``…the state consists not only of politicians, but also those who make use of the politicians for their own ends; that would include those we call pressure groups, lobbyists and all who wrangle special privileges out of the politicians. All the injustices that plague "advanced" societies, are traceable to the workings of the state organizations that attach themselves to these societies.”-Frank Chodorov, Gentle Nock at Our Door
The mainstream is loaded with booby traps.
Without critical thinking it would be easy for anyone to get entranced or fall victim to the metaphorical enchanting ‘songs of the Sirens’, as in one of Odysseus’ tests in his voyage home to Ithaca.
PIMCO’s Bill Gross: Do What I Say, Not What I Do
Basically a major objection to an upside market is that policy reversals from central banks are likely to lead to a withdrawal of liquidity, thereby adversely affecting market outcomes.
Here are some examples:
Pimco’s Bill Gross: ``if exit strategies proceed as planned, all U.S. and U.K. asset markets may suffer from the absence of the near $2 trillion of government checks written in 2009. It seems no coincidence that stocks, high yield bonds, and other risk assets have thrived since early March, just as this “juice” was being squeezed into financial markets. If so, then most “carry” trades in credit, duration, and currency space may be at risk in the first half of 2010 as the markets readjust to the absence of their “sugar daddy.”
From John Maudlin: ``The Fed is going to stop the music in March. There will be a scramble for the chairs. This is a huge experiment with no precedent.”
The World Economic Forum chimes in, ``The risks of a sovereign-debt crisis, asset-price-bubble collapse and a hard landing for the Chinese economy will be high on the agenda of global leaders convening in Davos, Switzerland, for the World Economic Forum this month…
``The report found a collapse in asset prices to be the most severe and likely risk, amid concerns that the weak dollar and low global interest rates could fuel a liquidity-driven, rather than debt-driven, bubble.”
Note: Either the journalist here misquotes the authority interviewed or the authority doesn’t understand that liquidity is driven by debt.
In contrast, Morgan Stanley analyst Manoj Pradhan argues that liquidity won’t get affected by the reversal of policies, (bold highlights mine, italics his)
``Barring a major policy error, the exit from ultra-low interest rates should not mean a removal of accommodative monetary policies. The GCB [Global Central Bank] is unlikely to move rates back to neutral in 2010 - and there appear to be no dissenters on this ‘vote'. As the experience of front riders in the monetary peloton has shown, sharp interest rate hikes when major central banks are still in expansionary territory creates headwinds via currency appreciation and reduced policy traction in asset markets. Very few of the smaller economies will be able to hike aggressively, given these headwinds and weak export sectors in 2010, while monetary policy in the larger economies will be constrained by the BBB recovery. Thus, the ‘AAA' liquidity cycle (ample, abundant, augmenting) is likely to remain largely intact in 2010. The slow exit to a relatively less expansionary stance and the arrival of a sustainable recovery will be a key combination that will support growth and asset prices, in the G10 and even more so in emerging markets.
David Kotok of Cumberland Advisors has what I think the better perspective,
``In our opinion, we think the Fed is now trapped.
``By becoming the buyer of last resort, the Fed has now impacted the markets in such a way that the very idea that it may withdraw has caused mortgage interest rates to rise. Markets aren't dumb, and they realize that rates will rise, for two reasons. First, if the supply of funds to Freddie and Fannie stops with the Fed's purchases, then home-mortgage interest rates will have to rise. Moreover, they will rise even further if the Fed starts selling its existing securities into the market. What this also means is that the interest-rate risk associated with any future increases in interest rates will be shifted from the private sector to the Fed and ultimately the taxpayer – and this risk will grow as the Fed begins to unwind its current low-interest-rate policy.” (bold emphasis mine)
In other words, like us, Mr. Kotok believes that markets have essentially been propped up by the Fed and “exiting” the market could prompt for unwarranted uncertainty and result to increased volatility. Hence, Mr. Kotok prescribes a more transparent and credible strategy to alleviate the ‘exit risks’, as well as, raising reserve deposits to mitigate any incidental upsurge of the risks of inflation.
It’s true that markets aren’t dumb, but they haven’t been negatively reacting to the alleged ‘exit risks’ either, which is due on March. Maybe it’s because the Fed still covertly supports the stock market [as argued in Politics Ruled The Market In 2009].And importantly, markets aren't representative of their actual state, instead they represent distorted markets from massive interventions.
Moreover, it would also be quite naïve to think that Fed Chair Ben Bernanke or the US Federal Reserve backed by its huge platoon of economists and the sundry of employed experts, aside from their extensive network of allies in Wall Street or in the academia, are nitwits.
What we are suggesting is that these concerns are apparently NOT out of bounds for the Fed officials or authorities including Mr. Bernanke.
They know it.
On the contrary, asset prices seem to exhibit the top concern in the scale of priorities for authorities. And this has been flagrantly echoed by the official from the World Economic Forum, `` a collapse in asset prices to be the most severe and likely risk”.
They see it.
In short, global officials appear to prioritize the asset market dimensions as we have been arguing for the longest time.
They’d most probably act on it.
Hence, the other way to read the insights from Wall Street mainstays as Bill Gross is that they’re engaged in a psy-war, or particularly reverse psychology.
Being a political entrepreneur, who have constantly benefited from policy maneuvers by their central bank, one can’t ignore that the current missive by Mr. Gross signifies as tacit appeal to Ben Bernanke for maintaining or even expanding current policies.
Mr. Gross seems to be an avid adherent of the recent Nobel Prize winner and Keynesian high priest Paul Krugman, who proposed last December that the Federal Reserve should buy $2 trillion MORE of assets to jumpstart credit!
In other words, many of the talking heads seem to operate like masquerading propagandists, whose overall agenda have been cosmetically dressed up or disguised as ‘analysis’.
In putting money where his mouth is, Mr. Gross’ PIMCO has actively been expanding its global equity exposure by incorporating emerging market specialists (‘pirated’ from the top notch Franklin Templeton firm) to its team.
According to citywire.co.uk, ``The group is also going on the offensive in the equity space, last month hiring leading global equity fund managers Anne Gudefin, Charles Lahr and Neel Kashkari from franklin Templeton to improve its level of expertise in the area.”
Moreover, PIMCO pared its holdings of US and UK debt and appears to have switched into Southeast Asia’s sovereign debts!
So if Bill Gross sees an ominous reckoning for 2010, ``If so, then most “carry” trades in credit, duration, and currency space may be at risk in the first half of 2010 as the markets readjust to the absence of their “sugar daddy”, then why has he been aggressively expanding on his global equity-bond markets to even add Southeast Asian debts on his portfolio mix?
Apparently actions don’t match with rhetoric.
This category of bluffing appears to reinforce our thesis discussed last week. [see Poker Bluff: The Exit Strategy Theme For 2010].
The PIIGS Bogeyman
Another objection recently brought up has been the possible risks of contagion from Europe’s crisis affected PIIGS-most notably Greece, (as Ireland has reportedly been coping positively with present austerity policies).
I would place such “concern” in the same category of the Dubai Debt Crisis, as it would seem more of a political than of an economic/financial problem [see Why Dubai’s Debt Crisis Isn’t Likely THE Next Lehman].
Yet again this would seem to uphold my contention that today’s trend will be more on political bluffing aimed at perpetuating inflationary policies.
This fabulous excerpt from Danske Bank’s Fixed Income Research team (all bold highlights mine),
``Moody’s sent out a report on the European Sovereign outlook on Wednesday, in which they argue that countries such as Portugal and Greece could be facing a “slow death” as higher debt costs will cause the economies to “bleed” economic potential. Hence, a large part of the future public revenues would have to be spent paying off the debt rather than on welfare etc. Moody’s thinks that the risk of a “sudden death” is negligible, but warned that the countries have to act and do NOT have an open window indefinitely in order to restore public finances. Moody’s highlighted Greece, saying that it would have significantly less time than Portugal. Hence, if the forthcoming fiscal austerity plan from Greece is not considered to be sufficient, then Moody’s is very likely to downgrade Greece, and this will bring Greece closer to ECB’s temporary threshold of BBB-, as the other rating agencies will also act. Portugal tried to distance itself from Greece…
``Furthermore, the current rating threshold is only temporary and is valid until the end of 2010, and we do not think that Greece will have been able to stabilise its finances such that its rating will be at or above A-. The risk of Greece not being able to use its government bonds as eligible collateral was highlighted at yesterday’s ECB meeting. Here, Trichet said that ECB “would not change its collateral rule for the sake of any particular country”, although on the question as to whether Greece or any other country could leave the Euro area, Trichet replied that "I do not comment on absurd hypotheses".
What’s the article been saying?
For Greece, it means ‘Heads I win, Tails you lose’, a bailout is in order. Just look at Trichet’s statement, the dice is loaded for a Greece rescue.
Why?
Because the European Central Bank (ECB) is likely to suffer more from the ripples of a withdrawal (unlikely expulsion) which appear likely to risk materially undermining the political and monetary significance of the European Union.
More proof?
The ECB has recently issued a report on the prospects of a withdrawal or expulsion from ECB based on the LEGAL aspects,
Here is the Wall Street Journal Blog (all bold emphasis mine), ``Written by the ECB’s legal counsel, it notes that “recent developments have, perhaps, increased the risk of secession (however modestly), as well as the urgency of addressing it as a possible scenario.”
``It concludes that unilaterally withdrawing from the European Union “would not, as a matter of public international law, be inconceivable, although there can be serious principled objections to it; and that withdrawal from EMU without a parallel withdrawal from the EU would be legally impossible.”
``As for expulsion, “the conclusion is that while this may be possible in practical terms — even if only indirectly, in the absence of an explicit Treaty mechanism — expulsion from either the EU or EMU would be so challenging, conceptually, legally and practically, that its likelihood is close to zero.”
“Absurd hypotheses, legally impossible and close to zero” reverberates as strong political phrases which seem to reinforce our view that the obvious course of political action will be a bailout of Greece.
Yet even assuming the worst scenario that if Greece were to withdraw, considering its present financial and economic state, the most likely actions that she would undertake would be similar to the others-inflate by devaluing its resurrected currency, the drachma.
So it would be just a matter of WHO does the inflating, the ECB or Greece.
Of course the ECB bailout would come with the attendant ‘disciplining chastisement’ policies which mostly likely would signify melodious political leadership face saving soundbytes.
Besides, PIIGS sovereign debts account for only 38% of the Euro denominated Government Debt securities as of November 2009 as per the ECB. The biggest exposure would be Italy (20.16%) and Spain (12%) the balance spread between Ireland (1.506%), Portugal (1.91%) and Greece (2.43%).
Finally, if one were to argue that the hubbub over Greece should translate to a contagion, we should be seeing rising default risks in the credit standings of broader Europe (see figure 5)
Figure 5 Danske Bank: Smooth Credit Ratings Still Intact, Peak In Default Risks
Apparently this has not been the case, as seen in the iTraxx Europe CDS (left window) which consists of 125 investment grade companies, the iTraxx Crossover CDS (middle window) which comprises of 50 sub-investment grade credits and the default rates of Europe and the US (right windows) which appears to have peaked as measured by Moody’s and Danske Bank.
Like in last week’s article, I wouldn’t be calling on their bluff. Neither should you.
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