In the press

This post provides links to some thought-provoking articles I have read over the past few days that you may also find interesting:

- Derivatives still pose huge risk, says BIS (Telegraph): The global market for derivatives rebounded to $426 trillion in the second quarter as risk appetite returned, but the system remains unstable and prone to crises, according to the Bank for International Settlements (BIS).
Stephen Cecchetti, the bank's chief economist, said over-the-counter markets for derivatives are still opaque and pose "major systemic risks" for the financial system. The danger is that regulators will again fail to see that big institutions have taken far more exposure than they can handle in shock conditions, repeating the errors that allowed the giant US insurer AIG to write nearly "half a trillion dollars" of unhedged insurance through credit default swaps.

- Cheap dollars are sowing the seeds of the next world crisis (Telegraph): After years of selling cheap goods to debt-fuelled Western consumers, China now has $2 trillion dollars of foreign exchange reserves. That's 2,000 billion – a reserve haul no less 25 times bigger than that of the UK.
More than half of China's reserves are denominated in dollars. So when the dollar falls, China loses serious money. When you're talking about a dollar-reserve number involving 12 zeros, even a modest weakening of the greenback sees China's wealth takes a mighty hit.
(...)
Last weekend, Cheng Siwei, a leading Chinese policy maker, said that his country's leaders were "dismayed" by America's recourse to quantitative easing. "If they keep printing money to buy bonds, it will lead to inflation," he said. "So we'll diversify incremental reserves into euros, yen and other currencies".
(...)
China is now more worried about America inflating away its debts than about those debts being exposed to currency risk. Economists at Western banks making money from QE still say deflation is more likely than inflation.
(...)
The dollar is now being used as a "carry" currency. Traders are using low Fed rates to take out cheap dollar loans, then converting the money into currencies generating higher yields.
(...)
This presents serious systemic danger. A dollar weighed down by Chinese divestment, then suppressed further by carry-trading, could easily spring back. Those who had borrowed in dollars would owe more, while their dollar-funded investments would be worth less. This "unwinding" could send financial shock around the globe. This is what happened in 1998, when yen carry-trades went wrong, causing the collapse of Long-Term Capital Management and sparking a global slowdown.

- Hedging loses its lustre for gold (Financial Times): The gold industry’s legacy of forward sales is set to all but disappear by next year following the decision by the largest gold miner to buy back its hedges. The size of the industry’s hedge book is set to drop to a residual of less than 200 tonnes by the end of 2010, the lowest in almost 25 years, according to industry estimates. The reduction is a 95 per cent drop from 3,000 tonnes a decade ago.
(...)
Barrick Gold, the Canadian-based miner, said it had decided to buy back its forward sales because of “an increasingly positive outlook on the gold price”. It added: “Global monetary and fiscal reflation will be necessary for years to come, resulting in an increased risk of higher inflation and a future negative impact on the value of global currencies.”

- Trade tensions boost dollar (Financial Times): The dollar index, which tracks the greenback’s progress against a basket of six leading currencies, last week fell to its weakest level since September 2008 as growing confidence over a global economic recovery boosted stocks and risk appetite, denting demand for the US currency as a haven. However, that trend was reversed on Monday as confidence was knocked by the eruption of the US-China trade spat over Chinese tyre exports. (...) Hans Redeker at BNP Paribas said investors had been immediately reminded that it was trade sanctions that pushed the 1929 recession into a depression. (...) “Trade sanctions will weaken the emerging market outlook and will reduce demand for emerging market assets. The dollar will rise as a result.”

- Wall Street's New Gilded Age (Newsweek): A year after the crash, a few financial giants are back to making millions, while average Americans face foreclosure and unemployment. What's wrong with this picture?

- Accountants Misled Us Into Crisis (New York Times): The accountants let us down. That is one of the clear lessons of the financial crisis that drove the world into a deep recession. We now know the major banks were hiding dubious assets off their balance sheets and stretching rules if not breaking them. We know that their capital was woefully inadequate for the risks they were taking.

- Towards a better measure of well-being (Financial Times): GDP will continue to be used as a measure of market activity, but when it comes to measuring societal welfare, we will have to look to other metrics.

- To fix the banks, we must break up the banks (Financial Times): In coming up with solutions that address the immediate crisis but fail to tackle dangerous systemic issues, the Group of 20's emerging ideas on the banking industry bear a striking resemblance to the Americans’ response to the dotcom crash of 2001-02.