Though it might seem a churlish observation to make amid so much barely-suppressed exuberance about the prospect for the markets in 2013, in many respects the past twelve months have shown much the same pattern as has marked each of the preceding four years. Characterized by the grinding hysteresis which we foresaw as far back as the end of 2008, this has broadly materialized in the form of rallies which stretch from one year end into the succeeding spring before a sell-off occurs which then extends into late summer-early autumn, whereupon the cycle reverts to rally and so on round again.
Each time the Groundhog recovery in asset prices has been based upon the delivery of a stimulus from one or other of the major central banks which has temporarily brightened sentiment – and even improved the macro numbers for a while – before what a physiologist would call a ‘tolerance’ of the credit injection has set in, the economic data has deteriorated, and the unresolved and unliquidated problems which still linger from the preceding Boom have surfaced again to frustrate the optimists.
Last year began amid ever more undeniable evidence that China was suffering a mini crisis of its own, with profits evaporating, unpaid bills mounting, and trade stagnating, while the disparities between Europe’s sorely-afflicted south and its better-placed north blew up in to surging sovereign spreads and a €1 trillion-plus mountain of blocked credits piled up across the T2 system. A further hiccup was then suffered as the two main American political parties acted out their tired old kabuki over the dire state of the nation’s budget.
However, on all three continents, the Keystone Kops aboard the imperilled paddy wagon just managed to wrench the wheel over in time to avoid the looming cliff edge.
For their part, the Chinese did exactly what they assured us they were not going to do and launched a vast new wave of stimulus in order to ease the new regime into office. Eastward, across an increasingly tense stretch of sea, the soon-to-be-Premier of Japan browbeat the BOJ into conducting an escalating series of interventions while, the other side of the wide Pacific, the defeat-disheartened Republicans bent the knee to their triumphantly re-elected opponent and quailed at the thought of being blamed for slashing government spending while the cynically–opportunist Bernanke Fed exploited a patch of economic softness to go all-in with a promise of unlimited bond buying.
In Europe meanwhile, ECB Chief Mario Draghi declaimed with a truly operatic flourish that he would ‘do whatever it takes’ to keep the cash flowing to the olive basket and so magically relieved the tension in the Eurozone in true Wizard of Oz style.
After a last lurch down around the time of the US presidential vote, the markets have responded with increasing enthusiasm to the realisation that disaster has been postponed once more (if, sadly, not definitively averted). Hope has sprung eternal as stock markets have rallied, junk and emerging market debt spreads have collapsed, volatility has been crushed, and the erstwhile safe havens – such as US Treasuries and gold – have begun progressively to lose their allure.
Alas and alack, as a reflection of the growing disenchantment with what have frankly been the disappointing returns offered by the asset class over the past eighteen months, commodities have taken a deal longer than the other ‘Risk On’ assets to respond to this perceived good news, only beginning to hold their own (on a relative basis) as the new year began.
And so, at January’s close, we found ourselves flushed with the glow of higher prices and complacent in the face of further central bank largesse. Adding to the urge is the undeniable fact that we are all heartily tired of sitting on a stockpile of boring old, precautionary cash for quarter after fretful quarter.
Around such intangibles a new consensus has formed that equities are king, bonds are dead, and commodities—if we must pay them any heed at all—are the things to buy to protect against those few dark clouds, no bigger than a man’s hand, which serve to remind us that central banks cannot go on indefinitely adding money to the system at or below zero real interest rates while budget deficits yawn in undiminished magnitude without risking a conflagration of values too awful to fully contemplate.
The irony is, of course, that the thing most likely to blow these few wisps of cumulus up into a terrifying inflationary gale is simply that people come to express more and more confidence that neither this eventuality, nor its gloomy deflationary opposite, will come to pass and so the money which is currently only burning a hole in their trouser pockets is brought out to set light to the world at large.
While we must be careful not to be trampled in such a bullish stampede by standing too incautiously in its path, there are both flaws to the premises on which such a Blue Sky mentality has been founded and more immediate concerns that the eagerness to believe has become so widespread and the voices of dissent so lacking that everyone is already leaning over the starboard side of what has therefore become an alarmingly heeling ship, one all to ready therefore to be tipped overboard with the first contrary gust of wind.
Let us (briefly) take China. Still in a policy hiatus due to the regime change and about to enter the macroeconomic purdah of the Lunar New Year, that has not precluded the Herd from wilfully taking as bullish a view as possible about likely developments there – even to the point that one senior analyst from a major bank could bring himself to tell his audience at a mining conference that to him the outlook for the commodity market was very much like it was in 2002 (from which secondary low, the reader might recall, it embarked on what some measures show was the best nine years in its history!)
It seems that nothing will stop the idiot savants – as well as the consciously misleading – from plugging whatever numbers the state propaganda machine churns out straight into their ‘models’ in order to lend some spurious gloss of calculation to such pronouncements, no matter how unreliable, contradictory, or plain incredible these may be.
Take the Chinese GDP number for the broadest of these: Officially, last year’s nominal total came to CNY51.9 trillion, an increase of 9.8% or CNY4.6 trillion on 2011’s count. Yet, by adding up the individual data produced separately by the nation’s constituent 31 provinces and autonomous regions, we can calculate that the annual sum reached to CNY57.7 trillion (11% higher), and that growth accelerated to 11.1% yoy, representing an increment of CNY5.8 trillion which was a quarter larger than that given by the official tally. Spreadsheets, anyone?
By now it has become almost trite to compare the electricity stats with those for GDP or industrial production, yet we have a rather worrying disconnect in other areas of energy use, too. Industry up by a double-digit amount alongside a gain in refined oil product use of no more than half of that (5.2% yoy), of which diesel consumption barely ahead at 1.5%? Makes perfect sense to me!
Then we have the miraculous rebound in ‘profits’ posted in December (and we will risk a roll of the eyes by asking, once again, how can businesses even begin to compute earnings on a monthly basis?). Setting the seal on QIV’s auspicious rebound and so helping the Shanghai Composite to a further 8% gain, December’s winnings were supposedly a cool 68% greater than the average of the previous three months; revenues were no less than 13% higher and, hence, margins were reported to have jumped by half from 6.5% to 9.7%. Oh, for such levels of operational gearing in an expanding market!
In the short run, what may come to haunt the China bulls is the fact that even this brief relaxation of policy has unleashed the same old dark forces of shopping basket inflation and property speculation. For example, the all-important pork price has risen by more than 10% in the past two month, prompting a release of supplies from the central reserve to try to quell the surge.
More worrying still – especially given the news that the much-bruited property tax will not now be rolled out across the country – land sales in China’s ten main cities were up by a factor of 3.6 last month from January 2012, according to the Shanghai E-house Real Estate Research Institute. Given that the area sold increased ‘only’ 77%, this also implies that the average price paid more than doubled. Stop-Go rules OK!
In light of this what would have been merely risible if it did not simultaneously display China’s increasingly belligerent response to foreign criticism alongside an utter lack of economic understanding, the mouthpiece People’s Daily this week carried an aggressive repudiation of assertions that the country’s monetary incontinence posed a threat to global stability.
Putting the cart firmly before the horse, the editorial argued that if a company had made a hypothetical land purchase ten years ago and if, on going public this year, that same land had been valued higher by a factor of 2,000 (sic!), if the central bank did not issue new money to the tune of around a quarter of that latest appraisal, the increase would be ‘just a bubble’!
On top of this, the writer contended, ‘price reforms can also lead to a substantial increase in the demand for money’ since, he went on, if prices rise, both companies and consumers have to pay more, ergo more money is patently needed – a problem which is moreover said to be ‘unique to China’! Truly, to invert Milton Friedman, monetary inflation is everywhere a real side problem!
Heaping a cloud-capped Pelion of further confusion upon this already lofty Ossa of muddle-headedness, a separate justification for the deluge is apparently that while America’s attempts of the last four years at disaster recovery have naturally focused on its predominant, highly-leveraged financial sector – meaning that every new, FRB-printed dollar could be multiplied up sixty times (sic) – poor, old, metal-bashing China, by contrast, has been doomed to rely on a mere 4:1 multiplier to assist its key industrial base (the limitation being imposed lest it blew its companies’ balance sheets up to imprudent levels of gearing) and hence it had to keep its central bank’s printing presses fifteen times as busy as those of the Fed!
Working up a full head of steam, the author closed this truly Swiftian self-parody with one last, glorious volley of logical howlers, by asserting that the crisis-averting increase in money supply has increased the risk (but only the risk, you will note) of debt expansion before the authorities became ‘scared’ enough to tighten policy and thus to usher in a ‘slump in domestic stock markets, a surge in loan demand, persistently high interest rates, and such financial risks as usurious loans, shadow banking, and trust loan expansion.’
Well, yes, but surely those were merely the unfortunate side effects of an attempt to address the dangerously building excess before the system exploded under its own pressure? No, this hero of socialism-with-Chinese-characteristics confidently concludes, ‘…the greater risk lies in an increasingly weak real economy.’
And this is the spokesman for a preternaturally-gifted ruling elite which is supposed to be reforming and rebalancing its economy in a ‘scientific’ manner and whose rarefied heights of dispassionate calculation we benighted Westerners cannot ever hope to match? Heaven help us all!
But if the ongoing suspension of disbelief regarding China is one of the great enormities of the current mini-bull market, the effort to disregard the sorry history of Japan’s last two decades by a semi-mystical appeal to the half-remembered exploits of eighty years ago is surely the other.
For now it seems, after twenty-plus years of evergreening loans while covering whatever real verdure there was in swathes of economically otiose concrete, the ‘one more heave’ generalship of the LDP will finally enact all of Paul Krugman’s wildest fantasies by further unbalancing its budget – this time with the untrammelled assistance of the central bank – and thereby repeat Finance Minister Korekiyo Takahashi’s feat of ‘rescuing’ his country from the clutches of the Great Depression.
That Takahashi’s real achievements are still somewhat moot is, of course, besides the point even though debate still rages about whether it was his 60% devaluation of the yen in late 1931; his reliance on proto-Keynesian pump priming and his insistence that the BoJ monetize at least some of the resulting deficits (not a small fraction of which were incurred by the country’s simultaneous annexation of Manchuria); his elimination of the capitalists’ ‘wasteful competition’ via his promotion of industrial cartelisation; or whether it was simply that the wider world was already coming out of the worst of its trough by the time his policies were being put into effect. Suffice it to say that a multitude of PhD dissertations and many a professorial citation count still depends on the construction of intricate counterfactuals about this episode, together with the conducting of exhaustive econometric testing of this ultimately untestable dispute.
We should perhaps first pause to take note that Takahashi is an unlikely hero, given that he once declared, in reminiscence of his mentor: ‘After two days of talking with Maeda, I realized that my concept of the state was shallow. The state was not something separate from the self. The state and the self were the same thing.’ Mussolini would have been proud of him.
Moreover, this particular ‘genius’ seems to have subscribed to the same old canards of the underconsumptionist school, with all of its superficial appeals to the so-called circular flow mechanism. Hence, we have this pronouncement from the lips of the great man:-
If someone goes to a geisha house and calls a geisha, eats luxurious food, and spends 2,000 yen, we disapprove morally. But if we analyze how that money is used, we find that the part that paid for food helps support the chef’s salary, and is used to pay for fish, meat, vegetables, and seasoning, or the costs of transporting it. The farmers, fishermen, and merchants who receive the money then buy clothes, food, and shelter. And the geisha uses the money she receives to buy food, clothes, cosmetics, and to pay taxes. If this hypothetical man does not go to a geisha house and saves his 2,000 yen, bank deposits will grow, but the efficacy of his money will be lessened. But he goes to a geisha house and his money is transferred to the hands of farmers, artisans, and fishermen. It goes in turn to various other producers and works twenty or thirty times over. From the individual’s point of view, it would be good to save his 2,000 yen, but when seen from the vantage point of the national economy, because the money works twenty or thirty times over, spending is better.
No wonder his shade is being summoned as the tutelary deity of what is inevitably being termed ‘Abenomics’. Martin Wolf must be positively beaming with delight.
Our own thoughts on this matter should need little exposition so let us content ourselves by citing the wise words of a man who is being sacrificed to this kami of inflationism, outgoing BOJ head Masaaki Shirakawa. In a speech given almost two years ago, he pointed up the dangers of overplaying the supposed similarities between 1930s Japan and the country of the 2010s before issuing a stark warning regarding the dangers of embarking upon a like course to that followed on that earlier occasion:-
As many of you know, Mr. Takahashi was assassinated in 1936 by militarists when he was trying to stop ever-growing demand for military spending, and the course of events led to the eventual rampant inflation. I would argue that the introduction of the scheme of the Bank’s underwriting of government securities itself paved the way for eventual ballooning of fiscal spending, precisely because the scheme lacked the checking process through the market mechanism.
We often use the words of ‘entrance’ and ‘exit’ to discuss the conduct of monetary policy nowadays. In that terminology, we should interpret that the ‘entrance’ of the introduction of the Bank’s underwriting of government bonds in the early 1930s led to the ‘exit’ of the failure in containing growing demand for fiscal expenditure. In retrospect, we should note that the Bank’s underwriting of government bonds started as a ‘temporary measure’.
Though Mr. Takahashi stated that he issued government bonds by a means of the Bank’s underwriting just temporarily in his address at a Diet session, history tells us that it was not temporary.
For reference, the toxic legacy of a government debt of 200% of GDP (sound familiar?), a vast monetary overhang, and shrunken markets eventually cast the defeated nation into a rapid inflationary whorl. After a one third reduction in 1946 as a result of that year’s currency conversion and capital levy, money supply shot back up by a factor of six between the end of that year and 1951/2, as official wholesale prices rose one hundredfold (even if the more representative black market ratio was closer to a more proportionate fivefold).
As a noted economist of the time, Martin Bronfenbrenner, remarked:
no serious attempt was made… to control either the volume of currency printed or the volume of bank deposits created to support not only the Government deficit but also the similar deficits of private firms
We can only hope that the contemporary Japanese will not suffer too much from what seems to be an active programme of decontrolling such an efflux.
And what of those hoping for a mercantile boost for Japan as the currency falls at its second fastest rate of the past generation? Well, perhaps it will turn out not to be the smartest thing to prosecute a policy guaranteed to increase input costs from abroad during a period when the country’ trade gap is the highest on record, when the terms of trade have already fallen by a fifth over the cycle, and when the ratio of imports to national income has only briefly been exceeded at any time in the modern era for the four quarters leading up to 2008’s global peak.
Rather than waiting in vain for some instant miracle, it would be as well to heed the caution of Toshiba Executive Vice President Makoto Kubo who told a press conference recently that:
The semiconductor-related business will benefit from a weak yen, but the rapid fall in the currency will increase costs because it uses a massive amount of electricity.
Or might we be led to doubt by noting, as was long ago remarked:
…‘because each farmer and the situation in each farm village differs, it would be wrong to impose a comprehensive relief program. Each region has its unique disease. We must begin by investigating these sicknesses and applying the correct cures. If we scatter money uniformly from the centre to the regions, we cannot eliminate the diseases.
Who said that, you ask? Why, a certain beatified inflationist by the name ofKorekiyo Takahashi.
Back in that other Sick Man of the global economy, there has finally been a minor test of the complacency which has increasingly categorized the European scene. Naturally, since Draghi’s deus ex machina nothing very concrete has been achieved, for all the endless summitry and fevered shuttle diplomacy, as joblessness has climbed, state indebtedness has worsened, and business confidence has further eroded.
Cyprus is only the latest to be – or not be, depending on the swing of the political weathercock – a potentially ‘systemic’ problem. Italy is on the verge of another Dantean descent into political chaos as the same-old, derivatives-enabled fudging of the account books to which the Japanese were so prone has come to haunt the Urprovinz of European banking. This, even though the cynic might enquire as to why a (quasi-)private European bank shouldn’t do what so many of its sovereign overlords once did with the help of exactly the same sorts of TBTF pirates to ensure that they met the Maastricht criteria for euro-entry?
Though this may only comprise the latest of a long line of financial imbroglios, the political repercussions stretch further, not only by giving the irrepressible Silvio Berlusconi one last chance to strut his hour upon the stage, but in calling into question either or both of the competence and integrity of the current head of the ECB, a man who happened to be in office with the local central bank at the time. With an even more socially-incendiary corruption scandal having recently erupted in Spain – implicating many of the kingdom’s nomenklatura in a seedy little brown envelope scheme – it may be that another round of drama will ensue in the Eurozone after months of spread-tightening quietude.
Conversely, unease among the moral hazard jockeys has been sown by the steps taken by the Dutch government in taking over the failed mortgage company SNS Reaal (no, property crashes are not just an Anglo-Latin phenomenon). As part of this, at long last – almost five years too late, some might say – the subordinate bond holders have been made to share the pain of a bail-out. So, finally, someone has had the cojones to follow the lead of the doughty Danes and intrepid Icelanders and put a great, fat slug of risk back from whence it should never have been removed.
Adding to the general angst, Germany and Finland have seized upon the action to join the Netherlanders in calling for the good and great to advance the implementation of a tougher rescue regime from the formerly proposed temporal wilderness of 2018 to a politically imminent (if still Augustinian ’Not yet, O Lord’) starting point of 2015 – though why this should happen any later than a week next Wednesday is beyond us!
Ironically, all this has blown up as the banks have brashly repaid some €130-odd billion of last year’s LTRO funding – a close and suggestive mirror of the €125 billion reduction in the big four TARGET2 creditors’ balances (and, hence, of the EUR130 billion drop in Spain and Italy’s debits) which has taken place since the summer. Given that the euro has itself become the forex market’s new RORO bell-whether, a disruption in Spanish and Italian asset markets, Eurobanking stocks, or the currency itself could therefore see a widespread series of interlocking liquidations if confidence is not quickly restored.
It’s nice that such doubts resurface when US equity margin debt has hit its highest dollar amount since the 2007 top (indeed, it may well be a good deal higher than these December figures, given that the last three weeks have seen what look like record, pro rata inflows). Moreover equity mutual fund liquid assets have hit their own record low-equalling proportion of total assets and a multi-year low one of market cap: the bullish combo of high leverage and a reduced margin of safety has only previously been matched in the blow-off high of summer 2007.
Notwithstanding the fact that S&P reported that the credit quality of leveraged loan and high-yield bond issuers is deteriorating, with downgrades outnumbering upgrades for the first time since 2009 and with the growth in debt outpacing that of cash flow for U.S. leveraged-loan issuers, junk bond yields have hit a record low while EM bond spreads stand at their narrowest since 2007. Volatility in stock and bonds, oil and gold, have also gone off the bottom of the chart thereby implying that no-one wants to buy protection in what is seen to be an unimpeded one-way path to the sunlit uplands where bogies are made by all and sundry, skilled or no.
Yes, we have clear signs of a breakout (at long last) from the channel drawn off the 2011 high which has been constraining industrial commodities (though neither these nor the broader CCI combo have yet quite breached the pennants drawn off their 2008/9 extremes) and, yes again, we can project up from this to new cyclical highs if we measure from the 2009 lows via the intervening consolidation; and, yes, ‘overbought’ can easily become more ‘overbought’ until a shock to sentiment occurs but, but, but…. the danger must surely be that everyone has already positioned so far for this best of all possible worlds, so well ahead of the expected CB largesse upon which much of this has been predicated, that disappointment looms even if its trigger remains to be determined.
What we have to try to gauge is whether this is really the long-awaited easy money blow-off move, or whether we will once again be nursing our disappointments, come the Dog Days of summer. If the market can shake off the last few days’ attack of nerves then we might at least muster the confidence to play an extension of this tactical rally before we have to decide upon its candidacy for the much more significant role presaged by the likes of no lesser mortals than Ray Dalio and Bill Gross.
If, conversely, the few, hardy sellers win this particular round, we can resign ourselves to having nothing better to which to look forward than to suffer another tedious bout of up-and-down, cyclical déjà vu
“A formidable set of difficulties is encountered when we ask what there is left of the notion of monetary neutrality for a society which has once, for whatever reason, been thrown off the rails of steady advance, or for one which, like our own, has never really succeeded in adhering to them.
Does it… imply the maintenance of the situation existing at the moment, or the restoration of some previously existing situation, or the attainment of some situation never hitherto obtained?”
Sir Dennis Robertson, A Survey of Modern Monetary Controversy, 1937
“Mr. Harrod… pins his faith chiefly to a policy of government borrowing, initiated at the very onset of the recession, to finance both a carefully prepared plan of capital works and also if necessary the maintenance of consumption… so soon as the transition is effected, the borrowing policy is to be reversed. It is not easy to square this programme with the pessimism of Mr. Harrod’s central analysis and indeed in the end he admits that he feels bound to contemplate the possibility that the government debt may on balance continually increase.
After all, he consoles us, there are worse things than debt, alias the ownership of claims to income by poets and other worthy people; and fortunately it will be possible to combine the apotheosis of the rentier with his euthanasia”
Sir Dennis Robertson, Harrod: The Trade Cycle, 1937
Much to everyone’s relief – if to few people’s real surprise – the official Chinese numbers for the fourth quarter ‘improved’ from the previous trimesters’ mini-slough, with GDP accelerating from 7.4% yoy to 7.9% and industrial production ending the year at a 10.3% rate which was the fastest in nine months.
As usual, these data came with any number of attached caveats. Was it really possible, for example, that heavy industry grew at just under 10% in 2012 as a whole, while only using 3.8% more electrical power? Could this be done while rail freight actually dipped by 1.5% over the year or container traffic at the nation’s two biggest ports of Shanghai and Shenzhen only managed a combined 2.1% increase?
It does seem a touch problematical, doesn’t it?
Then again, what we do know – as we laid out in our last weekly edition [Material Evidence 13-01-25] – is that both fiscal outlays and credit provision grew markedly in the final quarter. Nevertheless, what we must look askance at is what supposedly resulted – the credibility-stretching 22% gain in profit and 15.6% jump in revenues (neither figure annualized) enjoyed by the SOE’s between the last three months of the year and the prior three. In yuan terms, we are asked to accept that QIV’s increment to revenues was the greatest on record; that to its profits, one not beaten since the first half of 2009 when the economy was roaring out of the post-Lehman slump.
What is also noticeable is that gross urban fixed asset investment for the year amounted to a massive Y34 trillion which, while computed on a different basis from the GFCF component of the number, represents a record high 70% of GDP. Moreover, the marginal extra UFAI undertaken in 2012 versus 2011 amounted to Y6.3 trillion (or +21%), which was a cool 136% of the Y4.9 trillion in declared extra nominal GDP (+9.8%), a surproportion only previously in evidence during the great reflation between June’09-June’10 – an episode to which much official hand-wringing has been devoted for having sown many of the troubles of misplaced investment and widespread peculation which so plagues the economy today.
Furthermore, the past twelve months’ cumulative CNY1.46 trillion positive trade balance was the largest since September 2009 and its YOY growth of CNY440 billion accounted for almost 10% of incremental GDP, the largest such contribution since 2007 despite the intent to focus henceforth on domestic, not foreign, sources of growth.
So, even if we take the Chinese numbers at face value (and all we have to say here is ‘Caterpillar’), the much vaunted ‘rebalancing’ would seem to have been postponed, once again, for reasons of short-term political expediency.
Any more confident analysis of China is being complicated by the fact that not only are the various institutions which comprise its leadership giving off conflicting signals – not least the obvious clash between the schedule of eye-wateringly expensive infrastructure schemes and the financial authorities’ moves to limit local governmental abuse of Off Balance Sheet platforms – but it is almost certain that we must wait until the formal handover of power in March for any major new policy initiatives to be given a more concrete form.
In the meanwhile, the market’s attention has been turned out past the Diaoyu/Senkaku islands towards a formerly slumbering Japan.
Not that the simmering territorial dispute is to be too lightly dismissed – not now we have Chinese militarists issuing nuclear-tipped warnings to the Australians not to run with the US ‘tiger’ or the hated Japanese ‘wolf’, or while Japanese foreign officials criss-cross the sea lanes seemingly intent on marshalling all of China’s fractious neighbours behind them – but the immediate focus has been the Bank of Japan’s capitulation to the Abe government’s threats to pack its governing council with Yes men and to rewrite the law defining its powers if it did not throw its weight behind the latest attempt to deprive the archipelago’s many pensioners – as well as its other purchasers of imported stuffs – of a living income.
Not that this is how the matter is being presented, of course, as the dark forces of global Keynesianism exult at the prospect of yet another New Deal being launched somewhere in the world. After all, it must be about time that oneof them actually ‘did what it said on the tin’ and restored prosperity by means of a clod-hopping bout of fiscal-monetary intervention to a people from whom it was taken by an earlier series of similarly ill-judged interventions from on high.
Given the already heated political situation in the region, the timing could be better, particularly with regard to a yen whose 10-week decline has only been exceeded (benignly) in the reversal of safe haven flows once the Lehman crisis began to abate and (less happily) during the Sakakibara episode in 1995 which arguably set the stage for the global instability of 1997-98. Already, Japan’s neighbours and export competitors – the equally growth-scarce Korea and Taiwan – have begun to make noises about the policy implications, while the Bundesbank’s Jens Weidmann has also expressed hopes that this does not mean a return to the dark days of competitive devaluation.
But, more fundamental than this is the very question of what the Bank and the LDP think they can achieve. Does the country really need any further, grandiose, state-financed spending programmes even if it could apparently bear to spend Y200 trillion (sic) on disaster-’toughening’ schemes, according to Abe advisor Satoshi Fujii? Can the country really be languishing so badly under the crushing burden of nominal interest rates which have barely inched above the giddy heights of 1% at the short end and 2.5% at the long these past fifteen years? Is the fall off in exports really either attributable to – or curable by – developments in the level of a real exchange rate which at its most unfavourable lay only 0.5 sigmas above its stationary, three-decade mean?
For now, the system has held together, with JGBs rallying under the same old QE rationale that has kept US yields from backing up in the face of yawning deficits. Given the presence of a non-price-sensitive buyer, wielding an inexhaustible cheque book, one would have to be truly foolhardy to short the bonds in one’s own currency though it is quite another matter if you come at them from abroad and later hope to spend the returns in your own, foreign domain.
It would not, however, be too wise for the authorities to flout the wishes of their long-suffering citizens, especially not when they have such a deep, vested interest in seeing neither their money, nor the banks and government debt which provide its backstop undermined. At a massive 115% of GDP, M1 money plays a bigger role in the economy than it does in most other developed nations (c.f., the ~50% in the Eurozone, or the ~20% which prevails in the US). As such, it makes up 55% of household financial assets and over 70% of financial net worth, with another 25% of the total exposed directly or otherwise to government debt.
For their part, banks hold over Y400 trillion in JGBs to back up their customers’ deposits, a total which is perhaps eight times larger than their equity capital (meaning a 180bp back up in 10-year yields would effectively wipe them out, if properly marked to market), while other financial institutions hold as much again. This is clearly not a country where one should knowingly tinker with people’s faith in either of these instruments – cash or bonds – in the pursuit of a serially failed and oft-vitiated nostrum.
Perhaps that is why the BOJ seems to have both postponed the onset of its Fed-like QEternity programme to 2014 and to have hedged about the wider terms of its abasement with a number of caveats. Even though it has committed to covering not just the deficit twice over this year, but actually the entirety of government outlays, its outgoing governor did publicise the valid objections of board members Kiuchi and Sato, while reserving to the Bank the right to ‘ascertain whether there is any significant risk to the sustainability of economic growth, including from the accumulation of financial imbalances‘ and to attempt to hold the government to its pledge to ‘flexibly manage macroeconomic policy but also [to] formulate measures for strengthening competitiveness and [the] growth potential of Japan’s economy‘ while ensuring it will ‘steadily promote measures aimed at establishing a sustainable fiscal structure with a view to ensuring the credibility of fiscal management’.
Good luck with that, we would be tempted to say, but the more fundamental point is not whether we gaijin think (along with the likes of Kyle Bass) that all this must soon break apart, but rather when Japanese banks, Japanese insurers and pension providers and, above all, Japanese individuals lose faith in their own money. Here, we might note that they have been quiet net sellers of JGBs for a few quarters now, their actions only being offset by the increased absorption of the BOJ itself. One thing is for sure; the ‘end to deflation’ will not be a gentle or controllable affair, if and when it comes, nor will its impact be limited to Japan alone.
An Inflationist’s Charter
Beyond the fact that most of the biens pensants have uncritically accepted that Japan is finally ‘doing the right thing’ in acting in this manner and aside from the rather incongruous paranoia they nonetheless seem to share about whether perfidious Nippon will steal a march on them as the yen falls under the programme’s influence, renewed mutterings have emerged regarding the advisability of moving towards some form of NGDP targeting everywhere else within their purlieu.
Though there are a few rags of respectability to this concept, to most of those who espouse it these serve only to clothe the stark nakedness of what is, at root, yet another inflationary nostrum. After all, what is the point of being a member of the clerisy if you do not have some blinding wheeze to advocate as a means of extracting the world from its present mess without first having to face the reality that indebtedness is too high, capital has been misallocated on a grand scale, and that – by and large – we have all been seduced by both easy credit and the promise of unearned welfare into living just a little too much for the pleasures of the moment given the paltry gains concurrently being made in our real incomes.
The scanty raiments of reason associated with this canard are those which seek to limit fluctuations emanating from the monetary side of the economy not just by controlling an ‘M’ (upon whose exact composition, naturally, very few agree!) but also the rate at which it courses through the system (its ‘velocity’, if you must). Given that even the later Hayek mused aloud about whether this might not, in fact, be advisable (though most of those citing him conveniently forget to mention that he immediately went on to express grave doubts as to how exactly such a programme would be implemented), the idea has had a certain fatal allure even for those who generally would not endorse any more intrusive forms of monetary engineering.
But, even if we concede this point – arguendo – to the fractional free bankers, if to no others, the ugly truth is that the kind of automatic, bottom-up, self-governing mechanism which the likes of George Selgin argue their system would comprise is not at all what is being envisaged at present. Instead, the likes of incoming BOE governor Mark Carney – a man conveniently escaping the worst consequences of the bout of Dutch disease allied to a housing bubble to which his policies have contributed in his own land – do not just want to stabilize NGDP, but to target its growth AND, moreover to move it back towards the trend it was following before the Crash.
For example, in the US, the 1984-2008 log trend ran at around 5.5% p.a.: currently, we find ourselves some 15% below that trajectory trend, while growing at approximately 4% pa.
Ergo, to get back on trend in, say, three years’ time would require a growth spurt amounting to 45% – or almost 10% p.a. What sort of money growth do you suppose we are talking about to achieve THAT? And how much will arrive simply in the form of higher prices and not increased output, given that this is the sort of growth rate last seen in the Great Inflation of 1970-80?
For comparison, the UK faces a similar arithmetic, finding itself 16% below the pre-Crash trend and growing at less than half the prior pace, which means a 12% per year burst is needed, faster than was achieved during the booming 1980s when the RPI index ended up rising at a double digit rate. Then there is Europe. How are we to assure that the sorely-afflicted Latins reap the main benefit of any ECB largesse without blowing the still-affluent Teutons through the roof, especially given the fact that a three-year return to trend would have to double the pre-Lehman speed of increase?
Laying aside the question of what distortions and inducements to further capital wastage would occur were such at thing to be attempted on the necessary scale and quelling all doubts as to the advisability of even seeking to return to a trend which was artificially boosted by the nitro of the largest, arguably the most damaging, credit bubble in history, the very concept of NGDP suffers from problems of accuracy of measurement, representativeness, and timeliness.
NGDP under-represents the total flow of money in an economy by a good 50-60% by focusing only on the arbitrary Keynes-Kuznets final spending components and hence by ignoring activity in the more volatile, higher-order goods sectors whose smooth functioning are intrinsic to the very business of continued wealth creation and income generation.
Thus, even if we were to embark upon some semblance of this folly, the least we could do is to gauge our success with reference to the development of the more timely and accurate measurement of overall business revenues, not NGDP. Taking either sales themselves or, where not so readily available, an adjusted gross output measure as a proxy for these, it is also notable that the biggest present laggards in the US are to be found in residential construction, finance, non-food retail and – yes – government, while manufacturing has not only been growing faster than before the crash, but now lies only 4% or so below trend. Extractive industries are, of course, blazing the way forward as America’s energy revolution takes hold.
Thus, it could be argued that, however painful the process is for those who either work to a foreshortened, political timeframe or else who itch to earn some fleeting glory by ‘making the most of a good crisis’, the US is sluggish only in the areas which were responsible for the worst of the pre-crisis excess and conversely is doing pretty well, thank you, in the formerly neglected ones wherein tomorrow’s prosperity may be rebuilt. Pray tell how we are going to encourage this commendable re-orientation by lumping them all together and inflating the hell out of asset prices in order to make their aggregate rise more rapidly?
When Tomorrow Comes
In his recent allusion to this argument, there was a good deal of belated merit in what Raghuram Rajan had to say about why ‘stimulus has failed’. While it is always heartening to see one of the nomenklatura express such good sense in public, it never comes without a certain sense of frustration for, as readers of this publication will know only too well, we have been travelling – largely unaccompanied – this same road to Damascus for many a long year now.
That said, indulge us while we rehearse the main line of reasoning, once more, in the interests of clarity.
When large scale borrowing takes place beyond people’s ex-ante willingness to save (i.e., to abstain from complete, much less beyond-income, gratification), the builders and the buyers, the fabricators and the food shoppers will eventually find they are working at cross purposes and basing their (often unconscious) estimates of future income and outgo on premises which run into conflict with one another and to schedules which cannot be synchronized as they should.
Such borrowing may arise of its own volition – especially under the promise of a technological or territorial ‘New Era’ – but, ultimately, it must rest on the willingness of the commercial banks to create sufficient means to underpin it and they, in their turn, are no less dependent on the central bank and its regulatory peers committing sins of omission, if not of outright commission, in allowing such a pervasive and prolonged departure from the desirable norm as will eventually end in a general ruin.
Borrowing in this manner means that more are ‘bringing spending forward’ than are postponing it. Thus, as a group we end up anticipating and alienating too much of what is, after all, an uncertain future income stream in order to indulge ourselves today. Worse yet, this communal Rake’s Progress means that we are all but ensuring that our future income will indeed fall short of what it is we – and our lenders – expect when we mortgage so much of it to them in the present.
Activity of this kind is bad enough when the borrowing is mainly directed at over-consumption of ephemeral goods and services – whether by governments or by private individuals – but at least such a ‘simple’ inflation (to use the Austrian parlance) can be easily recognised for the evil it is and can be hardly less easily dealt with. In principle, the same should apply when the objects of desire are more durable, even if the dangers here are compounded (a) by the monetary authority’s reluctance to countenance any action to prevent the rise in such politically-sensitive things as house prices and (b) by the high loan-income ratio and higher loan-to-value leverage often extended upon what always seem such sturdy forms of collateral.
In contrast, when the borrowing is devoted to building out industrial capacity – when it represents ‘cyclical’ inflation, as we would say – the scope for error becomes much larger even as it is insidiously less apparent. This is because the market for the planned new output lies not only further out into an unknowable future which is very unlikely to reflect the current pretensions of even the most confident of prognosticators, but because that market is only indirectly linked to the final consumer and is therefore all the more highly contingent upon the actions of others – whether suppliers, customers, competitors, providers of complementary goods, and users of similar resources, not to mention regulators, politicians, and warlords.
Again, while the problems increase the ‘higher’ such an enterprise lies ‘up’ the productive structure, away from the ultimate storefront, it is often here that the longest and largest financial commitments must be made, making the receipt of any false signals, in the form of overeasy credit conditions and overbouyant equity markets, not only more decisive as to its to its inception, but all the more perditious once ground has actually been broken.
When ‘tomorrow’ finally comes – as it progressively, day by day, must do – we are then all too apt to find that increasingly onerous degree of debt service to which we have blithely been contracting leaves us too little left over to spend on the consumables so called into being, meaning that the scale and composition of the capital stock laid down when we earlier availed ourselves of all that temptingly easy money can not hope to find a retrospective justification.
One way or other, a recognition must now be made of the magnitude of our error and if not blame, at least responsibility, must be apportioned where it is due; losses must be realised; and titles transferred as quickly as possible not only in order to make a fresh start at the earliest possible juncture – one which will ipso facto be based on a much more sober reckoning of our wants and means – but so that the effort to escape or to procrastinate does not itself forge a chain with which to weigh us further down. Write-offs and write-downs are much more salutary and far less invidious than the determined application of transfer politics by the horde of economically-illiterate careerists who populate the chambers of the legislature.
At this point, we are poorer than we assumed we would be and we may even be absolutely poorer than we were before we strayed off the path of intertemporal co-ordination which is illuminated by the beacons of self-regulating, time preference-determined ‘natural’ interest rates. Though it may seem callous to call now for a ‘liquidation’ of our mistakes, it is the attempt to camouflage this wherein the most pressing dangers lie. The so-called ‘secondary depression’ which are told to avoid at all costs is one thing (and it is still not proven that, only assuming a core quantity of money supply is assured, Pigou – or ‘real balance’ – effects will not cause this to blow itself out so long as prices are sufficiently flexible downwards in the slump to increase that unshrunken kernel’s overall purchasing power), but the progressive petrification of the whole spirit of free enterprise which is its alleged preventative is quite another.
Pricing out Recovery
Alongside the clamour for more monetary monkey business, much lip service is also being paid to the need for ‘structural reform’ and, in the Austrian sense of increasing responsiveness and removing barriers to initiative – what Fritz Machlup called an ‘Auflockerung’ – this is indeed a necessity. But this is not something which will be enacted by governments eager to extend corporate welfare to failed Wall St. Banks, uncompetitive French car companies, needlessly duplicated Chinese steel manufacturers and the like. Nor are they and their central banking friends likely to aid the requisite process of ‘recalculation’ – of working out what one should pay for something today and what one is likely to get for it or the things fashioned from it, tomorrow if interest rates are being falsified, taxation is volatile (upwards, at least), and exchange rates are subject to sudden wrenching shifts.
At bottom, to be coherent, interest rates should correspond to the price ratio between present and future goods and the eagle-eyed entrepreneur is the man who can recognise an arbitrageable disparity between the two in specific instances and hence can put something which is currently being undervalued to a better, alternative use. But, if he judges the spread between current inputs and his expected, risk-adjusted output is too narrow to be worth his effort, he will not be willing to provide an income to those selling the first, or employment to those who might otherwise make a living by transforming them under his guidance into the second.
Yet much of the thrust of today’s rabid Rooseveltianism is conspiring to keep this critical spread overly compressed and entrepreneurs understandably coy to embark upon major new undertakings.
Raw inputs cost too much because of easy money, ZIRP storage arbitrage, green rent-seeking, and welfare-subsidized consumption
Labour remains expensive due to dole-encouraged withholding and the high ancillary costs imposed by an overweening and unaffordable state apparatus
Expected returns on capital – outside of those to be gained by gaming the capital markets, that is – are depressed by the anti-capitalist thrust of taxation and the regulatory and legal flux to which entrepreneurs are being subjected to an unnecessarily elevated degree
The prospective flow of sales receipts is also being diluted by the presence of so much state- and bank-supported, sub-marginal deadwood in the market.
One of the features of a slump in which can be found the seeds of a subsequent regeneration is that the inputs to a more sustainable and inherently profitable production process can be had cheaply. To this end the irrational fear of the bogeyman of ‘deflation’ is itself the root cause of the process by which the aptitude for change and the appetite for risk can become quasi-permanently suppressed.
Bankruptcy breaks up unviable capital combinations and frees up willing workers for the business of founding new industries and of identifying and satisfying new tastes, a point that Ludwig Lachmann was every ready to extol. ‘Capital’ is a concept; it is a dynamic, it is not an inert, physical lump of easily-stilled mechanisms. In the right hands, yesterday’s failed crop can become the fertilizer of tomorrow’s harvest as long as its owners are encouraged to realize their losses and to sell it on to those with a better vision of how to utilize it at a price commensurate with the new endeavour’s chances of success.
Sadly beguiled by their own theoretical cleverness, those setting policy today are so fixated on the idea of forcing people to buy things just to be rid of the excess money which is being forced upon them and so dead set against anything actually costing less than it used to, no matter how ludicrous the previous valuation or how commercially wrong-headed the purpose to which it was being dedicated, that their own efforts at ‘stimulus’ are forestalling this act of revaluation and release – this recapitalization of the decapitalized – and so are turning them instead into the greatest mass sedative ever prescribed to the mercantile classes.
The Big Freeze
In our Austrian narrative of a ‘cyclical’ inflation, fiduciary (unsaved) credit is preferentially funnelled towards investment in new capacity and expanded business. This soon leads to an unlooked-for degree of competition for resources with the earners of increased wages who are mostly still unsated in their demand for the existing array of consumables, items which the expansionists are either not planning to provide just yet, if at all. Such a conflict of desire can only end up in widespread over-extension; in the appearance of large quantities of ‘frozen’ capital; and hence in disappointed creditors and investors amid a general disco-ordination of plans.
In contrast to such an overheated condition, much of today’s unsaved credit is being directed at ensuring that zombie companies can display the barest signs of animation so as to enable their bankers to justify the ‘evergreening’ of their loans. Working on a cash basis, possibly too unprofitable to pay tax, certainly not amortizing their debt and probably bleeding capital by eating into their depreciation allowances, such ICU-institutions do little more than clutter up their lenders’ balance sheets, cling on to experienced and diligent staff, occupy prime property, burn electricity, and buy in stock – and so deny their more vibrant, self-reliant counterparts, whose innate abilities are greater but who have to operate on a fully commercial basis, the room and the means to grow.
Every great efflorescence of life, every great evolutionary advance in the long and violent history of dear old Mother Earth has come in the wake of a mass extinction. Without the Alvarez meteorite, after all, we hairless apes would probably not be here to debate the finer points of how our policies are only serving to maintain the economic dinosaurs in command of their niche, far beyond their natural span.
Making matters worse, the remainder of the credit inflation is being monopolised by incontinent states and their skulk of rent-seeking jackals, elites whose intrinsic capital efficiencies are vanishingly small (if not actually negative) and whose activities are therefore particularly likely to contribute to capital consumption.
Here we are faced with the awful irony that, in their manful attempt to lighten the load of indebtedness, central banks are helping generate ever more debt. Whereas the money they are creating is supposed to be a final means of settlement which extinguishes debt at the completion of a contracted period of service, it is instead giving rise to more of that which must, one day, be settled. Hence the source of that widely-shared and intensely pernicious confusion of what are static accounting identities in the macro reports with the dynamic process of economic life. We do not need someone else to borrow in our place if we choose to pay down our debts: if we sell without buying in order to discharge our obligations, our satisfied creditor now has both the wherewithal and the available wares to buy in our stead. Even if we find, alas, that we cannot fulfil our contract, to substitute another claim for it by transferring it to some larger, less constrained entity such as the state is to fall for a sunk cost fallacy. We took and used the present goods over which command was given us by our lender and we turned out not to be able to replace them: thus they are irrevocably lost, no matter what anyone cares to scribble in the pages of their accounting ledger.
Unable as we are to see this, we will continue to invest in negative productivity and purposely to select against the fittest. Instead of a classic Austrian overheating, we now have an Ice Age: instead of a credit bubble, we have a debt black hole.
Just as in Japan, we have transferred private actor difficulties into public sector ones where no legal framework exists to resolve the resulting problems. Worse than this, we now face a classic ‘public choice’ trap, to introduce the concept elucidated by the late, great James Buchanan.
Once we decide to move private liabilities onto the public balance sheet instead of swiftly excising them in the crisis, not only are the protocols for later resolution sorely lacking, but the incentives are almost entirely absent, too. Being ‘public’ debts which no individual entity can be said to have incurred, there is too diffuse a sense of responsibility for them – if not an outright tragedy of the commons. Since there are no identifiable culprits for the evils they entrain, outside the hated ‘capitalist’ caricatures of popular invective, it is all too easy for the economic illiterates in parliament to pretend that they were in no way responsible for the debt the incoming regime has inherited (even if often in great part from its own former time in office).
Wedded to the state’s arbitrary ability to imposefinancing charges on third parties (and the fact that pressure-group politics will see the regime’s court favourites and swing voters militate not to bear any concentration of this cost) is the fact it runs completely counter to political ambition to say “we will do less - less intervention, less spending, less feather-bedding – than the losers you just ejected”.
Given a further boost by the almost universal faith in half-fdigested Keynesian nostrums (exemplified perhaps by the recent apoptheosis of the dreadful old Leftie patriarch, Robert Skidelsky), we are about to discover that by saving the banks, we are destroying the pension and insurance companies upon whom the average man is no less reliant. As a result, many of our present day states are fast approaching the limits of budget credibility and so have no choice but to resort more and more to seigniorage in order to survive. Some would, indeed, already have exhausted that reservoir, too, were it not that such infernal devices as TARGET2 allow them to draw heavily upon the reputation and good-standing of their neighbours.
That this policy has not yet led to a resurgence of old-fashioned, shopping-basket price rises (even if, in contrast, its malign, if seductive, effect on asset prices is not to be denied) is largely down to luck.
An increase in the supply of money leads to higher prices only to the extent its recipients’ desire to hold it does not increase in due proportion. What we have seen in the past four years is that, largely, it has. Firstly, higher degrees of credit have lost much of their superficial sheen of ‘moneyness’ since the collapse, meaning that the parties to an exchange are now far less willing to rely upon the ready negotiability and unquestioned fungibility of lesser IOUs as a means of settlement than they were during the boom. Secondly, the banks themselves have not been able to throw off so many of their more dubious accommodations into the ask-no-questions-tell-no-lies underworld of a now-moribund ABS market. Adding to the squeeze, as we have already set out, they have encumbered their balance sheets with a host of low-grade borrowers at the same time that both regulatory capital requirements and wholesale market funding possibilities have become a good deal less conducive to blind expansion than they were in the Blue Sky days of yore. Thus, a greater proportion of a money supply which is having to ‘do more work’ than has been the norm is being generated ‘outside’ the commercial banks rather than ‘inside’ them – i.e., by the central banks through their vastly expanded range of operations.
This, too, is a case of lowest common denominator lending, since what these central banks prefer to monetize above all is government (and quasi-government) debt. In this way they are temporarily satisfying people’s heightened need for money by removing the worst constraints from those closet Jacobins who, we have argued above, are the very people obstructing the process of recuperation and regeneration.
With a nod to the ideas of Axel Leijonhufvud, what this also may imply is that the income-constrained recipients of welfare (personal or corporate) are the agents least likely to cling on to any of their dole, while the still-healthy who receive it at one remove are fast becoming Ricardian equivalence hoarders – knowing, as they do, that, as the only obviously identifiable sources of wealth and with very little patronage to shield them, Leviathan will soon come ravening after them. So, with the associated opportunity costs eradicated by the central banks’ flawed attempts at stimulus, they are clutching tight to their caches of sterile silver ahead of the day when they fear they must render it up wholesale to an aggressively insistent Caesar.
Beyond the Impasse
Thus we have the paradox that, on the one hand, we must be grateful that the central banks are finding too few takers for the snake oil of inflation to do its corrosive work because the supposed solution it offers is not only arbitrary and dishonest, but because it also confounds accounting and so destroys capital and wastes further resources – progressively the moreso, the more rapid and variable its rate of propagation. That it also tends to favour the least savoury elements of society (i.e., the plutocrats and the politically-protected), means that any stay of execution is further to be welcomed on moral, as well as on material, grounds.
On the other hand, the maintenance of ZIRP – and its extension across the maturity spectrum is doing little to help and much to harm. Some say it counter-intuitively promotes saving as those who still can set more current income aside to make up for the lowered returns they receive on their nest eggs. If only this were so, for even though this is something the mainstream perversely insists on decrying, it is actually the wellspring of our well-being. Your author, however, doubts it does much to promote saving in any productive sense: instead it serves to keep capital locked up in dead undertakings and so slowly bleeds the rest of us dry, therefore destroying real savings, not adding to them and continuing the recession, not curtailing it.
At some point, this dangerous impasse will have to be resolved, either in an admission that macroeconomic means have failed and that renaissance must at last be sought – as we have long argued – in providing a more conducive microeconomic milieu (an epiphany which will be a long time coming since it implies the headlong retreat of the Provider State militant) or, alas, in a ‘flight to real values’ and a conflagration of financial claims to wealth amid the rubble of a monetary collapse.
But perhaps we must not be too hasty in calling for the turning point to arrive. Japanese experience teaches us that the stand-off can be maintained for nigh-on a generation if the benefits of slow price declines (not ‘deflation’, please) become widely recognised and if people further accept that if the state is to subsume their unserviceable private debt contracts while not taxing the skin from their backs in order to do so, they must volunteer to surrender up a good part of their income to it by continually adding to their holdings of its obligations (both dated – JGBs – and perpetual – currency). Of course, it helps if the people in question are both productive and thrifty enough to have no need for external finance and possess a high home-bias in their investments and so are not overly susceptible to sudden reversals of sentiment on the part of the hot-money crowd.
As for the rest of us – who are not necessarily endowed with such commendable attributes of forbearance – whether we further resist it or no, everything points to the conclusion that the Mighty Ozzes at the central banks have not yet lost their will for the struggle and that the creeping ‘euthanasia of the rentier’ and ‘monetary policy à outrance’ will be further prosecuted, no matter how high the cost or how exiguous the results.
Such is the curse of the Platonic arrogance of our masters and their willing enablers.
Episode 69: Harvard Professor Niall Ferguson talks to GoldMoney’s Alasdair Macleod about global politics, with special emphasis on China’s prospects and challenges in the years ahead.
They discuss the political and economic situation in China, and the need for the Chinese government to start privatising state enterprises, reshape the country’s rule of law and globalise the renminbi. For Ferguson, the key question is whether or not Beijing will introduce reliable private property rights so that the rising middle class can feel secure.
China fears that its large dollar claims will be worth much less in the future. Besides complaining about this, they are looking for ways to diversify their wealth and revenue stream. Ferguson points out though that there are limits to their ability to secure hard assets. They also discuss China’s relationship with Russia and its role in the Shanghai Cooperation Organisation.
Ferguson states that the gold flow from “the West to the Rest” is reflective of declining Western power. The world’s centre of gravity is shifting east – a shift that is going to continue, and that is taking place at an extremely fast pace when looked at in a historical context. Though China’s economic expansion could slow, Ferguson expects another 20 years of solid growth before demographic problems force the country’s economy to stall.
Finally they talk about Japan’s debt problems and the faulty design of the European currency union. Though Ferguson expects the eurozone to stay together, he expects a Japanese-style “lost decade” – and one sadly lacking in Japanese-style social harmony.
This podcast was recorded on 14 November 2012 and previously published at GoldMoney.com.
Conveniently coming just in time for the crucial Party conference, the official China PMI index inched above the 50-level watershed and so was enough to gladden the heart of loyal cadres and sell-side analysts everywhere. Truly now the bottom is in place and we can return to unbroken months of expanding economic activity under the wise guidance of the new leaders, all the while looking forward to inexorably higher asset prices across the globe!
Well, perhaps. But, is it really sensible to suppose that the weight of evidence offered by this one, single datum is enough to tip the scale of judgement, or would it be better to seek for confirmation elsewhere – not least in the next instalment of said series, given that it is not seasonally adjusted and so is subject to the vagaries of the Chinese lunar holiday calendar?
Certainly, we might be allowed to nurse our scepticism a little longer, if only because one of the main economic sectors contributing to this uptick was the otherwise badly bruised steel industry. Having increased production by a bare 1.7% in the first nine months over the like period in 2011, October’s more favourable constellation of input prices has combined with a long-overdue reduction of inventories to spur the country’s mills to encompass a PMI-boosting, 8% jump in the daily rate of output when compared to late September.
All well and good, but recall this is an industry in which profits of the so-called ‘above-scale’ firms fell 68% YOY, while the listed steel companies actually made an aggregate net loss. Even the mighty Baosteel has been suffering; printing a ‘profit’ partly by dint of asset dispositions – and, even then, returning less on capital than would one of China’s notoriously unremunerative bank deposits. Incidentally, we put the quotation marks around the ‘profit’ to highlight the fact that the explosion in the firm’s accounts receivable has amounted to almost four-fifths of reported operating income over the last six months.
Rationalization, in a business with fast approaching 900mt of capacity servicing no more than 680mt of domestic demand, has proved elusive, largely because of the usual curse of local government politics. Not only are steel companies major local employers, but they pay taxes based on output, not profit, greatly increasing the perverse incentives to which their management is subject.
Adding a certain frisson to the situation is a Bernstein Research report into steel trader fraud. Here, with echoes of the Great Salad Oil Swindle perpetrated by Tino de Angelis exactly fifty years ago, it appears that a number of firms have not only been pledging the same steel as collateral several times over, but that some of the alloy so committed consisted of nothing more than a surface layer of steel laid on top of a pile of near-valueless sand. As a result of this discovery, it is said that Guangzhou traders are now only making good on half their orders, rather than on the already recession-shrunken 70% characteristic of the previous three months, raising the question of just who will buy the new product pouring out of the mills.
Though there are the inevitable murmurings of better things to come as the government launches yet more, white elephant, infrastructure projects, those pinning their hopes on a sustainable upswing manifesting itself in the near future would do well to listen to what Ma Guoqiang, Baosteel’s general manager recently said in an online briefing.
Judging from current global and domestic economic growth, it is realistic to expect the ‘cold winter season’ to last for three to five years, and the steel sector will not be an exception.
Some heed of this ill wind seems to have been taken by the big miners, notably BHP Billiton, which has radically restyled its corporate message in recent months to the point that the most prominent slogan in its latest presentational material was that its “focus has shifted from the marginal tonne to the capital efficient tonne.”
A far cry, indeed, from last year’s defiant emphasis on the super-cycle; on ever mounting, Chinese per capita usage; and on the heady plans for the $80 billion in new capex need to surf this envisaged wave.
Highlighting the contrast, Chief Executive Marius Kloppers – fresh from cancelling no less than $68 billion of those projected expenditures – struck a much more sombre note last month, telling his audience that:-
Miners have responded to unsustainably high prices for some commodities such as iron ore and metallurgical coal over the past decade by building new production capacity. Over that period, robust demand growth from China and other developing nations outstripped production growth as the industry grappled with escalating mining costs and strengthening currencies in commodity producing countries…
But the industry has improved its ability to meet incremental demand with low cost supply and commodities demand growth from emerging economies, particularly in China, is forecast to moderate as developing economies transition to consumption-led growth from infrastructure-led growth…
…what we are now witnessing is the rebalancing of supply and demand and a progressive recalibration of prices back to long term sustainable pricing levels. In effect, what this means is that the record prices we experienced over the past decade, driven by the ‘demand shock’, will not be there to support returns over the next 10 years. What we can instead expect is demand growth at more predictable and sustainable levels and more moderated pricing. This ‘mean reversion’ in prices and returns is something we at BHP Billiton have anticipated for some time…
…The physical iron ore demand of China will go down. That high end of the cost curve will disappear. Still a very good business but not the massive EBIT margins we have today… a very significantly less amount of revenue…
It may well be, of course, that Mr. Kloppers will prove no more prescient regarding the genesis of this tough, new reality than he was in foretelling the demise of the old, Klondike era but it would seem foolhardy not to assume that the head of one of the largest and most successful integrated mining companies might be able to give us some pointers as to conditions on (or may be, under) the ground.
Elsewhere in Asia, PMI’s were mixed in terms of month-on-month changes, but were almost universally mired on the contractionary side of the ledger – though you would never have guessed this to be the case, given the positive glow elicited by the one or two less gloomy releases seen in the region of late. We would only reiterate that the place still suffers from a widespread reliance on exports to a faltering Europe as well as to a still-tepid America. Together with the complex entanglement which much of the Orient has woven with a China still wrestling with the superposition of a Gosplan-like growth directive and layers of rampant nest-feathering on top of a very Austrian credit bust, this strongly implies that it will take more than a brief – and possibly random – interruption of the downwave to instil any confidence that the worst truly is behind us. Just ask Panasonic, HTC, Dongyang, or Sharp.
Adding to the suspicion that things are not exactly steaming full ahead, the first intimations of October’s banking figures from China suggest that an almost complete reversal of the prior month’s large deposit increase was suffered by the Big 4, while, on the other side of the balance sheet, lending was very weak right up to the last three days of the month when an extraordinary CNY100 billion late burst saved the day. Word is that much of this took the form of corporate credit – but how much of that represents distressed borrowing, only time will tell.
Amid press comments to the effect that SME loan demand was weak (not surprising perhaps, given the lacklustre showing at the autumn instalment of the Canton Fair), that lending was ‘about complete’for the year, and that even local infrastructure finance was largely being limited to roll-overs and to ensuring completion of existing projects, matters seem a deal less settled than the permabulls would have us believe.
And let us be in no doubt just how pivotal Chinese banks are to the whole, top-heavy, output-driven, malinvested superstructure. In the year through end-September, just sixteen of them were responsible for no less than 54% of the entire sum of aggregate profits posted by the country’s 2,493 listed companies – even if they could only manage this unhealthy predominance by the determined misrepresentation of their bad loan levels. After they had extracted their bounteous harvest of rents, the nation’s commercial and industrial rump of 2,477 firms saw their revenues inch up by less than 5%, their pre-receivable ‘profits’ fall 18%, and their already exiguous operating margins slump 22% to a mere 4.3 cents on the dollar.
Nor was there much cheer to be had from Li Zibin, president of the China Association of Small and Medium Enterprises, who announced that his members were facing more difficulties this year than they did in 2008. Citing the slowdown both home and abroad, Li said that rising labour costs, pricier raw materials, fund-raising difficulties, and the appreciation of the RMB were among the private sector’s litany of woes.
Then again, a certain degree of caution is only to be expected when we take into account the ongoing rumours that the imminent leadership handover is still the subject of internecine strife between the factions. Not only has former leader, éminence grise – and ‘conservative’ hard-liner – Jiang Zemin been unusually prominent of late but reformists Zhu Rongji and Li Ruihuan have also resurfaced from self-imposed obscurity to root for the opposing team, if to little obvious effect if we believe the spin the SCMP has put on events.
Tellingly, the PLA Daily issued a forthright declaration of its loyalty to the Party and Chairman Hu, warning of the need to guard against the existence of “hostile forces in and outside China… ready to make trouble.” Note the ominous use of the first of those two positional prepositions.
Faced with what could be the appearance of the most tenebrous of cygneous waterfowl in Economy No.2, the results of the upcoming vote in Economy No.1 might seem to offer far less chance of triggering a decisive shift. After all, the cynic would see the difference between the candidates as one more of degree than of kind, especially if he were to limit his concern to the policies the two candidates will actually get around to enacting, rather than those whose superficial distinctions have been grossly exaggerated at the hustings.
As the inimitable H. L. Mencken long ago phrased it:
Each party steals so many articles of faith from the other, and the candidates spend so much time making each other’s speeches, that by the time election day is past there is nothing much to do save turn the sitting rascals out and let a new gang in.
Yes, there is a chance that, freed from the personal need to secure further re-election, Obama might become more radical in his final term – and thus enact a greater programme of tax-and-spend, as well as giving rein to a more undiluted brand of eco-alarmism and green energy boondoggling. Little of that strikes your author as at all helpful to the chances of a meaningful American renaissance.
Against this, Romney promises to be more business-friendly – though one has to doubt whether his proposed menu of tax cuts will really be offset as it should by a like, much less by a desirably greater, reduction in outlays. One unalloyed plus is that he purports to offer far less in the way of impediments to further entrepreneurial success in securing the development of America’s rich mineral legacy. In contrast, his rather crude, eschatological take on foreign policy could prove horribly disruptive to us all if he surrenders control over his country’s might to the implicit furtherance of another, far less heedful country’s warlike agenda.
Whoever wins, we are sure to wake up on Wednesday morning with the Bernanke Fed continuing to wreak havoc by destroying the pricing ability of capital markets; with Federal debt growing at the rate of $40,000 a second – not all that far shy of what a typical family earns in a year – with a debilitating dependency on the state all too elevated, and with any number of restraints to peace and progress not only unresolved, but utterly unresolvable under present conditions and under the leadership of two such solidly mainstream candidates.
It’s not as if we’re going to give Ron Paul a chance to fix things, now is it?
Already, real net private product per capita has been stagnant for more than a decade, mirroring its poor showing during the inflationary disaster of forty years ago. Even if Romney and Ryan were to win and Bernanke were then to tender his resignation to two men who have openly disparaged him during the campaign, the latter’s replacement would be both outnumbered by a dovish FOMC and a prisoner of the initial conditions from which he must start. To expect a radical turnaround under such conditions would be to display as much naivety about the prospects for ‘change’ as did the incumbent’s worldwide fan club of bien pensants four short years ago.
In Europe, the Greeks and Spaniards continue to play fast and loose in the face of looming catastrophe – each seemingly about to founder between the Scylla of economic inevitability and the Charybdis of an ECB intransigence which is fully buttressed by the craven mendacity of those northern politicians who have tried to pretend that the dispelling of that illusion of EMU ‘convergence’ on whose maintenance they have long staked their careers will bear no direct consequences for their own electorates.
Beyond this we must repeat our recent – and ever more widely echoed – musings about the vulnerability of a French nation almost completely bereft of any fiscal sea-room while it wallows, rudderless on the lee shore of its intrinsic lack of industrial competitiveness and as its leaders either squabble on the bridge or fly hither and yon as diplomatic busybodies, full of empty pretensions to winning La Gloire abroad.
In recognition of this, no less a figure of the European left than Gerhard Schröder – the former German Chancellor and the present, heavyweight sponsor of prime SPD candidate (and after-dinner entertainer par excellence) Peter Steinbruck – has publicly called upon President Hollande to admit that his election promises cannot possibly be kept; that the lowering of the retirement age cannot be financed; that his taxation policy will lead both to capital flight and to lower job creation; and that problems will arise as soon as France starts to struggle to rollover its debts.
In France itself, the employers’ lobby Medef has talked of an economic ‘hurricane’ afflicting its members and of business leaders being in a state of ‘quasi panic’ at the prospect of a further turn of the screw. Bearing this out, the INSEE reading of employer expectations for their own future production has slumped to a two standard-deviation low, putting it well down among the depths recorded during the GFC, the Maastricht crisis, and the turmoil of 1983 when a former socialist President – François Mitterand – nearly wrecked the ship of state in his turn.
All this is taking place in a land which was the locus of much of the dreadful banking policy which financed the boom and, ergo, is the place for whose defence the current, ill-conceived interventions have largely been concerted. It is a country clearly in decline. The current account has slid, slowly but surely, from the typical surplus of around €40 billion-a-year when the euro was launched to the point where the French are now piling up an equal-and-opposite deficit of €40 billion a year. Debt/GDP has doubled in twenty years to reach a ratio of close to 90%. Overall unemployment has hit a 13-year high, with 25% of those under-25 officially currently out of work. Total employment has barely grown in a decade, while almost half the country’s manufacturing jobs have disappeared over the past generation.
Taxes are already at their highest proportion of private income in more than a decade helping the state spend an eye-watering 55% of GDP (where, naturally, its outlays greatly outstrip private, net income) and yet all M. Hollande can think of to do is to expand its enervating sway even further. Hardly the best way to promote a national revival, one feels.
Whether the ECB can afford to make good on the Draghi boast in the case of Spain is one thing (whether it can do so by adhering to its own rules on collateral eligibility appears to be a second!). Whether it could go beyond that and shore up an increasingly restive Italy is another. But the idea that it could then keep France afloat in its hour of need seems altogether a stretch too far. Even such consummate operators as Merkel and Schäuble would struggle to tell their weary voters that the only way to avoid another, Versailles-scale transfer of resources to Paris would be to undergo another socially-destructive bout of unbridled monetary inflation.
If the Hollande administration does as expected, it will this week reaffirm its purblindness by quietly burying the forthcoming report on national competitiveness being compiled by former EADS boss Louis Gallois. Worryingly wedded to the failed prescription of the Keynesian mainstream – and hence terrified that consumption will suffer, however unaffordable it may be when production is so unprofitable – ministers have already spoken out against Gallois’ eminently sensible suggestion to cut welfare payments, to lower employment charges, and to hike VAT as a budgetary offset – which combination would make work pay better for both contracting parties while introducing many of the rebalancing forces to be expected of an internal devaluation without entraining many of its unnecessary side effects.
Here, in the response to Gallois’ report, we may look for our first indications of whether France’s political elite are even aware of the monumental nature of the task which confronts them. If not, we may begin to end our doubts about whether their policies will end up posing the greatest threat to the Grand Project by which they and their predecessors in office have long set such great store.
The minor uptick in China’s ‘flash’ PMI estimate for October – from 47.9 to 49.1 – has sparked the usual explosion of uncritical hopefulness (on the part of those who, by and large, thought there never could be a slowdown under the aegis of the all-powerful CCP to begin with,) that this finally marks a bottom in that country’s economic cycle.
In giving vent to such optimism, the Sinomaniacs conveniently overlooked the fact that much of the improvement was down to the fact that it was the price indices, rather than those relating to output or employment, which struggled back above the expansion/contraction threshold of 50 – a circumstance which might just temper their extend-and-pretend expectations of an ever-imminent monetary relaxation, were they to reflect on it for a moment between jubilations.
Worse still, the Pollyannas appear to have forgotten that the PMI simply gauges whether things are generally better or worse than they were last month – and that in a non-quantitative manner, to boot. The unequivocal answer is worse (if marginally so, this time) for the twelfth consecutive month and for the fifteenth out of the last sixteen occasions. Thus, it may be true that the rate of decline seems to have slowed – how enduringly, only time will tell – but the fact of that ongoing decline itself remains, even after so many uninterrupted months of economic deterioration.
China bulls and the other assorted, ‘next quarter’ blue-skyers may have either venal or psychological reasons to puff this one reading up as a sign of a coming (and oft-postponed) dawn, but the test of an analyst who knows his stuff – and who is not afraid to be honest with you – is whether he makes this simple, but crucial, distinction in his commentary.
Of course, such an outpouring of positive sentiment will be very much to the taste of those in Beijing who have managed the seemingly miraculous feat of going into the Party Congress to the glowing accompaniment of an official GDP series which has been accelerating all year, quickening from a 6.1% annualized pace in the first quarter to 8.2% in the second and a resounding 9.1% in the third.
The fact that those same quarters have seen rail freight traffic slow from 3.7% YOY to 0.8% and on to a contraction of 5.8%; or have witnessed Shanghai port container throughput reverse from an expansion of 3.5% YOY to a shrinkage of 1.2% is, apparently, not to be invested with any significance.
Nor is the fact that while industrial production is officially up 10% YTD, those same industries have managed to consume smaller and smaller marginal increments of electrical power along the way; sliding, month by month, from a 4.1% YOY gain in March to a 3.2% one in June and on to a paltry 0.9% increase in September (which slender, overall uptick was comprised of an actual fall in heavy industrial usage).
In much the same manner, apparent consumption of refined oil products was up only 3.4% YTD, with diesel barely ahead at +1.1%. Again, not much evidence of a robust economy, there.
As the slowdown progresses, everywhere but in the reports of the authorities and the minds of their cheerleaders, profits have collapsed in their turn. So far this year, the chemical industry has seen earnings decline 18.1%; cement makers returned 53% less than in 2011; flat glass makers swung to a loss equivalent to around one-third of last year’s reported profits. Miners – whether ferrous or non-ferrous – saw income slip by around 5%, while that accruing to smelters/processors in the first group slumped by no less than 81%, flattering the performance of companies in the second category, even though they themselves booked 30% less.
The other side to this has been a surge in the debts companies owe to one another. As Caixin reported, the China Iron & Steel Association said that, at the end of July, the amount of net receivables and net payables of the 81 steel companies it monitored were up 17.8% and 10.6% respectively from the same month the previous year.
In even worse straits, the 90 enterprises monitored by the China National Coal Association reported an increase of 48.7% in net receivables from 2011, while the China Machinery Industry Federation said those for its members were up 16.9% YOY to a monster CNY 2.5 trillion. No wonder Caterpillar announced it was ‘ramping down’ production in the country.
To see these trends in a little more detail, let us examine those cosseted children of the latest economic cycle, the SOEs. These reported 9-month revenues of CNY 31 trillion which represented a relatively anaemic 9.5% gain from the like period in 2011 when sales had stormed ahead by almost a quarter from 2010. Costs were up 11.1% and hence profits fell a sharp 11.4% to CNY1.6 tln.
That represented a nominal ROE of 5.1% overall, split as to 5.5% for the centrally-controlled firms and a bare 2.9% for their local peers – which latter therefore made a big fat zero in real terms after accounting for the concurrent rise in consumer prices.
Even that does not tell the full horror of the troubles afflicting them, for the simultaneous rise in the tally of accounts receivable amounted to 1/3 of those ostensible ‘profits’ (the overall stock of receivables now stretches to 1.7 times annualised earnings), while inventories swelled by an amount equivalent to the whole of reported income. Days’ sales of inventory rose from 83 to 94.4, while days of receivables climbed to 31.8 from 28.8, putting their combined drain on working capital up to a whopping 126 days-equivalent!
So, here we have a bleak vista of mounting credit, declining margins, unpaid bills, underemployed capacity – even the rare earth market has swung so far from dearth to glut that plant is now being mothballed! – and there also remains precious little hope for making non-operating gains by diverting preferentially-granted credit into a bubbling property market. A clear indicator of this stress is that credit (deferred payment) is rising much faster than money (immediate payment).
This is an ugly constellation indeed, especially since it is giving rise to official concerns about the state of local government finances. Faced with slowing – even falling – tax revenues, these latter are squeezing already pincered companies by demanding advance payment of taxes, as well as by organizing sweeps whose aim is the mass-levying of ‘fines’ for alleged regulatory violations (presumably something of a shock after all these years of turning a blind eye in the pursuit of growth at all costs). These are also, of course, the very same local authorities who are nursing the sickliest of the SOEs and they are the same institutions who will supposedly be riding to the rescue by showering trillions of yuan on even more infrastructure and real estate developments of dubious commercial worth.
According to a report issued by the Development Research Centre of the State Council, the final months of this year will be critical to the pretence of providing ‘stimulus’ via this medium as something of the order of two-fifths of all local government debts fall due by the end of this year, with another 10% or so scheduled to mature by the close of 2013.
Having all but tripled in the last six years, something in excess of CNY11 trillion is now owed by such entities – largely through the conduits offered by the infamous ‘financing vehicles’ – leaving Wei Jianing, deputy director of the Macroeconomy Department at the DRCSC, to fret that: “There are worries over whether local governments could pay off the principal and interests when the repayment hike comes.”
Presumably Mr Wei will be taking little comfort from the happenstance of a nugatory uptick in the Purchasing Managers’ Index!
Far across the Senkaku Islands, Japanese money supply has been decelerating from its recent impressive lick, while small business confidence has plummeted below even the post-Fukushima trough. Meanwhile, the nation’s exports languish at levels first seen in 2004, thanks to the toxic mix of the fallout from the territorial spat with the Chinese and the general Asian weakness – also evident this week in Singapore (IP -2.5% YOY), Thailand (manufacturing output off 13.7% YOY to rest where it was in 2007), and the Philippines (exports off 9% YOY to stand no higher than in 2005).
All this sufficed to bring about a record trade deficit of close to Y1 trillion in Japan itself last month, at which point it was threatening to swallow the large monthly investment income component whole and, hence, to restrict the growth of the capital pool on which the country so heavily relies.
Nothing daunted, after two decades of bluebottle-against-a-windowpane policy-making, the country is again to be dosed with the same old, ineffective, patent medicine as the BoJ prepares to increase its version of QE by a cool Y10 trillion ($125 billion), some of which will help fund the already over-indebted government’s imminent Y700 billion fiscal injection.
You would think they would long since have have learned the futility of what they are about; the fact that this has eluded them for all these years should worry us greatly about our own masters’ willingness to draw the correct lessons on that grim tomorrow when their own programmes are undeniably seen to have failed. Can we not admit it is folly always to resort to the crude economics of a Krugman – the macroeconomic equivalent of the château generalship of the Somme – and to whine that we have only failed because we have not thrown enough money or lives into the fray.
In Europe meanwhile, the gaudy circus of summitry has again rolled through town to little effect. Greece seems to be back to playing brinkmanship with the Troika. ‘Two more Years of Foot-dragging’ was the headline in one German newspaper as it was rumoured that our inveterate Hellenic hand-out seekers were about to pouch another €20 billion, together with extended payment terms and a reduced coupon on their Pelion upon Ossa of existing loans. Talk about creating financial zombies!!!
Draghi bearded the lions in their den when he dissembled before the Bundestag, giving them his earnest that he would never exceed his mandate; that it was simply inconceivable that his unlimited bond purchases could be construed as monetizing state debt, or that it could in any way turn out to be inflationary.
No-one asked the obvious question that if all this was true, and if the OMTs were to exert such a subtle influence on the economy, why he felt compelled to ride roughshod over the (adopted) traditions of the institution he heads in order to implement them.
Among the few dissenting voices was that of the president of the German Savings Bank Association, Georg Fahrenschon, who declared that: “Private savings should not be further penalised. The ECB should not direct itself to minimizing the outlays of the debtor countries, but to ensuring monetary stability, today, tomorrow, and the day after that”
At the same press conference, however, he revealed the schizophrenia which Draghi’s actions have induced. German savers prefer to hold their wealth in the form of savings accounts – out of distrust and uncertainty – yet half of them see a house as the best guarantee for their old age and a third of them intend to buy one now.
If the former impulse gives way only a little in favour of the latter, that double-digit rate of increase in the local money supply will soon deliver the thrifty German burgers, almost the last of their breed, into that vortex of balance sheet ruination which is widely seen (if less openly articulated) as the real key to solving Europe’s otherwise intractable debt crisis.
Before then, however, it would seem that the country might be in for more testing times than has been the case to date. Certainly the decline in the IfO index this past six months – registered despite a rising stock market and a diminution of the sense of crisis in the Zone – is of a magnitude which has typically accompanied significant downturns in activity. With monetary creation running so hot in Germany, it would be unusual, to say the least, for revenues and profits to fall sufficiently far to trigger a serious setback – which is essentially what the IfO index is telling us is expected to occur – but nevertheless this does bear close attention.
Finally, there are one or two hints that the US is starting to sputter. Certainly, the rapid decline in core (ex-defence and aircraft) capital goods numbers tells us so. At -10% YOY, orders are now falling at the sorts of rates experienced in both the Tech bust and the GFC itself. In the past three months, nominal levels have come to rest where they were in the late 1990s while, in real terms, the series has not been this depressed since it was first compiled in the current form, two decades ago.
Those, like us, who have tended to regard the States as the best of a bad bunch, will have to hope this is nothing more than a little pre-election caution and that it will be accordingly reversed in a month or two’s time.
I make no apology for returning to the subject of China, its role in the Shanghai Cooperation Organisation, and gold. Gold is now a strategic metal for present and future SCO governments, which between them have over 40% of the world’s population; and now that the price of gold is re-establishing its rising trend, understanding its future role as a replacement for the US dollar is increasingly urgent, because gold is wealth and this wealth is being transferred from west to east.
The SCO is an economic bloc consisting of China, Russia, Kazakhstan, Kyrgyzstan, Tajikistan, and Uzbekistan. Between them they produce about 26% of the world’s gold, none of which leaves the SCO. Other nations accepted as future members are India, Iran, Pakistan, Mongolia and as soon as NATO leaves, Afghanistan. Belarus and Sri Lanka are on the waiting list. It is no less than the economic unification of most of Asia, with a combined population of three billion. All their central banks are buying gold, and the gold imported by the citizens of just two of them (India and China) accounts for all but 400-500 tonnes of the rest of the world’s mine production – and some of that (particularly in Africa) is now also controlled by China.
One of the SCO’s economic objectives is to do away with the dollar for cross-border trade between members. Any doubts we may have on the matter have now been dispelled as a result of the US Government’s monetary sanctions on Iran.
Iran is important, because it supplies crude oil to China and India, and the Americans have banned all countries from buying Iranian oil on pain of sanctions. The consequence has been to force Iran to settle some of her trade in gold, giving SCO members both a de facto remonetisation of gold, and a solid reason to want higher prices for it in US dollar terms, so that it buys more.
This creates a dilemma for the US. If she escalates her attacks on Iran, she threatens the interests of China, India and other SCO members. At this stage it is too early to judge the political reactions of the SCO members to this threat, but there are broadly two possibilities: either military or economic.
It is too early for China to fight a currency war. She is developing her internal market, and in time the SCO will provide her with the most powerful captive market since the British Empire. However, she still depends on declining markets in the West for much of her economic activity. However, the reason she has accumulated gold and encourages her citizens to do so as well is ultimately to transfer wealth from the West.
The Iranian situation is already undermining the position of the dollar as the international currency in the context of pan-Asian settlements, because oil is simply more important. Attempts over the years by western central banks to bluff us out of gold ownership have given China and its SCO affiliates a tremendous wealth-transfer windfall, as we may be about to discover. That’s what the geo-politics of gold is actually about, and it is a pity our leaders seem to be blind and deaf to it.
As noted in last week’s column about the rising recognition by authorities in Germany about the virtues of gold, the gold standard is receiving impressive new recognition internationally. The GOP plank calling for a commission to study “possible ways to set a fixed value for the dollar” — with an unmistakable nod to gold — is the most prominent element of the 2012 GOP platform still being heard to “reverberate around the world.” Meanwhile, it continues to gain impressive momentum in the United States.
One platform of the recent U.S. Republican National Convention that, ultimately, could reverberate around the world is a plan to study a possible return of the U.S. to the gold standard. While it was perceived as a move to appease the party’s extreme right wing, economists like Mundell think the world needs a limited return to the gold standard.
China is … increasing its monetary gold reserves at an alarming rate. Five years ago China surpassed the US in gold production and five years from now it will own more gold than the US Federal government.
China is preparing for a world beyond the inconvertible paper dollar, a world in which the renminbi, buttressed by gold, becomes the dominant reserve currency.
The Chinese government has recently removed all restrictions on personal ownership of gold; legalized domestic gold exchange traded funds; is currently purchasing 100% of domestic gold mine production; has imported over 750 tons of gold (27% of global output) in the last 12 months; stated publicly its intention to add 1,000 tons per year to its central bank gold reserves; and is buying major stakes in foreign gold mining companies. The scale of this initiative is extraordinary.
Commenting on the recently announced acquisition of African Barrick Gold Ltd. by state-owned China National, CEO Sun Zhaoxue stated,
As gold is a currency in nature, no matter if it’s for state economic security or for the acceleration of renminbi internationalization, increasing the gold reserve should be one of the key strategies of China.
This is not the first emergence of authoritative attention to the power of gold as the monetary unit by China in recent years.
Wikileaks provided a notable cable dated February 8, 2010 sent from the U.S. embassy in Beijing excerpting a story from Shanghai’s China Business News that observed:
If we use all of our foreign exchange reserves to buy U.S. Treasury bonds, then when someday the U.S. Federal Reserve suddenly announces that the original ten old U.S. dollars are now worth only one new U.S. dollar, and the new U.S. dollar is pegged to the gold – we will be dumbfounded.
This implies a preposterous devaluation, which is not the direction toward which the key gold standard proponents are progressing. Gold’s proponents have no interest in scalding creditors … or debtors.
A better grasp of the implications of gold is demonstrated by Zhou Qiren, Dean of Peking University’s National School of Development and a member of the People’s Bank of China Monetary Policy Committee. Zhou was interviewed by China 2011 Economy staff reporter Ye Weikian last year.
Q: Proposals to go back to the gold standard are now reappearing. Do you think this is feasible?
A; If the currency of each major country is bound to gold, financial headaches would of course be reduced. Taking QE2 as an example, if this were the 1880s, the currencies of the major western countries would be measured in gold. Unless the U.S.Treasury suddenly gained a large quantity of gold reserves, it would be impossible for (U.S. Federal Reserve Chairman Ben) Bernanke to print US$ 600 billion to purchase long-term debt. If there is a commitment to a gold standard system, such as the Bretton Woods system in place until 1971, the Fed could not easily ease its monetary policy, because not only could each country with dollar holdings hold them accountable, they could also redeem their dollars for gold to see how much Uncle Sam’s promise is worth.
A gold standard also would eliminate exchange rate wars. Since all major currencies could be exchanged for gold or other currencies pegged to a currency that follows the gold standard, exchange rates would remain stable without anyone doing anything. Where would exchange rate disputes come from? In short, the gold standard would effectively prevent each country’s government from recklessly levying ‘inflation taxes’ domestically and passing troubles to others by manipulating currency exchange internationally.
Of course, this is an excellent monetary system.
Dean Zhou presented, later in the interview, as pessimistic about the political possibilities of implementing the gold standard. He shouldn’t be.
Respected figures from the United States are now taking a more forward leaning stance in growing recognition of gold’s potential significance. Joint Economic Committee Vice Chairman Kevin Brady addressed the Prosperity Caucus on September 19th in Washington DC. He alerted the Caucus to the significant and rapidly growing support for the Sound Dollar Act. This columnist has termed that bill, sponsored in the Senate by Sen. Mike Lee, the most important monetary reform legislation in 40 years.
The Sound Dollar Act isn’t the gold standard. Yet it is widely seen as a major step toward creating a process to enable the reform of American monetary policy to a rule-based one. Furthermore, the Sound Dollar act is well designed to provide a context in which official reconsideration of which rule — the Taylor Rule or the classical gold standard — is, empirically considered, the better foundation for American monetary policy.
The day after Rep. Brady’s address Rep. Ron Paul held what likely will prove his final hearing as chairman of the House Domestic Monetary Policy subcommittee. Its purpose was to review the economic distortions caused by artificial manipulation of interest rates by the Fed. The hearing featured two of the leading proponents of what could be called the “American Principle” gold standard: journalist/belle-lettrist James Grant and financier/philanthropist Lewis Lehrman.
Both Grant and Lehrman outlined the severe problems that the Fed’s central planning of our financial system are causing. Rather than focusing on the fiendish problems caused by paper money, Lehrman extolled the dignity and moral heroism of Ron Paul for keeping the issue of monetary reform alive and concluded:
Now we are able to formulate an authentic, bipartisan program to restore 4 percent American economic growth over the long term. … [T]hese reforms can be made effective for America and the world by a modernized gold standard and stable exchange rates.
The most riveting political commercial of the 2010 election cycle was an independent expenditure by Citizens Against Government Waste entitled “Why do great nations fail?” — generally known as “the Chinese Professor.” It portrays a Chinese Professor, in Beijing 2030, attacking Obama’s profligate spending policies and the debts America incurred. It concludes, to the laughter of the audience, “and now they work for us,” and received millions of YouTube views.
Chinese mercantilist policies are beginning to emerge as a subject of the 2012 presidential race. Rather than engaging in a blame — and maybe trade — war, however, a more optimistic possibility is emerging: the gold standard.
The road to the restoration of harmony, and mutual prosperity, is becoming the subject of renewed recognition both in China and America (as well, as noted last week, in Germany both by Deutsche Bank and the Bundesbank president Jens Weidmann).The classical gold standard, conjoined with other free market policies, offers the very real, very attractive, possibility of renewed worldwide prosperity. To quote one of the great supply-siders of modern history, Deng Xiaopiing: 致富光荣:“To get rich is glorious.” There is a dawning recognition, the hilariously reactionary Paul Krugman notwithstanding, that the road to prosperity is paved with gold.
This article was previously published at Forbes.com.
Ralph Benko is senior advisor, economics, for American Principles in Action, in Washington, DC, specializing in the gold standard and advisor to and editor of the Lehrman Institute's The Gold Standard Now. He is editor-in-chief of thesupplyside.blogspot.com. With Charles Kadlec, he is co-author of The 21st Century Gold Standard: For Prosperity, Security, and Liberty available for free download here. Benko and Kadlec are co-editors of the Laissez Faire Books edition of Copernicus's Essay on Money. He also manages the Facebook page The Gold Standard. Follow him on Twitter as TheWebster. | Contact us
4 October 12 | Tags: China, gold standard | Category: Economics | 3 comments
The world of ‘alternative’ energy has been no stranger to embarrassment of late, whether it be leading windmill-maker Vestas’ 96% plunge to a 14-year low or the threat of bankruptcy stalking the cloudy, Northern Europe’s own welfare queens as the continent’s ill-conceived ‘Energiewende’ staggers onward, squeezed between the pressing fiscal need to abjure all such dirigiste fantasies and the growing backlash from both consumers and industrialists who are slowly awakening to the harsh reality that the aspirations inherent in their right-on, Green indoctrination cannot be squared with their anguish at needlessly soaring utility bills.
In the US, too, the red faces have been multiplying, with the Obama administration generating far more political heat than economical light for its complicity in several hopeless boondoggles, perhaps best epitomised by the failure of erstwhile campaign donors, Solyndra, $535 billion federal loan guarantee and all.
But, of course, when it comes to ‘blind investment’ larded with goodly helpings of political – and often pecuniary – advantage-seeking, nothing ever quite trumps what the Chinese get up to.
Thus it was that, last week, the National Energy Administration announced that, henceforth, it would ‘tighten approval’ for solar projects so as to ensure that they were actually hooked up to a grid, or at least one of sufficient capacity to deal with their potential output! The trigger for this blindingly obvious diktat seems to have been that the agency feared that an arms race of cadre self-promotion might result if the decision by Qinghai province to install a 1 GW solar ‘farm’ were to give rise to a wave of indiscriminate keeping-up-with-the-Jiangses on the part of the other regional heads.
Nor does the competition for the wooden spoon end there, as the case of LDK Solar – the nation’s second largest producer – exemplifies. With debts of CNY30 billion stacked up against a collection of assets with a stated value of CNY33 billion, this was not a firm which was well placed to survive a 65% YOY slump in revenues, nor a disastrous six months during which $620 million in sales generated $740 million in losses. Little wonder it finds itself in such a parlous condition when the company has suffered a cumulative negative free cash flow of $3.6 billion (~CNY23 billion) over a four year stretch when the market price of polysilicon has slumped 95% from $475/kg to barely more than $20.
Controversy mounted over this private company’s failure when one of its creditors – a member of one of China’s burgeoning shadow army of Trust Co.s – managed to cajole the local Xinyu municipality into including the CNY500 million it had extended to LDK into the region’s annual budget and so secure repayment. Given the widespread, if often unfocused, fears about the role of such Trusts in what appears to be a massive, CNY39 trillion layering of credit on top of the nation’s CNY113 trillion mountain of on-balance sheet, bank assets (equivalent to 75% and 215% of GDP, respectively) – not to mention the tangled webs of mutual credit guarantees prevalent among such lenders and creditors – one can perhaps understand the municipality’s pliability in keeping this particular can of worms firmly sealed.
Since then, there have been further rumours (officially denied) that the Shanghai Pudong Development Bank was on the hook for CNY1.5 billion in unsecured loans to the firm. Whatever the case may be, what has been reported in the official media is that several SOEs have been ‘invited’ to sniff over the corpse of LDK, while “creditor banks including China Development Bank, Bank of China, and China Construction Bank have established a ‘special committee’, working with local government, to oversee LDK’s capital flows.”
But why focus on LDK? For hardly a day now goes by without some other tale of misplaced investment, financial chicanery, or growing commercial distress filling the pages of the local business press.
In real estate, for example, Beijing is said to have become sufficiently alarmed at what the creaking state of developers’ finances could mean for bank balance sheets that they have formed a ‘task force’ to investigate the true extent of exposure. Another story is of the deceits practised by credit-hungry developers, whether ‘paying’ suppliers in apartments, not cash; lending otherwise unqualified buyers the deposit they need to secure a mortgage; or raising false sale documentation with which to provide anxious lenders evidence of cash flow.
But, if the central government is sticking to its story about keeping residential real estate in check, it appears that no such qualms exist when it comes to the commercial kind. Take the city of Chengdu where more than 90 such complexes are under development and where there are plans to construct a brand-new financial centre, consisting of 30 skyscrapers, each of 60 stories or more. Nationwide, 2011 saw a 26% increase in floor space, the increment of 11.6 million square metres being greater than four years’ worth of US development at current rates of construction.
Already, signs of duplication are in evidence as the word ‘bubble’ is bandied about by domestic investors. So mad has the rush become that prestige Western retailers are said to be able to take up space on terms which saddle the property company with all the costs in the event that the site does not prove viable. Let us just hope the owners are not relying too heavily on business generated by local firms instead, given that the nation’s No.1 home appliances retailer, Suning, just warned of a possible 30% fall in profits, while industry No.2, Gome, saw its shares hit their lowest ever level when it indicated it was actually trading at a loss.
No word how much of this new retail space will be located at the airport, but with plans announced to build 82 new ones and to upgrade 101 more by the end of the current Five Year Plan in 2015 – putting the joys of baggage checks and the scramble for overhead locker space no further than 100kms away from 80% of the population by the time the programme has been fulfilled – we can be forgiven for expressing doubts. Whether any return on capital will be made is the crucial issue since more than two-thirds of the existing 182 facilities are losing money at present, while UPS has just slashed Asian flights by 10%, declaring that business there had ‘fallen off a cliff’.
No matter, says CAAC chief Li JiaXiang, the current woes are not the result of a surfeit, but a dearth of landing strips “It’s like planting trees,” he explained gnomically. “One tree will die, but if you plant more, it will become a forest, and the trees will grow higher and higher.”
It might be a novel slant on business economics, but it certainly encapsulates China’s whole approach to modernisation in one, fortune cookie-sized soundbite.
Where next shall we venture? The textile industry where Adidas has followed the lead of rival Nike by closing down production? Understandable enough when business leaders in the key province of Zhejiang are to be heard bemoaning the loss of business not just to lower-wage Asian competitors such as Vietnam and Cambodia, but also to Eastern European alternatives such as Romania.
What about metal-bashing? Well, despite the plunge in profitability in the steel business – HRC has fallen 15% in price in just three months to touch the lowest levels since the autumn of 2009, while rebar is a quarter cheaper than a year ago and no more expensive than it was in 2003 – naturally, no-one has thought to trim production which is still therefore running at close to a record 2 million tonnes a day, comprising 45% of the world’s total output. Note, too that the pain is being spread wider, given that net steel exports have climbed nearly 50% yoy of late to reach a 4-year high.
Across in the aluminium smelters – also responsible for 45% of planetary output – the mighty Chalco spent the first half of the year mired in red. In fact, Charles McLane, Alcoa’s CFO reckons that almost a third of such companies ran at a loss last year. So, production cuts, anyone? Not likely, that’s only something which need be contemplated by capitalist running dogs like Alcoa, Rio, or Rusal! No, instead output hit a new record of 1.7 Mt in June as, according to Yao Xizhi, an analyst at state-backed research firm Antaike, around 500,000 tonnes of idled capacity came back online in May, while the first half as a whole saw a million tonnes added, with another million likely to come on stream in the second half. How can this be? Well, the clue is that several local governments were said to be offering artificially cheap electricity in order to keep the fires burning. Helps with the nation’s Himalayan-scale, 300 million tonne stockpile of coal, one supposes.
Not surprisingly, about the only business being done in the machinery industry is the classic Chinese one of buying something physical on long-term credit and then raising one (or more) cash loans using the ‘purchase’ as collateral. As a case in point, the finger of suspicion has been pointed at Zoomlion which managed QI profits of CNY2.1 billion – practically unchanged from QIV despite a fall in turnover of 11.5% which was ostensibly quite creditable given rival Lonking’s 37% sales plunge. Interestingly, accounts receivable rose by a slightly greater CNY2.2 billion (these have doubled since the end of 2010 while sales have only risen 40% in the same period). Cash flow from operations was, needless to say a negative CNY1.7 billion, or -76% of reported profit. It’s not only in front of the company’s diggers that red flags are being waved.
In this context, it is also of note that Caterpillar saw a QII fall in regional revenues of 11% in QII which, it noted, consisted of a ‘large decrease in China which more than offset increases in other countries’. The company announced plans to scale back production, to increase exports (!), and to offer more ‘merchandising incentives’. Have bright, yellow, cellophane-wrapped, wheel-loader – will rehypothecate.
Shipyards? Overbuilt enormously in the boom and now facing a 50% slump in orders as global freight rates plunge, taking new-build prices to an 8-year low on an index compiled by shipbrokers Clarkson. About half of China’s 1,536 shipbuilders may close within three years, Tan Zuojun, general manager of state-owned China State Shipbuilding Corp was quoted as saying in the Serenities Daily. Meanwhile, even the coastal trade is suffering, the Ministry of Transport admits. As Crienglish reported, even the important Qinhuangdao Port on China’s northern coast – ‘seen as a barometer of the economy’ – has seen daily throughput drop from ‘at least 50 vessels per day’ to ‘only one-quarter of that capacity’ so far this month.
The vehicle market, then? Granted, passenger car ‘sales’ rebounded smartly in June – possibly in a rush to beat the looming registration restrictions shortly to be imposed in several major cities – though even this only took the overall YOY tally for the first half up to an anaemic 2.9% increase, but the problem is that a ‘sale’ in China means the maker has delivered the car to a dealer, not to a satisfied customer who will soon be proudly driving off the lot in his gleaming new roadster.
The mismatch becomes apparent when we take the testimony of Cui Dongshu, deputy secretary-general with China Passenger Car Association, who told Reuters that: “Previously, only dealers that sell local Chinese brands were under the inventory pressure, but now those handling foreign brands have also started to feel the pain too”. Other spokesmen confirmed his gloomy assessment, revealing that at many dealers selling BMW and other luxury models, inventory levels over the past few months have swelled to 60 to 90 days of stock, compared with more normal levels of 30 to 45 days. More ominously yet, for a nation still supposedly ploughing its way resolutely through the softest of soft landings, commercial vehicle sales slid 10.4% in the first semester, compared to the same period in 2011.
Far from being a picture of robust health, more than half of China’s plethora of 1,300 domestic automakers – many of which are little more than shell companies used by outside investors to play what was once a booming market – will disappear over the next three to five years, in the eyes of Dong Yang, vice chairman and secretary general of the China Association of Automobile Manufacturers. With a quarter of these already in or near bankruptcy, the relevant Ministry is pondering steps to disbar them from further production so as to tidy up the market, it was announced this week.
As the China Daily noted, against a hoped for 20 million sales this year, it is estimated that the planned auto capacity of China’s 12 major automakers will soon surpass 30 million units, thus exceeding market demand by a cool 50%, according to the National Development and Reform Commission, the country’s top economic planner.
“There is overcapacity in the automotive industry. We will most likely see some consolidation,” said James Chao, Asia-Pacific director with IHS Automotive Consulting, in what sounds like an heroic understatement of the case.
China bulls will not heed any of this, of course, for they are prisoners of the nested illusion that all increases in outlay represent genuine growth (cf, Occidental property bubbles) and that higher growth must imply greater profitability. They will also argue, on any uptick in the macro numbers, that the worst is not only behind us, but that it has been more than fully priced in.
That remains a matter of debate. For it is not to be overlooked that the Chinese authorities are still giving off signals that they will not repeat the indiscriminate orgy of spending which was unleashed at their behest in 2009-10. Indeed, the very same day that President Hu noisily categorised the employment situation as ‘complicated and grim’ (his own included, one might add), the usual party organs were rehearsing front-page arguments against another mass infusion of credit, while positing the view that some ‘friction’ was an unavoidable concomitant of the nation’s necessary rebalancing.
Attacking the problem from another angle, we might wonder how – if things have gone as far as they seem to have done – even an authoritarian regime can drive sufficient temporarily-productive credit outside the coterie of its biddable, capital-destructive, princeling-packed, SOEs and into the hands of owners and managers of less coddled enterprises which are already struggling with chronic over-capacity, elevated costs, and, consequently, vanishing returns.
OK, enough about China. It’s time to take a look at marvels performed by SuperMario, the Goldmanite of the hour, who single-handedly saved Spain and Italy several €10s of billions in interest payments this week with one lapidary utterance.
‘Within our mandate’ – a framework he had craftily tried to exceed by pretending that high Olive Belt yields were enough to put the debtor nations’ shrinking ability to finance themselves somehow within the remit of monetary, rather than fiscal/structural, policy – ‘the ECB is ready to do whatever it takes to preserve the euro,’ he boldly declared to a London conference audience, before vaunting, ‘believe me, it will be enough.’
We had begun the week, you will recall in a paroxysm of selling, after the Bundestag debate on the Spanish bank bailout left the impression that its endorsement by Europe’s paymasters was, after all, conditional upon any aid so granted becoming a full liability of the state. This was a setback quickly compounded by the plea for assistance issued by a number of that blighted country’s semi-autonomous provinces and made worse by news that, across the wine dark sea, not only was Sicily in similar straits, but potentially several major Italian cities, as well.
12% was wiped off the IBEX and 10% off the MIB in a blink, triggering the usual short covering ban. 10-year Bonos quickly climbed 100bps in yield, with the front end suffering even greater pain in soaring from 4.65% to a 16-year high of 7.20%.
Enter our Mario and, to the eager applause – if not the outright complicity – of the French (who publicly exulted at the prospect of an ‘inexhaustible source of money’), his Jovian admonition served to unwind 195 bps of the damage wrought at the short end and almost all of it at the long as the shorts scrambled to cover and the bottom fishers (aided, for now by a juicy looking price excess on the charts) dared to trawl these perilous waters, once again.
There are, of course, only a few minor problems which lie betwixt turning a cleverly timed piece of verbal intervention into a concrete programme of action. Firstly, it must be asked whether he will be able to persuade a sufficient number of his colleagues on the ECB council to endorse his naked casuistry and so attempt to put a Draghi Cap on Club Med spreads and, beyond that, whether he will be able to do so without provoking another ruinous round of Bundesbanker resignations.
The Dutch have said that bond-buying remains in ‘deep sleep’ and, as we write, word emanates from Frankfurt that such measures are ‘not the best way to address the crisis’ and that the Buba remains ‘critical’ of the proposals because they ‘blur’ the policy line in the sand. As for the status of the ESM: “A banking licence for the bailout fund would factually mean state financing via the printing press and would be a fatal route, which therefore is prohibited by the EU treaty.”
Though we should perhaps be more dubious of his consistency, if not his sincerity, FinMin Schäuble also sneered that ‘the world won’t end if people have to pay a few percent more on their bonds.’Perhaps not, but it still remains to be seen if he will be again culpable of telling the German public one thing and agreeing another with his pals in Brussels.
Beyond this internecine squabble, we must consider the ramifications of such an avowed policy of Philaustralic Bernanke-ism for an increasingly febrile German domestic politics – not to mention the possible impact it might have upon certain delicate deliberations being undertaking in the quiet, judicial chambers of Karlsruhe.
Predictably, the first reactions from that quarter have been savage. Die Welt fulminated that “The ECB is turning into a Trojan Horse” – ‘Beware of Greeks demanding gifts’, perhaps – which “no longer stands for stability and a principled course, but for a Europe in which the South has the say” with the bitter prospect that there would be “a giant shifting of burdens onto the North without solving a single one of the current problems”
FDP finance spokesman Frank Schäffler was equally forthright, Handelsblatt reported, saying it made an outbreak of inflation the most likely outcome. “Draghi is no rescuer,” he thundered, “but the plunderer of the peoples’ nest-eggs!” From Hesse, his party colleague Jörg-Uwe Hahn demanded that the ECB be hauled before the European Court of Justice for its temerity in mounting a “direct attack on German savings”.
CDU member Klaus-Peter Willsch lent his voice to the chorus, telling the same paper that “An increased inflation rate is the unavoidable consequence of this policy.” He went on to warn that: “The signs are already clearly to be observed – rising prices for prime property, farm and forest land, gold, and collectibles such as coins and art prices show us that the ‘Flight to Real Values’ has already begun”. A resonant phrase indeed, for those with a knowledge of the 1920s
Does this sound extreme, given Europe’s current woes? Not at all, for the drain of money from South to North, from Crust to Core, has mean that while the rest of the EZ languishes under a real monetary contraction 1.5% pa, German M1 is rising at a whisker under 10% per annum in nominal terms and at 7.4% in real ones – rapid enough by anyone’s lights. German M3 is also brisk enough at 7.1% nominal v the Rest’s lacklustre 1.5% gain.
If we have been taught anything by recent events it is not to map directly from rates of monetary growth to price rises, since the picture is complicated here by shifts from credit substitutes to money proper, from ‘inside’ (or bank) money to ‘outside’ (or CB) money, and by changes in the willingness of the recipients of that money to hold onto it. However, it cannot be denied that, in the country least likely to be affected by a penchant for precautionary ‘hoarding’ (by dint of its residual economic strength), the differential between the rate of its money growth and that of its neighbours has only been exceeded twice before in a three-decade record – the first time during Reunification, the second, briefly, during the post-Lehman money flood.
No wonder the GfK Institute surveys find that: “The lack of trust in financial markets and historically low interest rates mean that saving money does not appeal. Consequently, consumers are more likely to make high-value purchases, such as real estate and also furniture.”
Be that as it may, a further near-term worry shared by Herr Willsch and his colleagues – not just in the coalition, but also by members of the opposition SPD – is that the government has set up an all-party ‘Committee of Nine’ which is empowered to decide – in secret – on the purchase of bonds, as opposed to the offer of a formal assistance package, which latter still requires open debate and ratification by the full assembly. The rationale for this derogation was the insidious concept of not alerting market speculators to the possibility of bond purchases being conducted: a precaution which, as Capital magazine tartly points out, is rather redundant, given that such a policy is the burning issue of the day, not least thanks to the intervention of Signor Draghi.
The farce, it seems, has plenty of time to resolve itself in tragedy ere we are done.
That only leaves us to consider the US where the whole of Wall St. is still hoping and praying that Blackhawk Ben will be firing up his twin T700s any day now in order to lift all their bad analyses and foolish wagers up on the flood tide or a renewed monetary helicopter drop.
Things are certainly no where near as bright as they were a month or two back, but whether that means they are dusty enough to allow the Fed to surmount the ever-rising hurdle of the electoral calendar is another matter. The danger is that the associated hope that action is imminent is giving artificial support to an equity market reporting barely positive income growth and a troubling, per-share aggregate earnings decline. Other data remains in No Man’s land, too.
Money growth is running at a 4.6% annualized real rate, the slowest since QEII was launched in the autumn of 2010 and surely sluggish enough to depress not just speculative asset pricing, but macro variables as well.
Sure enough, core durable goods orders are going nowhere – a doldrums into which the formerly vibrant core capital goods orders have also wandered. For all the bally-hoo about a recovering housing market, the MBA purchase index is still where it has been for the past two-years – stuck at 1995-6 levels. The lesser Richmond Fed index went so far as to offer a frisson or two when it effected its steepest drop in history, but this is hardly a bellwether series. Of more import – if less methodological validity – was the fact that the first estimate of QII GDP crept in at a mediocre 1.5% yoy with HI private GDP slipping to the bottom end of the last three year’s range at 2.7% annualized. Soggy enough, but a reason for Ben to get his flight suit on? We think not.
The US will not this time be the cause of our woes, but neither is it – nor its monetary chief – likely to be counted among our ‘saviours’ or the more violent ‘plunderers of our nest-eggs’ any time soon.
Sean Corrigan is an economist of the Austrian School Liberal Tradition. Corrigan is Chief Investment Strategist at Diapason Commodities Management. | Contact us
31 July 12 | Tags: China, ECB | Category: Economics | One comment
Around the start of the year, in the course of a routine set of market overviews which we have to set out twice a year for one of our clients, we laid down two themes and a thesis.
The first of these was that the then-rapid pace of growth of money supply proper in the US – already becoming something of an exception on a global perspective – would continue to favour the maintenance of a pace of recovery there, above all in corporate revenues and hence, in all likelihood, in corporate profitability.
Such developments, we said, typically lead not only to an appreciation of stock market valuations, but also lend support to wider economic measures, such as employment and investment, however cautious CEOs and CFOs may be in padding out their balance sheets with cash.
So it proved to be, with the S&P putting in its best first quarter since the rebound from the depths of the 1997/8 Asian Crisis. Lending a certain (if possibly temporary) corroboration to this, operating margins also reached or approached record highs (depending upon whether you take data for the S&P, for all non-financial corporations, or just the domestic subset), as did reported EPS. Given the plain accounting intertwining of profits and investment on the consolidated balance sheet – as well as the motivational nexus on the individual one – it was perhaps no wonder that, even if coming from relatively depressed levels, the growth in capex outstripped that of GDP as a whole, or that manufacturing payrolls enjoyed their fastest percentage gain (subject to later revisions) in almost three decades.
Sadly, there is reason to believe that this creditable performance may have represented a high-water mark. Certainly, since spring turned into summer, there have been signs of a deceleration. Revenue growth has dipped to a two-year low – and in nominal terms has all but stalled – new orders have mostly turned lower, employment gains have dwindled and the rise in the real ‘wage fund’ become suddenly snail-like. This sudden shift to a lower gear was brought home dramatically by the shocking 12.3 unit drop in the ISM index of new orders, a plunge which was both the greatest suffered since 9-11 and the second largest since the second oil shock and which took the measure into contractionary territory for the first time in over three years. Adding to the gloom, this was followed by the steepest fall in two year in the NFIB small business index, suggesting the malaise is becoming widespread – perhaps, in the latter instance, due to the costs associated with Obamacare.
Again, no-one who pays attention to the marked deceleration of money growth these last six months should be too surprised at this. If not yet by any means a tailwind, the raging gale which filled the economy’s spinnaker in the run-up to year-end has lessened to the gentlest of zephyrs since then. With the economy vulnerable to a further deterioration of offshore conditions, it is hard to see the rate of progress doing anything other than diminish while this less extravagantly favourable monetary situation persists domestically.
As Dallas Fed President Richard Fisher so colourfully puts it, the US may well be the ‘best nag in the glue factory’, but that does not mean it is about to earn a place in the winners’ enclosure at the Kentucky Derby any time soon.
Meanwhile, in Asia, our second theme was predicated upon our very Austrian perceptions of the likelihood of anyone being able to engineer an instance of that semi-mythical beast, the ‘soft landing’, in a system as overly dependent on credit-fed, fixed capital spending as is China’s – much less in one where real money supply crashed from a monstrous 38% rate of climb (where it stood 5.7 sigmas above the previous 13 years’ average) to a petrifying minus 1.4% (3.6 sigmas beneath it) in the space of a year!
Those within the policy apparatus can perhaps be forgiven for assuming that they (and they alone) could manage a manoeuvre which has classically proven to lie beyond the compass of their Occidental rivals. Had not, after all, they ‘succeeded’ beyond compare in bringing about a QE-fuelled boom far beyond the envy of a Bernanke, a King, or a Trichet when the world first fell apart in 2008/9? Besides, were their armies of Western apologists and the even more serried divisions of mainstream macro dullards not almost unanimous in declaring that either the slow-down would conform to a gentle glide path or that, conversely, at the first sign the descent was indeed quickening, the afterburners would be lit, the stick pulled back, and the whole, ponderous, creaking, billion-man flying-boat would go round again for another pass in, oh say, 2014 or 2015?
That the first of these assumptions would prove to be amiss was an easy call to make for those with a more established pedigree of economic reasoning: the bet that the second would not even be attempted until far too late in the day was a less certain failure, predicated as it was upon what little we outsiders really know about the political imperatives at work within the confines of the Forbidden City, but it was still where the smart money piled its chips.
To understand why this was the case, consider the phrase a very senior member of the Chinese Communist Party recently employed: ‘the only two things that can threaten the regime are inflation and corruption’. So has it ever been, throughout China’s long history.
Given that, the observation that the 2009-10 stimulus delivered a massive, socially-imperilling dose of both these evils, it did not require too much nerve to hold to the idea that the relief of the monetary stringency gradually imposed (in the official markets for money and credit, at least) last year would be maintained until the fear of an imminent implosion rebalanced the scales of political calculus – above all, in this, a leadership transition year and doubly, trebly so when the Party apparat’s inner schisms were revealed with the dramatic purge of Bo Xilai and his Chongqing henchmen.
Thus, it is that, wherever you look, you see signs of distress in China. Shipbuilding, steel making, aluminium smelting, textiles, construction – even sectors such as these, which are dominated by the privileged oligopolies of the state-owned enterprises, are palpably struggling. Meanwhile, stockpiles of raw materials continue to mount on the wharfsides and in the warehouses, entailing who knows what dangers for those who have raised grey-market funding by using them as collateral and who thus owe monies both at home (in loan-sharked yuan) and abroad in an inconveniently appreciating dollar. Meanwhile, accounts receivable pile up on balance sheets at rates greatly in advance of those at which reported revenues advance and the spreading stench of fraud poisons the waters for those looking to plug the gaps with gullible gweilo money.
The authorities’ response? To insist that the Big 4 accounting firms do not co-operate with the SEC in investigating any such accusations and to issue a media directive that no bad news may be reported without prior approval in the run up to the autumn’s Politburo handover.
Indeed, there are clear signs that some of these dangers are beginning to be realised. Taking the difference between the reported size of China’s forex reserves and the sum of trade and FDI inflows (and making some best-guess reckoning of the effects of reval changes and interest gains), one gets an estimate of hot money movements being diffused across the porous barrier of capital controls – most famously via the metals L/C rehypothecation scam. Between March’09 and February of this year, such ‘unexplained’ flows amounted to no less than $560 billion – roughly two-fifths of China’s total reserve accumulation and a third of its coincident increase in M1.
The last four months of increasing angst about the state of the ‘landing’ have seen a dramatic reversal of these flows, to the point that the discrepancy in the books suggests that China may have lost no less than $128 billion – a flight which exceeds that suffered during the worst of the Lehman crisis. Taken at face value, this implies further, self-reinforcing pressure for the renminbi to weaken, for the Dim Sum bond bubble to deflate, and for commodity loans to be unwound, either suddenly – by means of re-exporting some of the swelling inventories of copper, et al – or gradually – by cutting back on new imports until the excess has worn off and the bills settled.
Either way, a chilling prospect, even if this does not trigger a new financial crisis among China’s complex and shadowy interweaving of ‘loan guarantee’ companies and off-balance sheet ‘wealth management products’
It should go without saying that China is not the be-all and end-all of this story, for it is also the nexus whereat much of the value-added is booked, if not strictly accrued, from the embodiment into the consumer goods we Europeans and Americans so avidly buy off the higher-tech component marvels of its more sophisticated neighbours, especially Japan, South Korea, and Taiwan. Nor is China’s fate a matter of indifference to its suppliers and fellow users of less rarefied inputs, whether directly – e.g., Australia, Brazil, South Africa, and the Gulf – or indirectly, wherever similar goods have their prices boosted by means of China’s disproportionate take-off from world market supply.
China has now begun to react, of course, cutting the effective bellwether, one-year lending rate from 5.9% (6.55% official less the permitted discount of 10%) to 4.2% (6.0% less the widened 30% rebate) in the space of a month. As Wang Shuo, Managing Editor of the influential and highly-regarded Caixin Magazine blogged at once on his Weibo page: “This is an admission that the hard landing is already here.” In this, he only anticipated his sovereign overlord, President Hu, by a few hours, for this latter worthy soon thereafter started bleating that the economy faces ‘severe downwards pressure’.
You bet it does! Take a range of key indicators – from electricity usage, to Shanghai container throughput, to nationwide rail freight ton-miles, to steel output – and you will notice that none of these shows a rate of growth during the second quarter of more than 4% from 2011, and some are as low as 1%. Whatever fictive GDP number we are presented with this week, the message is clear: “Brace! Brace! Brace!”
The trick will now be to avoid re-inflating the property bubble – and information suggesting 125% of June’s overall loan total was comprised of household credit offers little reassurance on that score. It is also imperative that the regime acts to assuage the fears of a populace who were already, in the aftermath of the first rate reduction, responding to official survey questions in a high and increasing proportion that they feared an imminent ‘surge’ in consumer goods prices. Good luck with that, Comrades!
Last of all we come to Europe and here is where, six months ago, we only had a thesis, or rather a litmus test, for, when we last wrote the report in question, we said that the key issue was whether or not the massive LTRO operations then just being enacted would actually stimulate a long-awaited increase in money supply in the Zone.
We know now that the answer was a qualified negative since the bulk of the impact of the operation went towards providing a mechanism through which credit withdrawal and outright capital flight into the core could occur, without collapsing the banking systems of the periphery, there and then. Thus the qualification on the above negative: money supply has continued to shrink in the Olive Belt debtor nations (especially after deducting the wastage due to CPI price rises), while it has begun to accelerate in what is not far from becoming an alarming manner in the creditor nations of the north, thanks to the arcane wonders of the TARGET2 apparatus.
A cynic might point out that such a sub-alpine price and wage suppression, coupled with the converse trends among the supra-alpine elite is exactly what is needed to ‘rebalance’ the Eurozone without breaking the single currency apart.
The problem with the adoption of such a sanguine view comes in two parts. The first is the quibble that a suitable capital base through which to make this shift in relative prices immediately effective is sorely lacking: unemployed Greek school teachers are not going to pose a threat to Dutch petrochemical engineers, nor Spanish carpet-layers to Mittelstand machine tool assemblers, any time soon. The second is that while the debt overhang persists – and, indeed, while it is being made progressively more onerous by the ongoing deflation – any Northern man of affluence or entrepreneurial daring tempted to speed the process through taking up productive assets or property in the afflicted zones will be greatly inhibited both by the knowledge that some highly arbitrary credit revision still lies ahead and by the fear – justified only last week by M. Hollande’s ill-judged razzia – that the state’s roving marauders will be happy to seize any gains made from such investments, however inequitable and retrospective – not to mention ultimately self-defeating – the deed might be.
In contrast to their policy-making peers elsewhere, by continuing to cite the need for ‘structural reform’, much of the European political elite is at least paying lip service to the principles contained in our oft-repeated mantra that there are no macro-economic issues which can be solved other than by micro-economic means (though, for us, that also includes case-by-case debt renegotiation, write-down, and transmutation into equity).
Sadly, while their mouths may be making such pious utterances unto the Gods, their hands – as M. Carmignac so forcefully pointed out in the European press a few days ago – are reaching ever more boldly into the pockets of those who still have reserves of capital and a viable means of support, thus bleeding the healthy in the forlorn attempt to palliate the sick. A case in point here is the latest brainwave of resurrecting the time-dishonoured method of forcing the rich to subscribe to state ‘loans’ – a levy on what might otherwise be productive capital last practiced by arbitrary princes of the ancien régime, as well as by the bellicose proto-republics with whom they were often at war.
With markets showing less and less response to the same, wearily repeated prescription of longer-lowered interest rates and more intrusions into the markets – LIBOR rigging on a universal scale, we cannot refrain from adding – the worry is that the piecemeal expenditure of the wrong sort of ammunition in pursuit of ill-counselled operational objectives will yet see the whole Grande Armée of bureaucrats, technocrats, and corporocrats arrive at its very own Berezina just in time to celebrate the two-hundredth anniversary of the utter dissolution on those pitilessly icy banks of the once-proud remnants of the first.
Last week it was announced that Beijing was reversing an earlier decision to allow local governments to issue their own bonds, causing eyebrows to be raised everywhere among the sceptics who may also have noted that the Chinese Index Academy were reckoning that the latter’s crucial revenues from land sales were some 38% lower in the first half of this year, on a national count, with declines in the capital and Shanghai suffering drops of up nearer 60%.
In a classic sign of policy confusion, it was also reported that the authorities were simultaneously giving tacit encouragement to the banks – which are otherwise struggling to hit their fatally-conceited, top-down targets for loan growth – to make up some of the resulting shortfall, as well as launching a $14 billion bond under the auspices of the MOF in order to raise funds for these stalwarts of misplaced spending and crass Keynesian malinvestment.
Meanwhile, Tao Zuojin, head of the China State Shipbuilding association, vouchsafed that up to a half of all his members might go bust within the next two years, reeling under a 60% decline in the gross tonnage of orders (90% of yards are said, in some quarters, to have won ZERO orders so far this year) as global economic deterioration compounds the widespread glut of maritime freight capacity and the lessened availability of cheap credit continues to haunt a sector largely expanded during the super-stimulus years.
Granted, the problem is not just confined to China – the global trade and resource rebound has suckered in all too many from outside the Middle Kingdom, too, as can be attested by the fact that 60% of the world’s dry bulk fleet has an average age of little more than three years, with deliveries scheduled this year likely to expand the fleet by around a sixth, even after scrappage is taken into account. But matters have come to such a pass in the earthly capital of Schactianism that Shanghai Shipping Exchange president Zhang Ye (no, not Zheng He!) told a regional industry forum that the state might not only soon require all cargo to be carried by domestic lines, but that all their vessels might have to have been built in Chinese yards, too.
Whether this resurrection of the infamous English Navigation Acts of the seventeenth and eighteenth centuries is truly a matter of official study – one shudders at the implications for world trade were so nakedly protectionist a measure to be enacted – it does show how desperate the situation has become for it even to be floated as a trial balloon.
Across at the local steel mill, things are not much better, with YTD losses rising appreciably from the same time last year to leave the businesses who pour half the world’s alloy with their already slender profits cut in half, stranding the group as a whole with a knife edge 0.1% operating margin and a decidedly sub-inflation ROA of just 0.6%. The worst third of them, all in the red, were actually left nursing a combined income gap of $2 billion, substantially higher than the losers’ tally this time last year.
If you think it might be important – not just to users of steel, but to diggers of dirt in the iron ore and metallurgical coal game – whether there is any immediate prospect of achieving an acceptable real return on capital in this moiety of the global industry, you should perhaps ponder on the fact that, since the comparable, pre-Crash semester in 2008, China’s steel production has risen by fully one-third (total capacity stands perhaps another 35% in excess of that), while the rest of the world has trimmed its output by some 5-6%. In other words, it is not just true of oil that China’s ill-advised crash stimulus package has been responsible for a share of incremental consumption much greater than unity in the past four years, but for materials associated with this particular destruction of capital, too.
Nor is business exactly humming in the thermal coal market, either. Indeed, the storage facilities at Qinhuangdo in Hebei province – the world’s largest coal terminal and one responsible for one-half of all China’s import needs – came perilously close to overflowing, with the peak stockpile of 9.5 million tonnes registered in mid-June representing 93% of the port’s total capacity and standing two-thirds higher than the seasonal average. Across the country, the total estimate which Li Xin of the China Coal Transportation and Distribution Association gave to the China Times was a mountainous 300 million tonnes – equivalent to 3-4 months’ imports and one month’s total consumption.
For reference, steel stockpiles are said to stretch to 12 million tonnes – up 35% since the start of the year – with dockside iron ore inventories not far short of 100 million tonnes – or around 7 weeks of imports.
Citing weakness in the electronics, machinery, and transport sectors – as well as an absence of major government outlays – state researcher Antaike lowered its estimates for domestic copper consumption growth to 5% in the current year. Elsewhere, it was reported that cement production had only risen 4.4% yoy in May (a gain of 5% in the first five months as a whole) with that of flat glass slumping 10.2% to depress the YTD total to a scanty 1.7% gain versus a 19.6% rise in the corresponding period in 2011. Needless to say, businesses in the first are seeing profits tumble by 50% or more, while those in the second are collectively in the red.
Is it any wonder that Deputy Director Shao Ning of SASAC – the body charged with oversight of the major SOE’s – said that these coddled giants should be girding their loins for ‘the next three to five years (sic) of winter conditions’ by striving to ‘strengthen their basic management practices… attaching great importance to cost reduction and enhancing efficiency… Increasingly a matter of life and death in times of austerity and contraction… central enterprises must fully understand the gravity and urgency of the current situation, and devote attention to being able to survive …’?
All in the price, the optimists say, but we – with our Austrian theories of boom and bust reinforcing our admittedly far less expert reading of the political tensions at work – are not so sure. Those expecting another massive monetary infusion should bear in mind that a PBOC survey of Beijing residents showed last week that an increased majority of 73.1% of respondents said that prices of goods were unacceptably high and that almost half of them feared a ‘surge’ in their prices over the coming quarter – a pessimism largely rooted in the Bank’s recent interest rate reduction, one suspects.
Whether or not such anxieties are well-grounded, their currency will not allow the policy-makers to place too much faith in the idea that the ongoing fall in the official CPI index will, of itself, be sufficient to give them room to conduct any grand, counter-cyclical manoeuvres in the coming months.
But, of course, the week’s main focus has not been China, but whether or not the Germans really did suffer two defeats at the hands of the Italians, or just the one.
The tenor of the press coverage in the Heimat is fairly one-sided in the interpretation that ‘Madame Non’ did in fact give in to an Italo-Hispanic threat of boycott by means of which we were presented with the ludicrous spectacle of two inveterate starvelings making the threat that if they could not dine on caviar they would not accept carrots to a woman who was not all that keen on sharing any crumbs from her table with such as they (she was, after all, only cajoled into accepting the so-called Growth Pact which they were blocking out as a gambit to secure the two-thirds parliamentary majority needed in order to pass the ESM enabling legislation – a programme which she and hers were also not that keen on in the first place!)
The editorials and op-eds were bad enough, with their talk of ‘democratic deficits’, ‘witch-hunts’, ‘tearing up treaties before the ink is dry on them’ and ‘reaching into the German pocket’, but some of the readers’ comments went so far as to invoke images of the infamous ‘Kohlruebenwinter’ when the besieged German populace barely fended off starvation on a monotonous diet of root vegetables in 1917, as well as the even more emotive leitmotiv of betrayal, the ‘Dolchstoss’ – or stab in the back – by means of which the Allies overcame a supposedly undefeated Imperial Army a year later.
And yet it may not be entirely a piece of political slipperiness for the Chancellor’s team to argue that nothing much actually has changed.
Several commentators have pointed out that there are, in fact, no new ‘instruments’, just as Frau Merkel promised. It remains the case, they contend, that the ESM has neither been extended, nor allowed to leverage itself up; that its use as a means of financing banks directly is subject both to the inevitably fraught process of first establishing a pan-European banking supervisor-cum-Resolution Trust (and one possibly equipped with a Scandinavian doctrine of managerial dismissal and stock and bondholder loss-sharing, to boot); that, in the meanwhile, if Spain needs to re-cap its banks, the overstretched Spanish budget will still have to bear the strain; that, theoretically at least, each and every emergency loan is supposed to be decided on a case-by-case basis by national legislatures on the typical EZ-weighted calculation – leaving the Bundestag with a final right of veto, should it ever screw its courage to the sticking place; that she can rely on the disgruntled Finns and Dutch also to block whatever they can; that the whole vexed issue of seniority of claims has not been precluded, merely finessed away by means of not insisting on an explicit declaration of what, much like the IMF, is likely to be an implicit priority, once implemented; and, finally, that the Grim Reaper may put away his scythe for now, since she has NOT in any fashion given way to the issue of joint Euro-Bonds.
Thus, as is so often the case in financial markets – for all their pretence at scientific objectivity in analysis – this largely comes to down to a matter of what its participants want to believe. If you are ready to scoff at German pusillanimity, or to despair at the cynicism of its leaders’ political calculation, or to rejoice at the prospect of another dose of global Keynesianism – or simply to exult that, finally, risk assets can rise and you can look good for a few weeks – you will tend to believe that the once-forbidding Siegfried Line is now bedecked with newly-scrubbed Allied underwear.
If, conversely, you believe that additional debt is no solution for over-indebtedness; that the extreme time-preference of the venal place-holders who comprise the political class will never allow them to introduce much-needed reforms except under the most exigent outside pressures; that the deliberate ruination of a nation of savers and profit-makers is too high a penance to observe in order to absolve their opposites of their sins; if you are predisposed to a bearish outlook for assets which you suspect still bear the artificial premium attached to them by the past quadrennium’s over-zealous interventionism, you will be eagerly reading between the lines for signs that the triumph of Monti, Rajoy, and Hollande has been an illusory one and that the sell-off may soon resume.
In any case, the next scene of the farce-cum-tragedy will take place in Karlsruhe on the 10th, when the German Constitutional Court will – somewhat unusually – take oral depositions from the pros and antis, as a preliminary to making a more considered judgement later.
As this all plays out, it should also be noted that all the past year’s summitry and special operations have effectively reinforced the business of capital withdrawal and banking dis-integration across the ‘natural frontiers’ of the Rhine and the Alps. As the ECB balance sheet has doled out an extra €800+ billion in new credits, TARGET2 creditor-debtor balances have swollen by €590 billion (€390 billion v-a-v Germany alone) with M1 only adding around €210 billion, with half of that increment having taken place in Germany and two-thirds of it in the wider creditor group which includes the Netherlands, Finland, and Luxembourg.
Thus, German real M1 growth has accelerated smartly from 0.9% pa to 5.2% (the median rate of the past three decades), driven by a veritable explosion in the local monetary base. Across the combined Creditor-4 grouping, real M1 is rising at a rapid 5.7% annual rate while – alack and alas! – the same key measure in the rest of the Zone is deflating at 3.9% annualized.
Were we to write down debts, entitlements, subsidies, wages, and costs and free up balance sheets, capital means, and labour in the latter unfortunates at the same time that we allowed the extra monetary infusion to go about its accustomed work among the former blessèd quartet, it would eventually effect the necessary rebalancing – in classic Humean stock-flow terms – that the bloc so badly needs. Thus, our condemnation of the process should really confine itself to the observation that it is precisely those same necessary accompaniments that so much of the Latinate policy thrust is aimed at avoiding, at the direct expense of their unsullied northern neighbours.
While the combatants take a brief respite from the battle, we can instead entertain ourselves with the spectacle of Monsieur Oui – the new incumbent of the Elysée Palace – trying to keep his rash electoral promises to reverse the sweeping tide of ‘neoliberalism’ and to stimulate growth while simultaneously being forced to trim his budgetary outlays to the not inconsiderable tune of €40 billion. Bon chance, mon brave!
The soak-the-rich measures we can expect, in what will be a victory for blind ideology over both economic theory and empirical verification, will further poison what are already noisome waters for investment and capital formation. As such, this is a prospect which is already said to be impelling elevated numbers of the likely soakees to quit the nest, in a less sanguinary replay of the Revocation of the Edict of Nantes.
Ironically, many of these would be émigrés are said to be looking, in time honoured fashion, across the narrow waters of La Manche for their haven. Ironic, because perfidious Albion herself is a shining example of how not to manage a recovery.
For Britain remains locked into a grinding recession of its own with its banks not just being hauled, again, before the court of public opinion, but still sheltering far too many zombie companies on their books, to the decided detriment of those better entrepreneurs who are now being bled in a cut-throat competition with living dead businesses able to operate, at their creditors’ behest, only for cash.
Thus, despite allowing its currency to sink further than any major nation in the Crash, to the point of a post-war low; despite passing a sentence of death upon the rentier class, as per the Great Apothecary’s quack prescriptions from the 30s; despite the continuation of such a vast scale of government exhaustiveness-amid-‘austerity’ that Leviathan – and Leviathan alone – has swallowed up nigh unto £1/2 trillion in private sector and foreign savings this past 3 ½ years – so that the Beast has devoured 5 months of total private national output while moving its share of GDP back up towards those same peacetime highs which have twice in a generation seen the country reduced both to internal ruin and external derision – despite all this, Britain remains in enough of a recession to trigger a dangerous attack of populist headline-grabbing from its hapless ruling trio.
It seems the new Huguenots may well avoid the worst depredations of their own leadership by hopping on the ferry at Calais, but they should not count on alighting amid a Land of Milk and Honey, by any means.
Far away, across the Western Ocean, the US – still the best horse in the glue factory as Dallas Fed president Richard Fisher so colourfully puts it – has so far stood above this fray. Not least of the reasons for this is that, despite a dip in the offshore component in QI, corporate profits plus proprietors’ income have reached close to the best levels seen, as a proportion of private GDP, in the past five-and-a-half decades, while manufacturers’ operating margins have reached their best levels in the past four-and-a-half. Returns on equity are none too shabby, either. The incentives to produce, to invest, and to hire, would seem to be present even if a natural caution still pervades the owners and managers of capital, given both the domestic political uncertainties and the cloudy foreign horizons.
But, of course, THAT was then and THIS is now. With monetary growth slowing at home, and economic weakness afflicting Latam (Brazil’s IP just printed its weakest reading in 2 ½ years of -4.3% yoy, taking the level back to those of five years ago), Asia, and much of Europe abroad, the past may not be prologue. Certainly, that seemed to be the message being given by the latest NAPM number which suddenly dropped to what is almost a 2-year low, led by the biggest single month fall in new orders since 9/11 – a plunge only otherwise exceeded in the last half-century by the outbreak of the Iran-Iraq war and the onset of the second oil shock.
Was this a one-off, or is it the first crack in the foundations of a modest American recovery and re-orientation? Only time will tell.