The Last Time The Market Was This Short, Stocks Crashed

It is common knowledge among those that prefer to see the glass of aggregate demand always half-full (in need of fiscal or monetary stimulus and thus always time to BTFD) that stocks “climb a wall of worry” and that stocks can’t drop if so many people are negative. However, while we are sorry to steal the jam from their exuberant ‘cash on the sidelines’ donut, the truth is that eventually ‘strong hand’ short positions build to a point where they dominate and provide the tipping point of weakness in stocks. As Goldman Sachs highlights in the following two charts of short interest ratio (days to cover) and aggregate short interest (dollars), the last time there was this much money short was mid-2007… and that didn’t end well.

 

Short interest ratio is at pre-crisis high levels…

 

and aggregate dollars short is now at levels just before the market crashed…

 

Yet another market meme broken by the facts of the data…

 

Charts: Goldman Sachs




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India’s Futile ‘War On Gold’ Ending – Demand To Rise

 

Today’s AM fix was USD 1,294.50, EUR 945.93 and GBP 767.02 per ounce.

Yesterday’s AM fix was USD 1,292.00, EUR 942.65 and GBP 764.81 per ounce.


Gold remains in lock down in an unusually tight range between $1,284/oz and $1,306/oz this week. Gold in Singapore again traded down to the $1,292/oz level prior to slight gains in London which led to gold over $1,295/oz and then a run to $1,304.oz prior to determined selling was seen again.


Gold in U.S. Dollars, Daily, January – May – (Thomson Reuters)

India Gold Demand To Rise As Central Bank Eases Tough  Import Rules
India’s central bank, the Reserve Bank of India (RBI), eased tough gold import rules late last night,by allowing seven more private agencies to ship and import gold bullion. Industry officials and gold analysts say the easing of restrictions will increase supplies, reduce premiums and lead to increased demand in the peak wedding season.


The move allows “star trading houses”, private jewellery exporters which had been barred from importing gold since July 2013, to resume imports, with immediate effect. India raised the gold import duty last year to a large 10% from 4% and also mandated that 20% of imported gold be exported, known as the 80:20 rule.

There are no changes to the more stringent 80/20 rule as of yet, but sources have told Reuters that the Reserve Bank of India and finance ministry officials will recommend that the new government relax strict gold import rules to head off a surge in illegal buying and the continuing wave of gold smuggling into India.

The easing of the import rules is bullish for gold bullion and the gold sector. Shares of jewellery companies surged after the RBI allowed banks to provide gold loans to the sector.

The moves by the RBI, is likely to increase demand for gold. Curiously, gold prices saw little gains after the announcement.

Although the two steps alone are not expected to impact India’s current account deficit, they could reinforce expectations that RBI and finance ministry officials will soon move towards removing some of those curbs.

HSBC commenting on India’s move to allow more firms to import gold, said that “the announcement is a sign that the RBI is slowly starting to address the onerous restrictions put in place last year on the gold trade and may raise optimism for an eventual roll back of the bullion import taxes.”


Russian Central Bank Gold Reserves, Millions of Troy Ounces  – (Gold Charts R Us)

Russia’s significant 900,000 ounce or 28 tonne gold purchase worth over $1 billion in April continues to be digested by the market. Ordinarily we have seen gold react positively to surprise large central bank purchases. Another bullish development has not led to rising gold prices. Gold prices appear tethered to the $1,300/oz level.

RUSSIA CHINA HISTORIC GAS DEAL
Another important geopolitical development yesterday was China and Russia signing a $400 billion gas supply deal involving payments in the yuan and ruble.

The deal secures the world’s top energy user a major source of cleaner fuel. It opens up a new market for Russia as it gives itself options and the ability to cut off dependent European countries should the Ukraine crisis escalate and further sanctions be imposed on Russia.

The deal is important from a monetary perspective as Russia and China are planning to increase the volume of direct payments in mutual trade in their national currencies, according to a joint statement.


Chinese President Xi Jinping with Russian President Vladimir Putin after deal

It has significant ramifications for the dollar as global reserve currency. The era of the dollar as the sole global reserve currency is gradually coming to a close – see Currency Wars: Bye, Bye Petrodollar – Buy, Buy Gold.   We will explore the Russian Chinese deal and its important geopolitical ramifications  in more detail tomorrow.

Follow GoldCore and GoldCore’s Head of Research Mark O’Byrne on Twitter

 




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Miami Beach Cop Says Mayor Tried to ‘Instigate’ Confrontation Along With Democratic Fund-Raiser During Party Crashing Incident

do you know who i am?Last December, police in Miami Beach, Florida,
responded to a call from a resident holding an invitation-only art
party on Star Island. Up to 1,000 uninvited guests looking to crash
the party showed up anyway, according to an Internal Affairs (IA)
report on the incident. The newly-elected mayor of Miami Beach,
Philip Levine, filed a complaint when he witnessed one officer,
Giordano Cardoso, firing his Taser into the ground in an attempt to
control the crowd and allegedly waving the Taser around.

IA found the use of the Taser by police appropriate. In the
report Officer Cardoso claimed the mayor was trying to intimidate
officers on the scene. Via
the IA report
:

As the crowd dispersed, Mayor Philip Levine was
overheard by them “encouraging” a male known to the Mayor to try
and enter the residence again. According to witness Marquez, Mayor
Levine “witnessed his friend excite the crowd and described the
friend’s actions as very strange (challenging the officers as he
looked back at the crowd).” According to witness Marquez, “the
friend seemed to be “putting on a show” by arguing with the officer
and looking back towards the Mayor.”


The Miami Herald fills in some details
:

Though the report doesn’t identify him, the man is
Christopher Korge, a high-level Democratic fundraiser who hosted
President Barack Obama at his Pinecrest home in 2012.

Cardoso told Korge that “if he continued to try to enter, that it
would be considered trespassing.” That’s when, the report says,
Levine approached Cardoso, shook his hand and said, “I’m the new
mayor of Miami Beach,” and repeated it several times.

The mayor claims he spoke to someone with the police department
the next day but could not provide a name. Police say they
attempted to contact him several times for a sworn statement but
could not reach him.

Levine was
endorsed last year by Bill Clinton
, and his official bio
describes
him
as an “integral” member of the Miami Beach community for
the past 30 years. The homeowner who threw the party said the mayor
was a friend and had been among 300 invitees. He called the party
crashing scene “absolutely insane” and a “horror.” 

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Sheldon Richman on U.S. Intervention in Libya

All has not been well in Libya since the U.S. military led NATO
forces in an air campaign to overthrow former ruler Muammar
Gaddafi. American officials assured us that “moderates” would
succeed the cruel and unpredictable dictator, who had become a U.S.
ally during the Iraq war. However, it turns out that the moderate
victors were not so moderate; in fact they resembled
al-Qaeda. 

The overthrow of Gaddafi should stand as a lesson in the dangers
of interfering with other countries, writes Sheldon Richman.
Gaddafi was a brutal dictator, of course, and the people would have
been justified in kicking him out. But outsiders can never know
what will follow their intervention. And if the first rule
governments should follow is, “Do no harm,” the second rule is:
Assume that intervention will do far more harm than good.

View this article.

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Congress Passes Gutted Anti-NSA Spying Bill Beyond Recognition; Original Co-Sponsor Votes “No”

Submitted by Mike Krieger of Liberty Blitzkrieg blog,

It’s shameful that the president of the United States, the chairman of the House Permanent Select Committee on Intelligence, and the leaders of the country’s surveillance agencies refuse to accept consensus reforms that will keep our country safe while upholding the Constitution. And it mocks our system of government that they worked to gut key provisions of the Freedom Act behind closed doors.

 

– Rep. Justin Amash of Michigan, original cosponsor of the USA Freedom Act

In what will come as no surprise to any of you, there are very few members of Congress I have even the slightest degree of respect for. However, Justin Amash is one of them.

Rep. Amash is 34 years old and was first elected to Congress in 2010. He has been on my radar screen for several years now as one of the few elected representatives who act more like statesmen than politicians. He has been on the right side of many civil liberties related issues, including his opposition to the NDAA’s provision that allows for the indefinite detention of American citizens without a trial. More recently, last summer he authored an anti-NSA amendment known as the “Amash Amendment,” which was defeated by establishment authoritarians in both political parties. I covered that story in my post: NSA Holds “Top Secret” Meeting to Stop Powerful Anti-Spying Amendment.

Being the fighter that he is, Amash regrouped and came back with an anti-NSA spying bill with some teeth to it: The USA Freedom Act. This bill concerned the establishment to such a degree that Senator Feinstein launched her own competing bill, which believe it or not, intended to codify the NSA’s unconstitutional practices into law.

In the end, what the status quo did was water down the once robust USA Freedom Act into oblivion. Don’t take my word for it, Justin Amash wrote the following on his Facebook page:

Today, I will vote no on ?#‎HR3361?, the ?#‎USAFREEDOMAct?.

 

I am an original cosponsor of the Freedom Act, and I was involved in its drafting. At its best, the Freedom Act would have reined in the government’s unconstitutional domestic spying programs, ended the indiscriminate collection of Americans’ private records, and made the secret FISA court function more like a real court—with real arguments and real adversaries.

 

I was and am proud of the work our group, led by Rep. Jim Sensenbrenner, did to promote this legislation, as originally drafted.

 

However, the revised bill that makes its way to the House floor this morning doesn’t look much like the Freedom Act.

 

This morning’s bill maintains and codifies a large-scale, unconstitutional domestic spying program. It claims to end “bulk collection” of Americans’ data only in a very technical sense: The bill prohibits the government from, for example, ordering a telephone company to turn over all its call records every day.

 

But the bill was so weakened in behind-the-scenes negotiations over the last week that the government still can order—without probable cause—a telephone company to turn over all call records for “area code 616″ or for “phone calls made east of the Mississippi.” The bill green-lights the government’s massive data collection activities that sweep up Americans’ records in violation of the Fourth Amendment.

 

The bill does include a few modest improvements to current law. The secret FISA court that approves government surveillance must publish its most significant opinions so that Americans can have some idea of what surveillance the government is doing. The bill authorizes (but does not require) the FISA court to appoint lawyers to argue for Americans’ privacy rights, whereas the court now only hears from one side before ruling.

 

But while the original version of the Freedom Act allowed Sec. 215 of the Patriot Act to expire in June 2015, this morning’s bill extends the life of that controversial section for more than two years, through 2017.

 

I thank Judiciary Committee Chairman Bob Goodlatte for pursuing surveillance reform. I respect Rep. Jim Sensenbrenner and Rep. John Conyers for their work on this issue.

 

It’s shameful that the president of the United States, the chairman of the House Permanent Select Committee on Intelligence, and the leaders of the country’s surveillance agencies refuse to accept consensus reforms that will keep our country safe while upholding the Constitution. And it mocks our system of government that they worked to gut key provisions of the Freedom Act behind closed doors.

 

The American people demand that the Constitution be respected, that our rights and liberties be secured, and that the government stay out of our private lives. Fortunately, there is a growing group of representatives on both sides of the aisle who get it. In the 10 months since I proposed the Amash Amendment to end mass surveillance, we’ve made big gains.

We will succeed.

So it is this watered down, toothless bill that passed this morning. Just in case you still had any doubt what the cretins in Congress are all about. As Mark Twain famously stated:

“There is no distinctly American criminal class – except Congress.”




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Workers Really Are Dropping Out of the Job Market

UnemploymentA new poll of unemployed
Americans finds that almost half of them have given up looking for
a job. That casts a depressing light on the debate over why the
labor force participation rate has rolled downhill in recent years.
Folks saying the economy isn’t as sucky as it looks claim that
demographic changes—especially an aging population—drive the
plunge. Others say the job market is sluggish at best and that
people are just giving up. The poll lends support for that
depressing second bunch—and maybe for the idea that some job
seekers need a nudge.

The April poll of 1,500 unemployed, conducted by Harris Poll on
behalf of Express Employment Professionals, finds some
not-so-encouraging results:

  • 47 percent agree with the statement, “I’ve completely given up
    on looking for a job.” (7 percent said they “agree completely,” 7
    percent “agree a lot,” 15 percent “agree somewhat,” and 18 percent
    “agree a little.”)
  • 46 percent report not having gone on any job interviews in the
    prior month. Among those unemployed for more than two years, 71
    percent report not having gone on any interviews in the prior
    month.
  • 23 percent say their last interview was in 2012 or before.
  • 60 percent say looking for work has been harder than expected.
    10 percent say it’s been easier than expected.

In recent years, the Labor Force
Participation Rate
nosedived from above 66 percent of the
potential workforce to below 63 percent, which is the lowest level
since 1978. This has engendered much rending of garments and
gnashing of teeth—and the public debate mentioned above about
“why.”

Labor Force Participation

An
aging work force
gets some of the “credit” for the drop.
Americans age and retire and there are relatively fewer young
workers to take their place. A
report from the Philadelphia Federal Reserve Bank
, published
earlier this year, attributed about two-thirds of the decline since
2000 to a combination of retirement and disability, with a surge in
retiring Baby Boomers over the past couple of years. (Disturbingly,
“the number of disabled persons has been steadily rising.”)

But the report found that discouraged workers, with a big
increase in that category during the recession, explained 30
percent of declining labor force participation. In addition,
“nonparticipation due to schooling has been steadily increasing,”
which could well reflect another form of dropping out, as potential
workers continue along or return to the education track after
taking a look at the job market.

The poll does raise some concerns over whether all turned-off
job seekers are willing to go the extra mile to find a paying gig.
Forty-four percent are not willing to change towns in search of
work, and 60 percent won’t cross a state line.

That might have something to do with the 72 percent who call
unemployment compensation a “cushion” and the 48 percent who say
they “haven’t had to look for work as hard” because of it.

Or maybe they just think things are lousy all over.

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Andy Levy, on his V.A. care: ‘It was absolutely awful, and nothing horrible I hear about it ever surprises me’

Last night on
The Independents
, Red Eye co-host Andy Levy, who is a military
veteran, talked bluntly about his (and his comrades’) experience
with the Veterans Administration. “I have yet to meet a veteran who
was satisfied with their V.A. care,” Levy said, in a panel segment
that also included Reason Managing Editor Katherine
Mangu-Ward
:

On
Tuesday night’s
episode, National Review Online
contributor Deroy
Murdock
also talked about the scandal:

Reason on the V.A. mess here.

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“What Could Go Wrong” – China’s “Worst Case Negative Loop”

Yesterday, as we reported, in a surprisingly scathing report, Goldman announced that it was now positioning for an “imminent” two year real estate property downturn, which has significant probability of becoming a hard landing as many others, most notably Barclays in recent days, have pointed out. Which is perhaps why Goldman was one of the few banks this morning to trash last night’s “better than expected” HSBC manufacturing PMI report, as a softish landing is now clearly Goldman’s base case.

But under what conditions could the soft landing scenario become a hard landing? In other words, what could go wrong?

Here is Goldman’s answer:

We are concerned about policy uncertainties, and the possibility that potential policy changes could be too little or too late. In particular, we believe potential policy missteps could lead to a self-fulfilling bear-case scenario, i.e. further property market weakness, which could in turn lead to weak corporate earnings, rising unemployment, forex outflow, lower GDP and bank asset quality risks.

We believe the two policies discussed below are critical in preventing a prolonged property market slowdown while not increasing the property over-investment risks:

  • Lower the minimum down-payment ratio for property upgrades, e.g. to 50% from the current 60% (nationwide) and 70% (in some big cities).

We note that during the housing reform in 2001 when many government and SOE employees obtained subsidized houses from the government at much reduced prices, China house-ownership within urban areas already reached c. 80%, according to the Ministry of Housing.

As such, property demand has been mainly driven by households improving their living standard, or upgrading need. In 2011, to control housing prices, China adopted a mortgage policy that imposed minimum 60% downpayment ratios for second home purchases. Second home purchase is defined as: 1) a family that already has a flat; or 2) a family that historically already borrowed a mortgage (even though the family already paid off the mortgage and no longer owns the flat).

We believe such a high down payment for second homes effectively significantly hurt property upgrade needs, which is the main demand for property markets, rather than the first home purchase.

As such, we believe lower downpayment ratios for second home purchases will be fundamentally positive for increased property demand, while not increasing property bubble risks as China still prohibits the purchase of third homes.

  • Lower the funding costs for mortgage and corporate sectors, by RRR cut, removal of loan/deposit ratios, etc., per our earlier discussion.

That said, we are not sure whether these policies will be changed, and when.

In the bear case, if China fails to address the above-mentioned policy mix, we believe worse-than-expected mortgage rate rise could lead to a more severe property downturn, a FAI/GDP slowdown, and corporate earnings weakness, and in turn, could lead to higher unemployment, forex outflow, and more GDP/property/banks’ asset quality downside risks.

We define our base case assumptions for bank earnings estimates below:

  • China selectively eases mortgage policies for property upgrade needs in certain areas in 4Q14 (on May 12, 2014, PBOC held a meeting with banks to encourage mortgage offering);
  • No RRR cut. China banks’ funding costs continue to rise, which retain relatively high corporate/mortgage funding costs.

* * *

A simple way of grasping the above is with this useful diagram which summarizes the negative loop that China’s economy (which essentially means housing market which as SocGen recently explained is indirectly responsible for 80% of local GDP) could fall into should the government not promptly move to address the emerging dangerous situation, i.e., resume aggressive easing.

So is China taking this warning seriously? Why yes: as the WSJ reported today, China’s central bank is set to inject the most cash this week into the financial system since late January to help meet rising demand from companies and to boost the sluggish economy.

The People’s Bank of China will pump a net 120 billion yuan ($19.2 billion) into the interbank market this week, said traders participating in the operation Thursday. That’s the most since the last week of January.

 

“It’s to a certain extent a form of monetary policy easing as looser funding conditions will definitely facilitate the ongoing economic recovery,” said Steve Wang, research director at Reorient Financial Markets Limited.

Keep in mind that this is happening as China is also easing at the fiscal and macro level, having pushed the Yuan to its lowest official fixing since September, a move which in itself has largely offset the concerns about liquidity following the ongoing credit drought. However, the favorable impact of FX may be passing:

Despite the supply of funds, it wasn’t enough to cool rising stress in the financial system. A seven-day benchmark cost of short-term loans among banks rose to 3.43% Thursday, from 3.39% Wednesday…. China’s central bank and financial institutions bought a net 116.92 billion yuan ($18.8 billion) of foreign currency in April, compared with a net purchase of 189.20 billion yuan in March.

Yet on the surface, it appears that China’s liquidity injection is merely being implemented to sooth the memory of last year’s near collapse of the nation’s money market when the 7-day repo rate briefly exploded as high as 25%.

“This week’s large injection is also aimed at stabilizing sentiment in the market, because obviously the authorities don’t want the cash crunch to repeat itself,” said Mr. Wang. “To achieve stable economic growth, you need to stablize people’s mood first,” he added.

In other words, once this temporary liquidity injection passes, the storm clouds over China’s “negative loop” may promptly gather once again…




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How Scalia Helped Legalize Gay Marriage in Pennsylvania

In his decision this week striking down Pennsylvania’s ban on
gay marriage in
Whitewood v. Wolf
, U.S. District Judge John E. Jones
III quoted extensively from the jurisprudence of Supreme Court
Justice Anthony Kennedy. That came as no surprise, of course, since
Kennedy has written all of the Court’s biggest decisions in favor
of gay rights, from Lawrence
v. Texas
(2003), which invalidated that state’s ban on
homosexual conduct, to United
States v. Windsor
(2013), which stuck down part of the
1996 Defense of Marriage Act.

But Judge Jones also relied on a more surprising
ally to reach his conclusion. That ally was Justice Antonin Scalia,
the same conservative jurist who once railed
against his Supreme Court colleagues for “sign[ing] on to the
so-called homosexual agenda.” How did Scalia help Jones? It’s
relatively simple. When it came time for Jones to perform a crucial
piece of legal analysis on the constitutionality of the
Pennsylvania gay marriage ban, he found Scalia to be a more useful
guide than Kennedy. That sealed the deal and allowed Jones to
legalize same-sex unions in the Keystone State. Here’s how these
strange judicial bedfellows came together.

Last term in U.S. v. Windsor, the Supreme Court was
tasked with deciding whether Section 3 of the Defense of Marriage
Act (DOMA), which had forbidden the federal government from
recognizing same-sex unions that were permitted under state law,
violated the equal protection component of the Fifth Amendment.
Kennedy’s majority opinion held that it did.

In dissent, Scalia lambasted Kennedy for sidestepping the
Court’s precedents governing equal protection cases. “The opinion,”
Scalia wrote in Windsor, “does not resolve and indeed does
not even mention what had been the central question in this
litigation: whether, under the Equal Protection Clause, laws
restricting marriage to a man and a woman are reviewed for more
than mere rationality.”

Scalia had a point. Typically, when the Equal Protection Clause
of the 14th Amendment (or the equal protection component of the
Fifth Amendment) is at issue, the courts first decide what degree
of judicial review is appropriate for resolving the case. There are
three basic settings. The most lenient is rational-basis review
(Scalia’s “mere rationality”), where the courts extend broad
deference to the government. The next level is called intermediate
scrutiny, or sometimes heightened scrutiny. Here the government
must shoulder most of the burden of proof and demonstrate that its
statute is substantially related to an important government
objective. Finally, there is strict scrutiny, the most exacting
standard, which requires the government to prove both that the law
serves a compelling government interest and that it is the least
restrictive means for achieving that interest.

That may sound like a bunch of lawyers splitting hairs; but the
real-world impact cannot be overstated. Rational-basis review

stacks the deck
overwhelmingly in favor of the government. (“It
is enough,” the Supreme Court
held
in one rational-basis case, “that it might be thought that
the particular legislative measure was a rational way” for
lawmakers to proceed. Emphasis on might be thought.)
Intermediate scrutiny, by contrast, reverses the odds and forces
lawmakers to mount a persuasive and verifiable defense of their
contested statutes. In practical terms, rational-basis review
allows a gay marriage ban to remain in force; intermediate scrutiny
requires the ban to fall.

Yet when Kennedy wrote his Windsor opinion invalidating
part of DOMA, he did not clearly adopt any of one of those
differing levels of review. Instead, he spent the bulk of the
opinion emphasizing the fact that DOMA singled out one class of
Americans for abuse. At the same time, however, he also included
certain language taken from rational-basis cases. But as Scalia
complained in dissent, “the Court certainly does not apply
anything that resembles that deferential framework.” In other
words, Scalia accused Kennedy of quietly deploying intermediate
scrutiny without bothering to justify why that heightened approach
was appropriate under the Court’s precedents.

Which brings us back to Judge Jones and his ruling this week in
Pennsylvania. Like every other federal judge weighing a state ban
on gay marriage, Jones was duty-bound to follow relevant Supreme
Court jurisprudence. But as noted above, the most directly
applicable case, Kennedy’s ruling on DOMA, offers no clear guidance
on the appropriate level of judicial review a lower court judge
should apply. That put Jones in a legal pickle. Should he defer to
the Pennsylvania ban or not?

To answer that question, Jones turned to Scalia. “As Justice
Scalia cogently remarked in his dissent,” Jones wrote, “‘if
[Windsor] is meant to be an equal-protection opinion, it is a
confusing one.'” Then, lest anyone miss the point, Jones proceeded
to adopt Scalia’s reading of Windsor: “Its discussion is
manifestly not representative of deferential review.” As Scalia saw
it, Windsor was an intermediate scrutiny case in all but
name. Jones happily signed on to that interpretation and applied a
fatal dose of heightened scrutiny to Pennsylvania’s gay marriage
ban.

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Echoes Of 1937 In The Current Economic Cycle

Submitted by Brendan Brown via the Ludwig von Mises Institute,

It is not too early to ask how the present US business cycle expansion, already more than five years old, will end. The history of the last great US monetary experiment in “quantitative easing” (QE) from 1934-7 suggests that the end could be violent. Autumn 1937 featured one of the largest New York stock market crashes ever accompanied by the descent of the US economy into the notorious Roosevelt Recession. Should we take comfort from the fact that Friedman and Schwartz, in their epic monetary history, claim to have discovered the policy error by the Federal Reserve which was responsible for the 1937 denouement. And that today’s Fed officials are adamant about having learned their lesson? The short answer is no.

According to the now mainstream narrative, the strong economic recovery of 1935-6 could have continued for much longer if it had not been for the successive hikes in reserve requirements through late 1936 and early 1937, together with the sterilization of gold inflows from the start of that year. This meant the end of rapid growth in high-powered money supply. The trigger for these monetary policy changes was concerns within the Federal Reserve and White House about the intense speculative climate which had developed in equity and commodity markets during 1936, coupled with apparent upward pressure on goods prices. Friedman and Schwartz imply that these concerns were misplaced. And indeed, as regards the rise in goods prices, this was a benign recovery from a deep cyclical low-point in 1933 rather than something symptomatic of monetary inflation. It was, however, quite a different story for asset prices.

The monetary manipulations of the Roosevelt administration in combination with the Federal Reserve (dollar devaluation, monetization of subsequent huge gold inflows, interest rates pegged at zero throughout) had been fueled by 1936 serious asset price inflation most of all in the US equity and commodity markets. Today we recognize irrational exuberance as the salient feature of this monetary disease. Some combination of yield desperation and fears concerning an eruption of goods inflation in the far distant future lies behind the irrationality. The manipulating of long-term rates below neutral also encourages various feedback loops in which rising asset prices appear to justify otherwise wild speculation.

There is no simple empirical test which detects and measures speculative froth. We do not know the “underlying value” which would correspond to a sober rational weighing of all the risks. Traditional benchmarks of valuation such as normal price-earnings ratios are particularly misleading in a period such as the mid-late 1930s when the geo-political, domestic political, monetary, and economic climates are highly turbulent.

Asset price inflation would come to an end even without monetary action. It is sufficient that the real world outside becomes so much worse than what the irrationally exuberant investors have been seeing through rose colored spectacles (which filter out dangers and exaggerate expected returns) that the lenses splinter. In late summer 1937 that is what may well have happened. The rapid economic recovery of 1936 was evidently stalling by mid-1937. In July, Imperial Japan had launched its full-scale invasion of China. German rearmament accelerated following the military re-occupation of the Rhineland. In May 1937 the Supreme Court had ruled in favor of the Roosevelt administration’s trade union legislation. As markets crashed from August through autumn 1937, business confidence and investment plummeted.

The importance of monetary policy actions in late 1936 and early 1937 in contributing to this bad outcome is dubious. When market rates of interest are at zero, high-powered money lacks power, as banks are willing hoarders of large reserves well beyond normal levels (relative to their deposit base). Short-term rates hardly rose in response to the raising of reserve requirements through late 1936 and early 1937. Long-term Treasury bond yields climbed briefly in March 1937 by around 30 basis points to a peak of 2.75 percent before falling back, partly due to evidence of economic slowdown, and partly to a Fed bond-buying program as demanded by the Roosevelt administration. That political intervention surely signaled to contemporary investors that long-run inflation dangers were still live — a positive factor for continuing asset price inflation.

What are the parallels with the present? We have had some similarly ambiguous Federal Reserve policy actions. This time long-maturity T-bond yields have climbed more sharply from their low point (early 2013) but the announced curtailment of QE has so far been less striking. A more important parallel is the amount of irrational exuberance now evident in a range of asset classes (high-yield bonds, European periphery sovereign debts, real estate in various global hotspots, German equities, US financial and technology sector equities, private equity). A failure of the US economy to take off into a higher flight path beyond the winter stall and spring re-bound, disappointment regarding a German economic mini-miracle, a Chinese “hard landing,” geo-political storms, and a host of idiosyncratic factors which could setoff waves of profit-taking, are all possible triggers to asset price deflation and an early end to this cycle.

 

As we noted previously – it's never different this time…

While chart analogs provide optically pleasing (and often far too shockingly correct) indications of the human herd tendencies towards fear and greed, a glance through the headlines and reporting of prior periods can provide just as much of a concerning 'analog' as any chart. In this case, while a picture can paint a thousand words; a thousand words may also paint the biggest picture of all. It seems, socially and empirically, it is never different this time as these 1936 Wall Street Journal archives read only too wellfrom devaluations lifting stocks to inflationary side-effects of money flow and from short-covering, money-on-the-sidelines, Jobs, Europe, low-volume ramps, BTFD, and profit-taking, to brokers advising stocks for the long-run before a 40% decline.

Things look eerily similar eh?

 

But when we look at the headlines in the Wall Street Journal from mid 1936 to mid 1937 as the market topped out (orange oval), dipped, was bought back, then collapsed 40% in 3 months, nothing ever changes…

 

Government Bailouts Repaid – Bullish Implications…

N.Y. Central Has Repaid All Government Loans
The Wall Street Journal, 978 words
Dec 1, 1936
WASHINGTON Numerous railroad developments here yesterday were climaxed by the announcement of RFC Chairman Jesse H. Jones that New York Central had repaid all of its government loans, totaling $16,858,950, most of which was not due until 1941.

The Buying Is Not Speculation – Cash On The Sidelines…

It's Cash Bull Market With Little Inflation, Says Exchange Bulletin
The Wall Street Journal, 169 words
Dec 16, 1936
"This is eminently a cash market, and as such is relatively devoid of that major characteristic of speculative inflation, the use of borrowed money." says the December Bulletin of the N.Y. Stock Exchange.

Inflationary Side-Effects – Buy It All It's Going Up…

Wheat Prices Soar To 7-Year Highs On Heavy Buying Stimulated by Broad Advances in Foreign Pits
The Wall Street Journal, 1497 words
Dec 19, 1936
CHICAGO An avalanche of buying, encouraged by buoyancy in foreign markets, particularly in Winnipeg, swept wheat prices to the highest levels since December, 1929, Friday.

 

But… 3 days before…

The Wall Street Journal, 1027 words
Dec 16, 1936
As commodity prices continued to advance yesterday to the accompaniment of increasing public speculation in futures markets, signs of a feeling of caution appeared from widely separated centers.

As Goes The US So Goes The Rest Of The World…

London Trade Stimulated By Wall Street Strength; Averages at New Highs
The Wall Street Journal, 859 words
Nov 6, 1936
LONDON Overnight strength in Wall Street considerably stimulated the stock market yesterday. Dealers again arrived earlier than usual in anticipation of activity in international issues and found large buying orders in these stocks awaiting execution.

Global Economy To Lift Stocks…

London, New York Stock Transactions Largest in Months – British Brokers Stand in Queues to Fill Orders Activity Ascribed to World Efforts to Revive Trade
The Wall Street Journal, 956 words
Oct 8, 1936
Growing realization that the determined international effort now being made to sweep away trade barriers will be followed by improved business conditions throughout the world brought a rush of business to the security markets in New York and London yesterday such as not been seen for months.

Devaluation Always A Winner… (Market Prices Prove Economy Likes It)

Wall Street Weighs Devaluation Effects On U.S. Markets; Sees Little Likelihood of Dumping

 The Wall Street Journal, 1759 words
Sep 28, 1936
Rising security and commodity markets Saturday gave ample indication of the financial district's "bullish" interpretation of the U.S. Anglo-French monetary agreement.

Markets Cheerful Over Devaluation; Morgenthau Not Afraid of Dumping
Selective Buying Here and Abroad Motors and Other Shares Held To Benefit From Improved World Trade Are Strong Commodities Less Responsive International Markets
The Wall Street Journal, 1726 words
Sep 29, 1936
A note of cautious optimism was sounded by leading stock exchanges of the world which were open for business yesterday.

Equity Valuations Irrelevant…

Earnings Yield of 15 Stocks 4.8%, Compared with 9.4% Ten Years Ago
The Wall Street Journal, 1280 words
Aug 7, 1936
Industrial earning power is valued nearly twice as highly in the current stock market as it was ten years ago.

Europe Ever The Optimist Even In The Face Of Dismal Reality…

France Optimistic Despite Continuing European Tension – Growing Franco-English Cooperation Inspires Confidence
The Wall Street Journal, 652 words
Dec 5, 1936
Despite the unabated international tension and sudden menace of a constitutional crisis in Great Britain, the continuance of quarrels between Right and Left wings of the Popular Front, and the persistent antagonism between employers and labor, the general feeling in France is rather optimistic than pessimistic.

Short Covering As Ever…

Active Short Covering Sweeps Grain Prices To New High Levels – Chases Bears
The Wall Street Journal, 1345 words
Dec 2, 1936
New highs for the season were recorded in wheat, corn, rye and oats Tuesday. Spot red winter wheat advanced to the highest level since February, 1929. The sharp upturn, which boosted December corn almost 5 cents, and December wheat about 3 cents, was due principally to short covering by those made uneasy over the sale of an unusually large quantity of spot wheat out of local store, and by generous snowfall over the grain belt. Early in the session the market ruled easy on reports of rain and snow, and predictions for continued unsettled weather.

Government Spending Cuts Cause Concern…

Sabotaging Federal Economy
The Wall Street Journal, 412 words
Dec 5, 1936
Even the modest beginning which is attempted by WPA officials to reduce cost of government by cutting down the relief roles is encountering strong opposition. It is perhaps only natural that the workers themselves should object, although their methods of protesting through "sitdown" strikes, not to mention the violence which has manifested itself, may be open to question. But much more …

States And Taxes…

Sales Tax Repeal May Unbalance Kentucky Finances
The Wall Street Journal, 1002 words
Jan 14, 1936
LOUISVILLE, Ky.–Repeal of Kentucky's 3% sales tax, effective the moment Governor Albert B. Chandler signs it, probably Wednesday will deprive the state of $3,500,000 of revenue budgeted to the expiration of the biennium ending June 30, 1936 and the counties of $1,750,000.

The Foreign Money Will Save Us…

Financial Centers Expect Greater Foreign Interest in Our Securities As Congress Delays Alien Tax Boost – Foreign Interest Here
The Wall Street Journal, 765 words
Aug 6, 1937
Some resumption of foreign interest…

Money On The Sidelines…

The Wall Street Journal, 590 words
Jul 1, 1937
While the Street remains in a cautious frame of mind, there are undoubtedly more possible buyers than sellers around, and it would not take a lot of encouragement to get these gentlemen aboard. Feeling in brokerage circles is that stocks are more likely to advance on any break in the unpleasant headlines these days than to decline far on a continuation of current uncertainties.

Jobs And Europe never far from fear…

The Wall Street Journal, 683 words
Jun 29, 1937
Certainly the market was more active on the downside, which surprised a lot of traders who had expected otherwise. The labor and foreign situations remain the main factors in the picture, and brokers feel that these have not changed one whit for the better thus far.

Buy The F##king Dip…

The Wall Street Journal, 508 words
Aug 24, 1937
A rather depressed feeling is extant in Wall Street as small volume and lower prices continue. Yet there are not many bears in the Street so far as the long pull is concerned. Traders still are stubborn in their theory that stocks are reactionary at the moment from lack of interest rather than any important liquidation. This is the period of the year when business takes a final breathing spell before the more active Fall and some think the stock market is doing likewise and that better days are ahead.

Rallies had Real Volume Then – No Low Volume Ramps…

The Wall Street Journal, 564 words
Aug 16, 1937
If Saturday's volume was any indication, revived interest in the stock market is here in the opinion of the Street. Furthermore the scope of trading Friday and Saturday indicated a broadening interest which included medium priced as well as low priced issues on contrast to the extended period wherein so-called "quality" stocks held sway in a limited market with small volume.

And At The Top… Brokers Suggest Stocks For The Long-Run (based on 'expectations')

The Wall Street Journal, 665 words
Aug 7, 1937
Profit taking for the week-end brought prices down in yesterday's market, but the undertone remained steady and brokers said there was nothing important in the character of the selling. Many houses were advising the purchase of favored issues on any further reactions. Metal shares ended the day with advances in many cases. There was impressive buying reported in the copper issues largely for long pull purposes.

The Wall Street Journal, 649 words
Aug 10, 1937
While volume left much to be desired, the expectation of stronger and more active markets continued to pervade Wall Street. Moreover, the general business picture is regarded as more pleasing than at any time since the so-called Summer "lull" came into force. Incidentally, the seasonal letdown thus far has not proved to be as extensive as many predicted and expected. Brokers say that many clients are away and that there are others who will be replacing their sold-out long positions in coming weeks.

See – it really is never different this time. It merely appears so since – as Kyle Bass so eloquently noted, the brevity of financial memory is about two years…

 

(h/t @ParagonCap)

 




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