As we wrap up a most interesting, and volatile, week there are some things that I have discussed previously that are now brewing, interesting points to consider and risks to be aware of. In this regard I thought I would share a few things that caught my attention as I look forward to wrapping up the week that was.
1) Angela Merkel Election No So Assured
Some months ago in a missive entitled "Is The Eurozone Crisis Set To Flare Up?" I discussed the potential threat to the Eurozone being the dethroning of Angela Merkel by her opponents who are staunchly opposed to further bailouts for the weak Eurozone members and would prefer to see countries like Greece be expelled.
My friend Tyler Durden at Zero Hedge picked up on worry stating:
"On the back of our detailed discussion of the inner workings of the German election (here and here), it appears that we are no nearer understanding the two major political narratives that appear dominant currently. As Reuters reports, Angela Merkel's center-right coalition and Germany's combined opposition are running neck and neck, a poll showed on Tuesday, five days before the national election. Crucially, if the figures are repeated in Sunday's election, Merkel will lack the support to renew her coalition with the FDP and Germany will most likely end up with a 'grand coalition' of conservatives and SPD, like the one Merkel led in 2005-2009.
Chancellor Angela Merkel's center-right coalition and Germany's combined opposition are running neck and neck, a poll showed on Tuesday, five days before a national election that will decide who steers Europe's largest economy through the next four years.
The Forsa poll for Stern magazine showed Merkel's conservatives still well ahead of other parties on 39 percent, unchanged from the previous survey, and their current coalition partner, the liberal Free Democrats (FDP), were on 5 percent, down one point and only just enough to enter parliament.
The main opposition Social Democrats (SPD) and their Green allies were on 25 percent and 9 percent respectively, both unchanged from the previous Forsa poll, and the far-left Left had 10 percent. The SPD has ruled out a coalition with the Left.
If the figures are repeated in Sunday's election, Merkel will lack the support to renew her coalition with the FDP and Germany will most likely end up with a 'grand coalition' of conservatives and SPD, like the one Merkel led in 2005-2009."
The worry, as I have stated previously, is that if Angela Merkel loses control of the Chancellorship it could well mean significant turmoil to an already very weak Eurozone situation. Furthermore, since Germany is the primary funding source of the European Central Bank, a lack of financial support could well mean the end of the ECB and its Eurozone lifelines.
2) The Debt Ceiling Debate
The Republican's on Friday passed a bill, 230-189, that would keep the government funded past the September 30th deadline but would also strip funding for the Affordable Care Act. If anyone has been paying attention the ACA represents a huge economic problem in 2014-2015 due to massive increases in the cost of healthcare for the middle class which has seen both incomes and net worth decline in recent years.
The problem is that the bill will be immediately rejected by the democratically controlled Senate. This will kick the bill back to the House once again which is becoming increasing entangled in its own division within its rank and file. The question then becomes whether, or not, the Republican controlled house will allow for a temporary government shutdown to promote a compromise on budgetary issues.
As we approach the deadline the markets could be roiled by the heated debates as the President threatens "default" if Congress doesn't act quickly to increase the debt limit. As I stated in the recent missive "The Real Reason For No Fed Taper:"
"The problem for the Federal Reserve currently is that they are once again facing an issue that nearly cratered the markets, and the economy, back in 2011. As we quickly approach the limit of the government's borrowing capability the threat of a government shut down and "debt ceiling" debate once again looms. Bernanke is currently fearful of such a repeat event given an already weak economy coupled with rising interest rates. Any shutdown of the government, fear of "default" or restrictive fiscal policies could collapse what incremental recovery there has been to date."
However, Ruth Marcus summed up the risks to the economy and the markets eloquently stating:
"The chilling part is obvious. Having the government shut down, especially briefly, is stupid but survivable. (Economically, that is. The political ramifications are another matter.) We've been down this idiotic path before, and we may well be stumbling there again.
But leaving the government unable to borrow enough money to pay the debts it has already incurred is a different matter entirely. Breaching the debt ceiling evokes words like catastrophic and unthinkable, which is why it has never happened.
And why the notion that it might is so surprising. Astonishing, actually. Washington is used to government by crisis and deadline. Our creaky system is capable of rousing itself only when the train is bearing down the tracks.
So my usual way of analyzing these moments is to reason backward: The debt ceiling must be raised.
Therefore it will be. The situation will seem to be at an unbreakable stalemate until, suddenly, a solution appears. Everyone will breathe a sigh of relief -- until the inevitable next act in our political psychodrama. Panic, solve, repeat.
And this could well happen in the coming showdown. Let's hope so. But steady Washington hands worry that this time really could be different -- and, remember, even edging close to default is costly."
3) The "Taper" Indecision Is Back
It certainly didn't take long for the markets to go from indecision, to decision, back to indecision on the Fed's future actions regarding its current bond buying program. On Friday, Senior Federal Reserve Official James Bullard suggested that the current bond buying programs could begin being scaled back as early as October. This would correspond with my views above on getting past a potential debacle in Washington over the debt ceiling debate.
However, what is particularly important about his speech was that he acknowledged that Fed policy has conventional monetary impacts.
"Financial market reaction to the June and September FOMC meetings provides sharp evidence that changes in the expected pace of asset purchases have conventional monetary policy effects. Using the pace of purchases as the policy instrument is just as effective as normal monetary policy actions would be in normal times”
The importance of this statement should not be dismissed. The implication is that "tapering" is effectively the same as "tightening" monetary policy which would be a negative for the stock market in the short run.
4) In The "Economy Is Improving" Camp
If the economy is indeed improving then why do officials continue to change the way we calculate the measures of the economy. First, the Bureau of Economic Analysis changed the calculation of GDP to include pension deficit liabilities and intellectual property, such as research and development, which boosted GDP by roughly $500 billion in total.
Now, the European Union is changing the budget calculation to ease austerity. From ABC News:
"The nature of the change is very technical — changing the methodology of measuring the output gap between potential and structural growth — but it could have significant repercussions. The result is used to calculate the structural deficit figure — that is the deficit adjusted for the cyclical strength or weakness of the economy — upon which the European Commission bases its policy recommendations..."
So, if your debt is increasing to the point that it becomes unlikely you can qualify for further bailouts and supports - change the way you measure it.
While you can mask problems in the short term through accounting gimmickry, and other shenanigans, eventually the issue will have to dealt with. The problem is that by the time that point is reached it has historically been the catalyst for a crisis.
"1.-Syria: While there has been a tentative agreement between Syria, the U.S. and Russia, to destroy Syria’s arsenal of chemical weapons; the reality is that this is the same “dog and pony” show we witnessed with the WMD inspectors in Iraq. Syria will agree to comply up front and then will subsequently move their weapons to other locations such as Iraq and Lebanon. They will only allow the U.N. inspectors to “see what they want them to see” and “compliance” will be nothing more than an act. Of course, this is assuming the Syrian rebels will even let the inspectors into the country as they are highly offended by this agreement as they now feel the U.S. has abandoned them in their 2-year long crusade to oust the current leadership. The reality is that in the next few months we will likely be once again talking about limited strikes in Syria as history is once again repeated."
That certainly didn't take long as Syria, according to the LA Times, is already set to miss an initial deadline in the U.S.-Russia chemical arms deal.
"The ambitious U.S.-Russian deal to eliminate Syria's chemical weapons, hailed as a diplomatic breakthrough just days ago, hit its first delay Wednesday with indications that the Syrian government will not submit an inventory of its toxic stockpiles and facilities to international inspectors by this weekend's deadline."
It is likely that in the months ahead that the markets will once again be faced with turmoil in Syria. This is particularly the case now that a third faction has now formed in region and is now exposing rifts between the FSA and Assad's forces in the region. Islamic State in Iraq and Syria, or ISIS, recently drove the Free Syrian Army out of Azaz. ISIS is primarily composed of Al Qaeda linked terrorists and hardline jihadists.
"The new study by IHS Jane's, a defence consultancy, estimates there are around 10,000 jihadists - who would include foreign fighters - fighting for powerful factions linked to al-Qaeda. Another 30,000 to 35,000 are hardline Islamists who share much of the outlook of the jihadists, but are focused purely on the Syrian war rather than a wider international struggle. There are also at least a further 30,000 moderates belonging to groups that have an Islamic character, meaning only a small minority of the rebels are linked to secular or purely nationalist groups.
The stark assessment, to be published later this week, accords with the view of Western diplomats estimate that less than one third of the opposition forces are "palatable" to Britain, while American envoys put the figure even lower. Fears that the rebellion against the Assad regime is being increasingly dominated by extremists has fuelled concerns in the West over supplying weaponry that will fall into hostile hands."
With President Obama recently turning over the ban to provide arms to terrorist organizations the blow-back in the future could be significant leading to further turmoil for the financial markets. This is particularly the case if you add in Lindsey Graham's recent proposal to gain authorization for a U.S. attack on Iran:
"...We're going to put together a use-of-force resolution allowing our country to use military force as a last resort to stop the Iranian nuclear program, to make sure they get a clear signal that all this debacle about Syria doesn't mean we're confused about Iran."
6) Video Interview Of The Week
This interview with Stanley Druckenmiller earlier this week is a must watch. As per Zero Hedge:
"Reflecting on exactly what was said yesterday, Duquesne's Stanley Druckenmiller is initially perplexed as Bernanke explained 'financial conditions' - not interest rates - have prompted the decision to forestall any taper. His confusion is that financial conditions are actually slightly better than they were in June and "a stock market at an all-time high would suggest we don't have a problem with financial conditions." While he dismisses surveys, the big-money was betting that they were going to taper as is clear from the moves in gold, bonds, and stocks; and it appears the Fed "lost their nerve." In fact, Druck continues, the Fed "blew it... they had a freebie," they could have started the process to "get us off the dope." This action, or inaction, he warns "is going to make it so much harder for the next Chairman to start the process." In fact, he concludes, that from beginning to end - once markets adjust from these subsidized prices - that the wealth effect of QE will have been negative not positive.
His discussion focuses on the transparency mistakes, the cornering they have managed, and the concerns he has over QE in general...
QE1 he supported as a crisis-fighting tool at the time - but from QE2 onwards and 5 years and he "doesn't think the academics at the Fed understand the unintended consequences of the exit."
At around 13:45 he also provides a clear explanation of the 'other side' of the Fed's expanding balance sheet - the average investor who is 'forced' to sell them the bonds and take on more risk... this has forced us to buy securities at subsidized prices and when they adjust, at whatever point in the future, they will adjust immediately and on no volume.
In fact, he concludes, that from beginning to end - once markets adjust - that the wealth effect of QE will have been negative not positive.
At 15:00, he explains how this is the biggest redistribution of wealth from the middle class and the poor to the rich ever - "who owns assets" he asks rhetorically...
Druckenmiller begins at 8:03...
Complacency Not An Option
While the recent Federal Reserve inaction is bullish for stocks in the short term there are plenty of reasons to remain somewhat cautious. Stocks are overvalued, rates are rising, earnings are deteriorating and despite signs of short term economic improvements the data trends remain within negative downtrends. Investors, however, have disregarded fundamentals as irrelevant as long as the Federal Reserve remains committed to its accommodative policies. The problem is that no one really knows has this will turn out and the current assumptions are based upon past performance.
However, as anyone who has ever invested should already know, past performance is no guarantee of future results.
MONETARY POLICY - The underlying risks that are building
In the comedic movie Young Frankenstein with Gene Wilder, a brilliant experiment went awry by an unexpected mistake. When Igor fetched the 'genius brain’, he accidentally dropped it, so he simply got another one. Only when the creature turned into an uncontrollable monster did Dr. Frankenstein ask Igor whose brain it was. Igor's response was "Abby-someone". Logically, Dr. Frankenstein asked, "Abby who?" Igor replied, "Abby Normal."
The Fed’s well-intentioned experiment to bring life to the dead economy is analogous to this movie with QE-Infinity analogous to the “Abby-normal” brain.
For the sake of argument, let’s assume ZIRP (Zero Interest Rate Policy), Operation Twist, QE1 and QE2 were necessary to stabilize financial markets, arrest deflation, and/or help jumpstart the economy. For the moment, let’s reserve judgment on QE-Infinity.
QE-Infinity is dissimilar to the earlier QE actions for three very important reasons: 1) it began under different economic conditions; 2) its’ open-ended time frame hijacked the market’s typical price discover mechanism; and 3) it originated subsequent to earlier actions that had already changed investor behavior. I will address each of these factors.
#1- When QE-Infinity was announced in September of 2012, the economy was healing and progress was being made toward the Fed’s dual mandates. The FOMC was already providing extraordinary accommodation through two policy actions, ZIRP and forward guidance. At the time, the unemployment rate was headed in the right direction having fallen from 10% to 8.2%. The equity market was higher by 15% YTD and had more than doubled from its low in March 2009. And, core CPI inflation was steady and near target.
Yet, Dr. Bernanke was dissatisfied with the pace of the recovery, so he consulted his Great Depression reference guide prior to altering and intensifying the patient’s medicine to QE-Infinity. Unfortunately, I believe this decision has resulted in a toxic combination of drugs that could ultimately lead to the patient’s overdose (which I explain below).
#2 - Price discovery became distorted by QE1 and QE2, but it was QE-Infinity that demolished it completely. Remember, financial assets are valued simply by aggregating the discounted value of future cash flows. Yet, when QE was not given an end date, the market had to accept ZIRP as extending infinitely into the future. Thus, the discount rate used to value those cash flows was assumed to be zero in perpetuity. Dividing a number by zero equals the empty-set. This triggered talk of markets “melting up”.
It was only when QE was viewed as actually having an end-date during ‘tapertalk’ in May that a forward increase in interest rates was priced into the discount rate mechanism. It is for this reason that the market adjusted accordingly after May, thus leading to an increase in bond yields. (100+ bps).
Furthermore, QE-infinity destroyed the foundations of the Capital Asset Pricing Model by flipping the capital structure upside-down. Interest rates had been forced to such artificially low levels that risk/return characteristics became too skewed. In other words, an asymmetric distribution existed, the closer interest rates and credit spreads got to the zero-bond. Government bonds (the risk free rate), which converge to par, offered limited upside potential, but great downside risk. Equities became the preferred asset class, simply because it provided uncapped upside price appreciation that bonds did not. Many asset managers even moved into dividend paying stocks as a substitute for their fixed income exposures. This shift in perception has had a material impact on asset allocation models, and has significantly increased systemic risk.
#3 - The situation is magnified since the QE-Infinity follows the QE1 and QE2 regimens, which had dramatically changed investor behavior. Fed ‘promises’ since 2009 have provided a market ‘put’ that incentivized risk-taking and search for yield. Investors have been afraid of missing out. Or, they fear underperforming benchmarks, competitors, or inflation. Investors have imprudently been chasing the ‘least-bad’ relative return not wanting to ‘fight the Fed’. Fed policies have fostered a herd mentality; an embedded and complacent psychology of bullishness.
Once tapering actually occurs, the discount re-adjustment equation will rise away from zero, making stock and bond valuations less attractive. Prices will ultimately have to be supported by their fundamental values, so a large price adjustment process will almost certainly occur. More importantly, a volatile over-shoot in equity and fixed income markets is likely, because investors will shift current positions from one of accepting the Fed’s ‘easy candy’ toward pricing in the Fed’s new final destination.
FOMC members will not be able to micro-manage that transition as they have suggested. Changing its already complex message and ‘tapering the taper’ seem to be revealing an FOMC vacillating between over-confidence and fear.
Investors, for their part, may be trapped in a ‘greater fool theory’ in thinking they can all unwind risk at the same time. Over-regulation, shrinking bank balance sheets, and fewer market makers mean that market liquidity is challenged. Retracting Fed dollars is always far more difficult than creating them, particularly in the current environment.
In summary, the FOMC scientists have been working in their lab tweaking models to assess marginal benefits, but it is blinding them from seeing the underlying risks that are building. They openly ask what signs of troubles are evident, but the morphine drip has been in use for so long that they can’t see that the current calm may be replaced with an uncontrollable monster unleashed when the sedation fades.
In looking at this chart you will see 3 distinct bubbles. Each one bigger than the previous one and each one has the same characteristics except for the last. In looking at the first during the early 1920’s we saw a huge expansion in both equity prices and real estate followed by a huge collapse in 1932. During that depression, we saw equity prices and home prices all fall dramatically and converge at the price of gold in 1932.
From the 1950’s thru the 1970’s, our economy made great economic progress. We became a global super power, innovation and technological advances flourished and we became the beacon of prosperity around the world. With that, equity and real estate prices once again expanded at a tremendous rate. In the early 1970’s, with sky high interest rates and massive inflation, we saw yet another market bubble eviscerate. Ironically, all of these asset classes once again converged on gold in 1979. Only this time the bubble was larger from the 1929 bubble. The 80’s were ushered in by Ronald Reagan and a new feeling of optimism spurred in much part by patriotism and great global economic expansion. From the early 80’s to the present we have enjoyed much prosperity until 2008.
If the past is a reflection of the future, then shouldn’t have equity prices, real estate prices and gold all have converged as they did in 1932 and 1979 in 2008 or 2009?
In looking at the chart, it’s clear that they began that convergence once again but something different happened. The FED started pumping massive amounts of liquidity into the system. Something they have never done before at this level and certainly, never seen in our history. I would speculate that if the FED did not intervene, then we may have seen all of these asset levels converge at around the 256 level and we may have had a normal reset.
But instead, what we got was a complete reversal in all of these asset prices. Today we sit at historic highs in the equity markets and home prices are just off a time high. Gold on the other hand has taken a sharp decline and I can only speculate that if the pumping continues, we will only see this bubble inflate even more.
All of these asset classes are being artificially inflated to levels never seen before. What happens when it stops? And how does the FED exit? I hope we will not be Yellen and screaming when it pops...
EARNINGS - Caterpillar Global Sales Drop At Fastest Pace Since March
"Don't Taper Me, Bro" - Caterpillar Global Sales Drop At Fastest Pace Since March 09-20-13 Zero Hedge
There was a time when the only geographic region that made up for contracting global Caterpillar sales was Latin America, which was the only silver lining amongst an otherwise dreary year-over-year sales performance landscape. As of August, that is no longer the case, with LatAm sales for the heavy industrial equipment maker plunging from a positive 11% to -3%. This was the first Y/Y drop in LatAm sales for Cat since September of 2012, and joins virtually every other global region in posting a drop in year over year sales. It also dragged total world sales down to -10% on a year over year basis, down from -9% and -8% in July and June, and is the lowest sales "growth" since March. Just three more percentage points and Cat will have the biggest annual drop in global sales since 2010. The only good news in the report: North American sales cautiously peaked out from negative territory where they were hiding since December, and posted a measly +1% growth in August, even as every other world region was substantially in the red. The implications of this report are of course great for stocks: bad CAT, bad end demand, bad global economy, no taper, Turbo QE. Because bad news has never been gooder for the BTFATH chasers.
As The Telegraph reports, ex-BIS Chief Economist William White exclaims, "All the previous imbalances are still there. Total public and private debt levels are 30pc higher as a share of GDP in the advanced economies than they were then, and we have added a whole new problem with bubbles in emerging markets that are ending in a boom-bust cycle."
Crucially, the BIS warns, nobody knows how far global borrowing costs will rise as the Fed tightens or “how disorderly the process might be... the challenge is to be prepared." This means, in their view, "avoiding the tempatation to believe the market will remain liquid under stress - the illusion of liquidity."
The Swiss-based `bank of central banks’ said a hunt for yield was luring investors en masse into high-risk instruments, “a phenomenon reminiscent of exuberance prior to the global financial crisis”.
[The BIS] was the only major global body that clearly foresaw the global banking crisis, calling early for a change of policy at a time when others were being swept along by the euphoria of the era.
Mr White said the five years since Lehman have largely been wasted, leaving a global system that is even more unbalanced, and may be running out of lifelines. “The ultimate driver for the whole world is the US interest rate and as this goes up there will be fall-out for everybody. The trigger could be Fed tapering but there are a lot of things that can go wrong. I very am worried that Abenomics could go awry in Japan, and Europe remains exceedingly vulnerable to outside shocks.”
The BIS quietly scolded Bank of England Governor Mark Carney and his eurozone counterpart Mario Draghi, saying the attempt to use “forward guidance” to hold down long-term rates by rhetoric alone had essentially failed. “There are limits as to how far good communications can steer markets. Those limits have become all too apparent,” said Mr Borio.
Think its different this time and that we are indeed invincible - after all Maria Bartiromo and Hank Paulson told us so on Meet The Press this morning, right? Wrong! Here are the fact... (Via The BIS),
A trend favouring riskier lending was also evident in the syndicated loans market. A concrete manifestation was the growing popularity of “leveraged” loans, which are extended to low-rated, highly leveraged borrowers paying spreads above a certain threshold. The share of these loans in total new signings reached 45% by mid-2013, 30 percentage points above the trough during the crisis and 10 percentage points above the pre-crisis peak.
Market commentary attributed part of this increase to renewed investor demand for collateral loan obligations, which furthered a shift of negotiating power to borrowers. Thus, just as leveraged loans were gaining in importance, a declining portion of the new issuance volume featured creditor protection in the form of covenants.
and so back to Mr. White for the endgame...
Mr White said the world has become addicted to easy money, with rates falling ever lower with each cycle and each crisis. There is little ammunition left if the system buckles again. “I don’t know what they will do: Abenomics for the world I suppose, but this is the last refuge of the scoundrel,” he said.
5- Sovereign Debt Crisis
BAML WARNS - If The US Economy Does Not Significantly Accelerate Now, It Never Will
Significant monetary stimulus, the end of fiscal austerity, a booming housing market, a cheap dollar, record corporate cash balances... BofAML warns - if the US economy does not significantly accelerate in coming quarters, it never will.
An unprecedented financial and economic crisis, crystallized by the September 15th 2008 bankruptcy of Lehman Brothers, was followed by an unprecedented monetary policy response, which in turn has been followed by unprecedented bull markets in bonds, stocks and now real estate. Wall Street has soared, but Main Street has soured. The exceptional “sweet spot” engendered by generous central banks and selfish corporations has been great for owners of capital, but bad for labor.
Wall Street vs Main Street
The "race to reflate" in the developed world and faltering Chinese macro leadership dictated the winners & losers of the past 5 years: Gold, High Yield, EM debt & Asian equities have been big winners; Commodities, Government Bonds & Japanese equities have been the big losers.
QE was the prime driver of the ‘09 trough in stocks & the ‘11 trough in real estate, and liquidity withdrawal has driven the jump in global interest rates in 2013. A further rapid, jump in rates would destabilize asset markets, but this threat remains low in coming quarters. The 100 basis point summer surge in the 30-year Treasury yield has tethered the S&P500 index to a tight 1600-1700 range and traumatized many fixed income & emerging markets.
We previously discussed BofAML's CRASH meme here - Conflict (policy, military), Rates (liquidity), Asia, Speculation (forced selling) and Housing are all potential catalysts for a much more contagious autumn market event - it is well worth a reminder.
First, the bad news; the un-Taper-inspired collapse in the USD is not helping the JPY weakness that Abe desires and the NKY is now 200 points off its US day-session highs (though still green from yesterday) and the JASDAQ is red. But everywhere else there is much rejoicing... EM FX is back at 5 to 6 week highs with MYR, INR (fwds), and IDR all having major surges. Equity markets are green in general but the Philippines PSEi (+3%) and Indonesia's JCI (+4% but was +7.7% at one point) are an illiquid mess of over-exuberance. Gold, US Treasuries, and US equity futures are all holding gains or inching slightly better. Thai bonds are 22bps lower in yield, Indonesia -10bps, but Indian bonds for now are quiet. MSCI's AsiaPac Ex-Japan equity index is now back at highs from May 2011, having risen 12 of the last 16 days for a 9.7% gain.While the moves are large, they are not unprecedented and certainly don't signal a wholesale charge back in of new hot-money since volumes remain on the low side for now.
MSCI AsiaPac (ex-Japan) stocks regain 28 month highs after a ~10% rally in the last 2 weeks...
MACRO INDICATORS GROWTH
39 - Financial Crisis Programs Expiration
EMERGING MARKETS - Increasing Liquidity Problem In Selected Markets
The Euro area is no longer the centre of all the stress... EM countries are! Despite their significant correction in recent months, SocGen notes that valuations remain far more extreme (or cheap) and outflows are dominating (despite a 24% discount on a price-to-book basis across EM stocks, they reain rich historically). Significant structural issues like balance of payments, deficit or inflation may lead to further turmoil in emerging markets, potentially destabilising the underlying economies.
Via Societe Generale,
Epicentre of the crisis is moving towards EM Countries
We read history in a simple way.
In 2007/08, what was supposed to be a liquidity crisis at the beginning finally switched into a full blown financial and economic crisis centred in the US. Since 2008, the US has climbed a wall of worries, allowing US assets (both bonds and equities) to outperform.
In the period 2009/mid-2012, the epicentre of the crisis switched to the eurozone, where a mix of bad governance and structural weaknesses led to bailouts and recession. Eurozone assets (except in Germany) are today where the US assets were in 2009, ready to “climb their wall of worries”, with significantly improved governance and an improving growth outlook.
Since 2013, signs of weaknesses have appeared in the EM World, burdened by the prospect of a tighter US monetary policy (read: higher USD) and huge outflows. Significant structural issues like balance of payments, deficit or inflation may lead to further turmoil in emerging markets, potentially destabilising the underlying economies.
When the liquidity tide turns, EM assets are hurt
Recent outflows from EM assets: minor compared to previous inflows
EM assets (both bonds and equities) have suffered strong outflows this year. However, these outflows remain minor compared to cumulative inflows over the last 5 years. So potentially, much more outflows should be expected when the Fed effectively tightens its policy.
When the liquidity support falls, all EM assets (FX, bonds, equities) suffer
The average correlation between EM equities, EM bonds and EM FX has strongly increased since Bernanke first signalled he was considering the tapering of asset purchases.
EM: some structural issues around
The bull story has turned sour in some emerging markets as external balances have deteriorated
Countries with a deteriorating external balance have seen their currencies depreciated strongly since 22 May (e.g. India).
On the contrary, South Korea has been relatively resilient.
EM currencies now fully floating
Compared to historical crises in EM countries, fewer and fewer EM currencies are directly pegged to the USD. While this may be a source of vulnerability in times of market turmoil, it has helped EM countries absorb external shocks more easily.
As always, the market will concentrate on the weakest countries, putting their currency under strong pressure and drying up liquidity.
Elections in sight likely to paralyse decision making for some months ahead
On top of the economic imbalances highlighted above, some EM countries risk paralysis in the coming quarter due to political events. Governments that seek to be re-elected will want to avoid policy tightening, increasing the risk of a market attack.
EM asset valuations have further to fall
EM bonds: spread (versus US Tresuries) is far from extreme and could widen further
Despite the strong correction of EM bonds (+44bp since May 2013), their valuation is far from extreme.
The EM bonds spread over US Treasuries has recently widened. Nevertheless, it remains far from last year’s level and could widen again.
EM equities: do not catch the falling knife yet!
EM equities started to correct in 2010, when they traded at a premium of around 20% relative to developed markets (as measured by the price to book value ratio).
We continue to stay away from EM equities (despite a 24% discount), as outflows are running at high levels.
EM equities and commodities: six versus half a dozen!
Commodity and EM equity cycles have been strongly synchronised over the last 15 years. They obviously have some common key drivers: Chinese demand, the liquidity factor and sensitivity to the USD.
Nevertheless, commodities have recently been more resilient, as many of them are getting close to their cost of production.
MACRO INDICATORS GROWTH
39 - Financial Crisis Programs Expiration
ASIAN CRISIS II - The plight of four Asian countries - China, India, Indonesia and Japan.
If there's one thing which stands out about the West since 2008, it's this: there's been almost no substantive economic reform. There's been a lot of money printed, talking up of prospects (forward guidance in central banker parlance), huge subsidies to save certain sectors, but little restructuring of economies to put them on a more sustainable footing. Where the financial crisis showed the dangers of relying on ever-expanding debt to fund consumption, that reliance has only increased since.
Asia isn't immune from criticism on the reform front either. Much of the region has been busy congratulating itself for avoiding the worst of 2008, while ignoring the growing problems at home. China has fallen into the western-style trap of relying on more debt to produce enough economic growth to ward off a serious downturn. India's in trouble after backtracking on the broad-ranging reforms of the early 1990s which fuelled an average 6% GDP growth over the past two decades. Meanwhile, Indonesia - considered the rising star of Asian economies only a short time ago - has slowed quickly after keeping interest rates too low for too long and failing to sufficiently cut spending on the likes of energy subsidies.
Unlike the West though, the problems in Asia - barring Japan - appear soluble. But the time for reform is now if Asia's to take the next leap forward in its economic development. Today we're going to look at what Asia needs to do to get back on track.
Easy gains are over
If you'd told someone just 20 years ago that emerging markets - of which Asia is by far the largest - would account for more than 50% of global GDP or that China would be the world's second-largest economy, they'd have probably laughed at you or recommended that you visit the nearest psychiatrist. Such has been the rapid rise of the East.
Asia's astonishing progress can be put down to a mix of good management and good luck. The former includes:
1) Bold reform . Think Deng Xiapao's dramatic opening up of China's economy from 1978, India's 1991 balance of payments crisis resulting in broad-ranging economic deregulation, the 1997 Asian crisis and subsequent political, economic and social overhaul of Indonesia, Malaysia, Thailand, South Korea and the Philippines.
2) Relatively stable politics, particularly during the past five years. For instance, Indonesia has had a stable, albeit minority-ruling, government for almost a decade. Even Thailand and the Philippines - both notorious for throwing out leaders through violent and non-violent means - now have well-entrenched governments.
3) Regional integration . Intra-Asia trade has flourished as barriers have come down. The formation of associations such as Asean has helped (though Asean has suffered setbacks of late).
Luck has also played a part, including:
1) The fall of the West from 2008 resulted in investors looking to park their cash in a better, higher-yielding growth story and Asia fit the bill.
2) The commodities boom from 2000 disproportionately benefited the region, particularly China and South-East Asia.
3) Most of Asia has benefited from positivedemographics with young populations driving increased economic productivity.
But many of the trends mentioned above are now turning around. Reform has stalled across the region. While politics remains relatively stable, that could change with key elections in India and Indonesia next year. Regional integration has taken a step backward as U.S.-China rivalry in Asia heats up. Potential QE tapering in the U.S. has already led to investors cashing out of Asia. That hasn't been helped by faltering growth as the commodities boom fades. Finally, demographics have turned negative in the likes of China where the working age population is now in decline.
That doesn't mean the Asian growth story is over. It just means that the easy gains of yesteryear are over. And the region needs to adapt quickly. Kick-starting economic reform to drive growth should be a key priority.
Asia is a large, diverse region though and its countries are at different stages of development and have different issues which need to be tackled. Today, we're going to explore the plight of four Asian countries - China, India, Indonesia and Japan.
Will Xi be the next Deng?
Many people forget how far China has come in a relatively short period of time and yet how poor it remains. In 1978, GDP per capita in China was just US$228. That figure has risen 26x to today's US$6,000. Amazing work. But to put it into context, Chinese GDP per capita is only 12% of the U.S. equivalent of close to US$50,000. China still has a long way to go.
What's got China to this point though has been an aggressive reform zeal. In 1977, the National Congress of the Communist Party chose Deng Xiaoping as Mao Zedong's replacement after the chaos and disastrous social experiments of the Mao years. Deng quickly freed rural households to farm their own plots and keep the earnings. That led to a huge acceleration in farm profits and productivity. Deng also allowed farmers to sell their produce in the city, opening the way for the vast migration of people from country to city, which has transformed China.
From 1982, Deng also proceeded to promote a younger generation of like-minded leaders. These leaders extended many of the reforms into the cities and loosened control of government enterprises and regulations.
And in 1992, Deng kick-started the reform process again by endorsing market experiments of export manufacturing zones on the southern coast. This paved the way for China to become the exporting powerhouse that it is today.
Importantly, however, though Deng died in 1997, the like-minded leaders he groomed carried on his legacy. Deng handpicked his successor, Jiang Zemin, and was also a mentor to Jiang's successor, Hu Jintao.
In 2001, China pushed to enter the World Trade Organisation and was eventually accepted. To join the organisation, China had to roll back trade barriers. In effect, the country opened itself up to foreign trade. This had an enormous impact in subsequent years.
What's clear though is that the economic reform which propelled China's rise stalled under regime of Hu Jintao. Since 2009, the country has instead relied on increasing amounts of debt to sustain its growth. That's led to significant distortions in the economy (real estate and alternative lending bubbles, for instance). And the debt seems to be achieving less and less, with GDP growth decreasing from the 10% average of 1980-2010 to the current 7.5%.
China needs a fresh bout of economic reform to increase productivity and reduce the reliance on debt to fuel growth. Here are some of the things that it needs to do:
Decrease the influence of state-owned enterprises (SOEs). These SOEs number close to 114,000 and account for anywhere from 33-50% of economic output. All academic literature shows government agencies are much less productive than private businesses. Moreover, the more influence they have, the more they crowd out entrepreneurial activity. In China, SOEs control all the key industries, such as banking and resources. That needs to change to unleash growth.
Deregulate the finance sector. China has an immature financial system. It regulates interest rates and deposit rates. It continues the yuan currency peg to the U.S. dollar. Its bond market is still relatively new. Further deregulation will allow capital to flow more freely and to be allocated more effectively.
Clean up the banking sector. China has a bad debt problem that it hasn't owned up to. The stimulus of 2009 was financed via state-owned banks and many of the investments have undoubtedly gone bad. Everyone knows it. Better to acknowledge it now, otherwise it will be a drag on banks and the economy for several years to come.
Boost the services sector. Clearly China's economy has become too reliant on investment spending at the expense of consumption. To increase consumption, it needs to boost the services sector. Doing this will provide more jobs (services are more labour-intensive than manufacturing), a key positive amid a slowing economy.
Increase the social safety net. China's retirement system has assets of US$30 billion compared with the country's foreign exchange reserves totalling more than US$3 trillion. Given the rapidly ageing population, social programs need to be ramped up.
Reduce corruption. There have been well publicised moves against Bo Xilai and, more recently, against the head of the commission which oversees state-owned enterprises. The question is whether these moves are politically motivated or a genuine attempt to reduce corruption. The truth is probably a bit of both but time will tell. Rampant corruption is not only costing the economy (some estimates suggest costs of up to 10% of GDP) but is a direct threat to the legitimacy of the Communist Party (where most of the corruption occurs).
The Communist Party holds a key economic meeting in November where the announcement of wide-ranging economic reforms is expected. I remain cautiously optimistic that Xi Jinping can deliver the necessary reforms but their impact will only be felt in the long-term. In the meantime, China may slow further as it deals with the unwinding of the recent credit bubble.
The move against India seems overdone
Unlike China, India seems to need a large crisis for change to happen. In 1991, a balance of payments crisis precipitated widespread economic deregulation which is credited for driving the rapid economic growth of the past two decades. Another crisis in the early 2000s led to further deregulation and privatisation of key industries. Like clockwork, a decade later, another crisis beckons. And the calls for reform grow stronger.
Unlike many commentators though, I believe the current crisis has been less about India's current account deficit (which essentially means you're investing more than you're spending) and more about capital flows and confidence. The fact is that India's trade deficit (a key component of the current account) has been decreasing since May and is likely to continue to decrease. And there's no correlation between the fall in the currencies of emerging markets and their respective current account deficits. If this view is right, the substantial depreciation in the rupee seems overdone.
The best way to stabilise the rupee would be to raise interest rates but this would impact the economy which has already slowed markedly. Not to mention that increasing rates in the lead-up to a general election is never favoured by incumbent governments.
Alternative options to stabilise the situation include measures to reduce the large budget deficit - at close to 5% of GDP-, the phasing out of energy subsidies - accounting for 2.3% of GDP - and the issuing of international sovereign bonds, denominated in rupee, to bring in capital to fund the current account deficit.
In the long-term, the subsidy issue is crucial. Growing subsidies from a government intent on bribing rural voters has been a central cause of the high inflation. Fertiliser subsidies have increased almost three-fold over the past five years, while petrol subsidies have grown by more than 20x!
India's legendary bureaucracy and corruption will also need to be addressed. The country ranks 94th out of 176 countries in Transparency International's Corruption Perception Index. The likes of China and Sri Lanka, not exactly doyens of clean government, rank higher than India (ie. are perceived as less corrupt). There are some estimates that suggest corruption has cost India more than US$120 billion over the past ten years.
Indonesia: that sinking feeling
Of course, Indonesia is the other country whose currency is under attack. Only 18 months ago, Indonesia was the darling of the investment community. Now, it's become a pariah.
Investors have focused on Indonesia's large current account deficit, which is 3% and growing, versus the 0.7% average of 2008-2011. Clearly the economy has overheated as interest rates were kept too low for far too long (which should have been obvious to the investors who piled into the country's bonds in 2011-2012). To stabilise the currency, the government has hiked rates by 150bps this year. Further rate rises are likely until the trade deficit improves.
A key issue remains reducing fuel subsidies. The government has taken some positive steps on this front, but needs to do more. It raised petrol prices by 44% this year. But the budget deficit is still expected to swell to 3.8% of GDP this year, with fuel subsidies expected to cost 200 trillion rupiah, equivalent to 13% of government revenue.
Like India, Indonesia has a huge corruption problem. The government has long promised to address the problem but few results have been achieved. Indonesia ranks 118 out of 176 countries in Transparency International's Corruption Perception Index. India ranks much better on this index, as noted above, which shows you how much work that Indonesia has to do to tackle corruption.
Decentralisation of government probably hasn't helped the corruption issue. Decentralisation has been lauded for redistributed economic gains from the capital, Jakarta, to regional cities. On the flipside though, corruption has spread with decentralisation, making it harder to detect and fix.
Savings from cutting subsidies and corruption should be used to bolster infrastructure. Anyone who's spent time in Jakarta traffic (the worst of any capital city in Asia if not the world?) knows the extent of the infrastructure problem. To put it into context, Indonesia spends less than 5% of GDP on infrastructure compared with China's 9%. Granted, China has probably overspent on infrastructure, but that shouldn't detract from Indonesia having a much greater need than China for better roads and transport systems and yet it's spending less.
Yes, Indonesia has its problems but let's not forget how far the country has come since 1997 when it was on its knees. Now it's a flourishing democracy, with a relatively strong economy and low debt. Indonesia's issues should prove temporary if a new government can provide fresh impetus to economic reform.
Japan's third arrow may come too late
Japan is very different from the rest of Asia as it's been a developed country for more than 20 years. It's so different that the geniuses in finance developed an Asia ex Japan stock market index, which spawned many Asia ex-Japan funds. This was recognition that Japan was indeed different, but for all the wrong reasons as the country's growth stalled while the rest of Asia boomed. Better to cut Japan off to bring in investor money, the financial world thought.
How things have changed. Japan has attracted droves of investors of late, drawn to the world's biggest turnaround story (at least in their eyes). These investors have followed a simple equation: more stimulus equals a higher stock market. Recent history has taught them as much as the correlation between U.S. stimulus and the stock market there sits at more than 90% since 2009.
The bulls on Japan certainly outnumber the bears at present. They argue the massive stimulus being undertaken, unprecedented in scope, is the best for the country to move its way out of deflation. And promised economic reforms will provide the necessary tonic for sustainable, long-term growth. These reforms, the so-called third arrow of "Abenomics", may include the following:
Labor reform. It's been long recognised that Japan is a tough place to fire people, which makes for a rigid workforce and reduced economic flexibility. That's held back productivity and needs to change for Japan to move forward.
Streamlined regulations. Japanese bureaucracy is entrenched and holds immense power. Too much power, from the perspective of most outsiders. Cutting bureaucracy and regulation would prove positive steps.
Cutting corporate taxes. At 38%, Japan's corporate tax is among the highest in the industrialised world. Economic studies are relatively unanimous in concluding that higher taxes stunt growth.
Increased immigration to address labour shortages. This is highly unlikely given the political sensitivities involved. But Japan's ageing population is a huge issue. Remember that GDP growth equals population growth plus productivity growth, which means a declining working age population provides a significant drag to GDP.
The bears on Japan, of which I am one (see this post for more), argue that the country debt burden is so huge that the country is cornered, whatever it does. If inflation rises to the government's target of 2%, interest rates will rise too and so will the interest burden on government debt. At 2%, this interest burden would be the equivalent of 80% of government revenue. If the stimulus strategy fails, the government will be forced to print more and more money to stay solvent. Either way, the bond market will revolt at some point. And the impact from any reforms is likely to come too late.
39 - Financial Crisis Programs Expiration
MACRO News Items of Importance - This Week
GLOBAL MACRO REPORTS & ANALYSIS
US ECONOMIC REPORTS & ANALYSIS
CENTRAL BANKING MONETARY POLICIES, ACTIONS & ACTIVITIES
The Fed's failure yesterday to announce some sort of tapering of its QE program, despite the consensus of an overwhelming percentage of economists who expected action, once again reveals the degree to which mainstream analysts have overestimated the strength of our current economy. The Fed understands, as the market seems not to, that the current "recovery" could not survive without continuation of massive monetary stimulus. Mainstream economists have mistaken the symptoms of the Fed's monetary expansion, most notably rising stock and real estate prices, as signs of real and sustainable growth. But the current asset price bubbles have nothing to do with the real economy. To the contrary, they are setting up for a painful correction that will likely be worse than the one we experienced five years ago.
Getting out will be infinitely harder than getting in. In fact it will be likely impossible to get out without tipping the country back into recession.
If stock and home prices continue to rise, and if the unemployment picture appears to brighten as a result of a shrinking workforce, the Fed may have an increasingly difficult time explaining why they are failing to cut back on a policy that many mistakenly assume is no longer needed. Look for the rhetorical pretzels to get ever more complex and the goalposts that would trigger an action to become completely mobile.
But the reality is that the economy will never regain true health as long as the stimulus is being delivered. Despite trillions already administered,
the workforce is shrinking,
energy usage is down,
the trade balance is weakening,
savings are down,
inflation is showing up in inconvenient places,
debt is up, and
wages are flat.
So while QE has succeeded in hiding the truth, it hasn't accomplished anything of substance. Unfortunately, the Fed is only interested in the headlines.
We also must understand that even if the Fed were to deliver a small reduction in bond purchases, such a move would change nothing. The Fed would still be adding continuously to its enormous balance sheet while presenting no credible plans to actually withdraw the liquidity. As I have pointed out many times, it simply can't do so without pushing the economy back into recession. Although this would be the right thing to do, you can rest assured that it won't happen.
We should also recall where this all began. When QE1 was first launched Bernanke talked about an exit strategy. At the time I maintained the Fed had no exit strategy. But now questions about an exit strategy have been replaced by much more delicate taper talk. But easing up on the accelerator without ever hitting the brakes will not stop the car or turn it around.
HIDDEN LIE: ITS MONETIZATION
Bernanke has maintained that his purchases of government bonds should not be considered "debt monetization" because the Fed intends to only hold the bonds temporarily. In recent years however talk of actively selling bonds in the portfolio have given way to more passive plans to simply hold the bonds to maturity. But this is a convenient fiction. When the bonds mature, the Fed will have little choice but to roll the principal back into Treasury debt, as private bond buyers could not easily absorb the added selling that would be required to repay the Fed in cash. Judged by his own criteria then, Bernanke is now an admitted debt monetizer.
Following this playbook, the Fed will likely maintain the pretense that tapering is a near term possibility and that it has a credible plan on the shelf to bring an end to QE. In reality the Fed is stalling for time and hoping that the economy will inexplicably roar back to life. Unfortunately, hope is not a strategy.
REDUCED FED OPTIMISM: The Aleph Blog provides a series of interesting charts tracking Fed member expectations over time. The charts show consistently declining optimism regarding recovery. As stated:
After almost two years of giving guidance, they are no closer to tightening than when they started. Tightening is 27 months away, if their estimates are right, same as they thought in January 2012.
Tightening seemed further away when more aggressive QE was introduced, but that quickly abated, like a drug addict adjusting to higher doses.
CURRENCY WARS: An interesting aspect of yesterday’s decision is the potential risk of a currency war. All developed economies are weak and looking for improvement. Currency depreciation alters the terms of trade among nations and can provide short-term advantages. That happened yesterday. As a result of the Fed’s announced continuation of liquidity injections, the dollar weakened against competing currencies. Trade terms shifted to the advantage of the US at the expense of other nations. A “beggar thy neighbor” card was played by the US. Who, when and how many may follow in an attempt to offset this US move will be known over the next several months. Risk of a currency war raises the risk of world-wide inflation.
Pressures on the Fed to fund continuing government deficits eased recently as a result of deficits shrinking. For the first time in almost two years, the Fed had room to move. They chose not to.
In his prepared remarks Bernanke pointed to three factors staying the Committee's hand from tapering today:
First, a desire to see MORE DATE (presumably labor market data) before feeling comfortable with the outlook,
Second, a desire to assess the degree to which tighter financial conditions -- particularly MORTGAGE RATES -- are affecting the real economy, and
Third, a desire to gain some clarity on "upcoming FISCAL DEBATES ."
Realistically, by the time of the October meeting the Fed will only have, at best, more visibility on the last of these three issues. Thus we see December as the more likely time of the first taper. We should mention that there is no guarantee that housing and the labor market will look better by December. In which case to get out of the "QE infinity" box the Fed may have to resurrect issues relating to the costs and efficacy of asset purchases.
Federal Reserve officials on Wednesday kept the central bank's $85 billion-per-month bond-buying program in place, saying that they wanted to see more evidence that the economy can sustain improvement before scaling back its bond purchases, but they made clear that they are poised to reduce the program if they saw more evidence of a strengthening economy.
Fed officials pointed to concerns that financial conditions had tightened in recent months and that those conditions could slow the economy if sustained.
Fed officials were on the fence in the days leading up to the meeting, even though many investors were convinced the central bank would make a small reduction to the bond-buying program at the September meeting.
The Fed's policy-making committee said it "decided to await more evidence that progress will be sustained before adjusting the pace of its purchases" in the formal statement released after the meeting. The Fed said its bond purchases were "not on a preset course."
The Fed employed the latest round of bond buying about a year ago in a bid to push down long-term interest rates and spur more investing, spending and hiring. So far this year it has been buying $85 billion per month in mortgage and U.S. Treasury bonds.
Fed officials also voted to keep short-term interest rates near zero, where they have been pinned since late 2008. Most Fed officials indicated in their latest economic projections, also released Wednesday, that they expect to make the first interest-rate increase in 2015 or later.
New Fed forecasts for the economy and monetary policy show most officials expect to keep interest rates low well into the future. Ten of 17 Fed officials said they expected the central bank's benchmark interest rate, which is called the fed funds rate, to be at or below 2% by the end of 2016. 14 of 17 officials said they don't expect the Fed to start raising the fed funds rate until 2015 or later.
And here is where Hilsy gets downright apologetic:
The forecasts also highlight the complex economic environment that Fed Chairman Ben Bernanke confronts. Fed officials, who have been consistently disappointed by economic growth, nudged down their growth forecast for this year and next year, projecting growth between 2% and 2.3% in 2013 and between 2.9% and 3.1% in 2014. Yet Fed officials' view of unemployment hasn't changed much. They expect the jobless rate to keep falling to between 7.1% and 7.3% by the end of next year, which is little changed from their June projections.
In other words, the persistently wrong Fed will continue doing more of what has failed to achieve any success to date. What can possibly go wrong?
Confused why the Fed stunned everyone, and is willing to anger the TBAC by soaking up to a whoping 0.4% in 10 Year equivalents from the bond market each week thus crushing bond market liquidity even more? The reason is simple: even further trimming in the Fed's economic forecasts, which now sees 2014 GDP growth of 2.9%-3.1%, well below the 3.0%-3.5% seen in June, driven by yet another reduction in its PCE inflation forecast from 1.4%-2.0% to 1.3-1.8%.
With the Taper now off the table, and with the next earliest probable discussion of a Taper at the December FOMC meeting if then even, Bernanke - who may now stay have no choice but to stay for a third term - has decided to reflate the bubble to end all bubbles, along the lines of what we speculated may be the case in "Bernanke's Helicopter Is Warming Up", it is worth refreshing what Bernanke Asset Management's year end stock market target is. As a reminder, back in April we highlighted that in a world of central planning the only relevant thing to risk assets is the size of the Fed's balance sheet, and since there will be no change in the rate of ascent, we can once again repost what we showed nearly 6 months ago as to where the Fed believes the fair value of the S&P500 should be. The answer: 1,950 or bust.
There is a modest rebound from knee-jerk levels but in general everything is moving how one would expect since the Fed chickened out... The USD is collapsing, Gold and stocks soaring, and 10Y yields tumbling... VIX and Bond vol has also collapsed. Let's just wait for Ben to bugger it all up with his communications...
The Fed will blow up the economy if it continues money-pumping, but it will choke off the fragile recovery if it cuts back its money-pumping.
The Federal Reserve is in a classic double-bind: as its policies to boost growth bear fruit, interest rates rise, threatening the very recovery the Fed has lavished trillions of dollars of quantitative easing (QE) to generate.
Higher growth naturally leads to higher interest rates, which then choke off growth.
The Fed's goal was a self-sustaining recovery, in which growth reaches "escape velocity," i.e. is strong enough to support higher interest rates.
But the pursuit of that goal via trillions of dollars of asset purchases has inflated asset bubbles in stocks and real estate. The Fed's goal was to push speculative and institutional money into risk assets such as stocks, generating a "wealth effect" that was supposed to spill over into the real economy via higher borrowing and spending.
The pursuit of "the wealth effect" via inflating asset bubbles has created another double-bind: now that markets have become dependent on Fed money and liquidity pumping, the Fed cannot reduce its QE money-pump (currently $1 trillion a year) without tipping the stock market into free-fall.
If the Fed continues its massive monetary easing programs, asset bubbles will only inflate to speculative extremes, to the point where violent bursting becomes a matter not of "if" but of "when." (This is also known as "the music stopping.")
If the Fed cuts back its money-pumping and asset purchases, interest rates will rise, as interest rates will seek a market level that isn't pushed to near-zero by the Fed's financial repression.
Higher rates will choke off tepid Fed-induced growth. We already see home refinancing rates plummeting to 2009 recessionary levels.
So the Fed risks blowing asset bubbles that will devastate the economy if it continues the QE pumping, but it risks killing the tepid recovery if it cuts back its pumping. Darned if you do, darned if you don't.
Put another way: if growth is needed to boost corporate sales and profits, but growth leads to higher interest rates and reduced central-bank suppport of markets, this is a double-bind with no exit.
FEDERAL RESERVE - At the very heart of our economic problems
As we approach the 100 year anniversary of the creation of the Federal Reserve, it is absolutely imperative that the American people understand that the Fed is at the very heart of our economic problems. It is a system of money that was created by the bankers and that operates for the benefit of the bankers.
The American people like to think that we have a "democratic system", but there is nothing "democratic" about the Federal Reserve. Unelected, unaccountable central planners from a private central bank run our financial system and manage our economy. There is a reason why financial markets respond with a yawn when Barack Obama says something about the economy, but they swing wildly whenever Federal Reserve Chairman Ben Bernanke opens his mouth.
The Federal Reserve has far more power over the U.S. economy than anyone else does by a huge margin. The Fed is the biggest Ponzi scheme in the history of the world, and if the American people truly understood how it really works, they would be screaming for it to be abolished immediately. The following are 25 fast facts about the Federal Reserve that everyone should know...
#2 The United States never had a persistent, ongoing problem with inflation until the Federal Reserve was created. In the century before the Federal Reserve was created, the average annual rate of inflation was about half a percent. In the century since the Federal Reserve was created, the average annual rate of inflation has been about 3.5 percent, and it would be even higher than that if the inflation numbers were not being so grossly manipulated.
#3 Even using the official numbers, the value of the U.S. dollar has declined by more than 95 percent since the Federal Reserve was created nearly 100 years ago.
#4 The secret November 1910 gathering at Jekyll Island, Georgia during which the plan for the Federal Reserve was hatched was attended by U.S. Senator Nelson W. Aldrich, Assistant Secretary of the Treasury Department A.P. Andrews and a whole host of representatives from the upper crust of the Wall Street banking establishment.
#6 The following comes directly from the Fed's official mission statement: "To provide the nation with a safer, more flexible, and more stable monetary and financial system. Over the years, its role in banking and the economy has expanded."
#7 It was not an accident that a permanent income tax was also introduced the same year when the Federal Reserve system was established. The whole idea was to transfer wealth from our pockets to the federal government and from the federal government to the bankers.
#8 Within 20 years of the creation of the Federal Reserve, the U.S. economy was plunged into the Great Depression.
#10 According to an official government report, the Federal Reserve made 16.1 trillion dollars in secret loans to the big banks during the last financial crisis. The following is a list of loan recipients that was taken directly from page 131 of the report...
Citigroup - $2.513 trillion Morgan Stanley - $2.041 trillion Merrill Lynch - $1.949 trillion Bank of America - $1.344 trillion Barclays PLC - $868 billion Bear Sterns - $853 billion Goldman Sachs - $814 billion Royal Bank of Scotland - $541 billion JP Morgan Chase - $391 billion Deutsche Bank - $354 billion UBS - $287 billion Credit Suisse - $262 billion Lehman Brothers - $183 billion Bank of Scotland - $181 billion BNP Paribas - $175 billion Wells Fargo - $159 billion Dexia - $159 billion Wachovia - $142 billion Dresdner Bank - $135 billion Societe Generale - $124 billion "All Other Borrowers" - $2.639 trillion
#11 The Federal Reserve also paid those big banks $659.4 million in fees to help "administer" those secret loans.
#12 The Federal Reserve has created approximately 2.75 trillion dollars out of thin air and injected it into the financial system over the past five years. This has allowed the stock market to soar to unprecedented heights, but it has also caused our financial system to become extremely unstable.
#13 We were told that the purpose of quantitative easing is to help "stimulate the economy", but today the Federal Reserve is actually paying the big banks not to lend out 1.8 trillion dollars in "excess reserves" that they have parked at the Fed.
#14 Quantitative easing overwhelming benefits those that own stocks and other financial investments. In other words, quantitative easing overwhelmingly favors the very wealthy. Even Barack Obama has admitted that 95 percent of the income gains since he has been president have gone to the top one percent of income earners.
#15 The gap between the top one percent and the rest of the country is now the greatest that it has been since the 1920s.
#16 The Federal Reserve has argued vehemently in federal court that it is "not an agency" of the federal government and therefore not subject to the Freedom of Information Act.
#19 The Federal Reserve system greatly favors the biggest banks. Back in 1970, the five largest U.S. banks held 17 percent of all U.S. banking industry assets. Today, the five largest U.S. banks hold 52 percent of all U.S. banking industry assets.
#21 The Federal Reserve was designed to be a perpetual debt machine. The bankers that designed it intended to trap the U.S. government in a perpetual debt spiral from which it could never possibly escape. Since the Federal Reserve was established nearly 100 years ago, the U.S. national debt has gotten more than 5000 times larger.
#23 If the average rate of interest on U.S. government debt rises to just 6 percent (and it has been much higher than that in the past), we will be paying out more than a trillion dollars a year just in interest on the national debt.
#24 According to Article I, Section 8 of the U.S. Constitution, the U.S. Congress is the one that is supposed to have the authority to "coin Money, regulate the Value thereof, and of foreign Coin, and fix the Standard of Weights and Measures". So exactly why is the Federal Reserve doing it?
#25 There are plenty of possible alternative financial systems, but at this point all 187 nations that belong to the IMF have a central bank. Are we supposed to believe that this is just some sort of a bizarre coincidence?
This is beginning to feel like 1999, although you don’t have to cue Prince if you don’t want to. Just consider the following:
In 1999, we had a Federal Reserve which pushed liquidity into the system ahead of Y2K concerns. Now, we have a Fed newly recommitted to liquidity operations to spark a better economic recovery.
In 1999, many investors – including some the Street’s best and brightest – openly mocked the ridiculous valuations afforded to tech stocks in the dot-com bubble. Now, we have many very smart people voicing similar opinions about U.S. equities generally.
In Q4 1999, those smart hedgies ended up buying the market with both hands to play catch up for three quarters of underperformance. History doesn’t repeat itself, of course, but it isn’t hard to see the AABBA rhyme scheme of the bawdy limerick here. It may well be retail investors who finally capitulate and start buying, or hedge funds, or still cautious long-only managers. After all, who has really caught the whole move since March 2009?
Make no mistake – there is more than enough to be worried about as we get ready to hit the 2013 home stretch. Everything we listed as concerns, plus a host of other issues, wait in the wings. They will have their turn.
But in the meantime, we have a newly dovish (in the eyes of the market, anyway) Federal Reserve, a winning stock market year-to-date, and a raft of investors surprised by the central bank’s move yesterday. All that feels like a recipe for a melt-up. It may not rival a cute set of twins, but it won’t take 9 months to deliver either.
This is Very Much Similar to the 1999 Dotcom Run-Up
Having crossed the $1,000 Maginot Line, Priceline.com became the first company in the S&P 500's 56-year history to trade at that level. As WSJ reports, the company reached a high of $1,001, before settling at $995.09, up 2.6%. It's up 60% so far this year. 25 of the 30 analysts that cover the stock still have this firm as "Buy" with a target of $1,112 trading at a P/E of 32. Priceline's shares have flirted with $1,000 before. During the dot-com bubble, it topped out split-adjusted closing high of $974.25 in April 1999. The stock had a meltdown in the years that followed, closing below $7 a share in October 2002. Of course, it's different this time...
COMMODITY CORNER - HARD ASSETS
PRIVATE EQUITY - REAL ASSETS
2013 - STATISM
STATISM - The process of globalized economic and political governance
Ultimately, QE cuts will be detrimental because they are MEANT to be detrimental, and this is in pursuit of one of only two possible goals: Either the Fed is seeking to deliberately undermine the U.S. economy in order to set in motion a final collapse, or, the Fed wants to create just enough desperation in order to force the American people to beg for more stimulus, and thus force us to accept partial responsibility for the eventual inflationary demise of the dollar. In either case, the Fed's tactics serve one purpose – to secure the globalization of America by any means necessary. A wounded America is more liable to embrace centralization and abandon sovereignty than a strong America. I’ll let George Soros explain one more time just to drive the point home:
The process of globalized economic and political governance has been a long and carefully planned one, and the existence of a prosperous U.S. is not a part of the program. There have been many events over the past several decades that we can look back on objectively and understand the role they played in the destruction of the U.S. as a sovereign nation. At the edge of the Federal Reserve’s 100th anniversary, it is vital that we see the current developments for what they really are – history changing, in a fashion so violent they are apt to scar America forever.
The amounts of money that have been spent in the past decade can only be characterized as obscene. But the point that really matters is this: Military spending is just part of the bubble. The military-industrial-intelligence-law enforcement complex has only a few choices left in front of it. (Aside from rational things, like giving up their immoral and abusive game.)
...In addition to the military complex, we have a massive intelligence complex.
Not only that, but we also have a massive law enforcement complex. The Department of Homeland Security has given them at least $34 Billion in the past several years, on top of their take from local taxes, state taxes, fines, seizures, and other Fed money.
Take a look at these graphs. First, defense spending:
Then, intelligence spending, or as close as I’ve been able to get to real numbers:
Lastly, War on Drugs spending, which we’ll use as a proxy for overall law enforcement spending (numbers that are more difficult to acquire):
Needless to say, this multi-headed beast is huge, requiring oceans of money… and it’s about to have its rations cut. Actually, that may be why they’re so hot for a war in Syria – they need to goose spending again, and quickly.
Power Corrupts, but Arrogance “Stupidizes”
Yeah, I know that word’s not in the dictionary, but it should be.
These agencies are drunk on power and stupid on arrogance.
There’s no other way to describe a situation where the intelligence and law enforcement branches of this beast have been waging a war against the American people for the last few years.
Think of the endless search for “domestic terrorists,” the sickening NSA spying on everyone, and the 135 SWAT team raids per day in America. Apparently it has never entered their minds that people might eventually resent being abused.
It’s also useful to understand that “intelligence agency” is the same thing as “secret service,” and very little different from “secret police.” They’ve had secret courts for some time, after all.
I won’t even talk about the rampant corruption that runs through all of these departments; you can either trust me on that one or not.
And this situation reaches all the way to local cops. I had a conversation recently with a young man who recently completed a stint with the US Marines and didn’t know what he wanted to do next. At one point, he said that he thought about being a police officer (an easy fit for a Marine), but he rejected the idea.
“Why?” I asked.
“Cops are bullies,” he responded.
And indeed they are. They lie all the time, they intimidate people all the time, and they treat everyone as a violent perp. (Except if you’re rich or politically connected, of course.) Like the rest of the military-industrial complex, they are out of control.
There used to be cops who were exceptions to this young man’s “bully” statement, but they have been vanishing rapidly. Cops are routinely taught to intimidate and lie.
What Dooms Them
So, while things look absolutely horrible at the moment, the rug is being pulled out from underneath these wastrels.
The issue here (as it so often is) is fiat currency. The money for all of this War Welfare has NOT come from taxes. Instead, it has come from deficits, a.k.a. money printing. The problem is, the money printing game is sputtering. And without a strong money printing program, future increases in military spending will have to come from increased taxes – and there simply isn’t any more to be taken.
American workers already have about half their money taken from them. The now-denuded middle class is surviving on food stamps, disability payments, and a dozen other programs that dish out federal money. They’ve undergone a long, hard fall, from working machines to working government programs.
The military-industrial-intelligence-law enforcement complex has only a few choices left in front of it. (Aside from rational things, like giving up their immoral and abusive game.)
Those choices include:
Find a way to legitimately juice the economy. (Good luck.)
Make people want to be poorer. (Again, good luck.)
Act like Stalin and terrorize your populace openly. (Americans still have guns.)
Create a really, really scary foreign devil. (A tough sell these days, but not for lack of trying.)
Create an iron-clad, world monetary system and government. One that can feed them no matter what. (Probably requires a nuclear war first.)
Create a truly scary war, with piles of dead people in US cities. Then folks will be frightened enough to hand over the rest of their money.
Down-size: Work with their politicians and bankers to dominate only the major cities, the major corporations, and those who will live as dependents to the system. Abandon most of the rest and stop meddling in all the world’s affairs.
The one other possibility for them is to convince the Fed to print faster and damn the consequences. And they may choose that option first, since it would allow them to kick the can just a little bit further down the road.
But once that’s done, they’ll be right back to these seven choices.
GLOBAL FINANCIAL IMBALANCE
STANDARD OF LIVING
CORRUPTION & MALFEASANCE
NATURE OF WORK
CATALYSTS - FEAR & GREED
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