My Weekly Commentary: Store of Value

Credit Bubble Weekly • Feb 14 2015

Doug Noland Posted on February 14, 2015

If I had my druthers, politics would be kept a safe distance apart from economic analysis. The economics profession, however, is guided by a policymaking focus. Economists are compelled to choose sides – Democrat or Republican – “liberal” or “conservative.” This arrangement has proved the death knell for objective analysis. Worse yet, such divergent views of how the world works ensure there can be no meeting of the minds or compromise – especially during crucial periods of economic instability.

I admit to providing space for Krugman on my bookshelves. There was a time when I respected the Nobel prize-winning economist as a thoughtful and provocative economic thinker. He’s evolved into a forceful political commentator. Paul Krugman’s New York Times’ columns are widely read. Of importance to me, Krugman has become the most public figure espousing the virtues of inflationism.

It’s crunch time for money and Credit analysis – discredited Greek debt and the question of ongoing participation in the euro monetary experiment; faltering currencies and Credit at the EM “periphery”; a runaway Credit Bubble in China; flagrant competitive currency devaluation; ongoing open-ended QE by the world’s major central banks; collapsing commodities markets, general global disinflationary forces in real economies and record securities prices; and generally unprecedented central bank intervention at home as well as around the globe. A Friday headline from the Financial Times: “Central Banks Take Extreme Action to Stave off Deflation.” Thursday from Bloomberg: “Central Banks Now Open 24/7 Fighting Currency Wars and Deflation.”

After six years of unprecedented central bank monetary measures, an end is still nowhere in sight. The highly abnormal has become the enduring normal. Indeed, the global monetary backdrop gets crazier by the week – and everyone’s fine with it. Federal Reserve policymaking is now celebrated as an indisputable success – testament to what injecting $3.6 TN of new “money” into securities markets can accomplish. And each week the world seems a bit closer to coming completely unglued.

Of late, Dr. Krugman has directed his attention – and caustic partisan aggression – around the critical issues of money and Credit. There was Monday’s “Nobody Understands Debt”, Tuesday’s “There’s Something About Money (Implicitly Wonkish)” and Friday’s “Money Makes Crazy.”

From “Money Makes Crazy: Monetary policy probably won’t be a major issue in the 2016 campaign, but it should be. It is, after all, extremely important, and the Republican base and many leading politicians have strong views about the Federal Reserve and its conduct… So it matters that the emerging G.O.P. consensus on money is crazy — full-on conspiracy-theory crazy. Right now, the most obvious manifestation of money madness is Senator Rand Paul’s ‘Audit the Fed’ campaign. Mr. Paul likes to warn that the Fed’s efforts to bolster the economy may lead to hyperinflation; he loves talking about the wheelbarrows of cash that people carted around in Weimar Germany. But he’s been saying that since 2009… So now he has a new line: The Fed is an overleveraged bank, just as Lehman Brothers was, and could experience a disastrous collapse of confidence any day now. This story is wrong on so many levels that reporters are having a hard time keeping up, but let’s simply note that the Fed’s ‘liabilities’ consist of cash, and those who hold that cash have the option of converting it into, well, cash. No, the Fed can’t fall victim to a bank run.”

“Monetary policy… after all, is extremely important” – is an understatement. I have argued misguided policy activism unleashed the “global government finance Bubble” – the “Granddaddy of All Bubbles”. I remain a proponent of sound central banking, having never called for abolishing the Federal Reserve. I have pleaded instead for a disciplined rules-based approach to monetary management. Giving a small group of unelected officials full discretion to experiment with “printing” Trillions of new “money” is a recipe for unmitigated disaster. Indeed, global central bankers are these days at the precipice of a crisis of confidence in the “money” they too freely propagate. This runaway six-year (plus) monetary experiment should be hotly debated right now – outside the realm of political mudslinging.

From “There’s Something About Money (Implicitly Wonkish)”: “Here’s my current thought: in some sense money is a really weird thing, which can look to individuals like a real asset — cold, hard, cash — but is ultimately, as Paul Samuelson put it, a ‘social contrivance’ whose value is more or less conjured out of thin air. Mainstream macroeconomics acknowledges the weirdness — in particular, makes heavy reliance on the ability of central banks to create more fiat money at will — but otherwise treats money a lot like ordinary goods. But that intellectual strategy doesn’t come naturally to many people, so there’s always a constituency for monetary cranks.”

Finding rare common ground, I agree “there’s always a constituency for monetary cranks.” Throughout hundreds (for that matter, thousands) of years of history, inflationism has time and again been debunked and the inflationists revealed as “monetary cranks.” Yet these days monetary inflation’s sordid history goes completely neglected – as if it doesn’t even exist. Krugman’s discussion touches upon money as a “medium of exchange.” Naturally, the critical issue/attribute of money as a “Store of Value” goes, as it invariably does, unmentioned by inflationists and monetary quacks alike. And using monetary inflation to inflate securities and asset markets ensures an inflation constituency of tens of millions (certainly including the “rich and powerful”).

This gets to the heart of today’s critical issue – just as it did about 300 years ago with John Law’s failing paper money experiment in France (“Mississippi Bubble” period): Once commenced, monetary inflation and resulting unsustainable Bubbles and economic maladjustment swell beyond control. At some point, money’s critical “Store of Value” attribute begins to be questioned. Officials invariably counter with a (terminal) reckless Credit expansion in a desperate attempt to sustain the teetering financial scheme. A crisis of confidence becomes inevitable.

Krugman: “But the conclusion of generations of macroeconomists has been that for most purposes models that treat money as if it were an ordinary good are good enough; whereas attempts to ground everything in models in which the role of money is in some (weak) sense derived rather than assumed have been generally useless. Still, there’s always an undercurrent of unease. And you can find heterodox economists on the left as well as the right unhappy with the standard approach. Now, the elder and younger Pauls know nothing of this, nor, I suspect, does Paul Ryan. But that may be the point: having no contact with the intellectual tradition of macroeconomics, they find the role of money in the economy a great mystery and possibly an outrage — how dare banks/governments/the Illuminati pretend to create value out of nothing! Fiat money, whether created by the government or by banks, seems to them to be a violation of natural law; creating more fiat money in an attempt to relieve economic distress must surely lead to disaster.”

Unless they’ve exposed themselves to a lot of “outside” reading, contemporary economists are poorly prepared for today’s Great Monetary Debate. After all, economic curriculums are sadly devoid of money and Credit history and theory. As lunatic fringe as it sounds, one can throw out virtually everything conventional economics has to say on the subject. “The intellectual tradition of macroeconomics” – at least from the fashionable American perspective – leads to misunderstanding, confusion, misdiagnosis and deeply flawed policies.

“This in turn leads to the basic Hicks model of an economy in which there are three markets — for money, bonds, and goods — which are treated symmetrically; add price stickiness and that model becomes IS-LM. New Keynesian economics pretty much takes that base and adds explicit modeling of intertemporal choices and rational expectations. Dealing with monetary economics this way lets you address monetary and fiscal policy in terms of lucid, elegant little models that are quite intuitive once you get used to them, but not at all intuitive to people who haven’t learned to think this way — witness the debates we’ve had since 2008… The sad thing is that this epistemological panic is gaining a growing hold over American conservatives at a time when the standard way of dealing with money has, in fact, been covering itself in glory. That Hicksian approach, in which money is treated symmetrically with bonds and goods, made strong predictions about what happens with interest rates near zero — predictions that the Fed could expand its balance sheet many times over without inflation, that governments could borrow vast sums without driving up interest rates, that slashing government spending would cause private spending to fall rather than rise.”

“The standard way of dealing with money has, in fact, been covering itself in glory.” Showing restraint, I’ll simply say, “history will be unkind”. And toss out the “Hicks model,” “IS-LM” modeling and econometric models in general. They add no value when discussing today’s world dominated by market-based finance and aggressive market-distorting monetary management. Today’s inflationists call upon archaic econometric tools, at best, as pretext for sophistication and analytical credibility. At worst, it’s blatant obfuscation.

From “Nobody Understands Debt.” “All this austerity has, however, only made things worse — and predictably so, because demands that everyone tighten their belts were based on a misunderstanding of the role debt plays in the economy. You can see that misunderstanding at work every time someone rails against deficits with slogans like ‘Stop stealing from our kids.’ It sounds right, if you don’t think about it: Families who run up debts make themselves poorer, so isn’t that true when we look at overall national debt? No, it isn’t. An indebted family owes money to other people; the world economy as a whole owes money to itself. And while it’s true that countries can borrow from other countries, America has actually been borrowing less from abroad since 2008 than it did before, and Europe is a net lender to the rest of the world. Because debt is money we owe to ourselves, it does not directly make the economy poorer (and paying it off doesn’t make us richer). True, debt can pose a threat to financial stability — but the situation is not improved if efforts to reduce debt end up pushing the economy into deflation and depression.”

Credit is an economy’s lifeblood. Mismanage Credit and a system will eventually confront myriad problems – financial, economic and social. This truism has been on full display for a number of years now. Early economic thinkers were preoccupied with how seemingly sound economic booms could end in such mayhem. Post-mortem analysis inevitably came back to debasement of money and Credit.

“Because debt is money we owe to ourselves, it does not directly make the economy poorer (and paying it off doesn’t make us richer).”

One of monetary inflation’s myriad problems is that it instills a (fleeting) perception of rising wealth. Meanwhile, pernicious underlying forces perpetuate economic wealth destruction through the forces of misdirected spending, malinvestment and general misallocation of real and financial resources. Resulting wealth destruction, redistribution and misperceptions are for the most part masked so long as monetary inflation runs unabated. Hence, the more protracted the boom the greater the pressure for “activist” policy measures that inflate and obfuscate. In the end, systemic risk rises exponentially – in the face of rising perceptions of wealth and policy success – ensuring policymakers won’t either rock the boat or come clean on policy failings.

U.S. securities prices are at record highs. After peaking at about 14,000 in 2007, the DJIA Friday traded above 18,000. Friday’s record S&P 500 level is about a third higher than 2007 record highs. Broader market gains have been even more spectacular. The S&P 400 Mid-Cap index is up almost 270% from 2009 lows, with Friday’s close near 1,500 compared to 2007’s high of 927. The point is that perceived wealth has never reached such lofty levels. Monetary inflation has well-masked underlying maladjustments – at least at home. Elsewhere, the forces of monetary inflation – along with wealth misperceptions – are not holding up as well.

“You can see that misunderstanding at work every time someone rails against deficits with slogans like ‘Stop stealing from our kids.’”

The social instability resulting from wealth redistribution – between generations, classes and nations – is on increasing display throughout Europe. Indeed, the Greek economy, society and politics are today’s global poster child for the consequences of unsound money and Credit. As part of the euro experiment, Greek debt luxuriated in the perception of moneyness. This, in concert with global monetary abundance, ensured that Greece issued way too much Credit – extraordinarily loose finance that fueled unsustainable booms and attendant maladjustment. Over-issuance ensured Greek debt destroyed its moneyness attribute.

The powerful perception of a “Store of Value” was lost, with the resulting crisis of confidence in Greece’s debt having devastating consequences. After years of recurring crises, bailouts and failed policy responses, the Greeks have given up on the conventional. Too much of their population has come to believe they have little to lose. Desperation has taken over and the status quo is no longer acceptable. Radical policymakers have been elected to lead the country in a different direction. It’s time to regain sovereignty and dignity. Indicating the end of the status quo with important global ramifications, Greece will be forging closer relationships with Russia and China.

The Russian ruble has collapsed 43% in six months. It appears Russia’s leaders have also given up on the conventional. It’s time to regain sovereignty and respect – at the barrel of a gun if necessary. In Putin’s eyes, the status quo of a U.S.-dominated world is no longer acceptable. Both Russia and China are moving aggressively to build alliances, trading blocks and a financial apparatus that will function outside of U.S.-dominated systems. The Russians and Chinese have taken issue with U.S. monetary management – policies they now see as running counter-productive to their nations’ interests.

I have posited that recent decades have been unique in economic history. For the first time on a global basis, there were no constraints on either the quantity or quality of Credit. History has shown Credit’s proclivity for instability. I have argued that the transformation to market-based Credit – first in the U.S. and then globally – ensured acute instability. We’ve now seen global monetary managers go to incredible extremes – zero rates, massive ongoing monetization and previously unthinkable market intervention and manipulation – desperate to keep this financial scheme from imploding.

Inflationism is always the same. There’s never recognition that money printing is the root of the problem. Instead, the inflationists proclaim that policy has actually not been forceful enough. The answer is always to be found with just one more round of monetary inflation. The propaganda drifts precariously farther and farther away from reality.

“But I also suspect that conservatives have a deep psychological problem with modern monetary systems. You see, in the conservative worldview, markets aren’t just a useful way to organize the economy; they’re a moral structure: People get paid what they deserve, and what goods cost is what they are truly worth to society… Modern money — consisting of pieces of paper or their digital equivalent that are issued by the Fed, not created by the heroic efforts of entrepreneurs — is an affront to that worldview.”

By now, many should view “modern monetary systems” with deep concern. But record securities prices and market exuberance provide powerful palliative. They clearly ensure that the widening cracks in the global financial system go unnoticed. The inflationists have at this point succeeded fully in convincing everyone that deflation is the greatest risk to mankind. Meanwhile, the “Store of Value” issue festers. Gangrene is apparent at some extremities, as central bank “money printing” (as far as the eye can see) holds a crisis of confidence in global “money” and Credit at bay. Still, global policymakers won’t be able to create new debit and Credit electronic journal entries and convince folks it’s real wealth forever.

There will be no separating economics from politics – monetary management from ideologies. But could we at least debate the issue of sound money and Credit without resorting to partisan demagoguery. Considering what’s at stake, it is so pathetic it’s embarrassing.

For the Week:

The S&P500 jumped 2.0% (up 1.0% y-t-d), and the Dow gained 1.1% (up 1.1%). The Utilities sank 3.4% (down 5.1%). The Banks gained 1.7% (down 2.3%), and the Broker/Dealers advanced 1.5% (down 1.7%). The Transports increased 1.0% (down 1.2%). The S&P 400 Midcaps rose 1.8% (up 3.5%), and the small cap Russell 2000 gained 1.5% (up 1.5%). The Nasdaq100 surged 3.7% (up 3.5%), and the Morgan Stanley High Tech index jumped 3.8% (up 2.7%). The Semiconductors spiked 5% higher (up 2.7%). The Biotechs rose 3.0% (up 8.0%). With bullion down $4, the HUI gold index fell 1.0% (up 16.4%).

One- and three-month Treasury bills rates ended the week at less than a basis point. Two-year government yields were little changed at 0.64% (down 2bps y-t-d). Five-year T-note yields gained six bps to 1.54% (down 12bps). Ten-year Treasury yields jumped nine bps to 2.05% (down 12bps). Long bond yields rose 12 bps to 2.65% (down 10bps). Benchmark Fannie MBS yields gained seven bps to 2.77% (down 6bps). The spread between benchmark MBS and 10-year Treasury yields narrowed two to 72 bps. The implied yield on December 2015 eurodollar futures declined about two bps to 0.84%. Corporate bond spreads narrowed. An index of investment grade bond risk declined one to 65 bps. An index of junk bond risk dropped six bps to 344 bps. An index of EM debt risk fell four bps to 363 bps.

Greek 10-year yields dropped 82 bps to 9.12% (down 63bps y-t-d). Ten-year Portuguese yields slipped two bps to 2.37% (down 25bps). Italian 10-yr yields rose three bps to 1.60% (down 29bps). Spain’s 10-year yields gained six bps to 1.55% (down 6bps). German bund yields declined three bps to 0.34% (down 20bps). French yields added three bps to 0.64% (down 18bps). The French to German 10-year bond spread widened six to 30 bps. U.K. 10-year gilt yields increased three bps to 1.68% (down 8bps).

Japan’s Nikkei equities index gained 1.5% (up 2.7% y-t-d). Japanese 10-year “JGB” yields jumped a notable eight bps to 0.42% (up 10bps y-o-y). The German DAX equities index advanced 1.1% (up 11.8%). Spain’s IBEX 35 equities index gained 1.6% (up 4.5%). Italy’s FTSE MIB index jumped 2.1% (up 11.5%). Emerging equities were mostly higher. Brazil’s Bovespa index rallied 3.8% (up 1.3%). Mexico’s Bolsa gained 0.8% (down 0.2%). South Korea’s Kospi index was little changed (up 2.2%). India’s Sensex equities index gained 1.3% (up 5.8%). China’s volatile Shanghai Exchange surged 4.2% (down 1.0%). Turkey’s Borsa Istanbul National 100 index rose 1.0% (up 0.1%). Russia’s MICEX equities index surged another 4.7% (up 31.6%).

Debt issuance was decent. Investment-grade issuers included Microsoft $10.75bn, Wells Fargo $2.5bn, Citigroup $4.5bn, Lockheed Martin $2.25bn, Wynn Las Vegas $1.8bn, Key Bank $1.0bn, Rockwell Automation $600 million, Goldman Sachs $500 million, ERAC USA Finance $500 million, Lazard Group $400 million, Affiliated Managers Group $350 million and Johns Hopkins $165 million.

Convertible debt issuers included Wright Medical Group $550 million, Primero Mining $80 million, Global Eagle Entertainment $75 million and Oclaro $55 million.

Junk funds saw a third straight week of big inflows, $2.9bn according to Lipper. Junk issuers included Univision Communications $1.95bn, Citgo $1.5bn, American Tire Distribution $805 million, Ally Financial $650 million, Lennar $600 million, MPLX LP $500 million, KB Home $250 million, Cogent Communications $250 million, Suburban Propane $250 million, NWH $135 million and Third Point RE $115 million.

International debt issuers included BP Capital $2.75bn, Deutsche Bank $2.5bn, Asian Development Bank $2.25bn, Cleopatra Finance $2.7bn, European Bank of Reconstruction & Development $1.0bn, Instituto de Credito Official $800 million, Buenos Aires $500 million and International Bank of Reconstruction & Development $250 million.

Freddie Mac 30-year fixed mortgage rates jumped 10 bps to 3.69% (down 59bps y-o-y). Fifteen-year rates increased seven bps to 2.99% (down 34bps). One-year ARM rates were up three bps to 2.42% (down 13bps). Bankrate’s survey of jumbo mortgage borrowing costs had 30-yr fixed rates down eight bps to 4.36% (down 2bps).

Federal Reserve Credit last week added $0.9bn to $4.462 TN. During the past year, Fed Credit inflated $389bn, or 9.6%. Fed Credit inflated $1.651 TN, or 59%, over the past 118 weeks. Elsewhere, Fed holdings for foreign owners of Treasury, Agency Debt last week gained $2.4bn to $3.260 TN. “Custody holdings” were down $53bn over the past year, or 1.6%.

Global central bank “international reserve assets” (excluding gold) – as tallied by Bloomberg – were down $74bn y-o-y, or 0.6%, to a new one-year low $11.629 TN. Reserve Assets are now down about $400bn from the August 2014 peak. Over two years, reserves were $670bn higher, for 6% growth.

M2 (narrow) “money” supply surged $71.6bn to a record $11.786 TN. “Narrow money” expanded $713bn, or 6.4%, over the past year. For the week, Currency was little changed. Total Checkable Deposits surged $52.0bn, and Savings Deposits gained $21.1bn. Small Time Deposits slipped $0.9bn. Retail Money Funds declined $0.6bn.

Money market fund assets gained $4.3bn to $2.690 TN. Money Funds were down $23.2bn over the past year, or 0.9%.

Total Commercial Paper increased $6.1bn to $995bn. CP increased $4bn over the past year, or 0.4%.

Currency Watch:

The U.S. dollar index declined 0.5% to 94.201 (up 4.4% y-t-d). For the week on the upside, the New Zealand dollar increased 1.3%, the British pound 1.0%, the euro 0.7%, the Canadian dollar 0.6%, the Danish krone 0.6% and the Japanese yen 0.3%. For the week on the downside, the Brazilian real declined 1.9%, the South African rand 1.4%, the South Korean won 0.7%, the Swiss franc 0.6%, the Australian dollar 0.4%, the Swedish krona 0.3%, the Mexican peso 0.3% and the Singapore dollar 0.2%.

Commodities Watch:

The Goldman Sachs Commodities Index jumped 3.8% (up 1.9% y-t-d). Spot Gold slipped 0.4% to $1,229 (up 3.8%). March Silver rose 3.6% to $17.29 (up 11%). March Crude gained $1.09 to $52.78 (down 1%). March Gasoline jumped 4.3% (up 11%), and March Natural Gas rallied 8.7% (down 3%). March Copper increased 0.8% (down 8%). March Wheat gained 1.1% (down 10%). March Corn rose 0.4% (down 3%).

U.S. Fixed Income Bubble Watch:

February 10 – Bloomberg (Elliott Stam): “The riskiest companies face $791 billion of maturing debt during the next five years, underscoring concern that issuers that have been gorging on junk-rated bonds and loans will struggle to refinance as interest rates rise, according to Moody’s… Corporate borrowers will need to refinance or repay $476 billion in bank credit facilities and $315 billion in high-yield bonds between now and the end of 2019… The refinancing needs are the highest since Moody’s projections in 2010, according to the report.”

U.S. Bubble Watch:

February 10 – Bloomberg (Alan BjergaJeff Wilson): “Declining commodity prices will reduce the 2015 cash profits of U.S. farmers to $89.4 billion, the third straight decline and the biggest single-year drop since 1931-1932, according to the Department of Agriculture. Revenues from corn, wheat and other crops will be $182.6 billion, a 7.9% decline from 2014… Livestock sales will fall 4.9% from last year’s record…Our ability to produce is outrunning our markets,’ said Harwood Schaffer, an agricultural economist at the University of Tennessee… ‘Farmers are getting squeezed.’ Boom times are ending for U.S. farmers, who are tightening their belts as low crop prices and rising costs erode incomes that peaked earlier this decade. Decreasing profits is also eroding the value of land, Farmers National Co., which manages 2.1 million acres of farmland in 24 states, said last week.”

February 11 – New York Times (William Alden and Sydney Ember): “They are only in their early to mid-20s, but some young bankers on Wall Street are the most sought-after financiers around, with lucrative pay packages dangling before them. Junior investment bankers who graduated from college only last year are being madly courted by private equity firms like Apollo Global Management, the Blackstone Group, Bain Capital and the Carlyle Group in a scramble that kicked off last weekend… Fearful of missing the best talent being developed at investment banks, the giants of private equity have turned Wall Street’s white-collar entry-level workers into a hot commodity. ‘It’s as if these were star athletes,’ said Adam Zoia, chief executive of the recruiting firm Glocap Search… ‘The irony is they are professionals six, seven months out of undergrad. It’s hard to imagine you can tell if someone’s a star or not.’”

February 12 – Bloomberg (Masahiro Hidaka): “Operating in the shadow of Freddie Mac’s business as America’s second-largest guarantor of home loans, the company’s unit serving apartment landlords is booming as borrowers take advantage of looser lending terms. The mortgage company underwrote $21.2 billion of debt on apartment buildings in the second half of 2014, triple the total in the first six months… Melvin L. Watt, who took over as director of the Federal Housing Finance Agency last year, is rolling back policies aimed at shrinking the government-controlled finance companies, letting Freddie Mac push into segments of multifamily lending that had been off limits. That’s helping bolster demand for apartment buildings, already the hottest part of the commercial real estate market… Apartment values have been rising steadily since 2010… Multifamily buildings in large cities such as New York and San Francisco have had the biggest gains in the real estate recovery, with prices 40% higher than the record reached in November 2007, during the last boom.”

Federal Reserve Watch:

February 10 – Wall Street Journal (Michael S. Derby): “Federal Reserve Bank of Kansas City President Esther George said it is a mistake for policymakers to rely on regulatory powers alone to deal with financial market imbalances. In a speech… the central banker argued that modest rate rises early in a business cycle can help restrain the sort of forces that can later metastasize into damaging financial bubbles. ‘Interest rate policy used earlier in the cycle can foster a more stable financial landscape as a business cycle matures,’ Ms. George said… Ms. George has long been uneasy with the ultra-easy stance of near-zero interest rates currently maintained by the Fed. She is one of a small group of Fed officials who have worried Fed policy is creating too much risk in financial markets. Very easy Fed policy is designed to drive investors into riskier assets because that type of buying is more likely to create stronger levels of growth. But with stock indexes moving sharply higher, amid rock bottom borrowing costs and signs of excess in some sectors, some worry Fed policy is distorting markets… ‘Policymakers should reassess the assumption that monetary policy and macroprudential regimes can be used independently,’ she said. ‘Modestly tighter policy earlier in the business cycle expansion could moderate risk-taking and the potential for destabilizing financial imbalances to build…’ Getting ahead of markets is important: ‘Once asset values or credit growth has risen to a level warranting concern, it is likely too late for monetary policy to smoothly unwind these imbalances without triggering a sharp reversal that ultimately inflicts damage on the real economy,’ she added.”

Global Bubble Watch:

February 13 – Bloomberg (Matthew Boesler): “When Group of 20 finance ministers this week urged the Federal Reserve to ‘minimize negative spillovers’ from potential interest-rate increases, they omitted a key figure: $9 trillion. That’s the amount owed in dollars by non-bank borrowers outside the U.S., up 50% since the financial crisis, according to the Bank for International Settlements… The dollar debt is just one example of how the Fed’s tightening would ripple through the world economy. From the housing markets in Canada and Hong Kong to capital flows into and out of China and Turkey, the question isn’t whether there will be spillovers — it’s how big they will be, and where they will hit the hardest.”

February 10 – Bloomberg (Christine Idzelis and Sally Bakewell): “Mario Draghi’s trillion-euro stimulus plan is proving a boon to Europe’s junk-debt market. After the European Central Bank helped push borrowing costs for the riskiest companies toward a record low, Swiss packaging company SIG Combibloc Group AG scrapped plans to help fund its buyout with dollar-denominated bonds, issuing the entire amount this month in euros… Speculative-grade borrowers have issued the equivalent of $19.1 billion of bonds in Europe this year, more than double the amount sold by this time in 2014… That’s the busiest start to a year ever. In the U.S., sales are up 10% to $33.1 billion.”

February 10 – Bloomberg (Christian Wienberg): “Less than a week after Denmark resorted to its deepest rate cut ever amid historic currency interventions, forward rates suggest some traders and investors still aren’t convinced the central bank can save its euro peg. SEB AB, the largest Nordic currency trader, says capital flows into AAA-rated Denmark forced the central bank to dump about $4.6 billion in kroner in the first three days of February alone, almost a third the record amount it sold in all of January…‘The pressure on the krone hasn’t eased yet,’ Jens Naervig Pedersen, an economist at Danske Bank… said… ‘We can see from the forward rates that the market views the current upward pressure on the krone as the greatest ever.”

February 10 – Reuters (Karen Freifeld): “New York’s financial regulator has sent subpoenas to Goldman Sachs, Credit Suisse, BNP Paribas and Societe General, expanding its probe into the possible rigging of foreign exchange rates through computer programs, people familiar with the matter said… The department is already probing Barclays and Deutsche Bank over their electronic trading platforms and installed monitors in those banks for a closer inside look at what’s going on.”

Europe Watch:

February 12 – Reuters (Jan Strupczewski): “The European Central Bank could help reduce the euro zone’s debt overhang by acquiring all euro zone bonds maturing between 2016 and 2020 as well as the associated interest payments, the chief economist of Syriza, Greece’s ruling party, said. John Milios told a debt seminar in the influential Bruegel think-tank in Brussels that each euro zone country would then buy back its debt from the ECB once their value fell to below 20% of that country’s gross domestic product. ‘The ECB will pay the bill, but it would also keep the profits. By 2040 the ECB would be able to erase all losses through these profits,’ Milios told the seminar. The idea would help kick start the economies all over the euro zone, he said, including Italy and Spain.”

February 13 – Financial Times (Peter Spiegel): “After two weeks of public sniping and closed-door debating, it comes down to this: on Monday, eurozone finance ministers gather in Brussels for a final showdown with Athens over whether to extend, or end, Greece’s €172bn bailout. Technical teams from Athens and its international creditors — the European Commission, European Central Bank and International Monetary Fund — are due to spend the weekend laying out the differences between the current bailout and the alternatives demanded by Greece. But the job of narrowing these differences falls to Yanis Varoufakis, the Greek finance minister, and his 18 counterparts. So how might Monday’s showdown end? An extension. This has long been the preferred option of Brussels and Berlin. They have urged Athens to give itself breathing room by requesting a six-month extension of the bailout, due to expire on February 28, and negotiating the terms for its completion which will trigger the release of a final €7.2bn in aid. Then, EU officials have argued, a new bailout more to Athens’ liking could be worked out.”

February 11 – Reuters (Lefteris Papadimas and Alastair MacDonald): “Greek Prime Minister Alexis Tsipras comfortably won a confidence vote on his plan to cancel a deeply unpopular bailout programme… In a rousing speech to parliament, Tsipras hailed the decisive role ‘little Greece’ was playing in reshaping Europe and promised Athens would not cave in to demands it extend its international bailout ‘no matter how much’ German Finance Minister Wolfang Schaeuble asked for it. ‘We are not negotiating the bailout; it was cancelled by its own failure,’ he told parliament before winning the vote with the backing of 162 lawmakers in the 300-seat chamber. ‘I want to assure you that there is no going back. Greece cannot return to the era of bailouts.’ That came after Schaeuble said that if Greece did not want a new aid programme, ‘then that’s it,’ adding to a chorus of warnings from European policymakers urging Athens to seek an extension to the programme when it expires at the end of the month.”

February 13 – Bloomberg (Lorenzo Totaro and Alessandra Migliaccio): “Italy’s economy stagnated in the three months through December, failing to rebound from its longest recession on record. Gross domestic product was unchanged from the previous quarter when it dropped 0.1%… From a year earlier, GDP fell 0.3%.”

ECB Watch:

February 13 – Bloomberg (Jeff Black): “The European Central Bank is sending a message to the euro-area’s leaders: don’t make us pull the trigger on Greece’s banks. After the… ECB blessed the expansion of so-called Emergency Liquidity Assistance to the debt-stricken country’s lenders by about 5 billion euros ($5.7 billion) on Thursday, officials are insisting that continued support is contingent on political talks over Greece’s bailout… The ECB does not want to be pushed into a position where it is making decisions on the future of the Greek banking system — and the country’s membership of the euro — without political cover from European capitals. If talks on a ‘bridge’ financing deal for Greece break down again, ECB President Mario Draghi will have to weigh whether to ration funds further or threaten a veto, just as he did in Cyprus two years ago. ‘Ending ELA would be a very last-resort type of intervention, paramount to a nuclear option,’ said Henrik Enderlein, professor of political economy at the Hertie School of Governance in Berlin. ‘The ECB would never really want to use it, as it is basically the same as pushing Greece out of the euro area.’”

February 13 – Wall Street Journal (Todd Buell): “There was no urgent need for the European Central Bank to embark on a program of quantitative easing, since the current decline in inflation rates is temporary and it isn’t having a negative effect on the broader economy, ECB Governing Council member Jens Weidmann said… Mr. Weidmann said that ECB rate-setters face a tough task but that he felt ‘there was no immediate need for this particular measure,’ referring to the ECB’s purchases of government bonds, known as QE. ‘What we are currently seeing is a disinflationary process, not a deflationary spiral of decreasing prices and wages… The risk of self-reinforcing deflation is still considered to be very low. And this is not only my assessment, but that of most other Governing Council members, too.’”

Central Bank Watch:

February 12 – Bloomberg (Simon Kennedy): “Central banks are now open all hours. Just as they worked weekends through the financial crisis, policy makers are again signaling they can strike at any time for the good of their economies. Spooked by the threat of deflation, Sweden’s Riksbank became the latest to put investors on alert when it said on Thursday that it’s ‘prepared to do more at short notice’ after cutting its main interest rate below zero and unexpectedly saying it will buy government bonds. ‘To ensure that inflation rises towards the target, the Riksbank is prepared to quickly make monetary policy more expansionary, even between the ordinary monetary policy meetings, should the need arise,’ it said… The world’s oldest central bank is not alone in throwing out its normal agenda. The Reserve Bank of India ignored its calendar of policy meetings to cut its key rate on Jan. 15, while Russia’s central bank increased its benchmark at 1 a.m. on Dec. 16… The ad-hoc actions undermine the traditional preference of central banks to be predictable and transparent.”

February 13 – Financial Times (Chris Giles in London and Richard Milne): “Central banks are resorting to ever more radical means to prevent deflation strengthening its grip over European economies, with the Swedish Riksbank on Thursday becoming the first to set a negative main policy interest rate. Many monetary policy authorities have set negative deposit rates for banks in recent years, including the European Central Bank, Swiss National Bank and Nordic central banks, but the Swedish move was a first for the main repo rate paid to the banking system.”

China Bubble Watch:

February 12 – Financial Times (Gabriel Wildau): “China’s central bank engineered a quiet revolution in monetary policy last year, newly released data have shown, as authorities invented tools to grow the money supply in response to a dramatic fall in capital inflows. For most of the past decade, the People’s Bank of China’s main challenge was to sterilise huge inflows of foreign exchange in order to prevent runaway money growth. Its task now is the opposite: find new ways to inject funds to fill the gap as huge inflows turn to moderate outflows. The PBoC’s latest monetary policy report shows that base money creation through central bank purchases of foreign exchange fell to Rmb640bn last year, a decrease of Rmb2.1tn from 2013. By contrast, monetary policy tools — including open market operations and other forms of lending by the PBoC to commercial banks — injected Rmb2tn in base money last year, compared with a Rmb100bn drain in 2013… In a sign of the capital outflow with which authorities are grappling, the PBoC’s foreign assets fell by Rmb155bn in the past six months, compared with a Rmb1.4tn increase in the same period of 2013, as investors swapped renminbi for foreign currency.”

February 13 – Bloomberg: “China’s broadest measure of new credit rose for a third straight month, suggesting stimulus measures are cushioning a slowdown in the world’s second-largest economy. Aggregate financing was 2.05 trillion yuan ($328bn) in January, the People’s Bank of China said… Trust and entrusted loans, vehicles for shadow lending, dropped from December as local-currency bank lending doubled from a month earlier… ‘Bank lending is stronger than expected, and it can help keep economic growth from slowing further,’ said Xu Gao, chief economist at Everbright Securities Co. in Beijing. ‘It’s particularly positive for January because most of the new yuan loans were probably used for economic activities on the ground’ after the government sought to curb lending for stock purchases last month, he said. New yuan loans totaled 1.47 trillion yuan, up from 697.3 million in December. M2 money supply rose 10.8% from a year earlier, the slowest pace since at least 1996…”

February 10 – Reuters (Kevin Yao and Judy Hua): “China’s outstanding total social financing (TSF), a broad measure of liquidity in the economy, rose to 122.86 trillion yuan ($19.7 trillion) at the end of 2014, up 14.3% from a year earlier, the central bank said… This is the first time the People’s Bank of China has released data on outstanding TSF, which captures lending outside traditional loans, such as trust loans and other forms of shadow financing… Policymakers have been trying to reduce the economy’s reliance on credit and investment – a legacy of massive stimulus launched during the height of the global crisis in 2008-09, but they have to tread cautiously to keep economic growth on track. The government is also reining in riskier types of lending while trying to ensure that more funds from shadow financing are invested in the real economy rather than speculative activities. The central bank said outstanding TSF has kept an annual average growth of 19.3% since 2002, 2.7 percentage points faster than loan growth.”

February 13 – Bloomberg: “When consultant Bill Russo visited Chery Automobile’s headquarters in China’s eastern Anhui province about three years ago, he listened to the company’s plans to expand its factories to make as many as 1 million vehicles a year. But demand didn’t grow as planned. So Chery today has the capacity to make 900,000 vehicles annually—twice the number of cars it sold last year. Sales have slumped by one-third since their peak in 2010. ‘Chery is a classic case’ of overcapacity, says Russo… ‘The pressure is that once they receive the permission [from government authorities] to build, they feel like they have to build.’ …Domestic and foreign-based carmakers are building more factories in China than anywhere else, a construction binge that risks hurting margins in what remains one of the world’s most profitable vehicle markets. By 2017 there will be 140 car production plants in China, vs. 123 at the end of 2014… According to IHS Automotive forecasts, factories across the mainland in 2015 will be able to build 10.8 million more vehicles than will be sold in Greater China.”

February 13 – Financial Times (Gregory Meyer): “The emergence of ‘financial players’ from China has distorted the soyabean trade in the world’s biggest importer of the oilseed, helping depress results at trading house Bunge, the company said. The comment underlines the extent to which the rise of a Chinese shadow banking business that uses bulk material to back loans has upended commodities markets… Bunge said China-based ‘financial players’ had obtained financing at favourable rates to buy soyabeans because they were seen as ‘strategic commodities,’ then cashed in the stocks and re-lent at higher rates to retail borrowers. ‘The way they act in markets is not always logical,’ Soren Schroder, chief executive, said… ‘They’re in it for the financial arbitrage and not for the fundamental reason’ of processing a commodity.’”

February 13 – Bloomberg: “The latest hot product in China’s shadow-banking industry is giving Chen Ruogang the convenience of Internet commerce, triple the returns of deposits and regular free fruit hampers. It hasn’t bought him peace of mind. The 58-year-old film maker is earning a 9% return on an online platform connecting individuals with businesses in need of cash, higher than the 2.75% benchmark savings rate and the 6% he used to make on similar offline wealth-management products. The peer-to-peer lending site he invests with, called Lufax.com, finances everything from property to infrastructure, with some products carrying guarantees from China’s second-largest insurer. ‘I don’t care what the projects are about, I care more about the returns,’ Chen said…”

February 11 – Bloomberg (Fion Li): “Offshore yuan bond sales slumped 53% this year as borrowing costs in Hong Kong surged on bearish bets against the Chinese currency. Dim Sum note issuance fell to 26.2 billion yuan ($4.2bn), compared with 55.6 billion yuan a year earlier… The overnight interbank lending rate for yuan in Hong Kong has surged 217 bps since the end of last year and touched a record 8.6% on Feb. 6. That’s more than triple the past year’s average of 2.5%…”

Russia/Ukraine Watch:

February 13 – New York Times (Michael R. Gordon and Andrew E. Kramer): “The United States accused Russia on Friday of massing artillery and rocket systems around a contested town in eastern Ukraine and joining pro-Russian rebels in attacking Ukrainian forces, calling such actions a violation of the spirit of a cease-fire agreement signed just one day earlier. The accusation… also said that the Russian military had deployed air defense systems near the town, Debaltseve. Thousands of Ukrainian soldiers in Debaltseve have been reported to be surrounded by pro-Russian insurgents and fighting has escalated there ahead of the scheduled Saturday night start of the cease-fire. ‘The Russian military has deployed a large amount of artillery and multiple rocket launcher systems around Debaltseve, where it is shelling Ukrainian positions,’ Ms. Psaki said… ‘We are confident that these are Russian military, not separatist systems.’”

Brazil Watch:

February 11 – UK Guardian (Marussia Whately and Rebeca Lerer): “It should be the rainy season. Instead Sao Paulo state is experiencing a third consecutive year with soaring temperatures and rainfall patterns well below historic records. The main water reservoirs are operating at their lowest capacity. The Cantareira reservoir system, which serves more than nine million people in the state, is only 5% full. At the Alto Tietê reservoir network, which supplies three million people in greater Sao Paulo, water levels are below 15%. Simple calculations indicate that given the current level of consumption versus the predicted raining patterns there is only enough water on the system to last four to six months… Since 2013, after decades of warnings about misguided development policies and destructive land use practices, experts and civil society organisations have been calling for increasingly strong measures to reduce water consumption to keep the minimum secure levels for supply reservoirs. The calls have been ignored by the state government – the system’s main operator – and federal and municipal authorities turned a blind eye to the severity of the situation.”

February 9 – Bloomberg (Julia LeiteFilipe Pacheco): “The corruption scandal battering Petrobras has already cost bondholders $4 billion. With the oil producer facing billions of dollars in writedowns, investors are bracing for even more pain. Petroleo Brasileiro SA’s $41 billion of dollar-denominated debt has lost 10% of its value since Nov. 13, the day before the federal police said they found ‘strong evidence’ that at least seven builders formed a cartel to win public contracts, including 59 billion reais ($21bn) in orders from the state-controlled oil company.”

February 11 – Bloomberg (David Biller): “Brazil’s retail sales in December declined the most in 15 years and more than all estimates as the central bank continues to raise rates in the world’s second-biggest emerging market. Sales fell 2.6%, the weakest showing since the series began in 2000… That was below every estimate from 34 economists surveyed by Bloomberg… Consumption that was the locomotive for growth in Brazil over the last decade has undergone a downturn. Confidence plummeted in the face of a combination of stagnant growth and above-target inflation.”

EM Bubble Watch:

February 13 – Bloomberg (Charlie DevereuxEric Martin): “Argentine President Cristina Fernandez de Kirchner’s last 10 months in office were thrown into turmoil Friday when a prosecutor formally accused her of trying to cover up Iranian involvement in the 1994 bombing of a Jewish community center that killed 85 people. The accusation could lead to a trial and calls for the impeachment of the president, who under Argentine law has immunity while in office. Fernandez has denied the allegations, while her cabinet chief has called the evidence ‘flimsy.’ The charges came one month after Alberto Nisman, the former prosecutor in the case, was found dead with a bullet to the head.”

February 13 – Bloomberg (Anatoly Kurmanaev and Nathan Crooks): “Venezuela allowed the bolivar to devalue 69% against the U.S. dollar on its first day of trading on a new alternative market as President Nicolas Maduro struggles to boost confidence in the economy and avoid a default.”

February 13 – Bloomberg (Anoop Agrawal): “Citigroup Inc. is advising Indian companies to avoid unhedged overseas debt sales as central bank Governor Raghuram Rajan warns borrowers of exchange-rate risks. ‘Borrowing in dollars is like playing Russian roulette, especially if you’re borrowing relatively short term,’ Rajan said… Companies should hedge more or they ‘may find they are at the wrong end of the level given the global risks around.’ Citigroup is the leading underwriter as Indian companies raised $2.6 billion from global bond issues this year, adding to the record $18.8 billion in 2014 and $14.7 billion in 2013…”

Geopolitical Watch:

February 10 – UK Guardian (Ian Traynor): “In Brussels and other European capitals, the fear of Vladimir Putin is becoming palpable. The mood has changed in a matter of weeks from one of handwringing impotence over Ukraine to one of foreboding. The anxiety is encapsulated in the sudden rush to Moscow by Angela Merkel and François Hollande. To senior figures closely involved in the diplomacy and policymaking over Ukraine, the Franco-German peace bid is less a hopeful sign of a breakthrough than an act of despair. ‘There’s nothing new in their plan, just an attempt to stop a massacre,’ said one senior official. Carl Bildt, the former Swedish foreign minister, said a war between Russia and the west was now quite conceivable. A senior diplomat in Brussels, echoing the broad EU view, said arming the Ukrainians would mean war with Russia, a war that Putin would win.”

February 13 – Reuters (Benjamin Kang Lim and Ben Blanchard): “Chinese troops are rehearsing for a major parade in September where the People’s Liberation Army (PLA) is expected to unveil new homegrown weapons in the first of a series of public displays of military might planned during President Xi Jinping’s tenure, sources said. China will hold up to four PLA parades in the coming years in the face of what Beijing sees as a more assertive Japan under Prime Minister Shinzo Abe… The parades are also intended to show that Xi has full control over the armed forces amid a sweeping crackdown on military graft that has targeted top generals and caused some disquiet in the ranks… As military chief, Xi will review the parades and be saluted by PLA commanders during events expected to be broadcast nationwide. ‘Military parades will be the ‘new normal’ during Xi’s (two 5-year) terms,” the source with leadership ties said, referring to the phrase ‘xin changtai’ coined by Xi to temper economic growth expectations in China.”

February 13 – Bloomberg (Brian Bremner): “Japan’s shock, grief, and anger over the recent beheadings of two of its citizens by Islamic State has drawn into sharp focus the country’s ambivalence about the use of its military to protect its citizens and its interests. For decades, Japan was bound by its 1947 constitution to mobilize troops solely for self-defense. The country didn’t have the legal right to send armed troops abroad to protect its own people or back up allies who come under attack. Prime Minister Shinzo Abe is determined to change this Cold War arrangement…Today the country faces a far more complex set of threats than the Soviet invasion that it feared 70 years ago… Japan has also verbally clashed with China in a territorial dispute over islands in the East China Sea. And on Feb. 7, North Korea announced it had tested an ‘ultraprecision’ antiship rocket near Japan’s maritime border… Abe, a defense hawk and the scion of a prominent political family, has embarked on an overhaul of national security strategy.”

February 11 – Wall Street Journal (William Kazer): “U.S. businesses in China have voiced increased concerns over what they see as rising anti-foreign sentiment and more difficult operating conditions as the economy posts slower growth. An annual survey… of about 500 members of the American Chamber of Commerce in China found that most companies believe that foreign firms have been targeted in widely publicized government investigations for a range of anticompetitive practices. Many of those companies said this had reduced their interest in making fresh investments in China. Some 47% of the companies surveyed by the business group also said they felt they were less welcome than a year ago… Only 10% said they believed they were more welcome.”

February 10 – Financial Times (Sam Jones and Hannah Kuchler): “Chinese hackers hijacked the Forbes website and used it to target thousands of computers linked to blue-chip companies, including US defence contractors and banks, in one of the most brazen cyber espionage campaigns apparently launched by Beijing-linked groups so far. During a four-day period from November 28 to December 1 last year, any visitor to the Forbes website would have been infected by the Chinese attack, according to the cyber security company iSight Partners… It blamed a Chinese hacking group known as Codoso.”

Japan Watch:

February 12 – Bloomberg (Sarah Mulholland): “Bank of Japan policy makers view further monetary easing to shore up inflation as a counterproductive step for now, amid concern it could trigger declines in the yen that damage confidence, people familiar with the talks said…”

Doug Noland Posted on February 14, 2015