The Influence of Foreign Investors - Aussie Stock Forums

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  1. #1

    Default The Influence of Foreign Investors

    At the start of 2003, foreign investors held 33% of the ASX market capitalisation.

    The hedge funds and "international hot money" became aware of the value buying in Australia and started buying big. This group started the bull market run from the trough of the current cycle.

    By the end of 2004, foreign investors held 40% of the now increased market capitalisation of the ASX.

    Hedge funds have extracted over $200 million of capital gains from the WMR (WMC) takeover play. This is at the expense of local investors.

    Hedge funds sold some ASX shares in March 2005 and started the decline in the market.

    What am I getting at?

    Never underestimate the power of this group to move market pricing. I try to keep track of their movements as best as I can.

    Currently, there are around 10,000 hedge funds (around 7,000 are American) across the world with assets estimated at around USD 1 trillion. They operate on huge leverage with the attendant financial risks. I forecast that some will collapse over the process of time when the next major dislocation in global financial markets occur.

    Hedge funds thrive on volatility and exploit market mispricings or arbitrage.

    Anyone wanting to know what happened when the most famous hedge fund in the world's history collapsed in 1998, can type in Long Term Capital Management (LTCM) on Google and read about the debacle. The Masters of the Universe that crashed down to earth. Alan Greenspan had to engineer a "cushion" to prevent contagion.

  2. #2

    Default Re: The Influence of Foreign Investors

    Quote Originally Posted by Investor
    Anyone wanting to know what happened when the most famous hedge fund in the world's history collapsed in 1998, can type in Long Term Capital Management (LTCM) on Google and read about the debacle. The Masters of the Universe that crashed down to earth. Alan Greenspan had to engineer a "cushion" to prevent contagion.
    I've actually read the book about it all 'how genius failed - rise and fall of LCTM'

    It is an amazing story, they had the nobel prize winners for finance/economics and when it can down to it all - they failed in one of the most simple aspects of trading..... money/capital management.

    They actually distributed I think $1 billion in profits to equity holders, only to become insolvent a year later!!!


  3. #3

    Default Re: The Influence of Foreign Investors

    Quote Originally Posted by Investor
    At the start of 2003, foreign investors held 33% of the ASX market capitalisation.

    The hedge funds and "international hot money" became aware of the value buying in Australia and started buying big. This group started the bull market run from the trough of the current cycle.

    By the end of 2004, foreign investors held 40% of the now increased market capitalisation of the ASX.

    Hedge funds have extracted over $200 million of capital gains from the WMR (WMC) takeover play. This is at the expense of local investors.
    Where were you able to obtain this information from???

    After reading LTCM story you definitly get the feeling that hedge funds are the X factor for the financial markets at the moment. But I was also under the assumption that true hedge funds only dabble in the equities market - because there aren't many true arbitrage opportunities??


  4. #4

    Default Re: The Influence of Foreign Investors

    Quote Originally Posted by TjamesX
    Where were you able to obtain this information from???

    From reading.

    Combination of The Economist (an international economics journal); BRW; The Bulletin; Financial Review.

    Never assume anything about hedge funds. They are opaque in their modus operandi, have limited reporting requirements, do not have capital adequacy requirements and are unregulated.

  5. #5

    Default Re: The Influence of Foreign Investors

    I read the following on the internet this morning. It confirmed my suspicions about the hedge funds selling shares to cover losses on bonds held:

    "In New York last night markets fell on concerns about a fifth consecutive day of oil price rises and worries over US hedge fund exposures to risk The markets decline came as oil reached US$53 per barrel amid concerns about supplies of fuel ahead of an expected rise in demand, while rumours abounded among traders that hedge funds were selling stocks because of trading decisions gone bad this year."

    Some hedge funds also lost some money on the PRK takeover offer for VBA. It remains to be seen how extensive the issue is with some hedge funds going awry. Time will tell.

  6. #6

    Default Re: The Influence of Foreign Investors

    In 1994, John Meriwether, a previous Salomon Brothers bond trader, founded a hedge fund called Long-Term Capital Management. He assembled a team of traders and academics to create a fund that would profit from the combination of the academics' quantitative models and the traders' market judgement and execution capabilities.

    Investors, including many large investment banks, invested $1.3 billion at inception. But four years later, at the end of September 1998, the fund had lost substantial amounts of the investors' equity capital and was teetering on the brink of default.

    To avoid the threat of a systemic crisis in the world financial system, the Federal Reserve orchestrated a $3.5 billion rescue package from leading U.S. investment and commercial banks. In exchange the participants received 90% of LTCM's equity.

    LTCM had Nobel-prize winning economists Myron Scholes and Robert Merton, as well as David Mullins, a former vice-chairman of the Federal Reserve Board who had quit his job to become a partner at LTCM. These credentials convinced 80 founding investors to place the minimum investment of $10 million apiece. Merrill Lynch purchased a significant share to sell to its wealthy clients.

    LTCM's main strategy was to make convergence trades. These trades involved finding securities that were mispriced relative to one another, taking long positions in the cheap ones and short positions in the rich ones. There were four main types of trade:

    - Convergence among U.S., Japan, and European sovereign bonds;
    - Convergence among European sovereign bonds;
    - Convergence between on-the-run and off-the-run U.S. government bonds;
    - Long positions in emerging markets sovereigns, hedged back to dollars.

    Because these differences in values were tiny, the fund needed to take large and highly-leveraged positions in order to make a significant profit. At the beginning of 1998, the fund had equity of $5 billion and had borrowed over $125 billion — a leverage factor of roughly thirty to one. LTCM's partners believed, on the basis of their complex computer models, that the long and short positions were highly correlated and so the net risk was small.

    What LTCM had failed to account for is that a substantial portion of its balance sheet was exposed to a general change in the "price" of liquidity. If liquidity became more valuable its short positions would increase in price relative to its long positions. This was essentially a massive, unhedged exposure to a single risk factor.

    Fast forward to the recent 8 weeks....... I am reading increasing warning signs about Hedge Funds.

    In recent months, the world has seen an increase in the "price" of liquidity.

    To use sensitivity analysis;

    The hedge funds have assets around USD 1 trillion (highest ever).

    A 10% loss of assets would be sizeable and could cause a financial tremor.

    A 20% loss could cause a severe financial dislocation.

    A 30% loss (highly unlikely, I think) could bring a global financial earthquake.

    I cannot estimate the probability of occurrence of each risk level. I do not know whether anyone can???

    I hope the eventual losses (which I think is already occurring in real time, but is yet to be quantified) will be less than 3% of assets.

    I do not know how much more (if any) selling pressure the hedge funds will bring to the local ASX market, as they unwind some of their positions, but I sense that it is still happening.

  7. #7

    Default Re: The Influence of Foreign Investors

    I think (could be wrong) that the wave of selling this morning, is primarily being done by foreign investors.

    The profit downgrade by Wal Mart in America was another warning sign of an economic slowdown.

  8. #8

    Default Re: The Influence of Foreign Investors

    What do you think of the hedge fund rumours (from a few days ago).

    Is it possible that a few hedge funds really have blown up and had to liquidate thier positions on the LME? - and have been pulling out of BHP and RIO over recent weeks.

    Offshore selling could also be coming because of the depreciation of the aussie dollar (and cause more depreciation).

    Also, I assume the wal-mart sales are looking over the last 3-4months, whereas US had strong sales figures last night.

  9. #9

    Default Re: The Influence of Foreign Investors

    Quote Originally Posted by markrmau
    ....Offshore selling could also be coming because of the depreciation of the aussie dollar (and cause more depreciation).
    Yes. I had expected this as well. See the following in the news today:

    "Yesterday, Westpac Bank predicted the local dollar would plunge back below US70 as commodity prices come off highs and foreign investment into Australia slows, according to Westpac Bank.

    Westpac has forecast the local dollar will fall to US72 cents by December 2005 and to US64 cents by December 2006.

    "The Australian dollar looks set for a fall in the second half of this year," said Westpac in a research report.

    "The fundamentals do not improve in 2006 either. In fact, the unfavourable trend accelerates."

    It is logical that some foreign investors would sell. What I could not estimate is how much that selling would be offset by some of the placement of cash by the local fund managers into the ASX. If the former is "bigger" than the latter, clearly, the market would fall.

  10. #10

    Default Re: The Influence of Foreign Investors

    Quote Originally Posted by markrmau
    What do you think of the hedge fund rumours (from a few days ago).

    Is it possible that a few hedge funds really have blown up and had to liquidate thier positions on the LME? - and have been pulling out of BHP and RIO over recent weeks.

    Here are some snapshots from the internet:

    May 13 (Bloomberg) -- All week, there's been a not-so-subtle undercurrent in financial markets of potential hedge fund losses; of popular General Motors trades (long the bonds, short the stock) gone sour, courtesy of Standard & Poor's and Kirk Kerkorian, respectively; of untoward responses in the riskiest tranches of collateralized debt obligations; and even of ``correlation trades'' becoming uncorrelated.

    The Tick, Tick of GM in Hedge Fund Derivatives: Mark Gilbert

    May 13 (Bloomberg) -- The aftershocks from the drop to junk by General Motors Corp. and Ford Motor Co. are rippling through the credit markets, testing the theory that derivatives redistribute rather than exacerbate risk.

    Hedge Fund Losses in April Spark Stock Market Drop

    May 11 (Bloomberg) -- Hedge funds declined 1.75 percent in April, the worst monthly performance since September 2002, according to Hennessee Group LLC, a New York-based consulting firm that tracks industry returns.

    U.S. Stocks Fall on Oil, Hedge Funds;

    May 10 (Bloomberg) -- U.S. stocks fell as oil prices climbed for a fifth day and speculation increased that hedge funds may be taking on too much risk.

  11. #11

    Default Re: The Influence of Foreign Investors

    Interesting point. The ABC had an item on their Sunday morning Business Show about Hedge Funds and their place in the scheme of things. The issues raised were: the apparent ease in setting up a fund, the variety of players in the market and whether or not the hedging is actually driving the market in some dangerous ways (which runs contrary to why you hedge in the first place!). Whilst I'm not into conspiracy theory, given how eratic the domestic market has been and its apparent preoccupation with commodity prices on the back of GM & Ford being downgraded by S & P, I suspect you might be onto something.

  12. #12

    Default Re: The Influence of Foreign Investors

    Fresh from the internet, I bring you today's 'harvest':

    "City hedge funds head for domino collapse

    BAD investments by some of the biggest hedge funds in London have triggered unprecedented losses, record demands for money back and talk of a death spiral weighing heavily on stocks and bonds.

    GLG, a hedge fund started in 1995 by a group of former Goldman Sachs bankers, has in recent weeks had demands for more than $500m (£270m) from investors wanting to pull out of its $4 billion market-neutral fund.

    The predicament of GLG, the biggest group in Europe, with $13 billion under management, highlights the stress being felt at many hedge funds in Europe and America after four months of deteriorating results.

    Prime brokers and the credit departments in investment banks have been calling clients to check their capital strengths as rumours of a big hedge-fund blow-out grip the industry.

    London-based Cheyne is thought to be down by at least 10% in its credit fund after the downgrading of debt at General Motors and Ford. Ferox, another of London’s most successful funds, is thought to be down nearly 20%. Bailey Coates, Polygon, Rubicon, Vega, Moore Capital and Brevan Howard are all nursing heavy losses of about 5% each in April. Bailey Coates, whose losses reported in The Sunday Times three weeks ago first alerted the wider market to the industry crisis, has had yet more redemption calls.

    “What you’re seeing is like a run on the bank,” said Narayan Naik, director of hedge-fund studies at the London Business School. “Selling forces more selling and there’s a cascade effect.”

    Although industry experts said there was no hedge-fund blow-out on the scale of Long Term Capital Management in 1998, many are concerned that the worst might not be over.

    “There’s not a panic like when LTCM nearly went bust,” said Naik, “but prices will keep dropping until excess money is squeezed out of the hedge-fund industry and a new floor is established.”

    After performing well in the fourth quarter last year, funds have run into increasing difficulty this year as a downturn in consumer spending has sparked fears of a broader slowdown.

    While GLG reported that one of its key funds was down 5.2%, a Man Group scheme suffered a 3.1% decline and Madrid-based Vega told investors one of its leading funds was down 6%.

    May has also started rockily. Some hedge funds were wrongfooted when Standard & Poor’s downgraded General Motors and Ford bonds to junk levels, and US investor Kirk Kerkorian used the opportunity to buy shares. Bond prices fell and share prices rose, the opposite of what fund managers thought would happen.

    Hedge funds that specialise in convertibles — bonds investors can exchange for shares — have also had a hard time. Funds had bought up nearly 80% of all convertibles, so when their prices fell it turned into a stampede."

  13. #13

    Default Re: The Influence of Foreign Investors

    The following article was in The Age a few weeks ago. It provides another indication of the current state of uncertainty with the extent of problems with Hedge Funds.

    "The critical question raised by the abrupt fall in world equity markets over the past month is whether it is, in Peter Costello's terms, the markets taking a "breather" after a massive run in the preceding 11 months, or more fundamental forces at play.

    The answer is almost certainly the latter, with a combination of economics and developments in the structure of financial markets exerting considerable downward pressure on equity markets.

    It is no coincidence that the major equity markets peaked last month, just after the US Federal Reserve raised US official rates by a quarter of a percentage point - the seventh such rise in this cycle. The release of the minutes of the Federal Open Market Committee meeting on March 22, which showed increasing anxiety over the outlook for inflation, increased the markets' nervousness about the outlook for rates.

    Within the US, weaker employment and retail spending, falling factory output and slowing corporate profits have undermined the expectations of future profitability that had been built into US share prices. Outside the US, slowing growth in Europe and Japan has also tempered world growth. The 70 per cent increase in crude oil prices in the past two years and soaring commodity prices are starting to impact on growth and inflation.

    With Western consumers over-leveraged, the US running unsustainable trade and budget deficits, signs of global supply-demand imbalances, Asian countries maintaining undervalued currencies and trade tensions rising, there are also some potentially destructive global structural imbalances to unsettle markets.

    Those issues alone would be sufficient to explain why the US market has fallen about 7 per cent since peaking on March 4 and why our market - where some, although not all, of the US settings are replicated - has fallen almost 5 per cent over that same period.

    The market's response to the signs of a weakening in the US economy even as the Fed hints at an acceleration of its rate-raising program - which raises the threat of stagflation - has, however, been quite dramatic.

    After the 2000 dotcom and telecommunications bubble burst, one of the easier opportunities in history to make money opened up. Big investors were able to borrow in US dollars at negative real interest rates and invest those funds in assets generating real returns elsewhere. The so-called "carry" trade fuelled the explosive growth of hedge funds, which added massive leverage to the basic investment proposition.

    Even households seized on the classic arbitrage opportunity, albeit in a somewhat less sophisticated fashion. Consumers in most of the developed countries took advantage of historically low rates to invest in income- or capital-gain producing housing, as well as going on a massive consumption binge.

    Not surprisingly, the surge in investing powered by cheap money was reflected in similar surges in asset prices. Since its post-bubble nadir in early 2003, the US market has risen almost 100 per cent. Our market (which didn't fall as far when the bubble burst) is up almost 60 per cent over that period.

    From shares to houses to oil, the prices of assets and commodities exploded, helped by the China phenomenon but leveraged in the financial markets by the hedge funds.

    The global addiction to cheaply funded risk peaked last month but really started after the Fed's earlier rate rise in February, which triggered a large-scale sell-off in emerging market assets. Capital has been withdrawn from emerging Europe, Latin America and Asia (excluding China and Japan). Bond yields started to rise, volatility in equity and commodity markets soared and investors started switching from riskier asset classes to less vulnerable investments.

    In our market it is notable that the ASX 200 is down 4.85 per cent over the past month, while the "Small Ordinaries" is down 7.5 per cent - there has been a flight away from the small caps towards quality. There has also been a shift from cyclical stocks to defensive stocks.

    That broad trend away from riskier asset classes potentially carries with it the seeds of something unpleasant, given the extraordinary growth of the hedge fund sector and its latent combustibility as a result of the levels of leverage in many of the funds.

    After 2001, when real rates in the US became negative, company profits and cash flows were swollen by the cheap funding and the consumption boom triggered by low interest rates. With inflation not an issue, investors were prepared to pay more and more for future earnings because they weren't discounting those earnings for either inflation or high nominal rates. Not surprisingly, price/earnings ratios expanded and the risk premiums assigned to financial assets were compressed.

    With rising rates and inflation, a stronger US dollar, increasing volatility in financial markets and US real rates having just surpassed the spreads available in euro-denominated funding, the appeal of the carry trade has waned and the positions it funded are being unwound. Hence the sharp rise in volumes and volatility in the major markets.

    Future earnings no longer look as rosy and will now have to be discounted by a rising real rate.

    That is why there is no certainty that our market will be able to hold its ground, despite its statistics looking defensible at current levels - or at least not expensive by historical standards.

    There has been a worldwide bubble of sorts in financial assets and commodities which has developed a leak. The opacity of the hedge fund activity and their condition means it isn't possible to state with any precision either the size of the bubble or the gravity of the leak.

    It is possible that the past month has just been "the correction we needed to have," or the "pause that refreshes", or Costello's "breather". It is equally possible, however, that the vague threat the hedge funds were seen to pose to the stability of financial markets and real economies may be materialising, with unpredictable but presumably fairly unpleasant consequences."

  14. #14

    Default Re: The Influence of Foreign Investors

    Uncertainty in global markets goes up a notch. See the following article from today's The Australian:

    CURRENCY markets are bracing for volatile trading ahead of China's move on Wednesday to allow the yuan to be traded against eight extra currencies, including the Australian dollar.

    The reform is being viewed as a precursor to the much-awaited upward revaluation of the yuan, which would hamper China's export competitiveness to the benefit of the US.

    While China's central bank on Friday dismissed reports of an imminent change to its policy of pegging the yuan-$US rate, the Government has also said it intends to surprise the market with such an announcement. Wednesday's forex market reform is seen as a step towards China's currency liberalisation by boosting the yuan's liquidity.

    "There will be nervous traders watching their screen on May 18 (Wednesday)," AMP Capital Investors chief economist Shane Oliver said. "The market was pricing (a revaluation) in, but that reversed in the last couple of days. If sentiment reverses again, you might see big swings."

    A revaluation would most likely involve a widening of the narrow 0.3 per cent band in which the yuan is allowed to vary against the $US. US-led pressure for a revaluation has been mounting, given the nation's current account deficit, which has been fed by cheap Chinese imports.

    A stronger yuan, in contrast, would boost China's internal consumption by making exports cheaper.

    Australian exports would also become cheaper for Chinese buyers, while Chinese imports to Australia would become become more expensive, creating inflation and interest rate pressures, but improving out current account deficit.

    "We expect China's authorities will broaden the yuan's trading band tenfold to 3 per cent, which will allow the yuan to appreciate 1.5 per cent," investment bank JP Morgan said in a report.

    "JP Morgan expects a further 5 per cent yuan appreciation by the end of 2005 and total appreciation of 10 per cent within 12 months."

    After Wednesday's reforms, the Australian dollar can be directly tradeable with the yuan, through interbank dealings with seven authorised foreign banks.

    The yuan currently can be traded only against the $US, the Hong Kong dollar, the Japanese yen and the euro.

    Westpac Bank economist Huw McKay said the $A inclusion was not likely to have near-term implications for the $A, but could reduce costs for Australian companies dealing with China. "It will reduce risk to importers by taking out third currencies," he said.

    Mr McKay said most Sino-Australian trading was in $US-dominated resources, such as iron ore and coal. "But, as we export more sophisticated goods ... we may well have the power in the relationship to say 'please pay us in Australian dollars'."

    JP Morgan economist Stephen Walters agreed. "Convertibility won't open the drawbridge but it might make things a little bit easier," he said. "The real impact is when China revalues its currency."

    But economists said the Chinese were unlikely to move on a revaluation this week, despite the X-factor of surprise.

    "My guess is it will be some time in the next three months," Dr Oliver said.

    Mr McKay warned that such a move would weaken China's banking system, which relies on a vast pool of captive local savings.

    The Australian newspaper.

  15. #15

    Default Re: The Influence of Foreign Investors

    May 16 (Bloomberg) -- Japanese resource stocks fell, led by Dowa Mining Co. and Nippon Oil Co., after a slump in commodity prices raised concern that slowing global growth may cut demand for raw materials.

    ``Excess money that people made when the global economy was booming was put into commodities and now that growth is being questioned, the money is starting to be taken out,'' said Takashi Miyazaki, who helps oversee about $20 billion in assets at UFJ Partners Asset Management Co. in Tokyo.

    ``Almost inevitably, commodity stocks will face some tough times'' as a result of the recent slump in raw material prices.

    Investors could be reluctant to take any large bets before Japan's gross domestic product report due tomorrow, analysts including Yutaka Miura at Shinko Securities Co. in Tokyo said.

  16. #16

    Default Re: The Influence of Foreign Investors

    In the Financial Review:

    Miners hit as hedge funds unwind
    May 16 12:50

    Falling commodity prices dragged the resource sector down heavily on Monday to kick off a weak start for the Australian sharemarket amid talk that troubled hedge funds are unwinding their big bets of recent years.

    An ex-dividend ANZ and heavy losses by blood products group CSL, after a broker downgrade, added to the downward pressure on the local market, as did weakness in steelmakers and market-sensitive wealth managers.

    The benchmark S&P/ASX-200 was down 0.6 per cent at 3989 in afternoon trade. After hitting five-month lows early this month, the market has rebounded by 1.6 per cent, but remains 6.5 per cent off the record highs of mid-March.

    The big theme, say analysts, is one of risk aversion. Global hedge funds, having placed major bets on commodities and other assets leveraged to the economic cycle, are suddenly unwinding those positions to cover losses elsewhere.

    "Screen chatter on potential issues in the hedge fund sector has continued to percolate through the market," Deutsche Bank analysts said in a morning note.

    "This appears to be driving a climate of risk reduction, with investors looking to exit the consensus trades that are perceived to be the darlings of the hedge funds or even put on the reverse trade on the prospect of forced hedge fund unwinding."

    Resource stocks were the biggest weight on the market on Monday after another decline in commodity prices on Friday. Copper eased 3 per cent, bringing its losses to 7 per cent over three days, as the US dollar extended its rebound.

  17. #17

    Default Re: The Influence of Foreign Investors

    Some good news out of Japan, which has been in economic stagnation for over a decade since the bursting of the bubble.

    If it is sustainable and not another false dawn (only time will tell), it will take some of the "burden" for world economic growth out of America.

    Japan is the world's largest creditor nation, owning 1/3 of the world's credit supply (including a chunk of Australia's net foreign debt of around $422 billion).

    Its companies like Toyota, Sony, Panasonic, Honda, Mitsubishi and Nissan are still formidable on a global scale.

    See the following article released today:

    Japan Economy Grows at 5.3% Pace, More Than Expected (Update3)

    May 17 (Bloomberg) -- Japan's economy, the world's second- largest, grew at more than twice the rate economists forecast as rising wages prompted consumers to increase spending on clothing and food. Stocks and the yen gained.

    Gross domestic product rose at an annual 5.3 percent pace in the three months ended March 31, a report by the Cabinet Office in Tokyo showed today. The median forecast of 28 economists surveyed by Bloomberg was for a 2.4 percent rate of growth. The economy grew a revised 0.1 percent in the fourth quarter.

    Consumers are shopping more at retailers including Aeon Co. and Matsuzakaya Co. as employers raise wages and hire more workers, helping Japan extend its recovery from a fourth recession since 1991. Spending by households, which accounted for more than half of growth, is helping Japan withstand a slowdown in overseas demand.

    ``We're seeing increasing signs that the economy is on the path to a stable recovery,'' Eishi Yokoyama, an economist at AIG Global Investment Corp., said before the report was released. ``Consumers are more willing to spend.''

    The yen rose to 106.69 to the dollar at 9:36 a.m. in Tokyo from 106.74 late yesterday in New York. The Nikkei 225 Stock average advanced 0.9 percent to 11,042.35, led by Toyota Motor Corp.

    Japan's growth compares with a 3.1 pace of expansion in the U.S. in the first quarter, the slowest in two years. The 12 nations sharing the euro grew 0.5 percent from the previous quarter.

    Employment Rises

    Quarter-on-quarter, the economy grew 1.3 percent in the three months to March 31, compared with economists' expectations of a 0.6 percent gain. From a year earlier, growth was 1.2 percent in real terms, today's report showed.

    Consumer spending rose 1.2 percent from the previous three months, the first gain in a year, more than the 1.1 percent increase forecast by economists.

    Japanese companies are hiring more workers and paying them better after reducing excess capacity and cutting debt since the nation's asset-price bubble burst in 1991.

    Aeon, Japan's largest retailer, said on April 6 that net income rose 12 percent to 62.1 billion yen ($577 million) in the year ended Feb. 28 and sales rose 18 percent to 4.2 trillion yen. It expects sales to increase 3.4 percent this year.

    Executives at retailers including Matsuzakaya say they are hopeful about the outlook.


    ``I'm not pessimistic about consumer spending at all,'' Kunihiko Okada, president of Matsuzakaya, a Nagoya-based department store chain, said in an interview on May 13. ``The composition of the Japanese population is changing now as baby boomers and their children are leading consumption, and we think this is a big business opportunity for our industry.''

    Twice-yearly bonuses, which usually amount to several months' salary, rose for the first time in eight years in December to 430,278 yen ($4,026).

    The number of full-time workers in Japan rose in January for the first time since 1997, and the unemployment rate fell to 4.5 percent in March, matching a five-year low.

    Household spending rose a seasonally adjusted 2.2 percent in the three months to March 31, the biggest gain in eight years, the government said on May 10. Retail sales rose 0.1 percent in the first quarter from a year earlier, the first gain in four quarters, the government said on April 28.

    Capital Spending

    Companies including Sharp Corp. and Elpida Memory Inc. are planning to spend more on factories and equipment as they prepare for a rebound in overseas demand for electronics after companies built up excess stockpiles last year.

    Capital spending rose 2 percent from the previous quarter, today's report showed, and accounted for more than a fifth of the economy's expansion. Economists expected capital spending to rise 0.6 percent.

    Machinery orders, which point to spending in three to six months, unexpectedly rose 1.9 percent in March, the government said on May 13, suggesting that gains in corporate investment will continue.

    Tokyo-based Elpida Memory, the world's fifth-largest memory- chip maker, will increase spending to 143.6 billion yen in the fiscal year started April 1, more than the 100 billion yen it initially planned, President Yukio Sakamoto said on April 25.

    Osaka-based Sharp, the world's biggest maker of liquid- crystal display televisions, said on April 26 it will raise spending 3.3 percent to 220 billion yen.

    Overseas Sales

    Sumitomo Metal Industries Ltd., Japan's third-largest steelmaker, said this month it will spend 100 billion yen to boost annual capacity at its Wakayama mill.

    ``Manufacturers are replacing old furnaces and that means we can expect capital spending to increase into next year and the following year,'' Nobusato Suzuki, chief financial officer at Osaka-based Sumitomo Metal, said in an interview on May 10.

    Overseas sell fell 0.2 percent, and imports rose 0.5 percent in the first quarter. Net exports, or the difference between exports and imports, subtracted 0.1 percentage point from growth.

    Export volumes, which don't take into account price fluctuations, rose for the first rose for the first time in three months in March, government data on April 21 showed.

    ``Exports are improving considerably,'' Kakutaro Kitashiro, head of the Japan Association of Corporate Executives, said on May 10. ``The inventory adjustment in the information technology sector has made a lot of progress.''

    Nominal GDP, which isn't adjusted for price changes, rose at an annual 2.3 percent pace, today's report said. Quarter-on- quarter, it expanded 0.6 percent, more than the 0.2 percent growth predicted by economists.

    Seven years of deflation have taken a toll on the economy. Prices as measured by the GDP deflator fell 1.2 percent from a year earlier, compared with the 0.7 percent drop predicted by economists.

  18. #18

    Default Re: The Influence of Foreign Investors

    In The Australian today, comments by Robert Gottliebsen (a very experienced and seasoned business commentator, the previous editor of BRW):

    Hedges trim the dollar, shares
    May 18, 2005

    "SPECULATIVE money, often administered by hedge funds, is playing a big role in the latest fall in the Australian dollar and share market.

    If the exodus to the US dollar were to gather momentum, it might even affect our apartment market because all Australian asset classes have delivered bonanzas to speculators via increases in value and a higher dollar.

    Now they are jittery, although some of the forces currently boosting the US dollar are good for Australia.

    It's worth following at least some of the money trails, although I must emphasise that these trails are far more complex and numerous than I portray.

    The big US deficits have created large buckets of US dollar capital sloshing around Asia. A significant amount of this money has found its way into China and represents a big portion of China's foreign exchange reserves.

    Often the Chinese speculative money was parked in real estate and this is why Shanghai has large numbers of unoccupied apartments and empty hotels are common in some parts of China.

    If the Chinese currency were sharply increased in value, this money would stop flowing into China and much of it would attempt an exit that would explode the Chinese capital investment bubble.

    Commodity prices would fall, so Australia would be affected.

    The US is putting great pressure on China to increase the value of the yuan but the Chinese are resisting, partly because they know the dangers.

    Small steps are likely. But in recent weeks there has been a significant directional change in the speculative money flows.

    For over a year many speculators have been switching out of the US dollar into the euro and other currencies. But America is again sucking in large sums and the US dollar has been rising despite the deficits.

    One of the reasons for the sudden return to US popularity is that its relatively low interest rates are attracting huge real estate speculation.

    Americans are even more skilled at creating real estate mania than Australians, and global speculators have joined the game.

    In addition, reports from big companies around the US show that it is becoming much easier to lift prices and in the process this is making the corporate profit outlook much stronger. This is being reflected in higher earnings projections by analysts and this increases the value of US stocks and sucks money into Wall Street.

    Suddenly Federal Reserve chief Alan Greenspan is potentially facing both an inflationary problem and a real estate asset bubble.

    Accordingly, the pressures on him to maintain the current higher interest rate momentum will be intense and short-term rates of 4 per cent to 4.5 per cent by the end of 2005, or early next year, look highly likely.

    There is no doubt that such a rate increase would slow the US economy in 2006 and this would quickly spill over into China, commodity prices and Australia.

    Those projected budgetary surpluses would be severely trimmed. So the speculators betting against the Australian dollar basically have two tickets in the raffle -- a slowdown in China because of a currency move and a US slowdown because of higher interest rates.

    But timing is important and the current stronger corporate US outlook will not suddenly disappear and we could see a period of global strength which would see strong share prices and the local currency hold its ground.

    What we are really looking at is the realisation by both the Chinese and Americans that there is a need for a slowdown.

    The debate is about who takes the brunt of any reverse. But either way Australian commodities will be affected.

    We should not forget that underpinning the commodity market is very big long-term basic demand from China and India, which will not go away. But China is encouraging Brazil and others to lift production."

    The Australian newspaper.

    My comments - to me, the global financial / equity / property markets are currently in disequilibrium, to use economic jargon. The adjustments have been happening and will continue to happen for some time, while markets move back towards equilibrium.

    I will explain further as I go along, but I emphasise that no one has to agree with anything I say, i.e. do not take any cheap shots for the time being.

  19. #19

    Default Re: The Influence of Foreign Investors

    May 17 (Bloomberg) -- U.S. 10-year Treasury notes rose after the Federal Reserve said April industrial production unexpectedly fell, a sign the economy may be struggling to pull out of a first- quarter slowdown.

    The gains kept the notes' yields, which are a guide for corporate and consumer borrowing rates, near a three-month low. The drop in production follows a report yesterday from the central bank's New York branch that showed manufacturing in its area declined this month.

    ``Demand, especially for the 10-year note area, remains very strong,'' said David Brownlee, who manages $7 billion of debt securities at N.L. Capital Management in Montpelier, Vermont. ``There's a bid in the Treasury market that simply does not go away,'' said Brownlee, adding that ``there's very little value'' in Treasuries at these yields.

    The benchmark 4 1/8 percent Treasury note maturing in May 2015 gained 1/16, or 63 cents per $1,000 face amount, to 100 1/32 at 4 p.m. in New York, according to bond broker Cantor Fitzgerald LP. The yield fell almost 1 basis point, or 0.01 percentage point, to 4.12 percent, and is down from this year's high of 4.69 percent in March.

    The note rose as much as 1/4 of a point before a late rally in benchmark stock indexes sapped demand for government debt. The Standard & Poor's 500 index gained 0.67 percent.

    Industrial production declined 0.2 percent in April, the Fed said. A rise of 0.2 percent, half last year's monthly average, was forecast, according to the median estimate of economists surveyed by Bloomberg. The New York Fed's Empire index yesterday fell to minus 11.1, from a revised 2 in April.

    `Soft Patch'

    ``It definitely points towards the soft patch we're currently probably in,'' Kevin McNair, who oversees $7 billion in bonds at BB&T Asset Management Inc. in Raleigh, North Carolina, said of today's production report. Yields will still rise later in the year as the Fed will add to its eight interest rate increases since June 2004, he said.

    The economy expanded at a 3.1 percent annual rate in the first quarter, the slowest pace in two years. Debt yields will likely remain low for the time being, McNair said. He declined to be more specific.

    Also today, a Labor Department report showed prices paid to factories and other producers rose 0.6 percent in April. The median forecast in a Bloomberg News survey was for an increase of 0.4 percent. Excluding food and energy, producer prices rose 0.3 percent, compared with a median forecast of 0.2 percent.

    Some investors said the report wasn't all bad for Treasuries because excluding food and energy, the cost of intermediate goods, those used in earlier stages of production, rose 0.2 percent, the smallest rise since December 2003.

    There is evidence the longer-term inflation risk ``is still very controlled if the Fed continues to be a staunch fighter of inflation, which the market believes them to be,'' said Sadakichi Robbins, head of proprietary fixed-income trading at Bank Julius Baer & Co. in New York. Quicker inflation erodes the purchasing power of fixed-income payments.

    Real Yields

    ``The ability to stay below 4.25 (percent on 10-year yields) despite pretty bullish surprises on the economy -- that gives some comfort'' to bond bulls, Robbins said.

    Treasury yields adjusted for inflation are low by historical standards. The 10-year note's yield as of yesterday was about 1.8 percentage points higher than the rate of core consumer inflation. Over the past decade the so-called real yield averaged about 3 percent.

    ``Tomorrow's CPI report will give a better indication if there's inflation in the system or not,'' said Jay Bryson, a global economist at Wachovia Corp. in Charlotte, North Carolina, and a former economist at the Fed.

    The Labor Department may say tomorrow that core consumer prices rose 0.2 last month, half the 0.4 percent gain in march, according to the median estimate of economist surveyed by Bloomberg.

    ``The inflation uptick doesn't seem to be getting through the consumer, so it doesn't worry us much,'' said Barry James, who manages $1 billion in bonds and stocks for James Investment Research in Dayton, Ohio.

    Fed Outlook

    Fed policy makers on May 3 raised their target for the overnight lending rate between banks for the eighth time since June, to 3 percent, and indicated they are likely to raise it further in the coming months. The rate probably will rise to 4 percent by year-end, according to the median forecast in a Bloomberg survey of 63 economists taken from April 29 to May 6.

    The Fed ``still need to rise'' to keep inflation contained, Fed Governor Donald Kohn told the Australian Business Economists Conference earlier today. There is still a risk of prices rising further, he said.

    ``Kohn gave the impression that he'll certainly be voting for more rate rises at upcoming meetings,'' Michael Thomas, a Sydney- based economist at ICAP Australia Ltd., said before the report. ``The Fed seems to be more worried about inflation upside risks than growth downside risks.''


    A drop in energy and commodities prices led traders in recent weeks to pare expectations that inflation will accelerate, as measured by yields on Treasury Inflation-Protected Securities, or TIPS.

    The gap by which 10-year Treasury yields exceed yields on 10- year TIPS shrank to 2.46 percentage points last week, the least since February. It was little changed today at 2.50 percent.

    The difference represents the expected average inflation rate over the life of the notes and is down from the high this year of 2.78 percentage points in March.

    Investor Sentiment

    Treasury investors are less bearish, according to a weekly poll of clients by JPMorgan Chase & Co. The share of investors betting on lower prices fell to 44 percent from a record 66 percent. The percentage betting on rising prices increased to 17 percent from 8 percent. The rest expected no change.

    A separate survey by Merrill Lynch & Co. shows 25 percent of investors believe government bonds are ``fairly'' or ``under'' valued, the poll, which was conducted at the start of the month, showed. The percentage compares with 83 percent for equities. The survey of 339 money managers, who together oversee more than $1 trillion, took place between May 6 and May 12.

    Interest-rate expectations have fallen with a net balance of 80 percent of investors forecasting global short interest rates will be higher a year from now compared with 94 percent in March.

    Demand for Treasuries has also risen over the past week amid concerns about losses at hedge funds, causing a flight to the relative safety of government debt. One or two hedge funds may have ``notable failures'' because on credit investments, Martin Fridson, a New York-based analyst who publishes Leverage World, a high-yield bond research service, said yesterday in an interview

  20. #20

    Default Re: The Influence of Foreign Investors

    The event on Sept 11 shocked the world in many ways. The subsequent wars in the Middle East also led to considerable uncertainties.

    From my reading, it seemed to me that the world's major central bankers (West and East) did everything that they could to ease monetary policy to prevent global recession. The end result was the biggest creation of M3 money supply the world had ever seen (this was later to be called the carry trade - money at nil 'real inflation adjusted' borrowing costs). Whether this huge supply of liquidity has averted or merely delayed a global recession remains to be seen.

    The carry trade (free ride on the yield curve) ended earlier this year, after many 0.25% interest rate rises by Alan Greenspan. The world is now adjusting to the effects. Bond markets are in adjustments. Global equity markets are in adjustments. Property markets are starting to adjust, but still patchy depending on location. As in all property cycles, Sydney led on the way up and leads on the way down. The downturn in Sydney is now evident and falling (it has to - the city is facing net interstate outward migration due to the absurd prices - reported in the newspapers this week). The downturn in Melbourne has started but is patchy (not broad based like Sydney) but will probably become more evident before the year is out - apartments in the CBD and South Melb. are recording falls of around 20% from peak. Brisbane's prices might have started a reversal. As in all previous cycles, the other capital cities will soon follow the decline after the time lag effect, as happened when prices were on the way up. Refer to the latest aireview issue no. 59 released a short while ago for another indication.

    Economic history provides some guidance that after a period when there has been excess liquidity, some of that liquidity eventually is lost through some investments going awry. Any of the previous local or global recessions (including the spectacular bursting of the bubble in Japan over a decade ago that Japan has yet to recover from) would be instructive.

    The following is an article (of some depth in macro economics) that might explain what has happened with the carry trade.

    How Japan financed global reflation
    By Richard Duncan
    FinanceAsia February 2005

    In 2003 and the first quarter of 2004, Japan carried out a remarkable experiment in monetary policy – remarkable in the impact it had on the global economy and equally remarkable in that it went almost entirely unnoticed in the financial press. Over those 15 months, monetary authorities in Japan created ¥35 trillion. To put that into perspective, ¥35 trillion is approximately 1% of the world's annual economic output. It is roughly the size of Japan's annual tax revenue base or nearly as large as the loan book of UFJ, one of Japan's four largest banks. ¥35 trillion amounts to the equivalent of $2,500 for every person in Japan and, in fact, would amount to $50 per person if distributed equally among the entire population of the planet. In short, it was money creation on a scale never before attempted during peacetime.

    Why did this occur? There is no shortage of yen in Japan. The yield on two year JGBs is 10 basis points. Overnight money is free. Japanese banks have far more deposits than there is demand for loans, which forces them to invest up to a quarter of their deposits in low yielding government bonds. So, what motivated the Bank of Japan to print so much more money when the country is already flooded with excess liquidity?

    The Bank of Japan gave the ¥35 trillion to the Japanese Ministry of Finance in exchange for MOF debt with virtually no yield; and the MOF used the money to buy approximately $320 billion from the private sector. The MOF then invested those dollars into US dollar- denominated debt instruments such as government bonds and agency debt in order to earn a return.

    The MOF bought more dollars through currency intervention then than during the preceding 10 years combined, and yet the yen rose by 11% over that period. Historically, foreign exchange intervention to control the level of a currency has met with mixed success, at best; and past attempts by the MOF to stop the appreciation of the yen have not always succeeded. They were very considerably less expensive, however. It is also interesting, and perhaps important, to note that the MOF stopped intervening in March 2004 just when the yen was peaking; that the yen depreciated immediately after the intervention stopped; and that when the yen began appreciating again in October 2004, the MOF refrained from further intervention.

    So, what happened in 2003 that prompted the Japanese monetary authorities to create so much paper money and hurl it into the foreign exchange markets? Two scenarios will be explored over the following paragraphs.

    In 2002, the United States faced the threat of deflation for the first time since the Great Depression. Growing trade imbalances and a surge in the global money supply had contributed to the credit excesses of the late 1990s and resulted in the New Paradigm technology bubble. That bubble popped in 2000 and was followed by a serious global economic slowdown in 2001. Policy makers in the United States grew increasingly alarmed that deflation, which had taken hold in Japan, China and Taiwan, would soon spread to America.

    Deflation is a central bank's worst nightmare. When prices begin to fall, interest rates follow them down. Once interest rates fall to zero, as is the case in Japan at present, central banks become powerless to provide any further stimulus to the economy through conventional means and monetary policy becomes powerless. The extent of the US Federal Reserve's concern over the threat of deflation is demonstrated in Fed staff research papers and the speeches delivered by Fed governors at that time. For example, in June 2002, the Board of Governors of the Federal Reserve System published a Discussion Paper entitled, "Preventing Deflation: Lessons from Japan's Experience in the 1990s." The abstract of that paper concluded "...we draw the general lesson from Japan's experience that when inflation and interest rates have fallen close to zero, and the risk of deflation is high, stimulus-both monetary and fiscal- should go beyond the levels conventionally implied by baseline forecasts of future inflation and economic activity."

    From the perspective of mid-2002, the question confronting those in charge of preventing deflation must have been how far beyond the conventional levels implied by the base case could the economic policy response go? The government budget had already swung back into a large deficit and the Federal Funds rate was at a 41 year low. How much additional stimulus could be provided? A further increase in the budget deficit seemed likely to push up market determined interest rates, causing mortgage rates to rise and property prices to fall, which would have reduced aggregate demand that much more. And, with the Federal Funds rate at 1.75% in mid- 2002, there was limited scope left to lower it further. Moreover, given the already very low level of interest rates, there was reason to doubt that a further rate reduction would make any difference anyway.

    In a speech entitled, "Deflation: Making Sure 'It' Doesn't Happen Here", delivered on November 21, 2002, Federal Reserve Governor Ben Bernanke explained to the world exactly how far beyond conventional levels the policy response could go. Governor Bernanke explained that the Fed would not be "out of ammunition" just because the Federal Funds rate fell to 0% because the Fed could create money and buy bonds of longer maturity in order to drive down yields at the long end of the yield curve as well. Moreover, he said, "In practice, the effectiveness of anti-deflation policy could be significantly enhanced by cooperation between the monetary and fiscal authorities. A broad-based tax cut, for example, accommodated by a program of open-market purchases to alleviate any tendency for interest rates to increase, would almost certainly be an effective stimulant to consumption and hence to prices."

    He made similar remarks in Japan in May 2003 in a speech entitled, "Some Thoughts on Monetary Policy in Japan". He said, "My thesis here is that cooperation between the monetary and fiscal authorities in Japan could help solve the problems that each policymaker faces on its own. Consider for example a tax cut for households and businesses that is explicitly coupled with incremental BOJ purchases of government debt-so that the tax cut is in effect financed by money creation." These speeches attracted tremendous attention and for some time financial markets believed the Fed intended to implement the "unorthodox" or "unconventional" monetary policy options Governor Bernanke had outlined.

    In the end, the Fed did not resort to unorthodox measures. The Fed did not create money to finance a broad-based tax cut in the United States. The Bank of Japan did, however. Three large tax cuts took the US budget from a surplus of $127 billion in 2001 to a deficit of $413 billion in 2004. In the 15 months ended March 2004, the BOJ created ¥35 trillion which the MOF used to buy $320 billion, an amount large enough to fund 77% of the US budget deficit in the fiscal year ending September 30, 2004. It is not certain how much of the $320 billion the MOF did invest into US Treasury bonds, but judging by their past behavior it is fair to assume that it was the vast majority of that amount.

    Was the BOJ/MOF conducting Governor Bernanke's Unorthodox Monetary Policy on behalf of the Fed? There is no question that the BOJ created money on a very large scale as the Fed would have been required to do under Bernanke's scheme. Nor can there be any question that the money created was used to buy an increasing supply of US Treasury bonds being issued to finance the kind of broad-based tax cuts Governor Bernanke had discussed. Moreover, was it merely a coincidence that the really large scale BOJ/MOF intervention began during May 2003, while Governor Bernanke was visiting Japan? Was the BOJ simply serving as a branch of the Fed, as The Federal Reserve Bank of Tokyo, if you will? This is Scenario One.

    If this was globally coordinated monetary policy (unorthodox or otherwise) it worked beautifully. The Bush tax cuts and the BOJ money creation that helped finance them at very low interest rates were the two most important elements driving the strong global economic expansion during 2003 and 2004. Combined, they produced a very powerful global reflation. The process seems to have worked in the following way:

    US tax cuts and low interest rates fuelled consumption in the United States. In turn, growing US consumption shifted Asia's export-oriented economies into overdrive. China played a very important part in that process. With a trade surplus vis-à-vis the United States of $124 billion, equivalent to 9% of its GDP in 2003 (rising to approximately $160 billion or above 12% of GDP in 2004), China became a regional engine of economic growth in its own right. China used its large trade surpluses with the US to pay for its large trade deficits with most of its Asian neighbors, including Japan. The recycling of China's US Dollar export earnings explains the incredibly rapid "reflation" that began across Asia in 2003 and that was still underway at the end of 2004. Even Japan's moribund economy began to reflate.

    Whatever its motivation, Japan was well rewarded for creating money and buying US Treasury bonds with it. Whereas the BOJ had failed to reflate the Japanese economy directly by expanding the domestic money supply, it appears to have succeeded in reflating it indirectly by expanding the global money supply through financing the sharp increase in the MOF's holdings of US Dollar foreign exchange reserves. There is no question as to if this happened. It did. The only question is was it planned (globally coordinated monetary policy) or did it simply occur by coincidence, driven by other considerations?

    What other considerations could have prompted the BOJ to create ¥35 trillion over 15 months? A second scenario is that a "run on the dollar" forced the monetary authorities in Japan to intervene on that scale to prevent a balance of payments crisis in the United States. This is Scenario Two.

    During the Strong Dollar Trend of the late 1990s, foreign investors, both private and public, invested heavily in the United States. Those investments put upward pressure on the dollar and on US asset prices, including stocks and bonds. The trend became self-reinforcing. The more capital that entered the US, the more the dollar and dollar denominated assets rose in value. The more those assets appreciated, the more foreign investors wanted to own them. Because of the large sums entering the country, the United States had no difficulty in financing its giant current account deficit, even though that deficit nearly tripled between 1997 and 2001.

    By 2002, however, with the US current account deficit approaching 5% of US GDP, it became increasingly apparent that the Strong Dollar Trend was unsustainable. The magnitude of the current account deficit made a downward adjustment in the value of the dollar unavoidable. At that point, the Strong Dollar Trend gave way and the Weak Dollar Trend began. Foreign investors who had invested in US dollar denominated assets during the late 1990s naturally wanted to take their money back out of the United States once it became clear that a sharp correction of the dollar was underway. Moreover, many US investors, and hedge funds in particular, also began selling dollar- denominated assets and buying non-US dollar-denominated assets to profit from the dollar's decline.

    The change in the direction of capital flows can be seen very clearly in the breakdown of Japan's balance of payments.

    The preceding chart shows the balance on Japan's current account and financial account, the two principle components of Japan's balance of payments, going back to 1985. Traditionally, Japan runs a large current account surplus and a slightly less large financial account deficit, with the difference between the two resulting in changes (usually additions) to the country's foreign exchange reserves.

    Beginning in 2003, however, there was a startling change in the direction of the financial account. Instead of large financial outflows from Japan to the rest of the world, there were very large financial inflows. For instance, in May 2003, Japan's financial account reflected a net inflow of $23 billion into the country. The net inflow in September was $21 billion. These amounts increased considerably during the first quarter of 2004, averaging $37 billion a month.

    The capital inflows into Japan at that time were massive, even relative to Japan's traditionally large annual current account surpluses. But, why did Japan, which normally exported capital, suddenly experience net capital inflows on a very large scale in the first place? The most likely explanation is that very large amounts of private sector money began fleeing the dollar and seeking refuge in the relative safety of the yen.

    When the Strong Dollar Trend broke, had the BOJ/MOF not bought the dollars that the private sector sold in such large quantities, the United States would have faced a balance of payments crisis, in which, in addition to having to fund a half a trillion dollar a year trade deficit, it would have had to find a way to fund a deficit of several hundred billion on its financial account as well.

    Any other country facing a large shortfall on its balance of payments would have experienced a reduction in its foreign exchange reserves. The United States, however, maintains only a limited amount of such reserves; only $75 billion as at the end of 2003, far too little to fund the private capital outflows occurring at that time.

    Once those reserves had been depleted, market-determined interest rates in the US would have begun to rise, in all probability, popping the US property bubble and throwing the country into recession. Under that scenario, a reduction in consumption in the United States would have undermined global aggregate demand and created a severe world-wide economic slump.

    The US current account deficit more or less finances itself since the central banks of the surplus countries buy the dollars entering their countries to prevent their currencies from appreciating and then recycle those dollars back into US dollar-denominated assets in order to earn interest on them.

    Large scale private sector capital flight out of dollars presented the recipients of that capital with the same choice. The central bank of each country receiving the capital inflow had the choice of either printing their domestic currency and buying the incoming capital or else allowing their currency to appreciate as the private sector swapped out of dollars. The European Central Bank chose to allow the euro to appreciate. The Bank of Japan and the People's Bank of China chose to print yen and renminbe and accumulate the incoming dollars to prevent their currencies from rising. If some central bank had not stepped in and financed the private sector capital flight out of the dollar, then sharply higher US interest rates most likely would have thrown the world into a severe recession. It is quite likely that this consideration also played a role in influencing the actions of the Japanese monetary authorities during this episode.

    The BOJ/MOF stopped intervening in March 2004. By that time, the Fed had indicated that it planned to begin tightening interest rates. That put a stop to the private sector capital flight out of the dollar. Therefore no more intervention was required. At the same time, by the end of the first quarter of 2004, it was becoming clear that strong economic growth in the US was creating higher than anticipated tax revenues. That meant a smaller than expected budget deficit. In July, the President's Office of Management and Budget revised down its estimate of the budget deficit from $521 billion to $445 billion. The actual deficit turned out to be $413 billion. Thus less funding was required than initially anticipated.

    So, what did motivate the monetary authorities in Japan to create the equivalent of 1% of global GDP and lend it to the United States? Was it simply, straightforward self interest to prevent a very sharp surge in the value of the yen? Was it globally coordinated monetary policy designed to pull the world out of the 2001 slump and prevent deflation in the United States? Or, was it necessary to stave off a US balance of payments crisis that would have produced a global economic crisis?

    Perhaps it was only straightforward foreign exchange intervention to prevent a crippling rise in the value of the yen. Intentionally or otherwise, however, by creating and lending the equivalent of $320 billion to the United States, the Bank of Japan and the Japanese Ministry of Finance counteracted a private sector run on the dollar and, at the same time, financed the US tax cuts that reflated the global economy, all this while holding US long bond yields down near historically low levels.

    In 2004, the global economy grew at the fastest rate in 30 years. Money creation by the Bank of Japan on an unprecedented scale was perhaps the most important factor responsible for that growth. In fact, ¥35 trillion could have made the difference between global reflation and global deflation. How odd that it went unnoticed.

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