First it was Abenomics, then Ben Bernanke dithering about tapering, followed by crisis-rates in Chinese wholesale money markets. It has been quite a week capping quite a month. Gold and silver got hit badly, which tells us that so far investors think this is no more than overbought equity and bond markets unwinding. As long as no one in western capital markets is seriously considering systemic risk, they are unlikely to flock to gold or silver.
Systemic risk should not be treated lightly. There are two worries for Mr. Bernanke that explain his indecisiveness: Firstly, falling equity prices undermine consumer and business confidence (at least in the central bankers’ playbook); and secondly, rising interest rates along the yield curve are bad for bank solvency.
This latter point needs more explanation. During the Libor scandal, it became apparent that a small interest rate fall boosted derivative values significantly. Citigroup helped us quantify the effect when in 2009 it reported that a 1% fall in interest rates would enhance its derivative values by nearly $2 billion a quarter. Citigroup is one of the smaller players in the derivatives market, with only $14.2 trillion of interest rate swaps at the time. This explains why zero interest rates were a necessary component of the rescue package at the time of the Lehman failure.
According to the Bank for International Settlements, last December there were $370 trillion of interest rate swaps. Using the Citigroup numbers as a guide, a 1% rise in interest rates would cost the banking system more than $200 billion in a year. Bear in mind that this cost is concentrated in a few too-big-to-fail banks, and this is only part of the total derivative market, which amounted to $633 trillion. The reality of tapering is that the Fed is going to have to tell Congress that their interest bill is going to rise, so they better cut their spending, and that he is going to have to find an extra $1 or $2 trillion to give to the banks.
Instead, the reality is there is no going back from QE, and current instability in financial markets is probably only the beginning of an acknowledgement of this dilemma. The trade-off is between escalating systemic risk and being locked into further monetary inflation, either of which justifies protection by owning precious metals.
Less noticed is the havoc wrought in emerging market currencies. The Indian Rupee has fallen 8% against the U.S. dollar in the last month, the Turkish lira by 6.5%, and the Brazilian real by nearly 11%. Perhaps it is the cost of living in the latter two that is driving civil protests.
Monday will be anticipated with trepidation: Will equities continue to accelerate their slide, or will complacency return? It will be a quiet week ahead for announcements, but a raft of Japanese statistics overnight on Thursday/Friday.
Monday. U.K. Nationwide House Prices.
Tuesday. U.K. BBA Mortgage Approvals. U.S. Durable Goods Orders, S&P Case-Shiller Home Price Index, New Home Sales, Consumer Confidence Index.
Wednesday. U.K. CBI Distributive Trades. U.S. Core PCE Price Index (final) GDP Annualised (final).
Thursday. Eurozone M3 Money Supply, Business Climate Index, Consumer Sentiment, Economic Sentiment, Industrial Sentiment. U.S. Core PCE Price Index, Initial Claims, Personal Income, Personal Spending, Pending Home Sales. Japan CPI, Real Household Spending, Unemployment, Industrial Production, Retail Sales.
Friday. Japan Construction Orders, Housing Starts. U.K. Index of Services. U.S. Chicago PMI.