Scary Time

Doug Nolan

Just another week of the “new normal”. Celebratory talk of “helicopter money,” a melt-up in stocks, another terrorist attack in France and a coup attempt in Turkey. Let’s start with Japan, with the preface that “Bubbles Go to Unimaginable Extremes – and Then Double!” and “Things Get Crazy Near the End – During ‘Terminal Phase’ Excesses.”

July 12 – Bloomberg (Emi Nobuhiro and Yoshiaki Nohara): “Japanese Prime Minister Shinzo Abe told former Federal Reserve Chairman Ben S. Bernanke at a meeting in Tokyo he wants to speed up the nation’s exit from deflation, underscoring his commitment to implementing fresh economic stimulus. ‘We are only halfway to the exit from deflation,’ Abe said at the start of the meeting… ‘We want to be steadfast in accelerating our breakaway from deflation.’ Abe’s remarks at the meeting, also attended by the Ministry of Finance’s top currency official Masatsugu Asakawa and adviser Koichi Hamada, came before he ordered Economy Minister Nobuteru Ishihara to compile stimulus measures this month.”
As global markets celebrate Japan’s reckless move to further ramp up fiscal and monetary stimulus, it’s important to place things into a little perspective. Japan has been sporadically ramping up stimulus for more than 25 years. Federal government debt to GDP was about 65% back when the Japanese Bubble burst in 1990. Massive fiscal stimulus saw debt to GDP surge to 140% by the end of the nineties. By 2009, ongoing aggressive deficit spending pushed the ratio through 200%.  It's now almost reached 250%.  Meanwhile, expanding $1.0 TN annually, the Bank of Japan’s (BOJ) balance sheet is rapidly approaching 100% of GDP. BOJ assets hovered between 30% and 40% of GDP in the ten-year period through 2012.

Prime Minister Abe must be an eternal optimist if he actually believes Japan is “halfway to the exit from deflation.” The Japanese government this week sharply lowered their fiscal 2017 CPI forecast to 0.4%. After three years of (egregious) “shock and awe” fiscal and monetary stimulus, CPI is now running below the 2013 level. And in the face of massive stimulus, the Japanese economy is forecast to expand less than 1% this year. It’s Scary Time.

Abe seeks “to be steadfast in accelerating our breakaway from deflation.” In reality, Japan is trapped in destructive runaway monetary inflation. And that’s the age old dilemma with inflation: once commenced it becomes almost impossible to rein in. Japan also highlights the problem of discretionary central banking: mistakes are invariably followed with only greater blunders. In Japan and throughout the world, there is today no turning back from the massive inflation in central bank Credit and government borrowings. It may be fallacious, ineffective and frighteningly self-destructive, but there’s no dissuading global central bankers from even more destabilizing monetary inflation and monetization.

Global markets were giddy with anticipation of additional Japanese stimulus. Ben Bernanke traveling to meetings in Japan surely signaled “helicopter money” in the offing. These days I often feel as if I’m living in a different world. I see Dr. Bernanke as the champion of deeply flawed – and failing – inflationist doctrine. It’s just hard to believe at this point that Japanese leadership doesn’t recognize that Bernanke’s experiment is failing and that they should seek guidance elsewhere. And, at this point, it’s remarkable that markets can get excited about yet another round of Japanese stimulus. Squeeze the shorts…

I guess there’s little mystery surrounding market complacency: QE liquefying securities markets indefinitely. To be sure, huge global fiscal deficits support corporate earnings and cash flow. Negative sovereign yields spur flows to risk assets, particularly corporate debt, while historically low corporate yields and ultra-loose Credit Availability stoke share repurchase financial engineering. Reduced debt service costs coupled with diminished share counts inflates earnings per share.

It’s worth nothing that first quarter U.S. stock buybacks jumped to $166.3 billion (from Factset), up 15.1% from Q1 2016. This was the second largest quarter of buybacks ever and the strongest since record Q3 2007 ($178.5bn). Forty-one S&P500 companies had repurchases exceeding $1.0 billion during the period. Stock buybacks have provided key market support in a backdrop of mutual fund outflows. That companies have a penchant for purchasing their shares when the markets come under pressure provides a critical backstop, both from liquidity and market psychology standpoints.

Returning to unfolding Asian train wrecks, Japan and China are increasingly open adversaries yet they do share a common hope for inflating out of debt problems. From financial, economic and geopolitical points of view, it’s alarming to watch both Chinese and Japanese finance in full self-destruction mode.

From Friday’s Wall Street Journal headline: “Massive Stimulus Keeps China GDP Steady in Second Quarter.” At 6.7% (beats estimates!), China’s economy appears relatively stable. 


Industrial production increased 6.8%. Retail sales were up 10.6% from a year ago. Government fixed asset investment rose 23.5% during the first half, largely offsetting the ongoing drop in private investment.

Chinese finance is anything but stable, with its unwieldy Credit boom running hot in June. 


Beating forecasts by about 60%, Total Social Financing expanded $244 billion for the month. 

This was up from May’s $102 billion to the strongest pace of system Credit expansion since a huge March ($370bn). A strong June put first-half Chinese Credit growth at about $1.5 TN, a sufficient sum to sustain the Bubble. Credit expanded at an almost 15% annualized rate during the first half, more than double the stated pace of economic expansion.

It’s worth noting that June’s big Credit push was primarily in bank lending. Bank loans surged $206 billion during the month, more than double May and almost equal to March’s lending bonanza. A resurgent real estate Bubble now drives bank lending. According to Bloomberg, June new home (apartment) sales were up 22% y-o-y to $150 billion. And from the WSJ: “Property sales in 2016 have jumped by up to 50% year on year in top markets.” “Terminal Phase”…

July 15 – Reuters: “Government spending in China jumped 19.9% in June from a year earlier, while revenue rose 1.7%, the Ministry of Finance said… Government spending in the first half of the year was up 15.1% from a year ago, while revenues rose 7.1%.”
Both Chinese and Japanese policymakers had intended to rein in financial excess. The Chinese government moved to (too cautiously) reign in Credit growth. The Japanese government had pronounced their plan to impose fiscal restrain in what was sold (in 2012/13) as a temporary boost in deficit spending. Both have inflated major Bubbles and both have now clearly capitulated: massive and persistent monetary inflation as far as the eye can see, and global securities markets are overjoyed.

That Abe and Kuroda essentially see no constraints on deficits and monetization hammered the Japanese currency. For the week, the yen dropped 4.3%, the “Biggest Weekly Drop Since 1999”. Stocks took flight. The Nikkei 225 index jumped 9.2%, amazing yet not even close to keeping up with the TOPIX Banks Index that surged a remarkable 17.7%.

Stimulus developments in Japan and a sinking yen provided a powerful boost to global “risk on.” A worldwide short squeeze was especially conspicuous in Europe. Italian banks jumped 10.9%, while Europe’s STOXX 600 bank index surged 6.7%. Major equities indexes rallied 4.5% in Germany, 4.3% in France and 4.2% in Spain and Italy.

Rallying global equities stoked an already powerful short squeeze in the U.S. market. The banks (BKX) surged 4.3%, the broker/dealers (XBD) 4.0% and the Transports 3.9%. The S&P500 gained 1.5% to a new record high.

The currency market remains acutely unstable. The British pound rallied 1.8% this week. Most EM currencies posted gains, except for the late Friday sell-off that left the Turkish lira down 4.3% for the week.

Watching an unfolding coup and attendant chaos live on television is a writing distraction, to say the least. Turkey, a country of 80 million and NATO ally, is at the epicenter of geopolitical dynamite. At this writing, the coup appears to have failed. Yet Friday’s developments will surely exacerbate instability that has been festering badly for some time. The Erdogan government will turn only more autocratic, and a highly polarized society will become only more fractured. Coming just a few weeks after Brexit, mayhem in Turkey is yet another troubling reminder of the rapidity and extent of geopolitical deterioration on a global basis.

Turkey is also today emblematic of the wide chasm that has developed between inflating securities markets and deflating economic prospects. Turkish stocks have been among the top performing markets globally, ending the week with 15.5% y-t-d gains. Running large current account deficits (4.5% of GDP) and having accumulated significant international debt (much denominated in U.S. dollars), Turkey has been on my list of countries at high risk of financial and economic crisis. The country is now on the downside of what was a significant Credit boom, which surely helps explain at least of some of the increasingly problematic social tension and political instability.

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