Saturday, February 13, 2016

Tech and Banking Giants Ditch Bitcoin for Their Own Blockchain

SEVERAL MAJOR COMPANIES from across both the technology and financial industries—including IBM, Intel, and Cisco as well as the London Stock Exchange Group and big-name banks JP Morgan, Wells Fargo, and State Street—have joined forces to create an alternative to the blockchain, the global online ledger that underpins the bitcoin digital currency.
Overseen by the not-for-profit Linux Foundation, this open source project aims to build blockchain-like technology that can bring a new level of automation and transparency to a wide range of services in the business world, including stock exchanges and other financial markets.

Dubbed the Open Ledger Project, this effort is a re-imagining of several big ideas. The blockchain is essentiallya database that runs across a worldwide network of independent machines—a database that’s controlled by no single entity but can still reliably track the exchange of assets, thanks to some nifty mathematics. With bitcoin, the blockchain tracks the exchange of money. But it can also track the exchange of anything else that carries value—including stocks, bonds, and other financial securities, as well as assets like houses and car titles. And in recent months, several projects have seized on many of these possibilities.“The current blockchain is a great design pattern,” says Jerry Cuomo, vice president and chief technology officer of IBM’s software group. “Now, how do we make that real for business? What are the key attributes needed to make that happen? That’s what this organization is about.”
Nasdaq OMX—the company behind the Nasdaq stock exchange—is using the blockchain to oversee the exchange of private stock, while online retailer Overstock—through a subsidiary called TØ—has built a system that will allow businesses to issue and even borrow securities via the blockchain. Just last week, the Securities and Exchange Commission approved Overstock’s blockchain stock plan.
IBM and a startup called Digital Asset Holdings, or DAH, led by former JP Morgan exec Blythe Masters, have been exploring similar technology, and both are now part of the rather large group that has agreed to participate in the Open Ledger Project. Other participants include tech companies Fujitsu and VMware; Japanese financial outfit Mitsubishi UFJ Financial Group; and SWIFT, a company that builds technology for securely driving financial applications. IBM apparently led the creation of this group effort. Earlier in the year, the tech giant said it would open source the code for its bitcoin project, and this code will provide part of the foundation for the Open Ledger Project.

Their Own Blockchain

The promise of blockchain technology is that it can provide a more secure, more reliable, more transparent, and more automatic way of exchanging money, securities, and other assets. It lets you trade assets as easily as you trade emails today—and you can trade them without putting your trust in any one person or organization. This could eliminate many of the slower technologies and expensive middlemen that clog up today’s markets, says Marley Gray, who oversees blockchain work at Microsoft. People like Gray and Overstock CEO Patrick Byrne believe the blockchain can also close loopholes in the market that allow traders to game the current system on Wall Street. All this could potentially apply to the Open Ledger Project. Cuomo says its technology could streamline the exchange of car titles, track supply chains, and oversee vast amounts of data from environmental censors.

Indeed, some companies involved in the project may feel threatened by existing efforts to reinvent the financial markets with the blockchain. State Street bank, for instance, stands to lose if companies start using Overstock’s technology to borrow stock. In the US, the stock loan business is a $954 billion market; State Street, known as an agent lender, is a big part of that. Its future depends on getting ahead of the game.It’s notable, however, that IBM and its cohorts ar creating a new distributed ledger—rather than embracing the blockchain itself. In backing a new project, they can exert more control over how it’s built and how it is used. Like the Open Ledger Project, the bitcoin blockchain is open source, meaning the code is freely available to the world at large and anyone can potentially contribute to the project. But in creating a new open source effort, giants like IBM can put themselves at the center of things. Open source is about giving stuff away. But there’s sometimes a self-interest driving the magnanimity. One open source project can battle another or refine its ideas or take those ideas in new directions.

Keeping the Blockchain Open

All that said, IBM and its collaborators are not building a proprietary blockchain. And no one company is trying to run the project. A large group of companies has set up the project at the Linux Foundation, which has long overseen the Linux open source operating system. The foundation is widely respected in the tech world as an organization that knows how to run truly open projects—projects where many participants have a say.
At this point, only IBM and DAH have vowed to contribute existing code (DAH has also contributed the name “Hyperledger,” which could be used to brand the effort in the future). But Jim Zemlin, who heads the Linux Foundation, reiterates that this project is fundamentally designed for widespread collaboration. “We have a lot of confidence in this process,” he says.
IBM’s Cuomo says there’s plenty of room to use this code to create something that is like the blockchain but separate. “We are very excited about blockchain, less as a once-and-only-once implementation of an idea, but as an idea that can be implemented and extended in ways that are consistent but enhanced,” he says. It’s unclear how, specifically, these companies hope to enhance the idea. But Cuomo believes that the project may also end up dovetailing with other distributed ledgers.
“Like with the web, there is no one thing to rule them all,” he says. “There is no one blockchain to rule them all. There will be multiple implementations of the blockchain. And it will be a sin if they don’t interoperate and work together.”

More Than One Party

It’s important not only that the Open Ledger Project is open source, but also that this group aims to create a ledger that’s distributed—a ledger that spans machines controlled not by one organization but many organizations. For Microsoft’s Gray, this is what makes the blockchain so powerful, and why it could be so useful in the world of financial trading. “A blockchain is basically worthless within a single work organization. There is no reason to have this trustless environment within your own corporation,” Gray says. “You have to have parties that are not yourself.”
Certainly, IBM isn’t the first to take this kind of approach. Others, including Ripple, have created alternative blockchains in the past as a way of taking the idea in new directions. Many believe that multiple blockchains can actually enhance the distributed nature of the idea. Though these projects are separate, Ripple is already leading an effort to create a central protocol that would allow for communication between multiple ledgers.
In a way, the Open Ledger Project competes with the existing blockchain—and existing blockchain-based technologies like the system built by Patrick Byrne and Overstock. But in other ways, it doesn’t. Judging from what IBM and others have said about the project, Byrne applauds its arrival. He’s been worried that the big Wall Street banks would “circle the wagons,” creating tech that locks everyone else out. But because IBM’s new project is open source—because anyone can use it and contribute to it—he’s pleased. He believes in more than a single technology. He believes in a big idea. “I’m not wed to bitcoin’s blockchain,” he says. “I’m blockchain agnostic.”

Thursday, February 11, 2016

Sweden Slides Further Into NIRP, Cuts Rates To -0.50%

Ever since the BoJ took the plunge into NIRP late last month analysts and commentators alike have begun to express a high degree of skepticism about the wisdom of adopting negative interest rates.
Once seen as a kind of peculiar policy experiment confined to Switzerland, Denmark, and Sweden, NIRP has escaped the lab so to speak and now that Kuroda is negative and Draghi is contemplating another depo rate cut in March, people are starting to realize that the entire developed world might be about to go Keynesian crazy. Even the US.
Indeed it was just yesterday that we brought you the latest from JP Morgan, where analysts made the following rather shocking predictions about how low rates could go under tiered implementation system:
As we’ve explained on a number of occasions, this is becoming a never-ending race to the bottom. It’s an all-out currency war and when one central bank eases, so too must the others or risk seeing their inflation targets jeopardized. That’s especially true for Sweden where governor Stefan Ingves is concerned about what the Riksbank sees as excessive krona strength and still sluggish inflation.
On Thursday, in an effort to get out ahead of the ECB, the Riksbank cut again, taking the repo rates by 15bps to -0.50% in a move that Nordea calls “a bit more than expected.” QE will continue as planned and the Riksbank “will reinvest maturities and coupons from the government bond portfolio until further notice.”
“Uncertainty regarding global developments is still high, with low inflation and several central banks pursuing more expansionary monetary policy,” the bank continued. “Swedish monetary policy must relate to this. Otherwise the krona exchange rate is at risk of strengthening at a faster rate than in the forecast, which would make it harder to push up inflation and stabilize it around 2 percent.” Here was the move in the krona:
The bank also reiterated that it's prepared to intervene directly in the FX market to curb krona strength if necessary and contended that there's still more room to cut rates further. "So far, at least in this economy, these things have worked actually pretty much the way one would expect," Ingves said, addressing the effect deeply negative rates have on Swedish banks. “When it comes to Swedish banks, their profit level is very, very good so at this level that’s not an issue."
Analysts are divided on how things play out from here. Here's some commentary (via Bloomberg):
From Standard Bank: 
  • After Riksbank cut its key rate to -0.5%, European central banks’ dive into deeper rates will continue, Steven Barrow, analyst at Standard Bank, says in e-mailed comments.
  • Riksbankoutcome is a bit more dovish than market expected and so weighs on SEK and yields
  • This is of significance because European banks are acting as a guide to how negative rates can go
  • Should the likes ofRiksbankand SNB lower rates further, that could offer more clues as to where the real lower bound is on rates
From Nordea:
  • Interpret the comment on the operational framework as a potential move toward a tiered-rates system in Sweden, as seen in Denmark, Switzerland and Japan, Martin Enlund, analyst at Nordea writes in e-mailed comment.
  • Says comment is very dovish and could wreak havoc with Swedish money-market rates
  • ECB likely to decide how much the Riksbank will do in the rates space, and some market participants are now looking for ECB to cut 20bps in March and another 20bps in June; would almost surely pushRiksbankinto a tiered-rates system later this year
  • Overall dovish surprise; Nordea would be a bit hesitant in buying SEK until dust settles, which could take a day; the normal pattern is that EUR/SEK drops 1% in the 2 wks after a softRiksbankdecision
From Danske:
  • Swedish central bank will probably have to ease monetary policy further as inflation forecasts are still too optimistic, says Michael Grahn, an analyst at Danske Bank.
  • PredictsRiksbankwill expand government bond purchases beyond June; doesn’t exclude more repo rate cuts
From Swedbank: 
  • Riksbank’s decision to cut its repo rate to -0.50% was expected but there’s now increased disagreement among board members, Anna Breman, chief economist at Swedbank AB, says by phone.
  • “Interesting” that two board members entered reservations against the rate cut and Floden against extension of FX intervention delegation mandate
  • Repo rate path indicates possible further rate cuts
  • Says that Riksbank further move into negative will lead to “big discussion”on mon. policy and the inflation target, as negative rates will remain below zero for a long period
From SEB:
  • SEB sees 40% likelihood that Riksbank will ease monetary policy further, mainly due to downside risks in world economy, says Olle Holmgren, an SEB analyst.
  • Riksbankinflation forecasts are still too optimistic
  • Further rate cut, expanded QE most likely stimulus tools
  • Still, reservations against today’s cut by two of six board members may suggest repo rate is starting to near bottom
  • FX interventions remain an option if SEK strengthens to 9-9.10 against EUR; uncertainties about scope ofRiksbank’s intervention mandate decreases likelihood of intervention
Your move Draghi.

Kyle Bass Steps Up Attack on China’s Currency

Investor Kyle Bass said Wednesday that China’s liquid foreign reserves are “already below a critical level,” intensifying a debate over China’s ability to keep its currency from falling.
Mr. Bass, whose Hayman Capital Management LP has a multibillion-dollar bet that the yuan and Hong Kong dollar will fall, told clients in a letter that his firm estimates that China’s liquid foreign reserves are $2.2 trillion at most. That compares with the $3.23 trillion reported by the People’s Bank of China, the central bank, for the end of January.
The comments from the Dallas hedge-fund manager highlight mounting investor unease about the degree to which the official Chinese number reflects reserves the nation can quickly use to prop up the value of its currency.
Market sentiment about China has turned sharply negative in recent months amid a torrent of capital outflows from the world’s most populous nation. Investors fear that development presages a sharp devaluation of the yuan that could threaten to intensify the currency wars encircling the globe and send a wave of deflation that would further enfeeble economic growth. China devalued the yuan in August, but officials have said they would like to maintain it at a stable level.
China hasn’t fully disclosed the composition of its foreign reserves, making it a contentious point between bulls and bears. Official data showed that China’s foreign reserves had dropped 19% from its peak in mid-2014. But questions have been raised as to what comprises the reserves and how quickly China can liquidate the assets, if needed, to meet the demand for foreign currencies.
“The view that China has years of reserves to burn through is misinformed,” Mr. Bass wrote. “China’s back is completely up against the wall today, which is one of the primary reasons why the government is hypersensitive to any comments regarding its reserve levels or a hard landing.”Mr. Bass said in his letter that some of China’s reserves already are tied up in institutions such as policy banks and one of its sovereign-wealth funds.
Last month, a spokeswoman of the State Administration of Foreign Exchange said China has ample foreign-exchange reserves as measured by the absolute amount and against other adequacy ratios such as imports and external debt.
“It’s a robust foundation for the country to withstand any external shocks,” said Wang Chunying, the spokeswoman.
China’s reserve holdings include U.S. securities—government bonds, agency debt and stocks—that totaled $1.76 trillion as of last October. China also held about $100 billion in bonds in Japan and $60 billion in German securities, according to Goldman Sachs GroupInc.
Beyond that it isn’t clear whether China’s total includes capital injected into China’s policy banks, foreign-currency loans to other countries and its commitments for multilateral initiatives, such as the Asian Infrastructure Investment Bank.
It also isn’t known whether China’s sovereign-wealth fund, China Investment Corp., is counted. In 2007, China’s Finance Ministry issued 1.55 trillion yuan in specialty treasury bonds and used the proceeds to purchase $200 billion in foreign-exchange reserves, which was injected into CIC. Though the initial capital infusion came from a reduction in the reported reserves at the time, it is unclear whether any of the subsequent injections were taken from the same source. Total assets at CIC were at $652.7 billion as of 2014, according to the company.
The letter from Mr. Bass marks the latest effort by hedge funds and other investors to raise doubts about the underlying health of the Chinese economy, which has slowed sharply in recent years amid a global commodity bust, and whether officials in China will be able to avoid devaluing their currency, the yuan.
The 11-page letter, Mr. Bass’s first to his investors in more than two years, contains some of his most-detailed comments yet on the thinking behind his fund’s China short. Hayman, starting last year, sold off the bulk of its investments in stocks, commodities and bonds to focus on shorting Asian currencies in the biggest concentrated wager it has made since its profitable bet years ago against the U.S. housing market, The Wall Street Journal reported last month.
Hayman began repositioning its portfolio after studying China’s banking system and being stunned at its rapid expansion of debt. The firm’s analysis suggested that past-due loans would rise sharply and eventually require a huge injection by the central government to recapitalize the banks.
In the letter, Mr. Bass wrote that the assets in China’s banking system are equivalent to 340% of the country’s gross domestic product and that the PBOC would need to print more than $10 trillion worth of yuan to recapitalize its banks. The magnitude of losses by China’s banking system “could exceed 400% of the U.S. banking losses incurred during the subprime crisis,” he wrote.
China has several levers to pull, including cutting interest rates to zero and using reserves to recapitalize its banks, the letter said, but “ultimately a large devaluation will be a centerpiece of the response.”
Other investors say they are more focused on the speed of reserve drainage. “The number we’d look at is more the pace than the absolute level. If we have many more months of $100 billion-plus outflows, that starts to become worrying,” said Maziar Minovi, a managing director at Goldman Sachs.

Tuesday, February 9, 2016

The Nixon Shock

“Inauguration Day was cloudy, grim,” wrote Arthur Burns in his diary on Jan. 20, 1969. As he watched President-elect Richard Nixon, Burns—an immigrant from Galicia, the son of a housepainter who had risen to become the foremost expert on U.S. economic cycles and chief economist to Dwight Eisenhower—saw a man with “a look of exaltation about him.” It was not a feeling Burns shared. “I would have felt better if his head were bowed and his body trembled some.” 

Nixon was inheriting an overheated economy—inflation was already a concern. Burns, 64, would be joining the Administration as a uniquely trusted adviser. In 1960, when then Vice-President Nixon was seeking the White House, Burns had warned him that if the Federal Reserve tightened interest rates, it could damage Nixon’s chances. It had played out just so: The Fed tightened, the economy suffered a recession, and Nixon lost to John F. Kennedy. Nixon never forgot the power of the Fed, and he remembered Burns as an economist with political savvy.

So it was that a year into his term, with the economy faltering, Nixon tapped Burns to replace William McChesney Martin Jr., the Fed chief who had dashed his hopes in 1960. According to Burns biographer Wyatt Wells, Nixon issued his appointee some blunt instructions: “You see to it,” Nixon said. “No recession.”

Burns had more to address than a faltering economy and a famously meddlesome patron. By December 1969, inflation had topped 6 percent—its highest level since the Korean War.
Inflation had disturbing international implications because, in the system known as Bretton Woods that had prevailed since the end of World War II, the U.S. was committed to backing every dollar overseas with gold. Thus, foreign countries had the right to exchange their greenbacks at the rate of $35 per ounce. The other currencies were fixed to the dollar, and the dollar—the sun in the monetary sky—was pegged to gold.

For the first years after World War II, Bretton Woods (named for the New Hampshire resort where delegates from 44 Allied nations met in 1944) worked perfectly. Japan and Europe were still rebuilding, and foreigners were eager for dollars they could spend on American cars, steel, and machinery. Even as they accumulated currency reserves, America’s trading partners were content to park them in interest-bearing dollars rather than in inert metal. And since the U.S. owned over half the world’s official gold reserves—574 million ounces at the end of World War II—the system seemed secure. 

But from 1950 to 1969, as Germany and Japan recovered, the U.S. share of the world’s economic output fell decisively, from 35 percent to 27 percent. Other nations had less need for dollars and more for deutsche marks, yen, and francs. Also, U.S. spending on Vietnam and domestic programs flooded the world with dollars. Bit by bit, America’s allies began to ask for gold. 

The official charged with monitoring gold and other international exchanges was the Undersecretary for Monetary Affairs, a gruff, 6-foot, 7-inch banker named Paul Volcker. He had been worried about the gold market for quite some time. Although the U.S. fixed the official gold price, a market existed in London, in which, in effect, companies sold metal to jewelers and dentists, with central banks sopping up the surplus. Generally, the banks kept the price near to $35. One day in 1960, when Volcker was working at Chase Manhattan, someone burst into his office with news: Gold was at $40. Volcker couldn’t believe it. The price receded, but it was a worrisome foretaste. Jitters in the gold market were an early symptom of domestic inflation. 

By the time Nixon took office, officials knew they were sitting on a powder keg. As Volcker, then 41, recalls, he warned incoming Treasury Secretary David M. Kennedy that they had two years to save the dollar. America’s balance of payments deficit in 1969 had reached $7 billion—small by today’s standards but scary then. This meant more dollars accumulating in London, Bonn, and Tokyo. Volcker pressed the Europeans to revalue their currencies; if Americans had to pay more for French wine, fewer dollars would pile up overseas. Germany modestly revalued; others refused. The Europeans, as well as Japan, were caught in a trap: They were reluctant to hold dollars, but unwilling to give up their dependence on exporting goods to America. 

Nixon had minimal patience for the details of international finance. When an aide informed him of monetary problems in Rome, Nixon snapped, “I don’t give a s— about the lira.” What he did care about was the domestic economy, especially the politically sensitive unemployment number. And despite his instructions to Burns, in 1970 the U.S. suffered a recession, triggering a rise in unemployment to 6 percent, its highest mark in a decade. 

Nixon was furious with Burns. He began taking economic cues from George Shultz, the Labor Secretary and then Budget Director. Shultz argued that Burns had erred by limiting the expansion of the money supply, which over the course of 1970 was less than 4 percent. Shultz, a former business school dean at Chicago, was echoing the theories of his close friend, Milton Friedman, the architect of the Chicago School. To Friedman, money supply was the single key tool at the Fed’s disposal. Friedman viewed money in terms of supply and demand: If the Fed printed more dollars, then money would be worth less and goods would cost more, i.e. inflation. But he also saw overly tight money as having worsened the Great Depression.

Burns, only eight years older than Friedman, had taught Friedman at Rutgers and been a mentor to him since. The two maintained a close friendship, and their families summered at nearby homes in Vermont. However, Burns didn’t share the rigid Friedman-Shultz belief that the money supply was everything. Burns distrusted single-answer diagnoses and blamed inflation partially on other factors, such as the growing power of labor unions. When even the 1970 recession failed to curb inflation, Burns was stumped. “What the boys around the White House fail to see,” Burns scribbled in his diary, “is that the country now faces an entirely new problem—sizable inflation in the midst of recession.” As Burns would tell a congressional committee, “The rules of economics are not working the way they used to.” Prices were going up even when factories stood idle—a seeming refutation of the economic rules. 

Despite the galloping inflation, Nixon pressured Burns to loosen monetary policy. White House aides, violating the central bank’s supposed independence, inundated the Fed with memos on the need to lower rates. “The pressure that Nixon exerted was unbelievable,” says Joseph Burns, the late Fed chief’s son. Volcker agrees that it got “very rough.” 

As the economy shifted into a tepid expansion in ’71, Burns allowed the money supply to expand at an annual rate of 8 percent in the first quarter, 10 percent in the next. This was wildly expansionary. Allan Meltzer, a Fed historian, says Burns’s policy was partly attributable to honest miscalculations. (Determining the rate of money supply growth is fiendishly difficult.)
But Meltzer says Burns was also influenced by Nixon’s bullying. The President alternately flattered Burns and excluded him, and Burns careened between feisty shows of independence and toadying displays of loyalty. In his diary, Burns assures the President that “his friendship was one of the three that has counted most in my life”; a few months later he is recoiling at Nixon’s “cruelty” and, still later, at his anti-Semitic outbursts. He feared the consequence of higher unemployment, yet was committed to the success of the Nixon Administration. This conflict led Burns to a dramatic about-face. In 1970, the Democratic-led Congress had authorized the President to impose wage and price controls. Nixon, who had played a small role in administering war-time price controls while working for the Office of Price Administration, thought they wouldn’t work. The issue became a political football. Then, at the end of 1970, Burns gave a speech advocating a wage and price review board that would issue guidelines and try to restrain inflation through suasion and public statements. Milton Friedman regarded it as an endorsement of centralized planning—and a personal betrayal. He stayed up all night writing his mentor what, he said later, was an overly harsh letter; Burns and Friedman were never friends again. 

In the first half of 1971, unions representing copper, steel, and telephone workers negotiated wage increases of more than 30 percent over three years, in addition to cost-of-living adjustments. To modern readers, it may seem odd that the chairman of the Federal Reserve was reluctant to raise interest rates in the teeth of double-digit inflation, but the modern view that only the Fed can control inflation was not widely accepted. Balanced budgets were thought to be of equal importance. And, as Meltzer notes, few Americans thought inflation was worth sacrificing jobs for. That summer, Time magazine opined that, “once an inflation starts, no government could accept the severe recession and unemployment needed to stop it cold.” This was the conventional view—that the Fed was powerless.

Friedman argued that it was better to snuff out inflation because, in the long run, inflation (which merely amounted to printing money) wouldn’t truly create jobs. Friedman’s position was later to become gospel. At the time, though, many economists believed that by adding to the money supply, the central bank could spur growth. Burns, therefore, urged the White House to curb inflation by non-monetary means. He encouraged the President to “jawbone” industries to show restraint and to form a council of wise men who would publish guidelines. Nixon feared guidelines were a step toward controls; his solution was to bring inflation down without a recession, by working toward a balanced budget. Herbert Stein, his economic adviser, told him flatly it wouldn’t work. Burns chafed: “I am convinced that the President will do anything to be reelected.” 

Rampant domestic inflation was mirrored, franc for franc, in markets overseas. Foreign governments intervened to buy dollars to shore up America’s currency (and their export trade). This left their central banks swollen with greenbacks. “Foreigners buying dollars caused a monetary expansion, similar to today,” says Ronald McKinnon, an economist at Stanford University. Meanwhile, America’s gold stock had dwindled to $10 billion, half its 1960 level. The gold standard now existed only in name, for foreign banks held far more dollars than the U.S. held gold. This left the U.S. vulnerable to a run.

With shrewd timing, in early 1971, Nixon appointed a new Treasury Secretary, John Connally, a hulking former Texas governor, who saw these various financial trials—inflation, the pressure on the dollar, the mounting trade deficit—as affronts to the national honor. It was the peak of the Vietnam protest movement, and Connally felt the U.S. had absorbed enough humiliations. He had no abiding economic philosophy; as he proclaimed to Nixon, “I can play it square, I can play it round, just tell me how you want me to play it.” What he brought to the Nixon team was enormous ego, force of personality, and a political intuition that economic reforms, which appeared imminent, had to be presented in a program acceptable to ordinary Americans. That Connally lacked financial expertise bothered him not a whit. “I can add,” he said upon taking the job. His role, as he saw it, was to pull together the competing recommendations of Shultz, Burns, and Volcker into a policy suggesting coherence. 

Burns continued to back a wage council; he also thought the U.S. should devalue against gold (that is, raise the gold price above $35). Volcker believed this would be ineffectual, as other countries would simply devalue their currencies by the same percentage. To Volcker, the key to restoring balance was a 10 percent-to-15 percent devaluation of the dollar against the yen and the European currencies. Even if America’s allies refused to budge, Volcker thought the U.S. could force the issue by temporarily halting gold-dollar convertibility.

The pressure intensified that spring. In April and into May, as speculators sold dollars and hoarded deutsche marks, Germany was forced to purchase $5 billion to stabilize the exchange rate. This was a huge sum in an era in which hedge fund goliaths did not exist. On May 5, Germany caved to the upward pressure on its currency and let the deutsche mark float. This brought the West a step closer to Friedman’s dream of freely trading currencies, but it did not alleviate the crisis.

The gold exodus continued and, to make matters worse, the U.S. began running a substantial trade deficit, a politically charged issue given that unemployment remained at 6 percent. Nixon had to act, but his advisers were split. Volcker, as well as Shultz, wanted to close the gold window. Burns was vehemently opposed. Severing the gold link would turn money into  paper.
If the government no longer had to preserve the dollar’s value in metal, how could the Administration claim, with any credibility, to be countering inflation?

This question prompted officials to give controls a second look. No one in the Administration, from Nixon down, believed in controls in an economic sense. They were Sovietized economics, an attempt to force markets where they didn’t want to go. But the economics didn’t matter to Connally; what counted was a forceful display of power. Over the summer, Connally, with Nixon present, briefed Shultz—essentially so the latter could air his objections and then get behind the program. Secrecy was imperative. “Don’t tell your wife,” Nixon warned Shultz.

The intent was to move after Labor Day, but on Aug. 12, a Thursday, Britain stunned the U.S. by demanding that it guarantee the value of $750 million. On Friday, Nixon summoned 15 advisers to Camp David; he insisted no outsiders be told. Volcker wisely took exception and briefed a colleague in the State Dept. and also the Japanese. Stein, the economic adviser, told William Safire, the speechwriter, that they were embarking on the most momentous economic decision since March 1933. “[Are] We closing the banks?” Safire asked. Stein said no, but the gold window might be disappearing. “What a tragedy for mankind,” wrote Burns in his diary.

The plan, presented by Connally, had three key points. First, America would stop converting dollars to gold. Second, to combat the potential inflationary effects, wages and prices would be frozen for 90 days. And third, the U.S. would impose an import surcharge of 10 percent. Connally’s idea was to use the surcharge as a cudgel, to pressure other countries to renegotiate their exchange rates.

The Camp David weekend was intended for Connally to get everyone’s support before the program was announced. People slept two to a cabin (the bed was too short for Volcker) and convened in the dining room. Nixon remained cloistered in his cabin, the Aspen Lodge, but called anxiously for updates. Burns spent an evening pacing the grounds with Volcker, wringing his hands over the gold standard. Burns alone was invited to the President’s cabin for a private audience. Although Nixon regarded the pipe-smoking Fed chairman as pompous and long-winded, he knew Burns was trusted by the public, and he needed his support. Otherwise, it was Connally’s show. 

Connally brilliantly packaged the program not as America abandoning its commitment to the gold standard but as America taking charge. He turned the dollar’s collapse, which could have appeared shameful, into a moment of hubris. The emphasis would be on righting America’s trade balance, as well as minor points such as a 5 percent cut in foreign aid. An aide to William P. Rogers, the Secretary of State, called and interjected, “You can’t cut foreign aid.” Connally said, “Tell him if he doesn’t shut up we’ll make the cuts 15 percent.” Shultz muzzled his disquiet over price controls; even Burns joined ranks. The group feverishly debated whether Nixon should address the country on Sunday night, which would mean preempting the popular Gunsmoke. The public relations aspect was paramount. Stein wrote later that the discussion at Camp David assumed “the attitude of scriptwriters preparing a TV special.” No one pretended to know how controls would work; the question was scarcely debated.
Addressing the nation on Sunday, Nixon blamed currency speculators and “unfair” exchange rates rather than U.S. monetary policy. Politically, he hit the jackpot. Monday’s nearly 33-point rise in the Dow was the biggest ever to that point. Nixon’s “New Economic Policy” drew raves from the press. “We unhesitatingly applaud the boldness with which the President has moved,” read the New York Times editorial. In the present era, America’s inability to repair its fiscal problems has tarnished its credibility and hampered its currency negotiations with China. The Nixon Shock showed the U.S. taking action. That December, Shultz and Volcker successfully negotiated a broad revaluation of exchange rates. 

Volcker envisioned that once exchange rates were modified, Bretton Woods would be restored, perhaps with a more flexible mechanism for adjusting rates. He tirelessly negotiated with Europe and Japan, but Bretton Woods could not be put back together. The gold window stayed shut. More devaluations followed, and by 1973, currencies were freely floating. 

Friedman’s prediction that, left to the market, currencies would regulate themselves with only gradual adjustments proved wildly incorrect. The dollar plunged by a third during the ’70s, and currency volatility has threatened several national economies since; in 1997, Asian and Latin American countries were wrecked by currency runs. To this day, Volcker regrets that Bretton Woods was abandoned. “Nobody’s in charge,” he says. “The Europeans couldn’t live with the uncertainty and made their own currency and now that’s in trouble.” The effect on America’s domestic economy was even worse. As Shultz says, “Price controls gave the illusion of doing something about inflation.” They further liberated Nixon from concern for the normal rules. Late in 1971, he wrote to the Fed chief, “You have given me absolute assurance that money supply growth will be adequate to maintain growth.” Burns scrawled in the margin, “Never gave him absolute assurance. What nonsense!” But Burns, intentionally or not, delivered on Nixon’s demand for an expansionary monetary policy. 

Controls had the desired short-term effect; inflation was quiescent through the end of 1972, when Nixon easily won reelection. The controls, however, proved difficult to end. The 90-day freeze begat a more complicated wage and price regime, a Phase II, followed by a Phase III, lasting into ’74. And Burns’s easy money fostered a monetary steam cooker that controls could not suppress. By August ’74, when Nixon resigned, inflation had topped 11 percent. Soon it would go even higher. Expectations of rising prices became embedded in the system. 

The Nixon Shock was a central cause of the Great Inflation. It also spelled the end of the fixed relationships that had governed the financial universe. Previously, people took out mortgages for set periods and at fixed rates. They had virtually no options for saving money other than in banks, and the interest rates that banks could pay were capped. Floating currencies unleashed a new world of risk and instability. For the first time, investors could bet on the direction of interest rates or the Swiss franc. New financial instruments, new speculative tools, proliferated.
The world gravitated from the certainties of Bretton Woods to the dizzying market cycles we’ve lived with since. Donald Kohn, who joined the Fed in 1970 and retired last year as vice-chairman, thinks Bretton Woods was doomed. But bankers have yet to find as rigorous a standard as gold. And they have become ever more apt to please politicians, deferring recessions at the risk of inflating asset bubbles.

Burns was replaced by Jimmy Carter in 1978. The following year, with inflation rocketing toward 15 percent, Burns delivered a keynote speech, “The Anguish of Central Banking,” in which he argued that central bankers around the world were failing because elected leaders were unwilling to risk displeasing constituents. The new Fed chief, Volcker, did tame inflation; unlike Burns, he had the fortitude to subject the country to a brutal recession. But the dilemma faced by Burns—how to withstand the demands of the public for limitless monetary expansion—did not go away. We see it now in the troubles of nations from Greece to Ireland to the U.S. And the anguish that Burns felt is Ben Bernanke’s unfortunate inheritance.

Lowenstein is a columnist for Bloomberg News.

5 Most Galling Lines From Barclays Forex Chats

Law360, New York (May 20, 2015, 8:54 PM ET) -- “If you ain’t cheating, you ain’t trying.” This isn’t just an overused and cynical sports adage, it’s one of many jaw-dropping exchanges by a group of traders who called themselves the “cartel” and teamed up to manipulate global foreign exchange markets, according to Barclays PLC's settlements with regulators.

In addition to pleading guilty to criminal antitrust violations, Barclays paid $710 million to the U.S. Department of Justice, $342 million to the Federal Reserve, $400 million to the U.S. Commodity Futures Trading Commission and $485 million to New York’s Department of Financial Services. The U.K. Financial Conduct Authority also fined the British bank £284 million ($441.8 million) for violations of U.K. antitrust law.

In settlement documents and statements announcing those deals, regulators cited examples of the egregious language used by forex traders at Barclays and other banks in secret, multibank chat rooms. One invitation-only chat room, referred to as “The Cartel” included forex traders from Citigroup Inc., JPMorgan Chase & Co., UBS AGRoyal Bank of Scotland Group PLC and Barclays who specialized in trading the euro, according to the NYDFS. 

Here, Law360 looks at a few of the choicest conversation snippets from that chat room and others, as cited by the CFTC and NYDFS.

'yes, the less competition the better'

As part of their scheme to manipulate the prices in certain forex currency pairs and certain forex benchmark rates, traders would “build ammo” by amassing a large portion of currency and then unload the “ammo” just before or during a fix in order to move prices, according to the NYDFS.

Traders in the multibank chat often agreed to stay out of each other’s way around the time of a fix and avoid executing contrary orders while a price was being deployed. Traders also cooperated with price manipulation by trying to “clear the decks” of contrary orders so as not to dilute the “ammo,” the NYDFS said.

In a June 2011 chat with a trader from HSBC, one Barclays trader reported that another trader was building orders to execute at the fix, contrary to HSBC’s orders, but Barclays helped HSBC by executing trades ahead of the fix in order to decrease that other trader’s orders, according to NYDFS.

In a separate chat several months later, a Barclays trader told a trader from Citigroup, “If u bigger. He will step out of the way. . . We gonna help u,” NYDFS said.

Forex traders in the U.S. dollar/Brazilian real market colluded in a more straightforward way, according to the New York regulator.

In an October 2009 chat, an RBC trader reportedly wrote, “everybody is in agreement in not accepting a local player as a broker?”

A Barclays forex trader reportedly responded, “yes, the less competition the better.”

'u dont have clients . . . u dont make money .  . . so dont be stupid.'

According to the NYDFS, members of the Barclays forex sales team also routinely misled their clients by applying so-called hard markups to the prices traders gave them without their clients’ knowledge. These markups were a significant revenue source for the bank and sales managers pushed their employees to use them as much as possible, the NYDFS said.

Forex sales employees allegedly determined customer markups by calculating the best possible rate for Barclays that wouldn’t raise any red flags with the customer. These calculations were based on the bank’s relationship with the customer, their recent pricing history and the clients’ expectations, according to NYDFS.

One forex sale employee reportedly put it this way to an employee at another bank in December 2009: “hard mark up is key . . . but i was taught early . . . u dont have clients . . . u dont make money .  . . so dont be stupid.”

'if you aint cheating, you aint trying'

When one forex sales employee admitted to a colleague in June 2009 that he had “come clean” to a client about a hard markup, the colleague told him, “i wouldnt normally admit to clients if you pip them. i think saying you rounded is fine.”

The first employee agreed and then clarified that he didn’t really come clean, but rather that he told the client he had rounded the amount. 

In a November 2010 chat message, the future co-head of Barclays' UK forex hedge fund sales, who was then a vice president in the New York office, wrote: “markup is making sure you make the right decision on price . . . which is whats the worst price i can put on this where the customers decision to trade with me or give me future business doesn’t change . . . if you aint cheating, you aint trying.”

'we do dollarrr'

As they colluded to fix the markets, the traders in the chat rooms kept each other abreast of their activities, according to the CFTC.

In one chat cited by the futures market regulators, a trader from Barclays and a trader from “Bank Y” coordinated their trading in order to manipulate a WM/R 4 p.m. London fix.

At 3:43:50, the Barclays trader reportedly asked the Bank Y trader whether he needed to buy Euros in the market in the forthcoming fix. The Bank Y trader told him that he had a net buy order for the fix, which he said totaled 105 million. Less than a minute later, the Bank Y trader reportedly offered to transfer that net buy order to the Barclays trader. The Barclays trader chatted “maybe” and said he had a net buy order for 150 million, according to the CFTC. 

The two traders then had the following exchange:

“Barclays trader: i'd prefer we join forces
Bank Y trader: perfick/ lets do this .../lets double team them
Barclays trader: YESssssssssssss”

Once the fixing window closed, the traders congratulated themselves, the CFTC said:

“Barclays trader: sml rumour we haven't lost it
Bank Y trader: we/ do/ dollarrr”

'dont want other numpty' s in mkt to know'

Throughout the yearslong scheme to rig the foreign exchange markets, forex traders often had multiple chat rooms open simultaneously within their trading terminals, according to Barclays’ settlement order with the CFTC.

Being a member of certain chat rooms, like “The Cartel,” was considered very exclusive. When inviting new members, existing traders often discussed whether a new addition would be in the best interests of the group first.

In one chat, traders from three other banks reportedly discussed whether to invite a Barclays trader into a chat room:

“Bank Z trader: are we ok with keeping this as is ../ ie the info lvls & risk sharing?
Bank X trader: well ...
Bank Z trader: that is the qu[ estion]
Bank X trader: you know him best obv .../ if you think we need to adjust it/ then he shouldn't be[] in chat
Bank Y trader: yeah that is key/ simple question [Bank Z Trader]/ I trust you implicitly [Bank Z Trader]/ and your judgement/ you know him/ will he tell rest of desk stuff/ or god forbin his nyk ...
Bank X trader: yes/ that's really imp[ortant] q[uestion]/ dont want other numpty' s in mkt to know/ but not only that/ is he gonna protect us/ like we protect each other against our own branches/ ie if you guys are rhs .. and my nyk is lhs .. ill say my nyk lhs in few”

A numpty, for those unfamiliar with the term, is a common Scottish slang word for "idiot."

- from Law 360

EES: Liquidity Forex System released on MQL5 marketplace

Elite E Services has published today a Forex algorithmic system designed for banks, IBs, fund managers, brokers, and traders who want to create Forex volume.  Check it out on the MQL5 marketplace.

Saturday, February 6, 2016

Here Are The Banks The Market Is Most Concerned About

While there are numerous financial institutions in the world that are full of hidden NPLs and over-leveraged, trading at extreme levels of risk, the FSA's "Too-Interconnected-To-Fail" list of systemically critical banks is where global investors' attention is really focused.
BMO Capital Markets breaks down the world's most systemically critical financial institutions using their own "special sauce" of CDS levels, CDS term structure, equity price, liquidity, and spread trends.

Frankly, as we explained previously, these are the "Musketeer" banks - one for all and all for one as any system failure in Deutsche, Credit Suisse, or Bank of China will leak immeasurably and contagiously around the world via the interconnectedness of the collateral chains used to fund these behemoths.

A Badly Wounded Deutsche Bank Lashes Out At Central Bankers: Stop Easing, You Are Crushing Us

Ten days ago, when Deutsche Bank stock was about 10% higher, the biggest German commercial bank declared war on Mario Draghi, as we put it, warning him that any further easing by the ECB would only push stocks (with an emphasis on DB stock which has gotten pummeled over the past few months) lower. What it got, instead, was a slap in the face in the form of a major new easing program when the Bank of Japan announced it is unveiling negative rates just three days later.
Which is why overnight a badly wounded Deutsche Bank has expanded its war against the ECB to include the BOJ as well, and in a note titled "The Risks From Further ECB and BOJ Easing" it wants that with the Zero Lower Bound already breached in nearly a third of global markets, the benefits to risk assets from further easing no longer exist, and in fact it says that while central banks have hoped that such measures would "push investors out the risk spectrum" the "impact has been exactly the opposite."
In other words, we have reached that fork in the road within the monetary twilight zone, where Europe's largest bank is openly defying central bank policy and demanding an end to easy money. Alas, since tighter monetary policy assures just as much if not more pain, one can't help but wonder just how the central banks get themselves out of this particular trap they set up for themselves.
Here is DB's Parag Thatte explaining the "The risks from further ECB and BOJ easing"
The BOJ surprised with a move to negative rates last week, while ECB rhetoric suggests additional easing measures forthcoming in March. While a fundamental tenet of these measures, in particular negative rates, has been to push investors out the risk spectrum, we remind that arguably the impact has been exactly the opposite:
  • Declining bond yields have been robustly associated with larger inflows into bonds at the expense of equities. Though a large over allocation to fixed income at the expense of equities already exists as a result of past Fed QEs and a lack of normalization of rates, further easing by the ECB and BOJ that lower bond yields globally will only exacerbate the over allocation to bonds;
  • Asynchronous easing by the ECB and BOJ while the Fed is on hold risks speeding up the dollar’s up cycle, pushing oil prices lower and exacerbating credit concerns in the Energy, Metals and Mining sectors. It is notable that the ECB’s adoption of negative rates in mid-2014 which prompted the large move in the dollar and collapse in oil prices, marked the beginning of the now huge outflows from High Yield. These flows out of High Yield rotated into High Grade, ironically moving up not down the risk spectrum. The downside risk to oil prices is tempered somewhat by the fact that they look cheap and look to be already pricing in the next leg of dollar strength;
  • Asynchronous easing by the ECB and BOJ that is reflected in the US dollar commensurately raises the trade-weighted RMB and increase the risk of a disorderly devaluation by China. The risk of further declines in the JPY is tempered by the fact that it is already very (-29%) cheap, but there is plenty of valuation room for the euro to fall.
Broad-based move across asset classes towards neutral amidst uncertainties
  • US equity fund positioning inched closer to neutral; as anticipated the returning buyback bid is being offset by large persistent outflows (-$42bn ytd);
  • European equity positioning is also close to neutral amidst slowing inflows; Japanese funds trimmed exposure from very overweight levels while flows turned negative for the first time in 2 months;
  • The large short in US bond futures has started to be cut; 2y bond shorts were cut by half this week while short-dated rates futures are already long. Robust inflows into government bond funds which began this year have continued while the pace of outflows from HY and EM funds has slowed;
  • A move toward neutral was also evident in FX positions. The surprise BoJ cut to negative rates caught yen longs by surprise, with the large initial subsequent depreciation in the yen partly reflecting a paring of positions. Meanwhile, the euro rose to a 3 month high as crowded leveraged fund shorts were being covered despite the ECB’s dovish rhetoric;
  • As the dollar fell, net speculative long positions in oil rose, reflecting mainly an increase in gross longs while shorts remain at record highs; copper shorts continue to edge back from extremes; gold longs are rising.
Declining bond yields mean larger inflows into bonds at the expense of equities
  • A fundamental tenet of central bank easing has been to push investors out the risk spectrum. The impact has arguably been exactly the opposite
  • Beyond any negative signal further monetary easing sends on underlying growth prospects, historically falling bond yields with the attendant capital gains on bonds have seen inflows rotate into bonds at the expense of equities. The correlation between equities and bond yields remains strongly positive. Notably, the best period of inflows for equities was after the taper announcement in 2013 when bond yields rose sharply
Large over-allocation to fixed income already
  • Past Fed QEs, a lack of normalization of Fed rates and easing by other central banks means that a large over-allocation already exists in fixed income while the underallocation in equities remains massive
  • Additional easing by the ECB and BoJ by encouraging inflows into bonds will only exacerbate the over allocation to fixed income
Asynchronous easing behind decline in oil and flight from HY
  • Asynchronous monetary easing by the ECB or BoJ while the Fed is on hold puts upward pressure on the dollar, downward pressure on oil prices and heightens credit concerns in the Energy, Metals and Mining sectors
  • It is notable that the huge outflows from HY began to the day with the ECB’s adoption of negative rates in Jun 2014. Those outflows from HY moved into HG, ironically moving up not down the risk spectrum
  • The risk to oil prices is somewhat tempered by the fact that oil prices are cheap to fair value and look to be pricing in the next leg of dollar strength
Asynchronous easing that is reflected in a higher dollar is reflected commensurately in the trade-weighted RMB
  • By virtue of the near-peg to the US dollar, by early 2015 the trade-weighted RMB had risen along with the US dollar by 32% in trade-weighted terms and has been in a relatively narrow range since
  • A variety of Chinese economic indicators have been strongly negatively correlated with the US dollar: Chinese data surprises (-42%); IP (-65%); and retail sales (-59%)
Further dollar strength raises the risk of a disorderly Chinese devaluation
  • Asynchronous easing by the ECB and BOJ reflected in the US dollar and in turn the trade-weighted RMB increases the risk of a disorderly devaluation by China
  • The risk of further declines in the JPY is tempered by the fact that it is already very cheap (-29%), but there is plenty of valuation room for the euro to fall
  • The surprise BoJ easing in January prompted a paring of longs, while investors are unwinding short positions in the euro despite dovish rhetoric by the ECB
* * *
A few last words. Since DB, whose CDS has soared to very dangerous levels in recent days suggesting the market is suddenly concerned about its counterparty status, is effectively the Bundesbank, one can make the argument that any incremental easing by the jawboning Mario Draghi during the ECB's next meeting suddenly looks very precarious.
On the other hand if Draghi once again isolates Weidmann and does cut rates to -0.40% as the market has largely priced in, because the ECB head fulfills the desires of his former employer Goldman Sachs first and foremost, one would wonder if as we speculated last summer Deutsche Bank is not indeed the next Lehman, if for no other reason than Goldman has decided the German financial behemoth should be the next bank to fail, and unleash the next global taxpayer-funded bailout episode.