Thoughts on the Electronic Printing Press

May 12, 2013

Indicators of serious market excess abound. The yen was hit for 2.6% this week, with the dollar/yen breaking above 100 to the highest level since 2008. Gold was down 1.5%, silver 1.5%, and platinum 2.0%. Japan’s Nikkei jumped 6.7%, increasing 2013 gains to 40.5%. Japan’s 10-year government bond (JGB) yield jumped 13 bps to the highest level since February, as sovereign yields generally moved higher across the globe. Global equities generally added to recent gains. Meanwhile, currency markets have turned increasingly unsettled. The dollar index gained 1.2%. So called “commodities currencies” came under pressure. The South African rand fell 2.3%. The Australian dollar dropped 2.9%, falling below parity to the U.S. dollar for the first time in almost a year. The New Zealand dollar sank 2.7%. Other notable currency declines this week included the Swiss franc down 2.2%, the Indian rupee down 1.6%, and the Russian ruble 1.2% lower.
May 9 – Bloomberg (Simon Kennedy and Jennifer Ryan): “Global central bankers are poised to ease monetary policy even further after a wave of interest-rate cuts from India to Poland. As Group of Seven finance chiefs gather in the U.K. tomorrow, economists at Morgan Stanley and Credit Suisse Group AG are among those predicting policy makers will keep deploying stimulus amid weak global growth, slowing inflation and the need to thwart currency gains. ‘Most central banks in our coverage universe still have a bias to ease,’ Morgan Stanley economists led by… Joachim Fels said… ‘South Korea’s rate cut today was the 511th reduction worldwide since June 2007… While the tide of liquidity has sent stock markets surging, it has yet to prove as effective in generating economic growth. ‘Central banks are our best friends not because they like markets, but because they can only get to their macro objectives by going through the markets,’ Mohamed El-Erian, chief executive officer at Pacific Investment Management… said.”

Global central banks around the world continue to push monetary easing like never before. The Fed and Bank of Japan currently combine for almost $180bn of monthly quantitative easing, an historic experiment in monetary inflation. And as economies respond little to unprecedented monetary stimulus, global central banks resort to only more dramatic measures. In the face of virtually unlimited global liquidity, commodities prices trade poorly. It seems an appropriate market juncture to take a little deeper dive into contemporary “money printing.”

To set the analytical backdrop, keep in mind core facets of my Global Credit Bubble thesis. First, the world is in the midst of a unique episode of unconstrained Credit on a global basis. There are today essentially no limits to either the quantity or the quality of debt issued, which I see as a multi-decade experiment in unanchored global electronic “money” and Credit.

Importantly, the evolution to non-bank marketable debt accelerated rapidly during the nineties. Facing an impaired banking system early in the decade, the Greenspan Fed accommodated an explosion of securitized lending, derivatives, securities finance and leveraged speculation. As financial Bubbles took root, Fed doctrine increasingly gravitated to backstopping vulnerable securities markets. In the process, monetary policy came to heavily incentivize financial speculation. As the world’s leading market – and the dominating central bank of the world’s “reserve currency” – U.S. financial and policy trends rapidly spread around the globe. Massive U.S. current account deficits, dollar devaluation and limitless liquidity for speculation helped export the U.S. Credit Bubble to financial and economic systems everywhere.

Predictably, a prolonged global Credit boom spurred epic imbalances and wreaked havoc on economic structures. Inflationary impacts have been uneven and notably disparate. Throughout Europe, years of maladjustment have created highly indebted, wealth-deficient economies dependent upon the ongoing expansion of non-productive Credit. In China and throughout Asia, unending Credit expansion and massive “hot money” flows have fueled an historic boom in manufacturing capacity (basic goods and technology). Especially since the post-2008 stimulus free-for-all, overheated “developing” Credit systems and economies have created acute vulnerabilities to any Credit slowdown, general tightening of finance or reversal of "hot money" flows.

In the U.S., many years of easy “money” and unstable Credit engendered an experimental consumption and services-based economic structure – along with an asset-inflation prone financial sector. As the U.S. deindustrialized and inflated Credit, massive global imbalances accumulated on an annual basis in the rapidly industrializing Chinese and “developing" economies. The Fed’s most recent QE measures ensured U.S. economic and financial systems develop an only more acute dependency on ultra-loose monetary conditions.  Aggressive QE also ensured yet another bout of destabilizing financial flows for our Bubble cohorts in China and “developing” Asia.

In Japan, decades of loose monetary policy have accommodated an astonishing buildup in government debt. While different countries and regions suffer divergent ill-effects, financial and economic systems everywhere are today dependent on uninterrupted aggressive monetary stimulus. One would have to go back to the 1920’s to see any comparable period with such extreme maladjustment and imbalances on a global basis.

Over the years, I’ve remained focused on that nature of monetary inflations. In particular, there is the powerful dynamic whereby policymakers fall prey to the inflationary expedient - and they invariably find it impossible to break free. History is replete with examples of how once the printing presses gets revved up there’s no turning them down: the presses inevitably run for more hours - and when there become insufficient hours in the day the presses seamlessly shift to cranking out currency with additional zeros.

Yet each monetary inflation has its own dynamics and nuances. These days, we’re dealing with central banks and their electronic “printing press” – injecting liquidity into the marketplace as these banks acquire marketable debt securities (monetization). After a number of years of quantitative easing, we’re beginning to gain a better understanding of how these electronic printing presses actually operate.

The traditional printing press inflation worked generally to disburse currency throughout the real economy. Such currency devaluations would work to inflate prices generally, in the process reducing real purchasing power (nominal currency units buy less). This inflation would work to raise interest rates and impinge investment, while also working to boost wage demands throughout the economy. Inflation’s myriad negative effects would devalue the currency, especially on the foreign exchange market.

The contemporary electronic “printing press” is an altogether different animal. It essentially feeds liquidity directly into the financial markets – first and foremost inflating securities prices. There is little generalized inflation in nominal purchasing power, hence in prices throughout the real economy. Indeed, abundant marketplace liquidity actually works (unevenly) to stimulate investment. And with consumer prices in aggregate seemingly well contained, most will find justification for quite elevated stock and bond prices. And as securities markets booming and traditional inflationary risks stay seemingly nonexistent, one is easily enamored with the central banks’ new electronic toys.

It’s my view that asset inflation and Bubbles potentially have significantly more pernicious effects than traditional consumer price inflation. I would definitely argue that consumer price inflation is easier for central banks to rectify. As such, the electronic version is proving itself a more dangerous tool than the traditional currency printing press. In the end, asset market Bubbles are vehicles for wealth redistribution, resource misallocation and wealth destruction, although these heavy burdens remain masked by the boom-time perception of wealth creation and abundance.

The traditional overheated printing press worked to devalue currencies. How about the electronic version? Notably, gold and many commodity prices have been under pressure in the face of recent unprecedented QE. In one sense, an argument could be made that contemporary central bank “money printing” inflates debt and equities prices and, in effect, seemingly inflates the value of some currencies. Indeed, QE has significantly inflated tens of Trillions of U.S. stocks and fixed-income securities. In somewhat of a replay of late-nineties “king dollar” dynamic, the Federal Reserve’s market support operations have provided a competitive advantage to U.S. markets and, hence, the U.S. dollar. Essentially, Fed monetary inflation coupled with a financial mania is currently inflating U.S. securities markets relative to gold and commodities. This speculative dynamic is increasingly pressuring the “global reflation trade” more generally.

Traditional printing press or the newfangled version, monetary inflations always have unintended consequences. Incentivizing speculation is a prominent flaw in current (inflationist) central bank doctrine. And the larger and longer that speculative Bubbles are nurtured, the more precarious they become. This is a major part of the trap that global central bankers have fallen into. And the more fragile maladjusted global economies become the more aggressively they resort to the electronic printing press. The upshot has been increasingly unstable market Bubbles on a globalized basis – which translates into only greater systemic fragilities.

Highly speculative markets become really unpredictable affairs. Greed, fear and gamesmanship take over. Short squeezes, dislocations and melt-ups wreak havoc with market stability. “Greater fool” dynamics take on a life of their own. And never has there been such a massive pool of highly sophisticated speculative finance seeking to extract wealth from an equally massive pool of unsophisticated “money” searching for markets returns - on a global basis. On the one hand, years of manipulated interest rates, markets backstops and interventions ensured that sophisticated market operators accumulated astronomical wealth and assets under management. And, going on five years now, Fed zero interest rate policy has pushed the unsuspecting saver out into the risk market jungle.

To attempt to return to some semblance of monetary stability, the Fed and global central banks should be moving forcefully to remove excess market liquidity and dampen speculation. But instead of removing accommodation, the electronic printing press is providing highly speculative and unstable global markets with incredible amounts of additional liquidity.

More recently, Bank of Japan policymaking has set loose a major yen devaluation. This has opened the flood gates to God only knows how much “money” from Japanese institutions and retail investors – not to mention hot “carry trades” which sell yen instruments to speculate in securities markets around the world.

The way things have been shaping up, the Abe yen devaluation play could provide one of history’s most bountiful speculative forays. Actually, 2013 has all the makings for a historic year in speculative finance – a proliferation of global market Bubbles providing opportunities to make fortunes – that is, if gains can be retained throughout the year. On CNBC and elsewhere the airwaves are filled with bullish analysis. What I don’t see is discussion of what I see on my Bloomberg screens: wild and increasingly unstable markets dominated by speculation.

I see heightened instability in the currency and commodities markets, where yen weakness and dollar strength are feeding extraordinary marketplace uncertainties. In unsettled commodities markets, general weakness coupled with the potential for a dollar upside lurch has created uncertainty and instability. In bonds and throughout global fixed income, a historic issuance boom at record low yields - especially in the riskiest segments of the marketplace - is indicative of late-cycle froth now conspicuous throughout global Credit markets.

In equities markets, well, speculative dynamics have taken full command. The bears have been squeezed into oblivion, with a dearth of selling pressure now allowing speculators to easily push prices higher. Bringing back memories of 1999, heavily shorted Tesla Motors was up 41% this week and Green Mountain Coffee jumped 33%. It was a week where I was again contemplating “how crazy could things get?”
The Fed and global bankers should never have become such active players in the financial markets. Asset inflation is indeed more dangerous than consumer price inflation. Central banks will actively support asset prices, while refusing to remove the punchbowl. At all costs, Chairman Bernanke will avoid being a Bubble Popper. And when you read his comments from Friday morning (below), keep in mind that as Bubbles become more systemic they actually become less conspicuous. Today, Bubbles proliferate throughout the securities and asset markets. It’s all become one big historic global Bubble. Yet the Bernanke Fed won’t even begin tapering its $85bn monthly “money printing” operation in the midst of increasingly conspicuous market excesses.

Federal Reserve Bank of Chicago President Charles Evans: “You talked about monitoring markets at great length. A major cause of the recent financial crisis was the failure to identify the housing bubble, and you spoke on that. Could you expand a little bit more on what's being done to identify current and future asset bubbles, and are you optimistic that we've identified them and nothing like that is going on at the moment?”

Chairman Bernanke: “Well, our monitoring -- there's really two parts to it. So the first is that we do, in fact, do what we can to try -- I would say the word ‘bubbles’ is a freighted word. And let me just say we try to identify situations where asset valuations relative to fundamentals are historically anomalous, where, for example, in the case of housing, we would have seen house prices relative to rents as being much higher than historically normal.

So we have an extensive program to try to assess whether major asset classes are in fact within historically normal ranges… In the stocks and equities, we look at dividend rates and earnings and the equity premium, those various kinds of standard finance indicators. In corporate debt, we look at measures that would help us assess the amount of default risk and therefore to assess whether spreads are appropriate or not. In more complex instruments like structured credit products, we look at a variety of things, including the terms and conditions. Are we seeing, for example, as we are in some cases, covenant-lite types of agreements in certain kinds of structured credit products. So we do try to identify, much more so than in the past, whether major asset classes are deviating in terms of their price or valuation from historical norms.

Now, that being said, two comments. One is that I think it would be hubristic to believe that we could always identify such deviations. On the one hand, sometimes changes in price-to-earnings ratios are justified by some fundamentals. You know, Microsoft stock is worth more than it was some time ago, and this may still yet prove to be a bubble. But so far so good, right? At the same time -- it’s not evident that having a misalignment or historically unusual relationship is a problem, though it may be. But of course, we can also miss changes in valuation that are, in some sense, not fundamentally justified.”

Reserve Currency (US Dollar) Demise — Circa 2013?

By: Ashish Advani

So the Dow Jones Industrial Average closed above the psychological 15,000 barrier Tuesday.

The surge in stock prices must be pleasing the stock jockeys and the blind analysts. The media and newspapers are full of the U.S. recovery stories and how we are now nearly out of the woods.

Just look at the jobs number last Friday. The United States apparently created 165,000 jobs in April. I was watching some of the acclaimed economists that adorn TV stations, who all unanimously acknowledged after "checking under the hood" that the number is solid and deserves a standing ovation.

Hurray USA. NOT!!

OK. Once the flag waving is over, let's really see what made up this number. I have often spoken about the Birth/Death Rate Model, which is published by the Bureau of Labor Statistics (BLS — same guys who publish the monthly data on jobs growth). This is a model that is supposed to predict the number of jobs that "ought" to have been created on a bunch of different measures. In other words, we are not sure if these jobs really got created, but we believe they ought to have been created — says the BLS.

The BLS "ghost" jobs for the month of April was 193,000.

In other words, if the "ghost" jobs were not added, we would have lost jobs for the month.

So much for the feel good factor!

Moving from make-believe news to real news …

Monday night, Chinese Premier Li Keqiang pledged to come up with a plan by the end of this year to allow investments and currencies to move freely in and out of China. In other words, he is pledging to free the Chinese yuan of currency restrictions and freely float the currency. While we have seen the yuan gain over 30 percent during the past several years, one of the biggest reservations to claiming reserve status is free trade in the currency.

Even if the premier misses the launch date by a few months, the yuan is about to float freely. Once this happens, we will see a surge of countries that will rush to join the already 40+ nations that have signed bilateral currency trade agreements with China. That will signal the beginning of the rapid decline of the U.S. dollar and the loss of its reserve currency status as it slides into an irrelevancy.

This does not mean that the U.S. dollar will be worthless. Like the British pound, it will still be traded, but with less dominance in the world.

Many of the actions that the U.S. government takes are based on the U.S. dollar being the reserve currency. Once we lose that, the loss will affect each one of us as our standard of living deteriorates and we become less critical to world growth.

Making the U.S. dollar worthless seems to be the prerogative of the current fiscal policies. The continuation of deficits, the lack of will to suffer austerities, the impatience to suffer minor inconveniences at airports (withdrawal of sequestration cuts to air traffic controllers) and the resistance to bring about real reform by forcing our congressmen to pass bitter but fiscally responsible policies are all dragging the dollar down.

Despite a rate cut, the euro did not decline last week. What does that tell you about the plight of the U.S. dollar?

If this does not urge you to diversify away from the dollar, what will?

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