Thursday, April 2, 2009

Yuan Swaps, $UUP $24-25 Puts Open Until June and SDRs.

This continues from my previous post about $UUP April $25 put action after the Fed's decision to buy Treasuries, agency-MBS and agency debt. Now Russia and China are trying replace the US Dollar with a "Super Reserve Currency" (Special Drawing Rights consisting of currencies, gold, baseball cards etc.) to diversify sovereign credit risk. The idea was put off at the G20 meeting because #1 priority was saving the global economy (Reuters). But leaders were definitely tweeting about it probably.

Zhou Xiaochuan, Chairman of the Peoples Bank of China, thought 'Special Drawing Rights' should play a bigger role as a reserve asset. Here are quotes from his speech via on March 23, 2009.

Reform the International Monetary System

Zhou Xiaochuan

I. The outbreak of the crisis and its spillover to the entire world reflect the inherent vulnerabilities and systemic risks in the existing international monetary system.

Issuing countries of reserve currencies are constantly confronted with the dilemma between achieving their domestic monetary policy goals and meeting other countries' demand for reserve currencies. On the one hand,the monetary authorities cannot simply focus on domestic goals without carrying out their international responsibilities on the other hand,they cannot pursue different domestic and international objectives at the same time. They may either fail to adequately meet the demand of a growing global economy for liquidity as they try to ease inflation pressures at home, or create excess liquidity in the global markets by overly stimulating domestic demand. The Triffin Dilemma, i.e., the issuing countries of reserve currencies cannot maintain the value of the reserve currencies while providing liquidity to the world, still exists.

When a national currency is used in pricing primary commodities, trade settlements and is adopted as a reserve currency globally, efforts of the monetary authority issuing such a currency to address its economic imbalances by adjusting exchange rate would be made in vain, as its currency serves as a benchmark for many other currencies. While benefiting from a widely accepted reserve currency, the globalization also suffers from the flaws of such a system. The frequency and increasing intensity of financial crises following the collapse of the Bretton Woods system suggests the costs of such a system to the world may have exceeded its benefits. The price is becoming increasingly higher, not only for the users, but also for the issuers of the reserve currencies. Although crisis may not necessarily be an intended result of the issuing authorities, it is an inevitable outcome of the institutional flaws.

II. The desirable goal of reforming the international monetary system, therefore, is to create an international reserve currency that is disconnected from individual nations and is able to remain stable in the long run, thus removing the inherent deficiencies caused by using credit-based national currencies.

1. Though the super-sovereign reserve currency has long since been proposed, yet no substantive progress has been achieved to date. Back in the 1940s, Keynes had already proposed to introduce an international currency unit named "Bancor", based on the value of 30 representative commodities. Unfortunately, the proposal was not accepted. The collapse of the Bretton Woods system, which was based on the White approach, indicates that the Keynesian approach may have been more farsighted. The IMF also created the SDR in 1969, when the defects of the Bretton Woods system initially emerged, to mitigate the inherent risks sovereign reserve currencies caused. Yet, the role of the SDR has not been put into full play due to limitations on its allocation and the scope of its uses. However, it serves as the light in the tunnel for the reform of the international monetary system.

2. A super-sovereign reserve currency not only eliminates the inherent risks of credit-based sovereign currency, but also makes it possible to manage global liquidity. A super-sovereign reserve currency managed by a global institution could be used to both create and control the global liquidity. And when a country's currency is no longer used as the yardstick for global trade and as the benchmark for other currencies, the exchange rate policy of the country would be far more effective in adjusting economic imbalances. This will significantly reduce the risks of a future crisis and enhance crisis management capability.

Here's Geithner's response to his proposal at the Council on Foreign Relations. The White House did come out on 3/31/09 saying the USD would remain the worlds reserve currency (Reuters).

It's interesting that China is making Yuan swap deals with importers so they can "avoid paying for Chinese goods in US Dollars". Read the Bloomberg and Reuters articles below.

"The People’s Bank of China has agreed to provide 650 billion yuan ($95 billion) to Argentina, Belarus, Hong Kong, Indonesia, Malaysia and South Korea through so-called currency- swaps" (Bloomberg).

"But the potential repercussions for global currency politics are more far-reaching: if Asia got accustomed to the practice, the yuan could evolve into a regional currency, giving Beijing the status and influence that goes with it." (Watch China's FX swaps, not just super-currency plan -Reuters)

The return of risk appetite, inflation expectations and all of this chatter about the USD losing reserve status could put pressure on the USD. However a strong safe haven bid would delay this reaction. Moves by Central Banks could also ruin currency bets here.

Either way... I saw more put activity on UUP (US Dollar Bullish ETF) a week ago. 5,000 traded on the May $24 put and 5,000 traded on the June $24 put. As you can see 5,000 contracts traded previously on the April $25 put. These could be calendar put spreads or longs hedging short exposure, either way the $24-$25 area is being played until June. Plus the OI could disappear tomorrow for all I know, check for better information. $UUP is right around trend line support and if breached these puts, if bought-to-open, would make some money (before April 17 on the $25 puts). Being naked on the USD would be scary during these times imo.

**If the USD catches a safe haven bid here and breaks through ALL overhead resistance b4 April 17 let's hope this person was short 15k puts.

UUP (US Dollar ETF) via
UUP April 2009 Option Chain (Yahoo Finance)
UUP May 2009 Option Chain (Yahoo Finance)
UUP June 2009 Option Chain (Yahoo Finance)

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