Central Banker’s Conning Themselves, and Us

Banning Recessions, by edict. …suspending reality. ….preventing anyone going out of business. Money for all, all the time. …well, mostly, bar the poor.

That’s what is happening. A remarkable story broke over the wires last week. First the CEO of major European insurer criticized the ECBs recent extenuating policy of lower (negative) rates and more quantitative easing. I noted the key points last week in a recent blog: making it possible for people and firms to spend money they don’t have.

This last weekend some EU banking giants from the past clubbed together and highlighted how such policies have changed the way capital works in the economy and the damage being done by such policies are becoming far worse, and long standing, than otherwise perceived. Today I read how the new guard are criticizing the old guard! Here are a few interesting stories:

From the US print edition of the FT Oct 5/6:

⁃ Oped: Negative rates tarnish central banker’s halos

⁃ Old Guard attacks ECB monetary easing

And then today October 7 in the FT:

⁃ The Euro’s Guardians face roar of the Dinosaurs

In this Opinion piece we are led to believe that the old guard have forgotten how good these policies are for us. They saved our economy. There are even points about how such policies help firms continue in business; what the hawks call zombie firms.

In cycles long past, such firms would have gone to the wall. Creative destruction is what recycles assets to their most efficient use. Zero interest rates and quantitative easing prevents such reallocation and so inefficiencies continue. The bubbles and the rot build up in sync. The madness continues.

Check out from same FT today:

⁃ ECB should let mediocre banks fail, says SocGen Chief.

And if you think this madness is limited to the EU, check this out (below) from today’s US print edition of the WSJ. The US is on the same trajectory as the EU, only not quite as bad. But bad enough.

⁃ Fed Looks Anew at its Balance Sheet

The ECB has lost the plot

This last week members of the ECB governing board dissented with the majority view of the bank after Mario Draghi, is president, announced announced a resumption of bond buying and a further reduction of interest rates further into negative territory. Some of his own peers think the policy is crazy; several German bankers and banking professionals suggest the policy has suffered from diminishing returns and now does more damage to the economy than good. See ECB in turmoil over Draghi Stimulus in this weekends US print edition of the Financial Times.

We are in right pickle. This act will further crowd out and distort traditional economic investment Behaviour and further damage savers. The very system that should drive organize growth is being pummeled and there is no let up. Central banks have lost the plot and think such actually no encourage capital investment. It does not. Firms do not sit around with shovel-ready investment plans just waiting for a particular interest rate. Central bankers would know this if they ever spoke to CFOs or CEOs.

See:

• Opinion – Why Central Bankers Missed the Crisis, WSJ, November 17-18, 2019

Braced for the global downturn, FT, August 12, 2019

Opinion – Central banks need new rolls to tackle the next downturn, FT, September 3, 2019

Frustrated central bankers cast around for fresh thinking, FT, July 27/28, 2019

As it stands, the ECBs actions will elicit a similar response from the US. US interest rates will ,likely need to fall at the next chance the Fed has, If only to help the dollar from appreciating too much against the Euro. This will ease pressure on China though as fewer reserves will be needed to prevent the RMB from falling to much against the dollar, assuming data from China on its economic conditions do not paint a deteriorating picture.

See:

• Opinion – Central banks can no longer afford to act in isolation, FT, August 30, 2019
• Capital Account by Greg Ip – How the ECB forces the Fed’s hand, WSJ, July 31, 2019

The damage from long standing near zero or negative interest rates are mounting. Global growth is suffering. Even EU neighbors are too. Even the ECB itself is starting to wonder what it has unleashed on the world, with increased inequality being the primary result.

See:

• ECB easing would line up Swedish krona for more pain, FT, July 23, 2019
• ECB co consider damage done by negative rates, FT, September 6, 2019

Finally, it’s not just the ECB. Central banks did their bit to save the world for itself with some unique medicine. But instead of recovering rates rapidly to near normal levels, central bankers allowed the equities markets and high roller investors to get drunk. Now we are all drinking at the same party and unless we all want to turn Japanese, which we all can’t at the same time, it’s all going to end badly.

See:

• Free exchange – The world’s monetary system is breaking down. What comes next is unclear, The Economist, August 17, 2019
• Open letter to Christine Lagarde, head of the IMF, August 21, 2015, Andrew White blog.

Brexit, Banking, and Bonfires

November 5th has come and gone- so too the bonfire-bashing stories of Guy Fawkes that go along with that date. But one date remains before us, where playing with fire is about to burn the hand that reached out. That date is March 29, 2019. The Brexit negotiations where a sham: Britain was never going to get a fair deal, as politicians were involved; the EU was never motivated to help anyone other than themselves. In the US we call that, America First and get pilloried for it. Frances Macron let the cat out of the bag when he said that the backstop would be leveraged to get advantages over Britain.

The terms of the deal are a travesty. Britain is neither in or out of the EU and there is no clear plan how it ever will be. A clean break with fair trade rules was never possible. Many politicians avoid rational arguments; they seek advantage for their own position, not fairness. Fair trade and zero tariffs without freedom of movement, though logical and reasonable, was never possible: The French want to protect their farmers; Italy their factory workers, and Spain its fisheries. Competition and openness has been corrupted for years. Why is the EU anything different? See The Crisis of Good Intentions in this week’s US print edition of the Wall Street Journal.

Elsewhere in that newspaper is another article that highlights how the politicians in Brussels are close to ignoring a fire for which they have little awareness. ‘Finance Area Must Make Key Brexit Choices Now’ explains how certain financial transaction take three months to complete. The March 29 date when Britain leaves the EU is nearly 3 months away, yet the methods to assure safe passage for such derivative transactions remain in limbo.

Most of will never use or know what these $66 trillion of swaps and futures transactions actually do. Financiers do and will soon be in the front page of finance rags when they have to explain to their masters why costs are ballooning and finances settlements grinds to a halt. London is still an important central hub for a range of these transactions that are specialized; and aspects of global trade market operations. The EU, in their political stubbornness, are about to uncork a bottle of pandora; or they will light a fuse that will burn and brightly, very soon.

For the love of Pete, can Britain just get out from under the manifolds of madness and can we work an honest days effort without political oversight?

IMF selling snake oil advice…in places…

I had little choice but to hot-foot over to the IMF webpage once I spied the alert in my inbox today: UK’s Economic Outlook in Six Charts. Really, in just six charts? Awesome. Show me the money. Well it turns out a bit of a fiddle. Yes there are six charts and some of them are really interesting. Some however are pushing a political agenda.

Chart 1: UK GDP 2011-2018 compared to G7.

Yes, in the last couple of years the recorded GDP growth of the UK has fallen from being in the top set of G7 counties to the bottom. How much of that is due to Brexit or natural economic cycles or other causes?

Chart 2; Brexit will be costly to the UK.

Ok so now my spider-senses are tuned in. Have you read The Economics of Brexit – a cost-benefit Analysis of the UKs economic relationship with the EU, by Philip Wyman and Alina Petrescu? I would recommend it. Page by page, chapter by chapter, these two researchers explore the small print of the analysis completed by the IMF, OECD, the Bank of England and others, that all point to (or pointed to) the economic decline of the UK assuming Brexit takes place. The small print of every analysis that concluded and concludes depression, resection, decline, all point to assumptions about how the UK policies will change (or not) and how other countries responses will change (or not). Quite frankly the conclusion is embossing.

Virtually every analysis that falls back on WTO or other frameworks assumes something that is just not practical or likely. Won’t the UK adjust interest rates if prices increase? Won’t the UK devalue sterling if wages exceed global competitive rates? Won’t the UK’s innovation seek higher rents and drive new innovation? Won’t tax policy favor growth? These are all ignored in one or other analysis. Thus every analysis is misleading. The IMF is just as bad as everyone else. In fact I conclude that there is no fair or practical economic analysis of what will happen with Brexit. Few economists can prove what net change in GDP came ab-out from joining the EU; how can they estimate the losses when you leave?

I will let you look at the other charts. They are interesting and somewhat informative, if you take the time to understand the assumptions and try to think of the argument the author wants to message. Either way, I recommend the book.

Warning Noted Re Germany’s Recent Election

William Gibson of the WSJ wrote on Sept 26th in the  WSJ (see The Populist Wave Reaches Germany) an Opinion piece that neatly calls out the major issues now liberated in the recent general election that apparently awarded Chancellor Angela Merkel another four years in office. Mr. Gibson goes beneath the headlines to highlight what are actually disturbing issues.

The news that masks the issues suggest that the share of the popular vote won by the ruling coalition dropped from two thirds in 2013 to just over half. So far, ok. But as a result of declining popularity of the classic parties, the center-left Social Democrats have announced they will not participate in the next government. This is where issues emerge.

To creat a coalition this means Angela Markel has to work with either the Greens and the Free Democrats, or she and her party lead a minority government that limps along one parliamentary vote at a time, aligning with any party that works with her decision at the time. The bad news is the Greens are demanding the phase out of the internal combustion engine; the Free Democrats are skeptical of an ‘ever deeper’ EU. Their leader wants to phase out the European Stability Mechanism. All told its a deal with the devil or devils.

If that was not enough, there was a 7.9-point gain by the Alternative for Germany, or AfD, a far-right populist party. The AfD is incredibly the third largest party in Germany, and second largest in the old East Germany. This is more than incredible; this is significant and could be a sign of great and growing dissatisfaction. We all need to keep on guard. This situation can easily and quickly, and quietly, shift further.

UK Election Results Capture Political Schism

In under two years since the country stunningly voted to leave the EU, the same electorate shifted yet again and leant away from the idea of a clean break with Europe and threw the whole thing now into chaos. The youngest of voters sided with Labour, who were selling polices in a throw-back to those last seen in the 70s that, if followed, would lead the country to financial ruin. Corbyn’s plan is not even realistic; yet the youngest among us just have no memory of such irresponsibility. Only the old do, and so they voted Conservative.  

Now hostage to a 10-seat minority of the DUP, Theresa May will be saddled with a back-seat driver at negotiations with the EU. Decision making responsibility will not fall to May; she will have to keep ‘calling home’ to get approval.

Worse of all, the result of this election shows how the entire political system is corrupted. We have the worst of both worlds: a disenfranchised and ignorant electorate (e.g. Most of the young) that falls for platitudes and made-up promises. Of course, the left calls such things as false truths or fake news if the right puts such things out.

Britain will now have a much riskier time with Brexit. All we can hope for is a bank run that requires a bail-out or for the IMF to drop Greece ‘in it’ and a run on the Euro. It’s a matter of time. But now we need it sooner rather than 

The EU – Creaking at 60

The title of this blog is the title of the Economist Special Report last week. The title refers, of course, to the 60th anniversary of the Treaty of Rome, the founding of the EU at its source, being celebrated by EU members, less the U.K., last week. Oddly the U.K. is still a member but since she wants out, political correctness prevents Albion from upstaging proceedings.

The Economist special report is really good. It is well balanced and actually concludes that Europe needs a multi-speed system to respect all the differing political and economic challenges across the EU. What is irksome though is that while a two-speed or multi-speed approach has been proposed before, why is it now that the Economist has finally woken up to reporting it and making it the basis of its views regarding the success of the EU?

It is as if the Economist has woken up just in time to see the final deck chair arrangement on the titanic. Correctly the special report calls out the weakness and fallacy of the EU’s monetary policies for all members and now current monetary union is flawed. We all knew this a while ago. If this had been addressed perhaps the U.K. vote for Brexit might never have happened!

But ignoring my cryptic criticism, the article is very up to date and very down to earth. It’s just a shame that it took Brexit and the near break up of the EU, and continuing mess in Greece and Italy to come to the conclusion we needed four years ago.

US Government Sets Up Next Financial Crisis & Brexit Not the Risk at All

Two articles came accross my desk this week – one caused consternation on my part and the other seemed to offer a sanity check.  The former concerned the US economy and specifically how there are signs that consumers, and lenders, are returning to the same behavior that led to the financial crisis at the source or our current economic challenges.  The latter concerned the hype and over blown concern with Brexit and its impact on Britain’s economy.

In the US print editions of the Wall Stree Journal (Wednesday January 11th) there was an article titled, “New Loans, Same Old Dangers“.  This front page article described a government-led initiative (Property Assessed Clean Energy) that provides subsidies loans to encourage homeowners to buy energy saving devices.  The article gives an example of a homeowner who is not able to afford the loan is still encouraged to take it out.  As is common practice this loan is then sliced up with other loans and sold on as a bond – what is called securitization in the financial industry.  This is analogous to the risky mortgage loans offered, and taken up by people who should have known better, and sold on to governments in Iceland as “AAA” opportunities.

The market is very small – the article suggests around $3.4bn of loans have been made so far – but the model is just damning.  FIrst you have big government trying to force its policies on a free market.  With the housing issues that triggered the financial crisis this was Government demanding ever greater home ownership among poor people and those that could not afford it.  Second you have the lowering of standard for the setting up of loans.  This is identical to what happened with dubious sales efforts of mortgage brokers during the 1990’s and early 2000s.  Finally you have the build up of risky loans and owners of the loans not knowing where the real risk is.

The popular uprising that has brought Trump to the White House would do well to heed these stories.  After all people will be people and when offered a bad apple that looks and smells sweet, many will take it.  Perhaps we should not fault those that do – or should we expect a stronger moral aptitude?  Either way we need to get big government out of the way.  It should not seek to foist its social or political wants on you and me – we should be free to do what we want, how we want, when we want, as long as it does not harm our fellow citizen.  Innovation and opportunity will drive improvement in the energy sector.  And perhaps tax credits would be a safer way to encourage small changes in behavior that do not create risky loans.  

The other article, a commentary piece in the US print edition of the Financial Times (Thursday Janary 12th) was titled, “The City has nothing to fear from Brexit“.  It was penned by Stanislas Yassukovich who is a former chief executive officer of European Banking Group.  The article is a breath of fresh air since it refutes many of the risks and issues that most other “specialists” report in the press.  For example we have heard a lot about “passporting” – the idea that a financial institution authorized to trade in one country of the EU can freely trade in another country.  It turns out that non-member states can use this capability quite easily – so it’s not even needed as a negotiation.  The article goes further.

Passporting was a means to try to level set the complexities of rules across what was meant to be a single market.  It turns out that even with passporting there remains complex and different rules that still need to accommodated when trading across the member-states.  As such, “core retail financial activities – residential mortgages, deposit and savings products and so on – remain almost entirely national, and highly protected.”   This whole think stinks to me.  

The recent news that PM Thresa May fired her senior most civil servant who worke with the EU was greeted in the press as bad news.  It seems he kept repeating to the PM that it was not going to be possible to complete all negotiations in time before the two year window closed for leaving the EU.  Why is this?  He may have had a practical view on things but he certainly did not have a positive view on what is possible.  I think we need clean out the cupboard and get a fresh new look at everything.  Good for PM May to do so.  If the author of this article is right, there is little we should fear from Brexit.   

The Home Owners/Renters Market is Upside Down

Two articles today suggest that two of the world’s largest economies are swapping roles and focus for home ownership and renting. Germany has been a nation of renters; home ownership has run at relatively low levels compared to the UK or US. The US has operated under the assumption that home ownership is central to the American Dream.

As we all now know, policies adopted by the US government in the 1980s led to a relaxation of requirements for those seeking a mortgage and low income, even zero-income families, obtained mortgages they could never afford. The result, when combined with human greed both by home buyers and the investment community, led to the financial crisis that is the cause of the situation we are in today: near zero interest rates and massive influx of quantitive easing that has filled the coffers of the investor class.

But what is happening now? It seems that the near zero interest rates in Germany are driving record levels of home ownership and low interest rates in the US is driving up demand for rental property with record low-levels of home ownership. The world is turning upside down!

In the US print edition of the Financial Times, the article, “German’s switch to home ownership fuels bubble fears“, reports that house prices are rising as demand for mortgages continues to rise. The good news is that many of these new mortgages are fixed rate plans- which protects home owners as interest rates increase.  Germany has been a relative laggard when it comes to home ownership. See Most Germans don’t buy their homes: Theey rent.  Here’s why.  

In the US print edition of the Wall Street Journal, in an article, “Millennials Fuel House Rental Boom“, we hear of the later boom afflicting the US market. It turns out that US home ownership is at record lows, yet house prices around the country are recovering and in some regions, back to pre-crisis levels. How can this be?   Turns out that firms flush with cash and low cost loans have been buying up property in the cheap and renting them. The article above goes even further and explains how firms are now increasing investing in entirely new property developments specifically for the rental market.  

This all might alarm you. The American Dream, perhaps western democracy, was assumed to be predicated on home ownership. But this is not the case. The German economy has done very well with relatively low home ownership rates. The US might have to learn from the Germans how to run such an economy; likewise the Germans need to take a leaf out of the US’ books to avoid bubble blow-out.  

But in all practical terms we should be alarmed. Germany is an export-based economy. Other counties want (or need) to buy Germany’s products. Exports from the US is vastly less of a proportion of it’s GDP than it is for Germany. So there is little room for the US to behave more like Germany. Additionally Germany cannot set its own interest rates; even now the stresses between the EU center and periphery are growing again. Greece, Spain and Italy continue to need low interest rates to help nurture their local economies to recovery. Germany, never near a recession, is showing signs of too rapid growth (and growing inflation) and may approach overheating before the periphery is even back to positive growth.  

Bottom line: zero interest rates and quantitive easing (and resulting central bank balance sheet ballooning) is changing our economic foundations. This will impact our societies in ways it is hard to predict. Hang on guys, it’s gonna be a bumpy ride!

My Top 5 Biggest New Year Risks to the Global Economy

In order or scale, priority and impact, here are my picks for the five most critical trigger-points that may impact, negatively, a return to ‘old normal’. Currently we stand at the edifice of a new normal, the great stagflation, but the anti-establishment and populist changes taking place seem to suggest a knew-jerk reaction by nations fed up with socialist dressed-up-as-market politics that have led the West for 20 years.

1. China’s economy stagnates or crashes. Debt levels are above EM levels and are now among the largest, approaching the incredulous Japanese levels. This dynamic is not sustainable for a nation whose currency is not a reserve currency. However the economy is the world second largest even without the development and emergence of whole swathes of other sectors such as healthcare and leisure, which may offset contracting first world growth over the next year or two. So the risk is there and there is no clear leaning one way or the other, yet. But debt is growing faster than these new sectors; exchange reserves at $3bn are limited (though huge), and currency value management is not market-bases. So greater risk is with the downside. China’s growth flags, currency sinks, counterbalancing US growth and confidence, creating a massive imbalance in the global economy. Europe watches on as global GDP sinks under its own debt weight. KPI’s to avoid/watch out for: China GDP falls to or below 4.5%; China’s debt load surpasses 300% of GDP.
2. Trump quits after 18 months due to intractable political limitations that prevent policy changes he seeks related to healthcare, regulatory complexity, tax reform and trade. Trump’s political rhetoric is being replaced with solid business-based policy. However not all such policies have ever been tested at a national level and scale. Some efforts will fall foul to physical, social and political limitations. This may prove frustrating for Trump. As growth will return short term, such medium term frustration will lead Trump to claim, “My policies worked, see? But now the system has reached its limit and there is nothing I can do until the country agrees with me to shut down the whole government system! Since they are not ready, yet, I am ‘outa here’ until they are!” Markets crash, interest rates balloon, inflation rages all within a year. World economy sinks into the abyss. KPI’s to avoid/watch out for: US GDP 1H 2017 reaches 4.5% but Congressional conflict leads to policy deadlock ; vacancy in position at Whitehouse. 
3. Emerging Marker currency crisis as massed capital investment is siphoned away towards a resurgent US economy and dominant dollar, as well as a stable and even growing China economy. This situation is already underway. The risk is that what is currently a reasonably ordered trend becomes a financial route. This is possible since the financial markets are starved of yield due to the collective policies of central banks to keep interest rates very low for too long and for the build up in their massive balance sheets. If the trend becomes a torrent, EM’s will have to yank up interest rates far beyond what their local economics can support and economic disaster will follow. This will ferment more political instability and drive increased destabilizing ebonies to ruin. Though the US may be growing well, compared to its peers, it’s the imbalance they tips the ship over. KPI’s to avoid/watch out for: dollar index, the weighted value against basket of currencies, surpasses 115. It is currently at 103.33, which is a 14 year high; EM interest rate differential balloons.
4. Hard Brexit forced through by intransigent Europeans who think the EU experiment is more about political union than economic liberalism. A new trade deal, legal framework and social contract can be negotiated within a two year window. But only if politicians and civil servants want it too. Continental politicians however, under the strain from populist pressures, will equate intransigence over Brexit negotiations with an improved politicos standing with their electorates. Fool for them as this will actually create the opposite response for such behavior will simply worsen the economic climate. The lack of any sign of return to old normal will lead to political paralysis and the clock will time-out. Hard Brexit will be forced upon a supplicant Britian. Europe and UK economies will tank; currency wars will wage; global trade will collapse further. This will not sunk the global economy short term but will act as a dead weight slowing its resurgence down. KPI’s to avoid/watch out for: no agreement at end of two year period lost triggering of Article 50. 
5. Latin or Indian debt or economic crisis. Much like with other EM’s, growing sectors of significant size around the world may blow up- India being the best example. India’s growth is different to China. It is more integrated socially and politically with the west, but it’s corruption levels are far greater than what one can see or observe in China. It is possible that local economic difficulties, hard to observe today, may trigger a collapse in confidence that leads to a destabilizing debt or currency crisis. Brazil’s economy is certainly in the dock currently; Argentina is struggling. India’s economy looks like paradise right now but the growth across the country is extremely uneven- you only have to look at public sector infrastructure investment. So should two such countries suffer local difficulties, the combination may result in significant risk to the global financial system. KPI’s to avoid/watch out for: two simultaneous financial/debt crisis afflicting EM or India.

These are my top 5 risks the global economy faces in 2017. I hope I am wide of the mark, in a positive way. I left Japan off the top 5 list yet their economy remains anathema to growth. The Japanese market invented the whole new normal cycle with a anaemic growth, massive debt, low inflation, and demographic contraction. And Japan has an amazing debt load that refuses to spook investors. Things may yet have a Japanese tinge before the year end. Does Japan, along with the US, lead the global economy back to the old normal!
What potential risks do you see?