Tuesday, October 05, 2010

Fiscal and Monetary Insanity

Peter Boockvar writing at The Big Picture notes two stories today which I find truly remarkable.

"If you have it, the Bank of Japan will buy it. The BoJ cut interest rates from .1% to a range of zero to .1% and announced a 5T yen fund to buy not just JGB’s but corporate debt, commercial paper, ETF’s and Japanese REIT’s. If you live in Japan and thought about selling stuff in the closet on EBAY, hawk it to the BoJ instead."

Amazing.  ETFs?  But Boockvar's second story is even crazier, and seems to be getting less attention:

"Evidence of how extraordinary the demand for yield has become, Mexico today plans on selling $500mm of 100 year debt with a coupon of about 6%. It’s an amazing leap of faith on the part of investors for a country that saw y/o/y CPI inflation in 1988 of 179% and 52% as early as 1996. We also can’t forget the 1994 Mexican Peso currency crisis that led to a multinational bailout for Mexico that consisted of loans and guarantees totaling $50b. Investors also have to hope that at least over the next few years, the drug wars don’t suffocate their economy. Bottom line, artificially cheap rates can finance anything at historically unforeseen levels when the demand for yield is strong. Sound familiar?"

Oh, how quickly we forget.



IF said...

It does sound to me like a dollar bond:

So what does peso inflation have to do with it? Even if they were denominated in peso, the British Consols are still paying. (Not that I would trust the Mexicans.) Whether Consols ever were a good deal is left to the individual. And the price paid.

So, how about putting them as potential trading sardines on a watch list and remembering them during the next peso crisis?

scharfy said...

Id like to see where those mexican 100 years get put up at.....

Bond fever continues.

Kid Dynamite said...

IF - I see how you're reading it as a dollar issue - it's possible that bberg just quote the dollar equivalent, but it seems unlikely that anyone would be crazy enough to buy 100 year peso bonds at 6% right?

I'm not sure what your second paragraph means - if its peso-denominated, peso inflation matters.

In any case, I think i'd rather own the Norfolk Southern century bonds I wrote about previously than Mexico century bonds at the same yield.

which brings up another question - how can Mexico issue debt at the same price as NSC? Mexico is rated much much lower... (I think)

Kieran McCarthy said...

It's not insane as long as the incentive structure is what it is in the financial industry. I'd bet six margaritas that most, if not all, of the bond managers that buy these 100 years know that over a 100-year cycle, owning these instruments will likely be a very bad idea. But that doesn't matter. In the meantime, their bond portfolios will outperform, which means that they will be paid better than their peers. Heck, if you know you're only going to be around in the business another 10 years, your incentive structure demands that you get the extra 2% yield on these bad boys, because the risk (for you) is the same as buying a 10 year at 4%, but you get to pocket the difference, and slough off the risk to your successor.

john said...

BTW, it definitely is a Yankee bond.

Mark said...

Actually, I think the Mexicans are pretty savvy here. They will get to raise tons of money and if things don't work out, big deal. The U.S. and Europe will bail them out, just like they did before.

I assume that the World Bank and the IMF have signed off on this, or do those organizations have no financial authority over Mexico any more?

wcw said...

Mexico is not considered a risky creditor.

But What do I Know? said...

And yet the yen continues to strengthen. . . Is the only way to get the Chinese to stop buying a currency to destroy it?

ndk said...

Are you gonna carry through on your Canada threat when our Fed starts buying spoos?

Central banks: putting the Capitol in capitalism, since time immemorial.

"Is the only way to get the Chinese to stop buying a currency to destroy it?"

Remember that the currency imbalance with China arose basically out of us getting our pasty asses kicked in the marketplace over the last ten years, not through the initial establishment of the peg.

Filed under "things we quickly forget", China had faced recurrent bouts of deflation from ~'99 onward. It's probably structural, and if it wasn't then, with all the insane investment in overcapacity and the rapid aging of their populace, it certainly will be going forward.

If the ulterior motive here is a wager that the world can engineer such painful inflation in China that China will break the peg, I think it's:

a) a stupid way to go about pegbusting versus simple tariffs, with incredible collateral damage(total credit to nominal GDP lol);
b) likely to fail in time, as the end result of bubbles is basically always overcapacity. That oil is not really along for our wild leveraged ride is a testament to the effects of lingering oversupply in a market that is painfully constrained by reality.

But frankly, I have no clue WTH the Fed is doing anymore. They've gone beyond a credible commitment to insanity to the generalized theory of moral hazard. It won't end well, but it's a hell of a ride until then.

Kid Dynamite said...

Mark - I certainly didn't mean to imply that Mexico was insane.

I like Kieran's comment as an explanation.

WCW - I think Mexico and NSC are actually both BBB +/- one notch.

Kid Dynamite said...

NDK - the Fed won't buy Spoos (i am repeating that over and over again while clicking my heels together and putting my hands over my ears, PRAYING it's true)

I didn't want to get into it in the post body, but how can Japan pretend that buying ETFs is legit? it's so sick. it bastardizes their markets in a sick sick way. At least we and they can pretend that Treasuries/JGBs, Agencies/REITS are money good and that you're just "changing duration", but you can't even possibly pretend that when you start buying ETFs or stocks.

ndk said...

At least we and they can pretend that Treasuries/JGBs, Agencies/REITS are money good and that you're just "changing duration", but you can't even possibly pretend that when you start buying ETFs or stocks.

The rules and mores of central banking are changing whether we want them to or not. Backing a currency with not just the diminishing power of taxation and the rule of law, but also direct ownership over and control over national champions, probably actually strengthens it in our fascist era.

Bad for innovation? Like mixing church and state? Favoring certain players over others? Helping the segments of society that need it most? Who the hell cares?

And while we're getting philosophical, what's the highest and best use of a market, anyway? Is it rapid and large-scale transmission of accurate pricing signals? Or is it something else? And does your answer differ from the Government's answer?

I'm willing to bet that this trend catches on in a big way in the next ten years.

Anonymous said...

to do the math simply:

extra 2% yield, if translated into risk (say 50% recovery and 4% default rate per year) means that in a risk neutral sense there is about a 1.98% chance of these bonds existing in 100 years. (so there is plenty of risk priced in.)

But What do I Know? said...

I can see the central banks creating money to weaken their currencies, but why don't they buy something useful with it, like copper or oil or rare earths :>) I mean, it's pretty obvious that the Chinese are buying yen to drive the Japanese crazy--so why don't the Japanese turn around and give them the yen in exchange for something useful. This buying financial assets is stupid.

If Bernancke really wants inflation, he should take his $500 billion and buy oil for future delivery with it. Buying Treasuries is stupid.