The Shortcomings of Quantitative Easing in Europe

Martin Feldstein

 Euros
CAMBRIDGE – Why has the US Federal Reserve’s policy of quantitative easing been so much more successful than the version of QE implemented by the European Central Bank? That intellectual question leads directly to a practical one: Will the ECB ever be able to translate quantitative easing into stronger economic growth and higher inflation?
 
The Fed introduced quantitative easing – buying large quantities of long-term bonds and promising to keep short-term interest rates low for a prolonged period – after it concluded that the US economy was not responding adequately to traditional monetary policy and to the fiscal stimulus package enacted in 2009. The Fed’s chairman at the time, Ben Bernanke, reasoned that unconventional monetary policy would drive down long-term rates, inducing investors to shift from high-quality bonds to equities and other risky securities. This would drive up the value of those assets, increasing household wealth and therefore consumer spending.
 
The strategy worked well. Share prices rose 30% in 2013 alone, and house prices increased 13% in the same twelve months. As a result, the net worth of households increased by $10 trillion that year.
 
The rise in wealth induced consumers to increase spending, which restarted the usual expansionary multiplier process, with GDP up by 2.5% in 2013 and the unemployment rate falling from 8% to 6.7%. The expansion continued in subsequent years, bringing the current unemployment rate down to 5% – and the unemployment rate among college graduates to just 2.5%.
 
The ECB has been following a similar strategy of large-scale asset purchases and extremely low (indeed negative) short-term interest rates. But, although the policy is the same as the Fed’s, its purpose is very different.
 
Because Europe lacks the widespread share ownership that exists in the United States, quantitative easing cannot be used to stimulate consumer spending by raising household wealth. Instead, a major if unspoken purpose of the ECB’s low-interest-rate policy has been to stimulate net exports by depressing the value of the euro. The ECB succeeded in this, with the euro’s value falling by some 25% – from $1.40 in the summer of 2014 to $1.06 by the fall of 2015.
 
I have been an advocate of reducing the value of the euro for several years, so I think this strategy was a good one. But, although the fall in the value of the euro has stimulated the eurozone’s net exports, the impact on its members’ exports and GDP has been quite limited.
 
One reason for this is that much of the eurozone countries’ trade is with other eurozone countries that use the same currency. Moreover, exports to the US don’t benefit much from the decline of the euro-dollar exchange rate. European exporters generally invoice their exports in dollars and adjust their dollar prices very slowly, a point made clear in an important paper that Gita Gopinath of Harvard presented at the Federal Reserve’s Jackson Hole conference in August 2015.
 
As a result, total net exports from the eurozone rose less than €3 billion ($3.2 billion) between September 2014 and September 2015 – a negligible amount in an €11 trillion economy.
 
A further motive of the ECB’s bond purchases has been to increase the cash that eurozone banks have available to lend to businesses and households. But, as of now, there has been very little increase in such lending.
 
Finally, the ECB is eager to raise the eurozone inflation rate to its target of just under 2%. In the US, the QE strategy has increased the “core” inflation rate – which excludes the direct effect of declining prices of energy and food – to 2.1% over the past 12 months. This has been a by-product of the increase in real demand, achieved by reducing unemployment to a level at which rising wages contribute to faster price growth.
 
This strategy is unlikely to work in the eurozone, because the unemployment rate is still nearly 12%, about five percentage points higher than it was before the recession began. The ECB’s quantitative easing policy can probably achieve higher inflation only through the increase in import prices resulting from a decline in the value of the euro. This very limited process still leaves core inflation in the eurozone below 1%.
 
ECB President Mario Draghi recently responded to the new evidence of eurozone weakness and super-low inflation by indicating that the Bank is likely to ease monetary conditions further at its next policy-setting meeting in March. This could mean further reducing already-negative short-term interest rates and expanding and/or extending its bond-purchase program.
 
Eurozone financial markets reacted in the expected way. Long-term interest rates fell, equity prices rose, and the euro declined relative to the dollar. But past experience and the reasons spelled out here suggest that these policies will do very little to increase real activity and price inflation in the eurozone. To make real progress toward reviving their economies, the individual countries need to depend less on quantitative easing by the ECB and focus squarely on structural reforms and fiscal stimulus.
 


Economics in the Age of Abundance

J. Bradford DeLong
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Newsart for Economics in the Age of Abundance


BERKELEY – Until very recently, one of the biggest challenges facing mankind was making sure there was enough to eat. From the dawn of agriculture until well into the Industrial Age, the common human condition was what nutritionists and public-health experts would describe as severe and damaging nutritional biomedical stress.
 
Some 250 years ago, Georgian England was the richest society that had ever existed, and yet food shortages still afflicted large segments of the population. Adolescents sent to sea by the Marine Society to be officer’s servants were half a foot (15 centimeters) shorter than the sons of the gentry. A century of economic growth later, the working class in the United States was still spending 40 cents of every extra dollar earned on more calories.
 
Today, food scarcity is no longer a problem, at least in high-income countries. In the US, roughly 1% of the labor force is able to grow enough food to supply the entire population with sufficient calories and essential nutrients, which are transported and distributed by another 1% of the labor force. That does not account for the entire food industry, of course. But most of what is being done by the remaining 14% of the labor force dedicated to delivering food to our mouths involves making what we eat tastier or more convenient – jobs that are more about entertainment or art than about necessity.
 
The challenges we face are now those of abundance. Indeed, when it comes to workers dedicated to our diets, we can add some of the 4% of the labor force who, working as nurses, pharmacists, and educators, help us solve problems resulting from having consumed too many calories or the wrong kinds of nutrients.
 
More than 20 years ago, Alan Greenspan, then-Chair of the US Federal Reserve, started pointing out that GDP growth in the US was becoming less driven by consumers trying to acquire more stuff. Those in the prosperous middle class were becoming much more interested in communicating, seeking out information, and trying to acquire the right stuff to allow them to live their lives as they wished.
 
Of course, the rest of the world still faces problems of scarcity; roughly one-third of the world’s population struggles to get enough food. And there is no guarantee that those problems will solve themselves. It is worth recalling that a little over 150 years ago, both Karl Marx and John Stuart Mill believed that India and Britain would converge economically in no more than three generations.
 
There is no shortage of problems to worry about: the destructive power of our nuclear weapons, the pig-headed nature of our politics, the potentially enormous social disruptions that will be caused by climate change. But the number one priority for economists – indeed, for humankind – is finding ways to spur equitable economic growth.
 
But job number two– developing economic theories to guide societies in an age of abundance – is no less complicated. Some of the problems that are likely to emerge are already becoming obvious. Today, many people derive their self-esteem from their jobs. As labor becomes a less important part of the economy, and working-age men, in particular, become a smaller proportion of the workforce, problems related to social inclusion are bound to become both more chronic and more acute.
 
Such a trend could have consequences extending far beyond the personal or the emotional, creating a population that is, to borrow a phrase from the Nobel-laureate economists George Akerlof and Robert Shiller, easily phished for phools. In other words, they will be targeted by those who do not have their wellbeing as their primary goal – scammers like Bernie Madoff, corporate interests like McDonalds or tobacco companies, the guru of the month, or cash-strapped governments running exploitative lotteries.
 
Problems like these will require a very different type of economics from the one championed by Adam Smith. Instead of working to protect natural liberty where possible, and building institutions to approximate its effects elsewhere, the central challenge will be to help people protect themselves from manipulation.
 
To be sure, it is not clear that economists will have a comparative advantage in addressing these problems. But, for now at least, behavioral economists like Akerlof, Shiller, Richard Thaler, and Matthew Rabin seem to be leading the field. In any case, one need only glance at the headlines to comprehend that the issue has become a defining feature of our economic epoch.
 


Gold And Silver - Current Prices Do Not Matter

By: Michael Noonan



Truth be known, short of an uprising or revolution by the masses, which is highly unlikely, the elites have won over the masses, hands down, and the end game is in the final and irreversible stages. Time and again, we have reiterated the elites formulaic strategy of Problem, Reaction, Solution. The most current is the outrageous Mid East refugee situation where European countries are being forced to accept hundreds of thousands of displaced refugees from the war-torn Middle East.

It is no secret that the US has been covertly responsible for much of the destruction and strife in that area. Where not covertly involved, the US has provided arms and logistics to Saudi Arabia as the Saudis are destroying helpless Yemenis in the proxy war against Iran.

None of the bought-and-paid-for Western press is questioning how and why, all of a sudden, Middle Eastern refugees have the money and means to escape to various parts of Greece and Europe, en masse. How is it that black Africans were never able to be in a position to migrate from far worse war atrocities? Unseen forces are behind this.

Problem, refugees, Reaction, growing antagonism of Europeans justifiably against the rabble rousing, sexual assaulting of women, robbing trucks on highways, etc, etc, etc, creating instability in an already weakened EU. The Solution is yet to come, but you know it will entail further weakening of individual freedom and eroding of the ability of individual countries to protect against this politically motivated destabilization of Europe where the elites will strengthen their stranglehold over Europeans via the artificially created European Union.

Banks, and now select individual countries, are increasing the call for getting rid of cash altogether, ostensibly to fight terrorists who use cash, the prevention money laundering, and a few other nefarious reasons. The terrorists also use cell phones, but there are no plans to ban cell phones, and perhaps the biggest money launderers, by far, are large banks dealing with drug money to keep their banks afloat. However will the CIA launder all of its drug money from Afghanistan being funneled to support groups like al Qaeda and ISIS?

Guess what happens when cash disappears and all so-called "money" becomes digital?
The elite's bankers now keep track of every single transaction you make, where and how you spend your digital "currency." Banks will have a ledger for everyone on which all inflows and outflows of funds are tracked.

"Now that we track and control your money, it would be better if we just deduct all taxes directly from your account," say the bankers.

"Is there some reason why you are spending your money on gold and silver? Did you not know these are transactions not favorably looked upon?"

Control. It is all about control. Get rid of cash. Get rid of all means of hiding anything from the Orwellian elite governments. Should your spending activities raise questions, or if you hold any kind of dissenting political views, you may find there was an inexplicable computer glitch, and your account has been frozen, or simply disappeared. Try feeding and providing for your family under those conditions.

If you do not have, and literally hold gold and silver, or you are waiting for the "right" or a "better" price, how relevant is your reasoning "stacked" up against the increasing odds of what is yet to come? Privacy? You will have none. Right now, governments cannot track whatever gold/silver people hold, and that is unacceptable and it will change.

If anyone thinks China and the BRICS nations are going to be a counter move to the Western globalists, think twice. China will become to the elite's East to what the US has been to the elite's West. Now that the elite's controlling bankers have sucked the wealth out of the US and Europe, China becomes their agenda for the next 100 years, or more. Rinse and repeat.

China has had a relationship with the Rockefellers for decades. Many Fortune 500 companies have been doing business with China since the late 1980s, early 1990s, and to date. China has been vying to become a member of the IMF for over a decade. What more elite-driven a financial tool is there than the IMF, controlled by the Bank for International Settlements [BIS, the central bank for all Western central banks]?

China has developed a social behavior card for each and every Chinese citizen to monitor their citizen's behavior, much like a report card. Citizens will be graded and/or held accountable for the contents of their behavior code, ensuring each good little citizen is conforming to the Chinese model of what constitutes acceptable behavior and attitudes.

China and the BRICS will not be a part of the solution. They will become a greater part of the problem. Anyone who thinks China's massive purchases of thousands upon thousands of tons of gold is for an eventual gold-backed Yuan is not keeping in touch with reality.

China does subscribe to the tenet of the Golden Rule, in that he who has the gold, rules. China wants to rule, not be the world's policeman against the globalists.

In addition to a social behavior card, China is also developing its own digital currency.

From the People's Bank Of China:
The People's Bank attaches great importance from 2014 to set up a special research team, and in early 2015 to further enrich the power of digital distribution and business operations monetary framework, the key technology of digital currency, digital currency issued and outstanding environment, digital currency legal issues facing the impact of digital currency on economic and financial system, the relationship between money and the private digital distribution of digital currency, digital currency issuance of international experience conducted in-depth research, has achieved initial results. [Our emphasis]
This effort is being conducted in concert with the international agencies, foreign financial institutions, and traditional credit card entities. Christine LaGarde, head of the globalist's IMF, has embraced this means of virtual currencies.

Welcome to our world, China. Rule or be ruled. That choice was made long ago.

What possible relevance can there be to the current artificially suppressed price for gold and silver, in light of all that is going on around the world in full view, with no attempts to hide either motive or intent?

If you do not have, or are planning to purchase gold and/or silver, price is not the issue.
It is personal and financial survival at risk, and the globalists take no prisoners. Under this scenario, it is better to be a year, even two too early, than a day too late. We are just scratching the surface for reasons why world enslavement may not be far-fetched, or even far off.

The US military might and Federal Reserve continue to keep the fiat FRN propped up.

The developing activity, seen in the weekly TR, could be setting the stage for a final gasp to the upside, or the globalists are losing control sooner than expected, and we are seeing a distribution phase. In artificial markets, it is unreasonable to be reasonable in reading a chart with a greater degree of reliability.

The sharp decline, week of 30 Nov '15 noted on the chart, shows greater EDM [Ease of Downward Movement], particularly compared to the labored rally over the next eight weeks. In a strong up trend, ease of movement should be up, and reactions down more labored, so while nearing recent highs, the market is not internally strong.

If a new high is to be had, it could be short-lived, but this is not an interpretation for picking a top, just seeking context in this fiat.

US Dollar Index Weekly Chart

Beyond gold and silver, the next keen interest, maybe even greater than gold and silver, is oil.

The highest monthly volume occurred at an area of support. More than once, we say that increased volume comes about from what we call smart money, controlling market interests.

Smart money buys low and sell high, trite but accurate. There is a growing likelihood that this could be the start of a base or rapid turnaround rally in oil. If a base, a nominal lower low is possible, but price may find more support at current levels.

Crude Oil Monthly Chart

Viewing these PM charts in a vacuum, ignoring many of the existing factors evolving around the world, a few of which we covered above, absent a surprise sustained rally, gold is not indicating a turn around in its current down trend. It is at an area where some basing can be expected, but there is not sufficient positive activity to say it is happening.

Monthly Gold Chart

As with the analysis of the fiat FRN, there was a shape EDM at the end of October going into November, and the ensuing rally off the November low has been labored with bars overlapping, indicative of a lack of buyer control. The last volume can be troublesome.

For all of that buying effort, the range of last week's bar was small. The reason for that is sellers were meeting the effort of buyers and prevented the range from extending higher.

Weekly Gold Chart

The daily activity supports what the weekly chart shows in potential weakness. For the paper market, it is too risky to pay up and buy into a rally, at this early stage. We need to see more evidence that buyers are gaining control.

Daily Gold Chart

Sellers have ceased making any meaningful gains lower in silver, not surprising given the ultra bullish fundamentals, and that may be the reason. However, we read charts without consideration to underlying fundamentals. The premise is all considerations have already been taken into account, is a known factor, and has been priced in. For as little downward direction sellers are making, buyers are totally unable to take advantage and push price higher. Until you see such change where rally bars have a wider range and strong closes on strong volume, silver remains stuck at these levels.

Monthly Silver Chart

We look for synergy between the various time frames, and the weekly supports what the monthly chart conveys. There has been no meaningful rally over the past three months, and price remains well under a 50% retracement, a general guide to lack of market strength.

Weekly Silver Chart


All three time frames tell the same "story" of weakness, an inability to rally above TR resistance. Trading ranges are hard to analyze, so we leave this one alone, other than to reiterate is stems from weakness and shows no internal strength.

There are no reasons to buy paper gold or silver. The reasons for buying and holding physical gold and silver are more compelling than ever, and we expect those reasons to become even more compelling. Price is irrelevant and way, way undervalued.

Daily Silver Chart
 


Up and Down Wall Street

Japan’s Devaluation and Iowa Voters

The candidates in both parties have been stubbornly swinging at each other. But Japan’s decision to go to negative interest rates could soon give them another target: currency manipulation that could hurt U.S. workers.

By Randall W. Forsyth

Iowans are so stubborn they could stand touching noses for a week at a time and never see eye-to-eye, according to a lyric from Meredith Wilson’s The Music Man.
 
That notion is as out of date as the musical, especially for the Iowans who will caucus on Monday to choose presidential candidates. Iowans have a history of being anything but predictable, let alone stubborn.
 
The candidates are another matter. Donald Trump refused to participate in Thursday’s debate on Fox News despite earnest on-air entreaties by Bill O’Reilly. (At this point, we’re obliged to state that Barron’s and Fox News were part of the same corporate entity until mid-2013; now we mainly share an elevator bank.)
 
The show went on without Trump, generating far less heat than the previous debates, but no more light on the issues. Perhaps the best moment was the joust over immigration legislation between freshmen Sens. Ted Cruz of Texas and Marco Rubio of Florida, which was broken up by New Jersey Gov. Chris Christie with a withering comment contrasting inside-Washington wrangling with running a state. Nobody thought to mention the numerous rating downgrades of the Garden State’s credit on Christie’s watch, not exactly a winning credential for a chief executive.
 
As for the rest of the field, longtime Washington watcher Greg Valliere of Horizon Investments thought that Jeb Bush had a good night without Donald there, although his campaign is “on life support,” with a second-place finish in next week’s New Hampshire primary possibly needed to keep him in the game. Rubio “may be making a move in Iowa,” Valliere says, but the bottom line is “this race is Trump’s to lose, and he knows it.”
 
As for the Democrats, lots of Iowans, especially the young ones, apparently feel the Bern and could give Vermont Sen. Bernie Sanders heady momentum going into the primary next door in New Hampshire. After that, the self-described democratic socialist has a tougher road, especially in primaries in more diverse states. For him to beat Hillary Clinton, once the prohibitive favorite, would remain a major upset, even with the private e-mail controversy hanging over her.
 
Meanwhile, reports that former New York City Mayor Michael Bloomberg is considering a run as an independent, were there to be a Donald-Bernie presidential race, further increased the political intrigue. That’s despite Bloomberg’s memorable declaration in an interview that there was no way he’d run for president. I paraphrase, however, omitting the modifier inserted between “no” and “way” that Mike no doubt learned as an impressionable youth in the legendary Salomon Brothers trading room.
 
The biggest surprise on Thursday night—at least for market fans and participants who watched the debate on one screen and overseas developments on another—was the move to negative interest rates by the Bank of Japan. The central bank’s governor, Haruhiko Kuroda, just a week earlier had declared that the BOJ wouldn’t follow the lead of the European Central Bank, the Swiss National Bank, and others on the Continent in imposing negative interest rates. But he showed himself to be anything but stubborn in that view, which added the element of surprise to his move.
 
While Japanese short-term rates have hovered near zero since Clinton’s husband was in the White House, putting a minus sign in front of some of them had a significant impact on global markets.

Currency-exchange rates become the main thing that affects the real economy when interest rates already are essentially nil. And the yen weakened sharply, by nearly 2%, to over 121 to the dollar from under 119.
 
That 2% gain in the dollar versus the yen doesn’t sound like much, but it was almost as much as the surge that Kuroda’s decision sparked in Japan’s Nikkei 225 and Hong Kong’s Hang Seng, although shy of the 3% bounce in the Shanghai Composite. And it compared favorably to rallies in the major U.S. equity benchmarks on Friday, as the Dow Jones Industrial Average, the Standard & Poor’s 500, and the Nasdaq Composite added 2.4% to 2.5%.
 
It’s clear how a lower yen would benefit Japanese companies: Cheaper exports help sales, while currency translations of overseas earnings also benefit. All textbook stuff. A lower yen also boosts “carry trades”—borrowing in yen to buy higher-returning assets, in the expectation of repaying those margin loans with cheaper yen.
 
How much Kuroda’s action will bolster Japan is questionable. As Barrons.com’s William Pesek pointed out in his Jan. 29 Up & Down Asia column, the ball is now in Prime Minister Shinzo Abe’s court. He has to effect the structural reforms that Abenomics promised in order to stir the economy out of its two-decade torpor.
 
For the rest of the world, the implications are different. While negative Japanese interest rates will provide more cheap credit to bid up risk assets, the impact in the political sphere could be rather less benign.
 
Trump has railed against China and Japan because of their large trade surpluses versus the U.S., claiming that America is losing billions because of those nations’ alleged currency manipulations. By objective standards, it’s not clear that the Chinese yuan or the Japanese yen are undervalued. In the case of the former, it’s more likely that the yuan remains overvalued against most other currencies, as a result of its rise in tandem with the U.S. dollar.
 
No matter. Moves such as the BOJ’s have the potential to exacerbate the currency wars. The 2% effective devaluation of Japan’s yen had knock-on effects on Asian competitors. But for Japan’s biggest rival, China, it’s more complicated.
 
Chinese officials have made it a major point of pride that the yuan will remain stable and strong in the eyes of global markets. They even took aim at financier George Soros for his forecasts that China’s economy inevitably is heading for a hard landing. Soros, of course, is famous for his successful bet in 1992 that the Bank of England couldn’t hold the pound’s peg against the (then) German mark.
 
China is fighting capital outflows that some estimates put as high as $1 trillion in the past year or so.

Part of that represents Chinese corporations’ rush to repay foreign-currency debt that would increase in real terms if the yuan declines. Part also represents acquisitions of foreign assets, such as the recent purchase of the appliance business of General Electric (ticker: GE) by Haier (1169.Hong Kong).
 
But another part is the effort of Chinese nationals to get their money out of the country. Reuters reported last week that HSBC is curbing mortgage loans offered to Chinese citizens to purchase property in the U.S.
 
At the same time, China’s monetary authorities have kept the liquidity spigots open to replace the money fleeing the country. That means they’re trying to fulfill contradictory aims: Keep money easy at home and the yuan firm internationally.
 
Clearly, that’s impossible. If China’s yuan declines further, as fundamentals dictate, and Japan eases policy and lets the yen fall, there could be political repercussions in the U.S. during the election campaign.
 
At week’s end, global equity markets were looking only at the upside of more cheap money via Japan.

But the winners in Iowa and New Hampshire aren’t likely to take kindly to what they see as currency manipulation that hurts U.S. workers. And they’re apt to be rather stubborn about it.

TRUMP MIGHT DISAGREE, given the origins of his sparring mate Ted Cruz, but there’s something to be said for hiring somebody born in Canada. Take Mark Carney, the Canadian-born governor of the Bank of England, who recently said it wasn’t time yet to raise British interest rates. The United Kingdom and U.S. economies had been thought to be on roughly the same track and that the BOE would follow the Fed in raising rates.
 
Turns out that the Canadian had the right idea. Just as the U.S. central bank initiated its rate liftoff in December, the American economy was sputtering. Fourth-quarter gross domestic product grew at an anemic 0.7% annual rate, which was close to economists’ steadily lowered estimates. As ever, the details were revealing.
 
The strong point was consumer spending, which talking heads never tire of pointing out accounts for about 70% of the U.S. economy. The mystery has been why Mr. and Ms. America haven’t gone on a shopping spree with their windfall from lower fuel prices.
 
The GDP data show that real personal consumption expenditures were indeed a strong point, growing at a 2.2% seasonally adjusted annual rate in the fourth quarter, as Steve Blitz, chief economist of ITG Investment Research, notes. While spending on goods slowed, spending on services expanded at a healthy annual 2% pace. Of that, 47% of the increase was for medical costs, he observes. In other words, much of the savings at the gas pump went for health-care expenses, which left less to leave at the mall.
 
The Fed last week left interest rates unchanged, as expected, as it acknowledged slower economic growth, despite the apparent improvement in the jobs data. The financial-futures market is giving only slightly better-than-even money to one more rate hike by December. As sub-zero rates take hold around the globe, even that seems less likely.

jueves, febrero 04, 2016

BIG BANKS: CHOP CHOP / THE ECONOMIST

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Big banks

Chop chop

Why haven’t banking giants got a lot smaller?



BOSSES at big banks would once have cringed at releasing the kind of results they have been serving up to investors in recent days. This week, for instance, Deutsche Bank posted a loss of €6.8 billion ($7.4 billion) for 2015. In the third quarter of last year the average return on equity at the biggest banks, those with more than $1 trillion in assets, was a wan 7.9%—far below the returns of 15-20% they were earning before the financial crisis. Exclude Chinese banks from the list, and the figure drops to a miserable 5.7%. Returns have been languishing at that level for several years.

In response, the banks’ top brass are following a similar template: retreats from certain countries or business lines, along with a stiff dose of job cuts. Barclays, which earlier this month said it would eliminate 1,000 jobs at its investment bank and shut up shop altogether in Asia, is typical. More radical measures, such as breaking up their firms into smaller, more focused and less heavily regulated units, do not seem to be on the cards.

In fact, in spite of investors’ frustration at dismal returns and regulators’ insistence that banks that are “too big to fail” will be cut down to size, the world’s mightiest banks have scarcely shrunk at all since Lehman Brothers collapsed. The 11 behemoths considered the most pivotal by the Financial Stability Board (FSB), a global grouping of regulators, had $22 trillion in assets at the end of 2008; they now have $20 trillion. The assets of the wider group of 30 institutions the FSB describes as “global, systemically important banks” have grown, not shrunk, in recent years.

On the face of it, this is a puzzle. To forestall future crises, regulators have piled on new rules intended explicitly to make life harder for the banks that are thought to present the greatest risks to the stability of the global financial system. All banks must meet higher capital ratios these days, funding a greater share of their activities with money put up by shareholders rather than by borrowing. This crimps returns but ensures a stouter buffer if they run into trouble. But the extra capital requirements are especially severe for the biggest banks.

Whereas a smaller bank might be required to hold capital equivalent to 7% of its risk-weighted assets, HSBC and JPMorgan Chase, the two institutions the FSB judges to be most systemic, have to hold 2.5 percentage points more. American regulators have imposed a further surcharge on JPMorgan Chase which will push its minimum ratio to 11.5% by 2019. The intention is not just to make sure that big banks are safer, given the expense of bailing them out, but to discourage banks from getting too big in the first place.

Other bits of regulation also hamper big banks in particular. America has banned “proprietary trading” (a bank making investments with its own money, rather than on behalf of clients); Britain is “ring-fencing” the retail units of big banks to protect their assets in case of disaster in other parts of the business. And whereas regulators used not to make much fuss if the subsidiary of a multinational bank in their country was not brimming with capital, as long as the bank as a whole was, most now require local units to be able to withstand shocks on their own. These rules have little impact on smaller banks, which tend not to sprawl across so many countries or to combine retail and investment banking.

By the same token, small banks have not been fined quite so heavily by prosecutors in America and elsewhere. The penalties—some $260 billion and counting for big American and European banks—have fallen mainly on commercial and investment bankers who have fiddled markets. Some banks have regulatory staff sitting in on most meetings, even at board level. “For every maker there are four checkers these days,” grumbles one investment banker.

Such changes have had some impact. Although the 11 banks that most perturb the FSB have not really shrunk, they have at least stopped growing. There has been a marked change since the pre-crisis period. In 1990 the world’s ten biggest banks had just $3.6 trillion of assets ($6.6 trillion in today’s prices)—equivalent to 16% of global GDP. By 2008 they had assets of $25 trillion (40% of global GDP). They now have assets of $26 trillion, or 35% of global GDP.

The geographical spread of the two “global” banks, HSBC and Citi, has shrunk markedly as they have left many countries. Many investment banks, particularly in Europe, have retrenched to areas of particular strength: UBS has largely abandoned the trading of bonds, currencies and commodities, for example. In general, banks are shifting away from risky and so capital-intensive activities, such as trading financial instruments, towards safer areas such as helping firms raise capital and managing the money of wealthy investors.

Some of the titans have been more radical. Once the largest bank in the world by assets, Royal Bank of Scotland (RBS) has shrunk by more than half under its new majority owner, the British government. General Electric, once a bank-within-a-firm, shed most of its financial assets over the course of the past year. Credit Suisse is mulling spinning off its domestic retail bank; Deutsche Bank is selling Postbank, a big retail-banking unit in Germany.

Yet big banks could still go much further. Many of them currently trade below book value, suggesting that they would be more valuable broken up. Richard Ramsden, an analyst at Goldman Sachs, suggested last year that JPMorgan Chase should be split into four units.

MetLife, a big American insurer, is splitting itself up in part to reduce its capital requirements and thus boost profits. There is a “gravitational pull” towards being smaller, says the boss of one bank high up the FSB’s list. Competing with non-systemic banks, which have a lower capital ratio, is hard. “If you have a unit competing head-on against a bank that isn’t [systemically important]…that unit is worth more outside than inside.”

Jamie Dimon, JPMorgan Chase’s boss, claims that having all its units under one roof brings $18 billion a year in synergies. Such claims are basically unverifiable, but researchers have long struggled to find much in the way of economies of scale in finance. Costs tend to rise roughly at the same clip as revenues. Some studies posit that savings peter out above $50 billion in assets—a tiny fraction of the trillions held by really big banks. Others see benefits continuing further up the scale, though these are relatively small. But heft could also carry costs. The creaking IT systems of big banks, some of which run code adapted from the 1950s, certainly suggest that. Smaller banks, let alone “fintech” upstarts, can adapt faster.

Big banks can borrow more cheaply than smaller ones. In part, that is because they are typically more diversified than smaller banks. But investors have also lent more cheaply to big banks on the assumption that they will get bailed out in case of trouble. New rules should make it easier to force banks’ creditors, rather than taxpayers, to foot the bill if a bank fails. This has undoubtedly shrunk the subsidy—but not eliminated it. An IMF study from 2014, for instance, found that it still amounted to a discount of a quarter of a percentage point on their borrowing in quiet times, and potentially more during times of crisis.
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Even so, there is no correlation between size and returns. The most profitable banks appear to be the middling ones, with assets of between $50 billion and $1 trillion. Bigger and smaller ones are markedly less profitable (see chart).

So if regulators want them to shrink and decent returns are hard to come by, what is holding the big banks together? The risks and costs of breaking up a large bank are one consideration in favour of the status quo. As the boss of another systemic bank puts it: “Breaking up would be a gamble, and we are not paid to gamble.” Byzantine behind-the-scenes plumbing would prove a nightmare to disentangle. That gives regulators pause as well as bankers.

In all industries, not just banking, few bosses enjoy the prospect of slimming the empires they have built. Banks are both very complex and highly regulated: that puts off activist shareholders.

Bondholders, who put up much of the money big banks use to buy assets, may also be reluctant, having contracted a debt against a diversified set of banking businesses rather than just one fragment of it. Tax can be a factor: banks that made large losses in the downturn can still write them off against today’s profits, in a way that might be compromised by a break-up. This argument once blunted calls for Citi to be dismembered. The clearing mechanisms that exist in other markets are jammed in banking: small banks are put off making big acquisitions by capital charges.
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All the same, shareholders are growing impatient. Bosses seen as too timid are being sent packing.

Anshu Jain, who built up Deutsche Bank’s investment bank over 20 years, was removed as co-chief executive in June after moving too slowly to overhaul his creation. His successor, John Cryan, an avowed cost-cutter, has warned staff of the need for “a fair balance between staff and shareholder interests”. That means less for staff and more for shareholders, reversing a decades-long trend (see chart 2). The big banks may not have changed shape radically since the crisis. But that doesn’t mean life is fun.


Is Russia in for a Hard Fall?




Russia is reeling under the double attack of Western sanctions and low oil prices hurting its revenues. Its currency has been devalued. Unemployment is rising. Inflation is running high.

Wages are falling, benefits are being cut and pensions are getting eroded.

But Western powers may be overestimating the impact of all those factors to force Russian President Vladimir Putin into submission, according to experts. They note that several factors work in Russia’s favor: chiefly, strong currency reserves to ride out low oil prices; a continued, long-term growth in oil demand in the foreseeable future; the likelihood of oil prices strengthening, and the limited impact of Western sanctions on the lives of ordinary Russians.

However, even as Putin seems set to wait out the crisis until oil prices pick up, Russia’s best long-term interests are in a rapprochement with the West, they add.

“[Russia] was flying high two or three years ago with a lot of surplus cash, and many opportunities to do dramatic programs in terms of geopolitical ambitions and new economic forays,” said Rudra Sil, professor of political science at the Penn School of Arts and Sciences (SAS) and co-director of the Huntsman Program in International Studies & Business. The drop in oil prices has forced the country to scale all of that back dramatically, he added.

“In hurting Russia we also hurt ourselves,” said Brenda Shaffer, a professor at Georgetown University’s Center for Eurasian, Russian and East European Studies, and an expert on energy and foreign policy. She noted that the Russian sanctions have cost the European Union one-half of a percentage point in GDP growth, citing recent EU statistics. Germany, as Russia’s second-biggest trading partner in Europe, is “bearing the brunt of the sanctions,” she added. (Sil and Shaffer discussed the impact of oil prices and sanctions on Russia and the global economy on the Knowledge@Wharton show on Wharton Business Radio on SiriusXM channel 111. Listen to the podcast at the top of this page.)

Russia will have “a hard fall,” predicted Mitchell A. Orenstein, professor in the department of Slavic languages and literatures at the Penn School of Arts & Sciences. Orenstein’s specialties include the political economies of Central and Eastern Europe.

Orenstein noted that the fall in oil prices prevents Russia from making large investments in industrial modernization. That will be further constrained “under the shadow of Western sanctions that prevent investment in key sectors and cut Russia off from Western finance,” he added. “Russia will be forced into austerity and to spend down its substantial reserves in order to protect public consumption … or to continue or accelerate foreign military adventures.”

“Russia is in a bit of a bind,” said Wharton professor of legal studies and business ethics Philip Nichols. He noted that the country was forced to change when the Soviet Union dissolved.

While Boris Yeltsin faced difficulties in steering the country after the dissolution, “Putin brought much-needed stability,” he added. “One of the ways he did so was by using incentives outside of the formal, market economy. That is not very efficient, but Russia could get away with it because of the high price of oil. Well, the crutch of the high price of oil is gone.”

Impact of Sanctions and Cheap Oil

Sil said the oil price fall has made the sanctions important for Russia. “It has cut off opportunities to cushion the blow from the drop in oil prices,” he explained. “[Yet], they are not on a scale so dramatic within Russia that we can afford to expect sanctions alone to bring about regime change and pressure administrative change in Moscow. It’s a much more complex and nuanced issue.”

According to Nichols, the sanctions have selective and limited impact on Russians. “When I walk around Moscow or St. Petersburg, I do not see shuttered store windows or people lined up outside of food distribution centers,” he said. “More accurately, Western sanctions and Russia’s counter-sanctions in response have constrained the country.”

Nichols pointed out that for the most part, the sanctions targeted the actions and assets of individual Russians and were not meant to have an effect on the broader economy. It was only in the third round of sanctions that limits were imposed in the financial and extractive sectors, he noted. “For most Russians whom I speak with, it is actually the Russian counter-sanctions that have had a greater effect on daily life,” he added. “In particular, they really miss parmesan cheese.”

Financial sanctions have hurt Russia the most, according to Nichols. The impact goes beyond irritants Russians initially faced in using credit cards, he said. “Far more deleterious to the Russian economy, it is difficult to structure transactions that require international financing,” he added. “Foreign investors are worried about financing and payments, and there is increased uncertainty.”

Russia’s problems will no doubt hurt the world economy, but not as much as the contraction in China, said Sil. “China seems to drive so much of the global economy; relative to that, Russia’s problems are more of a domestic issue.”

Sil added that the EU as a whole might be able to survive the impact of the Russian sanctions.

However, “countries like Greece, Spain and Italy are struggling a lot more, and these divisions are starting to come out this year.”

Positive Effects

“Ironically, the sanctions have to some extent had a salubrious effect on an economy that may have depended too much on imports from just a few places,” Nichols said. “The sanctions have forced businesses that sell foodstuffs and consumer products to Russian consumers to find different sources of goods, and for the most part they have.”

Nichols talked of how such local sourcing has helped McDonald’s in Russia. McDonald’s increased its profitability in Russia last year by increasing local sourcing to about 85%, he said.

The fast food chain now plans to open 60 new restaurants in Russia in the coming year, to begin franchising outlets instead of owning them all, and to increase local content to 100% in the next two years, he added. “McDonalds had to look for supply sources not affected by sanctions, and that actually increased its profits.”

Options for Russia

Nichols said the options for Putin depend on how Russian citizens choose between stability on the one hand, and economic growth and global integration on the other. “If the Russian people desire economic growth and global integration, it seems that the government should wean itself from these informal structures and incentives and should promote leaner, more competitive and transparent enterprises,” he noted.

“Russia’s best strategy would be to back down from its confrontation with the West, pull out of Ukraine, and agree to turn the Ukrainian border over to Ukraine, in exchange for a face-saving lifting of the sanctions and counter-sanctions, which would also improve domestic consumption by making food, in particular, less expensive,” said Orenstein.

However, Orenstein does not expect Putin to budge. “Given the opposing logics of creating foreign adventures to distract Russians from domestic troubles and making peace with the West to lift consumption, however, it is unlikely that Putin will want to choose one or the other, but rather keep his options open and simply survive the bad times however he can,” he said. “It was difficult dealing with Putin when he was flush with oil money; it will be equally difficult dealing with him backed into a corner.”

Meanwhile, Russia is not showing any signs of relenting. The Russian foreign minister, Sergey Lavrov, said that while he wanted to see a “reset” of Russia’s relations with the United States, Moscow would not budge on any of the issues that put it at odds with Washington, the New York Times reported. He added that Russia would not negotiate the status of Crimea, which it annexed in 2014.

According to Nichols, Russia’s best interests lie in resolving the Crimean issue. In such a scenario, “Russia may have to give up something — perhaps debt owed it by Ukraine,” he said.

The benefits would be both the re-engagement of Russia with global institutions and the lifting of sanctions, he added. “In general, Russia would free itself of a damaging problem and could reclaim its position as a leading voice in global, rather than just regional, issues.”

Putin’s Mixed Record

Putin is unlikely to view the current trend of low oil prices as a “real crisis situation,” said Shaffer.

“Putin knows a lot about oil.” She noted that when he came to power as prime minister in 1999, the oil price was $12 a barrel, or $29.5 in today’s dollars. Currency reserves in Russia at the time were about $12 billion and have since grown significantly, she noted. As of December 2015, Russia’s foreign currency reserves were more than $368 billion, according to TradingEconomics.com. In addition, Russia has rainy-day funds of another $120 billion.

Shaffer said Putin “also knows that oil works in cycles.” In fact, prevailing oil prices are setting the stage for an oil price spike, she added. “The oil price collapsing trends lead us to behavior such as non-investment in the oil sector, buying larger cars, becoming complacent about conservation, and set the stage for the oil price rise. Putin knows that.”

Sil credited Putin with some astuteness in handling Russia’s oil wealth. “He is the one who organized the reserve funds — the rainy-day funds — in 2004,” he said. “This is not a country that is simply squandering oil wealth. They have used it in a targeted fashion, and the result has been that the population more or less trusts the government to — at the moment at least — keep things together.” That said, Sil gave Putin “two or three years to get himself out of this jam” of the combined impact of weak oil prices and the sanctions.

For sure, Putin has also stumbled badly. Orenstein recalled how in late 2009, Russia under its then president Dmitry Medvedev made an abortive attempt to attract investments to modernize its industry. Medvedev had launched the so-called Skolkovo initiative to create a Russian version of Silicon Valley infrastructure, and succeeded in recruiting MIT and Stanford as partners.

“Putin (who was then prime minister), however, treated this program as a test balloon and at some point decided that it had failed, instead emphasizing ramping up the defense industries in addition to oil and gas,” said Orenstein. “From the perspective of today, that looks like an historic mistake. Many believe, however, that the Putin regime can never really succeed at innovation because it is too repressive and corrupt.”

Oil Demand Will Grow

Sil said that notwithstanding the current weakness, global oil demand will recover with the population growth and industrialization in developing countries. He cited Russia signing a $400 billion gas supply contract with China in late 2014 and its subsequent oil and gas deals with India. He also pointed to the untapped potential from “up and coming African countries.”

According to Shaffer, there is “nothing exceptional” about the current weakness in oil prices.

She pointed out that $30 a barrel is actually the average price over the last 45 years, and that it is “not a historical low.” In fact, “what was exceptional was the high oil prices between 2012 and 2014.”

Shaffer added that the Chinese economy “is still growing,” even if it has slowed down, and that its oil demand hasn’t fallen, but is only growing at a less significant rate than earlier. This year, “not everything is set for oil prices to stay the same,” she said, alluding to a price increase. Instability in the Persian Gulf, with tensions among Saudi Arabia, Iran and Iraq, and other events “could knock off production there.”

The experts also saw some ominous signs. Instead of serving as a tool to force submission, lower oil prices “might make Russia more dangerous in some ways,” said Sil. “It can create a sense of panic that might lead to some more dangerous types of approaches than we’ve seen so far.”

Orenstein agreed. “The next few years will be the most dangerous in Russia-West relations,” he said. “Low oil prices may have to last for a long while before Russia is willing to make a serious agreement with the Europeans and Americans that will allow it to become a country in good standing in the West again, and one that is perceived as safe for investors.”

Misplaced Expectations?

Both Sil and Shaffer maintained that Western nations overstate the ability of declining oil prices to weaken Russia into submission. “When the price drop started, there was huge glee that Russia is going to pull out of Crimea and Iran is going to stop its nuclear program,” said Shaffer. “We don’t see any modifying effect on the foreign policy behavior of the oil producers.”

Orenstein noted that while devaluation will cushion the blow for Russia, it will not be enough.

“Without lifting sanctions, very little new investment will flow into Russia to take advantage of lower costs,” he said. “Therefore, Russia has a strong incentive to initiate a rapprochement with the West. The West has a strong incentive to make sure that Russia gives up some of its core objectives in Ukraine and Syria.” He expected that Putin “will try to [wait] out” the current crisis.

According to Shaffer, among the factors working in Putin’s favor is that the ruble’s devaluation has helped Russia bridge its budget deficit. Also, polls in Russia show Putin’s popularity is high. She cautioned against using American foreign policy tools to analyze foreign governments in general, and especially authoritarian governments such as in Russia. “To think that somehow, because people are unhappy about the economy, it is going to bring down a government is often wishful thinking.”

Optimistic Outlook

Nichols is bullish about Russia in the long run. “Russia will be a prosperous and deeply engaged actor in the global community and economy,” he said. He added that the West has “not always been sympathetic or helpful” as Russia grappled with its problems. “Maybe without the prop of outrageously high oil prices, Russia will be forced to become more efficient, and people who can lead Russia through the next set of transitions will rise to leadership positions.”

Nichols also said that while he does not condone the seizure and annexation of Crimea, Russia and Putin have been overly demonized. “Perhaps the most damaging effect of the sanctions and the oil slump is that Russians are travelling less, and fewer people from North America are going to Russia,” he said. “The absence of human interaction and the subsequent caricaturing and demonization of each other might inflict the greatest long-term damage.”


Donald Trump vs. Fox News: The Big Picture

BY JOHN CASSIDY
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Donald Trump has announced that he will skip the last Republican debate, which is being aired on Fox News with Megyn Kelly as a moderator. CREDITPHOTOGRAPH BY SEAN RAYFORD / GETTY


If you’re like me, you can’t get enough of the story about Donald Trump skipping the Fox News debate in Iowa on Thursday night. We have: Trump trying to bully Roger Ailes, the chairman of Fox News, into dumping Trump’s supposed tormentor Megyn Kelly, who is scheduled to be one of the three debate moderators on Thursday, reportedly because he feared that he wouldn’t receive fair treatment; Fox responding with a press release, reportedly put together by Ailes and a crony, which began, “We learned from a secret back channel that the Ayatollah and Putin both intend to treat Donald Trump unfairly when they meet with him if he becomes president”; Trump pulling out of the debate; and virtually every journalist in America, and some from overseas, speculating about what it all means.

Did Trump make a big mistake, as Tuesday’s conventional wisdom held? Was it a Machiavellian stroke of genius that will spare him the possibility of slipping up on the eve of the Iowa vote, while costing Fox millions of viewers and millions of dollars in advertising revenue? Or was it, as my colleague Amy Davidson wryly suggested, a well-timed exit from a series of G.O.P. debates that are simply “no longer what Trump might call a classy venue”? As for Ailes, has he lost it? If not, why did he approve such a juvenile press release? Why did Kelly invite Michael Moore, the liberal documentary filmmaker, who detests everything that Fox News stands for, onto her show on Tuesday night, where he revelled in Fox’s woes? And what does Rupert Murdoch, the ultimate power at Fox, think of it all?

I admit it: I’ve spent much of the past twenty-four hours pondering these imponderables. But there are also larger issues at stake, one of which is freedom of the press. Trump’s efforts to bully Fox into excluding a journalist he doesn’t like—or, rather, appears to loathe with a venom that is glaringly incommensurate with anything that Kelly has said or done—is quite reprehensible. And, sadly, it’s nothing new. Whenever a journalist or media outlet criticizes Trump, he slimes them, verbally or on Twitter, and tries to disempower them. Sometimes he succeeds.

Last week, the Republican National Committee disinvited the National Review, which had published a special issue of articles criticizing Trump, from co-hosting a Republican debate scheduled for February 25th. Something similar happened a couple of weeks previously, when ABC News dropped the Union Leader, a conservative New Hampshire newspaper that has attacked Trump, as a partner in a debate on February 6th. “I am pleased to announce that I had the Union Leader removed,” Trump tweeted after ABC made its announcement.

Evidently, these craven moves by the R.N.C. and ABC News encouraged Trump to try his luck again. To its credit, as of Wednesday evening, Fox News was still refusing to buckle to his demands. In a statement issued to the Washington Post, Ailes said, “Megyn Kelly is an excellent journalist, and the entire network stands behind her. She will absolutely be on the debate stage on Thursday night.” Meanwhile, the Fox News Web site was featuring a promo for the debate in which Martha MacCallum, another Fox anchor, says, “Our job is to get America’s questions answered,” and Kelly adds, “And we are going to do our job.”

Of course, it’s a bit rich for Fox News to promote itself as a source of independent, hard-hitting journalism. Ever since it was founded, in 1996, the network has been avowedly conservative, friendly toward the Republican Party, and, with a few individual exceptions, hostile to Democrats. Indeed, that’s why Murdoch founded Fox News in the first place: to fill what he viewed as a big gap in the television-news market. But, in this instance, Fox’s ideological slant is not the issue. The network is in the right, and Trump is in the wrong. Case closed.

Press freedom isn’t the only issue here. It’s also a battle over who controls the Republican Party. Trump is doing what he has already done in many other areas: challenging established customs and establishment institutions—of which, in the Republican world, there aren’t many bigger and more powerful than Fox News. On his talk-radio show on Tuesday, Rush Limbaugh, who is a Trump supporter, was quite explicit about this. “There isn’t any fear here,” Limbaugh said of Trump’s approach. “What there is is a desire to control this—and not put himself in a circumstance where other people want to make him look bad. It isn’t really any more complicated than that.” Shortly after Limbaugh’s show was broadcast, Trump tweeted, “Just got to listen to Rush Limbaugh—the guy is fantastic!”

Fox News insists that it had no intention of making Trump look bad, but that isn’t the point here. In saying that he would skip the debate, Trump was effectively sending a message that he’s bigger than the event. Since Fox News became popular, virtually no one in Republican circles has been willing to challenge the network like this. In the normal run of things, Republican campaigns compete fiercely for the attention of Fox shows, and Republican politicians and operatives compete fiercely for cushy jobs as network pundits. When Fox drops a Republican, as it dropped Sarah Palin last year, it is widely seen as a crushing blow.

Trump needs to reach Fox News’s conservative viewers, too, of course. That’s why he has appeared on the network and its sibling Fox Business more than a hundred and thirty times. But he is now seeking to dictate the terms of his relationship with Fox, and demonstrating that if it doesn’t accede to his demands he won’t back down. Which is, of course, precisely the approach he has adopted with other G.O.P. candidates, such as Rick Perry and Ted Cruz, and other G.O.P.-related institutions, such as the conservative print media. It’s how he does business, and it’s shaking up the Republican Party and its environs in a remarkable way.

The members of the Washington-based Republican establishment, of which Fox News is an offshoot, aren’t pleased to be in Trump’s path, of course. Conceivably, however, the levelling effects of the tornado could end up benefitting the Party, which, in recent years, has concentrated almost entirely on placating its elderly conservative base (the average age of a Fox News viewer is sixty-eight) and its rich financial donors.

Trump has the support of some elderly conservatives, but his populist blend of American nativism and economic nationalism, and his enthusiastic raspberry-blowing at cultural élites, also appeal to other voters: to working-class Reagan Democrats in the industrial states, such as Pennsylvania and Ohio; to younger voters alienated from regular politics; and to a broad swath of Republican suburbanites who do not think of themselves as particularly ideological.

“Trump’s support has largely been spread across the party, with substantial strength among moderate and liberal Republicans,” Sean Trende, the senior elections analyst for Real Clear Politics, wrote on Wednesday. In Trende’s view, which I share, the real roots of Trumpism aren’t to be found in Barry Goldwater’s 1964 campaign or in the rise of the Tea Party but in Ronald Reagan’s 1980 campaign, which united a number of different groups into a populist coalition.

What makes Trump different from, and more ideologically flexible than, Reagan is that he is also willing, on occasion, to question the free-market, trickle-down economics that have defined Republican domestic policy for much of the past forty years. Of course, that is also one of the things that makes him so unpopular with other Republican politicians and conservative intellectuals. (In the National Review special issue, it was notable that some of the critiques of Trump focussed not on his statements about Muslims or Mexicans but on his record of expressing support for single-payer health care and the auto bailout.) But Trump’s economic heresies, which also extend to trade, offer at least the possibility of widening the G.O.P.’s appeal.

For now, though, all eyes are on Trump’s squabble with Fox and on Thursday night’s debate. Will Trump be there? I doubt it, but with him you can never be sure. He is, after all, a deal maker.


The Fed Refuses To Fold Its Hand

by: Lawrence Fuller


Summary
 
- The Fed struck a modestly more dovish tone in its statement today, but continues to suggest that the US economy is strengthening.

- The stock market is calling the Fed's bluff, demanding more certainty on future interest rate increases.

- The chances of an interest rate increase in March now appear to be off the table.

- I continue to think the S&P 500 will rebound to overhead resistance levels in the coming days before falling to new lows in the months ahead.

 
There were no expectations that the Fed would raise interest rates today. The focus was on the language used in the statement that followed its meeting for clues about the possibility of additional interest-rate increases in 2016. Cascading oil prices, a plunge in the stock market and more intensified concerns about China's slowing rate of economic growth have led to hopes that the Fed would ease off the brake pedal of monetary policy normalization.
 
These and other foreboding developments, some new and others old, run completely counter to the optimistic outlook for the US economy that Janet Yellen expressed last month during her post-meeting press conference when she suggested that the US economy would continue to strengthen.
 
I have voiced my view that the Fed raised rates last month in order to rubber-stamp the recovery. It wanted to mark a definitive moment in time for historians to look back on as the moment when its policies were finally deemed a success. Perhaps Fed officials felt the need to stake that imaginary claim, fearing that the economy and markets were in the process of rolling over, after which they would have lost their chance.
 
I think Yellen had one additional objective in advocating the idea that the US economy is strengthening. She was trying to influence investor sentiment, and to a lesser extent, consumer confidence, in hopes that investors and consumers would buy into the idea that the crisis-level monetary stimulus of the past seven years was no longer needed. In other words, she wanted investors and consumers to invest and consume as though the US economy is strengthening.
 
That would be a self-fulfilling prophecy.

If she had been playing poker at last month's press conference, she would have been putting all of her chips on the table, while holding nothing more than a pair of deuces. It was a very big bluff. Investors obviously didn't buy into that bluff, or the stock market, as the S&P 500 (NYSEARCA:SPY) has declined as much as 11% since the beginning of the year. The jury is still out as to whether or not the rate of consumer spending growth will accelerate or not, but the year-over-year rate of growth in personal consumption expenditures continues to decline, so that doesn't look good either.
 
The S&P 500 index declined by more than 1.5% during the hour that followed the release of today's statement, whining like a spoiled child that didn't get what he wanted. The stock market is calling Janet's bluff. It appears that Yellen is trying to pull a few chips off the table, reducing the size of her wager, while still refusing to fold what is a losing hand.
 
In what was a modestly more dovish tone, the Fed quietly downgraded its assessment of the economy by removing the reference from its previous statement that the risks to the economic outlook were balanced. It stated that it is "closely monitoring global economic and financial developments and is assessing their implications for the labor market and inflation." In other words, we don't think it is likely that there will be a rate hike in March. The stock market obviously wanted a more forthcoming acknowledgement of the deteriorating circumstances we have seen since the Fed's last meeting. It also wanted an emphatic "no" on a March rate hike.
 
Yet the Fed wants to save face after having been so optimistic just a few weeks ago.
 
I suspect that Fed officials will be deployed in the coming days to emphasize the more dovish aspects of the statement. It certainly didn't want to see the type of stock market response we saw today.
 
I continue to believe that we will see a short-lived rally up to overhead resistance levels for the S&P 500 index in the days and weeks ahead, before eventually moving to new lows in the months thereafter.


Bank selloffs replacing oil rout as stock market pressure point

By Lu Wang


Breakdowns in financial stocks are becoming a little too routine for comfort of late.

Dragged lower by falling interest rates and credit concern, the KBW Bank Index extended its three-day decline to as much as 7.5 percent earlier Wednesday -- the fifth time this year a loss has exceeded 5 percent over such a stretch, data compiled by Bloomberg show. At times this week, losses from Bank of America Corp. to Citigroup Inc. have exceeded 10 percent.

Daily drubbings in financials are rapidly supplanting anxiety over oil and its related shares as the equity market’s biggest headache. At 15.7 percent of the Standard & Poor’s 500, banks, brokerages and insurance companies are second only to technology companies as the biggest group and more than twice the size of energy producers.

“Crushing the banks like this is a macro narrative,” Michael Antonelli, an institutional equity sales trader and managing director at Robert W. Baird & Co. in Milwaukee, said by phone. “It definitely puts a different tone on this selloff.”

More than $350 billion have been erased in financial shares in 2016, the worst start to a year in data going back to 1990. The selloff in Goldman Sachs Group Inc., Citigroup and Bank of America continued Wednesday, driving the industry down another 1.6 percent at 12:30 p.m. in New York. So far this year, the group has lost 13 percent, almost double the benchmark gauge’s decline.

Volatility in bank shares is spiking to levels not seen since the financial crisis, deepening the rout that just sent stocks to the worst January in seven years. Instances when the KBW Bank Index fell more than 5 percent over three days in 2016 have exceeded all the occurrences in the past three years combined. At 23 percent of trading days, the annualized frequency is greater than any year except 2008 and compares with a two-decade average of 4.4 percent.

The losses came as the 10-year Treasury yield fell below 1.86 percent for the first time since April while credit rating agencies warned of rising debt defaults among American businesses. Moody’s Investors Service Ltd. on Wednesday said that the number of U.S. companies that have the highest risk of defaulting on their debt is nearing a peak not seen since the height of the financial crisis, just one day after S&P downgraded some of the biggest U.S. explorers, citing oil’s plunge.

The gap between the two-year and 10-year Treasury yields shrank to its smallest since January 2008.

At the same time, predictions for 10-year yields are being cut as U.S. economic data falls short of expectations, potentially curbing further Fed increases. The year-end weighted average forecast in a Bloomberg survey has fallen to 2.69 percent, from about 3.2 percent six months ago.

The catalyst of wider net interest margin “just flew out the window,” said Brian Barish, the chief investment officer of Denver-based Cambiar Investors LLC. “The memory of 2008 is still deep and painful for most investors, and when the markets descend, banks wind up having some beta to the downturn,” he said, referring to banks’ volatility relative to markets.


New Home Sales Surge but Prices Down Sharply; Prices Have Room to Fall; Is Everybody In?

By: Mike Shedlock


December new home sales surged well over the high end Econoday estimate.
The outlook for the housing sector just got a boost from a sharp jump in new home sales, up 10.8 percent to a 544,000 annualized rate that is 44,000 over the Econoday consensus and 24,000 over the high estimate. The gain, however, may have been boosted by discounting as the median price slipped 2.7 percent to $288,900 for a year-on-year rate of minus 4.3 percent. 
With builders slow to bring new homes to market, low supply remains a central factor holding back sales. Supply did rise 6,000 in the month to 237,000 but supply relative to sales fell back to 5.2 months from 5.6 months. A reading of 6.0 months is considered to be the balance point between supply and demand. 
Regional data show a 32 percent sales surge in the Midwest where the year-on-year rate of 39 percent is the strongest. Sales in the West and Northeast both rose 21 percent in the month with the year-on-year rate in the West, which is a key region for new housing, up 22 percent while the Northeast, which is a very small region in this report, down 6.5 percent on the year. The South, which is the largest region, shows a fractional gain in the month and no change on the year. 
For full year 2015, new home sales rose 14.7 percent to 501,000 from 437,000 in 2014. 
Sales of new homes have been noticeably higher than prices, suggesting that prices have room to accelerate. This report follows special strength in existing home sales with both perhaps benefiting from December's warm weather but with both pointing nevertheless to new momentum for 2016. 

Negative Momentum

Why did sales surge 39% in the Midwest? Because this was one of the warmest December on record even discounting global warming silliness.

Bloomberg calls this "new momentum" for 2016. Indeed it is, but that momentum is negative.

This statement by Bloomberg caught my eye: "Sales of new homes have been noticeably higher than prices, suggesting that prices have room to accelerate."

Prices Have Room to Fall

I suggest home prices have room to fall. Curiously so does Bloomberg, albeit in different ways, and in a different article.

Please consider Bloomberg's article The Surge in U.S. Mansion Prices Is Now Over, published just two days ago.
The world's economic woes -- from China to Russia to South America -- are damping sales in the high-end real estate market. Haywire overseas stock markets and dropping currency values caused in part by plummeting oil prices are dulling demand for mansions, penthouses and winter escapes. 

US Luxury Home Boom Goes PFFT

Luxury Pfft
 
Prices for the top 5 percent of U.S. real estate transactions remained flat in 2015 while all other houses gained 4.9 percent, according to data from Redfin Corp., a real estate brokerage and data provider. 
Stronger Dollar 
The stronger dollar is driving South American buyers away from the 23,000 condos in the pipeline for Miami's downtown area, said Peter Zalewski, owner of South Florida development tracker CraneSpotters.com. Buyers signed about one-fourth fewer pre-construction contracts last year than in 2014, according to Anthony M. Graziano, senior managing director at Integra Realty Resources Inc., which tracks condo data for the Miami Downtown Development Authority. 
In nearby Sunny Isles, Florida, faraway currency fluctuations are endangering the sale of a $3.7 million condominium. 
In Houston, the plunge in oil prices to a 12-year low is killing the luxury boom.  
Sales for homes priced at $500,000 or more dropped 17 percent in December from a year earlier, according to the Houston Association of Realtors. 
Manhattan resale prices for the top 20 percent of the market peaked in February and have fallen every month since, according to an analysis through October by listings website StreetEasy. 
Even in San Francisco, where the market for luxury properties remains strong, the inventory of listings for $2 million or more jumped in October to a record level, said Patrick Carlisle, chief market analyst for Paragon Real Estate. 
"More sellers are jumping in and more buyers are holding off because they're worried about where the volatility is going," Carlisle said. 
Buyers are now on the hunt for deals, said Nela Richardson, chief economist at Redfin. 
"There's a limit even to what a wealthy person will spend," she said.
Is Everybody In?

Bloomberg did not make the necessary connection, but they did provide the chart. Let's tie up some loose ends.

In bonds, rot starts with junk and spreads to the core. With homes, price rot starts at the high end.

With Chinese West-coast buyers now not feeling so wealthy after a 47% plunge in the stock market, and with "Temporary" Capital Controls likely on the way, that segment of the high-end market is toast.

The strong dollar is having the same effect in Florida. And in New York, well ... "There's a limit even to what a wealthy person will spend."

And every decrease in the price at the high end, affects every level below it. A mansion that was $1,000,000 but is now $900,000 is going to affect the price of homes listed for $850,000 to $900,000, etc., all the way down the ladder.


Is Everybody In?

Let's return to the Econoday "room to accelerate" misanalysis.

If homebuilders could sell more expensive homes, they surely would. And at the very high end, it appears we have hit the peak. That group is "all in".

Median Sales price for New Houses


It was one hell of a bubble-reblowing effort by the Fed, but another slide lower awaits. New homes prices will likely get cheaper and cheaper with more and more features added.

In turn that will lower the price of similar existing homes. This stuff does cascade. We have seen it before.

Lack of Supply

There's plenty of talk about lack of supply. Actually, there's an ample supply of homes. There's just no supply at prices people are willing and able to pay.

Expect lower, not higher prices. And if you need to get out, beat the rush, if you still can.