Making Depressions Great Again

The U.S. may renounce its trade leadership at a dangerous economic momento.

Political leaders have made many mistakes since the 2008 financial panic, but by some miracle a trade war isn’t one of them. There are signs that this luck is running out, at a moment the world economy can least afford it.

The pace of global trade continues to tumble, an ominous trend for growth. Meanwhile, the U.S. may renounce its historic role as the anchor of the open international trading system. Both Democratic presidential candidates are trade skeptics, or claim to be. And the leading Republican, Donald Trump, would be the first avowed protectionist to lead a ticket since the 1920s.


                                              Photo: Getty Images/Ikon Images 

Forecasters expect world GDP to grow by only 2.2%-2.4% this year, and one reason is that trade flows are historically weak. Trade volumes have flattened among advanced economies and continue to shrink in emerging markets. The OECD estimates that the trade slowdown since 2012 has subtracted about half a percentage point a year from the overall growth rate in the developed world.

The reason to worry is that trade growth typically outpaces GDP by a wide margin, as the nearby chart shows. After a post-recession rebound in 2010 to 12%, trade growth slipped to 7% in 2011, stagnated at 3% for the next three years and then fell below 2% for 2015—well below GDP for the first time since 9/11. The 1987-2007 average was 7.1%.

Reviving trade is crucial to driving faster growth, yet the paradox of trade politics is that it is least popular when economic anxiety is high and thus trade is most crucial. And so it is now: Four of the remaining U.S. candidates claim to oppose the Trans-Pacific Partnership, and Congress now lacks the votes to pass it.

The loudest voice of America’s new antitrade populism is Mr. Trump, who has endorsed 45% tariffs on Chinese and Japanese imports and promises to punish U.S. companies that make cookies and cars in Mexico. When Mr. Trump visited the Journal in November, he couldn’t name a single trade deal he supported, including the North American Free Trade Agreement (Nafta).

He says he’s a free trader but that recent Administrations have been staffed by pathetic losers, so as President he would make deals more favorable to the U.S., and foreigners would bow before his threats. “I don’t mind trade wars,” he said at Thursday’s debate.     

He should be careful what he wishes. Trade brinksmanship is always hazardous, especially when the world economy is so weak. A trade crash could trigger a new recession that would take years to repair, and these conflicts are unpredictable and can escalate into far greater damage.

The tragic historic precedent is the Smoot-Hawley tariff of 1930, signed reluctantly by Herbert Hoover. In that era the GOP was the party of tariffs, which economist Joseph Schumpeter called the Republican “household remedy.” Smoot-Hawley was intended to protect U.S. jobs and farmers from foreign competition, but it enraged U.S. trading partners like Canada, Britain and France.

As economic historian Charles Kindleberger shows in his classic, “The World in Depression, 1929-1939,” the U.S. tariff cascaded into a global war of beggar-thy-neighbor tariff reprisals and currency devaluation to gain a trading advantage. Each country’s search for a protectionist advantage became a disaster for all as trade volumes shrank and deepened the Great Depression.

Kindleberger blames the Depression in large part on a failure of leadership, especially by a U.S. that was unwilling to defend open markets in a period of distress. “For the world economy to be stabilized, there has to be a stabilizer—one stabilizer,” he wrote. Britain had played that role for two centuries but was then too weak. The U.S. failed to pick up the mantle.

From those economic ruins, FDR’s Secretary of State Cordell Hull slowly rebuilt the world trading system in the 1930s, leading to the postwar Bretton Woods accords and the Global Agreement on Tariffs and Trade. A consensus emerged in both U.S. political parties that preserving a liberal trading order was in America’s national interest.

But maintaining this American leadership abroad for eight decades has required presidential leadership at home. The Constitution assigns express authority over foreign trade to Congress, but since Smoot-Hawley the legislature has delegated those powers to the executive, knowing its own weakness for populist temptations. Presidents of both parties have, with periodic deviations such as George W. Bush’s steel tariffs, fulfilled that obligation.

But since 2009 this presidential leadership has been diffident. As a candidate Barack Obama promised to reopen Nafta, and early in his first term he slapped a 35% tariff on Chinese tires and endorsed the “Buy American” provisions of the stimulus. Once the President recovered his trade bearings, Mitt Romney promised in 2012 to sanction China for currency manipulation and even ran TV ads claiming that “for the first time, China is beating us.”


Mr. Trump is now escalating this line into the centerpiece of his economic agenda—protectionism you can believe in. And what markets and the public should understand is that as President he would have enormous unilateral power to follow through.

Congress has handed the President more power over the years to impose punitive tariffs, in large part so Members can blame someone else when antitrade populism runs hot.

The tools include so-called Super 301, which allows the U.S. to impose tariffs on countries that supposedly engage in unfair trade practices. Section 201 lets a President impose tariffs or limit imports on a finding by the U.S. International Trade Commission of injury to a U.S. industry.

Section 232 lets a President declare that certain imports pose a national security threat. The Treasury can trigger punitive trade actions by declaring a country to be a “currency manipulator.”

In an exchange with Bill O’Reilly on Feb. 10, Mr. Trump said that’s exactly what he plans to do. The Fox News host suggested a trade war is “going to be bloody.” Mr. Trump replied that Americans needn’t worry because the Chinese “will crash their economy,” adding that “they will have a depression, the likes of which you have never seen” in a trade war. He might be right about China, but the U.S. wouldn’t be spared.

The Trump candidacy thus introduces a new and dangerous element of economic risk to a world still struggling to emerge from the 2008 panic and the failed progressive policy response.

A trade war would compound the potential to make depressions great again.

ECB’s greatest risk is the danger of doing nothing

The eurozone needs be given further monetary stimulus this week
Ahead of the European Central Bank’s governing council meeting later this week, the single currency’s bankers are buffeted by even stronger pressures than usual — from all sides. They should heed those calling for stronger action over those advocating restraint.
The case for more forceful monetary stimulus builds on the many deflationary signals that have accumulated since the start of the year: market turmoil; unexpectedly sharp disappointments in current and forecast inflation; and a global slowdown where US weakness has put the brakes on what last year looked like a promising acceleration in Europe.

On the other side are warnings that the ECB may achieve the opposite of what it wishes if it goes deeper into uncharted monetary territory. Many think the asset purchase programme launched in January 2015 is buying ever less stimulus bang for each quantitative easing buck.

Others warn that a lopsided use of monetary policy stimulus is tantamount to engaging in a currency war, surreptitiously targeting a lower exchange rate to steal demand from other countries.

The fiercest resistance has been reserved for negative interest rates, a policy now used to a lesser or greater extent by central banks covering a quarter of the world economy, including most of Europe.
One pushback comes courtesy of the Bank of International Settlements. In research released just days ahead of the ECB decision, the so-called central bankers’ central bank has suggested that interest rate cuts may no longer stimulate the real economy once they cross zero. The BIS fears banks will not pass on lower central bank rates to borrowers, and perversely will tighten their lending as their profitability suffers.
Meanwhile, some banks are reportedly planning to hoard physical cash to circumvent the ECB’s negative rate on reserve deposits, thus blunting the transmission of the policy to households and businesses.

Many of the ECB top brass have pushed back against these naysayers, laying the ground for loosening eurozone monetary policy further this Thursday. They should not now get cold feet; nor should the rest of the governing council weaken them with merely lukewarm support (or worse).
Markets are pricing in a further cut in the deposit rate, and analysts foresee expanded asset purchases and new long-term loans to banks. The ECB should not now disappoint their expectations. Not because it is a central bank’s job to please the markets, but because the fall in market rates prove that the market policy transmission is alive and well. More aggressive loosening will ultimately force banks to follow where markets have already gone.
The euro’s central bankers need not fear accusations of warmongering. There is no evidence that the eurozone has stolen demand from anyone: its external balance has barely budged since the end of 2014. Instead, the expectation of QE coincided with the end of the eurozone’s credit crunch two years ago, and its implementation with the pick-up in lending growth in 2015. If growth and inflation are not responding as much as one would like, the conclusion should be to do more of the same, not less.

In his most pointed refutation of his critics, Mr Draghi said in a speech early this year that “they warn us about the side-effects and risks of what we’re doing. But what I never hear them discuss is the risks of doing nothing.”
Not only are the risks of inaction greater than the risks of action, but that balance has also continued to tilt in favour of doing more.

2008 Revisited?

Nouriel Roubini

Reading newspaper economy

NEW YORK – The question I am asked most often nowadays is this: Are we back to 2008 and another global financial crisis and recession?
My answer is a straightforward no, but that the recent episode of global financial market turmoil is likely to be more serious than any period of volatility and risk-off behavior since 2009. This is because there are now at least seven sources of global tail risk, as opposed to the single factors – the eurozone crisis, the Federal Reserve “taper tantrum,” a possible Greek exit from the eurozone, and a hard economic landing in China – that have fueled volatility in recent years.
First, worries about a hard landing in China and its likely impact on the stock market and the value of the renminbi have returned with a vengeance. While China is more likely to have a bumpy landing than a hard one, investors’ concerns have yet to be laid to rest, owing to the ongoing growth slowdown and continued capital flight.
Second, emerging markets are in serious trouble. They face global headwinds (China’s slowdown, the end of the commodity super cycle, the Fed’s exit from zero policy rates). Many are running macro imbalances, such as twin current account and fiscal deficits, and confront rising inflation and slowing growth. Most have not implemented structural reforms to boost sagging potential growth. And currency weakness increases the real value of trillions of dollars of debt built up in the last decade.
Third, the Fed probably erred in exiting its zero-interest-rate policy in December. Weaker growth, lower inflation (owing to a further decline in oil prices), and tighter financial conditions (via a stronger dollar, a corrected stock market, and wider credit spreads) now threaten US growth and inflation expectations.
Fourth, many simmering geopolitical risks are coming to a boil. Perhaps the most immediate source of uncertainty is the prospect of a long-term cold war – punctuated by proxy conflicts – between the Middle East’s regional powers, particularly Sunni Saudi Arabia and Shia Iran.
Fifth, the decline in oil prices is triggering falls in US and global equities and spikes in credit spreads. This may now signal weak global demand – rather than rising supply – as growth in China, emerging markets, and the US slows.
Weak oil prices also damage US energy producers, which comprise a large share of the US stock market, and impose credit losses and potential defaults on net energy exporting economies, their sovereigns, state-owned enterprises, and energy firms. As regulations restrict market makers from providing liquidity and absorbing market volatility, every fundamental shock becomes more severe in terms of risk-asset price corrections.
Sixth, global banks are challenged by lower returns, owing to the new regulations put in place since 2008, the rise of financial technology that threatens to disrupt their already-challenged business models, the growing use of negative policy rates, rising credit losses on bad assets (energy, commodities, emerging markets, fragile European corporate borrowers), and the movement in Europe to “bail in” banks’ creditors, rather than bail them out with now-restricted state aid.
Finally, the European Union and the eurozone could be ground zero of global financial turmoil this year. European banks are challenged. The migration crisis could lead to the end of the Schengen Agreement, and (together with other domestic troubles) to the end of German Chancellor Angela Merkel’s government.
Moreover, Britain’s exit from the EU is becoming more likely. With the Greek government and its creditors once again on a collision course, the risk of Greece’s exit may return. Populist parties of the right and the left are gaining strength throughout Europe. Thus, Europe increasingly risks disintegration. To top it all off, its neighborhood is unsafe, with wars raging not only in the Middle East, but also – despite repeated attempts by the EU to broker peace – in Ukraine, while Russia is becoming more aggressive on Europe’s borders, from the Baltics to the Balkans.
In the past, tail risks were more occasional, growth scares turned out to be just that, and the policy response was strong and effective, thereby keeping risk-off episodes brief and restoring asset prices to their previous highs (if not taking them even higher). Today, there are seven sources of potential global tail risk, and the global economy is moving from an anemic expansion (positive growth that accelerates) to a slowdown (positive growth that decelerates), which will lead to further reduction in the price of risky assets (equities, commodities, credit) worldwide.
At the same time, the policies that stopped and reversed the doom loop between the real economy and risk assets are running out of steam. The policy mix is suboptimal, owing to excessive reliance on monetary rather than fiscal policy. Indeed, monetary policies are becoming increasingly unconventional, reflected in the move by several central banks to negative real policy rates; and such unconventional policies risk doing more harm than good as they hurt the profitability of banks and other financial firms.
Two dismal months for financial markets may give way in March to a relief rally for assets such as global equities, as some key central banks (the People’s Bank of China, the European Central Bank, and the Bank of Japan) ease more, while others (the Fed and the Bank of England) will remain on hold for longer. But repeated eruptions from some of the seven sources of global tail risk will make the rest of this year – unlike the previous seven – a bad one for risky assets and anemic for global growth.

Rolling Up the Welcome Mat

Berlin Moves to Curb Afghan Refugee Influx

By Wolf Wiedmann-Schmidt, Susanne Koelbl, Christiane Hoffmann and Konstantin von Hammerstein

 German Interior Minister Thomas de Maiziére in Afghanistan
DPA German Interior Minister Thomas de Maiziére in Afghanistan

Hundreds of thousands of Afghans are seeking refuge in Germany from their country's turmoil. Berlin plans to increase its deportations and scare tactics in order to lower the number of asylum-seekers from the region.

Here at least, things seem to be safe. The grounds of the German consulate in downtown Mazar-e-Sharif, Afghanistan are surrounded by a massive concrete wall. The Americans turned the former hotel into a fortress before they rented it to the Germans: There are vehicle gateways with automatic steel gates, thick bullet-proof window panes, panic rooms and heavily armed police officers in combat uniforms.

On this sunny afternoon in early February, Hayatullah Jawad is tasked with conveying the truth to the German Interior Minister in the consulate's unadorned conference room.

"Everyone who can is currently leaving the country," the migration expert says, before letting the sentence sink in for a moment.

Thomas de Maizière only has one question: Why? "There are three reasons," says Jawad.

"Firstly: the departure of foreign troops. The people don't believe that the Afghans can take care of security by themselves. Secondly: It is simple to reach Europe." And thirdly? Jawad keeps a straight face. "Smiley government." German Chancellor Angela Merkel's message of welcome to the refugees has made all the difference, he says. Everyone is getting a passport as quickly as possible. After all, who knows how long the German government's warmth will last.

And it can't last. There are simply too many. Since the fall, the number of Afghan refugees who reach Germany has grown markedly. In the past year they represented the second largest group among asylum applicants. This January, one out of five refugees registered in Germany came from the Hindu Kush region.

If Merkel wants to lower the number of refugees as the has pledged to do, then the chancellor absolutely needs to take Afghanistan into account. But it's a difficult proposition. Since its military intervention a decade and a half ago, the West has carried a special responsibility for the country -- a land that is now once again in danger of sinking completely into civil war. The idea of categorizing Afghanistan as a safe country of origin, like the Balkan states, is unthinkable. On the contrary: The security situation is getting worse. If it continues along these lines, millions of Afghans could be entitled to protection under the Geneva Convention. And the smugglers on the route to Europe are highly professional. This maelstrom is a nightmare.

In order to have more power to deport people to Afghanistan, the government has declared part of the country safe. But the Taliban are constantly expanding their influence. The government in Kabul is weak, the economic prospects are dire. "Afghanistan is at serious risk of a political breakdown during 2016," US Director of National Intelligence James Clapper recently said during a Senate hearing.

Despite this, the German government is hoping to convince a high four-digit number of Afghans to voluntarily make the return trip. A week ago, 125 Afghans returned to Kabul in a Czech charter plane with the media watching. In exchange, Germany is giving them €700 ($760) for a new start in their homeland.

But according to current plans by the government, rejected asylum applicants who do not want to return of their own free choice will soon also be deported in larger numbers. According to an internal German government memo, forced repatriations will be "tackled" in a next step, which is already being prepared behind the scenes.

Worsening Situation in Afghanistan

This marks yet another change of direction in German asylum policy. For years, a general ban on deportations to Afghanistan had been in place, with only 47 people having been sent back to the country since 2011. Last year, just nine were sent packing.

Deportations to Afghanistan are morally dubious, laborious and costly. But the interior minister doesn't see any alternative. In 2015, three times as many Afghans applied for asylum than in 2014. In total, 154,000 refugees came from the Hindu Kush. A further 18,099 were registered by the authorities this January. For that reason, measures like the one taken last Wednesday are mostly meant to have a symbolic effect. De Maizière is hoping that the news will spread around Afghanistan that the generous times have passed. The welcome mat has been rolled up.

Since the withdrawal of the International Security Assistance Force's (ISAF) protective troops in 2013, the security situation in the country has deteriorated dramatically. "There are safe provinces and there are less safe provinces," de Maizière said during his visit in early February -- an optimistic description. A Western diplomat in Kabul expresses it this way: "There are unsafe and less unsafe provinces."

In practice, the Interior Ministry is already well aware of this. Each week the officials of the Group 22 in the Federal Office for Migration and Refugees (BAMF) compile an Afghanistan briefing based on the most up-to-date information available. It is a litany of horrors: military clashes, suicide bombings, kidnappings, assassinations. According to the latest statistics released by the UN's Afghanistan mission, the number of civilians injured or killed last year -- 11,002 -- is the highest since the toppling of the Taliban.

In order to determine the level of security in a province, the German Federal Administrative Court has developed a macabre "body count" calculus. If the ratio of civilian victims to overall inhabitants is lower than 1:800, then the risk to life is too low to receive protection in Germany.

The last thorough situation analysis by the German Foreign Ministry and the BND foreign intelligence service makes for grim reading. It describes a "downward spiral." The "performance, reliability and operational morale" of the Afghan army is sinking and after the Taliban's brief conquest of Kunduz in September 2015, the militants see themselves "justifiably in a position of strength against the government." In addition to the Taliban, the Islamic State terror militia is also gaining a foothold in some provinces.

For the BAMF and the German administrative courts, the situation is has become rather chaotic, with officials left to answer some very tough questions. Is someone who flees from the Taliban in Kunduz safe in Kabul? Does a man have a right to asylum in Germany if he is supposedly being forced to fight by two opposing militias and he'd rather stay neutral? Can a feud between two rival clans be a justification for asylum? Or a planned forced marriage?

According to an internal report by the German Foreign Ministry about the "situation pertaining to asylum and deportation" the status of women has improved since the end of Taliban rule, but their human rights are "still frequently violated" by way of abuse, forced marriages, sexual assaults or murder. Children have been forcibly recruited, sexually abused and afterwards sometimes killed.

"Within the ranks of army and police in particular," it claims, the sexual abuse of children and youths is a "large problem."

New Guidelines in Germany

Still, the German Foreign Ministry has picked out individual regions in which "the situation is comparatively stable despite selective security incidents." In the view of the German government, rejected asylum applicants can be sent to these provinces.

BAMF is now expected to investigate more thoroughly whether "domestic refuge alternatives" are feasible -- ie. whether it is imaginable that a person could stay afloat in one of the country's safe regions. They are considering young men who are fit to work, who are neither pursued by the Taliban nor persecuted for their religion, and merely made the journey to Europe with the hope of a better future.

Members of the German government believe the new guidelines will lead to a decrease in the number of Afghan applicants ultimately granted asylum status. But it's unclear whether the calculation will pay off. The administrative courts have the final word in decisions. These courts can also be soft in their rulings.

It's 9 a.m. on Feb. 23 in a Berlin court. A young Afghan stands in front of Administrative Judge Claudia Perlitius. With its green carpet and gray chairs, the environment has an aura of bureaucratic sadness. The Afghan's application for asylum has been rejected by BAMF, and now he is taking legal action against it. The man grew up in Iran, which isn't rare: About 1 million Afghans have fled to their neighboring country.

The judge explains clearly that the man has no right to asylum in Germany because he is not being persecuted in Afghanistan. And the so-called subsidiary protection as a refugee from civil war doesn't apply to him. But during questioning, it becomes clear that the man doesn't have any contact with his relatives in Afghanistan. The judge decides it is untenable to send a man to Afghanistan who has no network of family there to provide him with support. The judge lifts the deportation and orders that the man can stay in Germany.

After Syria, Iraq and Eritrea, it is Afghans who are most frequently granted asylum status in Germany. And even a rejected application doesn't necessarily result in deportation. Obstacles could include medical treatment that cannot be interrupted, or a missing passport. Of the approximately 200,000 foreigners who are set to be deported in Germany, the orders have been dropped in almost 150,000 of those instances.

News of that fact has also spread in Afghanistan. Reports on social media suggest that Afghans have little to worry about in terms of getting deported back to the Hindu Kush, an internal Foreign Ministry memo states. This, in turn, has spurred the refugee smuggling business in the country, where market forces appear to be alive and well. High demand has created a wide array of offerings, sophisticated infrastructure and sinking prices in trafficking.

One and a half years ago, migration expert Hayatullah Jawad explains, his uncle had to pay $15,000 to get his relatives to Vienna. Their trip took three months. Now an entire family can come to Europe via Iran or Turkey in only 12 days for the same price.

'Have You Thought About It?'

That's what Hussain Saydi wants. The electrical engineer is a member of the Shiite Hazara minority.

He comes from the Qarabagh district in the eastern part of the country. Now he's sitting in the living room of a friend in Kabul. Saydi is waiting for his passport, and next week he wants to leave -- for Germany.

As an employee at a human right's organization, the 28-year-old once wrote an article about the "double standard" of men who believe themselves to be good Muslims because they attended the mosque, but don't allow their wives or daughters to leave the house or go to school. After it came out, the Qarabagh ulama, the local council of Muslim clerics, summoned him, at which point Saydi says he was threatened. Now he's planning his escape together his wife, who studied business administration.

It's expected to cost $10,000, with each smuggler immediately receiving a portion after performing his part of the service. Arrival in Germany is guaranteed.

None of this is good news for Thomas de Maizière. That's why the German government is now testing a Facebook campaign to try to deter young Afghans from fleeing to Germany. Large signs in Pashtu and Dari read: "Leaving Afghanistan? Have you given this careful consideration?" It sounds rather discursive and many people wouldn't consider that much of a deterrent. The Australians, for example, air ads on Afghan television that dispel any illusions.

They show a grim officer in a uniform: "If you travel by boat without a visa, you will not make Australia home. There are no exceptions!"

Why Deflation Matters More Than Recession - Part 2

by: SG PrivateWealthBanker

- There are presently many cases worldwide where selling prices are deflating, yet the cost of goods sold is holding constant or falling at a slower rate.

- Manufacturing inventories are elevated everywhere in the World, and liquidation pressures among global industrial enterprises are considerable.

- A drop in selling prices is often not compensated by a drop in cost of goods sold.

- Wages are rigid on the downside, and labour compensation often makes for a noticeable share of variable costs.

- The deflation trade is alive and well.

Why deflation matters more than recession - Part 2.

After the publication of ' Where Deflation Comes From And Why It Matters More Than Recession? '' earlier this month, as I received a lot of comments and questions, I have decided to update this previous article, giving more details on the subject. To refresh readers' memories, we are republishing the table that illustrates that a 2% drop in output prices and a 2% in units sold causes profits to contract by double-digit rate. Meanwhile, the inverse - a 2% drop in volumes and a 2% rise in prices - produces double-digit profit growth. In these examples, we maintain the cost of goods sold per one unit (variable costs per unit) and fixed costs remain constant.
Source: BCA Research.
True, if one were to reduce the cost of goods sold by the same percentage as the deflation in output prices, profits would not be more sensitive to a drop in prices than to a decline in volumes. However, there are presently many cases worldwide where selling prices are deflating, yet the cost of goods sold is holding constant or falling at a slower rate. In particular:
  • Final output goods prices in China are deflating by 5% and export prices are falling at annual rate of 2.3% in RMB terms. At the same time, industrial wages in China are still growing.
In fact, a bullish view on China rests on the assumption that wages will continue to grow rapidly. If this is true, the cost of goods sold cannot drop as much as the deflation in final products' prices, which is currently running somewhere between 2% and 5% for manufacturing goods. Provided wages are not a small part of the cost of goods sold, and because wages are still rising, deflation among Chinese industrial/manufacturing companies will produce material profit contraction, even if volumes continue to expand modestly.

Source: BCA Research.

  • Now consider the example of Korean or US industrial firms that are competing with their Japanese and German counterparts. Due to the EUR and JPY depreciation over the past few years, let's assume German and Japanese companies have been able to cut their USD product prices by 10%. In order to preserve market share both worldwide and domestically, let's also assume that Korean and US industrial firms have matched the price reduction of their competitors by also cutting prices by 10% in USD terms. Notably, Korean and US export prices are deflating rather rapidly.

Source: BCA Research.

Nevertheless, wages at Korean and US companies are not contracting, but rising in their local respective currencies. Provided wages are a sizeable part of the cost of goods sold, the latter cannot deflate much, even if non-wage input prices decline. Consequently, the cost of goods at these US and Korean industrial firms cannot drop as much as the deflation in their output prices.
  • Moreover, manufacturing inventories are elevated everywhere in the world, and liquidation pressures among global industrial enterprises are considerable. As these producers have to cut their selling prices to liquidate their inventories, the impact on their profits will be devastating, even if their volume rises. The reason is that the costs for production of these goods have already been incurred and cannot be reduced.
These are just few examples that demonstrate how a drop in selling prices is often not compensated by a drop in cost of goods sold. The key point is that wages are rigid on the downside, and labour compensation often makes for a noticeable share of variable costs.

Meanwhile, fixed costs are constant not only in the short-run but even in the medium-term.

Therefore, our thesis that deflation can lead to profit contraction without a decline in volumes is, by and large, reasonable. As such, it should not be surprising to witness contracting profits among industrial firms in many countries, even though their GDP growth remains positive.

The World’s Reluctant Central Banker

Andrés Velasco

 United States dollar and euro coins hanging 

NEW YORK – This is supposed to be the era of powerful central banks, ready to wield their firepower worldwide. Yet the most powerful of all central banks – the United States Federal Reserve – is also the most reluctant to acknowledge its global reach.
Like all central banks, the Fed has a local mandate, focused on domestic price stability and employment. But, unlike most central banks, the Fed has global responsibilities. This tension is at the root of some of the most threatening problems facing the world economy today.
The Fed has global responsibilities for two closely related reasons, neither of which has much to do with the need to avoid the “currency wars” that so concerned former Brazilian Finance Minister Guido Mantega.
First, despite the birth of the euro and talk of the Chinese renminbi’s ascendancy, the dollar remains the currency of choice for borrowing and lending around the world. When a bank or corporation in Kuala Lumpur, São Paulo, or Johannesburg borrows abroad, the loan is more likely to be denominated in dollars than in any other currency.
If local banks suffer a run, or if corporations have trouble rolling over their debt, they need to be able to borrow dollars from the local central bank, which in turn may have no choice but to get those dollars from the Fed. When the Fed in 2007-2008 entered into swap agreements with 14 central banks, including those of four emerging economies (Brazil, Mexico, Singapore, and South Korea), it de facto acknowledged that it is the world’s lender of last resort in dollars.
Yet the Fed, its governors argue, cannot be expected to do that on a regular basis. In a 2015 speech, Stanley Fischer, one of the most internationally-minded of the Fed’s governors, acknowledged that world financial stability could be supported by a global central bank, yet concluded: “I should be clear that the US Federal Reserve is not that bank.”
The second reason why the Fed has global responsibilities is that its policies affect monetary conditions worldwide. There is mounting evidence that monetary-policy shocks affect risk premia, and that this channel operates internationally as well as domestically, with sizeable effects. In the 2013 episode known as the “taper tantrum,” the mere hint that the Fed might slow the pace of its bond-buying program triggered large capital outflows and asset-price drops in most emerging economies.
The traditional Fed response, expressed eloquently by former Fed Chairman Ben Bernanke at the 2015 IMF Research Conference, is simple: Float your currency. The standard trilemma of international monetary policy holds that countries cannot have fixed exchange rates, monetary independence, and free capital movement simultaneously, but they can have two of the three.
Countries that float their currencies can be free to set interest rates and determine financial conditions at home, even with substantial international capital mobility. If they don’t float – because they have targets for exports or the real exchange rate – that is their problem. The Fed, Bernanke argued, cannot be expected to help them.
But Bernanke’s argument is not entirely convincing. As London Business School’s Hélène Rey has argued, the “risk-taking” channel of monetary policy is so powerful internationally that Fed policy helps determine credit conditions in many countries quite independently of their exchange-rate regimes. When the Fed loosens policy, credit grows all over the world, and vice versa. So it is not a policy trilemma but a dilemma: capital-account restrictions –not just flexible exchange rates – may be necessary for central banks to exercise effective control over domestic credit conditions.
The Fed’s reluctance to serve as the world’s lender of last resort, or to acknowledge that exchange-rate movements cannot undo its actions abroad, would seem to condemn it to being a parochial and inward-looking institution. But Donald Trump should not start applauding yet.
The Fed’s domestic mandate requires it to recognize, in Fischer’s words, that “the US economy and the economies of the rest of the world have important feedback effects on each other.” And those effects are getting larger.
When justifying its interest-rate decisions, the Fed has historically paid little attention to the effect of international conditions on the US economy. But it broke with tradition in September 2015. Both the official minutes of the rate-setting meeting and Chairman Janet Yellen in her press conference mentioned heightened uncertainties abroad, including weakness in the Chinese economy, as key reasons to delay the Fed’s increase in interest rates.
Other international linkages are also receiving greater attention. As the US economy becomes more open to international trade and capital movements, the dollar’s value matters more because of its effect on inflation and on domestic financial conditions. In the current debate about what the Fed should do next, Governor Lael Brainard has been arguing that real dollar appreciation of 20% in 2014 and 2015 reduces the need for further monetary-policy tightening.
Of course, caring about how the world affects the US is not the same as concern about the economic health of the rest of the world. And yet these small steps are significant. Berkeley’s Barry Eichengreen has shown that international considerations have long played a key role in the conduct of Fed policy, and that the last three decades, in which the Fed turned mostly inward, were something of an aberration.
So perhaps the 102-year-old Fed is returning to its original tradition. Or perhaps its outlook already is quite internationalist – as its actions during the financial crisis suggest – and it is only domestic political constraints that prevent this from being acknowledged openly.
Either way, even incremental movement in this direction is welcome, for the last thing the world needs is a parochial Fed. Recent financial history suggests that the next liquidity crisis is just around the corner, and that such crises can impose enormous economic and social costs. And in a largely dollarized world economy, the only certain tool for avoiding such crises is a lender of last resort in dollars.
The IMF could have been that lender, but it is not. The Fed is. The sooner the US and the rest of the world fully recognize this, the safer the world economy will be.

Markets Remain Extremely Overbought

3-7-2016 3-08-43 PM

Stocks started the day Monday lower but quickly dip buyers entered even as conditions remain overbought in the extreme.

High oil prices continue to be highly (almost 90%) correlated to these price movements. It’s comical, to me anyway, that almost all commentary having to do with rising energy prices contains “hope” as the reason for higher prices.

And, “hope” is OPEC and others will “freeze”, or in fact “cut”, production to curtail oversupply. If markets were self-regulating giving free economic pressures, there wouldn’t be any need for all this nonsense. Nevertheless, even if producers overseas stated they would freeze/cut production, experience has shown cheating by participants would immediately take place.

The major thing U.S. producers have noticed that as production as increased domestically they can’t even find storage for the product. That in itself is how a free market should regulate itself.

Economic data Monday included Labor Market Conditions falling -2.4% vs prior -0.8% and Consumer Credit imploding to $10.5 billion vs prior adjusted much lower from $21.5 billion to only $6.5 billion. Um, not “solid”.

One thing supporting stocks are corporate stock buyback activity. It expanded 39% YoY and according to Goldman Sachs corporate share buyback programs have increased greatly as stocks have fallen. This activity has been the tailwind bulls have thrived on as corporations are using cheap credit to engage in these activities.

Since it’s become routine in this low interest rate environment nothing been done to increase the company’s long-term growth.

Another positive for stocks is the bizarre thinking that since economic data is so weak we’ll likely not see an interest rate hike as March Fed Meeting next week, so that’s bullish right? Bad news is good in that regard.  

Below is the heat map from Finviz reflecting those ETF market sectors moving higher (green) and falling (red).

Dependent on the day (green) may mean leveraged inverse or leveraged short (red).

 3-7-2016 3-20-14 PM

Volume was once again very light and breadth per the WSJ was positive.

Sign up to become a premium member of the ETF Digest and receive more of our detailed charts with actionable alerts.
You can follow our pithy comments on twitter and like us on facebook.
3-7-2016 3-21-15 PM
12-17-2015 9-04-44 PM Chart of the Day
3-7-2016 3-30-35 PM USO

Charts of the Day
















    The NYMO is a market breadth indicator that is based on the difference between the number of advancing and declining issues on the NYSE. When readings are +60/-60 markets are extended short-term.


    The McClellan Summation Index is a long-term version of the McClellan Oscillator. It is a market breadth indicator, and interpretation is similar to that of the McClellan Oscillator, except that it is more suited to major trends. I believe readings of +1000/-1000 reveal markets as much extended.


    The VIX is a widely used measure of market risk and is often referred to as the "investor fear gauge". Our own interpretation has changed due to a variety of new factors including HFTs, new VIX linked ETPs and a multitude of new products to leverage trading and change or obscure prior VIX relevance.

So again, it’s back to bad news is good as weak economic data means Fed can’t raise interest rates, the high correlation from stocks to crude oil remains as do stock buybacks.

Beyond that, words fail me.

Let’s see what happens.

Gold Stocks Reverse at Resistance Targets

By: Jordan Roy-Byrne

Two weeks ago, regarding the miners we wrote:
If it (GDXJ) surpasses its 80-week moving average then its next target is $27-$28. Meanwhile, GDX is holding above previous resistance at $18. Its next strong resistance targets are $21 and $22.
Earlier today GDX and GDXJ came within pennies of $21 and $29 respectively while Gold touched $1280 before reversing. While Gold and gold stocks could continue a bit higher, their rebound may have ended Friday morning.

A weekly candle chart of GDXJ and GDX is below. The miners over the past six weeks have formed six white candles and taken out their 80-week moving averages, which contained the strongest rallies during the bear market. However, the miners formed a nasty reversal on Friday after touching resistance earlier in the day. The miners could, at the least, test their 80-week moving averages which are now support.

Market Vectors Gold Miners and Junior Gold Miners Weekly Charts

The recent rebound was similar to that from the October 2008 lows. Then, GDX rebounded 69% (from low tick to high tick) in five weeks while over the past six weeks GDX surged 68%.

Then, GDX corrected 20%. GDX also corrected 29% during that rebound. In recent weeks GDX has not corrected more than 10%. It would not be unreasonable for GDX to correct 20% or even 25% from Friday's high.

Meanwhile, Gold reversed course after reaching a confluence of resistance which includes the 40-month moving average. There remains a small chance that Gold could test $1300/oz before correcting. Gold has support at $1240/oz and $1200/oz.

Monthly Gold Chart

The bearish reversal at resistance coupled with history makes a strong argument that gold stocks could correct recent gains in the days and weeks ahead. A 20% decline would be normal and reasonable given the context. For those of us waiting for a correction, it could be coming.

The month of March may provide the best buying opportunity in the miners since December 2015.

Is the Most Hated Bull Market in History Over?

By: Sol Palha

"An ounce of patience is worth a pound of brains."

 ~ Dutch Proverb

Throughout this bull-run, a plethora of reasons has been laid out to indicate why this bull should have ended years ago. Mind you most of those reasons are valid, but that is where the bucket stops. Being right does not equate to making money on Wall Street. In fact, the opposite usually applies. The Fed recreated all the rules by flooding the markets with money and creating and maintaining an environment that fosters speculation.

The reason this is the most hated bull market in history is because there is no logical reason to justify it. In 2008-2009 volume on the NYSE was in the 8-11 billion ranges and sometimes it surged to 12 billion. Before that, every year, the volume continued to rise, this indicates market participation.

From early 2010 volume just vanished, it dropped to the 2-3 billion ranges and even lower on some days. Hence, all market technicians and students of the markets assumed that the markets would tank as markets cannot trend higher on low volume and that is where they erred.

We were and still are in a new paradigm; the US government stepped in and started to support the market directly that is why volume dropped so dramatically. However as there were no sellers, the markets drifted upwards. Later on, they got the corporate world in on the scam.

They set up the environment that propelled corporations to buy back their shares by borrowing money for next to nothing and then using this trick to inflate t EPS (earnings per share), without doing any work or even increasing the profitability of the company.

In between a few minor corrections were allowed to transpire almost all of which took place on ever lower volume, to create the illusion that there was some semblance of free market forces at play. The current correction is the only one since 2011 that is real in nature, and it could prove to be a precursor to a larger upward move. If you recall, the era, the markets corrected strongly in 1998, it looked like the end was near but then the NASDAQ had its best year ever in 1999. It had tacked on gains of roughly 100%. The chart below highlights this dramatic reversal.

NASDAQ Composite 1997-2001 Chart

Finally, we also have something known as dark pools, this, in essence, allows institutions to purchase large blocks of shares without leaving any tracks. Dark pools now account for over 40% of all U.S stock trades. Theoretically, it provides the government via the PPT (plunge protection team) an avenue to manipulate the markets without leaving any evidence of foul play.

Game Plan

The Fed is hell bent on forcing everyone to speculate, and that is why we have moved into the next stage of the currency war games; the era of negative interest rates. Negative rates will eventually force the most conservative of players to take their money out of the banks and speculate. This process will be akin to another massive stimulus and will provide the bedrock for another monstrous rally.

Make a list of stocks that you would like to own and use strong pullbacks to add to or open new positions in blue chip companies or companies with strong growth rates. Some examples are OA, AMZN, BABA, GOOG, RTN, CHL, etc

When negative rates become a zero sum game

Stimulus policies should be structured in ways that boost demand
Bank of England governor Mark Carney takes part in a press conference at the Bank of England in London on December 1, 2015. Britain's seven top lenders have passed the Bank of England's stress tests, the central bank said today in its latest healthcheck on the sector. AFP PHOTO / POOL / Suzanne Plunkett / AFP / POOL / SUZANNE PLUNKETT (Photo credit should read SUZANNE PLUNKETT/AFP/Getty Images)©AFP
Bank of England governor Mark Carney
Anyone hoping for a concerted effort to boost global growth will have been disappointed by the familiar combination of bland public conclusions and behind the scenes sniping at the G20 gathering in Shanghai. Policymakers committed to use all tools — monetary, fiscal and structural — to strengthen the recovery. But in reality, many are deferring difficult reforms and hoping that others will shoulder the burden of fiscal expansion. As for monetary policy, there is a clear concern that the latest weapon in central banks’ armoury — the adoption of negative interest rates — may amount to little more than a new way to wage an old-fashioned, beggar-thy-neighbour currency war.
Mark Carney, the Bank of England governor, set out this concern most forcefully. It is critical for central banks to structure stimulus measures in ways that boost domestic demand, he argued, so that a “rising tide” of global demand could “lift all boats”.

Negative interest rates are intended to achieve this, forcing banks to seek out riskier lending opportunities and assets, and encouraging consumers and borrowers to spend. It is plausible and technically possible for them to do so. However, many banks, and policymakers, are proving unwilling to make retail customers feel the full effects.

Mr Carney therefore argues that there are limits to what the latest burst of innovation by central banks can achieve. If they craft policies in ways that shield retail customers, negative rates are unlikely to do much to stimulate domestic demand. Instead, the main effect will be on the exchange rate.

This is attractive to the country concerned but it rapidly becomes a zero sum game, since “for monetary easing to work at a global level it cannot rely on simply moving scarce demand from one country to another”.

This is a clear criticism of negative interest rates as they are practised in countries such as Japan, which adopted the policy in January but has kept paying interest on most bank reserves, allowing banks to keep rates positive for retail depositors. In the clubby world of central banking, such a forthright attack by Mr Carney on his peers is remarkable.

His intervention is also important because the European Central Bank is considering adopting a similar tiered system, which might enable it to cut rates even further below zero without undermining confidence in the eurozone’s fragile banks.

The ECB faces a difficult choice. With the latest data showing that the eurozone has once more slipped into deflation, policymakers are under pressure to cut the deposit rate further into negative territory at this month’s meeting. If they leave lenders exposed to the full effects, they risk triggering a fresh sell off in banking shares. If they follow Japan’s lead and try to shield banks and retail depositors, they lay themselves open to accusations of currency wars.

Yet Mr Carney’s criticism is fair. His concerns are likely to be shared in the US, where policymakers are increasingly calling attention to the risks a stronger dollar poses to growth.

It is also correct to warn that “at the global zero bound, there is no free lunch”. The surge in the value of the yen since the Bank of Japan’s move suggests that using negative rates as a tool for devaluation is at best an unreliable strategy. At worst, it risks reinforcing the impression that central bankers are acting out of desperation.

Mr Carney contends it is a myth that central banks are “out of ammunition”. But he ends his speech with an admission that central bankers cannot restore the global economy to health without help from governments.

We’re in the Eye of the Financial Hurricane

 Justin Spittler

American stores are hurting…

Two weeks ago, we pointed out that giant retailer Wal-Mart just had its worst year since 1980. Sales fell for the first time in 35 years. The company plans to close 269 stores.

Since then, retailers have announced a flood of ugly results, The Wall Street Journal reports.

On Thursday, Kohl’s Corp. said it would close 18 stores after reporting weak sales, while Sears Holdings Corp. is looking to sell $300 million in assets after reporting yet another loss. Best Buy Co. warned of weak demand for electronics, and shares of Restoration Hardware Inc. plunged as much as 29% Thursday after it blamed poor sales on a “pullback by the high-end consumer.”

Earlier this month, Kohl’s (KSS), another major retailer, reported that its profits fell 20% last quarter.

Profits for clothing company Ralph Lauren (RL) fell 29%. Profits for The Gap (GPS), another clothing company, plunged 33%.

Dispatch readers know retail stocks can give advance warning of economic problems. Consumer spending accounts for 67% of the U.S. economy. When folks start to cut back on buying clothes, furniture, and televisions, these companies feel it first.

• Retail stocks were hot over the past seven years…

The SPDR S&P Retail ETF (XRT), which tracks 100 U.S. retailers, surged 500% from March 2009 to July 2014. The S&P 500 only climbed 215% over that same time.

Since July, XRT has dropped 14%. It hit its lowest level since 2013 this month.

• Many huge U.S. corporations are losing money…

Industrial conglomerate General Electric (GE) lost $6.1 billion last year. Profits at Exxon (XOM), the world’s largest oil company, plummeted 58%. Profits for Caterpillar (CAT), the world’s biggest machinery maker, plunged 43%.

As of Friday, 96% of the companies in the S&P 500 had reported quarterly earnings. Based on those results, S&P 500 earnings are on track to drop 3.3% for the fourth quarter. This would mark the third straight quarter of declining earnings for the S&P 500. That hasn’t happened since the 2009 financial crisis.

• E.B. Tucker, editor of The Casey Report, called the end of the stock bull market in September…

E.B. warned that stocks and the economy were about to enter a “very tough time.” It was a lonely call...the S&P 500 had been rallying for six straight years. And the stock market was still very close to its all-time high.

But E.B. was right. The rally has died out. None of the major U.S. stock benchmarks have hit new highs since July. The S&P 500 and Dow Jones Industrial Average have both fallen 10% since hitting record highs last year. The tech-heavy NASDAQ has dropped 13%.

• We recommend investing with caution…

We think the risk far outweighs the reward in U.S. stocks right now. If you want to continue owning certain U.S. stocks, consider pairing each stock with a “short” position.

“Shorting” a stock is betting that it will go down. By adding shorts to your portfolio, you can make your portfolio “market neutral.” This means you don’t need the overall stock market to rise to make money.

Your long positions will make money when prices rise. Your short positions make money when prices fall. This strategy allows you to own stocks while greatly reducing the damage a bear market could do to your portfolio. We use this strategy in The Casey Report to help readers make money in any environment.

We also suggest you own a significant amount of cash and physical gold. As we often say, holding cash and gold will help you avoid big losses if stocks keep falling.

• Casey Research founder Doug Casey believes a major financial crisis is just around the corner…

We entered a gigantic financial hurricane in 2007. We’ve been in the eye of the hurricane since 2010. It’s a large eye, yes, but that’s in proportion to the huge size of the hurricane. I admit: I’ve been early on this, since the degree of what governments have been doing—with ZIRP, QE, and now the War Against Cash, is unprecedented. But we’re exiting the eye of the storm and going into its trailing edge. The global economy will be engulfed in the trailing edge of the storm before this year is over. There are many indications that this is starting right now, as we speak. And the second half of the storm is going to be much worse, much different, and last much longer than what we saw in 2008 and 2009.

If you share Doug’s concern, you’ll want to “crisis-proof” your wealth. Our new book—Casey Research’s Handbook for Surviving the Coming Financial Crisis—explains strategies that will protect you from a major stock crash, economic depression, or even a full-blown currency crisis. Click here to claim your copy.

• Moving along, important news in the oil market…

Dispatch readers know the oil market is a disaster. The price of oil has plunged 70% since June 2014. Earlier this year, oil hit its lowest level since 2003.

Yesterday, we explained how low oil prices have decimated shale oil companies. In short, few shale oil companies can make money at today’s oil prices.

• Shale oil stocks have collapsed…

The Market Vectors Unconventional Oil & Gas ETF (FRAK), which tracks 50 companies in the shale oil and gas industries, has plunged 65% since June 2014.

• Shale oil companies are starting to cut back on production…

The Wall Street Journal reported yesterday:

So after years of boosting oil and gas flows across Oklahoma, Texas and North Dakota, Continental Resources Inc., Devon Energy Corp. and Marathon Oil Corp. say they plan to pull roughly 10% less from the ground in 2016 than they did last year. EOG Resources Inc. joined the chorus Friday, telling investors it has curbed production and expects to pump 5% less oil this year.

This is a big deal. For months, we’ve been saying that the world has too much oil. But until now, most oil companies have refused to cut production. According to The Wall Street Journal, these production cuts could put a significant dent in the U.S. oil production by summer.

IHS, the consulting firm that held the energy gathering in Houston last week, is forecasting that U.S. oil output could fall from more than 9 million barrels a day to as little as 8.3 million barrels a day by this summer.

Chart of the Day

U.S. stocks are expensive.

Today’s chart shows the U.S. stocks’ CAPE ratio since 1900. The CAPE is similar to the popular price-to-earnings (P/E) ratio…with one tweak. The CAPE uses earnings from the last 10 years instead of just one year. This smooths out the impact of booms and recessions. It gives us a longer-term view of the market.

A high ratio means stocks in the S&P 500 are expensive. A low ratio means stocks are cheap.
You can see that the S&P 500 is about 47% more expensive than its historic average. Since 1881, the S&P 500 has only been more expensive three other times: before the Great Depression, during the dot-com bubble, and before the 2008 financial crisis.