Fed Interest-Rate Plan: Even Lower for Even Longer

In opting not to raise interest rates, the Fed painted a decidedly dovish picture of what its policy will look like in the years ahead.

By Justin Lahart

Federal Reserve Chairwoman Janet Yellen is seen in July.Federal Reserve Chairwoman Janet Yellen is seen in July. Photo: shawn thew/European Pressphoto Agency

Lower for even longer.

The surprising thing coming out of the Federal Reserve’s meeting on Thursday wasn’t so much policy makers’ decision to keep rates on hold. Rather, it was that what had been expected to be a closely fought decision on whether to raise rates for the first time in nine years doesn’t seem to have been very contentious.

The Fed’s postmeeting statement said that Jeffrey Lacker, the hawkish President of the Federal Reserve Bank of Richmond, preferred to raise the Fed’s target range on overnight rates. But the overall tone was dovish, emphasizing how troubled economies abroad and unsettled financial markets could weigh on the U.S.

That is supportive of bond prices, even as stocks may struggle in the face of still-sluggish global growth.

Underscoring the lower-for-longer view, updated projections showed that Fed officials expect to raise their target range on overnight rates just once in their two remaining meetings this year. And several were calling for no change.

Moreover, the median, longer-run projection for overnight rates fell to 3.5% from 3.75% in June, and 4% at the start of last year. So, even when the storm from overseas passes, officials don’t think rates will need to be as high as they used to.

This may stem from a growing recognition of just how hard it may be for the Fed to reach its 2% target for inflation.

The Fed isn’t close to achieving that goal now, something openly acknowledged by Fed Chairwoman Janet Yellen in her postmeeting news conference. The median projection called for the central bank’s preferred measure of overall consumer prices to be up 0.4% in the fourth quarter from a year earlier. Core inflation, which excludes food and energy prices, is seen running at 1.4%.

And inflation’s trend has been well below 2% for some time now. Since the recession’s start at the end of 2007, core prices have averaged a gain of just 1.5% annually—to be expected, perhaps, since the period encapsulates a severe economic downturn. But in the 10 years before that, core inflation averaged 1.8%.

The persistence of low inflation also suggests the economy might be able handle tighter labor markets, and Fed officials took a step in this direction. Their median estimate of the longer-run unemployment rate slipped to 4.9% from 5% in June. Further, they now expect the unemployment rate to run slightly below that level, at 4.8%, over the next three years.

That suggests a willingness to try to get inflation higher by letting the job market run a little hot.

For investors, the overall message is that even though the Fed is still aiming to raise rates before the year is out, it is by no means a sure thing. Especially with incoming data suggesting that inflation in the fourth quarter will if anything come in below the Fed’s projections.

And even if that rate increase does come, the hurdle to future moves looks high, contingent not just on strong jobs growth but on a real sense at the Fed that inflation is turning higher.

They say don’t fight the Fed, but for now the Fed doesn’t seem to have much fight in it.

Markets Crashing: Is It Time To Panic?

By: Sol Palha

"Come to the edge," He said. They said, "We are afraid." "Come to the edge," He said. They came. He pushed them... and they flew. ~ Guillaume Apollinaire
The answer to this plain question should always be a resounding no: it never pays to give into panic.
The smartest option is to derail this emotion before it gains any traction. Once fear takes over, the end is nigh.
When the markets were disintegrating approximately two weeks ago and if you were one of the lucky few that opted against joining the bandwagon of panic, you should have had a feeling of déjà vu; sort of like the movie Groundhog Day. The same-old twaddle that was broadcasted before was once again intoxicating the masses; like cockroaches, these naysayers emerge from the woodwork and hum the same-old hymn "the world is going to end" and or financial disaster is around the corner. In each instance, you will find that the same rubbish is spun in a different way; this is recycling at its best. What they so conveniently omit is how each and every single one of these so-called end of the world events proved to be nothing but a mouth-watering opportunity for the astute investor. Now we are not stating that caution should be thrown against the wind. What we are simply stating is that if you become one with the fear, then this useless emotion will take over and blind you from seeing any opportunity, even if it slaps you hard on the face. Never become one with fear; understand that when it comes to trading fear is on par with toilet paper.
Let's take a sombre look at what is actually going on, and why these events are unfolding.
It's more than obvious that the market was in a corrective phase or crashing if one joins the naysayer's camp; the more appropriate term would be letting out steam that was long overdue. The last week of August, was the worst week for equity markets since 2011. One could also point out that the markets have not experienced a significant pullback since 2011.
So what changed over the span of 1-2 weeks to warrant such negativity? Very little actually
  • China devalued its currency to boost exports; it had to; we are in the midst of a currency war, and most nations other than the U.S. are allowing their currencies to literally collapse. However, devaluing the currency affects sales and profits at many multinational companies, including those back in the U.S. So expect the U.S. to do something that has a negative impact on the dollar.

  • The next issue is that the world's second-largest economy is no longer growing as fast. Growth is slowing down and so far it appears the government's response to address this has been ineffective. In the short term, this will continue to be the case, but over the long term, we think their policies will be conducive for the economy and stock market.

  • Manufacturing activity is slowing down in China, and this has a big impact on the commodity markets. This is the primary reason many markets in this sector are experiencing severe corrections. Copper, oil, and iron to name a few have just fallen apart.
  • The extreme plunge in energy prices while a relief for consumers, has unnerved investors. Though to be fair, a lot of this had to do with excess supplies. Demand is not keeping up with supplies, which is a clear indication that worldwide demand for oil is softening.
  • Up until recently, the Fed's decision to start raising rates was another factor weighing on the markets. That uncertainty is no longer an issue as the Fed has now signalled that it will not be raising rates. There is really no inflation problem to tackle. We are referring to the manufactured numbers that suggest all is well when the opposite holds true. This is what the masses believe and so this is what counts, as what they believe drives the markets. Energy prices are down significantly, and the raw materials sector is basically in a bear market. Wages are not rising; at best, they are stagnant. Over 50% of the components of the CPI (consumer price index) have declined in the past six months. TIPS are also signalling that for the foreseeable future, inflation is not going to be an issue. Under these circumstances, a rate hike would make no sense, and only further destabilize the markets. Let's not forget the additional turmoil; a rate hike would cause in the currency markets. A rate hike would further strengthen the dollar, and adversely affect U.S. exports, making them less competitive in the global markets.
  • Again, we do not necessarily agree with the low inflation scenario as rents are rising and the cost of many goods over the past several years have risen dramatically. What we believe in is not of importance, for, in the end, it's the crowd that drives the market, up to a certain point. When emotions hit a boiling point, which they have not, then one can start taking a position that is opposite to that of the masses.

So what's on the horizon?

Any expert who claims to know precisely what will occur should be ignored. Even a broken clock is correct twice a day. Hence, if an expert makes a large enough number for pronouncements, one of them is bound to come to pass. It does not mean that individuals cannot determine the direction of the markets. As we have stated many times before, there is a vast chasm that separates spotting market bottoming and topping action, with trying to identify the exact top or bottom.

Investor confidence has taken a beating. Under these conditions, many investors will either sit on the sidelines or take some money out of the markets. This is good for it will drive stocks to even more attractive levels. The masses are well-known for their ability to buy and sell at precisely the wrong time.

Some bullish or reassuring factors to consider
  1. Traders are not overtly bullish.
  2. Stocks are selling for roughly 17 times their trailing earnings. While not cheap, these valuations are by no means excessive. The long-term average is roughly 16.5 times earnings.
  3. Unemployment is down, and U.S. Manufacturing levels are rising.
  4. Corporations are flush with money.
  5. Banks are in much better shape than they were in during the financial crisis a few years ago.
  6. Insiders are not dumping shares; they are actually stepping in and buying them. .

The Technical Outlook

Our proprietary strength indicator has turned negative on the markets and this indicates that the lows will be tested again. The trend based on our Trend indicator has also turned neutral and V readings (our proprietary tool that measures market volatility) has soared to an all-time new high. Hence, we expect extreme moves to be the norm for the next few months. It would not surprise us if the Dow experiences a 1500-2000 point move over the span of one week.

The Dow is having a remarkably hard time of trading above 17000, former support turned into resistance. After the selloff in August, a lot of technical indicators moved into the extremely oversold ranges. Thus, the corresponding rally should have been much stronger. Additionally our own indicators are not validating the current move up, which strongly hints that the lows will have to be tested again. If the Dow closes below 15500 on a weekly basis, then we expect the Dow to make a quick move down to the 14500-14700 ranges; if this were to occur, we could term it a screaming buy event.


Some additional factors to keep in mind:
  • The housing sector is relatively strong. Purchase applications are up 18% year over year.
  • U.S. employees added 215,000 jobs in July
  • Latest data shows that U.S. Economy grew at 3.7% in the 2nd quarter, up from the initial estimate of 2.3%
It is interesting to note that the naysayers like clockwork start their chanting and howling specifically after the markets have started to correct; their screams are rather muted when the market is trending upwards. If you look at history, their record is rather dismal, as every so-called disaster and or end of the world scenario, these naysayers pandered about turned to be exactly the opposite of what they predicted. Instead, each of these so-called disaster scenarios proved to be nothing but splendid buying opportunities in disguise. Disasters will come and go.

Depending on the lens you use to view such a situation, it can either represent a splendid opportunity or a monumental tragedy. History is replete with examples quite clearly illustrating that financial disasters usually make for splendid opportunities.

We are not advocating that you run out and lunge into the markets; we have been stating for quite some time that the markets needed to let out some steam. Note, that the markets have not experienced significant correction since 2011. It would be folly to assume that the markets will trend in one direction without letting out a burst of steam. The markets have already shed roughly 15% from high to low. Given the heights they have run to since 2011, a 20% move would still be acceptable and nothing to fear. At this point, prudence is warranted, but a massive sell-off should be viewed as a buying opportunity, in contrast to a colossal tragedy. Our general suggestion would be to buy when panic sets in, and blood is flowing freely in the streets.

Be wary when the masses are joyous and delighted when they are not.

I envy paranoids; they actually feel people are paying attention to them. ~ Susan Sontag

Markets Insight

Fed rate rise history reveals familiar dilemma

Scott Minerd

Previous delays led to inflated asset prices and recessions

Twice in the past 30 years the US Federal Reserve has faced the prospect of prematurely abandoning tightening during market turmoil. Today, global currency devaluations, market volatility and plunging commodity prices have trapped the Fed in a similar policy dilemma.
In 1987, the central bank aborted rate rises and reversed course after a stock market crash.

Again, in 1998, after the failure of Long-Term Capital Management, a highly leveraged hedge fund, the Fed abandoned its planned rate increases to stabilise markets and avoid a global crisis. In both cases, the unintended result of delaying was inflated asset prices, which ultimately destabilised the economy and led to severe financial consequences and recession.

In 1986, inflation slowed as oil prices collapsed, raising serious concerns about US economic expansion following the worst postwar recession up to that time. Policymakers were slow to raise rates, allowing for a surge in equity prices in early 1987 as energy prices rebounded.

After falling behind the curve, aggressive Fed actions to address inflation inadvertently pricked the stock market’s speculative bubble. In October 1987, US equities plummeted more than 30 per cent. The Fed quickly reversed course and reduced rates.

By mid-1988, markets stabilised and the Fed again raised rates to head off inflation. By this time, more than four years of accommodative monetary policy had led to a commercial real estate boom with a glut of new properties. As the economy tumbled toward recession in 1990, a sharp decline in property values caused defaults and the failure of financial institutions. The government-sponsored Resolution Trust Corporation was set up in response to resolve troubled banking assets.

After the ensuing recession and another period of accommodation, the Fed again raised rates in the mid-1990s. During this time, many Asian nations had pegged their currencies to the US dollar. By 1997, the pressure to maintain these pegs amid rising US rates became too much for some. Thailand was first to break its peg, allowing the baht to collapse and increasing pressure on neighbouring economies in a dramatic round of competitive devaluation.

By 1998, contagion from emerging markets reached the US, pressuring domestic markets. A collection of 14 major financial institutions convened by the Fed intervened to stem the collapse of the LTCM hedge fund that threatened the solvency of the global financial system.
Once again, the Fed aborted plans to raise rates, allowing equity prices to skyrocket. When the Fed finally tightened, stocks began a long, deep slide. Numerous companies that flourished amid the speculative wave failed.

Today, policymakers are caught in this familiar dilemma. Labour markets are moving toward full employment, and declining energy prices and a stronger dollar have resulted in languishing inflation. Still, questions remain about the viability of sustained economic expansion in the US and around the world, and volatility is rising.

At the same time, currency devaluation, particularly in Japan and the eurozone, is putting pressure on countries to devalue to improve export competitiveness. Those countries slow to devalue, like China, are feeling economic pressure at home, driving down asset prices and increasing deflationary pressures, escalating the risk of financial contagion abroad.
The Fed is hard-pressed to justify a rate increase based on its self-prescribed metrics, which include rising inflation and an improved employment situation with clearly rising wages. At best, policymakers can argue that the prospects for wage growth and inflation are improving, but clear evidence is lacking.

A pre-emptive rate increase seems risky and opens the Fed to potential criticism given the fragility in financial markets and the prospect that rising US rates could exacerbate foreign economic turbulence.
But while prices and wages remain tame, the risk of another asset bubble is increasing. If policy remains highly accommodative, the likelihood grows that asset classes including commercial real estate, equities or certain categories of bonds could become dangerously overvalued.
Regardless of the path the Fed chooses, after seven years of accommodation and now facing volatile global markets, the likelihood of regret is high.

Scott Minerd is global chief investment officer and chairman of investments at Guggenheim Partners

Banks Hit Capital Targets But More Will Be Needed

Banks have raised $1.9 trillion but capital calls not done

By Paul J. Davies

Big banks have bolstered their defenses, but they still have fixing up to do.

Across the globe, banks are hitting their capital targets, according to the Basel, Switzerland-based committee that sets global rules. Only a handful of small banks have a slight shortfall.

However, some troubling characteristics still suggest investors will have to wait longer for banks to finish repairs and become predictable, attractive stocks.

The very biggest banks—the global systemically important banks—are still most highly leveraged, while all banks still hold zero capital against large books of government bonds.

Also, in spite of fears about the growth of shadow banking, there has been no reduction in traditional bank assets. In fact, since mid-2011 total assets have grown 7%-12% at large banks.

Banks have replaced some risky assets with less risky ones, which helped capital ratios, but the main way they have hit targets is by raising equity. Most of the €1.7 trillion in capital raised has gone to the biggest banks.

And yet, global systemic lenders still have fewer euros or dollars of capital set against assets than their smaller rivals. On average their capital ratios are 10.8%: other banks have ratios above 11%. This is despite the fact that systemic banks have much higher capital targets to hit.

One sign that even more equity will be needed is the amount of government debt all banks still treat as risk free: almost half of the liquid assets that banks are required to hold—or €5.2 trillion—are government backed securities with no capital requirements.

Rules on treating government debt as risk free are, unsurprisingly, set to change: that means more pain for bank investors.

Solving Syria in the Security Council

Jeffrey D. Sachs

Damascus Syria

NEW YORK – The ongoing bloodletting in Syria is not only the world’s greatest humanitarian disaster by far, but also one of its gravest geopolitical risks. And the United States’ current approach – a two-front war against the Islamic State and President Bashar al-Assad’s regime – has failed miserably. The solution to the Syrian crisis, including the growing refugee crisis in Europe, must run through the United Nations Security Council.
The roots of US strategy in Syria lie in a strange– and unsuccessful – union of two sources of American foreign policy. One comprises the US security establishment, including the military, the intelligence agencies, and their staunch supporters in Congress. The other source emerges from the human-rights community. Their peculiar merger has been evident in many recent US wars in the Middle East and Africa. Unfortunately, the results have been consistently devastating.
The security establishment is driven by US policymakers’ long-standing reliance on military force and covert operations to topple regimes deemed to be harmful to American interests. From the 1953 toppling of Mohammad Mossadegh’s democratically elected government in Iran and the “other 9/11” (the US-backed military coup in 1973 against Chile’s democratically elected Salvador Allende) to Afghanistan, Iraq, Libya, and now Syria, regime change has long been the coin of the US security realm.
At the same time, parts of the human-rights community have backed recent US military interventions on the grounds of the “Responsibility to Protect,” or R2P. This doctrine, adopted unanimously by the UN General Assembly in 2005, holds that the international community is obliged to intervene to protect a civilian population under massive attack by its own government. In the face of the brutality of Saddam Hussein, Muammar el-Qaddafi, and Assad, some human-rights advocates made common cause with the US security establishment, while China, Russia, and others have argued that R2P has become a pretext for US-led regime change.
The problem, as human-rights advocates should have learned long ago, is that the US security establishment’s regime-change model does not work. What appears to be a “quick fix” to protect local populations and US interests often devolves into chaos, anarchy, civil war, and burgeoning humanitarian crises, as has happened in Afghanistan, Iraq, Libya, and now Syria. The risks of failure multiply whenever the UN Security Council as a whole does not back the military part of the intervention.
The US intervention in Syria can also be traced to decisions taken by the security establishment a quarter-century ago to overthrow Soviet-backed regimes in the Middle East. As then-Under Secretary of Defense Paul Wolfowitz explained to General Wesley Clark in 1991: “We learned that we can intervene militarily in the region with impunity, and the Soviets won’t do a thing to stop us…

[We’ve] got about five to ten years to take out these old Soviet ‘surrogate’ regimes – Iraq, Syria, and the rest – before the next superpower [China] comes along to challenge us in the region.”
When al-Qaeda struck the US on September 11, 2001, the attack was used as a pretext by the security establishment to launch its long-desired war to topple Saddam. When the Arab Spring protests erupted a decade later, the US security establishment viewed the sudden vulnerability of the Qaddafi and Assad regimes as a similar opportunity to install new regimes in Libya and Syria. Such was the theory, at any rate.
In the case of Syria, America’s regional allies also told President Barack Obama’s administration to move on Assad. Saudi Arabia wanted Assad gone to weaken a client state of Iran, the kingdom’s main rival for regional primacy. Israel wanted Assad gone to weaken Iran’s supply lines to Hezbollah in southern Lebanon. And Turkey wanted Assad gone to extend its strategic reach and stabilize its southern border.
The humanitarian community joined the regime-change chorus when Assad responded to Arab Spring protesters’ demand for political liberalization by unleashing the army and paramilitaries. From March to August 2011, Assad’s forces killed around 2,000 people. At that point, Obama declared that Assad must “step aside.”
We don’t know the full extent of US actions in Syria after that. On the diplomatic level, the US organized the “Friends of Syria,” mainly Western countries and Middle East allies committed to Assad’s overthrow. The CIA began to work covertly with Turkey to channel arms, financing, and non-lethal support to the so-called “Free Syrian Army” and other insurgent groups operating to topple Assad.
The results have been an unmitigated disaster. While roughly 500 people per month were killed from March to August 2011, some 100,000 civilians – around 3,200 per month – died between September 2011 and April 2015, with the total number of dead, including combatants, reaching perhaps 310,000, or 10,000 per month. And, with the Islamic State and other brutal extremist groups capitalizing on the anarchy created by the civil war, the prospect of peace is more distant than ever.
Military intervention led or backed by the US in Afghanistan, Iraq, and Libya has produced similar debacles. Toppling a regime is one thing; replacing it with a stable and legitimate government is quite another.
If the US wants better results, it should stop going it alone. The US cannot impose its will unilaterally, and trying to do so has merely arrayed other powerful countries, including China and Russia, against it. Like the US, Russia has a strong interest in stability in Syria and in defeating the Islamic State; but it has no interest in allowing the US to install its choice of regimes in Syria or elsewhere in the region. That is why all efforts by the UN Security Council to forge a common position on Syria have so far foundered.
But the UN route can and must be tried again. The nuclear pact between Iran and the Security Council’s five permanent members (the US, China, France, Russia, and the UK) plus Germany, has just provided a powerful demonstration of the Council’s capacity to lead. It can lead in Syria as well, if the US will set aside its unilateral demand for regime change and work with the rest of the Council, including China and Russia, on a common approach.
In Syria, only multilateralism can succeed. The UN remains the world’s best – indeed its only – hope to stop the Syrian bloodbath and halt the flood of refugees to Europe.

Read more at https://www.project-syndicate.org/commentary/syria-civil-war-un-security-council-by-jeffrey-d-sachs-2015-09#5tVV1TXwdvThlgY7.99

Germany’s Hegemony Trap

Wolfgang Ischinger. Germany flag Reichstag
MUNICH – The prolonged Greek debt crisis and the ongoing influx of refugees into Europe have ignited a debate about Germany’s role within the European Union. Has Germany become the European hegemon? And if not, should it assume that role, as some commentators have suggested, in order to prevent the European project from failing?
‎The idea of German hegemony – as should be clear to any student of history – is self-defeating.

Instead, Germany should assume the position of Europe’s “Chief Facilitating Officer,” as German Foreign Minister Frank-Walter Steinmeier aptly called it, focused on strengthening the EU by working to create the conditions necessary for a truly common European foreign and security policy, one that proactively prepares the continent to meet the challenges it confronts.

By throwing its full weight into this task, Germany would not only promote Europe’s influence in the world; it would also deflate the discussion of hegemony.
The 2007 Treaty of Lisbon was based on the idea that the EU’s prosperity and security depend on its members looking beyond their parochial interests and act jointly, in their common interest. In order to achieve this, the treaty created posts, such as the President of the European Council and the High Representative of the Union for Foreign Affairs and Security Policy, whose incumbents could speak and act on behalf of the entire EU.
As former Belgian Prime Minister Paul-Henri Spaak once noted, “There are only two types of states in Europe: small states, and small states that have not yet realized that they are small.”

Unfortunately, for the moment, too many of the EU’s member states fall into the latter category.
The new offices established by the Treaty of Lisbon have helped the EU achieve some important successes – most notably during negotiations with Iran and with Serbia and Kosovo.

But there has been no consistent effort to strengthen their powers. Far too often, when it comes to dealing with foreign-policy crises and strategic challenges, EU institutions are assigned a minor role. The Ukraine crisis, where France and Germany have taken the lead, is but one example of this.
And yet, even as Euro-skepticism has been rising across the continent, there remains widespread popular support for a common, more powerful European foreign policy. In a recent article in the Financial Times, former Polish Foreign Minister Radosław Sikorski outlined how this might be achieved. When a foreign-policy issue arises, member states should assess whether it would be most appropriately addressed by individual states or at the European level.
In the vast majority of cases in which common action would be preferable, member states would provide full support to the EU. As a result, European Council President Donald Tusk, EU High Representative Federica Mogherini, and EU Commission President Jean-Claude Juncker would play leading roles in European foreign policy.
Unfortunately, this is far from established practice. The EU’s members tend to pursue dissonant policies, weakening, rather than strengthening, Europe’s global position. And there are few things the rulers of China and Russia enjoy more than playing the EU’s members off against one another.
Germany has an opportunity to provide a counterweight to long-standing British objections to a unified foreign policy. By putting its considerable influence in the service of a cohesive, strategically focused foreign and security policy, Germany would simultaneously achieve two key objectives: a stronger and more capable EU and a more European Germany.
A good starting point would be to act on longstanding calls for closer integration of EU members’ armed forces. Germany should put its full weight behind “pooling and sharing” military resources, even if the United Kingdom is resistant to such an effort. After all, the time when EU member states went to war alone ended more than three decades ago, with the Falklands War.
“Poor old Germany,” Henry Kissinger once quipped. “Too big for Europe, too small for the world.” Fortunately, Germany has a way out of this trap. As a proactive and constructive part of the EU, Germany is big enough for the world, and at the same time not too big for its neighbors.
As Steinmeier and German Minister of Economic Affairs Sigmar Gabriel, recently wrote, “Only together, and only at the European level, will we be able at all to find rational solutions.”

They were writing about the refugee crisis, but they could just as easily have been referring to Germany’s place in the EU today.

Will emerging economies cause global “quantitative tightening”?

Gavyn Davies

Global investors have been in thrall to the central banks ever since quantitative easing (QE) started in 2009 and, of course, all eyes are on the Federal Reserve this week. The Fed has now frozen its QE programme, and may raise rates sometime this year, though perhaps not as early as next Thursday.

Nevertheless, global investors have been comforted by the extremely large increases in balance sheets proposed by the Bank of Japan (BoJ) and the ECB, and the overall scale of worldwide QE has seemed likely to remain sizeable for the foreseeable future.

However, in recent months, an ominous new factor has arisen. Capital outflows from the emerging market economies (EMs) have surged, and have resulted in large declines in foreign exchange reserves as EM central banks have intervened to support their exchange rates.

Since these reserves are typically held in government bonds in the developed market economies (DMs), this process has resulted in bond sales by EM central banks. In August, this new factor has more than offset the entire QE undertaken by the ECB and the BoJ, leaving global QE substantially in negative territory.

Some commentators have become concerned that this new form of “quantitative tightening” will result in a significant reversal of total central bank support for global asset prices, especially if the EM crisis gets worse. This blog examines the quantities involved, and discusses the analytical debate about whether any of this matters at all for asset prices.

The conclusion is that the EM factor is likely to offset part, but perhaps not quite all, of the QE planned by the ECB and the BoJ in the next year. Overall, global QE will provide much less stimulus than it has since 2006.

The major sources of central bank balance sheet expansion at present are of course the bond purchase programmes announced by the BoJ and the ECB. Together these programmes are running at an average of about $130 billion a month. The average maturity of the bonds purchased is probably around 7 years, so an enormous amount of “bond duration” is still being removed from private sector hands in the developed economies.

The question is how much of this stimulus is likely to be offset by the sale of EM bond holdings as a result of the foreign exchange intervention by EM central banks. Fulcrum estimates that total EM central bank balance sheets may have declined by about $450 billion in the 3 months since the crisis worsened in the summer, of which about $170 billion has come from China alone.

Consequently, global QE, measured by this metric, has probably turned substantially negative [1]. Nomura (and others) estimate that foreign exchange intervention by the EMs was probably around $160 billion in August alone, and this would have directly triggered bond sales in the US and Europe.

Of course, no-one can prove that this drain of central bank liquidity caused the rise in global bond yields and the drop in risk assets last month; market interpretations of Fed policy have probably been just as important. Nevertheless, it is an interesting fact that has grabbed the attention of macro investors. The release of China’s foreign exchange reserve figures has suddenly become one of the most watched global data releases each month.

What is the outlook for this measure of global liquidity over the next year or so? The BoJ and the ECB are, if anything, considering further extensions of their bond purchase programmes. Consequently, global QE will return to positive territory unless the large drain on EM foreign exchange reserves continues.

But this drain is likely to be maintained for a while. A recent detailed analysis of global reserve holdings by Deutsche Bank economists [2] suggests that total global reserves could fall by $1,500 billion during the current drawdown, about a third of which has already happened. This might take EM central bank balance sheets roughly back to where they were just before the 2008 financial crash as a share of EM GDP – a pessimistic but not extreme outcome.

On this and other assumptions, Fulcrum estimates that the total increase in global central bank balance sheets as a percentage of world GDP, which is one indicator of the stimulus from global QE, would be fairly close to zero next year, compared to an average injection of about 2 per cent of global GDP in recent years. Apart from a short period at the end of 2009, this would be the lowest rate of expansion since 2006:

There is huge uncertainty here. If China and other EMs stop intervening in the foreign exchange markets, then the drain on reserves and on global liquidity would soon end as EM exchange rates fall towards their equilibrium levels. Alternatively, private sector EM capital outflows might end spontaneously, as they did after the “taper tantrum” in 2013. But the deterioration in economic fundamentals in the EMs looks more serious than in 2013, so the current shock could be long lasting.

What then? Some economists, like Matthew Klein at FT Alphaville, and Paul Krugman, argue that sales of bond holdings by foreign central banks do not matter anyway. Krugman argues that they hold bonds of very short maturity, which are close to cash, and he points out that sales of these bonds can always be easily offset by Fed action to hold short rates down. But the average maturity of US bond holdings by foreign central banks, at 3.95 years, is not negligible.

Furthermore, since the Fed is thinking about raising rates, it may not want to offset the impact of foreign bond sales on US medium dated bond yields.

In my opinion, one of the few analytical lapses made by the Keynesian camp after 2010 has been a reluctance to believe that QE – or bond buying by foreign central banks – could impact asset prices and economic activity, except through a signalling effect about the future path of Fed short rates. Yet studies by the Fed [3] and the ECB [4] suggest that these bond purchasing programmes have had important effects on yields through “portfolio balance” effects, as private investors are induced to extend bond duration and hold riskier assets.

Surely, the same could now happen in reverse when EM central banks trim their bond holdings. If so, the EM reserve drain is another item to add to investors’ long list of concerns at the moment.


[1] There is a potential trap here, because part of this decline has been due to asset revaluation effects as the dollar has risen. This would not lead to sales of bonds in the developed markets, even though global liquidity measured in dollars has tightened.
[2] See Winkler, Robin et al (September, 2015), “The “Great Accumulation” Is Over: FX Reserves Have Peaked, Beware QT”, Deutsche Bank Market Research.
[3] Bernanke, Ben et al (2011), “International Capital Flows and the Returns to Safe Assets”, Federal Reserve Finance Discussion Papers 1014. See also Beltran et al (2013), “Foreign holdings of US Treasuries and US Treasury yields”, Journal of International Money and Finance.
[4] See Carvalho, D. and M Fidora (June 2015),“Capital inflows and euro area long-term interest rates”, ECB working paper 1798. Thanks to Deutsche Bank for these references.

US Government Is Going To Monitor All

 Your Financial Transaction Very Soon



Ever since Nixon took the United States off the gold standard, the US dollar has continued to lose it’s redeemable for gold or silver. Now, money derives its value purely from faith, a dogmatic faith in our government and the laws of the land.

This no good given how many rights we’ve already lost.

Even as the Federal Reserve tries to maintain control over the physical cash system, various companies (IT giants and financial backers) are hacking at the system, trying to kill it in an attempt to make a ghost of its former self.

It will create a digital ghost, one that would then roam in the new cashless society.

At one extreme are the world’s leading IT giants and financial companies tirelessly working to completely replace paper money with a wireless payment system for the smartphones  Apply Pay set to drive contactless payments up to $300m by 2016, rivaling with Samsung Pay, and Google Wallet, to name a few. On the other extreme are the technology giants such as  IBM developing highly sophisticated biometric systems that create a highly unique personal ID using (do hold your breath) a person’s eyes, fingerprints, face, facial expressions, voice, heartbeat, and more.

The end result is the same: loss of not just paper money, but also plastic money.

It will lead us into a new world order with a cashless society.

It may sound fantastic, and within this cashless system are various traps ranging from loss of our freedoms and rights to leaving a significant part of the society in a tough situation.

Let’s start with stating the cases being made for the cashless society, identifying the proponents, and dissecting the reality of it all.

The Cases for Cashless Societies across the globe

Cashless is gaining momentum. It is often portrayed as an ode’ to progress and development…

Here are the primary cases being made for a cashless society, let’s start with the one’s given by its biggest proponent, the United Nations’ Better Than Cash Alliance who has partnered with  Bill & Melinda Gates Foundation UNCDF, CITI, MasterCard, Ford Foundation, USAID, Omidyar Network, and Visa Inc., and offers the following reasons:

1.     Transparency — In a cashless society where payments can easily be tracked and traced, theft of payments and hence corruption can be dramatically reduced

2.     Security — The money goes where it is meant to. The biggest threat to a digital transaction is the loss of information. Hence in case of the digital payment systems, it is extremely easy to shut down a digital wallet if it gets stolen whereas in case of biometric, your ID is yours alone and very hard to copy.

3.     Financial inclusion — The unbanked of the society will be able to create a record of their timely payments, allowing them to get other services including loans for instance

4.     Cost savings —Digital payments reduce bank processing fees

Apart from these, early adopters have a lot to say about convenience.

There is no doubt about it, the system does offer convenience. Money simply becomes another function of the smartphone, an app that eliminates the need for carrying and protecting cash or plastic money and which allows payments at the touch of your fingers.

If you think the case for the cashless society is becoming longer, then bear with me. Because only from knowing all these “pros” can we see the new methods of surveillance they are establishing.

Now from the perspective of the economy, a cashless payment system will:

1.     Enhance our tax base because the government can easily trace almost every transaction throughout the economy from a centralized location.

2.     It can put down the parallel economy, especially one based on various illicit activities.

3.     Increase GDP and perhaps employment by forcing people to convert bank savings into either investments or consumptions, and

4.     Create an environment where people start adapting cashless and wireless technologies.

Despite how it sounds (an easier and more convenient method of purchasing goods and services) fear is in the air across the globe.


The Problems with Cashless Society

The risks posed by the new cashless society go far beyond simple loss of money or an inability to use the system.

Yes, let’s not go into the debate that the technology is not perfect, not yet, and that hackers could easily get into it or that your information can be stolen.

It’s more than that now.

Let’s begin “Google Wallet makes it easy to pay - in stores, online or to anyone in the US with a Gmail address. It works with any debit or credit card, on every mobile carrier.” That means more and more information about you is being centralized and gathered at a single place.

As Bill Gates makes a case for cashless society yet again in his 2015 Annual Letter “By 2030, two billion people will be storing money and making payment with their phones.”

And here’s the most alluring part “Already, in the developing countries with the right regulatory framework, people are storing money digitally on their phones and using their phones to make purchases, as if they were debit cards.”

The regulatory frameworks are very important to this debate.

So what happens when the society goes cashless?

  • We Go Greece — in a cashless society, the government loses a robust alternative for paying debts. We’re already observing how Greece’s unwillingness or inability to print more Drachma bills to pay its debt (a precondition for securing the euro loans) has put it on the plank
  • We Face Incremental Risks — The only incremental risk paper money carries with it is physical theft. However, when you move to a cashless society and convert it into bank deposits you not only pay a fee but are also exposed to negative interests, and a substantial loss in case of bankruptcy. I mean, by going cashless we’ll be giving our currency that was backed by the central bank and swap it for a currency backed by the local bank.
  • Consequences for the Retirees and Poor —   What do you think will happen for the people incapable of transacting using plastic money? The retirees who have liquid savings will have to bear a disproportionate costs for holding it in bank accounts, whereas the poor who have no access to the banking system will become dependent (more than ever) on government handouts.
  • Unemployment — What about illegal immigrants? They’ll be out of job creating significant civil unrest.
  • Cyber Risk — The cashless society is solely dependent on electronic forms of transactions, if any form of disruptions occurs, the economy will come to a halt.
  • Penalties and New Regulations — How will the new government mandates for a cashless society be enforced? With a ban on cash transactions right? This implies penalties which in turn means more stringent regulations, compliance costs/penalties, disclosure requirements, and even jail.

But consider how banning cash transactions will affect the position of US dollar as the world’s reserve currency. It will roll the downhill.

This would mean that regulatory frameworks are being implemented on the world. A much different approach than simply forcing it on just US citizens. What do you think the foreigners will think and do with their US dollars?

Dump the bills and flock to the new currency capable of offering the needed liquidity.

It is true that the cashless society trend is rising and at an alarming rate because of its convenience:

Image curtesy of Highcharts.com

Cash seems to be dying slowly.

Countries such as Denmark (which has already become the first developed country moving towards becoming a cashless society and is followed suit by Sweden), the people believe in the system for their security, and unlike us (or the rest of the world) are much less concerned about what the NSA revelations had meant for us.

For US citizens that is the biggest problem.

A cashless society with implanted microchip with a new mode of discipline and monitoring people, tearing what remains of our privacy after various customer tracking technologies have been implemented for retargeting ads and tracking behavior.

With the fast paced lifestyle and faster creation and deployment of technologies, we will soon be at a standoff, where the market itself will only have technologies that offer no other alternative but a cashless payment system.

The United Nations, alongside the Bill and Melinda Gates Foundation, is already moving across the globe wanting societies to forego cash for more virtual transacting. It is playing its trumpet: of a cutting costs and improving transparency.

The stakeholders are already working with the private sectors and governments to create the new market for the new regime.

Here’s a list of the various constitutional rights we’ve already lost, a showcase of the government’s power (including the right to indefinitely detain and assassinate any American citizen without charge).

Now it’s come to a cashless society and near total surveillance using our digital transactions.

With all this said, there are ways to protect our capital, assets, and investments and we can actually prosper from the change if you understand how to take advantage of the system.

Read This, Spike That

Welcome to the ‘No Place to Hide’ Market

It’s not just bad news for stocks and commodities: Even bonds have lost ground in 2015.

By John Kimelman           

Even casual investors are aware that stocks have taken it on the chin over the past month.

But here’s what might surprise many: The troubles this year are extending to asset classes that often perform well when stocks are down.

A post on the Capital Spectator blog offers a sobering look at 14 asset classes ranging from emerging markets stocks to inflation-protected Treasuries.

It is widely known that U.S. stocks are down modestly and that emerging markets and commodities have been particularly hard hit. (The latter two classes are down roughly 25% and 30%, respectively.)

But bonds, from Treasuries to U.S. corporates, have lost anywhere from a fraction of a point to a few percentage points.

“For first time since the 2008-2009 financial crisis and Great Recession, we have the following worrisome trend hobbling all the ETF proxies for the major asset classes: negative year-over-year returns,” writes James Picerno, the editor of Capital Spectator. “That’s a formidable force.”

Picerno’s advice: “Beyond nibbling on the edges for speculative purposes, strategic-minded investors may want to wait for more encouraging signs before redeploying capital into risky assets in a meaningful way.”

This across-the-board negativity also caught the attention of Cullen Roche, the editor of the Pragmatic Capitalism site.

“If you had told me that China might be falling apart in 2015, emerging markets were falling 25% and we’d have a flash crash I’d have guessed that long-term bonds were up 10% in that period,” writes Roche. “But no, even bonds have been suppressed.”

He adds, “There has been almost nowhere to hide this year. Except for cash of course.”

Meanwhile, for investors who have long wondered about whether the time of day should be of significance to investing, The Wall Street Journal has an illuminating answer.

The article assets that “rising stock-market volatility is proving especially costly for retail investors who typically buy and sell stocks soon after the market opens—often the most perilous time of the trading day.”

The piece tells us that buying and selling by individual investors is “especially heavy in the minutes immediately after the market opens in the U.S. at 9:30 a.m. Eastern time, when the chances of getting the best price for a stock are lower and swings tend to be bigger, traders and other market observers said. But within minutes, the gap between the price sellers want for a stock, known as the “ask” price, and what buyers are offering, the “bid,” shrinks sharply and continues to narrow up until the end of the trading session. This quirk in the market has been amplified in recent weeks amid the big market swings.”

Investors know that the smaller gap, or spread, is better for investors because they are less likely to overpay for a stock or sell below the prevailing price in the market. “The wider the spread, the more exposed investors are to high costs, which can erode returns at a time when major stock indexes are down for the year,” the Journal article states.

The Journal reports that in the first half of 2015, the difference between the bid and ask prices of shares in the Standard & Poor’s 500 was 0.84 percentage point in the first minute of trading, according to data from ITG, a brokerage. That gap shrinks to 0.08 percentage point after 15 minutes and to less than 0.03 percentage point in the final minutes of the trading day.

“This difference often amounts to only pennies a share,” the article states. “But it can add up for the many individual investors who pile into the market early in the trading day.”

Get Ready for a Huge Wave of Bankruptcies

Justin Spittler

Global companies are having trouble paying their bills…

Last week, credit rating agency Standard & Poor’s (S&P) downgraded Brazil’s government debt from “investment grade” to “junk” status. “Junk” status means Brazil’s bonds are at a high risk of default.
This is no surprise…
In 2011, socialist Dilma Rousseff took over as president of Brazil. She has wrecked the country’s finances in just four years. 

Brazil’s government had a significant surplus when Rousseff took over in 2011. But last year the Brazilian government racked up its largest deficit in history. It spent $129 billion more than it took in.
As you can see, Brazil’s government surplus has shrunk every year since Rousseff took power. It finally turned to an outright deficit last year.
Brazil recently entered its worst recession since the Great Depression. And Brazilian stocks are in a severe bear market. EWZ, a major Brazil ETF, is down an incredible 52% in just the last year.

•  Yesterday we explained how abnormally low interest rates have fueled a huge borrowing binge in America

We explained how the Fed’s easy money policies have encouraged Americans to borrow record amounts of money. Americans have borrowed to buy things like stocks, houses, and cars.

But it’s not just America…

Low interest rates in the U.S. have also encouraged companies in emerging markets to borrow record amounts of U.S. dollars. The Wall Street Journal reports:

“…the amount of dollar-denominated loans to borrowers in emerging markets, excluding banks, has nearly doubled since 2009 to more than $3 trillion.”

Brazilian companies alone have amassed $270 billion in foreign debt since the last financial crisis. Bloomberg reports that banks and non-financial companies in Brazil have doubled their dollar-denominated debts since just 2007.
•  The dollar has soared in the past twelve months…
Regular Casey readers know the U.S. dollar has soared 20% vs. other major currencies in the past 12 months.

This is a HUGE problem for foreign companies that have borrowed U.S. dollars.

Take Brazil, for example. The Brazilian real is down an incredible 40% vs. the dollar since the beginning of 2015.

This means that a Brazilian company that borrowed in dollars suddenly owes 40% more.

Here’s a simple example of how the math works:
Say a Brazilian company pays $100 per month in interest on US dollar-denominated debt.

It must pay this interest in U.S. dollars. But like many Brazilian companies, it earns most of its revenue in its domestic currency, the Brazilian real.

At the beginning of 2015, this company had to earn 260 Brazilian reals to pay $100 in interest.

But because the real has lost roughly 40% of its value vs. the dollar…it now must earn 380 reals to pay the same $100 in interest.
This company’s monthly interest bill went up 40%.
•  This is happening on a large scale around the world…
It’s a big reason why corporate default rates are rising.

Bloomberg Business reports that “the global tally [of corporate defaults] has reached at least 65 this year, surpassing 60 for the whole of 2014.”

Bloomberg continues…

Emerging-market downgrades are 4 times the amount of upgrades at S&P -- the worst ratio since 2009 - as a record $5.2 trillion of bonds comes due for the debtors this year, according to Bloomberg-compiled data.

The Market Vectors Emerging Markets Local Currency Bond ETF (EMLC), the largest ETF that tracks local currency emerging market bonds, is down 17% this year.

  This is another unintended consequence of the global monetary experiment

By pushing rates to near zero and holding them there for seven years, the Fed hasn’t just warped the American economy. It has warped the entire global economy.

Many foreign companies that borrowed in U.S. dollars thought they were getting a “free lunch.” They thought borrowing in U.S. dollars would save them money since U.S. interest rates are so low.

Borrowing dollars looked like a cheap source of financing. But it has backfired badly.

The Fed’s zero-interest policy causes people to make bad financial decisions.
This is just one example of the trillions of dollars of bad decisions people have made in the last seven years due to near zero interest rates. Another word for these bad decisions is “malinvestments.”

The trillions of dollars of malinvestments created in the last seven years need to be liquidated. And the corporate defaults we’re seeing are likely just the beginning.

The coming liquidation phase will cause massive shifts in wealth. Very soon, protecting your savings will likely become more important than ever.

Chart of the Day

Today’s chart shows the U.S. dollar index going back to the 1970s. This index tracks the dollar’s performance versus other major currencies.

As you can see, the dollar generally goes down. Casey readers know the U.S. dollar has lost 96% of its value since 1913.

But as you can also see, the dollar recently made a big move up. It broke above its 30-year downtrend, and is now at its strongest level since 2003.

The dollar’s strength won’t last forever. The Fed’s easy money policies will eventually take the dollar to new lows.

However, breaking above a 30-year trend line can be significant. We wouldn’t be surprised if the dollar stays strong for at least another few months.
Justin Spittler
Delray Beach, Florida
September 15, 2015
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