Libertarian Party nominee Amanda
Swafford, currently polling at around 4 percent in the
neck-and-neck race for a Senate seat in Georgia, will be on to talk
about her candidacy. Former LP presidential nominee Gary Johnson
will also show up to address the
perennial “spoiler” debate as we hurtle toward another tight
election day. Country music DJ Bobby Bones will assess the
New Jersey high school
football hazing/assault story, because why not. And Kennedy
hits the streets of New York, looking for wisdom about
Columbus Day.
“When sorrows come,” wrote Shakespeare, “they come not single spies, but in battalions.”
True. And Jeremy Warner for the Daily Telegraph identifies ten such sorrows in his ‘ten biggest threats to the global economy’:
1) Geopolitical risk;
2) The threat of oil and gas price spikes;
3) A hard landing in China;
4) Normalization of monetary policy in the Anglo-Saxon economies;
5) Euro zone deflation;
6) ‘Secular stagnation’;
7) The size of the debt overhang;
8) Complacent markets;
9) House price bubbles;
10) Ageing populations.
We’ll start with point #7: the size of the debt overhang.
Since this was never addressed in the immediate aftermath of the Global Financial Crisis, it’s hardly a surprise to see the poison of debt continue to drip onto all things financial.
ALL German government paper out to three years, for example, now offers a negative yield. Investors must pay rent to the German government in order to buy its debt.
This has implications. And much of the rest of Warner’s ‘threats’ are inextricably linked to this debt overhang.
Point #8: Complacent markets? Check. (Though stocks have lost a lot of their nerve…)
Point #9: House price bubbles? Check. Since the monetary policy response to having too much debt in the system has been to slash rates and keep them at multi-century lows, it’s hardly a surprise to see property prices in a bubble. Again.
Point #5: Euro zone deflation? Check. This is less of a threat to solvent consumers, but deadly for indebted governments.
Point #4: Pending normalization of monetary policy in the UK and US? Check.
This threatens the integrity of the credit markets. And it’s worth asking whether central banks could possibly afford to let interest rates rise and risk bankrupting their governments.
We saw one particularly eye-catching chart last week, via Grant Williams, comparing the leverage ratios of major US financial institutions over recent years (shown below).
The Fed’s leverage ratio (total assets to capital) now stands at just under 80x. That compares with Lehman Brothers’ leverage ratio, just before it went bankrupt, of just under 30x.
Sometimes a picture really does paint a thousand words.
And this, again, brings us back to the defining problem of our time: too much debt in the system.
In a recent interview with Jim Grant, Sprott Global questioned the famed interest rate observer about the likely outlook for bonds. Grant responds:
“I’m not sure what a bear market would look like, but I think that it would be characterized at first by a lot of people rushing through a very narrow gate. ”
Grant was also asked if it was possible for the Fed to lose control of the bond market:
“Absolutely, it could. The Fed does not control events for the most part. Events certainly will end up controlling the Fed. To answer your question – yeah. I think the Fed can and will lose control of the bond market.”
As we have written on innumerable prior occasions, we wholeheartedly agree. What will drive pretty much all asset markets over the near, medium and longer term is almost entirely down to how credit markets behave.
The fundamentals (again, take one look at the chart) are utterly shocking, as are the implications.
And let us not confuse the prognosis by arguing over the diagnosis.
As Professor Antal Fekete writes in his Monetary Economics 101: The real bills doctrine of Adam Smith –
“Hyperinflation and hyper-deflation are just two different forms of the same phenomenon: credit collapse.
Arguing which of the two forms will dominate is futile: it blurs the focus of inquiry and frustrates efforts to avoid disaster.”
While today’s market dump was certainly dramatic, it was a function of the scant liquidity in the market (as we warned would be the case first thing) and outsized moves following last week’s mauling, not the result of any fundamental (or not so fundamental) news.
That could change tomorrow, and change for the worse, because as Barclays reminds us, tomorrow is when the European Court of Justice (ECJ) is scheduled to hear testimony on the ECB’s non-existent Outright Monetary Transactions program (OMT). Recall that the OMT is the imaginary (again: non-existent) byproduct of Draghi’s “whatever it takes” speech: a byproduct that was supposed to exist purely in the imaginary realm (as it was merely a verbal bluff, one which was never meant to be actually activated), and never actually take practical shape (hence, why the OMT’s legal term sheet still does not exist, over two years later).
Sadly for Draghi, and the entire Deus Ex theater that managed to send European peripheral bonds from record wides yields to record low, tomorrow it will attain some much dreaded shape.
And while a ruling on the legal questions forwarded by Germany’s Constitutional Court is not expected this year, the hearing and questions posed by EU judges may give some early insights into their views and to what extent they might share the view of the German court that, unless several restrictions are imposed, the OMT should be considered illegal under European law.
As Barclays notes, specifically the EU court may agree that the ECB cannot promise pari passu treatment with other creditors in the case of nominal losses (haircuts) on its public bond holdings but must insist on full repayment.
What’s worse is that in addition to undercutting and mooting all of Draghi’s July 2013 bluster, next to the OMT itself, the ruling could also have an adverse impact on the effectiveness and design of broad-based ECB government bond purchases (QE) which many banks believe will be announced by Q1 15. Unless they aren’t of course, should the ECJ shoot itself in the foot and demand more clarity on the OMT which can only have an adverse outcome.
Full comment from Barclays:
European Court of Justice scheduled to hear testimony on the ECB’s OMT on 14 October
The ECJ has scheduled a hearing on the ECB’s OMT for next Tuesday, 14 October (starting at 9am CET), which we expect to last all day. Under the OMT, the ECB could purchase, without limitation, bonds of a member state that has entered into an ESM aid programme and agreed to be subject to its conditions. Earlier this year (see German Constitutional Court’s referral of key legal OMT aspects to European Court of Justice is good news, 7 February) the German Constitutional Court (GCC) in an unprecedented move referred a long list of questions to the ECJ (see Appendix below) for a preliminary ruling after it declared admissible a constitutional complaint by some 30,000 plaintiffs (Gauweiler and others) against the OMT. The discussion and specifically questions posed by the EU judges to the parties involved (the ECB, etc) during the hearing might give some early insight on their views. We do not expect the ECJ to come to a ruling this year but the court’s advocate general may announce the schedule for the proceedings next week. Usually, it takes the ECJ about 16 months on average to rule on cases referred by national courts which implies that the OMT ruling could come by June.
German court insists on several restrictions for the OMT
The German constitutional court put some pressure on the EU court and made clear its view last February that there are important reasons to assume that the OMT would be illegal under EU law as it exceeds the European Central Bank’s monetary policy mandate and violates the prohibition of monetary financing of the budget, unless certain restrictions are imposed. These should require “that the acceptance of a debt cut must be excluded, that government bonds of selected Member States are not purchased up to unlimited amounts, and that interferences with price formation on the market are to be avoided where possible.”
Clearly the latter would make an ECB option to proceed with full blown public QE virtually impossible.
So for all those who, rightly, point to the market’s oversold condition, news out of Europe tomorrow could lead to even more selling especially where it really hurts: Europe’s peripheral, and massively mispriced, bonds. A fair warning, just in case anyone is feeling particularly BTFDippy.
At 1532ET today (Columbus Day – with half the market absent), someone – apparently having waited to see if the almost ‘ubiquitous’ 330pm Ramp would occur – decided it was time to dump three-quarters of a billion dollars notional of US equity market exposure in 1 second. The results of this forced liquidation (or utter disregard for fiduciary duty) were as follows…
A complete collapse of all liquidity in the S&P 500 e-mini futures contract – the world’s most liquid equity exposure vehicle…
The liquidity evaporation began at 15:32:37 after 4,492 eMini contracts were dumped in 28 milliseconds $ES_F$SPY
And total chaos in the S&P 500 ETF (SPY) which saw offers below bids for what is hours to liquidity-providing HFTs (who appeared to step away for coffee)…
This chart shows just 1 second of SPY trading (corresponding to the volume spike above)
As Nasdaq quotes fell dramatically behind reality…
Given that NYSE margin debt at record highs and investor net worth at record lows…
The vicious cycle feedback from any extended push lower on liquidations is more than a little concerning (and may well explain the aggressive VIX buying today – and massive inversion of the VIX term structure)
Friday’s theme episode of The Independents was on
“Governmental
Breakdown,” and as such included some Q&A with various
whistleblowers who tried to go through “proper channels” to let
superiors know that things at their agency were seriously messed
up. Their experiences are a stain on our national
conscience.
First up, the Veterans Administration’s Scott
Davis:
Then a man known to Reason
readers and
viewers: former NSA whistleblower William Binney:
‘Everyone‘ knows that the Japanese economy is weakening (apart from Abe and Kuroda obviously), ‘everyone‘ knows that the European economy is tumbling towards another recession, ‘most‘ know that China is really slowing (no matter what the magic of excel enables GDP to be)… and ‘everyone‘ knows that the US economy is the cleanest dirty shirt, will decouple from the rest of the world, and thanks to endless extrapolated dreams, will lead the world to escape velocity. Except… recent macro data suggests otherwise…
The US is hockey-sticking higher as the rest of the world’s economies slump… phew thank goodness for that!!
But… we hate to steal the jam from the market’s all-knowing donut, but recent US macro data suggests GDP growth may be slowing here too…
Without the mirage of American growth – how will equity market valuations ever be achieved…
So, given the recent jawboning, it seems the Fed is in panic mode to either a) revive the “recovery is on and that’s why we’re tightening” meme, or b) fold, and retreat back to QE, tail between their legs and admit that’s all they have left to juice nominal growth…
Hey gang, it looks like we’ve got another mystery
on our hands. Authorities discovered the body of a man in Detroit a
few months back. He was wearing a fancy German-made watch,
according to The Detroit News. The watch was
stashed away in an evidence locker; the case itself went cold after
Sgt. Alex Vinson, lead investigator, failed to even determine the
identity of the man. Then the watch went missing!
After the case was re-opened, police discovered that the watch
had been stolen from the evidence locker and replaced with a
cheaper replica.
That mystery, at least, has been solved:
This week, while Vinson was in Idaho for advanced police
training, fellow homicide detectives decided to reopen the
case.
The detectives wanted to take another look at the watch — but
when they removed the victim’s belongings from the property room,
the watch wasn’t the same one that was photographed at the start of
the case. Instead, it was a cheaper model, [Police Chief James]
Craig confirmed.
Craig added the FBI helped police recover the watch,
which Vinson was wearing during the training session.
Vinson returned to Michigan Wednesday, and was read his Miranda
rights by Internal Affairs officers.
This ad (funded by The Agenda Project – a progressive non-profit political organization founded in 2010 by author Erica Payne), as RealClearPolitics reports, featuring clips of Mitch McConnell, Pat Roberts, and many other Republicans implies that austerity cuts to the CDC and NIH are responsible for the 2014 Ebola outbreak.
This ad will run in Kentucky and other states leading up to the election.
The old adage that if something is repeated often enough it is soon assumed to be true couldn’t be more apt with respect to the Fed’s 2% inflation target. Last week, Bloomberg had a piece that did exactly that, describing how “Federal Reserve officials are hunting for new tactics to raise price increases to their target” because “inflation is descending toward the danger zone”.
In fact, the September meeting notes cited several officials who worried that “inflation might persist below” the committees target for “quite some time.” Accordingly, the Bloomberg author, Craig Torres, pulled out his editorial pen and offered his opinion as if it were objectively obvious:
The Fed needs a clear strategy for getting the inflation rate higher after falling short of its 2 percent target for 28 consecutive months.
Well, now. Twenty-eight straight months of misses. Let’s see, even using the Fed’s systematically understated measure of inflation, the PCE deflator ex-food and energy, consumers’ savings and paychecks have lost 3.3% of their purchasing power during the last 28 months.
Apparently, had they instead suffered a 4.7% loss of purchasing power (2% inflation for 2.33 years) everything would be copasetic. Instead of remaining in a funk, as has been evident since it unexpectedly snowed last winter, they would have been spending up a storm. Presumably the US economy would have long ago hurtled through that pesky “escape velocity” barrier.
Isn’t it amazing that over the relatively brief period in question that shrinking the purchasing power of the dollar by 4.7%% versus 3.3% could make such a profound difference. Or maybe not.
But don’t expect the “journalists” at Bloomberg to even ask. Like their “competitors” at the WSJ and Reuters, they are about as mainstream, lazy and intellectually sloppy as they come. In this case, it is not likely that a writer who cites two ex-central bank true believers as his main source—-former Fed governor and macro-model peddler, Larry Meyer, and former Bank of England policy committee member and current Keynesian snake oil salesman, Adam Posner—-would trouble himself with proof that a 2% annual gain on the CPI is a proven economic elixir.
Supposedly, if inflation is a tad on the weak side, or even remotely veers off in the direction of the dreaded “deflation” zone, consumers will sit on their wallets waiting for prices to fall further. Soon you are sliding down the slippery slope into the maws of a deflationary malaise, and then Great Depression 2.0. So Bloomberg even found a consumer to illustrate this point.
It was a rather prosperously proportioned lady in an appliance store who would apparently be put out of a buying mood if prices were not increasing with sufficient vigor. And Bloomberg even included that proposition in the caption, lest any reader miss the point:
Consumers anticipating falling prices may postpone discretionary purchases. This can combine to create a vicious circle of less spending and further downward pressure on prices.
So it must be true. Its right there in the (online) papers.
For the life of me, therefore, I can’t figure out how the Apple shoppers pictured below are still even functioning. Prices of their favorite i-Gadgets have been falling for years—but here they are lined up an Apple Store as far as the eye can see fixing to spend up a storm.
Ok, digital age products are different. I get that. Not only do their prices drop consistently, and sometimes even plunge precipitously, but they also give you huge increases in function and quality. So what’s involved, apparently, is some kind of consumer addiction to getting more bang for the buck in this allegedly idiosyncratic corner of the marketplace.
Unfortunately, that doesn’t explain the graph below which is distinctly not new age, but the BLS wholesale price index for all finished consumer goods less food. Year-in-and-year-out since Alan Greenspan’s arrival at the Fed in August 1987, it has risen at relatively consistent annual rate—- averaging 2.4% over the 27 year period as a whole. The occasional minor dips in the rate of increase have absolutely no correlation with consumer spending rates over the period.
The only serious dip is during 2008-2009 when the oil price plunged from $150 per barrel to less than $40, and took the whole index with it. But consumer spending skidded during that period due to the fact that jobs and incomes were plunging owing to the Great Recession—- not because oil prices were crashing from speculative peaks that were undone by the laws of supply and demand.
What is embodied in the above chart is actually the “stuff” sold at Wal-Mart outside of the food department—where presumably people need to eat whether prices are rising or falling.
As it happened, Wal-Mart’s slogan was not “everyday rising prices” but “everyday low prices”. During the 27 years pictured above, it is absolutely certain that Wal-Mart’s average prices did not grow anything close to the 2.4% CAGR embedded in the BLS index. Yet its domestic sales nevertheless soared by orders of magnitude more than the growth of consumer spending during the same period.
2012
In fact, nominal PCE grew at an annual rate of 5% during the period or by only two-fifths of Wal-Mart’s 12+% CAGR. That is, as a result of scouring the earth for the lowest prices available, its market share of the American consumer’s wallet rose dramatically. Low and often falling prices did not drive consumers away; it attracted them in droves.
The Wal-Mart saga alone knocks the 2% inflation story into a cocked hat. The latter is a complete myth made of whole cloth.
Indeed, the very idea that the hard-pressed main street consumers of America – most of whom have virtually no discretionary income to spend after the basics anyway— will go on a buyer’s strike if they don’t get enough inflation is just plain ludicrous.
That Keynesian central bankers peddle this nostrum with a straight face is amazing in itself, but it is at least understandable because it gives them a reason to keep the printing presses humming. That journalists like Mr. Torres at Bloomberg repeat it with no questions asked is even more remarkable. It proves that the impending replacement of financial journalists with robo-writers may not be so bad after all. It won’t make any real difference.