#greenspan

Why discontinue?

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This is a chart of the change in the US Fed balance sheet, a series that has just been discontinued. Is this because the Fed is about to step up its activity and offering wider disclosure on tapering activity might spook markets? Given that 72% of the growth in S&P earnings has been driven by buybacks since 2012, it stands to reason the market is not exactly providing the type of confidence inducing organic lift the index reflects. Bank of America revealed that “net buying of Tech sector in the 1H was entirely buyback-driven.” 

Kind of reminds CM of the day Bernanke’s Fed announced it would no longer report M3 money supply a year before the financial markets headed into the GFC. CM estimated on p.4 of a report several years ago that M3 money supply by 2018 on constant long-term growth rates would turn into around $35 trillion from the $10 trillion at the time it was discontinued.

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Nothing to see here? Throw a deteriorating fixed income market with fewer buyers and corporates that have binged on cheap credit to fuel buybacks, it doesn’t look like the stuff dreams are made of. The chart below shows that quarterly pre-tax US profitability is struggling since 2011. Earnings (E) are not doing so well. It is by the grace of falling number of traded shares (S) that makes the EPS look flattering.

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We took the liberty of comparing corporate profitability since 1980 and correlating it to what Moody’s Baa rated corporate bond effective 10yr yields. An R-squared of almost 90% was returned.

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Why not use the Aaa spread instead? Well we could do that but looking over the last decade the average corporate debt rating profile looks like this. We have seen a massive deterioration in credit ratings. If we look at the corporate profitability with Baa interest rates over the past decade, correlation climbs even higher.

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We shouldn’t forget that the US Government is also drunk on debt, much of it arriving at a store near you. $1.5 trillion in US Treasuries needs refinancing this year and $8.4tn over the next 3.5 years. Couple that with a Japan & China pulling back on UST purchases and the Fed itself promising to taper (but now hide the results of) its balance sheet. So as an investor, would you prefer the relative safety of government debt or take a punt on paper next to junk heading into a tightening cycle?

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Discontinuation of series always carries a sense of deep cynicism for its true intention. It is not an onerous data set to cull. Sure we can fossick around and try to find it hidden in the archives of the Fed website but the idea is that they probably don’t want to publicise how much more they intend to flog.

Waking up to a horror of our own creation

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Some will say I am a pessimist. I’d prefer to be called an optimist with experience. At only age 16 (in 1987) I realized the destructive power financial markets had on the family home. Those memories were etched permanently. We weren’t homeless or singing for our supper but things sure weren’t like they use to be. It taught me much about risk and thinking all points of view rather than blindly following the crowd. That just because you were told something by authority it didn’t mean it was necessarily true. It was to critically assess everthing without question.

In 1999, as an industrials analyst in Europe during the raging tech bubble, we were as popular as a kick in the teeth. We were ignored for being old economy. That our stocks deserved to trade at deep discounts to the ‘new economy’ tech companies, no thanks to our relatively poor asset turnover and tepid growth rates. The truest sign of the impending collapse of the tech bubble actually came from sell-side tech analysts quitting their grossly overpaid investment bank salaries for optically eye-watering stock options at the very tech corporations they rated. So engrossed in the untold riches that awaited them they abandoned their judgement and ended up holding worthless scrip. Just like the people who bought a house at the peak of the bubble telling others at a dinner party how they got in ‘early’ and the boom was ahead of them, not behind.

It was so blindingly obvious that the tech bubble would collapse. Every five seconds a 21 year old with a computer had somehow found some internet miracle for a service we never knew we needed. The IPO gravy train was insane. One of my biggest clients said that he was seeing 5 new IPO opportunities every single day for months on end. Mobile phone retailers like Hikari Tsushin in Japan were trading at such ridiculous valuations that the CEO at the time lost himself in the euphoria and printed gold coin chocolates with ‘Target market cap: Y100 trillion.’ The train wreck was inevitable. Greed was a forgone conclusion.

So the tech bubble collapsed under the weight of reality which started the most reckless central bank policy prescriptions ever. Supposedly learning from the mistakes of the post bubble collapse in Japan, then Fed Chairman Alan Greenspan turned on the free money spigots. Instead of allowing the free market to adjust and cauterize the systemic imbalances, he threw caution to the wind and poured gasoline on a raging fire. Programs like ‘Keep America Rolling’ which tried to reboot the auto industry meant cheaper and longer lease loans kept sucking consumption forward. That has been the problem. We’ve been living at the expense of the future for nigh on two decades.

Back in 2001, many laughed me out of court for arguing Greenspan would go down in history as one of the most hated central bankers. At the time prevailing sentiment indeed made me look completely stupid. How could I, a stockbroker, know more than Alan Greenspan? It was not a matter of relative educations between me and the Fed Chairman, rather seeing clearly he was playing god with financial markets.  The Congressional Banking Committee hung off his every word like giddy teenagers with a crush on a pop idol. Ron Paul once set on Greenspan during one of the testimonies only to have the rest of the committee turn on him for embarrassing the newly knighted ‘Maestro.’ It was nauseating to watch. Times seemed too good so how dare Paul question a central bank chief who openly said, “I know you think you understand what you thought I said but I’m not sure you realize that what you heard is not what I meant.”

We all remember the horrors of the collapse of Lehman Brothers and the ensuing Global Financial Crisis (GFC) in September 2008. The nuclear implosions in credit markets had already begun well before this as mortgage defaults screamed. The 7 years of binge investment since the tech bubble collapse meant we never cleansed the wounds. We would undoubtedly be in far better shape had we taken the pain. Yet confusing products like CDOs and CDSs wound their way into the investment portfolios of local country towns in Australia. The punch bowl had duped even local hicks to think they were with the times as any other savvy investor. To turn that on its head, such was the snow job that people who had no business being involved in such investment products were dealing in it.

So Wall St was bailed out by Main St. Yet instead of learning the lessons of the tech bubble collapse and GFC our authorities doubled down on the madness that led to these problems in the first place. Central banks launched QE programs to buy toxic garbage and lower interest rates to get us dragging forward even more consumption. The printing presses were on full speed. Yet what have we bought?

Now we have exchange traded funds (ETFs). Super simple to understand products. While one needed a Field’s Medal in Mathematics to understand the calculations of a CDO or CDS, the ETF is child’s play. Sadly that will only create complacency. We have not really had a chance to see how robots trade in a proper downturn. ETFs follow markets, not lead them. So if the market sells off, the ETF is rapidly trying to keep up. Studies done on ETFs (especially leveraged products) in bear markets shows how they amplify market reactions not mitigate them. So expect to see robots add to the calamity.

Since GFC we’ve had the worst post recession recovery in history. We have asset bubbles in bonds, stocks and property. The Obama Administration doubled the debt pile of the previous 43 presidents in 8 years. Much of it was raised on a short term basis. This year alone, $1.5 trillion must be refinanced.  A total of $8.4 trillion must be refinanced inside the next 4 years. That excludes the funding required for current budget deficits which are growing despite a ‘growing economy’. That excludes the corporate refinancing schedule. Many companies went out of their way to laden the balance sheet in cheap debt. In the process the average corporate credit rating is at its worst levels in a decade. Which means in a market where credit markets are starting to price risk accordingly we also face a Fed openly saying it is tapering its balance sheet and the Chinese and Japanese looking to cut back on US Treasury purchases. Bond spreads like Libor-OIS are already reflecting that pain.

Then there is the tapped out consumer. Unemployment maybe at record lows, yet real wage growth does not appear to be keeping up. The number of people holding down more than one job continues to rebound. The quality of employment is terrible. Poverty continues to remain stubbornly high. There are still three times as many people on food stamps in the US than a decade ago – 41 million people. Public pension unfunded liabilities total $9 trillion. Credit card delinquencies at the sub prime end of town are  back at pre-crisis levels. We could go on and on. Things are terrible out there. Should we be in the least bit surprised that Trump won? Such is the plight of the silent majority, still delinquent after a decade. No wonder Roseanne appeals to so many.

A funny comment was sent by a dyed-in-the-wool Democrat, lambasting Trump on his trade policies. He criticized the fact that America had sold its soul for offshoring for decades. Indeed it had but queried that maybe he should be praising Trump for trying to reverse that tide, despite being so late to the party. Where were the other administrations trying to defend America all this time? Stunned silence.

Yet the trends are ominous. If we go back to the tech bubble IPO-a-thon example. We now have crowd funding and crypto currencies. To date we had 190 odd currencies to trade. Of that maybe a handful were liquid – $US, GBP, JPY, $A, Euro etc – yet we are presented with 1,000s of crypto currency choices. Apart from the numerous breaches, blow ups and cyber thefts to date, more and more of these ‘coins’ are awaiting the next fool to gamble away more in the hope of making a quick buck. Cryptos are backed by nothing other than greed. Yet it sort of proves that more believe that they are falling behind enough such they’re prepared to gamble on the biggest lottery in town. One crypto used Wikipedia as a source for its prospectus.

Yet the media remains engrossed on trying to prove whether the president had sex with a porn star a decade ago, genderless bathrooms, bashing the NRA, pushing for laws to curtail free speech, promoting climate change and covering up crime rather than look at reporting on what truly matters – the biggest financial collapse facing us in 90 years.

There is no ‘told you so’ in any of this. The same feelings in the bones of some 30 years ago are back as they were at the time of Greenspan and Lehman. This time can’t be avoided. We have borrowed too much, saved too little and all the while blissfully ignored the warning signs. The faith and confidence in authorities is evaporating. The failed experiment started by Greenspan is coming home to roost. This will be far worse than 1929. Take that to the bank, if it is still in operation because you won’t be concerned about the return on your money but the return of it!

Sloppy senators who snigger at the seriousness of the situation

Regardless of whether one believes in climate change or not, surely even deniers should get access to transparent data, especially from taxpayer funded bodies. Just being told the science is settled is not acceptable. Indeed if the science is settled, what is there to hide? Allow all the ‘raw’ and ‘homogenised’ data to be independently scrutinized. Surely it will corroborate the facts and convert the heretics.

The argument that I am not a scientist is irrelevant. 99% of the people who are alarmists are not either. Yet, should one be vilified for questioning so many blatant acts of  fraudulent behaviour? As often in the world of ‘settled’ topics, the contrarian opinion is often laughed it. Yet, if 99% of people tell you one thing are you not curious to the counter arguments? So often the conventional wisdom has often turned out to be false.

What Senator Dastyari here has done is take allegations of data manipulation by the Bureau of Meteorology (BoM) as just a joke and an opportunity to cheap shot one of his fellow senators who is absent. It is willful behaviour to undermine a serious hearing. What is the constant faith that we are asked to put in government bodies that somehow they are above the law and beyond the scope of audit because we should trust them? That is like leaving candies on the table in reach of your kids but telling them they mustn’t eat any. The crack and eat some but when questioned swear they didn’t even though the blue M&M stain on the tongue proves they’re lying.

Former US Fed Chairman Alan Greenspan regularly spoke to the US Senate House Banking Committee. With the exception of Ron Paul, pretty much all other members used to hang off every word, not questioning anything that came from his mouth. It was nauseating to watch them heap praise on him. He was not held to account. Ron Paul used to ask questions about rampant monetary supply growth, asset bubbles and extreme borrowing to income ratios but his fellow law makers would gang up on him for having the hide to interrogate the ‘Maestro’. It is this type of unwillingness to question group think that is much more worrying. To all of the questions asked of Greenspan by Paul, we still got GFC – avoidable if the group thinkers in the Senate were prepared to challenge.

As CM has written frequently – so many bodies have been busted for data manipulation – the UNIPCC, NASA, NOAA and the BoM to name a few. Yes, even NASA, the people who have the brainstrust to launch man to the moon. Human greed is the issue. This discussion with President of the Sierra Club Aaron Mair who tells Senator Cruz there should be no debate as the science is settled yet can’t reliably argue his position even with a bench full of his flunkies pushing the same garbage.

In all seriousness, Dastyari wants to copy Aaron Mair. Shut down any plausible debate and avoid scrutiny that might upset his own constituents. People often use the argument that investing in renewables is like insurance. That we take it on the off chance we’re wrong. Well, in a sense what many scientists are doing is insurance fraud. Then again it is also an unanswered question. Why is it bankers get thrown into jail and fined exorbitant sums yet scientists riddled with conflicts of interest and deliberate ‘forgery’ of data to fit narratives escape scot-free even if caught.

Playing with Financial Plutonium

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I am still dumbfounded by the level of complacency in financial markets. How  can there be any confidence in our financial system?  Reality is that confidence continues to wane. I mentioned a while back that the headline stock index in Europe has no financial stocks in it. Never in my history in financial markets have I witnessed this. It isn’t because other stocks have got bigger. Financials in Europe have shrunk to such irrelevant levels that they don’t make the cut. Argue all you want about FinTech revolutionizing banking as we know it however don’t dismiss that the core of financial markets resembles a rotting carcass with so little meat that even vultures are considering vegetarianism so slim are the pickings. If the financial sector is sick and it is what greases the economy beware this signal.

One thing that hasn’t changed is the arrogance of the banks. Deutsche proudly protesting that the DoJ’s $14bn fine is just a “starting point” all the while its shares dwindle at all time lows.  Europe’s most powerful bank 1/3rd the size of Australia’s NAB. I’m working on a report looking at the deterioration of financial profitability and market relevance.

All the while though I keep shouting from the rooftops like the tramp from Blazing Saddles and the bell chimes right as I try to warn of impending  global economic disaster.

“The world economy is dying (clang!)”

“what did he say?”

“I think he said the world economy is flying!”

“No, goddamnit!, I said the world economy is dying (clang!)”

You get the picture. What people still haven’t grasped is the velocity of money continues to slow rapidly. For every dollar pumped into the economy, smaller fractions of GDP are created. In Europe it takes €7 to create €1. In China it takes RMB8 to create RMB1. In the US it takes around $4.5. The more morphine that is pumped into the patient the less efficacy. The debt burden mounts to unsustainable levels. Asset bubbles abound. Central banks keep pushing on sweeping the damage under the carpet. Europe is at stall speed. France and Italy didn’t grow last quarter. The US stumbled into 1% territory while the previous quarter was revised to 0.8% – hardly cracking growth.

The most recent worrying red flag is Greenspan weighing into the central bank policy debate. If there was ever a tail-end Charlie behind the curve he is it. I look at the propaganda pushed by the White House in a self congratulatory tone. This idea that everything is fine. American wealth at all time highs and poverty at 50 year lows. The problem with such fiction is that Main Street is actually living the struggle. They are not theory. They are reality. Whether crushing pensioners with a lack of sensible low risk income products, or celebrating recent inflation through rent rises and healthcare costs is not to pat one’s back over. Real wages are falling, consumption is waning and life is getting tougher. Steeper Obamacare prices and higher rents don’t boost economic growth. This is bad inflation and most other items continue to struggle under the weight of chronic overcapacity. Hanjin Shipping woke us up to that sad fact.

It’s brutal out there but the Democrats talk of prosperity at the same time complaining at the lack of progress on welfare despite having their wise sage Obama at the helm for the past 8 years.

More misguided central bank policy continues in group think like fashion.  It is as if they are enriching financial plutonium to such dangerous levels that imminent detonation could occur. The experiment keeps going but the scale of the collateral damage is growing exponentially. Many central bankers know how bad things have got but pray they can leave their ivory towers and seek shelter before it blows up on their watch so they can evade direct responsibility.

For all of the pump priming, toxic asset buying and NIRP strategies of central bankers, there is one constant in all of this. Pain must eventually be taken to restore equilibrium. The longer we store up the gangrenous irradiated mess that has and is being created for almost two decades the bigger the scale of fall out.

So many are totally unprepared for the coming event. People will still argue that the most experienced and brightest minds work within these banks so we should back their collective wisdom but I’d bet money that most if not all have no idea about how the average Joe and Joanne works. Funny thing is the average Joe and Joanne are feeling the pain everyday as they struggle to get by. They’ve had enough.

I’m surprised the Democrats, the party that is supposed to favour the afflicted, continue to miss the obvious. Trump would never have seen the light of day had the establishment listened to their cries for help.

In closing, I feel the same vibes I did when I called the impending crisis that was GFC1. This time will be much worse.  Financial plutonium is too rich and reaching fissile levels. Discount everything coming from the authorities. Pure common sense tells us the numbers don’t match reality.

There will be no “I told you so!” moment for me. Who would want to bask in misery?

Japan’s moral hazard plan would be harakiri

I’ve said it before and I’ll say it again. Central banks are in such dire straits. ECB President Draghi admitted that he is merely doing what every other central bank is doing. Group think. Perhaps more telling is  Alan Greenspan has started to put himself into the public again saying we are in trouble. You know we are in really big trouble because he’s always ‘behind the curve’. My bigger concern is how the Central Banks cannot play moral hazard like the private sector has. If central banks decide to magically make debt disappear through a debt jubilee the financial devastation would be 100x worse than 1929.

The Japanese have been toying with a plan to wipe out the US$10 trillion of public debt by converting the JGBs they’ll buy with printed money into zero coupon perpetual bonds.The value of a zero coupon perpetual is mathematically zero. So in a heart beat the Japanese government debt gets written down to zero. The Bank of Japan has a $10 trillion asset which is now worth nothing. 200% of GDP gone in an instant. Mauldin also made this assertion that monetising all debt at once by all countries would be unthinkable but the only way you could do it.

Let’s entertain the premise if Japan did this. What would happen? Global markets run on confidence. Nothing more. Nothing less. Without confidence markets will fret. People forget that the Japanese government STILL needs to fund Y40-50 trillion every year to plug the hole in the deficit. Tax take is less than Y56 trillion. Expenditures, thanks to an ageing society are rising above Y100tn. That gap won’t close easily. Sure the BoJ could print that gap every year but honestly, how could Japan’s yen be worth anything if they printed $400-500bn per annum? That’s right Japan would press start on the printing presses and produce the GDP of Thailand or Austria or Sweden or Belgium or Taiwan. Does this pass any sniff test?

Japan imports 60% of its food. It imports most of its energy sources like coal or LNG. It imports iron ore and coking coal to make steel. They must pay these foreigners in their currency. What supplier would want to accept a currency where the central bank just prints it. No country would accept yen pricing. Yes, hyper inflation would be the result. 

The debt service costs of the Japanese banks would become extreme. The low interest fixed mortgages which drives bank income are funded by predominantly depositors. However to avoid the Japanese banks witnessing capital flight they would need to raise deposit rates to dizzying levels and even then as Mrs Watanabe realises the Japanese yen is becoming like the Zimbabwean dollar she’ll convert into another currency exacerbating the downward pressure. Japanese banks would quickly become insolvent. Then corporations would start collapsing causing widespread unemployment.

The Global Financial Crisis (GFC) of 2008 taught us about moral hazard. People just walked away from their interest only mortgages and left the taxpayer to clean up the mess. Moral hazard is not good under any circumstances but if central banks and governments start playing moral hazard by ‘walking away from debt’ then effectively you permanently ruin trust and financial markets are destroyed. Think about. If people think that the end game will always result in a bail out then moral hazard becomes the default. It is permanent helicopter money. There is absolutely zero incentive to act prudently. Everyone should have a $50mn home, a Rolls-Royce and not have to work for it. Simple economics means that this solution is completely untenable. In a sense paper money would be worthless, we would have full unemployment and society would cease to function.

Now before we start reeling off the resumes of the incredibly intelligent people who can mathematically prove theories like this, note that was exactly the same type of argument hurled at me back in 2001 when I heavily criticised Greenspan predicting he would lead the world off a cliff in 5 years. I was right and they were wrong. Central banks have no idea. Their policies are group think. They don’t live in markets. They don’t breath markets 24-7. The only thing Greenspan was right on was to say “The gut feel of the 55-year old trader is more important than the mathematical elegance of the 25-year old genius.” Ask any of your experienced financial sector friends and get them to give you their gut feeling in private (publically they’e always bullish) and their answer to an almost 100% degree will be funereal.

If Japan makes the move to make $10 trillion dollars disappear (i.e. the GDP of China, home to 1.2 billion people) it will be the biggest mass suicide the world has ever seen in financial markets. You can take that to the BANK.

The Central Banker’s karaoke song

Alan G

I was listening to World Party’s ‘Ship of Fools‘ today and thought a few changes to the lyrics would be quite apt for Central Bankers to sing…

We’re setting sail
To the place on the map where the economy  we think we can turn
Drawn by the promise of inflation and growth
By the light of the currency we burn
Drawn by the promise of the cycle from negative rates
Not the gold or the savings or pearls
It’s the place where we keep all the printing presses we need
We sail away from the plight of the world on this trip baby
Pay, they will pay tomorrow
They’re gonna pay tomorrow
They will pay tomorrow
Save us, save us from tomorrow
They don’t want to sail with this ship of fools, no no
Oh, save us, save us from tomorrow
They don’t want to sail with this ship of fools, no no
They want to run and hide

Right now
Lies and hope are gonna drive them over the endless sea
We will leave them drifting in the shallows
Drowning in the debts of history
Travellin’ the world, we’re in search of hope
But I’m sure we’ll build their Sodom like we knew we would
Using all their good people for our galley slaves
As our deflating boat struggles through the warning waves
But they will pay, they will pay tomorrow
They’re gonna pay tomorrow
They gonna pay tomorrow
Save us, save us from tomorrow
They don’t want to sail with this ship of fools, no
Oh, save us, save us from tomorrow
They don’t want to sail with this ship of fools, no
Where’s it comin’ from or where’s it goin’ to?
It’s just a, it’s just a ship of fools