The European Central Bank has lost the plot on inflation

 
There is nothing fundamentally wrong with any of the decisions except that the bank missed a trick
 
 
 
Better than expected.” How often have we heard these three words after a policy decision by the European Central Bank? My advice is to stop reading immediately whenever you see them.
 
After all, what the markets expect to happen is entirely in the control of the ECB. The only thing that matters is the policy decision itself: the extent to which it can help achieve a target — in this case an inflation rate of just under 2 per cent. It may have been better than expected. But was it sufficient?
 
The components of the decision an­nounced on Thursday by Mario Draghi, ECB president, were: cuts in the three official interest rates; an increase in the volume of asset purchases; and more generous terms on targeted longer-term refinancing operations, a liquidity facility for banks pegged to the quantity of loans on their balance sheet.

The deposit rate, at which banks park their reserves at the central bank, is down from -0.3 to -0.4 per cent. Mr Draghi hinted that we should not expect further cuts in that rate. And that line was the really big news of the day. He did not so much cut the rates as end the rate cuts.

This is why the euro first fell — then rose when investors realised this rate cut was not what it seemed.

There is nothing fundamentally wrong with any of the decisions except that the ECB missed a trick. It could have widened the spread between short-term and long-term interest rates — or, in financial parlance, it could have steepened the yield curve. One method would have been to make a bigger cut in the deposit rate and a smaller increase in the size of asset purchases. Since asset purchases reduce long-term rates, a small increase in purchases would have reduced them by less.

There are big problems with a flat yield curve. It is a nightmare for the banks because their business consists of turning short-term savings into long-term loans. When long rates are similar to short rates, banks find it hard to make money. They have to find other ways to generate income. Think also about the deeper meaning of a flat yield curve with all interest rates near zero per cent.

Assume you trust Mr Draghi’s commitment to the inflation target. Would you, as a private investor, buy a 10-year corporate bond that yields 0.5 per cent? If inflation really were to reach 2 per cent within two or three years, you would surely make a loss. The only reason you would want to make a long-term investment at these rates is that you do not believe in the target.

Long-term rates are low because people believe the ECB has lost the plot on inflation. I, too, believe this.
Mr Draghi and his colleagues retort that their monetary policy is working. They are right. But not as well as it should. Monetary policies, like the ECB’s quantitative easing programme, filter into the real economy through various channels. One is the exchange rate. In the past two years, the trade-weighted exchange rate of the euro has fallen by 13 per cent. This has improved eurozone competitiveness. But the gains occurred more than a year ago. In the past year the exchange rate has actually gone up 2 per cent.
 
The second channel through which the programme worked was through higher bank lending.

The QE programme ended the credit crunch in Italy last year. But the marginal benefits of these policies have been diminishing. Piling on a few more purchases will not make a huge difference.
What about the targeted longer-term refinancing operations? The nominal rate charge to banks using this will be zero but they will receive a discount, the size of which depends on how much they lend. For the first time, it will be possible for them to secure ECB money at negative rates — at up to -0.4 per cent. So when they borrow €1,000 today, they repay only €996 in a year’s time.

Will that offset the negative effects of a flat yield curve and the impact of the negative deposit rate on profits? It would if there was ample demand for loans. But there does not seem to be any evidence of that. The ECB’s bank lending survey for the fourth quarter of 2015 reported a sharp drop in participation of banks in the most recent TLTRO auctions. Remember that this policy instrument was once called a bazooka.
 
What I found mildly encouraging was Mr Draghi’s open-mindedness about a helicopter drop — printing money and distributing it directly to the people. There has also been good news on industrial production in some eurozone countries, notably Italy and Germany.

Maybe the pessimism is overdone, the recovery is stronger than many think and the eurozone will perform “better than expected”. But, since this has not happened in a long time, it would be wise not to base policy on that hope.


Inflation Is Coming, Are You Prepared?

by: William Koldus, CFA, CAIA

 
- For a majority of the last five years, global financial markets have been stuck in a disinflationary spiral.

- Investors responded by going long the U.S. Dollar, long U.S. Treasury’s, long U.S. stocks, short emerging market stocks, and short commodity stocks.

- A historic reversal of the prevailing trades and sentiment is occurring, with inflationary pressures emerging.


 
"Development is of primary importance to China and is the key to solving every problem we face."
 
"Pursuing development is like sailing against the current: you either forge ahead or you drift downstream."
 
- Chinese Premier Li Keqiang
 
 
"No-one has ever made real money following the crowd."
- Bill Bonner
 
 
"There's a trick to the 'graceful exit.' It begins with the vision to recognize when a job, a life stage, (an investment cycle) or a relationship is over - and let it go. It means leaving what's over without denying its validity or its past importance to our lives. It involves a sense of future, a belief that every exit line is an entry, that we are moving up, rather than out."
- Ellen Goodman
 
Source: HBO.
 
Introduction
 
For the past five years, financial markets have been "stuck" in a self-repeating cycle, where economic growth disappointed, central banks came to the rescue, and global capital flows were recycled into the perceived safety of U.S. stocks and bonds.
 
This resulted in unusual price action, with leading U.S. large-capitalization stocks, particularly large-cap growth stocks, becoming a safe-haven destination from 2011 through 2015. The outperformance of U.S. stocks, and bonds, over this time frame produced a virtuous cycle that culminated when seven large-cap growth stocks, including Alphabet (NASDAQ:GOOGL), (NASDAQ:GOOG), Amazon (NASDAQ:AMZN), Apple (NASDAQ:AAPL), Facebook (NASDAQ:FB), Microsoft (NASDAQ:MSFT), Gilead Sciences (NASDAQ:GILD), and Walt Disney (NYSE:DIS), dominated the S&P 500 Index's price action for a majority of calendar year 2015.

The rolling, stealth bear market, that had felled emerging markets, international stocks, and a majority of U.S. stocks over the past year, with the average U.S. stock falling over 25% from its highs, transformed from a quiet tropical storm into a full-fledged hurricane in January and February of 2016.
 
Much like hurricanes can reshape entire islands in the Caribbean, transferring one island's precious sand to another beach across the ocean, the investment landscape has taken a decided change after the latest storm has come and gone.
 
Notably, for the first time in five years, inflationary assets are outperforming and inflationary pressures are rising. Additionally, crowded trades are unwinding, as institutional and retail investors reassess their positions. In the aftermath of the storm, it is clear that the playbook that worked over the past five years for investors is going to have to be changed going forward.
 
Thesis
 
The investment landscape is transitioning from a deflationary environment to an inflationary environment.
 
Not A Typical Bull Market Thus Far
 
 
Normally in a bull market, the last phase of the bull market is dominated by economic sensitive stocks, including industrial and material companies. This phase is characterized by rising inflation, as a growing economy, for a prolonged period, of time stimulates pricing pressures.
 
This is best illustrated by the following graphic from the website of one of my favorite analysts, Martin Pring.
 
 
 
Pring popularized the concept of investing according to the business cycle. In theory, this works wonderfully, but in practice, it has proved less than adept, as the current, extended seven-year bull market, has largely left behind these inflationary investments, as there simply has been no inflation, despite the proliferation of central bank "extraordinary measures", including repeated, and ever increasing "doses" of quantitative easing.
 
Investors Feared Deflation In 2015
 
Denmark, Europe, Japan, Sweden, and Switzerland have all embraced negative interest rates, and sovereign bond yields around the world plunged to record lows during 2015, and they generally remained anchored near these lows in 2016.
 
 
 
Low government bond yields across the globe were indicative of the prevalent deflationary pressures.
 
The sheer depth that higher quality sovereign bond yields plummeted to, which is shown by the chart of the 10-Year Germany Treasury Bond, provided a window into the panic and capitulation that was taking place in the global bond markets.
 
 
Worries About Deflation Have Overlooked Inflationary Pressures
 
As financial market participants struggled to cope with historically low yields, and embraced the inevitability of deflation, a funny thing happened - inflationary pressures began to build.
 
Fellow Seeking Alpha author Robert P. Balan, has published a terrific series of articles that have overviewed this changing investment landscape. His latest research piece, published on February 25th, 2016, and titled, "Inflation And GDP Growth Rise; Bond Yields Must Follow," was one of the best articles on Seeking Alpha in February, in my opinion. Please click on the link above to read it, if you have not already.
 
In the article, Mr. Balan included a number of charts and graphs that explained why investors should think about inflation, not deflation going forward. I have included three of these charts as follows:
 
 
 
 
 
 
The headline of Robert's last chart captures the mood perfectly, saying that, "All classic, fundamental drivers of Core Inflation suggest acceleration to year-end 2016." Within his article, Robert wrote that, "That may set up for the Core CPI a 'perfect storm' of several combined factors which will make it soar in a degree that nobody has expected."
 
To summarize, perhaps the Fed will be forced to raise short-term interest rates more than the market anticipates right now in 2016, and perhaps the era of deflationary concerns is giving way to inflationary concerns.
 
Winners & Losers
 
U.S. stocks and bonds were clear winners over the past five years, where disinflationary and deflationary pressures reigned, while emerging market equities, commodities, and commodity stocks were distinct losers.
 
This is clearly illustrated in the chart below, that depicts the respective performances of the S&P 500 Index, as measured by the SPDR S&P 500 ETF (NYSEARCA:SPY), which increased 70%, the iShares 20+ Year Treasury Bond Fund ETF (NYSEARCA:TLT), which advanced 62%, the iShares MSCI Emerging Markets ETF (NYSEARCA:EEM), which declined 21%, the SPDR S&P Metals & Mining Index ETF (NYSEARCA:XME), which declined 69%, and the United States Oil Fund (NYSEARCA:USO), which lost 76% of its value.
 
From the chart above, "winning" and "losing" trends have been unambiguously defined, and investors and speculators from sophisticated hedge funds to plain vanilla retail day traders, have all been participating in these one-way trades.
 
A Turning Point - Stocks Suggest Inflation
 
As 2016 has unfolded, a startling reversal of fortune has taken place in out-of-favor stocks and industries. This is best exemplified by the downtrodden XME, which had declined 69% over the past five years, but has now risen 30% year to date (YTD), while the SPY has declined 2% in 2016.
 
 
 
The top ten holdings of the XME have risen dramatically this year. AK Steel (NYSE:AKS), the largest holding, has risen 85% YTD. U.S. Steel (NYSE:X), the second largest holding has risen 81%. Newmont Mining (NYSE:NEM) is up 52%, CONSOL Energy (NYSE:CNX) is up 41%, and Cliffs Natural Resources (NYSE:CLF) is up 57% in 2016, thus far. The sixth largest holding, Hecla Mining (NYSE:HL) is up 42%, the same as Freeport-McMoRan (NYSE:FCX), while Coeur Mining (NYSE:CDE) has returned an eye popping 97% YTD. Closing out the top ten holdings, Royal Gold (NASDAQ:RGLD) has risen 38%, and Steel Dynamics (NASDAQ:STLD), one of the best performing material stocks the last several years, has appreciated a relatively pedestrian 18% in 2016.
 
A Front Row Seat With "The Contrarian."
 
Through a premium research service on Seeking Alpha, "The Contrarian," that I launched in December of 2015, I have been chronicling the changing investment landscape, pontificating about portfolio strategy, and generally trying to take advantage of what I feel is another once in a generation inflection point in the capital markets.

There are a series of portfolios within "The Contrarian" that have been designed to benefit from a reversal of the investment trends that have prevailed over the past five years. Recently, I profiled the "Bet The Farm" Portfolio, the most aggressive of the portfolios, and the thought process behind its strategy. The "Bet The Farm" Portfolio is an options based portfolio, and some investors may be uncomfortable dealing with the unique risks and rewards that participating in an options portfolio entails.
 
There is another, primarily stock based portfolio in "The Contrarian," with the moniker of "Best Ideas" Portfolio. I have copied and pasted the 3/7/2016 update below to document the reversal we have seen in out-of-favor stocks.
 
 
 
Last week, the "Best Ideas" Portfolio surged higher, advancing 28%, as the three intertwined, crowded trades, including long the U.S. Dollar, short emerging markets, and short commodity stocks, began to unwind.
 
Conclusion - Prepare For Inflation
 
After a historic bull market over the past seven years, where both stock and bond prices rose unremittingly in a disinflationary environment, the stage has been reset without most investors noticing. Inflation, not deflation, is the primary risk to investors, at this juncture. Meanwhile, most market participants are still looking in their rear view mirrors at the risks behind them (deflation), instead of looking forward at the challenges staring them in the face (inflation).
 
With stock and bond prices at record highs, and their corresponding valuations in nosebleed territory, especially if interest rates would rise, negative "real" returns, or flat returns at best, are now anticipated for the next seven years. This is illustrated with the table I have put together using data from GMO.
 
 
As Jon Snow famously opines in HBO's hit show, Game Of Thrones, "Winter Is Coming," and no one seems to care because they are busy fighting their own battles. In the investment markets, "Inflation Is Coming," so focus on how rising inflation could impact your portfolios.
 
The change in trend has just started, so it is not too late to reconsider some out-of-favor assets, and asset clases.


Can Trump Start a Trade War?

From his first moment in office, he can take the world economy on a wild ride.

By Holman W. Jenkins, Jr.

Donald Trump campaigns in Cadillac, Mich., March 4.

Donald Trump campaigns in Cadillac, Mich., March 4. Photo: Jim Young/Reuters
 

Donald Trump is a businessman who gets things done, he keeps telling us. His prowess as a negotiator is central to his pitch for granting him the powers of the presidency to “make America great again.”

 
Not that he actually reminds us of any business great we’ve heard of— Steve Jobs, Bill Gates, Jack Welch or Indra Nooyi, say. Nor does he attract endorsements from any. His latest claim to fame, in fact, was a TV show in which he acted out a lowbrow parody of a business titan.
 
Countless have been the incoming emails suggesting that any doubts voiced about President Trump are but the wailing of a deranged and impotent “establishment.” Countable—in fact, the number is zero—have been those laying out an actual case for a Trump presidency.
 
As the polls keep telling us, Trump voters are Reagan Democrats—that is, not conservatives but people who landed in the Republican Party because they were tired of being looked down on by liberals.
 
President Obama’s most immortal phrase may turn out to be one he didn’t mean us to hear, accusing these voters of clinging to guns and religion. “What’s the matter with Kansas?”
 
Democratic gurus once asked, referring to the alleged blindness of the white working class to their own economic interests. In Donald Trump these voters have found a champion. His lip service to their social values may be perfunctory, but he gives full voice to their distrust of foreigners, minorities and the panoply of protected identity groups that Democrats worship. He also serves up the complete menu of protectionism-plus-welfare for the traditional working class that Democratic Party populists of the “Kansas” school once urged on their own party.
 
Which brings us to an increasingly urgent question. What would President Trump do in office?
 
He may be the narcissist his critics say, but he would arrive in the White House looking for something to do consistent with his promises and his supporters’ expectations, and with his own penchant for action.
 
His wall with Mexico may or may not be an intentionally symbolic figment of his imagination, but is not immediately actionable. Whereas, contrary to what you may have read elsewhere, President Trump would have considerable power to provoke trade wars to create an instant opportunity for his negotiating acumen.
 
As the University of Houston’s Brandon Rottinghaus and Wesleyan’s Elvin Lim point out in a highly relevant 2009 paper, the Constitution may reserve for Congress the power to regulate international trade, but presidents increasingly have claimed “delegated unilateral powers” to issue proclamations under the 1974 Trade Act.
 
That law is aimed at expanding trade and lowering barriers, but presidents have used it to justify trade-restricting actions by invoking unrelated laws instructing the executive to pursue some definition of the national interest.
 
Though such proclamations can be overturned by Congress, they never are. And President Trump would find no shortage of recent statutes—having to do with terrorism, pollution, cybersecurity, consumer safety, labor rights, etc.—that he could plausibly cite as an excuse for unilateral action against trade partners.
 
What’s more, he would invoke an impeccable precedent, none other than Ronald Reagan, who, within weeks of taking office in 1981, imposed sweeping “voluntary” restraints on Japanese cars that amounted to price fixing for Detroit’s benefit.
 
Reagan further “negotiated” unilateral restraints on memory chips, forklifts, motorcycles, color TVs, machine tools, textiles, steel, Canadian lumber and even mushrooms—any one of which, if done today, would likely hit our more interdependent and currently fragile global economy like a bombshell.
 
Reagan never campaigned as a protectionist. He did not argue that America’s problems were caused by other countries. Privately, his team excused his behavior as necessary to defuse protectionist rage in Congress while waiting for tax cuts and deregulation to waken America’s animal spirits during a disastrous recession. And Reagan made sure his “voluntary” restraints were palatable to the Japanese, who, in return for going along, were rewarded with a share of the price-fixing profits at the expense of American consumers.
 
Mr. Trump would be launching his trade war in a very different world, and as a solution to America’s ills, so we can start “winning again.” Since Reagan’s day, the U.S. economy has grown 2.5-fold, but trade has grown eightfold. International capital flows, once a fraction of global GDP, now are a multiple of global GDP. Plus, today’s economies are bogged down with debt. Markets would likely respond to Trump economic war in chaotic ways Reagan didn’t have to worry about (until he did, with the 1987 crash).
 
But here’s the important point: Anybody who believes that a President Trump would land in office bound by checks and balances, unable to do much, is kidding himself. He would have all the powers he needs to take the U.S. and world economy on a wild ride from the moment he sets foot in the Oval Office.


Why China Will Find It Hard to Exercise Leverage Over the ASEAN Región
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china-asean-1


John Lee is an expert on China’s political economy, Southeast Asian foreign policy and security, and U.S.-China relations. As a scholar at the Hudson Institute in Washington, he advises the Japanese and U.S. governments on strategic and economic issues. Lee is the author of Will China Fail?

For more than a decade, Lee has questioned the viability of China’s so-called market socialism model, arguing that without significant political reform, the country cannot sustain its economic and peaceful rise. He has predicted that its flawed and dysfunctional system will unravel at some stage, and this will have consequences for the world and especially its ASEAN neighbors, which have become dependent on its market and largesse.

Lee spoke with Knowledge@Wharton about China’s impact on its Southeast Asian neighbors. The following is an edited version of the interview.

Knowledge@Wharton: Is China going through the collapse that has been long predicted by experts like yourself?

John Lee: It depends on what you mean by collapse. If you’re talking about an American-style Lehmann Brothers collapse, that won’t happen because China still has adequate control of its financial system [and] guaranteed liquidity in the system. It’s still a pretty closed banking system so all those factors mean it’s got a resilience that a Western financial system doesn’t have.

If you’re talking about a Japanese-style stagnation, a structural tapering down, then I very strongly believe that is what China is going through now. The reason why I say that is, as we all know, the problem with the Chinese economy is too much debt [and] over-capacity. The cost of managing debt, using more and more natural resources to ensure that defaults don’t occur, is precisely what happened in Japan. We are seeing very clear signs of that occurring in China now.

Knowledge@Wharton: And what are the consequences for some of China’s nearest neighbors, like Japan, South Korea and ASEAN?

Lee: China will be more desperate to find new ways to generate growth. One obvious way is through export, which has become less important to China over the last five years or so. But as the domestic economy slows … China will implement policies that will aid its exporters. This will range from currency depreciation policies, increase [in] taxes and better subsidies for local producers for exporting. You’ll probably find that China will increase aspects of its domestic consumption market, to reserve these for [its] domestic firms. So I think we’re moving towards … a mercantile mind set for the Chinese, as they become more worried about trying to generate growth.

Knowledge@Wharton: How will that play out in details with, say, Cambodia, which has in recent times developed a deeper relationship, economically and politically, with China?

Lee: One way that it may play out is [in the area where] China has used its development aid to seduce a lot of these governments. When you look at where they get their money from — they get it from their foreign exchange reserves — we’re now seeing that China is using tens of billions of its foreign reserves to maintain stability in its currency. One immediate consequence is that it will [be] harder and harder for the Chinese to throw money at foreign governments in an attempt to achieve political objectives. There are also more subtle ways that may affect the capacity of China to exercise leverage.

China has always proffered the argument that its economic growth and growing domestic market will be the major source of opportunities for its neighbors, including Indochina, [but] as the Chinese economy slows, the narrative that China could use its domestic market as a carrot for other countries becomes less persuasive. China will still be [an] important source for every country, but it may not be as dominant a market as many people believed 15 years ago.

Knowledge@Wharton: But China would be hard pressed to let go some of those leverages it has gained?

Lee: China has found it relatively easy to exercise leverage through financial means for developing countries like Cambodia [and] Laos. But it has found it to be harder when it comes to more developed or larger countries like Indonesia, Singapore, even Malaysia … In their rhetoric, [these countries] have taken a very soft view on China, but if you look at what they have been doing behind the scenes, they have actually moved a lot closer to America.

China’s capacity to use economics to exercise leverage in more developed and successful societies in Southeast Asia has always been limited. And if you look at the numbers, what these countries need are two things. The first is capital, and the major source of capital into most of Southeast Asia outside of Indochina countries has been European countries, Japan, South Korea and America, not China — China is not even [in] the top five in any of these countries.

The second thing these countries need [is] export markets, and the dominant export markets are still America [and] Europe. Trade with China is largely processed trade, or intermediate trade, so the bottom line is that China still lacks a lot of the formal or actual economic levers to change the political and strategic trajectory of these countries. In the recent past, China has used the prospect of its future economic power for current leverage, but that becomes more difficult as China slows down.

Knowledge@Wharton: What about Thailand? It has become more reliant on China in recent years. Its tourism industry, for instance, is geared towards the Chinese market.

Lee: Thailand is a rare case in Southeast Asia. It is different than the other maritime countries like Singapore, Malaysia and Indonesia. First, China has never been the big bad guy for [Thailand] historically, unlike countries like Vietnam or even Singapore in more recent times.

Secondly, because of [recent] political developments in Thailand, its relationship with the West is strained, so China has taken opportunities to move closer to Thailand. The third thing is, Thailand is less interested in what happens in the maritime region in Southeast Asia, compared to Malaysia, Indonesia, Singapore, Vietnam. Thailand isn’t as worried about China’s behavior in the South China Sea as these other countries.

So when you look at all these factors, it is true that Thailand is much more willing to move closer to China, not just economically but even politically. And I would also note that there is significant concern within the United States about Thailand’s trajectory towards China. There are active debates, not so much openly in government, but in the think-tank community in America, as to whether the alliance with Thailand can be sustained over the next decade or so because of Thailand’s move towards China.

Knowledge@Wharton: At the same time, China’s play in the South China Sea has driven countries like Vietnam closer to the U.S. Do you think China has overplayed its hand in the South China Sea dispute?

Lee: I think China has overreached. If you go back a few years when China was trying to convince the region of its peaceful rise, when China was undertaking its rapid military build-up, it justified it by saying that it was about Taiwan — preventing Taiwanese independence.

Now, given that the South China Sea is, in its own words, a core or essential interest, no one believes any more that China’s military build-up is about Taiwan’s straits.

So if you look at what China has done in the last five years, [they] have systematically exacerbated things in the East China Sea; the Taiwan Strait has never been good; and [now there is tension] in the South China Sea. When you look at the end result, whereas countries were before trying to remain neutral between the Chinese and the Americans, now, almost every major country is either hedging or balancing with the Americans. Japan has gone further with the Americans. Singapore, behind the scenes, [and] Malaysia [have] gone further with the Americans. Indonesia is hedging against China.

Vietnam is looking towards America once again. And Australia has gone closer to America.

Now this doesn’t look like a great strategy to me … so I do think they have overreached.

Knowledge@Wharton: So much of that power play has been funded by years of double-digit growth, what happens now during the current downturn?

Lee: I think it’s under-appreciated that there will be a huge impact. If you look at the last 15 years up to 2013, China’s fiscal revenue has gone up about 20% a year on average. If you look at 2014, it grew about 7% to 8%. If you look at 2015, it’s about 6% to 7%. So you’ve gone from an average of 20% to 6% to 8% growth. Now, the PLA’s [People’s Liberation Army] budget has grown about 10% to 15% each year during that period, so it’s pretty obvious that it will be harder and harder for China to sustain those sorts of increases in military spending, particularly when you consider that more and more of the fiscal budget is being used to stimulate the economy or bail out either banks or indebted state-owned enterprises or local government entities. You’re [going] to get more pressure on the public purse.

Knowledge@Wharton: What about funding for its AIIB [Asian Infrastructure Investment Bank]?

Lee: The funding for China’s infrastructure bank was to come from its foreign exchange reserves. Now it still has about $3.2 trillion, but that’s gone down by something like $800 billion over the last year or so, largely to support its currency. China still has a war chest, but it can’t allocate too much towards speculative projects, compared to a few years ago. Second, if you look at China’s rationale behind the Asian infrastructure bank, it’s essentially a way of trying to export excess capacity, that is, [to] find markets for its infrastructure companies because the Chinese domestic market has become too saturated.

The problem for China now is that a lot of countries have suspicions about the political motivations of China in allowing billions of dollars of capital into their countries, so countries will still want some of the money China is offering to build infrastructure, but I think they will be more wary about the consequences.

So the bottom line, to answer your question, is that [the] infrastructure bank will still go ahead.

China will still fund some projects, but I don’t think it will be a game-changer in the region.

Actually, if we look at the numbers, China’s infrastructure bank — [the amount] being talked about is $100 billion.

Compared [with] the Asian Development Bank, which has a little bit more than that and the World Bank, which has about four times more than that, when you look at the infrastructure needs of the region — which needs a trillion — [the AIIB is] a small drop in the ocean. It’s significant, but it’s not a game-changer.

Knowledge@Wharton: How long do you think the Chinese currency will continue to fall?

Lee: The Chinese currency is falling at the moment because … of the capital flight out of the country. Investors and firms are losing confidence, at least [in] the short-, medium-term future of the Chinese economy. It’s not because China has been trying to depreciate its currency to help exporters, it’s actually more because of market forces. The problem for China is that [if] their currency falls too much, then imports become too expensive into China, which increases the cost of living … It has all sorts of negative consequences for the local economy, so the Chinese government has been using its foreign exchange reserves to buy Chinese currency to ensure that it’s not too volatile. That’s where we are at the moment.

In terms of a regional impact, other countries in the region are quite export-dependent. This ranges from advanced economies like Japan and South Korea to middle-income countries like Thailand and Malaysia — and these countries have suffered in terms of their share of exports, particularly to advanced economies. So it will be irresistible for those countries to depreciate their own currencies, and you’ve seen Japan doing that, for example.

What we may be seeing now is a currency war emerging in Asia. If that happens, that’s particularly bad for the developing economies, because if they depreciate their currencies, investors won’t invest in their countries because their currencies are worth less. And so these countries are stuck between China and exports … and trying to encourage foreign direct investment into their countries, which they desperately need. My summary is that the advanced economies like Japan and Singapore are better able to tolerate a currency war than the developing and undeveloped countries.


Trade in a Time of Protectionism

Ranil Wickremesinghe
 asian merchant 

COLOMBO – As China’s economy slows and growth in the developed world remains anemic, governments across Asia are working to keep their economies on an upward trajectory. In Sri Lanka, where I am Prime Minister, the challenge is to find a way to accelerate our already steady economic growth.
 
One thing is clear: We cannot expect the rest of the world to welcome our economic ambitions the way it once opened its arms to China’s rapid rise as an economic power or – in earlier decades – cheered on the growth of Japan and the so-called Asian Tigers, including South Korea.
 
Today, we Asians are witnessing, on an almost daily basis, fierce political assaults on the tools and policies that have helped lift hundreds of millions of our citizens out of poverty. Indeed, this year, free trade appears to be the scapegoat of choice among the world’s assorted populists and demagogues.
 
In the United States’ presidential election campaign, for example, the leading candidates in both the Republican and Democratic primaries have questioned the wisdom of seeking greater openness in world trade. In the United Kingdom, euroskeptics campaigning for the country to leave the European Union denigrate the benefits of the single European market. Elsewhere in Europe, populists are demanding that the drawbridges of trade be raised.
 
Open trade is under attack even in parts of Asia. Japanese Prime Minister Shinzo Abe had to drag some of his country’s special-interest groups kicking and screaming into the Trans-Pacific Partnership. Similarly, Indian Prime Minister Narendra Modi has been unable to convince state governors to lower trade barriers within the country. And in Sri Lanka, the “economic and technology agreement” that my government recently planned to sign with India, in order to bring about greater economic integration, has come under ferocious political attack.
 
For the most part, however, Asia’s political leaders retain a very positive view of the benefits of open trade. After all, much of the past four decades of robust growth can be attributed to the fact that world markets were receptive to Asian goods. All we needed to do to get our economies growing, it seemed, was to identify our comparative advantage, produce quality goods at competitive prices, and then export as much as we could.
 
For decades, this model worked extraordinarily well, and China, Japan, South Korea, and the countries of Southeast Asia benefited greatly from it. Even today, with world trade in the doldrums, regional trade remains a key component of these countries’ growth strategies. In South Asia, however, we have been much slower to take advantage of the opportunities that can arise from more open trade – with regrettable consequences: The region is home to 44% of the world’s poorest people.
 
We have an obligation to try to use trade to lift our people out of poverty. But with free trade rapidly becoming a global bugbear, the window for generating growth by tapping into world markets appears to be closing quickly. If trade is to become a key driver of growth in Sri Lanka or elsewhere in the region, we will most likely have to generate it ourselves – by transforming South Asia from one of the world’s least economically integrated regions into one of its most integrated.
 
Today, intra-regional trade accounts for just 5% of South Asia’s total trade, compared to 25% for the Association of Southeast Asian Nations. This vast untapped potential presents the region with an opportunity for growth that does not rely on the strength of the world economy. Last year, the World Bank estimated that annual trade between India and Pakistan could jump from $1 billion today to $10 billion – if tariffs and other barriers were slashed to levels recommended by the World Trade Organization.
 
Tariffs and other needless restrictions hobble trade among all South Asian countries. These obstacles were supposed to be swept away with the establishment of the South Asian Association for Regional Cooperation, the largest of all the world’s regional trading blocs, with close to two billion people. But SAARC’s reliance on bilateral negotiations has slowed the process to a crawl, keeping the region much poorer than it needs to be. If SAARC is to succeed, a new multilateral mechanism for cooperation will be needed.
 
As climate change takes its toll, the stakes will only get higher. Our still largely agrarian countries, with much of their territory in low-lying coastal regions, are dangerously exposed to rising sea levels and violent weather. Receding Himalayan glaciers will disrupt the lives – and livelihoods – of some 600 million people in Pakistan, Nepal, and northern India.
 
The political obstacles to effective action will be stiff. Indeed, there is political opposition to greater regional economic integration in every SAARC country. But the scale of the challenges facing the region should impel all of SAARC’s members toward greater cooperation.
 
It is time for SAARC’s member governments to rise to the challenge. By working together, we can lay the foundations of a regional economy as dynamic as that of our neighbors to the east.
 
 


Will Gold Rally Stall In April?

by: Tom Lydon




- The SPDR Gold Trust ETF is up 17.6% year-to-date.

- Gold’s rally has been accompanied by doubts, as is often the case when the yellow metal soars.

- Turning to the chart, we see the rally in April Gold starting to stall, reports OptionsExpress.

 
Up 17.6% year-to-date and easily ranking as this year's top asset-gathering ETF, the SPDR Gold Trust ETF (NYSEARCA:GLD), the world's largest physically-backed gold exchange traded fund, is leaving little about just how hot gold and gold ETFs are.
 
However, gold's rally has been accompanied by doubts, as is often the case when the yellow metal soars.
 
A potential problem for gold this year is that some market observers believe the Fed charting a course for more rate hikes, though at a measured pace, in 2016 sets the stage for further upside in the U.S. dollar.
 
Of course, that would be punishing for gold and other commodities, which are denominated in dollars. Negative interest rates throughout the developed world are also seen as a catalyst for gold upside.
 
However, that issue was quelled a bit last week when the Fed, as expected, did not raise interest rates. More importantly, it looks as though the central bank will only raise rates, at the most, twice this year. Heading into 2016, many market observers expected four rate hikes, which could have been damaging to gold's potential upside.
 
"Conversely, the Fed announcement came at an opportune time for Gold traders. It seems as though some traders were cooling a bit on Gold prices. The metal's value as a defensive instrument was high to start the year. Lately, the defensive value has been eroding due to better economic outlooks in Europe and the U.S. The economic optimism is not strong enough to drive inflation hedging, and global growth potential seems to have a low ceiling in 2016. It is an awkward spot for Gold," says OptionsExpress.
 
Bullion's bounce has not convinced all market observers that a sustained rally is in store. Although precious metals ETFs have recently displayed some strength, gold is still in a lengthy bear market, giving some traders pause about how much more near-term upside the yellow metal has in store.
However, the sell gold now thesis ignores the facts that the yellow metal is well off its highs set several years and that gold entered 2016 locked in a three-year long bear market. Less than three months of rallying this year does not erase those facts.
 
"Turning to the chart, we see the rally in April Gold starting to stall. The recent closes below the 20-day moving average suggest that a near-term high may be in place. This is supported by the failure of the April contract to retest recent highs," adds OptionsExpress.
 
SPDR Gold Shares


The Central Banks Are Leading The World Towards A Disaster

Chris Vermuelen
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Disaster


The ECB President, Mario Draghi, forced interest rates even further into negative territory, last Friday, March 11th, 2016. Nations like Sweden, Switzerland, Denmark and Japan have also initiated negative interest rates. The FED Chairwoman Dr. Yellen, confirmed having considered it, as well, at an earlier time and kept her options open to implement it in the future, if the situation warrants it.
 
Lower interest rates were intended to facilitate ‘easy credit’ to corporations, which, in turn, was supposed to create new jobs and increase wages. This money was used by the corporations to repurchase their stocks and implement dividends; thereby, leading to an ‘artificial’ massive stock market rally.
 
These funds were not allocated properly. They were to provide job security and extra disposable income into the hands of working people, hence, consumption would then increase, resulting in a lower growth environment in the economy. However, since the ‘last financial crisis’, the new jobs that were created, however, lacked in wage increases and are languishing at their slowest pace, since 1997.
 
chart 1


Despite several rounds of money printing and a zero interest rate policy, the Central Banks have not been able to achieve their objective. Hence, in desperation, they have resorted to negative interest rates, whereas, one will have to pay the banks an interest rate fee just to maintain cash in one’s account. Why would any sane person deposit money into the bank, rather than stuffing in their mattresses or in the wall. With no confidence in the Central Banks, chances are that people will want to save more for a rainy day, rather than spend, as shown in the chart below. People are saving more these days as compared to that of a decade earlier.

 
Chart 2


With the Central Banks resorting to negative interest rates and pushing it yet further into negative territory, it is possible that we will witness a run on the banks and they will close down indefinitely.
 
Currently, the banks have not yet passed on the negative rates to the retail customers, as their margins will take a hit. In order to save their reputation, chances are that they will lend recklessly, similar to what occurred in 2006 and the entire world will end up in a much larger disaster causing a crisis which cannot be controlled. Hence, the Central Banks are now out of ‘ammo’ and are the cause of this reoccurring crisis.

 
Some shocking data, as reported by The Telegraph;
  1. Currently $8 trillion of sovereign debt is trading at a negative yield.
  2. Interest rates have been cut 637 times by the Central Banks, globally, since March of 2008.
  3. The Central Banks have printed a staggering $12.3 trillion of money, since March of 2008.
  4. What have they achieved? Since ‘The Great Recession’, the nominal GDP, of the world, has grown by a paltry 11 percent, according to Bank of America Merrill Lynch.
With all of the resources and the expertise which are available, the only actions that Central Bankers performed, was to come forward on the day of the monetary policy announcement and declare a rate cut and a certain amount of money printing. If this is the only solution they can find to do a better job everyone is in trouble. It seems as though any fifth grader is capable of performing these responsibilities and repeating the same process. After all, the world has survived for thousands of years, without the Central Banks and probably prospered better during the ‘Gold Standard’, at which time, the Central Banks had limited scope to alter monetary policies, as they are now doing.
 
How can you save yourself and your family from this madness?
 
Banks will charge you for holding on to your own cash, hence, there is no point in parking your money in such funds. The stock markets are in a ‘Asset Bubble’ and a “Earnings Bubble’ just waiting to’ burst’, I witnessed a precursor to this situation in the first two months of this year.

Currency wars are escalating in the world and are moving towards ‘economic self-destruction’.
 
Gold is the only asset which will increase value:
 
Gold is the only asset class, which will maintain its value during times of ‘financial crisis’. It has done so previously in the past and I observed its performance during the beginning of the year, in which its status affirms it as the preferred safe haven. There will be times during this ‘crisis’ when different assets classes will be in focus. I will continue to guide you as to the best profit making assets, during these periods of time. If you are holding any stocks, this current rally is the last chance to liquidate your holdings; gold will give one an excellent buying opportunity within a few weeks of time and should be used to purchase this for the long-term period.
 
Chris Seebert the President and CEO Gold Gate Capital where they specialize in helping clients roll over there  IRAs and 401k into Physical Gold that they can store at their house or in a depository, to help protect their assets from the next crash said this to me.
 
For Institutional portfolios a typical classic asset mix achieves a higher long term return with a percentage gold component depending on base currency (based on research going back to 1987). With likely further acceleration of money printing by the largest economies in the world, leading to further destruction of paper money, investors will become even more aware of the necessity to owning real money. Gold has been money for 5,000 years and maintained its purchasing power throughout history because it cannot be printed.”
 
Mr. Seebert also agrees with my forecast of what is to unfold and his free book called "The Looming Financial Crisis" that focuses on how to properly invest in metals and how to do it properly. He also mentioned their key clients who can benefit the most are those between the ages of 65-85.
 
Unfortunately, I foresee very difficult economic times ahead for all. Therefore, it is best to be prepared and take proactive measures, in advance, so as to avoid the pain rather than regret it later!
 
Follow my lead if you want to safely navigate the financial markets over the next couple year to protect and profit from the coming the bursting of some asset classes and rise of bull markets emerging in others.


Emerging Markets: The Fear, The Facts And The Future

by: Neuberger Berman


Following years of net inflows, portfolio capital began to look for a way out of emerging markets in 2015. Investors are concerned about China's difficult economic transition, slowing growth, low productivity, rising debt, sour political and geopolitical headlines, weak consumer demand, and the prospect of global interest rate normalization. Many are questioning the strategic role that emerging markets play in their portfolios and even those staying for the long haul recognize that these economies face an important crossroads. 
 .
 
 
In this paper, we consider data on financial stability and growth and consumption to describe how the emerging markets got to this crossroads, which road they need to take to reach the next stage of development - and what it all means for investors.
 
Not so long ago, in the teeth of the 2007-09 financial crisis, emerging markets were the saviours of a stricken world. After growing at four-times the pace of the highly-indebted developed world since the mid-1990s, they had the fiscal buffers to forge their own way, building their cities and realising the promise of vast populations poised on the threshold of the middle class.
 
Less than five years later, growth has slowed dramatically. A rout in emerging market currencies is coinciding with a tightening of financial conditions, reflected in stock market selloffs and widening credit spreads - all against a backdrop of rising political and geopolitical risk. A decade of declining government leverage was arrested in 2007 and, according to the Institute of International Finance (IIF), net capital flows to emerging markets turned negative in 2015 for the first time in almost 30 years.
 
Sceptical voices have long argued that the emerging world owed its "catch-up growth" to a mix of China's expansion and low global interest rates, which led to an unsustainable run-up in commodity prices and a flood of capital. As those trends reverse, the resulting glut of often questionable investments lies exposed.

Moreover, while the end of the commodity supercycle is broadly accepted as a consequence of the transition to more consumption-led growth, recent analyses of income distribution suggest that the emerging world's middle class may not be growing fast enough to smooth that transition.
 
With this background in mind, we have looked at two sets of data - on financial stability and productivity and consumption - to describe where emerging markets are today and where they need to go next. We believe the data suggest three things for investors to remember amid the gloomy headlines.
 
The first is to keep things in perspective. Yes, measures of financial stability have deteriorated since 2007, but they remain substantially better than in the late-1990s, and better than the developed world's today. Similarly, while we may not have seen the middle-class expansion that we hoped for 10-15 years ago, more than 600 million people have lifted themselves out of poverty this century, crossing significant income and consumption thresholds.
 
The second is that one metric rarely tells the whole story of a country or region. News headlines like to zero-in-on current accounts one day, fiscal balances or corporate leverage the next. But what do current account balances tell us without reference to reserves? How does the flow of debt relate to the stock? Is it significant that the places with higher debt levels are often the ones with higher incomes and consumption?
 
Finally, emerging markets are far from homogeneous. Globalization has caused convergence between emerging and global financial markets, and we find substantial regional themes in our data. But they also reveal extreme differences between regions and countries. Investors should take note of these idiosyncrasies not only to maximise return, but also to allocate capital efficiently to facilitate the next phase of "catch-up" convergence with the developed world.
 
Debt Ratios in the Emerging World Remain Low, but Are Rising
 
Gross Government Debt as a Percentage of GDP
Source: IMF. Estimates start after 2014. 
 


US$ Strength is a Manifestation of US$ Shortage

By: Gordon Long


FRA Co-Founder Gordon T.Long and Jeffrey P. Snider, Head of Global Investment Research at Alhambra Investment Partners discuss a broad array of Global Macro subjects in this 48 minute video discussion with supporting slides.

As Head of Global Investment Research for Alhambra Investment Partners, Jeff spearheads the investment research efforts while providing close contact to Alhambra's client base. Jeff joined Atlantic Capital Management, Inc., in Buffalo, NY, as an intern while completing studies at Canisius College. After graduating in 1996 with a Bachelor's degree in Finance, Jeff took over the operations of that firm while adding to the portfolio management and stock research process.

In 2000, Jeff moved to West Palm Beach to join Tom Nolan with Atlantic Capital Management of Florida, Inc. During the early part of the 2000's he began to develop the research capability that ACM is known for. As part of the portfolio management team, Jeff was an integral part in growing ACM and building the comprehensive research/management services, and then turning that investment research into outstanding investment performance. As part of that research effort, Jeff authored and published numerous in-depth investment reports that ran contrary to established opinion. In the nearly year and a half run-up to the panic in 2008, Jeff analyzed and reported on the deteriorating state of the economy and markets. In early 2009, while conventional wisdom focused on near-perpetual gloom, his next series of reports provided insight into the formative ending process of the economic contraction and a comprehensive review of factors that were leading to the market's resurrection. In 2012, after the merger between ACM and Alhambra Investment Partners, Jeff came on board Alhambra as Head of Global Investment Research.

Jeff holds a FINRA Series 65 Investment Advisor License.


US TIC Report, Treasury Sales

US TIC 6-Month Cumulative Change Holdings of US $ Assets


TIC is a compilation done by the US Treasury based on their access to data on foreign accounts and holdings of Dollar accounts and securities, and estimates the foreign Dollar market. Over the last decade or so, it is clear that the Eurodollar market grew steadily at a rapid rate until about August 2007, at which point it pivots and comes back down. The TIC data shows the tendency of dollar markets to essentially be stable, usually addressed through selling Treasury.

However, the private dollar markets offshore are in disarray to the extent that central banks around the world are forced to fill the dollar deficiency with their own holdings. Of especial note is China's reduction of their US Treasuries and foreign currency reserves, and OPEC countries incurring serious Current Account deficits in an attempt to maintain their pegs with the US dollar. In addition are the emerging markets who borrowed about $7-9T in USD, who now have difficulty paying back debts due to slowing trade and falling currencies.

This all leads to the US dollar strengthening, which is the manifestation of the dollar shortage.

In recent days, Japan using NIRP will further disrupt the dollar system.

"US Dollar Strength is a manifestation of a US Dollar Shortage!"

 Japan: QE failure and What NIRP Means


Japan Real GDP


Under QE, Japan obtained a burst of inflation around 2014. Instead of leading to sustained economic activity, household income and spending dropped about 7%, which was also not offset by growth in GDP and demand. The surge in expansion, due to cheaper money, increases supply which then demolishes pricing power. In addition to the reduced value of savings, large companies have also shifted production offshore, thus increasing the effect and emphasizing the failure of QE/QQE to stimulate the economy.

NIRP also carries with it the threat of failing like QE, along with numerous other particle effects that cannot be currently measured or predicted, mostly as this type of system has not existed for over a hundred years. This is an indicator of the lack of power central banks have over the economy, but can be put down to overemphasizing the value of monetary policy over fiscal policy in the developed world. The dollar system has been artificially expanded past any control by banks and monetary policy, globally, over the last decade. The only way to stop it is to focus on other fiscal factors that would allow economic potential to be realized again and to refrain from following Keynesian economics once it has been proven to be ineffective.
"Japan is a test case in almost clinical conditions for QE and QQE, and it failed on every count."

China: Collapsing Trade and Credit


China Industrial Production


China is both an impediment to growth and a casualty of the rest of the world, but recently more of a reflection of the global dollar economy as they are most sensitive to changes there.

The lack of growth over several years forces a fundamental shift toward a Keynesian response of fiscal and monetary stimulation that creates asset buffers at odds with overcapacity.

Meanwhile, China still lacks any real method for economic growth and is forced to react to outside influences while juggling the problem of overcapacity with the falling export industry.

This then leads to capital flight, which furthers the struggle to grow GDP.

China is clearly attempting to manage the Yuan by selling dollars to strengthen it, but will eventually falter like any pegged currency. Many currencies pegged to the US dollar, Eurodollar, and Petro dollar will likely collapse. Keynesian economists believed that 2007 was the beginning of a temporary deviation from sustainable global growth, but was in fact the structural revaluation of higher economics of the financial system. We are likely headed for a systemic reset and reorientation, which will be disruptive with significant risk but can be adapted to.
"I think we are headed for a systemic reset."


Retail: January Sales and Continuing Trend

Retail Sales


Retail sales have been near recession levels of low, indicating that consumers are under pressure, but inventories are still rising despite manufacturers cutting back. Retail slowing is a fixed trend starting from 2012, amplified in 2014-2015 with the disappearance of the manufacturing industry and loss of export goods. This is likely due to lack of real recovery that slowly eroded US consumers' ability to continuously expand their activity. The middle class has no savings, so thus the capitalist system that relies on savings to reinvest into productivity.

Over the last several years, companies have been spending on buybacks instead of investing in productive capacity. 1900 of the S&P companies spent more on buybacks and dividends than they were earning, thus creating more debt.
"Recession is a necessary process, like anything else. It's creative destruction."


Labor: Full Employment -- Not Really!

Accounting for all Labor


There is a major disconnect between major unemployment statistics and the rest of the economy, where even having a job is not necessarily enough to support the expected standard of living. There are low prospects for growth in the job market, and people sense that there is a need for a restructuring of the system. Job growth is mostly in low income occupations, which results in potential workers entering college with a loan but failing to actually enter the labour force.

The current economic state is similar to the suppressed state of the 1930's and 1940's, and once the systemic reset is allowed to occur, the economic potential released will be tremendous.

Recessions are necessary to allow risk to be properly priced, which in turn creates confidence in investment. The resulting reset should shift away from one centered around banks and the value of credit toward a capitalist system that prioritizes "money is money" over "money is credit".
"Monetary policy is designed for companies to borrow more; it's just that economists expected they'd borrow more for productive capacity rather than financial capacity."