It seems our recent re-introduction of the world to Robert Triffin has struck a note among a number of market participants. The gold-convertible U.S. dollar became the global reserve currency under the Bretton Woods monetary system, which lasted from 1944-1971. This arrangement ended because foreign central banks accumulated unsustainably large reserves of U.S. Treasuries, threatening price stability and the purchasing power of the dollar. Today, central banks are once again stockpiling massive Treasury reserves in an attempt to manage their currency values and gain advantages in export markets. We have, effectively, returned to Bretton Woods. The trouble is, as Guggenheim's Scott Minerd notes, that the arrangement is as unsustainable today as it was during the middle of the last century. None of this should come as a surprise given the unorthodox growth of central bank balance sheets around the world. The collapse of Bretton Woods in 1971 caused a decade of economic malaise and negative real returns for financial assets. Can anyone afford to wait to find out whether this time will be different?
Just as we will not tire of pointing out the unintended consequence of the Fed's central-planning efforts, so it is time, courtesy of the IMF's latest missive, to point out the vicious circle that the ECB has created and encouraged in Europe. The unintended consequence of the ECB's intervention - as both perpetual backstop and lender of last resort - has created an ever-increasing fragmentation between the core and the periphery (exactly the supposed 'issue' Draghi is attempting to fix with his OMT). The toxic-debt-loop as capital leaves the periphery for the core, pressuring peripheral bond yields/spreads, and forcing private sector borrowing to be replaced by public-sector not only clouds the true picture for real-money investors or depositors (risk-based pricing has been destroyed) but encourages front-running fast-money flows which do nothing but provide short-term cover for banks/sovereigns to delay the inevitable (and potential market-clearing) deleveraging/restructuring that is required. Because the fundamental issue is one of solvency - not liquidity - the ECB's continued artifice of plugging liquidity shortfalls does nothing but lessen the confidence in the system and reduce any faith in price levels as without addressing the real insolvency, trust will never return.
While yesterday it was the sovereigns who suffered the wrath of the IMF's wholesale growth outlook downgrade (unbeknownst to Christine Lagarde), today it is the turn of the financial sector (which is increasingly being blurred with the former in a world in which central banks are used to both backstop bank liabilities and fund endless public deficits, unafraid of the consequences in a closed loop fiat world in which defection is, so far, impossible) to be greeted by a cold dose of reality emanating from the IMF's "Global Financial Stability Report" especially as pertains to Europe's insolvent banking system. The most notable finding of said report is the admission that the IMF was only kidding when it said six months ago, in April of this year, that the worst case outlook now has European banks deleveraging to the tune of $3.8 trillion through the end of 2013, or over the next 14 months: now this number is 18% higher, or a gargantuan $4.5 trillion (12% of bank assets). This is how much debt Eurobanks will need to shed in a "weak policies" case in which Europe continues to delay implementing fiscal reform, aka austerity, as per Figure 2.14. Even the baseline (and this being the IMF it means it has zero chance of happening) scenario is not much better, at a revised $2.8 (7.3%) trillion in deleveraging. The reason for the increase is due to "lower expected earnings, higher losses linked to worsened economic conditions, and greater funding pressures on banks."
Nothing materially new here from David Rosenberg's latest letter, but it is useful to keep being reminded over and over how central planning has totally destroyed the primary function of capital markets: discounting, and replaced it with a dumb terminal which only responds to red flashing headlines reporting of neverending liquidity. "If the Fed really had its way, the economy would be booming. But it is sputtering. For all the talk of one month's employment report — look at the entire quarter for crying out loud. Looking at total labour input, aggregate hours worked, it eked out a tepid 0.8% annualized gain in Q3....That the stock market is up 16% this year (on track for the best year since 2009) with earnings contracting underscores the major success of Fed policy in 2012 — managing to deflect investor attention away from negative profit trends and towards its pregnant balance sheet. So welcome to the new normal: the Fed has managed to negotiate a divorce between the economy and equity market behaviour.
Many times what "should" happen does not happen. For example, global stock markets "should" decline as the global economy free-falls into recession, as global recession is not exactly an ideal scenario for rising corporate sales and profits or demand for commodities. Yet global markets are by and large rising significantly. Sometimes what "should" happen is simply being delayed. In other cases, some other dynamic is at work. Stock market bulls, for example, say the "other dynamic" is global money-printing by central banks, and this "easing" will power stocks higher even as sales and profits sag. Analysts who believe fundamentals eventually over-ride monetary manipulation believe the stock market decline has only been delayed, not banished. A similar tug-of-war is playing out between those who feel the U.S. dollar "should" decline in the years ahead and those who see the dollar strengthening significantly.
IMF Cuts Global Growth, Warns Central Banks, Whose Capital Is An "Arbitrary Number", Is Only Game In TownSubmitted by Tyler Durden on 10/08/2012 18:05 -0400
"The recovery continues but it has weakened" is how the IMF sums up their 250-page compendium of rather sullen reading for most hope-and-dreamers. The esteemed establishment led by the tall, dark, and handsome know-nothing Lagarde (as evidenced by her stroppiness after being asked a question she didn't like in the Eurogroup PR) has cut global growth expectations for advanced economics from 2.0% to only 1.5%. Quite sadly, they see two forces pulling growth down in advanced economies: fiscal consolidation and a still-weak financial system; and only one main force pulling growth up is accommodative monetary policy. Central banks continue not only to maintain very low policy rates, but also to experiment with programs aimed at decreasing rates in particular markets, at helping particular categories of borrowers, or at helping financial intermediation in general. A general feeling of uncertainty weighs on global sentiment. Of note: the IMF finds that "Risks for a Serious Global Slowdown Are Alarmingly High...The probability of global growth falling below 2 percent in 2013––which would be consistent with recession in advanced economies and a serious slowdown in emerging market and developing economies––has risen to about 17 percent, up from about 4 percent in April 2012 and 10 percent (for the one-year-ahead forecast) during the very uncertain setting of the September 2011 WEO. For 2013, the GPM estimates suggest that recession probabilities are about 15 percent in the United States, above 25 percent in Japan, and above 80 percent in the euro area." And yet probably the most defining line of the entire report (that we have found so far) is the following: "Central bank capital is, in many ways, an arbitrary number." And there you have it, straight from the IMF.
If interest income as a percentage of total personal income had remained at its 2008 level, the total would now be over $1.5 trillion. It is this $550 billion annual delta that the Fed has directly, though its policies, taken away from US consumers in terms of purchasing power. So while the Fed has taken away the bond market as a venue in which to generate current income, it is the structural failures of equities in a post-HFT world (stories of mini, amd maxi, Flash Crashes are now a daily occurrence) that prevent investors from having the same confidence about current income in a market in which terminal and fatal capital loss are all too real fears. And there are those who still wonder why the US consumer is withering away, and absent such crutches as soaring Federal non-revolving debt, used for anything but its designated purposes, would have less purchasing power now than before the crisis as a result of the Fed's failed policies. As George Magnus so peotically summarizes it "What the left hand giveth, the right hand taketh away."
Spain was already experiencing a banking crisis as well as a sovereign crisis. It’s now on the verge of a constitutional crisis (as well as its ongoing sovereign and banking crises).
We have mentioned the little-known Belgian economist's works a couple of times previously (here and here) with regard his exposing the serious flaws in the Bretton Woods monetary system and perfectly predicting it's inevitable demise. Triffin's 'Dilemma' was that when one nation's currency also becomes the world's reserve asset, eventually domestic and international monetary objectives diverge. Have you ever wondered how it's possible that the USA has run a trade deficit for 37 consecutive years? Have you ever considered the consequences on the value of your Dollar denominated assets if it eventually becomes an unacceptable form of payment to our trading partners? Thankfully for those of us trying to navigate the current financial morass, Robert Triffin did. Triffin's endgame is simple. A rapid diversification of reserves out of the dollar by foreign central banks. The blueprint for this alternative has been in plain sight since the late 1990's, and if you watch what central banks do – not what they say – you can benefit.
Precious metals have all run up with the recent loose money policies enacted by various governments. Clearly the market darling of late is silver which is now gaining favour in Asia for its value appeal. Spot silver traded in New York has risen by 27% since the end of June, while the price of spot gold has increased by a meek 12%. Analysts say future Indian demand is key for silver’s price to climb. Futures contracts for silver at India's largest commodity exchange, the Multi Commodity Exchange, rocketed 30% in September compared with July, while volumes fell by 10% for gold futures contracts over the same period. Indian rupee weakness sent gold prices in rupees to an all time high this year, while silver never exceeded the record it hit last April. Rupee-denominated silver is currently being quoted around 20% below the record. Indian investors have ceased purchasing because the 2 weeks ending Oct. 15th is regarded as inauspicious. The buying will commence and peak during the week ahead of the Hindu festival of Diwali on November 13th. In China, on the Shanghai Futures Exchange silver futures were up 29% at the end of September verses the end of June, while gold climbed 13%, according to data from the exchange's website.
The market is so focused on this morning's BLS number it has completely ignored the latest round of Reuters "news" (after their last two market-testing, unsourced "exclusives" about European developments were roundly refuted nobody can blame it) on how the OMT will proceed once operational (assuming of course Spain ever requests an activation of the mechanism that has allowed it to consider not requesting it). So, on to the thing of importance via BBG: expectations is for a NFP print of 115,000 and an unemployment rate of 8.2%. Any major surprises to either side will likely be risk negative. The unemployment rate has held above 8% level for 43 consecutive months; U.S. labor force participation rate last month declined to 63.5%, lowest since Sept. 1981. Back to Europe, a possible bailout for Spain is not imminent, a European Union official said, as concerns grow over the country’s ability to reach its deficit-reduction targets. The German recession accelerates as factory orders fell 1.3% in August, more than forecast. Switzerland’s foreign-currency reserves rose to a record 429.3 billion francs at the end of September from 420.8 billion francs at the end of August.Around the world: the Bank of Japan held off from more easing after adding to stimulus last month; shoppers from China’s mainland curbed spending at Hong Kong luxury stores during the Golden Week holiday.
A common theme among many of our insights is the reality that lurks behind the proposed perception of many of our economic, financial, and political leaders' projections. From Spain not needing a bailout to Juncker's lies, from Bernanke's transitory inflation to Dimon's not needing TARP, the list is endless. Artemis Capital, whose insights we have discussed here and here, use the metaphor of the impossible object (e.g. Penrose Triangle or Necker's Cube) to explore the role of perception in modern markets, monetary policy, and risk. In a world where global central banks manipulate the cost of risk, the mechanics of price discovery have disengaged from reality resulting in paradoxical expressions of value that should not exist according to efficient market theory. Fear and safety are now interchangeable in a speculative and high stakes game of perception. The market is no longer an expression of the economy... it is the economy; and common sense says do not trust your common sense.
Hint: It's not the "sovereigns." The chart below (an update of a chart we showed some years ago: not unexpectedly, Dexia no longer made the cut) shows the ratio of the biggest European and American bank assets to domicile nation GDP. The red line is the 50% assets/GDP breakeven. It is safe to say that if a bank's "assets" whether marked to myth, unicorns, or markets (sadly nobody has done the latter in the past 3 years) represents at least half of a domicile nation's GDP, the bank is obviously Too Humongous To Fail, and when it comes to leverage it is its unelected executive committee which calls the real shots for not only the host country, but any monetary union it may be part of. This is how 20 or so corner offices hijacked Europe. The ironic observation is that for all the complaints about the TBTF phenomenon in the US (banks in red), it is Europe where the TBTF spectacle will truly unfurl once the central banks finally lose control, and the giant unwind begins.
While the discussions between these two legends varied from Phat Phong nightlife to Dow 30,000, and from China bullishness to AAPL bearishness, it was the conversation about the actions of Bernanke, and more importantly our political leaders that summed up perfectly the dreadful reality in which we find ourselves. The punchline: "It is very dangerous to have ignorant people believing that they know something."
Alan Wheatley, Global Economics Correspondent for Reuters has written a very interesting article, 'Analysis: China's currency foray augurs geopolitical strains’ where he emphasizes China’s desire to wean out the US dollar’s currency reserve status. China is actively taking steps to phase out the US dollar which will decrease volatility in oil and commodity prices and deride the ‘exorbitant privilege' the USA commands as the issuer of the reserve currency at the centre of a post-war international financial architecture which is now failing. In 1971, U.S. Treasury Secretary John Connally said, "It's our currency and your problem". China is frustrated with what it sees as the US government’s mismanagement of the dollar, and is now actively promoting the cross-border use of its own currency, the yuan, or also called the renminbi, in trade and investment. China’s goal is to decrease transactions costs for Chinese importers and exporters. Zha Xiaogang, a researcher at the Shanghai Institutes for International Studies, said Beijing wants to see a better-balanced international monetary system consisting of at least the dollar, euro and yuan and perhaps other currencies such as the yen and the Indian rupee. "The shortcomings of the current international monetary system pose a big threat to China's economy," he said. "With more alternatives, the margin for the U.S. would be greatly narrowed, which will certainly weaken the power basis of the U.S."