A moving target

Since last we wrote, some three weeks ago, there has been little diminution in the frantic torrent of policy proposals, policy adjustments, and policy adoptions with which every economic Actor must brace himself to contend each day before he goes out to earn himself a living.

It has been a constant refrain of ours that such infernal, Stalinist tinkering is one half of the reason that the recovery has been so muted and so uneven in its spread—the other causative factor being the refusal to write off losses and price what this recognition will inevitably leave as a reduced stockpile of capital in an appropriate fashion, once more.

One could almost yearn for the harmless tomfoolery of Roosevelt trying to reinflate the US by arbitrarily setting the price of gold while taking his morning breakfast egg in bed!

The prize for the most dramatic intervention (if hardly that for the most unforeseeable one) is probably due to the move to reactivate 2008’s central bank swap lines, as a means to pull back from the excruciatingly 2008-like levels of basis swaps which had opened up between euro and dollar money market rates.

The danger therein may be truly incalculable for, as the deplorable case of MF Global is beginning to reveal, the dark underside of the zero-interest phase of these past few years and of the generally buoyant asset markets which have accompanied them is that unquantifiable amounts of leverage lurk in the twilit corridors of ‘rehypothecation’—the indefensible process by which one piece of collateral may be pledged many times over to stand as a parody of security for a loan—not least among the 1,400 or so, $1 trillion-plus ETFs (US only) whose issuers avail themselves of such fiduciary ’flexibility’.

No-one would really like to see the network integrity of this Hieronymus Bosch underworld tested by a market-induced seizure: ’For in that Sleep of Death what Dreams may come?’

Ironically, what the swap programme will also serve to do is to add an extra-Zone parallel to arrangements thrown up by the existing intra-Zone logjam, by incorporating yet another layer of central bank involvement in what should be a wholly private matter between consenting-adult, commercial entities.

What is involved in the current impasse is that the surplus countries and their structurally better-funded banks will now only continue to play the systemically critical ‘childish game of marbles’ of Jacques Rueff’s characterisation—i.e., to keep rolling over the mountain of vendor finance obligations being piled up by the cash-poor banks of the deficit nations—if they have a central bank ’credit wrapper’ within which to do so.

Thus, within the Eurozone, for example, since spreads between Bunds and Bonos and BTPs began to widen in the spring of 2010, German banks have so far redirected their focus towards their mother hen on Frankfurt’s Taunusanlage, that they have eliminated 90% of their earlier €200 billion in gross liabilities towards it, moving instead to becoming net creditors to the tune of a nearly equal-and-opposite amount.

Simultaneously with this switch—and offsetting it nigh on euro for euro—it has fallen to the Bundesbank to treat the threatening thrombosis this has created in the Eurozone’s financial circulation by increasing its TARGET-2 net lending to other system central banks from an already elevated €220 billion to a towering €480 billion at the end of October.

Just pause to think what is at work here. In the 2 1/2 years from the end of 2008, Germany ran a current account surplus of around €335 billion, two-thirds of which (~€220 billion) originated in the trade surplus the country ran with its EZone partners.

In this period, German households put €385 billion into building their nest egg of net financial assets, with non-financial German corporates likewise adding €125 billion to theirs. With the state swallowing up €190 billion as a result of its lurch back into hefty deficit financing, a closely comparable €320 billion was therefore left to be disposed of abroad, sending the funds back whence they came—in aggregate at least, if not necessarily in every devilish detail.

Ordinarily, this would mean that those among the ‘Zone’s net importers would borrow the necessary balance from their banks, while those receiving cash either directly or indirectly as a result of German export success would lend it to theirs and these, in turn, would extend credit to their cross-border counterparts, so allowing them to fund their burgeoning domestic loan books.

Come the crisis, however and that has increasingly not been the case. Banks in the importers have had to call ever more heavily upon a local central bank which has then covered its exposure by drawing down on its TARGET–2 account. Surplus CBs, principally the Bundesbank, have then taken monies from the reluctant recyclers in the Heimat and stepped in to discharge the required closing of the circuit in their place.

Thus, the last 19 months’ of growing European discomfort has seen TARGET-2 lending by Germany not only cover the whole of the estimated trade flow of €135 billion, but has put a comparable sum to work in absorbing part of the outstanding stock of the unredeemed bills run-up in earlier years.

Meanwhile, many of the region’s banks had become so desperate to borrow USD that 3-month basis swaps had blown out to a crippling 160bps differential (in world where you have to go more than six years out on the German and up to eight years out on the American govvy curve to fund a comparable outright yield), despite the fact that, between them, they account for a goodly part of the $730 billion or so cashpile parked passively by foreign banks with the Fed.

As such then, the move to offer (primarily) ECB-FRB swaps once more as means to bridge this particular chasm, was effectively the reinstitution of a TARGET-2.i between the two—though it should not go unnoticed that the BoE joined in the arrangement while simultaneously introducing a new collateralised lending facility—purely as a precaution, you understand—under the less-than discriminating terms of which, as one correspondent of ours wryly put it, even luncheon vouchers would be henceforth acceptable.

With a much-reduced, but still imposing £260 billion gap between Sterling M4 (domestic bank liabilities) and M4 lending to close (offshore!) we can perhaps see why the Old Lady was also attempting to meet trouble half way.

Thus far then, the move has been a palliative—a means of applying an official sticking plaster to a suppurating wound of mistrust, of shrunken capital value, unreserved losses, and sharply-reduced franchise value. To prevent this from itself becoming more of a complicating factor in the patient’s condition is, perhaps, laudable enough: but a fix for the underlying pathology it is not.

Nor is it hard to see why the ECB should fly so resolutely in the face of good sense by insisting that no bank should be required to bear any responsibility for the loans it has extended to any Euro-sovereign (or to any of the banks it has bullied them into guaranteeing, in turn). Self-preservation is a powerful solvent of good conscience.

Alas! Given their own terrors of being consumed in the firestorm of cross default which they fear would be the result of such an otherwise restorative seisactheia, we cannot look to the less intellectually-compromised members of the Bundesbank to break ranks with their Bernanke-wannabe colleagues in this crucial matter as the suspicion must remain that their angst on this account makes them all too vulnerable to the scaremongering tactics of those monetary hammer-holders who see every problem as a nail to be pounded in with the application of ever more ‘liquidity’.

But the ECB did not hog all the limelight in the past week, of course, since the new swap deal came in almost the same news cycle as the surprise cut in the Chinese required reserve ration (RRR)—an action which is still open to a much wider range of interpretations than one might think.

On the one hand there is the straightforward bullishness being espoused by the usual crowd of ’Only Way is Up’ Pollyannas who see this as merely the first step in a grand repeat of the insensate orgy of Keynesian folly the Party unleashed in 2009, thereby lucratively bearing up the prices of financial assets and commodity prices and rebalancing the world, go hang!

Well, perhaps they will be that foolhardy. Unlike some we do not pretend to understand the intricacies of the dimly-glimpsed yet constant power struggle which goes on within the various branches of the CCP, nor are we entirely certain to which one of the myriad, contradictory ’advisors’ to this, that, or the other agency or ministry who never cease to perturb the airwaves it is actually worth paying attention for insight about the likely outcome of such strivings.

What we do know is that the PBOC is not the Fed and that the regime does not play by the same rules as do ours. We know that it seeks at all times to enhance its prestige and to maintain its grip on power by persuading the ordinary Chinese that they cannot do without its supposedly benign, Confucian oversight. More we cannot say.

Along those lines, the tightening cycle of the past year was not exactly inexplicable given that the most obvious threats to the Party’s standing was the widespread discomfort occasioned by the rising cost of living and by the growing outrage at the excesses of the plutocracy with which the  Apparat has become so visibly infested.

It was also patent that the means at the PBoC’s disposal with which to address this did not include a rational pricing of monetary capital—not least the introduction of meaningfully positive real interest rates—since this requires both a free(ish) market in money and the termination of the vast, covert subsidy to state-sponsored industrial gigantism which the standard, flagrantly-suppressed funding costs leach out of the average Chinese’s hard-won savings.

Thus, the prospect was for pretty much what we in fact did see: a needlessly protracted game of regulatory whack-a-mole while both real and merely political entrepreneurs engaged in increasingly ingenious ways to avoid the constraints being imposed upon them from above.

The problem with all this policy gradualism was exactly the same one that we ourselves have experienced twice in the past decade—both in the Tech Bubble and the Housing Boom which was intended to be its remedy. Given no fear of sudden shocks and given continued access to funds—albeit via more shadowy, less-legally certain and, hence, more expensive channels—speculation was further encouraged, as it always is in circumstances when the prospective rates of return in the speculative vehicle long outruns the tangible cost of participation in the mania.

Typically, too, more and more economic activity has been sucked into this bubble, to the extent that companies of all shapes and sizes and individuals of widely varying means and sophistication have diverted more and more of their energies, capital, and financial possibilities to playing the bubble, to the point that it would hardly be a shock to discover that a good part of the ostensibly impressive ‘profits’ routinely being booked by the makers of steel and steam irons, of telecoms and teapots, of chemicals and cuddly toys have their origins in purely notional gains on non-core—and possibly ultra vires—property holdings.

Thus, not only do we have the concern that those capitally-intensive, high-order goods expansions unleashed by a lavish application of easy money do not ever end well once the spigots begin to close; or that ‘shadow’ finance can easily morph from being a useful lubricant, to becoming a ramshackle framework of ominously creaking hinges; or that the eager accommodation of over-exuberant, multiply-leveraged purchases of that notoriously illiquid, shelter-providing, durable good which is housing is a guaranteed bank-killer, but we also harbour the awful suspicion that all of these three potential crash-makers may now have become fatally intertwined.

Now, it may be that the RRR hike was purely technical. The PBoC may simply have been practising its avowed ’fine-tuning’ and so, when confronted with preliminary data suggesting that bank lending fell precipitously in November as the scaled-in inclusion of formerly off-balance sheet liabilities in the reserve count took hold, it wisely adjusted the trim on the controls a touch.

This, in turn may have been related to the fact that the reversal in sentiment on the likely trajectory of the Yuan (as signalled by the 12-month NDF rate moving back above the spot quotation) called—as it seems to have done in the past—for a lesser immobilization of funds on the grounds of sterilizing forex inflows. Indeed, this would have been greatly reinforced by news that the tide of those flows had, in fact, turned outward in the last few months and were thus exerting their own degree of automatic restriction.

Finally, the Bank may have been playing good global citizen (or else narrow mercantilist free-rider, according to taste) by responding to the FX swap liquidity announcement from abroad. Who can say?

What we do know, however, is that the authorities have since been at pains not to let the market run away with the idea that the Land of Milk and Honey is just around the corner and that they have not yet finished wringing the excesses out of the property market.  So successful have they been in this, in fact, that the Chinese stock market has continued to meet with selling—an otherwise strange behaviour on the part of those who are purported to think that the clarion has just been sounded for a resumption of 2009’s Bacchanal.

What we also know is that the attempt at mollification is so far being effected mainly through fiscal means—look at the announcement that the official poverty threshold will be raised to such a degree that four times as many people as before (100 million, as opposed to 27 million) will henceforth be eligible for a range of government subsidies and stipends. Further measures include a cap on coal prices and a hike in non-residential electricity tariffs, aimed at assisting badly-squeezed power companies

Economically-conflicted all this toing-and-froing may be: politically, however, the issue is less clear cut since the rigmarole does at least mean the Party can give itself an unlimited role as the arbiter of difficulties and the resolver of problems, regardless of the fact that these are largely those of its own making.

By contrast, to flood the country with money now—with price rises still painful in the memory (and probably in the pocket)—would be to risk not only reigniting popular wrath the minute that those prices reaccelerate in their upward flight, but to throw a large, juicy bone to that salivating Pavlov’s dog of market misbehaviour which answers to the name of ‘Moral Hazard’.

But, but… there is also a hint that the All-Knowing Central Planners may have shocked themselves at what they have wrought, for all their pretensions at close control. Land sales have slumped; lending is evaporating; ‘profits’ have melted like the first snows of spring; unrest is beginning to grumble at the street corners and at the factory gate; SME bodies are comparing this episode unfavourably with the travails of 2008.

As a result, the Party is now trying to demonise internet ’rumour-mongers’ by comparing them to cocaine dealers and the new head of the main TV station has  reminded journalists their first duty was to serve as ‘mouthpieces for the State’. Even more ominously, Politburo law-and-order member Zhou Yongkang told provincial officials last week it was time for ‘innovative approaches to social management’—a euphemism, we are told, for anything from stepped-up policing to boosting unemployment insurance.

“Especially when facing the negative effects of the market economy, we still have not formed a complete mechanism for social management,” Xinhua quoted him. “How to do so is the great and urgent task before us.”

In the circumstances, it is an obvious folly to assert that one knows which way the chips will fall. To quote Heraclitus: all is flux

One thing should, however, give even the most red rag-focused China bulls pause for thought. This is, namely, the question of why they think the Chinese understand the exact state of their complex, sprawling economy of 1.3 billion people patrolled by 80 million Yes-men when, clearly no-one in authority in the US, the UK, or Europe—not Bernanke, not Paulson, not King, not Trichet, no-one—had a clue what was happening to theirs in not entirely dissimilar circumstances, four years ago?

Why, too, do they think that a rapid monetary easing will necessarily reinflate the bubble swiftly and painlessly (or trigger a new one to take its place seamlessly) in China, when it does not quite seem to have worked its fairy dust, inflationist magic outside the Middle Kingdom in the ready manner prescribed by the Beelzebub of Bloomsbury?


  • the Beelzebub of Bloomsbury = John Maynard Keynes?

  • Corrigan says:

    who else? :-)

  • Tim Lucas says:

    “It was also patent that the means at the PBoC’s disposal with which to address this did not include a rational pricing of monetary capital—not least the introduction of meaningfully positive real interest rates”

    Which inflation aggregate would you choose, Sean, in order to attempt to determine whether countries have policies of meaningfully positive interest rates? While not the case in China, the monetary aggregates in the US and Europe are falling. Hence, despite CPI increases, QE etc, one might argue that credit conditions are already tight in the developed world.

    Aggregates – can’t live with them. Can’t comment without them.

  • corrigan says:


    As you say, we have to talk in the shorthand of aggregates even as we must make continual mental notes to beware the illusion that they mean something ‘Ding an sich’. After all, even Mises and Hayek bowed to convention and spoke of the ‘price level’ from time to time, however much they warned against the use of the concept.

    As for ‘inflation’, the most theoretically sound (and empirically solid) measure, to my taste, is some sort of M1+ (depending upon individual definition and institutional practice). Swings in this tend to cause whole-structure expenditures to change (dominated by those business expenditures which are largely cancelled out of standard GDP accounting, but which are nonetheless integral to and arguably definitive for the economic process).

    Some part of any gain here may represent a genuine upswing in activity (and/or a lengthening of the monetized chain of specialization) and hence come with limited rises in price: some, however is simply a dilution effect, more money chasing the same (turnover of) goods – one might almost (shudder) talk of their ‘velocity’ here, if one were forced to, but only with the caveat that this latter is shorthand for an emergent artefact of individual choices and valuations, not a fundamental, causative force of nature and, as such, it can itself be a source of great variation!

    Along those lines, I do also go one iteration more and look at what the stock of money will theoretically buy (by using – err-hem! – the ‘price level’ as a rule of thumb) to see whether an extra nominal sum is actually able to intermediate the same or a greater number of transactions, given unchanged (velocity) preferences to hold it.

    That said, I agree that the UK looks like it is suffering a nasty deflation and that the current CPI/RPI rise SHOULD be a transitory effect of the change in a number of components (especially imported goods and commodities, as well as administered prices) of an index basket so fixed as to ignore those price changes’ effects on their volume of uptake.

    The Eurozone, too, has near zero expansion (though, as yet no actual, across the board deflation) with the disaggregated data suggesting that individual countries are seeing such a contraction (but are national borders not porous in a currency union-Single Market?).

    Even China and HK are now in that boat – especially in ‘real’ terms. So look out for the possibility of the oft-derided ‘hard landing’ next year.

    The case in the US is v-e-r-y different, with some of the most expansive reading in the modern era, (though the end of QEII means this is beginning to subside) while Japan, too, is experiencing above average nominal and real growth.

    Different strokes for different folks.

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