Taking a quick run through eight of the Eurozone’s larger banks before the rebound into the weekend, we could see that they had a theoretical book value of around €450 billion but, given their extremely depressed price/book ratios, a market cap of only some €200 billion.
In essence, then, the market was already pricing this octet as if it would have to write-off €250 billion in losses as the sovereign crisis is unwound, at the same time (hopefully) that they finally realize some of their mark-to-magic carry-overs from the CDS bust.
Such is the pass we have reached, almost three years after an arrogant EU commissioner declared that ‘no strategic Eurobank will be allowed to fail—and they are ALL strategic’ – the sum achievement of such hubris having been nothing less than to bring them ALL to the verge of failure, ‘strategic’ or otherwise.
While not wishing to ignore any hidden non-linearities or lurking systemic risks, such is the scale of this discount to what the officially sanctioned balance sheets are telling us should be the case that we must wonder why no European politician can draw the obvious conclusions; namely, that (a) there might not be much more downside to a restructuring/partial forgiveness of the most hopelessly indebted and (b) if the losses were actually to be taken, the survivors—of whom there would be many—would no longer face that paralysing discredit which has wrecked the ability of financial markets to function properly and which has hence frustrated much of the re-inflationary thrust of official policy making these past four years.
Were such write-offs to be forcibly realized, it is inevitable that there would be bond and shareholder losses—but at least these would be apportioned fairly to those who lent to, or took stakes in, firms and polities to whose management far too free a rein was accorded during the boom years, and they would not therefore be heaped upon the broader public by means of direct transfer payments or the insidious taxation of inflation.
In this way, the governing authorities could minimize their intervention in the economy to the useful one of overseeing and expediting a rapid transfer of property claims from failed enterprises to their better-run peers, while the central bank could quit both its ultra vires role as a fiscal agency and its pretence at macroeconomic fine-tuning, reverting instead to its true (if Austrian-contentious) role in preventing or mitigating fractional deposit runs.
Then, not only could investors resume their job of trying to make rational assessments of the prospective value of the multitude of different assets laid out before them, mercifully relieved of the Black Swan regime uncertainty which is so clearly stultifying them today, but so too—far more importantly, perhaps—could entrepreneurs be freed to do the same!
That way we might actually spark a real recovery. That way, we might allow prices to find their own level and markets to clear. That way, we might build up from the ashes of our collective folly, this time on a secure foundation which does not rely on the of Chairman Bernanke coming up with another bright idea to abuse his institution’s overweening power in the service of his intellectual vanity.
Certainly, our broken markets could do without any more of his—or his peers’—brainstorms.
It would be nice if the transmission mechanisms which we have for so long taken for granted were not so completely jammed up with New Deal experimentalism that, in a world awash with US dollars, there is so little appetite to distribute them (especially for such vanishingly small returns) that gold lease rates and Treasury repo rates have been both firmly negative.
If this strikes you as being right down the Carrollean rabbit hole, you would not be alone in the suspicion—for although the faith in gold has waxed as strong as that in fiat currencies, the US dollar, and the Federal Government, respectively, has waned, here we are, paying someone to take the first away from us and paying again to replace the dollars we got for our tangible metal with an insubstantial promise issued by the lattermost!
Still undaunted by its serial failures at reinvigorating any genuine economic renaissance, the market has come to persuade itself that the Fed will make good on its threat to employ its vaunted ‘range of tools’ by migrating outward into duration space in the composition of its $1.6 trillion UST stash, so flattening the yield curve and thus reducing long interest rates.
Quite what the merit will be when nominal yields are at their lowest in seventy years and ex-post long ones at their lowest in thirty (a benchmark also applicable to BAA corporate bonds), is anyone’s guess. As John Hussman cogently argued in his latest letter, for a policy to be effective, it must relax the constraint that binds the most and it is hardly likely that the current level of interest rates—nor, in our oft-expounded view, ANY macroeconomic target variable—is the one which takes that particular palm.
The only ‘positive’ from this policy might be that it would offset what just might be a wholly unlooked-for rise in long yields if the White House goes ahead with its kite-flown proposal and offers a full and instant refi to all Agency mortgagees, Otherwise, apart from inflicting losses on anyone holding an above-par bond (not least among them, those inveterate wards of the state, Fannie and Freddie, with their joint $1.4 trillion portfolio, and the Fed itself with its $890 billion to be set against their miserly aggregate of $45.3 billion in capital), the need to reset exposures could trigger a tsunami of Treasury sales and swap paying—(and jam repo rates even tighter up against their theoretical –3% penalty fee floor?).
The other wheeze being suggested is that of reducing, or even eliminating the interest rate currently payable on the $1.6 trillion in excess reserves piled up at the Fed, in the hope that this will propel them out into the market and so trigger an orgy of credit creation.
Pity, in that case, the poor foreign banks, who have accumulated around half of that massive total and who are so itching to go out and mobilize them that they are having to negotiate bend-over–and-close-your-eyes repo deals with their US counterparts and whose desperate need for dollar liquidity has just had to be assuaged by another multi-CB, FX swap programme, between now and year end.
Never mind! If the Fed or the ECB can’t do it; if the SNB can’t quite give the whole world all the Swiss francs it wants (something it will accomplish without any inflationary consequences, we are assured); if the BOE’s very own yank-crank, Posen, cannot get Merv and the rest of the team to push the pace of UK price rises up through the top of a twenty-year range, there’s always the Chinese to rescue us.
Except the Chinese, rather astutely, seem to be attaching certain inconvenient political conditions to any offer of help they might make. Except that one might think the Chinese have enough potentially-irredeemable, stimulus-related, public debt slopping about their system already – ‘Our version of subprime in the US’, according to Cheng Siwei, head of Beijing’s International Finance Forum and a former deputy speaker of the People’s Congress. Except that the rampant abuse of unorthodox financing methods is still severely hindering the PBoC’s efforts to rein in both price rises and property speculation, meaning that, as Premier Wen re-emphasised only this week, containing inflation is still the policy priority there.
With a further tranche of reserve requirements being scaled in on ‘shadow’ banking loans over the next five months, all this suggests that China may well be adding to the stress, not alleviating it.
So, how do we make sensible decisions in a world turned upside down, where wild swings take place from one headline to the next, and where all the norms of pricing and all the precious historical correlation data are deeply suspect?
With caution obviously!
Take the case of equities. By their own lights, they are, if not ‘cheap’, certainly ‘cheaper’ than they have been for some time, at a trailing P/E of around 14:1. Moreover, the S&P collectively pays a dividend yield in excess of any US Treasury of less than 11 years to maturity. When set against corporate bond yields (in a manner we argue implies a real, credit-adjusted, long-term growth forecast), they are also at their most advantageous relative price in thirty years, ditto the comparison to current (or trend) GDP to which earnings tend to bear at least some long-run correspondence.
But what is this really telling us? That stocks are a good investment in and of themselves, or simply that bond yields have been artificially suppressed (even though, as a percentage of ‘risk-free’ rates, they are more elevated than at any time except at the height of the LEH-AIG panic itself)?
Whatever your conclusions (and you should be able to guess which of the choices we would opt for), this is still more of a relative environment than an outright one, perhaps nowhere moreso than for commodities.
One canard we have to nail in this regard is the one the Fed advances, namely that it had nothing whatsoever to do with the rise in raw materials prices endured in the period when it was buying US Treasuries with gay abandon in through the latter months of 2010 and into the first half of 2011.
In that period, global money supply reckoned in dollars rose 14.5% – an increment for which the Fed’s own, 10.5% increase was responsible for about a tenth. Another two-thirds or so was brought about by impact of the near equal-and-opposite drop in the greenback’s TWI on everyone else’s money supply. The only other sizeable, active contributors were the PBOC and the BOJ, who independently accounted for another 10% each.
As our own studies of the last quarter century of data show, it is very rare indeed that an increase in this measure does not translate rapidly into a positive change in commodity prices—of varying magnitudes and with a changing degree of immediacy, it has to be said, but a readily observable effect nonetheless.
Whether or not the market has come to recognise this in quite such explicit terms, there is plenty of indirect evidence that commodity prices are beginning to diverge from those of the equities they have tracked so faithfully since the Bust because traders and investors are betting that crude and copper and corn may be the best place to direct whatever new money the Fed will call into existence in the course of its next great policy initiative.
Far from being a ‘stimulus’ then, if the few good men on the FOMC who are opposed to any more dangerous experiments cannot rein in their chief and his inflationist Myrmidons, real incomes everywhere may be in for yet another unwelcome squeeze and the process of recovery postponed once again.