Every moment of stress in the global financial system is a test of lines of interconnection and power. The most obvious example of this right now is the sanctions regime imposed on Russia. That has provoked a surge in debate about possible alternatives to the dollar, ruble-yuan systems, commodity-based networks of finance etc. The line I have been taking in Chartbook is that talk of alternatives to the dollar is not so much premature as reflective of an unease with the present, which finds relief in
There are so many ways to "hedge" UST positions by Japanese investors that can be impacted that I am suspect of this explanation. First, investor could truly hedge all future USD cash flows (all coupons and final principal at maturity) back into JPY through a cross-currency swap. No-arb pricing demands this would generate a synthetic yen asset (ignoring counterparty risk) that would return about same as JGBs. So this is not very common. Alternatively investor could interest rate and/or basis swap only the fixed USD coupons into either fixed or floating JPY for all or part of the life of the UST and leave principal un-hedged. This protects income statement from FX risk (and who cares about balance sheet impact with new accounting for financial institutions allowing most bonds to be carried at cost without MTM -- I say this only partly in jest). More common, I think, is to hedge through outright FX forwards only the principal. And this is often hedged for only 6 months or one year into the future (so not out to 10 year maturity of a UST -- 10-year outright FX forwards are not particularly liquid). Higher and rising USD rates relative to JPY rates mean, of course, that the forward sales of USD for the hedges are at growing discounts, thereby hurting expected returns. But note the word EXPECTED. There is so much left UNHEDGED in these strategies (most if not all of the coupons and the remaining life of the UST after the FX forward hedge maturity -- whatever that might be -- are left unhedged) that I find arguments for asset demand based on currency hedging costs to be unreliable. NB: be careful of the use of the simple single word "swap". It can mean many different things (interest rate, cross currency, basis, interest differential forwards, etc) and is used differently by players in different parts of the world. FT journalists are some of the worst for confusing this, and most Bloomberg writers are not much better.
Great post as usual Adam! I'm not sure how many Japanese investors in treasuries actually hedge via cross currency swaps and I can't remember where I read something to the effect that the cross currency swap market isn't large enough for the holders to hedge all of their exposure. Therefore, the vast majority wear the currency risk precisely bc it is expensive to hedge and the market can't accommodate them.
Michael Hudson points to a crisis on Wall Street happening in 2019 that got wrapped up into the Covid response you describe in Shutdown. I read both of y'all's books and assume you may look at him askance, but I was wondering if there was already some instability in the system we should account for in our decision whether or not to panic.
I'm not personally panicked because things usually go slowly, and I generally take your word for stuff I don't understand well, but I think de-dollarization will eventually happen, and we seem to be pushing it along, driving our "enemies" togther. And when it happens it seems like something we should do in an orderly way. Or is splitting the globe into two halves the "orderly" solution US actors/owners have landed on?
Hi Adam! I loved the question. I would need to re read it before I understand your attempt at answering it. I do have a remark, at the end you mention the low inflation in Europe, i believe last week German inflation number was like 8%? Thats in line with the US number. What is out of whack policy wise is the ECB and BOJ keeping their low interest policies while the FED is pressed to Hike (6x this year).
Why is the whole world somehow capitulating to US aggression? Have they forgotten 2008? It makes no sense. The US prints its currency. It is propped-up by the likes of Petrodollars. The US literally gets a way with murder, gets away with flooding regions and specific conflict areas with weapons, gets away with punishing emerging nations, gets away with devaluing the quality of life in dmmm near every nation. And the world bows to the US. This concept of employing sanctions and threats thereof should be banned altogether. And still the world bows to the US. If you do global business, you have no guarantee of not getting screwed by the US the next day. You have no guarantee that what happens in the US won't cause your own nation to fail. As one body, nations together should tell the US that it will no longer buy its debt, until the US govenment assures everyone that it will only promote peace and not more of this manipulation seen in every part of the world... especially this Ukraine debacle.
Ask yourselves, why does Scandinavia just now see the need to join Nato? Ask yourselves why the Emiratis and Saudis won't return a call from the WH. Ask yourselves, which emerging nation sees any hope of recovery from inflation,since sanctions now threaten global supplies? Ask yourselves, why has each nation decided to abandon a trade partner in Russia after years and thru Jan 2022 of doing business with little incident? Chinese companies listed on NYSE? Nations dependent on wheat exports, aka the basic necessities for life? Everyone is having to play ball with the US.
And one field nuke into Kyiv, one into Lviv, one into any nuclear facility, one into Odessa and one into Mariupol simultaneously really will show just how f....n stupid sanctions are, and how useless they are to the biggest of pictures for all but the crappy US elite. Prove me wrong.
There are so many ways to "hedge" UST positions by Japanese investors that can be impacted that I am suspect of this explanation. First, investor could truly hedge all future USD cash flows (all coupons and final principal at maturity) back into JPY through a cross-currency swap. No-arb pricing demands this would generate a synthetic yen asset (ignoring counterparty risk) that would return about same as JGBs. So this is not very common. Alternatively investor could interest rate and/or basis swap only the fixed USD coupons into either fixed or floating JPY for all or part of the life of the UST and leave principal un-hedged. This protects income statement from FX risk (and who cares about balance sheet impact with new accounting for financial institutions allowing most bonds to be carried at cost without MTM -- I say this only partly in jest). More common, I think, is to hedge through outright FX forwards only the principal. And this is often hedged for only 6 months or one year into the future (so not out to 10 year maturity of a UST -- 10-year outright FX forwards are not particularly liquid). Higher and rising USD rates relative to JPY rates mean, of course, that the forward sales of USD for the hedges are at growing discounts, thereby hurting expected returns. But note the word EXPECTED. There is so much left UNHEDGED in these strategies (most if not all of the coupons and the remaining life of the UST after the FX forward hedge maturity -- whatever that might be -- are left unhedged) that I find arguments for asset demand based on currency hedging costs to be unreliable. NB: be careful of the use of the simple single word "swap". It can mean many different things (interest rate, cross currency, basis, interest differential forwards, etc) and is used differently by players in different parts of the world. FT journalists are some of the worst for confusing this, and most Bloomberg writers are not much better.
Great post as usual Adam! I'm not sure how many Japanese investors in treasuries actually hedge via cross currency swaps and I can't remember where I read something to the effect that the cross currency swap market isn't large enough for the holders to hedge all of their exposure. Therefore, the vast majority wear the currency risk precisely bc it is expensive to hedge and the market can't accommodate them.
Michael Hudson points to a crisis on Wall Street happening in 2019 that got wrapped up into the Covid response you describe in Shutdown. I read both of y'all's books and assume you may look at him askance, but I was wondering if there was already some instability in the system we should account for in our decision whether or not to panic.
I'm not personally panicked because things usually go slowly, and I generally take your word for stuff I don't understand well, but I think de-dollarization will eventually happen, and we seem to be pushing it along, driving our "enemies" togther. And when it happens it seems like something we should do in an orderly way. Or is splitting the globe into two halves the "orderly" solution US actors/owners have landed on?
Another outstanding take
Hi Adam! I loved the question. I would need to re read it before I understand your attempt at answering it. I do have a remark, at the end you mention the low inflation in Europe, i believe last week German inflation number was like 8%? Thats in line with the US number. What is out of whack policy wise is the ECB and BOJ keeping their low interest policies while the FED is pressed to Hike (6x this year).
Why is the whole world somehow capitulating to US aggression? Have they forgotten 2008? It makes no sense. The US prints its currency. It is propped-up by the likes of Petrodollars. The US literally gets a way with murder, gets away with flooding regions and specific conflict areas with weapons, gets away with punishing emerging nations, gets away with devaluing the quality of life in dmmm near every nation. And the world bows to the US. This concept of employing sanctions and threats thereof should be banned altogether. And still the world bows to the US. If you do global business, you have no guarantee of not getting screwed by the US the next day. You have no guarantee that what happens in the US won't cause your own nation to fail. As one body, nations together should tell the US that it will no longer buy its debt, until the US govenment assures everyone that it will only promote peace and not more of this manipulation seen in every part of the world... especially this Ukraine debacle.
Ask yourselves, why does Scandinavia just now see the need to join Nato? Ask yourselves why the Emiratis and Saudis won't return a call from the WH. Ask yourselves, which emerging nation sees any hope of recovery from inflation,since sanctions now threaten global supplies? Ask yourselves, why has each nation decided to abandon a trade partner in Russia after years and thru Jan 2022 of doing business with little incident? Chinese companies listed on NYSE? Nations dependent on wheat exports, aka the basic necessities for life? Everyone is having to play ball with the US.
And one field nuke into Kyiv, one into Lviv, one into any nuclear facility, one into Odessa and one into Mariupol simultaneously really will show just how f....n stupid sanctions are, and how useless they are to the biggest of pictures for all but the crappy US elite. Prove me wrong.
Good point! When you’re operating inside a box, every corner looks like an opportunity!