Hedge Funds and Central Banks
Friday, as the stock market went to 3 1/2 year highs, the dollar declined, the bond market rallied and interest rates went down. Today, we witnessed pullbacks in raw materials, commodities and energy. The dollar surged and gold went up also.
In general, in a deflationary environment, bond prices will rise, yields and interest rates will fall, currency valuation and commodity prices will fall. The inverse is also generally true, in an inflationary environment, bond prices decline, yields and interest rates increase, currency valuation and commodity prices rise.
Usually when the economy takes a downturn, and prices deflate, the central bank attempts to contain weakening price levels through open market sales of bonds. This puts money into circulation, bond prices then rise, yields and interest rates fall, the currency devalues. Investors and speculators, seeing the rising bond prices, usually sell stocks and commodities to buy more bonds.
When the economy improves and inflation hits pricing, the central bank attempts to contain strengthening prices through increased interest rates. This takes money out of circulation through credit contraction by increasing the risk of borrowing money, bond prices fall, yields and interest rates increase, the currency appreciates. Investors and speculators, seeing the decline in bond prices, usually sell bonds and buy commodities and stocks.
Some of the market actions are self reinforcing, some are counter balancing. In an improving economy, a stronger dollar should drive down rising commodities prices. Conversely, in a deteriorating economy, a declining dollar should cause falling commodities to rise.
Hedging and market manipulation further complicates the markets with counter cyclical actions. In a deflationary economy, bond prices should rise. Investors should buy bonds and drive down interest rates. Instead hedgsters and speculators sell bonds, keeping rates higher, while buying commodities, thus increasing commodity prices through stagflation.
In an inflationary economy, bond prices should fall. Investors should sell bonds to drive interest rates higher, and buy stocks and commodities. Instead, hedgsters and speculators buy more bonds and commodities, to hold interest rates lower and cause further inflation to the commodities.
Real economic growth needs to occur to discourage this counter cyclical market behaviour. Our currency valuation and interest rates need to be stabilized at normal levels that are the lowest compatible with increasing the savings rate, spurring economic growth at home, and discouraging speculation on equities, commodities and housing. Is that possible? In a truly honest market, yes. In the hedge filled, speculator manipulated market we find ourselves in, probably not.
Foreign interests can manipulate and distort the market as well. Much like the Chinese Yuan being pegged to the Dollar, there is an existing carry-trade between the Japanese and American bond markets. Over valued Japanese bonds are sold and the proceeds are put in undervalued American bonds. This carry trade has actually been helped by the devaluation of the dollar. The Japanese exchanges are far in excess of the need to finance the American trade deficit with Japan. The only purpose of this exchange would be to prevent a run on the dollar by other central banks and foreign exchange speculators.
The resulting market distortions of the hedge funds, Chinese Yuan peg, Foreign Central Bank purchases of our Bonds, and the Japanese Bond carry trade are counter cyclical to our long term interest rate, liquidity and pricing levels. As long as these exchanges continue, our interest rates and currency will be held at artifically low levels and controlled by third party investment and foreign governmental entities.
In general, in a deflationary environment, bond prices will rise, yields and interest rates will fall, currency valuation and commodity prices will fall. The inverse is also generally true, in an inflationary environment, bond prices decline, yields and interest rates increase, currency valuation and commodity prices rise.
Usually when the economy takes a downturn, and prices deflate, the central bank attempts to contain weakening price levels through open market sales of bonds. This puts money into circulation, bond prices then rise, yields and interest rates fall, the currency devalues. Investors and speculators, seeing the rising bond prices, usually sell stocks and commodities to buy more bonds.
When the economy improves and inflation hits pricing, the central bank attempts to contain strengthening prices through increased interest rates. This takes money out of circulation through credit contraction by increasing the risk of borrowing money, bond prices fall, yields and interest rates increase, the currency appreciates. Investors and speculators, seeing the decline in bond prices, usually sell bonds and buy commodities and stocks.
Some of the market actions are self reinforcing, some are counter balancing. In an improving economy, a stronger dollar should drive down rising commodities prices. Conversely, in a deteriorating economy, a declining dollar should cause falling commodities to rise.
Hedging and market manipulation further complicates the markets with counter cyclical actions. In a deflationary economy, bond prices should rise. Investors should buy bonds and drive down interest rates. Instead hedgsters and speculators sell bonds, keeping rates higher, while buying commodities, thus increasing commodity prices through stagflation.
In an inflationary economy, bond prices should fall. Investors should sell bonds to drive interest rates higher, and buy stocks and commodities. Instead, hedgsters and speculators buy more bonds and commodities, to hold interest rates lower and cause further inflation to the commodities.
Real economic growth needs to occur to discourage this counter cyclical market behaviour. Our currency valuation and interest rates need to be stabilized at normal levels that are the lowest compatible with increasing the savings rate, spurring economic growth at home, and discouraging speculation on equities, commodities and housing. Is that possible? In a truly honest market, yes. In the hedge filled, speculator manipulated market we find ourselves in, probably not.
Foreign interests can manipulate and distort the market as well. Much like the Chinese Yuan being pegged to the Dollar, there is an existing carry-trade between the Japanese and American bond markets. Over valued Japanese bonds are sold and the proceeds are put in undervalued American bonds. This carry trade has actually been helped by the devaluation of the dollar. The Japanese exchanges are far in excess of the need to finance the American trade deficit with Japan. The only purpose of this exchange would be to prevent a run on the dollar by other central banks and foreign exchange speculators.
The resulting market distortions of the hedge funds, Chinese Yuan peg, Foreign Central Bank purchases of our Bonds, and the Japanese Bond carry trade are counter cyclical to our long term interest rate, liquidity and pricing levels. As long as these exchanges continue, our interest rates and currency will be held at artifically low levels and controlled by third party investment and foreign governmental entities.
Comments