Saturday, July 18, 2009

Relative Central Bank Balance Sheets And Currency Races To The Bottom

Zero Hedge posts a weekly update of the Federal Reserve's bloated balance sheet as we believe it is critical to visualize the spiraling debt burden at our "central bank" especially since any day now the Fed will begin purchasing treasury securities outright in defiance of Geithner's lies to the contrary (China can't sell its planned Bills: at 0.925 Bid-To-Cover does anyone honestly think they will instead prefer to buy dollar denominated toiler paper and not roll out their own QE version momentarily?). As Cornelius pointed out earlier the dollar can't find a floor these days: rerisking is rampant the argument goes and that kills the greenback. However, the circular logic also holds: create dollar pain (by whatever means possible) and thus stimulate the market, Larry Summer's all time wet dream (would anyone like to wager that when hedge fund positional disclosure become mandatory DE Shaw will fight until the bitter end). And in this simplistic trilateral world (have fun gaming the yuan), the strength of any one of the trio in the dollar-yen-euro triangle results in implicit weakness of the other two. And vice versa. Yet aside from major broker-dealers who are axed in a given equity direction and thus have all the incentive to impact underlying currencies, is it possible that specific governments may manipulate currency strength via central bank positioning? Why yes.

Comparing the balance sheets of the Federal Reserve, the Bank of England and the ECB indicates that certain shanningans by the former two (and particularly massive agency purchasing specifically by the former former) may be responsible for persistent weakness of their respective currencies to the detriment of a (hyper)inflation allergic Europe (America's brush with the Weimar Republic was luckily offset by 3,000 miles of salt water, and even the UK had the Chunnel to thank). The bottom line is that while the Fed and the BE's balance sheets continue expanding, that of the ECB has been in shrinkage mode for a while now. Behold:

Federal Reserve:

Bank of England:

European Central Bank:

The most curious thing is that the absent the half a trillion reduction in foreign bank liquidity swaps the Fed's balance sheet would be in the stratosphere. But the premise is Europe is stable so Bernanke can rein those in. Ironically the more pressured Europe is to take up America's and Britain's economic slack, the more pronounced will be the pressure on Europe, both fiscally and monetarily, resulting in yet another eventual round of liquidity swap bail outs (and that is without even mentioning the "Eastern European Question"). But for now America is happy (the dollar is getting pillaged) and a disorganized Eurozone is dropping deeper into deflationary chaos (has anyone heard a peep out of Raiffeisen Bank lately? - speaking of RZB, it is enough to note that a Google search of the bank results in the first two hits being its Czech and Russian subsidiaries). How long can this persist? For a direct answer, the best proxy may, ironically, be the S&P500 yet again. Keep a close eye: the unwind of the central bank balance sheet game theory defection race (as well as every other unwind) will manifest itself there first.

Hat tip Andy Dufresne who seems to have found a good internet connection in Zihuatanejo

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