"Whatever They Want" Coming Home to Roost
Doug Nolan
Let's begin with global. China's yuan (CNY) traded to 6.9644 to the dollar in early-Friday trading, almost matching the low (vs. dollar) from December 2016 (6.9649). CNY is basically trading at lows going back to 2008 - and has neared the key psychological 7.0 level. CNY rallied late in Friday trading to close the week at 6.9435. From Bloomberg (Tian Chen): "Three traders said at least one big Chinese bank sold the dollar, triggering stop-losses." Earlier, a PBOC governor "told a briefing that the central bank would continue taking measures to stabilize sentiment. We have dealt with short-sellers of the yuan a few years ago, and we are very familiar with each other. I think we both have vivid memories of the past."
The PBOC eventually won that 2016 skirmish with the CNY "shorts". In general, however, you don't want your central bank feeling compelled to do battle against the markets. It's no sign of strength. For "developing" central banks, in particular, it has too often in the past proved a perilous proposition. Threats and actions are taken, and a lot can ride on the market's response. In a brewing confrontation, the market will test the central bank. If the central bank's response appears ineffective, markets will instinctively pounce.
Often unobtrusively, the stakes can grow incredibly large. There's a dynamic that has been replayed in the past throughout the emerging markets. Bubbles are pierced and "hot money" heads for the exits. Central banks and government officials then work aggressively to bolster their faltering currencies. These efforts appear to stabilize the situation for a period of time, although the relative calm masks assertive market efforts to hedge against future currency devaluation in the derivatives markets.
If policymakers then lose control - market pressures prevail - those on the wrong side of (now outsized) derivative hedges are forced to aggressively sell/short the underlying currency. This type of self-reinforcing selling can too easily foment illiquidity, dislocation and currency collapse. As I highlighted last week, for a list of reasons such a scenario would have devastating consequences for China - and the world.
As I've noted in previous CBBs, the current global environment has some critical differences compared to China's last currency instability episode in early-2016. Global QE was ramped up to about a $2.0 TN annual pace back then, versus today's QE that will soon be only marginally positive. Buoyed by zero rates, sinking bond yields and rising equities prices, global speculative leverage was expanding - versus today's problematic contraction. China's Credit system and economy were significantly more robust in 2016. EM, in general, was still enveloped in powerful financial and economic expansion dynamics. Moreover, the global trade and geopolitical backdrops have deteriorated dramatically since 2016.
October 26 - Bloomberg: "Investors are turning up the temperature on Chinese policy makers, who were already feeling the heat. That may cause the government to resort to even tighter controls on money flowing in and out of the country, according to Citi economists. Net foreign exchange settlement by banks in China on behalf of their clients -- a proxy for capital flows -- was negative in September for a third straight month, according to… the State Administration of Foreign Exchange. At -110.3 billion yuan, purchase of foreign currencies was the most since December 2016. An escalating trade war with the U.S. has contributed to souring investor sentiment and put downward pressure on China's currency, which Friday came within striking distance of a 10-year low against the dollar. It's fallen 9% over the last six months. Measures taken by the People's Bank of China this month to support the economy as the outlook has darkened… haven't helped the exchange rate."
October 26 - Bloomberg (Alfred Liu and Benjamin Robertson): "China's finance ministry has warned the country's state-owned financial assets need further protection from mismanagement, following the release of new data on the size of their balance sheets. Total assets of state-owned financial enterprises amounted to 241 trillion yuan ($34.6 trillion) in 2017, according to a report published by China's Ministry of Finance… Their liabilities were 217.3 trillion yuan last year… 'While we are gradually upgrading the management of state financial assets, we have to be aware that there are still institutional and structural contradictions and problems,' said Liu Kun, China's finance minister… 'The mission of preventing massive risks remains tough.'"
A disorderly breakdown of the Chinese currency has the potential to be one of the most destabilizing developments for global finance and the world economy in decades. I am not confident that Chinese officials have the situation under control. At the same time, there is no doubt that Chinese finance and financial institutions have inflated to previously unimaginable dimensions. And it appears Beijing is increasingly cognizant of unfolding risks. This likely explains why officials appear less inclined than in the past to push through aggressive fiscal and monetary stimulus. A key aspect of the bullish global thesis (Chinese stimulus on demand) is due for reassessment.
The Shanghai Composite rallied 1.9% this week. It was difficult for global markets to sense anything more than fleeting relief, suspecting the "national team" was hard at work. Markets throughout Asia were under pressure. Hong Kong's Hang Seng index fell 3.3%. Major indices were down 6.0% in South Korea, 6.0% in Vietnam, 4.3% in Taiwan, 3.2% in Thailand, 2.8% in Malaysia, 2.8% in India and 1.2% in Philippines. Japan's Nikkei 225 index sank 6.0%, with the TOPIX Bank Index's 4.7% drop boosting y-t-d declines to 17.1%.
Asian bank weakness is a primary Systemic Contagion Link globally. Europe's STOXX 600 bank index fell 3.5% this week, increasing 2018 losses to 24.0%. Italian banks were down another 3.9% this week (down 28.2% y-t-d). Deutsche Bank dropped 11.4% this week (to an all-time low). Deutsche Bank (senior) credit-default swap (CDS) prices rose 11 bps this week to 156 bps, the high since early July. Many of the big global banks saw CDS prices rise this week to near one-year highs. Curiously, Goldman Sachs CDS rose seven this week to 79 bps, an almost 19-month high. The U.S. bank equities index (BKX) sank 5.0% this week, and the Broker/Dealers dropped 4.8%.
In a further indication of heightened global systemic risk, German bund yields sank 11 bps this week to 0.35%, the low since September 4th. With Italian yields declining only four bps (to 3.45%), the spread to bunds widened seven bps to 310 bps. Portuguese yields dropped 11 bps to 1.96%, and Spanish yields fell 17 bps to 1.57%. UK 10-year yields sank 19 bps to 1.38%, the low since August.
It certainly has all the appearance of bond markets beginning to discount ramification of the bursting of the global Bubble. WTI crude declined another $1.52 to $67.62, a two-month low.
The dollar index increased 0.7% to 96.412, near a 16-month high. The British pound declined 1.9%, the Norwegian krone 1.6%, the Swedish krona 1.6%, the New Zealand dollar 1.4%, the South African ran 1.3% and the euro 1.0%.
October 26 - Bloomberg (Jacob Bourne): "Inflation expectations are tumbling in the U.S. bond market, suggesting traders are worried that the Federal Reserve's monetary policy is becoming too tight -- potentially by a quarter-point -- amid the slide in equities. The five-year breakeven rate, which represents bond investors' view on the annual inflation rate through 2023, dropped Friday to 1.88%, the lowest since January."
The headline for the above article was "Inflation Bets Are Tanking, Showing Bond Traders See a Tight Fed." Ten-year Treasury yields did drop 12 bps this week to 3.08%. But the overarching issue is escalating systemic risk associated with a faltering global Bubble - and not a "tight Fed." The Fed would prefer to remain "data dependent." The early read on Q3 GDP came in at 3.5%, with Personal Consumption growing at a 4.0% rate (strongest since Q4 '14). A number of Fed officials this week downplayed U.S. stock market weakness.
I'm not at all sure Fed officials appreciate their predicament. The global Bubble is bursting, yet the U.S. economy at this point maintains a decent head of steam. Bond markets are quickly adjusting to the changing global backdrop. Treasuries have had more of a domestic focus but that has begun to shift. And having shown resilience until recently, junk bonds (HYG) have now declined 1.1% over the past two weeks. With yields jumping this week to a two-year high, junk bond funds suffered net outflows of $2.364 billion.
October 26 - Bloomberg (Adam Tempkin): "One of Wall Street's go-to shelters in times of trouble is showing cracks as broad concerns pile up. Bouts of selling have hit bonds backed by mortgages, auto loans and credit card payments -- typically havens during periods of stress -- amid the carnage in financial markets this month. Certain sectors of so-called securitized loans are 'experiencing some headwinds,' said Neil Aggarwal, senior portfolio manager and head of trading at Semper Capital. 'A combination of rates, earnings, and global concerns are having an ongoing impact.' The debt class usually does better than corporate bonds during market turmoil because the securities are linked to consumer payments, rather than company performance, and typically have cash cushions to absorb initial losses. But recent weakness highlights how the sector may be unable to shrug off the chaos enveloping other assets."
Financial conditions have now begun to meaningfully tighten at the "Core." I suspect de-risking/de-leveraging dynamics have begun to unfold throughout U.S. corporate Credit. There are also indications of tightening liquidity conditions in securitized Credit. These are important developments.
October 26 - Bloomberg (Suzy Waite and Nishant Kumar): "Hedge funds using computer-driven models to follow big market trends have been whiplashed as volatility has spiked, among the biggest casualties of a stock rout that has accelerated worldwide. Funds known as commodity trading advisers, or CTAs, have traditionally shielded investors during market selloffs such as the global financial crisis, especially when mathematical models show a clear or pronounced trend. But this time, they've been unable to navigate sharp reversals in asset prices… 'It's a bloodbath out there across almost every strategy with very few exceptions,' said Vaqar Zuberi, head of hedge funds at Mirabaud Asset Management… 'CTAs have been caught by a double-whammy with rising rates and equities plummeting,' said Zuberi. 'There's only one exit and everyone is trying to exit now because the models are telling them to do so.' Computer-driven hedge funds were already headed for their worst year ever before this month's volatility…"
As an industry, hedge funds were already struggling for performance prior to the recent bout of "Risk Off." Many funds have seen 2018 gains quickly morph into losses. There is now the distinct risk of escalating losses into year-end spurring significant industry outflows. This dynamic elevates the odds of a destabilizing de-risking/deleveraging dynamic.
Treasuries provided somewhat of a hedge against equities losses this week. Yet, overall, markets have been particularly uncooperative to popular "risk parity" hedge fund strategies. Leveraged portfolios of stocks, government securities and fixed-income are not experiencing the diversification benefits they've enjoyed for most of the past decade (or two). Losses and general performance volatility will force these strategies to deleverage, with negative consequences for liquidity across various markets.
With de-risking/deleveraging gaining momentum globally - and some of the big global "banks" under pressure - it's reasonable to begin contemplating counter-party risk. And anytime markets start indicating waning liquidity and dislocation risk, my fears return to the derivatives markets. How much market "risk insurance" has been sold by strategies that plan on hedging this risk by selling into declining markets? Stated differently, what is the risk that derivatives "insurance" "dynamically (delta) hedged" by quant models could erupt into self-reinforcing sell programs, illiquidity and market dislocation?
October 26 - Financial Times (Alfred Liu and Benjamin Robertson): "Mario Draghi has pushed back against the wave of political attacks on the world's central banks, warning that the rising pressure could lead to lower growth and undermine a vital line of defence against future financial crises. Speaking just hours after he was criticised by Italy's deputy prime minister as 'poisoning the climate' against Rome, the European Central Bank president called on legislators around the world to instead 'protect the independence' of rate-setters. 'The central bank should not be subject to . . . political dominance and should be free to choose the instruments that are most appropriate to deliver its mandate,' Mr Draghi said in a thinly-veiled rebuke to his native country."
I see things similarly as the great statesman, the ailing Paul Volcker: "A hell of a mess in every direction." The stock market is only a few weeks past all-time highs, yet the finger-pointing has already begun in earnest. The Powell Fed cautiously raising rates just past 2.0% is certainly not responsible for the world's problems. A decade of central bank-induced monetary inflation, well that's a different story. More than a couple decades of central bank experimentation and inflationism, now you're on to something. It was always going to Come Home to Roost. That's the harsh reality that no one was willing to contemplate.
Draghi: "The central bank should not be subject to… political dominance and should be free to choose the instruments that are most appropriate to deliver its mandate."
It's ridiculous to bestow a small group of global central bankers the power to do Whatever They Want in the name of delivering on some arbitrary index level of consumer price inflation. To create $14 TN of "money" and unleash it upon global securities markets is undoubtedly history's most reckless monetary mismanagement.
Inevitable Blowback has commenced. "The dog ate my homework." "The inflation mandate made us do it." With a full year remaining in his term, Draghi won't be sharing Bernanke's good fortune. This whole historic monetary experiment will be unraveling while he's still on watch. But, then again, the Trump administration already has its scapegoat. Perhaps the whole world will blame Chairman Powell - or the man that appointed him.
Following a terrifying trajectory, things somehow turn more disturbing by the week. Political travesty has degenerated into a surreal quagmire. And to see this degree of division and hostility at this cycle's boom phase should have us all thinking carefully about what the future holds. As a nation, we are alarmingly unprepared. And it's back to this same issue that's troubled me for a number of years now.
Bubbles are always mechanisms of wealth redistribution and destruction. Akin to central banking, they can inflict immeasurable harm and somehow deflect culpability. As we've already witnessed as a society, they wreak subtle - and, later, more overt - havoc. And the current astounding Bubble has been on such an unprecedented global scale. Harsh geopolitical fallout is unavoidable. For me, it's been scary for a while. It's just more palpable now. We'll see if the midterms can provide an impetus for a market rally. If not, this has all the appearances of something that could turn sour quickly.
OFF-BALANCE: THE WORLD ECONOMY LOOKS DEPENDENT ON BOOMING AMERICA / THE ECONOMIST
Off-balance
The world economy looks dependent on booming America
What will happen when its growth slows?
IT HAS been a nervy few days for financial markets. A sell-off in bond markets, prompted by monetary tightening in America, this week infected global stockmarkets, too. The S&P 500 share-price index fell by over 3% on October 10th, its worst day in eight months. Markets in Shanghai hit their lowest level for nearly four years the next day; those in Japan and Hong Kong closed around 3.5% lower.
At first glance, the sell-off seems odd. The world economy is still growing briskly enough: this week the IMF only slightly trimmed its forecast for world GDP growth for 2018, from 3.9% to 3.7%. But investors are right to fret. Whereas acceleration was synchronised across much of the world in 2017, the global economy’s expansion now looks increasingly unbalanced.
Two divides stand out. The first is between emerging markets, which are suffering from particularly volatile financial conditions, and advanced economies. The cause of this divergence is a strong dollar, which is making emerging markets’ debts that are denominated in the currency costlier to service. The latest casualty is Pakistan. On October 8th it announced that it would seek an IMF bail-out, which is expected to amount to $12bn. It joins the ranks of other emerging markets in distress, notably Argentina, which has negotiated a record $57bn credit line from the IMF, and Turkey.
Sustained falls in emerging-market currencies and stocks have been painful for investors. Several countries have raised interest rates to stem capital outflows. Yet the damage to the real economy has for the most part been confined to those with large current-account deficits, such as Argentina. From a global perspective, the bigger worry is China. Authorities there are trying to reduce leverage in the financial system at the same time as American tariffs are squeezing their exports. The currency is under pressure; growth expectations are being lowered.
The second divide exists within the ranks of advanced economies. Rich countries seem to be gently slowing, with one big exception: America. There, growth has sped up dramatically, exceeding an annualised rate of 4% in the second quarter of 2018. America is the only large advanced economy in which the IMF projects activity will expand more quickly this year than it did last year.
This acceleration is because of President Donald Trump’s tax cuts. In September the unemployment rate fell to 3.7%, the lowest since 1969; wage growth is slowly but surely rising.
Rampant demand is pushing up interest rates. The Federal Reserve has raised short-term rates by two percentage points since it started tightening monetary policy in 2015. This week Mr Trump described the Fed’s policy as “crazy”. The yield on ten-year Treasury bonds has risen by more than in most other rich countries (see chart). It now stands at over 3.2%, higher than at any time since 2011.
America first
These different growth paths could yet separate further, because many of the immediate economic risks threaten countries other than America. One emanates from Italy, where bond yields are also rising rapidly—and not because of a robust economy. Instead, an extravagant budget put forward by its populist coalition government has sparked a confrontation with the European Commission and reignited fears about the sustainability of the country’s huge public-debt burden. The spread between yields on Italian and German ten-year bonds now stands at around three percentage points, its widest in over five years. Those rises will chill the Italian economy. Rising yields have not so far spread beyond Italy’s borders, but further increases could mean that crisis engulfs the euro zone again. Such fears will do no favours to European business confidence, which has already softened this year.
Another threat is a rising oil price. In September the price of Brent crude surpassed $80 per barrel for the first time since 2014, driven in part by falling Venezuelan supply and the prospect of American sanctions on Iran. It now stands at around $82. Costly fuel used to threaten the American economy. Today, however, it spurs investment in shale rigs. That gives America a natural hedge against oil-price shocks, even though, in the short term, limited pipeline capacity might mean investment responds only slowly.
Finally, there is Mr Trump’s trade war. America will eventually suffer from the distortive effects of rising tariffs, but it is not all that dependent on trade to fuel demand in the short term. Forecasts of the effect of existing tariffs on American growth and inflation predict only a small impact. The result is that the trade war so far also looks like an asymmetric shock—certainly as far as China is concerned.
The danger is that America’s outperformance pushes the dollar even higher, leading to more volatility in global finance and crimping growth in emerging markets. Yet America’s boom will not last for ever. Tax cuts will no longer provide incremental stimulus after 2019. Some forecasters fret that an end to the largesse, together with higher interest rates, may be sufficient to tip the country into recession by 2020. Analysts expect America’s economy, with its ageing population, to expand by less than 2% a year in the long run. That suggests that, unless productivity surges, a slowdown must eventually come.
The question then is whether the rest of the world can withstand, let alone make up for, an eventual slowdown in America. Not long ago, the consensus may have been that it could cope.
Now there is more to worry about.
SAUDI ENERGY MINISTER AL-FALIH SPEAKS TO TASS ON OPEC+, OIL PRICES AND KHASHOGGI / RUSSIAN NEWS AGENCY
Saudi energy minister Al-Falih speaks to TASS on OPEC+, oil prices and Khashoggi
Saudi Arabia’s Minister of Energy Khalid Al-Falih is considered to be one of the most influential individuals on the global oil market. Traders, investors and officials keep close tabs on his comments, which can spark serious price changes to the world’s ‘black gold’. Al-Falih, who has worked his entire life in the oil sector, has gone through all corporate hierarchy levels of the Saudi Aramco oil giant and naturally, after having served as the company’s chief executive, he took over the leadership of the country’s oil sector.
Under Al-Falih, relations between Russia and OPEC started developing by leaps and bounds and resulted in a deal being reached between OPEC member-states and oil producing countries, which are not part of the cartel (OPEC+), and this made the situation on the oil market more predictable. It is also mainly thanks to Al-Falih’s efforts that Saudi Arabia has been actively working with the Russian Direct Investment Fund and its head Kirill Dmitriev. Al-Falih said RDIF is “an important bridge” between the two countries.
In his interview with TASS, the Kingdom’s Minister of Energy Khalid Al-Falih spoke about what the future holds for the OPEC+ deal in 2019, whether oil prices in 2019 will surpass $100 per barrel, and whether Saudi Arabia will use oil as political leverage in the case of Saudi journalist Khashoggi, who went missing in Istanbul. In addition, he will also talk about working with the Russian Direct Investment Fund, and Saudi plans for investing into Russian companies, and a joint venture with Rosneft and meetings with Igor Sechin.
TASS — Over the last year and a half, Saudi Arabia has been widely mentioned in the Russian media because of the OPEC+ deal, signed by OPEC and Russia that helped to stabilize the market quite significantly. Are you happy with how this agreement has been working out so far and what was the main outcome for the global oil market from this deal?
Consequently we started our discussions with our Russian colleagues, most notably there were discussions at the leaderships level in 2016 during the G20 meeting in China, where president Putin met with His Highness The Crown Prince.. And they agreed that Russia and Saudi Arabia needed to help the world to get out of the slump. Because the slump was hurting the world, not only the producers, but even the consumers, who were affected by the slowdown of industrial growth, inflation, negative interest rates. After that first meeting we met later. And not the two of us agreed, but 24 countries in Vienna in December 2016 agreed to create the OPEC+ alliance to manage production . We did not shock the market by constraining supply.
We did it very gently. And the result was that by early this year the market was returning to balance. Excess inventories, which were very high and depressed the market, disappeared. We are now close to 5 year normal average of oil stocks. Supply and demand are close to each other, and the market is balanced. Of course, it helped producing countries like Russia and Saudi Arabia. But, also it helped consumers a lot. Returning the oil markets to balance was the lubricant for the global economy to return to the growth to the very healthy rate we are seeing now. All the parameters of the global economy are healthy. So, in a nutshell, we appreciate Russia’s role. What we want to do? This cycle is ending, and oil market will ultimately go through another cycle. We want to keep supply and demand balanced in the long term. In last three to four month we have coordinated with minister Novak to increase supply, because by May this year there was a lot of stress in the market about the shortage of oil, especially with sanctions and with reductions in some countries like Venesuela and Mexico . There were concerns, that there would be a shortage of oil. And if we continued the same policy that we had had in the previous 1.5 years, we would see the oil above 100 again. So we intervened.
We had discussions with minister Novak during the Saint Petersburg Economic Forum in May and we met in Moscow during the opening of the World Cup. Finally we agreed that it was time to change the course. The policy of withdrawing supply has accomplished its mission, and now it is time to gradually release supply. We have managed to convince the OPEC+ group. And from June till now we see the market has relaxed. So we have proved to ourselves that we can work with Russia and keep the markets balanced whether there is the shortage or oversupply. So I want to emphasize that given the success of two years coordination between KSA and Russia, we need to establish the framework for the long-term coordination.
Oil market is always cyclical, and without cooperation that cyclicity causes the severe volatility. And it is important to help moderate the volatility so that all participants and especially investors know that big producers like Russia and Saudi Arabia are working together to balance the markets.
— When you talk about long-term stability what do you mean in particular? What will be the future of the OPEC+ deal given that the current deal expires at the end of the year? Do you plan to extend this agreement for the long term?
We have started OPEC+ as a six month agreement. And we saw that six month is not enough to bring inventories down. Partially because US shale had continued to increase and partially because it took Russia almost four months to reduce its production by 300,000 bpd because there were many oil producing companies in Russia. So it took us some time to achieve that. But we extended the 6 months deal, and now it has been working for almost 2 years. In practice we only apply production reduction for Russia for 1.5 years, because for the last few months we agreed for Russia to produce as much as it can.
But nevertheless we want to sign a new cooperation agreement that is open-ended. That does not expire after 2020 or 2021. We will leave it open. And what we would like to do is continue for OPEC and non-OPEC to work together. And the difference is that there will be no fixed term for the agreement, which allows us to bring production up or down.
It should not have fixed production target. But it allows us to perform regular coordination and sharing information on what are our views on the market, supply and demand, how healthy the market is, what kind of intervention we need, if any, and when. Another new aspect is to create a secretariat for OPEC+. For now there is no secretariat. Only OPEC secretariat both serves OPEC and OPEC+. For non-OPEC countries from OPEC+ we will offer to them to create a secretariat in Vienna to work closely with OPEC. Of course, if any of OPEC+countries wants to join OPEC, we have a process in OPEC to consider membership. But many countries expressed the desire to work closely with OPEC, but not to join OPEC. And we respect this approach.
Russia is one of those countries. But there are many variations on how to cooperate. The latest discussions we had in June showed that OPEC+ countries want to continue to work within a longer-term framework.
— When do you expect to finalize this new deal?
I hope, when we meet on Dec 7 in Vienna we will be able to sign it.
— Will it be an open-ended agreement?
Yes, it starts in January 2019 and it will allow us to intervene to rebalance the market in any appropriate time from January onward.
— And who do you believe will be the driving force for organizing this new secretariat?
I think, Russia will have to take the leadership. Total non-OPEC participation is 20 mln bpd, but Russia’s alone gives 11 mln bpd. So obviously Russia is a heavy weight both in terms of production and in terms of political influence. So Russia’s leadership for OPEC+ is indisputable. That’s why I expect Russia would play a key role. Of course, we are keen to work with Mr Novak and Russian team to invite other countries from outside OPEC to join OPEC+. We have started some quiet contacts with some countries to join and hope we will succeed.
— Will the principles for OPEC+ be the same as for OPEC: one country – one voice?
Yes, we ultimately want everybody to be on board. But my experience is that countries like Russia and Saudi Arabia with bigger scale and bigger impact ultimately carry more weight. It is not through voting and through formal process,but through convincing. Because people know that if we agree to cut five percent , as we did, our volumes are huge. Our production cuts were close to 600,000 bpd every month through the duration of the agreement out of 1.8 mln bpd of total OPEC+ cut. So when we sit around the table, our voice carries more weight. The same with Russia, which cut 300,000 bpd out of 560,000 for total non-OPEC cuts.
And all OPEC+ countries are very respectful of Russia. So I think we should not hang on voting and formal process, but focus more on alignment and objectives. Once you get the trust of other countries and understand their objectives and you are serving those objectives with your actions, formal voting becomes irrelevant, most decisions are made by consensus very fast. This is how it works.
— You have mentioned that the new agreement will be signed in December. Do you have any objectives in mind already? Will you cut or increase the supply for a certain period? And what will this period be?
I think there are many uncertainties about 2019 that it is very premature for us to say what we will do.
The only certainty for 2019 is that we need to be ready to act promptly and effectively. You have got uncertainty with the demand for many reasons. There are trade frictions that affect major trading countries. You have developing countries like Turkey, Argentina, India, which have a lot of pressure on their currencies. As a result you have strong dollar and weak emerging economies. So potentially a world economic slowdown could hurt oil demand. And if demand is low, we know oil markets will respond. On the supply side we could have problems with disruptions of production. First, we have sanctions on Iran, and nobody has a clue what Iranians export will be. Secondly, there are potential declines in different countries like Libya, Nigeria, Mexico and Venezuela. If any of these countries’production is significantly impacted, it will have an impact on the balance in the market. Then there is uncertainty about the US shale oil. Also many people say that in 2019 there will be pipeline constraints on moving oil production in the US. So we need to be ready to look at the balance. And if supply is too long, we should be able to cut. If supply is short, we have to be able to respond. We would like to do it in a coordinated way. We do not want to confuse the market and surprise the market. 2019 is a very critical year to keep the market in balance , which we have achieved after a lot of hard work, and we should not lose this hard work. If the Group [OPEC and OPEC+ – TASS] works together, we can quickly act to adjust production.
— In a worst case scenario with Iran do you have enough spare capacities in OPEC and OPEC+, and particularly in Saudi Arabia to fill this gap?
Obviously, since June we increased our production a lot. We were at 9.9-9.8 (mln bpd) in April and May, and now we are at 10.7. At the same time our friends from Russia and UAE have increased production as well. So our spare capacities for the entire globe at the moments are much less today than they were back in the past. We have relatively limited spare capacities and we are using a significant part of them. For now we in Saudi Arabia have 1.3 mln bpd of spare capacity, UAE has assured me they have over 200,000 bpd remaining. But we do not know what is going to happen in other countries. We know Kazakhstan plans to increase production with Kashagan and Tengizoilfields., Brasil is expecting to increase production. And US shale could bring additional volume of oil. So it may happen that we may not need to use spare capacities. But if you have other countries to decline in addition to the full application of Iran sanctions, then we will be pulling all spare capacities.
— So do you think you have enough opportunities, and enough capacities to keep the oil market balanced, to avoid sending prices soaring to over $100 per barrel?
I cannot give you a guarantee, because I cannot predict what will happen to other suppliers. Saudi Arabia now in October produces oil at the level of 10.7 mln bpd. I can say that we can go up, if necessary, to 12 mln bpd. This I can assure. But if 3 mln bpd disappears, we cannot cover this volume. So we have to use oil reserves. But it is very important for the world to support Saudi Arabia, because it is the only country that invest heavily in spare capacities. We invest tens of billions of dollars constantly to in-build capacity we do not use, only in shortage situations. It does not work for us; money is parked as insurance for the rest of the world. Today we are using some of it, tomorrow we will be using most of it, if disruptions in other countries will take place. We see there were disruptions in the past like Gulf War, but there were no shortages of oil because of our spare capacities. That requires us to continue our policy of investing. But Saudi Arabia needs to be appreciated and supported, recognized for doing very honorable duty for the rest of the global community. It is important for us to highlight that our production is likely to go up in the near future to 11 mln bpd on a steady basis. So we have to make a decision do we increase our total production capacities from currently 12 to 13 mln bpd. And this decision requires incremental investments from $20 bln to $30 bln. This is the capital cost for each one million barrels of additional capacity.
— You say that the world should support and appreciate Saudi Arabia. But now we are weathering a difficult period of turmoil because of the case of the Saudi journalist that has disappeared in Istanbul. Some analysts, based on comments from the Saudi media, say that because Riyadh is unhappy with the treatment by the West in this case, Saudi Arabia could cut supplies by up to 0.5 mln bpd. What sort of response can you provide to these predictions?
I think that rational people in the world know that oil is a very important commodity for the rest of the world. If oil prices will go too high, it will slow down the world economy and would trigger a global recession. And Saudi Arabia has been consistent in its policy. We work to stabilize global markets and facilitate global economic growth. That policy has been consistent for many years. We suffered in the past from political crises, this is not the first time.
This incident will pass. Of course, this is not my mandate to speak about it. Our government through political channels is addressing this issue. But Saudi Arabia is a very responsible country, for decades we used our oil policy as responsible economic tool and isolated it from politics. So lets hope that the world would deal with the political crisis, including the one with Saudi citizen in Turkey, with wisdom. And we will exercise our wisdom both in political and economic fronts. My role as the energy minister is to implement my government’s constructive and responsible role and stabilizing the world’s energy markets accordingly, contributing to global economic development.
— So can people relax? There won’t be a repetition of 1973, correct?
There is no intention.
— Let’s then move on from global oil market issues to more specific matters regarding the Saudi oil industry. Saudi Aramco’s IPO was supposed to be one of the largest in modern financial history, but recently it was postponed. What were the reasons behind this decision? Were they only business reasons? Did you need to finalize planned M&As? Or are there some political reasons as well – say you want to avoid US legal risks, if you launch a listing on the NYSE?
— What other assets do you see for Aramco? And do you have any particular interest in including Russian assets into Aramco’s new downstream strategy?
Aramco continues to grow, petrochemicals in particular. Sibur is an interesting company, we have talked with Novotek (the main shareholder of Sibur)and Mr Mikhelson (Leonid Mikhelson, CEO of Novatek). There is a potential project in Jubeil (petrochemical JV with Aramco and Total in Saudi Arabia) for Sibur. Aramco has a target of 3 mln bpd to convert into chemicals, and part of it could be Russian oil, it does not necessarily have to be all Saudi oil. So JV between Sibur and Aramco is one possibility. As well as buying equity in Russian companies, especially in the companies with technologies. Sabic will not be the last deal that Aramco does in chemicals. Aramco continues to look for the right companies. We are doing a lot of projects in many countries – Malaysia, China, and recently in India. But in addition to the mega projects we are looking for the large, medium and small companies to acquire.
— You have expressed your interest in the Arctic LNG project. Do you have any particular terms?
I have attended the inauguration of Yamal 1 and it was very impressive just to see that Russian companies can operate in such difficult environment. It was also impressive to see president Putin, his vision, his leadership, his determination to open new frontiers for Russia. At that time we had initial understanding that we will look at the next project[Arctic LNG-2 - TASS].
Early indications are positive, reserves are there. We expressed interest, now what we have to do is to agree on the terms and negotiate them with Novatek. We hope to be the second largest investor in [Arctic LNG-2] after Novatek. We not only want to come in, we want to come in with the substantial stake. Hopefully our terms will be accepted. But regardless of what happens with [Arctic LNG-2], Aramco will be a major player in the global LNG market. That decision has already been taken.
— So when can we expect any decisions on the next project?
The sooner, the better. I think with Aramco the project will also benefit. We have good upstream and project management capabilities. Arctic climate is not our expertise, but we will learn very quickly.
— Aramco is also mulling over buying some oil and manufacturing services from Russian companies. Could you provide some details on that?
Thanks to Russian Direct Investment Fund we are looking at this opportunity. There is also PIF, with whom as partner we are looking to do this. PIF allocated 10 bln dollars for investment in Russia, out of which 1 bln are for oil and gas fields services. We are very close to invest into Novomet. And we are also looking to EDC. These are two companies we hope to invest. But this is not final.
— What is your general view of Russia’s investment climate?
Extremely positive. I am very bullish on Russia. I think president Putin and Russian government are focusing on developing the country for the people, and they are doing it by working with the business community. You have friendly regulatory system, which promotes private business. My only complaint is that every time I go to Russia I need to get a visa, so my passport is running out of pages. But I say it in a friendly way, because it indicates the frequency of my visits to Russia. The more we see, the more we like.
— In July, you met with Igor Sechin from Rosneft. Do you have any projects with this company in the pipeline?
We talked to Mr Sechin about global cooperation. We will grow our downstream, and soon we will have over 10 mln bpd of downstream capacity. And there is no way we can supply it only with Saudi oil. We need other crude, and Russia is number 2 exporter after us. And Rosneft is the biggest Russian company. So swapping crudes and products is the natural area of cooperation. We have noticed that Rosneft and Lukoil have started to invest into refineries around the world. So together with Russian partners we could form joint venture with this refineries. We could supply oil to these refineries. Mr Sechin is also very important leader for the Russian industry, and having a constant dialog with him is a good for us.
Interviewed by TASS Editor-in-chief Maxim Filimonov and energy correspondent Iuliia Khazagaeva
WHY IS DEMOCRACY FALTERING? / PROJECT SYNDICATE
Why is Democracy Faltering?
Kaushik Basu
While technological progress has brought important gains, it has also left many segments of the population feeling vulnerable, anxious, and angry, fueling a crisis of democratic legitimacy. Though it is not immediately clear how we can confront this crisis, it is clear that business as usual won't cut it.
NEW YORK – Jair Bolsonaro, the frontrunner for the Brazilian presidency, is a far-right, gun-loving, media-baiting hyper-nationalist. The fact that he would be right at home among many of today’s global leaders – including the leaders of some of the world’s major democracies – should worry us all. This compels us to address the question: Why is democracy faltering?
We are at a historical turning point. Rapid technological progress, particularly the rise of digital technology and artificial intelligence, is transforming how our economies and societies function. While such technologies have brought important gains, they have also raised serious challenges – and left many segments of the population feeling vulnerable, anxious, and angry.
One consequence of recent technological progress has been a decline in the relative share of wages in GDP. As a relatively small number of people have claimed a growing piece of the pie, in the form of rents and profits, surging inequality of wealth and income has fueled widespread frustration with existing economic and political arrangements.
Gone are the days when one could count on a steady factory job to pay the bills indefinitely. With machines taking over high-wage manufacturing jobs, companies are increasingly seeking higher-skill workers in areas ranging from science to the arts. This shift in skill demand is fueling frustration. Imagine being told, after a lifetime of body-building, that the rules have been changed and the gold medal will be awarded not for wrestling, but for chess. This will be infuriating and unfair. The trouble is that no one does this deliberately; such changes are the outcome of natural drift in technology. Nature is often unfair. The onus for correcting the unfairness lies on us.
These developments have contributed to growing disparities in education and opportunity. A wealthier background has long improved one’s chances of receiving a superior education and, thus, higher-paying jobs. As the value of mechanical skills in the labor market declines and income inequality rises, this difference is likely to become increasingly pronounced. Unless we transform education systems to ensure more equitable access to quality schooling, inequality will become ever-more entrenched.
The growing sense of unfairness accompanying these developments has undermined “democratic legitimacy,” as Paul Tucker discusses in his book Unelected Power. In our deeply interconnected globalized economy, one country’s policies – such as trade barriers, interest rates, or monetary expansion – can have far-reaching spillover effects. Mexicans, for example, do not just have to worry about whom they elect president; they also need to concern themselves with who wins power in the United States – an outcome over which they have no say. In this sense, globalization naturally leads to the erosion of democracy.
Against this background, the ongoing transformation of politics should not be surprising. The frustration of large segments of the population has created fertile ground for tribalism, which politicians like Trump and Bolsonaro have eagerly exploited.
Mainstream economics is founded on the assumption that human beings are motivated by exogenously given preferences – what economists call “utility functions.” Though the relative weights may differ, all individuals want more and better food, clothes, shelter, vacations, and other experiences.
What this interpretation fails to account for are “created targets” that arise as we move through life. You are not born with an essential drive to kick the ball through a goal post. But once you take to soccer, you become obsessed with it. You do not do it to get more food or clothes or houses. It becomes a source of joy in itself. It is a created target.
Even becoming a sports fan is similar. Nobody is essentially a devotee of Real Madrid or the New England Patriots. But, through family, geography, or experience, one might become deeply connected to a particular sports team, to the point that it becomes a kind of tribal identity. A fan would support players not because of how they play, but because of the team they represent.
It is this dynamic that is fueling tribalism in politics today. Many who support Trump or Bolsonaro do so not because of what Trump or Bolsonaro will deliver, but rather because of their tribal identity. They have created targets related to being part of “Team Trump” or “Team Bolsonaro.” This damages democracy by giving political leaders a license they did not have earlier. They can do what they want without being constrained by the will of the people.
It is not immediately clear how we can rectify these problems, protect the vulnerable, and restore democratic legitimacy. What is clear is that business as usual will not cut it.
The Industrial Revolution – another major turning point for humankind – brought massive changes in regulations and laws, from the various Factories Acts in the United Kingdom to the implementation of income tax in 1842. It also brought the birth of modern economics, with major breakthroughs by the likes of Adam Smith, Augustin Cournot, and John Stuart Mill.
But we are at a historical juncture where the subject of political economy deserves a rethink.
The dinosaur did not have the capacity for self-analysis and headed toward extinction 65 million years ago. We, too, run the risk of civilizational collapse. But, luckily we are the first species with the capacity for self-analysis. Therein lies the hope that, despite all the turmoil and conflict we see around us, we will ultimately avert the “dinosaur risk” and pull ourselves back from the brink.
Kaushik Basu, former Chief Economist of the World Bank, is Professor of Economics at Cornell University and Nonresident Senior Fellow at the Brookings Institution.
GOLD UPLEG FUEL ABOUNDS / SEEKING ALPHA
Gold Upleg Fuel Abounds
by: Adam Hamilton
- Despite speculators’ record gold futures short covering on that drop, the lion’s share of that stage one gold-upleg-driving buying is still yet to come. And stage two gold futures long buying is barely starting.
- That futures buying ultimately ignites the far larger stage three investment buying, which soon takes on a life of its own. The shock of that out-of-the-blue stock market plunge started attracting investors early.


A EUROPEAN IMF: THE NEW FACE OF THE EUROZONE BAILOUT FUND / DER SPIEGEL
A European IMF
The New Face of the Eurozone Bailout Fund
The erstwhile bailout fund known as the European Stability Mechanism may soon be granted far-reaching new powers, including the kinds of functions currently possessed by the IMF. But there's a hitch.
By Christian Reiermann
One of Europe's most promising startups can be found in an unassuming low-rise in Luxembourg City's Kirchberg district. Despite its rather pallid surroundings, it has all the characteristics of a promising new company: dynamic growth, international staff, bright prospects and tons of money. It even has its own gym.
Eight years ago, just five people worked for the company's predecessor, which was located a few streets away. Today, though, it has 180 employees on the payroll and they deal with hundreds of billions of euros. They hail from 43 countries and speak two dozen languages.
In contrast to other business models of other startups, though, this place is not focused on identifying and attacking new markets. On the contrary, their mandate is defense. They are tasked with defending the eurozone and the euro against turbulence. And soon, even more people are set to join the staff. After all, this startup is adding to its portfolio of expertise.
The startup operates under the acronym ESM, which stands for European Stability Mechanism: But it is more commonly referred to as the euro rescue fund.
The finance ministers of the 19 eurozone member states, who make up the ESM's board of governors, have been discussing for months how the organization should be further developed.
They have big plans.
The board of governors would like to see the ESM become a European version of the International Monetary Fund (IMF). To achieve this, the ESM would have to be given new powers to better monitor euro countries' fiscal policies. The organization would also be expected to play a bigger role in bank bailouts -- not exactly an unimportant responsibility should a new financial crisis arise. And last but not least, the ESM would be empowered to better assist governments that find themselves in a tight spot. The board of governors hopes such reforms would bolster the rescue fund such that it could even handle a situation such as that developing in Italy, where the government is pursuing a heedless fiscal policy that has for the first time pushed a large European country to the brink of bankruptcy.
Strict Conditions
The fact that the ESM has come to play such a central role in European fiscal policy has to do with its own success. The organization and its predecessor, the European Financial Stability Facility (EFSF), have helped five eurozone member states grapple with the consequences of the financial crisis. Tens of billions of euros were loaned to Greece, Ireland, Portugal, Cyprus and Spain -- either because investors no longer wanted to provide these countries with follow-up loans, or because they simply lacked the money to save their own banks.
The billions of euros made available by the ESM, of course, were linked to strict conditions, including fiscal belt-tightening, social system reform and labor market liberalization. By now, every country that received an EFSF or an ESM bailout has completed the program. The last to do so was Greece, in August. The countries still have debts to pay back to the ESM, but each has different conditions regarding how quickly that must happen.
From his corner office on the second floor, Klaus Regling, the German head of the ESM, takes stock after eight years of crisis and his satisfaction is obvious. "No one can imagine us not playing a role in the future," he says. There was a time when that wasn't true. At first, Regling, who was also a founding member of the ESM's predecessor organization, EFSF, thought his job would be to coordinate an emergency response and then close up shop after a few years. Several years later, when the ESM was given permanent status, Regling was still planning to put the ESM into a kind of hibernation once the euro crisis was over, including massive staff cuts.
That is not, however, how things have turned out. Regling and his superiors, the financial ministers of the eurozone, have changed their thinking. "Fire departments, after all, don't lay off their people just because nothing's burning," he says.
The first step is that of transforming the ESM into a kind of European replacement for the IMF. The IMF played a central role in Greece during the crisis, but there were often clashes over the best way to help the country. In the future, the IMF does not intend to participate in state bankruptcies in Europe.
To enlarge graph click here
For the ESM to function as a European IMF, the organization is to be granted oversight rights to look over the individual finances of eurozone member states. Should a new crisis crop up, the ESM would be armed with additional control and enforcement rights.
Alarm Bells
The ESM is better equipped for this task than any other European institution. It's in regular contact with financial markets and knows much more quickly than, say, the European Commission when a eurozone member state's creditworthiness is in danger.
Communication with the markets takes place in a couple of different ways. First of all, the ESM invests its on-hand capital -- some 80 billion euros. Secondly, and much more importantly, the organization issues bonds, which generates the money necessary to help distressed governments out of financial jams. The bustling atmosphere at the organization's office in Luxembourg City is like that of the trading floor at an investment bank. Everyone is sitting in front of computer screens full of numbers, symbols and graphs that are constantly updating. Some of the traders have decorated their workspace with the European flag.
One of the ESM's new tasks is ringing the alarm bells early when there are signs of an approaching crisis. The ESM possess a deep knowledge of the financial situations of former crisis countries, in part because analysts tag along when donor state representatives visit those countries' capitals. The organization also knows a lot about larger member states like Germany and France, Regling says. "But if, purely hypothetically, something were to happen in, say, Austria or Malta, we would currently be at a loss." To fulfill its role as an early-warning system, the ESM must recruit experts on all member countries.
ESM head Klaus Regling
A larger staff is also needed for the ESM's second area of operation. In the future, the plan is for the ESM to provide financial backing for the European mechanism for the resolution of failing credit institutions. For this, Regling needs banking experts.
The ESM will also receive a set of new financial instruments geared toward helping ailing countries quickly. A precautionary line of credit is in discussion that could be extended to countries not yet in acute need but which require help to calm wary investors.
Expanding Workforce
In a paper for the Eurogroup, as the board of eurozone finance ministers is known, the ESM also proposes another instrument. It would provide short-term liquidity assistance to countries that have temporarily run out of money because they have unfairly landed in speculators' crosshairs. "These funds would be paid out without a big fuss, and the country wouldn't have to subject itself to a complete adjustment program," the paper reads.
Still, the countries in need of such aid would have to fulfill a number of conditions and requirements.
In the future, the ESM could also help to stabilize sluggish economic cycles in individual member states. To do so, the paper suggests empowering the organization to grant a line of credit to countries who experience an asymmetric shock. With a fresh injection of cash for the ESM, a government could, for example, quickly bolster demand. Such an instrument is necessary, Regling says, because the European Central Bank (ECB) can't intervene with lower interest rates. The ECB, after all, controls monetary policy for the eurozone on the whole, not for individual countries.
To manage these new ambitions, Regling will have to expand his workforce. "Were the ESM to get all of the new assignments that are currently being discussed, we would have to increase our staff from 180 to 250 in the coming years," he says.
The flood of potential new competencies is not without risks and side effects. There's plenty of money available: At the moment, the ESM has only loaned out a hundred billion euros of the half a trillion at its disposal. But at the same time, Regling's people are worried that politicians could saddle the ESM with too much responsibility.
The Money Everyone Needs
One thing that is particularly difficult is financially safeguarding the resolution mechanism for failing banks. To do so, Regling must set aside 60 to 70 billion euros of his overall budget. That sum would no longer be available for the other instruments, warns an internal ESM paper that Regling sent to the finance ministers of the eurozone member states. In addition, the paper noted, the ESM's own creditworthiness could be damaged.
Moreover, it's still not entirely clear who has the power to decide when funds are released. Some member states want to give Regling carte blanche to decide when to spend money on a bank bailout. But representatives of the German government, including Finance Minister Olaf Scholz, insist that German constitutional law means that Berlin must be granted veto power. The dispute is ongoing.
Not everyone's happy about the expansion of the ESM's list of duties. Representatives of the European Commission, in particular, are very keen to not see their own authorities curtailed, particularly when it comes to analyzing a country's financial well-being.
The most recent effort to hinder a transfer of power to the ESM is the insistence by the Commission that such a thing cannot be done because the rescue fund isn't an official EU agency. That is true: The ESM is a structure established solely by eurozone member states. But the Commission's argument is disingenuous. The executive body knows only too well that there will be no majority in the foreseeable future in favor of enshrining the ESM in EU law.
Regling can afford to view the political wrangling with equanimity. After all, he controls the money everyone needs. "It's not about strengthening the ESM," he says. "Our job is to strengthen the euro."
Bienvenida
Les doy cordialmente la bienvenida a este Blog informativo con artículos, análisis y comentarios de publicaciones especializadas y especialmente seleccionadas, principalmente sobre temas económicos, financieros y políticos de actualidad, que esperamos y deseamos, sean de su máximo interés, utilidad y conveniencia.
Pensamos que solo comprendiendo cabalmente el presente, es que podemos proyectarnos acertadamente hacia el futuro.
Gonzalo Raffo de Lavalle
Las convicciones son mas peligrosos enemigos de la verdad que las mentiras.
Friedrich Nietzsche
Quien conoce su ignorancia revela la mas profunda sabiduría. Quien ignora su ignorancia vive en la mas profunda ilusión.
Lao Tse
“There are decades when nothing happens and there are weeks when decades happen.”
Vladimir Ilyich Lenin
You only find out who is swimming naked when the tide goes out.
Warren Buffett
No soy alguien que sabe, sino alguien que busca.
FOZ
Only Gold is money. Everything else is debt.
J.P. Morgan
Las grandes almas tienen voluntades; las débiles tan solo deseos.
Proverbio Chino
Quien no lo ha dado todo no ha dado nada.
Helenio Herrera
History repeats itself, first as tragedy, second as farce.
Karl Marx
If you know the other and know yourself, you need not fear the result of a hundred battles.
Sun Tzu
We are travelers on a cosmic journey, stardust, swirling and dancing in the eddies and whirlpools of infinity. Life is eternal. We have stopped for a moment to encounter each other, to meet, to love, to share.This is a precious moment. It is a little parenthesis in eternity.
Paulo Coelho

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