An Interesting Background Noise Amid Increasing Bubble Talk
As we have previously pointed out, a sharp increase in “bubble talk” is often a danger sign (see “Circular Bubble Logic” for details). There is some anecdotal, as well as some quantifiable evidence for this (such as Google search statistics). There has certainly been quite a bit of talk about certain bonds having reached unsustainable levels, but generally our impression was that there was actually a lot of complacency as well. This is especially true with regard to low or even negative yielding European government bonds, which reflected one of the most egregious central bank-directed market distortions yet (more on this further below).
More Ominous Charts
We have decided to expand a bit on our recent post about “ominous charts” and show a few more charts that should at least give one pause. We hasten to add that none of them should be seen as timing indicators. It must be stressed that we continue to be in unprecedented situation, with central banks worldwide cutting interest rates to the bone with policy rates in the major currency areas having been kept at or near zero for an unusually long time period.
Party on dudes!
Painting by Vasily Alexandrovich Kotarbinsky
US Dollar – Positioning and Sentiment
Between the summer of 2014 and its recent peak in March this year, the US dollar index was a one-way street – a blow-off like move that mainly mirrored the equally relentless decline in the euro, which has been suffering from the ECB’s misguided ministrations. The euro has the by far largest weighting in the dollar index (nearly 58%). In the meantime, euro area money supply growth has begun to significantly exceed US domestic money supply growth (year-on-year growth in money TMS: euro area 12.4%, US dollar 7.5%) and interest rate differentials have turned in the dollar’s favor as well, so the revival of the dollar does make some sense from a fundamental perspective – only the size of the move has been a surprise. Recently the dollar has gone through its biggest correction since the rally began. Below we will take a look at a wide range of relevant positioning and sentiment data to illustrate where things now stand.
Image via Istock
An Accelerating Trend
While the euro itself has recovered a bit from its worst levels in recent sessions, euro basis swaps have fallen deeper into negative territory. In order to bring the current move into perspective, we show a long term chart below that includes the epic nosedive of 2011. We are not quite sure what the move means this time around, since there is no obvious crisis situation – not yet, anyway.
A negative FX basis usually indicates some sort of concern over the banking system’s creditworthiness and has historically been associated with euro area banks experiencing problems in obtaining dollar funding. This time, the move in basis swaps is happening “quietly”, as there are no reports in the media indicating that anything might be amiss. Still, something is apparently amiss:
Not Quite Right in the Head?
The belief that the market economy requires “steering” by altruistic central bankers, who make decisions influencing the entire economy based on their personal epiphanies, has rarely been more pronounced than today. Most probably it has actually never been stronger. It is both highly amusing and disconcerting that so many economists who would probably almost to a man agree that it would be a very bad idea if the government were to e.g. take over the computer industry and begin designing PCs and smart phones by committee, think that government bureaucrats should determine the height of interest rates and the size of the money supply.
Photo credit: Michael Probst
The Fed has Provided the Bulk of Money Supply Growth since 2008
We have discussed the topic of money supply growth extensively in these pages over time. Below is a brief recap of how the system works in the US. Note that although fractional reserve banking and central bank-directed and backstopped banking cartels are in place all over the world, there are several “technical” differences between them. So the workings of the US system cannot be transposed 1:1 to e.g. Japan’s system or the euro system.
There are two possibilities of growing the fiat money supply: In “normal” times, commercial banks will extend loans which are partially “backed” by fractional reserves. These loans create new deposit money, which once again can serve as the basis of further credit creation, which again creates new deposit money, and so forth. It can be shown mathematically that based on a hypothetical fractional reserve requirement of 10%, extant deposit money in the system can be grown 10-fold (for a detailed discussion of the “money multiplier”, see here).
A Relentless Downturn
When Chinese investors discovered that Bitcoin might offer an avenue for circumventing China’s exchange controls, the digital currency soared to an incredible $1,250 per unit (on some, but not all Bitcoin exchanges – prices tend to vary a bit between the different exchanges). This was of course not only due to the perception that exchange controls could be evaded with Bitcoin; the Chinese are well known for their love of gambling after all. As real interest rates were in negative territory for long stretches of time in recent years, China’s citizens have sought out all sorts of investments to preserve the purchasing power of their savings – Bitcoin was just one more option, but China’s authorities ultimately cut this option off.
Image credit: fmh
Game of Chicken Continues, EU Ratchets Up Pressure on Greece
After the ECB has made Greek debt no longer eligible for repos (note that this mainly concerns government bonds however, bank bonds that have been “guaranteed” by the government will however no longer be eligible after February 28 2015 either – these amount to a quite large € 25 billion), fears of an intensifying bank run in Greece are growing. At the end of December, Greek banks owed about € 56 billion to the euro system. This is estimated to have jumped to about € 70 billion since then.
These debts to the system have grown concurrently with a sharp decline in deposit liabilities since November last year, when it dawned on people that there might be an election. Unfortunately more up-to-date data aren’t available as of yet, but we will try to post them as soon as the Bank of Greece makes them available. However, there exist estimates regarding the extent of the decline in deposits since the end of December as well – very likely an additional € 15 billion has fled from the Greek banking system since then.