Chart Update

 

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:

 

1-euro basis swapsParty like it’s 2011: Three month, one year, three year and five year euro basis swaps – click to enlarge.

 

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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.

 

germany-european-central-bank-48-630x437

Photo credit: Michael Probst

 

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Oil Production and Consumption

 

oilstock

Image via Taylor Russell

 

The first chart shows global oil production, by month, based on latest EIA data.  2014 saw significant production increases after fairly flat production in ’12 and ’13.

 

1-global oil productionGlobal crude oil production (source, EIA) – click to enlarge.

 

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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).

 

dollar-stack

 

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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.

 

P1160701

Image credit: fmh

 

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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.

 

chicken-620x412

Photo credit: Pressmaster via Shutterstock

 

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Central Bank Madness is Contagious

Lately central banks around the world are busy slashing interest rates (if they still have any to slash), or printing money more or less outright if they have bumped into the much-dreaded zero-bound. In fact, the newest fad is to cut interest rates even if there aren’t any left to cut. The minus sign on the keyboard has turned out to be useful after all!

Not only are the Keynesian dunderheads running the SNB at it (there is absolutely no reason to elevate them to quasi-sainthood just because they kicked an untenable peg out from under the euro), but lately also Denmark’s central bank. Note here that Denmark is home to one of the biggest household and mortgage debtbergs on the planet, relative to economic output. We somehow doubt that the credit bubble will be kept in check by slashing interest rates to minus 75 basis points.

 

1-Denmark, Household debt to GDP-annThe Danish situation – Denmark’s household debt to GDP ratio and the central bank’s crazy negative benchmark interest rate. Note how two tiny baby-step rate increases were enough to send the credit bubble into wobble mode – click to enlartge.

 

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No More Dancing Naked in the Streets …

When the BoJ’s board last voted in favor of enlarging its “QQE” (qualitative and quantitative easing) program even further, from already enormous amounts to nothing short of gigantic amounts, the board’s vote was 5:4 in favor, with outgoing board member Ryuzo Miyao considered to have cast the “swing vote”.

As Chris Woods of CLSA remarked at the time, in a society like Japan’s with its strong focus on consensus, “they might as well have been dancing naked in the streets”. Indeed, something like this has never happened before, although some resistance to Kuroda’s plans already reared its head previously. At most though there would be one or two members voting against further inflationary measures, but never nearly half of the board.

As Reuters reports, this problem is about to be dealt with this year. The newest nominee to the BoJ’s board is Yutaka Harada, reportedly a “committed reflation supporter”. That should actually read “inflation supporter”, because “reflation” is really just a euphemism for “inflation”. While he replaces another inflationist, the government will soon have the oipportunity to tilt the balance on the board more permanently toward loose monetary policy with the next appointment, as one of those who voted against further easing will leave the board in June. At this point one can probably be fairly certain that no suspected “hawk” stands a chance of being nominated by Shinzo Abe’s government anytime soon.

 

hamada4
Inflation proponents Koichi Hamada (the Tuntex Professor Emeritus of Economics at Yale University), left and Yutaka Harada, right (as an aside, another well-known Yale-educated inflationist is former Argentine central bank governor and serial money printer Mercedes Marco Del Pont)

Photo credit: tokyofoundation.org

 

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Getting Short Term Overbought

Here is a brief technical and positioning update on gold. In euro terms, gold has just experienced a scorching rally – as a result, the previously discussed resistance levels in gold’s dollar price have been overcome as well. However, gold seems now quite overbought relative to the euro in the short term, and it also seems quite overbought relative to commodities.

The rally in the HUI index has recently been rejected near the 200 day moving average, and the HUI-gold ratio has pulled back somewhat, which also increases the probability that a corrective/consolidation period has begun.

Also shown below is the net hedger short position in COMEX gold futures (the inverse of the net speculative long position), which has in the meantime reached the highest level since early 2013. In short, everything seems to argue in favor of at least a short term pullback.

However, one reason why it is worth keeping a close eye on things now is that a number of markets – especially currencies – have lately tended to ignore such “overbought” signals. Obviously we don’t know with certainty what will happen next in the gold market. Normally, a correction should be expected, i.e., this outcome has the highest probability at the moment (even a resumption of the bear market cannot be ruled out completely yet, although it has become a lot less likely from a technical perspective).

However, should the correction turn out to be only very shallow and the rally resume quickly, it would be a sign of great underlying strength. It would also signal that faith in central banks is slowly but surely crumbling and that economic confidence is continuing to wane in spite of the recent strength in global stock markets.

 

Geldanlage in echtem Gold als Goldbarren und Goldmünzen

 

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Governments in Dire Straits

A number of governments find themselves in severe financial trouble – these represent the fringe of the fiat money bubble, the fraying edge of it, if you will. They will provide us with a preview of what is eventually going to happen on a global scale. It would actually be better to say: what is going to happen on a global scale unless significant monetary and economic reform is undertaken in time. Obviously, we cannot be certain what the future holds in store – however, we can certainly extrapolate the path we are currently on.

Looking at efforts that have been undertaken in this respect thus far, they are partly insufficient and partly extremely wrong-headed. For instance, the euro zone received a rather clear wake-up call in the sovereign debt crisis of 2009-2012. The effort to create a “fiscal compact” that forces governments to limit their deficits and public debt to specific percentages of economic output is a laudable attempt to bring the problem under control. However, the effort is lacking in many respects. For one thing, the accord will likely prove unenforceable when push really comes to shove. It is already meeting with considerable resistance, and one suspects that enforcement against core countries like France will continue to be lax.

Secondly, there are many ways in which such fiscal targets can be achieved, and we can be certain that in many cases European politicians will opt for the worst methods. Simply hiking taxes and bleeding the private sector dry is not a workable or sustainable policy. What is required are massive cuts in government spending, combined with economic liberalization on a vast scale. In other words, the kind of reforms that the ruling classes of the European socialist super-state project are most unlikely to consider. Even if they were considering them, they would have to overcome a plethora of vested interests to implement them.

Thirdly, one of the methods chosen to get a grip on government finances is financial repression, aided and abetted by the central bank’s ultra-loose monetary policies. This is certain to lead to capital consumption and impoverishment, thus making the long term success of the fiscal compact strategy even less likely.

 

Venezuela supermarket

Empty shelves in a supermarket in Caracas. The government has tried to counter spiraling inflation with price controls – this is the inevitable result.

Photo credit: Getty Images

 

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Communication Breakdown

This morning the Swiss National Bank did what central banks supposedly don’t do anymore nowadays: it surprised the socks off the markets. After still solemnly insisting in its most recent monetary policy assessment that it would “defend the minimum exchange rate of the Swiss franc against the euro with the utmost determination”, the SNB’s planners finally got cold feet and decided to abandon the policy without warning overnight (not that a warning would have done any good).

 

1-EURCHF, peg dropped, dailyThe market swiftly reassesses the EUR/CHF exchange rate – click to enlarge.

 

In so doing, the SNB’s board members have not only violated modern-day central bank etiquette, but have presented us with a reminder of how wonderfully stable today’s fiat currencies are. Bloomberg adopts a miffed tone of voice in its report on the matter:

 

“The Swiss National Bank unexpectedly scrapped its three-year policy of capping the Swiss franc against the euro in a U-turn that may change the perception of a century-old institution known for reliability.

In a surprise statement that sent shock waves through equities and currency markets, the central bank ended its cap of 1.20 franc per euro and reduced the interest rate on sight deposits, deepening a cut announced less than a month ago.

The shift marks an attempt by the SNB to reinforce its defenses of the economy before government bond purchases by the European Central Bank that could crumple the franc cap. The currency surged after the announcement, Swiss stocks including UBS AG tumbled and the chief executive of watchmaker Swatch Group AG said the policy shift would hurt exports. SNB President Thomas Jordan defended the move, saying surprise was necessary.

“It’s amazing that such a stoic central bank could end up abandoning such a long held policy with such short shrift,” said George Buckley, an economist at Deutsche Bank AG in London. “I thought we were out of the situation where central banks surprise so significantly as this.”

With reverberations hitting everyone from currency traders in London to mortgage holders in Poland, economists responded to the SNB announcement with comments including “surprise” and “seismic.” Coming from a nation that has attracted investors for its stability, the change captures the scale of the battle policy makers have repeatedly faced going back decades to rein in a currency popular with investors at times of crisis.”

 

(emphasis added)

 

surpriseFX trader Margo Spreadbottom upon hearing the news

Youtube screenshot

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A Look at a few Charts

Our friend T.R., who has constructed the gold-silver ratio adjusted VIX, an excellent indicator for timing short term peaks and lows in stocks, has provided us with a few annotated charts that show that a number of markets are very close to important support and resistance levels. Note that some of these charts are about a week old, but this doesn’t alter the message and doesn’t matter much since they are all very long term charts anyway.
In some cases, these levels have already given way. In some markets it should probably be expected that a short to medium term counter-trend reaction is imminent, while others seem likely to break these levels.
One very interesting chart is the first one, which compares 5-year US inflation break-evens to the MSCI emerging markets index. There has been a very close correlation between the two data series, and inflation break-evens have recently broken through a support trend line:

 

1-5-yr.-breakevens and MSCI-EM5 year US inflation break-evens and the MSCI EM Index – click to enlarge.

 

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A Brief Update on Yields, CDS Spreads and Implied Default Probabilities

Currently there are a number of weak spots in the global financial edifice, in addition to the perennial problem children Argentina and Venezuela (we will take a closer look at these two next week in a separate post).

There is on the one hand Greece, where an election victory of Syriza seems highly likely. We recently reported on the “Mexican standoff” between the EU and Alexis Tsipras. We want to point readers to some additional background information presented in an article assessing the political risk posed by Syriza that has recently appeared at the Brookings Institute. The article was written by Theodore Pelagidis, an observer who is close to the action in Greece.

As Mr. Pelagidis notes, one should not make the mistake of underestimating the probability that Syriza will end up opting for default and a unilateral exit from the euro zone – since Mr. Tsipras may well prefer that option over political suicide.

Note by the way that the ECB has just begun to put pressure on Greek politicians by warning it will cut off funding to Greek banks unless the final bailout review in February is successfully concluded (i.e., to the troika’s satisfaction). The stakes for Greece are obviously quite high. There are two ways of looking at this: either the ECB provides an excuse for Syriza, which can now claim that it is essentially blackmailed into agreeing to the bailout conditions “for the time being”, or Mr. Tsipras and his colleagues may be enraged by what they will likely see as a blatant attempt at usurping what is left of Greek sovereignty, and by implication, their power.

 

32a94b4f860c9ea010c2508169f36f36_XL

Image via Arabia Monitor

 

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The Greek Conundrum

As you can see above, we have created a new term describing deliberations regarding the possibility of a Greek default combined with an exit from the euro area. The reason why the time for the term “Grexitology” has come is that opinions on Greece’s future in the euro zone are plentiful and are covering the entire imaginable range, from “it would actually be a good thing” (getting rid of the weakest link in the euro chain) to “it won’t happen” to “it doesn’t matter” to “it will bring about the end of the world”.

In the latter category we find the always dependable Ambrose Evans-Pritchard, pronouncing imminent doom. He thinks that everybody is too complacent about the “contagion danger” in light of financial markets so far confining their negative reaction to Greek bonds and stocks instead of meting out more broad-based punishment (e.g. Spanish and Italian government bond yields have so far barely budged from recently attained all time lows). He believes that unless Spain and Italy are getting into trouble as well, the German government just doesn’t care what happens with Greece.

 

Alexis TsiprasAlexis Tsipras: with these here hands I will tear up the bailout agreement…or not. What day of the week is it?

Photo credit: Remy De La Mauviniere / AP

 

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Happy Holidays!

We wish all our readers happy holidays and a prosperous and healthy new year. As we announced last week, the blog will go on a one week hiatus over the holidays until year end – unless something especially noteworthy happens that requires immediate comment (asteroid strike, Greek presidential election going awry, etc.).

We also want to extend a special thank you to all readers who have helped us with our funding drive over the past week – we are greatly honored by your generosity.

 

santa

 

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