Imaginary Prosperity

World sentiment and confidence seemed to sag towards the end of 2015 and the trend has accelerated into early 2016 in spite of continuing comforting media headlines and words from world leaders. So what is going on?

Since the great recession (2008-2009), world leaders, the IMF and central banks have taken the road of “whatever it takes” to get the world economy moving again: 

• ·         Stimulus and bailout programs
• ·         Zero Interest Rate Policy (ZIRP)
• ·         Central Bank exchange of toxic debt for Sovereign Debt (such as US Treasuries)
• ·         Encouraging (manipulated) statistics and rosy projections
• ·         Positive propaganda

The message to markets, firms and ordinary citizens was basically “We’ve got your back”, “Fear not – spend and borrow”. And by and large, that is what most did. Money was almost free. Real estate started to move, autos were purchased, and stock markets ramped up and up. Riskier and riskier debt instruments such as “high-yield” bonds became popular. Indebtedness soared at almost all levels of society: consumers, business and government.

An examination of some of the cheer leading is most amusing: “growth”, “green shoots” and recovery are always just around the corner. Today may be a problem but tomorrow it’s going to be great. The IMF’s successive revisions are a good example.

Virtually everyone has been in the game. The worst information manipulator is likely China. Yet, by late 2015, even these statistics started to show some negative trends.

Also, there were many visible signs early on that something was very wrong, at least for those who paid attention to indicators that were difficult to manipulate. By early 2011, for example, world commodity prices were sinking. Why?

The plummeting price of oil was easy to explain away as a Saudi thing, say,  but what about rice, wheat, copper, nickel, iron, soybeans, sugar, etc? By 2013 even lumber prices had started to decline. This didn’t look like a recovering world economy at all. Yet China, while not growing at the previously torrid rates, was still supposedly exhibiting growth. Really? I was in China in the Spring of 2015 and while their achievements are amazing and construction activity was evident, the number of vacant buildings everywhere also amazed me. China is definitely slowing.

Another small matter: World trade! How come world trade volume is contracting?

 

World trade volumes started to slip in early 2015. Prices paid are even worse (lower)!

Another indicator related to World Trade is the Baltic Dry Index, a measure of world shipping demand/supply. It has reached levels below that of the “Great Recession” of 2008-2009.

 

 

 

Meanwhile consumers are getting tapped out, even at current low interest rates. Indebtedness is rising almost everywhere. 

In Canada, for example, household debt to disposable income has reached 171%.

 

In the U.S., many indicators are contradicting the Cheerleader in Chief (Obama) and the Federal Reserve chiefs. Manufacturing has been slumping and inventories have been rising, for example. 

 

 

And the much vaunted automobile sector has been spun shamelessly. But look at the U.S. Census Bureau’s own reports.

 Peaked in 2013!

  

But the actual situation is likely worse still because automobile inventories have been piling up.

  

Similar problems for U.S. Steel Production.

And then there are new home sales that are sputtering along but even at today’s low mortgage rates, aren’t anywhere near the rate 10 years ago:
 

 And what about the U.S. consumer? Well, there has been considerable deterioration since mid 2012, with debt to income ratios widening steadily.

Much the same has been repeated around the globe. Trillions in central bank stimulus (printing) by the likes of the Federal Reserve, The People’s Bank of China, the Bank of Japan, The Swiss National Bank, The European Central Bank and the Bank of England have kept economies sputtering along with the bulk of the money going into securities such as stock markets and bonds. It has been wonderful for the banks and financial centres such as Wall Street but not that good for the middle classes around the world.

 

Since the end of the “Quantitative Easing” stimulus period dubbed QE3, things have started to get wobbly in the stock markets again and also in lower quality (high yield) bonds. In some parts of the world, real estate prices have begun to deteriorate sharply.

 

The continuing decay in commodity prices as well as rising commercial, consumer and government debt loads have also taken their toll.What will the Debt to GDP charts look like if a world recession takes hold? Will any of this be manageable?

Let’s face it; interest rates cannot be lowered much from where they are now, though they may go a bit negative. Governments and Central Banks have almost run out of tools. Another round of distortion creating stimulus may soon be upon us in spite of clear evidence that these measures have at most kicked the problems down the road at the expense of increasing the structural problems that led to the various rounds of stimulus in the first place. We now have much bigger problems than we already had. The scary thing to me is that unlike other periods in history, the world has embarked almost in unison on a coordinated and massive mission to keep economies afloat.

When this crisis finally breaks, it won’t be an Asian crisis or a South American crisis or an emerging economies crisis, it will likely be a world-wide crisis with virtually no major pockets of strength to moderate its effects. In such a scenario, valuations in almost all asset classes including currencies, real estate, stocks, bonds and commodities will change drastically. Financial dislocations and misery will abound. Be on guard!

China, the Dollar and Sovereign Debt

Quite a few observers are suggesting that China could/will bring the U.S. down by suddenly dumping its dollar-denominated Treasuries and Bonds, thereby creating a mass exodus from the delicately-perched $US, dramatically raising bond yields and thereby interest rates in general, resulting in a global economic crash and a “reset” in currency values and a realignment of world powers. As the second largest holder of $U.S. sovereign debt (the Federal Reserve has now moved into the #1 position), it is certainly plausible for the Chinese to do this. But in my view this scenario, at least as a deliberate action, as opposed to a reaction to some other external trigger, is extremely unlikely. Why would the Chinese rock the boat unless the perceived benefits outweighed the associated costs (such as loss of the remaining value of their $U.S. denominated paper assets, crippling of their export-oriented manufacturing base, etc.)?

However, our financial system is increasingly perched atop an unstable ledge. Interest rates are held artificially low by constant central bank backstopping of sovereign debt in an attempt to keep the economy (and banks!) from collapsing. Remember, bond yields are inversely related to bond prices! The U.S. Federal Reserve, for example is pumping at least $85 Billion a month into Treasuries, bonds and other debt instruments. The resulting super-low-interest rate environment has created a mad scramble for investments that have a higher rate of return than the 1% or 2% available from traditional “safe” investment vehicles. Middle class savers can either join this scramble into increasingly higher-risk ventures or be savaged by returns lower than inflation. Those funding their own retirements are finding that even $2 Million savings earns a paltry $40,000 in annual interest. Meanwhile, stock markets have surged to record highs and sovereign debt yields, even for Italy and Spain, have declined. All this is taking place while outstanding sovereign debt continues to accumulate. The chart below shows the deteriorating European debt situation.

 The divergence between the actual situation and the financial pricing of risk in bonds and securities is increasing. As recently as last week, S&P downgraded France's credit rating. Did this cause French bond yields to rise? Of course not. They are stuck at a nice 2.2%. In layman terms, everything is increasingly out of whack in the financial, investment and monetary world. Price discovery is dying. Manipulation of interest rates and other markets is forcing money where money shouldn't be and forcing risk to be mispriced by a large margin. New bubbles are forming.

The Chinese and most everyone else with big money on the table know this but are riding out the trend supported by ever-increasing central bank intervention variously labeled as stimulus, quantitative easing, monetary aggregate adjustment, etc. So the Chinese seem to be preparing for that day, whether they, the Chinese, or some other event triggers a run from sovereign debt and the affected currencies, say, the Euro, the British Pound, the Yen and the $US. They have been purchasing large amounts of gold and entering into increasing numbers of Renminbi/Yuan currency swaps with other nations in an apparent move to initiate the internationalization of their currency as a possible prelude to eventual reserve currency status for their currency. 

Perhaps a rapid transition in mind-set is not imminent but some unexpected trigger could cause a rush for the exits at any time. It's really a state of mind as well as a collective assessment of when the end of the rope is reached for central bank printing actions. Most folks know none of this is repayable, after all, and the wiser ones are warily eying the exit doors for signs of  mass exodus. I suspect that the Chinese are in that category. They have too much to lose to be the last ones out the door.

Culture of Ignorance

I've been quiet lately. I feel like I'm in a trance some days, watching the world spin but not really comprehending how or why things are evolving as they are, seemingly oblivious to facts and reality. On occasion, it has struck me that willful ignorance within the world's population, somewhat akin to the lemming paradigm may have something to do with it. But then I drift off.
Today I was jarred out of my periodic apathy again by Jim Quinn's fine post entitled "Culture of Ignorance". He has eloquently put down in words what I've often begun to assemble in disjointed thoughts over the last 10 years or so (maybe longer) but never managed to output in a cohesive way. Well sprinkled by quotes from thinkers, I strongly endorse Quinn's "Part 1 - Culture of Ignorance".

The Next Financial Crisis

Many observers are predicting further banking and financial crises and collapses. Why? Well, the 2008-2009 collapse did little to cleanse the world's sovereign debt and fiscal deterioration or to correct banking and financial system excesses. We have kicked the proverbial can down the road. Beneath it all most indicators continue to atrophy. Sovereign debt keeps on rising and personal indebtedness across most countries is doing the same. The back-stops provided by the Federal Reserve, the European Central Bank, Bank of Japan and myriads of others along with increasingly ingenious albeit contrived rescue schemes have so far managed to prevent another, worse, collapse. The latest "solution" for America is in the realm of the surreal - a trillion dollar platinum coin that even the esteemed? Paul Krugman seems to endorse.
Attention of markets and the media have careened back and forth between Europe, China, Japan, the U.S., and the Middle East. Sometimes the focus is energy (as in oil), sometimes concern about the future of the EU or the breathtaking public debt in Japan or the insolvency of U.S. States or the U.S. itself. It seems that markets and media alike get tired of focusing on any one issue or part of the world for any length of time. Nothing has really changed in the European financial situation, for example. In fact everything continues to deteriorate. Yet bond yields have dropped for Spanish, Greek, Portuguese and other European debt. The focus has shifted once again away from Europe and back to the U.S., perhaps in part due to the mind-numbing pounding on the U.S.  fiscal cliff and the U.S. debt ceiling.
So, where is the next financial breakdown going to occur? Nobody knows, but I am going to focus on a potential U.S. flashpoint - U.S. Treasuries and Bonds.
In a previous post, I discussed a chart that was relevant to foreign holders of 30 Year U.S. T-bonds. The chart depicts the value of T-Bonds, corrected for the value of the US dollar, by incorporating the widely quoted U.S. dollar index. So, in other words, it shows how well a typical foreigner's investment in such bonds is doing after cashing in and converting to his home currency of Euros or Japanese Yen, or whatever. In my previous post I observed that foreign investors were doing very well indeed. But look at the chart today:

Are bondholders getting nervous? If they are and if they stampede to the exits to finally dump U.S. bonds, it will precipitate a major crisis for the U.S. and the world. The $US will go into a tailspin. The Federal Reserve will need to buy all bonds presented for redemption with freshly created dollars. Sellers will then convert their U.S. dollar proceeds into . . . what? Other currencies? Stocks? Gold, Silver? What do you think? Keep an eye on the above chart, updated by stockcharts.com once a day (evening Canada/US Eastern Time) to gauge the risk and progress of the U.S. bond bubble if indeed it becomes the flashpoint to the next financial crisis.

How well are foreign holders of US$ debt doing?

Folks have fretted over the possibility of a huge U.S. bond bubble for a long time. In particular, some have warned that China, in particular, might suddenly begin dumping large amounts of accumulated Treasuries. In fact, China has been dumping US Treasuries and the Federal Reserve has been forced to compensate by printing up the difference (quantitative easing) to a good degree. See here. But so far this exit from the US$ has been controlled. Partly this may be because other major currencies are also having trouble so that the US$ is seen as the best of the worst. Since the 2008 crisis, Central Banks around the world have been pumping - buying their own debt - see here. So, while the US debt infrastructure may slowly be crumbling, a fast look at the recent performance of US$ denominated long-term debt (30 year Treasuries) from the perspective of foreign holders shows that for the time being everything looks pretty good.

The above chart depicts the performance of 30-Year US Treasury Bonds in terms of the US$ index. Typical foreign holders make money in their own currencies if 1) the US$ rises and 2) the Bonds themselves rise. By charting the US$ index divided by the bond yield, we get an approximation of the combined effects of bond price and US$ price relative to other currencies.

Thus, while many participants may be nervously glancing at the EXIT doors to spot an incipient mass exodus which would precipitate an implosion of the so-called bubble, those exiting now are actually doing very well from an investment perspective. Anyway, the current focus is still on Europe - Greece, Portugal, Italy, etc. But markets will eventually turn to the biggest debtor of them all - the U.S.

John Corzine can't find the money!

So John Corzine, former Chairman and CEO of MF Global, has no idea where the firm's missing money might be found. Interesting people, the likes of John Corzine. These are the people under whose direction all sorts of clever investment vehicles and trading algorithms have been created over the years. We've been assured by these same folks that countless derivatives and trading mechanisms are OK, in fact - good. When challenged, we sometimes get told that we don't have the necessary basics to understand these complex instruments. But of course he has an MBA and is a former Goldman Sachs Chairman and CEO and even former U.S. Senator and State Governor as well. His membership in the Bilderberg Group further establishes his luminary qualifications. Along the way, he and his cohorts have earned hundreds of millions of dollars for the services they have rendered humanity. Anyway, I digress.
My question is this: If a firm like MF Global with all its computer and investment resources and savvy can't find its investors' missing money, wouldn't you have to conclude that either they are crooks and are lying or that they really didn't understand their business so well, after all, and might not even understand basic accounting that well either? Well, there seem to be enough facts on the table already to support the "crooks" part, as the firm is known to have co-mingled its clients' funds with the firm's funds when they "needed" it. Further investigations will likely reveal a lot more illegalities, cover-ups, lying etc. But I suspect my other suspicion has played a role, too. Do these guys really know what they are doing? If they did, they wouldn't be in the pickle they are in right now, I would think.
As a matter of fact, I suspect that John Corzine would have plenty of company if some of his peers in the investment, brokerage, insurance and banking businesses were suddenly cut off from the bailout/stimulus/insider info train of the Federal Reserve. Most of their Ponzi schemes would collapse within a week. Look what happened to Lehman. But it doesn't help if for whatever reason you are no longer part of the club?

Can the U.S. ever really balance its budget?

Every once in a while, I visit the US Debt Clock Site to get a handle on the current U.S. fiscal and general financial situation. An interesting exercise is to see what kind of cuts would be necessary to achieve a balanced budget, that is, to reduce the deficit to zero and thereby to stop adding to the national debt every year. Well, we have to come up with more than $1,300 Billion in cuts. Gee, lots of ways to go about this but one combination is to eliminate defense altogether (scuttle the ships, close all the bases, send the soldiers home without pay or pensions, abrogate all military supply contracts, etc., and pray for peace - this saves $700B), then eliminate all federal pensions (too bad, folks - just sink or swim- this saves another $214B), then also eliminate all income security programs - too bad for all you unemployed folks! - this saves another $407B). That was easy, eh? Well, of course, politically, this is not doable! Furthermore, such cuts would devastate the economy, and with it, tax revenues, so you would need to cut much more than this to compensate. You see where I'm going.
Ok, let's try another angle - we'll just raise income taxes and do some minor expenditure cutting. So, if we doubled everyone's income taxes and eliminated all federal pensions, that might almost also do it, but whoops, since nobody has any money to spend, the economy would tank and therefore incomes and tax revenues would be affected, so we would need to raise taxes far more and/or cut more programs. H'mmm, nothing seems to work here, right?
Did you see the Congressional Super-Committee at work? Boy, did they ever agree on cuts, huh? Well, now you know why. It isn't doable, not politically, anyway. Not likely possible socially, either. Americans would be torching Capitol Hill, the White House, etc. So what do you think the U.S. will do/are doing? There is only one answer, and it is not a real solution but it kicks the can down the road, albeit at an even higher price down that road. The U.S., as well as most other western nations will simply continue to print ever vaster sums of money to make up for fiscal shortfalls. The likes of the Federal Reserve, the European Central Bank (ECB) and the Bank of Japan will just keep buying up more of their governments' IOU's (bonds and bills and other clever securities). This will happen under various guises such as QE1, 2,3,4, . . n, Operation Twist, "liquidity injections", whatever. The middle class will will get poorer and poorer and most will not understand why. The printing will continue until folks recognize that their currencies are being destroyed and enough folks lose their confidence in it, that a wholesale dumping of currency gets underway. Too bad the fiscal redress was not seriously attempted 20 to 30 years ago, when some of the measures needed might, while painful, still have been politically and socially doable given a committed President and Congress. But are the politicians wholly to blame for what has happened? No, I don't think so. After all, did voters elect politicians with "responsible" platforms or those that promised combinations of government programs and tax structures that were way too good to be true? As the old saying goes - It's hard to cheat an honest man".

U.S. Debt Farce

It's sad to watch the U.S. debt talks. The wrangling is bad enough but the really sad part, in my view,  is that virtually nobody in the halls of power is ready to propose actually balancing the budget right now! Not tomorrow, the next year, in the next 10 years - but right now. America and most other nation seem incapable of doing what every parent or credit counselor would tell his 21-year old who was spending way beyond his means - cut up the credit cards, cut back on the spending and work harder to pay off the debts you should not have acquired in the first place. Americans have been living beyond their means for decades now. After all, that's what running a deficit is. Every deficit adds to the existing debt or national mortgage. What a concept! A growing mortgage! It's entirely nonsensical but nations the world over have bought into this as a new normal, a kind of global financial insanity whereby even known economists with many degrees and awards spout such gibberish as "manageable deficits". State/provincial governments as well as municipalities have also fallen victim to the disease. No, the talks on raising the debt limit in the U.S. are really pretty well a side-show. It's just arguing about how far to kick the can down the road before doing it all over again. In any event, in the case of the U.S., it should be renamed the "Printing Limit" because no one is willing or able to lend the U.S. that kind of money any more. As has increasingly been the case in the last few years, the Federal Reserve simply prints up what the Treasury needs and couldn't borrow through new bond issues. Sad, very, very sad to see how a once proud and independent country is becoming a deadbeat.

QE3 Gets Closer as U.S. Economic Indicators Falter

As economic storm clouds gather (see CNBC for example), pressure mounts on the Federal Reserve to launch QE3. They will deny and obfuscate as long as possible but at a certain point they will mount their white stallions again and sally forth to the "rescue". Trillions more will be printed and trillions more in debt accumulated. Currencies, stock/bond markets and commodities will gyrate. Gold and silver will make new highs while U.S. credit ratings will be downgraded. But I'm getting ahead of myself a bit. The economic situation and especially the stock markets will first need to suffer a bit, enough to be noticed by the general public, maybe even some panic drops in market values, for example. Political and public consensus will then build around the new imperative of QE3 although it may be called something else to avoid the obvious embarrassment of creating a string of failed initiatives.

Is Greece the next Lehman?

Is Greece the next Lehman? Well, there are many who are suggesting a comparison, including me, but I'll just point to some published thoughts.

Federal Debt Ceiling and QE3

There is much talk about raising (or not) the U.S. debt ceiling and ending Quantitative Easing Round 2 (QE2). Honestly, I see all this as clumsy posturing. Americans and their leaders do not have the stomachs for living within their means, at least not yet. Obama and Congress are fooling around with $30B cuts, when the deficit is more like $1,400B. The world is awash with U.S. Treasury debt. The Chinese and others are pretty well saturated now. The Federal Reserve will have to continue printing to buy up most of the new bonds and bills issued by the Treasury. Raising the debt ceiling is also a priority for Wall Street - take a look at this. So QE3, in my opinion, is guaranteed. The U.S. will kick the can down the road yet again rather than face a default now.

Thoughts on "In Fed We Trust" by David Wessel

I just finished reading "In Fed We Trust" by David Wessel. The author details the drama within the Federal Reserve, the Treasury and other financial and regulatory organs leading up to and through the financial crisis of 2008-2010. Many behind the scenes revelations provide an insight into Ben Bernanke, his changing views and ultimate mantra of "Whatever it takes".
The problem with "whatever it takes" is that the collateral damage has likely been greater than the crisis that was being avoided. In fact, I would argue that at best we have merely kicked the can down the road. None of the underlying problems of debt, derivatives, pyramids, excessive speculation, financial wizardry and gimmickry have been addressed. There has been no return of focus on true economic output, balancing city, state and federal budgets and living within one's means. The recent Obama budget is based on rosy revenue forecasts, sheer make-believe. The Federal Reserve now holds more government Treasury securities than China and is set to print trillions more, since the world is awash with dollar-denominated debt and the Treasury must borrow or have budget shortfalls covered increasingly by printed dollars. So whatever it takes - wherever will it take us?

Governments increasingly propping up markets

The U.S. has been increasingly funneling money into a broad class of risk assets via the Federal Reserve's POMO and Quantitative Easing actions. POMO's are running 2 to 3 times a week lately. Thus, for example, in spite of continuing  equity fund outflows, stock prices continue strong and bond prices are close to major highs as the Federal Reserve now has purchased and holds about as much in U.S. Treasury Securities as Japan.

Now Japan has announced that it too will get into this game by allowing the Bank of Japan to purchase a broad class of assets, including ETF's.

What a spectacle!  Governments using taxpayers' future money (they are just printing it up for now) to buy mortgage securities, bonds (their own, especially), stocks and derivatives! I'm pretty sure this will all end up very, very badly. And we thought that central state control and manipulation was the preserve of the old Soviet Union and China . . .

Why can't we just say "Printing" or "creating more dollars"?

This evening, I was just perusing the mainstream media, such as the WSJ, Marketwatch, Globe & Mail, etc.). There are many articles focusing on and worrying about what the Federal Reserve will do next (inflate or not). It seems that the FED has become the principal driver of almost every market now. Anyway, it is truly amazing how they just can't say "printing dollars" or "creating more dollars". Here are some of the terms used instead: boost liquidity, quantitative easing, opening the tap, further easing, monetary expansion. If it's a dirty act, maybe it sounds a little less dirty if couched in sophistry or made into a cool analogy.

I may as well use an analogy as well - watering down the wine! I'd prefer mine full strength, thanks.

The U.S. is quickly running out of "tools"

After watching the antics of central bankers over the last several weeks, especially the failed attempts of the Japanese and Swiss efforts to bring down the exchange rates of their currencies and the increasingly pathetic attempts of the U.S. Federal Reserve to keep the economy and monetary systems afloat, it seems that there are fewer and fewer tools available to central bankers in the game of resuscitating a terminally ill patient.

Basically, what I see from the U.S. administration is a terrific amount of spin to put the best possible face on any release of economic info, from jobs to industrial production, clever techniques of revising previous months stats lower to make it appear that the current month's info is positive and above all, "quantitative easing", or "printing" by continuing to guarantee bad debt and by buying its own Treasury Bonds. Interest rates are at zero. They can't go lower. Gold is steadily rising and US debt is rising like a rocket. And Ben Bernanke says that he stands ready to print as required.

We are running out of time to arrive at anything resembling an elegant admission that we are living well beyond our means and to take the necessary albeit difficult road to reorient our policies towards far less consumption and far more production. Alas, it seems that we have chosen the futile path of printing and deceit to keep the entrenched system in place, however rotten and however more costly and difficult this will be when it inevitably topples.

Federal Reserve to Remove Bank Reserve Requirements?

Looks like the same bright lights who created the ideas of no money down on home mortgages and "you tell us what you earn - wink, wink", are at it again, this time at the Federal Reserve. Capital requirements for banks? What for?
Look here.

Now would you want to put your savings in a bank that didn't have any capital in reserves? Isn't fractional reserve banking already a shaky proposition when banks start to have less than 20% in reserve capital?

It's just another sign of the Alice in Wonderland thinking that is taking us further off the surface of this planet and closer to much bigger financial chaos.

Lehman revelations continue

Articles appeared this week detailing fresh revelations on how Lehman "misled" investors. An example from BusinessWeek here. To me it is just more evidence of the fraudulent mentality that has overtaken a lot of Wall Street. For a lot more on the shenanigans on Wall Street and the Federal Reserve, see this special report.

The Fed's "Exit Plan"

As if the banks have not had a good enough series of meals at the public trough, here we go again. See this article from businessinsider.