Authors

Economics

Global M

[You can find the original article here http://truesinews.com/2015/03/11/global-m/]

As part of our analytical process, we frequently consult our proprietary estimate of global money supply, something we construct by combining the individual measures for 15 countries (strictly 33, since we include the euro as one of them) which together account for almost three-quarters of global output.

When we do so, it immediately becomes apparent how much more closely trends in global equity markets – here approximated by the MSCI All-Country index – have tended to follow developments in the supply of this money since the onset of the financial crisis.15-03-04 G70 ACWI

This strengthening of the relationship can be seen to hold even better for the advanced economies in our group:-15-03-04 G70 MXWO

while when we instead consider the emerging market members as a subset, we discover that the relationship has held reasonably well over a much more prolonged period of time.

15-03-04 G70 MXEF

It should be apparent then that it is not just a truism to declare that, since the extraordinary easing cycle began in the wake of the Lehman collapse, the only game in town for stock investors has been the one being played so unremittingly by the central banks. Episodes of faster or slower money growth have increasingly come to correspond to rises or falls in the price of equities

Given that our aggregation must involve the translation of component monies into a common currency – the US dollar being the obvious choice – it should further be evident that the two main sources of variation in this composite are firstly the changes in the supply of the individual countries’ money and secondly the ups and downs of the foreign exchange value of the dollar by means of which they must be translated. A strong dollar – other things being equal – therefore tends to diminish the effect on the international purchasing power of the whole and thus gives some theoretical underpinning to what is also a commonplace of the market, namely that a rising dollar is in some way expected to be contractionary.

Aside from these purely arithmetical considerations, several current account surplus countries tend to magnify the effects of US dollar developments by pegging their currencies to it more or less closely. To the extent they do this through a process of unsterilized intervention, a surfeit of dollar receipts therefore gives rise to an equal increment of domestic money since, at its most straightforward, the denizens of that country may take their USD earnings to the local central bank and have this latter institution issue new ‘outside’ money claims upon itself in the form of extra banking reserves.

Patently, these new claims can be freely spent at home – and, indeed, in good times, can be greatly leveraged up by the creation of the additional, spendable ‘inside’ money which the commercial banks can pyramid upon them. The inconvenient fact, however, is that no new goods or services have been made available to those now endowed with an expanded count of funds. We can surely see in this disco-ordination where trouble might soon arise. Indeed, we are twice cursed here since the exports which first gave rise to all this new money constituted nothing other than the act of putting a sizeable quantum of goods explicitly beyond the reach of local buyers. This is therefore a case where the often vexed concept of the reserve issuer ‘exporting inflation’ actually bears up under scrutiny

As for those living beyond their productive capacities in the US, the fact that their IOUs are accepted globally, without quibble, and that the acceptors have no choice but to place them back in the market and so ‘recharge’ the pool of loanable funds gives rise to the infamous ‘deficit without tears’ and hence to the not wholly inaccurate observation that the issuer of the principal reserve currency enjoys an ‘exorbitant privilege’ on that account. We say not wholly inaccurate because this treatment ignores the workings of the offshore or eurocurrency market by which a Spanish petrochemical company, say, can pay its Qatari supplier of natgas in dollars, too, having simply asked that its own bankers in Bilbao create them ab novo in much the same manner as its American competitor might demand of its bankers in Boston.

15-03-10 Big3 FXRes

As can be seen from the foregoing chart, over the past decade of what was mostly a rapid expansion of an often dangerously unbalanced trade, the world has effectively split into three blocks of ‘privilege’ granters, with the developed nations, China, and all other developing nations respectively now being responsible for just short of $4 trillion each – i.e., for roughly equal shares in a total which amounts to around nine months’ worth of global merchandise trade.

We note in passing that this partly understates the advanced nation’s quota since this latter has been suppressed by the introduction of the European single currency. This device has enabled its participants to hide the disparities between them which still amount to the $700 billion or so left of a peak $1.3 trillion creditor position in the Target 2 balances which have come to substitute for forex reserves within the Eurozone.

Though we should not fixate too simplistically on the cross-border movement of goods and services when independent flows of capital can amount to solid multiples of these, several factors have nonetheless conspired in more recent years to slow the growth of the reserves associated with the former. For one, America’s growing oil output has helped reduce its current account gap by more than half in the past eight years, reducing the supply of dollars emanating therefrom by over $400 billion a year. In turn, finance-starved Spain, Portugal, Italy, and Greece have had little choice but to reduce their external deficits from the Boom’s peak by a sum which comes to around $350 billion combined.

In recent months, too, the plunge in energy prices has exacerbated the general diminution of commodity country exports – slicing crude and product flows alone by over $1 trillion a year – while China has seen its capital account halve and its financial outflows soar to the point that a cumulative $280 billion goods trade surplus in the final semester was not enough to prevent the country from experiencing a $150 billion net reserve drain. As a whole, the IIF projects emerging market surpluses to dwindle to less than a third of their 2008 peak this year – for an overall decrement of around $370 billion.

With the dollar having strengthened by more than 20% nominal since the second half of 2012 began – at a rate which has now equalled the fastest recorded like-period 30 weeks of the Volcker-Reagan ‘SuperDollar’ era, set in 1981 – stresses are palpably beginning to mount.

 

Courtesy:Bloomberg
Courtesy:Bloomberg

In the first instance, the Greenback’s rise is pushing down global money growth simply by translation, as explained above. Perhaps, the best example of this is to be had by noting that, to the end of January, both Japan and the Eurozone have seen double-digit USD-denominated declines in M1 since the summer, to set the sum of the two back to the levels of late 2009, Draghi and Kuroda notwithstanding. Given that the yen has dropped 3% and the euro more than 5% since then, we can safely assume that worse is to come.

 

Courtesy: Bloomberg
Courtesy: Bloomberg

As yet hard to quantify but undoubtedly a very real concern, financial stresses will also be mounting among all those who have spent the last several years borrowing cheap and often depreciating dollars in order to fund assets which are often no longer throwing off anything like the cash flows they once were expected to generate. In the context, it will be cold comfort to recall that the SuperDollar did not take long to cause substantial casualties among the LDCs (as they were then known) who had been the grateful recipients of ‘recycled’ petrodollar surfeit as means of plugging home-grown financing shortfalls.

Courtesy: Bloomberg
Courtesy: Bloomberg

Under the circumstances, it is problematic to disentangle cause and effect between endogenous money growth, currency effects, and resource country exchange management practices, but what is undeniable is that, with only a brief interlude in the mid ’00s, swings in money growth from strong to weak and back again have been matched by similar oscillations in commodity prices. Given what we suspect is happening to the money numbers, therefore, further commodity price weakness would hardly come as a surprise.

15-03-04 G70 M1

The upshot of all this is that, on the broadest of horizons, global trade growth has slowed to a crawl with the pace these last three years the slowest in three decades and the second most tardy in six.

15-03-10 WTO 3yrCAR

Within these numbers, for all the talk of a quickening of the European economy, exports of the most important six economies in the Zone have only managed to look respectable under the camouflage of a falling numeraire: strip away that disguise by tallying them up in USD and we can see that the last couple of quarters have been an absolute horror show.

Courtesy: Bloomberg
Courtesy: Bloomberg

If you were looking for an explanation for why the Baltic Dry index has been so sickly of late, you need look no further. What is intriguing though is the relative value of  stocks in the MSCI Marine index – companies which may well have the partial offset of dramatically lower bunker fuel prices to compensate for fewer cargoes but which are still off the scale in terms of the recent history of their relative standing.

Courtesy: Bloomberg
Courtesy: Bloomberg

Similarly, the best, most timely gauge of US business sales has also slipped badly over the autumn and winter. Although these are nominal falls which are not so much the result of lower volumes but of declining prices – and so are not an unmitigated evil – the fact remains that no contraction of similar magnitude has taken place without the occurrence of an official NBER declaration of recession.

In that context, it should be noted that the S&P ex-financials index is now on a price:sales ratio only matched at the very peak of the Tech bubble. We await the Flow of Funds numbers later this week to see just how flattering all that QE-inspired, debt-financed buyback activity has also been for easily engineered EPS as opposed to hard-won ROIC.

Courtesy: Bloomberg
Courtesy: Bloomberg

To conclude, one should be aware that even though the price of oil has been hogging the headlines, non-energy commodities are facing their own demons in this environment. For example, copper is just starting to show signs of fading once more after a vigorous and very necessary bounce off the lower bound of the profile laid down over the course of the past nine years (barring a brief interruption for the GFC itself). Were that barrier ever to give way, an enormous low-volume area would be encountered, stretching down almost 40% from its ceiling and thus offering exceedingly low resistance to a substantial, downward rotation.

Courtesy: Bloomberg
Courtesy: Bloomberg

Gold is also pushing its luck. Any serious probe lower here will not only take out the November low but also break the major trend line of the rally while allowing us to entertain swing targets drawn off the $1290 high volume price of around $1000 and even $800/oz. Caution!

15-03-10 GOLD
Courtesy: Bloomberg

 

 

Money

Money, Money, Money

[For the original article, please see here: http://truesinews.com/2015/03/04/money-money-money/]

As the title of the blog suggests, we pay close attention to developments in money and credit since the twin precepts of our outlook are that ‘the credit cycle IS the business cycle’ and that ‘silver [i.e., money] is the true sinews of the circulation’.

It is all very well for both macro-economists and stock-pickers to look at flows, but unless a weather eye is kept on how they are being financed and what that implies for the future vulnerabilities of the contracting parties, a very important element is being overlooked.

Indeed, when, in the immediate wake of the collapse, Her Britannic Majesty somewhat querulously asked the foregathered luminaries of the DSGE crowd with whom she was mingling at the LSE, ‘why did nobody see it coming?‘, the one-line answer she might have been given is because none of them have ever cared much to look at the balance sheet, since they are trained to view finance as nothing more than a conduit to be safely neglected in their thickets of unrealistic matrix algebra.

In recent posts, we have dealt with some aspects of the debt issue – that ‘web of contracts’, as Axel Leijonhufvud calls it – which is the deadweight partly responsible for shackling our material aspirations to the ground (the other being the ghastly, taloned hand of the grasping and capricious, interventionist state). So, now, on the eve of the upcoming ECB meeting, let us take a quick look at a few of the monetary developments instead.

As a prelude to this, we should like to point out that, on our twitter account – where the compressed nature of the communications means that a certain sloganeering is not only permissible but almost de rigeur – we have adopted one or two mottos in the attempt to try to bind our monetary text-bites into a more coherent narrative.

One is simply, ‘Abenomics fail’ – shorthand for our disdain for a programme of pretending that an ageing nation of import-reliant savers can get rich by devaluing their currency and by promoting a speculative hunger for equities. Another leitmotif is the‘Ghost of ’37’ – a reference to the widely shared folk mythology that a combination of monetary and fiscal tightening in 1937 prematurely put paid to America’s burgeoning recovery from the earlier slump when in fact the proximate cause was that a new front was opened that year in the New Deal’s regulatory and ideological war on ‘Capital’ – i.e., on entrepreneurship itself.

The fiction persists however that it was an instance of what we might now call ‘austerity’ that did it. As if it alone did not suffice to stay the policy-maker’s hand, this stultifying belief mingles with the perverse incentive that while central bankers might have to endure a mild and momentary criticism of their approach if the ‘controlled’ inflation they so desire ever threatens to go critical, they know that they will be burnt in effigy and their memory forever accursed if they ever have the temerity to try to allow markets to function once again and any noticeable relapse in hot-house growth eventuates as a consequence.

Our most commonly used meme, however, is ‘QEuro = 2 much, 2 late’ – a blunt reference to the fact that Draghi’s long-awaited Whatever initiative has arrived well after any conceivable need for it has passed; indeed, that it has come at a point where the consequences may rapidly be revealed to be almost exclusively counter-productive.

Just look at the GfK readings of Germans’ desire to spend – now at the highest since Dec 2006. Or at the harder confirmation contained in the just-released retail sales numbers  – up 5.3% in real terms yoy – or at the fact that IG Metall managed a 3.4%-plus-benefits wage rise with barely a wave of a red, ‘Wir Streiken’ banner needed. We shall forebear to make overmuch of the fact that the Deauville sale of yearling race-horses also set new records last month.

Yes, French industry may be contracting more sharply again, if we take the latest Markit survey at face value; yes, the Greeks are still trying unsuccessfully to roll that infernal rock up their Hadean hill; yes, Austrian embarrassment is intense as that captive funding arm of local political corruption – Hypo Alpe – is again making the wrong sort of headlines. But money – ever more copiously provisioned money – is beginning to burn a hole in the pockets of more than just stock market plungers and would-be real estate moguls.

A look at the graph of European monetary trends shows us why.15-03-03 EZ M1

Not exactly a dearth of the folding stuff, is there, neither among the T2 creditors, the middle ranking countries, nor the sinful PIIS (Greece, for obvious reasons we exclude from the roll of shame, just now)?

Moreover, if we focus on changes in the balance sheets of the residents of the latter four problem children – specifically with regard to their deposits at and loans from the region’s banks – we arrive at the remarkable observation that, for the whole of the last 2 1/2 years, the non-financial private sector has improved its net position by just over €1 billion per working day for a €750 billion total – with two-fifths of that betterment coming from a household sector biased toward deposit acquisition and the remaining three-fifths resulting from corporates’ efforts at reducing debt levels.15-03-04 PIIS PVT

Indeed, corporate liquidity has not been this favourable since early 2006 while households are enjoying the biggest surplus to be found in our sample. As a pairing, the private sector is back where it was eleven years ago, having worked off the entire €1 trillion cumulative deficit it disastrously ran up between the end of 2003 and the latter part of 2007.

15-03-04 PIIS PVT net

As we said,  ‘QEuro = 2 much, 2 late’

Malign consequences elsewhere are already becoming evident. For example, S&P has calculated that the actuarial shortfall in defined benefit pension plans worsened by anything up to €90 billion last year (widening an already substantial gap by a quarter in one bound). The agency went on to point out – rather superfluously, one might think – that things will only deteriorate again this year.

Insurers also face a squeeze between their long-term liabilities – many of which carry minimum pay-out clauses well above today’s nugatory bond yields – and the medium-duration assets they hold and roll in order to meet these. Despite the plaintive acknowledgement of their likely future difficulty – and who better to compute long-term probabilities than members of an actuarial industry? – they are all presently hiking dividends and raising pay-out ratios in order to disburse some of last year’s one-shot gains on equities and on the MTM value of their bonds in a crass attempt at trying to massage their share prices upwards!

It is supposed to be rapid rises in the price of goods which promotes such economic short-termism and which encouragesunwitting capital consumption, but here we see asset-price inflation inducing those who really should know better into aconscious dissipation of their substance.

Other harmful side effects are that despite what Nick Nelson of UBS told Reuters were “47 months uninterrupted of earnings downgrades,” and with nary a care that Q-IV revenues were down 6% yoy, record amounts of money are flowing into European equities. Presumably most of the foreign component is arriving with the currency exposure well-hedged in that same Gutenberg Trade manner by which the world and his wife went long Nikkei/short yen when the BOJ got the printing press humming back in 2013/14.

A glance at the following two charts (courtesy of Nikko Asset Management) might give some pause for thought, however, even as the markets ratchet ever upward. The first shows the eternal over-optimism with which the all-important earnings estimates for Europe are routinely framed at the beginning of every season and how they are doomed to dwindle inexorably as each successive year rolls on:

Courtesy: Nikko AM
Courtesy: Nikko AM

The second shows whence investor returns to date have been derived as a consequence of this (Answer: not through the agency of anything tangible):-

Courtesy: Nikko AM
Courtesy: Nikko AM

As the team at Nikko dryly conclude their examination of this trend:-

‘…there are several credible reasons to expect that QE will boost corporate earnings in Europe, though by not as much as in the US. However, the risk of disappointment relative to inflated expectations remains high.

And finally, of course, there is property – always the first and last outlet for the Middling Sort but, as ever, too, an unproductive, Ponzi-prone use of funds which is fraught with long term danger on that same account. Even in Hollande’s benighted France, SCPIs – a kind of local REIT – saw a 10% rise in inflows to set a new record last year, while BNP Paribas reported that foreign buying ‘drove European hotel investment’ to the extent that France, Germany, Italy, Spain and the UK attracted two-thirds more cash than the year before and so topped 2007’s pre-crash record.

Would you like some more? Well, German ratings agency FERI reported that institutions it surveyed there were intending ‘strong’ increases in allocations to residential and retail RE together with a widely expressed appetite for higher-risk and indirect investment vehicles. Property giants CBRE, for their part, noted that 2014 saw €218 bln ploughed into Europe with the final quarter’s €78 billion just failing to top 2006’s bubble highs. Sweden, Spain, and Ireland did, indeed, set new records, we are told, while Portugal and Holland were also notaly strong. Any prizes for guessing what might happen this year with bond yields negligible or even negative in most of these countries?

Given all the foregoing, one final Twitter tagline of ours is of relevance, viz., ‘CBs, 2 save the Few, ruin the Many’

Sadly, this is not likely to turn out to be much of an exaggeration. Sadly, too, Snr Draghi is unlikely to pay the slightest attention to our worries when he convenes his cabal for the scheduled away-day meeting in Cyprus this week.

Economics

What’s in a Word?

[You can find the original here http://truesinews.com/2015/02/27/whats-in-a-word/]

After yet another masterly performance before Congress – one which was immediately confounded by the usual cacophony of cross-talk from the Pigeons and Doves (no Hawks!) among her colleagues – Madame Yellen has left no-one really the wiser as to what the all-things-to-all-men Federal Reserve thinks it is actually doing with regard to monetary policy.

Is she ‘patient’ or not? And is ‘patient’ a nudge-nudge, wink-wink code for a period stretching beyond the next few FOMC meetings or is it just a tacit admission that the Fed will start checking its parachute harness only after the plane’s engines have at last caught fire?

Given all this prevarication, have you lost patience with the whole weary rigmarole, as have we, Dear Reader? If so, can we suggest you join us in setting aside your frustrations by concentrating on the one abiding truth of current policy: that even if theredoes exist a door marked ‘EXIT’ in the haunted house in which the world’s central bankers have long confined themselves, it would be one guarded by that most fearsome of all the ghastly bogeymen of economic myth – the Ghost of ’37.

But why not, you ask? Is the Fed not right to hold fire in this world of ‘secular stagnation’ Is it not only prudent to avoid tipping the country headlong into ‘deflation’ by spooking the financial markets and so risking a full-scale reprise of the Lehman moment of six years ago?

Perhaps not. For even as has been belatedly recognised by the ‘professional second-hand dealers in ideas’ who write, for example, for the FT – when not flitting to Davos or popping up to sing for their supper at self-flattering symposia sponsored by billionaire financial St. Augustins (‘O Lord, help me eradicate all inequality, but just not by setting a personal example’) – what the world urgently needs is not any further incentive to take on debt. but a means of expunging some of its gross, existing burden of the stuff.

Yes, without any acknowledgement of the error of their ways and lacking any display of contrition at the long misery to which their pontifications have greatly contributed, the Clerisy are starting to realise that they may as well help Atlas to shrug off his crushing load and that the world must thereafter be ordered to allow the newly liberated Titan to enjoy as much freedom as possible (‘structural’ reforms must be enacted, as they put it) if he is to help rebuild both his and our prosperity.

It is almost mischievous to say so but, in the circumstances, a genuine bout of deflation could actually represent a useful Plan B. After all, few can argue that the authorities’ Plan A has so far been a rather dismal failure; that the Powers-that-Be have not managed to alleviate the real impact of all that debt as they had planned, in an inflation of anything other than the price of prestige property, race-horse yearlings, modernist daubings, and all manner of financial assets. To their mounting frustration, their efforts so far have achieved little more than to ignite a version of inflation which has served only to aggravate the divide between the rest of us poor saps and the same plutocratic 1% which is so vilified by the very bleeding heart Progressives who are to be found at the forefront of the mob noisily advocating the current policy mix.

Without wishing to call the glib ‘liquidationist’ slur down upon our heads, one might point out that the one guaranteed way to cancel debt is to allow a sufficiently rapid deflation that creditors can no longer hold out for the soothing money-illusion balm of a repayment in debased coin but must instead face up to the reality that their debtors are unable to comply with the terms of their mutual contract as originally drawn up.

If you agree with a man that you will feed him and his co-workers for a month in exchange for them delivering a tonne of coal to you at the end of the period and he later finds he and his team cannot possibly comply with his undertaking, it serves no very great purpose to redefine the mass which makes up a tonne to half its former value in place of either accepting the reduced physical repayment your debtor can make for what it is, or of otherwise working out some alternative scheme of mutually-agreed recompense which will at least allow him and his mates the chance to continue to make a living – an activity from which you might yet hope to derive some ancillary benefits.

Inflation is not, therefore, a panacea, especially when the principal means of injecting the posion into the economic circulation is by encouraging people to continue to borrow more than they should.

Deflation in this sense is, of course, unmitigatedly ugly but it is at least a purgative. The soothing inflationary alternative nurtures a more chronic disease in place of that febrile crisis, but this is an illness whose mortality rate may well turn out to be higher, not lower, than its more acute cousin. Arguably, too, it is one which introduces even more inequity into the system for while neither the struggling debtor, nor the prudent, middling sort see any benefit from the asset-heavy, differentiated increase in prices, the members of  the speculative class make out like the state-sponsored bandits they are.

QE may thus prove to be little more in form than an issue of letters of marque to our era’s financial privateers on a truly unimaginable scale. Every new higher close on the stock market and every notch lower in bond yields and credit spreads should therefore be added to the charge sheet of financial larceny, even if the move does not end up inducing a panicky rush for the wheelbarrows.

But, in any case, what do we mean by ‘deflation’? In truth this should imply an increased perception that money has become more scarce, whether because the quantity available has actually shrunk or because money – final-settlement, trust-no-man money – is being demanded in place of the Good-time Charlie credit which was formerly allowed to assume some of its functions.

15-02-27 Bank Credit

On that score, we can hardly talk of the United States being at risk of ‘deflation’. To consult but two of the more timely gauges of the financial temper of the times, commerical bank balance sheets – minus the hoard of excess reserves they have been forced to pile up at the Fed – are again growing smartly, rising by 7.8% YOY, close to the best in five years and not too far removed from the 8.4% median of the two decades preceding the collapse of Lehman. Money proper is also not in short supply, rising 10.4% nominal, 8.1% real in the past twelve months and so moving far, far above the long-term trend.

15-02-27 USM1+

Even if we do succumb to the dubious practice of defining deflation by means of a simple fall in what we imagine to be the general price level, it is not at all clear that any ‘threat’ to any but the most confirmed sufferer of katatimophobia exists either at present.

Take the Cleveland Fed’ s Median CPI index, for example, an index whose primary virtue is that it throws out the outliers, high and low, and so is less affected by either positive or negative ‘shocks’ to small numbers of its constituents.

As it has for some little while now, this is giving a thoroughly, unexceptional, if not impressively stable reading: one which, moreover, manages to meet that cabbalistic ideal of modern central bankerhood of a rise of close to 2% per annum – at which sacred pace, we are constantly assured, the doors to earthly paradise will instantly be thrown open.

15-02-27 MCPI

And lest this observation give rise to the opposite argument that if the maintenance of this Babylonianly perfect rate requires no countermeasures on the downside, it need call forth no monetary tightening either, just be aware that, as for much of the past four years, this leaves the real Fed Funds rate at highly unsettling 2%-negative. For comparison, the seventeen years of the so-called ‘Great Moderation’ between 1992 and 2008 saw a typical CPI rate not much more elevated than at present – at 2.7% – but also experienced a nominal funds rate of around 4% and an ex-post real one of plus-1.2%.

Given that, with the benefit of hindsight, this supposed golden era was the one in which were actively sowing the seeds of our own ruin, it might give pause for thought about quite how much harm our masters ‘ stubbornly accommodative stance is causing us again today.

 

Economics

Chart(s) of the Day

[This piece can be seen at Sean’s blog here http://truesinews.com/2015/02/24/chart-of-the-day/]

Taken over a forty year history, US gasoline is trading in its 3rd percentile – 1.8 sigmas from the mean – when expressed as a ratio of the price of heating oil. In seasonal terms, this makes sense as the winter draw for space heating coincides with the consumption lull in (discretionary) road transport and the anticipatory change of emphasis by the refiners. Given the severe weather being endured Stateside these past several weeks, it should surprise no-one to learn that stocks of heat are more than 8% below the mean for thetime of year, while those for mogas are 4.3% above that norm. Hence the wider price differential.

15-02-24 XBvHO lt
Courtesy: Bloomberg

On a much shorter timeframe, however, we can see heat coming under pressure in the current trading session as the recent crude-led rally fades. Gasoline, conversely, is so far holding up rather better. Time to spread ‘em in anticipation of the arrival of spring?

15-02-24 HO-XB
Courtesy: Bloomberg

With the yuan-dollar rate edging ever higher (led by pressures which seem to emanate from activity in the offshore version in HK), the Chinese press is starting to resound to the sound of calls for a more active policy of devaluation interspersed with a counterpoint of official denials that this is in any way being contemplated.

Apart from the slump in the euro – the ‘Zone being at least as important as the US as a Chinese export destination – the real killer has been the post-Abenomics move versus the yen, especially when gauged in terms of real (i.e., domestic price-adjusted) effective (trade-weighted) rates. Since the latter part of 2012, China’s currency has undergone a 73% overall, 19% annualized, rise versus that of Japan, prompting some of the latter’s companies to start thinking about relocating production back to their homeland. Not so much yendaka, as yuandaka, this time.

15-02-24 CNY TWI
Courtesy: Bloomberg

As WantChina Times put it  in a recent piece, the effects may already be beginning to make themselves felt:-

‘Citizen China, which produces Japanese Citizen watches, to fold its production base in Guangzhou, on the heels of Microsoft which announced on Dec. 17 its decision to close the mobile-phone factories of Nokia, under its auspices, in Beijing and Dongguan by the Spring Festival moving facilities to Nokia’s factory in Hanoi.

A number of other foreign enterprises are scheduled to join the exodus this year, including Panasonic, Sharp, Daikin, and TDK, all Japanese firms, which plan to transfer some capacity from China back to Japan or to other countries. Others, such as Uniqlo, Nike, Foxconn, Funai, Clarion, and Samsung, are setting up new factories in Southeast Asia and India, while scaling down their Chinese operations.’

So, you can see why some think China will be tempted to – err – address the balance, shall we say?

One thing is for sure, whether we look at Asian currencies’ relationship to the Greenback with (ADXY+J) or without (ADXY) the yen, the charts are pointing lower and that, in turn, suggests there is only one way for commodites to trade, too.

15-02-24 ADXY CMDT
Courtesy: Bloomberg

 

15-02-24 ADXYJ CMDT
Courtesy: Bloomberg

Finally, as Mme. Yellen gives us the usual rigmarole of soft-cop-hard cop-soft cop in her Congressional testimony, the market’s first reaction has been to believe that the Ghost of ’37 is still far from being laid: bonds have rallied nicely, especially in the belly where mid-curve euro$ have jumped 12bps or so in the immediate aftermath of her comments.

If, however, we compare the actual real Fed funds rate to the state of the job market – either using continuing jobless claims as a percentage of the population (here inverted) or the real wage fund (hours x pay rates / CPI) – you can see that Ms. Yellen is taking rather more of a gamble than she is willing to admit. From the Volcker Era to the Anti-Vocker Era, indeed.

Courtesy: Bloomberg
Courtesy: Bloomberg

Economics

Macro & Market Update

[This piece can be seen at Sean’s blog here http://truesinews.com/2015/02/17/macro-market-update/]

More than half a century ago, in his role as an advisor to the men responsible for trying to set Taiwan on the road to prosperity, a redoubtable economist called Sho-Chie Tsiang argued that the monetary authorities should stop suppressing interest rates and directly rationing credit and should move instead toward a more market-oriented system where real rates were sufficiently elevated to encourage productive saving.

His reasoning was that the existing combination of what we might call Z(Real)IRP with ‘macro-prudential’ control was plagued with several significant drawbacks.

Firstly, rationed credit tended to be crony credit – with only the politically-favoured having any hope of persuading the banks to lend to them. Secondly, the erosion of purchasing power suffered by any one depositing money in the bank at the prevailing yields meant that savers looked for other outlets for their surpluses, such as property and precious metals, neither of which did much to augment the stock of productive capital. Thirdly, this lack of genuine saving meant that all extra funding had to rely on inflationary credit creation and thus necessitated even more macro-prudential monkeying with the price mechanism. Fourthly, anyone outside the charmed circle of accepted borrowers – which tended to mean anyone with a hint of genuine entrepreneurship – had to raise funds in a quasi-illicit and certainly non-transparent manner and so had to promise exorbitantly high ‘curb’ rates of interest to compensate their lenders for the extra hazards involved.

Tsiang argued – and was soon to be proved totally correct in his assertions – that by allowing the rate of interest to find a level where market for funds cleared – essentially where the impulse to thrift intersected the expectation of profit – not only would all these disadvantages be eradicated, but the funding rate applicable to the WHOLE economy, as opposed to that charged to the privileged few, would be lower on average, not higher, as the risk premia associated with the ‘shadow’ market were removed.

In the decades after the Second World War, Taiwan, not entirely coincidentally, transformed itself from a backward, low-value added, crisis-wracked basket case into the economic prodigy to which we still look for so many of our high tech gizmos today.

The reason for the history lesson should be obvious if we consider that much of the same reasoning is relevant to mainland China today, even if the scale of the problem is somewhat larger in a country of 1 1/3 billion people.

Beijing knows that it cannot afford to persist with ‘business as usual’, that the ‘three overhangs’ relating to past over-expansion and misdirected effort have to be overcome while moving to the ‘new normal’ of less force-fed growth-for-growth’s sake. The issues with this are twofold: will the authorities stick to their course, even when the waters get choppy and, if they do, can they then hope to bring the ship of state safely into harbour before the leaks springing from its every timber send it to the bottom?

On the monetary front alone, the issue is fraught. The PBoC, as everyone knows, was moved to cut the required reserve rate a week or so back and so sparked a renewed clamour for further, substantial easing even though the main reason for the reduction was technical: the traditional Lunar New Year cash squeeze was bumping up against the very substantial reserve drain occasioned by the last few months’ sizeable forex outflows.

[CLICK TO ENLARGE ALL GRAPHS]

15-02-16 China M1

Against such a backdrop, the monthly money and credit numbers were exceptionally hard to read. TSF rose, but less than it did in each of the past two years. Loan growth, however, was the second highest on record. On the other side of the balance sheet M2 slowed to a multi-year low increase of 10.2% (even though overall deposits jumped by the most on record!) and yet, within that total, M1 money remained unchanged in a month in which it often falls so its rate of climb therefore rose to a 20-month high of 10.6%. Confusion confounded, indeed!

15-02-16 China TSF

What is key here is that Lui Lei of the central bank came out to argue that any intervention should henceforth only be aimed at alleviating liquidity shortages, not at fostering hothouse growth, while Xu Lin of the NDRC hinted that the latest Five-year Plan would insist on a ‘floor’ for growth of a mere 6.5% – a significant psychological climb down from the economy-doubling 7-handles to which the regime has heretofore grimly clung. Guan Tao of the SAFE next went so far as to make explicit reference to the parallels between his country today and its Asian neighbours back in 1997 on the eve of their great crisis (and he should know: $10 billion+ leaked out again in January, his employers had just revealed).

Courtesy: Bloomberg

For all the worries, this was not enough to prevent the ChiNext from making a new high – taking its run to 233% these past two years. We suspect, however, that it will pay to sell a reversal somewhere in the next 10%. We are also intrigued by the similarity between the HK H-Shares chart and that for pre-collapse crude – or, for that matter, between the index and all manner of commodity-related indices in recent months.

Courtesy: Bloomberg

It is also fascinating to watch sentiment start to dissolve among the US punditry. As the newsflow become more nuanced, market participants have become schizophrenic with regard to oil prices – lower is ‘a tax cut for the consumer’ but is also about to blow up the junk bond market, depending on who is talking. The Dow, for its part, has rallied on cheap energy, but also rallied on a rebound in oil prices which was said to signal continued demand. So long as it rallies, one supposes…

Amid a stretch of numbers which, aside from those concerning employment, were somewhat disappointing to a consensus only lately set four-square behind the thesis of US economic triumphalism, some unusual attention has been paid of late to the lacklustre retail and wholesale sales numbers – mainly becuase they, too, looked weak.

For our part, since these are the nearest thing we get to a timely measure of economy-wide revenues (and hence not just to an NGDP number, all you market monetarists and Neo-Hayekians out there, but to an NSOP – a nominal structure-of-production flow) we tend to pay close attention to them as a matter of routine. What is at issue here, however, is the very fact that these arenominal numbers and are therefore hard to interpret when large, supply-side price changes are underway, as is arguably the case in all things related to natural resources as well as, for the US with its persistently strengthening currency, to imported goods of a more general character.

Since it is the sales margin that ultimately counts for the success of an enterprise, the first thing we need to assure ourselves is that falling revenues need not be wholly bad, as long as costs fall commensurately alongside them. There are, as ever, several caveats to this broad pronouncement.

Firstly, we have to hope that the aggregate decline in selling and buying prices does not mask too great a disparity between conditions in one business and the next. We must also beware the fact that any resulting windfall for one is not ruined by the shortfall for another when the impact is not a simple matter of addition and subtraction but acts in a non-linear fashion – e.g., through its implications for the credit structure. Finally, we have to wonder how the necessary fall in nominal costs will be achieved when it comes to those associated with the payroll. We should all recognise that real wages are what determine our standard of living, but we must also bear in mind that it is the nominal ones over which we fight and for whose maintenance jobs are often sacrificed.

Courtesy: Bloomberg
Courtesy: Bloomberg

With that in mind, let us note three broad trends which are at work. Number one, inventory/sales ratios are rising to levels not seen (barring the Snowball Earth episode of the Lehman Crash) in anything up to thirteen years across manufacturing, wholesale, and retail. To what extent this just reflects a lag in marking down inventory values but having instantlyto recognise lower sale sprices, rather than something much more sinister, only time will tell. Nevertheless, the adjustment, when it comes, will have to be reflected in both a capital write down and a temporary reduction in profits in the relevant period, so there is scope for further anguish.

Courtesy: Bloomberg
Courtesy: Bloomberg

Number two, wage bills in relation to sales receipts have also been pushed to their least favourable in more than a decade and, again, while the marginal return on labour could come out unchanged if the margins are unaltered, lowered revenues could nonetheless serve to jeopardize employment levels. Number three is that the value of outstanding C&I loans is rising in relation to the stock it is financing i.e., collateral coverage is slipping to an extent which may soon start causing jitters among the lenders.

Courtesy: Bloomberg
Courtesy: Bloomberg

While bearing this wobble in mind, also consider that P/Es are back to where they were on the eve of the last crash as is price/book. Price/sales is where it was at the height of the Tech Bubble and returns on capital – measured using both cash flow and free cash flow – are at or approaching their lowest in five years. As ever, the main source of support for the stock market is the deliberately suppressed level of bond yields.

15-02-16 REGF SPX

One way of illustrating this distortion of the bond market is to look at bond risk – such as modified duration – versus bond return, i.e., yield-to-worst. Off the scale, is the simplest way to describe it.

Courtesy: Bloomberg
Courtesy: Bloomberg

As unsustainable as all this looks – not to mention how perilous it all is – the key is to try to find a reversal clear enough to be played. A week or two back, we suggested that the T-bond might be headed to 2.20% and that, if such a level held, one should try to sell against it, scaling in above 2.45/50%. Well, 2.22% has been the low so far and we have had a smart 43bp, 8.3% price reversal since hitting it. So far, so good, so short.

Courtesy: Bloomberg
Courtesy: Bloomberg

As for the rest of the market, WTI is testing the top of a neat profile built at the bottom of the rout (and so, theoretically signalling much lower lows ahead). If it breaks the top of this band, it could swing up to a nice, round $60/bbl where the mid-point of the Thanksgiving Day massacre comes in. Brent looks a touch more positive, so signals are mixed and while not yet convinced we have seen the worst, we would hesitate just yet to position too aggressively as a result of the disparity.

Courtesy: Bloomberg
Courtesy: Bloomberg

Copper, too has seen a little cautious buying, taking it back to the bottom of the old range. On the one hand we have maximum spec shorts both outright and as a percentage of O/I: on the other, the recent, hefty cash premium has almost disappeared as LME inventories have built rapidly, rising 85% since Christmas to a 16-month high. Sell any identifiable failure here but stop out if it does build back above $6000

Courtesy: Bloomberg
Courtesy: Bloomberg

Likewise, gold – while below $1245/50  – stays negative, looking for a possible retest of $1180 and, one day, a break of the decade-old uptrend to usher in the opening up of a route back to the LEH crisis levels down around $800/oz.

If gold is to weaken further, that almost presumes that risk will not spike higher and also that dollar strength will continue at what is now an important technical level for the greenback – at the 50% retracement of the 2002-11 decline and at fairly overbought levels.

Courtesy: Bloomberg
Courtesy: Bloomberg

While below $1.450/00 the euro does not look like spoiling the party but rather giving it a boost by falling to the long-term linear mid at $1.0700 (and possibly, since the trend on this chart has already given way to the log one at $9275/00)

Courtesy: Bloomberg
Courtesy: Bloomberg

However it is espressed in the weakness of pair currencies, a continued USD advance should mean positive feedback with other US asset classes so it is worth noting that the MSCI US index is fast approaching its historic peak relative to the ROW equivalent. Bears will hope that top holds: bulls will be wishing for a full, swing pattern repeat of the 1988-2002 move and hence for much more upside to come.

Courtesy: Bloomberg
Courtesy: Bloomberg

The Nikkei, meanwhile, remains locked – once we peel back the veil of weak Yen money illusion – in the range which has contained it these last 18 months or so. the best hope is that this consolidation wil eventually move the longest line higher both on the medium term scale of the last 5 years of rebound and on the larger scale of the whole three decades of bubble-and-bust.

Courtesy: Bloomberg
Courtesy: Bloomberg

The sad fact remains that, if we adjust for changes in the yen’s international worth via the TWI, returns for the entirety of that period sweep out a quasi-normal, mean reverting distribution. Still, a push to the top of that formation’ s value area would be nothing to sniff at, were it to come about through the processes just discussed.

Courtesy: Bloomberg
Courtesy: Bloomberg

Finally to Europe, where NIRP is beginning to preclude even momentum-driven returns on bonds and is pushing people instead into the stock market. The DAX appears to have broken out against the REX as a result, meaning it has every chance to test the last cyclical highs, set back in 2007, in the weeks ahead.

Courtesy: Bloomberg
Courtesy: Bloomberg

Note, however, that though the idea of European outperformance is becoming more widely shared – not least because of effects of the rapid growth in money supply even pre-QEuro – there is actually little in the graph of Germany v the USA in common currency to suggest this presentiment will be borne out in practice. If you do wish to play for a rise on the Continent, therefore, it seems as though you would be best advised to hedge up your forex exposure when you do so.

Courtesy: Bloomberg
Courtesy: Bloomberg

Good hunting!

Economics

A World In Debt

In his magisterial 1936 work, ‘A World in Debt‘, Freeman Tilden treated the business of contracting a loan with a heavy serving of well-deserved irony, describing how the debtor gradually mutates from a man thankful, at the instant of receiving the funds, for having found such a wise philanthropist as is his lender to one soon becoming a little anxious that the time for renewal is fast approaching. From there, he turns to the comfort of self-justification, undertaking a little mental debt-to-equity conversion in persuading himself that his soon-to-be disappointed creditor was, after all, in the way of a partner in their joint undertaking and so consciously accepted a share of the associated risks.

Next he adopts an air of righteous indignation at the idea that he really must redeem his obligation on the due date, before rapidly giving into a growing fury in contemplation of how this wicked usurer has duped him into contracting for something he cannot hope to fulfil, as so many poor fools before him have similarly been entrapped by this veritable shark.

Likewise, our author quotes the 19th century utilitarian, Jeremy Bentham, to much the same effect.

‘Those who have the resolution to sacrifice the present to the future are natural objects of envy’ for those who have done the converse, our sage declared, like children still with a cake are for those who have already scoffed theirs. ‘While the money is hoped for… he who lends it is a friend and benefactor: by the time the money is spent and the evil hour of reckoning is come, the benefactor is found to… have put on the tyrant and the oppressor.’

Here we should realise the pointlessness of trying to decide whether the Greeks or the Germans are at fault in the present impasse and press on toward the crux of the matter. As Tilden rightly argued about the consequences of a bust:-

‘It follows that any scheme looking towards the avoidance of panics and depressions must deal with this cause [viz., debt] and any plan that does not do so is not only idle, but may be a dangerous adventure.’

‘Hence, the way to deal with a collapse of exchange is not to pretend that “prosperity” is merely in a temporary eclipse, to return again if everybody will act optimistically; but frankly to acknowledge that conditions were unsound, and to permit the natural impulses of trade to rectify them. This prescribes a bitter medicine, which people do not like and politicians cannot collect upon, but quack remedies merely put off the final reckoning.’

Are you listening, Mario?

‘The natural remedies, if the credit-sickness be far advanced, will always include a redistribution of wealth: the further it is postponed, the more violent it will be. Every collapse of credit expansion is a bankruptcy and the magnitude… will be proportional to the magnitude of the debt debauch. In bankruptcies, creditors must suffer.’

The problem with our modern world is that the ‘quack remedies’ we most routinely favour are ones which involve adding another layer of ‘debt debauch’ on top of the still uncleared detritus of the previous one. If you doubt this, I must ask what else, pray, do you think is entailed by QE in all its many variants if not the attempt to find new, biddable debtors to take the place of the grumbling, undischarged old ones?

Even if you are loth to accept this line of reasoning, you surely must concede that a ‘putting-off of the reckoning’ comes with many disadvantageous features and several self-aggravating tendencies and that this should be obvious enough to anyone with sufficient intellectual honesty to consult the record of the past few years – if not decades – objectively.

Firstly, it encourages a wasting forbearance of dead or dying enterprises in a kind of lunatic refusal to recognise that the associated costs are well and truly sunk and that the only valid criterion for continued investment is the judgement that the undertaking will be viable from today, not whether we can thereby avoid booking the losses incurred by it yesterday. Such ‘zombification’ retards, if not prevents, the necessary reallocation of men, machinery, and financial means toward more profitable (and hence more socially beneficial) employment. By propping up the diseased trunks of the past, it prevents light and nutrients from reaching the thrusting saplings of tomorrow. Creative destruction is out and destructive continuation is in to the detriment of all.

Worse, yet, the feeble, ‘stimulus’-dependent manifestation of growth which does then occur leads to that dreadful, anti-Hippocratic impatience to which all our electoral cycle overlords are prone. Bad policy thus leads to more bad policy – whether by way of simple reinforcement of ineffective treatment or by jejune ‘innovation’. As more and more market signals become scrambled, as larger and larger swathes of the economy are turned over either to run-‘em-for-cash basket cases or to newly malinvested Bubble 2.0 entrants upon the stage, the space for genuine entrepreneurship becomes progressively restricted. Growth therefore slows, cycle after cycle, until men in authority – who really should know better – start to mutter rehashed 1930s pessimism about ‘secular stagnation’.

Compounding all this, of course, is the awful truth that practitioners of mainstream economics are in thrall to age-old underconsumptionist fallacies and so require – nay, demand – that no debt must ever be paid down in aggregate (or, as they like to put it, in order to give the idea a thin sheen of respectability, the total of outstanding credit must never fall). Thus, with each successive cycle, new strata of debt are laid down upon the barely eroded bedrock of stale, older ones. Thus it is that the burden of servicing such a growing mountain of claims – an orogenesis of obligation, we might say – can only ever go up. In turn, this results in the officially-imposed interest rate cycle becoming more and more truncated, with each peak lying below the preceding one and with each trough being pushed to – and lately through – the zero bound so that the income drain imposed by that tower of debt does not become too onerous or the old problems re-emerge with renewed venom.

As official rates trend downward, the private sector usually seeks to go one better. Knowing that the debt principal holds little place in the popular imagination but that the monthly payment is the true determining factor in the bargain, lenders start to push out maturities and/or forego the requirement that loans should be smoothly amortized. Not only does this allow the already-indebted both to refinance and then to add to the sums they owe, but it helps entice new cohorts of previously unwelcome borrowers to live beyond their means as well. A fifty-year mortgage or an eight-year car loan? Step this way, sir, we’ll see what we can do.

Soon so much income has been alienated – much of it for such entirely unproductive purposes that little extra earning potential has been acquired in the process – that what we call the intertemporal imbalances again become insupportable. In the current jargon, so much spending has been ‘brought forward’ to prop up today’s faltering system that ever more desperate measures are required to find new expenditures to accelerate and new prodigals to accelerate them when arrives that tomorrow whose fruits we have ‘brought forward’ and the orchard is seen to have been long since stripped bare of its bounty.

On top of this, the eradication of any appreciable opportunity cost in keeping money for its own sake in preference to owning one of the many recognisable claims on greater future money payments (loans, bonds, etc.) leads to a dilution of the principal source of demand for money, the one only transiently expressed in respect of its imminent use as the medium of exchange. This not only confuses the indicators by which we try to balance today’s thrift with tomorrow’s hopes of improved output, but it begins to poison the monetary manipulators’ own wells, to boot.

Accordingly, if money is seen as conferring no great disadvantage should one hold it in place of an ultra-low yielding bond, then the disingenuous assertion first made by Chairman Bernanke that QE is not inflationary because it comprises nothing more than an ‘asset swap’, starts to become all too true.

The central authority, desirous of creating just such an inflation out of a predominant fear of the effect of flat or falling prices on all those whom it has been ceaselessly exhorting to continue to overborrow, easily generates base or ‘outside’ money on which new loans could theoretically be pyramided. But, alas, the commercial banks passively book a good part of these reserves as the primary balance sheet counterparts to the largely inactive settlement deposits of the sellers of the bonds earlier ‘swapped’ for them. Thus, excess reserves do not induce the creation of many additional earning assets – and hence of ‘inside’ money deposits – on top of the original influx.

Moreover, where those same depositors do start to feel their trouser pockets heating up, they typically start to play pass-the-parcel with one another by engaging in a bidding war for bulk credits or listed equities on the financial market, inflating their values and further reducing yields below their optimum levels. What they do not do is rush out and make loans to small businessmen so that these latter earnest souls can improve their capital stock or expand their workforce, no matter what M. Sarkozy may have blustered in 2008 about wanting to ‘…put down the foundations of a capitalism of the entrepreneur and not of the speculator’ as a response to the ongoing financial apoplexy.

With barely a nod to the operation of the much vaunted ‘transmission channels’ so beloved of academia, real-side monetary ‘velocity’ is therefore seen to decline and before too long, the central bank is casting about again for new, more ‘unorthodox’ ways to engineer a perceived surfeit of money and hence to promote a more rapid transactional circulation of the stuff. The vicious circle takes another turn as it does: rates decline further across the curve and yet both borrowing and real-side activity are again only modestly excited.

Before long, men in authority – who really should know better – start to mutter freshly cooked forms of idiocy, claiming that the ‘natural’ rate of interest has fallen to a negative value – a state of affairs in which they must imagine that all of us intemperate, impatient, indulgent mortals have somehow switched en masse to a rare preference for the delayed, rather than the instant, gratification of our wants. Even worse, they find no paradox in supposing that the inexhaustible Horn of Plenty, without which no such unmitigated satiation can have been brought about, must have made its wondrous appearance in a period of mass unemployment and so, presumably, also one of mass want.

In the Looking Glass world of ‘secular stagnation’ and ‘negative real natural rates’ to which all this monetary accommodation has supposedly consigned us, can you guess what the prescription for a restoration of normality must be? Of course! A determined effort to swamp the world with yet more central bank money, to further suppress interest rates, to co-opt more of the decision-making to the central planners, and to annexe more of the economic realm to the fiefdoms of Frankfurt, Washington, and Threadneedle St.! Whatever it takes, don’t you know?

So, with all that said, we come today to yet another major confrontation between lender and borrower in the respective shape of Germany and Greece, one which has foolishly been delayed for more than seven years by the unshakable intransigence of those in power.

This all began with the early crisis vainglory that ‘no strategic bank will fail – and, yes, they are all strategic’. It continued into 2010 when M. Trichet pointed his metaphorical revolver of the refusal to continue with emergency support right at the head of the unfortunate Irish Finance Minister Brian Lenihan – a kind of financial Melian dialogue which the Greeks seem to have well taken to heart, now that such threats are being repeated once more. It rolled on and on with the efforts of the so-called Troika and with the ever-changing, but never truly effective programmes of the ECB itself. It mounted with the widespread abuse of Target2 – something that is, after all, supposed to be a clearing system, not a continent-wide credit wrapper – and with the inordinate strain placed on the balance sheet of the neighbouring SNB.

All the while, the insidious transfer of debt from the private sector to the state (or at least to banks which could not survive absent either explicit or implicit support from that state) has continued, so rendering the necessary resolution between creditor and debtor too diffuse, too indirect, and too legally undefined ever to achieve.

Pity then a Greece which is unfortunate enough to be stuck at Europe’s bottom-right corner instead of at Asia’s top-left, or an Iberian peninsula separated from its neighbours by the Pyrenees to the north rather than by the Atlas mountains to the south, for can we find it at all conceivable to think that they would both not have long ago have seen their debts meaningfully restructured, much of their dead wood cut away, and many of their people set back on the road to prosperity if they had been ‘emerging market’ nations and not satrapies subject to the reality-denying Canutes who run the EU?

For all the hand-wringing about ‘mindless austerity’ on the part of that economic luminary who occupies the Oval Office between golf rounds and for all the wailing conducted over ‘deleveraging’, the sorry truth, of course, is that neither a shrinkage of government outlays nor an overall reduction in debt levels is to be found in even the smallest corner of the globe.

15-02-11 McK Debt

To take one much quoted recent study, this month’s McKinsey report estimates that, since the start of the Crisis in 2007, global debt has risen by some $57 trillion (so, by around $8,000 for every man, woman, and child on the planet) with almost exactly half of the increase in the sub-total attributable to non-financial entities being the fault of those oh-so heartlessly austere governments who have run up an additional tab of a cool $25 trillion in that brief space of time! This means that, in the 6 ½ years of slump and reflation, Leviathan has treated himself to almost $11 billion a day in deficit spending, a sizeable deterioration of almost 2 ½ times the paltry $4.3 billion it was gobbling up during Pharaoh’s preceding seven years of plenty.

It may not be enough to satisfy a Krugman or a Lagarde, but for our taste that represents a dreadfully large quota of capital either frozen in place, shovelled (sometimes literally) into sub-marginal, make-work projects, or simply squandered on recipients of welfare – whether corporate, individual, or among the serried and largely sacrosanct ranks of the place-holding bureaucracy.

15-02-11 APAC v ROW

Looking instead to the subset represented by the BIS numbers for ‘global liquidity’ – i.e., the loans extended to and securities bought by banks from non-bank borrowers –we see a similar picture. Since Lehman fell, $25 trillion has been added to this particular pile, an increase of one-third from its starting point. Somewhat alarmingly, two-fifths of that increment has its origins in the Asia-Pacific combination of China, Taiwan, Indonesia, India, Korea, Malaysia, the Philippines, and Thailand. Indeed, the last twelve months’ 21.4% increase in cross-border lending to the region has capped off a nearly 80% rise in debt owed by this octet in the period under consideration. To gain some perspective on the magnitude of this, it should be noted that the $10.3 trillion which this involves matches the sums jointly accumulated by governments, households, and non-financial companies in the whole of Europe, the US, Japan, and Latam put together.

Inflation is a rich man's game
Inflation is a rich man’s game

A sizeable proportion of that, it almost goes without saying, lies at the door of the Chinese and, coincidentally, the PBoC has been gracious enough this week to reveal its estimate of what it calls Total Social Finance (a hybrid of bank and non-bank credit, together with a smattering of non-bank equity issuance) – an inclusive agglomeration which the likes of Fitch would argue even so does not in any way account for the whole of the web of obligations being woven so densely across the Middle Kingdom.

 

Nevertheless, the totals we are given are impressive enough. As of the end of last year, the central bank reckons that TSF outstanding came to CNY124 trillion (around $20 trillion). Having pretty much been stable at a ratio of just over 120% of GDP in the prior six years, the massive stimulus programme unleashed in the immediate aftermath of the GFC and never truly attenuated since has seen the credit measure more than triple in absolute size the most recent six, pushing the ratio dangerously skyward to 193% of national income.

15-02-11 TSFvGDP

This is the legacy whose baneful influence makes up those ‘Three Overlays’ of debt overhang, surplus capacity, and urgent restructuring with which Beijing likes to remind us it has to tussle on the (Silk) road to its ‘new normal’ of slower, more rational growth, and more market-oriented, value-added activity.

So here we have both a major peril and a possible source of hope. The Chinese authorities appear to have recognised that, by following the practices preached by the execrable Western mainstream – albeit on a truly gargantuan, command-economy scale – it has gone beyond the bounds of merely diminishing to reach the Omega point of no return.

So far, as its economy has stuttered and stumbled along, it has resisted the temptation to add just one last, generous coup de whiskey in order to postpone the inevitable hangover (which does not mean it has been entirely abstemious since the new boys took over in 2013). But now not only is growth stuttering, but many prices are falling, too – principally, if not exclusively, those of the raw materials for which it has such a voracious appetite. However beneficial this discount may be to cash-strapped processing firms, it has nevertheless raised the bogey of so-called ‘deflation’ in the counsels of the wise

The question therefore presents itself: will Xi and Li stick to their guns and rely on broader micro-economic and institutional reform to foster a national renaissance – albeit one backed up with a little judicious concrete pouring ‘Along the Way’, i.e., along the route of the new trade routes being constructed to Europe? Or will the pressure to deaden the pain in the interim prove too intense and so unleash both indiscriminate policy easing and possibly an export-boosting devaluation of the yuan?

So far, all the signals are that they will resist the urge, despite a barrage of domestic commentary to the contrary, but a great deal hangs on the fortitude of Xi himself, that one lonely man, perched at the top of the CCP hierarchy – an organisation which itself sits uneasily at the very peak of a true Mount Olympus of debt.

Economics

How did we end up here?

While money can be made in markets on the minutest of scales, sometimes it helps to have a broader sense of perspective. After all, if you can’t locate yourself on a map – without the aid of GPS, children! – you don’t know where you are and if you have no grasp of history, you don’t really know who you are either.

15-01-31 IMF ALL (2)
Courtesy of Bloomberg

So, focusing on commodities in this instance, we here use the monthly IMF price report to construct an overall index composed of energy, ags, base and precious metals by blending them with the typical sort of weightings favoured by the major tradable indices of today.

As can be seen from the graph, commodities – priced in the dollar of the day over the last four decades of floating exchange rates and unanchored policy – form a neat, symmetrical pattern when plotted on a log scale (on which equal percentage, not arithmetical, moves have the same length). At the bottom left lies the substantial, two-stage rise in prices which finished by defining the upper and lower bounds of what would turn out to be a 33-year central value area, This took place, as needs little recounting, over the course of the two Oil Shocks of ’73-4 and ’79-80.

A long decline followed that first peak, one punctuated both with the 1986 oil crash – from which many are drawing a chastening lesson today – and with the spike which attended Saddam’s invasion of Kuwait and the First Gulf War, before the move came to an end in the chaos of the 1998 Russian bankruptcy and the climax of the shattering Asian Contagion.

From that nadir, we have lived through the so-called ‘Super-Cycle’, whose salient features were the run to near $150/bbl oil in 2008, the ensuing financial collapse, and the Great (Chinese-led) Reflation which followed. Three years were spent zigzagging lower in a narrow corridor thereafter – during which ags hit their highs, metals ground ever lower, and silver and gold each made record highs before going into their own, separate tailspins – then came the dramatic, front-led breakdown of the energy complex, the last resort of the commodity bull to that point, a man who luxuriated complacently in a narrowing range, falling volatility, and a then-remunerative inverted (‘backwardated’) forward curve.

From here, the question is whether the current uptick is any more than a bout of short-covering which is doomed to relapse and print new lows once the overstretch inherent in an almost uninterrupted 60% plunge is worked off, or whether some more meaningful recovery can be staged. We still have our doubts about the latter outlook and would watch for behaviour near the 2009 low and the old range high (or in terms of the most heavily weighted of the constituents, crude oil, whether it will hold above first $40/bbl then $35).

If not, we face the possibility of a reversion to the mean/mode of that 1974-2005 band at a level loosely corresponding to $20/bbl oil.

Courtesy of Bloomberg

Courtesy of Bloomberg

Of course, the foregoing discussion has all been conducted in nominal terms – that is, without allowing for the general decline in the purchasing power of the dollars in which the index is measured (itself something of a tail-chasing concept since we calculate that same depreciation by looking at how much ‘stuff’ a dollar buys today compared with yesterday and some of that same ‘stuff’ is energy itself, so this recalculation inevitably contains an inseparable mix of relative and absolute prices changes).

We choose here to make the adjustment not in terms of that often rejigged and housing-heavy basket of goods, the CPI index,, but in terms of what that aristocrat of the labour force, the American manufacturing worker, can buy with an hour’s worth of his time on the assembly line.

Once we make the necessary reckoning, the long decline over the last quarter of the last century is thrown into an even starker relief. It also becomes clear that the rise from the secondary, post-9/11 low to 2011’s reflation peak lasted almost exactly as longas did the first great lurch higher and that it reached its apogee at almost exactly the same height as did its forerunner.

Here, we would note that, while trading below the 199o spike and/or its nearby fib level, the distribution’s mid and the 2008 lows look well nigh unavoidable from a technical perspective.

Courtesy of Bloomberg
Courtesy of Bloomberg

Having adjusted for the dollar one way, let us now do so in another. For the world beyond America’s boundaries, it matters not a jot if the dollar price of corn or cotton goes up by 10% if the greenback moves a similar proportion in the opposite direction in terms of the local unit of exchange. In order to isolate the history of price changes from the worst of this effect, the simplest – if very approximate – operation is to multiply the index by the trade-weighted value of the dollar and so we do.

Here, too, we can see how clearly delineated was the ‘Super-Cycle’ – i.e., that coincidence of China’s ‘opening up’ and the Europeriphery’s enjoyment of cheap German finance with a sustained spell of preternaturally low interest rates around most of the world (rates which now, of course, seem unattainably lofty!). the ‘Committee to Save the World’ has a lot to answer for!

We can also see just how decisive the last six month’s break has been and note that technicals, at least, offer little support for something still so historically elevated and presently so remote from any momentum-sapping area of well-populated precedent.

Courtesy of Bloomberg
Courtesy of Bloomberg

Finally, since only very few participants in our markets buy commodities for their own sake, but rather do so with a nod to the Modern Portfolio Theory superstition of ‘decorrelation’,  we offer up a graph of commodity prices (not returns) versus stock prices (not returns). Now it is the various highs and lows which seem to define an all-encompassing, downward-sloping channel of chronic underperformance.

Within this long, gloomy run, we can identify two periods of relative commodity glory of roughly equal extent and duration, spaced some thirty years apart. The first occurred during the Great Inflation which bracketed the break-up of Bretton Woods and the first fumblings toward its replacement monetary order, the Age of the Independent Central Bank (reverentially capitalized, of course). The second, one might contend, coincided with the end of the so-called Great Moderation which followed and – we would suggest – with the ongoing transition to a new and yet unspecified era wherein the follies and failings of our generation of manically-active, inveterately hubristic, printing-press central planners will be utterly repudiated in its turn.

Ask not for whom the Bell Tolls; it Tolls for QE.

Economics

One Leg to Stand on

Here’s a question for all the cheering QEuro fans out there. If you came across a country where both real and nominal money supply were growing at rates in the low teens – something its people had not experienced for almost a decade and close to the fastest seen in the last four – would you consider it to be a victim of ‘deflation’? If not, what help do you suppose an expansionary central bank would be to it?

Courtesy of Bloomberg
Really, Mr. Draghi?!?

 

Imagine next what would be the state of that nation if, in a five year burst of temporary insanity, it had it had contracted 2 ½ times as many bank loans as it had when it first went mad and that it had thus registered four times the net indebtedness (loans less deposits) as when it began– a deficit which nearly equalled the combined shortfall of its two largest neighbours put together, despite the fact that they were three times as heavily populated.

Now you might well suppose that, if such a thing could ever be advisable in such circumstances, the central bank could readily offer an effective incentive to carry the tendency further were it only to act to suppress interest rates across the curve.

But consider instead what would be the case if, after another five, nearly six, years of blood, sweat, toil and tears, that nation had rid itself of 30% of its loans, had added 25% to its stock of deposits, and had therefore shrunk its net indebtedness by an impressive two-thirds to return itself to where it was in relation to national income eleven years previously. If you were also told that households, having gone into hock to the tune of 28% net from an initial position of small surplus, were now, thankfully, back in credit, would you imagine that the plight of the saver might outweigh that of the borrower in the ordering of their priorities?

If so, you would be considering whether Spain should rejoice at Snr. Draghi’s latest coup de main or whether it should balefully consider that he was not only gilding a lily, but bedizening one from which the bloom had long since faded, into the bargain?

Courtesy of Bloomberg
The Prodigal returns. Spanish finances & liquidity improving

 

Nor might you sing Hosannas if you were Swiss or Danish since it is principally in those two peripheral nations that the overspill is most violent. Denmark has cancelled this year’s government bond auction schedule in a kind of QE by omission even as the central bank has continued to force interest rates deeper and deeper into negative territory – to the point where there are apocryphal tales being told of a people who are among the developed world’s most indebted being paid to take out floating-rate mortgages.

That will end well, if true!

As for the Swiss, it seems that the habit dies hard of putting the national balance sheet at the disposal of those wanting to short the euro at subsidised rates. We say this because, even though the €1.20 hard floor was abolished in the middle of the month, in the two weeks since, sight deposit balances have risen by some CHF44 billion – clearly a much higher run rate than during the preceding six weeks when a mere CHF29 billion was accumulated. The most that can be said for this is that the SNB has been improving its average (assuming the very strong hints of continued intervention are confirmed), getting euros on board at rates from CHF0.85 to CF1.05 so far and again depressing bond yields further below zero.

Courtesy of Bloomberg
Courtesy of Bloomberg

With Syriza trying to work out how far they can push a Union which would gladly be shot of them if that were not to open the infamous box of a certain over-inquisitive Greek lady; with Bepe Grillo still trying to engineer a referendum on the euro membership of his native Italy; Podemos pulling the aggrieved of Spain into the streets in their thousands; and the AfD having come out of their conference in Bremen all signed up to fighting the mainstream parties, not each other, the pressure will persist. There will be many trying to find a safer haven for all those shiny new euros with which Mario will be happy to furnish them so they can express their doubts over the course he is taking in cold, hard(er) cash. The Danes and the Swiss may therefore end up with rather more of them than they otherwise might wish.

If we look beyond this to the wider markets, we can see the ripples from the stone thrown in by the ECB spreading as far away as China where the press is starting to run stories about how disadvantageous the rise of the yuan is becoming for a nation tacitly hoping for a quick, external outlet for some of the unwanted goods which its heavily underutilized industrial base is all too capable of producing.

Coupled with the growing unease of some of those who have borrowed those ever rising dollars to dabble in the onshore market – possibly via the medium of one of those commodity plays whose collateral value is not exactly beyond question these days – this is beginning to test the mettle of the PBoC at its idiosyncratic daily fix (the one where it simply refuses to entertain any bids beyond the rate it has settled upon and so allows a recalcitrant market no outlet for its frustrations).

Though nothing definitive has yet occurred and even if, rather than breaking any key levels, the stock market is tending to churn up and down near the highs, one is hard pressed not to give in to the foreboding that the sands are shifting: that, grain by grain, the cosy consensus of the last several quarters is starting to erode.

Courtesy of Bloomberg
Courtesy of Bloomberg

Take for example the fact that the US market is beginning to lose some of the effortless predominance it has so long enjoyed. Indeed, that leadership – wherein a rising stock market draws in the capital with which to move the dollar higher while the rise in the dollar makes the equities denominated therein gain more ground on their global rivals – has been challenged these past three weeks or so to a 2-sigma extent not seen since mid-2010.

Courtesy of Bloomberg
Courtesy of Bloomberg

This reversal, though not yet so large as to magnify our nascent sense of alarm, does add to the suspicion that change is in the air. That said, however, some longer term projections do still allow for the possibility that stocks might yet press on to complete the current 3QE pattern which began with assistance from all three big CBs, back in late 2012, and so map out a full TMT bubble move before the reaction truly sets in (q.v., the Nasdaq Composite). So what we are presented with is another case of letting the market decide which way it wants to move before committing ourselves too heavily to one side or the other. Note, too, that this is a waiting game which itself marks a very different phase from the straightforward momentum chase of recent months.

Courtesy of Bloomberg
Courtesy of Bloomberg

If stocks are ambivalent, fixed income seems to entertain no such doubts. Even that bear market dog-with-fleas, the 5-year T-Note, is back to its lowest yield since the ‘taper tantrum’ while the next quinquennial slice of the curve has made record lows, narrowing the spread between spot and forward 5s by 175bps in three months to reach the lowest level of recent times. We can perhaps best observe the developments by a glance at the eurodollar curve.

Courtesy of Bloomberg
Courtesy of Bloomberg

But, far from placating the market, even the remarkable run of successive record lows in bond yields is starting to raise the eyebrows of many of those whose wills are beginning to be bent to the policymakers’ doom-laden croaking about the imminence of ‘deflation’. It would be amusing if it were not so serious: in order to justify their crass, hyperactive heterodoxy, the central bankers are having to scare the very horses they are simultaneously trying to lead oh-so calmly to water.

Another frequently cited storm warning is the 5-year forward break-even inflation reading as derived from the difference between vanilla and index-linked govvies. Your author must here confess to feeling this is far too arbitrary a number. We gauge the ‘inflation expectations’ which the authorities have insisted are key to judging the success of monetary policy from a spread – and now, worse, from a hypothetical forward spread which is the derived difference of two other arbitrary pairs of differences. Yet all this is reckoned in a segmented bond market subject to both institutional and regulatory imperatives, to vicissitudes of issuance, and to a vast official distortion made worse by the fact that, at very low nominal rates the reluctance to price the residual ‘real’ yields on linkers too far into the negative column is compressing the BEI spread between them – a phenomenon additionally exacerbated in the forward version by dint of the rapidly flattening yield curve.

WHAT DOES BEI ADD?   Courtesy of Bloomberg
WHAT DOES BEI ADD? Courtesy of Bloomberg

It would be wiser to bear in mind that just because we can define and measure the 5y5y break-even does not of itself imbue the measure with any genuine informational significance even if one cannot deny that it has come to exercise a certain lurid fascination in the mind of the market as well as in that of the official rate-setter.

Adding a further strand to this hangman’s noose, many of yesterday’s Peak Resource commodity bulls have undergone a temperamental slump which matches for its giddiness that of the prices of the industrial commodities themselves. Again, the spectre of ‘deflation’ has come to peer over our shoulder as we watch the tape.

Here we would only caution that the inferences people are deriving from commodity prices may not be as cast-iron (sorry) as they appear because it is not, in fact, so easy to disentangle the factors contributing to that decline in a world where we have so many broken pricing mechanisms in play.

Take crude, for one. Given the extraordinary growth in supply of which we have long been aware and given, too, the muted growth of (physical) demand in a world unable to shake off the shackles of the last boom, the presence of record long positioning in speculative markets at the end of July was a clear omen of doom, even if the timing of the sudden, catastrophic phase shift from a three-year sideways, ever-narrowing range to a runaway cascade was impossible to predict in advance.

All sorts of commodities in their turn have acted similarly over this last cycle; silver, gold, copper, tin, nickel, iron ore, rubber, uranium, minor metals, some ags, and so on – but the booms and busts have not all been coincident, a divergence from which we can infer that they are as much a story of a rolling wave of fickle, speculative over-exposure and subsequent mass liquidation as they are of anything to do with underlying, real-side economic factors at work in their use.

‘Doctor’ Copper is another commodity to which many outsiders like to refer, yet its medical credentials have been called into question by the huge distortions entailed in many years of shadowy Chinese malfeasance. What is therefore impossible to decide is how much the current slide relates to weaker contemporary real demand and how much is due to the unwinding of the greatly exaggerated, financially-enhanced, apparent demand from which we are presently correcting.

Again, the malinvestment bubble in mining itself was both enormous and – given the echo effects of loose credit firstly on selling prices and then on project finance – thoroughly comprehensible. But to move from diagnosis to prognosis, what we again have to ask is this: if we accept that there was a period of widespread over-expansion in the industry – albeit one formerly hidden by a credit-enabled take-up of the end product at ever higher prices – is today’s fall-out the same thing as evidence of a generally weaker economy, or is it just a belatedly more accurate reflection of what the state of that economy has truly been all along? The solution to that riddle, if one could reach one, would tell one whether the big losses to come will be confined mainly to the commodity sector itself or dispersed more generally across the equity universe.

What today’s reverse Malthusianism does overlook is the inarguable case that, if we made a miraculous scientific breakthrough tomorrow which unlocked what was an essentially limitless and near-free source of energy, we would all be unequivocally better off. Reasoning from such a Garden of Eden scenario, we can be resolute in maintaining that a supply-led fall in prices is good overall – not just for ‘consumers’ – but for intermediary producers of all other goods and services, too. And, yes, it may well be, as has been bandied about, that some 10% of US earnings are energy related and so in jeopardy, but devotees of Bastiat’s Things Which are Not Seen will have already asked themselves how much the earnings of energy users have been depressed by the success of the energy providers and whether, therefore, the ongoing rebalancing is the unmitigated evil some fear it to be.

Above all, we might take comfort from the realisation that oil & gas consumption still only amounts to 5% or so of global GDP. Or we could, were we not also to bring to mind the injunction that in a non-linear system such as ours we cannot entirely discount that large effects emanate from small causes or that, given its high profile, the sector’s travails could contribute meaningfully to a souring of general sentiment and so perhaps take us across that critical mass threshold beyond which rotations and reversals morph into landslides of liquidation. But to see why we think this is even possible, we need to go back a step or two to explain what we think is the source of such fragility.

Back in the immediate aftermath of LEH, we wrote that the scale of the coming reflation would be unprecedented and that it would certainly boost commodity and asset prices in the short run, but we also warned that we needed the debt overhang to be rapidly eradicated, renewed entrepreneurship to be promoted, and heavy-handed state intervention to be avoided (we entertained few real hopes on that that last score) if the recovery were to take root. Otherwise, we predicted, we would find ourselves on a tedious roller-coaster of anaemic growth interspersed with weary episodes of recurrent stagnation where the supposed triumph of the authorities’ 1933 moment would give way to their dread of repeating a 1937 one, meaning they could never pull the trigger on ending their stimulus programmes. This, we envisaged, would ensure that the whole system would become ever more addicted to the medicine and ever more subject to its unwelcome side-effects.

We also felt, back then, that if we were to avoid this switchback turning into a negative-g log flume of downturn, the West had to have its house in order by the time that China realised it was doing more harm than good with its own gargantuan injections and that it had to revise its whole approach as a consequence. So it is proving to be.

In the interim, we have all been strung along by the persistent faith that, this quarter, the next, or the one after that, Europe would once more arise from the ashes. When that seemed too much of a stretch we were briefly distracted instead with the foolishness that was Abenomics, and all the while we had the cheery presumption that the Daddy of them all, the US, was slowly getting back on track and so would be enough to keep our illusions alive.

But now we have nothing – or close thereto – to which to cling except for the fact that while so many central banks remain so doggedly accommodative we cannot seem to bring ourselves not to plunge for a further rise in the market. The pockets of our trousers have, after all, long since burned through as a result of all the hot money which has been thrust into them these past several years.

But, whatever the imperatives to remain fully invested and highly leveraged, it cannot be denied that the underpinnings of our optimism are becoming ever more slender. Japan has predictably disappointed. Europe again stands on the verge of major political upheaval and the reaction to the oft-promised QEuro has either been muted (in the real world) or actively counter-productive (in its disruptive, possibly system-threatening effect on the capital and currency markets), suggesting that clinical tolerance is setting in there, too.

EMs are over-owned, are becoming disfavoured, and are anyway not weighty enough to swing the balance. Add to this the sad fact that America is fostering conflict and instability all around the Eastern and Southern rim of Europe and we are left only with the belief in US economic recovery – at first stoutly resisted, but later held with all the fervour of the true convert – to maintain our faith. Hence, as we said, the outperformance of Wall St amid the growing strength of the dollar, a constellation which has even induced high-ranking pundits of the kind who should – but somehow never do – know better to start exulting recklessly at the putative ‘decoupling’ of the Land of the Free from the rest of the poor, huddled mass of humanity.

Now though, the States is starting to stutter as well – with a run of softer-than-expected macro data, fears of what the shale shock will mean both for jobs and credit, and a few wobbles on the corporate earnings front (even if many of these are only strong-dollar, money illusion effects).

In the recent past, such bad news would have been perversely seen as market positive for its capacity to call forth more from the Mighty Oz’s bag of monetary tricks. But what can we now expect from the ‘Goldilocks’ scenario of weakness calling forth some form of official, ‘Greenspan Put’ compensation? Only the weak, negative assistance that it might further delay the day the Fed finally takes its first baby steps to renormalization. There is therefore not much by way of porridge in that particular bowl, we fear!

In such a world, it would not take much for the multitude of stale longs to become anxious. Though it will be said – as it always is – that there is copious ‘cash on the sidelines’ waiting for exactly such an opportunity or, conversely, that a setback in one market must lead to a rise in another (‘the money has to go somewhere’), this overlooks the fact that asset prices can only advance on such a broad and enduring front as they have if they are being fed a steady nourishment of a credit created expressly for that purpose.

When this is the case, it is just as true in reverse; that when people take fright and the assets begin to fall, or the carry trade starts to go awry, the associated credit can quickly evaporate – that where the money ‘goes’ is whence it came: into fractional reserve oblivion. The one place where the classic Fisherian ‘debt deflation’ – or, if you prefer, the Hayekian ‘secondary depression’ – can most easily occur is in the market for financial claims, especially when that market may already have reached its ‘permanently high plateau’.

It may not happen just yet, but it certainly pays to be alert to the possibility that, one fine morning, it surely will.

Economics

Technical Update

Wracked by the actions of the various central banks – which gave us another key reminder that volatility does not equate to risk – yet not wishing to start rethinking their entire thesis, a characteristic loss confidence has started to set in among those who were telling themselves over the Christmas trukey just what geniuses they were. We could have an interesting couple of weeks in store – not helped by the fact that we are about to enter the great Chinese data avoid as the lunar new year approaches.

In China, the poorest industrial profit and revenue results in years, the slowest growth in the money supply, and the not unrelated presure on the yuan – where CNY6.27 looks increasingly important –  are still none of this is enough to halt the flood of hot money into equities.

15-01-28 China PftThe main boards may have temporarily found a ceiling but the Nasdaq/Neumarkt equivalent, ChiNext, has just threatened to resume the upmove. Sentimentals, remember, can always trump fundamentals. Or, as Frederick Lewis Allen put it a l-o-n-g time ago: ‘Hope can be exchanged for cash on a speculative market.’

Courtesy of Bloomberg
Courtesy of Bloomberg
Courtesy of Bloomberg
Courtesy of Bloomberg

As for other stock markets, it appears that something of a tug-of-war has developed. Just enough bad news to keep the bulls from becoming too enthusiastic, but not enough gloom to cede dominance to the bears. Another one of those situations where you have to wait to see who takes control before throwing your weight behind the move. Eg, MSCI World ex-USA:-

Courtesy of Bloomberg
Courtesy of Bloomberg

And the USA itself. Still some upside if this broad brush picture is going to deliver some wonderfully symmetric culminating action. But…..

Courtesy of Bloomberg
Courtesy of Bloomberg

…buyer beware: the ‘one-off’ shocks are starting to add up and the resulting rise in uncertainty can be seen in the usual places – vols, junk and EM spreads, the gold/industrial ratio and, arguably, the safe haven dollar trade (or, if you prefer, the end of carry).

Courtesy of Bloomberg
Courtesy of Bloomberg

Look, too, at how swings in yield differentials between the bellies of the US and German curves tend to signal turning points in the economic cycle.

Courtesy of Bloomberg
Courtesy of Bloomberg

The T-Bond, too, is pausing for breath after making a minor new historic yield low. While below 2.45/50%, the post-87 profile suggests a bottom at 2.25% (as we have already pointed out), but if things get really hairy, we might have to widen the range and plump for 1.50% for the Bond and 1.10% for the T-Note. RIP all bond vigilantes – a short memorial service will take place, followed by a reading from Homer & Sylla.

Courtesy of Bloomberg
Courtesy of Bloomberg

There is also a possible, very neat confluence of time and price coming together for USDDEM/EUR – a pairing which seems to oscillate on a cycle of roughly 15 years – 1970, 1985, 2000, and 2015 (?) marking the peaks for the dollar/troughs for the mark. $1.065/00 suggests itself as an objective. If we have to go beyond that, $0.9250/00 marks the log middle

Courtesy of Bloomberg
Courtesy of Bloomberg

As for commodities, the plain gold-in-dollar 2-year profile mapped out since 2013’s collapse looks balanced and, hence, potentially ready for a new trend move away from the mid-mean levels either side of $1300. Behaviour is somewhat harder to read of late for, since the turn of the year, the dynamic has not so much been dollar up, gold down (and v.v.) but euro weakness = gold strength. Such a confusion of signals – and hence of the underlying reasoning – is what we might expect at a turning point but do note that there is now a whole lot of positioning already in place betting on a further rise.

Courtesy of Bloomberg
Courtesy of Bloomberg

 

Courtesy of Bloomberg
Courtesy of Bloomberg

Industrial metals are again staring into the abyss,  as are iron ore, rebar, and coking coal on Shanghai.

Courtesy of Bloomberg
Courtesy of Bloomberg

Ags, too, are threatening support once more. Not only have harvests been good, but the collapse in crude is neutralising the single most important factor in the sector’s repricing these past ten years – biofuel. Ethanol is at 10-year lows, soy and palm oil are at levels not seen since 2009, sugar was first here all of four decades back and cheap petchems are forcing cotton and rubber lower, too.

Courtesy of Bloomberg
Courtesy of Bloomberg

Finally, oil itself. We have had almost three weeks of relative calm – itself a newsworthy event given what went on prior to that. But nothing seems able to actually reverse the trend, rather than simply suspend it. Specs are still heavily long, cracks are back to normal, production continues to defy the rig count, inventories are bulging, RSIs are now neutral – and all the while, value is building, not rejecting, right down here at the extremes.

Even allowing for the fact that the dollars you hand over for oil are themselves worth more these days, it is hard to resist the feeling that we will probe lower still before we are done. And some where down there lurks the 1974-2004 mean….

Courtesy of Bloomberg
Courtesy of Bloomberg linear scale
Courtesy of Bloomberg
Courtesy of Bloomberg log scale

Money

Whatever it Takes

So, finally, the world’s most open conspiracy came to full fruition and Magic Mario actually got to do a little of ‘whatever it takes’ after 2 1/2 long years of bluster. Sweeping aside the objections of what appears to have been most of Northern Europe, the triumph of the Latins was near complete. For all his stubborn resistance, Jens Weidmann proved no Arminius and the airy council rooms of the ECB building in Frankfurt no Teutoburger Wald whose mazy forest tracks and swampy margins proved so deadly to the legions of that earlier Roman legate, Publius Quinctilius Varus.

Indeed, there was some suggestion in the Dutch press that Mario got his way without even putting the issue of his vast ‘stimulus’ programme to a formal vote and so prevented Jens, his fellow German, Sabine Lautenschläger, the Netherlander Klaas Knot, and their Estonian and Austrian colleagues from registering their opposition to the decision and also therefore from making concrete the divisions which it has sharpened within an already fractious governing body.

In pressing ahead with the implementation of its own version of QE, the ECB has taken a further, significant step away from the template of the old Bundesbank and one more towards that of such latter-day, Gosplans of all-intrusive macro-management as the Fed and the PBoC. While any model of central banking is a very poor alternative to a system of genuinely free banking, one cannot quite suppress a pang of nostalgia for the traditions of the ECB’s predecessor, with its rigid insistence on being as far removed from politics as possible; for eschewing any taint of pliant fiscalism; and of sticking reasonably consistently to its primary task of preventing easy money from encouraging reckless behaviour – whether on the part of home-buyers, stock market plungers, Alexander-complex industrialists, or office-hungry politicians.

The hallowed institution of our youth may well have dished out a very tough form of love, but its true virtue was that its heads did not presume to sit at some metaphorical control centre of the economy, constantly flipping switches and pushing buttons to ordain whose traffic lights should be red and whose green; whose heating should be turned up and whose down; whose satellite dish should receive which channels and at what hour. Instead, the old Buba simply tried to ensure that the generators were running smoothly, that there would be neither blackouts nor power surges, and by and large left the choice of what its fellow did with their electricity down to them.

Sadly, as the crisis has dragged on and as the cost in forgone human opportunity has mounted, the established political architecture – a structure populated largely by careerist pygmies who clutch eagerly at anything which might boost them a few points in the next focus group assessment and who are therefore only too happy to absolve themselves of any duty of true statesmanship – has visibly crumbled. That degradation has elevated, almost by default, the central bank itself to the cloud-topped heights of an interventionist Olympus – and rare the presiding member of that august body who does not relish a taste of ambrosia and a sip of nectar before going out to hurl thunderbolts among the weaklings thronging helplessly among the mountain’s gloomy foothills.

No longer is the job seen as one of trying to ensure the wheels do not come off the creaking old Trabant of fractional reserve banking, or of trying to ensure that the nation does write too many cheques – whether issued abroad or at home – against its actual ability to generate income. No, now we must make constant appeal to the gods of central banking to assist us with all the minutiae of our lives in a show of the same touching naivety our ancestors displayed in regard to their tutelary deities. ‘O Holy Draghi, Thrice Blessed One, let it please Thee to ripen the corn in my field, to keep my children’s teeth from rotting too soon, and to allow me to win a few denarii when I play at dice in the tavern this evening!’

Such is the Zeitgeist that we deem it to be sacrilege even to look objectively back at the sorry record of the past seven years lest we start to wonder if we are in fact suffering from is the toxic side-effects of the attempted cure rather than from the disease we are aiming to treat with it. We see it as blasphemy, therefore, to ask whether the sanctimonious Austrian ‘liquidationists’, on the one hand, or those careful Japanese students of their own country’s long malaise – such as Keiichiro Kobayashi and Tadashi Nakamae – on the other, might be right in saying that we Westerners currently have everything back to front in our reasoning.

Might it be so hard to imagine that to try to tempt into renewed borrowing the very people who are still suffering the effects of their previous over-borrowing might not only be economically futile but ethically indefensible, too? Could it be that what is shackling enterprise and hobbling endeavour; that what prevents the crewing of a hopeful new fleet of merchantmen with the slaves loosed from the oars of a now obsolete galley, is the attempt to weld in place the rusted links of their chains of past obligation? Can we not simply strike off the irons even if some do collapse after their manumission? Or must we continue to prevaricate by slyly skewing all contractual terms in favour of the debtors – whether by forcibly suppressing the interest rates applicable to their claims (and so penalising the prudent everywhere); by depreciating the currency in which they are serviced and redeemed (with all the inequities that visits on buyers and sellers); or by transferring the IOUs to the government so that the non-exempt Estates might share the cost through a hike in their already burdensome taxes?

Apparently it is so hard to reconsider our methods that all we are left with is to double and redouble the dose of the poison we have been so unavailingly prescribed. Given the prevalence of this dogma, it was only to be expected that, once it had insidiously secured the political backing for the move, the ECB would not be in any way half-hearted about its first real foray into the world of Bernanke’s ‘making sure it‘ – i.e., that phylloxera of finance, the wasting disease of deflation – ‘doesn’t happen here.’ With a programme of €60 billion a month in bond purchases the Bank will henceforth be gorging on duration to the tune of €720 billion a year, a total heavily in excess of the past five years’ €315 billion average net new sovereign issuance.

Whether it will end up doing more harm than good, or indeed, doing anything at all, is another matter entirely. To see why we say this, we should first recall that Blackhawk Ben himself once tried to allay the fears being provoked by his bond buying drives by saying they were nothing more than an asset swap. Our response at the time was to say, ‘Yes, but you are swapping non-money for money on an unprecedented scale’ – an act that can have the most far-reaching consequences, indeed.

Moreover, the ‘swap’ is not just a monetary, but also an overtly fiscal act if you reckon with the reduction in the interest charged when rolling over some of the outstanding debt, as well as the naked seigniorage to be had from substituting reserves (especially those to which are appended negative interest rates) for higher-yielding securities in all their tens of hundreds of billions. The cynic might say that this is in fact nothing less than the most perfect form of debt repudiation ever carried out in the long, weary infamy of sovereign default.

The fact that the most feared of the likely effects of such a programme – a widespread, self-aggravating spiral of price rises to rage like a pestilence though the markets for goods, services, and labour – has not yet materialised is seen by the smug – and among them, we must count Friend Draghi, with his supercilious call for a ‘statute of limitations’ on the promulgation of such concerns – as a complete justification of their actions.

Ironically, since the QEasers are wedded to the same sort of cart-before-the-horse shamanism that Roosevelt and Morgenthau practised when setting the price of gold over the former’s breakfast egg – namely, the superstition which holds a rise in prices to be in and of itself the most effective trigger for a return to prosperity – the refusal to date of said prices to budge very far at all should have occasioned the Serial Stimulators to question the efficacy of their nostrums and not to stoop to throwing brickbats at those who expect the same thing to ensue which the policy-makers themselves so greatly desire, if admittedly in a somewhat less vigorous fashion than the one the wheelbarrow worrywarts have been publicly dreading.

Faced with the patient’s continued lack of response, the physician should really be posing the question not only of whether the medicine is appropriate for the case but whether he completely misdiagnosed the ailment in the first place. There are many plausible explanations for why recorded ‘inflation’ has been so subdued, among which narratives are several common themes t be found. One such is that the debt overhang and the consequent evergreening of loans keeps other lenders chary of becoming exposed to firms being run for cash at their bankers’ behest lest the first hint of a better liquidation value, or the arrival of a new, get-all-the-bad-news-out-now, broom as CEO, signals a ruinous end to the lender’s forbearance.

Another postulates that the straitened condition of the public treasury leaves people anxious about the next wave of confiscatory taxation. A third contends that mere basis point levels of interest rates are counterproductive in serving to eradicate the necessary distinction between money – whose main purpose is to circulate uninterruptedly from one transaction to the next – and savings – which are supposed to pass the baton of spending on to a third party, giving them the power to transact in one’s place. One can see elements of all these at work today, frustrating the designs of those in command of the printing press.

But yet another feasible diagnosis is that ‘inflation’ is not so much as dead as it is hidden: that its true measure is the admittedly unobservable one of how much policy has propped up prices which should have fallen much, much further when the overabundance caused by the credit-driven malinvestment of the past met with the much lessened appetite and much reduced means of purchase of consumers who also had succumbed to the lure of too much cheap credit in the boom.

Central bankers would view that last scenario as something of a triumph, for they are utterly wedded to the myth that falling prices are especially pernicious in the face of unresponsive or ‘sticky’ wages – a credo to which the Swiss may be about to give the lie as they consider whether to offset the franc’s dramatic rise with the introduction of extra, unpaid hours for workers, or even the dismissal and re-engagement on inferior terms of their entire staff. The central bankers also subscribe to the risible theory that the very expectation that prices may be about to fall is enough to send the Body Economic into an instant catatonia of abstention: a state of utter pecuniary paralysis where we all sit around, bellies rumbling, fires unstoked, children unshod – and latest tech upgrades unqueued for – until those prices finally bottom out.

The greater truth, however, may be that what is being done prevents markets from clearing; that it magnifies entrepreneurial uncertainty (and so effectively raises hurdle rates much faster than low market rates can reduce them); and that, by avoiding the bankruptcy of the few, it ensures the enervation of the many, as sub-marginal businesses cling on to labour and capital which could be better used elsewhere and where the life-support afforded them absorbs too much space on bank balance sheets – much to the detriment of the would-be creatively destructive who must wait in vain to snap up the bargains with which they stand ready to reorder the commercial world.

Beyond this, it is also doubtful whether this sort of QE is even well-grounded in the basic theory of how it is supposed to take effect, rather than at the more rarefied levels we have visited above regarding why we should wish it to do so. While no one can condemn the lack of effort expended by the BOJ, the Fed, the BOE, or even the PBoC, the track record is in truth a spotty one.

This is not least because it is not at all evident that central bank gavage can always do much to get the golden goose laying again. Instead, the record suggests that its creation of vast increments of ‘outside’ money – currency and reserve balances – is not quite so ‘high-powered’ as the textbooks would have us believe, not in a world where it has for long not been banks’ reserve quotients which matter for the application of Liebig’s Law of the Minimum to credit policy. Indeed, if we look at what has happened to the other big central banks when they have opened the sluice-gates, we must conclude that their ‘outside’ money has largely come to substitute, not provide the catalyst for ‘inside’ money creation by the commercial banks.

Take the UK. There, since the Crash of 2008, the BOE has quintupled the monetary base, no less: yet money supply is up only a third (and M4 lending has actually declined £158 billion or ~7%), meaning that while at least positive in this case, the ‘multiplier’ has amounted to a paltry 16p of extra ‘inside’ money for every £1 sterling of the ‘outside’ kind. [Draghi, Deflationistas more generally and retro-Radcliffian ‘total liquidity’ fans should all take note that falling bank lending has been clearly trumped by the impact of rising money supply in exciting Britain’s typically unbalanced recovery]

15-01-27 US AMS-MB

For its part, QEI-III in the US has seen roughly $2.7 trillion added to reserves and so – with currency included – the monetary base has been pumped up by $3.2 trillion since the LEH-AIG crisis. However, money supply proper (essentially M1+) has ‘only’ risen by $1.8 trillion (actually an ‘only’ which constitutes an historically high deviation from trend). This is a combination which bears the construction, therefore, that far from boosting its stock, the Fed has destroyed 45¢ of bank ‘inside’ money for every $1 of the ‘outside’ variety it has injected.

15-01-27 US M1xMB

Capping it all, since the assault on good sense that is Abenomics was first perpetrated two years ago, the BOJ has doubled the monetary base there, an increase of Y138 trillion. Yet M1 has grown by no more than 11%, or Y60 trillion, in that same period, implying that the BOJ has managed to vaporise 57 ‘inside’ sen for every ‘outside’ yen it writes onto its own books.

15-01-27 EZ M1xMB

As for the ECB itself, it has actually managed to keep the nominal money supply growing at the eminently reasonable clip of 6.6% CAR since the Crash. Moreover, 2014 closed with the growth of real money accelerating to almost 7% – a whisker off the best in nearly a decade if we ignore the anomalous rebound from 2008’s tailspin. In the background, the reader should be aware, the monetary base has been wildly erratic as policy has coughed and spluttered, fortunately with very little correlation to what has being going on beyond the corridors of power.

Why is it, then, that the members of the Southern Front of the ECB have pushed through such a controversial policy now? Are they really that anxious to prevent the hard-pressed Spanish housewife from reaping the benefits of lower fuel costs in her household budget? Do they really suppose they will advance the cause of ‘structural’ reform when even the most reckless government can now turn to the Bank to ensure that its debt will always find a willing buyer? Do they think they are unwinding the ‘Doom Loop’ between banks and their governmental masters or that, if they do, this will again spur the banks to lend to every businessmen crossing their threshold or – a proposition harder yet to defend – that it will make businessmen more eager to borrow from the banks? Do they ever stop to work out whether this would be a good thing if it were to occur, rather than a three-lane highway to hell?

One thing the policy will certainly do is bleed income from those very same, sorely afflicted banks their Guardian Angel purports to protect. Why do we say this? Simple arithmetic shows us that once banks have satisfied their circa €100 billion minimum reserve requirement (and earned the associated €50 million interest on it) they start to become subject to the negative deposit rate – as they are already to the tune of around €140 billion in excess holdings. In a year’s time, Messrs. Draghi et Cie will have bought their €720 billion allotment, so banks will be paying 20bps on €860 billion per annum, or €1.72 billion, to their overlords in Frankfurt. Six months later, they will be the grateful recipients of another €360 billion and will be paying a further €720 million to keep them safe, too. Potentially, they will simultaneously lose earnings on their €1.87 trillion in holdings of government securities (the average interest rate at issuance for all of which is 3.0% but whose replacement rate and/or running yield will be not only be appreciably lower now but destined to decline further as a result of the ECB’s actions).

Now given that the Bloomberg European Banks index has a market cap of €900 billion and trades on a multiple of approaching 45, we can see that earnings for its members amount to roughly €20 billion (including the winnings of British, Swiss, and Scandinavian, as well as Euro banks). That €2 billion deposit tax therefore represents a sizeable chunk of profit, even without reckoning on income losses elsewhere in the portfolio and before allowing for the cost of any extra capital which has to be raised as balance sheets swell and leverage ratios rise.

But what of the wider effects? Well, householders earn around €70 billion in net interest a year (before taxes), so that is about to take a hit. They also keep around 60% of their financial assets – a sum of €12.2 trillion as of QI’14 – in the form of deposits, debt securities, and loans, around a third of which resides in their pension and insurance plans rather than being directly owned. Against this, they are collectively on the hook for €6.1 trillion in loans, so putting their chances of loss at twice those of the possibilities for gain even before they start to cough up higher pension contributions and insurance premia as institutional income dwindles.

For all those involved in this grouping, the main hope – apart from some miraculous burst of hiring and productive expansion suddenly occurring in response to Draghi the Magnificent’s latest conjuring trick – is that the notional gains on their €8.2 trillion of equity exposure (€3 trillion of that at the pension and insurance companies) continue to accrue and that these can actually be used to pay the bills, as and when they arrive.

The caveat here is that contained in our previous piece and embedded in our header: that ‘silver is the true sinews of the circulation’. Let us try to explain.

One of the most evident effects of all the reflationary attempts to date is that while it is no more than arguable that they may have had some marginal impact on actual wealth creation above and beyond what would have happened anyway as people readjusted to the post-Crash, they have without doubt unleashed one speculative wave after another in the markets.

Rather than the greater weight of nominal money at people’s disposal being recalibrated as the kind of precautionary realbalance one holds against one’s foreseeable regular outlay on goods and services (a phenomenon which comprises the old-school inflationary reapportionment for which the authorities so yearn), it has taken place in terms of the portfolio balance of assets to be held in a minimal interest rate environment. If the excess money burns a hole in one’s pocket, the ‘inside’ type cannot be collectively diminished, except by paying down debt (and the ‘outside’ type not all unless the central bank is complicit in the deed). Thus, it will be used mainly to pass other assets around in an ascending spiral of price appreciation until a new level of comfort is reached between notional net worth and cash at hand.

The problem is that such a spiral can all so easily go into reverse if the money is now withdrawn from its job of passing parcels between the players so it can be used to buy things outside the circle. Prices will assuredly dip and if the check delivered to the rise in valuations as the first few cash out their chips dislodges one or two too many margined grains of sand, the resulting avalanche can swiftly come to make boring old money seem winningly secure once more and so give rise to further waves of selling. What goes up, and all that.

So has it largely been these past several years. A perceived surfeit of money has not circulated with much renewed vigour against tangible goods and real side transactions, as was hoped would be the case, but it has swirled with often cyclonic fury among all the buyers and sellers, firstly of commodities, then of EM securities, then of junk debt, tech stocks, equities in general, and lately of US equities in particular.

Hence the overstretched valuations in both bond and stock markets and hence the politically-sensitive perception that ‘inequality’ is rising – that only the 1% is benefiting. To the extent that latter charge holds water, the great irony is that – pacePiketty and the rest of the petulant Progressives – it is not because the evil Plutocrats have somehow rigged the game in their favour, but because the Global Left, being avowedly Keynesian-Inflationist for the most part, has got its redistributional arithmetic horribly wrong.

The ‘euthanasia of the rentier’ is not, dear Maynard, taking place to the advantage of the horny-handed sons of toil, nor even to the gain of the scowling industrialists who ‘exploit’ them so mercilessly, but the spoils are rather going to the remuneration committee royalists in the corporat(ist)e boardroom – furnished as it is in C-Suite plush with trimmings of ESOP perverse incentive. And what is true of Davos Man holds true in spades of the grandest of punters of Other People’s Money who can nowfont leurs jeux in a global financial casino made even bigger and brasher than before by the misplaced arguments and ill-judged actions of the Krugmans, Kurodas, Carneys, and Coeurés of this world.

Too low interest rates and falsified capital calculation is at the root of much of what afflicts us, gentlemen of the central bank, and the sooner you accept this truth and retreat humbly to your appointed place, adopting as you do the self-effacing demeanour and taciturn approach of the Bundesbanker of yore, the better it will be for all us in the sorely put-upon 99% for a change.


Addendum: Some members of the Euroclerisy have been stamping their feet in pique in recent days, moaning that the tattered fig leaf offered by Draghi to the dwindling band of constitutionalists – viz., that four-fifths of QE will be a home-grown affair whereby the National Central Banks will be charged with buying whatever bonds and incurring whatever risks they see fit – has been a gross breach of the principle (!) of solidarity and that it enshrines a dreadful obeisance to those outdated tenets of democratic sovereignty which is anathema to all good servants of the Apparat.

That this is nothing more than a straw man, served up to hide their, the QEasers’, end run around the spirit of the law should be obvious from a scan of the Eurobanks’ own accounts (much less from a glance at the still lofty T2 totals extant out there).

As of the third quarter of last year, Euro MFIs had, as a group, non-bank deposit liabilities of €12.2 trillion, 87% of which were taken from individuals and businesses in their own country and just 5% from other members of the Zone. Of the €12.7 trillion in loans to non-banks, again seven-eighths were domestic and a piffling 5% were extended to residents among their Euro ‘partners’. Seen in that light, an inspection of the geographical origin of securities held showed they were, by comparison, the souls of impartiality with a mere 65% issued within the home borders and 23% coming from across the frontier.

That’s integration for you!