[Editor's note, this piece, by Richard Ebeling, is from EpicTimes]
It is an old adage that there are lies, damn lies and then there are statistics. Nowhere is this truer that in the government’s monthly Consumer Price Index (CPI) that tracks the prices for a selected “basket” of goods to determine changes in people’s cost-of-living and, therefore, the degree of price inflation in the American economy.
On August 19th, the Bureau of Labor Statistics (BLS) released its Consumer Price Index report for the month of July 2014. The BLS said that prices in general for all urban consumers only rose one-tenth of one percent for the month. And overall, for the last twelve months the CPI has only gone up by 2 percent.
A basket of goods that had cost, say, $100 to buy in June 2014 only cost you $100.10 in July of this year. And for the last twelve months as a whole, what cost you $100 to buy in August 2013, only increased in expense to $102 in July 2014.
By this measure, price inflation seems rather tame. Janet Yellen and most of the other monetary central planners at the Federal Reserve seem to have concluded, therefore, that they have plenty of breathing space to continue their aggressive monetary expansion when looking at the CPI and related price indices as part of the guide in deciding upon their money and interest rate manipulation policies.
Overall vs. “Core” Price Inflation
The government’s CPI statisticians distinguish between two numbers: the change in the overall CPI, which rose that 2 percent for the last year, and “core” inflation, which is the rate of change in the CPI minus food and energy prices. Leaving these out, “core” price inflation went up even less over the last twelve months, by only 1.9 percent.
The government statisticians make this distinction because they argue that food and energy prices are more “volatile” than many others. Fluctuating more frequently and to a greater degree than most other commonly purchased goods and services, they can create a distorted view, it is said, about the magnitude of price inflation during any period of time.
The problem is that food and energy costs may seem like irritating extraneous “noise” to the government number crunchers. But to most of the rest of us what we have to pay to heat our homes and put gas in our cars, as well as buying groceries to feed our families, is far from being a bothersome distraction from the statistical problem of calculating price inflation’s impact on our everyday lives.
Constructing the Consumer Price Index
How do the government statisticians construct the CPI? Month-by-month, the BLS tracks the purchases of 6,100 households across the country, which are taken to be “representative” of the approximately 320 million people living in the United States. The statisticians then construct a representative “basket” of goods reflecting the relative amounts of various consumer items these 6,100 households regularly purchase based on a survey of their buying patterns. They record changes in the prices of these goods in 24,000 retail outlets out of the estimated 3.6 million retail establishments across the whole country.
And this is, then, taken to be a fair and reasonable estimate – to the decimal point! – about the cost of living and the rate of price inflation for all the people of the United States.
Due to the costs of doing detailed consumer surveys and the desire to have an unchanging benchmark for comparison, this consumer basket of goods is only significantly revised about every ten years or so.
This means that over the intervening time it is assumed that consumers continue to buy the same goods and in the same relative amounts, even though in the real world new goods come on the market, other older goods are no longer sold, the quality of many goods are improved over the years, and changes in relative prices often result in people modifying their buying patterns.
The CPI vs. the Diversity of Real People’s Choices
The fact is there is no “average” American family. The individuals in each household (moms and dads, sons and daughters, and sometimes grandparents or aunts and uncles) all have their own unique tastes and preferences. This means that your household basket of goods is different in various ways from mine, and our respective baskets are different from everyone else’s.
Some of us are avid book readers, and others just relax in front of the television. There are those who spend money on regularly going to live sports events, others go out every weekend to the movies and dinner, while some save their money for an exotic vacation.
A sizable minority of Americans still smoke, while others are devoted to health foods and herbal remedies. Some of us are lucky to be “fit-as-a-fiddle,” while others unfortunately may have chronic illnesses. There are about 320 million people in the United States, and that’s how diverse are our tastes, circumstances and buying patterns.
Looking Inside the Consumer Price Index
This means that when there is price inflation those rising prices impact on each of us in different ways. Let’s look at a somewhat detailed breakdown of some of the different price categories hidden beneath the CPI aggregate of prices as a whole.
In the twelve-month period ending in July 2014, food prices in general rose 2.5 percent. A seemingly modest amount. However, meat, poultry, fish and egg prices increased, together, by 7.6 percent. But when we break this aggregate down, we find that beef and veal prices increased by 10.4 percent and frankfurters went up 6.9 percent, but lamb rose by only by 1.7 percent. Chicken prices increased more moderately at 2.7 percent, but fresh fish and seafood were 8.8 percent higher than a year earlier.
Milk was up 5.4 percent in price, but ice cream products decreased in price by minus 1.4 percent over the period. Fruits increased by 5.7 percent at the same time that fresh vegetable prices declined by minus 0.5 percent.
Under the general energy commodity heading, prices went up by 1.2 percent, but propane increased by 7.3 percent in price over the twelve-month period, while electricity prices, on the other hand, increased by 4 percent.
So why does the overall average of the Consumer Price Index seem so moderate at a measured 2 percent, given the higher prices of these individual categories of goods? Because furniture and bedding prices decreased by minus 3.1 percent, and major appliances declined in price over the period by minus 6.2. New televisions went down a significant minus15 percent
In addition, men’s apparel went down a minus 0.2 percent over the twelve months, but women’s outerwear rose a dramatic 12.3 percent in the same time frame. And boys and girls footwear went up, on average, by 8.2 percent.
Medical care services, in general, rose by 2.5 percent, but inpatient and outpatient hospital services increased, respectively, by 6.8 percent and 5.6 percent.
Smoke and Mirrors of “Core” Inflation
These subcategories of individual price changes highlight the smoke and mirrors of the government statisticians’ distinction between overall and “core” inflation. We all occasionally enter the market and purchase a new stove or a new couch or a new bedroom set. And if the prices for these goods happen to be going down we may sense that our dollar is going further than in the past as we make these particular purchases.
But buying goods like these is an infrequent event for virtually all of us. On the other hand, every one of us, each and every day, week or month are in the marketplace buying food for our family, filling our car with gas, and paying the heating and electricity bill. The prices of these goods and other regularly purchased commodities and services, in the types and combinations that we as individuals and separate households choose to buy, are what we personally experience as a change in the cost-of-living and a rate of price inflation (or price deflation).
The Consumer Price Index is an artificial statistical creation from an arithmetic adding, summing and averaging of thousands of individual prices, a statistical composite that only exists in the statistician’s calculations.
Individual Prices Influence Choices, Not the CPI
It is the individual goods in the subcategories of goods that we the buying public actually confront and pay when we shop as individuals in the market place. It is these individual prices for the tens of thousands of actual goods and services we find and decide between when we enter the retail places of business in our daily lives. And these monetary expenses determines for each of us, as individuals and particular households, the discovered change in the cost-of-living and the degree of price inflation we each experience.
The vegetarian male who is single without children, and never buys any types of meat, has a very different type of consumer basket of goods than the married male-female couple who have meat on the table every night and shop regularly for clothes and shoes for themselves and their growing kids.
The individual or couple who have moved into a new home for which they have had to purchase a lot of new furniture and appliances will feel that their income has gone pretty far this past twelve months compared to the person who lives in a furnished apartment and has no need to buy a new chair or a dishwasher but eats beef or veal three times a week.
If the government were to impose a significant increase in the price of gasoline in the name of “saving the planet” from carbon emissions, it will impact people very differently depending up whether an individual is a traveling salesman or a truck driver who has to log hundreds or thousands of miles a year, compared to a New Yorker who takes the subway to work each day, or walks to his place of business.
It is the diversity of our individual consumer preferences, choices and decisions about which goods and services to buy now and over time under constantly changing market conditions that determines how each of us are influenced by changes in prices, and therefore how and by what degree price inflation or price deflation may affect each of us.
Monetary Expansion Distorts Prices in Different Ways
An additional misunderstanding created by the obsessive focus on the Consumer Price Index is the deceptive impression that increases in the money supply due to central bank monetary expansion tend to bring about a uniform and near simultaneous rise in prices throughout the economy, encapsulated in that single monthly CPI number.
In fact, prices do not all tend to rise at the same time and by the same degree during a period of monetary expansion. Governments and their central banks do not randomly drop newly created money from helicopters, more or less proportionally increasing the amount of spending power in every citizen’s pockets at the same time.
Newly created money is “injected” into the economy at some one or few particular points reflecting into whose hands that new money goes first. In the past, governments might simply print up more banknotes to cover their wartime expenditures, and use the money to buy armaments, purchase other military supplies, and pay the salaries of their soldiers.
The new money would pass into the hands of those selling those armaments or military supplies or offering their services as warriors. These people would spend the new money on the particular goods and services they found desirable or profitable to buy, raising the demands and prices for a second group of prices in the economy. The money would now pass to another group of hands, people who in turn would now spend it on the market goods they wanted to demand.
Step-by-step, first some demands and some prices, and then other demands and prices, and then still other demands and prices would be pushed up in a particular time-sequence reflecting who got the money next and spent in on specific goods, until finally more or less all prices of goods in the economy would be impacted and increased, but in a very uneven way over time.
But all of these real and influencing changes on the patterns of market demands and relative prices during the inflationary process are hidden from clear and obvious view when the government focuses the attention of the citizenry and its own policy-makers on the superficial and simplistic Consumer Price Index.
Money Creation and the Boom-Bust Cycle
Today, of course, virtually all governments and central banks inject new money into the economy through the banking system, making more loanable funds available to financial institutions to increase their lending ability to interested borrowers.
The new money first passes into the economy in the form of investment and other loans, with the affect of distorting the demands and prices for resources and labor used in capital projects that might not have been undertaken if not for the false investment signals the monetary expansion generates in the banking and financial sectors of the economy. This process sets in motion the process that eventually leads to the bust that follows the inflationary bubbles.
Thus, the real distortions and imbalances that are the truly destabilizing effects from central banking inflationary monetary policies are hidden from the public’s view and understanding by heralding every month the conceptually shallow and mostly superficial Consumer Price Index.
You’d think that the US dollar has suddenly become strong, and the chart below of the other three major currencies confirms it.
The US dollar is the risk-free currency for international accounting, because it is the currency on which all the others are based. And it is clear that three months ago dollar exchange rates against the three currencies shown began to strengthen notably.
However, each of the currencies in the chart has its own specific problems driving it weaker. The yen is the embodiment of financial kamikaze, with the Abe government destroying it through debasement as a cover-up for a budget deficit that is beyond its control. The pound is being poleaxed by a campaign to keep Scotland in the union which has backfired, plus a deferral of interest rate expectations. And the euro sports negative deposit rates in the belief they will cure the Eurozone’s gathering slump, which if it develops unchecked will threaten the stability of Europe’s banks.
So far this has been mainly a race to the bottom, with the dollar on the side-lines. The US economy, which is officially due to recover (as it has been expected to every year from 2008) looks like it’s still going nowhere. Indeed, if you apply a more realistic deflator than the one that is officially calculated, there is a strong argument that the US has never recovered since the Lehman crisis.
This is the context in which we must judge what currencies are doing. And there is an interpretation which is very worrying: we may be seeing the beginnings of a major flight out of other currencies into the dollar. This is a risk because the global currency complex is based on a floating dollar standard and has been since President Nixon ended the Bretton Woods agreement in 1971. It has led to a growing accumulation of currency and credit everywhere that ultimately could become unstable. The relationship between the dollar and other currencies is captured vividly in the illustration below.
The gearing of total world money and credit on today’s monetary base is forty times, but this is after a rapid expansion of the Fed’s balance sheet in recent years. Compared with the Fed’s monetary base before the Lehman crisis, world money is now nearly 180 times geared, which leaves very little room for continuing stability.
It may be too early to say this inverse pyramid is toppling over, because it is not yet fully confirmed by money flows between bond markets. However in the last few days Eurozone government bond yields have started rising. So far it can be argued that they have been over-valued and a correction is overdue. But if this new trend is fuelled by international banks liquidating non-US bond positions we will certainly have a problem.
We can be sure that central bankers are following the situation closely. Nearly all economic and monetary theorists since the 1930s have been preoccupied with preventing self-feeding monetary contractions, which in current times will be signalled by a flight into the dollar. The cure when this happens is obvious to them: just issue more dollars. This can be easily done by extending currency swaps between central banks and by coordinating currency intervention, rather than new rounds of plain old QE.
So far market traders appear to have been assuming the dollar is strong for less defined reasons, marking down key commodities and gold as a result. However, the relationship between the dollar, currencies and bond yields needs watching as they may be beginning to signal something more serious is afoot.
[This article, by Peter St. Onge, first appeared at mises.org]
One of the great economic myths of our time is Japan’s “lost decades.” As Japan doubles-down on inflationary stimulus, it’s worth reviewing the facts.
The truth is that the Japanese and US economies have performed in lock-step since 2000, and their performances have matched each other going as far back as 1980.
Either Japan’s not in crisis, or the US has been in crisis for a good thirty-five years. You can’t have it both ways.
Here’s a chart of per capita real GDP for both Japan and the US from 2000 to 2011. Per capita real GDP is the GDP measure that best answers the question: “is the typical person getting richer?”
The two curves look like they came from the same country:
Next, we can go back to 1980, to see where the myth came from. Japan was just entering its “bubble” decade:
We can see what happened here: Japan had a boom in the 1980s, then Japan busted while the Americans had their turn at a boom. By 2000 the US caught up, and Japan and the US synched up and shadowed each other, reflecting boom followed by the inevitable bust.
The only way you can get to the “lost decades” story is if you start your chart exactly when Japan was busting and America booming. Unsurprisingly, this is standard practice of the “lost decades” storytellers.
Of course, this would be like timing two runners, and starting the clock when one of them is on break. It’s absurd, but it gives the answer they want.
Things get worse when you include the artificial effects of inflation and population. Higher inflation and population growth both make the economy appear bigger without making people richer. If America annexed Mexico tomorrow, the US economy would grow by 30 percent. But that’s not going to make the average American 30 percent richer.
Adjusting for inflation and population is Macro 101. It’s so basic, in fact, that we might wonder if the “lost decades” macroeconomists are being intentionally forgetful. Why on earth would they do that?
Who Benefits from the “Lost Decades” Myth?
Who promotes the “lost decades” myth? Are the storytellers trying to make Japan look bad, or the US look good?
I suspect it’s a little of both: politicians in Japan need the sense of crisis to push their vote-buying schemes. It’s a lot easier to sell harmful policies if you can just convince the voters that everything’s already fallen apart. They’ve got nothing to lose at that point. In a crisis we are all socialists.
This cynical PR campaign is bearing fruit already, as Japanese voters accept inflationary policies from their new prime minister. In the name of reviving an economy that’s supposedly on its death-bed. Hard-working Japanese are losing their savings through low rates and inflation, but honor demands sacrifice so long as the future of the children supposedly hangs in the balance.
In reality, the re-telling of Japan’s myth reminds one of a doctor who lies to a patient so he can sell a cure that harms the patient.
On the American side, the myth of Japan’s “lost decades” is similarly useful: it makes our economic overlords seem like they actually know what they’re doing. And it serves to warn the naysayers: the “lost decades” myth is a bogeyman waiting to pounce if we ever falter from our bail-outs and vote-buying stimulus.
The truth, hidden in plain view, is that Japan’s not bad enough to be a battering ram for Japan’s Keynesian vote-buyers, and the US economy isn’t good enough for our home-grown vote-buyers to keep their jobs.
What is Super Mario up to?
First, he gave an unexpectedly dovish speech at the Jackson Hole conference, rather ungallantly upstaging the host, Ms Yellen, who was widely anticipated to be the most noteworthy speaker at the gathering (talking about the labor market, her favorite subject). Having thus single-handedly and without apparent provocation raised expectations for more “stimulus” at last week’s ECB meeting, he then even exceeded those expectations with another round of rate-cuts and confirmation of QE in form of central bank purchases of asset-backed securities.
These events are significant not because they are going to finally kick-start the Eurozone economy (they won’t) but because 1) they look rushed, and panicky, and 2) they must clearly alienate the Germans. The ideological rift that runs through the European Union is wide and deep, and increasingly rips the central bank apart. And the Germans are losing that battle.
As to 1), it was just three months ago that the ECB cut rates and made headlines by being the first major central bank to take a policy rate below zero. Whatever your view is on the unfolding new Eurozone recession and the apparent need for more action (more about this in a minute), the additional 0.1 percent rate reduction will hardly make a massive difference. Yet, implementing such minor rate cuts in fairly short succession looks nervous and anxious, or even headless. This hardly instils confidence.
And regarding the “unconventional” measures so vehemently requested by the economic commentariat, well, the “targeted liquidity injections” that are supposed to direct freshly printed ECB-money to cash-starved corporations, and that were announced in June as well, have not even been implemented yet. Apparently, and not entirely unreasonably, the ECB wanted to wait for the outcome of their “bank asset quality review”. So now, before these measures are even started, let alone their impact could even be assessed, additional measures are being announced. The asset purchases do not come as a complete surprise either. It was known that asset management giant BlackRock had already been hired to help the ECB prepare such a program. Maybe the process has now been accelerated.
This is Eurozone QE
This is, of course, quantitative easing (QE). Many commentators stated that the ECB shied away from full-fledged QE. This view implies that only buying sovereign debt can properly be called QE. This does not make sense. The Fed, as part of its first round of QE in 2008, also bought mortgage-backed securities only. There were no sovereign bonds in its first QE program, and everybody still called it QE. Mortgage-backed securities are, of course, a form of asset-backed security, and the ECB announced purchases of asset-backed securities at the meeting. This is QE, period. The simple fact is that the ECB expands its balance sheet by purchasing selected assets and creating additional bank reserves (for which banks will now pay the ECB a 0.2 percent p.a. “fee”).
As to 2), not only will the ECB decisions have upset the Germans (the Bundesbank’s Mr. Weidmann duly objected but was outvoted) but so will have Mr. Draghi’s new rhetoric. In Jackson Hole he used the F-word, as in “flexibility”, meaning fiscal flexibility, or more fiscal leeway for the big deficit countries. By doing so he adopted the language of the Italian and French governments, whenever they demand to be given more time for structural reform and fiscal consolidation. The German government does not like to hear this (apparently, Merkel and Schäuble both phoned Draghi after Jackson Hole and complained.)
The German strategy has been to keep the pressure on reform-resistant deficit-countries, and on France and Italy in particular, and to not allow them to shift the burden of adjustment to the ECB. Draghi has now undermined the German strategy.
The Germans fear, not quite unjustifiably, that some countries always want more time and will never implement reform. In contrast to those countries that had their backs to the wall in the crisis and had little choice but to change course in some respect, such as Greece, Ireland, and Spain, France and Italy have so far done zilch on the structural reform front. France’s competitiveness has declined ever since it adopted the 35-hour workweek in 2000 but the policy remains pretty much untouchable. In Italy, Renzi wants to loosen the country’s notoriously strict labour regulations but faces stiff opposition from the trade unions and the Left, not least in his own party. He now wants to give his government three years to implement reform, as he announced last week.
Draghi turns away from the Germans
German influence on the ECB is waning. It was this influence that kept alive the prospect of a somewhat different approach to economic challenges than the one adopted in the US, the UK and, interestingly, Japan. Of course, the differences should not be overstated. In the Eurozone, like elsewhere, we observed interest rate suppression, asset price manipulations, and massive liquidity-injections, and worse, even capital controls and arbitrary bans on short-selling. But we also saw a greater willingness to rely on restructuring, belt-tightening, liquidation, and, yes, even default, to rid the system of the deformations and imbalances that are the ultimate root causes of recessions and the impediments to healthy, sustainable growth. In the Eurozone it was not all about “stimulus” and “boosting aggregate demand”. But increasingly, the ECB looks like any other major central bank with a mandate to keep asset prices up, government borrowing costs down, and a generous stream of liquidity flowing to cover the cracks in the system, to sustain a mirage of solvency and sustainability, and to generate some artificial and short-lived headline growth. QE will not only come to the Eurozone, it will become a conventional tool, just like elsewhere.
I believe it is these two points, Draghi’s sudden hyperactivity (1) and his clear rift with the Germans and his departure from the German strategy (2) that may explain why the euro is finally weakening, and why the minor announcements of last Thursday had a more meaningful impact on markets than the similarly minor announcements in June. With German influence on the ECB waning, trashing your currency becomes official strategy more easily, and this is already official policy in Japan and in the US.
Is Draghi scared by the weak growth numbers and the prospect of deflation?
Maybe, but things should be put in perspective.
Europe has a structural growth problem as mentioned above. If the structural impediments to growth are not removed, Europe won’t grow, and no amount of central bank pump priming can fix it.
Nobody should be surprised if parts of Europe fall into technical recessions every now and then. If “no growth” is your default mode then experiencing “negative growth” occasionally, or even regularly, should not surprise anyone. Excited talk about Italy’s shocking “triple-dip” recession is hyperbole. It is simply what one should expect. Having said this, I do suspect that we are already in another broader cyclical downturn, not only in Europe but also in Asia (China, Japan) and the UK.
The deflation debate in the newspapers is bordering on the ridiculous. Here, the impression is conveyed that a drop in official inflation readings from 0.5 to 0.3 has substantial information content, and that if we drop below zero we would suddenly be caught in some dreadful deflation-death-trap, from which we may not escape for many years. This is complete hogwash. There is nothing in economic theory or in economic history that would support this. And, no, this is not what happened in Japan.
The margin of error around these numbers is substantial. For all we know, we may already have a -1 percent inflation rate in the Eurozone. Or still plus 1 percent. Either way, for any real-life economy this is broadly price-stability. To assume that modest reductions in any given price average suddenly mean economic disaster is simply a fairy tale. Many economies have experienced extended periods of deflation (moderately rising purchasing power of money on trend) in excess of what Japan has experienced over the past 20 years and have grown nicely, thank you very much.
As former Bank of Japan governor Masaaki Shirakawa has explained recently, Japan’s deflation has been “very mild” indeed, and may have had many positive effects as well. In a rapidly aging society with many savers and with slow headline growth it helped maintain consumer purchasing power and thus living standards. Japan has an official unemployment rate of below 4 percent. Japan has many problems but deflation may not be one of them.
Furthermore, the absence of inflation in the Eurozone is no surprise either. There has been no money and credit growth in aggregate in recent years as banks are still repairing their balance sheets, as the “asset quality review” is pending, and as other regulations kick in. Banks are reluctant to lend, and the private sector is careful to borrow, and neither are acting unreasonably.
Expecting Eurozone inflation to clock in at the arbitrarily chosen 2 percent is simply unrealistic.
Draghi’s new activism moves the ECB more in the direction of the US Fed and the Bank of Japan. This alienates the Germans and marginally strengthens the position of the Eurozone’s Southern periphery. This monetary policy will not reinvigorate European growth. Only proper structural reform can do this but much of Europe appears unable to reform, at least without another major crisis. Fiscal deficits will grow.
Monetary policy is not about “stimulus” but about maintaining the status quo. Super-low interest rates are meant to sustain structures that would otherwise be revealed to be obsolete, and that would, in a proper free market, be replaced. The European establishment is interested in maintaining the status quo at all cost, and ultra-easy monetary policy and QE are essentially doing just that.
Under the new scheme of buying asset-backed securities, the ECB’s balance sheet will become a dumping ground for unwanted bank assets (the Eurozone’s new “bad” bank). Like almost everything about the Euro-project, this is about shifting responsibility, obscuring accountability, and socializing the costs of bad decisions. Monetary socialism is coming. The market gets corrupted further.
The following is a commentary I wrote for The Forum section of London business-paper City A.M. The link is here.
It is now six years since the collapse of Lehman Brothers, and considering that the US economy has officially been in recovery for the past five years, that equity indexes have put in new all-time highs, and that credit markets are once again ebullient to the point of carelessness, it is worth contemplating that monetary policy remains stuck in pedal-to-the-floor stimulus mode. Granted, quantitative easing is (once again) scheduled to end, and the first rates hikes are now expected for next year, but the present policy stance certainly remains highly accommodative. A full ‘exit’ by the Fed is still merely a prospect.
Expectations appear to be for the US economy to finally emerge from its long stay in monetary intensive care healthier and fit for self-sustained, if modest, growth. I think this is unlikely. The lengthy period of monetary stimulus will have saddled the economy with new dislocations. And if central bank intervention did indeed manage to arrest the forces of liquidation that the crisis had unleashed, then some old imbalances will also still hang around.
“Easy money” is – contrary to how it is frequently portrayed – not some tonic that simply lifts the general mood and boosts all economic activity proportionally. Monetary stimulus is always a form of market intervention. It changes relative prices (as distinguished from the ‘price level’ that most economists obsess about); it alters the allocation of scarce resources and the direction of economic activity. Monetary policy always affects the structure of the economy – otherwise no impact on real activity could be generated. It is a drug with considerable side effects.
The latest crisis should provide a warning. As David Stockman pointed out, it did not arrive on a meteor from space, but had its origin in distortions in the housing market in the US – and the UK, Spain and Ireland – and in related credit markets, and therefore ultimately in the “easy money” policies of the early 2000s. Administratively suppressing short rates down to 1 percent for a prolonged period was then the “unconventional” policy du jour, and it was a success of sorts. A credit crunch and deleveraging were indeed avoided, which were then feared as a consequence of WorldCom and Enron defaulting and the dot.com-bubble bursting, but only at the price of blowing an even bigger bubble elsewhere.
This is the problem with our modern fiat money system. With the supply of money no longer constrained by a nature-given, scarce commodity (gold or silver), but now fully elastic, essentially unlimited, and under the control of a lender of last resort central bank, the parameters of risk-taking are forever altered.
Allegedly, we can now stop bank-runs and ignite short-term growth spurts, or keep the overall “price level” advancing on some arbitrarily chosen path of 2 percent. But we can achieve all of this only through monetary manipulations that must create imbalances in the economy. And as the overwhelming temptation is now to use “easy money” to avoid or shorten any period of liquidation, to go for all growth and no correction, distortions will accumulate over time.
As we move from cycle to cycle, the imbalances get bigger, asset valuations become more stretched, the debt load rises, and central banks take policy to new extremes to arrest the market’s growing desire for a much needed cleansing. That policy rates around the world have converged on zero is not a cyclical but a structural phenomenon.
Central bank stimulus is not leading to virtuous circles but to vicious ones. How can we get out? – Only by changing our attitudes to monetary interventions fundamentally. Only if we accept that interest rates are market prices, not policy levers. Only if we accept that the growth we generate through cheap credit and interest-rate suppression is always fleeting, and always comes at the price of new capital misallocations.
The prospect for such a change looks dim at present. Last year’s feverish excitement about Abenomics and this year’s urgent demands for Eurozone QE show that the belief in central bank activism is unbroken, and I remain sceptical as to whether the Fed and the Bank of England can achieve a proper and lasting “exit” from ultra-loose policy in this environment. The near-term outlook is for more heavy-handed interventions everywhere, and the endgame is probably inflation. This will end badly.
In recent months talking heads, disappointed with the lack of economic recovery, have turned their attention to wages. If only wages could grow, they say, there would be more demand for goods and services: without wage growth, economies will continue to stagnate. It amounts to a non-specific call to stimulate aggregate demand by continuing with or even accelerating the expansion of money supply. The thinking is the same as that behind Bernanke’s monetary distribution by helicopter. Unfortunately for these wishful-thinkers the disciplines of the markets cannot be bypassed. If you give everyone more money without a balancing increase in the supply of goods, there is no surer way of stimulating price inflation, collapsing a currency’s purchasing power and losing all control of interest rates.
The underlying error is to fail to understand that economising individuals make things in order to be able to buy things. That is the order of events, earn it first and spend it second. No amount of monetary shenanigans can change this basic fact. Instead, expanding the quantity of money will always end up devaluing the wealth and earning-power of ordinary people, the same people that are being encouraged to spend, and destroying genuine economic activity in the process.
This is the reason monetary stimulation never works, except for a short period if and when the public are fooled by the process. Businesses – owned and managed by ordinary people – are not fooled by it any more: they are buying in their equity instead of investing in new production because they know that investing in production doesn’t earn a return. This is the logical response by businesses to the destruction of their customers’ wealth through currency debasement.
Let me sum up currency debasement with an aphorism:
“You print some money to rob the wealth of ordinary people to give to the banks to lend to business to make their products for customers to buy with money devalued by printing.”
It is as ridiculous a circular proposition as perpetual motion, yet central banks never seem to question it. Monetary stimulus fails with every credit cycle when the destruction of wealth is exposed by rising prices. But in this credit cycle the deception was so obvious to the general public that it failed from the outset.
The last five years have seen all beliefs in the manageability of aggregate demand comprehensively demolished by experience. The unfortunate result of this failure is that central bankers now see no alternative to maintaining things as they are, because the financial system has become horribly over-geared and probably wouldn’t survive the rise in interest rates a genuine economic recovery entails anyway. Price inflation would almost certainly rise well above the 2% target forcing central banks to raise interest rates, throwing bonds and stocks into a severe bear market, and imperilling government finances. The financial system is simply too highly geared to survive a credit-driven recovery.
Japan, which has accelerated monetary debasement of the yen at an unprecedented rate, finds itself in this trap. If anything, the pace of its economic deterioration is increasing. The explanation is simple and confirms the obvious: monetary debasement impoverishes ordinary people. Far from boosting the economy it is rapidly driving us into a global slump.
The solution is not higher wages.
This month we observe the 40th anniversary of the resignation, under threat of imminent impeachment, of President Richard M. Nixon. Nixon aide and loyalist Pat Buchanan sums up, in a column in USA Today Liberal Elites Toppled Nixon his view:
“Richard Nixon was not brought down by any popular uprising. The breaking of his presidency was a product of the malice and collusion of liberal elites who had been repudiated in Nixon’s 49-state landslide in 1972.”
Nixon, as it happens, was not 1974’s only casualty. As William Safire recalls, Nixon’s secretary of the treasury, John Connally, “was indicted for taking graft on the same day the President was charged by the House Judiciary Committee for abuse of power.”
Both men were instrumental in the repudiation of the Bretton Woods gold-dollar monetary system that had undergirded post-war American (and world prosperity). Bretton Woods, indeed, was coming apart (as a gold+paper pastiche standard inevitably is prone to do). A gold-based international monetary order called out, however, to be mended not ended. Nixon ended it.
The House Judiciary Committee’s charges and the Connally indictment uncannily fulfill a prophecy by Tom Paine. Paine’s Common Sense triggered the American Revolution. Paine later wrote a tract, Dissertations On Government; The Affairs of the Bank; and Paper Money in 1786. It was issued the year before the Constitutional Convention that would send the confederated former colonies into the epic called the United States of America. It was, in part, a perfect diatribe against paper-based (rather than gold or silver defined) money.
But the evils of paper money have no end. Its uncertain and fluctuating value is continually awakening or creating new schemes of deceit. Every principle of justice is put to the rack, and the bond of society dissolved: the suppression, therefore; of paper money might very properly have been put into the act for preventing vice and immorality.
As to the assumed authority of any assembly in making paper money, or paper of any kind, a legal tender, or in other language, a compulsive payment, it is a most presumptuous attempt at arbitrary power. There can be no such power in a republican government: the people have no freedom, and property no security where this practice can be acted: and the committee who shall bring in a report for this purpose, or the member who moves for it, and he who seconds it merits impeachment, and sooner or later may expect it.
Of all the various sorts of base coin, paper money is the basest. It has the least intrinsic value of anything that can be put in the place of gold and silver. A hobnail or a piece of wampum far exceeds it. And there would be more propriety in making those articles a legal tender than to make paper so.
The laws of a country ought to be the standard of equity, and calculated to impress on the minds of the people the moral as well as the legal obligations of reciprocal justice. But tender laws, of any kind, operate to destroy morality, and to dissolve, by the pretense of law, what ought to be the principle of law to support, reciprocal justice between man and man: and the punishment of a member who should move for such a law ought to be death.
The death penalty for proposing paper money? Paine called for the criminal indictment as a capital crime, and for impeachment, of any who even would call for tender laws.
Connally was acquitted on the charges of graft and perjury. Later he underwent bankruptcy before dying in semi-disgrace. Nixon resigned rather than undergoing impeachment, also living out his life in disgraced political exile. The spirit of Paine’s declaration was fulfilled in both cases. Connally and Nixon engineered this violation, abandoning the good, precious-metal, money contemplated by the Constitution. Nemesis followed hubris.
The closing of the “gold window” was based, by Connolly, on deeply wrong premises. It was sold to the public, by Nixon, on deeply false promises.
On August 15, 1971 President Nixon came before the American people to announce:
We must protect the position of the American dollar as a pillar of monetary stability around the world.
In the past 7 years, there has been an average of one international monetary crisis every year. Now who gains from these crises? Not the workingman; not the investor; not the real producers of wealth. The gainers are the international money speculators. Because they thrive on crises, they help to create them.
In recent weeks, the speculators have been waging an all-out war on the American dollar. The strength of a nation’s currency is based on the strength of that nation’s economy–and the American economy is by far the strongest in the world. Accordingly, I have directed the Secretary of the Treasury to take the action necessary to defend the dollar against the speculators.
I have directed Secretary Connally to suspend temporarily the convertibility of the dollar into gold or other reserve assets, except in amounts and conditions determined to be in the interest of monetary stability and in the best interests of the United States.
Now, what is this action–which is very technical–what does it mean for you?
Let me lay to rest the bugaboo of what is called devaluation.
If you want to buy a foreign car or take a trip abroad, market conditions may cause your dollar to buy slightly less. But if you are among the overwhelming majority of Americans who buy American-made products in America, your dollar will be worth just as much tomorrow as it is today.
The effect of this action, in other words, will be to stabilize the dollar.
Now, this action will not win us any friends among the international money traders. But our primary concern is with the American workers, and with fair competition around the world.
To our friends abroad, including the many responsible members of the international banking community who are dedicated to stability and the flow of trade, I give this assurance: The United States has always been, and will continue to be, a forward-looking and trustworthy trading partner. In full cooperation with the International Monetary Fund and those who trade with us, we will press for the necessary reforms to set up an urgently needed new international monetary system. Stability and equal treatment is in everybody’s best interest. I am determined that the American dollar must never again be a hostage in the hands of international speculators.
Nixon’s promise that “your dollar will be worth just as much tomorrow as it is today” has, of course, completely falsified. The 2014 dollar is worth only 15 cents in 1971 terms, buying 85% less than it did in 1971. Some bugaboo. All of Nixon’s other rationalizations for going off gold also have been falsified.
The closing of the gold window turned out to be the slamming of the golden door to social mobility and equitable prosperity. In the wake of the closing of the gold window median family income stagnated, never again experiencing secular recovery. Meanwhile the income of the wealthy has continued apace. This has produced the very income inequality so loudly denounced by progressives who, ironically, are the last defenders of the very policy which is the probable cause of our inequitable prosperity.
Brother Pat Buchanan states that Nixon
…ended the Vietnam War with honor, brought all our troops and POWs home, opened up China, negotiated historic arms agreements with Moscow, ended the draft, desegregated southern schools, enacted the 18-year-old vote, created the EPA, OSHA and National Cancer Institute, and was rewarded by a grateful nation with a 61% landslide.
Even as Watergate broke, he ordered the airlift that saved Israel in the Yom Kippur War, for which Golda Meir called him the best friend Israel ever had.
His enemies were beside themselves with rage and resentment.
Buchanan, while admirably loyal, ignores the correlation between Nixon’s embrace of paper money and Paine’s prophetic call for impeachment for that high crime. Let us now, in this month of the 40th anniversary of Nixon’s resignation and the 43rd of his abandonment of the gold standard, pause to wonder. It is bewildering circumstance that the very liberal elites Buchanan indicts as malicious in their treatment of Nixon today represent the most reactionary of defenders of the most pernicious, and only enduring, residue of the Nixon Shock: paper money, “a most presumptuous attempt at arbitrary power.”
Originating at http://www.forbes.com/sites/ralphbenko/2014/08/18/pat-buchanan-ignores-the-underlying-reason-richard-nixon-was-forced-to-resign/
First it was the government’s miraculous ability to deliver on-target GDP growth that got the permabulls bellowing again, then it was the striking (world-beating, one might even say), 12% currency-adjusted rally in its stock market that got them triumphantly pawing the ground. Nor did the drop in interest rates serve in any way to dampen the eternal hope that China was once again deferring meaningful structural reform in the face of a threat to near-term output.
Quite what was actually behind the equity rally is not easy to say. There were whispers that the Russians (who else?) were piling in, now that their assets were subject to arbitrary seizure as part of Nova Roma’s vilification of their leader and proxy war against their homeland. There was also talk that the imminent linkage of the Shanghai and HK bourses was driving an arbitrage between the unusually-discounted mainland A-shares and their offshore H-share equivalents. Finally, in a typically neat piece of circular reasoning, the imminent rebound in the economy which we have even seen some brave (or foolhardy, according to preference) souls project at a startling 8.5% (sic) early next year was held to be at work to push up what was an otherwise under-owned and thus optically ‘cheap’ emerging market.
On the face of it, news that, over the first seven months of the year, the increase in SOE earnings had accelerated from June’s 8.9% YOY to July’s 9.2% – well up on the first quarter’s paltry 3.3% pace – may have seemed to have offered some much-needed confirmation of this optimistic thesis. However, a closer glance at the figures would not have proven quite so reassuring, had anyone bothered to actually take one.
Over the past, supposedly brighter three months, revenues advanced a modest 6.2% compared to the like period in 2013, though with as-reported profits up an ostensibly more creditable 12.1%. There, all grounds for positive spin, alas, were exhausted. For one, operating profits were, in fact, only up 4.0% like-for-like (a wide discrepancy which can only excite suspicion as to the nature of the headline surplus) while financing costs vaulted a fifth higher.
Worse still, in eking out even this degree of improvement since May, liabilities have soared by an incredible CNY2.320 trillion (around $125 billion a month) – an increment fully half as big again as that registered twelve months ago and a sum which is actually greater than the entire reported sum of ‘total social finance’ over the trimester (that latter ‘only’ managed CNY 2.240 trillion after last month’s thoroughly unexpected swoon).
And what did our proud commanders of the economic heights achieve for shouldering such a hefty weight of obligations? An addition to revenues of CNY719 billion (extra debt to extra ‘sales’ therefore coming in at a ratio of 3.2:1); a pick-up in ‘profit’ of CNY76 billion (d[Debt]:d[Income] = 30:1); and a blip up in operating profit of just CNY16 billion (at a truly staggering ratio of 144 to 1).
Reversing these latter relationships, we can see that while swallowing up all of the nation’s available new credit since the spring, China’s SOEs added 31 fen per one renminbi in sales, 3.3 fen in reported profit, and a bare 0.7 fen in the operating version of income. Just the sort of performance on which to base expectations of a significant coming rise in growth and prosperity!
Armed with such an underwhelming use of resources – both physical and financial – it is perhaps no wonder that MIIT is again trying to shut down swathes of superfluous capacity, issuing what are effectively cease-and-desist orders against 132 firms in a whole range of heavy industries – iron, steel, coke, ferroalloy, calcium carbide, aluminium, copper and lead smelting, cement, flat glass, paper, leather, printing and dyeing, chemical fibres, and lead-acid batteries. Shipbuilding may not be far behind, either, given that it formed the main topic of discussion at a meeting of the National Committee of the CPPCC this week.
The language used was, in some cases, pretty uncompromising, too: “Total industrial capacity in cement and plate glass is still growing, but the industry-wide sales rate is in decline and accounts receivable are increasing… there are to be no new projects in the sector for any reason,” thundered the MIIT communique.
This time around, given Chairman Xi’s rigorous ‘anti-corruption’ campaign, there might well be a little less of the back-sliding and wilful defiance which has greeted such edicts in the past. The emperor is no longer quite so fare away, nor the mountain quite so high, if you are a recalcitrant local cadre these days!
Even before this, the signs were there for those with eyes to see. Despite the much-bruited pick-up in activity, Chinese power use, excluding the residential component, SLOWED to 4.5% YOY in the three months to July from 8.1% in the preceding three months. Nor did this come without a significant deceleration in so-called ‘tertiary’ industry sector (loosely, that encompassing services and light indstry) which is henceforth supposed to be the torchbearer for growth and employment. Here, consumption dropped from the spring’s 10%-plus rates to just 7.4% YOY last month. Added buring of lights and turning of lathes in the secondary industry category – essentially manufacturing – was a tardy 4.2% even though growth in industrial production, we were told, had averaged 9.0% in that same period.
Hmmmm. No wonder the PMI seems to be shedding some of its recent, rather inexplicable exuberance.
Round and round the circle of vicious consequences swirls. As Wang Xianzheng, President of the China Coal Industry Association, admitted: ‘Currently, more than 50 percent of enterprises are in payment arrears and have delayed paying wages.’ Of 26 large companies spread across nine provinces, he revealed that 20 are making losses, only 9 are still in the black, and the remainder are hovering uneasily between (commercial) life and death.
Other obvious signs of distress are to be had among the loan guarantee networks which had everywhere come into being with the then-laudable aim of persuading constitutionally reluctant banks to lend to customers other than SOEs when times were good. Now trapped in flagging businesses which are more correlated than perhaps the participants had realised – and often having succumbed to the diversion of funds to less commendable ends in the interim – they are all going sour together and the same interconnectedness which was once their mainstay is proving instead a sheet anchor with which to drag them all under.
As Zhou Dewen, president of Zhejiang Federation of Private Enterprise Investment, told the Global Times, the rash of bankruptcies in Zhejiang and Jiangsu provinces has disrupted production and led to lay-offs, with 80% of all sour loans in the area associated with such mutual guarantee schemes. So elevated is the level of distrust, as bad debts have risen at an annualized 30% pace this year, that banks are now trying to call loans in early and obtaining court orders to freeze the assets of those firms that are unable to comply with their demands.
The banks themselves are beginning to accelerate write-offs dramatically – even though the official NPL ratios still look woefully understated. They are also drawing heavily upon the markets in order to bolster their capital as a precaution. As the WSJ reported, the four largest state-owned lenders have started raising a planned $73 billion in debt and equity this year – a call which is expected to jump to more than $300bn in the next five years, according to the banking regulator.
In addition, five local governments in the south and east of the country are setting up so-called ‘asset-management companies’ – effectively state-sponsored ‘bad banks’ – in a mirror of the system used by Zhu Rongji in the 1990s to shuffle the more toxic stuff off its originators’ balance sheets and thus allow them to continue to lend while the bitter fruits of their previous mistakes were hidden away elsewhere.
Though this only disguises and does not in any way alleviate the economic waste spawned by the boom, it might at least allow banks to issue new equity-like capital – perhaps to the insurers who are themselves being heavily promoted by Beijing as the next battalion of systemic saviours – at above notional book value and hence to enable them to remain a viable source of new credit. Note that the last time this was done, the losses were essentially fiscalized: banks simply swapped the bad loans on their books for what have since proven to be irredeemable – but nonetheless fully par-valued – loans to the state entities which, in turn, financed the obliging AMCs. Balance sheets will not shrink, therefore, only become sanitised, by the operation of this mechanism.
Here, however, is where it all gets fraught once more, because the same local governments who are being marshalled to assume the banks’ bad debts (many of them ensuing from extending credit to LGFPs) are themselves becoming desperate for funds given that all too many of their own, sure-fire investment gambits are turning out to be the dampest of damp squibs.
As the Economic Information Daily reported, an audit of 448 eastern township platform companies found that two-fifths of them were curently loss making, while a further thirty percent barely broke even. With these bodies so heavily dependent on land sales to generate the revenues needed to cover their current outlays, much less their ambitious capital expansion plans and ongoing debt service costs – and with such ‘sales’ only being possible in large part if the authorities extend the credit to the purchasers in the first place – a decidedly negative feedback loop has begun to tighten around their necks as the property market itself enters a slump.
Indeed, according to research conducted by brokerage company Centaline Property Agency, twenty major developers have between them spent CNY182.5 billion yuan so far this year to purchase new sites – a drastic 38% down on the like period last year.
‘Worsening property sales have undercut the willingness of developers to buy land. Their focus now is on raising cash from the sales of what they’ve already built. Few are in the mood to buy more,’ said Zhang Dawei who headed up the company’s research team.
In July alone, aggregate land sales revenue for 300 Chinese cities was off by a half from the same month in 2013, as reported by the China Index Academy. Sales in the four largest cities of Beijing, Shanghai, Guangzhou, and Shenzhen – normally a slam-dunk – sank by a staggering 70%.
‘The downturn means that the scale of land sales for the remainder of this year could continue to contract. Developers have pushed the “conservative” button,’ said Zhang with commendable understatement.
And quite right, too, as anecdotal evidence grows that formerly avid house-buyers are beginning to adopt that age-old American practice of ‘jingle mail’ – that is, they are simply walking away from properties they either cannot afford or do not believe will again appreciate in price.
At one end of the scale, one Nanjing online estate agent recorded a growing back-log of such defalcations and referred to the ‘unspeakable pain’ in the local market – an agony apparently shared in at least six other of the districts neighbouring his.
Despite the widespread belief that Chinese buyers are sitting on a typical equity cushion of 30-40% of the property value – and hence, unlike their less well-endowed US, Irish, and Spanish cousins, are impervious to all bar the most extreme events in the market – the scary truth is that much of the real estate to which they do hold title has been, how shall we say, ‘rehypothecated’ – i.e., pledged as collateral for a range of business loans as well as for the more speculative use of funds.
‘In the past few years, many small business owners blindly invested in real estate, mining and other industries. These industries are now suffering from overcapacity and falling asset prices, so business owners are unable to pay their debts,’ said one general manager of a Wenzhou microfinance company.
‘Many [of these] use the house as collateral when business loans go wrong,‘ Ge Ningbo, a county bank manager, told a journalist.
To get a feel for the scale of the problem, consider press reports that in Wenzhou, 1,000 homes were abandoned as a result of the decline, homes with an ostensible market value of more than Y6.4 Billion – or roughly $1 million a pop! No scrabbling rural migrants, these, but possibly members of an increasingly scrutiny–shy party apparatus! Clearly, the banks will need to suck in even more money from their gullible preference shareholders if this phenomenon starts to spread and, in the meanwhile, it is hard to see how they will be empowered to make sufficient revenue-positive new loans to keep the whirligig in motion in such a climate of confusion and disabusal.
Sadly, we have not finished our tale of woe there because there are also stories circulating in the official media that those same local governments, who are in many ways the lynchpins of the whole merry-go-round, may be far deeper into the mire than has been recognised to date.
As the articles detail, a member of the relevant NPC standing committee confided to a press contact that when hidden liabilities are taken into account alongside those uncovered in a recent audit, the true total of LG debt almost doubles to a wince-inducing Y30 trillion. Just for sheer size – some 50% of national GDP – this would be a matter of concern, but it also should not be overlooked that far too much of that monstrous total is comprised of short-term obligations against which are held long-term, illiquid, and often economically redundant ‘assets’.
Given that the last NAO study showed that are some 3,700 governmental bodies across various categories which had debts in excess of 100% of their local GDP, something patently needs to be done if the mad Chinese juggler is to keep his profusion of balls bobbing in the air.
So, welcome to local scrip issues. Yes, it seems that ingenious local cadres have dusted off their depression-era news clippings and revisited the age of the mediaeval mint and simply started using their own IOUs as media of exchange wherever their writ may run.
Economic Information Daily reported that in Hubei, Hunan and Guangdong, among others, government IOUs have become a ‘discount currency.’ In fact, commentary on Caijing suggests that not only are even small, rural communities now doing likewise, but that some companies, too, are paying their workers in scrip – just as in the early days of the Western factory age when resort by employers to what was called the ‘truck’ or ‘Tommy’ system was widespread.
As the early 19th century English radical, William Cobbett noted, ‘… when this tommy system… makes its appearance where money has for ages been the medium of exchange, and of payments for labour; when this system makes its appearance in such a state of society, there is something wrong; things are out of joint; and it becomes us to inquire into the real cause of its being resorted to…’
His answer? The state of economic depression brought about by the costs imposed upon entrepreneurs by the dead-weight of government:-
‘It is not the fault of the masters, who can have no pleasure in making profit in this way: it is the fault of the taxes, which, by lowering the [net] price of their goods, have compelled them to resort to this means of diminishing their expenses, or to quit their business altogether, which a great part of them cannot do without being left without a penny… Everything was on the decline… I was assured that shop-keepers in general did not now sell half the quantity of goods in a month that they did in that space of time four or five years ago… need we then wonder that the iron in Staffordshire has fallen, within these five years, from thirteen pounds to five pounds a ton [metal-bashers were similarly bearing the brunt, it appears]… and need we wonder that the iron-masters, who have the same rent and taxes to pay that they had to pay before, have resorted to the tommy system, in order to assist in saving themselves from ruin!’
‘Here is the real cause of the tommy system; and if [we wish] to put an end to it… prevail upon the Parliament to take off taxes to the amount of forty millions a year.’
Caijing devoted quite some space to ‘netizen’ comments on this state of affairs, several of which reflected a considerable degree of awareness that this had come about because of the unbridled spending and lavish self-indulgence of the relevant officials, while some were also aware that such an emission of fiat money was a direct parallel of the official money-creation process and further that it could only persist for so long as some minimal degree of trust resided in the councils’ ability one day to redeem the claims. Moreover, it was noted that since people ultimately expect the discount between township paper and that issued by the PBOC to widen, they were using the former preferentially to buy and sell and clinging on to the latter – a classic, Gresham’s Law example of bad money driving out good.
If the localities are in such dire straits as these, then it is hard to resist the temptation to believe that we are approaching some sort of end-game. But what, we should ask ourselves, might be the trigger for its no-doubt jarring denouement?
Well, here we come full circle with the latest act of Xi Jinping’s grand ‘anti-corruption’ drive. For, as well as Our Glorious Leader’s insistence at last week’s Leading Group get-together that everyone must ‘truly push forward reform with real guns and knives’ (ulp!), news has come out that the National Audit Commission will next conduct a full, ‘rigorous’ check of all land sales and related transactions carried out between 2008-13 and that, moreover, the results will be to hand when the top men convene for their next Plenum this coming October.
One can only imagine the consternation in the ranks which this announcement has unleashed. After all, there is unlikely to be overmuch evidence that any of these deals were conducted transparently, competitively, honestly, and legally, in the absence of any and all inducements, kickbacks, or displays of favouritism, not only since such was the accepted practice during the reign of Wen and Hu – especially during the infamous, no questions asked, frenzy of post-Crash stimulus – but also because this is a sphere notoriously subject to peculation in what we fondly imagine to be our more enlightened polities, too.
We can therefore not only expect the bodycount to rise substantially as officials fearful of censure seek to avoid their imminent disgrace and subsequent punishment, but we should also be prepared for the possibility that when this most capacious of all cylindrical metallic containers of vermiform invertebrae is opened, it will be accompanied by a blast of sufficient megatonnage to bring the whole flawed edifice crashing to the ground.
Under such circumstances, we find it very hard to shake off the presentiment that, on the one side, some commentators’ touching faith in an incipient re-acceleration are horribly misplaced while, on the other, the tired old ‘Goldilocks’ scenario whereby all bad news is good because it presages the launch of another round of sustained, indiscriminate ‘stimulus’ seems equally out of key with what Xi tells us he is trying to achieve.
Having dealt at such length with China, let us try and dispose of the rest of the globe in as short a space as possible.
Japan: Abenomics is still a horrible failure as drooping machine orders, frozen store sales, and exports back at 4 ½ year (currency-adjusted), one-quarter-from-the-peak lows reveal. So, guess what? As the PM’s approval ratings slip, another ‘stimulus’ package is said to be in the offing (sigh!)
Europe: Even one of Hollande’s own ministers confided to the press a couple of weeks back, ‘the truth is, he thinks we don’t have a chance’ – who are we to disagree? Meanwhile, the chap at the head of the other Sick Man, Matteo Renzi, has undergone a moment of almost Caligulan delusion, assuring supporters that the hour had come for Italy ‘to tow Europe out of the crisis’ and ‘to assume… the leadership’ of the Continent.
And what of his first steps to make good on such a vaunting claim? Why, in an Onion-like act of farce, to insist that ISTAT no longer releases the GDP numbers a week ahead of its peers and thereby afford underemployed analysts and commentators more opportunity to be critical of the country’s performance! And then there’s the Neocon-inspired catastrophe unfolding on the bloc’s eastern fringe from which the emergence of a bout of renewed economic difficulty is the very least of our worries.
USA: Chairperson Yellen is currently holding court at Jackson Hole as the US numbers continue their rebound from the winter’s retardation. What a moment for her to take the stage. Non-financials (large cap-led) are at new records, Tech at new, post-Bubble highs; junk spreads have narrowed sharply; vol has again crashed, correlations fallen, and put-call ratios evaporated. With the Bund-UST spread at a 15-year high and equities outperforming, the USD stands on the verge of a break out and up from what is already its best level in a year. The cycle is still running in favour of the States on a comparison basis, no matter how ninety-Nth percentile many of its valuations are when considered in isolation.
With money supply still swelling rapidly – and amid hints that it is being more actively utilised than of late—it is hard to see quite what will bring that run to an end in the near term. Were we to really be critical, one of the few clouds ‘no bigger than a man’s hand’ is that the growth of both inventories and payroll expenses are outstripping sales in the durable goods sector. Thus, while US assets are hardly ‘investible’ in the Benjamin Graham sense, they are also a tough short in the Sell’em Ben Smith one.
Britain: While MPC member David Miles saw fit to describe the EU as ‘dead in the water’ as a trade partner, closer to home some of the gloss is finally coming off the reputation of one of the country’s most expensive recent imports, its egregious Bank governor.
No doubt, dear reader, you too were shocked – shocked! – to hear local Tory Mark Field, the Honourable Member for the Cities of London and Westminster, opine to his mates in Grub Street that “…from the moment Mark Carney became governor in July 2013, it was pretty clear forward guidance was an indication rates would not rise this side of the election – for all the talk of Bank of England independence, there was a clear bargain between him and George Osborne.” Be that as it may, it is surely not too cynical to note that Fred Carney’s Army will not want to contibute to a possible defeat by Alex the Bruce’s forces in the coming Scottish independence vote.
You can just hear it now, that ringing oration:-
‘Aye, vote ‘Yes’ and interest rates may rise. Vote ‘No’ and they’ll stay as is … at least a while. And dying in your beds, many years from now, would you be willin’ to trade ALL the days, from this day to that, for one chance, just one chance, to come back here and tell our neighbours that they may take our pound and their nuclear subs, but they’ll never take… OUR FREEDOM!
Truth be told, it has not been the kindest of summers for commodities. Since reaching their late June peak, returns have suffered a 7.5% slump to touch six month lows even as US equities have added 2%. For the record, in that crumbling eight week stretch EM stocks put on 4.7%, US bonds were up 1% and junk was flat.
Within commodities themselves, what some commentators have been calling a ‘Garden of Eden’ summer in the US grain belt has ensured that the corn is as high as an elephant’s eye almost everywhere you look, while oilseeds and wheat have been similarly profuse. A loss of 11.3% and, in fact, the casting into jeopardy of the entire cyclical bull market in prices has been the result.
Energy, too, has suffered, as the record longs in oil finally began to liquidate, triggering the biggest 6-week sell-off of positions in WTI on record. IN notional value terms, net spec longs in Brent and WTI combined crashed from close to $97 billion worth of contracts to $59 billion. It is possible to read the charts to declare that this swoon has violated the uptrend in place for the last five years, as well as breaking all major MAs. Against that, we are arguably a touch oversold and the last four years’ sideways stationary, Arab Spring range remains intact. Tacticians, Faites vos jeux!
Dollar strength, the subsidence of financial market anxieties alluded to above, and the cessation of labour unrest in SA have hardly been conducive to higher PM prices (palladium — and Russia—excepted). Gold has also broken 200, 100, 50-day MAs and is threatening the uptrend drawn from the June 30-Dec 31 $1180 double bottom and June 3rd’s $1240 probe. Lease rates remain positive and net specs—at 43% of total O/I – as long as they have been on average throughout the last 12 years’ bull market.
Only Base metals seem to offer any hope (they rallied 4.2% while everything else was collapsing). Strength has partly been predicated upon what we think are decidedly ephemeral signs of a Chinese renaissance, but also on evidence of dwindling stockpiles and the litany of capex cuts and asset disposals emanating from the mining industry. They appear, therefore, to offer the least dirty shirt in the laundry basket.
Despite all the massive monetary pumping over the past six years and the lowering of interest rates to almost zero most commentators have expressed disappointment with the pace of economic growth. For instance, the yearly rate of growth of the EMU real GDP fell to 0.7% in Q2 from 0.9% in the previous quarter. In Q1 2007 the yearly rate of growth stood at 3.7%. In Japan the yearly rate of growth of real GDP fell to 0% in Q2 from 2.7% in Q1 and 5.8% in Q3 2010.
In the US the yearly rate of growth of real GDP stood at 2.4% in Q2 against 1.9% in the prior quarter. Note that since Q1 2010 the rate of growth followed a sideways path of around 2.2%. The exception is the UK where the growth momentum of GDP shows strengthening with the yearly rate of growth closing at 3.1% in Q2 from 3% in Q1. Observe however, that the yearly rate of growth in Q3 2007 stood at 4.3%.
In addition to still subdued economic activity most central bankers are concerned with the weakness of workers earnings.
Some of them are puzzled that despite injecting trillions of dollars into the financial system so little of it is showing up in workers earnings?
After all, it is held, the higher earnings are the more consumers can spend and consequently, the stronger the economic growth is going to be, so it is held.
The yearly rate of growth of US average hourly earnings stood at 2% in July against 3.9% in June 2007.
In the EMU the yearly rate of growth of weekly earnings plunged to 1.3% in Q1 from 5.4% in Q2 2009.
In the UK the yearly rate of growth of average weekly earnings fell to 0.7% in June this year from 5% in August 2007.
According to the Vice Chairman of the US Federal Reserve Stanley Fischer the US and global recoveries have been “disappointing” so far and may point to a permanent downshift in economic potential. Fisher has suggested that a slowing productivity could be an important factor behind all this.
That a fall in the productivity of workers could be an important factor is a good beginning in trying to establish what is really happening. It is however, just the identification of a symptom – it is not the cause of the problem.
Now, higher wages are possible if workers’ contribution to the generation of real wealth is expanding. The more a particular worker generates as far as real wealth is concerned the more he/she can demand in terms of wages.
An important factor that permits a worker to lift productivity is the magnitude and the quality of the infrastructure that is available to him. With better tools and machinery more output per hour can be generated and hence higher wages can be paid.
It is by allocating a larger slice out of a given pool of real wealth towards the buildup and the enhancement of the infrastructure that more capital goods per worker emerges (more tools and machinery per worker) and this sets the platform for higher worker productivity and hence to an expansion in real wealth and thus lifts prospects for higher wages. (With better infrastructure workers can now produce more goods and services).
The key factors that undermine the expansion in the capital goods per worker are an ever expanding government and loose monetary policies of the central bank. According to the popular view, what drives the economy is the demand for goods and services.
If, for whatever reasons, insufficient demand emerges it is the role of the government and the central bank to strengthen the demand to keep the economy going, so it is held. There is, however, no independent category such as demand that drives an economy. Every demand must be funded by a previous production of wealth. By producing something useful to other individuals an individual can exercise a demand for other useful goods.
Any policy, which artificially boosts demand, leads to consumption that is not backed up by a previous production of wealth. For instance, monetary pumping that is supposedly aimed at lifting the economy in fact generates activities that cannot support themselves. This means that their existence is only possible by diverting real wealth from wealth generators.
Printing presses set in motion an exchange of nothing for something. Note that a monetary pumping sets a platform for various non-productive or bubble activities – instead of wealth being used to fund the expansion of a wealth generating infrastructure, the monetary pumping channels wealth towards wealth squandering activities.
This means that monetary pumping leads to the squandering of real wealth. Similarly a policy of artificially lowering interest rates in order to boost demand in fact provides support for various non-productive activities that in a free market environment would never emerge.
We suggest that the longer central banks world wide persist with their loose monetary policies the greater the risk of severely damaging the wealth generating process is. This in turn raises the likelihood of a prolonged stagnation.
All this however, can be reversed by shrinking the size of the government and by the closure of all the loopholes of the monetary expansion. Obviously a tighter fiscal and monetary stance is going to hurt various non-productive activities.
At the end of July global equity bull markets had a moment of doubt, falling three or four per cent. In the seven trading days up to 1st August the S&P500 fell 3.8%, and we are not out of the woods yet. At the same time the Russell 2000, an index of small-cap US companies fell an exceptional 9%, and more worryingly it looks like it has lost bullish momentum as shown in the chart below. This indicates a possible double-top formation in the making.
Meanwhile yield-spreads on junk bonds widened significantly, sending a signal that markets were reconsidering appropriate yields on risky bonds.
This is conventional analysis and the common backbone of most brokers’ reports. Put simply, investment is now all about the trend and little else. You never have to value anything properly any more: just measure confidence. This approach to investing resonates with post-Keynesian economics and government planning. The expectations of the crowd, or its animal spirits, are now there to be managed. No longer is there the seemingly irrational behaviour of unfettered markets dominated by independent thinkers. Forward guidance is just the latest manifestation of this policy. It represents the triumph of economic management over the markets.
Central banks have for a long time subscribed to management of expectations. Initially it was setting interest rates to accelerate the growth of money and credit. Investors and market traders soon learned that interest rate policy is the most important factor in pricing everything. Out of credit cycles technical analysis evolved, which sought to identify trends and turning points for investment purposes.
Today this control goes much further because of two precedents: in 2001-02 the Fed under Alan Greenspan’s chairmanship cut interest rates specifically to rescue the stock market out of its slump, and secondly the Fed’s rescue of the banking system in the wake of the Lehman crisis extended direct intervention into all financial markets.
Both of these actions succeeded in their objectives. Ubiquitous intervention continues to this day, and is copied elsewhere. It is no accident that Spanish bond yields for example are priced as if Spain’s sovereign debt is amongst the safest on the planet; and as if France’s bond yields reflect a credible plan to repay its debt.
We have known for years that through intervention central banks have managed to control the prices of currencies, precious metals and government bonds; but there is increasing evidence of direct buying of other financial assets, including equities. The means for continual price management are there: there are central banks, exchange stabilisation funds, sovereign wealth funds and government-controlled pension funds, which between them have limitless buying-power.
Doubtless there is a growing band of central bankers who believe that with this control they have finally discovered Keynes’s Holy Grail: the euthanasia of the rentier and his replacement by the state as the primary source of business capital. This being the case, last month’s dip in the markets will turn out to be just that, because intervention will simply continue and if necessary be ramped up.
But in the process, all market risk is being transferred from bonds, equities and all other financial assets into currencies themselves; and it is the outcome of their purchasing power that will prove to be the final judgement in the debate of markets versus economic planning.