Whatever It Takes to Never Give Up

Doug Nolan


Any central bank head that passes through an eight-year term without once raising rates has some explaining to do. To leave monetary policy extremely loose for such an extended period comes with major consequences (can we at least agree on that?).

So, what went wrong? How did policy measures not operate as expected? With the benefit of hindsight, what could have been done differently?

What will be Draghi’s legacy? How will history view his stewardship over eurozone monetary policy? The years sure pass by. I still ponder how history will judge Alan Greenspan and Ben Bernanke. At this point, with securities prices (equities and bonds) basically at all-time highs, contemporary monetary policy - and its major architects - are held in high regard. I don’t expect this to remain the case following the next crisis.

A reporter question from Draghi’s Thursday news conference: “A recent survey by the Bank of America reveals that impotence and ineffectiveness of central banks, including the ECB, are the second risk perceived by investors. My question is: do you think that these investor concerns are justified? In other words, is there a risk of financial bubbles?”

Mario Draghi: “…You asked whether the expansionary monetary policies of central banks is the second-largest risk. I can answer for the eurozone; in the eurozone, and it’s a question we ask ourselves every day, many times a day, and I’m saying this because we monitor market developments very closely. We see some segments of financial markets where valuations are overstretched. One case is real estate, for example, and especially prime commercial real estate. Now, the causes of these overstretched valuations often don’t lead directly to our monetary policies. For prime commercial real estate, it’s the action of international investors… We may have other segments to watch, but frankly, all in all we don’t see bubbles. When we see some bubbles, they are local bubbles that should be, for example, some segments of the bond market, the high-yield leveraged bond market – which by the way is not a big issue in Europe. It's more of a big issue in another jurisdiction… Certainly the other important issue is that much of this danger, much of this risk, much of this search for yield happens in the non-banking sector and more specifically in the so-called shadow banking sector. Unfortunately there, the perimeter of macro-prudential policies does not include that sector. We have some visibility, pretty good visibility, into what happens in the banking sector… But we don't have much visibility for the rest of the financial sector. I’m talking for the non-banks, so for the shadow banking sector.”

Reminiscent of mortgage finance Bubble era Alan Greenspan, Draghi references “local Bubbles.” Yet Draghi concludes his term staring eye-to-eye with one of history’s most spectacular Bubbles – and it’s anything but “local” and it is not in real estate or high-yield. I’ll assume when ECB officials are monitoring markets “very closely” and pondering risks “many times a day,” perhaps sovereign bond markets garner some occasional attention.

Greek yields were at 22.31% when Mario Draghi began his term on November 1, 2011. Italian yields were at 6.09%, with Portuguese yields at 11.79%, Spanish at 5.54%, French at 3.10% and German yields at 2.03%. At 2011/12 highs, Italian yields reached 7.26%, Spain 7.62%, Portugal 17.39% and Greece 31.68%.

The collapse of eurozone yields has been nothing short of miraculous. Greek 10-year yields ended this week at 1.20%, and Italian yields closed at 0.95%. Portuguese and Spanish yields are down to 0.22% and 0.27% - and those are among the high-/positive-yielding instruments. German and French yields ended the week at negative 0.36% and negative 0.06%. Other negative-yielding eurozone 10-year bonds include Netherlands (-0.24%), Austria (-0.14%), Finland (-0.14%) and Belgium (-0.08%). Latvia’s 10-year yields ended the week at zero, slightly ahead of Slovakia (0.03%), Ireland (0.04%), Slovenia (0.08%) and Cyprus (0.46%). It’s curious that one of history’s greatest bond market inflations didn’t garner so much as a mention during Draghi’s final ECB press conference.

Scant interest in the ECB’s holdings as well. The ECB balance sheet doubled in size over the course of Draghi’s eight-year term. Total ECB Assets ended October 2011 at 2.333 TN euros, having already inflated dramatically from 2005’s one TN (euro). ECB assets are now at 4.687 TN ($5.230TN). There were the Long-Term Refinancing Operations (LTRO), Outright Monetary Transactions (OMT), and Quantitative Easing (QE). ECB assets surged 2.6 TN euros during the 2015 QE program that ran through the end of 2018. After a brief hiatus, the restart of QE (20 billion euro monthly) was announced in September.

Draghi will forever be known for “whatever it takes…” (“...and believe me, it will be enough”). He is hailed as having saved the euro. The dire consequences of a collapsing monetary union certainly afforded him extraordinary leeway. When the euro stabilized, he then leaned on the ECB’s inflation mandate to basically do whatever he wanted. Similar to central bankers around the world, global disinflationary forces associated with globalization, manufacturing over-investment, technological advancement, and changes in the nature of output (i.e. digitization) were used to justify unrelenting unprecedented monetary stimulus and policy experimentation. When these inflation mandates were created, did anyone ever contemplate that they would be justification for creating Trillions of new “money” through the monetization of government bonds and other securities?

Central banking has a long history of prudence and conservatism. After all, risks associated with bold measures and experimentation are too great: inflation, Bubbles, wealth redistribution, loss of trust, wars and so on. The role of central banks should be well contained; the scope of mandates limited in nature. Allow central bankers to drift into the domain of bolstering securities markets and you’re asking for trouble. Any “buyer of last resort” crisis-period operation should be concluded at the earliest available juncture. Never promise a market backstop. Efforts to use inflating securities markets as a mechanism for system reflation – to boost spending, borrowing, investment and incomes – is fraught with great risk. To have a central bank assume the role of savior for an ill-conceived monetary union guarantees precarious runaway monetary inflation.

There were momentous unintended consequences when Dr. Bernanke in 2008 unleashed his monetary experiment. Mario Draghi was a paramount one. I doubt Draghi would have even been considered for the ECB’s top post if not for Bernanke’s radical stimulus gambit. With the guardian of the world’s reserve currency having flung open the doors to rank inflationism, traditional central bankers in Germany were blown back on their heels. All the uncertainty and confusion created an opening. Articulate, diplomatic and with deep experience (including a stint as Goldman Sachs vice chairman and managing director), the smooth Italian fatefully overcame opposition from the sound money Germans to win the job.

For posterity, I’ll include a few headlines. “Mario Draghi, Hailed as the Euro’s Savior, Leaves With the ECB Divided” (Wall Street Journal). “How Mario Draghi Brought Determination to Calm Market Turmoil” (Financial Times). “Mario Draghi Reaches the End of His Fight to Save the Euro” (Bloomberg). “Mario Draghi Leave Europe Near Recession, in a Deflation Trap – and Out of Ammunition” (UK Telegraph). And my personal favorite from Axios: “ECB Head Mario Draghi Saved by the Bell as the Eurozone’s Mess Escalates.” A more forward-looking headline: “Lagarde Will Seek to Heal ECB Policy Split with Review Plan.”

Question: “What advice are you giving to Christine Lagarde – that you can tell us about anyway?”

Draghi: “…No advice is needed. She knows perfectly well what she has to do. By the way, she has a long period of time ahead during which she will have to form her own view, together with the Governing Council, about what to do.”

Bernanke and Yellen left Chairman Powell in a difficult predicament. It was up to him to move forward with a much delayed “normalization” (brought to a screeching halt in less than a year). Draghi has essentially set a policy course that will run much beyond the end of his term.

There are no expectations for any so-called “normalization.” Negative deposit rates will continue indefinitely, as will QE. No difficult decisions anywhere on the horizon. The Governing Council will surely present a unified front. Christine Lagarde will have an easy time of it – that is, until trouble strikes.

The “ammo” issue will not be going away. The entire world will deeply regret having disregarded the sordid history of inflationism. And that has been the momentous unintended consequence of Bernanke and Draghi’s grand monetary experiment: once you travel down the path of using monetary stimulus to reflate financial and economic systems, there will be no turning back.

I don’t believe Draghi saved the euro – he merely postponed monetary breakdown.

In so many ways, delaying the day of reckoning only makes things (much) worse. The world over the past couple weeks has experienced riots in an expanding number of countries – including Lebanon, Egypt, Iraq, Spain, Chile, Bolivia, Ecuador and Hong Kong. Wait until the global Bubble bursts. Similarly, wait as it expands further, with wealth inequalities mounting and social and geopolitical stress festering.

It’s crazy that central bankers have expended such precious resources to sustain the unsustainable.

What does the ECB have remaining in its arsenal to expend when the next crisis erupts? One thing: Trillions of QE. And markets are perfectly aware of this reality, which explains the historic speculative Bubble that has engulfed eurozone and European bonds. European yields have been a major force pulling international bond markets along for the ride - and why not? The next crisis will be global, with the ECB’s Trillions of QE joined by Trillions from the Fed, ECB, PBOC, BOE and the rest.

It’s fitting that Mario Draghi’s final meeting in charge of the ECB came with the S&P500 trading right at all-time highs, while Italy’s two-year bond issue was oversubscribed with a yield of negative 0.11%. And then there was the announcement of the U.S. fiscal deficit of almost $1 TN, despite decent growth, unemployment at a 60-year low and historically low funding costs.

There is a long list of developments that were only possible because of the superhuman feats of “Helicopter Ben” and “Super Mario.” Paul Krugman has referred to Draghi as “the greatest central banker of modern times.” I’ll assume Dr. Bernanke is a close runner-up.

I’m convinced China’s historic Credit Bubble would not have inflated to such extremes without unprecedented monetary stimulus from the Fed, ECB and BOJ. The Chinese banking system doesn’t inflate to $40 TN without China’s massive holdings of international reserves underpinning its currency. China’s currency doesn’t sustain its international value without devaluations in the world’s reserve currency, along with the euro and the yen. And it was all made possible by Team Bernanke and Draghi, with the resulting Chinese-led investment boom a major factor behind global downward pressure on technology and manufactured goods prices.

Consequences of unprecedented monetary stimulus are now used as justification for only more outrageous monetary stimulus. Sinking “real rates” – “the natural rate” – “r star” – the “neutral rate” – now apparently demand lower for longer. And markets appreciate that global central bankers are trapped – nowhere to go but ongoing aggressive stimulus. With a straight face, investment managers assert on Bloomberg and CNBC that Federal Reserve policy is “too tight.”

Even with the S&P at highs, unemployment at lows, financial conditions loose, and “money” growing crazily, the Fed apparently has no alternative but to cut rates for a third time in three months - to avoid at all cost the Scourge of Disappointing Markets. At the minimum, the Fed should signal it will now pause. Most view this as unlikely, as such a bold maneuver risks upsetting fragile markets (trading at record highs). It’s hard to believe the FOMC is comfortable having highly speculative markets dictate monetary policy, but it’s similarly difficult to see them willing to break this dynamic. Right, no appetite for rattling markets.

I’ll be really curious to see how history views this cast of characters. When asked about his future, Draghi said “ask my wife.” I’ll assume he’ll follow in Dr. Bernanke’s footsteps – rake in millions. It’s an absolutely wonderful time to be an ex head of one of the world’s major experimental central banks. Such powerful incentives to keep the game going – the Bubble inflating. “‘Never Give Up!’ Draghi Tells Lagarde as He Leaves ECB,” read a Reuters headline.

Warrensworld

Elizabeth Warren’s many plans would reshape American capitalism

For better and for worse




IN 1936 Franklin Delano Roosevelt said of the big businesses lining up against his re-election: “They are unanimous in their hate for me—and I welcome their hatred.” Elizabeth Warren, who is seeking the Democratic nomination in next year’s presidential election, takes a similar approach. After a cable news personality reported that executives of big companies are anxious about the possibility of a Warren presidency, she tweeted: “I’m Elizabeth Warren and I approve this message.”

Ms Warren, a former professor at Harvard who is currently a senator for Massachusetts, is offering Democratic primary voters a menu as ambitious as anything seen since FDR’s New Deal: a fundamental reworking of American capitalism. It is going down well.

In The Economist’s average of public-opinion polls, as of October 23rd, Joe Biden has just a narrow lead over Ms Warren. Her support stands at 24%, the former vice-president’s at 25% (see chart 1). Betting markets rank her the clear favourite, with a nearly 50% chance of grasping the nomination. Polls pitting her against President Donald Trump see her beating him.

Ms Warren has been fishing for primary support in many of the same pools as Bernie Sanders, a senator for Vermont. But there is a sharp ideological distinction between them. Mr Sanders calls himself a “democratic socialist”; he talks of class struggle and wants workers to own 20% of big companies.

This resonates with much of the old left, and has support from new leftists such as Alexandria Ocasio-Cortez, a representative from New York. Ms Warren, in contrast, proclaims herself “a capitalist to my bones”. Mr Sanders would never say, as Ms Warren did last year, “I love what markets can do...They are what make us rich, they are what create opportunity.”



It was a paean with a crucial proviso: “But only fair markets, markets with rules.” Ms Warren believes that the rules under which American markets operate are unfair. She sees a system corrupted by cash turned into political capital. Thus most carbon emissions remain unpriced, tech giants accumulate more power and oligopolies dominate health care. Such market failures—or, in this view, market sabotage—gum up competition and widen income inequality, leaving millions of working families “hanging on by their fingernails”. Setting them right requires a wide range of reforms.

That this assessment thrills Democratic primary voters should perhaps not come as a surprise. Healthy capitalism depends on healthy competition. Yet two-thirds of American industries have seen market concentration rise in the past two decades. Competition should constrain profits as companies fight for customers; in America profits have soared.

In 2016 the incomes of the highest 1% of American earners were 225% higher in real terms than they had been in 1979 (see chart 2). For the middle-class, the growth was 41%. Today’s tight labour market gives American workers more negotiating power than they have had in years.

But that does not make up for the long-term shift towards inequality, both between the top 1% and everyone else, and between college graduates and less-skilled workers. Higher education, good health care and decent housing are unaffordable to many. America has some of the highest levels of poverty of any rich nation, and some of the lowest life expectancies.




To tackle inequality Ms Warren proposes a pincer movement. “Predistribution”, an idea developed by Jacob Hacker, a professor at Yale, would seek to boost pre-tax incomes for working families and limit economic gains perceived to be unjust, thus tempering the engines of inequality.

Hence a variety of actions aimed at breaking up or reining in big firms and better equipping workers. Old-fashioned redistribution would also seek to right the damage already done with taxing and spending. Ms Warren would not just reverse Mr Trump’s tax cuts. She would also impose new taxes on large companies and rich individuals—who would see their taxes rise more steeply than they have for almost a century, reversing a decades-long fall.

Companies would face an extra 7% tax on all profits above $100m—an amount levied on the profits the firms report in their accounts, rather than their taxable profits under current law.

There is often a large discrepancy between the two; tax exemptions created by a well-lobbied Congress result in many profitable companies paying little tax. The highest earners would also face heftier payroll taxes. Blaming the shortfalls that loom for Social Security (public pensions) by 2035 on “inadequate contributions by the rich”, Ms Warren would introduce new levies worth nearly 15% on roughly the top 2% of households.

Rich pickings

Then there is the wealth tax. Targeting the super-rich, Ms Warren promises a 2% annual levy on net worth over $50m, rising to 3% on fortunes above $1bn. Rich people expend a lot of effort avoiding such taxes. Indeed, the complexity of working out what they should cough up is one reason only three rich countries have them, compared with 12 in 1990.

The sense that a Warren presidency would be costly to them personally, as well as forcing change on their companies, doubtless adds to the antipathy felt towards her among most of America’s business elite. But the Social Security benefits for the elderly, free public college for students and universal child care which, among other ideas, these trillions could fund appeal to many voters.

Some of these plans would also show positive effects on economic growth, according to independent analyses by Mark Zandi, chief economist at Moody Analytics. The campaign, which has published some of his reports, has not yet shared the number-crunching Mr Zandi has done on free public college and student-debt cancellation, which may be less positive. (The Warren campaign would not confirm or deny this.) “Broadly speaking, she pays for what she has proposed,” says Mr Zandi. The only exception is Medicare for All. “It’s not clear to me how she is going to pay for it all. She hasn’t asked me to evaluate it.”

Medicare for All is a nationalised health-care plan proposed by Mr Sanders which Ms Warren endorses. The plan illustrates the sheer size of the changes Ms Warren envisages (see chart 3).

It would get rid of private health insurance, an industry with a market value of $530bn. Her more mainstream rivals for the nomination have started to press the senator on whether the $3trn in annual costs that come with that policy would require her to increase taxes on the middle class. She has not come up with a convincing answer—though she says that one is forthcoming.




Private equity would also be at risk.

The “Stop Wall Street Looting Act” she has introduced in the Senate changes the way private-equity firm employees’ income is taxed. Currently they pay capital gains and investment tax of just 23.8% on their earnings.

Under her plan they would pay income tax of up to 37%. But not everything Ms Warren wants to do to the industry is a matter of redistributing its gains. Her predistribution agenda requires the power of such concentrations of capital to be reduced.

Measures on “joint and several liability” in private equity contained in the act would in effect shut down their business, say industry bosses. By making the partners who manage and invest in the funds liable for the debt and pension costs of companies they acquire, they would impose a burden that public companies do not have to shoulder, scaring away institutional investors.

That would affect the ownership of 8,000 companies, more than twice the number of listed firms.

Other companies would also be broken up. She would revive the Glass-Steagall Act, separating banks’ deposit-taking business from their riskier investment activities. Federal regulators have allowed some giants to gain more power by acquiring potential rivals. Ms Warren would unwind those mergers.

Bayer, a huge life-sciences company, would have to sell Monsanto, a seed and chemicals company it acquired in 2018; Facebook would have to spin off Instagram and WhatsApp.

Online marketplaces with global revenues of more than $25bn would be regulated as “platform utilities”, and stopped from offering their own products and services on the regulated platforms. Google would have to sell its online advertising exchange, Amazon would not be able to sell on its marketplace.

Ms Warren also wants companies to be generally more accountable. In big companies, 40% of board seats would be reserved for workers’ representatives. All companies with revenues of more than $1bn would need to obtain a federal charter requiring their directors not just to serve their shareholders but also consider the effects of what they were doing, or not doing, on their workers, their suppliers, their neighbours, the environment and so on. State attorneys-general could petition the commerce department to revoke a company’s charter if they felt those norms were repeatedly being flouted.

In this she can claim to be going with the flow. In August nearly 200 chief executives, including JPMorgan Chase’s Jamie Dimon, Johnson & Johnson’s Alex Gorsky and Walmart’s Doug McMillon pledged “a fundamental commitment to all of our stakeholders”. “I completely agree with her that businesses need to be focused on stakeholders, not just shareholders,” says Marc Benioff, the chief executive of Salesforce, a software giant. But Ms Warren wants to turn these promises into state-monitored action.

Whether Ms Warren’s many plans would have their desired effect is open to question. So are their unintended consequences. A big investment bank might be enmeshed in credit markets in such a way as to need a government bail out in a crisis even if it had no deposit-taking arm. Workers on boards would probably garner higher wages, but that brings other complications.

A multinational company might have its headquarters in America but have more staff outside it, says Luigi Zingales of the University of Chicago. Why should American workers get a bigger say than those overseas? Dissuading corporate takeovers would limit companies’ ability to change with the times. Most disturbing, to Mr Zingales and many others, is the notion of company charters which the federal government could revoke. “Imagine a Trump administration with the power to go after companies in this way,” he says.

Not all of the predistribution agenda is aimed at humbling the mighty. Like most of the Democratic contenders Ms Warren wants paid family leave, a $15 federal minimum wage within five years, government investments in training and reforms that will make it easier for people to unionise. She would also ban forced arbitration and non-compete clauses, giving workers more power to challenge their employers and find new jobs. “Gig economy” companies would be required to treat workers as salaried employees.

Trading places

Ms Warren is not just seeking to change the rules for business. She also sees a big role for government in making America competitive: a role built on industrial policy and protectionism.

A new uber-agency called the Department of Economic Development would be charged with creating American jobs. Products made possible by taxpayer-funded R&D would have to be made in America.

If that sounds like a Warren policy that Mr Trump might support, it is not the only one. Ms Warren promises to run a government “more actively managing our currency value to promote exports and domestic manufacturing” in response to other countries manipulating their exchange rates.

She wants new committees representing consumers, rural areas and each region of the country to be able to delay trade deals that worry them. Since every trade deal will worry someone somewhere that sounds like an end to trade deals.

This brings to the fore a tension at the centre of Ms Warren’s capitalism. Many of her domestic policies are justified in terms of increasing competition. Blocking anti-competitive deals may be troublesome for Facebook but is generally good for everyone else. Yet when it comes to industrial and trade policy her love of competition wanes. She becomes, instead, a conventional protectionist.

Take the example of clean energy. Ms Warren sees environmental policy as an opportunity to play favourites and to protect American manufacturing. She wants an accelerated phase-out for carbon-free nuclear electricity and a ban on fracking, which has not only made America the world’s top oil producer but also provided it with a lot of cheap natural gas. This appeals to the Democrats’ base; but it would also make America’s transition to cleaner energy more expensive and less effective. Ask someone selling coal-fired electricity what they want for Christmas and an end to nuclear power and cheap gas will come high on the list.

Ms Warren abhors lobbying—she proposes an “excessive lobbying tax”, rising up to 75% for companies spending more than $5m annually. Nevertheless, despite this, her approach creates a lot more direct government investment that firms might lobby for. She seems unfazed by the possibility of government’s capture by insiders when those insiders are the right people with the right intentions. It is worth noting that Ms Warren designed her biggest governmental achievement to date, the Consumer Financial Protection Bureau, in a way that gave its director unusual power and autonomy.

Ms Warren has tried to avoid the practice of meeting Wall Street executives and big donors to help shape her agenda. Her solutions are instead informed by consultations with professors and think-tankers. Despite this, within these academic circles, Ms Warren’s ideas spark debate.

Because the proceeds of her new taxes are to be spent, they should not suck demand from the economy. More competition could encourage innovation. Subsidised child care could encourage more work; subsidised health care more willingness to chase dreams. That said, a disorderly dismantling of the fracking and private-equity industries, continued trade strife and the possible disincentives to work and invest caused by much higher taxes would cut the other way.




Larry Summers, a professor who led Barack Obama’s National Economic Council, and Natasha Sarin of the University of Pennsylvania argued earlier this year that a wealth tax would be difficult to implement and could depress enterprise. They also think it would raise less money than the Warren campaign claims.

Income inequality would surely fall somewhat, especially by taxing the very top of the income distribution. Emmanuel Saez and Gabriel Zucman, two economists at the University of California, Berkeley, who influenced Ms Warren’s tax policy and who have written a new book on inequality (see article), estimate that her proposals would increase the tax bill of the richest 0.01% of Americans. Currently, they pay 33% of their pre-tax income in tax, which would rise to 61%. But there is a limit to how much inequality can be fought through taxing the very rich. Much depends on Ms Warren’s policies to improve the life of the precarious middle class, for instance through health insurance and subsidised child care.

A roll of the dice

The fact that most of the Democratic field is less radical than Ms Warren suggests that, even if her party were to take the Senate and retain the House in 2020, much of her agenda would be watered down. If Republicans retained control of the Senate there would be a lot less she could do. But she would still have some scope to act.

The Environmental Protection Agency could reverse regulatory rollbacks set by the Trump administration. The federal government could enforce stricter labour standards, such as a $15 minimum wage in the public sector.

Warren appointees to the Federal Trade Commission and the justice department could reverse previously approved mergers and reject new ones, though such actions would probably be challenged in the courts. A National Labour Relations Board in her hands could decide that “misclassification” of workers as independent contractors was a violation of labour law, upending the gig-economy. Her power over trade and tariffs would be comparatively unconstrained.

A good position months before the first primaries and a year before the election is no one’s idea of a guaranteed win. But Democratic voters like what they see. In a recent poll by Quinnipiac University, 40% of respondents said Ms Warren had the best policy ideas, compared with 16% for Mr Biden and 12% for Mr Sanders. This suggests that real change is afoot within the party, even if it is not quite yet a new New Deal. But as well as worrying about what Ms Warren proposes, American bosses need to realise that she is no longer the outlier she may once have appeared to be.

The EU needs to be a power project

The emerging world order will increasingly be shaped by might, rather than law

Gideon Rachman


© Efi Chalikopoulou


In Britain and the US, the idea that the EU could aspire to be a superpower is usually treated as either ludicrous or sinister.

So when Guy Verhofstadt, a prominent member of the European Parliament, recently made the case for the EU to be part of an emerging “world order that is based on empires”, there was a predictable backlash. At the Conservative party conference a few days ago, his words, taken from a speech to their anti-Brexit enemies the Liberal Democrats, were cited as evidence of the dangerous imperial ambitions of the EU — and proof that leaving the bloc is the UK’s only safe option.

Mr Verhofstadt can be arrogant. But, in this case, he also happens to be right. The rise of China and India, and the America First policies of Donald Trump’s US, makes it more important than ever that European countries defend their interests collectively.

The EU once dreamt that the whole world would move towards a law-based system, similar to the EU method. But a world order, shaped by Xi Jinping’s China and Trump’s America, will be based on power rather than rules. The outbreak of a global trade war underlines that small European countries can no longer rely on international rules to protect them. They need the bulk and heft that the EU provides.

The former Belgian prime minister’s choice of the word “empire” — with its connotations of conquest — was unfortunate. The EU is an empire by invitation. Nobody is forced to join. And, despite the difficulties of Brexit, any member is free to leave. It would be more accurate to say that the EU can and should aspire to be a superpower — one of four or five major global powers, capable of shaping the world order.

That aspiration is eminently achievable. Indeed, in important respects, it has already been achieved. Last week provided an interesting illustration when the European Court of Justice ruled that individual countries can demand that Facebook take down defamatory content, on a global basis.

The ECJ ruling was made in response to a complaint from an Austrian politician — and prompted an immediate and concerned response from Facebook. If this had just been a ruling by an Austrian court, the Californian internet giant would have been able to brush it off.

But the ECJ has sway over a market of more than 500m people — compared with the 9m in Austria. Facebook’s ambitions for Libra, a digital currency, will also be shaped by rulings made in Brussels. The EU’s decisions — good or bad — change the behaviour of the world’s largest firms, from Silicon Valley to southern China.

The EU is most comfortable and powerful when acting on economic issues such as trade or competition policy. But it is also a geopolitical force. Russia’s annexation of Crimea and continued interference in Ukraine has been met with sanctions and travel bans that have slowed the Russian economy and hemmed in the Russian elite. Last August in Moscow, I found myself commiserating with a member of President Vladimir Putin’s inner circle who is now banned from taking his summer holiday in southern France or Italy. Bodrum in Turkey, we agreed, was just as nice.

The collective power of the EU is also evident over Brexit. The British elite is still trying to adjust to the fact that, for the first time in centuries, Ireland is pushing Britain around — rather than vice versa. The EU economy (even without Britain) is more than five times the size of the UK economy. Backed by the rest of Europe, the Irish can stand their ground on Brexit.

Of course, those who scorn the idea that the EU can ever be a superpower have some powerful points. They stress that the EU lacks the military muscle to back up its geopolitical ambitions — a problem that will get worse when Britain leaves. The critics can also point to damaging disagreements within the EU — on issues ranging from migration to the future of the eurozone.

It is also true that EU countries spend less on the military, as a percentage of gross domestic product than the US, Russia or China. Europe’s reliance on US military deterrence continues to anger the White House. But even if the US pulled all its troops out of Europe, which is unlikely, it would still be a huge gamble for Russia (or anyone else) to risk military aggression against a collective with the size and wealth of the EU.

The fact is that, in the nuclear age, advanced industrial nations tend not to go to war with each other. Big power struggles are played out through other means — such as the current trade war. And here, the EU — with its huge internal market and a unified trade and competition policy — is well-equipped to slug it out with China and the US; it comfortably outmatches Russia or India.

It is true that the EU is riven by internal divisions. But all political entities that are large enough to aspire to superpower status are also large enough to be plagued by internal splits. This is true of the US, where political rivalries are so acute that the president is tweeting about civil war. It is also true of China and India — just look at the problems in Hong Kong and Kashmir.

Like all “empires”, the EU could eventually fly apart. But the external pressures on European nations makes it more likely that the EU nations will manage their differences and continue to pull closer together. The EU used to be called a peace project. In the modern world, it is more of a power project — and rightly so.

The world economy

Inflation is losing its meaning as an economic indicator

Economic policy must adapt, says Henry Curr

Why Gold Has Stalled

by: Adam Hamilton

 

 

 

Summary

 

- Gold’s strong summer advance stalled out for good reasons. Gold surged to super-overbought levels, sucking in all available near-term buying. Gold-futures speculators’ bets became excessively-bullish exhausting all their buying firepower.

- Once gold’s advance flagged, the momentum-driven gold investment demand withered. Speculators’ collective gold-futures bets can stay extreme for some time, but eventually a catalyst hits forcing them to start normalizing.

- Gold, silver, and the stocks of their miners are going to remain precarious with serious downside risks until that necessary gold-futures selling comes to pass.
 

 

Gold has stalled out, drifting sideways to lower for nearly a couple months now. Traders are becoming more frustrated its preceding powerful rally has failed to resume. That is inexorably eroding this past summer's bullish psychology. Corrective phases to rebalance sentiment are normal and healthy after strong uplegs. Gold had grown too overbought, exhausting traders' near-term buying firepower in the process.

 

Bull markets are simply an alternating series of uplegs and corrections. Visualize the core bull-market trend as a rising straight line, and uplegs and corrections are like a sine wave oscillating around it.

 

Prices power to new bull highs in uplegs, surging well above trend. That generates much greed, sucking in all available capital. Both speculators and investors interested in buying anytime soon pile in near bull highs.

 

That overdone buying late in uplegs necessitates corrections. They drag prices lower long enough to bleed off toppings' excessive greed. The selling they spawn generates fear, eventually resetting traders' buying potential and paving the way for the next upleg. The duration of corrections depends on how fast they can rebalance sentiment. They run on a continuum between big and quick to slow and drawn-out.

 

Gold's last major interim high was 7 weeks ago, $1554 on September 4th. That followed a strong upleg, where gold powered 32.4% higher over 12.6 months. And like most uplegs, a large fraction of its gains accrued disproportionately in its final months. During the last 1/5th of this upleg which ran from gold's decisive bull-market breakout in late June until its early-September peak, over half of its entire gains were seen!

That self-feeding buying frenzy last summer catapulted gold to extremely-overbought levels. The bigger and faster price gains, the greater the odds unsustainable overboughtness will result.

 

After decades of study, my favorite indicator for quantifying overboughtness is where prices trade relative to their trailing 200-day moving averages. I developed a trading system around this over 15 years ago, called Relativity.

 

By early September gold had rocketed so far so fast that its price divided by its 200dma yielded a relative multiple of 1.166x. In other words, gold's price had stretched 16.6% above its 200dma. That was the most-extreme seen in 8.0 years, since September 2011 right after gold's last secular bull peaked! The current bull's maiden upleg topped in early July 2016 after gold clocked a couple daily closes exceeding 1.15x.

 

What happened next wasn't pretty, extreme overboughtness isn't to be trifled with. Over the next 4.2 months into late 2011, gold plunged 18.3% in a severe correction that would later prove the start of a new bear market. And after that mid-2016 episode, gold dropped a similar 17.3% during the following 5.3 months. There are many more examples of major gold selloffs emerging out of extreme overboughtness.

 

It is such an ominous short-term omen because of how prices, sentiment, and buying firepower interact. Prices can only blast higher too far too fast when popular greed grows excessive. Big rallies breed greed, motivating traders to buy aggressively to chase the mounting gains. So they swiftly throw all the money they are willing to risk at that market. While that does quickly bid prices higher, it rapidly exhausts buyers' capital.

 

The upward price velocity of uplegs is a direct function of how much buying speculators and investors are doing. The more they rush to buy, the more capital they throw at a hot market, the faster they expend their available buying firepower. Once that is tapped out and dries up, only sellers remain. Uplegs fail and roll over into corrections once all available buyers are essentially fully deployed. That just happened in gold.

The gold price has two dominant primary drivers, speculators' collective gold-futures trading and investors' investment demand. I discussed the former in depth in mid-September soon after gold's latest peak, warning of a very-bearish gold-futures-selling overhang. Then a couple weeks ago I wrote on the fragile gold investment demand. Today's essay melds these research threads to try and help frustrated traders.

 

Gold-futures trading overwhelmingly drives gold's short-term price action for two reasons. Gold futures allow extreme leverage, greatly multiplying their capital's collective impact on gold. And the resulting price happens to be the world's reference one, which heavily colors gold's overall psychology. Without a doubt the biggest mistake most traders of gold, silver, and their miners' stocks make is not watching gold futures.

 

Most traders buy gold or gold ETFs outright, with each dollar deployed exerting that same amount of price pressure on gold. But gold-futures speculators punch way above their weight, giving them wildly-outsized influence on gold prices. This week each 100-troy-ounce gold-futures contract controlling $150,000 worth of gold at $1500 only required a maintenance margin of $4,500. That enables extreme leverage up to 33.3x!

 

So fully-margined gold-futures speculators can effectively multiply their capital's price impact on gold up to 33x when buying and selling. Each dollar they deploy has the same price impetus as thirty-three dollars invested outright. Running extreme leverage is hyper-risky, as gold merely moving 3.0% against a position at 33.3x leverage will obliterate 100% of the capital risked! This necessitates an ultra-short-term focus.

 

While investors have time horizons measured in years, and normal speculators in months, gold-futures speculators are forced to think in terms of days or weeks at most. Their extreme leverage doesn't give them the luxury of riding multi-month trends. All they can care about is what the gold price is doing and likely to do in the immediate future. This myopic focus renders most normal gold analysis irrelevant to them.

This chart superimposes gold over speculators' total gold-futures long and short contracts, which are published weekly in the CFTC's famous Commitments of Traders reports. Their longs or upside bets on gold are drawn in green, and shorts or downside bets in red. Note how gold's price throughout this entire bull has closely mirrored what the gold-futures speculators as a herd are doing! That will continue to hold true.

 

 

 

In gold-futures trading, there are two ways to both buy and sell. Speculators can buy gold futures to add new longs, or buy to cover and close existing shorts. And they can sell to exit current longs, or sell to open new shorts. The gold price impact of buying and selling gold futures is identical whether it is done to open new or close current positions. Gold-futures buying and selling always drives gold's uplegs and corrections.

 

Gold's strong 32.4% upleg that peaked in early September was mostly fueled by specs adding 172.9k long contracts and buying to cover another 157.5k short ones. That added up to a huge 330.4k contracts of total spec gold-futures buying between mid-August 2018 to early-September 2019. That made for the equivalent of 1027.6 metric tons of gold buying! Keep that in mind to compare with investment buying later.

 

Note in this chart that this latest upleg's strongest gold advances occurred when gold-futures specs were aggressively buying longs and covering shorts. This is evident in a rapidly-rising green line and a fast-falling red one. Conversely when specs' positioning was stable, gold flatlined. And when they started selling, gold was dragged lower. Gold is hostage to specs' gold-futures trading thanks to its extreme leverage.

 

I've actively traded for decades now, earning my fortune in the markets. In all that time, I've never once used margin. I think it is crazy. There is plenty of risk and great rewards to be won without taking on the wildly-amplified additional risks leverage entails. The large majority of speculators and investors share the same opinion on this. The fraction of traders willing to run 10x, 20x, 30x+ leverage is very small.

So both the pool of available gold-futures speculators and the collective capital they command is finite. Eventually their buying firepower gets exhausted, leaving them nothing to do but sell. While we can't know exactly when that happens in real-time, we can certainly game the odds it is close. Both total spec gold-futures longs and shorts have carved trading ranges over the decades. These help define extremes.

 

As of the latest CoT week ending last Tuesday, speculators held 382.4k gold-futures long contracts and 94.2k short ones. These are really high and really low historically, suggesting there's not much room to buy and drive gold higher. But there's vast room to sell and pummel gold lower. The main reason that gold stalled since early September is speculators had exhausted their buying firepower on both sides of the trade.

 

Their total long contracts hit 433.0k and 431.0k in late August and early September, and bounced slightly higher in late September to 433.9k. These are extreme levels by any measure, the 2nd, 3rd, and 4th highest seen out of all 1085 CoT weeks since early 1999 in gold's modern era! They were only eclipsed by early July 2016's all-time-record high 440.4k, which again preceded a monster 17.3% gold correction.

 

In this chart it is crystal-clear that gold stalled out exactly when specs stopped buying gold-futures longs. With their positioning so excessively-bullish and extreme, that left a massive gold-futures-selling overhang threatening gold. Gold hasn't corrected hard yet, only drifting modestly sideways to lower, because these guys haven't been scared into selling en masse. But that could still happen anytime with the right catalyst hitting.

 

In this latest CoT week, total spec longs remained way up in the 97th percentile of all CoT weeks.

 

There is far more likely to be major selling than big buying from here. Anything over 350k contracts is worrying, and that happens to coincide with about the 94th percentile. For 17 CoT weeks in a row now, total spec longs have been above 350k. They averaged a lofty 396.6k over that recent span, or the 98th percentile!

These recent persistent extreme spec-long levels are eerily reminiscent of mid-2016. This gold bull's maiden upleg peaked then after rocketed 29.9% higher in just 6.7 months. Spec gold-futures longs remained above 350k continuously for 17 CoT weeks, averaging 409.8k or almost the 99th percentile of all modern CoT weeks. Spec longs can remain excessively-high for some time, but eventually they must normalize.

 

And that was seriously painful for traders ignoring the gold-futures situation, as gold again plunged 17.3% over the next 5.3 months. The major gold miners' stocks amplified that downside by 2x to 3x like usual, with the leading GDX VanEck Vectors Gold Miners ETF (GDX) plummeting 39.4% in roughly that same span! It doesn't pay to buy gold and gold stocks high once speculators' gold-futures buying nears exhaustion levels.

 

Compounding gold's near-term downside risks, total spec shorts are near major lows. Back in late August they sunk to a deep 4.5-year low, and extended that slightly to a 4.6-year one just 3 CoT weeks ago. In this latest CoT week they were trading just 8% up into their gold-bull-market trading range since mid-December 2015. That compares to spec longs running 77% up into their own, after hitting 97% in late September.

 

As is apparent in this chart, spec shorts have an effective floor. No matter what gold does, there are always traders betting it will fall lower. Today's spec shorts remain right near those bull-market lows, so there is little room left to buy to cover additional shorts. Instead there is vast room to add new shorts to pile on to gold's downside momentum driven by specs dumping longs when the right catalyst inevitably arrives.

 

Considered from this bull's extremes, in this latest CoT week speculators had room to add 57.9k longs and buy to cover another 14.5k shorts. That adds up to 72.5k contracts of potential buying. But they had room to sell 195.7k longs and short sell another 162.6k. That makes for 358.2k contracts of potential near-term selling. With room for selling outweighing room for buying by 4.9x, it's hard to be bullish on gold.

Gold stalled out because these gold-dominating traders exhausted their buying in early September.

 

And gold is going to struggle until those excessively-bullish bets are normalized by selling longs and adding shorts. Gold will remain saddled with serious downside risks until spec longs and shorts mean revert. I don't like it either, and am eager for gold's next upleg. But with this spec positioning, we have to stay wary.

 

The secondary reason gold has stalled out is identifiable investment inflows have disappeared as gold's futures-fueled upleg peaked and started drifting lower. This next chart looks at this gold bull compared to the physical gold bullion held in trust by the world's leading and dominant GLD SPDR Gold Shares gold ETF (GLD). It publishes its holdings daily, making them the best high-resolution proxy for gold investment demand.

 

 

 

While successful investment requires buying low then later selling high, gold investors love to buy high. They get most excited about gold when it is surging, succumbing to greed to pile in to ride that upside momentum. Differential buying of GLD shares during gold's recent 32.4% upleg forced this ETF to add 122.5 metric tons to its holdings. That was less than 1/8th of spec gold-futures buying during that span!

 

New-high psychology is a powerful motivating force for investors to buy, and fueled a massive 131.8t GLD build in the 2.5 months between gold's decisive bull-market breakout in late June and its early-September peak! That was actually bigger than GLD's build over this entire upleg, since this ETF's holdings slumped even lower in June than when gold's upleg was born. American stock investors were buying big.

 

But once gold's new highs ceased as gold-futures speculators' buying firepower exhausted, so did the outsized gold investment demand soon after. With US stock markets hovering near all-time-record highs, investors feel little need to prudently diversify their stock-heavy portfolios. They aren't worried about any material stock-market selloffs, so the only reason they flooded into gold recently was to ride the momentum.

That's why this recent gold-investment-demand surge is quite fragile. As long as US stock markets don't plunge, gold investors will flee when gold rolls over on the inevitable spec gold-futures selling coming. American stock investors in particular will dump GLD shares faster than gold is being sold, forcing this ETF's managers to sell gold bullion exacerbating gold's selloff. Gold's momentum-dependent demand isn't durable.

 

Again mid-2016's precedent is ominous. Investors poured into gold early that year as this gold bull's strong maiden upleg soared higher. And investors were mostly content to remain in gold as long as its price stayed near highs. But once gold turned south materially on gold-futures selling, investors rushed for the exits as evident in GLD's holdings. The result was that miserable 17.3% gold correction in late 2016.

 

Every day I get e-mails from subscribers wondering why I'm not buying gold stocks right now. And my answer is simple. Why buy now if odds heavily favor materially-lower gold prices in the near future? The major gold stocks leverage gold corrections by 2x to 3x, so if gold corrects 10% GDX is going to fall 20% to 30%. At worst so far in late September, gold had merely retreated 5.2% from its early-September peak.

 

Successful trading isn't about doing what you want to do, but what you ought to do. While you won't win every time, the goal is to only trade big when the odds are most in your favor. A poker player who bets big holding a hand with just two pairs isn't brave, but a fool. The smart ones won't throw all-in unless they are holding something strong like a full house or four-of-a-kind. Probabilities need to offer high chances of success.

 

And the current still-overbought gold-price levels, still-excessively-bullish speculator positioning in gold futures, and momentum-driven gold investment make for high odds gold's correction is not over. Few are taking it seriously so far because it has looked like a benign high consolidation. But until specs' lopsided gold-futures bets mean revert to more-normal levels, it is highly likely gold faces more sizable selling soon.

Gold's powerful upleg stalled out a couple months ago for major reasons, so as long as they persist there is no reason to expect this bull's next upleg to start marching. We can't change the markets, so it is futile to fight them and counterproductive to worry about what they are doing.

 

When corrections are likely, the best course is to patiently wait them out in cash to preserve capital and boost buying power at their bottoms.

 

The bottom line is gold's strong summer advance stalled out for good reasons. Gold surged to super-overbought levels, sucking in all available near-term buying. Gold-futures speculators' bets became so excessively-bullish that they exhausted all their capital firepower. And once gold's advance flagged, the momentum-driven gold investment demand withered too. Gold won't rally materially until all this is rectified.

 

Speculators' collective gold-futures bets can stay extreme for some time, but sooner or later a catalyst hits forcing them to start normalizing. The radical leverage inherent in that market makes selloffs self-feeding. Gold, silver, and the stocks of their miners are going to remain precarious with serious downside risks until that necessary gold-futures selling comes to pass.

 

Jumping the gun on buying will be punished.

A Crash Will Come. And That’s OK.

Trying to prepare for the next cataclysm could mean missing some of the market’s best days

By Spencer Jakab


Illustration: Giulio Bonasera


A crash is coming.

Relax, it probably isn’t imminent. For something so infrequent, though, the “c” word is awfully good at grabbing investors’ attention. This Tuesday is the 90th anniversary of the granddaddy of them all, Black Tuesday, so it is natural to dwell a bit more than usual on the timing of the next wealth-destroying cataclysm.

There were U.S. stock market collapses before 1929, of course, such as the Panic of 1907, which also reached a crescendo in October. And by far the largest single-day crash of all happened in October 1987. Anyone sense a pattern? Well there isn’t one, but the coincidence has unfairly given October a reputation as a risky month to be in the market.

Fed Votes to Lighten Regulations for All but the Largest Banks

Banks including Capital One, U.S. Bancorp, Barclays and Credit Suisse can file ‘living wills,’ which describe how they would wind down in a failure, less often.

By Jeanna Smialek


Lael Brainard, a Fed Board governor, said that while she supported some of the adjustments approved on Thursday, the overall package of changes went too far.CreditCreditEric Baradat/Agence France-Presse — Getty Images


Federal Reserve Board members voted on Thursday to adjust key bank regulations put in place after the financial crisis, enacting a series of changes that one board governor, Lael Brainard, warned could weaken “core safeguards.”

Regulators are tying rules more closely to bank size, reducing the necessary level of cash and government bond stockpiles at all but the largest and most complex institutions. Affected banks will also be allowed to submit “living wills” — documents detailing how a bank would wind itself down in the event of failure — less frequently.

Banks with $250 billion to $700 billion in total assets, including firms like Capital One and PNC Financial, will now have to submit a resolution plan every three years, alternating between full and partial filings. They are currently required to submit a full report annually, though in practice they have usually received extensions because the process is so complex. Foreign banks with operations in the United States, including Deutsche Bank, Barclays and HSBC, will also be allowed to file less often.

Ms. Brainard said that while she supported some of the changes approved on Thursday, the overall package went too far.

“I support some reduction in the frequency of plan submissions to temper the substantial work entailed,” Ms. Brainard said. But, she added, the changes go beyond what is mandated by a regulatory relief law “in ways that may weaken the resolution planning process for very large banking firms and leave the system less safe.”

By contrast, both the Fed chair, Jerome H. Powell, and the vice chair for supervision, Randal Quarles, said the changes maintained critical safeguards while making regulation more efficient.

The framework “more closely ties regulatory requirements to underlying risk, in a way that does not compromise the strong resiliency gains we have made since the financial crisis,” Mr. Quarles said.

Requirements for the largest and most globally important banks went mostly unchanged in the rules the board approved on Thursday, though the package does formalize a longer cycle for living wills for such banks. They are now required to submit every two years, alternating between partial and full plans, bringing actual regulation in line with current practice.

Partial living wills require that banks describe most core activities, but can leave out some aspects of bank operations — corporate governance practices, for example — that have not changed between filings.

Ms. Brainard, the lone dissenter, also objected to the fact that Thursday’s overhaul will reduce some banks’ “liquidity coverage ratios,” which require banks to keep a stock of cash and government bonds on hand to meet financial obligations in case of trouble.

Institutions in the $250 billion to $700 billion range will see their requirements reduced by 15 percent.

“It is premature to reduce core capital and liquidity requirements for large banking institutions, since they have not yet been tested through a full cycle,” she said. “At this point late in the cycle, we should not give the green light to large banking organizations to reduce the buffers they worked so hard to build post-crisis.”

The changes will also allow some bigger banks to omit an accounting measure that takes into account unrealized losses when calculating regulatory capital, slightly reducing their capital requirements.

The rules still need to be approved by the Federal Deposit Insurance Corporation and, in one case, the Office of the Comptroller of the Currency. Many of the adaptations were required by a regulatory relief act that President Trump signed into law in May 2018, though regulators had discretion in shaping them.

Thursday’s tweaks are the latest installment of a broader regulatory fine-tuning that has been underway since last year. Supporters say the changes to post-crisis restrictions placed on America’s banks amount to a right-sizing, since the new regulation was slapped on quickly and often without considering individual characteristics.

Skeptics have argued that the changes together amount to a substantial weakening of post-crisis regulation, and could leave the system vulnerable to future shocks.

This week, the Fed voted to simplify the so-called Volcker Rule, which prohibits banks from making risky bets with customer deposits. The updated rule is easier on banks than the initial version proposed in May 2018, dropping an accounting test that would have exposed a broader swath of trades to regulatory scrutiny. Ms. Brainard also voted against that change.

This is unlikely to be the final chapter in simplifying regulations. Mr. Quarles, who is overseeing the Fed’s regulatory revisions, seems to be turning next to banking supervision — how Fed employees apply regulations to the banks the central bank oversees in real time.

He told lawyers gathered at a Georgetown University conference last month that he “would welcome greater legal scholarship on the due process considerations associated with bank supervision.”

And on Thursday, he said that he was “eager to identify other process improvements to our supervisory framework that would not sacrifice the important strides we have made in resilience since the crisis.”

That focus on supervision seems to be shared by the banking industry. The Bank Policy Institute, which represents banks affected by the rules, said in a statement after the board vote that the Fed has enacted the regulatory relief law “faithfully.”

“The next step is equally important,” Greg Baer, the organization’s president, said in a statement. “To ensure that the examination process is aligned with the new regulatory framework and not allowed to reimpose the same old requirements.”


Jeanna Smialek writes about the Federal Reserve and the economy for The New York Times. She previously covered economics at Bloomberg News, where she also wrote feature stories for Businessweek magazine.