. Unless they do so, the risk of widespread market failures between derivative counterparties will threaten to collapse the entire global banking network. And that is in addition to existential risks from customer loan defaults and collapsing collateral values. Central banks will have to stand ready to rescue failing banks and underwrite the entire commercial system.

To avert this risk, they will wish to stabilise markets and prevent further increases in interest rates. And all central banks which have indulged in QE already have mark-to-market losses that have wiped out their own balance sheet equity. We now face the prospect of central banks that by any commercial measure are themselves financially broken, tasked with saving entire commercial banking networks.

When the trend for interest rates was for them to fall under the influence of increasing supplies of credit, the deployment of that credit was substantially directed into financial assets and increasing speculation. For this reason, markets soared while the increase in the general level of producer and consumer prices was considerably less than the expansion of credit suggested should be the case. That is no longer so, with manufacturers facing substantial increases in their input costs. And now, when they need it most, bank credit is being withdrawn.

It is not generally realised yet, but the financial world is in transition between economies being driven by asset inflation and suppressed commodity prices, and a new environment of asset deflation while commodity prices increase. And it is in the valuations of unanchored fiat currencies where this transition will be reflected most.

Physical commodities are set replace paper equivalents

The expansion of derivatives when credit was expanding served to soak up demand for commodities which would otherwise have gone into physical metals and energy. In the case of precious metals, this is admitted by those involved in the expansion of London’s bullion market from the 1980s onwards to have been a deliberate policy to suppress gold as a rival to the dollar.

According to the Bank for International Settlements, at the end of last year gold OTC outstanding swaps and forwards (essentially, the London Bullion Market) stood at the equivalent of 8,968 tonnes of bullion, to which must be added the 1,594 tonnes of paper futures on Comex giving an identified 10,662 tonnes. This is considerably more than the official reserves of the US Treasury, and even its partial replacement with physical bullion will have a major impact on gold values. Silver, which is an extremely tight market, is most of the BIS’s other precious metal statistics content and faces bullion replacement of OTC paper in the order of three billion ounces, to which we must add Comex futures equivalent to a further 700 million ounces.

On the winding down of derivative markets alone, the impact on precious metal values is bound to be substantial. Furthermore, the common mistake made by almost all derivative traders is to not understand that legal money is physical gold and silver — despite what their regulating governments force them to believe. What they call prices for gold and silver are not prices, but values imparted to legal money from depreciating currencies and associated credit.

While it may be hard to grasp this seemingly upside-down concept, it is vital to understand that so-called rising prices for gold and silver are in fact falling values for currencies. Some central banks, predominantly in Asia are taking advantage of this ignorance, which is predominantly displayed in western, Keynesian-driven derivative markets.

Perhaps after a currency hiatus and when market misconceptions are ironed out, we can expect legal money values to behave as they should. If a development which is clearly inflationary emerges, it should drive currency values lower relative to gold. But instead, in today’s markets we see them rise because speculators take the view that currencies relative to gold will benefit from higher interest rates. A pause for thought should expose the fallacy of this approach, where the true relationship between money and currencies is assumed away.

In the wake of the suspension of the Bretton Woods agreement and when the purchasing power of currencies subsequently declined, interest rates and the value of gold rose together. In February 1972, gold was valued at $85, while the Fed funds rate was 3.3%. On 21 January 1980 gold was fixed that morning at $850, and the Fed funds rate was 13.82%. When gold increased nine-fold, the Fed’s fund rate had more than quadrupled. And it required Paul Volcker to raise the funds rate to over 19% twice subsequently to slay the inflation dragon.

In the seventies, the excessive credit-driven speculation that we now witness was absent, along with the accompanying debt leverage in the financial sectors of western economies and in their banking systems. A Volcker-style rise in interest rates today would cause widespread bankruptcies and without doubt crash the entire global banking system. While markets might take us there anyway, as a deliberate act of official policy it can be safely ruled out.

We must therefore conclude that there is another round of currency destruction in the offing. Potentially, it will be far more extensive than anything seen to date. Not only will central-bank currency and QE expansion fund government deficits and attempt to compensate for the contraction of bank credit while supporting financial markets by firmly suppressing interest rates and bond yields, but insolvent central banks will be tasked with underwriting insolvent commercial banks.

At some stage, the inversion of monetary reality, where legal money is priced in fiat, will change. Instead of legal money being priced in fiat, fiat currencies will be priced in legal money. But that will be the death of the fiat swindle.

Source : Goldmoney

Chart: China’s Yuan Extends Advance as Reopening Bets Boost Sentiment

Source : Blomberg

Hong Kong Peg Creator Says Sky-High Rates One Way to Defend It

Tania Chen wrote . . . . . . . . .

Hong Kong is willing to tolerate sky-high borrowing rates and near term economic pain to defend its currency peg with the dollar in the wake of renewed attacks by speculators.

“They would be willing to let Hong Kong dollar rates to rise to whatever level necessary to maintain the fixed exchange rates,” said John Greenwood, the architect behind the currency board mechanism created in 1983. “There’s a cost, but the dislocation caused by a fluctuating currency would have much bigger impact on domestic prices, import costs, and capital markets.”

Hedge fund titans Bill Ackman and Boaz Weinstein are shorting the currency to test and profit from that pain threshold. Ackman, the billionaire founder of Pershing Square Capital Management LP, said the peg no longer made sense for Hong Kong, referencing a Bloomberg Opinion column which argued that the social and economic toll of maintaining the link is too much to bear.

While financial conditions appear ripe for bears to emerge, those speculators underestimate the Hong Kong Monetary Authority’s willingness to preserve the peg, Greenwood said. That’s because the range-bound currency tied to the US dollar remains the city’s biggest draw for doing business with mainland China, a role it’s not looking to give up.

For the better part of this year, the Hong Kong dollar has traded at the weak end of the HK$7.75 to HK$7.85 band, which has prompted the de-facto central bank to step in to buy local dollars, sending borrowing costs higher. The three-month Hong Kong interbank offered rate now sits at 5.27%, the highest since 2007. The economy has also taken a hit after a prolonged Covid exit, with growth expected to decline more than expected this year into next.

Still, these signs of distress have yet to convince officials to change their official stance: Hong Kong doesn’t need nor intend to change its linked exchange rate system in response to Ackman’s comments, the HKMA said in a statement. The local currency traded at around 7.8112 per dollar on Tuesday.

“As long as Hong Kong authorities maintain high interest rates to attract flows, there will always be liquidity to counter those shorts,” Greenwood said. “They would allow domestic rates to rise as high as the sky rather than undermine four decades of currency stability.”

Source : BNN Bloomberg

Pressure on the Hong Kong Dollar Peg Keeps Building

Richard Cookson wrote . . . . . . . . .

I wrote in April that the financial and social prices of protecting the Hong Kong greenback pegged to the US greenback had been turning into unsustainable and may need to be deserted. The pressures I’ve described have solely elevated and at the moment are most likely larger than anybody outdoors of the Hong Kong Monetary Authority – which challenged my authentic evaluation – realizes.

The HKMA is remitted to maintain FX buying and selling inside a variety of HK$7.75 to HK$7.85 per US greenback. The present band was discontinued in 2005 and has by no means been damaged. If it will get too near both finish of the band, the HKMA intervenes by both shopping for or promoting the metropolis’s forex. As the chart beneath reveals, the forex traded at the extraordinarily weak finish of the vary for many of the 12 months, below stress from the strengthening US greenback. This stress has eased considerably not too long ago as rate of interest expectations have eased considerably. But that is solely prone to be a short-term repair, as the social and financial prices of defending the bond are monumental. The peg to the Hong Kong greenback is sort of a gold customary and, like the gold customary, the weaknesses of such mechanisms are all the time social and financial.

Because of its peg to the US greenback, Hong Kong has no impartial financial coverage; it needed to observe the Federal Reserve and tighten at a time when it needs to be doing the reverse. If the Chinese financial system as a complete has been struggling on the again of its extraordinary “zero Covid” coverage and the mom of all debt bubble hangovers, Hong Kong has fared even worse, contracting 4.5% 12 months on 12 months in the third quarter. The benchmark Hang Seng index is down almost half since its 2018 excessive, even after a latest rebound.

With development headed in the improper path and the HKMA compelled to hike rates of interest, Hong Kong has needed to resort to the solely choice for currency-pegged international locations: large authorities spending. However, there may be very restricted room for any nation to extend fiscal spending with out traders worrying about the accompanying improve in borrowing (debt) and the sustainability of the peg. No surprise, then, that fiscal coverage has achieved little to mitigate the sharp downturn.

This is not only a cyclical drawback both. Hong Kong’s finest days are behind him. China’s political interference has solely elevated. The labor pressure, particularly the increased earners in finance, is shrinking. I doubt the weak point is solely cyclical, and if not, Hong Kong’s tax base has been completely eroded. That’s an issue as a result of Hong Kong is now a massively leveraged financial system.

That the authorities has little or no debt is not actually the level, as personal sector debt greater than makes up for it. Andrew Hunt, an impartial economist who has adopted Asia carefully for many years, factors out that the exterior debt is almost $500,000 for each particular person working in Hong Kong. According to the World Bank, home debt has doubled since 2007. Housing debt has been rising notably quick, and regardless of a worth slide exhibiting all indicators of accelerating, Hong Kong property remains to be amongst the costliest in the world.

It is that this large rise in debt, falling asset costs and the more and more gloomy outlook for Hong Kong’s financial system that makes defending the peg a lot extra problematic than it was throughout the Asian disaster of the late Nineties. The ramifications of all this may be seen in the HKMA’s Exchange Fund, which, amongst different issues, manages Hong Kong’s international change reserves. His wealth has fallen to $417 billion from $500 billion at the finish of final 12 months, the largest drop ever, in accordance with the HKMA.

Most of the decline in Exchange Fund property over the previous few months, nonetheless, shouldn’t be as a consequence of intervention, however quite to 2 different sources. The first is that the authorities needed to faucet into the Exchange Fund to make up for misplaced income, in accordance with HKMA and authorities information. Barring a slight surplus in 2020-2021, the authorities has reported a consolidated finances deficit since 2019. To cut back these deficits – and create this very small surplus – the authorities tapped into the collected finances surplus managed by the Exchange Fund. From a peak of HK$1.17 trillion ($150 billion) in 2018-2019, the finances surplus shrank to HK$957 billion by the finish of March and HK$704 billion by the finish of September. Over a four-year interval starting in 2019-2020, the authorities additionally put aside HK$82.4 billion as a housing reserve, in accordance with authorities and HKMA information. Although saved individually, this was additionally cash from earlier finances surpluses.

These transfers are counted as present income in authorities accounts, though they’re the product of earlier years’ income. The authorities says it is because it makes use of money accounting. That’s why the proceeds from the $10 billion inexperienced bonds it has issued are counted as earnings. It has not handled different money owed this manner, nor would every other accounting system on the planet. Over the previous 12 months, the authorities doubled the quantity of inexperienced bond debt it may have excellent at any given time.

In addition, potential authorities liabilities are rising. Since 2019, the quantity of mortgage ensures supplied by the authorities, principally for smaller companies, has elevated from HK$27.8 billion to HK$133.4 billion, annual studies present. These solely enter the authorities’s steadiness sheet when corporations default, and the present default charge is simply 2.6%, in accordance with the authorities. But it’s also possible to preserve failing corporations afloat in case you lend them sufficient cash at rock-bottom rates of interest.

To me, the fascinating method the authorities should generate income reeks of desperation. And if spending is minimize, the financial system will virtually definitely fare even worse, making a vicious circle of even slower development, extra defaults and fewer income. The authorities says these are one-off issues brought on by the pandemic and different remoted circumstances. The drawback is that finances deficits predated Covid. And given the seemingly profile of the Chinese financial system usually and Hong Kong particularly, I do not see that altering.

The second motive why the Exchange Fund’s property have gone down is funding losses. Although most look to complete property when contemplating the firepower at the HKMA’s disposal, that is not solely correct. The peg is not backed by the full $417 billion, however by the backing fund, which is about half that quantity and simply 10% greater than the HKMA’s financial base calculations (the identical proportion increased than a 12 months in the past). The totals are smaller, nonetheless, as the cash provide has contracted by about 9%. Although this provides a sign of the deflationary forces gripping Hong Kong, the cash provide would have contracted extra had the HKMA not tapped into the Exchange Fund.

In numerous annual studies and statements, the HKMA says it may use the remainder of the portfolio to defend the peg if mandatory. There is a mechanism whereby this occurs robotically when the property of the companion fund shrink to simply 5% above the financial base. On the different hand, if the worth of the companion fund is no less than 12.5% ​​increased than the financial base, cash shall be transferred to its funding portfolios. What the HKMA will not inform me is whether or not there may be any discretion on this course of.

There are three different portfolios: the Strategic Fund, which incorporates solely its pursuits in Hong Kong Exchanges and Clearing; the mutual fund, which incorporates public debt and shares; and the Long-Term Growth Fund, which invests in actual property and personal fairness.

How a lot is all this cash price now? HKMA doesn’t rely the beneficial properties and losses of its strategic fund in complete returns. As good as. But the assist fund comprises nothing however {dollars} and possibly short-dated authorities bonds or comparable substitutes (however because it had mark-to-market losses we will not be certain). The different two portfolios maintain most of the HKMA’s threat. Based on some cheap assumptions, round 1 / 4 of the Funds’ exposures are prone to be in non-US greenback denominated property.

This can also be the place, in accordance with the HKMA, sits the overwhelming majority of HKMA’s fairness and credit score threat, of which there are loads. Total fairness publicity, detailed in the annual report late final 12 months, was HK$745 billion. But there may be virtually definitely extra. Exposure to personal fairness and actual property joint ventures is lumped in with actual property in one other class of unlisted and pretty nebulous HK$443 billion ‘mutual funds’. The HKMA makes it very tough to determine what’s the place.

The fund comprises all publicly traded bonds and shares. It’s cheap to imagine, though I do not know for certain and the HKMA will not say that each one inventory is marked to market month-to-month. Its long-term strategic development fund is one other matter. At the finish of final 12 months, this fund had property price round HK$515 billion. Valuations of its unlisted investments are printed semi-annually, however the newest efficiency numbers are primarily based on valuations as of late March.

Apparently, the HKMA is excellent at actual property and personal fairness investing, having made a small revenue not like virtually everybody else. These outcomes needs to be taken with warning. As anybody concerned in such valuations will know, they are usually expressions of hope, fashions, and heroic assumptions quite than something approaching a worth at which such property may very well be offered. And it is gotten lots worse since then anyway.

Call me old style, however a authorities that clearly wants money and a bunch of property which might be prone to proceed to fall in worth makes it fairly seemingly that the Exchange Fund’s property might want to proceed shrinking — and that the causes for doing so will add much more stress the cone.

Source : Bloomberg

Read also at BNN Bloomberg

Morgan Stanley Says HK Dollar Peg Will Stay, Rebutting Ackman . . . . .

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Billionaire investor Ackman bets Hong Kong dollar peg can break . . . . .

The End of World Dollar Hegemony: Turning the USA into Weimar Germany

Patrick Barron wrote . . . . . . . . .

In a recent essay, I explained how over time the US abused its responsibility to control the supply of dollars, the world’s premier reserve currency for settling international trade accounts among nations. This abrogation of its duties is leading to the likely adoption of a new reserve currency, commodity based and controlled not by one nation but by members, all watchful that the currency is not inflated.

Let us continue the analogy of an individual receiving a “magic checkbook” which allows him to write as many checks for as much money as he desires. Receivers of these checks could only pass them along to others through the normal course of trade. Over time the owner of the magic checkbook becomes increasingly irresponsible. He funds all kinds of welfare and warfare initiatives.

Naturally dollar reserves build to levels completely unnecessary for peaceful exchange. Prices start to rise at a faster and faster rate. Then a reform consortium assembles a team to offer an alternative currency. Why, one may ask, is that such a problem for the dollar and dollar users?

The Weimar Republic: A Lesson in Supply and Demand

A successful alternative reserve currency would dilute demand to hold dollars. When demand for dollars drops, its price must drop unless and until its supply drops. (A drop in the dollar’s “price” is just another way of stating that its purchasing power falls—i.e., more dollars are required to buy the same goods and services.) Through irresponsible use of the magic checkbook, you have obligated yourself to funding a free-for-all of entitlements such as Social Security, Medicare, and the military-industrial complex being the largest by far. Politically, it may be almost impossible to cut any of these three categories of spending to the extent necessary to arrest the dollar’s drop in purchasing power.

The world has seen all this before, and not just in less developed nations like Zimbabwe. The US will find itself in the same trap as experienced by Germany’s Weimar Republic following World War I. The Reichsbank, Germany’s central bank, printed papiermarks to placate powerful constituencies within Germany. As the Reichsbank printed more money, the purchasing power of papiermarks dropped. And herein lay the trap. Rising prices led powerful constituencies to demand increases in pay and benefits. Industrial labor unions, government civil servants, welfare recipients, old age pensioners whose life savings were being decimated—all demanded more money. Strikes and violence became endemic. So, the Reichsbank printed more money … which, of course, simply led to higher prices and another round of payment increases … which led to even higher prices until the papiermark became worth more as wallpaper than money.

Why did the Weimar Republic government continue to increase payments, and why did the Reichsbank continue to print papiermarks? Many sophisticated answers have been advanced, such as that the government and the Reichsbank deliberately destroyed the papiermark in a roundabout plot to thwart the financial terms of the Versailles Treaty in which a defeated Germany was ordered to pay reparations to the Allied powers. But the simplest answer is that both believed that there was no other choice than to increase payments and print money in a crisis. It was felt that powerful constituencies must be placated in the short run.

But short run tactics just made things worse. There was neither the political will nor the economic understanding of the need to end excessive spending and currency debasement and endure the pain thereby induced.

The US and the UK: A Lack of Political Will and Economic Understanding

I fear that the same is true today. In fact, the seeming lack of adverse consequences (all in the long term) and advantages of money printing in the short term have led to a knee-jerk response by the US Treasury and the Federal Reserve Bank to increase the money supply and lower interest rates in the face of any economic problem, even higher prices themselves. For example, just look to Britain. Its energy shortages have caused prices to rise. The government’s response has been to pledge payouts to households! That’s right. No pledge to dismantle barriers to increased energy production … just a pledge to increase the government’s deficit, which requires more money printing! As the saying goes, you can’t make this stuff up.

One thing is certain, however. What Britain can do, the US can and will do in spades. Hyperinflation is a real possibility. Remember, the Reichsbank in Weimar Republic Germany actually had to print physical money. The US Federal Reserve Bank need only click a few buttons on a computer. As prices rise, powerful groups demand more money. Police, firemen, road workers, etc. Demand that they not suffer a lowering of their lifestyle. Since government is spending someone else’s money, it accedes to these demands.

Back to our British example. The exchange value of the pound has been plummeting in currency markets, leading to serious consequences. The Bank of England was forced to raise interest rates and now government debt has become unaffordable. So, the Bank, as handmaiden to the government, has applied the only politically permissible remedy that it knows: its computers’ money printer is forced into overdrive, just to keep up.

What Happens on the Ground

Where does government get its money? State and local governments get money from state and local taxes. So captive property owners get increased tax bills to pay for maintaining public school teachers, police, etc. Social Security recipients must be compensated, of course, so payroll taxes are increased, which depresses business. American products become less competitive on the national and world market.

The price spirals continue to destroy all in their path until the dollar loses all purchasing power and society descends into chaos. And not one politician in a thousand understands what happened, or if he does understand, does not have the political will to do anything about it—i.e., reduce public spending, liquidate the Fed, and tie the dollar to our still significant gold reserves. It can be done.

Source : Mises Institute

Charts: The US dollar Is Falling, and It’s Falling Fast.

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Source : All Star Charts

Singapore and Thai Currencies Most at Risk From Yuan’s Slump

Marcus Wong wrote . . . . . . . . .

Investors in the Singapore dollar and Thai baht will have to brace for losses if the Chinese yuan, the worst-performing Asian currency on Monday, continues its fall against the dollar as the country sticks to Covid zero approach.

Both currencies have the highest 3-month daily correlation with the offshore Chinese yuan in emerging Asia, signaling a further drag from extended weakness in the Chinese currency. The People’s Bank of China’s move on Monday to end its string of stronger-than-expected yuan fixings that had been in place since August has traders betting that Beijing is reducing its support for its currency.

Onshore and offshore yuan fell the most among peers in Asia after Chinese health officials over the weekend vowed to “unswervingly” stick to a Covid Zero approach. Singapore’s open and export-oriented economy will be impacted by a slowdown in the Chinese economy, while the lack of Chinese tourists will weigh on the baht, as they contributed around 20% to its economy pre-pandemic.

Source : BNN Bloomberg

Chart: King Shekel – The Only Currency Up Against the US$ in the Past 10 Years

Source : Bloomberg

Bitcoin Traded Below US$17,000

Source : Trading Economics