Tag: finance

Authored by Andrea Tambalotti and Argia Sbordone via The New York Fed's Liberty Street Economics blog,

The severe recession experienced by the U.S. economy between December 2007 and June 2009 has given way to a disappointing recovery. It took three and a half years for GDP to return to its pre-recession peak, and by most accounts this broad measure of economic activity remains below trend today. What precipitated the U.S. economy into the worst recession since the Great Depression? And what headwinds are holding back the recovery? Are these headwinds permanent, calling for a revision of our assessment of the economy’s speed limit? Or are they transitory, although very long-lasting, as the historical record on the persistent damages inflicted by financial crisis seems to suggest? In this post, we address these questions through the lens of the FRBNY DSGE model.

DSGE models are a particularly suitable tool to look under the economy’s hood and illuminate its inner workings. Their structure allows us to decompose the evolution of the key macroeconomic variables that we can measure—such as GDP and inflation—in terms of their underlying driving forces, which are unobserved. In terms of the automotive metaphor, with a model of the car/economy in hand, we can trace back its observed behavior—direction and speed, say—to its fundamental determinants, such as the conditions of the road and the actions of the driver on the accelerator and the brakes. The key difference of course is that the economy is much more complicated than a car, and does not have one driver behind the wheel. Therefore our model can only provide a simplified, and in many cases imperfect, account of its workings. Even with these simplifications, however, the model provides useful insights.

The FRBNY DSGE model attributes the observed movements in macroeconomic variables to several fundamental disturbances, as explained in the previous post in this series and in more detail in our staff report. As it turns out, only four of these shocks account for the bulk of the movements in GDP and inflation since the Great Recession.

• A shock to total factor productivity (TFP), which affects the overall ability of the economy to produce output from any given amount of labor and capital inputs. A positive TFP shock results in higher GDP and, at the same time, in lower costs of production and hence lower inflation. In our model, shifts in TFP have a permanent effect on the economy’s productive potential. They capture a whole range of “structural” factors that will affect the growth trajectory of the economy for the foreseeable future.
• A financial (or spread) shock stemming from increases in the perceived riskiness of borrowers, which induces banks and other intermediaries to charge higher interest rates on loans, thereby widening credit spreads. An increase in perceived risk (a positive realization of this shock) leads to a large increase in the cost of capital for entrepreneurs, which depresses investment demand and hence GDP growth. As a result of the lower demand, inflation also falls. Although the spikes in spreads associated with this shock tend to be relatively short-lived, as they were during the crisis, their effects can linger well past the most acute phase of market disruptions, with persistently tight credit conditions depressing demand, and hence output and inflation, for several years. Unlike the TFP shocks, however, these financial disturbances are not permanent, and their effects will ultimately dissipate, returning the economy to its pre-crisis growth trajectory.
• A shock to investment demand, whose negative realizations persistently depress capital formation, leading to lower growth and lower inflation. This shock has very similar macroeconomic effects to the risk shock we just described, with the crucial difference that it does not move credit spreads. Therefore, this disturbance can be thought of as capturing financial and other factors that do not manifest themselves in higher spreads, but that nonetheless affect firms’ willingness or ability to invest. Examples of such factors are a reluctance to lend by banks that does not lead to higher interest rates on loans, but for instance to a rationing of credit to certain borrowers, as well as the perception by firms of a particularly uncertain outlook, which delays their investment decisions.
• Shocks to monetary policy, capturing changes in the monetary policy stance not reflected in the policy rate, such as the introduction of forward guidance.

The two charts below present the contributions of these four factors to the evolution of past observed and future projected GDP growth and inflation between 2007 and 2018. The variables are in deviation from their sample mean. Released data are represented by the black line. The projections for the rest of 2014 and beyond, captured by the red line, come from the model, as explained in more detail in the last post in this series. The colored bars represent the contribution of the corresponding driving force to the observed (or projected) outcome at any given point in time.

The first feature of this decomposition that we want to highlight is the paramount importance of spread shocks (in purple) during the recession. Starting at the end of 2007, the economy experiences a sequence of large shocks to credit spreads, driven by an increase in the perceived riskiness of borrowers. This progressive increase in risk is accompanied by deteriorating credit conditions, culminating in two spikes in spreads in the third and fourth quarters of 2008 with the failure of Lehman Brothers. These abrupt increases in the cost of credit account for a decline in quarterly GDP growth of more than 5 percentage points (annualized), which is about half of the total drop in output growth at the nadir of the recession. Inflation is also significantly affected by these shocks, which account for about three quarters of the decline in inflation in the second half of 2008.

The other half of the decline in GDP growth in 2008 stems from significant declines in TFP (the red bars). As we already pointed out, TFP shocks have permanent effects on the productive capacity of the economy in our framework, suggesting that the recession caused some lasting damage. However, the negative shocks of 2008 are followed by positive shocks, with the red bars primarily contributing to GDP growth. As a result, the level of TFP, and hence of potential output in our model, emerges largely unscathed at the present time.

As 2008 unfolds and the recession quickly worsens, the only force pushing against the fast deterioration in economic conditions is monetary policy. The orange bars—monetary policy shocks—do not represent the overall reaction of monetary policy to economic developments, which includes changes in the policy rate, but rather the extent to wh
ich this reaction exceeds what “normal,” historical reaction patterns would imply. Therefore, the large contributions of the orange bars suggest that the Federal Reserve was particularly aggressive in fighting the crisis early on, deploying several tools that went beyond its conventional weaponry. According to our model’s accounting, this extra effort is worth 2 to 3 percentage points of annual GDP growth in the middle of 2008, for a total boost to GDP of roughly 2 percent for 2008 as a whole. And this estimate does not even include the effects of the many credit and liquidity programs the Fed engaged in to ameliorate conditions in financial markets at the height of their stress.

Moving on to the recovery phase, which according to NBER dating starts in the middle of 2009, we can see that shocks to investment demand (in light blue) are the main headwinds holding back the economy. As credit spreads return to normal, the effect of financial risk shocks (in purple) dissipates, even though their overall effect continues to be a drag on growth and inflation. At this point, however, investment shocks start taking on a very large negative role in pushing down both GDP growth and inflation. The key feature of these shocks is the persistence of their effect on both variables, which remain depressed throughout the recovery phase, and into the forecast horizon. Admittedly, the fundamentals of investment shocks are harder to characterize than those of the spread or TFP shocks, representing any factor unrelated to credit spreads that might still restrain investment demand. Many such factors have been identified over time as playing a role in the sluggish recovery, including an overall reluctance of banks and other intermediaries to expose their balance sheets to risk, regardless of the pricing of that risk, and the tendency of firms to delay projects in the face of unusually uncertain prospects. Either way, our model squarely points to investment demand shocks as playing a fundamental role in retarding the recovery, consistent with the view that weak investment, more than consumption, has been behind the slow pace of growth and subdued inflation.

Monetary policy remains on the other side of the ledger over the recovery period, serving to counteract the negative effects of the shocks weighing on the economy. Even with the policy rate against its zero lower bound, monetary policy continues to lift economic activity and prevent inflation from falling too far below target, as demonstrated by the positive orange bars in the chart. In the model, this stimulus is achieved through forward guidance, whose effect on expected future policy rates, and hence on long-term rates, is explicitly taken into account in the model estimation.

The model’s forecast for the evolution of the economy over the next few years (the red lines in both charts) remains persistently subpar, with GDP growth about half a percentage point below its mean and inflation recovering very slowly—scenarios that will be discussed in more detail in the last post in this series. Decomposing the forecasts into their determinants highlights two main features. First, the headwinds represented by tight credit and the other factors holding back investment demand abate only gradually, contributing to restrain the economy over the medium term. Second, monetary policy starts representing a drag on growth and inflation over the forecast horizon, even though the policy rate remains lower than it would otherwise be. The reason is that, in the model, monetary policy has no long-run effects on the real economy, so monetary policy shocks can only affect the level of output temporarily.

In conclusion, this analysis finds little evidence of the permanent structural damage to the economy’s productive potential that many commentators see as the main culprit for the subpar recovery from the Great Recession. Instead, our decomposition is quite supportive of the narrative popularized by Reinhart and Rogoff and more recently by Mian and Sufi, according to which a slow recovery is what we should have expected owing to the very persistent damage inflicted by the financial crisis on the real economy. In the FRBNY DSGE model, this damage manifests itself as a sequence of negative shocks to investment demand—shocks that capture many of the headwinds often mentioned as an impediment to a more robust recovery. At the same time, our model suggests that monetary policy played an important role in cushioning the blow from the financial crisis and in sustaining the recovery, which could have been significantly more disappointing without the aggressive actions undertaken by the Fed.

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

Authored by Andrea Tambalotti and Argia Sbordone via The New York Fed's Liberty Street Economics blog,

The severe recession experienced by the U.S. economy between December 2007 and June 2009 has given way to a disappointing recovery. It took three and a half years for GDP to return to its pre-recession peak, and by most accounts this broad measure of economic activity remains below trend today. What precipitated the U.S. economy into the worst recession since the Great Depression? And what headwinds are holding back the recovery? Are these headwinds permanent, calling for a revision of our assessment of the economy’s speed limit? Or are they transitory, although very long-lasting, as the historical record on the persistent damages inflicted by financial crisis seems to suggest? In this post, we address these questions through the lens of the FRBNY DSGE model.

DSGE models are a particularly suitable tool to look under the economy’s hood and illuminate its inner workings. Their structure allows us to decompose the evolution of the key macroeconomic variables that we can measure—such as GDP and inflation—in terms of their underlying driving forces, which are unobserved. In terms of the automotive metaphor, with a model of the car/economy in hand, we can trace back its observed behavior—direction and speed, say—to its fundamental determinants, such as the conditions of the road and the actions of the driver on the accelerator and the brakes. The key difference of course is that the economy is much more complicated than a car, and does not have one driver behind the wheel. Therefore our model can only provide a simplified, and in many cases imperfect, account of its workings. Even with these simplifications, however, the model provides useful insights.

The FRBNY DSGE model attributes the observed movements in macroeconomic variables to several fundamental disturbances, as explained in the previous post in this series and in more detail in our staff report. As it turns out, only four of these shocks account for the bulk of the movements in GDP and inflation since the Great Recession.

• A shock to total factor productivity (TFP), which affects the overall ability of the economy to produce output from any given amount of labor and capital inputs. A positive TFP shock results in higher GDP and, at the same time, in lower costs of production and hence lower inflation. In our model, shifts in TFP have a permanent effect on the economy’s productive potential. They capture a whole range of “structural” factors that will affect the growth trajectory of the economy for the foreseeable future.
• A financial (or spread) shock stemming from increases in the perceived riskiness of borrowers, which induces banks and other intermediaries to charge higher interest rates on loans, thereby widening credit spreads. An increase in perceived risk (a positive realization of this shock) leads to a large increase in the cost of capital for entrepreneurs, which depresses investment demand and hence GDP growth. As a result of the lower demand, inflation also falls. Although the spikes in spreads associated with this shock tend to be relatively short-lived, as they were during the crisis, their effects can linger well past the most acute phase of market disruptions, with persistently tight credit conditions depressing demand, and hence output and inflation, for several years. Unlike the TFP shocks, however, these financial disturbances are not permanent, and their effects will ultimately dissipate, returning the economy to its pre-crisis growth trajectory.
• A shock to investment demand, whose negative realizations persistently depress capital formation, leading to lower growth and lower inflation. This shock has very similar macroeconomic effects to the risk shock we just described, with the crucial difference that it does not move credit spreads. Therefore, this disturbance can be thought of as capturing financial and other factors that do not manifest themselves in higher spreads, but that nonetheless affect firms’ willingness or ability to invest. Examples of such factors are a reluctance to lend by banks that does not lead to higher interest rates on loans, but for instance to a rationing of credit to certain borrowers, as well as the perception by firms of a particularly uncertain outlook, which delays their investment decisions.
• Shocks to monetary policy, capturing changes in the monetary policy stance not reflected in the policy rate, such as the introduction of forward guidance.

The two charts below present the contributions of these four factors to the evolution of past observed and future projected GDP growth and inflation between 2007 and 2018. The variables are in deviation from their sample mean. Released data are represented by the black line. The projections for the rest of 2014 and beyond, captured by the red line, come from the model, as explained in more detail in the last post in this series. The colored bars represent the contribution of the corresponding driving force to the observed (or projected) outcome at any given point in time.

The first feature of this decomposition that we want to highlight is the paramount importance of spread shocks (in purple) during the recession. Starting at the end of 2007, the economy experiences a sequence of large shocks to credit spreads, driven by an increase in the perceived riskiness of borrowers. This progressive increase in risk is accompanied by deteriorating credit conditions, culminating in two spikes in spreads in the third and fourth quarters of 2008 with the failure of Lehman Brothers. These abrupt increases in the cost of credit account for a decline in quarterly GDP growth of more than 5 percentage points (annualized), which is about half of the total drop in output growth at the nadir of the recession. Inflation is also significantly affected by these shocks, which account for about three quarters of the decline in inflation in the second half of 2008.

The other half of the decline in GDP growth in 2008 stems from significant declines in TFP (the red bars). As we already pointed out, TFP shocks have permanent effects on the productive capacity of the economy in our framework, suggesting that the recession caused some lasting damage. However, the negative shocks of 2008 are followed by positive shocks, with the red bars primarily contributing to GDP growth. As a result, the level of TFP, and hence of potential output in our model, emerges largely unscathed at the present time.

As 2008 unfolds and the recession quickly worsens, the only force pushing against the fast deterioration in economic conditions is monetary policy. The orange bars—monetary policy shocks—do not represent the overall reaction of monetary policy to economic developments, which includes changes in the policy rate, but rather the extent to which this reaction exceeds what “normal,” historical reaction patterns would imply. Therefore, the large contributions of the orange bars suggest that the Federal Reserve was particularly aggressive in fighting the crisis early on, deploying several tools that went beyond its conventional weaponry. According to our model’s accounting, this extra effort is worth 2 to 3 percentage points of annual GDP growth in the middle of 2008, for a total boost to GDP of roughly 2 percent for 2008 as a whole. And this estimate does not even include the effects of the many credit and liquidity programs the Fed engaged in to ameliorate conditions in financial markets at the height of their stress.

Moving on to the recovery phase, which according to NBER dating starts in the middle of 2009, we can see that shocks to investment demand (in light blue) are the main headwinds holding back the economy. As credit spreads return to normal, the effect of financial risk shocks (in purple) dissipates, even though their overall effect continues to be a drag on growth and inflation. At this point, however, investment shocks start taking on a very large negative role in pushing down both GDP growth and inflation. The key feature of these shocks is the persistence of their effect on both variables, which remain depressed throughout the recovery phase, and into the forecast horizon. Admittedly, the fundamentals of investment shocks are harder to characterize than those of the spread or TFP shocks, representing any factor unrelated to credit spreads that might still restrain investment demand. Many such factors have been identified over time as playing a role in the sluggish recovery, including an overall reluctance of banks and other intermediaries to expose their balance sheets to risk, regardless of the pricing of that risk, and the tendency of firms to delay projects in the face of unusually uncertain prospects. Either way, our model squarely points to investment demand shocks as playing a fundamental role in retarding the recovery, consistent with the view that weak investment, more than consumption, has been behind the slow pace of growth and subdued inflation.

Monetary policy remains on the other side of the ledger over the recovery period, serving to counteract the negative effects of the shocks weighing on the economy. Even with the policy rate against its zero lower bound, monetary policy continues to lift economic activity and prevent inflation from falling too far below target, as demonstrated by the positive orange bars in the chart. In the model, this stimulus is achieved through forward guidance, whose effect on expected future policy rates, and hence on long-term rates, is explicitly taken into account in the model estimation.

The model’s forecast for the evolution of the economy over the next few years (the red lines in both charts) remains persistently subpar, with GDP growth about half a percentage point below its mean and inflation recovering very slowly—scenarios that will be discussed in more detail in the last post in this series. Decomposing the forecasts into their determinants highlights two main features. First, the headwinds represented by tight credit and the other factors holding back investment demand abate only gradually, contributing to restrain the economy over the medium term. Second, monetary policy starts representing a drag on growth and inflation over the forecast horizon, even though the policy rate remains lower than it would otherwise be. The reason is that, in the model, monetary policy has no long-run effects on the real economy, so monetary policy shocks can only affect the level of output temporarily.

In conclusion, this analysis finds little evidence of the permanent structural damage to the economy’s productive potential that many commentators see as the main culprit for the subpar recovery from the Great Recession. Instead, our decomposition is quite supportive of the narrative popularized by Reinhart and Rogoff and more recently by Mian and Sufi, according to which a slow recovery is what we should have expected owing to the very persistent damage inflicted by the financial crisis on the real economy. In the FRBNY DSGE model, this damage manifests itself as a sequence of negative shocks to investment demand—shocks that capture many of the headwinds often mentioned as an impediment to a more robust recovery. At the same time, our model suggests that monetary policy played an important role in cushioning the blow from the financial crisis and in sustaining the recovery, which could have been significantly more disappointing without the aggressive actions undertaken by the Fed.

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

With a 66% chance of default/devaluation implied by the Venezuelan credit market, BofA economist Francisco Roriguez sprung an unusual question on the struggling socialist nation’s central bank – Can you show me your gold?

As Bloomberg reports, the answer was “yes”…

He’d been itching to take a peek for years and now was the time to ask. With the government’s bonds sinking toward prices that indicate investors are bracing for the possibility of default, the country’s $15 billion of gold bars are crucial to ensuring debt payments are met.

 

His first impression once inside the vaults? Those bars don’t take up a lot of room.

 

“You picture that amount of money requiring a lot of space when, in reality, it all fits in five small cells that were not even full to the top,” Rodriguez, a Venezuela native who covers Andean economies for Bank of America Corp. in New York, said in a telephone interview yesterday.

 

He said he started counting frantically in his head, summing up figures scrawled out on signs near each pile of the metal. By his quick math, the gold was all there.

At least they have all their gold thanks to Chavez’ repatriation, which is more than can be said about Germany.

Gold accounts for about 71 percent of Venezuela’s $21.4 billion of foreign reserves, according to the World Gold Council. About $13 billion of the gold is held at the central bank in downtown Caracas, with another $2 billion at the Bank of England, according to Rodriguez. Those gold assets have grown in importance as Venezuela’s overall foreign reserves plunged 34 percent in the past five years, the result largely of a drain of its more liquid assets.

 

The central bank didn’t reply to an e-mail seeking comment on the meeting. In a Sept. 23 note to clients, Rodriguez said the “rare” look at the gold was “largely symbolic yet reassuring.”

 

“It’s not that the majority of the people doubt that the gold is there,” he said by phone. “But it’s one of these things that linger, something that’s nagging you and makes you wonder: What if it’s not?”

*  *  *

As one commenter noted, “It’s quite sad when Venezuela’s Central Bank demonstrates more transparency with its assets than The Federal Reserve.”

via Zero Hedge http://ift.tt/1B8S92R Tyler Durden

Having infamously "thrown in the bearish towel" late last year (must read), Hugh Hendry's Eclectica fund has not enjoyed the kind of money-printing melt-up euphoria he had hoped for in 2014. According to his August letter to investors, the fund is -10.9% year-to-date, shrinking the firm's performance since inception to a mere +0.7%. His positions are intriguing but his commentary can be summed with this sentence alone, "when central banks are actively pursuing a goal of higher prices the most rational course is to tenaciously remain invested in equities." And so he is…

 

Via Eclectica's Hugh Hendry,

Performance Summary

The Fund lost -1.2% in August.

The best performing strategies were those within the Short EM theme which made +0.4% in aggregate, led by our long Mexican Peso/short Chilean Peso holding (a component of the “good versus bad” EM FX strategy) which performed well on evidence of a continued slowdown in the Chilean economy leading to interest rate cuts.

Additional gains came from our Russian FX short, which we have traded tactically throughout the course of the year. Having begun 2014 short the ruble as a result of our concerns regarding the health of the Russian economy, the situation in eastern Ukraine has provided an additional catalyst.

Within the China theme (which gave back -0.2% during the month), we initiated a tactical long position in the Hang Seng China Enterprises Index via call options. This reflects our view that the Chinese Government will underwrite the domestic banking system. Furthermore, the authorities have embarked on a coordinated push to encourage investment in Chinese stocks, both through increasing domestic interest and by further opening the market to international investors through the Hong Kong – Shanghai stock connect. With Chinese stock valuations and sentiment at rock bottom the potential is there for a strong outperformance.

Gains from holdings in European pharma and global internet companies were insufficient to offset losses incurred during the early part of the month on European index positioning and peripheral equities as the Long DM component returned – 1.1% in aggregate.

In Japan, Nikkei futures were the main drag on performance as, in contrast with equity markets elsewhere, the index fell – 1.3% after three consecutive months of gains. The total return for the theme was -0.6%. Elsewhere, our holding in the US 30 year Treasury generated a return of +0.6% as geopolitical events ensured that demand for “safe” assets held up and speculation regarding further ECB intervention made the yield on US bonds look relatively appealing.

Manager Commentary

We should have done better in August. We shuffled our equity cards rather than buying more into the weakness. This has prompted us to rethink our book.

As we have said previously, the global macro environment continues to be defined by a historically tepid recovery from the depths of the 2008 contraction. And this demand-light, low inflation recovery has been met by a wholesale purging of those public officials charged with running the largest central banks.

The presence of Draghi and not Weber, Trichet or Duisenberg (or in Japan Shirakawa, or an American hawk such as John Taylor) helps to explain why the German, Japanese and American stock markets all rose 30% in dollar terms last year. It also helps explains why, with the European recovery wilting and medium term inflation expectations making new lows, the ECB found the wherewithal to ease further. With European stock prices down over 10% during the summer, the central bank eased policy considerably and stock prices are rising once more. Clearly this marks a monumental shift in Europe: the once austere German based central bank has jettisoned its tradition and is explicitly targeting higher prices.

The same could be said about Japan. Japan’s recovery has been shaken by the consumption tax hike and any further economic weakness will most likely be met by further monetary accommodation. Again, price weakness has presented an opportunity to buy. Japan’s stock market had fallen 15% earlier this year, today it is not far from challenging its previous high. When central banks are actively pursuing a goal of higher prices the most rational course is to tenaciously remain invested in equities.

Following this latest announcement of policy easing in Europe we have been actively accumulating more equities. In mid-September, we are currently long 107% equities, with 25% invested in the Nikkei, a further 10% invested in European stock indices and 8% equivalent exposure from short dated options on China’s Hang Seng China Enterprises Index, not to mention a further 63% invested in an equity book that spans Europe’s largest pharmaceutical franchises, Japan’s robotic machinery businesses and a global internet basket.

That is not all. We also have a further 6bps DV01 exposure to receiving rates, predominantly long dated Treasuries. The reasoning is similar to our equity book. Central banks seem capable of expanding their price setting franchise to establish nominal rates low enough to support the tepid global recovery. We have simply cherry picked anomalous rates where market prices are not consistent with this view that very low rates are required to ensure that domestic expansions are sustained.

 

*  *  *

As Hendry concluded previously,

Where will it all end?

Remarkably, the aftershocks of Japan's volte-face seemed to catch American policy makers out. In May, the Fed, convinced that its QE program had succeeded in re-distributing global GDP away from China and towards the US economy, began signalling its intent to taper its easy money by autumn. However, with 10-year Treasury rates having moved from 1.75% to 3% and its fourth largest trading paltrier having devalued by 20% since the previous November, the anticipated vigorous domestic American growth never actually materialised; it was captured instead by the new and even looser monetary policy of Japan. Yet again the reflexive loop had worked to sustain the monetary momentum that is feeding global stock markets. And the not so all-knowing Fed? It had to shock market expectations in October by removing the immediacy of its tighter policy and stock markets rebounded higher. Where will this all end? Can it ever end?

There are multiple possible outcomes. The one markets are most vulnerable too is the re-emergence of bullish bankers. They could lend such that the consumer boom in the US and Europe finally sparks and in doing so provoke the Fed to finally tighten policy. That would spook developed market equities but not as much as you might think – they will have the palliative of the stronger GDP growth. Emerging market equities are closer to the edge of a bubble and could prove more susceptible to a greater drawdown owing to th
e fragilities of their debt fuelled economies. But for now, the re-emergence of risk-seeking bankers fuelling a lending boom in the West seems remote. We aren't too worried about it. In Europe for instance the banking system has an estimated 2.6trn euros of deleveraging (circa 30% of GDP) still to complete, having shed 3.5trn euros already.

So we are happy to run a long developed market stock position with a short hedge composed of emerging market equity futures. We are running an unhedged long in Japanese equities as our wild bullish card (we have, of course, hedged the currency).

It seems then to us that the most likely outcome is that America and Europe remain resilient without booming. But with monetary policy set so much too loose it is inevitable that we will continue to witness mini-economic cycles that convince investors that economies are escaping stall speed and that policy rates are likely to rise. This will scare markets – and emerging markets in particular – but it won't actually materialise: stronger growth in one part of the world on the back of easier policy will be countered by even looser policy elsewhere (the much fabled "currency wars"). So market expectations of tighter policy will always be rescinded and emerging markets will recover rather than crash. Developed markets just keep trending positively against this background – and might accelerate. Remember what we said about 1928 and 1998 at the beginning.

Just be long. Pretty much anything.

So here's how I understand things now that I am no longer the last bear standing. You should buy equities if you believe many European banks and their sovereign paymasters are insolvent. You should buy shares if you put a higher probability than your peers on the odds of a European democracy rejecting the euro over the course of the next few years. You should be long risk assets if you believe China will have lowered its growth rate from 7% to nearer 5% over the course of the next two years. You should be long US equities if you are worried about the failure of Washington to address its fiscal deficits. And you should buy Japanese assets if you fear that Abenomics will fail to restore the fortunes of Japan (which it probably won't). Hey this is easy…

And then it crashed

I have not completely lost my senses of course. Eclectica remain strong believers in the most powerful force in the universe – compounding positive returns – and avoiding large losses is crucial to achieving this.

We have built a reputation for getting the calls right in the difficult space that is macro investing, which has served us and our clients well during both trending bull markets and times of crisis. Today, of course, the market is "golden" which is to say that the 50 day price trend is above the 200 day. But remember that during those forays into the "dead-zone", years like 2008 and 2011 when equity markets crashed, Eclectica performed handsomely. I like to think therefore that I own an alpha crisis management franchise that has rewarded our investors at limes of stock market stress.

via Zero Hedge http://ift.tt/1B8S92I Tyler Durden

While it is easy, even sentimental, to pin what may (or may not) be a bubble, or as some call it – market – top on the recent liquidity and euphoria-soaking IPO of China’s megaretailer Alibaba and its sliding chart since it broke for trading, a la what the Blackstone IPO did to the previous bubble, it is also wrong. The reality is that the attention of what few carbon-based investors and traders are left, is glued to very different chart: the one below from Deutsche Bank, showing the  between the S&P and the total assets owned by the Fed.

Read on for the reason why:

Less central bank liquidity

 

In Figure 8 we show what has probably been one of our most used charts of the last year or so. It looks at the relationship between the size of the Fed balance sheet and the S&P 500 (as a proxy for risk generally). As you can see, since the Fed balance sheet was used as an aggressive policy tool post-GFC, the graph suggests that the S&P 500 is well correlated with its size with the former leading the latter by 3 months. For the past 5 years or so the times where we have seen strong performance from risk assets have broadly coincided with periods where the Fed was aggressively expanding its balance sheet. In the periods where the balance sheet wasn’t increasing we generally saw a more challenging environment. So as we have highlighted recently the wobbles seen during the summer months may in part have been due to the imminent end to asset purchases next month (given the 3-month lag in the relationship) and arguably demonstrate the potential challenges facing investors in a world where liquidity is less freely available.

However…

Here we’ve focused only on the actions of the Fed. Since the GFC it’s not just the Fed that has increased the size of its balance sheet. In Figure 9 we track the YoY growth rate (in dollar terms) of the four main central banks globally (Fed, ECB, BoJ, PBoC). We can see that pre-crisis overall balance sheet growth was fairly strong due to the expansion in China. We then get the post-GFC boost from the Fed and to a lesser extent the ECB. We can see that central bank balance sheet expansion seems to have come in waves since then following the various different forms of policy accommodation and QE. Having reached a peak of around 13% in Q1 this year with the growth rate declining since. With the Fed balance sheet likely to be static as of next month much might depend on the BoJ and the ECB from a global liquidity standpoint. China’s actions are less predictable and it could be they react to slower growth by expanding the money base.

However, as of today, they appear far more predictable. Recall: “Get To Work Mr. Chinese Chairman”: China Set To Fire Its Central Bank Head, Unleash The Liquidity Floodgates

So, Deutsche Bank’s conclusion: “Overall we would argue that markets might experience a few more bumps in the road as the global liquidity picture is not as supportive as it has been.”

Also known as Euphemism 101.

via Zero Hedge http://ift.tt/Y5ZCTj Tyler Durden

While it is easy, even sentimental, to pin what may (or may not) be a bubble, or as some call it – market – top on the recent liquidity and euphoria-soaking IPO of China’s megaretailer Alibaba and its sliding chart since it broke for trading, a la what the Blackstone IPO did to the previous bubble, it is also wrong. The reality is that the attention of what few carbon-based investors and traders are left, is glued to very different chart: the one below from Deutsche Bank, showing the  between the S&P and the total assets owned by the Fed.

Read on for the reason why:

Less central bank liquidity

 

In Figure 8 we show what has probably been one of our most used charts of the last year or so. It looks at the relationship between the size of the Fed balance sheet and the S&P 500 (as a proxy for risk generally). As you can see, since the Fed balance sheet was used as an aggressive policy tool post-GFC, the graph suggests that the S&P 500 is well correlated with its size with the former leading the latter by 3 months. For the past 5 years or so the times where we have seen strong performance from risk assets have broadly coincided with periods where the Fed was aggressively expanding its balance sheet. In the periods where the balance sheet wasn’t increasing we generally saw a more challenging environment. So as we have highlighted recently the wobbles seen during the summer months may in part have been due to the imminent end to asset purchases next month (given the 3-month lag in the relationship) and arguably demonstrate the potential challenges facing investors in a world where liquidity is less freely available.

However…

Here we’ve focused only on the actions of the Fed. Since the GFC it’s not just the Fed that has increased the size of its balance sheet. In Figure 9 we track the YoY growth rate (in dollar terms) of the four main central banks globally (Fed, ECB, BoJ, PBoC). We can see that pre-crisis overall balance sheet growth was fairly strong due to the expansion in China. We then get the post-GFC boost from the Fed and to a lesser extent the ECB. We can see that central bank balance sheet expansion seems to have come in waves since then following the various different forms of policy accommodation and QE. Having reached a peak of around 13% in Q1 this year with the growth rate declining since. With the Fed balance sheet likely to be static as of next month much might depend on the BoJ and the ECB from a global liquidity standpoint. China’s actions are less predictable and it could be they react to slower growth by expanding the money base.

However, as of today, they appear far more predictable. Recall: “Get To Work Mr. Chinese Chairman”: China Set To Fire Its Central Bank Head, Unleash The Liquidity Floodgates

So, Deutsche Bank’s conclusion: “Overall we would argue that markets might experience a few more bumps in the road as the global liquidity picture is not as supportive as it has been.”

Also known as Euphemism 101.

via Zero Hedge http://ift.tt/Y5ZCTj Tyler Durden

Submitted by Martin Armstrong via Armstrong Economics,

The Canadian government has had to warn its citizens not to carry cash to the USA because the USA does not presume innocence but guilt when it comes to money. Over $2.5 billion has been confiscated from Canadians traveling to the USA, funding the police who grab it.

If you are bringing cash to the land of the free, you will find that that saying really means they are FREE to seize all your money under the pretense you are engaged in drugs with no evidence or other charges.

It costs more money in legal fees to try to get it back so it is a boom business for unethical lawyers to such an extent than only one in sixth people ever try to get their money back and the cops just pocket it. That’s right. Money confiscated is usually allowed to be kept by the department who confiscated it.

This is strangely working its way into funding police and pensions.

This is identical to the very issue that resulted in the final collapse of Rome when the armies began to sack cities to pay for their pensions. We are at that level now with respect to seizing whatever they want knowing you will have to spend more in legal fees to assert your rights that do not really exist.

Those trying to flee tyranny elsewhere can not bring money with them for the police get to take it on this end.

This pretend war on terrorism is really a wholesale war against the people. It serves as the justification to seize whatever they desire ever since 9/11 as reported by the Washington Post.

via Zero Hedge http://ift.tt/Y5ZCmf Tyler Durden

On a day when a French hostage is beheaded by an ISIS splinter group, the bungling of French police’s attempts to arrest returning jihadists is simply incredulous…

 

As Bloomberg reports,

The French government struggled to explain its bungling of the arrest of three men suspected of having fought for Islamic State in Syria and deported by Turkey, after police waited for them at the wrong airport.

The men turned themselves in this morning at a gendarme station in southern France, BFM TV reported.

“We went through customs, we showed our passports, and there was no one to meet us,” one of the three men, who gave his name as Imad, told Europe1 radio. “We were quite surprised,” he said, adding that they planned to turn themselves in.

 

They rang the bell at the station in the town of Caylar and were told to wait outside because there was no one there. A police car came 20 minutes later to pick them up and take them to a nearby police station, according to BFM.

The missteps, which Defense Minister Jean-Yves Le Drian called a “major foul-up,” led to accusations of incompetence from the opposition and forced Interior Minister Bernard Cazeneuve to promise an investigation.

Not Their Fault though, right?

After being arrested in Turkey last month, the three men were put on a flight to Orly airport in Paris yesterday. The pilot of that plane refused to fly with them on board, according to a statement from the French Interior Ministry. Turkish police then placed them on a flight to Marseille without informing their French counterparts of the change until after their arrival in France, the ministry said.

 

A computerized passport system at Marseille airport that should have alerted police about the suspects’ arrival was broken, Le Drian said on France Info radio today.

 

“It’s a complete mess but a large part of it is due to a lack of good cooperation with the Turkish authorities,” he said. Cazeneuve told reporters he’ll be speaking today to his Turkish counterpart to improve cooperation.

 

…

 

France has joined the U.S. in airstrikes in Iraq. “This affair didn’t go as it should have,” Prime Minister Manuel Valls said during a parliamentary debate today. “The Interior Minister has spoken about it, and will have the chance to do so again.”

 

About 580 French have fought or are fighting in Syria, and 36 died there, Valls said today. He said 189 have returned, of which 114 have been arrested, 78 charged, and 53 sent to jail.

*  *  *
But at least they know how to ‘plan’ an economy? oh wait…

via Zero Hedge http://ift.tt/1v0TkRV Tyler Durden

As Mises Canada's David Howden introduces,

Do you have a friend who consistently borrows 30% of his income each year, is currently in debt about six times her annual income, and wanted to take advantage of short-term interest rates so that he needs to renegotiate with his banker about once every six years? Well, if Uncle Sam is your friend you do!

*  *  *

Lehman Brothers filed for Chapter 11 bankruptcy protection six years ago this month. The event has become famous as the spark that ignited the global financial crisis. Since that date, millions have lost their jobs and livelihoods, and countless others have seen their futures evaporate before their eyes, sometimes permanently.

At the heart of the crisis of 2008 was a common cause acknowledged by almost all commentators. Borrowers now infamously known as “subprime” (or more politely, “non-prime”) were the main reason behind the meltdown. As financial institutions extended loans to those with less than stable means to repay their debts, the foundation of the financial world was destabilized.

Six years on and these subprime debtors are largely a relic of the past. That fact notwithstanding, there is a new threat lurking in the global financial arena. This one borrower is far larger than all the previous subprime characters combined, and poses a far more dangerous hazard to the financial stability of nearly all (if not all) of the world’s citizens. I am speaking, of course, of the United States government.

Subprime borrowers are defined by FICO scores which are largely inapplicable to sovereign nations. We can instead look at the type of loans that these borrowers took on to understand how precarious the United States federal government’s finances are.

To simplify matters greatly, consider three types of loans that made debt attractive to subprime borrowers. The first was the adjustable rate mortgage. After a short period at a low introductory teaser rate, the interest rate would reset higher. Second was the interest only loan. Borrowers could take out a sum of money and for a period not worry about paying down the principal. An extreme form of the interest only loan is the final type: the negative amortization loan. In this case, not only does the payment not reduce the principal of the loan, it doesn’t even cover all the accrued interest! The effect is that each month that goes by, the borrower slips further in debt as interest deferral is added to the principal to be repaid.

In the wake of the crisis, a lot of commentators focused on two measures of the government’s financial stability. The first was its debt to GDP level, which was added to on a yearly basis by its deficit (also expressed as a percentage of GDP). At its nadir in 2010, the federal government ran a budget deficit of nearly 10 percent of GDP (the highest since World War II). As of today, the federal debt level (ignoring unfunded liabilities such as Social Security or Medicare) amounts to 102 percent of GDP.

While these numbers are indeed high, they really understate the problem. After all, the denominator in both cases is the total income of the whole United States, not just that of the government.

To get a better feel for these figures, consider how much the federal government borrows as a percentage of its income (the sum of its tax receipts).

Figure 1: Net federal government borrowing as a percentage of federal tax revenue (percent). Source: St. Louis Federal Reserve Economic Data

In figure 1 we can see that not only does the federal government often finance itself with debt, but it does so by borrowing a lot relative to its income. In 2009 it borrowed 85 percent as much as it was able to raise through taxes! While commentators praise the government for getting its budget deficits under control and down to a more “reasonable” level of 4 percent of GDP, we can see that it still needs to borrow more than 20 percent of its income to keep its operations afloat.

Of course, this is just the yearly deficit. Turning our attention to the cumulative effects of this in terms of the gross federal debt outstanding we can see that the situation is even more precarious.

Figure 2: Gross federal debt as a percentage of federal tax revenue (percent). Source: St. Louis Federal Reserve Economic Data

As of last year, the gross amount of debt owed by the federal government was about 5.5 times its tax receipts. That would be equivalent to someone earning $30,000 a year owing $165,000. Somehow people are up in arms about students graduating with an average of $30,000 in debt and landing a measly $30,000 a year job, but few want to face the realization that the federal government is in five times worse shape.

The federal government is in worse financial state than is commonly recognized, but few would call it a subprime debtor, right? Let’s look at the type of borrowing the government does and you can make up your own mind.

Many subprime borrowers were caught when they borrowed for short periods only to see their interest charges increase when their adjustable rate mortgages reset higher.

Figure 3: Weighted average maturity of federal debt outstanding (months). Source: United States Treasury Department

In figure 3 we can see that the average maturity of debt was about 5.5 years as of last year. Nearly half of its outstanding debt is due within three years, and a full two-thirds needs to be repaid within five. This may not be as short-term as some other debtors, but it’s not exactly a fixed rate mortgage either. On the other hand, it is troubling because the Federal Reserve has dedicated itself explicitly to a policy of fostering higher inflation. Accompanying this higher inflation will be increased interest rates, and a new problem for the government to “solve” as it is forced to borrow at higher interest rates.

What about interest-only, or negative-amortization loans? As we can see in figure 4, for the last decade (at least) the Treasury has underpaid its annual interest expense by about $200 billion per year. Last year that amounted to about 5 percent of its total tax receipts. This amount is added to the principal outstanding each year to increase the gross level of indebtedness of the federal government.

Figure 4: Federal Interest Expense and Payments ($bn.) Source: St. Louis Federal Reserve Economic Data and United States Department of the Treasury

Of course, this is not a strict example of a negative amortization loan. However, it has the same effect in the end, with the only difference being that the Treasury borrows money each year and incurs more interest in order to pay off the interest on its existing debt.

The United States government not only borrows in the same way that those destabilizing subprime lenders did six years ago, it does so on a much larger scale. Back in 2008, there were almost $15 trillion of mortgages outstanding (around 100 percent of 2008 US GDP). Many, if not most of these, were not subprime. By comparison, there is about $2 trillion more than this amount in federal debt today, the majority of which is repaid under conditions similar to those troublesome subprime borrowers. To make ma
tters worse, since not all the nation’s income is the government’s, this amounts to more than 5.5 times the relevant tax base that it can repay it with. (Of course, unlike subprime borrowers who lost their jobs and income during the recession, the federal government can unilaterally increase its income by raising or introducing new taxes. I don’t think many want to see this option pursued.)

I will end by answering a troubling question: who lends this money to the federal government? After all, if the federal government’s “subprime” borrowing debacle goes down like the private one did six short years ago, it would be nice to know who to point the finger at. Banks and other financial institutions received the lion’s share of the blame for their part in so-called predatory lending of money to those who couldn’t repay, but who is lending to the government?

Lots of “little people” own a few T-bills, but they pale in comparison to the Federal Reserve.

Before the crisis, the Fed kept its Treasury purchases fairly steady and low relative to the total issuance (around 6-7 percent until 2007). Despite some early shedding of Treasuries early in the crisis in lieu of lower quality mortgage-backed securities and federal agency debt (something Philipp Bagus and I called “qualitative easing” at the time, see here (pdf) and here (pdf) and here), by 2010 over half of all Treasury debt was bought by the Fed. Even today, while talk of tapering QE abounds, the Fed is still responsible for over 40 percent of the federal government debt.

The federal government’s finances were not always so shoddy. While it is convenient to blame Congress for the present situation, it takes two to tango. The will to spend was apparent in the government, but the Fed provided the means.

Six years ago financial institutions were demonized as subprime borrowers who could not repay their loans. If the federal government turns out to be just another subprime debtor, we should expect the blame to be placed on the Federal Reserve for fostering such a situation and allowing it to persist for so long.

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

As Mises Canada's David Howden introduces,

Do you have a friend who consistently borrows 30% of his income each year, is currently in debt about six times her annual income, and wanted to take advantage of short-term interest rates so that he needs to renegotiate with his banker about once every six years? Well, if Uncle Sam is your friend you do!

*  *  *

Lehman Brothers filed for Chapter 11 bankruptcy protection six years ago this month. The event has become famous as the spark that ignited the global financial crisis. Since that date, millions have lost their jobs and livelihoods, and countless others have seen their futures evaporate before their eyes, sometimes permanently.

At the heart of the crisis of 2008 was a common cause acknowledged by almost all commentators. Borrowers now infamously known as “subprime” (or more politely, “non-prime”) were the main reason behind the meltdown. As financial institutions extended loans to those with less than stable means to repay their debts, the foundation of the financial world was destabilized.

Six years on and these subprime debtors are largely a relic of the past. That fact notwithstanding, there is a new threat lurking in the global financial arena. This one borrower is far larger than all the previous subprime characters combined, and poses a far more dangerous hazard to the financial stability of nearly all (if not all) of the world’s citizens. I am speaking, of course, of the United States government.

Subprime borrowers are defined by FICO scores which are largely inapplicable to sovereign nations. We can instead look at the type of loans that these borrowers took on to understand how precarious the United States federal government’s finances are.

To simplify matters greatly, consider three types of loans that made debt attractive to subprime borrowers. The first was the adjustable rate mortgage. After a short period at a low introductory teaser rate, the interest rate would reset higher. Second was the interest only loan. Borrowers could take out a sum of money and for a period not worry about paying down the principal. An extreme form of the interest only loan is the final type: the negative amortization loan. In this case, not only does the payment not reduce the principal of the loan, it doesn’t even cover all the accrued interest! The effect is that each month that goes by, the borrower slips further in debt as interest deferral is added to the principal to be repaid.

In the wake of the crisis, a lot of commentators focused on two measures of the government’s financial stability. The first was its debt to GDP level, which was added to on a yearly basis by its deficit (also expressed as a percentage of GDP). At its nadir in 2010, the federal government ran a budget deficit of nearly 10 percent of GDP (the highest since World War II). As of today, the federal debt level (ignoring unfunded liabilities such as Social Security or Medicare) amounts to 102 percent of GDP.

While these numbers are indeed high, they really understate the problem. After all, the denominator in both cases is the total income of the whole United States, not just that of the government.

To get a better feel for these figures, consider how much the federal government borrows as a percentage of its income (the sum of its tax receipts).

Figure 1: Net federal government borrowing as a percentage of federal tax revenue (percent). Source: St. Louis Federal Reserve Economic Data

In figure 1 we can see that not only does the federal government often finance itself with debt, but it does so by borrowing a lot relative to its income. In 2009 it borrowed 85 percent as much as it was able to raise through taxes! While commentators praise the government for getting its budget deficits under control and down to a more “reasonable” level of 4 percent of GDP, we can see that it still needs to borrow more than 20 percent of its income to keep its operations afloat.

Of course, this is just the yearly deficit. Turning our attention to the cumulative effects of this in terms of the gross federal debt outstanding we can see that the situation is even more precarious.

Figure 2: Gross federal debt as a percentage of federal tax revenue (percent). Source: St. Louis Federal Reserve Economic Data

As of last year, the gross amount of debt owed by the federal government was about 5.5 times its tax receipts. That would be equivalent to someone earning $30,000 a year owing $165,000. Somehow people are up in arms about students graduating with an average of $30,000 in debt and landing a measly $30,000 a year job, but few want to face the realization that the federal government is in five times worse shape.

The federal government is in worse financial state than is commonly recognized, but few would call it a subprime debtor, right? Let’s look at the type of borrowing the government does and you can make up your own mind.

Many subprime borrowers were caught when they borrowed for short periods only to see their interest charges increase when their adjustable rate mortgages reset higher.

Figure 3: Weighted average maturity of federal debt outstanding (months). Source: United States Treasury Department

In figure 3 we can see that the average maturity of debt was about 5.5 years as of last year. Nearly half of its outstanding debt is due within three years, and a full two-thirds needs to be repaid within five. This may not be as short-term as some other debtors, but it’s not exactly a fixed rate mortgage either. On the other hand, it is troubling because the Federal Reserve has dedicated itself explicitly to a policy of fostering higher inflation. Accompanying this higher inflation will be increased interest rates, and a new problem for the government to “solve” as it is forced to borrow at higher interest rates.

What about interest-only, or negative-amortization loans? As we can see in figure 4, for the last decade (at least) the Treasury has underpaid its annual interest expense by about $200 billion per year. Last year that amounted to about 5 percent of its total tax receipts. This amount is added to the principal outstanding each year to increase the gross level of indebtedness of the federal government.

Figure 4: Federal Interest Expense and Payments ($bn.) Source: St. Louis Federal Reserve Economic Data and United States Department of the Treasury

Of course, this is not a strict example of a negative amortization loan. However, it has the same effect in the end, with the only difference being that the Treasury borrows money each year and incurs more interest in order to pay off the interest on its existing debt.

The United States government not only borrows in the same way that those destabilizing subprime lenders did six years ago, it does so on a much larger scale. Back in 2008, there were almost $15 trillion of mortgages outstanding (around 100 percent of 2008 US GDP). Many, if not most of these, were not subprime. By comparison, there is about $2 trillion more than this amount in federal debt today, the majority of which is repaid under conditions similar to those troublesome subprime borrowers. To make matters worse, since not all the nation’s income is the government’s, this amounts to more than 5.5 times the relevant tax base that it can repay it with. (Of course, unlike subprime borrowers who lost their jobs and income during the recession, the federal government can unilaterally increase its income by raising or introducing new taxes. I don’t think many want to see this option pursued.)

I will end by answering a troubling question: who lends this money to the federal government? After all, if the federal government’s “subprime” borrowing debacle goes down like the private one did six short years ago, it would be nice to know who to point the finger at. Banks and other financial institutions received the lion’s share of the blame for their part in so-called predatory lending of money to those who couldn’t repay, but who is lending to the government?

Lots of “little people” own a few T-bills, but they pale in comparison to the Federal Reserve.

Before the crisis, the Fed kept its Treasury purchases fairly steady and low relative to the total issuance (around 6-7 percent until 2007). Despite some early shedding of Treasuries early in the crisis in lieu of lower quality mortgage-backed securities and federal agency debt (something Philipp Bagus and I called “qualitative easing” at the time, see here (pdf) and here (pdf) and here), by 2010 over half of all Treasury debt was bought by the Fed. Even today, while talk of tapering QE abounds, the Fed is still responsible for over 40 percent of the federal government debt.

The federal government’s finances were not always so shoddy. While it is convenient to blame Congress for the present situation, it takes two to tango. The will to spend was apparent in the government, but the Fed provided the means.

Six years ago financial institutions were demonized as subprime borrowers who could not repay their loans. If the federal government turns out to be just another subprime debtor, we should expect the blame to be placed on the Federal Reserve for fostering such a situation and allowing it to persist for so long.

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