Have Central Banks Lost Their Bite?
Most "experienced" traders will remember vividly the Plaza Accord of 1985; the then G-5 agreed to devalue the USD by concerted intervention in the currency markets. In the ensuing two years, the JPY declined by over 50 percent, and the DEM (the deutschemark prior to the creation of the EUR) declined by over 40 percent. There were numerous other cases, less dramatic in their impact, where central banks succeeded in moving currency rates in the direction of their choosing.
However, the Louvre Accord, signed in 1987 to arrest the USD's slide, was notably less successful; since then, major currency market intervention has been minimal and infrequent, with no discernible impact. Indeed, in 1992, George Soros decided to "short" (sell) the GBP. Despite the Bank of England's attempts to defend the currency using various methods (including currency intervention and raising overnight rates in a dramatic fashion), the strategy worked for Soros and netted the Quantum Fund over USD 1 billion.
The Bank of Japan spent a lot of effort and money trying to keep the JPY from strengthening in the early 1990s, with virtually no impact on the currency markets; all they achieved was to accumulate a war chest of USD that went into the U.S. Treasury market. Ever since then, currency intervention has occurred in smaller, emerging-market currencies, but virtually never in the major currencies.
The Plaza Accord worked for several reasons: the USD had begun to weaken anyway, so the trend favored the central banks; the central banks spent in excess of USD 10 billion on the intervention, which was a very significant number in the mid-1980s foreign exchange market; the U.S. Current Account Deficit was over 3.5 percent of GDP (and the economy was in a recession), so fundamentals supported the intervention. The Plaza Accord succeeded in most aspects, but failed to correct the trade deficit with Japan, which was structural for the most part and not currency-related.
The efforts by the BOJ to reverse JPY strength failed in the 1990s for the reasons the Plaza succeeded: trade and capital flows supported the JPY and the BOJ often acted alone in proportionately smaller amounts, causing market players to realize that their effect would be minimal and need not be feared.
The success of the Plaza Accord and subsequent failures by the BOJ and BOE might explain why intervention is less successful and less used. In general, currencies are now better aligned with their fundamentals, private capital flows can dwarf most amounts of intervention, and speculators use intervention as an opportunity to increase their currency bets. Far from fearing central banks, they use them as liquidity providers. Central banks have also discovered that verbal intervention and interest rate changes are more effective and less expensive than physically intervening in the currency markets.
Does this mean that central banks can no longer use market intervention successfully? It will be harder for it to work now; they will need to intervene in far greater amounts, with a higher degree of coordination and the intervention will need to be accompanied by other policy adjustments. It will also need to be used sparingly — and only at times of obvious and extreme imbalances, such as existed in the 1980s. Trying to reverse a trending market with strong fundamentals is virtually impossible to achieve.
If the U.S. economy were to slip into a recession later this year, a less dramatic version of 1985 would exist — a weak economy, large trade and budget deficits, and an over-valued currency. This time around, though, the chances are the market would self-correct without the central banks needing to lend a hand. The pace of decline for the USD might therefore be less precipitous, but the objective would be achieved nonetheless.
— Dave Bhagat, Senior FX Strategist, Silicon Valley Bank's Global Financial Services
|
|
Who Controls the Pipes?
Telephone companies are considering offering a new prioritization service to Internet businesses. For an extra fee, a Web business would have priority access for their data packets, enabling end users quick, unimpeded access to their site. Without the service, a site might conceivably lose smooth access for its customers. Currently, the pipes carrying Internet data are neutral and do not make any distinctions between those packets. As Congress considers the scope of telecommunications reform, one issue is whether to allow telecoms to prioritize packets in this way or to keep Internet traffic neutral. Their decision may have a profound impact on the future of information access. (PC World)
Health Trackers
A new incentive program from Intel, Cisco, and Oracle is encouraging hospitals and medical groups to adopt electronic records systems. The companies are offering financial awards of up to $150,000 per year to health care providers that adopt technologies such as electronic medical records, physician-patient chats, and services that send online medical reminders to patients with chronic diseases. The award recipients must participate in a program that tracks adoption of the technology and pay $1000 to $3000 per year in fees. (San Jose Mercury News)
Biopiracy Threat
At last week's U.N. conference in biodiversity, an international coalition led by India and Brazil insisted that current patent law be amended because it permits biopiracy, a scenario in which pharma companies find plants in foreign countries, pay a nominal fee to develop profitable, patented drugs, and reap large financial rewards. The coalition believes that countries should have the right to authorize the use of any patented product derived from a genetic resource found within their borders. Opponents of the plan fear such a process would undermine the value of a patent that was dependent on approval of a third party. (Wall Street Journal)
Energetic Funding
President Bush's recent call for energy independence has underscored the importance of funding alternative energy startups. Venture capitalists are ahead of the game, financing the sector with almost $4.4 billion from 1999 to 2004 and continuing to ramp up investment with $500 million in 2005. Nth Power, a San Francisco venture fund that focuses on new energy technologies, believes that Bush's push to develop new ethanol sources within six years will spur a flurry of additional venture activity. Most of the interest is aimed at new sources of energy and at efforts to make existing energy cleaner and more efficient. (Wall Street Journal)
'Intel'ligent Deals
Intel's international corporate venture activity has expanded. The company currently has investments in almost 1,000 companies in 27 countries. Encouraged by the high valuation of foreign startups, Intel gave 67 percent of its $265 million in 2004 funding to startups outside the U.S., especially in China, Russia, and India. In its 140 deals in 2005, 47 percent were international deals. Intel focuses on companies with products that will broaden their market, particularly offerings built on WIMAX standard for the wireless transmission of data. (VentureWire)
Valley Still Makes Tech Happen
Despite the many changes in Silicon Valley since the tech bust, the region remains the center of tech innovation due to its preeminence in three areas: sources of funding, highly trained people, and laws that encourage entrepreneurial activity. Although there's no denying that investors are looking outside the Valley, no other region can compare in terms of venture capital — California pulled in $2.03 billion in Q3 2005 alone. The recent popularity of global syndication (local VCs partner with offshore investors) has facilitated international investing. The region's legal structure supports innovation as well, with its well-established investment process, mature stock market, and protection of intellectual property. (Red Herring)
|
|
Do you enjoy the ISO each week? Share it with colleagues or peers. Invite them to sign up using the link below.
|
|
|
 |
|
|
|
February 6, 2006
Redemption and Renewal with a Fine Wine
Dinner discussions with successful venture capitalists usually focus on the next hot trend in their sector, foolhardy new entrants to the business supporting ridiculously high valuations, and governmental barriers to success. In this instance, I was suddenly hearing worries about new changes to U.S. bankruptcy law. They made the point that the new law is an affront to the U.S. tradition of redemption and renewal. How many millions among those huddled masses have come to these shores to find a new start, escaping oppression and meager opportunities in the old country? How many of our founding fathers were debtors? Weren't Washington's significant obligations to his British suppliers erased as a result of victory in the Revolutionary War? One core concern around the table was the inability of failed entrepreneurs, marked with personal bankruptcy and loaded down with lingering debts, of ever getting that fresh start. Or worse yet, would the draconian changes to the law stifle risk taking from the outset? These are important questions, so we decided to have a look.
The first thing we noticed was that filings through the first three quarters of last year hit 1.7 million, double the rate of the previous year. So, why were all these people suddenly running to court? The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 dramatically modified the 1978 statute signed by President Carter. According to data from the St. Louis Fed, the 1978 law sparked a statistically significant increase in filings to a 7.6 percent annual rate, well ahead of growth in population and GDP. Filings have even outpaced the rate of increase in consumer debt as a percentage of personal income, which has increased to 11.1 percent — up only 2 percent since 1980. The old Chapter 7 law allowed individuals to keep some key assets, get a stay from collection actions, and, in most cases, simply erase all the consumer debt on their books. Under its homestead provision, a principal residence was protected. Credit card companies were the big losers in most of these actions.
Relief seekers under the new Chapter 7 must pass a means test, showing their net income (after allowable expenses) is less than the median income for their state. If they are above that amount and they have sufficient cash flow to pay off 25 percent of the debt over five years, then they must file a plan of reorganization under Chapter 13. (Yes, the IRS had a hand in drafting this language.) Oddly, if you intend to file Chapter 7, you must dump sources of income and run up your debts quickly. Attorneys handling filings must "certify" that the filing is well-grounded or face fines and stiff civil penalties. Finally, the homestead exemption is limited to $125,000 plus accumulated equity (about enough to afford a well-appointed garage in San Francisco), except for convicted felons and securities-law violators (who are limited to a total of $125,000). Recall the ubiquitous aerial photos of WorldCom CFO Scott Sullivan's $15 million estate under construction in Florida. Florida became a haven for felons by sporting the most expansive homestead exemption in the U.S. We wonder if property values are declining in Florida as demand from the criminal class goes offshore.
So, who files for bankruptcy anyway? Research suggests personal bankruptcy results from high levels of consumer debt coupled with an unexpected insolvency event (major medical expenses, job loss, divorce, or the death of a spouse) — in essence, a mix of poor choices and bad luck. Are there any entrepreneurs in that group of 1.7 million? Probably. Will they give up on their dreams because of a five-year cash drain from old creditors? We don't think so. In our little corner of the world, an entrepreneur that has crashed and burned a couple times is often seen as further up the learning curve to success.
In some sense, the new law is a throwback to the time when not repaying one's debts was seen as a moral failure. This is why the term moral hazard describes individuals continuing to engage in risky behavior because, having been forgiven once, they don't worry about adverse consequences in the future. Canceling Third World sovereign debt is an oft-cited example of moral hazard. Old World debtors were put in prison and required to pay for their own upkeep until their debts were discharged. Some died there. It wasn't until 1842 that the last debtors' prison closed in the United States. So, how will the new law play out? Frankly, our biggest concern is not discouraged entrepreneurs, but rather, all those bankruptcy attorneys who won't take the risk of certifying their clients' filings. As that source of income vanishes, we worry about that army of entrepreneurial lawyers and what other mischief they might produce.
Awakened with a Start
Like some child jolted out of a deep sleep by a nightmare, the bond market was suddenly careening from visions of higher inflation and more rate increases. The first part of the nightmare was data driven as the strong jobs report (with unemployment at 4.7 percent), coupled with hourly earnings that seemed to rise more each month (latest at 3.3 percent), and higher unit labor costs (up 3.5 percent) implied that that days of productivity-powered, inflationless GDP growth are ending. The second chapter of this dark vision came from the FOMC's press release. In the traditional parsing of the Fed lingua franca, the market seized upon the word shift from "some further measured policy firming is likely to be needed" to "some further policy firming may be needed." (We're sure you spotted the nuance there.) In the one case, measured firming is likely, whereas in the other potential, unmeasured firming may be needed. Remember, bond buyers are, by their very nature, pessimists. Roll this all together with the uncertainly of having a new master at the helm and the market took a beating. Yields on bonds from six months to three years were up almost eight bps, bringing the 2-year to 4.57 percent. Futures are now trading with a 45-percent probability that the Fed will get to 5 percent this summer, and the bond bears are talking 5.5 percent.
— Jim Anderson, Chief Investment Officer
Investment Strategy Outlook is published each week to highlight issues we hope you find relevant and topical. The views expressed in this newsletter are solely those of its authors and do not reflect the views of SVB Asset Management, Silicon Valley Bank, or any of its affiliates.
|
|
|
|
|
|
$2.77 Trillion Budget: Raises Defense, Cuts Programs
President Bush sent Congress a $2.77 trillion budget request for next year that would shrink Medicare and other entitlement spending by $65 billion over five years, as defense and homeland security funds surge. This year's deficit forecast is a record $423 billion. The Defense Department budget increase doesn't include the extra $120 billion the president wants for military operations in Iraq and Afghanistan. The 2007 budget plan, the biggest in U.S. history, projects the economy will grow 3.3 percent in 2007. (Bloomberg)
Jobless Rate Falls to 4.7% in January
The unemployment rate fell to a 5-year low of 4.7 percent in January as 193,000 jobs were added to nonfarm payrolls. The January payroll figures fell short of expectations of a gain of 248,000; but with upward revisions to November and December of 81,000, the total payroll gain in the past few months was slightly more than expected. "This is a Fed tightening trifecta: strong economic growth (via payrolls), resource utilization pressures (via the unemployment rate) and inflation risks (via average weekly earnings)," said Sherry Cooper, chief economist for BMO Nesbitt Burns. (MarketWatch)
Import Addicts
President Bush's comment that America is addicted to oil from the Middle East generated plenty of headlines, but it's just one in a long list of imported goods that the U.S. is addicted to. Trade-deficit data shows that American consumers are also hooked on consumer products and manufactured goods with a price tag that's two and a half times larger than that of oil. These habits will help set a record trade gap for 2005 this week, as the Commerce Department releases the December monthly trade report and the trade deficit for the entire year. (MarketWatch)
|
|
|
|
|
|
The 'Long Bond' Is Back, Lower Than Ever
The U.S. Treasury may pay the lowest yield ever to borrow for 30 years in the first sale of the government's longest-maturity bonds since August 2001. Yields on 30-year bonds dropped more than three-quarters of a percentage point since the government's last sale of so-called long bonds. Pension funds, which will have an expected $150 billion of debt due in 10 years or longer to pay for retirees, are expected to be big buyers. (Bloomberg)
More Supply Hurts Treasuries
U.S. Treasury notes fell this morning on speculation that as many as two more Fed rate hikes will soften demand for the $48 billion of debt being sold this week by the government. The declines extend a slump that pushed 10-year yields to their highest levels since mid-November, as government reports showed gains in consumer spending and wages, and a drop in unemployment. The Treasury will sell 3- and 10-year notes and 30-year bonds starting tomorrow. (Bloomberg)
Bush Spending 'Comes Home to Roost'
President Bush has increased the national debt 45 percent while cutting the share of the budget spent on interest by almost a third. Until now that is. Declining rates under Bush's watch allowed interest expense to drop to 14.2 percent of the budget in fiscal 2005, from 20.2 percent in fiscal 2000. Move to 2006 — debt is still rising but so are interest rates. The impact of this rising debt will be felt for the first time. (MarketWatch)
|
|
|
|
|
Printer Friendly Version
