Mounting Global Financial Instability, The UK Pension Industry Bailout; Entrenching Forces of Inflation

 Mounting Global Financial Instability, The UK Pension Industry Bailout; Entrenching Forces of Inflation 

 

The speed of the plunging currencies of China, Japan, and Europe (or the surging USD) makes the world vulnerable to a sudden stop and subsequently, a crisis. 

 

That was from this author last week.  

 

Are the following recent events the proverbial writing on the wall? (bold added) 

 

Euronews/Reuters, September 21: LONDON -The Bank of England stepped into Britain’s bond market to stem a market rout, pledging to buy around 65 billion pounds ($69 billion) of long-dated gilts after the new government’s tax cut plans triggered the biggest sell-off in decades. Citing potential risks to the stability of the financial system, the BoE also delayed on Wednesday the start of a programme to sell down its 838 billion pounds ($891 billion) of government bond holdings, which had been due to begin next week. “Were dysfunction in this market to continue or worsen, there would be a material risk to UK financial stability,” the BoE said. “This would lead to an unwarranted tightening of financing conditions and a reduction of the flow of credit to the real economy.” 

 

Financial Times, September 29: A pension meltdown forced the Bank of England to intervene in gilt markets on Wednesday. Executives told the Financial Times that markets barely dodged a Lehman-Brothers-like collapse – but this time with your mum’s pension at the centre of the drama. Problems with “pension plumbing” are what caused the mess. The culprit is said to be a popular pension strategy called liability-driven investing, or LDI. Leverage is a key element of many LDI strategies, and are basically a way pension funds can look like they’re an annuity without making the full capital commitment of becoming one.  

As one would note, the developing market tumult starts with malinvestments funded by extensive leveraging, which are all products of the zero-bound rate or "easy money" regime and financial engineering. 

 

In the ten years through 2020, reports have indicated the UK pension industry's liabilities through their exposure to Liability Driven Investing (LDI) hedging strategies have tripled to £1.5 trillion ($1.7TN)!   

  

The industry's massive exposure to fixed income, derivatives, repos, and other forms of securitizations through leveraging made them increasingly fragile to extreme market volatility.  Thus, the sharp drop in bond prices and the sterling forced the industry to face a chain of collateral and margin calls, compelling the frantic and intense liquidations to raise cash! 

  

And with liquidity rapidly drying up, the Bank of England (BoE) attempted to stanch the bleeding with an incredible policy U-turn from the initial plan of Quantitative Tightening (reducing balance sheet) to Quantitative Easing (expansion again)!  Or, to infuse liquidity, it will buy instead of selling bonds.  

 

But there is no free lunch. 

 

Such subsidies have sent the UK's credit default swaps (CDS) to pandemic highs! 

 

And instead of pruning its assets, the BoE's balance sheet will rise further or remain at ALL-Time highs. 

 

And as liquidity in the treasury markets has been swiftly depleting, not only in the UK but in other major European sovereigns, including the US, sooner or later, these nations may also mimic the BoE. 

 

For the same reasons, South Korean authorities have floated to the public its intent to buy bonds. 

 

Xinhua, September 28: South Korea's finance ministry and the central bank said Wednesday that they will buy back government bonds later this week to tackle soaring bond yields. Senior officials from the Ministry of Economy and Finance, the Bank of Korea (BOK) and financial regulators had a meeting to deal with the recent volatility surge in the financial market. The finance ministry decided to buy back 2 trillion won (1.4 billion U.S. dollars) worth of government bonds on Friday, while the BOK will purchase Treasury bonds worth 3 trillion won (2.1 billion dollars) from the market Thursday. (bold added) 

 

So while many central banks may still be hiking, the unfolding events may prompt them to reconsider their present actions.  

 

They may slow or stop rate hikes altogether while reopening the tap of asset purchases for liquidity injections.  

 

Global financial markets have responded violently to the slight trimming of central bank assets of the Fed, ECB and BoJ, indicating the embedded fragility. 

 

And the more chaotic the events, the greater the likelihood that central banks may elect towards a 'pivot.' 

Yet, the other options authorities are likely to impose are a chain of interventions and eventual controls: currency or FX, capital, price and wage, trade, border/mobility, and even people. 

 

Let us cite some recent instances. 

 

The Bank of Japan (BoJ) reportedly exhausted some USD 19.6 billion in September to intervene in the currency market to support its currency, the yen. 

 

In support of the USD-Hong Kong peg, the Bangkok Post and SCMP reported a few days ago that the Hong Kong Monetary Authority intervened "in the market 32 times this year, buying a total of HK$215.035 billion and selling US$27.39 billion amid persistent capital outflows. Its current intervention has surpassed in size measures taken to support the weak Hong Kong dollar during the last interest-rate rise cycle when it bought HKcopy03.48 billion in 2018 and HK$22.13 billion in 2019." 

 

Taiwanese officials initially floated the idea of FX and a ban on short sales. Later, they denied this. 

 

Interventions to prop up domestic currencies have led to substantial declines in the US Treasury holdings of global central banks. 

 

Finally, as the energy crunch sweeps into Europe, member states have already embarked on bailing out consumers and producers. 

 

Yahoo/Bloomberg, September 21: Germany and the UK announced energy bailouts to avoid an economic collapse and take the sting out of soaring prices, with European governments spending 500 billion euros ($496 billion) by one estimate to help consumers and businesses…The bailouts announced in Berlin and London coincide with fresh estimates from the Bruegel think-tank that the total spend by European nations on easing the energy crisis for households and businesses is nearing 500 billion euros. The European Union’s 27 member states have so far earmarked 314 billion, not including other major spending like nationalization plans, it said 

 

Winter is coming, and we can only guess that the bailouts will intensify. 

 

So how will European authorities finance this, given the current climate? 

 

For these reasons, "inflation" would only become structurally embedded as the path-dependent stance of policymakers remains in favor of inflating the system. 

 

And yet one of the immediate backlashes from these bailouts is the developing fissure among member states of the Eurozone. 

 

But even if central banks "pivot," such conditions are unlikely to fuel the return of TINA. 

 

There is much to deal with, but we can't cover them at once. 

Financial Times: The UK economy is a ticking time bomb

Sovereign Man’s Simon Black quotes of the “scathing assessment” by the Financial Times on the UK’s political economy

(bold original)

Despite being an otherwise staid, traditional news service, the professional banking division of the Financial Times recently released an utterly scathing assessment of the British economy.

It was entitled, “The UK economy is a ticking time bomb,” and the editor didn’t pull any punches in completely shattering the conventional fantasy that ‘all is well’, and that advanced economies can simply print and indebt their way to prosperity.

I’ll quote below, emphasis mine:

“What is the problem? Quite simply, the key numbers are terrible. According to the OECD, after five years of ‘austerity’ the UK’s budget deficit is 5.3%, down from 11.2% in 2009.

“In other words, it has gone from being close to meltdown to a situation that is merely dreadful.

“Since the government is spending more than it earns, it is hardly surprising that it is borrowing more, and that the debt-to-GDP has risen from 68.95% in 2009 to 93.30% in 2013, again according to OECD figures.

“As the UK is currently growing it should really be running a budget surplus, providing it with the means to run deficit financing during the next downturn.

“This is one of the tenets of the Keynesian philosophy that underpins a lot of left-of-centre economic thinking.

“Unfortunately Europe’s political parties of all persuasions have bastardised Keynes’ ideas – running deficits in both good and bad times – so as to render them almost meaningless.

“To make matters worse the UK, again similar to most advanced economies, is an ageing society with pension, welfare and healthcare systems that are wrongly structured and financially unsustainable.”

“We can blame the politicians for failing to be honest with the electorate about the challenges ahead.

“Or we could blame the voters who punish at the ballot box any party that tells them anything other than good news and wants to hear that taxes can be cut, spending raised and the budget balanced all at the same time.”

Is a Bust in UK’s Housing Sector in the Near Horizon?

Rising input costs have emerged to hamper on UK’s housing boom

From the Independent: (bold mine)

Rising costs are putting recovery at risk as the building industry comes up against severe skills shortages and soaring material prices, the industry warns today.

Construction – which accounts for around 6 per cent of the total economy – was badly hit by the recession but has seen a rapid expansion in the past year as the Chancellor’s Help to Buy scheme spurs housebuilding activity.

The majority of the building industry expects stronger growth over the next 18 months, according to industry trade bodies, but the cost of tendering work is rising as builders adjust to the new realities of shortages of both materials and skills.

Rising costs are manifestations of the insufficiency of savings and or resources and of the misdirected allocation of capital which has been induced by central bank easy money policies.

The unfolding developments in UK’s housing markets looks like a textbook Austrian Business Cycle phenomenon.

The transition from inflationary boom to deflationary bust as explained by the great dean of the Austrian School of economics, Murray N. Rothbard: (bold mine)

Once the consumers reestablished their desired consumption/investment proportions, it is thus revealed that business had invested too much in capital goods and had underinvested in consumer goods. Business had been seduced by the governmental tampering and artificial lowering of the rate of interest, and acted as if more savings were available to invest than were really there. As soon as the new bank money filtered through the system and the consumers reestablished their old proportions, it became clear that there were not enough savings to buy all the producers' goods, and that business had misinvested the limited savings available. Business had overinvested in capital goods and underinvested in consumer products.

The inflationary boom thus leads to distortions of the pricing and production system. Prices of labor and raw materials in the capital goods industries had been bid up during the boom too high to be profitable once the consumers reassert their old consumption/investment preferences. The "depression" is then seen as the necessary and healthy phase by which the market economy sloughs off and liquidates the unsound, uneconomic investments of the boom, and reestablishes those proportions between consumption and investment that are truly desired by the consumers. The depression is the painful but necessary process by which the free market sloughs off the excesses and errors of the boom and reestablishes the market economy in its function of efficient service to the mass of consumers. Since prices of factors of production have been bid too high in the boom, this means that prices of labor and goods in these capital goods industries must be allowed to fall until proper market relations are resumed.

Well, perhaps signs of depression may have surfaced as UK’s home prices has recently suffered a substantial pullback. The price retrenchment echoes on the 2007-8 crisis.

chart from Zero Hedge

From the Telegraph: (bold mine)

Asking prices have fallen steeply this summer as sellers slash their expectations in the face of dampening demand for new homes.

The price tag on the average UK property coming to market dropped by 2.9pc in the first half of August, the biggest summer fall ever recorded by the UK's largest property website, Rightmove.

Vendors, who have been trying to cash in on record high values, are now discounting to attract buyers who have been deterred by talk of interest rate rises and the eradication of cheap mortgages.

A glut of sellers coming to the market - there has been an 8pc increase in the number of homes up for sale compared with August last year - and a drop in buyer demand has driven down asking prices and tipped the UK into a buyers' market.

As one would notice, UK’s housing woes comes from both the supply side and demand side. If the above isn't an aberration, or if current trends in the housing market will be sustained, then UK's inflationary boom may just have hit the proverbial wall.

On the supply side, rising input cost in the housing sector will squeeze on profits, this will also limit expansion (corporate demand) as well as, expose on the accrued excess supplies that has developed out of the illusory expectations of perpetually strong demand from zero bound rates.

And all of the above will contribute to magnify the leverage problems used to finance the supply side ‘boom’.

On the consumption side, the law of demand—the higher the price, the lower the quantity demanded—has apparently been in motion. The previous uptrend of property prices has apparently reached an invisible critical threshold level that has commenced to impact demand negatively.

Yet for leveraged speculators, falling housing prices will most likely entail credit problems that will prompt for prospective liquidations, thereby compounding on both price and supply pressures in UK's housing bubble.

As one would further note, price distortions from central bank interventions has been fostering misperceptions. Consumers appear to be retrenching via ‘drop in buyer demand’ as against the producers who still ‘expects stronger growth’. 

The growing disparities or widening of gaps in expectations are signs of the consumer's evolving choices or of the consumer's re-establishing of their 'desired consumption/investment proportions'. The realignment of consumer's choices away from the producers will continue to divulge on the current state of accumulated imbalances that can be seen via the housing sector's overinvestment or overconsumption of resources or malinvestments.

Of course, other factors like sanctions against Russia may have also weighed on the UK housing predicament, but such would account for as aggravating circumstance or subsidiary cause.

Has UK’s recent housing downturn signaled the reversal of UK’s inflationary boom and a forthcoming depression? We shall soon see.

Don't worry be happy, stocks are bound to go up forever!