Have Central Banker Priests of Money Gone to the Dark Side?
Jens Weidmann and the boys at the Bundesbank must think their priests of money central bank peers have gone to the dark side, preaching the blasphemy of ever-escalating debt monetization, now called "quantitative easing". Germany's Bundesbank has become essentially the only central bank in the world that has not embraced quantitative easing, continually warning at every opportunity that rampant and gratuitous debt monetization with fiat money has become addictive as a drug, and like any drug overdose, can be fatal.
For the other central bankers, led by the Fed, this move to the dark side is a desperate response to fiscal paralysis, dangerously fragile financial systems and malaise-ridden economies; i.e., an aggressive bet that monetary policy remains a viable force.These central bankers have ventured out on the limb of "unconventional" monetary policy to the nth degree in first ensuring the viability of the financial system, but increasingly to trying to revive economies. Naturally, they trot out research that shows QE is having a positive impact. Research by economists at the Fed last year estimated its first two rounds of asset purchases reduced unemployment by 1.5 percentage points and staved off deflation. The Bank of England estimated in July that 200 billion pounds ($311 billion) of bond buying between March 2009 and January 2010 raised UK GDP by as much as 2 percent and inflation by 1.5 percentage points.
As former Bank of England's Danny Gabay told Bloomberg, everything in central banker eyes is a monetary problem..."What we have now is a monetary problem, so it's time for a monetary solution,..It's tough to make monetary policy effective, but it's the only way." "Old school" central bankers like Mervyn King (BoE), Jean-Claude Trichet (ECB) and Masaaki Shirakawa (BoJ) that question how much more monetary policy can achieve, and insisting monetary policy alone is no "panacea." are being ignored.
No Currency Wars, Just a Symptom of Increasingly Desperate Stimulus Measures
The respected, conservative Economist magazine outright dismisses the current buzzword "currency wars" to describe what is happening, because weak currencies are merely a symptom of so far ineffective but increasingly desperate central bank efforts to revive economies stumbling under an ever-growing albatross of government debt. The recent round of GDP growth numbers underscores the continued fragility of the recovery, with Japan recording its third quarter of minus growth, and GDP being noticeably weak in Euroland, even Germany; underscoring the cold hard fact that all that QE is just about the only thing standing between investors and renewed recession. Ergo, investors remain particularly keyed on central banker machinations.
|Source: Natixis, HatTip: Business Insider|
1 Trillion USD Coin Madness
|Note: US GDP, Source: Brad DeLong|
Everyone of the current generation has heard scare stories of the dangers of unmitigated fiat money printing since John Law invented the Mississippi scheme in the early 1700s. Over the past 100 years, Germany of course has seen first hand the devastating effects of hyperinflation or quintuple-digit inflation caused by unmitigated debt monetization during the Weimar Republic of the 1920s. What is really scary is US economists recently (half) seriously debating the merits of a USD 1 trillion platinum coin. In 1923, a 1 trillion mark Zeigenhain German Gutschein coupon was actually issued.
As with their predecessor French elite in the early 1700s, governments who, like France after Louis XIV's death in 1715 found their finances "in a state of utmost disorder", have fallen for central banker fiat money schemes such as John Law's bank of Law scheme (later erected into the Royal Bank of France) to inundate their countries and indeed the world with paper fiat money.
To hard money proponents and the average person on the street, nations financing their own debt by simply printing more fiat money is essentially a Ponzi Scheme, the natural progression ostensibly of which is to issue ever-increasing amounts of new money is issued to pay off prior debt holders, the eventual result being an eventual collapse of the currency that devalues all wealth based on that currency, including all financial asset wealth.
All That Increased "Cash" On the Sidelines is the Flip-Side of Government Debt
On the surface, the pain from the 2008 financial crisis and Great Recession was rather mild compared to the 1930s, at least for the top 10%. The following chart from McKinsey Global Institute shows global financial assets have increased some $16 trillion from the 2007 peak, and have rebounded some $37 trillion from the trough in 2008. A closer look however shows that the increase has come from public debt securities ($16 trillion) and non-secured loans ($8 trillion), while stock market capitalization is still $13 trillion below its 2007 peak. In other words, all that debt being issued by governments has become someone's financial asset, and that the surge in financial deficits in the public sector is behind the financial surpluses (excess financial assets) in the private sector.
|Hat Tip: Business Insider|
Then Why Isn't Gold Already At $3,000/Ounce?
As everyone knows, the US has been the most chronic currency debaser over the past 40 years, with the trade-weighted USD depreciating well over 30% since 1970. Despite this, USD has remained the primary currency for global trade and central bank reserves. Since USD is essentially a key component of the global money supply, any attempt by the Fed merely to reign in the growth of greenbacks negatively affects the global economy. In other words, if the Fed were to adopt a real "beggar thy neighbor" currency policy, it would be to reign in what hard money proponents consider rampant debt monetization.
As the global financial meltdown morphed into a Eurozone meltdown, the US Fed was joined by the ECB, the BoE and now the BoJ in the race to debase, not as a policy per se, but as the result of desperate measures to revive their economies. Seeing nothing but endless QE on the horizon, hedge funds and large institutions were convinced that all this fiat money printing would push gold to $3,000 or even $5,000 per ounce, and gold for a period went almost parabolic.
Yet the smart money (like George Soros and Louis Moore) is now dumping its gold holdings and Bloomberg is saying that hedge funds have cut their bets on gold by 56% from highs in October as gold prices consolidate, ostensibly on increased confidence in the economic recovery. Technically, gold could drop below $1,600 as it has broken below key medium-term support levels, despite continued buying by the world's central banks, ostensibly to keep something that is not rapidly debasing in their reserves.
Thus the rapid appreciation (i.e., parabolic move) in gold over the past five years vs the major currencies seems to be behind us, Given the proclivity of central banks to flood the markets with newly printed script at the first signs of economic weakness. it is still very much in doubt that the secular bull market in gold versus all major fiat currencies since the early 70s is over. However, a break below 1,600 could signal a medium-term correction to as low as 1,100, especially if central banks begin backing off the QE accelerator and real bond yields began to back up.
It would probably take a serious setback in what progress has been made in the Eurozone debt crisis, or as some suggest, a crisis in Japan's debt problems, to set gold surging again.
MMT Theorists: Simply Printing Money Does Not Lead to Hyperinflation
| Source: Galmarley.com|
As for unmitigated mone printing causing hyperinflation and therefore a melt-up in gold prices, James Montier and MMT'ers (modern monetary theorists) insist hyperinflation is"not just a monetary phenomenon, as money supply is endogenous (and hence that interest rates are exogenous), and that budget deficits are often caused by hyperinflations rather than being the source of hyperinflations. This is because money (credit) is created almost entirely by private sector banks, not central banks.
As a result, the government's loss or even reduction in the power to tax the output base is the real foundation for many hyperinflations. Thus in the case of an extremely advanced nation (such as Japan) with a powerful productive base and a sovereign that can tax that output, the odds of a hyperinflation (ostensibly from a currency collapse) are extremely low, barring the presence of such factors as a) large supply shocks (like during wars), b) big debts denominated in foreign currencies, or c) runaway cost of living, wage price inflation. Montier's conclusion is that those forecasting hyperinflation/collapse from aggressive central bank money printing in the US, the UK and Japan are suffering from hyperinflation hysteria.
|Source: Wall Street Journal|
Indeed, the movement in US 10yr bond yields suggests ongoing deflation, not inflation
, with growth expectations incorporated in these yields having yet to recover from the 2010 and 2011 "growth scares", as long-bond yields are still lower than they were even one year ago. The need for central banks to introduce successive QE stimulus strongly suggests the developed economies remain in a classic liquidity trap.
The Next Trigger for a Stock Market Correction
Given the above, the BoA Merrill Lynch and other surveys suggest that investors have for the time being over-done their optimism, with the February ML survey showing four consecutive months of rising sentiment about the global economy. These investors continue to perceive value in equities despite the strong rally since June of last year, as most remain convinced that bonds are due for a tumble, with 82% saying bonds are overvalued. Other market sentiment indicators also point to short-medium-term over-enthusiasm for equities.
The VIX has plunged from the last growth share, which admittedly was overdone in the VIX as the selloff was not as severe as the VIX's reaction. While the balance of market commentators (i.e., investors, traders interviewed by the financial press) now say stocks are "over-done" for the time being, but with the same breath say they want to jump in again with any sign of weakness. What this means of course that stock prices will not correct as much as many who have missed most of the latest up-leg would like to see.
Investors were also non-plussed by the latest round of disappointing economic news, partially because these are backward looking indicators, but also because anyone who does not understand that the price of every stock and every bond is being artificially altered by the fact that interest rates are being heavily manipulated by major central bank QE consistently has underestimated the staying power of this market recovery.
BoJ Will Have to Continue Battling Weak Euro Growth, Continued Fed QE to Keep JPY Weakening
Hedge funds have piled into the short yen trade convinced that JPY may well have crossed the rubicon. But hedge funds have already made a ton of money on the short JPY trade, with George Soros alone reportedly making a cool USD 1 billion. The plunge in JPY has also recently slowed by more dovish Japanese comments ahead of the G-20 meeting, which are of course politically motivated to ameleorate criticism at the conference. G-7 officials have muddied the "verbal intervention" waters by issuing a currency statement, "clarifing it" it and then criticizing the clarification. Japan's government (and JPY bears) were relieved when the Group of 20 finance ministers and central bank governors avoided specifically going after Japan's reflation efforts as currency manipulation. Instead, the pledged "to monitor negative currency spillovers to other countries caused by monetary policies implemented for domestic purposes, and to refrain from competitive devaluation." Meanwhile, the G-20 also put off plans for new austerity-inducing debt-cutting goals.
As seen below, the Bank of Japan's asset purchase program was already on track to purchase a cool JPY101.1 trillion (over 20% GDP), but investors/traders were largely ignoring this until new PM Abe began talking about even more aggressive BoJ action. After some uncertainty about whether the G20 would take Japan to task for the rapid JPY depreciation since late October 2012, investors/speculators took the mild G20 statement as tacit approval for further weakening of JPY, and giving encouragement to those predicting an eventual fall in JPY/USD to 200~300/USD. But these bears are basically talking their book. Ex-Soros Advisor Fujimaki (who says JPY400/USD is possible), makes his living advising Japanese clients to move their money offshore. BNP Paribas economist Ryutaro Kono, who sees a Japan fiscal crisis in 2015, was passed up for consideration for a BoJ post.
|Source: Morgan Stanley|
Speculative Short Positions Already Beginning to Unwind
The CFTC net open short position of non-commercial traders already peaked on 24 November 2012 after reversing sharply from a net long position peak on 21 August. Given the massive gains, traders are now taking profits, with the net short position now down some 20%, and the hot money is now looking for an excuse to lock in gains. Consequently, we view it unlikely that short traders can repeat these gains over the next couple of months. Indeed, the true test of weak JPY sustainability will be how JPY/USD trends as these short positions are cleared, as the shelf life of such overhangs of long-short positions have historically lasted only about six months.
What investors/speculators can expect is, 1) more currency volatility, 2) more interest rate convergence as central banks succumb to the Fed's "whatever it takes" approach, which implies continued downward, not upward pressure on rates. As a result, the so-called "great rotation" could be much more prolonged than those recommending you dump all your bonds would have you believe. Technically, the JPY sell-off has breached its first target (the 92 handle), with the next target just under 95, and currency markets should remain extremely sensitive to US, Japan and Eurozone comments about JPY or factors that would affect central bank stance, interest rates, etc.
Bond Yields at Some Point Will Have to Get in Sync with Currency Market
The JPY selloff to date has come mainly from the concept, not the fact. If the BoJ fails to deliver what is already discounted in JPY/USD price, there is room for a significant setback. Even investment banks like HSBC argue the currency market is "attaching a probability to excess success".
While strong "behavioral bias" from over a decade of falling JGB yields may have domestic investors still (undeservedly) tilted strongly to JGBs over equities, the fact is that JGB yields are not signing off the same song sheet as JPY/USD, and, we believe, not merely because of the prospect of aggressive BoJ JGB purchases. Indeed, the latest drop in JGB yields could be more attributable to the disappointing third quarter of declines in Japan's GDP. We are in complete agreement with JP Morgan's Kanno that a weak JPY and more aggressive BoJ won't be enough to provide Japan's economy with enough velocity to escape from its decades long slump without some 'ole Junichiro Koizumi-style structural reforms. Thus domestic investors will have to be shown that Abenomics is for real, that the new BoJ policy board is completely on board with Abenomics, and that Japan's economy is really pulling up before they really commit, despite the GPIF now beginning to consider the price risk in their extensive JGB portfolio from Abenomics.
|Hat Tip: FT Alphaville|
Japan Crisis Begins with a Collapse in JPY?
While most mainstream strategists and economists that follow Japan closely continue to downplay Kyle Bass's widow-maker trade, as previously outlined, the scenario does have its fans, especially among the fast money crowd. Last October, Atlantic magazine called the Japan debt problem "The Next Panic", suggesting Japan could be the next Black Swan event that really derails the central bank money printing-driven recovery. As Mark Twain said, "it ain't what you don't know that gets you into trouble, its what you know for sure that just ain't so". "Everyone" overseas is convinced the Japan debt situation is a bug in search of a windshield, and that the crisis in Japan will most likely come from a collapse in confidence in JPY.
However, Japan does not fit the pattern of countries that have had fiscal/currency crises, a) because the vast bulk of the debt is owed to its own people and b) Japan (still?) remains the largest net creditor nation. Japan's rapidly growing elderly hold the bulk of their savings in cash and bank deposits. The banks and financial institutions in turn hold the bulk of government debt, with the Bank of Japan becoming an increasingly large factor in JGB demand. If Japan is going to default, it will more likely "soft" default against its own citizens in a form of financial repression. Japan's savers could also effectively lose their savings through high inflation,but as James Montier has pointed out, central bank money printing alone is unlikely to cause this.