Age of Wisdom, Age of Foolishness (14)
The fox knows many things, but the hedgehog knows one big thing.
(Archilocus: Greek mercenary and poet)
Going into Davos, Policy Maker Speak and market price action conspired to create the global perspective that the global economic recovery was losing momentum. Observers had become hedgehogs; and this was the big thing that they thought they knew. Would this signal a greater market correction and economic slowdown, or would this just be a dip to be bought? Would policy makers understand the threat and adjust policy accordingly to sustain the economic momentum and rising price action?
The future’s so bright because I wear rosy shades.
Coming out of Davos, the next hurdles to be jumped by clever foxes appeared in the form of the ECB’s February meeting, followed in quick succession by the US Unemployment Report. The ECB kept its powder dry on a liquidity injection; but sent the strong signal that this injection was under way, based on faltering economic performance and the weak inflation backdrop. The market immediately switched back to risk on mode, so that the weak US Unemployment report which followed was then perceived as a signal that the “Taper” would be cut-back or even put on hold. Markets then set about discounting the positive growth impacts of these two liquidity events. Global perceptions had been reframed over the course of two days. The blinkers, created by these two events, obscured some objects in the field of vision which obstructed and even contradicted the mental picture being discounted. The clever foxes were perhaps being too clever by half, in missing the big picture.
“Europeans can’t get no ……”
Last week the Fourth European Estate known as the Trade Unions opined that[i]:
“The 25 largest fortunes represent 10% of the Portuguese GDP, which means an increase of 17.8% since 2010”.
“If ever there is another troika intervention, it should be less ideological, more skilled at listening and dialogue and exclude the ultra – conservative ideologues from the ECB”.
“The implementation of the Troika’s austerity programme on Greece is incompatible with social justice, has led to the dismantling of the Welfare State and strengthened extremist and intolerant elements. Nationalism, racism, xenophobia and violence rush in to fill the gap left caused by the non-respect of democratic institutions and by the disintegration of the social fabric”.
“The Troika stated that it will only hear the trade unions and will not negotiate with them. The Troika will only negotiate with the government”.
There is a clear feeling in countries in the European Periphery, but also increasingly by members of the Core, that the Austerity sanctioned by the central EU power and facilitated by the ECB is undemocratic. The European Project is a hedgehog which is about to be attacked by many democratic foxes. The endangered species of European Hedgehog has taken note of this existential threat; and is now in the process of trying to reform itself after admitting that corruption and waste is endemic.
The next wave of ECB liquidity, is also no forgone conclusion. The ECB leaked very publicly, before the last Council Meeting, its intentions capabilities to refrain from sterilising its OMT bond purchases[ii]. The inference is that a future liquidity injection, via OMT, will have the impact of inducing permanent unsterilized liquidity in the system. The clever trader foxes took this as a signal that Unsterilized QE is the ECB’s next policy tool. Closer inspection of the ECB’s tactical leak however suggests that it was actually done with the intention of enlisting support of the monetary hedgehog, known as the Bundesbank, to endorse this project. The Bundesbank has so far not opined on the issue; however the German legal system has ‘suddenly’ decided to refer the legality of the ECB’s whole OMT programme to the European Court[iii]. A clever fox, who was buying the market, would suggest that Germany was complying with EU legal opinion on the OMT; and that said EU legal opinion would rule that the ECB had acted legally. It should however be noted that the ECB’s mandate unequivocally precludes it from monetizing the deficits of nations. Furthermore, Germany’s constitution expressly forbids deficit monetization. Even if the EU courts rule that the OMT is legal, this only refers to the Sterilized part of the OMT. Unsterilized OMT is unconstitutional in Germany and also by ECB Mandate. It is unlikely that the clever foxes, who are trying to be bulls, have fully understood these finer legal points. A German hedgehog could therefore at any time wound the clever fox by raising the point that Unsterilized QE via the Unsterilized OMT is simply a form of deficit monetization. We believe that Germany has quietly flagged that this issue is to be used at a point and time of Germany’s choosing in the future. The sly fox Draghi has been cornered by the German hedgehog. The German hedgehog has regained the initiative.
Beware of Greeks and their friendly hedge-funds
Beware of Hedge Funds Bearing Gifts December 13th 2013
This German initiative has been seized because the very delicate matter of the next wave of Greek bailouts is currently being negotiated with the Troika behind closed doors. In a report entitled “Beware of Hedge Funds Bearing Gifts”, posted on December 13th 2013[iv], we suggested that Greece was in the advanced phase of negotiations. The Greeks were threatening to use their existing primary surplus as a bargaining tool to extract further concessions from the Troika.
A clever fox, from the hedge-fund community, had been enlisted in this exercise with the promise of rich rewards, in the form of capital gains, in the Greek sovereign debt market that it had cornered. Ostensibly the EU part of the Troika has fallen into the Greek trap, by signalling that it may offer to extend the Greek bailout loan to fifty years and reduce the rate of interest by fifty basis points[v]. We would suggest that this “50/50” kicking the down the road is not exactly in the interest of either the Greeks or the clever fox hedge-fund.
Extending the maturity of the loan would signal that Greece will never be able to pay the loan off; and is therefore being put in the same position as an indebted African nation. One remembers what the Spanish Prime Minister said about his nation not being Mozambique. He may soon find cause to repeat this statement. Under the “50/50” scheme, future generations of Greeks will be perpetual debt slaves. The rate of usury will be lowered to make the burden manageable over the long term without ever triggering an outright default.
We suggest that the clever fox hedge-fund will be in a great rush to claim victory and sell into any rally. Greek citizens however can be expected to rebel violently over this form of enslavement.
As the Greek PIIG morphs into a clever fox it is being joined by an Italian cousin from the herd. Italy is taking the perverse position of valuing its “tangible” historical and cultural assets as part of its “intangible” sovereign credit rating; despite the fact that these assets are not directly income generating[vi]. In fact it can be argued that the GDP of the nation actually accounts for the monetary value of these antiquities, in the form of tourism and media related revenues already. The present value of future revenue streams is not currently valued, so perhaps this is what Italy is trying to do; but we doubt it.
“Someone has lost their marbles!!!”
Greece with all its antiquities, many of which were pilfered by generations of Anglo-Saxons and Northern Europeans, may also feel inclined to follow Italy’s precedent. Much of Northern Europe’s cultural assets, especially Germany’s, were destroyed or plundered in two World Wars; so it is in cultural deficit with the South. In fact those in the South will assert that democratic European values, currently being threatened by the “austere” Northern barbarians, originated in the South.
The sublime message is that cultural assets equate to democracy; and Austerity equates to barbarity. It is a noble effort, as worthy as the labours of Solon and Pericles. The asset-rich (democracy-rich)/cash-poor South wishes to revalue itself versus the cash-rich/asset-poor (democracy-poor) North on the consolidated European Balance Sheet. But as some clever fox once remarked to the Bill Dudley of the NY Fed however, that one can’t eat an i-Phone, one could also opine that one can’t eat a Michaelangelo either. What this exercise, in cultural capital asset pricing, reflects is the level of desperation in the cultural asset-rich nations to build their balance sheets for future problems in their liquidity statements; using any form of rhetoric possible.
One can also imagine the swift repost by the Northern “Schweinhunds” against the “Schweins” in the PIIG countries. The “Schweinhunds” will bark that these cultural assets should therefore be sold to pay down “Schwein” debt; indeed Germany has already said as much to Greece. The spectre of plunder, in addition to enslavement, now threatens to haunt the European polity for the third time in the last century; just as Europe celebrates the centenary of the first iteration.
Mr Kocherlakota’s Versailles Moment
It is with this simmering “cultural” melting pot in mind, that we found the latest signals from the Fed in relation to the Eurozone very enlightening. It was confirmed that Bernanke will immediately start work at Brookings, without any time to catch his breath; or to monetize his breath to make a fortune on the lecture circuit. Clearly his work is not done; and will now take on a greater global dimension at Brookings.
The signal that the Fed has got its eyes on Europe came from the Minneapolis Fed. This institution is now infamous, for the kind of groupthink associated with Stalin, since its leader Mr Kocherlakota has become an evangelical (and late) convert to perpetual QE. Kocherlakota resembles the worst kind of reformed smoker, who will not tolerate smokers in his house even if they smoke outside. His last egregious act was to fire personnel with dissenting economic opinions to his own. Now it appears that he has taken a step to promote the global remit of his dogma. In a pamphlet, similar to ones that can be imagined to have advised Presidents Woodrow Wilson and FDR, the Minneapolis Fed asked the rhetorical question:
“Is It Too Late to Bail Out the Troubled Countries in the Eurozone?”[vii].
One can see that this is the kind of rhetorical question that an organization like the Brookings Institution, with its newly installed former Fed Chairman, was created to answer. It is a subject that is clearly way beyond the remit of the Minneapolis Fed; and way above the pay grade of Mr Kocherlakota.
European destruction and reconstruction of the Twentieth Century was financed by American capital. Alas, America is a deficit nation today; with no capital to export to Europe. Germany is however a capital surplus nation. It therefore seems logical to assume that the strategy of America should be to make Germany finance European reconstruction, whilst at the same time weakening itself relative to the already weakened United States. Germany, thus first has to be blamed for European destruction; as it was at Versailles. Germany however, is reciprocating with alacrity by enforcing austerity.
The Minneapolis Fed uses the Mexican Debt Crisis and its skilful handling by President Clinton as the model. The analysis concludes as follows:
How Can the Eurozone Debt Crises End?
Our model is simplistic along many dimensions and includes simplifying assumptions that are worth relaxing. Nonetheless, using the model as a lens through which to compare the 1994–95 Mexican crisis with the ongoing threat of crises in the Eurozone suggests that there are four ways that the ongoing problems in each of these Eurozone countries can end:
- First, and most obviously, vigorous economic growth in the country could resume.
- Second, the government could default and the country could leave the Eurozone. This would allow the country to devalue its real exchange rate and perhaps induce the sort of growth that Mexico experienced after its crisis.
- Third, the Troika could take over the public finances of the country and force the government to run down the debt, ignoring the incentives to gamble for redemption and gamble for a bailout. Forcing the government to accept a bailout with a high penalty interest rate and a large collateral requirement would be an obvious way to do this.
- Fourth, the government and households of the country, in their role as voters, could realize that they are significantly poorer than they thought that they would be during the 2000–2008 boom, eliminating much of the incentive to gamble for redemption.
Clearly the first option is not going to happen, so we are left with the other three. There are therefore three European foxes that are about to be let out of the bag this year. It was interesting to note that the Minneapolis Fed avoided making any direct comment about its sister central bank the ECB and its role. So what is the real objective of the Minneapolis Fed? In actual fact, we do not think that the parochial Mr Kocherlakota has any ambitions of global domination. We think that he is positioning the European issue as the greatest headwind facing the Fed as it attempts to “Taper” in 2014. Since he is noted for his position, which demands more QE rather than the “Taper”, we believe that this research paper is being positioned as justification for ending the “Taper” and doing more QE.
Another headwind, to justify less “Taper” and more QE, is also being opined and vigorously blown in the media. This headwind is Japan. Abe and Abenomics are now being written off as abject failures[viii]. He is being given one last chance in the upcoming wage negotiation round[ix]. If salaries are not raised, then swift progress will be made to end his political career. As we have observed in “The Melt Up Melts Down”, imported energy inflation removes the ability of Japan Inc. to pay higher wages and preserve its bottom line. If Japan Inc. pays higher wages it will self-destruct, unless energy costs fall rapidly. In order for energy costs to fall, the Yen must strengthen; which then has a negative impact on Japanese exports and Japanese equities. The clever foxes who are long Japanese equities and short the Yen are about to meet a large hedgehog.
The hedgehogs and foxes on the FOMC were also back at work last week; after the quiet period surrounding the last meeting expired. Two famed Hawks became the putative hedgehogs. Jeffrey Lacker remained unflustered by the recent slide in equities; and saw this sell-off as no reason to adjust “Taper” plans. Richard Fisher, who used to act like a fox, now officially becomes an FOMC hedgehog; and also concurred with Lacker’s view[x].
Charles Plosser is a Hawk in hedgehog’s clothing by nature. He knows only one thing; and this is that the “Taper” should end immediately. Charles Evans and Dennis Lockhart[xi] were the putative Doves in foxes clothing. In fact, so clever are these two foxes that, they have decided to move the goalposts on the “Evans Rule”. Based on their new analysis, even if unemployment falls to between 7 and 6.5%, the Fed should not end QE. Evans and Lockhart now welcome a single inflation mandate; because it suits their view on QE.
One suspects that the hedgehog Plosser has established a new challenge to the Fed’s dual mandate. Being clever, these foxes have noted the chink in Plosser’s spiny armour; which is the fact that falling inflation justifies more QE. By agreeing with Plosser, over adopting a single inflation mandate, they have undermined him by forcing him into a low inflation trap which gives no way out of QE.
“Who’s the pig Bill?”
It seemed that Animal Farm, or even perhaps Lord of the Flies, had replaced Clash of the Titans over at PIMCO’s California Studios last week. In order to downplay the resignation of the economic Titan, Mohammed El Erian, the Bond God Bill Gross employed some medieval mystery plays in his latest newsletter. The apostate imagery in his latest newsletter, involving a pig in stocks, was seen by some Islamophiles as a crude reference to Mr El Erian. Europhiles thought it referred to the PIIGS. Americaphiles thought it referred to the state of the American credit markets.
All this speculation was however easily refuted by the Bond God’s discourse. Mr Gross hinted that the “bacon” is allegedly of Chinese provenance. The jury is still out. The jury is also out on whether clever fox Mr Gross is really a strategic hedgehog, who only believes in bonds and missed the opportunity to diversify; or if he is an omnipotent Bond God, who has just called the move out of equities into bonds. Timing and luck are everything in this game; unless one believes in miracles.