What Happened to the ECB's Bazooka? Euro Surges as European Stocks Clobbered!

Last January I wrote: 

My point is that these central bank policies to subsidize the stock markets via monetary policies, as shown by the experiences of Japan, China and Germany, have conspicuously been increasingly afflicted by the laws of diminishing returns. 

The narrowing windows of gains only punctuate on the risk of severe or dramatic downside ‘flight’ actions overtime. Yet central banks refuse to heed reality. But they continue to focus instead on the short term. The result should be the worsening of the unintended consequences from present day ‘rescue’ actions.

Last night, ECB's Super Mario launched the much awaited stock market bailout via the "bazooka".

The result?

Just what happened to the honeymoon?  The honeymoon didn't even lasted a day as Europe's stocks got crushed!  

US stocks marginally declined, although they bounced back from intraday deep losses.

And the euro rallied hard!

Could the Super Mario's bazooka have been a buy the rumor sell the news? Or could this have been a lagging effect, where the rally may happen later?

If the bazooka failed to whip up on the risk ON appetite, what's to keep global stocks up? The FOMC meeting next week, where the doves are expected to prevail?

Truly interesting developments.

Former Bank of England Mervyn King Warns the Eurozone is Doomed!

It's interesting to see to former officials eschew establishment line to adapt a radical perspective. And it's even more intriguing when such proselytism comes from an ex highest central bank official of a developed economy.

I am talking of Mervyn King, the previous Governor of the Bank of England, who in his recent book, predicted that Eurozone will not only be headed to the gutters, but would likely dismember.

Here's the Telegraph:(bold mine)

He warns of a looming “economic [and] political crisis” triggered by endless bail-outs, austerity demands and pressure from the “elites in Europe” and the US to create “a transfer union” to solve the eurozone’s woes.

In the second extract of The Telegraph’s exclusive serialisation, Lord King warns that this has “sowed the seeds of division” in the bloc and created support for populist parties. Further steps towards political union, where countries are forced to cede sovereignty and yield to Brussels diktats, could spark a public backlash.

“It will lead to not only an economic but [also] a political crisis,” he says. “Monetary union has created a conflict between a centralised elite on the one hand, and the forces of democracy at the national level on the other. This is extraordinarily dangerous.”

However, Lord King, who often used sporting analogies during his decade at the helm of the Bank of England, says the alternative of struggling countries such as Greece being “temporarily relegated” from the bloc to regain competitiveness may also be “too late”.

Policymakers, already scarred by repeated rounds of brinkmanship, are unlikely to reach an accord, he argues. “The underlying differences between countries and the political cost of accepting defeat have become too great.

“That is unfortunate both for the countries concerned – because sometimes premature promotion can be a misfortune and relegation the opportunity for a new start – and for the world as a whole because the euro area today is a drag on world growth.”

Germany and the rest of the eurozone must “face up” to the fact that uncompetitive countries in the south can only prosper again if the bloc is broken up, Lord King argues.

Europe’s biggest economy faces the “terrible choice” of writing a blank cheque to support the bloc “at great and unending cost to its taxpayers” or calling “a halt to the monetary union project”, he says.

The “only way” to stop countries staring into the abyss of “crushing austerity, continuing mass unemployment” with “no end in sight to the burden of debt” faced by debtor nations is for them to abandon the euro.

“The counter-argument – that exit from the euro area would lead to chaos, falls in living standards and continuing uncertainty about the survival of the currency union – has real weight,” Lord King says.

“But... leaving the euro area may be the only way to plot a route back to economic growth and full employment. “The long-term benefits outweigh the short-term costs.”

The misguided ramrodding of inflationism to the public, or hidden taxation through currency debasement as subsidy to the political elites in order to prolong an unsustainable debt financed welfare warfare state,  the efforts to empower the unelected bureaucracy through increased centralization at the expense of the average citizenry, the deepening suffocation of the economic agents through imposition of byzantine taxes, regulations and mandates, the forcible integration of divergent societies, and presently, the 'refugee crisis' as consequence of the warfare state only provides clues to the path of the eventual demise of the EU.

I am reminded by the mainstream's economic icon, JM Keynes's trenchant perspective on inflationism which leads to the destruction of society. (bold added)

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.

EU's modern day application of "all permanent relations between debtors and creditor...become so utterly disordered": from ZIRP to NIRP to war on cash.

Quote of the Day: The Euro, the EU and the European Central Bank are Doomed

From the legendary investor, author, libertarian philosopher, anarcho capitalist Doug Casey at the International Man:

The economy of the European Union is a constipated, sclerotic, malfunctioning entity that only registered real economic growth of 0.2% in the recent quarter—assuming you can credit their numbers at all. The continent is a giant monument to socialism, where everyone believes they can live at the expense of everyone else. As a result, the average European sees his government as a magic cornucopia, a source of unlimited wealth. When something goes wrong, Europeans look to their governments to “do something.” With this in mind, European Central Bank President Mario Draghi made the front pages by saying he is “ready to act” with a “whole menu of monetary policy instruments.”

This is central banker speak for “I’m willing to print an incredible amount of money in my attempt to keep my job and stimulate the economy by making people think they’re richer than they really are.”

Draghi’s money printing is a disastrously misguided attempt at creating prosperity. It will create bubbles, and cause people and companies to do all manner of things they’d never consider without the false economic signals he will send. If printing money were the path to prosperity, Zimbabwe and Venezuela would be the richest countries on earth instead of economic basket cases.

Traders who take positions based on the words of a central banker are naïve, and just asking for losses. Not only does the ECB believe printing money is a good thing, but they’re forced to do more, to keep the system from collapsing. This will send the value of the euro much lower; the currency will accelerate its descent toward its intrinsic value, namely zero.

The euro is a sure bet to join the ranks of many hundreds of defunct paper currencies. Not one currency in today’s world is backed by a commodity (like gold); they’re backed only by confidence (which can vanish like a pile of feathers in a hurricane). And, of course, the ability of governments to steal from the people. But the euro doesn’t even have that going for it. The European Union doesn’t have the power to tax. Right now, the Eurocrats in Brussels really only have the power to regulate. I’ve long said, “While the U.S. dollar is an ‘IOU nothing,’ the euro is a ‘who owes you nothing.’”

The EU itself is a completely artificial and dysfunctional union. The Swedes are very different from the Sicilians, and the Portuguese very different from the Austrians. These people have little in common besides a history of fighting with each other. Force them together into a phony union and they’ll become mutually resentful, the way the Germans and the Greeks now are. The EU was put together partly to avoid future wars, but it may turn out to be a war incubator.

The European Union itself makes no real sense. Its sole good aspect, the abolition of internal barriers to the free passage of goods and people, could have been had simply by dropping barriers. Setting up another huge, costly bureaucracy in Brussels was idiocy.

Incidentally, people think of these countries—Italy, France, Germany and so on—as though they are fixtures in the cosmos. But they aren’t. In their current forms, they’re all newcomers on the stage of history.

The average person doesn’t realize that the country we know as Italy today was only created in 1861, a consolidation of many completely independent and very different entities that had been separate states since the collapse of the Roman Empire. Germany was only unified in 1871, out of scores of principalities, dukedoms, baronies and whatnot. Both unifications were very bad ideas; World Wars I and II are just at the head of a long list of reasons why that’s true. Even today, there are separatist movements in big Western European countries, like the Basques and Catalans in Spain, and the Scots in the United Kingdom, who wish it weren’t quite so united. There are many others.

Centripetal force will eventually tear it apart, with the EU as a whole disintegrating long before its individual parts—France, Italy, Germany the U.K., etc.—fall apart. The colors of the map are always running.

The European continent reminds me of that poorly managed cruise ship that sank off the coast of Italy in 2012. It is dying financially, with all the debt bankrupting governments, businesses and individuals. It is sinking economically, weighted down with stifling regulations and taxes. It is being strangled demographically, with birth rates far below replacement. Except among African and Muslim immigrants, who are not integrating. And now, millions of migrants, who seem to expect free food, shelter, clothing and money to hang around coffee houses all day to complain. Europe has long been a hotbed of religious, ethnic and race wars—quite frankly, I see the next one building up right now.

So, I think the euro will reach its intrinsic value long before the dollar does. The euro, in anything like its present form, will likely cease to exist within a decade, and probably far sooner. If I had a lot of my wealth in euros, I would get it out ASAP.

Has SNB’s actions functioned as the Causa Proxima for the Return of Global Financial Volatility?

More on Swiss National Bank’s pulling the plug on the franc-euro cap which I posted Thursday.

SNB’s governor Thomas Jordan on the discontinuation of the franc euro policy:

Recently, divergences between the monetary policies of the major currency areas have increased significantly – a trend that is likely to become even more pronounced. The euro has depreciated substantially against the US dollar and this, in turn, has caused the Swiss franc to weaken against the US dollar. In these circumstances, the SNB has concluded that enforcing and maintaining the minimum exchange rate for the Swiss franc against the euro is no longer justified.

The Wall Street Journal Real Times Economic Blog provides a list of foreign exchange brokers which suffered heavy losses from the SNB’s actions.

-FXCM Inc., the biggest retail foreign-exchange broker in the U.S. and Asia, said in a statement that because of unprecedented volatility in the euro against the Swiss franc, clients’ losses left them owing it about $225 million and that it was trying to shore up its capital. 

-In the U.K., retail broker Alpari Ltd. entered insolvency after racking up losses amid the currency turmoil following the SNB’s decision. 

-Global Brokers NZ Ltd., which is registered in New Zealand, said it would close its doors as it could no longer meet regulatory minimum-capitalization requirements of 1 million New Zealand dollars ($782,500). The firm is connected to online currency trading websites Cashback Forex, Forex Razor and Excel Markets and appears to be owned by entities in the British Virgin Islands. 

-Japan’s Finance Ministry was checking on trading firms Friday after industry sources said the country’s army of mom-and-pop foreign exchange traders suffered big losses.

Oh by the way, Swiss stocks which collapsed 8.97% on Thursday, had a follow on 5.96% meltdown on Friday. For two days the SMI has lost 14.93%! 

Stock market crashes and sharp financial volatility have become real time events!

The Swiss equity bellwether has apparently diverged from many other European stocks where the latter has rallied strongly. Last week’s stock market bids have largely been anchored on next week’s highly anticipated full scale QE from the ECB.

Nonetheless here are some interesting commentaries from various experts.

Austrian economist Patrick Barron at the Mises Canada Blog says that Switzerland has implicitly abandoned the European Monetary Union (bold mine)

Oh. You didn’t know that Switzerland was part of the European Monetary Union? You thought that the Swiss used their own currency, the Swiss franc? In a definitional sense only, you are correct. Within its monopolized currency area, the political boundaries of Switzerland, the Swiss franc is legal tender. But for approximately three years the Swiss National Bank has maintained a Swiss franc to euro ratio of 1.2 francs per euro. The usual suspects, exporters, were the driving political force behind the SNB’s policy. They feared fewer sales to eurozone countries should the franc cost more in euro terms. This policy made the European Central Bank (ECB) the determinant of monetary policy in Switzerland and relegated the Swiss National Bank to the mechanical role of currency board. When the Swiss franc started to appreciate against the euro, meaning that buyers were willing to accept fewer than 1.2 francs per euro, the Swiss National Bank printed francs and bought euros. Over the last three years as demand for Swiss francs from euro holders increased, the SNB’s balance sheet exploded with new euro reserves. However, as the world now knows, in a surprise move the SNB abandoned its currency peg policy. Today the franc exchanges approximately one for one with the euro, meaning that the franc has appreciated by approximately twenty percent against the euro.

As far as I know the SNB has made no official announcement of the reason for its surprise move. I suspect that the Swiss people had made themselves heard that they feared inflation from the ECB’s imminent quantitative easing policy.  The Swiss gold referendum on November 30 would have required their central bank to hold a fixed percent of reserves in the form of gold. It was defeated only after the major political parties and the SNB amounted a concerted anti-referendum blitz. Still in control of their own currency, it was a relatively simple matter for Switzerland, in effect,  to veto the ECB’s proposed policy by abandoning the currency peg. This shows the rest of Europe that at least one nation does not fear returning to full control of its currency nor does it fear the consequences of a temporary drop in exports. (The drop will be temporary, because Swiss import prices will fall and eurozone users will be awash with depreciated euros and willing to pay more for the Swiss franc.)

The lesson is clear. If Switzerland can retake control of its money, so can any eurozone nation. The process may take longer, as the country reissues is own currency and re-denominates its bank accounts in local currency terms, but it can be done. Already there are reports that the Danish central bank is contemplating abandoning its currency peg of approximately 7.5 krone per euro.  If the sky does not fall on Switzerland and Denmark, other nations may follow. Does anyone know how to say deutsche mark?

To visualize on the explosion of euro reserves on the SNB’s balance sheets, as of November 2014, the SNB's balance sheet has swelled to 540 billion CHF and now accounts for 80% of GDP (chart from Danske).  

Austrian economist Frank Hollenbeck at the Mises Institute notes that the surprise SNB action has been intended to shield Swiss political economy from ECB’s forthcoming irresponsible actions (emphasis added)

In theory, the Swiss could have held the floor. To keep your currency from appreciating, all you need to do is print, print print. Of course, this printing is not without consequences. With this bold move, the Swiss have crossed the Rubicon. They cannot go back. They have in dicated to speculators there is a pain threshold, or monetary expansion, that the Swiss are not willing to bear. Any attempt to set a new floor would set up a one way bet for speculators.

By pegging your currency to that of a bigger neighbor, you are essentially letting your neighbor determine your monetary policy. Dubai fixed its currency, the dirham, to the dollar and imported the US’s excessive monetary policy which led to the same real estate bubble in Dubai as the bubble in the US. In other words, by fixing your currency, you have to follow your bigger neighbor’s irresponsible monetary policy.

With the increasing likelihood that the European Central Bank would violate the Maastricht treaty and purchase sovereign debt, the Swiss finally decided they had had enough. The talk now is that the ECB will purchase over a trillion euros worth of bonds. To keep the peg, the Swiss would have had to increase the money supply by the same percentage, which would have been irresponsible monetary policy for such a small country.

By letting the peg go, Switzerland did the right thing. It should now concentrate on eliminating most EU debt from its balance sheet. There is an EU storm brewing, and Switzerland will no longer be one of the innocent bystanders.

In an interview, American entrepreneur and financial commentator Peter Schiff said that the SNB has been the first central bank to "surrender" or to back away from them global ‘currency war’. 

The transcript of the interview from LewRockwell.com (bold mine)

“First of all, it’s not just the euro that collapsed. The US dollar collapsed almost as much. I think it was the right thing to do. I think it was a mistake for the Swiss to have adopted that peg in the first place. In fact, by abandoning the peg, they’re admitting it was a mistake, because now the Swiss franc has appreciated anyway, which was something the peg was designed to prevent. Now the Swiss National Bank has tens of billions of francs worth of losses on a 500 billion plus cash of euros and dollars that they’ve accumulated to defend that ridiculous peg. Of course, had they not ended it, the losses would have mounted. If Europe launches QE, they could have lost hundreds of billions of francs…

“Central bankers rarely admit their mistakes. What’s changed? It’s not necessary because it didn’t work. It was never necessary. They probably have a much greater supply now of euros and dollars on their balance sheet than they bargained for. The prospect of having to back up the toboggans and fill them full of euros was very daunting. So they abandoned this peg, thankfully for the Swiss… Swiss people are going to benefit. Look at the drop of oil prices in terms of Swiss francs. Prices are going to come down and the Swiss are going to be that much more prosperous because of a stronger franc…

“I think that is a mistake. I don’t think they need negative interest rates. I think that is taking some of the luster off of the franc. It would be even stronger had they not done that. But a strong currency is not a bad thing. A weak currency is a bad thing. Switzerland should take pride in the strength of its currency. Now they have to deal with the losses by trying to prevent it from rising. Of course, there have been some economic mistakes made in Switzerland and elsewhere, because of this monetary policy, that now have to be corrected. Unfortunately, these were needless mistakes that didn’t have to be made. I think a lot of people are now jumping to the conclusion that Europe is going to do a big QE program, and that’s why the Swiss are backing away. Without the Swiss, I think it makes it that much more difficult for Europe to do QE. So maybe they’re not going to be able to do it, because they no longer have the Swiss to support their currency. Maybe they’ll do some more substantive economic reforms instead. That would be a positive for Europe. I think that it could mean the US is the last central bank standing with QE, because I think we’re going to be doing QE4…

“I think that you’re going to see a complete breakdown in the confidence that people have for central banking over the next several years. The Swiss were saying, ‘Over my dead body. We will defend this peg to eternity.’ Then they went around and they didn’t do it. Of course, that’s generally what central banks do. They have to deny, deny, right up until the point where they do what they were denying they were going to do. I think you have a lot of confidence and trust and faith in central bankers. I think that bubble in central bank confidence is going to burst, is going to be shattered. Particularly when it comes to the confidence people have in the Federal Reserve and in Janet Yellen, because they’ve been talking about how great the US economy is. To anyone who has been payingattention to the statistics, this mirage of a recovery, this illusion is fading fast. I think instead of the promised recovery that Janet Yellen has been talking about, we’re going to have a relapse to recession. Instead of rate hikes, we’re going to have QE4. That’s going to be the end of their credibility…

We see the same concerns even in the mainstream. 

The stock market bullish fund manager David R. Kotok chairman of Cumberland Advisors Chairman suddenly seems skittish: (bold mine)

Markets can handle good news, and they can handle bad news. Markets have trouble, however, with uncertainty. The pressure on stock markets and the volatility that has spiked due to the SNB’s move are the results of rising uncertainty about the foreign-currency-denominated debt and abrupt changes in central bank policy.

The Swiss have punched new holes in their cheese. They have boiled their chocolate so that it smells bad. They committed to a course, reversed themselves, and have now lost their credibility. This is the second governor of the Swiss central bank who has suffered a loss of credibility. The first one had to resign because a member of his household was allegedly trading a foreign currency position against the euro peg. The second governor has derailed billions in loans and pressured his citizens through his unexpected policy change.

When one central bank loses its credibility, all central banks suffer. The burdens on the Federal Reserve, the European Central Bank, the Bank of Japan, the Bank of England, and others have now intensified.

Finally, chief advisor to Allianz and economic commentator and author Mohamed El Erian, writing at the Financial Times says that the SNB’s actions looks like signs of widening cracks on the central bank induced low volatility environment: (bold added)

The implications of this historic policy turnround extend well beyond a period of bumpy economic and financial adjustment for Switzerland itself. They risk destabilising some other countries and decision-making in the neighbouring eurozone will become even more complicated and contentious.

Confirming the historical lesson that large currency moves tend to break things, they also highlight the extent to which central banks, operating in a world of growing economic and policy divergence, are struggling to maintain the paradigm of low market volatility that is central to their efforts to generate higher economic growth…

Following the abrupt removal of the currency peg, Switzerland is now looking at a period of bumpy economic and financial adjustment. Being a relatively “open economy”, in which trade and tourism play an important role, Swiss companies face a considerable competitiveness challenge ahead. The country will also have to deal with issues of currency mismatches, as well as having to battle larger, externally-induced deflationary forces.

But the implications extend far beyond Switzerland. Countries with Swiss franc denominated liabilities, such as Hungary, now have to deal with a major adverse valuation shock.

More importantly in terms of global systemic effects, politicians in the core economies within the eurozone — including Germany, Austria, Finland and the Netherlands — will see the SNB’s move as a reaffirmation of the dangers of substituting financial engineering for real economic reform. As such, they will be less willing to accommodate the hyperactivism of the ECB. And while this is unlikely to stop the ECB from doing more, it may increase the legal, reputational and unity risks it takes in doing so. 

Then there are the consequences for a global economy which, in the absence of a comprehensive policy response in the advanced world, has ended up overly reliant on central bank interventions. Given that their tools cannot reach directly and sufficiently at what holds back growth and jobs, these central banks have been forced to use the partial channel of financial asset prices to influence real economic outcomes.

To this end, central banks have sought to repress market volatility as a means of encouraging risk taking that would then boost asset prices and thus encourage greater household consumption (via the wealth effect) and corporate investment (via animal spirits). 

The SNB’s decision is further evidence that central banks are finding it harder to implement a policy of volatility repression that already was being challenged by the growing divergence in policy prospects between the eurozone and the US.

The ECB better deliver the highly expected "bazooka" next week because if not market volatility may return with a vengeance.

Yet has last week’s action by the SNB functioned as the causa proxima* for the return of global financial market volatility as the Swiss franc carry trade unravels that may lead to the breakdown of the euro and of bursting of the central banking confidence bubble?

*Causa Promixa is what historian Charles Kindleberger calls as "some incident that saps the confidence of the system" in Manias, Panics and Crashes p 104

Italian Politician Beppe Grillo Says Italy at War with the ECB

Italian politician, comedian and blogger, Beppe Grillo founder of the Five Star Movement which in the 2014 Italy’s European parliamentary election placed second says Italy has been at “war” with the European Central Bank (ECB), from the ANSA.it:

The European Central Bank is a greater foe than Islamic militant group ISIS, said Beppe Grillo, leader of the 5-Star Movement (M5S), as he headed for a meeting Wednesday with the president of the European Commission, Jean-Claude Juncker.

"We are not at war with ISIS or with Russia, but with the ECB," said Grillo.

The M5S leader was planning to present his campaign for a referendum on pulling Italy out of the single-currency euro to the European Parliament in Brussels.

"We are tired of the sacrifices, we want to regain sovereignty over our currency, (and) save our businesses," said Grillo

As I have previously noted, not only has the ECB been faced with legal and technical hitches on their recently implemented credit easing (QE) programme, political roadblocks like in Germany or the above have likewise been mounting, thus narrowing the window of ECB’s Risk ON joy ride.

The ECB has essentially been underwriting the demise of the euro

Tick tock.Tick tock.

ECB’s Coming QE: ABCP, Interest Rate Cut or Negative Deposit Rates?

The latest melt-UP phase (record run) in mostly developed economy stocks has mostly been prompted by the the European Central Bank’s recent signaling of fresh easing measures which may be announced this June 5.

Here is another sign of financial schadenfreude: the ECB’s Mario Draghi’s induced dilemma for the euro (the euro has been plunging since late April) has extrapolated to a booming Stoxx 50 and the US S&P.

David Stockman at his Contra Corner website explains the possibility of the revival of asset-backed commercial paper (ABCP) as the focal point of ECB’s easing this week. (bold original)

You can smell this one coming a mile away:

The European Central Bank and Bank of England on Friday outlined options to reinvigorate the market for bundled bank loans, which was “tarnished” by the global financial crisis, saying a better-functioning market for asset-backed securities can help boost lending to the private sector, particularly small businesses.

Yes, the ECB is now energetically trying to revive the a market for asset-backed commercial paper (ABCP)—-the very kind of “toxic-waste” that allegedly nearly took down the financial system during the panic of September 2008. The ECB would have you believe that getting more “liquidity” into the bank loan market for such things as credit card advances, auto paper and small business loans will somehow cause Europe’s debt-besotted businesses and consumers to start borrowing again—- thereby reversing the mild (and constructive) trend toward debt reduction that has caused euro area bank loans to decline by about 3% over the past year. 

What they are really up to, however, is money-printing and snookering the German sound money camp. That is, the ECB is getting set to launch QE in financial drag by purchasing or discounting ABCP while loudly proclaiming that it’s not “monetizing” any stinking sovereign debt!…

So in clearing the way to “monetization” of ABCP, the ECB is simply heading down the path of Bernanke/Yellen style quantitative easing though a transparent gimmick that may or may not bamboozle the Germans. But it most certainly will succeed in snookering the financial press as the post below from the ever gullible Brian Blackstone of the WSJ clearly conveys.

But here’s the thing. The ABCP market is not a place where hard-pressed business borrowers or consumer’s can find a new source of credit outside the banking system. Instead, it is a financial engineering arena in which banks will have a chance to mint phony overnight profits through an accounting expedient known as “gain-on-sale”. 

What that means is that when credit card receivables or small business loans are “bundled” by their commercial bank issuers and sold into an off-balance conduit which issues ABCP against these “assets”, the life-time profits of these loans can be booked instantly. Indeed, modern technology allows the credit card swipe to be booked as a profit nearly the same nanosecond as it happens, and accounting convention allows the profits from a 7-year car loan issued at 110% of the vehicle’s value to be recorded virtually at the time it rolls off the dealer lot.

Aside from the ABCP, many have been speculating too that the ECB may engage in either interest rate cuts or even adapting a Negative Deposit Rate. At any rate, it’s all about promoting bank credit expansion.

Some charts that has prompted the ECB’s likely actions:

Bank lending remains in doldrums

Eurozone’s disinflation amidst skyrocketing debt levels

The decline in loans has been manifest in money supply growth (left). Unfortunately lower interest rates hasn’t translated to credit expansion

But despite the lackluster bank lending growth, Europe’s leverage loans and corporate debt department continues to sizzle, which has been an important influence to sky bound stock markets.

This comes as Stoxx 600 earnings continue to be dismal.

So again, who says stock markets are about the economy and earnings?

Bottom line:  the du jour central bank policies today, has been to solve existing DEBT problem by promoting even more DEBT.  This is like solving alcoholism by prescribing even MORE intake of alcohol!

Current policies that promote more debt build-up, which have been meant to buy time, will translate to even greater systemic risk that is bound for implosion. 

Of course, the main beneficiaries here are no less than the governments (see huge debt levels above) via interest rates (financial repression) subsidies, the Wall Streets of major economies via inflated balance sheets that keeps their debt burdened banking system afloat and the political economic elites whom are further enriched by inflated asset markets that comes at the expense of society.

Aldous Huxley once warned that “That men do not learn very much from the lessons of history is the most important of all the lessons that history has to teach.” Central banking policies simply highlight on this.

Euro and European Periphery Bonds strength hooked on BoJ’s Abenomics, Reversal Time Coming?

Speaking of carry trades, do you know that BoJ’s ‘Abenomics’ stimulus has fostered the the recent strength of the euro and the latest comeback or reprise of the European peripheral bond’s convergence trade? Part of today's risk ON landscape has been due to this too.

From Bloomberg’s chart of the day: (bold mine)

Euro-area peripheral bonds are hooked on Japan’s monetary stimulus.

The CHART OF THE DAY shows Europe’s peripheral bond rally stalled this month as the yen strengthened versus the euro. Last week the Bank of Japan refrained from adding to the 60 trillion yen ($589 billion) to 70 trillion yen poured into the monetary base each year that has encouraged Japanese investors to put money into higher-yielding European assets.

“Peripheral yield spreads appear vulnerable to a correction following the strong rally and the yen tends to often strengthen on credit risk,” said Anezka Christovova, a foreign-exchange strategist at Credit Suisse Group AG in London. “Japanese portfolio flows usually have an impact. Those flows could now divert elsewhere. We don’t expect any substantial action from the Bank of Japan in coming months and that could also lead the yen to strengthen.”

Japanese investors bought a net 1.41 trillion yen of long-term foreign debt in the week ended May 16, the most since Aug. 9, data from the finance ministry in Tokyo showed on May 22. Flows into Europe may be tempered as yields in Europe’s periphery climb. The average yield spread of 10-year Portuguese, Greek, Spanish and Italian bonds over German bunds has risen 20 basis points this month to 270 basis points, after touching 239 basis points on May 8, the lowest since May 2010, based on closing prices.

New York-based BlackRock Inc., the world’s biggest money manager, said on May 8 it had cut its holdings of Portuguese debt, while Bluebay Asset Management said on May 9 it had seen the majority of spread tightening it was looking for.

This yen euro carry perspective has been shared by my favorite laser focused bubble watcher Credit Bubble Bulletin’s Doug Noland: (bold mine)

Importantly, Draghi’s “ready to do whatever it takes… And believe me, it will be enough” was a direct threat aimed at speculators that had accumulated large bets against European debt and the euro. It’s my view that the Fed and BOJ’s extraordinary measures to devalue the dollar and yen – as the ECB refrained from QE - were instrumental in bolstering the vulnerable euro. And with global central banks supporting the euro coupled with Draghi promising a bond backstop, suddenly European periphery bonds were transformed into an incredible opportunity for speculation - in a world awash in free-flowing speculative finance. Stated differently, the major central banks dictated that the hedge funds and speculators reverse their bearish euro-related bets and instead go leveraged long. This powerful Bubble flourishes to this day.

Aside from ensuring financing flows of government, QEs and ZIRPs have implicitly been meant to suppress “shorts” or bearish bets on the asset markets. In other words, monetary policies have directed to massage market prices by fueling a an asset boom. This is the Bernanke/Yellen-Kuroda-Draghi put in action.

Yet if the BoJ will remain resolute in abstaining from providing further stimulus, then the Yen-Euro carry will reverse and most likely bring back Risk OFF environment. But will the BoJ just take the heat from the Wall Streets of the world?

Also, has the Philippine central bank chief's repeated mentioning of the concerns over foreign "hot money" flows been tacitly referring to this yen-euro carry?

Very interesting times indeed.

Phisix: Will Domestic Fundamentals Outweigh External Factors?

The Philippine central bank, the Bangko ng Pilipinas (BSP) released its 2^nd quarter inflation report last week. 

And as expected, the BSP, which interprets the same statistical data as I do, sees them with rose colored glasses. On the other hand, I have consistently been pointing out that beneath the statistical boom based on credit inflation, has been a stealth dramatic buildup of systemic imbalances

BSP Predicament: Strong Macro or Fed Policies?

In a special segment of the report, the BSP recognizes of the tight correlation between US Federal Reserve policies and the price action of the local stock market (as noted above)

The BSP implicitly infers of the influence or the transmission mechanism of the actions of the US Federal Reserve (FED) on foreign portfolio flows to emerging markets, such as the Philippines, by stating that Fed policies “followed generally by upward trends in portfolio investment inflows”. 

The BSP also sees portfolio flows as having contributed to the recent stock market boom, “A similar trend was observed with the Philippine stock exchange index; that is, QE announcements were followed generally by an increasing trend in prices, with varying lags.”[1]

And when the jitters from the FED “taper” surfaced on the global markets late May, the BSP admits that foreign funds made a dash for the exit door, “In May 2013, portfolio investment flows registered a net outflow of US$640.8 million, a reversal from the previous month’s inflow of US$1.1 billion. Net capital flows for the period 3-14 June 2013 have recovered somewhat to US$65.13 million”

The BSP also noted that the sudden reversal of sentiment affected other Philippine markets, particularly

a) Philippine credit outlook represented by credit default swap (CDS), “The credit default swap (CDS) index exhibited a widening trend to 157 bps on 24 June after trading below 100 bps in the past month, as the market increased its premium in holding emerging market bonds. The country’s CDS narrowed to 145 bps as of 25 June 2013, improving further to 139 bps by 27 June 2013” and

b) The currency market, “the peso weakened significantly by 6.36 percent year-to-date against the US dollar, closing at a low of P43.84/US$ on 24 June 2013. Subsequently, the peso began to recover, closing the quarter at P43.20/US$ on 28 June 2013.”

The BSP dismissed the domestic market’s convulsion as having “overreacted to some extent”, and put a spin on a recovery “are now beginning to bounce back”.

But curiously the BSP justifies the selloff as having a beneficial effect of “reducing the build-up of stretched asset valuations and in making the growth process more durable in long run”, this predicated on the “inherent strength of Philippine macroeconomic fundamentals”.

See the contradictions?

If the BSP thinks that the domestic market’s reactions to external forces reduced the “build-up of stretched asset valuations”, which essentially represents an admission of overpriced domestic markets, then what justifies significantly higher markets from current levels?

And in my reading of the BSP’s tea leaves, domestic markets should rise but at a gradual pace to reflect on the “growth process” over the “long run”.

But this hasn’t been anywhere true in the recent past where mania has dominated sentiment.

The BSP doesn’t explain why markets reached levels that “stretched asset valuations” except to point at foreign portfolio flows (which they say has been influenced by the external or US policies).

And similarly in the opposite spectrum, the BSP doesn’t enlighten us why markets “overreacted to some extent” except to sidestep the issue by defending the ‘stretched’ markets with “strong macroeconomic fundamentals”.

Basically the BSP connects FED policies to rising markets, but ironically, sees a relational disconnect from a threat of a reversal of such external factors, banking on so-called strong “macroeconomic fundamentals”.

The BSP, thus, substitutes the causality flow from the FED to domestic macroeconomic fundamentals whenever such factors seemed convenient for them.

Notice that the May selloff hasn’t been limited to the stock market, but across a broad range of Philippine asset markets, which the BSP acknowledges, specifically, domestic treasuries, local currency (Peso) and CDS. Yet if ‘macroeconomic fundamentals” were indeed strong as claimed, then there won’t be ‘overreactions’ on all these markets.

And it would be presumptuous to deem actions of foreign money as irrational, impulsive, finical and ignorant of “macroeconomic fundamentals”, while on the contrary, latently extolling the optimists or the bulls as having the ‘righteous’ or ‘correct’ view.

The BSP also misses that the point that the impact by FED policies, and more importantly, their DOMESTIC policies, has not only influenced the stock market, but other asset prices and the real economy, as well, via credit fueled asset bubbles.

Central banks have become the proverbial 800 lb. gorilla in the room for the interconnected or entwined global financial markets. 

Take the Peso-Euro relationship. The balance sheet of the European Central Bank (ECB) began to contract in mid-2012 (right window[2]), which has extended until last week[3].

On the other hand the balance sheet of the BSP continues to expand over the same period[4]. The result a declining trend of the Peso vis-à-vis the euro (left window[5]).

The Peso-Euro trend essentially validates the wisdom of the great Austrian economist Ludwig von Mises who wrote of how exchange rates are valued[6],

the valuation of a monetary unit depends not on the wealth of a country, but rather on the relationship between the quantity of, and demand for, money

The BSP seem to ignore all these.

And because today’s artificial boom has been depicted as a product of their policies, the BSP thinks that the market’s politically correct direction can only be up up up and away!

Cheering on Unsustainable Growth Models

The BSP cheers on data whose sustainability has been highly questionable.

On the aggregate demand side, the BSP admits that household spending growth has been at a ‘slower pace’.

With slowing household, the biggest weight of the much ballyhooed statistical growth of domestic demand has been in capital formation. This has been attributed to the massive expansion in construction (33.7%) and durable (9.4%) equipment, and in public (45.6%) and private (30.7%) construction[7]

As pointed out in the past, construction and construction related spending has all been financed by a bank deposit financed or credit fueled asset bubbles.

The other factor driving demand has been government demand or public spending.

As I have been pointing out, this supposed growth in demand via government deficit spending means more debt and higher taxes over the future. Frontloading of growth via debt based spending signify as constraints to future growth.

Pardon my appeal to authority, but surprisingly even a local mainstream economist, the former Secretary of Budget and Management under the Estrada administration and current professor at University of the Philippines[8], Benjamin Diokno, acknowledges this.

In a 2010 speech Mr Diokno noted that[9]

Deficit financing leads to lower investment and, in the long run, to lower output and consumption. By borrowing, the government places the burden of lower consumption on future generations. It does this in two ways: future output is lowered as a result of lower investment, and higher deficits now means higher debt servicing thus higher taxes or lower levels of government services in the future.

The above debunks the populist myth which views the Philippine economy as having been driven by a household consumption boom[10].

The aggregate supply side dynamics mirrors almost the same as the above—bank deposit financed credit fueled asset bubbles.

While agriculture has pulled down or weighed on the growth statistics, production side expansion has been largely led by construction (32.5%) and manufacturing (9.7%).

On the service sector side, financial intermediation (13.9%) led the growth, followed by real estate and renting (6.3%) and other services (7.6%)[11].

In short, except for manufacturing, most of the supply side growth has centered on the asset markets (real estate and financial assets).

These booming sectors, which has benefited a concentrated few who has access to the banking system and or on the capital markets, have mostly been financed by a massive growth in credit. Yet this credit boom has fundamentally been anchored on zero bound interest rates policies.

The reemergence of the global bond vigilantes have been threatening to undermine the easy money conditions that undergirds the present growth dynamic, a factor which ironically, the BSP seems to have overlooked, and intuitively or mechanically, apply the cognitive substitution over objections or over concerns on the risks of bubbles with the constant reiteration of: “strong macroeconomic fundamentals”—like an incantation. If I am not mistaken the report noted of this theme 4 times.

And yet the recent market spasms appear to have been a drag on credit growth of these sectors (although they remain elevated).

And as noted last week, the rate of credit growth on financial intermediation, so far the biggest contributor of the services sector, has shriveled to a near standstill (1.45% June 2013)[12]. Financial intermediation represents 9.73% share of the total supply side banking loans last June.

This should translate to a meaningful slowdown for the growth rate of this sector over the next quarter or two.

It remains unclear if the growth in the other sectors will be enough to offset this. But given the declining pace of credit expansion in the general banking sector lending activities, particularly in sectors supporting the asset boom, growth will likely be pared down over the coming quarters.

So far the exception to the current credit inflation slowdown as per June data, has been in mining and quarrying (85.66%), electricity gas and water (13.84%), wholesale and retail trade (15.74%) and government services—administration and defense (17.11%) and social work (47.21%)—however these sectors only comprise 31% of the production side banking loan activities. Half of the 31% share is due to wholesale and retail trade; will growth in trade counterbalance the decline in the rate of growth of financial intermediation?

Interestingly, the BSP does not provide comprehensive data on bank lending except to deal with generalities. And puzzlingly, the BSP report has been absent of charts on the bank loans and money supply aggregates such as M3, which like the banking loans, the latter has been treated superficially. Why?

So far market actions in the Phisix and the Peso appear to be disproving the BSP’s Pollyannaish views.

Asia’s Credit Trap

The financial markets of Asia including the Philippines appear to be ‘decoupling’ from the Western counterparts, particularly the US S&P (SPX) and Germany (DAX) where the latter two has been drifting at near record highs.

Has the nasty side effects of “ultralow rates” where Southeast Asian economies, as Bloomberg’s Asia analyst William Pesek noted[13], “didn’t use the rapid growth of recent years to retool economies” been making them vulnerable to the recent bond market rout?

The appearance of current account surplus, relatively low external debt, and large foreign reserves, doesn’t make the Philippines invulnerable or impervious to bubbles as mainstream experts including local authorities have been peddling.

Japan had all three plus big savings and net foreign investment position[14] or positive Net international investment position (NIIP) or the difference between a country's external financial assets and liabilities[15], yet the Japanese economy suffered from the implosion of the stock market and property bubble in 1990 (red ellipse). 

As legacy of bailouts, pump priming and money printing to contain the bust, Japan’s political economy presently suffers from a Japanese Government Bond (JGB) bubble.

And given the reluctance to reform, the negative demographic trends, and the popular preference of relying on the same failed policies, the incumbent Japan’s government increasingly depends on surviving her political economic system via a Ponzi financing dynamic of borrowing to finance previously borrowed money (interest and principal) where debt continues to mount on previous debt. Japan’s public debt levels has now reached a milestone the quadrillion yen mark[16], which has been enabled and facilitated again by zero bound rates.

And this strong external façade has not just been a Japan dynamic.

China has currently all of the supposed external strength too, including over $3 trillion of foreign currency reserves, NIIP of US $1.79 trillion (March 2012[17]).

But a recession, if not a full blown crisis from a bursting bubble, presently threatens to engulf the Chinese economy.

As growth of “new” credit sank to a 21 month low where new loans grew by ‘only’ 9% in July and ‘only’ 29.44% y-o-y[18], the Chinese government via her central bank the People’s Bank of China (PBOC) continues to infuse or pump ‘money from thin air’ into the banking system[19]. 

Such actions can be seen as bailouts by the new administration on a heavily leverage system.

Incidentally, debt of China’s listed corporate sector stands at over 3x (EBITDA) earnings before interest, taxes, depreciation and amortization[20]. Notice too that listed companies from major Southeast economies (TH-Thailand, ID-Indonesia, and MY-Malaysia) have likewise built up huge corporate debt/ebitda.

State Owned Enterprises (SoE), their local government contemporaries and their private vehicle offsprings plays a big role in China’s complex political economy. Hence, latent bailouts targeted at these companies have allowed for the ‘kicked the can down the road’ dynamic. China recently announced a railroad stimulus[21], again benefiting politically connected enterprises.

I cast a doubt on the recent reported 5.1% surge in in export growth[22] considering her recent propensity to hide, delete or censor data[23]. These claims would have to be matched by declared activities of their trading partners. Nonetheless, eventually markets will sort out the truth from propaganda.

The point is that Asian economies have become increasingly entrenched in debt dynamics in the same way the debt has plagued their western contemporaries.

And the deepening dependence on debt as economic growth paradigm puts the Asian region on a more fragile position.

Asia is in a ‘credit trap’ according to HSBC’s economist Frederic Neumann[24]. Asian economies have traded off productivity growth for the credit driven growth paradigm, where Asian economies have “become increasingly desensitized to credit”. Yet lower productivity growth will mean increasing real debt burdens.

And if the bond vigilantes will continue to assert their presence on the global bond markets, then ‘strong macroeconomic fundamentals” will be put to a severe reality based stress test.

And the validity of strong macroeconomic fundamentals will also be revealed on charts.

Risk remains high.

---

[1] Bangko Sentral ng Pilipinas Inflation Report, Second Quarter 2013, BSP.gov.ph p. 37-41

[2] JP Morgan Asset Management Weekly strategy report – 28 January 2013

[3] Reuters.com ECB balance sheet shrinks to 2.391 trillion euros, August 6, 2013

[4] see Phisix: BSP’s Tetangco Catches Taper Talk Fever July 29, 2013

[5] Yahoo Finance PHP/EUR (PHPEUR=X)

[6] Ludwig von Mises Trend of Depreciation STABILIZATION OF THE MONETARY UNIT—FROM THE VIEWPOINT OF THEORY On the Manipulation of Money and Credit p 25 Mises.org

[7] BSP op. cit., p.9-10

[8] Wikipedia.org Benjamin Diokno

[9] Benjamin Diokno Deficits, financing, and public debt UP School of Economics.

[10] see Phisix: The Myth of the Consumer ‘Dream’ Economy July 22, 2013

[11] BSP op. cit., p.19

[12] see Phisix: The Impact of Slowing Banking Loans August 5, 2013

[13] William Pesek Specter of Another Bond Crash Spooks Asia, June 7, 2013

[14] Bank of Japan Japan's International Investment Position at Year-End 2012, May 31, 2013

[15] Wikipedia.org Net international investment position

[16] see Japan’s Ponzi Finance: Public Debt Tops Quadrillion Yen Mark! August 10, 2013

[17] China Daily China's intl investment position reaches $1.8t July 14, 2012

[18] Bloomberg.com China’s Credit Expansion Slows as Li Curbs Shadow Banking August 10, 2013

[19] China Daily China central bank continues liquidity injection August 6, 2013

[20] Businessinsider.com 17 Reasons Why Experts Are Convinced China's Economy Is Doomed, July 15, 2013

[21] see China’s Railroad Stimulus is now Official: It’s an $85 billion boondoggle July 25, 2013

[22] Bloomberg.com China Trade Rebounds in Further Sign Economy Stabilizing August 8, 2013

[23] see China’s Government Hides, Deletes and Censors Economic Data, July 5, 2013

[24] AsianInvestor.net Asia in a credit trap, warns HSBC's Neumann August 8, 2013