from ZeroHedge:
By Eric Peters, CIO of One River Asset Management
Desk-mates
“What will it take for the Fed to pause?” I asked, early morning, screens aglow, the smell of impending policy-maker panic drifting across our trading floor like freshly brewed coffee. We were discussing relentless dollar strength, what it means, where it leads. “It’s harder to answer in this cycle, because I don’t really think that dollar strength is specifically because of the Fed, at least not completely,” said Lindsay Politi, our inflation-strategies portfolio-manager, brilliant. “It’s the logical consequence of the QE bubble bursting. Fed tightening is part of it, sure, but it’s not like when the Fed pauses all the root cause of the problems will go away.”
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One thing I’ve learned about market collapses is that what gets you into them won’t get you out of them, and the people who rode the wave on the way up will not be the ones stepping in to buy the bottom,” continued Lindsay. “That’s why, this time, I wouldn’t be looking to central banks to save us,” she said. “Some of this is also because, in a high debt, inflationary world, the US is just a better credit. In this crisis, markets are going to go after sovereign credits. And remember, pricing default risk is about combining default probability and recovery rate.”
“Sovereign nations represent the ultimate collateral free asset,” said Lindsay. “They’re not like corporations, where you can take the plane or factory in bankruptcy; you can’t show up to a nation’s Treasury and seize assets. With sovereign nations, you can’t easily calculate a recovery rate, so it’s all about default probability. For countries whose debt is denominated in currency they can create, default is usually considered very remote. Because it’s not about the ability to pay, they always have the money to pay, it’s about willingness to pay.”
“The only reason a country wouldn’t print money to pay their debt is the social and political costs of depreciating the currency by printing money becomes greater than the cost of defaulting on the debt. The dollar is strong, and in a way it’s a good reserve currency, because the US is economically the least currency-sensitive economy in the world. The US is the ultimate large, closed economy.” According to World Bank data on openness – a measure of an economy’s dependence on trade – the US is at the far extreme.
“The US produces large amounts of food and energy and has a diverse domestic services and manufacturing economy. Americans rarely notice even large currency fluctuations and it has minimal impact on inflation.” The UK, by comparison, is substantially more open than the US and it’s much more dependent on the rest of the world for necessities like food and energy. “By contrast, the average Brit is very aware of sterling weakness and currency fluctuations impact inflation more directly. The point where the UK decides the cost of currency weakness to pay creditors is higher than the cost of default is much closer than it is in the US.”
