Category: zerohedge

Submitted by F.F. Wiley of Cyniconomics

What Can Valuation, Debt and the Fed Tell Us about the Next Bear Market?

We last wrote about stock valuation in August, when we looked at three types of P/E multiples and argued that stocks were more stretched than you would think if you only relied on the simplest measure.

Since then, we’ve had the non-taper, non-Larry Summers Fed, non-Syria ultimatum, non-keeping your plan if you like it, and non-market bubble (according to Janet Yellen’s soon-to-be authoritative judgment).  You might say we’ve had an unusual amount of non-sense.

After all that’s happened – and with the S&P 500 (SPY) about 7% higher – it seems time to update our research. We’ll look at the three P/Es again as part of a new analysis that ties in credit markets and the Fed and ends with a prediction about the next bear market.

We start with a chart that marks and categorizes 11 historical bears that will play a part in our conclusions:

These bears are slightly different to other lists you may have seen because we’re using Robert Shiller’s long data history, which shows average figures for each month without the daily detail. We’re also identifying all corrections of over 20% as bears, even if the market failed to make a new all-time high at the prior peak.  “Mega-bears” are corrections of more than 40%, while “über-bears” are corrections of over 60%.

Now for the valuation history, starting with traditional P/Es based on trailing 4 quarter earnings:

Here are Shiller’s P/Es, which are based on 10 year trailing averages for earnings:

And here are P/Es derived from 40 years of trailing earnings but using trend lines instead of Shiller’s averages (click here for further detail):

Trailing P/Es are inferior to the other two measures because they don’t account for earnings cycles. As we wrote in August:

[I]t’s clear that changing perceptions about earnings explain a substantial portion of the market’s volatility. Just as investors can easily forget that P/E doesn’t rise forever, they sometimes forget that earnings don’t climb forever. And when earnings are unusually high, traditional P/E multiples fail to capture the full risk of a correction.

Moreover, earnings cycles are more pronounced in recent decades, due to the Fed’s increasing interventions.  (See here for more on this topic.)  Interventionist policies suggest an even stronger case for following the Shiller P/Es or trend earnings P/Es – not the more traditional measure – and we’ll come back to these results in a moment.

Turning to the credit markets, the next chart combines the Fed’s “Flow of Funds” data on nonfinancial private debt with an earlier series that isn’t exactly the same but captures credit trends, nonetheless:

Three time periods stand out as distinct debt or policy regimes:

1929 to 1946 (the Great Deleveraging). Private debt fell from a pre-Great Depression high of 163% of GNP in 1928 to 83% in 1947. Moreover, there was an even greater fall from the economic trough in 1932-33, when nominal GNP dropped to about half the 1929 amount and pushed private debt above 250% on a GNP ratio basis.

1946 to 1998 (the Long Re-Leveraging). Using the Flow of Funds data this time, nonfinancial private debt climbed from only 37% of GDP in 1945 to about 130% by 1998.

1998 to today (the Big Experiment). While re-leveraging continued through the housing boom, it was further supported during the Alan Greenspan and Ben Bernanke Feds by a new policy approach, which combines limited intervention in good times (leaving bubbles alone, for example) with ample stimulus at any whiff of volatility, deleveraging or deflation. The Greenspan/Bernanke “puts” have emboldened risk takers and pushed valuation measures upward, as shown in the P/E charts. For credit and asset markets, the puts mark a new regime that stands far apart from the old-fashioned approach of “taking the punch bowl away when the party gets going.” We’ll call the new regime a “Big Experiment.”

The Big Experiment began, arguably, with the Fed’s actions after the 1987 market crash and then strengthened progressively. But we chose a 1998 start date because it coincides with Greenspan’s aggressive response to the LTCM crisis and implicit support for the Internet bubble, while also marking the early stages of the housing and mortgage booms.  By the end of the 1990s, the Fed had clearly crossed the Rubicon into a new era that David Stockman aptly calls “bubble finance.”

The three regimes’ relevance may not be immediately clear, but consider what happens when we sort all bear markets since 1929 by size:

It turns out that sorting by size is the same as sorting by our three regimes. Together with the P/E histories, the table gives us a few reasons to expect the next bear to be a big one. (Note that we’re separating the size of the bear from its timing, which we’ll discuss in a later post and doesn’t depend much on valuation.)

First, one thing we’ve learned about the Big Experiment is that stocks tend to fall a long way after the Fed loses its grip.  The bear markets of 2000-03 and 2007-09 were more severe than all but the Great Deleveraging bears of the 1930s and 1940s.

Second, stocks are more expensive than at any of the Long Re-Leveraging peaks, which is the only period in
which bear market losses fell short of 40%.  In fact, the Shiller P/E is now higher than it was in any bull market before the Internet bubble except for the 1929 peak, while the trend earnings P/E has breached even the 1929 levels.

What’s more, it’s reasonable to expect big cycles to persist in today’s policy environment, because it relies so heavily on the Fed. When so much depends on a single, binary factor (in this case, faith in the FOMC’s support), corrections tend to be particularly severe after the factor reverses (when judgment swings from full faith to loss of faith). By comparison, a less manipulated market responds to a wider variety of inputs, most of which develop gradually.

Why so doom and gloomy?

If you disagree with these conclusions, you probably believe we’re headed for another long re-leveraging, thanks to the fall in private debt since the housing boom. The Fed’s policies, you may say, are merely cushioning the path to a lower debt burden and more balanced economy. It’s only a matter of time before the post-WW2 credit boom reignites. In Ray Dalio’s parlance, this scenario would be a “beautiful deleveraging.”

While the beautiful deleveraging is worth contemplating, it seems highly unlikely. Here are three reasons for skepticism:

1. Private debt hasn’t fallen all that much. Nonfinancial private debt was 156% of GDP as of the latest data point, which is exactly where we were in the second quarter of 2006 as the housing boom was running out of steam.
2. The Fed’s actions have barely registered with the all-important middle class. Not only is median household income 8% below its 2007 peak after adjusting for inflation, but it was still falling as of 2012 (the latest data point). The median household is now earning the same real income as it was in 1989 – 24 years ago! In addition, the jobs picture is abysmal by any honest assessment (which should include the composition of job gains, unemployed folks who’ve dropped out of the labor force and involuntary part-time workers).
3. Just about everywhere you turn these days, you’re looking at another classic sign that credit and asset markets are getting out of hand. From record margin debt to a deluge of covenant-lite loans to 1990s-like enthusiasm for Internet companies, it’s hard not to see froth (regardless of your views on bubbles). When we compare these warning signs to the slow progress on debt reduction and no progress for the middle class, the financial economy is too far ahead of the real economy for the eventual outcome to be beautiful.

Put differently, the giant gap between the financial and real economies tells us that any normalization of the real economy will prove fleeting.

Think of it this way:

You’re a baseball player trying to break into the majors despite mediocre fielding skills, no foot speed, and a batting average that hovers around 250. Egged on by your friend, A-Rod, you think you can make it by using steroids and turning yourself into a power hitter. But it doesn’t work out as planned. After a year, you’re losing hair, your skull’s gotten bigger, there’s fatty tissue on your chest that wasn’t there before, and you’ve still only managed 18 home runs in a season. You finally accept that it’s not going to happen for you.

In the baseball scenario, steroids didn’t show enough payoff before the side effects told you enough was enough. And you can say pretty much the same thing about our economic scenario and monetary steroids.  We’re seeing dubious benefits and fast developing side effects from the Fed’s actions, causing many observers to recommend a rethink of the Big Experiment. Yet, the experiment continues.

Getting back to our question about the next bear market, the Fed’s unshakable commitment to its approach – despite growing evidence that it may do more harm than good – is our last reason to expect the next bust to be another killer. When the bull finally runs out of steam, it’s likely to be March 2000 or October 2007 all over again.

Bonus result for Austrians

Although we started our analysis with the Great Depression (because of limited debt data and less familiarity with earlier markets), we sized up all of the bear markets in the Shiller database, which goes back to 1871.

These include a fourth regime: the classical gold standard from 1880 to 1914. There’s also an extra period from 1914 to 1921 that was marked by both World War 1 and the fact that the newly hatched Federal Reserve hadn’t yet established its so-called stabilization policies.  I’ll call this period “transitional.”

Here’s the full list of bear markets, sorted by size:

Note that every one of the pre-Fed stabilization bears is less severe than:

• All of the Great Deleveraging bears
• The most extreme Long Re-Leveraging bear (the 43% drop in 1973-74, which would look much worse if you were to factor in inflation)
• All of the Big Experiment bears

In other words, our stock market history doesn’t reflect very well on the Fed.

(Click here for technical notes about this article and a few more charts.)

via Zero Hedge http://feedproxy.google.com/~r/zerohedge/feed/~3/BNtB9BqwXS8/story01.htm Tyler Durden

The British pound was the only major currency to have gained against the US dollar over the past month.  Its 2% gain helped it finish November at its highest level since August 2011. The dollar rose against the other majors, with its 4.1% rise against the Japanese yen being the largest.

 

 The dollar-bloc currencies, alongside the Norwegian krone were also laggards, losing between 1.2% (Canadian and New Zealand dollars) and 3.6% (Norwegian krona and Australian dollar).  The Swedish krona fell 2.5%.   Most emerging market currencies also fell against the dollar over the past month.  This is not the of price action one would expect if the yen’s carry trade status has been rekindled, as many observers have claimed in recent weeks as the yen as fallen.

 

The US dollar’s weakness seen over the past week is very narrowly based, largely concentrated against the euro (and its two shadow currencies Swiss franc and Danish krone) and sterling.   Given that the US Dollar Index is heavily weighted toward Europe, it has traded heavier, but it is not truly reflective of its overall performance.  It finished last week with its seventh consecutive session of recording lower highs.  Technical indicators warn of scope for additional near-term declines.  Key support is seen around 80.00.

 

Of the currencies reviewed here, the Australian dollar may have the greatest potential for a trend change in the period ahead.  The MACDs are about to turn and the RSI did not confirm the new 12-week low.  The Aussie bears struggled to sustain the downside momentum in the second half of last week. The first real test of the Aussie bears comes in near $0.9200.   If the technicals are anticipating fundamentals, it may suggest either better than expected data and/or a central bank that continues to seem to be in no hurry to cut rates again from record lows.  That said, we still do not want to rule out a rate cut in late Q1 2014.

 

Maybe it was the lack of participation in the second half of last week, but the euro’s (upside) momentum appeared to stall around $1.36.  A retracement of the euro’s fall from the $1.3830 area is found near $1.3630, which also corresponds to the top of the Bollinger Band.  The technical indicators we look at are still constructive for the single currency.  A break to the upside would encourage another run at the $1.38 area.

 

Sterling’s advance has taken it to within striking distance notable resistance in the $1.6400-25 area.  It is where the long-term trend line drawn off the 2009 high near $1.70 and the 2011 high near $1.6750 intersects.  It is also a retracement objective of the decline since from the 2007 high near $2.1150.  If offers in this area are successfully absorbed, technically potential may extend into the $1.70-$1.73 area. Support is likely what appeared to be a double top in October near $1.6260.  

 

The dollar finished November at its highest level against the yen since May.  It appears to have broken out of the six month consolidative pattern.  The next target is JPY103.75, but the measuring objective of the chart pattern may be closer to JPY109.  

 

The yen is also weak against the euro.  The euro is pushing through to new five year highs and although the JPY140 area may mark psychological resistance, but the JPY141 area may be more significant from a technical perspective as it represents a key retracement (61.8%) of the euro’s slide from JPY170 in 2008 to last year’s low near JPY94.  

 

Sterling is at its best level against the yen since late-2008.  At the end of last week, it approached the 38.2% retracement of the more from the 2007 high near JPY251 and the 2009 and 2011-2012 low near JPY117. A break above here would suggest a move toward JPY180-JPY185. 

 

The Korean won’s appreciation against the yen is also noteworthy.   It is trading at 5-year highs against the yen and is approaching the JPY10 level, which is thought to be important for Korean corporations and, consequently, politicians as well.   The won is also strengthening against the US dollar too.  Some reports suggest that Korean officials have been intervening by buying dollars.  

 

Besides the Hong Kong dollar, which is of course pegged to the US dollar, the Korean won was the only Asian currency to have gained against the dollar in November (~0.25%).  Over the past three months, the won has gained almost 5% against the dollar.  This is second in the region, behind the Indian rupee, which was still recovering from the June-August swoon.  Officials will likely escalate their defense especially if the yen remains weak and the dollar threatens the KRW1000 level.  We note that in the past week, foreign investors have bought back about 2/3 of the Korean shares they had sold in the first part of the month.  

 

The US dollar finished November at 2-year highs against the Canadian dollar.  The next target is seen in the CAD1.0660-80 area.  A break of that could open the door to another 1-2 big figure move (CAD1.0760-CAD1.0860.  It is notable that the Canadian dollar failed to get any traction before the weekend despite better than expected GDP figures (Q3 2.7% annualized).   

 

The greenback has been consolidating against the Mexican peso and the technical indicators are not particularly helpful presently in handicapping the direction of the breakout.  The range that has dominated in recent sessions is MXN13.03-MXN13.1450.  However, a breakout will not be confirmed until the wider MXN12.96-MXN13.20 band broken.  

 

The latest CFTC Commitment of Traders report on the CME currency futures is delayed by the Thanksgiving holiday.  We will resume our position 

via Zero Hedge http://feedproxy.google.com/~r/zerohedge/feed/~3/5dLwPGboAqY/story01.htm Marc To Market

Submitted by Mike Krieger of Liberty Blitzkrieg blog,

It was only a matter of time before the success of Bitcoin led to a new attempt to create a digital currency backed by gold. It seems as if that day has now arrived.

Douglas Jackson is the founder of e-gold, which was shut down by U.S. authorities a little over five years ago under accusations of money laundering. While I fully think the ultimate monetary solution will be a decentralized payment protocol that merges Bitcoin-like technology with the ability to back it with gold, silver or whatever people want, I am of the view that it cannot be done from an overly centralized authority or protocol. There are several reasons for this.

First, when you have a centralized single issuer of a currency who also is responsible for vaulting the gold within the payment system you have an enormous degree of counter-party risk. The vault itself could be seized by “authorities” in whatever jurisdiction it is located in.

 

Second, the human beings or company behind any currency system can themselves be pressured or threatened in order to comply with more powerful interests. The beauty of Bitcoin is that there is no “Bitcoin corporation.” It truly is decentralized and anarchic in nature. It basically puts “the powers that be” in a position that if they want to completey destroy it, they’d have to destroy the internet itself.

That said, I do believe the evolution of money is headed to a Bitcoin type system with the ability to have whatever backing is desired by the market. So at this point my questions to Mr. Jackson would be:

1) How decentralized is this currency system intended to be if at all?
2) Will there be an open source protocol available to all?
3) Are the units of currency distributed to those that own gold in a particular vault or vaults under a the custodianship of a particular company?
4) Is the currency limited to those who own gold in the currency issuer vaults, or will they be linking vaults all over the world if such vaults care to be linked.

While I love the idea, it would have to be done right or it will be doomed to fail. I’m very curious to learn more about this and I’d also love to hear reader feedback on this.

From the Financial Times:

The founder of one of the earliest virtual currencies has re-emerged with a rival to Bitcoin, more than five years after his first venture, e-gold, was shut down by the US Department of Justice

 

Douglas Jackson is consulting for a membership organisation called Coeptis that hopes to launch a new version of his gold-backed currency, which attracted millions of users at its height.

 

Coeptis’s “global standard currency” would be fully backed by reserves of gold, held in a trust, in effect turning the precious metal into a medium of exchange.

Full article here.

via Zero Hedge http://feedproxy.google.com/~r/zerohedge/feed/~3/Cppe1Sm7Bfk/story01.htm Tyler Durden

Forget “A Tale Of Two Cities,” the entire world is “A Fiction Of Two ‘Economies'”…

 

 

h/t @Not_Jim_Cramer

via Zero Hedge http://feedproxy.google.com/~r/zerohedge/feed/~3/j9v94XOYGDE/story01.htm Tyler Durden

Submitted by James H. Kunstler via Peak Prosperity blog,

via Zero Hedge http://feedproxy.google.com/~r/zerohedge/feed/~3/AqBzaeq3N0Y/story01.htm Tyler Durden

The early effects of the reform program have triggered a surge in the Japanese stock market, accelerated by the anticipation of growth revival. So far, so good for the markets and traders. But how will Abenomics accommodate public debt of over 200% GDP, and will Abe’s radical policies inspire a long-term economic recovery in Japan? Saxo Capital Markets’ new infographic explores the efficacy of Japan’s prime minister’s dangerous experiment to stimulate economic growth.

(click image for large legible version)

 

Via Saxo Capital Markets,

Can Abenomics save the Japanese economy?

Abenomics is based on the untested formula of monetary easing, fiscal stimulus and structural reforms. In early 2013, Abe promised to increase public spending across Japanese infrastructure and renewable energy, committing $116 billion to reignite Japan’s struggling economy. This short-term stimulus aims to boost GDP and job creation by building business confidence and inspiring private investment.

A new inflation target of 2%, conceived by Abe and enacted by the Bank of Japan, prompted a massive quantitative easing programme worth $1.4 trillion. This stimulus measure was introduced with the aim of buying up government debt in a battle to counter deflation. Monetary easing has resulted in a weakening of the yen to the point of a rise in inflation. A devalued yen is a boon to Japanese exports, as manufacturers can sell more goods to a more receptive foreign market. As a result, the Nikkei stock index has rallied by gaining more than 40%, driving stock price increases and, consequently, invigorating business growth. Japan’s lower currency has dipped against the US dollar, with forecasts suggesting wages, prices, employment and business investment will all rise.

The third, and potentially most critical, strategy of Abenomics is the unrolling of proposed structural reforms. Abe’s move to revamp Japan’s healthcare field, energy policies and IT industry is an overhaul in key industry sectors to maintain economic growth beyond short-lived QE lifts and fiscal spending. To what extent does Japan’s financial stability hinge on these structural reforms? Abe’s decision to join negotiations on the Trans-Pacific Partnership (TPP), a regional free trade agreement, may be crucial to elevating the ratio of Japan’s international trade from 20% to 70%, under the free trade agreements.

A series of initiatives to lay the groundwork for future growth includes schemes to help Japanese engineering companies to sell more nuclear power plants and high-speed trains abroad as well as a domestic-based proposal to increase female numbers in the workforce.

For Abenomics to succeed, Japanese households will need to reverse the recent deflationary trend of excess saving and encourage consumers to spend more. In the infographic, Mads Koefed, Head of Macro Strategy at Saxo Bank, suggests that ‘the new experiment in Japan has boosted consumer sentiment and that has now resulted in consumers spending more of their money’. Will a more optimistic outlook translate into a revival for the world’s third largest economy? It is premature to gauge the success of Abenomics at this stage, and there are question marks over the proposed structural reforms. Fears remain over Japan’s alarming national debt, and an eventual rise in interest rates would add a greater burden on the government, undercutting reform measures. Will an offshoot of Abe’s remedies to Japan’s macroeconomic problems inflict a greater debt load?

Further problems await Japan: the unsustainable ratio of the elderly to the working population, fallout should fiscal stimulus fail, and snowballing costs for imports. This symptom of a weakened yen is exemplified by Japan’s post-Fukushima nuclear programme, which relies heavily on imports. Although Japan’s aggressive monetary easing programme has helped the yen devalue against the US dollar, Abe’s monetary easing plans threaten to distort the financial markets. The Bank of Japan’s purchases of financial assets have created significant uncertainty in the bond markets, with Japan’s 10-year government bond unexpectedly rising to a record high in May 2013.

Abe’s structural reforms carry with them several risks. The domestic agriculture sector could suffer from increased marketplace competition should tariffs on imports be removed. Any agreements with the TPP would mean greater dependency on government support among Japanese farmers, adding a further load on finances.

Finally in the infographic, Saxo have looked at the percentage of their clients, based in the UK, that hold a net-long position in the US dollar against the Japanese yen, compared to the number of those who are net-short USDJPY. The majority (83%) hold a net-long position, which reflects the position many traders take on the success of Abenomics.

Data published in late November indicates that household spending has risen 0.9% in October (from 2013 figures), but is this a long-term ascent, leading to stable economic growth?

Recent data suggests the Japanese economy is recovering from its deflationary cycle, with inflation at its highest for a half a decade. Japan’s consumer price index (CPI), which identifies the change in prices of consumer goods and services over a specific period, reveals an upward trend in consumer costs. Is this a sign of Abenomics in action? Next year’s consumption tax increase means the BOJ’s fiscal stimulus is expected to continue during 2014 to target the 2% inflation rate, despite the promising figures in the CPI release.

The early effects of the reform program have triggered a surge in the Japanese stock market, accelerated by the anticipation of growth revival. So far, so good for the markets and traders. But how will Abenomics accommodate public debt of over 200% GDP, and will Abe’s radical policies inspire a long-term economic recovery in Japan? Saxo Capital Markets’ new infographic explores the efficacy of Japan’s prime minister’s dangerous experiment to stimulate economic growth.

(click image for large legible version)

 

Via Saxo Capital Markets,

Can Abenomics save the Japanese economy?

Abenomics is based on the untested formula of monetary easing, fiscal stimulus and structural reforms. In early 2013, Abe promised to increase public spending across Japanese infrastructure and renewable energy, committing $116 billion to reignite Japan’s struggling economy. This short-term stimulus aims to boost GDP and job creation by building business confidence and inspiring private investment.

A new inflation target of 2%, conceived by Abe and enacted by the Bank of Japan, prompted a massive quantitative easing programme worth $1.4 trillion. This stimulus measure was introduced with the aim of buying up government debt in a battle to counter deflation. Monetary easing has resulted in a weakening of the yen to the point of a rise in inflation. A devalued yen is a boon to Japanese exports, as manufacturers can sell more goods to a more receptive foreign market. As a result, the Nikkei stock index has rallied by gaining more than 40%, driving stock price increases and, consequently, invigorating business growth. Japan’s lower currency has dipped against the US dollar, with forecasts suggesting wages, prices, employment and business investment will all rise.

The third, and potentially most critical, strategy of Abenomics is the unrolling of proposed structural reforms. Abe’s move to revamp Japan’s healthcare field, energy policies and IT industry is an overhaul in key industry sectors to maintain economic growth beyond short-lived QE lifts and fiscal spending. To what extent does Japan’s financial stability hinge on these structural reforms? Abe’s decision to join negotiations on the Trans-Pacific Partnership (TPP), a regional free trade agreement, may be crucial to elevating the ratio of Japan’s international trade from 20% to 70%, under the free trade agreements.

A series of initiatives to lay the groundwork for future growth includes schemes to help Japanese engineering companies to sell more nuclear power plants and high-speed trains abroad as well as a domestic-based proposal to increase female numbers in the workforce.

For Abenomics to succeed, Japanese households will need to reverse the recent deflationary trend of excess saving and encourage consumers to spend more. In the infographic, Mads Koefed, Head of Macro Strategy at Saxo Bank, suggests that ‘the new experiment in Japan has boosted consumer sentiment and that has now resulted in consumers spending more of their money’. Will a more optimistic outlook translate into a revival for the world’s third largest economy? It is premature to gauge the success of Abenomics at this stage, and there are question marks over the proposed structural reforms. Fears remain over Japan’s alarming national debt, and an eventual rise in interest rates would add a greater burden on the government, undercutting reform measures. Will an offshoot of Abe’s remedies to Japan’s macroeconomic problems inflict a greater debt load?

Further problems await Japan: the unsustainable ratio of the elderly to the working population, fallout should fiscal stimulus fail, and snowballing costs for imports. This symptom of a weakened yen is exemplified by Japan’s post-Fukushima nuclear programme, which relies heavily on imports. Although Japan’s aggressive monetary easing programme has helped the yen devalue against the US dollar, Abe’s monetary easing plans threaten to distort the financial markets. The Bank of Japan’s purchases of financial assets have created significant uncertainty in the bond markets, with Japan’s 10-year government bond unexpectedly rising to a record high in May 2013.

Abe’s structural reforms carry with them several risks. The domestic agriculture sector could suffer from increased marketplace competition should tariffs on imports be removed. Any agreements with the TPP would mean greater dependency on government support among Japanese farmers, adding a further load on finances.

Finally in the infographic, Saxo have looked at the percentage of their clients, based in the UK, that hold a net-long position in the US dollar against the Japanese yen, compared to the number of those who are net-short USDJPY. The majority (83%) hold a net-long position, which reflects the position many traders take on the success of Abenomics.

Data published in late November indicates that household spending has risen 0.9% in October (from 2013 figures), but is this a long-term ascent, leading to stable economic growth?

Recent data suggests the Japanese economy is recovering from its deflationary cycle, with inflation at its highest for a half a decade. Japan’s consumer price index (CPI), which identifies the change in prices of consumer goods and services over a specific period, reveals an upward trend in consumer costs. Is this a sign of Abenomics in action? Next year’s consumption tax increase means the BOJ’s fiscal stimulus is expected to continue during 2014 to target the 2% inflation rate, despite the promising figures in the CPI release.

via Zero Hedge http://feedproxy.google.com/~r/zerohedge/feed/~3/FEJezTYfw3g/story01.htm Tyler Durden

Submitted by Charles Hugh-Smith of OfTwoMinds blog,

Longtime correspondent Jeff W. succinctly explains the difference between metallic money (gold and silver) and credit money.

You've probably read many articles about money–what it is (store of value and means of exchange) and its many variations (metal, paper, etc.). But perhaps the most important distinction to be made in our era is between metallic money and credit money.

Longtime correspondent Jeff W. succinctly explains the difference between metallic money (gold and silver) and credit money:

We use credit money every day. It’s the only kind of money we have. But because people in Europe and America have historically used metallic money for over 2,500 years, we still have cultural habits that come from the gold money era.

When the U.S. removed gold and silver coins from circulation in the 1930’s and 1960’s and replaced paper gold certificates and silver certificates with Federal Reserve notes, the paper money looked very much the same. But the thing that the paper money represented changed dramatically. The paper money now represents units of credit money that have no guaranteed relationship with the prices of gold or silve r or anything else.

Because the nature of credit money and metallic money are not well understood, and because money is so important in our lives, it is worthwhile to examine and discuss how these two kinds of money are different.

1. Tangible vs. intangible. A gold or silver coin is a physical object that has weight, volume and physical characteristics. Credit money is a record of the existence of a debt. Credit money exists in the intangible world of information and human relationships. Where Mr. A owes Mr. B a specified unit of money, and where that debt is recorded on paper or another recording medium, and where the record of that debt passes from one person’s possession to another as a medium of exchange, you have credit money.

Gold coins are minted; debts are recorded. The two forms of money could hardly be more dissimilar.

2. Old vs. oldest. Metallic money has been used by people for about 2,600 years. It has been used sporadically and in certain places. Credit money has been used for at least 5,000 years, when people first started recording debts on clay tablets, pieces of wood or ivory, etc., and trading those IOU’s as money. Before debts were recorded in writing, they were, in prehistoric times, discussed verbally, remembered, and sometimes traded in verbal transactions. This is how very primitive people still trade using debt today.

3. Persistent vs. ephemeral. Some gold coins more than 2,000 years old are still in existence today. But it would be very rare for any performing loans to be more than 100 years old, and many loans are of very short duration. Much of the U.S. Treasury’s debt issue is very short term, lasting only 90 days or one year. Where gold coins can last for thousands of years, debts are constantly coming into existence and going out of existence.

The U.S. debt holdings of the Federal Reserve are constantly churning and rolling over, whereas gold holdings in vaults can lie stationary and do not need to be replaced or rolled over.

4. Hard to create vs. easy to create. To create a gold coin, someone has to first mine the gold from the earth, refine it, mill it, stamp it into circular shapes and then stamp the governmental pattern on it. To create a piece of credit money, a debt has to be created and then a piece of paper printed or a record created on a computer. Anyone who has no intention of paying back his debt, such as the Federal government, can potentially issue debt in infinite amounts. There is an issue of whether that debt is worth anything, however.

5. Always good vs. sometimes good. A gold coin that is legal tender will always be accepted as money. With credit money, some of it is good and some of it is bad. In recent years Zimbabwe’s credit money went bad. Before that, the Weimar Republic’s credit money became worthless. All circulating debt has a mixture of good and bad. When a lot of it goes bad at the same time, it causes a crisis, where the “toxic debt” must be guaranteed or purchased by government or else banks and other financial institutions will go bankrupt.

6. Non-interest bearing vs. interest bearing. Most debt specifies interest payments as part of the loan agreement. The Federal Reserve notes we use as money are claims on interest-bearing debt owned by the Federal Reserve. Credit money has the quality that there is a continuing flow of interest payments away from the users of money in the general population and toward creditors. There is no such continued flow of wealth from debtors to creditors in a gold money system.

7. Does not need money supply expansion vs. needs expansion. Because interest payments are constantly flowing out from families, businesses and communities to financial centers and wealthy creditors, credit money results in economic sluggishness unless there is a constant expansion of the supply of credit money. Under a gold money system, people can function much better with a constant money supply because there is no leakage of interest payments. Each community can continue to circulate its own holdings of gold money without having to pay any of it out in the form of interest payments.

8. Government does not need to enable creating more debt vs. government must enable debt creation. In order to keep a credit money economy going, more debt must be continually created. Government and financial leaders who do not want to be blamed for a downward spiral of slowing economic activity must see to it that more debt is constantly being created. Under a gold money system, there is no pressure to constantly increase the burden of debt.

9. Not as bubble prone vs. more bubble prone. The fractional reserve method of banking encourages asset bubbles because new money is created as borrowers take out new loans. When people borrow money to buy bubble assets (e.g., houses 1981-2006), it creates enormous amounts of new money to feed the asset bubble. Many asset bubbles were also created during the gold money era due to fractional reserve banking, but where the unit of currency is guaranteed by government to be equal to a fixed weight in gold, the inflation threat is taken out of the picture and that restrains bubble creation somewhat.

To support the value of their currencies under a gold money system, governments must also often raise interest rates in order to encourage investors to sell gold in exchange for bonds paying good interest. Higher interest rates also discourage the formation of asset bubbles.

10. Does not enable ZIRP vs. enables ZIRP. A zero interest rate policy is impossibl e under a gold money system. The demand for gold would soon deplete government’s gold holdings to zero. Under a credit money system a policy of low interest rates and financial repression can be imposed for an indefinite period of time.

11. Does not increase lending activity vs. increases lending activity. Low interest rates and the ease with which credit money is created lead to increased lending activity and higher debt loads. Under a gold money system, debt will necessarily be created at a slower rate. By stepping up the pace of debt creation, a credit money system serves the interests of the banks.

12. Has no problem with debt saturation vs. has serious problems with debt saturation. Continually increasing debt leads ultimately to debt saturation. When a country’s people and businesses are saturated with debt, it makes it much more diffic
ult to continue to increase the debt load. That leads to stagnation and slowing economic activity in a credit money system. A gold money system does not tend to lead to debt saturation and has no similar problems with debt saturation.

13. Increases wealth disparities vs. does not increase wealth disparities. The higher debt load facilitated by a credit money system results in greater flows of wealth from the debtor class to the creditor class. The higher debt load leads to increased disparities in income, more very poor and very rich and fewer of the middle class.

14. Holds its value vs. does not hold its value. Gold-backed currencies have an excellent track record of holding their value. Credit money tends to inflation, the rate of which largely depends on how fast new debt is being created.

15. Government as a guarantor of savings vs. government provides no guarantee. One of the three functions of money is as a store of value. (The others are a medium of exchange and a unit of account.) When the U.S. government guarantees that 35 U.S. dollars will buy an ounce of gold, as it did in the years 1934-67, government aid savers by acting as a guarantor of that store of value.

When the U.S. went off the gold standard in 1971, it changed the relationship between citizens and their government when government no longer provided that guarantee.

16. Defaulters are bad vs. defaulters are only partly bad. In a gold money system, a person who takes out a loan and does not repay it is considered a bad person, almost a thief. He has robbed his creditors of the money they were rightfully owed. In a credit money system, however, the creation of new debt is so important that anyone who goes into debt is a hero of the economy.

That is why under a debt money system, it is considered more important that new debt be created (e.g., as student loans) than to worry about whether they will ever be paid back or to pin blame and guilt on loan defaulters.

Conclusion: As we see, it is no exaggeration to say that the transition from gold money to credit money changes everything. It changes every individual’s relationship with his own money, with government, and with banks. It changes the power relationships within society. It changes the patterns of ownership and wealth accumulation.

It is very important that citizens and investors understand the credit money system that they are trying to operate within. For people with over 2,500 years of experience with gold money, it is difficult to understand it and get used to it. But anyone who does understand it will be better off because of making better-informed decisions. We might as well get used to it because we shall likely have to live with a credit money system for a very long time.

Thank you, Jeff, for an insightful and extremely important overview of the critical differences between credit money and gold/silver. The key distinction of all these important distinctions is the ephemeral nature of credit-money (and any form of fiat currency). History teaches us that a financial-political crisis of sufficient magnitude reveals the underlying value of credit-money–i.e. zero–in a brief but cataclysmic loss of faith/trust.

As correspondent Harun I. observed in Why Is Debt the Source of Income Inequality and Serfdom? It's the Interest, Baby: "Governments cannot reduce their debt or deficits and central banks cannot taper. Equally, they cannot perpetually borrow exponentially more. This one last bubble cannot end (but it must)."

When the current bubble bursts, the difference between metallic money and credit money will be starkly visible: no one will trade gold or silver for any amount of paper/credit money, and the ephemeral financial instruments ("assets") that dominate today's financial system will be revealed for what they are: phantom promises of value.

Of related interest:

Gold: The Once and Future Money by Nathan Lewis

Could Bitcoin (or equivalent) Become a Global Reserve Currency?
November 7, 2013

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After being essentially nationalized as a result of the Fukushima explosion, and following years of denial finally admitting that TEPCO has lost control of the clean up effort of the Fukushima nuclear power plant corpse, one would think Tokyo Electric Power Company may have second thoughts about installing additional capacity around ground zero. One would be wrong.

Tokyo Electric Power Company will build 2 advanced coal-fired power plants in Fukushima. The utility says it wants to contribute to the prefecture’s recovery from the nuclear disaster.

The same prefecture, mind you, that TEPCO’s reckless disregard for safety standards and abject avoidance of repeated warnings about the potential threats to the Dai-Ichi NPP, was made into a ghost town. Very kind of TEPCO, three years after the explosion, to spend government money to “contribute to a recovery” from a disaster it created.

TEPCO’s Fukushima headquarters chief announced the project on Friday. Yoshiyuki Ishizaki said the coal-fired power generation systems will be built on the compounds of 2 existing power plants in Iwaki City and Hirono Town. Ishizaki said the planned facilities will use both gas and heat from coal to achieve the world’s highest level of power-generating efficiency.

 

Each facility will have a capacity of 500 megawatts and will be operational by the early 2020s.

 

TEPCO says the project will create up to 2,000 construction jobs per day, and its total economic benefit to the region will amount to 1.5 billion dollars.

 

Ishizaki said Japan has the top-of-the-line coal gasification technology. He added TEPCO will make sure the investment won’t affect nuclear compensation payments or delay the decommissioning of its Fukushima Daiichi nuclear plant.

What could possibly go wrong, besides everything of course. Then again, after providing infinite ammo for the anti-nuke lobby, it is only fair that in 7 years (assuming it is not a province of China by then), Tepco does everything in its power to crush the supporters of coal-power as well.

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As the S&P 500 continues to make higher highs, Citi's FX Technicals group attempts to identify important levels to watch. As they have highlighted before, while they respect the price action and the fact that the markets are making higher highs, there is an underlying degree of skepticism surrounding the sustainability of this uptrend from a more medium term perspective. Important levels/targets on the S&P 500 converge between 1,806 and 1,833. A convincing rally through this range (weekly close above) may open the way for a test of the 1,990 area (coincidentally the Fed balance-sheet-implied levels for end-2014); however, at this stage they are watching closely over the coming weeks as we approach the New Year.

Via Citi's FX Technicals group:

As regular readers are aware, the chart of consumer confidence is among our favourite Techamental charts. Confidence is a key underlying factor to any economy/market and in this case the similarities in the way it trends and behaves in each cycle is quite telling.

In each of the three cycles, consumer confidence rose for exactly 4 years and 4 months and then turned down.

The recent prints have taken out what were support levels at 72.00-73.10 which further suggests lower levels will be seen.

As the overlay clearly shows, there is a serious disconnect between where confidence lies (and other factors
such as small business confidence and economic performance) and where the S&P 500 trades. The lower the confidence index, the less comfortable we are and would be with the sustainability of the stock market rally, even though we must respect the near term price action.

A closer look at the chart reveals some difference between the previous two major highs in 2000 and 2007 and may shed some light on which time period we should be more focused on in terms of price action on the S&P 500…

– 2000: The Consumer confidence index peaked in the month of January and again at the same level in May (i.e. double top at 144.70). The S&P 500 peaked in March. However the real move down in the S&P 500 was not seen until October so equities traded sideways for more than 6 months before turning lower.

– 2007: Consumer confidence peaked in July and the S&P 500 made a higher high in October. On this occasion we saw a quicker turn off the highs in both the consumer confidence and the S&P 500 as the reality set in that the credit crisis was worse than expected, especially by the time we got into early 2008 (Bear Sterns, inversion of yield curves, coordinated emergency rate cuts among major central banks etc)

– 2011: So far this year the consumer confidence number peaked in June and the equity market has continued to move higher. This makes is less similar to 2007 because under than comparison, we should have seen a stock market high in and around September but that did not happen. Could the pattern still be similar to 2000? The charts below make some comparisons.

Within the uptrend that took the S&P 500 to the 2000 high, there was a significant correction down of 22% in 1998 which was reversed by a bullish monthly reversal.

From that 1998 low at 923, the S&P 500 rallied 68.1% to 1,552.

Within the recent uptrend that started in 2009, we got a serious correction down in 2011 of 22% which ended with a bullish monthly reversal.

If we were to replicate the 1998-2000 rally in magnitude from the 2011 low, we would have peaked at 1,806 (and the high has been 1,808 so far as we have rallied 68.3%).

The parallel line on the log scale chart above comes in at 1,821.

In 2000, the high on the S&P 500 was 13.4% above the 12 month moving average. The same now would put the S&P 500 at 1,833.

Overall, when making a comparison with the 1998 – 2000 price action and how the market trades relative to the 12 month moving average, we would expect the S&P 500 to test and potentially peak between 1,806-1,833.

There are other measures that put further important on this price range…

In 2000, the S&P 500 high was 13.8% above the 55 week moving average

If replicated here we would trade at 1,824 (i.e. within the price targets set out in the previous chart when using the 12 month moving average)

A closer look at this chart reveals another level which converges here…

The channel top comes in at 1,822 while the channel base converges with the 55 week moving average at 1,594-1,603

From a medium term perspective, a break of the 55 week moving average would open the way for the 200 week which is at 1,364 (though it could be quite a while before we need to pay more attention to that)

This chart however is a warning sign that the uptrend may still have further to run.

In 2000, the S&P 500 peaked at 47% above the 200 week moving average.

If replicated again here, we could be talking about the S&P 500 trading around 1,990 before peaking. That is still 10% above current levels

In summary –

We believe the uptrend in the S&P 500 is stretched relative to the underlying economy and consumer confidence

The consumer confidence indicator is a leading one, especially given the similarities with previous cycles

As a consequence we remain sceptical in the medium-long term about the sustainability of the uptrend in the S&P 500 though have to respect that at least for now the trend is still up.

As we make higher highs, important levels that converge between 1,806 and 1,833 are now being tested.

A clear break of that region may open the way for a stretch to 1,990 though for now there is need for some caution at and around current levels.
 

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