US and China tighten in unison, and damn the torpedoes

The world has changed abruptly for investors as the US Federal Reserve and the People's Bank of China both brush aside deflation warnings and press ahead with monetary tightening

By Ambrose Evans-Pritchard, International Business Editor

3:20PM GMT 30 Oct 2014

100 yuan banknotes

Mind the monetary gap as the world's two superpowers turn off the liquidity spigot at the same time. 
The US Federal Reserve and the People’s Bank of China have both withdrawn from the global bond markets, each for their own entirely different reasons. The combined effect is a shock of sorts for the international financial system.
The Fed’s message on Wednesday night was hawkish. It did not invoke the excuse of a stronger dollar or global market jitters to extened bond purchases. It no longer sees “significant” constraints to the labour market. Instead it spoke of “solid job gains” and a “gradual diminishing” of under-employment.
This a tightening shift, and seen as such by the markets. The euro dropped 1.5 cents against a resurgent dollar within minutes of the release, falling back below $1.26. Rate rises are on track for mid-2015 after all.
The Fed is no longer printing any more money to buy Treasuries, and therefore is not injecting further dollars into an interlinked global system that has racked up $7 trillion of cross-border bank debt in dollars and a further $2 trillion in emerging market bonds. The stock of QE remains the same. The flow has changed. Flow matters.

The Fed has ended QE3 more gently than QE1 or QE2. This helps but it may also have given people a false sense of security. The hard fact is that the Fed has tapered net stimulus from $85bn a month to zero since the start of the year.
The FOMC tried to soften the blow in its statement with pledges to keep interest rates low for a very long time. This assurance has value only if you think QE works by holding down interest rates, as the Yellen Fed professes to believe.
It cuts no ice if you are a classical monetarist and think that QE works its magic through the quantity of money effect, most potently by boosting broad M3/M4 money through purchases of assets outside the banking system.

Pessimists argue that the world economy is so weak that it needs a minimum of $85bn a month of Fed money creation (not to be confused with zero interest rates) just to avoid stalling again.
Or put another way, there is nagging worry that tapering itself may amount to an entire tightening cycle, equivalent to a series of rate rises in the old days. If they are right, rates may never in fact rise above zero in the US or the G10 states before the global economy slides into the next downturn.
It is no great mystery why the world is caught in this "liquidity trap", or "secular stagnation" if you prefer. Fixed capital investment in China is still running at $5 trillion a year, and still overloading the world with excess capacity in everything from solar panels to steel and ships, even after Xi Jinping’s Third Plenum reforms.
Europe has been starving the world of demand by tightening fiscal policy into a depression, running a $400bn current account surplus that is now big enough to distort the global system as a whole. George Saravelos, at Deutsche Bank, dubs it the "Euroglut", the largest surplus in the history of financial markets. The global savings rate has risen to a fresh record of 25.5pc of GDP, the flipside of chronic under-consumption.
Of course, it is not the job of the Fed to run monetary policy for the world, and that is the new problem facing QE-addicted investors. The US economy is growing briskly at a 3pc rate. It can arguably handle monetary tightening, at least for now.
New home building is up 17.8pc over the past year. The Case-Shiller 20-City index of house prices is up 22pc since early 2012. Unemployment has tumbled to 5.9pc. Lay-offs have dropped to a 14-year low.
We are entering a new phase of the monetary cycle where the US is strong (relatively) and the world is weak (relatively). The Fed has switched from a being the friend of global asset prices, to being neutral at best, with a strong hint of menace.
It is a very odd environment. The US Treasury market is pricing in near-depression conditions.

Five-year inflation expectations have suddenly collapsed. You could say it is remarkable that the Fed should be withdrawing any stimulus at all in such circumstances.
Janet Yellen has to navigate a perilous course between the Scylla of deflation and the Charybdis of corrosive asset booms, just the like the Riksbank this week, or indeed the Bank of Canada, or the Bank of England. Yet the precipitous slide in commodities since June may be a warning sign that stress is building.
There are echoes of 1928, when commodity prices buckled even as the boom on Wall Street was still gathering pace, and as the credit bubble in Weimar Germany was still gathering towards a crescendo. Fed hawks, led by Benjamin Strong, chose to ignore the deflation risk, instead raising rates to teach “speculators” a lesson. The move set off a global chain reaction.
Mrs Yellen is unlikely to repeat that error, but there are many pushing her to do so, and since she is not a monetarist, she may have misjudged the quantity effects of tapering. Note that the growth rate of Divisia M4 – a broad measure of the money supply tracked by the Center for Financial Stability - has dropped to 2pc from 6.2pc in early 2013.
The Fed pivot comes at a delicate moment because China’s (PBOC) is at the same time winding down stimulus, trying to tame China’s $25 trillion credit monster before it is too late. The central bank has not yet blinked - beyond minor short-term liquidity shots - even though bad loans are rising fast at the big state banks.

China became a net seller of global bonds in the third quarter (even adjusting for currency effects). It was buying $35bn a month earlier this year.
The move was well-flagged in advance. Premier Li Keqiang said in May that excess foreign reserves had become a "burden" and were making it impossible for China to run a sovereign monetary policy.

The policy shift automatically entails monetary tightening – vis-à-vis the status quo ante – unless China acts to sterilise the effects. It has not done so. We have seen a sudden stop in China’s “proxy QE”.
Brazil, Malaysia, Singapore and Thailand all cut their foreign reserves in the third quarter. Korea slashed net purchases from $25bn to $9bn, and India from $43bn to $12bn. Russia is now burning through its reserves to defend the rouble. Others oil states will have to do the same to cover their budgets. 
Net bond stimulus by all the global central banks together has fallen by roughly $125bn a month since the end of last year, an annualised pace of $1.5 trillion. We have seen an abrupt halt to the $10.2 trillion of net reserve accumulation since 2000 that has played such a role in the asset boom of the modern era. That does not automatically mean asset prices will fall, but it removes a powerful tailwind. 
Hopes that the Europe would pick up the QE baton to keep the asset boom going border on wishful thinking. The European Central Bank’s balance sheet has contracted by almost €150bn due to passive tightening since the Mario Draghi first spoke of buying asset-backed securities in June. 
There is much chatter from peripheral ECB governors, a talkative lot. Listen instead to Sabine Lautenschläger, Germany’s member of the ECB’s executive board. Her predecessor backed the Draghi rescue plan for Italy and Spain (OMT) in August 2012 against objections from the Bundesbank, and that is what made it possible. 
I may be wrong, but it strikes me as implausible that the ECB will risk launching QE on a massive scale as long as both German members are opposed. The bank can dabble at the edges, as it is doing now, but a reflation blitz requires German political assent. 
So what is Dr Lautenschläger saying? "I take a more critical view of some areas of the ECB's unconventional measures. If we talk about large-scale purchase programmes of securitised assets, the so-called ABS plan, or even large-scale sovereign bond purchases - then I take a more critical view, because for me the balance between costs and needs is negative at the moment. Those are measures one uses as a last resort if deflation is visible and that is by no means the case.”

October 30, 2014 4:39 pm

John Paul Rathbone
The region is looking at a slowdown, but things could be worse, says John Paul Rathbone
Illustration of Latin America fiesta
In the past 10 years, South America never had it so good. The continent surfed a global commodity price boom, helped by abundant global capital. In Sir Martin Sorrell’s clever marketing phrase, the 2010s were to be the “decade of Latin America”. Maserati dealerships opened in Bogotá, while Brazil minted 22 millionaires a day . Nor was it only the rich who gained. Poverty fell and, uniquely, social inequality shrank across the continent.
Like all good things, though, the party is ending. As commodity prices fall with China’s slowing economy, there is a new sense of anxiety. Everywhere, countries are vibrating with mildly suppressed panic – and the end of US quantitative easing does not help the mood. As the economic cycle turns, many governments seem confused as to which direction to take. Given how much has been achieved, there is often profound disagreement about what should come next.
Growth is already slowing fast, to just 1.2 per cent for the region this year. As the World Bank warns in its most recent regional outlook: “It is not clear whether the slowdown is bottoming out.” Levels of investment that had reached heights comparable to those in Asia, spurred by the “commodity supercycle”, are falling. Meanwhile, social protest is on the rise – through both the ballot box, as in Brazil’s closely fought election, and direct action, such as last year’s Colombian farmers’ protests or Brazil’s street riots. Everywhere, the region fizzes with social effervescence.
This mood of agitation spans the political divide. At one end of the spectrum lies Venezuela, a spectacularly mismanaged country blessed with the world’s largest energy reserves yet flirting with default, thanks to a state so incompetent that it gives fresh meaning to the word “lemming”.

Remember the last scene in Thelma & Louise, when the heroines gun their car towards the cliff edge? No wonder polls show that most Venezuelans think President Nicolás Maduro should resign.

At the other end lies Chile, often taken as a model of sober economic management. But in just a year, the growth of its copper-dominated economy has slowed from almost 5 per cent a year ago to as little as 1.5 per cent in the third quarter. Santiago’s political atmosphere has turned poisonous and Michelle Bachelet has seen her ratings slide after last year’s landslide electoral win.

Between these extremes lie a range of experiences, and one big exception: Mexico. Unlike commodity-rich South America, it suffered rather than enjoyed the past decade. But now rising Chinese wage costs have lifted the competitive pressure on its manufacturing-led economy, and the terms of trade are turning in its favour. In time, despite serious security issues, it should deliver growth.

Old Latin American hands may feel: we have seen this all before. Nothing changes. Commodity booms come and go – and during the booms the region always seems to get ahead of itself. False hopes are a particular weakness. In Latin America, as Spanish philosopher José Ortega y Gasset wrote: “Everyone lives as though his dreams of the future were already reality.” But now that future has arrived and, sadly for countries such as Brazil, it is laden with consumer debt after a prolonged credit binge – another reason growth will slow.

Still, despite this rather gloomy prognosis, it is not all bad. There is a natural tendency to assume good things (such as more growth and more democracy) go together. Yet this is not always so. By the same token, it is also true that not all bad things go together.
Amid the social effervescence, Latin America has not suffered a return to the coups of yesteryear, although in some countries there has been a subtle erosion of constitutional checks and balances (as in Bolivia, where Evo Morales just won a third consecutive election).

Economic policy making – with some notable exceptions – has improved since the last cycle. Floating exchange rates are proving an essential buffer during the commodity slowdown. Most commodity prices remain historically high and global interest rates are still low (quantitative easing has ended in the US, but when will we ever see interest rates rise in deflation-drenched Europe or Japan?). Latin America is looking at a slowdown, not a collapse.

Crucial, however, will be how that slowdown is managed politically, especially with regard to the region’s newly emergent petty bourgeoisie. Some 50m people have joined the region’s middle classes in the past decade, and typically they hold down three jobs, look to the future and believe in the worth of educating their children. They pay taxes and, naturally, want greater government accountability, less corruption and better public services. How their demands are satisfied when there is less money to pay for them will require a spirit of open-ended and sceptical inquiry from politicians rather than the ideological certainties of the recent past.

Se acaba la fiesta”: the party is ending. For a decade, many in the region congratulated themselves on their achievements. Some national egos grew to Amazonian proportions. Yet it was the false pride of most booms: many of those achievements were due to events elsewhere.

Now the freewheeling years are drawing to a close. Like a cyclist approaching the bottom of a hill after enjoying a long and easy ride, growth may slow to a crawl. There is another slope on the horizon and it will take hard work to get to the top. That is not the end of the world, though; it is the way with all hills.

lunes, noviembre 03, 2014




The revolution is over

Changes in Iran make a nuclear deal more likely—not this month, perhaps, but eventually

Nov 1st 2014  


TALKS to curb Iran’s nuclear programme have less than a month to run. Even now, after 12 years of sporadic argument, Iran insists that it wants civilian nuclear power and not a bomb.

But nobody really believes that. If the talks break down, atomic weapons could proliferate in the Middle East; or, in a bid to stop Iran, America or Israel could launch a military attack on its infrastructure. Either outcome would be a disaster.

Plenty still separates Iran and, on the other side, the permanent members of the UN Security Council plus Germany (known as the P5+1). Much of the focus is on the mechanics of a deal (see article). The two sides cannot agree on how many centrifuges Iran should be able to use to enrich uranium, how long an agreement should last, or how fast to lift sanctions.

The gap would be easier to close if Iran and America trusted each other. One reason why the relationship is so poisonous is that popular Western views of Iran are out of date to the point of caricature. A better understanding of the country would help the talks reach a comprehensive settlement—or, at least, avoid a catastrophic collapse.

Prelude and centrifuge
Much that Iran does is wrong. It finances terrorists and militias in Lebanon and the Palestinian territories and backs the murderous regime of Bashar Assad in Syria. Its politicians routinely deny Israel’s right to exist. They treat opponents at home with cruelty and injustice. On Saturday a woman was hanged for killing the man she accused of molesting her, shortly before a UN envoy condemned a surge in executions and the treatment of Iran’s women. His colleague at the UN’s nuclear agency recently complained that Iran is failing to come clean about its nuclear research—part of a litany of evasion and deceit.

Bad as that is, however, Western denunciation casts Iran in an almost uniquely grim light. It is an implacable enemy. It was part of George W. Bush’s Axis of Evil. It is a dictatorship bent on exporting revolution and prey to a dangerous, millenarian Islam that might just be irrational enough to welcome a nuclear apocalypse. Barack Obama, America’s president, has been condemned for even talking to such a pariah.

Thirty-five years have passed since a senior American official last visited Iran. It has changed.

Our special report in this issue describes a country whose revolutionary fire has been extinguished. As people have moved from their villages to the cities they have got richer and acquired a taste for consumer goods and Western technology. Over half of Iranians go to university, up from a third five years ago. The disastrous presidency of Mahmoud Ahmadinejad, the failed Green revolution—which sought to topple him in 2009—and the chaotic Arab spring have for the moment discredited radical politics and boosted pragmatic centrists. The traditional religious society that the mullahs dreamt of has receded. With the passing of time, the mosques have started to empty. The muezzins’ call to prayer is heard less often, because people complain about the noise. In Qom, the religious capital, seminaries are dwarfed by a vast shopping mall. As a caliphate takes root in Iraq and Syria, here is one Islamic state where religion is in retreat.

Iran is not a straightforward dictatorship. The supreme leader, Ayatollah Ali Khamenei, has the last word. But his role is to adjudicate between the claims of an elite made up of thousands of politicians, clerics, generals, academics and business people. They form a confusing and ever-shifting pattern of competing factions and coalitions. Although this hardly amounts to democracy, it is a political marketplace and, as Mr Ahmadinejad discovered, policies that tack away from the consensus do not last. That is why last year Iran elected a president, Hassan Rohani, who wants to open up to the world and who has reined in the hardline Islamic Revolutionary Guard Corps. Mr Rohani belongs to the establishment, naturally, but it says a lot about today’s Iran that his cabinet contains more doctorates from American universities than Barack Obama’s.

No Qompromise
What does this mean for a nuclear deal? For a start, that on balance Iran will act pragmatically, in what it sees as its own interests, rather than out of a messianic desire to pull down the world order, and is therefore worth talking to. Secondly, that power in Iran moves between factions, just as in America, so any deal must be future-proofed against the day when a hardliner returns to the presidency. And thirdly—and most important—that the world has time on its side.

The further the 1979 revolution recedes, the more normal Iran will tend to become. Dogma will be further eclipsed by everyday worries, like making money and doing business. Iran will not suddenly abandon its nuclear programme, which ordinary Iranians would see as humiliation; it is not about to become friendly to America, nor to stop meddling in its region. But if the regime comes to feel that it can escape the fate of Libya’s Muammar Qaddafi, who gave up on nuclear weapons only to be toppled, a curb will seem less of a gamble.

Time also helps because a deal is increasingly in Iran’s interests. Mr Rohani needs relief from sanctions. After growing by over 5% a year for a decade, the economy shrank by 5.8% in 2012.

Oil pays the government’s bills; its recent 25% fall in price is squeezing the economy further. Iran’s region is dangerous, too. Islamic State threatens its Shia allies in Iraq, and both Mr Assad and Hizbullah, its ally in Lebanon, are engulfed by war in Syria. Iran hints that America should give ground in the nuclear talks so as to secure Iranian help in the Middle East. In fact, Shia Iran is the one who stands to gain: America would risk a backlash from its Sunni allies in Saudi Arabia and from the Sunnis it is trying to win over in Iraq and Syria.

Despite this month’s deadline, the P5+1 should be patient. The interim agreement that paved the way for talks, under which no new centrifuges are being installed, creates a pause in the nuclear programme. The world should neither break the talks with impossible demands, nor give way to Iran for fear that there will never be a better opportunity. Instead, the P5+1 should hold out for the right deal. It would be good if they got one next month, but if they don’t it will not be a disaster.

Europe: Building a Banking Union


The European Central Bank had two basic short-term goals for this year's stress tests. On one hand, it had to come up with a test that was tough enough to be credible after tests held in 2010 and 2011 were widely seen as too soft and lacking in credibility. On the other hand, the tests could not produce results dire enough to generate panic. The European Union is going through a phase of relative calm in financial markets, and the European Central Bank was not interested in creating a new wave of uncertainty over the future of Europe's banks.

While the tests did attract some criticism, the central bank achieved both goals. Of the 130 banks involved in the tests, 25 had capital shortfalls, a finding slightly more severe than forecasts projected. Of those 25 banks, 13 must raise fresh capital and come up with 9.5 billion euros ($12.1 billion) in the next nine months. None of the failed tests came as a surprise, however. Italy's Monte dei Paschi, the worst performing bank in the tests, has been in trouble for a long time and had to receive assistance from the Italian government in 2012. Other failing banks are located in countries such as Slovenia and Greece, which have been severely affected by the financial crisis. And while the price of several banks' shares dropped during the Oct. 27 trading session, no collapses occurred.

The tests were not perfect -- they used data from December 2013 and were mostly done by each participating state. The methodology and scenarios were also criticized. For example, the most extreme "adverse scenario" included in the tests considered a drop in inflation to 1 percent this year, although the rate has already fallen to around 0.3 percent. The decision to include only 130 "systemic" banks while turning a blind eye on smaller -- and probably weaker -- institutions also drew criticism. But overall, markets considered the tests legitimate, especially in comparison with the weak tests that have taken place since the beginning of the European crisis.

The stress tests, however, are only the starting point in the much deeper and complex process of creating a banking union in Europe. The issue has traditionally been very controversial in the Continent. As Europe became more integrated, several policymakers proposed the creation of a banking union to complement the Continent's internal market and common currency.

Nationalism and diverging political interests, however, made this quite difficult, and the idea was abandoned during the Maastricht Treaty negotiations in 1991 and again after it was reconsidered during deliberations for the Treaty of Nice in 2000.

But the eurozone crisis -- and the fear of financial instability spreading among the countries that share the euro -- has reignited the debate about a banking union. Simultaneous crises in countries such as Spain and Ireland, where national governments were forced to request international aid to rescue failing banks, made Europe consider the need to break the vicious circle between banks and sovereigns.

The Upcoming Political Debate

In 2012, the European Union announced that the banking union would be implemented in two stages. During the first stage, the European Central Bank would centralize the supervision of participating banks' financial stability. At a later stage, Brussels would introduce a "Single Resolution Mechanism" and a "Single Resolution Fund" to be responsible for the restructuring and potential closing of significant banks.

The first stage of the banking union was controversial because some member states refused to give the central bank full power to supervise every single bank in the European Union. A compromise was eventually found, and the bank was given supervisor powers over banks with holdings greater than 30 billion euros or 20 percent of their host nation's gross domestic product. This was not a minor compromise. National regulators remained in charge of supervising smaller banks such as Spain's cajas and Germany's Landesbanken, institutions generally having strong ties with local political powers -- and troubled balance sheets. The stress tests were a precondition for this stage of the banking union implementation process.

As the November implementation of the banking union's first stage draws nearer, the Europeans will have to make difficult political decisions regarding the second phase of the project. Twenty-six members of the European Union (Britain and Sweden decided not to participate) signed an intergovernmental agreement in May to create a special fund and a central decision-making board to rescue failing banks. According to the agreement, the fund will be built up over eight years until it reaches its target level of at least 1 percent of the amount of deposits of all credit institutions in all the participating member states, projected to be some 55 billion euros. The fund will initially consist of national compartments that will gradually merge into a single fund. The agreement also made official the "bail-in" procedure for future rescue plans.

Members of the European Parliament have said the fund should be larger because it may not be enough to deal with a new banking crisis. There is also the question of how the Single Resolution Fund will be financed. On Oct. 21, the European Commission proposed that the largest banks, representing some 85 percent of total assets, contribute around 90 percent of the funds. Opponents have criticized that instead of designating the contributions in proportion to the risks each bank presents, the proposal assigns contributions using a bank's total assets. The European Council, which represents member states, will have to ratify this proposal.

More important, the transfers of banks' contribution to the Single Resolution Fund are scheduled to start in January 2016. Before that happens, however, the parliaments of member states will have to ratify the intergovernmental treaty that was signed in May, a difficult proposition in the wake of rising Euroskeptical parties. In addition, a group of German professors have said they would challenge the banking union before the German Constitutional Court. According to this group, the banking union represents a huge risk for German taxpayers while leaving Berlin without any oversight authority. This is the same group that is currently challenging the European Central Bank's Outright Money Transactions bond-buying program.

The Real Problem: A Lack of Easily Accessible Credit

While the stress tests and asset quality review offer a clearer view of banks in Europe, most European households and businesses are facing more immediate problems. On Oct. 27, the central bank revealed that loans to the private sector fell by 1.2 percent year-on-year in September after a contraction of 1.5 percent in August. The data shows a slower rate of contraction in credit lending but does not signal a strong recovery of credit in the eurozone. The data also confirmed that credit conditions remain particularly tight in the eurozone periphery.

Since banking credit is crucial to households and companies, credit conditions are intimately linked to Europe's economic recovery. The European Central Bank has recently approved a battery of measures, including negative interest rates and cheap loans for banks. However, as banks are still trying to clean up their balance sheets, lending remains timid. Even in those cases where banks are willing to lend, they tend to impose strict conditions that are hard for customers to meet. There is also a demand problem. With weak economic activity and high unemployment in the European periphery, many households and companies are simply not asking for credit.

Finally, the central bank's latest policies have created significant disagreement within the institution. Some members of the governing council -- most notably Germany's Bundesbank -- are wary of measures that could finance governments and weaken the pace of economic reforms. The Germans are also concerned about the legality of measures such as quantitative easing and its potential impact on inflation.

The current frictions within the central bank are representative of the wider debate that is taking place in Europe between countries led by Germany that believe reforms should come before stimulus packages, and those led by France that think crises are not the best time to apply deep spending cuts. In the coming weeks and months, this debate will be key in deciding the future of the European Unión.

QE central bankers deserve a medal for saving society

The QE experiment has worked on one level for those countries that did it, but may have destabilized the global financial system yet further and stored up future trouble

By Ambrose Evans-Pritchard

9:00PM GMT 29 Oct 2014

former head of the Bank Of England Mervyn King in the garden of his home in Kent
What Mervyn King's QE programme did was distribute the costs of crisis evenly between creditors and debtors Photo: Andrew Crowley
Flow of Funds data show that total non-financial debt has dropped from a peak near 260pc of GDP in 2009 and since stabilised at 237pc of GDP. Public debt did jump, matched by falls in household and corporate debt ratios.

On cue, federal debt is now falling as well. The deficit is down to 2.8pc of GDP, low enough to erode the debt ratio in a growing economy through the magic of the denominator effect.
This is not a "pure" economic experiment, of course. There are other variables: the shale boom and the manufacturing renaissance in chemicals and plastics that it has spawned; quick action by the US authorities to clean up the banking system. Yet it is indicative.
By contrast, the eurozone carried out its fiscal austerity without monetary stimulus to cushion the shock, lurching from crisis to crisis as a result. The region has yet to reclaim it former levels of output, a worse outcome than during the Great Depression by a wide margin. Not even the 1840s were this bad. You have to go back to the Thirty Years War in the 17th century to trump the economic devastation of EMU.
The eurozone's public debt ratios have rocketed, yet unlike America there has no been no drop in private debt to compensate.
The latest Eurostat data are staggering. They show that Italy's debt has jumped by 5.5pc of GDP to 133.8pc over the past year despite a primary surplus, purely because of EMU contractionary policies. The eurozone has bent every sinew to cut debt, and ended up in a worse predicament, exactly as Britain did under its infamous deflation policies in the 1920s.
At the end of it all, Euroland is again on the cusp of a triple-dip recession, with unemployment stuck at 11.5pc. It faces devastating hysteresis effects in southern Europe, where a large chunk of those under 30 have never had a permanent job. Leaving aside the social destruction, this will reduce the economic growth of these countries for two decades or more. It overwhelms the alleged benefits of EMU-imposed reforms.
The contrast with the US is so stark that there can be little argument. The US suffered broadly the same economic shock in 2008 and had a similar jobless rate in the white heat of the crisis. Its unemployment rate has since tumbled to 5.9pc. Lay-offs have dropped to a 14-year low. There is even an acute shortage of truck drivers, now able to command $40,000 a year.
Britain's workforce has reached fresh records above 30m. Some are highly-educated refugees from the EMU victim states, a loss to them, a boon to us. The British recovery may be unhealthy in many ways - not least the current account deficit - but it is surely better for the long-term prospects of this country than the cosmic gloom gripping the Maastricht bloc.
It is true that Japan is struggling despite the most radical QE blitz ever attempted in a large economy - roughly $70bn a month since Shinzo Abe took power, and began to shake Japan out of its fatalism - but it had a bigger mountain to climb, and it has in fact weathered the shock of its sales tax rise this year. Those who say QE has failed in Japan are premature, and offer no counterfactual argument. Clearly the status quo ante was a path to ruin.
You can argue that zero rates robbed savers, and that QE robbed them a fraction more, but let it never be forgotten that the state rescued the banking system across much of the industrial world in 2008. If governments had let banks collapse - and 4,000 went under across the US in the early 1930s - savers would have lost their shirts. They were in fact bailed out by the taxpayers, and little gratitude some show for it.
What QE has done is to distribute the costs of crisis evenly between creditors and debtors, a matter of natural justice. Eurozone policies are by contrast an enforcement mechanism for creditors alone. Debtors in Spain have been reduced to servitude by a combination of medieval debt laws and the "internal devaluation" imposed by the EMU regime.
We will never know whether extreme monetary stimulus averted social and political breakdown, a slide into beer-hall thuggery and street militias, but would you ever wish to put the matter to a test? So let us give due credit to the heroes of our time - Ben Bernanke, Mervyn King and those who stood by them against the mob of howling critics.
And yet, there is a problem. The Bank for International Settlements and others such as India's central bank governor Raghuram Rajan argue that QE is in essence a beggar-thy-neighbour ploy that shifts the burden onto others in a "Pareto sub-optimal" for the world as a whole.
They argue it led to a flood of liquidity into emerging economies and that they were not able to neutralise the effects. Most of the world has now been drawn into an all-engulfing debt trap that has left the international system more vulnerable than ever.
Debt has risen by 20 percentage points to a record 175pc of GDP in emerging markets, with China already around 250pc, according to Standard Chartered. These are unprecedented levels for countries without mature financial markets and deep layers of wealth. Morgan Stanley calculates that gross global leverage has risen from $105 trillion to $150 trillion since 2007. The BIS says the world is on a hair-trigger, at risk of "violent" effects if there is slightest loss of liquidity.
This may soon be out to the test since it is not only the Fed that is tightening, tapering QE3 from $85bn a month to zero since the start of the year. By a quirk of fate, China's central bank has stopped accumulating foreign bonds as well, for its own reasons. Let us hope they are talking to each other.

The Chinese central bank became a net seller of Treasuries, Bunds, Gilts and French bonds in the third quarter. This is a major change of strategy. It was buying $35bn a month earlier this year, before premier Li Keqiang announced that excess reserves had become an inflationary "burden". This shift is not exactly "reverse QE" but is analogous.
The world must deal with a double shock from the two monetary superpowers. Investors had hoped that the European Central Bank would pick up the baton in a seamless transition. This has not yet happened, and may not happen on any worthwhile scale for a long time given the "German problem".

The ECB's balance sheet has contracted by €150bn to just over €2 trillion since Frankfurt first unveiled its "QE-Lite" more than four months ago. The ECB bought €1.7bn of securities last week but this is a toe in the water.

If so, let us inject the stimulus directly into veins of the economy money next time, using it to build roads, houses and an infrastructure fit for the 21st century. Experts call that "fiscal dominance", a dirty concept, a slippery slope towards to monetary financing of deficits. To which the condign reply in a global deflationary trap with chronic lack of demand is, all the better.


Eliminate the negative

A new strategy reduces pension funds’ risks, but it has a cost

Nov 1st 2014

PITY the pension-fund manager. Cash pays close to zero in many developed economies and ten-year Treasury bonds offer a yield of 2.3%. But many managers need much higher returns if they are to pay the benefits they have promised. That forces them to pile into equities, despite the risks of big bear markets like 2001-02 or 2008-09, not to mention minor scares like mid-October’s wobble.

The problem afflicts firms that maintain “defined-benefit” pension plans, which pay retirement incomes linked to a worker’s final salary. A plunge in the stockmarket creates a big deficit in the pension scheme and a nasty hole in the sponsoring company’s balance-sheet. That can weigh on the share price: a new study by Llewellyn Consulting found that a £100 increase in the pension deficit of a FTSE 100 company reduces its market value by £160.

The alternative approach, of avoiding risk altogether, may be no more palatable. The company would have to invest in inflation-linked government bonds that offer very low real returns. There would need to be a big increase in contributions to ensure benefits were paid.

The holy grail would be a combination of equity-like returns with reduced volatility. It is unattainable, of course. But it may be possible to get part-way there.

Redington, a consultancy firm, says the latest compromise, which is being adopted by many clients, revolves around a “volatility-control index”, such as the one created by Standard & Poor’s. The approach aims to keep the volatility of an equity portfolio (the amount by which it fluctuates) constant at, say, 10%. If market volatility falls below that level, then investors take more risk by borrowing money to invest in equities. When volatility surges above that level, investors sell shares and hold more cash.

The effect is to produce a portfolio with a much smoother ride than a conventional investment in the stockmarket (see chart). Of course, there are no free lunches: in return for eliminating the downside, some upside can be lost as well. Such a strategy will underperform in a steadily rising market, but can make up the shortfall and more in bear markets.

There is a further risk. Sometimes, bad news can appear from nowhere. Low volatility, in other words, can be a sign of complacency. To protect against such events, investors buy put options on the volatility-control index. That gives them the right to sell their holdings at a given price. Put options on a portfolio that tracks the broader market are very expensive; options on the volatility-control index are much cheaper, because it tends to move less sharply.

Nevertheless, the cost of these options (around 0.68% a year) does reduce returns. That may be a price worth paying, however, for a firm worried about its balance-sheet. The biggest peak-to-trough loss this approach produced in the past 20 years was 28%, compared with a 56% loss for an unhedged investment in the S&P 500.

Those with good memories may also feel that the strategy is reminiscent of “portfolio insurance”—an earlier attempt to reduce risk. This required institutional investors to protect themselves against stockmarket falls by selling contracts in the futures market. Some people believe this tactic led to “Black Monday” in October 1987, when the Dow Jones Industrial Average fell almost 23% in one day. As the market dropped, investors sold futures, causing the price to plummet; the decline in the futures price triggered a further sell-off in the underlying equity market, triggering more futures sales and so on.

Something similar could happen with this controlled-volatility approach if it were adopted by a large chunk of the pension industry. If the market became more volatile, such investors would sell equities, making the market more volatile still, necessitating further sales and so on.

For the moment, however, that is unlikely to be a problem, since the approach is still new. The adoption of these strategies also suggests that pension funds are taking a more sophisticated attitude towards investment risk, instead of just placing their chips on equities and hoping for the best. In a similar vein, some funds have attempted to hedge their longevity risk (that workers live longer) and the inflation risk (that wages, and thus benefits, rise faster than expected).

What such strategies cannot do is create higher returns out of thin air. Public-sector pension funds in America that are still counting on long-term returns of 7-8% when the risk-free rate is so low, are living in fairy-tale land. Indeed, their best hope might be to buy some magic beans.

The $75 trillion shadow hanging over the world

Value of risky investment products and other shadow banking assets climbs 7pc to $75 trillion in 2013

By Szu Ping Chan

4:01PM GMT 30 Oct 2014

Shadow banking describes financial institutions that act like banks but exist outside the constraints of bank regulation 
"Intermediating credit through non-bank channels can have important advantages and contributes to the financing of the real economy; but such channels can also become a source of systemic risk, especially when they are structured to perform bank-like functions and when their interconnectedness with the regular banking system is strong," the FSB said in its annual shadow banking report.             

While regulators have highlighted that the size of the shadow banking system does not pose a systemic risk on its own, many non-bank lenders obtain short-term funds to invest in longer-term assets, which can trigger fire sales if nervous investors decide to withdraw their money at once.
During the financial crisis, the rapid sell-off reduced asset values and spread the stress to traditional banks, some of which controlled shadow lenders.
"The system-wide monitoring of shadow banking is a core element of the FSB's work to strengthen the oversight and regulation of shadow banking in order to transform it into a transparent, resilient, sustainable source of market-based financing for real economies," said Mark Carney, chairman of the FSB and Governor of the Bank of England. 

Emerging markets experienced the fastest growth in shadow banking, according to the FSB.
The FSB's report said there had been "a clear increase in the share of emerging market jurisdictions, particularly China". Shadow banking assets in the world's second largest economy increased by 37.6pc to almost $3 trillion - or 31pc of GDP. 

While the FSB said this was small compared to other jurisdictions such as the Netherlands, where non-bank entities account for more than 750pc of GDP due to a large amount of "special financial institutions" set up to take advantage of tax planning opportunities, the FSB said double-digit growth in emerging markets such as China and Argentina should be "carefully monitored".

"The rapid expansion of non-bank intermediation in these jurisdictions should be carefully monitored to account for any early indications of a build-up of systemic risk," it said.
Granular data from 23 countries which stripped out assets not related to credit intermediation - or taking money from savers and lending it to borrowers - showed the size of the shadow banking system stood at $34.9 trillion in 2013, compared with $34 trillion in 2012.
Under this measure, growth of shadow banking in China was even larger than under the headline measure, rising by 40pc in 2013 to $2.7 trillion.
The FSB data follows a report by the International Monetary Fund this month which urged regulators to do more to police activity in the non-bank sector.

The FSB and IMF said more data were needed to conduct in-depth healthchecks of the sector.

Heard on the Street

U.S. Economic Growth Should Keep in Private

GDP Could Mask Economic Strengthening in Fourth Quarter

By Justin Lahart

Oct. 30, 2014 4:12 p.m. ET

Viewed through the prism of gross domestic product, the U.S. economy looked better in the third quarter than its underlying performance really was. The fourth quarter could be just the opposite.

GDP grew at a robust 3.5% inflation-adjusted annual rate in the third quarter, the Commerce Department reported Thursday. That was better than the 3.1% forecast by economists. But that unexpected performance was due to a 16% jump in military spending that will probably reverse in the current quarter. A narrowing trade gap also provided a boost that probably won’t be repeated.

To exclude the often volatile effects of swings in government spending, trade and business inventories, some economists keep track of private domestic final purchases. This measures combined household and business spending. Forecasting firm Macroeconomic Advisers calculates that this gauge of private spending grew at a 2.3% annual rate in the third quarter—substantially weaker than GDP.

In the fourth quarter, private spending should do better. With the job market showing signs of acceleration and gasoline prices falling, consumer spending will likely pick up. Residential investment—money spent on new homes and other housing related items—looks likely to improve after a soft third quarter. With the willingness to hire likely paired with a willingness to invest, business spending should stay firm. Macroeconomic Advisers forecasts that GDP growth will slow to 2.4%, but that private spending will grow by 3.2%.

Put differently: While GDP looks poised to slow in the fourth quarter, this may mask an economy that is actually gaining in strength. Investors focused too much on where the headline number is heading risk ending up wondering what they missed.

Precious Metals

Understanding Gold's Massive Impact on Fed Maneuvering

By Peter Krauth, Resource Specialist, Money Morning

October 30, 2014 



For that, some called him "The Maestro."




Greenspan Was Molded Decades Before Heading the Fed

Greenspan has been an economic adviser to two presidents and a director at several corporations, including JP Morgan & Co., as well as a director of the Council on Foreign Relations.

But his ideas about economics and money change dramatically depending on when you ask him, or where he works.

Back in the early 1950s Greenspan became a member of Ayn Rand's inner circle. His essay "Gold and Economic Freedom" was published in Rand's newsletter The Objectivist in 1966 and in her book, Capitalism: The Unknown Ideal in 1967. He even read Atlas Shrugged while it was being written.

In case you're confused, yes… it's the same Alan Greenspan.

In the "Gold and Economic Freedom" essay, he wrote: "… gold and economic freedom are inseparable, that the gold standard is an instrument of laissez-faire and that each implies and requires the other."

He went on to say: "In the absence of the gold standard, there is no way to protect savings from confiscation through inflation. There is no safe store of value."

Does this sound like a guy who would be in charge of the world's most powerful central bank?

Remember, the raison d'être of central banks, and of course central bankers, is to promote and defend a system of fiat money creation and debt. Gold is neither of those. Actually it's the complete opposite. It's the anti-fiat money and anti-credit.

It's not perfect, but it's still the best money that fiat money can buy.

Greenspan knows it. He's always known it.

Now, no longer obliged to toe the Fed's line, he's again free to say what he really thinks.

Which has him back to extolling the virtues of gold, a topic he was outspoken on before selling out to the dark side of central banking…

Recycling a Tired Stance

"The Maestro" recently shared his thoughts through an op-ed piece in Foreign Affairs magazine, published by the Council on Foreign Relations.

That's the same publication that brought us the "brilliant" article we recently discussed in Money Morning, suggesting the Fed should print and give cash directly to citizens.

In Greenspan's piece, "Golden Rule: Why Beijing Is Buying," he suggests:

If China were to convert a relatively modest part of its $4 trillion foreign exchange reserves into gold, the country's currency could take on unexpected strength in today's international financial system. It would be a gamble, of course, for China to use part of its reserves to buy enough gold bullion to displace the United States from its position as the world's largest holder of monetary gold. (As of spring 2014, U.S. holdings amounted to $328 billion.) But the penalty for being wrong, in terms of lost interest and the cost of storage, would be modest.

Greenspan is even on the pro-gold standard bandwagon:

The broader issue – a return to the gold standard in any form – is nowhere on anybody's horizon… For more than two millennia, gold has had virtually unquestioned acceptance as payment. It has never required the credit guarantee of a third party. No questions are raised when gold or direct claims to gold are offered in payment of an obligation… If the dollar or any other fiat currency were universally acceptable at all times, central banks would see no need to hold any gold. The fact that they do indicates that such currencies are not a universal substitute.

Here's a guy who's as connected as one gets in the realm of central banking, and yet he's extolling the virtues of gold as money, suggesting a return to a gold standard. Heck, he even thinks China ought to beef up its gold reserves, enough to overtake the U.S. as the largest owner of gold.

Why? Because he realizes that's what it would take to partially back China's currency, the renminbi, with gold, or at least challenge the dollar's status as world reserve currency. He also appreciates that it's a strategy that would be impossible to implement without sufficient gold.

In fairness, as Fed chief, Greenspan did display some affinity towards the precious metal.
In fact, he even followed his own system of a "virtual gold standard" for years, a principle he eventually abandoned the moment it became inconvenient…

The "Virtual Gold Standard" Was Quietly Cultivated

Greenspan recounts how, back in the 1990s at a G-10 governors' meeting, the discussion was all about the European counterparts itching to sell off their gold.

They knew their simultaneous dumping risked depressing the gold price. So they set up the first Central Bank Gold Agreement in 1999, whereby 15 European central banks agreed to limit sales to 400 metric tons annually over the next 5 years. Curiously, Greenspan points out that Washington abstained.

Clearly he was the savviest of the bunch, knowing that gold is the ultimate form of payment, something a central bank should never sell unless it's absolutely necessary.

Understanding the positive effects of gold as money, Greenspan devised his own method to reap the benefits.

While heading the Federal Reserve, Greenspan appears to have imposed a "virtual gold standard," at least according to Donald Luskin of Trend Macrolytics.


Gold, it seemed, acted as the barometer.  As its rising price signaled inflation, Greenspan would raise the funds rate. As gold's price fell, he would inject liquidity by lowering the funds rate.

But in 1997, that relationship was severed.

The Maestro dropped his "virtual gold standard," and raised rates as gold prices fell, and vice versa.

That fueled the blow-off phase of the dot-com bubble and its inevitable crash. Greenspan then drastically cut rates again, inflating the housing bubble.

By 2006 Greenspan had exited, leaving the reins to Bernanke. The housing bubble soon popped, and we all know how that ended. On Ben's watch, the funds rate was slashed and has flat-lined near zero for the past five years running.

Smell any bubbles? Poor Janet.

Back to Alan…

Let's follow the Maestro's original advice. The fact remains that Greenspan knows sound money, and he recognizes the deleterious side effects of fiat money.
In testimony before the U.S. Banking Committee in 1999, Greenspan said, "Gold still represents the ultimate form of payment in the world." Later, when Maryland Senator Sarbanes asked him if he endorsed a return to the gold standard he replied: "I've been recommending that for years, there is nothing new about that."

Yet it's intriguing that for all the ambiguous talk Greenspan spewed out during his tenure, his thoughts on gold seem to be clear as crystal.

Greenspan summed it up best when addressing the Council on Foreign Relations back in 2010: "Fiat money has no place to go but gold… It signals problems with respect to currency markets. Central banks should pay attention to it."

Indeed they should. Indeed we all should. If you're ever going to follow any the Maestro's advice, follow that bit and ignore the rest.

It's just Fedspeak.

lunes, noviembre 03, 2014



Nuclear talks with Iran

Diplomatic spin


Nov 1st 2014 












lunes, noviembre 03, 2014



Greenspan: Price of Gold Will Rise
Axel Merk, Merk Investments
October 29, 2014



Who finances social programs?
The maestro says the Fed merely does what it is mandated to do, merely playing along. If something doesn’t go right, it’s not the Fed’s fault. That credit bubble? Well, that was due to Fannie and Freddie (the government sponsored entities) disobeying some basic principles, not the Fed.

But fear not because he assured us:
Greenspan: “They (FOMC members) are very smart”
Q: Why do central banks (still) own gold
Greenspan: “This is a fascinating question.”
Greenspan: Price of Gold will rise

Greenspan: “Higher.”

Q: “How much?”

Greenspan: “Measurably.”
Axel Merk
Axel Merk is President & CIO , Merk Investments
Manager of the Merk Funds