Things That Make You Go Hmmm...

The End Of The Innocence

By Grant Williams

February 10, 2014

Unus pro omnibus, omnes pro uno

– Traditional Motto of Switzerland

O' beautiful, for spacious skies
But now those skies are threatening
They're beating plowshares into swords
For this tired old man that we elected king
Armchair warriors often fail
And we've been poisoned by these fairy tales
The lawyers clean up all details
Since daddy had to lie

– Don Henley, The End Of The Innocence

"Then the great hour struck and every man showed himself in his true colours."

– Fyodor Dostoyevsky

Take a long, hard look, Janet.


The landscape over which you cast your eyes when you accepted the poisoned chalice prestigious role of Fed Chair changed last weekjust two days before you were confirmed in a rather lovely ceremony.

On January 30, in an interview in Mumbai, Raghuram Rajan (one-time Chief Economist at the IMF and current Governor of the Reserve Bank of India) rather UNceremoniously dropped something of a bombshell that went largely unreported (perish the thought, in this era of dogged journalism) but that most definitely queers your pitch in a major way:

(Bloomberg): India central bank Governor Raghuram Rajan warned of a breakdown in global policy coordination after the Federal Reserve further cut stimulus, weakening emerging-market currencies from the rupee to the Turkish lira.

Rajan, a former chief economist at the International Monetary Fund, called for greater cooperation among policy makers weeks before finance chiefs from the world's top developed and emerging markets gather in Sydney. The Fed's Jan. 29 statement made no mention of developing economies. "International monetary cooperation has broken down," Rajan, 50, said yesterday in an interview in Mumbai with Bloomberg TV India, noting how emerging markets helped pull the global economy out of crisis starting in late 2008. "Industrial countries have to play a part in restoring that, and they can't at this point wash their hands off and say we'll do what we need to and you do the adjustment."

Now this is going to be a problem, Janet.

Potentially, a BIG one.

The standout feature of central bank policy over the last five years has been the spirit of cooperation amongst the men ("And women!" — Sorry, Janet, "and women") in charge of the world's central banks.

Whilst this spirit of cooperation has been somewhat unwilling in a few cases (yes, Glenn, I'm talking about you), it has been vital to establish a unified message that would give investors the sense that these guys ("And girls!" — Sorry, Janet, "and girls") were talking (a) to each other and (b) to us from a common perspective, that perspective being low rates and free money forever.

Then came The Taper.

The mantra being chanted by FOMC officials around The Taper has been this:

"Tapering isn't tightening."

Well maybe it hasn't been yet — in the USA, but thanks to the unintended consequences of Fed actions, it sure as hell has been elsewhere:

(IOL): South Africans should expect more shocks to their finances as the Reserve Bank is poised to raise interest rates further to stem inflation.

This prediction was made yesterday by Citi Research, which said the bank's monetary policy committee (MPC) would raise interest rates twice more by July despite the view held by many economists that this would happen only in the second half of this year.

Citi said that the MPC was likely to raise interest rates by at least 150 basis points to dampen domestic demand and inflation but said the economy was likely to suffer as a result.

This statement follows last week's 50 basis point rate hike, the first in almost five years.

For those of you keeping score at home, the chart below shows what South African interest rates have looked like for the past five years when everybody was, to quote the cast of High School Musical, "all in this together." (Finally, all the years of having that damned thing playing on a TV in the background on a continuous loop have paid off! Thanks, Brontë. Thanks, Molly.)

Everyone is special in their own way
We make each other strong (we make each other strong)
We're not the same 
We're different in a good way
Together's where we belong

We're all in this together 
Once we know
That we are 
We're all stars 
And we see that
We're all in this together
And it shows
When we stand 
Hand in hand

Sorrygot distracted. Where were we? Oh yes, the chart:

Source: Bloomberg

Nothing to worry about, I hear you cry ... except, HERE'S what it looks like going back to 1998:

Source: Bloomberg

Yes... that average line is correct. Rates in South Africa have averaged 9.51% over the last 15 years (a number which includes record low rates for the last three years).

But it isn't just South Africa feeling the pinch of the Fed's tightening tapering. Ohhhhh no.

Across the world, emerging markets are suffering from the Fed's unilateral declaration that it's every man ("And woman!" — Sorry, Janet, "and woman") for him- or herself.

In Brazil, as The Economist points out this week, the timing couldn't have been worse:

(Economist): Later this month [Dilma Rousseff] will launch her campaign to win a second term in a presidential election due on October 5th. Normally at this stage of the political cycle, as in the run-up to elections in 2006 and 2010, the government would be ramping up spending. But when Ms Rousseff spoke to the World Economic Forum in Davos last month, with the São Paulo stockmarket and the real dipping along with other emerging economies, she felt impelled to stress her commitment to being strait-laced.

So far so predictable:

Brazil's economy has disappointed since she took office in January 2011. Growth has averaged just 1.8% a year; inflation has been around 6%; and the current-account deficit has ballooned, to 3.7% of GDP. Her government has some good excuses. She inherited an overheating economy, the world has grown sluggishly, and cheap money in the United States and Europe prompted an exaggerated appreciation of the real.

So, tepid growth, persistent inflation, and a painfully strong currency. What could POSSIBLY have caused that situation, I wonder?

But Ms Rousseff has scored some own goals as well. Her predecessor, Luiz Inácio Lula da Silva, left monetary policy to the Central Bank and mostly stuck to clear fiscal targets. By contrast, Ms Rousseff chivvied the bank into slashing interest rates; her officials tried to micromanage investment decisions with subsidies and to cover up the fiscal damage through accounting tricks. Rather than the promised recovery of growth, the result was that Brazilian businessmen and foreign investors lost confidence in the economic team — and just at the wrong time. When America's Federal Reserve last year announced a possible "tapering" of its bond-buying, the real began to slide. Against the dollar, it is now 17% below its value in May.

Stick around, here comes the rub:

A weaker currency is just what Brazil needs if it is to balance its external accounts and its manufacturers are to thrive. But it also risks adding to inflation, the upward creep of which was one factor (along with poor public services) in mass protests that shook Ms Rousseff's government last year. This has prompted a change of mind. Alexandre Tombini, the Central Bank governor, has been allowed to raise interest rates (from 7.25% to 10.5%).

Rising rates. We know a word for that, don't we boys and girls? It begins with T and rhymes with frightening.

And here, in all its glory, is the Brazilian real versus the US dollar, alongside the reserves of the Banco Central do Brasil (with a couple of milestones added for clarity):

Source: Bloomberg

To defend their ailing currency, the Brazilian central bank has had to prop up the real and, finally, to raise interest rates to try and stem the outflows and dampen inflation, just as GDP turns negative on a Q0Q basis and falls below 2% annually hardly the kind of number the world has come to expect from a member of the BRICs.


The results of this shift in Brazilian viability have shown up in some rather surprising places as return-seeking investors who piled into "Brazil" through a real-denominated ETF suddenly decided that the currency, which had been steadily weakening for months, had apparently passed the point of no return:

(Bloomberg): The WisdomTree Brazilian Real Fund (BZF), an exchange-traded fund tracking Brazil's currency, lost more than 90 percent of its assets this week after redemptions of $473 million.

The fund, which had $513 million under management as of Jan. 24, lost the assets on Jan. 28 and 29, according to data compiled by Bloomberg and the latest fund data from New York-based WisdomTree Investments Inc.... It's the only U.S.-registered ETF that follows the real, which fell to a five-month low on Jan. 29.

Data posted on WisdomTree's website show the fund received an inflow of more than $500 million on Oct. 10. Brazil's currency has depreciated 9.6% since then, the second-most among major currencies tracked by Bloomberg.

I've said it before and I'll say it again:

Nothing matters to anybody until it matters to everybody — and by then it's too late.

Brazil and South Africa aren't the only poor unfortunates being forced by decisions made in the Marriner S. Eccles Building into taking actions they would otherwise shy away from.

This year may be only a month old, but already several of the world's central bankers have been busy trying to keep intact their New Year's resolutions to stay fit and healthy — by hiking more:

Current Rate
Previous Rate
South Africa

At the bottom of that little table you see the current champion, Turkey, whose central bank recently took aggressive action to stem an unpleasant tide:

(NY Times): Turkey's central bank aggressively raised rates late Tuesday, in a drastic move aimed at bolstering the currency. But it is unclear whether the move will be enough to satisfy international investors and repair the central bank's reputation.

Turkey is facing increased political and economic pressure to take action. The Turkish lira has been among the most battered of developing-market currencies in recent weeks. After the central bank's decision, the lira strengthened in after-hours trading.

See? I told you they took aggressive action. It looked like this:

Source: Bloomberg

The Turkish lira did, indeed, respond to the more-than-doubling of rates — for about 24 hours:

Tyler & the gang naturally had a few thoughts on the goings-on in Ankara:

(ZeroHedge): So much for the credibility of the CBRT? After the Lira soared, and the USDTRY plummeted by just under 1000 pips yesterday when the Turkish Central Bank announced its "shock and aweintervention, it has since pared back virtually all gains, and at last check was just over 2.24 having nearly roundtripped in 12 hours. Why the loss of faith? Two reasons: First, as we pointed out yesterday, suddenly the domestic situation in Turkey takes front stage again, with 4.25% added elements of instability, causing the political instability to soar, leading to an even higher probability of a social and political overhaul. Second, as Goldman pointed out overnight, "the CBRT stated that liquidity '… will be provided primarily from one-week repo rate instead of the marginal funding rate in the forthcoming period'. This implies that the effective rate hike is 225bp (to 10.00%; the 1-week repo rate), as the Non-PD lending rate was 7.75% prior to the announcement."

In other words, when looked at on a corridor basis, the CBRT hiked not by a shocking and awing 425 bps but by precisely the predicted 225 bps!

Which means the central bankers merely went along consensus, and not a basis point above it, which is the worst of all worldsgiving the impression of massive tightening (for domestic political purposes), while in reality not doing all that much.


The poor old Turks just couldn't catch a break as, late on Friday, those "evil" ratings agencies just HAD to join the dogpile:

(Bloomberg): Turkey's credit rating outlook was cut to negative from stable by Standard & Poor's, which said there's a growing risk of a "hard economic landing" as reserves decline and policy makers spar over interest rates.

The move by S&P, the only one of the three main credit rating companies that doesn't classify Turkish debt as investment grade, comes after the country's central bank reversed policy and raised interest rates to halt a currency slump. The government has been calling for borrowing costs to be kept low, and says it has alternative plans to revive the economy and the lira.

"Turkey's policy environment is becoming less predictable" and "this could weigh on the economy's resilience and long-term growth potential," S&P said in a statement explaining its decision. It cited "constraints on the independence and transparency" of Turkey's central bank.

"Constraints on the independence and transparency of the central bank," eh? Well that's nice.

On a completely and totally unrelated tangent, let's look at Argentina.

Back on January 23rd, the Central Bank of Cristina Fernández de Kirchner Argentina decided that to senselessly throw away more of its rapidly dwindling reserves was a foolish thing to do, and so it withdrew its support for the peso.

Remember this chart from the last edition of Things That Make You Go Hmmm...?

Source: Bloomberg

Well, admittedly, not ALL of the blame can be laid at the door of the Fed for THIS particular disaster, as the Argentine government and its puppet central bank have been serial offenders, defaulting (to name but a few occasions ) in 1826, 1870, 1989 and, of course, 2001 when its default on $93 billion of external debt set a new high (or low, depending on your point of view).

What happened next is in the books, but let's recap anyway:

(Wikipedia): Foreign investment fled the country, and capital flow toward Argentina ceased almost completely during 2002 and 2003. The currency exchange rate (formerly a fixed 1-to-1 parity between the Argentine peso and the U.S. dollar) was floated, and the peso devalued quickly to nearly 4-to-1, producing a sudden rise in inflation to over 40% and a fall in real GDP of 11% in 2002.

This time WAS different, though, as the geniuses at the Argentine central bank threw everything at the problem — and by everything, I mean most of their foreign currency reserves, which were depleted to the point where Kirchner felt compelled to delve into The Book Of Idiotic Economic Ideas once again:

(Libre Mercardo — via Google Translate): The fourth day of falling reserves has the Argentine central reeling. This Wednesday reserves fell by 180 million and this month reserves declined by $2 billion. Due to demand and the low level of foreign exchange reserves, the central bank has stopped payment of imports, according to Argentine newspaper La Nacion.

"Almost all the customers who went to the bank did so to hoard dollars," claimed the cashier of a national bank to the southern newspaper.

"Today almost no imports were approved," confided the head of the table of a major bank in the nation.

After banning imports (due to their own mismanagement of reserves), the Kirchner government turned on the stupidity afterburners:

(El Economista — via Google Translate): Economic war has moved to Argentina. The Argentine government said it will apply an "iron fist" against the shops and businesses that raise prices following the sharp devaluation of the local currency last week, hoping to avoid tripping high inflation in the country.
Argentina has one of the highest inflation rates in the world, which in 2013 was around 25% according to private estimates.

Prices of products with imported components such as appliances and vehicles rose immediately after the devaluation. Moody's expects a devaluation of the Argentine peso by 50% in 2014.

Before the devaluation, the government launched a plan to fix maximum prices on about a hundred products sold in supermarkets. But the incentive is limited and includes products that are hard to find on the shelves.

How depleted were Argentina's reserves? Well, it turns out that it's hard to tell.

Opticallyaccording to the Argentine central bank, at least — they look like this:

Source: Bloomberg

... BUT ... (there's always a "but" when dealing with Argentina) there MAY just be a slight wrinkle:


(Bloomberg): The gap between the Argentine central bank's preliminary international reserves figures and official data released 48 hours later is at the widest since 2008, a discrepancy that may lead investors to question the bank's reliability, according to JPMorgan Chase & Co.

The central bank said yesterday that reserves in January fell $2.85 billion to $27.7 billion, a loss that's $365 million, or 15 percent, bigger than what was reported in the bank's preliminary reserve statement, according to central bank data compiled by Bloomberg....

Hey, guys ("And gals!" — Sorry Janet, "and gals"), economics shouldn't stretch to the truth:

A year after the country was censured by the International Monetary Fund for misreporting economic data, the central bank's tactic may backfire as the bank risks damaging its own reputation, he said.

"It is a dangerous game to play," Werning wrote in a report yesterday. "During a balance of payments crisis — as Argentina is undergoing such manipulation of official statistics (and one so critical for market sentiment) is detrimental to the needed confidence building around the transition" in the foreign exchange regime.

Central bank preliminary data has over-stated reserves by an average $257 million per day since the government began devaluing the peso Jan. 22, compared with an average $15 million in the previous month.

The central bank declined to comment on the discrepancy.

So, as Argentine central bankers were put on the spot over falsifying their reserves data, it seemed as though there was no way out for them. They would have to own up to fudging the numbers and admit to the... wait... what? A fire? What fire? Where?

(Washington Post): Nine first-responders were killed, seven others injured and two were missing as they battled a fire of unknown origin that destroyed an archive of bank documents in Argentina's capital on Wednesday...

The destroyed archives included documents stored for Argentina's banking industry, said Buenos Aires security minister Guillermo Montenegro.

The cause of the fire wasn't immediately clear.

Boston-based Iron Mountain manages, stores and protects information for more than 156,000 companies and organizations in 36 countries. Its Argentina subsidiary advertises that its facilities have multiple protections against fire, including advanced systems that can detect and quench flames without damaging important documents.

Oh come ON!!!! Guys, really? ("And gals!" — Look, Janet, I'm using it as a unisex term, OK? Can we drop it now? We all KNOW that you're there now, and we're all very much looking forward to your coming-out party on Tuesday.)

Now, I won't bother going into the capital controls instituted in Ukraine as that country falls apart, or the "Law of Fair Prices" being instituted by the Venezuelan government ("Atlas se encogió de hombros," anybody?) as they try to stop another unraveling; but the point is that at precisely the time when the world's central banks are going to need to present a unified front, they are being forced to splinter as tightening tapering by the FOMC sucks capital away from the all-too-fragile developing economies.

Everywhere you look, concern is rising amongst those charged with applying the copious amounts of sticking plaster that are vital to ensuring the world financial system doesn't fall apart; and so, a couple of days after Rajan delivered his incendiary comments, IMF head Christine Lagarde was wheeled out to try and get the kids to play nice in the sandbox again:

(WSJ): The head of the International Monetary Fund on Monday called for greater collaboration among the world's central banks, citing the threat of turmoil spreading through the global financial system.

Global stakeholders must take "collective responsibility for managing the complex channels of the hyperconnected world," IMF managing director Christine Lagarde said in a speech prepared for the Richard Dimbleby Lecture in London.

That translates into "all monetary institutions cooperating closelymindful of the potential impacts of their policies on others," she said....

Ms. Lagarde said the proliferation of global financial and trade linkages over the past decade, combined with the emergence of the major developing economies, requires greater global collaboration. She called it "a new multilateralism."

"In such an interwoven labyrinth, even the tiniest tensions can be amplified, echoing and reverberating across the worldoften in an instant, often with unpredictable twists and turns," she said.

"The channels that bring convergence can also bring contagion," she added.

Best of luck with that, Christine. It's every "man" for himself now; and a big problem is that, over the course of the ongoing financial crisis (yes, it is), the power wielded by central bankers has reached unprecedented levels as one extraordinary measure after another has been implemented simply in order to maintain the status quo.

Not only that, but the emerging-market countries that have seen strong inflows as the Fed's QE program sent billions of dollars their way in search of returns, are now in a bit of a fix, as the chart below demonstrates:


Jeremy Warner tackled the subject earlier this week, and his comments resonate:

(UK Daily Telegraph): More or less everywhere, from Britain to America and Japan, and from Nigeria to India and Europe, central bankers have become the first, second, third and last line of defence for almost every economic problem that arises.

In Japan, the central bank has been ordered to print money until deflation is finally exorcised; Shinzo Abe's second and third arrows of economic rebirthfiscal and structural reform — are meanwhile fast running into the sand, leaving the promised return to decent levels of nominal GDP growth entirely reliant on whatever further actions the central bank can conjure up.

In America, they've had money printing, credit easing and just about everything else the central bank armoury has to offer, but are now finding it impossible to rid themselves of the addiction.

Already Federal Reserve tapering has prompted financial chaos in the developing world, while new data announced on Monday suggest that easing back on the monetary accelerator is once again causing the domestic economy to lose steam. Engage in quantitative easing, and the economy grows; start to turn off the printing press and the economy slows to stall speed.

In the end, central banks can offer no more than sticking-plaster solutions, yet both the power and the expectation vested in them grows by the day.

Precisely, Jeremy.

The great Anatole Kaletsky put his own twist on the problems facing central bankers on the eve of Ben Bernanke's last day in office; and in doing so, not only did he hit the nail squarely on the head, he also laid bare a truth that far too many people are happy to willfully ignore:

(Anatole Kaletsky): Federal Reserve Chairman Ben Bernanke, who retires this week as the world's most powerful central banker, cannot be trusted.

Neither can Janet Yellen, who will succeed him this weekend at the Federal Reserve.

And neither can Mark Carney, governor of the Bank of England; Mario Draghi, president of the European Central Bank, or any of their counterparts at the central banks of Turkey, Argentina, Ukraine and so on.

I am not trying to aim a valedictory insult at Bernanke or his central banking colleagues. On the contrary, I am drawing attention to the skill and determination required by central bankers to perform one of the world's most demanding and important jobs. For just as James Bond has a "License to Kill" in the Ian Fleming books, so central bankers possess a "License to Lie" — or, putting it more diplomatically and politely, to make promises about the future that cannot be honored and often turn to be false.

Nobody ever blamed a central banker for promising to support the currency and then suddenly allowing a massive devaluation — as happened in Argentina last week and may soon happen in Turkey, Ukraine, Russia and many other emerging markets.

To mislead investors is actually a key skill required by a central banker's job description. Revealing the true state of national finances at a time when a devaluation or comparable financial crisis is looming might be to guarantee the loss of the central bank's entire reserves.

Yes, folks, central bankers lie. The job demands it. That means that they join politicians in the category marked "cannot be trusted," and yet investors the world over are not only relying on the promises made by these individuals but also trusting them to be both transparent and honest when the job demands they be neither.

Given that they lie to us, and given that they are making two key representations to us, should we not perhaps take a moment to think about the two inputs to this particular equation?

Politicians across the globe are assuring us that (amongst other lies things):

1) The "recovery" is either here or right around the corner.

In fact, it is neither.

2) Remaining in the EU is the best option for Greece, Spain, Italy (and France).

It is not.

3) Soaking the rich is the answer to a multitude of problems.

It isn't.

4) Raising taxes will generate the necessary revenue without having a negative effect on the economy.

It won't.

5) Future promises of entitlement payments are solid

They aren't. Defaults are inevitable.

Meanwhile, the central bankers of the world are promising us that:

1) Interest rates will remain low for a very long time.

In the end, it's not central bankers' choice to make.

2) Quantitative easing has no ill effects and can be withdrawn at will without causing any problems.

It can't be.

3) Printing money will not translate into higher inflation.

It will. It just hasn't yet.

4) They will do "whatever it takes," and that will be enough.

There is a limit to what they can do, and it will ultimately not be enough.

5) They are all in this together.

They're not. It is every man for himself now, and the Fed will screw them all.

So here we are.

Having established that, like politicians, central bankers are required to lie to us in order to be able to do their jobs, we are left facing a couple of crucial questions. First, IS tapering tightening, or not? Secondly, what does all this chaos in emerging markets in the wake of The Tighten Taper mean, and where does it take us from here?

Fortunately, the great Albert Edwards of Soc Gen fame took the words right out of my mouth this week:

(Albert Edwards): Tapering is tightening, which inevitably ends in recession, bailout and tears.

Our warnings throughout last year that an unraveling of emerging markets (EM) was the final tweet of the canary in the coal mine have still not been taken on board. The ongoing EM debacle will be less contained than sub-prime ultimately proved to be.

The simple fact is that US and global profits growth has now reached a tipping point and the unfolding EM crisis will push global profits and thereafter the global economy back into deep recession. Our thesis on how EM would be pushed to crisis was simple, especially as we saw close parallels with the 1997 Emerging Asia currency crisis.

We saw yen weakness further undermining an already weak balance of payments situation in the emerging world as a direct replay of 1997. A strong dollar/weak yen environment is typically an incendiary combination for EM, and so it has proved once again. Having reached tipping point the yen will often rally strongly as it has now and as it did in May 1997. This may or may not delay the impending EM implosion for a few weeks. Indeed the Thai Baht, the first domino to fall in the Asian crisis, briefly rallied strongly (vs the US$) in early June 1997, reassuring investors just ahead of its ultimate collapse.

There has never been any shadow of doubt in my mind that tapering = tightening, and I marvel that the Fed convinced anyone otherwise. A Fed tightening cycle inevitably plays a key role in triggering the next crisis (see below). Plus ça change, hey?

1970 Recession/Penn Central Railroad

1974 Recession/Franklin National Bank

1980 Recession/First Penn/Latin America

1984 Continental Illinois Bank

1987 Black Monday

1990 Recession/S&L and banking crisis

1997 Asian currency collapse/Russian default/LTCM

2007 The Great Recession/Collapse of almost the entire global financial system

2014 Emerging Market collapse/deflation/recession/another banking collapse etc.

Albert is right, of course.

Not only is tapering most definitely tightening (don't listen to what they say, watch the results), but we have likely seen just the beginning of the fallout from the Fed's new course.

Will they stick to it? No. They won't be able to. They MAY taper another $10 bn in March when Janet Yellen's first rate decision is announced, but I suspect that by then markets will be in such a state of disrepair that excuses will be made as to why the taper has been suspended. You can bet your bottom dollar that there will be some frantic calls put in to Ms. Yellen's office by her peers around the world between now and March 20, all of which will be begging calling for an end to The Taper.

Ultimately, QE will continue to be expanded until it implodes in a fireball the like of which has never been seen before. There's no choice, I am afraid, because the alternative would involve the telling of some very harsh truths by politicians and central bankers and the bestowing of some serious pain on an electorate that already holds them in contempt.

Think those truths are going to be volunteered?

Me neither.

The splintering of central bank policy is just the beginning.

This is the end of the innocence.