So much of social science is dependent on various actors making rational decisions. Economics has regularly proven that “actors” certainly fail to act rationally as manias, crashes and panics in repeated form are proof (see Charles Kindleberger). In the realm of politics, the dependence on nation-states to behave rationally has led to many major policy errors. During the Cold War the balance of nuclear weapons prompted both super powers to remain reticent to embark on direct confrontations and avoid an unthinkable shooting war. The fear of world destruction also meant that the USSR and UNITED STATES would leash their “allies” to prevent any direct conflict between the two major hegemonists.
I bring this into the discussion because the Internet was filled with many articles suggesting that Erdogan would ultimately cave into the demands of the developed world and instill policies of raising interest rates, curtailing government spending and allowing the IMF to lead a bailout plan. However, the last few years of President Erdogan’s reign should dispel any notion of the Turkish president acting rationally. We just don’t know what Erdogan wants but I will offer this: If the Turkish president fails to allow an increase in interest rates while spurning IMF involvement, look to a heightened possibility of the Turks imposing FOREIGN EXCHANGE controls.
I am not a fan of IMF programs but an aid proposal would buy time for Turkey to work out some of its serious problems. The IMF typically proposes fiscal austerity coupled with interest rate hikes in order to stem the outflows of needed foreign reserves, two proposals that Erdogan has labeled as non-starters. The world believes Erdogan is a rational actor but what is it that Erdogan so desperately desires Trump continues to bait the Turkish President with the calls for release of the U.S. pastor.
Let’s hope that each of these actors has some desired rational outcome they are trying to pursue. Watch Erdogan’s response to potential IMF bailout programs, but if the policy is foreign exchange controls in invoked the volatility in global financial markets will increase dramatically. Oh, this is difficult in the realm of 2+2=5.
***Key news item over the weekend from the Financial Times: “Beijing Orders Banks to Boost Lending to Exporters.” The opening paragraph of the story is a great summation of the thinking from the Chinese leaders:
“China’s banking regulator has ordered banks to boost lending to infrastructure projects and exporters as the government seeks to bolster economic confidence on the eve of a new round of trade negotiations with the U.S.”
This is an important statement as it reflects that President Xi is concerned about the impact from increased tensions over trade and the potential damage to the Chinese economy. Chinese companies with dollar liabilities coupled with a weakened YUAN increases the cost of funding debt denominated in greenbacks.
Watch the copper market and other commodities for market sentiment in regards to the top-down directions from the Chinese authorities. Global equity markets should also respond positively as anything that tends to lessen tensions between the two economic powerhouses is deemed a positive.
***This weekend brought news of a meeting between German Chancellor Merkel and Russian President Putin. What was ostensibly discussed was Syria and the Ukraine, as well German concerns over the Nordstream 2 pipeline that avoids the Ukraine as a transit point for Russian energy exports to Europe. This meeting reveals the importance of Putin as a keystone in resolving several of the world’s flashpoints.
The problem for Merkel and the Europeans is that the more credibility they give to Putin the more they elevate President Trump’s stance at the G-7 in suggesting that Russia be brought back into the group. It is difficult to criticize the Trump administration for seeking improved relations with Russia when the Europeans, and even the Japanese,keep meeting with the Russian leader. Before the Merkel meeting, Putin was in Austria attending the wedding of Austrian foreign minister Karin Kneissl.
There is far more intrigue in the world than the rational actor models would lead us to believe. The increased meetings with the Russian leader certainly raises questions about what Putin is striving to achieve. Now about those sanctions and their impact on the Russian economy…
Tags: China, Erdogan, foreign exchange controls, IMF, Merkel, Putin, Russia, trade war, Turkey, Yuan
August 19, 2018 at 7:04 pm |
Irrational actor? What if Erdogan wants de-dollarization if Turkish economy?
There is nothing irrational about that. Russia has largely done it, isn’t dollar denominated debt forbidden in certain Russian loans. So before someone is labeled ‘irrational’ it’s best to examine self recognition failures.
August 19, 2018 at 8:01 pm |
Comodus–you make a very good point but with the huge amount of dollar exposure it would be a difficult time to de -dollarize as it would totally collapse the Turkish economy.But my calling Erdogan irrational was a poke at the western establishment who believes it can direct outcomes based on a rational actor model for in their parochial world everyone believes and acts as they believe is in the best interests of the rational actor model
August 19, 2018 at 11:08 pm |
I believe the greatest of economic physicists are already suggesting that Robert Mueller begin an investigation of Karin Kneissl and Frau Merkel for possible Russian collusion. Assume a can opener….
August 20, 2018 at 5:34 am |
Yra, Too early to tell but looks like 8,000 Yuan gold could be the new Maginot LIne
August 20, 2018 at 5:50 am |
Richard—too early to tell indeed but it is an important theme on your part and certainly has history and the 200 week moving average
August 20, 2018 at 7:42 am |
The IMF is a believer in Bagehot’s patent medicine of the lender of last resort. They have to be. To admit that national defaults cannot be solved by international cooperation is to commit the ultimate heresy against Keynes’ 1919 wisdom. It is absolute heresy.
Turkey’s present situation is what happens when debtors can no longer gain from trade or borrow from others the currency that their current lenders want to be paid in. Neither the gold standard with immediate retail redemption nor the pseudo-gold standard of the central banks nor the expertise of the gloabl financial mind can save companies or countries from going bust when they are (pick one or more) stupid, unlucky or stubborn.
Turkey’s only solution is the one that Chapter 11 offers domestic creditors: instead of cash, the creditors get majority or complete title to whatever assets remain. Turkey cannot sell shares in itself but it can offer Treasury debt payable in lira with covenants that commit the country to waiving all exchange controls and other restrictions on open securities and currency trading.
When Britain defaulted in 1931, this is precisely what Mellon told Coolidge to do for the U.S. – continue open exchange of the dollar and redemption of gold and let the bankruptcy laws work.
Being a modern man with a proper formal education, Stanford’s only President knew better: international authorities had to take control of the chaos. As always, with academically-based political economy, the operation was a success; it was entirely the markets’ fault that millions of patients died.
August 20, 2018 at 12:13 pm |
Stefan—in the analysis of Minsky.It is hedge risk,speculative risk or the final is of course Ponzi.Where is Turkey on the Minsky spectrum
August 20, 2018 at 8:09 am |
Of note Jeffery Gundlach… record positions short treasury futures and long dollar futures…
https://www.cnbc.com/2018/08/20/gundlach-warns-record-bond-market-speculation-could-cause-big-move-in-interest-rates.html
August 21, 2018 at 6:10 am |
“What is Putin trying to achieve?” According to Dr Pippa Malgrem, in her book Signals. Putin figures since the US is exporting inflation, we’ll just take or aquire assets. Such Crimea, Syria. China is taking shipping lanes.
How will Turkey be divided up if there’s a collapse?
August 21, 2018 at 7:23 am |
Pierre–as I continue to state–Putin wants out of the sanctions in order to develop with China and others a way out of the control of the SWIFT mechanism and its choke hold on the global financial system.Sanctions have only a modicum of effect because of SWIFT.Putin has a very strong negotiating position because of Russian influence in the Mideast–that is my opinion past,present and future
August 21, 2018 at 7:02 am |
Yra: My persistent nostalgia for the system of foreign exchange that existed before 1914 is based in large part on its being a different kind of Minsky world. All of the known and unknown risks – Ponzi schemes, head cashiers with their heavy suitcases on board taking steamers to distant lands, palace revolts – were priced by the private bankers and money brokers. Local currency’s reliability of redemption also entered into the question; but the final exchange into Money – i.e. bullion and coin – was not even considered. Gold itself was only the what the Italian and Jewish money brokers of the early 15th century called “book money”. It was the unit of account into which the brokers discounted all their questions, and they did so independent of national Treasuries and central banks. Their only concern with the Bank of England was how well it regulated domestic counter-parties in the same way the Fed inspects its member banks.
Instead of reducing all paper by a single relative FX price (lira vs. dollar), foreign credit issues were assayed individually.
There was a persistent fallacy in the reformist tradition that took control during the Great War and that governs our thinking to this day. It was the belief interconnecting national currencies and reserves would make “the system” stronger. By now, it should be clear – even to the professors with tenure – that “the sytem” is now far more fragile. In the good old days of the golden fetters, Turkey’s troubles would have been cleared bond issue by bond issue even as current trade continued and was priced transaction by transaction.
When Minsky claimed that markets were inherently fragile, we made the correct diagnosis; but he was looking at the wrong patient’s chart. He was doing what almost all all present earth scientists have done – subscribing to the belief that nature itself is inherently vulnerable. What biologists have learned is that markets are a fundamental mechanism of nature and that they are, like nature itself, robustly adaptable in their evolution.
What Minsky “discovered” was the fragility that always comes with the religious belief that human beings need a permanent, unchanging hierarchy of authority to save them from the persistent yet orderly chaos of their individual lives. The inherent instability that he found is what the auguries and the Oracles inject, not what is there in the changes of open commerce.
August 21, 2018 at 7:26 am |
Stefan–having read copious amount from Braudel,Arrighi and Wallerstein I have great respect for your views on the pre-War economic system.As Arrighi points out –look to the dutch to understand much about the modern world system.The effort here is to take knowledge and put it into profitable investments—PRAXIS
August 21, 2018 at 8:03 am
No problem. Be Long in Treasuries that mature in the first quarter of next year and avoid everything else.
August 21, 2018 at 8:20 am |
That valueless free advice is for the people who play in the major leagues; for those of us who indulge in retail gambling, covered call writing in the October contracts for your favorite American companies (my list: ADBE, LSTR, NVDA, TXN, VRTX).
FWVLIW, none of your authors would have agree with what I just wrote. They were all committed believers in “world history”. Knowing what people actually did matters because it offers us the wisdom of hindsight; we can see where people’s theories and predictions went wrong. But, thinking we can use history as the fulcrum for our Archimedes levering of space-time is a faith I no longer share. On that question I am afraid I agree with Henry Ford (great salesman, lousy mechanic, awful anti-Semite and father): “The uses of history (to predict the future) are bunk.”
August 21, 2018 at 9:49 am |
Or, to put it more precisely and politely, in Shannon speak, “information is stochastic, not deterministic”.
August 21, 2018 at 12:40 pm |
Anyone notice the dollar collapsed 300+ pips in just over 4 business days against Euro and some others? After key levels held in eur, xau, cny, dxy, almost everything except try.
One might blame Trump’s attack on JP but the dollar bear market rally had already ended beforehand. DXY at its best was still 700 pips below its level of twenty months ago. The “strong dollar” narrative is now obviously false on the charts as USD bullish invalidation technical levels have fallen like flies. USD weakness will be the norm for months, which should be supportive for US stocks in nominal terms. Even gold should rally.
The dollar bear could gather pace as foreigners pull out of dollar based investments considering the tumbling USD. Plus US elections on the horizon and its prospect of an electoral lurch to the far left and empowering those whose agenda is to impeach the US president (a market stmt, not political). Not rosy fundamentals for the buck.
How will the Treasury fund the soaring US deficit as foreign investors shun the dollar? Particularly if US interest rates are held down as Mr Trump wants? US rates need to go higher quickly, to stem large capital outflows the US is experiencing this week like it was before February and like China was earlier this summer. Else the dollar tumbles. I’ll bet on dollar weakness. Sell dollar rallies IMHO.
August 21, 2018 at 1:04 pm |
Is it Rational if Powell acquiesces to Trump’s demands on interest rates in order to not get fired by a sometimes visibly less-than-Rational Trump?
August 21, 2018 at 5:06 pm |
David–I don’t believe the president can fire him/her unless???I don’t know but it makes Trump appear as an ineffectual[yet again] as he seems to have chosen his FED pick without any forward thought–he passed on larry Lindsey or some others he was told he couldn’t control—poor leadership and now he has to absorb it
August 23, 2018 at 9:26 am |
Now for the peanut gallery’s point of view. What we are seeing is the outcome of all and any QE. I fall into to the camp that history is not bunk but rather that it rhymes. Why one thought our fate and those of others that followed the yellow brick road of financial repression and NIRP would be different than Japan’s is beyond me The Fed stuck its legs into the tar pit of QE and now 4 trillion dollars later hasn’t been able to inflate either out. What happened to all that capital: stock buybacks (most of which will be destroyed in the next bear market), bad risk loans(read student loans), social investment(read Solyndra). So we have two interest rates- the 2 year which is a proxy for FED and the 10 year still some what market driven. Which is correct? Since I have always been told the bond guys are the smartest, I go with the 10 year. In theory I guess QE should lead to inflation but in practice that just doesn’t seem to happen perhaps because much of the capital created is destroyed. Either way it likely will lead to ruin. I agree with Stefan- to paraphrase Former President Obama: Cling to your short term treasuries, gold, religion and guns. As far as Russia, Putin is the poster boy for tyranny (watch the documentary Icarus on Netflix and/or read Bill Browder’s The Red Notice). He gives not one wit for Russia or its people only his own self interest. To successfully trade on RSX or the ruble one must align one’s interests with those of Putin- not my cup of tea.
August 23, 2018 at 10:35 am |
Thx, Bigman. What Ford said was that “the uses” of history were bunk. He did not say and did not think that the facts of history were; no one who put as much time and attention and money into Greenfield Village – a gem more than equal to Rockefeller’s Williamsburg – could be an atheist or even an agnostic about the value of knowing what happened in the past.
https://www.thehenryford.org/visit/greenfield-village/
Where Ford disagreed fundamentally with our host and almost all academics was in the question of whether or not the data about the human past could be treated as scientific discoveries that could be described accurately in a theory that would predict the future.
He was right, of course. That is what makes the man so maddening.
His greatest competitor agreed with him. Alfred Sloane thought General Motors could predict its next quarters’ sales based on what the last quarter’s service demands were. That is why he arrived unannounced and spent time in his dealers’ parts departments. But he never believed that the fluctuations of business and credit were any more predictive than waves are. They only give you a picture of the sea state; and, as the prayer goes, the ocean is so large and even the largest enterprise is so comparatively small.
As for QE, I am afraid I end my visits to Yraland where I started – with Chicago’s best economist – the baseball player. Fama’s point, that Mr. Santelli was and still is – alas – unable or unwilling to accept was this: in a system where the central bank’s IOUs are the legal tender, the Fed’s buying Treasury bonds directly has no greater effect on the sum of credit in the U.S. and, indeed, the world economy than its using the same “buying power” to reduce overnight rates to the point where the primary dealers can hold their inventory at no cost.
President Trump knows that he does not need to lecture the Fed about interest rates because Volcker’s Jolly Green Giant checkbook was taken away by the Emergency Economic Stabilization Act of 2008. The Fed itself no longer gets its money for free. If it wants to keep short-term rates “low” by buying the near maturities, it has to “pay” for those purchases by adding to the member bank’s own excess reserves, on which it will be paying interest. For the public debt the discount rate is now, as Fama pointed out, part of a fundamental equilibrium. Wherever the Fed squeezes the Treasury debt balloon by reducing its own supply of credit, it shifts the volume elsewhere; it does not pop the bubble. If it “ends” QE by not buying more and more Treasuries but actually letting some of them mature and be “paid”, it pulls that money from the member bank/dealer’s excess reserves. That would seem to be Powell’s intention: to give the primary dealers the choice of where in the curve they want to find their own spreads.
That is why “the curve” no longer matters.
P.S. The importance of the discount rate – like Libor – only matters when private lenders are BUYING reserves in order to fund their lending and the rates are pegged to the “official” rate. The private economy of enterprises no longer needs or wants the banks as their lenders because they can sell straight rates to the bond market and let the smartest guys in the room do the hedging for them.
August 24, 2018 at 11:29 am |
Thx Stefan due to my amateur status I have read your reply several times but am confused. Are you saying that the shorter term treasury rates are indepedent of the discount rate and determined by the primary dealers alone? Could say the 3 month treasury rate then fall below the discount rate? Seems to me the discount rates is a floor that the Fed is now raising. Help
August 24, 2018 at 12:17 pm |
bigman:
Mea culpa. I used the term discount rate when I should have written Fed Fund’s rate. The Official Discount Rate gets the headlines because it is an explicit signal that the Fed has the statutory authority to set (there are, as you know, 3 Discount Rates: the main one, 1 for distressed banks and 1 for the country banks). But, since no one who is solvent ever borrows reserves from the Fed but borrows them from another bank, the Fed Fund’s rate is what matters. That is why Yra and others read the Minutes – to decode from the economist tea leaves what the Fed’s intentions are for manipulating the Fed Fund’s rate through open market operations. Even the Fed concedes that they cannot “control” the Fed Funds rate in any way that would allow them to profit from direct speculation in the futures/options markets for money; they set a target that has at least a 1/4 point range.
To answer your question directly: Can 1 year-Treasury rates fall below the Fed Funds rate? Yes. That is why happened throughout most of the period from 1875 (restoration of the full gold standard in the U.S.) to World War 1. For those 40 years the interest curve was inverted. Banker’s call loan rates – what is now the Fed Fund’s rate – were regularly higher than the interest on even 1 year Treasury Notes. Call loans were priced higher because the risk was greater; the loans were unsecured and a borrower might be about to blow up because his portfolio was permanently under water. That risk has been removed from the system by the Federal Reserve’s being the lender of last resort. But, another risk has been put in its place – the risk of foreign exchange. The buyers of 1 year Treasury Notes might be and probably are the timid savers who have welcomed a chance to receive at least 2% on their money – which remains a great deal more than what is being offered on 1-year bank CDs. (Current national average: 0.72 APY.) Those timid savers are not ever going to be supplying funds to the Fed Funds market. But, what if enough banks subject to reserve requirements, which includes the U.S. branches of foreign banks, suddenly find themselves needing to shift balances overseas? What Yra and others want to define as a warning sign of a slowing U.S. economy would, in fact, be a shrinkage in the overnight supply of reserves caused by a need for dollars abroad.
For the U.S. economy “the curve” no longer matters because (1) U.S. businesses do not depend on floating bank loans for capital, (2) mortgage loans are set off of floating rates, but there is absolutely no empirical evidence that mortgage rates alone govern the supply and demand for housing finance, (3) the Treasury’s need to borrow money is off-set by the Fed’s need to pay it out to its own reserve depositors. That is Fama’s point: since 2008 when Treasuries are bought by the Fed, they no longer use “free money”. They have to pay the same overnight rates on the additions their purchases make to the primary dealers’ accounts.
This time “it” is different because the old “it” – like the horse and buggy that Ford and Sloane’s autos replaced – is no longer the way things (in this case, money) move around.
All the best.
P.S. I am probably more of an amateur than you. I manage a family firm’s money; but I have never once sat at a trader’s desk or even set foot as a visitor on a trading floor. Unlike Larry Williams whose work is worth reading and whose handle his “I Love to Trade”, I have always been the person who has neither the nerve nor the skill to hold a open one-way position. I avoid being the sucker at the table by never, ever even watching the daily card play.