Central Banks

Explaining why and how the global monetary system is failing, why it is too late to stop, what will come next, and why the crisis is only financial – not commercial.

"One of my favourite comedians, Eddie Izzard, has a rebuttal that I find most compelling. He points out that “Guns don’t kill people; people kill people, but so do monkeys if you give them guns.” This is akin to my view of financial models. Give a monkey a value at risk (VaR) model or the capital asset pricing model (CAPM) and you’ve got a potential financial disaster on your hands." - James Montier, May 6

When wonkish blogs suggest gold ownership as a hedge for the political idiocy of the world, it is mockingly shrugged off. When the BRICs add gold, it is eschewed in a 'well, its diversification' argument. But when the bankers' bankers' bank - The IMF - starts adding Gold to its reserves to cover higher expected credit risk losses (read major devaluations of fiat currency exposure), perhaps - just perhaps - the 'rationality put' we noted earlier is becoming a little more expensive in the minds of Lagarde and her colleagues. As Bloomberg News reports, “The Fund is facing increased credit risk in light of a surge in program lending in the context of the global crisis,” the IMF staff wrote in a report released today, adding "there is a need to increase the Fund’s reserves in order to help mitigate the elevated credit risks,” and as CommodityOnline added: "The International Monetary Fund (IMF) is planning to purchase more than $2 billion worth of gold on account of rising global risks. The IMF currently holds around 2800 tonnes of gold at various depositories".

Many floor types think that there is a kind of “rationality put” in the markets. It evolved in the post-Lehman chaos. The premise goes something like this: world leaders were shocked and stunned by the scope and size of the nearly instant damage from Lehman’s fall. That shock caused them to rescue AIG, a far, far bigger project than Lehman. Since then, central banks and governments have stepped in quickly as each new crisis emerged. However, as UBS' Art Cashin notes somewhat ominously, the Greek exit / Euro-breakdown risk has made it hard to exercise a “rationality put” if things turn irrational beyond your control.

While gold is now negative year to date in dollar terms, it remains 0.7% higher in euro terms. Gold prices dropped 3.7% last week and silver fell 5.1% to $28.89/oz. The smart money, especially in Asia, is again accumulating on the dip. Demand for jewellery and bullion in India has dipped in recent weeks but should resume on this dip – especially with inflation in India still very high at 7.23%. Also of interest in India is the fact that investment demand has remained robust and gold ETF holdings in India are soon to reach the $2 billion mark. This shows that recent gold weakness is primarily due to the recent bout of dollar strength.  Morgan Stanley has said in a report that gold’s bull market isn’t over despite the recent price falls. Morgan Stanley remains bullish on gold as it says that the ECB will take steps to shore up bank balance sheets, U.S. real interest rates are still negative, investors have held on to most of their exchange traded gold and central banks are still buying gold.

Unbelievable.

That is the only way to express this author’s utter bewilderment that former Federal Reserve chairman Alan Greenspan is still given an outlet to speak his mind.  Actually, I am surprised Mr. Greenspan has the audacity to show his face, let alone speak, in public after the economic destruction he is responsible for. It was because of Greenspan, of course, that the world economy is still muddling its way along with painfully high unemployment.  His decision to prop up the stock market with money printing under any and every threat of a downtick in growth, also known as the Greenspan Put, created an environment of easy credit, reckless spending, and along with the federal government’s initiatives to encourage home ownership, the foundation from which a housing bubble could emerge. It was moral hazard bolstering on a massive scale.  Wall Street quickly learned (and the lesson sadly continues today) that the Federal Reserve stands ready to inflate should the Dow begin to plummet by any significant amount.  Following his departure from the chairmanship and bursting of the housing bubble, Greenspan quickly took to the press and denied any responsibility for financial crisis which was a result in due part to the crash in home prices. 

Trading in markets dominated by the Icelands and AIGs of 2012 can be very challenging. 

With the Greek tempest-in-a-teapot about to hit Whale-size, as Tsipras says he will not join the coalition and Venizelos says that Syriza's participation is a prerequisite (via Bloomberg), it seems now would be an opportune time to look forward (not backward at the GGB2s dropping below EUR17 for the first time ever!). As we were among the first to state that their would be a second (if not more) election in Greece, we look at the schedule of events in Europe over the next few weeks (including the payments due on the PSI holdout bonds), and discuss the scenarios and consequences of a Greek exit (for both Greece living without Euro support and the Euro-zone coping with a Lehman-event).

Highly respected economist and strategist David Rosenberg has told that Financial Times in a video interview (see below) that gold “will go to $3,000 per ounce before this cycle is over.” Markets are repeating the downturns of 2010 and 2011 and it is time to search for safety, David Rosenberg of Gluskin Sheff tells James Mackintosh, the FT Investment Editor. Rosenberg sees a “very good opportunity in gold” as it has corrected and seems to be “off the radar screen right now”. He sees gold as a currency and says the best way to value gold is in terms of money supply and “currency in circulation.” As the “volume of dollars is going up as we get more quantitative easing” he sees gold at $3,000 per ounce. Mackintosh says that Rosenberg’s view is a “pretty bearish view”. To which Rosenberg responds that it is “bullish view on gold and gold mining stocks.” Mackintosh says that it is “bearish on everything else”. Rosenberg  says that it is not about being “bullish or bearish,” it is about “stating how you view the world” and he warns that the major central banks are all going to print more money and keep real interest rates negative “as far as the eye can see.”

• China Industrial Output Growth Slows Sharply In April (WSJ)
• Indian industrial output shrinks unexpectedly (AFP)
• China’s Inflation Moderates, Adding Room for Easing (Bloomberg)... a nickel for every "imminent RRR-cut" prediction
• Drew Built 30-Year JPMorgan Career Embracing Risk (Bloomberg)
• Spain Offered Time to Curb Deficit (FT)
• France Entrepreneurs Flee From Hollande Wealth Rejection (BBG)
• Venizelos Eyes Unity Deal After Agreement With Democratic Left (Ekathimerini)
• Berlin Reaches Out to the Periphery (FT)
• Bernanke Speaks About Risks From End of Pro-Growth Plans (Bloomberg)

While we have heard a lot from Jim Grant recently - all pointedly correct and substantial - today marked the pinnacle of propaganda-brinksmanship. Explaining to Maria B just why the world in which she lives, Bernanke-lovers-all, is nothing but a hall of mirrors - a fake mirage - of the true reality thanks to central bank repression of all that we know about risk and return. "By changing interest rates, central banks change the perception of every asset class - so what seems cheap may not be cheap" as Grant notes that when you can fund investment at 0%, we are collectively being manipulated and moreover should try to realize - as an investing public - that we are Jim Carrey in The Truman Show. Of course the 75% of professional investors who believe Bernanke is doing a great job would prefer to stay inside the fake reality where their bonuses get paid and leveraged tranche losses get soaked up by some account transfer from the fed or loan loss provisioning adjustment - for the rest of us - wake up and smell the unreality. The money-honey pulls the blame and deflect card - noting the ECB are just as bad - but Grant brings her back to the reality that we are facing as he suggests being in the crowd who own Treasuries and Bunds when the next risk flare occurs will not end as well as many hope, preferring gold (and gold stocks) as a hedge as "The Gold move is not over".

"should only 2% of the Fed's assets go into default — or if there is a loss in value of 2% — the Fed becomes insolvent"

With the need for exponentially larger expansions of the central bank balance sheets - and most importantly, the rate of expansion (flow) not just the size (stock) - we thought it useful to see just how the Fed's actions had impacted the S&P 500. From the lows in March 2009, 1150 S&P points have been 'created-or-saved' thanks to central bank largesse. That is a cost of $2 billion (not million!) for every S&P 500 point since the Fed started to expands its balance sheet by $2.3 trillion. Money-well-spent, we are sure you'll agree. In the meantime, it is the printing-endgames that we care about and the horrible sense of deja vu that the following chart inspires should at minimum see investors scaling back (which it appears the sensible retail investor is) - despite the imploring of every long-only asset manager.

In what S&P calls a 'Perfect Storm', the next four years will see a minimum of $30 trillion in companies' refinancing needs related to maturing bonds and loans and further they expect $13-$16 trillion more debt will be required to finance growth. With bond portfolios over-stuffed with corporate debt (since angst over sovereign risk has skewed asset allocation away from that cohort) the rating agency is concerned that ongoing bank deleveraging, these huge debt re-funding requirements, and the diminishment of central banks and governments to do anything about it leave serious problems with a credit overhang so large. Critically, especially as we hear calls for 'growth' plans from Europe, is the increasing likelihood that, as Reuters reports, this will potentially influence corporate credit quality and "alter the fragile equilibrium that currently exists in the global corporate credit landscape". While S&P expect the refinancing needs may well be met "This global wall of nonfinancial corporate debt will potentially compound the credit rationing that may occur as banks seek to restructure their balance sheets, and bond and equity investors reassess their risk-return thresholds" which "raises the downside risk in global markets" as an inability to finance growth may well be the catalyst for another risk flare. "Governments and central banks have less fiscal and monetary flexibility to prevent serious problems emanating from future market disturbances. A perfect storm scenario would likely cause financing disruptions even for borrowers that are not highly leveraged."

The ESM funding idea is really just Spain playing for time (the ESM doesn’t actually have the funds to bail Spain out). But the fact that Germany is now making the ESM a political issue indicates the degree to which political relationships are breaking down in the EU. And once the political relationships break down... so will the Euro.