Global Quantitative Easing - Hyperion and Tree Article Series

[specuvestor]

Few comments:

1) FX rate is relative in a fiat world. What that means is that competitive devaluation is actually dependent on the anchor you are talking about. In this case USD is the anchor and the current trend is that it is actually tightening not easing. Hence QE in US is significant globally rather than QE even in Japan nowadays, global QE per se may not be that significant as you think. Nonetheless obviously RMB will be a major factor in near future as it internationalises. It is interesting to note that SNB, RBI, RBA, MAS, PBoC and even Russian Central Bank eased in the course of 5 short weeks of 2015. IMHO I think there is a global reverse-Plaza accord happening due to the nature of the timing.

2) "For countries whose economy is doing well, however, the real interest rate should increase due to more economic activity. The effect will be although nominal interest rates are low, deflation will occur. This is because Nominal Interest Rates minus Inflation gives Real Interest Rates. If Real Interest Rates increase but Nominal Interest Rates stay low due to government intervention, Deflation has to occur. " - I think you got the horse and cart mixed up on this

3) "Assuming that most countries will have to print money to counter effects of global QE, the country that can invest the printed money well would likely generate high real interest rates. Thus, one way is to look for countries that 1) have a capable government and 2) have a plenty of projects that can be invested to give high returns"
- I think in almost all instances, effective use of public money will be net economic positive in the long run, whether high or low real interest rate. Lousy projects have low or zero returns, but good public projects might not have great returns in a direct way. But in an indirect way, tax revenue and efficiencies can be increased in the economy. that's where the attirbution is much less precise and complicated and policy makers have to decide if they want to do the easy but ineffective way, or the hard to attribute but long term effective way

4) SGD is a controlled currency so you can't use a US textbook to understand it. Secondly SGD is managed through FX and not interest rate so FX is the primary conduit. For example in the event that SGD is to appreciate against the NEER, and the currencies of the basket is depreciating, SGD interest rate might actually be stable or even decline because the reference NEER currencies are already weakening.

If things are so simple looking then everyone can succeed in investing. Scratching the surface and looking at events unfolding and solving them one at a time is not going to work. WB has his own ways to succeed at his time but today is not yesterday. reading history and predicting future is what alot of investment gurus are doing. Contrary thinking is what WB is advocating not his style of investment or his past glorious. If anyone think they can understand who who more and by reading some AR or FS he/she can fully understand this or that then it is in itself this thinking that is dangerous and leading to self review risk.

Actually the genius of WB is his ability to explain very complex things in very simple terms.

However not many people have the discipline, patience and tenacity to follow his style. That is also probably why he is actually very open to sharing his investment philosophy. You can actually learn a lot by reading his AR.

WB is not a contrarian investor but value focused. there is a difference. He is not interested to be outstanding or different, or doing opposite to what the market participants are saying. He just do things simple yet effective.

http://www.valuebuddies.com/thread-5705-...#pid106429

[Life is a game]

Ok thanks Specuvestor.

[HyperionTree]

Few comments:

1) FX rate is relative in a fiat world. What that means is that competitive devaluation is actually dependent on the anchor you are talking about. In this case USD is the anchor and the current trend is that it is actually tightening not easing. Hence QE in US is significant globally rather than QE even in Japan nowadays, global QE per se may not be that significant as you think. Nonetheless obviously RMB will be a major factor in near future as it internationalises. It is interesting to note that SNB, RBI, RBA, MAS, PBoC and even Russian Central Bank eased in the course of 5 short weeks of 2015. IMHO I think there is a global reverse-Plaza accord happening due to the nature of the timing.

2) "For countries whose economy is doing well, however, the real interest rate should increase due to more economic activity. The effect will be although nominal interest rates are low, deflation will occur. This is because Nominal Interest Rates minus Inflation gives Real Interest Rates. If Real Interest Rates increase but Nominal Interest Rates stay low due to government intervention, Deflation has to occur. " - I think you got the horse and cart mixed up on this

3) "Assuming that most countries will have to print money to counter effects of global QE, the country that can invest the printed money well would likely generate high real interest rates. Thus, one way is to look for countries that 1) have a capable government and 2) have a plenty of projects that can be invested to give high returns"
- I think in almost all instances, effective use of public money will be net economic positive in the long run, whether high or low real interest rate. Lousy projects have low or zero returns, but good public projects might not have great returns in a direct way. But in an indirect way, tax revenue and efficiencies can be increased in the economy. that's where the attirbution is much less precise and complicated and policy makers have to decide if they want to do the easy but ineffective way, or the hard to attribute but long term effective way

4) SGD is a controlled currency so you can't use a US textbook to understand it. Secondly SGD is managed through FX and not interest rate so FX is the primary conduit. For example in the event that SGD is to appreciate against the NEER, and the currencies of the basket is depreciating, SGD interest rate might actually be stable or even decline because the reference NEER currencies are already weakening.

Dear Specuvestor,

Thank you for your comments. Please correct us if we are wrong.

Hyperion:
1) Yes. USD is still the dominant currency for trade and US is tightening. At the moment, it might not be clear whether if global QE is significant or not yet as it is early in the game. And you are right that it seems like a reverse plaza accord. Thus, the model discussed is a simplified model and would not be able to account for multiple factors. A detailed case by case consideration of each country, building on this basic model would likely yield more tailored insights.

2) At the moment, deflation has occurred in many countries likely because of lower oil prices. As such, you are right that, now deflation is not the effect of the interplay between real interest rates and nominal rates. However, in the long run, it is likely that economic activity should determine real interest rates and thus deflation or inflation.

Tree:
3) As an example of controversial use of printed money consider the Eurozone. In this case, printed money was used to provide credit to nations in economic trouble. However, buying more time via this way sometimes do not work out as the structural problems are too serious and there is just not enough time. Further, if the structural problems are linked in part to too much debt, providing more credit might actually worsen the situation. In this case, maybe, printed money was not wisely spent. In such a situation, over the long run like 5 to 10 years, economic activity is expected to drop and real interest rates in the affected country should drop.

In the case of the Great Financial Crisis, printed money was used to stabilise the financial system initially. Subsequently, some argue that too much money was printed since the system is already stable. Again, if the printed money was actually well spent, more economic activity should be expected in the economy and thus real interest rates should increase.

While most people focus on inflation and QE, Tree argues that the focus should be on real interest rates for long term analysis. Because fundamentally, investors earn the real interest rate and thus the discussion should be on how QE affects real interest rates, and how should QE be spent. Inflation or deflation is observed as a result of the interaction of the above two factors, keeping other things constant of course.

4) Yes. Indeed, SGD is special and the inverted yield curve did not turn out as well as expected when back tested historically. If Tree's understanding is correct, MAS can be viewed as using printed money to manage the exchange rate to provide stability in prices(inflation stable). For example, if the exchange rate is too high, MAS can print more SGD and exchange the printed SGD for the USD. So now the SGD is backed by USD. So freshly printed SGD is used to managed the exchange rate. If this usage of printed money is a positive for Singapore, more economic activity should result and real interest rate should rise over the long run. In the past few years, the costs of such a policy have been quite high as real interest rates were very negative for a few years. This suggest that there is less economic activity as a result of such policy. Some even claim the exchange rate policy caused high housing prices because people are earning negative real rates and decide to buy property to hedge.

Thank You.

Regards,
Hyperion and Tree.

[specuvestor]

Hi HyperionTree... so there's actually 2 of you using the same ID? Are you new graduates?

1) Main thing I want to highlight here is that becuase the anchor is USD, QE at USD is much more significant than competitive devaluation in other competitor countries because like you said, all of them depreciating against USD is not going to help much. But if the anchor USD is depreciating againist majors like post GFC, it becomes much more complex if competitive devalustion happens.

2) Inflation generally follows when economy does well. There is also differentiation of core inflation and non-core which are external supply related. There should be difference in policy response to these 2 type of inflation. So when core inflation increases when economy does well but nominal interest rate stays the same, the real interest rate actually goes DOWN. That is why during boomtown, central banks try to increase nominal interest rates to normalise or increase real rates. I cannot recall any instance when deflation occur when economy is growing well in line with potential output

3) From a neo-monetarist point of view, inflation is always a monetary phenomenon. However the real world with global trades is becoming more complex than that as deflation/ inflation can also be imported, depending on the structure of the economy.

I think you are right that the key is structural reform... QE only helps to smoothen the pain... but if the pain-killers been adminsitered so long that the patient no longer realise there is a sickness, it becomes a problem in itself. I am supporter of monetary easing/ QE for the simple reason of avoiding systemic risk that are not moral hazards. There is a big difference if u ask someone to pay in 1 year vs if you spread over 10 years. It's the same issue when you charge NPL to banks over 1 year vs over 10 years the same amount which will have differing impact on the CAR.

Your premise seems to be Austrian without government intervention hence you are trying to observe the outcome of a passive/ non-existent central bank environment. But in the current world system, the central banks are actually changing the dynamics by changing the nominal rates and hence the real rates so the real rates is not a passive outcome at all.

4) There are a lot of controlled currency system besdies SGD from currency board, to hard peg like ERM to EUR, to soft peg like Middle Eastern countries to USD, to managed float like Singapore, and capital control like NTD, KRW and INR. In Singapore's context, our SGD is not backed by USD. There is no obligation for MAS to give you USD if you hand in SGD. This is unlike HK currency Board System. SGD is strong and AAA by the implied strength of our foreign reserve. MAS don't allow the internationalisation of SGD hence technically it can determine the FX rate of SGD if it wants to (not without collateral damage of course), and longer than SNB for sure because the CHF is internationalise, which shows us the stark difference of the 2 regimes.

So different regime has different dynamics. You can't use the same textbook for all. We are fortunate in Asia to see different type of regimes because most developed countries don't even understand these terms.

Negative real interest rate is in general trying to pump up the economy by transfering risk to the lender and wealth to the borrower. However negative real rates in Singapore is more a function of USD QE and yes it is also why asset prices rose in general globally with cheap money.

Cheers

[HyperionTree]

Dear Specuvestor,

Yes. There are more than two. Hyperion consults his friends to check his facts and all his friends are call Trees. And no, we are not graduates. Please forgive us if we are all wrong.

But we'll provide references when we make our points. It is because something weird is happening in the economy now which is why we think it is worth a post to get responses to check our ideas. Basically, deflation or inflation, we opined that investors should evaluate a currency based on the prospects in real interest rate terms and the amount of goods that can be bought in the currency reliably for the longer term as we believe central bank intervention might not be able to last forever against the fundamentals.

Hyperion
1) Agree.

2) Yes inflation has been observed to always occur when economy is doing well. But, Hyperion is not the first to propose the prospects of a deflationary boom. There are some who are considering this possibility, please see this link as an example:
https://finance.yahoo.com/tumblr/blog-pr...29135.html

3) Yes the view is Austrian. This is not a conventional theory on how inflation, nominal interest rate interact.

Austrian link here: http://mises.org/sites/default/files/qjae9_2_5_5.pdf

Tree:
4) Sorry, the sentence "SGD is backed by USD" was misleading. Probably, Tree meant that the MAS accounts will record USD on the asset side, and SGD on the liability side. So the understanding is that the new SGD is used on FX interventions.

Indeed without internationalisation, there is more control.

Thanks for the great comment!

Regards
Hyperion and Tree

[specuvestor]

Wow interesting and i will have to think thrice carefully first before replying you in future with your army of trees

2) yes I've read about it before but I've never observed it do note that deflation is not the same as dis-inflation. Declining rates of inflation is not deflation, especially if aggregate output is still growing. Lower input cost with globalisation translating to higher profit and wealth effect is not likely to lead to deflation.

3) IMHO Austrian premise is flawed and runs contrary to observation. Disclaimer: I'm pragmatic so my style is more Keynesian. The stranger thing is Austrian economists proposing reverting back to gold standard... How do u peg to gold when prices are supposed to be market determined to be optimal as per Austrian? Isn't that a fundamental oxymoron? Back to the topic: Do you think gold standard will solve the real interest issues that you described?

[HyperionTree]

Wow interesting and i will have to think thrice carefully first before replying you in future with your army of trees

2) yes I've read about it before but I've never observed it do note that deflation is not the same as dis-inflation. Declining rates of inflation is not deflation, especially if aggregate output is still growing. Lower input cost with globalisation translating to higher profit and wealth effect is not likely to lead to deflation.

3) IMHO Austrian premise is flawed and runs contrary to observation. Disclaimer: I'm pragmatic so my style is more Keynesian. The stranger thing is Austrian economists proposing reverting back to gold standard... How do u peg to gold when prices are supposed to be market determined to be optimal as per Austrian? Isn't that a fundamental oxymoron? Back to the topic: Do you think gold standard will solve the real interest issues that you described?

Dear Specuvestor,

Please don't be afraid to comment. We want to be your friend. And in fact your comment is right on point because you understood that Hyperion wants to discuss the prospects of deflation in a booming economy.

Tree:
2) Tree told Hyperion about a famous value investor, Prem Watsa, who has and is continuing to bet that deflation is coming. He started to bet on deflation in 2010 -2011.
See:
http://www.fool.ca/2014/04/11/canadas-wa...investors/
http://business.financialpost.com/2011/0...deflation/

This provides the background on why Hyperion and Tree is looking into this possibility. While Tree agrees to some extend that Prem Watsa is onto something, Tree does not agree that investors should thus bet on deflation by buying some puts that inflation will go down.

Hyperion and Tree suggests that deflation or inflation should not be the main consideration but real interest rates should be the focus. Investors should look at real interest rates when deciding whether to hold cash in a certain currency and should not bet on inflation or deflation.

Hyperion:
3) There are some good parts in Austrian economics and there are the weird. Hyperion tries to extract the good only. This is similar to the efficient market hypothesis and the idea of beta which is strongly opposed by Warren Buffet himself. But this does not mean other parts of economics like the work of Jean Tirole does not merit consideration.

The model Hyperion propose builds on the foundation that the cost of QE is increase money supply and thus inflation. And as suggested by Austrian economist, the first who spent the printed money, which is usually the government, benefits to the expense of others who experience inflation. Inflation can be viewed as a wealth tax on cash and affects the lower income most because lower income group usually holds higher proportion of their wealth in cash. If wealth is taxed, arguably, economic activity decreases and real interest rates should decrease if there is no short term liquidity problem. In addition, Hyperion proposes that printed money if well spent, benefits everybody. So the net effect of the costs and benefits of QE have to be evaluated.

A major flaw here is that sometimes inflation, nominal interest rates, and real interest rates might have circular cause and effects. Thus there is divergence in theory on what cause what to happen in what order. In this case, Hyperion says QE cause real interest rate to drop or increase depend on how successful is QE. Next, depending on nominal interest rates you get inflation or deflation. Alternative models do consider lowering nominal rates cause inflation and thus cause real interest rate to drop, or lowering nominal rates cause real interest rates to drop and thus inflation occurs, and etc in different order.

On gold standard:
Hyperion had to admit to believing in the idea of a gold standard in the past but he has since moved on.

Major proponents of gold standard argue that the ability to print money in a fiat money system is unsustainable and the end game is hyperinflation so value should be stored in gold due to limited supply. However, the ability to print money allows governments to introduce projects to stabilise the economy in crisis or fund budget deficits to build infrastructure and provide necessary service to its people. This spending allows real interest rate to increase if done correctly which may outweigh the cost inflicted on people - inflation. This is the counter to why despite money printing, hyperinflation as an end game is not always true. The fallacy was that the Austrians seem to only consider the costs while ignoring the benefits.

Tree:
Once there were many videos on Youtube proclaiming that major countries in the world are abandoning the USD as the reserve currency and thus you should buy gold because you can store your value when USD becomes worthless due to hyperinflation. Other versions claimed that RMB will replace USD so buy RMB as RMB will appreciate. Here, Tree propose that the fundamental value of a currency depends on 1) the real interest rate earned and 2) the amount of goods and services can be bought in the currency reliably.

At the moment if you look at cutting edge research by Cesar A. Hidalgo on complexity of economy, it is not hard to observe that USA still ranked 5th in the world while China ranked a distant 18 in 2012. Complexity means that the economy can better react and change, if a sudden shock happens. Further, it also means there are more goods and services to be purchased from the country in the international market. However, Tree believes the complexity measure did not account for how important a particular good needs to be purchase from the international market and thus USA ranked only 5th but not 1st. If there are more goods and services to be purchase in USD than RMB as measured by complexity, it is likely that the reserve currency status of USD will remain and cannot be replaced.

Hyperion argues that RMB will remain cheap partly because of a lack of trust in dealing in RMB. The China brand suffers from bad reputation of fraud, low quality and dishonesty. Thus a business man who convert USD into RMB to deal with exporters in China have to face the prospects of being cheated significantly. As such, RMB will remain cheap due to lack of trust in dealing with people who buy and sell in RMB.

Thank you.

Regards
Hyperion and Tree

[specuvestor]

Chanced upon this old discussion 5 years ago

Interesting for me to note that in fact disinflation happened and 1997 didn't re-occur. Deflation generally didn't come true though one can argue stagnation for Europe. But people are starting to question effectiveness of monetary policy at lower interest rate levels

USD is much stronger than imagined despite QE and as expected remains the dominant hard currency and reserve. Slower than expected progress of RMB internationalisation though.

No one could have foreseen a Trump preidency or Trade War. This is the unknown unknowns that we just have to adapt on the go