Central Banks

     

 

 

Another Early Warning Siren Goes Off

Our friend Jonathan Tepper of research house Variant Perception (check out their blog to see some of their excellent work) recently pointed out to us that the volume of mergers and acquisitions has increased rather noticeably lately. Some color on this was provided in an article published by Reuters in late May, “Global M&A hits record $2 trillion in the year to date”, which inter alia contained the following chart illustrating the situation. This snapshot was taken shortly after a particularly busy “Merger Monday” in May, which saw $28 billion in takeover announcements:

 

Getting frisky: captains of industry and private equity funds evidently feel supremely confident again and have embarked on a major shopping spree. This mainly goes to show that no-one ever learns a thing in financial markets (presumably this goes for “learning from history” generally, but the remarkable thing in this case are the small time intervals between the markets teaching lessons and the subsequent collective forgetting exercise). The people responsible for all this breathless activity get paid more than at any other time in history, both in nominal and real terms – and one of their major characteristics is apparently that they have the attention span of gnats.

 

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Redefined Terms and Absurd Targets

At one time, the Federal Reserve’s sole mandate was to maintain stable prices and to “fight inflation.”  To the Fed, the financial press, and most everyone else “inflation” means rising prices instead of its original and true definition as an increase in the money supply.  Rising prices are a consequence – a very painful consequence – of money printing.

 

Fed Chair Jerome Powell apparently does not see the pernicious effects of inflation (at least he seems to be looking around… [PT])

Photo credit: Andrew Harrer / Bloomberg

 

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Junk Bond Spread Breakout

The famous dead parrot is coming back to life… in an unexpected place. With its QE operations, which included inter alia corporate bonds, the ECB has managed to suppress credit spreads in Europe to truly ludicrous levels. From there, the effect propagated through arbitrage to other developed markets. And yes, this does “support the economy” – mainly by triggering an avalanche of capital malinvestment and creating the associated boom conditions, while “investors” (we use the term loosely) pile into ridiculously overvalued bonds that will eventually saddle them with eye-watering losses.

 

The famous dead parrot

 

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Tightening Credit Markets

Daylight extends a little further into the evening with each passing day.  Moods ease.  Contentment rises.  These are some of the many delights the northern hemisphere has to offer this time of year. As summer approaches, and dispositions loosen, something less amiable is happening.  Credit markets are tightening.  The yield on the 10-Year Treasury note has exceeded 3.12 percent.

 

A change in pace: yields are actually going somewhere. There is a fly in the ointment for treasury bears though: the net speculative short position in futures across the yield curve is seemingly establishing new record highs every week. While this is not bullish for treasuries per se, it definitely makes yields vulnerable to a sharp pullback. The question is what might cause such a pullback. Our guess would be that either “unexpected economic weakness” will enter the scene, or crisis conditions in emerging markets will worsen and eventually spark “flight to safety” behavior. [PT]

 

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Effects of Monetary Pumping on the Real World

As long time readers know, we are looking at the economy through the lens of Austrian capital and monetary theory (see here for a backgrounder on capital theory and the production structure). In a nutshell: Monetary pumping falsifies interest rate signals by pushing gross market rates below the rate that reflects society-wide time preferences; this distorts relative prices in the economy and sets a boom into motion – which is characterized by widespread malinvestment of scarce capital and over-consumption; eventually, the distorted capital structure proves unsustainable – interest rates begin to rise, and boom turns to bust. Many businessmen belatedly realize that the accounting profits of the boom were an illusion – in reality, capital was consumed. Many as yet unfinished investment projects have to be abandoned, as they either turn out to be unprofitable at higher rates and/or the resources needed to complete them are lacking.

 

When capital runs short: several of countless housing developments in Spain which had to be abandoned when the bust of 2007-2009 started. The image on the right hand side shows a Spanish construction machinery graveyard in 2010. Money supply growth in the US and the euro area exploded after the turn of the millennium, as central banks pumped heavily to combat the demise of the tech boom. In the process they egged on an even more dangerous bubble in real estate. In their great wisdom they have now replaced the expired real estate boom with an even larger, more comprehensive bubble in everything.

 

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Good Intentions

One of the unspoken delights in life is the rich satisfaction that comes with bearing witness to the spectacular failure of an offensive and unjust system. This week served up a lavish plate of delicious appetizers with both a style and refinement that’s ordinarily reserved for a competitive speed eating contest. What a remarkable time to be alive.

 

It seemed a good idea at first… [PT]

 

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Seeing Things for What They Are

Picture, if you will, a group of slaves owned by a cruel man. Most of them are content, but one says to the others, “I will defy the Master”. While his statement would superficially appear to yearn towards freedom, it does not. It betrays that this slave, just like the others, thinks of the man who beats them as their “Master” (note the capital M). This slave does not seek freedom, but merely a small gesture of disloyalty. Of course, he will not get his liberty (but maybe a beating).

 

Hayek’s Road to Serfdom illustrated (via www.fee.org). An arrant conceit that remains fashionable in the face of veritable mountains of theoretical and empirical evidence arrayed against it, is the idea that benevolent philosopher-kings can somehow improve humanity’s well-being by centrally planning the economy, or at least important aspects of it. The notion is based on a fundamental error: It is held that social sciences are no different from natural sciences, that the actions of thinking and purposefully acting human beings can be expressed and foreseen by mathematical equations and should be steered in “desirable” directions by experts; that theoretical models which have their uses in explaining economic laws should somehow serve as templates for the planning of an “ideal” real world economy. Since money is the sine qua non of a modern, rational economy – without it, economic calculation and the division of labor would not be possible – it is of considerable importance that money has been handed over completely to a central planning bureaucracy. Keeping the state’s management of money one step removed from the political class by ostensibly “independent” central banking may well be preferable to giving politicians completely free rein in the coin-clipping business, but that doesn’t change the fact that central economic planning remains literally impossible. The benevolence, the intelligence and education of the planners, what information they have at their disposal – none of it matters one whit. Whatever they try, the outcome will always be inferior to that an unhampered free market would have produced. But no matter how many socialist economies collapse for everyone to see, central planning continues to be pursued with great vigor. Note that the downfall of command economies lately often seems to be driven by monetary chaos, which is a rather strong hint.  The most recent examples were Zimbabwe and Venezuela, which went down in hyperinflation conflagrations.  Argentina escaped a similar fate by a mere hair – its socialist leaders allowed the population to vote them out of office, so the country’s citizens got lucky. Why are nominally capitalist free market countries not ditching such failing strategies? To answer this, just ponder how many people in positions of substantial social prestige, influence and power would have to look for real jobs (i.e., would be forced to make a living by offering something people want to pay for voluntarily in the market); how many people depending on their favors would have to do the same; and the extent to which social and economic power in society would therefore shift. The existence of the excessively powerful and overbearing welfare-warfare State of today is predicated on the economic system that is in place now: one that still allows the generation of a sizable amount of real wealth, but at the same time has the capacity to create money from thin air in theoretically unlimited amounts, which inter alia allows it to amass enormous mountains of debt. However, this arrangement is not workable forever. The fiat money system continually fosters capital consumption and leads to a creeping breakdown in both morals and morale in society. There is an unknown threshold that will prove to be a tipping point when crossed. There is much to suggest that we are currently in a period of transition close to this tipping point. Both negative and positive outcomes remain possible. [PT]

 

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Son of the Imperial City

What are the chances of Federal Reserve Chairman Jerome Powell being wrong?  The chances he’ll be wrong on the economy’s growth prospects, the direction of the federal funds rate, and inflation itself?  Our guess is his chances of being wrong are quite high.

 

The new central planner-in-chief. Central banks are facing a special case of the socialist calculation problem pertaining to the financial system. Like the comrades in the former Eastern Bloc, who tried to adjust their plans based on prices they were able to observe in the capitalist West, their best bet is to simply follow market rates. Unfortunately market rates – especially at the short end of the yield curve – are subject to an observer-participant feedback loop with the Fed, so the dilemma cannot be entirely avoided. The   ritual pouring over reams of “data” may feel like a sensible activity, but ultimately it cannot solve the problem either. [PT]

 

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Fake Responses 

One month ago we asked: What kind of stock market purge is this?  Over the last 30 days the stock market’s offered plenty of fake responses.  Yet we’re still waiting for a clear answer.

 

As the party continues, the dance moves of the revelers are becoming ever more ominous. Are they still right in the head? Perhaps a little trepanation is called for to relieve those brain tensions a bit?  [PT]

 

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A Finite Life Span

We have been promising to get back to the topic of capital destruction, which we put on hiatus for the last several weeks to make our case that the interest rate remains in a falling trend. Today, we have a different way of looking at capital destruction.

 

A Soviet propaganda poster extolling the virtues of the plan… a succession of such plans ultimately ended in economic collapse – eventually, not even basic staples could be supplied to the population anymore. It was easily the biggest bankruptcy in history.  [PT]

 

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Ridiculous Minutia

Jerome Powell, the new Chairman of the Federal Reserve, just completed his third week on the job.  He’s hardly had enough time to learn how to operate the office coffee maker, let alone the all-in-one printer.  He still doesn’t know what roach coach menu items induce a heinous gut bomb.

 


The perpetually slightly worried looking new Fed chairman Jerome Powell, here seen warily inspecting the Rose Garden at the White House. Everybody wants to know if he has a “better plan” – but there is no better plan, thus no-one has one. [PT]

Photo credit: A. Brandon / AP

 

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Contradictory Palaver

The recent hullabaloo among President Trump’s top monetary officials about the Administration’s “dollar policy” is just the start of what will likely be the first of many contradictory pronouncements and reversals which will take place in the coming months and years as the world’s reserve currency continues to be compromised.  So far, the Greenback has had its worst start since 1987, the year of a major stock market reset.

 

A modern-day reenactment of the famous “our currency, your problem” play that went over so extremely well in the 1970s… [PT]

 

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