Central Banks


A Generous Offer He Couldn't Refuse

The tireless advocate of European-style socialism for America, the New York Times' famous promoter of Keynesian snake-oil, Paul Krugman, has joined the 'war against inequality' by deploying himself right on the front lines.

No, he still isn't going to debate Robert Murphy on economic theory so that $100,000 can be donated to New York food banks. That would be tantamount to participating in a 'circus'. Only 'serious debates' would be of interest to the great man. $106,000 have been pledged to help poor people? Well, f*** the poor people, the great man simply has no time for Mr. Murphy's 'circus'.

So what does he have time for? After all, the poor are dear to his heart, as he never tires to stress when he reminds his followers that the market is far 'too free', and that more regimentation, higher taxes and more deficit spending and money printing are absolutely needed to save the day and help the downtrodden against the nefarious schemes of the plutocrats (this is quite ironic, because the plutocrats probably agree wholeheartedly with Krugman's proposals).

Enter the University of New York (CUNY) and its Luxembourg Income Study Center , a research arm devoted to “studying income patterns and their effect on inequality”. Via 'Gawker' we learn that the institute has hired the selfless crusader to support its work on 'income inequality studies' for the pittance of $225,000, which he will receive for an engagement lasting 9 months. Surely an onerous workload awaits the poor man at the 'Income Study Center' if he should accept.

One imagines that there should at least be some 'serious debate', or perhaps that he will even teach a course that explains to students why free markets are bad. After all, growing inequality is only to be expected if one allows capitalist exploiters to run wild, as is the case in the completely unregulated free-for-all the world is forced to endure at present.


“According to a formal offer letter obtained under New York’s Freedom of Information Law, CUNY intends to pay Krugman $225,000, or $25,000 per month (over two semesters), to “play a modest role in our public events” and “contribute to the build-up” of a new “inequality initiative.”

It is not clear, and neither CUNY nor Krugman was able to explain, what “contribute to the build-up” entails.

It’s certainly not teaching. “You will not be expected to teach or supervise students,” the letter informs Professor Krugman, who replies: “I admit that I had to read it several times to be clear … it’s remarkably generous.” (After his first year, Krugman will be required to host a single seminar.)”


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It looks as though the US stock market is in the process of topping out. But if you’d bet heavily on a bear market, each time you saw one coming, you’d be broke by now. We will wait to see what happens…

Meanwhile, we are still puzzling over the miracle produced by the Fed. Uri Geller could bend spoons. The Fed bends the entire economy. Hardly a single price is unaffected. Hardly a single business plan or investment strategy goes forward without an eye on the central bank.

Jesus turned water into wine and multiplied loaves and fishes. But the Fed make the Nazarene seem like a two-bit shell game hustler. The loaves and the fishes couldn’t have had a market value of more than a few thousand shekels!


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Something for Nothing

Today, we return to familiar territory. We have seen it before: The slowdown in the economy. The overpricing of assets (particularly stocks). The huge increase in debt. The Fed’s QE and ZIRP. But for all its familiarity, it remains strange… and mysterious. Let’s backtrack…

The foundation for today’s peculiar economy was laid in the 1960s and 1970s. In 1968, President Johnson asked Congress to end the requirement that US dollars be backed by gold.

Then in 1971, President Nixon issued Executive Order 11615, which “closed the gold window.” This meant the dollar was not directly convertible to gold. The supply of money and credit no longer had any anchor in a physical commodity. It could now be created ex nihilo and ad nauseam by private banks, aided and abetted by the Fed.

The PhDs running the Fed had a theory – one that seems childishly naïve but that, nevertheless, seems to work in practice (so far). The more you could get people to borrow, they reasoned, the more demand for goods and services there'd be… and the more the economy would produce to meet this new demand. This would give Americans more access to jobs, incomes… and the satisfaction of getting something for nothing.


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Watch What They Do, Not What They Say

On Wednesday Kremlinologists were treated to the bizarre spectacle of the release of the Fed minutes (abridged version) again. It has recently been argued that the market has been buffeted by alternately being led to believe that administered interest rates may rise sooner than expected (Ms. Yellen hinted in her March press conference at '6 months after QE ends'), or later than expected (she corrected herself on a subsequent occasion).

The Fed minutes released yesterday seemed to indicate – at least that was the interpretation, i.e., the effect of market participants hearing what they wanted to hear – that 'later' it shall be. Surprise, surprise, the Fed is dovish! Who would have thought? What an unexpected turn of events!

However, people already know (or should know) that the central bank will forever err in favor of easy monetary policy. When was the last time it has done otherwise? That was a brief period most of today's market participants don't even remember, namely 1979-1980. The Fed is always reactive, and as such it remains perennially 'behind the curve'. What is discussed in its meetings today is meaningless – it has precisely zero bearing on its policy decisions of tomorrow.


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Where to Go?

Our subject on Friday was the destruction of our civilization. Today, we take up a related question: So what?

You’ll recall that we’ve been reporting on the work of Richard Duncan, who is currently chief economist at Blackhorse Asset Management in Singapore. We went down the road with him, from the causes of the stock market boom to the inevitable bust … thence to the Fed's inevitable reaction and to another leg up in the stock market. But here is where we part company.

Duncan believes a credit deflation would be devastating. We have come to rely so heavily on credit from the Fed, he says, that taking it away would mean chaos, depression and war.

“In all probability, our civilization would not survive it,” he concludes. Faced with such a calamity he believes there is no way to go back to the sound principles of 19th century banking and finance. Instead, we have no choice but to go ahead.

But to where? And how?


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Thanks a Bunch, but Keep the Advice to Yourself Please …

The most amusing moment of Mr. Draghi's press conference after yesterday's ECB board meeting, was when he proceeded to put down the IMF's Ms. Lagarde who had only one day prior to the meeting admonished the ECB to step up its money printing efforts so as to counter allegedly 'too low' inflation (see “Lagarde Worries About ‘Not Enough Inflation’ Again”).

The ECB once again left policy unchanged, instead continuing to rely on threats and/or promises (depending on whether one is a saver or a debtor, one can interpret its announcements as either one or the other) of what it would do if 'required'. As the WSJ reports, Draghi actually looked 'cross' for once, seemingly losing his usual detached cool. We think it's just theater, but anyway, here is what the WSJ wrote:


“For a moment Thursday, European Central Bank President Mario Draghi, arguably one of the coolest, most collected central bankers on the planet, looked cross.

Mr. Draghi was explaining to reporters why the ECB’s governing council had decided to take no action in response to a decline in the inflation rate to 0.5%, a quarter of the rate it targets. It’s a job he does well, and indeed, by the end of the monthly news conference, Mr. Draghi had managed to convince investors that the central bank may yet loosen policy further, as evidenced by the fact that as he left the podium, the euro was weaker than before he had started.

But along the way, Mr. Draghi was asked one question that appeared to set him on edge: how did he respond to a suggestion by the head of the International Monetary Fund Wednesday that the ECB should loosen policy, and quickly?

With a little sarcasm, is the short answer.

“I think the IMF has been of recent extremely generous in its suggestions on what we should do or not do,” he said. “And, we’re really thankful for that. But the viewpoints of the Governing Council are in a sense different. Frankly, I would like the IMF to be as generous as they have been towards us also with other monetary policy jurisdictions, like for example issuing statements just the day before an FOMC meeting would take place. Anyway, I think we would certainly value the advice of the IMF and certainly it’s an important contribution to our analysis.”


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ECB: What is its Talk Actually Worth?

Many people are beginning to wonder these days how long the ECB's trick of promising action instead of delivering action will continue to 'work' (allow us to interpose here, that we believe the less they do, the better it is). To understand the activities of the ECB in recent times, one must keep in mind that central bankers far and wide have become convinced that their ' forward guidance' is an extremely powerful tool in the central banking 'tool-box'. We would argue that this is only a half-truth. It is true that psychological factors are an important driver of financial market activity, but if one analyzes historical contingencies on a case by case basis, one soon realizes that  whatever psychological effects one was able to observe were always supported by real forces.

In order to bring this into context with the ECB, it has often been argued that Mario Draghi, by merely holding out the promise of 'OMT', managed to steer the euro area's sovereign bond markets from panic to relative calm. Lately the 'calm' has actually evolved into a state of utter complacency:


Spain-2yr. govt. bond yieldSpain's 2 year government note yield: from total panic to serene complacency. Meanwhile, Spain's public debtberg has continued to grow by leaps and bounds – click to enlarge.


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A New Term For the Economic Lexicon

We have previously written extensively about the absurd worrying about 'inflation being too low' in Europe, even while millions are out of work and forced to live from their savings or meager hand-outs from their governments. It should be self-evident that they need rising consumer prices like a hole in the head. Both Ms. Lagarde of the IMF and Mr. Draghi of the ECB have uttered remarks about this in the recent past (see: “Ogre Spotting” and “No, Deflation is Not a Danger” for details).

The bellyaching and whining continued this week, with Ms. Lagarde taking the lead again. In the process, she seems to have coined a new economic term, namely “low-flation”. No new term seems actually needed, as “low-flation” of course remains “inflation”, or rather its effect, namely rising prices.


“"Low-flation," particularly in the euro area, is an emerging risk to advanced economies, International Monetary Fund Managing Director Christine Lagarde said Wednesday.

"A potentially prolonged period of low inflation can suppress demand and output-and suppress growth and jobs," she said at the School of Advanced International Studies as she called for more monetary easing by the European Central Bank and continued action by the Bank of Japan.

It may be the first time Lagarde has used such a phrase, though she has made clear her concern over the lack of euro-zone inflation for some time. Lagarde also saw emerging-market economies and geopolitical tensions as short-term risks, and unemployment, high levels of debt and financial uncertainty as medium-term concerns. Lagarde said overall growth remains too slow and weak, and the IMF projects "modest improvements" in 2014 and 2015.”


(emphasis added)

Allow us to repeat here that this is simply long discredited hokum, that our bien pensants never fail to drag up again and again. Keynesian voodoo-economics should by rights have been buried after the experience of the 1970s, but it has tenaciously clung to life (we believe we know why, and it has nothing to do with its qualities as an economic theory).

Falling consumer prices would be the natural state of affairs in a free, unhampered market economy. This cannot be stressed often enough. Once again it must be pointed out that the periods of the highest and at the same time most broad-based real economic growth in the US occurred in concert with falling prices. This was before the Federal Reserve entered the scene, not surprisingly.

The only reasons why Lagarde and Co. are worried about falling prices are:


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A Word to the Wise

Readers may remember former BuBa board member and ECB chief economist Otmar Issing, who probably like few others personified the image of the stern, conservative German central banker (Jürgen Stark and Axel Weber were also people in this mold). Issing now and then still offers his opinion to those interested, most recently in an editorial in the FT, entitled “Get your finances in order and stop blaming Germany”.

As one might expect, Issing is no fan of 'euro-zone bonds' and similar ideas attempting to create shared responsibility for the debts of independent sovereign countries running their own fiscal policy. Several of his points are worth commenting on.


Germany Shoots Own Goal

Issing starts out by noting that Germany should best lead by example – and not by throwing money at the euro area's problems. He also reminds us that Germany's economic success is not irrevocable, and that there is a threat it won't be preserved:


“Germany is not only the biggest economy in Europe, it is also the best performing – and it would be in everyone’s interest if the country led by example. Unfortunately, it may be undermining its economic dominance by undoing past reforms and reinforcing labour market regulations. It is perhaps not too pessimistic to argue that the time will come when Germany’s economy is no longer the subject of envy.”


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Dying Cows


Praying for Nicaragua when you live in Tunbridge Wells is the first sign of madness.

Evelyn Waugh


“Three more cows died,” Jorge, our Argentine ranch manager, reported yesterday. We had reacted as fast as we could. Still, the disease – whatever it is – moved faster.

Jorge and his crew of five gauchos worked for three days – including a Sunday and a national holiday – almost without rest. From first light ‘til after dark they rounded up the cattle and ran them through the stocks.

It was hard work. But there were no complaints. They all knew it had to be done. All the animals have now been given an injection. Whether that stops the epidemic, or not, we wait to find out …


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Driving Cattle

Today, we go even farther into the unknown … beyond eventually and past sooner or later … to what happens next. Specifically, we don’t think central bankers are going to take the end of the world lying down. They’ve got tricks up their sleeves. These are not new tricks. They’ve been used many times in many different forms. But they’ve never been used on the scale we now foresee.

But before we begin guessing, let us tell you a bit about what is really happening here at Finca Gualfin, our ranch here in northwestern Argentina. Three days ago, Jorge – the farm manager – came to us with a problem:

“Señor Bonner, we found two calves dead. They looked fat and healthy. I’m afraid it is a disease called la mancha. I saw it many years ago. Healthy young cows just all of a sudden fall down and die. It almost wiped out our herd.”

We still don’t know what la mancha is. But it is evidently not something to trifle with. Word went to Salta, a city about six hours away, that we had an emergency. A veterinarian advised us to inoculate the whole herd. Within hours, the medicine was on a bus bound for the hamlet of Molinos, about an hour and a half from the ranch.

The next morning, all the hands were turned out – including your editor. We mounted up and headed out to the campo – an immense valley of some thousands of acres. Our job was to sweep the valley of all the cows … driving them to the main corral, where they would be vaccinated.

The operation took three days. Your editor was probably more of a liability than a help. Driving cattle is not as easy as the local gauchos make it look. More on this later …


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Nejat Seyhun's Take on the Flood of Insider Sales

It should be pointed out that insiders have been heavy sellers of stocks for quite some time. Insiders are almost always early, both in their buying and selling. This is no surprise, as by the very nature of the situation, they have an  informational advantage and are bound by legal constraints, which expresses itself inter alia as an often considerable lead time in their activities. If one tries to time one's investments by relying solely on insider data, one will often find one's patience taxed, since what is needed for the investment to produce a positive return is usually that other market participants begin to recognize what the insiders have known all along.

So what is the current situation? As noted at the beginning, insider selling hasn't just picked up recently – it has been quite heavy for a long time now. What makes the current situation remarkable is only that insiders haven't expressed this much skepticism about valuations for some 25 years, as Mark Hulbert reports. He has some interesting information on how the data on insider activity need to be parsed to arrive at actionable intelligence:


“Corporate insiders are more bearish than they have been in almost 25 years. That isn’t good news for the stock market, since these insiders — corporate officers and directors— know more about their companies’ prospects than the rest of us. In fact, you may want to take their pessimism as a signal to ditch some of your stocks or shift into industries in which insiders aren’t heavily selling, such as energy, financials and basic industrials. Just be aware that this record bearishness isn’t evident from many of the insider indicators that get widespread attention on Wall Street—those based on a ratio of insiders who are selling to those who are buying.

According to the Vickers Weekly Insider Report, published by Argus Research, which calculates a proprietary version of this sell-to-buy ratio, insider selling over the last eight weeks, relative to insider buying, is higher than average, but no higher today than it was one year ago—when the S&P 500 was poised to produce an impressive double-digit gain. And in late 2003, just as the 2002-07 bull market was gathering steam, the insiders’ sell-to-buy ratio rose to even higher levels than it is today.

But insider sell-to-buy ratios can be misleading, says Nejat Seyhun, a finance professor at the University of Michigan who has extensively studied insider behavior. That is because the government’s definition of insiders includes a group of investors whose past transactions, on average, have shown no correlation with subsequent market moves: those who own more than 10% of a company’s shares.

Though on rare occasions such a large shareholder also will be an officer or director, in almost all cases it will be an institutional investor—such as a mutual fund or a hedge fund. These entities are outsiders in all but name, and they have the least forecasting ability. For example, Seyhun found that far from being a laggard, the average stock sold by these largest shareholders actually outperformed the market by 0.7% over the subsequent 12 months.

For his calculation, Seyhun strips out the largest shareholders from the sell-to-buy ratio. Currently that adjusted figure shows a record level of insider bearishness. According to this measure, corporate officers and directors in recent weeks have sold an average of six shares of their company’s stock for every one that they bought. That is more than double the average adjusted ratio since 1990, which is when Seyhun’s data begin. One year ago, Seyhun’s adjusted ratio was solidly in the bullish zone, he says. And in late 2003, the ratio was more bullish still. The current message of the insider data “is as pessimistic as I’ve ever seen over the last 25 years,” he says.


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Explaining the End


I sometimes get the feeling that somewhere across that huge puddle, in America, people sit in a lab and conduct experiments, as if with rats, without actually understanding the consequences of what they are doing.

  • Vladimir Putin, 4 March 2014


We promised to explain how it ends. The world, that is. The world we live in now. The one in the middle of a rapidly inflating central bank bubble.

First, we need to understand that this is a very different world from the world of the 19th and early 20th centuries. It is a world where central bankers play a role somewhere between con artists, mad scientists and God Himself.

They deceive and cheat. They conduct their experiments without any real idea how they will affect people. And they move almost every price in the world – sending investors, householders and business people all running in one direction.

Their experiments change not only prices quoted on the Big Board and the supermarket. They also change the physical world. Jobs are lost to machines that – without such low interest rates – would not have been built.


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Treading Water on Borrowed Money

As promised, today we enter the time that hasn’t come yet … the point where the poor camel’s back gives way.

On Thursday, the Fed announced it would withdraw another $10 billion of artificial demand from the US bond market. And Janet Yellen let slip that the Fed would consider raising short-term interest rates about six months after QE ends. The Dow fell 114 points. Gold dropped $17 an ounce. What to make of it?

You’ll recall that, as long as ZIRP (zero-interest-rate policy) continues, the Fed is draining more and more resources from the future. It encourages people to borrow – by dangling near-zero interest rates in front of them. This debt must be serviced and retired from future earnings. This reduces the amount of capital available for current wants and needs. Thus the future is placed in debt bondage to satisfy the desires of the here and now.

The whole world is in on it. With total global debt of $100 trillion, even if the world could set aside $5 trillion a year, it would take about 30 years to pay off the debt (including interest at “normal” rates). But the world cannot set aside $5 trillion a year. It can’t even stumble along at break even. Instead, every year it needs an extra $5 trillion of borrowed money (net) just to stay at current levels of unemployment, asset prices, consumption and interest rates!

In other words, today, instead of paying down the past debt, we borrow more from the future just to stay in the same place.


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Convoluted Statement Becomes More So

As always, Kremlinologists can check the WSJ's trusty FOMC statement tracker to see what has actually changed. Ever since the first 'taper' announcement in December, the statement has become a lot more convoluted. As far as we can tell, the reason for this is that there is a plan underway to slowly replace actual money printing with something called 'forward guidance'. This consists of promises about the future conduct of policy that are worth precisely nothing, since the Fed can definitely not see the future. Not only are there no trained fortune tellers in its employ, but what insights into the future state of the economy it tends to offer have a well-worn record of being worse than a coin flip, especially near economic turning points.

This is not necessarily a complaint, mind. One cannot fault people for their inability to correctly anticipate the future, least of all bureaucrats. If they were able to make correct forecasts, they wouldn't be bureaucrats, but businessmen or speculators.  In that sense, 'forward guidance' is a waste of ink. In fact, the statement itself indicates as much:


“In determining how long to maintain the current 0 to 1/4 percent target range for the federal funds rate, the Committee will assess progress–both realized and expected–toward its objectives of maximum employment and 2 percent inflation. This assessment will take into account a wide range of information, including  measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial developments. The Committee continues to anticipate, based on its assessment of these factors, that it likely will be appropriate to maintain the current target range for the federal funds rate for a considerable time after the asset purchase program ends, especially if projected inflation continues to run below the Committee's 2 percent longer-run goal, and provided that longer-term inflation expectations remain well anchored.

When the Committee decides to begin to remove policy accommodation, it will take a balanced approach consistent with its longer-run goals of maximum employment and inflation of 2 percent. The Committee currently anticipates that, even after employment and inflation are near mandate-consistent levels, economic conditions may, for some time, warrant keeping the target federal funds rate below levels the Committee views as normal in the longer run.


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THE GOLD CARTEL: Government Intervention on Gold, the Mega Bubble in Paper and What This Means for Your Future