Quote of the Day: Monetary policy is contributing to risk taking...is unsustainable and will collapse on itself

I think monetary policy is contributing to risk taking. The whole point of zero interest rates is to force borrowers and lenders out on the risk curve. So, if you are a bank and you can't make your cost of capital if you are holding a lot of government securities or highly-rated corporate debt, you go out on the risk curve to get a higher rate of return and that is what we are seeing now.

So, we're seeing banks that traditionally held large quantities of high quality debt dramatically reduce those holdings. They are holding less liquid, riskier assets, which in and of itself creates problems. One is because they have more risk – the risk of credit losses is greater. The other is that the market may need liquidity if we have a lot of volatility in the fixed income markets as the Fed moves to raise interest rates. The traditional providers of liquidity are not there anymore and that creates instability in the system.

And, then, unfortunately, you are seeing households taking on more debt now, too. They are borrowing more. Their rising debt levels are outstripping their meager income gains. That always raises a red flag: when income gains are insufficient to support repayment of that debt, that’s when you start having instability build in the system. That’s what we saw prior to the crisis: when real wages were flat, mortgage debt was increasing dramatically. That is unsustainable. At some point it collapses on itself. I think we are still some ways away from that happening, but nonetheless you see that trend is again at play.

(bold mine)

This excerpt is from an interview of Sheila Blair—Senior Advisor, Pew Charitable Trusts and Chairman, Systemic Risk Council; former Chairman, Federal Deposit Insurance Corporation; former Assistant Secretary of the Treasury for Financial Institutions; former Commissioner of the Commodity Futures Trading Corporation; and former Counsel, Senate Majority Leader Robert Dole—at Professors Stephen Cecchetti and Kermit Schoenholtz’s Money and Banking

More Central Bank Panic: Bank Of England Warns of Elevated Risks to Financial Stability, Four More Central Banks Cut Rates Last Week!

Global central banks and governments remain in a state of panic. That’s if we account for their actions and statements over economic and financial conditions.

Last year, issuance of mostly ‘sanitized’ warnings had been the fad.

This year has been marked by policy actions, particularly a wave of easing measures of mostly interest rate cuts from different central banks.

Yet warnings has not diminished. 

Add to the alarm sirens recently rang by the US Treasury’s Office of Financial Research, the Bank of England (BoE) has just jumped on the bandwagon of declaring heightened risks of financial instability.

From the Wall Street Journal’s Real Time Economic Blog: (bold mine)

The Bank of England said Thursday that risks to the stability of the U.K. financial system remain elevated, citing threats ranging from Greece’s debt troubles to diverging central-bank policies.

The BOE’s Financial Policy Committee, which safeguards the stability of the financial system, made no new policy recommendations at its quarterly meeting that ended March 24, the BOE said Thursday.

But the panel highlighted a slate of issues in the world economy and global financial system that it is monitoring closely.

Among officials’ top concerns is the risk that participants in financial markets are too sanguine about their ability to quickly sell assets if economic news sours, a fragility the BOE has been highlighting for some time.

This drying-up of market liquidity risks heightening volatility in financial markets and could undermine financial-sector stability, the panel said.

The committee instructed BOE staff and U.K. regulators to work together to get a better grasp of which markets may be especially vulnerable and to find out what strategies asset managers have in place to manage their liquidity needs. It asked officials to prepare an interim report on the risks surrounding market liquidity by June and a full report by September.

The panel also highlighted potential risks to the financial system from a slowdown in the Chinese economy and from the U.K.’s yawning current account deficit, which has widened to around 6% of annual gross domestic product.

And officials said they are monitoring lending standards closely, particularly in the leveraged loan market, where banks lend to companies before selling on the debt to investors.

The BoE seem to expect volatility ahead even as market participants haven’t taken various risks into considerations. 

Funny but, in the past government agents used to blind to such risks. It appears that risks have become so brazen that political agents can't ignore them anymore. Ironically, the same agents continue to apply the same measures which has spawned the current imbalances. 

Current policies as I have been saying represent: “Yes I recognize the problem of addiction but a withdrawal syndrome would even be more cataclysmic”.


So current warnings seem like escape clauses designed to exonerate them when risks transforms into reality.

Oh by the way, after my post on Russia and Serbia’s interest rate cuts, rate cuts by Sweden, Pakistan and Hungary adds to a total of 9 interest rate cut by global central banks this month and 27th for the year.

(table from CBrates.com)

If we add Sierre Leone which also cut rates last week, this makes for the 10th and 28th respectively.

Here is Central Bank News on Sierra Leone’s action: (bold mine)

Sierra Leone’s central bank cut its monetary policy rate (MPR) by 50 basis points to 9.50 percent to promote private sector credit growth in an effort to stimulate economic activity against a backdrop of a challenging environment created by the twin shocks of Ebola and the collapse of international commodity prices, particularly iron ore.

Measures against twin shocks and collapse. Nice.

Well again that’s only the interest rate segment. There are many more non interest rates easing actions that have not been included in the above tabulations.

Yet all these point to global central banks deploying crisis resolution measures on a massive scale even without a crisis yet.

So while stock markets have been euphoric, governments have been panicking. Two different agents moving in different directions. Obviously one will be wrong here.

Yet it’s a wonder what tools will be left for global central banks, since they have munificently used them, when the real thing appears.

Governments in a Panic Mode: India and Poland Cut Rates as China’s Lowers GDP Growth Targets to 7%!

A few days back I wrote about the divergence between central bank actions and record stocks

Record high stocks have spawned an ocean of misimpression that such dynamic has been about G-R-O-W-T-H and the ebbing of risk.

But on the other hand, the rush to ease by many central banks extrapolate that these monetary institutions have seemingly been in a panic mode. Insufficient G-R-O-W-T-H has been exposing credit risks that have only been pressuring central banks to lower the cost of servicing debt through policies.

Two different responses to divergent perceptions.

Yesterday India’s central bank unexpectedly cut interest rates for the second time this year.

From the Wall Street Journal

RBI governor Raghuram Rajan explained his decision to cut rates ahead of the central bank’s next scheduled monetary-policy meeting in April, saying: “The still-weak state of certain sectors of the economy as well as the global trend toward easing suggest that any policy action should be anticipatory.”

With its latest move, the RBI joined a dozen central banks, from Singapore to Switzerland, which have cut rates since January to stimulate economic growth and stave off deflation. The People’s Bank of China lowered rates Saturday for the second time in less than four months.

But jumping on the easy-money bandwagon carries risks for India and other emerging markets. If the U.S. Federal Reserve starts tightening, developing economies could face large capital outflows…

Mr. Rajan said he moved in part because “disinflation is evolving along the path set out by the Reserve Bank in January 2014 and, in fact, at a faster pace than earlier envisaged.”

Ah disinflation, euphemism for deflation risk. Too much debt which leads to depressed economic activities that subsequently heightens credit risk.

As I previously said, central bank creed of the euthanasia of the rentier will dominate the sphere of monetary policy making. This will be complimented by political pressures, social desirability bias and path dependency.

Last night Poland also jumped into the easing bandwagon.

From Reuters:

Poland ended its monetary-easing cycle on Wednesday with a deeper-than-expected rate cut intended to curb deflation and prevent excessive zloty gains as the euro zone begins a massive stimulus programme.

The central bank's Monetary Policy Council cut the benchmark rate 50 basis points to 1.50 percent, a record low. Most analysts polled by Reuters had expected a 25-basis-point reduction.

The zloty weakened after the decision, then reversed losses and gained up to 0.9 percent after the bank said its easing cycle was over.

"There is never a situation that the promise of the MPC in any country is carved in stone," Governor Marek Belka said. "But taking into account the current economic situation ... I cannot see room for further rate cuts and expectations thereof."

Belka said the European Central Bank's bond-buying programme was one factor leading to the reduction.

"If a major currency ... is a subject to a quantitative easing at a significant scale, then one can expect appreciation pressure at currencies surrounding the euro," he said at a conference following the decision.

Same dynamics with India but with an added dimension. One intervention begets another intervention. The snowballing rate of interventions will bring about unintended consequences such as swelling rate of government securities having negative yields and record stocks.

By the way, India and Poland’s actions accounts for 20 central banks cutting rates (Central Bank Rates). And this is aside from other easing measures, lowering reserve requirements, QE and etc…

So financial markets continues to rise even as real economic fundamentals deteriorate from which central banks respond to with amplified easing

And as proof of worsening of economic conditions, the Chinese government just announced a lowering of economic growth targets to 7%

From the Wall Street Journal:

China lowered its economic growth forecast to about 7% this year at the opening of the country’s biggest political event of the year, ushering in what leaders have dubbed a “new normal” of slower growth in the world’s second-largest economy.

Premier Li Keqiang ’s speech on the economy opened the National People’s Congress, China’s annual legislative session. Last year’s goal was “about 7.5%” though when actual growth came in at 7.4%—the slowest in more than two decades—officials disputed that it represented a miss…

In recent weeks, Beijing has unveiled increasingly dramatic moves to spur bank lending in a bid to rekindle economic momentum. But such moves could set back its efforts to shift away from excessive reliance on exports, a bloated property market and government spending.

What strategy Chinese leaders pick matters on a global level. A plan that emphasizes short-term growth could give a boost to a world economy suffering from Europe’s malaise and an unsteady recovery in the U.S., but it could also raise questions about China’s long-term role as a global economic growth engine.

At home, leaders face pressure for more action. Many businesses say they don’t want to borrow or expand given weak demand. Smaller companies that do say banks are holding back credit because of worries about bad loans.

The trajectory of declining economic growth rate aligns with the hissing credit and property bubble trends. And symptoms of balance sheet problems have been apparent; as noted above, businesses don't want to borrow or expand due to weak demand. You can lead the horse to the water but you can't make it drink. And for those who do, banks are withholding access to credit for the same reasons: balance sheet problems...worries about bad loans. 

As I recently noted, if the US experience should serve as a paragon, China could be consumed by a recession in mid 2016. Yet domestic and international policy actions could play a wild card, they could either buy time or even accelerate the process.

Going back to central bank actions. Harvard economist and former chairman of the Council of Economic Advisers under ex-US president Ronald Reagan, Martin Feldstein, explains at the Project Syndicate why central bank easing to combat deflation signifies a 'bogeyman'. For now, this unsustainable arrangement has camouflaged a massive build up of systemic risks.

Why, then, are so many central bankers so worried about low inflation rates?

One possible explanation is that they are concerned about the loss of credibility implied by setting an inflation target of 2% and then failing to come close to it year after year. Another possibility is that the world's major central banks are actually more concerned about real growth and employment, and are using low inflation rates as an excuse to maintain exceptionally generous monetary conditions. And yet a third explanation is that central bankers want to keep interest rates low in order to reduce the budget cost of large government debts.

None of this might matter were it not for the fact that extremely low interest rates have fueled increased risk-taking by borrowers and yield-hungry lenders. The result has been a massive mispricing of financial assets. And that has created a growing risk of serious adverse effects on the real economy when monetary policy normalizes and asset prices correct.

Again, two different responses to divergent perceptions.

Central Bank Easing and Record Stocks: Two different responses to divergent perceptions

There are about 20 national central banks that just eased via cut rates (17), lower reserve requirements, QEs et. al.

Just to be make clear what the streak of central bank rates have been about, I posted below some of the news covering these actions

[all bold mine]

India (January 2015)

From BBC

The RBI cited a "sharper-than-expected decline" in the price of fruits and vegetables since September last year as one reason for the policy shift.

It also said "ebbing price pressures in respect of cereals and the large fall in international commodity prices, particularly crude oil" had played a part in the move.

The RBI has been under pressure from government and businesses to reduce its interest rate to give the struggling economy a boost.

China (February 2015)

Reuters:

China's central bank made a system-wide cut to bank reserve requirements on Wednesday, the first time it has done so in over two years, to unleash a fresh flood of liquidity to fight off economic slowdown and looming deflation.

The announcement cuts reserve requirements - the amount of cash banks must hold back from lending - to 19.5 percent for big banks, a reduction of 50 basis points that would free up 600 billion yuan ($96 billion) or more held in reserve at Chinese banks - which could then inject 2-3 trillion yuan into the economy after accounting for the multiplying effect of loans.

Indonesia (February 2015)

Bloomberg:

The country’s economy shrank last quarter from the previous three months, capping the weakest year since at least the global financial crisis on falling commodity prices and cooling investment. Policy makers are cutting borrowing costs before potential interest-rate increases in the U.S. this year raise the risk of fund outflows from emerging markets….

“The policy is in line with efforts by Bank Indonesia to manage the deficit in the current account toward a healthier level,” the central bank said in its statement. “The recovery of the global economy is expected to still be ongoing, although uneven.”

Russia (January 2015)

New York Times:

The rate cut suggested that Russia viewed the banking troubles as a more pressing worry than the high inflation caused by the declining value of the ruble. Inflation is now about 13 percent.

“Today’s decision,” said Elvira Nabiullina, the governor of the Bank of Russia, “is intended to balance the goal of curbing inflation and restore economic growth.”

Russia is fighting a swirl of forces. The oil-dependent economy has been battered by the low price of crude, which is down more than 50 percent since this summer. Western sanctions over the Ukraine crisis only complicate matters, particularly for Russia’s banks. The economy is expected to fall into recession this year.

Israel (February 2015)

Bloomberg:

The Bank of Israel is pushing rates toward zero and considering alternative tools as it seeks to revive an economy growing at the slowest pace for five years, and halt the decline in consumer prices. Last year’s growth rate of 2.9 percent was the weakest since 2009, and the country has experienced several months of deflation, with consumer prices falling 0.5 percent in 12 months through January.

The rate cut “is a preventative measure meant to avoid a slide into a deflationary reality,” Yaniv Pagot, chief strategist at Ayalon Group Ltd. in Ramat Gan, said by phone. “Quantitative easing steps in the not so distant future cannot be discounted.”

Turkey (February 2015)

Bloomberg:

Prime Minister Ahmet Davutoglu said the reduction should have been bigger, extending the feud between the country’s politicians and technocrats that has unnerved investors.

The bank in Ankara reduced its benchmark one-week repo and overnight borrowing rates by 25 basis points each on Tuesday, to 7.50 percent and 7.25 percent respectively. It trimmed the overnight lending rate by 50 basis points to 10.75 percent, according to a statement on its website. Analysts had forecast cuts to all three rates, according to Bloomberg surveys.

The government has persistently called for Basci to lower borrowing costs to boost economic growth since the bank more than doubled the main rate in an emergency meeting in January last year, to halt a run on the currency. Basci has so far only partially unwound that increase, saying that a cautious policy stance is necessary until there is a marked improvement in the inflation outlook.

Denmark (February 2015)

Wall Street Journal

Denmark’s central bank scrambled to defend its currency peg Thursday, cutting its benchmark interest rate for the fourth time in less than three weeks.

The krone’s peg to the euro has been under strain since the European Central Bank announced a large-scale bond-buying program in January, sending the shared currency spiraling downward.

Singapore

Bloomberg/Bangkok Post

"Since the last Monetary Policy Statement in October, developments in the global and domestic inflation environment have led to a significant shift in Singapore's CPI inflation outlook for 2015," the MAS said. "MAS has assessed that it is appropriate to adjust the prevailing monetary policy stance."

The central bank guides the local dollar against a basket of currencies within an undisclosed band and adjusts the pace of appreciation or depreciation by changing the slope, width and centre of the band. Singapore's consumer prices fell for a second straight month in December.

Singapore will keep a "modest and gradual appreciation" in its currency policy band, the central bank said. It made no change to the width and level at which it is cantered.

"This measured adjustment to the policy stance is consistent with the more benign inflation outlook in 2015 and appropriate for ensuring medium-term price stability in the economy," the MAS said.

Has the above easing measures been about responses to ‘strong’ economic growth or to ‘slowing’ economic growth? 

Has the above easing measures been about responses to the risk of inflation (defined by media as rising consumer prices) or deflation (falling consumer prices)?

Record high stocks have spawned an ocean of misimpression that such dynamic has been about G-R-O-W-T-H and the ebbing of risk. 

But on the other hand, the rush to ease by many central banks extrapolate that these monetary institutions have seemingly been in a panic mode. Insufficient G-R-O-W-T-H has been exposing credit risks that have only been pressuring central banks to lower the cost of servicing debt through policies.

Two different responses to divergent perceptions.

Remember that the global central banks has largely been on an easing trend since 2008. And like narcotics, financial markets have become totally addicted to it.

Yet global debt has swelled by $57 trillion from 2007 to reach 286% of the global GDP in 2Q 2014 based on estimates by McKinsey Quarterly. The mainstream belief has been that debt is a free lunch

So one of this divergent perceptions will be proven wrong. Perhaps soon.

Example of Speculation Gone Wild: CYNK Technology

Here is an example of central bank induced speculation gone wild.

From Daily Reckoning’s Peter Coyne on “How to Make 35,966% in 56 Days” (link unavailable) [bold mine]

You would've had to buy about 17,000 shares of a company on the Pink Sheets called CYNK Technology for $1,000. You could've done that when it was trading for just 6 cents on May 15.

Then, prophetically, on July 10 -- you would've sold your shares when the stock was trading at $21.64, turning your original $1,000 into $359,600.

After that, you could've gone and bought your brand-new Bentley coupe (or whatever) and still have had more than $100,000 to play around with. Not too shabby…

Of course, hindsight is 50/50.

In reality, on May 15, you wouldn't have been able to distinguish a share of CYNK from a used tissue or crumpled candy bar wrapper. Yet in the past three weeks, the Belize-based penny stock has rallied higher than Apple rallied over all 34 years of its life as a public company.

What does CYNK do to justify it?

Something unclear dealing with social media -- a website called Infobiz. No matter, popular delusion and the madness of crowds brought the company's market cap to $4 billion.

Now all that's left is for Facebook to buy it up for two or three times that.

Now the kicker…

After all, CYNK is the ideal growth acquisition.

It has no revenue… no physical location… and no working phone numbers. It doesn't even have employees. Potential for growth doesn't get much better than that. And for $4 billion?

Anyways, even if you were foolish and lucky enough to buy shares ahead of their herculean run-up… you'd have to time your exit perfectly too.

$4 billion for nothing, Yikes!!!!

The US government steps in...

For example, if you have held until just one day after its peak on July 10 -- you wouldn't have been able to sell your shares, because the SEC suspended trading on Friday.

Why?

Because something -- and no one really knows what yet -- appears out of the ordinary to the SEC. Some people say it's a pump-and-dump scam… others say it's simply a short squeeze.

We don't know which it is… because we're too busy cracking up.

This hasn't just been a one issue affair.  The small cap Russell 2000 with trailing PERs at 78.06 (July 11 2014) is an example of widespread speculation madness.

 

This exhibits that by the temporary elimination or deferral of risks via the magical spell from central bank put, market participants have been transformed into mindless, market zombies going for one way trade gambits.

And this also shows how central bank hocus focus has mangled price discovery where in the frantic chase for yield, traditional "fundamentals" have become like dinosaurs--fossils. 

Such are symptoms of how central banks have essentially destroyed the essence of capital markets in order to put up a Potemkin economy.

No bubble?

Bernanke’s Dogma in Action: Global Central Banks Secretly Acquired $29 trillion of Equities!

Recently I wrote, “when Ben Bernanke, yet as a university professor wrote a “smart central bank can protect the economy and the financial sector from the nastier side effects of a stock market collapse”, which became a social policy, popularly known as the Bernanke/Greenspan PUT, this translates to an implicit subsidy to equity market owners, financed by the ordinary citizens.” 

Such dogma, which turned out as real social policies, became much more than just about manipulating yield curves via zero bound rates and asset purchases on bonds and mortgages, central banks have stealthily made $29 trillion of direct interventions in the stock markets 

From the Financial Times (hat tip Zero Hedge) [bold mine]

Central banks around the world, including China’s, have shifted decisively into investing in equities as low interest rates have hit their revenues, according to a global study of 400 public sector institutions.

“A cluster of central banking investors has become major players on world equity markets,” says a report to be published this week by the Official Monetary and Financial Institutions Forum (Omfif), a central bank research and advisory group. The trend “could potentially contribute to overheated asset prices”, it warns.

Central banks are traditionally conservative and secretive managers of official reserves. Although scant details are available of their holdings Omfif’s first “Global Public Investor” survey points out they have lost revenues in recent years as a result of low interest rates – which they slashed in response to the global financial crisis.

The report, seen by the Financial Times, identifies $29.1tn in market investments, including gold, held by 400 public sector institutions in 162 countries.

Who has been buying? Some clues from the FT:

A chapter in the report on Chinese foreign investment trends argues Safe’s interest in Europe is “partly strategic” because it “counters the monopoly power of the dollar” and reflects Beijing’s global financial ambitions.

In Europe, the Swiss and Danish central banks are among those investing in equities. The Swiss National Bank has an equity quota of about 15 per cent. Omfif quotes Thomas Jordan, SNB’s chairman, as saying: “We are now invested in large, mid- and small-cap stocks in developed markets worldwide.” The Danish central bank’s equity portfolio was worth about $500m at the end of last year.

Overall, the Omfif report says “global public investors” have increased investments in publicly quoted equities “by at least $1tn in recent years” – without saying from what level, or how the figure is split between central banks and other public sector investors such as sovereign wealth funds and pension funds.

At what costs does this interventions come with?

Growth in countries’ official reserves has increased fears about potential risks to global financial stability. In a contribution to the Omfif report, Ted Truman, a senior fellow at the Peterson Institute for International Economics, writes: “Reforms are urgently needed to enhance the domestic and international transparency and accountability for this activity – in the interests of a better-functioning world economy.”

He adds: “Changes, real or rumoured, in the asset or currency composition of foreign exchange reserves have the potential to destabilise exchange rate and financial markets.”

Central banks around the world have foregone between $200bn and $250bn in interest income as a result of the fall in bond yields in recent years, Omfif calculates, without giving details. “This has been partly offset by reduced payments of interest on the liabilities side of the balance sheets,” it adds.

The same equity market interventions can be seen in the Philippines mostly coursed through government pension funds.

Oh by the way here is one unintended cost, in Europe, equity valuations have been stretched to a decade high

From Bloomberg:

The two-year rally that has restored more than $4 trillion to European share prices is sending equity valuations to levels not seen in a decade just as investors turn away from record low bond yields.

Gains have pushed the StoxxEurope 600 Index to 17.5 times annual earnings, the highest since 2002, data compiled by Bloomberg show…

The advance in the Stoxx 600 since June 2012 has pushed the gauge up 48 percent and sent its price-earnings ratio 26 percent above its decade average relative to reported earnings, according to Bloomberg data.

Through repeated central bank interventions which function as guarantees, the mainstream have become deeply addicted to the magic wand of inflationism which they believe can boost stocks (and DEBT) forever. They hardly realize that central bank actions has unintended social-economic and political consequences that will ultimately backfire.

The thought provoking question is: what happens to central bank balance sheets when the current stock market boom turns into bust?  A follow through question is what happens to the currencies supporting these inflated balance sheets? Interesting.

World Millionaires Parties on Central Bank Policies

I am not a fan of the political correct issue called “inequality”, whereby populist politics calls for political solution to redistribute wealth in order to make economic standings “equal”. 

This inequality issue for me is really nonsense. Simple reasons, there is no such thing as “equal” (e.g. even public schools’ rating of students have ranks). Second, political ways of solving inequality extrapolates to a shift in inequality from the markets to politics or from market inequality to political inequality. Wealth (or resource distribution) will be skewed towards those whom political patrons anoint as beneficiaries. So when you hear "it is not what you know but who you know", those are signs of politically based inequality.

For instance when Ben Bernanke, yet as a university professor wrote a “smart central bank can protect the economy and the financial sector from the nastier side effects of a stock market collapse”, which became a social policy, popularly known as the Bernanke/Greenspan PUT, this translates to an implicit subsidy to equity market owners, financed by the ordinary citizens. 

And since global central banks have embraced and assimilated US Federal Reserves’ policies of ZIRP and QEs that has inflated asset markets, these has increased “wealth” of mainly of equity (as well as other asset) owners around the world.

From the Wall Street Journal Real Time Economic Blog

Overall, the world’s wealth grew by 15% to $152 trillion, led by a 31% jump among countries in the Asia-Pacific region (excluding Japan) to $37 trillion. In North America, the world’s richest region, wealth grew by 16% to $50.3 trillion, thanks largely to strong returns in the stock market.

Globally, the number of millionaire households hit 16.3 million in 2013, a 19% rise from the previous year.

Millionaires in China have reportedly eclipsed Japan to place second behind the US.

The difference has been that growth in the millionaires of Chinese, instead of coming from equity markets, has been mostly a product of shadow banking.

The Chinese saw their portfolios swell as wealth in the country grew by a whopping 49% to $22 trillion last year. The report’s authors attributed that explosive rise to specialized financial products such as trusts — the amount of wealth in trusts rose 82% in 2013 — “reflecting the country’s rapidly expanding shadow-banking sector.”

While booming stock markets fueled wealth growth in many other countries, including the U.S., China’s investors experienced the opposite: Wealth in equities actually fell 6.8% on the year among Chinese.

Notice that inflated assets markets have been the basis of “wealth” which means they are artificial and depends on sustained central bank subsidies. This includes China’s shadow banking system.

And as I pointed out here, in the US booming stocks mostly benefit the elites.

The sad part is that while inflationary boom supports a few, when the bust comes most will get hurt.

In short, central bank policies have both serious externality and inequality issues.

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.

PBOC’s Zhou Admits China May Have Housing Bubble in ‘Some Cities’

Last Sunday I wrote (bold original)

As you can see, bubbles have risen to levels where authorities can’t hide them anymore. Instead of denying them, what they are doing today has been to downplay their risks.

China’s central bank governor has just affirmed my observation.

From the Bloomberg:

China may have a housing bubble only in “some cities,” a issue that’s difficult to resolve with a single nationwide policy, the nation’s central bank Governor Zhou Xiaochuan said.

China is a big country with multiple housing markets, many of which are still drawing new inhabitants from the countryside, Zhou said yesterday in an interview in Kigali, Rwanda, where he was attending the African Development Bank’s annual meeting.

“China is still in the process of urbanization, so there may be some kind of volatility in the supply-demand relationship,” Zhou said. “But if you look at the medium-term of urbanization, I think we still have a very good market for home sectors.”

The downscaling of risks by suggesting that bubbles are local rather than national have been an institutional or conventional response of authorities.

The US experience. 

The Washington Post on outgoing US Fed Chair Alan Greenspan in 2005…

Greenspan has said recently that he sees no national bubble in home prices, but rather "froth" in some local markets. Prices may fall in some areas, he indicated. And he warned in a speech last month that some borrowers and lenders may suffer "significant losses" if cooling house prices make it difficult to repay new types of riskier home loans -- such as interest-only adjustable-rate mortgages.

some fantastic quotes from Ben Bernanke the above video (bold mine)

In 2005

INTERVIEWER: Tell me, what is the worst-case scenario? Sir, we have so many economists coming on our air and saying, "Oh, this is a bubble, and it's going to burst, and this is going to be a real issue for the economy." Some say it could even cause a recession at some point. What is the worst-case scenario, if in fact we were to see prices come down substantially across the country?

(1:05)  BERNANKE: Well, I guess I don't buy your premise. It's a pretty unlikely possibility. We've never had a decline in house prices on a nationwide basis. So what I think is more likely is that house prices will slow, maybe stabilize: might slow consumption spending a bit. I don't think it's going to drive the economy too far from its full employment path, though.

More:

INTERVIEWER: So would you agree with Alan Greenspan's comments recently that we've got some areas of that country that are seeing froth, not necessarily a national situation, but certainly froth in some areas?

(1:34) BERNANKE: You can see some types of speculation: investors turning over condos quickly. Those sorts of things you see in some local areas. I'm hopeful — I'm confident, in fact, that the bank regulators will pay close attention to the kinds of loans that are being made, and make sure that underwriting is done right. But I do think this is mostly a localized problem, and not something that's going to affect the national economy.

When the real estate bubble bust became apparent July 2007

(4:0) BERNANKE: The pace of home sales seems likely to remain sluggish for a time, partly as a result of some tightening in lending standards, and the recent increase in mortgage interest rates. Sales should ultimately be supported by growth in income and employment, as well as by mortgage rates that, despite the recent increase, remain fairly low relative to historical norms. However, even if demand stabilizes as we expect, the pace of construction will probably fall somewhat further, as builders work down the stocks of unsold new homes. Thus, declines in residential construction will likely continue to weigh on economic growth in coming quarters, although the magnitude of the drag on growth should diminish over time. The global economy continues to be strong, supported by solid economic growth abroad. U.S. exports should expand further in coming quarters. Overall, the U.S. economy seems likely to expand at a moderate pace over the second half of 2007, with growth then strengthening a bit in 2008 to a rate close to the economy's underlying trend.

Déjà vu?

The PBoC, the US Federal Reserve, or even the Bangko Sentral ng Pilipinas all speak of the same language. It’s the language of statistical smokescreens, blanket deniability, blindness, the defense of the status quo, and most importantly, the implied worship of bubbles.

Quote of the Day: Tobin’s Bathtub Economics

when it comes to interest rates, Tobin did not teach economics; he lectured about monetary plumbing. Under bathtub economics, the Federal funds rate is a dumb plumbing control—-the pavlovian lever you pull when you want more aggregate demand. But here’s a news flash.  Its actually the smartest thing in the financial firmament—that is, its the price of hot money. 

Indeed, its the most important single price in all of capitalism because it regulates the protean and  combustible force of speculation—that is, the deeply embedded human instinct to chase something for nothing if given half the chance. Accordingly, the very last lever the Fed should toy with is the price of money;  and the very last economic precinct it should try to “stimulate” is the money markets of Wall Street. That’s where the demons and furies of short-run, lightening fast financial speculation lurk, work and mount their momentum trading campaigns—ripping, dipping and re-ripping as they go.

Stated differently, the Federal funds rate is the price of trading risk—the regulator that drives the carry trades. It is the mechanism by which credit is expanded in the Wall Street gambling channel through the process of re-hypothecation.  When the funds rate is ultra low for ultra long it massively expands the carry trades. That is, any financial asset with a yield or short-run appreciation potential gets leveraged one way or another through repo, options or structured trades—- because re-hypothecation produces a large profit spread from a tiny sliver of equity.

Needless to say, the massive carry trades minted in the Fed’s Wall Street gambling channel are a deep and dangerous deformation of capitalism. In money markets that are not pegged by the central banking branch of the state, outbreaks of fevered speculation drive short-term market rates skyward in order to induce more true savings from the market or choke off demand for funds. The money market rate is therefore the economic cop which keeps the casino in check.

Accordingly, the carry trade profit spread can go from positive to negative quickly and drastically, meaning that there are always two-way markets in the underlying financial assets. There is no shooting fish in a barrel full of free money. There are no hedge fund hotels where carry-traders can drive in-the-money strike prices higher and higher because premiums are dirt cheap.

Needless to say, the Fed’s 30-year encampment in the heart of the money markets has destroyed them; it has turned price discovery into the primitive, computerized act of red-green-and-orange-lining the Fed’s latest meeting statement to see which word, tense or adjective has changed.

At the end of the day, the Fed has been implanted in the money markets for so long that it does not even recognize it own handiwork. The speculative disorders and financial bubbles which are the inherent results of its interest rate pegging are seen as exogenous forces which emanate from almost any place on the planet except the Eccles Building. And even if some ultimate responsibility is acknowledged as to errors inside the great house of monetary central planning it’s always put off to failures on its regulatory and supervisory desks, and always after the fact.

(italics original, bold mine)

This is from David Stockman’s appraisal of Fed Chair Janet Yellen’s latest speech at his Contra Corner.

Oh mind you, this observation applies not only to the US FED but also to contemporary central banking, including the Philippine BSP, where the latter believes blowing bubbles uplifts ‘aggregate demand’ with a cavalcade of 9 months 30+% money supply growth!

Video: Peter Klein on the Fundamental Flaws of Thomas Piketty’s view of Inequality

Professor and Mises Institute’s Executive Director Peter G. Klein exposes on the fundamental flaws of Thomas Piketty’s view of inequality. From the Mises Blog

I’d like to add more...

The above chart is from Picketty’s book. 

Editors of the New York Sun uses Picketty’s chart to expose on a major source of inequality—the fiat money standard—which unfortunately Mr. Piketty fails to account for.

From the Zero Hedge [bold fonts and underline original]

Well, feature the chart that Professor Piketty publishes showing inequality in America. This appears in the book at figure 9.8; a similar version, shown alongside here, is offered on his Web site. It’s an illuminating chart. It shows the share of national income of the top decile of the population. It started the century at a bit above 40% and edged above 45% in the Roaring Twenties. It plunged during the Great Depression and edged down in World War II, and then steadied out, until we get to the 1970s. Something happened then that caused income inequality to start soaring. The top decile's share of income went from something like 33% in 1971 to above 47% by 2010. 

Hmmm. What could account for that? Could it be the last broadcast of the “Lawrence Welk Show?” Or the blast off of the Apollo 14 mission to the Moon? Or could it have something to do with the mysterious D.B. Cooper, who bailed out of the plane he hijacked, never to be seen again? A timeline of 1971 offers so many possibilities. But, say, what about the possibility that it was in the middle of 1971, in August, that America closed the gold window at which it was supposed to redeem in specie dollars presented by foreign central banks. That was the default that ended the era of the Bretton Woods monetary system.

That’s the default that opened the age of fiat money. Or the era that President Nixon supposedly summed up in with Milton Friedman’s immortal words, “We’re all Keynesians now.” This is an age that has seen a sharp change in unemployment patterns. Before this date, unemployment was, by today’s standards, low. This was a pattern that held in Europe (these columns wrote about it in “George Soros’ Two Cents”) and in America (“Yellen’s Missing Jobs”). From 1947 to 1971, unemployment in America ran at the average rate of 4.7%; since 1971 the average unemployment rate has averaged 6.4%. Could this have been a factor in the soaring income inequality that also emerged in the age of fiat money? 

This is the question the liberals don’t want to discuss, even acknowledge…

The New York Sun’s conclusion

There is an irony here for Monsieur Piketty. It was France who gave us Jacques Rueff, the economist who had the clearest comprehension of the importance of sound money based on gold specie. He was, among other things, an adviser of Charles De Gaulle. It was De Gaulle who in 1965, called a thousand newspapermen together and spoke of the importance of gold as the central element of an international monetary system that would put large and small, rich and poor nations on the same plane. We ran the complete text of Professor Piketty’s book “Capital” through the Sun’s own “Electrically-operated Savvy Sifter” and were unable to find, even once, the name of Rueff.

The same kind of inequality induced by central banking fiat money bubble blowing policies plagues the Philippines.

It’s funny how the statist mindset works.

Step 1. Statists adapt bubble blowing policies. But when a bust surfaces, they blame capitalism for various societal ills such as “inequality” (straw man). This leads to Step two:  calls for more financial repression via inflationism and taxes which leads back to Step 1.

So the statist logic has all been about circularity or doing the same thing over and over again and expecting different results. Some people call this insanity.

Central Bankers are the Real Centers of Political Power

Central bankers have already been portrayed or regarded by media as superheroes.

In the modern economy, which operates on fiat money based fractional reserve banking system, central bankers have served as the proverbial power behind the throne. 

Such dynamic has especially been reinforced in the post 2007 crisis landscape, where monetary policies via asset purchasing program has encroached on the fiscal space (Hussman 2010)

Sovereign Man’s prolific Simon Black explains why central bankers, led by the US Federal Reserve, have been in command of the US political economy since 1971: (bold mine)

Check out this chart below. It’s a graph of total US tax revenue as a percentage of the money supply, since 1900.

For example, in 1928, at the peak of the Roaring 20s, US money supply (M2) was $46.4 billion. That same year, the US government took in $3.9 billion in tax revenue.

So in 1928, tax revenue was 8.4% of the money supply.

In contrast, at the height of World War II in 1944, US tax revenue had increased to $42.4 billion. But money supply had also grown substantially, to $106.8 billion.

So in 1944, tax revenue was 39.74% of money supply.

You can see from this chart that over the last 113 years, tax revenue as a percentage of the nation’s money supply has swung wildly, from as little as 3.65% to over 40%.

But something interesting happened in the 1970s.

1971 was a bifurcation point, and this model went from chaotic to stable. Since 1971, in fact, US tax revenue as a percentage of money supply has been almost a constant, steady 20%.

You can see this graphically below as we zoom in on the period from 1971 through 2013– the trend line is very flat.

What does this mean? Remember– 1971 was the year that Richard Nixon severed the dollar’s convertibility to gold once and for all.

And in doing so, he handed unchecked, unrestrained, total control of the money supply to the Federal Reserve.

That’s what makes this data so interesting.

Prior to 1971, there was ZERO correlation between US tax revenue and money supply. Yet almost immediately after they handed the last bit of monetary control to the Federal Reserve, suddenly a very tight correlation emerged.

Furthermore, since 1971, marginal tax rates and tax brackets have been all over the board.

In the 70s, for example, the highest marginal tax was a whopping 70%. In the 80s it dropped to 28%.

And yet, the entire time, total US tax revenue has remained very tightly correlated to the money supply.

The conclusion is simple: People think they’re living in some kind of democratic republic. But the politicians they elect have zero control.

It doesn’t matter who you elect, what the politicians do, or how high/low they set tax rates. They could tax the rich. They could destroy the middle class. It doesn’t matter.

The fiscal revenues in the Land of the Free rest exclusively in the hands of a tiny banking elite. Everything else is just an illusion to conceal the truth… and make people think that they’re in control.

Money, which represents half of almost every transactions made every day, has been in the control of a few unelected technocrats who have the capacity to run society aground.

Said differently centralization of money equates to a top-down dynamic of risk distribution in terms of money thereby making risks systemic, e.g. boom bust cycles, stagflation and hyperinflation

Unknown to many, central planning and control of money represents one of the 10 planks of the communist manifesto:

5. Centralization of credit in the hands of the state, by means of a national bank with state capital and an exclusive monopoly.

It's an oxymoron for the public, who supposedly oppose communism, to adhere to one of communism's major creed. 

Yet the rapidly expanding role by central banks applied today will lead to a train wreck. As Austrian economist Thorsten Polleit warns:

Central banks will become the real centers of political power. You could even say they are on the way to assuming the role of a “Politburo.” Central banks will effectively decide who is going to get credit at what conditions. They will decide which governments, which banks, and which kind of business sectors and companies will flourish or go under. The truth is that if the fiat money regime is not brought to an end — either by political will or by economic collapse — the economies will end up in a kind of socialist-totalitarian dead-end. But I tend to be optimistic: namely, that the fiat money scheme will break down before such a situation is reached.