The easing of credit conditions (in other words, the enhancement of banks’ ability to create credit and thus enhance their own purchasing power) following the breakdown of Bretton Woods — as opposed to monetary base expansion — seems to have driven the growth in credit and financialisation. It has not (at least previous to 2008) been a case of central banks printing money and handing it to the financial sector; it has been a case of the financial sector being set free from credit constraints. Monetary policy in the post-Bretton Woods era has taken a number of forms; interest rate policy, monetary base policy, and regulatory policy. The association between growth in the financial sector, credit growth and interest rate policy shows that monetary growth (whether that is in the form of base money, credit or nontraditional credit instruments) enriches the recipients of new money as anticipated by Cantillon. This underscores the need for a monetary and credit system that distributes money in a way that does not favour any particular sector — especially not the endemically corrupt financial sector.
Two weeks ago we noted the transmission channels that Mr. Draghi had pointed out having become broken, clearly enunciating the chasm that is developing in the interbank market. Goldman's Huw Pill takes this a step further and notes a 'red line' - running along the Pyrenees and the Alps - that has descended with banks south of this line having difficulty accessing Euro interbank markets, whereas banks north of that line remain better integrated and retain market access. This is the exact segmentation that Draghi worries is interfering with policy transmission (and thus affecting macroeconomic outcomes - in his view). Banks in the periphery have been 'red-lined' and while last week's ECB announcements initiated a policy response to this segmentation, the obvious (to anyone who actually comprehends the situation) reality is that ECB purchases of government bonds does not eliminate this 'red line'; only convincing markets through fundamental adjustment (fiscal consolidation, structural reform, and institutional building) will the red-line be lifted. This is highly improbable in the short-term and means an expectation of more direct intervention in bank funding markets (with all its encumbrance) will occur soon enough (and perhaps that is why European financial credit is underperforming).
Expansionary monetary policy constitutes a transfer of purchasing power away from those who hold old money to whoever gets new money. This is known as the Cantillon Effect, after 18th Century economist Richard Cantillon who first proposed it. In the immediate term, as more dollars are created, each one translates to a smaller slice of all goods and services produced. How we measure this phenomenon and its size depends how we define money.... What is clear is that the dramatic expansion of the monetary base that we saw after 2008 is merely catching up with the more gradual growth of debt that took place in the 90s and 00s. While it is my hunch that overblown credit bubbles are better liquidated than reflated (not least because the reflation of a corrupt and dysfunctional financial sector entails huge moral hazard), it is true the Fed’s efforts to inflate the money supply have so far prevented a default cascade. We should expect that such initiatives will continue, not least because Bernanke has a deep intellectual investment in reflationism.
European equities are seen in decent positive territory heading into the Wall Street bell, though a clear lack of direction has been observed as well a thin summer volumes . The FTSE-100 is the day's underperformer following last night's allegations made by the State of New York against UK bank Standard Chartered that the company violated US sanctions by making secret transactions to the tune of USD 250bln with Iran. The Spanish 10-year yield has held below the key 7.00% level, though higher than yesterday's close at 6.76 with the spread over the benchmark Bund is slightly wider by 1.2bps. Steepening seen in the Spanish 2-year over the last couple of days as ECB's Draghi commented that any periphery bond-buying programme would be in the short end has halted and is now wider by 13bps. The Italian 10-year yield briefly traded above the 6.00% level though has since pulled back to lows printed earlier, currently standing at 5.91%, its spread tighter by 10.4bps on the session.
In the weeks and months directly ahead, we need to monitor the tone of business capital spending and hiring. If businesses freeze up, economic growth will slow even further. This may be great for Bernanke in terms of providing cover to implement more QE, but for the real economy and financial asset investors it’s another story entirely. In fact it’s a story that stands in direct contrast to outcomes in the latter parts of 2010 and 2011. Moreover for equity investors, we need to remember that in the latter half of 2010 and 2011, the trajectory of corporate earnings growth was very strong. That’s not the case any longer in terms of growth rate. That tells us that economic growth must reaccelerate in good part to justify the already seen upward movement in financial assets largely driven to this point by QE sugar plum fairies dancing. Stay tuned. We know the key drivers to monitor. In the months ahead, it’s all about the interaction of key economic drivers, central bank QE drive by’s, and potential US fiscal cliff dives.
Eventually — because the costs of the deleveraging trap makes organicy growth very difficult — the debt will either be forgiven, inflated or defaulted away. Endless rounds of tepid QE (which is debt additive, and so adds to the debt problem) just postpone that difficult decision. The deleveraging trap preserves the value of past debts at the cost of future growth. Under the harsh discipline of a gold standard, such prevarication is not possible. Without the ability to inflate, overleveraged banks, individuals and governments would default on their debt. Income would rapidly fall, and economies would likely deflate and become severely depressed. Yet liquidation is not all bad. The example of 1907 — prior to the era of central banking — illustrates this. Although liquidation episodes are painful, the clear benefit is that a big crash and depression clears out old debt. Under the present regimes, the weight of old debt remains a burden to the economy.
The very vocal head of the world's largest bond fund has long been critical of the global ponzi system better known as the "capital markets." Now, finally, he shifts his attention to Europe, where the interests of his parent - Europe's largest insurance company Allianz are near and dear to the heart, and deconstructs not only the biggest challenge facing Europe: getting access to your money, but also the fatal flaws that will make achieving this now impossible. To wit: "Psst! Investors – do you wanna know a secret? Do you wanna know what Angela Merkel, François Hollande, Christine Lagarde and Mario Draghi all share in common? They want your money!" .... but... "private investors are balking – and for what it seems are good reasons – because policy makers’ efforts have been, until now, a day late and a euro short, or more accurately, years late and a trillion euros short." And so they will continue failing ever upward, as permissive monetary policy which allows failed fiscal policy to be perpetuated, will do nothing about fixing the underlying problems facing the insolvent continent. Then one day, the ECB, whose credibility was already massively shaken last week, will be exposed for the naked emperor it is. Only then will Europe's politicians finally sit down and begin doing the right thing. It will be too late.
- Monti Warns of Euro Breakup as Tussle Over Spain Aid Hardens (Businessweek)
- Italy doesn't need German cash, Monti tells Germans (Reuters) - at least we know who needs whose cash...
- Spain has time to Wait for Clarity on EU Aid -Econ Min (Reuters) - which came first: the Spanish bailout request or the denial to need a Bailout request? Ask the Spanish 2 year...
- Bundesbank Weidmann’s opposition to a proposed new wave of ECB bond purchases has support of Merkel’s CDU - Volker Kauder
- China media tell U.S. to "shut up" over South China Sea tensions (Reuters)
- Top Chinese Leaders Gather in Annual Summer Conclave (WSJ)
- Greece Agrees With Troika on Need to Strengthen Policy (Bloomberg)
- Coeure Says ECB Should Look at Getting Loans Into Real Economy (Bloomberg)
- Italy Central Banker Sees Potential Rate Cut as Euro Economy Slows (WSJ)
- A Dose of Dr. Draghi's 'Whatever It Takes' (WSJ)
- Greek bank head sent savings abroad (FT)
Even as the ECB is desperately doing its best to stick a finger in every hole in the leaking European dam, in which just like in the US failed monetary policy is a substitute for sound fiscal one, and in which the pattern of interventions and cause and effect will now follow that of Japan until the bitter end, others are not waiting around to see the results. Reuters reports that Royal Dutch Shell is pulling some of its funds out of European banks "over fears stirred by the euro zone's mounting debt crisis, The Times reported on Monday." And shell is not the only one: more and more institutional are actively preparing to lock up their cash on a moment's notice, an eventuality which can be seen best at the ECB itself, where deposits with the ECB (collecting 0.00%), dropped to just €300 billion the lowest since 2011, while the ready for withdrawal current account saw holdings rise to a record €550 billion overnight, a €20 billion increase overnight. And so the cycle repeats anew, and Gresham's law rises to the surface, as bad money pushes out good money, and in return the situation deteriorates once more, until the next time much more than just harsh language out of the ECB will be needed just to preserve the status quo.
After last week's event-a-palooza, where the headlines, the spin, the erroneous HFT trading, and the propaganda (Draghi is too cold; Draghi is too hot; Draghi is just right) just refused to stop, we finally enter the summer proper where all of Europe is on vacation, as is congress. Add on top of this a very light macro event week and an earnings season which has seen the bulk of companies already report, and we expect the volume in the coming 5 days to be among the lowest recorded in 2012, and thus in the past decade. Which of course means that the cannibalization among the market makers will continue as more and more firms succumb to "trading anomalies."
And, as expected, it's not happy. The punchline:
The central bank is to become subordinate to finance ministers in crisis-stricken countries. In Draghi's homeland Italy, such a situation was the norm for decades -- and the result was chronic inflation. Now, he is accepting a repeat of history. On the short term, it will create relief in the debt crisis. On the long term, vengeance will be bitter."
There has been much confusion over last week's remarks by Mario Draghi, with the prevailing narrative being that the market first got what Draghi meant wrong (when it plunged), then right (when it soared). The confusion is further granulated by attempts to explain what was merely a desperate attempt at delaying a decision for action, which was inevitable considering the now open opposition by Buba's Weidmann, into a formal and planned plotline: "Inverse Twist" or other such technical jargon is what we have seen floating around. The reality is that, just like all other central bankers, Draghi did what he does best: use big words and threats of action in hope it will buy him a few extra days of time. The reality is also that, just like when the LTRO was announced, the market did get it right initially, when peripheral bonds plunged, and got it wrong over the subsequent 3 months when bond prices rose, only to collapse to new lows (and in the case of Spain - record high yields as of two weeks ago). Back then, the ECB merely bought a few months time with its transitory intervention. This time it has at best bought a few days with the lack of any actual action. And yet, Draghi did leave a way out, for at least another brief respite (where unless Europe expands the available bailout machinery yet again, the respite will have an even briefer half life than that from the LTROs). The way out is simple, and in order to avoid any confusion, we will use an allegory from the movie Batman: Spain and Italy can be saved. But first they must be destroyed.
John Tamny of Forbes is one of the more informed contributors in the increasingly dismal state of economic commentating. Tamny readily admits he is on the libertarian side of things and doesn’t give into the money-making game of carrying the flag for a favored political party under the guise of a neutral observer. He condemns the whole of the Washington establishment for our current economic woes and realizes that government spending is wasteful in the sense that it is outside the sphere of profit and loss consideration. In short, Tamny’s column for both Forbes and RealClearMarkets.com are a breath of fresh air in the stale rottenness of mainstream economic analysis. Much to this author’s dismay however, Tamny has written a piece that denies one of the key functions through which central banks facilitate the creation of money. In doing so, he lets banks off the hook for what really can be classified as counterfeiting. In a recent Forbes column entitled “Ron Paul, Fractional Reserve Banking, and the Money Multiplier Myth,” Tamny attempts to bust what he calls the myth that fractional reserve banking allows for the creation of money through credit lending. According to him, it is an extreme exaggeration to say money is created “out of thin air” by fractional reserve banks as Murray Rothbard alleged. This is a truly outrageous claim that finds itself wrong not just in theory but also in plain evidence. Not only does fractional reserve banking play a crucial role in inflationary credit expansion, it borders on being outright fraudulent.
Promises Of More QE Are No Longer Sufficient: Desperate Banks Demand Reserves, Get First Fed Repo In 4 YearsSubmitted by Tyler Durden on 08/03/2012 12:03 -0400
While endless jawboning and threats of more free (and even paid for those close to the discount window) money can do miracles for markets, if only for a day or two, by spooking every new incremental layer of shorts into covering, there is one problem with this strategy: the "flow" pathway is about to run out of purchasing power. Recall that Goldman finally admitted that when it comes to monetary policy, it really is all about the flow, just as we have been claiming for years. What does this mean - simple: the Fed needs to constantly infuse the financial system with new, unsterilized reserves in order to provide bank traders with the dry powder needed to ramp risk higher. Logically, this makes intuitive sense: if talking the market up was all that was needed, Ben would simply say he would like to see the Dow at 36,000 and leave it at that. That's great, but unless the Fed is the one doing the actual buying, those who wish to take advantage of the Fed's jawboning need to have access to reserves, which via Shadow banking conduits, i.e., repos, can be converted to fungible cash, which can then be used to ramp up ES, SPY and other risk aggregates (just like JPM was doing by selling IG9 and becoming the market in that axe). As it turns out, today we may have just hit the limit on how much banks can do without an actual injection of new reserves by the Fed. Read: a new unsterilized QE program.
When we started reading the LA Times article reporting that "the federal government has quietly been completing an audit of U.S. gold stored at the New York Fed" we couldn't help but wonder when the gotcha moment would appear. It was about 15 paragraphs in that we stumbled upon what we were waiting for: "The process involved about half a dozen employees of the Mint, the Treasury inspector general's office and the New York Fed. It was monitored by employees of the Government Accountability Office, Congress' investigative arm." In other words the Fed's gold is being audited... by the Treasury. Now our history may be a little rusty, but as far as we can remember, the last time the Fed was actually independent of the Treasury then-president Harry Truman fired not one but two Fed Chairmen including both Thomas McCabe as well as the man after whom the Fed's current residence is named: Marriner Eccles, culminating with the Fed-Treasury "Accord" of March 3, 1951 which effectively fused the two entities into one - a quasi independent branch of the US government, which would do the bidding of its "political", who in turn has always been merely a proxy for wherever the money came from (historically, and primarily, from Wall Street), which can pretend it is a "private bank" yet which is entirely subjugated to the crony interests funding US politicians (more on that below). But in a nutshell, the irony of the Treasury auditing the fed is like asking Libor Trade A to confirm that Libor Trader B was not only "fixing" the Libor rate correctly and accurately, but that there is no champagne involved for anyone who could misrepresent it the best within the cabal of manipulation in which the Nash Equilibrium was for everyone to commit fraud.