All posts by TTMYGH Administrator

The Sweet, Sickly Stench of Success

Corbyn & Trump

Six years ago, hardly anybody outside financial circles had any idea what Quantitative Easing was - hell, many within financial circles had no idea what QE entailed.

The Fed, and the BoE did the heavy lifting in explaining it to Western audiences (Japan had been doing it so long that its citizens were bored of it and paid little attention when iterations 16, 17 and 18 were rolled out in recent years) with then-Chairman of the Federal Reserve, Ben Bernanke, leading the way as only he could:

(Jackson Hole Speech, 2010): The channels through which the Fed’s purchases affect longer-term interest rates and financial conditions more generally have been subject to debate. I see the evidence as most favorable to the view that such purchases work primarily through the so-called portfolio balance channel, which holds that once short- term interest rates have reached zero, the Federal Reserve’s purchases of longer-term securities affect financial conditions by changing the quantity and mix of financial assets held by the public.

Specifically, the Fed’s strategy relies on the presumption that different financial as-sets are not perfect substitutes in investors’ portfolios, so that changes in the net supply of an asset available to investors affect its yield and those of broadly similar assets. Thus, our purchases of Treasury, agency debt, and agency MBS likely both reduced the yields on those securities and also pushed investors into holding other assets with similar characteristics, such as credit risk and duration. For example, some investors who sold MBS to the Fed may have replaced them in their portfolios with longer-term, high-quality corporate bonds, depressing the yields on those assets as well.

Yeah, I know.

Others took a swing at explaining QE in terms more accessible to the layman (and woman):

(The Economist): To carry out QE central banks create money by buying securities, such as government bonds, from banks, with electronic cash that did not exist before. The new money swells the size of bank reserves in the economy by the quantity of assets purchased—hence "quantitative" easing. Like lowering interest rates, QE is supposed to stimulate the economy by encouraging banks to make more loans. The idea is that banks take the new money and buy assets to replace the ones they have sold to the central bank. That raises stock prices and lowers interest rates, which in turn boosts investment.

But the general narrative that the general public was beaten over the head with by central bankers and politicians was, essentially this:

We are going to pull a few levers and create money which is going to solve all the problems we face. Don't worry, there will be no negative effects as a result of this policy. We will be able to maintain full control of everything and, when the time comes, we will gracefully exit the program and go back to the way things used to be just as soon as everything is fixed. In the meantime, carry on with your lives, go out, spend money, borrow more and leave the worrying to us.

The campaign to take a complicated concept and dumb it down sufficiently for a public that really didn't want to have to do the mental gymnastics required to understand its implications had one significant tailwind - complicity on the part of the public. They wanted to be told it was all going to be OK and they were positively inclined towards the idea of 'free' money being printed which would, in turn, lessen their own chances of being directly impacted by the economic downturn which had come so perilously close in 2008.

Those in charge of designing and implementing QE programs knew that it was all too hard for the public to understand and they played that knowledge brilliantly.

Unfortunately for them, they were wildly successful.

The public neither knows nor cares what QE actually is. All they know is that, optically at least, it has worked because a) they are being told it has and b) the stock market is going up.

That's essentially been the extent of the burden of proof.

 

They don't understand this:

BOE Balance Sheet copy

Or this:

But here's where the success in creating the narrative that free money does no harm and has no unintended consequences turns into a potential disaster.

In the UK, left-winger Jeremy Corbyn was a last-minute addition to the leadership ballot for the Labour Party (US readers can think in terms of the Democratic Party nomination) - thrown into the mix to supposedly 'broaden the debate'.

Well he's broadened it alright:

(UK Daily Telegraph): the joke has backfired. Mr Corbyn is now the clear front-runner, and on Thursday the bookies installed him as the favourite.

Oops!

Corbyn's own understanding of economics is on par with that of the average British citizen - which is perfectly fine - however, it's what he's doing with that knowledge that makes him far more dangerous.

Ladies and gentlemen, I give you; People's QE:

(UK Independent): Jeremy Corbyn said that future rounds of the monetary stimulus should be redirected from the financial sector to brick-and-mortar projects.

“I am calling for a people's quantitative easing - and asking my fellow candidates to join me in that call,” he wrote in an article for Huffington Post UK.

“The Bank of England must be given a new mandate to upgrade our economy to invest in new large scale housing, energy, transport and digital projects.

Jeremy Corbyn, MP for Islington North“This would give our economy a huge boost: upgrading our outdated infrastructure and creating over a million skilled jobs and genuine apprenticeships.”

Corbyn has been convinced that QE is a free ride, just like the majority of the electorate and so, of course, he will promise them more of what he knows appeals to them.

And, if they get the chance, they will vote for him. Of course.

(Jeremy Warner): ...It sounds a bit like The X Factor – perhaps we could get Simon Cowell to chair the MPC live on TV and we could all text in to say how much cash we want the Bank of England to print this month. It turns out, however, that the idea is for the Bank to “be given a new mandate to upgrade our economy to invest in new large-scale housing, energy, transport and digital projects”. 

Mark Carney might well feel he has enough to do already, what with controlling interest rates, inflation and regulating the City. But, heck, in a few spare hours on a Friday afternoon, he could just print a couple of hundred extra billion, and use the money to start building publicly-owned housing estates. Yet a few hundred years of history suggest that central banks financing governments directly creates inflation, and another few hundred suggest that state-owned companies don’t usually work well.

Jeremy Warner's warning was stark - its implications terrifying:

(Jeremy Warner): Everything about “Corbyn-omics” is delusional. Unfortunately, that does not mean it does not have an audience. By September, Mr Corbyn might well be leading the Opposition – or at least be shadow chancellor under Mr Burnham.

The success of the narrative created around QE; that it is the mythical 'free lunch' that we all intuitively know can't exist but secretly hope does, has played perfectly to the public and now, having endured for two electoral cycles, the next wave of politicians also believe it will have no consequences and are actually using it when planning the message they feel will endear them to the electorate.

What plays better than free money?

The same phenomenon will be front and center again tonight when the first GOP debate takes place with billionaire reality TV star, Donald Trump front and centre.

Nobody is better equipped to pander to a public who desire impressive promises of handouts which bear little or no scrutiny, as this remarkable excerpt from The Guardian demonstrates:

(UK Guardian): "Asked recently what he would replace Obama’s signature healthcare law with, [Trump] replied: “Something terrific.”

Who wouldn't vote for something terrific?

Here Beginneth The Lesson

There is a salutary lesson being given right now to anybody who invests in Western markets but few are paying attention. If the penny drops, things could get very ugly indeed.

Overnight, the Shanghai Composite Index fell another 8.5% - with the real damage being done in the last hour as sellers, spooked by a Bloomberg story which suggested intervention in Chinese markets may be curtailed at the behest of the IMF (who, somewhat hilariously, feel that the level of intervention from the Chinese government is a little over the top).

Shangai Collapse 2

Was the IMF story the cause of the meltdown? Well, it's hard to see why anybody would think for a second that the Chinese would listen to the IMF about such matters (not even in the face of their desire to be admitted to the SDR), and anyway, it doesn't matter. There doesn't have to be a reason for falls like this one.

This is exactly what I wrote about in my most recent Things That Make You Go Hmmm... 'The Sum of Both Fears' (www.ttmygh.com).

Whatever the reason, the selling overwhelmed the bids of both natural buyers AND the massive interventionist forces of the PBoC and the seemingly myriad regulatory bodies.

75 stocks fell for each one that rose and those hit hardest were the stocks (such as PetroChina) which had been the recipients of state largesse in the form of direct intervention in recent weeks.

Adding to the woes was the release on Friday of Chinese Industrial Profits, which fell 0.3% YoY.

Again, nobody really believes the numbers emanating from the Chinese National Bureau of Statistics, but when markets are rising, cognitive dissonance reigns supreme.

This time, however sentiment being tilted towards fear was all it took to generate the second-largest fall in the history of the Shanghai Composite.

The lesson? Well, Chinese investors' confidence was buoyed by the explicit promises (and actions) of the Chinese State machine who directly bought stocks and, seemingly, put a cast iron bid under the market but when investors' level of nervousness reached a certain point (a point that nobody could have pinpointed in advance), everything changed and even bans on not only those 'evil short sellers' we continually hear about in the West, but selling, period, were not enough to stem the tide.

Nor were threats of arrest for short sellers.

Nor were hundreds of billions of dollars (equivalent) in direct market support.

When Fear took over, the Central Bank was powerless to react.

In the West, there are no explicit official sector stock buying programs in place. There are no threats of arrest against short sellers and there are no bans on outright selling.

Everything..... EVERYTHING..... rests on one ephemeral thing - the market's confidence in the power of Central Banks to ensure a good outcome no mater what.

Anybody paying attention to the lesson should not just be thinking about what might happen when that fragile confidence evaporates, but taking steps to ensure they don't get caught out when it does.

The problem comes in leaving such precautions a day too long...

Ask anybody who was considering selling their Chinese equities last Friday but didn't...

Download Problems – July 23, 2015

Dear subscribers,

Unfortunately, the download links to the PDF files for Things That Make You Go Hmmm... are non-functioning today. I have notified the developers who are working to fix the issue as quickly as possible. In the meantime, letters can still be read inside your browser.

My sincere apologies for this inconvenience. The Gremlins clearly have it in for me.

I will notify you as soon as the issue is fixed.

Many thanks for your patience

Grant

Varoufak off

Greek finance minister Varoufakis in Germany

So, the EU finally got the 'yes' they wanted, only this time it was from Yanis Varoufakis, who resigned yesterday morning after posting the following on his blog (this is how politicians and central bankers communicate with the world these days - immediately - which is perhaps why many of their problems arise):

"Soon after the announcement of the referendum results, I was made aware of a certain preference by some Eurogroup participants, and assorted ‘partners’, for my… ‘absence’ from its meetings; an idea that the Prime Minister judged to be potentially helpful to him in reaching an agreement. For this reason I am leaving the Ministry of Finance today.
"I consider it my duty to help Alexis Tsipras exploit, as he sees fit, the capital that the Greek people granted us through yesterday’s referendum.
"And I shall wear the creditors’ loathing with pride."

You could take that as a sign that a deal is likely going to be done in very short order. The Eurocrats needed SOMETHING to save face and Varoufakis' head was the prize.

However, the reality is that, with the 'Oxi' vote ringing across Europe, the balance of power has shifted enormously towards the Greeks (and not just them, but the Portuguese, the Spaniards and the Italians too). Meanwhile, in Brussels, the Eurocrats' overwhelming desire to punish the Greeks for their temerity in defying them is evident in the tightening of ELA provisions by the ECB overnight.

How dare the Greeks 'act up' like this!

Somewhat fittingly, this blind refusal to accept the shortcomings of the euro project will be its undoing and the foolhardiness of those who seek to protect it at all costs will be the architects of its demise.

In any ordinarily-functioning financial system, Greece's creditors would do the deal which made most sense financially - in this case, a debt restructuring and a BIG haircut on the amount owed to Greece's creditors - BUT, this is the EU.

Instead of being fiscally prudent and saving well over a hundred billion euros of taxpayer money, the Eurocrats are still looking to make an example of Greece (after all, money does grow on trees these days so a hundred billion here or there is no big deal). It makes no difference that the Eurocrats themselves lent Greece money they knew could never be paid back - the EU had to be saved regardless of the future cost.

Europe's leaders' own stupidity has led them into a prison cell of their own construction. Their blind insistence on preserving their precious idea of what 'Europe' was supposed to be was, in fact, nothing more than the protection of a series of legacies and the staunch refusal to consider the possibility that they may just have got a few things wrong when they put the EU together in the first place.

A monetary union without a fiscal union was always going to work until it didn't and the time when it didn't was always going to be the first 'crisis'.

There are a series of very good reasons why Italians, Spaniards and Greeks have historically been charged more to borrow money and a series of equally good reasons why German credit has always been worthy of a far lower risk premium. In these politically correct times, such words can be twisted into carrying all kinds of intention that didn't exist at the time they were said - such is the way of the world - but twisting the words doesn't alter the facts that they represent.

Greece got into the EU by cooking the books to ensure their entry. That is not speculation, but a fact confirmed by Greek officials. THAT was the time when action needed to be taken, but throwing hundreds of billions of euros at the problem instead of facing up to a stark reality which would have meant tough choices about EU membership was symptomatic of the 'extend and pretend' culture that pervades the 'leaders' of the world everywhere you look.

Now the Eurocrats face a stark choice of their own creation:

Make good on their implicit threats and kick Greece out of the euro which means waving auf wiedersehn/adieu/au revoir to a couple of hundred billion euros of taxpayer money OR, buckle, do a deal on something far closer to Greece's terms (and along the guidelines of the IMF's recent 'shock' recommendation - see this week's TTMYGH 'IMF'ed') which will involve huge debt relief but will cost a lot less, knowing full well that the leaders of Podemos in Spain and Five Star in Italy will be licking their lips at the prospect of speaking to their own austerity-ravaged electorates.

The man taking Variufakis' seat is Euclid Tsakalatos the Oxford-educated academic economist who has been described as 'the brains behind Milli Vanilli's talent' 'the brains behind Syria's economic policy'.

Prior to Sunday's referendum, he had this to say about Greece's plight:

"Even if they forgave all the debt and gave us €300bn we would still be in deep trouble"

One way or another, the Eurocrats are eventually going to get everything they deserve.

1-2-3

Remember when we were sitting at 1 having fallen from 2 in what seemed like a few days?

The idea of ever being at 3 in our lifetimes seemed utterly ridiculous.

Hell... suggesting we might make it back to 2 was enough to get anybody branded an idiot.

And yet here we are.

3.

With a bullet.

Actually, not with a bullet, but with an arsenal of central bank ammunition that, had the level of it been suggested when we were wallowing at 1, we'd have, once again, called for the straightjackets.

TARP's $787 billion was deemed such an outrageous amount of money that Congress actually voted it down because they couldn't believe such a sum was either needed or warranted. At least the reaction to that decision was predictable:

Thus was the relationship between the denial of stimulus dollars to markets and the possible (terrifying) adverse reaction to it cemented.

Now, just a mere 6 years after the world was languishing at 1, watching all the wealth that had been created in the surge to 2 evaporate and truly believing that we would never again reach 2, we find ourselves at 3.

The trouble with 3 is that it's an inconceivably long way down to 1 again from there. Hell, I get vertigo just looking at 3 on that chart.

Stepping back and looking at this chart makes you realise (or should do) just how stretched we have become.

Valuations? Stretched

Margin debt levels? S-T-R-E-T-C-H-E-D

Length of time without any major correction? S--T--R--E--T--C--H--E--D...

But most importantly of all, Central Bank credibility? O-V-E-R-S-T-R-E-T-C-H-E-D

There is no recovery (at least not the kind of recovery that the world believed you could buy for $4 TRILLION as it lay at 1), there is no growth (certainly not the kind we believed we saw at 2 - even if it did turn out to be an illusion fuelled largely by credit expansion) and there is no good reason why we should find ourselves at 3.

But there are reasons.

Central bank stimulus, a corporate debt binge, monumental levels of share buybacks, multiple expansion, the intentional removal of coupon interest as a viable means of saving and faith in the omnipotence of central banks just about covers it.

However, that omnipotence is not what it seems (it never is) and in his book, Stress Test, the person who held the office of Treasury Secretary before Jack What's-his-name, Timothy Geithner, laid the reality of central bank omnipotence bare for the world to see. Unfortunately, nobody seems to have been listening:

(via Zerohedge): T]hings deteriorated again dramatically in the summer which ultimately led to him saying in August, these things I would never write, but he off-the-cuff – he was in London at a meeting with a bunch of hedge funds and bankers. He was troubled by how direct they were in Europe, because at that point all the hedge fund community thought that Europe was coming to an end. I remember him telling me [about] this afterwards, he was just, he was alarmed by that and decided to add to his remarks, and off-the-cuff basically made a bunch of statements like ‘we’ll do whatever it takes’. Ridiculous.

Interviewer: This was just impromptu?

Geithner: Totally impromptu…. I went to see Draghi and Draghi at that point, he had no plan. He had made this sort of naked statement of this stuff. But they stumbled into it.

That's how 'calculated' the ECB's actions were (and, doubtless, are) and, based on the statements of recent departees from inside the Federal Reserve, there is a similar level of competence at play there too. The BoJ? Well if they have ANY plan beyond "print it and they will come" then they've yet to articulate it and Mark Carney is (quite rightly) in hiding.

At 1 we longed for 2 and daren't even dream about 3.

At 3, 2 seems like a world away and we barely remember 1.

But, as I wrote in my most recent Things That Make You Go Hmmm..., 'Mercury Rising', the warning cries are coming thick and fast and from an ever-more impressive array of voices. To that list, in the last week alone, we can now add Felix Zulauf and Julian Robertson.

The countdown has begun.

3...2...1