Monetary Policy

As Europe's exuberance from the LTROs fades (with Italian banks now negative YTD, Sovereigns wider than LTRO2 levels, and financials desparately divided by the LTRO Stigma) Jefferies David Zervos uncovers the sad reality that faces peripheral creditors and Northern Europeans - as we noted a month ago here. The 'success' of the LTRO monetization scheme (as opposed to EFSF/ESM transfer dabacles) is what enabled the Greek restructuring, and as Zervos notes, the losses that the big boys (Spain and Italy) need to take will not be taken via a haircut but a monetization as the number 1 rule is we must always assume that losses will be taken in a way that protects the large northern banks, northern jobs and most importantly Northern politicians. If the loss realization is not managed correctly (and losses there will be), then the ugly truth will escape but the North's large-scale vendor-financing scheme with the periphery will have to continue - even in the knoweldge that the debt will never get paid back.

The income and savings of Northern workers must be ploughed (directly or indirectly) into the rest-of-Europe or the entire structure becomes insolvent and the breaking of that social contract (that they will be looked after when they are old) will inevitably lead to revolt and nasty nationalist political forces being unleashed. The hope to avoid this is the 'wealth illusion' as the workers of the north can never be allowed to realize they have only 50% of their worth in reality. Ireland will be next on the loss-realization-monetization path but as we move from relatively small and containable sovereigns to the big-boys, the idea that Spain and Italy will roll over and accept a decade of austerity in exchange for a haircut is pure folly. These countries hold too much clout in the Eurozone and their threat of exit is a material threat to the northern jobs and hence northern politicians. The only way the northern politicians will be able to save face when it comes to Spain and Italy is through massive monetary policy accommodation. Inflation will rebalance Europe; but let's hope that the process of restating northern wealth and wage rates does not lead to revolt in the northern streets. The politicians will need to carefully execute this trade.

Dr. Constantin Gurdgiev, a non Executive member of the GoldCore Investment Committee, has again analysed the data of US Mint coin sales in  Q1 2012 and has looked at the data in their important historical context going back to 1987.  He finds that the data regarding gold coin sales in Q1 2012 confirms that there is “no hysteria and no bubble here”.  Dr Gurdgiev finds that while volume of sales in Q1 2012 fell from the quite high levels seen Q1 2009, 2010 and 2011, demand was much stronger than “in the pre-crisis average for 2000-2007.” Also of note is the fact that despite the worst financial and economic crisis the modern world has ever seen being experienced since 2008 demand has remained below the record levels seen in the aftermath of the Asian debt crisis and unfounded Y2K concerns.  Interestingly, Dr Gurdgiev finds that the historic data (since 1987) shows that the "gold price has virtually nothing to do with demand for US Mint coins - in terms of volume of gold sold via coins." He finds that the demand for gold coins has little to do with the price in general and that “something other than price movements drives demand for coins”.

Dear Ben:

You have publicly gone on record with some off-the-wall assertions about the gold standard.  What made you think you could get away with it?  Your best strategy would have been to ignore gold.  Although I concede that with the endgame of the regime of irredeemable paper money near, you might not be able to pretend that people aren’t talking and thinking about gold.  You can’t win, Ben.  In this letter I will address your claims and explain your errors so that the whole world can see them, even if you cannot.

The week ahead will offer significant inputs to our views. ISM and payrolls will likely set the market tone for the next few weeks. Despite the softer signals from regional surveys, Goldman expects the ISM to improve at the margin relative to last month’s print. In contrast, it expects payrolls to grow by 175k, down from last month’s 227k jobs gain. FOMC minutes will likely show that Fed officials had a discussion on further easing but are unlikely to offer strong hints about the likelihood and possible timing of a third round of Quantitative Easing.

By forcing private firms and individuals into spending money on things they don’t believe they need, government can create demand, which will lead to jobs via the magic of Keynesian multipliers. Central planners know better than individuals and businesses. That is because they tend to be better educated, having attended the best schools and universities. Central planners tend to think about the bigger economic picture, while businessmen and individuals tend to have small parochial horizons. They are simply not qualified to know how to spend their money. The biggest problem with “free” markets is the stupidity of the common people. How can they possibly know what they want, or what they want to achieve when they have not attended prestigious universities like Oxford, Harvard, or Yale? Without help from central planners working with fact-based information derived from simulations, mathematical models, and empirical studies the common people will never be able to make informed economic choices. Thanks to the genius of central planning for the common good — as well as the hard work and self-sacrifice of central planners — the common people are liberated from making difficult economic decisions.

The real story of Germany, to be blunt, is that it is a parasite economy. Its domestic demand lags. It has a labor force with different values than most. It will live with low wage increases and low inflation. It has lured other EMU members into a currency bloc and let them run such persistently higher rates of inflation (with no criticism of it!) that Germany now OWNS any domestic demand that other EMU countries can generate. Germany is like the vampire squid economy of Europe. Now it’s kind of caught in its own huge blinding squirt of ink, since its banks have lent to these other EMU countries to finance their excessive consumption and Germany is entangled. But on the real-economy side of things, the German economy is eating their lunch, however, meager.

The sharp drop in the personal savings rate in the month of February, which just hit to lowest level since January of 2008, is indicative of the problem.  While personal savings rates could be bled down further to sustain the current level of subpar economic growth - the world today is vastly different than prior to the last two recessions where access to credit and leverage we very easy to obtain.  It is entirely possible, that in the very short term, we could see personal consumption expenditures continue to make some gains even in the face of the obvious headwinds.  However, it is important to keep these month to month variations in context with longer term historical trends.  Personal consumption is ultimately a function of the income available from which that spending is derived.  As such, the current decline in the growth rate of incomes, without the tailwind of easy credit, poses a much greater threat to the current level of anemic economic growth than we have seen in past cycles.

Our feeling is that Germany is establishing a "Plan B" in place in case it needs to leave the Euro at some point. The catalyst(s) that might provoke this are the upcoming French, Irish, and Greek elections, which could see a resurgence in leftist, anti-austerity measures in these countries. Moreover, inflation is kicking up in Germany which will exacerbate tensions between it and the ECB.

European markets got off to a bad start following early reports that the Greek PM has not ruled out a further aid package for the country, however European cash equities are now trading higher as US participants come to market. Markets have been reacting to the announcement from EU’s Juncker that the Eurogroup has agreed upon Eurozone bailout funds of EUR 800bln. Elsewhere in the session, FPC member Clark commented that the FPC should not aim to stimulate credit growth in the UK, adding that direct intervention in the mortgage market is too politically volatile, but may be considered in the coming years. Following the reports, GBP/USD spiked lower around 15 pips, however it remains in positive territory, moving above the 1.6000 level in recent trade. In terms of data, the Eurozone CPI estimate for March came in just above expectations at 2.6%, 0.1% above the 2.5% consensus. The market reaction to this data, however, was relatively muted as participants await Eurogroup commentary. Looking ahead in the session, participants await commentary on the Spanish budget, US Personal Spending and Canadian GDP.

All you need to read and more.

• Greek PM does not rule out new bailout package (Reuters)
• Euro zone agrees temporary boost to rescue capacity (Reuters)
• Madrid Commits to Reforms Despite Strike (FT)
• China PBOC: To Keep Reasonable Social Financing, Prudent Monetary Policy In 2012 (WSJ)
• Germany Launches Strategy to Counter ECB Largesse (Telegraph)
• Iran Sanctions Fuel 'Junk for Oil' Barter With China, India (Bloomberg)
• BRICS Nations Threaten IMF Funding (FT)
• Bernanke Optimistic on Long-Term Economic Growth (AP)

• Obama budget defeated 414-0 (Washington Times) yes, the Democrats too...
• German Central Banker: ECB Loans Only Buy Time (AP)
• Baku grants Israel use of its air bases (Jerusalem Times)
• Japan May Understate Deflation, Hampering BOJ, Economist Says (Bloomberg)
• BRICS flay West over IMF reform, monetary policy (Reuters)
• Five Portugal Lenders Downgraded by Moody’s (Bloomberg)
• SEC Registration Captures More Hedge Fund Advisers (Bloomberg)
• EU Nears One-Year Boost in Rescue Fund to $1.3 Trillion (Bloomberg)
• Consumers plot emergency oil release as Saudi decries high prices (Reuters)
• Japan Plans to Draft Stopgap Budget for First Time in 14 Years (Bloomberg)

The price of gold is being actively managed by central planners and their proxies. The main culprit here appears to be the US authorities, as the manipulation is most apparent in the US open gold market. For the most part, this 'management' has resulted in letting the price of gold rise, but not too much, or too quickly.  The price of gold has always been an object of interest for governments and central bankers. The reason is simple enough to understand: Gold is an objective measure of the degree to which fiat money is being managed well or managed poorly. As such, whenever paper money is being governed poorly, the price of gold becomes an important barometer. And this is why the actual price of gold is a strong candidate to be 'managed.' Or 'influenced'. Or 'manipulated'. Whichever word you prefer, they all convey the same intent. Some who are reading this are likely having an eye-rolling moment because they hold a belief that there is no conspiracy to manage the price of gold. This is an interesting belief to hold because it runs heavily against the odds. We could spend a lot of time discussing how a belief such as 'gold is not being manipulated' gets promoted and inserted into the popular consciousness, but we won't. Instead, we'll simply note that the people who hold this belief -- and you may be among them -- react to the concept at a visceral level, often with strong emotions such as anger or contempt, and even anxiety. When a strong emotional response surfaces during a conversation of ideas, it usually means that beliefs are in play -- neither facts nor logic. Experience has taught me that when someone becomes dismissive or angry or hostile when the idea of price manipulation is discussed, it's best to simply drop the conversation and move on. No combination of logic or facts is effective against a deeply-held belief. It's better to wait until some new evidence calls that belief into question, opening the door for revisiting the topic. But for those with an open mind, there is a very interesting trail of dots to connect.

For every semi-positive data point the bulls have emphasized since the market rally began, there's a counter-point that makes us question what all the fuss is about. The bulls will cite expanding US GDP in late 2011, while the bears can cite US food stamp participation reaching an all-time record of 46,514,238 in December 2011, up 227,922 participantsfrom the month before, and up 6% year-over-year. The bulls can praise February's 15.7% year-over-year increase in US auto sales, while the bears can cite Europe's 9.7% year-over-year decrease in auto sales, led by a 20.2% slump in France. The bulls can exclaim somewhat firmer housing starts in February (as if the US needs more new houses), while the bears can cite the unexpected 100bp drop in the March consumer confidence index five consecutive months of manufacturing contraction in China, and more recently, a 0.9% drop in US February existing home sales. Give us a half-baked bullish indicator and we can provide at least two bearish indicators of equal or greater significance. It has become fairly evident over the past several months that most new jobs created in the US tend to be low-paying, while the jobs lost are generally higher-paying. This seems to be confirmed by the monthly US Treasury Tax Receipts, which are lower so far this year despite the seeming improvement in unemployment. Take February 2012, for example, where the Treasury reported $103.4 billion in tax receipts, versus $110.6 billion in February 2011. BLS had unemployment running at 9% in February 2011, versus 8.3% in February 2012. Barring some major tax break we've missed, the only way these numbers balance out is if the new jobs created produce less income to tax, because they're lower paying, OR, if the unemployment numbers are wrong. The bulls won't dwell on these details, but they cannot be ignored.

Having been heralded around the world for solving Europe's crisis, ECB head Mario Draghi confidently states (as does every other central banker in the world) that "should the inflation outlook worsen, we would immediately take preventive steps". However, a recent analysis by Tornell and Westermann at VOX suggests the ECB has hit its limit with regard to its anti-inflationary fighting measures. The ECB appears to have lost control over standard measures of tightening: short-term interest rates (since short-term lending to banks has dropped to practically zero), increase in minimum reserve requirements (practically impossible withouit crushing the banks that they have propped up due to the sharp asymmetries - the recent cut from 2% to 1% minimum reserves saw a remarkable EUR104bn drop), and finally asset sales (the quantity of 'sensitive' or encumbered assets on the ECB's books has reached such a scale - due to LTRO, SMP, and ELA programs - leaving the 'sellable' non-sensitive assets at a level below excess deposits for the first time in ECB history). As the authors note, while this does not immediately produce an inflation flare, the lack of maneuvering space will induce an inflationary bias to ECB monetary policy as Draghi will find it increasingly expensive  at the margin to hit the anti-inflationary brakes. "This bias puts the Eurozone at risk of de-anchoring long-run inflationary expectations. The danger is not inflation today, but the de-anchoring of expectations about future inflation." As we have noted many times before, the ECB (and for that matter most central banks in the world) need Goldilocks.