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Well another day, another horrible piece of economic data out of Brazil.

Core retail sales in South America’s most important economy slid 2.7% M/M in December, erasing a meager gain the country eked out in November when the numbers got a boost from promotions.

Broad retail sales, meanwhile, declined 0.9% marking the eleventh decline in thirteen months. They’re now off more than 16% since peaking in August of 2012.

The breakdown is a veritable disaster, with sales of office and telecommunications equipment down 9.1%, furniture and appliances down 8.7%, and clothing and footwear lower by 2.1%. Goldman sums it up: “The near-term outlook for private consumption and retail sales remains challenging owing to the continuing deceleration of credit flows from both private and public banks, high levels of household indebtedness, declining employment and real wages, higher interest rates, rising local and federal taxes (including via inflation), higher utility and transportation tariffs, heightened economic and political uncertainty and depressed consumer confidence.” Oh, is that all?

Here’s what “disaster” looks like:

As we wrote on a number of occasions last summer (when things really began to go south in earnest), the depth of Brazil’s depression recession is astounding. But you’d think that after six months of abysmal data, one would eventually become desensitized to the numbers.

But not in Brazil’s case.

Every time we think nothing else could surprise us it seems to get worse. In the latest example of a shockingly bad economic outcomes from the “B” in BRICS we learn that in 2015, 5,525 companies went bankrupt. That’s the most since 2008. 

“It’s legitimately a credit crisis,” says Fitch’s Joe Bormann, who, as Bloomberg writes, “has never seen the nation’s companies in such a dire state.” 

“No Brazilian company has raised financing in overseas bond markets since June as an unprecedented corruption scandal at the state-owned oil producer and ratings downgrades have prompted investors to shun the nation’s financial assets,” Bloomberg goes on to note. 

As is evident from the retail sales data outlined above, things aren’t likely to get better any time soon. Of course the worse it gets, the more the market will punish the country’s corporate borrowers. Have a look at the following chart, again from Bloomberg, which shows how quickly credit spreads have blown out for Brazilian issuers who are now effectively shut out of international markets:

So consider that, then note that the BRL plunged 33% last year:

If that trend continues and Brazil remains mired in recession crimping corporate profits, one has to wonder if the country’s corporate sector may have trouble servicing its USD debt. Some $24 billion in debt service payments come due this year and next. 

We close with what we said in early December, when we took a look at Deutsche Bank’s assessment of the EM corporate debt picture: When Deutsche looks at what the bank says is a representative sample of corporate borrowers across LatAm and Ceemea, they find that only 14% of the sample is “in danger” based on net debt-to-EBITDA and cash-to-short term debt. However, when the bank uses 9%+ bond yields as a proxy for “oh shit,” it turns out that a whopping 27% of the LatAm sample is in trouble. Specifically, Brazil has some $89 billion in USD bonds trading above 9% (a large chunk is Petrobras paper). Here’s the full breakdown: Petrobras (USD37bn), USD20bn of industrials, USD15bn of banks (mostly subordinated), USD6bn of rigs, USD3bn of royalty-backed bonds and USD8bn of other sectors.

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Submitted by Frank Hollenbeck via The Mises Institute,

It is now just a matter of time before the US central bank follows the central banks of Japan, the EU, Denmark, Sweden and Switzerland in setting negative rates on reserve deposits.

The goal of such rates is to force banks to lend their excess reserves. The assumption is that such lending will boost aggregate demand and help struggling economies recover. Using the same central bank logic as in 2008, the solution to a debt problem is to add on more debt. Yet, there is an old adage: you can bring a horse to water but you cannot make him drink! With the world economy sinking into recession, few banks have credit-worthy customers and many banks are having difficulties collecting on existing loans.

Italy’s non-performing loans have gone from about 5 percent in 2010 to over 15 percent today. The shale oil bust has left many US banks with over a trillion dollars of highly risky energy loans on their books. The very low interest rate environment in Japan and the EU has done little to spur demand in an environment full of malinvestments and growing government constraints.

Central bank policies have also driven government bond yields into negative territory. Nearly $7 trillion of government bonds are currently trading at negative rates.

But, economic theory presupposes that negative rates are an impossibility. After all, why would you buy a one-year treasury bill for $1,005 that will get you $1,000 in a year, when you can stuff your mattress with the $1,005 and still have $1,005 in a year? Some would say that storing money is costly and risky, but that is also true for most assets.

The reason is actually quite simple and shows how distortive monetary policy has become worldwide: It makes sense to purchase a bill for $1,005 if you intend to sell it before it matures to the central bank for more than $1,005. In today’s world, the central bank is often ultimately expected to purchase the bill and lose money on it. It’s just another type of debt monetization.

(And it is, by the way, something the Germans emphatically wanted to avoid when the ECB was initially created.)

We Just Need to Print More Money!

The real problem is the way monetary policy is taught in almost every undergraduate and graduate program in the world. Pick up any macroeconomics textbook and it will explain how interest rates are determined by the demand and supply of liquidity. The economy is treated as a car, and interest rates are viewed as the gas petal. When reality does not match up with the model, today’s economist, instead of questioning the model and theory, assumes that more of the same will ultimately force reality into the model.

The problem arises from a fundamental misunderstanding about the role of interest rates. Mises in 1912 had this to say about our current enlightened view on money:

[This view of money] regards interest as a compensation of the temporary relinquishing of money in the broader sense — a view, indeed, of unsurpassable naiveté. Scientific critics have been perfectly justified in treating it with contempt; it is scarcely worth even cursory mention. But it is impossible to refrain from pointing out that these very views on the nature of interest holds an important place in popular opinion, and that they are continually being propounded afresh and recommended as a basis for measures of banking policy.

In fact, interest rates reflect the ratio of the value assigned to current consumption relative to the value assigned to future consumption. That is, money isn’t just some commodity that can solve our problems if we just create more of it. Money serves a key function of coordinating output with demand across time.

So, the more you interfere with interest rates, the more you create a misalignment between demand and supply across time, and the greater will be the adjustment to realign output with demand to return the economy to sustainable economic growth with rising standards of living (see here and here). Negative rates will only ensure an ever greater misalignment between output and demand.

As with Japan, Western economies that pursue a long-term policy of low or negative interest rates can expect decades of low growth unless these “unorthodox” monetary policies are rapidly abandoned. Recessions are not a problem of insufficient demand. They are a problem of supply being misaligned with demand.

The War on Cash

Meanwhile, a goal of some of the attendees at Davos and others has been to push the world toward a cashless society since an increase in cash holdings would limit the effectiveness of negative rates. They know that if they eliminate cash, central banks will have greater control over the money supply and the ability to guide the economy toward their macroeconomic goals.

As long as there is physical cash, people will hold cash in times of uncertainty. It is a wise alternative when all other options seem unproductive or irrational — and keeping cash in a bank at a time of negative rates is, all things being equal, irrational. Central banks, not surprisingly, would therefore like to take away the ability to hold cash outside the banking system. Worst of all, people who hold cash outside the system might be saving it instead of spending it. Naturally, from the Keynesian perspective, this must be stopped.

This is just the latest frontier in the radical monetary policy we’ve been increasingly witnessing since the 2008 financial crisis. The best monetary policy, however, is no monetary policy at all, and central bankers should take an extended holiday so that the world economy can finally heal itself.

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We’re nearly two months into the new year and one of the defining themes for markets thus far has been the extent to which investors have seemingly woken up to the fact that central bankers are not, in fact, omnipotent.

That rather unpleasant revelation has in turn caused some to reconsider the wisdom of the policies that drove stocks to nosebleed levels off the 2009 lows. That is, if it’s now clear that ZIRP, NIRP, and QE have failed when it comes to stimulating global demand and trade and reinvigorating the inflationary impulse, one is left to wonder what happens when the world careens back into recession against a backdrop of extreme capital misallocation and exhausted counter-cyclical policy maneuverability.

What happens, for instance, if stocks begin to crash and authorities are powerless to arrest the slide because rates have hit the lower bound and there are no more monetizable bonds? Do all DM central banks simply go “full-Kuroda”/ “full-Chinese national team” and provide daily plunge protection? Which brings up another point: the BoJ, the SNB, and Norway’s $830 billion SWF are big holders of equities. What happens when the value of those stakes plunges?

Here to ponder those questions and more is Bloomberg’s Richard Breslow.

*  *  *

From Richard Breslow

“Moral hazard” has become a hackneyed phrase when warning about asset prices, investor behavior and quantitative easing. In fact, money managers have been merely doing the bidding of policy makers. Doing God’s work and making a buck, too. Now that seems like a plan. The lack of downside risk, which has perverted the normal functioning of markets, has been a vital element of the wealth effect strategy.

• If putting risk back into risk management were the only challenge for policy normalization it would be hard enough. It takes only days or weeks to form a habit: they’ve had us hooked on the juice for seven years. But there is a much more systemic problem our leaders have created. Sovereign wealth funds have taken to plowing the people’s money into those same assets
• How does the calculus change, or not, when considering that Norway is the largest shareholder in Switzerland’s second- biggest bank? The Swiss apparently love Apple and Exxon. The Japanese are itching to get in at these levels
• Should regulators be reclassified as activist investors? Will there be a new concept for tax authorities of “earnings after taxes, dividends and appreciation?” It can be acronymized to TADA. How appropriate
• There is no way to know where this will all lead. These aren’t holdings that run down over time. Too big to fail needs to be reconsidered. Desirability of oil prices up or down for national accounts takes on an interesting ambiguity. Indeed the mere concept of economic gain for a country becomes clouded when it ceases to strictly refer to GDP
• Last week, the world was coming to an end. Today, I have sitting in my inbox messages imploring buy at market, you can’t afford to miss the rally. The market rally has been accompanied with assurances that central banks are back, indeed ready once again to do whatever it takes. So goes the sovereign wealth fund, so goes the nation. WIRP at zero, hurrah
• There has been a simple justification driving the reach for yield. It is for the people. The ethos of central banks as traders is now firmly entrenched. It may appear that it is working, but it isn’t a coincidence that so many languages include the phrase, “it just isn’t done”

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Oil prices (and the broader financial markets) have suffered from acute bouts of volatility so far in 2016, with dramatic intraday swings the most worrying feature, and as OilPrice.com's Charles Kennedy warns, this shows no signs of letting up.

With realized volatility soaring…

 

The CBOE Crude Oil Volatility Index, that tracks (as it name suggests) the implied volatility of crude oil, has spiked to a level not seen since the global financial meltdown in March 2009. While energy analysts have closely watched the crash of oil prices since mid-2014, only in the past two months – largely since OPEC’s December meeting – has crude oil volatility surged to its highest level in seven years.

 

Oil prices are at their lowest levels in more than a decade, but the daily up and down moves are leaving investors with whip lash. After crashing last week following bearish comments from the Federal Reserve, oil prices surged by more than 12 percent on Friday, the largest percentage gain in seven years, on more credible news that OPEC might be coming around to the idea of coordinated production cuts. What’s more, even after the 12.3 percent gain, crude oil still ended the week lower than it was on Monday.

What explains the volatility? Part of it is due to computerized trading that leads to feedback loops of buying and selling as large volumes of capital get moved around. But computerized trading is not a new phenomenon.

What is new is the instability in the financial markets. After nearly a decade of near zero interest rates from the U.S. Fed, the global economy still looks rather unsteady. There is no shortage of factors influencing oil prices today. Just to name a few: China’s growth is slowing; emerging market currencies have crashed; oil supply continues to exceed demand; oil in storage is at record levels; and Fed rate hikes may or may not be forthcoming.

This all adds up to a period of incredible volatility. That outlook probably won’t change over the course of 2016.

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Coming as a replacement to perhaps the biggest dove in Fed history, few were expecting former Goldman and Pimco staffer Neel Kashkari to be as vocally outspoken on a topic that is so near and dear to regulators everywhere: their own cluelessness, and more importantly, the topic of “too big to fail” banks, which according to the Fed are a pillar of stability in an unstable world, and which according to Kashkari are anything but.

It is doubly surprising because it was none other than Kashkari himself who served as one of the key architects of the bank bailout plan in the aftermath of the financial crisis.

As MarketNews reports, “having seen the financial crisis first-hand while at the U.S. Treasury Department, the Federal Reserve’s newest regional bank president Neel Kashkari Tuesday said he is concerned that the largest banks are still too big to fail and perhaps should be broken up into smaller units.”

Kashkari, who assumed the leadership of the Minneapolis Federal Reserve Bank in November, said his bank is drafting a plan by the end of the year to end the threat he sees posed by the largest banks to bring down the financial system.

If anyone should know, Neel it is: he worked at two of the most systematically important firms in history: first Goldman, then Pimco.

Kashkari also oversaw the Treasury Department’s Troubled Asset Relief Program, known as the TARP, which parceled out bail-out funds to recapitalize many banks large and small, even to some critics said did not need the help. Originally an aerospace engineer, Kashkari lost his bid to unseat Jerry Brown as governor of California in 2014.

As Marketnews continues, Kashkari expressed skepticism that the Dodd-Frank array of banking reforms goes far enough, Kashkari told  the Brookings Institution, in prepared remarks, “that despite these best efforts, banks will still sometimes make mistakes and run into trouble.”

Kashkari, joining FDIC Vice Chairman and former Fed bank president Thomas Hoenig as a foe of the idea that big is better, said, “I believe the biggest banks are still too big to fail and continue to pose a significant, ongoing risk to our economy.“He said that the Dodd-Frank regulator apparatus, with its bank stress tests being assembled and partially implemented in the past six years, is proving insufficient.

Here are some of the key highlights from his speech:

• “We won’t see the next crisis coming, and it won’t look like what we might be expecting.”
• “Failures of large financial institutions pose massively asymmetric risks to society that policymakers must consider.”
• “A very crude analogy is that of a nuclear reactor. The cost to society of letting a reactor melt down is astronomical. Given that cost, governments will do whatever they can to stabilize the reactor before they lose control.”

And the punchline:

Unfortunately, I am far more skeptical that these tools will be useful to policymakers in the second scenario of a stressed economic environment. Given the massive externalities on Main Street of large bank failures in terms of lost jobs, lost income and lost wealth, no rational policymaker would risk restructuring large firms and forcing losses on creditors and counterparties using the new tools in a risky environment, let alone in a crisis environment like we experienced in 2008. They will be forced to bail out failing institutions—as we were.

It appears we may have found one more avid reader of this website. Which makes us wonder two things i) how long until he is fired, or ii) just like in the case of Kocherlakota, who started of as an uber-hawk and ended up as a permadove, how long until Kashkari has a similar moment of involuntary “epiphany” and begins cheering for even more mega-TBTF mergers…

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