The Messy Politics of Economic Divergence
Mohamed A. El-Erian
MAR 16, 2015
The Messy Politics of Economic Divergence
The Fed Drops 'Patient'
By: David Chapman
Thursday, March 19, 2015
The Fed lost patience. Well they did not so much as lose patience but they dropped the word "patient" in their "guidance" language. It seemed to be widely expected that they would. Then the Fed talked out of both sides of its mouth simultaneously (aka - Fed speak). The Fed may no longer be "patient" but in the same breath they downgraded the expected pace of growth and inflation. In other words, they are no longer using the word "patient" but they will still be "patient". Go figure that one out. The word "patient" may have become the most overused word in the English language over the past few months.
The Fed has held the official rate at 0%-0.25% since late 2008 following the financial crash of 2008. It has been an unprecedented length of time for an abnormally low official rate. Prior to that, the lowest rate was 1% following the High Tech/Internet crash of 2000-2002. Since 1954, the key Fed rate has never been so low. The highest was 19% plus in 1981. But that was in another time.
With the Fed losing its patience but still concerned about growth and inflation, the market took that as a signal that there would be no interest rate hike any time too soon. Some still believe that the rate hike could come by June 2015 but others now don't see a rate hike until 2016. The markets celebrated as stocks, bonds and even gold and silver all rallied. Oh and oil reversed off new lows and closed higher on the day. The big loser was the US$ Index as it tumbled 1.2%.
The currencies (Euro, Pound, Yen, Swiss Franc and Cdn$) all enjoyed a strong up day.
If one wants to figure out what the Fed was actually talking about on March 18, 2015 following the FOMC meeting there is a word for it all. "Gibberish"! Or as I noted in the opening paragraph it is Fed speak. How else can one explain how one can drop the word "patient" from their guidance then in the same breath state that they have downgraded their outlook for growth and inflation? Even Janet Yellen was quoted as saying at the press conference after the Fed statement "Just because we removed the word 'patient' from the statement doesn't mean we're going to be impatient". Talk about double speak.
Granted the Fed is in a quandary. The rest of the developed world is in a funk with both Japan and the Euro zone in recessionary conditions or low growth. No other major OECD country is raising interest rates. If anything, the tendency has been to cut interest rates. The Fed has no wiggle room if the US were to also see growth slow or worse slide into recession. How does one cut interest rates when they are already at zero? Or do they go the way of the Euro zone and even Japan with negative interest rates?
It is also possible that the Fed has noted that the stock markets appeared poised on the edge of breaking down under a possible ascending wedge triangle. At the end of the day, the best way to keep people's minds off a struggling economy is to help push the stock market higher. If a rising stock market is the measurement of a strong economy than one might think that the economy was doing just fine. Instead, at best it is muddling. As to inflation, the recent PPI and CPI releases are indicating that the US economy could be joining the Euro zone and Japan in sliding into deflation. That is a far cry from the desired 2% inflation target of the Fed.
As to the economy, I am sure the Fed is looking at many of the same charts that I look at from time to time. After all, the Fed produces these charts. First, a word on employment, which everyone continues to hail as to why the Fed might hike interest rates sooner rather than later.
The nonfarm payroll number may be one of the most overestimated numbers produced. The number is largely a guesstimate. Many of the so-called jobs are low wage, part-time or the over used self-employment, which for many is a euphemism for "I am out of work so I am now a consultant".
The first chart shows the unemployment rate (U3) overlaid with the unemployment rate (U6) that includes marginally attached workers plus total employed part-time for economic reasons.
John Williams www.shadowstats.com publishes one more unemployment rate, which is U6 plus discouraged workers unemployed beyond one year. The U3 unemployment rate is 5.5% and the U6 unemployment rate is 11% but Williams unemployment rate is 23% and has been at that level for months.
The U3 unemployment rate remains above levels seen in the late 1990's and prior to the financial crash and recession of 2007-2010. Quite tellingly, the U6 unemployment rate is nowhere near its lows. The spread between U3 and U6 unemployment is currently 5.5 points.
At the peak in 2010, it was 7.3. In December 2007, the spread was 3.8. The U6/U3 ratio is at its highest level at 2. The ratio saw its lows back in 2002 at 1.63.
As has been noted on numerous occasions the unemployment rate is falling not because more people are working but because the labour force participation rate is falling. The labour force participation rate at 62.8 is at levels seen back in the late 1970's. The civilian employment population ratio is also dragging along at multi-year lows. That ratio takes the number of people employed in relation to the total population. Again, that ratio is back at levels last seen in the late 1970's. There are actually fewer people working today then there was in 2000 (148.5 million today vs. 153.4 million in 2000).
Those working part-time remains at multi-year highs. Current levels are 27.5 million vs. 28.1 million in July 2013. These levels are higher than at any time prior to the recession of 2007-2010.
People are also unemployed longer. Prior to the recession of 2007-2010, the average duration of unemployment was 17 weeks. At its peak in 2011, the average duration of unemployment hit 40 weeks. Today it is just under 32 weeks albeit it has been declining slowly. Going back to 1950 the highest it had ever been prior to the 2007-2010 recession was 21 weeks during the recession of 1980-1982. Overall fewer people are working despite an increase in population and people are unemployed for a longer period than they ever have been over the past 65 years.
One thing that zero percent interest rates and three rounds of QE has been successful with is pushing up the value of the stock market. While traditional measurements of inflation are showing signs of deflation, the real inflation has been in assets. As I have noted in the past the stimulus of low interest rates and QE for the most part has never really made it into the real economy. It has instead resulted in inflating assets. Now the value of equities in relation to GDP is at its highest level since the dot.com bubble of the late 1990's. Today it is at levels even higher than they were in 2007. It is a potential measurement of overvaluation in the stock market.
The indicator is known as the Buffett Indicator named after Warren Buffett. The indicator takes the ratio of market capitalization of corporate equities to GDP. That chart is shown below following the three employment charts from the Federal Reserve.
Larger Image - Source: www.dshort.com
Household net worth has also risen sharply over the past number of years along with equity valuations. As with the stock market, the rise is primarily due to asset inflation. While household net worth is up 83% from where it was at the peak of the dot.com bubble in inflation adjusted terms it is only up 40%. Wages on the other hand are only up 17% in the same time and real median household income is actually down almost 10%. So where is the boom?
Another interesting figure is the average net worth of the US household is $310 thousand but the median net worth is $45 thousand meaning half of US households have a net worth less than $45 thousand.
Retail sales are another case in point about an economy not as strong as it would appear. While actual retail sales are at record levels (despite slipping the past few months) when one adjusts retail sales for inflation and population growth retail sales are back about where they were ten years ago. An interesting chart is shown below that reflects that while retail sales have grown since the 2007-2010 recession from roughly $180/person to roughly $207/person it remains below the peak of 2006 when it was roughly $212/person. Given weak retail sales over the past few months since this chart was produced, the current level may well be lower than where it was in January 2015.
Larger Image - Source: www.dshort.com
Many tout the housing recovery as evidence that the economy is improving. Well yes, housing has improved but overall it remains well below peaks seen in 2006. Existing home sales remain not only below the peak seen in 2006 but are below levels seen in 2000. Existing home sales have started once again to turn down and have failed a recent peak. Technically that suggests weakness and the possibility for new lows.
With new home sales, the situation is even worse. New home sales are not only well below the peak of 2005 but they are down to levels seen in the early 1990's and early 1980's recessions. This is not what one would call a robust recovery. Finally housing starts are at levels seen at recessionary lows during the late 1960's, and the recessions of 1974-1975, 1980-1982 and 1990-1992.
Given three rounds of QE since the financial crash of 2008 plus interest rates held at historical lows one would think that the housing market would be a lot stronger. Not only is the housing market not stronger (ok barely) but it is in some cases at levels seen 20-40 years ago.
Three housing charts follow that show this situation.
Finally, one cannot ignore the debt situation. Total US debt has grown $8.6 trillion since the end of 2007 to $58.7 trillion at the end of 2014. Government debt has seen the largest growth up $7.9 trillion (note: this is public debt growth only - Total or grosses US government debt has grown by about $9.2 trillion. Debt to GDP was 68% at the end of 2007. Today debt to GDP is 103%. Countries with a government debt to GDP over 100% tend to experience weak economic growth and are subject to economic shocks). In addition, the US has roughly $95.6 trillion of unfunded liabilities. Corporate debt has also gone up sharply from $6.3 trillion at the end of 2007 to $7.6 trillion today.
If there have been declines it has been financial debt (banks etc.) that have seen a decline of just over $2 trillion. The prime reason for that is that banks have seen their loan books fall because they are not able to find sufficient credit worthy customers to lend to. As well, banks tightened their credit requirements considerably following the financial crash of 2008.
Households have seen their debt decline by roughly $500 billion. Most of it has occurred because households are taking on less mortgage debt even as consumer debt (credit cards) has soared. Given the shock of the 2008 financial crisis the consumer has deleveraged but not by very much. Consumer debt had soared for the previous three decades. At least US households have deleveraged to some extent. In Canada, the consumer continues to leverage higher and their debt to income ratio is the highest ever.
The Fed is caught between a rock and hard place. That may explain why the Fed's official statement and Janet Yellen's press conference were both in some respects confusing. The Fed is no longer "patient" but they are concerned about weakness in economic data and inflation (or in this case deflation). An interest rate hike could occur but the Fed faces pressure from other countries to hold off even as they have no wiggle room for lowering interest rates if another recession were to develop.
The Fed effectively signaled that ultra-loose monetary policies are to continue and they dampened expectations that any rate hike would happen by June. This pushed out interest rate hike expectations to September and maybe even later into 2016.
The Fed is too well aware that the global and US debt situation remains fragile and the economy would have difficulty with higher interest rates. Despite six years of QE and an ultra-loose monetary policy with interest rates historically low, many aspects of the economy remain sluggish at best even as it has created an asset bubble given the high level of the US stock market. All the talk about hiking interest rates coupled with economic weakness in the Euro zone and Japan has driven the US$ to multi-year highs. It is now at levels that threaten the recovery as the export market contracts and US multinationals have lower global earnings because of the strong US$.
The US$'s position as the world's sole reserve currency remains under constant attack because of currency wars. China is leading the charge to weaken the role of the US$ in the world and strengthen the Chinese Yuan through the creation of financial institutions led by China that would challenge the supremacy of the IMF and the World Bank. Many believe that the military build-up in Europe vs. Russia and even in Asia vs. China is a result of this direct challenge to the US$ and US global hegemony. We live in interesting times. The Fed may have dropped "patient" but the world is increasingly becoming "impatient".
Review & Outlook
Japan’s Devaluation Warning for Europe
Monetary easing without reform has reduced real wages.
March 16, 2015 7:28 p.m. ET
Amid the excitement as the European Central Bank began sovereign bond buying last week, Europeans might have missed that real wages in Japan fell again in January. Japanese households earn 7.5% less in inflation-adjusted terms now than before the 2008 financial panic, and about half of that decline has come during Tokyo’s “quantitative easing” program. This is a warning for Europe.
The similarities between Japan in 2013 as Prime Minister Shinzo Abe took power and the eurozone now are striking. Japan was in deflation; Europe has appeared close to it. Japanese worried that the yen, which had risen to around ¥77 per dollar in 2012, was badly overvalued. European Central Bank President Mario Draghi warned in April last year, when the euro was about $1.38, that “a rise in the exchange rate, all else being equal, implies a tightening of monetary conditions, a downward impact on inflation and potentially a threat to the ongoing recovery.”
So the Bank of Japan and ECB have fired their monetary bazookas at the deflation threat. The main goal has been competitive devaluation. With loan demand and banks weak, the traditional mechanism of monetary stimulus—increased liquidity and lower interest rates stimulating more lending—wouldn’t work. But policy makers hope a weaker currency will boost exports, higher earnings for exporters will trigger stronger business investment and trickle down to higher wages, which will lead to more domestic consumption and growth.
The falling earnings of workers tell you how well that has worked in Japan. Exporters haven’t responded to yen depreciation by cutting their prices overseas to boost global market share. Instead, Japanese firms have kept overseas prices roughly the same and exploited the weaker yen to book higher yen-denominated earnings. After adjusting for the exchange rate, exports are flat—still roughly 25% less than their level before 2008.
Because investment is declining, worker productivity isn’t increasing and wage increases are negative after inflation. Meanwhile, the weak yen has driven up import prices. This leaves households paying more for goods they consume every day, while wages don’t keep up.
Europe might appear immune to some of these negative effects. Today’s low oil price will offset the rising prices Europeans pay for other imports, a benefit Japan didn’t enjoy in 2013 and most of 2014.
Parts of Europe, especially Germany, have seen real wage growth in recent months from cheaper energy. No eurozone government seems ready to enact as monumentally foolish a policy as Japan’s consumption-tax hike, which dealt another blow to consumers.
Look closer, though, and similarities appear. The main explanation for Japan’s stagnant business investment and falling real wages is Mr. Abe’s failure to enact the “third arrow” of reform. Businesses face the same disincentives to invest as ever—overregulation, high taxes, protectionism and lack of competition.
The unreformed labor market is a particular offender. Job creation is concentrated on part-time workers as companies shy away from hiring full-timers who come with onerous restrictions on firing. That explains why real wages aren’t rising despite a tight labor market.
The same lack of reform typifies the eurozone. The boldest reform on offer is France’s proposed Macron Law, which among other things increases the number of Sundays a shop can open each year—to all of 12 from five. Spain, Portugal and Ireland have liberalized labor markets somewhat and implemented other pro-growth measures, but basketcases like Italy remain mired in red tape.
And sure enough, as in Japan, exporters in these unreformed economies have exploited the euro’s downward slide—to a 12-year low of $1.0457 Monday from $1.40 last May—mainly to boost profit margins. The eurozone is more regionally varied than Japan, so in some countries this earnings boost could stimulate production, investment, productivity gains and eventually rising wages.
But rising import prices are a particular danger in less-competitive southern Europe, which needs reform to bring business costs into line with the Germans, Dutch and other northerners. Instead, euro devaluation could push up prices for imports without compensating cost reductions as QE’s low interest rates ease the political pressure for reform. Workers could find themselves in a vise familiar to the Japanese.
***Japan’s present isn’t Europe’s inevitable future. The eurozone isn’t aging as fast, and its regulatory ossification isn’t as severe. Perhaps something in the culture, or the water, will spur more competitive business behavior if export profitability improves. Maybe Europe’s relatively stronger unions will extract bigger pay increases.
But no less an authority than Mr. Draghi understands the limits of monetary policy and competitive devaluation—and perhaps the dangers, too. He has spent the past year begging Europe’s political class to enact the supply-side reforms that would keep his monetary policies from turning Europe Japanese.
Beware of The Inverted Yield Curve!
By: Michael Pento
Monday, March 16, 2015
In the movies, an edgy musical score is an effective tool that warns the audience something really bad is about to happen. Like the shrill screech in Psycho, certain sound effects forebode impending doom. In like manner, economics also has a similar warning sign of imminent market chaos. This omen is called the inverted yield curve. And it's no coincidence that the last seven recessions have been preceded by this ominous predictor of economic and stock market disaster.
The yield curve graph depicts the slope of sovereign bond yields across all maturities. When investors desire to purchase longer-dated maturities, they typically demand a higher yield to compensate for inflation risks that tend to increase over time. Therefore, under normal circumstances, longer-term bonds yield more than their short-term counterparts. Typically, the yield on 30-year Treasury bonds is three percentage points (300 basis points) above the yield on three-month Treasury bills. When the yield curve steepens from that usual spread it means long-term bond holders believe the rate of inflation will increase sharply in the future.
At the other end of the spectrum we have the inverted yield curve. This occurs when the Fed Funds Rate and short-term U.S. Treasuries offer higher yields than longer-dated issues. The signal here is that investors anticipate an environment of sharply slowing economic growth, deflation and economic turmoil.
How This Played Out During The Past Two Recessions?
By the late spring of 2000, the rate on the 10 year note was lower than the Fed funds rate; thus officially inverting the yield curve. The Federal Reserve raised the Fed funds rate 25 basis points on March 21st from 5.75, to 6.0%. Afterwards, the Fed ended its rate hike campaign in May of that year with a 50 basis point rate increase to 6.5%, while the Ten-year Note traded below 6.0% by June. After this, the S&P 500, which was not a part of the tech bubble, peaked in July of 2000 and dropped 40% by September of 2002.
Likewise, in June 2006 the Fed ended its multi-year cycle of rate increases, taking the Funds Rate up 25 basis points to 5.25%, while the 10-year Note yielded around 5.0% during that same timeframe.
The yield curve officially inverted for the second time that decade -- investors once again heard the ominous music playing. The backward yield curve first caused the massive housing bubble to rollover in the summer of 2006. And, since the yield curve remained inverted for over one year, the equity market quickly followed the collapsing real estate market. The S&P 500 plummeted 50% from July of 2007, to March 2009.
Today the 10 year note is trading around 2.25% and the Fed Funds rate is in the 0-25 basis point range. During the Fed's previous rate hike campaign, it had to move short-term rates up 400+ basis points before the yield curve became inverted. However, this time around the Fed will only have to increase the Fed Funds Rate half that amount before the yield curve will become inverted. And it may take even less than that, as the economy is already experiencing anemic growth and disinflation -- which will put downward pressure on long-term rates. In addition, interest rates on foreign sovereign debt are well below those in the United States, which will push domestic rates down even further.
Therefore, this time around the yield curve will invert at a much lower level than at any other time in history. What's more, the Fed has historically raised rates in order to combat a rising rate of inflation, a weakening U.S. dollar and rapid GDP growth. Now, it will be raising rates in the midst of low inflation, a soaring Greenback and anemic economic growth. And, the Fed won't have to make many rate hikes before the yield curve inverts.
So Why Will The Fed Raise Rates?
The Fed has drawn a Maginot line with its use of the unemployment rate as the main indication of when to raise rates. The Fed is relying on an indicator for when to raise rates that is painting an inaccurate picture of growth and inflation. The U-3 unemployment rate, which is now sitting at 5.5%, isn't taking into account the unusual amount of part-time and discouraged workers.
That U-6 unemployment rate, which includes those partially and fully separated from the workforce, is currently 11%. That figure is two full percentage points higher than where it was the last time the U-3 rate was at this level, which was during the epicenter of the financial crisis.
But the Fed's Keynesian illogic dictates that a low unemployment rate is the very cause of all that is inflationary, despite alternative measures of labor slack. Therefore, in Pavlovian fashion, it will feel compelled to start raising rates in the next few months.
Most importantly, it will be raising short-term rates when the long end of the yield curve has been artificially manipulated to a record low level. Our hapless central bank may be venturing down the short and dangerous path to an inverted yield curve. But at the same time, economic growth and inflation are decelerating.
Interest Rate Obsession
Foreign central banks will also soon have to abandon their reckless policies of QE to infinity due to its futile effect on GDP growth. Likewise, since sovereign yields are near zero percent in Japan and Europe, it will take just a few basis points in rate hikes to send the entire developed world into an inverted yield curve situation for the first time in global economic history. This is what lies ahead for global investors as central banks begin to move away from the massive distortion of asset prices for the last 7 years. Unfortunately, in the aftermath of this next deflationary collapse, global governments will embark on an unprecedented economic experiment that will involve the further erosion of free markets as part of their effort to reflate asset prices.
In the movies, when a character is unaware of the ominous warning signs that the director has provided the audience, it usually leads to their imminent demise. Ms. Yellen and company may be unaware how important an inverted yield curve is to the banking system and money supply growth. But investors should not let the ignorance of central banks lead to the demise of their wealth.
Dollar Flash Crashes: Currency Market Pulverized As Dollar Implodes After Close
by Tyler Durden
on 03/18/2015 22:31 -0400
Heard on the Street
Bonds Hit Boiling Point Thanks to ECB
European bond markets are looking increasingly stretched as capital gains gain focus at the cost of income
By Richard Barley
March 16, 2015 7:43 a.m. ET
For a policy so long and so public in the making, the start of government-bond purchases by the European Central Bank last week had a surprisingly big effect. Already superlow sovereign-debt yields fell even further—the 10-year German yield dipped at one point under 0.2%. But bond markets are looking increasingly stretched.
In the near-term, ultra-low yields can persist in Europe. The presence of a big, price-insensitive buyer, the ECB, will have a powerful impact. Continued tensions between Greece and the eurozone are likely to support bond prices, too; a flare-up that raises the risk of a Greek exit could push German yields lower still.
Japan’s experience also shows yields can stay low for longer. Meanwhile, bonds have demonstrated an unexpected capacity to produce outsize capital gains as yields have turned negative for vast swathes of the market.
Still, it is hard to escape the idea this process has its limits—and may be approaching them.
Even during the many years of quantitative easing in the U.S. yields for all but the shortest-maturity debt never turned negative. On a long-term investing horizon, today’s European yields look decidedly bubbly.
If nothing else, low and negative yields, are challenging a fundamental reason for buying bonds: steady income. Instead, buyers increasingly appear to be betting on capital gains. That is effectively turning debt managers into stock investors; “fixed income” increasingly looks like a misnomer. That is a worrying development, especially given most investors have become so used to the decades-long bond bull market.
Over the bond’s remaining lifetime, investors will receive €562.5 ($590.2) in interest and €1,000 at maturity, for a total of €1,562.5. So, the price is 99.1% of total future cashflows an investor has the right to receive. In other words, the bond will produce virtually no income over its lifespan.
Sure, the bond’s price could yet rise further. Unless yields go massively negative, though, gains won’t be that large. Meanwhile, downside risks are big: a one-percentage-point rise in yields—taking them to where they were in June—would push the price down around 7%. And if Europe’s economy gains traction, investors may find they really have been trying to gather pennies, and in some cases not even that, in front of the proverbial bulldozer.
It’s not just German bonds that are behaving unusually. Austria’s government bond due in 2062—originally issued as a 50-year bond—is trading at 210% of face value and yields just 0.9%. Corporate bonds aren’t far behind. French energy company GDF Suez early in March issued €2.5 billion of debt that included a €500 million two-year zero-coupon slice—essentially borrowing for free.
ECB purchases may even have exacerbated this problem. Understandably, much focus is on technical factors such as flows, liquidity and issuance: how much will the ECB buy of what bond at what price? These factors are undeniably powerful. But they are essentially divorced from economic fundamentals.
Until recently, those fundamentals were more supportive of low yields: inflation was plummeting and eurozone growth was a fabled hope. But the growth outlook has improved; inflation expectations are still low but have started rising. Indeed, the point of the ECB’s bond buying is to revive the European economy. That should ultimately prove bad news for bonds.
At some point, albeit perhaps not quickly, fundamental factors should reassert themselves.
When that happens, the realization that bonds have had their innate investment characteristics crushed and that capital gains are a thing of the past will result in a rude awakening for many investors.
From Munich to Kyiv
Petr Kolář, Juraj Mesík
MAR 13, 2015
As citizens of a region that endured both Nazi and Soviet occupation, we know all too well the danger of euphemism.
Bohemia and Moravia became a Reich protectorate, and Slovakia was given nominal independence under a puppet regime. Czechoslovakia's impressive industrial capacity and human resources were placed fully at the service of Hitler's war machine. By the time Hitler attacked France, one-quarter of all German weapons came from the occupied Czech lands.
Negotiations can succeed only if conducted alongside the toughest and broadest possible sanctions on the Russian economy and the provision of effective and extensive help to Ukraine.
Read more at http://www.project-syndicate.org/commentary/west-dishonor-ukraine-by-petr-kolar-and-juraj-mesik-2015-03#hd5K63s5cOSrEGi7.99
Greek Crisis Tests ECB’s Credibility
The central bank must decide if Greek banks should be allowed to use scarce liquidity to roll over their existing holdings of T-bills
By Simon Nixon
Updated March 15, 2015 10:14 p.m. ET
Yet the banking union involved a far greater transfer of sovereignty than has been widely understood, arguably greater even than the creation of the euro itself. After all, the banking union has handed the European Central Bank, as the eurozone’s new single banking supervisor, powers that directly affect citizens’ property rights and the ability to take decisions with potentially far-reaching fiscal consequences.
Now, just four months after assuming its new powers, the ECB faces an acute test of its credibility in the shape of the latest Greek crisis.
The success of the banking union hinges on the ECB convincing markets that it offers a decisive break with a European past in which national authorities were seen as too susceptible to political pressure, too willing to overlook weak bank balance sheets to shield government balance sheets.
To break this toxic link between banks and sovereigns that has undermined trust in the eurozone financial system, the ECB needs to show that it can take decisions independent of political pressures.
Most analysts agree that the SSM has got off to a promising start. Last year’s asset-quality review and stress test of the balance sheets of the largest eurozone banks was seen as more rigorous than past European efforts. The ECB has also been using its discretionary powers to push banks to improve the quality of their capital, circumventing national opt-outs from the Basel framework that had been baked into European rules.
Recent moves by Spanish lender Banco Santander SA to raise capital, as well as steps to boost the capitalization of small Italian lenders, bear the hallmarks of the new regulator flexing its muscles.
But the Greek crisis has put the ECB in an uncomfortable position. Prime Minister Alexis Tsipras complains that the ECB has a noose around Greece’s neck because it won’t allow Athens to issue more short-term bonds. The ECB has defended its position primarily in terms of monetary policy: It says that allowing Greek banks to buy more T-bills would amount to central-bank financing of the government, prohibited by European treaties.
But as supervisor of the four largest Greek banks, the ECB faces an even more delicate question: Should Greek banks even be allowed to use scarce liquidity to roll over their existing holdings of T-bills?
Officials acknowledge that at a time of such acute stress, banks should ideally be cutting their exposures to illiquid government securities. Yet they also know that ordering banks to do so would have dire consequences for financial stability.
For the moment, the ECB is allowing banks to roll over T-bill exposures. But some officials say that the longer this continues, the greater the risk to the ECB’s credibility as a bank supervisor.
Meanwhile the ECB also faces another critical judgment: Do Greek banks have sufficient capital?
The economic crisis is already taking a clear toll on bank asset quality. Eurobank Ergasias SA, one of Greece’s largest lenders, said last week that its nonperforming loan ratio has already returned to comparable levels to the first half of last year, with arrears picking up on both mortgages and commercial loans.
Default rates will almost certainly worsen if the government starts delaying payment to its own suppliers because of a cash crunch, as seems likely given the lack of progress toward unlocking bailout funds.
Credit conditions are also likely to tighten as a result of the deposit flight since the start of the political crisis in December. Although outflows have stabilized since Athens signed a four-month extension to its current bailout program on Feb. 20, the Greek banks are still reliant on central-bank facilities for €100 billion ($104.96 billion) of funding, equivalent to almost 70% of Greek gross domestic product.
That suggests Greek banks will face a further period of deleveraging as they try to put their funding back on a sound footing.
And if Athens pushes ahead with a proposed new law outlawing foreclosures on some home loans, the banks will be forced to take further bad debt charges to reflect the weaker incentives for homeowners to honor their debts.
True, the four large Greek banks passed the ECB’s stress test last year and so far, any deterioration is within the range of the adverse scenario used in the test, say officials familiar with the situation. But the snag is that a large share of the capital held by Greek banks consists of deferred tax credits, which the ECB has indicated it doesn’t regard as sufficiently loss-absorbing to qualify as true core capital, since its availability depends on the ability of banks to generate profits for decades to come.
Strip out these tax credits and Eurobank’s core-capital ratio fell to about 5% at the end of 2014, notes Citigroup. That is far below the 10% standard for European banks.
Not surprisingly, Greek bank stocks have lost up to 80% of their value in the past year and now trade at deeply distressed multiples.
Some central bankers believe that substantial capital injections into Greek banks may already be necessary. Yet the only plausible source of capital today is money earmarked for bank recapitalizations held by the Hellenic Financial Stabilization Fund. To access these funds, the banks would need the approval of the European Stability Mechanism, which in turn would require that Greece comply with its bailout program.
If HFSF funds weren’t available, any bank deemed to be inadequately capitalized would have to be resolved in line with the EU’s tough new bail-in rules, which could lead to losses for some depositors.
Of course, technocratic officials are reluctant to take decisions with such profound political implications. But the ECB also has an obligation to discharge its responsibilities independently and in accordance with eurozone laws.
The longer the impasse between Athens and its creditors continues, the greater the pressure on the ECB to act to safeguard its own credibility. After all, that was the point of the banking union.
The bigger, the less fair
The growing size of firms may help to explain rising inequality
Mar 14th 2015
SINCE its publication last year, Thomas Piketty’s “Capital in the Twenty-First Century” has ignited a furious debate about inequality in the rich world. He focuses on the increasingly unequal distribution of wealth, and pays less attention to the growing disparity in wages over the past three decades. Yet that disparity is ballooning, too: in America, for instance, the best-paid 1% of workers earned 191% more in real (ie, inflation-adjusted) terms in 2011 than they did in 1980, whereas the wages of the middle fifth fell by 5%. Similar trends can be observed all over the world, despite widely varying policies on tax, the minimum wage and corporate pay.
The standard explanation says that technology plays a big role: modern economies require more skilled workers, raising the pay premium they can demand. A new paper* by Holger Mueller, Elena Simintzi and Paige Ouimet adds a new and intriguing wrinkle to this: the rising size of the average firm. Economists have long recognised that economies of scale allow workers at bigger firms to be more productive than those at smaller ones. That, in turn, allows the bigger firms to pay higher wages. This should not, in theory, cause a rise in inequality. If the chief executive and cleaner at a larger firm are both paid 10% more than their counterparts at a small firm, the ratio between their wages—and thus the overall level of inequality—should remain the same.
But the paper shows that the benefits of scale are not shared equally among all workers. Using data on wages at British firms, they divide workers into nine groups according to how skilled they are.
Over time, they find that the proportional difference in wages between the groups grows as firms get bigger. This trend is driven entirely by a rising gap between wages at the top compared with the middle and bottom of the distribution. As the authors note, this is very similar to the trend in income inequality in America and Britain as a whole since the 1990s, when pay for low and median earners began to stagnate (see chart).
The authors suggest two possible explanations. First, larger firms should find it easier to automate tasks than smaller ones, and may therefore find it easier to resist demands for pay rises from relatively unskilled workers who could be replaced by machines. In addition, entry-level workers in the middle of the income distribution may be willing to accept lower pay from big firms since in the long run the chances of winning a promotion are greater than at small firms.
The authors find that the relationship between the growth in the size of companies and the level of inequality holds across the rich world. They looked at data from 1981 to 2010 on wages and the size of largest firms for 15 countries in the OECD, a club mostly of rich countries. The relationship between rising levels of income inequality and the size of firms was strong.
This effect is particularly noticeable in America and Britain, where firms have grown rapidly in recent decades. In America, for instance, the number of workers employed by the country’s 100 biggest firms rose by 53% between 1986 and 2010; in Britain the equivalent figure is 43.5%. On the other hand, in places where the size of firms has not changed much, such as Sweden, or where it has shrunk, such as Denmark, wage inequality has grown much less. Part of what is perceived as a global trend towards greater disparity in wages may actually be the result of the biggest firms employing a greater share of workers.
Another new paper**, which looks at manufacturing in America, China and India from 1982 to 2007, suggests that the trend towards bigger firms is only likely to accelerate. Big firms’ higher productivity, it argues, raises the barriers to entry for new—and presumably smaller—competitors.
Larger factories are more productive than smaller ones, so bigger firms can entrench their position over time. That will skew the income distribution even more. There is plenty of evidence across America and Europe that startup rates for companies are falling, allowing the biggest firms to get bigger unhindered by competition. Since the financial crisis, higher barriers to entry in the form of limited access to capital has caused the number of new businesses to collapse.
Not all economists see this as a dreadful thing. After all, bigger firms have much higher investment rates than smaller ones, which helps to fuel growth throughout the economy. The preponderance of small firms in such places as Greece, Italy and Portugal, seems to be one of the factors holding those economies back.
But if governments wish to reverse the inequality big firms foment, reforms to the labour market are unlikely to do the trick. Instead, they will have to spur competition by reducing barriers to entry for smaller firms, most notably by improving their access to credit. That should reduce income inequality and boost economic growth at the same time.
Voters dislike the growing inequality of incomes, and often agitate for redistributive policies to reverse it. Yet too much crude redistribution can be counterproductive in that it tends to dampen economic growth. The link between firm size and inequality suggests a better option. By boosting competition, policymakers can please both populists and economists at the same time.
* H. Mueller, E. Simintzi and P. Ouimet, “Wage inequality and firm growth”, LIS Working Paper 632 (March 2015).
** A. Bollard, P. Klenow and H. Li, “Entry costs rise with development”, SCID Working Paper 518 (December 2014).
Something Big is Coming to Markets
By: Robert McHugh
Sunday, March 15, 2015
We are about to see a series of cycle turns occur simultaneously over the next 30 trading days, a period which includes a Fibonacci Cluster turn window with 10 observations. Within this 30 trading day period are a number of very unusual astrological events, which can affect markets. In the past, we have pointed out that major trend turns often come around the spring equinox, which this year arrives within the important Fibonacci Cluster we discuss below, on March 20th, 2015. Within this cluster turn period we also have a rare Total Solar eclipse (also on March 20th, 2015), the first day of the Hebrew calendar, (Nissan 1, evening also on March 20th), and a New Moon on March 20th. March 20th is also a quadruple witching hour on Wall Street, an options and futures expiration date. Also within this Fibonacci cluster turn period, on April 1st, 2015 is a phi mate turn date, and on April 4th we see a Bradley model turn date, which is also Passover, and also has a Full Moon -- not just any Full Moon, but a Blood Moon, the third of four in the 2014-2015 tetrad, a very rare event, that has the additional extremely rare occurrence that all four of these Blood Moons fall on the Hebrew Holy days of Passover and the Feast of Tabernacles (see Genesis 1:14). Something big is about to change.
In our weekend report to subscribers at www.technicalindicatorindex.com, we show that contemporaneous with these events, the stock market has now formed two Megaphone topping patterns that look complete, a Jaws of Death topping pattern that is over two decades old, that started back in 1988 and is reaching conclusion now, and also a Jaws of Death pattern from mid-2014 that is also completing now. See the charts for these patterns below:
The significance of this confluence cannot be overstated. A huge directional change in markets is fast approaching. We believe there could be a stock market crash later this year, perhaps in the September - October time period, after the approaching major trend turn begins. The Federal Reserve is about to lift short-term interest rates during a period of time when except for Manhattan and the surrounding areas that enjoyed a $5.0 trillion influx of cash from the Fed's various Quantitative Easing programs, most of the U.S. economy is not prospering. This is a formula for a recession or worse.
The higher value of the Dollar has placed increased pressure on U.S. exports which will eventually show up in a retardation in the growth of corporate earnings. Real Estate remains at a standstill.
Newly created family supporting jobs are not sufficient to handle demand as evidenced by the failure of the involuntary part-time employment figures to decline along with the reported increase in non-farm payroll jobs in the latest bogus employment figures, which included an estimate, a guess, a hope from the Bureau of Labor Statistics that half the jobs created came from new businesses they think started up in February. Anybody who knows anything about jobs in new businesses knows that most of the time the cash compensation is below market -- if new employees are being paid in cash at all.
These new jobs that supposedly were created in February from new businesses are not counted by the BLS. They are a guesstimate. The point is, fundamental economic growth is not what we are being led to believe is the case. Our economy remains weak, so an increase in interest rates would be a repeat of what the Fed did back at the start of the Great Depression in the 1930s.
There are systemic issues of risk that are a serious threat to our economy, the out of control amount of derivatives to mention one, the out of control federal debt, for another, the unfunded federal liabilities for entitlements a third, and the risk of another Wall Street meltdown contagion should a major bank go down the tubes.
Back to the technicals, we saw another stock market Hindenburg Omen observation on Friday, March 13th. If we get a second observation over the next 30 days, that will generate the third independent Hindenburg Omen that contemporaneously remains on the clock over the same next 30 trading days as mentioned at the start of this article. We also got an H.O. in December that remains on the clock through April, and also got an official H.O. in January that remains on the clock through May 2015.
This is a highly unusual event, a series of Hindenburg potential stock market crash signals within a few months. An H.O means there is a 20 percent chance for a stock market crash, which is substantially above random, and we must also mention that there has only been one decline greater than 15 percent over the past 30 years that was not preceded by a Hindenburg Omen. H.O.'s mean the stock market is a seriously unhealthy condition.
I will wrap up this article with details of the coming Fibonacci Cluster turn window we have identified. There is a major trend turn coming to stock markets sometime over the next one to four weeks, and the below chart analysis suggests sometime between March 18th and April 22nd. While it is unusual for us to present a Fibonacci cycle turn window with such a wide range of date possibilities, in this case 25 trading days (normally we point out turns with a 5 to 7 day possibility range), this time is different. Normally we see 4 to 6 past tops or bottoms a Fibonacci number of trading days from a future turn period, however this time we have spotted ten. That is not all, these ten are consecutive Fibonacci turn numbers starting at 34 trading days and running through 2,584.
That is incredibly unusual.
While not a certainty, as there are no guarantees, if I was to venture an educated opinion, I believe it is probable that the stock market will top during the above Fibonacci cluster turn window, and continue to decline for years. I also believe that this autumn 2015 will see a stock market crash within this imminent multi-year stock market decline. It is possible this turn is so important that it started early, on March 2nd.
We have found that when there is a cluster of trading days within a short period of time that are a Fibonacci number of trading days from a key top or bottom turn from the past, there is a higher than normal probability that a significant trend turn is coming around that cluster time period.
What are Fibonacci numbers? They are an incredible set of numbers that seem to rule markets, both in terms of distance of price moves and timing, and rule physics and art throughout the universe.
The Fibonacci number sequence starts with the number one, and then when it adds it to itself, it produces the next Fib number, which would be 2 (1+1), then if we take that resultant number and add it to the previous Fib number in the sequence, it produces the next Fib number, which would be 3 (2+1), then the next number is 3 + the previous number in this sequence which was 2 resulting in 5 (3 + 2), then 8 (5 + 3), then 13 (8 + 5), then 21 ( 13 + 8), etc..., which gets us the sequence 34, 55, 89, 144, 233, 377, 610, 987, 1597, 2584, etc....
What is incredibly unique about this sequence is the two component numbers, when divided by their combined result, will approximate at the low end, and otherwise equal either .382 or .618. The ratio .618 is known as phi. For example, for the Fibonacci number 21, its two components are 13 and 8. If we divide 13 into 21, 13/21 = .618 and 8/21 = .382. The larger the numbers, the more precise they come to .382 and .618. 233/377 = .618 and 144/377 = .382.
So, getting back to our Fibonacci Cluster for mid-March through mid-April:
- * April 6th, 2015 is a Fibonacci 2,584 Trading Days from the December 28th, 2004 Top.
- March 27th, 2015 is a Fibo 1,597 Trading Days from the November 20th, 2008 Major Low.
- April 22nd, 2015, is a Fibonacci 987 Trading Days from the May 19th, 2011 Top.
- April 9th, 2015 is a Fibonacci 610 Trading Days from the November 1st, 2012 Top.
- April 10th, 2015 is a Fibonacci 377 Trading Days from the October 8th, 2013 Major Low.
- April 16th, 2015 is a Fibonacci 233 Trading Days from the May 13th, 2014 Minor High.
- April 17th, 2015 is a Fibonacci 144 Trading Days from the September 19th, 2014 Top.
- April 16th, 2015 is a Fibonacci 89 Trading Days from the December 5th, 2014 High.
- March 18th, 2015 is a Fibonacci 55 Trading Days from the December 26th, 2014 Top.
- March 20th, 2015 is a Fibonacci 34 Trading Days from the January 30th, 2015 Low.
How to rescue Petrobras
Mar 15 11:54
The corruption investigation initiated by the Brazilian prosecutor, Rodrigo Janot, into 54 individuals including leading politicians is just beginning. The allegations behind the inquiry concern the diversion of huge amounts of money from Petrobras, the state oil company.
No one know how much money is involved, which means that no one knows what the company is now worth.
Petrobras’s share price has fallen by 44 per cent over the last year, with some some $90bn wiped off the value of the company in just six months.
Part of that is due to falling oil prices, but more is the direct result of the company’s internal problems. There are no signs yet of the ambulance-chasing investors who like to pick up undervalued assets for a song piling in. They must think, probably with good reason, that the worst is yet to come.
In the US a class action law suit has begun. The scandal could yet bring down the Brazilian government, not least because for most of the period when the corruption is said to have happened Dilma Rousseff just happened to chair Petrobras. It could also be a deep embarrassment for the audit firms who seemed to have missed what was happening.
The question for the moment is what happens now to Petrobras itself.
Last time I wrote about Petrobras and suggested there were problems the company wrote in through a PR agency to say that it was in brilliant shape and that I was completely wrong. I’m happy to admit my last article on Petrobras was wrong. The situation of the company was far worse and the mismanagement far greater than I suggested in the article, or was aware of at the time.
Petrobras is a strong engineering business with a good operational record. The company produces more than 2.5m barrels of oil a day and has been instrumental in developing Brazil’s offshore oil resources. Without Petrobras, Brazil would be much poorer and would never have been listed as one of the Brics – the now rather tainted acronym invented by Goldman Sachs for the next generation of major world economies – Brazil, Russia, India, China and South Africa. The achievements of the technical side of the company make me feel even sorrier for the 87,000 Petrobras staff.
The company has been damaged over the last decade not just by the alleged corruption but also by politically motivated price manipulation which has left the downstream business much weakened.
Few companies can be expected to cope with the $44bn of operating losses imposed on the business by fuel subsidies since 2011. There has also been gross mismanagement at board level.
That is reflected not just in the share price fall but also by successive failures to meet production targets, especially for new fields. International partners have been misled into accepting unrealistic timescales and cost schedules. The result of all this is that the company is no longer trusted. For what should be a national champion, and what is still one of the largest energy companies in the world that is a disaster.
What then can be done?
The corruption case will take its course and no doubt a long time. That could be debilitating for the business – and in turn for the national economy. I hope the Brazilian government, regardless of the alleged involvement of individuals in what has happened will now make sure that Petrobras can survive and regain its reputation.
It would be foolish to expect that to include privatisation. This is the wrong moment to sell, and under the current government there is no support for the idea. A much better approach would be to separate out the different elements of the company into distinct businesses.
There is a strong case for a separate retail business and for distinct entities managing oil and gas. It would be also be possible to create an exploration company that would be international in scope – applying the skills Petrobras has created in other areas of the world. Some of that has been done, but much more is possible.
The second element of a corporate renaissance would come if the company were allowed to operate independently of government. Mrs Rousseff and Guido Mantega, the current chairman, have clearly failed as corporate leaders. It is hard to see why another politician such as Nelson Barbosa, the planning minister whose name has been suggested as the likely successor, would be any better.
As proved by many examples from around the world over the last two decades politicians really don’t belong in the board room. The company should be run by professionals with reputations to protect, and managed as an independent entity.
Key to this, and the third element of radical change, is a policy of transparency. Energy companies should be doing nothing that cannot be seen in public. Since we can no longer rely on auditors and accountants to spot things going wrong, companies will have to put into the public domain even more details about what they doing. Companies hate this of course – it takes up time and resources.
But the only answer to distrust is a change of culture.
The fourth element would be for the government to stand back and let the new companies do their job. This is particularly true for the downstream business. Imposing price controls never works. It distorts corporate decision making and in the long run always costs more than it achieves. Companies are not instruments of social policy. If there is a case for subsidising prices to particular consumers or softening the volatility of an erratic market that is a matter for public policy which should be managed by direct transfers.
Brazil will survive the current crisis, even if the government and individual politicians don’t. So will Petrobras – I hope in a different form as a professional business rather than as a political tool.
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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