edit: a bunch of my images aren't working but I don't have it in me to fix them now. Maybe later. Sorry :/
I know there are a few people here interested in finance, economics, and foreign policy so I just figured I'd point out two things I found interested this past week.
First, the most recent FOMC press conference following the Fed's June meeting (which currently can be viewed here, transcript here). Something to note is that the Fed agonizes over the phrasing of these statements and spends a great deal of time debating exactly what to say down to the very. last. word.
From my knowledge of the process, I'd say that they spend almost as much time deciding exactly what to say about policy as they do in deciding where policy should actually go. What I heard that stood out:
This is a good segue into "what" the Fed is actually looking at and why the Fed has suddenly pivoted. As Powell mentioned in the press conference, the "fundamentals" for the U.S. economy are still solid. Consumption is solid, employment is solid (referenced recent poor jobs number but also referenced job creation running ahead of workforce entry), inflation is soft, and investment and business sentiment are both a bit weak. That said, the Jay Powell and FOMC of a year ago would have looked at this data and probably kept on tightening. What changed?
There's a global dollar funding crisis brewing (if it isn't already here).
What a lot of people don't realize about global trade is that an enormous portion of it (~80%) is either settled in USD or is hedged in USD (that is to say settled in Euros but the Euros are hedged in Dollars). For example, let's say that Australia wants to buy bauxite from New Zealand and New Zealand wants to buy wheat from Australia. How do you think this trade is settled? Barter? No. Settle in the Kiwi? Lol, no. Settle in the AUD? Nope. Both parties agree to settle the trade in U.S. Dollars because:
Well, one could look at the quantity theory of money and say "MV=PY, therefore the the velocity of those dollars must increase". However there's a logistical problem with increasing velocity and banks outside of the U.S. don't have the power to actually create new dollars. In times of financial stress, velocity drops as people want to hold cash. So we're to simply supply/demand: supply is fixed (or falling in a crisis) and demand is rising with global growth. Anyone with a brain will realize this results in a stronger dollar.
So you have a rising USD even though many currencies are undervalued relative to the dollar on a PPP basis (this is the best graphic I have available to me at the moment).
Anyone who thinks that the USD is going to be replaced by another currency in international trade any time soon is dreaming. I could write an entire post about that. So we're stuck with the USD and there's a distinct chance that, going forward, fewer dollars make it out into the global system, not more. This is a direct result of the White House's policy (though said policy is like throwing fuel on a fire) but a result of more fundamental force: domestic oil production. The U.S. is already a net exporter of refined fuels and, if current trends hold, the U.S. will be a consistent net-exporter of oil sometime around 2021. A side note for those who research as much: oil production has one definition for the EIA and oil consumption has another. Because of the technicalities of refining, you have to sum oil production and natural gas liquids production to get a true, functional picture of U.S. petroleum production. Once the U.S. becomes a steady net-exporter of oil and other refined petroleum products it will become a mechanism to bring USD back in to the U.S. financial system rather than sending them out to the global financial system.
So why does the Fed care about the rest of the world? Well, they actually don't. As far as the Fed is concerned, the world can burn so long as it doesn't affect the U.S. economy. Let me explain that. Individual members of the Fed might care about the wellbeing of the world, but, as an institution the Fed is very politically aware and risk adverse. The Fed sees nationalist undertones rising in the U.S. and they're going to do whatever they can to be politically neutral. The one time the Fed violated this policy was when it single-handedly bailed out Europe back in 2008 with FX swaps but, luckily, the world was burning and most politicians are idiots.
So, again, why does the Fed care about "global" financial developments? Why does the Fed care about the Eurodollar market? Powell told us near the end of the press conference when a reporter asked him about risks to the U.S. banking system with regards to "leveraged loans" and "corporate credit." Powell basically said (paraphrasing) "those factors don't pose a risk to U.S. banks. U.S. banks are extremely well capitalized and the banks aren't carrying those risks. Those risks are being carried by non-bank lenders."
If global trade were to seize up because of dollar funding issues, the transmission mechanisms for that to affect the U.S. are surprisingly few. Except for one: the U.S. "shadow banking" sector aka "non-bank lenders." That's where you'll see the next financial crisis manifest in the U.S. and, if you were listening carefully, Powell told you as much. So why care about the eurodollar market? Well, eurodollar market funding conditions are one of the best proxies for funding conditions for U.S. non-bank lenders. In other words, if dollar funding conditions get bad enough outside of the U.S, it could affect U.S. non-bank lenders (after all, would you rather underwrite a USD denominated, asset backed trade deal between Siemens and an Australian utility company or lend money to XYZ funding which will buy U.S. junk bonds?) and thus affect corporate borrowing (and on and on).
This went on a lot longer than I thought and I'm getting tired of typing so I'll cut it off here.
The second point I was going to bring up was Lighthizer's testimony before the Senate Finance Committee last week.
https://www.youtube.com/watch?v=lqIomb4_7VU
I watched Lighthizer's testimony in its entirety and... man... that might have been the most professional, non-partisan hearing I've seen on Capital Hill in a long time. The most "combative" exchange was between Stabenow with regards to how a trade deal might affect the ability of the U.S. to regulate its own healthcare industry. I'd say that the exchange ended up being quite professional and the resolution was amiable and constructive with Lighthizer saying (nearly verbatim) "I agree, Senator, that's an issue to be concerned and I agree that our trade agreements should not affect your ability to set domestic policy and address domestic issues. Since we are time constrained here, I suggest that we set up a meeting and talk about it and that we review any trade deal before it is made to make sure that it wouldn't impact your ability to set domestic policy." Stabenow took this response well. In general, members of the committee basically all said the same things regardless of party alignment "we appreciate your work and we hope you continue to do whatever you can to protect U.S. intellectual property and domestic jobs... oh but my consitutents need the items on list X to be exempt for just a little bit longer while they find domestic replacements."
This might sound absurd but I think there's a distinct possibility that if Trump loses in 2020 that Lighthizer will keep his job based on how well he was received by members of both parties.
I know there are a few people here interested in finance, economics, and foreign policy so I just figured I'd point out two things I found interested this past week.
First, the most recent FOMC press conference following the Fed's June meeting (which currently can be viewed here, transcript here). Something to note is that the Fed agonizes over the phrasing of these statements and spends a great deal of time debating exactly what to say down to the very. last. word.
From my knowledge of the process, I'd say that they spend almost as much time deciding exactly what to say about policy as they do in deciding where policy should actually go. What I heard that stood out:
- Inflation ("subdued" "falling" "below target")
- Global financial conditions ("deteriorating" "concern")
- Repeated references to responding to "trends" and not just data points
- When asked by a reporter from the WSJ if the Fed had considered raising rates, Powell replied that eight members made a case for cutting rates. Translation: hikes are completely off the table, cuts are almost certainly coming.
- Powell's reaction to the question from the NYT reporter about "acting too fast vs waiting too long" seemed to indicate to me that if the trends in place continue to hold (low inflation, low investment, declining business sentiment) that the Fed will cut rates. Translation: if the outlook deteriorates considerably we could see a cut next month. If the status quo holds we might not see a cut until September.
- Don't recall the reporter, but Powell responded to one question by saying that "multitude of factors" had caused FOMC members to make the case for a rate cut. I'll discuss this after the bullet points.
- Responding to Mckee from Bloomberg, Powell basically said that the Fed would respond to "anything" that "threatened the success" of the Fed fulfilling its dual mandate. Translation: if we see a setback in financial markets or economic data, the Fed will respond regardless of the cause.
- Responding to a question regarding shifting the Fed's inflation target to 4%, Powell responded by saying it's "not practical". Translation: hard enough to hit 2% inflation, don't count on seeing inflation run significantly above 2%. 4% would require absurd policy accommodation and might not be achievable.
This is a good segue into "what" the Fed is actually looking at and why the Fed has suddenly pivoted. As Powell mentioned in the press conference, the "fundamentals" for the U.S. economy are still solid. Consumption is solid, employment is solid (referenced recent poor jobs number but also referenced job creation running ahead of workforce entry), inflation is soft, and investment and business sentiment are both a bit weak. That said, the Jay Powell and FOMC of a year ago would have looked at this data and probably kept on tightening. What changed?
There's a global dollar funding crisis brewing (if it isn't already here).
What a lot of people don't realize about global trade is that an enormous portion of it (~80%) is either settled in USD or is hedged in USD (that is to say settled in Euros but the Euros are hedged in Dollars). For example, let's say that Australia wants to buy bauxite from New Zealand and New Zealand wants to buy wheat from Australia. How do you think this trade is settled? Barter? No. Settle in the Kiwi? Lol, no. Settle in the AUD? Nope. Both parties agree to settle the trade in U.S. Dollars because:
- the price of most commodities, historically, is more stable in USD than virtually all other currencies
- USD denominated capital and FX markets are just so much deeper and more liquid than markets denominated in other currencies and, importantly...
- if either party wants to buy something else from someone else in the world, the USD is far more likely to be a useful currency than, say, the Kiwi or the AUD.
Well, one could look at the quantity theory of money and say "MV=PY, therefore the the velocity of those dollars must increase". However there's a logistical problem with increasing velocity and banks outside of the U.S. don't have the power to actually create new dollars. In times of financial stress, velocity drops as people want to hold cash. So we're to simply supply/demand: supply is fixed (or falling in a crisis) and demand is rising with global growth. Anyone with a brain will realize this results in a stronger dollar.
So you have a rising USD even though many currencies are undervalued relative to the dollar on a PPP basis (this is the best graphic I have available to me at the moment).
Anyone who thinks that the USD is going to be replaced by another currency in international trade any time soon is dreaming. I could write an entire post about that. So we're stuck with the USD and there's a distinct chance that, going forward, fewer dollars make it out into the global system, not more. This is a direct result of the White House's policy (though said policy is like throwing fuel on a fire) but a result of more fundamental force: domestic oil production. The U.S. is already a net exporter of refined fuels and, if current trends hold, the U.S. will be a consistent net-exporter of oil sometime around 2021. A side note for those who research as much: oil production has one definition for the EIA and oil consumption has another. Because of the technicalities of refining, you have to sum oil production and natural gas liquids production to get a true, functional picture of U.S. petroleum production. Once the U.S. becomes a steady net-exporter of oil and other refined petroleum products it will become a mechanism to bring USD back in to the U.S. financial system rather than sending them out to the global financial system.
So why does the Fed care about the rest of the world? Well, they actually don't. As far as the Fed is concerned, the world can burn so long as it doesn't affect the U.S. economy. Let me explain that. Individual members of the Fed might care about the wellbeing of the world, but, as an institution the Fed is very politically aware and risk adverse. The Fed sees nationalist undertones rising in the U.S. and they're going to do whatever they can to be politically neutral. The one time the Fed violated this policy was when it single-handedly bailed out Europe back in 2008 with FX swaps but, luckily, the world was burning and most politicians are idiots.
So, again, why does the Fed care about "global" financial developments? Why does the Fed care about the Eurodollar market? Powell told us near the end of the press conference when a reporter asked him about risks to the U.S. banking system with regards to "leveraged loans" and "corporate credit." Powell basically said (paraphrasing) "those factors don't pose a risk to U.S. banks. U.S. banks are extremely well capitalized and the banks aren't carrying those risks. Those risks are being carried by non-bank lenders."
If global trade were to seize up because of dollar funding issues, the transmission mechanisms for that to affect the U.S. are surprisingly few. Except for one: the U.S. "shadow banking" sector aka "non-bank lenders." That's where you'll see the next financial crisis manifest in the U.S. and, if you were listening carefully, Powell told you as much. So why care about the eurodollar market? Well, eurodollar market funding conditions are one of the best proxies for funding conditions for U.S. non-bank lenders. In other words, if dollar funding conditions get bad enough outside of the U.S, it could affect U.S. non-bank lenders (after all, would you rather underwrite a USD denominated, asset backed trade deal between Siemens and an Australian utility company or lend money to XYZ funding which will buy U.S. junk bonds?) and thus affect corporate borrowing (and on and on).
This went on a lot longer than I thought and I'm getting tired of typing so I'll cut it off here.
The second point I was going to bring up was Lighthizer's testimony before the Senate Finance Committee last week.
https://www.youtube.com/watch?v=lqIomb4_7VU
I watched Lighthizer's testimony in its entirety and... man... that might have been the most professional, non-partisan hearing I've seen on Capital Hill in a long time. The most "combative" exchange was between Stabenow with regards to how a trade deal might affect the ability of the U.S. to regulate its own healthcare industry. I'd say that the exchange ended up being quite professional and the resolution was amiable and constructive with Lighthizer saying (nearly verbatim) "I agree, Senator, that's an issue to be concerned and I agree that our trade agreements should not affect your ability to set domestic policy and address domestic issues. Since we are time constrained here, I suggest that we set up a meeting and talk about it and that we review any trade deal before it is made to make sure that it wouldn't impact your ability to set domestic policy." Stabenow took this response well. In general, members of the committee basically all said the same things regardless of party alignment "we appreciate your work and we hope you continue to do whatever you can to protect U.S. intellectual property and domestic jobs... oh but my consitutents need the items on list X to be exempt for just a little bit longer while they find domestic replacements."
This might sound absurd but I think there's a distinct possibility that if Trump loses in 2020 that Lighthizer will keep his job based on how well he was received by members of both parties.
Last edited by:
GreenPlease: Jun 23, 19 16:32