When and how will the Fed and other central banks wind down
their mammoth asset purchases, also known as quantitative easing (QE)? Since the
start of the financial crisis, the Fed, the European Central Bank, the Bank of
England, and the Bank of Japan have used QE to inject more than $4 trillion of
additional liquidity into their economies. When these programs end, governments,
some emerging markets, and some corporations could be vulnerable. They need to
prepare.

• Research by the McKinsey Global Institute suggests that
  lower interest rates saved the US
  and European governments nearly $1.6 trillion from 2007 to 2012. This windfall
  allowed higher government spending and less austerity. If interest rates were
  to return to 2007 levels, interest payments on government debt could rise by 20%,
  other things being equal. Governments in the US and the eurozone are
  particularly vulnerable as interest rates
  rise, governments will need to determine whether higher tax revenue or stricter
  austerity measures will be required to offset the increase in debt-service
  costs.
• Likewise, QE saved firms $710
  billion from lower debt-service payments, thus ultra-low interest rates boosted profits by about 5% in the US
  and the UK,
  and by 3% in the eurozone. This source of profit growth will disappear as
  interest rates rise, and some firms will need to reconsider business models –
  for example, private equity – that rely on cheap capital.
• Emerging economies have also benefited from access to cheap
  capital. Foreign investors’ purchases of emerging-market sovereign and
  corporate bonds almost tripled from 2009 to 2012, reaching $264 billion. As QE programs end, emerging-market countries could see an outflow
  of capital.
• By contrast, households in the US
  and Europe lost $630 billion in net interest
  income as a result of QE. This hurt older households that have significant
  interest-bearing assets, while benefiting younger households that are net
  borrowers. 
• QE may have also generated NEW asset-price bubbles in
  some sectors, especially real estate. The International
  Monetary Fund noted in 2013 that there were already “signs of overheating in
  real-estate markets” in Europe, Canada,
  and some emerging-market economies. 

Of course, QE and ultra-low interest rates served a purpose.
If central banks had not acted decisively to inject liquidity into their
economies, the world could have faced a much worse outcome. Economic activity
and business profits would have been lower, and government deficits would have
been higher. When monetary support is finally withdrawn, this will be an
indicator of the economic recovery’s ability to withstand higher interest rates.

Nevertheless, all players need to understand how the end of QE
will affect them. After more than five years, QE has arguably entrenched
expectations for continued low or even negative real interest rates – acting
more like addictive painkillers than powerful antibiotics, as one commentator
has put it. Governments, companies, investors, and individuals all need to
shake off complacency and take a more disciplined approach to borrowing and
lending to prepare for the end – or continuation – of QE.

The recent years have been a frustration for anyone trying to make sense of China’s capital control policies. Capital controls have been an important part the Chinese economic policies since the communist revolution in 1949. At present, the dominant view both among Chinese policy makers and analysts is that at some point the restrictions have to go. They are incompatible with the pursuit of a
free market economy especially for a country with a leadership role in international commerce.

However, as with many other reforms, the chosen model of capital account liberalization has been baby steps. So far, capital account liberalization measures have opened up only new channel for Chinese firms to transfer funds abroad or new channels for foreigners to invest in China. Hong Kong has emerged as a renminbi (RMB) hub, where off-shore Euro-RMB can be deposited and freely traded. After all these developments, are the controls still effective?

Yin-Wong Cheung and Risto Heralla study the covered interest differential (CID) between onshore and offshore RMB (interest rates on RMB assets in China and outside China). The CID is a much used measure of the effectiveness of capital account restrictions because it vanishes by arbitrage under free capital mobility. So, if the CID is still large (in absolute value), we can be confident that capital account restrictions are still important (“binding”), and the arbitrageurs have not yet been able to arbitrage away the interest differential. Cheung and Heralla find that Chinese Capital Controls are still binding (see graph below) in fact the CID seems to be getting larger over time..

Apparently, China still considers capital control policy to be an indispensable tool to manage and stabilize the economy. However, the use of capital controls to restrict capital inflows and thereby undervalue the RMB comes at high cost: it is at variance with the goal to develop the domestic economy, since it depresses credit
availability within China. 

Source:

In  the Past 7 Days Yuan Devalues Most In 20 Years
By Tyler Durden 2/25/2014 [edited]
 
The last 7 days have seen the end of the unstoppable 'sure-thing', the one-way bet-of-the-decade, – yes Durden is referring to the end of the appreciation of the Chinese Yuan. ince the currency has gained nearly 1%, the largest gain since 1994, suggests the Chinese Central Bank is intervening. 

As for the causes, there is clear evidence of intervention from the People's Bank of China. We think that the recent yuan move is intended to discourage arbitrage inflows. If short-term capital inflows abate, the depreciation will probably halt. 

The yuan appreciated by nearly 3% against the greenback and 7% against in nominal effective exchange rate terms in 2013. Over the same period, China's FX reserves added another $500bn, despite the repeated talk from officials that China has had enough reserves. These seemingly contradictory messages and signs, in our view, suggest that the PBoC never really wants too much yuan appreciation, especially if it is driven by short-term speculative capital inflows.

The recent divergence of Chinese RMB interest rates and off-shore RMB interest rates raise suspicion that the Chinese Central Bank is behind the move. As the Chinese Central Bank buys more USD, it creates natural liquidity in the CNY, leading to much lower interest rates. For the Chinese authorities, this intentional weakening seems to be aimed at trade – specifically exports (and maintained export growth).

But this certainly will not please the Japanese (trying to devalue and manufacture their own recovery) or any other beggar thy neighbor nation. Welcome to the Currency Wars China… Potential asset deflation is a risk, as the carry trades diminish/unwind.  

Here are entirely unexpected obstacles to the Law of one Price:

The BBC tracks the Sterilization of Chinese Foreign Currency Interventions: 

 China removes $8bn from money markets to control lending

China's central bank has removed nearly $8bn (£4.7bn) from the money markets in a bid to control the amount of credit in the country's financial system.

According to reports, the People's Bank of China (PBOC) did so by issuing 14-day forward bond repurchase agreements, also known as forward repos.

It is the first time since June the PBOC has used forward repos, and comes after China released unusually strong economic data earlier this year.

Chinese stocks fell in Shanghai.

A trader at a Chinese commercial bank in Shanghai told the Reuters news agency that the move "sent a strong signal to the markets that the central bank is not letting liquidity ease".

"If money market conditions remain sloppy, the central bank could even step up efforts to mop up excess," he said.

China has been looking to suck excess cash from its open-market operations to reduce the risks of shadow banking, or informal lending to businesses.

Shadow banking has been identified as a major risk to China's future growth, because of the possibility of large debts turning sour.

Chinese banks traditionally see a spurt in lending at the beginning of the year, as businesses and consumers borrow money to fund spending in the new year.

In January, new local currency loans nearly tripled from the month before to $218bn.

By reducing the amount of money available, the government makes it harder for banks to borrow and move the money into risky investments.

However, in its attempt to rein in credit, China's money conditions have been volatile over the past six months.

China's seven-day bond repurchase rate – a measure of short-term liquidity – surged to double digit territory last year on concerns there was not enough money in the system.

This caused a sell-off in global markets last year, spurring China's central bank to make a series of short-term capital injections to soothe investors.

In a monetary policy report released in February, the PBOC said volatility in money-market rates is set to persist.

"When the valve of liquidity starts to tame and curb excessive credit expansion, money-market rates, or the cost of liquidity, will reflect that," it said.

"The market needs to tolerate reasonable rate changes so that rates can be effective in allocating resources and modifying the behaviour of market players." 

To address issues with its Big Mac Index, the Economist Magazin now has a revised index displayed interactively (here)

This is an update to my depressing Spanish recession blog entry from 4 years ago: The WSJ finally announced the

"End of Recession in Spain Fuels Hopes for the  for Euro Zone"

The article neglects to mention that Spanish unemployment is still exceeding 26%. Yes, this is no typo. Youth unemployment (16-24 year olds) has dropped below 55%. But these are good numbers compared to the Spanish economic situation in the past (see the Guardian's analysis)! 

Bloomberg has a great application to practice how the external balance line behaves in times of risk and crisis. 

1. Describe the major thesis,
the central idea, or set of ideas in
the reading. 

2. Citing specific lines in the article, quote verbatim a statement
or brief passage that is interesting to you or elicits in you some type of
emotional response.  Then identify your emotional response or why you
found it interesting, describe the meaning(s) that the statement or
passage has for you, and provide actual or possible reasons for your
response.

3. Show how the External Balance line behaves after the first riots, and explain why.