posted on 08 March 2015
The fun and games in Europe, post Greek election, took centre stage last week. Epoch of Belief, Epoch of Incredulity (3) "Disabling Acts" suggested that the devil was in the detail of the ECB's QE announcement.
Having bought the QE headline, speculators then became rather more circumspect as to what they had actually bought into[i]. Those fundamentally interested in what they had bought into, found that they had been sold a hurriedly cobbled together compromise between Draghi and the Northern Europeans; which was long on big number headlines and short on detailed execution plans. There is no clear guidance on how the purchases of each asset class will be announced, executed and coordinated. Neither is there any detail on how the programme’s impact upon the bond markets and real economy will be monitored.
The whole QE plan resembles an onion that will bring tears to the eyes of those who watch closely as each layer is peeled away. At the heart of the onion, is the realization that the national central banks and ECB get themselves deeper into the realms of insolvency, at each successive round of asset purchases. Dutch finance minister Dijsselbloem set the stage for the unfolding Greek tragedy, when he opined that the ball was heavily in the Greeks’ hands in terms of dealing with their debt obligations[ii].
When it swiftly became clear that the bond markets were struggling to digest the big lies, which they had swallowed at Draghi’s press conference, ECB members were swiftly mobilised to extemporise a little further to keep the positive momentum going.
Benoit Coeure is the go-to guy, when market momentum driving words are required. He swiftly opined that the ECB QE will follow the current debt buying profile[iii]. This however obviously cannot be the case; because the existing buying programme is not circumscribed by the latest ECB edict on buying of covered bonds, agencies and sovereigns by national central banks. Clearly the latest QE has just been grafted on to what exists today. What Couere is saying is that there is no new tactical plan for QE, therefore it will just continue in the same way until the Germans call halt, because in their opinion the new rules have been broken.
Coeure was then followed by Ewald Nowotny. Nowotny opined that the bond markets will feel the impact of the new wave of QE by the summer[iv]. Given the parlous state of credit growth in the Eurozone, summer is way too late. If the ECB can’t meaningfully impact the capital markets for the next five to six months, then clearly the latest QE is all words and no action.
In the classic ECB style, of shooting itself in the foot, the macro-prudential policy executive arm signalled that the institution is preparing for a Eurozone breakup, whilst the monetary policy making Governing Council is trying to avert it. Daniele Nouy announced that Eurozone banks will no longer be allowed to subjectively apply zero risk weightings to the sovereign bonds that they own[v]. Sovereign debt holdings account for approximately 9.3%, or roughly 2.7 Trillion Euros, of Eurozone commercial bank assets. Most banks have actually been holding them as core capital on their balance sheets. Just as the ECB is allegedly trying to coax forth lending with the monetary policy hand, the macro-prudential hand takes it away. Compounding the problem is the impact that this will have on the new wave of QE bond buying. Removing the zero risk weighting implicitly means that not all sovereign bonds are created equal for QE purposes. The removal of the zero risk weighting in fact suggests that there is some inherent credit risk in Eurozone sovereign bonds; which logically extends to an implicit risk of default. This inherent default risk therefore also suggests the fact that sovereign debt risk is not going to be mutualised across the Eurozone any time soon. This implicit default risk therefore hints at the increased potential for Eurozone breakup. The ECB’s macro-prudential team is thus signalling Eurozone breakup, whilst the Governing Council signals otherwise. Such dysfunctionality epitomises the unsustainability of the whole Eurozone financial system.
Standard and Poor’s clearly took a dim view of the situation; and swiftly downgraded some of the European banks, based on the removal of the implied taxpayer bailout[vi]. As it is now going through the process of settling expensive lawsuits, for its poor rating track record during the credit bubble, this rating agency is not taking any chances as the next crisis looms large. What this illustrates, is that the institutional framework to deal with the Eurozone breakup is moving into the minutiae of detail associated with credit ratings.
Greek tactics, in dealing with the Troika, appear to have been heavily influenced by its finance minister; whom is alleged to be an expert in game theory. Understanding that Greece has got nothing to lose, because it will cease to exist as a functioning sovereign entity either inside or outside the EU, Mr Varoufakis decided to gamble. The opening Greek gambit was an offer to renegotiate with private creditors, whilst repaying the Troika and ECB in full[vii]. The Troika is evidently more afraid of international financial courts and the issue of cross default clauses, in the face of Greek attempts to subordinate the legal rights of private capital to political capital, so this offer was dead on arrival. Simultaneously, the “Game Theorist” was dispatched to tour the European capitals; in order to seek out sympathizers in the South, who could be leveraged into allies against the North[viii].
By engaging in this bizarre Odyssey, in which he appeared to wear the same clothes for the whole journey, Varoufakis unwittingly framed himself as the potential breaker of the Eurozone.
This absurd posturing, of the Greek wide boy from Essex[ix], guaranteed the amusing ambivalent reception which he encountered in the various European capitals where he was welcomed; and hence it guaranteed his failure. Presumably Greece thought that it had frightened the Troika enough, by threatening to secede into the Russian sphere of influence, in order to drive a wedge between it and the interests of private capital. Little did the Greeks know that Merkel and Hollande would be meeting with Putin later in the week; so that this base had already been covered. The moral of the story is that small countries should not try and come between larger ones, unless they wish to be crushed by both.
George Osborne, a finance minister with national debts on a scale of the Greeks, is evidently of the view that private capital and political capital rank equally in the shaky capital structure that is the Greek economy. He was therefore happy to meet with Varoufakis and inform him that both he and his country were the biggest headwind for the global economy[x]. With an eye on the election, Osborne may need a scapegoat to blame if there is a meltdown before Britons go to the polls. Varoufakis therefore presented the figure, of a “useful idiot”, that Osborne could capitalize upon. Britain is currently playing the traditional role of sitting on the fence in Europe, until a referendum on the “Brexit” occurs in the next parliament; so Varoufakis provides a useful Eurosceptic card for Osborne to put in his hand to be played at a later date.
Angela Merkel’s procrastination was even more amusing than that of Osborne. Appearing to stand behind a united European front in relation to Greece, despite the fact that German austerity terms are breaking it up, Merkel refused to meet with any delegation from the Greek government and diverted them back to the EU[xi]. In addition she opined that the Greek taxation plans, in order to meet debt payments, are impractical. Merkel therefore showed Greece the door to the EU and hence the “Grexit” by default.
When Varoufakis finally got his audience with Wolfgang Schaeuble, he decided to use the allegory of Greece as defeated Weimar Germany[xii]; facing the real threat of a Nazi dictatorship if it is forced to pay its debts. Given the German loss of lives, in a conflict that Greece used to wriggle out of the grip of Germany’s Ottoman ally during the humiliation of Versailles, this allegory is more likely to insult Germans rather than to motivate them to write-off Greek debts. Germans do not take kindly to be reminded of the version of history written by the victors of the two great European conflagrations. Germany lost blood and hard currency, Greece borrowed and consumed in a hard currency that it lied about its ability to repay its debts in. It’s a comparison of apples and oranges, or rather men and boys therefore, as far as Germany is concerned. German sources alleged that both gentlemen “agreed to disagree”[xiii]; although it is not clear on whether the disagreement was about the terms of the bailout of Varoufakis’s crude calumny of European history.
Matteo Renzi is more interested in securing his position and that of his president Sergio Matarella, after defeating the challenge of Berlusconi and Beppe Grillo in the recent presidential elections, therefore there is little for Greece in Italy[xiv].
The Spanish reaction was even more interesting. Careful not to arouse Catalan aspirations of secession, the door was kept firmly closed on the Greek delegation[xv]. In Epoch of Belief, Epoch of Incredulity (5) “Surprise Surprise”, these aspirations to secede, with the added bonus of a credit rating upgrade, weighed heavily on the minds of all Catalans. Prime Minister Rajoy was careful not to entertain such notions any further.
Mario Draghi, who has been given his QE by Germany and must now follow the German line, therefore had no alternative other than to immediately dismiss the Greek request; for emergency short term funding, whilst it attempted to reschedule its outstanding debts with the Troika[xvi].
Having failed with this card, Greece then played the next card of trying to exchange existing debt for new securities, which presumably will have a lower coupon and an extended maturity[xvii]. This Greek climb-down, on debt write-down, was taken by the markets as the signal that the Eurozone has been preserved; and that Greece will now be a debt slave in perpetuity, with a slightly lower rate of interest paid. The can was therefore kicked down the road until the issue of slow economic growth, which does not create the tax receipts to pay down Eurozone debts, resurfaces later in the year. The road only extends to the end of the month for Greece however, since Draghi’s denial of a request for emergency funding effectively makes the country insolvent by then[xviii]. The rest of the Eurozone can limp along until 2016, which is the date at which the latest round of QE is supposed to end.
The Greeks are not waiting for the end of the month however. They have understood that, if the Troika prevails, they will be shaken down for all their savings; in order to pay the Carthaginian Troika’s terms. If Greece is forced to exit the Eurozone, on the other hand, their Euros will buy more of whatever currency replaces the Euro after the “Grexit”. Greeks are therefore literally withdrawing their savings and even borrowing from their banks in Euros; and then hiding the hard currency notes in secret locations[xix]. Some even convert the Euros into US Dollars just to be on the safe side, in the event that the Euro is split into discrete Northern and Southern currency zones. The presidential election was therefore a waste of time; and Greeks have voted with their pecuniary feet. The economy has the appearance of an active lending and borrowing market, whilst this wealth protection process occurs. Any further financial support, which the Troika provides, will then be a target for this same kind of wealth appropriation. The Troika will therefore have to directly control how its money is spent, in order to make sure that it gets anything back at all. The real economy will however be starved of capital and liquidity; and will therefore implode.
Epoch of Belief, Epoch of Incredulity (5) “Surprise Surprise” observed how Chinese policy makers were just making things up as they went along, to frame the recession as the “New Normal”. Last week, the country saw its biggest capital outflows since 1998[xx]. Epoch of Belief, Epoch of Incredulity (5) “Surprise Surprise” also noted that the PBOC was between a rock and hard place. In order to stimulate the economy it needs to add monetary stimulus, but any injection of liquidity will only accelerate the capital flight abroad. The PBOC signalled its concern over capital flight last week; and hinted that new policy tools[xxi], such as widened currency fluctuation bands and lowering the official fixing rate versus the Dollar, were under consideration to manage a desired smooth depreciation of the Yuan.
By way of illustration of this lame duck position, the PBOC cut reserve requirements last week[xxii]. In consequence, the banks can in practice lend more with same amount or less deposits. This book keeping monetary stimulus however, will simply weaken the banks liquidity positions and encourage the capital flight process to arbitrage the new rules. As a result, the banks will therefore be enabled to stimulate more capital flight on shrinking deposit bases. Banks will therefore become illiquid and insolvent much faster, if they do not raise equity capital to underwrite the new round of capital flight. Local Government Finance Vehicles (LGFV’s), which have been effectively barred from onshore borrowing, are now following the money abroad by attempting to borrow offshore[xxiii]. The authorities will need to watch the LGFV’s carefully, to make sure that individuals are not using these alleged foreign borrowing facilities as financial structures to move money abroad; via interest and principal payments on fictitious book-keeping loans.
The credit data from China[xxiv] shows that loan demand, from real businesses and consumers, has actually declined in the face of a rising credit supply. This rising credit has therefore ended up in real estate and other hard assets, which are surplus to the requirements of normal Chinese businessmen and consumers. This bubble, in real estate and hard assets, can be associated with the double digit economic growth that was demanded by the Politburo. Latterly this credit has been disappearing offshore, in what can be described as bubbles in capital flight and fraud.
Australia showed up late, to the globally coordinated easing round last week, with a rate cut[xxv]. The timing of this, owed more to the poor showing of the Abbott coalition in the Queensland State election than anything else[xxvi].
Abbott will now face some hostile deliveries, as the much anticipated constitutional crisis, that was predicted in Age of Wisdom, Age of Foolishness (55) “Yes Virginia”[xxvii], ensues in the coming days[xxviii].
Abbott and the not so independent Australian central bank, are now both betting on a property bubble[xxix] to drag the economy and their own fortunes along. They have got 225 basis points of ammunition left, to inflate this bubble and destroy the currency.
On the subject of not so independent central banks, there are signs that the alleged big deal between Mark Carney and George Osborne will be exposed before the election. Pundits have noted that Osborne can only get around, increased election winning budget spending, because Carney’s QE is allowing him to effectively borrow more money; by nature of the fact that the interest cost is so low[xxx]. QE therefore reduces the budgetary constraints on the government, by allowing it to finance more spending through leveraged low interest cost borrowing. The ultimate liability for all this is of course worn by the British taxpayer as usual, rather than the Bank of England; since as Osborne just told Yanis Varoufakis debt haircuts are out. Carney now has to talk up Sterling, with threatened but never delivered rate hikes, so that lumpen Gilt investors will continue to subsidize Osborne’s vote purchasing franchise.
The hilarious situation, in the unfolding Hispanic Spring in Argentina, became even more so last week. Whilst ostensibly meeting a Chinese delegation, to support her crumbling economy, the accident prone President Kerchner decided to ridicule their accents on Twitter instead. At first glance, this appears to be another own goal that will hasten her demise. Closer inspection will reveal the hand of God, which has a habit of popping to the rescue of Argentinians in times of crisis. Ridicule of China equates to praise of America in Realpolitikal terms. President Kerchner was therefore throwing her hand in with America; which is a very perspicacious thing to do given China’s current internal financial problems.
Brazil continues to implode violently. At the beginning of last week, Brazilians were told that the value of their alleged cash cow Petrobras has slumped from $310 billion to just $48 billion[xxxi]; and with it has gone the opportunity for both further grand larceny and genuine economic salvation. The government controlling shareholder, then instated a career state banker as the new CEO[xxxii];
thus signalling to the markets that the financial loss is more important than pumping oil in order to recover it. The implication of the appointment, is that the money trail leads straight back to the ruling party and hence to Dilma Rousseff herself. A move to impeach her is now expected, which her own party has signalled will be the start of a civil war[xxxiii].
Faced with these global headwinds, one would expect the Fed to be loosening its tight rhetoric a little faster than it has been doing. There is however a huge spanner in the works; and this spanner is called Rand Paul. Paul has just successfully re-sponsored a new “Audit the Fed” bill[xxxiv], because both houses are now Republican controlled.
Janet Yellen’s ability to deliver, her desired Helicopter Money, has been radically challenged by the optics and politics in Washington. Suddenly the less than independent so far Fed, now has to appear independent. Independence means taking the monetary punch bowl away from the drunken economy. It was therefore no surprise to hear “Wobbly” James Bullard opine that the Fed should now be dropping the word “patience” and adhering to a more hawkish exit route[xxxv]. Paul and the GOP are just about to obstruct the Fed from saving the global economy and the US recovery all in one go. It was a similar obstinate Congressional refusal to obey the Wall Street agenda back in 2008 that triggered the last crisis. This time around, Congress is wearing the black hat again, before it is swiftly forced to don the white one and come to the rescue. In an attempt to hold the Dovish line, whilst also fighting back against Paul, Eric Rosengren reiterated that the FOMC could still afford to be “patient”[xxxvi]. The Hawks and the Doves may disagree on the timing of the tightening, however they all agree to cooperate when threatened by politicians. Fed newbie Loretta Mester, therefore bridged the Hawk-Dove divide when she showed herself to be a Hawk by calling for a June tightening[xxxvii]; and then strongly rebuked Paul for trying to extend political control of independent monetary policy[xxxviii].
Charles Plosser could not resist one last defiant dig at Yellen and the Doves, before he effectively checks out from active Fed policy making[xxxix]. Using the analogy, of the lyrics of the song Hotel California, he suggested that QE was in danger of conforming to the line which suggested that it was a guest that could check in any time but could never leave. For Plosser, the March FOMC meeting is the critical date; at which guidance and language must be changed, with the implied removal of the words “patience” and “considerable time”. Fedwatchers and pundits can now wile away the hours, between now and then, with pages of rhetoric deliberating on the likely editing of these words from the big March announcement.
Rand Paul’s timing is terrible from the economy’s perspective. The initial Q4/2014 GDP report[xl] showed a significant slowdown. A recent survey of American CEO’s , by Bespoke Investment Group LLC, has not seen them this pessimistic since 2008[xli]. Just as Yellen was hoping to remove the tightening bias to anticipate these events, the politicians have gotten in the way. Gold, which had been moving higher in US Dollar terms in addition to all other currencies, also hit an obstacle; in the form of potentially rising US interest rates and the stronger US Dollar that this creates, last week. It now seems, as though consensus must first discount the Fed tightening, followed by the US recession, before ultimately discounting the Helicopter Money response.
What had been lacking thus far, was an American policy maker opining upon global matters, specifically in Europe and China. The farthest that the Fed would go, was to refer to these locations as headwinds at the last FOMC announcement. Secretary Lew finally made the closest thing to an American take on global events last week. He opined that neither China nor Japan are currency manipulators[xlii]. In so doing, he confirmed that the strong US Dollar policy remains in place; and that China and Japan have the green light to destroy their currencies as much as they care to do.
When the January employment situation numbers erupted at the end of the week, suggesting sustainable strength in the jobs market thanks to revisions to the last three numbers, the scene was set for a major rally in the US Dollar. The most notable boost was the average earnings data, which suggested that an employable American worker now has pricing power in relation to his/her salary. Given the fall in gasoline prices, this pricing power can now go towards consumption, which is what the Fed has been looking for. The fall in gasoline prices has therefore been a net monetary stimulus, which the Fed must now counter by adhering to its original June tightening commitment. Jumping in immediately after the numbers, Dennis Lockhart intimated that whilst wages and employment are still a concern there is now no obstacle to tightening this year[xliii]. Even the Doves at the Fed must give the global strong US Dollar strategy priority over their own parochial concerns.
One should question why America is pursuing the strong Dollar. The Fed clearly has no choice, because it is boxed in by Rand Paul and Congress. The Treasury is another matter. The recent de-pegging of the Swiss Franc and the accumulation of Gold, by the German and Netherlands central banks, has not gone unnoticed by America; neither have the preparations in Northern Europe for a Eurozone breakup. Hard currency economics is coming back to challenge the global hegemony of the debt-backed US Dollar. America cannot afford to go into another debt crisis with a weakened Dollar. It therefore needs a strong Dollar, not only to head off the challenge from the emerging powers; but also to stand up to the emerging hard currency economies orbiting around the German star. Secretary Lew is therefore happy for the Chinese to get themselves into even more of a debt bubble; because this will harden the Dollar and undermine the Chinese threat. Japan is a more nuanced case. Japan is the proxy in Asia through which America will blunt the Chinese threat. Christine Lagarde showed that she is mindful of the demise of her predecessor Strauss Kahn for supporting IMF reform. She therefore continued with the recent tradition of a Japanese deputy managing director, by handing the position from Naoyuki Shinohara to Mitsuhiro Furusawa. The real tradition at the IMF is for a European managing director and an American deputy; however America is using a Japanese proxy in order to appear multipolar to its critics. Furusawa is in fact an advisor to Abe and also to Taro Aso. Abenomics and the weak Yen are therefore implicitly supported by the IMF. The strong US Dollar policy is therefore being coordinated by the IMF and the BOJ. Japan and China can now go head to head in an Asian currency war; that will presumably also drag in the likes of South Korea and the other modern Asian economies which are export dependent.
The menu of the food for thought, for the Fed to digest in the form of the spectre of the next debt crisis, was scripted by McKinsey last week[xliv]. It should be viewed as the corollary of the argument set forward, by former BIS chief economist Bill White, which was reviewed in Epoch of Belief, Epoch of Incredulity (4) “Disabling Acts”. In reprise, White said that QE and the debt which enabled it will end very badly. McKinsey puts some numbers on the magnitude of the ending.
Global debt continues to increase its share of GDP, as it now converges on 300% of global GDP. Looked at in bubble terms, the stock of global debt is now three times the value of the global economy. The world therefore makes Greece look abstemious by comparison. Since the global economy is only growing at around 3% per annum, it will never grow fast enough to pay down the debt. The world therefore needs bailing out by some other galactic Troika. Since, according to NASA and SETI, this is unlikely to be in the foreseeable future, some members of the global economy must therefore go under so that the survivors can either bail them out or conquer them. Germany is clearly preparing, for this global end of days, by balancing its budget and getting its gold reserves under firm lock and key.
The Eurozone is in effect a microcosm of the bigger global picture. Within the Eurozone, the weak and overly indebted now face defeat and enslavement. Liberal democracies which have run on platforms of providing economic reward to their voters at any cost, rather than providing laws and rules of commerce in order for the voters to create their own economic rewards, now ultimately face the same painful soul searching that Greece is undergoing. In the advanced economies of Europe, which have become entombed in this social welfare democratics, coalition governments which represent the individual demands of the various affinity groups in the polity are now the order of the day.
America has the edge over its European partners, because it never espoused Socialism; for the simple fact that it emerged as the sole victor of World War II. When the GI’s came home, they all found jobs because America was the factory and source of capital investment that rebuilt the global economy. Returning allied European soldiers demanded a welfare state, even though their economies were flattened and in debt to America. Returning German soldiers were first given the Morgenthau Plan, by way of punishment, to make them into a passive pastoral community. Returning Russian soldiers were given more of what they had been receiving since 1917; which was then exported to captive returning soldiers of former Axis nations now under Soviet control.
When America noted that the passive pastoral Germans needed to become traditional martial Teutons, in the face of the advancing Soviet threat, the Morgenthau Plan was dropped for the Marshall Plan. The Marshall Plan was then woven into the fabric of the Europe to create the Eurozone of today. American capital financed the global architecture; and then sustained it through the willingness of American consumers to import the goods and services from the global producers that they had financed with seed money after World War II. America relied upon debt to finance this global economic system; and it is this debt that now threatens America’s ability to maintain control of the global system that it has created.
After the Credit Crunch of 2008, consumers in developed nations are no longer willing to shoulder the debt burdens that have sustained their standards of living and the global economy. In a traditional Keynesian response, governments have filled the void created by the absent consumers and absent taxpayers. Governments however have had reduced tax revenues, because consumers have become abstemious and companies have become more efficient. Whilst voters demand that governments maintain this level of social largesse, they have also signalled that they are unwilling to shoulder a higher tax burden in order to sustain it.
Governments made up of the political class, who exist only to hold power itself, have therefore come up with ingenious ways of appearing to deliver this Keynesian largesse whilst simultaneously clawing back expenditures in order to appear solvent. Such methods have been financed by central banks holding down interest rates, so that governments can borrow more money at lower rates of interest in order to sustain expenditures. When the central banks however own the lion’s share of the governments’ debts, they themselves face insolvency; at which point default and economic chaos threatens. And when all else fails, there is the not so subtle inflation way out; whereby a permanent increase in the money supply, in order to pay government debt and principal interest, is used as the last resort. America, Japan and most of continental Europe with the exception of Germany, are now at this point of monetary inflation. McKinsey quantifies White’s qualitative description of the problem.
McKinsey also reserves a special mention for the special case of China; which allegedly is in the worst shape of all.
Just as the global capital markets were starting to wake up to this problem, clearly articulated by Mr. White and McKinsey, a massive diversionary tactic has been deployed by the indebted nations. America is now promoting the idea of the strong US Dollar, to avoid an ugly wake-up call of its own. China and Japan, both oriental nations who are traditionally hung up on face-saving, have been happy to comply; by inflating their way out of debt whilst clinging on to export markets with much weakened currencies. This distraction will however be short lived, once it becomes apparent that American consumers have limited the amount of debt that they will run into, in order to sustain the exporters in China and Japan.
This is why Germany has done the sensible thing and balanced its fiscal books. The big US Dollar bull-run, will therefore be an elegant distraction; until the music stops, when the Fed has been forced to play along with the charade by raising borrowing costs for these consumers. With interest rates at current low levels, consumption is way still off its previous highs; therefore interest rates will not have to rise by much in order to choke off all consumption again. At this point, Helicopter Money and monetary inflation come back again as the only policy options in a liberal democracy. Until then, buy Dollars and wear diamonds!
As readers who have persevered, with the bad jokes and even worse economic theory, since Terminal Velocity (1) in 2013[xlv] will understand; the global capital markets have now moved up through the levels of Exter’s Inverted Pyramid to the unstable top level. As the value of Gold falls and the value of the top layer grows; the pyramid becomes inherently more unstable. The strong US Dollar will no doubt convince many that this time it’s different and the pyramid scheme is sustainable for a “considerable time”. Bill White, McKinsey and the Germans don’t think so. What is unfolding is the final stage of a bull market, which has confounded all the sceptics since it began in 2009. The final stages are traditionally the most violent, in terms of volatility and the squeeze higher in valuations. It is these higher valuations that convince participants to ignore the tell-tale volatility; and jump in for the ride. It is better to travel than to finally arrive.
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