More Keynesian than Keynes.

Niall Ferguson
JUN 1, 2015
. Robert Skidelsky

CAMBRIDGE – Like most people who create an “ism,” John Maynard Keynes quickly found his followers running ahead of him. “You are more Keynesian than I am,” he once told a young American economist. Now it is the turn of his biographer, Robert Skidelsky, to become distinctly more Keynesian than Keynes.
Keynes was not averse to changing his mind. But, as far I am aware, he did not change his predictions after the fact. This does not seem to be the case for Skidelsky.
In November 2010, Skidelsky described British Chancellor of the Exchequer George Osborne as a “menace to the future of the economy,” whose policies “doomed” the United Kingdom to “years of interminable recession.” In July 2011, he declared that Osborne was making a “wasteland.”
None of this happened; the honest thing to do would be to admit that. But, in pseudo-science, you never acknowledge that a prediction was wrong and thus that the model might be defective.

So now Skidelsky retrospectively “predicts” something quite different: “that the start of austerity aborted the recovery in 2010; that recovery would have come sooner if the pre-austerity level of public spending had been maintained; [and] that it was the reduction of austerity in 2012 that enabled the economy to expand again.” With a flourish, he concludes: “The facts are consistent with Keynesian theory.
Keynesians said austerity would cut output growth. Output growth fell.”
Yet even Skidelsky admits that he and his fellow Keynesians “cannot prove” this. Indeed, nothing in Keynes’ theory would allow such simplistic causal inferences. After all, other forces were at work after 2010 – not least the eurozone crisis (which some non-Keynesians, including me, actually predicted before it happened).
Nor would Keynes have been as confident as Skidelsky that the counterfactual of continued high deficits would have been without risk or cost. Historical experience – including in the United Kingdom in the 1970s – tells us that financial markets are not always convinced by heavily indebted governments that promise to solve their problems by borrowing even more.
Responding to some early critics of his General Theory, Keynes showed that he recognized the importance of uncertainty in economic life, and consequently the difficulty of making predictions. “The whole object of the accumulation of wealth,” he wrote, “is to produce results, or potential results, at a comparatively distant, and sometimes at an indefinitely distant, date.”
But, Keynes continued, “our knowledge of the future is fluctuating, vague, and uncertain.”

There are simply too many things – from the “prospect of a European war” to the “price of copper and the interest rate 20 years hence” – about which “there is no scientific basis on which to form any calculable probability whatever.”
There was much that we did not know in 2010. We did not know if the UK’s banking crisis was over; if its very large fiscal deficit (amounting to nearly 12% of GDP) was sustainable; or what the interest rate would be in two years, much less 20. The situation was so grave that no responsible politician favored the type of policies that Skidelsky argues should have been adopted.
In fact, at that point, the only real difference between the approach of the Labour government’s chancellor of the exchequer, Alistair Darling, and that of Osborne consisted – as is clear from Darling’s last budget statement – in the timing of austerity. In March 2010, Darling vowed to reduce the deficit to 5.2% of GDP by 2013-2014. Under his Conservative successor, the actual deficit in that year was 5.9%.
Skidelsky argues that “austerity hit the economy, and by hitting the economy, it worsened the fiscal balance.” But that presupposes what he cannot prove: that a larger deficit could have been run without any costs.
All Skidelsky can offer as evidence to support this supposition is the view of the bond markets: “Long-term nominal and real interest rates were already very low before Osborne became chancellor, and they stayed low afterwards.” But, if it were true that “austerity worsened the fiscal balance,” the markets should have punished Osborne. They did not.
Likewise, if it was true that higher deficits carried no risks, but brought increased benefits, then the Financial Times would have been full of articles by investment-bank economists saying just that. It was not.
To be sure, I must acknowledge that I erred in one respect, which I am grateful to Skidelsky for pointing out. In May, I wrote that “at no point after May 2010 did [business confidence] sink back to where it had been throughout the past two years of Gordon Brown’s catastrophic premiership.” As Skidelsky rightly pointed out, confidence recovered from its low point in the first quarter of 2009, and reached a plateau in the first half of 2010. So I should have written: “At no point after May 2010 did it sink back to its nadir during Gordon Brown’s catastrophic premiership.”
But that does not alter my point that the more Paul Krugman talked about the “confidence fairy” – a term he coined after Osborne became Chancellor to ridicule anyone who argued for fiscal restraint – the more business confidence recovered in the UK. Although confidence fell somewhat in the first two years under Prime Minister David Cameron, it never approached the low point of the Brown period, and it later recovered.
Nowadays, some economists seem to believe that pointing out a single factual error (out of more than 20 statements of fact) invalidates an entire argument. But, while it may cause a flutter on Twitter, that is not the way serious intellectual debate works.
Similarly, Skidelsky cannot prove that austerity was responsible for the dip in confidence. The eurozone crisis is a more likely culprit. After all, Darling had promised his own version of austerity in March 2010.
Skidelsky attempts to salvage his and Krugman’s claim that the UK’s economic performance since 2010 was somehow worse than its performance during the Great Depression, writing that “real per capita GDP has taken longer to recover this time around.” But a serious student of the Depression – which Skidelsky used to be – knows that, compared to the 1920s, the UK had a relatively smooth ride in the 1930s, not least because abandoning the gold standard in 1931 allowed for monetary-policy easing. In any case, unemployment was far higher in the 1930s than in the 2010s. And that is the measure that should matter to Keynesians.
To muddy the waters, Skidelsky cites work by David Bell and David Blanchflower on “underemployment.” He also raises the issue of productivity, referring to research by the Trades Union Congress. But at no point in this discussion have I made any claims about the quality of the jobs created in the UK since 2010, or about the productivity of workers.
As a general rule, union leaders would rather see their members in “good” jobs, even if that means unemployment for others. My view is that employment, even in low-paid or part-time jobs, is better than unemployment. Were he alive today, I think Keynes would agree.
Nevertheless, I am glad to see that Skidelsky (unlike Krugman) acknowledges the need for supply-side reforms “to improve skills, infrastructure, and access to finance,” and concedes that he and his fellow Keynesians “have been slow to understand that a government cannot increase the national debt without limit for a cause in which most people do not believe.” He may be beginning to see the light.
Given the way Keynesianism came to be associated with inflationary fiscal and monetary policies in the 1970s, it is easy to forget what a hawk Keynes was in his final years. The whole point of his 1940 pamphlet How to Pay for the War was that higher taxes were needed to avoid the kind of inflation Britain had experienced during World War I. Toward the end of World War II, he fretted about the high level of military spending, and was depressed by the loss of power that came with Britain’s large external debts.
How do I know all this? Because I read it in the third volume of Skidelsky’s masterful biography of Keynes. Perhaps, before firing any more salvos at a fellow historian, its author should re-read his own book. It might make him a bit less Keynesian.

Draghi says ‘get used to’ bond volatility

Bund yields climb to highest in 8 months on ECB head’s comments

Mario Draghi fuelled a sharp sell-off in eurozone bonds on Wednesday, after the European Central Bank president said debt markets had to “get used” to volatility in an era of ultra-low interest rates.

Yields on benchmark eurozone sovereign debt, which move inversely to prices, spiked to their highest level so far this year. The yield on German 10-year bonds — Bunds — hit 0.897 per cent, its highest since October last year. It has risen 32 basis points in two days, a jump not seen since 1998, according to Citi.

The movements mark the latest bout of instability to hit Europe’s sovereign debt markets since the ECB launched its €1.1bn quantitative easing programme.

“There was some latent hope that Mr Draghi might try to smooth the market volatility,” said Justin Knight, a fixed-income strategist at UBS. “The fact that he was not only relaxed about higher yields but said that we would have to get used to higher volatility, suggested he was super-relaxed — and that has played into market sentiment.”

The sovereign bond buying scheme initially pushed European borrowing costs sharply lower, but its effects were suddenly thrown into reverse at the end of April when Bund yields leapt higher. There was no obvious single trigger, but strategists blamed market distortions as well as shifts in investor sentiment, and Mr Draghi’s comments on Wednesday reignited that turbulence.

“The market is so illiquid that you have very violent and quick movements — it’s not a very efficient market these days because QE is distorting everything,” said Yoram Lustig, a fund manager at Axa Investment Managers.

The ferocity of the recent bond rout has drawn parallels with the “taper tantrum” sparked by the US Federal Reserve’s plans to end QE in 2013, and reawakened concerns that global bond markets are heading into a more uncertain era after a three-decade bull run.

The market moves sparked by Mr Draghi’s comments rippled across the Atlantic, sending the US 10-year Treasury yield 11 basis points higher to 2.37 per cent, the highest since November last year.
Treasuries have historically tended to push other global bond markets around, but the eurozone has led movements since the ECB first announced plans to start QE.

Before Mr Draghi’s remarks, positive economic data, investor concerns over bond market liquidity and anticipation of a deal between Greece and its creditors had already encouraged investors to shed their exposure to Bunds. The sell-off gathered pace following the ECB president’s comments, made at a press conference in Frankfurt at mid-afternoon local time.

“We should get used to periods of higher volatility. At very low levels of interest rates, asset prices tend to show higher volatility,” Mr Draghi said. “The [ECB’s policy making] governing council was unanimous that we should look through these developments and maintain a steady monetary policy stance.”

The council left its benchmark interest rate at its record low of 0.05 per cent on Wednesday. It continues to charge 0.2 per cent on a portion of banks’ deposits held at the ECB.

The central bank’s staff nudged up their forecast for inflation this year while expectations for growth in 2017 were a little lower.

The latest forecasts show inflation at 0.3 per cent in 2015, 1.5 per cent in 2016, and 1.8 per cent the following year. Meanwhile, growth is expected to hit 1.5 per cent this year, before rising to 1.9 per cent in 2016 and 2 per cent in 2017.

Signs the threat of a serious bout of deflation is receding in the eurozone are yet to impact the ECB’s plans to continue buying debt at its current pace until September 2016.

The ECB president on Wednesday signalled the governing council had every intention of keeping to the schedule unveiled in January, saying that planning exit strategies was a “really high-class problem.”

“We’re really far from that, so we are not discussing anything about that,” Mr Draghi said.

Additional reporting by Ralph Atkins

Eurozone sovereign borrowing costs surged to their highest level of the year on Wednesday with selling of bonds accelerating after Mario Draghi, president of the European Central Bank, said higher volatility loomed for the market.

The yield on German 10-year Bunds, which moves inversely to prices, hit 0.89 per cent, the highest level since October last year and eclipsing the peak scaled in late April, when the market swooned for the first time after the ECB launched quantitative easing. The benchmark yield has risen 32 basis points in two days, a jump not seen since 1998, according to Citi.

During the current era of extraordinary monetary actions from central banks, investors have benefited from low market volatility and poured money into bonds and equities, confident that policy makers have their back.

But investors have dramatically altered such thinking and switched from owning government bonds as eurozone data have proved surprisingly positive in recent weeks. An aversion towards holding government debt as a haven has also been fanned by the lingering anticipation of a deal between Greece and its creditors.

Against that febrile backdrop, Mr Draghi said the bond market needed to get used to “periods of high volatility”.

“If Draghi says volatility is going to be higher, volatility is going to be higher,” said Yoram Lustig, a fund manager at Axa Investment Managers.

The remarks immediately sparked renewed selling of bonds and a sharp climb in the single currency.

Eurozone equities remained broadly firmer as the tone of Mr Draghi’s remarks suggested increased confidence in the ECB’s aim of reflating the economy. The central bank also raised its inflation forecasts for 2015 to 0.3 per cent and expects the economy will expand by 1.5 per cent.

Justin Knight, a fixed-income strategist at UBS said: “The fact that he was not only relaxed about higher yields but said that we would have to get used to higher volatility, suggested he was super relaxed — and that has played into market sentiment.”

The ECB’s upward revision to inflation forecasts — which looms as bad news for bond investors — reinforced better-looking economic data from the eurozone earlier on Wednesday, where numbers from France’s service sector beat forecasts and a closely watched purchasing managers’ index for the wider eurozone also came in ahead of expectations.

Rising yields have hit fixed income returns over the full year. This week, investor returns on sovereign and corporate debt this year have been erased.

S&P’s Eurozone Sovereign Bond 7-10 years Index, which tracks the asset class on a total return basis and is calculated once a day, is now in negative territory for the year to date, a drop of 0.9 per cent, after a slide of 1.4 per cent since the start of this week.

Returns on corporate investment grade bonds — which are closely linked to the sovereign benchmark — have also turned negative. Total returns on Markit’s iBoxx € corporates index are down by 0.4 per cent for the year so far, having posted steady returns in the first three and a half months of 2015.

“The spreads over benchmark yields are so tight now that any volatility in government rates is magnified and reflected in investment grade bonds,” said Simon Colvin, an analyst at Markit, the data provider.

He added that high yield corporate debt, which trades at much wider spreads over benchmark yields, had continued to perform well.

The move had implications across other markets, with the 10-year US Treasury yield reaching its highest level since last November at 2.34 per cent.

Additional reporting by Ralph Atkins and Joe Rennison

June 3, 2015 1:33 pm

Harsh realities dawn on Switzerland’s private Banks

Laura Noonan


The advantages that brought business to the Swiss private banking centre of Zurich have been eroded

By 2013, Banque Cramer knew it had a problem. With just SFr2bn of client money, the 300-year-old Swiss private bank was too small to weather the radical changes sweeping through its industry.

Extra regulatory and compliance demands were driving up costs. Big advantages that traditionally helped Swiss banks lure customers were falling away as banks faced being forced to disclose information about their clients to foreign authorities and mandatory co-operation with tax probes.

Banque Cramer went all in, making the first of two acquisitions in a deal in which its founding family gave up some ownership. The banks’ assets under management are now just over SFr5bn but Christian Grütter, the chief executive, believes it remains too small for comfort.

“SFr15bn is the first hurdle that you need to pass to get into a comfortable environment to be able to withstand regulatory changes more easily,” he says. The bank remained on the lookout for more acquisitions.

Banque Cramer’s predicament is by no means unique. While UBS and Credit Suisse, the biggest Swiss banks, have client assets of SFr1tn and SFr860bn respectively, there are more than 100 Swiss private banks with assets below the SFr15bn mark. Most have not yet taken transformational action.
“The market is still underestimating the change,” says Stefan Jaecklin, a consultant with Oliver Wyman who works with private banks in Zurich. “Out of 280 banks [in the entire Swiss market] there are still a large number where I cannot tell you what they stand for and they cannot either.”

Ironically, experts say the Swiss private banking market has not already been whittled down to size because of continuing investigations into allegations that some helped clients avoid tax. Most Swiss private banks have yet to settle with the US on tax issues, and probes from other countries could follow.
“We would have seen twice as many transactions if we hadn’t had the US topic,” says a Zurich-based corporate finance adviser. “The entire sector has huge overcapacity . . . Most foreign institutions have in principle decided to exit the Swiss market, the only question they’re asking themselves is how and when.”

Money laundering is when someone channels the cash from robbery, fraud or expropriation into a Swiss bank account, or an expensive apartment in Manhattan, to make it look clean. So what is the term for sullying profits from legal enterprise with tax evasion and shenanigans?

The industry’s challenges are widely acknowledged. Georg Schubiger, a former chief operating officer at Danske Bank, joined Vontobel in 2012 and was given three tasks by the midsized bank’s now 98-year-old chairman — restore profitability, get the business growing again and “create a value proposition in the new world”.
Mr Schubiger argues there is still a sweet spot for private banks even though he admits some traditional Swiss banking business models no longer work. He says “affluent” clients, or those with assets below SFr1m, have “basically disappeared” since the fee structure of private banking no longer makes sense for them now they do not get tax benefits.

Switzerland’s biggest banks, which are increasingly looking at private banking as an earnings driver, make much of their ability to create products in their investment banks or asset management units and sell them on. “In the areas we chose to compete in, we’re strong,” says Mr Schubiger. “I can buy brilliant products if we don’t have them.”

He says Vontobel has steered clear of the interest rate rigging, money laundering and other scandals that have ensnared many larger banks.

“Our bank is 91 years old; it has the same shareholders [since then],” he says. “Entrepreneurs love that, people with money in Asia are people who built up companies. They don’t want to be served by anonymous shareholders.”

Swiss authorities have taken a further step towards dismantling once untouchable bank secrecy laws by unveiling draft legislation paving the way for automatic information exchange about offshore accounts.
Frédéric Rochat, director of midsized Lombard Odier, says clients from emerging markets seeking safety and stability still flock to Swiss private banks, as do European clients seeking diversification. The “Swiss-made quality of service” remains a selling point, he adds.

Yet Swiss banks must now be more selective in the emerging markets they target. “Relationship managers 10 years ago didn’t care where the money came from,” says Mr Jaecklin of Oliver Wyman.

“Now you have to understand when you’re allowed to call clients in a particular jurisdiction, when and how you’re allowed to advise him.”

Large banks responded by restricting relationship managers to one market. Smaller banks — with assets under management of SFr5bn to SFr25bn — sometimes have more markets than they have staff. “I’ve worked with [small] banks covering 90 markets, there’s no way you can do that now,” says Mr Jaecklin. “They have to come down to 10, five, two — even one in some cases.”

Zurich-based Falcon Private Bank, which has assets under management of SFr16bn, serves clients in about 100 jurisdictions. Tobias Unger, its deputy chief executive, admits this is “way too much” and says the bank will cut its coverage to about 50 countries.

It still sees its future in emerging markets. “The growth rates are higher, regulation is lower,” says Mr Unger. “There are a lot of good reasons for clients to want their money offshore.”

Despite being confident about their own businesses, the bankers interviewed all believe many of their competitors will merge or close down. “There are quite a few banks that have realised this is the last generation,” says Mr Jaecklin. “They’ll milk it for as long as it still walks, and then it’s done.”

Good News: Investors Cut Gold Holdings to Six-Year Low; Good Timin'

By: Mike Shedlock

Wednesday, June 3, 2015

Investors in general do not give a rat's ass about gold.

Here's proof: Gold Out of Favor as Investors Cut Holdings to Six-Year Low.

Investors cut holdings in bullion-backed exchange-traded products to the lowest since 2009 as surging stock markets from the U.S. to China hurt demand and prospects for rising U.S. interest rates boosted the dollar.

The assets contracted 5.45 metric tons, or 0.3 percent, to 1,594.08 tons as of Tuesday, according to data compiled by Bloomberg. The holdings slumped 39 percent since reaching a record 2,632.52 tons in December 2012, shrinking by 33 percent in 2013 and a further 9.3 percent last year.

World equities surged in 2015 as U.S. stocks reached a record and the main stock gauge in China more than doubled in 12 months. The Federal Reserve has signaled it expects U.S. growth to pick up after a contraction in the first quarter and, while unlikely to raise interest rates this month, it's left the door open to tightening later this year. Higher rates curb gold's allure because it usually gives returns only by price gains.

"You're seeing some significant, excess returns from U.S. stock markets and China's stock market as well," Victor Thianpiriya, an analyst at Australia & New Zealand Banking Group Ltd. in Singapore, said before the data was released. "That's not positive for gold demand."

Gold Weekly Chart
Weekly Gold Chart

Good Timin'worse.

As I have commented before, sentiment is not a timing indicator. Bad sentiment can always get

The good news is gold has been holding a steady bottom for nearly two years as investors dump it chasing insanely priced equities and junk bonds.

The precious metals slump will reverse. I just cannot say when.

What you do not want to see is bullish sentiment in the face of declining prices, something I eventually expect to see with equities and junk bonds. We were there in 2000, 2007, and it's going to happen again.

Investment Philosophy

Buy assets when no one loves, sell then when everyone loves them.

Buy gold and silver now, and sit on it. Both are very much out of favor.