October 21 – Reuters (Andreas Framke, Eva Taylor and Paul Carrel): “The European Central Bank is considering buying corporate bonds on the secondary market and may decide on the matter as soon as December with a view to begin buying early next year, several sources familiar with the situation told Reuters. The ECB has already carried out work on such purchases, which would widen out the private-sector asset-buying program it began on Monday - stimulus it is deploying to try to foster lending to businesses and thereby support the euro zone economy. ‘The pressure in this direction is high,’ said one person familiar with the work inside the ECB, speaking on condition of anonymity.”
Early Tuesday morning trading provided another dicey juncture, with a semblance of global market stability at risk of unravelling. European stocks were under heavy selling pressure, with Germany’s DAX index trading to the lowest level since September 2013. Italian, Portuguese and Spanish bonds were getting hit hard. Italian Credit default swaps (CDS) were trading at 146 bps, up 26 bps from Friday’s close to the highest level since March. Portugal CDS traded as high as 217 (last Friday’s close 185), and Spain rose to as much as 110 (last Friday’s close 97). Popular European corporate and financial CDS were spiking to one-year highs. Safe haven bunds and Treasuries were being bought, while commodities and EM were being sold. S&P500 futures were trading down 20 points. “Risk off” was gathering momentum.
The timely Reuters’ article - with unnamed sources claiming the ECB was readying corporate debt purchases - worked wonders for struggling global markets. After trading as low as 8,645, the DAX ended Tuesday’s session at 8,887 - and then traded as high as 9,068 on Thursday. Italian stocks enjoyed a 6.1% rally off of trading lows and Spanish stocks bounced 5.75%. After trading to 392, a popular European high-yield corporate CDS contract sank back to 350 bps. A European subordinate financial debt CDX dropped from 186 to end the week at 155.
After trading as low at 1,886 in the pre-market, S&P500 futures rallied 2.8% to end Tuesday’s session at 1,938. By the end of the week the S&P500 had surged 4.1%, as U.S. equities enjoyed "the best week since 2013.” The corporate debt market came back to life. And it’s easy to miss the significance the Reuters article had for global markets. Importantly, talk of ECB buying in the huge corporate bond market helps ameliorate the markets' waning confidence in the potential scope of Draghi's QE. I believe European markets are now a key weak link in the global securities Bubble.
Especially with a now vulnerable global speculator community, an unwind of leveraged positions in European high-yield and periphery sovereign debt would have major “risk off” ramifications.It’s worth noting that the yen weakened soon after European market rallied. A strengthening yen would also be problematic for the leveraged crowd (yen “carry trade”). Anyways, “Do Whatever it Takes” central banking won the day and week.
October 24 – Reuters (Noah Barkin, Eva Taylor and Paul Taylor): “In early October, European Central Bank board member Benoit Coeure paid a discreet visit to the Chancellery in Berlin to express concerns about rising criticism of the bank from German politicians. The Frenchman… hoped for reassurances that the bank bashing, led by Finance minister Wolfgang Schaeuble, would stop. But the message from Chancellor Angela Merkel's advisers was not entirely comforting…
Merkel would continue to refrain from questioning the ECB's policies in public. But the broader backlash would be difficult to contain, especially if Draghi pressed ahead with unconventional measures… ‘Then you would see a real debate,’ a top German official told Reuters… ‘Public criticism in Germany would take off.’ Back in 2012, Draghi appeared to save the euro zone from breaking up with his promise to do ‘whatever it takes’ to defend the single currency, a stance that won swift backing from Merkel… But two years on, the Italian's relationship with his most important stakeholder - the Germans - is fraying, with worrying implications for Europe and its faltering economy. This tension is most obvious in the relationship between Draghi and Bundesbank President Jens Weidmann, which… has almost broken down… According to German officials, Merkel felt betrayed by Draghi's speech at a central banking conference in Jackson Hole… in which he pressed Berlin for looser fiscal policy to stimulate the economy. Her entourage is also deeply skeptical about Draghi's plan to buy up asset-backed securities (ABS) and covered bond…”
Markets have grown completely dependent on “Do Whatever it Takes” central control. And six years into a historic global experiment in central bank monetary stimulus, the maladjusted global economy has become dependent upon inflated (and dangerously speculative) securities markets. Meanwhile, the consequences of reckless “money” printing spur deepening social and political tensions. As more begin to question contemporary central bank doctrine, the issue of economic inequality is finally becoming an issue. “Hats off” this week to Yves Mersch, Luxembourg central banker and member of the ECB’s Executive Board, for his presentation “Monetary Policy and Economic Equality.”
"...I would like to discuss an unusual topic for central bankers – namely the interactions between monetary policy and inequality. All economic policy-makers have some distributional impact as a result of the measures they introduce – yet until relatively recently, such consequences have been largely ignored in the theory and practice of monetary policy. Of course, central banks are not charged with the task of addressing inequalities in the distribution of wealth, income or consumption – nor are they dealing with the broader challenge of promoting economic justice for society as a whole… But particularly at a time of exceptionally low interest rates and non-standard monetary policy measures, it is essential for us to be aware of all collateral effects – including the distributional ones, i.e. the potential economic damage to some parts of society; and the potential benefits for others. So I would like to take this opportunity to explore some of the emerging evidence on the distributional effects of monetary policy. I will begin with a brief discussion of the rising prominence of inequality as an issue of global public concern."
“Let me begin with inequality, which has recently re-emerged as a topic of wide public debate. From a central banker’s perspective, the most relevant aspects of recent works concern the assessment that monetary policy can have sizeable distributional effects. Indeed, inequality has been largely ignored in discussions of monetary policy. But this might be changing. In part, this is because of the potentially negative impact of rising inequality on financial stability. For example, some – not least the current governor of the Reserve Bank of India – have argued that US policies to circumvent the consequences of inequality fuelled financial instability ahead of the crisis. More generally, inequality is of interest to central banking discussions because monetary policy itself has distributional consequences which in turn influence the monetary transmission mechanism. For example, the impact of changes in interest rates on the consumer spending of an individual household depend crucially on that household’s overall financial position – whether it is a net debtor or a net creditor; and whether the interest rates on its assets and liabilities are fixed or variable.”
There are so many signs pointing to the present as an extraordinary juncture in history. For one, the misconceptions, flaws and unfolding failure of contemporary central banking are coming into clearer view. Yet fragilities associated with a flagging global Bubble ensure only more radical monetary measures. In the name of fighting “deflation” risk, everything has become fair game. God only knows how much “money” they might end up printing.
It seems an opportune time to revisit Fed governor Bernanke’s speech from almost 12 years ago, “Deflation: Making Sure ‘It’ Doesn't Happen Here.” Since Bernanke’s 2002 “U.S. government has a technology, called a printing press” dissertation, the Fed’s balance sheet has inflated from $800 billion to $4.5 TN. Treasury debt has inflated from about $4.5 TN to $12.6 TN. Total system marketable debt has jumped from about $30 TN to almost $60 TN. On the rate side, despite booming mortgage Credit growth, the Fed waited until June 2004 to nudge rates up 25 bps (to 1.25%). Rates didn’t make it to 4% until late 2005, just as mortgage Credit was wrapping up its fourth consecutive year of double-digit expansion.
Bernanke: “But the U.S. government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at essentially no cost. By increasing the number of U.S. dollars in circulation, or even by credibly threatening to do so, the U.S. government can also reduce the value of a dollar in terms of goods and services, which is equivalent to raising the prices in dollars of those goods and services. We conclude that, under a paper-money system, a determined government can always generate higher spending and hence positive inflation. Of course, the U.S. government is not going to print money and distribute it willy-nilly (although as we will see later, there are practical policies that approximate this behavior).
Normally, money is injected into the economy through asset purchases by the Federal Reserve. To stimulate aggregate spending when short-term interest rates have reached zero, the Fed must expand the scale of its asset purchases or, possibly, expand the menu of assets that it buys… Thus, as I have stressed already, prevention of deflation remains preferable to having to cure it. If we do fall into deflation, however, we can take comfort that the logic of the printing press example must assert itself, and sufficient injections of money will ultimately always reverse a deflation.”
It’s been painful to watch. Federal Reserve Credit has inflated 460% in twelve years (most of it in the past six). Federal debt has about tripled (excluding wildly inflating contingent liabilities). Rates have been held at near zero for almost six years. Savers have been punished as financial operators have made billions. Two years of previously unimaginable “money” printing have coincided with a collapse in global commodities prices and general downward pressures on consumer price inflation.
Arguably, financial, economic and geopolitical stability have all suffered at the hands of two years of rampant QE. Inarguably, there are serious flaws in central bank doctrine that need to be resolved. For me, so much goes back to Dr. Bernanke and his defective theories.
Bernanke: “Deflation is defined as a general decline in prices, with emphasis on the word ‘general.’ At any given time, especially in a low-inflation economy like that of our recent experience, prices of some goods and services will be falling. Price declines in a specific sector may occur because productivity is rising and costs are falling more quickly in that sector than elsewhere or because the demand for the output of that sector is weak relative to the demand for other goods and services.
Sector-specific price declines, uncomfortable as they may be for producers in that sector, are generally not a problem for the economy as a whole and do not constitute deflation. Deflation per se occurs only when price declines are so widespread that broad-based indexes of prices… register ongoing declines. The sources of deflation are not a mystery. Deflation is in almost all cases a side effect of a collapse of aggregate demand--a drop in spending so severe that producers must cut prices on an ongoing basis in order to find buyers.”
There’s always been an arrogance surrounding Bernanke’s view of deflation and the power and omnipotence of contemporary central bankers. He blames inept central banking and associated insufficient Fed money printing for the Great Depression. He places blame for the 1929 crash on the “Bubble poppers” and excessively tight monetary policy. He apparently has little issue with the 1920s Bubble. In general, Bernanke is dismissive of risks associated with Bubbles, convinced that aggressive “mopping up” policies can simply inflate away problematic debt loads and shortfalls in aggregate demand. It’s been an incredibly dangerous six-year experiment: “Sufficient injections of money will ultimately always reverse a deflation.” Well, we do have evidence that injections inflate securities market Bubbles.
I have for years argued that Bubbles – rather than deflation - were the prevailing risk to global financial and economic stability. Deflation and faltering demand are certainly risks that I associate with protracted Credit and speculative Bubbles. Dr. Bernanke has referred to understanding the forces behind the Great Depression as the “Holy Grail of economics.” I am instead convinced that understanding this protracted Bubble period is the real “Holy Grail.” And once we come to a more coherent understanding of this period we can attempt to go back and correct the historical revisionism that made such a phenomenal mess out of 1920s and 1930s analysis.
There are key analytical parallels between this prolonged Bubble period and the Bubble that commenced with the First World War and ended with the 1929 stock market crash. The “Roaring Twenties” Bubble period saw incredible technological innovation and stunning productivity gains.
Importantly, the fledgling Federal Reserve took an increasingly activist role in managing the economy and markets (fledgling Greenspan Fed “activism” took hold in the early-nineties). The Fed succeeded in prolonging the boom, but at the high cost of deepening maladjustment in the real economy and distortions in increasingly speculative financial and asset markets. When the Bubble finally burst, all the structural deficiencies – including gross wealth disparities – came home to roost. Fed money printing would have had minimal impact in the face of a devastating collapse in confidence and Credit.
I am convinced that protracted booms bolstered by aggressive policymaking are the root cause of so-called “deflation risks”. Prolonged booms become more global in nature, with major ramifications for financial and economic stability. The benefits of “Globalization” spur trade, investment and outsized financial flows. Later, growing imbalances, speculative excess and runaway booms become prominent. To sustain increasingly unwieldy booms and to ward off fragility require that policies become more “activist”/inflationist. The combination of aggressive monetary inflation and unstable booms over time leads to gross imbalances and increasingly conspicuous wealth redistributions and inequality. Various price levels in real economies and assets markets go haywire, feeding wild wealth disparities and animosities.
I was always uncomfortable with Bernanke’s prescription of aggressive “mopping up” monetary inflation with basically no consideration whatsoever for the associated costs/risks. It was always presented that the scourge of deflation was so utterly horrendous that nothing else really mattered.
Yet what we’re seeing in the world today can be explained as the foreseeable consequences of inflationism – financial fragility, economic imbalances and maladjustment, and social and geopolitical tensions reflective of increasingly conspicuous wealth redistribution and inequality. And I feel quite comfortable stating that more QE – from the ECB, Fed, BOJ, Bank of China and others – will in no way stabilize the situation.
Air needs to come out of dangerously inflated global securities markets. Right now, however, the bull has taken a sword and he’s turned crazy violent – just wants to hurt people. After the 1929 crash there was a big crackdown on large financial institutions. My own theory is that in the late phase of protracted Bubble periods the markets turn dangerously speculative and the marketplace becomes increasingly dictated by dominant market operators. A general perception takes hold in the marketplace that these big players and reliable policy interventions ensure that the game keeps rolling on. This helps explain why speculative markets for a while continue to inflate in the face of deteriorating fundamentals. Moreover, I believe prolonged booms underpinned by policy measures tend to nurture myriad financial schemes and shenanigans, again disregarding fundamental factors. It regresses to the point of being little more than one big precarious game.
I appreciate that comparing today’s backdrop to the late-twenties is considered Wackoism. And I don’t make these comparisons as some prediction of an imminent crash. Markets will do what the markets will do. I just believe strongly that the Credit Bubble Analytical Framework has become invaluable for better understanding the extraordinarily complex and precarious global backdrop. When Bernanke back in 2002 was outlining his policy course to fight deflation, he would not have contemplated today’s social and geopolitical tension. He would not have seen how his “mopping up” could lead to so much instability and angst around the world. He surely would have scoffed at the notion of a new cold war.
“Vladimir Putin took part in the final plenary meeting of the Valdai International Discussion Club’s XI session. The meeting’s theme is The World Order: New Rules or a Game without Rules. This year, 108 experts, historians and political analysts from 25 countries, including 62 foreign participants, took part in the club’s work. The plenary meeting summed up the club’s work over the previous three days, which concentrated on analysing the factors eroding the current system of institutions and norms of international law.”
Putin’s Friday speech did nothing to temper my apprehension that an unstable world is turning more confrontational. Rather than excerpt, a bunch of Bloomberg headlines pretty well captured the gist of his message:
“Putin says world order changing… World growing less secure, predictable; No guarantee of global security; Global security system is weak, deformed; Cold war ended without peace being achieved; Cold war ‘victors’ dismantling international laws, relations; U.S. has worsened disbalance in international relations; U.S. acting like nouveau riche as global leader; World leaders being blackmailed by ‘Big Brother’; U.S. leadership brings no good for others; Sees global media under control, undermining truth; Unipolar world like dictatorship over other countries; Russia sees attempt to carve up world, create image of enemy; Business under unprecedented pressure of western governments; …Many countries disenchanted with globalization; U.S. risks losing trust as globalization leader; Russia won’t beg for anything; U.S. can’t humiliate its partners forever; Pressure from sanctions won’t sway Russia; Ukraine conflict isn’t last to affect world balance; Ukraine crisis itself caused by unbalanced international ties; Putin says current conflicts may lead world order to collapse.”