Posts Tagged ‘Central Planners’
Saturday, August 11th, 2012
The Solution…is the Problem, Part II
When we wrote Part I of this paper in June 2009, the total U.S. public debt was just north of $10 trillion. Since then, that figure has increased by more than 50% to almost $16 trillion, thanks largely to unprecedented levels of government intervention.
Once the exclusive domain of central bankers and policy makers, acronyms such as QE, LTRO, SMP, TWIST, TARP, TALF have found their way into the mainstream. With the aim of providing stimulus to the economy, central planners of all stripes have both increased spending and reduced taxes in most rich countries. But do these fiscal and monetary measures really increase economic activity or do they have other perverse effects?
In today’s overleveraged world, greater deficits and government spending, financed by an expansion of public debt and the monetary base (“the printing press”), are not the answer to our economic woes. In fact, these policies have been proven to have a negative impact on growth.
While it hasn’t received much attention in recent years, a wide body of economic theory suggests that government policies and their size relative to the total economy can have a significant detrimental impact on economic growth. A recent paper from the Stockholm Research Institute of Industrial Economics compiles evidence from numerous empirical studies and finds that, for rich countries, there is overwhelming evidence of a negative relationship between a large government (either through taxes and/or spending as a share of GDP) and economic growth.1 All else being equal, countries where government plays a large role in the economy tend to experience lower GDP growth.
Of course, correlation does not imply causation. While the literature is not definitive on causation, it still provides strong evidence that more taxes and government spending as a share of GDP (except for productive investments such as education) is associated with lower growth.
One exception to these findings is the experience of Scandinavian countries. They have both high taxes and high government spending as a share of GDP but have experienced relatively rapid growth over the past 20 years. However, a significant share of their spending goes to education, which has been found to foster growth. They also counterbalance the large role of the state with very liberal, pro-market reforms and low levels of public debt.2
Debt overhang and economic growth
Even if one believes that temporary Keynesian-type fiscal stimulus, in the form of tax breaks and increased government spending, can spur growth in the short-term, these actions inevitably lead to larger deficits and higher government debt (see July 2010 Markets at a Glance, “Fooled By Stimulus”). As Figures 1 and 2 below show, the U.S. Federal Government deficit and debt levels are already at their highest levels since the end of World War II and the scope of future stimulus appears to be rather limited. According to our projections (which assume there will be no fiscal cliff), the U.S. federal debt will increase significantly as the deficit remains sustained and elevated. For many European countries the situation is even worse.
FIGURE 1: U.S. DEFICIT AS A SHARE OF GDP
FIGURE 2: U.S. DEBT-TO-GDP*
Source: The White House: Office of Management and Budget (OMB) and Sprott Calculations
*For reasons discussed in May 2009 Markets at a Glance The Solution … is the Problem, Part 1, we show total federal debt subject to the debt ceiling.
High levels of debt, or debt overhangs, cause more problems. Recent work by Carmen Reinhart and Kenneth Rogoff (Harvard University) demonstrates that banking crises are strongly associated with large increases in government indebtedness, long periods of unemployment and, ultimately, some form of default. They identify a threshold of 90% debt-to-GDP as the trigger to a debt crisis.3 As shown in Figure 2, the U.S. has already passed that threshold.
The historical evidence shows that countries with large governments and high levels of debt have on average, achieved lower economic growth. Given the already high level of debt and deficits in most developed countries, it is doubtful that increased fiscal stimulus will really help the recovery. It’s clear that debt is the problem and the solution does not lie in piling on even more of it. The current debt situation, coupled with the increasing lack of transparency of politically motivated regulations and interventions, leaves little room for a healthy deleveraging of our economies. Here is what central planners have in mind.
Debt overhang resolution and implications for the future
Througout history, high debt-to-GDP ratios have been resolved through five channels:4
- Economic growth
- Sudden bursts of inflation
- Steady financial repression and inflation
Clearly, number one and two are not working right now and, in some European countries, are actually negatively reinforcing each other. The U.S. is facing its homegrown fiscal cliff and political polarization makes its resolution doubtful. Number three seems politically unacceptable for rich, developed nations, which see default as the realm of developing countries. Sudden bursts of inflation are hard to contain and work only so many times as investors, assuming a normal bond market, demand higher interest rates to compensate for inflation risk. Moreover, with interest rates already, at zero it seems that we are left with number five: steady financial repression and inflation. This terminology was first introduced in the early 1970s by Edward Shaw and Ronald McKinnon, both from Stanford University.5
They define financial repression as:
- Explicit or indirect caps or ceilings on interest rates
- The creation and maintenance of a captive domestic audience (i.e.: forced holdings of government debt by financial institutions and pension funds)
- Direct ownership of financial institutions and/or entry restriction in the financial industry (i.e.: China, India)
We are clearly living through a period of financial repression. The symptoms include:
- Artificially low interest rates in most of the G20 countries and commitments to keep them low for long periods of time combined with inflation, which results in negative real interest rates
- Large expansion of central banks’ balance sheets through the purchase of government bonds
- Basel III liquidity rules which force banks to hold more government debt on their balance sheets6,
- Newly nationalized banks in many countries (UK, Ireland, Spain, etc.), which have drastically increased their holdings of government debt
- and it will bet worse…
Figure 3 below shows that financial repression can be observed within the holdings of U.S. financial institutions and pension funds, which have steadily increased their holdings of U.S. Treasuries since 2009.
FIGURE 3: HOLDINGS OF U.S. TREASURY SECURITIES BY DOMESTIC FINANCIAL INSTITUTIONS
Source: Federal Reserve Flow of Funds
It’s clear that governments are preparing for more. A key component to erasing government debt through inflation is extending the duration (maturity) of one’s outstanding bonds. In a normal bond market, negative real interest rates make it difficult to roll over short-term debt at low borrowing rates (although financial repression and captive financial institutions certainly help to keep rates lower than they normally would be). Due to this tendency for short-term rates to rise with inflation, however, it is in the best interests of highly-indebted countries to issue the majority of their bonds at the long end of the yield curve. As Figure 4 shows, the US Treasury is proactively planning to increase the maturity of its outstanding debt (green line) in order to maximize its benefit from inflation erosion. In other words, they are capitalizing on the current flight to safety to set the stage for further financial repression down the road. The same is true for the U.K., which benefits from one of the longest weighted-average maturity of debt in the developed world. For Eurozone countries to do away with their current debt overhang they will either have to default (the least preferred option for political reasons) or use the good old combination of steady inflation and financial repression (feared by the Germans and the ECB central planners).
FIGURE 4: U.S. TREASURY WEIGHTED AVERAGE MATURITY OF MARKETABLE DEBT
Source: U.S. Treasury Office of Debt Management, Fiscal Year 2012 Q1 Report
On both sides of the Atlantic, the largest contributors to the current crisis are excessive debt and spending. We are now at a point where additional government stimulus measures will have negligible, if not detrimental effects on the economy and long-term growth. Debt has to be reduced, not increased by more deficits. Central planners have demonstrated that they don’t have the discipline to implement the Keynesian model of surplus in good times in order to finance deficits in bad times. We have now reached the limit of indebtedness and need to muddle through a painful but necessary deleveraging.
The politically favoured option of financial repression and negative real interest rates has important implications. Negative real interest rates are basically a thinly disguised tax on savers and a subsidy to profligate borrowers. By definition, taxes distort incentives and, as discussed earlier, discourage savings. Also, financial institutions, which are traditionally supposed to funnel savings towards productive investments, are restrained from doing so because a large share of their balance sheets is encumbered by government securities. The same is true for pension funds, which instead of holding corporate paper or shares, now hold an ever growing share of public debt. Pensioners, who are also savers, get hurt in the process.
The current misconception that our economic salvation lies with more stimulus is both treacherous and self-defeating. As long as we continue down this path, the “solution” will continue to be the problem. There is no miracle cure to our current woes and recent proposals by central planners risk worsening the economic outlook for decades to come.
1 Bergh, A., Henrekson, M. (2011): “Government Size and Growth: A Survey and Interpretation of the Evidence”, Research Institute of Industrial Economics, IFN Working Paper No. 858, April 2011.
2 Bergh, A., Karlsson, M., (2010): “Government Size and Growth: Accounting for Economic Freedom and Globalization”, Public Choice 142 (1–2): 195–213.
3 Reinhart, C., Rogoff, K. (2010): “From Financial Crash to Debt Crisis”, National Bureau of Economic Research, NBER Working Paper #15795, March 2010. Reinhart, C., Rogoff, K. (2011): “A Decade of Debt”, National Bureau of Economic Research, NBER Working Paper #16827, February 2011. Reinhart, C., (2012): “A Series of Unfortunate Events: Common Sequencing Patterns in Financial Crises”, National Bureau of Economic Research ,NBER Working Paper #17941, March 2012.
4 Reinhart, C., Sbrancia, B. (2011): “The Liquidation of Government Debt”, Bank of International Settlements – Monetary and Economic Department, BIS Working Paper #363, November 2011. Reinhart, C., Reinhart, V., Rogoff, K. (2012): “Debt Overhangs: Past and Present”, National Bureau of Economic Research ,NBER Working Paper #18015, April 2012.
5 McKinnon, R., (1973): “Money and Capital in Economic Development”, Washington DC: Brookings Institute. Shaw, E., (1973): “Financial Deepening in Economic Development”, New York: Oxford University Press.
6 Bordeleau, E., Graham, C., (2010): “The Impact of Liquidity on Bank Profitability”, Bank of Canada Working Paper, WP#2010-38, December 2010.
Tags: Central Planners, Detrimental Impact, Economic Theory, Economic Woes, Empirical Studies, Eric Sprott, GDP Growth, Government Intervention, government spending, India, Industrial Economics, Investment Outlook, Monetary Base, Monetary Measures, Negative Relationship, Overwhelming Evidence, Perverse Effects, Productive Investments, Public Debt, Rich Countries, Sprott, Unprecedented Levels
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Wednesday, July 25th, 2012
It is not often we double-dip in the Sausalitan’s soliloquies but tonight’s glorious truthiness from Charles Biderman, CEO of TrimTabs, is worth the price of admission. After explaining that the only way he could be any more bearish is to be double-levered – and that he believes that besides “believing in miracles” this market will see the March 2009 lows once the market-rigging is fully exposed, he makes probably the most clarifying statement we have heard regarding our central-planners-in-chief. With regards to Messrs. Bernanke, Geithner, and Obama: “The most damage is caused by those who are not as smart as they think they are.” They continue to believe they are smart enough to fix all our financial problems (and Europe’s – if they would just listen to Timmay) by building a bridge over the recession – thanks to asset-buying and ZIRP. “The only problem is we are running out of bridge and are nowhere near recovery” is how he sees it and reflecting on the massive gains that have been made on short-dated Treasuries as the Fed (who is the one buying them) extends the ZIRP horizon – it is clear that this is nothing but a huge Ponzi scheme.
Tags: Bernanke, Building A Bridge, Central Planners, Ceo, Europe, Geithner, Horizon, Lows, Market Rigging, Massive Gains, Messrs, Miracles, Obama, Ponzi Scheme, Price Of Admission, Recession, Soliloquies, Treasuries, Trimtabs, Truthiness
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Monday, May 14th, 2012
Just because it is always amusing to watch the cognitive dissonance in the head of a permabull, here is Jim ‘Soon to be head of the BOE… allegedly’ O’Neill’s latest missive to (what?) GSAM clients. Yes, the same O’Neill who week after week, letter after letter kept on saying that 2012 is nothing like 2011, finally being forced to admit that 2012 is, as we have been saying since January 1, nothing but 2011, as the central planners’ script writers prove painfully worthless at coming up with anything original. That, of course, and that the lifelong ManU fan had to suffer the indignity of interCity rivals picking up the trophy this year after a miraculous come back win against QPR. Oh, the horror…
Is it One of Those May’s Again?
Not another one, surely? It is almost too simple to be true. I have been saying to people all year that we would have a great rally into May. Then, it might be quite a challenge for the Summer and, like clockwork, we could come back in the Autumn to take the markets to fresh highs. I had expected that the S&P would get to the 1470-1480 area before the correction would set in. In this sense, it has happened quicker, because of the fact that “May” started in April, just as it did last year? While I have read a few articles recently trying to dismiss the “May” factor, the evidence is annoyingly persuasive that if the May to October months could just be 6 month holiday periods, and we picked up our investments as though nothing had
changed, the long term annualized return would be notably higher. Of course, it is difficult to find a coherent reason why this occurs so often. And, as some doubters correctly point out, it often doesn’t occur.
Anyhow, as can be seen in the attached chart, the momentum in the S&P has clearly turned lower, but interestingly, we sit just above trend line support (and well above the 200-day moving average). So, this is probably just a correction.
For some of us spoilt Manchester United fans, for the best part of the past 20 years at least, we have been able to take solace with the May issue, because around about this time, we are usually picking up the Premier League Trophy, and often there is a European Champions League Final to be thrown in as well as an FA Cup Final. Alas, this year, the cupboard might be empty and, of course, City could be picking up the League for the first time in 44 years.
Europe. Could it get any Messier?
I went to visit a rather weird play with my wife early last week, and I found myself thinking at one point “This is nearly as screwed up as the Euro Area.” I did warn last weekend that the French, and especially the Greek election, might have some impact this past week. It is quite ironic, as a couple of people pointed out to me given that I am always dismissing Greece’s economic relevance, that I suggested it might be more important in the short term than the French election. I shall discuss the French election issue more below, but given we all knew this was coming for months, and that Hollande won with the majority reasonably similar to the polls, I am not sure what was really new last week on this score (except for the German reaction).
Greek voters appear to now face another election in a few weeks with some simple choices. Do you want to remain in the EMU and stick with the commitments and support that your international allies have generously given you? Or, do you want to recreate the Drachma and run the risk of a massive banking collapse and lots of other unpredictable consequences? Polls appear to suggest the far left is likely to do well, so these questions are pretty real ones. As for the Euro, as I argued last week, it is not entirely clear to me that, once the dust settles, Greece leaving would be material either way. But we shall see.
French Election and Germany.
As I said above, there was not really a lot of new information about Hollande’s plans last week. Therefore, in some ways, it was all discounted. Quite a few contacts of mine suggested that, despite the rhetoric, France under Hollande will not do anything dramatic against the spirit of the Fiscal Compact, although they will push the issue of a supplementary plan for a Growth Pact. And as I reminded many of my colleagues, they are probably more fundamentally “pro Euro” than Sarkozy, which many people seem to have forgotten. Importantly, in this regard, this Administration is another one now in power in Europe that supports a true
Euro bond at the core of a more integrated Europe.
As I found myself thinking as the week wore on, this means that the German elections in the Autumn of 2013 are going to be really important. Anyone who wants to be in a coalition with either the SPD or Greens (or both) is going to have to support the idea also. I suspect Chancellor Merkel will be more than happy to support it. A number of meetings that I coincidentally had this week added to my confidence on this score.
Against this “big picture” background, the most interesting aspect of the French election is how German policymakers responded. Suddenly there is a fresh tone of what I would regard as welcome realism and open mindedness. First of all, Finance Minister Schauble talked about the need for higher German wages, which would help rebalancing within the EM. And a few days later, some Bundesbank officials acknowledged that Germany would probably have to accept inflation above 2 pct for some time. As one of the people I was referring to above put it to me, it would be through “gritted teeth,” but the reality is that they really have no alternative if the EMU is to persist following the shifting ground demanded by European voters. All of this should be good, and it will probably mean that the ECB will be less hawkish as a result.
Tags: Amp, Annualized Return, Autumn, Boe, Central Planners, Cognitive Dissonance, Coherent Reason, Goldman, Holiday Periods, Indignity, January 1, Manu, Missive, Momentum, Moving Average, O Neill, Rally, Rivals, Script Writers, Trend Line
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Monday, April 16th, 2012
From the first day of 2012 we predicted, and have done so until we were blue in the face, that 2012 would be a carbon copy of 2011… and thus 2010. Unfortunately when setting the screenplay, the central planners of the world really don’t have that much imagination and recycling scripts is the best they can do. And while this forecast will not be glaringly obvious until the debt ceiling fiasco is repeated at almost the same time in 2012 as it was in 2011, we are happy that more and more people are starting to, as quite often happens, see things our way. We present David Rosenberg who summarizes why 2012 is Deja 2011 all over again.
From Gluskin Sheff
It is incredible how things are playing out so similarly to this time last year. We closed the books on 2010 at 1,257 on the S&P 500, then hit an interim high of 1,343 on February 18th of 2011 and then corrected to 1,256 on March 16th. We later had a nice bounce off that low to 1,363 on April 29th (a higher high). Who knew then that by October 3rd, the index would roll all the way back to 1,099 and was in dire need yet again for more central bank intervention?
This time around, the S&P 500 kicked off the year at 1,257 to hit an interim high of 1,374 on March 1st. We then corrected down to 1,343 as of March 6th and then rallied our way back to 1,419 on April 2nd (again, a higher high). Only time will tell if the 1,419 close on April 2nd proves to be the peak for the year as the 1,363 high as back on April 29th of last year.
In fact, the exact same pattern occurred in 2010. Out of the gates, the S&P 500 shot up from 1,115 to a brief peak of 1,150 by January 19th. After a brief correction (as we had in early March of this year) to 1,056 by February 8th, the market soared to 1,217 by April 23rd — literally, a straight line up —just as we saw happening two weeks ago. Again, who knew then that we would be at 1,047 by August 26th? Once again, it took aggressive action by the Fed to revive the bull. This is an incredible seasonal pattern. It works for bonds too. Has anyone recognized how the yield on the 10-year T-note surged in the winter-spring of 2008, 2009, 2010 and 2011? In each of the past three years, 4% was either pierced, tested or approached. These were the peaks of the year each time. This time, the seasonal high was 2.4%. Are you kidding me? Our pal Gary Shilling may well be onto something when he says the ultimate low may be somewhere close to 1.5%.
To some extent, the bounce we are seeing reflects how deeply oversold the market was with the Dow losing 550 points over a five-day span. The AAII sentiment poll showed the bull camp shrinking 10 points in the past week to 28.1% and the bear share expanding 13.8 points to 41.6% so quite the shift here. It does not take much at all in these nerve-racking times to get investors to switch their views on a dime. So much of the move has been technical. Sentiment perhaps in some cases washed out — very quickly. It is still too early in the earnings reporting season to make a call here on the fundamentals — Alcoa is not the canary in the coalmine for the overall economy. And the economic data are still broadly mixed. Much of this rally actually is based on quite a bit of fluff like renewed expectations that the Fed is actually going to embark on more stimulus after all, following comments yesterday from two senior Fed officials:
Based on such analysis, I consider a highly accommodative policy stance to be appropriate in present circumstances. But considerable uncertainty surrounds the outlook, and I remain prepared to adjust my policy views in response to incoming information. In particular, further easing actions could be warranted if the recovery proceeds at a slower-than-expected pace, while a significant acceleration in the pace of recovery could call for an earlier beginning to the process of policy firming than the FOMC currently anticipates.
Vice Chair Janet L. Yellen, The Economic Outlook and Monetary Policy
Remarks at the Money Marketeers of New York University
Also, we cannot lose sight of the fact that the economy still faces significant headwinds and that there are some meaningful downside risks. In the headwinds department, I would include the run-up in gasoline prices mentioned earlier because that will sap purchasing power, the continued Impediments to a strong recovery from ongoing weakness in the housing sector, and fiscal drag at the federal and state and local levels. In terms of downside risks, these include the risk that growth abroad disappoints and the risk of further disruptions to the supply of oil and higher oil prices.
On the inflation front, the overall rate of increase of consumer prices, as measured by the 12-month change of the price index for personal consumption expenditures slowed to 2.3 percent in February from a recent peak of 2.9 percent last September. Even though the recent rise of gasoline prices mentioned above could interrupt this pattern, we expect this moderation of overall inflation to resume later this year.
William C. Dudley, President of the New York Federal Reserve Bank
Remarks at the Center for Economic Development, Syracuse, New York
Beyond a brief jolt to investor risk appetite, it is debatable as to what these rounds of Fed balance sheet expansion really accomplished in terms of helping the economy out. Three years of near-0% policy rates and a tripling in the size of the Fed’s balance sheet hasn’t changed the fact that this goes down as the weakest recovery ever — we’ve never gone this long without seeing a quarter of 4% GDP growth or better — or that the economy remains extremely fragile.
One thing seems sure. If the stock market were truly telling us anything meaningful about the economic outlook, then we wouldn’t be having the yield on the 10-year T-note at 2.05% and barely budging as the S&P 500 nudged even higher to close at the highs of the session in yesterday’s impressive positive price action.
Tags: Aggressive Action, Amp, Blue In The Face, Bounce, Carbon Copy, Central Bank Intervention, Central Planners, David Rosenberg, Debt Ceiling, Deja, Deja Vu, Dire Need, Fiasco, Gates, Imagination, Recycling, Screenplay, Scripts, Sheff, Straight Line
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Monday, February 27th, 2012
Once again, if one wants to get nothing but schizophrenic noise from several momentum chasing vacuum tubes which very way may take the market to all time highs on 1 ES contract churned back and forth, by all means focus on the “market” which for the past three years is merely a policy vehicle of the monetary-fiscal fusion regime (thank you Plosser for confirming what we have been saying for years). For everyone else, here is the traditionally solid economic commentary from David Rosenberg. Considering that the central planners have pumped $7 trillion, or 50% of their balance sheet, in the stock market in the past 4 years, to offset precisely the warnings that Rosenberg issues on a daily basis, we are far beyond debating whether or not those who observe the economy realistically are right or wrong. The only question is whether the central banks can continue to expand their balance sheet at an exponential phase to offset the inevitable. Answer: they can’t.
From Gluskin Sheff’s David Rosenberg
IT’S A GAS, GAS, GAS!
“There are fluctuations in the market that don’t mean anything.”
Ira Gluskin, February 14, 2012
If there was a Rule #11 added to Bob Farrell’s list of gems, this would be it. We have added this ditty before from Ira, and will continue to do so as a reminder. A reminder of what you ask? A reminder of how the stock market can be divorced from economic realities for a period of time. The stock market ignored the perils of the busted tech bubble for a good eight months back in 2000, ultimately to its own chagrin. It ignored the meltdown in the housing and mortgage market for at least 10 months back in 2007. The examples can go on, but hopefully the point is taken.
At any given moment of time, the market is driven by a variety of factors. Some are more important than others, and they include technicals, seasonals, sentiment. fund flows, valuations and, Of course, the fundamentals. The key driving force this year has been the expanded P/E multiple, in line with a 16 reading on the VIX index, as the markets seem to believe that the massive expansions of global central balance sheets will end up saving the day for dilapidated sovereign government balance sheets and woefully undercapitalized European banks. Too bad the Graham and Dodd classic text on value investing didn’t include a chapter on central bank money-printing.
From our lens, liquidity-based rallies are fun to trade, but tend to have a relatively short shelf life. Imagine what is on everyone’s minds for the coming week is not the economic data or earnings results but instead the second LTRO round on Wednesday — this is what investors are biting their nails over: will it be 1 trillion euros or ‘just’ 300 billion? Page M10 of Barron’s dubs this the ‘LTRO put’, which “sparked a massive risk-on rally in global markets”. Incredible how easy it is to avert a bear market why didn’t the Fed do this in 2007 and 2008, simply print money — and help us avoid the Great Recession?
What about the fundamentals? Well, let’s have a look at earnings. It is completely ironic that we would be experiencing one of the most powerful cyclical upswings in the stock market since the recession ended (the S&P 500 is now up 25% from the October 3rd nearby low) at a time when we are clearly coming off the poorest quarter for earnings, in every respect. The YoY trend in operating [PS is now below 6%, and without Apple, growth has basically vanished altogether (down to a mere +2.8%). Corporate guidance over the past three months is at the lowest point since August 2009 — before the term ‘green shoots’ was invented! Only 44% of companies beat their revenue targets, the weakest since the first quarter of 2010: and 64% surpassed their profit estimates and this too is the lowest since the third quarter of 2008.
If memory serves me correctly, you did not want to go long the market heading into either the second quarter of 2010 or the fourth quarter of 2008 with these factoids in hand. I have to admit that I find it perplexing as to why so many folks dub this a tech-led rally when we came off a week that saw both Hewlett- Packard and Dell disappoint in their Q4 earnings results — the former with a 7% YoY revenue dive.
All that said, the S&P 500 did manage to close out the week at 1,365.74 and establish a level not seen since June 5, 2008 (only 200 points shy of setting a new all-time high —Jeremy Siegel must be licking his chops). If you are wondering why it is that consumer sentiment jumped to 75.3 in February (better than the reading that was widely expected), this is the reason. The University of Michigan index does a much better job tracking the equity market than it does the labour market or consumer spending for that matter.
Page 13 of the weekend FT quotes a strategist as saying
“… we also had a combination of a couple of good earnings reports and little bright signs coming from the housing and labour markets. Some people are even talking about the S&P 500 hitting the 1,400 mark.”
Actually, earnings growth and earnings estimates are going down on net. As is corporate guidance, what little of it there is. The bright signs from housing are really a commentary on the balmy weather skewing the seasonally adjusted data and there is certainly no sign of any recovery in prices (it’s incredible how so many people get excited over a 321,000 new home sales tally — never mind that they are still near record lows in per capita terms). To be sure, the new housing inventory is down to a six-year low of 5.6 months supply, but taking into account the supply coming down the pike from foreclosures, the entire backlog in the pipeline is at least double that posted number.
The precious metals market is hardly signalling good times ahead — rather more turbulent times ahead — as gold finished last week near a three-month high (silver has been behaving even better and platinum has hit its best level in five months).
Meanwhile, what is largely being ignored is the rapid move up in oil prices as Iran-based tensions escalate further. The WTI crude price rose to nearly $110/bbl and more importantly. Brent has soared over $125/bbl (highest level since August 2008), and forward contracts are pointing to gasoline breaking back above $4 a gallon in the next two to three months (already there in California and within 10 cents in New York state). The nationwide average has already risen 37 cents in just the past month and 7 cents last week alone — it hasn’t been long enough to show through in the confidence surveys, though let’s face it, we are seeing early signs already of some fraying at the edges in the retail sector — despite the apparent improvement in the labour market (indeed, it is income that people spend, and growth on this front, let’s be honest, has been less than stellar).
Meanwhile, as if to represent the consensus of opinion out there. page A2 of the weekend WSJ quotes a pundit as saying “$4 probably isn’t going to be the threshold that changes peoples’ behavior this time. I think people have gotten used to $4″.
What claptrap. Its not that people have gotten used to $4 — it’s only there in the Golden State, Hawaii and Alaska … wait until it grips the whole country. And consumers have yet to fully process this rapid move up in gas prices, but recall what happened a year ago. To be sure, there was no recession, but economic growth came to a virtual halt in the first half of the year because of the impact that energy costs exerted on the GDP price deflator. Second, it is not the level but the change in prices at the pump that influences the growth rate of the economy — every penny at the pumps siphons away around $1.5 billion from consumer wallets into the gas tank. Moreover, a little history lesson for the pundit quoted above. According to work conducted by the University of California at San Diego and cited on page 14 of the weekend FT. all but one of the 11 post-WWII recessions followed an oil shock (the lone exception was the 1960 downturn). Recall what happened the last two times Brent hit current levels — in 2008 (recession) and 2011 (stall speed). Neither outcome was very good.
The key is how long this elevated energy price environment sticks around in terms of overall economic impact. Brent had already been hovering near $110/bbl for 12 months but this most recent price run-up has actually taken the 200-day moving average higher now than it was in the 2008 recession year. Let’s keep in mind that the jump in crude prices has occurred even with the Saudis producing at its fastest clip in 30 years — underscoring how tight the backdrop is. Even with slowing demand in the weak economies of the ‘developed world’, continued rapid growth in emerging markets is providing an offset on the demand side (which does little good for the American or European consumer).
Meanwhile, estimates of spare capacity are all over the map but what we do know is that just to meet the burgeoning demands of the emerging market world requires a further 1 mbd this year of production — and yet supplies are being withdrawn. It will not be very difficult to see oil retest $150 a barrel, and we are talking WTI here, not Brent.
It is also fascinating to watch the action in the much-despised Treasury market (the net speculative short position on the 10-year 1-note is 63,328 contracts on the CBOT while the comparable for Dow contracts is net long 14.803 contracts). Despite the slate of supply last week ($99 billion of new issue activity) the yield on the 10-year T-note closed at 1.98%. Someone out there (Bernanke?) is
coming in and buying whenever the yield pops above 2% — a level that simply is not being sustained on apparent break-outs. The long bond yield actually finished the week lower in yield at 3.1% from 3.14% (the 10-year was down 2bps).
At a time when energy prices are spiking, this is a clear sign that the bond market is treating this as a deflationary shock rather than a durable increase in inflation. That makes total sense to us. It’s not as if global consumption is going up — even with higher auto sales, Americans are spending less time on the road: miles driven are down 1% over the past year. And the IEA (International Energy Agency) has cut its 2012 forecast for global oil demand twice since the beginning of the year. This is an exogenous supply shock, pure and simple.
And now the consensus is that the recession in the euro area will be mild because of one month’s worth of diffusion indices. Such is human nature — extrapolate the most recent economic indicator into the future. The region suffers from a credit shock, a fiscal shock, and now an oil shock and at the same time, an overvalued currency. What is the euro doing at an 11-week high and how does this help the region export its way out of its economic downturn? Yet there are still a net short 137,479 speculative euro contracts on the CME, which could have a further impact as they cover in the near-term; there are 17,136 net long yen contracts and 29,101 net long speculative U.S. dollar contracts.
Brent crude oil hit a record high in euro terms (in Sterling as well) last week and has surged 11% in just the past month on this basis, and even if prices stay where they are, what energy is going to absorb out of Eurozone GDP this year will be 5.5%, which would surpass the 2008 recession shock of 4.8% (the highest drainage from the economy in three decades — see Soaring Oil Price Threatens Recovery on page 14 of the weekend FT).
The U.S. economy is either generating jobs in low-paying service sector jobs or the employment that is coming back home in manufacturing is doing so at lower wage rates than when these jobs left for Asia years ago. So much for wage stickiness. Throw in rising gasoline prices and real incomes are in a squeeze, and there is precious little room for the personal savings rate to decline from current low levels. On a year-to-year basis, real after tax incomes are running fractionally negative and in the past that was either associated with an economy in recession, about to head into recession or just coming out of recession. So perhaps there is no contraction in real GDP just yet. but there is one in real incomes.
What else do people spend? Their wealth. And here too, courtesy of a flat equity market performance and renewed declines in home values, household net worth also contracted in the past year. So here we have real incomes and wealth both deflating and the masses believe that recession is off the table because of a liquidity-induced four-month rally in the stock market. Go figure.
Tags: All Time Highs, Bob Farrell, Central Banks, Central Planners, Chagrin, Daily Basis, David Rosenberg, Ditty, Economic Commentary, Economic Realities, Eight Months, Fund Flows, Gluskin Sheff, Inevitable Answer, Meltdown, Mortgage Market, Perils, S David, Stock Market, Vacuum Tubes
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Saturday, February 18th, 2012
It was one short week ago that both Australia surprised with hotter than expected inflation (and no rate cut), and a Chinese CPI print that was far above expectations. Yet in confirmation of Dylan Grice’s point that when it comes to “inflation targeting” central planners are merely the biggest “fools“, this morning we woke to find that the PBOC has cut the Required Reserve Ratio (RRR) by another largely theatrical 50 bps. As a reminder, RRR cuts have very little if any impact, compared to the brute force adjustment that is the interest rate itself. As to what may have precipitated this, the answer is obvious – a collapsing housing market (which fell for the fourth month in a row) as the below chart from Michael McDonough shows, and a Shanghai Composite that just refuses to do anything (see China M1 Hits Bottom, Digs). What will this action do? Hardly much if anything, as this is purely a demonstrative attempt to rekindle animal spirits. However as was noted previously, “The last time they stimulated their CPI was close to 2%. It’s 4.5% now, and blipping up.” As such, expect the latent pockets of inflation where the fast money still has not even withdrawn from to bubble up promptly. That these “pockets” happen to be food and gold is not unexpected. And speaking of the latter, it is about time China got back into the gold trade prim and proper. At least China has stopped beating around the bush and has now joined the rest of the world in creating the world’s biggest shadow liquidity tsunami.
First, here is a chart showing the collapse in the Chinese housing market in all its glory – without a shadow of a doubt the primary reason for the PBOC to do what it did today:
Will the PBOC be able to redirect the “Austrian” money flow into ponzi encouraging prospects? Here is Sean Corrigan with some thoughts:
Chinese Real M1 joins that of parts of Europe, the UK, India, and several other, key EM nations in dropping into negative territory and hence strangling the monetary impetus towards both dubious short-term output gains and more certain quickening of the pace of price appreciation which has driven so much of the recovery so far. This means that only the US is left creating sufficient real new money to keep things supported at present – a phenomenon not surprisingly being reflected in its run of somewhat improved macro numbers in recent months.
For China itself, this is unprecedented – at least in the last 15 years or so during which China has assumed the role of marginal buyer of inputs a fortiori – and it represents the latest stage in a jarring, screeching, airbag-triggering deceleration from 2010′s extraordinary 37.5% growth rate. You don’t have to be an Austrian to see what this must imply for all the non-remunerative, hyper-Keyensian, ‘stimulus’ projects launched to offset the Western slump, post-LEH/AIG which litter the Middle Kingdom’s landscape, both figuratively and literally.
While we must be slightly tentative in our inferences – due to the disruptive arithmetical effect of that highly moveable feast which is the Lunar New Year – it cannot be denied that several other indicators – imports, container traffic, power consumption, for example – are also flashing Hard Landing Red here.
Watch this space…
Here is the MSM take on today’s event via Reuters:
China’s central bank cut the amount of cash banks must hold in reserves on Saturday, boosting lending capacity by an estimated 350-400 billion yuan ($55.6-$63.5 billion) in a bid to crank up credit creation as the world’s second-biggest economy faces a fifth successive quarter of slowing growth. The People’s Bank of China (PBOC) is on the course of gentle policy easing to cushion the world’s fastest-growing major economy against stiff global headwinds as Europe’s debt crisis grinds on, although it has been treading warily.
The PBOC cut big banks’ reserve requirement ratio (RRR) by 50 basis points to 20.5 percent, effective from next Friday, after repeatedly defying market expectations for such a move after it first cut the ratio last November.
“It’s not a big surprise. Although they (Chinese leaders) stress policy stability, an RRR cut is necessary. Trade and monetary data in January pointed to some downward pressure on the economy,” said Hua Zhongwei, an economist at Huachuang Securities in Beijing.
“But policy easing will be gradual given the central bank sounded cautious about inflation in its fourth-quarter monetary policy report.”
Slower growth also has ramifications for the world economy — already hampered by decaying demand from debt-ridden Europe and still under-spending U.S. consumers — given that China now adds more each year to net global growth than any other nation.
China’s leader-in-waiting, Xi Jinpeng, assured an audience of business executives in Los Angeles on Friday that China’s growth would not falter it would continue to rebalance its economy to import more from other countries.
“There will be no so-called hard landing,” said Xi, who is almost sure to succeed Hu Jintao as Chinese president in just over a year, on the final day of his tour of the United States.
The central bank announced its first cut in RRR in three years on Nov. 30, 2011, taking the rate down by 50 bps.
Investors had expected another RRR cut ahead of the Chinese Lunar New Year in late January, but they were wrong-footed as the central bank opted for open market operations to provide short-term cash for banks.
More meaningless RRR cuts coming?
“We still see four more RRR cuts in the remainder of the year,” said Shen Lan, an economist at Standard Chartered Bank in Shanghai. “The central bank may still stress policy stability. The next cut should be in Q2.”
Oh well, if the perception of encouraging inflation is what the PBOC wants, the perception of encouraging inflation is what the Chinese gold bugs get.
Tags: Animal Spirits, Austrian Money, Beating Around The Bush, Bps, Brute Force, Central Planners, Corrigan, CPI, Gold Trade, Grice, Housing Market, Market Collapse, Michael Mcdonough, Money Flow, Pboc, Reserve Ratio, Shadow Of A Doubt, Shanghai Composite, Time China, Uk India
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Monday, February 6th, 2012
Over the weekend, we commented on Dylan Grice’s seminal analysis which excoriates the central planning “fools”, who are perpetually caught in the “lost pilot” paradigm, whereby the world’s central planners increasingly operate by the mantra of “I have no idea where we’re going, but we’re making good time!” and which confirms that in the absence of real resolutions to problems created by a century of flawed economic models, the only option is to continue doubling down until terminal failure. Basically, the take home message there is that once “economists” get lost in trying to correct the errata their own models output as a result of faulty assumptions (which they always are able to “explain away” as one time events), they drift ever further into unknown territory until finally we end up with such monetary aberrations as “liquidity traps”, “zero bound yields” and, soon, NIRP (which comes after ZIRP), if indeed the Treasury proceeds with negative yields beginning in May under the tutelage of the Goldman-JPM chaired Treasury Borrowing Advisory Committee. Today, it is Bill Gross who takes the Grice perspective one step further, and looks at implications for liquidity, and the lack thereof, in a world where one of the three primary functions of modern financial intermediaries – maturity transformation (the other two being credit and liquidity transformation) is terminally broken. He then juxtaposes this in the context of Hyman Minsky’s monetary theories, and concludes: “What incentive does a US bank have to extend maturity to a two- or three-year term when Treasury rates at that level of the curve are below the 25 basis points available to them overnight from the Fed? What incentive does Pimco or banks have to buy five-year Treasuries at 75bp when the maximum upside capital gain is two per cent of par and the downside substantially more?” In other words, Pimco is finally grasping just how ZIRP is punking it and its clients. It also means that very soon all the maturity, and soon, credit risk of the world will be on the shoulders of the Fed, which in turn labor under a false economic paradigm. And one wonders why nobody has any faith left in these here “capital markets”…
Some of Gross’ thoughts in the FT:
Zero-based money is at risk of trapping the recovery
Isaac Newton may have conceptualised the effects of gravity when that mythical apple fell on his head, but could he have imagined Neil Armstrong’s hop-skip-and-jumping on the moon, or the trapping of light inside a black hole? Probably not. Likewise, the deceased economic maestro of the 21st century – Hyman Minsky – probably couldn’t have conceived how his monetary theories could be altered by zero-based money.
Minsky, originator of the commonsensical “stability leads to instability” thesis; the economist with naming rights for 2008’s “Minsky Moment”; the exposer of the financial fragility of modern capitalism; probably couldn’t imagine the liquidity trap qualities of zero-based money, because who could have conceived 30 or 40 years ago that interest rates could ever approach zero per cent for an extended period of time? Probably no one.
Nor, more importantly I suppose, can Ben Bernanke, Mario Draghi or Mervyn King. In their historical models, credit is as credit does, expanding perpetually after brief periods of recessionary contraction, showering economic activity with liquid fertiliser for productive investment and inevitable growth.
If they were to adopt Minsky’s framework, they would visualise a credit system expanding from “hedge” to “securitised” to “Ponzi” finance, pulling back after 2008 to the stability of the less levered “securitised” segment, but then expanding again as government credit substituted for private deleveraging, providing a foundation for future growth of the finance-based economy.
Well, maybe not. In modern central bank theory, liquidity traps are a function of fear and unwillingness to extend credit based upon the increasing probabilities of default. This world is the second half of Will Rogers’ famous maxim uttered in the Depression: “I’m not so much concerned about the return on my money, but the return of my money.”
The modern capitalistic model depends on risk-taking in several forms. Loss of principal – as in default – necessitates the cautious extension of credit to those that presumably can use it most efficiently. But our finance-based Minksy system is dependent as well on maturity extension. No home, commercial building or utility plant could be created if the credit liability matured or was callable overnight. Because this is so, lenders require and are incentivised by a yield premium for longer term loans, historically expressed as a positively sloping yield curve.
What incentive does a US bank have to extend maturity to a two- or three-year term when Treasury rates at that level of the curve are below the 25 basis points available to them overnight from the Fed? What incentive does Pimco or banks have to buy five-year Treasuries at 75bp when the maximum upside capital gain is two per cent of par and the downside substantially more?
Maturity extension for Treasuries, and then for corporate and private credit alike, becomes riskier. The Minsky assumption of rejuvenation once the public sector stabilises the credit system then becomes problematic. Instability may slouch back towards stability, but that stability may resemble more closely the zero-bound world of Japan over the past 10 years than the dynamic developed economy model of the past half century.
The global economy’s quest for a modern day Keynes or Minsky may be frustrated by zero-based money that rations credit just as fiercely as it does risk. Minsky’s economic theory is now at the zero-bound.
Continue reading here.
Tags: Aberrations, Bill Gross, Central Planners, Economic Models, Faulty Assumptions, Financial Intermediaries, Grice, Hyman Minsky, Jpm, Liquidity Trap, Liquidity Traps, Monetary Theories, PIMCO, S Central, Seminal Analysis, Time Events, Treasury Rates, Unknown Territory, Us Bank, Zirp
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Monday, March 28th, 2011
By far, this video gives new meaning to the specific, ruthless, brutal force of nature and the scale of devastation in Japan.
Click on image below if you wish to donate to disaster relief to Japan, via IRC.
Tags: Advent, Brutal Force, Brute Force, Central Planners, Devastation, Disaster Relief, Force Of Nature, Image, Irc, Japan Tsunami, Japan Video, March 11, Shocking Video, Trillions, Tsunami, Tsunami Video, Zeroes
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