I keep harping on the subject of imbalances. This is a philosophical belief system that is very, very, very ancient: all things must be balanced or they will tip over and collapse. But we dream of gods that can magically walk on water or make two fishes into many fishes. We dream of flying like gods and we wish we could pry open the door to infinite wealth. This is why the concept of ‘balance’ has to be taught. We lived through an era that believed heartily, ‘Greed is good!’ But this is causing all systems to collapse just like gluttony kills our own bodies.Tonight, I wish to examine a very recent Bank of International Settlements report about the ‘dollar dearth’: the need for everyone to get their paws on lots and lots of dollars due to all systems collapsing and thus, exposing many counter-parties to payments they cannot afford. Like the ‘savings glut’, this is the same thing at work. Namely, the two halves of one system. How can we have a ‘savings glut’ a mere two years ago and now, have a ‘dollar dearth’ today?
This is one of many puzzles which can only be solved if we keep in mind, the two sides of a scale. In this case, the false savings glut vanished in a flash when we hit a wall, this wall was the end of the greatest imbalanced duality: the US dollar/Japanese yen relationship suddenly switched when the yen began to strengthen.
The report below has no data concerning China so all the data here tells only half of the story. It is primarily concerned with the availability of dollars for unwinding all these bizarre and often stupid deals. But it doesn’t do the opposite: track the affairs of the yen and why it suddenly went from a global excess of lending to, overnight, a complete cessation of all lending from top to bottom, across the entire planet. This was NOT caused by US homeowners defaulting for the defaults barely began in July, 2007.
Goetz von Peter
The US dollar shortage in global banking
The current financial crisis has highlighted just how little is known about the structure of banks’ international balance sheets and their interconnectedness. During the crisis, many banks reportedly faced severe US dollar funding shortages, prompting central banks around the world to adopt unprecedented policy measures to supply them with funds. How could a US dollar shortage develop so quickly after dollar liquidity had been viewed as plentiful? Which banking systems were most affected? And how have funding pressures affected lending to non-bank end users of funds?
I, for one, was not shocked by this sudden switch from a flood of US-dollar-based lending to a collapse of lending coupled with a run to two currencies: the dollar and the yen. The euro was pulled into the position of being a fulcrum between the US $ on one side and the Japanese ¥ on the other. As the yen got weaker, the dollar also became weaker…against the euro. Both the ¥ and $ represented the world’s #1 and #2 economies for a long, long while. But the EU grew greater and greater in size until, during this last 5 years, it overtook the US and Japan and became the world’s biggest economy.
The euro’s strength was due to this fact. When the Japanese carry trade abruptly ended at the end of July, 2007, there was this sudden boomerang effect: the dollar and the yen, both of which were weak against the euro, shot upwards in value while the euro dropped. This is a classic example of how dynamic systems try to reach balance.
The concept of a floating currency is, all things naturally balance out as countries running deficits see their currency fall while countries with profits and excess see their currencies rise in value. But this whole system has been twisted badly by various manipulations so this natural evolution doesn’t happen at all.
The US has run consistent deficits, both in trade as well as government, nearly continuously for the last 35 years. We paid for this by de-industrializing and now, moving all possible white collar jobs offshore. Japan coped with trying to weaken the yen for export strength by reducing Japanese worker’s incomes to the point of nearly no return. Now, both the US and Japan are running a ZIRP banking system and both are racing each other to see how many more jobs can vanish. Even as both claim, they wish for more employment. Let’s go back to the BIS report:
This special feature draws on the BIS international banking statistics to provide some tentative answers to these questions. It splices together two sets of statistics to reconstruct the global balance sheet positions for each of the major national banking systems. The dynamics of the crisis can then be analysed across banks’ consolidated balance sheets rather than along geographical (ie residency-based) lines. With information on both the currency and the type of counterparty for banks’ foreign assets and liabilities, we can investigate how banks funded their foreign investments, and thus can better identify the vulnerabilities that threatened the financial system.
A noble cause. I applaud all organizations when they give us comprehensive data and well-organized graphs and charts so we can get a good look at things, ourselves. I am happy the BIS has been doing this service for us. I assure everyone, these graphs are most interesting.
Global banking activity had grown remarkably between 2000 and mid- 2007. As banks’ balance sheets expanded, so did their appetite for foreign currency assets, notably US dollar-denominated claims on non-bank entities, reflecting in part the rapid pace of financial innovation during this period. European banks, in particular, experienced the most pronounced growth in foreign claims relative to underlying measures of economic activity.
Now, one thing that irritates me is this: the ‘expansion of money’, the ‘growth of money’ wasn’t magical or accidental. It came from one point and moved across the planet. It had a wellspring, a source, a place where it first emerged. I figured, this source was the Bank of Japan since no other nation on earth was running a ZIRP system until this year. And in 500 years of banking, no one has ever run a ZIRP system for more than a few weeks or maybe two months, but not for 15 years!
And certainly, not a top economic power. Switzerland, for example, isn’t a top economic power. Neither is Singapore or Bahama. So, the day Japan went ZIRP, the entire banking system of the planet was put on a footing it had never been on before. This is probably why so many experts are puzzled by events. Since they ignored the Japanese ZIRP system by saying, ‘Japan has a depression,’ they didn’t realize how this ‘depression’ was being used by Japanese exporters to enter and dominate many markets.
We explore the consequences of this expansion for banks’ financing needs. In a first step, we break down banks’ assets and liabilities by currency to examine cross-currency funding, or the extent to which banks fund in one currency and invest in another (via FX swaps). After 2000, some banking systems took on increasingly large net on-balance sheet positions in foreign currencies, particularly in US dollars. While the associated currency exposures were presumably hedged off-balance sheet, the build-up of large net US dollar positions exposed these banks to funding risk, or the risk that their funding positions could not be rolled over.
This is quite amusing. Before 1998, few hedge funds existed. The Derivatives Beast was still manageably small. The global banking system did have a major change from 1990 to 2000: computers! Yes, to program, run and use computers required lots of training and virtually none of the bankers or employees over the age of 40 knew much or even, anything about how to use computers so they hired a huge, huge number of newbies who were computer-savvy.
This army of rash, eager, wild youth took over the banking system. We know that some of them crashed or even utterly destroyed venerable banks, playing wild games on their own. Whenever they discovered the computers could override a control or a slow system could be exploited by super-fast computers to exploit glitches in the system, an ethos that involved ignoring all danger signs evolved.
Risk was ignored because the computer whizzes joined with greedy executives to park all risk elsewhere. Once this was done, when all risk was shoved into the laps of the bond market or retirement funds, etc, they went wild, RUNNING UP TREMENDOUS DEBTS. Namely, they also figured out how to exploit the differential between Japan’s interest rates and the rates of the entire planetary banking system. And since Japan was running tremendous trade surpluses with the world, they were more than happy to lend to other countries…so long as no one held yen in reserves!
To gauge the magnitude of this risk, we next analyse banks’ US dollar funding gap. Breaking down banks’ US dollar assets and liabilities further, by counterparty sector, allows us to separate positions vis-à-vis non-bank end users of funds from interbank and other sources of short-term funding. A lower- bound estimate of banks’ funding gap, measured as the net amount of US dollars channelled to non-banks, shows that the major European banks’ funding needs were substantial ($1.1–1.3 trillion by mid-2007). Securing this funding became more difficult after the onset of the crisis, when credit risk concerns led to severe disruptions in the interbank and FX swap markets and in money market funds. We conclude with a discussion of how European banks, supported by central banks, reacted to these disruptions up to end- September 2008.
Now, here are the graphs. Remember, over a trillion dollars appeared magically thanks to hedge funds using the Japanese carry trade:
- Britain: funnel for many offshore hedge funds and other pirates. See how their holdings grew in a classic, unsustainable rate. Virtually most of the growth is in dollar holdings.
- Swiss banks grew with fits and starts. In 2007, significantly shrinking growth. It, too, is mostly dollars.
- Germany is quite different: most of the growth was in euros, not dollars. The growth also sees a surge in euros from 2005-2008. Virtually no yen, just like UK and Swiss banks.
- Spanish banks saw, by far, most of its growth in other currencies [I am assuming, Eastern European, for the most part]. Spain’s banking system is near total collapse.
- France saw belated growth but made up for lost time, it is nearly a ‘hockey stick’ graph which is very dangerous. It, like Germany and Switzerland, saw shrinkage after 2007.
- Belgium is nearly all euros and virtually nothing else, not even a tiny bit of yen.
- Ditto, Dutch banks which incidentally, more than the others, saw a very sudden explosion in all forms of money beginning abruptly in 2002.
- Japan: HAHAHA. Totally, utterly different from all the above graphs! First, all the others show ‘mirror’ images of plus and minus. BUT NOT JAPAN! Also, it is the only one holding more than 5% of its money in the form of yen! It also holds virtually no euros and about the same amount of ‘other currencies’ which I bet are YUAN. But the other feature is, this didn’t grow smoothly. Instead, the amount of dollars changed only slightly over the decade. I suspect, this is because every year, Japan held more dollars. After all, look at the other graphs: none held nearly as many dollars in 1999, for example.
- Last is the US: Unlike the other graphs, we are the REVERSE of Japan: Japan’s positive numbers are much, much bigger than its negative. We have overwhelming negative numbers. And we hold mostly US dollars. Talk about demented. We hold nearly no yen.
Banks’ global expansion
Banks’ foreign positions have surged since 2000. The outstanding stock of BIS reporting banks’ foreign claims grew from $11 trillion at end-2000 to $31 trillion by mid-2007, a major expansion even when scaled by global economic activity. The year-on-year growth in foreign claims approached 30% by mid-2007, up from around 10% in 2001. This acceleration coincided with significant growth in the hedge fund industry, the emergence of the structured finance industry and the spread of “universal banking”, which combines commercial and investment banking and proprietary trading activities.
Nothing, nothing, nothing can ever grow at a 30% rate forever. Not even for a decade. Anything greater than 3% is dangerous. I am just furious that no one seems capable of calling a bubble when things grow obviously too fast. The growth of the Derivatives Beast, for example, was horrific and the regulators knew this and did absolutely nothing.
To have a huge thing triple in size in just 7 years is very dangerous! Note also, this is a 7 year ‘fatted cow’. The cow got so fat, it couldn’t squeeze into the barn. Now, it is on a severe diet and is shedding pounds like crazy. Back to the craze of using young, foolish recent graduates to run the computer systems of the hedge funds and investment banks led to utter recklessness. These callow young experts with using computers didn’t know that their splendid returns were actually a danger sign, not good news.
But the bosses were even happier. They saw riches pouring into their pockets while computers silently added incredible numbers, nonstop, day and night. Why, this was a genie in a bottle!
The fact that this sum grew to over $31 trillion [and I suspect, this doesn’t include China’s sums] is interesting since the Derivatives Beast is multiples of this, the $666 trillion nature of that creature is pretty interesting. This ‘universal banking’ was due to kicking over all restrictions of movements of money. This was coupled like a pair of oxen with a yoke, with free trade. All barriers were to be removed so trade and money could flow madly from point to point. The parties who enabled and pushed for this business were very happy with this unregulated, unrestricted madness.
At the level of individual banking systems, the growth in European banks’ global positions is particularly noteworthy. For example, Swiss banks’ foreign claims jumped from roughly five times Swiss nominal GDP in 2000 to as much as eight times in mid-2007. Dutch, French, German and UK banks’ foreign claims expanded considerably as well. In contrast, Canadian, Japanese and US banks’ foreign claims grew in absolute terms over the same period, but did not significantly outpace the growth in domestic or world GDP.
And that is very significant! How did Japan escape the madcap growth of holdings? And we know that Canada is an oil export power, so it doesn’t surprise. The US and Japan both poured in funds into Canada via energy trade. But Japan isn’t a commodity country, it is more like Germany and Britain!
Maturity transformation across banks’ balance sheets
From the perspective of financial stability, a key metric of interest is the extent to which banks engage in maturity transformation. A sudden inability to roll over their short-term funding positions will require that banks “deliver” foreign currency, which may force them to sell or liquidate assets earlier than anticipated, typically in distressed market conditions (“distress selling”).8 Unfortunately, data limitations make it difficult to obtain an aggregate maturity profile of banks’ foreign assets and liabilities. However, the counterparty sector breakdown available in the BIS banking statistics may serve as a rough proxy for maturity transformation, and hence funding risk, since the maturity of positions is likely to vary systematically with the type of counterparty. We use this counterparty information to construct a measure of banks’ US dollar funding gap, or the amount of US dollars invested in longer-term assets which is not supported by longer-term US dollar liabilities, this gap being the amount that banks must roll over before their investments mature. We build up this argument in several steps.
- UK net positions shows ‘NON-BANKS’ holdings shooting upwards like a rocket from 2002 to 2007, then, it collapses right when the Japanese carry trade ended.
- Swiss banks are choppy.
- Germany is worse than the UK: the non-banks shot upwards at a giddy rate and has barely paused, even today. I suspect, this is due to the UK currency, the £, weakening and falling badly against the euro.
- Spain: unlike Germany, Switzerland and Germany, is totally reversed!
- France is a mixed bag.
- Ditto, Belgium.
- Dutch banks are an echo of the British mess.
- Japan, again: how odd. Not like any of the other graphs. And is steady as a rock.
- Then comes the US: utterly different from everyone. And what an ugly mess! Look at the flow of funds: OUT. The hedge funds sucked out much of our money. Nearly a trillion dollars! Isn’t that funny? This is the amount the BIS mentions just a paragraph ago!
The crisis has shown how unstable banks’ sources of funding can become. Yet the globalisation of banks over the past decade and the increasing complexity of their balance sheets have made it harder to construct measures of funding vulnerabilities that take into account currency and maturity mismatches. This special feature has shown how the BIS banking statistics can be combined to provide measures of banks’ funding positions on a consolidated balance sheet basis. The analysis suggests that many European banking systems built up long US dollar positions vis-à-vis non-banks and funded them by interbank borrowing and via FX swaps, exposing them to funding risk. When heightened credit risk concerns crippled these sources of short-term funding, the chronic US dollar funding needs became acute. The resulting stresses on banks’ balance sheets have persisted, resulting in tighter credit standards and reduced lending as banks struggle to repair their balance sheets.
Look at that graph below! The European side is UTTERLY different from the US side of the scales! Is this balance? Or total imbalance? The answer is obvious!
We have virtually NOTHING. Europe has over $8 TRILLION. How on earth can a global banking system work smoothly when it is this badly out of whack. And this doesn’t show China or Japan’s holdings! This would bring it to well over $13 trillion. Seeing these graphs, the BIS should hold meetings to discuss how to rebalance all systems!
This means trade, too! And this is no easy nut to crack. Especially, since the elites want to revive the past, not fix the present.
P.O. BOX 483
BERLIN, NY 12022
Make checks out to ‘Elaine Supkis’