Tag Archives: finance

Going Coastal

I just wanted to take a brief moment and inform all three of my readers (myself included) I am going to be taking a break from the normal financial and macro-related fare you find on this piece of blog.  I’ll be at the beach with my family for the rest of the month, taking a well-deserved and long overdue reprieve.

I’ll still have some posts, but they’ll be a different kind.  Perhaps a bit more personal, maybe even a bit more poignant.  There’s bound to be more photos.  Maybe even a video or two.  I haven’t thought that far ahead.

But it’s good to get away.  The ongoing nightmare known as European interbank lending isn’t going anywhere.  Neither is the debate on FinReg.  Nor the bigger macro backdrop complete with de-leveraging and debates about fiscal stimulus and whether or not central banks drove the macroeconomic bus off the proverbial cliff.  If all of that changed on a dime simply because I wasn’t blogging it, well, I guess I’ll shut up and let everything turn for the better.

But I know it won’t and you know it won’t.  These issues and the debate about how we respond to them will rage on, regardless of what any one of us might think or feel.

So in the meantime I’m going to take the opportunity to listen more attentively to my wife when she asks me to do something (an area I’m sure I have constant room to improve on), to play a bit more with my son and in general, let some of this stuff fade into the background…

And find something else to talk about for a little while…

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Libor and the Bataan Death March for European Banks

I’m a little late in getting this out, but the charts will speak for themselves:

That was just the actual Euro Libor curve.  Here are two ways to look at Euro Libor funding relative to Dollar Libor:

The pace of widening between Euro-denominated Libor and dollar-denominated Libor has dramatically increased over the past week or two.  And if you take a look at the EURUSD chart:

You can see the Euro low was set in June which coincides with the increase in Euro-denominated Libor.  What I am sensing here is a surge both in the Euro and rates being driven by the liquidity crunch in Europe that’s building to some sort of apex at which point the true nature of the deflationary, lackluster conditions present there will be visible to everyone.  So that means you can add Europe to the list of economies that will be dealing with a significant overhang of deflation/deleveraging.

Longer term, this is setting itself up to be the Deflationary Derby: Japan, the US, Europe and other participants to be named at a later date.

But before we get there, there are some banks in Europe that are bound to be casualties of the ongoing liquidity squeeze we’re seeing.  Something like the Bataan Death March in WWII: the soliders taken prisoner by the Japanese had no food and water.  The banks have no commercial paper and little to no short-term funding. 

But both have one thing in common: they happened under the hot, sweltering sun…

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On Gold, Guns, Bread and Cadillacs…

Well, maybe not guns.  This isn’t that kind of post.  But I am going to talk about gold briefly.  One of the more interesting ways to think about the value of gold is its value in purchasing household items.  Because back in earlier times that was exactly how you paid for things.  Gold is money, after all.  Indeed, in the book “Hedgehogging” Barton Biggs refers to gold in such a manner:

The Old Testament recounts how, in 600 B.C., one ounce of gold bought 350 loaves of bread.  As of today, one ounce will still buy 350 loaves of bread in the United States.

Barton Biggs: Hedgehogging

In my area of the country in North Carolina, one ounce of gold will get you 446 loaves of bread.  So when measured in those terms, we’re overvalued even after the action we’ve seen over the past few months:

Today I heard it referred to in another way: gold vis-a-vis Cadillacs.  So first, I have to present to you the definitive video clip on Cadillacs…

And now back to the gold/Caddy ratio.  I stumbled across this post (hat tip: @hedgefundinvest and @FinanceTrends) that looked at the fact that in 1971 with gold pegged at $35 an ounce you needed about 11 pounds of gold to buy a ’71 Eldorado.  Take away the peg and it would’ve been much less gold (at $103 an ounce you need about 5 pounds).

Now?  You can get 2 Cadillac XLR-Vs for the same 11 pounds if you’re taking the $35 per ounce as your starting point.  If you used 5 pounds, well you’re out of luck because you won’t have enough based on Friday’s close at $1193.50.  So the starting point you choose is important.

But as for the overvaluation or lack thereof currently?  At these levels it may still be overbought even though we’ve seen a pretty sharp pullback from $1,250.  But I’d be wary about how much more of a decline we see here because volume has been higher even on up days and the revolt against central banks isn’t over by any stretch.

So in my mind, we’re in for more volatility not less.

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Paul McCulley does Modern Monetary Theory | Credit Writedowns – And My Thoughts

I’ve been trying to make sense of the macro landscape since, well, that’s just what I do.  One of the frameworks I’ve been trying to learn more about is Modern Monetary Theory, but I have to admit it has been a bit of a mind-bending experience and I’ve not always had the greatest success getting my head around it.

Having said that, when I read about Paul McCulley of PIMCO doing MMT, I wanted to see what I could find out.  So I wrote up a question for Edward Harrison at Credit Writedowns, who I have a great deal of respect for:

Interesting stuff. Edward, I have two questions for you:

1) I agree with you about this being a secular change in aggregate demand instead of a cyclical change. So in your mind, will the MMT approach work? Maybe you said it already, but perhaps you could re-state.

2) China taking on the consumer of last resort makes sense given their surpluses. Do you think the news regarding the Dagong’s rating of the US vis-a-vis China is about getting cheaper costs of funds to take this role on or is about capital inflows because credit and real estate are facing headwinds there now?

Thanks as always.

via Paul McCulley does Modern Monetary Theory | Credit Writedowns.

Here’s Edward’s response:

Yes, MMT works. But, remember MMT is just a framework -a lens – through which to view actual economic events. It is a very useful framework though because it forces one to look at all individual transactions or any aggregate shift as having two parties with balance sheet effects.

If I reduce my purchases from you that has implications not just for me but for you too. A lot of politicians try to talk about the budget deficit in a unitary way without working through the numbers.

This still doesn’t get away from the longer term problems regarding the (mis)allocation of real resources (monetary and physical). But it doesn’t allow people to cheat intellectually and act like austerity will be positive for the economy.

I was actually in bed when I saw this via my friend Scott and got up just to write a quick blurb on it. So I am headed back there now! More in the morning.

Looking forward to what he has to say on this…

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I Guess I’ll Say it Here…: America’s Lost Decade

Left this comment for Sean McLaughlin, but I thought I’d share it here as well (emphasis, mine):

Sean, this is great.  Thanks for sharing.  As someone who focuses on long term/bigger picture timeframes as opposed to intraday, what your post talks about is the importance of keeping your risk/return objectives and timeframe in sync.

I’ll tell you for me, the noise I strive to filter out is the daily/intraday moves a lot of traders are looking to in order to make money.  But the big picture moves I use to strategically build/unwind positions are the things intraday guys filter out.  So we’re running around each other trying to block out what the other group is doing.

It can drive you mad, but it’s worth it if you do it right.

via I Guess I’ll Say it Here…: America’s Lost Decade.

And sometimes I should listen more to my own advice…

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And So It Begins…

I asked people about a scenario like this unfolding two years ago and was looked at like I had three heads…

The financial calamity of the European Union’s sovereign debt woes has shaken the pillars of the postwar ideal of a united Europe. The debt crisis and the global downturn have left many European countries looking inward these days and viewing Brussels as increasingly irrelevant.

Germany, long a postwar champion and financier of European integration, is flexing its muscles more independently. And more of its citizens are questioning the country’s leading role in the European project.

On a recent day, Christian Gelleri buys a sandwich and a glass of Hefeweizen at a rustic, sun-filled outdoor beer garden along the Inn River in the Upper Bavarian town of Stefanskirchen.

But the 40-year-old isn’t paying with euros. The bar also accepts chiemgauer, the thriving local currency named after a region in Bavaria.

via From Stalwart To Skeptic, Germany Rethinks EU Role : NPR.

Me and my other two heads aren’t looking so out of place anymore, I gather…

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A Trillion Here, A Trillion There, Pretty Soon You’re Talking About Real Money

What a way to start out the week:

The European Central Bank, the Bank of England and the International Monetary Fund have all recently warned of a looming crunch, especially in Europe, where banks have enough trouble raising money as it is.

Their concern is that banks hungry for refinancing will compete with governments — which also must roll over huge sums — for the bond market’s favor. As a result, credit for business and consumers could become more costly and scarce, with unpleasant consequences for economic growth.

via Crisis Awaits World’s Banks as Trillions Come Due – NYTimes.com.

Wow.  I didn’t know I could get a S**t Sandwich special first thing on a Monday…

And in case that wasn’t enough, they threw in a menacing chart for emphasis:

And just in case you still didn’t get the message, there’s this quote from the article:

“There is a cliff we are racing toward — it’s huge,” said Richard Barwell, an economist at Royal Bank of Scotland and formerly a senior economist at the Bank of England, Britain’s central bank. “No one seems to be talking about it that much.” But, he added, “it’s of first-order importance for lending and output.”

And so this is where I roll out one of those Minsky charts that illustrates this.  Oh, wait:

But why all the fuss over banks being able to roll the debt over?  Forget the amount for a second.  The key is to look at the average maturity:

A study in November by Moody’s Investors Service found that new bond issues by banks during the past five years matured in an average of 4.7 years — the shortest average in 30 years.

Now why does that matter?  It matters because there’s this issue called a maturity mismatch, where the assets and liabilities have different maturities.  Usually the assets are longer dated than the liabilities because when a yield curve is upward-sloping like this (from the FT)…

The incentive is to borrow short-dated funds and lend on long-dated assets.  I’ve covered this in similar ways before talking about duration hedging in the past where you measure sensitivities to interest rate moves, and this follows in a related vein.  When the yield curve inverts, or you have rate shocks at the front-end of the curve, you can find yourself in a precarious position if you have a lot of paper to roll.  Which is exactly where a lot of banks are finding themselves now.

But take a look at this section from the article (emphasis mine):

The financing crunch has its origins in a worldwide trend for banks to borrow money for shorter periods.

The practice of short-term borrowing and long-term lending contributed to the near-collapse of the world financial system in late 2008 when short-term financing dried up. Banks suddenly found themselves starved for cash, and some would have collapsed without central bank support.

Government bank guarantees extended in response to the crisis also inadvertently encouraged short-term lending. The guarantees were typically only for several years, and banks issued bonds to match.

So the maturity mismatch issue played a huge role in getting us into this mess, and the government’s response may very well end up in exacerbating the problem.

Brilliant… I might as well go build a house and then torch it myself…

And Tim Backshall has a very interesting chart that shows the spreads between senior bank debt and sovereign are highly correlated and compressing.  That means the lines between sovereign and bank debt in Europe are getting blurrier:

One other facet about this problem: the link between external bank funding and Euro Libor:

Bond issuance by financial institutions in Europe plunged to $10.7 billion in May, compared with $106 billion in January and $95 billion in May 2009, according to Dealogic, a data provider. New issues have recovered somewhat since, to $42 billion in June and $19 billion so far in July.

My take: proof positive that the funding crisis for European banks is ongoing and getting worse.  How so?  Simple.  Longer dated bond issuance has fallen, which has led to a change in the maturity profiles of European bank liabilities.

Because the banks are rolling into shorter-dated Libor based funding…

Which has lead to the run-up in the Euro…

One way to mitigate this risk is matched maturity funds transfer pricing – where the asset side of the balance sheet has the same maturity profile your liabilities has.  I’m going to leave you with this paper which I also posted on Scribd:

And a link to this post by Don van Deventer at Kamakura, that has some really good ideas on how to implement funds transfer pricing effectively.

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