From Russell Napier of Eric
The failure of the SNB, invisible cloth and a one-way ticket to Palookaville
Definition of ‘fix’ (Oxford English Dictionary):
(v) To fasten, make firm; to deprive of volatility or fluidity
(v) To adjust, make ready for use
(v) To mend, repair
(n) Any arrangement through which laws rules or regulations are
(n) A dose of a narcotic drug
The Swiss National Bank (SNB) failed to ‘fix’ the exchange rate between the Swiss Franc and the Euro. The simple lesson which investors must learn from this is --- central bankers cannot fix very much. The inability of the Swiss National Bank to ‘fix’ the exchange rate will come to be seen as the end of the bull market in the omnipotence of central bankers.
Think for just a moment of all the key variables which you believe are ‘fixed’ (made firm), fixed (repaired) , fixed (circumvention of the laws of supply and demand) or fixed (dosed with monetary narcotics) by central bankers. These various fixes by central bankers across the world can also fail. That process of failure began in Bern and Zurich early one morning on January 15th 2015.
As the OED entries for the word ‘fix’ make clear, the failure of the SNB to fix the exchange rate was on many levels. It failed to ‘ fix’ the exchange rate in terms of making the Swiss Franc ‘firm’ to the Euro and hence ‘deprive it of volatility or fluidity’. It failed to ‘fix’ the exchange rate as the ‘laws‘ of supply and demand were ultimately not circumvented.
For many, particularly Swiss exporters, the material appreciation of the Swiss Franc on the international exchanges will not ‘fix’ the currency in terms of making it ‘ready for use’. Finally, the adjustment in the exchange rate removes, rather than administers, the dose of monetary ‘narcotic’ in the form of excess growth in Swiss Franc liquidity and cheap funding for speculators in Euro. The monetary ‘fix’, which was the by-product of fixing the exchange rate, has ceased to be and the price of equities has collapsed.
Let us now list some of the other other things which investors believe that central bankers have fixed:
Central bank policy is creating liquidity.
Wrong --- the growth in broad money is slowing across the world.
Central bank policy is allowing a frictionless de-gearing.
Wrong --- debt to GDP levels of almost every country in the world are rising.
Central bank policy is creating inflation.
Wrong --- inflation in most jurisdictions is now back to, or below, the levels recorded in late 2009.
Central bank policy is fixing key exchange rates and securing growth.
Wrong --- in numerous jurisdictions, from Poland to China and beyond, this exchange rate intervention is slowing the growth in liquidity and thus the growth in the economy.
Central bank policy is keeping real interest rates low and stimulating demand.
Wrong --- the decline in inflation from peak levels in 2011 means that real rates of interest are rising. The growth in demand in most jurisdictions remains very sluggish by historical standards.
Central bank policy is driving up asset prices and creating a positive wealth impact which is bolstering consumption.
Wrong --- savings rates have not declined materially.
Central bank policy is creating greater financial stability.
Wrong --- whatever positives impact central banks are having on bank capital etc they have failed to prevent the biggest emerging market debt boom in history. That boom is particularly dangerous because either the borrower or lender is taking huge foreign exchange risks and because a large proportion of that debt has been provided by open-ended bond funds which can be subject to runs.
The above is a list of some of the very important things that central banks have very clearly failed to fix since the bull market in central bank omnipotence began in 2009. Investors, enriched by the central banks’ attempts to fix things, find themselves victims of the same self-delusion which afflicted the ‘honest old minister’-
So the honest old minister went to the room where the two swindlers sat working away at their empty looms.
"Heaven help me," he thought as his eyes flew wide open, "I can't see anything at all". But he did not say so.
Both the swindlers begged him to be so kind as to come near to approve the excellent pattern, the beautiful colors. They pointed to the empty looms, and the poor old minister stared as hard as he dared. He couldn't see anything, because there was nothing to see. "Heaven have mercy," he thought. "Can it be that I'm a fool? I'd have never guessed it, and not a soul must know. Am I unfit to be the minister? It would never do to let on that I can't see the cloth."
"Don't hesitate to tell us what you think of it," said one of the weavers.
"Oh, it's beautiful -it's enchanting." The old minister peered through his spectacles. "Such a pattern, what colours!" I'll be sure to tell the Emperor how delighted I am with it."
The Emperor’s New Clothes (Hans Christian Andersen)
Nobody today is extolling the wonderful patterns and colours of the SNB’s fixing policy. So, if you see the failure of the SNB as the signal that the bull market in central bank omnipotence has peaked, where should you be looking for other failures to fix to become visible? This is a long list but some obvious places to start are:
Poland and the Czech Republic
The ‘fix’ to the Euro has created huge foreign currency borrowing, some in Swiss Francs, which is increasingly difficult to service in two economies already subject to deflation. Devaluation would bring bankruptcy so weathering deflation and sharply higher real rates of interest is now the consequence of the central bank ‘ fix’. Equities in general and highly geared equities in particular (banks) will not fare well in such an environment.
The ‘fix’ of the exchange rate at a time of a deterioration in the external accounts brings tighter monetary policy to China as it needs monetary easing. Here foreign currency debt to GDP levels are low enough to allow the central bank to walk away from the exchange rate ‘fix’ and de-value.
How can the Fed fix the key global problem of collapsing global US$ liquidity as manifested by an ever rising US$? QE failed to depreciate the US$ and no other policy responses to its rise and rise over the past six months have been mooted. Perhaps, in extremis, swap lines and the extension of the Fed’s balance sheet to buy government securities denominated in foreign currencies might be possible. However, that particular ‘fix’ will remain politically toxic until the impact of the global slowing is felt much more strongly within the US. Until things get significantly worse, the rise in the US$ cannot be fixed.
The above is a short list of central bank ‘fixes’ which are already failing. Investors need to react to these failures today because there are more to come. However, the greatest failure of all will be the realization that with nominal rates close to zero the inability of the central banks to generate inflation means they are powerless to prevent a steep rise in real rates of interest for the first time since the nineteen thirties. The consensus continues to argue that the rise in real rates of interest is irrelevant, as it is more than offset by a ‘tax cut’ for consumers driven primarily be lower oil prices. Perhaps.
But, then again, perhaps not. As US inflation falls to its lowest level since 1961, apart from the lower level seen in the GFC, let us remember why Ben Bernanke thought that deflation was best avoided:
‘Deflation is in almost all cases a side-effect of a collapse of aggregate demand, a drop in spending so severe that producers must cut prices on an on-going basis in order to find buyers. Likewise, the economic effects of a deflationary episode, for the most part, are similar to those of any other sharp decline in aggregate spending: namely, recession, rising unemployment, and financial stress.’
November 21st 2002, before the National Economists’ Club, Washington D.C.
In that speech Bernanke makes it clear that the central bank must ‘fix’ inflation within the safety buffer of 1% to 3% to prevent dramatic rises in real rates of interest. QE has failed to do this as inflation reached 0.8% in 4Q 2014. The TIPS market now expects prices to be lower one year out than they are today. (Inflation-linked government debt markets are pricing in deflation in Italy, Germany and the US). The current failure to ‘fix’ inflation is a failure to control real rates of interest, with the dire economic consequences Bernanke outlined in November 2002.
So, if central bankers cannot use their weapons of market distortion to ‘fix’ things, do policy makers abandon intervention and allow the laws of supply and demand to prevail? Of course they don’t. They simply move on from using central bank powers of market distortion to legislative/regulatory powers of distortion. Like the money-men manipulating second-rate prize fighters, the owners of capital have been the key beneficiaries since the ‘fix’ came in from central bankers in 2009 to try to defeat deflation. History, however, is very clear that the owners of capital will not be the beneficiaries when the ‘fix’ is in from government.
The failure of the SNB to ‘fix’ their exchange rate will be seen as the watershed when we moved from one type of ‘fix’ to another. And being on the wrong side of any fix means, if you need reminding, you don’t get to go where you always wanted to be when you started off and you never come back from where you end up.
‘Remember that night in the Garden? You came down to my dressing room and you said, "Kid, this ain't your night. We're going for the price on Wilson." You remember that? "This ain't your night!" My night! I coulda taken Wilson apart! So what happens? He gets the title shot outdoors on the ballpark and what do I get? A one-way ticket to Palookaville! ‘
Marlon Brando as Terry in On The Waterfront (Budd Schulberg)