QE Departs

QE, we hardly knew ye …

Hang the black crepe. Get out the whiskey. Say goodbye. And try to keep the tears from your eyes.

The Dow rose back above 17,000 points on Tuesday, near its all-time high. Higher stock prices should settle nerves at the Fed’s FOMC meeting. It should leave the central bankers free to let their emergency bond-buying program die in peace [indeed, it did die in peace, ed.].

The Financial Times announced the end even before it happened. On Monday, its headline read: “RIP QE: The quiet death of a radical US monetary policy.”

But the Fed has to be careful. If it announces that QE is truly dead, it is likely to set off some untoward scenes of wailing and keening in the stock market. Investors will feel a deep sense of loss.

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Well-Trained Japanese Investors are Shorting the Nikkei

We have been a bit surprised to learn that short bets on Japanese stocks have recently surged significantly. Evidently, Japanese investors are well-trained by now: they don’t expect rallies in Japan’s stock market to hold or continue. However, Japanese stocks actually remain fundamentally quite cheap, in spite of the notable surge from their 2012 interim lows.

According to Bloomberg:

 

 

 

“As bets pile up against Japanese stocks, investors with $293 billion in client assets see the pessimism as a signal to buy. History is on their side. Short-selling on Tokyo’s bourse jumped to the highest on record this month, as the Topix index tumbled 7.7 percent from a six-year high in September. Shares have rallied an average 9.7 percent over the three months following surges in bearish bets since 2009, according to data compiled by Bloomberg.

For Sydney-based AMP Capital Investors Ltd., that’s one reason for optimism. The outlook for company profits is another. Government-backed steps to put a floor under Japanese equities may prove dangerous for short-sellers: the central bank says it’s ready to add stimulus if the economy falters, while on Oct. 20, a Nikkei newspaper report the country’s $1.2 trillion pension fund would buy local shares roused the Topix from a three-week rout.

“Fear is hitting extreme levels and it’s time to get into the market,” Nader Naeimi, who helps manage about $125 billion as head of dynamic asset allocation at AMP, said by phone on Oct. 14. “When these sentiment indicators flash excessive pessimism, it usually suggests we’ve reached the lows.”

Bearish bets accounted for 36.6 percent of all transactions on the Tokyo Stock Exchange by value on Oct. 14, according to bourse data compiled by Bloomberg. That’s the highest since the exchange started publishing the figures in 2008. The ratio was 33.4 percent on Oct. 24.”

 

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Stingy Usurers at IMF Won’t Lend SDRs at Negative Rates

No negative rates for the putative Bancor … Keynes must surely be rotating in his grave. It turns out the IMF is not going to lend SDRs for less than nothing, thus breaking ranks with some well-known central banks out there (no need to name names), and even the central bank-manipulated “market” in which investors accept negative rates on certain government bonds as if that made any sense.

Instead, the IMF has decided to set a floor for its SDR interest rate to maintain its role as a profit center…it will be at what is nowadays a downright usurious height of 0.05%. So at least at the IMF, there will be no pretense that time preferences can actually turn negative.

 

christine-lagardeThere will be no funny money for nothing from me, busters!

(Photo credit: REUTERS / Fahad Shadeed)

 

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Readers Comment on War

An old friend responds to our recent comments about war:

 

“I can tell you that I fully agree with your points about the war. It was particularly interesting to me to read your thoughts, as I was born and lived in Leningrad, where everyone remembered the blockade during 1941-1944.

When I was a teenager, I went to the famous Piskaryovskoye Memorial Cemetery, where, in a small museum, the Savicheva diary [the diary of a Russian girl who endured the Siege of Leningrad] is displayed.

Have you been there too? I still remember reading it, like it was yesterday. Very emotional stuff, indeed. Now, we are having over 3,000 dead in Ukraine. What a pity! And what for?”

 

Another reader (a German immigrant to Canada) adds:

 

“My dad was near Leningrad, and he was very fortunate that he was wounded. That was the only way he was able to escape the carnage. Since at that time wounded soldiers were sent back by airplane to the nearest hospital.

He survived but did not return to our hometown of Berlin until the end of 1946. My mother and I assumed he was dead. The stories my dad told me later on did not make pleasant reading.

I was also fortunate that I was not hurt during the war years in Berlin. Although there were many times my mother and I had to walk over dead or dying people to escape shelters that were bombed.”

 

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Italian Bankers are Not Amused

Italy’s banks were among the hardest hit by the ECB’s “comprehensive assessment” and the associated demands to increase their capital. The protests of Italian banks which were even echoed by the Bank of Italy (i.e., Italy’s national central bank) are widely seen as a lending the stress tests legitimacy.

For instance, the FT reports:

 

 

 

“Analysts and investors have taken the howls of protest from Italian central bank officials on Sunday as evidence that the European Central Bank’s health check on the continent’s banking system is sufficiently tough.

Complaints from Rome about the outcome of the ECB’s comprehensive assessment have demonstrated how Italy has emerged as the biggest loser from the process, which was designed to restore confidence in the EU’s financial system.”

[…]

“The debate over whether the European banks have lots of holes in their balance sheets is over,” said Davide Serra, founder of hedge fund Algebris. “Banks didn’t know if they had enough capital to lend until now and this will change that.”

“We now know that we can have a 5 per cent contraction in the eurozone economy and the banks will still have more than 8 per cent capital – that is very positive for the sector,” he said.

 

Alas, as this Bloomberg video shows, the debate is far from “over” – not least as numerous banks just sort of scraped by.

In fact, there are other reasons to doubt the toughness of the stress test. We already discussed the large amount of legacy NPLs in the European banking system yesterday, which implies that if a severe downturn were to occur in the near future, this amount would skyrocket to an even more astronomical level.

Moreover, a post stress test aggregate capital shortfall of a mere € 24 billion is just not very believable considering all the other data, especially in light of the fact that the great bulk of this shortfall is concentrated in the tiny countries of Cyprus and Greece.

 

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It Walks Like a Duck, Quacks Like a Duck, Has Webbed Feet and Swims … Could it be a Duck?

Here is one from the “told you so” department. On June 26, we wrote the following in an article entitled “The Democracy Delusion”:

 

“It is fair to say that ISIS has all the trappings of a State: it collects taxes, it runs its own oil production facilities and sells the oil, it has a slick media/propaganda arm, it has its own (highly effective) army and so forth. The organization has overrun and conquered Northern Iraq in just 10 days.”

 

(emphasis added)

In an earlier article on June 13 (“ISIS Attempts to Establish Islamic Caliphate”) we pointed out that:

 

“It is worth noting that people apparently celebrated in Mosul, welcoming the ISIS takeover (those that didn’t flee that is). In another indication how extremely well organized this group is, it has immediately restored electricity and is running city services – something the previous administration of Mosul was apparently not capable of.

 

A very interesting 5-part documentary on ISIS by VICE news shows in some detail how the organization administers its de facto capital Raqqa in Syria. IS runs a judicial system (complete with courts, judges, prisons, etc.), a welfare agency, collects taxes, enforces price controls in markets, runs electricity and water services and provides police services. The police not only engages in standard policing services, but is at the same time a “religious police”, similar to the one Saudi Arabia employs. This is to ensure that everybody adheres to the sharia. Small offenses (such as violations of Islamic dress codes) usually result only in a rebuke and warning, but presumably repeat offenders must expect harsh punishment.

Offenses considered more serious, such as drug and alcohol dealing, theft, etc., are punished according to the prescriptions of the Q’ran. Again, this is precisely what is done in Saudi Arabia as well, which even executes people for allegedly practicing “sorcery and witchcraft”. In fact, Saudi Arabia’s sharia-based justice system is probably just as harsh as that of ISIS. Saudi Arabia has just carried out its 61st execution of 2014, beheading a man for drug trafficking. In August alone, there were 19 executions in Saudi Arabia, including executions for sorcery. Moreover, five members of Saudi Arabia’s Shia minority have been sentenced to death this year for the crime of taking part in pro-democracy protests.

We are mainly bringing this up in order to show that ISIS’ brand of justice is already well established in another Islamist State on the Arab peninsula, with the main difference being that instead of bombing it, the US government is regarding it as an ally and is supplying it with modern weapons and other goodies. Although ISIS is currently at the receiving end of a US bombing campaign, it is of course also the grateful recipient of a great many US-made weapons, which find their way to it via theft from other US-supplied armies in the region (mainly Iraq’s), donations from allegedly “moderate” Syrian rebels and former Libyan rebels that have joined ISIS, as well as via recent airdrops that have provided it with fresh supplies.

 

APTOPIX Mideast IraqISIS supporters in a demonstration near the provincial administration headquarters in Mosul

(Photo credit: STR / AP)

 

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Introductory remarks by Pater Tenebrarum:

We have recently discussed the backdrop to the Swiss gold referendum in these pages (see: “Switzerland’s Referendum on Gold” for details), pointing out that the Swiss National Bank is no different from other central banks in terms of its money printing proclivities. In fact, it is even worse, if we merely look at the money supply expansion in Switzerland since 2008 (and they are afraid of “deflation”, which is surely the height of absurdity).

Egon von Greyerz similarly notes that Swiss monetary policy has slowly but surely gone from prudence to “what everybody else is doing”, which is actually quite contrary to Swiss tradition. Consequently, the Swiss Franc is actually rather risky these days. He makes the additional important point that the Swiss banking industry is extremely large relative to the country’s economic output, a fact that brings its own risks with it (as e.g. the Cyprus debacle has shown).

Swiss citizens take their referendums seriously – direct democracy is cherished in Switzerland and people generally participate quite actively. We also noted that what might be loosely termed “conservative” and even – gasp! – libertarian causes often tend to find the necessary support, while the Swiss have usually proved to be quite sane on the question whether socialist measures should be introduced (see e.g. our previous missive “The Swiss Remain Sane” for a pertinent example). They hate being dictated to and at times their decisions are greeted with howls of outrage by etatistes around the world, always proof positive that the decisions were the right ones.

Not surprisingly, Switzerland is in the top four of the list of the economically most free countries in the world, and is the undisputed number one in Europe. As the Heritage Foundation summarizes:

 

#4 Switzerland

Switzerland’s economic freedom score is 81.6, making its economy the 4th freest for the first time ever in the 2014 Index. Its score is 0.6 point higher than last year, with improvements in trade freedom and the management of public spending partially offset by declines in monetary freedom and labor freedom. Switzerland is ranked 1st out of 43 countries in the Europe region. Read More About Switzerland

 

As you can see, there is some scope for improvement in the area of “monetary freedom”. We assume, meaning: scope for reducing central bank intervention in the economy. The Swiss now have the unique opportunity of achieving just that. At this point in time polls show the two camps running neck-on-neck, with the yes vote enjoying a small lead. So it is still too early to call the outcome of the referendum.

The Swiss government and the SNB are working overtime trying to convince the population against reducing the central bank’s flexibility, but as noted above, the Swiss don’t like being told what they are supposed to think (least of all, we assume, by a bunch of Keynesian dunderheads). So there is actually a reasonably good chance this initiative will fly.

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Stuck in a Box

Among the many things still to be discovered is the effect of QE and ZIRP on the markets and the economy. We can’t wait to find out.

The Fed has bought nearly $4 trillion of bonds over the last five years. You’re bound to get some kind of reaction to that kind of money. But what? Higher stocks? More GDP growth? Higher incomes? More inflation?

Washington was hoping for a little more of everything. But all we see are higher stock and bond prices. And if QE helped prices to go up, they should go back down when QE ends this week. Unless the Fed changes its mind …

If the Fed makes a clean break with QE, it risks getting blamed for a big crack-up in the stock market. On the other hand, if it announces more QE, it risks creating an even bigger bubble… and getting blamed for that.

Our guess is we’ll get a mealymouthed announcement that leaves investors reassured… but uncertain. The Fed won’t allow a bear market in stocks, but investors won’t know how and when it will intervene next.

 

rock-and-a-hard-place

Between a rock and a hard place …

(Photo credit: Routledge Chapman & Hall)

 

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Bribing a Voting Bloc Out of Existence …

In the EU parliament, forming a voting bloc requires that parties from seven different countries come together in a coalition. Whether one has such a bloc or not is actually quite important, both in terms of funding and in terms of influence. Earlier this month, socialist EU commissioner Martin Schulz tried to sabotage the bloc formed by euro-skeptic UKIP and Italy’s 5-Star movement by allegedly bribing a lone member of a Latvian party (the Latvian Farmer’s Union) by offering here a post (presumably a well-remunerated one).

Readers may remember that in spite of their huge electoral success, UKIP initially found it difficult to form a coalition, as Mr. Farage refused to get into bed with the far right French Front National. Nevertheless, the supporters of the socialist EU-superstate are quite disturbed by the successes of EU-skeptic parties like UKIP and 5-Star, so the allegations may well have merit. Mr. Farage has become a bit of a celebrity on the internet. His speeches in the EU parliament regularly gather far more views on You-tube than any delivered by establishment apparatchiks like Mr. Schulz. How can one not like someone who dishes out speeches like this one?

 


Farage’s famous “Who are you Mr. President” speech in 2010, where he notes en passant that Herman van Rompuy had “the charisma of a damp rag”.

 

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Signs of Media Bias?

We have come across a funny statistic in a recent article at the Washington Examiner. Readers may have heard that there is actually a mid-term election in the US this year. The emphasis is on the word “may” here, especially for US residents, depending on where the get their news from. If they get them from the one of the big three networks, they may actually not know. Especially if they get them from ABC’s evening news programs – whose election coverage to date apparently amounts to precisely zero:

 

2006vs2014ChartThe mid-term elections may as well not exist.

 

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25 Banks Failed, Sort of …

We noted on the eve of the publication of the ECB’s “comprehensive assessment” of European banks (here is the ECB’s complete report, pdf) that the central bank’s review would likely be more stringent than the EBA’s stress tests during the euro area crisis, because the central bank will become their supervisor.

However, it would also not be too harsh in its assessments, as it probably wants to avoid unnerving the markets. Apparently, this is precisely what happened. For instance, the WSJ informs us that “ECB Says Most Banks Are Healthy”. 25 banks failed the test technically, but only 13 of them actually need to come up with additional capital. A similar feelgood article appeared at Reuters, entitled ECB fails 25 banks in health check but problems largely solved”.

The WSJ writes:

 

“Hoping to quell years of anxiety about Europe’s financial health, regulators said Sunday that all but 13 of the continent’s leading banks have enough capital to ride out another economic storm.

The European Central Bank and the European Banking Authority announced the results of a nearly yearlong effort to assess the finances of 150 banks, identifying 13 that still need to come up with a total of €9.5 billion ($12 billion) in extra capital. Overall, 25 banks technically failed the so-called stress tests, facing a cumulative shortfall of €24.6 billion. But most have already taken steps to solve their problems since the end of 2013, the cutoff date for the exercise.

To pass the tests, banks had to show that they had ample capital to survive a crisis that would cause Europe’s economy to fall 7% below current forecasts and the unemployment rate to rise to 13%.

The exams are part of an effort to reassure investors and the public that, following years of destabilizing banking meltdowns and long after the U.S. defused its financial crisis, Europe’s lenders are back on solid footing. Restoring that confidence is a top priority, because the continent’s sluggish economy needs healthy banks to provide loans to households and businesses.

For the ECB, Sunday’s results are the final milestone before it takes over supervision of major eurozone banks on Nov. 4. Turning the ECB into the currency union’s bank watchdog is a key step to setting up a so-called eurozone banking union. The hope is that moving control over important banks out of national hands will prevent the kind of banking crises that rocked Ireland, Spain and Cyprus in recent years.

Investors and analysts mostly applauded the tests, saying they appeared to be much more rigorous than previous years’ versions. But some expressed disappointment that European Union supervisors didn’t take the opportunity to get more banks to thicken their capital cushions.

Philippe Bodereau, global head of financial research at Pimco, said the regulators’ strictures were a step in the right direction. But “I would have preferred they be a bit tougher and force more [banks] to raise capital,” he said.

 

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Fans of Central Banking Have an Achilles Heel

Most of my writing about the gold standard is about how it works, and how the paper dollar standard doesn’t. A casual conversation I had with someone recently underscored that there is an even stronger argument.

Our opponents, those who support central banking and irredeemable paper money, have to make two cases. One is to defend the theory and practice of central banking, that central bankers are wise and honest and that their debt-based paper money works. They have to argue that the dollar does everything you want money to do, such as hold its value, enable proper accounting, encourage savings, support a stable economy, etc. Well, they can go through the motions and fool the ignorant.

The other is that they have to defend the use of force against innocent people.

 

five year plan in four

Full speed ahead for the fourth and final year of the five year plan! (this poster was made when Stalin decided the 5 year plan had to be fulfilled in four years)

 

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Don’t Make Us Laugh

 

1024-DRE-blogStreet of Ottawa, the capital of Canada.

(Screenshot – Stéphane Leclerc)

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Another “Convenient” Terror Attack

On October 16, press reports informed us that Canada was about to “update” its national security legislation to, you guessed it, better fight terrorism. Specifically, this new legislation is ostensibly designed to not only better counter actual terrorism, but “potential” terrorism:

 

“Canada’s Minister of Public Safety joined justice ministers from across the country in Banff on Thursday to unveil new measures to give CSIS agents more authority and better tools to track potential terrorist threats to Canada’s national security. Steven Blaney held a press conference from the Banff Centre and outlined the decision to join Canada’s global allies to fight the terrorist acts of ISIL.

“We are taking a clear stand against those who are committing atrocities against innocent civilians. We are also discussing how this action works in tandem with our efforts here in Canada under the Counterterrorism Strategy to address terrorist threats and to prevent Canadians from traveling to the Middle East, joining ISIL and other terrorist groups.” said Blaney.

Blaney says the government will take steps to thwart the radicalization of Canadians by terrorist groups.

“We are firmly committed to take strong action to address the threat of individuals who become radicalized to violence and the growing problem of extremist travellers. Canada like all nations has a responsibility to guard against its citizens travelling to areas of turmoil and participating in terrorist acts,” he said. Blaney says the CSIS Act, which was created in 1984, is now outdated and needs to be adapted to allow agents to better operate and investigate threats to our national security from abroad.

[…]

Blaney says the government will also take action to help agents protect the identity of sources, which is critical in the fight against home-grown terrorism.

 

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ECB’s Comprehensive Bank Assessment Finalized

A considerable level of apprehension was noticeable in the financial press in recent days, as the ECB just finished its “stress tests” and its comprehensive assessment of 130 systemically important banks in the euro are. This time, the stress tests are a bit more interesting than previous exercises of this sort were.

Contrary to the white-wash attempts that characterized the laughable stress tests performed during the euro area’s sovereign debt crisis by the EBA (European Banking Authority), the ECB is forced to walk a slightly finer line. The reason is that it will become the regulator of these 130 large banks and will therefore be held responsible if anything goes wrong. On the other hand, the ECB is also eager to avoid a panicky market reaction to the results, and will therefore presumably try not to be too harsh in its assessments. In fact, looking at press reports, it certainly appears as though the criteria have been watered down quite a bit. Some observers argue that the ECB is far too beholden to political and market expectations to make its assessment credible (see also further below).

To this it should be noted that no fractionally reserved bank can be regarded as truly solvent, for the simple reason that such banks cannot actually fulfill their payment obligations to holders of overnight deposits. It works only as long as only a small percentage of depositors attempt to withdraw the money that they have been promised to receive “on demand”. Under normal conditions, this doesn’t pose a big problem, as banks continually receive new deposits and most deposit money tends to stay inside the system. Up to a point, a bank threatened by a run on its deposits can also rely on the lender of last resort (i.e., the central bank) to supply it with liquidity by discounting its securities.

Since money is nowadays a mere token signifying nothing, there is also no limit on its production. The ECB seems quite confident with regard to this aspect of the banking system, as its minimum reserve requirement for demand deposits stands at a mere 1%. In theory, the European banking system could multiply every deposit a hundred-fold by creating additional fiduciary media on the back its existing deposit base. In practice, this is highly unlikely to happen, but it shows that it is nowadays not seen as necessary anymore to even pretend that deposits are sufficiently “backed” with standard money (in the fiat money system, standard money = currency and bank reserves with the central bank).

The banks themselves have already received the results of the ECB’s assessment yesterday, but they will only be made public on Sunday – apparently the intention is to avoid roiling the markets. European bank stocks have recently tested an important short term technical support level and rebounded from there over the past few days:

 

1-Euro-Stoxx Banks, STEuro-stoxx Bank Index, daily – click to enlarge.

 

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