Why has the dollar been falling, and the Euro climbing, through 2017 ?
This is my stream of consciousness attempt to work out things about the economy I think are important. Things I have a hard time finding someone explaining using Google searches.
I’m interested for investment purposes, and effect on peoples’ standards of living, and all the things currents in the economy effect.
Sometimes I get things wrong, but I don’t go back and correct them. I just proceed with my new and improved knowledge, to tackle the next topic, which again, may involve misconceptions or partial understandings.
I welcome anyone to correct me where I’m wrong.
I should go back and get more charts and references for things I mention, but I’m too lazy. So you’ll just have to read my mind. I’ll try to make it legible.
To me, these charts say the market thought Trump in office, meant good for business, meant the Fed raises rates, which contracts our money supply, relative to other currencies still being printed (eased…Euro, Yen, Yuan, etc).
Trump being pro-business leads to a strong economy, which leads to fed tightening, which means stronger dollar…makes sense, right?
Wrong! But why?
Why is the dollar going down and the Euro up in 2017?
And why is the dollar going down in general, when our Fed is tightening, while everyone else is still loosening?
When the Fed has long since stopped QE, and the ECB is still printing money, shouldn’t the US money supply be contracting, while the Euros expand?
I have Googled this question, and it’s surprisingly hard to find an answer. Search results are old, and mired in rudimentary talk about QE.
I have also asked the question in trader chats, and to random strangers. Crickets. Guesses? I guess all I can do is guess.
Fed So and So
A related question that also arose, is in the recent Fed Head speeches, one of the main ones, not Yellen, but, anyway, he said, even though the Fed had started to raise rates, the economy is perplexingly still “easing.” What did he mean? And that therefore, the Fed can accelerate towards further rate raises, and also unbalancing (unwinding, deleveraging, reducing) their $4.5 trillion balance book.
This is also hard to Google. Again, you get the gatekeepers talking about QE and whatnot, again. But I persisted. And found this article that helped my guess a little better.
The current in currency
Originally, I had simplistically thought that printing money, the way the Fed did it, just injected money into our economic veins, which increased the money supply, and therefore leads to inflation (more money = less value per bit of money.)
And this is true, in the sense that, if the government takes a loan, and the Fed creates the money to give it to them, and the government spends it, it does enter circulation.
But there are also other reasons this action has economic repressions.
I had also thought, surely also the frequency of transactions matters. If you had a smaller amount of money, but it changed hands more, you’d get more GDP, and more earning, and quicker producing, and so on, right?
At first I never saw discussion about this. But eventually, I did find it popping up in things I read, like the article I just linked. So it is a thing. An economic indicator on central banker dashboards.
This adds a little more nuance to my understanding of how their actions reprecuss. I still believe they are telegraphing to the world loud and clear, that they are going to drive down prices of stocks and bonds, by “unwinding” their balance sheet.
But I want to more clearly understand the mechanism. And also why the dollar and euro are not behaving the way I had expected.
The big idea
So their idea is, they lower the base loan rate. But normally banks still charge positive interest on loans, or they won’t make a profit. They add something to it, a premium.
And if you wanted to sell bonds, and you were the government, or IBM, you’d want to offer the least interest possible, get the best rate possible, when you borrow.
So in addition to lowering the floor on how low bonds and loans can be priced, the Fed comes in and buys up shitloads of bonds at near zero or zero or subzero or whatever.
The bond market is an open market, a free market. But normally, no one would buy a zero interest rate bond, let alone a negative rate bond. So there are no free market takers for these new bonds.
There are two things the free market can do, in order to invest. Either buy bonds issued in the past, which had more interest (which drives up the prices for old bonds, and bond futures prices), or put their money somewhere else. Much of that money went in to stocks, and gold, and stuff.
I remember one of the things that dismayed central bankers, was that a lot of that money, that they scared out of “safe” investments, like bonds, just sat there, stagnant. It lost all velocity, currency, it just laid there, dead cash.
Why, btw, are bonds considered “safe?”
Because you don’t expect the US government, or a state or city government, or IBM, or the EU, to go out of business. Which, come to think of it, is a little scary, since the EU does seem like it could go out of business.
Scary yield-less zombie bonds
Anyway, the idea of the central bankers was, that by scaring money out of bonds, people would spend it. Some did. But a lot bought stocks or gold, and then again, it just sat there, until the next guy bought their stocks, or gold, if the first guy ever sold.
In order to create earnings, and raise GDP, money has to change hands. If a smaller amount of money changes hands more times, it creates the same effect as if there is more money supply moving more slowly.
If the frequency of money speeds up, that means demand is greater, supply gets tighter, prices go up, hence inflation.
Inflation, good. We likey inflation, because it reduces the amount we have to pay back on loans.
Deflation, bad! Our loans cost more than our equity is worth. Default, money supply shrinks, cascade effect. Until central bankers step in, print more money, to reverse the process yet again.
I’ve seen charts that show how the frequency of transactions has fallen since the 1970, when the curve of “financialization” started. You’ll just have to imagine them, or remember them, or look them up yourself.
In the 70s it took $2 of new debt to create every $1 of GDP growth. That means, half if it was being squirreled away, “invested.” Now it takes $6 of new debt to create $1 changing hands. The other $5 are in the stock market, and gold, old bonds, and so on.
This is how the rich get richer, parabolically, while the trend is flat for most people, or slightly up, depending on each strata lower you go, in the top % of earners.
If all the money created through debt flowed the economy as currency, then the economy would increase as the same speed as the money supply. Whatever part of the money supply is not circulating is “invested.” So investments, things that hold value, generally grow at a rate exponentially larger than the economy itself.
So there ideally would also be a measure of: if the quantity of transactions, and the speed of transactions, took place as a few big transactions, or lots of little ones. Lots of little ones would be like an early stage in life. A few big ponderous ones, probably later. At least, that has been the trend over time.
Why then €up$down?
Does this tell us what is happening in the Euro Zone and the US right now, to make the Euro go up, and the dollar go down?
When Fed speaker so and so, said that the US economy is surprisingly continuing to “ease,” even though the Fed had started to raise rates, and telegraph more future “tightening,” it doesn’t necessarily mean that people and businesses are taking more loans, creating more money, and therefore transactions. It can also be more transactions with the already existing money.
And in fact, for 2017, the % of new commercial and industrial loans being taken has been crashing towards zero. Which is normally a bearish sign for the economy, leading towards recession. So it’s probably the other thing, the economy speeding up, “heating up.” Imagine the chart.
One thing that seems to have caused this, is the pro-business rhetoric, image and hopes pinned to Trump.
As a person with a business, catering to businesses, we can attest that business has picked up. There are more transactions.
Therefore, more transactions, does indeed lead to the effect of an increasing money supply, hence, a weaker dollar (“inflation”). Don’t worry, the Fed will put a stop to that!
Meanwhile, in Europe…
Having not heard Draghi’s comments, we can only guess that what is happening in Europe is something very different. Even though the EU is STILL printing money, as fast as the US Fed ever printed it, the Euro zone is not increasing transaction speed, circulation, as fast as the US…or otherwise getting the money they are printing in to some form of transaction, GDP.
And the Euro zone has gone in to the heretofore never heard of extreme life support tactic of negative rates! So when they are borrowing this money in to existence, they are forcing bondholders (themselves…obviously not the free market in its right mind) to pay for the privilege to hold the bond.
And the EU DOES buy corporate bond. So it’s like IBM says, I want to borrow $1billion. How much interest do I have to pay you if you loan it to me. The ECB is like, dude, we’ll loan you $1billion, and pay you 1% per year, as long as you hold it!
So, IBM says, cool. Borrows the $1billion. And what do they do with it? We’ll, possibly nothing. They are already earning 1% on it (still a flabbergaster.) And of course, if they do nothing, no transactions take place, there is no current in the currency. It’s more like a swamp of money.
But they could also do something else, like buy stock. Hey, how about their own, we (IBM) pays 1.5% dividends, or whatever. This “buyback” reduces stock on the open market, raising the stock price, raising the bottom line of IBM, and raising their profits; but again, creating no current in the money supply.
They can also buy other things, like stocks of other companies, ETFs, whatever. There are lots of things they can buy to make money with money, but not produce products, paychecks, transactions.
So this, process, again, grows the stock market, but not the economy. Therefore, the EURO zone, while printing money, has the net effect of less new earnings and GDP (inflation) than the US, even while printing money. It’s the same as less total money supply, if you took time (transactions, frequency) out of the equation.
This means the Euro zone economy sucks!
Now that we think we understand the seemingly weird play in the dollar and euro values for 2017, using the same new guesses about how this all works, what should we surmise will happen when the Fed starts to “unwind” their balance book?
Deleveraging means that, when bonds expire, that they bought from the government, or mortgage backed bonds, they are not going to renew the loan.
Since the government always runs a deficit, it needs to not only renew its old bonds (at current interest rates), but sell more of them. And we hope there is always a net deficit of mortgages too, since we want more of the private sector to be taking loans to buy houses.
In order to get real free market participants (you, me, China, IBM, whoever) to buy these bonds, the government and Fanny Mae will have to offer them with some interest, some reward.
At first, the Fed will unload $6 billion per month of bonds on to the free market, which they intend to increase quarterly, until they are either unloading $80 billion bonds per month, or disaster hits, or looks immanent.
The more they unload, the more buyers they need to attract, so the higher the interest rates will have to be on new bonds.
So what this would cause would be slowly raising interest rates, making old bonds less valuable. New bond buyers start to buy actual new bonds. They sell their old bonds, or stocks, to buy new bonds. And therefore the bond and stock market both go down.
If you had a geostrata type chart of the amount of bonds floating around at zero % interest, then .25%, .5 % and so on, you’d have a granular view of the pace at which money would flow out of old bonds, and in to new ones, as new ones hit each successive layer. But that would just be one measure.
Amounts of stocks and bonds
At what point do people start selling stocks, or gold, or whatever, and start buying new treasury bonds instead? And in what way, and when, does this affect “the economy,” which is that above equation, quantity of money x velocity of money, which translates in to GDP, which can be broken down in to types of transactions, big and small, and their effect on various businesses, and their earnings reports.
It might behoove us to remember that the bond market is many times the size of the stock market. So when bond money was scarred out of bonds by Fed buying, there was a lot of it. The bond market is about 4x the size of the stock market. So money flowing in or out of the bond market might have outsized effects on the stock market.
One thing we can surmise is that stock prices falling will lead to lower earnings reports from companies, since the big ones used the aforementioned scheme (borrowing and investing money) to add to their bottom lines. I think this figure is actually listed in Finviz. The financial earnings of the company, or something.
We also have the wild card of the Swiss National Bank, and the ECB and so on, who did something our Fed (presumably) did not, which was acting like a hedge fund, and using their “balance book” to buy stocks. It’s probably not wild, once we dig through it. But it’s a side topic.
So, seemingly, the Fed reducing their balance book, should result in a decline in the stock and bond markets. An orderly one, or so they hope.
How does orderly become less so?
If hedge funds, mutual funds, giant holders of stocks, believe that the stock market will fall, they begin to unwind large positions. It’s the same as an uptrend in reverse. The large entities “distributing” their stocks on to the market have to do this in tranches.
Their positions are so large, they cannot acquire nor unload them all at once. So prices tend to move in big lurches, when the whale are feeding, or, whatever is the opposite of that.
This is all natural, and ok, as long as it’s orderly. Make your way to the exits, in an orderly fashion, please.
But there is the idea that the stock market leads the economy normally, be 6 to 9 months. Why would that be? If the stock market went down, why would the economy follow?
Well, one thought that comes to mind, particularly in an increasing “financialized” corporate world, is that some big corporations will become less profitable, simply because the stock market is going down, and part of their profit comes from stocks they own.
They are not necessarily changing what they produce, or the economy. But when they earn less, they produce less GDP, and they might shed some jobs. Meanwhile, automation might combine with that trend. Some of the lost jobs don’t become new jobs. Some people default on loans. Sell their stocks and to get by. The defaulted loans shrink the money supply, etc. There are lots of factors, like with any complex system, involved with deflation, of whatever asset.
The story of the Fed is that when they stopped printing money, and the stock market flattened out, and the economy didn’t crash, and then after a couple of years, even surged forward, showed that the heart paddles of QE worked. And the patient was fit as a fiddle again.
To the extent that this is true, in theory, they’d be able let the free market take up the slack that they created with cheap, free money. This will cause the stock and bond markets to fall, but in theory would not make the economy falter.
I think that has not historically been the case, and is not likely. But that’s another topic requiring more digging. And when we do that further digging, we should probably think through the “yield curve,” the ratio of interest yield on bonds, depending on their expiration.
Typically, the yield curve inverting has been a precursor to a recession. This means when the short term bonds, like 1 or five years, starts paying more interest than longer dated bonds, that’s a bad sign.
Why? Another topic for further thought. I’m sure it’s secrets will reveal themselves under sufficient scrutiny.
You can see if the yield curve is inverted yet, here.