Tuesday, July 01, 2008

A Tale of Two CBs

It was the best of times; it was the worst of times. It was the age of prosperity; it was the age of inflation. It was the epoch of globalization; it was the epoch of kleptocracy. It was the springtime of emerging economies; it was the summer of discontent in the West.

Once, there were two central banks. Each was the member of a secret society, an exclusive club known only to outsiders as the 'BRICs.' While each of these CBs represented a different constituency with very different strengths and weaknesses, they fought against a common opponent: inflation.

In India, the central bank faced a sharp rise in inflation which hit poor rural workers the hardest. Economic (8.8% y/y) and money supply (M3 21.4% y/y) growth were robust, prompting the central bank to tighten reserve requirements and raise interest rates. However, because of the country's current account deficit, the currency faced pressure- causing the central bank to defend the rupee at a level of 43.00 to the $. Eventually, however, the weight of money seeking to leave India forced a rearguard action, and today the RBI pulled its offer, which will no doubt reappear at higher levels. Despite the RBI's efforts, the outcome is likely to be higher inflation.
In Russia, the central bank faced a sharp rise in inflation which hit poor rural workers the hardest. Economic (8.1% y/y) and money supply (M2 28.3% y/y) growth were robust, prompting the central bank to procalim that they would really like inflation to be lower. Because of the country's current account surplus, the currency faced upward pressure- which should have been a use weapon in the inflation-fighting arsenal. Eventually, however, the weight of money looking to enter Russia so infuriated the central bank, that they decided that it would be more socially useful to try and screw speculators than to fight their inflation problem. And so, in the name of "introducing volatility" in the exchange rate, they intervened to weaken the currency today- only slightly, but hey: it's the thought that counts! Because of the CBR's efforts, the outcome is likely to be higher inflation.
While it is perhaps churlish to wish hyperinflation on any country, or any other economic development that reduces living standards, one can't help but think that if there is such a thing as karma, it will come back to bite the CBR, who seem intent on snatching economic defeat from the jaws of victory in the name of a misguided attempt to screw foreigners.

Elsewhere, it was interesting to observe that the Russell 2000 put in a howler yesterday. As one poster observed yesterday, Friday was an index reweighting day in the Russell universe, when natural selection hit the R2k with a ton of bricks. Leaving the index were a number of high-flying energy companies, which had grown too big for the small cap index. Entering were dross like Ambac and MBIA, companies whose share prices may well be headed towards zero in the not-too-distant future.
After a torrid May and June, perhaps small cap shorts will finally have their day?


CP said...

Hi Macroman,

I read this morning that the Russians are to kick energy consumers while they're down by raising the export duty on crude oil to $494.90/tonne from $390.10.

This and the TNK-BP battle are more examples of Russians doing whatever they can to screw the West. It really amazes me why anyone would want to park cash in that country given its history!

Love the blog - keep up the good work! I share your frustration with CrossYen!


golden alcuzini said...

YOur call on the stock markets turning out to be spot on.....and as I have said before: all roads lead to gold (for now). Simple rule of thumb that still works.

D said...

I love your rants on Russia...LOL

Russians just like to fight, it is in their nature. I would know, my girlfriend was born there!

My 2 cents on gold is that the goldbugs still aren't satisfied and as this global smackdown shifts into the next gear the money needs to find somewhere to go. The US treasury has a lot of gold and we know Paulsen knows how to trade!


Anonymous said...


My wife came from Russia, and I know that cultural type very well. :)


Yes they did raise the duty (effective August 01, I believe). It matters not to the buyer, they will pay the same price, but the beleagured Russian oil companies (basically, the government gets almost everything over 30 USD a barrel) and their shareholders will feel the effects.

Not too long ago, the Russian government said that they wanted to reduce taxes on oil companies to encourage exploration and production, but no government can top Russia when it comes to saying one thing and doing the opposite.

Corey said...

With regards to gold, being an experienced trader in the market, I would be remiss if I didn't mention the possible weakness ahead in the metals. Even though I think dollar weakness will likely play out near term, and my bet is 20% more to go in the Yen, gold might succumb to sympathy selling if crude starts to slide...that is a big if near term, but medium term the rise in defaults and the credit contraction will absolutley put pressure downward on inflation. I'm not saying gold can't try to tag $1,000 again, but gold won't be a homerun trade. I started rebuying yen at 103 per USD and have been hit for 550 ticks, but I doubled down at 108 and now believe Yen is on a road to the 80's. Unfortunately I tend to watch the market now All Night Long.

Anonymous said...

Corey, Do you wish to elaborate further on Yen long thesis?
I have similar ideas- While I think the inflationary pressures will begin to subside or at least remain tempered down in the Developed countries because of the pressure sagging economic conditions put(esp. US), but I don't think the 'slowdown' in the EM's will materialize on as big of a level as some expect. Esp. in Asia, the consistent inflationary pressures, will force them to adjust towards domestic spending etc. and this should lead to more trade on a regional level. Japan should benifit from that, and if interest rates can tick a little bit higher there, I think a lot of importers/exporters in the Asian region might wanna use Yen instead of dollar as the currency of choice. This will help Japan relieve itself of its reliance on US-

this is the only way JYen makes a trip low 80's as I think it will, If however Japanese remain in the same economic state as they are now, they will probably heavily intervene in mid 90's.

either way, I do expect JYEN short term to make a trip to 110-114, and that's where I see better risk/rewards to begin a build up of a long Yen position.

Corey said...


if i have my personal timing correct, tomorrow will be the last day to pick up size in yen at a good price. i have 9350-9400 (sept) zone as a target during the next 24 hrs...after which we start heading higher very quickly. i also have 20 handles potential higher on the sp futures tomorrow, then that's all she wrote before a break of march lows in sp. i think your analysis on the asian block is pretty good btw.

good luck.

ps, i also have crude topping tomorrow to monday just above 144 (not to get too detailed...;)

Anonymous said...

corey, you are reading wrong the gold market, in the last 2 weeks currency volatility has diminished and gold has started to rise in all currencies.