Perspectives on the global economic changes

[vish_mulay]

I am buying the house and its not a financial but family decision. With 2nd child on the way, we need space and anchor to raise the family. I am buying at a location which is in perpetual bubble (Sydney inner west, NSW ~20 % CG/yoy for last 4 years after 10 years bust). I dont think it will sustain and will bust. When it will bust i have no idea. Doomsday scenario has been advocated for last 4 years and i was waiting and watching. In the mean time i have paid ~100000 AUD in rent in last 4 years. For 35K per year mortgage repayment i am getting a 3 bedder house on 500sm plot (550K AUD total loan). My simple take is that for 10k per year (250K total) i will get my own place in 25 years. Even if i get inflation adjusted cg for those years, i will be better off rather than paying 25K rent/year (625000 AUD total). we are making sure that we can pay mortgage and living expenses with one salary and other salary is used to pay off lean asap.
Whats the catch? We are very close to CBD but with purchase we have to commute 40 min one way. Also moving from safe neighborhood to not so safe one which is just starting to gentrify. We will also move from flat dwelling to single standing house with garden. Lots of weekend jobs for me.

[ramana]

Good luck. Its not so bad and you will be glad you did it when you could.

Also guys how is all this discussion about housing etc related to thread title?

ramana

[panduranghari]

Paging panduranghariji....ECB talking about QE. WTF???

Don't know! UdayM ji
Strengthening dollar, weakening Euro... who knows. But not very relevant in the big picture, IMO.
FOFOA from Dirty Float:
"Wait… WHAT?! Is the dollar too strong or too weak? Does the Fed want it stronger or weaker, and what does Europe want? I'm confused!" Yes, I know it's confusing. It's not about too weak or too strong at this point. The dollar is simply overvalued, and has been since 1958 when the Bretton Woods gold flow reversed. In the 1960s, that overvaluation was reflected in the European accumulation of dollars and the one-way gold flow. Today it is reflected in the perpetual US trade deficit, which over 40 years has become structural and immutable within the status quo."

FOFOA from Just Another Hyperinflation
"Somewhere in the 1970s era I was exposed to the thinking of several different deflationists. It seemed that all of their conclusions came to the same end: that dollar deflation would rule the day, no matter what. Mind you now,,,,,, most of them were split on the finer points of the issue, but for all of them; Deflation was always the final outcome."

"My friend, debt is the very essence of fiat. As debt defaults, fiat is destroyed. This is where all these deflationists get their direction. Not seeing that hyperinflation is the process of saving debt at all costs, even buying it outright for cash. Deflation is impossible in today's dollar terms because policy will allow the printing of cash, if necessary, to cover every last bit of debt and dumping it on your front lawn! (smile) Worthless dollars, of course, but no deflation in dollar terms! (bigger smile)"


FOFOA again in Euro Gold:
"Now I want to talk about "the process of saving debt at all costs, even buying it outright for cash" because this is something they are doing in Europe as well, and, therefore, is one of the arguments the euro critics use to claim that the euro is no different—or even worse—than the dollar. Should we be surprised or shocked that they are doing this in Europe having read A/FOA all those years ago? Well, no. Unless, like many, you didn't really understand what you read.

In my 2009 post Gold is Money – Part 2, I wrote, "And it was always known, but has now been proven, that the system will be saved at ANY cost." When I wrote that I was discussing the dollar and the dollar system, aka the $IMFS, aka Wall Street. But this applies to any monetary and financial system. The system always takes political precedence over the currency. The currency will always be debased if that is needed to keep the system functioning nominally. This is nothing new and it should not be surprising, yet it's apparently very surprising to 99.9% of all financial analysts"

FOFOA said "If you thought it was hard to think like a giant, it's even harder to think like a CB." Perhaps an addendum should be added to that quote- "and it's even harder to think like a CB in the current $IMFS!"
-------

So that is all I can discern from FOFOA.

Vina ji alluded to this - perhaps without understanding its full implication -

After that , when the US itself needed an expanded monetary base, the system fell apart. So moral of the story, you can't put back a failed system based on gold standard in this day and age!

So, Vinaji, in you opinion how much of expansion was warranted and do you believe current expansion of the fiat currency is enough, not enough thus more needed, or excessive expansion?

[panduranghari]

Per ECB QE:

Copycatting is the most sincere form of flattery.

And nothing inspires it more than success.

from UdayM's link https://www.ecb.europa.eu/press/pressco ... 22.en.html

Question: My first one is on inflation expectations. You mentioned that they have decreased further in recent days and weeks, and this is despite the fact that markets were increasingly pricing in QE and seeing it as a done deal. What makes you confident that this trend will now be reversed now that you have decided and you are going for QE?

And the second one is on fiscal policy and monetary policy. In your speech at Jackson Hole in last August you said that fiscal policies in other large advanced economies has been more available and more effective compared to the euro area. And you said, and I quote, this reflects the fact that the central bank in those countries could act and has acted as a backstop for government funding. And your argument was that this allowed fiscal consolidation to be more back-loaded. So my question is, is the ECB, with this QE program, now this kind of support for government funding in the euro area?

Draghi: Well the answer to the second question is absolutely no. Absolutely no. We shouldn’t forget that --perhaps today is the first time I say it, usually by now I am in the fifth time-- We shouldn't forget that our mandate is price stability, price stability defined as keeping inflation rate close but below 2%. And we are, at this point in time, distant from that objective.

And to give you a few ideas, the average inflation rate for 2014 was 0.4%. The five-year, the average inflation rate over the next five years is 0.3%. And the inflation rate, the average inflation rate over the next 10 years at this point in time, these are market-based measures, are 0.9%. The 5y-5y inflation expectation is today, I think should be around 1.64, to be compared with an average of 2.30.

So there is little doubt, in our view at least, that one should act. We believe and are convinced and have good arguments to think that the monetary policy measures that we have decided today will contribute to lift inflation expectations. You said that they are already priced in the market. Well, I would agree with you. Some, it's hard to say how much, but certainly some of the effects have already been priced in the market. But there is a difference between expectation and actual announcement that things are going to be undertaken. So I think that's, in the end, after months pass by, it's the announcements that really matter. In other words, expectations work only if there is certain credibility. And we are showing that this credibility is deserved with today's action

[panduranghari]

, haven't i lost 800 USDX12 monthsX30 years to rent with nothing to show for it at the end? !

Don't beat yourself up for this. I know many many people in the UQ who were burnt due to the Black Wednesday of 1987. Some are very close friends who lost houses due to rising rates and were never able to buy again even to date.

Life plays strange games.

[chanakyaa]

Good luck. Its not so bad and you will be glad you did it when you could.

Also guys how is all this discussion about housing etc related to thread title?

ramana

Thanks Ramanji. I was about to suggest changing the thread title to reflect "Mortgage Finance of Rental/Ownership in the Land of Milk'n Honey". But, on a serious note, looking at the interest and enthusiasm on the subject, looks like the BRFites want little nukkad area to discuss/share notes on this subject. Not a bad idea.

[chanakyaa]

After that , when the US itself needed an expanded monetary base, the system fell apart. So moral of the story, you can't put back a failed system based on gold standard in this day and age!

While on the subject of overrated and hyped role playing by central bankers (CB), I found a very interesting conversation from Ray Dalio of Bridgewater while on a panel at Davos. Among many topics discussed in the following clip, discussion I found very interesting is how interest rates allowed CBs to manage boom/bust economic cycles. After the 1980s periods, the interest rates trajectory has been downward. While CBs, over these periods, raised rates numerous time, the overall trend has been downward to zero. Although, CBs know how to raise the rates, in today's debt junkie environment, CBs are clueless how to respond.



I wouldn't be surprised this plays out for India in the next 15-20 years....

International Monetary Fund Managing Director Christine Lagarde, former U.S. Treasury Secretary Lawrence Summers, Goldman Sachs Group Inc. President Gary D. Cohn, Banco Santander SA Chairman Ana Botin and Ray Dalio, who runs the investment firm Bridgewater Associates LP, speak on a Bloomberg Television debate on quantitative easing. Francine Lacqua moderates the session at the World Economic Forum's annual meeting in Davos, Switzerland. (Source: Bloomberg)

Lagarde-Cohn-Summers-Botin-Dalio-on-Bloomberg-panel
(It is a long clip, but the first 15 mins covers interest areas from Dalio)

[TSJones]

Keeping your stash in good, safe Switzerland? Maybe not so safe.

http://www.ft.com/cms/s/0/c96a7fdc-a25a ... z3ProBhMFy

[TSJones]

Per gold standard:

If you expect any nation to commit their economy to underwrite and defend the price of gold, you're living in a dream world where everything is cupcakes and ice cream..

[chanakyaa]

Greece election: Anti-austerity Syriza wins election

Anti-austerity Syriza party has won Greece's general election, putting the country on a possible collision course with the EU over its massive bailout.

Is this in part why ECB resorted to money printing/QE?

[svinayak]

https://www.youtube.com/watch?v=5Pj1s7Le7RQ

Celente: We live in bankism, not capitalism, ECB QE is massive fraud

The introduction of quantitative easing by the European Central Bank has raised doubts about the effectiveness of such a move. To discuss this measure taken by the ECB RT talks to the publisher of Trends journal, Gerald Celente.

[panduranghari]

Greece election: Anti-austerity Syriza wins election

Anti-austerity Syriza party has won Greece's general election, putting the country on a possible collision course with the EU over its massive bailout.

Is this in part why ECB resorted to money printing/QE?

Its a side show. Syriza or no Syriza. Greeks do not want to leave EU.

For the sake of exercise, lets think what could happen if Greece leaves Euro;
1. Drachma will be devalued overnight against Euro or Dollar.
2. Bone crushing hyperinflation will ensue as the government tries to keep palliative printing from preventing loss of liquidity.
3. Bank runs - obviously.
4. It will go on until the Greeks demand return to Euro as at least prices remained stable while in Euro for over 15 years.

[Neshant]

The one thing Greece would leave behind is their debt if they left the euro. Since the euro is a currency that is set to fall apart anyways in the future, the ones who leave earliest will have the first-movers advantage. The ones who stay till the bitter end will be the ones holding the bag.

The market has a very short term memory. Within a couple of years, Greece will become a good place to invest with much lower labor costs and zero debt if they left.

The other euro countries will try to punish Greece for defaulting and leaving the euro no doubt. But that would only highlight that the euro is a mafia club where members turn on members when issues of money are concerned.

Thank god India is one country and not a fake union of states & failed experiment like the EU.

Their decision to depart would have to be sudden and not a gradual one as if the market came to know, it would react against them. So just like the Swiss National Bank, they gotta let loose the bazooka without warning. Overnight changing of euros in the bank to drachmas would be the biggest shock.

[disha]

Good luck. Its not so bad and you will be glad you did it when you could.

Also guys how is all this discussion about housing etc related to thread title?

ramana

The recessions I know of (and lived through) and of the depression I have read about., were preceded by the real estate bubble. I do not know if a RE bubble is a canary in the mine or the root cause., neither one knows (on an average) if one is in a RE bubble or not and further, I believe that with increased globalization., the RE prices itself will become super-relative* (*RE prices itself are relative, and now will be compared across localities and lifestyles half-way across the world thus becoming what I call it as super-relative)

In that sense, we do need to understand (and also educate ourselves) with the RE price movements globally.

[abhischekcc]

Its a side show. Syriza or no Syriza. Greeks do not want to leave EU.

For the sake of exercise, lets think what could happen if Greece leaves Euro;
1. Drachma will be devalued overnight against Euro or Dollar.
2. Bone crushing hyperinflation will ensue as the government tries to keep palliative printing from preventing loss of liquidity.
3. Bank runs - obviously.
4. It will go on until the Greeks demand return to Euro as at least prices remained stable while in Euro for over 15 years.

The greeks have a lot of their own natural resources and agriculture to fall back on. Also, it is a nation of small time shopkeepers, everybody does their own business. Hence, when they have material goods, they can manage a service economy as well. Also, the greek economy is highly dependent on remittance by greeks employed in their merchant navy. So, if the global economy remains stable (zero growth scenario), they will still be able to manage.

[JE Menon]

^^Yup, Greece will manage...

They're very much like us in many ways. Individualistic and family oriented - to the point of anarchy sometimes. They think they basically sub-contracted the big-bang to God (luckily no one has sent them the PPT on 36% of Indians own Nasa - or they would have just changed the nationality and remailed it!!!).

On the whole, wonderful, fiercely free and accepting people and also HIGHLY nationalistic and political. I have lived among them most of my life with almost zero negative atmospherics. Very liberal for the most part in terms of social life, to the point of what traditionalists back home might consider stir-crazy. Adult living arrangements can appear incomprehensible, but all perfectly ok and neither looked down upon, nor pedestalised. Again, very free and very entrepreneurial but with a strong global sense of entitlement - as in "We are Greeks, founders of Western Civilisation, WTF?"

So they will manage, but it will take some time - as in maybe a couple of decades. Their sovereignty will be eroded in the years ahead, but not their sense of "Greekness" which is in fact likely to be enhanced. Eventually they will thrive again. They have been around for a while people.

[panduranghari]

The greeks have a lot of their own natural resources and agriculture to fall back on.

It still did not help them when they have inflated the currency before they joined Euro. Inflating the M0 is the easiest thing for a politician. And that is what they cannot do because Euro takes away the ability of the government to print at leisure. Historically, Greek Drachma has always been a weak currency because of their profligacy.

After the formation of the modern Greek state in 1829 the country went on to default on its debts in 1843, 1860 and 1893. According to calculations by the economists Carmen M. Reinhart and Kenneth S. Rogoff Greece has spent more time in default to its creditors than any other European country. It has been skipping its repayments for 50 per cent of the years since 1800, compared with a mere 39 per cent of the time for the next worst offender, Russia. Indeed, even if you moved it across to Latin America – generally regarded among bond traders as default central – it would still be among the worst offenders. Only Ecuador and Honduras have a worse record of meeting their debts. link

Also, it is a nation of small time shopkeepers, everybody does their own business. Hence, when they have material goods, they can manage a service economy as well.

There is no evidence for this statement.

Also, the greek economy is highly dependent on remittance by greeks employed in their merchant navy. So, if the global economy remains stable (zero growth scenario), they will still be able to manage.

How? In 1929 the Harvard economist Charles Bullock published a magnificent essay on a monetary experiment conducted by Dionysius the Elder, ruler of the Greek city state of Syracuse from 407 BC until his death in 367. After running up vast debts to pay for his military campaigns, his lavish court and spectacles for the common people he found himself painfully short of ready cash. No one wanted to lend him any more money and taxes were drying up. So Dionysius came up with a great wheeze. On pain of death he forced his citizens to hand in all their cash. Once all the drachmas were collected he simply re-stamped each one drachma coin as two drachmas. Simple. Problem solved. Syracuse was rich again.link

^^Yup, Greece will manage...

They're very much like us in many ways. Individualistic and family oriented - to the point of anarchy sometimes. They think they basically sub-contracted the big-bang to God (luckily no one has sent them the PPT on 36% of Indians own Nasa - or they would have just changed the nationality and remailed it!!!).

On the whole, wonderful, fiercely free and accepting people and also HIGHLY nationalistic and political. I have lived among them most of my life with almost zero negative atmospherics. Very liberal for the most part in terms of social life, to the point of what traditionalists back home might consider stir-crazy. Adult living arrangements can appear incomprehensible, but all perfectly ok and neither looked down upon, nor pedestalised. Again, very free and very entrepreneurial but with a strong global sense of entitlement - as in "We are Greeks, founders of Western Civilisation, WTF?"

So they will manage, but it will take some time - as in maybe a couple of decades. Their sovereignty will be eroded in the years ahead, but not their sense of "Greekness" which is in fact likely to be enhanced. Eventually they will thrive again. They have been around for a while people.

Yes everyone manages. India did when it was a socalist utopia run by the congress and so did weimar germany. A good book to read would be When Money Dies by Adam Fergusson http://thirdparadigm.org/doc/45060880-W ... y-Dies.pdf <<<<<free reading PDF. Its selling for 1000$ in hard copy in Davos says a little birdie.

[TSJones]

Greece in all likely hood will proceed with a default, at least partial if not entirely. Like Mexico, it's what they do. However, the Greek voters are apparently against leaving the Euro so this will present an interesting conundrum. Sort of like the city of Detroit defaulting and declaring bankruptcy but still being served by the state of Michigan and the Federal government. Reportedly, Germany has invested over 200 billion euros in propping up Greece and keeping them out of default. The Germans will lose and this will be in the court systems for years. The Germans should have known better given Greece's history on defaults. This will be an expensive lesson for them. When a country is in a bad state of arrears as Greece was, DO NOT throw good money after bad. The US gave Mexico billions in loans in their last default in 1994 BUT we got their oil revenue receipts until they made good on the loan. The Mexicans paid it off in a few years. Greece has no such resource. It's just gonna be an ugly court problem. If the Greeks manage to stay within the Euro system they will pay a high premium for their currency because nobody wants to loan to a defaulter. So the Greeks may not like paying that premium for the Euro after defaulting. Sin in haste, pay in leisure for a long, long time.

[Suraj]

Gundlach speaks up:
Fed should hold line, ECB QE will fail: Jeff Gundlach

The Federal Reserve has little justification to raise interest rates amid a deflationary global backdrop, bond expert Jeff Gundlach said.

"There was a year, 1937, when the Federal Reserve tightened credit conditions prematurely and it led to the second leg of the Great Depression," said Gundlach, who confessed to being "worried" that the Fed would do the same thing even though there are no inflationary pressures that would indicate a need for tightening.

The head of DoubeLine Capital, who was nearly alone in predicting that government bond yields would fall in 2014, also said he doubts that the European Central Bank's foray into quantitative easing will work.

"The Europeans have decided to do quantitative easing, and I expect they'll have very little success," Gundlach said, speaking Tuesday at ETF.com's Inside ETFs conference in Hollywood, Fla. "You wonder if all the king's horses and all the king's men will be able to keep Humpty Dumpty together."

The various cross-currents have created some notable market moves.

Oil prices have plunged and the U.S. dollar, after years of being suppressed by Fed policy, has become a strong player on the global currency stage.

Gundlach said he believes the greenback will continue that role. Interestingly, he also sees gold, a traditional inflation hedge, as another positive story for 2015.

Read MoreLew: Strong US dollar is 'good for the world'
"Gold does act as a safe haven, and it seems like gold is predicting trouble correctly," he said. "I'm bullish on gold. I increased my position in gold a couple weeks ago."

As he addressed the conference, the stock market was in the midst of an aggressive selloff triggered by weak economic data. The numbers showed a decline in business investment, which Gundlach attributed to falling energy prices.

He predicted that crude would not return to its lofty price range, and that in turn would zero out capital investments from energy companies. He specifically disputed a prediction from noted oil man T. Boone Pickens, who said recently that oil was heading back to $100 a barrel.

"He knows more about energy than I do, but I know a lot about markets and I just think he's wrong," Gundlach said.

"I don't think it's going to rebound quickly," he added. "It's dropped enough that there's somebody out there that's on the edge of bankruptcy...This is enough of an event that it truly classifies as a black swan."

Gundlach sees the biggest long-term market risk being the amount of debt companies have piled up in the low interest rate environment that the Fed has created. However, he believes that the full disruption probably won't be felt for several years.

[Suraj]

Singapore cuts interest rates.

[chanakyaa]

Greece's New FinMin Explains "This Is What Happens When You Humiliate A Nation & Give It No Hope"

[ramana]

Newsinsight article on the Swiss Franc Delinking and the resultant turmoil

http://www.newsinsight.net/BlackSwanday ... age=page-1

Black Swan day

The Swiss Franc crisis vindicates Nassim Nicholas Taleb.

By Rakesh Mital (21 January 2015)

New Delhi: Human beings shape their beliefs and base propagation and survival strategies on what they observe in nature and in everyday life. Right up to the Middle Ages, the conventional belief was that all swans are white because only white swans existed in Europe. Nobody had seen a swan of another colour and no one thought otherwise. That was until a black swan was observed in Australia. The Dutch navigator Willem de Vlamingh was among the first Europeans to see black swans as he sailed up what subsequently he named the Swan River in the late seventeenth century. And by that observation the age-old belief that all swans are white was negated. This created turmoil among ornithologists specifically and in the scientific world generally where it was also appreciated that a single rare event can falsify established theory.

The notion of a rare, unanticipated event has significant import in the world of financial risk management. Nassim Nicholas Taleb, a fund manager and self-proclaimed empiricist, brought this into mass public consciousness in 2007 with his book, The Black Swan: The Impact of the Highly Improbable. Taleb postulates a Black Swan as an event that, firstly, is an outlier. It lies outside the realm of regular expectations because nothing in the past convincingly can point to its possibility. Secondly, it carries an extreme impact. Thirdly, in spite of its outlier status, human nature makes us concoct explanations for its occurrence after the fact, making it explainable and predictable. The third criterion seems improvised and originates from his earlier book, Fooled by Randomness.

Human beings are hardwired and genetically programmed to live in a "normalized world" where they plan for low volatility and high predictability. This assumed stability is essential for human civilization to invest in the future with reasonable certainty and forms the bedrock of progress. In statistics, this is called the probability of normal distribution where most of the risk/ return projections are based on 1 sigma movements from the mean of the expected gain. Hence, when rare, high sigma events, eloquently called Black Swans, occur, financial managers are ill-prepared to mitigate losses, not to speak of profiting from these occurrences. This can lead to sudden implosions where the largest institutions or the smartest people can rapidly go bankrupt.

Last week, such an event happened with enormous consequences in the financial sphere and now impacting the real world of ordinary people. On Thursday, 15 January, the Swiss National Bank (SNB) announced that it would immediately delink the Swiss Franc (CHF) from the Euro. In other words, the previous cap of 1.20 CHF to the Euro would not apply and the Swiss currency would be permitted to appreciate unhampered. Instantly, the CHF rose close to 40 percent (it peaked at 42%) against the Euro, sending global currency and bond markets into a tailspin.

The first of Taleb’s three-set criteria of a Black Swan event was validated. The event of the CHF being “depegged” from Euro was thought impossible by financial markets. For the last three years, SNB had made the peg the cornerstone of Switzerland’s monetary policy; as recently as Monday, 11 January, SNB had reaffirmed the peg. Breaking away caught financial markets completely unawares and chaos ensued.

The first casualties were a bunch of retail currency brokerages that allow retail “investors” to play the foreign currency market by providing leverage as high as 100:1 (i.e., for every US$1 that the customer brings, they can borrow $100 for trading). Leverage is a rocket fuel in a rising market where it helps multiply the return on your equity. But in a wrong-way bet like the CHF appreciation, even a small movement in the opposite direction can wipe out the customer’s equity. This is what happened. In a moment, customer accounts had negative balances exceeding the equity capital of the brokerages. Brokerages went belly up.

FXCM, the largest retail currency broker in the US, had to be bailed out by an investment manager who injected USD 300 million. Many large banks have lost to the tune of USD 400 million (and counting) on currency hedges they sold. A large hedge fund with a corpus of USD 800 million has gone bust with short positions in CHF.

Even the middle class has been singed. In Poland, the Czech Republic, Slovakia and some other East European states, people were accustomed to taking home loans in CHF which attracted lower interest rates than local currencies. Unwittingly, homeowners were carrying a currency risk as their income was in local currency and the loans had to be repaid in CHF. As long as the CHF was stable, it was good going. But when the CHF appreciated, the loans instantly increased by a third in local currency. This has raised the spectre of large mortgage defaults; local governments have been forced to intervene. Meanwhile, Swiss exports and tourism have overnight become 30-plus percent more expensive. The damage and losses from this event are still being assessed. Taleb's second criterion has also been validated; the impact has been widespread and severe.

Finally, in the aftermath of the sighting of the Black Swan, a whole cottage industry has sprung up. Many know-all analysts are now pedantically rationalizing the circumstances and the logic of the Swiss National Bank action post-facto. The reality is that even moments before the SNB announcement, no one had a clue about it and the repercussions. None of these wise men (and a few women!) in their wildest nightmares would have predicted this even as an improbable possibility. On his third supposition as well, Nassim Nicholas Taleb stands vindicated.

The Swiss Franc saga of last week underscores the reality of extreme events and the havoc they can wreak on “normal” plans. Financial risk managers have to realize that Black Swan events do occur (the so-called 100 sigma events seem to be occurring with startling frequency since the Long Term Capital Management debacle of 1998) and that they have to model such events. Having a diversified, adequately-hedged portfolio may make all the difference between financial survival and death.

Postscript: Would the 50 percent decline in oil prices over the last six months qualify as a Black Swan event? Probably not, given their somewhat more gradual and orderly decline. Perhaps, it is a Grey Swan event!

[vina]

Ramana, this kind of write up is a regurgitation of stuff that is well know. In Taleb's book "Dynamic Hedging", first print in late 80s I think (I have a copy of course), he talks about the earlier time this happened, much before the Euro came into existence. That was the time when George Soros and others broke the Bank of England by betting against the GB Pound.

The European Monetary rate agreement had the currencies pegged against each other and had to move within a narrow band. The trouble is with East German unification and the fact that the Germans gave one Deutsch mark for each wampum the east germans held, the Bundesbank had to raise interest rates to tamp down the resulting inflation from the expanded monetary base. Clearly, the German Mark was going to appreciate, while the GBP with it's slumping economy and low interest rates was in the Kakoose/Pakistan/Bradfordistan.

The book clearly says how the guys who bet against the pound, started buying options that was outside the band. The broker instead of trying to fill it himself,just called up the two main market makers. One guy in the US was a dyed in the wool trader who cut his teeth in the pits at CBOE @ Chicago and said it was too dangerous , and if they insist on it, will sell at a much higher implied volatility, and that too of very limited quantity. The other market maker was an Engineer from a prestigious French School who said "Zis is outside the band no ? Zis is impossible. You are better off giving your money to charity.. Of course, I will sell you how much ever you want!" . After the few months the French guy was back to Engineering and was out of the markets.

Having a diversified, adequately-hedged portfolio may make all the difference between financial survival and death.

This kind of homily and plain quackery is the root cause of all this. Most of the risk models, including VaR use Gaussian distributions (the max exepcted loss at a 95% confidence for a 5% or 10% market move) and come up with spooky numbers of a 1 in 10,000 or 1 in million year losses with some 10 sigma /whatever. This was also the root cause of the subprime crisis that set off the 2008 US meltdown. The idea was that home prices have possibly never gone down all over the US in a loooong time and hence you are "safe" if you are diversified across all markets (buy buying conveniently packaged MBS of course) to a 6 sigma or 10 sigma or whatever level. We know how that ended.

This is a bad example of trying to fit reality into the mathematics you know. The same quackery that the ISI/DSE/JNU ding dongs and their four factor models inflicted with far more devastating effects on the Indian people for close to 40 years (it was all good for you of course,.. we ding-dongs are Oxbridge trained and know our Stat-is-sticks.. WTF do you dhotiwallahs know ?).

Yeah, Taleb describes this much better in his inimitable style as Physics Envy and Soviet-Harvard economics.. I think his more memorable quote is on the RiskMetrics Models & database (now owned by Morgan Stanley), which is very widely used industry wise for risk management and quantification.

"They are intellectual charlatans. And you can quote me on that"

Our ISI/DSE/St Stephens folks are EXACTLY that as well, Intellectual Charlatans AND Quacks. The ISI folks are brilliant statisticians, but the moment they stopped being statisticians and stepped into providing intellectual muscle to the Nehruvian statist project, they stopped being scientists and become ideologues and hence quacks.

JNU was an out and out Quack shop right from the beginning. They can be safely ignored.

[Singha]

and all these fountainheeds of deep wisdom have direct neural channel into the hive-mind that is the policy making apparatus of 10 Janpath and the NAC.

tsk tsk.

[panduranghari]

The Federal Reserve has little justification to raise interest rates amid a deflationary global backdrop, .

I wonder why he is saying that. If the interest rates on long bonds falls to ZERO, The value of the debt those bonds represent is INFINITE. Can his fund go bankrupt?

[TSJones]

Please keep actions taken by the Federal Reserve at the discount window for member banks separate from actions taken by of the US Department of Treasury in issuance at auction of its bills, notes and bonds. I am no expert but I think it is the same for the Indian government treasury and its central bank.

[vina]

I wonder why he is saying that. If the interest rates on long bonds falls to ZERO, The value of the debt those bonds represent is INFINITE. Can his fund go bankrupt?

How ? Show the math. It cannot be infinite and it is not.

[vina]

Please keep actions taken by the Federal Reserve at the discount window for member banks separate from actions taken by of the US Department of Treasury in issuance at auction of its bills, notes and bonds. I am no expert but I think it is the same for the Indian government treasury and its central bank.

You mean the Federal Funds rate. That is the "normal" rate that the Fed targets via it's Open market operations. The discount rate for banks is when the banks get into liquidity trouble. Any bank that goes to the Fed and has to access the discount window will be summarily cavity searched and every orifice probed by a Fed auditor. Wont be pleasant at all.

The equivalent "normal" for India would be the repo rate.

[panduranghari]

I wonder why he is saying that. If the interest rates on long bonds falls to ZERO, The value of the debt those bonds represent is INFINITE. Can his fund go bankrupt?

How ? Show the math. It cannot be infinite and it is not.

I does not matter 'if' in your opinion 'it cannot be'. It is. Go read any educational material about interest rates and their co-relation to bond yields.

Mathematics, innit?

I could have rephrased the statement as;

THEORETICALLY, If the interest rates on long bonds falls to ZERO, The value of the debt those bonds represent is INFINITE.

or

MATHEMATICALLY, If the interest rates on long bonds falls to ZERO, The value of the debt those bonds represent is INFINITE

It still does not detract from the theory.

[nandakumar]

Panduranghari/ vina
I think there is no fundamental disagreement between the propositions of the two of you. If the coupon rate on a bond is greater than zero and current yield rate is zero then the value of the bond should be infinity. I mean if the discount rate is zero then the present value of all cash flows by way of interest plus redemption value in the future, which is what bond valuation is all about, must be infinity isnt it?

[Suraj]

The Federal Reserve has little justification to raise interest rates amid a deflationary global backdrop, .

I wonder why he is saying that. If the interest rates on long bonds falls to ZERO, The value of the debt those bonds represent is INFINITE. Can his fund go bankrupt?

I don't think he's referring to long bonds. 30 years falling below 3% would set off a home buying and refinancing boom, even if it skewers his own funds that thrive on the long vs short rate arbitrage play. Such activity would preclude the deflationary spiral. The US still has a large backstop in the form of a substantial homeowning population who would generate economic activity if 30 years fell enough to lead them to refinance or buy homes.

[vina]

Go read any educational material about interest rates and their co-relation to bond yields.

Mathematics, innit?

The relationship between interest rates, yields and bond prices are mathematically precise. No airy fairy statistical "correlation". Yes, you can lookup the mathematical formula for any bond prices, including for a 30 year bond which is what called as the "Long Bond" in the US.

You can lay out the cash flows over 30 cells in a spread sheet and calculate the present value of the cash flows (coupons and bullet payment) and that gives the price of the bond.

Nandakumar talked about the discount factor which is what you apply to the cash flows . The discount factor is 1/(1+r)^n . Now r is zero, (which is what you say the fed will do, not true the yield on 30 year treasury is quoting at 2.32, the interest rate will be north of that) you can see the discount factor rises to 1 for all the cashflows 30 years out. Yeah, the bond will be pretty expensive, but it surely is not Infinite.

This is a classic case of a Victor Babu in LCA Thread kind of "feeling and thinking" rather than actually putting pen on paper and working it out. Reality is quite different from what you "feel".

[nandakumar]

Vina, thanks for pointing out the error in my argument. The interest rate becoming zero in the PV formula doesn't make the bond value rise to infinity. Nominal cashflow of say, Rs 100 (be it interst or redemption value received in the 50 th year is still Rs 100 as the discount factor with which it is multiplied, to arrive at its present value is still 1, as the formula 1/(1+0)raised to the power 50, is unity. Don't know how I missed it.

[panduranghari]

The relationship between interest rates, yields and bond prices are mathematically precise.

Anything divided by zero is infinity. Now that was taught to me in my vernacular marathi medium school lets see in standard 3. Now that you have made a fool of yourself, go back to school. And pay attention.

Reality is quite different from what you "feel".

Misfortunately, that is egjactly the Duo of Scholes and Merton believed. You know what that lead to. Mathematical models are just that- models. They have no bearing with reality. They work sometimes, they don't otherwise.

Just because you do not think anything divided by zero is not infinity, does not make it so. If your Bina Model is that good, why not start LTCM part 2. Who knows you might be beat George Soros.

[panduranghari]

Vina, thanks for pointing out the error in my argument. The interest rate becoming zero in the PV formula doesn't make the bond value rise to infinity. Nominal cashflow of say, Rs 100 (be it interst or redemption value received in the 50 th year is still Rs 100 as the discount factor with which it is multiplied, to arrive at its present value is still 1, as the formula 1/(1+0)raised to the power 50, is unity. Don't know how I missed it.

Saar, you are making a wrong argument. Your mathematical model States one thing. But you have not yet thought models are dependant on human variables.

[nandakumar]

What can one say? Human factors do result in mispricing of assets, financial or real. They are often the outcome of irrational exuberance and what not. Viewed thus, any value is possible including numbers approximating to infinity.

[ldev]

When the amount payable on maturity is very finite and fixed, why on earth would anybody ask for or pay an "infinite amount" today for that bond?

[nandakumar]

When the amount payable on maturity is very finite and fixed, why on earth would anybody ask for or pay an "infinite amount" today for that bond?

Idev
Let me confess at the outset, my fundas on mathematics of finance are a bit dodgy. My education, such as it is has been in accounting. However let me give it a shot. There are bonds in perpetuity. So technically the value (which is the sum of interest plus principal) can reach infinity. This happens when the factor that you apply to discount a sum of future money to its present value does not increase exponentially. It doesn't increase and infact remains a constant whose value is unity, when yield rates on current investments are zero. But that is the maths. But from a practical stand point, how does one write out a cheque for an indeterminate number even if one wants to purchase such a bond? So, from that perspective, it is a non starter. Another thing. The discount rate is zero now because the short term Central Bank's rate on funds borrowed from it, is zero.But who is to say that is what it will be for all time to come? So it boils down to a guessing game on how future interest rates will behave and what premium or discount they will offer to the coupon rate on a particular bond that is available in the market.

[ldev]

^^
The relationship between the interest coupon and current interest rates is not the only thing that price reflects. The price of the bond also reflects default/credit risk i.e. just look at roller coaster yields on the Greek 10 year Government bond. In March 2012 at the height of the crisis the yield on the bond went up from about 5% to 40%, as Greece being part of the Eurozone could not print its own Euros, but has to rely on the ECB and hence could default. When the ECB relented and agreed to buy Greek debt, the yield came all the way down to below 3% before the risk flare up in the recent elections. Compare that with the decision of Standard and Poors to downgrade US Treasury debt. Former Fed Chairman Greenspan said that it makes no sense to downgrade the US, as the US could never default and print more dollars to retire the debt.

Perpetual bonds with a coupon are like preferred shares and should be priced as such.

[nandakumar]

Deleted as incomplete post.