The musicians — Brian Travers, Astro, James Brown (no, not that one), Earl Falconer, Norman Hassan, Mickey Virtue, and twins Ali and Robin Campbell — had a unique approach to the music business.
Eighteen months prior to completing their first album, Ali Campbell and Travers had plastered the streets of Birmingham with leaflets promoting the band, which had taken its name from the document issued to people claiming unemployment benefits from the UK government’s Department of Health and Social Security (DHSS). The name of the form — and thus the band — was UB40.
Having advertised themselves and with dreams of making a big splash on Britain’s reinvigorated music scene running wild in their heads, the band had just one remaining item on their to-do list — learn to play their instruments.
The members of UB40 made an agreement to spend the next year doing nothing other than learning their instruments and practising their songs until they felt they were good enough.
(I know, I know! This IS analagous to many modern-day Central Bank policy efforts, but that’s not where I’m going with this, so stop jumping ahead.)
Anyway, after about a year, the band felt competent enough to play in public; and they made their debut on the 9th of February, 1979, in an upstairs room at the Hare & Hounds, a small pub in King’s Heath. They had been “booked” by a friend to celebrate his birthday.
Following on the success of their first gig (apparently, the birthday boy was delighted), the band secured a series of similar shows, all in local pubs, at which they planned to unleash their blend of reggae and dub onto an unsuspecting public who, though they didn’t realise it, had been waiting for UB40 for years.
Remarkably, at one of these pub gigs, Chrissie Hynde just happened to be in attendance, no doubt supping a couple of pints of Throgmorton’s Dubious Explanation (a real ale so thick it’s served by the slice); and she liked what she saw so much, she offered the band a supporting slot on The Pretenders’ upcoming tour of the UK.
Fast-forward to Christmas 1979, and the story of the recording of the band’s debut album burnishes the legend yet further:
(Wikipedia): The band approached local musician Bob Lamb as he was the only person they knew with any recording experience. Lamb had been the drummer with the Steve Gibbons Band for much of the 1970s and was a well-known figure within the Birmingham music scene.... However, as the band were unable to afford a proper recording studio, the album was recorded in Lamb’s own home at the time, a ground-floor flat in a house on Cambridge Road in Birmingham’s Moseley district....
Brian Travers recalled just how basic the recording facilities of the original Cambridge Road “studio” really were:
Because we couldn’t afford a studio and he was the only guy we knew who knew how to record music, we did the album in his bedsit. I remember he had his bed on stilts. So underneath the bed was a sofa and mixing desk. And so we recorded the album there on an eight-track machine, with the same 50p coin going through the electric meter continually because we’d booted the lock off it. And, with it being a bedsit and us being eight in the band, we’d record the saxophone in the kitchen — because there was a bit of resonance off the walls, a bit of reverb — before putting the machine effects on it. While the percussion — the tambourines, the congas, the drums — we’d do in the back yard. Which is why you can hear birds singing on some of the tracks! You know, because it was in the daytime we’d be shouting across the fences “Keep it DOWN! We’re RECORDING!”
Lamb remembered the process fondly:
Nothing was hard work about that album, it was a bit of a dream that sort of fell out of the sky... It was almost effortless to make in that they were so good at the time, and so happy at the time with the success that they got, there was no effort in it.
The title of the album, “Signing Off,” was inspired by the process of the band members ending their claim on UK unemployment benefits — and becoming pop stars.
The LP (Google it, Gen Y-ers), released on August 29, 1980, spent 71 weeks on the UK albums chart, peaking at number 2 and turning platinum (when doing such a thing used to mean something). It was greeted with rapture by Britain’s music press:
(Sounds): Five stars out of five. It is an (almost) perfect album.... It’s rare to find a debut album so detailed, so excellently played and so packed with bite — I sometimes think it hasn’t really happened since The Clash.
The album would go on to make Q Magazine’s “100 Greatest British Albums Ever” (#83, if you’re interested) and is featured in a book somewhat somberly titled 1001 Albums to Hear Before You Die.
I think it’s fair to say I played my part in the success of the band by spending the pocket money I had saved up on a copy of “Signing Off” (though the band have so far not publicly acknowledged my involvement).
Anyway, as I am now signing off from Mauldin Economics, I felt it would be appropriate to take stock of a few of the issues I have covered ad nauseum repeatedly during my two-plus years working with John and his team; and I thought I’d also take those of you unfamiliar with UB40’s debut album through a few of the tracks (and remind those of you who know the band just how spectacular that album was).
Track 2. King — 4:35
The “King” referred to in the second track on “Signing Off” was, of course, Martin Luther King, Jr. The song was short on lyrics but big on impact; however, the undoubted “King” in markets today is once again King Dollar, and the world’s reserve currency is making some serious waves right now, which threaten to cause chaos in world markets.
At this point I’ll throw things over to my friend and partner in Real Vision Television and author of The Global Macro Investor, Raoul Pal, who has been warning of the likelihood of a major move in the dollar for longer than just about anybody. In his most recent report, he explained the ramifications of a dollar bull market in the clearest, most concise way possible:
(Raoul Pal): Debt dynamics, deflation, positioning and technicals all suggest that a dollar bull market of some considerable velocity and length is underway.
When dollar bull markets occur, emerging markets get hit.
When dollar bull markets occur, carry trades get unwound.
When dollar bull markets occur, they tend to usher in disinflationary forces as commodities and goods get re-priced.
The preceding three factors lead to a self-reinforcing of the dollar bull market, creating more of the same in a cycle of liquidation and bad debts, creating more demand for US dollars.
As I said, clear and concise.
I watched Raoul present at the iCIO Summit this past week, and his presentation was compelling, to say the least. As he pointed out in a panel discussion with Mark Yusko, Dennis Gartman, David Rosenberg, and myself, “When currencies begin to trend, they can do so for decades.”
A sobering thought.
A look at the long-term charts of the DXY Index shows just how massive the potential reversal of this trend is; and based on Raoul’s roadmap, the sheer size of the reversal gives us a strong hint of the degree of carnage that will be wrought upon a world in which the dollar carry trade has reached somewhere between $5 trillion and $9 trillion.
Incidentally, one of those estimates is Raoul’s, and one belongs to the BIS, and I bet your first guess as to which is which would have been wrong.
A closer look at a shorter-term chart demonstrates the recent break clearly:
The BIS report to which I refer was published last week, and it was astounding in terms of the sheer size of the dollar carry trade it depicted.
According to the BIS, US dollar loans to China’s banks and companies have jumped to $1.1 trillion — that’s TRILLION — from virtually zero just five short years ago. The annual rate of increase of those loans is a mind-boggling 47%.
However, the fun doesn’t stop there.
Consider Brazil, for example, where cross-border dollar credit now stands at $461 billion, or roughly 20% of GDP. For Mexico those numbers are even more eye-watering. A country with a GDP of just $1.1 trillion has outstanding cross-border dollar credit of $381 billion — or roughly 30% of GDP. Frightening.
Meanwhile, in Russia the same metric has reached $751 billion. Why does this matter? Well, the charts below, which show the appreciation of the US dollar against those three currencies in the last five years, highlight the danger to countries that have been able to borrow seemingly endless amounts of (relatively) stable dollars to finance business operations and expansion.
Lastly — and perhaps most importantly — witness the change in direction of the Chinese renminbi which, after trending higher against the dollar for many years (and, in the process, moving virtually everybody to the same side of the boat in the belief that a stronger Chinese currency was a given), has suddenly started to look as if it may also succumb to the renewed strength of the dollar. The only difference here being that the Chinese may actively be looking now to devalue their currency in light of the ongoing attempt by the Japanese to devaluetheir way back to competitiveness. Few thought this a likely scenario until very recently; consequently, few are positioned accordingly; and when things like that happen in the macro world, you can get some REALLY funky moves.
When currency wars break out, they can get very nasty very quickly.
Under no circumstances should you take your eyes off the US dollar, folks. The sheer number of places where you will witness the knock-on effects of a soaring dollar — chief amongst them emerging markets and the commodity space — will be breathtaking.
I will write at greater length on the likely effects of the dollar’s move on gold in a few weeks, as it warrants a piece all its own; so stay tuned for that one.
In a series of conversations I’ve been fortunate to have had with some of the best macro traders in the world in recent months through Real Vision Television, there has been one overarching takeaway from every one of them: macro is back, and 2015 is shaping up to be an epic year for the guys who trade these fundamental shifts. To a man, after several years of little action in the macro world, they are positively licking their lips at the potential opportunities that are headed their way next year.
One person’s opportunity is another person’s crisis. You have been warned.
Track 3 was an instrumental number called “12 Bar,” a reggae reimagining of the 12-bar blues that highlighted Brian Travers’ remarkably good saxophony skills (given his lack of attention to learning to play the instrument before forming the band).
Obviously, during my time with Mauldin Economics, the “bars” which have preoccupied me have been those of the gold variety — and for the most part, their constant movement in an easterly direction.
I have written article after article and given presentation after presentation about the dichotomy between paper and physical gold and have regularly highlighted the magnitude of the flow of gold out of the West and into strong Eastern hands. In the previous edition of this publication (“How Could It Happen?”), I imagined a future in which this stunning relocation of physical gold had finally mattered; and between publishing that piece and penning this one, a couple of interesting things have happened. Firstly, my friend Barry Ritholtz took a big, fat shot at me in a Bloomberg column entitled “The Gold Fairy Tale Fails Again.” Barry’s article (which was entirely consistent with his very public and oft-stated thinking and was, as is always the case with Barry, very well-written) took apart what he sees as the various failed narratives in the gold markets. He began with gold’s link to QE:
(Barry Ritholtz): [T]he most popular gold narrative was that the Federal Reserve’s program of quantitative easing would lead to the collapse of the dollar and hyperinflation. “The problem with all of this was that even as the narrative was failing, the storytellers never changed their tale. The dollar hit three-year highs, despite QE. Inflation was nowhere to be found,” I wrote at the time...
... moved on to the recent SGI:
Switzerland was going to save gold based on a ballot proposal stipulating that the Swiss National Bank hold at least 20 percent of its 520-billion-franc ($538 billion) balance sheet in gold, repatriate overseas gold holdings and never sell bullion in the future. This was going to be the driver of the next leg up in gold. Except for the small fact that the “Save Our Swiss Gold” proposal was voted down, 77 percent to 23 percent, by the electorate....
... then hit upon the recent Indian import restrictions and reports of gold shortages, which Barry clearly feels are spurious, before eventually finding his way to yours truly:
Perhaps the most egregious narrative failure came from Grant Williams of Mauldin Economics. He imagined a conversation 30 years from now about China’s secret three-decade-long gold-buying spree, dating to November 2014. Well, we only need to wait 30 years to see if this prediction is correct.
Now, in response to the lighting up of my Twitter feed after Barry’s article was posted (and my thanks to all those who kindly pointed it out to me), I would say this: Barry is right on all counts.
I am delighted to be able to call Barry a friend and have absolutely no problem with his calling me out on what I said. Those of us who possess sufficient hubris to deem our thoughts worthy of distribution wider than the inside of our own heads are absolutely there to be taken to task should others disagree with us. We make ourselves fair game the second we hit the wires.
Sadly, none of us actually KNOW anything. How could we? We all take whatever inputs we find and then use them to reach our own conclusions based mostly on probability, and more often than not those conclusions are wrong.
HOWEVER... if your logic is sound and your thought processes rigorous, being wrong is often a temporary state — something that can also be said about being right, of course. In my humble opinion, the issue with gold today is not one of narrative, as Barry suggests, but rather that the extent of the current interference in markets by our friends at the various central banks around the world has meant that being wrong (no matter which part of the financial jigsaw puzzle you may be concerned with) has never been easier — even though being right has never, in my own mind at least, been more assured in the long term, certainly as far as gold is concerned.
As I slumped against the literary ropes, Barry threw one more punch when he suggested that the reader would “only need to wait 30 years to see if this prediction is correct,” but this is where I stop covering up and finally flick a jab or two of my own.
I think the chances of having to wait 30 years to see the gold conundrum resolve itself (in materially higher prices, I might add) lie close to those of Barry’s being invited to give the opening address at the next GATA conference. The evidence is crystal clear that significant quantities of physical gold have been pouring into Eastern vaults (due to both private- and public-sector activity); and gold is, after all, a finite resource. Not only that, but the “weakness” in gold (which remains roughly 500% above its turn-of-the-century low, despite the recent 30% correction) is confined to the paper market.
Whilst this distinction between paper and real gold hasn’t mattered up until now, there will come a day when it absolutely does — to everybody — and at that point, anyone not positioned correctly will be in a world of hurt.
(Charts above and below courtesy of Nick Laird at Sharelynx and Koos Jansen)
Tightness in the physical market has increased consistently as the likes of Russia continue to stockpile ever-increasing amounts of gold and as Chinese imports as well as withdrawals from the Shanghai Gold Exchange maintain a torrid pace. The only missing piece of the puzzle is the lack of any official acknowledgement that the Chinese have been doing the same thing to a far greater degree; and, as I wrote in “How Could It Happen?”, there is a curious demand for absolute proof from those who dispute official figures, whilst the principle of reasonable doubt continues to hold sway on the other side of the argument.
I suspect that imbalance will right itself — possibly very soon — and when it does there will be absolutely no putting the genie back into the bottle.
In the meantime, as Barry so confidently predicted, the Swiss Gold Initiative failed, but that was overshadowed (in my mind at least) by a couple of very interesting developments that were covered beautifully by two of my buddies, Willem Middelkoop (author of The Big Reset — a phenomenal read) and Koos Jansen.
Firstly, Koos reported on the increasing drive to allocate the gold held within the Eurosystem:
(Koos Jansen): [M]ost of the Eurosystem official gold reserves are allocated, and since January 2014 (which is as far as the more detailed data goes back) the unallocated gold reserves are declining, as we can see in the next chart.
Unfortunately we do not know what happened prior to 2014.
Note, allocated does not mean the gold is located on own soil, but it does mean the gold is assigned to specific gold holdings, including bar numbers, whether stored on own soil or stored abroad. Unallocated gold relates to gold held without a claim on specified bar numbers; often these unallocated accounts are used for easy trading... The fact the Eurosystem discloses the ratio between its allocated and unallocated gold and, more important, the fact that the portion of allocated gold is far greater and increasing, tells me the Eurosystem is allocating as much gold as they can.
Secondly, another repatriation request was unearthed — this time made by perhaps the least likely source imaginable:
(Koos Jansen): In Europe, so far, Germany has been repatriating gold since 2012 from the US and France, The Netherlands has repatriated 122.5 tonnes a few weeks ago from the US, soon after Marine Le Pen, leader of the Front National party of France, penned an open letter to Christian Noyer, governor of the Bank of France, requesting that the country’s gold holdings be repatriated back to France; and now Belgium is making a move. Who’s next? And why are all these countries seemingly so nervous to get their gold ASAP on own soil?
Funnily enough, the answer to Koos’ rhetorical question about who’s next was answered just a few days later:
(Bloomberg): The Austrian state audit court says central bank should address concentration risk of storing 80% of its gold reserves with the Bank of England, Standard reports, citing draft audit report. Court advises central bank to diversify storage locations, contract partners.
Austrian central bank reviewing gold storage concept, doesn’t rule out relocating some of its gold from London to Austria: Standard cites unidentified central bank officials. Austria has 280 tons gold reserves, according to 2013 annual report. Austrian Audit Court Will Review Nation’s Gold Reserves in U.K.
Say what you want about the gold price languishing below $1200 (or not, as the case may be, after this week), and say what you want about the technical picture or the “6,000-year bubble,” as Citi’s Willem Buiter recently termed it; but know this: gold is an insurance policy — not a trading vehicle — and the time to assess gold is when people have a sudden need for insurance. When that day comes — and believe me, it’s coming — the price will be the very last thing that matters. It will be purely and simply a matter of securing possession — bubble or not — and at any price.
That price will NOT be $1200.
A “run” on the gold “bank” (something I predicted would happen when I wrote about Hugo Chavez’s original repatriation request back in 2011) would undoubtedly lead to one of those Warren Buffett moments when a bunch of people are left standing naked on the shore.
It is also a phenomenon which will begin quietly before suddenly exploding into life.
If you listen very carefully, you can hear something happening...
Click here to continue reading this article from Things That Make You Go Hmmm… – a free newsletter by Grant Williams, a highly respected financial expert and current portfolio and strategy advisor at Vulpes Investment Management in Singapore.
The simmering cold war involving the NYPD and various elements of New York's population just went nuclear when a little before 3:00 PM, reports hit that two NYPD officers were shot in their patrol car, and subsequently died, in what has been dubbed an "execution style" ambush in Brooklyn's Bed-Stuy area. The alleged shooter was chased by police and subsequently died of a self-inflicted gun wound.
Two Police Officers have been shot in the 79 pct. please pray for them
— NYPD 121st Precinct (@NYPD121Pct) December 20, 2014
According to Fox both officers died from gunshot wounds, citing city councilman Robert Cornegy. As RT reports, the shooting took place in Brooklyn outside of the Tompkins Houses at around 3pm. The shooter reportedly came out of the building before shooting the officers patrolling the area.
The suspect reportedly fled into a subway station where officers found him suffering from a gunshot wound that appeared to be self-inflicted. He was pronounced dead at the hospital, according to the Times.
The manager of a nearby liquor store told the Times that he saw the officers hunched over in their cruiser and said at least one of them looked like they were shot in the head.
A possible suspect on a stretcher at the scene via the NYP.
NYC: Man who murdered 2 NYPD cops killed his girlfriend in Baltimore this morning Picture from his Instagram Page pic.twitter.com/PFbogbCicQ
— NY Scanner (@NYScanner) December 20, 2014
Screengrabs from the alleged shooter's instagram page
The wounded officers were rushed to Woodhull Hospital in “grave” condition as at least one of them was hit in the head. The New York Post further reports that that both officers were shot in the head at point-blank range.
“It’s an execution,” a law enforcement source told The Post about the ambush.
Based to preliminary reports, the uniformed officers were working overtime as part of an anti-terrorism drill as they sat in their marked police car on a Bedford–Stuyvesant, Brooklyn, street corner.
As the NYT's David Goodman reports, the name of the shooter appears to have leaked and it is Ismail Brinsley (this is unconfirmed by the NYPD).
Both officers now dead; suspect identified by a senior police official as 28-yr-old named Brinsley. First name Ismail or Ishmael
— jdavidgoodman (@jdavidgoodman) December 20, 2014
Some more details about the shooter and his motives from the NY Post:
“I’m Putting Wings on Pigs Today,” a person believed to be the gunman wrote on Instagram in a message posted just three hours before the officers were shot through their front passenger window.
The post included an image of silver automatic handgun with a wooden handle. Another post showed camouflage pants and blue sneakers which matched the clothing the dead gunman was wearing as his body was carried from the scene on a stretcher.
“They Take 1 Of Ours … Let’s Take 2 of Theirs,” the post continued, signing off with, “This May Be My Final Post.”
The gunman was a fugitive who had just murdered his girlfriend in Baltimore Saturday morning, sources told The Post.
Chief Royster said the suspect opened fire on the police officers, ran up Myrtle and went into a subway station. The man died from a self-inflicted gunshot wound to the head, Chief Royster said.
Fire Department officials said that a 911 call came in around 2:50 p.m. reporting that two people had been shot.
Charlie Hu, the manager of a liquor store at the same corner, said he saw two police officers slouched over in the front seat of their patrol car. At least one of the officers, Mr. Hu said, appeared to have been shot in the head.
The last officer killed by gunfire in the line of duty was Peter Figoski in 2011.
More details on the shooting:
Minutes after shooting the two officers, he, too, was dead. He fled to a nearby subway station, the G-train station at Myrtle and Willoughby avenues, where, as pursuing cops closed in, he shot himself on a crowded platform, sources told The Post.
“They engaged the guy and he did himself,” one investigator said of the gunman’s demise.
Both shooting scenes — above and below ground — were scenes of blood and terror.
“I heard shooting, — four or five shots,” ear-witness Derrick McKie, 49, told The Post of the cops’ tragic murder. “It sounded like from a single gun,” he said. Ambulances and police cars rushed to the scene, he said. “I seen them putting the cop in the ambulance. He looked messed up,” McKie, a barber, added. “He took a high caliber weapon to the face. He was lifeless…I couldn’t see where the holes was that, all I could see was blood. His body was lifeless.”
Modal Trigg Carmen Jimenez, 32, a social worker from Bedford-Stuyvesant, was on the subway platform when the gunman ran inside, pursued by officers.
“Everything happened so quick,” said Jimenez, who is eight months pregnant. “We were standing waiting for the G train. We heard arguing from the other end of the platform.
It looked like two cops came in there was lots of yelling and they said, ‘Everybody get down.’
Scenes from the daylight execution:
Photo's from the scene:
— Silver Surfer (@RobPulseNews) December 20, 2014
— RT (@RT_com) December 20, 2014
— Renee Stoll (@ReneeStollABC7) December 20, 2014
at the corner of Tompkins and Vernon pic.twitter.com/kRiaZLo7q7
— ?_? (@MikeIsaac) December 20, 2014
A live webcast from the scene of the crime is available below:
For the past 150 years, crude oil prices have varied between around $10 per barrel and around $120 per barrel. For many decades, oil prices were relatively "stable" but a funny thing happened in the early 70s and everything changed - whether coincidental or causative the linkages between the oil crisis and Nixon's Gold-Standard-busting of Bretton Woods are clear in the chart below. Goldman expects continued high oil price volatility with risks skewed to the downside as the market searches for a new equilibrium... and a period of macroeconomic adjustment to structurally lower oil prices. Is oil adjusting to a new 'gold-standard-esque' normal?
As Goldman noted back in July...
The security situation in the Middle East remains highly unstable. The Islamic State (IS) has taken control of swaths of Iraq and Syria, employing brutal tactics throughout its advance. Shiite militias, the Kurdish peshmerga, and Iraqi forces have struggled in recent months to contain the insurgency. A US-led coalition has conducted airstrikes in the region since August. In Iraq, Haider al-Abadi has replaced Nouri al-Maliki as prime minister after the latter resigned in August amid political gridlock. Elsewhere in the region, the deadline to reach an agreement on the future of Iran’s nuclear program was extended until July 1, after Iran and the five permanent members of the UN Security Council + Germany failed to clinch a deal before the late November deadline. A seven-week war between Israel and Hamas militants ended on August 26 with an Egyptian-brokered ceasefire on August 26, but tensions continue to fester.
Despite the unstable situation in the Middle East (as well as in Russia), oil prices have plummeted by +40% since we published. A lack of oil supply disruptions in Iraq and Russia as well as the return of Libyan output, which relaxed near-term supply concerns, likely triggered the initial sell-off. However, major underlying drivers ultimately set the magnitude of the price decline – namely, continued strong non-OPEC production growth, weak demand growth, as well as a critical shift in the OPEC reaction function in favor of maintaining market share. Indeed, the cartel’s decision on November 27 to hold output steady signaled a major step away from its long-standing strategy of supporting prices with production cuts. Exacerbating the recent sharp price declines have been falling oil production costs given moves in other commodity prices, currencies and oil service costs, which means that oil producers can spend less to get the same or potentially even more in terms of production.
In terms of Iraqi production, as of November, Iraq was producing 3,380 kb/d, compared with a peak of 3,600 kb/d in February. At 2,810 kb/d, overall pipeline exports (2,510 kb/d from the South combined with 300 kb/d from the semi-autonomous Kurdistan region) were comparable to early 2014 levels (2,800 kb/d). Starting January 1, under a long-awaited revenue sharing agreement between Baghdad and Kurdistan, Kurdistan and the disputed province of Kirkuk will contribute 250 kb/d and 300 kb/d of their production, respectively, to the Iraqi national oil company’s exports. In return, Baghdad will release Kurdistan’s 17%share of national revenue. The Kurds will retain the right to exports above the 250 kb/d sold to Baghdad, and additional private pipeline capacity coming online makes it likely that Kurdish exports will increase over the next few months. In the meantime, independent exports from Kurdistan (of over 380 kb/d) have continued via private pipeline and by truck.
And what to look for in 2015:
Continued high oil price volatility with risks skewed to the downside as the market searches for a new equilibrium. Sharp declines in oil production costs, on top of a strong consensus view that the recent extreme oil price weakness will prove temporary (which is motivating oil producers to position for a rebound in price rather than to cut production), suggests that oil prices could fall lower and for longer. Given the expected future supply glut in oil, we believe that the market is actively looking for the new equilibrium price that will take out the excess marginal production. As the industry takes the “fat” out of the system that was built up over the past decade, the new equilibrium price is dropping sharply; where it settles is unknown right now, but we can comfortably say it is likely below our earlier estimates (Brent in the $80-85/bbl range). New cost data early next year should help narrow down what this equilibrium “new normal” might be.
A period of macroeconomic adjustment to structurally lower oil prices. EM oil importers such as India and Turkey should benefit the most, while EM exporters will face the greatest challenges, particularly in those countries with higher breakeven oil prices, such as Algeria, Iraq, and Iran.
Continued instability in the Middle East, as the IS insurgency and Syrian civil war – among other sources of conflict – remain far from being resolved. The severe extent of the oil sell-off also threatens to heighten political instability in the region (as well as in Russia and other oil producers).
* * *
Source: Goldman Sachs
The stock market takes off in holiday celebration of the FOMC being even less clear than it really has been in some time; perhaps going all the way back to Alan Greenspan’s intentional mush. Equity “investors” are happy that the Fed may be happy about the economy, even though there is nothing in actual markets (outside of stocks) to suggest that anything the Fed proclaims carries even the slightest validity. Growth and inflation are going to be good, so the philosopher kings in DC say for the sixth year in a row, this time enough to end ZIRP (after almost seven years) and get to tightening.
Axiomatically, ambiguity is not certainty but the degree to which ambiguous language is taken as a comfortable conviction shows exactly the game being played here. Stock investors expected this exact vagueness and since the received abstruseness was as expected it was certainly reassuring to bid equity prices. This is how far rational expectations theory has devolved.
It is very curious, then, to see vastly larger markets unperturbed by anything that occurred at the FOMC this week. Sure, nominal yields rose in the treasury market a bit, though only slightly after an immense buying spree. Overall there was a distinct lack of distinction, and thus positive conviction, in credit and funding. The eurodollar market is only slightly tighter in the shorter tenors to where it was before the FOMC’s “radical” and “revolutionary” semantical modification.
The eurodollar market’s companion forward rate gauge, interest rate swaps, were also less than impressed by so much mushiness. There is nothing but more of the same here:
Given how much noise has been made over this last policy statement, you would think there would at least be a small imprint somewhere. Swap spreads have settled into this spread level going back to the first “dollar” tightening back in late June/early July which coincided with exactly zero FOMC policy shifts. Now, as the FOMC proclaims greater economic accomplishment, spreads remain undisturbed instead of decompressing still further as in stock-based rapture.
That was the case, though again not drawn out by policy language, in certainly the 5-year swap spread that had finally broken above 20 bps for the first time in over a year in late September and early October. However, the end of that trend on October 8 suggests reasoning there had nothing to do with economic confidence and everything to do with hedging against growing illiquidity and downright desperation. The timing of that and the following durability of the flatline trend in swap spreads more than suggests little anxiety about what the Fed might do and instead a concern about the world as it really is.
Again, we see that the illiquidity prior to October 15 was rather narrowly focused, and instead of being the end of the episode contributing to stability it has spread far and wide since then. That is particularly true of December, as there have been no shortage of global instability for stock markets to ignore.
The yield curve collapse (and breakdown of “inflation” expectations) in December is strikingly reminiscent of the tumble in Brazilian reals and even the collapse of the Russian ruble. The treasury curve is plumbing new depths of flattening in a trend that is totally contrary to the end of “considerable period” consideration. The bearishness in credit and funding did not just start this month; not even back to October or June. This is a trend that has been in place for one day shy of thirteen months. That “resilience” plus the unbelievable size of these moves argue that shifting from “considerable period” is totally and completely irrelevant.
The latest iteration of credit revulsion on October 15, 2014, is shaping up in retrospect much like November 20, 2013. The first “event” back in November last year showed that exiting from QE-driven positions and capacities was going to be fraught with extreme difficulty, to the point, as expressed in the change in yield curve shape going back to that day, that it would be impossible without incurring significant disorder. Thus, the illiquidity that began in June 2014 was really confirmation of that, leading up to the liquidity system deformities that finally broke open on October 15.
Try as they might to address it differently, the commonality of the eurodollar standard here is actually the erasure of central banks’ last stand. Looking at the charts for the UST curve (below) two aspects really stand out – that the curve had actually drawn steeper starting with Mario Draghi’s July 2012 “promise” to save the euro (followed not long after by Bernanke’s entrant into the “last ditch” efforts) and that “market” expression of economic “normalcy” along those lines has not just been erased but rather completely obliterated these past thirteen months.
So the difference between the credit reaction in May 2013 and that of March 2014, as I keep harping on, was not only that central bank exits would eventually be messy due in full part to the artificial approach which artificially pulled resources in artificially inefficient directions (especially liquidity capacity), but, more importantly, that there was and is no true economic recovery there to cushion the blow. In other words, October 15 and the behavior of the funding markets (the “dollar”) thereafter combines both aspects of monetary failure; that exits are messy and there is no sustainable or actual economic progress to successfully absorb either withdrawal or comprehensive and global recognition of this monetary miscarriage.
Thus, not only has the treasury curve flattening completely unwound any past optimism about what really amounted to nothing more than faith in monetary efficacy (steepening in 2012 and most of 2013), it has gone so far beyond as to revisit 2009 and even 2008. Central banks had only one more shot at it back in 2012 and credit markets have figured out that not only did it fail to work on the real economy, the distortions they created were actually harmful and thus there is nothing really left to support any of this.
The recovery is over because it never was. The Fed is now kamikaze and stuck on this course, having painted itself into a smaller and smaller corner in which to operate. Their only hope is that their confidence turns into your confidence, but credit and funding markets are impenetrable at this moment to such utter nonsense. For many places, it is already “look out below.”
Brian Kelly, Curtis Erickson and Jerremy Newsome will all be guests on ...
Back in May 2013, when we wrote "How "Modern Money" Really Works" and noted that in the current environment, as a result of prudential regulation, derivative clearing requirements, bilateral margin requirements and general economic uncertainty including deflationary scares and other flights to quality/safety, there could be a gargantuan shortage of "high-quality collateral" amounting to as much as $11.2 trillion, we explained that demand for Treasury paper will increase with every passing month as the market realizes that traditional supply/demand dynamics in the rates market no longer exist and have been supplanted by regulatory demand-side technicals coupled with supply calculus which is predicated almost exclusively by what central banks do, or rather, how much Treasurys they monetize.
In retrospect, our observation also explains why everyone got the bond trade wrong in 2014, as everyone - most certainly Goldman Sachs and its clients - not only expected a global economic rebound (clearly that did not happen in 2014, when Chinese growth hit the brakes to record lows, and when both Japan and Europe re-entered recession absent GDP-fudging semantics), but were oblivious to the key considerations behind the high-quality collateral theme. Why, none other than Goldman in its Global Economics Weekly from June 27, 2012 and Fixed Income Monthly from July 2012 concluded that "there is not much evidence in favor of the explanation" of the high-quality collateral (HQC) thesis as a driver of Treasury demand. To see just how wrong Goldman was, compare the 10Y's Friday close with Goldman's 3.50% year-end target, and now add some 30x Total Return Swap leverage.
Which bring us to Friday afternoon, when as Goldman observes in a new note, "since then, the regulatory environment has further developed, with Dodd Frank now in place. Also, given this year’s rally in fixed income, the topic has become of interest again."
So where do we stand now that there is still trillions of explicit demand of HQC. Well, it seems that contrary to all expectations that the global recovery will stabilize inflation (or maybe deflation now plunging oil prices are actually a good thing: it seems Keynesian dogma was only kidding after all)?
Well, according to Goldman's own calculations, the demand squeeze for the High Quality Collateral that is global "Developed Market" Treasurys is about to go through the roof mostly thanks to central banks which will - even in the Fed's temporary hiatus from the monetization scene - soak up an unprecedented amount of Treasury collateral from both the primary issuance and secondary private market in their scramble to push global equity prices to unseen bubble levels and achieve the kind of Keynes-vindicating, demand-pull inflation that Russia was delighted to enjoy in the past several weeks.
How much? The answer: a lot, as in a whopping 20% collapse in supply, once the ECB joins the fray!
To compute 2015 gross and net issuance, we take data on medium- and long-term bonds maturing in 2015 from Bloomberg and use our own government deficit forecasts. We assume that G4 sovereigns fund two-thirds of the 2015 deficit by issuing bonds and one-third via bills. We net out central bank purchases from the estimated gross issuance, assuming that the Bank of Japan buys JPY120trn (the middle of the range set in the new guidelines published in October 2014 by the BoJ), and that the ECB purchases about EUR130bn of German government bonds. This is in line with our expectation that the ECB will announce a EUR500bn sovereign QE program in 2015Q1 and buy bonds according to each EMU country’s ECB capital key contribution.
The data on demand from different categories of investors are from the central banks’ flow of funds statistics. For the US, we also consider flows recorded by TIC data published by the US Treasury. We cumulate over a year quarterly net purchases of government medium- and long-term securities for various categories of investors. Because central banks' flow of funds data are available only with a significant lag, actual 2014 data include flows up to Q3 for the US and to Q2 for the other countries. We assume that in the quarters for which 2014 data are not yet available, purchases by the various categories of investors continue at the same average pace observed in the quarters for which we have data.
Yearly gross (bond issuance funding bond redemptions and the government deficit) and net (bond issuance funding the government deficit only) issuance of G4 government bonds, both including and excluding central bank purchases, declined significantly from 2012 to 2013, but not from 2013 to 2014.
For 2015, we project that the gross supply of G4 government bonds will decline by 4%. But, once we net out central banks’ purchases of government bonds, the 2015 supply available to private investors will fall by more (minus 20%). Scarcity will be concentrated in Bunds and JGBs, while we expect US Treasuries supply available to the private sector to increase and Gilts supply to be flat at 2014 levels.
Please note: it doesn't matter where the scarcity is located in a fungible, instantly interconnected, globalized world. Offshore dumb money, pension funds, and everyone else frontrunning them, will end up buying US Treasurys as a pair trade once spreads blow out once again, which means that with the 10Y Bund on its way to 0%, we may well see the US Treasury trade sub-2% and the spread to Bunds will still be a record wide.
How do the numbers stack up by geography?
In the US, 2015 issuance should increase slightly on the back of our forecast for a higher government deficit. Moreover, since the Fed has ended QE3, USTs supply available to the private sector will be $250bn greater than in 2014. In the UK, Gilt issuance will be little changed relative to 2014.
By contrast, the supply of Japanese and German government bonds available to the private sector will decline significantly. In Japan, gross JGB issuance, net of the BoJ’s purchase of JPY120trn (the middle of the range set in the new guidelines published in October 2014 by the BoJ), will fall to JPY22trn from JPY90trn in 2014.
Which is to be expected: recall that as we noted previous, Japan will monetize all gross issuance in 2015!
But the big wildcard is the ECB.
According to the government’s issuance schedule, Germany expects to issue about EUR147bn medium- and long-term nominal bonds and about EUR10-14bn inflation-linked securities to repay EUR155bn of maturing bonds, while the government budget will be roughly balanced. But, in Q1, we expect the ECB to announce a EUR500bn sovereign QE program and buy EMU government bonds according to each EMU country’s ECB capital key contribution. This implies that the ECB would purchase EUR130bn of German bonds, i.e., 90% of the 2015 gross issuance of German Bunds.
In case anyone missed the punchline, here it is again: "the ECB would purchase EUR130bn of German bonds, i.e., 90% of the 2015 gross issuance of German Bunds."
In short, between Europe and Japan, thanks to the BOJ and ECB, there will be literally no bonds that will make their way from the primary to the secondary market! Which means only one thing: those looking for the marginal, and only, source of high quality collateral in 2015, will find it coming right out of 1500 Pennsylvania Avenue, NW in Washington. And that assumes, very generously, that that other famous institution located on Constitution Avenue Northwest doesn't come out of hibernation and resume soaking up collateral on its own if and when the S&P500 finally corrects from its unprecedented, and manipulated, bubble levels.
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But even if one ignores all of the above, the only thing one really needs to know about where Treasurys are headed is the following chart from Goldman, ironically enough included in the same report as GS observed all of the above:
See you all at 1.5% or much lower.
Having recently given us a two paragraph synopsis of all that is wrong with our financial market faith in fed officialdom, Jim Grant unleashes his critical wit and insight on CNBC to explain the Fed's new remit, as Bill Dudley recently explained, "the administration of American equity prices." The Fed will find it difficult ro raise rates - both technically (for reasons we have explained in detail previously) and "they will find many blocks in the way having to do with financial markets' reaction." Simply put, the Fed wants to raise rates but mostly it wants peace and quiet, which it does not have: "The Fed is America's central bank but it is the steward of the world's currency," and as Grant concludes, "it is raining currencies around the world... and the Fed must be coginizant of that."
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As he notes, it is indeed raining currencies around the world...
A specter is haunting the world, the specter of two percent inflationism. Whether pronounced by the U.S. Federal Reserve or the European Central Bank, or from the Bank of Japan, many monetary central planners have declared their determination to impose a certain minimum of rising prices on their societies and economies.
One of the oldest of economic fallacies continues to dominate and guide the thinking of monetary policy makers: that printing money is the magic elixir for the creating of sustainable prosperity.
In the eyes of those with their hands on the handle of the monetary printing press the economic system is like a balloon that, if not “fully inflated” at a desired level of output and employment, should be simply “pumped up” with the hot air of monetary “stimulus.”
The Fallacy of Keynesian Macro-Aggregates
The fallacy is the continuing legacy of the British economist, John Maynard Keynes, and his conception of “aggregate demand failures.” Keynes argued that the economy should be looked at in terms of series of macroeconomic aggregates: total demand for all output as a whole, total supply of all resources and goods as a whole, and the average general levels of all prices and wages for goods and services and resources potentially bought and sold on the overall market.
If at the prevailing general level of wages, there is not enough “aggregate demand” for output as a whole to profitably employ all those interested and willing to work, then it is the task of the government and its central bank to assure that sufficient money spending is injected into the economy. The idea being that at rising prices for final goods and services relative to the general wage level, it again becomes profitable for businesses employ the unemployed until “full employment” is restored.
Over the decades since Keynes first formulated this idea in his 1936 book, The General Theory of Employment, Interest, and Money, both his supporters and apparent critics have revised and reformulated parts of his argument and assumptions. But the general macro-aggregate framework and worldview used by economists in the context of which problems of less than full employment continue to be analyzed, nonetheless, still tends to focus on and formulate government policy in terms of the levels of and changes in output and employment for the economy as a whole.
In fact, however, there are no such things as “aggregate demand,” or “aggregate supply,” or output and employment “as a whole.” These are statistical creations constructed by economists and statisticians, out of what really exists: the demands and supplies of multitudes of individual and distinct goods and services produced, and bought and sold on the various distinct markets that comprise the economic system of society.
The Market’s Many Demands and Supplies
There are specific consumer demands for different kinds and types of hats, shoes, shirts, reading glasses, apples, and books or movies. But none of us just demands “output,” any more than there is just a creation of “employment.”
When we go into the marketplace we are interested in buying the specific goods and services for which we have particular and distinct demands. And businessmen and entrepreneurs find it profitable to hire and employ particular workers with specific skills to assist in the manufacture, production, marketing and sale of the distinct goods that we as individual consumers are interested in purchasing.
In turn, each of these individual and distinct goods and services has its own particular price in the market place, established by the interaction of the individual demanders with the individual suppliers offering them for sale.
The profitable opportunities to bring desired goods to market results in the demand for different resources and raw materials, specific types of machinery and equipment, and different categories of skilled and lesser skilled individual workers to participate in the production processes that bring those desired goods into existence.
The interactions between the individual businessmen and the individual suppliers of these factors of production generate the prices for their purchase, hire or employment on, again, multitudes of individual markets in the economic system.
The “macro” economist and his statistician collaborator then proceed to add up, sum and averages all these different individual outputs, employments and specific prices and wages into a series of economy-wide measured aggregates.
But it should be fairly clear that in doing so all the real economic relationships in the market, the actual structure of relative prices and wages, and all the multitude of distinct and interconnected patterns of actual demands and supplies are submerged and lost in the macro-economic aggregates and totals.
Balanced Markets Assure Full Employment
Balanced production and sustainable employments in the economy as a whole clearly requires coordination and balance between the demands and supplies of all the particular goods and services in each of the specific markets on which they are bought and sold. And parallel to this there must be comparable coordination and balance between the businessmen’s demands for resources, capital equipment and different types of labor in each production sector of the market and those supplying them.
Such coordination, balance, and sustainable employment requires adaptation to the every-changing circumstance of market conditions through adjustment of prices and wages, and to shifts in supplies and demands in and between the various parts and sectors of the economy.
In other words, it is these rightly balanced and coordinated patterns between supplies and demands and their accompanying structures of relative prices and wages that assure “full employment” and efficient and effective use of available resources and capital, so entrepreneurs and businessmen are constantly and continuously tending to produce the goods we, the consumers, want and desire, and at prices that are covering competitive costs of production.
All this is lost from view when reduced to that handful of macro-aggregates of “total demand” and “total supply” and a statistical average price level for all goods relative to a statistical average wage level for all workers in the economy.
The Keynesian Government “Big Spender”
In this simplified and, indeed, simplistic view Keynesian-type view of things all that needs to be done from the government’s policy perspective is to run budget deficits or create money through the banking system to push up “aggregate demand” to assure a targeted rise in the general price level so profit-margins “in general” are widened relative to the general wage level so employment “in general” will be expanded.
We can think of government as a “big spender” who comes into a town and proceeds to increase “aggregate demand” in this community by buying goods. Prices for final output rise, profit margins are widened relative to the general wage level and other general cost-prices. Private businesses, in general, employ more workers, purchase or hire other inputs, and “aggregate supply” expands to a point of desired “full employment.”
The presumption on the part of the center bankers in targeting a rate of an average annual price inflation of two percent is that while selling prices are to be pushed up at this average annual rate through monetary expansion, the average level of cost prices (including money wages in general) will not rise or not by the same percentage increase as the average increase in the “price level.”
If cost prices in general (including money wages) were to rise at the same rate as the price level, there would be no margin of additional profits to stimulate greater aggregate output and employment.
Market Anticipations Undermine Keynes’ Assumptions
The fallacy in thinking that cost-prices in general will permanently lag behind the rate of increase in the price level of final goods and services was pointed out long ago, in 1898, by the famous Swedish economist, Knut Wicksell:
“If a gradual rise in prices, in accordance with an approximately known schedule, could be reckoned on with certainty, it would be taken into account in all current business contracts; with the result that its supposed beneficial influence would necessarily be reduced to a minimum.
“Those people who prefer a continually upward moving to a stationary price level forcibly remind one of those who purposely keep their watches a little fast so as to be more certain of catching their train. But to achieve their purpose they must not be conscious or remain conscious of the fact that their watches are fast; otherwise they become accustomed to take the extra few minutes into account, and so after all, in spite of their artfulness, arrive too late . . .”
The Government “Big Spender” Unbalances Markets
But the more fundamental error and misconception in the macro-aggregate approach is its failure to appreciate and focus on the real impact of changes in the money supply that by necessity result in an unsustainable deviation of prices, profits, and resources and labor uses from a properly balanced coordination, the end result of which is more of the very unemployment that the monetary “stimulus” was meant to cure.
Let’s revert to our example of the “big spender” who comes into a town. The townspeople discover that our big spender introduces a greater demand into the community, but not for “goods in general.” Instead, he announces his intention of building a new factory on the outskirts of the town.
He leases a particular piece of land and pays for the first few months rent. He hires a particular construction company to build the factory, and the construction company in turn increases its demand not only for workers to do the work, but orders new equipment, that, in turn, results in the equipment manufacturers adding to their workforce to fulfill the new demand for construction machinery.
Our big spender, trumpeting the wonders for the community from his new spending, starts hiring clerical staff and sales personal in anticipation of fulfilling orders once the factory is completed and producing its new output.
The new and higher incomes earned by the construction and machinery workers, as well as the newly employed clerical and sales workers raise the demand for various and specific consumer and other goods upon which these people want to spend their new and increased wages.
The businesses in the town catering to these particular increased consumer demands now attempt to expand their supplies and, perhaps, hire more retail store employees.
Over time the prices of all of these goods and services will start to rise, but not at the same time or to the same degree. They will go up in a temporal sequence that more or less tends to match the pattern and sequence of the changed demands for those goods and services resulting from the new money injected by the “big spender” into this community.
Inflationary Spending Has to Continue and Increase
Now, whether some of the individual workers drawn into this specific pattern of new employments were previously unemployed or whether they had to be attracted away from existing jobs they already held in other parts of the market, the fact remains that their continued employments in these particular jobs is dependent on the “big spender” continuing to inject and spend his new money, period-after-period of time, in the same way and in sufficient amounts of dollar spending to assure that the workers he has drawn into his factory project are not attracted to other employments due to the rise in all of these alternative or other demands, as well.
If the interdependent patterns of demands and supplies, and the structure of interconnected relative prices and wages generated by the big spender’s spending are to be maintained, his injection of new money into the community must continue, and at an increasing rate of spending if they are not be fall apart.
An alternative imagery might be the dropping of a pebble or stone into a pond of water. From the epicenter where the stone has hit the surface of the water a sequence of ripples will be sent out which will be reversed when the ripples finally hit the surrounding shore, and will then finally come to rest when there is no longer any new disturbances affecting the surface of the pond.
But if the pattern of ripples created are to be sustained, new pebbles or stones must be continuously dropped into the pond and with increasing force if the resulting counter-waves coming back from the shore are not to disrupt and overwhelm the ripple pattern moving out from the original epicenter.
The “Austrian” Analysis of Inflation
It is no doubt that this way of analyzing and understanding the dynamics of how monetary expansion affects market activities is more complex and complicated than the simplistic Keynesian-style of macro-aggregate analysis. But as the famous Austrian-born economist, Joseph A. Schumpeter emphasized:
“The Austrian way of emphasizing the behavior or decisions of individuals and of defining the exchange value of money with respect to individual commodities rather than with respect to a price level of one kind or another has its merits, particularly in the analysis of an inflationary process; it tends to replace a simple but inadequate picture by one which is less clear-cut but more realistic and richer in results.”
And, indeed, it is this “Austrian” analysis of monetary expansion and its resulting impact on prices, employment and production, especially as developed in the 20th century by Ludwig von Mises and Friedrich A. Hayek, that explains why the Keynesian-originated macro-aggregate approach is fundamentally flawed.
As Hayek once explained the logic of the monetary inflationary process:
“The influx of the additional money into the [economic] system always takes place at some particular points. There will always be some people who have more money to spend before the others. Who these people are will depend on the particular manner in which the increase in the money stream is being brought about . . .
“It may be spent in the first instance by government on public works or increased salaries, or it may be first spent by investors mobilizing cash balances for borrowing for that purpose; it may be spent in the first instance on securities, or investment goods, on wages or on consumers’ goods . . .
“The process will take very different forms according to the initial source or sources of the additional money stream . . . But one thing all these different forms of the process will have in common: that the different prices will rise, not at the same time but in succession, and that so long as the process continues some prices will always be ahead of others and the whole structure of relative prices therefore will be very different from what the pure theorist describes as an equilibrium position.”
An inflationary process, in other words, brings about distortions, mismatches, and imbalanced relationships between different supplies and demands, and the relationships between the structure of relative prices and wages that only last for as long as the inflationary process continues, and often only at an accelerating rate.
Or as Hayek expressed it on a different occasion:
“Any attempt to create full employment by drawing labor into occupations where they will remain employed only so long as the [monetary and] credit expansion continues creates the dilemma that either credit expansion must continue indefinitely (which means inflation), or that, when it stops unemployment will be greater than it would be if the temporary increase in employment had never taken place.”
The Inflationary “Cure” Creates More Market Problems
Once the inflationary monetary expansion ends or is slowed down, it is discovered that the artificially created supply and demand patterns and relative price and wage structure are inconsistent with non-inflationary market conditions.
In our example of the “big spender,” one day the townsfolk discover that he was really a con artist who had only phony counterfeit money to spend, and whose deceptive promises and temporary spending drew them into in all of those specific and particular activities and employments. They now find out that the construction projects began cannot be completed, the employments created cannot be maintained, and the investments started in response to the phony money the big spender injected into this community cannot be completed or continued.
Many of the townspeople now have to stop what they had been doing, and try to discover other demanders, other employers and other possible investment opportunities in the face of the truth of the big spenders false incentives to do things they should not have been doing from the start.
The unemployment and under utilization of resources that “activist” monetary policy by governments are supposed to reduce, in fact, set the stage for an inescapable readjustment period of more unemployment and temporary idle resources, when many of the affected supplies and demands have to be rebalanced at newly established market-based prices if employments and productions are to be sustainable and consistent with actual consumer demands and the availability of scarce resources in the post-inflationary environment.
Thus, recessions are the inevitable result from prior and unsustainable inflationary booms. And even the claimed “modest” and “controlled” rate of two percent annual price inflation that has become the new panacea for economic stability and growth in the minds of central bankers, brings in its wake a “wrong twist” to many of the micro-economic supply and demand and price-wage relationships that are the substance of the real economy beneath the superficial macro-aggregates.
Governments and their monetary central planners, therefore, are the cause and not the solution to the instabilities and hardships of inflations and recessions. To end them, political control and manipulation of the money and banking systems will have to be abolished.
A photo posted to Twitter last week by Ansar al-Din Front, an Islamic extremist brigade, clearly shows a Ford truck with a "Mark-1 Plumbing" decal on the door and a militant standing in the bed firing the anti-aircraft gun...
As Haaretz reports, the Texas plumber whose truck was photographed in Syria says he has no idea how it ended up thousands of kilometers away in the war-torn country...
Mark Oberholtzer, who has owned and operated Mark-1 Plumbing in Texas City for the past 32 years, confirmed it was his truck in the picture. He said he no longer owned the vehicle and had no idea how it ended up in Syria.
Oberholtzer said he had traded in the truck to second-hand dealership three years previously. He left the decal on the truck in the expectation that the dealership would remove it.
A spokesman for the dealer said that they had passed it on to a car auction house.
Oberholtzer has been besieged by phone calls - some threatening - since the picture was posted. “A few of the people are really ugly,” he told The Galveston Daily News.
Later in the week, federal Homeland Security officials arrived at Mark-1 Plumbing to question Oberholtzer and his staff.
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It seems US exports are indeed picking up!!
As the world grows used to hearing of reserve depletion among less-developed nations defending their currencies from collapse, we thought the following chart might open a few eyes as to the real driver of attempting to create 'stability' by intervention. In the run-up to October's parliamentary election in Ukraine, the Hryvnia became oddly stable - signaling to the world that the current government had everything under control and should be re-elected. Since the re-election, the Ukrainian currency has re-collapsed to record lows. How did the Ukrainian government 'ensure' re-election via 'stability'? By blowing almost $4bn (a record 23% of reserves) in one month to maintain the currency's level...
Money well spent we are sure...
The powerful divergence theme re-emerged and effectively ended the dramatic correction throughout the capital markets. The FOMC statement strengthened conviction of a mid-2015 lift off, even if the pace of tightening may be somewhat slower than previously anticipated. At the same time, the Swiss National Bank's decision to move to negative interest rates, partly in anticipation of the ECB expanding its asset purchases as early as next month, underscores that Europe remains well behind the US in the credit cycle.
Rather than attribute the downdraft in the dollar and equity markets to a shift in underlying fundamental drivers, we had seen the hand of a technical correction, driven by short-term market positioning, and aggravated by year-end portfolio adjustments. Indeed the euro peaked within a few ticks of the 50% retracement objective of its losses from the October 15 high near $1.29. For its part, the dollar's dramatic slide against the yen stopped just shy of a key retracement objective of its rally from both October 15 and October 31 that was found near JPY115.50.
We expect the dollar's higher trend to continue. However, the lack of participation over the next two weeks could obscure this trend. The Dollar Index made a new high before the weekend near 89.65. A move above 90.00, which has held back previous dollar bounces since the onset of the Great Financial Crisis, would signal an acceleration of the dollar 's advance. Initial support is pegged in the 88.80 area.
The euro recorded a new low for the move just before the weekend near $1.2220. A break of $1.2200 would suggest losses toward $1.20. It has not been able to resurface much above $1.2300 since breaking below in response to the SNB's decision.
Technical indicators suggest the dollar's uptrend against the yen will resume. The move above JPY119.50 strengthens the conviction that the greenback is on its way back to the December 8 high near JPY121.85 and beyond. Initial dollar support is seen in the JPY118.50-80 area.
Sterling is not particularly interesting at the moment. It caught between the strength of the dollar and the weakness of other currencies, including the euro, Swiss franc, yen and Australian dollars. Against the greenback, it has been confined largely to a $1.56-$1.58 trading range since mid-November. There has been a handful of violations of the two-cent range. Technical indicators suggest risk remains to the downside. Sterling set a low near $1.5540 on December 17, but the snap back into the range seemed halfhearted. Resistance is seen $15680-$1.5700.
The dollar-bloc currencies are still headed lower. They did not participate in the bounce that the euro and yen enjoyed. Resistance in the Australian dollar is now pegged near $0.8200. Our next important target is near $0.8000, ahead of that are the lows from 2010 around $0.8060-70. The US dollar reached a high of roughly CAD1.1675 on December 15, this was the lower end of the range we have been suggesting the greenback had near-term potential toward. The upper end of that range is near CAD1.1725. Since recording the highs, the US dollar has not been below CAD1.1560.
The dollar peaked against the Mexican peso on December 12 near MXN14.95. Five days later it had slumped to MXN14.37. By the end of the week, the dollar's bull move appears to have had recovered to above MXN14.70 In the days ahead, the dollar may consolidate its gains. It could pullback toward MXN14.50, though, over the medium term, it appears the dollar can retest the 2009 high near MXN15.60.
The US 10-year yield bounced off of the 2.0% level to near 2.25%, where the rally faded. Economic data out next week are expected to show stronger capex (durable goods orders) and stronger growth momentum (upward revision to Q3 GDP to above 4%). This may limit the pullback in yields.
At the same time, we note that the premium the US pays over Germany widened out to almost 160 bp this week. This is the largest premium since mid-1999. It began the year near 110 bp. The widening was a result of German bund yields falling further than US yields fell.
Although the US 10-year yield remains relatively low, the 2-year yield has firmed, and at 65 bp is 1-2 bp below the five-year high set earlier this month. The US premium over German at this tenor is about 73 bp, which represents a new three-year high. These relative interest rate developments are understood to be constructive for the dollar.
The S&P 500 gapped higher December 18 following a strong close the previous day after the FOMC meeting and seemingly aided by the Swiss National Bank's move to negative interest rates. It had advanced further before the weekend. From the mid-week low to the pre-weekend high, the S&P 500 gained about 95 points or 5.2%.
That gap is between 2016.75 to 2018.98. We do not look for this gap to be filled in the near-term. Rather the gap, like the one on October 21, signals the end to the corrective losses and the resumption of the bull advance that carries it to new highs.
There is a reasonable chance that the February crude oil futures contract has put in a short-term low around $54.30-60. The RSI is turning up, and the MACD is about to cross. The sellers were pulling back, and bargain hunting was reported. The $60.00 level is the first hurdle and near $63.00.
Observations based on the speculative positioning the in futures market:
1. There was only one significant position adjustment of more than 10k in the latest CFTC Commitment of Traders report for the week ending December 16. It was the 12.4k contract reduction in the gross short euro position, leaving 182k contracts still short. The net short position has been reduced by 52k contracts since peaking in early November, which is fully accounted for by short covering.
2. There were several other gross currency positions that changed by almost 10k contracts. The short yen position was reduced by 9.6k contracts to 132.6k. The gross long Swiss franc position doubled to 18.9k. The speculative gross long Australian dollar position increased by 9.4k contracts to 26.8k.
3. All the currency futures we track here but the Canadian dollar saw gross short positions trimmed in the latest week. This seems very much consistent with squaring up ahead of the holiday season. For its part, the gross short Canadian dollar position rose a by 300 contracts.
4. The speculative net short US 10-year Treasury futures position increased by 20% to 258k contracts. A full 10% of the gross long position was liquidated, or 32.3k contracts were sold to leave 273.4k still long. The gross short position increased by 24.6k contracts lifting the short position at 531.6k contracts. It has risen by 70k contracts over the past three reporting weeks. Over the same period, the gross long position has fallen by 110k contracts.
A federal judge, Judge Arthur J. Schwab of the Western District of Pennsylvania, used a deportation decision to probe the constitutionality of President Obama’s executive order on amnesty, declaring it “unconstitutional.”
It is about time that Executive Orders are challenged in court for they are absolutely unconstitutional since they smack of a dictatorial abuse of power that denies the people the right to decide the fate of their nation.
Indeed, Texas and other states have already initiated lawsuits challenging the order. Nonetheless, the key here is that ANY such Executive Order is unconstitutional violating the entire concept of a Republic where it is at least a pretense that it is a government by the people rather than a king acting on a personal whim. This is what the law should be – not because of the subject-matter, but any issue.
Obama could just as easily order that the IRS increase taxes to 85% without Congress. Anything would be possible. This is the immigration issue, but the act of an Executive Order is everything. Obama just issued such an unconstitutional order to the FCC directing them to regulate and license the Internet. There is nothing any President could do without a vote from the people
Consequently, Judge Schwab wrote:
“President Obama’s unilateral legislative action violates the separation of powers provided for in the United States Constitution as well as the Take Care Clause, and therefore, is unconstitutional.”
Full Decision below:
Just hours after the FBI announced that, with absolute certainty, it had determined that North Korea was behind the Sony hack, a "theory" that has become the butt of global jokes, we learned, in a far less prominent release, that according to an internal inquiry, FBI evidence if "often mishandled." According to the NYT, "F.B.I. agents in every region of the country have mishandled, mislabeled and lost evidence, according to a highly critical internal investigation that discovered errors with nearly half the pieces of evidence it reviewed.
The evidence collection and retention system is the backbone of the F.B.I.’s investigative process, and the report said it is beset by problems.
It gets better: according to the report, the F.B.I. was storing more weapons, less money and valuables, and two tons more drugs than its records had indicated. Almost as if the FBI was siphoning off cash, while hoarding guns and blow.
The report’s findings, based on a review of more than 41,000 pieces of evidence in F.B.I. offices around the country, could have consequences for criminal investigations and prosecutions. Lawyers can use even minor record-keeping discrepancies to get evidence thrown out of court, and the F.B.I. was alerting prosecutors around the country on Friday that they may need to disclose the errors to defendants.
A majority of the errors identified were due in large part to human error, attributable to a lack of training and program management oversight,” auditors wrote in the report, which was obtained by The New York Times.
F.B.I. officials on Friday said that they decided on their own to conduct the review after discovering during an internal audit that there might be issues with the record keeping for evidence.
In other words, there was human error, as well as willful "record keeping" lies.
But that's ok, because the FBI has released a YouTube clip proving that North Korea hacked the US subsidiary of a Japanese company in a matter that has escalated to a national security issue. Right? Because the US had doctored photos of Iraq WMDs, and a doctored YouTube clip of Syrians "dead" after an Assad chemical attack.
Well, maybe not. Which perhaps explains why a defiant North Korea not only refuses to take responsibility for the infamous Sony "hack", something which makes little sense for the regime that would love to take full credit for crippling of the evil Imperialist pigs' Christmas movie schedule, but that, as Reuters reports, it wants a joint probe investigation into the incident with the United States.
An unnamed spokesman of the North's foreign ministry said there would be "grave consequences" if Washington refused to agree to the joint probe and continued to accuse Pyongyang, the official KCNA news agency reported on Saturday.
In fact, earlier today, North Korea warned of “serious consequences” if the United States retaliates against it.
As a reminder, on Friday, President Barack Obama blamed North Korea for the devastating cyberattack, which led to the Hollywood studio cancelling "The Interview", a comedy on the fictional assassination of North Korean leader Kim Jong Un.
But the epic punchline, is that even a tiny backwater, dictatorship can now make fun of US "moral high ground" courtesy of the recent CIA torture disclosure. “We have a way to prove that we have nothing to do with the case without resorting to torture, as what the C.I.A. does,” the statement said.
We can't wait to see it. We also can't wait to see America's own proof for what is shaping up to be yet another false flag intervention. Alas, we may be waiting for a long time.
While some computer experts still express doubts whether the North was actually behind the attack, American officials said it was similar to what was believed to be a North Korean cyberattack last year on South Korean banks and broadcasters. One key similarity was the fact that the hackers erased data from the computers, something many cyberthieves do not do.
Some American officials have said that North Korea appears to have embraced cyberterrorism as its new weapon of choice for making political points, and is possibly trying to extort new concessions out of the United States and its allies. While North Korea is an impoverished nation with so little Internet usage that it is essentially a black hole in cyberspace, the attacks showed a high level of sophistication and hacking expertise.
The hackers did considerable commercial damage to Sony Pictures, posting embarrassing emails, detailed breakdowns of executive salaries, digital copies of unreleased movies and even the unpublished script for an upcoming James Bond movie.
Sony said the threats against theaters left it no choice but to cancel the Dec. 25 release of “The Interview,” in which Seth Rogen and James Franco play television journalists who get a scoop interview with Mr. Kim, and then find themselves recruited by the C.I.A. to kill him.
On Friday, Mr. Obama faulted Sony’s decision to withhold the movie, saying that it created a precedent of studios giving into intimidation.
Yes, the "terrorists won", which is precisely the cover that the US needed to maintain its imploding "Pax American" status quo. Oh, and whatever happened to all that media coverage of US "enhanced interrogation techniques" anyway?
With two reports a day, and often more, readers sometimes complain that keeping tabs on the thoughts of the various Gavekal analysts can be a challenge. So as the year draws to a close, it may be helpful if we recap the main questions confronting investors and the themes we strongly believe in, region by region.1. A Chinese Marshall Plan?
When we have conversations with clients about China – which typically we do between two and four times a day – the talk invariably revolves around how much Chinese growth is slowing (a good bit, and quite quickly); how undercapitalized Chinese banks are (a good bit, but fat net interest margins and preferred share issues are solving the problem over time); how much overcapacity there is in real estate (a good bit, but – like youth – this is a problem that time will fix); how much overcapacity there is in steel, shipping, university graduates and corrupt officials; how disruptive China’s adoption of assembly line robots will be etc.
All of these questions are urgent, and the problems that prompted them undeniably real, which means that China’s policymakers certainly have their plates full. But this is where things get interesting: in all our conversations with Western investors, their conclusion seems to be that Beijing will have little choice but to print money aggressively, devalue the renminbi, fiscally stimulate the economy, and basically follow the path trail-blazed (with such success?) by Western policymakers since 2008. However, we would argue that this conclusion represents a failure both to think outside the Western box and to read Beijing’s signal flags.
In numerous reports (and in Chapters 11 to 14 of Too Different For Comfort) we have argued that the internationalization of the renminbi has been one of the most significant macro events of recent years. This internationalization is continuing apace: from next to nothing in 2008, almost a quarter of Chinese trade will settle in renminbi in 2014:
This is an important development which could have a very positive impact on a number of emerging markets. Indeed, a typical, non-oil exporting emerging market policymaker (whether in Turkey, the Philippines, Vietnam, South Korea, Argentina or India) usually has to worry about two things that are completely out of his control:
1) A spike in the US dollar. Whenever the US currency shoots up, it presents a hurdle for growth in most emerging markets. The first reason is that most trade takes place in US dollars, so a stronger US dollar means companies having to set aside more money for working capital needs. The second is that most emerging market investors tend to think in two currencies: their own and the US dollar. Catch a cab in Bangkok, Cairo, Cape Town or Jakarta and ask for that day’s US dollar exchange rate and chances are that the driver will know it to within a decimal point. This sensitivity to exchange rates is important because it means that when the US dollar rises, local wealth tends to flow out of local currencies as investors sell domestic assets and into US dollar assets, typically treasuries (when the US dollar falls, the reverse is true).
2) A rapid rise in oil or food prices. Violent spikes in oil and food prices can be highly destabilizing for developing countries, where the median family spends so much more of their income on basic necessities than the typical Western family. Sudden spikes in the price of food or energy can quickly create social and political tensions. And that’s not all; for oil-importing countries, a spike in oil prices can lead to a rapid deterioration in trade balances. These tend to scare foreign investors away, so pushing the local currency lower and domestic interest rates higher, which in turn leads to weaker growth etc...
Looking at these two concerns, it is hard to escape the conclusion that, as things stand, China is helping to mitigate both:
Beyond providing stability to emerging markets, the gradual acceptance of the renminbi as a secondary trading and reserve currency for emerging markets has further implications. The late French economist Jacques Rueff showed convincingly how, when global trade moved from a gold-based settlement system to a US dollar-based system, purchasing power was duplicated. As the authors of a recent Wall Street Journal article citing Reuff’s work explained: “If the Banque de France counts among its reserves dollar claims (and not just gold and French francs) – for example a Banque de France deposit in a New York bank – this increases the money supply in France but without reducing the money supply of the US. So both countries can use these dollar assets to grant credit.” Replace Banque de France with Bank Indonesia, and US dollar with renminbi and the same causes will lead to the same effects.
Consider British Columbia’s recently issued AAA-rated two year renminbi dim sum bond. Yielding 2.85%, this bond was actively subscribed to by foreign central banks, which ended up receiving more than 50% of the initial allocation (ten times as much as in the first British Columbia dim sum issue two years ago). After the issue British Columbia takes the proceeds and deposits them in a Chinese bank, thereby capturing a nice spread. In turn, the Chinese bank can multiply this money five times over (so goes money creation in China). Meanwhile, the Indonesian, Korean or Kazakh central banks that bought the bonds now have an asset on their balance sheet which they can use to back an expansion of trade with China...
Of course, for trade to flourish, countries need to be able to specialize in their respective comparative advantages, hence the importance of the kind of free trade deals discussed at the recent APEC meeting. But free trade deals are not enough; countries also need trade infrastructure (ports, airports, telecoms, trade finance banks etc...). This brings us to China’s ‘new silk road’ strategy and the recent announcement by Beijing of a US$40bn fund to help finance road and rail infrastructure in the various ‘stans’ on its western borders in a development that promises to cut the travel time from China to Europe from the current 30 days by sea to ten days or less overland.
Needless to say, such a dramatic reduction in transportation time could help prompt some heavy industry to relocate from Europe to Asia.
That’s not all. At July’s BRICS summit in Brazil, leaders of the five member nations signed a treaty launching the US$50bn New Development Bank, which Beijing hopes will be modeled on China Development Bank, and is likely to compete with the World Bank. This will be followed by the establishment of a China-dominated BRICS contingency fund (challenging the International Monetary Fund). Also on the cards is an Asian Infrastructure Investment Bank to rival the Asian Development Bank.
So what looks likely to take shape over the next few years is a network of railroads and motorways linking China’s main production centers to Bangkok, Singapore, Karachi, Almaty, Moscow, Yangon, Kolkata. We will see pipelines, dams, and power plants built in Siberia, Central Asia, Pakistan and Myanmar; as well as airports, hotels, business centers... and all of this financed with China’s excess savings, and leverage. Given that China today has excess production capacity in all of these sectors, one does not need a fistful of university diplomas to figure out whose companies will get the pick of the construction contracts.
But to finance all of this, and to transform herself into a capital exporter, China needs stable capital markets and a strong, convertible currency. This explains why, despite Hong Kong’s pro-democracy demonstrations, Beijing is pressing ahead with the internationalization of the renminbi using the former British colony as its proving ground (witness the Shanghai-HK stock connect scheme and the removal of renminbi restrictions on Hong Kong residents). And it is why renminbi bonds have delivered better risk-adjusted returns over the past five years than almost any other fixed income market.
Of course, China’s strategy of internationalizing the renminbi, and integrating its neighbors into its own economy might fall flat on its face. Some neighbors bitterly resent China’s increasing assertiveness. Nonetheless, the big story in China today is not ‘ghost cities’ (how long has that one been around?) or undercapitalized banks. The major story is China’s reluctance to continue funneling its excess savings into US treasuries yielding less than 2%, and its willingness to use that capital instead to integrate its neighbors’ economies with its own; using its own currency and its low funding costs as an ‘appeal product’ (and having its own companies pick up the contracts as a bonus). In essence, is this so different from what the US did in Europe in the 1940s and 1950s with the Marshall Plan?2. Japan: Is Abenomics just a sideshow?
With Japan in the middle of a triple dip recession, and Japanese households suffering a significant contraction in real disposable income, it might seem that Prime Minister Shinzo Abe has chosen an odd time to call a snap election. Three big factors explain his decision:
1) The Japanese opposition is in complete disarray. So Abe’s decision may primarily have been opportunistic.
2) We must remember that Abe is the most nationalist prime minister Japan has produced in a generation. The expansion of China’s economic presence across Central and South East Asia will have left him feeling at least as uncomfortable as anyone who witnessed his Apec handshake with Xi Jinping three weeks ago. It is not hard to imagine that Abe returned from Beijing convinced that he needs to step up Japan’s military development; a policy that requires him to command a greater parliamentary majority than he holds now.
3) The final factor explaining Abe’s decision to call an election may be that in Japan the government’s performance in opinion polls seems to mirror the performance of the local stock market (wouldn’t Barack Obama like to see such a correlation in the US?). With the Nikkei breaking out to new highs, Abe may feel that now is the best time to try and cement his party’s dominant position in the Diet.
As he gets ready to face the voters, how should Abe attempt to portray himself? In our view, he could do worse than present himself as Japan Inc’s biggest salesman. Since the start of his second mandate, Abe has visited 49 countries in 21 months, and taken hundreds of different Japanese CEOs along with him for the ride. The message these CEOs have been spreading is simple: Japan is a very different place from 20 years ago. Companies are doing different things, and investment patterns have changed. Many companies have morphed into completely different animals, and are delivering handsome returns as a result. The relative year to date outperformances of Toyo Tire (+117%), Minebea (+95%), Mabuchi (+57%), Renesas (+43%), Fuji Film (+33%), NGK Insulators (+33%) and Nachi-Fujikoshi (+19%) have been enormous. Or take Panasonic as an example: the old television maker has transformed itself into a car parts firm, piggy-backing on the growth of Tesla’s model S.
Yet even as these changes have occurred, most foreign investors have stopped visiting Japan, and most sell-side firms have stopped funding genuine and original research. For the alert investor this is good news. As the number of Japanese firms at the heart of the disruptions reshaping our global economy – robotics, electric and self-driving cars, alternative energy, healthcare, care for the elderly – continues to expand, and as the number of investors looking at these same firms continues to shrink, those investors willing to sift the gravel of corporate Japan should be able to find real gems.
Which brings us to the real question confronting investors today: the ‘Kuroda put’ has placed Japanese equities back on investor’s maps. But is this just a short term phenomenon? After all, no nation has ever prospered by devaluing its currency. If Japan is set to attract, and retain, foreign investor flows, it will have to come up with a more compelling story than ‘we print money faster than anyone else’.
In our recent research, we have argued that this is exactly what is happening. In fact, we believe so much in the opportunity that we have launched a dedicated Japan corporate research service (GK Plus Alpha) whose principals (Alicia Walker and Neil Newman) are burning shoe leather to identify the disruptive companies that will trigger Japan’s next wave of growth.3. Should we worry about capital misallocation in the US?
The US has now ‘enjoyed’ a free cost of money for some six years. The logic behind the zero-interest rate policy was simple enough: after the trauma of 2008, the animal spirits of entrepreneurs needed to be prodded back to life. Unfortunately, the last few years have reminded everyone that the average entrepreneur or investor typically borrows for one of two reasons:
Unfortunately, the second type of borrowing does not lead to an increase in the stock of capital. It simply leads to a change in the ownership of capital at higher and higher prices, with the ownership of an asset often moving away from entrepreneurs and towards financial middlemen or institutions. So instead of an increase in an economy’s capital stock (as we would get with increased borrowing for capital spending), with financial engineering all we see is a net increase in the total amount of debt and a greater concentration of asset ownership. And the higher the debt levels and ownership concentration, the greater the system’s fragility and its inability to weather shocks.
We are not arguing that financial engineering has reached its natural limits in the US. Who knows where those limits stand in a zero interest rate world? However, we would highlight that the recent new highs in US equities have not been accompanied by new lows in corporate spreads. Instead, the spread between 5-year BBB bonds and 5-year US treasuries has widened by more than 30 basis points since this summer.
Behind these wider spreads lies a simple reality: corporate bonds issued by energy sector companies have lately been taken to the woodshed. In fact, the spread between the bonds of energy companies, and those of other US corporates are back at highs not seen since the recession of 2001-2002, when the oil price was at US$30 a barrel.
The market’s behavior raises the question whether the energy industry has been the black hole of capital misallocation in the era of quantitative easing. As our friend Josh Ayers of Paradarch Advisors (Josh publishes a weekly entitled The Right Tale, which is a fount of interesting ideas. He can be reached at email@example.com) put it in a recent note: “After surviving the resource nadir of the late 1980s and 1990s, oil and gas firms started pumping up capex as the new millennium began. However, it wasn’t until the purported end of the global financial crisis in 2009 that capital expenditure in the oil patch went into hyperdrive, at which point capex from the S&P 500’s oil and gas subcomponents jumped from roughly 7% of total US fixed investment to over 10% today.”
“It’s no secret that a decade’s worth of higher global oil prices justified much of the early ramp-up in capex, but a more thoughtful look at the underlying data suggests we’re now deep in the malinvestment phase of the oil and gas business cycle. The second chart (above) displays both the total annual capex and the return on that capex (net income/capex) for the ten largest holdings in the Energy Select Sector SPDR (XLE). The most troublesome aspect of this chart is that, since 2010, returns have been declining as capex outlays are increasing. Furthermore, this divergence is occurring despite WTI crude prices averaging nearly $96 per barrel during that period,” Josh noted.
The energy sector may not be the only place where capital has been misallocated on a grand scale. The other industry with a fairly large target on its back is the financial sector. For a start, policymakers around the world have basically decided that, for all intents and purposes, whenever a ‘decision maker’ in the financial industry makes a decision, someone else should be looking over the decision maker’s shoulder to ensure that the decision is appropriate. Take HSBC’s latest results: HSBC added 1400 compliance staff in one quarter, and plans to add another 1000 over the next quarter. From this, we can draw one of two conclusions:
1) The financial firms that will win are the large firms, as they can afford the compliance costs.
2) The winners will be the firms that say: “Fine, let’s get rid of the decision maker. Then we won’t need to hire the compliance guy either”.
This brings us to a theme first explored by our friend Paul Jeffery, who back in September wrote: “In 1994 Bill Gates observed: ‘Banking is necessary, banks are not’. The primary function of a bank is to bring savers and users of capital together in order to facilitate an exchange. In return for their role as [trusted] intermediaries banks charge a generous net spread. To date, this hefty added cost has been accepted by the public due to the lack of a credible alternative, as well as the general oligopolistic structure of the banking industry. What Lending Club and other P2P lenders do is provide an online market-place that connects borrowers and lenders directly; think the eBay of loans and you have the right conceptual grasp. Moreover, the business model of online market-place lending breaks with a banking tradition, dating back to 14th century Florence, of operating on a “fractional reserve” basis. In the case of P2P intermediation, lending can be thought of as being “fully reserved” and entails no balance sheet risk on the part of the service facilitator. Instead, the intermediary receives a fee- based revenue stream rather than a spread-based income.”
There is another way we can look at it: finance today is an abnormal industry in two important ways:
1) The more the sector spends on information and communications technology, the bigger a proportion of the economic pie the industry captures. This is a complete anomaly. In all other industries (retail, energy, telecoms...), spending on ICT has delivered savings for the consumers. In finance, investment in ICT (think shaving seconds of trading times in order to front run customer orders legally) has not delivered savings for consumers, nor even bigger dividends for shareholders, but fatter bonuses and profits for bankers.
2) The second way finance is an abnormal industry (perhaps unsurprisingly given the first factor) lies in the banks’ inability to pass on anything of value to their customers, at least as far as customer’s perceptions are concerned. Indeed, in ‘brand surveys’ and ‘consumer satisfaction reports’, banks regularly bring up the rear. Who today loves their bank in a way that some people ‘love’ Walmart, Costco, IKEA, Amazon, Apple, Google, Uber, etc?
Most importantly, and as Paul highlights above, if the whole point of the internet is to:
a) measure more efficiently what each individual needs, and
b) eliminate unnecessary intermediaries,
then we should expect a lot of the financial industry’s safe and steady margins to come under heavy pressure. This has already started in the broking and in the money management industries (where mediocre money managers and other closet indexers are being replaced by ETFs). But why shouldn’t we start to see banks’ high return consumer loan, SME loan and credit card loan businesses replaced, at a faster and faster pace, by peer-to-peer lending? Why should consumers continue to pay high fees for bank transfers, or credit cards when increasingly such services are offered at much lower costs by firms such as TransferWise, services like Alipay and Apple Pay, or simply by new currencies such as Bitcoin? On this point, we should note that in the 17 days that followed the launch of Apple Pay on the iPhone 6, almost 1% of Wholefoods’ transactions were processed using the new payment system. The likes of Apple, Google, Facebook and Amazon have grown into behemoths by upending the media, advertising retail and entertainment industries. Such a rapid take- up rate for Apple Pay is a powerful indicator which sector is likely to be next in line. How else can these tech giants keep growing and avoid the fate that befell Sony, Microsoft and Nokia? On their past record, the technology companies will find margins, and growth, in upending our countries’ financial infrastructure. As they do, a lot of capital (both human and monetary) deployed in the current infrastructure will find itself obsolete.
This possibility raises a number of questions – not least for Gavekal’s own investment process, which relies heavily on changes in the velocity of money and in the willingness and ability of commercial banks to multiply money, to judge whether it makes sense to increase portfolio risk. What happens to a world that moves ‘ex-bank’ and where most new loans are extended peer-to-peer? In such a world, the banking multiplier disappears along with fractional reserve banking (and consequently the need for regulators? Dare to dream...). As bankers stop lending their clients umbrellas when it is sunny, and taking them away when it rains, will our economic cycles become much tamer? As central banks everywhere print money aggressively, could the market be in the process of creating currencies no longer based on the borders of nation states, but instead on the cross-border networks of large corporations (Alipay, Apple Pay...), or even on voluntary communities (Bitcoin). Does this mean we are approaching the Austrian dream of a world with many, non government-supported, currencies?4. Should we care about Europe?
In our September Quarterly Strategy Chartbook, we debated whether the eurozone was set for a revival (the point expounded by François) or a continued period stuck in the doldrums (Charles’s view), or whether we should even care (my point). At the crux of this divergence in views is the question whether euroland is broadly following the Japanese deflationary bust path. Pointing to this possibility are the facts that 11 out of 15 eurozone countries are now registering annual year-on-year declines in CPI, that policy responses have so far been late, unclear and haphazard (as they were in Japan), and that the solutions mooted (e.g. European Commission president Jean-Claude Juncker’s €315bn infrastructure spending plan) recall the solutions adopted in Japan (remember all those bridges to nowhere?). And that’s before going into the structural parallels: ageing populations; dysfunctional, undercapitalized and overcrowded banking systems; influential segments of the population eager to maintain the status quo etc...
With the same causes at work, should we expect the same consequences? Does the continued underperformance of eurozone stocks simply reflect that managing companies in a deflationary environment is a very challenging task? If euroland has really entered a Japanese-style deflationary bust likely to extend years into the future, the conclusion almost draws itself.
The main lesson investors have learned from the Japanese experience of 1990-2013 is that the only time to buy stocks in an economy undergoing a deflationary bust is:
a) when stocks are massively undervalued relative both to their peers and to their own history, and
b) when a significant policy change is on the way.
This was the situation in Japan in 1999 (the first round of QE under PM Keizo Obuchi), 2005 (PM Junichiro Koizumi’s bank recapitalization program) and of course in 2013-14 (Abenomics). Otherwise, in a deflationary environment with no or low growth, there is no real reason to pile into equities. One does much better in debt. So, if the Japan-Europe parallel runs true, it only makes sense to look at eurozone equities when they are both massively undervalued relative to their own histories and there are expectations of a big policy change. This was the case in the spring of 2012 when valuations were at extremes, and Mario Draghi replaced Jean-Claude Trichet as ECB president. In the absence of these two conditions, the marginal dollar looking for equity risk will head for sunnier climes.
With this in mind, there are two possible arguments for an exposure to eurozone equities:
1) The analogy of Japan is misleading as euroland will not experience a deflationary bust (or will soon emerge from deflation).
2) We are reaching the point when our two conditions – attractive valuations, combined with policy shock and awe – are about to be met. Thus we could be reaching the point when euroland equities start to deliver outsized returns.
Proponents of the first argument will want to overweight euroland equities now, as this scenario should lead to a rebound in both the euro and European equities (so anyone underweight in their portfolios would struggle). However, it has to be said that the odds against this first outcome appear to get longer with almost every data release!
Proponents of the second scenario, however, can afford to sit back and wait, because it is likely any outperformance in eurozone equities would be accompanied by euro currency weakness. Hence, as a percentage of a total benchmark, European equities would not surge, because the rise in equities would be offset by the falling euro.
Alternatively, investors who are skeptical about either of these two propositions can – like us – continue to use euroland as a source of, rather than as a destination for, capital. And they can afford safely to ignore events unfolding in euroland as they seek rewarding investment opportunities in the US or Asia. In short, over the coming years investors may adopt the same view towards the eurozone that they took towards Japan for the last decade: ‘Neither loved, nor hated... simply ignored’.Conclusion:
Most investors go about their job trying to identify ‘winners’. But more often than not, investing is about avoiding losers. Like successful gamblers at the racing track, an investor’s starting point should be to eliminate the assets that do not stand a chance, and then spread the rest of one’s capital amongst the remainder.
For example, if in 1981 an investor had decided to forego investing in commodities and simply to diversify his holdings across other asset classes, his decision would have been enough to earn himself a decade at the beach. If our investor had then returned to the office in 1990, and again made just one decision – to own nothing in Japan – he could once again have gone back to sipping margaritas for the next ten years. In 2000, the decision had to be not to own overvalued technology stocks. By 2006, our investor needed to start selling his holdings in financials around the world. And by 2008, the money-saving decision would have been to forego investing in euroland.
Of course hindsight is twenty-twenty, and any investor who managed to avoid all these potholes would have done extremely well. Nevertheless, the big question confronting investors today is how to avoid the potholes of tomorrow. To succeed, we believe that investors need to answer the following questions:
The answers to these questions will drive performance for years to come. In the meantime, we continue to believe that a portfolio which avoids a) euroland, b) banks, and c) commodities, will do well – perhaps well enough to continue funding Mediterranean beach holidays – especially as these are likely to go on getting cheaper for anyone not earning euros!
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