In response to an FT article by Martin Wolf on 16th February 2016, entitled 'Banks are still the weak links in the economic chain'
“Banks are still the weak links in the economic chain…A slowdown is more likely than a crisis…”
No – Central Banks are the weakest links…and Europe is on the verge of another banking crisis…
Sometimes a fundamental change occurs without being immediately obvious at the surface. It can take time to see the connections between disparate events. We’ve had such a fundamental change over the past few weeks. Since 2009 ‘bad’ news has been ‘good’ news in markets, because bad news meant the imminent re-opening of the money spigot. No more. Bad news is now being seen for what it was all along – bad news. The ‘belief’ underpinning the markets has changed; and I believe this will prove to be a tectonic shift - central banks have lost their power to move the markets to their will.
Central Bankers use equilibrium models that do not include money, banking or debt, and put their faith in the Phillips curve, which describes a supposed mathematical connection between inflation and employment, but has nothing to say about asset price inflation, the effect of declining labour participation, and/or a decrease in breadwinner jobs combined with an increase in part-time low wage jobs –I.E.: it says nothing about what is happening in the real world.
CB’s ‘power’ over markets has never been based on anything real - it has always been based on ‘confidence’ in their academic credentials, and ‘faith’ in their big bazooka. After 7 years it turns out that the big bazooka is more akin to a loud popgun; and the confidence in their infallibility has been nothing more than a confidence trick – a ‘con’.
And now the ‘con’ is unraveling - markets are not doing the Central Banks’ bidding. It is tempting to try to identify exactly when this change occurred, but it doesn’t matter. What does matter is that we have had three ‘signals’ from three different continents, which suggest that there has been a fundamental shift in financial markets – a shift in how they perceive central banks, and in their confidence in the so-called ‘recovery’:
1. The Fed’s December 0.25% rate hike fell flat on its face. After a one-day rise, stock markets failed to end 2015 with their customary Santa rally, spoiling a few year-end bonuses that can normally be relied upon to guarantee such a rally, and ending a 5 year winning streak for the S&P500. The index is down 7% YTD and 10% off its monthly peak from May 2015. The yield on the ‘ten year’ reached an all time low a few days ago. The Fed’s forecast of four more rate hikes in 2016 looks increasingly ridiculous – none of this was supposed to happen
2. Mr. Kuroda’s negative rate ‘surprise’ went down like a lead balloon. The Nikkei was supposed to go up, and the yen was supposed to go down. The Nikkei is down 15% YTD and is 22% off its monthly end peak from July 2015. One of the worst kept secrets is that CBs are in a race to the bottom – Mr. Kuroda was expecting the yen to go down, importing inflation as it did so – he got the exact opposite. That was not supposed to happen either
3. Meanwhile we’ve had a deeper dive into negative rates from Mr. Draghi, who quickly discovered that the banks didn’t want rates to go down, they wanted more free chips for the roulette table. Not to be cowed, Mr. Draghi released ‘Whatever it takes – the sequel’. As with many sequels this has not lived up to the original. The Eurofirst 300 is down 12% YTD and is 20% off its monthly peak from May 2015. The euro is going in the ‘wrong’ direction – on January 5th the EUR/USD stood at 1.075, as at Friday’s close it was 1.125 – almost 5% in the ‘wrong’ direction. You guessed it…this was not supposed to happen
Perhaps none of this would matter so much if economies were strong. They are not: Europe is on the verge of another banking crisis; Japan is teetering on the edge of deflation; China cannot supply the emerging markets with demand for their commodities and is struggling to contain capital outflows; the EMs are suffering from the unwinding of the carry trade; the US is much weaker than the Fed’s preferred lagging indicators suggest; junk bonds are imploding, the oil price collapse has collapsed, Venezuela is on the verge of a sovereign debt crisis which will bring contagion. $7 trillion of global sovereign debt will return less than its nominal value to anyone who holds it to maturity, whilst most are in the trade because they expect ‘the greater fool’ to turn up – one day he won’t.
In short, the change in market sentiment is well founded – by fundamentals, as opposed to bravado and spin.
This deterioration will not produce a change of heart or a new approach from the CBs, for they are in denial, and they fail to see the wider implications. They are intellectually committed to a neo-Keynesian/monetarist view of the world; and the three words that most scare them are ‘we were wrong’. They will not utter those words unless and until they seem like the only way to respond to a hostile senate enquiry.
So what will they do? They will continue to sow the seeds for negative rates, and will continue to insist that this is showing promising signs of success in the Europe, even though that claim is ludicrous. But ultimately they will go for the ‘big one’ – the helicopter drop. Despite my sense that there is more justice in giving ‘money’ to long-suffering citizens rather than to the charlatans on Wall Street – it will not return the economy to health.
Why not? Because the global economy is saturated with debt; because governments and central banks have presided over decades of relentless credit creation; because blowing more air into a bubble just stretches it one puff closer to a loud pop; because the real economy is trying to deleverage; because we haven’t had 8 years of recovery – we’ve had 8 years of new debt being passed off as growth.
In the twenty years from 1994 to 2014, global debt rose from $40 trillion to $225 trillion; an increase of over 5.5 times; twice the rate of GDP, which rose from $28 trillion to $78 trillion. Debt has been rising at a compound rate of 9.0% whilst GDP has been rising at 5.3%. Fast forward another twenty years from now, incorporate the demographic changes and the entitlements currently hidden off balance sheet…and do the math – this is utterly unsustainable; and any policy maker who tells you otherwise, or says that they have revealed an acceptable plan to address it, is a shameless liar.
Things have changed, but not for the central banks. They are stuck in an endless cycle of monetary madness. I am reminded of an old song:
“You can check out any time you like
But you can never leave”
The Eagles - ‘Hotel California’