Central Banks


It Can't Be A Bubble!

Articles claiming that the current situation in financial markets does not deserve the epithet “bubble” are a dime a dozen – we come across several every week since at least late 2013. Before continuing, we should point out that there is a big difference between recognition of a bubble and forecasting the timing of its actual bursting. For instance, we were well aware that there was a bubble in the late 1990s, but not only did it still take a good while before it hit its peak (a peak that was then retested in terms of the broader market half a year later), it also expanded considerably further before it did so, and only started collapsing in earnest in late 2000.

It is important to realize in this context that this particular bubble – the one in technology stocks that peaked in early 2000 – is not some sort of “standard measure” for what constitutes a bubble. It was certainly the most extreme stock market bubble in all of history in a major developed market (in terms of valuation expansion in this particular sector) – beating even the Nikkei's famous 1989 blow-out by a huge margin. Again, only if one compares the tech sector's then trailing P/E of more than 300 to the Nikkei's trailing P/E of more than 80 in 1989.

In terms of the broader market's valuation, the bubble peak in 2000 was less than half as spectacular as the Nikkei's, but it was still the top of the greatest valuation expansion ever experienced in the US stock market. We merely want to point out here that it would be wrong to claim that “well, the year 2000 was a bubble, and therefore anything that doesn't look quite as extreme as this one outlier isn't”.

We came across another article of this type recently and want to discuss what we believe the flaws in its arguments are. The article in question is “Bubble paranoia on S&P 500 is a storm in a teacup”, which was posted at Saxo's tradingfloor.com by Mr. Peter Garnry. Note here that we don't want to make an argument about the likely timing of the bubble's bursting or its potential for further expansion (that is a different subject) – we only want to discuss whether a bubble actually exists or not.


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Legal Tender Renders Planning Impossible

There is much confusion over what the legal tender law does. I have read articles, written by people who are otherwise knowledgeable about economics, claiming that legal tender forces merchants to accept dollars under threat of imprisonment. Recently, I wrote a short article for Forbes clarifying how legal tender law works in the US.

Legal tender law has nothing to do with merchants. If you want to sell steak dinners in your restaurant for silver, you may legally have at it. Unfortunately, the tax code discourages your would-be customers as I wrote in another article.

The legal tender law targets the lender. It grants to debtors a right to repay a debt in dollars. In practice, this means that if you lend gold, the debtor gets a free put option at your expense. If the gold price rises, he can repay in dollars. If it falls, of course he will be happy to repay in gold. It’s a rotten deal for the lender.

The relationship between lender and borrower is mutually beneficial, or else it would not exist. The parties are exchanging wealth and income, creating new wealth and new income in the process. The government is displeased by this happy marriage, and busts it up by sticking a gun in the lender’s face. His right to expect his partner to honor a signed agreement is violated.

Because no lender will lend gold under such circumstances, gold is relegated to hoarding and speculation only. This strikes a blow to savers, because the best way to save is to lend and earn interest. Savers are forced to choose betweenhoarding gold, getting no yield, or holding dollars and getting whatever yield crumbs are dropped by the Fed.

If there’s no lending in gold, what takes its place? The Fed force-feeds credit in ever-larger amounts, and at ever-falling interest rates.

The Fed is supposed to make its credit decisions in order to optimize two variables. First, employment shouldn’t be too high or too low. Second, consumer prices shouldn’t rise too quickly or too slowly. The Fed has little ability to predict employment and prices, and even less control over them.


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Equal Opportunity Offender

Let us begin with some criticism from a reader:


“What you said about Janet Yellen is disrespectful to All Women. You said you meant no disrespect, and then you go ahead and say most women her age are baking cookies for their grandchildren and saying she has soft shoulders.

You would not make the same kind of sexist comment about a man holding the position that she does. You should grow up… your comments are so old fashioned and out of touch. If you are going to put someone down because you don’t agree with what they are doing, resorting to sexist commentary as a metaphor only makes you look like the fool.”


Ouch! We thought we headed off this kind of complaint with our frank alert a few weeks ago. Didn’t we warn readers?




Sexist … ageist … religionist … racist … abilityist … intelligencist. We are an equal opportunity offender. We disrespect all groups without favor or distinction. Especially those we like.

Besides, didn’t we advise those with delicate feelings and hypersensitivities to cover their ears and eyes, lest they discover some calumny?

The dear reader says she speaks for “All Women.” We don’t know if she’s polled them all… but wow! We offended half the world’s population in a single paragraph. And without even breaking a sweat.

And we stick by our point: It’s better to bake cookies than to wreck the world’s biggest economy! So, let us divert the conversation, from our personal failings to the coming disaster.


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There Could be Some Bubble Risk Somewhere … Maybe …

Ms. Yellen has inter alia shared her insights about financial markets with the Senate Banking Committee – while wearing her bubbly dress, no less!  According to her, there may be a “risk of bubbles” in leveraged loans and low grade debt – to which we say, it is way too late to worry about whether there “may” be such a risk. That horse has left the barn long ago. We have the biggest bubble in low grade debt ever, and central banks are 100% responsible for it.

Interestingly, she thinks that stocks at the third highest CAPE in all of history are just fine, valuation-wise (CAPE or Shiller P/E at 25,5 currently, approximately at the 92nd percentile of the 1602 data points in this series according to Doug Short). Note here that there are some measures by which stocks are actually valued at the second highest level since the 2000 mania peak (e.g. price/revenues).

Our guess? She is probably consulting the long-discredited “Fed model” when she is trying to divine whether stocks are overvalued. 

Bloomberg reports:


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Europe's Cage is Rattled a Bit

The little disturbance in Portugal's banking landscape hasn't been entirely overcome yet. New management has been installed at Banco Espirito Santo, but the problem is that the bank apparently sits on quite a few dubious assets, and the new management cannot wish them away. BES appears to have sunk a lot of money into former Portuguese colony Angola, and these loans are the subject of growing concern. On Tuesday, the stock of BES collapsed to a new low, but the losses have been recovered in Wednesday's trading session.

In parallel with the still growing worries about BES, Germany's ZEW institute issued its economic confidence indicator, which showed the 7th monthly decline in a row. Wasn't there supposed to be a recovery?

A few excerpts from a Reuters summary:


“European stocks and the euro fell on Tuesday after shares in Portugal's biggest listed bank hit a record low, while a plunge in German economic sentiment pushed up borrowing costs for some peripheral euro zone countries.

Global stock markets have recently been supported by dovish policy measures from major central banks and signs that economies are recovering, though worries persist over the pace of growth in Europe and the health of the region's banks.


The banking sector was a sharp underperformer, with Portugal's Banco Espirito Santo  slumping 17.5 percent to a fresh record low. Traders blamed concerns over the bank's Angolan loan portfolio and the sale of a stake at a low price by the bank's founding family on Monday.


"The key takeaway is that the banking sector globally continues to struggle despite time having been bought, and policy being tremendously supportive," said Jeremy Batstone-Carr, head of private client research at Charles Stanley.

"The sector feels like a minefield."


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Critical Lessons

When we left off yesterday, we were explaining how the feds had unlearned the three critical lessons of more than 2,000 years of market history:


1) Make sure the money is backed by gold (otherwise it loses its buying power).
2) Don’t let the government spend too much money it doesn’t have (otherwise it will cause havoc).
3) Don’t try to centrally plan an economy… especially not with fixed prices (or you’ll soon have a wealth-destroying mess on your hands).





The US took gold out of the global monetary system through two closely related measures: the first, taken by President Johnson, in 1968, when he removed the requirement of the dollar to be backed by physical gold; the second, taken by President Nixon, in 1971, when he ended the direct convertibility of the dollar to gold.


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Mr. Draghi Regrets His Inability to Debase the Currency

Mario Draghi has managed to talk the bonds of completely insolvent governments up, merely by making vague promises of doing something that sounded somewhat dodgy, even illegal. Since he never actually had to keep his promise, this must surely count as an astonishing feat in central banking history.

Convinced of his power to move markets by mere utterances, he is lately engaging in what superficially appears to be a far easier task for a central banker,  namely trying to talk down the currency the bank is issuing. Given that there is no theoretical limit to how much of its confetti a central bank can create, this should be a piece of cake. In a way this is however really a head-scratcher. Hasn't said currency only just recently come out of intensive care? We still happen to remember news magazine covers like these:


100507 NewsweekEuropeanEditionNewsweek times an interim low in the euro …


Newsweek-juny_ARAIMA20120614_0059_1And another one …


end-of-euro-economistThe Economist didn't want to be left out (perfect timing here as well)


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Nothing to Fear?


Everybody knows you never go full retard.

Kirk Lazarus, Tropic Thunder


sbSouthern Bourbon Punch

(Photo © FlickrLickr / wikipedia)


It looked as though US stocks were about to correct last week. But the market steadied on Friday. Calm, complacency, confidence – almost every measure (save for valuations) tells us we have nothing to worry about.

Still, since we have nothing to worry about, we will worry about nothing. Or as Churchill might say, if we have nothing more to fear than fear itself… surely, we’re missing something.

But let us move on by turning our heads around and looking at the road that led us here. We have been greatly aided by reading David Stockman’s book The Great Deformation as well as his blog, Contra Corner.

Stockman had a big advantage. He was at the heart of the federal government, as Ronald Reagan’s first budget director, serving from 1981 until 1985. Then he was in the belly of the beast on Wall Street, as one of the original partners at private-equity firm The Blackstone Group.

In government and in finance Stockman was on the inside when the major decisions and developments of the past 40 years occurred.


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Pitfalls of the “Exit Strategy”

This is simply too funny. Here are a few excerpts from a recent Reuters article on the planned “normalization” of monetary policy (which will likely never happen, and if it against all expectations actually does happen will be reversed again at warp speed…):


“Federal Reserve officials are cautiously nearing completion of a new plan for managing interest rates, concerned that some of the new tools they are likely to rely on could pose unintended risks in a crisis.

The central bank has devoted extensive debate to the matter over the past two months and officials "have made a lot of progress" on a strategy to return monetary policy to a more normal footing after years of coping with crisis, Chicago Federal Reserve Bank President Charles Evans said on the sidelines of an economic conference here.

However, the sheer magnitude of the amounts of money used to combat the crisis – $2.6 trillion sitting at the Fed as bank reserves and $4.2 trillion held by the Fed in various securities – may complicate the U.S. central bank's ability to control its target interest rate once the decision is made that it should be raised. A decision to begin increasing interest rates is expected in the middle of next year.

In recent weeks, the Fed has neared consensus that its workhorse tool will be the interest it pays banks on excess reserves on deposit at the Fed – giving the central bank a direct way to encourage banks to either take money out of circulation and leave it at the Fed, or lend it elsewhere.

Another tool would have a similar impact but apply more broadly, using overnight repurchase agreements that would let money market funds and other institutions as well as banks essentially make short-term deposits at the Fed.

The worry is that if financial conditions tighten, those large funds of money would flee to the repo facility as a safe haven, depriving the economy of credit and making a potential crisis even worse.

Still, the repo tool, which is being tested by the New York Fed, is expected to form part of the new exit strategy, although it is likely to be in what Lockhart described as a "supporting role." The minutes from the Fed's June meeting said that restrictions could be placed on the use of the repo tool to limit the potential risks.


(emphasis added)

Who writes this stuff? This sentence is simply complete nonsense: “…giving the central bank a direct way to encourage banks to either take money out of circulation and leave it at the Fed, or lend it elsewhere.”

Bank reserves have nothing to do with money being 'taken out of circulation' and certainly cannot be 'lent elsewhere'. There are only two (count 'em) things that can be done with bank reserves besides leaving them parked at the Fed: they can be lent to other banks that are short of reserves (not many of those around after years of 'QE'), or they can be transformed into cash currency when customers withdraw cash from demand deposits. And that's it. No 'lending elsewhere'.

Bank reserves can be used as the basis for pyramiding credit – money the commercial banks literally create from thin air. It is only in that sense that raising the interest rate on excess reserves can potentially put a brake on new credit creation, by making it comparatively less attractive to take the risk of extending credit and by undermining interbank lending of reserves.


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Risk? What Risk?

Fed chair Janet Yellen recently uttered what sounded to us like a stunningly clueless assessment of the potential danger the echo bubble represents. She indicated on the occasion that she was certainly in no hurry to raise the administered interest rate from its current near-zero level.


“I do not presently see a need for monetary policy to deviate from a primary focus on attaining price stability and maximum employment, in order to address financial stability concerns,” said Ms Yellen.

“That said, I do see pockets of increased risk-taking across the financial system, and an acceleration or broadening of these concerns could necessitate a more robust macro-prudential approach.”


“Because a resilient financial system can withstand unexpected developments, identification of bubbles is less critical,” said Ms Yellen.


(emphasis added)

Of course no Fed chair of recent memory has displayed even the slightest ability to recognize bubbles or to realize that they might pose a danger.

As to the remark about the “resilient financial system”, this is surely a joke. Does anyone remember how Fed officials and politicians (such as then treasury secretary Hank Paulson) were going on and on about the supposed ruddy health of the US banking system in 2007? Never had they seen the system in better shape than in 2007! By late 2008 it was close to complete collapse, but as they say, errare humanum est.

Don't get us wrong: we are not trying to dispense advice as to what the Fed should do. We would welcome its dissolution and the replacement of central monetary planning with free banking and a free market in money, but that's about it. We have no intention of recommending a “better plan”, given that we think there should be no plan at all (there are certainly different degrees of competence even among central planners, but that is beside the point; as previously noted, they are faced with an impossible task). We also certainly don't think that monetary policy should be turned over to politicians. That would be the one thing even worse than having a central bank.

We only want to point out that the capacity of monetary bureaucrats to learn anything from the events of recent years is at almost precisely the same level as the Federal Funds rate: namely zero.

We leave you with one more comment by the Chair (put the coffee down):


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A Get-Together of Central Planners

Christine Lagarde, the well-baked looking leader of the IMF, was recently dragged away from her ultraviolet light arrays to put in an appearance at an event by the name of the “Michel Camdessus Central Banking Lecture”. No kidding, that's what that pow-wow is actually called.

It may be remembered that Michel Camdessus was the longest-serving IMF chief, after a stint at the Bank of France. A quintessential statist establishment globalist/central planner, who would certainly not have looked out of place as the head of GOSPLAN either. He received his postgraduate degrees in economics at  the Institut d'Etudes Politiques de Paris (Sciences Po) in Paris and more importantly, the traditional breeding ground of French bureaucrats and politicians, the  École nationale d'administration. He presided inter alia over the Asian crisis, and we wouldn't be overly surprised if his name has become a swear word in places like Indonesia.

The people getting together at such meetings likely number among the biggest obstacles to sustainable economic growth in the modern age. They would undoubtedly disagree vehemently with this assessment, but the reality of the matter is that their usefulness is indeed not far removed from that of Soviet commissars. They may be intelligent and well educated, but they are tasked with doing what is literally impossible. Leaving aside for the moment that every single major central bank was founded to promote special interests, the modern-day justification of central banking has been thoroughly refuted a long time ago already.

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Feeling the Pain


Infidi maris insidis virisque dolumque
ut vitare velint, neve ullo tempore credant
subdola cum ridet placidi pellacia ponti.


(Never trust her at any time, when the calm sea shows her false alluring smile.)

– Lucretius, “De Rerum Natura”




We hardly know where to begin. There are so many people to laugh at … and so little time. We can’t laugh at them all. So, we’ll have to take our best laugh. And that must be a laugh at Janet Yellen.



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Macroprudential Mumbo-Jumbo

It is a well known "fact" that if you are in a foreign country and you cannot speak the language of the land, just speak slower and louder.  Somehow the locals will understand you.

In economic terms, when you have no understanding as to what the economy is doing, just resort to big words and obscure concepts.  Yellen just offered a demonstration in her recent speech on Monetary Policy and Financial Stability.

It was with effort that I forced myself to read that random assembly of words and in the end, I really have no idea what Yellen meant when she said:


Today I will focus on a key question spurred by this debate: How should monetary and other policymakers balance macroprudential approaches and monetary policy in the pursuit of financial stability?


Yellen is still living in the dream world of academia.  Look at the footnotes of the speech.  Take a theory here, take a theory there, take some big words from other papers and voilà, out comes the new and improved Fed policy.  What on earth is this "balance macroprudential approach"?  Is that some proven monetary policy that is equal or better than QE?


Open meeting of the Board of Governors of the Federal Reserve System.

Ms. Yellen wearing a macro-prudential frown.

(Photo via EFE)


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The Bold and the Dumb

What’s happening in Japan? We ask because, in the race to financial catastrophe, Japan is ahead of us. And this week in the Financial Times Japanese prime minister Shinzo Abe gave us an update.

You may recall, dear reader, that Abe came into office on a reform ticket. He had three arrows, he said. One for fiscal policy. One for monetary policy. One for other things that were never clearly identified but nevertheless needed to be killed.


800px-Bank_of_Japan_Head_Office2Chuo-cityTokyoJapanThe BoJ's charming head office in Tokyo

(Photo source: Wikimedia Commons / Author: Katorisi)


As bold as he is dumb, Abe has let his arrows fly. Among his achievements so far, he claims his monetary arrow hit its mark. Deflation is gone from Japan, he says. Now, prices are rising. For the first time since 1997, the inflation reading – at 1.4% in April – is positive.

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EU Approves Emergency Liquidity Injection

Over the past week, there has been a run on two of Bulgaria's biggest banks – late last week, the central bank ordered one of them closed, since it could not possibly pay all the deposits that were supposedly available “on demand” -  as is always the case in fractionally reserved banking systems. On Monday the situation calmed down somewhat after the EU approved an emergency liquidity injection of 1.7 bn. Euro:


“Bulgaria’s banking system appeared to be stabilizing late on Monday after the EU approved a Lev3.3bn (€1.7bn) emergency credit line from the central bank, following runs on two of the country’s biggest lenders in a week.

The liquidity move followed assurances from political leaders over the weekend  that Bulgarians’ savings were safe and the banking system was stable and well capitalized, in spite of a speculative attack involving anonymous text messages and emails.


Yes, well capitalized, but not well enough to actually withstand a bank run without emergency aid and a “bank holiday”. The story of how the run started is certainly a strange one:


The Bulgarian National Bank had warned on Friday of an “attempt to destabilize the state through an organized attack against Bulgarian banks”, as Bulgarians withdrew Lev 800m from branches of First Investment Bank, the country’s third-biggest lender.

Those withdrawals came just days after a run on Corporate Commercial Bank, the country’s fourth largest bank. Six people were arrested over the weekend, accused of sending electronic warnings that FIB was about to collapse; two were indicted on Monday for spreading false information on banks.

Rosen Plevneliev, Bulgaria’s president, also announced late on Sunday that after talks with party leaders he would dissolve parliament by July 25 and then name a caretaker administration, ahead of early elections called for October 5. That move helped ease political uncertainty that had fueled the crisis.

Bank shares recovered sharply on Monday after news of the central bank credit line. The European Commission also noted that the country’s bank sector was “well capitalized and has high levels of liquidity compared to its peers in other member states”.

“The situation has stabilised over the course of the day,” said Alex Bebov, managing director at Balkan Advisory Company, a Sofia-based brokerage.

“This was a very different style of banking crisis than, for example, in Slovenia, where you had a lot of fundamentals. Here it was much more an issue of cyber attacks, via SMS [text messages] and the internet.”


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