Category Archives: Banking

Politics and Spin Over Observation

The March 30th US print edition of the Wall Street Journal carried an Opinion piece titled, “Britain’s Monetary ‘Stimulus’ Has Fed the Pension Crisis“. The article highlights the plight of many firms whose pension funds are under water and how persistently low interest rates have crippled the chances to grow the returns on a number of investment vehicles. This is due to the widening gap between the value of assets and liabilities. The article happens to highlight this plight in conjunction with true fight in Britain over a venerable old British firm, GKN, who has impressively damaging pension liability any suitor needs to accommodate.

The real point of the article however is not really about GKN. It is that the Bank of England recently published a paper that argued its loose monetary policy and massive quantitative easing were in fact good for us. The argument of the report is that things would have been much worse, therefor whatever we have must be better. This is a strange argument. Much research has been published that correlated near-zero interest rates and QE with debt and credit price distortions, record-levels of M&A, record-levels of stock buy-backs, Stu only low capital investment levels, low productivity, and to top it all off, increased inequality. To be fair, if you didn’t watch the news and all those around you, the Bank of England report might be credible. If we had had a real crash, the pain might have been worse for a while, but the economy would have recovered as fast as other recessions due to the lack of credit and debit distortions.

The article closes on a useful warning and observations. Old firms with such large pension obligations and short-falls are suffering from a double-whammy. Such firms have to divert funds to stem the pension fund blessing that might otherwise have helped source the needed growth in the future to pay for those persons. Even if central banks had not kept rates so low for so long and stuff they investor-classes pockets with cheap money, such firms might still be in trouble-or anyway.

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The Debt Chickens Are Coming Home to Roost

A story it today’s Us print edition of the financial times highlights a building ‘bubble’ of disquieting proportions. The article, ‘Britain’s Pizza Chain Boom Faces Debt Reckoning’, highlights how a large number of restaurant chains have been snapped up over recent years using debt. This might be by a private equity firm or a leveraged buy-out. In either and other cases, many acquisitions were executed using cheap debt which was facilitated by central bank policies such as near-zero interest rates and quantitative easing (QE), both of which massively distorted the price of corporate bonds and debt. Add to this public policy and pressure on banks to increase loans to help drive growth, you can see signs of a perfect storm.

The UK example is specific, but the problem is wide and applicable to most developed economies. The US has just come off a long-run marathon of high and record levels of corporate acquisitions, again much funded by cheap debt. There must be many organizations hanging by a thread, just waiting for interest rates to nudge up resulting in unsustainable debt burdens and interest payments. Unless growth drives the top-line of these businesses at a faster rate, the chances are many such firms will go to the wall.

This situation was created as an unintended consequence of near-zero interest rates for such a long time and massively price-distorting quantitative easing. Though most governments have ceased buying sovereign and corporate debt, the damage is done. Massive, trillion dollar, balance sheets at central banks need to be unwound in such a way as again, not upset the market. The act of creating the balance sheet did upset the market. In reducing their balance sheets, central banks will do it again.

And the sad part about all this, as it will play out? Smart investors with lots of money and a high risk-tolerance will hedge against such business failures and reap huge rewards. The rich investor-class will get richer, and the poor will just lose their jobs or otherwise miss out. Politicians will have a field day, calling out the failure of capitalism. Of course, it’s not a failure of capitalism since central banks and their policies are not part of any capitalist model: central bank operations are closer to a socialist model where the few take decisions to ‘help’ the many, as if they know better and how to help us.

Oh well, such is life. Just buckle down and wait the storm. The debt chickens will soon be home to roost. Maybe not by this Easter but expect them home by next year.

Italy – The Next Euro Crisis Catalyst?

Two articles lead one to expect a new (or renewed) crisis in the EU. One in today’s US print edition of the Financial Times and the other in this week’s US print edition of the Economist.

In the FT’s, “The Spreading Pain of Italy’s Bank Saga“, Sarah Gibson explains how, beyond the shenanigans related to the letting-off of Italy by the EU for bailing out its unsound banks, Italy is headed for a risky referendum in the fall. It concerns government modernization but Prime Minister Renzi has turned it into a referendum on himself, by insisting that should the vote fail, he will resign.

The problem is that many firms have gone bust, taking with them bad loans written-off by banks, reducing their assets (and liabilities), and increasing unemployment. This tends to further harm already anemic economic growth. So Renzi is at risk since the electorate may very well vote, ‘no’ more as a statement against the current performance of the Italian economy, rather than a rational response to the proposal. The result would be turmoil in Italy and possibly the return of extremist policies that would then further threaten economic recovery and EU stability.

The Economist article, “Britain and Europe: The Start of the Break-Up” reports on how other nations view, in an Ipsos Mori poll, the UK’s recent decision to vote for Brexit. There were some interesting results.

More member states (58% over 55%) felt Brexit was worse for Euro zone than for Britain. This is indeed logical but hardly the stuff that the media wants to see. Only 35% of those polled in big developed countries outside the Union felt Britain had made a mistake.  So what do they know that the press don’t?

Interestingly two other points stand out. Sweden, of all countries, is most concerned for Europe (68% polled said Brexit was bad for Europe). This is due to the economic impact of such a sizable economy leaving. Let’s be frank- the UK is not better than other country in the EU; it’s just a very big, free-trade oriented ex super-power with good connections. A fool would negotiate restrictive policy to trade and not collaborate with such a neighbor.

As issues such as Italy’s wobbly banks become more serious and risky referendums are executed, and as Britain’s economic future will be observed to be guided by their own decisions versus those from outside, other countries may soon conclude that the grass might be greener outside the EU….

Long live the EU. Let’s get on with building a new elective EU II Constitution!

Alarm Bells Ringing: Productivity Dives and Credit Card Debt Soars in US; Private Investment in China Falls

Today’s US print edition of the Wall Street Journal was not a happy bunny. Articles on the front page (Productivity Fall Imperils Growth), inside front cover (Plastic Is Back In Style), and back cover (China’s Private Sector Withers as Growth Slows), pretty much portrayed a state of global gloom.

First, productivity. Readers of this blog will know my thoughts about productivity. Advanced economies are struggling to demonstrate productivity improvements and so our collective long-term growth prospects are falling. We can’t just adding more hours to get back to reasonable economic growth and pay off our debts- we need to become more productive.

Increasing red tape, political gridlock or uncertainty, uncompetitive tax rates, quantitive easing, low interest rates, and a regulatory framework that dissuades both business risks (in banking) and start-ups and capital investment (private sector investment) are crimping opportunities for productivity improvements.  Capitalism is being strangled.  I might even go as far to say that the technology or the IT industry is also struggling to demonstrate the value it can bring to business. Whatever the case, productivity is critical to our long-term success and few governments or leaders are even talking about it.

Second, credit card debt. From an economic cycle perspective the US economy is past the high-point of the recovery and most likely moving down toward the next down-cycle. Though you would not know this from the economic data. However, consumer debt is suggesting a bit of a problem is bubbling away.

After the financial crisis US consumer debt (and private sector debt, for that matter) took a bit of hiatus. We all took time off to unload some of our liabilities. However the report suggests that all the debt cycles are now trending up: mortgage debt ‘recovered’ first, then student loans, automobiles, and finally now we see credit card debt on the increase. What is interesting though is that this growth is mainly associated with those of us with a subprime or low credit score. In other words, that part of the consumer population that is most at risk of non-payment are stoking up on credit. The percent of the population with high credit scores has remained the same over the last ten years.  

Finally, China. The news is not good. The article clearly only refers to a few individual company interviews but does report on some economic data, for what it is worth. Private sector capital investment in things like factories and vehicles grew 2.8% in 1H 2016, compared to 30% in the last 10 years. June was the first time it actually fell since China started tracking the data in 2004.

Public sector spending has been very high recently, partly as an attempt to replace the loss of private investment and also to support of the needed investment to convert the Chinese economy from a supply-based manufacturing oriented economy to a demand-based consumer model. This will take years; all the while public sector debt is pilling up. The article also highlights a government official who suggests that falling productivity is part of the problem.

So with just one coffee out of the way, I was already not feeling good about the world. Off to go cook breakfast for the boys. I hope they have a better time back at school today!

Two Long Term Concerns Stand Taller then Brexit

Two articles in this weekend’s US print editions of the Wall Street Journal and Financial Times highlight the real concerns that threaten global growth, far more so than the ministrations of (hopefully) rational politicians soon to embroil in Brexit negotiations. One concerns China and the other Italy.
In “Rising Worries Cloud China GDP“, Alex Frangis of the WSJ reports that GDP continues to show signs of weakness and more importantly, how the declining GDP is accounted for, is more troubling than its decline. It seems private investment continues to decline and public debt continues to raise.
The declining private sector investment is bad since it already represents the lions share of investment. So as that declines, overall GDP declines and the smaller sector of public debt has to step up. But this is exactly the opposite trend China needs to help transition its economy from product based to consumer based.
Housing prices show signs of cooling though by western standards the numbers are impressive. At the same time anecdotal data on unemployment shows troubling shifts too. Overall the article suggests all the wrong data points we need to suggest positive changes. If anything, China is headed towards more problems and with that, so do we.
The second article, “Exploiting the fine print to save Italy’s Banks“, Dan MccRum a and Thomas Hale of the FT, report the troubling challenges facing EU regulators that still have not closed all the leaks that sprang up post the Greek crisis. Forget the fact that Greece’s economy remains a basket case, Italy’s banks are in trouble. Italy never addressed the bed debt problem overhanging their economy; they neither farmed out all major losses to debt holders, nor give off the bad debts to a ‘bad bank’. The chickens are coming home to roost.  
The resolution will be yet another fiddle by the EU. The Italian banks will need a bail out using public funds. Italy is always over budget and should face an EU penalty for financial promiscuity. It will be waived, as it has been waived for France and Germany before. Why do we even accept such rules if they just don’t count?  
If we ignore the politics of rule setting and bypassing then, and just focus on Italy’s financing, we can determine that the fundamental issues facing Greece are not dissimilar to Italy. What differs is how such nations seek to address those challenges. Italy needs to modernize and revamp its banking and investment sector. It needs to address losses that have piled up. Until, and if, it does, the Euro will remain a troubled currency. This is what sits at the heart of a rotten Europe.

Brexit: Mainly the Right Decision for Mostly the Wrong Reasons?

The title of this blog captures how I would summarize Brexit, the U.K. Referendum to leave the European Union. After watching the story unfold intently from afar, the visiting and immersing myself in local dialog over the last three weeks, the tittle of this blog captures the essence of the situation.

The reality is much worse, again for the wrong reasons. Let’s first look at the decision.

  • Technically the process and the method by which the UK will leave the EU has not even started and won’t until October.
  • How the divorce will shape up will be subject to protracted negotiation. Clause 50 has never been tested. Also the UK is a large economy, with several advantages, namely its own currency and exchange rate (to buffer any risks) and the city of London financial center.
  • There are numerous related dominoes that make scenario planning more useful than predicting one single outcome. This includes the foolish attempt by the leader of the SNP who wants to turn Brexit, a UK referendum, into something about Scotland.  

Now let’s look at the pre-Brexit political, or should I say marketing, spin:

  • Neither those for Remain or Leave debated honestly. They could not even agree common terms of reference; how much money the UK gave to the EU versus how much was given back in terms of subsidies, could not be agreed. 
  • There was significant scaremongering from the Remain campaign, led by the generally liberal or progressive establishment, supported by economic groups including the IMF. Yet a minority of smart investors who have continually beaten the pundits like the IMF identified great opportunity for the UK. One wonders if much of the ‘economic advice’ was more political than practical. No act by the EU to penalize the UK would be countenanced long since a) it penalizes both sides, and b) the very arguments used by the EU for open, friendly, collaboration would be exposed for what they really are- unelected dictatorial bureaucrats.
  • The Leave campaign led their supporters in the belief that immigration would stop with a vote for Brexit, as if humanitarian aid were an EU and not a national or moral concern.  There are significant immigration challenges for all countries; remaining or leaving the EU is not central to the real issue.  

The bottom line is therefore the Brexit vote was more an emotional vote, and nor a rational vote.

Finally let’s look at the post-Brexit situation on the ground. In no particular order:

  • The leader of the Scottish National Party wants to reposition the UK referendum as if it was a Scottish referendum. Since the majority of scots voted ‘remain’, and since the UK voted ‘leave’, surely it means Scotland is being forced against its wishes? Utter rubbish. London also voted to ‘remain’- does London cede from the Union?
  • The Prime Minister, David Cameron, is to step down. This is a great shame as he is a good negotiator and politician. He has fallen in his own sword, a rare political act these days. By comparison, the socialist leader of the Labour Party, equally culpable in losing the ‘remain’ vote, has no idea where his sword is. I am not so sure he has one. But 24 hours later he is being stalked by his own resigning front and back benchers.
  • The pound has taken a beating. This was to be expected. It will recover soon, though it may take time. The recovery against the euro will be dependent on the stability of the euro, not the fragility of the U.K. economy. Spanish and other elections in the next 12-24 months will sort this out.
  • U.K. stocks took a beating but already they are recovering, whereas continental markets are suffering more pressure. This is a leading indicator of sentiment that will again show up in currency values in the next year or so. 

And to top it all off you have to understand the irony of Brexit. In the 1960s France vetoed the UK (twice!) and prevented it from joining the Common Market. And this was only 20 odd years after the close collaboration during the Second World War. De Gaulle felt that the UK’s demands for joining would weaken France’s position, and they would have. The result was that aspects of the Common Market and EEC developed without direct UK input and one could argue therefore that the groundwork of the EU was therefore weakened, and the UK never felt central to the initiative.  This was to haunt the experiment as Britain never really forgave France this veto.

More recently dissatisfaction with ever closer European integration was rejected. Initially countries would vote “no” and reject the the EU Constitution changes. Then those same countries were pressured to re-vote in order to get a “yes”. Finally the Dutch and French rejected the Constitution and it was killed off. However the EU continued. Fifty years after De Gaulle’s unfortunately selfish veto hobbled Europe, it is the UK that triggers what could be the straw that breaks the EU. Fair play, and what irony.

The divorce won’t be clean. There will be much acrimony and hard, complex negotiation. The City of London will be diminished initially, until the cracks in euro fracture and break open.  The U.K. economy will reflect increased short-term uncertainty across the global economy, yet will bounce back towards more positive UK growth within a year. Again, as the euro struggles, so the pound will benefit.  

But in truth no one wins with Brexit. The U.K. will suffer more short term; europe, the EU and euro zone in the longer term.  Everyone will be poorer for Brexit. The reality is that we need a rethink for how Europe wants to live and work together. An unelected bureaucracy is not the answer. We need a new model. The real valuable question is not what happens to the EU now; the visionary question should be “who will document, discuss and lead the ideal EU II framework?”   Let’s demand our moribund politicians work for us and work for a future, not argue over the trappings of an idea that died years ago.

The Peculiar Thing about Currencies and Bonds

As every day passes by our central banks and currency czars head further and further into uncharted territory. What is going on now could not have been predicted, and the resulting behavior cannot be anticipated. Worse, there are no lights at the end of the tunnel, just ever growing darkness.
This weekends newspaper headlines highlight the nightmarish situation:

Japan’s nightmare roots are well known, starting with record breaking public sector debt, which continues defy logic but has yet to become an active challenge. This makes Japan different to other sovereign states but the other roots are common across other nations as follows.

The Bank of Japan (BoJ), like many other central banks, has a never-seen-before burgeoning balance sheet as a result of Quantitative Easing (QE), a process whereby central banks purchase debt and therefore drop billions of dollars (or local currency) from the sky. This policy helps lower interest rates and thus, so the theory goes, encourages private sector investment and so economic growth (e.g. GDP). This has not happened. The ghoulish result is that:

  • Firms did not increase capital spending 
  • But instead took out low cost bonds to fund massive and ongoing share buy-backs and unproductive or natural-cycle meters and acquisitions.

The result is that the investor class has gotten richer and inequality has gotten worse. As the data published by central statistical agencies around the world report the depressing news, corrosion in trust by the public in the political system increase now to the point where national elections are being fought more on distrust with government than with positive policy comparison.

QE encourages the exchange markets to disinvest in the local currency, thus lowering the exchange rate. This should then, so the theory goes, encourage exports. However this has not happened either. The monstrous condition now is that other large, mature, trading nations are in the same boat and all are engaged in the same QE effort. So all markets are flooded with cash, and the trillions of dollars that slosh around in the currency exchange have no clear direction where to call home. In fact, as one nation lowers its rates, in the hope encouraging some increased exports, other nations have reacted with additional QE this neutralizing any advantage sought. The result is a rush-to-the-bottom where we continuously lower rates without any resulting benefits. And bottom we are approaching with zero, even negative rates. At some point banks will have to pas such rates onto households.

As the article about Japan reports, the BoJ must be considering new action at some point, but political considerations will likely figure strongly due to the pending US election. More crucially when everyone is in the same sinking boat, one would think that coordination, nay, collaboration might be the order of the day. And when I mean collaboration, I am thinking along the lines of Bretton Woods or Plaza Accord. We cannot get out of these woods, or prevent the boat from taking on more water, with the current beggar-thy-neighbor approach. 

The other side of this nightmare is just as confounding.  

German yields, the return for holding a bond of government debt over a long period of time, is approaching zero. It could well go negative very soon. Japanese yields went negative earlier this year and US yields are very close to zero too. If you take into account (meager) inflation, real US yields are already negative.

Note that the Federal Reserve holds about 20% of outstanding government bonds (i.e. debt); the Bank of England holds about 26% of the U.K. Government gilts (i.e. debt); and the Bank of Japan holds about 30% of their government debt, as of March. The ECB holds about 10% of outstanding German government debt. So the market is hugely distorted, and private buyers are crowded out. 

But the complication does not stop there. In the interests of QE, the ECB is now expanding beyond government debt into corporate bonds, which crowds out even more the private sector. This changes the dynamics for how forms seek long term capital investment. Investors (see WSJ ECB’s Debt Purchases Cause Concern) are now worried that should private bind holders sell any amount of debt, the price will swing violently due to the loss of liquidity as a result from central banks owning large swathes of the market and not being active in it.

The perverse logic of negative rates means that there is no incentive for investing in the debt. More staggeringly we are slowly learning that we can only just guarantee the return of the capital ‘stored’ in those bonds. And the assumption is that the cash when returned the will be worth less than it is now. But as demand increases for this unproductive asset we have to assume that this is the best of a bad bunch of investment options. What does that say about our confidence in waking up and getting out of this situation?

But do our economic and financial leaders work together to find a global solution? No they do not. They seem happy to assume our problems are not at a global level but can be handled one decision, one policy, one central bank at a time. They have signally failed to solve this problem alone and in tandem. They need to work in parallel and that requires real collaboration, the kind not seen since Bretton Woods and the Plaza Accord.  I have been talking about this need for global collaboration for some time – see my last missive, Preserving our Future Wealth for Future Generations, and my earliest from 2015 Open Letter to Christine Laguarde, head of IMF.

This is an inside down financial world and there are literally no signs of getting out of it. The one hope, the one glimmer of an way out, is if inflation does take root. That once enemy incarnate is now needed to save our economy before our leaders ruin it. They show now signs of taking a global leadership role. So we pin our hopes on inflation. And by the way, if inflation ever did take hold, that won’t be pretty either. Remember the central bank’s balance sheet and amount of QE ‘out there’ in the market? That would have to be sucked out pronto and yields would alike immediately and rates would raise dramatically. We are set for a nightmare that will just go on, and go on.