Tag: finance

European monetary policy/monetary conditions are too tight and, Citi's FX Technical group explains, the EURO is too strong thereby exacerbating the effects of the internal devaluation in Europe (as we noted here). Looser monetary policy and a weaker currency are becoming increasingly necessary conditions for the Eurozone to recover/survive. The present period in the Eurozone, Citi adds, where the financial architecture is coming apart at the seams is not remotely unprecedented and in fact offers a very compelling historical perspective for significant devaluation of the EUR in the years ahead.

Via Citi FX Technicals,

Given the lack of economic growth and employment growth combined with the precipitous fall in the inflation rate since July last year the ECB should be embracing looser policy and a lower EURO.

The present period in the Eurozone where the financial architecture is coming apart at the seams is not remotely unprecedented

Quick history recap:

1989-1991: We had the savings and loan crisis in the US; a sharp down turn in housing activity and a deep economic recession

 

1992-1994: The “travails” in the World’s largest economy found their way into the “flawed” financial architecture of Europe (The Exchange rate mechanism) which collapsed under the stress

 

1997-1998: Saw the “third leg” of this dynamic feed into Emerging markets as the aggressive easing in the World’s major economic zones created a “bubble” in EM and in particular Asia. Between 1989 and 1992 the Fed lowered the Fed funds rate from 9.75% to 3%.(The USD-Index fell about 27% in this period) From 1992 to 1996 the Bundesbank lowered rates from 8.75% to 2.5%.(The cycle low was put in for the USD-index in 1992 in a similar fashion to 2008 when we also reached the cycle low in the Fed funds rate) Three years later we saw the USD-index begin a 5 year plus rally-something we believe started again in 2011.

USD-index and the Fed easing cycles (Fed funds) of 1989-1992 and 2007-2009 on the back of a housing downturn, banking stress and economic downturn

We continue to believe that we are close to the next rally in the USD-index which we expect to continue for the next 2-3 years.

When we look back to that period in the early 1990’s we see a number of stimulus dynamics that eventually helped Europe “regain its footing”

Firstly the peripheral states got two distinct elements of stimulus. Most of the ERM currencies continued to weaken against the DEM into March of 1995 as the excessively tight monetary regime (Short term rates) put in place to defend the currencies was abandoned. This was further assisted by the easing of official rates by the Bundesbank from 8.75% in 1992 to a low of 2.5% by 1996.

European currencies continued to weaken into early 1995 against the Deutsche Mark.

The Italian Lira, Spanish Peseta and French Franc (Amongst many others) weakened substantially against the DEM into the spring of 1995.(Internal FX devaluation in “Euro bloc”)

As they strengthened again from 1995 onwards the Bundesbank was still lowering rates

Long term rates then started to fall sharply from 1995 and spreads converged with Germany providing further stimulus.

This move lower generated a rapid convergence of Bond yields.

Take Italy for example: Between 1995 and 1998 the 10 year Italy-Germany spread narrowed from about 650 basis points to ZERO on the back of the convergence trade.

That provided a huge monetary stimulus at the long end of the curve (And did not even need QE to do it) the magnitude of this move was much greater than what we have seen since this spread peaked just under 2 years ago.

Between 1995 and 1999 not only did we see spreads converge but long term rates in Italy (10 year) fell from 13.8% to 3.9% (Almost 1000 basis points). Compare that to today where we have seen a high to low fall of about 380 basis points between 2011 and 2013

Further as mentioned above we then saw the EURO (As its components) drop from 1.3770 in March 1995 to .8200 by October 2000 (40%) and from a peak of 1.4900 seen in 1992 (45%). Between 1995 and 1997 the convergence trade saw European currencies strengthen against the DEM (internal devaluation) but lower long term yields, short term yields and a much weaker “EURO bloc” against the USD all provided strong offsetting monetary stimulus.

Huge external devaluation for the EURO “bloc”

Sharp fall in the EURO bloc against the USD from 1995 to 2000 and in particular the 2 years from 1998-2000 (Fall of 32%)

That 2 year fall is important for a few reasons

– It happened after we had seen pretty much the “lion’s share” of the stimulative benefit of the “convergence trade” and drop in long term yields into 1998.

 

– The cycle low in Bundesbank rates (2.5%) in 1996 and subsequently ECB rates (2.5% in 1999) had been met at this point

Therefore the currency became the last “vestige” of monetary easing in the post ERM crisis cycle.

So reviewing the Crisis and post crisis dynamics of the ERM collapse and comparing to today

European peripheral currencies got a massive “Euro bloc” devaluation from 1992-1995. For example the Italian Lira depreciated from around 750 against the Deutsche in 1992 to about 1,240 by 1995 (About 65%). Between 1995 and 1997 some of that was unwound (internal EURO bloc) as it retraced to around 990 which became the rate at which the EURO conversion took place. That was still a devaluation of 32% from the 1992 level. Today the internal exchange rate is fixed so Italy in this crisis has had no internal devaluation.

 

From 1995 to 1998/1999 Italian long term yields fell precipitously (1,000 basis points) and the spread with Germany went to ZERO providing huge stimulus. During today’s crisis Italian 10 year yields have fallen from a peak of around 7.5% in 2011 to a low of around 3.7% in 2013 and now sit over 4% while German 10 year yields are around 1.75%. By definition this is much less stimulus as well as less convergence.

 

The EURO came into existence in January 1999 and the ECB refinancing rate hit a cycle low at 2.5% by April 1999, a move lower from the “heady peak” Bundesbank discount rate of 8.75% in 1992 and by definition large short term monetary stimulus.(fall of 625 basis points). Today we have seen a
less stimulative fall from 4.25% to 0.5% over about 5 years (375 basis points with minimal future potential to fall from here)

 

Between 1995 and 2000 the “EURO bloc” devalued against the USD by 40% (45% since 1992). Today, if we use October 2009 as the start of this EURO crisis (The point at which peripheral yields led by Greece began to surge) EURUSD has gone from around 1.46 at that time to around 1.35 today (A net depreciation of only about 7.5%)

The bottom line here is that in all respects the stimulative post crisis dynamics this time have been much lower than those seen after a “lesser” crisis in 1992-1995.This is before we even talk about the excessive Government debt that now exists, the stresses in the European banking system, the default by Greece, the bailout of Ireland and Cyprus and the fiscal austerity measures being employed.

In addition there is minimal new stimulative potential from traditional monetary policy with ECB rates now at 0.5%.

This leaves really two major tools for further stimulative activity following this week's rate cut…

Renewed ECB bond buying (They can no longer rely on an LTRO transmission mechanism inducing financial institutions to buy European sovereign bonds especially as they have shown the propensity for haircuts when things go wrong)…this would likely then transmit into…

 

A sharp external devaluation of the EURO. Given the poor economic dynamics in Europe, the collapsing inflation, global feedback loop concerns regarding tapering, some concerns about the ability of China (A major export market for Europe and Germany in particular) to maintain the prior pace of economic growth etc. there should be no concern in Europe about this. The authorities have to stop viewing a weaker EURO as part of the problem (financial crisis) and more as part of the solution (External devaluation is stimulative to the MCI (monetary conditions index) and supports export led growth). Even Germany should embrace this given the sluggishness of the EURO area economies and sharply lower and falling inflation. When we look at the longer term EURUSD chart it is very supportive of this outcome in a fashion very similar to the 1995-2000 period.

URUSD monthly chart: A very compelling historical perspective

We continue to expect a significant fall in EURUSD over the next 2+ years as we saw in 1998.We believe Europe needs and should embrace this dynamic given the ongoing danger of a deep recessionary/depressionary/deflationary environment as a consequence of fiscal austerity and the sharp internal devaluation dynamics already seen.

Within this we believe Europe should (and ultimately will) embrace the stimulative effects of such a move in conjunction with further traditional (refinancing rate) easing (Albeit at these levels the move is more psychological than anything) and non-traditional (bond buying)

On top of this the position of both the relative economic and monetary policy dynamics leaves the US further down the road and closer to a potential turn than Europe (Despite those dynamics still being weak by historical recovery standards)

via Zero Hedge http://feedproxy.google.com/~r/zerohedge/feed/~3/uP0g2kNd47Y/story01.htm Tyler Durden

One of the most trumpeted stories justifying the US economic “recovery” is the resurgence in car sales, which have now returned to an annual sales clip almost on par with that from before the great depression. What is conveniently left out of all such stories is what is the funding for these purchases (funnelling through to the top and bottom line of such administration darling companies as GM) comes from. The answer: the same NINJA loans, with non-existent zero credit rating requirements that allowed anything with a pulse to buy a McMansion during the peak day of the last credit bubble.

Bloomberg reports on an issue we have been reporting for over a year, namely the ‘stringent’ credit-check requirements for new car purchasers by recounting the story of Alan Helfman, a car dealer in Houston, who served a woman in his showroom last month with a credit score lower than 500 and a desire for a new Dodge Dart for her daily commute. She drove away with a new car.

So there you have it: No Car, no FICO score, no problem. The NINJAs have once again taken over the subprime asylum.

This time, it seems, is different: because anyone can get a loan. A year ago, with a credit ranking in the bottom eighth percentile, “I would’ve told her don’t even bother coming in,” said Helfman, who owns River Oaks Chrysler Dodge Jeep Ram, where sales rose about 20 percent this year. “But she had a good job, so I told her to bring a phone bill, a light bill, your last couple of paycheck stubs and bring me some down payment.”

Nevermind that a FICO < 500 means that not only will her job be gone in a few weeks, and that she will likely repay a single-digit percentage fraction of the total loan. What matters is she showed, well, signs of life – which makes her immediately eligible for all the loans that the government is fit to hand out. And frankly why not: with the US essentially insolvent, and now holding on to every day that the USD is still a reserve currency like dear life, who can blame her or the countless others like her, who have given the impression the economy is recovering when it is merely going through all the final strokes before it all, once again, comes crashing down?

Is it possible that barely five years later, everyone has forgotten what happened the last time anyone who wanted credit got it? And what will happen when those who don’t even have a phone bill or a light bill, nevermind a job, come asking for a Dodge Dart? Why yes: the Pied Piper of Marriner Eccles is playing the music ever louder, and so all must dance.

Luckily, even the mainstream media is finally catching on to the fact that all the “gains” in the best economic sector have been on the back of subprime.

While surging light-vehicle sales have been one of the bright spots in the U.S. economy, it’s increasingly being fueled by borrowers with imperfect credit. Such car buyers account for more than 27 percent of loans for new vehicles, the highest proportion since Experian Automotive started tracking the data in 2007. That compares with 25 percent last year and 18 percent in 2009, as lenders pulled back during the recession.

 

Issuance of bonds linked to subprime auto loans soared to $17.2 billion this year, more than double the amount sold during the same period in 2010, according to Harris Trifon, a debt analyst at Deutsche Bank AG. The market for such debt, which peaked at about $20 billion in 2005, was dwarfed by the record $1.2 trillion in mortgage bonds sold that year.

Of course, the enablers of this destructive behavior see nothing wrong, and live under the delusion that sub-500 FICO borrowers will actually pay them back.

“It’s a good investment” for lenders, Helfman said. “A person that has to get from point A to point B, they’re not going to jeopardize their job. They have to pay the car payment before they pay anything else.”

 

His Dodge Dart customer with the bad credit had to pay a higher than average interest rate.

 

“It wasn’t pretty, but it wasn’t crazy,” he said. She was “so happy she couldn’t see straight.”

Of course she did: Greece too was happy when it found Germany – an idiot lender who fund the Greek drunken spending for a decade (mostly on made in Germany military equipment). And like the lender, Germany too was happy: it found a willing idiot to buy everything it had to sell funded by “vendor financing.” Well all know how that relationship ended.

And end again it will, because subprime borrowers are the ones who can least afford the highest interest rates, which by definition flow through to the riskiest borrowers.

Fifty-eight percent of loans taken out to purchase Chrysler Group LLC’s Dodge brand vehicles in October were with loans above the industry average of 4.2 percent annual percentage rate, according to Edmunds, a researcher that tracks vehicle sales.

 

The average loan for a Dodge charged an APR of 7.4 percent, and 23 percent of the loans had APRs of more than 10 percent, making it the brand with the highest percentage of loans for more than 10 percent, followed closely by Chrysler and Mitsubishi. Rates on subprime auto loans can climb to 19 percent, according to S&P.

 

Dodge U.S. sales rose 17 percent this year through October compared with a year earlier, propelling Chrysler Group to 43 straight months of rising sales.

 

“Right now, you have to have fairly bad credit to be paying above 3 percent,” Jessica Caldwell, an analyst with Edmunds, said in a telephone interview.

But since nobody has blown up to date as a result of this latest micro credit bubble, it must mean everyone is welcome to dance. Sure enough:

An influx of new competitors into subprime auto-lending since 2010 is sparking concern of eroding underwriting standards, according to S&P. About 13 issuers have accessed the asset-backed market to fund subprime auto loan originations this year, according to Citigroup Inc.

 

Among the issuers accessing the asset-backed market this year are GM Financial, the lender founded in 1992 and known as AmeriCredit before it was acquired by General Motors Co. in 2010, and new entrants such as Blackstone Group LP’s Exeter Financial Corp.

 

“We are still skeptical that all of today’s subprime auto players will thrive,” Citigroup analysts led by Mary Kane said in an Oct. 10 report. The successful companies will be those that can underwrite and collect on loans while holding costs and defaults to a minimum, the Citigroup report said.

We are skeptical that Citi will thrive when the bubble pops, but that’s irrelevant. For now, let the good LTV times roll. LTVs of a whopping 114.5%.

Consider Exeter Finance Corp., which was acquired by Blackstone Group LP in 2011. Moody’s Investors Service won’t grant high-investment-grade rankings to asset-backed deals sold by the Irving, Texas-based company, citing its limited experience and performance history.

 

It has
had higher loss rates compared with other lenders, S&P said in a Sept. 17 report. Julie Weems, a spokeswoman for Exeter, declined to comment on the company’s losses.

 

Exeter has issued $900 million of the bonds this year, including $589 million of securities rated AAA by Toronto-based DBRS LTD and AA by S&P, data compiled by Bloomberg show.

 

In Exeter’s most recent deal in September, a $500 million issue backed by 26,591 loans, the average loan was 112.4 percent of the value of the car, up from 111.9 percent in a previous offering sold in May, according to a presale report from S&P. The average loan-to-value ratio, or LTV, on vehicle sales to consumers with spotty credit is 114.5 percent this year, compared with a peak of 121 percent in 2008.

It is so bad that even Morgan Stanley now gets it:

“Perhaps more than any other factor, easing credit has been the key to the U.S. auto recovery,” Adam Jonas, a New York-based analyst with Morgan Stanley, wrote in a note to investors last month. The rise of subprime lending back to record levels, the lengthening of loan terms and increasing credit losses are some of factors that lead Jonas to say there are “serious warning signs” for automaker’s ability to maintain pricing discipline.

And who gets to eat the losses? Well, as we showed yesterday, the bulk of consumer credit issuance in the past year, a massive 99%, has been sourced by the government to go straight into auto and student loans.

Which means you, dear US taxpayer, will once again be on the hook when the music ends.

via Zero Hedge http://feedproxy.google.com/~r/zerohedge/feed/~3/O45vlMWgeRM/story01.htm Tyler Durden

Submitted by Lance Roberts of STA Wealth Management,

This past week saw the initial public offering of the single most anticipated IPO of 2013 – Twitter.   If you tweeted about it then you are not alone as the news dominated the media headlines and the market.  With Twitter already sporting a 11x price-to-sales ratio, and no earnings, what could possibly go wrong?  However, it is that growing complacency among investors that should be the most concerning as the general sentiment has become that nothing can stop the markets as long as the Fed is in the game.  This week's issue of things to ponder over the weekend provides some thoughts in this regard.

1) Are We Heading Towards A Cliff?  

Andy Xie – Caixin Online

"The odds are that the world is experiencing a bigger bubble than the one that unleashed the 2008 Global Financial Crisis. The United States' household net wealth is much higher than at the peak in the last bubble. China's property rental yields are similar to what Japan experienced at the peak of its property bubble.

 

The biggest part of today's bubble is in government bonds valued at about 100 percent of global GDP. Such a vast amount of assets is priced at a negative real yield. Its low yield also benefits other borrowers. My guesstimate is that this bubble subsidizes debtors to the tune of 10 percent of GDP or US$ 7 trillion dollars per annum. The transfer of income from savers to debtors has never happened on such a vast scale, not even close. This is the reason that so many bubbles are forming around the world, because speculation is viewed as an escape route for savers.

 

The property market in emerging economies is the second-largest bubble. It is probably 100 percent overvalued. My guesstimate is that it is US$ 50 trillion overvalued.

 

Stocks, especially in the United States, are significantly overvalued too. The overvaluation could be one-third or about US$ 20 trillion.

 

There are other bubbles too. Credit risk, for example, is underpriced. The art market is bubbly again. These bubbles are not significant compared to the big three above.

 

When the Fed does normalize its policy, i.e., the real interest rate becomes positive again, this vast bubble will burst. Given its size, its bursting will likely bring another global recession worse than the one after the 2008 crisis."

2) Three Potential Headwinds For US Housing

A while back I wrote an article about the real underpinnings of the housing market which pointed out that, despite media headlines to the contrary, home ownership was at the lowest levels since the 1980's and was showing no real signs of recovery.  I stated then:

"As I stated previously the optimism over the housing recovery has gotten well ahead of the underlying fundamentals.  While the belief was that the Government, and Fed's, interventions would ignite the housing market creating a self-perpetuating recovery in the economy – it did not turn out that way.  Instead, it led to a speculative rush into buying rental properties creating a temporary, and artificial, inventory suppression.  The risks to the housing story remain high due to the impact of higher taxes, stagnant wage growth, re-defaults of the 6-million modifications and workouts and a slowdown of speculative investment due to reduced profit margins.  While there are many hopes pinned on the housing recovery as a 'driver' of economic growth in 2013 and beyond – the data suggests that it might be quite a bit of wishful thinking."

That statement of "wishful thinking" was confirmed this past week by Trulia chief economist Jed Kolko: (via ZeroHedge)

• Census 3Q homeownership, vacancy survey shows household formation “alarmingly slow,” vacancies “remain stubbornly high,” 
• "Slow household formation number is one of the most alarming housing indicators to come out this year"
• Share of millennials living with their parents rose to 31.6% vs 31.4% y/y
• Household formation 380k in yr leading up to 3Q vs L-T “normal” increase of 1.1m
• No increase over past yr in young adults moving out of parents homes or getting jobs is “most worrying”
• Vacant homes still pose “problem” for recovery
• 53% of vacant homes were held off mkt in 3Q, highest share since before bubble
• 10.2% of all housing units are vacant, unchanged y/y, higher than pre-bubble level of 8.9% in 3Q 2001

 Furthermore, Sober Look also noted:

"While the US housing market remains relatively robust, it is likely to face a couple of headwinds going forward. One is the lower affordability index, which is declining due to higher prices and higher mortgage rates (see discussion). On a year-over-year basis the declines have been quite steep."

The Federal Reserve has consistently been noting the strength of the housing recovery as evidence of a recovering economy.  Those hopes are likely to fade in the months ahead as household formation lags, millennials remain on parent's couches and affordability declines.

3) Seeds Are Sown For The Next Financial Crisis

Represent Us Blog

After the crash in 2008, Congress leapt into action to pass legislation, which has yet to be fully written, to make sure the financial shenanigans of Wall Street were never repeated.  Unfortunately, that was then, and this is now. 

"A new law written by Citigroup lobbyists (we couldn’t make this stuff up if we tried) exempts derivatives trading from regulation, and was passed this week by the House of Representatives with broad bipartisan support.

 

It sounds bad… but don’t worry, it gets much, much worse:

 

The New York Times reports that 70 of the 85 lines in the new House bill were literally written by Citigroup lobbyists (Citigroup was one of the mega-banks that brought our economy to its knees in 2008 and received billions in taxpayer money.)

 

The same report also revealed “two crucial paragraphs…were copied nearly word for word.” You can even view the original documents and see how Citigroup’s lobbyists redrafted the House Bill, striking out ideas they didn’t like and replacing them with ones they did.

 

The bills are sponsored by Randy Hultgren (R – IL), and co-sponsored by Rep. Jim Himes (D-CT) and others. Himes is a former Goldman Sachs executive, and chief fundraiser for the Democratic Congressional Campaign Committee.

 

Maplight reports that the financial industry is the top source of campaign funding for 6 of the bills’ 8 cosponsors.

 

Maplight’s data shows that members of the House received $22,425,740 million from interest groups that support the bill — that’s 5.8 times more than it received from interest groups opposed.

 

“House aides, when asked why Democrats would vote for this proposal even though the Obama administration opposes it, offered a political explanation. Republicans have enough votes to pass it themselves, so vulnerable House Democrats might as well join them, and collect industry money for their campaigns.” — New York Times

4) Valuations And Future Returns

by Mebane Faber

I have discussed the importance of valuations on future returns many times in the past, however, Mebane Faber did an excellent job recently noting that if you are still heavy U.S. equities it may be a good time to reevaluate.

5) Budget Deficit Reduction Only Temporary

In my post on Q3-2013 GDP, I pointed out that the reduction in the budget deficit was due to a temporary anomaly in tax receipts.  I stated:

"The reality is that the surge in tax revenues was a direct result of the "fiscal cliff" at the end of 2012 as companies rushed to pay out special dividends and bonuses ahead of what was perceived to a fiscal disaster.  The large surge in incomes was primarily generated at the upper end of the income brackets where individuals were impacted by higher tax rates.  Those taxes were then paid in April and October of 2013 and accounted for the bulk of the surge in tax revenue to date.  Also, it is important to remember that payroll taxes also increased due to the expiration of the payroll tax cut from 2010."

However, the Rockefeller Institute recently wrote a research report entitled "Temporary 'Bubble' in Income Tax Receipts" which points out a secondary anomaly created by just one state:

"Personal income tax collections had the strongest growth among the major taxes, at 20.3 percent.

 

However, the strong growth is attributable not only to the acceleration of income into calendar year 2012 and the 2012 stock market, but also to strong growth in a single state, California, where income tax collections grew by nearly $7.1 billion, or 40.7 percent, in the second quarter of 2013. The large growth in income tax collections in California reflects the acceleration, as well as recent increases in income tax rates that were only partially reflected in withholding. On November 6, 2012, California voters adopted Proposition 30, which increased the personal income tax rate on taxpayers making over $500,000 for a seven-year period that is retroactive to January 1, 2012, through December 31, 2018. If we exclude California, income tax collections in the remainder of the nation grew 14.9 percent in the second quarter of 2013…"

Plus 1)  The Boy Who Cried "Wolf"

Lakshman Achuthan, from the Economic Cycle Research Institute, has been chastised in the press over the last couple of years for calling for an economic recession that didn't occur.  However, he remains adamant that the U.S. has actually been in a recession for the last year and remains so accordingly to the underlying economic data.  Once again, he has been summarily dismissed by the media for his statements because with the stock market near all-time highs that surely means the economy is recovering, right?  Well, as he states, if that was indeed the case then "you wouldn't have four years of zero-interest rate policy and quantitative easing."

He also has a take on something that I have be
en questioning myself with regards to the ISM and PMI data which has come completely detached from the underlying fundamental data.

There is one important point to remember about the "boy who cried wolf;" eventually the wolf did come.

 

Have a great weekend.

via Zero Hedge http://feedproxy.google.com/~r/zerohedge/feed/~3/YS73nR-mtgQ/story01.htm Tyler Durden

The “commodity king” author of the “world renowned” Gartman momentum chasing and perpetual contrarian fade newsletter, if not so much of an ETF under the same name anymore, does it again. From this morning.

Now with the S&P forging a massive reversal to the downside, we not only must abandon being bullish we must become bearish… and very so…. Our bearish friends, having been wrong for so long, are now right; it is time to be bearish of stocks, while the time for having been bullish is now past… We trust we are clear. The game’s changed and when the game changes, we change…. We had heretofore consistently erred bullishly of simple things… of coal; of steel; of railroads; of ships and shipping… but we are not now.

…

 

The Game Changed Utterly In The Capital Markets Yesterday

And… wrong again. Or said otherwise, short of subscribers in breaking even terms.

via Zero Hedge http://feedproxy.google.com/~r/zerohedge/feed/~3/Csv3urXPhx4/story01.htm Tyler Durden

The “commodity king” author of the “world renowned” Gartman momentum chasing and perpetual contrarian fade newsletter, if not so much of an ETF under the same name anymore, does it again. From this morning.

Now with the S&P forging a massive reversal to the downside, we not only must abandon being bullish we must become bearish… and very so…. Our bearish friends, having been wrong for so long, are now right; it is time to be bearish of stocks, while the time for having been bullish is now past… We trust we are clear. The game’s changed and when the game changes, we change…. We had heretofore consistently erred bullishly of simple things… of coal; of steel; of railroads; of ships and shipping… but we are not now.

…

 

The Game Changed Utterly In The Capital Markets Yesterday

And… wrong again. Or said otherwise, short of subscribers in breaking even terms.

via Zero Hedge http://feedproxy.google.com/~r/zerohedge/feed/~3/Csv3urXPhx4/story01.htm Tyler Durden

It seems like the last 2 days have been a massive NASDAQ-TWTR pairs trade… Today saw broad stock indices best day in a month despite the early "good news is bad news" sell-off as newly minted TWTR heads towards its first bear market threshold off the highs. The Dow managed to get back to a record high close by the end of the day. Treasury prices were clubbed like a baby seal with yields jumping their most in over 4 months. Shorts were grossly squeezed today ("most shorted +2.9% vs Russell +1.1%). Gold was down 1.4% on the day (oil and copper flat) and 2% on the week. All in all – only equity markets reacted "positively" to the good news with a panic-buying-frenzy in the last 30 minutes as rates, FX, and precious metals all shifted in a "taper-on" trend…

 

POMO and 330RAMP took care of business today…

 

 

All you need to know about today in 2 tweets…

 

Stocks desperate for today's Mega POMO to begin already

— zerohedge (@zerohedge) November 8, 2013

 

 

 

It's 1 hour until 3:30 pm. Do you know where Ramp Capital LLC is?

— zerohedge (@zerohedge) November 8, 2013

 

 

Volume was notably lower today…

 

Two words – short squeeze…

 

Treasuries were battered to a ley technical levels…

 

But rates, Gold, and stocks diverged…

 

 

as PMs slid with oil flat…

 

Charts: Bloomberg

Bonus Chart – Another all-time low in TWTR (within 1% of a bear market…)

 

via Zero Hedge http://feedproxy.google.com/~r/zerohedge/feed/~3/M2DLbs9VSZc/story01.htm Tyler Durden

Submitted by Charles Hugh-Smith of OfTwoMinds blog,

All financial schemes for retirement are misdirections of the real challenge, which is creating enough real-world surplus to support 75 million retirees.

I received a number of interesting comments on my recent series on the insolvency of the Social Security Ponzi Scheme:

The Generational Injustice of Social (in)Security (November 6, 2013)

The Problem with Pay-As-You-Go Social Programs: They're Ponzi Schemes (November 5, 2013)

There are two questions here:

1. How can we sustainably pay for 75 million beneficiaries in 2020?

2. Are there sufficient resources, labor and capital to support 75 million beneficiaries in the manner that they were promised?

The first question presumes there are limits on the creation of 'free money," and the second presumes there are limits on the surplus generated by the economy that can be devoted to supporting retirees.

As a quick primer on Social Security: the program, paid by payroll taxes on earned income, has two funds: one for worker/retirees and survivors of workers, and another for disabled workers and their dependents.

As of 2011 ( Annual Report of the Trustees of the Social Security Trust Funds), there were 38 million retirees, 6 million survivors and 11 million disabled and their dependents drawing benefits from the program. The latest numbers from the Social Security Administration (SSA) show 57 million beneficiaries as of 2012.

Since there will be 53 million people 65 and older in 2020, and the number of survivors and disabled are rising as fast or faster than the number of retirees, we can project the program will have around 75 million beneficiaries in 2020, seven short years away.

(Given that the number of people choosing to retire early at 62 rather than wait for full benefits at 66 is exceeding SSA projections, this estimate is probably conservative.)

Reader D.L.J. proposed a solution that many believe would be sustainable: dispense with payroll taxes, illusory trust funds and borrowed money entirely, and just print the money and transfer it directly to retirees:

 

Now set aside your traditional view of 'how the system now works'.

What if each of the 50,000,000 retirees received a monthly check for $2500 for $30,000 per year. It doesn't come from a trust fund and it doesn't come from a working member of the workforce; it comes directly from the USTreasury. There are no bonds issued to raise the money, no interest to pay and no maturity schedule–just money credited to the accounts of the seniors.

Now, what if at the same time, there is no payroll tax to fund the, well, trust fund.

The 50,000,000 retirees would/could spend their $30,000 each into the economy to support the production of goods and services of 50,000,000 active workers providing an average contribution to income of $30,000 each. Of course the workers would actively purchase goods and services from one another as well.

Over the years, I have received many similiar proposals from readers, the key component being the issuance of cash by the U.S. Treasury rather than the Treasury borrowing money on the bond market via selling Treasury bonds.

The conventional economic concern with issuing freshly printed "free money" in this way is that this expansion of the money supply would soon trigger inflation that robs every holder of the currency. Expanding the money supply debases the existing stock of currency.

Since such a proposal has never been tried to my knowledge, we don't have any direct experiential data on the unintended consequences of direct distribution of newly created cash on a large scale. I suppose if an equivalent sum of money were destroyed or removed from the money supply, inflation could be controlled, but destruction of such a large sum of money elsewhere would have negative consequences for those whose capital was destroyed.

Perhaps there is some dynamic here I am missing, but to the best of my knowledge history suggests that inflating the money supply is only sustainable if the production of goods and services rises in analogous fashion. If the surplus generated by the economy remains flat, inflating the money supply leads to a depreciation of the currency being printed, i.e. inflation or theft by other means.

I conclude that this idea, however appealing, boils down to a "free lunch." In my view, a nation can only spend what it generates in surplus from labor and the productive investment of capital. Priting money is a short-term shortcut that raises the apparent surplus being generated but does not expand the actual surplus.

What if the surplus being generated simply isn't large enough to support 75 million beneficiaries in the manner that they were promised? Correspondent Philip C. explains that the money for retirement is the least of our concerns: it's the actual stuff needed for living/consuming that may be insufficient:

You point out correctly that there is no trust fund for Social Security payments. However it is easy to show that even if there were, the system could still not function. The reason is quite simple: the goods and services that retirees require (food, energy, medical, consumable goods, recreational, entertainment, etc.) in practical terms cannot be stored and therefore must be provided by the current working population.

Even if retirees had their Social Security pensions it wouldn&r
squo;t do them any good because the stuff they needed would be scarce and the good old law of supply and demand would price them out of the market. What young people would tolerate working in such an environment with such an onerous load?

It seems to me that the root of the looming disaster is not so much the Ponzi aspect, despicable as it is, but the unrealistic expectation that people can actually retire at age 65 (or whatever age) and continue to consume resources and the productive output of an ever decreasing working population.

Trust fund or no trust fund, the working population will be burdened by retirees; an important question is how long will they put up with it?

 

The social disruption will be of major proportions. Retirement ages will have to rise (they are already programmed to rise here in Australia in a couple of years) and expectations will have to be rationalised or there will be enormous stresses in our societies.

This seems to get at the heart of the matter. Money is after all a claim on real-world resources, goods and services. Printing or borrowing money into existence does not create more resources, goods or services to exchange for the money.

In this sense, all financial schemes for retirement are misdirections of the real challenge, which is creating enough real-world surplus to support 75 million retirees (not to mention the other 75 million people drawing government benefits). Census: 49% of Americans Get Gov’t Benefits; 82M in Households on Medicaid.

Printing or borrowing money are both attempts to get a free lunch; alas, there is no free lunch. We can only spend what we extract or generate in surplus, i.e. what's left after subtracting the costs of production, labor and capital.

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Ben Bernanke is participating in an IMF panel with Larry Summers, Ken Rogoff, and former Bank of Israel chief Stan Fischer… full speech below…

 

Live stream via BBG (if embed not working clck here)

Full Speech below:

 

The Crisis as a Classic Financial Panic

I am very pleased to participate in this event in honor of Stanley Fischer. Stan was my teacher in graduate school, and he has been both a role model and a frequent adviser ever since. An expert on financial crises, Stan has written prolifically on the subject and has also served on the front lines, so to speak–notably, in his role as the first deputy managing director of the International Monetary Fund during the emerging market crises of the 1990s. Stan also helped to fight hyperinflation in Israel in the 1980s and, as the governor of that nation's central bank, deftly managed monetary policy to mitigate the effects of the recent crisis on the Israeli economy. Subsequently, as Israeli housing prices ran upward, Stan became an advocate and early adopter of macroprudential policies to preserve financial stability.

Stan frequently counseled his students to take a historical perspective, which is good advice in general, but particularly helpful for understanding financial crises, which have been around a very long time. Indeed, as I have noted elsewhere, I think the recent global crisis is best understood as a classic financial panic transposed into the novel institutional context of the 21st century financial system.¹ An appreciation of the parallels between recent and historical events greatly influenced how I and many of my colleagues around the world responded to the crisis.

Besides being the fifth anniversary of the most intense phase of the recent crisis, this year also marks the centennial of the founding of the Federal Reserve.² It's particularly appropriate to recall, therefore, that the Federal Reserve was itself created in response to a severe financial panic, the Panic of 1907. This panic led to the creation of the National Monetary Commission, whose 1911 report was a major impetus to the Federal Reserve Act, signed into law by President Woodrow Wilson on December 23, 1913. Because the Panic of 1907 fit the archetype of a classic financial panic in many ways, it's worth discussing its similarities and differences with the recent crisis.³ 

Like many other financial panics, including the most recent one, the Panic of 1907 took place while the economy was weakening; according to the National Bureau of Economic Research, a recession had begun in May 1907.⁴ Also, as was characteristic of pre-Federal Reserve panics, money markets were tight when the panic struck in October, reflecting the strong seasonal demand for credit associated with the harvesting and shipment of crops. The immediate trigger of the panic was a failed effort by a group of speculators to corner the stock of the United Copper Company. The main perpetrators of the failed scheme, F. Augustus Heinze and C.F. Morse, had extensive connections with a number of leading financial institutions in New York City. When the news of the failed speculation broke, depositor fears about the health of those institutions led to a series of runs on banks, including a bank at which Heinze served as president. To try to restore confidence, the New York Clearinghouse, a private consortium of banks, reviewed the books of the banks under pressure, declared them solvent, and offered conditional support–one of the conditions being that Heinze and his board step down. These steps were largely successful in stopping runs on the New York banks.

But even as the banks stabilized, concerns intensified about the financial health of a number of so-called trust companies–financial institutions that were less heavily regulated than national or state banks and which were not members of the Clearinghouse. As the runs on the trust companies worsened, the companies needed cash to meet the demand for withdrawals. In the absence of a central bank, New York's leading financiers, led by J.P. Morgan, considered providing liquidity. However, Morgan and his colleagues decided that they did not have sufficient information to judge the solvency of the affected institutions, so they declined to lend. Overwhelmed by a run, the Knickerbocker Trust Company failed on October 22, undermining public confidence in the remaining trust companies.

To satisfy their depositors' demands for cash, the trust companies began to sell or liquidate assets, including loans made to finance stock purchases. The selloff of shares and other assets, in what today we would call a fire sale, precipitated a sharp decline in the stock market and widespread disruptions in other financial markets. Increasingly concerned, Morgan and other financiers (including the future governor of the Federal Reserve Bank of New York, Benjamin Strong) led a coordinated response that included the provision of liquidity through the Clearinghouse and the imposition of temporary limits on depositor withdrawals, including withdrawals by correspondent banks in the interior of the country. These efforts eventually calmed the panic. By then, however, the U.S. financial system had been severely disrupted, and the economy contracted through the middle of 1908.

The recent crisis echoed many aspects of the 1907 panic. Like most crises, the recent episode had an identifiable trigger–in this case, the growing realization by market participants that subprime mortgages and certain other credits were seriously deficient in their underwriting and disclosures. As the economy slowed and housing prices declined, diverse financial institutions, including many of the largest and most internationally active firms, suffered credit losses that were clearly large but also hard for outsiders to assess. Pervasive uncertainty about the size and incidence of losses in turn led to sharp withdrawals of short-term funding from a wide range of institutions; these funding pressures precipitated fire sales, which contributed to sharp declines in asset prices and further losses. Institutional changes over the past century were reflected in differences in the types of funding that ran: In 1907, in the absence of deposit insurance, retail deposits were much more prone to run, whereas in 2008, most withdrawals were of uninsured wholesale funding, in the form of commercial paper, repurchase agreements, and securities lending. Interestingly, a steep decline in interbank lending, a form of wholesale funding, was important in both episodes. Also interesting is that the 1907 panic involved institutions–the trust companies–that faced relatively less regulation, which probably contributed to their rapid growth in the years leading up to the panic. In analogous fashion, in the recent crisis, much of the panic occurred outside the perimeter of traditional bank regulation, in the so-called shadow banking sector.⁵ 

The responses to the panics of 1907 and 2008 also provide instructive comparisons. In both cases, the provision of liquidity in the early stages was crucial. In 1907 the United States had no central bank, so the availability of liquidity depended on the discretion of firms and private individuals, like Morgan. In the more recent crisis, the Federal Reserve fulfilled the role of liquidity provider, consistent with the classic prescriptions of Walter Bagehot.⁶ The Fed lent not only to banks, but, seeking to stem the panic in wholesale funding markets, it also extended its lender-of-last-resort facilities to support nonbank institutions, such as investment banks and money market funds, and key financial markets, such as those for commercial paper and asset-backed securities.

In both episodes, though, liquidity provision was only the first step. Full stabilization requires the restoration of public confidence. Three basic tools for restoring confidence are temporary public or private guarantees, measures to strengthen financial institutions' balance sheets, and public disclosure of the conditions of financial firms. At least to some extent, Morgan and the New York Clearinghouse used these tools in 1907, giving assistance to troubled firms and providing assurances to the public about the conditions of individual banks. All three tools were used extensively in the recent crisis: In the United States, guarantees included the Federal Deposit Insurance Corporation's (FDIC) guarantees of bank debt, the Treasury Department's guarantee of money market funds, and the private guarantees offered by stronger firms that acquired weaker ones. Public and private capital injections strengthened bank balance sheets. Finally, the bank stress tests that the Federal Reserve led in the spring of 2009 and the publication of the stress-test findings helped restore confidence in the U.S. banking system. Collectively, these measures helped end the acute phase of the financial crisis, although, five years later, the economic consequences are still with us.

Once the fire is out, public attention turns to the question of how to better fireproof the system. Here, the context and the responses differed between 1907 and the recent crisis. As I mentioned, following the 1907 crisis, reform efforts led to the founding of the Federal Reserve, which was charged both with helping to prevent panics and, by providing an "elastic currency," with smoothing seasonal interest rate fluctuations. In contrast, reforms since 2008 have focused on critical regulatory gaps revealed by the crisis. Notably, oversight of the shadow banking system is being strengthened through the designation, by the new Financial Stability Oversight Council, of nonbank systemically important financial institutions (SIFIs) for consolidated supervision by the Federal Reserve, and measures are being undertaken to address the potential instability of wholesale funding, including reforms to money market funds and the triparty repo market.⁷ 

As we try to make the financial system safer, we must inevitably confront the problem of moral hazard. The actions taken by central banks and other authorities to stabilize a panic in the short run can work against stability in the long run, if investors and firms infer from those actions that they will never bear the full consequences of excessive risk-taking. As Stan Fischer reminded us following the international crises of the late 1990s, the problem of moral hazard has no perfect solution, but steps can be taken to limit it.⁸ First, regulatory and supervisory reforms, such as higher capital and liquidity standards or restriction on certain activities, can directly limit risk-taking. Second, through the use of appropriate carrots and sticks, regulators can enlist the private sector in monitoring risk-taking. For example, the Federal Reserve's Comprehensive Capital Analysis and Review (CCAR) process, the descendant of the bank stress tests of 2009, requires not only that large financial institutions have sufficient capital to weather extreme shocks, but also that they demonstrate that their internal risk-management systems are effective.⁹ In addition, the results of the stress-test portion of CCAR are publicly disclosed, providing investors and analysts information they need to assess banks' financial strength.

Of course, market discipline can only limit moral hazard to the extent that debt and equity holders believe that, in the event of distress, they will bear costs. In the crisis, the absence of an adequate resolution process for dealing with a failing SIFI left policymakers with only the terrible choices of a bailout or allowing a potentially destabilizing collapse. The Dodd-Frank Act, under the orderly liquidation authority in Title II, created an alternative resolution mechanism for SIFIs that takes into account both the need, for moral hazard reasons, to impose costs on the creditors of failing firms and the need to protect financial stability; the FDIC, with the cooperation of the Federal Reserve, has been hard at work fleshing out this authority.¹⁰ A credible resolution mechanism for systemically important firms will be important for reducing uncertainty, enhancing market discipline, and reducing moral hazard.

Our continuing challenge is to make financial crises far less likely and, if they happen, far less costly. The task is complicated by the reality that every financial panic has its own unique features that depend on a particular historical context and the details of the institutional setting. But, as Stan Fischer has done with unusual skill throughout his career, one can, by stripping away the idiosyncratic aspects of individual crises, hope to reveal the common elements. In 1907, no one had ever heard of an asset-backed security, and a single private individual could command the resources needed to bail out the banking system; and yet, fundamentally, the Panic of 1907 and the Panic of 2008 were instances of the same phenomenon, as I have discussed today. The challenge for policymakers is to identify and isolate the common factors of crises, thereby allowing us to prevent crises when possible and to respond effectively when not.

 

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It’s quite simple.

h/t Lance

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Submitted by Peter Tchir of TF Market Advisors,

A Pseudoscience Stuck in Place

I am growing more concerned by the day by the actions of the central banks.  It isn’t just that markets popped and dropped dramatically before and after Draghi’s rate cut, or that any policy seems particularly bad, just that the policies don’t seem to be working great, and are leaving a changed landscape that will need to be corrected, somehow, in the future.  I am quite simply concerned that too much faith is being placed in untested theories that may or may not work, or may or may not even be correct.

Here are a few things that concern me the most:

1. Central Bankers seem to rely on economic theories that have remained largely unchanged for years

 

2. Central Bankers seem of an age that they aren’t willing to incorporate theories that might change their favored models or might make those models too complex to be easily understood by those in charge (the Nobel prize committee has given out multiple awards for work in behavioral economics, yet central bank models seem to rely on pretty basic econometric models where behavior doesn’t rapidly change based on policies)

 

3. Central Bankers seem focused on domestic issues without really considering the ramifications and ripple effects that they potentially create

From Newton to Bohr

I liked Newtonian physics.  I could do the math easily and it was intuitive.  It was so easy that I took physics 101 right along with econ 101 because I needed some easy A’s.

But physics has changed.  The relatively simple world of Newtonian physics turned out to be inadequate to explain what was needed to propel science forward.  As comforting as it was to know that “each and every action has an equal and opposite reaction” that just doesn’t cut it in high end physics.

Personally, I started to lose interest and any real intuitive skills in physics around the time we learned that light is both a wave and a particle.  The math was getting more complex, but I could muddle my way through that.  What I lost was any instinctive or intuitive feel for what was being modeled.  I tended to focus on areas that I felt comfortable with, hampering any potential for intellectual growth.

Quantum mechanics really revolutionized physics. It was a new paradigm and you either had to adapt, understand it, or get some intuitive feel because brute force math might be enough to be adequate in the field, but not enough to excel.

I wonder why economics hasn’t had its “quantum mechanics” moment?

Did Keynes and Hayek really discover all there is to know?  Is Yellen’s beloved “Taylor rule” really the epitome of the “scientific” advancement of economics?  I realize there have been advances, but most seem to be “more of the same”.  No one seems to have challenged the central tenants of macroeconomics.

In physics, once Newtonian physics failed to explain the world, brilliant minds concocted experiments to test hypothesis.  This is what led to quantum mechanics.  The old theory was failing in that it couldn’t explain some observed phenomena, so it was ultimately supplanted by a new, much more complex theory, but one that explained much more of what was observable.

Why is that not happening in economics?  Personally, I don’t think economics has done a great job in explaining the world, otherwise we shouldn’t have so many periods of boom and bust globally.

Maybe it is the inability to experiment?  This is potentially a bigger issue than it seems at first.  We do experiment in economics, but it is a small group of elite, and mostly collegial economists who get to experiment.  Actually they get to put their beliefs into practice and then argue that the situation is better than if they hadn’t been allowed to implement their theories.  While costs and access can stop scientific progress, there certainly was a time that it was more readily available.  Hypothesis could be tested and failures catalogued and successes expanded on AND verified by repetition.  This capability just doesn’t exist in macroeconomics.  There are NO TWO economies that are identical except for the policies implemented.

Young professors could and did challenge the system in the hard sciences.  It is probably no co-incidence that most scientific Nobel prizes are awarded for work “conceived of” when the person was in their 20’s and “performed” in their 30’s.  That might be a generalization, but it isn’t entirely inaccurate.

Maybe economics is failing to attract good new people?  There may be something to this.  To some extent the economists that I know and respect the most (yes, I do like and respect some economists) had strong quantitative skills but an interest in business.  The didn’t want to be a “math” geek and liked working with the “real world”.  I am willing to make the conjecture that as computer science grew and the opportunities there grew, it was an even better match for many quantitative students who wanted something other than pure math, or physics, or chemistry, than economics.  Maybe even as MBA’s started looking for more “quants” even more people who would be the new economists didn’t pursue that?

Or maybe economists just ignore their own?  I have read a little about “behavioral economics”.  My take is that it demonstrates that people don’t always do what would produce the best “expected outcome”.  That the “rational man” that economic models are built on may not exist, and what is rational on a purely “economic” level might not be applicable on an overall evaluation.  We tend to hate losses more than we like winning.  How is that incorporated into the econometric global macro models used by the Fed?  The Fed runs the treasury/dividend yield model.  Yeehaw, except for the graphs that is nothing a good old fashioned HP12C couldn’t handle.  Why aren’t we incorporating some new techniques?  Maybe, because just like I hit the wall in physics at a certain point, the economists in charge have no interest in trying to incorporate things into their models that they don’t intuitively understand, might call into question their own body of “prestigious” work, and where quite frankly they might not have the technical expertise needed to incorporate them?

The Observer Effect.  Science understands that the act of observation can actually impact whatever is being observed.  Attempting to measure something affects the measurement.  First, I question how that plays into anything that is a “survey” or that is “subjective” in the first place.  How many purchasing managers hoping for better year-end bonuses say things are better than they are because they know their boss will like it, and at this point, they know the stock market will like it.  What about the “household survey” for non farm payrolls that we will get tomorrow.  Does it make a difference how you respond depending on your political party?  Does it amaze you that we still conduct door to door surveys to figure out how many Americans are working?  This is all a relatively minor effect, yet probabl
y real, and as far as I can tell, largely ignored at the “policy” level.

Learned Behavior.  Humans learn over time.  We are pretty adept and maximizing return while minimizing risk.  This is where I think economics does the worst job of integrating its own new theories.  QE seems based on a pretty simplistic model.  Provide more money, take risky investments out of the market, and the market will take that money and be encouraged to take more risk.  It will create asset price inflation which will encourage further real risk taking.  What if it turns out it is easier not to take the risk but end up with a pretty darn good reward?  How many companies took risk and a lot better off for it?  But how many have decided it is easier to do some financial engineering and let QE take care of their stock price?  How is that accounted in the models?  It probably isn’t and is probably too complicated, but we don’t try and predict the weather by licking our finger and sticking it in the air, yet economists seem in many ways content to run their policy on little more than that.

Equal and Opposite Reactions.  Such a basic concept.  It extends beyond science.  If you punch someone in the face, you can reasonably expect a certain reaction.  You might be able to qualify even that reaction based on the size and personality of the person you punch in the face.  Then why don’t we seem to use that in economics?  We live in a global economy apparently some of the time, but inflation is local wage driven only?  Hmm.  Bernanke, who claims protectionism was part of the problem with the Great Depression, basically told the Emerging Market countries (through lackey’s in Jackson Hole) that we will do what we need and they can worry about themselves.  Draghi cut rates today.  What does that to their currency?  Does that help or hurt what we have been trying to work on?  Central bankers all too often seem to act as though they are playing golf when the game is really chess.

Kasparov to Big Blue

Which brings us to chess.

Maybe the central bankers are aware that they are playing chess.  Maybe Bernanke is aware that each of his moves will cause another move by his “opponent” which he will then have to react to.  The problem is that if he is playing chess, and he is “thinking a few moves ahead” he is assuming too much, and making a classic mistake of expecting his opponent to fall into his “traps”

In the early days of “computer” chess, a modestly better than average human player could beat most computers after a few matches.  That was because of how computers evaluated the chess board.  There were far too many moves for a computer to analyze all the possibilities.  So they used “heuristics” to “score” boards.  They found ways to estimate how strong or weak a position was.  They could then “truncate” paths that lead to weak positions and explore only “strong” paths. The trick was figuring out what the computer was doing incorrectly.  To take it down a path that looked “strong” for several moves that could be then turned around.  The computer literally “fell for the trap”.

But “Big Blue” changed that.  It literally was so fast that it didn’t have to “truncate” paths early.  It could play out 200 million positions in a second and ultimately beat Kasparov.  That was back in 1997.

It was a sad day for many since it turned something that was elegant with a certain flair where imagination was respected and turned it into a brute force mechanical process.

I am not arguing that economics is something that is purely brute force, but I do think there are two lessons to be drawn from this:

1. Computer power and the evolution and development of computer power to analyze complex systems is useful and I am not sure we do enough of that, and

 

2. Don’t expect people to make the moves you want them to make, expect them to make the moves that they think are in their own best interest

That latter point is critical, especially as we now have rates at 0% in Europe, Japan, and the U.S.  We have QE programs in the U.K., the U.S., and Japan.  We have who knows what in China.  But each of these actions is causing other actions that may actually be the reason nothing seems to be working as well as it should in theory.

Do companies and executives really respond to QE the way the models predict or is their reaction different?  Maybe their reaction produces a better outcome for the company than the reaction the central bankers want and need out of those executives?

Too much of policy seems to assume certain moves will be made by other players when it is far from clear that those moves are either optimal for those other participants from their overall perspective.

As our balance sheet grows, as we create negative real rates, are we really sure we aren’t doing more harm than good, and what will the world look like 10 moves from now, or 50 moves or 100 moves?

Sadly, I don’t think anyone honestly knows.

What Does this Mean?

Mostly it lets me get this off my chest.  Somehow this topic has been bothering me a lot lately so I feel better having written about it.

But on a serious note, I think it is another reason to scale back positions.  Liquidity already seems abysmal, and this is a market largely supported by the faith that central bankers can continue to support it.  It is circular because the central bankers do keep getting forced to support it.  The longer this goes on, the greater the risk that we find that there is a problem, and that this “circularity” has been distorting values to the detriment of the economy and that the market loses this crucial element of support.

I find more and more people questioning the usefulness of central bank policy.  While I can see that the most likely path is a continued grind higher/tighter/better, it seems to me that there is growing doubt that the policies are working and any shift away from a full on love affair with central bankers is likely to be disruptive in a negative way.  I still think that is a low probability event, but that risk is growing and at this stage of the year, with so little liquidity, keeping risk low and even slightly bearish now is the right trade.

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