One problem with traditional monetary tools is that as inflation heightens, real interest rate falls, which actually fuels inflation because inflation reduces expected real interest rates. Central banks have then to raise interest rates, but with inflation expectations uncertain, how much nominal interest rates need to be raised is not clear. As a result, there is a tendency for gradualism, as central banks need to take one step at a time and watch what happens. It is anybody's guess as to where the interest rate hike is going to reach, and conversely when interest rates are to fall, it is anybody's guess as to where the interest rate decline is going to end up.
With a currency anchored to the WCU, or with indexed instruments, however, real interest rates will not fall when inflation rises. So there is an automatic check against borrowing on the assumption that inflation will relieve real borrowing cost. With a currency anchored to the WCU or with monetary policy directly determining real interest rates using indexed instruments, therefore, the inflation fight will be easier.
Aug 26, 2008
An Announcement: A new quotations page soon
We are now testing a new quotations page. Watch out for new features in the quotations page in about a month's time.
We hope that by revamping the quotations page the meaning of the different columns will become clearer. Quotations on the value of the Canadian dollar and that of the Australian dollar in terms of the WCU will also be available.
I have been watching the WCU price of the RMB for quite some time. The recent surges are extremely worrying for the trade and industrial sector of the Chinese economy. On the other hand, weaknesses in the pound sterling and an impending interest rate drop could help the British economy steer away from a recession.
We hope that by revamping the quotations page the meaning of the different columns will become clearer. Quotations on the value of the Canadian dollar and that of the Australian dollar in terms of the WCU will also be available.
I have been watching the WCU price of the RMB for quite some time. The recent surges are extremely worrying for the trade and industrial sector of the Chinese economy. On the other hand, weaknesses in the pound sterling and an impending interest rate drop could help the British economy steer away from a recession.
Aug 22, 2008
Speculation and Commodity Prices
When speculation is rampant, spot prices may also rise, but a rise in spot prices must imply some form of hoarding. In the absence of hoarding, spot commodity prices are determined by supply and demand, where demand refers to demand by the users of the commodities.
When intense speculation pushes up oil futures prices, suppliers who do not believe the prices can sustain may want to sell in the futures market. If they do not believe that the high prices will sustain, it makes sense to sell in the futures market while prices are still high. On the other hand, if further price rises are expected, then suppliers may want to withold some of their supplies now; at the same time some users may also want to buy more now and hold them in inventory. This will push up spot prices, and the final users of commodies will then suffer for having to pay higher prices.
Speculation without a surge in real demand however cannot sustain. Without a surge in real demand by users, speculative price increases must lead eventually to a price crash. Inventories have to be disposed off some day. Real demand must also fall with higher prices, adding pressures on inventory accumulation.
It is unfortunate that today commodities have become a vehicle for fighting inflation and a declining US dollar. That is to say, the prospect of higher inflation encourages hoarding and speculative demand for commodities. If commodities are priced in WCU2000 or WCU2005, however, real prices would not need to change as the effects of inflation and US dollar depreciation would be completely offset, leading to more stable commodity markets.
When intense speculation pushes up oil futures prices, suppliers who do not believe the prices can sustain may want to sell in the futures market. If they do not believe that the high prices will sustain, it makes sense to sell in the futures market while prices are still high. On the other hand, if further price rises are expected, then suppliers may want to withold some of their supplies now; at the same time some users may also want to buy more now and hold them in inventory. This will push up spot prices, and the final users of commodies will then suffer for having to pay higher prices.
Speculation without a surge in real demand however cannot sustain. Without a surge in real demand by users, speculative price increases must lead eventually to a price crash. Inventories have to be disposed off some day. Real demand must also fall with higher prices, adding pressures on inventory accumulation.
It is unfortunate that today commodities have become a vehicle for fighting inflation and a declining US dollar. That is to say, the prospect of higher inflation encourages hoarding and speculative demand for commodities. If commodities are priced in WCU2000 or WCU2005, however, real prices would not need to change as the effects of inflation and US dollar depreciation would be completely offset, leading to more stable commodity markets.
Aug 13, 2008
RMB surging against WCU2000
Although RMB has been "depreciating" against the US dollar over the past 10 days or so, the RMB is actually becoming the strongest currency around for this year to date. This is because of the rapid appreciation of the US dollar against most currencies. In the first half of this year, the strongest currency had been the Swiss Franc. As of today, the RMB has gained over 3 per cent against the WCU2000 while the Swiss Franc has gained by less than one per cent since January 1. Relative to the benchmark basket of WCU currencies(GDP2005 weighted), the RMB has gained 6.13 per cent since the beginning of the year. The Swiss franc has only gained 4.03 per cent. The US dollar has lost only 0.34% against the benchmark currency basket. The British pound is now the weakest of the currencies listed in our Quotations table as of today.
The strength of the RMB is expected to put downward pressure on inflation on the mainland. At the same time it is going to be a major drag on the economy as exports are expected to decline dramatically over the rest of the year.
The strength of the RMB is expected to put downward pressure on inflation on the mainland. At the same time it is going to be a major drag on the economy as exports are expected to decline dramatically over the rest of the year.
World Inflation Soon to Fall
Andy Xie recently wrote in the South China Morning Post that the world is now facing a decade of inflation fire. The reason is that the central banks around the world, especially the Fed, have been overly expansionary. According to him the US has been engulfed in piles of debt, and asset values are declining to the extent that “the US financial system may be bankrupt as a whole.”
It is true that the US has been engulfed in piles of debt. In fact, the corporate sector, the household sector, and the government sector are all net debtors. It is also true that the Fed has been very aggressive in providing liquidity to the financial system since August last year. However, I had determined that the Fed had been overly slow in responding to signs of trouble. If the Fed had started easing early last summer, the calamity would have been scaled down considerably. But better late than never: thanks to the Fed’s aggressive actions, the financial system has been saved. If the Fed had set its eyes on containing inflation single-mindedly instead as some analysts had advised, a repeat of the Great Depression in the 1930s could not be ruled out. Inflation would be contained, and deflation would set in, and unemployment from 15 to 25% could become reality, with tens of millions of people around the world falling into bankruptcy.
Although the Fed has been aggressive in injecting liquidity to the financial system, the assumption that this would cause inflation is wrong. The liquidity served mainly to counteract a contraction, so that the economy could continue to grow. The Central Bank has acted wisely, and has taken its lessons from the Great Depression. Thanks to Ben Bernanke, the humble student of the Great Depression, this time around the Fed will not take any chances.
It is true that many speculators had placed their bets on oil and commodities, and thus fueling a spectacular price surge. But speculative demand cannot go against the law of supply and demand forever. Speculative demand in the final analysis has to be supported by concrete demand for the hard commodities. With a slowing economy, the required buoyancy of demand was simply not there. Consequently commodity prices including oil prices have fallen sharply in recent weeks.
In the final analysis, inflation is a phenomenon of supply against demand. It is true that if money expansion keeps pulling demand beyond supply, inflation will flare up. But demand depends on many factors. The major declines in asset prices is in itself a demand-suppressing force. The rise in unemployment is another demand-suppressing force. The surge in the pricing of risk is yet another demand-suppressing force. Investment is slowing down; consumption is slowing down. US exports have been strong so far, but are expected to weaken considerably with the European and Asian economies slowing and the US dollar strengthening. With the strong RMB the Chinese economy will slow down very rapidly over the next few quarters. All of these factors are eroding aggregate demand, so that real growth has slowed down and will remain very mild over the next few quarters. The injection of liquidity is only preventing the slow-down from aggravating into a fully-fledged recession or even depression.
Three cheers for Ben Bernanke! His innovative and bold ways of lending support to the fast weakening financial system are needed. His proposals to tighten up regulations especially in the lending practices and to improve the governance of financial institutions are both required. He has my full support, and I am positive inflation will not flare up as Xie predicted. Instead, inflation is going to ease considerably. The world economy has been saved!
It is true that the US has been engulfed in piles of debt. In fact, the corporate sector, the household sector, and the government sector are all net debtors. It is also true that the Fed has been very aggressive in providing liquidity to the financial system since August last year. However, I had determined that the Fed had been overly slow in responding to signs of trouble. If the Fed had started easing early last summer, the calamity would have been scaled down considerably. But better late than never: thanks to the Fed’s aggressive actions, the financial system has been saved. If the Fed had set its eyes on containing inflation single-mindedly instead as some analysts had advised, a repeat of the Great Depression in the 1930s could not be ruled out. Inflation would be contained, and deflation would set in, and unemployment from 15 to 25% could become reality, with tens of millions of people around the world falling into bankruptcy.
Although the Fed has been aggressive in injecting liquidity to the financial system, the assumption that this would cause inflation is wrong. The liquidity served mainly to counteract a contraction, so that the economy could continue to grow. The Central Bank has acted wisely, and has taken its lessons from the Great Depression. Thanks to Ben Bernanke, the humble student of the Great Depression, this time around the Fed will not take any chances.
It is true that many speculators had placed their bets on oil and commodities, and thus fueling a spectacular price surge. But speculative demand cannot go against the law of supply and demand forever. Speculative demand in the final analysis has to be supported by concrete demand for the hard commodities. With a slowing economy, the required buoyancy of demand was simply not there. Consequently commodity prices including oil prices have fallen sharply in recent weeks.
In the final analysis, inflation is a phenomenon of supply against demand. It is true that if money expansion keeps pulling demand beyond supply, inflation will flare up. But demand depends on many factors. The major declines in asset prices is in itself a demand-suppressing force. The rise in unemployment is another demand-suppressing force. The surge in the pricing of risk is yet another demand-suppressing force. Investment is slowing down; consumption is slowing down. US exports have been strong so far, but are expected to weaken considerably with the European and Asian economies slowing and the US dollar strengthening. With the strong RMB the Chinese economy will slow down very rapidly over the next few quarters. All of these factors are eroding aggregate demand, so that real growth has slowed down and will remain very mild over the next few quarters. The injection of liquidity is only preventing the slow-down from aggravating into a fully-fledged recession or even depression.
Three cheers for Ben Bernanke! His innovative and bold ways of lending support to the fast weakening financial system are needed. His proposals to tighten up regulations especially in the lending practices and to improve the governance of financial institutions are both required. He has my full support, and I am positive inflation will not flare up as Xie predicted. Instead, inflation is going to ease considerably. The world economy has been saved!
Aug 11, 2008
Greenspan's Remarks about Regulation and Financial Crises
Alan Greenspan recently rebutted allegations about his excessively expansionary monetary policy giving rise to the housing bubble and remarked that regulations would not reduce financial crises.
I agree that monetary policy is indeed not the cause of the US housing bubble. It is also true that regulations cannot eliminate financial crises. But inadequate regulations will certainly lead to more crises.
With the subprime crisis, inadequate regulations certainly played a role. Indiscriminate lending, with loans generously extended to people who did not have any financial commitment to the homes they bought, and who might not even have the ability to service the loans, reduced the quality of the “collateral.” This should not have been allowed.
Because there is often no or very little down-payment with many subprime loans, there was really no real collateral. Borrowers have little commitment to service their loans should home prices head south, and lenders had virtually no margin of safety.To say that regulators had little responsibility behind the turn of events that led to major write-downs among banks and investment houses is irresponsible. If the US had followed the HK Monetary Authority in requiring banks to lend at most 70% or even 60% of appraised values(the latter, more conservative, ratio applies to luxury homes) there would have been no crisis. The HK Monetary Authority requires borrowers to buy default insurance if the loan ratio exceeds these ratios.
I agree that monetary policy is indeed not the cause of the US housing bubble. It is also true that regulations cannot eliminate financial crises. But inadequate regulations will certainly lead to more crises.
With the subprime crisis, inadequate regulations certainly played a role. Indiscriminate lending, with loans generously extended to people who did not have any financial commitment to the homes they bought, and who might not even have the ability to service the loans, reduced the quality of the “collateral.” This should not have been allowed.
Because there is often no or very little down-payment with many subprime loans, there was really no real collateral. Borrowers have little commitment to service their loans should home prices head south, and lenders had virtually no margin of safety.To say that regulators had little responsibility behind the turn of events that led to major write-downs among banks and investment houses is irresponsible. If the US had followed the HK Monetary Authority in requiring banks to lend at most 70% or even 60% of appraised values(the latter, more conservative, ratio applies to luxury homes) there would have been no crisis. The HK Monetary Authority requires borrowers to buy default insurance if the loan ratio exceeds these ratios.
Aug 7, 2008
Inflation in China Set to Decline
With the RMB appreciating against the WCU2000, there is little doubt that inflation on the Mainland is going to decline rather noticeably in the next few months.
The RMB is now one of the strongest currencies around. Imports are getting cheapter; domestic demand is easing--especially investment; exports growth is declining.
The economy is going to slow down markedly. World commodity prices are easing. Pressures for further monetary tightening are easing.
There is of course a chance that the RMB could stop appreciating against the USD. But in the foreseeable future it is unlikely for the RMB to weaken against the WCU2000. Accordingly, quite independently of the course of the US dollar, I still expect inflation on the Mainland to slow down considerably.
The RMB is now one of the strongest currencies around. Imports are getting cheapter; domestic demand is easing--especially investment; exports growth is declining.
The economy is going to slow down markedly. World commodity prices are easing. Pressures for further monetary tightening are easing.
There is of course a chance that the RMB could stop appreciating against the USD. But in the foreseeable future it is unlikely for the RMB to weaken against the WCU2000. Accordingly, quite independently of the course of the US dollar, I still expect inflation on the Mainland to slow down considerably.
Aug 5, 2008
Poor Governance, Not Easy Money, is the Cause of Current & Many Other Crises
Former Fed chairman Alan Greenspan, as well as current chairman Ben Bernanke, have been blamed for following an easy money policy that was supposed to have engendered and aggravated the current financial market crisis. But these accusations are almost certainly misplaced.
While money was probably eased excessively at one point, that is not the reason why many CDOs went sour and why mortgaged backed securities lost value plunging many banks and financial companies into a relentless decline, with not a few actually falling under.
The main reason is poor governance. This was also the reason behind the S&L crisis during the eighties, the collapse of Enron in the fall of 2001, and dozens of other disasters.
Many academics have tried to design various warning indicators. But warning indicators are no substitute for good governance. Poor governance will lead to disaster sooner or later. When there is a conflict of interest and the person making important decisions looks after his personal interest ahead of the interest of the corporation, the corporation suffers. When there is a conflict of interest and the corporation making important decisions looks after its self interest ahead of the social responsibility entrusted to it, society suffers. Thus an auditor is supposed to do its job on behalf of society, but his fees are paid by the firm audited by him, there is a strong temptation for him to compromise his professionalism. There is now a report from Reuters saying that Freddie Mac Chief Executive Richard Syron refused to heed warnings about risky loans that were issued as early as 2004. Buying the questionable loans and other choices initially paid off for Syron, who “collected more than $38 million in compensation since 2003, the NY Times said.” Earlier on, some commentators had pointed to the conflict of interest besetting rating agencies, whose ratings may well have been contaminated by financial incentives.
One must ask why loans were made to people without the ability to repay the loans. Why were financial institutions allowed to lend to home buyers without the ability to come up with a reasonable down-payment? The fact is: if lenders had lent only 70% of the market value of homes, all the mortgaged backed securities would still have been able to maintain their market values. Bear Stearns would still have been a viable company. We need to relearn the same lesson we thought we had learnt before: we need good corporate governance and common sense risk management.
While money was probably eased excessively at one point, that is not the reason why many CDOs went sour and why mortgaged backed securities lost value plunging many banks and financial companies into a relentless decline, with not a few actually falling under.
The main reason is poor governance. This was also the reason behind the S&L crisis during the eighties, the collapse of Enron in the fall of 2001, and dozens of other disasters.
Many academics have tried to design various warning indicators. But warning indicators are no substitute for good governance. Poor governance will lead to disaster sooner or later. When there is a conflict of interest and the person making important decisions looks after his personal interest ahead of the interest of the corporation, the corporation suffers. When there is a conflict of interest and the corporation making important decisions looks after its self interest ahead of the social responsibility entrusted to it, society suffers. Thus an auditor is supposed to do its job on behalf of society, but his fees are paid by the firm audited by him, there is a strong temptation for him to compromise his professionalism. There is now a report from Reuters saying that Freddie Mac Chief Executive Richard Syron refused to heed warnings about risky loans that were issued as early as 2004. Buying the questionable loans and other choices initially paid off for Syron, who “collected more than $38 million in compensation since 2003, the NY Times said.” Earlier on, some commentators had pointed to the conflict of interest besetting rating agencies, whose ratings may well have been contaminated by financial incentives.
One must ask why loans were made to people without the ability to repay the loans. Why were financial institutions allowed to lend to home buyers without the ability to come up with a reasonable down-payment? The fact is: if lenders had lent only 70% of the market value of homes, all the mortgaged backed securities would still have been able to maintain their market values. Bear Stearns would still have been a viable company. We need to relearn the same lesson we thought we had learnt before: we need good corporate governance and common sense risk management.
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