Central Banks

Three weeks ago we discussed the ultimate-doomsday presentation of the state of Spain which best summarized the macro-concerns facing the nation and its banks. Since then the market, and now the ratings agencies, have fully digested that meal of dysphoric data and pushed Spanish sovereign and bank bond spreads back to levels seen before the LTRO's short-lived (though self-defeating) munificence transfixed global investors. However, the world moves on and while most are focused directly on yields, spreads, unemployment rates, and loan-delinquency levels, there are two critical new numbers to pay attention to immediately - that we are sure the market will soon learn to appreciate. The first is 5%. This is the haircut increase that ECB collateral will require once all ratings agencies shift to BBB+ or below (meaning massive margin calls and cash needs for the exact banks that are the most exposed and least capable of achieving said liquidity). The second is 10%. This is the level of funded (bank) assets that are financed by the Central Bank and as UBS notes, this is the tipping point beyond which banks are treated differently by the market and have historically required significant equity issuance to return to regular private market funding. With S&P having made the move to BBB+ this week (and Italy already there), and Spain's banking system having reached 11% as of the last ECB announcement (and Italy 7.7%), it would appear we are set for more heat in the European kitchen - especially since Nomura adds that they do not expect any meaningful response from the ECB until things get a lot worse. The world is waking up to the realization that de-linking sovereigns and banks (as opposed to concentrating that systemic risk) is key to stabilizing markets.

Way back in 2009, we remember fielding all manner of questions from people wanting to invest in gold, having seen it spike from its turn-of-the-millennium slump, and worried about the state of the wider financial economy. A whole swathe of those were from people wanting to invest in exchange traded funds (ETFs). John Aziz always and without exception slammed the notion of a gold ETF as being outstandingly awful, and solely for investors who didn’t really understand the modern case for gold — those who believed that gold was a 'commodity' with the potential to 'do well' in the coming years. People who wanted to push dollars in, and get more dollars out some years later. 2009 was the year when gold ETFs really broke into the mass consciousness. Yet by 2011 the market had collapsed: people were buying much, much larger quantities of physical bullion and coins, but the popularity of ETFs had greatly slumped. This is even clearer when the ETF market is expressed as a percentage of the physical market. So what does this say about gold now? Especially as Zhang Jianhua of the PBoC noted "No asset is safe now. The only choice to hedge risks is to hold hard currency — gold."

Over the past several months, starting with the great US stock market surge back in October 2011 which was not paralleled by virtually any other index in the world (and especially not Spain which recently breached its March 2009 low), there has been a great deal of speculation that just because the US stock market was doing "better", that the US economy has by implication "decoupled" from Europe. Well, as yesterday's GDP number showed in Q1 the economy ended up rising at a pace that was quite disappointing, but more importantly, which even Goldman admits is due for a substantial slow down in the coming months. And ironically, in the past 6 months it was not the Fed, but the ECB, that injected over $1.3 trillion in the banking system. One would think that this epic "flow" of liquidity from the central bank would result in a surge in the only metric that matters to 'Austrians', namely the expansion in money (or in this case the widest metric officially tracked on an apples to apples basis - M2). One would be very wrong. Because as the chart below shows, while US M2 has soared from the 2009 troughs, money "movement" in Europe has barely budged at all.

The good days are over, at least according to Goldman's Jan Hatzius. Now that "Cash For Coolers", aka April in February or the record hot winter, has ended, aka pulling summer demand 3-6 months forward, and payback is coming with a bang, starting with what Goldman believes will be a 125,000 NFP print in April, just barely higher than the disastrous March 120,000 NFP print which launched a thousand NEW QE rumors. But before you pray for a truly horrible number which will surely price in the cremation of the USD once CTRL+P types in the launch codes, be careful: from Hatzius - "Despite the weaker numbers, we have on net become more, not less, worried about the risks to our forecast of another round of monetary easing at the June 19-20 FOMC meeting. It is still our forecast, but it depends on our expectation of a meaningful amount of weakness in the economic indicators over the next 6-8 weeks. In other words, our sense of the Fed’s reaction function to economic growth has become more hawkish than it looked after the January 25 FOMC press conference, when Chairman Bernanke saw a “very strong case” for additional accommodation under the FOMC’s forecasts. This shift is a headwind from the perspective of the risk asset markets....So the case for a successor program to Operation Twist still looks solid to us, and the FOMC’s apparent reluctance to deliver it is a concern."

The European Central Bank prints money and hands it to the banks in undiminished size and at an interest rate which compels massive carry trades. The European banks buy sovereign debt that helps to lower the price of the sovereign’s funding costs, the banks use some of the money to increase their own capital and lend some of the money to individuals and corporations in the nations where they are domiciled. The money gets used and eventually dries up and a some of the capital is used to come into compliance with Basel III. The yields of the periphery nations fall but then begin to rise again. Germany, using Target-2, keeps lending money to the other central banks which use part of the money to support their currency, the Euro. The circle is then completed and the equity markets, notably in America, trade off of the strength of the Euro and some days at almost a point by point movement. Never before in the history of the world has such a grand scheme been implemented and in such an all-encompassing fashion. The unlimited amount of money that is available, because they can print all the money they want, has allowed Europe to game the world’s financial system while no one looked or caught on to the scheme. The world’s fiscal system has been rigged by Europe.

It must be difficult for the BRICS countries today. On one hand, they continue to jockey for respect among the Western powers, insisting on participating in quasi-European bailout funds like the IMF. On the other hand, they are also clearly aware of the Western nations' continuing efforts to surreptitiously devalue their domestic currencies, and the pernicious effect that has had on them as exporters and as lenders of capital. In that vein, it was interesting to note that during the latest BRICS Summit held this past March in New Delhi, the main topic of discussion centered on the creation of the group's first official institution, a so-called "BRICS Bank" that would fund development projects and infrastructure in developing nations. Although not openly discussed, reports suggest what they were really talking about was creating a type of BRICS central bank - an institution that could facilitate their ability to "do more business with each other in their local currencies, to help insulate from U.S. dollar fluctuations…" Given the incredible scale of western central bank intervention over the past six months, the BRICS' increasing frustration with their printing efforts should be a given by now. The real question is what they're doing about it, and what assets they're accumulating to protect themselves from the inevitable, which brings us to gold.

While many will remember 1982 for its disco and the movie E.T., it is perhaps best known by an investing public as the end of a 16 year secular bear market. The 10% decline from 1966 was better, however, than the 38% loss from 1937 to 1941 and the 80% loss from 1929-1932 but together this triumvirate make up the secular bear markets. Luckily, as IceCap's Keith Dicker notes, for most of the investment industry they can gloss over these extended loss periods and instead focus on the long-run secular bull markets (cue Jeremy Siegel). However, he points out that unknown to many and ignored by the rest, "we are in the middle of another long and dragged out Secular Bear Market which has seen investors lose 7% since the year 2000 - that's 12 years of hopes for nothing." Understanding secular markets and how they transition from BULL to BEAR is perhaps the most rewarding investment perspective you won’t hear from anyone else. While financial markets continue to yo-yo with our retirements, the truth is, the next Secular BULL Market is not quite ready to perk its head up just yet as Dicker addresses P/E ratios during inflationary and deflationary periods summing up his view of the world rather succinctly: "As central banks continue to bail out banks and countries, they implicitly create an investment culture whereby failure is rewarded and success is taxed to reward those who failed."

Better late than never. All you need to read. 

The Fed’s promise to use more QE should the economy falter is supporting gold.

The global economic picture remains grim, with euro zone economic sentiment falling more than

expected in April and the US job market recovery showing signs of a slowdown.

Apple earnings and the tech boom and indeed possible tech bubble remains one of the primary

drivers of continuing irrational exuberance and risk appetite.

The poor and deteriorating economic backdrop is gold supportive.

PIMCO's Bill Gross spent a longer-than-soundbite period discussing QE3, the chance of a US double-dip, and Europe's ongoing dysfunction with Trish Regan on Bloomberg Television this afternoon. Given more than his typically limited-to-ten-second thoughts some other media outlets appear to prefer, the old-new-normal-bond-king believes the Fed will resist another round of quantitative easing in the short-term but "if unemployment begins to rise for two-to-three months then QE3 is back on". Noting that investors should focus on nominal GDP growth tomorrow, he goes on to dismiss the idea that the US can decouple from a troubled Europe pointing the political dysfunction between the Germans and the rest as greater than the polarity between Democrats and Republicans here at home. Preferring to play a slightly levered long bet on low rates holding for a longer-period, he like MBS (as we have discussed in the past) but does not see the 10Y yield dropping precipitously from here though he does echo our thoughts entirely in his view of the 'flow' being more critical than the 'stock' when it comes to the Fed's balance sheet and hence the June end-of-Twist may be a volatile period for all asset classes.

As if our recent discussion of Austerity were not enough, Citi's Steve Englander invokes 'String theory' to open the door to multiple universes, and in one of them Paul Krugman is undoubtedly Fed Chairman. Start with the assumption that a Paul Krugman Fed would advocate strong fiscal and monetary measures and tolerate a significant run-up in inflation. The question is how the USD would respond in this world. The presumption is that the Krugman Fed would cooperate by financing the fiscal expansion, allowing government spending or (or in a very strange Republican Krugman parallel universe) tax cuts to have a real impact without affecting government debt, making a strong distinction between pumping liquidity into the banking system and directly into the real economy. In conventional terms,  this is Financial Repression 101, but inflation is desired, achieved and beneficial. As Krugman points out there is a cost to an extended period of long-term unemployment. The bottom line is that unless you make low inflation a canonical virtue, you have to compare the long-term losses from lower credibility (if they exist) against the long-term gains from moving to full employment quicker (if they exist).

As we noted (here and here) earlier this week, the world increasingly looks like 'Japan' with little aggregate way out. The following chart perhaps confirms the repressive wave of ongoing intervention across the developed world. Extrapolating trends into the future implies that since the world's central banks will need to have a short-term rate of negative 2% by 2020, there is a lot of QE-equivalent easing still to come. As Simon Black noted, "The ironic triumph of the Keynesians means that, in trying to save the economy, our central banks may end up destroying it completely by means of the printing press; as a consequence, we now get to experience some of the full-on horror of the Japanese malaise."

TedBits:  The Economic and Financial NO SPIN Zone
Global Macroeconomic Analysis Through the Austrian Lens
By Theodore (Ty) Andros

An underwater earthquake has occurred in Spain and is quite possibly occurring now in Italy.  Killer waves are now headed directly at the central banks and financial systems throughout the developed world and at Europe in Particular.  How long until they hit and do the financial equivalent of Japan’s recent tsunami?  Socialist bureaucrats and progressives on both sides of the Atlantic are locked in death struggles with Mother Nature.  THEY WILL LOSE.

Socialist public servants and banksters in Brussels and Washington are DESPERATELY trying to repeal the law of nature:  You MUST produce more than you consume or PERISH.  Economic systems which are predicated upon the consumption of wealth rather than the production of it are now on their deathbeds.  The obscenity of counting consumption as production, as does Keynesian economics, is exposed for its fundamental flaw -- it counts wealth consumption and destruction as wealth production.  How absurd. 

I do not believe that China or Russia are in any position to dump the US dollar, at least not in the near-term. The US Dollar may one day no longer be the reserve currency of the world. But that day is years and possibly decades out. But the notion that China or Russia could just dump the Dollar and move around the US in terms of trade is unbelievably naïve and greatly underestimates the importance of the US to the global economy.

Support for gold is at $1,612/oz and resistance is at $1,663/oz and $1,684/oz.