Money, Money, Everywhere

FX Concepts' John Taylor is out with today's slam dunk de-noisification of all that is irrelevant with the following summary of what is really going on as the world's central banks embark on the latest and hopefully final attempt to reliquify everything. All we can add to Taylor's analysis, especially in light of today's incremental easing in ECB collateral requirements, is that the biggest beneficiary by far of what in a few months will be another multi-trillion balance sheet expansion, is and continues to be hard, non-dilutable, i.e., real, money. Because as fiat currency loses all relevance in a world in which it is printed on a daily basis by the central banks, whether or not we end up with a Weimar scenario, the cash thrown out by the even profitable companies will be increasingly more meaningless. Yet the take home message is that banks will never, ever stop diluting existing money. They simply can't as the past few months have so vividly demonstrated.

From John Taylor of FX Concepts

Money, Money, Everywhere

My desk is littered with analysts’ charts showing the explosion of central bank assets over the past four years.  As interest rates have dropped to just above the infamous “zero bound” while the global banking system and the developed economies have threatened to collapse, the central banks have responded with new forms of monetary stimulus to keep the financial system alive and to push their economies toward growth.  The acronyms might be different for the methods used by the US Fed, ECB, Bank of England, Bank of Japan, and Swiss National Bank, but these various techniques have all served to expand the high-powered money available to their banking systems by at least a factor of three.  These five countries all have ratios of central bank assets to GDP over 18%, and in Switzerland it is over 40%, a far cry from the old days.  Add to this the extension of swap lines between the Fed and other central banks, and liquidity is everywhere. Those of us in the financial world are surrounded by a sea of money, but just like the ditty of my youth when sailing on the ocean, ‘water, water, everywhere, but not a drop to drink,’ there seems to be nothing economically constructive to do with this money.  If the idea was to keep the banking system alive, it is obvious that this strategy will work.  Clearly, giving money to banks at no cost or, at the worst, extremely low cost means that they don’t have to pay anything for their liabilities – a perfect match for all of their bad-loan assets, which give them no revenue either.  This allows the banks to avoid: calling their bad loans, causing companies to go bankrupt or real estate to go on the auction block, and admitting economic reality.  To us, this seems to be exactly the strategy followed by the Bank of Japan for years, the one that was so harshly criticized by Bernanke ten years ago.

Europe and the US now have their own zombie banks – dead but they keep on walking, not lending money or clearing out the bad debts.  If this massive infusion of liquidity was meant to help ‘main street,’ the operating economy, or the average worker, it has been a complete failure in each country, except Switzerland where this was not its goal.

This gigantic flood of extremely inexpensive high-powered money does have a major impact, not in the real economy, but in the liquid investment markets.  Free money sets a very low hurdle for a short-term investment and as long as the transaction has decent liquidity, why not do the trade.  As a result, almost every equity, commodity, and credit market is moving higher.  High beta currencies are moving higher as well, as risk is clearly on the front foot.  This positive mood began at the start of October, a bit more than a week after Bernanke announced the start of ‘Operation Twist,’ a subtle way to improve the profits of the banks and increase the risk of the Fed without expanding its balance sheet. Global equity markets began to climb. Bernanke then announced an expansion and cheapening of the US swap lines with Europe, which currently have $103 billion outstanding, adding massively to Europe and Japan’s liquidity. Mario Draghi’s move into the ECB Presidency on November 1 was the next harbinger of a new wave of liquidity, as he dropped the refinancing rate a few days later and then announced the LTRO on December 8, expanding the ECB balance sheet by over 4% of the GDP in one day later in the month.  By the end of December things were clearly moving up in all the traded markets, and Bernanke put the cherry on the top of the sundae not once, but several times in the last few weeks. First, he announced that US rates would be extremely low into late 2014, then, a bit later, he emphasized the likelihood of QE3 if there were any economic pause, and then Tuesday he told the US Senate that he was not happy with the way the economy was growing – more hopes for QE3.  As the markets always respond to monetary stimulus when the trend is already positive, prices will be forced even higher.  Although we can’t be positive about the real economy, this expanding liquidity will keep us happy until a political accident intervenes.   Europe offers some candidates: Greece in March, followed by France in April.