DE-DOLLARIZATION - AIIB & The Beginning of the End

China Takes Aim At Dollar Reserve Status: Promotes Yuan In Investment Bank 04-15-15

As regular readers know, we’ve variously described the China-led Asian Infrastructure Investment Bank as representing both an attempt by China to

• Cement its regional dominance by implicitly adopting a sino-Monroe Doctrine, as indicative of Beijing’s desire to supplant to US-dominated multinational institutions that have been a fixture of the post WWII economic world order, and, perhaps most importantly,
• As a not-so-subtle indication that dollar hegemony may be on the way out and yuan hegemony may be around the corner. 

Essentially the AIIB will (either intentionally or unintentionally depending on who you believe) serve as an instrument of Chinese foreign policy and any hope of keeping this between the people who are privy to the country’s various hidden agendas (because all countries have agendas), went out the window early last month when the UK staged a coup by breaking with Washington and joining the development bank triggering a flood of applications from Western countries and culminating in membership bids from US “allies” Australia, Israel, and even Canada. Adding insult to injury, the AIIB is now looking to hire officials away from the World Bank and rival ADB. 

Amid the March membership frenzy, Beijing sought to play down the degree to which the venture would serve to help establish a new world economic order with China at the helm. An article which appeared in The Global Times (a paper run by the state-controlled People’s Daily) very specifically denied any notion that China has designed on establishing a yuan-based global economic system. Here’s an excerpt:

The establishment of the Asian Infrastructure Investment Bank (AIIB) has been depicted by a few overseas media outlets as if China is building its own version of the Bretton Woods system...

Some foreign observers claim that the AIIB is the beginning of the Chinese yuan's hegemony. What they are actually trying to imply is that "China is another US."

This kind of statement is nonsensical, which uses historical experience to fool readers. It is divorced from the truth and shows no common sense and doesn't stand up to any scrutiny. 

Through the Bretton Woods system, the US was able to wield supreme influence over its allies which had been severely battered during the war. China today is in a totally different position. 

The AIIB will not confront the WB or IMF, nor will it turn the current international monetary order upside down. The spirit of the AIIB is diversity and justice. 

Perhaps, but as we noted at the time, it was on the very same day that the following came across the wires:

“China plans to push for yuan to take prominence in loans under the Asian Infrastructure Investment Bank and the Silk Road Fund, people familiar with the matter said. China may encourage $100b AIIB and $40b Silk Road Fund to issue loans directly in yuan or set up yuan-denominated funds under the two institutions, according to the people, who ask not to be identified because deliberations are private.” 

This prompted us to suggest that “actions speak louder than words.”

Today, The South China Morning Post reports that the bank will establish an AIIB currency basket with China set to push for the yuan to take a prominent role and for “special currency funds” to be established in order to issue yuan-denominated loans through the fund. Here’s more:

Beijing will push for the yuan to be included in a basket of currencies used to denominate and settle loans from the Chinese-led Asian Infrastructure Investment Bank (AIIB), according to think tank sources.

Beijing will also encourage the AIIB and the Silk Road Fund to set up special currency funds and issue yuan-denominated loans through both institutions, the sources said.

If the US dollar is used, it weakens China’s bid for the yuan to be a global currency.

The efforts are part of a drive to internationalise the Chinese currency and come as the International Monetary Fund prepares to discuss the possible inclusion of the yuan as its fifth reserve currency and as part of the basket that forms the IMF's Special Drawing Rights.

The sources' claims appeared to be confirmed by a state media report, which said that a basket of currencies called the "AIIB currency" would most likely be adopted as the bank's currency of settlement… 

Hao Hong, chief economist and managing director of research at Bocom

International, said the AIIB's grand vision for infrastructure investment came with challenges but China should do its best to establish the yuan as a currency for settlement and denomination.

"If the US dollar is used instead, it weakens China's bid for the yuan to become a truly global currency and to challenge the hegemony of the US dollar," Hong said.

Yifan Hu, chief economist with Haitong Securities International, said it would be too hard to reach a consensus on an AIIB currency basket...

"In my view, the US dollar will be used in the early stages of the AIIB, and then [the bank] will gradually move to a mix of the yuan and US dollar," Hu said.

The sources said China would push for broader use of the yuan at the AIIB and the Silk Road Fund, as part of efforts to promote the yuan as an international currency…

The sources said that there was still a long way to go in the internationalisation of the yuan and the greenback would continue to dominate the global financial system for the next few years.

Yes, “for the next few years,” which really isn’t that long, especially when compared with how long the dollar has dominated the global economic order. Perhaps even more interesting — and more alarming for Washington — is that the move by China to expand the yuan’s influence via a fund that is now backed by nearly every major country on the planet save the US and Japan, comes just as petrodollar mecantilism, which has been perhaps the driving force behind dollar dominance for decades, crumbles in the face of slumping oil prices.

As we’ve reported on several occasions,

2014 marked the first year in nearly two decades that oil producers' petrodollar exports (i.e. the recycling of oil proceeds into USD assets) turned negative.

In other words, falling oil prices mean producing nations are now removing liquidity from the system rather than adding it, a process Goldman estimates will will sum to nearly $900 billion by 2018. 

The combination of these two forces could serve to cause a dramatic shakeup in a world that heretofore functioned on a unilateral system, both politically and economically.

THE MONEY ILLUSION - Selling Time

Central Banks Made The Whole World “Buy Time”... There Are Signs We’re Beginning To Sell It 04-14-15 Zero Hedge

By Paul Mylchreest of ADM International

Selling Time

Can you arbitrage time? Central banks made the whole world “buy time”. There are signs that we’re beginning to sell it

Central banks artificially lengthened time horizons in financial markets and the real economy by distorting time preference. There is evidence that time horizons are now shortening, e.g. weak capital investment, flattening yield curves, dollar strength & physical gold demand. Perhaps the tsunami of global speculative capital—a result of extreme “financialism” - is getting nervous and seeking safer havens. Historically, volatility in currency markets has led to destabilising flows in speculative capital which have subsequently impacted other financial assets. One way to “sell time” is, paradoxically, buying long-term Treasuries and, therefore, “bond-like” equities, such as financially strong Consumer Staples and Utilities companies. For equities in general, we found two indicators which gave well-timed sell signals at the last two peaks in the S&P 500 in 2000 and 2007. Both of them – Treasury yield curve (7s10s) and “adjusted” MACD - are getting close to giving the first sell signals in nearly eight years.

Executive Summary

Can you buy and sell time? We think that you can from the perspective of time horizons. In our view, financial markets are operating on the wrong time horizon – one that is too long (thanks to central banks ZIRP/NIRP and credit creation) - although there are signs that this is beginning to change.

We are in a global debt bubble and debt has a “time function” given its ability to bring forward consumption from the future into the present. Debt essentially “buys time” and the world has bought a (hell of a) lot of time. The “present” is inexorably catching up with what was the “future.”

Time preference reflects the relative valuation placed on goods at an earlier date versus a later date. While current goods (including cash) should always have a higher valuation than future goods, time preference declines as an economy becomes wealthier, i.e. the proportion of income devoted to current consumption falls versus that devoted to saving/capital accumulation.

Since the crisis, central banks have sought to address “under-consumption” (how many people do you know who voluntarily under-consume?) by distorting time preferences in the real economy and financial markets via zero interest rates and excessive credit creation. Negative interest rates are another step in this direction. At the heart of their policy, however, is a fundamental contradiction.

• On one hand, their policies seek to increase current consumption, at the expense of long-term saving & capital accumulation, in an over-leveraged world. This increases time preference and would normally equate with higher interest rates, shortening time horizons and diminution in wealth.
• However, by forcing down interest rates, the substitution of savings (real wealth) by cheap credit and by supporting financial markets, they have created an impression that time preference is lower than it really is. This lengthens time horizons, implies that current/rising consumption levels are more easily sustainable and induces incorrect spending decisions.

While artificially increasing time preference fundamentally weakens an economy, there is no immediate concern unless there is evidence that businesses, consumers and investors are recognising that time preference is too high and are responding accordingly.

We detect signs that time horizons are shortening in both the “real” economy and financial markets.

* * *

Time, Debt and Central Banks

We are in a global debt bubble and debt brings forward consumption into the present from a more distant point in the future – since it removes the need to save the loan value out of disposable income.

Consequently, the accumulation of debt has a time function.

Debt essentially “buys time”, so borrowers are literally “long” time and short the currency/credit which they must return to the lender at a later date. While lenders lend money, they are also “lending” or “selling” time to the borrowers.

While it has a geared effect on economic growth, “buying” more and more time becomes problematic.

As time progresses, what is “the present” begins to catch up with what was “the future.”

In the US, total credit market debt outstanding is US$58.0 trillion, or $62.4 trillion if you include the Fed’s balance sheet. At 331.7% of GDP, it is significantly higher than the 275% reached at the peak of the Great Depression.

What deleveraging?

It’s noticeable how central bankers almost never mention that TOO MUCH DEBT is the key factor holding back growth in what is a credit-driven global economy. This is the sleight of hand to deflect guilt. In fact, their strategy has been to address the fallacy (think about it) of under-consumption by an all-out attempt to make it cheaper to borrow so that the world accumulates even more debt.

And the US is only a part of the story.

The total amount of debt accumulated on a global basis is approximately US$200 trillion according to a recent report from the management consulting firm, McKinsey.

The world is “long” (a hell of) a lot of time.

Looked at in another way, central banks have artificially lengthened time horizons in the real economy and financial markets by distorting time preference. They have created an illusion at the heart of which is a fundamental contradiction.

Time preference is the relative valuation placed on goods (including money) at an earlier date versus a later date. It almost goes without saying that, in general, people would rather fulfil their desires today than tomorrow. Who wouldn’t? People value present goods more highly than future goods. This concept is obviously used in DCF calculations to value financial assets/projects, i.e. cash flows at an earlier date have a higher valuation than cash flows at a more distant date.

In an economy, the way that time preference alters the balance between consumption today versus saving/investment for the future - and how debt accumulation interacts with this process – has major implications for growth. As an economy becomes wealthier, time preference declines.

Time preference plays a key role in the formation of interest rates along with diminishing marginal utility (e.g. if you were on a desert island with nothing but 2 bananas, it probably makes sense to eat the other one tomorrow).

Implicit in time preference is that interest rates should be positive. Borrowers have to compensate lenders for the use of cash now if they don’t want to (or can’t) save it out of disposable income. Lenders require positive interest rates to defer consumption over and above some level of precautionary cash reserve.

Negative interest rates violate the normal concept of time preference, implying the premium of present goods to future goods is reversed. A person who saves SFr100 and gets SFr 99 back in a year’s time must judge that the value of SFr 99 for consumption in a year’s time is more than SFr100 now.

Switzerland was the first country to see its 10-year yield slip into negative territory.

More than 15% of all developed market sovereign bonds are now trading on a negative yield. Swiss yields are currently negative out to nine years, German yields out to six, Danish out to five and Swedish out to four.

This strikes us as an extraordinary market signal. How could things have become so distorted and why is the consensus view so complacent? It seems that as long as stock markets are buoyant and sovereign bond yields of major nations remain very low, the majority will bask in the status quo.

Many suggestions are being put forward to explain negative yields so far out on the curve.

• Rising deflation risk;
• SNB’s negative policy rate (reduced from 0.00% to -0.75% since December 2014);
• A shift towards “safe” assets as some investors question the future stability of the current financial architecture;
• Limited guarantees on bank deposits and risks to the banking system;
• A view that Swiss government bond prices will continue rising, so there will be an opportunity to sell them at a higher price to someone else;
• Supply shortages of specific assets relative to the massive liquidity injections from central banks;
• The financial system has been so distorted by central banks that it’s almost impossible to value anything even with a degree of objectivity any more; and
• Asset prices are increasingly driven by flows of capital as markets try to front-run changes in central bank policy.

All might be contributing, to a greater or lesser extent, but most are reflecting economic weakness and/or risk aversion on one hand and extreme policies of central banks on the other.

In contrast to the Fed, BoJ, BoE and (now) the ECB, the Swiss National Bank has never bought its own sovereign bonds. Nor should we forget that there are still alternative sovereign bonds with respectable credit ratings and much higher (it’s all relative) yields, e.g. US Treasuries. Yet the yield differential has not been arbitraged away, or at least not yet. And if it was, which way would it go?

What’s happening made us think about time preference and the way in which it is being distorted.

An increase in time preference implies that a higher ratio of income is devoted to consumption versus saving/investment for the future.

It should be obvious that this is precisely the aim of central bank policies to “correct” what they view as under-consumption. At its heart is a cynical inducement for businesses and consumers to make what are, in some cases, incorrect or risky spending decisions. Increasing consumption when savings ratios are low and debt is high suggests that central banks are trying to create the illusion that time preference is lower/falling when it’s actually higher/rising.

If we look at the US, for example, while debt is at an all-time high, the savings ratio is at a very low level by historical standards.

The problem becomes clear when you think more deeply about rising time preference in an economy. An increase in time preference means a corresponding reduction in saving. Saving/investment, in case we forget these days, is the basis of wealth creation, i.e. the creation and productive application of surplus. An economy with a time preference of 100% would spend all of its income on consumption and would never have any surplus for capital investment in order to increase its standard of living. Indeed, in no way is it an exaggeration to say that it was only by lowering time preference that civilisation was possible.

In normal circumstances, the more that time preference is raised, the more people live a hand-tomouth (or “paycheck to paycheck”) existence. Current levels of consumption become harder to sustain, there is less confidence in the future and time horizons shorten. In this environment, capital investment, which is the basis for wealth creation, suffers. All things being equal, high time preference would normally equate with higher interest rates as borrowers compete for scarce funds and need to offer high rates to induce people into saving.

Time preference tends to be higher for the very old, the very young, people living in less developed societies and for individuals and entities which are heavily indebted (which increasingly includes governments).

In extreme cases, it can be associated with a rise in central planning, “big government”, the subversion of property rights and rule of law and when a system starts decaying towards socialism.

Venezuela is an example of this. In such circumstances, governments “kill” productive investment, there is hoarding/shortages and capital flight emerges. What about the opposite situation?

When time preference is low or declining, a smaller ratio of income is devoted to consumption versus savings and investment. This implies a comfortable level of financial “surplus”. Current levels of consumption should be sustainable and time horizons lengthen due to greater confidence in the future. Abundant savings implies lower interest rates for borrowers. Businesses and entrepreneurs react to the higher savings/confidence with new capital investment, particularly in higher orders of production which are more distant from the final consumer. This includes natural resources, like oil & gas and metals and mining, and capital goods projects.

In a big picture sense, time preference tends to decline when a society experiences a broadly-based rise in wealth/capital accumulation. It is often associated with other factors such as technological progress, free-market capitalism, “small” government, the respect for property rights and the rule of law.

This was Douglas French writing in “High Rises and High Time Preferences”.

“The lower the time preference rate, the earlier the onset of the process of capital formation, and the faster the roundabout structure of production will be lengthened. Civilization is set in motion by individual saving, investment, and the accumulation of durable consumer goods and capital goods.”

It should be clear how central banks are attempting to distort time preference and how their policies contain a fundamental contradiction in terms of time horizons and wealth creation. In essence, they are creating an illusion.

While aggressively seeking to increase time preference, with all its negative implications, on the one hand, they are trying to give the impression that time preference is lower than it really is by making current levels of consumption seem more sustainable by forcing down interest rates and replacing savings with cheap credit. This artificially extends time horizons and increases confidence. But, lest we forget, a rising time preference is indicative of a weakening economy, not a strengthening one, and one which is more vulnerable than it looks.

It doesn’t take a genius to realise that the end result of trying to artificially lower time preference is to exacerbate the volatility of the business cycle and financial markets.

We know the result.

Each bubble is bigger than the last because the recovery from the previous bubble requires even lower interest rates and more credit creation…which induces some businesses and consumers to make a new round of risky spending decisions…and eventually…investment decisions.

There comes a point when the illusion should start to fade. The average person will start to realise that, in spite of historically low interest rates and all around central bank largesse, their time preference is not that low. In fact, it’s been rising and increasing it further would be irresponsible. Time horizons will shorten and risk increases.

The focal point of the last bubble was US house prices and associated securitised loans. House prices, which (according to Bernanke) were never supposed to fall, but were already falling more than a year and a half before Lehman collapsed.

This got us thinking about what signs we should we look for to tell if the central banks’ time preference illusion is running out of road.

Selling Time

FINANCIAL REPRESSION - Negative, long-term effects of massive Money Printing

American Thinker posted essay emphasizes the negative, long-term effects of massive money printing through quantitative easing (QE) &  of the zero interest rate policy (ZIRP) .. it's all about the financial repression of interest rates - the thinking being that if this were not done, the pain of allowing the free markets to determine interest rates would be unbearable -

"One need only imagine the bipartisan political panic were the interest paid by the U.S. federal government on its debt to double or triple, squeezing out hundreds of billions of dollars of spending on military and social programs. It is becoming ever more obvious to ever more people that sustaining these 'financial repression' policies is making economies ever more comatose; ever less dynamic. Exactly when the accumulating long-term economic damage becomes more onerous to central bankers and politicians than the short-term damage of ending QE and ZIRP can’t be known. But that inflection point will come, desired or not; willed or not. It is not avoidable."

LINK HERE FOR ORIGINAL ESSAY

If the world’s central bankers are successful in pursuit of their short-term goals by the use of Quantitative Easing (QE) and Zero Interest Rate Policy (ZIRP) -- winning the race to the bottom in currency devaluation to the cheers of economically dogmatic, faux-literate media -- these bankers can’t then avoid being failures over the intermediate and longer terms in the race to attract productive, job creating investment.

This appeared on April 10 in ZeroHedge.com:

Global central banks cut their euro holdings by the most on record last year to help mitigate losses ahead of the European Central Bank's (ECB) QE. The euro now accounts for just 22% of global reserves, down from 28% before the EU's debt crisis five years ago, according to the International Monetary Fund (IMF). "As a reserve currency, the euro is falling apart," says SocGen's Daniel Fermon. The numbers may be music to (ECB Chairman) Mario Draghi's ears -- a cheaper currency is theoretically a more competitive one.

There is no argument now that what has been and is currently missing from the global economic recovery is private market investment in the means of production -- land, building, equipment, productivity-related technology, and software. Attempts in the last 7 years by governments to tax, print, borrow, and regulate their way to prosperity are ever more clearly the reason that this private market investment has been and is being delayed, deferred and cancelled. 

No sane corporate manager invests long term into a currency that is being persistently undercut by official doctrines -- QE and ZIRP -- nor into an economy undermined by unpredictable waves of regulation and potentially confiscatory tax regimes. 

This cause and effect is now being denied only by the most dogmatic of progressive ideologues and blindest “social economists”.