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.

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

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

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

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

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

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

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

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

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

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

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

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

Nonetheless here are some interesting commentaries from various experts.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

We see the same concerns even in the mainstream. 

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

SNB Abandons Swiss Franc Euro cap, Swiss Stock Market Crashes

In a world of central planning, all it takes to destabilize the markets is for authorities to succumb to their caprices.

The Swiss central bank, the Swiss National Bank, suddenly decides to end the 1.2 franc per euro cap.

From the Bloomberg:

The Swiss National Bank unexpectedly scrapped its three-year policy of capping the Swiss franc against the euro in a u-turn that may change the perception of a century-old institution known for reliability.

In a surprise statement that sent shockwaves through equities and currency markets, the central bank ended its cap of 1.20 franc per euro and reduced the interest rate on sight deposits, deepening a cut announced less than a month ago.

The shift marks an attempt by the SNB to reinforce its defenses of the economy before government bond purchases by the European Central Bank that could crumple the franc cap. The franc surged after the announcement, Swiss stocks including UBS AG tumbled and the chief executive of watchmaker Swatch Group AG said the policy shift would hurt exports. SNB President Thomas Jordan defended the move, saying surprise was necessary.

It’s pandemonium on Swiss financial markets as the EUR/CHF collapse.

Yields of 10 year Swiss bond collapses.

Just look at that bond yield collapse (bond rallies)! Yields of 7 year Swiss bonds turn negative! (all charts above from investing.com)

Swiss stocks, as of this writing, have crashed 10%!

As been repeatedly stated here, crashes have become real time events.

Speculations are rife that SNB actions have signified as hints to a massive ECB QE that may come next week. And has most likely been the reason for the massive swing from losses to substantial gains for other European Stocks.

(charts above from Bloomberg)

Gold has so far soared 2%. US stocks have been wildly fluctuating from losses to gains back to losses.

Curiously just last Monday the SNB said that they would maintain the franc-euro cap.

From Reuters (hat tip Zero Hedge)

The Swiss National Bank's cap on the franc at 1.20 per euro will remain its key monetary policy tool, the central bank's vice-chairman said in a television interview broadcast on Monday.

"We took stock of the situation less than a month ago, we looked again at all the parameters and we are convinced that the minimum exchange rate must remain the cornerstone of our monetary policy," Jean-Pierre Danthine told RTS.

The above is an exhibit of how financial markets have become almost entirely dependent on central bank policies.

And yet the outcome of centralization is a black swan event. So far this has been a Swiss financial markets affair. How this will affect trades and investments embedded on the franc-euro cap outside Switzerland remains to be seen.

We truly live in interesting times.

The French Government Uses Free Speech as Pretext to Suppress Free Speech

At the Ron Paul Institute, Daniel McAdams comments that the French government has used the Charlie Hebdo incident as a convenient excuse to crack down on Free speech (“After Free Speech Rally, France Cracks Down on Free Speech”)

Well that didn't take long. Just three days after the French government hosted dozens of foreign leaders in a "unity rally" to defend free speech in the wake of last week's shooting at the Charlie Hebdo magazine, France has begun arresting its citizens for actually exercising free speech.

According to news reports, more than 50 French citizens were arrested today and charged with offensive speech — the same kind of speech that was the trademark of of the Charlie Hebdo publication. 

None of those arrested were charged with links to terrorism or any real crime. Instead, they are facing up to seven years in prison for making statements the French authorities claim are supportive of the shootings or are anti-Semitic.

New directives from the French Justice Ministry provided the legal basis for arresting those deemed "supportive" of the attacks or who express anti-Semitic or racist sentiment. Anti-Muslim sentiment was not included in the government's new arrest orders, despite a dramatic spike in actual attacks on French Muslims since the shootings. The justice ministry claimed the new anti-speech measures were necessary to protect freedom of expression.

Among those arrested is controversial French comedian Dieudonné M’bala M’bala, charged with being "an apologist for terrorism" and facing jail time over a Facebook post making fun of Sunday's "unity rally." Exercising free speech by making fun of the French government as it celebrates free speech is apparently a crime.

The French government has long banned Dieudonné's comedy performances over his controversial jokes, even as French authorities celebrate Charlie Hebdo's controversial jokes.

Those arrested for exercising free speech in France will be charged under "special measures" put into place after the shooting, which provide for immediate sentencing of the accused. Some 130,000 military and security forces have been deployed on the streets of France and ordered to keep a particular eye on incidents that could bring violence against the police.

Unreported in the US, Charlie Hebdo has long ties with the French Communist Party and after the shooting has moved its headquarters to the offices of Libération, a French newspaper with roots in the Communist Party-inspired unrest of May, 1968. One of most famous Charlie Hebdo cartoonists,Stéphane Charbonnier ("Charb"), was a long-time member of the French Communist Party. Currently the newspaper is considered "left wing" and is controlled by Edouard de Rothschild of the international banking family, which should provide some additional fodder for the conspiracy-minded.

France and Europe chokes under the noxious cloud of hypocrisy.

Judge Andrew Napolitano at the LewRockwell.com sees the same (bold mine)

The French government has prohibited speech it considers to be hateful and even made it criminal. When the predecessor magazine to Charlie Hebdo once mocked the death of Charles de Gaulle, the French government shut it down — permanently.

The theory of anti-hate speech laws is that hate speech often leads to violence, and violence demands police and thus the expenditure of public resources, and so the government can make it illegal to spout hatred in order to conserve its resources. This attitude presumes, as Wilson did when he prosecuted folks for publicly singing German songs during World War I, that the government is the origin of free speech and can lawfully limit the speech it hates and fears. It also presumes that all ideas are equal, and none is worthy of hatred.

When the massacres occurred last week in Paris, all three of the murderers knew that the police would be unarmed and so would be their victims. It was as if they were shooting fish in a barrel. Why is that? The answer lies in the same mentality that believes it can eradicate hate by regulating speech. That mentality demands that government have a monopoly on violence, even violence against evil.

So, to those who embrace this dreadful theory, the great loss in Paris last week was not human life, which is a gift from God; it was free speech, which is a gift from the state. Hence the French government, which seems not to care about innocent life, instead of addressing these massacres as crimes against innocent people, proclaimed the massacres crimes against the freedom of speech. Would the French government have reacted similarly if the murderers had killed workers at an ammunition factory, instead of at a satirical magazine?

And how hypocritical was it of the French government to claim it defends free speech! In France, you can go to jail if you publicly express hatred for a group whose members may be defined generally by characteristics of birth, such as gender, age, race, place of origin or religion.

You can also go to jail for using speech to defy the government. This past weekend, millions of folks in France wore buttons and headbands that proclaimed in French: “I am Charlie Hebdo.” Those whose buttons proclaimed “I am not Charlie Hebdo” were asked by the police to remove them. Those who wore buttons that proclaimed, either satirically or hatefully, “I am Kouachi” were arrested. Arrested for speech at a march in support of free speech? Yes.

What’s going on here? What’s going on in France, and what might be the future in America, is the government defending the speech with which it agrees and punishing the speech with which it disagrees. What’s going on is the assault by some in radical Islam not on speech, but on vulnerable innocents in their everyday lives in order to intimidate their governments. What’s going on is the deployment of 90,000 French troops to catch and kill three murderers because the government does not trust the local police to use guns to keep the streets safe or private persons to use guns to defend their own lives.

Meanwhile former Assistant Secretary of the US Treasury and former associate editor of the Wall Street Journal Paul Craig Roberts deems that the unfortunate Charlie Hebdo incident was instead a false flag

The Two Faces of Japan’s November Machinery Order Report

The mainstream sees the November Japanese Machinery Order report as  “positive”

For instance, this CNBC headline says “Japan November core machinery orders rise 1.3% on month” (bold mine)

Japan's core machinery orders rose a smaller-than-expected 1.3 percent in November from the previous month, government data showed on Thursday, suggesting capital expenditure among manufacturers could weaken.

The rise in core orders, which exclude those of ships and electric power utilities, compared with a 5.0 percent rise forecast by economists in a Reuters poll. It followed a 6.4 percent decline in October, the Cabinet Office data showed.

Compared with a year earlier, core orders, a highly volatile data series regarded as an indicator of capital spending in the coming six to nine months, fell 14.6 percent, against the median estimate of a 5.8 percent annual decline. The Cabinet Office lowered its assessment of machinery orders, saying the recovery is showing signs of stalling.

Japan’s Machinery Order based on Tradingeconomics.com charts

On the other hand the Zero Hedge reports a big slump on the same report: (bold original)

So much for that short-lived hope-fest that Abenomics was not a total and utter disaster. Japan Machinery Orders (excluding -rather ironically- volatile orders) plunged 14.6% Year-over-Year in November (missing expectations of a 6.3% drop) for the biggest fall since Nov 2009

What’s the difference? The framing.

Both looks at the same report but the point of emphasis differs. 

The mainstream sees the ‘positive’ the month on month change. On the other hand, the Zero hedge accentuates on the ‘negative’ or the year on year change.

What you see depends on where you stand.

But observe that in the mainstream report above, the 14.6% plunge in core orders was also reported, except that this has been buried in the third paragraph 

Yet here is the official data and report from Japan’s Cabinet  office: (bold mine)

-The total value of machinery orders received by 280 manufacturers operating in Japan decreased by 10.4% in November from the previous month on a seasonally adjusted basis.

-Private-sector machinery orders, excluding volatile ones for ships and those from electric power companies, increased a seasonally adjusted by 1.3% in November.

Notice of the omission of the total value of machinery orders? 

Yet Japan’s Cabinet office illustrated the collapsing total value of machinery orders, as well as, the private sector segment of the machinery orders statistics.

Now which of the two sources of information looks more like propaganda: the mainstream or the contrarian?

Philippine Bonds: Marginal Improvements for the Week, Deflation Signs in the Construction Industry!

It will be a truncated work week due to the Pope’s visit to the Philippines.

The Philippine bond markets closed the week with marginal improvements.

This comes in the light of the recent $ 2 billion fund raising by the Philippine government in the international bond markets as discussed last weekend.

Given the new funds injected, signs of liquidity strains should have materially eased.

Well it hasn’t. Maybe in the coming weeks but so far the pace of improvements hasn’t been substantial.

For now, only yields of 3 month bills have markedly eased. But it remains at June 2013 levels. Yields of 6 months and 1 year has moderated marginally.

Interestingly, not only has the inversion between yields the 5 year and 4 year deepened, the 5 year has also inverted with its 3 year treasury counterpart!!!

In short, 3 year yields have closed the week higher than 5 year. Why???

Overall, a glimpse at the spreads between 10 and 20 year vis-à-vis the shorter maturities, namely 6 months, 1 year and 2 years have hardly made any significant change this week.

Yet if we compare the effects of the latest borrowing by neighbor Indonesia which also raised $ 4 billion last week, the rally in Philippine bonds at the long end has been dwarfed by the Indonesian counterpart whether seen in both the yields of 10 or 20 year bonds (charts from investing.com)

All these are based on today’s actions.

The rally in Indonesian bonds is the scale of what I initially expected to happen here.

So everything hunky dory for Philippine bonds eh?

I have said this weekend that deflation has landed on Philippine shores as seen via crashing M3, negative CPI, the flattening of the yield curve and the spike in CDS.

Well to add to this, here is a more striking development: wholesale prices of construction materials in December has CONTRACTED!

Let me quote the National Statistics Office: (bold mine)

Compared to a year ago level, the Construction Materials Wholesale Price Index (CMWPI) in the National Capital Region (NCR) posted a negative rate of 0.1 percent in December. Last month it was recorded at 0.8 percent and in December 2013, 2.4 percent. The downtrend was due to 14.9 percent decline in fuels and lubricants index. Slower annual increments were also noted in the indices of cement at 2.3 percent and tileworks, 2.7 percent. The rest of the commodity groups either had higher annual mark-ups or retained their last month’s rates with the indices of asphalt and machinery and equipment rental still registering a zero growth...

On a monthly basis, the wholesale prices of selected construction materials in NCR further went down by 0.8 percent in December. This was attributed to the decreases registered in the indices of fuels and lubricants at -7.0 percent and cement, -0.2 percent. Higher monthly growths were, however, seen in the indices of hardware and reinforcing steel at 0.2 percent; plywood, 0.5 percent; plumbing fixtures and accessories, 0.6 percent; and PVC pipes, 0.1 percent. Movements in the other commodity groups either remained at their last month’s rates or had a zero growth. A series of price rollbacks was observed in gasoline, diesel and fuel oil during the month. Likewise, prices of cement were on the downtrend. On the other hand, higher prices were noticed in plywood, steel bars, PVC pipes, plumbing fixtures and accessories like faucet, kitchen sink and angle valves.

One can partly impute to construction deflation to crashing oil prices, but the declining prices of cement, machinery and equipment rentals and the others have likely been more about demand. 

In addition, rising prices of plumbing fixtures and other accessories could be about the falling peso, rather than demand based increases.

So why the collapse in construction material prices? Has there been a deluge of imports or production by domestic supply which has not been met by demand? Or has this been an essentially demand slowdown problem?

If this has been a manifestation of diminished demand, then this should be portentous for statistical GDP for the 4Q. 

Just to remind you of the contribution of construction industry on 3Q 2014 statistical GDP

From the expenditure side, based on NSCB data, construction grew 12.3% in 3Q 2014 year on year. Construction accounted for 9% of 3Q GDP.

From the industry side, construction expanded 11.94% in 3Q 2014 with the share of the industry to overall GDP at 5.83%.

The 5.3% 3Q GDP owes largely to construction and finance activities as discussed here.

From the expenditure perspective, if statistical CPI on a month-on-month basis, which has SHRANK for two successive months, could most likely be indicative of decreased consumption activities by domestic households (compounded by falling oil prices), if exports hardly picked up and where its gains has been offset by import growth (X-M) and if the above signifies a manifestation of a slowdown in construction, then where will 4Q statistical GDP come from?

It looks as if a big negative surprise for 4Q statistical GDP is in store for the high growth one way street looking consensus. We will know by January 29th.

So what has today’s orgasmic bidding spree to push the Phisix beyond 7,500 all about? The Philippine economy has reached a state of utopia where risks have all vanished?

US Stock Markets: Wild Intraday Pendulum Swings

Remember the fantastic volatility in December marked by 2 round trips which led to a 6.5% intraday swing in the Phisix? Such astounding bout of volatility has been replicated in the US last night

The tale of two roundtrips.

The Dow Jones Industrial opened the session strongly, as shown in the above chart from Google Finance. It reached a zenith of 274 points (+1.5%), then gave up all those gains towards midday.

By the afternoon, the Dow was down 136 points (-.77%).

From the intraday high to the lows was a swing of 410 points!!!  And from the lowest point, the main US bellwether crept up by 109 points to end the day off by only 27 points.

The sum of the nearly two round trips was an stunning 793 points or a 4.4% pendulum swing!

It’s not just the Dow, all key equity benchmarks as shown above from stockcharts.com experienced similar sharp gyrations.

Such sharp bouts of volatilities are hardly about stability, but about deepening tensions between the bears and the bulls. Sharp volatility as these usually surface during inflection points.

Ron Paul: Lessons from Paris

Former US congressman and libertarian Ron Paul explains that the latest terror events in Paris partly represented a blowback from foreign policies.

From the Ron Paul Institute  (bold mine)

After the tragic shooting at a provocative magazine in Paris last week, I pointed out that given the foreign policy positions of France we must consider blowback as a factor. Those who do not understand blowback made the ridiculous claim that I was excusing the attack or even blaming the victims. Not at all, as I abhor the initiation of force. The police blaming victims when they search for the motive of a criminal.

The mainstream media immediately decided that the shooting was an attack on free speech. Many in the US preferred this version of “they hate us because we are free,” which is the claim that President Bush made after 9/11. They expressed solidarity with the French and vowed to fight for free speech. But have these people not noticed that the First Amendment is routinely violated by the US government? President Obama has used the Espionage Act more than all previous administrations combined to silence and imprison whistleblowers. Where are the protests? Where are protesters demanding the release of John Kiriakou, who blew the whistle on the CIA use of waterboarding and other torture? The whistleblower went to prison while the torturers will not be prosecuted. No protests.

If Islamic extremism is on the rise, the US and French governments are at least partly to blame. The two Paris shooters had reportedly spent the summer in Syria fighting with the rebels seeking to overthrow Syrian President Assad. They were also said to have recruited young French Muslims to go to Syria and fight Assad. But France and the United States have spent nearly four years training and equipping foreign fighters to infiltrate Syria and overthrow Assad! In other words, when it comes to Syria, the two Paris killers were on “our” side. They may have even used French or US weapons while fighting in Syria.

Beginning with Afghanistan in the 1980s, the US and its allies have deliberately radicalized Muslim fighters in the hopes they would strictly fight those they are told to fight. We learned on 9/11 that sometimes they come back to fight us. The French learned the same thing last week. Will they make better decisions knowing the blowback from such risky foreign policy? It is unlikely because they refuse to consider blowback. They prefer to believe the fantasy that they attack us because they hate our freedoms, or that they cannot stand our free speech.

Perhaps one way to make us all more safe is for the US and its allies to stop supporting these extremists.

Another lesson from the attack is that the surveillance state that has arisen since 9/11 is very good at following, listening to, and harassing the rest of us but is not very good at stopping terrorists. We have learned that the two suspected attackers had long been under the watch of US and French intelligence services. They had reportedly been placed on the US no-fly list and at least one of them had actually been convicted in 2008 of trying to travel to Iraq to fight against the US occupation. According to CNN, the two suspects traveled to Yemen in 2011 to train with al-Qaeda. So they were individuals known to have direct terrorist associations. How many red flags is it necessary to set off before action is taken? How long did US and French intelligence know about them and do nothing, and why?

Foreign policy actions have consequences. The aggressive foreign policies of the United States and its allies in the Middle East have radicalized thousands and have made us less safe. Blowback is real whether some want to recognize it or not. There are no guarantees of security, but only a policy of non-intervention can reduce the risk of another attack.

Who will be the Victim of Propaganda: The Conformist or the Critical Thinker?

I have been accused of relying on a website that allegedly peddles "propaganda". 

First, what is propaganda? Based on Dictionary.com’s definition, propaganda has been about “information, ideas, or rumors deliberately spread widely to help or harm a person, group, movement, institution, nation, etc.” 

In short, propaganda essentially is deliberate disinformation or bluntly a lie. So I am, in effect, a believer of lies.

Yet the consensus thinking has revolved around the following themes:

-Debts are free lunches or have no limits or consequences to an individual or to a business entity, to the markets or to the government or to the political economy. 

-Stocks markets are a one way street

The money question is: are these about reality?

Isn’t economics about the law of scarcity?

So which is propaganda? Information that defies economic logic and reality or information designed to sell to the public what they want to hear—confirmation bias?

Let me further spell the difference between a conformist and an independent thinker

A conformist relies on information that conforms with one’s biases. Such person thinks along with the crowd. They are likely to reject information that goes to the contrary regardless of the validity of the reasoning. Crowd information or wisdom is like gospel truth for them.

On the other hand, a critical thinker attempts to distinguish between reality and quackery. Such person, who thinks out-of-the-box, is likely interested with the validity of reasoning or theories rather than finding comfort with the crowd.

So who will likely be a victim of propaganda, the critical thinker or the conformist?

Cracks in Singapore’s Credit and Housing Bubble?

Interestingly, mainstream media seems worried over signs of Singapore’s deflating housing markets.

Last year I posted here that Singapore’s central bank the Monetary Authority of Singapore warned of a domestic debt bubble.

Apparently the diffusing property slowdown appears to be raising anxiety over potential escalation of credit risks

From Yahoo.com (bold mine)

Local rates have already started ticking up. Sibor, or the Singapore interbank offered rate, used as the basis for setting mortgage and other loans, climbed around 15 basis points in early January, to its highest since April 2010 after years of stability, Maybank (Kuala Lumpur Stock Exchange: MBBM-MY)-Kim Eng noted in a report this week.

The bank estimates a one percentage-point rise in Sibor increases monthly mortgage payments by 12 percent, under certain conditions. It expects Sibor will rise to 1.0 percent by the end of this year and 2.0 percent by the end of 2016, compared with 0.46 percent at end-2014.

While the rate is still relatively low -- the three-month Singapore-dollar Sibor was at 0.639 percent Thursday -- analysts expect it could continue to push higher. They lay the rise at the feet of U.S. dollar strength against the Singapore dollar (Exchange:SGD=) spurring fund outflows from the city-state, a situation unlikely to reverse anytime soon. Once the U.S. Federal Reserve begins a rate hike cycle, Sibor is likely to push even higher, they said…

Whether most households can handle a big bump in mortgage payments will be a key policy test. Singapore's central bank, the Monetary Authority of Singapore (MAS), introduced a total debt servicing ratio (TDSR) in mid-2013 to help contain property prices and limit how much debt households could take on.

Here is the USD-SGD

The USD-Singapore trades at 2010 highs

Yet the debt numbers:

Consumers' debt is still growing, rising 5.6 percent on-year in the third quarter, although that's down from an average 9.2 percent over the past five years, the MAS said.

Housing loans accounted for around 74 percent of household liabilities in 2014's third quarter, the data show.

More signs of the emergence of deflation…

Despite a lot of handwringing forecasts for property price declines of as much as 20 percent, official data show private residential prices fell just 4 percent in 2014, although the number of transactions fell around 50 percent in the year-to-November. But analysts generally expect property price declines to continue this year.

Other cracks have begun to show in the property market, such as indications some buyers may have found ways to skirt the TDSR to get approval for larger mortgages. This week, local bank UOB(Singapore Exchange: UOBH-SG) filed a 181 million Singapore dollar (around $136 million) lawsuit against a unit of Indonesian company Lippo Group and some individuals, claiming a conspiracy to obtain inflated mortgages for 38 units at a luxury development on tony Sentosa island. All but one of those 38 loans have defaulted. Lippo has reportedly denied involvement in a conspiracy…

However, lower property prices will limit financially troubled households' ability to sell their homes as a means of exiting debt.

Another worry is the around 3 percent of credit card holders with unsecured debt greater than their annual incomes, although the MAS plans policies this year to prevent these people from getting further credit.

After the credit fueled boom, the legacy will always be the problem of debt, debt and debt…

This reports says Singapore’s banks are vulnerable to a housing deflation. From Nikkei Asia (bold mine) 

The slow-down in Singapore's property market has reduced high-end condominium prices and raised concerns that major local banks could be vulnerable to a surge in non-performing housing loans.

According to Singapore's Urban Redevelopment Authority, the price of private residential properties dropped 4% in 2014. Maybank Kim Eng notes that loan defaults have concentrated mostly among luxury homes which are more popular with foreign investors, particularly those located near Orchard Road, Singapore's retail hub, and Sentosa Island, a vacation destination with sandy beaches and resort hotels.

Among the three largest Singaporean banks, United Overseas Bank (UOB) is the most exposed on Sentosa. The report indicated UOB's non-performing housing loan volume has risen 61.4% since the end of 2013…

Other vulnerable banks…

Despite this case, Maybank Kim Eng concluded that among the three largest Singaporean banks, Oversea-Chinese Banking Corp. (OCBC) is most at risk in the event of a meltdown in the housing market, followed by UOB. DBS Group is least at risk.

Although OCBC's exposure to the luxury properties most favoured by foreigners is lower, the bank lent more heavily overall to property buyers than its competitors from mid 2009 to 2012 when prices in Singapore were breaking records and "speculation was high."

Here are several questions: what happens when Singapore’s housing and debt deflation intensifies? Will Singapore’s problems be isolated to the property sector and to the city state? Will there be no contagion via trade and financial linkages with the region or the world?

How about Singapore’s stocks? Will housing-debt deflation be vented on stocks?

So far Singapore’s stocks appear to be ignoring such risks.