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by Ashraf Laidi
Posted: Feb 20, 2010 5:00
Comments: 30765
Posted: Feb 20, 2010 5:00
Comments: 30765
Forum Topic:
EUR
Discuss EUR in this thread
they need to get a room at the library :)
anyway let’s not overcomplicate things.. simply since “QE .. reduces US Treasury supply” this drives prices of every other financial asset as money have to be deployed somewhere if it is not real economy which is not.. and in particular reduces demand for US$ as various CBs are forced to look elsewhere to invest their reserves eg. in net issuance export countries like Australia and NZ.. eg. over 60% of NZ issuance is foreign own now and growing, and consequently pushing NZD far beyond fair exchangeable value..
Nevertheless for the time being, the fixed exchange convertible regime is actually traded.
That is currency is money and hence an asset to own and hold.
Thus the question is how is the conversion , that is the price of a currency in terms of another currency determined. Basically, the present value is determined by expectations of value in the future. This is kind of a hyperset logically and a function which has itself as argument mathematically, the latter more usable and known as "chaotic".
But in practice I think it is just value at risk and hence depending on boundary conditions.
While apparently a set of differential equations exists, the focus is on determining boundary conditions..
What QE does do is the following: 1) it essentially negates US Treasury issuance from the Treasury, net on net resulting in a comparable effect as if the Treasury never issued those securities (eventually bought by the Fed), and 2) it decreases coupon interest income that the private sector otherwise would have received (from the vertical component). The "profits" the Fed distributes back to the Treasury that are reported on an annual basis is no more than the net coupon interest income that otherwise would have gone into the private sector.
As a result, rather than being inflationary (QE is no more than an asset swap involving funds and securities that are confined to the inter-banking system rather than the incorrectly reported "flood of US Dollars"), QE is deflationary because it reduces US Treasury supply (less supply can drive a lower rate environment) and it removes coupon interest income that otherwise would have gone to the private sector.
The financial markets, including Ashraf, have completely misinterpreted the operational reality of QE even though QE has been performed a number of times in history (US Fed Chairman Marriner Eccles essentially executed QE in 1948 after Pearl Harbor, and Japan). QE is not a flood of US Dollars; it is not resulting in a surplus of US Dollars. Rather it is reducing coupon interest income that otherwise would have been paid to the private sector AND it is reducing available US Treasury supply.
"The bond market continues to flash warning signals. We must stress that its likely that a major round of risk aversion is likely to show up in bonds first. Ten-year Treasury yields fell to 2.87% -- the lowest since the credit crisis. "
And that is of course USD negative....
(scratching head )
And yes the FED continues to "print money" and QE3 is just 'round the corner.
Nope.
The key question in fx is : how is the value of a fiat currency determined?
Hint: not by sentiment and not by chart astrology. It is applied maths.
The approach by Scholes and Black to determine option price holds also for determination
of value of currency. The Scholes Black partial differential equation has , as every partial differential equation, infinitely many solutions. But the idea is valid for currencies as well
namely perfect hedging of risks. Thus the value of every fiat currency is determined by its value at risk.
And yes the yields of bonds indicate the value at risk.
Thus from bond yields one cannot guess but just read what will happen with USD and with EUR.
No nead for charts.
Proverbial nightmare updating my charts after vacation :-(