ECB Draghi’s “Do Whatever It Takes” Promise Now a €60 billion a month Reality, Global Stocks Parties

So the widely anticipated ECB Mario Draghi’s “do whatever it takes” promise of Quantitative Easing has become a € 60 billion a month reality beginning March 2015 until September 2016.

From the European Central Bank’s Press Release: (bold mine)

22 January 2015 - ECB announces expanded asset purchase programme:

-ECB expands purchases to include bonds issued by euro area central governments, agencies and European institutions

-Combined monthly asset purchases to amount to €60 billion

-Purchases intended to be carried out until at least September 2016

Programme designed to fulfil price stability mandate

The Governing Council of the European Central Bank (ECB) today announced an expanded asset purchase programme. Aimed at fulfilling the ECB’s price stability mandate, this programme will see the ECB add the purchase of sovereign bonds to its existing private sector asset purchase programmes in order to address the risks of a too prolonged period of low inflation.

The Governing Council took this decision in a situation in which most indicators of actual and expected inflation in the euro area had drifted towards their historical lows. As potential second-round effects on wage and price-setting threatened to adversely affect medium-term price developments, this situation required a forceful monetary policy response.

Asset purchases provide monetary stimulus to the economy in a context where key ECB interest rates are at their lower bound. They further ease monetary and financial conditions, making access to finance cheaper for firms and households. This tends to support investment and consumption, and ultimately contributes to a return of inflation rates towards 2%.

The programme will encompass the asset-backed securities purchase programme (ABSPP) and the covered bond purchase programme (CBPP3), which were both launched late last year. Combined monthly purchases will amount to €60 billion. They are intended to be carried out until at least September 2016 and in any case until the Governing Council sees a sustained adjustment in the path of inflation that is consistent with its aim of achieving inflation rates below, but close to, 2% over the medium term.

The ECB will buy bonds issued by euro area central governments, agencies and European institutions in the secondary market against central bank money, which the institutions that sold the securities can use to buy other assets and extend credit to the real economy. In both cases, this contributes to an easing of financial conditions.

The programme signals the Governing Council’s resolve to meet its objective of price stability in an unprecedented economic and financial environment. The instruments deployed are appropriate in the current circumstances and in full compliance with the EU Treaties.

As regards the additional asset purchases, the Governing Council retains control over all the design features of the programme and the ECB will coordinate the purchases, thereby safeguarding the singleness of the Eurosystem’s monetary policy. The Eurosystem will make use of decentralised implementation to mobilise its resources.

With regard to the sharing of hypothetical losses, the Governing Council decided that purchases of securities of European institutions (which will be 12% of the additional asset purchases, and which will be purchased by NCBs) will be subject to loss sharing. The rest of the NCBs’ additional asset purchases will not be subject to loss sharing. The ECB will hold 8% of the additional asset purchases. This implies that 20% of the additional asset purchases will be subject to a regime of risk sharing. 

The press release includes a technical annex.

Here is the official statement issued by ECB president Mario Draghi (bold original)

Based on our regular economic and monetary analyses, we conducted a thorough reassessment of the outlook for price developments and of the monetary stimulus achieved. As a result, the Governing Council took the following decisions:

First, it decided to launch an expanded asset purchase programme, encompassing the existing purchase programmes for asset-backed securities and covered bonds. Under this expanded programme, the combined monthly purchases of public and private sector securities will amount to €60 billion. They are intended to be carried out until end-September 2016 and will in any case be conducted until we see a sustained adjustment in the path of inflation which is consistent with our aim of achieving inflation rates below, but close to, 2% over the medium term. In March 2015 the Eurosystem will start to purchase euro-denominated investment-grade securities issued by euro area governments and agencies and European institutions in the secondary market. The purchases of securities issued by euro area governments and agencies will be based on the Eurosystem NCBs’ shares in the ECB’s capital key. Some additional eligibility criteria will be applied in the case of countries under an EU/IMF adjustment programme.

Second, the Governing Council decided to change the pricing of the six remaining targeted longer-term refinancing operations (TLTROs). Accordingly , the interest rate applicable to future TLTRO operations will be equal to the rate on the Eurosystem’s main refinancing operations prevailing at the time when each TLTRO is conducted, thereby removing the 10 basis point spread over the MRO rate that applied to the first two TLTROs.

Third, in line with our forward guidance, we decided to keep the key ECB interest rates unchanged.

As regards the additional asset purchases, the Governing Council retains control over all the design features of the programme and the ECB will coordinate the purchases, thereby safeguarding the singleness of the Eurosystem’s monetary policy. The Eurosystem will make use of decentralised implementation to mobilise its resources. With regard to the sharing of hypothetical losses, the Governing Council decided that purchases of securities of European institutions (which will be 12% of the additional asset purchases, and which will be purchased by NCBs) will be subject to loss sharing. The rest of the NCBs’ additional asset purchases will not be subject to loss sharing. The ECB will hold 8% of the additional asset purchases. This implies that 20% of the additional asset purchases will be subject to a regime of risk sharing.

Read the rest here

In the question and answer portion, asked whether Greek debt and  bonds with negative yields will be included in the program?

Mr. Draghi’s reply:  

Second question, the answer is yes. And to the first question, let me say one thing here. We don't have any special rule for Greece. We have basically rules that apply to everybody. There are obviously some conditions before we can buy Greek bonds. As you know, there is a waiver that has to remain in place, has to be a program. And then there is this 33% issuer limit, which means that, if all the other conditions are in place, we could buy bonds in, I believe, July, because by then there will be some large redemptions of SMP bonds and therefore we would be within the limit.

And by the way, let me add, if there is a problem, if there is a waiver, all these are not exceptional rules. They were rules that were already in place before. So we're not creating.

It’s important to point out here that the ECB's buying of negative yields will mean that as part of the program, the ECB will be absorbing losses.

In addition, as noted above the ECB has a risk sharing provision; the risk sharing component essentially attempts downplay the politics of redistribution from the ECB program. But at the end of the day, the burden of transfer will fall on the shoulders of the productive nations.

And this is why the ECB’s 60 billion QE has hardly been unanimous, as again German representatives reportedly expressed opposition. From the Wall Street Journal: The 25-member governing council’s wasn’t unanimously in favor of the new program. While the vote breakdown will not be published, it’s likely the decision was opposed by the two German members, and possibly others. German policy makers don’t believe there is a risk of deflation in the eurozone, while Germans also worry that QE is a form of central bank financing of government deficits, a taboo in the eurozone’s largest members. German policy makers also fear it will ease pressure on governments to press ahead with painful economic reforms.

Yet today’s ECB action represents a product of a series of previous actions that has not worked but has not deterred seemingly desperate central banks, along with the BoJ, from trying.

As I wrote last November,

Yet the ECB has been easing since 2008. The ECB has pared down interest rate from 4.25% in 2008 to merely .05% today. The ECB cut the Eurozone’s interest rate twice this year.

Not only that, the ECB has imposed negative deposit rates on banks last June in order to “stimulate lending”. Along with the negative deposit rates, the ECB likewise pumped liquidity to the banking system to promote loans to small and medium enterprises via the Targeted Long Term Re-financing Operations (TLTRO). The ECB expected at least €100 billion to be availed of by the banking system. Unfortunately, last September the first tranche of TLTRO only induced €82.6 billion worth of borrowings from 255 banks.

Obviously all these hasn’t worked, so despite interest rate cuts, negative deposit rates and the TLTRO, the ECB finally embarked on asset purchases initially involving covered bonds and asset backed securities (ABS) during the height of October’s selloff. In realization that that markets has been unsatisfied, the ECB floated the idea to include corporate bonds.

With Thursday’s unpalatable data comprising a contraction or stagnation in the Eurozone’s largest economies, specifically the shriveling of French manufacturing PMI and services PMI, the flat lining of Germany’s manufacturing PMI while services PMI was sharply lower than expected, such has been manifested on the Eurozone’s manufacturing PMI which hardly grew, while the services PMI came below consensus expectations. These may have prompted Mr. Draghi to unleash the bazooka—implicit promises to buy of government debt.

So today’s actions have merely doing the same things over and over again, expecting different results. Some people call this “insanity”. Yet today, insanity has been embraced as economic policies.

The reason why this won’t work?  Simple it represents invisible redistribution. Growth comes from addition not subtraction and one can’t print the real economy.

Even the mainstream’s idol John Maynard Keynes clearly recognized this:

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.

Let me repeat: There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency. 

The euro-usd has been collapsing along with consensus expectation of the Eurozone’s gdp.(chart from zero hedge)

And who will be the lucky enriched some from the stealth transfer or 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”?  

Well of course the establishment, via the direct beneficiaries or biggest owners of European debt ranging mostly from foreign governments, domestic banks and domestic non banks (chart from Wall Street Journal) and indirectly the domestic government through subsidized debt via suppressed interest rates.

QE is part of Financial repression policies. Financial repression introduced in 1973 by Edward Shaw and Ronald McKinnon as per Wikipedia.org states of "policies that result in savers earning returns below the rate of inflation" in order to allow banks to "provide cheap loans to companies and governments, reducing the burden of repayments”

Of course the financial markets love this, that’s because these surreptitious transfers have been channeled through financial assets which artificially boosts the balance sheets of these beneficiaries and which has been sold to the public as to benefit the economy via the “wealth effect” transmission.

Unfortunately, speculative activities represent unproductive activities therefore are temporal and unsustainable. Such activities instead signify capital consumption process which leads to depression.

Those previous actions have already been showing this, why change today because the bailout is bigger?

Stock markets celebrated Draghi’s “best way to destroy the capitalist system” by debauching the currency (from Bloomberg)

Yet milestone highs of European equities have hardly been accompanied by earnings and dividend growth (chart above from zero hedge). On the contrary, as shown by the second chart below from Yardeni.com, annual and forward estimates of earnings and revenues per share of Europe ex-UK MSCI have been collapsing! 

This means that European stock markets have become Frankensteins of the ECB, whose false confidence has been entirely based on inflation subsidies (ECB’s liquidity) that has only led to massive multiple expansions, ergo a bubble.

At the end of the day, these booms will morph into busts. And the bust will confirm the ECB’s actions that “the best way to destroy the capitalist system” is by debauching the currency.

The Untold Story of November’s Philippine Remittance Data

I belatedly stumbled on the BSP’s November remittance data.

The official disclosure on personal remittances: Personal remittances from overseas Filipinos (OFs) reached US$2.3 billion in November 2014, higher by 1.8 percent than the year-ago level. This brought the cumulative remittances for the period January-November 2014 to US$24.4 billion, representing a year-on-year growth of 6.2 percent, Bangko Sentral ng Pilipinas Governor Amando M. Tetangco, Jr. announced today.  The steady growth in personal remittances for the first eleven months of the year was supported by the sustained expansion of remittance flows from land-based workers with work contracts of one year or more (5.3 percent) as well as sea-based and land-based workers with work contracts of less than one year (7.3 percent).

The framing looks glossy of course, but here’s what the BSP didn’t say…

As the old saw goes: a picture is worth a thousand words.

On cash remittances, again the BSP:  Likewise, cash remittances from OFs coursed through banks rose by 2 percent year-on-year to US$2.1 billion in November 2014. For the period January-November 2014, cash remittances increased by 5.7 percent to US$22 billion, compared to the US$20.8 billion registered in the same period in 2013. Cash remittances from land-based and sea-based workers reached US$16.9 billion and US$5.1 billion, respectively.  The bulk of cash remittances came from the United States, Saudi Arabia, the United Arab Emirates, the United Kingdom, Singapore, Japan, Hong Kong, and Canada.

Again here is what the BSP didn’t say…

It’s their data.

Both personal and cash remittances reveal of a sharp drop in remittance growth rate  as of November on a monthly basis. It’s the lowest since 2009!

Considering that November has over the past 5 years been one of the strongest months (most likely due to pre-Christmas seasonality), the collapse in November growth looks disconcerting. 

On a cumulative basis, growth trends of both cash and personal remittances appears to have peaked in January 2013 and has seemingly been on a downtrend since.

So the cumulative data series (green trend lines on both personal and cash remittances charts) suggest that this may not be an anomaly but perhaps an incipient trend. 

I am tempted to impute that this could be part of the repercussions of the collapse in oil prices and crashing stock markets in the Middle East.

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

But I will withhold judgment until more confirmation.

Yet the collapse in the growth rates of remittances seems to align or appears to be consistent with the government’s contracting or negative month on month consumer spending or consumer price inflation (CPI) data for two successive months through December  (from tradingeconomics.com).

This implies of a materially slowing internal (domestic output) and external (remittances) financed consumer demand. By the way, contraction in the m-o-m in CPI means ‘deflation’ in technical lingo.

All these reveals that 4Q 2014 GDP, which will be released next week, will be very interesting.

China’s Stock Market Vaudeville: Powerful Two Day Rally Almost Offsets One Day Crash

Over the past two days the China’s equity benchmark the Shanghai Composite mounted a powerful rally (6.56%) that has thus far erased about 85% of losses from Monday’s 7.7% crash.

First I noted of what looked like a conflict in policies between Chinese central bank, the PBOC and the Regulatory Commission

The Chinese central bank, the PBoC wants to more credit into the system--yet  part of these funds finds its way to the stock markets--while the Regulatory Commission desires to curtail speculative credit flows into the stock markets.

So which agency will prevail, the PBoC or the Regulatory Commission?

Here is how media sees yesterday’s 4.74% comeback. From Bloomberg: (bold mine)

Chinese stocks posted the biggest two-day rally since 2009, led by financial companies, as investors speculated Monday’s rout was overdone given prospects for further monetary stimulus…

Stocks rebounded after China’s securities regulator said it isn’t trying to curb equity trading.

Perhaps, the Regulatory Commission had been surprised by the market's intense reaction, and consequently, has eluded the burden of responsibility from the ramifications of their policies, so the regulatory commission folded.

The two day rally has apparently been indirectly supported by the PBoC.

Just a day back, the PBoC injected funds to troubled companies 

From Bloomberg:

The People’s Bank of China rolled over a medium-term lending facility to Shanghai Pudong Development Bank Co. today, and lent additional money to the bank, according to people familiar with the matter, who asked not to be identified because they aren’t authorized to speak publicly.

The central bank extended 20 billion yuan ($3.2 billion) of matured MLF to the Shanghai-based lender, and gave an additional 20 billion yuan via the same facility, Sina.com.cn reported today, citing unidentified people. Industrial Bank Co. was granted an additional 20 billion yuan, after the PBOC extended 30 billion yuan that matured.

So a stealth bailout by the PBoC.

As I noted during the one day crash

Given the huge growth of stock market credit or the record levels of margin debt, losses from today’s crash will likely lead to margin calls which may prompt for even more selling. And absent access to new credit many heavily levered firms will see their balance sheets impaired from sustained stock market losses.

But if regulators are here just to put a brake, or in effect, a façade at it, then today crash could just be part of the script to a manipulated boom.

And perhaps, the other way to look at it is that the seeming clash in policies has really been part of the theatrics to contain the stock market mania which apparently has failed.

Of course, Chinese stocks have dependent on PBOC’s policies where expansionary credit will find ways (like the Shadow Banking system) to chase yields. Again as I noted the other day:

For as long as the PBoC promotes financial repression (zero bound) policies via expansionary credit into the system, yield chasing via asset speculation will be funded via different channels whether it is the formal or the informal system. There will always be novel ways to go around the curbs.

What the current episode reveals has been the intense buildup of volatility which implies of very unstable markets or that stock markets that have morphed into grand casinos.

Wow. Malaysian Prime Minister Talks and Denies a Crisis!

Who says Malaysia is in a crisis (or could be heading for one) anyway as to warrant the attention of Malaysia’s PM to publicly address the issue?

Writes the Nikkei Asian Review: (bold mine)

In a live television address on Tuesday, Prime Minister Najib Razak said Malaysia is "not in crisis" but needs "proactive measures" to counter the changing economic environment that has caused the ringgit to fall 12% against the US dollar in six months and fuelled a foreign capital flight on the stock market.

Last week, foreign investors sold 1.42 billion ringgit in equities, the "highest level since August 2013", according to brokerage MIDF Equity Research.

Razak's government responded on Tuesday by announcing it will trim 5.5 billion ringgit ($1.5 billion) from the 273.9 billion budget allocated for 2015.

The belt-tightening measures include reducing grants to state-owned companies worth 3.2 billion ringgit, and cuts of 1.6 billion on overseas travel and other government expenses.

What has PM Razak been reacting to?

Has it been due to the domestic currency, the ringgit? The USD-Ringgit currently trades at 2008 levels!

Or has been due to this?

Malaysia’s equity markets as measured by the FMBKLCI have been under pressure. As of Friday’s close, the formerly hot KLCI has been down 1% year to date. In 2014 the KLCE was down by 5.6%

Or this?

The cost to insure government debt via Credit Default Swaps, based Deutsche Bank’s calculations, has been spiking for Malaysia, Thailand and the Philippines (left window). But to a lesser degree Indonesia (right window).

Or a combination of the above?

Media refers to the stock markets, but definitely it has not just been stocks.

Something 'wrong' has been brewing in Malaysia’s political economy, for incipient signs of capital flight to surface. As shown above, such has been presently ventilated on her financial markets.  

Late last year, even the BBC highlighted on Malaysia's Savings Retirement Crisis, as I posted here. 

So it appears that Malaysia's woes have also been generating wider mainstream recognition.

In response, Malaysia's PM goes to public to deny the existence of a crisis.

Well, "denials" signify a symptom of any crisis in progression.

In a working paper comparing the Asian Crisis with the European Crisis, Edwin Truman of the Peterson for Institute for International Economics wrote about the transition of the stages of financial crisis which underpinned both the 1997 Asian crisis and the recent European crisis (bold and italics mine) 

Financial crises with significant international ramifications are generally preceded by credit booms. The booms turn into busts with severe negative consequences for the real economy. During the boom period, irrational exuberance takes hold. Policymakers and domestic and foreign investors, as a group, inevitably believe that this time is different. All countries are different in their precise circumstances, but certain regularities are evident. Various indicators give warnings of crisis (as well as false positives), but when a crisis occurs, most policymakers and many market participants are surprised and unprepared. For policy-makers, the surprise tends to manifest itself in denial that there is a crisis until the evidence is irrefutable.

For market participants—domestic as well as foreign—the response is a rush to exit from investments and markets in the country and, often, exit from countries perceived to be in similar circumstances…

Additionally…

All crises involve surprise, denial, and delay essentially by definition. If markets and outside authorities were not surprised, they would have sounded an alarm and, one would hope, the country’s policymakers would have taken some preventative action. Of course, some voices can always be identified ex post that issue warnings of crises, but in general they are soft voices and, again by definition, are largely ignored. 

In short, even the mainstream now recognizes that the seminal phase towards a transition to a crisis has always been "denial" by the establishment.

Yet announced reforms by the PM will be good (if implemented), but will it be enough to offset imbalances accumulated from the previous credit boom? 

Now that Malaysian's housing bubble has been slowing, how will this affect credit quality and credit risks of domestic institutions?

Déjà vu 1997?

Germany’s Bundesbank Repatriates 120 Tons of Gold

Apparently pressured by the public Germany’s central bank the Bundesbank announced the transfer of gold held overseas (Paris and New York) to Frankfurt

From Yahoo news:

The German central bank or Bundesbank said Monday that it stepped up the repatriation of its gold reserves from overseas storage last year.

"The Bundesbank successfully continued and further stepped up its transfers of gold," the central bank said in a statement.

"In 2014, 120 tonnes of gold were transferred to Frankfurt from storage locations abroad: 35 tonnes from Paris and 85 tonnes from New York."

Germany's gold reserves are the second-biggest in the world after those of the United States and totalled 3,384.2 tonnes this month, according to the latest data compiled by the World Gold Council.

Stated reasons:

But surging mistrust of the euro during Europe's debt crisis fed a campaign to bring home Germany's gold reserve from New York and London, with some political parties fuelling fears the gold might have been tampered with.

Under the Bundesbank's new gold storage plan in 2013, it decided to bring back 674 tonnes from abroad by 2020 and store half of its gold in its own vaults.

Ironically in today’s world of modern technology as seen through the coming of driverless cars and hypersonic planes, the Bundesbank’s plan to bring back 674 tonnes from abroad by 2020 has been a sign of how wishy washy German’s central bank has been. Or has been that German's Bundesbank knows something about real inventories of gold stored at the US Federal Reserve which they have failed to disclose?

Perhaps as I blogged last January 2013 they would ship gold via ancient triremes.

And 674 tons represents just 19% of German’s declared gold holdings of 3,384 tons. How long to ship the entire bulk?

More questions

Why does it take such lengthy period of time to ship gold to Bundesbank?

Has there really been physical gold stored at the New York Fed? Or will it take several market operations to bring back into physical form gold that may have possibly been leased out into the markets?

If the reason for the repatriation has been “surging mistrust of the euro”, what happens if the Draghi’s QE fail and or if the fallout from the SNB’s termination of  the franc-euro cap spreads to deepen the mistrust? Will the public’s demand surge enough to pressure the Bundesbank to accelerate repatriation? How will the central banks like the NY Fed respond?

In 2014, the government of Netherlands stealthily brought back 122 tons of gold reserves from New York as part of the overall plans to ship 612 tons intended to spread its gold stocks in a “more balanced way” (WSJ).  Will there be more demand from various central banks to bring back gold held mostly by the US Federal Reserve? On the other hand, will there be enough stocks to fulfill such demand?

What the German –Netherland gold repatriation events has been indicative of has been that demand for gold seem as getting to be more about physical, rather than just paper speculative gold.

Will Shadow Banks Offset the Chinese Stock Market Margin Debt Crackdown?; China's GDP for 2014: 7.4%

During yesterday’s stock market meltdown, I pointed to the seeming clash of government policies between the central bank, the PBoC and the Regulatory Commission.

The Chinese central bank, the PBoC wants more credit into the system--yet  part of these funds finds its way to the stock markets--while the Regulatory Commission desires to curtail speculative credit flows into the stock markets.

So which agency will prevail, the PBoC or the Regulatory Commission?

Today’s Bloomberg report provides a clue to the possible resolution of this conundrum: Shadow banks will most likely step in or fill in the void from the formal banking. (bold mine)

China’s clampdown on margin lending by brokerages risks fueling an upswing in shadow banking as investors look for new ways to leverage their stock bets.

Wealth-management products, known as WMPs, have been used to channel 300 billion yuan ($48 billion) to 500 billion yuan into shares, Goldman Sachs Group Inc. estimated in a Jan. 19 note. Sinolink Securities Co. put the figure at 1.5 trillion yuan, up from 800 billion yuan at the end of June. Outstanding margin loans totaled a record 1.1 trillion yuan at the end of last week, China Securities Finance Corp. data show.

Chinese equities plunged the most in six years yesterday, derailing a world-beating rally, after three of the nation’s biggest brokerages were suspended from loaning money to new equity-trading clients. The amount invested in WMPs surged 24 percent in the first half of 2014 to 12.7 trillion yuan and Bank of Communications Co. said last week that the total may climb through 20 trillion yuan this year.

“The tightening of margin finance by brokerages will cause more funds to flow into stocks through banks’ WMPs,” Ma Kunpeng, a Shanghai-based analyst at Sinolink Securities, said yesterday by phone. “Money can always find its way into stocks one way or another.”

For as long as the PBoC promotes financial repression (zero bound) policies via expansionary credit into the system, yield chasing via asset speculation will be funded via different channels whether it is the formal or the informal system. There will always be novel ways to go around the curbs.

Yet here is another Bloomberg report validating my thesis that stocks and speculative assets are driven by credit and liquidity from which confidence functions as an offspring--applied to the Chinese financial markets. (bold mine)

For China’s central bank, the 36 percent stock market rally through Jan. 16 spurred in part by a surprise November interest-rate cut is the latest reminder that it’s easier to unleash money than to guide it to the right places.

Since Zhou Xiaochuan became People’s Bank of China governor in late 2002, the broad money supply base has expanded almost seven times to 122.8 trillion yuan ($20 trillion) while the economy has grown about five times. That translates to a M2/GDP ratio of about 200 percent versus about 70 percent in the U.S., according to data compiled by Bloomberg.

That liquidity springs up like a jack-in-the-box, driving property prices, then shifting to stocks, before moving on to whatever may be next. Such sprees help explain the PBOC’s reluctance to cut banks’ required reserve ratios even as the economy slows. Instead, it’s trying targeted tools to guide money to preferred areas such as farming and small business.

Nice line… “That liquidity springs up like a jack-in-the-box, driving property prices, then shifting to stocks, before moving on to whatever may be next.”

So the Chinese real economy has morphed into one gigantic speculative bubble whose economic activities have become too dependent on credit, liquidity and its offspring: confidence.

As of this writing, Chinese stocks have recovered about a quarter of yesterday’s losses.

The official figures of the Chinese economy had been released: in 2014 China’s statistical economy grew by 7.4%.

Yet here is a caustic take by the Wall Street Journal Real Times Economic Blog on the official figures: (bold mine)

Economists say it is daft to get hung up on changes of a few tenths of a percentage point in the official growth rate. The statistics bureau’s methodology is “not so scientific,” as Harry Wu, a skeptic at Hitotsubashi University in Japan, puts it. And even if statisticians at the central government level are immune to political pressure, few doubt that the local bureaus underneath them are capable of fudging the numbers to produce a more flattering picture.

Still, the general trend seems to be clear. If the government says the economy is slowing down, you can bet the slowdown is real.

Yeah, believe those government massaged statistics.

Ron Paul: If the Fed Has Nothing to Hide, It Has Nothing to Fear

The great Ron Paul on Audit the Fed

From the Ron Paul Institute

Since the creation of the Federal Reserve in 1913, the dollar has lost over 97 percent of its purchasing power, the US economy has been subjected to a series of painful Federal Reserve-created recessions and depressions, and government has grown to dangerous levels thanks to the Fed’s policy of monetizing the debt. Yet the Federal Reserve still operates under a congressionally-created shroud of secrecy.

No wonder almost 75 percent of the American public supports legislation to audit the Federal Reserve.

The new Senate leadership has pledged to finally hold a vote on the audit bill this year, but, despite overwhelming public support, passage of this legislation is by no means assured.

The reason it may be difficult to pass this bill is that the 25 percent of Americans who oppose it represent some of the most powerful interests in American politics. These interests are working behind the scenes to kill the bill or replace it with a meaningless “compromise.” This “compromise” may provide limited transparency, but it would still keep the American people from learning the full truth about the Fed’s conduct of monetary policy.

Some opponents of the bill say an audit would somehow compromise the Fed’s independence. Those who make this claim cannot point to anything in the text of the bill giving Congress any new authority over the Fed’s conduct of monetary policy. More importantly, the idea that the Federal Reserve is somehow independent of political considerations is laughable. Economists often refer to the political business cycle, where the Fed adjusts its policies to help or hurt incumbent politicians. Former Federal Reserve Chairman Arthur Burns exposed the truth behind the propaganda regarding Federal Reserve independence when he said, if the chairman didn’t do what the president wanted, the Federal Reserve “would lose its independence.”

Perhaps the real reason the Fed opposes an audit can be found by looking at what has been revealed about the Fed’s operations in recent years. In 2010, as part of the Dodd-Frank bill, Congress authorized a one-time audit of the Federal Reserve’s activities during the financial crisis of 2008. The audit revealed that between 2007 and 2008 the Federal Reserve loaned over $16 trillion — more than four times the annual budget of the United States — to foreign central banks and politically-influential private companies.

In 2013 former Federal Reserve official Andrew Huszar publicly apologized to the American people for his role in “the greatest backdoor Wall Street bailout of all time” — the Federal Reserve’s quantitative easing program. Can anyone doubt an audit would further confirm how the Fed acts to benefit economic elites?

Despite the improvements shown in the (government-manipulated) economic statistics, the average American has not benefited from the Fed’s quantitative easing program. The abysmal failure of quantitative easing in the US may be one reason Switzerland stopped pegging the value of the Swiss Franc to the Euro following reports that the European Central Bank is about to launch its own quantitative easing program.

Quantitative easing is just the latest chapter in the Federal Reserve’s hundred-year history of failure. Despite this poor track record, Fed apologists still claim the American people benefit from the Federal Reserve System. But, if that were the case, why wouldn’t they welcome the opportunity to let the American people know more about monetary policy? Why is the Fed acting like it has something to hide if it has nothing to fear from an audit?

The American people have suffered long enough under a monetary policy controlled by an unaccountable, secretive central bank. It is time to finally audit — and then end — the Fed.

Chinese Stocks Crash 7.7% on Margin Trades Crackdown by Authorities

As I have repeatedly been saying here, stock markets have been about credit and liquidity from which confidence is an offspring.

Take away credit and liquidity and the whole illusion of confidence built on them collapses.

Today, events in China has validated my thesis. A rigid crack down by the Chinese regulators on margin trades or credit extended by brokerage firms to clients has resulted to a harrowing one day stock market crash!

From the Bloomberg: (bold added)

Chinese equities plunged the most in six years, led by brokerages, after regulatory efforts to rein in record margin lending sparked concern that speculative traders will pull back from the world’s best-performing stock market.

The Shanghai Composite Index (SHCOMP) sank 7.1 percent to 3,138.59 at 1:59 p.m. local time, poised for the steepest drop since June 2008. Citic Securities Co. (600030) and Haitong Securities Co., the nation’s two biggest listed securities firms, fell by the 10 percent daily limit after they were suspended from lending money to new equity-trading clients. Industrial & Commercial Bank of China Ltd. tumbled 9.7 percent. The stock gauge’s 30-day volatility rose to a five-year high.

The penalties have raised concern that policy makers are trying to curb a surge in stock purchases using borrowed money, after outstanding margin loans surged to 1.08 trillion yuan ($174 billion) as of Jan. 13 from about 400 billion yuan at the end of June. The Shanghai Composite index has jumped 61 percent during the past 12 months on record volumes as individual investors piled into the market…

Citic Securities, Haitong Securities and Guotai Junan Securities Co. (1788) were suspended from lending money and stocks to new clients for three months, the China Securities Regulatory Commission said on its microblog on Jan. 16 after the market closed.

The regulator punished nine other brokerages for offenses including allowing unqualified investors to open margin finance and securities lending accounts, it said.

Last December I asked if the PBOC has been funneling banking loans indirectly to the stock market.

The same news report provides an affirmation of my suspicions:

On the same day, the China Banking Regulatory Commission banned banks from lending to companies that borrow to invest in equities, bonds, futures and derivatives. So-called entrusted loans extended by banks increased to about 458 billion yuan in December, the most since data became available in 2012.

So we seem to be witnessing a clash in policies.  The Chinese central bank, the PBoC wants to more credit into the system--yet  part of these funds finds its way to the stock markets--while the Regulatory Commission desires to curtail speculative credit flows into the stock markets.

So which agency will prevail, the PBoC or the Regulatory Commission?

The Shanghai Composite closed the day with a 7.7% crash! This again as reported, represents the steepest one day drop since 2008.

Also today’s episode highlights the reality that market crashes have become real time events.

And today’s 7.7% SSEC crash have virtually erased the year’s early sharp gains. The blue horizontal line above shows the level of today’s close.

Now of course, the Shanghai index had a 5.43% crash last December which it swiftly recovered.

The question now is how consistent will Chinese regulators implement the margin debt curbs? Margin trade controls essentially implies tightening of credit on stock market speculations.

So if regulators will continue to tighten then today’s crash could mark an inflection point for Chinese stock markets.

Given the huge growth of stock market credit or the record levels of margin debt, losses from today’s crash will likely lead to margin calls which may prompt for even more selling. And absent access to new credit many heavily levered firms will see their balance sheets impaired from sustained stock market losses.

But if regulators are here just to put a brake, or in effect, a façade at it, then today crash could just be part of the script to a manipulated boom.

At the end of the day, any credit inspired stock market ramp, is by its very nature, unsustainable. Chinese regulators seem to have become cognizant of its perils for them to implement today's crackdown.

As I always say here, the obverse side of every mania is a crash.

Charts of the Day: Why a Pope from a ‘Poor’ Country

Domestic media inquires: Why has the incumbent Pope been chosen from a ‘poor’ country (emerging markets)?  Pope Francis hails from Argentina. Previously Popes were elected from mainstream Europe

The following charts from Pew Research via washingtonpost.com may explain why:

Bluntly put, to revive Catholicism in Latin America, a Pope must represent the region.

However so far this doesn't seem to be working. Again the Washington Post (November 2014):

Pew notes that its own data may not show the "Francis Effect," as he only took the papal position in March 2013. However, the report then adds: 

[Former] Catholics are more skeptical about Pope Francis. Only in Argentina and Uruguay do majorities of ex-Catholics express a favorable view of the pope. In every other country in the survey, no more than roughly half of ex-Catholics view Francis favorably, and relatively few see his papacy as a major change for the Catholic Church. Many say it is too soon to have an opinion about the pope.

Jim Rogers and James Grant Accurately Predicted the end of the SNB’s Disastrous Policy

What has Jim Rogers and James Grant have in common?

Well, not only have they predicted the outcome of the SNB’s policies, both lean on or use Austrian economics for their analysis.

The legendary investor Jim Rogers’ warned of the unsustainable policies embraced by the SNB in his book 2013 book Street Smart.

Here’s an excerpt (sourced from Business Insider Australia) [bold mine]

I had opened my first Swiss bank account in 1970 in the face of coming turmoil in the currency markets. By the end of the decade, as the markets grew more volatile, people all over the world were trying to open Swiss accounts. And the same thing is happening today. The dollar is suspect, the euro is suspect, and again people are rushing to the franc. In 2011, the CHF (the Swiss franc) escalated to record highs against both the euro and the dollar, rising 43 per cent against the euro in a year and a half as of August 2011.

It was a “massive overvaluation,” according to the country’s central bank, the Swiss National Bank (SNB). Under pressure from the country’s exporters, the SNB announced that “the value of the franc is a threat to the economy” and said it was “prepared to purchase foreign exchange in unlimited quantities” in order to drive the price down.

A threat to the economy? It was the exporters who were doing the screaming, but everybody else in Switzerland was better-off. When the franc rises, everything the Swiss import goes down in price, whether it is cotton shirts, TVs, or cars. The standard of living for everybody goes up. Every citizen of Switzerland benefits from a stronger currency. Our dental technician down in Geneva is not calling up and moaning. She is happy. Everything she buys is cheaper. But the big exporters get on the phone and the government takes their call.

The franc went down 7 or 8 per cent the day of the SNB announcement. Nobody, at least in the beginning, wanted to take on the central bank. But the bank’s currency manipulation will turn out to be disastrous. One of two things is going to happen.

In the first scenario, the market will continue to buy Swiss francs, which means that the Swiss National Bank will just have to keep printing and printing and printing, and that will of course debase the currency. Now, there are major exporters in Switzerland who might benefit, but the largest industry in Switzerland, the single largest business, is finance. The economy rises or falls on the nation’s ability to attract capital. And the reason people put their money there is their trust in the soundness of the currency- they not that their money will be there when they want it, and that it will not be worth significantly less than when they put it there in the first place.

But people will stop rushing to put their money into a country where the value of the currency is deliberately being driven down. After the Second World War and for the next thirty years, people took their money out of the United Kingdom because the currency plummeted. (Politicians blamed it on the gnomes of Zurich.) London ceased to be the world’s reserve financial center because Britain’s money was no good. Similarly, if you debase the franc, eventually nobody will want it. You will have eroded its value, not simply as a medium of exchange, but also a monetary refuge. The money will move to Singapore or Hong Kong, and the Swiss finance industry will wither up and disappear.

The alternative scenario is what happened in July 2010, the last time the Swiss tried to weaken their currency. They did so by buying up foreign currencies to hold against the franc-selling the franc to keep the price down. But the market just kept buying the francs, and the Swiss central bank, after quadrupling its foreign currency holdings, abandoned the effort. At that point, when the bank stopped selling it, the Swiss franc rose in value, all the currencies the Swiss had bought (and were now holding) declined in value, and the country lost $US21 billion. In the end, the market had more money than the bank, and market forces inevitably prevailed.

In the late 1970s when everyone was rushing to the franc, the Swiss National Bank, to stem the tide, imposed negative interest rates on foreign depositors. The government levied a tax on anybody who bought the currency. It was their form of exchange controls back then. If you bought 100 Swiss francs, you wound up with 70 in your pocket. Today, with the rush on again, The Economist has described the Swiss currency as “an innocent bystander in a world where the eurozone’s politicians have failed to sort out their sovereign-debt crisis, America’s economic policy seems intent on spooking investors and the Japanese have intervened to hold down the value of the yen.”

All of which is true, but I think the problem runs deeper than that. The Swiss for decades had a semi monopoly on finance. And as a result they have become less and less competent. The entire economy has been overprotected. The reason Swiss Air went bankrupt is because it never really had to compete. Any monopoly eventually destroys itself, and Switzerland, in predictable fashion, is corroding from within. As a result, other financial centres have been rising: London, Lichtenstein, Vienna, Singapore, Dubai, Hong Kong.

Well again, James Grant of Grant’s Interest Rate Observer shares the limelight for having foreseen the unraveling of the ill fated franc-euro cap. 

From Grant’s Interest Rate Observer: “The Balance Sheet that Ate the World September 19, 2014 (source LinkedIn; hat tip zero hedge) [bold mine]

Like a celebrity in flight from the paparazzi, the Swiss Confederation demands protection from its pesky admirers. To beat back the unwanted appreciation of the Swissie, the Swiss National Bank is--once again--vowing to move heaven and earth. Now under way is a speculation. Prompted by a friend (that's you, Harlan Batrus),we venture that the SNB will sooner or later be forced to permit the franc to appreciate and thus to enrich the holders of low-priced, three-year call options on the Swiss/euro exchange rate. It's a long shot, to be sure--the options are cheap for a reason--but we judge that the prospective reward is worth the obvious risk.

Curiously, for all the damage that Swiss private banks have suffered at the hands of American regulators, and for all the Federal Reserve's throat clearing about the supposed imminent rise in dollar interest rates, the franc is still, for many, the monetary bolt-hole of choice. To the Swiss, whose exports generate 54% of Switzerland's GDP, it's a kind of popularity they can live without--indeed, they insist, must live without.

So the SNB prints francs. It drew a monetary line in the sand three years ago: The franc shall not rally through the 1.20-to-the-euro mark, the authorities commanded in September 2011. To enforce this dictum, they bought euros with newly created francs (the cost of production of the home currency being essentially zero). What to do with the rising euro mountain? Invest it, of course.

CFA fashion, the central bankers are diversifying across asset classes and currencies. Among these asset classes are equities, and among these currencies is the dollar. As of June 30, the Swiss managers held $27 billion in 2,533 different U.S. stocks, according to the bank's latest 13-F report (the gnomes file with the SEC just like ordinary big hitters, say George Soros or Goldman Sachs Asset Management).

Here's a metaphysical head scratcher. The Europeans conjure euros, which the Swiss buy with their newly materialized francs. The managers exchange the euros for dollars (also produced by taps on a keyboard) and with that scrip buy ownership interests in real businesses. The equities are genuine. The money, legally and practically speaking, is itself real--you never mind having a little more of it. But what is its substance? We mean, how is it different from air?

In any case, observes colleague Evan Lorenz, the scale of the Swiss operations is titanic. He reports that, from December 2007 to July 2014, the SNB's balance sheet expanded to the equivalent of 83% of Swiss GDP from 23% of Swiss GDP. For perspective, over approximately the same span of years--and after three successive QE programs that boosted the Federal Reserve's assets by $3.5 trillion--the Fed's balance sheet as a percent of U.S. output expanded to 25% from 6%.

Swiss interest rates have shriveled as the SNB's balance sheet has grown. Thus, in January 2008, the average rate on 10-year, fixed-rate mortgages was an already low 4.17%; as of June 2014, 10-year loans were offered at an average of 2.25%. "In other words," Lorenz points out, "Swiss homeowners can borrow more cheaply than Uncle Sam." They can and they do. From December 2007 to June of this year, Swiss mortgage debt as a share of GDP surged to 146% from 127%. (Between the first quarter of 2009 and the first quarter of 2014, chastened Americans reduced America's mortgage debt as a share of American GDP to 55% from 74%.)

In these stupendous interventions, the SNB is hardly unique. Nor is it alone as it attempts to undo, through administrative means, the distortions it creates through monetary policy. New "macro-prudential" directives have tightened standards for home-loan amortization schedules, minimum down payments, affordability, bank capital ratios, etc.

Though the UBS Swiss Real Estate Bubble Index continues to flash "risk," the mortgage market cooled a bit in the first half of the year, Philippe Béguelin, an editor at Finanz und Wirtschaft in Zurisch, advises Lorenz. Then, too, the foreign exchange market cooled late in 2013, which allowed the SNB to cease and desist from franc printing. Thus, the central bank's assets declined to CHF 492.6 billion in February from a peak of CHF 511.7 billion in March 2013.

Russia's accession of Crimea at the end of February reheated the forex market. ISIS and the Scottish referendum have continued to turn up the temperature. Business activity in China continues to dwindle (electricity production fell 2.2%, measured year-over-year, in August), and European growth registers barely above the zero line. On Sept. 4, Mario Draghi unveiled a plan for a kind of euro-zone QE. So growth in the SNB's balance sheet has resumed. In July, the latest month for which figures are available, footings reached CHF 517.3 billion in July, a new high.

"If the drumbeat of bad news continues, why wouldn't investors move more cash into Switzerland?" Lorenz inquires. "Successive rounds of easy money have made the opportunity cost of parking assets in Switzerland much lower today than at the outset of the SNB's currency ceiling. True, the Swiss 10-year yield has declined to 0.49% from 0.93% since Nov. 1, 2011. But yields on the Irish, Spanish and Greek 10 years have also plummeted--to 1.88%, 2.33% and 5.69%, respectively, from 14.08%, 7.62% and 37.1%, respectively, at their euro-panic peaks. It no longer avails the income seeker much to gamble on second- and third-tier sovereign credits. Swiss yields are at rock bottom, but so are the rest of them. On the combined, undoubted authority of Deutsche Bank, Business Insider and Bloomberg, Dutch yields stand at a 500-year low."

It's a funny old world when frightened people turn to the Swissie, which the SNB is again mass-producing, rather than to gold, which nobody can mass produce. While the franc yields something to gold's nothing, the spread is narrowing. And if as Thomas Moser, an alternate member of the SNB's policy-setting Governing Board, suggested in a Sept. 10 interview with The Wall Street Journal, the SNB finally has recourse to negative rates, the barbarous relic will outyield the franc. Way back in the 1970s, relates Christopher Fildes, a delegation of foreign newspapermen were visiting the old Union Bank of Switzerland in Zurich. In response to a casual remark about the proverbial strength of the franc, a Swiss banker scoffed. "We do not say 'as good as gold,'" declared this eminence. "Gold is not as good as the Swiss franc." And now?

A bet on a higher Swiss/euro exchange rate implies that the SNB will stop intervening. What monetary or political forces might converge to persuade the bank that a strong franc is the lesser of two or more evils? "John Bull can stand anything but he can't stand 2%," the saying goes. It's clear to listen to their anguished cries that broad segments of the life insurance industry can't stand one-half of 1%. The Tokyo Stock Exchange TOPIX Insurance Index is essentially unchanged since 1994, the year that Japan government bond yields began their inexorable slide. "We are the collateral victims of the monetary policy which has been designed to help governments and banks after the financial crisis," Denis Kessler, the CEO of Scor SE, the world's fifth-largest reinsurer, complained at a London conference on June 24. "We were not at the heart of the crisis nor did we create the crisis."

More money printing or sub-zero rates may once again set a fire under Swiss house prices, macro-prudential policies notwithstanding. It may ruin the life insurers. At some point, the Swiss National Bank would have to decide whether propping up the export sector is worth the cost. If these circumstances, a bet (and, to be clear, it is very much a bet) on the franc appreciating against the euro might pay. A three-year, at-the-money option on the franc appreciating against the euro is priced at 3.7% of notional today according to Bloomberg. To return to its high of 1.03 francs per euro on Aug. 10, 2011, the franc would appreciate by 17%.

While there is nothing especially exotic about this option, it is available only to institutional investors with an International Swaps and Derivatives Association agreement in place with a too-big-to-fail bank. For readers not so situated, there is always gold, which--in our opinion--the franc is no longer as good as.

Bottom line: as the fateful SNB episode demonstrates—there are natural limits to the policies of inflationism.

Quote of the Day: The Hemingway Law of Motion: Gradually, then Suddenly

Ernest Hemingway's 1926 novel The Sun Also Rises, which is available various places around the web like here, includes the following snippet of dialogue:

"How did you go bankrupt?" Bill asked.
"Two ways," Mike said. "Gradually and then suddenly."

Many economists will recognize this as a version of an apercu offered a number of times over the years by the prominent macroeconomist Rudiger Dornbusch, who liked to say (for example, in this interview about Mexico's economic crisis in the 1990s):

"The crisis takes a much longer time coming than you think, and then it happens much faster than you would have thought."

What I am dubbing the Hemingway Law of Motion clearly has wide applicability. It's when the creaking of your back porch doesn't matter much, until the day you put a foot through the floor. It's when the cracks and rust on the bridge don't seem to matter, until the day the bridge goes down. It's the concern that you can see signs that the risk of a financial crisis or a stock market run, but little action is taken until the crisis is upon us. It's the concern that the costs and risks of climate change may look quite reasonable, until something large and perhaps irreversible happens all at once. 

The Hemingway Law of Motion is simultaneously a useful reminder in some cases and a rhetorical trick in other cases. It's a useful reminder that the world often isn't smooth and linear. Instead, the world full of tipping points and thresholds. When warning signs exist, they may not steadily rise to a predictably timed crescendo. Instead, those who interpret the warning signs correctly and take action will often look like alarmists, because if they act in time, the negative event never actually materializes--and so was it really necessary for them to make such a fuss in the first place?

The excerpt above including a quote from Mr. Rudiger Dornbusch is from the Conversable Economist blogger, editor, author and lecturer Timothy Taylor.

My version of this: drip, drip, drip then a flood or a slomo downhill before a collapse.