We're Still Waiting for 'Globally Synchronized Growth'
Just this week the Brazilian real touched 3.60 to the dollar. Last week, the Russian ruble traded down to 64.00. China’s yuan recently retreated to 6.37. The Argentine peso continues to be pummeled.
Taking the last one first, Argentina’s central bank had begun the year by reducing interest rates. The peso was already in flight by then, but officials realized their best chance for arresting its decline was to get the economy restarted. That’s ultimately what all this comes down to: risk. We’ve been hearing about acceleration and globally synchronized growth for nearly two years, and we’re still waiting (for the third time).
With little chance of any economic boost, Argentina has been left to its fate. It’s the same one as it was attempting to meet in late 2015. What happened in between was a combination of “reflation” sentiment and eurobonds (though mostly the latter). With the bank channel for eurodollar redistribution still chronically chaotic, the country turned to issuing dollar-denominated, offshore bonds.
The market initially couldn’t get enough of them, especially as attitudes began to shift in 2016 counting on recovery (and central banks, for some reason). In April of that year, Argentina floated a record issue $16.5 billion (it has since been surpassed in the global bond bypass of the past two years). A Reuters story of the time observed that it was “a rare bright spot among gloomy emerging markets.”
It was just the beginning. Argentina’s finance minister Luis Caputo has been the world’s most visible bond salesman, so much so it’s a surefire guarantee that he has a bright future ahead on Wall Street however this all works out in South America. He even went so far as to successfully complete an underwriting for $2.75 billion of 100-year bonds in June last year. The coupon was just 7.1%.
What does it say about the state of the world if a country that less than two years before had been an international financial pariah but was now issuing forever bonds at just 7%? It suggests the market isn’t so sanguine about the prospects for much higher structural interest rates any time soon.
For his part, Caputo is miffed at bond investors. In early October, he admitted to Bloomberg in an interview that he was growing frustrated. Seven percent? That’s not what other countries get, and he wants even lower rates. This disconnect was succinctly described by the story’s sub-headline: “He’s Argentina’s finance minister, selling debt for the biggest bond issuer in the developing world, and he can't believe investors are still doubting the rebound story.”
Take no offense, Mr. Caputo, it’s not specifically Argentina that’s being questioned it’s the whole ball of wax. Despite the numerous and often emphatic cries of global recovery that are a constant even dominating feature of any financial news content, we’ve heard this all before and have more than a vague idea how it ends. For countries like Argentina, open and vulnerable, it’s not a pretty sight.
After lowering interest rates earlier this year, Argentina’s central banks has skyrocketed them upward. In two days at the end of last week, the benchmark rate for pesos was moved from 30.25% to 40%. And still the peso falls.
Since March, the country has expended an enormous $7 billion in “reserves” to defend the currency. Obviously, it hasn’t worked. It never works. That’s the problem.
To Economists and central bankers (redundant) foreign reserves are insurance. You stockpile largely US Treasury securities so that when the time comes and local banks have trouble sourcing “dollars” on offshore markets you can step in and save them. That might be true if whatever problem affecting local banks was a minor, one-off event. What if it’s enduring?
I don’t mean chronic in the sense of Argentina reverting to historical form, either, rather the other way around. Despite tangible progress, the country’s problem is the eurodollar system.
Its neighbor in South America, Brazil, provides yet another potent example. In April 2013, on the eve of the looming EM currency crisis that would become the full-blown “rising dollar” the following year, the IMF reported total Brazilian forex reserves (including gold and SDR’s) of $378.7 billion. It seemed a truly impressive balance, one of the largest in the world.
At its lowest point, Brazil’s officially reported reserves never got below $356.4 billion (December 2015). But in between those months, the real crashed anyway. The currency had begun at around two to the dollar in the spring of 2013, and by the end of 2015 it was four to the dollar (having sunk as low 4.40).
While the real plummeted, again despite at minimum $350 billion in reserves, Brazil’s economy collapsed. No actual recovery is as yet in sight despite bottoming out a year and a half ago. Like everywhere else in the world, GDP has been consistently positive but that means next to nothing. It is up 2% from the trough, but that’s still 7% below the peak set almost four years before in 2014.
A mere few weeks after Argentina first returned to eurobonds in April 2016, in early May a strange and almost poetic composition appeared in the official mouthpiece of China’s Communist government. The People’s Daily published the effort without attributing authorship. Written in the form of a question and answer, the person giving the A’s was described only as “an authoritative figure.”
Many speculated that it was none other than Xi Jinping. The context as well as what was contained within the missive left few other alternatives. It had to have been from someone deep within the power structure for what it foretold.
It appeared, at least to the Western mainstream, as a sharp rebuke of then-current policies; therefore, who else but Xi? That characterization, however, proceeded from several false premises.
The message was mistranslated not in terms of language but in terms of economics. People focused on some of the metaphors, such as how heavy use of leverage and debt was compared to “growing a tree in the air.” So, it was pegged as a warning about excesses and nothing more.
Except this person was a little more specific in how that might ever be applied. It was not a rebuke of all forms of debt nor even high levels of leverage. The problem was more succinct.
“I need to stress, that the L-shape will last for a certain period of time, and it’s certainly longer than one or two years.”
Massive credit growth can be fine if economic growth demands it. If there is no economic growth, only then are you growing a tree in the air. Economists around the world may still believe that debt leads to economy, they can now count the Chinese out.
We don’t know who wrote it, though I and many others suspect it was Liu He. Liu, often called affectionately Uncle He, is a close confidant of Xi Jinping. Their relationship spans decades, and it was Liu who outside observers thought was the odds-on favorite to replace Zhou Xiaochuan as the head of the PBOC this year.
Somewhat surprisingly, Yi Gang was given that post in March. Uncle He was made instead one of China’s four Vice Premiers and handed one of that country’s most powerful portfolios of responsibility. Essentially, as the Financial Times called him upon his ascent, he is now their Economic Tsar. In other words, he was promoted one step further than the central bank and now effectively oversees it.
While that doesn’t exactly settle who wrote what in May 2016, it does reinforce the ideas contained within the message. The Chinese are not looking forward to globally synchronized growth, they appear to be preparing for the consequences of a worldwide “L” economy.
They would know better than anyone else the reasons for it.
Where Brazil reported to the IMF in April 2013 some $378 billion in forex reserves, China declared almost ten times that amount, nearly $3.6 trillion. They would rise to more than $4 trillion in June 2014 before the fall.
Unlike Brazil, the Chinese actually mobilized a massive proportion of their stockpile. Or, more specifically, they outright sold the assets whereas Banco do Brasil engaged mostly in swap manipulations surrounding its local dollar interest rate, the cupom cambial. At the lowest point last January China’s holdings had dropped a truly staggering amount, by almost $1 trillion.
While they were “selling” their “UST’s”, the Chinese currency undertook devastating “devaluation.” It wasn’t nearly as bad as real or rubles, but it was more than sufficient to knock China’s economy down from mid-level growth and a plausible pathway back toward pre-crisis economic conditions to low-level growth (that isn’t growth) and a quasi-official adoption of now an “L” rather than “V”-shaped forward baseline.
That’s Argentina’s problem in a nutshell. And Brazil’s. And Russia, Europe, and the United States’.
Last Friday, Stanford University’s Hoover Institution hosted a conference trying to make sense of all this (thanks T. Tatteo). As stated in the background information for the gathering:
“Two related issues pervade discussions of monetary policy at individual central banks and reform of the international monetary and financial system: (1) The volatility of capital flows and exchange rates, and (2) The use of balance sheet policy by central banks. The key issues are whether capital flow management is appropriate to deal with volatility and whether the central bank balance sheet should be reduced to a level where interest rates are market-determined.”
The two are actually linked in a way that Economists forbid themselves from ever seeing. And even if they did appreciate it, their doctrinaire instincts would push them further in the wrong direction.
In other words, the issue with “dollars” is first that policymakers don’t have any idea what’s going on. They cling to the outdated notion that a currency applies only to its geographic region of origin. There is no offshore mass in the orthodox canon, even though one exists in plain sight. Volatile currencies are shadows on the wall of the cave.
One of the papers presented was ironically titled Rules of the Monetary Game. Authors Prachi Mishra of the IMF and Reserve Bank of India and Raghuram Rajan of the University of Chicago attempted to clarify what they determine as an issue of “spillovers.” Not once are the terms eurodollar or even offshore used.
“Given the undoubted importance of cross-border trade and capital flows, and the disruptions created by financial market volatility, it does seem an important issue to discuss. Nevertheless, with economic analysis of these issues at an early stage, it is unlikely we will get strong policy prescriptions soon, let alone international agreement on them, especially given that a number of country authorities like central banks have explicit domestic mandates.”
It does seem an important issue to discuss, doesn’t it? The paper might better have been labeled, We Don’t Really Know the Rules of the Monetary Game, And We’re Not Sure We Really Want To. Eleven years after the global offshore eurodollar system broke, “economic analysis of these issues” is “at an early stage.” What has the world done to deserve so much blatant and inflexible incompetence? In short, Economists are about fifty years behind the times – and even now, they still think in terms of closed systems and current monetary policy.
The bigger problem for them will be in still classifying central banks as central. These formerly monetary institutions have expanded their balance sheets in near constant fashion (there is almost always one major central bank doing so at any given time, often several) since 2008. Economists have called this “stimulus.” Markets sometimes believed them.
Thus, the crosscurrent of moneyless monetary policy, “cross-border trade and capital”, and global economy is in how participants view what central banks have done. Unlike the academic treatment, or even what’s reported in the mainstream media, there is little enthusiasm for it (collapsing curves at absurdly low nominal levels). What remains is instead far more of a harsh assessment running against them (Argentina’s 100-year bond at only 7%?)
Economists still believe that they’ve done a reasonably good job by being courageous (Bernanke’s word) particularly with LSAP’s. Uncle He or Brazil’s economy may have been somewhat inclined to believe it, but only up until 2013 or 2014. The deflationary years since have thoroughly disabused these notions in practice, which is why Stanford’s John Taylor is organizing a conference in May 2018 for those like him to commiserate for why the world seems so impenetrably miserable.
We are living with the consequences of the eurodollar “L.” Only it isn’t a single “L”, rather it has been several strung out over more than a decade. That’s what faces now Argentina, Brazil, China, etc., right on through into the developed world (Europe’s so-called boom took a big pause in Q1). They not only have to deal with the consequences of the last one, markets are starting to get the sense unlike mainstream rhetoric perhaps it wasn’t the final iteration after all. The eurodollar ratchet can, in fact, tighten the noose further.
For Mr. Caputo, it’s no comfort that it isn’t Argentina’s fault. Regardless, they are negotiating with the IMF for an emergency credit line and for what it’s worth the 100-year bond trades at around 85 cents on the dollar despite more than 99 years left until maturity. I’d make some dumb crack about Madonna’s 1996 performance in the movie Evita, but this is pure tragedy. Again. At this rate, Economists just might figure it out before the next meteor strike.