Once again, the European press is trumpeting the triumph of the prodigals after a week in which both the Spanish and the French were accorded more time to get their budgetary house in order – a move which, given the downward economic trajectory of the pair, has something of a whiff of force majeure about it – and the German Finance Minister Schaeuble acknowledged that, yes, the fiscal pact around which he and his boss have built so much of their electoral credibility did in fact encompass a ‘certain flexibility’.
In the wake of a mass demonstration on the streets of Paris at which the Left Front’s heavily-defeated presidential candidate Melenchon fulminated that “We do not want the world of finance in power!” – an expostulation delivered to the strains of ‘Ca ira!’, one supposes – Schaeuble’s Gallic counterpart Moscovici was hardly in a position to soft-pedal the German concession, instead vaunting grandiosely in his turn that, “We are witnessing the end of the dogma of austerity… we are at a decisive turning point in the history of the European Project”.
Brave words, indeed, but Frau Merkel, for one, begged to disagree – or, at least, to dissemble for the benefit of her domestic audience. “If one regularly spends more than one earns, something must be awry,” she opined, while one of her party’s spokesmen, Steffen Seibert declared that, “Our contention is that the… crisis has its roots in the overindebtedness of many member states… in to low a degree of competitiveness.” No prizes for guessing to whom he was referring.
Last week’s supposed poster boy for the new laxity, Commissar – sorry, Commissioner – Barroso, was also out on the circuit, denying that he had endorsed any such slippage by telling Welt am Sonntag that he had been “deliberately misinterpreted”, that – au contraire, mes amis – “growth which depends upon debt is unsustainable” and that the blame for the ‘Project’s’ woes should not be pinned on German policy but rather on “excessive outlays, lack of competitiveness” – that word again – “and irresponsible finance.” “Each nation,” he went on, “should look to clean up the mess on its own doorstep.”
Amid all this posturing, it does strike your author as a touch ironic that while the commentariat treats Europe’s persistence with its failed experiment in ‘fauxterity’ as a clear and undeniable symptom of the mental inadequacy of its ruling elite, the members of that same consensus themselves retain what is, if anything, an even more delusional faith in the combined evils of inflation and Big Government as the magical means with which to conjure away all our present woes.
In case you hadn’t noticed, fellas, we have been reinforcing monetary-fiscal failure for the past five years, by continuing to ply the patient with ever stronger doses of what it was that made him ill in the first place. Just multiply the DAX by the youth unemployment rate if you want a snapshot of where your approach has gone horribly wrong – of where you have let the GINI out of the bottle, as it were – and you might realise that if there is anyone who needs to reconsider their attachment to a discredited dogma, it is you!
Whisper it, but even your hero seems to be getting the drift. For witness that, in his latest speech in Rome, Mario Draghi was happy to say that “Fiscal policies must follow a sustainable path, separate and distinct from cyclical fluctuations. Without this prerequisite, lasting growth is not possible… Particularly for countries with structurally high levels of public debt…”, before going on to assert far more boldly that – as we have said since Day One of the crisis – “…to mitigate the inevitable recessionary effects of fiscal consolidation, the composition of such measures must favour the reduction of current public spending and of taxes, particularly in a context such as in Europe where taxation is already high by international standards….” [our emphasis].
Though we must be careful not to read too much into the man’s words, it is hard not to hope that this might reflect the first fragile flowering of a genuinely new approach – of the inauguration of a policy of REAL austerity, this time of the invigorating kind which incorporates a partial lifting of the deadening hand of the state, rather than the enervating, bastardized version of slower spending growth and rapidly rising taxes with which we have been so far afflicted and which has only served to compound the financial shock delivered by the collapse of the last bubble.
All this remains to be seen but, in the here-and-now, the temptation to use this effusion of political hot-air as an excuse to buy yet more stocks, more ailing sovereign debt, and more junk credit has become well-nigh irresistible, especially since Super-Mario not only overrode what he hinted was some internal opposition to an official rate cut at the latest ECB meeting, but also managed to leave dangling before a slavering crowd of stimulus junkies a tantalising hint that he might soon push the level below zero. In case we were too obtuse to get the point, he underlined his intentions with another of his famously portentous, almost Delphic pronouncements: that even though the ECB council was still scrambling to divine whether anything could possibly go wrong with such step into the unknown, he, Draghi, stood ‘ready to act’.
It was not the first time in recent days, of course, that the marbled halls of Mount Olympus had echoed to the sonorous baritone of the Gods as they sought to reassure us poor mortals that they had matters well in hand: that they had taken time off from their weighty contemplation of the sublime, the eternal, and the infinite to tend instead to our petty concerns. Had not the Bernanke Fed subtly quashed all thoughts that it might soon ‘taper’ its own open-handed distribution of milk and honey with that one, equally Pythian phrase: “the Committee is prepared to increase or reduce the pace of its purchases to maintain appropriate policy accommodation”?
How can a man NOT want to buy the market in the face of the solicitous stance being taken by the venerated possessors of such unchallenged omniscience?
For all this, the imposition of the near-mythical, negative deposit rate might seem to entail more problems than advantages, not least because it would effectively act as a tax, a drain upon the earnings, of the very same banks that the last five year’s ruinous policies have been attempting to bolster. Bear in mind that, even after the recent redemptions, European banks have a hefty €628 billion parked with the ECB and so a 50bp levy on this could amount annually to perhaps 15% of industry-wide profits.
Nor can banks simply avoid this by withdrawing their funds: outside money – the kind created by the central bank – is, after all – outside. This means that its supply can only be altered with the complicity of the bank of issue itself which must therefore allow its myrmidons to pay back more of their LTROs, covered bond repos, and so forth – a reduction of liquidity which one might think would run counter to the original intention. Thus, one supposes, the idea will be that the banks will enact the Gesellian wet dream of passing on the cost to their own depositors, of taxing their money instead.
Here we must consider the fact that while the individual can easily seek to disembarrass himself of what he now considers an excess proportion of money among his holdings, collectively the public can only have their aggregate stock of inside (bank-created) monies diminished in one of three ways: they must repay their loans (deleverage further); the banks themselves must call in said loans (intensify the crunch); or people who hold a demand account must swap it for a term deposit (which does not constitute money-proper), or invest in a long-term security issued by the bank itself (we specify this last because a moment’s thought will reveal that the purchase of non-bank paper simply passes the parcel to the seller or issuer of said obligations who must then rid himself of them in his turn).
While that latter condition might seem an ideal juncture at which the banks could seek to boost their levels of capital (albeit at an average price:book of significantly less than one), the truth is that what the authorities seem most keen to provoke is a what is technically called a ‘monetary disequilibrium’ – that is, the situation where the public’s demand to hold money is thrown out of kilter. Under such conditions – and given the nominal inflexibility discussed above – the money stock can only be effectively reduced if its real value falls; if prices rise and so reduce its worth; i.e., if there is an inflation.
In that regard, the impulse to buy stocks on what is no more than a vague expression of intent might not seem so wholly irrational, after all. To see this in what is admittedly a toy example, suppose that half the population holds only cash and no equities (call these sticks-in-the-mud Group A), while the remainder has a reverse proportion of all equities, no cash to an equal overall nominal value held in their portfolios (call the ‘Nothing but Blue Skies’ crowd, Group B). The aggregate cash ratio from which we start is therefore 50% (albeit thanks to a not-to-be-exceeded and somewhat unrealistic divergence of preferences between our two cohorts).
Now suppose the members of Group A change their outlook on life and seek to acquire equities from Group B, paying successively higher prices for ever smaller increments in order to tempt their counterparts into the trade. Under some fairly crude assumptions, after four rounds of such bidding, with one third of the stock of equities having exchanged against two-thirds the stock of money, equity prices will have tripled, the cash ratio of both groups will have converged on 25%, and aggregate net worth will have doubled (to the relative advantage of the initial equity holders, but to the outright, if decidedly notional, benefit of all).
Note, however, that none of this says that the equities are worth three times as much for even if the monetary disturbance has somehow meant that earnings have also tripled (and this is far from being guaranteed even should revenues rise in proportion), this may represent no material gain whatsoever, but only register the inflation of a wider range of prices which here has not been consequent upon an increase in the stock of money per se but solely upon a diminution in its societal valuation.
Herein lies the great gaping hole at the centre of official policy. Yes, the central banks can increase the stock of outside money almost without limit. Yes, they can make it as unattractive as possible for anyone to hold this (though when we come to think about the impact of negative rates, let us not forget that people are generally happy to pay to have their other valuables safely stored, or that bank charges used to be a routine imposition upon the short-term depositor). And yes, to some extent they can assume that their actions will enhance the relative appeal of things other than money or its partial substitutes.
But what they cannot ever gauge is how much influence they can exert, nor how quickly their will may be done, nor even upon what specific mix of goods, services, or claims their policy will have most impact. As the great Richard Cantillon pointed out three centuries since, the whole question is highly path dependent and the path actually followed will be the result of an incredible cascade of interactions between individual, subjective choices, each one altering the quantum field in which the next has to be taken. As we Austrians have been saying for the past one hundred years, this affects relative prices much more profoundly than it does average ones. Crucially, it is in that matrix of relative prices that you find the motivations for all economic actions and the justification or otherwise for both the composition of the capital stock and the distribution and employment of labour. If entrepreneurial uncertainty and personal bewilderment have been major contributors to our ongoing malaise, as many of us have been arguing, it should be clear that we seek to introduce further sources of instability and potential disruption only at our peril.
Nor can our Sorcerer’s Apprentices be entirely sure that, as the demons they have summoned out of the vasty deep continue to chip away at the foundations of trust in the very currency which they, the necromancers, are charged with upholding, they do not unleash a catastrophic collapse of the whole superstructure of values and contractual chains which towers above them, reducing the whole economic system to chaos in the process.
If you can convince me that any mortal can hold such a complex tangle of possible outcomes within their comprehension, I will allow that our monetary heretics may be right to do away with the combined practical experience and theoretical understanding of all those who have gone before them over the ages. Until you do, I shall be forced to withhold my endorsement and to mutter darkly about the unexpiable sin of hubris instead.
Continued from part 2 …
Finally to China where the only thing to note is that the meme of credit exhaustion is starting to spread, given that every CNY100 of reported GDP in the first quarter required the addition of CNY52 in new credit – much of that flooding back in from abroad to play the property boom.
That this is likely to lead to an implosion in fairly short order seems to have been recognised by the new men in charge. Hence the unusual convening of an April session of the Politburo Standing Committee for a meeting dedicated to the economy. From this there emanated an official press release containing the following injunction:
China needs to cement its domestic economic growth momentum and guard against potential risks in financial sectors
It doesn’t sound as if another dash for growth is on the cards, now does it?
After the rout in the gold and silver market, all we can say is that though conspiracy theories inevitably abound, we have warned on numerous occasions that such a sell-off was always possible given the number of stale, trapped longs who have had no return for months while sitting at very elevated real and nominal valuations – and all in the face of ever-mounting equity rises, to boot. One may or may not care much for the idea of technicals as predictive tools, but, just once in a while, the break of an obvious trend line convinces those who do subscribe and gives rise to an avalanche of me-tooism and that was very much the case in gold and silver.
Since then everyone has come up with their own pet, Just So Story about what or who exactly triggered it. In all likelihood there was a multiplicity of overlapping causes, of which the two most important were probably:-
- the absence of a Risk Off spike on Cyprus (with added piquancy of possible forced reserve sale at the ECB’s behest)
- the absence of an immediate inflationary rally on the BOJ move
More fundamentally, we have to face up to the fact that the Sell Side has simply l-o-v-e-d the fact that commodities are weakening while equities and credit are storming ahead since this enables it to spin a new tale to customers about why they should now revert to type and stick with their traditional, fee-generating asset classes.
Much has been made of the recent raft of negative reports from those who were formerly the bull market’s greatest boosters, but in truth, as consummate salesmen, these worthies are only telling their disappointed customers what they already want to hear. No spiel sells as well as the one which allows an after-the-fact rationalization of an unlooked-for outcome. If you can’t be smart about where the market is going, it at least assuages wounded pride (and patches up a tarnished professional reputation) to sound knowledgeable about where it has been.
All this has contributed to a poisonous mix of factors – fundamental, technical, and sentimental – among which we can include the following shifts.
Firstly, in terms of the guiding mantras which the crowd is so wont to adopt, ‘Peak Oil’ has given way to ‘Shale Glut’ and ‘Super-Cycle’ Chinese gluttony has been transmuted to an expression of faith in the all-seeing Confucian Mandarins who will shrewdly rebalance economy and unleash consumer spending, needing no copper in excess of the present quota to do so. (Big Mining itself has been reinforcing this shift, leading to the unusual result that Big Mining share prices are showing even worse returns than are commodities, despite the overall vogue for equities).
Next, financial momentum itself is now a killer, since the more commodities lag, the more people fear being left behind in any less than full commitment to the incipient equity bubble whose warm glow of instant mark-to-market gains they again avidly crave.
Again, given the appalling price action of late, the same trend chasers who did so much to boost commodities on the way up have been liquidating/shorting stuff and buying financial assets for some time, even before the gold/silver purgative. Their potential overstretch is our present best hope.
Finally, a glance at break-evens shows that inflation fears have dissipated, possibly in a very premature fashion. For our part, we have always argued that the CB actions will be slow burners, as in the 1960s, until debt re-gearing and bank expansion again come to magnify solo CB pumping. It will be the inevitable reluctance to withdraw stimulus that will lead to catastrophe more than the initial decision to provide it and then, as monetary trust first falls and then is entirely lost, velocity will rise, CPI will accelerate, and real commodity prices will turn.
The widespread impatience with the inflationary argument arises partly because no one understands that for there to be ANY price rises, however CPI-modest, in a world awash in un(der)employment and surplus capacity, this can only be evidence of a deliberate monetary excess. Alas, for us, as investors, the fact that we understand the root of this error does not make its consequences any less significant for the pricing calculus with which we must contend or for the timescale over which we must deal with it.
Thus, QExtreme is now exclusively bidding up financial assets (the Herd comfort zone, as we have said) and real estate (the default for the Ordinary Joe). Yet all the while it is preventing a genuine re-invigoration by keeping zombie companies alive and bad governments in funds, thus depressing organic, vigorous ‘growth’ and so acting without immediately igniting an inflationary holocaust which may well require a much longer gestation process than most are prepared to countenance. Not a great near-term mix for tangibles, it must be said.
Continued from part 1 …
Away from the brouhaha over fiscal policy, the intertwined issue of its monetary equivalent comes into focus. Perhaps in belated recognition of what we have been calling ‘biflation’ – i.e., the sharp divergence in monetary growth between Germanic and Latin Europe – Frau Merkel was moved to remark at a savings bank conference in Dresden that if the ECB were to be setting rates solely with an eye to conditions in the Heimat, it would probably have to raise, not lower, rates at the moment.
For their part, the two most senior Bundesbankers concurred – albeit in their typically divergent fashion. The ever urbane Asmussen, in a speech entitled, ‘Saving the euro’, alluded in no equivocal fashion to the lack of a one-size-fits-all approach, declaring that:-
…a more recent feature of our financial structure is financial fragmentation. This implies that lower interest rates have asymmetric effects, and not in the direction that we want them. Due to impaired monetary policy transmission, the pass-through of rate cuts to the periphery would be limited, and this is where they are most needed. At the same time, rate cuts would further relax already unprecedentedly easy financing conditions in the core. This is not per se a problem – but interest rates that are too low for too long can eventually lead to distortions…
Ah, yes! The ‘distortions’ to be expected from monetary incontinence. Nothing we Austrians ever allude to, of course!
In contrast, the imprimatur of Asmussen’s far more forthright colleague, Jens Weidmann, was all over the leaked copy of the Bundesbank’s submission to the Constitutional Court regarding the legality of the ESM. In what amounted to a veritable Philippic, as Handelsblatt reported it, the Bank strongly denied it was any part of its mission to prevent any given member state from exiting the single currency. In asserting that ‘higher finance costs for the private sector’ in certain countries ‘are related to greater national fiscal risks’, this report effectively launched a thinly disguised attack on the casuistry of Draghi’s argument that his monetary interventions are all about levelling the European playing field – and so are ostensibly undertaken with the aim of ensuring greater ‘transmissibility’ of monetary settings – and nothing whatsoever to do with financing otherwise bankrupt states.
Though all this would seem to close the door to an imminent easing of interest rates (a development which, for all the market’s Pavlovian enthusiasm, is in any case likely to be little more than symbolic in its import), there are ominous signs of a looming deceleration in German growth. Domestic monetary velocity has declined sharply of late – with or without the noise created by the build-up of Target balances – largely as a consequence of a decline in business revenues of 3% YOY in the domestic market and of around 4.5% v-a-v its Eurozone export markets.
Nor was the final quarter of 2012 much more cheery for the category ‘property and entrepreneurial income’ in the national accounts. This registered its worst result since the panic-stricken first quarter of 2009, and was at a level first attained eight years previously. No doubt this combination of stagnant sales and dwindling profits goes some way to explaining why it is that, after 8 years of fairly consistent co-movement, the GEX index of owner-controlled, smaller, ‘entrepreneurial’ companies has revisited GFC lows and so has diverged sharply from the record-setting MDAX, to the point that latter speculative vehicle has run up 174% in relative terms in the past two years.
The test, as ever, will come when it is deemed to be to Germany’s benefit to seek a relaxation in policy and, by extension, when it is in Merkel’s narrow political self-interest to signal her acquiescence to the other members of the ECB council and so to free herself from the opposition of her own troublesome, monetary priests. That day may well not be long delayed, but we would hazard it has not yet arrived.
Incredibly, there was a palpable sense of expectation going into the BOJ meeting this week, as the insatiable stimulus junkies conjured up fantasies of some new initiative being announced, barely weeks after ‘Corroder’-san’s QExtreme measures were launched. Embarrassingly, the meeting coincided with the release of a set of national CPI numbers which were falling at their fastest (if still decidedly moderate) pace in three years. More troubling for those who never cease to exult in the boost which Abenomics will supposedly give to asset markets everywhere, it is not at all evident that Mrs. Watanabe is familiar with her part in the playbook, either.
We say this because, far from unleashing the expected torrent of outward investment, the weakening yen has so far triggered what look to be the highest sustained liquidation of foreign portfolios in at least the last 15 years – a cumulative repatriation these last twelve weeks of around $85 billion USD. Meanwhile, foreign inflows have been sufficiently vigorous to push the invested sums to within a few percentage points of their 2007 highs, albeit that this has coincided with a rise in margin positions on the TSE which suggests that much of the money is being borrowed for the purpose.
That the vaunted ‘carry trade’ seems to be benefiting only the Nikkei so far, may have two separate, but not inconsistent explanations. The first is that, in contradistinction to the previous episode of yen-fuelled, global asset inflation which was instituted during the reign of Eisuke Sakakibara – that is, in the period between the 1994-5 Tequila Crisis (to which it was a response) and the 1997-8 LTCM collapse-Asian Contagion (in which it was a proximate cause) – the Japanese are not actively driving the yen lower (not least by not encouraging, as they did then, the big macro hedge funds and prop desks to participate in a one-way bet) and so residual forex risks remain unabated.
Secondly, it should be noted that, 15-20 years ago, Japanese interest rates were around 600bps below those prevailing in the UK, 500bps below those in the US, and 300bps below those in Germany: today those spreads are 40bps, 4bps, and -5bps, respectively. In other words, back then it clearly did not pay those using yen to buy foreign assets to hedge exposures, even if they had chosen to ignore the explicit policy of their own government to weaken it. Today, by contrast, there is no meaningful penalty attached to so doing and no strong disincentive to desist since a lower parity is not officially an objective. Thus, easy money in Japan may well induce leveraged asset purchases, but it is hard to see why this should drive a self-aggravating spiral of devaluation and further, induced carry trades, especially when sources of speculative finance are not exactly lacking in any other currency you could name.
Note here in passing that with gold at an all time high versus the yen, and with the Topix coming off a 90%, 21st century decline to a three-decade low in gold ounce-equivalent value, a similar urge to book profits and/or reduce exposure to overseas assets offering much less prospective gain could have been at work in pushing the yellow stuff to the edge of last week’s precipice.
In what was a banner week for the many serial inflationists and fans of Big Government out there, equity markets largely reversed the declines of the previous period on the hope for – what else? – yet more pump priming. Adding their vote of approval, fixed income players have also pushed junk and EM yields to new lows and touched new, post-Mario depths in BTP/Bono-Bund spreads.
On the fiscal front, much heart has been taken at EU Commission President Barroso’s assertion that the time has come to move beyond an exclusive reliance on ‘austerity’ and to begin to focus on encouraging growth. Indeed, such was the frenzy of press speculation whipped up on this account – not least by the bien pensant Guardian newspaper as part of its campaign to effect a change in British policy – that the EU’s official website quickly published a full transcript of Barroso’s remarks under the revealing title of “What President Barroso actually said” [our emphasis].
Needless to say, this was far less radical than anything whipped up by the journalists – the crux being that it was mainly matter of paying lip service to the ongoing need to trim debts and deficits, while calling for a range of largely unspecified microeconomic reforms and, as such, representing more of an exercise in expectations management than the signal of a clear break with the line being toed across the Rhine.
In the circumstances, however, the wilful desire to over-interpret (if not actively misinterpret) the message was far too powerful to resist, especially in the wake of the academic catfight going on over the state of Reinhardt and Rogoff’s Excel skills.
For those who have real lives to lead, the briefest of synopses of this spat will suffice and, indeed, it is only introduced here to illustrate the heedless Flucht nach Vorne mentality of the Krugmanites, ever eager as they are to peddle the line that the only reason stimulus has ‘failed’ is because there has been nowhere near enough of it, that the violation of both the principles of accounting and the tenets of good housekeeping on the part of the Provider State has somehow been too timid.
Loosely, R&R wrote a paper which suggested that high government debt is detrimental to growth but managed to overweight one particular input from little old New Zealand at the dawn of their sample. A caricature of the paper’s results had meanwhile been employed to argue that growth would evaporate the minute a 90% debt/GDP ratio was reached, but not an iota before. Since this, naturally, was being put about with as much conviction as would be accorded a cross between Holy Writ and Newton’s Third Law of Motion, the Left instantly seized upon the revelation of R&R’s faux pas to claim that the collapse of this particular straw man somehow ‘proved’ that all attempts at public economy were therefore misplaced and that Leviathan should return with renewed vigour to the fulfilment of its sacred duty to collectivise as much of the market as possible.
What larks, Pip, are to be had when positivists and macromancers fall out over their flawed pursuit of what Mises called ‘scientism’ – viz., the pretence affected by most of the mainstream that economics can be made into a simulacrum of physics or fluid mechanics!
But, as a focus of this war of the scholastics, the whole debt issue surely misses the crucial point that debt only swells in a polity where not only is government over large to begin with, but where it is serially profligate – i.e., where the political class persists in spending more than it dares ask its electors to contribute to the fulfilment of its whims.
Given that this diverts resources away from hard-budget, dispersed-knowledge, voluntarily-contracted endeavours (hence ones which must, over time, at the very least pay their way) and into the crony-ridden, cost-plus, soft budget quagmire of top-down, fatal conceit compulsion – every one of its endless stream of programmes a would-be Great Leap Forward – can it really be a matter of dispute that existence of a high debt level should be taken as convincing evidence of a country where the petty tyrants in office and the host of public drones which they employ have enjoyed far too much sway for far too long and so have clogged up the machinery of wealth creation with a plethora of regulations, a nest of subsidies, a tangle of vested interests, and a legacy of malinvested capital every bit poisonous as that left behind by a private sector credit bubble (itself a plague which can only be transmitted by means of a pervasive state interference in the free market)?
As Thomas Gordon wrote long ago in Discourse X of his 1753 publication, “The Works of Tacitus with Political Discourses” :-
Wars beget great Armies; Armies beget great Taxes; heavy Taxes waste and impoverish the Country
Just substitute ‘Welfare’ for ‘Wars’ and ‘Public employees’ for ‘Armies’ and the argument remains in full 260 years later.
And, since you ask, evidence of real ‘austerity’ remains elusive. Government revenues, it is true, fell – for obvious reasons – in Greece, Spain, Portugal, and Ireland in the five years after 2007, but they were still up an average of 7.2% across the Eurozone as a whole. Expenditures, meanwhile, have continued to expand, rising an average of 15%. Only Ireland has here managed to record a decrease and that of a paltry 1%. Debt has, needless to say, climbed ever upward to reach a Eurozone-wide level of 118% of non-government GDP (we prefer to measure the obligation shouldered by the Ants alone, not by them and the Grasshoppers who prey upon them). Debt/pGDP itself has climbed by an astonishing median 30% in that same quinquennium.
Now it may well be that the rise in debt during this sorry period is a consequence, rather than a cause, of the growth slowdown, but the reason for the crisis which entrained this slump nonetheless lies in the too great accumulation of debt during the boom years. That much of the offending mountain of unpayable claims was initially a private sector folly is hardly to the point: what we have always maintained is that the blank refusal to renegotiate or liquidate that debt at the earliest possible stage, instead of engaging upon an obstinate course of macroeconomic Micawberism, is why the crisis has generated a grinding depression which shows few signs of being alleviated almost five dreary years after the event.
If nothing else, today’s debt stands as a testimony to economic incomprehension and political stupidity on a tremendous scale. But then again, since we are supposed to be drawing all of our lessons from what the Americans did in the 1930s, it is no surprise that we, too, have managed to perpetuate our misery, as did the monetary cranks and bureaucratic meddlers of FDR’s crackpot Brain Trust, way back then.
As another week goes by, Europe continues to flounder – even German car sales were off by 17% YOY, a decline which was presumably not all to be laid at the door of the unusually severe winter. Among the shrinking band of triple-A nations on whose creditworthiness the whole of the Zone rests like the globe on Atlas’ weary shoulders, Finland’s industrial output has come close to registering another one of those pitiful ‘lost decades’ as the aggregate inches painfully down from 2010’s incomplete recovery peak to levels typical of 2004.
Then again, why pick on the Finns when France – despite the latest minor uptick – sits at 1990 levels, a sixth below 2008’s best and now only 4% off the 2009 Crash lows. Or Italy – off 25% from the top, barely 2% off the trough, and at a level first attained in 1980. Or Spain – off 30%, making new 19-year lows and back at 1987’s mark.
Output may have held up better in the Netherlands, but the 20% drop in property prices is threatening to test a banking sector with the highest exposure to real estate in the entire EU. At around 340% of domestic banks’ capital and reserves, the margin for error is slender indeed and it may just be that the market is beginning to cotton on to the vulnerabilities as the country’s CDS have moved from parity with Germany to 25bps over and from 60 less than France to only 35bps less. Could this be the little acorn of doubt from which a mighty oak of positioning could grow?
More generally in Europe, the authorities seem to have taken heart from their assault on Cypriot depositors to continue to talk up the idea of clipping their ilk in all in failing banks now that those egregious corporate welfare queens, the major money centre banks, have had time and Target enough to reduce their exposures to the weaklings and so flee the front-line of the capital structure.
Forming the other pincer of what seems like a looming double envelopment of confiscation, our masters have lately become intensely fixated on sniffing out all expropriable sources of wealth (taxed or untaxed, legitimate or dubious) wherever they may be found.
Amid the suspiciously convenient release of the BVI account records by the self-proclaimed ‘muckrakers’ at the ICIJ, there has been a flurry of announcements regarding cross-border data sharing and the abrogation of banking confidentiality (sorry, ‘secrecy’) in several key jurisdictions, all of which will further shrink the already dwindling domain of the private sphere and increase our thrall to Big Brother.
The hypocrisy is breathtaking, whether it be President Hollande calling for the ‘eradication’ of tax havens (so that he can see whether he’s as rich as his cabinet colleagues, one presumes), the Russian crony state demanding that all state employees close their foreign bank accounts by quarter-end (something which may well be adding to the bid in securities markets everywhere) or would-be Chancellor Steinbrück demanding the automatic release of his fellow citizens’ financial details of a kind he himself was all too reluctant to divulge when the gargantuan scale of his own venality became a matter for controversy last year.
In all of this there appears an almost unchallenged assumption that rather than the state being the instrument of the people – as laid out by more than three centuries of Enlightenment thinking – the people are the property of Leviathan itself and should count themselves lucky that the Beast does not make any more repressive demands upon them than it already does. But as well as being supremely counter-productive, this runs contrary to any concept of natural justice. Gemeinnutz geht nicht vor Eigennutz, we might once more reaffirm or, in the lapidary phrase of the late, great Margaret Thatcher, “There is no such thing as society: there are individual men and women and there are families…”
And, yes, since we have started on this tack, it is your author’s personal opinion that the whole business of offshore accounts, legal prestidigitation, and complicated tax structures are indeed grossly unfair, but only because the wholly defensible shelter to legitimate income and the worthy contribution to the preservation of carefully accumulated capital which they entail are denied to the populace at large, so that the ordinary man and the local entrepreneur are each rendered helpless and disadvantaged with regard to their better-off brethren (many of whom are, alas, rent-seekers who have themselves acquired their pile, or sheltered its source from honest competition, through the same sort of crass political manipulation which has now come to threatening their existing degree of privilege).
Thus, the market is hampered and opportunities for both personal advancement and the positive externalities of progress are squandered, not because we are not vigorous enough in soaking the established rich, but because we are soaking poor, that is to say the would-be rich, by denying them the exercise of their own natural right to render as little as possible of their hard-earned gains unto an arbitrary and insatiable Caesar.
But rather than abolishing such havens, while indulging in the invidious public vilification of anyone sufficiently well-heeled and astute to use them, they should simply be made redundant by making the same facilities available to everyone. It would do much for the common good, serving the material and moral improvement of us all, if every land became a tax haven.
No fancy lawyers and intricate chains of nameplate companies, no nested trusts and interlinked nominees would be needed, but only the introduction of a structure of taxation which was clear, simple, conducive to capital formation, and above all minimal. In that way, each man would rightly keep the maximum possible fraction of his income under his own control, while greatly limiting the ambition of the elective dictators such as Herr Steinbrück who presume to lord it over him. It would also fully emasculate the insidious, Tocquevillean tyranny of the clamouring ragtag of green millennialists, bien pensants, and Utopians, les Clercs from whose Trahison we have all so suffered since they were first sprung out of the Bastille 224 years ago.
And so it goes on in that continental-scale Potemkin village we know as Europe. Rather than attempt anything radical in diminishing the burden imposed on the outlay side of the ledger (which any businessman will tell you is usually the most efficacious way to restore lost profitability), the Commissars would much prefer that we few remaining Kulaks hand over even more of our already much-reduced harvest in order to feed their collectivist conceits. Ironically, the scale of this presumption is best revealed in the fact that for all her ill-humoured posturing about her partners’ budgetary indiscipline, Frau Merkel has, for the past 5 ½ years presided over a regime where the government ‘contribution’ to GDP has actually grown faster than has that of France.
Besides the ongoing troubles in the eurozone, the other burning issue for investors is, of course, what will emerge from the just-concluded ‘Two Meetings’ in China where the new team of Li Keqiang and Xi Jinping have formally taken up the reins.
Before we make any comments on what has transpired, we must offer the essential caution that all we have so far are words carefully calculated to strike the right notes with an expectant mass audience. To what extent these reflect a genuine intent and what degree of consensus within the Party any such intent might command is entirely unknown and may well remain so at least until after the autumn Plenum of the Party Congress.
With those qualifications attached, what we can gather from the coverage so far presented is that, by their own admission, the incoming leaders know they face major problems of over-capacity in all manner of key industries—solar, aluminium, steel, etc.—and yet we also know that, despite this week’s ground-breaking bankruptcy of Suntech—old habits die hard when it comes to desisting from propping these industries up. Witness the announcement last week that the State Reserves Bureau would buy one-sixth of the nation’s aluminium and one-eighth of its zinc output this year— a bailout of an ailing sector, however you consider it. Nor does it bode well that steelmakers are pouring record amounts of the alloy a few brief months after many of them were facing ruin (aggregate profits fell a mere 98% last year) and despite a 20% YTD rise in the stocks of cold-rolled coil, a 40% rise in hot-rolled, and 90% rise in those of rebar.
By their own admission, too, the problem of chronic property speculation remains a bugbear and while the optimistic may be happy to wait for the accelerated urbanisation programme (about which no details have, of course, been vouchsafed) to absorb any vacant buildings, they have not yet quite managed to explain how it is that people whose average urban wage is some CNY 40,000 a year will afford all those CNY 20,000/sq m properties currently changing hands in the main urban centres. One means to achieve this financial marvel may well be through the notorious rehypothecated copper dodge (Asian stocks of the metal are up 90% so far in 2013 from the previous three year average) and via mis-invoiced export earnings (q.v., the $25 billion YTD discrepancy between China’s reported exports to HK and the latter’s reported , one-third lower imports therefrom). ‘Reform’ will have to find a way either to close this loophole or make it far less lucrative.
Urbanization may also have a few other hurdles to overcome if we heed the CASS-NDRC joint report on how Beijing’s 20 million inhabitants have already overstrained the land and water resources available to them. More to the point, the authorities have yet to admit that while they keep money and credit growth powering along in the 10s and 20s of percent a year and simultaneously set interest rates at or below the consequent rise in the cost of living, people will naturally look to the property market as a more secure outlet for their surplus cash, whether or not they also hope to get rich quick along the way.
By their own admission, too, fears of financial fragility are rising, as speculation mounts about a coming crackdown on both the notorious LGFVs and the regulation end-running WMPs into which many of these are subsequently bundled. The fact that the new CSRC chairman will be none other than former BOC boss Xiao Gang—the man who dubbed such products ‘Ponzi schemes’ in a recent tirade—might add substance to these rumours.
All this comes at a time when, as our friend Jim Walker at Asianomics pointed out, a report published under the twin auspices of the China Association of Trade in Services and the Chinese Academy of International Trade and Economic Cooperation estimated that the total of accounts receivable on company balance sheets amounts to a vertiginous CNY22 trillion—almost 40% of GDP and pretty much on a par with that extant the much larger United States. If correct, we should compare the 18% reported increase in this book credit (an increment of CNY3.4 trillion) with ’above-scale’ industry reported profits (not an exactly overlapping sample) of around CNY5.5 trillion. Staggering, indeed.
By their own more tacit admission, the authorities are all too aware that they have a problem on their hands with the growing public ire at the polluted state of the environment—a disquiet we could actually read as a sign of substantial material progress having been made, since such concerns are often too much of a luxury for a poor people, too busy scrambling to fill their children’s bellies to fret about the ambient air quality.
For all the anecdotal horror at which we love to gawp, it does not do to be too superior about this. Just 60 years ago, the Great Smog which enveloped London for four cold, December days may have rendered 100,000 ill while contributing to the demise of up to 12,000 afflicted souls. Nor would any of us much care to stroll along the ordure-strewn thoroughfare of a Victorian city, much less eat the food or drink the water on offer there. Yet this, too, was a time of rapid material advance when wealth was being created across the social spectrum, at a hitherto unprecedented rate.
Nevertheless, China’s lack of accountable governance, its absence of private property rights, and its fetish for output regardless of many internal costs, much less external ones, makes this a difficult matter to address. Pampered metropolitan Lefties may bewail the role of capitalism in scarring the face of holy mother Gaia, but for a REAL disregard of one’s surroundings or one’s posterity, you have always had to look to the Collectivists to take the palm in the scorched earth stakes.
As well as extending the rule of law, the state needs to stop subsidizing heavy industry and making power and fuel artificially cheap while, conversely, it needs to insist upon proper waste disposal and to levy (or allow the market to levy, in an ideal world) a proper charge for rendering that detritus harmless. If the Chinese people now want cleaner surroundings, this is what they must demand of their leaders and, by extension, of themselves, but it will not come without some sizeable short– to medium-term sacrifices in growth-for-growth’s sake and therefore in employment. The effect on costs and profitability may be a harder prospect to judge since the bill for some inputs (and for the treatment of many unwanted outputs) will no doubt rise, but the overall call on resources could likewise end up being reduced as efficiencies are incentivised and mindless capacity overlaps eradicated. Along with that fall in demand, the price paid for this lesser but better-utilised quota should move in tandem.
How much if any of this we get is a matter of no little doubt, as we said at the beginning of this article, but the local press is foursquare behind the idea that the new team represents at once a radical change and a reversion to the better management of the system which, so the accepted wisdom holds, was the norm under the aegis of Zhu Rongji—several of whose protégés are to be found in the refreshed line up of officials.
Caixin, for one, had this to say:-
Contrary to the expectations of many investors, policymakers have decided not to seek any big increases in government investment this year. Rather, they want to prevent any possible financial trouble tied to local government debt and the off-balance-sheet operations of commercial banks. That means regulations covering local government financing platforms are likely to be tightened… Also highlighted in the government policy book are plans to seek quality over quantity in economic growth, adjust real estate and business tax structures, control housing prices, and reign in fiscal spending.
Or, as more pithily expressed to Reuters by an anonymous visitor to the National People’s Congress:-
Delegates… were clearly agreed that their biggest risk was doing nothing.
But let’s not rest there. Look at the following extracts from new Premier Li Keqiang’s headline, after-party press conference and judge for yourself which way the wind is blowing:-
“Reforming is about curbing government power, it is a self-imposed revolution, it will require real sacrifice, and this will be painful, but this is what is wanted by the Government and demanded by the people.”
“We need to build a clean government and make our government more credible … The important thing is action—talking the talk is not as good as walking the walk.”
“The highest priority will be to maintain sustainable economic growth.” [emphasis ours]
“We said that in pursing reform we now have to navigate uncharted waters. We may also have to confront some protracted problems. This is because we will have to shake up vested interests… Sometimes stirring vested interests may be more difficult than stirring the soul, but however deep the water may be, we will wade into the water. This is because we have no alternative. Reform concerns the destiny of our country and the future of our nation.”
As he proclaimed at the end of last year:-
Reform is like rowing upstream. Failing to advance means falling back. Those who refuse to reform may not make mistakes, but they will be blamed for not assuming their historical responsibility.
The old saying has it that ‘fine words butter no parsnips’ and there are few less root vegetable-greasing words than those which emanate from a politician’s mouth, but, in light of all the foregoing, it does very much seem as if the CCP regards the present juncture as an existential moment in its 90-odd year history.
Having raised expectations so high and having the luxury of a honeymoon period in their relationship with their long-suffering subjects in which to enact any radical changes, we must assume that the leadership would be very unwise to slip back into business-as-usual anytime soon and so disappoint the hopes of so many.
To what extent reform will be attempted—and how much resolve will be shown when, as is highly likely, the effects of those reforms expose the many interdependent flaws and critical fractures in the system—only time will tell but, one way or another, it is hard to resist the impression that those in China—and, by extension, those of us who make our living trying to account for that nation’s effects on the wider world—are truly about to ’live in interesting times’
Cyprus may or may not prove to be a ‘watershed’ for the European crisis but what we can say for now (tempting fate outrageously as we do) is that, for all the dire warnings that this ‘confiscation’ will provoke a Continent-wide bank run, the initial reaction of the wider populace has been to treat the matter as something of ‘a quarrel in a far away country between people of whom we know nothing’.
That said, there is a wider issue at stake, beyond the inequity or otherwise of penalising small depositors, or the opportunism of imposing a haircut on those stock music hall villains, the Russian oligarchs, whose holding companies populate the corporate register of this otherwise economically–insignificant little island.
This is, namely, that however much we might express our contempt for a European elite which has so far exhibited a mix of pusillanimity and shameless political calculation in trying to avoid having their constituents face up to the cost of either their caprice or credulousness during the boom, the Cypriot ‘tax’—in reality a haircut—must serve as a necessary, if horribly belated, reminder to all of what it is exactly that modern-day banking entails.
It is high time that the Man on the Clapham Omnibus realised that his banker is nothing more than his, the depositor’s, debtor—and not a very reliable one, at that. Nor will it do our Everyman any harm to be shown once more that, for all the marbled halls and pseudo-classical gravitas of the banker’s typical premises, his profession is nothing more than a highly-leveraged, actuarial gamble, largely reliant not so much on the shrewdness of the banker himself as upon his cynical awareness that he can stretch to almost no enormity of bad judgement or abused trust such that it will pierce the carapace of privilege and protection with which he is furnished by a venal political class itself hopelessly in hock to the lenders of the counterfeit monies with which it buys the votes necessary to keep its members in the enjoyment of the many perks of office. A further lesson might be drawn from this last assertion which is that, far from being the soundest of borrowers, sovereign entities throughout history have been the worst, zero risk-weighting and mandatory ‘liquidity’ holdings notwithstanding.
Though there has been much expression of outrage at this ‘assault upon private property’, the sorry truth is that this is only the most recent—if also the most blatant—of the many transfers of wealth from the populace at large to the balance sheets of their bankers. Should you need any convincing of this, I am sure the poor, put-upon Irish could quote you chapter and verse about the miseries of the debt slavery imposed upon them by their overlords in Frankfurt, while it is beyond human wit to reckon the number of the prudent and thrifty now being denied a due return on their hard-won savings by the arrogance of the central bankers to whose crass, ’reflationary’ redistributionism they are now subject.
It should also be emphasised that it is no more than just that the owners and creditors of a failed institution share proportionately in its ruin, or conversely contribute in due measure to its rescue—though, naturally, the choice between these alternatives should lie with them as individuals. That the institution in question is a purveyor of banking services, rather than of beauty products or bed linen is totally beside the point. As the latest of several heavyweight commentators (such as members of the Chapter 14 group or Richard Fisher of the Dallas Fed in the US), Willem Buiter endorses this view in his latest piece where, he says, it is high time we ‘resolved’ our commercial banks à outrance, relying on the near limitless power of the central bank to maintain the basic stock of money and to staunch any systemic haemorrhage as and where needed. After all, if we are to be saddled with the institutional evil of a central bank, we may as well enlist its baleful power in a good cause for once.
That the powers-that-be, having driven the masses through the drip-drip torment of ‘Fauxterity’ in the attempt to save their own banks, have only now dared to try to implement such a process of ‘bail-in’ in a small , politically-impotent country such as Cyprus certainly reeks of hypocrisy and double standards. Nor is it exactly a matter of justice that the admittedly nugatory exposures of the banks’ stock and bond holders have again gone unscathed, or that even depositors of healthy banks (assuming there are any) are being compelled to pay for the sins of their less sanitary peers. Nevertheless, as we have said several times before, the lesson that must be taught when dealing with bankers, as with any other recipient of one’s funds, is Caveat commodator! Let the lender beware
Slowly, slowly, amid all this chaos, the commentariat is coming around to espouse several key tenets of our Austrian creed. Five years too late for many of the downtrodden victims of the crash, alas, and with nary a nod of recognition to the fact that their beloved Keynes is an idol with feet of clay, but at least they themselves are beginning to inch tentatively along the road to Damascus-am-Donau.
The first of these contentions is that the crisis itself is always the result of an inflation of money and credit—whether this is unleashed as a deliberate act of commission before, or supinely accommodated by the monetary authority after, the fact. The danger here is not so much that consumer goods prices rise as the money and its substitutes swell in availability, but is rather that the inflation distorts, if not entirely suppresses, the critical signals sent about relative scarcities and the subjective human preferences which set these. Especially problematic are those least directly observable signals which act across time and which are therefore transmitted by interest rates in particular and by asset pricing in general. In scrambling these, inflation progressively fixes too much precious capital into the wrong, ultimately barren foundations and leads too many people to exert their limited human energies in pursuing foredoomed endeavours.
The second Austrian lemma is that when the boom turns to bust, the wisest course, that is to say the one which will involve the least long-run hardship and impose the lowest threat of a widespread descent into lingering hopelessness, is not one that will involve the exercise of either misplaced compassion (if we are charitable) or of naked, political short-termism (if we are not). The answer, when the bust threatens to push the economy beyond its self-regulating ‘corridors’ is to widen them as much as possible by pursuing an Auflockerung—a lifting of the man-made impediments to swift adjustment—and to eschew all attempts at propping up as much of the Boom’s inherently unsound and demonstrably unremunerative superstructure as is possible by a crude and usually fruitless macro-manoeuvring.
The dispelling of the boom-time enchantment typically leaves many saddled with ill-advised levels of obligation which they cannot now honour in the easy manner formerly envisaged. It reveals that many of those in command of economic assets have woefully misapplied and mismanaged them, even where this has not been deliberately fraudulent. It shows that large numbers of people have imagined themselves more prosperous than they really were and have therefore spent and borrowed according to a perniciously false scale of values.
Once this mass deception becomes known, it would be folly to assume that the ‘undeserving’ can be spared any and all suffering in the ensuing bust. It is also clear that there will be far greater numbers of the plaintive than the pleased when the Wheel of Fortune starts on its inevitable downward course. But nothing in this implies that any purpose is served by indulging in a denial of the gravity of the circumstance. It is a further grave misstep to trust that a ‘socialization’ of the problem will somehow help, or to expect genuine benefits to accrue from a wilful attempt to further confuse the accounts—which is essentially what the unholy concert of the fiscal and monetary authorities usually seek to do. To the contrary, to act to deaden the pain through a policy of obfuscation, procrastination, and the dispersion of responsibility is not only to prolong the suffering in the here and now but to make a future recurrence much more likely.
All of the misconceptions fostered in the easy money boom require for their remedy a forthright and fearless recognition of what can hardly fail to be unpalatable facts. Like a patient confronted with the news that his ailment is at once more serious and more advanced than he had been given to suspect, or like the general who discovers to his horror that his previously quiescent foe is even now marching in strength upon his flanks, this is no time for palliatives, or for futile ’If Only’s’. It is time for corrective action: for harsh treatment if necessary; for a rapid re-arrangement of one’s dispositions and for an immediate abandonment of one’s earlier illusions.
The more rapidly that a misguided lender and his now discomfited borrower can renegotiate their arrangement, the more resolutely they can each own up to their disappointments, and the more determinedly they can avoid the sunk cost fallacies of regret, the quicker each can disencumber himself of his past errors of judgement and so the earlier each may begin to re-establish what he has lost by acting henceforth in a manner more suited to the changed situation in which he and most of his fellows now find they must go about their business.
It is far preferable to undergo a timely, strategic withdrawal, the better to prepare both the recovery of lost ground and hopefully the advance beyond it, than to become trapped in a personal Stalingrad where a combination of an unwillingness to recognise the scale of the reverse suffered and a naïve hope in a rescue miraculously being effected from above condemns one both to an unavailing struggle and to a final reckoning of loss far more shattering than what was initially required.
One of the most insidious ways to postpone this catharsis is for the central bank to slash interest rates and to flood the world with liquidity, goading the populace into repeating that very falsification of price of assets and of the discount between today and tomorrow which led its members to their present state of ruin.
If we recognise that our savings have been wasted, that our investments have gone sour, that our wealth has been reduced, then the price of what must be a more scarce endowment of productive capital should reflect this. Rates should be higher, not lower. Moreover, with yesterday’s attempts at providing for our present needs having been led so far astray, we will all have to put more emphasis on securing current rather than future provision. Again, rates should be higher, not lower. With the sorry lesson fresh in our minds that any chancer can start a business when credit replaces capital and when its rent is set artificially low, we should all be more choosy about whom we are to entrust with our savings. A third time, rates should be higher, not lower
To clarify this last point, it should be obvious that we should never be overly willing to see funds placed, willy-nilly, at the disposal of men who, however praiseworthy their initiative, are sufficiently foolhardy as to want to undertake projects of such a marginal nature that they will fold at the first whiff of adversity—at the merest uptick of interest rates, the first drop in sales or hike in costs, at the smallest fluctuation of exchange rates. Instead we should look for men whose product is really likely to satisfy consumer demand, men whose entrepreneurial antennae have unearthed a reasonably durable arbitrage between input and output prices, and men whose confidence in the schedule of prospective returns to their efforts does not require a vanishingly small rate of interest for its maintenance. If this is true of start-up companies in the upswing, it is doubly true of those stranded on the beach when the flood tide of the boom recedes.
But what do we get instead? We get the present, abominable, inverted Bagehotism of lending on no very good security at all, to all and sundry, and at a highly subsidised rate of interest. By this perverse means we attempt to perpetuate people in the errors of the boom, to succour the weak at the expense of the strong, and to practice Aufhalterung—a gumming up of the system—in place of Auflockerung.
Miracle of miracles, there are those who are beginning to recognise this, whether from the ranks of Britain’s recovery professionals at R3, or in the shape of well-known UK investor John Moulton, who severally risk much ill-informed opprobrium by daring to bemoan the policy of allowing zombie companies to hoard resources, manpower, and space on overburdened bank balance sheets. On another tack, Ronald McKinnon and his Stanford University colleague John Taylor (he of ‘Rule’ fame) argue correctly that ZIRP discourages much lending — whether direct or disintermediated — since risk palpably outweighs a return which is deliberately ’repressed’ to or even, in real terms, below zero.
In Axel Leijonhufvud’s pithy characterisation, when depressions occur, we are made captives of the past while inflations act to preclude us from mapping out our course into the future. He also suggests that, in the former case, monetary policy may be less effective than might be thought because once it has percolated, as it inevitably will, from the wallets of the income-poor to the pockets of the income-sufficient, the latter may have little incentive to re-employ it—whether they seek to hold it as a backstop amid economic uncertainty, or from a Ricardian-equivalence foreboding about higher taxes, or again because an elevated appraisal of risk seems vastly to outweigh a purposefully scanty reward. If prices, moreover, are not allowed to fall out of an irrational fear of ‘deflation’, the real value of their reserve will not increase and so gently encourage them to transmute a portion of it back into a medium of exchange: the Pigou effect will not come into play and so another means of self-equilibration will be denied us.
Can we really say that such is not the fate to which Ben Bernanke will consign us, strive though he will to dissolve our contractual ties in the acid of inflation instead?
NB: The mischievous thought arises that since what Blackhawk Ben and his acolytes really seek is for us all to lose faith in our money as a store of value, so that we go out and spend it as fast as we can, they should be cheering the Cyprus experiment to the rafters!
Before we really get into the detail this week, let us just deal with one simple canard: this idea that if the US Congress does not immediately roll over and allow the Administration to have its head in consuming the capital of the nation at its present, unsustainable rate, the whole house of cards will come crashing down around its members’ ears.
Not least of the reasons for our rejection of this cheap exercise in scaremongering is that the $43 (and not the bruited $85) billion or so which will supposedly be trimmed back in the course of the next fiscal year, should the dreaded ‘Sequester’ actually take place, is no more than the amount of new money the Federal Reserve has pledged to inject into the system each and every month by way of purchases of USTs, for ever and ever, Amen.
It would also be remarkable if the fictional Keynesian ‘multiplier’ – so remarkable in its absence when the government was spending an extra $1 trillion annually with hardly any unequivocally attributable addition to jobs (Solyndra, anyone?) – will now become so magnified in its effects that a trimming of that largesse 1/24 the scale will instantly cause 700, 000 positions to evaporate. Right! What we are being asked to swallow whole is the idea that if government spending slips back by no more than 0.75% of its inordinately large total – a proportion which is actually more like 0.125% of total, economy-wide, annual turnover and which is equivalent to no more than 35-40 cents per head per day – then the Apocalypse will be ushered in forthwith
Well, your author, for one does not believe that the economy – any economy – is THAT fragile. After all, the sum in question is roughly of the order of half the official tally of retail sales of sporting goods. Where Nike goes, there goes America??
Nor is he convinced that the state controls or even monitors its budgets with that degree of accuracy in the first instance. Just think ‘Pentagon’, not to mention ‘black-ops budget’. In that light, $43 billion would be all noise and no signal even it were not a ‘reduction’ in a posited increase rather than an outright cut. Finally, if none of this has assuaged your worries then, by implication, you must believe that we are now locked in to spending over a $1 trillion more than revenues in perpetuity. If so, stop selling your gold, for heaven’s sake, give your assault rifle a quick once-over, and make sure the axle has been greased on your wheelbarrow.
Partly this lack of comprehension is just another example of the strategy of the ‘Big Lie’ as instituted by Bernays, refined by Goebbels, and institutionalized ad nauseam by today’s cradle-to-grave, career-politician spin-doctors. Partly it emanates from the dreadful pseudo-mathematical juggernaut which is macroeconomics and its intellectually impoverished inability to recognise that its devotees’ cherished time series aggregates are nothing more than a pale, fictional reflection of the joint actions of millions upon millions of disparate individuals, each ceaselessly selecting from their non-ordinal and ever-varying lists of subjective preferences in order to achieve a momentary elevation in their psychic and material condition.
It is bad enough that we routinely forget just how approximate all these numbers are when we apotheosize them to the status of the fundamental laws of nature by which we must ‘govern’ the running of our rigid economic machinery (another pernicious, but all-pervasive metaphor which obscures clear thinking about the functioning of what is really a complex, evolving ecosystem of interpersonal exchange).
But when we then lose sight of the underlying reality itself; when we put effect before cause and come to regard those numbers’ temporal trajectories as an end in themselves, we really begin to do mischief. All anyone can really ask of ’policy’ is that it provide the most conducive institutional conditions under which the average citizen can attempt to satisfy his own unique desires as best he can, and as only he knows how to do. Far from encouraging some Hobbesian, zero-sum hell, such a minarchist approach can only maximise our collective good fortune in that this is something the individual will find extremely hard to effect without contributing something in return to the well-being of the fellows with whom he interacts under a mutually enriching division of labour and subject to a clear and consistent rule of law.
If we, as policymakers, manage to achieve that—or, more realistically, if we refrain from acting in a manner likely to jeopardize it—then, as and when we next take a rough reading of the temperature of all the myriad economic processes currently underway, we may well be pleasantly surprised to see that it is has undergone a modest and entirely wholesome rise. If, however, we construct a spurious mechanics of the nation-at-large and start throwing levers willy-nilly because some statistical fiction or other seems to have had a fleeting numerical correlation with that temperature in the past—and if, moreover, we have already conflated an increase in this one scalar reading into our ultimate end of an improvement of the common weal—even if it should subsequently rise at all, we have no way of knowing whether this is all to the good, or whether this is because the organism is now suffering heatstroke, a fever, or is, indeed, spontaneously self-combusting.
To reiterate; instead of fretting that we have “blundered in the control of a delicate machine”, let us recognise that there is no such construction: that we must not rely on what are essentially static, equilibrium relations between non-existent, top-down concepts to guide our tinkering, but we must learn to deal—and very much at arm’s length!—with a dynamic, non-equilibrium, emergent order, bubbling up from the smallest scale; that what we are dealing with is a process not a pattern—a becoming not a being.
It is therefore not Keynes or Kuznets to whom should be looking, much less the ineffable Krugman, but the shining example of Sir John Cowperthwaite whose enlightened strategy of what he called ‘positive non-interventionism’ in 1960s Hong Kong—coupled with a near blanket ban on the collation of official statistics for fear their provision would tempt men into meddling (“If I let them compute those statistics, they’ll want to use them for planning.’’)—allowed the entrepot to more than quadruple its GDP per capita (it really is a hard habit to break, isn’t it?) in comparison with its colonial masters in dour, socialist Britain, in the space of single generation.
A man who eschewed tariffs in an era of protection; who abstained from government borrowing at a time when his peers were fast becoming ’all Keynesians now’; who capped income taxes at a modest 15% in an age when the rich were being ‘squeezed until their pips squeaked’; and who resolutely refused all blandishments to shower corporate welfare upon the taipans, Cowperthwaite’s assessment of his own role was nonetheless characteristically modest, once declaring that, as regards his contribution to Hong Kong’s success,
I did very little. All I did was to try to prevent some of the things that might undo it.
Today, when we are plagued with the grossest of governmental interventions, the maddest of monetary manipulations, and the most invidious of attacks on individual wealth, it might serve to reflect upon some of Sir John’s expressed principles.
On capital controls:
… money comes here and stays here because it can go if it wants to. Try to hedge it around with prohibitions and it would go and we could not stop it and no more would come.
Re the role of the state vis-à-vis the private sector in production:
…when government gets into a business it tends to make it uneconomic for anyone else.
On what we Austrians would call the great ‘knowledge’ problem—so routinely overlooked by the meddlers in office:
In the long run, the aggregate of decisions of individual businessmen, exercising individual judgment in a free economy, even if often mistaken, is less likely to do harm than the centralized decisions of a government, and certainly the harm is likely to be counteracted faster.
For us, a multiplicity of individual decisions by businessmen and industrialists will still, I am convinced, produce a better and wiser result than a single decision by a Government or by a board with its inevitably limited knowledge of the myriad factors involved, and its inflexibility.
I must confess my distaste for any proposal to use public funds for the support of selected, and thereby, privileged, industrialists, the more particularly if this is to be based on bureaucratic views of what is good and what is bad by way of industrial development. An infant industry, if coddled, tends to remain an infant industry and never grows up or expands.
Are you listening, Mr Cameron; écoutez-vous, M. Hollande?
But, setting aside the political philosophy for now, let’s return to the humdrum business of commenting upon that laboratory of central bankers, that Petri dish of those armed with the printing press, that we touchingly refer to as the ‘market’.
Much of the week has been an exercise in Google-translated rune-reading from China’s ongoing ‘Two Meetings’ at which the formal handover of power will be undertaken. Largely monopolized so far by the outgoing crew, we have to wonder whether Wen Jibao’s effusiveness reflects policy as it will be or whether it is simply a wistful, legacy-minded expression of policy as it should have been.
For what it’s worth, there has been plenty of open criticism of the GDP-at-all-costs model and some frank recognition of the scale of the malinvestment already in place. For example, NDRC chairman Zhang Ping candidly admitted that ‘a rising number’ of heavy industries were making losses and ‘lamented’ the overcapacity in steel, aluminium, cement, glass making and coking coal. Plants in these sectors, he said, were running at just 70-75% of capacity, while the once booming solar industry was operating at just 60%. To address their ‘huge difficulties’, Zhang said he was pushing to increase the pace of mergers in these sectors, but also confessed that such an approach has had ‘little success’ in recent years.
The financial flipside to this was made plain by Li Yining, professor at Beijing University, who warned a CPPCC press conference of nothing less than ‘a possible financial collapse caused by over-investment amid the country’s new urbanization wave.’ – you know, the same ’wave’ on which all the CCP’s hopes are being pinned for the coming years.
In the midst of this, we were treated to the release of the Chinese trade numbers for February which, for reasons of LNY calendar variability, are best combined with those for January when we attempt to gauge the state of play. Intriguingly, imports—not the least imports for number of key commodities, such as copper, iron ore, and oil—were relatively subdued and hence, in keeping with anaemic showing of neighbouring Korea and Taiwan. But, despite this, exports took a major jump, rising by almost a quarter on the same two months of 2012.
How did that happen? Had China suddenly and dramatically reduced the erstwhile heavy contribution of foreign inputs to its output? Was this a staggered liquidation of product built up in QIV’s hothoused burst of activity? Or was it perhaps an exercise in good, old fashioned, tax and subsidy arbitrage and/or chicanery aimed at evading the current account restrictions?
We ask this because, although they, too, rose in absolute terms, exports bound for the United States—after all, the fastest growing of all the large, net-deficit economies and hence there most likely destination—fell to a modern-era record low share while those to round-trip Hong Kong soared 60% to a new outright and relative share high. At the same time, the country saw record foreign exchange inflows of more than $100 billion—a marked contrast to last year’s hefty drain of hot money. Not coincidentally, this was a period in which the traditional speculative vehicles, the markets for stock and property, both, were on a violent upward tear.
So, were exports—possibly greatly overinvoiced—again being used to wash funds through the somewhat porous capital account barrier, picking up tax rebates along the way? Was this a means to exploit the yen’s twice-in-a-lifetime rate of decline by clandestinely borrowing some of that excess valuation in Abe-san’s fast depreciating currency? We have no way of knowing, of course, but we remain duly suspicious.
As for Japan itself, the yen’s fall has now matched the peak pace of that of the Sakakibara devaluation which started in the spring of 1995. In the sixteen months prior to that episode, it was the Chinese who had devalued, cutting the nominal yen-yuan cross in half before Mr (Anti)-Yen drove it up again by 80% in the succeeding three-and-a-bit years, and moving the ratio between the pair’s real effective exchange rates 110% higher along the way.
Lest it be lost in the mists of time, such gyrations were heavily implicated in, if not entirely responsible for, the last, least productive phases of the hot-money boom and the ensuing collapse in competiveness and shattering bust of most of the rest of Asia—‘Tiger’ economies and all.
Though technical targets for the Yen can initially be sketched to the Y110 level, a full-blown repeat of the mid-90s experience would take it all the way back to the mid-Y140s. Surely that couldn’t happen again, could it? Could it? It would surely take a heroic exercise of irresponsibility on the part of Kuroda & Crew even to contemplate; something crazy like—oh, let’s say—using derivatives to undermine the Yen.
Notwithstanding our initial lack of enthusiasm for the longer-term effects of the forex move on Japanese business profits and hence, employee and shareholder income, the market has not allowed any such cavil to hinder its rush to cut back on what is a widely-shared and long-entertained underweight position. This past three months, foreign buying of Japanese stock has hit, Y3.6 trillion, levels not seen since early 2007, while margin account balances on domestic exchanges have inflated by two-thirds in three months, jumping from near the lowest mark in 3 1/2 year to hit the highest in 4 1/2.
This has not only done some serious damage to charts of the Nikkei v other indices, but has also pushed it up beyond a grand trend-line in USD drawn off the unrivalled, Xmas 1989 high, the tech bubble peak, and all post-LEH recovery attempts.
Another 15% or so to the overall mid-point (with said trendline as a stop-loss area) is not beyond reasonable expectation, especially since the P/E is no longer in a league of its own (at 21.0 on the Topix v the same on the ASX, 22.8 on the Bovespa, 24.8 on the TAIEX, 37.1 on the KOSPI, 21.1 on the BE500, 18.3 on the FTSE, and 15.3 on the S&P), not to mention the fact that the index dividend yield—at 1.85%—is beyond anything on offer in the JGB market, exceeds any UST of under 9 years’ tenor, any Bund of less than 14 years to run, or any Gilt with less than 8 years remaining to maturity.
That may be crazy, but it’s certainly an accurate reflection of the world in which we live and of the policy intent of our lords and masters.
As for US equities, what is there left to say? Successive new highs are effortlessly being made on a daily basis; record buybacks are taking place (Miller-Modigliani and ESOP rules, OK!); multi-year heaviest mutual fund buying is underway; volatility is the merest whisker off its Crisis Era lows; margin debt is rising as fast as in 2000 and 2007; put-call ratios are depressed; the cumulative A/D stretches into the stratosphere; junk bonds are near yield lows; leveraged loan prices are back at Blue Sky, mid-2007 levels—and now the jobs numbers are giving everyone an all-over warm glow of Recovery-with-a-capital-R.
The only thing to argue against this is that it’s simply all too good to be true; that it’s a function of the crazed, macroeconomic theorizing of a sixty year-old, wannabe-Oz sitting in an office on 20th St. and Constitution Avenue in Washington, D.C., a man who almost got on the Congressional record last week waspishly telling his interlocutor to quit belly-aching about the income on his aged mother’s savings and to get her into stocks instead.
For all that we are able to surmise that this is just the latest in a long series of bubbles, each one inflated in its turn in the attempt to ward off the reckoning due from the collapse of its lengthening family tree of predecessors, this all-encompassing experiment – not just with our livelihoods but with the wider structure of our very society – shows no signs of being called off. Rather, if anything, it seems it will be intensified in scale and extended in geography, to what ultimate end we can only dimly glimpse in our darkest imaginings. While that assumption holds general sway, the line of least resistance for risk assets is upward, no matter how otherwise groundless their rise.
For several long months now, the market has been treated to an unadulterated diet of such gross monetary irresponsibility, both concrete and conceptual, from what seems like the four corners of the globe and it has reacted accordingly by putting Other People’s Money where the relevant central banker’s mouth is. Sadly, it seems we are not only past the point where what was formerly viewed as a slightly risqué ‘unorthodoxy’ has become almost trite in its application, but that like the nerdy kid who happens to have done something cool for once in his life, your average central banker has begun to revel in what he supposes to be his new-found daring – a behaviour in whose prosecution he is largely free from any vestige outside control or accountability.
Indeed, this attitude has become so widespread that he and his speck-eyed peers now appear to be engaged in some kind of juvenile, mine’s-bigger-than-yours contest to push the boundaries of what both historical record and theoretical understanding tell us to be advisable. After all, it was sixty years ago now that Mises was telling people, in an article decrying the malign influence of Keynes, that:-
The economists did not contest the fact that a credit expansion in its initial stage makes business boom. But they pointed out how such a contrived boom must inevitably collapse after a while and produce a general depression. This demonstration could appeal to statesmen intent on promoting the enduring well-being of their nation. It could not influence demagogues who care for nothing but success in the impending election campaign and are not in the least troubled about what will happen the day after tomorrow. But it is precisely such people who have become supreme in the political life of this age of wars and revolutions. In defiance of all the teachings of the economists, inflation and credit expansion have been elevated to the dignity of the first principle of economic policy. Nearly all governments are now committed to reckless spending, and finance their deficits by issuing additional quantities of unredeemable paper money and by boundless credit expansion.
In this vein and though we should by now have become numbed to displays of such insistent folly, we cannot but find it a touch ludicrous that the Fed’s Jeremy Stein could give a speech warning about the utterly undeniable dangers of ‘overheating in credit markets’ – presumably with a straight face – only to be pooh-poohed a week or so later by his boss when similar concerns were raised at that latter’s regular meeting with the pampered, corporate welfare insiders at the Treasury Advisor Borrowing Committee.
The wise will take cold comfort from this, being all too cognisant of the fact that our esteemed Fed Chairman – much like his once-revered predecessor in office – has clearly demonstrated, both in the record of his public pronouncements and the belatedly-published transcripts of what he said in camera as the late crisis unfolded, that he is dispositionally unable to recognise the signs of a bubble in a beer glass, much less in a bond price or a balance sheet, since such a phenomenon plays no role in either his dogmatic and mechanistic model of the real world while the possibility that he may be personally in error finds no place in his monumental intellectual conceit.
Adding to the sense that nothing will dissuade these quacks from bleeding and cupping their poor patient until he expires under their assault, in a speech (delivered before a union audience, no less!) that Madame Defarge of the rentier class, Janet Yellen, also vouchsafed the hint that the Fed’s newly-adopted ‘Evans Rule’ – of continued, massive intervention until such time as unemployment subsides below 6 1/2%, assuming that CPI ‘projections’ (Oh, I d-o-o-o love a hard, independently-verifiable, objective target) likewise remain below 2 ½% – was not to be seen so much a ‘threshold’ for restriction as a gentle reminder that a rethink might soon be in order.
Not that the Fed Vice Chair was alone in her infamy. The week’s earlier publication of the Bank of England minutes revealed that there are other central bankers itching to help Wall St. and the City make their bogey for the year. Indeed, it seems that the outgoing Governor had wanted to pre-empt his hubristic successor-elect by easing now and not waiting for said Canadian newcomer to make good his less than modestly declared mission to ‘refound’ the three hundred year-old institution over which he will be suzerain, as part of his personal goal to show the whole of Europe how to ‘get those economies going and fix those financial systems’.
Not content with this, up stepped King’s fellow dove, David Miles, to set out a ‘model’ (roll of the eye-balls) which, by dint of equating the propensity to ‘inflation’ (i.e., to ongoing price rises) not to the supply of money in the system (thereby denying three centuries of theorising) nor with any consideration for the demand for said money (so ignoring the whole 140-odd year history of subjective marginal economics), but solely to the estimated degree of physical and human ‘slack’ in the economy, gave us a QED in favour of more QE.
Having set up the metrics of his toy universe, Mr. Miles told us proudly that he then gave it over to the silicon gods to perform 20,000 iterations with it and arrived – Hey Presto! – at the precise conclusion that the Bank needed to be 16% (sic) more accommodative, in other words, to buy another £60 billion gilts, even though, as our Great Engineer himself admitted:-
The model does not say that asset purchases are the only way this should be achieved. If there are monetary policy tools that are more reliably effective in boosting demand, they should be used. But it is not clear what these are, which is why I have calibrated the model to reflect my own assessment of the evidence of the impact of asset purchases.
As every right thinking person should know (and hence climateers excepted), the principle problem of mathematical computation is encapsulated in the phrase GIGO – Garbage in, Garbage Out. One of the parameters Miles adopts in his latter-day difference engine is that UK GDP ‘should’ run at a steady 3% rate of increase. Since this was roughly the experience of the laughingly-dubbed ‘Great Moderation’ which stretched from the economic travails of the early 90s to the eve of the Crash, this superficially seems to be a reasonable assumption.
What he has overlooked, however, is that while real GDP currently lies some 20% below where an extrapolation of that trend would otherwise suggest, the reckoning of total hours worked in the economy has fully recouped its intervening losses, while, for the past five years of slump and sub-par growth, the RPIX measure of price changes has risen by an average 3.9% p.a. which is the worst performance in 17 years (a ‘remit’-busting failure of policy which, if the yields on gilts maturing in 2055 are any guide, is expected to persist for the entirety of the next four decades!)
Putting these gross aggregates charily together, we can see that, whereas GDP per hour worked rose, with only minor variations, at a trend of 2.5% per annum for the first 37-years of the floating rate era, in the succeeding five years of the crisis, it has declined by 0.8% a year – a fall of a duration and severity unprecedented in the modern record despite the Bank’s fivefold, £325 billion intervention (equivalent to 25% of average GDP over the period and to more than half the state’s cumulative deficit).
So, here’s a question: is it just possible that the long misrule of NeuenArbeiterPartei under the leadership of RobespiBlaire and Culpability Brown (as we always used to refer to them) led to a progressive stultification of the system to the point that the country effectively now lies broken? Sapping entrepreneurial endeavour, burdening the economy with costs and with a mare’s nest of legal and regulatory hindrances, swelling the tax-sucking ranks of patronage amid both the Apparat and the welfare proletariat, this was a reign during which people desperately tried to maintain the illusion of a progressive rise in living standards by incurring crushing levels of debt and relying for nourishment on the bitter fruits of property speculation.
Couple this with the uncomprehending inability of the successor ConDem(n)s to tackle the problems they inherited – as well as with the political elite’s right-on, Davos-man fetish for needlessly driving up energy prices in the service of that jealous pagan deity, Mother Gaia – and you have a nation about whose prospects it is all too easy to despair.
Never mind though, Mr Miles: just run the printing presses a little more – nay! 16% more – prolifically and we have no doubt that all will soon be well again!
How far we are from the pellucid wisdom of Ludwig von Mises can be gathered from what he told a lay audience, just as the groundwork was being laid for the Great Inflation which would ravage the 1970s and early 80s, viz.:-
The nineteenth century the slogan of those excellent British economists who were titans at criticizing socialistic enthusiasts was: ‘There is but one method of relieving the conditions of the future generations of the masses, and that is to accelerate the formation of capital as against the increase of population.’ Since then, there has taken place a tremendous increase in population, for which the silly term ‘population explosion’ was invented. However, we are not having a ‘capital explosion’, only an ‘explosion’ of wishes and an ‘explosion’ of futile attempts to substitute something else—ﬁat money or credit money—for money.
Meanwhile, Perfidious Albion is left with the sorry combination of activist central bankers, weak growth, a soaring visible trade gap, a record current account deficit, and a scramble to exit positions from those who had previously seen the country as something of a safe haven. With technical indicators already flashing red (if also a touch oversold, at present), is there any floor beneath a currency which its own supposed guardians would dearly love to depreciate further?
Such problems are not confined to the oceanic side of the Channel, of course, as has been highlighted in the deliciously barbed correspondence between the CEO of US tyre company Titan, Morry Taylor, and French industry minister Arnaud Montebourg over that country’s industrial outlook and business climate. Without getting too deeply into the spat, it should be noted that Eurostat data suggest that the French government typically spends (not including ‘investment’) two-thirds more on its almost 63 million citoyens than does the Italian on its 61 million, yet it is the latter who bear the brunt of the criticism.
(In the interests of fair disclosure, the same source shows that we virtuous 62 million Brits enjoy the dubious benefits of 45% more state largesse than do our Italian cousins, if 15% less than our French neighbours and even the ostensibly hard-core Dutch splurge as much on their 17 million as do the afflicted Spanish on their 47 million).
In Spain itself, we have had another failed property lender and the rather cheerless message from embattled Premier Rajoy that ‘there are no green shoots, there is no spring’. On the Western littoral of the peninsula, Portugal has also had to downgrade its forecasts to encompass a deeper shrinkage than was first pencilled in – as a result, by some unforeseeable mischance, of the deeper than anticipated slump which has ravaged the rest of the continent, to which it dispatches 70% of its exports and from which it receives the bulk of its tourists.
In Italy, the chorus of disquiet at the prospect that Il Cavaliere might just attract more votes than anyone else in the weekend elections is swelling to a Verdi-like crescendo (remember that democratic choice is all well and good as long as you vote for the candidate preferred by the global hegemons). More broadly, the signs are not good here either. Retail sales last year were at their lowest level in a decade, while industrial orders fell to their fewest (and at their fastest pace) since the slump, taking them down almost a quarter from their 2007 peak and landing them back where they stood at the very launch of the single currency. Hardly a ringing endorsement of the project!
Thankfully, Germany is potentially providing an offset. We use the qualifier because even if the IfO survey is beginning to show its typical lagged response to a surge in local liquidity, this has yet to translate into business revenues and hence, one has to fear, into earnings. Nonetheless, let’s take cheer where we can: Eurozone biflation is bringing a much-needed cheer to the bosses of the Mittelstand.
Abroad in Asia more attention is suddenly being paid to the fact that Shinzo Abe – after being mugged in the corridors of the recent G20 summit (and possibly warned there that he might need to cultivate some wider good will if he wishes to enlist third-party support in his ongoing dispute with China) – is having to back-pedal a touch in Japan as rumours circulate that he might not even get to appoint the most unredeemed, the wildest-eyed inflationist to the top spot at the BoJ next month.
J is for Japan, but J is also for J-curve – that unfortunate constellation whereby the effects of a lowered currency exert more of an upward influence on the import bill than on contemporaneous export revenues. Hence why the country suffered a record trade deficit last month. The fact that LNG prices in the Pacific basin surged to more than $19/mmbtu this month, even as the yen was shedding 10% of its value vis-à-vis the dollar is but one adverse side-effect of Abe’s quackery.
In the near-term, it may be that the accounts of a number of Japanese corporates are unduly flattered by the translation effect, but we doubt they themselves will be fooled by such transitory gains into a radical alteration of their business plans. What should be made clear here is that in volume terms Japanese exports are 10% lower than they were at the post-Fukushima rebound, one sixth lower than the last, pre-Crash spike, and no greater than they were in early 2006 (on a price-adjusted basis, the trajectory of imports is not wholly dissimilar).
Nor has the return from the Lunar New Year break seen China add any further fuel to the flames, either. To the contrary, yet another ‘decisive’ edict has been issued in the (so far vain) attempt to crack down on the nation’s re-inflating property bubble. Adding to a growing presentiment that the central bank may act to head off what looks like an outpouring of new credit from the banks these past 8 weeks, it has this week withdrawn a record CNY910 billion from the market. The smart money now has it that current PBOC chief Zhou Xiaochuan will be promoted to a level of party seniority sufficient to obviate the need to retire now that he has celebrated his sixty-fifth birthday, implying that there will be no radical loosening of policy on that account, either.
He might need to act soon: the new vogue measure of ‘total social financing’ recorded a 160% yoy jump in January while the pace of boring old bank lending so far this year has been similarly robust and could come in as much as 40%-50% above the combined Jan-Feb total for 2011. At this rate, there will be no notable diminution to the already incredible CNY110 trillion in reported urban fixed-asset investment undertaken these past four years – an amount equal to 145% of the US private economy and a number which has risen more than tenfold in a decade and which accounts for three-fifths of ‘national-scale’ industrial profits.
Whether this will be complicated by the problematical local government debt pile remains to be seen, but one sign that this is becoming a hot button issue is that the China Banking Regulatory Commission has just issued a directive insisting that any new loans extended to LGFVs must be covered by existing cash flows and that the projects for which the funds are intended must generate returns, while what it termed “irregular” lending to these vehicles was henceforth prohibited. That will be fun, given that the recently published provincial budget outlooks suggest the fact that more than half of their loans are due to mature this year.
In response to worries that the regime might act to rein in such developments, the Shanghai Comp underwent its biggest single-day plunge in 15 months, steel futures slipped to complete a 6% drop on the week, copper gapped lower to its weakest close of 2013, and rubber suffered further, making a 10% peak-trough decline from its pre-holiday highs. The FTSE A600 Bank index has, meanwhile, dropped 14%. With Komatsu telling us sales of diggers halved in the last nine-months of 2012 and rivals Caterpillar reporting its worst 3-month regional sales performance (-12%YOY) outside of either the GFC or the Asian Contagion of 1997-8, and with Foxconn announcing a hiring freeze, what little anecdotal evidence we can muster in this period of news blackout is not overwhelmingly positive.
On a broader front, ahead of the all-important National People’s Congress next month, the local press is positively buzzing with assorted calls for ongoing reform – even to the point of positing the formation of a new super-bureaucracy to supersede the NDRC in this task. President Xi and his allies have presumably had something to do with this campaign and the man himself has naturally been very active in trying to secure his power base in the run up to his full inauguration, but much will remain up in the air until the proceedings have been completed and we get a first look at his first full exercise of power.
Never mind, ever alert to the people’s needs, the planners have just announced that they are taking forceful steps to counter the awful quality of the air in China’s choking megalopolises – they have issued a fatwah banning urban barbeques!
Though it might seem a churlish observation to make amid so much barely-suppressed exuberance about the prospect for the markets in 2013, in many respects the past twelve months have shown much the same pattern as has marked each of the preceding four years. Characterized by the grinding hysteresis which we foresaw as far back as the end of 2008, this has broadly materialized in the form of rallies which stretch from one year end into the succeeding spring before a sell-off occurs which then extends into late summer-early autumn, whereupon the cycle reverts to rally and so on round again.
Each time the Groundhog recovery in asset prices has been based upon the delivery of a stimulus from one or other of the major central banks which has temporarily brightened sentiment – and even improved the macro numbers for a while – before what a physiologist would call a ‘tolerance’ of the credit injection has set in, the economic data has deteriorated, and the unresolved and unliquidated problems which still linger from the preceding Boom have surfaced again to frustrate the optimists.
Last year began amid ever more undeniable evidence that China was suffering a mini crisis of its own, with profits evaporating, unpaid bills mounting, and trade stagnating, while the disparities between Europe’s sorely-afflicted south and its better-placed north blew up in to surging sovereign spreads and a €1 trillion-plus mountain of blocked credits piled up across the T2 system. A further hiccup was then suffered as the two main American political parties acted out their tired old kabuki over the dire state of the nation’s budget.
However, on all three continents, the Keystone Kops aboard the imperilled paddy wagon just managed to wrench the wheel over in time to avoid the looming cliff edge.
For their part, the Chinese did exactly what they assured us they were not going to do and launched a vast new wave of stimulus in order to ease the new regime into office. Eastward, across an increasingly tense stretch of sea, the soon-to-be-Premier of Japan browbeat the BOJ into conducting an escalating series of interventions while, the other side of the wide Pacific, the defeat-disheartened Republicans bent the knee to their triumphantly re-elected opponent and quailed at the thought of being blamed for slashing government spending while the cynically–opportunist Bernanke Fed exploited a patch of economic softness to go all-in with a promise of unlimited bond buying.
In Europe meanwhile, ECB Chief Mario Draghi declaimed with a truly operatic flourish that he would ‘do whatever it takes’ to keep the cash flowing to the olive basket and so magically relieved the tension in the Eurozone in true Wizard of Oz style.
After a last lurch down around the time of the US presidential vote, the markets have responded with increasing enthusiasm to the realisation that disaster has been postponed once more (if, sadly, not definitively averted). Hope has sprung eternal as stock markets have rallied, junk and emerging market debt spreads have collapsed, volatility has been crushed, and the erstwhile safe havens – such as US Treasuries and gold – have begun progressively to lose their allure.
Alas and alack, as a reflection of the growing disenchantment with what have frankly been the disappointing returns offered by the asset class over the past eighteen months, commodities have taken a deal longer than the other ‘Risk On’ assets to respond to this perceived good news, only beginning to hold their own (on a relative basis) as the new year began.
And so, at January’s close, we found ourselves flushed with the glow of higher prices and complacent in the face of further central bank largesse. Adding to the urge is the undeniable fact that we are all heartily tired of sitting on a stockpile of boring old, precautionary cash for quarter after fretful quarter.
Around such intangibles a new consensus has formed that equities are king, bonds are dead, and commodities—if we must pay them any heed at all—are the things to buy to protect against those few dark clouds, no bigger than a man’s hand, which serve to remind us that central banks cannot go on indefinitely adding money to the system at or below zero real interest rates while budget deficits yawn in undiminished magnitude without risking a conflagration of values too awful to fully contemplate.
The irony is, of course, that the thing most likely to blow these few wisps of cumulus up into a terrifying inflationary gale is simply that people come to express more and more confidence that neither this eventuality, nor its gloomy deflationary opposite, will come to pass and so the money which is currently only burning a hole in their trouser pockets is brought out to set light to the world at large.
While we must be careful not to be trampled in such a bullish stampede by standing too incautiously in its path, there are both flaws to the premises on which such a Blue Sky mentality has been founded and more immediate concerns that the eagerness to believe has become so widespread and the voices of dissent so lacking that everyone is already leaning over the starboard side of what has therefore become an alarmingly heeling ship, one all to ready therefore to be tipped overboard with the first contrary gust of wind.
Let us (briefly) take China. Still in a policy hiatus due to the regime change and about to enter the macroeconomic purdah of the Lunar New Year, that has not precluded the Herd from wilfully taking as bullish a view as possible about likely developments there – even to the point that one senior analyst from a major bank could bring himself to tell his audience at a mining conference that to him the outlook for the commodity market was very much like it was in 2002 (from which secondary low, the reader might recall, it embarked on what some measures show was the best nine years in its history!)
It seems that nothing will stop the idiot savants – as well as the consciously misleading – from plugging whatever numbers the state propaganda machine churns out straight into their ‘models’ in order to lend some spurious gloss of calculation to such pronouncements, no matter how unreliable, contradictory, or plain incredible these may be.
Take the Chinese GDP number for the broadest of these: Officially, last year’s nominal total came to CNY51.9 trillion, an increase of 9.8% or CNY4.6 trillion on 2011’s count. Yet, by adding up the individual data produced separately by the nation’s constituent 31 provinces and autonomous regions, we can calculate that the annual sum reached to CNY57.7 trillion (11% higher), and that growth accelerated to 11.1% yoy, representing an increment of CNY5.8 trillion which was a quarter larger than that given by the official tally. Spreadsheets, anyone?
By now it has become almost trite to compare the electricity stats with those for GDP or industrial production, yet we have a rather worrying disconnect in other areas of energy use, too. Industry up by a double-digit amount alongside a gain in refined oil product use of no more than half of that (5.2% yoy), of which diesel consumption barely ahead at 1.5%? Makes perfect sense to me!
Then we have the miraculous rebound in ‘profits’ posted in December (and we will risk a roll of the eyes by asking, once again, how can businesses even begin to compute earnings on a monthly basis?). Setting the seal on QIV’s auspicious rebound and so helping the Shanghai Composite to a further 8% gain, December’s winnings were supposedly a cool 68% greater than the average of the previous three months; revenues were no less than 13% higher and, hence, margins were reported to have jumped by half from 6.5% to 9.7%. Oh, for such levels of operational gearing in an expanding market!
In the short run, what may come to haunt the China bulls is the fact that even this brief relaxation of policy has unleashed the same old dark forces of shopping basket inflation and property speculation. For example, the all-important pork price has risen by more than 10% in the past two month, prompting a release of supplies from the central reserve to try to quell the surge.
More worrying still – especially given the news that the much-bruited property tax will not now be rolled out across the country – land sales in China’s ten main cities were up by a factor of 3.6 last month from January 2012, according to the Shanghai E-house Real Estate Research Institute. Given that the area sold increased ‘only’ 77%, this also implies that the average price paid more than doubled. Stop-Go rules OK!
In light of this what would have been merely risible if it did not simultaneously display China’s increasingly belligerent response to foreign criticism alongside an utter lack of economic understanding, the mouthpiece People’s Daily this week carried an aggressive repudiation of assertions that the country’s monetary incontinence posed a threat to global stability.
Putting the cart firmly before the horse, the editorial argued that if a company had made a hypothetical land purchase ten years ago and if, on going public this year, that same land had been valued higher by a factor of 2,000 (sic!), if the central bank did not issue new money to the tune of around a quarter of that latest appraisal, the increase would be ‘just a bubble’!
No, really! We are not making this up as you can see here:- http://tinyurl.com/amzaczh
On top of this, the writer contended, ‘price reforms can also lead to a substantial increase in the demand for money’ since, he went on, if prices rise, both companies and consumers have to pay more, ergo more money is patently needed – a problem which is moreover said to be ‘unique to China’! Truly, to invert Milton Friedman, monetary inflation is everywhere a real side problem!
Heaping a cloud-capped Pelion of further confusion upon this already lofty Ossa of muddle-headedness, a separate justification for the deluge is apparently that while America’s attempts of the last four years at disaster recovery have naturally focused on its predominant, highly-leveraged financial sector – meaning that every new, FRB-printed dollar could be multiplied up sixty times (sic) – poor, old, metal-bashing China, by contrast, has been doomed to rely on a mere 4:1 multiplier to assist its key industrial base (the limitation being imposed lest it blew its companies’ balance sheets up to imprudent levels of gearing) and hence it had to keep its central bank’s printing presses fifteen times as busy as those of the Fed!
Working up a full head of steam, the author closed this truly Swiftian self-parody with one last, glorious volley of logical howlers, by asserting that the crisis-averting increase in money supply has increased the risk (but only the risk, you will note) of debt expansion before the authorities became ‘scared’ enough to tighten policy and thus to usher in a ‘slump in domestic stock markets, a surge in loan demand, persistently high interest rates, and such financial risks as usurious loans, shadow banking, and trust loan expansion.’
Well, yes, but surely those were merely the unfortunate side effects of an attempt to address the dangerously building excess before the system exploded under its own pressure? No, this hero of socialism-with-Chinese-characteristics confidently concludes, ‘…the greater risk lies in an increasingly weak real economy.’
And this is the spokesman for a preternaturally-gifted ruling elite which is supposed to be reforming and rebalancing its economy in a ‘scientific’ manner and whose rarefied heights of dispassionate calculation we benighted Westerners cannot ever hope to match? Heaven help us all!
But if the ongoing suspension of disbelief regarding China is one of the great enormities of the current mini-bull market, the effort to disregard the sorry history of Japan’s last two decades by a semi-mystical appeal to the half-remembered exploits of eighty years ago is surely the other.
For now it seems, after twenty-plus years of evergreening loans while covering whatever real verdure there was in swathes of economically otiose concrete, the ‘one more heave’ generalship of the LDP will finally enact all of Paul Krugman’s wildest fantasies by further unbalancing its budget – this time with the untrammelled assistance of the central bank – and thereby repeat Finance Minister Korekiyo Takahashi’s feat of ‘rescuing’ his country from the clutches of the Great Depression.
That Takahashi’s real achievements are still somewhat moot is, of course, besides the point even though debate still rages about whether it was his 60% devaluation of the yen in late 1931; his reliance on proto-Keynesian pump priming and his insistence that the BoJ monetize at least some of the resulting deficits (not a small fraction of which were incurred by the country’s simultaneous annexation of Manchuria); his elimination of the capitalists’ ‘wasteful competition’ via his promotion of industrial cartelisation; or whether it was simply that the wider world was already coming out of the worst of its trough by the time his policies were being put into effect. Suffice it to say that a multitude of PhD dissertations and many a professorial citation count still depends on the construction of intricate counterfactuals about this episode, together with the conducting of exhaustive econometric testing of this ultimately untestable dispute.
We should perhaps first pause to take note that Takahashi is an unlikely hero, given that he once declared, in reminiscence of his mentor: ‘After two days of talking with Maeda, I realized that my concept of the state was shallow. The state was not something separate from the self. The state and the self were the same thing.’ Mussolini would have been proud of him.
Moreover, this particular ‘genius’ seems to have subscribed to the same old canards of the underconsumptionist school, with all of its superficial appeals to the so-called circular flow mechanism. Hence, we have this pronouncement from the lips of the great man:-
If someone goes to a geisha house and calls a geisha, eats luxurious food, and spends 2,000 yen, we disapprove morally. But if we analyze how that money is used, we find that the part that paid for food helps support the chef’s salary, and is used to pay for fish, meat, vegetables, and seasoning, or the costs of transporting it. The farmers, fishermen, and merchants who receive the money then buy clothes, food, and shelter. And the geisha uses the money she receives to buy food, clothes, cosmetics, and to pay taxes. If this hypothetical man does not go to a geisha house and saves his 2,000 yen, bank deposits will grow, but the efficacy of his money will be lessened. But he goes to a geisha house and his money is transferred to the hands of farmers, artisans, and fishermen. It goes in turn to various other producers and works twenty or thirty times over. From the individual’s point of view, it would be good to save his 2,000 yen, but when seen from the vantage point of the national economy, because the money works twenty or thirty times over, spending is better.
No wonder his shade is being summoned as the tutelary deity of what is inevitably being termed ‘Abenomics’. Martin Wolf must be positively beaming with delight.
Our own thoughts on this matter should need little exposition so let us content ourselves by citing the wise words of a man who is being sacrificed to this kami of inflationism, outgoing BOJ head Masaaki Shirakawa. In a speech given almost two years ago, he pointed up the dangers of overplaying the supposed similarities between 1930s Japan and the country of the 2010s before issuing a stark warning regarding the dangers of embarking upon a like course to that followed on that earlier occasion:-
As many of you know, Mr. Takahashi was assassinated in 1936 by militarists when he was trying to stop ever-growing demand for military spending, and the course of events led to the eventual rampant inflation. I would argue that the introduction of the scheme of the Bank’s underwriting of government securities itself paved the way for eventual ballooning of fiscal spending, precisely because the scheme lacked the checking process through the market mechanism.
We often use the words of ‘entrance’ and ‘exit’ to discuss the conduct of monetary policy nowadays. In that terminology, we should interpret that the ‘entrance’ of the introduction of the Bank’s underwriting of government bonds in the early 1930s led to the ‘exit’ of the failure in containing growing demand for fiscal expenditure. In retrospect, we should note that the Bank’s underwriting of government bonds started as a ‘temporary measure’.
Though Mr. Takahashi stated that he issued government bonds by a means of the Bank’s underwriting just temporarily in his address at a Diet session, history tells us that it was not temporary.
For reference, the toxic legacy of a government debt of 200% of GDP (sound familiar?), a vast monetary overhang, and shrunken markets eventually cast the defeated nation into a rapid inflationary whorl. After a one third reduction in 1946 as a result of that year’s currency conversion and capital levy, money supply shot back up by a factor of six between the end of that year and 1951/2, as official wholesale prices rose one hundredfold (even if the more representative black market ratio was closer to a more proportionate fivefold).
As a noted economist of the time, Martin Bronfenbrenner, remarked:
no serious attempt was made… to control either the volume of currency printed or the volume of bank deposits created to support not only the Government deficit but also the similar deficits of private firms
We can only hope that the contemporary Japanese will not suffer too much from what seems to be an active programme of decontrolling such an efflux.
And what of those hoping for a mercantile boost for Japan as the currency falls at its second fastest rate of the past generation? Well, perhaps it will turn out not to be the smartest thing to prosecute a policy guaranteed to increase input costs from abroad during a period when the country’ trade gap is the highest on record, when the terms of trade have already fallen by a fifth over the cycle, and when the ratio of imports to national income has only briefly been exceeded at any time in the modern era for the four quarters leading up to 2008’s global peak.
Rather than waiting in vain for some instant miracle, it would be as well to heed the caution of Toshiba Executive Vice President Makoto Kubo who told a press conference recently that:
The semiconductor-related business will benefit from a weak yen, but the rapid fall in the currency will increase costs because it uses a massive amount of electricity.
Or might we be led to doubt by noting, as was long ago remarked:
…‘because each farmer and the situation in each farm village differs, it would be wrong to impose a comprehensive relief program. Each region has its unique disease. We must begin by investigating these sicknesses and applying the correct cures. If we scatter money uniformly from the centre to the regions, we cannot eliminate the diseases.
Who said that, you ask? Why, a certain beatified inflationist by the name of Korekiyo Takahashi.
Back in that other Sick Man of the global economy, there has finally been a minor test of the complacency which has increasingly categorized the European scene. Naturally, since Draghi’s deus ex machina nothing very concrete has been achieved, for all the endless summitry and fevered shuttle diplomacy, as joblessness has climbed, state indebtedness has worsened, and business confidence has further eroded.
Cyprus is only the latest to be – or not be, depending on the swing of the political weathercock – a potentially ‘systemic’ problem. Italy is on the verge of another Dantean descent into political chaos as the same-old, derivatives-enabled fudging of the account books to which the Japanese were so prone has come to haunt the Urprovinz of European banking. This, even though the cynic might enquire as to why a (quasi-)private European bank shouldn’t do what so many of its sovereign overlords once did with the help of exactly the same sorts of TBTF pirates to ensure that they met the Maastricht criteria for euro-entry?
Though this may only comprise the latest of a long line of financial imbroglios, the political repercussions stretch further, not only by giving the irrepressible Silvio Berlusconi one last chance to strut his hour upon the stage, but in calling into question either or both of the competence and integrity of the current head of the ECB, a man who happened to be in office with the local central bank at the time. With an even more socially-incendiary corruption scandal having recently erupted in Spain – implicating many of the kingdom’s nomenklatura in a seedy little brown envelope scheme – it may be that another round of drama will ensue in the Eurozone after months of spread-tightening quietude.
Conversely, unease among the moral hazard jockeys has been sown by the steps taken by the Dutch government in taking over the failed mortgage company SNS Reaal (no, property crashes are not just an Anglo-Latin phenomenon). As part of this, at long last – almost five years too late, some might say – the subordinate bond holders have been made to share the pain of a bail-out. So, finally, someone has had the cojones to follow the lead of the doughty Danes and intrepid Icelanders and put a great, fat slug of risk back from whence it should never have been removed.
Adding to the general angst, Germany and Finland have seized upon the action to join the Netherlanders in calling for the good and great to advance the implementation of a tougher rescue regime from the formerly proposed temporal wilderness of 2018 to a politically imminent (if still Augustinian ’Not yet, O Lord’) starting point of 2015 – though why this should happen any later than a week next Wednesday is beyond us!
Ironically, all this has blown up as the banks have brashly repaid some €130-odd billion of last year’s LTRO funding – a close and suggestive mirror of the €125 billion reduction in the big four TARGET2 creditors’ balances (and, hence, of the EUR130 billion drop in Spain and Italy’s debits) which has taken place since the summer. Given that the euro has itself become the forex market’s new RORO bell-whether, a disruption in Spanish and Italian asset markets, Eurobanking stocks, or the currency itself could therefore see a widespread series of interlocking liquidations if confidence is not quickly restored.
It’s nice that such doubts resurface when US equity margin debt has hit its highest dollar amount since the 2007 top (indeed, it may well be a good deal higher than these December figures, given that the last three weeks have seen what look like record, pro rata inflows). Moreover equity mutual fund liquid assets have hit their own record low-equalling proportion of total assets and a multi-year low one of market cap: the bullish combo of high leverage and a reduced margin of safety has only previously been matched in the blow-off high of summer 2007.
Notwithstanding the fact that S&P reported that the credit quality of leveraged loan and high-yield bond issuers is deteriorating, with downgrades outnumbering upgrades for the first time since 2009 and with the growth in debt outpacing that of cash flow for U.S. leveraged-loan issuers, junk bond yields have hit a record low while EM bond spreads stand at their narrowest since 2007. Volatility in stock and bonds, oil and gold, have also gone off the bottom of the chart thereby implying that no-one wants to buy protection in what is seen to be an unimpeded one-way path to the sunlit uplands where bogies are made by all and sundry, skilled or no.
Yes, we have clear signs of a breakout (at long last) from the channel drawn off the 2011 high which has been constraining industrial commodities (though neither these nor the broader CCI combo have yet quite breached the pennants drawn off their 2008/9 extremes) and, yes again, we can project up from this to new cyclical highs if we measure from the 2009 lows via the intervening consolidation; and, yes, ‘overbought’ can easily become more ‘overbought’ until a shock to sentiment occurs but, but, but…. the danger must surely be that everyone has already positioned so far for this best of all possible worlds, so well ahead of the expected CB largesse upon which much of this has been predicated, that disappointment looms even if its trigger remains to be determined.
What we have to try to gauge is whether this is really the long-awaited easy money blow-off move, or whether we will once again be nursing our disappointments, come the Dog Days of summer. If the market can shake off the last few days’ attack of nerves then we might at least muster the confidence to play an extension of this tactical rally before we have to decide upon its candidacy for the much more significant role presaged by the likes of no lesser mortals than Ray Dalio and Bill Gross.
If, conversely, the few, hardy sellers win this particular round, we can resign ourselves to having nothing better to which to look forward than to suffer another tedious bout of up-and-down, cyclical déjà vu