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1The process of lending and the uninterrupted flow of credit to the real economy no longer rely only on banks, but on a process that spans a network of banks, broker-dealers, asset managers, and shadow banks funded through wholesale funding and capital markets globally. – Pozsaret et al., 2013, p. 10

I. Introduction

According to the standard version of the Austrian business cycle theory (e.g., Mises, 1949), the business cycle is caused by credit expansion conducted by commercial banks operating on the basis of fractional reserve.2Although true, this view may be too narrow or outdated, because other financial institutions can also expand credit.3

First, commercial banks are not the only type of depository institutions. This category includes, in the United States, savings banks, thrift institutions, and credit unions, which also keep fractional reserves and conduct credit expansion (Feinman, 1993, p. 570).4

Second, some financial institutions offer instruments that mask their nature as demand deposits (Huerta de Soto, 2006, pp. 155–165 and 584–600). The best example may be money market funds.5 These were created as a substitute for bank accounts, because Regulation Q prohibited banks from paying interest on demand deposits (Pozsar, 2011, p. 18 n22). Importantly, money market funds commit to maintaining a stable net asset value of their shares that are redeemable at will. This is why money market funds resemble banks in mutual-fund clothing (Tucker, 2012, p. 4), and, in consequence, they face the same maturity mismatching as do banks, which can also entail runs.6

Many economists point out that repurchase agreements (repos) also resemble demand deposits. They are short term and can be withdrawn at any time, like demand deposits. According to Gorton and Metrick (2009), the financial crisis of 2007–2008 was in essence a banking panic in the repo market (‘run on repo’).

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China Furious After US Launches Trade War “Nuke” With 522% Duty

May 19, 2016

China Furious After US Launches Trade War “Nuke” With 522% Duty

Now that China’s brief infatuation with “rationalizing” excess capacity in its massively glutted (and insolvent) steel sector is over after lasting all of 2-3 months, China is back to doing what it did in late 2015 (and what it has always done) when as we reported, a surge in Chinese exports led to the first salvos in the trade war between China – the world’s biggest exporter of various steel products and is responsible for half the entire world’s steel output – and countries who are importing dumped Chinese products at the expense of their own steel and mining industries.

Nowhere has this trade tension been more obvious than in the UK, where in recent months angry, protesting steel workers have been demanding rising protectionist steps against a country they, rightfully, see as unleashing a global commodity deflation driven by out of control, and unprofitable by highly subsidized, production by Chinese steel mills.

The US was not left unscathed: we reported in December that “The Trade Wars Begin: U.S. Imposes 256% Tariff On Chinese Steel Imports” and since then things have progressively turned worse, finally culminating overnight with an outburst of anger from Chinese officials who, after attempting to flood not just the US but also the entire world with their commodity in general and steel in particular, exports…

… Pushing prices even lower…

…. have criticized U.S. anti-dumping penalties imposed on Chinese steel amid mounting complaints Beijing is exporting at improperly low prices to clear a backlog at home.

The numbers, however, do not lie and confirm that China is engaging in massive global commodity dumping.

Chinese exports hit a record 112 million tonnes last year, with rivals claiming that Chinese steelmakers have been undercutting them in their home markets. According to Reuters, in the four months to April, China’s steel exports have risen nearly 7.6% to 36.9 million tonnes.

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

The SPV Loophole: Draghi Just Unleashed “QE For The Entire World”… And May Have Bailed Out US Shale

April 22, 2016

The SPV Loophole: Draghi Just Unleashed “QE For The Entire World”… And May Have Bailed Out US Shale

Almost exactly one year ago, we wrote “Mario Draghi, Collateral Scarcity, And Why The ECB Will Soon Buy Corporate Bonds.” 11 months later, the ECB confirmed this when for the first time ever, Mario Draghi said he would do purchase corporate bonds when he launched the ECB’s Corporate Sector Purchase Programme (CSPP), confirming that with government bond collateral evaporating and the liquidity situation getting precariously dangerous and forcing moments of historic volatility (as in the April/May 2015 Bund fiasco), he had run out of other options.

And while we have been covering this key development closely since its announcement more than a month ago, we were surprised by how little attention most of the sellside was paying to what is clearly a watershed moment in capital markets as a central banks now openly backstops corporate bond issuance (among other things pointing out a month ago Why The ECB Will Be Forced To Buy Junk Bonds Next). Ironically, the market was fully aware of what the ECB’s action meant as we showed in the “The ECB Effect: European Telecom Issues Largest Ever Junk Bond After More Than 100% Upsizing.”

Now, following the release of the full details of its corporate bond buying program, analysts are once again keenly focused on hits program who impact will be dramatic over the coming years.

First, as a reminder, here are the big picture details:

May buy in primary and secondary markets
Issue share limit of 70% per ISIN
Inclusion of bonds issued by insurance companies
Can buy bonds of companies incorporated in the euro area whose ultimate parent is not based in the euro area
Remaining maturity of 6 months and maximum of 30Y

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

Bernanke’s Former Advisor: “People Would Be Stunned To Know The Extent To Which The Fed Is Privately Owned”

April 11, 2016

Bernanke’s Former Advisor: “People Would Be Stunned To Know The Extent To Which The Fed Is Privately Owned”

With every passing day, the Fed is slowly but surely losing the game.

Only it is not just former (and in some cases current) Fed presidents admitting central banks are increasingly powerless to boost the global economy, even if they still have sway over capital markets. What is far more insidious to the Fed’s waning credibility is when former economists affiliated with the Fed start repeating mantras that until recently were only a prominent feature in the so-called fringe media.

This is precisely what happened today when former central bank staffer and Dartmouth College economics professor Andrew Levin, special adviser to then Fed Chairman Ben Bernanke between 2010 to 2012, joined with an activist group to argue for overhauls at the central bank that they say would distance it from Wall Street and make its activities more transparent and accountable to the public.

Levin is pressing for the overhaul with Fed Up coalition activists. Many of the proposed changes target the 12 regional Federal Reserve Banks, which are quasi-private and technically owned by commercial banks in their respective districts.

All of that is not surprising. What he said to justify his new found cause, however, is.

“A lot of people would be stunned to know” the extent to which the Federal Reserve is privately owned, Mr. Levin said. The Fed “should be a fully public institution just like every other central bank” in the developed world, he said in a conference call announcing the plan. He described his proposals as “sensible, pragmatic and nonpartisan.”

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

The “Terrifying Prospect” Of A Triumph Of Politics Over Economics

March 9, 2016

The “Terrifying Prospect” Of A Triumph Of Politics Over Economics

The Triumph of Politics

All of life’s odds aren’t 3:2, but that’s how you’re supposed to bet, or so they say. They are not saying that so much anymore, or saying that history rhymes, or that nothing’s new under the sun. More and more theys seem to be figuring out that past economic and market experiences can’t be extrapolated forward – a terrifying prospect for the social and political order.

Consider today’s realities:

Global economies have grown to their current scale thanks to a glorious secular expansion of worldwide credit – credit unreserved with bank assets and deposits; credit extended to brand new capitalists; credit that can never be extinguished without significant debt deflation or hyper monetary inflation

Economies no longer form sufficient capital to sustain their scales or to justify broad asset values in real terms

Markets cannot price assets fairly in real terms without risking significant declines in collateral values supporting them and their underlying economies

Politicians that used to anguish (rhetorically) over the right mix of potential fiscal policies, ostensibly to get things back on track (as if somehow finding the right path would have actually been legislated into existence), have come to realize the limits of their power to have a meaningful impact

Monetary authorities have become the only game in town,assassinating all economic logic so they may juggle public expectations in the hope – so far successfully executed – that neither man nor nature will be the wiser.

The good news for policy makers is that man remains collectively unaware and vacuous; the bad news is that nature abhors a vacuum. The massive scale of economies relative to necessary production (not to mention already embedded systemic leverage) suggests this time is truly different.

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

The Global Run On Physical Cash Has Begun: Why It Pays To Panic First

February 28, 2016

The Global Run On Physical Cash Has Begun: Why It Pays To Panic First

Back in August 2012, when negative interest rates were still merely viewed as sheer monetary lunacy instead of pervasive global monetary reality that has pushed over $6 trillion in global bonds into negative yield territory, the NY Fed mused hypothetically about negative rates and wrote “Be Careful What You Wish For” saying that “if rates go negative, the U.S. Treasury Department’s Bureau of Engraving and Printing will likely be called upon to print a lot more currency as individuals and small businesses substitute cash for at least some of their bank balances.”

Well, maybe not… especially if physical currency is gradually phased out in favor of some digital currency “equivalent” as so many “erudite economists” and corporate media have suggested recently, for the simple reason that in a world of negative rates, physical currency – just like physical gold – provides a convenient loophole to the financial repression of keeping one’s savings in digital form in a bank where said savings are taxed at -0.1%, or -1% or -10% or more per year by a central bank and government both hoping to force consumers to spend instead of save.

For now cash is still legal, and NIRP – while a reality for the banks – has yet to be fully passed on to depositors.

The bigger problem is that in all countries that have launched NIRP, instead of forcing spending precisely the opposite has happened: as we showed last October, when Bank of America looked at savings patterns in European nations with NIRP, instead of facilitating spending, what has happened is precisely the opposite: “as the BIS have highlighted, ultra-low rates may perversely be driving a greater propensity for consumers to save as retirement income becomes more uncertain.”

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

G-20 Needs To “Man Up” Or Risk Sparking Market Chaos, Citi Warns

February 26, 2016

G-20 Needs To “Man Up” Or Risk Sparking Market Chaos, Citi Warns

Two days ago, the man who now signs your Federal Reserve notes threw cold water on hopes for a so-called “Shanghai Accord.”

Over the past month or so, anticipation has built among market participants for some manner of coordinated policy response at this weekend’s G20 summit in Shanghai. The hoped for agreement would ideally be something akin to the 1985 Plaza Accord between the United States, France, West Germany, Japan, and the United Kingdom, which agreed to weaken the USD to shore up America’s trade deficit and boost economic growth.

Calls for coordinated action come on the heels of a turbulent January in which collapsing crude, RMB jitters, and worries that central banks are out of bullets have sowed fear in the minds of investors. “We remain sellers into strength in coming weeks/months of risk assets at least until a coordinated and aggressive global policy response (e.g. Shanghai Accord) begins to reverse the deterioration in global profit expectations and credit conditions,” BofA said last week, ahead of the summit.

“Don’t expect a crisis response in a non-crisis environment,” Lew said in an interview broadcast Wednesday with David Westin of Bloomberg Television. “This is a moment where you’ve got real economies doing better than markets think in some cases.”

Whether or not you agree with Lew’s assessment of “real economies” or not, the message was clear. The US isn’t set to support some kind of joint statement on fiscal stimulus and may not even be willing to be part of a consensus on the need to implement emergency measures to juice global growth and trade.

On Friday, the soundbites are rolling in as the world’s financial heavyweights opine on the state of the decelerating global economy and the turmoil that likely lies ahead for markets.

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

These Are The Two Canadian Banks Most Exposed To A Severe Oil Shock According To Moody’s

February 22, 2016

These Are The Two Canadian Banks Most Exposed To A Severe Oil Shock According To Moody’s

Two weeks ago we asked if, in the aftermath of the dramatic selloff suffered by European banks over commodity exposure concerns, whether Canadian banks would not be next in line. The reason was that according to an RBC report, while US banks had already taken significant reserves against future oil and gas loans, roughly amounting to 7% of their exposure, Canadian banks were stuck in denial.

As RBC grudgingly noted, “The small negative moves in credit would normally not even “register” were it not for plenty of evidence of issues surround the oil and gas sector and the impact it could have on the oil producing provinces in Canada.” Yes, well, China already advised its media to stick to “positive reporting” – sadly for the energy-rich or rather energy-por province of Alberta it is now too late.

As for ths reason for this surprising reserve complacency, RBC said the following:

Canadian banks like to wait for impairment events to book PCLs rather than build reserves (called sectoral reserves in the past) for problematic industries.

In other words, let’s just wait with the reserves until the losses are already on the book: hardly the most prudent approach which may be why today, with its usual several week delay, Moodys opined on which Canadian banks it views as most susceptible to a “severe oil slump.”

As quoted by to Bloomberg, Moody’s said that “Canadian Imperial Bank of Commerce and Bank of Nova Scotia would be nation’s hardest hit lenders if the oil slump became sharply worse, while Toronto-Dominion Bank would best be able weather a worsening rout.”

“The prolonged slump in oil prices will increase the financial stress on oil producers and the drillers and service companies that support them, as well as on consumers in oil-producing provinces,” Moody’s said.

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

Deutsche Bank Is Scared: “What Needs To Be Done” In Its Own Words

February 9, 2016

Deutsche Bank Is Scared: “What Needs To Be Done” In Its Own Words

It all started in mid/late 2014, when the first whispers of a Fed rate hike emerged, which in turn led to relentless increase in the value of the US dollar and the plunge in the price of oil and all commodities, unleashing the worst commodity bear market in history.

The immediate implication of these two concurrent events was missed by most, although we wrote about it and previewed the implications in November of that year in “How The Petrodollar Quietly Died, And Nobody Noticed.”

The conclusion was simple: Fed tightening and the resulting plunge in commodity prices, would lead (as it did) to the collapse of the great petrodollar cycle which had worked efficiently for 18 years and which led to petrodollar nations serving as a source of demand for $10 trillion in US assets, and when finished, would result in the Quantitative Tightening which has offset all central bank attempts to inject liquidity in the markets, a tightening which has since been unleashed by not only most emerging markets and petro-exporters but most notably China, and whose impact has been to not only pressure stocks lower but bring economic growth across the entire world to a grinding halt.

The second, and just as important development, was observed in early 2015: 11 months ago we wrote that “The Global Dollar Funding Shortage Is Back With A Vengeance And “This Time It’s Different” and followed up on it later in the year in “Global Dollar Funding Shortage Intensifies To Worst Level Since 2012” a problem which has manifested itself most notably in Africa where as we wrote recently, virtually every petroleum exporting nation has run out of actual physical dollars.

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

The Spook In the Casino—–Recession Just Ahead, Part 1

February 9, 2016

The Spook In the Casino—–Recession Just Ahead, Part 1

The wise guys keep buying the dips owing to the simple proposition that there is never a lasting bear market without a recession. So after today’s blow-out we are likely to get another call to scoop up the “bargains” because the correction has run its course and the US economy is still chugging along notwithstanding the contretemps in China and other places of purportedly limited moment.

Indeed, on the basis of Wall Street’s muscle memory alone there is surely another dead cat bounce on its way any day. But here’s the memo. BTFDs is not working any more and, more crucially, there is a recession coming and soon. And then the bear will maul, not simply paw as today.

The fact is, BTFD hasn’t worked on a net basis hasn’t for about 730 days now. The S&P 500 closed today where it first crossed in February 2014.

^SPX data by YCharts

In light of this extended dwell time in no man’s land, it is not surprising that the market is getting spooked. After all, the real driver of the post-March 2009 rebound of the stock indices was the Fed’s massive intrusion in money and capital markets, not a sustainable recovery of main street business activity or real household incomes. Real net CapEx is still below 2007 levels, for example, as is the real median household income.

And most certainly the market’s 220% gain between the post-recession bottom of 670 and the May 2015 peak of 2130 was not owing to an explosion of corporate earnings. If you set aside Wall Street’s annually renewable ex-items hockey stick, what you actually have on the profits front is a paltry 8% cummulative gain since the pre-crisis earnings peak way back in June 2007.

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

Negative Interest Rates Already In Fed’s Official Scenario

February 2, 2016

Negative Interest Rates Already In Fed’s Official Scenario

Over the past year, and certainly in the aftermath of the BOJ’s both perplexing and stunning announcement (as it revealed the central banks’ level of sheer desperation), we have warned (most recently “Negative Rates In The U.S. Are Next: Here’s Why In One Chart”) that next in line for negative rates is the Fed itself, whether Janet Yellen wants it or not. Today, courtesy of Wolf Richter, we find that this is precisely what is already in the small print of the Fed’s future stress test scenarios, and specifically the “severely adverse scenario” where we read that:

The severely adverse scenario is characterized by a severe global recession, accompanied by a period of heightened corporate financial stress and negative yields for short-term U.S. Treasury securities.

As a result of the severe decline in real activity and subdued inflation, short-term Treasury rates fall to negative ½ percent by mid-2016 and remain at that level through the end of the scenario.
And so the strawman has been laid. The only missing is the admission of the several global recession, although with global GDP plunging over 5% in USD terms, we wonder just what else those who make the official determination are waiting for.

Finally, we disagree with the Fed that QE4 is not on the table: it most certainly will be once stock markets plunge by 50% as the “severely adverse scenario” envisions, and once NIRP fails to boost economic activity, as it has failed previously everywhere else it has been tried, the Fed will promtply proceed with what has worked before, if only to make the true situation that much worse.

Until then, we sit back and wait.

Here is Wolf Richter with Negative Interest Rates Already in Fed’s Official Scenario

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

Nigerian Currency Collapses After Central Bank Halts Dollar Sales To Stall “Hyperinflation Monster”

January 12, 2016

Nigerian Currency Collapses After Central Bank Halts Dollar Sales To Stall “Hyperinflation Monster”

Having told banks and investors “don’t panic” in September, amid spiking interbank lending rates and surging default/devaluation risks, it appears the massive shortage of dollars that we warned about in December has washed tsunami-like ashore in oil-producing Nigeria. Following the Central bank’s decision this week to halt dollar sales to non-bank FX market operators, black market exchange rates spiked to 282/USD (vs 199 official) and CDS spiked to record highs implying drastic devaluations loom.

As Reuters reports, Nigeria’s central bank is halting dollar sales to non-bank foreign exchange operators and letting commercial banks accept dollar deposits with immediate effect, its governor said on Monday, in an effort to shore up dwindling foreign reserves.

Africa’s biggest economy, an OPEC member state that depends on oil sales for about 95 percent of its foreign reserves, has been hammered by a collapse in global oil prices, which has triggered a slide in its naira currency.

Godwin Emefiele said the sale of foreign exchange to bureaux de change would be discontinued because they were using up the country’s foreign reserves for illegal transactions and selling the dollar at 250 naira compared to the official central bank rate of 197 naira.

The currency hit a record low of 282 per dollar on the unofficial market on Monday after the central bank’s announcement.

Emefiele said foreign reserves stood at around $28 billion compared with $37 billion in June 2014, and that the bureaux were depleting them at a rate of $28.4 million per week.

“This is a huge haemorrhage on our scarce foreign exchange reserves, and cannot continue,” Emefiele told a news conference in the capital Abuja.

To avoid devaluing the currency, a stance so far supported by President Muhammadu Buhari, the central bank adopted increasingly stringent foreign exchange rules last year and effectively banned dollar access for the purchase of 41 items, which has also been criticised at the World Trade Organisation by the United States and the European Union.

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

Oil Bankruptcies Hit Highest Level Since Crisis And There’s “More To Come”, Fed Warns

December 25, 2015

Oil Bankruptcies Hit Highest Level Since Crisis And There’s “More To Come”, Fed Warns

“Two things become clear in an analysis of the financial health of US hydrocarbon production: 1) the sector is not at all homogenous, exhibiting a range of financial health; 2) some of the sector indeed looks exposed to distress [and] lifelines for distressed producers could include public equity markets, asset sales, private equity, or consolidation. If all else fails, Chapter 11 may be necessary.” That’s Citi’s assessment of America’s “shale revolution”, which the Saudis have been desperately trying to crush for more than a year now.

As Citi and others have noted – a year or so after we discussed the issue at length – uneconomic producers in the US are almost entirely dependent on capital markets for their continued survival. “The shale sector is now being financially stress-tested, exposing shale’s dirty secret: many shale producers depend on capital market injections to fund ongoing activity because they have thus far greatly outspent cash flow,” Citi wrote in September. Here’s a look at what the bank means:

Of course this all worked out fine in an environment characterized by relatively high crude prices and ultra accommodative monetary policy. The cost of capital was low and yield-starved investors were forgiving, allowing the US oil patch to keeping drilling and pumping long after it should have been bankrupt. Now, the proverbial chickens have come home to roost. In the wake of the Fed hike, HY is rolling over and as UBS noted over the summer, “the commodity related industries total 22.8% of the overall HY market index on a par-weighted basis; sectors most at-risk for defaults (defined as failure to pay, bankruptcy and distressed restructurings) total 18.2% of the index and include the oil/gas producer (10.6%), metals/mining (4.7%), and oil service/equipment (2.9%) industries.”

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

“On The Cusp Of A Staggering Default Wave”: Energy Intelligence Issues Apocalyptic Warning For The Energy Sector

November 28, 2015

“On The Cusp Of A Staggering Default Wave”: Energy Intelligence Issues Apocalyptic Warning For The Energy Sector

The Energy Intelligence news and analysis creator and aggregator is not one to haphazradly throw around hyperbolic claims and forecasts. So when it gets downright apocalyptic, as it did this week in a report titled “Is Debt Bomb About to Blow Up US Shale?”, people listen… and if they are still long energy junk bonds, they panic.

The summary:

“The US E&P sector could be on the cusp of massive defaults and bankruptcies so staggering they pose a serious threat to the US economy. Without higher oil and gas prices — which few experts foresee in the near future — an over-leveraged, under-hedged US E&P industry faces a truly grim 2016. How bad could things get?”

The full report by Paul Merolli, a senior editor and correspondent at Energy Intelligence:

Debt Bomb Ticking for US Shale

The US E&P sector could be on the cusp of massive defaults and bankruptcies so staggering they pose a serious threat to the US economy. Without higher oil and gas prices — which few experts foresee in the near future — an over-leveraged, under-hedged US E&P industry faces a truly grim 2016. How bad could things get and when? It increasingly looks like a number of the weakest companies will run out of financial stamina in the first half of next year, and with every dollar of income going to service debt at many heavily leveraged independents, there are waves of others that also face serious trouble if the lower-for-longer oil price scenario extends further.

“I could see a wave of defaults and bankruptcies on the scale of the telecoms, which triggered the 2001 recession,” Timothy Smith, president of consultancy Petro Lucrum, told a Platts energy conference in Houston last week.

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

Saudis Poke The Russian Bear, Start Oil War In Eastern Europe

October 18, 2015

Saudis Poke The Russian Bear, Start Oil War In Eastern Europe

Any weakening of Russian support for Mr. Assad could be one of the first signs that the recent tumult in the oil market is having an impact on global statecraft. Saudi officials have said publicly that the price of oil reflects only global supply and demand, and they have insisted that Saudi Arabia will not let geopolitics drive its economic agenda. But they believe that there could be ancillary diplomatic benefits to the country’s current strategy of allowing oil prices to stay low — including a chance to negotiate an exit for Mr. Assad.

That’s a quote from a New York Times article that ran in February of this year.

At the time, we pointed to the piece as evidence that yet another conspiracy “theory” has become conspiracy “fact” as it effectively served to validate (to the extent The New York Times is validation) the thesis that at the end of the day, this is all about energy.

If the Saudis could use oil prices to force Moscow into ceding support for Bashar al-Assad in Syria, then the West and its regional allies could get on with facilitating his ouster by way of arming and training rebels. Once Assad was gone, a puppet government could be installed (after some farce of an election that would invariably pit two Western-backed candidates against each other) then Riyadh, Doha, and Ankara could work with the new government in Damascus to craft energy deals that would not only be extremely lucrative for all involved, but would also help to break Gazprom’s iron grip on energy supplies to Europe.

Those are the “ancillary diplomatic benefits” mentioned in The Times piece.

Only it didn’t work out that way.

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

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