Category: zerohedge

If yesterday Goldman was pitching going long of the S&P in AUD terms (the world renowned Goldman newsletter may cost $29.95 but is only paid in soft dollars) as its first revealed Top Trade of 2014, today’s follow up exposes Top Trade #2: which is to “Go long 5-year EONIA vs. short 5-year US Treasuries.” Goldman adds: “The yield differential between these two financial instruments is currently -61bp, and we expect it to reach around -130bp. On the forwards, the differential is priced at around -95bp at the end of 2014 at the time of writing. We have set the stop-loss on the trade at a spread of -35bp. The choice of Treasuries over OIS or LIBOR on the short leg is motivated by the fact that yields on the former could underperform more than they have already in relative space as the Fed scales down its asset purchase program.”

More from Goldman on this trade recommendation:

• We unveil today the second of our Top Trade recommendations for 2014
• Long 5-year EONIA vs. short 5-year US Treasuries at -61bp for a target of -130bp
• The spread is already priced to widen in the forwards, led mostly by the US leg
• We look for a bigger term premium at the belly of the US curve …
• …while disinflation and the AQR should preserve the ECB’s easing bias

We present today the second of our Top Trade recommendations for 2014: long Euro area 5-year rates vs short their US counterparts. Specifically, we recommend receiving 5-year EONIA fixed rates against shorting 5-year US Treasury Notes. The yield differential between these two financial instruments is currently -61bp, and we expect it to reach around -130bp. On the forwards, the differential is priced at around -95bp at the end of 2014 at the time of writing. We have set the stop-loss on the trade at a spread of -35bp. The choice of Treasuries over OIS or LIBOR on the short leg is motivated by the fact that yields on the former could underperform more than they have already in relative space as the Fed scales down its asset purchase program. We will, however, be watching to see if the decline in US borrowing requirements more than compensates for these effects. The greater liquidity of 5-year Treasuries compared with 5-year US$ OIS has also been a consideration. In the Euro area, we are of the view that German bonds may ‘cheapen’ further relative to EONIA as fixed income portfolios are rebalanced in favour of higher-yielding securities, particularly if the ECB eases further. Three macro factors underpin our new Top Trade recommendation, which we review in the sections below.

Separately, and from a tactical standpoint, we now recommend going long Mar-14 Australian Bank bill futures (IRH4) (see Trade Update: Position for further RBA easing, published earlier today). Our view is that the weakness in the Australian economy will remain in place through 2014. As such, we expect the RBA to cut rates by a further 25bp, most likely by the March policy meeting, with a move as early as in December quite possible. At this point, we believe the market only discounts a 25% chance of an easing move in March.

1. Growth Differential Widens

We expect real GDP growth to accelerate across the major developed economies over the coming quarters. As economic activity picks up speed, and core inflation slowly makes its way back up, we expect intermediate maturity yields to re-price higher. Against this backdrop, we note that:

• On our central forecasts, these dynamics are likely to materialize sooner and faster in the US than in the Euro area. In the former, we project sequential quarter-on-quarter annualized real GDP growth of 3.0%-3.5% during most of 2014 and 2015 – an above-trend expansion, following three years with growth close to its potential rate. We also expect an improvement in the economic outlook in the Euro area, but with GDP growth heading to around 1.0%-1.5% – roughly the potential rate of growth – over the corresponding period.
• Our 2014 GDP growth forecast for the Euro area is in line with the latest consensus (as collated by Consensus Economics), while our US GDP forecast is around 50bp above consensus. The downside skew to our crude oil forecasts (we see Brent at US$105/bbl at the end of 2014, from US$110/bbl at end-2013) could benefit the US economy more than Europe’s, given the larger pass-through to retail gasoline prices, which would support household disposable income.
• Downside risks to economic activity are arguably higher in the Euro area than in the US. As we have written in the past (See Global Viewpoint EMU Policies and Market Implications, October 21), ‘banking union’ represents a key institutional upgrade, which will help contain systemic risks and, over time, support the recovery. The transition towards it, however, presents several challenges. A further deleveraging of banks’ balance sheets and the possibility of private creditor ‘bail-ins’ as the Comprehensive Assessment is carried out could weigh on growth more than we already anticipate.

2. Service Price Inflation Diverges

Recent data show that consumer price inflation has stabilized in the US, while it is still trending downwards in the Euro area. Our forecasts indicate that the ongoing divergence in price dynamics on the two sides of the Atlantic will extend into next year: US CPI inflation is seen increasing from an estimated 1.5% in 2013 to 1.7% in 2014, while Euro area inflation goes from 1.4% to 1.1%, with no inflection point expected until the third quarter of 2014.

A significant cross-country divergence in inflation dynamics is also evident when looking beneath the surface (i.e., headline numbers), and accounting for the common international effect of lower commodity prices on retail prices. We notice that services, which typically exhibit a ‘sticky’ or persistent price behaviour, represent about half of the total CPI basket in the US and in the Euro area, and more than two-thirds of ‘core’ CPI. The spread between service price inflation in the US and the Euro area is wide, and possibly set to increase. According to the latest available data, inflation in this category is running at 2.3% in the US, and at just 1.2% in the Euro area. Our econometric estimates of trend service inflation, derived through an econometric approach following the methodology proposed by Stock-Watson (2007), point to an acceleration in the US and, by constrast, a deceleration in the Euro area.

3. Forward Guidance is in the Price

Our 2014 outlook is characterized by central banks cementing their ‘forward guidance’ on policy rates. Currently, a very accommodative monetary policy stance is largely priced in the US, while the market is underestimating the possibility that the ECB can provide further easing, even by cutting the deposit rate below zero. More specifically:

The US$ OIS curve discounts that Fed Funds rates will be kept low for all of 2014 and most of 2015. The 3-month US$ OIS rate in 2-years’ time is around 75bp, back to the levels it stood at in June. The US$ OIS curve steepens considerably beyond this horizon, with the 3-month US$ OIS rate in 3-years’ time currently at 1.65%. But this is just in line with our (dovish) Fed fund forecasts, indicating that the ‘ex-ante’ risk premium is extremely limited. In our previous work, we have shown that estimations of the ‘ex-post’ risk premium in the Eurodollar strip is also very depressed (i.e., investors price negative returns on cash through early 2017) conditioning for the current macro outlook. As we transition to an above-trend growth environment in 2014 and the tapering of Fed bond purchases gets underway, we believe investors may start to challenge the ‘time inconsistency’ of the Fed’s approach, and test its commitment to keep front-end rates so depressed for so long.

In the Euro area, the front end of yield curve is priced ‘fairly’ relative to our baseline views: the 3-month EONIA in 2-years’ time is currently at around 45bp, increasing to 100bp in the following year. That said, ECB officials have on several occasions said that they judge the costs of deviations from their central objective to keep inflation ‘close but below 2%’ as symmetrical, and may be prepared to ease further should disinflation become more entrenched. Even on our more optimistic central scenario for CPI (the annual inflation on our economists’ forecasts does not fall much below 1%), we expect the ECB to offset any sell-off emanating from developments in the US and any negative shock occurring in the Euro area while the Asset Quality Review gets underway.
All told, we see room for markets to re-price US rates higher during 2014 without much spillover into EUR rates. To be sure, our US economists expect the Federal Reserve to strengthen its forward guidance in March when tapering begins. As discussed above, however, this outcome appears to us already largely reflected in the forwards and its announcement could result in a steepening of the curve, as investors discount that more aggressive easing in the near term would result in more tightening later.

4. The Risks to the Trade

We see the main risks to this recommended trade coming from two sides:

The first is timing. The market reaction to the strengthening of ‘forward guidance’ could, contrary to our expectations, be associated with a flattening of the 2-5-year US curve, at least initially, as investors try to squeeze more ‘carry and roll down’ from the US term structure (for a 5-year UST note, the latter is currently in the region of 70bp per annum). Although the EONIA curve would also likely move in the same direction, the net result could be a tightening of the US-Euro area rates differential instead of the widening we expect. Under our central assumptions for growth and inflation, we would view such an outcome as an opportunity to build up positions in the direction we suggest, as the anchoring to short-term rates should result in an easing of US financial conditions, and increase inflation expectations.

The second risk, as is always the case, stems from the fact that our macro forecasts may not be realized, or at least not to the extent that they ‘beat the forwards’. Evidence of a softer US growth trajectory than we currently anticipate could, for instance, delay the tapering of Fed bond purchases and lead to a flattening rally in the US curve, led by the Treasury curve. This risk is amplified by the large consensus that growth will improve next year (albeit at a slower pace than we project). On the Euro area side, the trade we recommend would suffer from a faster normalization of inflation, which could lead market participants to reassess the ECB’s easing bias.

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In fitting with the pre-holiday theme, and the moribund liquidity theme of the past few months and years, there was little of note in the overnight session with few event catalysts to guide futures beside the topping out EURJPY. Chinese stocks closed a shade of red following news local banks might be coming  under further scrutiny on their lending/accounting practices – the Chinese banking regulator has drafted rules restricting banks from using resale or repurchase agreements to move assets off their balance sheets as a way to sidestep loan-to-deposit ratios that constrain loan growth. The return of the nightly Japanese jawboning of the Yen did little to boost sentiment, as the Nikkei closed down 104 points to 15515. Japan has gotten to the point where merely talking a weaker Yen will no longer work, and the BOJ will actually have to do something – something which the ECB, whose currency is at a 4 year high against Japan, may not like.

In Europe the main highlight with the outperforming Spanish IBEX index, where Repsol gained around 4% following reports that Argentina has reached an agreement to compensate Spain’s Repsol for the nationalisation of energy firm YPF. We wouldn’t get any hopes up until CFK actually wires the money and receipt is confirmed. The Italian FTSE-MIB was the underperformer with Monte Paschi under pressure amid reports that the bank is to consider a capital increase of EUR 3bln, which is bigger than previously planned. This, together with another uptick in EONIA fix, driven by month-end and touted liquidity squeeze linked to ECB’s suspension of LTRO repayments after December 23rd until mid-Jan supported Bunds, which as a result outperformed USTs.

In the US, building permits, Case-Shiller home prices, the Conference
Board Consumer Confidence and the Richmond Fed Manufacturing index
(Nov) are the highlights.

 

 

US event calendar:

US: Building permits, cons 930k (8:30)
US: S&P /CS comp-20 y/y, cons 13.0% (9:00)
US: Consumer confidence index, cons 72.4 (10:00)
US: POMO for bonds maturiting 02/15/2036 – 11/15/2043: $1.25 – $1.75 billion
US: sells $35bn 5y notes (13:00)

 

Overnight news bulletin:

Bunds continue to remain bid, supported by month-end related flow and also uncertainty over the stability of the Italian banking system, where Monte Paschi shares are down over 6% amid reports that the bank is to consider a capital increase of EUR 3bln.

Argentina has reached an agreement in principle to compensate Spain’s Repsol for the nationalisation of energy firm YPF.

Looking ahead for the session there is the release of US Building Permits, S&P CS 20 City, Consumer Confidence Index, API US Crude Oil Inventories, USD 35bln 5y Note Auction by the US Treasury.

 

Market Re-Cap

Stocks traded mixed in Europe, with the IBEX index in Spain outperforming throughout the session where Repsol gained around 4% following reports that Argentina has reached an agreement in principle to compensate Spain’s Repsol for the nationalisation of energy firm YPF. At the same time, Italian FTSE-MIB  lagged its peers, with Monte Paschi under pressure amid reports that the bank is to consider a capital increase of EUR 3bln, which is bigger than previously planned. This, together with another uptick in EONIA fix, driven by month-end and touted liquidity squeeze linked to ECB’s suspension of LTRO repayments after December 23rd until mid-Jan supported Bunds, which as a result outperformed USTs. Looking elsewhere, the recent removal of USD/JPY RKO barriers  which left market short JPY calls saw R/R lose topside bias and left the spot rate vulnerable to downside. Going forward, market participants will get to digest the release of the latest CaseShiller housing data, as well as the Consumer Confidence report for the month of November.

 

Asian Headlines

PBOC’s governor Zhou said that domestic inflation is stable and key China indicators are in reasonable range. Zhou added that they must continue prudent monetary policy and must continue proactive fiscal policy. In Japan specific news flow, BoJ minutes from October 31st Meeting stated that most members said 2% inflation is likely in the second half of the projection period. The JPY swap curve bull-flattened on the back of receiving in 10s and receiving ultra-long end following the strong 40y auction.

EU & UK Headlines

ECB’s Weidmann said government bonds should be risk weighted and banks’ exposure to sovereign debt should be capped. Weidmann also commented the ECB’s bank supervisor role should not be permanent, that he sees a gradual economic recovery in Europe and that data shows no need to revise forecast.

ECB’s Noyer said the Euro area recovery is weak and fragile and fragmentation in the Euro Areas is decreasing.
BoE’s Carney says timing of 7% threshold is subject to uncertainty.
BoE’s Dale says if we start to see inflation expectations pick up, we will react.

Barclays month-end extensions: Euro Aggr (+0.04y)
Barclays month-end extensions: Sterling Aggr (+0.06y)

US Headlines

The US wont change its flight operations to comply with China’s newly claimed air defence zone in the East China Sea, according to a Pentagon spokesman. There were also reports that Japan and US may deploy an unmanned plane to East China Sea.

Barclays month-end extensions: Treasuries (+0.10y) – Of note, although the avg. is around 0.06y, larger than avg. increase had been expected given the 3y, 10y and 30y refunding auctions last week.

Equities

As mentioned, the Spanish IBEX is very much leading the way for European equities after Repsol shares were seen up around 4% following reports that Argentina has reached an agreement in principle to compensate Spain’s Repsol for the nationalisation of energy firm YP. In comparison it is the FTSE-MIB is leading the way downwards after it was reported that Monte Paschi are to consider a capital increase of EUR 3bln. Therefore, marking a divergence in the performance of the periphery.

FX

From an FX perspective, EUR strength was being observed across the board following stops being tripped on the break of 1.3550 amid USD weakness which resulted from USD/JPY trading in negative territory following recent topside RKO barrier removal leaving market short JPY calls with risk reversals highlighting positioning as flows favour downside.

Commodities

Heading into the North American open WTI and Brent crude futures trade in positive territory in a continuation of the paring of yesterday’s declines, with the WTI-Brent spread narrowing amid increased doubts of how quickly the P5+1 and Iran deal could translate to increased supplies.

The Russian government mulls helping refinance debts of metals and mining giants. According to reports, the Russian government may guarantee loans and subsidize interest rates as well as urging sales of loss-making assets and allow layoffs.

Akbar Hashemi Rafasnjani, one of Iran’s most influential political leaders, has raised hopes of a comprehensive nuclear deal with world powers within a year, saying that Sunday’s interim deal has been the hardest step because it meant overcoming decades of diplomatic estrangement with the US.

 

SocGen recaps today’s macro events, or rather lack thereof:

A fifth straight monthly decline in US pending home sales in October (-2.2% yoy) does not send the message of a strong recovery in housing market demand but fortunately there are other indicators that do. As this is Thanksgiving week, the decline does not warrant a significant market response either. Part of the drop was blamed on
the government shutdown that helped to deflate UST yields for a third session on the trot which will help to set up for demand for this week’s 5y and 7y supply. Elsewhere, the fall in commodity prices has spilled over into a fifth successive week and is causing trouble for currencies like the AUD, NOK, RUB and BRL which staged the biggest losses yesterday vs the EUR and USD.

The release of US consumer confidence data and its employment sub-component will garner close attention today. A collapse of 9pts pulled confidence down to 71.2 in October but if we assume that this was related in part or in its entirety to the federal shutdown, then a bounce back should be on the cards for November. The labour differential deteriorated last month as well but given the statistical irrelevance for hiring trends last month, the data may not carry much significance as we start collecting anecdotal evidence ahead of next week’s US employment report.

It is set to be a quiet day for eurozone data, as it only features second tier Italian confidence data. We also look for decent demand for the EUR3bn DSL bonds up for sale from the Netherlands. Statistics from our FI colleagues show that the sovereign has completed 93% or EUR46bn of its EUR50bn annual issuance programme compared to this time last year. A turn for the better in the economic data has been observed in the Netherlands in recent weeks with industrial output rising at an annual rate of 0.4% and consumer confidence rising to levels last seen in July 2011. The Dutch central bank yesterday started a review of Dutch commercial banks’ commercial real estate loans which it hopes to conclude before the ECB inquiry.

 

DB’s Jim Reid concludes the overnight even recap:

It was by no means the most fascinating day for markets yesterday with the early boost from the Iran news failing to gather much momentum through the US session. Even Brent retraced most of its Asian session losses to finish the day broadly unchanged at around US$111/bbl. Some late selling in US equities saw the S&P 500 (-0.13%) finish the day on a softer tone. The US data flow was generally disappointing yesterday which may have impacted markets a touch. Although we can’t help thinking that slightly disappointing data is the ideal scenario for these liquidity hungry markets.

The earlier stronger European risk tone after the Iran story was perhaps cemented by dovish notes from ECB’s Hansson who suggested that a further ECB  rate cut could be ruled out. Indeed the day saw major equity benchmarks in Germany, France, and UK close +0.88%, +0.55% and +0.30% higher respectively. Credit continued to steadily grind tighter and barring any major macro events the appetite for spread products seems firm into year-end as the search for additional carry continues. Indeed the tightening in credit spreads has been fairly notable of late with Crossover and Main indices about 20bp and 5bp tighter since the end of October and 85bp and 26bp off their recent late September wides. On the other side of the pond, the CDX IG index is 5bp tighter this month and 17bps away from its early October wides.

Recapping yesterday’s data weakness, pending home sales fell -0.6% mom/-2.2% yoy in October. This was partly due to the government shutdown but higher mortgage rates and higher house prices may have also been a contributing factor so it will be interesting to see if we’ll get a rebound in the series next month. Away from housing the Dallas Fed survey (1.9 v 5.0 expected) was also disappointing which extends the weakness that we saw in earlier surveys from the New York and the Philly Fed. With this weakness the Chicago PMI tomorrow will be an interesting leading indicator for next week’s ISM manufacturing report.

Turning to the overnight session, North Asian equities are trading on a slightly stronger tone than those further south with bourses in China (+0.2%), Hong Kong (+0.2%), Taiwan (+0.7%), and Korea (+0.1%) faring better than markets in India (-0.3%) and Indonesia (-1.0%). Chinese banks might be coming  under further scrutiny on their lending/accounting practices according to Bloomberg. They are suggesting that the Chinese banking regulator has drafted rules restricting banks from using resale or repurchase agreements to move assets off their balance sheets as a way to sidestep loan-to-deposit ratios that constrain loan growth. Chinese banks shares are seemingly unaffected with ICBC and Bank of China up +0.2% and +0.5%, respectively as we type.

Staying on China, there seems to be increased focused on the rising sovereign and corporate bond yields domestically. Indeed China’s 10yr government bond yields have risen to around 4.6% from the lows of 3.4% in May this year. Using Bloomberg’s database the yield has never been this high since data started in June 2005. Issuance volumes have also declined steadily over the last few months and in recent weeks we have seen regular Chinese issuers either scale back or postpone bond deals as the appetite for onshore fixed income assets seemingly weakens. Some statistics reported by the WSJ showed that bond issuance in China fell to RMB687bn in October from RMB786bn in September and RMB822bn in August. Our CNY rates strategist, Linan Liu, noted that the recent sharp rise in CGB yields is a reflection of the tightening liquidity conditions onshore, supply pressure and the crowding out effect on the cash government bond market by commercial banks’ allocation to NSAs. She sees the 10yr yield capped at 4.8% in the near term as supply pressure will fade in December but a further squeeze in money market rates may drive 10Y CGB yield towards 5%.

Looking at the day ahead, Italian consumer confidence, and Spanish budget updates are the main releases from Europe. In the US, building permits, Case-Shiller home prices, the Conference Board Consumer Confidence and the Richmond Fed Manufacturing index (Nov) are the highlights.

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It might have been the Republican shutdown (according to one person at the White House, at least). It might have been the fault of the Syrian leader Bachar Al-Assad gassing his people with chemical weapons. It might have been the National Security Agency that listened in on our conversations and tapped our mails, while intercepting our calls. It might (or probably not) be the President of the USA that never knew about any of this (or all of it at the same time). But, when it boils down to it, it was and always will be Barack Obama. He was the man at the top. He might be the puppet stroke muppet (fill in the blanks as you will, cross the i’s and dot the t’s), but he will be the person that has to pay the price for what the country has got itself into and won’t be in a position to dig itself out of the hole. Perhaps, if the US government digs so far down in that hole, then they will surely come out raging on the other side. They may end up in Timbuktu, but they will certainly be in a damn better place than on Capitol Hill. It’s President Obama that will be burned at the funeral pyre and sent floating down the Ganges one of these days. That day may not be too far off if we believe the pollsters in the US. But, can we believe anyone these days?

Obama Isn’t Liked

A new poll that was carried out by CNN/ORC and released today shows that Obama has gone up in the ratings. Yes, he went up. Of course, we are talking about the fact that there are a growing number of Americans today that consider that he is not the man fit for the job.

• He is not honest and trustworthy either according to 53% of the people polled. Today, many people are starting to question the integrity and honesty of the most-powerful man on the planet.
• Some of us might be answering that we could have told them that long ago. Presidents aren’t trustworthy, they are politicians. That’s antagonist and an antonym if ever there were one! When was the last time you saw an honest politician? Please tell us!
• Since June the President has lost 12% regarding his ability to govern the country. He’s now at just 40% that believe he is able to do so.
• That means that 60% of those polled believed that he was inadequate at the head of the state.
• 56% did not admire President Obama. Although the question in itself begs disbelief. Presidents are not there to get admired; they are there to act and to act well. We don’t have to either look up to them or venerate them. They are people, that’s all. They just act as if they are demi-Gods from Olympus on an internship in the real world.
• 53% of the people polled believed that he was not a strong leader and that he did not take decisions.
• The same number believed that he did not inspire confidence.
• 70% of those polled said that he was ‘likeable’. Yet again. What does being likeable have to do with it all? Have we forgotten what the role of a President of the most powerful economy in the world (for the moment!) is? Have we forgotten that he’s not in office to be ‘liked’ by the people? Isn’t he there to act?

With the mights and may-have’s that are flying around there are times when people (read: ‘citizens, taxpayers and voters’) must take a decision and do away with wishy-washy wherewithal sit-on-the-fence politics. Take a stance. Who is to blame and why are we in this mess? Harping on about the past thirty years and the fact that governments are all the same isn’t going to get you off sitting on that fence. Replacing Obama with another muppet-like marionette that you can stick your fingers up inside like a glove puppet to bow and scrape and come out with the radiant set of teeth when the cameras start flashing isn’t going to change the way things are run or the way things are decided. Harping on about the fact that the governments are all run by the same mafia-like power-crazed and addicted families and have been for centuries now isn’t going to stop the stooges running the show at the Oval Office and in Washington.

The pollsters might be telling the people that they aren’t happy with the President right now after all the stuff that has been launched at the fan.

Remember what happens when the stuff hits the fun? It just gets blasted back and everyone ends up getting splattered; everyone except the one that turned the fan on. Get ready, the fan just got turned on again.

 

Originally posted: The Stooges are Running the Show, Obama

 Banks: The Right Thing to Do | Bitcoin Bonanza | The Super Rich Deprive Us of Fundamental Rights |  Whining for Wine |Cost of Living Not High Enough in EU | Record Levels of Currency Reserves Will Hit Hard | Internet or Splinternet | World Ready to Jump into Bed with China

 Indian Inflation: Out of Control? | Greenspan Maps a Territory | Gold Rush or Just a Streak? | Obama’s Obamacare: Double Jinx | Financial Markets: Negating the Laws of Gravity  |Blatant Housing-Bubble: Stating the Obvious | Let’s Downgrade S&P, Moody’s and Fitch For Once | US Still Living on Borrowed Time | (In)Direct Slavery: We’re All Guilty |

Technical Analysis: Bear Expanding Triangle | Bull Expanding Triangle | Bull Falling Wedge | Bear Rising Wedge | High & Tight Flag

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Submitted by Michael Krieger of Liberty Blitzkrieg blog,

“People don’t want granite countertops — they want marble costing at least 25 percent more,” said Mroz, owner of Michael Robert Construction in Westfield, an affluent town less than an hour’s commute to Manhattan. “Money is so cheap today, people can splurge on $1,000 faucets.”

 

– From today’s Bloomberg News article: Faucets at $1,000 Abound as Home Equity Spigot Opens

It’s interesting, disturbing and pathetic that this article emerged so shortly after I highlighted the fact that there is about to be a huge, and potentially disruptive reset in home equity loans over the next several years. So while we are still dealing with the ramifications of the prior housing bubble and the HELOCs associated with that debacle, we are right back at it. Extracting additional equity from another phony housing bubble to remodel homes that likely aren’t worth anywhere near what people think once private equity and money laundering oligarchs are done with their binge buying.

As I have said many times before, QE makes a society lose its mind. From Bloomberg:

A year ago, New Jersey contractor Michael Mroz’s customers were focused on saving money when renovating kitchens and baths, he said. Now, with a resurgence of home equity lending, they’re ready to pay for the best.

 

“People don’t want granite countertops — they want marble costing at least 25 percent more,” said Mroz, owner of Michael Robert Construction in Westfield, an affluent town less than an hour’s commute to Manhattan. “Money is so cheap today, people can splurge on $1,000 faucets.”

 

Spending on home renovations is rising to records as banks such as Wells Fargo & Co. and JPMorgan Chase & Co. increase lending for home equity lines of credit, or Helocs, after property prices this year gained at a pace not seen since the last housing boom. Heloc originations could rise 16 percent this year and reach another five-year high in 2014, according to Mustafa Akcay, an economist for Moody’s Analytics, powering the earnings of Home Depot Inc. and boosting the economic expansion.

 

Helocs were used during the housing boom to cash in on surging property values to spend on cars or take vacations. Often, lenders allowed the loans to exceed property values by 25 percent on the supposition that home prices were only going up, Gumbinger said.

 

Home equity production at Bank of America for the first nine months of 2013 was $4.4 billion, an increase of 69 percent from the first nine months of 2012 when production stood at $2.6 billion, according to Terry Francisco, a spokesman.

 

Renovation spending this year probably will rise to an all-time high of $146.1 billion, according to Harvard’s Baker. Last year, the spending was $126 billion, he said.

 

“People aren’t cheaping out anymore because more of them are getting Helocs instead of saving up cash,” said Mroz. Getting a Heloc is “a lot easier to do with home prices coming back,” he said.

Good lord.

Full article here.

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We are sure it was all planned a long time ago but the irony is not lost on us. A day after the US pisses the Israelis off with a sorta kinda deal with Iran, for the first time in Israel’s history, the Israel Air Force launched the “Blue Flag” training exercise – an international air force exercise with participation by the US, Italian and Greek air forces.

 

Via Israeli Defense Forces blog,

This past Sunday, Nov. 24, the Israel Air Force launched – for the first time in Israel’s history – the Blue Flag international training exercise at the Ovda airbase in southern Israel. The large-scale international exercise is a joint exercise of the US, Italian and Greek air forces and will be held entirely in English. The exercise, which will continue through Thursday, Nov. 28, is a part of the IAF’s elite training program. The goal of the exercise is to improve Israel’s general air defense capabilities while learning together and cooperating with global allies.

 

US Ambassador to Israel, Dan Shapiro, was present at the opening of the exercise. “Israel lives in a dangerous neighborhood. We need the best equipped, best trained forces as possible to protect our people and our security,” he said. “We also need allies and we have great allies here…all training together and reinforcing a partnership that gets stronger with each passing year.”

The exercise involves workshops that simulated enemy forces as well as training missions to identify anti-aircraft missiles. The exercise showcases the Israel Air Force’s aerial capabilities. Just last month, the IAF conducted a special long-range flight exercise in which squadrons practiced refueling planes in midair, testing the IAF’s ability to fly exceptionally long distances.

Watch as the IAF refuels midair: 

 

“For us, it is about training together,” a US Air Force soldier explained. “We have been leading up to this exercise for a couple years now. We’re here to continue to work together.”

“Blue Flag” has been in the works for over a year, and the IAF had conducted two training flights a day during the past six months in anticipation of the exercise, in addition to conducting a preparatory workshop earlier this year which had aerial teams train for flights conducted entirely in English.

 

 

Representatives from other countries observed the exercise, with the possibility of participating in future years.

via Zero Hedge http://feedproxy.google.com/~r/zerohedge/feed/~3/WZUsiQPr3oA/story01.htm Tyler Durden

We are sure it was all planned a long time ago but the irony is not lost on us. A day after the US pisses the Israelis off with a sorta kinda deal with Iran, for the first time in Israel’s history, the Israel Air Force launched the “Blue Flag” training exercise – an international air force exercise with participation by the US, Italian and Greek air forces.

 

Via Israeli Defense Forces blog,

This past Sunday, Nov. 24, the Israel Air Force launched – for the first time in Israel’s history – the Blue Flag international training exercise at the Ovda airbase in southern Israel. The large-scale international exercise is a joint exercise of the US, Italian and Greek air forces and will be held entirely in English. The exercise, which will continue through Thursday, Nov. 28, is a part of the IAF’s elite training program. The goal of the exercise is to improve Israel’s general air defense capabilities while learning together and cooperating with global allies.

 

US Ambassador to Israel, Dan Shapiro, was present at the opening of the exercise. “Israel lives in a dangerous neighborhood. We need the best equipped, best trained forces as possible to protect our people and our security,” he said. “We also need allies and we have great allies here…all training together and reinforcing a partnership that gets stronger with each passing year.”

The exercise involves workshops that simulated enemy forces as well as training missions to identify anti-aircraft missiles. The exercise showcases the Israel Air Force’s aerial capabilities. Just last month, the IAF conducted a special long-range flight exercise in which squadrons practiced refueling planes in midair, testing the IAF’s ability to fly exceptionally long distances.

Watch as the IAF refuels midair: 

 

“For us, it is about training together,” a US Air Force soldier explained. “We have been leading up to this exercise for a couple years now. We’re here to continue to work together.”

“Blue Flag” has been in the works for over a year, and the IAF had conducted two training flights a day during the past six months in anticipation of the exercise, in addition to conducting a preparatory workshop earlier this year which had aerial teams train for flights conducted entirely in English.

 

 

Representatives from other countries observed the exercise, with the possibility of participating in future years.

via Zero Hedge http://feedproxy.google.com/~r/zerohedge/feed/~3/WZUsiQPr3oA/story01.htm Tyler Durden

There was a time when the merest mention of gold manipulation in “reputable” media was enough to have one branded a perpetual conspiracy theorist with a tinfoil farm out back. That was roughly coincident with a time when Libor, FX, mortgage, and bond market manipulation was also considered unthinkable, when High Frequency Traders were believed to “provide liquidity”, or when the stock market was said to not be manipulated by the Fed, and when the ever-confused media, always eager to take “complicated” financial concepts at the face value set by a self-serving establishment, never dared to question anything. Luckily, all that changed in the past several years, and it has gotten to the point where even the bastions of “serious”, if 3-5 years delayed, investigation are finally not only asking how is the gold market being manipulated, but are actually providing answers.

Such as Bloomberg.

The topic of gold market manipulation during the London AM fix is not new to Zero Hedge: in fact we have discussed both the historical basis and the raison d’etre of the London gold fix, as well as the curious arbitrage available to those who merely traded the AM-PM spread, for years. Which is why we are delighted that none other than Bloomberg has decided to break it down for everyone, as well as summarize all the ways in which just this one facet of gold trading is being manipulated.

Bloomberg begins:

Every business day in London, five banks meet to set the price of gold in a ritual that dates back to 1919. Now, dealers and economists say knowledge gleaned on those calls could give some traders an unfair advantage when buying and selling the precious metal. The London fix, the benchmark rate used by mining companies, jewelers and central banks to buy, sell and value the metal, is published twice daily after a telephone call involving Barclays Plc, Deutsche Bank AG, Bank of Nova Scotia, HSBC Holdings Plc and Societe Generale SA.

 

The fix dates back to September 1919, less than a year after the end of World War I, when representatives from five dealers met at Rothschild’s office on St. Swithin’s Lane in London’s financial district. It was suspended for 15 years, starting in 1939. While Rothschild pulled out in 2004 and the discussions now take place by telephone instead of in a wood-paneled room at the bank, the process remains much the same.

That much is known. What is certainly known is that any process that involves five banks sitting down (until recently literally) and exchanging information using arcane methods (such as a telephone), on a set schedule that involves a private information blackout phase, even if temporary, and that does not involve instant market feedback, can and will be gamed. “Traders involved in this price-determining process have knowledge which, even for a short time, is superior to other people’s knowledge,” said Thorsten Polleit, chief economist at Frankfurt-based precious-metals broker Degussa Goldhandel GmbH and a former economist at Barclays. “That is the great flaw of the London gold-fixing.”

There are other flaws.

Participants on the London call can tell whether the price of gold is rising or falling within a minute or so, based on whether there are a large number of net buyers or sellers after the first round, according to gold traders, academics and investors interviewed by Bloomberg News. It’s this feature that could allow dealers and others in receipt of the information to bet on the direction of the market with a high degree of certainty minutes before the fix is made public, they said.

Yes, the broader momentum creation and ignition perspective is also known to most. At least most who never believed the boilerplate that unlike all other asset classes, gold is somehow immune from manipulation.

“Information trickles down from the five banks, through to their clients and finally to the broader market,” Andrew Caminschi, a lecturer at the University of Western Australia in Perth and co-author of a Sept. 2 paper on trading spikes around the London gold fix published online in the Journal of Futures Markets, said by phone. “In a world where trading advantage is measured in milliseconds, that has some value.”

Ah, theoretical – smart. One mustn’t ruffle feathers before, like in the case of Libor, it becomes fact that everyone was in on it.

There’s no evidence that gold dealers sought to manipulate the London fix or worked together to rig prices, as traders did with Libor. Even so, economists and academics say the way the benchmark is set is outdated, vulnerable to abuse and lacking any direct regulatory oversight. “This is one of the most concerning fixings I have seen,” said Rosa Abrantes-Metz, a professor at New York University’s Stern School of Business whose 2008 paper, “Libor Manipulation?” helped spark a global probe. “It’s controlled by a handful of firms with a direct financial interest in where it’s set, and there is virtually no oversight — and it’s based on information exchanged among them during undisclosed calls.”

Unless we are wrong, there was no evidence of Libor manipulative collusion before there was evidence either. And since the cabal of the London gold fix is far smaller than the member banks of Libor, it is exponentially easier to confine intent within an even smaller group of people. But all that is also known to most.

As is the fact that when asked for comments, ‘spokesmen for Barclays, Deutsche Bank, HSBC and Societe Generale declined to comment about the London fix or the regulatory probes, as did Chris Hamilton, a spokesman for the FCA, and Steve Adamske at the CFTC. Joe Konecny, a spokesman for Bank of Nova Scotia, wrote in an e-mail that the Toronto-based company has “a deeply rooted compliance culture and a drive to continually look toward ways to improve our existing processes and practices.”

Next, Bloomberg conveniently goes into the specifics of just how the gold price is manipulated first by the fixing banks, then by their “friends and neighbors” as news of the fixing process unfolds.

At the start of the call, the designated chairman — the job rotates annually among the five banks — gives a figure close to the current spot price in dollars for an ounce of gold. The firms then declare how many bars of the metal they wish to buy or sell at that price, based on orders from clients as well as their own account.

 

If there are more buyers than sellers, the starting price is raised and the process begins again. The talks continue until the buy and sell amounts are within 50 bars, or about 620 kilograms, of each other. The procedure is carried out twice a day, at 10:30 a.m. and 3 p.m. in London. Prices are set in dollars, pounds and euros. Similar gauges exist for silver, platinum and palladium.

 

The traders relay shifts in supply and demand to clients during the calls and take fresh ord
ers to buy or sell as the price changes, according to the website of London Gold Market Fixing, which publishes the results of the fix.

.. only this time the manipulation is no longer confined to a purely theoretical plane and instead empirical evidence of the fixing leak is presented based on academic research:

Caminschi and Richard Heaney, a professor of accounting and finance at the University of Western Australia, analyzed two of the most widely traded gold derivatives: gold futures on Comex and State Street Corp.’s SPDR Gold Trust, the largest bullion-backed exchange-traded product, from 2007 through 2012.

 

At 3:01 p.m., after the start of the call, trading surged to 47.8 percent above the average for the 20-minute period preceding the start of the fix and remained 20 percent higher for the next six minutes, Caminschi and Heaney found. By comparison, trading was 8.7 percent higher than the average a minute after publication of the price. The results showed a similar pattern for the SPDR Gold Trust.

 

“Intuitively, we expect volumes to spike following the introduction of information to the market” when the final result is published, Caminschi and Heaney wrote in “Fixing a Leaky Fixing: Short-Term Market Reactions to the London P.M. Gold Price Fixing.” “What we observe in our analysis is a clustering of trades immediately following the fixing start.”

 

The researchers also assessed how accurate movements in gold derivatives were in predicting the final fix. Between 2:59 p.m. and 3 p.m., the direction of futures contracts matched the direction of the fix about half the time.

 

From 3:01 p.m., the success rate jumped to 69.9 percent, and within five minutes it had climbed to 80 percent, Caminschi and Heaney wrote. On days when the gold price per ounce moved by more than $3, gold futures successfully predicted the outcome in more than nine out of 10 occasions. “Not only are the trades quite accurate in predicting the fixing direction, the more money that is made by way of a larger price change, the more accurate the trade becomes,” Caminschi and Heaney wrote. “This is highly suggestive of information leaking from the fixing to these public markets.”

Oh please, 9 out of 10 times is hardly indicative of any wrongdoing. After all, JPM lost money on, well, zero trading days in all of 2013, and nobody cares. So if a coin landing heads about 200 times in a row is considered normal by regulators, then surely the CTFC will find nothing wrong with a little gold manipulation here and there. Manipulation, which it itself previously said did not exist. But everyone already knew that too.

Cynicism aside, to claim that this clearly gamed process is not in fact gamed, not to say criminally manipulated (because it is never manipulation unless one is caught in the act by enforcers who are actually not in on the scheme) is the height of idiocy. Which is why we are certain that regulators will go precisely this route. That too is also largely known. Also known are the benefits for traders who abuse the London fix:

For derivatives traders, the benefits are clear: A dealer who bought 500 gold futures contracts at 3 p.m. and knew the fix was going higher could make $200,000 for his firm if the price moved by $4, the average move in the sample. While the value of 500 contracts totals about $60 million, traders may buy on margin, a process that involves borrowing and requires placing less capital for the bet. On a typical day, about 4,500 futures contracts are traded between 3 p.m. and 3:15 p.m., according to Caminschi and Heaney.

Finally what is certainly known is that the “London fixing” fix would be very simple in our day and age of ultramodern technology, and require a few minutes of actual implementation.

Abrantes-Metz, who helped Iosco formulate its guidelines, said the gold fix’s shortcomings may stretch beyond giving firms and clients access to privileged information. “There is a huge incentive for these banks to try and influence where the benchmark is set depending on their trading positions, and there is almost no scrutiny,” she said.

 

Abrantes-Metz said the gold fix should be replaced with a benchmark calculated by taking a snapshot of trading in a market where $19.6 trillion of the precious metal circulated last year, according to CPM Group, a New York-based research company. “There’s no reason why data cannot be collected from actual prices of spot gold based on floor or electronic trading,” she said. “There’s more than enough data.”

Which is precisely why nothing will change. Sadly, that is also widely known.

So did Bloomberg put together an exhaustive article in which virtually everything was known a priori? it turns out the answer is no: we learned one thing.

London Gold Market Fixing Ltd., a company controlled by the five banks that administers the benchmark, has no permanent employees. A call from Bloomberg News was referred to Douglas Beadle, 68, a former Rothschild banker, who acts as a consultant to the company from his home in Caterham, a small commuter town 45 minutes south of London by train. Beadle declined to comment on the benchmark-setting process.

You learn something new every day.

via Zero Hedge http://feedproxy.google.com/~r/zerohedge/feed/~3/gaHmS6aVHXg/story01.htm Tyler Durden

There was a time when the merest mention of gold manipulation in “reputable” media was enough to have one branded a perpetual conspiracy theorist with a tinfoil farm out back. That was roughly coincident with a time when Libor, FX, mortgage, and bond market manipulation was also considered unthinkable, when High Frequency Traders were believed to “provide liquidity”, or when the stock market was said to not be manipulated by the Fed, and when the ever-confused media, always eager to take “complicated” financial concepts at the face value set by a self-serving establishment, never dared to question anything. Luckily, all that changed in the past several years, and it has gotten to the point where even the bastions of “serious”, if 3-5 years delayed, investigation are finally not only asking how is the gold market being manipulated, but are actually providing answers.

Such as Bloomberg.

The topic of gold market manipulation during the London AM fix is not new to Zero Hedge: in fact we have discussed both the historical basis and the raison d’etre of the London gold fix, as well as the curious arbitrage available to those who merely traded the AM-PM spread, for years. Which is why we are delighted that none other than Bloomberg has decided to break it down for everyone, as well as summarize all the ways in which just this one facet of gold trading is being manipulated.

Bloomberg begins:

Every business day in London, five banks meet to set the price of gold in a ritual that dates back to 1919. Now, dealers and economists say knowledge gleaned on those calls could give some traders an unfair advantage when buying and selling the precious metal. The London fix, the benchmark rate used by mining companies, jewelers and central banks to buy, sell and value the metal, is published twice daily after a telephone call involving Barclays Plc, Deutsche Bank AG, Bank of Nova Scotia, HSBC Holdings Plc and Societe Generale SA.

 

The fix dates back to September 1919, less than a year after the end of World War I, when representatives from five dealers met at Rothschild’s office on St. Swithin’s Lane in London’s financial district. It was suspended for 15 years, starting in 1939. While Rothschild pulled out in 2004 and the discussions now take place by telephone instead of in a wood-paneled room at the bank, the process remains much the same.

That much is known. What is certainly known is that any process that involves five banks sitting down (until recently literally) and exchanging information using arcane methods (such as a telephone), on a set schedule that involves a private information blackout phase, even if temporary, and that does not involve instant market feedback, can and will be gamed. “Traders involved in this price-determining process have knowledge which, even for a short time, is superior to other people’s knowledge,” said Thorsten Polleit, chief economist at Frankfurt-based precious-metals broker Degussa Goldhandel GmbH and a former economist at Barclays. “That is the great flaw of the London gold-fixing.”

There are other flaws.

Participants on the London call can tell whether the price of gold is rising or falling within a minute or so, based on whether there are a large number of net buyers or sellers after the first round, according to gold traders, academics and investors interviewed by Bloomberg News. It’s this feature that could allow dealers and others in receipt of the information to bet on the direction of the market with a high degree of certainty minutes before the fix is made public, they said.

Yes, the broader momentum creation and ignition perspective is also known to most. At least most who never believed the boilerplate that unlike all other asset classes, gold is somehow immune from manipulation.

“Information trickles down from the five banks, through to their clients and finally to the broader market,” Andrew Caminschi, a lecturer at the University of Western Australia in Perth and co-author of a Sept. 2 paper on trading spikes around the London gold fix published online in the Journal of Futures Markets, said by phone. “In a world where trading advantage is measured in milliseconds, that has some value.”

Ah, theoretical – smart. One mustn’t ruffle feathers before, like in the case of Libor, it becomes fact that everyone was in on it.

There’s no evidence that gold dealers sought to manipulate the London fix or worked together to rig prices, as traders did with Libor. Even so, economists and academics say the way the benchmark is set is outdated, vulnerable to abuse and lacking any direct regulatory oversight. “This is one of the most concerning fixings I have seen,” said Rosa Abrantes-Metz, a professor at New York University’s Stern School of Business whose 2008 paper, “Libor Manipulation?” helped spark a global probe. “It’s controlled by a handful of firms with a direct financial interest in where it’s set, and there is virtually no oversight — and it’s based on information exchanged among them during undisclosed calls.”

Unless we are wrong, there was no evidence of Libor manipulative collusion before there was evidence either. And since the cabal of the London gold fix is far smaller than the member banks of Libor, it is exponentially easier to confine intent within an even smaller group of people. But all that is also known to most.

As is the fact that when asked for comments, ‘spokesmen for Barclays, Deutsche Bank, HSBC and Societe Generale declined to comment about the London fix or the regulatory probes, as did Chris Hamilton, a spokesman for the FCA, and Steve Adamske at the CFTC. Joe Konecny, a spokesman for Bank of Nova Scotia, wrote in an e-mail that the Toronto-based company has “a deeply rooted compliance culture and a drive to continually look toward ways to improve our existing processes and practices.”

Next, Bloomberg conveniently goes into the specifics of just how the gold price is manipulated first by the fixing banks, then by their “friends and neighbors” as news of the fixing process unfolds.

At the start of the call, the designated chairman — the job rotates annually among the five banks — gives a figure close to the current spot price in dollars for an ounce of gold. The firms then declare how many bars of the metal they wish to buy or sell at that price, based on orders from clients as well as their own account.

 

If there are more buyers than sellers, the starting price is raised and the process begins again. The talks continue until the buy and sell amounts are within 50 bars, or about 620 kilograms, of each other. The procedure is carried out twice a day, at 10:30 a.m. and 3 p.m. in London. Prices are set in dollars, pounds and euros. Similar gauges exist for silver, platinum and palladium.

 

The traders relay shifts in supply and demand to clients during the calls and take fresh orders to buy or sell as the price changes, according to the website of London Gold Market Fixing, which publishes the results of the fix.

.. only this time the manipulation is no longer confined to a purely theoretical plane and instead empirical evidence of the fixing leak is presented based on academic research:

Caminschi and Richard Heaney, a professor of accounting and finance at the University of Western Australia, analyzed two of the most widely traded gold derivatives: gold futures on Comex and State Street Corp.’s SPDR Gold Trust, the largest bullion-backed exchange-traded product, from 2007 through 2012.

 

At 3:01 p.m., after the start of the call, trading surged to 47.8 percent above the average for the 20-minute period preceding the start of the fix and remained 20 percent higher for the next six minutes, Caminschi and Heaney found. By comparison, trading was 8.7 percent higher than the average a minute after publication of the price. The results showed a similar pattern for the SPDR Gold Trust.

 

“Intuitively, we expect volumes to spike following the introduction of information to the market” when the final result is published, Caminschi and Heaney wrote in “Fixing a Leaky Fixing: Short-Term Market Reactions to the London P.M. Gold Price Fixing.” “What we observe in our analysis is a clustering of trades immediately following the fixing start.”

 

The researchers also assessed how accurate movements in gold derivatives were in predicting the final fix. Between 2:59 p.m. and 3 p.m., the direction of futures contracts matched the direction of the fix about half the time.

 

From 3:01 p.m., the success rate jumped to 69.9 percent, and within five minutes it had climbed to 80 percent, Caminschi and Heaney wrote. On days when the gold price per ounce moved by more than $3, gold futures successfully predicted the outcome in more than nine out of 10 occasions. “Not only are the trades quite accurate in predicting the fixing direction, the more money that is made by way of a larger price change, the more accurate the trade becomes,” Caminschi and Heaney wrote. “This is highly suggestive of information leaking from the fixing to these public markets.”

Oh please, 9 out of 10 times is hardly indicative of any wrongdoing. After all, JPM lost money on, well, zero trading days in all of 2013, and nobody cares. So if a coin landing heads about 200 times in a row is considered normal by regulators, then surely the CTFC will find nothing wrong with a little gold manipulation here and there. Manipulation, which it itself previously said did not exist. But everyone already knew that too.

Cynicism aside, to claim that this clearly gamed process is not in fact gamed, not to say criminally manipulated (because it is never manipulation unless one is caught in the act by enforcers who are actually not in on the scheme) is the height of idiocy. Which is why we are certain that regulators will go precisely this route. That too is also largely known. Also known are the benefits for traders who abuse the London fix:

For derivatives traders, the benefits are clear: A dealer who bought 500 gold futures contracts at 3 p.m. and knew the fix was going higher could make $200,000 for his firm if the price moved by $4, the average move in the sample. While the value of 500 contracts totals about $60 million, traders may buy on margin, a process that involves borrowing and requires placing less capital for the bet. On a typical day, about 4,500 futures contracts are traded between 3 p.m. and 3:15 p.m., according to Caminschi and Heaney.

Finally what is certainly known is that the “London fixing” fix would be very simple in our day and age of ultramodern technology, and require a few minutes of actual implementation.

Abrantes-Metz, who helped Iosco formulate its guidelines, said the gold fix’s shortcomings may stretch beyond giving firms and clients access to privileged information. “There is a huge incentive for these banks to try and influence where the benchmark is set depending on their trading positions, and there is almost no scrutiny,” she said.

 

Abrantes-Metz said the gold fix should be replaced with a benchmark calculated by taking a snapshot of trading in a market where $19.6 trillion of the precious metal circulated last year, according to CPM Group, a New York-based research company. “There’s no reason why data cannot be collected from actual prices of spot gold based on floor or electronic trading,” she said. “There’s more than enough data.”

Which is precisely why nothing will change. Sadly, that is also widely known.

So did Bloomberg put together an exhaustive article in which virtually everything was known a priori? it turns out the answer is no: we learned one thing.

London Gold Market Fixing Ltd., a company controlled by the five banks that administers the benchmark, has no permanent employees. A call from Bloomberg News was referred to Douglas Beadle, 68, a former Rothschild banker, who acts as a consultant to the company from his home in Caterham, a small commuter town 45 minutes south of London by train. Beadle declined to comment on the benchmark-setting process.

You learn something new every day.

via Zero Hedge http://feedproxy.google.com/~r/zerohedge/feed/~3/gaHmS6aVHXg/story01.htm Tyler Durden

Submitted by Pater Tenebrarum of Acting-Man blog,

Krugman, Summers and the First Keynesian

Paul Krugman has used the occasion of Larry Summers' speech at the IMF to lay out his economic views, or let us rather say, his economic fallacies. As we already mentioned, the fact that Krugman liked Summers' speech proves ipso facto that it was a bunch of arrant nonsense. Krugman has subsequently proved us right beyond a shadow of doubt. A great many long refuted Keynesian shibboleths keep being resurrected in Krugman's fantasy-land, where economic laws are magically suspended, virtue becomes vice and bubbles and the expropriation of savers the best ways to grow the economy. It is important to keep in mind in this context that most of what Keynes wrote in the General Theory wasn't original – it was mainly a rehashing of the underconsumption and inflationist fallacies propagated by his less famous predecessors. As Henry Hazlitt remarked in his detailed refutation of Keynes (“The Failure of the New Economics”):

“I have analyzed Keynes's General Theory in the following pages theorem by theorem, chapter by chapter, and sometimes even sentence by sentence, to what to some readers may appear a tedious length, and I have been unable to find in it a single important doctrine that is both true and original. What is original in the book is not true; and what is true is not original. In fact, as we shall find, even much that is fallacious in the book is not original, but can be found in a score of previous writers.”

If one looks back at the history of economic thought, the earliest proponent of what we know as Keynesian errors today was probably John Law, the infamous Scotsman who almost single-handedly managed to ruin the economy of France (in fact, all of Europe was thrown into a depression lasting decades as a result of Law's monetary experiment). He was convinced that what the economy lacked was 'spending' and so endeavored to provide it with the necessary means – in spades. The result was a giant asset bubble and crack-up boom that left the economy in utter ruins when it ended.

Although Law's scheme involved speculation in the shares of what turned out to be a company that was worth much less than advertised, at the heart of the operation was a monetary scheme based on his previously developed theories. The plan involved the printing of oodles of unbacked paper money which Law thought would spur a revival of France's moribund economy and concurrently fix the government's tattered finances. As is almost always the case with inflationary schemes, it appeared to work initially. In fact, it seemed to work almost too well (if Tonto had been around, he would have noticed that something was wrong). The world's first 'millionaires' were created, for a brief time at least (most of them ended up as paupers, similar to Law himself).

The problem with all such schemes is essentially that scarce resources end up being invested unwisely, as inflation makes it appear as though they were more plentiful than they really are. Once the inevitable collapse comes, these unwise investments are unmasked and it become obvious to all that capital has been squandered.

 

---

 

John Law – the world's first Keynesian

(Image via Wikimedia Commons)

 

---

 

One of the ultimately worthless paper promises issued by Law's Banque Générale

(Image via Wikimedia Commons)

 

---

 

The 'Logic' of Nonsense

What we noted above regarding 'wise' and 'unwise' investment is an important point to keep in mind when considering Krugman's rehashing of Keynesian fallacies. Krugman writes:

“Larry’s formulation of our current economic situation is the same as my own. Although he doesn’t use the words “liquidity trap”, he works from the understanding that we are an economy in which monetary policy is de facto constrained by the zero lower bound (even if you think central banks could be doing more), and that this corresponds to a situation in which the “natural” rate of interest – the rate at which desired savings and desired investment would be equal at full employment – is negative.

 

And as he also notes, in this situation the normal rules of economic policy don’t apply. As I like to put it, virtue becomes vice and prudence becomes folly. Saving hurts the economy – it even hurts investment, thanks to the paradox of thrift. Fixating on debt and deficits deepens the depression. And so on down the line.”

(emphasis added)

We already discussed that the idea that the natural interest rate can beco
me negative is a fallacy (see “Meet Larry Summers, Social Engineer” for more color on this). To briefly summarize, for the natural rate to go negative, time preferences would have to go negative too, as interest rates are merely the ratio between present and future goods. However, a situation in which human beings value attaining the same satisfaction in a more remote future more highly than attaining it in a nearer future is simply unthinkable (capitalistic saving, i.e., abstaining from present consumption, always aims at obtaining more goods and/or services in the future).

All this 'liquidity trap' and 'paradox of thrift' stuff makes no sense whatsoever. Savings are not 'lost' to the economy, they are the sine qua non without which capital accumulation and production are not possible. Virtue doesn't become vice in an economic downturn and economic laws don't change. As William Anderson points out in a recent article, the problem with this thinking is that it ignores capital theory. Attempts to revive the economy with deficit spending and inflation will never stimulate all factors of production simultaneously and to the same extent. The moment one considers the heterogeneity of capital it becomes clear that such interventions must lead to distortions which result in the boom-bust cycle (the housing bubble that expired in 2007/8 provides us with an excellent recent example for this).

Krugman elaborates further, once again invoking space aliens in the process:

“This is the kind of environment in which Keynes’s hypothetical policy of burying currency in coalmines and letting the private sector dig it up – or my version, which involves faking a threat from nonexistent space aliens – becomes a good thing; spending is good, and while productive spending is best, unproductive spending is still better than nothing.”

It is simply incorrect that 'unproductive spending is better than nothing'. Recall what we said above about 'wise and unwise investment'. Deploying scarce resources in unproductive fashion is not 'better than nothing', it will simply consume capital and destroy wealth. Krugman continues along these lines, seemingly eager to enlist everyone in his plan to waste as much capital as possible:

“Larry also indirectly states an important corollary: this isn’t just true of public spending. Private spending that is wholly or partially wasteful is also a good thing, unless it somehow stores up trouble for the future. That last bit is an important qualification. But suppose that U.S. corporations, which are currently sitting on a huge hoard of cash, were somehow to become convinced that it would be a great idea to fit out all their employees as cyborgs, with Google Glass and smart wristwatches everywhere. And suppose that three years later they realized that there wasn’t really much payoff to all that spending. Nonetheless, the resulting investment boom would have given us several years of much higher employment, with no real waste, since the resources employed would otherwise have been idle.

 

OK, this is still mostly standard, although a lot of people hate, just hate, this kind of logic – they want economics to be a morality play, and they don’t care how many people have to suffer in the process.”

(emphasis added)

So 'wasteful spending is a good thing unless it stores up trouble for the future' – Krugman says that this is an 'important qualification', only to proceed to show us in the next breath that he actually does not feel constrained by any such 'qualification' at all. Presumably he put that filler sentence in there so that when people in the future take a look at what he recommended in the past, he can claim to have 'qualified' his demand for wasteful spending (recall his vocal demand for a housing bubble before housing bubbles turned out to be uncool, which continues to cause him well-deserved embarrassment). When the latest scheme to 'rescue' the economy by inflation and deficit spending fails, he will be able to dig up this 'important qualification' (as if there could be any wasteful spending that doesn't store up trouble for the future).

The idea that 'idle resources' need to be pressed into service is also due to Krugman having no inkling of capital theory. In the Keynesian view of the world, capital is a self-replicating homogeneous blob, some portions of which are currently accidentally 'idled' and only need to be prodded back into action with the help of  government spending. This is not so. Capital is not only heterogeneous, much of it is highly specific and inconvertible. What appears to be unnecessarily 'idle' are simply the remnants of previous malinvestments. It may no longer make economic sense to employ the capital concerned. Workers who used to be employed in lines of production the products of which are no longer in demand may be holding out, hoping for the sector to 'come back' rather than accepting a lower wage in a different occupation.

As an example, consider the housing sector that was at the center of the previous boom. If building companies have invested in enough machinery to erect two million houses per year, but I has turned out that there is only demand for 400,000 houses, it wouldn't make sense to employ the superfluous machinery and construct two million houses per year anyway. People that were employed in construction may need to retrain or move and be willing to accept less remunerative work. It is certain that e.g. far fewer roofers are needed today than during the building boom. Renewed credit expansion is likely to affect different sectors of the economy, but if it leads to another artificial boom in the same sector, it will merely prolong the life of malinvested capital and delay the necessary adjustments. Krugman argues along Keynesian lines that  'stuff the government has dro
pped into coal mines should be dug up', but neglects that this activity doesn't come without costs (or rather, erroneously argues that the costs don't matter).

Krugman avers that this 'logic' is hated because people are informed by a warped sense of morality. The problem has nothing to do with morals though, the problem is that there is simply no 'logic' discernible. Krugman offers the most illogical ideas and then proceeds to call them 'logic' as if that could somehow dignify them and mitigate the fact that they are offending common sense.

 

More Bubbles Please

Believe it or not, it gets still more absurd. Not only does Krugman conclude that it is supposedly advisable to engage in unproductive spending because it is 'better than nothing', he also believes that Summers' speech contains an unspoken demand for more bubbles. And why not? After all, he has already concluded that 'prudence is folly', so why not throw prudence overboard, lock, stock and barrel? Never mind that this is what policy makers are already doing, so there hardly seems a great need to egg them on. According to Krugman:

“We now know that the economic expansion of 2003-2007 was driven by a bubble. You can say the same about the latter part of the 90s expansion; and you can in fact say the same about the later years of the Reagan expansion, which was driven at that point by runaway thrift institutions and a large bubble in commercial real estate.

 

So you might be tempted to say that monetary policy has consistently been too loose. After all, haven’t low interest rates been encouraging repeated bubbles? But as Larry emphasizes, there’s a big problem with the claim that monetary policy has been too loose: where’s the inflation? Where has the overheated economy been visible?

 

So how can you reconcile repeated bubbles with an economy showing no sign of inflationary pressures? Summers’ answer is that we may be an economy that needs bubbles just to achieve something near full employment – that in the absence of bubbles the economy has a negative natural rate of interest.”

(emphasis added)

The seemingly insoluble questions Krugman grapples with are not as difficult as he makes them out to be. The problem is that what he calls 'inflation' is only one of its many possible effects. Where the effects of inflation on prices first appear is a matter of the specific historical circumstances. Given strongly rising economic productivity, a huge expansion in international trade (and let us not forget, the transformation of the former communist command economies into market economies), it should be no great surprise that the effects of the huge credit expansion and money supply inflation of recent decades showed up in asset prices rather than consumer prices (incidentally, a very similar thing happened during the boom of he 1920s, during which economists also ignored a major credit and money supply expansion because consumer prices were tame due to strong increases in productivity).

This does not mean that other negative effects of these inflationary credit bubbles didn't put in an appearance. They all caused a distortion of relative prices and were thus all marked by massive capital malinvestment. Successive credit expansions led temporarily to higher employment even as capital was misallocted, but a steadily worsening underlying structural situation has become evident as these booms have inevitably turned into busts. So what solution does Krugman have to offer? He evidently thinks coercion and theft are the best way forward:

“Of course, the underlying problem in all of this is simply that real interest rates are too high. But, you say, they’re negative – zero nominal rates minus at least some expected inflation. To which the answer is, so? If the market wants a strongly negative real interest rate, we’ll have persistent problems until we find a way to deliver such a rate.

 

One way to get there would be to reconstruct our whole monetary system – say, eliminate paper money and pay negative interest rates on deposits. Another way would be to take advantage of the next boom – whether it’s a bubble or driven by expansionary fiscal policy – to push inflation substantially higher, and keep it there. Or maybe, possibly, we could go the Krugman 1998/Abe 2013 route of pushing up inflation through the sheer power of self-fulfilling expectations.”

(emphasis added)

Or putting it differently: do what John Law did and destroy what's left of the economy. The elimination of paper money (i.e., cash), would force people  (whether they like it or not) to keep their money in what are essentially insolvent fractionally reserved banks that have proved beyond a shadow of doubt that they cannot be trusted. This poses no problem for Krugman, because it would make it easier to steal people's savings via the imposition of 'negative interest rates' (i.e., a regular penalty to be deducted from their hard earned money).

Krugman then expresses his advance surprise at why anyone would be outraged by this combination of abject economic nonsense and outright theft. After all, it would amount to nothing but the good old 'euthanasia of the rentier' once recommended by Keynes:

Any such suggestions are, of cou
rse, met with outrage. How dare anyone suggest that virtuous individuals, people who are prudent and save for the future, face expropriation? How can you suggest steadily eroding their savings either through inflation or through negative interest rates? It’s tyranny!

 

But in a liquidity trap saving may be a personal virtue, but it’s a social vice. And in an economy facing secular stagnation, this isn’t just a temporary state of affairs, it’s the norm. Assuring people that they can get a positive rate of return on safe assets means promising them something the market doesn’t want to deliver – it’s like farm price supports, except for rentiers.

(emphasis added)

What Krugman proposes here is indeed tyranny. The 'liquidity trap' is a figment of the Keynesian imagination anyway – no such thing exists. A positive rate of return on savings doesn't need to be 'promised' by anyone, it would be the natural state of affairs in a free market economy. Krugman then jumps to yet another conclusion, namely that in light of the above, the size and growth rate of the public debt would of course no longer matter at all:

“Oh, and one last point. If we’re going to have persistently negative real interest rates along with at least somewhat positive overall economic growth, the panic over public debt looks even more foolish than people like me have been saying: servicing the debt in the sense of stabilizing the ratio of debt to GDP has no cost, in fact negative cost.

 

I could go on, but by now I hope you’ve gotten the point.”

(emphasis added)

Well, we can at least be grateful that he didn't 'go on'.

 

---

 

Too much debt? No problem, just impose negative interest rates! – click to enlarge.

 

---

 

Summary and Conclusion:

According to Paul Krugman, saving is evil and savers should therefore be forcibly deprived of positive interest returns. This echoes the 'euthanasia of the rentier' demanded by Keynes, who is the most prominent source of the erroneous underconsumption theory Krugman is propagating. Similar to John Law and scores of inflationists since then, he believes that economic growth is driven by 'spending' and consumption. This is putting the cart before the horse. We don't deny that inflation and deficit spending can create a temporary illusory sense of prosperity by diverting scarce resources from wealth-generating toward wealth-consuming activities. It should however be obvious that this can only lead to severe long term economic problems.

In fact, the last credit boom, in which policy makers fully implemented what Krugman and other Keynesians proposed, has done enormous structural damage. Not even the biggest spending spree and money supply expansion of the entire post WW2 era has been able to divert enough wealth into bubble activities to create a full-blown pseudo-'recovery' so far. Krugman's conclusion seems to be that more of the same is needed. In other words, we are supposed to repeat what clearly hasn't worked before, only on a much greater scale.

Finally it should be pointed out that the idea that economic laws are somehow 'different' in periods of economic contraction is a cop-out mainly designed to prevent people from asking an obvious question: if deficit spending and inflation are so great, why not always pursue them?

via Zero Hedge http://feedproxy.google.com/~r/zerohedge/feed/~3/3bA03w8EPiE/story01.htm Tyler Durden

Submitted by Pater Tenebrarum of Acting-Man blog,

Krugman, Summers and the First Keynesian

Paul Krugman has used the occasion of Larry Summers' speech at the IMF to lay out his economic views, or let us rather say, his economic fallacies. As we already mentioned, the fact that Krugman liked Summers' speech proves ipso facto that it was a bunch of arrant nonsense. Krugman has subsequently proved us right beyond a shadow of doubt. A great many long refuted Keynesian shibboleths keep being resurrected in Krugman's fantasy-land, where economic laws are magically suspended, virtue becomes vice and bubbles and the expropriation of savers the best ways to grow the economy. It is important to keep in mind in this context that most of what Keynes wrote in the General Theory wasn't original – it was mainly a rehashing of the underconsumption and inflationist fallacies propagated by his less famous predecessors. As Henry Hazlitt remarked in his detailed refutation of Keynes (“The Failure of the New Economics”):

“I have analyzed Keynes's General Theory in the following pages theorem by theorem, chapter by chapter, and sometimes even sentence by sentence, to what to some readers may appear a tedious length, and I have been unable to find in it a single important doctrine that is both true and original. What is original in the book is not true; and what is true is not original. In fact, as we shall find, even much that is fallacious in the book is not original, but can be found in a score of previous writers.”

If one looks back at the history of economic thought, the earliest proponent of what we know as Keynesian errors today was probably John Law, the infamous Scotsman who almost single-handedly managed to ruin the economy of France (in fact, all of Europe was thrown into a depression lasting decades as a result of Law's monetary experiment). He was convinced that what the economy lacked was 'spending' and so endeavored to provide it with the necessary means – in spades. The result was a giant asset bubble and crack-up boom that left the economy in utter ruins when it ended.

Although Law's scheme involved speculation in the shares of what turned out to be a company that was worth much less than advertised, at the heart of the operation was a monetary scheme based on his previously developed theories. The plan involved the printing of oodles of unbacked paper money which Law thought would spur a revival of France's moribund economy and concurrently fix the government's tattered finances. As is almost always the case with inflationary schemes, it appeared to work initially. In fact, it seemed to work almost too well (if Tonto had been around, he would have noticed that something was wrong). The world's first 'millionaires' were created, for a brief time at least (most of them ended up as paupers, similar to Law himself).

The problem with all such schemes is essentially that scarce resources end up being invested unwisely, as inflation makes it appear as though they were more plentiful than they really are. Once the inevitable collapse comes, these unwise investments are unmasked and it become obvious to all that capital has been squandered.

 

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John Law – the world's first Keynesian

(Image via Wikimedia Commons)

 

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One of the ultimately worthless paper promises issued by Law's Banque Générale

(Image via Wikimedia Commons)

 

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The 'Logic' of Nonsense

What we noted above regarding 'wise' and 'unwise' investment is an important point to keep in mind when considering Krugman's rehashing of Keynesian fallacies. Krugman writes:

“Larry’s formulation of our current economic situation is the same as my own. Although he doesn’t use the words “liquidity trap”, he works from the understanding that we are an economy in which monetary policy is de facto constrained by the zero lower bound (even if you think central banks could be doing more), and that this corresponds to a situation in which the “natural” rate of interest – the rate at which desired savings and desired investment would be equal at full employment – is negative.

 

And as he also notes, in this situation the normal rules of economic policy don’t apply. As I like to put it, virtue becomes vice and prudence becomes folly. Saving hurts the economy – it even hurts investment, thanks to the paradox of thrift. Fixating on debt and deficits deepens the depression. And so on down the line.”

(emphasis added)

We already discussed that the idea that the natural interest rate can become negative is a fallacy (see “Meet Larry Summers, Social Engineer” for more color on this). To briefly summarize, for the natural rate to go negative, time preferences would have to go negative too, as interest rates are merely the ratio between present and future goods. However, a situation in which human beings value attaining the same satisfaction in a more remote future more highly than attaining it in a nearer future is simply unthinkable (capitalistic saving, i.e., abstaining from present consumption, always aims at obtaining more goods and/or services in the future).

All this 'liquidity trap' and 'paradox of thrift' stuff makes no sense whatsoever. Savings are not 'lost' to the economy, they are the sine qua non without which capital accumulation and production are not possible. Virtue doesn't become vice in an economic downturn and economic laws don't change. As William Anderson points out in a recent article, the problem with this thinking is that it ignores capital theory. Attempts to revive the economy with deficit spending and inflation will never stimulate all factors of production simultaneously and to the same extent. The moment one considers the heterogeneity of capital it becomes clear that such interventions must lead to distortions which result in the boom-bust cycle (the housing bubble that expired in 2007/8 provides us with an excellent recent example for this).

Krugman elaborates further, once again invoking space aliens in the process:

“This is the kind of environment in which Keynes’s hypothetical policy of burying currency in coalmines and letting the private sector dig it up – or my version, which involves faking a threat from nonexistent space aliens – becomes a good thing; spending is good, and while productive spending is best, unproductive spending is still better than nothing.”

It is simply incorrect that 'unproductive spending is better than nothing'. Recall what we said above about 'wise and unwise investment'. Deploying scarce resources in unproductive fashion is not 'better than nothing', it will simply consume capital and destroy wealth. Krugman continues along these lines, seemingly eager to enlist everyone in his plan to waste as much capital as possible:

“Larry also indirectly states an important corollary: this isn’t just true of public spending. Private spending that is wholly or partially wasteful is also a good thing, unless it somehow stores up trouble for the future. That last bit is an important qualification. But suppose that U.S. corporations, which are currently sitting on a huge hoard of cash, were somehow to become convinced that it would be a great idea to fit out all their employees as cyborgs, with Google Glass and smart wristwatches everywhere. And suppose that three years later they realized that there wasn’t really much payoff to all that spending. Nonetheless, the resulting investment boom would have given us several years of much higher employment, with no real waste, since the resources employed would otherwise have been idle.

 

OK, this is still mostly standard, although a lot of people hate, just hate, this kind of logic – they want economics to be a morality play, and they don’t care how many people have to suffer in the process.”

(emphasis added)

So 'wasteful spending is a good thing unless it stores up trouble for the future' – Krugman says that this is an 'important qualification', only to proceed to show us in the next breath that he actually does not feel constrained by any such 'qualification' at all. Presumably he put that filler sentence in there so that when people in the future take a look at what he recommended in the past, he can claim to have 'qualified' his demand for wasteful spending (recall his vocal demand for a housing bubble before housing bubbles turned out to be uncool, which continues to cause him well-deserved embarrassment). When the latest scheme to 'rescue' the economy by inflation and deficit spending fails, he will be able to dig up this 'important qualification' (as if there could be any wasteful spending that doesn't store up trouble for the future).

The idea that 'idle resources' need to be pressed into service is also due to Krugman having no inkling of capital theory. In the Keynesian view of the world, capital is a self-replicating homogeneous blob, some portions of which are currently accidentally 'idled' and only need to be prodded back into action with the help of  government spending. This is not so. Capital is not only heterogeneous, much of it is highly specific and inconvertible. What appears to be unnecessarily 'idle' are simply the remnants of previous malinvestments. It may no longer make economic sense to employ the capital concerned. Workers who used to be employed in lines of production the products of which are no longer in demand may be holding out, hoping for the sector to 'come back' rather than accepting a lower wage in a different occupation.

As an example, consider the housing sector that was at the center of the previous boom. If building companies have invested in enough machinery to erect two million houses per year, but I has turned out that there is only demand for 400,000 houses, it wouldn't make sense to employ the superfluous machinery and construct two million houses per year anyway. People that were employed in construction may need to retrain or move and be willing to accept less remunerative work. It is certain that e.g. far fewer roofers are needed today than during the building boom. Renewed credit expansion is likely to affect different sectors of the economy, but if it leads to another artificial boom in the same sector, it will merely prolong the life of malinvested capital and delay the necessary adjustments. Krugman argues along Keynesian lines that  'stuff the government has dropped into coal mines should be dug up', but neglects that this activity doesn't come without costs (or rather, erroneously argues that the costs don't matter).

Krugman avers that this 'logic' is hated because people are informed by a warped sense of morality. The problem has nothing to do with morals though, the problem is that there is simply no 'logic' discernible. Krugman offers the most illogical ideas and then proceeds to call them 'logic' as if that could somehow dignify them and mitigate the fact that they are offending common sense.

 

More Bubbles Please

Believe it or not, it gets still more absurd. Not only does Krugman conclude that it is supposedly advisable to engage in unproductive spending because it is 'better than nothing', he also believes that Summers' speech contains an unspoken demand for more bubbles. And why not? After all, he has already concluded that 'prudence is folly', so why not throw prudence overboard, lock, stock and barrel? Never mind that this is what policy makers are already doing, so there hardly seems a great need to egg them on. According to Krugman:

“We now know that the economic expansion of 2003-2007 was driven by a bubble. You can say the same about the latter part of the 90s expansion; and you can in fact say the same about the later years of the Reagan expansion, which was driven at that point by runaway thrift institutions and a large bubble in commercial real estate.

 

So you might be tempted to say that monetary policy has consistently been too loose. After all, haven’t low interest rates been encouraging repeated bubbles? But as Larry emphasizes, there’s a big problem with the claim that monetary policy has been too loose: where’s the inflation? Where has the overheated economy been visible?

 

So how can you reconcile repeated bubbles with an economy showing no sign of inflationary pressures? Summers’ answer is that we may be an economy that needs bubbles just to achieve something near full employment – that in the absence of bubbles the economy has a negative natural rate of interest.”

(emphasis added)

The seemingly insoluble questions Krugman grapples with are not as difficult as he makes them out to be. The problem is that what he calls 'inflation' is only one of its many possible effects. Where the effects of inflation on prices first appear is a matter of the specific historical circumstances. Given strongly rising economic productivity, a huge expansion in international trade (and let us not forget, the transformation of the former communist command economies into market economies), it should be no great surprise that the effects of the huge credit expansion and money supply inflation of recent decades showed up in asset prices rather than consumer prices (incidentally, a very similar thing happened during the boom of he 1920s, during which economists also ignored a major credit and money supply expansion because consumer prices were tame due to strong increases in productivity).

This does not mean that other negative effects of these inflationary credit bubbles didn't put in an appearance. They all caused a distortion of relative prices and were thus all marked by massive capital malinvestment. Successive credit expansions led temporarily to higher employment even as capital was misallocted, but a steadily worsening underlying structural situation has become evident as these booms have inevitably turned into busts. So what solution does Krugman have to offer? He evidently thinks coercion and theft are the best way forward:

“Of course, the underlying problem in all of this is simply that real interest rates are too high. But, you say, they’re negative – zero nominal rates minus at least some expected inflation. To which the answer is, so? If the market wants a strongly negative real interest rate, we’ll have persistent problems until we find a way to deliver such a rate.

 

One way to get there would be to reconstruct our whole monetary system – say, eliminate paper money and pay negative interest rates on deposits. Another way would be to take advantage of the next boom – whether it’s a bubble or driven by expansionary fiscal policy – to push inflation substantially higher, and keep it there. Or maybe, possibly, we could go the Krugman 1998/Abe 2013 route of pushing up inflation through the sheer power of self-fulfilling expectations.”

(emphasis added)

Or putting it differently: do what John Law did and destroy what's left of the economy. The elimination of paper money (i.e., cash), would force people  (whether they like it or not) to keep their money in what are essentially insolvent fractionally reserved banks that have proved beyond a shadow of doubt that they cannot be trusted. This poses no problem for Krugman, because it would make it easier to steal people's savings via the imposition of 'negative interest rates' (i.e., a regular penalty to be deducted from their hard earned money).

Krugman then expresses his advance surprise at why anyone would be outraged by this combination of abject economic nonsense and outright theft. After all, it would amount to nothing but the good old 'euthanasia of the rentier' once recommended by Keynes:

Any such suggestions are, of course, met with outrage. How dare anyone suggest that virtuous individuals, people who are prudent and save for the future, face expropriation? How can you suggest steadily eroding their savings either through inflation or through negative interest rates? It’s tyranny!

 

But in a liquidity trap saving may be a personal virtue, but it’s a social vice. And in an economy facing secular stagnation, this isn’t just a temporary state of affairs, it’s the norm. Assuring people that they can get a positive rate of return on safe assets means promising them something the market doesn’t want to deliver – it’s like farm price supports, except for rentiers.

(emphasis added)

What Krugman proposes here is indeed tyranny. The 'liquidity trap' is a figment of the Keynesian imagination anyway – no such thing exists. A positive rate of return on savings doesn't need to be 'promised' by anyone, it would be the natural state of affairs in a free market economy. Krugman then jumps to yet another conclusion, namely that in light of the above, the size and growth rate of the public debt would of course no longer matter at all:

“Oh, and one last point. If we’re going to have persistently negative real interest rates along with at least somewhat positive overall economic growth, the panic over public debt looks even more foolish than people like me have been saying: servicing the debt in the sense of stabilizing the ratio of debt to GDP has no cost, in fact negative cost.

 

I could go on, but by now I hope you’ve gotten the point.”

(emphasis added)

Well, we can at least be grateful that he didn't 'go on'.

 

---

 

Too much debt? No problem, just impose negative interest rates! – click to enlarge.

 

---

 

Summary and Conclusion:

According to Paul Krugman, saving is evil and savers should therefore be forcibly deprived of positive interest returns. This echoes the 'euthanasia of the rentier' demanded by Keynes, who is the most prominent source of the erroneous underconsumption theory Krugman is propagating. Similar to John Law and scores of inflationists since then, he believes that economic growth is driven by 'spending' and consumption. This is putting the cart before the horse. We don't deny that inflation and deficit spending can create a temporary illusory sense of prosperity by diverting scarce resources from wealth-generating toward wealth-consuming activities. It should however be obvious that this can only lead to severe long term economic problems.

In fact, the last credit boom, in which policy makers fully implemented what Krugman and other Keynesians proposed, has done enormous structural damage. Not even the biggest spending spree and money supply expansion of the entire post WW2 era has been able to divert enough wealth into bubble activities to create a full-blown pseudo-'recovery' so far. Krugman's conclusion seems to be that more of the same is needed. In other words, we are supposed to repeat what clearly hasn't worked before, only on a much greater scale.

Finally it should be pointed out that the idea that economic laws are somehow 'different' in periods of economic contraction is a cop-out mainly designed to prevent people from asking an obvious question: if deficit spending and inflation are so great, why not always pursue them?

via Zero Hedge http://feedproxy.google.com/~r/zerohedge/feed/~3/3bA03w8EPiE/story01.htm Tyler Durden