Month: December 2014

One of the most important Zero Hedge posts of the last few years was "The "Muddle Through" Has Failed: BCG Says "There May Be Only Painful Ways Out Of The Crisis"" where The Boston Consulting Group (BCG) helped explain how the economic establishment is trying everything to move the system further with ever more cheap money and debt, why this will fail, and the inevitable wealth taxes that will be imposed to refloat the system from the ashes.

One of the authors of the infamous "Back to Mesopotamia" report (if 1984 is the instruction manual for political leaders, then this is the instruction manual for monetary leaders) was BCG senior partner Daniel Stetler, now blogger, and author "Debt In The 21st Century" who sees debt and leverage as the main factors driving wealth and inequality – a fact clearly overloked by Piketty.

Stetler was recently interviewed by Portugal's Janela na web magazine, his insights are significant and worrisome…

Some key excerpts:

"You have to think about a huge tower of debt on shaky foundations where central banks pump concrete in the foundations in an emergency effort to avoid the building from collapsing and at the same time builders are adding additional floors on top"

 

"Today central banks give money to institutions, which are not solvent, against doubtful collateral for zero interest. This is not capitalism."

 

"It is the explicit goal of central banks to avoid the tower of debt to crash. Therefore they do everything to make money cheap and allow more speculation and even higher asset values. It is consistent with their thinking of the past 30 years. Unfortunately the debt levels are too high now and their instruments do not work anymore as good. They might bring up financial assets but they cannot revive the real economy."

 

"In my view [Piketty] overlook the fact that only growing debt levels make it possible to have such a growth in measured wealth. Summing up, Piketty looks at symptoms – wealth – and not on causes – debt."

 

"We need to limit credit growth and make it tax-attractive to invest in the real economy not in financial speculation. This will happen automatically if we return to normal interest rates. The key point is, that we as societies should reduce consumption which includes social welfare and rather invest more in the future."

 

"We all are in a Ponzi world right now. Hoping to be bailed out by the next person. The problem is that demographics alone have to tell us, that there are fewer people entering the scheme then leaving. More people get out than in. Which means, by definition, that the scheme is at an end. The Minsky moment is the crash. Like all crashes it is easier to explain it afterwards than to time it before. But I think it is obvious that the endgame is near."

*  *  *

Full interview below:

Your most recent book “Debt in the XXI Century,” [Die Schulden im 21. Jahrhundert] is a reply to the “Capital” of Piketty, considered best book in Business for 2014, or it is the normal follow up of your “Trillion Debt Bomb”?

Both. In my view we have to deal with a major economic crisis in the western world: too much debt. Since 1980 the leading industrial economies have more than doubled their debt load relative to GDP from 160% of GDP to more then 320% in 2008. This is the debt load of governments, non-financial corporations and private households together. If you go by these sectors, governments have in real terms (means corrected for inflation) more than four times as much debt, corporations more than three times and private households more than six times as much debt. These additional debts allowed us to grow faster than we otherwise would have. A big party! Unfortunately debt cannot grow faster than income forever. In 2008 the party came to an end when it became clear, that a big part of these debts will not be served in an orderly way. The crisis was amplified by the fact that not only the real economy took on too much debt but the financial system as well and all sectors worked with ever lower equity and therefore capacity to absorb losses.

«You have to think about a huge tower of debt on shaky foundations where central banks pump concrete in the foundations in an emergency effort to avoid the building from collapsing and at the same time builders are adding additional floors on top»

The policies taken at the time were the right ones?

The reaction of politicians and central banks since 2008 was simple: fighting a crisis due to too much debt with even more cheap money and even more debt. In global terms, since 2007 the debt have grown by $45 trillion and the debt to GDP ratio is 20 percentage points higher than in 2007. You have to think about a huge tower of debt on shaky foundations where central banks pump concrete in the foundations in an emergency effort to avoid the building from collapsing and at the same time builders are adding additional floors on top. All this is discussed in my “Billion Debt Bomb”.

How we dismantle the debt bomb?

I discuss the different options: austerity, growth, inflation, default, or orderly debt restructuring. 1) Austerity does not work in a world where everyone has high debt levels and especially not in a system like the Euro. The more you try to save, the more you owe, a dynamic already described by American economist Irving Fisher ["The Debt-Deflation Theory of Great Depressions," Econometrica,1933]. 2) Growth would be nice but unfortunately high debts dampen the economic activity and demographics and slow productivity growth limit the growth potential. 4) Inflation requires growth in credit and therefore is impossible to achieve if everyone is already over indebted. You can only achieve it by ruining the trust in the currency. But then it is totally out of control. 4) Remain defaults, which could amplify the crisis or orderly debt restructuring which is in my view the best way of how to deal with the situation.

Why you refer to French economist Thomas Piketty in your recent book? Where “enters” Pikety’s thesis developed in his “Capital”, considered Best Book in Economics and Business of 2014?

I thought he is contributing to a solution to the crisis with his “Capital in the Twenty-First Century” in linking the debt problem with his analysis of global wealth levels and distribution. But after reading it I was disappointed: he is giving a very interesting overview of wealth but he is totally overlooking the effects of debt. He only looks at government debt, which he sees as a result of poor distribution of wealth between the private and the public sector. He does not mention the high private debt at all. Debt is for Piketty neutral but for me it is a key-driving factor for asset prices and wealth concentration. This is the reason why I wrote the book on Piketty.

But do you disagree with the policies he suggested?

When it comes to the solution of the crisis I am again closer to Piketty although broader: we need to have a joint debt restructuring of private and public debt. For the Eurozone I calculate the debt, which cannot be orderly, repaid to be at least 3 trillion euro. These debt need to be restructured in a joint effort of debtors and creditors and these losses have to be somehow financed and there Piketty’s ideas of higher wealth taxes will become highly relevant again as politicians can use his arguments to tax wealth.

«In my view [Piketty] overlook the fact that only growing debt levels make it possible to have such a growth in measured wealth. Summing up, Piketty looks at symptoms – wealth – and not on causes – debt.»

Do you agree with his findings regarding the re-emergence of a “patrimonial capitalism”?

The part in Piketty’s book which deals with the historical data is the best of the overall book and clearly an important contribution to the economic and political debate. In spite of some criticism on the data the overall picture seems to be right. We have seen wealth grow faster than income for several decades and the concentration of wealth has gone up in most countries, mostly in the US. Here lies the risk of political influence and a constant shift of power in the society. These are the main points of Piketty and explain the success of his book in the US. On the other hand his “world formula” r>g meaning that the return on capital (r ) is always bigger than the growth of the economy (g) is correctly challenged. Over time the return on capital might be higher but not all is saved and adds to the stock of capital as a part is consumed or taxed. In addition it is not guaranteed to get a return of 4 to 5 per cent forever, just look at current returns in Europe. I struggle finding a save asset with a return of 4 per cent these days. But he is not alone in assuming ever-growing wealth; the bank Credit Suisse does the same. In my view both overlook the fact that only growing debt levels make it possible to have such a growth in measured wealth. Summing up, Piketty looks at symptoms – wealth – and not on causes – debt.

Some analysts said that Piketty deserves the credit for the revival in the Economics field of the historical narrative methodology and perspective, ending the hegemony of formal mathematical models. Would you agree?

Definitely! Economics should come back to become a logical science in the sense of observing and analysing what can be seen in the real world instead of building abstract economic models which by definition are incomplete and therefore describe a reality which has nothing to do with the reality. Like in the joke, where an engineer and an economist reach a river which they have to cross. The engineer thinks about how to build a bridge, the economist says: “Let’s assume we are on the other side of the river”. Most visibly was this in the run-up to the crisis. Economists assumed efficient and rational markets and for them money and credit are neutral. Both terribly wrong assumptions.

The low-growth regime of the world economy, and particularly the average growth rate decline in the developed countries, is due to a “secular stagnation” or to the debt overhang?

Clear answer: too much debt. First of all the growth rates of the past were higher than fundamentally justified due to cheap money and credit. Just look at the real estate boom in Spain. Now we have to deleverage and reduce debt levels, which by definition is bad for economic growth. On the other side the debt boom has generated artificially high asset prices and allowed people to speculate with cheap money leading to high levels of wealth, a symptom as I said. Therefore we do not have excess savings leading to the secular stagnation but too much debt bringing down our economies.

«Today central banks give money to institutions, which are not solvent, against doubtful collateral for zero interest. This is not capitalism.»

Financial bubbles since the 1980s are one of the pillars of an artificial growth? Present capitalism needs always a “good bubble,” as someone once said ironically?

I would not say capitalism needs it, I would say politicians wanted it and central banks tried to deliver it. Whenever we had an economic problem – crash 1987, Asia Crisis, LTCM Crisis, Russia Crisis, Dot-com Bubble, 9/11, Housing Bubble – central banks helped with more easy credit and lower interest rates. But this was a one way bet, leading to ever more speculation and debt. The problem is that we never allow a small fire to burn and therefore create ever bigger fires like in California where the main reason for the big forest fires is the fact that they not allow small ones to happen. This is not what capitalism needs. Capitalism needs failures of companies and banks for wrong decisions. If we do not let this happen it is not very “capitalistic” but destroys capitalism in the long run. Walter Bagehot the founder of the Economist magazine and big thinker on central bank policy said a central bank should only give credit to institutions, which are solvent against first class collateral and at punishing interest rates. Today central banks give money to institutions, which are not solvent, against doubtful collateral for zero interest. This is not capitalism.

The huge private and public debt overhang trend since the 1980s was a spill over from the financialization of developed economies and also since the 2000s of great emerging economies?

It clearly helped. Worldwide politicians thought that by incurring more debt or by encouraging more debt in the private sector it is possible to create more growth and welfare. Short term this is right. In addition banks produce the money in our world. Most people still assume they have to have savings first to give a credit but this is wrong. The banking sector creates the money itself and the central banks can only indirectly influence what is going on. As the bankers have a big interest in giving as much credit as possible as this drives their profits and bonuses. If now the central bank and the state give an implicit guarantee the sky is the limit. The more credit you give, the better! This also explains the drive for ever more liberalisation of financial markets. And again: politicians are more then happy to get easy credit. It is a close linkage between banks and politicians; probably Piketty should have focussed more on this relationship, which also explains the ever-increasing asset values.

The debt trend had a boost with the monetary QE policies from the main central banks?

Of course! It is the explicit goal of central banks to avoid the tower of debt to crash. Therefore they do everything to make money cheap and allow more speculation and even higher asset values. It is consistent with their thinking of the past 30 years. Unfortunately the debt levels are too high now and their instruments do not work anymore as good. They might bring up financial assets but they cannot revive the real economy. It is like in a bar, which is full. When the bartender offers beer for free, only those standing directly at the bar get the beer. Those further away not. Then the guys at the bar, ask for more because the guys at the other end of the room did not get anything – but drink it again themselves. In todays world the guys standing at the bar are the bankers and the governments, the rest of us is at the other end of the room and do not benefit. We can only see financial speculation going on but no revival of the real economy.

The fiscal euro area consolidation policies stopped, or will stop, the debt trend?

It is one of the big myths that we have managed to stop the debt trend. In all countries debt – private and public combined – continue to grow faster than GDP. In Ireland debt is 84 per cent higher as in 2008, Portugal 69%, Greece 55%, Spain 40%, France 34% and Italy 27%. I would not call this saving. The point is even if you try to reduce your debt, like the Italian government does which is running a surplus in its budget before interest expense, without economic growth it is impossible to reduce your debt load. The policy of austerity is doomed to failure. Especially if governments reduce investments and by doing this reduce the growth potential even further. It is impossible to save us out of the problem. Debts are just too high. And as inflation is not setting in we have two options: defaults or orderly restructuring.

«We could still sit together and do a debt restructuring. Pooling the bad debt, which I estimate in the range of three to five trillion euro, refinance these debts with a loan by the ECB and pay it back over a period of 20 plus years.»

What you would suggest?

I would prefer a European restructuring fund, pooling the excess debt and paying it back jointly over a certain period, i.e. 20 years. The stronger countries would have to help the weaker ones, particularly Ireland and Portugal to deal with the debt overhang. But I doubt politicians will go down this path as it is highly unpopular at least in the countries paying more. Therefore we will see the ECB trying ever more desperate methods to revive the economy. I doubt it will succeed.

What can be done?

We could still sit together and do a debt restructuring. Pooling the bad debt, which I estimate in the range of three to five trillion euro, refinance these debts with a loan by the ECB and pay it back over a period of 20 plus years, as I said. With some solidarity between the European countries. Combined with a package for European growth, which is not based on more deficit spending as some are suggesting but by labour market deregulation and major investments in education and innovation. We also need an immigration policy as in spite of the current high unemployment we are facing a major demographic crisis, which we need to address. The true liabilities of governments are much higher than the official numbers as we have no reserves for the cost of an ageing society. For example in Germany the true debt level of the government is above 400 % of GDP if we incorporate these hidden liabilities – not at 75% as the official data suggest. We urgently need a program for growth and the faster we deal with the debt overhang the faster we come to a position in which we can work on that.

What is wrong with the current Eurozone mix of fiscal consolidation policies with monetary non conventional measures in the ZIRP boundary from ECB?

Well, the current policy buys time without using it. The debt tower gets new stories every day and the fundament on which it rests is not getting better. Therefore it is only a question of time until the public in some countries will not be willing to accept these policies any more. I am surprised how willing people in Spain, Portugal and Italy are to accept a long period of economic depression. The longer it continues – and it will – the higher the probability of a political earth quake. And then everything is possible, even defaults and Eurozone exits. We trick our selves when we believe the crisis is over. That’s why I proposed a few weeks ago to give every euro-zone citizen 10.000 euro from the ECB. I would prefer a debt restructuring as I laid out before but if this is not possible, the ECB should stop serving the free beer to those standing at the bar but give it to everyone directly. In doing so it would support the real debtors to help them paying back and support demand. The risk is obvious: people might loose trust in our monetary system and this could start inflation – but we need to lower the debt load and if all other ways don’t work and no one is willing to do the necessary debt restructuring, this might still be the second best.

When you suggested a €10K check per capita from ECB you are just suggesting an “Europeanization” of the famous Friedman “helicopter money”?

It is as you write an application of Helicopter money. The point is that Friedman thought about it mainly from the point of low demand, I see it to support over indebted real economy participants and to boost demand. In addition I think we should stop “funding” the banking sector/speculators and better help directly the real economy. An alternative would be by the way to introduce “sovereign money” which means to have only central bank money and the banks could only allocate these funds but not create money themselves. In the transition to such a system we could reap huge gains which could be used to deal with excessive private and government debt. Martin Wolf (Financial Times) has commented on this and thinks it might be a solution. I tend to agree

Do you think ECB will step further for a full QE, changing the composition of its balance sheet, including purchase of sovereign debt from its members? What could be Bundesbank and German reactions?

The ECB is the only working institution in Europe and it will do “whatever it takes” to rescue the Euro. Yes, they will go “all-in” trying to rescue the Euro. But in reality they will only buy time and give the guys at the bar a few more rounds of free beer. The ECB will not be able to fix the problem of too much debt and therefore we will see not only heavy buying of government bonds but also efforts to cancel these bonds on the balance sheet of the ECB. The ECB runs the risk of ending up as a debt redemption fund without any democratic legitimisation. This will cause trouble with the Bundesbank and Germany but in the end I believe that German politicians will prefer this way as it hides the true cost of “rescuing” Europe. I would prefer the open approach as by going via the ECB we still run the risk of political upheaval as this will be very slow and we will have to deal with depression for many years to come. It would be better to deal with the bad debt asap and then invest in making us more competitive and to support growth to get Europe in a position to compete on a global scale and to deal with the costs of an ageing society.

«We need to limit credit growth and make it tax-attractive to invest in the real economy not in financial speculation. This will happen automatically if we return to normal interest rates. The key point is, that we as societies should reduce consumption which includes social welfare and rather invest more in the future.»

A Keynesian “New Deal” in Europe, as the French calls considering Juncker’s 315 billion euros plan a fake promise, has a risk of debt addiction?

I participated in a discussion with French economists last week. What I found striking is the belief in the government to be able to fix all our problems. The French are truly socialist in my view. But the crisis we face is not a crisis of free market but of free markets in which the governments and central banks have taken away the risks and thereby changed the normal mechanisms of a market economy. The French believe we could just increase government spending and the problem is solved. Japan shows us, that this is by no means the case. The French also believe the government is the better entrepreneur and inventor. I doubt this as well. Only free markets can create innovation and new industries. The role of government is to ensure a good environment to make it possible. Now believing in 315 billion more spending of the EU to fix our problems is more than naïve. The only result will be even more debt which cannot be served.

Between austerity deflation plus some monetary stimulus and public fiscal spending plus a full QE, your’s is a kind of “third way”?

You are spot on. The starting point are the governments which in the crisis first cut their expenditures for the future: investment, education, innovation. This is totally wrong. We need to limit credit growth and make it tax-attractive to invest in the real economy not in financial speculation. This will happen automatically if we return to normal interest rates. The key point is, that we as societies should reduce consumption which includes social welfare and rather invest more in the future.

When do you think a new “Minsky moment” can arrive?

The late economist Hyman Minsky defined three ways of borrowing: hedge borrowing where borrowers were able to pay interest and principal out of income, speculative borrowing were the borrower could pay the interest but not the principal and relied on someone paying the same price for the asset like he did and Ponzi borrowing were the borrower could not pay the principal nor the interest and hoped that he be bailed out by the next buyer. We all are in a Ponzi world right now. Hoping to be bailed out by the next person. The problem is that demographics alone have to tell us, that there are fewer people entering the scheme then leaving. More people get out than in. Which means, by definition, that the scheme is at an end. The Minsky moment is the crash. Like all crashs it is easier to explain it afterwards than to time it before. But I think it is obvious that the endgame is near.

via Zero Hedge http://ift.tt/11WqCa5 Tyler Durden

Submitted by David Stockman via Contra Corner blog,

Keynesian economists are annoying enough when they are pitching inflated financial assets on Wall Street or the supposed curative powers of fiscal deficits on Capitol Hill. But they become positively dangerous when they populate the Eccles Building and usurp control of the nation’s capital and money markets lock, stock and barrel in the name of “monetary accommodation”.

Needless to say, the Fed is presently over-run with Keynesian money printers led by Janet Yellen and Stanley Fischer. Both of these famous PhDs are actually proponents of a primitive macroeconomic doctrine that should be called “bathtub economics”.  In their wisdom, these doctors of economics have simply postulated that the nation’s economic output “should” be at aggregate levels which far exceed current production, and that the resulting shortfall from “potential” output, incomes and jobs is due to insufficient “aggregate demand”.

This purported “output gap” is conveniently self-serving. It has been interpreted to mean that the Fed has a plenary mission to fill-up the nation’s economic bathtub by generating sufficient incremental aggregate demand to off-set the shortfall. This demand plugging function, in turn, is to be accomplished by the constant intervention of the Fed’s open market desk into money and capital markets. So doing, it is empowered to manipulate, massage, twist, bend and pump any financial variable that in its wisdom is deemed to influence the transmission of its monetary policy (i.e.”aggregate demand” stimulus) into the real economy.

Except this is all a fiction. There is no such economic ether called “aggregate demand”; it is an utterly artificial construct of Keynesian economic models. What actually exists out in the real main street economy is nothing more than the total spending by households and businesses; and the latter does not pre-exist as an independent variable. Instead, it is derived from either current income or from incremental borrowing—that is, extending the pre-existing leverage ratio of business and household balance sheets to steadily higher levels.

But here’s the thing. The Fed can do only do two concrete things to influence these income and credit sources of spending—–both of which are unsustainable, dangerous and an assault on free market capitalism’s capacity to generate growth and wealth. It can induce households to consume a higher fraction of current income by radically suppressing interest rates on liquid savings. And it can inject reserves into the financial system to induce higher levels of credit creation.

But the passage of time soon catches up with both of these parlor tricks. When household savings decline to the vanishing point, as has occurred since the turn of the century, there is no more incremental spending to be extracted from current income.

Likewise, when balance sheets become totally exhausted with leverage—as is also the case at present—there are no more one-time increments to spending available from the simple expedient of ratcheting-up household and business leverage ratios. That condition amounts to “peak debt” and it characterizes upwards of 90% of US households today.

The fact is, the Fed’s modern regime of inducing lower savings and higher leverage was not only an unsustainable, one-time proposition that prevailed roughly from 1971 to 2007, but also was only good on the margins of Keynesian GDP accounting. It was the booster shot which stimulated a simulacrum of prosperity and out performance on the measured macro variables.

Still, none of the Greenspan/Bernanke/Yellen era financial market interventions and manipulations by the Fed could impact the foundation of spending—-that is, current period organic income. The latter comes from production, invested capital, entrepreneurial activities and labor hours and productivity.

Stated differently, income is the fruit of the economy’s supply side operations. But the central banking branch of the state has no tools to grow the supply side. The latter is the unplanned result of workers, entrepreneurs, savers, investors and inventors interacting on the main street market.

Take the case of labor hours. The crucial variable here is not some academic concoction called “full employment” or an arbitrarily chosen unemployment rate of say 5.2% measured against an artificially designated proxy for the work force collected by the BLS.

Instead, what matters is the price of labor; the quantity supplied everywhere and always follows the price. Accordingly, if at current production and income levels, the price of labor on the margin is too high, there will be elevated levels of unemployment. But the Fed can do nothing about millions of wage arrangements in the main street economy—-except to make over-pricing of labor worse by inducing households to live beyond their means on cheap credit.

To be sure, the Keynesian money printers claim they are boosting labor inputs by enlarging demand for the services of unemployed workers. But this just another case of the economist who tumbled into a 30-foot hole, but quickly assured his colleague of an escape plan: Assume we have a ladder, he airily intoned.

In a similar manner, the Keynesian economists who run the Fed have no ability to create the fictional ether called “aggregate demand”, yet they have seized control of the entire capital and money market pretending to do just that. However, not withstanding the fact that the Fed has pumped $4 trillion of new reserves into the financial system since the year 2000, there has not been a single hour of gain in private non-farm labor inputs supplied to the US economy during the past 14 years. Self-evidently, all their “assumptions” to the contrary, the Keynesian economists at the Fed do not have a magic ladder called “aggregate demand” that can pull idle labor hours into production.

Yet here is where the Wall Street connection enters the picture. While the modern Fed’s incessant manipulation of money market rates, the yield curve and the price of risk assets generally can have no lasting effect on household and business spending, it does cause massive financial bubbles. The latter, in turn, can be harvested by adroit speculators during the 5-7 year intervals between the inevitable busts which result from central bank financial repression and artificial inflation of risk asset values.

That essentially is the reason for the present universe of some $3 trillion of hedge funds, and the trillions more of mutual funds and institutional investors which surf on their momentum driving waves. Their assigned function in the scheme is to be the first-in and first-out as these central bank financial bubbles inflate and bust.

Naturally, it was only a matter of time before Wall Street sought to institutionalize these beneficent policies by developing a financial market overlay on the bathtub economics of the academic Keynesians. This new element originated during the Greenspan era with the expansion of staff to include Wall Street economists and traders. But the arrival seven years ago of William Dudley straight from the top economics job at Goldman Sachs took the matter to a whole new level.

In effect, under Dudley’s supervision the New York Fed has been transformed from a dabbler in the money markets to the plenary master of the entire financial system. Thus, during the early Greenspan days the nearly exclusive tool of Fed policy intervention was the Federal funds rate, but that was a crude and imprecise lever for managing the flow of incremental demand into the nation’s economic bathtub.

Accordingly, the doctrine of “monetary accommodation” was evolved by the Wall Street contingent at the Fed led by Dudley. By the lights of this new dispensation, any financial variable that might conceivably encourage more mortgage borrowing or corporate stock buybacks or “wealth effects” driven household consumption (albeit by mainly the top 10%)  was fair game. Such variables were declared to influence “the transmission of monetary policy to the real economy”.

Thus, when Ben Bernanke averred a few years ago that the Fed’s success in stimulating the economy was evident in the soaring levels of the Russell 2000, he was merely noting a particular instance of this new monetary accommodation doctrine at work.

Yet the monetary accommodation doctrine surely does amount to an economic coup d’état by the unelected bureaucrats and academics who run the nation’s central bank. To be sure, they rationalize it in the name of their statutory mandate to achieve maximum employment and price stability, as contained in the Humphrey-Hawkins Act.

But read the act and the legislative history. Not even Hubert Humprhey himself ever envisioned a Fed which would target the Russell 2000 or deliberately punish main stream savers in order to inflate financial assets and encourage wealth effects driven levitation of the GDP and jobs count. The Fed’s plenary manipulation of prices across the warp and woof of the financial system thus amounts to the greatest instance of “mission creep” ever undertaken by an agency of the state.

Now in a recent forked-tongue effort to deny the existence of a Fed “put” under the stock market, Goldman’s plenipotentiary at the Fed, perhaps better referred to as B-Dud, has told us exactly that. If the monetary politburo deems that the nation’s economic bathtub is not full to the brim and therefore requires “extremely accommodative” policy, the central bank will indeed deliberately pump-up the S&P 500 to achieve its misguided ends.

A few weeks ago, the Fed’s hapless school marm and chair person lamented publicly about the severe shift of income and wealth to the top 1% during recent decades. Perhaps it is time for B-Dud to explain to her that its all about filling James Tobin’s economic bathtub with the requisite “aggregate demand”.

It goes without saying that Keynesian economists have always been a threat to free market capitalism. But now that they have hooked up with Wall Street agents like B-Dud they have become a clear and present danger.

….. we focus on how financial market conditions influence the transmission of monetary policy to the real economy.  At times, a large decline in equity prices will not be problematic for achieving our goals….. (if) it does not conflict with our objectives.  In contrast, when we want financial market conditions to be extremely accommodative—as has been the case in recent years when we have been far away from our employment and inflation objectives—then we will take into consideration a broad set of developments with respect to interest rates, the stock market and other measures of financial conditions in choosing the appropriate stance for monetary policy. 

via Zero Hedge http://ift.tt/1ygQZp6 Tyler Durden

Excerpted from the book “Dot.con”…

 

 

It’s different this time though silly!

 

h/t @StockCats

via Zero Hedge http://ift.tt/1rYn3XP Tyler Durden

Submitted by Alasdair Macleod via GoldMoney.com,

The hypothesis that follows, if carried through, is certain to have a significant effect on gold and the relationship between gold and all government-issued currencies.

The successful remonetisation of gold by a major power such as Russia would draw attention to the fault-lines between fiat currencies issued by governments unable or unwilling to do the same and those that can follow in due course. It would be a schism in the world's dollar-based monetary order.

Russia has made plain her overriding monetary objective: to do away with the US dollar for all her trade, an ambition she shares with China and their Asian partners. Furthermore, in the short-term the rouble's weakness is undermining the Russian economy by forcing the Central Bank of Russia (CBR) to impose high interest rates to defend the currency and by increasing the burden of foreign currency debt. There is little doubt that one objective of NATO's economic sanctions is to harm the Russian economy by undermining the currency, and this policy is working with the rouble having fallen 30% against the US dollar this year so far with the prospect of further falls to come.

Russia faces the reality that pricing the rouble in US dollars through the foreign exchanges leaves her a certain loser in a currency war against America and her NATO allies. There is a solution which was suggested in a recent paper by John Butler of Atom Capital, and that is for Russia to link the rouble to gold, or more correctly put it on a gold exchange standard*. The proposal at first sight is so left-field that it takes a lateral thinker such as Butler to think of it. Separately, Professor Steve Hanke of John Hopkins University has alternatively proposed that Russia sets up a currency board to stabilise the rouble. Professor Hanke points out that Northern Russia tied the rouble to the British pound with great success in 1918 after the Bolshevik revolution when Britain and other allied nations invaded and briefly controlled the region. What he didn't say is that sterling would most likely have been accepted as a gold substitute in the region at that time, so running a currency board was the equivalent of putting the rouble in Russia's occupied lands onto a gold exchange standard.

Professor Hanke has successfully advised several governments to introduce currency boards over the years, but we can probably rule it out as an option for Russia because of her desire to ditch US dollar relationships. However, on further examination Butler's idea of fixing the rouble to gold is certainly feasible. Russia's public sector external debt is the equivalent of only $378bn in a $2 trillion economy, her foreign exchange reserves total $429bn of which over $45bn is in physical gold, and the budget deficit this year is likely to be roughly $10bn, considerably less than 1% of GDP. These relationships suggest that a rouble to gold exchange standard could work so long as fiscal discipline is maintained and credit expansion moderated.

Once a rate is set, the Russians would not be restricted to just buying and selling gold to maintain the rate of gold exchange. The CBR has the power to manage rouble liquidity as well, and as John Butler points out, it can issue coupon-bearing bonds to the public which would be attractive compared with holding cash roubles. By issuing these bonds, the public is in effect offered a yield linked to gold, but higher than gold's interest rate indicated by the gold lease rates in the London market. Therefore, as the sound-money environment becomes established the public will adjust its financial affairs around a considerably lower interest rate than the current 9.5%-10% level, but in the context of sound money it must always be repaid. Obviously the CBR would have to monitor bank credit expansion to ensure that lower interest rates do not result in a dangerous increase in bank lending and jeopardise the arrangement.

In short, the central bank could easily counter any tendency for roubles to be cashed in for gold by withdrawing roubles from circulation and by restricting credit. Consideration would also have to be given to roubles in foreign ownership, but the current situation for foreign-owned roubles is favourable as well. Speculators in foreign exchange markets are likely to have sold the rouble against dollars and euros, because of the Ukrainian situation and as a play on lower oil prices. The announcement of a gold exchange standard can therefore be expected to lead to foreign demand for the rouble from foreign exchange markets because these positions would almost certainly be closed. Since there is currently a low appetite for physical gold in western capital markets, longer-term foreign holders of roubles are unlikely to swap them for gold, preferring to sell them for other fiat currencies. So now could be a good time to introduce a gold-exchange standard.

The greatest threat to a rouble-gold parity would probably arise from bullion banks in London and New York buying roubles to submit to the CBR in return for bullion to cover their short positions in the gold market. This would be eliminated by regulations restricting gold for rouble exchanges to legitimate import-export business, but also permitting the issue of roubles against bullion for non-trade related deals and not the other way round.

So we can see that the management of a gold-exchange standard is certainly possible. That being the case, the rate of exchange could be set at close to current prices, say 60,000 roubles per ounce. Instead of intervention in currency markets, the CBR should use its foreign currency reserves to build and maintain sufficient gold to comfortably manage the rouble-gold exchange rate.

As the rate becomes established, it is likely that the gold price itself will stabilise against other currencies, and probably rise as it becomes remonetised. After all, Russia has some $380bn in foreign currency reserves, the bulk of which can be deployed by buying gold. This equates to almost 10,000 tonnes of gold at current prices, to which can be added future foreign exchange revenues from energy exports. And if other countries begin to follow Russia by setting up their own gold exchange standards they likewise will be sellers of dollars for gold.

The rate of increase in the cost of living for the Russian population should begin to drop as the rouble stabilises, particularly for life's essentials. This has powerfully positive political implications compared with the current pain of food price inflation of 11.5%. Over time domestic savings would grow, spurred on by low welfare provision by the state, long-term monetary stability and low taxes. This is the ideal environment for developing a strong manufacturing base, as Germany's post-war experience clearly demonstrated, but without her high welfare costs and associated taxation.

Western economists schooled in demand management will think it madness for the central bank to impose a gold exchange standard and to give up the facility to expand the quantity of fiat currency at will, but they are ignoring the empirical evidence of a highly successful Britain which similarly imposed a gold standard in 1844. They simply don't understand that monetary inflation creates uncertainty for capital investment, and destroys the genuine savings necessary to fund it. Instead they have bought into the fallacy that economic progress can be managed by debauching the currency and ignoring the destruction of savings.

They commonly assume that Russia needs to devalue her costs to make energy and mineral extraction profitable. Again, this is a fallacy exposed by the experience of the 1800s, when all British overseas interests, which supplied the Empire's raw materials, operated under a gold-based sterling regime. Instead, by not being burdened with unmanageable debt and welfare costs, by maintaining lightly-regulated and flexible labour markets, and by running a balanced budget, Russia can easily lay the foundation for a lasting Eurasian empire by embracing a gold exchange standard, because like Britain after the Napoleonic Wars Russia's future is about new opportunities and not preserving legacy industries and institutions.

That in a nutshell is the domestic case for Russia to consider such a step; but if Russia takes this window of opportunity to establish a gold exchange standard there will be ramifications for her economic relationships with the rest of the world, as well as geopolitical considerations to take into account.

An important advantage of adopting a gold exchange standard is that it will be difficult for western nations to accuse Russia of a desire to undermine the dollar-based global monetary system. After all, President Putin was more or less told at the Brisbane G20 meeting, from which he departed early, that Russia was not welcome as a participant in international affairs, and the official Fed line is that gold no longer plays a role in monetary policy.

However, by adopting a gold exchange standard Russia is almost certain to raise fundamental questions about the other G20 nations' approach to gold, and to set back western central banks' long-standing attempts to demonetise it. It could mark the beginning of the end of the dollar-based international monetary system by driving currencies into two camps: those that can follow Russia onto a gold standard and those that cannot or will not. The likely determinant would be the level of government spending and long-term welfare liabilities, because governments that leech too much wealth from their populations and face escalating welfare costs will be unable to meet the conditions required to anchor their currencies to gold. Into this category we can put nearly all the advanced nations, whose currencies are predominantly the dollar, yen, euro and pound. Other nations without these burdens and enjoying low tax rates have the flexibility to set their own gold exchange standards should they wish to insulate themselves from a future fiat currency crisis.

It is beyond the scope of this article to examine the case for other countries, but likely candidates would include China, which is working towards a similar objective. Of course, Russia might not be actively contemplating a gold standard, but Vladimir Putin is showing every sign of rapidly consolidating Russia's political and economic control over the Eurasian region, while turning away from America and Western Europe. The fast-track establishment of the Eurasian Economic Union, domination of Asia in partnership with China through the Shanghai Cooperation Organisation, and plans to set up an alternative to the SWIFT banking payments network are all testaments to this. It would therefore be negligent to rule out the one step that would put a stop to foreign attempts to undermine the rouble and the Russian economy: by moving the currency war away from the foreign exchanges and into the physical gold market were Russia and China hold all the aces.

*Technically a gold standard is a commodity money standard in which the commodity is gold, deposits and notes are fully backed by gold and gold coins circulate. A gold exchange standard permits other metals to be used in coins and for currency and credit to be issued without the full backing of gold, so long as they can be redeemed for gold from the central bank on demand.

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Three months ago, we revealed that – with absolute certainty – foreign central banks trade (and by “trade” we mean “buy”) S&P 500 futures such as the E-mini, in both futures and option form, as well as full size, and micro versions, in addition to the well-known central bank trading in Interest Rates, TSY and FX products. The reason for the certainty was that one of the world’s largest futures exchange, the CME, was quietly peddling a service geared exclusively to central banks, called the Central Bank Incentive Program, whose purpose was to “incentivize” central banks to provide market liquidity, i.e., limit orders, by charging them 34% less than ordinary customers on every E-Mini trade.

Back then we left readers wondering “the next time you sell some E-minis, ask yourself: is the ECB on the other side? Or the BOE? Or, perhaps, you are selling S&P 500 futures to Kuroda. Who knows: there is no paper trail anywhere, although a FOIA request and/or the discovery from a lawsuit, class action or otherwise, of the CME’s central bank incentive program would likely yield some stunning results.”

Actually no it won’t: it is now a national security issue that nobody have proof that the biggest marginal buyer of equities are central banks themselves. Otherwise, “confidence” in central planning may crumble, even if everyone knows all too well that without central banks, the equity market’s artificially propped up prices would be obliterated overnight.

There was one small piece of good news: the foreign central bank rigging (because the Fed is still technically not allowed to buy equity derivatives directly: instead it has been doing so via Citadel) would end on December 31, 2014:

Well, we have some bad news.

According to a modification of the Central Bank Incentive Program, central bank rigging of, well, everything and certainly the E-mini S&P future, will go on for a much longer time, with the revised deadline now going through December 31, 2015. Further, as the CME notes, “The Exchanges certify that the Program complies with the CEA and the regulations thereunder. There were no substantive opposing views to this Program or the proposed modifications.”

Of course, there weren’t.

It is amusing to note that the CME decided to hike the fee for US Treasury Futures and Options: the central bank demand there must be soaring.

But that’s not the only place where the demand prompted the CME to hike rates. It did so with gold as well:

One wonders just what percentage of the total gold trading on the Globex takes place among the world’s central banks, if the CME felt compelled to push up the cost per side.

Finally, for those curious to learn more about this program, or if they are perhaps eligible to enjoy preferential “central bank” terms, they should send an email to CBIP@cmegroup.com or contact CME Group’s International Department in Chicago at 312.466.7473. As the CME conveniently advises, “staff at this office can provide you with additional information and assist you through the application process.”

 

h/t @Nanexllc; Source: Modifications to Central Bank Incentive Program. CME/CBOT/NYMEX/COMEX #14-038 and Modifications to the Central Bank Incentive Program CME Submission No. 14 – 433

via Zero Hedge http://ift.tt/1rYn3a9 Tyler Durden