Moral hazard or paranoia – January 21st 2013

The Bank of England has purchased 50% of the gilts issued since 2009 and owns 32% of the whole gilt issuance currently in existence. Do you think this has something to do with yields being down at all time lows? Assuming we had access to a printing press it would be illegal if we tried to pull the same stunt. Compared to the Fed, the BoJ and the ECB the UK is almost a minor league player in this systematic global rigging of sovereign debt markets.

 The definition of moral hazard has changed over time. It used to refer to the bailing out of “lesser” banks and “minor” economies, which just encouraged others to carry on regardless. Now we have the wholesale support of major economies, their governments and banking overlords to the detriment of anyone else. Government securities used to be the home, during periods of market unrest, for flight to safety investors and others of a cautious disposition. They were also the marker for the risk free rate when calculating the value of equity markets and other instruments. As an aside would the LIBOR scandal have happened if we had had a properly functioning bond market? Hmm.

 On the basis that most sovereign debt issues produce a negative real yield to redemption, investors are being “encouraged” to search for income elsewhere. High yielding corporate bonds have been one of the favourites, but didn’t we have an “issue” with this asset class a few years back or has that episode been consigned to the memory vacuum? Yes a very different set of underlying instruments I agree, but as Mark Twain said, “History doesn’t repeat but it rhymes.” Having enjoyed decades of capital growth from bond investments, those with a lower risk appetite have few other options than to increase their equity weightings.

 If you believe that money printing is the answer; that governments can continue to increase debt levels ad infinitum; that austerity in Europe will propel their economies, unfazed, onwards and upwards and that China will eventually get the hang of capitalism; then I would agree that equity markets look like a steal. In P/E terms the FTSE is at half the level it was at 10 years ago.

 But according to “Economics 101”, quantitative easing, on the heroic scale we have witnessed thus far, should already have led to rampant if not hyper inflation. That it hasn’t is down to the continuing decline in the velocity of circulation of money. In simple terms the banks aren’t lending (compared with the amount of money available to them), but instead are punting on financial assets, which is where “inflation” is ending up and benefitting their balance sheets… Charles Hugh-Smith put the Fed’s actions into context very well, if indelicately for some, on his recent Of Two Minds website. BoE, ECB and BoJ please take note.

 “We can view unprecedented Federal deficit spending as a misguided attempt to compensate for the implosion of money velocity. I say “attempt” because the Treasury borrowing and blowing $6 trillion over the past five years and the Federal Reserve printing $2 trillion, backstopping the parasitic financial cartel and buying over $1 trillion each of mortgage securities and Treasury bonds has only kept the economy stumbling along at essentially zero growth while real wages have declined by 7% to 9%.”

 Markets generally front run the economy, but if, as many folk believe, including our commentator above, that quantitative easing has been a failure from the start, then why are equity markets indicating an upturn in economic activity? At the end of the day, if the central banks continue to believe they have no other option than money printing and you can put up with the volatility, it’s all aboard the equity train. Bond yields won’t rise much either; if at all. The gold price should give some indication of whether this strategy is working or not, but that is a market that is far easier to rig than sovereign debt – the Germans seem to think so as they contemplate repatriating some of their bullion held by other central banks.

 Moral hazard or paranoia; your choice.

 


 

 

Reflections on 2012 – December 19th 2012

As ever the “View” cannot see into the future with any clarity, so here are some quotes gleaned during 2012; some contemporary, some timeless. Enjoy your Christmas festivities and may 2013 bring everything you wish for.

 Firstly two messages for our central bankers

“There is no means of avoiding a final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as a result of a voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved.” Ludwig von Mises

and

“Our analysis leads us to believe that recovery is sound only if it does come of itself. For any revival which is merely due to artificial stimulus leaves part of the work of the depressions undone and adds – to an undigested remnant of maladjustments – new maladjustments of its own.” Joseph Schumpeter

 There is however hope

“We are continually faced with a series of great opportunities brilliantly disguised as insoluble problems.” John W. Gardner

Or not as the case may be…

“If all else fails, immortality can always be assured by spectacular error.” John Kenneth Galbraith

 Followed by a rare, truthful observation from one of Europe’s finest

“We all know what to do, we just don’t know how to get re-elected after we have done it.” Jean- Claude Junker

And another from an American banker

“In hindsight, the new strategy was flawed, complex, poorly reviewed, poorly executed and poorly monitored.” Jamie Dimon

 The root of the problem

“The more I studied economic science, the smaller appeared the knowledge which I had of it in proportion to the knowledge I needed; and now, at the end of nearly half a century of almost exclusive study of it, I am conscious of more ignorance of it than I was at the beginning of the study.” Alfred Marshall

“Economics is extremely useful as a form of employment for economists.” John Kenneth Galbraith

 And wishful thinking doesn’t help either

“The road to hell isn’t paved with gold, it’s paved with faith. Faith in a dollar that’s backed by a belief that people have faith in other people’s belief in it.” Jarod Kintz

“The market is not an accommodating machine. It won’t provide high returns just because you need them.” Peter Bernstein

 Whatever happened to the democratic process?

“The best argument against democracy is a 5 minute conversation with the average voter.” Winston Churchill

“Bipartisan usually means that a larger-than-usual deception is being carried out.” George Carlin

 Are there any rational thinkers left?

“I can calculate the movement of the stars, but not the madness of men.”  Isaac Newton

“Two things are infinite: the universe and human stupidity; and I’m not sure about the universe.” Albert Einstein

 Can history help?

“History – one damned thing after another” Churchill

“History is a set of lies agreed upon.”  Napoleon Bonaparte

 Finally – to prove that many a true word is spoken in jest – The euro according to Blackadder

 Baldric: “What I want to know, Sir is, before there was a euro there were lots of different types of money that different people used. And now there’s only one type of money that the foreign people use. And what I want to know is, how did we get from one state of affairs to the other state of affairs?”

Blackadder: “Baldric. Do you mean, how did the euro start?”

Baldric: “Yes, Sir.”

Blackadder: “Well, you see Baldrick, back in the 1980s there were many different countries all running their own finances and using different types of money. On one side you had the major economies of France, Holland and Germany, and on the other, the weaker nations of Spain, Greece, Ireland, Italy and Portugal. They got together and decided that it would be much easier for everyone if they could all use the same money, have one Central Bank, and belong to one large club where everyone would be happy. This meant that there could never be a situation whereby financial meltdown would lead to social unrest, wars and crises.”

Baldric: “But this is sort of a crisis, isn’t it Sir?”

Blackadder: “That’s right Baldric. You see, there was only one slight flaw with the plan.”

Baldric: “What was that then, Sir?”

Blackadder: “It was bollocks.”

Plus ca change – December 13th 2012

Solidarity in our union is alive, ‘Grexit’ is dead. Greece is back on its feet. The sacrifices of Greek people have not been in vain. It’s not only a new day for Greece, but also a new day for Europe.”

 Greek Prime Minister Antonis Samaras declared that the Grexit era was dead; speaking in Brussels to reporters after the Eurogroup approved the mammoth bailout fund of €52.5 billion. Plus ça change, plus c’est la même chose. Nothing has changed; political spin is alive and well, Greece is still bust and the eurozone is in for yet another unsecured loan. He would probably have liked to have said a “new dawn for Greece” but the ultra right wing party – New Dawn – have the lien on that catchphrase. In a way he is right as the can has been given a seriously good kicking and Greece is off the agenda for a while, but we still have Spain and Italy to worry about. The ECB’s new mandate to regulate eurozone banks is all about sorting out the Spanish Cajas and Bunga Berlusconi has put a spanner in the Italian Job. That iconic film ended with a coach, full of gold bars, hanging over a precipice. Given Italy’s burgeoning gold reserves this is not a bad metaphor for the state that country finds itself in.

 Meanwhile in the US, as predicted, QE3 has morphed into QE4, with a specific target to reduce unemployment; another triumph of hope over reality in the Greek vein. Yes we are seeing an improvement in non-farm payrolls and the unemployment rate, but both are relatively anaemic compared to past recoveries. The assumption that we will return to previous employment rates and GDP growth is truly heroic. Hurricane Sandy has added a new dimension to “seasonal adjustments” and if you believe everything the US Bureau of Labor Statistics has to say, then your name is probably Antonis Samaras.

 The “Big Issue” that no one is prepared to address is how we unwind this enormous central bank largesse. If you throw enough money at the problem one part of the equation will go away, but how do you expunge the debt burden that it creates? Central bank printing creates the short term life blood for profligate government spending at very accommodative rates of interest, but the baby they are left holding is a going to be one hell of a problem child.

 As the world is coming to an end on December 21st, according to Mayan mythology, why should we care? As with any prediction timing is the problem. I have every intention of enjoying my Christmas turkey, complete with brussels sprouts (am I the only one who does), on the 25th, but I am still more than a little concerned about the pile of tin ware building up outside the doors of our central banks.


 

Remember, remember…5th November 2012

Back in 1605 Guy Fawkes attempted to blow up Parliament, along with King James I, with 6 barrels of gunpowder. At the beginning of the 17th century the Houses of Parliament were a much more modest structure and had he been able to light the fuse he might just have succeeded. He failed and was hung, drawn and quartered for his impudence and ever since back in Blighty we have celebrated this occasion of gunpowder, treason and plot, on November 5th, by burning effigies of him atop bonfires accompanied by the letting off of fireworks.

 Every four years around the same time presidential elections are held in the US, but this year, although there has been much “plotting”, there have been no fireworks. From a UK perspective the choice between Obama and Romney is about as unattractive as that between Camerlot and the Ed Miller band. Politicians – and central bankers – are no longer merely “economical with the truth” they have taken to outright lying, aided and abetted by the mainstream media and the banking cabal, who are their true masters, not the electorate, who, in the main, swallow the party line whole.

 This year’s election, like many in the recent past, is not the democratic process it is held up to be. Third party candidates are denied the right to debate along with the Democratic and GOP nominees and the two party debate itself is a series of secretly pre-arranged questions agreed by both sides. Even worse is that the US now has the equivalent of the “rotten borough” system, legislated against in the UK in 1832, whereby large corporates can make unlimited campaign contributions; and please don’t tell me it is all done in the name of altruism!

 Even Mother Nature has played her part allowing Obama to take on the role of a caring father figure in the aftermath of hurricane Sandy. He has obviously learnt from the errors of his predecessor, whom we must assume, from his nonchalance, thought that New Orleans was somewhere in France…Given the devastation along the eastern seaboard one can’t help wondering if the outcome of the election will again be decided in the courts if many voters are disenfranchised by having nowhere to vote.

 So tonight in the UK things will go with a “bang”, but on Tuesday, in the US, don’t expect anything other than a damp squib…especially if you are unfortunate enough to live on Staten Island or in Lower Manhattan.