Shifting sands – part 2

Continued from part 1

Away from the brouhaha over fiscal policy, the intertwined issue of its monetary equivalent comes into focus. Perhaps in belated recognition of what we have been calling ‘biflation’ – i.e., the sharp divergence in monetary growth between Germanic and Latin Europe – Frau Merkel was moved to remark at a savings bank conference in Dresden that if the ECB were to be setting rates solely with an eye to conditions in the Heimat, it would probably have to raise, not lower, rates at the moment.

For their part, the two most senior Bundesbankers concurred – albeit in their typically divergent fashion. The ever urbane Asmussen, in a speech entitled, ‘Saving the euro’, alluded in no equivocal fashion to the lack of a one-size-fits-all approach, declaring that:-

…a more recent feature of our financial structure is financial fragmentation. This implies that lower interest rates have asymmetric effects, and not in the direction that we want them. Due to impaired monetary policy transmission, the pass-through of rate cuts to the periphery would be limited, and this is where they are most needed. At the same time, rate cuts would further relax already unprecedentedly easy financing conditions in the core. This is not per se a problem – but interest rates that are too low for too long can eventually lead to distortions…

Ah, yes!  The ‘distortions’ to be expected from monetary incontinence. Nothing we Austrians ever allude to, of course!

In contrast, the imprimatur of Asmussen’s far more forthright colleague, Jens Weidmann, was all over the leaked copy of the Bundesbank’s submission to the Constitutional Court regarding the legality of the ESM. In what amounted to a veritable Philippic, as Handelsblatt reported it, the Bank strongly denied it was any part of its mission to prevent any given member state from exiting the single currency. In asserting that ‘higher finance costs for the private sector’ in certain countries ‘are related to greater national fiscal risks’, this report effectively launched a thinly disguised attack on the casuistry of Draghi’s argument that his monetary interventions are all about levelling the European playing field – and so are ostensibly undertaken with the aim of ensuring greater ‘transmissibility’ of monetary settings – and nothing whatsoever to do with financing otherwise bankrupt states.

Though all this would seem to close the door to an imminent easing of interest rates (a development which, for all the market’s Pavlovian enthusiasm, is in any case likely to be little more than symbolic in its import), there are ominous signs of a looming deceleration in German growth. Domestic monetary velocity has declined sharply of late – with or without the noise created by the build-up of Target balances – largely as a consequence of a decline in business revenues of 3% YOY in the domestic market and of around 4.5% v-a-v its Eurozone export markets.

Nor was the final quarter of 2012 much more cheery for the category ‘property and entrepreneurial income’ in the national accounts. This registered its worst result since the panic-stricken first quarter of 2009, and was at a level first attained eight years previously. No doubt this combination of stagnant sales and dwindling profits goes some way to explaining why it is that, after 8 years of fairly consistent co-movement, the GEX index of owner-controlled, smaller, ‘entrepreneurial’ companies has revisited GFC lows and so has diverged sharply from the record-setting MDAX, to the point that latter speculative vehicle has run up 174% in relative terms in the past two years.

The test, as ever, will come when it is deemed to be to Germany’s benefit to seek a relaxation in policy and, by extension, when it is in Merkel’s narrow political self-interest to signal her acquiescence to the other members of the ECB council and so to free herself from the opposition of her own troublesome, monetary priests. That day may well not be long delayed, but we would hazard it has not yet arrived.

Incredibly, there was a palpable sense of expectation going into the BOJ meeting this week, as the insatiable stimulus junkies conjured up fantasies of some new initiative being announced, barely weeks after ‘Corroder’-san’s QExtreme measures were launched. Embarrassingly, the meeting coincided with the release of a set of national CPI numbers which were falling at their fastest (if still decidedly moderate) pace in three years. More troubling for those who never cease to exult in the boost which Abenomics will supposedly give to asset markets everywhere, it is not at all evident that Mrs. Watanabe is familiar with her part in the playbook, either. 

We say this because, far from unleashing the expected torrent of outward investment, the weakening yen has so far triggered what look to be the highest sustained liquidation of foreign portfolios in at least the last 15 years – a cumulative repatriation these last twelve weeks of around $85 billion USD. Meanwhile, foreign inflows have been sufficiently vigorous to push the invested sums to within a few percentage points of their 2007 highs, albeit that this has coincided with a rise in margin positions on the TSE which suggests that much of the money is being borrowed for the purpose.

That the vaunted ‘carry trade’ seems to be benefiting only the Nikkei so far, may have two separate, but not inconsistent explanations. The first is that, in contradistinction to the previous episode of yen-fuelled, global asset inflation which was instituted during the reign of Eisuke Sakakibara – that is, in the period between the 1994-5 Tequila Crisis (to which it was a response) and the 1997-8 LTCM collapse-Asian Contagion (in which it was a proximate cause) – the Japanese are not actively driving the yen lower (not least by not encouraging, as they did then, the big macro hedge funds and prop desks to participate in a one-way bet) and so residual forex risks remain unabated.

Secondly, it should be noted that, 15-20 years ago, Japanese interest rates were around 600bps below those prevailing in the UK, 500bps below those in the US, and 300bps below those in Germany: today those spreads are 40bps, 4bps, and -5bps, respectively. In other words, back then it clearly did not pay those using yen to buy foreign assets to hedge exposures, even if they had chosen to ignore the explicit policy of their own government to weaken it. Today, by contrast, there is no meaningful penalty attached to so doing and no strong disincentive to desist since a lower parity is not officially an objective. Thus, easy money in Japan may well induce leveraged asset purchases, but it is hard to see why this should drive a self-aggravating spiral of devaluation and further, induced carry trades, especially when sources of speculative finance are not exactly lacking in any other currency you could name.

Note here in passing that with gold at an all time high versus the yen, and with the Topix coming off a 90%, 21st century decline to a three-decade low in gold ounce-equivalent value, a similar urge to book profits and/or reduce exposure to overseas assets offering much less prospective gain could have been at work in pushing the yellow stuff to the edge of last week’s precipice.

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