Wow. US Treasury’s Office of Financial Research warns of US Stock Market’s Extreme Valuations, Overleverage and Rising Risks of Financial Instability

Step aside Ms. Yellen, the US Treasury’s Office of Financial Research has explicitly warned of overvalued and overleveraged US stock markets!

In her recent report to the US Congress, Fed Chair Janet Yellen issued sanitized warnings in some areas of the Financial sector.

On the other hand, a recent report  from the US Treasury’s Office of Financial Research admonishes on heightened risks of financial instability from current conditions in details!

From OFR’s Ted Berg’s QuickSilver Markets (bold mine footnotes omitted)

Some Valuation Metrics Are Nearing Extreme Highs

Today, equity valuations appear reasonable based on commonly used metrics such as the forward PE, price-to-book, and priceto-cash flow ratios. But these metrics do not tell the whole story. 

Take, for example, the simple PE ratio, which is a quick and easy way to evaluate stock prices (see Figure 2). It’s a convention that emerged mostly as a result of “tradition and convenience rather than logic,” according to Robert Shiller. Forward PE ratios are potentially misleading for several reasons. First, forward one-year earnings are derived from equity analyst projections, which tend to have an upward bias. During boom periods, analysts often project high levels of earnings far into the future. As a result, forward PE ratios often appear cheap. Second, one-year earnings are highly volatile and may not necessarily reflect a company’s sustainable earnings capacity. Third, profit margins typically revert toward a longer-term average over a business cycle. The risk of mean reversion is particularly relevant today, because profit margins are at historic highs and analysts forecast this trend to continue.

Other fundamental valuation metrics tell a different story than the forward PE. This brief focuses on a few — the CAPE ratio, the Q-ratio, and the Buffett Indicator — that are approaching two-standard deviation (two-sigma) thresholds.

Why is two-sigma relevant? Valuations approached or surpassed two-sigma in each major stock market bubble of the past century. And the bursting of asset bubbles has at times had important implications for financial stability. The two-sigma threshold is useful for identifying these extreme valuation outliers. Assuming a normal distribution in a time series, two-sigma events should occur once every 40-plus years; in equity markets, they occur more frequently due to fat-tail distributions.

In the following, I post the OFR’s comments on the CAPE ratio, the Q-ratio, and the Buffett Indicator with the exclusion of their methodology and their caveats.

CAPE Ratio.

The historical CAPE average based on a 133-year data series is approximately 17 times, and its two-standard-deviation upper band is 30 times. The highest market peaks (1929, 1999, and 2007) either surpassed or approached this two-sigma level (1999 exceeded four sigma). Each of these peaks was followed by a sharp decline in stock prices and adverse consequences for the real economy. At the end of 2014, the CAPE ratio (27 times) was in the 94th percentile of historical observations and was approaching its two-sigma threshold.

Q-Ratio.

The Q-ratio, defined here as the market value of nonfinancial corporate equities outstanding divided by net worth, suggests a similar message of equity valuations approaching critical levels (see Figure 4).7 Instead of using a traditional accounting-based (historical cost) measure of net worth, the Q-ratio incorporates market value and replacement cost estimates. The Q-ratio also includes a much broader universe of nonfinancial companies (private and public) than CAPE.

Buffett Indicator.

The ratio of corporate market value to gross national product (GNP) is at its highest level since 2000 and approaching the two-sigma threshold (see Figure 5). This indicator is informally referred to as the Buffett Indicator, because it is reportedly Berkshire Hathaway Chairman Warren Buffett’s preferred measure to assess overall market valuation. Historically, this indicator’s message is consistent with CAPE, particularly in identifying periods of extreme valuation before the Great Recession and the 1990s technology stock bubble.

The earnings mean reversion.

High valuations equals High risk and lower returns

Evaluating the Possibility of a Market Correction

History shows a clear relationship between the CAPE ratio and forward 10-year compounded annual real returns (see Figure 7).11 High valuations today imply lower future returns. However, none of these valuation metrics — the CAPE ratio, the Q-ratio, or the Buffett Indicator — predicts the timing of inflection points, and markets may remain undervalued or overvalued for very long periods. But we can use these metrics as barometers to gauge when valuations are reaching excessively high or low levels. The timing of market shocks is difficult, if not impossible, to identify in advance, let alone quantify — a shock, by definition, is unexpected. When assessing asset valuation it is important to make a distinction between risk and uncertainty. Risk may be quantified and described in probabilistic terms, and analysts can factor this into their valuation models. However, uncertainty is hard to quantify because it refers to future events that cannot be fully understood or quantified. Today’s high stock valuations imply that investors underestimate the potential for uncertain events to occur.

Figure 8 shows the relationship between valuation and future returns more explicitly.

Historically, the highest returns follow periods of low valuations (CAPE < 10) and the lowest returns Figure 6. Earnings Mean Revert Over Time and Are Well Above Trend Figure 7. CAPE Is High Relative to Historical Levels 1 10 100 1881 1897 1914 1931 1947 1964 1981 1997 2014 S&P 500 real earnings vs. trend ($ per share, logarithmic scale) Twelve month Rolling 10-year Sources: Robert Shiller, OFR analysis Trendline (Rolling 10-year) Great Recession Great Depression OFR Brief Series March 2015 | Page 5 follow periods of high valuations (CAPE > 30). When setting expectations for future returns, CAPE appears most relevant at these extreme lows (expect above-average future returns) and highs (expect below-average future returns). In fact, real returns were negative, as shown in Figure 8, when CAPE exceeded the two-sigma threshold. Similar conclusions may be drawn from other metrics, such as the Q-ratio and Buffett Indicator, but the historical time series associated with them are shorter.

To be clear, extreme valuations (2-sigma) are only one characteristic of a potential bubble. Valuation in isolation is not necessarily sufficient to trigger a downturn, let alone pose risks to financial stability. Other factors are relevant for analyzing market cycles — most important, corporate earnings. 

Robust growth in corporate earnings is the primary driver behind the stock market’s gains over the past several years. But sales growth has been much more modest. Since the cyclical low in 2009, earnings have increased at a double-digit annual growth rate while sales have increased at a more modest mid single-digit rate. The higher trend growth in earnings versus sales is due to rising profit margins. S&P 500 profit margins reached a record 9.2 percent (trailing 4-quarter, GAAP) in the third quarter of 2014 (see Figure 9), well above the historical average of 6.3 percent. 

Broader measures of corporate profitability (before and after tax) tell a similar story (see Figure 10). The Bureau of Economic Analysis corporate profit data series covers approximately 9,000 companies, public and private, so it is a much broader measure than S&P 500 profits.

To date, record high margins are in part supported by favorable secular trends: a greater proportion of high margin sectors in the S&P 500 composite, lower corporate effective tax rates due to a higher mix of foreign profits, and productivity improvements such as automation and supply chain enhancements. The lower margin, capital-intensive sectors that dominated the market index in earlier decades have given way to more profitable and less capital-intensive sectors due to the computing revolution (early 1980s) and the gradual transition to a services-driven economy. Since the 1970s, lower margin, capital-intensive sectors (industrials, materials, and energy) have fallen from 39 to 22 percent of S&P 500 market capitalization, while higher margin sectors (technology, financials, and health care) have risen from 23 to 50 percent.

Other favorable cyclical factors have also helped to boost profitability, including low interest rates, low labor costs, cost-cutting initiatives, and positive operating leverage (high fixed costs relative to variable costs). However, many of these are not sustainable. Current historically low interest rates will eventually rise. Labor costs will increase as unemployment decreases, and cost-cutting initiatives, such as underinvestment in research and development and capital spending (key sources of future revenue growth), cannot continue indefinitely. Finally, positive operating leverage works in reverse when the sales cycle turns.

Of course, the current cycle could continue as long as revenue growth offsets these margin pressures.

Taking a longer-term view, beyond a single cycle, competitive market forces are another key factor that limits future margin expansion. Profitable industries eventually attract new capital and new competitors, ultimately reducing margins over time in mature industries. This is particularly true in a highly competitive global economy.

Mean reversion in margins has important implications for equity valuations. The current forward PE ratio appears reasonable only if record margins are sustained. During business cycle peaks, when margins are high, investors often fail to factor margin mean reversion into earnings estimates and then adjust forward PEs lower to compensate for this risk. 

I have always emphasized here that there are limits to anything including earnings growth. This is most especially relevant when zero bound rates induces a frontloading of growth through leverage.

Leverage.

Leverage can magnify the impact of asset price movements. Leverage achieved through stock margin borrowing played an important role in inflating stock prices in the 1929 stock market bubble and to a lesser extent in the late 1990s technology stock bubble. Margin debt, according to the Financial Industry Regulatory Authority, reached a record $500 billion at the end of the third quarter of 2014, representing just over 2 percent of overall market capitalization. Although this percentage is below the peak in 2008, it is higher than historical levels (see Figure 11). The percentage does not appear alarmingly high, but forced sales of equities by large leveraged investors at the margin could be a catalyst that sparks a larger selloff. Other forms of leverage, such as securities lending and synthetic leverage achieved through derivatives, may also present risks.

Another component of leverage in the system is the financing activities of corporations. Today, high profits have made corporate balance sheets generally quite healthy. As of the third quarter of 2014, U.S. nonfinancial corporations held a near-record $1.8 trillion in liquid assets (cash and financial assets readily convertible to cash). However, corporations also have racked up a record amount of debt since the last crisis. U.S. nonfinancial corporate debt outstanding has risen to $7.4 trillion, up from $5.7 trillion in 2006. Proceeds from debt offerings have largely been used for stock buybacks, dividend increases, and mergers and acquisitions. Although this financial engineering has contributed to higher stock prices in the short run, it detracts from opportunities to invest capital to support longer-term organic growth. Credit conditions remain favorable today because of the positive trend in earnings, but once the cycle turns from expansion to downturn, the buildup of past excesses will eventually lead to future defaults and losses. If interest rates suddenly increase, then financial engineering activities will subside, removing a key catalyst of higher stock prices

Zero bound rates signify as subsidy to interest rate sensitive sectors of the economy and markets, take these away, then there will be withdrawal syndroms.

Conclusion

Markets can change rapidly and unpredictably. When these changes occur they are sharpest and most damaging when asset valuations are at extreme highs. High valuations have important implications for expected investment returns and, potentially, for financial stability. 

Today’s market environment is different in many ways from the period preceding the Great Recession, because regulators and market participants have made adjustments to enhance financial stability since the financial crisis. In that time, stock returns have been exceptional and market volatility generally subdued. Today, many market strategists see the bull market extending throughout 2015.

However, quicksilver markets can turn from tranquil to turbulent in short order. It is worth noting that in 2006 volatility was low and companies were generating record profit margins, until the business cycle came to an abrupt halt due to events that many people had not anticipated. Although investor appetite for equities may remain robust in the near term, because of positive equity fundamentals and low yields in other asset classes, history shows high valuations carry inherent risk.

Based on the preliminary analysis presented here, the financial stability implications of a market correction could be moderate due to limited liquidity transformation in the equity market. However, potential financial stability risks arising from leverage, compressed pricing of risk, interconnectedness, and complexity deserve further attention and analysis.

You have been warned.

China Bubble: The Price-to-Whatever Ratio Stock Market

I have been repeatedly saying here that the Chinese government has purposely been inflating a stock market bubble as part of their public information campaign to project that economic conditions have been hunky dory, and that for skeptics, “there’s been nothing to see here, so move along”

The spurt  in Chinese stocks has initially been fueled by the PBOC’s targeted easing in June 2014 and subsequently the IPO price controls in August 2014 where the latter sparked a retail based mania.

Combined with these has been varied accounts of easing via rate cuts, increasing accounts of  liquidity injections, snowballing bailouts and the force feeding of credit into state owned companies. The Chinese government even introduced the HK-China Shanghai connect last November.

Charts from FT Alphaville

The result of these accrued policy actions has been to spur a nearly vertical takeoff in her stock markets as retail participants and the shadow banking sector go on a wild party!

The Chinese government initially attempted to contain their self created mania by a crackdown on margin trades early this year. But with her stock markets responding violently, apparently the government seemed to have realized that  for political goals, accommodation of the bubble has been better than prevention.

You see the Chinese government has been reversing its previously announced market reform through political centralization. Such actions has been justified in the name of 'anti-corruption' which in reality has been about persecution of the opposition in order for the incumbent to consolidate power amidst growing economic and financial stress, as well as, intensifying strains in the domestic political environment.

Nevertheless, even mainstream media seems to have noticed now  of the fantastically absurd degree of proportions the bubble in China’s stock market has reached.

This “Time is Different” rational and the stampede into the stock market by retail investors.

From Bloomberg: (bold mine)

The 40-year-old strategist, who turned bullish just as the steepest four-month surge in seven years began last September, is among a growing number of forecasters who say traditional measures of value have little sway in a market where individual investors drive 80 percent of volumes and the biggest companies are run by the state. As long as China’s government maintains its support for the rally and keeps borrowing costs low, they say money will flow into shares and drive prices higher.

Investors in the $6.3 trillion market are showing few signs of fatigue after the Shanghai Composite Index jumped 77 percent over the past year, the biggest gain among major global equity gauges tracked by Bloomberg. The Shanghai measure rose 0.6 percent at the close on Thursday, versus a 0.9 percent drop in the MSCI Asia Pacific Index.

Mainland traders opened a record number of new accounts to buy yuan-denominated A shares in the week to March 20, while the value of equities purchased with borrowed money rose to an all-time high on Tuesday. The Shanghai Composite climbed for 10 consecutive days through March 24, the longest winning streak since 1992, as daily turnover on mainland bourses surged to an unprecedented 1.4 trillion yuan ($225 billion).

The Chinese government sees rising stocks as alternative instruments to credit…

China needs a strong stock market to make it easier for companies to lure equity financing and invest in projects that drive economic expansion, said Kelvin Wong, a Hong Kong-based analyst at Bank Julius Baer & Co., which has about $304 billion under management. The country has relied on credit growth to spur the economy for the past five years, sending total debt to more than twice the nation’s gross domestic product.

So inflate a bubble to generate funds for corporate operations, and most importantly, for debt servicing. This is what the late economist Hyman Minsky calls as Ponzi finance. And considering that China's debt may have already reached its peak levels thus the next step has been to ignite asset inflation via stock market boom.

 

Chinese stocks has reached outrageous valuations…

The Shanghai Composite’s median price-to-earnings ratio, which is less influenced by the nation’s biggest banks than a market-capitalization weighted average, has climbed to 44. That level has been breached just twice during the past decade, in late stages of rallies in 2007, when it climbed as high as 66, and early 2010, when the peak was 47. The Standard & Poor’s 500 Index has a median ratio of about 20, data compiled by Bloomberg show.

The Shanghai index’s earnings yield, or profits as a percentage of the price, has shrunk to 5.6 percent, the lowest since May 2011 versus the nation’s highest-rated 10-year corporate debt, which has a 4.8 percent yield. Chinese companies with dual listings are 34 percent more expensive on the mainland versus Hong Kong, the widest gap since October 2011, according to the Hang Seng China AH Premium Index.

The article ends with a quote from John Maynard Keynes excerpted by a bullish analyst

There is nothing so disastrous as the pursuit of a rational investment policy in an irrational world.

It's all about a tsunami of liquidity and excessive leverage says the BNP

The Zero Hedge quotes BNP (italics, bold and underline original)

Against all odds, the best performing asset class on the planet over the last nine months or so has been Chinese equities…

...it’s not the economy (as we’ve been saying for months)...

What underlies these extraordinary gains? It is certainly not economic fundamentals. Led by the accelerating real estate slump (China: It’s Only Just Begun), China’s GDP growth has steadily slowed with reported 2014 GDP growth of 7.4% the slowest in almost twenty years. A range of ‘hard’ economic indicators such as electricity production and rail cargo volumes suggest even slower growth. Our preferred ‘real, real’ GDP estimate flags that output growth could have been as low as c.4½% in 2014 (China: Fit as a Fiddle). While the usual data fog around the Lunar New Year partially clouds analysis, high frequency indicators that generate early estimates of GDP growth suggest that the growth has continued to slide in 2015Q1…

...it must be liquidity….

By definition therefore equities’ stellar performance has been a function of liquidity driven multiple expansion. The P/E ratios for the Shanghai and Shenzhen markets have roughly doubled since August to c.19x and c.44x respectively. While still a long way short of the incredible highs of 70-80x reached during the 2006-2007 bubble, multiples are now rapidly approaching their post-GFC highs. One obvious source of fresh liquidity which could have powered equities’ bull-run is from the long-delayed introduction of the Hong Kong Shanghai ‘stock connect’ last November. The scheme, formerly known as ‘the through train’, allows two trading between the Shanghai A-share market and the Hang Seng. Two-way flows however have been relatively meagre. An initial aggregate quota of RMB300bn was set for northbound flows into Shanghai. So far only about a cumulative RMB125bn has flowed north, leaving RMB175bn of the aggregate quota unfilled. And northbound buy orders have in turn typically only accounted for around ¾% of the Shanghai market’s daily turnover…

...and it comes from a predictable place, leverage…

Far from a surge in external liquidity, an increasingly self-feeding domestic frenzy fuelled by leverage appears to be the key driver….Margin purchases have been running well ahead of redemptions ensuring that the outstanding stock of margin debt has ballooned by over RMB1 trillion since August; equivalent to more than 1% of GDP…

...and castles built on quicksand (i.e. margin debt) will likely collapse…

Margin purchases are now accounting for almost 20% of equities daily turnover which itself has soared to wholly unprecedented levels in another sign of self-feeding speculative frenzy. What happens next is clearly an ‘unknown-unknown’. By definition detached from fundamentals, speculative bubbles are inherently re-enforcing in the short-term and frequently last longer than expected. The longer they continue, however, the larger the eventual bursting. 

Well such ridiculous valuation levels hasn’t been isolated to Chinese stocks, the Philippines has been plagued by almost the same degree of outlandishness. For instance, the Philippine property index has PER valuations of 35.7 based on LTM 3Q 2014 reported earnings based on yesterday prices. 

So the same Price-to-Whatever Ratio afflicts the Philippines.

While bullish analysts may quote that “there is nothing so disastrous as the pursuit of a rational investment policy in an irrational world” in order to justify the utter disregard of risks to chase momentum or prices, unfortunately listening to such advise comes with a Damocles sword. 

That's because the same ‘illustrious’ economist also warned,

A sound banker, alas, is not one who foresees danger and avoids it, but one who, when he is ruined, is ruined in a conventional way along with his fellows, so that no one can really blame him.

So while 'the market can remain irrational longer than one can remain solvent', such that bullish analysts will line up their pockets with money from confirming on the biases of the hapless and gullible lemmings, when the disaster comes, the same people will hide under the skirt of crowd and get themselves absolved by claiming ignorance. How nice.

 

Hot: Saudi Arabia Begins Bombing Operations on Yemen

Wow. A new front in the Middle East war has just opened. The Kingdom of Saudi Arabia has just begun bombing operations on Yemen targeted against Yemen 'rebels'.

From the New York Times: (bold mine)

Saudi Arabia announced on Wednesday night that it had begun military operations in Yemen, launching airstrikes in coordination with a coalition of 10 nations.

The strikes came as Yemen was hurtling closer to civil war after months of turmoil, as fighters and army units allied with the Houthi movement threatened to overrun the southern port of Aden, where the besieged president, Abdu Rabbu Mansour Hadi, has gone into hiding.

Yemen shares a long border with Saudi Arabia, a major American ally, and the Saudis had been reported to be massing forces on the Yemen frontier as Mr. Mansour’s last redoubt in Aden looked increasingly imperiled.

The rapid advances by the president’s opponents included the seizure of a military air base and an aerial assault on his home. There were unconfirmed reports that the president had fled the country by boat for Djibouti, the tiny Horn of Africa nation across the Gulf of Aden.

The region’s most impoverished country, Yemen has been a central theater of the American fight against Al Qaeda, and its possible collapse presents complex challenges to the Obama administration as it struggles to deal with instability and radical extremism in the Middle East.

Along with Syria, Iraq and Libya, Yemen is now the fourth state to veer toward political disintegration in the aftermath of the Arab Spring revolts that first erupted four years ago.

By Wednesday morning, Houthi forces had seized Al Anad air base, which until recently had been used by American counterterrorism forces, about 35 miles from Mr. Hadi’s refuge in Aden, the country’s second-largest city.

If current developments represents “political disintegration in the aftermath of the Arab Spring revolts that first erupted four years ago”, then how much more will a sustained below $50 oil add to the current strains?

How will current developments impact both the Middle East's domestic and regional politics?

Interestingly, US president Obama once hailed Yemen's government as a model for fighting extremism. Apparently the imperialist strategy garbed as the "war on terror" has backfired and collapsed.

Yet more interesting developments from the said news…

The Houthis, a minority religious group from northern Yemen, practice a variant of Shiite Islam and receive support from Iran.

More questions. Will this proxy war lead to a tit for tat with Iran? Will this foment an expanded theater of conflict between the US backed by her allies against the Russia-China alliance? (As side note: Russia and Iran recently signed a defense pact)

Aside from politics, how will an expanded war frontier and low oil prices impact the economies of Middle East nations? 

How will an expansion of regional political strains impact Philippine OFWs and remittances?

Will the endless printing of money and zero bound rates by global central banks defuse such tensions to continually send stocks perpetually higher?  Or will inflationism aggravate on the tensions?

Very interesting.

Graphic of the Day: The Fundamental Difference between the Private Sector and the Government

It's all about incentives...

(source: Townhall's Glenn McCoy: March 24, 2015) [hat tip: Zero Hedge]

Periphery to Core Dynamic: Global Trade and Industrial Production Fall in January

Risks from global trade and industrial production may have emerged.

From the CPB Netherlands Bureau for Economic Policy Analysis

Developments in international trade and industrial production

-January 2015:world trade down 1.4% month on month, following a 1.3% increase in December.

-January 2015:world industrial production down 0.3% month on month, following a 0.6% increase in December

The charts of global trade

The distribution of world trade per region…

The above has been based on volumes. 

The downturn in global trade has been broad based. Emerging markets led the way for imports (sign of slowing domestic economies), while developed economies dominated the decline for exports.

It’s the opposite based on dollar per unit value: Emerging markets drove the downturn in exports, while advance economies spearheaded the decline in imports.

The above represents another wonderful exhibit which debunks the popular myth where cheap currencies have been thought to drive exports. The strong dollar hasn’t juiced up either exports by emerging markets or imports by the US.

Here is the global industrial production charts.

The above looks very much like a validation of my periphery to core theory in progress.

All actions have consequences. The adverse effects of bubble policies implemented by central bankers since 2008 to mount a global rescue (of bankers and cronies) seem as becoming more apparent. They have been transmitted to the world through, first the emerging markets and, next to developed economies. Eventually both EM and DM economies should falter.

As I wrote in early 2014

Even when the exposure would seem negligible, if the adverse impact of emerging markets to the US and developed economies won’t be offset by growth (exports, bank assets and corporate profits) in developed nations or in frontier nations, then there will be a drag on the growth of developed economies, which would hardly be inconsequential. Why? Because the feedback loop from the sizeable developed economies will magnify on the downside trajectory of emerging market growth which again will ricochet back to developed economies and so forth. Such feedback mechanism is the essence of periphery-to-core dynamics which shows how economic and financial pathologies, like biological contemporaries, operate at the margins or by stages.

I know one month doesn’t a trend make, yet could this herald a possible major inflection point? 

Will the world succumb to a recession soon?

Geopolitical Risk Theater Links: Russia Threatens Denmark with Nukes, Putin Signs Pact with Georgia Breakaway Group, US-China Square off over Missiles at South Korea

Underneath those record setting stocks and frantic central bank rescues have been risks developing in the sphere of geopolitics

Below are excerpts of some news articles and opinion columns and their corresponding links.

1) Russia threatens to aim nuclear missiles at Denmark ships if it joins NATO shield (Reuters, March 22,2015)

Russia threatened to aim nuclear missiles at Danish warships if Denmark joins NATO's missile defense system, in comments Copenhagen called unacceptable and NATO said would not contribute to peace.

Denmark said in August it would contribute radar capacity on some of its warships to the missile shield, which the Western alliance says is designed to protect members from missile launches from countries like Iran.

Moscow opposes the system, arguing that it could reduce the effectiveness of its own nuclear arsenal, leading to a new Cold War-style arms race.

War drums beat louder.

2) Putin Signs Pact With Breakaway Georgian Region (Radio Free Europe, March 18, 2015)

Russian President Vladimir Putin has signed a pact with a Moscow-backed breakaway region of Georgia, despite condemnation by Tbilisi and the West.

Putin and the de facto leader of South Ossetia, Leonid Tibilov, signed the "alliance and integration treaty" in the Kremlin on March 18. 

Part of the treaty gives Russia responsibility for ensuring the defense and security of South Ossetia, including guarding its borders.

Security and mliitary forces currently tasked with defending the region are to be incorporated into Russia's armed forces or Russia security bodies.

More brinkmanship geopolitics

3) U.S. Nuclear Warfighting Plan Could Wipe Out the Human Race (Executive Intelligence Review March 13, 2015)

The reality is that the United States is not only creating the “appearance” of preparing to fight and win a nuclear war, but it actually is preparing to fight and win a nuclear war, although the idea that the United States can do that against another nuclear power is a dangerous delusion. Gen. Maj. Andrei Burbin, chief of the Central Command Post of Russia’s Strategic Missile Forces (SMF), made this clear in an unusual March 1 on-air briefing on Russia’s RSN Radio. The message he delivered was that “utopian” military schemes for “limited nuclear war” or a “counterforce” destruction of Russia’s nuclear weapons are illusory: They will fail, and the result will be retaliation against the U.S. by Russia using the missiles of the SMF. (See “Hear These Russian Warnings: They Might Save Your Life,” EIR, March 6, 2015.)…

Indeed, the delusion that the U.S. could wage and win nuclear war against Russia could lead to the end of civilization itself.

Yikes!

4) Russia Sends Nuclear-Capable Bombers to Crimea (Daily Signal March 20, 2015)

As NATO and Russia simultaneously launch military exercises stretching from Eastern Europe into the Arctic, Russian defense officials said this week that supersonic bombers capable of carrying nuclear weapons will be deployed to Crimea.

According to the Russian news agency TASS, Tupolev TU-22M3 strategic bombers will be positioned in the former Ukrainian territory as part of a snap military exercise involving Russia’s Navy’s Northern Fleet, which has been put on full alert, and other ground and air units across Russia. The Russian military drills comprise 40,000 troops, more than 41 warships, 15 submarines and 110 aircraft and helicopters, according to RIA news agency.

The TU-22M3 is capable of carrying the Kh-22 anti-ship missile, which was designed by the Soviet Union to target U.S. warships and is capable of carrying both conventional and nuclear warheads.

Russia’s military exercises began Monday and are scheduled to last until Saturday. The stated intent of the mobilization, according to Russian defense officials, is to evaluate Russia’s northern defenses and the capabilities of its Northern Fleet.

5) Russia Orders Surprise Test of Central Nuclear Base (Newsweek March 4, 2015)

The Russian armed forces’ strategic missile command (RVSN) have ordered a snap inspection of the state of the nuclear arsenal in one of the country’s central military bases near the city of Yoshkar-Ola.

The surprise test, announced today by RVSN, will assess the condition of the intercontinental ballistic and nuclear missile units, as well as test the readiness of the nuclear facilities near Yoshkar-Ola in hypothetical emergency situations.

“During the tests, specific attention will be paid to matters of the command’s preparedness to eliminate hazards in the event of an accident related to the nuclear weapons and also in the instance and it will test the emergency squad of the command,” Colonel Igor Yegorov, the RVSN spokesman, told press.

6) ‘Tanks? No thanks!’: Czechs unhappy about US military convoy crossing country (RT.com March 22)

Czech anti-war activists have launched the ‘Tanks? No thanks!’ campaign to protest the procession of US Army hardware through the Eastern European country. They say it has been turned into a “provocative victory parade” near the Russian border.

The American military vehicles, which took part in NATO drills in Poland, Lithuania and Estonia, plan to cross the territory of the Czech Republic between March 29 and April 1 on their way to a base in the German city of Vilseck.

The exercise, entitled the ‘Dragoon Ride,’ will involve over a hundred Stryker vehicles, which the US is expected to station in Europe, and will see the convoy stop in a new city every night. Last week, it was authorized by the Czech government, without any debate in the parliament, Pressenza news agency reported.

The US procession has been labeled “an unnecessary and dangerously provocative military maneuvers, which only increase international tension” on the ‘Tanks? No thanks!’ page on Facebook.

7) Is Russia building a new supersonic aircraft? (news.com.au March 21)

ACCORDING to a Kremlin propaganda media outlet, Russia plans to be able to deploy its army anywhere in the world within seven hours. It’s a future that involves a fleet of huge heavy transport aircraft that will be capable of moving around 400 Armata tanks, with ammunition anywhere in the world.

According to the Military-Industrial Commission in Moscow, a new aircraft, named the PAK TA, will be capable of flying supersonic speeds (up to 1235km/h), can carry up to 200 tonnes and have a range of at least 7,000 kilometres. Or roughly the distance between Sydney and Hong Kong.

Russia is supposedly hopeful to build 80 of the new PAK TA cargo aircraft by 2024.

Woe to the average Russians whose resources will be rechanneled for the production of unproductive and destructive goods or instruments.

 

8) Russia's Vladimir Putin brandishes the nuclear option (CBC.ca March 17)

The Kremlin has hardly been secretive about its overall strategy. Two years ago it unveiled a new military doctrine of what it called asymmetrical warfare, in effect high-tech guerrilla fighting alongside unrelenting technological and propaganda offensives against smaller, less militarily able neighbours.

That so many in eastern Ukraine see themselves as victims of Kyiv and not of Moscow is testimony to the success of the propaganda offensive.

Along with the doctrine came a vast increase in Russia's military budget.

According to the World Bank, it stood at over four per cent of Russia's gross domestic product in 2014 and was due to climb by almost 25 per cent in 2015.

When it comes to its military, Russia far outspends its European neighbours and now even spends more than the U.S., at least when measured as a percentage of its GDP.

'No more illusions'

Putin has been equally open about his regime's goals.

After annexing Crimea in 2014, he delivered a triumphant speech saying the Kremlin reserved the right to intervene to protect and defend Russians wherever they lived.

Within weeks Russian-speaking separatists in eastern Ukraine had begun a military offensive, setting up Soviet-style local regimes with Soviet names — the Donetsk People's Republic and the Lugansk People's Republic.

In the following months, according to Western intelligence, these rebels were heavily armed by Russia, which has also provided hundreds, if not thousands of troops.

The Putin doctrine simply thumbed its nose at two international agreements, the Helsinki accords of 1974 signed by Russia's predecessor state, the USSR, and the Budapest Memorandum of 1994, signed by Russia.

The first guaranteed the inviolability of all borders in Europe and the second specifically guaranteed Ukraine's borders and independence in return for handing over to Russia 1,900 Soviet-era nuclear weapons on Ukrainian soil.

Thanks in part to these Ukrainian weapons, Russia now has the largest nuclear stockpile in the world, 8,400 warheads to the 7,500 controlled by the U.S.

While Putin unleashes psychological warfare, the Russian economy will suffer.

9) U.S. Squares Off With China Over North Korea Missile Defense (Bloomberg, March 22)

The U.S. and China are squaring off over deployment of an anti-missile system in South Korea, the latest source of tension between the world’s two biggest economies as they vie for influence in Asia.

The U.S. is considering placing a Thaad ballistic missile defense system in South Korea to counter improved North Korean weapon technology. A group of lawmakers from the ruling Saenuri party has also begun lobbying for South Korea to purchase the Lockheed Martin Corp. missile system directly. China fears the U.S. could use Thaad to target its missiles and has called on South Korea to reject deployment.

“How can we fight with a knife when North Korea is brandishing a gun?” Won Yoo Chul, a lawmaker who heads the ruling party’s policy-setting committee, said in a March 20 interview. “North Korea’s nuclear and missile threat is advancing by the day and China’s response over Thaad is excessive.”

The Thaad issue has left South Korean President Park Geun Hye caught between the U.S, which maintains more than 28,000 troops in the country to defend against North Korea, and China, its biggest trading partner and ally in efforts to resolve historical and territorial disputes with Japan. Mounting evidence that the Kim Jong Un regime has developed the ability to launch nuclear-tipped missiles is adding urgency to the debate.

More encirclement strategy by the US government that will provoke a response in China.

10) Indonesia's president says China has no legal claim to South China Sea: newspaper (Reuters, March 22)

Indonesian President Joko Widodo says China's claims to the majority of the South China Sea have "no legal foundation in international law," Japan's Yomiuri newspaper reported.

The comments, in an interview published on Sunday ahead of visits to Japan and China this week, were the first time Widodo, who took office in October, has taken a position on the South China Sea dispute.

10) China Dominates the Scramble for the South China Sea (National Interest.org March 19)

Far from revisiting its assertive posturing in adjacent waters, China is seemingly determined to consolidate its position in the South China Sea at the expense of its smaller neighbors. The latest satellite imagery, released by the Center for Strategic and International Studies, indicate extensive Chinese construction activities in highly contested areas, particularly the Spratly Islands, which have been actively claimed by Vietnam, Malaysia, China, Taiwan, and the Philippines.

Though Vietnam has occupied the greatest number of contested features in the Spratlys, China is the most capable, ambitious (and geographically distant) claimant in the area. Given the magnitude of the power asymmetry between Beijing and its Southeast Asian neighbors, China has the wherewithal to unilaterally dictate the tempo and trajectory of maritime disputes in the South China Sea. Despite being a relative late-comer, China has rapidly augmented its position, artificially transforming highly strategic features such as the Fiery Cross Reef, which has been enlarged to eleven times its original size.

The reef is a formidable military garrison, with up to two hundred Chinese troops stationed there. It is expected to host its own airstrip in the near future, a crucial prelude to what could become a de facto Chinese Air Defense Identification Zone (ADIZ) in the South China Sea. This would complement China’s ADIZ in the East China Sea, paving the way for China to dominate the skies above the entire first chain of islands in the western Pacific.

Beating the drums of nationalism to divert the public’s attention from deepening economic troubles?

11) U.S. Navy Urges Southeast Asian Patrols of South China Sea (Bloomberg, March 18)

The commander of the U.S. Navy Seventh Fleet called on Southeast Asian nations to form a combined maritime force to patrol areas of the South China Sea where territorial tensions flare with China.

Countries could streamline cooperation on maritime security while respecting sovereignty and coastal space, as in the case of counter-piracy efforts in the Gulf of Aden, Vice Admiral Robert Thomas said Tuesday at the Langkawi International Maritime and Aerospace Exhibition in Malaysia.

The U.S. has reassured allies in the region it will back them against China’s assertions to about four-fifths of the sea. China has ratcheted up pressure on some Association of Southeast Asian Nations members, and has accelerated reclamation work on reefs in the waters criss-crossed by claims from Vietnam, Taiwan, Brunei, the Philippines and Malaysia.

More business for the US military industrial complex at the expense of ASEAN's economies.

12) China's Military Can Beat The US In South China Sea And Diaoyu/Senkaku Island Conflicts: Poll (International Business Times, March 13)

Public confidence in China's military is higher than ever. According to a public opinion poll, an overwhelming majority of Chinese citizens think the People’s Liberation Army is capable of facing and beating the United States if it comes to that over various disputed islands and maritime territories.

According to a study by the Perth USAsia Center, a foreign policy think tank that focuses on the Indo-Pacific region, over 87 percent of those surveyed agreed that China’s military was already equipped to “retake” the Diaoyu Islands, a cluster of resource-rich islands in the East China Sea, known as the Senkaku to the area's other claimants, the Japanese. Regarding potential military action in the South China Sea, where several Southeast Asian countries like Vietnam, the Philippines and Brunei all dispute China’s territorial and maritime claims, the Chinese public still echo a sense of confidence, with 86 percent saying the PLA is capable of taking the area.

Incredible delusions. If there should be a war, then this will mean the end human civilization as we know of.

13) Islamic State Rises in Libya (FreeBeacon, March 20)

The Islamic State terrorist group is expanding its operations in Libya with high-profile attacks following the recent beheadings of 21 Christians, according to a State Department security report.

In Libya, Islamic State (IS), also known as ISIS or ISIL, formed out of existing al Qaeda-affiliated and Islamist extremist groups in early 2015. It is said to number between 1,000 and 3,000 fighters and has been exploiting the conflict between two Libyan groups fighting for control of the oil-rich North African state, Libya Dawn and Operation Dignity.

The Islamist and pro-al Qaeda Libya Dawn and the anti-Islamist Operation Dignity, headed by Lt Gen. Khalifa Haftar, have created rival parliaments and military forces and are said to receive foreign government support.

What happened to the supposed role by the US as 'policeman' of the world? Or has the ISIS--not only been a Frankenstein (a monster created by the US government)--but has really been an ally of the US? 

The more the global economy sinks, the greater the risk of an outbreak of societal upheaval via revolutions or war. Inflationism will entrench on such prospects.

Phisix 7,800: Peso Smashed, January Remittance Growth Rates Plunges, Short Term Treasury Yields Spike!

And as man cannot bear to be without the miraculous, he will create new miracles of his own for himself, and will worship deeds of sorcery and witchcraft, though he might be a hundred times over a rebel, heretic and infidel ― Fyodor Dostoyevsky, The Brothers Karamazov

In this issue:

Phisix 7,800: Peso Smashed, January Remittance Growth Rates Plunges, Short Term Treasury Yields Spike!

-US Dollar’s Domino Effect: Philippine Peso and Malaysian Ringgit Smoked!

-OFW Remittances: Growth Rates Crash in January! Structural Headwinds Compounded by Event Risks

-Short-Term Philippine Treasury Yields Spike as Yields Flatten! Basel Standards are No Guarantee of Adequate Risk Measurement

-Capital Flight from Local Elites? Asian Currencies and CDS Spreads Show Why This Time Won’t Be Different

-Sweden Cuts Rate Announces QE as BIS and OECD Warns on Low Interest Rates!

Phisix 7,800: Peso Smashed, January Remittance Growth Rates Plunges, Short Term Treasury Yields Spike!

Marking the close occurred in a stunning 4 out of the 5 trading days this week!

It’s just horrifying to see how the Philippine stock market has transmogrified into a broken system characterized by mass hysteria and rampant manipulation!

US Dollar’s Domino Effect: Philippine Peso and Malaysian Ringgit Smoked!

In noting of the Philippine pesos’ outperformance, last week I asked, “For now, the Philippine peso now takes on the leadership but for how long?”

The currency markets appeared to have answered my question.

Although the US Federal Reserve’s FOMC dropped the word “patient” from their recent policy meeting, a “surprisingly downbeat outlook” and Fed Chairwoman Ms. Janet Yellen’s implied assurances of stretching an interest rate hike via “doesn’t mean we are going to be impatient” sent the US dollar tumbling. The US dollar even experienced a flash crash! (see right window). Growing accounts of real time flash crashes represents another sign how fragile and vulnerable the current financial markets have been.

Compounding the US dollar’s plight has been reports that the Chinese government’s central bank, the PBOC, massively intervened in support of her currency, the yuan.

So these factors—the Fed’s dovish stance and PBOC intervention—sent Asian currencies rallying hard (see right also see JP Morgan Bloomberg’s Asian Currency Index ADXY). The same factors have likewise accommodated a risk ON environment.

Yet the Philippine peso and the Malaysian ringgit defied the general regional sentiment. Against the US dollar, the peso plummeted 1.19% while the ringgit has been once again crushed, down by 1.3%. 

This week’s meltdown has not only erased the gains of the year, but has dragged down the peso to a year to date loss of .2%. Current momentum suggests that the USD-peso may break the 45 levels soon (see right)

Meanwhile, the ringgit’s sustained losses have brought the USD MYR pair to the peak of 2008! (see left)

Aside from the US dollar’s relative strength over most currencies, there are likely internal factors that have led to the pesos’ decline.

OFW Remittances: Growth Rates Crash in January! Structural Headwinds Compounded by Event Risks

This week the BSP came out with a report on personal and cash remittances for the month of January. 

Strikingly, personal and cash remittances inched up by ONLY .2% and .5% respectively! This marks the second below 2% growth rate in 3 months!

January’s growth rate crash represents the worst level since January 2009!

Yet the trends of the rate of growth of personal and cash remittances have been on a downhill as noted above.

It would be facile to blame seasonality for this. I can also add the Dodd-Frank ACT 1073 remittance-transfer as potential obstacle to remittance flows as previously discussed.

But a showcase of the January activities since 1990 reinforce the downside trend of growth rates in remittance flows. As one would note from the left graph, since 1998, remittance growth rates have been on a steady decline.

It would appear that the law of compounding and diminishing returns likewise affects remittance trends. Nominal remittance levels have reached size and scale where growth rates have become incremental.

Yet January’s nominal remittance trend may have even broken its long term trend.

While seasonality and Dodd Frank may have contributed, they are likely to be secondary (epiphenomena) or aggravating factors. But January activities show that seasonal dynamic appear as minor events.

And current conditions like crashing oil prices may have likely been another more significant contributing cause too. As I warned last December[1]

And yet how will the blowing up of the Middle East bubble extrapolate to Philippine OFW remittances? More than half or about 56% of OFWs according to the Philippine Overseas Employment Administration (POEA) have been deployed to this region. Will OFWs (and their employers) be immune from an economic or financial crisis? This isn’t 2008 where the epicenter of the crisis was in the US, hence remittances had been spared from retrenchment. For this crisis, there will be multiple hotbeds. The ongoing crashes in oil-commodity spectrum have already been showing the way.

So the above suggests that the structural declining trend in remittance growth rates seems as being reinforced by secondary causes such as oil prices and possibly the Dodd-Frank statute.

What is the implication of the remittance slowdown?

Well, as I wrote this week[2]:

This partly explains the ongoing pressures in retail activities and the weakening of the consumer household activities (HFCE) as revealed by the 4Q 2014 GDP data provided by the government, as explained here.

The rising account of store vacancies at shopping malls appear as real world (not statistical) symptoms of this.

Yet ironically, the supply side (housing, shopping malls, hotel and related industries) continues to project consumer trends as perpetually headed to the sky for them to borrow and build with ferocity. For instance, the daughter of the Philippines' richest tycoon anchors her firm's expansion projects largely on remittances as posted here

The end result from the widely divergent expectations and activities will be a huge or massive excess capacity mostly financed by debt!

And yet the sellside industry, expects earnings growth rate for the Phisix in 2015 to be at the mid teens. If current trends continue, then they will not only miss by a mile or by an ocean but by a galaxy!

And whatever strength by the peso, or its outperformance in the region, will be further exposed if such trends continue.

Is it a wonder why the BSP chief adamantly insists of deflationary risks in his latest speeches?

Short-Term Philippine Treasury Yields Spike as Yields Flatten! Basel Standards are No Guarantee of Adequate Risk Measurement

There could have been another factor to last week’s peso meltdown. 

Yes symptoms of funding pressures have reappeared in the Philippine treasury markets. Short term rates have massively spiked to return to December levels! That’s just two months after the Philippine government raised $2 billion overseas. The $2 billion loans may have helped temporarily improve February Gross International Reserves now at $81.3 billion.

Yet to apply the BSP chief’s splendid advice to journalists (whom I previously quoted[3]):

Economic numbers rarely tell the complete story when taken at face value. Therefore, a responsible journalist who seeks to offer readers a fuller appreciation of the information will examine the figures within a broader context or against an array of other relevant indicators.

So even if the BSP declares that the Philippine banking system as having “adequate capital levels against risks” for commercial and universal bank and for rural and coop banks, “figures within a broader context or against an array of other relevant indicators” in the prism of the treasury markets suggests that the alleged diminished risk outlook has been inconsistent or incompatible. Said differently, what statistics say and what the treasury markets have signaled have diverged.

Further, the obsession towards statistical or quant models as measures of risks as to declare the system safe has been vastly misplaced. 

Proposed changes at the Basel standards or ‘Basel IV’ have already been raising a hubbub at the international banking world.

An officer from the American Bankers Association exposes on the flaws of the Basel standards (as excerpted by Euromoney)[4]. [bold mine]

"As Basel III was an admission that Basel II got things wrong, Basel IV is a clear recognition that there is much that is wrong with Basel III," he says. "Yet the folks at Basel have not yet looked in the mirror and asked whether what is mostly wrong might be happening in Basel, that the simple concept of Basel I, to have some basic global capital standards, has been lost in an effort to over-engineer and micromanage at the global level the fine details of capital standards."

Yet why have some bankers been pushing back on Basel Committee on Banking Supervision’s (BCBS) proposals?

BCBS wants to end the practice of risk-weighting lenders’ exposures by reference to external credit ratings and instead suggests using measures such as capital adequacy and asset-quality metrics on exposures to other banks, for example. For corporates, the BCBS argues a given borrower’s revenue and leverage should determine credit risk weights rather than ratings, with the latter typically discriminating between industries and local-accounting standards. 

Bankers see plenty of problems. Since this way of risk-weighting exposure to other banks is determined by common tangible equity ratios and the non-performing assets ratio, it does not adequately take into account divergent liquidity and business-risk profiles, nor differences in supervisory processes under Pillar 2 of the Basel regime, says a senior regulatory adviser to the CEO of a large European universal bank.

The adviser adds: "Credit rating agencies look at a multitude of factors and these metrics are always richer, incorporating thorough timely reviews, and engagement with counterparties and agencies. You can also never empirically replace these qualitative assessments. 

The answer to the push back; because there is no uniformity in the risk profile of each loan portfolio.

To repeat “You can also never empirically replace these qualitative assessments”. Hmmm

Doesn’t this resonate with what I wrote back in October 2014[5]?

Because the BSP doesn’t really know of the viability or credit worthiness of each of the loans that have been extended throughout the system. And this lack of knowledge is what they admit as “uncertainty” and thus the warning “risks that could challenge… financial stability pressures from repricing of credit; sharp downward adjustments in prices of real and financial assets; and, capital flow volatility”.

They have practically NO idea what happens when there will be a “repricing of credit” and or how intense and scalable will “sharp downward adjustments in prices” and or how volatile capital flow will be.

Even bankers and regulators see Basel standards as inadequate measures of risk. So the citation of accounting metrics or statistics does nothing to uphold the supposed soundness of the system.

Going back to the Philippine treasury markets, the spike in short term yields has once again steepened the yield curve flattening dynamics.

Such flattening dynamic posits for an implied tightening of the liquidity environment as banks has less incentives to lend in an economy that has become increasingly dependent on debt.

Again considering that the Philippine treasury markets have been tightly held or controlled by the Philippine government and their banking sector vassals, those short term yield spikes signify as signs of growing fissures in the system.

And could the peso selloff have been also prompted by increasing concerns over risks build up despite the government and media’s attempt to whitewash them?

Capital Flight from Local Elites? Asian Currencies and CDS Spreads Show Why This Time Won’t Be Different

Two more items.

Has the local elites been seeking refuge away from the peso and domestic equities?

The BSP’s Balance of Payment report[6] says that in 4Q 2014 and in the entire 2014, the financial accounts registered net outflows.

I quote below the BSP’s explanation per category and put an emphasis on the activities of residents

4Q Direct investments (bold added): The direct investments account yielded higher net outflows of US$977 million in Q4 2014, more than double the net outflows of US$471 million in Q4 2013. Residents’ net acquisition of financial assets of US$2.4 billion exceeded their net incurrence of liabilities (foreign direct investments in the Philippines or FDI) of US$1.4 billion. This developed as equity capital placement abroad by resident non-banks surged to US$1.7 billion from US$226 million.

4Q Portfolio investment holdings: The portfolio investments account posted net outflows of US$1.2 billion in Q4 2014, 7.5 percent higher than the net outflows in Q4 2013. This development was reflective of the prevailing volatility in financial markets amid lingering uncertainty over the global growth prospects. Residents’ net acquisition of financial assets amounted to US$930 million, a reversal of the US$81 net disposal of financial assets in Q4 last year on account of net placements by domestic deposit-taking corporations (US$777 million) and the central bank (US$171 million) in debt securities issued by non-residents.

4Q Other investment accounts: The other investment account recorded net outflows amounting to US$2.3 billion in Q4 2014, more than five times the US$426 million registered in the comparable quarter last year. Net outflows stemmed mainly from higher net acquisition of financial assets which reached US$4 billion from US$1.2 billion in Q4 2013, due largely to higher residents’ deposit placements (US$2.7 billion) and net lending (US$1.4 billion) abroad.

The same Balance of Payment report for 2014 reveals the same dynamics.

Direct investments: The direct investment account reversed to net outflows of US$789 million from net inflows of US$90 million a year ago. This developed on account of the 91.7 percent rise in residents’ net acquisition of financial assets to US$7 billion from US$3.6 billion due to resident corporations’ net placements in both equity capital (US$2.9 billion) and debt instruments (US$4 billion) abroad.

Portfolio Investments: Portfolio investment account recorded net outflows of US$2.5 billion during the period, a reversal of last year’s net inflows of US$1 billion. This was due to residents’ net acquisition of financial assets of US$2.5 billion, from a net disposal of assets amounting to US$638 million combined with non-residents’ net withdrawal of investments amounting to US$3 million, a reversal from the net placements of US$363 million in 2013.

Other accounts: The net outflows in the other investment account doubled to US$6.9 billion from US$3.4 billion in 2013 on account of increased net placements in currency and deposits abroad by resident banks and non-bank corporations, amounting to US$2.7 billion and US$1.4 billion, respectively), and to higher resident banks’ net lending of US$2.7 billion.

Have domestic elites been bullish on the outside, but bearish in the inside? Have they been engaged in ‘do as I say, but not as I do’? So why the seeming outgrowth in capital exodus?

Finally, a lot of people from the formal sector have come to believe that the Philippines have become invincible to exogenous factors as to price domestic financial assets to perfection.

This week’s peso activity shows why this won’t be true, and add to this the above, the cost of insuring government debt via ASEAN 5 year CDS spread from Deutsche Bank.

While so far the Philippines has outperformed, the seeming near synchronized movements of CDS spreads shows of the relevance of the region’s influence.

The above only shows that this time won’t be different.

Sweden Cuts Rate Announces QE as BIS and OECD Warns on Low Interest Rates!

As I have been saying, central banks have aggressively embarked on crisis resolution measures even as global stock markets have run amuck.

The Swedish central bank cut rates into negative territory last week, as well as, announced the Swedish version of QE. 

From the New York Times[7]:

The executive board of the Swedish Riksbank said that it had cut its main rate target by 0.15 percentage point to minus 0.25 percent, and that it would buy government bonds valued at 30 billion kronor, or about $3.5 billion, over the next few months.

The bank said in a statement that it saw signs “that inflation has bottomed out and is beginning to rise,” but that the strength of the currency “risks breaking this trend.” The measures on Wednesday were intended “to support the upturn in inflation,” said the Riksbank, which signaled its “readiness to do more at short notice.”

The actions of the Swedish Riksbank marks the seventh rate cut by global central banks for the month of March and 25th for the year based on the tabulation of the CentralBankRates.com. This has been a count for rate cuts alone and excludes other non interest rate actions.

Central banks seem as in a panic mode in the face of abruptly falling economic indicators as financial markets party! 

It is as if we exist in two different worlds

Yet when the crisis emerges, global central banks would have little or no ammunition left to mount rescues as they have been desperately frontloading them.

Yet in a follow up to their September call, the OECD once again issues a brief warning on low interest rates[8].

“Lower oil prices and widespread monetary easing have brought the world economy to a turning point, with the potential for the acceleration of growth that has been needed in many countries,” said OECD Chief Economist Catherine L. Mann. “There is no room for complacency, however, as excessive reliance on monetary policy alone is building-up financial risks, while not yet reviving business investment. A more balanced policy approach is needed, making full use of fiscal and structural reforms, as well as monetary policy, to ensure sustainable growth and public finances over the longer term.”

The Bank for International Settlements has been consistently, persistently determined to warn of a risk buildup since 2014.

In the media briefing for the BIS Quarterly Review[9], Mr Claudio Borio, Head of the Monetary & Economic Department, goes on the record to caution the world from current set of policies. (bold mine)

In the process, central banks have shown that the so-called zero lower bound on interest rates is quite porous. Negative policy rates at the short end, coupled in some cases with large-scale asset purchases at the longer end, have pushed both term premia and nominal yields firmly and farther into negative territory. If this unprecedented journey continues, technical, economic, legal and even political boundaries may well be tested. The consequences should be watched closely, as the repercussions are bound to be significant, on the financial system and beyond.

The unforeseen technical, economic, legal and even political boundaries repercussions from inflationism reminds me of this majestic quote from the high priest of inflationism[10] (bold mine)

Lenin is said to have declared that the best way to destroy the capitalist system was to debauch the currency. By a continuing process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens. By this method they not only confiscate, but they confiscate arbitrarily; and, while the process impoverishes many, it actually enriches some. The sight of this arbitrary rearrangement of riches strikes not only at security but [also] at confidence in the equity of the existing distribution of wealth.

Those to whom the system brings windfalls, beyond their deserts and even beyond their expectations or desires, become "profiteers," who are the object of the hatred of the bourgeoisie, whom the inflationism has impoverished, not less than of the proletariat. As the inflation proceeds and the real value of the currency fluctuates wildly from month to month, all permanent relations between debtors and creditors, which form the ultimate foundation of capitalism, become so utterly disordered as to be almost meaningless; and the process of wealth-getting degenerates into a gamble and a lottery.

Lenin was certainly right. There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose.

How so very relevant such quote have been today.

Has central banks implicitly functioned as communist Trojan horses whose policies could have been engineered to destroy the residual capitalist structure of the world?

---

[1]See Phisix: The October Syndrome is Back! Philippine Casinos as the Causa Proxima? December 15, 2014

[2] See Wow, Philippine Remittance January Growth Rates Collapse to Near Zero or Post 2009 Crisis Levels! March 17, 2015

[3] See Phisix 7,800: Record Phisix as the BSP Continues with Deflation Spiel! March 9, 2015

[4] Euro Money Bank regulation: ‘Basel IV’ sparks banker fury March 2015

[5] See Phisix: 7,400 is not the Technical Hurdle, the BSP Governor Is October 6, 2014

[6] Bangko Sentral ng Pilipinas Q4 2014 BOP Position Yields US$574 Million Surplus; Full-Year 2014 Registers US$2.9 Billion Deficit March 20, 2014

[7] New York Times Sweden Cuts Key Interest Rate to Minus 0.25% March 18, 2015

[8] OECD Newsroom Low oil prices and monetary easing triggering modest acceleration of global recovery March 18, 2015

[9] Mr Claudio Borio BIS Quarterly Review March 2015 - media briefing BIS.org

[10] John Maynard Keynes The Economic Consequences of the Peace 1919. pp. 235-248. PBS.org