Mar 14, 2009
Buyer beware
By Chan Akya
"There are two tragedies in life. One is to lose your heart's desire. The other is to gain it." - George Bernard Shaw
Central banks across the Group of Seven leading industrialized countries are opening their purse strings with the first wave of quantitative easing (QE) measures seen in the current generation. After the US Federal Reserve started buying eligible corporate debt directly from the end of last year, we now have the Bank of England completing its first wave of QE-related asset purchases this week.
As with the moves by the US Federal Reserve in the past, the Bank of England quickly found itself overwhelmed by sellers who were quite eager to get rid of their UK government bonds (termed "gilts" ), with requests for around 10 billion pounds sterling (US$1.4 billion) against the 2 billion pounds that had been initially expected.
What followed was interesting: the immediate decline in the yield of UK government bonds by around 50 basis points (five-year gilts fell to 2.12% from 2.61% at the end of February) made the Bank of England move an unqualified success. About the one thing we know for sure about the world's central banks is that they love to copy each other; therefore in short order it is highly likely that the US Federal Reserve, the Bank of Japan and perhaps even the European Central Bank (more on that later) will start buying up the bonds of their respective governments or member states.
In recent history, the Japanese government embarked on QE in the late 1990s after its policy of cutting interest rates to zero failed to produce any economic bounce: the failure was due to the significant losses on the balance sheets of Japanese banks and companies which rendered the actual interest rate moot as against the painful decline in asset value on the other side of their balance sheets. The QE policy of the Bank of Japan did not succeed in pulling Japan from the depths of its recession, and indeed may have only served to accentuate the deflationary forces that were unleashed by the country's demographic decline.
The UK on the other hand bears watching, for almost alone among the major economies it resembles the US in every respect - a house-price bubble, endemic leverage, bankrupt financial institutions and so on - with the main difference arising from the absence of a reserve currency status. In other words, Americans who wonder about what would happen to their country if the US dollar weren't the world's de facto currency would need to look no further than the UK.
Deliberately pushing down government yields in the UK would serve to push down the value of the currency against its major trading partners: the US and the European Union; which, given a service-oriented economy focusing on areas such as trade, insurance and financial services, would give the UK economy a significant competitive boost.
The move was repeated in Switzerland, which also this week acted deliberately to push down the value of its currency against the euro as it sought to maintain a competitive advantage in areas such as banking, tourism and manufacturing in the face of significant government intervention in neighboring European countries effectively supporting its competitors.
Meanwhile, in Asia, after revealing a current account deficit for the first time in recent memory, Japan has quietly seen its own version of devaluation as the yen now hovers around the 100 level from around 90 to the US dollar in late January - a level that presented tremendous difficulties for the country's exporters and even made the famously conservative Toyota Motor Corp at one stage request government assistance.
By now, readers will have recognized the game that is afoot: competitive devaluations across the G-7 - composed of Canada, France, Germany, Italy, Japan, the UK and the US - and the United States as every economy attempts to secure the future of its constituents, albeit at the cost of other major economies.
This phase will continue for a while longer, at least until the hapless European Central Bank (ECB) finally also caves into the demands of its member states and succumbs to the same logic - namely, of effecting a steady erosion of the purchasing power of their own currencies. The ECB is the central bank for Europe's single currency, the euro. According to its own web site, the ECB's "main task is to maintain the euro's purchasing power and thus price stability in the euro area". The euro area comprises the 16 European Union countries that have introduced the euro since 1999.
Who is the fish?
An oft-repeated saying from the game of poker holds that "around the table, you should always know who the fish is. If you don't, it's you." In this case, the "fish" refers to the worst player on the table, the one who is effectively paying for everyone else's winnings.
Non-Japan Asia is the unfortunate fish in the global game of devaluation being played by the major economies: the US, the EU, the UK, Switzerland, Japan and so forth. In particular, export powerhouses such as China, South Korea and Taiwan really have it bad, as do the Southeast Asian economies as we enter the next phase of the economic slowdown in the global economy.
It is not just in terms of currency values that the Asians are being made out to be the fish in this game. Adding insult to injury, it is the savings of Asians that actually help fund the government bonds of the major world economies. As interest rates are pushed down along with a parallel shift in the value of the currencies, savers in Asia are getting the worst possible deal, namely a decline in both current income and future purchasing power.
Central banks around the region are holding on to the bonds issued by the major economies because of fears that a large sell-off - by say, China - would damage the total value of their holdings and cause significant pain. However, this is to forget the longer-term, slow leakage that is currently on the cards anyway; leading as it will to the eventual destruction of values.
On the other side of the ring, we have countries such as South Korea, China and India all creating their own stimulus programs to push up domestic demand. Instead of participating in each other's government bond auctions though, the countries have been busy supporting the activities of the major economies and herein are the main problems for the region as a whole.
China certainly needs the experience of Korean construction companies in its initiative, much as India does too. The easiest way for both these countries to help Korea would be to award contracts to the latter; in return, the Korean government could easily buy infrastructure bonds denominated in US dollars issued by China or India. Similar instances of possible cooperation abound in areas ranging from energy to health.
A lot of this, though, will remain a pipe dream of this writer as Asian central banks continue their slavish purchases of whatever they have always been buying. For the citizens of the region though, the same question that should have been asked 24 months ago arises once again: who do these guys work for: their own citizens or those of the G-7?
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