Age of Wisdom, Age of Foolishness (40)
“Optimism: the Audacity of Hope.”
As President Obama’s political odyssey draws to a close, which is being hastened by those who wish to impeach and/or to sue him, it is time to start thinking about legacies.
“Optimisim… It is the obstinacy of maintaining that everything is best when it is worst.” (Candide)
His presidency started with a note of Panglossian optimism and a Nobel Prize. It was hoped that he would heal the international wounds created by eight years of Bush and war. After healing these wounds, it was also hoped that he would be able to work with trade partners to rebalance the global economy; and create a new age of prosperity based on the principles of globalization. His journey then “pivoted” to the East as a strategic reset with China was attempted; and the chapter in the book on the Middle East was simultaneously closed with the execution of “OBL”. Recently however, the story has degenerated into a pessimistic discord, worthy of Martin the Manichean, in the lands of former conflicts. In Age of Wisdom, Age of Foolishness (26) “Milking It for all It’s Worth”[i] it was noted that “Team America” had “struck out”, in terms of foreign policy.
“It is the best of times, it will be the worst of times in 2060.”
Policy Challenges for the Next 50 Years
Age of Wisdom, Age of Foolishness (36) – “By the Rivers of Babylon”
The OECD has recently tried to publish its own version of Obama’s legacy, as the wheels and momentum fall off his bandwagon; which was noted in Age of Wisdom, Age of Foolishness (36) “By the Rivers of Babylon”[ii] in the OECD’s report entitled “Policy Changes for the Next Fifty Years”[iii]. This document evinced the kind of optimistic global cooperation; which Obama has tried (and failed) to achieve during his presidency. In this Panglossian vision, the developing nations would grow and rebalance the global economy, in order to maintain the elevated position of the developed nations.
“We are at the end of all our troubles, and at the beginning of happiness.” (Candide)
Age of Wisdom, Age of Foolishness (38) “Rosebud”
The BRIC nations have recently started to write a conflicting version of this story; in which they create an alternative Panglossian Utopia of their own[iv], which is decoupled from the US Dollar (and Euro) hegemony and its global institutional architecture. The developed nations have therefore regrouped, around these existing pillars of the global economy which they have erected, in order to challenge this alternative BRIC vision. The institutions, which make up this existing developed nation status quo, are now being used to undermine the new BRIC challenge.
“We cannot all see dreams in the same way.”(Paulo Coelho)
The current Brazilian policy makers are now in direct conflict with the IMF over the exchange rate. The IMF advocates a weaker Brazilian currency[v]; whilst the current policy makers are intervening to support a stronger one. It is interesting to note that the official Brazilian opposition has taken the side of the IMF[vi]. Regime change in Brazil is clearly on the agenda therefore, as far as the IMF is concerned.
China is also skirmishing with the IMF over economic policy. The IMF advocates[vii] a much lower growth rate stimulus; which is not predicated on further debt creation. China directly rejects this; and is in fact using the cover story, of opening up its capital markets to international capital flows, to disguise the switch of risk from domestic shadow banking to credulous international investors. When the next Chinese debt bubble bursts, it will be international investors who suffer the losses; if the Chinese stealth transfer of risk is successful.
The BIS joined in on the side of the IMF last week[viii]; when it warned that this transfer of risk to global investors has now become an unsustainable global systemic risk. In addition to opening up the capital markets to foreign credit, the PBOC is also qualitatively easing to stimulate the economy; and to create the apparent conditions of economic growth which will attract more foreign capital. The recent PBOC loan to the Chinese Development Bank[ix] was of the equivalent size of the $162 Billion AIG bailout. The rate of interest on this loan effectively lowers the borrowing costs for this state development bank; which will allow it to stimulate the housing sector and create the impression of sustained economic growth that may then attract even more credulous foreign investors to China. The PBOC is in fact taking a leaf out of the book on central banking written by Jeremy Stein. Whilst avoiding a general quantitative easing[x] across the whole economy, the PBOC is selectively “qualitatively easing” in the sectors it favours for economic stimulus. The June Services PMI[xi] suggested that the weakening property sector is becoming a significant risk. The HSBC Markit services PMI for July[xii] fell back to the borderline expansion-contraction level of 50. The PBOC has therefore qualitatively eased in the property sector to address this risk. The immediate knock-on effect has been a return to bubble conditions. Developers are already holding back inventory to inflate prices[xiii]; leading to a dangerous oversupply glut build-up.
Slightly more worrying was the leaked military intelligence; which reported that China now has an ICBM which can deliver nuclear warheads to all Western nations[xiv]. A nuclear power without the ability to deliver is not a superpower; China can now deliver. Whether this news is just a bluff or not is a matter of debate. Military planners in the West must however behave as though the threat is real. President Obama’s Nobel Prize for nuclear disarmament now seems a little premature with hindsight.
China is at risk of being pulled into the amorphous global war with Islamic fundamentalists, by nature of its Uighur population.
“The Man in the Silk Pyjamas.”
China’s “final solution”, to this ethnic problem, is likely to open it up to the kind of global criticism that was reserved for Nazi Germany. It is reported that China’s “final solution” involves eugenics[xv]. At this point in time, the Uighurs have become Eurasia’s Palestinians. The blowback from this turning point in history will be felt globally in due course.
“It is better to live your own destiny imperfectly than to live an imitation of somebody else's life with perfection.”
( Anonymous, The Bhagavad Gita)
India has just scuttled the WTO; by reneging on the deal struck at Bali[xvi], which would have prevented it from shielding its agricultural sector behind subsidies. Once the issue of subsidies is reinvigorated, all developing nations can be expected to return to a system which allowed them to shield their economies from competition. RBI Governor Rajan[xvii] is already blaming the developed nations’ central banks for the next crisis to afflict Asia. By doing this he hopes to spare the policy makers from the adverse political backlash from their own populations; which will derail the BRICS new agenda and throw the developing nations back into the grip of the IMF and World Bank.
The conflict between Russia and the NATO countries, over Crimea and Ukraine, is well documented.
“I have conquered an empire but I have not been able to conquer myself.”(Peter the Great)
A web of lies
America has already called a foul on Russia’s failure to comply with a historic nuclear missile treaty[xviii]. Russia has now just been joined by China as a new strategic missile threat. Most recently, the institution of G7 has been added to the sanctions platform against Russia; in the latest initiative to block the World Bank from funding further projects[xix]. Russia responded in kind, in a barter agreement with Iran[xx], which effectively undermines sanctions on both nations; whilst maintaining Russian influence in the Middle East conflict zone. This was then followed up by the reciprocal ban on food imports from the US and the EU[xxi]. Russia is now in state of Trade War with these two allies.
“Expanding Conflict Zone.
Age of Wisdom, Age of Foolishness (18) “Beyond the Pale”
The Central European conflict zone has now expanded from the Black Sea to the Baltic; as Poland joins the chorus of central European countries calling for NATO protection against Russian invasion[xxii].
It is now clear why Russia swiftly embraced the alternative World Bank and IMF envisioned by the BRICS at the recent Fortaleza Summit. President Putin’s assessment[xxiii] of the robustness of the financial reserves of the new BRICS Bank was quoted thus:
“This mechanism creates the foundation for an effective protection of our national economies from a crisis in financial markets".
The currently unfolding crisis may give him cause to revisit this assessment. The Contingent Reserve Agreement (CRA) , which is the equivalent of an IMF crisis borrowing line, of the new BRICS Bank allows China, without being on an IMF program, to borrow up to $6.2 billion; Brazil, Russia, and India $5.4 billion, and South Africa $3 billion.
These CRA figures are way below the current IMF borrowing lines that the BRIC nations have in place; and massively lower than their individual foreign currency reserves . Private capital flows to the BRICS have been large during the inflating of the Credit Bubble which burst in 2008; and have also been boosted since then by quantitative easing from the developed nations. The Fed’s Taper period, earlier this year, caused a reversal of these flows and great instability in the BRIC nation capital accounts. The CRA of the BRIC Bank therefore looks too small to deal with any serious instability going forward. They will be forced to survive on their currency reserves, if and when the crisis comes to test them. If their currency reserves are used up in self-defence, there will then be very little left to use as the capital base for development loans to the emerging alternative trade bloc. To undermine the BRIC Bank and the new alternative trade bloc; the acme of skill is to create an emerging nation debt crisis which triggers a run on their reserves.
All this insubordination, by the leaders of Developing World, resembles the Anti-Imperialist stand taken at the end of World War II. Urbane western politicians and diplomats, talking quietly in the darker corridors of power, can secretly be overheard referring to the BRICS as the collective derogatory acronym for “Wiley Oriental Gentlemen”. To prepare the capital markets, for the developed nation inspired run on the BRICS in order to bring them to heel, Argentina[xxiv] has been presented as the example for those nations who test the occidental financial orthodoxy. If the BRICS have been thinking that they can welch on their debts to the World Bank and IMF, once their new alternative World Bank and IMF are up and running, they have been encouraged to think again.
“But in this country it is necessary, now and then, to put one admiral to death in order to inspire the others to fight.”
The “Buck” for all this insurrection however stops at the White House; at least according to Dick Cheney’s version of the story. America’s critics, from within and abroad, now believe that all this “Multipolarism” has gone too far. A rational observer can conclude with some justification that the geopolitical situation has deteriorated substantially on President Obama’s watch. America appears to have gone soft; and lost its stomach for a fight. President Obama is the epitome of this alleged cowardice and defeatism; or so the story goes. American cowardice has emboldened its would-be challengers to become more aggressive and overt in their threats. The American “Warmongers” are now coming back; to “cultivate the garden” to grow the way it used to; and to take out the poisonous weeds.
The pundits who write tomorrow’s fish and chip wrappers, were initially very slow to understand the significance of the Fortaleza Summit. They have now been brought up to speed; by their contacts embedded with the policy makers in the developed nations’ capitals. Consequently the editorial line in the West is now frightening the polity of readers, with tales of the dialectic challenge between Capitalism and Statism.
Dr Paul Craig Roberts, a man who should know a thing or two about geopolitics since his time as Assistant Treasury Secretary in the Reagan Administration, has read the tea leaves and opined that “War is Coming”[xxv].
His analysis is supported, in a new book by the French Authors Jean-Hervé Lorenzi and Mickaël Berrebi.
Age of Wisdom, Age of Foolishness (37) “The Third Mandate”[xxvi] suggested that “economic warfare is therefore underway”; between the BRICS and the established world economic order dominated by the developed nations. Age of Wisdom, Age of Foolishness (38) “Rosebud” qualified this suggestion with the observation that:
“This fight must however occur in the nations who are undecided over which rival trade bloc to join, in order to help them make up their minds or lose everything for choosing the wrong side.”
“A Sunny Place for Shady Dealings.”
Age of Wisdom, Age of Foolishness (22) “Jeux Sans Frontieres”[xxvii]
With this qualification in mind, it is suggested that the reader goes back and reads Age of Wisdom, Age of Foolishness (22) “Jeux Sans Frontieres”[xxviii] before reading on. Africa was pre-selected as a continent where this fight will occur. It was opined that:
“As in the past, Africa is more likely to be the dark alleyway where the nastier moves of the new chess game are played out.”
With this in mind, it was therefore with great interest that we observed the recent Washington Summit of African nations being hosted by President Obama[xxix]. There was no denying that one of the summit’s sublime themes was the rolling back of Chinese interest in the continent. A more interesting aside was the contemporaneous emerging economic crisis in Ghana[xxx]; which has forced the country’s leaders to call in the IMF to reverse a currency crisis which has spectacularly unfolded. A key theme in Age of Wisdom, Age of Foolishness (22) “Jeux Sans Frontieres”[xxxi] was the observation that American dependence on African Crude had been substituted by domestic Shale. In consequence, it was suggested that “capital will leave Africa, creating a balance of payments crisis”. Ghana was emerging as a Crude Oil producing nation, until it was “substituted” by US Shale. It now has a balance of payments crisis, which has forced it back into the embrace of the IMF. Ghana appears to be the first loser; of the game which was predicted in Age of Wisdom, Age of Foolishness (22) “Jeux Sans Frontieres”[xxxii]. The dominoes will now fall as contagion spreads from the capital markets across the continent. Logic suggests that African oil producing nations are in fact competitors of Russia, just as they are competitors of American Shale. It is therefore hard to see the BRIC trading bloc, which is driven by Russian oil and gas, being of any use to the Africans. Europe clearly offers the solution. The big question is now whether Europe will pay a fair price for its energy, or exploit Africa in the way that it has traditionally done.
Age of Wisdom, Age of Foolishness (28) “The # Numbers Game”[xxxiii]
Age of Wisdom, Age of Foolishness (28) “The # Numbers Game”[xxxiv] developed the theme; to accommodate the spectre of Islamic Fundamentalism threatening Africa and Crude Oil sources by default. Most readers will by now accept some degree of causality in this correlation; which has also been observed in Age of Wisdom, Age of Foolishness (34) “Blowback”[xxxv] in Iraq with the threat of ISIS. Specifically in relation to Africa however, the reader can see quite clearly that American Shale substitution for African Light Crudes has played a key role in the current instability of the continent’s oil producing nations.
Age of Wisdom, Age of Foolishness (29) “Don’t Think F-e-e-e-e-l”[xxxvi]
The African theme was then developed further in Age of Wisdom, Age of Foolishness (29) “Don’t Think F-e-e-e-e-l”[xxxvii]. Safari Club Chairman William Hague, was seen on safari in the African oil producing nations clustered around Nigeria; bolstering their resistance to Boko Haram. Allegedly, Hague has recently left the Cabinet; in David Cameron’s latest attempt to avoid being labelled a misogynist. The label still remains however, after Lady Warsi’s recent resignation over the handling of the Gaza situation. The real label however is the PM’s lack of affinity for colleagues who were “not at School”.
“The greatest adventure a man ever lived...with a woman!”
Hague still remains an American Honorary Secretary of State however; a nebulous office which would still seem to give him the licence to roam far and wide in Anglo-Saxon adventures on the Dark Continent. He will allegedly be standing down as an MP in 2015; so a future career beckons.
His leading lady Angelina Jolie, also likes to play shady characters when she is not saving the planet in real life; so perhaps the two will team up under cover in a future adventure[xxxviii].
“Remember people, be careful out there.”
(Age of Wisdom, Age of Foolishness (30) "Adullamites”)
Mindful of what Montaigne said, about people believing most in what they do not understand, it is very important to remain agnostic in the face of headlines opining the case for war. Mindful also of what Lenin said about “useful idiots”, it is important not to get carried away with the speculators who are now driving up the geopolitical risk premium in capital markets. Wars and bear markets are often the catalysts for change, which policy makers engineer specifically for this purpose. With this in mind, it is helpful to return to Age of Wisdom, Age of Foolishness (30) “Adullamites”[xxxix] and take another look at President Obama’s West Point speech. The President said:
“First, let me repeat a principle I put forward at the outset of my presidency - the United States will use military force, unilaterally if necessary, when our core interests demand it - when our people are threatened; when our livelihood is at stake; or when the security of our allies is in danger”.
We then said:
“Going forward, the use of semantics and definitions of unfolding events on the ground in relation to this “principle” will be applied both by the President and the ‘Warmongers’ to second guess each other. At each stage, there will presumably be an escalation in the level of carnage and atrocity, until an unequivocal definition which can be used to justify unilateral force is reached.”
Age of Wisdom, Age of Foolishness (36) “By the Rivers of Babylon”[xl] explained the unfolding humanitarian disaster in relation to the control of the Tigris and Euphrates rivers. This crisis was overlaid with the footprint of ISIS; and both footprints were overlaid on the oil reserves in Mosul. The latest spike in the geopolitical risk premium has come in response to President Obama’s recent decision to take unilateral airstrike action against ISIS in northern Iraq[xli]. ISIS has allegedly now created the humanitarian crisis threatening the lives of 50,000; children who are living under threat of execution and denial of access to water and food. Presumably the events on the ground have created the “unequivocal definition” which the President has been agonising over until now. It was interesting to note that in his announcement of unilateral action, that he listed the threats to American personnel; therefore consistently linking up current actions with announced intentions and capabilities back at West Point. It is also noteworthy that ISIS has taken control of a dam[xlii] and also seized oil production assets[xliii].
Age of Wisdom, Age of Foolishness (36) “By the Rivers of Babylon”[xliv] also said that:
“Clearly at some stage, in the very near future, the UN must become involved; to resolve an issue which if left to the militias will result in desertification and famine.”
It would seem that this point in “the very near future” has just been reached; as the UN Security Council has recently met[xlv] and called for humanitarian aid to the beleaguered residents of the region. The significance of UN involvement is that it gives the gun-shy Europeans the justification for putting boots on the ground. Having seen the predictions from Age of Wisdom, Age of Foolishness (36) “By the Rivers of Babylon”[xlvi] now occurring, the probability of the prediction of European boots on the ground has just been significantly increased.
No doubt the arrival of European boots on the ground will be greeted with a further increase in the geopolitical risk premium; however in our opinion value is now being created for the contrarian investor. The bigger picture shows that even though it appears that the world is spinning out of control and heading to war; there are some well-defined parameters which are setting limits on how far this can really go.
In relation to China, the Pentagon has a very clear and close communication with its opposite numbers in China. This was recently evinced by the cooperation of the two navies in the South China Sea[xlvii]; which was embellished in the media. The bottom line is that although the politicians may be at war; the two militaries won’t let this get out of control. Both sides have a very clear understanding of the conventions and signals in their relationship, which will prevent the political Cold War from going hot. The politicians can therefore fight over the rival economic solutions and institutions until a compromise is reached. This compromise, fortunately does not have a military option at this point.
In relation to India, Defence Secretary Hagel’s brogues are already on the ground in Delhi. India has recently become an elusive trade partner of America. A recent attempt was made to gain control of greater military technology transfers from America[xlviii]; but this was firmly headed off by US Defence Inc as we saw in Age of Wisdom, Age of Foolishness (38) “Rosebud”. Secretary Hagel is now in India, ostensibly to negotiate arms sales[xlix]. In practice, he will be testing Indian intentions and capabilities to act as a partner with America to counter the position of China. The recent creation of the BRICS trade bloc initiative clearly puts a question mark over Indian intentions and capabilities. Hagel will no doubt be having some frank discussions about India’s position; which will then back out a new relationship between the two countries. Volatility in emerging markets will no doubt also be used to show India the risks of trying to distance itself from the existing global financial architecture which America created.
Dilma Rousseff is already facing regime change in Brazil from an IMF sponsored opponent. The BRICS initiative, announced at Fortaleza, is therefore already being deconstructed by America; through the skilful creation and manipulation of an emerging markets crisis and diplomacy. The interesting take away from all this, is that Russia is set to be the big loser. President Putin is clearly portrayed as the bad guy, even though there are three other BRIC leaders who are his confederates. Putin has already had to sell oil and gas, earmarked for Europe, to China at deeply discounted prices in order to maintain his economy. If America comes to terms with China and India, Putin is out on his own. If he becomes even more aggressive in Ukraine, he will risk becoming isolated even further. If he does not become more aggressive in Ukraine, he risks a revolt from his own hardliners. Putin has therefore reached the end of his current global foray; and needs to consolidate his gains.
The threat from the BRICS is therefore circumscribed by well-defined political and economic boundaries, which the markets have not understood. What is also less understood is that the geopolitical headwinds play right into the hands of the central bankers who wish to permanently boost the temporary money supply known as QE.
There are some green shoots emerging in the “garden”, which seem set to bloom into a new superpower; that was once an old superpower. Age of Wisdom, Age of Foolishness (39) “OECDean’s ’14” observed the emergence of Germany as the leader of the EU sanctions against Russia movement. Germany burnished its medals for this campaign further last week, when it blocked the sale of a combat training centre to Russia[l]. Germany has now taken the initiative and the moral high ground from the French. The French were seen to put money before European solidarity; by allowing the consummation sale of a warship to Russia, even after their Dutch brothers and sisters had ostensibly been killed by the same customer. Germany’s decision to start spying on its allies[li], therefore still has a thin cloak of integrity around it; even though this act of counterespionage now puts Germany on a unilateral course which challenges its allies.
Economically speaking, there is no way that the developed nations can return to the status quo, once enjoyed by the developing nations; which allowed these developing nations to take jobs and capital from indebted developed nation borrowers. The recent chapter of fiscal austerity in the developed world, which has still not fully run its course, is one such example of this brave new world order. The signals are, that sovereign and public sector deficits may be about to rise again; but private sector borrowing by consumers and corporates still shows the signs of deleveraging. Indeed, the increase in public sector deficits will manifest itself as transfers to the most-needy consumers in the private sector.
Freddie Mac recently reported[lii] that, even though the great American mortgage deleveraging may have ended, a new demographic is emerging. This emerging American consumer demographic takes on less debt than in the past; and also pays it down on an accelerated repayment schedule, which is far more aggressive than the amortization sheet that the lender required when the debt was created. In addition, the recent great refinancing was not used to take out home equity to fund consumption; it was done to deleverage. American consumers are therefore becoming what emerging market consumers were traditionally known as being. America’s experience of the Credit Crunch of 2007/08 is similar to that of the subjects of the Asian Debt Crisis of 1997/98. Asia deleveraged; and then parasited off the developed nations after the Asian Debt Crisis. Americans now wish to deleverage; and parasite off the Asians after the Credit Crunch of 2007/08. The Germans have parasited off both parties for the last seventy years; and show no intention of reciprocating by becoming traditionally American in their consumer behaviour. The OECD has encouraged emerging market consumers to be more like traditional Americans; but in reply the BRICS have walked away from the negotiating table. We believe that the dialogue, regarding whose turn it is to leverage up and pull the world economy along, is now being bitterly argued over. In countries on the margins of this bitter debate, the conflict is literally getting violent. When the bitterness and violence threaten to create recessionary conditions again, the Fed and the Bank of England will permanently increase the current temporary money supply known as QE. Until then, things will be volatile and violent; as America “encourages” its trading partners to get with the programme.
Age of Wisdom, Age of Foolishness (37) “The Third Mandate”
Terminal Velocity (14) – “Goldilocks Economy and the Three Bear Markets”
In Age of Wisdom, Age of Foolishness (37) “The Third Mandate” it was suggested that:
‘We have now reached the point, identified in Terminal Velocity (14) – “Goldilocks Economy and the Three Bear Markets”[liii], at which the markets observe that asset prices and global growth are out of sync.’
“Rupert’s Bear Markets.”
Age of Wisdom, Age of Foolishness (38) “Rosebud”
This call was then followed up in Age of Wisdom, Age of Foolishness (38) “Rosebud”; with the observation that Rupert Murdoch had signalled the inflection point at which the correction in equity prices will occur.
Age of Wisdom, Age of Foolishness (39) “OECDean’s 2’14”
Age of Wisdom, Age of Foolishness (39) “OECDean’s ’14” highlighted the catalyst for this correction, provided in the form of the ugly rebound in US Q2/2014 inflation. Heading into Jackson Hole, Janet Yellen is said to be in danger of “crashing and burning” the Helicopter which she hopes to land there.
The markets then chose to narrowly focus on the inflation implied in the June US Employment Cost Index (ECI), as the catalyst for the correction in equities. Cognitive bias precludes the speculators from understanding that this sharp increase in the ECI, comes off the lowest print for the same statistic this year.
This same cognitive bias precludes them from understanding that the rebound in GDP is nothing more than an increase in inflation. The speculators therefore mistake inflation for growth; and then go even further by believing that this increase in inflationary growth is the cause for higher interest rates. The latest ECI number has been framed, as the trigger to bring forward the expected Fed tightening cycle.
“Fools have a habit of believing that everything written by a famous author is admirable. For my part I read only to please myself and like only what suits my taste.” (Candide)
Richard Fisher, clearly a Fed Governor suffering from this same cognitive bias, reinforced this groupthink; by suggesting that the timetable for tightening had been moved forward as a result of the apparent uptick in growth and inflation[liv]. Since he votes on the FOMC this year, speculators are encouraged to take his word as gospel truth. By bringing forward this expectation, through the market discounting mechanism of today, the speculators are actually creating economic headwinds; which will negate the case for the accelerated tightening currently being discounted by them and advocated by Fisher.
“Cognitive Bias Prize Winner.”
The prize for cognitive bias must however go to the Richmond Fed’s Jeffrey Lacker. In his latest speech, Lacker made much of his accurate forecasting track record; in order to give more credibility to his opinion that interest rates will be rising much sooner and faster[lv]. His belief in his own ability as a forecaster is a classic example of the cognitive bias explained by the school of Behavioural Economics. In layman’s vernacular, this is known as “pride before a fall”.
The cognitive bias evinced by Fisher and Lacker sounds dissonant, not-to-say a little unpatriotic, against the beating drums of war in the media; heralding the classic Hegelian dialectic between Capitalism and Statism. Fisher and Lacker will prove to have been on the wrong side of history, when the Western central bankers are tasked with the monetary support of the Capitalist cause.
The sheer panic created in the markets by the early rate hike discounting mechanism, during this year’s Taper period, should have convinced Fisher and Lacker; of the fact that the window for the Fed to exit its expanded balance sheet in actual fact does not exist in practice. The Fed’s balance sheet is the biggest systemic risk for the markets and the economy. The only way to mitigate this risk is to let the assets stay there until they mature. In practice, there has been no real economic growth in H2/2014. Growth collapsed in Q1 and the recovered in Q2 as a function of inflation. Age of Wisdom, Age of Foolishness (26) “Milking It For All It’s Worth”[lvi] explained how companies adapted to the conditions of slow growth by raising prices and creating Stagflation. Margins were raised, headcount was cut and shares were bought back or acquired in competitors. The cut in operating costs and headcount, therefore allows the raising in wages for those who remain in employment; hence the jump in the ECI and all other inflation indicators in Q2. For those who understand the principle of the geometric mean; the economic contraction in Q1 followed by recovery in Q2, actually comes out as a net economic contraction overall. This contraction has been hidden by the accounting trick, of using higher prices and wages to calculate the new Q2 GDP. Asset prices therefore need to fall to a level which reflects this real economic contraction. Once this contraction has been discounted, the markets can then go on to discount the central banks’ reaction to it. The central banks’ reaction however, depends on Janet Yellen saying that, even though there is inflation she intends to ignore it and focus on growth. The rebound in asset prices, to reflect the adoption of inflation accounting, will be the basis of the next multi-year equity bull market.
“Garbage In, Cherries Picked Out.”
Age of Wisdom, Age of Foolishness (39) “OECDean’s ’14”
We suspect that the New York Fed’s discovery of the benefits of the new inflation accounting measure known as the Underlying Inflation Gauge (UIG[lvii]), reported in Age of Wisdom, Age of Foolishness (39) “OECDean’s ’14”, will go a long way to allowing Yellen to discount the alleged inflation threat. This new inflation measure and the increasing geopolitical headwinds spreading from Ukraine and the Middle East, will give Yellen even greater motive and opportunity to ignore inflation threats. Once the new spat, between the developed nations and the BRICS, is factored into the geopolitical mix Yellen has an even greater spectre of Deflation to threaten the Inflation Hawks with. It should also be understood that the current reduced number of Fed Governors, than the full quorum, concentrates more power with Yellen. Jackson Hole will be the next available opportunity for her to scare the markets into accepting the permanent increase in the money supply, which she envisions. As Voltaire noted; “Fools admire everything in an author of reputation.” Yellen must therefore hope that the inflation blip has not damaged her reputation immeasurably, by the time she comes into to land at Jackson Hole; so that she may please herself (and the fools) with opinions which exclusively suit her own cognitive bias.
There was something more than serendipity at work, over the last two weeks, beginning with the last FOMC meeting and ending with the July Employment Situation[lviii] report. The Bears had chosen to read the FOMC announcement as bearish; indicating more Tapering followed by Tightening. Closer scrutiny of the announcement and Yellen’s commentary however, suggested that they were being set up. Age of Wisdom, Age of Foolishness (39)“OCDean’s ’14” analysed the FOMC announcement thus:
‘The latest FOMC announcement, suggests that Yellen has been successful in decoupling the notion of the growth mandate from the unemployment rate[lix]. The FOMC will now use a “range of indicators’; all of which currently suggest that there is still slack in the labour-force despite the unemployment rate suggesting otherwise. The monthly fun and games surrounding the release of Employment Situation report has therefore lost its importance, for all but the shallowest form of momentum traders. Yellen is therefore making good progress towards Stanley Fischer’s “Third Mandate”; which will allow the Fed to cherry pick the data it needs in order to meet an amorphous “Macroprudential Stability” mandate.’
The July Employment Situation[lx] report ticked all the boxes, to suggest that Yellen has effectively shifted the goalposts on tightening. The “range of indicators” chosen all provide ammunition for Yellen; which will allow her to shoot down the dissenters.
She received a further boost from the June Personal Income and Outlays data[lxi], released on the same day; which showed a flat-line rather than the nightmare suggested by the ECI data.
Age of Wisdom, Age of Foolishness (39) “OECDean’s ’14” explained how the commercial banks were creating a self-fulfilling prophecy of economic contraction, in order to boost the value of their US Treasury holdings, by replacing credit exposure with long US Treasury duration exposure. It was also explained that the Fed was complicit in this legerdemain; because these recessionary conditions were required in order for it to permanently increase the money supply without crushing the value of its own expanded balance sheet.
Elizabeth “Patsy” Warren
A convenient Patsy to blame for this monetary conspiracy has emerged in the form of US presidential candidate outsider Elizabeth Warren. In order to advance her own electability, Warren has been on a crusade; fighting the banks on their egregious lack of compliance with the Living Will guidelines established by Dodd-Frank. Her hostile questioning of Janet Yellen and also Jamie Dimon on this matter, indirectly exposed the complicity between what we have termed Too Big to be Allowed to Fail (TBTBATF) banks and the Fed. Yellen has now responded by accepting that the existing Living Wills are inadequate[lxii]. Warren should not however rejoice; because what this means is that the banks will have to tighten capital guidelines and cut back on lending, just as Dimon warned they would. When credit is tightened even further and banks are forced to replace it with even more Treasury duration exposure, to comply with Warren’s edict, this should give the economy another headwind it can least afford to deal with in these geopolitically challenged times. Well placed leaks in the media will soon put the blame for the economic contraction on the shoulders of tighter Living Will legislation; and firmly on the head of Elizabeth Warren. Wall Street and the Fed will then have the excuse needed to loosen monetary policy further and push back against tighter Living Will restrictions respectively.
“It’s a game of two halves.”
The upcoming debate at Jackson Hole, over whether to Taper or land the Helicopter, is now being prepared for. Two teams, both suffering from cognitive bias will face off. Age of Wisdom, Age of Foolishness (36) “By the Rivers of Babylon”[lxiii] suggested that the Bank of England will follow the Fed’s lead on the permanent increase in the money supply. Danny Blanchflower began the pre-match build-up, by suggesting that there is still plenty of slack in the UK Economy. This suggestion implies that the Bank of England has no need to tighten. Blachflower’s run was timed to perfection; as shortly after he opined on the economic slack the release of the retail price data signalled no inflation at the consumer level[lxiv]. The Bank of England therefore has time and space to land the Helicopter.
“Soon to be Singing from a Different Page.”
Age of Wisdom, Age of Foolishness (35) “Red Lines and Green Lights”
The emerging political superpower role of Germany is also reflected in its economic policy. Readers will by now be familiar with the “Three Teutonic Tenors”; who have been noisily creating another European debt crisis; in order to get the price to the German taxpayer for the ultimate bailout of the Eurozone down to as little as possible. Jens Weidmann has repeatedly warned over the risks of overheating in Germany, from the twin tailwinds of the looser ECB and a looser EU fiscal regime going forward. In Age of Wisdom, Age of Foolishness (39) “OECDean’s ’14” it was suggested that these singers would soon change their tune; in order to follow the new libretto in which Germany emerges to lead the EU into a more robust foreign policy stance. This more robust stance will become a necessity; once hostilities with Russia force the EU to look globally, specifically in the Middle East and Africa, for energy alternatives. Last week, the first signs that Weidmann had changed his tune emerged.
“Behold the Wirtschaftswunder”.
Bumper German Pay Deals and an Unrubbed Nose in Audi Town
The German productivity miracle[lxv], has allowed German companies to accept higher wages in the latest wage negotiations with their workers. Far from calling these wage hikes inflationary overheating, Weidmann has opined that they are totally acceptable and desirable. Productivity gains support his view. One has to look at the bigger picture however; to really appreciate his new oratorio.
In the bigger picture, he still advocates tighter fiscal policy at the EU level. He also still holds onto his principle of overheating risk; even though accepting that productivity gains negate it. It should also be remembered that Germany intends to deliver balanced fiscal budgets going forward. Weidmann is trying to demonstrate, that fiscal prudence and productivity translate into higher wages and sustainable growth, to a sceptical European audience. He will use this argument to counter Mario Draghi; when the latter tries to roll out more unconventional policies which amount to the monetization of sovereign deficits. Weidmann and presumably the other two tenors will also use this line of argument, when the PIIGS try and negotiate looser fiscal policy from the EU. The PIIGS will be entreated to follow the German example; to the ultimate reward of higher salaries, after the productivity gains have been made.
“Start Level 2.
There is however more than just the European dimension to Weidmann’s logic; there is also a strong domestic component. Whilst Germany whittles down the cost of an ultimate Eurozone bailout, to a smaller value, there is also the hurdle of selling the final bailout to a sceptical German audience. This sceptical audience will just have been given a big pay rise, which has not been offset by fiscal or monetary tightening. The audience will also have been motivated by the flag-waving prospect and rhetoric of a renewed age-old conflict with the old enemy to the East.
A by-product of this conflict is the need to lead a unified Eurozone on a crusade to find new energy sources. Sufficiently motivated and financially compensated, the German taxpayer will thus be more accepting of the need to bail out and lead its neighbours. The green shoots of Germany’s blossoming superpower status are therefore firmly rooted in the political and economic subsoil of the European “garden”. The latest Sentix European Sentiment Index[lxvi] signalled that the blowback from Ukraine has created economic pessimism across the Eurozone. Europeans now feel threatened, so the climate is ripe for German leadership to emerge. The June German Factory Orders number released last week was shocker[lxvii]. The headwinds from the Ukrainian blowback have basically derailed the German manufacturing train. The German productivity miracle formula has therefore been derailed; by a contraction in production and a rise in compensation. Weidmann is therefore deliberately talking through his hat, like a politician, when he talks up the rise in German wages. He is thus preparing the nation to pick up the tab for a Eurozone bailout and military adventures. Germany needs to align itself closely with its neighbours this time around; since historical experience has shown the dangers when it has become an overzealous leader of European nations. Mario Draghi is clearly on board with the new crusade. In his most recent presser, he admonished the Italians for creating their own recession by not reforming their economy[lxviii]. This is a direct copy of Weidmann’s vision of the productivity miracle from Germany that should be exported to all European countries.
He was also swift to seize upon the spectre of the geopolitical headwinds blowing from Ukraine and the Middle East; which will allow him to un-leash his next round of unconventional policy. Having squared this with Germany first, by vocally accepting the need for economic reforms along German lines, the base is already covered for Draghi to perform some European monetary “Shock and Awe” to support the European “boots on the ground”[lxix]. The timing of this “Shock and Awe” will no doubt be at the exact point that the European equity bulls capitulate and turn bearish.
- Milking It For All It’s Worth
- By the Rivers of Babylon
- Policy Challenges for the Next 50 Years
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