Fed to drink its own special Kool-Aid

[J]

Bloomberg link

Dollar Falls Most Since 2000 on Fed’s Plan to Buy Treasuries
By Ye Xie and Molly Seltzer

March 19 (Bloomberg) -- The dollar fell the most against the euro in almost nine years as the Federal Reserve said it will purchase $300 billion of longer-term Treasuries, spurring speculation the central bank is debasing the currency.

The greenback may extend its 5.6 percent decline against the currencies of six major U.S. trading partners since reaching the highest in almost three years in early March as the central bank prepared to flood the market with dollars. Citigroup Inc. currency analysts recommended adding to bets that the greenback will depreciate after it weakened beyond $1.34 per euro for the first time since Jan. 12.

“This is a full-court press by the Fed,” said Mike Moran, a senior currency strategist at Standard Chartered Bank in New York. “This is an aggressive move by the Fed to pump as much money as possible into the system. This will recharge bullish sentiment that spells more weakness in the dollar.”

The dollar traded at $1.3508 per euro at 6:18 a.m. in Tokyo, after depreciating as much as 3.6 percent, the biggest intraday decline since September 2000. The dollar was at 96.09 yen after falling 2.4 percent. The yen traded at 129.75 per euro after losing 1 percent.

The Federal Open Market Committee said in its statement yesterday that the central bank will buy longer-term U.S. government debt and purchase an additional $750 billion of agency mortgage-backed securities, in a policy known as quantitative easing.

“It did shock the market,” said Jack Iles, a money manager in Boston at MFC Global Investment Management, with $2.5 billion under management. “The Fed is printing money, which translates into general dollar weakness. There’s trillions being funded and committed. It’s a huge dollar negative.”

Dollar Index

The Dollar Index, which the ICE uses to track the greenback’s performance against the euro, yen, pound, Canadian dollar, Swiss franc and Swedish krona, dropped 2.7 percent to 84.595. The gauge fell 5.6 percent since reaching 89.62 on March 4, the highest level since April 2006.

Yields on the 10-year Treasury note dropped the most in one day since January 1962. At 2.53 percent, the yield on the benchmark security was 0.68 percentage point lower than that of the comparable-maturity German bund. The gap widened more than a half-percentage point from 0.18 percentage point yesterday, making U.S. assets less attractive.

“The dollar should weaken in the wake of lower U.S. yields,” currency strategists at Citigroup wrote in a research note yesterday. “We have long argued that U.S. policy would eventually drive sustained dollar depreciation.”

Krona Versus Dollar

Most major currencies rallied against the dollar, with the Swedish krona gaining 4.5 percent to 8.0797 and the Canadian dollar appreciating 1.9 percent to C$1.2470 as the Fed’s move encouraged investors to seek higher returns.

“Sell the dollar!” said Scott Ainsbury, a portfolio manager who helps manage about $12 billion in currencies at New York-based hedge fund FX Concepts Inc. “This is huge, huge. It’s equivalent to the Plaza accord. This is the last thing they have in the closet, and they used it a bit early.”

In 1985, the U.S., U.K., France, Japan and West Germany agreed at New York’s Plaza Hotel to coordinate the devaluation of the dollar against the yen and deutsche mark.

The yen earlier touched the weakest level against the euro this year as the Bank of Japan said after its two-day policy meeting that it will step up purchases of government bonds from banks, spurring concern it will flood the market with currency.

Weaker Yen

Japan’s currency was headed for a 2.2 percent decline against the euro this quarter as Japan’s deepening recession undermined demand for the currency as a refuge.

Sterling declined as much as 2.2 percent to 94.87 pence against the euro, the weakest level since Jan. 26, as the Office for National Statistics reported that unemployment claims rose by 138,400 to 1.39 million. The median forecast of 20 economists surveyed by Bloomberg News was for an increase of 84,800.

Bank of England policy makers voted unanimously to start printing as much as 75 billion pounds ($105 billion) to fight the recession as they cut the benchmark interest rate to a record low of 0.5 percent, according to minutes of the March 5 decision released in London yesterday.

U.S. policy makers maintained a fed funds target range of zero to 0.25 percent yesterday, matching the median forecast of 72 economists surveyed by Bloomberg News. The dollar fell to what was a 13-year low against the yen on Dec. 17, the day after the central bank last lowered the target lending rate.

To contact the reporters on this story: Ye Xie in New York at yxie6@bloomberg.net; Molly Seltzer in New York at mseltzer4@bloomberg.net
Last Updated: March 18, 2009 17:24 EDT

Oh boy, I don't think this is what China had in mind when their premier warned the US to "act responsibly and preserve the value of its assets". Printing money, buying another $750 billion in "troubled assets" which are worth pennies on the dollar at best, all in the mistaken idea it will somehow jumpstart the economy and get everyone spending again. It won't, though it caused one heck of a reversal in the markets today as the insiders and CNBC pumped the hell out of it. The fundamentals haven't changed and we've piled even more debt which has to be paid off, this is not how you start a recovery.

[Elfdart]

Isn't this the same thing Hoover did?

[chitoryu12]

Isn't this the same thing Hoover did?

I thought he put less money into circulation early in the Depression. Or I could just be thinking of someone else.

[Mr Bean]

I thought he put less money into circulation early in the Depression. Or I could just be thinking of someone else.

What Hoover did in essence is look at all the people not spending and say "Hey that looks like fun, lets make the government not spend any money either!"

I have the funny feeling that the Fed is stuck in 2002 mode and is busy trying to fight inflation that's not there. Trying to do so when their is no inflation is a recipe for trouble.

[J]

Isn't this the same thing Hoover did?

Bingo! Back then, the Fed bought up various government securities including Treasuries and printed a stack of greenbacks.
It didn't work then, it's not going to work now.

[Glocksman]

I thought he put less money into circulation early in the Depression. Or I could just be thinking of someone else.

What Hoover did in essence is look at all the people not spending and say "Hey that looks like fun, lets make the government not spend any money either!"

I have the funny feeling that the Fed is stuck in 2002 mode and is busy trying to fight inflation that's not there. Trying to do so when their is no inflation is a recipe for trouble.

Nah, if they were trying to fight inflation they'd do the exact opposite of firing up the presses.
I think they're trying to prevent a deflationary spiral but the danger is that they may overshoot the mark and ignite hyperinflation.
A choice between deflation and hyperinflation is like asking me if I prefer being shot to death over decapitation.

[Guardsman Bass]

Isn't this the same thing Hoover did?

Bingo! Back then, the Fed bought up various government securities including Treasuries and printed a stack of greenbacks.
It didn't work then, it's not going to work now.

Hoover did that? I thought it was FDR who took the dollar off the gold standard and let the government print away.

[Terralthra]

Isn't this the same thing Hoover did?

Bingo! Back then, the Fed bought up various government securities including Treasuries and printed a stack of greenbacks.
It didn't work then, it's not going to work now.

Hoover did that? I thought it was FDR who took the dollar off the gold standard and let the government print away.

A cursory google search says the dollar was taken off of any gold standard on August 15th, 1971, by President Nixon.

[Surlethe]

FDR didn't go all the way, but he essentially took it off the gold standard by, IIRC, making it illegal for people to own more than a certain amount of gold.

As for the supposed hyperinflation that's going to occur, you're going to have to meet a much higher standard of proof. The M1 multiplier is just a tad lower than 1, which means that M1 is going to rise by about $980 billion. M1 stock right now is $1.6 trillion, so at the end of this, M1 will be about $2.6 trillion - not quite doubling M1. The M2 money stock, which is what the Fed considers "money", is currently about $8.3 trillion; after, it will have about $9.3 trillion. So the net effect of this infusion of money into the system is a short-run increase in the money supply of about 12%. As a small-numbers approximation, with P = price level, V = money velocity, M = money stock, and Y = GDP, %P = %M + %V - %Y. The credit freeze has caused velocity to drop significantly, so the reason we haven't seen significant deflation already is because the Fed has been pumping money into the economy like crazy. In fact, since last July CPI has dropped about 3.5% - and that's with negative GDP growth.

What's the impact of this, then? Well, if velocity continues to drop we're looking at zero impact on the price level. If velocity stabilizes and GDP continues to drop (i.e., %V = 0 and %Y=-5%), then no more than 17% inflation. If velocity rises and GDP keeps falling, then we're edging into 20-25% inflation territory. In the long run, I suspect that the money supply will not rise by this much, since if the Fed has a brain they'll eventually sell the MBSs back to the private sector and burn the money they receive. If velocity stabilizes, it shouldn't be difficult for the Fed to control the inflation this will cause.

Painful? Could be. Zimbabwe? No.

[phongn]

A cursory google search says the dollar was taken off of any gold standard on August 15th, 1971, by President Nixon.

The USD has been on and off the gold standard at various points in its history; Nixon's abandonment of Bretton Woods was just the last time it happened.

[J]

Credit destruction is still occuring faster than the Fed is planning to print, and with the multiplier stuck around 1 it means inflation isn't happening. They'll have to print a lot faster to cause inflation and hopefully the Fed isn't dumb enough to do that, then again, I didn't think they'd be dumb enough to print after the Chinese sent them a warning to "preserve the value of their Treasuries" or words to that effect.

My feeling is deflation will continue, and helicopter Ben will be dumb enough to crank up the presses some more in the future in an attempt to fight it, this is afterall right out of his PhD thesis. The wildcard is if/when the Chinese and others start dumping their T-bill holdings into the Fed's bids, such that the Fed eventually ends up owning most or all of the T-bill market. The latest Treasury International Capital reports shows that the outflow is already starting, so far, China isn't selling, in fact they're one of the few which aren't running for the doors. How long this continues is anyone's guess.

[Elfdart]

I'm surprised they haven't pulled out of our T-bills already. There's such a tiny return on them now. The only explanation I can think of is that they got burned when they invested in Fanny Mae and Freddy Mac and are willing to accept zero return over getting ripped off. The rest is just waiting for everything to hit rock bottom before buying again.

My feeling is deflation will continue, and helicopter Ben will be dumb enough to crank up the presses some more in the future in an attempt to fight it, this is afterall right out of his PhD thesis.

Is that the one entitled Currency as Kindling: How to Heat Your Home with the Five Billion Deutsche Marks When They Won't Buy a Loaf of Bread?

[Surlethe]

If this unfreezes the credit markets (and it probably will, since what's keeping the markets frozen is the fact that every goddamn bank is insolvent because of these toxic assets), money will start to flow and the multiplier will rise as the velocity of money rises. So we could be looking at double-digit inflation this year. The real question is whether the Fed will let the inflation get out of hand, which it won't.

As far as China sitting on T-bills, they know better than to sell. If they sell, my sense is that the current financial crisis is going to look like 2000.

[J]

I'm not so sure about that. The last time I checked there was around $7 trillion in MBSs outstanding, or around 10 times what the Fed is planning to buy. In the commercial papers market where the Fed did its last round of liquidity injections/unfreezing last fall, there was roughly $1.6 trillion outstanding, ~$250 billion of which is currently owned by the Fed via their commecial paper liquidity facility. During the height of the CP lockup last year, the Fed owned up to $330 billion in commercial papers which is a bit over 1/5 of the entire market, and that's what it took to unfreeze the market and prevent a dislocation. It's actually worse since non-financial commercial papers were for the most part doing fine during that particular crisis so we can say that the majority of the money went towards the financials, which add up to around $750 billion outstanding. Say, $250 billion, or 1/3 of the market since I like simple fractions.

Which would imply around $1.4 to $2.5 trillion is required to unfreeze the MBS market. This of course neglects the derivatives, swaps, and other products written on the MBS products along with the effects of further drops in home prices on the prices of all the above. And it's still no guarantee that money & credit will start flowing since there's still lots of other fun stuff such as asset backed securities and a billion & one derivatives products on the banks' balance sheets just waiting to blow up & cause a few trillion more in losses.


And then we have this. Let's hope it stays as a discussion.

Reuters link

China backs talks on dollar as reserve -Russian source
Thu Mar 19, 2009 11:24am EDT

By Gleb Bryanski

MOSCOW, March 19 (Reuters) - China and other emerging nations back Russia's call for a discussion on how to replace the dollar as the world's primary reserve currency, a senior Russian government source said on Thursday. Russia has proposed the creation of a new reserve currency, to be issued by international financial institutions, among other measures in the text of its proposals to the April G20 summit published last Monday.

Calls for a rethink of the dollar's status as world's sole benchmark currency come amid concerns about its long-term value as the U.S. Federal Reserve moved to pump more than a trillion dollars of new cash into the ailing economy late Wednesday.

Russia met representatives of China, India and Brazil ahead of the G20 finance ministers meeting last week, as the big emerging powers seek to up their influence on decisionmaking globally. Their first ever joint communique did not mention a new currency but the source said the issue was discussed.

"They (China) did not formally put forward their position for the G20 summit but unofficially they had distributed their paper regarding the same ideas (the need for the new currency)," the source told Reuters, speaking on condition of anonymity.

The source said the Chinese paper envisaged the International Monetary Fund's Special Drawing Rights (SDRs) being first assigned a role of a clearing currency on some transactions and then gradually becoming the main global reserve currency. "They said that the role of reserve currency should be given to SDR," the source said.

A U.N. panel of experts is also looking at using expanded SDRs, originally created by the International Monetary Fund in 1969, but now used mainly as an accounting unit within similar organisations as a new reserve currency instead of the dollar.

Currency specialist Avinash Persaud, a member of the U.N. panel, told a Reuters Funds Summit on Wednesday that the proposal was to create something like the old Ecu, or European currency unit, that was a hard-traded, weighted basket.

The SDR and the old Ecu are essentially combinations of currencies, weighted to a constituent's economic clout, which can be valued against other currencies and against those inside the basket.

The Russian source said Moscow was aware that the emergence of the new global currency would not happen overnight and said its goal was to initiate a discussion about it at the G20 summit in London on April 2.

The source said that India did not object to the discussion but was not prepared to take the lead. The source said South Korea and South Africa backed the idea, while developed nations were not "allergic" to it.

"We are not waiting for everyone to say: 'How beautifully it has all been formulated, let's subscribe to it'," the source said. "The main idea is to start a discussion about it."

Russia holds about half of its reserves, the world's third-largest, in dollars, with the rest in euros and pounds. Prime Minister Vladimir Putin has called on reserve currency issuers to show more financial discipline.

Finance Minister Alexei Kudrin told reporters on the sidelines of the G20 finance ministers meeting that it would take up to 30 years to create a new super-currency, suggesting there was no unity in Russia on the issue.

President Dmitry Medvedev's top economic aide and G20 sherpa Arkady Dvorkovich is behind the Kremlin's G20 proposals, made public one day after Kudrin returned from England. (Reporting by Gleb Bryanski; editing by Mike Dolan/Patrick Graham)

[Surlethe]

Of the $7 trillion in outstanding MBSes, how many have no value? I think that's the real question - I don't see justification for assuming that every single one of those securities is junk. It could well be that the Fed is buying 90% of the bad assets and banks can take equity hits on the rest.

[Elfdart]

Which would imply around $1.4 to $2.5 trillion is required to unfreeze the MBS market. This of course neglects the derivatives, swaps, and other products written on the MBS products along with the effects of further drops in home prices on the prices of all the above.

That's roughly the entire amount of U.S. currency ever printed or coined (just over $2 trillion).

[aerius]

Of the $7 trillion in outstanding MBSes, how many have no value? I think that's the real question - I don't see justification for assuming that every single one of those securities is junk. It could well be that the Fed is buying 90% of the bad assets and banks can take equity hits on the rest.

I don't think it's possible to figure out with the way mortgages were mixed & matched in the process of structuring and packaging MBSs. As a rough ballpark guess, I'd say all the subprime, Alt-A, pay option ARM, and 2nd mortgage based MBSs are toast, as is pretty much every MBS based on a mortgage with less than 10% down originated within the last 5-6 years. Pulling numbers from my ass, I'd say $2-3 trillion are total write-offs, a similar amount will take substantial losses, and the rest is safe. We'll ever know the answer unless an army of forensic accountants & auditors goes through the books of all the major financial companies in the US.

[His Divine Shadow]

So this is why the euro-dollar widget on my desktop has changed so radically in a week(1.25 to 1.36 in a few days). Anyone know how long the dollar drop is likely to last or how much worse it'll get?

[aerius]

Anyone know how long the dollar drop is likely to last or how much worse it'll get?

Nope. If I knew I'd own my own tropical island by now. There's speculation that the rest of the world will also print or otherwise devalue their currencies so that they can continue to export to the US. I don't know how likely this is or what kind of unintended effects it'll have.