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Deus Ex Machina
"Human misery must somewhere have a stop; there is no wind that always blows a storm; great good fortune comes to failure in the end. All is change; all yields its place and goes; to persevere, trusting in what hopes he has, is courage in a man. The coward despairs."
"Talk sense to a fool and he calls you foolish."
"Those whom God wishes to destroy, he first makes angry."
"Question everything. Learn something. Answer nothing."
"The wisest men follow their own direction."
The tiny island of Salamis in Greece was the birthplace, in 480 BC, of one of the three great tragedians of the Classical Athenian era. Aeschylus and Sophocles were the other two, but the third member of that legendary triumvirate was not only the author of some 92 plays but also the subject of one of the earliest knock-knock jokes ever recorded:
Euripides trousers? You menda dese trousers.
OK, so the Ancient Greeks in general (and Athenian tragedians in particular) were hardly renowned for their jokes; and certainly, modern-day Greeks have painfully little to laugh about as their country slides headlong into a depression, thanks to political intransigence amongst European politicians; nonetheless, Euripides was a man who made his mark on the theatrical world and, despite his reputation as one of the great tragedians, he is widely acclaimed for having pioneered dramatic devices that were later adapted to comedy:
(Wikipedia): Euripides is identified with theatrical innovations that have profoundly influenced drama down to modern times, especially in the representation of traditional, mythical heroes as ordinary people in extraordinary circumstances. This new approach led him to pioneer developments that later writers adapted to comedy, some of which are characteristic of romance. Yet he also became "the most tragic of poets", focusing on the inner lives and motives of his characters in a way previously unknown. He was "the creator of ... that cage which is the theatre of Shakespeare's Othello, Racine's Phèdre, of Ibsen and Strindberg," in which "... imprisoned men and women destroy each other by the intensity of their loves and hates", and yet he was also the literary ancestor of comic dramatists as diverse as Menander and George Bernard Shaw.
Euripides' most famed works are familiar to anybody who studied the classics in school.
Heracles, The Suppliants, Helen, Medea, and Cyclops have all kept schoolchildren from having fun spellbound for hours, but there is one dramatic device with which Euripides became associated that has led to even his most celebrated works being heavily criticized by dramatic scholars (and by that I don't mean scholars with a flair for the dramatic, but rather those who study... oh, you know what I mean) down through the ages.
That dramatic device is known as deus ex machina, which literally translates as "god from the machine".
A deus ex machina plot device is something that solves a dramatic problem through the sudden (and often improbable) intervention of an outside agent in the form of a character, ability, object, or event.
(Wikipedia): Depending on how it's done, it can be intended to move the story forward when the writer has "painted himself into a corner" and sees no other way out, to surprise the audience, to bring a happy ending into the tale, or as a comedic device.
The first recorded usage of the term deus ex machina is widely acknowledged to have come in Horace's Ars Poetica, in which he warns aspiring poets never to use such a device to solve plot complexities. Horace makes reference to the usage of a primitive crane (mechane) by which the ancient Greeks used to lower actors playing gods onto the stage at opportune moments in order to resolve situations for which David E. Kelley himself could not have come up with a satisfactory plot twist.
Anybody not see where I'm going with this?
The massive global build-up of credit and leverage, fueled by cheap money, that was allowed to flourish in the years before the events of 2008 was as dead-end a plot progression as one could possibly imagine; and once the collapse post-Lehman manifested itself, it was clear that the only possible way to advance the story without having to go through an inevitable, even more painful second act, was through the use of a deus ex machina. And lo and behold, up stepped the world's central bankers, all of whom were blissfully happy to be lowered by crane onto the stage with instructions to employ whatever means they felt necessary — no matter how improbable these might seem to the audience — to move the story quickly towards the happy ending so craved by those in attendance.
Of course, one of the beauties of such dramatic devices is that, human nature being what it is, the audience is nearly always complicit in their willing suspension of disbelief — which, incidentally, is another term coined by a writer, this time Samuel Taylor Coleridge, who concluded, quite rightly, that:
... if a writer could infuse a "human interest and a semblance of truth" into a fantastic tale, the reader would suspend judgment concerning the implausibility of the narrative.
Perhaps these writer fellows are onto something.
Certainly, since the events of 2008, the "audience" has been only too happy to accept as perfectly normal many situations that previously would have had them stalking out of the theatre in droves.
I have covered many of these improbable situations in the pages of Things That Make You Go Hmmm... as well as in my various presentations, but the key point bears reinforcement: we are living in the midst of a gigantic laboratory experiment with all the attendant possibilities of something going BANG!
The more I ponder the situation in which the world finds itself as we approach the fifth anniversary of the Lehman bankruptcy, the more it is apparent to me that the deus ex machinae being dropped into each and every market around the world right now by our central banks, are dangling from a very rickety crane indeed.
The story so far is one of credit. Credit and debt. Credit and debt and confusion about the true driving forces behind world growth.
As can clearly be seen in the chart below, courtesy of the St. Louis Fed, the expansion of US GDP over the last 85 years pales in comparison to the growth in credit liabilities outstanding over the same period. In fact, since 2008, outstanding credit has picked up markedly and is once again tracing out a far steeper trajectory than GDP.
Source: St. Louis Fed
Felix Salmon addressed this phenomenon back in early 2012:
(Reuters): From 1970 through the beginning of the crisis in 2008, [US] GDP grew at a pretty steady pace. But the amount of debt required to generate that output just got bigger and bigger — the rate of growth of the credit market was much faster than the rate of growth of GDP.
In 1970, GDP was $1 trillion while the credit market was $1.6 trillion: a ratio of 1.6 to 1. By 2000, when GDP reached $10 trillion, the credit market had grown to $28.1 trillion: a ratio of 2.8 to 1. And by mid-2008, when GDP was $14.4 trillion, the credit market was $53.6 trillion. That’s a ratio of 3.7 to 1.
But, of course, this hasn't mattered to the audience, who thus far have felt richer, seen their standard of living improve, and enjoyed unprecedented prosperity, as first the West and latterly the East have boomed.
This story of credit outstripping real growth is hardly confined to the USA.
Take Australia for example. Slightly different credit metric, eerily similar chart:
Source: Mark the Graph
China? Well, they're not quite as forthcoming, of course, but a look at private-sector debt as a % of GDP certainly gives you the idea. Throw into the mix the stimulus package equal to 16% of GDP that was announced by the Chinese in November 2008, and the estimate (from S&P) that outstanding Chinese shadow banking credit totaled $3.7 trillion by the end of 2012 (equal to 34% of on-balance-sheet loans and 44% of GDP), and the picture starts to come into focus.
But what ingenious plot devices have the lowered gods been using to extricate the actors from the corner into which they have painted themselves?
Well, in a nutshell, they have taken a leaf out of The Book of Bruce (Dickinson) ... and called for more cowbell.
Now, I'm probably being presumptuous in assuming that everyone has seen the famous "More Cowbell" sketch from Saturday Night Live, so I include a link to it above; but, according to anecdotal evidence provided by none other than Christopher Walken himself in a Q&A session with Details.com, the sketch has certainly made it to my part of the world:
(Details.com): Q: A lot of guys my age are obsessed with your “More cowbell” routine from Saturday Night Live.
A: I was eating in a restaurant in Singapore, and an Asian couple was at the next table, and the guy turned to me and he said, “Chris, you know what this salad needs?” I said, “What?” He said, “More cowbell.”
QE has become the ultimate plot device of central bankers around the globe and, as many have predicted, they have now reached the point where the chances of extracting themselves gracefully have diminished to the point of virtual invisibility.
We have already seen QE morph from a switch...
(Alan Blinder): Chairman Bernanke first outlined the major components of its strategy in his July 2009 Congressional testimony, followed by a speech in October 2009 and further testimonies in February and March 2010. So by now we have a pretty good picture of the Fed’s planned exit strategy. Here are the key elements, listed in what may or may not prove to be the correct temporal order:
1. “In designing its [extraordinary liquidity] facilities, [the Fed] incorporated features ... aimed at encouraging borrowers to reduce their use of the facilities as financial conditions returned to normal”
2. “normalizing the terms of regular discount window loans”
3. “passively redeeming agency debt and MBS as they mature or are repaid”
4. “increasing the interest on reserves”
5. “offer to depository institutions term deposits, which ... could not be counted as reserves”
6. “reducing the quantity of reserves” via “reverse repurchase agreements”
7. “redeeming or selling securities” in conventional open-market operations.
... in which things are simply turned off once "normal conditions have been restored", to a dial:
(FOMC Minutes, May 2013): The Committee will closely monitor incoming information on economic and financial developments in coming months. The Committee will continue its purchases of Treasury and agency mortgage-backed securities, and employ its other policy tools as appropriate, until the outlook for the labor market has improved substantially in a context of price stability.
The Committee is prepared to increase or reduce the pace of its purchases to maintain appropriate policy accommodation as the outlook for the labor market or inflation changes. In determining the size, pace, and composition of its asset purchases, the Committee will continue to take appropriate account of the likely efficacy and costs of such purchases as well as the extent of progress toward its economic objectives. [emphasis added]
The Fed simply dials the stimulus up or down, depending on the market's requirements. Genius! What could be better?
But since the word tapering has entered the Fed's lexicon, things have been getting a little screwy around Chairman Bernanke's communications with the media.
It has become more than apparent to anyone paying attention that the market is focused on QE to the point of fixation, and now the gods have gotten themselves into something of a pickle as they try to advance the story.
Courtesy of this great chart from Soberlook, let's see what "tapering" might actually look like, shall we?
And there we have the facts of life on "tapering": the Fed's balance sheet will grow at an ever-so-slightly less steep rate once they start to taper.
Oh, but the fuss!
Stocks Plummet on Fed Tapering Fears — The Street
Mortgage Rates Surge as Fed Tapering Fears Mount — CNBC.com
Stocks Drift Higher as Weak Data Cool Tapering Fears — Fox Business
Bernanke's QE Dance: Fed Could Taper in Next Two Meetings — Forbes
Fed's Bullard wants inflation pickup before tapering QE — Reuters
Fed could start tapering QE3 this summer: Williams — Marketwatch
One thing that SHOULD be clear is that the audience has now completely forgotten about the play and is focused solely on the gods as they bounce about on the stage, waving their arms and agonizing over which of their dramatic devices to use in order to move the story along to its happy conclusion.
Will they use more cowbell ... or will they use less cowbell?
In Japan, the answer is "More Cowbell!"
Source: ECB, FRB, Boe, BOJ, Credit Suisse
In England, with Mervyn King about to give up his seat at the credenza and hand the pen and notepaper to Mark Carney, we hear a familiar sound:
(UK Daily Telegraph): Mark Carney will try to devalue the pound by as much as 15pc after he takes over as Bank of England Governor in July in a last ditch attempt to cement the UK recovery, Pimco, the world’s largest bond house, has warned....
“I think a lot of what Mark Carney is going to do — clearly he’s not going to state this upfront — is to try and keep sterling certainly from going up and, probably, he’s going to want to see it go lower,” [Mike] Amey [PIMCO managing director and sterling bond head] said....
He added that he expected Mr Carney to restart quantitative easing (QE) to buy gilts "as one of the routes to talk the currency down". Andrew Balls, Pimco’s European head and a member of its global investment committee, added: "With growth models hampered, lots of countries are looking to the trade channel to try to improve growth — and that leads you to the exchange rate channel".
Even in Europe, Mario Draghi seemingly has a fever, and the only prescription is ... you guessed it: MORE COWBELL!!!
(Reuters, May 2, 2013): The European Central Bank cut interest rates for the first time in 10 months on Thursday and held out the possibility of further policy action to support the recession-hit euro zone economy.... Draghi stuck with the ECB's forecast that economic recovery will take hold later in the year but highlighted "downside risks" to that position.
The ECB would "monitor very closely" all incoming evidence, Draghi said, a phrase which in the past has suggested further policy action to come....
The sudden slump in price pressures has also raised the possibility of the ECB having to look at policy tools beyond interest rates to counter any further slide in inflation.
"Ultimately, we think the ECB will have to purchase private-sector assets in order to fix the transmission mechanism," said Andrew Bosomworth at PIMCO, the world's largest bond fund.
Such asset purchases could take the ECB into the realm of quantitative easing (QE) — creating money to buy assets, a policy it has so far eschewed but which other major central banks have embraced.
Berenberg Bank's Holger Schmieding said that if other institutions, such as the European Investment Bank, helped promote an ABS market for SME loans, the ECB could eventually pave a way to some quantitative easing.
The ECB could accept such packaged loans as collateral at its liquidity operations, or even buy them outright, he said.
"If so, this would extend the ECB's toolbox and could potentially open the way for a little 'quantitative easing' by the ECB later on," Schmieding added.
Ah yes, that's how it starts: "a little quantitative easing", especially since all the cool kids are doing it.
But peer pressure is a dangerous thing — after all, if you're "easing" and there's one kid who isn't, it's human nature to try to get that one kid to join the gang.
Not surprisingly, then, on May 21st, 2013, the cool kids blatantly ganged up on Draghi, increasing the pressure on him to give them more damn cowbell:
(Bloomberg): Federal Reserve Bank of St. Louis President James Bullard said Europe risks an extended period of low growth and deflation like Japan’s unless the European Central Bank acts with an aggressive quantitative easing program.
“You should worry about it, and then take policy action to avoid it,” Bullard said in Frankfurt today in response to an audience question after a speech. “You want to be pretty sure that you don’t get stuck in that situation, and one way to get stuck would be to be passive in this situation and not take some aggressive action to try to get inflation back.”...
Speaking in the ECB’s home town, Bullard said the central bank’s governing council may want to consider a quantitative easing program that’s weighted to account for gross domestic product differences in the 17-member euro area.
Meanwhile the very same day, across the Atlantic, RBoC Governor Mark Carney stepped to the microphone to say his goodbyes to Canada as he left for the mustier confines of the Bank of England, but he opted to talk about ... well, read for yourself:
(WSJ): Europe faces a decade of stagnation without “sustained and significant reforms,” Mark Carney, the incoming governor of the Bank of England, warned Tuesday.
Mr. Carney, currently Canada’s top central banker, said Europe can draw lessons from Japan on the dangers of taking half measures.
It’s been almost six years since the global financial crisis, but Europe remains mired in recession, fiscal austerity, low confidence and tight credit conditions restraining economic activity, he said.
“Deep challenges persist in its financial system. Without sustained and significant reforms, a decade of stagnation threatens,” Mr. Carney said in his final public address as governor of the Bank of Canada.
Conspiracy? Coincidence? A slip of the veil? Who knows?
All I DO know is this:
No matter how hard the various and sundry gods decide they need to hit the cowbell, they have left themselves an essentially impossible task. Commentators talk about their having to "thread the needle"; but if that is indeed the right analogy, then they'll have to thread it by throwing the cotton through the eye of the needle from across the room — blindfolded.
Source: Things That Make You Go Hmmm...
Already, the rising sensitivity of markets to ANY kind of increased chatter from the gods is making it clear that, unless they execute flawlessly, they are going to have a disaster on their hands, as was demonstrated perfectly by last Friday's market action.
The chart below is the S&P 500, and as you can see, it fell pretty hard in the afternoon session. Why?
Well, according to Zerohedge, it came down to 34 little words:
(Zerohedge): There is much consternation about what triggered today's rapid escalation of selling pressure in US stocks. As the evening wends on and traders sip their Absinthe, it appears an embargoed record of the Fed's Advisory Panel minutes was at least a major concern as it raised the very real specter that those in charge are concerned at the monster they have created:
"There is also concern about the possibility of a breakout of inflation, although current inflation risk is not considered unmanageable, and of an unsustainable bubble in equity and fixed-income markets given current prices."
"Unsustainable bubble"? And this not from some fringe blog but from ... central bankers?
And there were some bonus words, which have to be read to be believed:
Uncertainty exists about how markets will reestablish normal valuations when the Fed withdraws from the market. It will likely be difficult to unwind policy accommodation, and the end of monetary easing may be painful for consumers and businesses. Given the Fed’s balance sheet increase of approximately $2.5 trillion since 2008, the Fed may now be perceived as integral to the housing finance system.
Now, if that is the reaction to any suggestion that the Fed is just looking at the possibilities of what might happen if they did decide to potentially pull back QE ... what does the world look like when they go ahead and do it?
Well, fortunately, the good folks at Bianco Research this week demonstrated quite succinctly how the S&P 500 reacts to QE On/QE Off and Taper/No Taper (Thanks, GN):
First Non QE Period – March 31, 2010 to August 27, 2010 (-8.97%)
QE 2 – August 27, 2010 to June 30, 2011 (22.81%)
Second Non QE Period – June 30, 2011 to August 26, 2011 (-9.99%)
Operation Twist – August 26, 2011 to April 4, 2012 (18.88%)
Hilsenrath Says QE to End with Twist’s End – April 4, 2012 to June 6, 2012 (-5.99%)
Hilsenrath Backtracks on QE’s End – June 6, 2012 to August 17, 2012 (7.83%)
QE 3 – August 17, 2012 to November 29, 2012 (-0.16%)
QE 3 Expanded - November 29, 2012 to May 1, 2013 (12.82%)
FOMC Says ‘Increase or Reduce” – May 1, 2013 to Present (4.53% as of May 30, 2013)
What can be clearly seen here is the new-found reliance that the market has placed on the communication of Fed policy.
Whether it comes from the mouths of the committee members themselves (as the Zerohedge article points out), or from media stooges who have been designated as quasi-official spokesmen (180 seconds after the release of most recent Fed minutes, the WSJ's Hilsenrath published a 410-word piece titled "Parsing the Fed Minutes: Debating When To Pull Back". Come on! Please! At least make an EFFORT to make it look like he didn't get a head start, guys), the market is watching for any sign that the free-money spigot is about to be turned off, and investors are ready to dump stocks at the drop of a hint hat.
That doesn't make threading that needle any easier.
Meanwhile, over in Japan, as I pointed out last time, a similar situation is brewing — only with two VERY significant differences: the stakes are MUCH higher (for now, at least), and the BoJ gods are even more hopeless than their US counterparts at communicating their intentions to the market. Their ineptitude is reflected in the elevated level of volatility in both the Nikkei and the JGB markets.
A random selection of Bloomberg alert headlines from the last month or so speaks to the communication difficulty:
Kuroda Wants to Avoid Increasing Volatility in Bond Market
Kuroda Confident Boj Can Buy Bonds as Pledged
Boj's Kuroda Pledges All Necessary Steps for 2% Inflation
Abe Says It's Possible Boj Will Fail to Reach Inflation Target
Abe Says Economy Subject to Unforeseen Circumstances
Kuroda: Forex Intervention Is Govt's Responsibility
Kuroda Says Price Rises Without Wages Gains Are Undesirable
Kuroda Says Boj Has Done What's Necessary and Possible for Now
Two simple charts (top: Nikkei, bottom: JGB futures) will demonstrate the dangers of uncertainty, when the gods are lowered onto the stage and the audience looks to them to resolve the seemingly intractable difficulties and conjure up a way (no matter how implausible) to move everything swiftly forward to the happiest of endings ... and they dither.
Sometimes, even greats like Euripides, Sophocles, and Aeschylus found themselves in situations so impossible to resolve that the audience refused to play ball and willingly suspend their disbelief.
I didn't serve with Euripides, Sophocles, or Aeschylus. I didn't know Euripides, Sophocles, or Aeschylus. Euripides, Sophocles, and Aeschylus weren't friends of mine. But Governor / Mr. Chairman, you're no Euripides, Sophocles, or Aeschylus.
So there we have it. The audience is forced to watch as the gods bang the cowbell and spout the worst dialogue since Ever After, when Drew Barrymore's character, Danielle (the purported inspiration for Cinderella), tries to explain to Leonardo da Vinci (just go with it) the hopelessness of her romance, with this bit of brilliance:
"A bird may love a fish, signore, but where will they live?"
(I had young kids in 1998.) Meanwhile the plot gets ever more mangled as unemployment soars across Europe, China slows down markedly, commodities markets smell deflation, and the US is undecided as to whether it is undergoing a real recovery. With bit-part players like Australia and Canada starting to get a little shaky with their lines and inflation once again beginning to bite in Brazil, there is no telling how the gods will manage to get everything to come out right this time.
All we do know is that whatever they come up with will need lots of cowbell accompaniment.
There's plenty for you to get your teeth into this week, including three pieces from Ambrose Evans-Pritchard (who has been on a roll lately), tackling EU unemployment, the slowing of the credit cycle, and some curious developments in Portugal.
My great friend David Hay of Evergreen has a rare treat for us this week, as he is kind enough to share the thoughts of Anatole Kaletsky on "Goldilocks and the Ten Bears"; Stephen Roach has concerns about the health of the American consumer; and we meet an aspiring lawyer from Oregon who failed the bar exam twice, locked his keys in his car, and ten years later won a landmark lawsuit that could open up an absolutely enormous can of worms.
Meanwhile, after a few months' absence from the front pages, Europe is warming up again; and this week an EU Commissioner calls Europe "truly abysmal" and calls for an overhaul, Irish officials take the Potemkin Village analogy to new (and ridiculous) levels, and the EU gets tough with France (finally) as the vaunted European core fractures just a little more.
The Economist weighs in on the great Japan debate; we look at charts of household debt, EU unemployment, and a fascinating take on physical gold demand, courtesy of Eric Sprott; and, as though that weren't enough, we have a video debate between gold bulls and bears, a history lesson from Jim Puplava, and Eric Sprott talking about that great chart — plus a whole bunch of other good stuff to boot.
Until Next Time.
The financial advice gets repeated as a mantra: Student loans are the one form of debt that can't be forgiven, even in bankruptcy. But a Klamath Falls man has proven that's not always true.
Mike Hedlund waged a 10-year legal battle to force his lender to discharge most of the $85,000 in federal student loans he built up while earning his 1997 law degree from Willamette University in Salem. He argued that, even when working full-time and living frugally, he could not repay that much money and also maintain a minimal standard of living for himself and his family.
Last week, in a decision that could affect debtors in eight states, a panel of the Ninth Circuit Court of Appeals in Pasadena, Calif., ruled in Hedlund's favor.
It upheld a bankruptcy judge's ruling that Hedlund proved all three factors necessary to have $53,000 of his debt forgiven: He made a good faith effort to repay the money; he can't earn enough to both repay the money and maintain a basic standard of living; and his inability to earn substantially more is likely to persist.
One twist to the case: Hedlund was unable to make much use of his expensive law degree. He failed the Oregon bar exam twice in his first year out of law school, then locked his keys inside his car on the way to his third scheduled test, and so missed it entirely. He did not try again.
Instead, Hedlund got a $40,000-a-year job as a Klamath County juvenile probation officer, a job he still holds.
"I had planned on making $200 an hour instead of $20 when I agreed" to take out loans totaling about $100,000, Hedlund said.
But testimony from an employment expert convinced judges that Hedlund holds a good-paying job for Klamath Falls and wouldn't likely earn a whole lot more as a starting lawyer there, particularly if he worked in the public sector.
Hedland expressed happiness and relief to have won, lowering his debt to $32,000 plus interest.
"I owe a car instead of a house now," he said. "It's huge for me. What I've wanted all along is something I can afford," not having the slate wiped clean, he said.
He and his wife have three daughters, and his wife works one day a week. He coaches soccer on the side to supplement his income and continues to live frugally, he said. "We don't go on many vacations, other than day trips. My newest car is six or seven years old and our other one is a '96 Explorer."
"I am happy that maybe this will help someone else in their dealings with the student loan people," he added.
When Hedlund graduated from Willamette, he owed two student loan companies. He struggled to pay either of them, but reached a deal with the smaller lender to repay $18,000 at $50 a month....
The European Commission will use sweeping new powers backed by sanctions to impose controversial social and economic reforms on European countries later this week.
France, Spain and Slovenia are set to be criticised in a major commission report on Wednesday as countries that have failed, amid recession and the financial crisis, to cut public debt and to implement structural reforms of their economies.
The commission is also expected to express concern over Britain, with a warning that the continuing credit crunch is jeopardising growth and attempts to cut public debt, although the Government, outside the eurozone, can escape the humiliation of having sanctions imposed.
European Union studies on “macroeconomic imbalances” have been given new teeth this year under eurozone “governance” legislation that gives the commission powers, backed by substantial fines, to override national sovereignty to impose reforms.
“The macroeconomic imbalance procedure is very broad, intrusive and has, for the first time, teeth. Sanctions can be taken unless countries implement structural reforms,” a senior European official told The Sunday Telegraph. “This has moved on over the last 12 months from a naming and shaming exercise to interventions with a cutting edge for the eurozone. The commission is going to go much further than ever before.”
Under the new eurozone rules, if a country fails to address “the gravity of imbalances [it] can eventually lead to the imposition of sanctions on euro area member states” under a new radical procedure that makes it easier for the commission to impose reforms.
“Enforcement is strengthened by the expanded use of 'reverse qualified majority’ voting. Under this voting system, a commission recommendation or proposal is considered adopted unless a qualified majority of member states votes against it,” EU legislation agreed last November has decreed.
Slovenia could be the first country to trigger the new intrusive imbalance procedure amid a lingering banking crisis that has been compared to Cyprus, but other countries, including France and Spain are expected to be given a “red card”....
Many European leaders have recently suggested that the Continent is on the road to economic recovery. EU Commissioner Günther Oettinger, however, says the bloc is in a "truly abysmal state" and that France, in particular, needs reform.
The European Union has done its best lately to exude optimism about its efforts to emerge from the ongoing euro crisis. Not only have important steps been made, say EU leaders, but increased political and economic integration mean that the future of the bloc is bright.
European Energy Commissioner Günther Oettinger, however, would beg to differ. Oettinger, Germany's representative on the EU's executive body, held a speech on Tuesday at the German-Belgian-Luxembourgian Chamber of Commerce in which he outlined what he sees as the EU's shortcomings.
"Europe is in dire need of an overhaul," he said, according to the German tabloid Bild. But Brussels, he continued, "still hasn't recognized its truly abysmal state."
The commissioner reserved most of his bile for France, identifying it as a principal point of concern and saying that it "is not prepared at all for that which is necessary." Specifically, he said that the country needs to undertake a far-reaching "pension reform, which in truth means pension cuts." In addition, he demanded that the retirement age be raised and that the number of public servants be slashed. He added that the country has "little innovation."
It is not the first time that Oettinger has given public vent to his frustrations regarding the EU's path. In an April interview with the Cologne daily Kölner Stadt-Anzeiger, he said the EU crisis wouldn't be over for another decade and that, despite comments from European Commission President José Manuel Barroso about austerity having reached its limits, Europe must continue to save.
"In the coming years, we can't offer services in the form of pensions, smaller class sizes, greater police presence, fewer potholes and other benefits" at the level we have until now, he said.
The spin-doctors are hard at work talking up America’s subpar economic recovery. All eyes are on households. Thanks to falling unemployment, rising home values, and record stock prices, an emerging consensus of forecasters, market participants, and policymakers has now concluded that the American consumer is finally back.
Don’t believe it. First, consider the facts: Over the 21 quarters since the beginning of 2008, real (inflation-adjusted) personal consumption has risen at an average annual rate of just 0.9%.
That is by far the most protracted period of weakness in real US consumer demand since the end of World War II – and a massive slowdown from the pre-crisis pace of 3.6% annual real consumption growth from 1996 to 2007.
With household consumption accounting for about 70% of the US economy, that 2.7-percentage-point gap between pre-crisis and post-crisis trends has been enough to knock 1.9 percentage points off the post-crisis trend in real GDP growth. Look no further for the cause of unacceptably high US unemployment.
To appreciate fully the unique character of this consumer-demand shortfall, trends over the past 21 quarters need to be broken down into two distinct sub-periods. First, there was a 2.2% annualized decline from the first quarter of 2008 through the second quarter of 2009. This was crisis-driven carnage, highlighted by a 4.5% annualized collapse in the final two quarters of 2008.
Second, this six-quarter plunge was followed, from mid-2009 through early 2013, by 15 quarters of annualized consumption growth averaging just 2% – an upturn that pales in comparison with what would have been expected based on past consumer-spending cycles.
That key point appears all but lost on the consumer-recovery crowd. In recent speeches and discussions with current and former central bankers, I have been criticized for focusing too much on the 0.9% trend of the past 21 quarters and paying too little attention to the 2% recovery phase of the post-crisis period.
At least it’s a recovery, they claim, and a sign of healing that can be attributed mainly to the heroic, unconventional efforts of the US Federal Reserve.
This brings us to the second part of the argument against optimism: analytics. One of the first concepts to which an economics student is exposed in a basic macro course is “pent-up” consumer demand. Discretionary consumption is typically deferred during recessions, especially for long-lasting durable goods such as motor vehicles, furniture, and appliances. Once the recession ends and recovery begins, a “stock-adjustment” response takes hold, as households compensate for foregone replacement and update their aging durable goods.
Over most of the postwar period, this post-recession release of pent-up consumer demand has been a powerful source of support for economic recovery. In the eight recoveries since the early 1950’s (excluding the brief pop following the credit-controls-induced slump in the 1980’s), the stock-adjustment response lifted real consumption growth by 6.1%, on average, for five quarters following business-cycle downturns; spurts of 7-8% growth were not uncommon for a quarter or two.
By contrast, the release of pent-up demand in the current cycle amounted to just 3% annualized growth in the five quarters from early 2010 to early 2011. Moreover, the strongest quarterly gain was a 4.1% increase in the fourth quarter of 2010.
This is a stunning result....
Portugal is waking up. A new book calling for withdrawal from the euro and a return to the escudo has vaulted to the top of the bestseller list.
The incendiary tract — “Porque Debemos Sair do Euro” (Why We Should Leave The Euro) — is written by Professor João Ferreira do Amaral from the Insituto Superior de Economia e Gestão (ISEG).
The professor has already secured the backing of Luís António Noronha Nascimento, the chief justice of Portugal’s Supreme Court.
This follows the apostasy of Jerónimo de Sousa, the Secretary-General of the Portuguese Communist Party, who has called for a referendum on both the euro and the EU. De Sousa says the EU is “unreformable”, has been hijacked by a “directorate” of dominant powers, and has led to the death of Portuguese sovereignty.
The new book makes a poignant parallel with Portugal’s subjugation by Phillip II of Spain, and its travails as a captive province of the Spanish Empire for 60 years.
“In 1581 Portugal surrendered to Spain. In 1992 it laid itself at the feet of a European Commission increasingly answering to Germany’s tune. There was no referendum, the voters were never consulted. The Portuguese elites, who hoped to benefit richly from European Structural Funds, cavalierly handed over our currency – and with it our monetary sovereignty. The rest is history.”
“From 2008 onwards, the European Commission broke with tradition and became an organ at the service of a new power. The Portuguese economy succumbed, choked by the new Mark. The tragedy was widely foretold in advance. In the 1990s several voices had alerted us to the dangers of joining the single currency.”
One of them of course was the economist João Ferreira do Amaral himself, now relishing his bitter/sweet moment of vindication. The nub of his argument is that euro exit is not a luxury choice. It is the only possible way for Portugal to recover under the current EMU structure.
Unlike some, the Professor does not think the situation will get any better for Portugal if the eurozone crisis calms down. On the contrary, the deeper damage will be ever greater.
He warns that the euro could rise to $1.50 or $1.60 to the dollar, leading to the final devastation of Portugal’s manufacturing industry (which often competes directly with China, emerging Asia, and North Africa).
This debate was bound to occur eventually. Portugal’s EMU position is self-evidently untenable, though many on this blog thread insist otherwise.
Its combined (non-financial) public and private debt has hit 370pc of GDP, the highest in the world after Japan. The difference is that Japan remains a fully sovereign nation with a sovereign central bank and currency, and can therefore do something about it.
The Portuguese economy is shrinking by 3pc to 4pc a year and keeps missing its deficit targets — like Greece before it, though less dramatically — as it chases its own tail in a downward deflationary spiral. The crucial point is that “nominal” GDP is contracting violently. This means that the nominal debt load is rising on a shrinking nominal base, what is known as a negative “denominator effect”.
Do the leaders of Portugal fully understand the implications of this? Does the brilliant finance minister Vitor Gaspar — an ECB veteran — have a credible answer to this fundamental point? Does he recognise that the policy of internal devaluation must necessarily make this worse?...
Hundreds of thousands of pounds have been spent on a Fermanagh facelift as the county prepares for the G8 summit in just under three weeks’ time, but locals complain the work paid for by the local council and the Stormont Executive is little more than skin deep.
More than 100 properties within range of the sumptuous Lough Erne resort which hosts the world’s wealthiest leaders, have been tidied up, painted or power-hosed.
However, locals say the makeover only serves to hide a deeper malaise which US president Barack Obama, German chancellor Angela Merkel, French president François Hollande and others will not get to see.
Two shops in Belcoo, right on the border with Blacklion, Co Cavan, have been painted over to appear as thriving businesses. The reality, as in other parts of the county, is rather more stark.
Just a few weeks ago, Flanagan’s – a former butcher’s and vegetable shop in the neat village – was cleaned and repainted with bespoke images of a thriving business placed in the windows. Any G8 delegate passing on the way to discuss global capitalism would easily be fooled into thinking that all is well with the free-market system in Fermanagh. But, the facts are different.
Jim Sheridan, director of Belcoo Enterprises Limited, welcomes any attempt to tidy the area but laments the wrecking effects recession and the demise of the Celtic Tiger have had locally.
“That work happened just a few weeks ago,” he said. “The council got that place painted but it went under sometime last year. A lot of people round here worked in construction and that work has gone now.”
The butcher’s business has been replaced by a picture of a butcher’s business. Across the road is a similar tale. A small business premises has been made to look like an office supplies store. It used to be a pharmacy, now relocated on the village main street.
Elsewhere in Fermanagh, billboard-sized pictures of the gorgeous scenery have been located to mask the occasional stark and abandoned building site or other eyesore.
All is paid for by so-called dereliction funding. About £300,000 was made available by the Department of the Environment and the Department for Social Development. A second round of funding is expected. Late last year the council wrote to the owners of properties in need of a facelift seeking permission for the work. The scheme was put together with the greatest haste to make sure the properties, mostly in Enniskillen itself, were authorised for improvements.
Council chief executive Brendan Hegarty said at the time the initiative was “a phenomenal opportunity”.
“We want to present the county as best as we can and promote it in terms of industry and tourism,” he said....
Two weeks ago, as the S&P 500 soared out of the trading range in which it had been trapped for 13 years we suggested that this break-out could mark the start of a secular bull market in global equities. This idea provoked derision and even outrage from many clients. While we cannot do justice to all of the objections we received, it seemed helpful to summarize the main criticisms and offer a defence of our bullish position. The counter-arguments we heard most often can be grouped under ten headings. To put things more colorfully, Goldilocks in the fairy tale faced only three bears, but our views are under attack from at least ten bears, with plenty of others lurking in the shadows.
Bear #1: There is no convincing evidence yet that the US will avoid another summer slowdown and the global economy has not yet improved sufficiently for a bull market to take off.
Goldilocks: The US economic indicators are looking increasingly healthy, the slowdown in March and April seems to have been an aberration, maybe due to cold weather. Europe is still very weak but it is no longer that important and the rest of the world is in decent shape.
Because of the rapidly increasing weight of fast-growing emerging markets in the global economy, the 3.3% global growth forecast by the International Monetary Fund this year is only a little slower than the average of 3.6% from 1995 to 2004. And even if the US and the world economy do run into another summer soft-patch, this will merely mark a pause in the post-2009 recovery and act as the launchpad for the next powerful leg of the bull market, to judge by the experience of the past four years. In any case, the economic outlook is never clear in the early phase of a bull market. If evidence for global economic recovery were unambiguous and undeniable, then equity prices would already be much higher.
Bear #2: In that case, how can you say that this is the start of a new bull market? This rally started in April 2009. This isn’t a frisky young bull with lots of upside potential but a geriatric ready for the knacker’s yard.
Goldilocks: The gains of the past four years were merely a recovery from one of the worst bear markets on record. Many investors were convinced that this was a dead cat bounce, to be followed by another slump once the losses of 2008 were retraced.
If the S&P 500 had recoiled from its 2000 and 2007 highs, bears would have hailed this as proof that equities were still stuck in a long-term trading range, with a serious risk that the lower half of the 13-year range was re-tested. But the S&P has now risen 6.5% above its previous all-time high. In the past 100 years each time US stock prices have broken decisively through previous record highs, large further gains have followed — ranging from 20% to 900%. Of course, past performance does not prove anything, but
it does remind that equity prices generally break out of previously established ranges for good reasons; because bullish forces are gaining ground in the world economy, even when analysts do not yet detect them.
Bear #3: But this break-out has nothing to do with economic fundamentals. It is totally dependent on monetary stimulus — mainly from the Federal Reserve but now also from the Bank of Japan.
Goldilocks: That may or may not be true, but who cares? As long as the stimulus continues equity investors will keep making money. And we now know that the stimulus will continue until the US economy is growing fast enough to get unemployment to 6.5%. So either the central banks will succeed in stimulating stronger growth (at least in nominal GDP) — or they will keep on printing money. Either scenario is bullish for equities. As the Roman Emperor Vespasian remarked when he taxed public toilets to raise money, pecunia non olet (“money doesn’t smell”)....
IT IS the one thing that was not supposed to happen. On April 4th the Bank of Japan (BoJ) announced its shock-and-awe plan to hoover up ¥7 trillion ($68 billion) of government bonds a month and double the monetary base. But instead of producing rising bond prices and falling yields, the central bank’s actions have so far led to the opposite. On May 23rd the yield on ten-year Japanese government bonds touched 1%, three times higher than before the BoJ’s April announcement. And on the same day Japanese stocks plunged, with the Nikkei 225 index dropping by 7% (see chart). Could “Abenomics”, the economic-revival plan of Shinzo Abe, Japan’s prime minister, already be coming unstuck?
The most tangible success for Abenomics had been a soaring stockmarket: the Nikkei share index rose by 79% in the year to May 22nd. Although its fall since its peak reached 13% on May 30th, this partly reflects profit-taking.
But the spike in bond yields is continuing to unnerve investors. In April Haruhiko Kuroda, the governor of the BoJ, had said the bank would encourage further falls in nominal interest rates. Given the rise in bond yields since, says Naka Matsuzawa, chief strategist at Nomura Securities, an investment bank, “you can say that the easing by the Bank of Japan has in one sense already failed.”
The nub of the problem is that the bank’s twin aims—generating inflation and bringing down yields—are somewhat contradictory. Holders of low-yielding government bonds who believe that the BoJ will achieve its inflation target of 2% in two years may respond by selling. Their sales over the past few weeks have pushed up nominal yields far more quickly than the BoJ expected. Higher inflation, which would bring down real rates, has not yet arrived. Pessimists therefore argue that borrowing costs are rising, posing a threat to any early economic recovery.
Optimists see things differently. First, they point out, bond yields may have simply returned to their recent trading range; at around 0.3% just before the BoJ’s April announcement they were unusually low, even for Japan. Second, the bank’s aim to generate inflation expectations seems to have succeeded (at least in the case of bond traders). And third, higher volatility in bond yields is to be expected after such a big intervention by the central bank.
Both Taro Aso, the finance minister, and Mr Abe last week called on the BoJ to reassure the bond market. Mr Kuroda has made some confusing statements. On May 22nd he said that the spike in rates would not affect the economy.
But he also argued that the central bank does not have full control over long-term rates. After plunging stockmarkets compounded worries about bond-market volatility, Mr Kuroda pledged to do more to keep rates stable.
A particular fear is that higher volatility could provoke a repeat of the value-at-risk shock of 2003, when market-risk models spurred further selling once volatility triggers had been breached. The worst scenario is that bond-market volatility could focus attention on Japan’s public debt, which stands at nearly 250% of GDP. Owning so many government bonds, banks are heavily exposed to any rise in yields: an increase of only one percentage point would mean a loss of ¥10 trillion for Japan’s banks overall, according to J.P. Morgan.
“So far there is no connection between volatile bond yields and the fiscal position,” says an official at the finance ministry. Mr Kuroda reminded the government this week that it, too, has a role to play in reassuring bond investors—by pursuing fiscal consolidation. It soon has to decide whether to go ahead with a planned rise in the consumption tax in April 2014 to boost tax revenues. A package of structural reforms to boost long-term economic growth, the details of which will be announced soon, would also calm nerves.
This may be as good as it gets for the world economy. The HSBC index for the global business cycle hit a three-year high around Easter, and has since rolled over.
Any country that has failed to lock in a self-sustaining recovery by now must expect to pay the price for the failings of its policy establishment, and some risk a slide into outright deflation.
“We see building evidence of a cyclical downturn,” said Fredrik Nerbrand, HSBC’s global asset guru. “We find it highly troubling that the eurozone is still marred in a recession at the same time as our cyclical indicators appear to have peaked.”
The bank said there is a market “disconnect” between the world’s gloomy outlook and talk of tapering by the US Federal Reserve, the supposed moment when it starts to wind down its $85bn of monthly bond purchases.
It is surprising to me that HSBC’s leading indicator has taken so long to buckle, since commodities topped in September and the Dutch CPB index of world trade contracted over the February-March period. Rarely has there ever been such an equity boom on such quicksand.
Mr Nerbrand said slowing momentum “should send shivers down the spine of any investors that are long risk”. Yet markets are betting that central banks will come to the rescue yet again if need be. This may be so, but only after they have first struck a blow against moral hazard and demonstrated their distaste for asset bubbles. The central banks take their time. Mr Nerbrand says they will not act until the markets have already priced in a “sub-optimal outcome”, Canary Wharf dialect for a nasty sell-off.
HSBC said it is cutting its holdings of high yield credit, emerging market debt, gold and real estate REITs. It is plumping instead for US Treasuries, the “least rotten apple in the barrow”. An astonishing 42pc of its tactical portfolio is now in US Treasuries.
We have been through these episodes of putative Fed tightening twice since the Lehman crisis. Markets tanked in 2010 and again in 2012 after the Fed turned off the spigot.
It took a while for the Fed to recoil on both occasions, and it may take even longer this time. Key insiders are fretting that the longer QE goes on, the harder it will be to unwind. The global consensus for QE is, in any case, crumbling. The Bank for International Settlements has more or less said that emergency stimulus is becoming a dangerous addiction.
Much of this critique is, in my view, misguided, and risks a repeat of the Fed’s great policy error of 1937, when it killed recovery stone dead. Yet QE critics clearly have a point. As Pimco’s Bill Gross puts it, there are “bubbles everywhere”. The Credit Suisse index of Global Risk Appetite has been flirting with the “euphoria” line, not far short of levels seen in 1987, 2000 and 2007.
The share of leveraged “cove-lite” loans issued this year without covenant safeguards has been twice as high as in 2007, the last peak just before Armaggedon. Companies are borrowing cheap to buy back their own stock at nosebleed prices, and doing so en masse with the carefree abandon of those pre-Lehman days. By some estimates this has driven half the US equity gains this year. No wonder Fed hawks such as Richard Fisher are watching this with horror....
Global bond markets posted their biggest monthly losses in nine years in May as the U.S. dollar rallied and stocks reached record highs amid speculation a strengthening U.S. economy will allow the Federal Reserve to reduce its monetary stimulus.
The over $40 trillion of bonds in the Bank of America Merrill Lynch Global Broad Market Index fell 1.5 percent on average, led by a 2 percent drop in Treasuries. The MSCI World Index lost 0.3 percent while the Standard & Poor’s 500 reached a record high. The U.S. Dollar Index jumped 2 percent as the greenback gained versus all its major peers. The S&P GSCI Total Return Index of metals, fuels and agricultural products dropped 1.5 percent a month after falling the most since May 2012.
Employment gains and increases in housing and consumer confidence suggested the recovery in the U.S. economy, the world’s largest, is gaining momentum, prompting traders to increase bets the Fed will scale back its $85 billion in monthly debt purchases later this year. The Organization for Economic Cooperation and Development predicts faster global economic growth, led by the U.S. and Japan.
“Investors’ attempt to access what the Fed will do with its bond-buying program has been pretty central to the performance of all asset classes,” Neil Mackinnon, a global macro strategist at VTB Capital Plc in London, said May 30 in a telephone interview. “The markets are very sensitive to the idea that the Fed might ease back on their debt purchases.”
Yields on U.S. Treasuries, German bunds and U.K. gilts are all forecast to rise by year-end from current levels, while those in Japan may fall, according to separate surveys of analysts by Bloomberg News.
Fed Chairman Ben S. Bernanke said during a response to questions following Congressional testimony on May 22 that the central bank could consider reducing the amount of Treasuries and mortgage debt it buys within “the next few meetings” if officials see signs of sustained improvement in the labor market.
The OECD sees growth among all its member countries accelerating to 2.3 percent next year from 1.2 percent this year. China, which isn’t part of the group, will expand 8.4 percent in 2014 after growth of 7.8 percent this year, according to the OECD report.
“The tone of the economic data has certainly been getting better and that is certainly one of the reasons why yields are pushing a little bit higher along with this talk of a Fed taper of debt purchases,” Ira Jersey, an interest-rate strategist in New York at Credit Suisse Group AG, said in a May 29 interview on Bloomberg Radio….
Source: The Economist
In the years leading up to the financial crisis, household debt soared in most rich countries. There were a couple of notable exceptions: Germany and Japan, neither of which experienced a housing boom that caused debt to accumulate. The ratio of debt to disposable income rose by an average of 30 percentage points, to 130%, in OECD countries between pre-boom 2000 and pre-crisis 2007. Since then debt levels have fallen in America, Britain and Germany, but they have continued to rise in countries such as France, Italy and the Netherlands, where property prices are still declining. In 2012 household debt in the Netherlands was a whopping 285% of disposable income.
It’s my hypothesis that there was a dearth (scarcity) of gold, and as you know I’ve written many articles questioning whether central banks had any gold left. The conclusion I had was of course that they didn’t because we could see all of this huge new demand coming in.
I’m talking over a 10-year period where I can identify approximately 2,300 tons of net-new demand coming into a market where the supply was staying the same at roughly 4,000 tons a year. I said, ‘Well, this is physical delivery. Where is the gold coming from?’
So it wasn’t a surprise for me to see that all of the sudden these anecdotal items were coming up about how people couldn’t get delivery (of gold). Then we start this decline by various major investment banks saying, ‘Short gold.’ What I think was really happening was that the shortage was becoming very, very acute.
So I decided to do a comparison of Shanghai premiums to what happens to the GLD. Pretty well any time that the Shanghai premiums go up, the GLD inventory starts declining. GLD has lost about 300 tons of gold, which is a lot of tons of gold when you figure that the miners, ex-China, ex-Russia, only produce 2,200 tons of gold. This was 300 tons in the first four months of the year."...
Another month, another 95,000 people lost their jobs in the eurozone.
The EMU unemployment rate nudged up a point to 12.2pc, but this understates those who have dropped out of workforce. The European Commission says the real rate for Italy is around 20pc, not the declared rate of 11.2pc.
There are now 19.4 million registered unemployed in Euroland and 26.6 million in the EU as a whole. There are 5.6m youths below the age of 25 looking for jobs.
Frankly, I have nothing further to say on this. The chart below contrasts EMU policy failure with the US and Japan....
Further to his fascinating chart of Shanghai gold premiums on page 30, Eric Sprott expands on what that phenomenon means in the broader context, addresses the smackdown in April, and posits an alternative, much rosier explanation for the drawdown in GLD holdings. Eric even waxes lyrical on the Japanese bond market. Definitely something for everyone in this interview...
Jim Puplava is not only an extremely nice man, but he's a great student of both markets and history. In this fascinating editorial, Jim compares today with the late 1960s and early 1970s and the subjects on everybody's lips back then. Interest rates, inflation, Middle East turmoil, gold, taxes, political scandals... the list is eerie indeed.
The Association of Mining Analysts in London held a bulls vs. bears debate on gold recently, so pick a side, pull up a chair, and join in...
At 14 years of age we are still fully entitled to be careless and unburdened, but 14-year-old Zev from Natick, Massachusetts, will make you feel you could’ve done more at that age. This teenager, now better known by his nickname ‘fiddle oak’, has already become an internet sensation thanks to his ‘Little Folk’ photo series that goes way beyond his age in ideas and technique.
Fiddle oak says he’s been into photography since he was 8, and today he works together with his 17-year-old sister Nellie, taking pictures with a camera he calls Betsy. Usually he makes himself miniature in these self-portraits, ending up at the height of the grass or a playing card...
Simply stunning. (Thanks, Simon.)
Grant Williams is the portfolio manager of the Vulpes Precious Metals Fund and strategy advisor to Vulpes Investment Management in Singapore — a hedge fund running over $280 million of largely partners’ capital across multiple strategies.
The high level of capital committed by the Vulpes partners ensures the strongest possible alignment between the firm and its investors.
Grant has 28 years of experience in finance on the Asian, Australian, European and US markets and has held senior positions at several international investment houses.
Grant has been writing Things That Make You Go Hmmm... since 2009.
As a result of my role at Vulpes Investment Management, it falls upon me to disclose that, from time to time, the views I express and/or the commentary I write in the pages of Things That Make You Go Hmmm... may reflect the positioning of one or all of the Vulpes funds—though I will not be making any specific recommendations in this publication.
A walk around the fringes of finance
THINGS THAT MAKE YOU GO
By Grant Williams
03 JUNE 2013
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