The wise learn from the experience of others, most from their own experience, and fools not at all.-- Proverb
In this issue
Phisix: Global Markets Parties on BoJ, PBoC and ECB’s Steroids!
-Has The Market Process Degenerated Permanently Into A Gamble And A Lottery?
-Financial Risk Warning from UK’s David Cameron, the BIS (again), RBA Glen Stevens and more…
-Record Stocks, Record Debt
-ECB’s QE: Hope is Now the ONLY Strategy
-Interest Rate Cuts: Beijing We Have a Problem. There is Big trouble in Big China!
-The Magic of Abenomics: Triple Dip Recession!
-Final Comments In Bullets
Phisix: Global Markets Parties on BoJ, PBoC and ECB’s Steroids!
Let me open this week’s note with the essence underlying today’s market actions
From John Maynard Keynes[1]: (bold mine)
Lenin is said to have declared that the best way to destroy the capitalist system was to debauch the currency. By a continuing process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens. By this method they not only confiscate, but they confiscate arbitrarily; and, while the process impoverishes many, it actually enriches some. The sight of this arbitrary rearrangement of riches strikes not only at security but [also] at confidence in the equity of the existing distribution of wealth.Those to whom the system brings windfalls, beyond their deserts and even beyond their expectations or desires, become "profiteers," who are the object of the hatred of the bourgeoisie, whom the inflationism has impoverished, not less than of the proletariat. As the inflation proceeds and the real value of the currency fluctuates wildly from month to month, all permanent relations between debtors and creditors, which form the ultimate foundation of capitalism, become so utterly disordered as to be almost meaningless; and the process of wealth-getting degenerates into a gamble and a lottery.Lenin was certainly right. There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose.
Has The Market Process Degenerated Permanently Into A Gamble And A Lottery?
It’s been a fascinating week as many stock markets in the world go into a melt-UP mode.
Here is how mainstream media describes last week’s euphoria.
From Reuters[2] (bold added): Stock markets around the world rose on Tuesday and the yen hit a seven-year low as news of a snap election and a delayed tax increase in Japan bolstered hopes for new stimulus measures a day after data showed the country was back in recession.
From Reuters[3](bold added): World stock markets and oil prices rallied on Friday, fueled by hopes for global growth after China rolled out a surprise interest rate cut and the European Central Bank indicated it would step up asset purchases to boost the euro zone economy.
Notice the difference? Have stock markets been rising because of POSITIVE real fundamental developments or has economic growth or earnings been the drivers? Or have markets been rising out of HOPES from political interventions? The follow-up question to the latter is WHY the need for political interventions?
Understanding the current pricing process is very important because they lay or build on the foundations of future trends. If the markets are indeed jubilant because of HOPES, how sustainable will hope be? Will hope be transformed to reality?
Yet until when will markets tolerate the gaping departure between asset price levels from fundamental economic developments? Or has pricing process been totally overhauled to reflect on ‘this time is different’? Or said differently, has the basic laws of economics been permanently overturned? What will be the response when hopes will not be met? Even more political interventions? Are there no limits on HOPE?
In short, has the process of wealth-getting degenerated permanently into a gamble and a lottery?
Yet there are two ways to focus on these. One is to observe the effects, the other is to vet on the causes. The mainstream has always opted to focus on the former than the latter. I will take a look at the latter.
The astonishing barrage of interventions this week, which really has been a continuation from the series of actions since the October volatility, emits the creepy feeling that the world have been in a crisis. Why the recourse to increasingly MORE emergency measures for the Bank of Japan (BoJ), the People’s Bank of China (PBoC) and the European Central Bank (ECB)? Why the acts of desperation? Or why the panic?
Financial Risk Warning from UK’s David Cameron, the BIS (again), RBA Glen Stevens and more…
Market risks as I have noted before has already gone mainstream.
I have previously pointed out that the Institute of International Finance (IIF), the Bank for International Settlements, the IMF, the OECD, the ADB, even the Philippine central bank Bangko Sentral ng Pilipinas has been directly or subtly warning of risk build-ups via different channels, particularly carry trades, excessive low volatility, over-valuations, property bubbles, credit risks, capital outflows or even “chasing the markets”. Even the POTUS (President Obama) and Fed chair Janet Yellen has raised similar concerns but in a more discreet manner.
The difference is that it is being ignored or dismissed as something alien.
“Bullish” market participants have either shunted such concerns in the belief that bad things will never happen to them or the denigration of history—which iconoclast Nassim Taleb author describes, “ gamblers, investors, and decision makers feel that the sort of things that happen to othrs would not necessarily happen to them”[4]—or have come to think that they know when to make the “exit” even when this comes in cognitive dissonance with the impression that every dip should bought—or have come to think that stock markets have become a one way street.
Well for the past two weeks, some international political agents went on air again to warn of financial risks.
At the close of the G-20 meeting this week, UK’s Prime Minister David Cameron writing at the Guardian raised the concerns on what he sees as red lights flashing for a global financial crisis[5]: (bold mine)
Six years on from the financial crash that brought the world to its knees, red warning lights are once again flashing on the dashboard of the global economy.As I met world leaders at the G20 in Brisbane, the problems were plain to see. The eurozone is teetering on the brink of a possible third recession, with high unemployment, falling growth and the real risk of falling prices too. Emerging markets, which were the driver of growth in the early stages of the recovery, are now slowing down. Despite the progress in Bali, global trade talks have stalled while the epidemic of Ebola, conflict in the Middle East and Russia’s illegal actions in Ukraine are all adding a dangerous backdrop of instability and uncertainty.The British economy, by contrast, is growing. After the difficult decisions of recent years we are the fastest growing in the G7, with record numbers of new businesses, the largest ever annual fall in unemployment, and employment up 1.75 million in four years: more than in the rest of the EU put together. But the reality is, in our interconnected world, wider problems in the global economy pose a real risk to our recovery at home. We are already seeing that, with the impact of the eurozone slowdown on our manufacturing and our exports.
In the past, political authorities used to be last in seeing the emergence of a crisis. Today, bubbles have become so apparent that even political authorities have jumped into the bandwagon to ring alarm bells.
Of course the interests of political authorities vary. Such has been expressed by their opinions or by their actions. Those who raise concerns are presently not suffering from any economic strains but are concerned of the risks, while those being affected have desperately been pushing the monetary tools in the hope for a miracle.
Just a week back, the Bank for International Settlement published a November speech[6] by its general manager, Mr. Jaime Caruana, who again for the fourth time this year, admonishes on the risks of a meltdown from a dramatic global debt build-up.
Donning the hat of the Austrian school of economics Mr. Caruana said,
This excess sensitivity is just a symptom of the fact that leverage increases procyclicality. Small downside shocks to the economy become transformed, through various channels, into large ones. But the seeds of the problems that materialise in the bust are in fact sown during the boom. There, the procyclicality operates on the upside: borrowers can expand their balance sheets and take on risks too easily, pushing up asset prices and making it easier still to borrow more. The boom sets the stage for the subsequent bust.
Mr. Caruana talks about the three stages of debt which he believes leads to a debt trap, namely the “origin is the build-up of financial imbalances”, “debt accumulation fosters misallocations of real resources” and finally “financial booms mask deficiencies in the real economy”.
And so that’s why I said debt trouble comes in threes. The combination of these three types of debt-related phenomenon together with policies that neglect the power of financial cycles can give rise to serious risks in the long term. A sequence of such boom-bust cycles can sap strength from the global economy. And policies–fiscal, monetary and prudential –that do not lean sufficiently against the build-up of the financial booms but ease aggressively and persistently against the bust risk entrenching instability and chronic weakness: policy ammunition is progressively eroded while debt levels fail to adjust. A debt trap looms large.
Meanwhile, Australia’s central bank governor Glen Stevens also cautioned on a boom-bust cycle in the nation’s housing markets which according to the Wall Street Journal[7] would damage the resource-rich economy. Governor Stevens seems to be in a fix since he says steps must be taken to cool surging lending for property investment but sees low levels of interest rates “well warranted on macroeconomic grounds”
The Reserve Bank of Australia’s conundrum reinforces my theory of the politics of monetary easing policies: I recognize the problem of addiction but a withdrawal syndrome would even be more cataclysmic.
Curiously since the melt-UP from the lows of October, Australia’s stock markets as measured by the S&P/ASX 200 was sharply down by 2.75% this week and 4.46% during the past two weeks which seems to have diverged from global stocks. Risk ON isn’t being shared by many Asian stocks.
The US Federal Reserve Open Market Committee (FOMC) in their last October meeting also voiced apprehensions over developing imbalances as manifested by systemic debt build up and excessive asset valuations which was reflected on the board's “minutes”.
While noting that “U.S. financial system appeared resilient to shocks” the Fed noted (bold added)[8]: However, the staff report also pointed to asset valuation pressures that were broadening, as well as a loosening of underwriting standards in the speculative corporate debt and CRE markets; it noted the need to closely monitor these developments going forward."
Interestingly even a Keynesian high priest, Financial Times’ Martin Wolf seems to have imbued the Austrian Business Cycle way of dissecting current risk conditions.
Mr. Wolf as quoted by Austrian economist Bob Murphy (bold mine)[9]: Huge expansions in credit followed by crises and attempts to manage the aftermath have become a feature of the world economy. Today the US and UK may be escaping from the crises that hit seven years ago. But the eurozone is mired in post-crisis stagnation and China is struggling with the debt it built up in its attempt to offset the loss of export earnings after the crisis hit in 2008. Without an unsustainable credit boom somewhere, the world economy seems incapable of generating growth in demand sufficient to absorb potential supply. It looks like a law of the conservation of credit booms….Incredibly, the eurozone seems to be waiting for the Godot of global demand to float it off into growth and so debt sustainability. That might work for the small countries. It is not going to work for all of them…These credit booms did not come out of nowhere. They are the outcome of the policies adopted to sustain demand as previous bubbles collapsed, usually elsewhere in the world economy. That is what has happened to China. We need to escape from this grim and apparently relentless cycle. But for now, we have made a Faustian bargain with private sector-driven credit booms. A great deal more trouble surely lies ahead.
No bubble eh?
Record Stocks, Record Debt
Interestingly as the above personalities aired their warnings, debt metrics continue to swell at unprecedented rates.
Global corporate bonds have bulged to a record $3.8 trillion, surpassing all the issuance of 2013, and have been fast approaching the $4 trillion mark with a month to go, according to a report from Bloomberg[10].
US investment grade (IG) has sold $1.1 trillion. Reuter’s tallyboard sees US IGs at $1.05 trillion (still) a record (see left chart).
Meanwhile junk bonds, with ratings below BBB (S&P) and Baa3 (Moody’s) has jumped to $336.2 billion from 2013’s $315.5 billion according to the same report from Bloomberg.
Who says borrowing and lending activities has been down in Europe? Well corporate bond issuance in 2014 has been at 816.5 billion euros ($1 trillion) so far, and this has exceeded 2013 levels at 761.7 billion which now has also reached the 2010 levels again from Bloomberg data.
Meanwhile global high yield borrowings for mergers and acquisitions have so far accrued to $92.5 billion up 40% from last year according to a Wall Street Journal Blog[11] (right window).
The recent October volatility seems to have affected M&A activities. Again the same report says that “While global M&A value for the year stood at $2.90 trillion as of Thursday, the highest level since 2007, October’s deal value, at $227.1 billion, was the weakest for October since 2011, according to Dealogic.”
The US accounts for two-thirds of the world’s junk bond offerings. And M&A based bond issuance accounts for roughly 30% of all bonds borrowings for the year
As a side note, milestone highs for IPOs too, again from Reuters[12]: This week’s $2.3 billion initial public offering from New York-based REIT, Paramount Group, lifted global IPO activity to $211.4 billion for year-to-date 2014, a 53% increase compared to a year ago and the strongest year-to-date period for new listings since 2010. Paramount’s offering was the 38th IPO greater than $1 billion so far this year — the highest number of multi-billion dollar IPOs since 2007.
Ok enough for statistics. The global economy has been materially slowing. Yet global borrowing has been racing to reach record highs.
Here are some vital questions: If central bank magic won’t immediately work, where expected growth will barely materialize, then how will record debt be repaid even at zero bound? Where will debtors get their resources?
Speaking in the context of Hyman Minky’s Ponzi finance, will the rise in equity prices be sustained and at a rate enough for highly levered companies to extract and convert their assets into cash to service debt? What happens if markets don’t perform as expected?
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A clue to the answers can be seen above: record US stocks has been starkly divergent with High yield securities (high yield ETF left from IIF’s latest outlook[13], and high yield index minus 10 year treasury right). As another Bloomberg report indicates[14]: Buyers in the riskiest part of the U.S. corporate bond market are demanding the highest relative yields in almost two years, a sign the era of wide-open funding to the neediest borrowers may be nearing an end.
There has been a strong correlation (.75%) between the actions of high yield securities with stocks, that’s because as pointed above, high yield debt has used financed M&As as well as buybacks and LBOs, thus helping spur asset price levels.
Can such the divergence last? The Gavekal team gives us a clue[15]: On June 24th, the spread between between high yield bonds and 10-year treasuries narrowed to 222 basis points. Since that day, the spread has widened by 158 basis points to 380 basis as of yesterday. On October 15th, the spread reached 431 basis points which was the widest spread since late 2012. Perhaps most importantly, however, junk spreads have widened back out during November even as the S&P 500 has pushed higher. We are now in a situation where either this relationship has come unhinged or we would need a sharp rebound in credit or correction in equity prices in order to reestablish the status quo from the past 5+ years. We will definitely be keeping our eye on this going forward.
Final question: in the face of collapsing commodity prices, conspicuous weakening of many emerging markets, a material slowdown in China, Japan’s recession and European stagnation in the face skyrocketing debt, has the concerns raised by the above parties been unwarranted?
Or have markets been afflicted by ignoring facts or what I call as Aldous Huxley syndrome (Facts do not cease to exist because they are ignored)? Or will there be a growth miracle that will emerge from the torrent of unproductive debt?
ECB’s QE: Hope is Now the ONLY Strategy
The mainstream focuses on rising stocks. But the whys have been dismissed.
Put differently, why have some of the major central banks embarked on a series of easing measures?
ECB President Mario Draghi sent global stocks into a buying frenzy when his Friday’s speech fired up speculations that the ECB will expand into a full-scale quantitative-easing program similar to the US.
The Bloomberg quotes Mr.Draghi’s speech: We will do what we must to raise inflation and inflation expectations as fast as possible, as our price-stability mandate requires,” the ECB president said at a conference in Frankfurt today. Some inflation expectations “have been declining to levels that I would deem excessively low,” he said…There is a combination of policies that will work to bring growth and inflation back on a sound path,” he said. “If on its current trajectory our policy is not effective enough to achieve this, or further risks to the inflation outlook materialize, we would step up the pressure and broaden even more the channels through which we intervene, by altering accordingly the size, pace and composition of our purchases.”
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Europe’s problem hasn’t been because inflation has been “low”, rather Europe’s economic woes has been mosaic of a heavily politicized economy: an outsized welfare state and bureaucracy, onerous taxes, boom-bust cycles and increasing interventions in the productive economy.
The huge level of government spending has extrapolated to the squeezing out of productive economic activities from economic agents. This has led intra Eurozone governments to become increasingly dependent on debt to finance political spending.
Since the unraveling of the Eurozone crisis, there has been much brouhaha over so-called ‘austerity’, yet much of the controversy over austerity hasn’t been true. The level of government spending[16] remains laughably high (right) as with Eurozone debt levels[17] (left). Major European economies added debt rather than having to trim them contrary to the design of austerity programs.
Generally, the Eurozone remains on a fiscal deficit as government debt-to-gdp ratio* nears a record 93% in spite of sham ‘austerity’.
These politically induced imbalances have been exposed by the ECB impelled boom bust cycle. Since the advent of the euro, the convergence of interest rates compounded by the expansionary central bank fueled an intra-regional bank lending financed asset inflation[18]. When the US mortgage crisis spread, such imbalances expressed through overleveraging of asset prices imploded. This was manifested through a financial crisis.
*When the smoke and mirrors of a credit driven statistical gdp have been exposed, then debt to gdp ratio soars. The Eurozone should serve as a fine example.
Henceforth, bank based credit activities have been curtailed because of excessive borrowing and lending has impaired the balance sheets by both borrowers and banks.
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”[19]. 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[20].
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[21]. In realization that that markets has been unsatisfied, the ECB floated the idea to include corporate bonds[22].
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.
But as I have previously noted, there are political and legal impediments to the inclusion of government debt[23]. In terms of politics for instance, Beppe Grillo leader of Italy’s second most powerful political group the Five Star Movement sees Italy at war with the ECB.
In addition, the acrimonious relations with Russia have also been contributing to the anxieties or to business uncertainties.
Because Eurozone’s problem has been fundamentally a balance sheet problem compounded by entrenched political obstacles, monetary easing has been failing to work as a strategy because it deals with the symptoms (dis-inflation, lack of bank lending) than the disease—impaired balance sheets. The public’s response can be analogized as: you can lead the horse to the water but you can’t make it drink.
The Eurozone needs to empower the productive segments of her society for them repair balance sheets by reducing, if not eliminating, political barriers. Real economic recovery should pave way for her residents to normalize credit activities.
And it has certainly been untrue that there has been a lack of credit activities because as noted above, the Europe’s corporate bond markets have been vibrant. Delving further, Investment Grade (IG) bonds have reportedly been in short supply[24] while equity convertible contingent convertible or coco bonds have doubled this year at $31 billion from $15 billion in 2013 based on 20 deals[25] basically due to zero bound subsidies.
In short, ECB’s credit easing programs (which confiscates arbitrarily an important wealth of their citizens) have been transferring resources to the big players through the bond and equity markets (thereby enriching some) that comes at the expense of or has been financed by resident euro holders (while in the process impoverishes many).
Same policies, same effects.
Finally, observe that the Eurozone’s current ferocious stock market rally comes in the face of a frantic doubling down on policies by the ECB—two interest rate cuts, negative deposit rates, TLRO, QE based on covered bonds and asset bonds with promises to include corporate bonds and sovereign debt.
So the ECB’s intensified program will only deepen the capital consumption process through boom bust cycles and or from more misallocation of resources rather than heal Europe’s economy.
The bet now from which the mainstream’s HOPE has been based on is if the ECB’s policies will usher in a temporary credit inflation boom.
So far, all what these time compressed policies have done has been to incite spurts rather than a boom.
Yet time will tell how the current economic slowdown will affect existing debt problems along with the newly acquired ones
Also the ECB’s problem hasn’t just domestic it has an international component which should be transmitted via the euro and capital flows. But this would be a topic for another day.
Interest Rate Cuts: Beijing We Have a Problem. There is Big trouble in Big China!
I have been writing about China’s government desire to pump a stock bubble in order to camouflage her deflating property bubble. It could also be that the Chinese government wishes to find alternative avenues for overleveraged companies to access funds.
Yet like the ECB, the Chinese government has infused a series of monetary and other political actions into the stimulus crucible. As noted last week, the Chinese government has launched “targeted easing” last June, has resorted to selective bailouts of firms which almost defaulted last July, imposed price controls on stock market IPOs last August, injected $125 billion over the last two months[26].
Last week, November 17, the much ballyhooed China-Hong Kong connect went on stream.
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And as expected, the hype turned out to be a dud. The Hang Seng Index fell 2.7% over the week, while China’s Shanghai index eked out a weekly gain of .32% from another Chinese government “pump” last Friday.
Based on available bias, mainstream media tries to rationalize the fund flow plunge to ludicrous post hoc narratives, such as prices has been “discounted”, “poor track record of Chinese managers” or resistance to change on new market rules.
Why has the lackluster interest from Hong Kong not been from signs of Hong Kong’s deflating bubble?
And since I expected this puffery to eventually fade, I wrote: Given the short term nature of government pump, the Chinese government would need more gimmicks to keep the stock market bubble inflating[27].
And more gimmicks it has been!
Given the weak reception via plummeting fund flows and prices, the Chinese government announced an offer to inject of 50 billion yuan ($8.17 billion) of short term funds to ease a shortage of cash due to an estimated 1 trillion yuan worth of lock up from IPOs[28]. Seven companies are supposed to list on Monday, November 24.
IPO lock up? An IPO lock up involves the supply of shares owned by majority shareholders and company insiders whose company has gone public. The lock up normally doesn’t include funds exchanged for allotted IPO shares sold to the public. That’s unless the Chinese government has a unique rule on money proceeds from IPOs
Besides since daily trades are determined by marginal buyers and sellers of stocks, majority shareholders are usually voluntarily “locked up” even if the latter trades some of their marginal shares.
So unless there has been a special rule, under normal conditions, there won’t be shortages of cash from IPOs, for the elementary reason that for every security bought is a security sold. There is NO fund flows in the stock market, the changes are in the composition of ownership.[29]
I would suspect that given rapidly slowing credit activities (as noted last week) which has been attendant with the spreading and intensifying decline of housing prices, it is here where the cash shortages have been apparent. Declining home prices has affected even China’s capital Beijing where home prices fell for the first time in almost two years as new-home prices dropped in October in 67 cities of 70 tracked by the government[30].
Of course my suspicion was strengthened when the Chinese central bank, PBoC, cut interest rates for the first time in two years.
Here is an interesting take by the Wall Street Journal[31] on Friday’s ‘surprise’ interest rate cut (bold mine): China’s central bank succumbed to political and market pressure and cut interest rates for the first time in more than two years, in a sign that the country’s leadership is leaning toward more sweeping measures to bolster flagging economic growth. The surprise move by the People’s Bank of China late Friday comes after a series of piecemeal easing measures that failed to encourage banks to lend and companies to borrow. Several economic indicators—from investment growth to factory production to retail sales—showed weakness last month. Economists say China could miss its annual growth target—set at about 7.5% for 2014—for the first time since the 1998 Asian financial crisis.
Why interesting? Because the article admits that “after a series of piecemeal easing measures that failed”, the Chinese government “succumbed to political and market pressure”, which implies that the Chinese government has been desperately attempting to cobble up every accessible resources to apply band aid patchwork to the spreading and deepening cracks of China’s credit-property bubble!
Beijing we have a problem. There is big trouble in big China!
And here’s more from the same article (bold mine): Meanwhile, a lack of real demand for loans, rather than a shortage of credit, is also holding the economy back. That explains a recent drop in the rate of overall credit expansion in China despite the PBOC’s easing efforts.
The “lack of real demand for loans rather than a shortage of credit” exemplify my analogy where you can lead the horse to the water but you can’t make it drink. One cannot ramrod credit to entities already satiated by or drowning in credit or has been suffering from balance sheet problems…even at zero bound!
Last week I noted that state owned companies have been taking over property activities in Guangzhou which should add to the existing glut of inventories. The same article says that: Big-ticket spending is already picking up: Since mid-October, Chinese authorities have approved railway and airport projects valued at 845 billion yuan ($138 billion).
It is unclear whether this has been part of the announced mini stimulus. In the past the Chinese government has vehemently denied that this will be in the same amount of the 2008 stimulus at $586 billion. But when one begins to add up spending here and there, injections here and there, these may eventually lead up even more than 2008
Yet again the Chinese government will be expanding ghost projects just to attain their 7+% statistical growth target.
Such obsession to statistical G-R-O-W-T-H has been a key ingredient to the Chinese boom bust cycle.
Friday’s interest rate cut involves the reduction of one-year loan rate by 0.4 percentage point to 5.6% while at the same time paring down deposit rate to 2.75% from 3% but gave banks greater flexibility to raise deposit rates above that benchmark.
Those cuts are clearly designed to punish depositors and reward debtors.
Yet if the “lack of real demand for loans rather than a shortage of credit” dynamic will persist, then why should the Chinese economy recover even if rates will be slammed down to zero?
Finally global investors are reportedly doubling their exposure on Chinese government credit default swaps as Chinese overseas debt balloon.
Here is the most interesting part from a Bloomberg report[32]: The number of listed non-financial Chinese companies with debt twice that of equity has jumped to 255 this year from 163 in 2007, according to Bloomberg-compiled data on 4,193 firms.
While still small, the rate of debt growth has been prolific. This partly explains why Hong Kong investors have avoided Chinese stocks.
If the ecstasy from the interest rate cuts fades, then the Chinese government will have to devise a new gimmick to spur the stock market higher.
The Magic of Abenomics: Triple Dip Recession!
Media says that Japan’s 3Q economic contraction which officially became a recession was a surprise. It may have been a muted jolt since markets moved aggressively up a day after the news.
Japan’s 2014 recession signifies the third recession in four years. This makes it a triple dip recession. The depth of the 3Q contraction equals that of 2011.
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But here is the more important picture. The breakdown of Japan’s 3Q performance (left) from Japan’s cabinet office reveals of MORE problems ahead.
Investments had really been totally devastated (red rectangle) which has prominently weighed on private demand[33].
This shows of how Abenomics has stymied investments, by reducing profits and transferring them to the 1% of companies who corralled 80% of record profits from April to September as I noted last week.
This also shows of the effects of the buybacks engaged by many of the firms where the opportunity costs of buybacks have been investments.
This signifies a fantastic showcase of how the distortion of the pricing mechanism adversely impacts entrepreneur’s economic calculation, disrupts on the market based allocation of resources, and induces imbalances.
While consumers spending have marginally recovered, they may signify a dead cat bounce. Why? Because a collapse in investments hardly will extrapolate to any consumption growth. Where will profit, earnings or income growth come from to finance consumption?
The only possible source: stock market speculation.
The saving grace for Japan’s 3Q statistics has been on “public demand” or government spending (green rectangle).
Yet this means that the real economy has been worse off MORE than the headline numbers suggest!
Secondarily, the lift from government spending means BIGGER BUDGET DEFICITS—(see right window from the Ministry of Finance) as tax revenues swoon due to recession while public spending surges.
And this would pressure Japanese politicians to impose even HIGHER TAXES in the FUTURE.
And this is why PM Abe has opted to dissolve the parliament last week where elections are likely to be held possibly in mid-December. PM Abe has emphasized that the elections will be a mandate on Abenomics[34]: "I want to make it clear through the debates during this general election, whether our economic policies are right or wrong, or if there is no other choice available to us" he said, "I will step down if we fail to keep our majority because that would mean our 'Abenomics' is rejected," the prime minister added.
The idea for the swift or snap elections may be to reduce campaign period for the opposition. So PM Abe will rely on his machinery and from his residual political capital to get a mandate. PM Abe seems confident to win from a campaign blitz against disorganized opposition.
Of course, cut spending, cut taxes and reform by liberalization are real alternatives, but this won’t be the route taken. The mainstream perspective on public management has been embedded from the path of least resistance; borrow, borrow, borrow in order to spend, spend, spend. As an old saw goes, you can’t teach old dogs new tricks
While PM Abe has pledged to delay sales taxes by 18 months, I doubt if this promise will be kept, so as with plans to cut corporate taxes in 2015. All he needs is a mandate to ensure of the tax raising projects.
Debt servicing already eats up almost 25% of Japan’s budget as of 2014. Yet 43% of the budget has been raised from debt. And the Bank of Japan with its QE plays an increasing role of monetizing Japan’s deficit. The Bank of Japan as of October holds 23% of JGBs.
And this reinforces if not validates my earlier suspicion that the QE 2.0 has been designed by the Japanese government for deficit monetization[35]:
And speaking of recession, I believe that the BoJ’s has positioned itself to cover the added fiscal deficits from a possible economic downturn. This is what the BoJ’s QE 2.0 has been about. The 2% inflation rate target is just a camouflage.With fiscal deficits expected to widen, where debt servicing is now equivalent to 25% of government budget and where the difference between taxes and social spending leaves Japan’s 2015 budget in a 7 trillion yen hole…all of which has been based on optimistic expectations, this leaves the BoJ as the only major source of financing for government or their JGBs.So the BoJ may have expanded her QE to accommodate more monetization of fiscal deficits aside from possibly including the possible shift by GPIF out of domestic bonds. Of course the latter could function as a decoy as to shield the Japanese government from revealing its anxieties. Time will tell. As September has passed, Japan’s quarterly GDP should be out anytime soon.
Japanese stocks suffered a one day sell off from the recession. The next day almost the entire losses had been wiped out.
Why? Because the Japanese government promised to include about ¥2 trillion in its fiscal 2014 supplementary budget[36] which include fuel cost subsidy to fishermen, revive a ¥ 100 billion housing eco-point system, discount on collection system on expressways in favor of trucks, and shopping coupons distributed by local governments.
So many plans with few resources other than to print money and to consume residual savings. Unless the Japan’s government realizes that the pillar of the economy are the markets then all fancy doleouts will eventually fail.
At the end of the day, there is no such thing as a free lunch. Costs of financing political free lunches will be paid for by more confiscation until there is nothing to confiscate.
Final Comments In Bullets
-I expect Friday’s buying orgy to spillover to Asia at the early week.
-Given the marvelously overbought conditions for most markets, another bout of correction seems in store. However if stock markets of developed economies continue with its vertical ascent, expect the unexpected. The basic rule: NO trend goes in a straight line; what goes up must come down.
-Central banks of Japan, ECB and China seem in a state of panic, this would mark the riskiest time for market positioning.
-Record stocks amidst record debt as the real economy means heightened credit and market risks.
-Those who believe that the Philippines will be immune from external forces should see how 2007-8 unfolded; as philosopher and essayists George Santayana famously warned, Those who cannot remember the past are condemned to repeat it
[1] John Maynard Keynes The Economic Consequences of the Peace 1919 PBS.org pp. 235-248.
[2] Reuters.com Markets up on Japanese stimulus hopes; Wall Street at new highs November 18, 2014
[3] Reuters.com China rate cut, European stimulus hints lift markets November 21, 2014
[4] Nassim Nicolas Taleb Fooled by Randomness: The Hidden Role of Chance in Life and in the Markets p.26 Google books
[5] See UK Prime Minister David Cameron Warns of Looming Global Financial Crash November 18, 2014
[6] See BIS Chief Jaime Caruana Warns of the Three Troubles from Debt and its Outcome: the Debt Trap November 15, 2014
[7] Wall Street Journal Australia’s Central Bank Warns on House Prices November 18, 2014
[8] Minutes of the Federal Open Market Committee October 28-29 2014 federalreserve.gov
[9] Robert P Murphy Martin Wolf Unwittingly Confirms Austrian Business Cycle Theory Mises Canada November 11, 2014
[10] Bloomberg.com Bond Record in Sight as Sales Near $4 Trillion: Credit Markets November 20, 2014
[11] Wall Street Journal CFO Blog Junk-Bond Surge Fuels M&A November 11, 2014
[12] Reuters Knowledge Effect Weekly Investment Banking Scorecard November 21, 2014
[13] IIF Weekly Insight WEAKER GROWTH, UNEASY MARKETS IIF.com November 20, 2014
[14] Bloomberg.com Riskiest Junk Borrowers Imperiled as Borrowing Costs Jump November 20, 2014
[15] Gavekal USA Team Junk Bonds Not Confirming S&P 500 Record Highs Gavekal Capital Blog November 20, 2014
[16] Steve H. Hanke E.U. Austerity, You Must Be Kidding October 7, 2014
[17] Zero Hedge Somone Really Needs To Explain To Europe What "Austerity" Means October 23, 2014
[18] See Phisix: The Convergence Trade in the Eyes of a Prospective Foreign Investor November 11, 2012
[19] See The ECB Takes Keynesianism to the Limits via Negative Deposit rates June 5, 2014
[20] Channel Asia Bank borrowing in new ECB loans programme disappoints September 18, 2014
[21] See ECB Embarks on QE, European Stocks Fall October 21, 2014
[22] See Rumors of ECB Expanded QE on Corporate Bonds Sends Global Stocks into a Buying Orgy October 22, 2014
[23] See Phisix: More Panic? BSP Orders Banks to Raise Capital as 2Q Consumer Property NPLs Swells! October 27, 2014
[24] Financial Times Blue-chip bond issuers cannot meet demand November 18, 2014
[25] Financial Times Big banks find strong appetite for coco bonds November 18, 2014
[26] See Phisix: Will Kuroda’s QE 2.0 Trigger a Global Financial Market Earthquake? November 17, 2014
[27] See More Chinese Government Massaging of the Stock Market: The Hong Kong-Shanghai Connect; Added Symptoms of HK’s Bubble: Prison Cell condos November 11, 2014
[28] Bloomberg.com PBOC Reported to Inject Cash as IPO Demand Leads to Cash Squeeze November 18, 2014
[29] See The Myth Of Money Flows Into The Stock Markets April 5, 2009
[30] Bloomberg.com Beijing Home Prices Drop for First Time in 2 Years on Discounts November 18, 2014
[31] Wall Street Journal China Central Bank Cuts Interest Rates November 21, 2014
[32] Bloomberg.com Hedge Hunters Double Default-Swaps as Views Split: China Credit November 21, 2014
[33] See The Magic of Abenomics: Triple Dip Recession! November 17, 2014
[34] Aljazeera.com The future of 'Abenomics' November 22 2014
[35] See Phisix: BoJ’s QE 2.0 Hail Mary Pass Sends Global Stocks Skywards! November 3, 2014
[36] AsiaOne Japan's GDP data may fuel calls for bigger stimulus measures November 19, 2014
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