Why Standard Economic Models Don’t Work – Our Economy Is A Network

Submitted by Gail Tverberg of Our Finite World blog,

The story of energy and the economy seems to be an obvious common sense one: some sources of energy are becoming scarce or overly polluting, so we need to develop new ones. The new ones may be more expensive, but the world will adapt. Prices will rise and people will learn to do more with less. Everything will work out in the end. It is only a matter of time and a little faith. In fact, the Financial Times published an article recently called “Looking Past the Death of Peak Oil” that pretty much followed this line of reasoning.

Energy Common Sense Doesn’t Work Because the World is Finite 

The main reason such common sense doesn’t work is because in a finite world, every action we take has many direct and indirect effects. This chain of effects produces connectedness that makes the economy operate as a network. This network behaves differently than most of us would expect. This networked behavior is not reflected in current economic models.

Most people believe that the amount of oil in the ground is the limiting factor for oil extraction. In a finite world, this isn’t true. In a finite world, the limiting factor is feedback loops that lead to inadequate wages, inadequate debt growth, inadequate tax revenue, and ultimately inadequate funds for investment in oil extraction. The behavior of networks may lead to economic collapses of oil exporters, and even to a collapse of the overall economic system.

An issue that is often overlooked in the standard view of oil limits is diminishing returns. With diminishing returns, the cost of extraction eventually rises because the easy-to-obtain resources are extracted first. For a time, the rising cost of extraction can be hidden by advances in technology and increased mechanization, but at some point, the inflation-adjusted cost of oil production starts to rise.

With diminishing returns, the economy is, in effect, becoming less and less efficient, instead of becoming more and more efficient. As this effect feeds through the system, wages tend to fall and the economy tends to shrink rather than grow. Because of the way a networked system “works,” this shrinkage tends to collapse the economy. The usage of  energy products of all kinds is likely to fall, more or less simultaneously.

In some ways current, economic models are the equivalent of flat maps, when we live in s spherical world. These models work pretty well for a while, but eventually, their predictions deviate farther and farther from reality. The reason our models of the future are wrong is because we are not imagining the system correctly.

The Connectedness of a Finite World 

In a finite world, an action a person takes has wide-ranging impacts. The amount of food I eat, or the amount of minerals I extract from the earth, affects what other people (now and in the future) can do, and what other species can do.

To illustrate, let’s look at an exaggerated example. At any given time, there is only so much broccoli that is ready for harvest. If I decide to corner the broccoli market and buy up 50% of the world’s broccoli supply, that means that other people will have less broccoli available to buy. If those growing the broccoli spray the growing crop with pesticides, “broccoli pests” (caterpillars, aphids, and other insects) will die back in number, perhaps contributing to a decline of those species. The pesticides may also affect desirable species, like bees.

Growing the broccoli will also deplete the soil of nutrients. If 50% of the world’s broccoli is shipped to me, the nutrients from the soil will find their way around the world to me. These nutrients are not likely to be replaced in the soil where the broccoli was grown without long-distance transport of nutrients.

To take another example, if I (or the imaginary company I own) extract oil from the ground, the extraction and the selling of that oil will have many far-ranging effects:

  •  The oil I extract will most likely be the cheapest, easiest-to-extract oil that I can find. Because of this, the oil that is left will tend to be more expensive to extract. My extraction of oil thus contributes to diminishing returns–that is, the tendency of the cost of oil extraction to rise over time as resources deplete.
  • The petroleum I extract from the ground will consist of a mixture of hydrocarbon chains of varying lengths. When I send the petroleum to a refinery, the refinery will separate the petroleum into varying length chains: short chains are gasses, longer chains are liquids, still longer ones are very viscous, and the longest ones are solids, such as asphalt. Different length chains are used for different purposes. The shortest chains are natural gas. Some chains are sold as gasoline, some as diesel, and some as lubricants. Some parts of the petroleum spectrum are used to make plastics, medicines, fabrics, and pesticides. All of these uses will help create jobs in a wide range of industries. Indirectly, these uses are likely to enable higher food production, and thus higher population.
  • When I extract the oil from the ground, the process itself will use some oil and natural gas. Refining the oil will also use energy.
  • Jobs will be created in the oil industry. People with these jobs will spend their money on goods and services of all sorts, indirectly leading to greater availability of jobs outside the oil industry.
  • Oil’s price is important. The lower the price, the more affordable products using oil will be, such as cars.
  • In order for consumers to purchase cars that will operate using gasoline, there will likely be a need for debt to buy the cars. Thus, the extraction of oil is tightly tied to the build-up of debt.
  • As an oil producer, I will pay taxes of many different types to all levels of governments. (Governments of oil exporting countries tend to get a high percentage of their revenue from taxes on oil. Even in non-exporting countries, taxes on oil tend to be high.) Consumers will also pay taxes, such as gasoline taxes.
  • The jobs that are created through the use of oil will lead to more tax revenue, because wage earners pay income taxes.
  • The government will need to build more roads, partly for the additional cars that operate on the roads thanks to the use of gasoline and diesel, and partly to repair the damage that is done as trucks travel to oil extraction sites.
  • To keep the oil extraction process going, there will likely need to be schools and medical facilities to take care of the workers and their families, and to educate those workers.

Needless to say, there are other effects as well. The existence of my oil in the marketplace will somehow affect the market price of oil. Burning of the oil may affect the climate, and will tend to acidify oceans. It would be possible to go on and on.

The Difficulty of Substituting Away from Oil 

In some sense, the use of oil is very deeply imbedded into the operation of the overall economy. We can talk about electricity replacing oil, but oil’s involvement in the economy is so pervasive, it can’t possibly replace everything. Perhaps electricity might replace gasoline in private passenger automobiles. Such a change would reduce the demand for hydrocarbon chains of a certain length (C7 to C11), but that only reduces demand for one “slice” of the oil mixture. Both shorter and longer chain hydrocarbons would be unaffected.

The price of gasoline will drop, (making Chinese buyers happy because more will be able to afford to use motorcycles), but what else will happen? Won’t we still need as much diesel, and as many medicines as before? Refiners can fairly easily break longer-chain molecules into shorter-chain molecules, so they can make diesel or asphalt into gasoline. But going the other direction doesn’t work well at all. Making gasoline into shorter chains would be a huge waste, because gasoline is much more valuable than the resulting gases.

How about replacing all of the taxes directly and indirectly related to the unused gasoline?  Will the price of electricity used in electric-powered vehicles be adjusted to cover the foregone tax revenue?

If a liquid substitute for oil is made, it needs to be low priced, because a high-priced substitute for oil is very different from a low-priced substitute. Part of the problem is that high-priced substitutes do not leave enough “room” for taxes for governments. Another part of the problem is that customers cannot afford high-priced oil products. They cut back on discretionary expenditures, and the economy tends to contract. There are layoffs in the discretionary sectors, and (again) the government finds it difficult to collect enough tax revenue.

The Economy as a Networked System

I think of the world economic system as being a networked system, something like the dome shown in Figure 1. The dome behaves as an object that is different from the many wooden sticks from which it is made. The dome can collapse if sticks are removed.

Figure 1. Dome constructed using Leonardo Sticks

Figure 1. Dome constructed using Leonardo Sticks

The world economy consists of a network of businesses, consumers, governments, and resources that is bound together with a financial system. It is self-organizing, in the sense that consumers decide what to buy based on what products are available at what prices. New businesses are formed based on the overall environment: potential customers, competition, resource availability, services available from other businesses, and laws. Governments participate in the system as well, building infrastructure, making laws, and charging taxes.

Over time, all of these gradually change. If one business changes, other business and consumers are likely to make changes in response. Even governments may change: make new laws, or build new infrastructure. Over time, the tendency is to build a larger and more complex network. Unused portions of the network tend to wither away–for example, few businesses make buggy whips today. This is why the network is illustrated as hollow. This feature makes it difficult for the network to “go backward.”

The network got its start as a way to deliver food energy to people. Gradually economies expanded to include other goods and services. Because energy is required to “do work,” (such as provide heat, mechanical energy, or electricity), energy is always central to an economy. In fact, the economy might be considered an energy delivery system. This is especially the case if we consider wages to be payment for an important type of energy–human energy.

Because of the way the network has grown over time, there is considerable interdependency among different types of energy. For example, electricity powers oil pipelines and gasoline pumps. Oil is used to maintain the electric grid. Nuclear electric plants depend on electricity from the grid to restart their operations after outages. Thus, if one type of energy “has a problem,” this problem is likely to spread to other types of energy. This is the opposite of the common belief that energy substitution will fix all problems.

Economies are Prone to Collapse

We know the wooden dome in Figure 1 can collapse if “things go wrong.” History shows that many civilizations have collapsed in the past. Research has been done to see why this is the case.

Joseph Tainter’s research indicates that diminishing returns played an important role in the collapse of past civilizations. Diminishing returns would be a problem when adding more workers didn’t add a corresponding amount more output, particularly with respect to food. Such a situation might be reached when population grew too large for a piece of arable land. Degradation of soil fertility might play a role as well.

Today, we are reaching diminishing returns with respect to oil supply, as evidenced by the rising cost of oil extraction. This is occurring because we removed the easy to extract oil, and now must move on to the more expensive to extract oil. In effect, the system is becoming less efficient. More workers and more resources of other types are needed to produce a given barrel of oil. The value of the barrel of oil in terms of what it can do as work (say, how far it can move a car, or how much heat it can produce) is unchanged, so the value each worker is producing is less. This is the opposite of efficiency.

Peter Turchin and Sergey Nefedov have done research on the nature of past collapses, documented in a book called Secular Cycles. An economy would clear a piece of land, or discover an approach to irrigation, or by some other means discover a way to expand the number of people who could live in an area. The resulting economy would grow for well over 100 years, until population started catching up with resource availability. A period of stagflation followed, typically for about 50 or 60 years, as the economy tried to continue to grow, but bumped against increasing obstacles. Wage disparity grew as wages of new workers lagged. Debt also grew.

Eventually collapse occurred, over a period of 20 to 50 years. Often, much of the population died off. An inter-cycle period followed, during which resources regenerated, so that a new civilization could arise.

Figure 2. Shape of typical Secular Cycle, based on work of Peter Turkin and Sergey Nefedov in Secular Cycles.

Figure 2. Shape of typical Secular Cycle, based on work of Peter Turkin and Sergey Nefedov in Secular Cycles.

One of the major issues in past collapses was difficulty in funding government services. Part of the problem was that wages of common workers were low, making it difficult to collect enough taxes. Part of governments’ problems were that their costs went up, as they tried to solve the increasingly complex problems of society. Today these costs might include unemployment insurance and bailing out banks; in ages past they included larger armies to try to conquer new lands with more resources, as their own resources depleted.

Today’s Situation 

Our situation isn’t too different. The economy started growing in the early 1800s, abut the we started using fossil fuels, thanks to technology that allowed us to use them. Oil is the fossil fuel that is depleting most quickly, because it is very valuable in many uses, including transportation, agriculture, construction, mining, and as a raw material to produce many goods we use every day.

Our economy seems to have hit stagflation in the early 1970s, when oil prices first began to spike. Now, some of the symptoms we are seeing are looking distressingly like the symptoms that other civilizations saw prior to the beginning of collapse. Our networked system has many weak points:

  • Oil exporters Governments can collapse, as the government of the Former Soviet Union did in 1991, if oil prices are too low. The fact that oil prices have not risen since 2011 is probably contributing to unrest in the Middle East.
  • Oil importers Spikes in oil prices lead to recession.
  • Governments funding Debt keeps expanding; infrastructure needs fixes but they don’t get done; too many promises for pensions and healthcare.
  • Failing financial systems Debt defaults are likely to be a major problem if the economic system starts shrinking. Debt is needed to keep oil prices up.
  • Contagion if one energy product is in short supply This happens many ways. For example, nearly all businesses rely on both electricity and oil. If either one of these becomes unavailable (say oil to supply parts and ship goods to customers), then the business will need to close. Because of the business closure, demand for other energy products the business uses, such as electricity and natural gas, will drop at the same time. Direct use of energy products to produce other energy products (mentioned previously) also contributes to this contagion.

Unfortunately, when it comes to operating an economy, it is Liebig’s Law of the Minimum that rules. In other words, if any required element is missing, the system doesn’t work. If businesses can’t get financing, or can’t pay their employees because banks are closed, businesses may need to close. Workers will get laid off, and the inability to afford energy products (economists would call this “lack of demand”) will be what brings the system down.

Modeling our Current Economy 

Everywhere we look, we see models of how the energy system or the economy can be expected to work. None of the models match our current situation well.

Growth will Continue As in the Past It is pretty clear that this model is inadequate. Every revision to growth estimates seems to be downward. In a finite world, we know that growth at the same rate can’t continue forever–we would run out of resources, and places for people to stand. The networked nature of the system explains how the system really grows, and why this growth can’t continue indefinitely.

Rising Cost of Producing Energy Products Doesn’t Matter In a global world, we compete on the price of goods and services. The cost of producing these goods and services depends on (a) the cost of energy products used in making these goods and services (b) wages paid to workers for producing these services (c) government, healthcare, and other overhead costs, and (d) financing costs.

One part of our problem is that with globalization, we are competing against warm countries–countries that receive more free energy from the sun than we do, so are warmer than the US and Europe. Because of this free energy from the sun, homes do not need to be built as sturdily and less heat is needed in winter. Without these costs, wages do not need to be as high. These countries also tend to have less expensive healthcare systems and lower pensions for the elderly.

Governments can try to fix our non-competitive cost structure compared to these countries by reducing interest rates  as much as possible, but the fact remains–it is very difficult for countries in cold parts of the world to compete with countries in warm parts of the world in making goods. This cost competition problem becomes worse, as the price of energy products rises because we are competing with a cost of $0 for heating requirements. If cold countries add carbon taxes, but do not surcharge goods imported from warm countries, the disparity with warm countries becomes even worse.

In the early years of civilization, warm countries dominated the world economy. As energy prices rise, this situation is likely to again occur.

Price is Not Important  Apart from the warm country–cool country issue, there is another reason that energy cost (in real goods, not just in financial printed money) is important:

The price of the energy used in the economy is important because it is tied to how much must be “given up” to buy the oil or anther energy product (such as food). If energy is cheap, little needs to be given up to obtain the energy. Because of energy’s huge ability to do “work,” the work that is obtained can easily make goods and services that compensate for what has been given up. If energy is expensive, there is much less benefit (or perhaps negative benefit) when what is given up is compared to the work that the energy product provides. As a result, economic growth is held back by high-priced energy products of any kind.

Supply and Demand Leads to Higher Prices and Substitutes  Major obstacles to the standard model working are (a) diminishing returns with respect to oil supply, (b) recession and even government failure of oil importers, when oil prices rise and (c) civil unrest and even government failure in oil exporters, if oil prices don’t keep rising. If there isn’t enough oil supply, oil prices rise, but there are soon so many follow-on effects that oil prices fall back again.

Reserves/ Production This ratio supposedly tells how long we can produce oil (or natural gas or coal) at current extraction rates. This ratio is simply misleading. The real limit is how long the economy can function, given the feedback loops related to diminishing returns. If a person simply looks at investment dollars required, it becomes clear that this model doesn’t work. See my post IEA Investment Report – What is Right; What is Wrong.

IPCC Climate Change Model Estimates of future carbon emissions do not take into the networked nature of the energy system and economy, so tend to be high.  See my post Oil Limits and Climate Change – How They Fit Together.

Energy Payback Period, Energy Return on Energy Invested, and Life Cycle Analysis These approaches look at the efficiency of energy production, comparing energy used in the process to energy produced in the process. In some ways, they work–they show that we are becoming less and less efficient at producing oil, or coal, or natural gas, as we move to more difficult to extract resources. And they can be worthwhile, if a decision is being made as to which of two similar devices to purchase: Wind Turbine A or Wind Turbine B.

Unfortunately, modeling a finite world is virtually impossible. These approaches use narrow boundaries–energy used in pulling oil out of the ground, or making a wind turbine. It doesn’t tell as much as we need to know about new energy generation equipment, together with (a) changes needed elsewhere in the system and (b) whatever financial system is used to pay for the energy generated with that system, will actually work in the economy. To really analyze the situation, broader analyses are needed.

Furthermore, there are the inherent assumptions that (a) we have a long time period to make changes and (b) one energy source can be substituted for another. Neither of these assumptions is really true when we are this close to oil limits.

Where the Peak Oil Model Went Wrong

Part of the Peak Oil story is right: We are reaching oil limits, and those limits are hitting about now. Part of the Peak Oil story is not right, though, at least in  a common version that is prevalent now.  The version that is prevalent is more or less equivalent to the “standard” view of our current situation that I talked about at the beginning of the post. In this standard view, oil supply will not disappear very quickly–approximately 50% of the total amount of oil ever extracted will become available after the peak in oil production. There will be considerable substitution with other fuels, often at higher prices. The financial system may be affected, but it can be replaced, and the economy will continue.

This view is based on writing of M. King Hubbert back in 1957. At that time, it was commonly believed that nuclear energy would provide electricity too cheap to meter. In fact, in a 1962 paper, Hubbert talks about “reversing combustion,” to make liquid fuels. Thus, not only did his story include cheap electricity, it also included cheap liquid fuels, both in huge quantity.

Figure 3. Figure from Hubbert's 1956 paper, Nuclear Energy and the Fossil Fuels.

Figure 3. Figure from Hubbert’s 1956 paper, Nuclear Energy and the Fossil Fuels.

In such a situation, growth could continue indefinitely. There would be no need to replace huge numbers of vehicles with electric vehicles. Governments wouldn’t have a problem with funding. There would be no problem with collapse. The supply of oil and other fossil fuels could decline slowly, as suggested in his papers.

But the story of the cheap, rapid nuclear ramp-up didn’t materialize, and we gradually got closer to the time when limits were beginning to hit. Major changes were needed to Hubbert’s story to reflect the fact that we really didn’t have a fix that would keep business as usual going indefinitely. But these changes never took place. Instead the view of how little change was needed to keep the economy going kept getting downgraded more and more. “Standard” economic views filtered into the story, too.

There is a correct version of the oil limits story to tell. It is the story of the failure of networked systems.




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Checkers Versus Chess

Submitted by Jeff Thomas via Doug Casey's International Man blog,

For quite some time, we have been predicting that the Russians and Chinese will, at some point, bring an end to the petrodollar system that has virtually guaranteed the US the position of having its currency be the world's default currency. This position has allowed the US, in recent decades, to go on a borrowing and currency-printing spree, the likes of which the world has never seen.

First, a Little History

It's important that we back up a bit here to have a look at how this came about in the first instance.

In 1971, the US government, under Richard Nixon, took the US off the gold standard. This meant that, from that point on, the dollar was backed by nothing. However, as long as the dollar was accepted as legitimate currency (even though it was now mere paper), not only could the game continue as before, but the US would then be free to print as much "currency" as it wished. It would also be free to borrow as much as it wished, thereby building as large an economic house of cards as it wished.

Of course, the foolhardiness of this decision would not be immediately clear to all and sundry. It would take some time before the chickens would come home to roost.

Enter the Petrodollar

Back in 1971, it was necessary to assure that the dollar would retain its position in world trade as the world's premiere currency, in spite of the fact that it was no longer backed by anything. The US reached an agreement with Saudi Arabia that, in trade for arms and protection, the Saudis would denominate all future oil sales, worldwide, in dollars. The other OPEC countries fell into line, and the "petrodollar" was assured.

Returning to the present, we have stated for some time that the methods by which the US, the Russians, and the Chinese have been playing the game have been very different. The Chinese, for over 4000 years, have played the game of wéiqí, and the wéiqí philosophy is a primary part of Chinese philosophy. The idea is to distract your opponent whilst you subtly surround him. Once he is enclosed, with no support from outside, it's game over.

By contrast, the Russians are perennial chess players. Chess, played correctly, involves the concept of imagining each move that your opponent may possibly make. For each possible move, you imagine each possible move you could make and how your opponent might retaliate. You then select your best move. A good chess player is one who has learned to imagine several moves in advance. Therefore, once your opponent makes his move, you are never taken off-guard. You are prepared for anything he does.

Mister Putin is a consummate chess player, and since he has returned to office, each time the US has made a move, he has been ready. Each of his moves has not only countered the US, but trumped them. At every step that the US gets tough on Russia, Russia immediately says, in effect, "Okay, remember, you brought this on yourselves." Russia then makes a move that puts the US in a far worse position than it was before.

The amazing fact here is that the US method recognises neither wéiqí nor chess. They appear to be playing checkers. The US has, since World War II, used the approach of "The Yanks are Comin'." The US has been the biggest boy in the schoolyard and has, through a combination of bluster and bullying, been able to intimidate the world and, as a result, get virtually everything it wanted for a very long time. Conventional diplomacy has taken a back seat with the US, and, particularly since the administration of George Bush, the US has very much ramped up its "biggest boy in the schoolyard" approach, much to the irritation of the rest of world.

Here Come Those Chickens

But now, the US is broke, and its stature as the biggest boy has begun to wane. The other kids in the schoolyard are playing smart, whilst the US is still playing tough…and it's no longer working.

Claiming that Russia was overstepping its power in the Ukraine (when, in fact, it was the US that was guilty of this move), the US applied economic sanctions to Russia. The US media treated this as a major blow to Russia, from which the Russkies had better back off if they knew what was good for them.

But, in fact, this served as an open invitation for Russia to retaliate. Since the very first thrust by the US, each parry and thrust by the Russians has been both effective and well planned. (It should be borne in mind that the latest announcement that Russia would not accept US dollars in payment for gas could only be enforced if Russia could get its international gas customers to agree. At the time of announcement, nine out of ten customers had, in fact agreed. These decisions were, unquestionably, not reached overnight. This chess move was planned well in advance.)

When Russia announced that Gazprom, the largest gas supplier in the world, would no longer be accepting US dollars from its clients, the West was shaken by the news.

End of the Petrodollar     

So, does this spell the end for the petrodollar? Not just yet. But it does add a nail to the petrodollar coffin, and a rather large nail, at that. It most certainly announces to the world that, if the US continues its schoolyard bully approach, both the Russians and the Chinese are more than ready. They have greater power than the US gave them credit for and, as we are witnessing, are more adept at the game itself.

Time after time, the US announces a flimsy new policy that is half-baked at best, and the US media announce, in effect, "This'll show 'em!" And yet, at every turn, the Sino-Russian tag-team deals blow after blow to US hegemony in the world.

The US is at war with China and Russia. It's an undeclared war, and it's monetary warfare, not military warfare. Yes, there are the military distractions, such as in the Ukraine and the Middle East, but the primary war is being fought monetarily.

If we observe the Asian responses to the US attacks in this war, and assess them objectively, we see that the Asians do not seek to kill off the US. In each battle, they, like skilled bullfighters, deflect the charging bull, then thrust the sword forward, wounding him again and again with every charge.

As this approach is becoming a pattern, it would indicate that the Russians and Chinese, much like a bullfighter, are wearing out the bull and provoking him to lose enough blood that, soon, he will no longer be able to continue the fight.

There will be no H-bomb moment here. No point at which the US, to the entire world's surprise, suddenly self-destructs. Just as Rome wound down 2000 years ago, we shall observe a similar winding down of the US. (Although there will be many sudden crashes along the way, the entire process will stretch out for years.)

And I believe the US will be kept alive by the victors. It will remain in business as a country and will serve the East, particularly as a consumer of Eastern-produced goods.

But it will cease to be the world's empire. Much as the British Empire wound down as a result of the world wars, the US will be greatly diminished in power.

More and more, US residents are coming to realise that the "recovery" that is forever being heralded as "just around the corner" will not arrive. No "green shoots," no "shovel-ready jobs" will materialise. The US are attempting to win a chess game by playing checkers, and they will not succeed. The US's place in the world will be a casualty of that error, as will be the US economy.

Editor’s Note: Unfortunately there’s little any individual can practically do to change the trajectory of this trend in motion. The best you can and should do is to stay informed so that you can protect yourself in the best way possible, and even profit from the situation.

This is what Doug Casey’s International Man is all about: helping you cut through the smoke and mirrors while making the most of your personal freedom and financial opportunities around the world. The free IM Communiqué is a great place to start.




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Record Stock Buybacks: First In The US, Now In Japan

It was a month ago when Zero Hedge first revealed that as QE was “tapering”, a just as powerful and even more indiscriminate force had stepped in to make up for the loss of Fed buying of last resort: corporations themselves, almost exclusively on a levered basis (issuing debt whose use of proceeds are stock buybacks). Specifically, we showed that the total amount of stock bought back by corporations in Q1 was the highest since the bursting of the last credit bubble. In fact it was the highest ever.

This was promptly noticed by both the WSJ and the FT. What the two financial media outlets likely have not grasped is that based on trading desk commentary, according to which the bulk of “flow” now originates almost exclusively at C-suites ordering banks to continue the buyback activity, the Q2 stock repurchase totals will be even greater than Q1, and likely surpass $200 billion. This means that every month this quarter companies are buying back about $70 billion of their own stock: an amount which at this runrate will surpass the Fed’s original QE(3) amount of $85 billion within a quarter!

But while the “mysterious, indiscriminate” buyer of US stocks has been fully unmasked now, what most likely do not know is that just this is happening at a comparable record pace nowhere else but the place which is mirroring and repeating every single Fed mistake tit for tit.

Japan.

According to Bloomberg, companies in the Topix index are acquiring their own stock at the fastest pace ever, led by NTT Docomo Inc. and Toyota Motor Corp., with $25 billion of announced purchases so far this year, data compiled by Bloomberg show. The buybacks are limiting losses in the world’s worst-performing developed equity market: Companies using the strategy have gained even as the Topix slid.

Only $25 billion you say? Why that is less than a fifth of what their US peers are doing. Well, yes. But remember that on a relative basis, the BOJ’s $75 billion or so in QE is orders of magnitude greater than the Fed’s own QE when one factors in the relative sizes of the US and Japanese stock markets.

Additionally, keep in mind that the net annual bond issuance in Japan is already well below half of the amount monetized every year by the BOJ (which means if you think US bonds are illiquid, just try to buy, or sell a JGB – good luck). This means that vastly more of the BOJ’s intervention ends up in the stock market: either Japan’s or that of the US, courtesy of immediately fungible global fund transfers.

But back to Japanese bond buybacks, which in a far more “concentrated” and illiquid market, are having an impact on stock prices that is orders of magnitude higher than their nominal value would suggest.

Bloomberg then proceeds to give a quick lesson on logic 101: “Share buybacks have the effect of supporting the market when it’s weak,” Daiwa Securities Group Inc. quantitative analyst Masahiro Suzuki wrote in a report on June 10. “Return to shareholders is a big theme.”

Companies’ purchases of their own equity can be seen as a vote of confidence by executives that their stock has room to rise. The buybacks can also suggest a company has run out of things to spend money on, curbing its growth potential.

The problem, whether Japanese corporate executives are merely doing the same as their US peers and cashing out on their equity-linked comp plans at a furious pace thanks to their stocks hitting record highs having used corporate cash to boost the stock price while saddling the company with massive debt which will be some other CEO’s concern down the line (a clear conflict of interest if there ever was one), is irrelevant. What matters is that stock buybacks have zero impact on the economy. Zilch. Nada. Because instead of investing capital in projects, either for maintenance or growth, all that happens is the shareholders get rich here and now, at the expense of economic, and certainly revenue, growth in the future (as we explained two years ago).

Even if buybacks continue, companies need to increase investments at a faster pace, according to Coutts’ Calder, a harder choice compared to improving return on equity with share repurchases in the short term. The amount of cash they hold means companies should able to afford both buybacks and capital investments, he said.

While businesses have boosted capital spending for three straight quarters, their investments in the period ended March remained 31 percent below a 2007 peak, Finance Ministry data show.

 

“Buybacks only result in raising ROE and share prices, so their effect on Japan’s economy is indirect,” said Masaru Hamasaki, a Tokyo-based senior strategist at Sumitomo Mitsui Asset Management Co. “Capital investment directly boosts the economy, so I think for now, they should invest more money there.”

 

Since the start of January, 152 companies on the Topix announced buybacks worth 2.5 trillion yen, data compiled by Bloomberg show. The previous high for an entire year was 1.5 trillion yen in 2008. Companies unveiled an average 567 billion yen in annual buybacks over the decade through 2013, the data show.

And here is where it all comes full circle, because the “economic theory” so to say seeking to reward corporations right now is that these same corporations will, out of the goodness of their heart, turn around and share their profits with their non-stock holding employees, i.e. the rank and file. Because the only way an economy can generate benign inflation is if there are real (not nominal) wage increases. Instead, Japan’s only inflation to date is in import cost, in “non-core” staples such as food and energy, and of course, the stock market.

This is what is also affectionately known as trickle-down economics. It also doesn’t work. Case in point – Japan’s soaring stock market has resulted in exactly zero wage increases in the past 23 months, and soon: straight years of declining wages. Of course, to the Keynesians in charge it simply means that any minute now Japanese wages will increase. Alas, they won’t. Because corporations realize that this emergency liquidity injection measure is merely confirmation by the central banks that the economy is failing and that companies should either be stockpiling cash for whatever comes after the Fed or BOJ withdraw, or, failing that, hand it over to shareholders who can do the same however without a corporate veil, and the money will simply reside in a personal bank account instead of a corporate one.

“The government recognizes that in order to resuscitate Japan’s economy, there needs to be a cycle where corporations profit, then return those profits to the public,” said Hisashi Kuroda, the head of Japanese equities and chief portfolio manager at Meiji Yasuda Asset Management Co. “Even if public finances are used to help companies make more money, it’ll be negative for the economy if the firms just stockpile the cash.”

Not surprisingly, with the BOJ injecting trillions into the market, some of it makes its way to corporations. Sure enough, “Non-financial firms’ holdings of cash and deposits rose to a record 232 trillion yen at the end of March, BOJ data show. Earnings by Topix companies swelled 69 percent last year as unprecedented central bank stimulus drove down the yen, boosting exporters’ profits. That added to balances built by executives to shield their companies amid more than a decade of deflation and economic malaise.”

Alas, as we noted every month, none of that cash is making its way to employees. Instead, in addition to buybacks it also going for other shareholder friendly activities like dividends. “Other types of returns to shareholders are also on the rise. Estimated annual dividends per share for the Topix climbed to 24.4 yen last week, close to the highest since 2008.” And while there has been a modest pick up in CapEx too, it is well below the expected, and certainly well below any level that is required to sustain a virtuous economic cycle. Because what idiot CEO would opt to invest in growth that materializes in 5 to 10 years (the typical peak IRR of CapEx) or when some other CEO is in charge, when there is an quick and easy option to cash out now if said CEO holds stock.

In the meantime, everyone in Japan, and the US, is ignoring the reality and sticking their noise in the sand.

Brokerages are touting stock-picking based on who’s next to buy back shares.

 

Societe Generale SA says investors should seek out cash-rich companies with low leverage and valuations. Top picks include regional lender Tottori Bank Ltd. and homebuilder Mitsui Home Co., analysts led by Vivek Misra wrote in a June 4 report.

 

“Many investors don’t realize that corporate Japan is changing,” said Meiji Yasuda Asset Management’s Kuroda.

It’s changing all right: in less than two years Japan has adopted all the worst qualities of the US financial system. And just like in the US, when the central bank liquidity music stops, the collapse will promptly follow.

Japan could have avoided this if it had merely continued it slow shallow drift into deflation: painful for debtors but sustainable for most, and most importantly, not some insane Ponzi game where the pensions of the population are being invested in overvalued, social-networking stocks. However, with its berserker rush into stimulating inflation at all costs, the next deflationary shock will be epic, and one whose only “fix” will be for the BOJ to go from mere JPY7 trillion liquidity injection per month, to literally pulling out the firehose and proceeding with creating the hyperinflation that results from a collapse in the currency which we have said since March 2009 would be the ultimate endgame of this entire failed economic and monetary experiment.




via Zero Hedge http://ift.tt/1yH9ktQ Tyler Durden

China’s Port-Ponzi-Probe Spreads To Entire Warehousing Sector

“The banks still haven’t looked under the hood,” warns one executive as the probe at Qingdao port (centering around the duplication of warehouse certificates in order to use a metal cargo multiple times to raise financing) begins to spread to the entire Chinese warehousing sector. As Reuters reports, even if banks or their customers have insurance for the metal, some warehouse sources said they might struggle to get paid if fraud is uncovered or their agents are implicated. Though many global firms are involved in the warehouse industry in China, there has been outsourcing to local firms to cut overheads and avoid dealing with complex local regulations. That appears to have back-fired. One thing looks certain, however, banks involved in commodity financing in China are set to charge higher fees: “The cost is certainly going to go up, whether it’s going to be from local banks or international.”

 

As Reuters reports,

Shaken by a fraud investigation into metal financing in the world’s seventh-busiest port, banks and trading houses have been made painfully aware of the risks they face storing commodities in China’s sprawling warehouse sector.

 

The probe at Qingdao port centers around a private metals trading firm suspected of duplicating warehouse certificates in order to use a metal cargo multiple times to raise financing.

 

China’s roaring commodity financing business, which has helped drive up stockpiles of commodities at ports to record levels, stored in warehouses not always regulated to the same extent as elsewhere.

And the concerns are spreading…

“The banks still haven’t looked under the hood,” said an executive at a bank involved in commodity financing in China, referring to China’s warehousing sector.

And the legal troubles are growing…

“Warehouse receipts are not title documents, they are documents of entitlement. But they are being used as title documents for sales and purchase and transfer of ownership,” said a person at a warehouse company with operations in Qingdao.

 

Everywhere else outside of China, a warehouse receipt is cut for one party.”

 

A source at a Western bank with direct knowledge of Qingdao said warehouse firms should bear the brunt of responsibility, while a senior official at a warehouse firm at the port said responsibility “remains very much up in the air.”

 

A lawyer, who has previously been involved in litigation over fraudulent warehouse receipts, said banks primary recourse would be against whoever had forged receipts.

 

“But if the fraudster is gone, the bank may decide that it wants to go against the warehouse,” said the lawyer, who did not want to be named because of the sensitivity of the issue.

The relocation of whatever metal there is has started…

Traders said there was a risk the metal could have been already claimed before part of Qingdao Port was sealed off, adding that at least two trading houses had moved metal out as soon as news of the scandal broke.

 

Some banks have asked clients to shift metal, used as collateral for loans, to more regulated London Metal Exchange (LME) warehouses outside China or those owned and operated by a single warehouse firm to limit their exposure.

But the LME appears a little nervous…

the Qingdao probe has prompted some movement of metal to LME-approved warehouses in locations such as South Korea.

 

The LME, which is owned by Hong Kong Exchanges and Clearing Ltd, has approved more than 700 warehouses and storage facilities in about 40 locations globally.

 

“The extension of the LME’s warehouse network into mainland China is an important issue for the LME and its users and we alongside HKEx put a high priority on this initiative,” said a LME spokeswoman.

 

But the reverberations from the Qingdao probe may not be clear cut, since global warehousing firms potentially exposed to the scandal are licensed by the LME to operate in other ports. The LME declined to comment further.

One thing is sure – credit is tightening and costs are rising…

“The cost is certainly going to go up, whether it’s going to be from local banks or international,” said analyst Colin Hamilton of Macquarie in London.

This is not over.




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Tonight on The Independents: Peter Suderman on the IRS Hearings, Katherine Mangu-Ward and Thaddeus McCotter on the Drone-Kill Memo, Michael Weiss on Iraq and Ukraine, Plus Harry Reid Hypocrisy, Clintons v. Obamas, and Operation Chokepoint

Purple hair, purple hair. |||Tonight’s live episode of The
Independents
(Fox Business Network, 9 p.m. ET, 6 p.m. PT,
with re-airs three hours later) will be filled with familiar
Reason characters. Besides yours truly, there
will be Managing Editor Katherine
Mangu-Ward
, who will be one half of the Party Panel (along with
former GOP congressman Thaddeus McCotter), and will
talk about the administration’s heavily redacted
legal justification for assassinating U.S. citizens
, the

Republican foreign-policy split
between Dick Cheney and Sen.
Rand Paul (R-Kentucky), the laughable notion by Minority Leader
Harry Reid (D-Nevada) that when it comes to financial backers, the
Democratic Party “doesn’t
have billionaires
“; plus the lurid claims made in the new
Clinton-Obama page-turner
Blood Feud
.

Are you watching the House hearings with Internal Revenue
Service Commissioner John Koskinenon the missing IRS emails? Well,
Reason Senior Editor Peter Suderman
probably is, and since he broke the relevant story about the IRS

having a contract with an email backup company
, he shall
certainly add value. Remember the federal government’s
controversial Operation
Choke Point
that allegedly targets politically disfavorable
businesses for prosecutorial sanction? Brian Wise from the United
States Consumer Coalition will be on to discuss the latest
developments, which involve
cease-and-desist letters
. And remember how international
borders are crumbling to meaninglessness in the Middle East and in
Russia’s Near Abroad? Michael
Weiss
of The Interpreter will add his two cents.

Sexy aftershow begins on http://ift.tt/QYHXdy
a few beats after 10. Follow The Independents on Facebook
at http://ift.tt/QYHXdB,
follow on Twitter @ independentsFBN, tweet
during the show & we’ll use the best of ’em. Click on this page
for more video of past segments.

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Kiev Doubles The Price Of Cold Water, Shuts Off Hot Water

Submitted by Simon Black via Sovereign Man blog,

No one ever thinks about the water. Or the toilet paper, as it were.

But these are among the many, many staples that become luxuries when one’s nation is in crisis.

Hours ago, the local gas company in Kiev (Kyivenergo) announced that they would be shutting off the hot water supply to most of the city.

While the official reason for the hot water shutoff is that Kyivenergo (the energy supplier to Kiev) owes a debt to the Ukrainian state gas company (Naftogaz) of over $100 million.

It’s just a quirky little coincidence that this debt suddenly became materially important only one week after Russia shut off natural gas supplies to Ukraine.

Funny thing is that Ukrainian politicians for years had been telling people not to worry about this.

You see, Ukraine has its own domestic natural gas supplies. And they tell people that the domestic gas is strictly for the people and their utilities (like hot water).

Russian gas, according to this story, is imported for businesses to use. But that domestic gas is sacrosanct, only for the people.

Clearly this turned out to be a big fat lie.

Bear in mind, it was just a few weeks ago that utility companies announced that the price of cold water would jump from 3.18 hryvnas per cubic meter to 6.22– a 95% increase, practically overnight.

So there’s an entire city now taking cold showers… and paying twice the price for the privilege! Insult. Injury.

I have several Ukrainian employees with family still in the country; they’re telling me how their loved ones are now finally starting to look at their options to get out of dodge.

It’s strange when you think about it– war, revolution, inflation, etc. All of that was OK. Cold showers?!?! “Honey pack the bags, it’s time to leave.”

I jest of course; all of this is accumulated pain that eventually culminates in reaching one’s breaking point… especially when a rational look into the future suggests this situation will not resolve itself anytime soon.

You know the outlook isn’t so great right now because Ukraine’s Vice Premier Minister is telling people that they can survive the -winter- (still months away) without Russian gas imports.

While I’m sure everyone appreciates the ‘turn that frown upside down’ approach, they’d probably just rather take a hot shower and not be lied to about the nation’s ability to sustain shrinkage.

A few key lessons I wanted to pull out of this:

1. Politicians always lie. They will tell you that your nation is stronger than it really is, that your country is prepared for whatever may come, that your benefits will never be cut, etc. And even though they may be well-intentioned, these are not promises that can be kept… especially by a nation in crisis.

 

2. A nation in crisis affects just about everything. It’s not just about numbers and data, or even Molotov cocktails. It’s hot water and toilet paper. It’s food on the shelves. It’s the stuff we all take for granted that suddenly doesn’t function anymore.

 

3. Even though the obvious warning signs are there, most people wait until it’s too late (or at least suboptimal) before considering their options. When you wait until a full blown crisis, you have to rush through critical decisions in haste instead of planning things out slowly, rationally.

Rational people have a plan B because we all have a breaking point. Do you know what you would do if you reached yours?




via Zero Hedge http://ift.tt/1mg6HKn Tyler Durden

IRS Commissioner Koskinen Vs Darrell Issa Round II – Live Feed

After last week’s fireworks, we suspect this rare evening hearing will have plenty more as the major Democratic donor (and IRS Commissioner) John Koskinen faces a fresh grilling over the technuical bullshit that led to the IRS destroying subpoena’d hard drives…

 

Via FoxNation,

IRS Commissioner John Koskinen is in the spotlight as he is set to further testify to Congress regarding the IRS targeting of conservative groups.

 

It is important to remember that Koskinen has shelled out nearly $100,000 to Democratic candidates and groups.

A quick reminder of last week’s theatrics (via HuffPo),

I will not tolerate your continued obstruction and game-playing in response to the Committee’s investigation of the IRS targeting,” Issa wrote to Koskinen. “For too long, the IRS has promised to produce requested — and later subpoenaed — documents, only to respond later with excuses and inaction.”

 

“Despite your empty promises and broken commitments to cooperation, the IRS still insists on flouting Constitutional congressional oversight,” Issa said.

 

Koskinen had a long record of government service before taking over as head of the IRS at the start of the year. He served in different positions under both Presidents Bill Clinton and George W. Bush, and worked for the District of Columbia.

 

“It’ll be the first time in my long career of testifying anybody ever subpoenaed me but if that’s the way they want to operate, that’s fine with me,” Koskinen said Friday. “I just got a subpoena announcing that I was to appear at 7 o’clock on Monday night with no inquiry, no request, no question whether I was even going to be in town.”

Live Feed Via Wapo,

 

Chairman Darrell Issa (R., Calif.) released a set of questions Sunday that suggests lawmakers will be digging even deeper into events surrounding the loss of the email records when Ms. Lerner’s computer hard drive failed. The questions, totaling about 50, seek details both about the hard-drive failure in mid-2011 and the agency’s later discovery that it affected the investigation, which started in 2013.




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Mapping Africa’s “Totally Out Of Control” Ebola Epidemic

“The epidemic is totally out of control,” warns medical charity Médecins Sans Frontières of the deadly Ebola outbreak in Guinea, Liberia, and Sierra Leone. “There is a real risk of it spreading to other areas…Ebola is no longer a public health issue limited to Guinea: it is affecting the whole of West Africa.” As of Friday, the Centers for Disease Control and Prevention put the number of cases at 362 — more than any other outbreak on record. Here’s everything you need to know about Ebola…

 

Ebola has a fatality rate of up to 90 percent and there is no vaccine and no known cure. The virus initially causes raging fever, headaches, muscle pain, conjunctivitis and weakness, before moving into more severe phases with vomiting, diarrhoea and haemorrhages.

As Reuters notes,

“The epidemic is totally out of control,” said Bart Janssens, MSF director of operations. “With the appearance of new sites in Guinea, Sierra Leone and Liberia, there is a real risk of it spreading to other areas.”

 

“Ebola is no longer a public health issue limited to Guinea: it is affecting the whole of West Africa,” said Janssens, urging WHO, affected countries and their neighbours to deploy more resources especially trained medical staff.

 

MSF has treated some 470 patients, 215 of them confirmed cases, in specialised centres in the region but the organisation said it had reached the limit of its capacity.

 

Patients have been identified in more than 60 locations across the three countries making it harder to curb the outbreak.

But locals remain apparently ignorant of the risks…

The disease has not previously occurred in the region and local people remain frightened of it and view health facilities with suspicion. This makes it harder to bring it under control, MSF said in a statement.

 

At the same time, MSF said, a lack of understanding has meant people continue to prepare corpses and attend funerals of Ebola victims, leaving them vulnerable to the disease, transmitted by touching victims or through bodily fluids.

 

Civil society groups, governments and religious authorities have also failed to acknowledge the scale of the epidemic and as a result few prominent figures are promoting the fight against the disease, the statement said.

 




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The Fed’s “Too Large & Too Illiquid” Bond Trap

Submitted by Peter Schiff of Euro Pacific Capital,

The American financial establishment has an incredible ability to celebrate the inconsequential while ignoring the vital. Last week, while the Wall Street Journal pondered how the Fed may set interest rates three to four years in the future (an exercise that David Stockman rightly compared to debating how many angels could dance on the head of a pin), the media almost completely ignored one of the most chilling pieces of financial news that I have ever seen. According to a small story in the Financial Times, some Fed officials would like to require retail owners of bond mutual funds to pay an “exit fee” to liquidate their positions. Come again? That such a policy would even be considered tells us much about the current fragility of our bond market and the collective insanity of layers of unnecessary regulation.

Recently Federal Reserve Governor Jeremy Stein commented on what has become obvious to many investors: the bond market has become too large and too illiquid, exposing the market to crisis and seizure if a large portion of investors decide to sell at the same time. Such an event occurred back in 2008 when the money market funds briefly fell below par and “broke the buck.” To prevent such a possibility in the larger bond market, the Fed wants to slow any potential panic selling by constructing a barrier to exit. Since it would be outrageous and unconstitutional to pass a law banning sales (although in this day and age anything may be possible) an exit fee could provide the brakes the Fed is looking for. Fortunately, the rules governing securities transactions are not imposed by the Fed, but are the prerogative of the SEC. (But if you are like me, that fact offers little in the way of relief.) How did it come to this?

For the past six years it has been the policy of the Federal Reserve to push down interest rates to record low levels. In has done so effectively on the “short end of the curve” by setting the Fed Funds rate at zero since 2008. The resulting lack of yield in short term debt has encouraged more investors to buy riskier long-term debt. This has created a bull market in long bonds. The Fed’s QE purchases have extended the run beyond what even most bond bulls had anticipated, making “risk-free” long-term debt far too attractive for far too long. As a result, mutual fund holdings of long term government and corporate debt have swelled to more $7 trillion as of the end of 2013, a whopping 109% increase from 2008 levels.  

Compounding the problem is that many of these funds are leveraged, meaning they have borrowed on the short-end to buy on the long end. This has artificially goosed yields in an otherwise low-rate environment. But that means when liquidations occur, leveraged funds will have to sell even more long-term bonds to raise cash than the dollar amount of the liquidations being requested.

But now that Fed policies have herded investors out on the long end of the curve, they want to take steps to make sure they don’t come scurrying back to safety. They hope to construct the bond equivalent of a roach motel, where investors check in but they don’t check out. How high the exit fee would need to be is open to speculation. But clearly, it would have to be high enough to be effective, and would have to increase with the desire of the owners to sell. If everyone panicked at once, it’s possible that the fee would have to be utterly prohibitive.

As we reach the point where the Fed is supposed to wind down its monthly bond purchases and begin trimming the size of its balance sheet, the talk of an exit fee is an admission that the market could turn very ugly if the Fed were to no longer provide limitless liquidity. (See my prior commentaries on this, including may 2014’s Too Big To Pop)

Irrespective of the rule’s callous disregard for property rights and contracts (investors did not agree to an exit fee when they bought the bond funds), the implementation of the rule would illustrate how bad government regulation can build on itself to create a pile of counterproductive incentives leading to possible market chaos.

In this case, the problems started back in the 1930s when the Roosevelt Administration created the FDIC to provide federal insurance to bank deposits. Prior to this,consumers had to pay attention to a bank’s reputation, and decide for themselves if an institution was worthy of their money. The free market system worked surprisingly well in banking, and could even work better today based on the power of the internet to spread information. But the FDIC insurance has transferred the risk of bank deposits from bank customers to taxpayers. The vast majority of bank depositors now have little regard for what banks actually do with their money. This moral hazard partially set the stage for the financial catastrophe of 2008 and led to the current era of “too big to fail.”

In an attempt to reduce the risks that the banking system imposed on taxpayers, the Dodd/Frank legislation passed in the aftermath of the crisis made it much more difficult for banks and other large institutions to trade bonds actively for their own accounts. This is a big reason why the bond market is much less liquid now than it had been in the past. But the lack of liquidity exposes the swollen market to seizure and failure when things get rough. This has led to calls for a third level of regulation (exit fees) to correct the distortions created by the first two. The cycle is likely to continue.

The most disappointing thing is not that the Fed would be in favor of such an exit fee, but that the financial media and the investing public would be so sanguine about it. If the authorities consider an exit fee on bond funds, why not equity funds, or even individual equities? Once that Rubicon is crossed, there is really no turning back. I believe it to be very revealing that when asked about the exit fees at her press conference last week, Janet Yellen offered no comment other than a professed unawareness that the policy had been discussed at the Fed, and that such matters were the purview of the SEC. The answer seemed to be too canned to offer much comfort. A forceful rejection would have been appreciated. 

But the Fed’s policy appears to be to pump up asset prices and to keep them high no matter what. This does little for the actual economy but it makes their co-conspirators on Wall Street very happy. After all, what motel owner would oppose rules that prevent guests from leaving? The sad fact is that if investors hold bond long enough to be exposed to a potential exit fee, then the fee may prove to be the least of their problems.




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The IMF, Lagarde and QE

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The lady has spoken.

Christine Lagarde of the International Monetary Fund has told the European Central Bank that they need to consider Quantitative Easing if inflation continues to remain low, which it will. She stated: “If inflation was to remain stubbornly low, then we would certainly hope that the ECB would take quantitative easing measures by way of purchasing of sovereign bonds”.

Apparently Lagarde’s version of ‘stubborn’ is something that persists despite taking measures to boost otherwise. In other words, is this the last resort of the ECB and the IMF? Is there nothing else to do apart from print the money and inject it into the financial markets to over-inflate them as the US has done with the Federal Reserve’s money being thrown from the helicopters?

So, prepare yourself for the hefty buzzing noises emanating from the cellars of the ECB. Mario Draghi will be starting them there printing presses rolling just as soon as he can. The French can start liking Europe again and stop hating their President, Mr. Flabby François Hollande. The Brits can carry on with their housing boom and not fear the collapse of their bubble (just quite yet). The rich can get richer and governments can hide the fact that they aren’t creating jobs for anyone but themselves and the boys that belong to their clubs. After all it’s all about the stock market increasing, isn’t it?

Has inflation remained stubbornly low? Despite the unprecedented decision of Mario Draghi to impose negative interest rates on banks depositing money at the ECB, there is going to be little effect on prices. The economic recovery in Europe is flagging to say the least. Europe has got the big economic droop to deal with.

• Never before has any central bank put the rate on its deposit facility for banks at -0.10%. Interest rates were also cut at the June policy meeting from 0.25% to 0.15%
• Consumer prices saw an increase of only 0.5% in May (year-on-year) and that was a fall from April’s 0.7%
• Whatever is happening in the Eurozone, that’s way below the desired target of the ECB (2%).

Lagarde was asked whether she believed that governments would become complacent regarding structural reforms after these measures. She stated: “They all seem convinced that they have to pursue structural reforms, support demand by good solid monetary policy, and continue the fiscal consolidation path they have agreed”. Optimism is a sign of virtue, Ms. Lagarde.

• But, the problems still remain. Jobs aren’t being created. 
• Both sovereign and corporate debts are still there. 
• Geopolitical tensions are just around the corner, if not already on the EU’s doorstep. 
• Who’s going to invest while those problems persist?
• The UK government borrowing has just been announced to have increased in May by £13.3 billion
• That was way over what the City had forecasted. Tax receipts are down in the UK and the budget deficit is not being reduced.

According to the IMF, Quantitative Easing “would boost confidence, improve corporate and household balance sheets, and stimulate bank lending”. Of course, we all saw the overt signs of stimulation in bank lending and increased confidence as well as corporate and households raking it in when the US’s Federal reserve di the money-printing thing for years. The signs are so obvious they are just impossible to see.

This is not the first time that the IMF has told the ECB to pull the punches and become more aggressive in its decisions. IMF officials have on many occasions told the ECB to start a US-style bond-purchasing program.

But, hang on a moment! Isn’t that against the statutes of the European Central Bank? Doesn’t the ECB have a clause saying that it simply can’t provide monetary finance to governments? Oh, well, never mind. Since when did any bank, central or otherwise, play by the rules. The governments put the people there into power, so they can certainly return the favor, can’t they?

Remember when all is said and done that 60% of the trades done on the stock market every single day are just for the wealthiest 5% of the world. Yes, the 95% of the other poor devils that think they are controlling the financial markets through their buying and selling of shares have absolutely no idea. Christine Lagarde’s advice on the benefits of Quantitative Easing can only be of major benefit to the 5%. There’s really no need to wonder why the rich have got richer around the world.

Originally posted: The IMF, Lagarde and QE




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