A quiet week to send off August ahead of a deluge of key data next week and as the fateful Septembr 18 FOMC announcement approaches. Still, quite a few macro events to keep track of.
Recently, Fox News interviewed a self-described beach bum named Jason Greenslate who was very open about the fact that he has no problem sponging off of all the rest of us. When he was asked if he ever had any interest in actually getting a job, his response was "not whatsoever". Instead, he says that his job is to "make sure the sun's up and the girls are out" and he would rather spend his days partying. Of course every American should be free to live their own lives as they see fit, but the problem is that Jason Greenslate is using food stamps to help support his lifestyle. Of course the vast majority of those enrolled in the food stamp program are not like this. But there are also those such as Jason Greenslate that are openly abusing the system and making it more difficult for those that actually need the help to get it. Sadly, he is a product of the system that he was raised in.
“For my own part I did not see and did not appreciate what the risks were with securitization, the credit ratings agencies, the shadow banking system, the S.I.V.’s — I didn’t see any of that coming until it happened.” - Janet Yellen, 2010
Next month promises to be more volatile than this month. Consensus views are unlikely to be challenged by the data in the week ahead.
- JPMorgan Nears Settlement With SEC on London Whale Loss (BBG)
- Without even a wristslap: Iksil to face no U.S. charges in 'Whale' probe (Reuters)
- China’s Credit Expansion Slows as Li Curbs Shadow Banking (BBG)
- China slowdown shows signs of abating (FT), even as...
- Australia central bank Lowers Growth Outlook as Economy Transitions From Mining (BBG)
- SAC Business Plan Goes to Judge, Plan Would Allow Firm to Maintain Business Operations but Restrict Its Ability to Move Assets (WSJ)
- Another buyer of Herbalife? - Norway’s oil fund plans to turn active (FT)
- Mark Carney plays down scepticism over interest rate policy (FT)
- Orders Evaporate for Celebrity Perfumes (WSJ)
For many years, we have been extremely focused on shadow banking and most specifically the repo markets (recently here and here). Most market participants will go through their trading life ignorant of the fact that the leverage in this market is what drives their assets up or down in most cases (because understanding something new is so 'old normal' even if it remains a major potential catalyst for problems ahead). The regulators get it though (kinda). As Barclays notes, changes to the risk-weightings of low-risk assets in the repo markets means US banks will need to deleverage by raising $30bn of fresh capital or reducing their (mostly low-risk) assets by $598bn - not chump change in a market dominated by the Fed (and one that some have already raised default and liquidity concerns about).
The rapid pace of China credit expansion since the Global Financial Crisis, increasingly sourced from the inherently more risky and less transparent "shadow banking" sector, has become a critical concern for the global markets. From the end of 2008 until the end of 2013, Chinese banking sector assets will have increased about $14 trillion. As Fitch notes, that's the size of the entire US commercial banking sector. So in a span of five years China will have replicated the whole US banking system. What we're seeing in China is one of the largest monetary stimuli on record. People are focused on QE in the US, but given the scale of credit growth in China Fitch believes that any cutback could be just as significant as US tapering, if not more. Goldman adds that China stands to lose up to a stunning RMB 18.6trn/$US 3trn. should this bubble pop. That seems like a big enough number to warrant digging deeper...
First it was the TBAC's May presentation "Availability of High Quality Collateral" piggybacking on reasoning presented previously by Credit Suisse. Then JPM's resident "flow and liquidity" expert Nikolaos Panigirtzoglou rang the bell on regulatory changes to shadow banking and how they would impact the repo market and collateral availability (and transformation) in an adverse fashion. Now, it is the turn of Barclays' own repo chief Joseph Abate to highlight a topic we have discussed since 2009: the ongoing contraction in quality collateral as a result of transformations in shadow banking and the Fed's extraction of quality collateral from traditional liquidity conduits (i.e., QE's monetization of bonds). To wit: "Several recent regulatory proposals will increase the pressure on banks to reduce assets that carry low risk weights. Repurchase agreements are a large source of banks’ low-risk assets, and we expect banks to reduce their matched book operations in response to these proposals."
A discussion of this week's key events and data within the context of the investment climate characterized by shifting Fed tapering expectations, evidence still pointing to a soft landing of the Chinese economy, a cyclical recovery in Europe and renewed capital outflows from Japan, while foreign investors slow their purchases of Japanese equities.
The Institute of International Finance (IIF) has released data that shows that the credit crunch in China is hitting harder than was thought at first and is secondly at the worst level since the global financial crisis landed on everyone’s plate.
China is preparing to admit that the level of problem Local Government Financing Vehicle debt is double the 10.7 trillion yuan first reported just two years ago, something many suspected but few dared to voice in the open. But not only that: since the likely level of Non-Performing Loans (i.e., bad debt) within the LGFV universe has long been suspected to be in 30% range, a doubling of the official figure will also mean a doubling of the bad debt notional up to a stunning and nosebleeding-inducing $1 trillion, or roughly 15% of China's goal-seeked GDP! We wish the local banks the best of luck as they scramble to find the hundreds of billions in capital to fill what is about to emerge as the biggest non-Lehman solvency hole in financial history (without the benefit of a Federal Reserve bailout that is).
Following up on yesterday's essay comparing Walter Bagehot to a modern-day shadow banker, we have received numerous requests for more information on this fundamentally critical financial topic. So without further ado, we present a full and unabridged map of the modern shadow banking system.
"At all times, ultimate collateral and ultimate money remain crucial reference points in modern financial markets, but the actual instruments are important only in times of crisis when promises to pay are cashed rather than offset with other promises to pay.... Our world is organized as a network of promises to buy in the event that someone else doesn’t buy. The key reason is that in today’s world so many promised payments lie in the distant future, or in another currency. As a consequence, mere guarantee of eventual par payment at maturity doesn’t do much good. On any given day, only a very small fraction of outstanding primary debt is coming due, and in a crisis the need for current cash can easily exceed it. In such a circumstance, the only way to get cash is to sell an asset, or to use the asset as collateral for borrowing."
Excessive monetary stimulus and low interest rates create financial bubbles. This is the biggest debt bubble in history. It is a potent deflationary force and central banks are forced into deploying increasingly aggressive (offsetting) inflationary forces. The avoidance of a typical deflationary resolution to this economic long (Kondratieff) wave is pushing the existing monetary system beyond the point of no return. The purchasing power of the developed world’s currencies will have to bear the brunt of the “adjustment”. Preparations for this by the BRICS nations, led by China, are advancing rapidly. The end game is an inflationary/currency crisis, dislocation across credit and derivative markets, and the transition to a new monetary system. A new “basket” currency is likely to replace the dollar as the world’s reserve currency. The “Inflationary Deflation” paradox refers to the coming rise in the price of almost everything in conventional money and simultaneous fall in terms of gold.
We've discussed Jiangsu before (dead pigs, TBTF Solar companies, and bird flu) but the Chinese province (that is big enough to be a Top 20 global economy with GDP greater than that of G-20 member Turkey and 79 million people) is on the brink of collapse under the weight of its own debt (cough Detroit cough). As China's leaders attempt to rein in over-capacity industries, tamp-down residential real-estate bubbles, and generally unwind "...the greatest misallocation of capital the world has ever seen, which was China’s 2009 stimulus," Jiangsu stands head-and-shoulders. With debt far higher than its peers, its mainstay industries (shipbuilding and solar panel manufacture) drowning in over-capacity, and massive 'empty' property developments now starved of funding, Jiangsu "can potentially pose a systemic and macro economic risk to the country."