"if they start to view the pound as Europe’s equivalent of an Agency bond …"

Brad Setser on the wild ride of the dollar recently:

"Only a few days ago, so it seems, it took about $1.25 to buy a euro. Now it takes closer to $1.45 (it was more earlier today, but the dollar subsequently rallied). And — as Macro Man notes — the dollar’s move pales relative to the recent slide in the pound. Not so long ago a pound bought 1.5 euros. Now it buys a euro and change. The Anglo-Saxon currencies haven’t had a good two week run.

Both the US and the UK ( 1 ) had housing and finance centric economies. Both have ( 2 ) significant external deficits. And both are ( 3 ) inclined to use monetary and fiscal policy aggressively to combat a downturn.

But with global trade collapsing, the euro’s rise can not be all that comfortable for members of the eurozone. It isn’t clear that any one wants a stronger currency right now ( THIS MEANS THAT THEIR EXPORTS WILL BE MORE EXPENSIVE IN OTHER COUNTRIES, AND THEY DON'T WANT TO LOSE EXPORT BUSINESS DURING AN ECONOMIC DOWNTURN ). Currencies though are relative prices — and can go up or down amid a global contraction. In theory, everyone could ease monetary policy equally without changing the relative value of any currencies ( THIS WOULD KEEP THE DOLLAR HIGHER ). In practice things rarely work out as neatly ( EXACTLY ).

Dr. Krugman, I would assume, hopes that the euro’s rise puts more pressure on Germany to join a coordinated European fiscal stimulus — with good reason. Germany’s export machine relies on global and European demand. That demand is falling (watch Russian imports for example). And if the euro’s rally is sustained, Germany will soon face an additional headwind. So too will the less competitive members of the eurozone. They are in an even more difficult position if Germany doesn’t lead a coordinated European reflation. ( GERMAN EXPORTS WILL BE TOO EXPENSIVE )

Four other thoughts:

1) Until fairly recently, all the European currencies tended to move in tandem against the dollar. That meant their cross-rates were stable. And it meant that the euro wasn’t as strong as it seemed. The euro was strong against the dollar and the yen, but not against the pound, the Swedish krona, the Norwegian krona and similar currencies. Right now the euro is rising against all the smaller European currencies — not just against the dollar.

2) Japan is starting too worry about yen strength, not surprising. Renewed intervention seems like a possibility if the yen continues to rise. That shouldn’t be a surprise. Japan tends to intervene heavily when the interest different between the yen and dollar goes away, reducing private market demand for dollars.

3) China has to be pleased by the euro’s rally. Dollar strength translated into RMB strength — and a rising RMB when Chinese exports were slowing (and likely now falling) made Chinese policy makers uncomfortable. There was even talk of moving to a real basket peg — which would have meant that RMB would depreciate against the dollar when the dollar was strong. But I rather doubt that China now wants to appreciate against the dollar to offset the dollar’s renewed weakness against the euro. Right now China is happy to see the dollar and thus the RMB weaken( THAT WAY THEIR EXPORTS DON'T GET MORE EXPENSIVE FOR US ) …

4) Central banks have been big buyers of the pound over the past few years. Reserves were growing, and the pound’s share was rising. Central banks liked its yield( PAID HIGHER INTEREST ) — and the fact that it an easy alternative to both the dollar and the euro. By my count, central bank inflows often were large enough to cover the UK’s current account deficit. Central banks reserves are shooting up, but if they “rebalance” their portfolios they should be big buyers of pounds now — as they need to hold more pounds to keep the pound’s share of their portfolio up as the pound’s value slides.

I’ll be interested to see if they do so — or if they start to view the pound as Europe’s equivalent of an Agency bond …( AND NOT BUY IT AS TOO RISKY )

Notice the Chinese Contradiction:

1) They don't want the dollar to weaken so that they can export to us

2) That's happening because we're printing money

3) Yet, they tell us not to borrow too much from them, and they don't want to spend too much

Problem: On 3, it has to be one or the other

Either we borrow more and they save more

or

we save more and they spend more

"Well guess what, the cycle has swung, and it's time to pay the piper (rather than the banker.)"

MacroMan with a post that contains the word "philippic":

philippic

1592, "bitter invective discourse," from M.Fr. philippique, from L. orationes Philippicæ, translation of Gk. Philippikoi logoi. The L. phrase was used of the speeches made by Cicero against Marc Antony in 44 and 43 B.C.E.; originally of speeches made in Athens by Demosthenes in 351-341 B.C.E. urging Greeks to unite and fight the rising power of Philip II of Macedon.

"It's the last work week of the year, and Macro Man is feeling the strain. After a skein of lunches, dinners, and assorted Christmas treats, he's begun to feel the inevitable expansion of the waistline despite his best efforts at the gym.

Yesterday he had lunch at Nobu with a couple of friends from a well-known (and, shall we say, "underperforming" bank.) It was an interesting afternoon, to say the least- not least because at least a quarter of the tables at the restaurant were empty. Long gone are the days of requiring several weeks' notice to secure a table...the reality of the recession is indeed beginning to bite.

But what stirred Macro Man's blood was the discussion around the current environment and the compensation expectations of staff in the financial industry. Without disclosing any details about the institution in question (so as to protect the innocent), it is fair to say that 2008 has not been a profitable year for his friends' institution.

Macro Man's friend in management has, for the past year or two, been fairly realistic about the environment that he's been living and working in- that is to say, he's been consistently downbeat. For the past month or two, he has consistently been attempting to talk down the bonus expectations of his staff.

Now, it is safe to say that the performance of this institution has been sufficiently poor that shareholders can legitimately question why bonuses are being paid at all. So Macro Man naturally assumed that "managing expectations" involved telling people that "your job is your bonus....if you actually get to keep it."

And yet there is, evidently, a small bonus pool, which has generated an unseemly political scramble to secure as much as of the scraps as possible. To call the scenario "Machiavellian" is an insult to the whole concept of political philosophy. None of this should come as a surprise, of course; bankers should always wear a stab-proof Kevlar vest at the best of times.

But what really got Macro Man's goat was the (unhappy) explanation that one mediocre performer will be awarded a disproportionately large share of the team bonus pool because, as his friend's boss's boos explained "so-and-so got a seven figure bonus two years ago and will be disappointed with anything less this year."

DISAPPOINTED? DISAPPOINTED? Are you effing kidding me? One of the reasons why bankers get paid so much in the good times is because of "the volatility of the cycle". Well guess what, the cycle has swung, and it's time to pay the piper (rather than the banker.)

To claim that you deserve a bonus because "we had a good year" on the desk blithely ignores the act that "you" collectively have become a watchword for incompetence and/or malfeasance."

Read the rest. I enjoyed this so much, I have to admit that I would like more people to Guy Fawkes MacroMan's posterior. I must also be feeling the strain. One question: Is Macro Man the writer of these posts, or is the writer a kind of Boswell?

"Perhaps any readers who are experts in monetary economics can explain why the Fed asset increase matters and the ECB's doesn't? "

MacroMan with some interesting charts:

1) Quant easing. The dollar is getting slagged, at least partially because of concerns about the long-term impact of the Fed's quantitative easing program. And while it's true that the size of Fed's balance sheet has increased dramatically over the last few months, the ECB's has also increased by quite a bit. Perhaps any readers who are experts in monetary economics can explain why the Fed asset increase matters and the ECB's doesn't?

2) Chinese IP. Oh dear. Year-on-year IP is up just 5.4%...no wonder the government has stepped up to the plate with stimulus programs. As is the case elsewhere in the world, it looks like it's going to gt worse before it gets better.
I would second the question on the first graph. My understanding is that it would be good news if there is a coordinated growth ( although differing in size ) in increasing assets.

As for China, it seems to be in the midst of a hastily arranged party, trying to figure out whom to serve first and what.

"For now, of course, Macro Man has to scratch his head at some of the pricing out there. "

MacroMan sees good news out there:

"Macro Man remains dubious that this is the appropriate conclusion. His view is that the actions of both the Fed and the Treasury, however ineptly communicated (here's lookin' at you, Hank!) simply represent the principle of Ricardian equivalence at work."

I guess he means that there will be no increase in demand.

"The past few decades, but particularly the past few years, have seem enormous rise in private sector leverage....both through traditional lending and derivatives contracts. The past couple of years have seen the total face amount of outstanding derivatives contracts increase at a run rate of $150 trillion dollars per year, according to the BIS.

And guess what? The value of that stuff has gone down. Financial institutions and private sector actors have learned the hard way that assets may come and go, but debt lasts forever. UBS estimates that banks need to raise an additional $1 trillion in capital to offset the amount of forthcoming losses and writedowns."

It seems he believes that banks, are, in essence, saving. I don't read that chart in quite the same way. I see a lot of derivatives yet to be worked out.

"At the end of 2007, Citigroup had more than $2 trillion of assets on their balance sheet. That number will be a lot lower by the time all is said and done. Not that US banks have a monopoly on absurd leverage, of course; at the end of last year Deutsche Bank had over €2 trillion of assets- that's 80% of German GDP. Again, trends in that figure are only going one way moving forwards."

The banks are saving.

"So in Macro Man's view, any dollars "created" by the Fed to expand its balance sheet (and let's not forget, they have yet to really crack out the printing presses by not sterilizing their asset purchases) will merely partially offset dollars lost through de-leveraging and the implosion of the shadow banking system, rather than finding their way into new the purchase of fresh turds."

There's no increase in demand.

"The impact of these programs will, in Macro Man's view, only submarine the dollar once the crisis is resolved and domestic demand begins growing organically again. That seems likely to be several years away, for there is another kind of Ricardian equivalence at work- the ballooning of the US budget deficit should be offset by a sustained rise in the US private sector savings rate.
I don't see how it's different, except that it's individuals saving money, as opposed to banks paying down debt.

"For now, of course, Macro Man has to scratch his head at some of the pricing out there. US sovereign CDS have ballooned out.....
...and are now trading merely a dozen bps below BNP! Are you kidding me? The US government (a flawed beast, to be sure, but the owner of a printing press for the current world reserve currency) a similar credit to a French bank? Puh-leeeez....."

Well, here's where MacroMan's thesis goes a bit sideways, because the CDSs on US Government Bonds, which I've already talked about today, are saying that the risk of default is worse. From MacroMan's point of view, they should have stayed the same, and, quite frankly, be getting better.

"His methodology has served him well this year, and he has little intention of becoming another footnote when the history of today's Ricardian equivalence is written."

Good luck to MacroMan and Casey Mulligan.

"any document containing the word "modalities" is a complete and utter waste of time and space. "

MacroMan agrees with me about the G20 statement:

"Well, that was exciting.

The weekend G20 meeting was evidently highly successful, at least if we are to judge by the length of the statement the resulted from the meeting. G7 statements are usually short and (relatively) punchy, and able to fit on a single printed sheet.

The G20 statement, on the other hand, was long and expansive, filling a full eleven pages when transposed onto Microsoft Word. If it were full of detailed policy prescriptions, the length could perhaps have been justified. As it was, Macro Man tried to read the whole thing but failed out of sheer boredom.

The sentence that did it for him was the following:

"Further, we shall strive to reach agreement this year on modalities that leads to a successful conclusion to the WTO's Doha Development Agenda with an ambitious and balanced outcome."

Macro Man has very few hard and fast rules in life. One of them, however, is that any document containing the word "modalities" is a complete and utter waste of time and space."

Here's an earlier post.