Month: September 2014

Submitted by Gavekal Capital blog,

You all remember March 6th, 2009, right? Some days are easier to remember than others and March 6th, 2009 will not easily be forgotten as that was the day when the S&P 500 made its now infamous "666" intraday low and it also marked the closing price low of 683 for the S&P 500 during the financial crisis. Seems like a very long-time ago as the S&P 500 is roughly 1300 points higher than the intraday financial crisis low.

Interestingly, as of the close yesterday, the spread between the 10-year treasury and the 30-year treasury fell to its lowest level (69 bps) since that infamous day.

Since April 2013, the long-end of the yield curve has steadily fallen by 55 basis points.

It is not just the long-end of the yield curve that has narrowed. Inflation expectations implied by both 10-year and 30-year TIPS have fallen substantially since the beginning of August.  

Breakeven inflation implied by 30-year TIPS has fallen by 25 basis points and breakeven inflation implied by 10-year TIPS has fallen by 34 basis points.

 

The spread between 10-year and 30-year TIPS has also narrowed by 25 basis points since August 13th.

 

If the dollar continues to strengthen, it seems reasonable to expect the spread between 10-year and 30-year TIPS has further to fall.

 

*  *  *

So what do bonds "know"?

via Zero Hedge http://ift.tt/1uzmlp7 Tyler Durden

Here it is.. the Fed’s buying guide for October. The Federal Reserve Bank of New York has released its $10 billion open market purchase plans… and the buy-into-the-weekend trade may get dented as there are no POMOs on a Friday in October.  After October 28th, equity bulls are on their own with their ‘fundamentals’ as its game over for QE.

 

 

Source: NY Fed

via Zero Hedge http://ift.tt/1rr5aEZ Tyler Durden

Back in the day, when the sophisticated deep thinkers who effuse deep economic thought, were deeply contemplating whether the Fed’s IOER was a better tool to assist if and when (hint: never) the Fed begins to hike rates, or whether the relatively new (conceived about a year ago) Reverse Repo was the better candidate to help push liquidity out of America’s bloated financial institutions, we made it very clear that the entire debate is completely irrelevant, as the only purpose of the Reverse Repo was to assist banks in pretending (with the Fed’s explicit knowledge) that they have a better balance sheet than they represent.

We did this first in January in “Window Dressing On, Window Dressing Off… Amounting To $140 Billion In Two Days”, then in April in “Month-End Window Dressing Sends Fed Reverse Repo Usage To $208 Billion: Second Highest Ever“, then in June “WTF Chart Of The Day: “Holy $340 Billion In Quarter-End Window Dressing, Batman“, then in July “Record $189 Billion Injected Into Market From “Window Dressing” Reverse Repo Unwind.”

Of course, the abovementioned deep thinkers ignored this because it would mean that all the argumentation about the Reverse Repo facility as a means to assist the rate hiking cycle was irrelevant, and that instead of hiking rates the Fed was far more concerned with the collateral shortage that the TBAC loudly complained about in the summer of 2013… just months before the RRP was unleashed (recall “Desperately Seeking $11.2 Trillion In Collateral“). Pure coincidence, right?

Well, the argument largely became moot when two weeks ago, following the Fed’s recent announcement Reverse Repo would be capped at $300 billion, leading even the deepest of pundits to realize they have been fooled all along, and the RRP facility was never meant to be a rate hike-facilitating mechanism, the Fed released this:

Statement to Revise the Time of Day of the Overnight Reverse Repurchase Agreement Operation for September 30, 2014

 

As noted in the September 17, 2014, Statement to Revise the Terms of the Overnight Reverse Repurchase Agreement Operational Exercise, the Open Market Trading Desk (the Desk) at the Federal Reserve Bank of New York (New York Fed) has been working internally and with market participants on operational aspects of tri-party reverse repurchase agreements (RRPs) to ensure that this tool will be ready to support the monetary policy objectives of the Federal Open Market Committee (FOMC).

Regarding the operation to be conducted on Tuesday, September 30, 2014, the Desk will conduct the operation several hours earlier than usual, from 8:00 to 8:30 a.m. (Eastern Time).  All other terms of the exercise will remain the same.

 

This change only applies to the operation conducted on September 30, 2014. The operations conducted from Monday, September 22, to Monday, September 29, and those conducted on and after Wednesday, October 1, will be conducted at the previous time of 12:45 to 1:15 p.m.  Any future changes to these operations will be announced with at least one business day’s prior notice on the New York Fed’s website.

Wait, why did the Fed explicitly warn that just one reverse repo operation would be temporally-adjusted, namely that of September 30, i.e., today? Simple: what is today?

Why quarter end, “window dressing” day of course.

In other words, the Fed ripped off the mask that RRP was anything more than a way for the Fed to allow banks to appear more palatable to… drumroll… Fed regulators. Regulators such as Carmen Segarra, who once again made the news, not only for being fired for daring to ask probing questions about the Fed’s “close” relationship with Goldman Sachs, but for providing 48 hours of recording confirming that the NY Fed is merely a branch of Goldman Sachs.

So fast forward to today at 8:30 am when the Fed announced the result of today’s “special” window-dressing Reverse Repo operation. What was unveiled blew our socks right off, because not only was the Reverse Repo an absolutely whopping $407 billion, but the low rate on the auction was an unprecedented -0.20%!

 

And here is what today’s operation looks like in historical context:

That’s right: at $407 billion, it far exceeded the $300 billion new cap on the program.

So yes: everyone can now admit that Reverse Repo was nothing more than Fed-mandated window dressing, no point in covering that up any more.

But what about that Low rate of -0.20%?

For the answer we go to Stone McCarthy which has done a forensic analysis of precisely what happened in today’s “Crazy” (as they call it) Reverse Repo operation.

From SMRA:

Quarter-End ON RRP Craziness

 

Today’s quarter-end ON RRP offering from the Fed included a total of $407.167 bln in submissions, far exceeding the new $300 bln overall cap on the program

 

As such the 5 bps fixed rate was not applicable, and the allocation was decided by an auction mechanism. Bidders (since September 22) are required to include in their submission a rate at which they would be willing to engage in the Fed’s RRP operation. Today these bids ranged from a low of -20 bps to a high of +5 bps.

 

The Fed by starting at the lowest rate and working upward was able to do the $300 bln max at a stop-out rate of 0%. All awards were at this stop-out rate. Thus the bidder at -20 bps was probably envisioning a stop out rate well above their -20 bps bid.

 

 

Today’s offering was a test of the program. The Fed conducted this operation at 8:30am this morning in anticipation of quarter-end considerations. Typically the dealine for the operation is 1:15pm. The stop-out rate was even lower than what we envisioned. We were thinking 1 or 2 bps.

 

What this means is that today’s offering was done at a rate below the fixed rate of 5 bps, and thus today the floor aspect of the ON RRP program was not effective. This will probably be the situation at most future quarter-end offerings.

Oops: this means that the RRP as a mechanism to hike rates will certainly fail due to the discontinuity of collateral requirements, which spike at quarter end. Because try as it might, the Fed simply has no way of hiking rates on all other days except March 31, June 30, September 30 and December 31.

Why such a surge in submissions?

 

As quarter-end approaches dealers typically pare positions for balance sheet dressing purposes. They may also be less willing to engage in matched-book RP activities in helping financing their customers.

 

The lull in dealer financing demand means that the MMFs, the primary counterparty party to the Fed offerings, have liquidity to put to work that is redirected to the Fed ON RRP offering.

 

At previous quarter-ends the MMFs have accounted for around 89% of the “take-up” of the ON RRP offerings.

 

 

This compares to around 82% on non-quarter-end dates.

 

 

Does this argue for a higher cap than the $300 bln?

 

Not necessarily. The MMFs, of course, wish that cap were higher. If so, such may have provided ample quarter-end investment opportunities with positive interest rates. Indeed, some Treasury bills were trading at negative interest rates in response to the capping of the ON RRP program at $300 bln, previously there wasn’t a cap.

 

The cap was imposed because the FOMC was worried that in times of financial distress (not routine quarter-ends) the MMFs would only engage in lending to the Fed with the dealers and other money market borrowers getting cut off.

 

Some worried that the Fed might become too dominate a player in the money markets.

 

The results of today’s offering are not really surprising. The Desk probably anticipated something close to what happened here. We think that what we saw in today’s offering will be typical of future quarter-ends. Despite that fact that the MMFs would probably prefer a much higher cap, thereby rendering somewhat higher quarter-end returns, what they are earning (0%) is still better than the negative returns on bills that mature early in the new quarter. In other words, the ON RRP program is still a better alternative than what would exist in the absence of this program.

And there you have it.

A bigger problem, however, emerges, now that it is empirically proven that the Reverse Repo is now meaningless and doomed as a means to allow the Fed to hike rates in a world in which the Fed Funds rates is irrelevant, and a parallel rate corridor somehow has to be established. Which means that only the IOER fallback exists, a rate hike environment fallback which as we wrote back in 2012 is also meaningless as it only controls for one half of the rate increase corridor.

So… still betting on a rate hike in mid-2015, when the Fed itself has just admitted, and the market has confirmed, it has no clue how it will hike rates?

We’ll take the much, much over.

via Zero Hedge http://ift.tt/YInAoj Tyler Durden

Back in the day, when the sophisticated deep thinkers who effuse deep economic thought, were deeply contemplating whether the Fed’s IOER was a better tool to assist if and when (hint: never) the Fed begins to hike rates, or whether the relatively new (conceived about a year ago) Reverse Repo was the better candidate to help push liquidity out of America’s bloated financial institutions, we made it very clear that the entire debate is completely irrelevant, as the only purpose of the Reverse Repo was to assist banks in pretending (with the Fed’s explicit knowledge) that they have a better balance sheet than they represent.

We did this first in January in “Window Dressing On, Window Dressing Off… Amounting To $140 Billion In Two Days”, then in April in “Month-End Window Dressing Sends Fed Reverse Repo Usage To $208 Billion: Second Highest Ever“, then in June “WTF Chart Of The Day: “Holy $340 Billion In Quarter-End Window Dressing, Batman“, then in July “Record $189 Billion Injected Into Market From “Window Dressing” Reverse Repo Unwind.”

Of course, the abovementioned deep thinkers ignored this because it would mean that all the argumentation about the Reverse Repo facility as a means to assist the rate hiking cycle was irrelevant, and that instead of hiking rates the Fed was far more concerned with the collateral shortage that the TBAC loudly complained about in the summer of 2013… just months before the RRP was unleashed (recall “Desperately Seeking $11.2 Trillion In Collateral“). Pure coincidence, right?

Well, the argument largely became moot when two weeks ago, following the Fed’s recent announcement Reverse Repo would be capped at $300 billion, leading even the deepest of pundits to realize they have been fooled all along, and the RRP facility was never meant to be a rate hike-facilitating mechanism, the Fed released this:

Statement to Revise the Time of Day of the Overnight Reverse Repurchase Agreement Operation for September 30, 2014

 

As noted in the September 17, 2014, Statement to Revise the Terms of the Overnight Reverse Repurchase Agreement Operational Exercise, the Open Market Trading Desk (the Desk) at the Federal Reserve Bank of New York (New York Fed) has been working internally and with market participants on operational aspects of tri-party reverse repurchase agreements (RRPs) to ensure that this tool will be ready to support the monetary policy objectives of the Federal Open Market Committee (FOMC).

Regarding the operation to be conducted on Tuesday, September 30, 2014, the Desk will conduct the operation several hours earlier than usual, from 8:00 to 8:30 a.m. (Eastern Time).  All other terms of the exercise will remain the same.

 

This change only applies to the operation conducted on September 30, 2014. The operations conducted from Monday, September 22, to Monday, September 29, and those conducted on and after Wednesday, October 1, will be conducted at the previous time of 12:45 to 1:15 p.m.  Any future changes to these operations will be announced with at least one business day’s prior notice on the New York Fed’s website.

Wait, why did the Fed explicitly warn that just one reverse repo operation would be temporally-adjusted, namely that of September 30, i.e., today? Simple: what is today?

Why quarter end, “window dressing” day of course.

In other words, the Fed ripped off the mask that RRP was anything more than a way for the Fed to allow banks to appear more palatable to… drumroll… Fed regulators. Regulators such as Carmen Segarra, who once again made the news, not only for being fired for daring to ask probing questions about the Fed’s “close” relationship with Goldman Sachs, but for providing 48 hours of recording confirming that the NY Fed is merely a branch of Goldman Sachs.

So fast forward to today at 8:30 am when the Fed announced the result of today’s “special” window-dressing Reverse Repo operation. What was unveiled blew our socks right off, because not only was the Reverse Repo an absolutely whopping $407 billion, but the low rate on the auction was an unprecedented -0.20%!

 

And here is what today’s operation looks like in historical context:

That’s right: at $407 billion, it far exceeded the $300 billion new cap on the program.

So yes: everyone can now admit that Reverse Repo was nothing more than Fed-mandated window dressing, no point in covering that up any more.

But what about that Low rate of -0.20%?

For the answer we go to Stone McCarthy which has done a forensic analysis of precisely what happened in today’s “Crazy” (as they call it) Reverse Repo operation.

From SMRA:

Quarter-End ON RRP Craziness

 

Today’s quarter-end ON RRP offering from the Fed included a total of $407.167 bln in submissions, far exceeding the new $300 bln overall cap on the program

 

As such the 5 bps fixed rate was not applicable, and the allocation was decided by an auction mechanism. Bidders (since September 22) are required to include in their submission a rate at which they would be willing to engage in the Fed’s RRP operation. Today these bids ranged from a low of -20 bps to a high of +5 bps.

 

The Fed by starting at the lowest rate and working upward was able to do the $300 bln max at a stop-out rate of 0%. All awards were at this stop-out rate. Thus the bidder at -20 bps was probably envisioning a stop out rate well above their -20 bps bid.

 

 

Today’s offering was a test of the program. The Fed conducted this operation at 8:30am this morning in anticipation of quarter-end considerations. Typically the dealine for the operation is 1:15pm. The stop-out rate was even lower than what we envisioned. We were thinking 1 or 2 bps.

 

What this means is that today’s offering was done at a rate below the fixed rate of 5 bps, and thus today the floor aspect of the ON RRP program was not effective. This will probably be the situation at most future quarter-end offerings.

Oops: this means that the RRP as a mechanism to hike rates will certainly fail due to the discontinuity of collateral requirements, which spike at quarter end. Because try as it might, the Fed simply has no way of hiking rates on all other days except March 31, June 30, September 30 and December 31.

Why such a surge in submissions?

 

As quarter-end approaches dealers typically pare positions for balance sheet dressing purposes. They may also be less willing to engage in matched-book RP activities in helping financing their customers.

 

The lull in dealer financing demand means that the MMFs, the primary counterparty party to the Fed offerings, have liquidity to put to work that is redirected to the Fed ON RRP offering.

 

At previous quarter-ends the MMFs have accounted for around 89% of the “take-up” of the ON RRP offerings.

 

 

This compares to around 82% on non-quarter-end dates.

 

 

Does this argue for a higher cap than the $300 bln?

 

Not necessarily. The MMFs, of course, wish that cap were higher. If so, such may have provided ample quarter-end investment opportunities with positive interest rates. Indeed, some Treasury bills were trading at negative interest rates in response to the capping of the ON RRP program at $300 bln, previously there wasn’t a cap.

 

The cap was imposed because the FOMC was worried that in times of financial distress (not routine quarter-ends) the MMFs would only engage in lending to the Fed with the dealers and other money market borrowers getting cut off.

 

Some worried that the Fed might become too dominate a player in the money markets.

 

The results of today’s offering are not really surprising. The Desk probably anticipated something close to what happened here. We think that what we saw in today’s offering will be typical of future quarter-ends. Despite that fact that the MMFs would probably prefer a much higher cap, thereby rendering somewhat higher quarter-end returns, what they are earning (0%) is still better than the negative returns on bills that mature early in the new quarter. In other words, the ON RRP program is still a better alternative than what would exist in the absence of this program.

And there you have it.

A bigger problem, however, emerges, now that it is empirically proven that the Reverse Repo is now meaningless and doomed as a means to allow the Fed to hike rates in a world in which the Fed Funds rates is irrelevant, and a parallel rate corridor somehow has to be established. Which means that only the IOER fallback exists, a rate hike environment fallback which as we wrote back in 2012 is also meaningless as it only controls for one half of the rate increase corridor.

So… still betting on a rate hike in mid-2015, when the Fed itself has just admitted, and the market has confirmed, it has no clue how it will hike rates?

We’ll take the much, much over.

via Zero Hedge http://ift.tt/YInAoj Tyler Durden

So what is Eric “bagman for Wall Street” Cantor’s new role as MD and Vice Chairman of Moelis & Co.? “He’s going to be guiding people on how the world works,” explains his former communications director. However, as Bloomberg reports, it is his policy advisor’s clarification that Cantor “is not chasing money” that is most interesting.

In a few short words, he summed up just what the Washington elite really think about how the world works…

“Smarter people get that’s not actually true. There have to be respectable men and women who run, quite frankly, the system.”

Cantor, 51, started this month as a managing director and vice chairman of New York-based investment bank Moelis & Co., where he’ll earn more than $3.4 million by the end of next year.

Republicans and Democrats have mocked Cantor’s ties to the banking industry. Robert Reich, a labor secretary for President Bill Clinton, wrote on his Facebook page that the new job shows Washington and Wall Street’s “entrenched culture of mutual behind-kissing.” David Stockman, a head of President Ronald Reagan’s Office of Management and Budget, said on his website that Cantor’s legislative support for big business made him a “bagman for Wall Street.”

But perhaps the most damning comment of all…

“We’ve all enjoyed having Eric in the Congress,” Goldman Sachs President Gary Cohn told Bloomberg Television the day after the primary defeat.

Source: Bloomberg

via Zero Hedge http://ift.tt/1vujtZM Tyler Durden

So what is Eric “bagman for Wall Street” Cantor’s new role as MD and Vice Chairman of Moelis & Co.? “He’s going to be guiding people on how the world works,” explains his former communications director. However, as Bloomberg reports, it is his policy advisor’s clarification that Cantor “is not chasing money” that is most interesting.

In a few short words, he summed up just what the Washington elite really think about how the world works…

“Smarter people get that’s not actually true. There have to be respectable men and women who run, quite frankly, the system.”

Cantor, 51, started this month as a managing director and vice chairman of New York-based investment bank Moelis & Co., where he’ll earn more than $3.4 million by the end of next year.

Republicans and Democrats have mocked Cantor’s ties to the banking industry. Robert Reich, a labor secretary for President Bill Clinton, wrote on his Facebook page that the new job shows Washington and Wall Street’s “entrenched culture of mutual behind-kissing.” David Stockman, a head of President Ronald Reagan’s Office of Management and Budget, said on his website that Cantor’s legislative support for big business made him a “bagman for Wall Street.”

But perhaps the most damning comment of all…

“We’ve all enjoyed having Eric in the Congress,” Goldman Sachs President Gary Cohn told Bloomberg Television the day after the primary defeat.

Source: Bloomberg

via Zero Hedge http://ift.tt/1vujtZM Tyler Durden

Just a month after announcing plans to deploy its newest S-500 air defense systems to protect Moscow and central regions, Xinhua reports that Russia has activated an air defense regiment armed with advanced S-400 surface-to-air missile systems in the Southern Military District to guard its southern frontiers. Furthermore, a spokesperson for Russia’s Aerospace Defense Forces, said that 12 missile regiments will receive the S-400 systems, as it seems NATO’s moves are prompting retaliatory advances by Russia.

 

 

As Xinhua reports, Russia activates S-400 missile systems in south to guard frontiers

Russia has activated an air defense regiment armed with advanced S-400 surface-to-air missile systems in the Southern Military District to guard its southern frontiers, the Russian military said Tuesday.

 

“An air defense missile regiment from the Fourth Command of the Air Force and Air Defense entered into service in the Krasnodar region. It is equipped with S-400 Triumph advanced missile systems and Pantsir-S air defense missile and gun complex,” the Southern Military District’s press service said in a statement.

 

Earlier this month, the S-400 systems arrived at their permanent base after completing tests at the Ashuluk firing range in southern Astrakhan region.

 

During the tests, they successfully destroyed high-speed targets simulating incoming ballistic missiles and other aerial targets.

 

In August, Russia also announced plans to deploy its newest S-500 air defense systems to protect Moscow and central regions.

 

Alexei Zolotukhin, a spokesperson for Russia’s Aerospace Defense Forces, said Monday that 12 missile regiments will receive the S-400 systems by 2020.

 

The S-400 system, which can engage targets at a maximum range of up to 400 km at an altitude of 40,000-50,000 meters, is expected to form the cornerstone of Russia’s air defense by 2020.

 

The S-500 systems will have an extended range of up to 600 km and is capable of engaging up to 10 targets simultaneously.

*  *  *

via Zero Hedge http://ift.tt/ZoIycR Tyler Durden

Just a month after announcing plans to deploy its newest S-500 air defense systems to protect Moscow and central regions, Xinhua reports that Russia has activated an air defense regiment armed with advanced S-400 surface-to-air missile systems in the Southern Military District to guard its southern frontiers. Furthermore, a spokesperson for Russia’s Aerospace Defense Forces, said that 12 missile regiments will receive the S-400 systems, as it seems NATO’s moves are prompting retaliatory advances by Russia.

 

 

As Xinhua reports, Russia activates S-400 missile systems in south to guard frontiers

Russia has activated an air defense regiment armed with advanced S-400 surface-to-air missile systems in the Southern Military District to guard its southern frontiers, the Russian military said Tuesday.

 

“An air defense missile regiment from the Fourth Command of the Air Force and Air Defense entered into service in the Krasnodar region. It is equipped with S-400 Triumph advanced missile systems and Pantsir-S air defense missile and gun complex,” the Southern Military District’s press service said in a statement.

 

Earlier this month, the S-400 systems arrived at their permanent base after completing tests at the Ashuluk firing range in southern Astrakhan region.

 

During the tests, they successfully destroyed high-speed targets simulating incoming ballistic missiles and other aerial targets.

 

In August, Russia also announced plans to deploy its newest S-500 air defense systems to protect Moscow and central regions.

 

Alexei Zolotukhin, a spokesperson for Russia’s Aerospace Defense Forces, said Monday that 12 missile regiments will receive the S-400 systems by 2020.

 

The S-400 system, which can engage targets at a maximum range of up to 400 km at an altitude of 40,000-50,000 meters, is expected to form the cornerstone of Russia’s air defense by 2020.

 

The S-500 systems will have an extended range of up to 600 km and is capable of engaging up to 10 targets simultaneously.

*  *  *

via Zero Hedge http://ift.tt/ZoIycR Tyler Durden

Remember when instead of pontificating on and explaining the consequences of three decades of devastating, ruinous, irresponsible Fed policies, and eagerly sharing ideas on how to “fix” these unfixable problems, Alan Greenspan was the primary culprit behind everything that is now wrong and broken with the world’s financial system? Oh, and also was not an “Austrian” economist?

Good times.

Today we bring you the “other” Greenspan: the one who is blissfully unaware that, almost singlehandedly, he destroyed western capitalism, which is now living day to day, on borrowed time from one central bank printer to another. Ironically, the topic of his most recent Op-Ed for the Council of Foreign Relation’s Foreign Affairs magazine, is none other than the default Kryptonite to every central banker, himself included if only a decade or so ago: gold.

And specifically the reason why, as we have covered consistently over the past 3 years, while the rest of the world is selling (if only paper gold), China just can’t get enough of (physical) gold.

So for everyone curious what the world’s most infamous central banker, probably of all time, thinks about China’s gold hoarding ambitions, read on.

* * *

Why Beijing Is Buying

By Alan Greenspan, first posted in Foreign Affairs

If China were to convert a relatively modest part of its $4 trillion foreign exchange reserves into gold, the country’s currency could take on unexpected strength in today’s international financial system. It would be a gamble, of course, for China to use part of its reserves to buy enough gold bullion to displace the United States from its position as the world’s largest holder of monetary gold. (As of spring 2014, U.S. holdings amounted to $328 billion.) But the penalty for being wrong, in terms of lost interest and the cost of storage, would be modest. For the rest of the world, gold prices would certainly rise, but only during the period of accumulation. They would likely fall back once China reached its goal.

The broader issue — a return to the gold standard in any form — is nowhere on anybody’s horizon. It has few supporters in today’s virtually universal embrace of fiat currencies and floating exchange rates. Yet gold has special properties that no other currency, with the possible exception of silver, can claim. For more than two millennia, gold has had virtually unquestioned acceptance as payment. It has never required the credit guarantee of a third party. No questions are raised when gold or direct claims to gold are offered in payment of an obligation; it was the only form of payment, for example, that exporters to Germany would accept as World War II was drawing to a close. Today, the acceptance of fiat money — currency not backed by an asset of intrinsic value — rests on the credit guarantee of sovereign nations endowed with effective taxing power, a guarantee that in crisis conditions has not always matched the universal acceptability of gold.

If the dollar or any other fiat currency were universally acceptable at all times, central banks would see no need to hold any gold. The fact that they do indicates that such currencies are not a universal substitute. Of the 30 advanced countries that report to the International Monetary Fund, only four hold no gold as part of their reserve balances. Indeed, at market prices, the gold held by the central banks of developed economies was worth $762 billion as of December 31, 2013, comprising 10.3 percent of their overall reserve balances. (The IMF held an additional $117 billion.) If, in the words of the British economist John Maynard Keynes, gold were a “barbarous relic,” central banks around the world would not have so much of an asset whose rate of return, including storage costs, is negative.

There have been several cases where policymakers have contemplated selling off gold bullion. In 1976, for example, I participated, as chair of the Council of Economic Advisers, in a conversation in which then U.S. Treasury Secretary William Simon and then Federal Reserve Board Chair Arthur Burns met with President Gerald Ford to discuss Simon’s recommendation that the United States sell its 275 million ounces of gold and invest the proceeds in interest-earning assets. Whereas Simon, following the economist Milton Friedman’s view at that time, argued that gold no longer served any useful monetary purpose, Burns argued that gold was the ultimate crisis backstop to the dollar. The two advocates were unable to find common ground. In the end, Ford chose to do nothing. And to this day, the U.S. gold hoard has changed little, amounting to 261 million ounces.

I confronted the issue again as Fed chair in the 1990s, following a decline in the price of gold to under $300 an ounce. One of the periodic meetings of the G-10 governors was dedicated to the issue of the European members’ desire to pare their gold holdings. But they were aware that in competing with each other to sell, they could drive the price of gold down still further. They all agreed to an allocation arrangement of who would sell how much and when. Washington abstained. The arrangement was renewed in 2014. In a statement accompanying the announcement, the European Central Bank simply stated, “Gold remains an important element of global monetary reserves.”

Beijing, meanwhile, clearly has no ideological aversion to keeping gold. From 1980 to the end of 2002, Chinese authorities held on to nearly 13 million ounces. They boosted their holdings to 19 million ounces in December 2002, and to 34 million ounces in April 2009. At the end of 2013, China was the world’s fifth-largest sovereign holder of gold, behind only the United States (261 million ounces), Germany (109 million ounces), Italy (79 million ounces), and France (78 million ounces). The IMF had 90 million ounces.

However much gold China accumulates, though, a larger issue remains unresolved: whether free, unregulated capital markets can coexist with an authoritarian state. China has progressed a long way from the early initiatives of Chinese leader Deng Xiaoping. It is approaching the unthinkable goal of matching the United States in total GDP, even if only in terms of purchasing-power parity. But going forward, the large gains of recent years are going to become ever more difficult to sustain.

It thus seems unlikely that, in the years immediately ahead, China is going to be successful in vaulting over the United States technologically, more for political than economic reasons. A culture that is politically highly conformist leaves little room for unorthodox thinking. By definition, innovation requires stepping outside the bounds of conventional wisdom, which is always difficult in a society that inhibits freedom of speech and action.

To date, Beijing has been able to maintain a viable and largely politically stable society mainly because the political restraints of a one-party state have been offset by the degree to which the state is seen to provide economic growth and material wellbeing. But in the years ahead, that is less likely to be the case, as China’s growth rates slow and its competitive advantage narrows.

via Zero Hedge http://ift.tt/1rBs3TU Tyler Durden