The Independent reports that small farmers are being challenged by food companies are becoming insanely concentrated:
Increasingly, a handful of multinationals are tightening their grip on the commodity markets, with potentially dramatic effects for consumers and food producers alike.
Three companies now account for more than 40 per cent of global coffee sales, eight companies control the supply of cocoa and chocolate, seven control 85 per cent of tea production, five account for 75 per cent of the world banana trade, and the largest six sugar traders account for about two-thirds of world trade, according to the new publication from the Fairtrade Foundation.
This is the year “to put the politics of food on the public agenda and find better solutions to the insanity of our broken food system”.
More people may be shopping ethically – sales of Fairtrade cocoa grew by more than 20 per cent last year to £153m – but, according to the report, the world’s food system is “dangerously out of control”.
How is that effecting the safety of our food supply? Reuters notes:
Multinational food, drink and alcohol companies are using strategies similar to those employed by the tobacco industry to undermine public health policies, health experts said on Tuesday.
In an international analysis of involvement by so-called “unhealthy commodity” companies in health policy-making, researchers from Australia, Britain, Brazil and elsewhere said … that through the aggressive marketing of ultra-processed food and drink, multinational companies were now major drivers of the world’s growing epidemic of chronic diseases such as heart disease, cancer and diabetes.
Writing in The Lancet medical journal, the researchers cited industry documents they said revealed how companies seek to shape health legislation and avoid regulation.
This is done by “building financial and institutional relations” with health professionals, non-governmental organizations and health agencies, distorting research findings, and lobbying politicians to oppose health reforms, they said.
They cited analysis of published research which found systematic bias from industry funding: articles sponsored exclusively by food and drinks companies were between four and eight times more likely to have conclusions that favored the companies than those not sponsored by them.
How are giant food manufacturers trying to influence legislation?
As Waking Times reports, they’re trying to gag all reporting:
Big Agriculture says you don’t and it shouldn’t. Armies of Big Ag lobbyists are pushing for new state-level laws across the country to keep us all in the dark. Less restrictive versions have been law in some states since the 1980s, but the meat industry has ratcheted up a radical new campaign.
This wave of “ag-gag” bills would criminalize whistleblowers, investigators, and journalists who expose animal welfare abuses at factory farms and slaughterhouses. Ten states considered “ag-gag” bills last year, and Iowa, Missouri, and Utah approved them. Even more are soon to follow.
Had these laws been in force, the Humane Society might have been prosecuted for documenting repeated animal welfare and food safety violations at Hallmark/Westland, formerly the second-largest supplier of beef to the National School Lunch Program. Cows too sick to walk were being slaughtered and that meat was shipped to our schools, endangering our kids. The investigation led to the largest meat recall in U.S. history.
The bills aren’t identical, but they share common language — sometimes even word-for-word. Some criminalize anyone who even “records an image or sound” from a factory farm. Others mandate that witnesses report abuses within a few hours, which would make it impossible for whistleblowers to secure advice and protection, or for them to document a pattern of abuses.
Ag-gag bills aren’t about silencing journalists and whistleblowers. They’re about curbing consumer access to information at a time when more and more Americans want to know where our food comes from and how it’s produced.
The problem for corporations is that when people have information, they act on it. During a recent ag-gag hearing in Indiana, one of the nation’s largest egg producers told lawmakers about a recent investigation. After an undercover video was posted online, 50 customers quickly called and stopped buying their eggs. An informed public is the biggest threat to business as usual.
An informed public is also the biggest threat to these ag-gag bills. In Wyoming, one of the bills has already failed. According to sponsors, it was abandoned in part because of negative publicity. By shining a light on these attempts, we can make sure that the rest fail as well, while protecting the right of consumers to know what they’re buying.
So what – exactly – are the giant food corporations trying to hide?
A devastating series by our colleagues at Bloomberg News shows that “the defense budget contains hundreds of billions of dollars for new generations of aircraft carriers and stealth fighters, tanks that even the Army says it doesn’t need and combat vehicles too heavy to maneuver in desert sands or cross most bridges in Asia, Africa, or the Middle East.”
BusinessWeek also notes that redundancy wastes a lot of money:
“One need only spend 10 minutes walking around the Pentagon or any major military headquarters to see excess and redundancy,” former Defense Secretary Robert Gates said in September at an event organized by the Center for Strategic & International Studies in Washington. He should know. As defense chief in 2009, he culled 20 weapons systems he thought unnecessary or too expensive, including the F-22 fighter. One place to start thinning the bureaucracy: the staff of the Joint Chiefs of Staff. That office has more than tripled in manpower, to 4,244 in 2012 from 1,313 in 2010, according to the Pentagon’s annual manpower report. (Fewer bureaucrats means fewer memos and fewer meetings. Win-win-win.)
BusinessWeek provides a list of cost-cutting measures which will not undermine national security. American Conservative does the same.
So why doesn’t Congress trim the fat? Because politicians want to bring home the pork. As BusinessWeek notes:
Why is sensible military budgeting so difficult? Because lawmakers, including small-government Republicans, protect defense business in their home states with the ferocity of Spartans. Even if the Pentagon offered up the cuts we’ve outlined here, Congress would almost certainly reject them. The senators and representatives don’t have the political courage to face voters and tell them that the republic simply does not need the weapon under construction in their hometown.
The cuts to the Pentagon budget will be only 7% or some $40+ billion, not the $500 billion they bandy about! Anyone who confuses the (unlikely) ten year cut with next year’s cut is just promoting lies. A good example is the Wall Street Journal editorial, “The Coming Defense Crackup,” warning that the cuts would create the smallest navy since 1914. It intentionally confuses next year’s cut with the consequences of 10 year cuts. [In reality, the size of the proposed sequestration cuts aren't really that big.]
Ok, but when every smart bomb and missile hits its target, why does one need as many shells as the old battleships where most shots missed? During the Korean war the Air Force tried futilely for months to bomb a bridge over the Yalu River. Today destroying a bridge takes one cruise missile from a hundred miles away. In Washington we find all the big media opposed to cutting defense spending, waste and all, even the Washington Post. Politico, usually a leftist paper, publishes articles also intentionally confusing 10 years of cuts with a one year cut. Today’s congressmen can’t oblige future congresses on what they will spend; defense apologists use the 10-year number to try to stop the sequestration for one year, 2013. All the big Washington newspapers are full of costly ads from defense contractors.
The Secretary of Defense acknowledged in May 2012 that the DOD “is the only major federal agency that cannot pass an audit today.” The Pentagon will not be ready for an audit for another five years, according to Panetta.
A $100,000 Defense Advanced Research Projects Agency strategy planning workshop including a session entitled “Did Jesus die for Klingons too?” that entailed a panel debating the implications for Christian philosophy should life be found on other planets
A DOD and Department of Agriculture co-produced reality cooking show called “Grill It Safe”
In addition, the defense department spends huge sums securing our access to oil. In 1991, the Government Accountability Office estimated that – between 1980 and 1990 – the US spent $366 billion to defend oil supplies in the Middle East. America was not fighting any major wars – in the Middle East or elsewhere – at the time.
Security experts – including both hawks and doves – agree that waging war against Iraq and in other Middle Eastern countries weakens national security and increases terrorism. See this, this, this, this, this, this, this and this.
[The war-monger's] big government program is unending wars, imperialist foreign policy, and ever expanding Homeland Security.
The money is not all for defense. At least half is for attacking other nations, as Ron Paul called it the defense/militarism budget. Roughly half goes for defense, the rest is for military adventures abroad, most of them quite unnecessary, indeed counterproductive as they just create more enemies for America. Look at Turkey where 90% of the population used to support America; now 85% oppose us. Obviously if we attacked fewer foreigners we could do with much less spending. Firing 250,000 bullets for each dead guerilla can get expensive. As also paying $400 per gallon to get fuel to the front lines.
Any lingering doubts about whether we can cut defense costs without undermining our national security can be dispatched with a few facts:
The American government has directly been supporting Al Qaeda and other terrorist groups for the last decade. See this, this, this, this and this.
(Remember, if there aren’t scary enough enemies in real life, we’ve got to create them. Oops … did I say that out loud?)
A lot of the bailout money is going to the failing companies’ shareholders
Indeed, a leading progressive economist says that the true purpose of the bank rescue plans is “a massive redistribution of wealth to the bank shareholders and their top executives”
The Treasury Department encouraged banks to use the bailout money to buy their competitors, and pushed through an amendment to the tax laws which rewards mergers in the banking industry (this has caused a lot of companies to bite off more than they can chew, destabilizing the acquiring companies)
And as the New York Times notes, “Tens of billions of [bailout] dollars have merely passed through A.I.G. to its derivatives trading partners”.
In other words, through a little game-playing by the Fed, taxpayer money is going straight into the pockets of investors in AIG’s credit default swaps and is not even really stabilizing AIG.
A study of 124 banking crises by the International Monetary Fund found that propping up banks which are only pretending to be solvent often leads to austerity:
Existing empirical research has shown that providing assistance to banks and their borrowers can be counterproductive, resulting in increased losses to banks, which often abuse forbearance to take unproductive risks at government expense. The typical result of forbearance is a deeper hole in the net worth of banks, crippling tax burdens to finance bank bailouts, and even more severe credit supply contraction and economic decline than would have occurred in the absence of forbearance.
Cross-country analysis to date also shows that accommodative policy measures (such as substantial liquidity support, explicit government guarantee on financial institutions’ liabilities and forbearance from prudential regulations) tend to be fiscally costly and that these particular policies do not necessarily accelerate the speed of economic recovery.
All too often, central banks privilege stability over cost in the heat of the containment phase: if so, they may too liberally extend loans to an illiquid bank which is almost certain to prove insolvent anyway. Also, closure of a nonviable bank is often delayed for too long, even when there are clear signs of insolvency (Lindgren, 2003). Since bank closures face many obstacles, there is a tendency to rely instead on blanket government guarantees which, if the government’s fiscal and political position makes them credible, can work albeit at the cost of placing the burden on the budget, typically squeezing future provision of needed public services.
In other words, the “stimulus” to the banks blows up the budget, “squeezing” public services through austerity.
And the Special Inspector General of the Tarp bailout program said that the Treasury Secretary lied to Congress regarding some fundamental aspects of Tarp – like pretending that the banks were healthy, when they were totally insolvent. The Secretary also falsely told Congress that the bailouts would be used to dispose of toxic assets … but then used the money for something else entirely. Making false statements to a federal official is illegal, pursuant to 18 United States Code Section 1001.
When David Cameron came to power he won praise for pursuing an austerity agenda (unlike Obama) but it's flopped. In a great post, the brilliant pseudonymous finance twitter/blogger @barnejek, asks if Britain has finally cornered itself with its current mix of policy. He starts by noting...
I would like to thank the British government for conducting a massive social experiment, which will be used in decades to come as a proof that a tight fiscal/loose monetary policy mix does not work in an environment of a liquidity trap. We sort of knew that from the theory anyway but now we have plenty of data to base that on.
This idea that Britain has conducted a huge social experiment is not spoken loudly, since it's insensitive, but it's one that economists have talked about. People like that Britain has blown its recovery, because it shows that the theory behind austerity is bunk.
After walking through some slightly technical economics, he goes on to argue that the only hope now is that Britain take a "stop loss" on its austerity agenda, and spend more.
I do believe that Britain has finally cornered itself into a situation where there is overwhelming evidence that Mr Osborne should really start spending. He should also assume that Mr Carney will not let that spending lead to appreciation of Real Effective Exchange Rate (a bit more on that mechanism in one of my previous posts entitled “Be careful what you target or am I in the right church?“). That is to say that the Bank of England will keep nominal and real rates very low. In my opinion this is the only rational way of the situation that we’re currently in. Then again, I am assuming the impossible here, i.e. that the politicians know what the stop-loss is.
Says Lyons: The UK must spend, and banks must lend.
Judging by the still pessimistic tone at the beginning of this year, it would seem few are expecting things to go well in 2013. Yet I just wonder whether this may be the year the economy surprises on the upside.
But if it is then the UK needs three things – to SPEND, LEND & CHANGE.
The economy is suffering from a lack of demand. There needs to be more spending by the Government on both infrastructure and construction and people and firms with the ability to spend need to be given the confidence to do so. There has to be more lending by the banks. And the supply side of the economy needs a helping hand and thus there has to be change – which is all part of repositioning the UK in the changing global economy.
The ratings downgrade by Moody's reflects concern about the growth outlook. That is understandable but we should not panic. The UK has gone from the highest to a still high rating and its borrowing rates will stay low.
That's right. In the wake of a debt downgrade, David Cameron must spend more money. This is incredibly difficult, since prima facie, it would fly in the face of the downgrade. And more importantly, it would basically require him (and his finance minister George Osborne) to admit that they were totally wrong since the crisis. That's the really hard part. Perhaps even impossible. But that's what it will take.
EU UK POLICY
9 - Global Governance Failure
MACRO News Items of Importance - This Week
GLOBAL MACRO REPORTS & ANALYSIS
US ECONOMIC REPORTS & ANALYSIS
CENTRAL BANKING MONETARY POLICIES, ACTIONS & ACTIVITIES
Bubble trouble: Is there an end to endless quantitative easing?
The publication, earlier this week, of the Federal Reserve’s Federal Open Market Committee minutes of January 29-30 ..... Here is the sentence that caused such consternation:
“However, many participants also expressed some concerns about potential costs and risks arising from further asset purchases (the Fed’s open-ended, $85 billion-a-month debt monetization program called ‘quantitative easing’, DS). Several participants discussed the possible complications that additional purchases could cause for the eventual withdrawal of policy accommodation, a few mentioned the prospect of inflationary risks, and some noted that further asset purchases could foster market behaviour that could undermine financial stability.”
Here is how one may freely translate it: “Guys, let’s face it: All this money printing is not without costs and risks.
Three problems present themselves:
1) END GAME: The bigger our balance sheet gets (currently, $3trillion and counting), the more difficult it will be to ever load off some of these assets in the future. When we start liquidating, markets will panic. We might end up having absolutely no maneuvering space whatsoever.
2) INFLATION: All this money printing will one day feed into higher headline inflation that no statistical gimmickry will manage to hide. Then some folks may expect us to tighten policy, which we won’t be able to do because of 1).
3) MISPRICIED RISK: We are persistently manipulating quite a few major asset markets here. Against this backdrop, market participants are not able to price risk properly. We are encouraging financial risk taking and the type of behaviour that has led to the financial crisis in the first place.”
... what is most likely to happen. There is no doubt that we should see an end to ‘quantitative easing’ but will we see it anytime soon? Has the Fed finally – after creating $1.9 trillion in new ‘reserves’ since Lehman went bust – seen the light? Do they finally get some sense?
Maybe, but I still doubt it. Of course, we cannot know but my present guess is that they won’t stop quantitative easing any time soon; they may pause or slow things down for a while but a meaningful change in monetary policy looks unlikely to me.
The boxed-in central banker - I consider central bankers to be captives of three overwhelming forces:
1) Their own belief system which still holds that they are the last line of defence between dark and inexplicable economic forces and the helpless public, and that therefore, whenever the data or the markets go down, it is their duty to ride to the rescue. Thus, when the withdrawal of the Cristal, whether actual or only prospective, dampens the party mood, the Fed will soon feel obliged, by its own inner logic and without any motivation from outside influences, to open another bottle. Just wait until the present debate about an end to QE leads to weaker markets and until, in the absence of the diversion from rallying equity markets, the almost consistently uninspiring ‘fundamental data’ becomes the focus of attention again, and we will witness another shift in Fed language, again back to ‘stimulus’. We had these little twists and turns a couple of times without any major change in trend. Anybody remember the talk of ‘exit strategies’ in the spring of 2011?
Of course, like most state officials, central bank bureaucrats are largely preoccupied with the problems of their own making. It is precisely the Fed’s frequent rescue operations that have created the dislocations (excessive leverage, asset bubbles) which cause instability and repeated crises in the first place. However, there are no signs anywhere that, intellectually, the Fed is willing and able to break out of this policy loop.
2) The size of the dislocations, which are – as I just explained – largely central-bank-made and now, after years and years of Greenspan puts and Bernanke bailouts and zero-interest rates, still sizable in my view, maybe as large as ever. The Wall Street Journal reported that total borrowing by financial institutions is down by about $3 trillion from its all-time high in 2008. That’s the widely heralded ‘deleveraging’. But does that mean that the current level of about $13.8 trillion is a new equilibrium? The Fed’s balance sheet expanded by almost $2 trillion over the same period, and super-easy monetary policy has provided a powerful disincentive for banks to shrink meaningfully. What is truly sustainable or not, will only be discernible once the Fed stops its manipulations altogether and lets the market price things freely. My guess is that
we would still have to go through a period of deleveraging and probably of headline deflation. This would be a necessary correction for a still unbalanced economy addicted to cheap credit but nobody is willing to take this medicine.
3) Politics. Falling stocks, shrinking 401K-plans, and shaky banks don’t make for a happy electorate. Additionally, the state is increasingly dependent on low borrowing costs and central bank purchases of its debt.
The chances of the US government repairing its own balance sheet look slim to non-existent so dependence on ultra-low funding rates and the Fed as lender of last resort (and every resort) will likely continue.
Look at Japan
When it comes to any of the major trends in global central banking of the past 25 years, Japan has consistently been leading the pack.
It had 1 percent policy rates for years in the mid 1990s when such rates were still deemed exceedingly low in countries like the US, and when the global community still looked upon them in disbelief – and growing annoyance at the small pay-off in terms of real growth.
Japan was the first to have zero policy rates and
the first to conduct ‘quantitative easing’, albeit on an altogether smaller scale – thus far at least – than some of the Western central banks managed since 2008.
Now the country seems to point the way towards the next phase in the evolution of modern central banking: the open and unapologetic politicization of the central bank and the demotion of the head central banker to PR man.
Any pretence of the ‘independence’ of central bankers has been unceremoniously dumped in Japan. Ministers take part in central bank meetings and give joint statements with central bank governors afterwards.
New Prime Minister Shinzo Abe has made it very clear what he wants the central bank to do (print more money faster, devalue the Yen, create inflation) and to that end he is looking for a new central bank governor. Of course, only accredited ‘doves’ need apply. A few days ago, Mr. Abe also spelled out what skill-set he is really looking for: good marketing skills. Salesmanship.
“Since we all have our national interests, sometimes, there will be criticism about the monetary policy we are pursuing. The person needs to be able to counter such criticism using logic.”
The course of monetary policy is pretty much fixed. Now it is all about marketing.
In the meantime, the debasement of paper money continues.
While cherry-picking individual macro data points to confirm self-referential biases appears to work for the majority of Wall Street's strategists and asset-gatherers, the sad truth is that fundamentally (top-down and bottom-up) things are not doing so great. We have exposed many of the divergences in the last few weeks and some cracks are appearing in the unbreakable vestibule of central bank liquidity; however, just as we saw late last summer (as gas prices rose once again), macro fundamentals have collapsed (based on Goldman's Macro data assessment platform) and with the normal hope-driven 2-3 month lag, equities are set to follow soon. The size of the shift implies a 5-10% correction to revert to 'reality' though we suspect - given positioning - if we ever saw it, the over-reach could be notably worse.
Chart: Goldman Sachs
COMMODITY CORNER - HARD ASSETS
2013 - STATISM
ADVANCING STATISM - Tools of Change
CREATING SOCIETAL CRISIS
Lord Keynes and Vladimir Lenin knew this clearly (thank you Paul Brodsky of www.qbamco.com for the expanded quote):
“Lenin is said to have declared that the best way to destroy the capitalist system was to debauch the currency. By a continuing process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens. By this method they not only confiscate, but they confiscate arbitrarily; and, while the process impoverishes many, it actually enriches some (authors note: banksters, leviathan government, crony capitalists, and special interest elites).
The sight of this arbitrary rearrangement of riches strikes not only at security, but at confidence in the equity of the existing distribution of wealth. Those to whom the system brings windfalls, beyond their deserts and even beyond their expectations or desires, become 'profiteers,' who are the object of the hatred of the bourgeoisie, whom the inflationism has impoverished, not less than of the proletariat.
As the inflation proceeds and the real value of the currency fluctuates wildly from month to month, all permanent relations between debtors and creditors, which form the ultimate foundation of capitalism, become so utterly disordered as to be almost meaningless; and the process of wealth-getting degenerates into a gamble and a lottery.
Lenin was certainly right. There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose”
UNSOUND MONEY (money printed out of thin air, backed by nothing, yielding nothing, always losing purchasing power and redeemable in nothing) is the father of the "something for nothing societies" we live in today.
POLITICIANS (Psychopaths and Sociopaths) historically have risen to power and met their demise on the shoals of inflation and deflation.
"We all know what to do, we just don't know how to get re-elected after we have done it."
"When it gets serious, you have to lie"
- Jean Claude Juncker, prime minister of Luxembourg
Fixing the bad policies is NOW impossible until the pain of economic and societal failure FORCES the
public servants and their
special interest elites
to change policies or be destroyed.
FIAT CREDIT MONEY IS A WEALTH CONFISCATION DEVICE!
The greatest transfer of wealth from those that hold/store it in paper to those that don’t is underway!
BONDS: IOU’s denominated in IOU’s
PRICE is what you pay, VALUE is what you get. WEALTH is the the accumulation of VALUE.
HOW DO YOU DETERMINE VALUE: REAL Wealth creation is producing more than you consume thereby creating capital to fuel savings and investment. Within a SOUND money economy, money is a store of value and wealth can be denominated in Money. In a fiat economy wealth must be denomiated in value. Asset valuations are based on Discounted Free Cash Flow (unemcumbered, inflation adjusted), then adjusted for currency debasement.
WHAT WILL CAUSE HYPERINFLATION?
"There are TWO reasons why INFLATION has not really accelerated to hyperinflation as all this money has been PRINTED and it is:
The second reason as the real economic activity must collapse as you saw in Zimbabwe, Wiemar Germany, and as you see TODAY in socialist paradises known as Venezuela and Argentina.
The developed world is just a step or two behind them, but rapidly following the same path…"
THE CONCEPT OF THE INDIRECT EXCHANGE
"There are TWO sets of canaries in the coal mine concerning the future and both singing very different tunes. In one corner you have: Ray Dalio of Bridgewater, Bill Gross of Pimco, Kyle Bass of Hayman capital, George Soros, David Einhorn all telling you to take your paper money get into real things, gold, commodities, CASH flowing businesses, etc. In Austrian terms this is called the INDIRECT exchange. It is sound advice from REAL money managers, in fact some of the best in the world.
In the other corner you have Paul Krugman, Larry Summers, Tim Geithner, Barack Obama, Mario Draghli, Francois Hollande, Mariano Rajoy, Mervyn King, Mark Carney, Ben Bernanke, Martin Wolf and The European Commission to name a few. Telling you they “will do whatever it takes” and PRINT THE MONEY as required. All Socialists and academics, with NO experience in the real world or have experience in the belly of the beast known as Banks and Government Treasury departments.
Use Applied Austrian economics, fix your paper currencies and restore the functions of money to stop the printing press.
2012 - FINANCIAL REPRESSION
FINANCIAL REPRESSION - The Meaning of Negative Real Rates
For most portfolio managers, investable assets can be thought of as sitting somewhere on the risk-return curve shown below. Of course, depending on valuations at a particular point in time, positioning in the economic cycle, or overall geopolitical risks, some of the relative positions may change. But over long periods, investable assets have tended to display the risk-reward characteristics highlighted by the efficient frontier below.
THE EFFICIENT FRONTIER
Now in recent decades, investors could assume that across the length of an economic cycle, almost all investments would provide a positive real return. Diversification across the curve made ample sense, and this is precisely what happened: looking at the stock of global assets, one sees that out of an estimated
$209trn in global financial assets (excluding real estate),
$52trn sits in equity with
$45trn in government debt,
$65trn in loans (possibly a good chunk of which finances real estate), and
$46trn in corporate debt.
In other words, roughly one quarter of the world’s financial assets are in equity (on the top-right hand of the risk-return curve) with three quarters in debt (at the bottom left of the curve). This asset mix brings us to the policies followed today by most Western central banks of guaranteeing negative real rates for as long as the eye can see.
This policy of negative real rates has an obvious goal:
push out investors from the bottom left of the curve to the top right, thereby boosting animal spirits,
creating jobs, and
returning Western economies to a more solid growth environment.
But could these policies suffer from the law of unintended consequences?
If we look at the risk-return curve today it is obvious that 75% of global financial assets are now locking in real losses, unless of course, inflation collapses and deflation takes hold in the major economies.
Consider a 2 year treasury bond yielding 0.25% as an example. With inflation running at around 1.7%, anyone buying such an instrument is locking in a -1.5% real capital loss for the next two years. The same argument can be made for Germany where yields are even lower than in the US, even if inflation is running at the same pace (and likely to accelerate further), or indeed Japan, France or the UK... In short, in today’s world, it is almost impossible to gather any kind of real returns on fixed income instruments without either taking significant duration risk and/or quality risk, i.e.: moving up to the right of the curve.
Now let us assume for a second that the world will be spared a massive deflationary wave and that, consequently, the assets at the bottom left of the curve will lose 1.5% real per year every year for the next five years. This means that, for global assets to stay roughly in the same place, equities will need to provide a real return of 4.5% per annum every year for five years. This is broadly in line with the long term return of equity markets and, given that global equities are not blatantly overvalued, such returns may well be achieved. However, it is important to note that such returns will only serve to compensate for the capital destruction taking place in the fixed income market. Real returns on equities of 4.5% will not leave us any richer compared to our starting level. This means that investors will have effectively spent five years on a treadmill running to stand still. When you consider that no asset growth was registered in the previous five years,
we are facing a whole decade devoid of capital accumulation.
Given the world’s ageing population, isn’t this bound to be problematic?
Indeed, at a time when most pension funds are already far under water, does a policy that locks in real losses for plan managers really make sense? In short, can the world today afford the real capital destruction central banks are engineering through negative real rates (perhaps we can if that capital destruction mostly occurs on the central banks’ own balance sheets?). This quandary brings us back to the law of unintended consequences: just like the pensioner who, sitting on a fixed amount of capital, will simply buy more and more bonds as interest rates are pushed down (for he needs a fixed level of income—witness Japan over the past twenty years), won’t the world’s pension funds, sitting on real losses because of their existing large fixed income holdings, prove ever more resistant to moving to the far right of the curve? Could the negative real interest rate policies, by destroying capital, guarantee the world a period of sub-par investment growth, sub-par productivity growth, and sub-par economic growth instead? This is what occurred in Japan for a decade, once the bank of Japan moved to a zero rate policy.
Basically, ZIRP meant the banks could not make much money, nor were they interested in taking much risk or making loans. And without bank credit, the economy just puttered along, while equities continuously de-rated.
Officials at the US Federal Reserve may be more worried than they have let on about the treacherous task of extricating America from quantitative easing. This is an unsettling twist, with global implications. A new paper for the US Monetary Policy Forum and published by the Fed warns that the institution's capital base could be wiped out "several times" once borrowing costs start to rise in earnest.
A mere whiff of inflation or more likely stagflation would cause a bond market rout, leaving the Fed nursing escalating losses on its $2.9 trillion holdings. This portfolio is rising by $85bn each month under QE3. The longer it goes on, the greater the risk. Exit will become much harder by 2014.
It argues the Fed is acutely vulnerable because it has stretched the average maturity of its bond holdings to 11 years, and the longer the date, the bigger the losses when yields rise. The Bank of Japan has kept below three years.
Trouble could start by mid-decade and then compound at an alarming pace, with yields spiking up to double-digit rates by the late 2020s. By then Fed will be forced to finance spending to avert the greater evil of default."Sovereign risk remains alive and well in the U.S, and could intensify. Feedback effects of higher rates can lead to a more dramatic deterioration in long-run debt sustainability in the US than is captured in official estimates," it said.
Europe has its own "QE" travails. The paper said the ECB's purchase of Club Med bond amounts to "monetisation" of public debt in countries shut out of global markets, whatever the claims of Mario Draghi.
"We see at least a risk that the eurozone is on a path to become more like Argentina (which of course is why German central bankers are most concerned). The provinces overspend and are always bailed out by the central government. The result is a permanent fiscal imbalance for the central government, which then results in monetization of the debt by the central bank and high inflation," it said.
In America, the Fed would face huge pressure to hold onto its bonds rather than crystalize losses as yields rise -- in other words, to recoil from unwinding QE at the proper moment. The authors argue that it would be tantamount to throwing in the towel on inflation, the start of debt monetisation, or "fiscal dominance". Markets would be merciless. Bond vigilantes would soon price in a very different world.
Investors have of course been fretting about this for some time. Scott Minerd from Guggenheim Partners thinks the Fed is already trapped and may have to talk up gold to $10,000 an ounce to ensure that its own bullion reserves cover mounting liabilities.
What is new is that these worries are surfacing openly in Fed circles. The Mishkin paper almost certainly reflects a strand of thinking at Constitution Avenue, so there may be more than meets the eye in last week's Fed minutes, which rattled bourses across the world with hints of early exit from QE.
Mr Bernanke is not going to snatch the punch bowl away just as the US embarks on fiscal tightening this year of 2pc of GDP, one of the most draconian budget squeezes in the last century. But he may have concluded that the Fed is sailing too close to the wind, and must take defensive action soon.
Monetarists say this is a specious debate -- arguing that the losses on the Fed balance sheet are an accounting irrelevancy -- but Bernanke is not a monetarist. What matters is what he thinks.
If this is where the Fed is heading, the world is at a critical juncture. The US economy has not yet reached "escape velocity", and in fact shrank in the 4th quarter of 2012. Brussels has slashed its eurozone forecast, expecting a second year of outright contraction in 2013.
The triple "puts" of the last eight months -- Bernanke's QE3, Mario Draghi's Club Med bond rescue, and Beijing's credit blitz -- have done wonders for asset markets but have not yet ignited a healthy cycle of world growth. Nor can they easily do do since the East-West trade imbalances that caused the 2008-2009 crisis remain in place.
We know from a body of scholarship that fiscal belt-tightening in countries with a debt above 80pc to 90pc of GDP is painful and typically self-defeating unless offset by loose money. The evidence is before our eyes in Greece, Portugal, and Spain. Tight money has led to self-feeding downward spirals. If bondyields are higher thannominal GDP growth, the compound effects are deadly.
America may soon get a first taste of this, carrying out the epic fiscal squeeze needed to bring its debt trajectory back under control with less and less Fed help. Gross public debt will hit 107pc of GDP by next year, and higher if the recovery falters as pessimists fear.
With the fiscal and monetary shock absorbers exhausted -- or deemed to be -- the only recourse left is to claw back stimulus from foreigners, and that may be the next chapter of the global crisis as the Long Slump drags on.
Professor Michael Pettis from Beijing University argues in a new book -- "The Great Rebalancing: Trade, Conflict, and the Perillous Road Ahead" - that the global trauma of the last five years is a trade conflict masquerading as a debt crisis.
There is too much industrial plant in the world, and too little demand to soak up supply, like the 1930s. China is distorting the global system by running investment near 50pc of GDP, and compressing consumption to 35pc. Nothing like this has been seen before in modern times.
This has nothing to do with the "Confucian" work ethic or a penchant for stashing away money. Fifty years ago the stereotype was the other way round. Confucians were seen as feckless. In fact, Chinese families never get the money in the first place. The exorbitant Chinese savings rate is due to a structure of taxes, covert subsidies, and banking rules.
Variants of this are occuring in many of the surplus trade states. Germany is doing it in a more subtle way within Euroland. The global savings rate is almost 25pc and climbing to fresh records each year. The overstretched deficit states in the Anglo-sphere and Club Med are retrenching but others are not picking up enough of the slack. Germany has tightened fiscal policy to achieve a budget surplus. This is untenable.
In the Noughties the $10 trillion reserve accumulation by Asian exporters and petro-powers flooded the global bond market. At the same time, the West offset the deflationary effects of the cheap imports by running negative real interest rates.
The twin policy regimes in East and West stoked the credit bubble, and this in turn disguised what has happening to trade flows. These flows were disguised yet further after 2008 by QE and fiscal buffers, but the hard reality beneath may soon be exposed as these are props are knocked away.
"In a world of deficient demand and excess savings, every country will try to acquire a greater share of global demand by exporting savings," he writes. The "winners" in this will be the deficit states. The "losers" will be the surplus states who cannot retaliate. The lesson of the 1930s is that the creditors are powerless. Prof Pettis argues that China and Germany risk a nasty surprise.
America's shale revolution and manufacturing revival may be enough to head off a US-China clash just in time. But Europe has no recovery strategy beyond demand compression. It is a formula for youth job wastage, a demented policy when youth a scarce resource. The region is doomed to decline until the boil of monetary union is lanced.
Some will take the Mishkin paper as an admission that QE was a misguided venture. That would be a false conclusion. The West faced a 1931 moment in late 2008. The first round of QE forestalled financial collapse. The second and third rounds of QE have had a diminishing potency, while the risks have risen. It is a shifting calculus.
The four years of QE have given us a contained depression and prevented the global strategic order from unravelling. That is not a bad outcome, but the time gained has largely been wasted because few wish to face the awful truth that globalisation itself -- in its current deformed structure -- is the root cause of the whole disaster.
It will be harder from now on if central banks conclude that their arsenal is spent. We can only pray that their help will not be needed.
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