Five years ago, when QE first started, we blasted the Fed's "Plan Z" systemic rescue "policy" - which was merely a tried and true dilutive fallback plan used by every collapsing monetary regime starting with the Romans - stating it does absolutely nothing to resolve the biggest underlying threat to the economy and the western way of life, namely the epic accumulation of debt (most of it bad), courtesy of a Fed which has now unleashed a perpetual "buyer of only resort" QE (as we predicted months before QEternity was revealed), which instead only redistributes wealth from the middle class to the wealthiest 0.01%, while providing scraps to the poorest to keep them occupied and away from very violent thoughts. Enter the FT, which in an Op-Ed today titled "QE has stigmatised the well-off" says that "despite it being entirely justified as a save-the-world policy in its first round, it is still at best an unfair and at worst an evil policy. Why? Because of the way in which it redistributes wealth" And now we lean back and await for even more of the incisive mainstream media to suddenly come up with this timely, non-conspiratorial observation.
A week ago, we first reported that Bridgewater's Ray Dalio had finally thrown in the towel on his latest iteration of hope in the "Beautiful deleveraging", and realizing that a 3% yield is enough to grind the US economy to a halt, moved from the pro-inflation camp (someone tell David Rosenberg) back to buying bonds (i.e., deflation). This was music to Bill Gross' ears who in his latest letter, in which he notes in addition to everything else that while the Fed has to taper eventually, it doesn't actually ever have to raise rates, and writes: "The objective, Dalio writes, is to achieve a “beautiful deleveraging,” which assumes minimal defaults and an eventual return of investors’ willingness to take risk again. The beautiful deleveraging of course takes place at the expense of private market savers via financially repressed interest rates, but what the heck. Beauty is in the eye of the beholder and if the Fed’s (and Dalio’s) objective is to grow normally again, then there is likely no more beautiful or deleveraging solution than one that is accomplished via abnormally low interest rates for a long, long time." How long one may ask? "the last time the U.S. economy was this highly levered (early 1940s) it took over 25 years of 10-year Treasury rates averaging 3% less than nominal GDP to accomplish a “beautiful deleveraging.” That would place the 10-year Treasury at close to 1% and the policy rate at 25 basis points until sometime around 2035!" In the early 1940s there was also a world war, but the bottom line is clear: lots and lots of central planning for a long time.
The situation in Italy appears to be going from bad to worse. With a confidence vote pending for Tuesday as the government dissolves into chaos for the umpteenth time, and following the resignation of the CEO of one of Italy's largest non-financial corporations (Telecom Italia), the largest bank (by assets) in Italy - Intesa SanPaolo has announced - effective immediately - the resignation of its CEO and replacement with Carlo Messina. According to sources, the now former CEO had lost the confidence of shareholders (which is odd given the bank's stock is near 2-year highs). We can't help but wonder Ayn Rand-like at the devolution of the ruling class in Italy and what happens next (in light of the crumbling manufacturing and production data).
This is at a time when we have real economic growth barely above 2% and nominal growth of just over 3% (abysmal by any standards) after six years of monetary easing and 5 years of QE1; QE 2; Operation twist; QE “infinity” and huge fiscal deficits. After last week Citi notes it is not clear that this set of policies is going to end anytime soon. It seems far more likely that these policies will be continued as far as the eye can see and even if there are “anecdotal” signs of inflation this Fed (Or the next one) is not a Volcker fed. This Fed does not see inflation as the evil but rather the solution. Gold should also do well as it did from 1977-1980 (while the Fed stays deliberately behind the curve). Unfortunately Citi fears that the backdrop will more closely resemble the late 1970’s/early 1980’s than the “Golden period” of 1995-2000 and that we will have a quite difficult backdrop to manage over the next 2-3 years.
Italy’s Stability Program targets a 5%-6% primary budget surplus, and 3% nominal GDP growth. Both strike JPMorgan's Michael Cembalest as unrealistic in the context of post-crisis Italy. Italy ran a 6% surplus for a brief moment in the 1990’s but it didn’t last, as it was the result of a prior devaluation helping growth, some asset sales and some tax increases. Only asset sales seem feasible in Italy right now, if anything. If Cembalest's concerns are correct, Italy will remain a country with almost twice the debt/GDP ratio as the US; unbreakable interdependency of the government, the banks, and the ECB; and low GDP and employment growth. If history is any guide, he will be right as the last few years have seen the biggest collapse in Italian GDP since The Unification in 1861...
As we warned two weeks ago in "Bernanke's Helicopter is Warming Up", it seems (from the Fed's once uberhawk and now superduperdove Kocherlakota's speech this morning) that the Fed is catching on as to what it needs to do. And what it has no choice but to do. Borrowing from the Europeans, Kocherlakota uttered those three special words: KOCHERLAKOTA SAYS FED MUST DO "WHATEVER IT TAKES" TO AID GROWTH.
Whether this also means that the fund is bearish on overall growth, bullish on deflation, and very bullish that in the Taper is not only off the table but there is potential for even more easing by the Fed, is unknown. What is known is that once the piggyback crew jumps on the Bridgewater bandwagon, which is now saying rates will drop (ostensibly leading to the end of the Great Rotation and perhaps the start of the Great Unrotation out of stocks and into bonds), expect to see some substantial price realignment between the two main assets classes: stocks and bonds.
The equity market’s reactions to monetary policy inflection points, when (or if) the Fed takes the first step to normalize monetary policy following easing in response to recession, have been reasonably similar. As Barclays' Barry Knapp notes, irrespective of the pace of policy accommodation removal – the average policy normalization-related correction during the prior six business cycles is 8.9%. While our memories of an extremely volatile September – five years ago – remain fresh, the last four have been exceptionally tame. However, while another period of fiscal uncertainty seems likely, Knapp fears there is a key difference between this September and the surprisingly low volatility Septembers in 2009-12. In those periods, the Fed was either buying assets or had pre-announced a new program; this year, it is preparing to weaken the portfolio balance effect.
Do you wonder what to make of America’s soaring government debt and what it means for the future? Or, if you already have it figured out, are you interested in research that might challenge your position? Either way, you might like to see the results of this exercise:
1... Take each historic instance of government borrowing rising above America’s current debt of 105% of GDP.
2... Eliminate those instances in which creditors received a lower return than originally promised, due to defaults, bond conversions, service moratoriums and/or debt cancellations.
3... Of the remaining instances, consider whether and how the debt-to-GDP ratio was reduced.
In other words, let’s see what history tells us about today’s debt levels and what comes next. You may find the answer surprising.
"A broad-based tax cut, for example, accommodated by a program of open-market purchases to alleviate any tendency for interest rates to increase, would almost certainly be an effective stimulant to consumption and hence to prices. Even if households decided not to increase consumption but instead re-balanced their portfolios by using their extra cash to acquire real and financial assets, the resulting increase in asset values would lower the cost of capital and improve the balance sheet positions of potential borrowers. A money-financed tax cut is essentially equivalent to Milton Friedman's famous "helicopter drop" of money ."
- Ben Bernanke, Deflation: Making Sure "It" Doesn't Happen Here, November 21, 2002
Even as the popular press if focused on the 5 year anniversary of Lehman, we decided to go back double that period, and take a look at what happened to the developed world economy in the past decade, starting with 2003. What we found was interesting.
For the right answer, we look to the past....
Moments ago the Treasury reported its deficit for the month of August, which was $148 billion, slightly less than the $150 billion expected. More importantly, it was over 22% less than the deficit from August 2012 when it was $191 billion. And that, in a nutshell, is the main reason why the Fed has no choice but to taper. What the chart below shows is the cumulative deficit of the US for fiscal 2012 and 2013. What becomes immediately obvious is that with the total deficit Year to Date of $755.3 billion running 35% below the $1,165 billion from a year ago, the Fed has far less room to monetize gross issuance.
With everyone focused on the 5th anniversary of the Lehman failure, we are taking a quick look at how the world's developed (G7) nations have fared since 2008, and just what the cost to restore "stability" has been. In a nutshell: the G7 have added around $18tn of consolidated debt to a record $140 trillion, relative to only $1tn of nominal GDP activity and nearly $5tn of G7 central bank balance sheet expansion (Fed+BoJ+BoE+ECB). In other words, over the past five years in the developed world, it took $18 dollars of debt (of which 28% was provided by central banks) to generate $1 of growth. For all talk of "deleveraging" G7 consolidated debt has been at a record high 440% for the past four years. So in the G7, which is a good proxy for the developed world, debt continues to increase whilst nominal growth remains extremely low thus ensuring that the deleveraging process has yet to start. As Deutsche Bank states, "at best we’re stabilising the ratio at or around record highs."
There's a growing view that America's energy boom will result in a higher U.S. dollar in coming years. There are some key holes in the argument though.