Terminal Velocity (5) – “The Wind Blows Towards Jackson Hole”

Written by Adam Whitehead, KeySignals.com

In Terminal Velocity 4 – “Bernanke’s Helicopter Landing at Jackson Hole“, the prospect of the infamous Helicopter was introduced; ETA Jackson Hole 2013. The following report points out the key signals that have emerged to support this hypothesis.

The economic headwinds blowing from the Eurozone were seen as conditional tailwinds for the Helicopter:

“What is required is a catalyst for the Helicopter; and the Eurozone, faced with the prospect of break-up, as the Germans refuse to pick up the tab for fiscal union without a global bank run, provides the lowest fruit on the tree to be picked this summer.”

It therefore makes sense to start here. In the recent week, there have been signs that Germany has started to position itself for the inevitability that countries will refuse the harsh “Bail In” terms presented in the case of default. The German litany of key signals is extensive:

• The German “Wise Men“, who advise Chancellor Merkel, have opined that Germany must stand firm behind the “Bail In” model^[i].
• Worried by the negative implications that the “Wise Men’s” advice has for the position of Deutsche Bank’s business model and balance sheet, the retiring CEO began to lobby for a Bailout solution rather than a “Bail In“^[ii].
• Chancellor Merkel has seen the way German public opinion is blowing, heading up to the elections, so she has taken the advice of the “Wise Men“; and opted for no more Bailouts^[iii].
• German industry has begun to prepare for life with an uncompetitive exchange rate outside the Eurozone; and/or uncompetitive high domestic production costs in a “Bailed In” Eurozone^[iv].
• The German Car Industry then announced that it was in recession^[v].
• Jens Weidmann opined that the crisis was far from over; and would take a “Lost Decade” to resolve^[vi]. He then decided to play “Bad Eurocop“, to Schaeuble’s “Worse Eurocop“. Weidmann offered the prospect of ECB liquidity in response to weak economic data; and then totally discounted the success of this move in resolving the crisis^[vii].
• Schaeuble then played “Worse Eurocop“, by suggesting that the ECB should withdraw liquidity^[viii]. In addition to causing this schism within Europe, Schaeuble has made it global; by openly challenging the wisdom of the Keynesian policies and accommodating monetary policies of the USA and Japan^[ix]. Schaeuble is spoiling for a fight and is taking on the world.
• Understanding that a Bailout would make the German Banking system insolvent and a “Bail In” would make the whole Eurozone Banking System insolvent, Germany has U-Turned on Banking Union in order to save itself^[x].

In France, Hollande tried to gain political capital, by forcing greater transparency in the financial dealings of his ministers. The result showed that France is insolvent; because its ministers and general public avoid their own equity market; and invest in assets that do not oblige them to pay taxes^[xi][xii]. His own ministers are now openly in revolt against his austerity and transparency measures^[xiii].

Spain, under heavy IMF scrutiny, quietly announced that it will miss its austerity targets this year, because there has been no growth^[xiv]. The situation in Spain is dire; and verges on some kind of Medieval usury play^[xv]. Spaniards who have been foreclosed upon, still carry the debt obligation for the rest of their lives. The EU has opined that this is “Un-European” and that it must be changed. The Spanish people have voted for it to be changed, in their own referendum. The Government holds back on this change, because to make it legal would force banks to announce that all these human “for life” assets are now liabilities that must be provisioned for and written off. Quite simply, if Spain joined the civilised world in its treatment of mortgage debt, it would immediately have another banking crisis.

The IMF then opined that 20% of European corporate debt is insolvent^[xvi]. Evidence suggests that European banks are raising lending standards; and choking off credit to the majority of European small and medium companies, that rely on them rather than capital markets^[xvii]. The bank lending market and the capital markets are therefore closed to the private sector. No wonder the Germans are baulking at Banking Union and Bailouts.

Mario Draghi felt the way the wind was blowing; and swiftly rejected further “do whatever it takes” measures, without the politicians taking the initiative^[xviii]. The best that Draghi can do is  to offer a conciliation rate cut, as a knee jerk reaction to the weakening data^[xix]. Weidmann and Schaeuble have already discounted the positive effects of this action; and undermined it as a consequence.

The situation in Europe was best summarised by Hubert Vedrine. Germany won’t pay and the other nations won’t lose sovereignty; the European Project as it has been conceived is now dead^[xx]. Europe once again is split along a Franco-German red line, which is stretching into the global economy.

Moving to America, members of the Federal Reserve have clearly shown the way the wind is blowing.

Starting with those who are fighting against the wind, Charles Plosser provides the strongest key signal that the Helicopter is gaining momentum^[xxi]. He recently opined that he would like to get back to where the Fed was in 2011, when it was considering exit strategies. He concedes that this is a lost cause; because the exit strategy envisioned back then has been totally undermined by the evolution of QE2, the Twist and QE3 since then. He provides the insight that the real benchmark rate is now the Interest Rate Paid on Reserves (IOR), rather than the Fed Funds Rate (FFR). The IOR is controlled by the Federal Governors rather than the FOMC; so that the FOMC has effectively introduced a duality into monetary policy and control in the economy, by expanding the balance sheet. Assuming that the balance sheet remains expanded, the role of the FOMC in the economy has been diluted and control of the dual mandate has been lost.

Jeffrey Lacker also tried his best to throw a spanner into the Helicopter works^[xxii]. Unfortunately, he has been disarmed by the fact that he must concede that inflation is falling. The best that he can do is to say that there is disinflation rather than deflation. This euphemism will get blown away, on the way to Jackson Hole, if inflation continues to fall.

Further key signals were provided by those who are blowing with the wind. James Bullard is the doyen of this cadre. With one eye on the soon to be vacated Chair, he is carefully crafting a CV that is bespoke to the economic and political imperative of the moment. He first eviscerated his opponents, Kocherlakota and Evans, by accusing them of being too “Employment-Centric“^[xxiii]. Having moved the debate onto an inflation basis, he then went on to carefully position himself as the gatekeeper to low inflation with more easy money; by hinting that, in his esteemed judgement, inflation was low enough to justify easier conditions^[xxiv]. Presumably, the new duality in control at the Fed, is the reason why the alert Bullard is anchoring the debate (and his CV!!!) back onto inflation; whilst appearing to go with the flow.

To counter Bullard and also Schaeuble’s global ambitions, Kocherlakota employed a unique circular logic^[xxv]. The market conditions which are the consequence of the Helicopter downdraft that the bears are supposed to run from, should be embraced in his New Normal. Rather than run from asset inflation, higher price volatility and out of control M&A rather than capital investment, speculators should embrace them and accept that they are part of the process of economic healing. What the classical bears see as reasons to sell, should be accepted as confirmation signals of successful execution of Fed policy. This process should be accepted for “several years“^[xxvi], implying that the balance sheet is expanded indefinitely.

The conditions precedent in Europe for the Helicopter and the preparation of global public opinion to light the Helipad are actively under management.