In the 2014-15 NFL AFC Championship game, it was discovered that eleven of the New England Patriots’ dozen footballs were deflated to 11psi (below the 13 psi standard), prompting every football fan to start learning about football protocol, and forever remember the moniker, “Deflategate.” Reducing the air in the football apparently makes it easier to grip and maintain control, especially in cold weather.
I have so many questions. For instance, why 11 out of 12 balls? Shouldn’t whoever inflated (or deflated) the balls have checked that they were all at 11psi, to have a plausible excuse, like the cold air in Foxboro, MA? And why don’t referees inspect the balls before the game to insure they are up to code? And given the 45-7 final score in favor of the alleged Deflators, how much of an advantage was it? Seems they could have won throwing volleyballs.
That got me to thinking about the current global currency wars being waged, and what they mean. As I have written, central banks are like World Series of Poker players at the final Texas Hold ‘Em table. The chip counts are high, the blinds are growing, and the flop just showed Queen, King, Ace. So, the players do what they must to win the diamond bracelet…they go ALL IN.
The backdrop is that globally, prices for goods, services and especially energy are dropping due to sluggish demand and oversupply. So, central bankers must pull whatever levers they can to stimulate banks to lend money to individuals and businesses, and to improve the fortune of their country’s industries, even at the expense of others.
Central banks set Monetary Policy for what securities they will take from other banks as collateral for funding, and the rate at which they borrow. The more accommodative they are on collateral and interest rate, presumably the less restrictive banks will be about lending to individuals and businesses, spurring more spending on capital, consumer goods and services.
In addition, central banks have a tool called Quantitative Easing, used aggressively by the US after the 2008 credit crisis, by which they purchase bonds, keeping prices high and yields low. This allows homeowners to refinance their debt at lower rates, banks to show gains on their balance sheets, and corporations to borrow from banks (short-term funding) and investors (longer-term) at lower rates.
Another common tool is Intervention in the currency markets. In other words, with a huge balance sheet and the ability to print money, central banks can enter the currency market and buy or sell currencies to move their values.
Well, the world outside the USA today, from Osaka to Barcelona to Toronto, is a growth flame in dire need of oxygen. Currency wars have produced a topsy-turvy landscape of anomalous quirks: as a result of central bank actions, trillions of dollars of bonds are now yielding negative rates. This means investors will pay governments to store their money and provide a return OF capital, rather than a return ON capital.
So, what does this have to do with #Deflategate? Well, macroeconomists and central bankers know that the higher a country’s expected trajectory of short-term interest rates, the more likely investors will sell their deposits (in their own currency), to exchange into the higher yielding deposit currency. So the foreign exchange rate between to currencies (known as a “cross rate”) is directly correlated to the interest rate differential between the pair.
In addition to deposit flows, countries experience foreign direct investment into their industries. So, aside from the pure math of the equation, currency markets also change based on the emotion of participants. If investors believe the central bank is aggressively lowering rates to stimulate the economy, they smell fear and loathing in the country and push currencies down further.
As bad as this sounds, this is all part of the plan. Central bankers are well aware of the health of their domestic industries. So whether the country sells cars, turbines, software or vacations to global investors, these become more affordable with a weaker currency, and those industries can borrow cheaply (remember lower rates), thus keep afloat, pay their workers and spur higher demand, and eventually higher prices (inflation—the Holy Grail). This is the “Beggar Thy Neighbor” strategy in currency deflation…the Currency #Deflategate.
The conspiracy theorist in me believes this is also part of the plan of various elected officials to stay elected. Central banks are supposed to be independent from governments, which have their own Fiscal Policy measures to stimulate the economy, encouraging wage and income growth. However, most legislative bodies are dysfunctional at best (perhaps the subject of another blog), so often the best they can do is to hold hearings with central bankers, cajoling them into changing monetary policy.
When prices increase, currencies recover; central banks raise interest rates, tapping the brakes on the economy. However, they are often behind the curve, and end up ratcheting up the cost of borrowing too fast, causing the economy to roll over and contract, causing a recession, or contraction in GDP.
That is obviously not the current picture, but brings to mind the image of a faulty shower – too hot, too cold, too hot, too cold – in every market cycle. It is about as regular an occurrence as the annual Super Bowl.
So during this coming Sunday’s Super Bowl, as New Yorkers are buying up fashions from Milan 25% cheaper than last year–due to the weak Euro–and football fans from Hamburg are cursing the high price of Bud Lights in the stadium in Arizona–owing to the strong dollar–I hope the refs check the pressure of the 108 footballs (yes, not 24, but 108!) so there is at least one level playing field.