Breaking Bad Habits

Stephen S. Roach

27 June 2013

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NEW HAVEN – It was never going to be easy, but central banks in the world’s two largest economies – the United States and Chinafinally appear to be embarking on a path to policy normalization. Addicted to an open-ended strain of über monetary accommodation that was established in the depths of the Great Crisis of 2008-2009, financial markets are now gasping for breath. Ironically, because the traction of unconventional policies has always been limited, the fallout on real economies is likely to be muted.
The Federal Reserve and the People’s Bank of China are on the same path, but for very different reasons. For Fed Chairman Ben Bernanke and his colleagues, there seems to be a growing sense that the economic emergency has passed, implying that extraordinary actionnamely, a zero-interest-rate policy and a near-quadrupling of its balance sheet – is no longer appropriate. Conversely, the PBOC is engaged in a more pre-emptive strikeattempting to ensure stability by reducing the excess leverage that has long underpinned the real side of an increasingly credit-dependent Chinese economy.
Both actions are correct and long overdue. While the Fed’s first round of quantitative easing helped to end the financial-market turmoil that occurred in the depths of the recent crisis, two subsequent rounds – including the current, open-ended QE3 – have done little to alleviate the lingering pressure on over-extended American consumers. Indeed, household-sector debt is still in excess of 110% of disposable personal income and the personal saving rate remains below 3%, averages that compare unfavorably with the 75% and 7.9% norms that prevailed, respectively, in the final three decades of the twentieth century.
With American consumers responding by hunkering down as never before, inflation-adjusted consumer demand has remained stuck on an anemic 0.9% annualized growth trajectory since early 2008, keeping the US economy mired in a decidedly subpar recovery. Unable to facilitate balance-sheet repair or stimulate real economic activity, QE has, instead, become a dangerous source of instability in global financial markets.
With the drip-feed of QE-induced liquidity now at risk, the recent spasms in financial markets leave little doubt about the growing dangers of speculative excesses that had been building. Fortunately, the Fed is finally facing up to the downside of its grandiose experiment.
Recent developments in China tell a different story – but one with equally powerful implications. There, credit tightening does not follow from determined action by an independent central bank; rather, it reflects an important shift in the basic thrust of the state’s economic policies. China’s new leadership, headed by President Xi Jinping and Premier Li Keqiang, seems determined to end its predecessors’ fixation on maintaining a rapid pace of economic growth and to refocus policy on the quality of growth.
This shift not only elevates the importance of the pro-consumption agenda of China’s 12th Five-Year Plan; it also calls into question the longstanding proactive tactics of the country’s fiscal and monetary authorities. The policy response – or, more accurately, the policy non-response – to the current slowdown is an important validation of this new approach.
The absence of a new round of fiscal stimulus indicates that the Chinese government is satisfied with a 7.5-8% GDP growth rate – a far cry from the earlier addiction to growth rates around 10%. But slower growth in China can continue to sustain development only if the economy’s structure shifts from external toward internal demand, from manufacturing toward services, and from resource-intensive to resource-light growth. China’s new leadership has not just lowered its growth target; it has upped the ante on the economy’s rebalancing imperatives.
Consistent with this new mindset, the PBOC’s unwillingness to put a quick end to the June liquidity crunch in short-term markets for bank financing sends a strong signal that the days of open-ended credit expansion are over. That is a welcome development. China’s private-sector debt rose from around 140% of GDP in 2009 to more than 200% in early 2013, according to estimates from Bernstein Research – a surge that may well have exacerbated the imbalances of an already unbalanced Chinese economy.
There is good reason to believe that China’s new leaders are now determined to wean the economy off ever-mounting (and destabilizing) debt – especially in its rapidly expandingshadow bankingsystem. This stance appears to be closely aligned with Xi’s rather cryptic recent comments about a “mass line education campaign aimed at addressing problems arising from the “four winds” of formalism, bureaucracy, hedonism, and extravagance.
Financial markets are having a hard time coming to grips with the new policy mindset in the world’s two largest economies. At the same time, investors have raised serious and legitimate questions about Japan’s economic-policy regime under Prime Minister Shinzo Abe, which unfortunately relies far more on financial engineering – quantitative easing and yen depreciation – than on a new structural-reform agenda.
Such doubts are understandable. After all, if four years of unconventional monetary easing by the Fed could not end America’s balance-sheet recession, why should anyone believe that the Bank of Japan’s aggressive asset purchases will quickly end that country’s two lost decades of stagnation and deflation?
As financial markets come to terms with the normalization of monetary policy in the US and China, while facing up to the shortcomings of the BOJ’s copycat efforts, the real side of the global economy is less at risk than are asset prices. In large part, that is because unconventional monetary policies were never the miracle drug that they were supposed to be. They added froth to financial markets but did next to nothing to foster vigorous recovery and redress deep-rooted problems in the real economy.
Breaking bad habits is hardly a painless experience for liquidity-addicted investors. But better now than later, when excesses in asset and credit markets would spawn new and dangerous distortions on the real side of the global economy.
That is exactly what pushed the world to the brink in 2008-2009, and there is no reason why it could not happen again.
Stephen S. Roach, Chairman of Morgan Stanley Asia and the firm's Chief Economist, is a senior fellow at Yale University’s Jackson Institute of Global Affairs and a senior lecturer at Yale’s School of Management. His most recent book is The Next Asia.

Up and Down Wall Street


Whom Are You Gonna Believe? The Press or Your Lyin' Eyes?


Contradictory, ex post explanations of market moves should make investors wary.

Sometimes the truth hurts. And as a card-carrying member of MSM -- the Mainstream Media -- the truth, and what is passed off as such, is even more obvious than to the non-professional.

Case in point is the absurdity noted by the acerbic blog,, which took to task various MSM outlets Wednesday for attributing market moves to both putatively strong and weak economic data ("It's Bizarro Headline 'Explanation' Day").

Editors, with little market experience, demand reporters, with even less, to construct neat, ex post explanations for whatever happens in the markets on any particular day.

By contrast, the outcome of a sporting contest is apparent from action visible to all. The account of a school board meeting should report the issues and the votes on them.

It is especially touching that, for instance, NPR continues to ring up some nice chaps who provide such service to the press but who, from my personal experience, provide no insight whatsoever to anybody with any knowledge of what's actually going on. I know this because one such source would eagerly pump me for market insights when we'd get together.

It's been at least two decades since I've chatted with him, and I'm surprised he's actually gainfully employed in his chosen field. But his continued ability to generate an income would seem to be mainly because of this nice guy's ready availability to reporters who need the obligatory quote on deadline, which attracts business for him. This is how the sausage is made, I'm sorry to say.

To presume to know the motivation for the results of events such as sporting events or school-board votes would be considered wacky. Yet it is what is presented as how markets work.

To assert that the action of the markets can be reduced to a Newtonian linearity akin to billiard balls striking one another is astounding to anyone who has ever dealt with the actors who comprise markets.

The reality more resembles the complex state of quantum mechanics, in which causality is not obvious. Moreover, Heisenberg's uncertainty principle shows the observation of a phenomenon affects the results. At the minimum, such concepts should introduce a bit of humility in reporters who describe definitive causality for any market move.

All of which is occasioned by the simultaneous surge in bond yields and the plunge in metals prices in the week since Federal Reserve Chairman Ben Bernanke indicated the U.S. central bank would begin to throttle back its $85 billion-a-month bond-buying program beginning late this year.

Those two market reactions are contradictory, except to the extent that the Fed's money-printing activities inflated all asset prices, be it financial or real ones.

The stunning further plunge in gold prices, with another $45 shed Wednesday to a three-year low of $1229.60 an ounce for the spot month Comex contract, is the strongest sign of the deflationary undertow in the global economy. Dr. Copper, the metal with a PhD in economics, is down 16% this year and more than twice as much from its early 2011 peak. Neither move would appear to be harbingers of either rising inflation or strengthening growth.

Just the opposite, in fact. Thursday's Wall Street Journal reports the uptick in interest rates suggests anything but an inflationary expansion ("Business Feels Pinch of Swift Rate Rise").
On the face of it, to argue the rise in long-term interest rates reflects something salutary in the global economy goes against the contradictory evidence of the metals markets.

How all these contradictory forces play out remains to be seen. The only certainty is that to attribute definitively any market moves to a single, simplistic reason beggars credulity.          
Copyright 2013 Dow Jones & Company, Inc. All Rights Reserved

June 27, 2013 11:18 pm

Investors pull $8.6bn from US bond funds
Bruised by the first widespread losses for bondholders, investors pulled $8.6bn from US bond funds in the last week, contributing to the worst four-week streak since the depths of the financial crisis.

The latest outflow takes the four-week total for withdrawals to $23.7bn, and marks the worst month of outflows since October 2008 when investors yanked a record $44bn from bonds, according to research group Lipper.

Investment managers are closely watching the flow data for signs of withdrawals rising, which would force managers to sell assets and place further pressure on bond prices.

Retail investors will return from the US Independence Day holiday next week to open brokerage statements for the second quarter that will show losses for the majority of bond funds.

“We’ve become very focused on what happens in mid-July,” said Peter Fisher, senior director of the BlackRock Investment Institute.

The market is also wary of a robust employment report at the end of next week, which will probably determine whether the Federal Reserve seeks to reduce some of its bond buying under quantitative easing later this summer.

So far this year four-fifths of 5,528 US bond funds tracked by Lipper have lost money for investors.

Rates are higher, spreads are higher, volatility is higher, it’s a very difficult environment if you’re a bond manager,” said Stephen Walsh, chief investment officer for Western Asset Management.

Since the start of May, benchmark Treasury yields have risen from 1.68 to 2.48 per cent on Thursday. However, the rise is widely viewed as representing an over-reaction to any reduction in Fed support, and so further outflows are seen as a wild card.

Gene Tannuzzo, portfolio manager at Columbia Management, said: “This sell-off has been about liquidity [QE] and not fundamentals. The Fed is still accommodative and inflation is low, a good backdrop for credit and high yield.”

Bond fund withdrawals have accelerated since Ben Bernanke, Fed chairman, told Congress on May 22 that a strengthening economy may prompt fewer bond purchases, prompting prices for government bonds to fall.
In the past four weeks, outflows from US high-yield mutual funds and exchange traded funds have totalled $11.4bn, according to the research group, and redemptions have dominated the market for exchange traded funds that have been very popular in recent years among retail and institutional investors.

So far this year, investors have pulled $5bn out of the two major exchange traded funds that track high-yield bonds, according to Index Universe. The iShares ETF for US investment grade corporate bonds has experienced an outflow of $4.4bn this year, after inflows of $6.9bn in 2012.

Additional reporting by Vivianne Rodrigues

Copyright The Financial Times Limited 2013.

Rickards: Falling Gold Signals Fed's 'Worst Nightmare'

Friday, 28 Jun 2013 08:08 AM

By Michelle Smith            


Gold bugs should not be worried about the metal's falling price, but Federal Reserve officials should be very concerned, says Jim Rickards, author of "Currency Wars" and senior managing director of Tangent Capital.
While gold prices have dropped over 20 percent since the beginning of the year and gold is down 30 percent from its peak in August 2011, "the fundamental bull case for gold has not changed at all," Rickards told Yahoo.
Rickards proclaimed that the decline in gold prices is more of problem for the Fed than it is for gold bugs.

If you hold the dollar constant, you see the price of gold is dropping, he explained, and when you reverse that, so gold is the constant factor, you see the dollar is getting a lot stronger.
"In other words, a lower dollar price for gold if gold is the constant means the dollar is getting really strong. That's deflationary. That's the Fed's worst nightmare," he told Yahoo.
Last year, the Fed made a historic move when it set an inflation target of 2 percent, but inflation is currently running below that level.
The Fed has shaken up markets with talk of possibly tapering its stimulus programs, but Reuters said some experts wonder if sub-target inflation will actually force the Fed to take a more aggressive approach.
Rickards believes it will, saying that the strong signs of deflation is one reason the Fed will likely have to back away from Fed Chairman Ben Bernanke's ruminations and either maintain or increase the level of asset purchases.
"If the Fed officials are reading market signals, if they even remember what those are, they should be very concerned about" declining gold prices, Rickards said.
He warned that gold prices are confirmation that the Fed's nightmare is materializing.
"The Fed would like real growth, but if they can't get it they will take nominal growth because debt is nominal," he noted.
"We have nominal debts and we need nominal growth and we're not getting it, or at least we're not getting enough of it," he added.

Not everyone agrees that investors shouldn't be worried about the drop in gold prices.
"You need to re-examine your expectations for the gold market if you're long — you need to stop thinking in terms of crisis and start thinking about where gold was pre-crisis," Tom Kendall, director and head of precious metals research at Credit Suisse, told CNBC.
He points back to the days before unlimited easing, and before rabid fears drove people to believe they needed to seek safety in metals. Back then, gold was trading at $1,100 or $1,150, he noted.