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Benn Steil: The Fed Could be Tightening More Than it Realizes

Ten years ago, before the collapse of Lehman Brothers rocked global financial markets, the Fed’s balance sheet stood at $925 billion—mostly U.S. Treasuries. After fifty-nine months of asset purchases to push down longer-term interest rates, it had ballooned to a peak of $4.5 trillion, including nearly $1.8 trillion in mortgage securities, in October 2014.

In October of this year, the Fed at last began a slow slimming-down of the balance sheet, allowing $10 billion in maturing securities to roll off without reinvesting the proceeds. All else being equal, this represents a tightening of monetary policy, as it tends to push up longer-term (10-year) market interest rates.

In Fed chair Janet Yellen’s words, the central bank “does not have any experience in calibrating the pace and composition of asset redemptions and sales to actual prospective economic conditions.” She has therefore stressed that the Fed sees its balance-sheet reduction as a primarily technical exercise separate from the pursuit of its monetary policy goals—in particular, pushing inflation back up to 2%. The Fed’s main tool for tightening monetary policy in a recovering economy would, therefore, she explained, be raising short-term market interest rates by paying banks greater interest on reserves (IOR). Since December 2015, the Fed has raised the rate on IOR by 100 basis points (1%), which has pushed up its short-term benchmark rate—the effective federal funds rate—in tandem.

But is Yellen right that the Fed’s gradual approach to balance-sheet reduction makes it relatively unimportant in its impact on monetary conditions? Our analysis suggests that it will be, in fact, considerably more important than the market, or the Fed itself, realizes. Here is why.

…click on the above link to read the rest of the article…

Gold, Interest Rates and Super Cycles

Gold, Interest Rates and Super Cycles

When the Fed raised interest rates last December, many believed gold would plunge. But it didn’t happen.

Gold bottomed the day after the rate hike, but then started moving higher again.

Incidentally, the same thing happened after the Fed tightened in December 2015. Gold had one of its best quarters in 20 years in the first quarter of 2016. So it was very interesting to see gold going up despite headwinds from the Fed.

Meanwhile, gold has more than held its own this year.

Normally when rates go up, the dollar strengthens and gold weakens. They usually move in opposite directions. So how could gold have gone up when the Fed was tightening and the dollar was strong?

That tells me that there’s more to the story, that there’s more going on behind the scenes that’s been driving the gold price higher.

It means you can’t just look at the dollar. The dollar’s an important driver of the gold price, no doubt. But so are basic fundamentals like supply and demand in the physical gold market.

I travel constantly, and I was in Shanghai meeting with the largest gold dealers in China. I was also in Switzerland not too long ago, meeting with gold refiners and gold dealers.

I’ve heard the same stories from Switzerland to Shanghai and everywhere in between, that there are physical gold shortages popping up, and that refiners are having trouble sourcing gold. Refiners have waiting lists of buyers, and they can’t find the gold they need to maintain their refining operations.

And new gold discoveries are few and far between, so demand is outstripping supply. That’s why some of the opportunities we’ve uncovered in gold miners are so attractive right now. One good find can make investors fortunes.

 

…click on the above link to read the rest of the article…

Central Bank Group Think: Convince the Public More Inflation is Coming 

Chicago Fed chief Charles Evans is worried about the lack of inflation primarily because he is clueless about where to find it. As further proof of his economic illiteracy, Evans says “Low inflation expectations keep inflation down”.

The Federal Reserve should take a more aggressive stance toward boosting inflation and stop talking so much about using interest rates to ensure financial stability, Chicago Fed President Charles Evans said.

Evans expressed concerns Wednesday that the public was losing faith in policy makers’ commitment to bring inflation back up to their 2 percent target.

The central banker has consistently argued for a slower pace of interest-rate increases than many of his colleagues on the policy-setting Federal Open Market Committee.

“In order to dispel any impression that 2 percent is a ceiling, our communications should be much clearer about our willingness to deliver on a symmetric inflation outcome, acknowledging a greater chance of inflation at 2.5 percent in the future than what has been communicated in the past,” he said in remarks prepared for a speech in London.

Two Asinine Economic Theories

  1. There is a need for inflation
  2. The Fed can achieve it by talking about it

For proof of number 2, look at Japan.

In regards to point number 1, the BIS agrees that routine price deflation may be beneficial.

BIS Deflation Study

The BIS did a historical study and found routine price deflation was not any problem at all.

“*Deflation may actually boost output. Lower prices increase real incomes and wealth. And they may also make export goods more competitive*,” stated the study.

For a discussion of the BIS study, please see Historical Perspective on CPI Deflations: How Damaging are They?

…click on the above link to read the rest of the article…

Sweden: The World’s Biggest Housing Bubble Cracks

Sweden: The World’s Biggest Housing Bubble Cracks

Sweden’s property bubble is probably the world’s biggest, despite which it gets relatively little coverage in the mainstream financial media – although that might be about to change. Warnings about this bubble are not new. In March 2016, Moody’s issued a very explicit warning that Sweden’s negative interest rates were propagating an unsustainable housing bubble.

The central banks of Switzerland, Denmark and Sweden (all rated Aaa stable) have been among the first to push policy rates into negative territory. A year into this novel experience, Moody’s Investors Service concludes that, from among the three countries, Sweden is most at risk of an – ultimately unsustainable – asset bubble…

“The Riksbank has not been successful in engineering higher inflation, while Sweden’s GDP growth continues to be among the strongest in the advanced economies,” says Kathrin Muehlbronner, a Senior Vice President at Moody’s.

“At the same time, the unintended consequences of the ultra-loose monetary policy are becoming increasingly apparent – in the form of rapidly rising house prices and persistently strong growth in mortgage credit”, adds Ms Muehlbronner. In Moody’s view, these trends will likely continue as interest rates will remain low, raising the risk of a house price bubble, with potentially adverse effects on financial stability as and when house prices reverse trends.

In October 2016, the Riksbank’s Governor, Stefan Ingves, spoke in grave terms to the FT about the impact of negative rates on house prices.

But despite a lack of drama so far, Mr Ingves remains worried about a bad ending due to risks over financial stability.

He said: “It remains an issue because we are mismanaging our housing market. Our housing market isn’t under control, in my view.” The ratio of household debt to disposable income in Sweden is one of the highest in the world at more than 180 per cent and the Riksbank estimates it will continue to rise in the coming years.

…click on the above link to read the rest of the article…

Close to the Edge

“Look at it this way. In 100 years, who’s gonna care ?”

  • Nancy, waitress, in ‘The Terminator’ (screenplay by James Cameron and Gale Ann Hurd).

Imagine that a cyborg from 10 years into the future paid you a visit back in 2007. Here is what is going to happen, he says, in a thick Austrian accent, his body looking like a condom stuffed with walnuts. After deregulation and a gaudy credit boom, Wall Street will face an extinction level event. So will the City of London. As a result, interest rates will be driven down to zero and kept there for a decade as a “temporary” emergency measure. The UK will vote to leave the European Union. Donald Trump will be elected US President. On the basis of these facts alone, what do you think would happen to global stock markets ? Would they be higher, or lower – and perhaps much lower ?

Since we know the answer, it’s hardly a fair question, and there can in any case be no counter-factual. But this thought experiment does reveal the vulnerability of ‘global macro’ investing in a world in which central banks are almost exclusively calling the shots. Which might explain why an increasing number of ‘global macro’ managers are quietly folding up their tents.

The first requirement to harvest superior long-term returns from the markets is to have some kind of edge. If you do not know what your edge is, you do not have one. It is difficult to see how many (or any) ‘global macro’ managers can possess any form of edge when the financial markets are largely at the mercy of the arbitrary behaviour of monetary central planners, either adding or withdrawing liquidity as they see fit. Which is just one of the reasons why we don’t invest in ‘global macro’ funds.

…click on the above link to read the rest of the article…

Weekly Commentary: “Money” on the Move

Weekly Commentary: “Money” on the Move

It’s been awhile since I’ve used this terminology. But global markets this week recalled the old “Bubble in Search of a Pin.” It’s too early of course to call an end to the great global financial Bubble. But suddenly, right when everything looked so wonderful, there are indication of “Money” on the Move. And the issues appears to go beyond delays in implementing U.S. corporate tax cuts.

The S&P500 declined only 0.2%, ending eight consecutive weekly gains. But the more dramatic moves were elsewhere. Big European equities rallies reversed abruptly. Germany’s DAX index traded up to an all-time high 13,526 in early Tuesday trading before reversing course and sinking 2.9% to end the week at 13,127. France’s CAC40 index opened Tuesday at the high since January 2008, only to reverse and close the week down 2.5%. Italy’s MIB Index traded as high as 23,133 Tuesday before sinking 2.5% to end the week at 22,561. Similarly, Spain’s IBEX index rose to 10,376 and then dropped 2.7% to close Friday’s session at 10,093.

Having risen better than 20% since early September, Japanese equities have been in speculative blow-off mode. After trading to a 26-year high of 23,382 inter-day on Thursday, Japan’s Nikkei 225 index sank as much as 859 points, or 3.6%, in afternoon trading. The dollar/yen rose to an eight-month high 114.73 Monday and then ended the week lower at 113.53.  From Tokyo to New York, banks were hammered this week.

Perhaps the more important developments of the week unfolded in fixed-income. Despite the selloff in the region’s equities markets, European sovereign debt experienced no safe haven bid. German bund yields traded at 0.31% on Wednesday, before a backup in rates saw yields close the week at 0.41%. Italian bond yields traded as low as 1.69% on Wednesday before closing the week at 1.84%. Spain’s yields ended the week up 10 bps to 1.56%.
…click on the above link to read the rest of the article…

Interest Rates will Double

QUESTION: Mr. Armstrong; Thank you for an excellent conference. I have been attending since 2011. Each time you deliver a different conference and they are always better than the last. I could not help to notice on Zero Hedge they ran a piece about a Harvard University’s visiting scholar at the Bank of England who claims:

“We trace the use of the dominant risk-free asset over time, starting with sovereign rates in the Italian city states in the 14th and 15th centuries, later switching to long-term rates in Spain, followed by the Province of Holland, since 1703 the UK, subsequently Germany, and finally the US.”

Besides claiming to calculate the 700-year average real rate at 4.78% suggesting that rates will rise sharply when your models are 5,000 years, the two ridiculous statements are a 700-year average as if this really means something in the near-term when rates have been below that for nearly 10 years, and second the statement that he traces “the dominant risk-free asset over time.” You have demonstrated that moving averages are not valid in forecasting and that government routinely defaults.

You forecast at the conference that rates would rise very rapidly as we move into the Monetary Crisis Cycle. When I returned home to Greece, the latest news here is that so many people do not even have the money left to pay taxes. Is this part of the first stone in the water that sets off the waves of the Monetary Crisis Cycle?

ANSWER: It is very nice to trace 700 years and come up with the average of 4.78% by switching to the dominant economy as the financial capital of the world moved. However, starting the study in the 14th century skips the crazy part. There was the Great Financial Crisis of 1092 in Byzantium.

…click on the above link to read the rest of the article…

Prepare For Interest Rate Rises And Global Debt Bubble Collapse

 Prepare For Interest Rate Rises And Global Debt Bubble Collapse

– Diversify, rebalance investments and prepare for interest rate rises
– UK launches inquiry into household finances as £200bn debt pile looms
– Centuries of data forewarn of rapid reversal from ultra low interest rates
– 700-year average real interest rate is 4.78% (must see chart)
– Massive global debt bubble – over $217 trillion (see table)
– Global debt levels are building up to a gigantic tidal wave
– Move to safe haven higher ground from coming tidal wave

Source: Bloomberg

Last week, the Bank of England opted to increase interest rates for the first time in a decade. Since then alerts have been coming thick and fast for Britons warning them to prepare for some tough financial times ahead.

The UK government has launched an inquiry into household debt levels amid concerns of the impact of the Bank of England’s decision to raise rates. The tiny 0.25% rise means households on variable interest rate mortgages are expected to face about £1.8bn in additional interest payments whilst £465m more will be owed on the likes of credit cards, car loans and overdrafts.

The 0.25% rise is arguably not much given it comes against backdrop of record low rates and will have virtually no impact on any other rate. However it comes at a time of high domestic debt levels, no real wage growth and a global debt level of over $217 trillion.

Combined with low productivity across the developed world, experts are beginning to wonder how the financial system (and the individuals within) will cope.

After a decade of seeing negative real rates of interest many investors will be quietly celebrating that they may be about to see a turnaround for their savings. Many hope they will start being rewarded for their financial prudence as opposed to the punishing saving conditions of the last decade.

…click on the above link to read the rest of the article…

What Hayek Tells Us About the Link Between Ultra-Loose Monetary Policy and Political Instability

The European Central Bank will increase the overall volume of its bond purchase program to 2.550.000.000.000 euros by September 2018. The main refinancing rate will remain at zero. Mario Draghi has stressed that this policy shall continue until inflation picks up sustainably (which is unlikely to happen in the foreseeable future). The works of Friedrich August von Hayek (1931, 1944, 1976) help to explain why the tremendous monetary expansion is increasingly causing growing economic and political instability in Europe.

Hayek’s (1931) Production and Prices explains boom and bust with central bank mistakes. During the upswing, the central bank keeps the interest rate too low. Investment projects with comparatively low marginal efficiency are launched, financed by credit creation of the banking sector. Share prices hike, because profit opportunities of enterprises and banks increase, while deposit rates are low. Wages do not rise as long as idle capacities in the labor market exist. As soon as wages start to rise, enterprises lift prices and inflation picks up. When the central bank increases the interest rate to contain inflation, investment projects with low marginal efficiency have to be dismantled. The boom turns into bust. The central bank aggravates the recession by keeping the interest rate too high.

To understand the economic development of the industrialized countries since the mid 1980s Hayek (1931) is important, but two modifications have to be made (Schnabl 2016). In line with Hayek, central banks around the globe have tended to keep interest rates too low during upswings, thereby causing exuberant booms. In contrast to Hayek’s theory, they cut interest rates fast during crisis to avoid painful recessions. In addition, increasingly expansionary monetary policies became visible in rising asset rather than goods prices (see Figure). Therefore, interest rates could converge towards zero and central bank balance sheet could be inflated without inflation targeting central banks being forced to tighten monetary policy.

…click on the above link to read the rest of the article…

700 Years Of Data Suggests The Reversal In Rates Will Be Rapid

700 Years Of Data Suggests The Reversal In Rates Will Be Rapid

Have we been lulled into a false sense of security about the future path of rates by ZIRP/NIRP policies? Central banks’ misguided efforts to engineer inflation have undoubtedly been woefully feeble, so far. As the Federal Reserve “valiantly” raises short rates, markets ignore its dot plot and yield curves continue to flatten. And thanks to Larry Summers, the term “secular stagnation” has entered the lexicon.  While it sure doesn’t feel like it, could rates suddenly take off to the upside?

A guest post on the Bank of England’s staff blog, “Bank Underground”, answers the question with an unequivocal yes. Harvard University’s visiting scholar at the Bank, Paul Schmelzing, normally focuses on 20th century financial history. In his guest post (see here), he analyses real interest rates stretching back a further 600 years to 1311. Schmelzing describes his methodology as follows.

We trace the use of the dominant risk-free asset over time, starting with sovereign rates in the Italian city states in the 14th and 15th centuries, later switching to long-term rates in Spain, followed by the Province of Holland, since 1703 the UK, subsequently Germany, and finally the US.

Schmelzing calculates the 700-year average real rate at 4.78% and the average for the last two hundred years at 2.6%. As he notes “the current environment remains severely depressed”, no kidding. Looking back over seven centuries certainly provides plenty of context for our current situation, where rates have been trending downwards since the early 1980s. According to Schmelzing, we are in the ninth “real rate depression” since 1311 as shown in his chart below. We count more than nine, but let’s not be picky.

…click on the above link to read the rest of the article…

For God’s Sake, Stop!

“Most economists, it seems, believe strongly in their own superior intelligence and take themselves far too seriously. In his open letter of 22 July 2001 to Joseph Stiglitz, Kenneth Rogoff identified this problem. ‘One of my favourite stories from that era is a lunch with you and our former colleague, Carl Shapiro, at which the two of you started discussing whether Paul Volcker merited your vote for a tenured appointment at Princeton. At one point, you turned to me and said, “Ken, you used to work for Volcker at the Fed. Tell me, is he really smart ?” I responded something to the effect of, “Well, he was arguably the greatest Federal Reserve chairman of the twentieth century.” To which you replied, “But is he smart like us ?”

  • Satyajit Das.

“..Every time a report lands on their desks, central bankers must stop to think about the economic, social and political havoc their policies have caused over the past 10 years.

“The desperate attempt to avoid deflation via quantitative easing and record-low interest rates has had horrible side effects, and this observation is hardly controversial. The rich have become much richer; corporate wealth has become more concentrated; soaring house prices have created intergenerational strife; low yields have made all but the super-rich paranoid that they will be entirely unable to finance their futures. Most markets have ended up overvalued (this will really matter one day), while pension fund deficits and a constant sense of crisis have discouraged capital investment — and have possibly held down wages in the UK.

“Set a target, get a distortion. This is standard stuff. But the fact that extreme monetary policy has been going on for so long means that central bankers do not just have macro problems to feel bad about.

…click on the above link to read the rest of the article…

Bank Of England Hikes Rates By 25bps In 7-2 Vote; First Increase In A Decade; Pound Plunges

Bank Of England Hikes Rates By 25bps In 7-2 Vote; First Increase In A Decade; Pound Plunges

Over ten years since the last rate hike by the Bank of England in July 2007 (when incidentally, cable was trading above $2.00), and following years of market expectations of an imminent rate hike that failed to materialize…

…. moments ago the BOE – which had telegraphed the move extensively in recent months despite some dovish misgivings – finally pulled the trigger, and raised rates by 25bps to 0.5% in order to curb the effect of high inflation brought about by the post-Brexit plunge in the pound, squeezing local households and pressuring the UK economy. However, while cable initially spiked higher on the news, it subsequently slumped on the news that the vote was not a unanimous 9-0 decision as some had expected, as would telegraph a normal rate hike cycle, and instead had a decidedly dovish tilt with a far more contested 7-2 vote, with Cunliffe and Ramsden dissenting based on insufficient evidence that domestic costs, particularly wage growth, would pick up in line with central projections.

Here is the BOE assessment:

The Bank of England’s Monetary Policy Committee (MPC) sets monetary policy to meet the 2% inflation target, and in a way that helps to sustain growth and employment.  At its meeting ending on 1 November 2017, the MPC voted by a majority of 7-2 to increase Bank Rate by 0.25 percentage points, to 0.5%.  The Committee voted unanimously to maintain the stock of sterling non-financial investment-grade corporate bond purchases, financed by the issuance of central bank reserves, at £10 billion.  The Committee also voted unanimously to maintain the stock of UK government bond purchases, financed by the issuance of central bank reserves, at £435 billion.

…click on the above link to read the rest of the article…

The Curious Case of Missing Defaults

Venezuela bank

THE CURIOUS CASE OF THE MISSING DEFAULTS

CAMBRIDGE – Booms and busts in international capital flows and commodity prices, as well as the vagaries of international interest rates, have long been associated with economic crises, especially – but not exclusively – in emerging markets. The “type” of crisis varies by time and place. Sometimes the “sudden stop” in capital inflows sparks a currency crash, sometimes a banking crisis, and quite often a sovereign default. Twin and triple crises are not uncommon.

Rising international interest rates have usually been bad news for countries where the government and/or the private sector rely on external borrowing. But for many emerging markets, external conditions began to worsen around 2012, when China’s growth slowed, commodity prices plummeted, and capital flows dried up – developments that sparked a spate of currency crashes spanning nearly every region.

In my recent work with Vincent Reinhart and Christoph Trebesch, I show that over the past two centuries, this “double bust” (in commodities and capital flows) has led to a spike in sovereign defaults, usually with a lag of 1-3 years. Yet, since the peak in commodity prices and global capital flows around 2011, the incidence of sovereign defaults worldwide has risen only modestly.

…click on the above link to read the rest of the article…

Low Interest Rates Subsidize Wealthy Households

When the economy begins to sink into recession, politicians, mainstream economists, policy wonks, and the Federal Reserve begin beating the economic stimulus drum.

Politicians, however, disagree over the type of stimulus to implement. The center-left party proposes greater expenditures on public assistance programs. The center-right party supports permanent tax rate reductions. The center-left party opposes tax cuts because they say it benefits the rich. The center-right party opposes raising government expenditures because it increases government debt. This discord generally results in a temporary compromise where government expenditures are boosted and tax rates are cut. This compromise is called “discretionary fiscal stimulus.”

While the debate over discretionary fiscal stimulus has to overcome Senate filibusters and heated House debates, the central bankers at the Fed quickly implement monetary stimulus. Boosting aggregate demand is the intended purpose of it and discretionary fiscal stimulus. In mainstream economic theory, greater aggregate demand lowers unemployment and raises GDP. In spite of grave warnings from Austrian-school economists, the Fed pursues these goals by lowering interest rates via an expansion credit.

Although the political parties disagree over the type of fiscal stimulus to implement, both support the Fed’s monetary stimulus. Perhaps they do so because lower interest rates lower the cost of the budget deficits their discretionary fiscal stimulus produces. The lower interest rates also reduce the interest Americans pay on their debts. The total of this debt is unevenly distributed across the richest 1 percent, the next 9 percent, and the bottom 90 percent of Americans (as ranked by wealth), according to the following table.

snarr1.png

Total household debt averaged $11.295 trillion dollars over the four quarters in 2013, according to the Federal Reserve Bank of New York. Multiplying this value by the percentages in the above table indicates that the richest 1 percent, the next 9 percent, and the bottom 90 percent have aggregate debts of $610 billion, $2.383 trillion, and $8.302 trillion, respectively. These values are listed in the Total Debt column below.

…click on the above link to read the rest of the article…

Necessity is the Mother of Invention–Retirees Desperate Reach for Yield

Ben Bernanke’s creativity inspired a generation of economists and central bankers. QE, ZIRP and NIRP established a new class of economics that is mathematically sound but practically disastrous. Billions of dollars were transferred from savers to investors to boost the economy, but the wizards of quant forgot that something has to give. In this case, it was the formation of a pension crisis that threatens the golden years of millions of retirees across the world. None of the econometrics models provide a solution for the growing gap in pension funding, other than unsustainable debt accumulation.

Creativity cascaded to the less sophisticated pension fund managers. In a desperate reach for yields they increased exposure to project finance. Perceived higher returns, long-term investment horizon and inflation protection made it the perfect match for pension funds. However, like their central banker peers, pension fund managers were completely mistaken. Actual risks were largely underestimated. The binary nature of cashflow risks makes conventional risk measures meaningless. This is best illustrated by looking at the cumulative default rates of project finance (1991-2011) in North America, which exceeded the default rate of the non-investment grade Ba bonds in the first 6 years and is more than triple that of investment grade default rates.

Cum Defaut Rates

The European Investment Bank (EIB) decided to ride the wave of project finance and waste taxpayers’ money by providing loans and insurance on risks that EIB cannot remotely comprehend. They ignored the fact that mono-liners in the US did the same a decade ago and paid a hefty price when the bubble burst where almost all bond insurers went out of the market.

…click on the above link to read the rest of the article…

Olduvai II: Exodus
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Olduvai
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Olduvai II: Exodus
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Olduvai III: Cataclysm
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