Monetary Base

While the stance of monetary policy around the world has, on any conceivable measure, been extreme, the question of whether such a policy is indeed sensible and rational has not been asked much of late. By rational we simply mean the following: Is this policy likely to deliver what it is supposed to deliver? And if it does fall short of its official aim, then can we at least state with some certainty that whatever it delivers in benefits is not outweighed by its costs? We think that these are straightforward questions and that any policy that is advertised as being in ‘the interest of the general public’ should pass this test. As we will argue in the following, the present stance of monetary policy only has a negligible chance, at best, of ever fulfilling its stated aim. Furthermore, its benefits are almost certainly outweighed by its costs if we list all negative effects of this policy and do not confine ourselves, as the present mainstream does, to just one obvious cost: official consumer price inflation, which thus far remains contained. Thus, in our view, there is no escaping the fact that this policy is not rational. It should be abandoned as soon as possible. This will end badly...

The main story overnight is without doubt the dramatic plunge in the Yen, which following the breach and trigger of USDJPY 100 stops has been a straight diagonal line to the upper right (or lower for the Yen across all currency crosses) and at last check was approaching 101.50, in turn sending the USD higher in virtually all jurisdictions. However it is not so much the Yen weakness that was surprising - a nation hell bent on doubling its monetary base in two years will do that - but the accelerating response in neighboring countries all of which are seeing Japan as the biggest economic threat suddenly and all are scrambling to respond. Sure enough, midway through the evening session, Sri Lanka cut its reverse repo and repurchase rate to 9% and 7% respectively, promptly followed by Vietnam cutting its own refinancing rate from 8% to 7%, then moving to Thailand where the finance chief Kittiratt called for a rate cut exceeding 25 bps, and more jawboning from South Korea suggesting even more rate cuts from the export-driven country are set to come as it loses trade competitiveness to Japan. Asian financial crisis 2.0 any minute now?

With equity valuations no longer levitating but in a different, 4th dimension altogether, and credit spreads compressing dramatically (and unreasonably)... It is in situations like these, when the crash comes, that the proverbial run for liquidity forces central banks to coordinate liquidity injections. However, something tells me that this time, the trick won’t work. Over almost a century, we have witnessed the slow and progressive destruction of the best global mechanism available to cooperate in the creation and allocation of resources. This process began with the loss of the ability to address flow imbalances (i.e. savings, trade). After the World Wars, it became clear that we had also lost the ability to address stock imbalances, and by 1971 we ensured that any price flexibility left to reset the system in the face of an adjustment would be wiped out too. From this moment, adjustments can only make way through a growing series of global systemic risk events with increasingly relevant consequences. Swaps, as a tool, will no longer be able to face the upcoming challenges. When this fact finally sets in, governments will be forced to resort directly to basic asset confiscation.

Nomura's Richard Koo destroys the backbone of the modern central bankers only tool in the tool-box in his latest paper. "As more and more people began to realize that increases in monetary base via QE during balance sheet recessions do not mean equivalent increases in money supply, the hype over QEs in the FX market is likely to calm down ...The only way quantitative easing can have a positive impact on economic activity is if the authorities’ purchase of assets from the private sector boosts asset prices, making people feel wealthier and thereby encouraging them to consume more. This is the wealth effect, often referred to by the Fed chairman Bernanke as the portfolio rebalancing effect, but even he has acknowledged that it has a very limitmed impact... In a sense, quantitative easing is meant to benefit the wealthy. After all, it can contribute to GDP only by making those with assets feel wealthier and encouraging them to consume more."

While the main, if completely irrelevant, macroeconomic news of the day will be the first estimate of US Q1 GDP due out later today, perhaps the best testament of just how meaningless fundamental data has become was the scheduled BOJ announcement overnight in which Kuroda's merry men simply stated what was expected by everyone: the Japanese central bank merely repeated its pledge to double the monetary base in two years. The lack of any incremental easing, is what pushed both the USDJPY as low as 98.20 overnight (98.60 at last check), over 100 pips from the highs, and has pressured the Nikkei into its first red close in days, and shows just how habituated with the constant cranking up of the liqudity spigot the G-7 market has truly become.

Six months in and a 30% devaluation in the JPY and it would appear Abenomics is not having quite the desired effect. With an oh-so-exciting 2% inflation target that we are sure will be appearing any second now, Nationwide CPI just printed -0.9% YoY - its worst (most deflationary) levels since April 2010, missing expectations by the most in 10 months! But wasn't Abenomics supposed to be... inflationary? Well it is in one place - Utilities costs are the only sub-index higher YoY (by 2.3%) - that's a good thing, right? Given that the only reason Abenomics will work is the propagandized concerns of inflation (as we noted here), this could be a problem for Kuroda (perhaps triple the monetary base will do it).

Caterpillar just can't catch a break. First, in January the firm was punk'd by a Chinese acquisition fraud, forcing the company to write off half of its Q4 earnings. This, of course, in the aftermath of the miss in both Q3 and Q4 earnings. And now we get the latest disappointing news from the firm as Q1 numbers are reported lower across the board.

• Q1 EPS $1.31, Exp $1.38; this includes a tax benefit of $87 million
• Q1 revenue: $13.2 billion, Exp. $13.8 billion
• Guides much lower, with revenue now seen at $57-61 billion, compared to $60-68 billion previously
• CAT forecasts profit per share of $7.00, compared to $7.00-9.00 previously.
• Operating cash flow of $900MM, but all of it generated from net working capital, i.e., inventory liquidation
• And when you can't spend on capex, you spend on buybacks: CAT to extend buyback through 2015

So much for that.

The main take away from events in Japan is that the BOJ shifted from a tactic of interventions (under former Governor Masaaki Shirakawa) to one of monetary policy (under current Governor Haruhiko Kuroda) . What strikes us is that the monetary policy is precisely to... well, destroy their money and in the process any chance of having a monetary policy. In our view, it was exactly because the Fed’s (undisclosed) intention was to engage in never ending Quantitative Easing, that Japan was forced to implement the policy undertaken by Kuroda. Coordination with the Fed was impossible. With Mr. Kuroda’s policy, we now have the BOJ with a balance sheet objective, the Fed with a labour market objective (or so they want us to believe), the European Central Bank with a financial system stability objective (or a Target 2 balance objective) and the People’s Bank of China (and the Bank of Canada) with soft-landing objective. It is clear that any global coordination in monetary policy is completely unfeasible. The only thing central banks are left to coordinate is the suppression of gold.

The existing (and ongoing) massive expansion of base money into the banking systems of the US, England, and Japan is without precedent. As Nomura's Richard Koo notes, at 16x statutory reserves, the liquidity 'should' have led to unprecedented inflation rates of 1,600% in the US, 970% in the UK, and 480% in Japan. However, it has not, yet. In short, Koo explains, businesses and households in these economies have stopped borrowing money even though interest rates have fallen to zero. There is little physical or mechanical reason for the BOJ’s easing program to work. But the program could also have a psychological impact - and Japanese media is on an 'inflation' full-court press currently. The risk here is that not only borrowers but also lenders will start to believe the lies. No financial institutions anticipating inflation could ever lend money at current interest rates. No actual damage will be done as long as the easing program remains ineffective. But once it starts to affect psychology, the BOJ needs to quickly reverse the policy and bring the monetary base back to 'normal'. If the policy reversal is delayed, the Japanese economy (and inflation) could spiral out of control.

In a world in which one bank after another has scrambled to downgrade its outlook on gold, both before the recent bank CEO huddle with Obama last Thursday - the day the bottom fell out of the gold market - but especially after, when the real onslaught on gold truly started, it has been an outright blasphemy for the sellside to even hint at having a bullish outlook on gold. After all, how dare someone allocate capital to the barbaric metal at a time when the US is recovering nicely (it's not), and when the US currency is one again deemed safe (with the Fed diluting its monetary base by 3% per month every month until the end of 2014 and likely forever, it isn't), any deviation from this latest script which desperately attempts to push savers out of the safety of gold into the fiat paper, where the proceeds are invested into stocks or simply spent (a la what happened in Cyprus and the latent fear of deposit confiscation everywhere in Europe), is not permitted. Yet this is precisely what CLSA's Chris Wood, author of the famous Greed & Fear, which is never afraid to be contrarian or to break the lemming mold, has done. His brief take on the recent gold plunge? "This is a buying opportunity too good for investors to miss." Buyers of physical gold everywhere in the world agree.

Former Soros' Japan advisor Fujimaki takes center stage: “The volatility in the JGB market as well as the fact that there is large selling represent fear among investors,” Fujimaki said. “They are early signs of a larger selloff and we should continue to monitor the moves in the long-term bonds.” Fujimaki said he recently bought put options for Japanese government bonds of various maturities, without elaborating. He continues to hold real estate in Japan and options granting the right to sell the yen against the greenback expiring in less than five years. He also holds assets in U.S. dollars and currencies of other developed nations. "Japan’s finance is sinking into the ocean,” Fujimaki said. “There’s no escape from a market crash in the future when you have such enormous debt.”  “By expanding the monetary base to 270 trillion yen, the BOJ is making a huge bet which I think it will ultimately lose,” Fujimaki said in an interview in Tokyo on April 11. “Kuroda’s QE announcement is declaring double suicide with the government. The BOJ will have to share the country’s fate and default together. Shirakawa did more than enough and he had good reasons to not do any more,” said Fujimaki. “There will be tremendous side effects from monetary stimulus. QE doesn’t work and has no exit... Things may look rosy for now as stocks rise, but should we see hyper-inflation, JGBs will see a huge selloff, leading to a stock market crash,” said Fujimaki, adding that he sold “almost all” of his Japanese stock holdings some time ago.

Curious how Abenomics is progressing six months after its announcement? These charts courtesy of Diapason should provide a convenient status update.

There was little in terms of overnight newsflow to spook algos, but the tone is decidedly sour this morning following a lack of either the now traditional Japan or Europen-open buying ramps. The primary reason for this may well be the ongoing decline in the USDJPY which failed to breach the 100 barrier yesterday, coming as close as 99.95 before the Mrs. Watanabe onslaught had to be called off despite some more jawboning from Kuroda whose headlines are now summarily ignored, and which appears to have set a line in the sand for Japan, whose market naturally closed lower following this strengthening in its currency. Similarly troubling was the dip in the SHCOMP which closed down -0.58%, this despite the epic M2 and credit injection reported yesterday: if new liquidity can't send the market higher, what can?

Typically the public enters the market after a large run up, in time to buy at the top. Not there yet. 

These are certainly days of miracle and wonder. Well, of absurd and extraordinary financial experimentation, at any rate. Last week, for example, saw the Bank of Japan abandon any last pretense of restraint and topple headfirst into a gigantic pile of monetary cocaine. It would be difficult to overstate the drama of this monetary stimulus (although we favour the word debauchery). Yet as the Japanese monetary authorities declare a holy war against deflation, it would only be fair to draw attention to the colossal opportunity being presented as the antidote to monetary intemperance, namely gold and gold miners. There is a clear mismatch between the prices of gold and silver mining shares and spot prices of gold and silver. But as to why the miners are trading so poorly relative to the physical is unclear to us.