Central Banks

All the pseudo-scientific yada-yada on economic theory are just hollow bones thrown to journalists and pundits to have something to “chew” on and write about. The only thing that matters is the monetization of more and more government debt, and how to sell it to the public. Paul Krugman would argue that despite all the “quantitative easing” inflation has not really picked up. At zero percent interest rates, money has no preference – there is no opportunity cost of just “lying around” without interest. Investing money for 4 years for 0.15% return is not “riskless return” – it’s “return-less risk”. Perversely, the Fed has created a situation where raising interest rates would probably lead to inflation. It is boxed into ZIRP (zero interest rate policy) for infinity. Things will get serious once the Fed adopts a policy called N-GDP targeting. Instead of inflation, the Fed will try to “target” nominal GDP. If real GDP growth is zero, the nominal GDP growth will be made up entirely of inflation. Debt is a nominal unit, and it is supported by nominal GDP. In order to keep the ratio between GDP and debt halfway bearable, GDP must be inflated. It is a tax on everybody holding dollars, since the value of those will decline. Meanwhile, the Japanese are resorting to stealth interventions to break the Yen’s strength.    Currency wars have gone from “cold” to “hot”. The Fed’s printing of dollars is forcing other central banks to purchase them and selling their own currency in the hope of stemming their own currency’s rise. This makes them involuntary buyers of Treasury bills and bonds, making it easier for the US government to finance its deficit.

What a difference a quarter makes: back in Q4 2011, in light of the imploding global economic reality, the only recourse equity bulls had to was to point out that corporate profitability was still at all time highs, and to ignore the macro. Fast forward a few months, when Europe's economic situation continues to deteriorate with the recession now in its second quarter, China's home prices have just slumped for a 4th consecutive month (forcing the PBOC to do only its second RRR cute since November), Japan is, well, Japan, yet where the US economic decoupling miracle is now taken at face value following an abnormally high seasonal adjustment in the NFP establishment survey leading to a big beat in payrolls and setting the economic mood for the entire month (with flows into confidence-driven regional Fed indices and the PMI and ISM, not to mention the Consumer Confidence data) as one of ongoing economic improvement. That this "improvement" has been predicated upon another record liquidity tsunami unleashed by the world's central banks has been ignored: decoupling is as decoupling does damn it, truth be damned. Yet the bullish sentiment anchor has flip flopped: from corporate profitability it is now the US "golden age." How long said "golden age" (which is nothing but an attempt to sugar coat the headline reality for millions of jobless Americans in an election year) lasts is unclear: America's self-delusion skills are legendary. But when it comes to corporate profit margin math, things are all too clear: the corporate profitability boom is over. As Goldman points out: with the bulk of companies reporting, in Q4 corporate profits have now declined by a significant 27 bps sequentially, and an even more significant 52 bps excluding Apple.

In the past week we have seen the Banks of Japan and China join the queue for printing ink along with the Fed, the Bank of England, the ECB and the Swiss National Bank; many other minor central backs have either cut rates or are about to. Admittedly the Chinese have not actually cranked up the Hewlett Packards but PBOC Governor Zhou said that “China will continue to invest in EU countries’ government bonds, and will continue, via possible channels, including the IMF, the EFSF and the ESM, to be involved in resolving the euro-zone crisis”. He added that he hopes Europe can offer “more attractive investment products”. I wonder what he has in mind. With the support he can muster Greek 2 year bonds on a 200% yield should do the trick surely…

The equities market is acting like we know Greece's default will be orderly and no threat to financial stability. It is also acting like we know the U.S. economy can grow smartly while Europe contracts in recession. Lastly, the high level of confidence exuded by market participants suggests we know central bank liquidity is endlessly supportive of equities. What do we really know about the coming default of Greece? Whether we openly call it default or play semantic games with "voluntary haircuts," we know bondholders will absorb tremendous losses that are equivalent to default. We also suspect some bondholders will refuse to play nice and accept their voluntary haircuts. Beyond that, how much do we know about how this unprecedented situation will play out?

Credit markets in Europe remain significant underperformers relative to equities this week, despite some short-covering yesterday that narrowed the gap. Global Financial Systemic Risk is rising again - dramatically. It seemed that the dramatic shift from early to mid-week was enough to scare some action back into the market and we can't help but feel that the rallies in Spanish and Italian govvies (on what was very likely thin trading) was all central banks, all the time. Today saw stocks rally in Europe to new post-NFP highs while credit leaked wider off its open and closed on a weak tone into the US long-weekend. The end of the week felt much more like covering to flat than any aggressive re- or de-risking which seems appropriate given the rising risk of binary events and an inability to hedge those jumps.

It is no secret to those who follow the daily nuances of global monetary policy that the primary reason for Europe's deplorable fate has little to do with liquidity, and everything to do with an ever diminishing base of money-good assets, which in turn is a solvency problem when run through the cash flow statement and balance sheet. Need an explanation for the ever declining collateral thresholds by the ECB? There it is: assets in Europe are generating ever lower returns, which means that an ever lower inverse LTV has to be applied to them by monetary authorities in order for the asset holder to get some return. And with trillions in incremental cash needs, before all is said and done, the ECB (and various regional central banks, as was discussed last week), will be forced to accept virtually anything that is not nailed down as collateral for 100 cents on par (not amortized) value. Yet while observing the symptom is simple, the diagnosis is much more difficult. In other words, why is Europe's asset base getting progressively worse. Courtesy of Goldman we may have found the answer. As the following chart shows, the average age of assets in years in Europe, has just hit a record high. The implications of this are substantial, and explain so very much about the core problem at the heart of the European quandary.

Market participants continued to react positively to yesterday’s reports that Euro-zone central banks, via the ECB, are to exchange the Greek bonds they hold for new bonds, without CAC’s, to help the Greek debt deal. As a result, stock futures traded higher throughout the session, led by the financials sector, while the health-care sector which is characterised by defensive-investment properties underperformed. Looking elsewhere, EUR/GBP traded briefly below the 0.8300 level, while GBP/USD continued to consolidate above the 1.5800 level following the release of better than expected retail sales. Hopes that a Greek deal is in the pipeline also lifted EUR/USD, which trades in close proximity to an intraday option expiry at 1.3110.

Sprott strategist John Embry has never been a fan of the existing financial system. Today, he makes that once again quite clear in this interview with Egon von Grayerz' Matterhorn Asset Management in which he says: "I think that the current financial system, as we know it, will be totally destroyed, probably sooner rather than later. The next system will require gold backing to have any legitimacy. This has happened many times in history." Needless to say, he proceeds to explain why a monetary system based on gold, one in which one, gasp, lives according to one's means, is better. Logically, he also explains why the status quo, whose insolvent welfare world has nearly a third of a quadrillion in the form of unfunded future liabilities, will never let this happen. Much more inside.

There are those who have been waiting to buy undilutable precious metals in response to a headline announcement from the Fed that it is starting to buy up hundreds of billions of Treasurys or MBS.  This is understandable - after all that is precisely the trigger that the headline scanning robots which account for 90% of market action in the past year are programmed to do. And the worst thing that one can do is put on the right trade at the wrong time. Yet it may come as a surprise to some, that while the world was waiting, and waiting, and waiting, for Bernanke to hit the Print button, virtually every other central bank was quietly unleashing it own mini tsunami of liquidity. In fact, as Morgan Stanley puts it, "the Great Monetary Easing Part 2 is in full swing." But wait, there's more: in an Austrian world, where fundamentals don't matter and only how much additional nominal fiat is created is relevant, it is sheer idiocy to assume that the printers will stop here... or anywhere for that matter. They simply can't, now that the marginal utility of every dollars is sub 1.00 relative to GDP creation. This means that by the time the Global Weimar is in full swing, we will see much, much more easing. Sure enough, MS anticipates an unprecedented additional round of easing in the months ahead. So for those waiting to buy gold et al at the same time as DE Shaw's correlation quants do, the time will be long gone. Because slowly everyone is realizing that it is not the Fed that is the marginal creator of fake money. It is everyone.

Yesterday, it was Thomas Stolper who capitulated on his latest incursion into the field of 0.000 batting, when he closed his long EURUSD reco (only for the EUR to jump today of course). We can hardly wait for him to announce he is again long the EURUSD for the clearest EUR short signal possible. That said, it still left outstanding the Goldman Russell 2000 recommendation noted here previously. Sure enough, in the aftermath of yesterday's return of risk with a vengeance, Goldman is taking steps to make sure it locks in at least some profits on its RUT 2000 target of 860 by hiking the stop to 810 from 765. The reason? "What has clearly changed in the past week -- and the catalyst for this "leash tightening" -- is that European sovereign risks have reemerged, with continued near-term support for Greece now much more uncertain than we or the markets had previously assumed. With the amplification of these hard-to-assess risks emanating from Europe, and data continuing to support our main thesis, we think that protecting the gains at this point with relatively tight stop is prudent" But why if Europe is suddenly fixed, on the completely meaningless news that the ECB is funding Eurozone central banks with magic money on their Greek bond losses, even as the actual debt notional is not changing at all. At this point, we doubt we are the only one who no longer care.

A number of headlines from Bloomberg, via Die Welt, that the ECB will undergo a bond swap on their greek government bonds and the 'profit' will flow to governments. This is absolute delusion. The ECB claims EUR50bn nominal value of GGBs - so likely took a EUR20-30bn loss on this given the prices they bought at under the SMP and the current market price. We explained last week (must-read) the delusional nature of these profits (given the losses that occur once the new bonds break) and assume this is yet another attempt to make market participants believe they wil help with PSI. However, there is more to this in our humble opinion. Since the ECB says they will distribute profits (which we know are illusory) to governments - it is nothing but a covert attempt to funnel money (think printing) to local government central banks - and the illusory profits here are simply giving away free money. Perhaps the loud screaming over the pain associated with even an 'orderly' Greek default is enough that the ECB needs to placate them with some new freshly printed money? For now, the PSI remains in limbo for the hold-out blocking stake reasons we have discussed at length - if the ECB were to step into the market and buy/swap with hold-outs all of their UK-law bonds at Par (for huge gains to the hedgies) then perhaps we get a deal done - but this would be astounding and leave the rest of the European sovereign debt market disabled as investors pushed for the same deal and vigilantes drove Portugal and then Spain to this point...

Is it perhaps cheaper for the Troika to fund the ECB's EUR30bn loss (and let Greece default) than pay the EUR130bn for them to stay?

Two formal requests to Mr. Draghi - please show where the profit is booked on your balance sheet and also explain how a notional swap (no debt reduction) in any helps the Greeks?

Of course, if only one had seen that there is absolutely nothing different or new about the gold "story" at all since March 2009, there would have been no need to strengthen positions. Otherwise, more or less as has been said here all along. Furthermore, below are some pretty charts from the latest World Gold Council demand trends letter, presented below.

Global demand for gold reached 4,067.1 tonnes last year, the highest tonnage since 1997, due in large part to a nearly 5% increase in investment demand, which hit a record 1,640.7 tonnes. Asian countries like China, India, Vietnam, Thailand and others see bullion as a store of value against the growing inflation and the ongoing debasement of their currencies. The fundamentals for gold in 2012 look good.  Continuing low and often negative real interest rates will continue to support gold’s safe haven status. The Fed’s statement that it will continue to see rates remain very low until 2014 is very bullish for gold. Central banks were net buyers of gold and their demand surged nearly 6 fold (570%) to 439.7 tonnes in 2011 (compared with 77 tonnes in 2010), more metal than at any time since the end of the gold standard in 1971. The World Gold Council noted that, “The buyers are all ... in Latin America, Asia and the Far East and they are basically enjoying strong growth, fiscal surpluses and growing foreign exchange reserves." 

As you know, back in December the ECB conducted a 3 year LTRO operation that drew far more interest than anticipated. The operation saw banks draw a Gross (net liquidity injection was ~210 Billion Euros) ~490 Billion Euros from the ECB (and not according to plan, turned around and parked it back at the ECB instead of buying up shitty bonds).

Today, people who believe that gold is money think that one should hoard gold. They seek to take possession personally. Or when they have it stored professionally, they look for a private vault outside the banking system where they can (hopefully) trust their warehouse receipt. And why shouldn’t they avoid the banking system? Its corruption was always inevitable. The advent of the central banks before World War I ensured it. The theft (in the US) of the gold of the people in 1933 cemented it, along with the dollar devaluation. The treaty at Bretton Woods in 1944, in which the world agreed to treat the US dollar as if it were gold nailed it in place. The default on the US government’s gold obligations in 1971 by President Nixon set it in stone. Today, we have a corrupt central bank that centrally plans money, credit, discount, and interest. The regime of irredeemable paper money is going to collapse. Anyone who understands it should want to get out of it, and not be a creditor to insolvent banks. This is a rational personal response to an irrational system. But it is not necessarily a vision for how the world ought to be run, or how a banking system should be designed. Today, it is necessary to hunker down, trust no one, hide one’s gold, and take no unavoidable or unnecessary risk. Today, one is concerned with one’s stocks of gold. One has what one has, one tries to get a little more while one can, and then one hopes that after “it” happens, one will have enough.