The Unleashing of Madness
A number of articles have recently discussed the ECB’s quantitative easing program, which entails inter alia the buying of covered bonds. Here is a quote from an article in the Financial Times:
“The European Central Bank has started to buy covered bonds, in its latest attempt to to revive lending in the euro zone and stave off a vicious bout of economic stagnation.”
It would be more correct to write: “ECB tries its best to revive the credit bubble that thankfully expired in 2008”. This one sentence from the FT above encapsulates already almost everything that is wrong about these currency debasement programs. It is presented as a “given” that central bank meddling with money and credit is necessary to revive, or as it is often put, “jump-start” the economy, which is held to be mired in stagnation for generally mysterious reasons.
And yet, his comment by the FT makes as much sense as the policy, namely zero (a big, fat zero). The ECB will effectively print money, or rather, create digital money ex nihilo, to pay for these purchases. The underlying assumption that creating additional amounts of money can “stave off economic stagnation” is 180 degrees wrong. It will achieve the exact opposite, namely a structural weakening of the economy – even if, or rather, especially if, economic activity as measured by aggregated data seems to “revive” as a result.
Those who have first access to the newly created money can exercise a demand for real goods without first having contributed anything to the economy’s pool of real funding. This makes it more difficult for those people who actually do make such contributions by their productive efforts to create wealth – as they are forced to compete for a shrinking pool of real resources. As Frank Shostak explains in recent article, what happens is that “exchanges of nothing for something” result from the creation of additional money:
How to Slow Down World Improvers
And how do you like that James Bullard?
Stocks have barely begun to correct (the S&P 500 is down about 7% from its September high) and the St. Louis Fed president is already preparing for QE4. But where is the proof – from logic or experience – that QE pays off?
It is a shame that quack philosophers, politicians and central bankers are not subject to penalty. After all, bridge builders and hedge fund managers suffer shame and ruin when their projects fall to pieces.
Couldn’t some suitable stick be laid on world improvers, too? Preferably before their wacky programs are put into service.
For example, when they make a claim that cannot be supported by rigorous proof, they should lose a year’s worth of income … or have their genitalia cut off. Maybe that would slow them down.
Is the next avalanche on its way?
More Back-Pedaling – This Time by a “Hawk”
We already pointed out on Tuesday and again on Wednesday that numerous signs of back-pedaling by Fed officials recently emerged – no doubt in reaction to the sudden wobble in “risk” assets (what else could have been the motivation?). On Wednesday we asked rhetorically whether San Francisco Fed president John Williams was actually serious.
Enter St. Louis Fed president James Bullard on Thursday, who only a few weeks ago was talking about wanting to alter the FOMC statement toward indicating a more hawkish tone. Nothing but a less than 10% dip in the spoos to completely change a monetary bureaucrat’s views these days. According to the FT:
“From the transcript of St Louis Fed president James Bullard’s interview with Bloomberg Television:
“I also think that inflation expectations are dropping in the U.S. And that is something that a central bank cannot abide. We have to make sure that inflation and inflation expectations remain near our target. And for that reason I think a reasonable response of the Fed in this situation would be to invoke the clause on the taper that said that the taper was data dependent. And we could go on pause on the taper at this juncture and wait until we see how the data shakes out into December. So… continue with QE at a very low level as we have it right now. And then assess our options going forward. …
My forecast is for rising inflation. That’s why I’m concerned about declining inflation expectations, the five-year TIPS in particular has declined below one and a half percent. The five-year forward is down from its previous levels. And the central bank has to guard against any expectations in the market that would suggest that the central bank is not going to hit its inflation target. So you have to be credible on your inflation target. So a simple – what I’m saying is that a simple step that we may be able to take or maybe the committee might consider at its October meeting would be to just take a pause on the taper, let more data accumulate and see how the U.S. is going to evolve over the rest of the year and into next year. …
I think you should quit numbering the QEs. I’ve been an advocate of having an open-ended program. I do think QE is our most powerful tool when the policy rate is at zero. And I think it’s far more powerful than forward guidance for instance. And I think we saw that during the taper tantrum of 2013. And therefore I think I’ve been for having an open-ended program that reacts to economic data. And so far we’ve been able to taper the program down on the face of really dramatically improving labor markets this year, but maybe this is a juncture where we’d want to invoke that clause about it being data dependent.”
The remarks follow the comments earlier this week by John Williams of the San Francisco Fed, who signaled his willingness to consider a new round of asset purchases if “a sustained, disinflationary forecast” emerges.”
You Can’t Be Serious …
Yesterday we came across this brief note on Marketwatch about an interview San Francisco Fed president John Williams gave to Reuters. We already pointed out in our market update on Monday that a whiff of back-pedaling by Fed officials was in the air, but it is getting utterly ridiculous now:
“San Francisco Fed President John Williams said that more bond buying could be needed if the economy faltered, according to a report. “If we really get a sustained, disinflationary forecast … then I think moving back to additional asset purchases in a situation like that should be something we should seriously consider,” Williams told Reuters.
Williams said he’s “worried” the European Central Bank response will be as timely and aggressive as needed. Williams told the publication he still expects the first rate hike in the middle of 2015. The Fed is expected to announce it will stop bond purchases at its October meetings.”
Say what? The ECB “won’t be as aggressive as needed”? A planned € 1 trillion ECB balance sheet expansion is not enough? We would also like to know – needed for what?
In the make-believe world of these ivory tower bureaucrats the economy can be “improved” by printing money, but in the real world it is actually severely undermined. If an economy is seen to be recovering in tandem with money printing, it is doing so in spite, and not because of it. In fact, chances are that the observed “recovery” is naught but an inflationary illusion anyway.
San Francisco Fed president John Williams
(Photo credit: Tony Avelar | Bloomberg | Getty Images)
How do you like that Dow? Down 272 on Tuesday. Then back up almost exactly as much on Wednesday. As we predicted, volatility is rising. Investors are beginning to squirm. Why?
The Fed is ending QE. And it could hike short-term interest rates as soon as next year. The EZ money is getting scarce.
“We are trapped in a cycle of credit booms,” writes Martin Wolf in the Financial Times. Wolf is wrong about most things. But he is not wrong about this. “On the whole,” he writes, “there has been no aggregate deleveraging since 2008.”
He does not mention his supporting role in this failure. When the financial world went into a tailspin, caused by too much debt, in 2008, he joined the panic – urging the authorities to take action!
As a faithful and long-suffering reader of the FT, we recall how Wolf howled against “austerity” in all its forms. His solution to the debt crisis?
Bailouts! Stimulus! Deficits! In short, more debt!
Martin Wolf pleading for more money printing in 2010 …
… and again in 2011 – now he wonders how it comes that we’re trapped in credit boom-bust cycles?
An Absurd Claim
Last week, a story broke about Fed whistleblower Carmen Segarra. I wrote an article on Forbes about it, Disgruntled Fed Lawyer Blows Whistle on Regulatory Capture. Segarra is a former Fed regulator assigned to supervise Goldman Sachs. She secretly recorded 46 hours of audio from her meetings, during her short stint on site at Goldman as a Fed employee.
This story does not come in a vacuum. There is an ongoing narrative, which is simple, even facile. We had a crisis in 2008, and therefore banks caused it. Because, greed. This is the backdrop for her story, and the story presented by This American Life and ProPublica. It is how every article I have read about that story, except this one by David Stockman, spins it.
Banks suffocate under a full-time, on-site team of government minders. In Sagerra’s words, “The Fed has both the power to get the information [i.e. whatever it demands] and the ability to punish the bank if it chooses to withhold it. And some of these powers involve criminal action.” The banks are monitored, controlled, regulated, and supervised. So how is it possible that they got away with crime on such a scale as to nearly collapse the monetary system?
Ex-Federal Reserve lawyer Carmen Segarra
(Photo credit: Nabil Rahman for ProPublica)
The Dow fell 238 points on Wednesday. And Treasury debt rallied. The yield on the 10-year T-note fell the most in nine months – to 2.4%. News reports blamed “geopolitical challenges” in Hong Kong, the Middle East, Ukraine and elsewhere.
That may be part of it. But this is also October – the month QE is expected to end. Between 2009 and 2014, the Fed bought $3.6 trillion of US government and mortgage-related notes and bonds. During that time $5 trillion has been added to the value of the US stock market. And the price of the average house has risen by $60,000.
This was achieved largely by holding Mr. Market’s head underwater until he stopped squirming.
(Photo via Deviantart)
The Good and the Bad
Bloomberg, which is a major purveyor not only of useful economic and financial data, but also a major proponent of economic central planning as practiced by modern central banks, informs us that Fed chair Janet Yellen has actually found the holy grail. Finally, central planning will work! At last, the promise of the “scientific monetary policy” is about to be fulfilled. Nirvana has practically arrived.
In a once again slightly confusing Bloomberg headline we are told: “Yellen Takes the Good Greenspan, Leaves the Bad”. If that’s so, obviously nothing can go wrong. It does make us wonder though what she’ll do about the ugly Greenspan.
In a way, this is an almost prophetic poster, with its references to risk taking and someone “doing the cutting”…
So what is the promising secret sauce discovered by Ms. Yellen? After a string of abysmal failures over the past century, how is central economic planning by the Fed finally going to lead us to salvation? As the headline already indicates, tweaking Alan Greenspan’s playbook is believed to do the trick:
“Janet Yellen looks to be taking one page out of Alan Greenspan’s playbook while tearing up another as she plots monetary strategy for 2015 and beyond.
The Federal Reserve chair and her colleagues signaled this month they would be willing to push unemployment below its so-called natural rate — a feat Greenspan as chairman managed in the late 1990s without fanning much inflation. Yellen showed less desire to pursue her predecessor’s “measured” approach to raising interest rates in the mid-2000s, suggesting his strategy may have fostered complacency that made a small contribution to the financial crisis.
The late 1990s “was a very good period for the U.S. economy, and Greenspan made the correct call on monetary policy,” said Michael Gapen, a former Fed official who is now senior U.S. economist for Barclays Capital Inc. in New York. On the other hand, “there is a general consensus the way they did policy wasn’t right” in the run-up to the housing bust that preceded the 2007-2009 recession.”
H.W. Sinn Chides Ms. Merkel
A friend pointed a recent editorial by German economist Hans-Werner Sinn in the FT out to us, in which Mr. Sinn – one of the staunchest opponents of stealth bailouts via central bank policy in Europe – takes Germany’s chancellor Angela Merkel to task for not doing anything to stop the latest schemes instituted by the ECB.
Specifically, Sinn points to the many ways in which the ECB has already skirted its statutory limitations, and how this trend continues and is actually getting worse with the most recent monetary policy announcements. An excerpt:
“Despite the Bundesbank’s protests, the European Central Bank is giving Europe’s banks a leg-up. To make them fit enough for the proposed banking union, the ECB proposes to relieve them of some of the potentially toxic loans they have extended to the private sector, which will be bundled into asset-backed securities and taken on to the central bank’s balance sheet. The ECB’s preference is to purchase the better tranches of these securities and leave the junk for the European Investment Bank. But since politicians are not playing along, the ECB will have to hold its nose – and complete its conversion into a bailout agency.
The ECB began as a central bank that carried out monetary policy, providing liquidity for domestic uses. But when the financial crisis hit in 2008, banks in Ireland and southern Europe faced a dearth of foreign loans, on which they had come to depend. The ECB allowed national central banks in these countries to end the drought by lending even more money against ever-weaker collateral. This exercise in money creation went beyond what was needed to ensure domestic liquidity; €1tn in central bank credit was created out of thin air to settle foreign bills. The citizens of the six countries that were indulged in this way used the money to pay off their foreign debts and to purchase foreign goods.
The ECB went on to instruct national central banks to grant crisis-afflicted states credit totaling €223bn under the so-called Securities Markets Program. Mario Draghi, the ECB president, moreover offered unlimited protection for their government bonds, formalizing his vow to do “whatever it takes” to save the euro under the rubric of “outright monetary transactions”. This lowered the interest rates at which overstretched euro zone members could obtain credit and reversed the losses of their foreign creditors, triggering another borrowing binge.”
Sinn then goes on to explain that what is being considered now, is going well beyond even these past interventions. He then chides Ms. Merkel for failing to look after the interests of German citizens as instructed by the rulings of Germany’s constitutional court over recent years, which tended to be of the “yes, but” kind: they allowed all sorts of bailout schemes to go forward, but with certain strings attached.
Contrary to Sinn’s interpretation of these rulings, we do not believe that they constrained the ECB much – rather, by making parliamentary consultations and votes on bailout proposals such as the ESM rescue fund a sine qua non, they increased the propensity of Germany’s government to leave the heavy bailout lifting to the formally independent ECB, as no parliament exercises control over it. In fact, Sinn himself suspects as much when he says:
Slow Uptake of TLTRO Funding
It seems European banks are not all that eager to take up more central bank credit. The ECB has begun to offer its dirigiste “targeted long term refinancing operations” at a spread of 10 basis points above the repo reference rate. Since the repo rate was lowered from 0.15% to 0.05% at the last ECB council meeting in early September, this type of funding has become even cheaper. However, when banks obtain funding by posting collateral with the ECB, this automatically creates additional bank reserves – and those bear a penalty rate of 20 basis points these days. We continue to be mystified by the introduction of the penalty interest rate on bank reserves. We have no idea what it is supposed to achieve and in fact we suspect that it actually achieves the opposite of what the ECB ostensibly wants.
One of the goals is to weaken the euro, which is quite a hare-brained idea, as a weaker euro will affect consumer purchasing power across the euro zone negatively. Note that the euro area just posted another strong increase in its trade surplus. So even those who believe that a positive balance of trade is in any way indicative of an economy’s health (which is nonsense to begin with), will have to admit that the euro zone’s export sector hardly appears to be in need of an extra boost.
As to the TLTRO funding, this is extra-cheap long term bank refinancing tied to certain conditions – banks must use these funds to extend private sector credit (exclusive of mortgages). In the event they use the funds for other purposes like e.g. more carry trades in government debt, they merely need to repay the TLTRO funds two years earlier, in 2016 instead of 2018. Since there is very little private sector credit demand, it should perhaps not be too surprising that the first round elicited very little demand. Reuters reports:
“The European Central Bank saw far less demand than expected on Thursday for its new four-year loans to banks, raising doubts about a stimulus package it hopes will stave off deflation and revive the euro zone economy.
The launch of the scheme, a central plank of the ECB’s efforts to coax reluctant banks to lend, saw the euro zone’s central bank hand out 82.6 billion euros of 400 billion euros ($515.16 billion) on offer to 255 banks. That was well below the 133 billion euros forecast by a Reuters poll of 20 money market traders. Banks will get a second chance on Dec. 11 to apply for the cash, granted at ultra-low interest rates on condition they lend it on to businesses, when the poll predicted take-up of 200 billion euros.
Berenberg Bank chief economist Holger Schmieding called the low demand “a disappointing result for the ECB” that cast doubt on the bank’s hopes of injecting 400 billion euros into the economy through this scheme. “Simply offering more liquidity at more generous terms to banks awash in cash will not make a huge difference to the outlook for growth and inflation,” he said.
But ECB Executive Board member Peter Praet warned against reading too much into the first result, stressing that it was part of a broader policy package that “will have a sizeable impact” on the ECB’s balance sheet. He added that expectations for the first round had always been lower than for the second offering in December.
“Markets have understood that the June and September measures should be seen as a combination aiming at addressing credit impairment,” Praet told Reuters in an interview, adding the measures could only be assessed once fully implemented. Praet also reiterated the ECB’s readiness to do more should it become necessary.
No Surprises in Carbon Copy Statement
If anything, the FOMC statement was probably interpreted by Kremlinologists as less hawkish than expected (although the Fed already leaked that fact via the WSJ’s John Hilsenrath on Tuesday, spurring yet another surge in risk assets). The reduction in QE by a further $10 bn. to a mere $15 bn. per month was widely expected, but the feared “change in language” was conspicuous by its absence – in short, there were no hints as to a change in the envisaged time table for eventual rate hikes.
This provoked two hawkish dissents (actually, to call them “hawkish” is a bit of an exaggeration), by regional presidents Richard Fisher & Charles Plosser, i.e., the usual suspects who were never really on board with the Fed’s unconventional policies anyway. Their beef was precisely with the unchanged guidance on the timing of rate hikes. Readers can compare the changes relative to the July statement with the help of the WSJ’s trusty statement tracker.
Interestingly, a number of markets reacted as though the guidance had been changed – gold was down $12, the dollar index jumped to a new high for the move, treasuries weakened. The stock market is usually the last market to get the memo, and at first rallied with some verve, but gave back much of its gain as the initial euphoria faded – however, it still managed to close in positive territory (after all, nothing bad can possibly happen).
“Conjuring Profits From Sub-Zero Yields”
The above is the title of the recent Bloomberg article that discusses the ECB’s penalty rate on bank excess reserves (which as one analyst recently remarked have become the proverbial “hot potato” now that a 20 bp fine is charged for their possession) and its effects on bond markets. In euro-land, government bond yields have already completely collapsed, partly to almost Japan-like levels – and yet, more capital gains can still be achieved, even with paper sporting negative yields. According to the article:
“David Tan got to help oversee $1.5 trillion at JPMorgan Asset Management by picking winning trades. Now he’s studying how to make money from investments that look sure to lose.
Across much of Europe in the past year, the yield on two-year government debt tumbled from little, to none, and then below zero. That means buyers would walk away with less cash when the securities matured — if they waited that long.
Money managers like Tan are navigating a market where positive returns are still possible on debt with negative yields provided others will pay a higher price before the notes come due. Those opportunities were enhanced last week when the European Central Bank increased the cost for financial institutions to park their money with it. After that, depositors were tempted to take their cash from the ECB and funnel it intogovernment bonds, because the negative yields hurt less than the central bank’s more punitive charge.
“If yields continue deeper and deeper into negative territory, the opportunities for capital gains remain,” Tan, who is head of rates in London for the fund-management unit of the U.S.’s biggest bank. “If your central hypothesis is that yields are going to converge” with the ECB’s charge on deposits then you still see “some potential price appreciation,” he said.
The list of institutions that may choose to lose includes asset managers so large they’re willing to pay for their cash to be held safely as well as banks that want to avoid the higher ECB charges. And it includes many large financial groups like insurers whose rules are too inflexible to give many alternatives. At the top of the heap probably are other central banks.
Central bankers “are a fairly value-insensitive bunch,” Michael Riddell, a London-based fund manager at M&G Group Plc, which oversees the equivalent of about $415 billion, said on Sept. 5. “They have to invest their FX reserves somewhere if they want to buy euro-area assets that have the top credit ratings, then they have no choice.”
ECB Cuts Rates From Nada to Zilch (and Less), Announces QE
In his Jackson Hole speech, Mario Draghi already hinted at further ECB interventions, pointing out that 5 year forward inflation breakevens indicated that long term inflation expectations had fallen below 2% (i.e., 2% CPI rate of change). Consumers would of course see this as a reason to rejoice, but not our vaunted planners. It was already widely expected than an ABS purchase program would eventually be announced, as preparations for this have been underway for several months.
Frankly, we thought that given that the TLTROs are beginning in September, the ECB would likely wait for their impact before announcing additional interventionist steps. As it turned out, they announced so many things at once on Thursday, they actually managed to surprise not only us, but apparently the great majority of market participants.
The announcement included: further rate cuts; with the repo rate now at 5 basis points, which we might as well call zero, this avenue is now rapidly closing. Since all rates were cut, they also increased the bizarre penalty rate on excess reserves to minus 20 basis points. All this measure achieves is that it costs the banks money. It's not going to make them more eager to lend, but it will lead to them cutting the paltry interest they pay to savers even further. So the war on savers is continuing at full blast.
Waiting Until 2158
All over the world stocks are rising. In the US, the S&P 500 rose over the 2,000 mark for the first time in history. The Dow is over 17,000. And if you want to buy a share of online TV network Netflix, Inc. (NASDAQ:NFLX), you will pay $144 for every dollar the company earned over the last 12 months.
The Current Path of ECB Policy
While the ECB keeps talking about what it might possibly do, its actual policy choice is a rather odd mixture, as Sharmila Whelan of Asianomics recently pointed out. On the one hand, it is evident that a policy of internal deflation has been embarked upon in the euro area.
However, on the other hand, this is combined with a policy of “pain avoidance”, which we can see by the frequent reactive ECB decisions to temporarily inject liquidity again with instruments such as its LTROs (and their new bastard child TLTRO) and keeping administered rates at ridiculously low levels, as well as by the continued increase in government debt. As we have previously noted in these pages, to the extent that credit expansion has taken place in the euro area in recent years, it has been focused almost exclusively on the funding of more government spending.
The private sector by contrast continues to slowly deleverage (see our previous article “Euro Area Credit and Money Supply”, which contains a recent update of the most important data points in this context).
Naturally, this combination of policies makes little sense, as it simply serves to prolong the pain of the adjustment. If the ECB and other policymakers in Europe were to let market forces make short shrift of the remaining bubble activities in the euro area, there would be a sharp, but short recession. This would indeed be quite painful, but it would also lay the foundation for a sustainable upswing. However, one would have to be politically prepared to endure the considerable short term pain associated with this approach, and a great many impediments to price and wage adjustments would have to be removed beforehand.
The current period of relative calm is likely to soon give way to a more “interesting” time period again, in the Chinese curse sense. This is so, because money supply growth in the euro area is recently decelerating significantly.
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