Sputnik News: Is Russia Preparing to Move to the Gold Standard?

Just a few days ago we ran this blog post about an article on the Mises Institute site. That article suggested that Russia might consider some kind of return to a gold standard. Now the Sputnik News has run a review of the Mises article which you can read here. This is interesting because Sputnik News is a Russian media outlet which means Russian officials are certainly aware of this article.

We have noted here that we have not found any indication from articles we research that either Russia or China are in the process of moving to a gold standard, despite both countries continuing to buy large amounts of gold. We also said if we did see any information supporting the idea that they might be moving towards a gold standard, we would cover it here. So this Sputnik News article is posted here for readers to consider. However, even this article still concludes with a quotation from a Russian expert that a return to a gold standard is unlikely. Below are quotes from this Sputnik News article and then a few added comments.

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"Mises Institute contributor Marcia Christoff-Kurapovna believes that Russia may be in the process of planning for the introduction of a gold-based currency, and would be better off for it."

"The columnist notes that several factors may play into the decision, including Russia's recent partial detachment from Western economic and financial structures, sanctions, the ruble's devaluation and economic decline."

. . . . 

"The expert argues that "while the Russian economy is structurally weak, enough of the country's monetary fundamentals are sound, such that the timing of a move to gold, geopolitically and domestically, may be ideal." The expert echoes commentary made by Russian economists and financiers, including recently by Central Bank Head Elvira Nabiullina,  namely, that Russia's debt to GDP ratio is low (equivalent to $478 billion in a $2 trillion economy), with most of its external debt in private hands, which has also declined by $100 billion, and with a budget deficit projected at less than 1 percent of GDP."

. . . . 

"Pointing out the potential benefits of the switch, the columnist argues that a gold-backed currency would turn the ruble into a more respectable world currency, while also making Russia "a more reliable and trustworthy trading partner."

. . . . .

"Christoff-Kurapovna points out that the transition to the gold standard would not be easy for Russia: "As a pro-gold stance is, essentially, anti-dollar, speculation about how the US would react raises the question of whether an all-out currency war would follow. The West would have to keep Russia regionally and militarily marginalized, not to mention kept within the confines of the Fed, the ECB, and the Bank of England (BOE)."
. . . . . 

Broaching the subject of Russia's possible switch to the gold standard, KavPolit.com columnist Evgeni Lihachev noted recently that even Russia's moves to shift its reserves to non-dollar-based assets and to trade energy resources in ruble-denominated valuations have been viewed with hostility by Washington. An attempt to transition to a gold reserve would be much more serious, Lihachev says, explaining that "the fates of [Iraq's Saddam] Hussein and [Libya's Muammar] Gaddafi in these matters serving as a litmus test." Many Russian geopolitics and economics experts are convinced that the 2011 Western military campaign against Gaddafi was related directly to the latter's plans to stop selling oil in US dollars and to introduce a gold-backed regional currency which would have devastated Western fiat currencies. The earlier invasion of Iraq is similarly believed to be linked to the country's move toward independence from the dollar.  Lihachev points out that the United States cannot "act like in Iraq and Libya in relation to Russia…and those measures which it could take it have already been taken."

. . . . . 

"In light of China's continued agreement to ruble denominated gas contracts, Lihachev notes that "one gets the feeling that China knows more than they let on." The expert further notes that "this is indirectly confirmed by the almost synchronous launch by Russia, China and Kazakhstan in actively buying physical gold for national reserves." Ultimately, Lihachev notes that "of course, we still have a long way to go to reach the 'official gold reserves' held by the US, but in the event of a transition to the gold standard, what is important is not so much the amount of gold as the ratio of the reserves to the money supply."

. . . 

In a bid to counter gold-rush sentiment among both the Russian government and Russian citizens, Former advisor to the Chairman of the Central Bank, financial Obudsman Pavel Medvedev recently told Russia's Svobodnaya Pressa that a gold-based currency is "absolutely impossible" for Russia or for any other country in the world, due to the precious metal's limited supply. He noted that the modern economy needs far more financial liquidity than a gold standard backed currency can provide. "In a word," he stated, "entering the gold standard is not possible –there is not enough gold to achieve it." It remains to be seen what the Russian leadership really thinks about the idea.
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My added comments:

This article is noteworthy because it comes from a Russian media source that we know Russian officials endorse. The article not only discusses a return to a gold standard for Russia, it quotes a Russian journalist as saying that the US attacks against Iraq and Libya were done to protect the US dollar. Of course, a Russian (or Chinese) move to a gold backed currency would be a direct attack on the US dollar. This journalist also notes that what matters in a gold standard is not how many ounces of gold you own, but the ratio of the gold you own to the total money supply (this is similar to a point Jim Rickards made in a recent article that a gold to GDP ratio is what matters).

While all this is interesting, keep in mind that the concluding paragraph of the article quotes a former advisor to the Chairman of the Russian Central Bank as saying, "a gold based currency is absolutely impossible for Russia or for any other country in the world" . . . 

After reading all that, keep in mind Jim Rickards article (The Fix is In) saying that Russia and China are buying gold not to back their own currencies, but to have more gold reserves later when there is a global conference to reset the monetary system. He says the movement of more gold to these nations is needed to to get them closer to what the western nations have when the monetary reset takes place. He believes that the SDR used at the IMF will become the new currency, with each nation's gold reserves giving them more stake in the negotiations. 

Whatever Russia's (and China's) intentions are related to gold, we will cover it here.

Added note: Here is an article about another BRIC's nation (India) preparing to monetize gold in that country.

Wanna Own Some Gold? - Just buy an Apple Watch (18k gold version)

The internet is abuzz with speculation about the new Apple watch coming soon. Apparently there will be a solid 18k gold version available. The Wall Street Journal says Apple is gearing up to make 1 million of the gold watches per month. How much gold would be in each watch? This is where speculation is running wild. Some say very little. But some estimates are as high as 2 ounces per watch. If there is even 1/2 ounce per watch, Apple is going to become a huge gold buyer alongside India and China.

Below are some articles popping up around the internet speculating about it:

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Wall Street Journal - Apple Orders More than 5 Million Watches for Initial Run

"Orders for Apple Watch Edition – the high-end model featuring 18-karat gold casing – are relatively small in the first quarter but Apple plans to start producing more than one million units per month in the second quarter, the person said. Analysts expect demand for the high-end watches to be strong in China where Apple’s sales are booming."

How Much Gold Will the Apple Watch Edition (18k gold) Consume?

"The Apple Watch Edition might be Apple’s most unusual product in years. Questions abound about the 18-karat gold smartwatch."  . . . . "But I have a broader question: how will it affect the world’s gold supply?"  

Apple Spotlight - The real value of gold in an Apple Watch

"Every time I write about the gold Edition models of Apple Watch being priced at $5,000 to $10,000, I get flooded with emails telling me I’m off my rocker. Here’s the thing. Gold has cost well over $1,000 per ounce for the last several years. Right after the 2008 recession it shot up close to $2,000 per ounce. Apple has stated that the Edition models of Apple Watch are not gold-plated — they’re solid 18K gold. The cost of the gold alone will be several thousand dollars."

Mining.Com - Apple to Buy a third of world gold supply for the i-watch?

"Technology giant Apple (NASDAQ:AAPL) may soon buy up one third of the world’s gold in order to meet the demands of its highly anticipated Apple Watch, according to reports.

Interest in the high-end model, featuring 18-karat gold casing, is picking up and the firm is already taking the necessary steps to have enough of them in stock. According to WSJ.com, Apple plans to start producing more than one million units per month in the second quarter of the year, anticipating high demand from Asian markets, mainly China."

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My added comments:

This is one of those fun stories. It does not look like the new watch will have more than a half ounce or so of gold to me (even if not gold plated). But Apple does seem to sell things like this in the millions (or even tens of millions). So who knows how much gold they will be buying to make these watches? Gold actually did pretty well price wise in 2014 around the world. Perhaps this buying will help it out in terms of its price in US dollars going forward.

Some fun thought questions: 

Will Apple become a top 10 buyer of gold in the world exceeding most of the nations on earth in gold buying and inventory? 

Will millions of Americans finally become gold owners by accident?

What happens to a gold Apple watch when version 2.0 comes out? Do you just chunk the old one in a drawer and have to buy a new one to have the latest updated software version?

If each watch contains one half ounce of gold and Apple sells 20 million of them, how many tons of gold will they have to buy? 

We'll give the answer to that last one. It's over 300 tons of gold. That amount of gold would put you in the top 20 gold holders in the world. And if there were an ounce of gold in these things? That would put you right near the Top 10 in the world. 600 tons of gold is more than 20% of the entire annual gold production in the world. Regardless, it looks like Apple is going to be buying a lot of gold in coming months and years.

Added note: This story certainly attracted a lot of interest. Many think the watch will only be gold plated and not use nearly so much gold. But here is a link to the guy who says he asked Apple directly and they confirmed the case is solid 18k gold. I don't know, but it will be fun to see how it turns out. Here is a quote from this link:

"There should be no confusion on that last part. The Apple Watch Edition is solid 18-karat gold, not gold-plated. I confirmed this with Apple last week. You can feel it when you try one on: the stainless steel watch is noticeably heavier than the aluminum Sport one, and the gold Edition models are noticeably heavier than the stainless ones."

GDP for 2014 revised to just below 2.5%

This morning the revision to the fourth quarter GDP was released. The Q4 number was revised down to 2.2% which brought the overall GDP number for 2014 down to just below 2.5%. This is viewed as pretty weak growth given the massive amount of stimulus the US Fed has injected to try and boost the economy. Below is a link to an interview Alan Greenspan did on CNBC in anticipation of this lower GDP number where he calls the US economy "not strong." Market reaction to the news was minimal as the revised number came in about as expected.

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CNBC: Greenspan - Effective Demand as Weak as During the Depression

"The fact that the market is anticipating that the Federal Reserve will raise interest rates, yet the yields on the 10- and 30-year Treasurys are falling is an indication of how weak the overall global economy is, former Fed Chairman Alan Greenspan told CNBC on Thursday.

In fact, effective demand is extraordinarily weak, he said.

"The way I measure it, it's probably tantamount to what we saw in the later stages of the Great Depression," Greenspan said in an interview with "Closing Bell."

That said, he acknowledged "it's not anywhere near what the problems were back then, but we haven't seen anything like that since then."

Greenspan, who served as Fed chair from 1987 to 2006, also called the overall economic data for the United States "not strong."

While the jobs growth has been very significant, there is evidence of weakened productivity, he said.

"That is a key statistic which tells how the economy is functioning."

. . . . . .

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My added comments:

Earlier this week Fed Chief Janet Yellen told Congress not to expect a rate hike from the Fed at least for the next two meetings and that they would continue to monitor the economy before making any rate moves. She also said the markets would get plenty of advance notice if a move on interest rates was coming.

This supports Jim Rickards prediction that the Fed would not raise rates, at least for now. Many analysts were forecasting a Fed move to raise rates early was about to happen. Now most have moved back their forecast to June at the earliest and more likely sometime in the fall. Jim Rickards continues to believe that the economy is weaker than the Fed models show and that they will not raise rates at all this year. 

Early estimates for GDP in the first quarter for 2015 are around 3%. While the US labor market shows some improvement, most agree that the numbers are still weak because the labor participation rate is still very low and wages are still low. This indicates some people who cannot find work are dropping out of the labor force (no longer counted in the unemployment rate calculation) and that some of those finding jobs are not finding high wage jobs or full time jobs. Unless those numbers improve, the Fed has not shown an inclination raise rates. 

There is also a lot of concern as to how world markets will react to higher interest rates which would impact housing sales, the stock market, and interest expenses for businesses. Higher rates could also trigger a sudden move out of various kinds of bonds in a disorderly way (too many people might try to sell at once). All these are concerns that have been expressed by various IMF and BIS reports. Also, how actions by the US Fed may impact other economies around the world is a concern.

Energy Wars: Ukraine People Caught in the Middle

We have the term currency wars everywhere these days. Now perhaps "energy wars" will become the new popular phrase. The Ukraine is a bizarre mess as we tried to say in this earlier blog article. Things seem to just get worse there. Now Russia is saying they may cut off gas supplies soon and it may impact Europe. The Ukraine is cutting off gas to the eastern areas under pro Russian control.

Watching all this on the sidelines is the IMF. They have to be wondering how much worse this is going to get. They are already in for many billions to the Ukraine. Now, because things are getting worse, they say they will need $40 billion more for the Ukraine to avoid a default. But now the Ukraine is saying they need the funds urgently and even $40 billion will not be enough. The currency is in a free fall as well. If the IMF really does send in more billions, how much of that will end up going to Russia (who is under sanctions from the west).

Below are several recent articles on all this. Below each link is a short quote or summary comment.

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CNBC: Ukraine desparate for IMF aid as money runs low

"Although the $40 billion aid package was substantial, Ukraine could need more, the finance minister said.

"This package is enough to stabilize the situation but if we are going to return to growth, if we are going to rebuild and regain access to our territory we are going to need something much greater and much more support."

UPI - Gazprom threatens to cut Ukrainian gas supply

"Russian energy company Gazprom said Tuesday it may halt natural gas deliveries to Ukraine within two days because of late payments."

Tass: Gazprom requests Ukraine repay its gas debt

"Ukranian partners do not acknowledge the debt, although being billed according to active contract, Minister of Energy of Russia Alexander Novak says."

NY Times - Russia Heightens Dispute with Ukraine over Natural Gas

"As Russia warned Ukraine on Tuesday that it could run out of natural gaswithin two days because of a dispute over payments, Britain said it was sending military trainers to aid Ukrainian forces while European diplomats labored to patch up a flagging peace agreement in eastern Ukraine."

Reuters: Ukraine Heaps on Economic Pressure as Central Bank Confuses

Ukraine came under greater economic pressure after unexpectedly banning most currency trading and then abruptly reversing course, wreaking havoc on the hryvnia, just as a truce in the east took hold on Wednesday with no combat fatalities reported.With the long-awaited ceasefire coming into force, Russian President Vladimir Putin once again threatened gas supplies for the fourth time in a decade if Moscow did not receive advance payment.

Zerohedge - Putin Slams Ukraine Decision to cut off gas to East

"Ukrainian authorities decision to halt gas supplies to Donetsk amid the ongoing humanitarian catastrophe occurring there "bear the hallmarks of genocide," blasted Russia's Vladimir Putin during an awkward press conference with Cyprus' President Nicos Anastasiades (who he had just agreed bilateral military and trade deals with)."

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Update: Boston Globe Opinion article on the Ukraine

CNBC: Why Greece Will Never Repay its Debt

CNBC runs this article which mentions the elephant in the room. Not only the Greek room, but probably many other rooms in the global financial house. This is something we have noted here on the blog a few times. The world's debt is simply too large now to ever be paid off. This includes the US debt as well. Below some quotes from this article and then a few comments.

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"European officials should accept that Greece may never repay its $366 billion debt, analysts told CNBC, even if the troubled economy secures a bailout extension."

"Greek debt is not repayable in this life, Kingsley Jones, founder and CIO of Jevons Global, told CNBC on Monday: "We have to be realistic here. Greek debt is now 175 percent of gross domestic product (GDP); it's higher than it was when this whole business first started."

"Just look at Japan. It has government debt rapidly approaching 300 percent of GDP. One day, that debt pile simply implodes. It is not ever going to be repaid, nor will the Greek debt. There is no use standing on the high moral ground," Jones said."
. . . . 

"The terms of the current agreement pretty much require Greece to attempt to run a primary budget surplus over 4 percent for well over a decade...No country with an unhealthy economy has ever managed to do that. So, we think that the current terms that are required of Greece are frankly pretty unrealistic," Jones added."

"While Tsipras is no longer demanding a haircut given his limited bargaining power, experts say European creditors must realize there's no other solution if they want Greece to remain in the euro zone given the country's weak finances."

"What the Eurogroup should accept is that Greece is insolvent and needs a material haircut. They should have done that in 2010, but they chose to extend Greece more credit and push out the problem," said Nicholas Ferres, investment director of global asset allocation at Eastspring Investments."    . . . . . .
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My added comments:

Every now and then we get a refreshing dose of honesty like this article. It points out the obvious fact that no matter what happens with this new agreement between Greece and the EU, the overhanging debt problem never goes away. In fact, the article notes that the Greek debt to GDP ratio is now HIGHER than when the whole bailout program started. Let that sink in. After years of living under this debt pressure and harsh living conditions imposed by the creditors, the debt ratio is now worse off than it started out.

It is kind of ironic that news reports quote German officials and other EU officials as saying that Greece finally adjusted to "reality." Meanwhile, they completely ignore the real reality. No matter what they do to try and force Greece to pay off the debt, it is never going to happen because the debt is already too large. The article points out Greece would have to run a 4 percent budget surplus for over a decade just to meet the terms of the current agreement (which still do not pay off the debt, they just reduce the debt to GDP ratio to 110 percent). Do you seriously think the people in Greece are going to accept a future like that?

This article also points out Japan is over 300 per cent debt to GDP and its debt is never going to be repaid. The US is in just as bad of shape if you account for all the unfunded future liabilities the US is obligated for (over 100 trillion dollars). Again, it is kind of ironic for some in the US to talk about Greece refusing to deal with reality. We talked about that earlier in this blog post.

So let's talk reality. Our family has been lucky enough to go to Disney World in years past. It's great fun to live in a fantasy world for a little while. But at some point you run out of money and it's time to go back to the real world. Because central banks have been able to create tens of trillions of dollars globally without anyone having to work for them, they have managed to create a Disney World financial system. It's getting harder and harder to keep the dream going because the debts are piling up so high. Their ability to just create new money (debt) to keep it all going is under  increasing stress. 

No one knows how much longer the dream world can last. It may last for several more years. But all it will take to send us back to the real world very quickly is one large sovereign debt failure somewhere in the world. Even Greece could be big enough if it defaulted because it is unknown how many derivatives are out in the system tied to the Greek debt. It is simply an unknown risk that sits out in the system all the time and no one can predict when it might surface. The derivatives tied to sovereign debt and interest rates are the real reason why there is such desparation to avoid admitting the reality that the debts cannot be paid. 

A new monetary system will have to be ready to step in to replace the current one before an admission like that can be made. Progress towards that continues, but could go on for some time before the change takes place. A sudden crisis could change things, but so far that has been avoided. 

All of this is why this blog got started in the first place (and why it will continue). Everyone knows (including Alan Greenspan) that at some point the present monetary system is not going to be able to sustain all this debt. All the debt everywhere in the world is much bigger now than it was when we had the 2008 financial crisis. Nothing at all has been solved regarding debt. The hope is that a crisis can be avoided (delayed) by simply continuing to extend all this debt out far enough that the interest payments can keep being made. But everyone knows it can't stay this way forever. Something has to give at some point in the future. But no one wants to discuss this elephant in the room yet.

We will just continue to cover it all here as best we can for however long it takes to resolve things. We still continue to believe that the eventual resolution will involve major change in the monetary system. Whether that change happens in 2015 or by 2025, we intend to follow it here.

Update from Reuters: Greece will find it hard to pay the IMF loan coming due

IMF: Greek Proposal Still Lacking - (Deal or No Deal?)

Deadlines have passed and something has been agreed to. But it appears the IMF is not yet satisfied with the new "deal." In a letter from Christine Lagarde, the IMF says the Greek proposal does not go far enough. Below are quotes from a Wall Street Journal article on the IMF letter.

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"Even if Greece and some Europeans would like to break up with the International Monetary Fund, both still need the fund’s cash and its credibility.

That’s why a new letter by IMF Managing DirectorChristine Lagarde to Eurogroup presidentJeroen Dijsselbloem, shooting down Greece’s new package of economic proposals, will continue to shape negotiations between Greece and Europe over bailout financing. The letter also points to months of of tough talks ahead."

"The IMF chief said the Athens proposals were “sufficiently comprehensive to be a valid starting point” for negotiations.

“In quite a few areas, however, including perhaps the most important ones, the [Greek proposal] is not conveying clear assurances that the Government intends to undertake the reforms envisioned” in the existing bailout program, Ms. Lagarde said in a letter that was requested by the Eurogroup.

In particular, she targeted pension and tax overhauls, privatization and opening up closed markets. Those measures are “critical for Greece’s ability to meet the basic objectives of its fund-supported program,” she said.

That’s why the IMF won’t release the remaining money designated for the Greek program."

. . . . . 

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My added comments:

I guess the next "deadline" is four months from now. We'll see.

Russia Ratifies the new BRICS Bank

While the Ukraine takes the media spotlight, Russia took another step towards the start up of the new BRICS Development Bank. This article in Russia Today notes that the Russian Duma just officially ratified the bank in Russia. The article also states "the bank is expected to start fully functioning by the end of 2015." 

Forbes also has a new article out on this bank. It notes that a Russian official will head the new bank and asks if this will lead to the US dollar getting dissed at the bank. Below are quotes from each article and then a few comments.

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From Russia Today

"The Russian State Duma has ratified the $100 billion BRICS bank that’ll serve as a pool of money for infrastructure projects in Russia, Brazil, India, China and South Africa, and challenge the dominance of the Western-led World Bank and the IMF.

The New Development Bank is expected to start fully functioning by the end of 2015, according to the Russian Finance Ministry.

Russia has agreed to provide $2 billion dollars from the federal budget for the bank over the next seven years."               . . . . . 

"The decision to establish the BRICS bank, along with a $100 billion reserve currency pool, was made in July 2014. Each of the five member countries is expected to allocate an equal share of the $50 billion startup capital that will be expanded to $100 billion."

From Forbes contributor Kenneth Rapoza

"The western world may be at odds with Russian leadership but the emerging markets that make up the BRICS are a-ok. Russian state media reported on Friday that Russian Finance Minister Anton Siluanov will likely head up the board of governors at the New Development Bank (NDB) later this year.

If we manage to hold the first board meeting, Siluanov will become the chairperson,” Deputy Finance Minister Sergei Storchak told Rossiya-24 TV channel today. The first board meeting is supposed to take place in April.  The NDB, dubbed the BRICS Bank by the media, will be up and running by year’s end."              . . . . . 

"The NDB charter was agreed upon by the country’s presidents last July in Fortaleza, the largest city in Ceara state in northeastern Brazil. Russia was the first country to make the bank official, with its parliament ratifying the bank this week in Moscow. Storchak said on Russian TV that he expected the bank to be ratified by other members before the BRICS Summit in Russia this July."

"The bank starts out with $100 billion set aside from central bank reserves of all five members. For now, loans will be made in U.S. dollars, making this hardly an alternative to the existing development banks in the region." . . . . .

"There is a chance that Russia will try convincing NDB members to lend in each other’s currency instead of the dollar. That will not be known until the first loan is made, however. Large development banks tend to lend in various currencies, anyway. The Asian Development Bank, one of the world’s largest, has a local currency loan product. And the world’s largest development bank by lending portfolio, Brazil’s BNDES, loans are based on a basket of currencies, including the dollar." . . . . .

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My added comments:

These articles point out that despite a lot of talk you see on the internet that the BRICS will lead an imminent attack on the US dollar, this new bank will not even have its first meeting until April. Only one of the BRICS has even ratified the bank yet. And the earliest the bank is expected to be fully in operation is by year end 2015. On top of that, right now the bank is setup to use the US dollar for loans. So, I wouldn't hold my breath in anticipation that a BRICS New Development Bank (NBD) attack on the US dollar is imminent.

BBC: Greek Government Delays Reform Plan Deadline

When I saw the headline for this BBC story, I had to chuckle a little. We had just done an update post on Greece where we made this comment:

"Deadlines these days are not really deadlines. They are just days that arrive so that new deadlines can be announced."


This is just a one day deadline delay, but it was still kind of funny. Below are some quotes from the BBC article. Most assume that this deal will go through thereby kicking the can down the road for another four months. Whether the Greek people will go for this deal remains to be seen. We probably won't know that for awhile.
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From the BBC article:

"Greece will send a list of reforms aimed at securing a bailout extension to EU partners on Tuesday morning, missing a Monday deadline, officials say.

The next few hours will determine whether last week's deal on Greece will hold or whether the two sides are still too far apart on the conditions needed for the loan extension.

The Greek government will prioritise clamping down on tax evasion and smuggling in its list of reforms, hoping that will avoid more cuts in the public sector and may free up money to rehire civil servants and increase social spending.

But Germany and others are likely to insist that past austerity measures are irreversible. The European Commission, IMF and European Central Bank will deliver their verdict on Tuesday. If there are deep disagreements, the deal could collapse.

The Greek government will continue to sell this to its voters as the first time it has a real say in the reforms it will take, but the reality is that the creditors will keep Athens on a tight leash and there is little room for manoeuvre."

. . . . .

"The four-month extension deal is widely regarded as a major climb-down for Prime Minister Alexis Tsipras, who won power vowing to reverse budget cuts.

In effect, the deal has kicked down the road some of the more difficult issues, like the future sustainability of Greek debt, the BBC's Chris Morris reports from Brussels."

Another day, Another IMF Work Paper Warning on Asset Bubbles

Just add this new work paper to the long list. IMF work papers don't reflect actual IMF policy or official opinion, but the IMF is publishing this white paper which means the content is viewed as worthwhile to consider. This one is titled "Asset Bubbles: Re-thinking Policy for the age of Asset Managment." 

It is yet another analysis of the potential dangers of asset bubbles and why they still exist. This paper concludes that financial incentives for investment managers lure them into "asset bubble riding."

Here are some paragraphs from the concluding remarks section of the report:

By process of deduction, this paper seeks to offer an explanation for why asset bubbles have posed—and will likely continue to do so—a threat to economic stability despite financial markets being characterized by more complete information, a greater array of securities through which to express views, and a more pronounced impact of sophisticated institutional investors, than ever before.

The arguments advanced here suggest other candidate explanations for the persistence of bubbles, such as limits to learning, frictional limits to arbitrage, and behavioral errors, are unsatisfactory (by themselves at least) as they are inconsistent with the aforementioned trends sweeping across global capital markets.

By contrast, investment manager incentives, the nature of the principal-agent relationship, and the growing presence of institutional investors, are all entirely consistent with the persistence of financial bubbles. Importantly, this explanation does not require a baseline assumption of widespread irrationality in the conventional sense.

Simply put, it can be entirely rational— from the perspective of business and compensation risk—for asset managers to knowingly ride bubbles because of benchmarking and the short-term performance appraisal periods often imposed on asset managers by asset owners.
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This is a fairly lengthy report, but the portion underlined above summarizes things pretty well. The paper says asset bubbles exist now and likely will continue to do so in the future due to financial incentives to investment managers to "ride bubbles."

The IMF and the BIS have completely covered themselves if we do get another financial crisis. They have analyzed and warned on this situation over and over and over again. We have documented that here on this blog by providing direct links to the reports. Unfortunately, the media gives these reports almost no attention and almost no one even knows they exist. But they are out there on the record and they are documented here for anyone willing to read them.

Bloomberg: Here's a $9 Trillion Question

This article on Bloomberg looks at the potential impact of the Fed raising interest rates on the existing US debt held by others around the world. The link also has a video interview with Jim Rickards explaining why he does not think the Fed can raise rates. Below are some quotes and then a few comments.

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"When Group of 20 finance ministers this week urged the Federal Reserve to “minimize negative spillovers” from potential interest-rate increases, they omitted a key figure: $9 trillion."

"That’s the amount owed in dollars by non-bank borrowers outside the U.S., up 50 percent since the financial crisis, according to the Bank for International Settlements. Should the Fed raise interest rates as anticipated this year for the first time since 2006, higher borrowing costs for companies and governments, along with a stronger greenback, may add risks to an already-weak global recovery."

"The dollar debt is just one example of how the Fed’s tightening would ripple through the world economy. From the housing markets in Canada and Hong Kong to capital flows into and out of China and Turkey, the question isn’t whether there will be spillovers -- it’s how big they will be, and where they will hit the hardest."

. . . . .

"Most central bank officials are forecasting that they will raise the benchmark federal funds rate this year from near zero, where it’s been since December 2008. The probability of a Fed liftoff by June, based on trading in futures and options, was about 23 percent on Thursday, with the odds of an increase by September at 56 percent, data compiled by Bloomberg show."

. . . . 

"The expected increase in U.S. interest rates makes the dollar-denominated debt of emerging markets “a source of concern,” World Bank Managing Director Sri Mulyani Indrawati said Tuesday. Developing nations “are going to have to face this new reality” of higher rates, Indrawati, a former Indonesian finance minister, said in an interview with Bloomberg Television."

"Fed tightening could be especially problematic for China, where policy makers are already battling capital outflows and may exacerbate them with easing measures, resulting in a “circular trap,” said Manik Narain, a currency strategist at UBS AG in London."

"The U.S. central bank should take into consideration the global impact of any interest-rate decision, China Vice Finance Minister Zhu Guangyao said at the G-20 meeting this week." . . . . 
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My added comments:

In an earlier blog post we noted a Bloomberg article that pointed out that central banks are making adjustments "on the fly" these days. It also said “Certain big central banks are making moves, leaving a lot of others having to respond on the fly to the implications of those moves,” said Carnell. “They have to keep a step ahead and we’ve seen that on a number of occasions. There will probably be more surprises.”

Here we have similar concerns being expressed by China. I don't think anyone really knows what will happen, not even the central banks.