Mar 27

Today’s News 27th March 2017

  • Trump Handed Merkel $375 Billion Invoice For NATO Defenses During Recent Visit

    A couple of weeks ago we wrote several notes about German Chancellor Angela Merkel’s painfully awkward visit to the White House.  After meeting in private, the pair sat down in the oval office for a brief press conference where you could cut the tension with a knife.  At one point someone from the media asked for a handshake but the request was promptly ignored.

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    Now, a couple of weeks later, we learn what may have prompted some of the tension in the room between Merkel and Trump that day.  According to a new report from The Times of London today, Trump apparently took advantage of Merkel’s visit to Washington D.C. to pass her a $375 billion invoice for ‘overdue’ NATO defense expenses.  Per The Hill, Merkel largely ignored the invoice though it certainly seems to have accomplished it’s goal of ruffling some feathers.

    “The concept behind putting out such demands is to intimidate the other side, but the chancellor took it calmly and will not respond to such provocations,” a German minister told the newspaper.

     

    Trump during his presidential campaign railed against the NATO alliance and has called for member countries to increase defense spending to support the organization.

     

    Merkel “ignored the provocation,” the Times said.

    As reported, the invoice was based on a 2014 pledge from NATO countries to spend 2% of their GDP on national defense.  As such, Trump allegedly instructed aides to calculate how much German spending fell below that 2% target for the past 12 years, added interest and created an invoice which he hand delivered.

    Meanwhile, with the benefit of this new information, Trump’s tweets from March 18th, after his meetings with Merkel, take on all new meaning.

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    And while Merkel has largely ignored the invoice, other German ministers have decided upon more aggressive responses.  Per the Independent:

    In response to the claims, German defence minister Ursula Von der Leyen rejected the notion the European nation owed the US or Nato.

     

    She issued a statement saying: “There is no debt account at Nato

     

    “Defence spending also goes into UN peacekeeping missions, into our European missions and into our contribution to the fight against [Isis] terrorism.”

     

    Her comments were backed by Ivo Daalder, permanent representative to Nato from 2009 to 2013 under the Obama administration, who queried the President’s understanding of the organisation.

     

    He tweeted: “Sorry Mr President, that’s not how Nato works. The US decides for itself how much it contributes to defending Nato.

     

    “This is not a financial transaction, where Nato countries pay the US to defend them. It is part of our treaty commitment.”

    Never a dull moment in the Trump White House.

  • Are America And China Destined For War?

    Authored by Harry Kazianis via The Stratgeic Culture Foundation,

    In his recent book The Improbable War, professor Christopher Coker explains that it is “of vital importance that the possibility of a conflict between China and the United States continues to be discussed.” Coker’s rationale for this is simple: “If the United States and China continue to convince themselves that war is too ‘improbable’ to take seriously, it is not they but the rest of the world that may ultimately pay the price.”

    It would seem the good professor’s wish is about to be granted. We are about to be treated to what surely will be a media blitz over what can only be described as the most comprehensive book to ever tackle the question of not only whether a US-China war is possible, but what steps Washington and Beijing can take to avoid such a calamity.

    Written by one of the world’s most prominent political scientists and strategic thinkers of the day, director of Harvard University’s Belfer Center, Graham Allison, anyone who has been following China in recent years likely guessed such an effort was in the works. The book is hooked on Allison’s popular “Thucydides Trap” concept. The trap, as Allison described in a prominent piece for the Atlantic in 2015, is “the attendant dangers when a rising power rivals a ruling power — as Athens challenged Sparta in ancient Greece, or as Germany did Britain a century ago.” Allison goes on to warn that in 12 of 16 cases he has studied throughout history, when such a situation takes place, war has been the result.

    US and China: A relationship in dangerous flux

    So what happens in case study number 17? Knowing the odds history has given us, is war between China and America unstoppable?

    To answer such questions, we first need to understand the complexity that is the US-China relationship. In fact, there are two US-China relationships.

    The first, is the economic relationship. At least until the election of Donald Trump, many scholars and Asia hands would argue that both sides prospered from their deep economic ties. US-China bilateral trade in goods and services has skyrocketed since the two nation’s opened their doors to each other in 1971 and is now more than US$600 billion per year. Trade between both Washington and Beijing has made both countries wealthier with millions of jobs created on both sides of the Pacific.

     

    The second part is the strategic relationship — something that was bound to become strained after the collapse of the Soviet Union, the real threat that brought America and China together. Without a common foe, tensions on both sides have begun to grow. Washington and Beijing now face off in various parts of the Asia-Pacific with no letup in sight.

    Such an odd, dual-sided relationship, filled with equal promise and peril, made sense for decades. When times got tough — look no further than the 1995-1996 Taiwan Crisis, the 1999 Chinese Embassy bombing, the 2001 EP-3 Crisis and many other smaller incidents — the dangers of severing the economic relationship always seemed to smooth out any talk of a rupture. But with Trump and advisers such as Death by China author Peter Navarro calling into question the economic benefits of trade with Beijing, the one thing that always seemed to anchor relations in times of trouble seems to be at an end.

    Why Destined for War is a must read:

    To be fair, there are many great articles, long-form pieces and books that detail the dangers of a US-China military clash and how to avoid it. So why read this one?

    I offer three reasons: Comprehensiveness, readability and telling hard truths most Asia experts here in Washington won’t want to hear.

    In the interests of full disclosure, I have published Allison’s works on many occasions as Executive Editor of the National Interest, but Allison’s efforts in Destined for War will surely be praised, and for good reasons.

    Any Asia hand will quickly be floored by the level of detail and research the manuscript includes. With a grounding in history, Allison takes his readers on a journey through many similar cases in the past where a rising nation challenged a status-quo power, detailing where things went wrong, and, in some instances, how war was avoided. This is all done in a style that makes the book a real page turner, written in a prose that is easy to understand, never getting bogged down in often pointless jargon, tables, graphs or pie-charts. Allison’s ideas flow easily, no matter how frightening they are.

    But some will likely have a problem with some of what the work offers. For example, he compares Xi Jinping and Donald Trump as two men who have similar goals: to make their nations great again. At the same time, Allison boldly, and quite correctly, couches China’s quest for primacy in Asia as something like what the United States did when it rose to power almost a century ago. While clearly stating that China has not acted as aggressively as America did in the past, especially back around the turn of century during the time of President Theodore Roosevelt, Allison skillfully hints at what could occur if China were to take such a step — and embark on a real path to war.

    Reasons for hope:

    While I don’t want to offer any spoilers, Allison offers four key ways to mitigate the possibility of conflict. One of my favorites, clarifying vital interests, is worth spoiling. What are America’s vital interests in the Asia-Pacific region? What are we willing to fight for? What are we willing to die for? And, perhaps, most importantly, what are we not willing to fight for? To this day, I would challenge any past Obama administration official to be able to explain that with clarity — they likely can’t, beyond mentioning the word pivot or rebalance — terms that are rightly relegated to the past. The Trump administration will need to take up this challenge fast, considering Xi and Obama have a big summit set for early next month.

    While many will sing the praises of Allison’s work, there is a much simpler reason why the good professor’s effort should be commended: it stands to reason a flood of op-eds, blogs, editorials and podcasts will flood the media as this books nears its release. We are finally about to have a real public debate about the very distinct possibility of a war between the US and China — and that itself might be the real accomplishment.

  • Putting Pennies in the Fusebox, Report 26 Mar, 2017

    Back in the old days, homes had fuse boxes. Today, of course, any new house is built with a circuit breaker panel and many older homes have been upgraded at one time or another. However, the fuse is a much more interesting analogy for the monetary system.

    When a fuse burned out, it was protecting you from the risk of a house fire. Each circuit is designed for only so much current. The problem is that higher current causes more heat, and it can start a fire. So they put fuses in, which burn out before the wire gets hot enough to be dangerous.

    The problem is that it’s annoying when a fuse burns out, especially when it’s the last one and the hardware store is far away and/or closed for the weekend. So people all too often put a penny in the place of the fuse. And then, human nature being what it is, they left it there long-term. As an aside, pennies in those days were solid copper, not the copper plated zinc they use today because it’s cheaper.

    We would guess that a disproportionate number of house fires were started because an overloaded circuit became overheated, and the protective fuse was replaced with a penny that would keep the juice flowing no matter what.

    So, what has that got to do with gold and silver? A penny in the fuse box is a perfect analogy for what President Roosevelt did in 1933. Many believe when he confiscated gold, it was to grab the loot. While we have no doubt that he and his cronies lusted for the gold of the people, he had a more serious purpose.

    Until 1933, gold was the core monetary asset in the banking system. When people withdrew their gold coin—redeeming their gold, not buying gold—that forced the bank to sell a bond to raise the gold to redeem depositors. If a bank could not raise enough gold, perhaps because bond prices were going down, then the bank was bankrupt. Another problem is that falling bond prices mean rising interest rates.

    Roosevelt was trying to stop the run on the banks, and trying to push interest rates down.

    He did stop the run, and interest continued to fall through the end of World War II. However, his act was the monetary equivalent of the penny in the fuse box. In making it illegal to own gold, he made the dollar irredeemable for Americans. Gold is the only financial asset that is not someone else’s liability. Deprived of this outlet, people were forced to be a creditor. The only choice was to lend to the Federal Reserve, the US Treasury, a commercial bank, a corporation, etc.

    When people are running to the bank to withdraw their gold coin, it’s like a fuse burning out. You really should find out the root cause when a fuse keeps burning out, and not just jam a solid copper conductor into the circuit. You really should find out why people keep pulling money (i.e. gold) out of the banks, and not just outlaw it.

    The reasons were simple. The rate of interest was below the marginal time preference of the savers. This is, of course, the purpose for which any central bank is established: to enable the government and its cronies to borrow more cheaply. And the banks had become unsound (due in no small part to the actions of the Fed taken prior to 1933).

    By corralling everyone in the banking system, FDR put a penny in the monetary fusebox. In 1971, President Nixon realized there was one last fuse that could still burn out and thereby signal that all was not well. Americans could not withdraw gold, but foreign governments could. And, led by France, they were doing. So Nixon “closed the gold window”, thereby inserting a second penny.

    Now the system was perfect—perfectly irredeemable. Money is credit and credit is money and there is no longer a way for the market to express concerns about either interest rates or soundness. An individual can escape being a creditor if he buys gold (legalized in 1975, after gold was entirely demonetized), but his dollars simply trade hands. The seller of the gold gets the credit-dollars, and the buyer gives them up for the gold. There is zero effect on the banking system (other than causing the price of the dollar to go down).

    Unlike the simple and elegant mechanism of the bank run in the gold standard, buying gold is awkward, clunky, and risky for the participants. With dollar-credit no longer being tied to gold, there is a price risk. And of course, price is the motivator for many participants.

    Two people, call them Joe and Mary, could both be right that the dollar-credit system is headed towards a crisis. Joe bought at $1,060 in the last week of 2015. Unfortunately, Mary bought at $1,375 in July of 2016. Both bought because of the same reason. But Joe has a big fat gain of $183 and Mary has a loss of $132. This volatility makes people alternatively greedy and fearful, which is not really providing a good signal that the monetary system has problems urgently in need of addressing.

    And so the system goes, careening around, from crisis to crisis and nothing gets fixed and there is no signal that is clear to everyone the way a run on the banks is clear.

    With this backdrop, we note that the price of gold is on the rise again. Since its low around $1,120 late last year, it has been rising to its current price about $120 above that. What’s more, the fundamentals have been getting stronger at the same time. What could be causing this, and now?

    Rising interest rates (which we believe is just a correction in the long falling rates trend) are putting more and more stress on banks and corporations alike. If you have borrowed short to lend long (as all banks do nowadays, this is called “maturity transformation”) then rising rates cause immediate pain. Your cost of funding goes up instantly. However, the interest you earn on long-term bonds does not go up. Instead, the market price of those bonds drops. Equity is disappearing from your balance sheet.

    Now consider major corporations, who too often borrowed in the short term bond markets. Their cost of funding is rising. Nearly every carmaker now offers 0% financing to qualified buyers. Their cost to offer this is now obviously much higher than it was a year or two ago. And that does not even count if they had used short-term borrowing to finance those loans, in which case their existing book is bleeding cash too.

    This same pressure is occurring anywhere a vendor is financing its customers. The vendor can always try to pass through the increased cost. However, if buying volume was anemic previously with lower interest cost, it will only get worse when this cost goes up.

    In the housing market, most people are monthly payment buyers. A higher interest rate means a lower price to get the same payment.

    And what happens to lower credit corporations who issue junk bonds? Like most corporations they have to roll over their bonds when mature. So far, rising rates has passed over this market and junk bonds have held up. However, should this tide turn, many of these companies will be forced to default under a deluge of rising interest expense, if not softer demand for their products. They are junk credits for a reason, and higher rates can be the final straw.

    Or let’s look at the pension funds. They are already badly underfunded. That is, they are already destined to arrive at terra firma. Many have bought equities and real estate in an attempt to juice up their returns. What happens if the prices of those assets comes down significantly?

    Finally, let’s look at municipalities. They derive revenue from home building and turnover of not only homes but home furnishings, remodeling, etc. If these markets slow down significantly, their ability to service their debts is going to be taxed to the limits and beyond.

    No wonder people are buying gold. Fundamental demand, as opposed to speculative, is when people buy gold coins and bars, presumably not to bring back to the market soon.

    Below, we will show the only true picture of the gold and silver supply and demand. But first, the price and ratio charts.

    The Prices of Gold and Silver
    The Prices of Gold and Silver

    Next, this is a graph of the gold price measured in silver, otherwise known as the gold to silver ratio. It moved down this week.

    The Ratio of the Gold Price to the Silver Price
    The Ratio of the Gold price to the Silver price

    For each metal, we will look at a graph of the basis and cobasis overlaid with the price of the dollar in terms of the respective metal. It will make it easier to provide brief commentary. The dollar will be represented in green, the basis in blue and cobasis in red.

    Here is the gold graph.

    The Gold Basis and Cobasis and the Dollar Price
    The Gold Basis and Cobasis and the Dollar Price

    The price of the dollar fell another 0.3 milligrams gold (this is the inverse of the rising price of gold, measured in dollars, +$14). However, this week, the cobasis (our measure of scarcity) decreased a bit. Gold buying this week was biased towards speculation. Last week, we said fundamental buying was a trend but it’s “sputtering”. This is an example.

    Our calculated fundamental price of gold is up $3, or still about $160 over the market price.

    Now let’s look at silver.

    The Silver Basis and Cobasis and the Dollar Price
    The Silver Basis and Cobasis and the Dollar Price

    The story is the same in silver. The price rose, a bit more than the price of gold did. With the rising price, we see decreasing scarcity this week.

    Our calculated silver fundamental price rose 4 cents, now about $0.85 over the market price.

    We leave on a question today. When interest returns to gold and silver, which metal will have the higher rate? We plan to publish something about this soon.

    © 2017 Monetary Metals

  • RBC Emergency Market Update: "Big Trouble For Consensus Trades"

    Markets may not be turmoiling yet, but as per this “emergency” Sunday night “hot take” from RBC’s cross-asset head Charlie McElligott notes, things are certainly starting to break.

    SPECIAL EDITION RBC Big Picture: BIG TROUBLE FOR CONSENSUS ‘REFLATION’ TRADES AS ‘FISCAL POLICY’ FEARS CONFIRMED
     
    #HOTTAKE: ‘Risk-off’ in a sloppy Asian opening to start the week (ES1 -18 handles, $/Y -100pips to 110.34, UST 10Y ylds at 2.36), as markets digest the scope and viability of the US ‘fiscal policy’ narrative going-forward off the tremors of Friday’s failed healthcare repeal vote. 

    “Reflation” themes were already staggering in recent weeks off-the-back of the recent the crude oil sell-off (and the implications for weakened ‘inflation expectations’)—but to now see the longer-term ‘US fiscal policy upside kicker’ looking especially threatened, it is likely that the ‘big three’ trade expressions (longs in US Dollar US Banks and shorts in US Rates) are looking very exposed for an acceleration of recent drawdowns (in conjunction with longs in HY, ‘cyclicals / defensives’ L/S pairs, equities ‘value’ factor, equities high beta, US equities small cap).

    ‘Long Dollar’ trades are currently seen unwinding ‘real-time’ as ‘the world’s most crowded trade’ and ‘reflation’ proxy earlier this evening broke the convergence of both its 200dma and the 76.4% Fibo Retracement of the entire Dollar move since the US election—exposing significant downside.  Legacy shorts held against the US Dollar in Euro (making 2017 highs vs USD), Yen (making 2017 highs vs USD), Pound and Canadian Dollar are being painfully squeezed as traders are liquidating after ‘processing’ the implications of the Trump Administration’s failed ACA repeal Friday, with many ‘late-comers’ to these trades significantly ‘under water’ already and looking to ‘tap out’ on losers.  Tactical funds and discretionary macro were already pivoting ‘short USD’ last week on the new “policy CONVERGENCE” dynamic, and now with momentum having clearly pivoted in the other direction, one would expect systematic / trend / CTA to be heavily-involved now as well on the short-side of USD trades.

    The story that we were getting Friday from some buyside traders and sellside strategists (by-and-large) was that a “no” vote was almost irrelevant to risk-assets, as market participants want the US Administration to ‘move on’ and ‘focus its efforts’ on tax policy anyhow (versus being mired in further debate with the ‘repeal and replace’ of the ACA).  What many were missing here though (and noted by Mark Orsley Friday afternoon) is that the sequencing of ‘healthcare’ and ‘budget’ before ‘taxes’ was intentional and critical, as spending cuts from a repeal of the ACA were effectively a ‘requirement’ against the pending new administration’s tax-plan which will only further increase the deficit.  This is obviously an impediment then to efforts to keep any new tax plan ‘deficit neutral,’ so essentially, the GOP is starting in a bigger hole, some say to the tune of $1T dollars….and this of course is not including the extremely controversial BAT component, which too has lost much momentum over the past two months, despite projections that it could provide upwards of $1T of revenues over a 10 year period in order to fund the individual and corporate tax cut proposals (ironically, the same ‘Freedom Caucus’ of GOP’ers which symbolically defeated the ‘new’ healthcare plan on Friday are also against the BAT…yikes).

    What does it all mean?  Some of the talk emanating from DC policy-circles is now of the view that this now means an almost certainty of a ‘watered down’ tax plan, which instead of deep ‘headline’ cuts planned will now feature much more modest cuts (corporates as priority over individuals) and focus on “streamlining” tax code / loopholes.  This is not the ‘joy’ that many of those 2500 S&P targets ‘signed-up’ for.

    What is at risk?  I noted many of the ‘consensual longs’ which have already showed significant signs of being de-grossed in recent weeks.  But as we now see a high likelihood of the potential for a rates reversal to accelerate and long duration’ rallies in the face of the ‘rates short’ crowd, there will be major implications within equities too, as ‘low vol’ defensives (REITS / Utes / Staples / Telcos) and ‘anti-beta’ market neutral strategies are certain to see further escalation of their recent strength.  The good news for equities-longs  is that ‘secular growers’ like tech, consumer discretionary and biotech is too likely to benefit from money rotating out of ‘deep cyclicals’and ‘value.’  

    Stay tuned…
     
     

  • Trump "Endorses" Jeanine Pirro's Call For Paul Ryan To Step Down

    Fox News host Judge Jeanine Pirro, whose show President Trump urged his followers on Twitter to watch earlier in the day, opened her program at 9pm on Saturday by calling for Speaker Paul Ryan’s resignation.

    “Ryan needs to step down as Speaker of the House. The reason, he failed to deliver the votes on his healthcare bill, the one trumpeted to repeal and replace ObamaCare, the one that he had 7 years to work on; the one he hid under lock and key in the basement of Congress; the one that had to be pulled to prevent the embarrassment of not having enough votes to pass.” Pirro said in her opening statement.

    “Speaker Ryan, you come in with all your swagger and experience and sell them a bill of goods which ends up a complete and total failure and you allow our president, in his first 100 days, to come out of the box like that, based on what?” Pirro said.

    What made Pirro’s fiery comments about Ryan especially notable is that they came hours after Trump tweeted to encourage his followers to watch “Justice with Judge Jeanine.”

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    While Trump has urged people to watch TV shows in the past, typically it was when the president himself was appearing on them. However in a twist, Pirro suggested that she had not coordinated her statement with Trump in advance.

    “I have not spoken with the president about any of this,” Pirro said of her call for Ryan to step down on her show, where president’s counter-terrorism adviser Sebastian Gorka also appeared on Saturday evening.

    On Friday Trump told Ryan to pull the Republican healthcare bill, upon learning there were not enough votes in support among House Republicans. The move marked Trump’s first legislative defeat as president and followed seven years of rhetoric from Republicans who campaigned on a pledge to repeal and replace former President Barack Obama’s signature healthcare law.

    In the initial round of fingerpointing, Trump blamed Democrats for not backing the GOP healthcare bill, warning that Obamacare would “explode” on its own, and signaled that he would move on to other priorities such as tax reform. On Saturday, the NYT reported that the blame among Trump’s closest circles had fallen on Reince Priebus and Health and Human Services Secretary Tom Price, while Ryan was spared Trump’s anger. Trump and White House press secretary Sean Spicer also indicated that they appreciated Ryan’s effort to get the bill passed, amid criticism from some Trump allies over the failed effort.

    Following the Pirro statement, the blame now appears to have shifted back to Ryan, as Bloomberg originally reported on Friday.

    Pirro insisted in her first segment that the failure was on Ryan and not on Trump. “Folks, I want to be clear. This is not on President Trump,” she said. “No one expected a businessman to completely understand the nuances, the complicated ins and outs of Washington and its legislative process. How would he know on what individuals he could rely?”

    “Ryan has hurt you going forward, and he’s got to go,” Pirro said.

  • Michael Hudson: Trump Is Obama's Legacy – Is This The End Of The Democratic Party?

    Authored by Michael Hudson via NakedCapitalism.com,

    Nobody yet can tell whether Donald Trump is an agent of change with a specific policy in mind, or merely a catalyst heralding an as yet undetermined turning point. His first month in the White House saw him melting into the Republican mélange of corporate lobbyists. Having promised to create jobs, his “America First” policy looks more like “Wall Street First.” His cabinet of billionaires promoting corporate tax cuts, deregulation and dismantling Dodd-Frank bank reform repeats the Junk Economics promise that giving more tax breaks to the richest One Percent may lead them to use their windfall to invest in creating more jobs. What they usually do, of course, is simply buy more property and assets already in place.

    One of the first reactions to Trump’s election victory was for stocks of the most crooked financial institutions to soar, hoping for a deregulatory scythe taken to the public sector. Navient, the Department of Education’s knee-breaker on student loan collections accused by the Consumer Financial Protection Bureau (CFPB) of massive fraud and overcharging, rose from $13 to $18 now that it seemed likely that the incoming Republicans would disable the CFPB and shine a green light for financial fraud.

    Foreclosure king Stephen Mnuchin of IndyMac/OneWest (and formerly of Goldman Sachs for 17 years; later a George Soros partner) is now Treasury Secretary – and Trump is pledged to abolish the CFPB, on the specious logic that letting fraudsters manage pension savings and other investments will give consumers and savers “broader choice,” e.g., for the financial equivalent of junk food. Secretary of Education Betsy DeVos hopes to privatize public education into for-profit (and de-unionized) charter schools, breaking the teachers’ unions. This may position Trump to become the Transformational President that neoliberals have been waiting for.

    But not the neocons. His election rhetoric promised to reverse traditional U.S. interventionist policy abroad. Making an anti-war left run around the Democrats, he promised to stop backing ISIS/Al Nusra (President Obama’s “moderate” terrorists supplied with the arms and money that Hillary looted from Libya), and to reverse the Obama-Clinton administration’s New Cold War with Russia. But the neocon coterie at the CIA and State Department are undercutting his proposed rapprochement with Russia by forcing out General Flynn for starters. It seems doubtful that Trump will clean them out.

    Trump has called NATO obsolete, but insists that its members up their spending to the stipulated 2% of GDP — producing a windfall worth tens of billions of dollars for U.S. arms exporters. That is to be the price Europe must pay if it wants to endorse Germany’s and the Baltics’ confrontation with Russia.

    Trump is sufficiently intuitive to proclaim the euro a disaster, and he recommends that Greece leave it. He supports the rising nationalist parties in Britain, France, Italy, Greece and the Netherlands, all of which urge withdrawal from the eurozone – and reconciliation with Russia instead of sanctions. In place of the ill-fated TPP and TTIP, Trump advocates country-by-country trade deals favoring the United States. Toward this end, his designated ambassador to the European Union, Ted Malloch, urges the EU’s breakup. The EU is refusing to accept him as ambassador.

    Will Trump’s Victory Break Up the Democratic Party?

    At the time this volume is going to press, there is no way of knowing how successful these international reversals will be. What is more clear is what Trump’s political impact will have at home. His victory – or more accurately, Hillary’s resounding loss and the way she lost – has encouraged enormous pressure for a realignment of both parties. Regardless of what President Trump may achieve vis-à-vis Europe, his actions as celebrity chaos agent may break up U.S. politics across the political spectrum.

    The Democratic Party has lost its ability to pose as the party of labor and the middle class. Firmly controlled by Wall Street and California billionaires, the Democratic National Committee (DNC) strategy of identity politics encourages any identity except that of wage earners. The candidates backed by the Donor Class have been Blue Dogs pledged to promote Wall Street and neocons urging a New Cold War with Russia.

    They preferred to lose with Hillary than to win behind Bernie Sanders. So Trump’s electoral victory is their legacy as well as Obama’s. Instead of Trump’s victory dispelling that strategy, the Democrats are doubling down. It is as if identity politics is all they have.

    Trying to ride on Barack Obama’s coattails didn’t work. Promising “hope and change,” he won by posing as a transformational president, leading the Democrats to control of the White House, Senate and Congress in 2008. Swept into office by a national reaction against the George Bush’s Oil War in Iraq and the junk-mortgage crisis that left the economy debt-ridden, they had free rein to pass whatever new laws they chose – even a Public Option in health care if they had wanted, or make Wall Street banks absorb the losses from their bad and often fraudulent loans.

    But it turned out that Obama’s role was to prevent the changes that voters hoped to see, and indeed that the economy needed to recover: financial reform, debt writedowns to bring junk mortgages in line with fair market prices, and throwing crooked bankers in jail. Obama rescued the banks, not the economy, and turned over the Justice Department and regulatory agencies to his Wall Street campaign contributors. He did not even pull back from war in the Near East, but extended it to Libya and Syria, blundering into the Ukrainian coup as well.

    Having dashed the hopes of his followers, Obama then praised his chosen successor Hillary Clinton as his “Third Term.” Enjoying this kiss of death, Hillary promised to keep up Obama’s policies.

    The straw that pushed voters over the edge was when she asked voters, “Aren’t you better off today than you were eight years ago?” Who were they going to believe: their eyes, or Hillary? National income statistics showed that only the top 5 percent of the population were better off. All the growth in Gross Domestic Product (GDP) during Obama’s tenure went to them – the Donor Class that had gained control of the Democratic Party leadership. Real incomes have fallen for the remaining 95 percent, whose household budgets have been further eroded by soaring charges for health insurance. (The Democratic leadership in Congress fought tooth and nail to block Dennis Kucinich from introducing his Single Payer proposal.)

    No wonder most of the geographic United States voted for change – except for where the top 5 percent, is concentrated: in New York (Wall Street) and California (Silicon Valley and the military-industrial complex). Making fun of the Obama Administration’s slogan of “hope and change,” Trump characterized Hillary’s policy of continuing the economy’s shrinkage for the 95% as “no hope and no change.”

    Identity Politics as Anti-Labor Politics

    A new term was introduced to the English language: Identity Politics. Its aim is for voters to think of themselves as separatist minorities – women, LGBTQ, Blacks and Hispanics. The Democrats thought they could beat Trump by organizing Women for Wall Street (and a New Cold War), LGBTQ for Wall Street (and a New Cold War), and Blacks and Hispanics for Wall Street (and a New Cold War). Each identity cohort was headed by a billionaire or hedge fund donor.

    The identity that is conspicuously excluded is the working class. Identity politics strips away thinking of one’s interest in terms of having to work for a living. It excludes voter protests against having their monthly paycheck stripped to pay more for health insurance, housing and mortgage charges or education, or better working conditions or consumer protection – not to speak of protecting debtors.

    Identity politics used to be about three major categories: workers and unionization, anti-war protests and civil rights marches against racist Jim Crow laws. These were the three objectives of the many nationwide demonstrations. That ended when these movements got co-opted into the Democratic Party. Their reappearance in Bernie Sanders’ campaign in fact threatens to tear the Democratic coalition apart. As soon as the primaries were over (duly stacked against Sanders), his followers were made to feel unwelcome. Hillary sought Republican support by denouncing Sanders as being as radical as Putin’s Republican leadership.

    In contrast to Sanders’ attempt to convince diverse groups that they had a common denominator in needing jobs with decent pay – and, to achieve that, in opposing Wall Street’s replacing the government as central planner – the Democrats depict every identity constituency as being victimized by every other, setting themselves at each other’s heels. Clinton strategist John Podesta, for instance, encouraged Blacks to accuse Sanders supporters of distracting attention from racism. Pushing a common economic interest between whites, Blacks, Hispanics and LGBTQ always has been the neoliberals’ nightmare. No wonder they tried so hard to stop Bernie Sanders, and are maneuvering to keep his supporters from gaining influence in their party.

    When Trump was inaugurated on Friday, January 20, there was no pro-jobs or anti-war demonstration. That presumably would have attracted pro-Trump supporters in an ecumenical show of force. Instead, the Women’s March on Saturday led even the pro-Democrat New York Times to write a front-page article reporting that white women were complaining that they did not feel welcome in the demonstration. The message to anti-war advocates, students and Bernie supporters was that their economic cause was a distraction.

    The march was typically Democratic in that its ideology did not threaten the Donor Class. As Yves Smith wrote on Naked Capitalism: “the track record of non-issue-oriented marches, no matter how large scale, is poor, and the status of this march as officially sanctioned (blanket media coverage when other marches of hundreds of thousands of people have been minimized, police not tricked out in their usual riot gear) also indicates that the officialdom does not see it as a threat to the status quo.”

    Hillary’s loss was not blamed on her neoliberal support for TPP or her pro-war neocon stance, but on the revelations of the e-mails by her operative Podesta discussing his dirty tricks against Bernie Sanders (claimed to be given to Wikileaks by Russian hackers, not a domestic DNC leaker as Wikileaks claimed) and the FBI investigation of her e-mail abuses at the State Department. Backing her supporters’ attempt to brazen it out, the Democratic Party has doubled down on its identity politics, despite the fact that an estimated 52 percent of white women voted for Trump. After all, women do work for wages. And that also is what Blacks and Hispanics want – in addition to banking that serves their needs, not those of Wall Street, and health care that serves their needs, not those of the health-insurance and pharmaceuticals monopolies.

    Bernie did not choose to run on a third-party ticket. Evidently he feared being accused of throwing the election to Trump. The question is now whether he can remake the Democratic Party as a democratic socialist party, or create a new party if the Donor Class retains its neoliberal control. It seems that he will not make a break until he concludes that a Socialist Party can leave the Democrats as far back in the dust as the Republicans left the Whigs after 1854. He may have underestimated his chance in 2016.

    Trump’s Effect on U.S. Political Party Realignment

    During Trump’s rise to the 2016 Republican nomination it seemed that he was more likely to break up the Republican Party. Its leading candidates and gurus warned that his populist victory in the primaries would tear the party apart. The polls in May and June showed him defeating Hillary Clinton easily (but losing to Bernie Sanders). But Republican leaders worried that he would not support what they believed in: namely, whatever corporate lobbyists put in their hands to enact and privatize.

    The May/June polls showed Trump and Clinton were the country’s two most unpopular presidential candidates. But whereas the Democrats maneuvered Bernie out of the way, the Republican Clown Car was unable to do the same to Trump. In the end they chose to win behind him, expecting to control him. As for the DNC, its Wall Street donors preferred to lose with Hillary than to win with Bernie. They wanted to keep control of their party and continue the bargain they had made with the Republicans: The latter would move further and further to the right, leaving room for Democratic neoliberals and neocons to follow them closely, yet still pose as the “lesser evil.” That “centrism” is the essence of the Clintons’ “triangulation” strategy. It actually has been going on for a half-century. “As Tanzanian President Julius Nyerere quipped in the 1960s, when he was accused by the US of running a one-party state, ‘The United States is also a one-party state but, with typical American extravagance, they have two of them’.”

    By 2017, voters had caught on to this two-step game. But Hillary’s team paid pollsters over $1 billion to tell her (“Mirror, mirror on the wall …”) that she was the most popular of all. It was hubris to imagine that she could convince the 95 Percent of the people who were worse off under Obama to love her as much as her East-West Coast donors did. It was politically unrealistic – and a reflection of her cynicism – to imagine that raising enough money to buy television ads would convince working-class Republicans to vote for her, succumbing to a Stockholm Syndrome by thinking of themselves as part of the 5 Percent who had benefited from Obama’s pro-Wall Street policies.

    Hillary’s election strategy was to make a right-wing run around Trump. While characterizing the working class as white racist “deplorables,” allegedly intolerant of LBGTQ or assertive women, she resurrected the ghost of Joe McCarthy and accused Trump of being “Putin’s poodle” for proposing peace with Russia. Among the most liberal Democrats, Paul Krugman still leads a biweekly charge at The New York Times that President Trump is following Moscow’s orders. Saturday Night Live, Bill Maher and MSNBC produce weekly skits that Trump and General Flynn are Russian puppets. A large proportion of Democrats have bought into the fairy tale that Trump didn’t really win the election, but that Russian hackers manipulated the voting machines. No wonder George Orwell’s 1984 soared to the top of America’s best-seller lists in February 2017 as Donald Trump was taking his oath of office.

    This propaganda paid off on February 13, when neocon public relations succeeded in forcing the resignation of General Flynn, whom Trump had appointed to clean out the neocons at the NSA and CIA. His foreign policy initiative based on rapprochement with Russia and hopes to create a common front against ISIS/Al Nusra seemed to be collapsing.

    Tabula Rasa Celebrity Politics

    U.S. presidential elections no longer are much about policy. Like Obama before him, Trump campaigned as a rasa tabla, a vehicle for everyone to project their hopes and fancies. What has all but disappeared is the past century’s idea of politics as a struggle between labor and capital, democracy vs. oligarchy.

    Who would have expected even half a century ago that American politics would become so post-modern that the idea of class conflict has all but disappeared. Classical economic discourse has been drowned out by their junk economics.

    There is a covert economic program, to be sure, and it is bipartisan. It is to make elections about just which celebrities will introduce neoliberal economic policies with the most convincing patter talk. That is the essence of rasa tabla politics.

    Can the Democrats Lose Again in 2020?

    Trump’s November victory showed that voters found him to be the Lesser Evil, but all that voters really could express was “throw out the bums” and get a new set of lobbyists for the FIRE sector and corporate monopolists. Both candidates represented Goldman Sachs and Wall Street. No wonder voter turnout has continued to plunge.

    Although the Democrats’ Lesser Evil argument lost to the Republicans in 2016, the neoliberals in control of the DNC found the absence of a progressive economic program to less threatening to their interests than the critique of Wall Street and neocon interventionism coming from the Sanders camp. So the Democrat will continue to pose as the Lesser Evil party not really in terms of policy, but simply ad hominum. They will merely repeat Hillary’s campaign stance: They are not Trump. Their parades and street demonstrations since his inauguration have not come out for any economic policy.

    On Friday, February 10, the party’s Democratic Policy group held a retreat for its members in Baltimore. Third Way “centrists” (Republicans running as Democrats) dominated, with Hillary operatives in charge. The conclusion was that no party policy was needed at all. “President Trump is a better recruitment tool for us than a central campaign issue,’ said Washington Rep. Denny Heck, who is leading recruitment for the Democratic Congressional Campaign Committee (DCCC).”

    But what does their party leadership have to offer women, Blacks and Hispanics in the way of employment, more affordable health care, housing or education and better pay? Where are the New Deal pro-labor, pro-regulatory roots of bygone days? The party leadership is unwilling to admit that Trump’s message about protecting jobs and opposing the TPP played a role in his election. Hillary was suspected of supporting it as “the gold standard” of trade deals, and Obama had made the Trans-Pacific Partnership the centerpiece of his presidency – the free-trade TPP and TTIP that would have taken economic regulatory policy out of the hands of government and given it to corporations.

    Instead of accepting even Sanders’ centrist-left stance, the Democrats’ strategy was to tar Trump as pro-Russian, insist that his aides had committed impeachable offenses, and mount one parade after another. “Rep. Marcia Fudge of Ohio told reporters she was wary of focusing solely on an “economic message” aimed at voters whom Trump won over in 2016, because, in her view, Trump did not win on an economic message. “What Donald Trump did was address them at a very different level — an emotional level, a racial level, a fear level,” she said. “If all we talk about is the economic message, we’re not going to win.” This stance led Sanders supporters to walk out of a meeting organized by the “centrist” Third Way think tank on Wednesday, February 8.

    By now this is an old story. Fifty years ago, socialists such as Michael Harrington asked why union members and progressives still imagined that they had to work through the Democratic Party. It has taken the rest of the country half a century to see that Democrats are not the party of the working class, unions, middle class, farmers or debtors. They are the party of Wall Street privatizers, bank deregulators, neocons and the military-industrial complex. Obama showed his hand – and that of his party – in his passionate attempt to ram through the corporatist TPP treaty that would have enabled corporations to sue governments for any costs imposed by public consumer protection, environmental protection or other protection of the population against financialized corporate monopolies.

    Against this backdrop, Trump’s promises and indeed his worldview seem quixotic. The picture of America’s future he has painted seems unattainable within the foreseeable future. It is too late to bring manufacturing back to the United States, because corporations already have shifted their supply nodes abroad, and too much U.S. infrastructure has been dismantled.

    There can’t be a high-speed railroad, because it would take more than four years to get the right-of-way and create a route without crossing gates or sharp curves. In any case, the role of railroads and other transportation has been to increase real estate prices along the routes. But in this case, real estate would be torn down – and having a high-speed rail does not increase land values.

    The stock market has soared to new heights, anticipating lower taxes on corporate profits and a deregulation of consumer, labor and environmental protection. Trump may end up as America’s Boris Yeltsin, protecting U.S. oligarchs (not that Hillary would have been different, merely cloaked in a more colorful identity rainbow). The U.S. economy is in for Shock Therapy. Voters should look to Greece to get a taste of the future in this scenario.

    Without a coherent response to neoliberalism, Trump’s billionaire cabinet may do to the United States what neoliberals in the Clinton administration did to Russia after 1991: tear out all the checks and balances, and turn public wealth over to insiders and oligarchs. So Trump’s his best chance to be transformative is simply to be America’s Yeltsin for his party’s oligarchic backers, putting the class war back in business.

    What a Truly Transformative President Would Do/Would Have Done

    No administration can create a sound U.S. recovery without dealing with the problem that caused the 2008 crisis in the first place: over-indebtedness. The only one way to restore growth, raise living standards and make the economy competitive again is a debt writedown. But that is not yet on the political horizon. Obama’s doublecross of his voters in 2009 prevented the needed policy from occurring. Having missed this chance in the last financial crisis, a progressive policy must await yet another crisis. But so far, no political party is preparing a program to juxtapose to Republican-Democratic austerity and scale-back of Social Security, Medicare and social spending programs in general.

    Also no longer on the horizon is a more progressive income tax, or a public option for health care – or for banking, or consumer protection against financial fraud, or for a $15-an-hour minimum wage, or for a revived protection of labor’s right to unionize, or environmental regulations.

    It seems that only a new party can achieve these aims. At the time these essays are going to press, Sanders has committed himself to working within the Democratic Party. But that stance is based on his assumption that somehow he can recruit enough activists to take over the party from Its Donor Class.

    I suspect he will fail. In any case, it is easier to begin afresh than to try to re-design a party (or any institution) dominated by resistance to change, and whose idea of economic growth is a pastiche of tax cuts and deregulation. Both U.S. parties are committed to this neoliberal program – and seek to blame foreign enemies for the fact that its effect is to continue squeezing living standards and bloating the financial sector.

    If this slow but inexorable crash does lead to a political crisis, it looks like the Republicans may succeed in convening a new Constitutional Convention (many states already have approved this) to lock the United States into a corporatist neoliberal world. Its slogan will be that of Margaret Thatcher: TINA – There Is No Alternative.

    And who is to disagree? As Trotsky said, fascism is the result of the failure of the left to provide an alternative.

  • Your Pension Will Be At The Center Of America's Next Financial Crisis

    Authored by Jeff Reeves via The Hill

    I’m not a fan of the “greed is good” mentality of Wall Street investment firms. But the next financial crisis that rocks America won’t be driven by bankers behaving badly. It will in fact be driven by pension funds that cannot pay out what they promised to retirees. According to one pension advocacy organization, nearly 1 million working and retired Americans are covered by pension plans at the risk of collapse.

    The looming pension crisis is not limited by geography or economic focus. These including former public employees, such as members of South Carolina’s government pension plan, which covers roughly 550,000 people — one out of nine state residents — and is a staggering $24.1 billion in the red. These include former blue collar workers such as roughly 100,000 coal miners who face serious cuts in pension payments and health coverage thanks to a nearly $6 billion shortfall in the plan for the United Mine Workers of America. And when the bill comes due, we will all be in very big trouble.

    It’s bad enough to consider the philosophical fallout here, with reneging on the promise of a pension and thus causing even more distrust of bankers and retirement planners. But I’m speaking about a cold, numbers-based perspective that causes a drag on many parts of the American economy. Consider the following.

    Pensioners have no flexibility

    According to a Bureau of Labor Statistics report from 2015, the average household income of someone older than age 75 is $34,097 and their average expenses exceed that slightly, at $34,382. It is not an exaggeration, then, to say that even a modest reduction in retirement income makes the typical budget of a 75-year-old unsustainable — even when the average budget is far from luxurious at current levels. This inflexibility is a hard financial reality of someone who is no longer able to work and is reliant on means other than labor to make ends meet.

    Social Security is in a tight spot

    So who will step up to support these former pensioners? Perhaps the government, via Social Security, except that program itself is in crisis and will see its trust fund go to zero just 17 years from now, in 2034, based on the current structure of the program. If millions of pensions go bust and retirees have no other savings to fall back on, it will be nigh impossible to cut benefits or reduce the drag on this program. But won’t a pension collapse mean we desperately need Social Security, even in an imperfect form, well beyond 2034?

    Pensions

     

    The guaranty is no solution

    There is an organization, the Pension Benefit Guaranty Corporation (PBGC), which is meant to insure pensions against failure. However, it was created in 1974 as part of a host of financial reforms and is far from a perfect solution, primarily because it is funded by premiums from defined-benefit plan sponsors and assets seized from former plan sponsors that have entered bankruptcy.

    What happens when a handful of troubled pension funds turns into dozens or hundreds? Remember, the PBGC guarantees a certain amount that is decidedly lower than your full pension — as members of the Road Carriers 707 pension fund learned when the group “protected” their pensions by helping to pay benefits, which had been reduced from $1,313 per month to $570. That’s better than zero, but hardly encouraging.

    This is not about helping Baby Boomers fund an annual cruise to the Caribbean. Older, low-income pensioners are not saving their money. Instead, they’re spending it on necessities such as food, housing, healthcare and transportation. That means every penny you reduce from their budget means a penny in spending that is removed from the U.S. economy.

    Anyone who has taken Econ 101 knows about the “multiplier effect” where $1 in extra spending can produce a much larger amount of economic activity as that dollar circulates around businesses, consumers and banks … or in this case, how $1 less in spending causes a an equally powerful cascade of negative consequences.

    By helping ward against a pension crisis, America will be protecting its economy for everyone — plain and simple. But that requires some tough decisions on all sides. For instance, the U.S. Treasury denied a cut to New York Teamsters’ pension plan that was proposed last year. But now the fund is on the brink of collapse, and its recipients are facing benefits that are in some cases one-third what they were 15 years ago.

    Like Social Security, current workers can’t contribute enough to offset the big obligations owed to retirees. And as with the flagship entitlement program, it’s up to regulators and legislators to step in — even when it may not be easy — in order to keep the system from collapsing. Let’s hope they make both pension reform and Social Security reform a priority in the near future.

  • On The Edge Of An "Uncontrollable Liquidity Event": The Definitive Guide To China's Financial System

    While most traders over the past month have been obsessing over developments in Washington, the real action – most of it under the radar – has played out in China, where as discussed over the past few weeks, domestic liquidity has tightened notably, culminating with an unexpected bailout by the PBOC of various smaller banks who defaulted on their interbank loans as interest rates, particularly on Certificates of Deposit (CD) – which have become a preferred funding conduit for many Chinese banks – but not only, spiked. Ironically, these mini PBOC bailouts took place only after the PBOC itself decided to tighten conditions sufficiently to choke off much of the shadow debt funding China’s traditional banks.

    As a result, the interbank CD rate rallied strongly, leaving a narrower or negative spread for some smaller banks, whose legacy carry trades (see below for details) suddenly became unprofitable. Also, as reported last Tuesday, several small banks failed to meet overnight repo obligations. This liquidity tightness has been mainly due to escalating financial deleveraging, as the PBOC has lifted market rates and rolled out stricter macroprudential policy rules.

    But all those events in isolation seem as merely noise against what otherwise appears to be a relatively benign, even boring, backdrop: after all, neither China’s stock, nor bond markets, has seen even remote volatility in recent months, and certainly nothing compared to what was experienced one year ago, when the Chinese turmoil nearly led to a bear market across developed markets. Then again, maybe the markets are simply once again behind the curve due to all the inherent complexity of China’s unprecedented, financialized and extremely complex pre-Minsky moment ponzi scheme.

    Last last week, Deutsche Bank analysts led by Hans Fan released what is the definitive research report summarizing all the latest troubling trends facing China, which judging by capital markets, nobody is paying any attention to. They should, because as Deutsche Bank puts it, if taken too far, they threaten an “uncontrollable liquidity event“, i.e., the financial cataclysm that Kyle Bass and other perma-china-bears have been waiting for.

    And, as usual, it all started with rising interest rates, which in turn is leading to increasing funding pressure, which if left unchecked, could lead to dire consequences for China’s underfunded banking system.

    Here is a fantastic explanation of everything that has happened in China in recent weeks, and more importantly, what may happen next, courtesy of Deutsche Bank. We urge readers to familiarize themselves with the content as we will refer back to this article in future posts.

    * * *

    Only in early stage of financial deleveraging

    China’s monetary policy has been shifting gradually towards a tightening stance since 2H16. Targeting the liabilities side of the banking sector, the PBOC hiked rates of monetary tools, such as MLF, SLF and OMO (Figure 1), and withdrew liquidity on a net basis after the Chinese New Year (Figure 2). At the same time, it targeted the asset side of the banking sector when it rolled out stricter MPA rules by including off-BS WMP credit in broader credit assessment and imposing stricter-than-expected penalties on banks that fail to comply.

    As a result, the key indicators in the money market, including repo and CD rates, all suggest stretched domestic liquidity. For example, the 7-day repo rate, which is the most representative liquidity indicator, has exceeded the interest rate corridor ceiling of 3.45% several times this year (Figure 3). Moreover, the interbank CD rate spiked to 4.6% on 20 Mar 2017, up c.180bps from last year’s low (Figure 4).

    We summarize in the below diagram recent financial deleveraging efforts by regulators.

     

    Why push forward financial deleveraging?

    We believe the PBOC aims mainly to contain the fast-growing leverage in China’s financial sector. In our view, the country’s financial leverage basically relates to speculators borrowing excessive wholesale funding to grow assets and chase yield, rather than relying on vanilla deposits. To measure this, we believe one of the good indicators of financial leverage is the credit-to-deposit ratio, calculated as total banking credit as a percentage of total deposits. The higher the ratio, the more fragile the financial sector, and the more likely the banking system will run into difficulties to finance unexpected funding requirements. Traditionally the loan-to-deposit ratio was widely used to measure system liquidity risk, but has become increasingly irrelevant in China, as banks are growing their bond investments and shadow banking books to extend credit.

    As shown in Figure 6, the credit-to-deposit ratio in China’s banking system has risen sharply by 27ppts since 2011 to reach 116% as of February 2017. We see the rising credit-to-deposit ratio basically is a function of increasing reliance on wholesale funding to support strong credit growth. As of end 2016, borrowing from banks and NBFIs accounted for 17% of total liabilities, against 8% 10 years ago (Figure 7).

    Which banks are more leveraged? Joint-stock banks and city/rural banks

    As we have long argued, the risks are not evenly distributed in China’s banking system; there are notable differences in the balance sheet structures of different types of banks. As shown in Figure 8, medium-sized banks, which mainly include joint-stock banks, recorded the highest credit-to-deposit ratios and hence are most reliant on wholesale funding. At the same time, small banks, which mainly include city/rural commercial banks, also delivered notable increases in credit-to-deposit ratios, despite a lower absolute level. The credit-to-deposit ratio for small banks has increased by 30ppts since 2010, vs. 14ppts for the big-four banks in the same period.

    On the liabilities side, medium-sized and small banks mainly rely on wholesale funding, i.e. borrowing from banks and NBFIs. As of 1H16, wholesale funding made up 31% and 23% for medium-sized and small banks, respectively, against only 13% for big-four banks, as shown in Figure 9.

    A closer look into interbank CDs – funding pressure ahead

    Wholesale funding for smaller banks has been obtained mainly by issuing CDs in the interbank market. Interbank CDs have supported 20% of smaller banks’ assets expansion over the past 12 months. Since the introduction of interbank CDs in 2014, CD issuance recorded strong growth and the balance jumped 89% yoy to Rmb7.3tr in Feb 2017 (Figure 10), or 3.4% of total banking liabilities.

    Joint-stock and city/rural banks account for 99% of issuance (Figure 12). In the coming months these banks have ambitious CD pipelines. More than 400 banks announced plans to issue CDs worth Rmb14.6tr in 2017. This represents 60% yoy growth from the issuance plan in 2016. Investor-wise, WMPs, various asset management plans and commercial banks themselves are the major buyers, which combined make up 79% of the total balance (Figure 13).

    However, we view banks that are more reliant on CDs as more vulnerable to rising rates and tighter regulations.

    Reflecting tighter liquidity, the interbank CD rate has rallied strongly, with the 6-month CD pricing at 4.6% on average. Some CDs issued by smaller rural commercial banks have been priced close to 5% recently. This would have pushed up the funding cost and notably for smaller banks. If banks invest in low-risk assets such as mortgages, discounted bills and treasury bonds, this would lead to a negative spread. Alternatively, banks can lengthen asset duration, increase the risk appetite, add leverage or slow down asset growth. Among these alternatives, we believe a slowdown in asset growth is the most likely.

    Caixin previously reported CDs are likely to be reclassified as interbank liabilities, capped at 33% of total liabilities. This potential regulation could add funding pressure for banks with a heavy reliance on interbank liabilities. With Rmb4tr interbank CDs to mature during Mar- Jun 2017 (Figure 16) and interbank liabilities exposure approaching the limit (Figure 17), joint-stock and city/rural banks are subject to notable funding pressure.

    We show the listed banks’ issuances in the chart below. INDB, SPDB and PAB are among the most exposed to interbank CDs.

    * * *

    What are the implications?

    Are we close to a “tipping point”?

    For now, probably not, especially in a year of leadership transition. In our view, the risk of an uncontrollable liquidity event is low, as the PBOC will do whatever it takes to inject liquidity if needed. In the domestic liquidity market, the PBOC exerts strong influence in both the volume and pricing of liquidity. With 90%+ of financial institutions directly or indirectly controlled by the government, PBOC will likely continue to give liquidity support. In 2H15, the central bank established an interest rate corridor to contain interbank rates within a narrow range and pledged to inject unlimited liquidity to support banks with funding needs.

    However, continuing liquidity injections do not come without a cost. A bigger asset bubble, persistent capital outflow pressure and a lower yield curve over the longer term are side effects that China will have to bear. At the same time, the execution risk of PBOC itself is rising.

    Implications on system credit growth

    We expect system credit growth to moderate from 16.4% yoy in 2016 (16.1% in Feb’17) to approximately 14-15% yoy in 2017 (Figure 23). As a result, the credit impulse is likely to trend lower from the current high level (Figure 24). The slower credit growth is mainly attributable to several factors: 1) a tighter liquidity stance to push up the funding cost of smaller banks and to force them to slow down asset growth; 2) further curbs on shadow banking; 3) a higher  bond yield to defer bond issuance; and 4) slower mortgage loan growth.

     

    Appendix A – Liquidity flows in China’s interbank market

    New deposits supported 55% of asset growth in China’s banking system in 2016. The remaining 45% of new assets were mainly funded by borrowing from PBOC (19%) and borrowing from each other (19%, including bond issuance). While borrowing from NBFIs remained flat for the entire system, it was the main funding source for medium-sized and small banks. We summarize the liquidity flows in China’s interbank market in Appendix A.

    Liquidity injection from PBOC. Over the past 12 months, to offset the liquidity drain from falling FX reserves, the PBOC has injected a huge amount of liquidity worth Rmb5.8tr into the banking system, which is equivalent to 400bps of RRR cuts (Figure 29). Of this injection, 30% and 24% have been made to support joint-stock banks and policy banks, respectively (Figure 30). For details, please see our report, PBOC liquidity facilities: Doing whatever it takes, 23 January 2017.

    Borrowing from interbank market. Policy banks and big-four banks are net interbank lenders, while joint-stock and city/rural commercial banks are net borrowers. Joint-stock and city/rural banks not only borrow from policy/big banks, but also from each other. This could potentially lead to stronger contagion effects if some of them run into liquidity stress.

    Lending/borrowing between banks and NBFIs. There has been a sharp rise in net claims to NBFIs from banks (Figure 33). We believe this is due to rising shadow banking transactions and also arbitrage activities with funds self-circulating within the financial sector. Clearly as shown in Figure 34, small banks are key lenders to NBFIs

    Appendix B – What is driving the financial leverage?

    From the accounting perspective, we believe the rising credit-to-deposit ratio is mainly due to bank credit circulating back into the banking system as non-deposit liabilities. In normal cases, when a bank makes a $100 corporate loan or purchases a $100 corporate bond, the bank books the credit to a corporate on the asset side while it also books a deposit on the liability side. We show a normal case in Figure 35. However, if a bank’s money circulates back into the banking system, just like in the two cases we illustrate in the diagram below, the $100 deposit is removed but interbank borrowing or borrowing from NBFIs would increase by $100. While there are likely to be many variants of bank credit circulation, we elaborate on two cases in detail.

    Case #1: Bank credit circling via NBFIs

    It is well known that NBFIs have been serving as SPVs to channel shadow banking credit from banks to corporates in past years. What is  insufficiently addressed though is that NBFIs also have been acting as channels for bank credit circling. Let us show a simple example below:

    • First, Bank A invests in an asset management plan packaged by an NBFI. This is booked as a receivable investment on Bank A’s balance sheet.
    • Second, the NBFI invests further in a CD issued by Bank B. Bank B books the CD under interbank borrowing. The money circulates back into the banking system and no deposit is generated.
    • In some cases, if the yield of the CD does not cover the cost of issuing the asset management plan, the NBFI will leverage up in the bond market by pledging the CD through repo transactions. The leverage could be built up by two transactions: 1) entrusted bond investment (“Daichi” in Chinese); or 2) entrusted investment (“Weiwai” in Chinese), which we discuss in detail in our 2017 outlook report.
    • In this case we use the investment in a bank’s CD as an example. In reality it applies to investment in interbank CDs, interbank negotiated deposits and financial bonds issued by banks, which are all circulating money back into the banking system.

    The bank credit circling through NBFIs is growing rapidly. This is evidenced by strong growth in banks’ receivable investments, which reached Rmb21tr as of end-2016 to account for 10% of commercial banking assets, as shown in Figure 36. This represents 80% CAGR in balance since 2013. The majority of these investments was made by medium-sized and small banks. Note that not all receivable investments are credit circling, but we believe it should make up a notable portion. We summarize the structure of banks’ receivable investments in Figure 38.

    The NBFI here could be any trust company, broker, fund subsidiary or insurance company. We believe brokers and fund subsidiaries should be the key players, as their bond trading leverage in the interbank bond market is much higher than other participants (Figure 37).

     

    Case #2: Bank credit circling via corporates

    Corporate loans may circle back into the banking system as well. This is because many corporates use borrowed but idle cash to buy bank WMPs. Below is a simple example:

    • Firstly, Bank A makes a loan to a corporate.
    • Secondly, the corporate uses the loan proceeds to buy a wealth management product issued by Bank A.
    • Thirdly, Bank A invests the WMP fund in a financial bond issued by Bank B. This corporate deposit would circle back to the banking system as a non-core liability.
    • To make this process economic, in many cases it would require leverage. The corporate borrowing cost may be at 4%, but the financial bond issued by Bank B may only yield 3.5%. To compensate the yield shortage, Bank A has to entrust the WMP fund to a third party and to leverage up by pledging the bonds through repo transactions. This process is called entrusted investment (“Weiwai” in Chinese, or entrusting to an external party).

    This type of transaction is not an individual case. As shown in Figure 39, corporates purchased Rmb7.7tr WMPs in 1H16. This accounted for 7% of total corporate debt in China, or 29% of total WMP AUM in the system. SOEs, large private corporate and listed companies enjoy ample bank lending resources with low interest cost. However, the lack of attractive investment projects in their own business prompts them to invest in the financial market (i.e. bank WMPs).

  • Visualizing The World's Deepest Oil Well

    In the world’s deepest gold mine, workers will venture 2.5 miles (4 km) below the Earth’s surface to extract from a 30-inch (0.8m) wide vein of gold-rich ore.

    While these depths are impressive, Visual Capitalist's Jeff Desjardins notes that mining is limited by the frailty of the human body. Going much deeper would be incredibly dangerous, as limitations such as heat, humidity, logistics, and potential seismic activity all become more intense.

    Luckily, the oil industry does not have such human obstacles, and drilling deep into the Earth’s crust is instead limited by a different set of circumstances – how deep can the machinery and technology go before the unfathomable heat and pressure renders it inoperable?

    THE WORLD’S DEEPEST OIL WELL

    Today’s infographic comes to us from Fuel Fighter, and it helps to visualize the mind-boggling depths of the world’s deepest oil well, which is located in a remote corner of eastern Russia.

    Courtesy of: Visual Capitalist

     

    The world’s deepest oil well, known as Z-44 Chayvo, goes over 40,000 ft (12 km) into the ground – equal to 15 Burj Khalifas (the tallest skyscraper) stacked on top of each other. That’s also equal to 2x the record height for air balloon flight.

    Perhaps more importantly to the operator, Exxon Neftegas Ltd., the wells on this shelf are expected to produce a total of 2.3 billion barrels of oil.

    THAT’S SOME SERIOUS DEPTH

    Before the Z-44 Chayvo Well and other holes like it were drilled on the eastern side of Russia, the famous Kola Superdeep Borehole held the record for drill depth.

    Located in western Russia, this time just 10 km from the border with Norway, the Kola Superdeep Borehole was rumored to have been discontinued in 1992 because it actually reached “hell” itself. At its most extreme depth, the drill had pierced a super-hot cavity, and scientists thought they heard the screams of “damned souls”.

    All folklore aside, the Kola Superdeep Borehole is super interesting in its own right. It revealed many important things about our planet, and it still holds the record today for depth below the surface.

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