"So their eyes are growing hazy
'Cause they want to turn it on
So their minds are soft and lazy, well
Hey, hey give 'em what they want" 10,000 Maniacs N.Merchant/D. Drew
This is a missive on Quantitative easing, recent currency moves, myths and misunderstandings.
The recent market gyrations and foreign reserve adjustments have given rise to a concept of "Quantitative Tightening." The story goes: Foreign currency adjustments lead to selling of Treasury holdings leading to monetary snugging and further curve flattening. That the Fed's balance sheet changes barely a wit is conveniently left out of the narrative.
But first, we have to rewind to 1985 with the Dollar index at 135 and dollar/yen at 242. The US was experiencing 3+% GDP growth and 3+% CA deficits. (3 to 3.5% CA deficits were/are viewed as the breaking threshold..but not by me) The G-5 (#GIK) finance leaders, a mean bunch of US manufacturing big-wigs and a gaggle of Board Directors from Chicago futures exchanges plugged into the Plaza Hotel in NY to - like Pinky and the Brain - plan to realign the world.
The key from a historical perspective is the US was growing and had the lowest inflation and interest rates in 2 decades. Europe and Japan experienced slightly negative growth rates and decent trade surpluses. (A few name changes but story matches up to today) The Illuminati at the Plaza decided it would be a good idea if they all dropped the value of the dollar by 50%. The Yen would rise to 153 by 1986 and 120 by 1988. The dollar index would stumble to 89 by Black Friday in 1987, and 81 in 1988.
[Sidebar: many of those Exchange heads quickly retired to their suites to call Sweet Home Chicago and trade a few cars in the growing IMM Division they had created, the chaos in the German Mark pit was astounding]
Fast forward to today. Modest, reactionary, non-cooperative currency adjustments are perceived to carry the monetary impact of the 1985 Accord. Logical, though violent in size, adjustments to reserve holdings are viewed as cataclysmic. The key player in the narrative, US, is firmly situated on the fence about a modest tweaking of the funding rate. And there in lies the rub.
Silently, in the weeks leading into and out of the Plaza Accord a now lionized central bank head named Paul Volcker had paved the way to EXIT a quantitative tightening regime - you know, the one that Forbes Magazine says doesn't exist - and morph to rates targeting. By the time a Woody Allen-esque economist with a very sketchy background in Thrift analysis (#GIK Lincoln Savings) took over the Fed, Funds targeting was all the rage. The trick the FOMC will debate pulling next week is tripping the switch back the other way. Similar inputs, less cooperation, completely different prescription. A sub-text on evil culprits would find Program Trading/ Portfolio Insurance swapped for HFT and Risk Parity Hedge Funds. Their minds have gone "soft and lazy." Hey, give 'em what they want.