October 18, 2013
by Doug Noland
The QE-enhanced 2013 version of “how crazy do things get?” is outshining even the 1999 speculative melee. The (post-LTCM bailout) year 1999 saw the small cap Russell 2000 Index jump from 422 to 505 (19.7%). This year, it has already run from 849 to 1,114 (up 31.3%). The S&P400 Midcap Index jumped from 392 to 445 in 1999 (13.5%). With more than two months to go, so far it’s 1,020 to 1,290 for the midcaps (up 26.5%).
It was not only U.S. investors that were enriched from Washington dysfunction. Germany’s DAX equities index added 1.6% this week to a new all-time high (up 16.5% y-t-d). Italian stocks jumped 2.1% (up 18.4% y-t-d) and Spanish stocks surged 3.5% (up 22.5%), both to more than two-year highs. Australian stocks gained 1.7% (up 14.5% y-t-d). Despite major economic issues, India’s stock market jumped 1.7% this week to within a couple percent of new highs. Stocks jumped 4.2% in Brazil and 4.3% in Argentina. Indonesian stocks rallied 4.5%. Around the globe, most equities markets pushed higher. Fueled by huge ETF flows, total equity mutual fund inflows this past week jumped to a whopping $12.7bn (from AMG/Lipper).
On a weekly basis, I track global central bank International Reserve Assets (data from Bloomberg). This data provide a decent proxy for global financial flows, especially to the emerging markets (EM). From $6.63 TN back in April of 2009, International Reserves surged this week to a record $11.415 TN. Reserves have inflated 330% in ten years.
Reserve Assets showed atypically slow growth between May 10th ($11.124 TN) and September 20th ($11.174 TN), not coincidently a period a heightened EM instability. Courtesy of the Fed, BOJ, and Chinese, the “money” spigot was reopened. Though the data tends to be lumpy, it is worth noting that Reserves jumped $240bn over the past month. Indonesian 10-year yields have declined about 100bps since September 30th to 7.34%. Yields in Turkey are down about 130 bps from August highs to 8.70%. In general, EM markets have bounced back strongly from May/June tumult. The Fed’s taper deferral and China’s retreat from Credit tightening reversed the “hot money” EM exodus – for now.
China’s International Reserves jumped a notable $164bn during the third quarter to a record $3.660 TN (from $250 billion when Dr. Bernanke joined the Fed back in 2002). This compares to Q2 Reserve growth of $54bn. The People’s Bank of China this week stated that trade and capital-related inflows were again bolstering excess: “The pressure for monetary and credit expansion is still large.” Myriad data, including stronger-than-expected 7.8% Q3 growth, support the view of a meaningful pickup in Chinese activity. And while the consensus sees China’s recovery as fundamental to a bullish global backdrop, I’ll offer a contrary opinion.
My Macro Credit thesis holds – and there is ample fundamental support for – the view that we’re now five years into history’s greatest global Bubble. I have posited that China is deep into its “Terminal Phase” of Credit excess. With China’s 1.35 billion people and Trillions of unrestrained Credit expansion, I’ll argue China’s “Terminal Phase” is integral to the overall “Terminal Phase” of a most protracted and dangerous global Credit Bubble. In general, post-2008 global monetary inflation pushed EM to precarious “Terminal Phase” Bubble excess, leaving deep wounds of economic maladjustment and financial fragility.
I believe the initial cracks in the EM Bubble developed this spring. Market turbulence from May and June provoked further global monetary accommodation, which somewhat reshuffled the deck in the global liquidity chase. And I wouldn’t be surprised if history looks back at this period as a final manic speculative blow-off in U.S. and global equities.
Despite generally bullish sentiment, I continue to believe that China faces serious imminent issues. Chinese officials in early June moved belatedly to try to rein in runaway Credit excesses. Not surprisingly, an increasingly powerful Credit expansion and attendant asset Bubbles had been impervious to cautious attempts to restrain mortgage and local government borrowing. When they resorted to more aggressive actions in June, financial and economic fragilities forced officials to quickly retreat from tightening measures. And, again not surprisingly, Credit excess bounced right back as powerful as ever.
The value of China’s September residential apartment sales surged 34% from August to $113bn. Year-to-date sales are running up about 35% from 2012. After bouncing back strongly in August (almost doubling July), September’s total system Credit growth (“social financing”) was reported at a stronger-than-expected $230bn. This puts year-to-date “social financing” at about $2.25 TN, a pace almost 20% above a record 2012. Some reports have mortgage Credit growing at a rate about 50% faster than last year. Additionally, forecasts are calling for Q4 corporate bond issuance to jump to $135bn from Q3’s $40bn.
There are multiple facets of “Terminal Phase” Credit Bubble excess at play today in China. In asset-based lending Bubbles, the rapid growth in both transactions and prices combine for exponential growth in underlying mortgage Credit. It’s worth recalling that annual U.S. mortgage Credit growth increased annually from 1997’s $313bn to 2003’s $1.011 TN to 2006’s $1.410 TN. Importantly, along with the exponential rise in mortgage borrowing comes a corresponding spike in the riskiness of late-cycle lending booms. Indeed, and fundamental to Credit Bubble analysis, “Terminal Phase” excesses foster an unsustainable parabolic rise in Credit and economic risks. Systemic stability becomes a major concern anytime circumstances dictate that officials prolong the “Terminal Phase.”
The surge in risky Credit tends to have myriad distorting effects on financial and economic systems. On the financial side, increasingly creative/aggressive risk intermediation is required to transform progressively risky mortgage debt into more “money”-like instruments palatable to savers, speculators and institutional holders. In the U.S. and now in China, so called “shadow banking” came to play an instrumental role. Here in the U.S., 2006’s $1.0 TN of subprime CDOs (collateralized debt obligations) provided a key and fateful risk intermediation mechanism. In China’s historic “shadow bank” Bubble, there is huge ongoing growth in trust deposits and various “wealth management” vehicles. A rapidly expanding chasm - between the perceived safety of “money”-like deposits/savings vehicles and the mounting risks inherent in system Credit - is fundamental to “Terminal Phase” processes and fragilities.
There is another key “Terminal Phase” dynamic at work in the Chinese Bubble, as was (and remains) the case in the U.S and elsewhere. As late-cycle financial and economic Bubble risks grow exponentially, policymakers turn increasingly timid. Powerful Bubble Dynamics become impervious to policy “tinkering,” while officials come to see the environment as too risky to implement the type of stringent (pain-inflicting) tightening measures required to quash (now well-entrenched) inflationary biases and rein in increasingly destabilizing excess.
The above reference to “serious imminent issues” reflects my expectation that the Chinese are likely gearing up for another stab at restraining Credit Bubble excess. It’s reasonable to presume they won’t do anything that would cause serious disruption. Yet, from my perspective, if they are serious about disrupting an increasingly destabilizing Bubble, there is no way around major global ramifications. And with international securities markets turning more intensely overheated by the week, this creates a potentially volatile dynamic.
There were more rumblings out of Beijing this week. At this point, it’s difficult to gauge whether they are more frustrated with Congress or the Federal Reserve. One of these days they may even be willing to rein in their Credit system and let the global chips fall where they will. Perhaps even one of these days global policymakers may actually part ways in what has been to this point concerted efforts to reflate global economies and markets. Over time, when monetary inflation’s fog begins to break, those on the losing end of inflationary processes begin to see things a little more clearly.
The dollar was hit relatively hard this week. Newfound dollar weakness may prove an important market development – perhaps even a crucial inflection point. Many speculators were positioned bullish the dollar, expecting a safe haven bid in the midst of unfolding EM instability. Months back I posited that a huge bearish short position had accumulated betting against the Japanese yen. There are mixed opinions as to how much the yen short has been reversed. Things could turn more interesting if dollar weakness spurs a short-covering rally in the Japanese currency.
Above I noted the possibility of a somewhat “reshuffled deck” in the resurgent global financial Bubble. While the liquidity high tide has so far elevated most markets, I would be surprised by a sustained reemergence of a generalized EM Bubble. We’ll closely monitor for a destabilizing “periphery” and “core” dynamic, expecting finance to flood into the inflating “core” (i.e. China) at the expense of the fragile “periphery” (i.e. Brazil, India, Turkey?). And there has been another out of “periphery” (EM) and into “core” (Europe) dynamic at play over recent months. Euro strength has been further bolstered by Washington dysfunction and resulting dollar weakness. Strong financial flows have been positive for European stock and bond prices (Spain and Italy, in particular), although a euro at about 1.37 to the dollar is particularly unhelpful for export competitiveness in struggling Italian, Spanish, Portuguese and French economies. Might dollar weakness push the ECB to counter with more aggressive monetary stimulus?
It’s been only about three weeks, but the fourth quarter has already shown itself worthy of the history books. If the leveraged speculating community can hold gains through year-end, the ranks of billionaires will surely inflate further. No winners?
The fiscal deal in Washington
Worse than Europe, really
None of the deeper problems with American government was solved this week
That is the journey Congress has taken the American people on over the past few weeks (seearticle). The last-minute deal to raise America’s debt ceiling, avoid a default and reopen the government at least until mid-January, which was signed by the president on October 16th, is welcome only compared with the immediate alternative.
For a long time American politicians have poured scorn on their European peers for failing to deal with the euro crisis. This week Washington equalled Brussels on one measure of dysfunctionality and surpassed it by another. The way in which the Democrats and Republicans, having failed to reach any agreement, decided to “kick the can down the road”, was deeply European. The deal allows the government to stay open till January 15th and the debt ceiling to be raised until February 7th. Just as America’s economy seems to be recovering, with the promise of GDP growing by 2.7% in 2014, it could face another shutdown of the kind that has just sent consumer confidence to a nine-month low and knocked back growth in the fourth quarter by an estimated 0.6 percentage points.
The way in which the Americans have surpassed the Europeans is the unreality of their discussion. The Europeans at least talk vaguely about banking unions and other solutions to their mess. In America the immediate budget deficit—at 3.4% of GDP—is smaller than that of many European countries.
Indeed the danger is of too much tightening in the short term. But the country’s long-term fiscal problem is immense: it taxes like a small-government country but spends like a big-government one. Eventually demography—and the huge tribe of retiring baby-boomers who expect pensions and health care—will bankrupt the country. By the IMF’s calculation, if America is to reduce its debt to what it regards as a sensible level by 2030, allowing for all this age-related spending, it needs a “fiscal adjustment” of 11.7% of GDP—more than any other advanced country other than Japan. Yet the Republicans refuse to discuss tax rises, without which Barack Obama and the Democrats refuse to discuss cuts to entitlements: neither of those things had anything to do with the impasse of the past few weeks.
And to what end? Politically, neither Mr Obama nor the Republicans has much to show for their combat: the president has not persuaded his rivals to get rid of the sequester, which continues to squeeze vital functions such as defence and research, while the Republicans have to keep paying for Obamacare, the health reforms they had hoped to kill in this process. It is the political equivalent of the Somme: great damage has been done, but barely any ground gained.
The bigger losers politically, though, are the Republicans. Their demand that the Democrats rescind the key parts of many of the laws that Mr Obama has passed over the past five years was the principal reason for a debacle that has embarrassed America. Americans have noticed: the proportion who view them favourably dropped to 28%, the lowest level for either party since Gallup started asking the question in 1992.
When the Republicans are a small government party, this newspaper has much sympathy for their views. As long as they remain the no-government one, it is not inclined to take a ride in their cab again.
The JPMorgan Problem Writ Large
American mortgage lending
Weak mortgage earnings are weighing on profits. That may be a good thing
The increase in rates is a direct response to the Federal Reserve’s signals that it may soon curtail its bond-buying scheme, which is intended to suppress long-term borrowing costs. A higher price for money is not just toxic to the mortgage-refinancing business, and thus bad for banks, it also hurts house prices. That would suggest that it hurts the economy as a whole as well. But a new paperby two professors at the Cox School of Business at Southern Methodist University and a third at the University of Pennsylvania’s Wharton Business School argues otherwise: that efforts to boost housing loans have impeded the flow of credit to more productive uses.
America has long taken steps to prop up housing construction and prices, including a tax deduction for mortgages, tax breaks for certain companies that hold property (real-estate investment trusts) and an implicit state subsidy for the entire industry via state-backed entities with access to cheap credit that buy mortgages (Fannie Mae and Freddie Mac). Since the financial crisis, this has been augmented by the Fed’s efforts to keep interest rates low in an attempt, among other things, to revive the housing market. As the paper notes, Ben Bernanke, the chairman of the Fed, said last year, “to the extent that home prices begin to rise, consumers will feel wealthier; they’ll feel more disposed to spend…that’s going to provide the demand that firms need in order to be willing to hire and to invest.”
In addition to this “wealth effect”, higher home prices can stoke the economy by providing owners with more valuable collateral to borrow against for other purchases; many entrepreneurs fund their businesses this way. Rising home values also make existing mortgages less risky. If higher prices lead to increased construction, they boost GDP directly.
The recent recovery in housing prices has carried with it all these virtues, and perhaps others as well. Banks talk up the idea that as the value of their clients’ assets rises, they have added incentive to deepen their relationship with them. As ties grow, banks have both more reason and more capacity to monitor credit quality. Wells Fargo came out of the crisis with the biggest mortgage operation among America’s banks, and has since become the country’s most valuable financial institution, in part because it has managed to persuade clients with mortgages to take up other offerings, such as personal and business accounts.
The implication is that the many policies that encourage lending for property investments do so at the expense of other, potentially more deserving borrowers. That would be a drag on the economy and perhaps also on banks’ future profits. But the paper also raises hope that the present, increasingly hostile climate for housing finance may have a hidden benefit: mitigating a damaging distortion in the system.
Where there’s money, there’s risk
Events in America show that no asset is copper-bottomed
A GOVERNMENT with debt denominated in its own currency need never default, or so the theory goes. It can simply print more money to pay off the debt. In practice, however, countries do default on local-currency debt: six have done so in the past 15 years, including Jamaica, Russia and Ecuador. Before this week’s budget deal, markets had feared that America could join the list, if only in a technical sense.
From the point of view of a creditor, however, the ability of a government to print money is of little comfort if the result is higher inflation (for domestic investors) or currency depreciation (for foreign ones). Investors who bought Treasury bonds in 1946, when yields were around current levels, did not suffer a formal default. But over the following 35 years they lost money in real terms at a rate of 2% a year. The cumulative real loss was 91%. By that standard, Greek creditors, who recently suffered a 50% loss via default, were lucky.
Given this baleful history, the idea that sovereign debt is “risk-free” is puzzling. When it comes to the purchasing power of an investor’s money, what does it matter if the loss comes in the form of a formal default or erosion in real terms?
The answer to that conundrum may be that default happens suddenly, whereas inflation and depreciation are slower, giving investors more time to adjust by demanding higher interest rates to compensate for their losses. This is particularly true in the case of short-term debt, such as Treasury bills; inflation is unlikely to do serious damage to a portfolio in the course of a few months.
Twenty years ago there was much talk of “bond vigilantes” who would respond to irresponsible fiscal policies by forcing up the interest rates on government debt. With the bond vigilantes on the prowl, any short-term real loss suffered by investors would be recouped in the form of higher real rates as the government’s debt was refinanced.
But by buying bonds in the name of “quantitative easing”, central banks are influencing interest rates of all maturities these days. By holding down bond yields, the authorities are employing a policy some have dubbed “financial repression”, in which real returns on government debt are reduced. The idea is to make investors buy riskier assets, such as equities and corporate bonds. In effect, the bond vigilantes have been neutered.
One way of protecting the real value of investors’ bond holdings is to buy inflation-linked debt. The repayment value and interest payments on such bonds are normally tied to a well-known inflation index. But even these bonds may not be completely risk-free; it is possible to imagine that future governments may find ways to redefine the inflation measure for their own benefit. And foreign buyers of inflation-linked bonds are still at risk from currency depreciation.
Inflation-linked bonds are extremely attractive to pension funds, since they are a neat match for the funds’ liabilities. So such bonds are snapped up quickly and tend to trade on low real yields; sometimes, those yields are even negative. An asset is hardly risk-free if it guarantees a real loss.
The concept of a risk-free asset is quite useful in finance. For a start, it provides the base from which other assets can be priced. Corporate borrowers pay an interest premium over the risk-free rate; equities have offered a higher long-term return than government bonds to reflect their higher risk. But what is the true risk-free rate? Multinational companies can borrow at a lower rate of interest than some governments: compare Apple with Greece, for example. And although America is the world’s biggest economy, its government does not borrow at the cheapest rate on the planet: Japanese yields have been lower for many years and German long-term yields are now significantly below those of Treasuries.
Where America does have a substantial advantage is that it borrows in the world’s reserve currency—the dollar—and that its debt market is by far the most liquid. The result is that Treasury bills, in particular, play a vital role in the system as cash equivalents and as collateral for short-term loans and derivative contracts.
Treasury bills are seen as risk-free in this context in that they are instantly and universally acceptable to all participants in the system. They are the oil that lubricates the global machinery of finance. That was the real risk of the latest stand-off: not that America would not pay its bills, which it could easily afford to, but that the system would grind to a halt.
Corruption in Peru Aids Cutting of Rain Forest
By The University of British Columbia School of Journalism
Les doy cordialmente la bienvenida a este Blog informativo con artículos, análisis y comentarios de publicaciones especializadas y especialmente seleccionadas, principalmente sobre temas económicos, financieros y políticos de actualidad, que esperamos y deseamos, sean de su máximo interés, utilidad y conveniencia.
Pensamos que solo comprendiendo cabalmente el presente, es que podemos proyectarnos acertadamente hacia el futuro.
Gonzalo Raffo de Lavalle
Las convicciones son mas peligrosos enemigos de la verdad que las mentiras.
Quien conoce su ignorancia revela la mas profunda sabiduría. Quien ignora su ignorancia vive en la mas profunda ilusión.
“There are decades when nothing happens and there are weeks when decades happen.”
Vladimir Ilyich Lenin
You only find out who is swimming naked when the tide goes out.
No soy alguien que sabe, sino alguien que busca.
Only Gold is money. Everything else is debt.
Las grandes almas tienen voluntades; las débiles tan solo deseos.
Quien no lo ha dado todo no ha dado nada.
History repeats itself, first as tragedy, second as farce.
We are travelers on a cosmic journey, stardust, swirling and dancing in the eddies and whirlpools of infinity. Life is eternal. We have stopped for a moment to encounter each other, to meet, to love, to share.This is a precious moment. It is a little parenthesis in eternity.
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