CLICK HERE LARGE PRINT EDITION: WHY FX CURRENCY SPREADS WIDER THAN THE SEVEN SEAS « Culture of Life News 2
As Israel bombs the Gaza Ghetto, we teeter yet again, on the edge of a dark precipice. As the US loses its grip on controlling history, we can take a moment to look backwards in time at the economic workings of this global financial collapse. Even now, many economics professors seek, like hounds on a false trail, the causes. The obvious event was the collapse of the US and then global housing bubbles. But they were symptoms, not causes of the collapse.
As I keep trying to prove beyond contention, the true nature of this collapse is due to the very system we have today: the free trade/floating currency regime. This replaced the free trade/gold standard of the British Empire which collapsed in 1914. There was an interlude where the US had a controlled trade/gold standard system from 1920-1971. That collapsed due to the Vietnam and Cold War overspending in the US.
Since 1971, we have been in the present system which did NOT start all at once at all but was slowly imposed upon the planet. Step by relentless step, treaty by treaty, starting with Bretton Woods II, US and European negotiators worked hard to create this obviously extremely flawed and even downright dangerous system.
Since all economists are propagandized into thinking, this is a GOOD system and not a totally screwed up system, they cannot understand how all the permutations are actually DESTABILIZATION POINTS which appear each time the EU/US/Japanese G7 nations fiddle with it to keep it rolling.
Periodically, I visit the Bank for International Settlements to see what sort of garbage they discharge via their think tanks. Remember: the BIS was founded to keep the three manic empires of Germany, Britain and France afloat after WWI and to uphold a collapsing system when Germany began to give up paying reparations for WWI. Hitler used the BIS to process Nazi loot in Switzerland before and even during WWII. So it is a bank with a very nasty history. And still exists and sits there, in the center of Europe, still playing global power games.
Interpreting deviations from covered interest parity during the financial market turmoil of 2007–08
The functioning of money markets was severely impaired in the summer of 2007. What began as a deterioration in a relatively limited segment of the US subprime mortgage sector quickly spread to other markets, especially those of credit and securitised products .
Uncertainty about losses increased the liquidity needs of financial institutions as well as their reluctance to lend to each other in money markets, particularly at maturities longer than one month. Reflecting these and possibly other factors, spreads of interbank short-term interest rates over overnight index swap (OIS) and treasury bill rates widened substantially in August 2007, and then, despite some degree of fluctuation, persisted at high levels.
A much less well documented aspect of the turmoil is how the turbulence in money markets spilled over to foreign exchange (FX) swap markets. One of the few works to address the question is Baba, Packer, and Nagano (2008), which documents heightened volatility in the FX swap markets across several G10 currency pairs soon after the financial market turmoil erupted.
As noted in that paper, the three-month FX swap-implied dollar rate using euro as a funding currency moved together quite closely with dollar Libor (London interbank offered rate) prior to the summer turmoil in money markets. From mid-August 2007, however, the spread between the FX swap-implied dollar rate and dollar Libor widened considerably, reaching 40 basis points in September 2007, pointing towards a large and persistent deviation from the short-term covered interest parity (CIP) condition.
Though the spread narrowed substantially after the beginning of 2008, it widened again from early March.3 Baba, Packer, and Nagano (2008) argue that dollar funding shortages of non-US financial institutions were largely responsible for these developments.
More specifically, soon after the turmoil began, European financial institutions increased activity to secure dollar funding to support US conduits for which they had committed backup liquidity facilities.
At the same time, US financial institutions appeared to become much more cautious about lending dollars to other institutions because of heightened counterparty risk and their own need to preserve funds on hand. Facing unfavourable demand and supply conditions and the associated impairment of liquidity in interbank markets, many European institutions moved to actively convert euros into dollars through FX swaps.
Deteriorating liquidity in the FX swap market likely contributed to further deviations of the FX swap market from the short-term CIP condition, despite coordinated efforts by central banks to make dollar funding more readily available to non-US financial institutions.
More specifically, as part of a series of coordinated measures to provide term dollar funding, on December 12, 2007, the establishment of swap lines between the Federal Reserve and both the European Central Bank (ECB) and the Swiss National Bank (SNB) was announced.
These swap lines allowed the ECB and SNB to conduct US dollar term funding auctions during European trading hours for depository institutions in continental Europe in a fashion that complemented the Federal Reserve’s own term auction facility (TAF) for US institutions.
No where in this paper, do the authors talk about the entire floating currency regime and how utterly ridiculous it is. Nor do they examine why we have to have this goofy, utterly screwy system. Nor do they talk about why the US, which instigated this system and sits dead center in it, is the victim of this system. As well as a fundamental cause of it collapsing today.
As per usual, the blame is popped into the laps of the lowliest players on the economic stage: home buyers. They gave up the game in 2007 because they could no longer play the international ‘pass the hot currency potato’ game. By focusing only on Europe, the BIS brainiacs here could leave out all the noise from Asia nor do they talk about the Asian Currency Crisis which was a harbinger of the storm that has enveloped the entire planet.
Nor do they mention FOREX reserves held by sovereign powers! Europe has nearly as much FOREX reserves as Japan but it is held by many countries and not by one. Since no one controls the $700 billion European government banks hold, it has much less power than the Chinese or Japanese central bank’s multi-trillion dollar reserves.
The narrow view of this paper is to turn what was a mega-banking collapse event into magic formulas. This way, they feel that they can ‘explain’ and even ‘predict’ what is going on. But of course, the formulas below are more like thermometers: they can express the temperature of the dying patient but do not diagnose the disease killing the patient. Below is a graph they referred to in the above excerpt:
Starting on 7/17/7, the chart, which is in harmony, suddenly has this spike. This is when China declared open banking warfare on the G7 after they jointly attacked China at the G7 meeting that week. People, as I recall from back then, were shocked when this big jolt hit. I said, ‘This is the end of the Japanese carry trade.’ As usual, I was right. The instant the Japanese carry trade collapsed and, despite ZIRP, the value of the yen which was 120 to the dollar, suddenly began its relentless rise to where it is today, 90 yen to the dollar [it hit 84 to the dollar this last month!].
When this event happened, the entire machinery based on the Japanese carry trade/weak yen began its vast collapse. Housing was screwed up in the US since 2006 so there was NO EVENT in the US to trigger both that sudden blip upwards and then the resulting complete collapse in the FX swap markets. Since that dark day in July, things have re-stabilized….at a very disjointed level with a wide spread that seems a permanent fixture. The creepy thing is, why has this become the NEW status quo?
This cool graph is cute! HAHAHA. Talk about a SIMPLE SYSTEM. How could such a childish system fail? Of course, it looks simple because is is only two parties. But the global FX market is very complex. The inherent problem with the stupid floating currency system is simple: if the currency that is the basis for all others and which is used to resolve all international trade goes off the cliff, the whole system collapses.
All the elaborate scaffolding, all the previous treaties creating this system, all the warty, ugly, nasty little processes, games, goofy systems set into motion by an army of speculating and banking gnomes eager to exploit weaknesses and drain wealth from the system into their pockets, all this collapses!
On top of this, all the trading powers that use this FX market to screw up the true value of their currencies so they can all export to the US as well as screw up each other’s trade: all of this has stability only so long as the dollar has stability. The US has destabilized the dollar at several key times in history: in 1914, in 1933, in 1964, in 1971 and from there, nearly continuously with increasing desperation.
We keep announcing, we will have a floating currency. Then, our trade rivals destroy us so we negotiate a sudden drop in the dollar. This, in turn, triggers tsunamis of money flows that cause humungous problems like the epic Japanese bubble that followed directly in the wake of the Plaza and Louver Accords. Germany dodged that bubble potential by purchasing East Germany from a collapsing Soviet Union which needed money very badly.
An FX swap is a contract in which one party borrows a currency from, and simultaneously lends a second currency to, another party. Although FX swaps can be viewed as effectively collateralised transactions, the collateral does not cover the entire counterparty risk. For example, if one party to the swap defaults during the contract period, the counterparty needs to reconstruct the position at the current market price, which entails replacement cost.
Furthermore, Duffie and Huang (1996) show that FX swaps are subject to greater
counterparty risk than are interest rate swaps because, unlike interest rate swaps, FX swaps entail the exchange of notional amounts at the start of the contract.
- A financial institution or other entity needing foreign currency funding can either borrow directly in that currency’s uncollateralised cash market or
- borrow in another (typically the domestic) currency’s uncollateralised cash market and convert the proceeds into an obligation in the desired currency through an FX swap.
This whole FX market is part of the Derivatives Beast. Note how the collateral is not equal to the risk! This means, when something goes bad, the party insuring the risks is HAMMERED TO DEATH! How dare anyone devise such an idiotic and unstable system! I am just aghast.
Foreign Currency Exchange (Forex) Trading allows an investor to participate in profitable fluctuations of world currencies. Forex trading works by selecting pairs of currencies and then measuring profit or loss by the fluctuations of one one currency’s market activity compared to the other. For example, fluctuations in the value of the $ U.S. Dollar are measured against another world currency such as the £ British Pound, € Eurodollar, ¥ Japanese Yen etc. Being able to discern price trends in market activity is the essence of all profitable trading and this is what makes foreign currencies so exciting, currencies are the world’s ‘best trending’ market. This gives Forex investors a profit making edge that is unavailable in most other markets.
Forex Trading is being called ‘today’s exciting new investment opportunity for the savvy investor’. The reason is that the Forex Trading Market only began to emerge in 1978, when worldwide currencies were allowed to ‘float’ according to supply and demand, 7 years after the Gold Standard was abandoned. Up until 1995 Forex Trading was only available to banks and large multinational corporations but today, thanks to the proliferation of the computer and a new era of internet-based communication technologies, this highly profitable market is open to everyone. The Forex Trading Market’s growth has been unprecedented, explosive, and continues to be unequaled by any other trading market.
Unlike traditional trading which brings buyers and sellers together in a central location (trading floors) in Forex Trading there is no need for a centralized location. Forex is a market where worldwide traders conduct business by high-speed Internet connections with the Interbank Foreign Currency Exchange via Forex Clearinghouses (also called Forex Brokerage Firms). Forex has not only become the fastest growing trading market, but also the most profitable trading marketplace in the world.
What the hell is this??? The mere trading of currencies, one of the most USELESS activities on earth, became, under the idiotic floating currency system, the most PROFITABLE betting game in town! This is due to increasing instability since day one. Here is a sober fact from the above article praising the insane and destructive FX markets:
Of the $1.2 trillion day trading in Foreign Currency Exchange, 83% of spot foreign exchange activity and 95% of swap activity involves US Dollars. The Euro is the second most active currency at 37%. The Japanese Yen (24%) and the British Pound Sterling (10%) are ranked third and fourth. The Swiss Franc is 7%, and the Canadian and Australian Dollars account for 3%.
Nearly the entire FX market is dollars! So when the dollar has difficulties, the entire FX market goes totally insane. And the graph at the top is the result of this. Is world trade between the US and all other nations 95% of all trade?
Of course not! Not even slightly! But the US has a dual role here: it is the destination of more trade than any nation and its output doesn’t come even slightly close to the input from abroad. Yet almost all of trade is negotiated in dollars. This puts the dollar at an disadvantage. This has forced all Presidents from Nixon to Bush Sr to resort to negotiations and treaties to artificially position the dollar vis a vis all other currencies.
Since the Japanese ZIRP and the Japanese plan to build up their FX funds to a trillion dollars, no US President has negotiated weakening the dollar. And US trade imbalances went from less than $50 billion a year to nearly a trillion dollars a year. This destabilizes the entire FX system, of course! Both Europe and Japan’s trade surpluses, before 7/17/7, dwarfed the rest of the world with the exception of China. So, the main currency for trade should have been the yen, yuan and euro. Not the dollar.
Here is a formula the BIS eggheads cooked up to explain what is going on, at least, at the most infantile level:
The LIBOR mess was a warning bell sounding, not a system that can be worked out. It simply noted that the US is going bankrupt, the ability of trade partners to suck down US debts and dollars has collapsed and the system must be reset. Instead of doing this, everyone is trying to get back to the 1994-2007 system whereby the US runs gigantic trade deficits with impunity. Below is the conclusion of the BIS report:
Our empirical results show a striking change in the relationship between perceptions of counterparty risk and FX swap prices after the onset of financial turmoil. That is, CDS spread differences between European and US financial institutions have a positive and statistically significant relationship with the deviations from CIP observed in the FX swap market.
The result holds when we consider the CDS spreads of a range of financial institutions wider than that of the Libor panel. Our findings suggest that concern over the counterparty risk of European financial institutions was one of the important drivers of the deviation from covered interest parity in the FX swap market.
The results hark back to the Japan premium episode in the late 1990s, when the creditworthiness of Japanese banks had substantially deteriorated. Faced with the extreme difficulty of raising dollars in global interbank markets, Japanese banks turned to FX swap markets, which resulted in substantial deviations from CIP.
While not significantly reducing the level of FX swap deviations over the period, the ECB’s US dollar liquidity-providing operations to Eurosystem counterparties do appear to have lowered the volatility (and thus the associated uncertainty) of the FX swap deviations.
Our estimation results thus support the view that the dollar term funding auctions conducted by the ECB, supported by dollar swap lines with the Federal Reserve, played a positive role in stabilizing the euro/dollar FX swap market. This study covers a period that ends in September 2008 shortly before the bankruptcy of Lehman Brothers. After the Lehman failure, the turmoil in many markets become much more pronounced.
In currency and money markets, what had principally been a dollar liquidity
problem for European banks deepened into a phenomenon of global dollar shortage. The provision of dollar funds by central banks, supported in some cases by unlimited dollar swap lines with the Federal Reserve, expanded greatly. One promising line of research would focus on the effectiveness of the diverse array of policy measures taken in this recent, more severe stage of the financial crisis.
Japan began ZIRP and with this, began the Japanese carry trade and solved their difficulties in collecting and holding FX dollars. This way, starting in 1994, the Japanese FX reserves began their climb. At first, slowly, for few people understood exactly how wonderful the ZIRP system would work. The trick being, to translate JAPANESE loans and monetary games into US dollars. Via other nations getting these loans in Japan. This was a successful offshoring of FX business trades that benefitted Japanese exporters on every possible level.
Which is why, once Japan and an army of newly -hatched offshore hedge funds began to play this game in ernest. So the Japanese FX reserves shot upwards from 1999-2006 as the hedge funds turned the Japanese carry trade into hostile buy-outs which dumped all that debt onto corporations across the entire planet, an epic amount that is directly responsible for the dual banking/manufacturing collapse we are seeing today.
The BIS claims, like everyone at the top, that we have a DOLLAR SHORTAGE. How can that be? There are already far too many dollars being held in a host of FX reserves across the entire planet! Poor nations even hold more than the US in foreign reserves! Dollar debts are the majority of debt holdings of nearly every nation on earth. They are ALL buying US debts, buying and holding US Treasuries. The last thing the floating currency regime needs is more dollars. This should be obvious even to children.
American International Group retired $16 billion in credit default swaps, the contracts that almost caused the company’s collapse, after buying the underlying securities with help from the Federal Reserve.The fund created by the Fed and AIG to protect the insurer’s customers from losses has now purchased collateralized debt obligations with a face value of about $62.1 billion, the firm said in a statement. The purchases bring AIG closer to winding down the financial products unit that triggered the worst of AIG’s losses. The business guaranteed more than $70 billion in securities created by pools of different kinds of debt, including subprime mortgages, that plunged in value. The federal government committed $150 billion to bail out AIG and prevent losses at investment banks that bought protection on fixed-income securities from the insurer.
The fund, called Maiden Lane III, paid about $6.7 billion to the investors for the securities in the latest purchases. The counterparties were also able to keep more than $9 billion that AIG had posted in collateral, reimbursing them at face value for the assets. AIG “continues to analyze” ways to retire another $12.3 billion in contracts it sold, the company said.
AIG retired their stupid deals via transferring it to the US public. We, not they, get to eat all the losses. Isn’t that just charming? And did it fix the problem created by AIG and the other banking, insurance and market gnomes?
Nope. It fixes absolutely nothing at all. If this sort of idiotic stuff was at least outlawed, I would accept the nasty necessity of eating this organization’s losses but only after all the top brass there are arrested and put in prison. Madoff, for example, is not in jail. He is relaxing in his NYC penthouse while the FBI and SEC pound on his door, demanding he figure out where all that loot went. The pace of arrests here is at a snail’s pace! The Maiden Lane bail outs are actually deflowering the female. The Maiden is now a whore. The ‘counter parties’ in this stupid CDO headbanger’s bash get to keep their loot, we are paying it for AIG.
And there is another $12+ billion to go! The numbers are huge. We are talking well over $150 billion here. They knew, from day one, this would be over $200 billion but didn’t dare bring that into the public eye, all at once. Thus, the dribbles and drabbles of amounts due. And why are we paying this?
Ah! Because Japan and China hold a lot of this counter party paper! And there is the clue we need: this is all about the damn FX games, global trade and the trap the US fell into when we ceased negotiating drops in the dollar’s value vis a vis Europe and Asia.
Its time to put a stake through this vampire’s heart and pronounce it dead, then go find the vampire that bit what was a human and turned it. Let’s first talk about what “Quantitative Easing” IS.
That phrase applies to a central bank (in this case our Fed) lowering interest rates to zero. You can’t lower rates below zero, so what comes next is to “quantitatively” ease money – that is, “in quantity” print up reserves and buy “assets”, thereby throwing yet more money into the economy.
In theory, anyway.
See, the economic theory is that when you lower interest rates people want to borrow more money, because it’s cheaper to do so. Therefore, when you want the economy to expand (faster) you lower interest rates, which makes it more likely that people will borrow.
When people borrow they either spend or invest those funds, and both produce more GDP. If I buy a new flatscreen TV on credit that counts in the GDP of the economy, as does the farmer who borrows to buy seed and grows a crop of corn.
The problem is that the flatscreen TV purchase isn’t really an increase in GDP; its a TIME SHIFT….
In short continuing demand becomes irrelevant because debt service chokes off available free cash flow.
“Quantitative Easing” into such an environment, which we are now in, is a complete and utter waste of time because it in fact requires that additional debt be taken on in the economy in order to do anything.
That is, buying assets from banks and pumping reserves back into them so they can loan them out only boosts aggregate demand if there are in fact qualified borrowers who wish to take out a loan to buy something.
Throughout this mess, debts has always been counted as wealth. This includes the business of the Treasuries. This is not wealth. It is IOUs owed by you, others and I. The US public, the ones bailing out AIG and all the other clowns. The Quantitative Easing’ is ‘MORE IOUs FOR THE USA’. That is it! That is all of it! The US government is running up huge debts against all of us so some of us can get super-cheap loans. Instead of simply seizing and handing over empty houses, the government is subsidizing house buying.
While not making a profit. Taking losses! And the worst losses are still in the trade arena. Only an epic collapse in US consumer markets can slow down our trade deficits.
China will allow two provinces sharing land borders with Asean member countries to trade in yuan currency to boost its exports which have been hit by the global financial crisis.
The move is part of a pilot project to allow the yuan to be used for trade with its immediate neighbours including Hong Kong and Macao, both special administrative regions belonging to the mainland, state media reported Thursday.
Yuan trade will be permitted between southwestern Yunnan province and the southern Guangxi Zhuang autonomous region and Asean, the China Daily said citing a State Council statement….
The mainland’s trade with Hong Kong, Macao and ASEAN nations has been rising rapidly to reach US$402.7 billion last year, accounting for a fifth of the mainland’s total trade.
As I predicted long ago, China would eventually move to make the yuan the world’s trade currency. Since both Europe and Japan, the other parts of G7, refused to take up this role, China will. And I am also predicting that China might even reestablish the gold standard. Watch out, when that happens. All governments on earth will confiscate their citizen’s gold hoards. Trust me on this.
And these changes happen very suddenly with virtually no warning. Sometimes, only two or three people decide to yank the rug out from under all the traders and hoarders. They do this all the time! So plan for it to happen. Will it be next year?
I don’t know. If China gets Saudi Arabia or other oil pumping nations to demand payment in gold, watch out! That will be the shot heard around the world.
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