According to “Economics 101”, quantitative easing, on the heroic scale we have witnessed thus far, should already have led to rampant if not hyper inflation. That it hasn’t is down to the continuing decline in the velocity of circulation of money. In simple terms the banks aren’t lending (compared with the amount of money available to them), but instead are punting on financial assets, which is where “inflation” is ending up and benefitting their balance sheets. Markets generally front run the economy, but if, as many folk believe, including our commentator above, that quantitative easing has been a failure from the start, then why are equity markets indicating an upturn in economic activity? At the end of the day, if the central banks continue to believe they have no other option than money printing and you can put up with the volatility, it’s all aboard the equity train. Bond yields won’t rise much either; if at all. The gold price should give some indication of whether this strategy is working or not, but that is a market that is far easier to rig than sovereign debt – the Germans seem to think so as they contemplate repatriating some of their bullion held by other central banks.
“Here we go again”
Demand for gold is likely to rise as the world heads towards a multi-currency reserve system under the impact of uncertainty about the stability of the dollar and the euro, the main official assets held by central banks and sovereign funds. This is the conclusion of a wide-ranging analysis of the world monetary system by Official Monetary and Financial Institutions Forum, (OMFIF), the global monetary think-tank, in a report commissioned by the World Gold Council, the gold industry’s market development body. The report warns of “twin shocks” to the dollar and the euro and of a “coming dollar shock” and points out how gold would be a safe haven in a dollar crisis. “Gold has a lot going for it; it correlates negatively with the greenback, and no other reserve asset seems safe from the coming dollar shock.” “The world is preparing for possible twin shocks from the parlous. position of the two main reserve currencies, the dollar and the euro... The OMFIF offers a confidential, convenient and discreet forum to a unique membership of central banks, sovereign funds, financial policy-makers and market participants who interact with them. They note that “western economies have attempted to dismantle gold's monetary role. This has failed.”
The newly elected Japanese Prime Minister, Shinz? Abe, has caused quite a stir. The leader of the Liberal Democratic Party, which scored a landslide victory in 2012’s election, he’s promised to restart the Japanese economy, whatever it takes. How will he do this? By “bold monetary policy”, what he means—and what he has said—is to end the independence of the Bank of Japan, and have the government dictate monetary policy directly. The perception is, the Bank of Japan will not only print yens and buy government bonds à la Quantitative Easing of old - it is also generally thought that Mr. Abe and the incoming Japanese government fully intend to target the yen against foreign currencies, like Switzerland has been doing with the euro. This perception is what has been driving the Nikkei 225 index higher, and driven the yen lower. But why was this decision triggered?
In this piece, I re-examine what many economists call "financial repression" and I find it to be sorely lacking as a description of what is happening. I also look at a related concern about the loss of central bank independence. Color me skeptical.
Sometimes the writing on the wall seems painfully obvious. But occasionally it's a good idea to step back and look at the big picture:
In one sentence, during 2013, we expect imbalances to grow. These imbalances are the US fiscal and trade deficits, the fiscal deficits of the members of the European Monetary Union (EMU) and the unemployment rate of the EMU thanks to a stronger Euro. By now, it should be clear that the rally in equities is not the reflection of upcoming economic growth. Paraphrasing Shakespeare, economic growth "should be made of sterner stuff". Many analysts rightly focus on the political fragility of the framework. The uncertainty over the US debt ceiling negotiations and the fact that prices today do not reflect anything else but the probability of a bid or lack thereof by a central bank makes politics relevant. Should the European Central Bank finally engage in Open Monetary Transactions, the importance of politics would be fully visible. However, unemployment is 'the' fundamental underlying factor in this story and we do not think it will fall. In the long term, financial repression, including zero-interest rate policies, simply hurts investment demand and productivity.
The Real Interest Rate Risk: Annual US Debt Creation Now Amounts To 25% Of GDP Compared To 8.7% Pre-CrisisSubmitted by Tyler Durden on 01/13/2013 18:32 -0400
By now most are aware of the various metrics exposing the unsustainability of US debt (which at 103% of GDP, it is well above the Reinhart-Rogoff "viability" threshold of 80%; and where a return to just 5% in blended interest means total debt/GDP would double in under a decade all else equal simply thanks to the "magic" of compounding), although there is one that captures perhaps best of all the sad predicament the US self-funding state (where debt is used to fund nearly half of total US spending) finds itself in. It comes from Zhang Monan, researcher at the China Macroeconomic Research Platform: "The US government is now trying to repay old debt by borrowing more; in 2010, average annual debt creation (including debt refinance) moved above $4 trillion, or almost one-quarter of GDP, compared to the pre-crisis average of 8.7% of GDP."
PIMCO founder and co chief investment officer Bill Gross gives no credence to the trillion dollar platinum coin scheme. "We feel that such an action would not only jeopardise the U.S. Fed and Treasury standing with Congress but with creditor nations internationally - particularly the Russians and Chinese." It appears to be a bit of a stunt by and may be a convenient distraction away from the substantive issue of how the U.S. manages to address its massive budget deficits, national debt and unfunded liabilities of between $50 trillion and $100 trillion. It may also be designed to create the false impression that there are easy solutions to the intractable US debt crisis - thereby lulling investors and savers into a false sense of security ... again. Gross said that subject to the debt ceiling, the Fed is buying everything that Treasury can issue. He warns that we have this "conglomeration of monetary and fiscal policy" as not just the US is doing this but Japan and the Eurozone is doing this also. Gross has recently criticised the Fed's 'government financing scheme.' He has in recent months been warning of the medium term risk of inflation due to money creation and recently warned of 'inflationary dragons.'
With the decision of the Federal Reserve to continue its policy of asset purchases (QE) as long as US employment remains depressed, we can say that inflation targeting as a tool of monetary policy, introduced in the early 80s under Paul Volcker, has finally been buried. Central banks are now moving towards a policy of targeting asset prices and other economic variables, primarily nominal GDP (or jobs per se). The consequences of this monetarist revolution on asset price formation are difficult to assess. However, we cannot overemphasise the potential disruption to the correlation and volatility regimes to which investors have become accustomed. In such conditions, proven investment strategies may prove obsolete. More than ever, investors will need to be able to challenge and fight against preconceived ideas. Lastly, and fundamentally, it is to be hoped that the policy of quantitative easing (QE) does not last too long, because, ultimately, it could lead to a massive distortion in the allocation of capital. However, as the charts below illustrate, every decade has been characterised by a different economic, monetary/fiscal policy, and investing environment and the limitations of Keynesian policy have been betrayed.
New Prime Minister Shinzo Abe’s pledge to spur inflation to 2 percent at the end of the yen’s appreciation means Japanese pension funds now have to hedge against rising prices and a currency decline after two decades of stagnation. Japanese pension funds are set to diversify some of their massive holdings, worth nearly $3.4 trillion into gold bullion. Corporate pension funds in Japan will diversify 72 trillion yen in assets after domestic stocks produced little return in the past two decades, according to Daiwa Institute of Research. “Bullion’s role as an inflation hedge, long ignored by Japanese fund operators, has come under the spotlight thanks to Abe’s economic policy,” Toshima, who now works as an adviser to pension-fund operators, said in an interview today in Tokyo. “Gold may be a standard asset-class in the portfolio of Japanese pension funds as Abe’s target is realized.”
Rather than attempt to predict the unpredictable – that is, specific events and price levels – let’s look instead for key dynamics that will play out over the next two to three years. Though the specific timelines of crises are inherently unpredictable, it is still useful to understand the eventual consequences of influential trends. In other words: policies that appear to have been successful for the past four years may continue to appear successful for a year or two longer. But that very success comes at a steep, and as yet unpaid, price in suppressed systemic risk, cost, and consequence.
Gold dropped $8.20 or 0.49% in New York on Friday and closed at $1,656.30/oz. Silver slipped to as low as $29.22 in London, but it then rallied to as high as $30.25 in New York and finished with a gain of 0.2%. Gold finished down 0.05% for the week, while silver was up 0.53%.
Friday’s U.S. nonfarm payrolls for December were 155K, 150K was expected and this was down from the previous data of 161K. The unemployment rate was still an elevated 7.8% suggesting a frail U.S. jobs market.
They say "be careful what you wish for", and they are right. Because, in the neverending story of the American "recovery" which, sadly, never comes (although in its place we keep getting now semiannual iterations of Quantitative Easing), the one recurring theme we hear over and over and over is to wait for the great rotation out of bonds and into stocks. Well, fine. Let it come. The question is what then and what happens to the US economy when rates do, finally and so overdue (for all those sellside analysts and media who have been a broken record on the topic for the past 3 years), go up. To answer just that question, which in a country that is currently at 103% debt/GDP and which will be at 109% by the end of 2013, we have decided to ignore the CBO's farcical models and come up with our own... To answer just that question, which in a country that is currently at 103% debt/GDP and which will be at 109% by the end of 2013, we have decided to ignore the CBO's farcical models and come up with our own. The bottom line: going from just 2% to 3% interest, will result in total 2022 debt rising from $31.4 trillion to $34.1 trillion; while jumping from 2% to just the long term historical average of 5%, would push total 2022 debt to increase by a whopping $9 trillion over the 2% interest rate base case to over $40 trillion in total debt!
In money management long term success lies not in garnering short term returns but avoiding the pitfalls that lead to large losses of invested capital. While it is not popular in the media to point out the headwinds that face investors in the months ahead - it is also naive to only focus on the positives. While it is true that markets rise more often than not, unfortunately, it is when markets don't that investors are critically set back from their long term goals. It is not just the loss of capital that is devastating to the compounding effect of returns but, more importantly, it is the loss of "time" which is truly limited and never recoverable. Therefore, as we look forward into 2013, we want to review three reasons to be bullish about investing in the months to come but also review three risks that could derail the markets along the way. The reality is that no one knows for sure where the markets will end this year; and while it is true that "bull markets are more fun than bear markets" the damage to investment portfolios by not managing the risks can be catastrophic.