Raphael Stevens

Thirty years ago, Britain’s snap decision to withdraw from the European Exchange Rate Mechanism made George Soros, a hedge-fund titan, more than $1bn from his short positions against sterling. Hedge funds may not be the financial giants they were in 1992, but some speculators still aspire to “break the bank”, to borrow the phrase used to describe Mr Soros’s bet. This time, it is not the Bank of England but the Bank of Japan that the would-be bank-breakers have their eyes on.The boj stands out like a sore thumb in the world of monetary policy. While the Federal Reserve, the European Central Bank and the Bank of England are rushing to combat inflation by reversing asset-purchase schemes and raising interest rates, the boj is sticking to its guns. After a meeting on June 17th it left its policy of “yield-curve control”, intended to keep yields on ten-year Japanese government bonds at around 0%, firmly in place. As the gulf between Japanese and rising American bond yields has widened, the yen has plunged: by 15% this year so far, to its lowest level against the dollar since the late 1990s.The boj adopted yield-curve control in 2016 as a way to maintain monetary stimulus, while slowing down the frenetic purchases of Japanese government bonds that it had been undertaking since 2013 to boost inflation. For most of the time its yield cap has been in place, the mere promise to buy more bonds if anyone tested its resolve was enough to keep a lid on yields. More recently, however, that commitment has itself been tested. In the five days to June 20th the central bank was forced to buy government bonds worth ¥10.9trn ($81bn) as it sought to suppress yields. By contrast, between 2015 and 2021 it never bought more than ¥4trn in a five-day period.Some investors are betting that the boj will eventually be forced to alter, or even abandon, its target. BlueBay Asset Management, an investment firm with more than $127bn in assets as of September 2021, is short-selling Japanese government debt. Mark Dowding, the firm’s chief investment officer, has called the central bank’s position “untenable”. Volatility in the typically calm Japanese government-bond market has surged to its highest level in more than a decade. The investors betting against the boj might be taking hope from moments when central banks abandoned similar commitments. Late last year the Reserve Bank of Australia’s yield-curve control policy, which targeted three-year Australian government bonds, collapsed spectacularly as yields surged and the central bank failed to defend its target. The Swiss National Bank insisted it would not break its currency peg to the euro in the months leading up to January 2015, before doing precisely that. So far, however, neither Japan’s economy nor the central bank’s internal dynamics hint that a change in policy is coming. Inflation has risen, but not exploded as in other parts of the world; consumer prices rose by 2.5% in the year to April, compared with 8.3% in America. Excluding fresh food and energy, Japanese prices are still up by less than 1% year-on-year, and wages by less than 2%. There is little sign of domestically generated price growth.The weak yen, meanwhile, has a mixed effect. It drives up imported inflation and magnifies the effect of rising dollar-denominated oil prices. But after many years in which Japan’s price level has barely budged, a shallow increase does not seem an urgent threat. Even with all these external shocks, inflation is barely above the central bank’s target of 2%. Rapid moves in the currency make planning difficult for businesses, but a weaker exchange rate benefits many exporters of manufactured goods, as well as the holders of Japan’s ¥1.2 quadrillion in overseas assets, which have gone up in yen terms.Nor does the mood within the boj so far hint at a coming change in policy. The central bank still has several monetary doves in its roosts. Kataoka Goushi was the sole board member to vote against holding policy unchanged in June, but because he wanted even more stimulus, not less. In early June Wakatabe Masazumi, the bank’s deputy governor, said that monetary easing should be pursued to maintain wage growth. And Kuroda Haruhiko, the governor of the boj, is a longtime advocate of monetary stimulus to revive Japan’s sluggish economic growth.Mr Kuroda is now into the final year of his term. His replacement may well be Amamiya Masayoshi, another deputy governor, who is so entrenched in the institution that he is known as “Mr boj”. Mr Amamiya has sometimes been seen as more hawkish than Mr Kuroda. But in his most recent comments on monetary policy, in mid-May, he spoke in favour of continuing current policy without reservations. Barring a change to the domestic picture, or a groundswell of hawkish sentiment within the boj, investors expecting a u-turn are likely to be disappointed. ■For more expert analysis of the biggest stories in economics, business and markets, sign up to Money Talks, our weekly newsletter. More

Before the pandemic it was a cause for excitement among economists that the real interest rate governments paid on their debts had fallen below the rate of economic growth in most rich countries, allowing governments to spend more freely and worry less about running up debts. But central banks’ battle with inflation today threatens to turn that relationship on its head, making the fiscal position of indebted governments more perilous.When interest rates are below growth rates, governments can run primary budget deficits (that is, deficits before interest payments are taken into account) without the debt-to-gdp ratio necessarily rising. But when rates exceed economic growth, primary surpluses are the only way to keep indebtedness stable. The higher the starting debt, the more belt-tightening needed.Fortunately, inflation reduces the real interest rate, and so most countries will gain a fiscal windfall this year. Some of their debt, in other words, will be inflated away. But if central banks successfully bring inflation down, and if high interest rates endure, things could get more painful. The picture looks especially worrying in Italy. The euro zone’s third-largest economy had net public debt worth nearly 140% of gdp last year. Its government currently pays about 3.5% to borrow for ten years.Precisely where Italy’s indebtedness and borrowing costs will settle after the energy crisis is uncertain. Our table shows a range of combinations for debt and financing costs, and what they would imply for the country’s budget were growth to match the average imf forecast during 2022-27, and were inflation to fall to the European Central Bank’s target of 2%. In reality, the average tenor of outstanding Italian debt is nearly eight years, so it would take time for its average financing cost to rise to the levels shown on the right-hand side of the table.At financing costs of 3% or below, Italy can run small primary deficits and still outgrow its debt. (The table also shows one weird effect of growth exceeding interest rates: that debt stability is easier to achieve when starting debts are higher.) As interest rates rise, however, stability requires primary surpluses of 2% or more. The only time Italy has run so tight a budget since the global financial crisis was in 2012, at the height of European austerity.For more expert analysis of the biggest stories in economics, business and markets, sign up to Money Talks, our weekly newsletter. More

This year’s Juneteenth holiday in America gave crypto buffs little time to reflect or rejoice. On June 18th bitcoin reached a low of $17,600—its first tumble below $20,000 since 2020—before recovering a little the next day. The sell-off sparked over $1bn in liquidations, as traders who had borrowed money to make big bets failed to post more collateral. Overall, bitcoin is about 70% below its peak in November; ether, another cryptocurrency, is down by around 80%. As prices have fallen, cracks have appeared in the crypto infrastructure. Babel Finance and Celsius, two crypto lenders, have paused withdrawals after struggling to meet redemptions; their rivals have trimmed their balance-sheets, causing a credit crunch. Third Arrow, a crypto hedge fund, has failed to meet margin calls, and Hoo, an exchange, has halted transactions. The risk of a fresh downward spiral remains. Traders that were not wiped out have managed to post more collateral with decentralised-finance (DeFi) lenders; the level at which margin calls are triggered briefly dipped. But data from Parsec Finance, an app, suggest that the threshold has risen again to nearly $900 a coin for ether, from $700 on June 20th (at the time of writing, the price of ether was $1,100). Recent events have also shown how three weaknesses in crypto can amplify trouble: fuzzy valuations, incestuous relationships and the lack of a liquidity backstop. Start with valuations. Some of the most commonly traded crypto tokens are complex products such as derivatives and “tokens” issued by DeFi platforms, for which there are no established valuation models. The lack of an anchor means trust in pricing can vanish in a jiffy; the effect is magnified on weekends, when trading volumes are thinner. Problems in parts of the crypto market can end up rippling outwards, not least to bitcoin, the benchmark for the entire universe. A second channel of contagion comes from the high degree of interconnectedness between DeFi platforms. This is partly the result of intensifying competition. The amount of money invested in DeFi, after a period of explosive growth, has fallen over the past year. As crypto lenders have vied to attract a shrinking pile of dollars, they have promised ever-higher yields to depositors, which, in turn, has led them to invest users’ funds in riskier projects—typically other lending and yield-generating platforms. When the price of one asset falls, the effects cascade through the system. Celsius is a case in point. In December it claimed to have $24bn in crypto assets under management, which it had lured by offering yields to depositors of as much as 18%. To achieve those returns, it made loans to marketmakers, hedge funds and DeFi projects. When prices sank, however, so did the value of those assets. Some, such as the $400m Celsius held in “staked ether”, a derivative, proved illiquid. That left the firm unable to meet growing demand for withdrawals. When Celsius eventually froze funds on June 14th, bitcoin sank by 25%, partly on fears of contagion.These goings-on revealed a third weakness: the lack of a liquidity backstop to prevent a free-fall in asset prices. In mainstream finance, regulators provide a safety-net. But no institution exists to mop up stressed crypto assets of systemic importance (at least to the crypto system), such as stablecoins, or to bail out important firms. Deposits with crypto lenders are not insured. In conventional finance, such fail-safes reduce the risk of panic-selling when prices tumble. Were bitcoin to drop below $15,000, liquidations could accelerate so much that posting enough collateral or raising funds to stop the fall may become hard, say Monsur Hussain and Alastair Sewell of Fitch, a rating agency. But it would probably take a trigger for that to happen: a huge hack at an exchange, say, or a big economic surprise. And time seems to be on crypto’s side. Crypto platforms, and the risks they take with their assets, may soon come under regulatory scrutiny. Some stablecoins are trying to build sounder reserves: Tether, the issuer of the world’s largest such coin, has said it plans to replace its holdings of commercial paper with safer Treasuries. Some of the makings of a frosty crypto winter, though, are still in place. ■For more expert analysis of the biggest stories in economics, business and markets, sign up to Money Talks, our weekly newsletter. More

Those old enough to remember the euro zone’s economic crisis of a decade ago may have felt a shiver of déjà vu on June 15th, when the European Central Bank (ecb) called an emergency meeting to discuss the widening spreads between member countries’ government-bond yields. It is nearly exactly a decade ago that, as yields soared, Mario Draghi, then the president of the ecb, promised to do whatever it took to preserve the single currency. In both instances, bond spreads began to narrow after the central bank intervened. Today the ecb is considering an “anti-fragmentation” tool to lower spreads, say by buying the bonds of weaker countries (provided they meet certain conditions). Nonetheless, worries that the currency union might start to look shaky remain in the air. The fiscal position of Italy in particular, which last year had net public debt in the region of 140% of gdp, is preoccupying investors. Should interest rates rise much more, financial markets might start to doubt its ability to pay its debts. One dangerous feature of the previous crisis was the infamous “doom loop” that connected banks and sovereigns. Crudely put, euro-area banks were loaded up with home sovereign debt. When fears of sovereign default intensified, banks’ balance-sheets crumbled, which then required them to be propped up by an already wobbly state. As banks cut lending, the real economy weakened, further worsening the public finances. How much of a worry is this doom loop today? A consideration of the various links in the chain suggests it is less fearsome—but that the monster has not been slain. Start with banks’ exposure to their home sovereigns. After the global financial crisis in 2007-09, banks in southern European countries started to buy large amounts of bonds issued by their home government (which banking regulators consider to be risk-free, meaning that banks do not need to fund their holdings of them with capital). Spanish lenders increased their holdings of national government bonds from around 2% of total assets in 2009 to more than 9% by 2015; Italian banks increased their holdings of home sovereign debt from 4% to nearly 11% over the same period. Banks in most big euro-area countries have since reduced their exposures to their home sovereign. Strikingly, the boss of one of the bloc’s big lenders says that it no longer has any exposure to any euro-area sovereign debt. But Italian banks are the big exception. They remain just as exposed to their government’s debt as they were a decade ago. In Italy, at least, this part of the doom loop is alive and kicking. What about governments’ exposure to collapsing banks? Severing this bit of the feedback loop has certainly been an important aim of policymakers. The eu’s banking union—which sought to set up a system of common supervision, resolution and deposit insurance—was born nearly a decade ago. The idea was to make banks more European, and rescuing them less of a national affair. The problem, however, is that the task is only half done. The ecb has been in charge of supervising banks since 2014. That, together with regulatory changes that have forced banks to fund lending with more capital, have made it more likely that troubled lenders can be restructured, meaning that sovereigns are less exposed to the risks stemming from collapsing banks than they used to be. But the European resolution of banks remains incomplete, and common deposit insurance has not been set up at all. All told, “the safety-net for banks and deposits remains predominantly national, and the exposure of banks to sovereigns has not been solved,” concludes Nicolas Veron of Bruegel, a think-tank in Brussels. If governments’ sensitivity to failing banks is somewhat lower than it used to be, what about the economy’s exposure to zombie lenders? Europe remains largely bank-based, with capital markets playing a minor role in financing firms. It helps at least that banks are less stuffed with non-performing loans than they used to be, and are in better shape overall. But a hit to a national banking system could still impair its ability to lend to firms and households, unless they find other sources of finance. In 2015 the European Commission launched a plan to bolster Europe’s capital markets. But little progress has been made. Most indicators that measure the size of capital markets, and the degree to which they are integrated, have moved sideways. The main problem, say observers, is that national politicians have not fully committed themselves to the difficult work of harmonising rules across countries. Regulation aside, there have been two big improvements within the euro zone that will help weaken the doom loop. The first is on fiscal policy. Without transfers between member states, a national economy will always suffer when its government is forced to cut spending. A sovereign under financial stress may have to cut benefits or raise taxes precisely when the economy is weak. That in turn lowers tax revenues, worsening the fiscal position. From the start of the euro area’s crisis in 2010 until about 2014, countries painfully shrank their deficits, hurting economic growth. It was only when interest rates came down and austerity was eased that the economy began to recover. The covid-19 pandemic has led to more fiscal integration. The eu’s recovery fund, financed by commonly issued debt, will spend about €750bn ($790bn) over the next five years, with more money going to support investment in the weakest economies. Such a mechanism of fiscal transfers, if repeated, could make the sovereign-to-economy loop less severe in the future. The second big improvement is political. Few politicians are agitating for their countries to leave the euro, which in turn means investors are not getting jittery about euro exit and debt default.About a decade ago, policymakers in the euro zone started off with bold plans to eliminate the doom loop. Some of those have come to fruition. But the overall picture is mixed. With a recession looming and interest rates rising, that might not be good enough. ■For more expert analysis of the biggest stories in economics, business and markets, sign up to Money Talks, our weekly newsletter. More

Estate agents are known for their sunny disposition. Lindsay Garcia, a realtor in Miami, is no exception. She talks about the city’s warm climate and low taxes, both of which have lured a wave of footloose outsiders. For much of the past two years agents enjoyed a bonanza. Buyers fought to outbid each other, waived property inspections and bought units sight unseen; many paid well over the asking price. Then mortgage rates began to climb this year, cooling the frenzy a little. Only houses that were newly renovated or ready to be moved into straight away received multiple offers, Ms Garcia says. Now a fresh spike in mortgage rates seems to have slammed the brakes on altogether.On June 15th the Federal Reserve raised interest rates by 0.75 percentage points. Figures released a day later revealed that the benchmark 30-year fixed mortgage rate had hit 5.78%, an increase of more than half a percentage point over the week before. By June 17th, two of Ms Garcia’s colleagues had been rung up by buyers abruptly calling off deals because they could no longer afford them.The plight of the would-be buyers illustrates just how swift and brutal the rise in interest rates has been, and how immediate its impact is on interest-sensitive sectors such as housing. In January mortgage rates were around 3%, only a little above their all-time low of 2.67%, reached during the pandemic. They have nearly doubled since (see chart); only in the 1980s was there a comparably rapid rise in interest rates. The increase has made houses even more unaffordable. In January a buyer with a deposit of $100,000 looking to spend $3,000 a month on housing could afford a home worth $815,000. Now they can afford one worth just $600,000. The prospect of a turn in the property market’s fortunes naturally calls to mind America’s housing crisis of 2007-09. But there are important differences between the two situations. Rising interest rates in the late 2000s revealed just how imprudent mortgage lending had been. By contrast, the median fico score—a measure of creditworthiness—for mortgages today is about 48 points higher than the pre-financial-crisis level of around 700. Household balance-sheets are robust, bolstered by pandemic stimulus, and in aggregate there has been far less borrowing for house purchases than in the early 2000s. The total value of mortgage debt is around 65% of household income, compared with nearly 100% in 2007.Though it is possible that pockets of dodgy debt lurk in the shadows today, it seems less probable that rising rates will uncover systemic weaknesses in lending standards that could set off a vicious cycle of falling prices and foreclosures. Instead the problem of 2022 is house-price growth itself. “The type of acceleration in house prices that we’ve seen over the past two years is unprecedented,” says Enrique Martínez-García of the Dallas Fed. By the first quarter of the year the increase in American house prices over the previous two years, at 37%, was the fastest on record. That rapid growth is a problem for the Fed, argues Mr Martínez-García, because it feeds into rents, which in turn contribute to headline inflation. According to Redfin, a property platform, asking rents in May were 15% higher than in the same month last year. As new leases are signed, these will eventually add to consumer-price inflation. Indeed, rising housing costs already accounted for 40% of the monthly increase in the consumer-price index in May. “Cooling the housing market is almost a precondition to being able to tame inflation,” says Mr Martínez-García. A housing slowdown, then, will this time be engineered, rather than uncovered. The best possible outcome is that the Fed manages to slow the property market by enough to bring inflation under control, without overdoing it. The events of the early 1980s, when interest rates last climbed so quickly, illustrate what such a controlled slowdown might look like. Inflation soared to well above 10%, Paul Volcker had just been appointed chairman of the Fed, and the federal funds rate was briefly raised to an all-time high of about 20%. Property prices did fall sharply—but only in real terms. From 1979 to 1982 real house prices fell by nearly a fifth, even as prices in nominal terms rose by a tenth. More notably, housing transactions fell off a cliff. Existing-home sales peaked at 4m in 1978; four years later, only 2m homes were sold. Higher interest rates this time are indeed likely to hit transaction volumes first. That the initial consequence will be a fall in property sales, rather than a rise in financial distress among homeowners, can be partly explained by a quirk in the America’s mortgage market. In most countries borrowers are offered fixed interest rates for only two to five years; when that period ends, the rate floats in line with the central bank’s policy rate. But the existence of America’s government-sponsored housing agencies, most notably Fannie Mae and Freddie Mac, which were set up to incentivise home ownership, means that the vast majority of American mortgages are on a 30-year fixed rate. That makes would-be sellers increasingly reluctant to move and give up their cheap mortgages when rates go up. Buyers, meanwhile, can no longer afford the kind of house they want. Daryl Fairweather of Redfin therefore expects the market to go into a “cold period” of scant activity for the rest of the year. Things could easily get more complicated than they did in the 1980s, though, if the Fed is unable to act with enough precision to stabilise the market without causing prices to crash. The fact that housing has been so frothy makes the task harder. What has been remarkable about the past couple of years of price growth is that it has been so difficult to square with any of the “usual explanations”, such as millennial household formation or supply constraints, says Mr Martínez-García. Once those explanations have been ruled out, all that is left is “expectations”, such as the fear of missing out on ever being able to buy a house. Cooling a hot property market by just enough to quell inflation is one thing. Deflating a bubble without popping it is another. ■For more expert analysis of the biggest stories in economics, business and markets, sign up to Money Talks, our weekly newsletter. More

USDD, a so-called “algorithmic” stablecoin that’s meant to always be worth $1, plunged as low as 93 cents on Sunday.
The situation has led to fears that USDD may suffer the same fate as terraUSD, a similar token that collapsed in May.
But despite concerns over a repeat of the Terra saga, experts say this is unlikely to be the case.

Cryptocurrencies have been under immense pressure after the collapse of a so-called stablecoin called terraUSD.
Umit Turhan Coskun | Nurphoto via Getty Images

A controversial stablecoin launched just before the collapse of a similar token called terraUSD is struggling to maintain its peg to the U.S. dollar.
USDD, a so-called “algorithmic” stablecoin that’s meant to always be worth $1, plunged to as low as 93 cents on Sunday. The coin’s creator has amassed a reserve of bitcoin and other digital tokens worth close to $2 billion to provide a buffer in case investors flee en masse.

The situation has led to fears that USDD may suffer the same fate as terraUSD, or UST, the wrecked so-called stablecoin that formed part of an experiment called Terra. UST’s meltdown triggered a wider sell-off in cryptocurrencies, which has been exacerbated in recent weeks by a growing liquidity crisis in the market.
The Tron DAO Reserve, which oversees and manages the stablecoin, said a certain degree of volatility in USDD’s price was to be expected given its “decentralized” nature.
“Certain % of volatility is unavoidable,” the organization tweeted last week. “Currently, the market volatility rate is within +- 3%, an acceptable range. We will watch the market very closely and act accordingly.”
USDD was trading at around 97 cents on Wednesday.
Despite concerns over a repeat of the Terra saga, experts say this is unlikely to be the case, since USDD is much smaller in size and has seen little uptake from crypto investors.

What is USDD?

USDD was launched in early May, days before UST began tumbling below $1. For the past week, it has consistently traded below its intended dollar peg amid increased selling.
Instead of sitting on piles of cash and other cash-like assets, USDD runs a complex algorithm — combined with a related token called tron — to maintain a one-to-one peg to the greenback.

If that sounds familiar, it’s because Terra’s UST operated in much the same way, creating and destroying units of UST and a sister coin called luna to get around the need to have reserves to back the stablecoin.
Another similarity USDD shares with UST is that it has accumulated a sizable cache of other digital tokens to help boost its price in case investors withdraw in droves. Terra bought billions of dollars worth of crypto in an effort to keep its stablecoin afloat, a move that ultimately proved futile.
USDD’s use of crypto as reserves expose it to “similar risks as UST,” said Monsur Hussain, senior director of financial institutions at Fitch Ratings.
“Cryptos are generally price-correlated during times of upheaval,” he added.

USDD also offers investors unusually high interest rates — up to 39% — on their USDD deposits. Anchor, a crypto lending platform, similarly touted yields of as much as 20% on UST holdings, a rate many investors now say was unsustainable.
The coin was created by Justin Sun, the outspoken crypto entrepreneur behind Tron, a blockchain that’s trying to compete with Ethereum. Like Do Kwon, the founder of Terra, Sun has often used Twitter to promote his projects — and challenge critics.
The Chinese-born businessman has been involved in numerous controversies and publicity stunts in the past. In 2019, he paid $4.6 million to have lunch with Berkshire Hathaway CEO Warren Buffett, only to then cancel abruptly. The lunch eventually took place in 2020.

Not another Terra

Upon closer inspection, though, it’s clear there are some notable differences between USDD and UST.
For one, USDD is nowhere near the scale of Terra, whose UST and luna tokens reached a combined value of $60 billion at their height. It would therefore be unlikely to have the same effect if it collapsed, according to analysts.
“USDD doesn’t have the weight to cause the same wake of destruction UST did,” said Dustin Teander, a research analyst at crypto data firm Messari.

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He added the use of USDD isn’t anywhere near as widespread as UST was before its demise.
According to public blockchain records, about 10,000 accounts hold the token on the Tron network, while just over 100 accounts hold it on Ethereum.
Were USDD to collapse, “it would not result in the same degree of contagion, or fear, as when UST/LUNA crashed,” Hussain said.
And unlike UST, which was only partially collateralized by crypto, USDD aims to be overcollateralized, meaning its assets always exceed the number of tokens in circulation.
The Tron DAO Reserve says its reserve contains more than $1.9 billion in bitcoin and other tokens, including the stablecoins USDC and tether. USDD has a supply of roughly $700 million. That reduces the chance of a Terra-style collapse, according to Teander.

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