Brexit Britain’s nervous breakdown

The country is upending the policies that have set its national course for 50 years

Philip Stephens



Familiarity is a distorting prism. All too easily the extraordinary becomes the unremarkable, the aberrant the commonplace. This is what has happened in Britain following the referendum decision to leave the EU. The attempt to wrench the nation out of its own continent has triggered a national nervous breakdown. Only the British cannot see it.

Open plotting against an enfeebled prime minister, civil war in the cabinet, a ruling Conservative party riven by faction, a Labour opposition led by a life-long admirer of Fidel Castro, parliament imprisoned by the referendum result, paralysis at the heart of government — all have become the stuff of everyday politics. Britain was once a sturdy, stable democracy. Anger and acrimony are the new normal, as likely to elicit a weary shrug as incredulity.

Historians will scratch their heads in wonder. These are truly extraordinary times. Britain is upending the economic and foreign policies that have set its national course for half a century. Nothing in modern peacetime matches the upheaval. The impact on the nation’s prosperity, security and role in international affairs will be felt for a generation and beyond. Unwrapping decades of integration is a task of huge complexity.

And yet Theresa May, the prime minister, dare not set out her preferred course for a post-Brexit settlement lest she be toppled by her own Tory MPs. Instead she pleads with Germany’s Angela Merkel to tell her what Berlin might offer in terms of a future relationship. The humiliation is excruciating.

With each step back from the melee, the picture becomes all the more incredible. Most MPs in the House of Commons consider Brexit an act of folly. They will vote against their judgment because the referendum, with its narrow majority for leave, has been invested with an absurd, almost mystical status. Let no one dare question “the will of the people”. With the odd, honourable exception, Tory and Labour pro-Europeans seem inclined to let Britain sink rather than make common cause across party lines. A nation that calls itself the mother of parliaments has somehow mislaid the meaning of representative democracy.

Brexit is an act of protectionism promulgated by English nationalists who inexplicably style themselves free-marketeers. Every study produced in Whitehall suggests departure from the single market will leave Britain poorer and less able to promote its interests overseas. Throwing up barriers across the Channel will weaken its voice across the Atlantic.

Only this week Mrs May sought unsuccessfully to suppress an official analysis showing the alternatives to EU membership will reduce growth and cut living standards. Tory Brexiters are unmoved. The cabinet Brexiter Michael Gove sets the intellectual tone when he pours scorn on the insights of experts.

Baffled historians will search in vain to find a single official in the high echelons of Whitehall — from the cabinet secretary down — who thinks Brexit is anything less than a catastrophe. But what of “global Britain”, the bold Elizabethan future imagined by the Brexiters? Alas, the historians will discover, the vision amounted to no more than rhetorical flatulence on the part of Boris Johnson, the foreign secretary.

Where all this leads, it is impossible to say. Mr Johnson, whose calculated mendacity is matched only by inflated self-regard, is determined Mrs May should be ousted. Personal ambition burns more brightly here than any convictions. The foreign secretary has no project or purpose in mind. He wants to be prime minister because, well, he wants to be prime minister. Parallels with US president Donald Trump are not far-fetched.

Mrs May could survive. But to what end? Without the confidence of her cabinet and deprived of a majority in the House of Commons by an ill-judged general election, Mrs May has neither the wit nor the authority to reach a sensible agreement with the EU27. Most MPs would back a “soft” Brexit, leaving Britain’s economy closely connected to Europe. Mrs May feels threatened by the English nationalists. Her strategy, if you could call it that, is to leave all the serious decisions until after Britain’s departure from the EU in March 2019.

In other circumstances Her Majesty’s loyal opposition might offer a counterpoint of stability. Instead Labour is led by Jeremy Corbyn, a 1970s hardline socialist who sees the EU as a capitalist conspiracy. Mr Corbyn may launch opportunistic strikes against the government but shows no enthusiasm for a close relationship with the EU27.

As for the voters, some may have changed their minds. Polls suggest the 52:48 per cent tally in favour of Leave would be reversed in a second referendum. Maybe. But these numbers are well within the margin for error. Why anyway should people take a different view before they have seen the deal on offer from Britain’s erstwhile partners and, pace Mr Gove, have weighed the evidence as to the likely effect on living standards?

If there is a slim hope that Britain can emerge wounded rather than broken, it lies in the possibility that things will get still worse in the short term. Mendacity, chaos and division could end in complete paralysis — with parliament failing to agree on any form of Brexit. If Britain does remain part of the EU after all this, it will be because, in its present state, it is simply incapable of leaving.

The World Embraces Debt At Exactly The Wrong Time

Take It To The Bank: Interest Rates Won't Rise

By: Keith Weiner



How Not to Predict Interest Rates

We continue our hiatus from capital destruction to look further at interest rates. Last week, our Report was almost prescient. We said:

The first thing we must say about this is that people should pick one: (A) rising stock market or (B) rising interest rates. They both cannot be true (though we could have falling rates and falling stocks).

We write these Reports over the weekend. At the time of last week’s writing session, Friday’s close on the S&P was 2757 (futures). Monday this week saw a crash, with the S&P down to 2529 at the low point in the evening. That is a drop of -8.3%.

We are not stock prognosticators, and we will neither tell you “short the market” nor “buy the dip”. We have a different point to make.

Rising interest rates, by a variety of mechanisms, cause stocks and all asset prices to go down.

We have touched on a few in this Report. One is that investors have a choice between the risk-free asset—the Treasury bond—and anything else (note: the Treasury bond is not risk free, but if it defaults then everything else will be wiped out in the collapse). Why would they accept a lower yield on stocks along with the greater risk? Another is that corporations can borrow to buy their own shares. Management may do this if the interest rate is lower than their shares yield. But they can sell shares to pay off debt if the shares have lower yield than the interest rate.

Let’s look at a few more.

Consider home buyers. It is well understood that most people are monthly payment borrowers.

That is, they have a budget for the mortgage payment and fit the house to that budget. If the typical middle class family can afford $2,500 a month, that’s it. When the 30-year fixed mortgage rate was 3.4% in 2013, this family could afford to finance $565,000. Today, at 4%, the amount is down to $525,000.

Interestingly, the 30-year mortgage rate illustrates our ongoing theme. Demand for credit is soft. In a time when 12-month LIBOR was under 0.8%, the 30-year mortgage rate was 3.4%.

Now that LIBOR has risen to 2.3%, a gain of 1.5%, the 30-year mortgage is going for 4%, or only 0.6% higher. If the mortgage had increased by the same 1.5%, it would be 4.9% and this family would be down to financing $472,000.

And it gets worse. In a falling rates environment, many people take Adjustable Rate Mortgages (ARMs) with a balloon payment at the end, which is another form of duration mismatch. So the relevant 2013 comparison is not 3.4% but 2.6%. At 2.6%, someone willing to use an ARM—we will call him the marginal home buyer—could finance $625,000.

In rising rates environment, we assume that most people will want to fix their mortgage rate.

And now there is a consensus, from Fed propagandists to the gold bugs and everyone in between.

Everyone thinks that rates are rising. So the relevant comparison for amount financed between 2013 and today is $625,000 to $472,000, a drop of -24%.

Let’s move on to the automakers. At least in the US (we don’t know if this occurs in other countries), they are advertising 0% to finance a new car for 72 months. Of course, the carmakers cannot borrow for free. Let’s assume they are playing the duration mismatch game, and using 1-year maturities, because it’s a lower rate. The disadvantage of financing a 6-year loan with a 1-year liability is that you must roll the liability five times, on each anniversary. The advantage is that the rate is lower.

In any case, their cost of borrowing has increased substantially. In late 2014, 1-year LIBOR was 0.56%. It has risen relentlessly since the end of 2014. Today, it is 2.31%, a gain of +1.8%. This adds $18 million a year of cost, for every billion financed.

Ford sales for the last 12 months are over $150 billion. Even if a quarter of their sales were financed this way, the increase in cost of borrowing over the last three years is $690 million.

That covers a year’s worth of sales. But since the company has to carry this debt for up to 6 years, assume annual increase in interest expense is double that (it would be complicated to calculate and we would need more information, but double seems conservative), or $1.38 billion.

Rising interest has added costs which are a big in relation to the automakers’ annual profits, Ford makes around $5 billion a year.

This situation—rising rates to the car companies, but zero interest to consumers—helps proves our case that we are in a falling-rates regime. A falling rates dynamic has soft demand for credit, which increases only when the interest rate ticks down.

The car companies rightly fear what would happen to sales volume if they tried to pass through even just the increase in the cost of borrowing. If they offered 1.8% financing, they would sell fewer cars. Many fewer.

If the rate ticked down enough for them to offer financing at -1%, then that would really boost sales!

This same thing is playing out in all consumer durables, from four-wheelers, to furniture, to boats, to kitchen cabinets.

And likely in commercial real estate. When a landlord finds a creditworthy tenant who is willing to sign a 5-year lease, the landlord may spend some money building out the space to the tenant’s needs.

The cost of this has to be amortized in the rent. How much should the landlord be willing to spend, and how does the landlord calculate amortization? A higher interest rate means it’s harder to subsidize the cost of accommodating the tenant’s needs. But if there is a high vacancy rate, the landlord may be caught between a rock and a hard place. Either don’t do it, leave the space empty, and default on the mortgage. Or do it, add to the monthly debt service burden, and risk default—in hopes of increasing the chance of finding other tenants for the other empty spaces in the building.

The rising cost of borrowing is squeezing landlords, making them less willing (and able) to borrow more for new projects.

Now let’s get back to that most people expect rates to rise. Last week, we discussed the causes and effects of the rising cycle (which last occurred 1947-1981) and the present falling cycle since 1981.

We said it would take either a miracle or a calamity to reverse and cause a rising cycle. A miracle would be rising productivity and rising profits. A calamity would be rising time preference. And rising rates would cause a calamity—a cascading series of defaults.

However, the idea of rising rates persists. One idea we have seen discussed this week is the effect of rising debt. Massive growth in the national debt is likely coming to America, thanks to a deal between the party of spend more and the party of tax less. This will likely cause an increase in money supply. Because of this, it is argued, interest rates must rise.

Let’s look at that. Here is a graph of the M2 money supply and US government debt along with the interest rate on the 10-year Treasury (all data courtesy of the St Louis Fed).

For this time period, we see that M2 and debt are highly correlated, and anti-correlated with interest.

We have indexed debt and M2 as we are only trying to show the correlation.





We went back only to 1981, not because it’s the start of the current falling rates cycle, but because the data does not go back farther. If we had looked 1947 to 1981, we would see debt going from $258 billion to $998 billion, an increase of 287%. At the same time, M2 went from $146 billion to $1.8 trillion (courtesy econdataus.com), or 1,133%. Due to a change in sources in this data set, the change could be overstated by perhaps 400%.

The point remains, the rising cycle and the falling cycle both have rising government debt and rising quantity of dollars. That’s just how a centrally banked fiat currency works. It’s a feature, not a bug. But it does not always have rising rates. It can have—and does right now—falling rates.

Therefore, we emphasize our conclusion. You cannot say that rising debt or rising quantity of dollars will cause rising interest rates. Rising debt/M2 has not correlated with interest rates for 37 years.

If you think that as of 2018 a new correlation will begin, we encourage you to describe your theory.

And please write to us. We would love to look at a new theory.

The above ideas are an application of Keith's Theory of Interest and Prices in Paper Currency.

Geocentric vs Heliocentric

Before Copernicus, people believed that the sun and planets revolved around the Earth. But it was pretty complicated to explain the retrograde motion of the planets. And it led to a question. What would cause an object to slow down and reverse? Nothing on Earth behaves like this.
The heliocentric model of Copernicus is much simpler. Each planet goes around the sun in a circle (later they realized the orbits are actually not circles but ellipses).

Today, we have a dollarcentric view analogous to the geocentric view of the Medievals. Analogous to retrograde motion of planets, is the question of whether gold or stocks are outperforming. According to the dollarcentric view, the S&P stock index fell from 2,757 to 2,619, or -5% this week. And gold fell from $1,333 to $1,316, or -1.28%. So most people say stocks underperformed. And most gold bugs are excited, because this (supposedly) supports a case that gold is going back into a bull market.

For reference, silver fell from $16.56 to $16.32, or -1.45%. So silver underperformed gold. Which would not be supportive of the gold bull market thesis.

When the markets realize that the dollarcentric view is wrong, we will have a revolution in monetary science, just as Copernicus ushered in a revolution in physical science.

We should be saying that the dollar went up, from 23.3mg gold to 23.6mg. And stocks fell from 2.07oz to 1.99oz gold.

This should not be a radical idea. Even dollar advocates admit that the dollar goes down—indeed the stated goal of the Fed is 2% decline per annum. And they also admit that there can be long leads and lags, years or decades. So this unit, which is an ever-stretching rubber band subject to unpredictable volatility is supposed to be the unit of measure.

And gold, which is not subject to central planning, is just one alternative of many investments—all to be measured in centrally planned rubber bands.

You cannot understand the solar system, if you are trying to measure the backward motion of Venus against the forward travel of Mars, using the Earth as the center. And you cannot understand the markets if you try to measure the upward motion of gold against the downward motion of stocks, using the dollar as the center.

Gold standard aside, this revolution is necessary, and we believe that it’s coming. It will have to, as our currency becomes more volatile. Those stuck believing that our gyrating, failing currency is the center, while it goes off the rails, will not be able to grasp what happens.

Supply and Demand Fundamentals

Let’s take a look at the only true picture of the supply and demand fundamentals for the metals. But first, here is the chart of the prices of gold and silver.





Next, this is a graph of the gold price measured in silver, otherwise known as the gold to silver ratio (see here for an explanation of bid and offer prices for the ratio). The ratio rose.





Here is the gold graph showing gold basis, cobasis and the price of the dollar in terms of gold price.





The uptrend of the cobasis (scarcity) continued this week. Not surprising with falling price.

The Monetary Metals Gold Fundamental Price rose $14 this week, to $1,386.

Now let’s look at silver.





The same thing is happening in silver (though beware the effect of the control roll, this is the March contract which hits First Notice day in a few short weeks).

The Monetary Metals Silver Fundamental Price fell 30 cents to $16.93.

We promised to write an article about the silver price and basis action of Friday last week (Feb 2). We did not do that, so please see the chart below.




What we look for when analyzing intra-day price moves is the behavior of the price in relation to the basis. Friday’s action is similar to many of our previous intra-day Forensic Analysis, where we see that price and basis move together, in this case both falling.

This is a picture of selling primarily in the futures markets, or to put it another way, that futures selling led the spot market lower. It is a common pattern because speculators in futures market predominantly operate on margin/leverage compared to the spot (physical) market, where a higher proportion hold fully paid up positions.

50 Percent for 5 Percent

A Look at Germany's Extremely Unequal Wealth Distribution

By Florian Diekmann



European Central Bank statistics show that wealth distribution in Germany is extremely unequal. But a new analysis by the German Institute for Economic Research shows that the situation is even worse than initially thought.

The gathering of global political and industrial leaders in Davos each year leads many observers to wonder: Who benefits in the long term from economic growth and corporate profits? Society as a whole or just a select few at the very top? One way to approach that question is by looking at how the entire wealth of a given society is distributed among individual members of that society.

The problem, though, is that it isn't so easy to calculate that distribution. Official data does, of course, exist. In Germany it is compiled by the Federal Statistical Office, and the European Central Bank (ECB) has been doing the same for the eurozone over the last few years. That data shows an extremely unequal wealth distribution.

But in reality, wealth is even more concentrated than the data shows, because the statistics have a blind spot: The superrich and their assets are consistently underestimated. This is because, on the one hand, there are so few of them that they aren't adequately accounted for in randomized surveys. On the other hand, the statistics are based on voluntary responses - and willingness to participate demonstrably sinks as wealth among respondents increases.

When it comes to the superrich, however, there are relatively reliable estimates in the form of lists of the world's wealthiest people, with the one compiled by the US business magazine Forbes leading the way. A similar list is compiled in Germany by manager magazin. A team of tax experts led by Stefan Bach of the German Institute for Economic Research (DIW) has examined the wealth statistics compiled by the ECB and augmented them with lists identifying the ultrarich. And the team did so for three countries: Germany, France and Spain.

The result: The 45 richest households in Germany own as much wealth as the bottom half of the population. Each group possessed a total of 214 billion euros in assets in 2014. The following graphic illustrates the distribution of wealth in Germany as it stood three years ago. The top 10 percent of the population is shaded in hues of blue while the remaining 90 percent is shaded red.

The darkest red section represents the bottom 50 percent of the German population while the darkest blue stands for the 45 wealthiest households in the country.

In compiling the more precise statistics, the DIW team adopted an approach that the ECB itself proposed as a correction to its own wealth statistics. (You can find a detailed description of the methods used and the results compiled in this English-language discussion paper released by the DIW.)

By incorporating lists of the wealthiest people in Germany, it becomes clear that wealth inequality is much greater than reflected in the official ECB numbers. According to the DIW study, the wealthiest 5 percent in Germany owned 51.1 percent of the country's entire wealth in 2014. ECB numbers, meanwhile, held that the richest 5 percent only owned 31.5 percent of the nation's wealth that year.

Furthermore, the top 1 percent of German households owns a third of the country's wealth (instead of the 23.6 percent shown by ECB statistics), and the top 0.1 percent owns 17.4 percent (instead of 6.3 percent). The richest 0.001 percent - just 400 households - own 4.7 percent of the country's wealth, according to the DIW, which is twice as much as the roughly 20 million households that make up the poorer half of German society. In the graphic, you can also see the absolute amount of wealth each category owns.

The analysis makes clear that in comparison with other countries in Europe, the distribution of wealth in Germany is weighted particularly unfairly in favor of the superrich. That becomes obvious when an analysis of Spain and France is included. ECB data leads one to believe that wealth is more concentrated in those two countries than in Germany. But once the statistics are augmented with lists of the wealthiest households from each country, a fundamentally different image emerges. In both France and Spain, those lists show that the share of national wealth owned by the superrich is higher than indicated by ECB statistics alone, but the difference is much more pronounced in Germany.

According to DIW calculations, the poorest half of the population in Spain owns just under 12 percent of the country's total wealth while in France, that number is slightly above 6 percent. In Germany, meanwhile, it is just 2.3 percent. The richest 10 percent of households in France and Spain own less than half of their country's wealth, respectively. In Germany, that bracket owns close to two-thirds of the nation's wealth.

That shows that wealth distribution in Germany is much less equal than statistics would seem to indicate - and much less equal than in other large European countries. DIW researcher Bach, though, does suggest that the consequences of inequality in Germany is likely less deleterious than it is elsewhere. His explanation is that the list of German billionaires compiled by manager magazin is largely made up of families that own successful companies, many of them typical representatives of Germany's strong medium-sized company sector.

"They are considered the backbone of the German economy. They strengthen competition with large corporations, create jobs all over the country and usually take care of their people and their regions," Bach says. Furthermore, the investments they make often come from their own capital reserves instead of from bank loans. All of that benefits lower income groups. In Germany, in other words, Bach believes it really is the case that the wealth belonging to the superrich also benefits society as a whole.

But Bach also sees the extreme concentration of wealth as a problem. Families that own successful companies have a particularly large influence on politics through direct access to the chancellor or state governors and by way of expensive marketing campaigns. The result is that privileges for the wealthy remain significant when it comes to inheritance tax. And Germany doesn't have a wealth tax.

A Decade of Dirtnap

By Jared Dillian

• Prices came down

• Wages game down

• Financial assets went up

• Hard assets went down

• Consumers benefitted

There Won’t Be Three Rate Hikes This Year

Source: The Daily Shot

Source: Bloomberg

1. People are assuming Jay Powell will be the exact same Fed Chair as Janet Yellen.
2. People are assuming the future composition of the Board of Governors will be hawkish.
3. People are assuming the volatility of inflation remains low.
4. People are assuming tax reform will lead to growth.
5. People are assuming the probability of a recession is low.
6. People are assuming the best of Trump.