Matt King's Fascinating Explanation Of How Central Banks Got It All Wrong

Tyler Durden's picture

Over the weekend, we posted Matt King's latest must read report, which showed "seven signs of a deeply dysfunctional market", and in which the Citi head credit strategist joined Paul Singer's warning, cautioning about "surprising, sudden, intense" tail risks, driven by failed central bank policies:

Most doctors – and even patients – know that when a course of drugs seems not to be working, you don’t simply keep on doubling the dosage. This applies particularly when the patient, if no longer as sprightly as they used to be, is nevertheless doing more or less fine. The side effects of such a course are more likely to kill than to cure. Yet this is what central banks now seem intent on doing. They have too much invested in their models to consider changing them in our view.

 

And yet the more stretched all these relationships become, and the more extreme the central banks’ policies, the greater is the tail risk, and the more nervous we become about investing in line with these forecasts. It’s not just the risk of Bill Gross’ “sputtering engine”; it’s the risk that Paul Singer is right, and that the end of the current environment proves “surprising, sudden, intense, and large.

So how did central banks manage to not only break the markets, but in the process fail to propel the economy, and inflation, higher?

Matt King gave the answer this morning in a follow up, terrific in its simplicity, presentation titled "Saturation point - or sweet spot", which explains so well how virtually everything went wrong during the period of financial repression, that even the central bankers - those responsible for the current state of the world - will get it. More importantly, it also gives a glimpse of what comes next. 

He starts by noting that even as central banks continue to offer free money, policymakers have a problem: nominal growth has remained painfully weak.

 

King then pivots, showing that declining growth should not be a surprise as a result of declining employment and productivity growth.

 

What is surprising, King asserts, is that nobody noticed the troubling trends earlier. The reason for this, perhaps, is that the obvious decline was masked by rising credit growth.

 

And while previously expansionary credit strategy would have been inflationary, something the central banks desperately need, this time subdued inflation allowed central banks to pursue the same policies for longer.

 

The reason why the underlying demographic, employment and economic trends are now becoming apparent is that credit growth is finally starting to fade: as King puts it "rock bottom yields have done little to stimulate loan demand."

 

King then shifts to what is the biggest flaw in central bank thinking over the cycle: namely that rate cuts never actually stimulated borrowing, as can be seen by the record drop in debt yields.

 

Lack of debt demand is not to be found in its cost as interest coverage metrics have "seldom looked better."

 

The Citi strategist looks at corporates for the answer why there has been no pick up productive borrowing and believes it can be found in the already substantial excess capacity.

 

Aging households, on the other hand, are not borrowing because they have to save even more for retirement: saving in the form of equity, not debt.

 

Which is not to say there is no borrowing: there is, and at the corporate level, it has rarely been higher, however, the issue - as we have said for years - is the use of proceeds: most of these have not gone into the real economy.

 

Instead, the new debt has been stuck in capital markets, propping up asset prices.

 

But even this process may have hit its limits, as the effect are "becoming uneven"

 

This brings us back to square one: why is growth starting to stagnate? The answer, as we have shown before in the case of China, is that the credit impulse from new credit creation - which until recently pushed global GDP ever higher, is now fading.

 

It's not just GDP that is set to suffer, however: so are asset prices, as "a weaker impulse means lower asset prices returns."

 

Which takes us to the key question: what happens at turning points. As King says, reducing borrowing exerts a negative impulse; debt/GDP may initially continue to rise; then once borrowing stops falling, deleveraging becomes much easier. That said, "Going on a diet is much harder than sticking to it." In other words, it's not the deleveraging that is difficult, it is the reduced borrowing which results in a negative credit impulse.

 

Now in a normal world, this would be the end of the leverage cycle - since debt is at near record highs across the globe: "we don't need more credit" as the world has already turned the corner.

 

This brings us to the punchline, because while the market is ready for a debt purge, "that's not how central banks see things." Instead, they remain dangerously obsessed with “potential.” To which King has a question: what do readers prefer: Growth = potential + debt crisis; or Growth < potential + deleveraging.

The conclusion follows: as central banks refuse to let the system delever, and instead as they "double up", expect the distortions to get bigger still.

 

Meanwhile, the S&P may and likely will continue to hit all time highs, propelled higher by even more misallocated debt (and outright central bank buying as the BOJ and SNB admit) giving the impression that all is well, when in reality the system continues to edge ever closer to the perilous edge, until one day it careens over with central banks powerless to offset the crash.

Which is why the head of credit strategy at Citi beckons central banks: "think not of potential, but of sustainability"

We doubt any central banker will listen.

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Ignatius's picture

"How central banks got it wrong."  ??!

They are a fucking criminal racket.  That's how they "got it wrong."

"Debt free money is the civil rights issue of the 21st Century."

THE SOLUTION IS DEBT FREE MONEY CREATION's picture

CORRECT. CREATE CURRENCY DEBT FREE!!!

END OVER 5000 YEARS OF DEBT SLAVERY TO USURIOUS ****

(((THIS COMMENT HAS BEEN CENSORED FOR THOUGHT CRIME AND THE COMMENTER LIQUIDATED)))

Mister Ponzi's picture

The relationship between monetary aggregates and inflation has changed in the 80s - but probably because the way inflation is measured changed dramatically.

nibiru's picture

The trend is clear.

Divorce from gold. Create Petrodollar. Inflate currency. Continue doing that. It works for decades so it is Perpetuum mobile! Continue printing till the kingdom come.

 

Or at least until deflationary forces are going to crush everything

http://independenttrader.org/how-big-is-the-inflation-rate-today.html

Peacefulwarrior's picture

And while we were watchin sports, chasin girls, goin to concerts, starting companies, having families... we let Psychopathic Academic's rise to run the Planet.

Madcow's picture

nevermind the fact that "central banking" and fiat money is a criminal fraud in the first place. 

RaceToTheBottom's picture

Geeze, do you think it might be associated with going completely off the gold standard?

lasvegaspersona's picture

Dear Matt:

Central banks have very little they can do... Either watch the economy crumble or act. They chose to act.

Neither changes the destination but it looks better to be trying and yes...it helps your friends too.

This economy cannot be saved. The dollar cannot be saved. I don't see how you cannot see this. Do you do math?

Everyone complains about the course the Fed has taken but no professionals at your level will speak the ugly truth.

I guess I don't blame you. People hate the truth when it is what we have here now.

Peacefulwarrior's picture

SO, it seems I read this 8 years ago! Did Matt King just visit the Burning Bush on Mt. Horeb/Sinai??

RaceToTheBottom's picture

"Going on a diet is much harder than sticking to it."

????????????

That is just a stupid example unless you are talking about Trump saying that he wants to reinstate Glass-Steagal or back the us Dollar with gold.  

Words are simple, sustained actions are hard....


 

KickIce's picture

Here we go again, another article that thinks that Central Banks are really our friends, that they’re really trying to help us but are just going about it in the wrong way, and as an added bonus we get more charts.   Well, hate to tell you, but these charts don’t mean a damn thing because tptb own everything and therefore this market will do exactly what they want to until it doesn’t.  IOW, they are going to be wrong once, and  it’s hard to bet against someone that is wrong only once.  Now, when the time comes that they are wrong it will be catastrophic and the only thing that will matter is your family and your preparation.

SheepDog-One's picture

Right, we're really supposed to believe the Central Banksters are our friends, working very hard to benefit us, but unfortunately they're just bumbling stumbling but lovable lugs who 'just can't seem to get it right'....uh huh sure.

KickIce's picture

It's my biggest pet peeve on ZH that we still get these type of posts, anything that gives these criminals any benefit of doubt as to what they really are is infuriating.  These people have been doing this for centuries, they know exactly what they are doing and they enjoy our misery.

Honest Sam's picture

I will not read anything by anyone who does not know, understand and analyzes accordingly the FED's actions. 

The FED NEVER  "gets it wrong'!

Don't you Mr.King think that you should be literate on the real function of this rogue agency, which refuses to disclose its books, and is not, so far obligated to do so, that purports to be one thing but instead is altogether quite another??

Until you grasp the real function of the FED and who its shadow ruling body is, quit making a hyped headline to attract eyeballs.

Most here understand completely that the FED exists to continually enrich a very select fraction of the 1%. Their moves are not as stated in their charter. That's just a poor smoke screen to fool the naive, the ignorant, and those who refuse to dig into the maneuvers of how it also runs the Treasury department.

 

 

Edward Morbius's picture

+10,000

 

The FED knows exactly what it is doing, and it ain't in Main Street's interest.

carbonmutant's picture

The FED decided to feed the whales instead of the Krill.

Now they have an overpopulation of whales and a shortage of Krill...

PS. The worker/consumer is the one at the bottom of the food chain.

FranSix's picture

um. buy volatility.....?

SheepDog-One's picture

This assumes Central Banksters work to benefit Main St, which is just ignorant. They got 'it' just right actually because at the end of the day the Central Banksters will own everything.

Diplodicus Rex's picture

Ahh, yes. Growth. Good old reliable growth. The problem is always "we tried this and never got growth". Well here's Dr Albert Bartlett to explain why you can't have perpetual exponential growth:

https://www.youtube.com/watch?v=u5iFESMAU58

"The greatest shortcoming of the human race is the inability to understand the exponential function" - Dr Albert Bartlett

Furthermore, printing the principal of any loan out of thin air is initially inflationary. However, paying back Principal+Interest when the Interest was never printed is highly deflationary. The fraudsters have no option other than to print new currency out of thin air in ever-increasing amounts. It's baked into the fractional reserve, fiat cake.

Vin's picture

Oh please, nobody "got it wrong". They got it exactly the way they want it.

They've had 100 years to plunder America and now they're going to destroy what's left of our currency in order to create their globalist world of slaves.

Stop the stupidity and stay focused on reality.

eekastar's picture

Central banking these days does absolutely nothing for the real economy where real people live.

I'm sorry to say.

QE, free money for corporations simply supports to the accumulation of wealth

RedDwarf's picture

I'll simplify things.  Debt based money is a Ponzi scheme.  Ponzi schemes always eventually fail.

flyweight's picture

But by the time the scheme is discovered, the initial fraudster might have already spent his money, perhaps getting maximum use out of it.

Fed-up with being Sick and Tired's picture

We are talking context here. The FED has been doing this for decades (forever and a day) and we are focusing upon a mere 7-8 years. It worked for all that time, so why change things. [I am not saying I agree but it may be the reason we see sustained QE - - hidden in the form of asset support - - and zero then to neg rates.

Manipulism's picture

The King of chartporn.

Batman11's picture

The productivity paradox:

1) CEO's receive productivity bonuses
2) Productivity doesn't rise

 

Batman11's picture

We wanted Central Banks to be able to control the world, but there is only one tool in the tool box, monetary policy.

Luckily it has two controls:

1) QE

2) Interest rates

This doesn't leave many combinations.

They have just noticed the interest rate dial goes negative and when you've already reached zero what else is there in the Central Banker's tool box?

Forward guidance   ......  we might do this in the future (new settings on the two dials) or we might not.

Great!

Batman11's picture

Now who would come up with a silly idea like this in the first place?   

“Let me issue and control a nation’s money and I care not who writes the laws.” Mayer Amschel Rothschild (1744-1812), founder of the House of Rothschild.

bada boom's picture

Just shut and take your medicine.  Dr. Yellen says its helping.

Batman11's picture

Central Bankers are still attributing 2008 to a “black swan” event.

Let’s find some real experts.

Twelve people were officially recognised by Bezemer in 2009 as having seen 2008 coming, announcing it publicly beforehand and having good reasoning behind their predictions.

He identifies four common aspects of their work:

1) Concern with financial assets as distinct from real-sector assets

2) With the credit flows that finance both forms of wealth

3) With the debt growth accompanying growth in financial wealth

4) With the accounting relation between the financial and real economy

In brief:

There is too much debt in the system and the repayments are sucking money out of the economy preventing normal growth.

Central Bankers still haven't figured out 2008 yet, don't waste your time listening to their convoluted rambling.

In 2007 Ben Bernanke could see no problems ahead.

In 2005 Steve Keen could see the private debt bubble inflating.

Steve Keen is my sort of expert; he knows what he is doing.

Batman11's picture

The Central Banker’s “black swan” .....

“Minsky Moments”

1929 – US (margin lending into US stocks)
1989 – Japan (real estate)
2008 – US (real estate bubble leveraged up with derivatives for global contagion)
2010 – Ireland (real estate)
2012 – Spain (real estate)

2015 – China (margin lending into Chinese stocks)

Irving Fisher looked at the debt inflated asset bubble after the 1929 crash when ideas that markets reached stable equilibriums were beyond a joke.

Fisher developed a theory of economic crises called debt-deflation, which attributed the crises to the bursting of a credit bubble.

Hyman Minsky came up with “financial instability hypothesis” in 1974 and Steve Keen carries on with this work today.

Steve Keen saw the debt bubble inflating in 2005.

After the bubble bursts you enter balance sheet recessions that Japan knows all about after having been in one for 25 years since 1989.

They found out what to do:

You need fiscal stimulus, monetary stimulus doesn’t work and austerity makes them worse.

Low interest rates do help with the debt repayments, but don’t really encourage anyone to borrow, the majority just want to pay down the debt they have already.

Let Richard Koo, who went through Japan’s 25 year balance sheet recession, talk you through the world today:

https://www.youtube.com/watch?v=8YTyJzmiHGk

The smartest Central banker’s read his books.

The US didn’t impose austerity as Ben Bernanke and Janet Yellen had read Richard Koo’s book. It is fairing the best.

The ECB did impose austerity on the Club-Med nations and they are fairing badly.

The UK did impose austerity and is not doing that well.

The Troika imposed harsh austerity on Greece and killed it.

If anyone has the e-mail address of the BIS, forward it to them so they can understand their "black swan". 


dizzyfingers's picture

The BIS maintains no office, branch, or affiliate other than those listed below.

Location: Centralbahnplatz 2
4051 Basel
Switzerland   View map Postal Address: Postfach
CH-4002 Basel Telephone: (+41 61) 280 8080 Fax: (+41 61) 280 9100 and
(+41 61) 280 8100 SWIFT address: BISBCHBB Website: www.bis.org

http://www.bis.org/about/contact.htm

wobblie's picture

Let the shiny colorful charts do the bankersplaining.

Love ZH but why go to finance and vultures for information? They are largely responsible for this mess. Why not go to real economists like Richard Wolff, Michael Hudson or Steve Keen? Rentiers don't do economics, they do finance.

Lots of this is old news. Doesn't mention at the outset why there's less employment. Blames credit expansion on population decline. Why? Declining population should mean higher wages.

Off-shoring, labor arbitrage are not mentioned. But they are the reasons for less employment and lower wages also not mentioned in article.

If you don't know these things you will only repeat them, which is probably the goal. You can masturbate with charts all you want but it won't change the status quo.

https://therulingclassobserver.com/2016/08/19/the-individual-among-us-pa...

fightapathy's picture

There's no decline in population as yet, only a decline in the increase. Essentially there are still too many people for too few jobs.

hooligan2009's picture

exactly right about going to the thieves to explain the actions of Fagin.

we know that economic metrics are inferior and do not capture the "truth" of inflation, unemployment and growth.

how productive has Uber made the economy? or tweets or pokemon?

these are just as valid economoterics as the the drivel captured using the unevolved ancient economic measures that are "gamed" by the trained poodles working at banks (yes there is a green "envy" color here, these poodles get a few million a year for creating nothing of use to anyone).

tricorn teacup's picture

Surrounding the inflation rate chart I see 2 critical problems, at least if the objective is a strong real world economy:

- real world inflation rates are closer to 10%.  The official figures are garbage.

- central banks are targeting something like 2% inflation rate, above what the garbage official figures report, when the real world economy would fare better with a 0% inflation target.

Between those above errors, and contraction in economic production, real world inflation is being driven far in excess of what is healthy.

rejected's picture

"Most doctors – and even patients – know that when a course of drugs seems not to be working, you don’t simply keep on doubling the dosage."

Not true....

With cancer they'll start you out on a mild course of chemo / Radiation. If the cancer continues they'll go aggressive and usually end up killing the patient. Of course everyone is told the patient died fighting cancer.

The problem with the FED fighting the economic problems is that the FED itself is the cancer. The whole thing is a splendid show for the proletariat.

PrometeyBezkrilov's picture

When are these fuckers with charts are going to figure out that everything the central banks did was right. Their mandate was to leave everyone broke and poor and they succeeded. What part of "...they will wake up poor and homeless on the continent their fathers conquered" they do not get?

honestann's picture

was right ===>> was intentional.

But your point is very important.  Even the smartest authors are rarely "brave" enough to drop ALL BS and perform a fully honest analysis devoid of ALL fallacies.  Which is yet another reason humans are a failed species.

Even when hundreds if not thousands of attempts at fiat currencies have failed over the millennia, writers ignore that most relevant fact and perform mental gymnastics (which they call "analysis") based upon totally absurd (and known false) premises.  Have they not heard the cliche... garbage in, garbage out?

Well, yes they have.  However, they have been so extensively trained, and so extensively habituated to never perform analysis based upon [nothing but] fundamentals, that they simply don't.  I guess "it just doesn't feel right" to them.

I'm exactly the opposite.  I invest as much time, effort and resources as necessary to identify the fundamentals behind the issue or phenomenon at hand.  I know from experience what happens when the correct fundamentals are identified... the answer to virtually every question about the issue become instantly obvious and trivial to identify.  And as an aside, at least one zillion gigatons of linguistic nonsense that others claim is relevant become tangential, unimportant or entirely irrelevant.  Comprehension becomes simple when [the correct] fundamentals are identified.

steelhead23's picture

Comprehension becomes simple when [the correct] fundamentals are identified.

Pray tell.  From where I sit, it appears that the errors of following false premises can persist for a very long time - and that even if/when a severe crisis occurs and asset values plummet, the accumulators (think Warren Buffet) will remain well ahead of laborers and following the crisis will once again devalue labor to increase asset value.  There is not a God-like overlord who will smite the rich.  The perception that there is some kind of rational entity called the market is a myth.  I anticipate that the elite will continue to extract value from labor, and that the global financial system will aid and abet this theft until labor revolts - which I don't expect to see in this lifetime.  This is the new normal - get used to it.

honestann's picture

When the correct (actual) fundamentals are identified, no false premises are assumed.  That's one requirement for being correct (actual) fundamentals.

This appears to be your misunderstanding of my message, because you are absolutely correct that false premises can persist for a very, very, very long time.  I'll mention on just to show how correct you are.

The mental-unit identified with the term "authority" is inherently FICTION.  In other words, authority has never existed, does not exist today, will never exist in the future, and cannot ever exist.

However, virtually 100% of what is called "social" or "political" discussion simply presumes that "authority" exists, and in fact, is one of the most important and fundamental aspects of reality --- when in fact "authority" is NOT an aspect of reality any more than SantaClaus or ToothFairy or EasterBunny.  The mental-unit associated with these terms exists in the brains of human beings, but those mental-units do not refer to any real existent.  And that is what constitutes a fiction (a fictional mental-unit).

The rest of your post is accurate too.  Yes, I am used to it, but I am rather unusual in that I escaped it (for practical purposes).  Close to 5 years ago I "got the hell outta dodge", moved to the extreme boonies ~125km from the nearest human being, and built out my own private, self-sufficient digs.  I haven't had any interaction with any predator-that-be or anyone from government of any kind since then, and almost zero interactions with corporations either (though I do purchase a few items I enjoy but didn't want to produce myself... like butter).  And except when I need scientific or technological equipment or devices, I buy from individuals (not corporations).

One could reasonably argue that I'm not 100% disconnected from the new normal, and I would not argue that.  However, I could be in the sense that I don't buy anything that I need to survive, remain healthy or remain comfortable.  The point is, with enough effort (and savings), one can escape the "new normal", even if others participate in the new normal, and thereby suffer the consequences.  Too bad so few individuals have the self-confidence to extract themselves from the new normal.  Just say no.  SHRUG.

-----

Speaking of fundamentals, I'll repeat again in simple terms how I think about the state of mankind in fundamentals.

Life has existed on planet earth for a billion years (more or less).  For all that time, all animals were either predators or parasites.  They survived by sucking the life out of other organisms (much like plants sucked the non-life out of inorganic soil).  Somewhere around 100,000 ~ 250,000 years ago some humans learned a new type of behavior and became producers.  They took actions that created goods and goodies that would not otherwise have come to exist.  The goods and goodies they created supported their life, health, comfort and happiness.

THIS IS PRECISELY THE WORLD WE STILL LIVE IN TODAY.

And understanding the current situation in terms of these FUNDAMENTAL facts makes about 100-million pages of other text mostly beside the point (other than a lesson on how humans waste so much time, effort and brainpower on total nonsense, and still come up with totally insane and bogus conclusions).

Part of coming to the point where one can clearly identify and understand this fundamental fact is a recognition that a great many mental-units that are presumed to be valid and crucial ARE IN FACT FICTIONS.

"law" is fiction... does not exist.
"state" is fiction... does not exist.
"nation" is fiction... does not exist.
"official" is fiction... does not exist.
"authority" is fiction... does not exist.
"corporation" is fiction... does not exist.
"government" is fiction... does not exist.

They do not exist, and therefore ARE NOT PART OF ANY SANE UNDERSTANDING OF REALITY... other than to recognize how utterly, totally, completely and overwhelmingly insane virtually all humans are (and why they have totally wacko notions of the nature of reality, including human behavior and interaction).

Hope this helps.