It seems more likely to Morgan Stanley's Gerard Minack that central bankers may win the battle: sustaining recovery in developed economies with extraordinarily loose monetary policy. For a while this would go hand-in-hand with better equity performance. The battle is against a crisis caused by too loose monetary policy, elevated debt and mis-priced risk. Ironically, he notes, central bankers may overcome these problems by running even looser monetary policy, encouraging a new round of levering up, and fresh mis-pricing of risk. However, winning the battle isn't winning the war. If central bankers do win this round, the next downturn could be, in Minack's view, an omnishambles. In short, it seems more likely that central bankers may add another leg to the credit super-cycle. The key question for investors in this scenario is when (and how) this cycle may end, and Minack's hunch is that this cycle is already closer to 2006 than 2003.
This is the third day in a row that an attempt to mount an overnight ramp out of the US has fizzled, with first the Nikkei closing down for the second day in a row and snapping a week-long rally, and then the Shanghai Composite following suit with its 5th consecutive drop in a row as the rumblings out of the PBOC on the inflation front get louder and louder, following PBOC governor Zhou's statement that inflation expectations must be stabilized and that great importance must be attached to inflation. Stirring the pot further was SAFE chief Yi Gang who joined the Chinese chorus warning against a currency war, by saying the G20 should avoid competitive currency devaluations. Obviously China is on the edge, and only the US stock market is completely oblivious that the marginal economy may soon force itself to enter outright contraction to offset the G-7 exported hot money keeping China's real estate beyond bubbly. Finally, SocGen released a note last night title "A strong case for easing Korean monetary policy" which confirms that it is only a brief matter of time before the Asian currency war goes thermonuclear. Moving to Europe, it should surprise nobody that the only key data point, Eurozone Industrial Production for January missed badly, printing at -0.4% on expectations of a -0.1% contraction, down from a 0.9% revised print in December as the European recession shows no signs of abating. So while the rest of the world did bad or worse than expected for the third day in a row, it will be up to the POMO and seasonally adjusted retail sales data in the US to offset the ongoing global contraction, and to send the perfectly manipulated Dow Jones to yet another all time high, in direct refutation of logic and every previous market reality ever.
Yo Liz: Subsidies for the zombie banks total more than $3 annually for every dollar in income reported by the industry...
Just like yesterday, it will be up to the US session to provide the perfectly expected, VIXterminating, volumeless ramp as the rest of the world just did not have it in i to take the S&P to all time highs in overnight trading. To summarize: currency talkfare out of Asia, hope springs eternal out of Europe despite the usual spate of ugly numbers, PIIGS bond auctions backstopped by the ECB and always "that much better" than the expected, a UK economy that is just imploding to provide an alibi for more open-ended QE and a crushed pound, and with the US due to make everything better by sending the SP to its all time high (just 9 points away) on the one week anniversary of the record high DJIA, as the NY Fed clobbers the VIX to a 10 handle or lower on even more ugly, unadjusted economic data.
- One in four Germans would back anti-euro party (Reuters)
- EU Chiefs Seeking to Stave Off Euro Crisis Turn to Cyprus (BBG)
- Ryan Says His Budget Would Slow Annual Spending Growth to 3.4% (BBG)
- Goldman leads decline as Wall Street commodity revenues plummet (Reuters)
- South Korea and US begin military drills (FT) and North Korea cuts off hotline with South Korea (Reuters)
- Karzai Inflames U.S. Tensions (WSJ)
- Algorithms Get a Human Hand in Steering Web (NYT)
- Meeting Is Set to Choose Pope (WSJ)
- More U.S. Profits Parked Abroad, Saving on Taxes (WSJ)
- Banks rush to redraft pay deals (FT)
- Fugitive Fund Manager Stuffed Underwear With Cash, Fled (BBG)
- Post-Newtown Gun Limits Agenda Narrows in U.S. Congress (BBG)
- China Hints at Shift in One-Child Policy (WSJ)
Thirty cities at the center of the nation’s most populous metropolitan areas faced more than $192 billion in unpaid commitments for pensions and other retiree benefits, primarily health care, as of fiscal 2009. Pew notes that these cities had 74 percent of the money needed to fully fund their pension plans but only 7.4 percent of what was necessary to cover their retiree health care liabilities. Cities typically count on investment earnings from their pension funds to cover two-thirds of benefits. During the Great Recession, though, returns were lower than expected, and unfunded pension liabilities grew in nearly all of the cities. Even cities with well-funded systems struggled to keep up their yearly contributions as local tax revenue plummeted during the recession, and while pension assets have largely returned to pre-recession levels, they still must make up for years of lost growth, as liabilities continue to rise. So pressure for reforms is not expected to lessen. New York and Philadelphia may have the largest unfunded liability per household, but it is Chicago and Pittsburgh that have the lowest funding levels for pensions and the lowest retiree health care funding levels - while Washington D.C. tops the list in both. Benefits down, taxes up.
There was once a rough and logical correlation between the level of government borrowing, and the rate of interest on government debt. If the government borrowed more money, the cost of borrowing rose and the private market’s appetite for government debt fell. But that correlation totally broke down around the year 2000. In 2008 we hit the Minsky moment, and today we are in the deleveraging phase. The spread between government borrowing costs and government borrowing levels remains huge. And the long, slow grind back to a sustainable debt-to-GDP ratio is slow and depressionary. Japan hit their Minsky moment in the 1990s, and today still remain trapped in the deleveraging phase. The question that remains unknown is how the distortions will resolve. In the long run, the data is clear. The Greenspan-Bernanke era Federal Reserve wilfully built up bubbles and distortions, which grew out of control, and sucked the economy into a black hole. At the very best, this has led to a Japanese-style depression.
A major shift is taking place in Central Bank policy. The herd is ignoring the language as usual... just like they did in 2008.
- Italy sold EUR 6.5bln in 5y and 10y BTPs this morning, solid b/c and competitive yields, especially when considering the uncertain political situation in Italy.
- Moody's also said that Italian election is indirectly credit negative for other pressured EU sovereigns.
- Fears rise that ECB plan has a weakness as the strings in the Eurozone bond buying programme may be its frailty.
In many Western industrialized nations, debt has overwhelmed or is about to overwhelm the economy's debt-servicing capacity. In the run-up to a debt crisis, bad debt tends to move to the next higher level and may ultimately accumulate in the central bank's balance sheet, provided the economy has its own currency. Many observers assume that, once bad debt is purchased by the central bank, the debt crisis is solved for good; that central banks have unlimited wealth at their disposal, or can print unlimited wealth into existence.
However, central banks can only create liquidity, not wealth. If printing money were equivalent to creating wealth, then mankind would not have to get up early on Monday morning. Only a solvent central bank can halt hyperinflation. The longer governments run large deficits, the longer central banks continue to monetize them, and the longer their balance sheets grow, the higher the potential for enormous losses and thus hyperinflation.
Necessary preconditions for hyperinflation are a quasi-bankrupt government whose debt is monetized by a central bank with insufficient assets. One way or another, owning physical gold is the safest and most effective way of insuring against hyperinflation.
The publication, earlier this week, of the FOMC minutes seemed to have a similar effect on equity markets as a call from room service to a Las Vegas hotel suite, informing the partying high-rollers that the hotel might be running out of Cristal Champagne. Around the world, stocks sold off, and so did gold. The whole idea that a bunch of bureaucrats in Washington scans lots of data plus some anecdotal ‘evidence’ every month (with the help of 200 or so economists) and then ‘sets’ interest rates, astutely manipulates bank refunding rates and cleverly guides various market prices so that the overall economy comes out creating more new jobs while the debasement of money unfolds at the officially sanctioned but allegedly harmless pace of 2 percent, must appear entirely preposterous to any student of capitalism. There should be no monetary policy in a free market just as there should be no policy of setting food prices, or wage rates, or of centrally adjusting the number of hours in a day. But the question here is not what we would like to happen but what is most likely to happen. There is no doubt that we should see an end to ‘quantitative easing’ but will we see it anytime soon? Has the Fed finally – after creating $1.9 trillion in new ‘reserves’ since Lehman went bust – seen the light? Do they finally get some sense? Maybe, but we still doubt it. In financial markets the press, the degrees of freedom that central bank officials enjoy are vastly overestimated. In the meantime, the debasement of paper money continues.
Day after day, whenever anyone challenges the TBTF banks' scale, they are slammed down with a mutually assured destruction message that limitations would impair profitability and weaken the country's position in global finance. So what if you were to discover, based on Bloomberg's calculations, that the largest banks aren't really profitable at all? What if the billions of dollars they allegedly earn for their shareholders were almost entirely a gift from U.S. taxpayers? The stunning truth is that the top-five banks account for $64 billion of an implicit subsidy based on the ludicrous (but entirely real) logic that: The banks that are potentially the most dangerous can borrow at lower rates, because creditors perceive them as too big to fail. Once shareholders fully recognized how poorly the biggest banks perform without government support, they would be motivated to demand better. The market discipline might not please executives, but it would certainly be an improvement over paying banks to put us in danger.
The Chinese New Year celebration is now over, the Year of the Snake is here, and those following the Shanghai Composite have lots to hiss about, as two out of two trading days have printed in the red. But a far bigger concern to not only those long the SHCOMP, but the "Great Reflation Trade - ver. 2013", is that just as two years ago, China appears set to pull out first, as once again inflation rears its ugly head. And where the PBOC goes, everyone else grudgingly has to follow: after all without China there is no marginal growth driver to the world economy. End result: China's reverse repos, or liquidity providing operations, have ended after month of daily injections, and the first outright repo, or liquidity draining operation, just took place after eight months of dormancy. From the WSJ: "Chinese authorities took a step to ease potential inflationary pressures Tuesday by using a key mechanism for the first time in eight months. The move by the central bank to withdraw cash from the banking system is a reversal after months of pumping cash in. That cash flood was meant to reduce borrowing costs for businesses as the economy slowed last year—but recent data has shown growth picking up, along with the main determinants of inflation: housing and food prices."
Let’s be very clear here: this is what the euro has wrought. This destruction of the non-German industrial bases has taken place with the active complicity of the European technocrats. They did not even realize that France, the EMU’s second largest economy, for example was becoming hopelessly uncompetitive. This is a zero sum game if there ever was one, with Germany being the main winner and the other three economies massive losers. Instead of leading to convergence in euroland economies, the euro project has led to massive divergences, with the strong getting stronger, and the weak getting weaker... The ECB has thrown enough money at the market to, for now, reduce borrowing costs and allow equity prices to rise (unfortunately so is the euro, threatening exports). This buys time—but these actions are not enough to solve the structural problems created by the euro. The private sector has shriveled in Southern Europe, as government spending and debt has soared. If we have France, Italy and Spain together enter a debt deflation/debt trap, the crisis will be far too big for Germany to handle: and if this happens before German federal elections are held (no later than October) we could see the European political crisis revive in full force.
This objective report concisely summarizes important macro events over the past week. It is not geared to push an agenda. Impartiality is necessary to avoid costly psychological traps, which all investors are prone to, such as confirmation, conservatism, and endowment biases.