- Lehman's Gift To Jeb Bush For Funneling Pension Money: A $1.3 Million Consulting "Job"
Submitted by Mike Krieger via Liberty Blitzkrieg blog,
At this point, it almost feels like kicking someone while he’s down. Jeb Bush can’t even stand up to Donald Trump, let alone his own growing series of scandals.
In the latest revelation from David Sirota and team at International Business Daily, we learn that:
For Florida taxpayers, the move by the administration of then-Gov. Jeb Bush to forge a relationship with Lehman Brothers would ultimately prove disastrous. Transactions in 2005 and 2006 put the Wall Street investment bank in charge of some $250 million worth of pension funds for Florida cops, teachers and firefighters. Lehman would capture more than $5 million in fees on these deals, while gaining additional contracts to manage another $1.2 billion of Florida’s money. Then, in the fall of 2008, Lehman collapsed into bankruptcy, leaving Florida facing up to $1 billion in losses.
But for Jeb Bush personally, his enduring relationship with Lehman would prove lucrative. In 2007, just as he left office, Bush secured a job as a Lehman consultant for $1.3 million a year, Bloomberg reported.
Next time, please just ride off into the sunset and paint landscapes with your brother.
Weeks after Bush took the Lehman job, the Florida State Board of Administration (SBA) — a three-member body that makes investment decisions about state pension funds and whose ranks had recently included one Jeb Bush — gave Lehman additional business: SBA purchased $842 million worth of separate investments in Lehman’s mortgage-backed securities. Over the course of one year from June 2007 to June 2008, the SBA would shift an additional $420 million of pension money into the same fund in which the state had begun investing under Bush.
In short, during Bush’s first year working for Lehman, his former colleagues in Tallahassee, the state capital, moved vast sums of Florida pension money into the doomed Wall Street investment bank, even as warnings about its financial troubles began to emerge.
“This is a breathtaking conflict of interest going on here,” said Craig Holman, governmental ethics lobbyist with Public Citizen, a good-government group. “This cost Florida very dearly, and it enriched Jeb Bush.”
Jeff Connaughton, author of the book “The Payoff: Why Wall Street Always Wins,” said the transactions illustrate a larger culture that dominates the politics of finance.
Florida originally began investing money in Lehman in 2005, while Bush was the highest profile member of the SBA, which oversees the $150 billion pension fund. The Bush-led SBA that year committed $176 million to Lehman; in 2006, as Florida moved another $87 million into the Lehman investment, the firm hired Jeb Bush’s cousin, George Herbert Walker, to run the firm’s investment management division.
The next year, Lehman offered the outgoing Florida governor the consulting job. Bush had worked briefly at a Texas-based bank after college, but he lacked significant Wall Street experience.
Fortunately for Jeb, being a crony doesn’t take any real skill.
Most of the investment losses that hit Florida starting in July 2007 were tied to the Lehman mortgage-backed securities bought the year Bush began his employment at the firm.
* * *
For related articles, see:
How Jeb Bush’s Recent Speech Bashing Lobbyists Was Organized by Lobbyists
A Message to the Peasants – Jeb Bush Says Americans Need to Work Longer Hours
Jeb Bush’s Deep Love Affair with Lobbyists and Cronyism While Governor of Florida Exposed
Jeb Bush Doubles Down on His Love Affair with the NSA in Recent Interview
An Oligarch Dilemma – Recent Poll Shows 42% of Republican Primary Voters Couldn’t Support Jeb Bush
Jeb Bush Exposed Part 1 – His Top Advisors Will Be the Architects of His Brother’s Iraq War
Jeb Bush Exposed Part 2 – He Thinks Unconstitutional NSA Spying is “Hugely Important”
- Economic Crisis Goes Mainstream – What Happens Next?
Submitted by Brandon Smith via Alt-Market.com,
Last year, when alternative economic analysts were warning that the commodities crush and oil crash just after the taper of QE3 were blaring signals for a downshift in all other financial indicators, the general response in the mainstream was that we were overreacting and paranoid and that the commodities jolt was temporary. Perhaps the fact needs repeating that it’s not paranoia if they are really out to get you.
Only a short time later, it is truly amazing how the rhetoric from the mainstream economic yes-men is changing. The blind analysts who were cheerleading for the nonexistent global recovery are now being carefully relegated to the janitor’s closet over at The New York Times, where Paul Krugman’s office should be. Media outlets are begrudgingly admitting to global instabilities like, for instance, a U.S. interest rate hike leading to a return to recession. (Special note to the mainstream media: Take away the fruitless manipulation of indicators through Fed stimulus, and we never left the recession.) They also are now forced to acknowledge that China’s market crash and yuan devaluation have far-reaching implications for global crisis, whereas a year ago the claim was that China’s problems would stay in China. Even China’s own media are now warning of the chain of fiscally interdependent economies and what the nation’s downturn means for everyone.
The MSM are finally entertaining the obvious notion that the vast financial problems of the EU have little to do with the crisis in Greece and more to do with crushing debt obligations and employment problems in primary nations like France and Italy.
And suddenly, pundits are once again concerned with Japan’s epidemic of mini-recessions and the truth of fiscal contraction that is not just a way of life, but an exponential dynamic that is getting worse fast, rather than staying static. This concern is, of course, always followed with suggestions that the light can be seen at the end of the tunnel and that growth will inevitably return. The mainstream media may be discussing points of reality, but that does not stop them at times from mixing in fairy tales.
This alteration in rhetoric from the mainstream may not necessarily be due to an awakening in the media. Rather, it may be due to the new narratives being put forth by core banking elite institutions like the International Monetary Fund and the Bank of International Settlements, institutions that have established a mission to appear competent in the wake of an economic crisis they KNOW is about to be triggered. The IMF is consistently making statements regarding potential disaster in global markets due to central banking stimulus measures (which it originally championed), as well as potential rate hikes, sending mixed messages to devout mainstream followers. The IMF’s latest overviews of global markets have been far gloomier than mainstream media outlets until recently. Suddenly, it would seem, the media has been given direction to parrot internationalist talking points.
The BIS warns that the world is currently defenseless against the next market crisis. I would point out that the BIS has a record of predicting economic crashes, including back in 2007 just before the derivatives and credit crisis began. This ability to foresee fiscal disasters is far more likely due to the fact that the BIS is the dominant force in global central banking and is the cause of crisis, rather than merely a predictor of crisis. That is to say, it is easy to predict disasters you yourself are about to initiate.
It is no mistake that the warnings from the BIS and the IMF tend to come too little too late, or that they are beginning to compose cautionary press releases today that sound much like what alternative analysts were saying a few years ago. The goal of these globalist organizations is not to help people prepare, only to set themselves up as Johnny-come-lately prognosticators so that after a collapse they can claim they warned us all, which can then be used as a rationalization for why they are the best people to administrate the economies of the planet as a whole.
So now that the mainstream is willing to report on clear economic dangers, what happens next?
The change in the MSM narrative is a bad sign. The initial media coverage of the derivatives implosion in 2008 did not become negative until we were well within the shadow of the avalanche. If the same holds true today, then a market event is imminent. Here are some of the issues you may hear more about as the year goes forward.
China ‘Contagion’
Forget about Greek contagion, we will be hearing far more about Chinese contagion over the next several months. The globalist run Carnegie Endowment for International Peace is already fielding the concept in their magazine 'Foreign Policy'. With the devaluation of the yuan, mainstream analysts are frantic over the possibility of currency wars, a concept they rarely ever entertained in the past. Yuan devaluation is not, though, necessarily a negative for China itself. In fact, the IMF in recent statements argues that China’s economy is entering a “new normal” of slower but more “stable” growth. The IMF also has announced that the recent shock of the falling yuan to global markets actually makes the currency MORE viable for inclusion in the Special Drawing Rights global currency basket, a decision that is supposed to be finalized by November (though a year long extension has been recommended by the IMF before approval).
Expect that economic news will be focused nonstop on China for the rest of the year, perhaps leading to the perpetuation of the false East/West paradigm and the idea that Americans should blame China for the overall financial crisis rather than the global bankers who engineered the mess. In the meantime, top globalists will continue to remain "neutral", presenting themselves as peacemakers and problem solvers arguing that the crash is "no one's fault", that over-complexity is the danger, and that interconnected economies must be simplified down to a single global currency and single global authority.
U.S. Economy Feeling Effects
The Federal Reserve push for a rate hike will likely be determined before 2015 is over. Talk of a September increase in interest rates may be a ploy, and a last-minute decision to delay could be on the table. This tactic of edge-of-the-seat meetings and surprise delays was used during the QE taper scenario, which threw a lot of analysts off their guard and caused many to believe that a taper would never happen. Well, it did happen, just as a rate hike will happen, only slightly later than mainstream analysts expect.
If a delay occurs, it will be short-lived, triggering a dead cat bounce in stocks, with rates increasing before December as dismal retail sales become undeniable leading into the Christmas season. It is important to remember that the Fed's job is to DERAIL the U.S. economy, NOT protect it.
In the meantime, the IMF’s SDR conference continues, with the inclusion of the yuan now widely considered a threat to the dollar’s world-reserve status. The mainstream media are now preparing the American people (or at least those who are paying any attention) for the coming loss of world-reserve status. The propaganda aims to paint the dollar’s reserve position as a bad thing. The MSM argue that loss of reserve status could actually help the U.S. economy get back on track and that a global harmonization of sovereign currencies will be a boost to our fiscal outlook. This is clearly an attempt to inoculate the public against any concern over the eventual crash of dollar value.
Oil Price Panic
Oil prices will continue to deflate, and the after-effects will be difficult to gauge. With John Kerry publicly warning that the failure of an Iran deal (including the lucrative oil export deals that would be included) could lead to the loss of the dollar’s world-reserve status, I am not very optimistic about the future prospects of energy markets.
Kerry claims that a failed Iran agreement would put the U.S. at odds with allies who brokered the deal, but this is not the whole story. What is really taking place is an attempt by Kerry to distract the public away from the real reasons for the future fall of the dollar, including the rise of the SDR and the likelihood that Saudi Arabia will soon decouple from the dollar as the solitary purchasing mechanism for their oil (Saudi Arabia is surprisingly one of the main supporters of an Iran deal). It is perhaps possible that a collapse of the Iran agreement could be used as an excuse for a loss of dollar reserve status that was going to happen anyway.
Events Moving Faster
Economic news is moving extremely fast this year, and it will only become more frenetic as we close in on 2016. The general consensus among alternative economic investigators seems to be that 2015 will be the year for trigger events and dead fantasies. In my six part series entitled 'One Last Look At The Real Economy Before It Implodes' I essentially agree with this timetable. If 2014 was the new 2007 with all its immediate warning signs, then 2015 is the new 2008 with all the chaos and broken paradigms.
- 10 Things Every Economist Should Know About The Gold Standard
Submitted by George Selgin via Alt-M.org,
At the risk of sounding like a broken record (well, OK–at the risk of continuing to sound like a broken record), I'd like to say a bit more about economists' tendency to get their monetary history wrong. In particular, I'd like to take aim at common myths about the gold standard.
If there's one monetary history topic that tends to get handled especially sloppily by monetary economists, not to mention other sorts, this is it. Sure, the gold standard was hardly perfect, and gold bugs themselves sometimes make silly claims about their favorite former monetary standard. But these things don't excuse the errors many economists commit in their eagerness to find fault with that "barbarous relic."
The false claims I have in mind are mostly ones I and others–notably Larry White–have countered before. Still I thought it would be useful to address them again here, because they're still far from being dead horses, and also so that students wrapping-up the semester will have something convenient to send to their misinformed gold-bashing profs (though I urge them to wait until grades are in before sharing!).
For the sake of those who don't care to wade through the whole post, here is a "jump to" list of the points covered:
1. The Gold Standard wasn't an instance of government price fixing. Not traditionally, anyway.
2. A gold standard isn't particularly expensive. In fact, fiat money tends to cost more.
3. Gold supply "shocks" weren't particularly shocking.
4. The deflation that the gold standard permitted wasn't such a bad thing.
5. It wasn't to blame for 19th-century American financial crises.
6. On the whole, the classical gold standard worked remarkably well (while it lasted).
7. It didn't have to be "managed" by central bankers.
8. In fact, central banking tends to throw a wrench in the works.
9. "The" Gold Standard wasn't to blame for the Great Depression.
10. It didn't manage money according to any economists' theoretical ideal. But neither has any fiat-money-issuing central bank.1. The Gold Standard wasn't an instance of government price fixing. Not traditionally, anyway.
As Larry White has made the essential point as well as I ever could, I hope I may be excused for quoting him at length:
Barry Eichengreen writes that countries using gold as money 'fix its price in domestic-currency terms (in the U.S. case, in dollars).' He finds this perplexing:
But the idea that government should legislate the price of a particular commodity, be it gold, milk or gasoline, sits uneasily with conservative Republicanism’s commitment to letting market forces work, much less with Tea Party–esque libertarianism. Surely a believer in the free market would argue that if there is an increase in the demand for gold, whatever the reason, then the price should be allowed to rise, giving the gold-mining industry an incentive to produce more, eventually bringing that price back down. Thus, the notion that the U.S. government should peg the price, as in gold standards past, is curious at the least.
To describe a gold standard as "fixing" gold’s "price" in terms of a distinct good, domestic currency, is to get off on the wrong foot. A gold standard means that a standard mass of gold (so many grams or ounces of pure or standard-alloy gold) defines the domestic currency unit. The currency unit (“dollar”) is nothing other than a unit of gold, not a separate good with a potentially fluctuating market price against gold. That one dollar, defined as so many grams of gold, continues be worth the specified amount of gold—or in other words that one unit of gold continues to be worth one unit of gold—does not involve the pegging of any relative price. Domestic currency notes (and checking account balances) are denominated in and redeemable for gold, not priced in gold. They don’t have a price in gold any more than checking account balances in our current system, denominated in fiat dollars, have a price in fiat dollars. Presumably Eichengreen does not find it curious or objectionable that his bank maintains a fixed dollar-for-dollar redemption rate, cash for checking balances, at his ATM.
Remarkably, as White goes on to show, the rest of Eichengreen's statement proves that, besides not having understood the meaning of gold's "fixed" dollar price, Eichengreen has an uncertain grasp of the rudimentary economics of gold production:
As to what a believer in the free market would argue, surely Eichengreen understands that if there is an increase in the demand for gold under a gold standard, whatever the reason, then the relative price of gold (the purchasing power per unit of gold over other goods and services) will in fact rise, that this rise will in fact give the gold-mining industry an incentive to produce more, and that the increase in gold output will in fact eventually bring the relative price back down.
I've said more than once that, the more vehement an economist's criticisms of the gold standard, the more likely he or she knows little about it. Of course Eichengreen knows far more about the gold standard than most economists, and is far from being its harshest critic, so he'd undoubtedly be an outlier in the simple regression, y = ? + ?(x) (where y is vehemence of criticism of the gold standard and x is ignorance of the subject). Nevertheless, his statement shows that even the understanding of one of the gold standard's most well-known critics leaves much to be desired.
Although, at bottom, the gold standard isn't a matter of government "fixing" gold's price in terms of paper money, it is true that governments' creation of monopoly banks of issue, and the consequent tendency for such monopolies to be treated as government- or quasi-government authorities, ultimately led to their being granted sovereign immunity from the legal consequences to which ordinary, private intermediaries are usually subject when they dishonor their promises. Because a modern central bank can renege on its promises with impunity, a gold standard administered by such a bank more closely resembles a price-fixing scheme than one administered by a commercial bank. Still, economists should be careful to distinguish the special features of a traditional gold standard from those of central-bank administered fixed exchange rate schemes.
2. A gold standard isn't particularly expensive. In fact, fiat money tends to cost more.
Back in the early 1950s, and again in 1960, Milton Friedman estimated that the gold required for the U.S. to have a "real" gold standard would have cost 2.5% of its annual GNP. But that's because Friedman's idea of a "real" gold standard was one in which gold coins alone served as money, with no fractionally-backed bank-supplied substitutes. As Larry White shows in his Theory of Monetary Institutions (p. 47) allowing for 2% specie reserves–which is more than what some former gold-based free-banking systems needed–the resource cost of a gold standard taking advantage of fractionally-backed banknotes and deposits would be about one-fiftieth of the number Friedman came up with. That's a helluva bargain for a gold "seal of approval" that could mean having access to international capital at substantially reduced rates, according to research by Mike Bordo and Hugh Rockoff.
Friedman himself eventually changed his mind about the economies to be achieved by employing fiat money:
Monetary economists have generally treated irredeemable paper money as involving negligible real resource costs compared with a commodity currency. To judge from recent experience, that view is clearly false as a result of the decline in long-term price predictability.
I took it for granted that the real resource cost of producing irredeemable paper money was negligible, consisting only of the cost of paper and printing. Experience under a universal irredeemable paper money standard makes it crystal clear that such an assumption, while it may be correct with respect to the direct cost to the government of issuing fiat outside money, is false for society as a whole and is likely to remain so unless and until a monetary structure emerges under an irredeemable paper standard that provides a high degree of long-run price level predictability.*
Unfortunately, neither White's criticism of Friedman's early calculations nor Friedman's own about-face have kept gold standard critics from repeating the old canard that a fiat standard is more economical than a gold standard. Ross Starr, for example, observes in his 2013 book on money that "The use of paper or fiduciary money instead of commodity money is resource saving, allowing commodity inventories to be liquidated." Although he understands that fractionally-backed banknotes and deposits may go some way toward economizing on commodity-money reserves, Starr (quoting Adam Smith, but failing to look up historic Scottish bank reserve ratios) insists nonetheless that "a significant quantity of the commodity backing must be maintained in inventory to successfully back the currency," and then proceeds to build a case for fiat money from this unwarranted assertion:
The next step in economizing on the capital tied up in backing the currency is to use a fiat money. Substituting a government decree for commodity backing frees up a significant fraction of the economy's capital stock for productive use. No longer must the economy hold gold, silver, or other commodities in inventory to back the currency. No longer must additional labor and capital be used to extract them from the earth. Those resources are freed up and a simple virtually costless government decree is substituted for them.
Tempting as it is to respond to such hooey simply by noting that the vaults of the world's official fiat-money managing institutions presently contain rather more than zero ounces of gold–31,957.5 metric tons more, to be precise–that response only hints at the fundamental flaw in Starr's reasoning, which is his treatment of fiat money as a culmination, or limiting case, of the resource savings to be had by resort to fractional commodity-money reserves. That treatment overlooks a crucial difference between fiat money and readily redeemable banknotes and deposits, for whereas redeemable banknotes and deposits are generally understood by their users to be close, if not perfect, substitutes for commodity money, fiat money, the purchasing power of which is unhinged from that of any former money commodity, is nothing of the sort. On the contrary: its tendency to depreciate relative to real commodities, and to gold in particular, is notorious. Consequently holders of fiat money have reason to hold "commodity inventories" as a hedge against the risk that fiat money will depreciate.
If the hedge demand for a former money commodity is large enough, resort to fiat money doesn't save any resources at all. Indeed, as Roger Garrison notes, "a paper standard administered by an irresponsible monetary authority may drive the monetary value of gold so high that more resource costs are incurred under the paper standard than would have been incurred under a gold standard." A glance at the history of gold's real price suffices to show that this is precisely what has happened:
From "After the Gold Rush," The Economist, July 6, 2010.Taking the long-run average price of gold, in 2010 prices, to be somewhere around $470, prior to the closing of the gold window in 1971, that price was exceeded on only three occasions, and never dramatically: around the time of the California gold rush, around the turn of the 20th century, and for several years following FDR's devaluation of the dollar. Since 1971, in contrast, it has exceeded that average, and exceeded it substantially, more often than not. Here is Roger Garrison again:
There is a certain asymmetry in the cost comparison that turns the resource-cost argument against paper standards. When an irresponsible monetary authority begins to overissue paper money, market participants begin to hoard gold, which stimulates the gold-mining industry and drives up the resource costs. But when new discoveries of gold are made, market participants do not begin to hoard paper or to set up printing presses for the issue of unbacked currency. Gold is a good substitute for an officially instituted paper money, but paper is not a good substitute for an officially recognized metallic money. Because of this asymmetry, the resource costs incurred by the State in its efforts to impose a paper standard on the economy and manage the supply of paper money could be avoided if the State would simply recognize gold as money. These costs, then, can be counted against the paper standard.
So if it's avoidance of gold resource costs that's desired, including avoidance of the very real environmental consequences of gold mining, a gold standard looks like the right way to go.
3. Gold supply "shocks" weren't particularly shocking
Of the many misinformed criticisms of the gold standard, none seems to me more wrong-headed than the complaint that the gold standard isn't even a reliable guarantee against serious inflation. The RationalWiki entry on the gold standard is as good an example of this as any:
Even gold can suffer problems with inflation. Gold rushes such as the California Gold Rush expanded the money supply and, when not matched with a simultaneous increase in economic output, caused inflation. The "Price Revolution" of the 16th century demonstrates a case of dramatic long-run inflation. During this period, western European nations used a bimetallic standard (gold and silver). The Price Revolution was the result of a huge influx of silver from central European mines starting during the late 15th century combined with a flood of new bullion from the Spanish treasure fleets and the demographic shift brought about by the Black Plague (i.e., depopulation).
Admittedly the anonymous authors of this article may not be professional economists; but take my word for it that the same arguments might be heard from any number of such professionals. Brad DeLong, for example, in a list of "Talking Points on the Likely Consequences of re-establishment of the Gold Standard" (my emphasis), includes observation that "significant advances in gold mining technology could provide a significant boost to the average rate of inflation over decades."
Like I said, the gold standard is hardly free of defects. But being vulnerable to bouts of serious inflation isn't one of them. Consider the "dramatic" 16th century inflation referred to in the RationalWiki entry. Had that entries' authors referred to plain-old Wikipedia's entry on "Price revolution," they would have read there that
Prices rose on average roughly sixfold over 150 years. This level of inflation amounts to 1-1.5% per year, a relatively low inflation rate for the 20th century standards, but rather high given the monetary policy in place in the 16th century.
I have no idea what the authors mean by their second statement, as there was certainly no such thing as "monetary policy" at the time, and they offer no further explanation or citation. So far as I can tell, they mean nothing more than that prices hadn't been rising as fast before the price revolution than they did during it, which though trivially true says nothing about how "high" the inflation was by any standards, including those of the 16th century. In any case it was not only "not high" but dangerously low according to standards set, rightly or wrongly, by today's monetary experts. Finally, though the point is often overlooked, the European Price Revolution actually began well in advance of major American specie shipments, which means that, far from being attributable to such shipments alone, it was a result of several causes, including coin debasements.
What about the California Gold rush, which is also supposed to show how changes in the supply of gold will lead to inflation "when not matched with a simultaneous increase in economic output"? To judge from available statistics, it appears that producers of other goods were almost a match for all those indefatigable forty-niners: as Larry White reports, although the U.S. GDP deflator did rise a bit in the years following the gold rush,
The magnitude was surprisingly small. Even over the most inflationary interval, the [GDP deflator] rose from 5.71 in 1849 (year 2000 = 100) to 6.42 in 1857, an increase of 12.4 percent spread over eight years. The compound annual price inflation rate over those eight years was slightly less than 1.5 percent.
Once again, the inflation rate was such as would have had today's central banks rushing to expand their balance sheets.
Nor do the CPI estimates tell a different story. See if you can spot the gold-rush-induced inflation in this chart:
*Graphing Various Historical Economic Series," MeasuringWorth, 2015.Despite popular beliefs, the California gold rush was actually not the biggest 19th-century gold supply innovation, at least to judge from its bearing on the course of prices. That honor belongs instead to the Witwatersrand gold rush of 1886, the effects of which later combined with those of the Klondike rush of 1896 to end a long interval of gradual deflation (discussed further below) and begin one of gradual inflation.
Brad DeLong is thus quite right to refer to the South African discoveries in observing that even a gold standard poses some risk of inflation:
For example, the discovery and exploitation of large gold reserves near present-day Johannesburg at the end of the nineteenth century was responsible for a four percentage point per year shift in the worldwide rate of inflation–from a deflation of roughly two percent per year before 1896 to an inflation of roughly two percent per year after 1896.
Allowing for the general inaccuracy of 19th-century CPI estimates, DeLong's statistics are correct. But that "For example" is quite misleading. Like I said: this is the most serious instance of an inflationary gold "supply shock" of which I'm aware. Yet even it served mainly to put an end to a deflationary trend, without ever giving rise to an inflation rate substantially above what central banks today consider (rightly or wrongly) optimal. As for the four percentage point change in the rate of inflation "per year," presumably meaning "in one year," it's hardly remarkable: changes as big or larger are common throughout the 19th century, partly owing to the notoriously limited data on which CPI estimates for that era are based. Even so, they can't be compared to the much larger jumps in inflation with which the history of fiat monies is riddled, even setting hyperinflations aside. Keep this in mind as you reflect upon Brad's conclusion that
Under the gold standard, the average rate of inflation or deflation over decades ceases to be under the control of the government or the central bank, and becomes the result of the balance between growing world production and the pace of gold mining.
Alas, keeping matters in perspective–that is, comparing the gold standard's actual inflation record, not to that which might be achieved by means of an ideally-managed fiat money, but to the actual inflation record of historic fiat-money systems, is something many critics of the gold standard seem reluctant to do, perhaps for good reason.
While we're on the subject, nothing could be more absurd than attempts to demonstrate the unsuitability of gold as a monetary medium by referring to gold's unstable real value in the years since the gold standard was abandoned. Yet this is a favorite debating point among the gold standard's less thoughtful critics, including Paul Krugman:
There is a remarkably widespread view that at least gold has had stable purchasing power. But nothing could be further from the truth. Here’s the real price of gold — the price deflated by the consumer price index — since 1968:
Compare Professor Krugman's chart to the one in the previous section. Then ask yourself (1) Has gold's price behaved differently since 1968 than it did before?; and (2) Why might this be so? If your answers are "Yes" and "Because gold and paper dollars are no longer close substitutes, and gold is now widely used to hedge against depreciation of the dollar and other fiat currencies," you understand the gold standard better than Krugman does. But don't get a swelled head over it, because it really isn't saying much: Krugman is one of the observations that sits squarely on the upper right end of y = ? + ?(x).
4. The deflation that the gold standard permitted wasn't such a bad thing.
The complaint that a gold standard doesn't rule out inflation is but a footnote to the more frequent complaint that it suffers, in Brad DeLong's words, from "a deflationary bias which makes it likely that a gold standard regime will see a higher average unemployment rate than an alternative managed regime." According to Ben Bernanke "There is…a high correlation in the data between deflation (falling prices) and depression (falling output)."
That the gold standard tended to be deflationary–or that it tended to be so for sometimes long intervals between gold discoveries–can't be denied. But what certainly can be denied is that these periods of slow deflation went hand-in-hand with high unemployment. Having thoroughly reviewed the empirical record, Andrew Atkeson and Patrick Kehoe conclude as follows:
Deflation and depression do seem to have been linked during the1930s. But in the rest of the data for 17 countries and more than 100 years, there is virtually no evidence of such a link.
More recently Claudio Borio and several of his BIS colleagues reported similar findings. How then (you may wonder), did Bernanke arrive at his opposite conclusion? Easy: he looked only at data for the 1930s–the worst deflationary crisis ever–ignoring all the rest.
Why is deflation sometimes depressing, and sometimes not? The simple answer is that there is more than one sort of deflation. There's the sort that's caused by a collapse of spending, like the "Great Contraction" of the 1930s, and then there's the sort that's driven by greater output of real goods and services–that is, by outward shifts in aggregate supply rather than inward shifts in aggregate demand. Most of the deflation that occurred during the classical gold standard era (1873-1914) was of the latter, "good" sort.
Although I've been banging the drum for good deflation since the 1990s, and Mike Bordo and others have made the specific point that the gold standard mostly involved deflation of the good rather than bad sort, too many economists, and way too many of those who have got more than their fare share of the public's attention, continue to ignore the very possibility of supply-driven deflation.
Of the many misunderstandings propagated by economists' tendency to assume that deflation and depression must go hand-in-hand, none has been more pernicious than the widespread belief that throughout the U.S. and Europe, the entire period from 1873 to 1896 constituted one "Great" or "Long Depression ." That belief is now largely discredited, except perhaps among some newspaper pundits and die-hard Marxists, thanks to the efforts of G.B. Saul and others. The myth of a somewhat shorter "Long Depression," lasting from 1873-1879, persists, however, though economic historians have begun chipping away at that one as well.
5. It wasn't to blame for 19th-century American financial crises.
Speaking of 1873, after claiming that a gold standard is undesirable because it makes deflation (and therefore, according to his reasoning, depression) more likely, Krugman observes:
The gold bugs will no doubt reply that under a gold standard big bubbles couldn’t happen, and therefore there wouldn’t be major financial crises. And it’s true: under the gold standard America had no major financial panics other than in 1873, 1884, 1890, 1893, 1907, 1930, 1931, 1932, and 1933. Oh, wait.
Let me see if I understand this. If financial crises happen under base-money regime X, then that regime must be the cause of the crises, and is therefore best avoided. So if crises happen under a fiat money regime, I guess we'd better stay away from fiat money. Oh, wait.
You get the point: while the nature of an economy's monetary standard may have some bearing on the frequency of its financial crises, it hardly follows that that frequency depends mainly on its monetary standard rather than on other factors, like the structure, industrial and regulatory, of the financial system.
That U.S. financial crises during the gold standard era had more to do with U.S. financial regulations than with the workings of the gold standard itself is recognized by all competent financial historians. The lack of branch banking made U.S. banks uniquely vulnerable to shocks, while Civil-War rules linked the supply of banknotes to the extent of the Federal government's indebtedness., instead of allowing that supply to adjust with seasonal and cyclical needs. But there's no need to delve into the precise ways in which such misguided legal restrictions to the umerous crises to which Krugman refers. It should suffice to point out that Canada, which employed the very same gold dollar, depended heavily on exports to the U.S., and (owing to its much smaller size) was far less diversified, endured no banking crises at all, and very few bank failures, between 1870 and 1939.
6. 0n the whole, the classical gold standard worked remarkably well (while it lasted).
Since Keynes's reference to gold as a "barbarous relic" is so often quoted by the gold standard's critics, it seems only fair to repeat what Keynes had to say, a few years before, not about gold per se, itself, but about the gold-standard era:
What an extraordinary episode in the economic progress of man that age was which came to an end in August, 1914! The greater part of the population, it is true, worked hard and lived at a low standard of comfort, yet were, to all appearances, reasonably contented with this lot. But escape was possible, for any man of capacity or character at all exceeding the average, into the middle and upper classes, for whom life offered, at a low cost and with the least trouble, conveniences, comforts, and amenities beyond the compass of the richest and most powerful monarchs of other ages. The inhabitant of London could order by telephone, sipping his morning tea in bed, the various products of the whole earth, in such quantity as he might see fit, and reasonably expect their early delivery upon his doorstep; he could at the same moment and by the same means adventure his wealth in the natural resources and new enterprises of any quarter of the world, and share, without exertion or even trouble, in their prospective fruits and advantages… He could secure forthwith, if he wished it, cheap and comfortable means of transit to any country or climate without passport or other formality, could despatch his servant to the neighboring office of a bank or such supply of the precious metals as might seem convenient, and could then proceed abroad to foreign quarters, without knowledge of their religion, language, or customs, bearing coined wealth upon his person, and would consider himself greatly aggrieved and much surprised at the least interference. But, most important of all, he regarded this state of affairs as normal, certain, and permanent, except in the direction of further improvement, and any deviation from it as aberrant, scandalous, and avoidable.
It would, of course, be foolish to suggest that the gold standard was entirely or even largely responsible for this Arcadia, such as it was. But it certainly did contribute both to the general abundance of goods of all sorts, to the ease with which goods and capital flowed from nation to nation, and, especially, to the sense of a state of affairs that was "normal, certain, and permanent."
The gold standard achieved these things mainly by securing a degree of price-level and exchange rate stability and predictability that has never been matched since. According to Finn Kydland and Mark Wynne:
The contrast between the price stability that prevailed in most countries under the gold standard and the instability under fiat standards is striking. This reflects the fact that under commodity standards (such as the gold standard), increases in the price level (which were frequently associated with wars) tended to be reversed, resulting in a price level that was stable over long periods. No such tendency is apparent under the fiat standards that most countries have followed since the breakdown of the gold standard between World War I and World War II.
The high degree of price level predictability, together with the system of fixed exchange rates that was incidental to the gold standard's widespread adoption, substantially reduced the riskiness of both production and international trade, while the commitment to maintain the standard resulted, as I noted, in considerably lower international borrowing costs.
Those pundits who find it easy to say "good riddance" to the gold standard, in either its classical or its decadent variants, need to ask themselves what all the fuss over monetary "reconstruction" was about, following each of the world wars, if not achieving a simulacrum at least of the stability that the classical gold standard achieved. True, those efforts all failed. But that hardly means that the ends sought weren't very worthwhile ones, or that those who sought them were "lulled by the myth of a golden age." Though they may have entertained wrong beliefs concerning how the old system worked, they weren't wrong in believing that it did work, somehow.
7. It didn't have to be managed by central bankers.
But how? The once common view that the classical gold standard worked well only thanks to its having been carefully managed by the Bank of England and other central banks, as well as the related view that its success depended on international agreements and other forms of central bank cooperation, is now, thankfully, no longer subscribed to even by the gold-standard's more well-informed critics. Instead, as Julio Gallarotti observes, the outcomes of that standard "were primarily the resultants [sic] of private transactions in the markets for goods and money" rather than of any sort of government or central-bank management or intervention. But the now accepted view doesn't quite go far enough. In fact, central banks played no essential part at all in achieving the gold standard's most desirable outcomes, which could have been achieved as well, or better, by systems of competing banks-of-issue, and which were in fact achieved by means of such systems in many participating nations, including the United States, Switzerland (until 1901), and Canada. And although it is common for central banking advocates to portray such banks as sources of emergency liquidity to private banks, during the classical gold standard era liquidity assistance often flowed the other way, and did so notwithstanding monopoly privileges that gave central banks so many advantages over their commercial counterparts. As Gallarotti observes (p. 81),
That central banks sometimes went to other central banks instead of the private market suggests nothing more than the fact that the rates offered by central banks were better, or too great an amount of liquidity may have been needed to be covered in the private market.
8. In fact, central banking tends to throw a wrench in the works.
To the extent that central banks did exercise any special influence on gold-standard era monetary adjustments, that influence, instead of helping, made things worse. Because an expanding central bank isn't subject to the internal constraint of reserve losses stemming from adverse interbank clearings, it can create an external imbalance that must eventually trigger a disruptive drain of specie reserves. During liquidity crunches, on the other hand, central banks were more likely than commercial banks to become, in Jacob Viner's words, "engaged in competitive increases of their discount rates and in raid's on each other's reserves." Finally, central banks could and did muck-up the gold standard works by sterilizing gold inflows and outflows, violating the "rules of the gold standard game" that called for loosening in response to gold receipts and tightening in response to gold losses.
Competing banks of issue could be expected to play by these "rules," because doing so was consistent with profit maximization. The semi-public status of central banks, on the other hand, confronted them with a sort of dual mandate, in which profits had to be weighed against other, "public" responsibilities (ibid., pp. 117ff.). Of the latter, the most pernicious was the perceived obligation to occasionally set aside the requirements for preserving international monetary equilibrium ("external balance") for the sake of preserving or achieving preferred domestic monetary conditions ("internal balance"). As Barry Ickes observes, playing by the gold standards rules could be "very unpopular, potentially, as it involves sacrificing internal balance for external balance." Commercial bankers couldn't care less. Central bankers, on the other hand, had to care when to not care was to risk losing some of their privileges.
Today, of course, achieving internal balance is generally considered the sine qua non of sound central bank practice; and even where fixed or at least stable exchange rates are considered desirable it is taken for granted that external balance ought occasionally to be sacrificed for the sake of preserving domestic monetary stability. But to apply such thinking to the classical gold standard, and thereby conclude that in that context a similar sacrifice of external for internal stability represented a turn toward more enlightened monetary policy, is to badly misunderstand the nature of that arrangement, which was not just a fixed exchange rate arrangement but something more akin to an multinational monetary union or currency area. Within such an area, the fact that one central bank gains reserves while another looses them was itself no more significant, and no more a justification for violating the "rules of the game," than the fact that a commercial bank somewhere gained reserves at the expense of another.
The presence of central banks did, however, tend to aggravate the disturbing effects of changes in international trade patterns compared to the case of international free banking. Central-bank sterilization of gold flows could, on the other hand, lead to more severe longer-run adjustments, as it was to do, to a far more dramatic extent, in the interwar period.
9. "The "Gold Standard" wasn't to blame for the Great Depression.
I know I'm about to skate onto thin ice, so let me be more precise. To say that "The gold standard caused the Great Depression " (or words to that effect, like "the gold standard was itself the principal threat to financial stability and economic prosperity between the wars”), is at best extremely misleading. The more accurate claim is that the Great Depression was triggered by the collapse of the jury-rigged version of the gold standard cobbled together after World War I, which was really a hodge-podge of genuine, gold-exchange, and gold-bullion versions of the gold standard, the last two of which were supposed to "economize" on gold. Call it "gold standard light."
Admittedly there is one sense in which the real gold standard can be said to have contributed to the disastrous shenanigans of the 1920s, and hence to the depression that followed. It contributed by failing to survive the outbreak of World War I. The prewar gold standard thus played the part of Humpty Dumpty to the King's and Queen's men who were to piece the still-more-fragile postwar arrangement together. Yet even this is being a bit unfair to gold, for the fragility of the gold standard on the eve of World War I was itself largely due to the fact that, in most of the belligerent nations, it had come to be administered by central banks that were all-too easily dragooned by their sponsoring governments into serving as instruments of wartime inflationary finance.
Kydland and Wynne offer the case of the Bank of Sweden as illustrating the practical impossibility of preserving a gold standard in the face of a major shock:
During the period in which Sweden adhered to the gold standard (1873–1914), the Swedish constitution guaranteed the convertibility into gold of banknotes issued by the Bank of Sweden. Furthermore, laws pertaining to the gold standard could only be changed by two identical decisions of the Swedish Parliament, with an election in between. Nevertheless, when World War I broke out, the Bank of Sweden unilaterally decided to make its notes inconvertible. The constitutionality of this step was never challenged, thus ending the gold standard era in Sweden.
The episode seems rather less surprising, however, when one considers that "the Bank of Sweden," which secured a monopoly of Swedish paper currency in 1901, is more accurately known as the Sveriges Riksbank, or "Bank of the Swedish Parliament."
If the world crisis of the 1930s was triggered by the failure, not of the classical gold standard, but of a hybrid arrangement, can it not be said that the U.S. , which was among the few nations that retained a full-fledged gold standard, was fated by that decision to suffer a particularly severe downturn? According to Brad DeLong,
Commitment to the gold standard prevented Federal Reserve action to expand the money supply in 1930 and 1931–and forced President Hoover into destructive attempts at budget-balancing in order to avoid a gold standard-generated run on the dollar.
It's true that Hoover tried to balance the Federal budget, and that his attempt to do so had all sorts of unfortunate consequences. But the gold standard, far from forcing his hand, had little to do with it. Hoover simply subscribed to the prevailing orthodoxy favoring a balanced budget. So, for that matter, did FDR, until events forced him too change his tune: during the 1932 presidential campaign the New-Dealer-to-be assailed his opponent both for running a deficit and for his government's excessive spending.
As for the gold standard's having prevented the Fed from expanding the money supply (or, more precisely, from expanding the monetary base to keep the broader money supply from shrinking), nothing could be further from the truth. Dick Timberlake sets the record straight:
By August 1931, Fed gold had reached $3.5 billion (from $3.1 billion in 1929), an amount that was 81 percent of outstanding Fed monetary obligations and more than double the reserves required by the Federal Reserve Act. Even in March 1933 at the nadir of the monetary contraction, Federal Reserve Banks had more than $1 billion of excess gold reserves.
Moreover,
Whether Fed Banks had excess gold reserves or not, all of the Fed Banks’ gold holdings were expendable in a crisis. The Federal Reserve Board had statutory authority to suspend all gold reserve requirements for Fed Banks for an indefinite period.
Nor, according to a statistical study by Chang-Tai Hsieh and Christina Romer, did the Fed have reason to fear that by allowing its reserves to decline it would have raised fears of a devaluation. On the contrary: by taking steps to avoid a monetary contraction, the Fed would have helped to allay fears of a devaluation, while, in Timberlake's words, initiating a "spending dynamic" that would have helped to restore "all the monetary vitals both in the United States and the rest of the world."
10. It didn't manage money according to any economists' theoretical ideal. But neither has any fiat-money-issuing central bank.
Just as "paper" always beats "rock" in the rock-paper-scissors game, so does managed paper money always beat gold in the rock-paper monetary standards game economists like to play. But that's only because under a fiat standard any pattern of money supply adjustment is possible, including a "perfect" pattern, where "perfect" means perfect according to the player's own understanding. Even under the best of circumstances a gold standard is, on the other hand, unlikely to achieve any economist's ideal of monetary perfection. Hence, paper beats rock. More precisely, paper beats rock, on paper.
And what does this impeccable logic tell us concerning the relative merits of gold versus paper money in practice? Diddly-squat. I mean it. To say something about the relative merits of paper and gold, you have to have theories–good ol' fashioned, rational optimizing firm and agent theories–of how the supply of basic money adjusts under various conditions in the two sorts of monetary regimes. We have a pretty good theory of the gold standard, meaning one that meshes well with how that standard actually worked. The theory of fiat money is, in contrast, a joke, in part because it's much harder to pin-down central bankers' objectives (or any objectives apart from profit-maximization, which is at play in the case of gold), but mostly thanks to economists' tendency to simply assume that central bankers behave like omniscient angels who, among other things, understand the finer points of DSGE models. That may do for a graduate class, or a paper in the AER. But good economics it most certainly isn't.
* * *
I close with a few words concerning why it matters that we get the facts straight about the gold standard. It isn't simply a matter of winning people over to that standard. Though I'm perhaps as ready as anyone to shed a tear for the old gold standard, I doubt that we can ever again create anything like it. But getting a proper grip on gold serves, not just to make the gold standard seem less unattractive than it is often portrayed to be, but to remove some of the sheen that has been applied to modern fiat-money arrangements using the same brush by which gold has been blackened. The point, in other words, isn't to make a pitch for gold. It's to make a pitch for something –anything– that's better than our present, lousy money.
* * *
*I'm astonished to find that Friedman's important and very interesting 1986 article, despite appearing in one of the leading academic journals, has to date been cited only 64 times (Google Scholar). Of these, nine are in works by myself, Kevin Dowd, and Lawrence White! I only wish I could attribute this neglect to monetary economists' pro-fiat money bias. More likely it reflects their general lack of interest in alternative monetary arrangements.
- It Begins – Hillary "Trump'd" By The Donald In Key Swing State
It appears the deceitful imbroglio of Hillary's campaign have begun to wear on her most admiring ("well everyone lies a little bit right?") apologists and voters. As The Hill reports, Donald Trump tops Hillary Clinton (45% to 42%) in the latest poll from swing-state North Carolina. Clinton tops Jeb Bush and Rand Paul, so there's that, but eight Republicans (including Trump) are beating the former secretary of state. Perhaps most notably however, is that a new survey from FOX shows Trump (45%) closing in on Hillary (51%) in the presidential election matchup.
Hillary Clinton lags behind eight Republican contenders in hypothetical head to head match-ups in North Carolina, including GOP front-runner Donald Trump.
Trump tops Clinton 45 percent to 42 percent in the latest survey from Democratic firm Public Policy Polling released Wednesday.
…
Democratic contender Sen. Bernie Sanders (I-Vt.) polls similarly against the Republican field, on average about 1.5 percent worse than Clinton, the party front-runner, according to PPP’s average.
North Carolina is considered a swing state in the general election. GOP nominee Mitt Romney won it by a small margin in 2012, four years after then-Illlinois Sen. Barack Obama won his own slight victory.
Trump continues to add to his large lead in the state. His lead on the GOP side has grown 8 percentage points over the past month, with support now from 24 percent of Republican primary voters. Carson currently polls second at 14 percent, followed by Cruz at 10 percent, Rubio at 9 percent, and Fiorina, Huckabee and Walker at 6 percent.
Carson’s stock rose 5 percentage points over the past month, while Cruz gained 4 percentage points.
The poll shows significant declines in support for Walker, Huckabee, Paul and Christie. Walker’s support dropped 6 percent, Huckabee is down 5 percent, Paul lost 4 percent and Christie fell 3 percent.
And from known knowns to known unknowns…
But it seems Trump's contenders have a trick up their sleeves (coming soon)… The Anti-Trump ad blitz starts after Labor Day…
Watch the latest video at video.foxnews.com
- China Strengthens Yuan By Most In 2 Months Following Another Massive Liquidity Injection
The PBOC set the Yuan fix 0.08% stronger – the biggest 'strengthening in 2 months, which is interesting because following The IMF's confirmation of a delay to Yuan inclusion in the SDR basket to Oct 2016 (pending a year-end decision and asking for more flexibility), Offshore Yuan forwards notably devalued (shifting 350pips higher to 6.65, the highest/weakest Yuan in a week) pricing a 20 handle (or 3%) devaluation by August 2016. Overnight saw another CNY110bn liquidity injection rescue from The PPT in the afternoon session (saving SHCOMP from a close below the 200DMA) and tonight we see promise to recap Ag Bank along with another CNY 120bn reverse repo injection. Shanghai margin debt declined for a 2nd day in a row and Chinese stocks look set to open weaker.
Offshore Yuan forwards point to further devaluation to come…
But The PBOC strengthened The FIx..
- *PBOC YUAN FIXING RISES 0.08%, THE MOST IN MORE THAN TWO MONTHS
- *CHINA SETS YUAN REFERENCE RATE AT 6.3915 AGAINST U.S. DOLLAR
More focused liquidity injections today…
- *PBOC TO REPLENISH CAPITAL OF AG DEVELOPMENT BANK: CHINA NEWS
But overnight saw another large liquidity injection…
The People's Bank of China intervened in the interbank market for a second time this week on Wednesday, pumping in 110 billion yuan through open market operations to steady interbank rates that have been shooting up as investors pull out of the yuan.
The PBOC confirmed after the market close that it injected 110 billion yuan to 14 financial institutions for a period of 6 months at a rate of 3.35 per cent.
This followed an injection on Tuesday when it added 120 billion yuan in repurchase agreements to the market.
The back-to-back cash injections came a week after the central bank allowed the yuan to devalue by more than 3 per cent over a three-day period, sparking concerns over capital outflow.
Last night's injection save stocks from a close below the 200DMA…
And today looks set to open weaker
- *CHINA'S CSI 300 INDEX SET TO OPEN DOWN 1% TO 3,848.40
- *CHINA SHANGHAI COMPOSITE SET TO OPEN DOWN 1% TO 3,754.57
Despite another massive liquidity injection:
- *PBOC TO INJECT 120B YUAN WITH 7-DAY REVERSE REPOS: TRADER
3,650 is today's level to worry about today in the Shanghai Composite
Commodity firms getting hammered:
- *GLENCORE SHARES FALL 5.8% TO HK$19.60 IN HONG KONG
- *NOBLE GROUP SHARES FALL 1.2% AT OPEN IN SINGAPORE
As Margin debt declined for 2nd day in a row…
Outstanding balance of Shanghai margin lending fell by 0.5%, or 4.5b yuan, from previous day to 875.4b yuan on Wed., according to exchange data.
Well it seems The PBOC has a different problem than wanting to devalue to save its 'exports'… the massive liquidity injection suggest the country has a dollar 'run' after all.
Charts: Bloomberg
- The Unlikely Rise Of Donald Trump And Bernie Sanders
Submitted by Bill O'Grady via Confluence Investment Management,
In the spring of 2014, we wrote a series of Weekly Geopolitical Reports that looked at the 2016 elections. In these reports, we described the economic and political environment that had the potential to make the 2016 election historically important. The emergence and remarkable staying power of Donald Trump and Bernie Sanders suggests that our earlier analysis and conclusions may be coming to pass.
In this report, we will recap the economic and political factors that led us to conclude last year that the next presidential cycle could be unusually significant. From there, we will look at the unlikely rise of Donald Trump and Bernie Sanders and what their success thus far signals about the electorate and the next presidential election. Finally, we will analyze their potential impact on the election, including the possibility that each might mount an extra-party candidacy. As always, we will conclude with market ramifications.
The Economic Problem
The U.S. economy is growing at a very slow pace, slow enough that some prominent economists are calling the current situation “secular stagnation,” a period of substandard growth. We think there is ample evidence that secular stagnation has developed in the U.S. and it is affecting global economic growth as well.
This chart shows real GDP from 1901 through 2018 on a logarithmic scale; the 2015-18 period, shown in gray on the above chart, is the consensus forecast from the Philadelphia FRB’s survey of professional forecasters. The key point of this graph is the deviation from trend. Note that GDP has been well below trend in two periods, the Great Depression and now. It is worth noting that the theory of secular stagnation originated during the 1930s.
Although the reasons for persistently below-trend growth are complicated, the most common factor from both eras is excessive private sector debt growth.
The chart below shows detrended GDP (the lower line on the above graph) along with private sector non-financial debt as a percentage of GDP.
In both periods of below-trend growth, debt levels had reached high levels. In the 1930s debt crisis, both household and business debt increased but the latter was probably the more important factor. In the current situation, household debt is more critical. It appears to us that until debt levels fall to what borrowers feel is a manageable level, economic growth will remain depressed.
The first debt increase mainly occurred due to the export boom that developed after WWI. After the 1921 recession, business activity rose as the U.S. economy began to take a pre-eminent position in the world. However, much like Japan in the 1980s or China today, the investment/export growth model only works if the rest of the world can absorb the goods that the exporting nation wants to sell. When that avenue began to falter,3 the U.S. found itself with too much productive capacity and too much debt.
In the 1930-45 period, debt levels were reduced by two methods—vicious foreclosures and bankruptcies before WWII and essentially a “debt swap” between the private sector and the government sector, facilitated by war spending. As the government increased defense spending, jobs were created that increased household income. Ration programs limited household spending which freed up cash for debt service, and increased business activity allowed the business sector to repair balance sheets. This allowed private sector debt to fall; however, it was replaced with expanding government debt that was used to fund the war effort. After the war ended, debt levels were at such low levels that both businesses and households were able to borrow to lift the economy. Financial repression where interest rates were held below the rate of inflation allowed the government to reduce the debt burden to manageable levels by the 1970s.
The steady increase in debt levels after the war peaked in 2008. This rising debt occurred mostly due to the burdens brought by the U.S. superpower role. As part of that role, America provides the reserve currency, meaning it must run persistent trade deficits in order to provide the reserve currency to support global liquidity and trade. The U.S. has used two methods to provide this liquidity since 1945. The first policy structure was designed to build a regulated economy that created a large number of high-paying, relatively low-skilled jobs. The program restricted disruptive technologies by concentrating industries and fostering the growth of labor unions.4 It also featured high marginal tax rates to discourage entrepreneurship as new businesses can upset the established order and lead to job losses. This led to hiring and rising incomes for average households.
Although the economy successfully created a broad path to the middle class, it was inefficient. Persistent inflation became a serious issue. To address inflation, President Carter implemented a series of supply side measures designed to improve the efficiency of the economy. These included the deregulation of financial services and transportation. He also appointed Paul Volcker as Federal Reserve Chairman; he implemented a “hard money” monetary policy. President Reagan took Carter’s reforms and expanded them further, leading to additional deregulation and globalization.
The good news was that the policies brought inflation under control. The problem was the broad path to the middle class in the developed world was dramatically narrowed. To now survive in the labor force, workers needed to rapidly adapt to new technologies and methods and compete on a global scale. Those who could were greatly rewarded; those who could not were left behind.
This chart shows the share of total income captured by the top 10% of income earners and inflation as measured by CPI. As the data shows, when this share is above 42%, inflation tends to be non-existent. When the top 10% share is below 42%, the CPI average is 5.3%. Inequality isn’t necessarily the cause of low inflation, but deregulation and globalization, which are effective against inflation, tend to cause increasing income inequality.
This led to a conflict between domestic and foreign policy. Containing inflation was a key domestic goal, but widening income differentials weakened the average household’s ability to consume, which undermined the reserve currency role of the superpower. The way the U.S. resolved this conundrum was through debt.
This chart shows how much of U.S. consumption is being funded through employee compensation. From 1950 to the early 1980s, wages generally funded between 90% and 95% of consumption. After deregulation, wages funded a steadily shrinking degree of consumption. Much of consumption was funded by household debt, as shown on the chart; note how it rose steadily as deregulation and globalization expanded. Of course, transfer payments played a role as well.
Donald Trump The Political Situation
Using debt to address the requirements of providing the reserve currency was never going to be a permanent solution to the problem of running a domestic economy and meeting the requirements of global hegemony. However, as long as credit was widely available, the political situation was manageable. The financial crisis of 2008 has made it clear that the debt option is no longer viable. And, to a great extent, the election of 2016 should be about answering these two questions:
- Should the U.S. continue to act as global hegemon, which includes providing the reserve currency?
- If the answer to #1 is yes, then how should the economy be restructured in order to fulfill the hegemon role in a sustainable fashion?
In the aforementioned 2016 reports we published in the spring of 2014, in Part 2 we described the four archetypes of American politics. There are two establishment classes and two populist classes. The establishment classes are the rentier/professional and the entrepreneurial. Within the first, there are two sub-categories, the center-left and center-right. Most of the Democratic Party establishment occupy the center-left whereas the GOP establishment is center-right. The rentier/professional groups have strong disagreements among themselves about social policy, but on economic policy they are firmly united behind deregulation, globalization and maintenance of America’s global hegemony. The entrepreneurial group strongly supports deregulation and globalization but tends to oppose the military part of the hegemonic role.
There are also two populist groups, left- and right-wing populists. In common parlance, these are the “bases” of the major political parties. For the most part, these groups represent those who have not fared well in the current environment of globalization, deregulation and global hegemony.
The political coalition that created the economic system in place from 1932 to 1980 was comprised of right-wing populists and the rentier/professional classes. The coalition mostly excluded the entrepreneurial class and the left-wing populists. However, the civil and gender rights movements of the 1960s and 1970s led the working coalition to broaden to include the left-wing populists as well. This action threatened the status and position of the right-wing populists and they opposed the decision. The turmoil experienced by the Democratic Party in the 1968 and 1972 presidential elections was due, in part, to this tension. In addition, the inability of this coalition to resolve the inflation problem led to this arrangement’s demise.
The Reagan Revolution meant that the establishment classes were in charge as the entrepreneurial class gained power. The establishment controlled political financing but did not have enough votes to win without the support of the populist classes. Thus, both the center-left and center-right used social issues to woo the “base”; the most successful political figures were able to inspire the base to vote for them. However, neither the left- or right-wing populists’ economic goals were ever met. In effect, the establishment classes ran the economy, an economy based on globalization and deregulation.
As time has passed, populists on both sides have discovered that they are not getting their economic needs met. However, to gain political power, either a durable relationship must reemerge with one of the establishment classes or the populist classes must create their own coalition.8 In our estimation, the populist classes will struggle to find common ground. Thus, we do not expect the right and left wing to agree on a common cause. Still, that doesn’t mean that politicians that take up the populist cause won’t have an impact on the next election.
Donald Trump and Bernie
Into this power vacuum enter two unlikely presidential candidates, Donald Trump And Bernie Sanders. The former is a billionaire real estate mogul who has an aura of celebrity. The latter is a socialist senator from Vermont, a small liberal-leaning state, who caucuses with Democrats but accuses most of them of being in league with the establishment class. They could not be more different. However, what they have in common is that their campaigns have captured the anger of the populists on both wings.
Donald Trump is gaining favor among the right-wing populists. How is this wealthy establishment figure wooing this populist group? One of the concerns among right-wing populists is that the expense of campaigns means that candidates must raise money from the establishment classes which prevents them from representing populist interests. Since Donald Trump is independently wealthy, he is viewed as “being his own man.” In fact, his comments stating that former Secretary of State Hillary Clinton had to go to his wedding because of his campaign contributions suggest that Donald Trump may “own” a few politicians. The brash statements he makes, comments that appear so offensive that they would have likely ended a traditional candidate’s chances, only seem to improve Donald Trump’s poll numbers.
Donald Trump’s economic message is that illegal immigration and unfair foreign competition are the reasons the economy is in trouble. If a “hard man” were in office, forcing other governments to trade fairly or halt illegal immigration, then the economy would do better.
Right-wing populists no longer trust government; that trust was lost when the rentier/managerial and the right-wing populist coalition was disrupted by the gender and civil rights movements of the 1960s and 1970s. The right wing doesn’t want the government to give handouts per se. However, it does want laws and regulations designed to recreate the economic structure that existed after WWII into the late 1960s. Trump’s “outsider” status resonates strongly with this class because they don’t trust government to support their interests. For example, right-wing populists are very skeptical of the Affordable Care Act (ACA).
Sanders’s message is that large corporations and the financial system are unfair to common people, and government policies are designed to protect those with power and money. Unlike Donald Trump, who faces a plethora of competitors, Sanders really only has one other candidate he is running against, Hillary Clinton. Sanders has been able to portray her as a member of the establishment who cannot represent the interests of “regular folks.” Thus, far, he is making the charges stick. Although he does not have the great wealth of Donald Trump, Sanders is well known as a man who does not need much money to exist; he can run a “cheap” campaign and thus isn’t beholden to establishment wealth.
Left-wing populists tend to be sympathetic to “identity politics” and are more trustful of government. They tend to support many government programs and generally approve of the ACA. Although they are currently angry at the government, they still seem to believe that if it worked properly (e.g., if regulators did their jobs), then bigger government would be acceptable.
The other issue that makes both candidates powerful is that neither is strongly affiliated with the parties they are trying to be nominated from. Donald Trump has endorsed policies over his history that have been more affiliated with Democrats. Sanders represents the Socialist Party; he isn’t even a Democrat. At the GOP debate, Donald Trump refused to rule out an extra-party candidacy. We suspect Sanders may consider such a position as well. And so, even if they fail to gain enough delegates to defeat an establishment candidate, they may still affect the outcome of the election in November 2016.
Among the pundit groups, both candidates are regularly written off as having no staying power. This stance is understandable. Donald Trump’s stump speeches fail the test of simple logic. For Sanders, the U.S. has almost no history of supporting socialist causes on a national level. The expectation is that as the nominating process wears on, both candidates will falter and join other failed fringe candidates seen throughout history.
We have our doubts. Populists of both stripes are angry. They feel that no one represents their interests. They don’t necessarily want politicians with well developed “wonkish” platforms that detail the nuance of tax policy or health care. What they want is someone who is independent and promises to “get things done.” The message that “your life would be better if you didn’t have politicians in Washington who oppose your interests” is one that resonates.
Donald Trump The Consequences
The key is to return to the two questions above; can populism exist alongside American hegemony? We don’t think so. For left-wing populists, that is probably acceptable. They are mostly Jeffersonian in foreign policy and would be comfortable with adopting a more isolationist stance. Right-wing populists are mostly Jacksonian; they want a military-focused hegemonic United States but fail to connect the financial role. The U.S. cannot run a trade surplus without threatening the global economy as such action would withdraw dollar liquidity from the world. Thus, the tough talk from Donald Trump about trade deals is really just that; as long as one is the superpower, domestic industries will always face strong foreign competition, in part because the rest of the world has strong incentives to skew policy to run trade surpluses with the U.S. It is hard to see how even the most crafty negotiator can overcome that issue. In addition, the global hegemon has an interest in encouraging other nations to use its currency as a way of projecting power.
To date, no one has developed a plan that would meet the needs of the domestic economy and maintain America’s superpower status. That fact partially explains why there is so much anger against the political establishment. It appears the current model has failed but the elites have not developed a replacement. The lack of replacement has led to the charge that the elites do not intend to change the system because it works for them. If the superpower status is jettisoned, it would be much easier to develop a new policy; after all, only domestic policy would matter at that point. However, history shows that periods when the world lacks a dominant superpower tend to have more frequent wars and revolutions.
Donald Trump Ramifications
Elections with four significant candidates are not common in U.S. history, but they are not unprecedented either. The 1948 presidential campaign featured Harry Truman, Thomas Dewey, Strom Thurmond (Dixiecrat) and Henry Wallace (Progressive), with Thurmond capturing 39 electoral votes. During that period, those votes would have gone to Truman, so Thurmond’s candidacy did not affect the outcome of the election. Perhaps the most famous four-candidate race was the 1860 election, featuring Abraham Lincoln (Republican), John Breckinridge (Southern Democrat), John Bell (Constitutional Union) and Stephen Douglas (Northern Democrat). All four candidates gained electoral votes, with Lincoln winning a majority within the college with 39.8% of the popular vote.
It is worth noting that both of these elections occurred during conditions of great uncertainty. In 1948, the country was trying to ascertain the best direction for both foreign and domestic policy. In 1860, the issues of slavery and the lack of clarity surrounding Federal and State power, an issue that emerged at the founding of the republic, were in dispute. In periods of great tumult, elections with multiple candidates often emerge.
If the establishment candidates win the major party nominations, but Sanders and Donald Trump decide to run as extra-party candidates, the uncertainty will likely weigh on financial markets. Handicapping elections with two major candidates is difficult enough. Determining a winner with three or four candidates is quite hard and the lack of certainty will not play well with risk assets.
The rise of populism is not just a U.S. issue. Globalization and deregulation, especially with regard to the open adoption of new technology and work structures, is increasingly being called into question. As we noted in our earlier reports on the 2016 election, there is increasing potential that major political and economic changes will emerge from this vote. The emergence of Donald Trump and Bernie Sanders is a reflection that the populists want a change in the direction of American policy. We will be watching closely to see whether any serious changes result.
- Facing Public Fury, China Reveals Owners Of Tianjin Warehouse
Last Wednesday’s catastrophic chemical explosion in Tianjin – that at last count had killed 114 people and injured more than 700 – put Beijing in a particularly tough spot at a decisively inopportune time.
Just two days earlier, China devalued the yuan in an effort to rescue its flagging economy which has stubbornly refused to respond to multiple policy rate cuts. Of course that wasn’t the official line. The PBoC’s excuse for the move is that it’s part of a larger effort to liberalize markets and allow the metaphorical invisible hand to play a larger role in determining everything from exchange rates to defaults. But as should be abundantly clear by the near daily interventions in both the FX and equity markets, Beijing is finding it difficult to relinquish control over the narrative.
The same dynamic often plays out outside of capital markets. That is, as China’s economy marks a difficult and sometimes tenuous transition towards consumption and services-led growth (i.e. towards a more Westernized system), egregious instances of censorship and the Communist party’s heavy-handed approach to shaping everyday life are seen as evidence that Beijing isn’t truly committed to liberalization.This was evident in the wake of the Tianjin explosion when China moved to shut down hundreds of social media accounts due to the dissemination of “blast rumors.” It also appeared as though China was set to leave the public in the dark regarding possible connections between the Party and the owners of Tianjin International Ruihai Logistics. As we noted on Tuesday, “it looks as though determining who actually owns Ruihai will be complicated by the fact that in China, it’s not uncommon for front men to hold shares on behalf of a company’s real owners. This is of course an effort to obscure Communist party involvement in some enterprises.”
With all eyes on China in the wake of the devaluation, just about the last thing Beijing needed in terms of shaping its international image and pacifying an increasingly agitated public was to be seen as complicit in a massive coverup of a completely avoidable disaster that ultimately caused the deaths of more than 100 people and may well have far-reaching environmental consequences for the blast zone and beyond.
So faced with a swelling public backlash, Beijing has embarked on an effort to prove how serious it is about launching a transparent and honest investigation. We certainly doubt anyone was impressed with the fact that a handful of Ruihai executives had been detained but now, it looks like China has compelled the mystery owners whose shares were held on their behalf by front-men, to reveal themselves – and their ties to the Politburo – to the public. The New York Times has the story:
The mayor of the northern Chinese city where huge explosions killed over 100 people last week took responsibility for the disaster on Wednesday, as the authorities sought to contain growing public anger about the accident.
“I bear unshirkable responsibility for this accident as head of the city,” said Huang Xingguo, the mayor and acting Communist Party secretary of the metropolis, Tianjin, in his first news conference since the blasts at a chemical warehouse on Aug. 12.
The mayor’s televised mea culpa appeared to signal a shift in the authorities’ response to the political fallout from the disaster. After days of official silence, the government has begun releasing information about the owners of the warehouse company, Rui Hai International Logistics, including their admission of corruption, in an effort to quash public accusations of a cover-up.
On Wednesday, China’s state-run Xinhua news agency reported that two major shareholders in Rui Hai had admitted to using their political connections to gain government approvals for the site, despite clear violations of rules prohibiting the storage of hazardous chemicals within 3,200 feet of residential areas.
Yu Xuewei, the company chairman, is a former executive at a state-owned chemical company, and Dong Shexuan, the vice chairman, is the son of a former police chief at the Tianjin port. The two executives, who deliberately concealed their ownership stakes behind a murky corporate structure, told Xinhua that they had leveraged their personal relationships with government officials to obtain licenses for the site. Both men have been detained.
“The first safety appraisal company said our warehouses were too close to the apartment building,” said Mr. Dong, 34, referring to a residential complex that was severely damaged and now stands empty. “Then we found another company who got us the documents we needed.”
The executives established Rui Hai in 2012 but had other people list their shares to avoid the appearance of a conflict of interest. Mr. Yu, 41, admitted that he held 55 percent of the shares through his cousin, Li Liang, the president of the company. Mr. Dong holds 45 percent of the shares through a former classmate.
“I had my schoolmate hold shares for me because of my father,” a former police chief who died in 2014, Mr. Dong told Xinhua. “If the news of me investing in a business leaked, it could have brought bad influence.”
Now clearly, these admissions are so straightforward and so obviously scripted that they almost certainly were handed down from above. In other words, rather than risk a series of exposés aimed at determining exactly who was involved in the manangement of Ruihai and how deep their political connections ran (FT had already picked up on the story), Beijing apparently thought the safer route to go was to simply out Mr. Yu and Mr. Dong along with their political connections, and force them to tell the public exactly what it wants to hear in the most unequivocal language possible.
Whether or not this will be sufficient to quell the growing public discontent remains to be seen, but it’s interesting to note that Sinochem, a state-owned chemical company, controls two other warehouses in Tianjin that, as WSJ notes, are “within a kilometer of residences, a hospital, a busy highway, schools and other public facilities, despite rules forbidding such proximity.”
In other words: Ruihai is more the rule than the exception when it comes to politically-connected enterprises skirting restrictions on the storage and handling of hazardous chemicals.
As for what everyday Chinese citizens think about the public admissions of guilt and corruption by Ruihai’s major shareholders, we go to Wang Baoshun, a newsstand owner in Beijing who spoke to The Times: “The corruption is like cancer, and we are a patient at a late stage. You can have a few surgeries, but you won’t be able to get rid of it for good.”
We can only hope that the cancerous corruption that helped pave the way for the disaster in Tianjin doesn’t end up causing an increased incidence of real cancer among the thousands of people who have now been exposed to toxic sodium cyanide and its gaseous derivative, hydrogen cyanide.
- After 6 Years Of QE, And A $4.5 Trillion Balance Sheet, St. Louis Fed Admits QE Was A Mistake
As you’re no doubt aware, the Fed is fond of using the research departments at its various branches to validate policy and analyze away bad economic outcomes. For instance, earlier this year, the San Francisco Fed came up with an academic justification for the now infamous double seasonally adjusted GDP print – they call it “residual seasonality.” Then there’s the NY Fed, where researchers recently took to the bank’s blog to explain why, despite all evidence to the contrary, Treasury liquidity is “fairly favorable.”
Be that as it may, someone will occasionally say something really inconvenient – like when, back in April, the St. Louis Fed warned that the American Middle Class was “under more pressure than you think,” a situation the bank blamed on the diverging fortunes (literally) of the haves and the have nots in the post-crisis world. The implication – made clear in the accompanying graphics – was that QE was effectively eliminating the Middle Class.
Now, the very same St. Louis Fed (this time in the form of a white paper by the bank’s vice president Stephen D. Williamson), is out questioning the efficacy of QE when it comes to stoking inflation and boosting economic activity.
Williamson says the theory behind QE is “not well-developed”, and calls the evidence in support of Ben Bernanke’s views on the transmission mechanisms whereby asset purchases affect outcomes “mixed at best.”
“All of [the] research is problematic,” Williamson continues, as “there is no way to determine whether asset prices move in response to a QE announcement simply because of a signalling effect, whereby QE matters not because of the direct effects of the asset swaps, but because it provides information about future central bank actions with respect to the policy interest rate.” In other words, it could be that the market is just reading QE as a signal that rates will stay lower for longer and that read is what drives market behavior, not the actual bond purchases.
But the most damning critique of Bernanke’s response to the crisis is this:
There is no work, to my knowledge, that establishes a link from QE to the ultimate goals of the Fed inflation and real economic activity. Indeed, casual evidence suggests that QE has been ineffective in increasing inflation. For example, in spite of massive central bank asset purchases in the U.S., the Fed is currently falling short of its 2% inflation target. Further, Switzerland and Japan, which have balance sheets that are much larger than that of the U.S., relative to GDP, have been experiencing very low inflation or deflation.
And then there’s this:
A Taylor-rule central banker may be convinced that lowering the central bank’s nominal interest rate target will increase inflation. This can lead to a situation in which the central banker becomes permanently trapped in ZIRP. With the nominal interest rate at zero for a long period of time, inflation is low, and the central banker reasons that maintaining ZIRP will eventually increase the inflation rate. But this never happens and, as long as the central banker adheres to a sufficiently aggressive Taylor rule, ZIRP will continue forever, and the central bank will fall short of its inflation target indefinitely. This idea seems to fit nicely with the recent observed behavior of the worldís central banks.
And this:
Thus, the Fed’s forward guidance experiments after the Great Recession would seem to have done more to sow confusion than to clarify the Fed’s policy rule.
So in sum, the vice President of the St. Louis Fed has taken a look around and discovered that in fact, not only have trillions in asset purchases not worked when it comes to creating “healthy” inflation and boosting growth in the US, these asset purchases haven’t worked anywhere they’ve been tried. Furthermore, he’s noticed that central bankers that adhere, in a perpetual state of Einsteinian insanity, to the Taylor principle, will never be able to raise rates and finally, he thinks that the more the Fed talks, the more confused the public gets about what it is the central bank intends to do.
We would agree on all accounts here, although when it comes to forward guidance and discerning what the Fed’s goal is, actions, as they say, speak far louder than words and with the S&P 500 having levitated some 200% since March of 2009, we don’t think anyone is truly “confused.”
- Presidential Candidate "Deez Nuts" Surges In Polls
If Donald Trump’s unlikely rise to the top of the polls tells us anything, it’s that Americans (or at least GOP primary voters) are sick of business as usual in Washington.
The endemic corruption, crony capitalism, rampant regulatory capture, and licentious logrolling that many voters have come to associate with the American political process has created a deep-seated desire for change and if there are two names which most certainly do not portend a break from business as usual inside the Beltway they are “Bush” and “Clinton.” Indeed, the prospect that America will once again be faced with a choice that really isn’t a choice by being compelled to choose between two candidates from Washington’s political aristocracy has only served to boost Trump’s appeal.
All of the above certainly seems to suggest that America is fully prepared to accept and embrace the candidacy of those who promise anything but the political status quo, which, we imagine helps to explain why the dark horse candidate “Deez Nuts” is now polling at 9% in North Carolina.
Deez Nuts is running for president. This is a true statement. pic.twitter.com/834etY4cMH
— Josh Moon (@Josh_Moon) August 19, 2015
From PublicPolicyPolling:
The specter of Trump running as an independent candidate in the general election continues to be a big potential problem for Republicans. In such a scenario Clinton leads with 38% with Bush at 28% and Trump at 27% basically tying for second place. Trump wins independents with 38% (to 28% for Clinton and 24% for Bush), takes 38% of Republicans, and 14% of Democrats.
Finally another declared independent candidate, Deez Nuts, polls at 9% in North Carolina to go along with his 8% in Minnesota and 7% in Iowa in our recent polling. Trump leads Clinton 40/38 when he’s in the mix.
Finally Deez Nuts get 9% in NC to go with their 8% in Minnesota and 7% in Iowa. Pretty consistent support: http://t.co/EIPkTvW3Ti
— PublicPolicyPolling (@ppppolls) August 19, 2015
As you can see from the following, North Carolina voters aren’t yet sure what to expect from Nuts, but 9% of voters know that if forced to choose between Hillary Clinton, Donald Trump, and Deez Nuts, they’ll take Nuts any day of the week.
Breaking down the polling data, it looks like 9% of voters who chose Mitt Romney in 2012 would go with Deez Nuts in 2016 while an astonishing 25% of voters who voted for someone other than Obama or Romney would prefer Nuts over Clinton or Trump. Most of Nuts’ support looks to come from the center of the policitcal spectrum and when broken down by gender, men seem to have a more favorable view of Nuts than women. When it comes to age, voters 18-29 were far more likely to have a favorable view of Nuts although surprisingly, when Nuts is pitted against Trump and Clinton, a shocking 15% of voters 30-45 say they would choose Nuts.
Full breakdown:
- "There Is No Other End Than A Bad One… It's A Mathematical Certainty"
Submitted by Thad Beversdorf via FirstRebuttal.com,
I recently watched a video clip of Bernie Sanders laying the boots to Alan Greenspan back in 2003, for Greenspan’s seemingly out of touch perspective of the average American. Now while we do have a repentant banker in Greenspan, a rare phenomenon for sure, I found the scolding interesting in that essentially every accusation Sanders lays on Greenspan could be repeated today to our subsequent central banking gods. During the video notice that all the figures Sanders explicates not only remain true today but have gotten far worse. Particularly note the national debt figure which has now increased by more than 400% since then!!! The clip is well worth the 5 minutes…
But so let’s dig in a little to what Bernie is really saying to Greenspan. The overall theme of the trouncing is that the Federal Reserve, the keeper of American monetary policy, had implemented policies that clearly had done significant damage to the vast majority of Americans. Specifically Sanders is suggesting that the policies were a cancer to the economic prosperity of Americans and all the while creating extreme wealth for a select few. And while that is bad in and of itself, what Sanders finds despicable is that the Fed seems to not only deny the harm they were responsible for but Greenspan seemed to be alleging success by focusing solely on the massive wealth it had provided to the very few on top.
Now in a recent whitepaper by Stephen Williams, VP of the St. Loius Fed, a case is made that the Fed’s ‘recovery’ policies have not helped to boost the economy. And while I agree with that conclusion, I feel the paper is a fraud. Not only on the surface of that argument does it create a false dichotomy of either helped or not helped (dismissing the idea that the policies may have actually been harmful) but Williams explicitly suggests the policies were not harmful to the economy. And that was the real intended message. Remember nobody publicly denounces their employer without being fired. And so if Williams keeps his job we know that this message was a coordinated message. Further, by the structure of his argument the objective is clear. The Fed is already setting up the argument that while they were not entirely effective in a recovery they are not to blame for the inevitable second coming of the credit crisis (a definite dead canary).
You see the problem comes down to the moral hazard created by fiat currency. Specifically, I mean that when you have essentially infinite resources you become very careless about each unit of resource. Subsequent to ending Bretton/Woods in 1971 the US has succumb to such a moral hazard. This is clear when looking at the collapse of fiscal discipline immediately following the end of Bretton/Woods, which was a quasi gold standard that necessitated fiscal discipline.
And so that chart tells us the moral hazard absolutely exists but it doesn’t explain why that is bad. To do that we need to look at a visual representation of this moral hazard and its respective destructive characteristics over time. But before we do let’s remember, as I recently laid out in some detail in The Fed’s Fatal Flaw, the central banking system is designed to require perpetually increasing money stock. The reason is simple. The Central Banking Act of 1913 was designed by three banking families (refer to Jekyll Island) whose profits expanded along with money supply. And so a system that necessarily required the expansion of money supply was to create immense wealth for banking families that drafted the Bill. While that is certainly unethical, it is the destructiveness of such a system that is the real evil. The system is such that profits for the very few come directly at the expense of the masses. Let’s look deeper into this matter.
What must be understood but seems to be lost on most PhD economists today is that money in our system can either be a fuel or a drag, but it cannot be neither. Remember that our system attaches a unit of debt to each unit of currency. That means that each unit of currency must return an amount greater than itself. If it does, it is fuel. If it doesn’t it is a drag.
The problem then with the system is the destructive force inherent of the moral hazard (having the ability to create infinite currency) as depicted in the next chart. That is, currency created and used for consumption rather than investment becomes a drag rather than a fuel and the economy becomes less efficient. This increasing inefficiency has been occurring since the end of Bretton/Woods or since the beginning of the moral hazard. That said, you will never hear very intelligent but also very disingenuous guys like Alan Goolsbee discuss the secular economic deterioration as it doesn’t suit their role of policy champions.
The following chart depicts corporate domestic investment as a percentage of M2 money stock (blue line) and real GDP (red line).
What becomes immediately apparent is the correlation between the percentage of money stock being used for corporate investment and real economic growth and the significantly negative slope of both.
One might wonder then what are corporations doing with their money if not reinvesting it?
Well the answer is clear. While for decades domestic investment (i.e. fixed capital reinvestment) as a percent of money stock averaged around 8% today it has declined to about 5%, a 40% decline. On the other hand corporate dividend payments (green line) have increased to a 15 year average of about 7% from 4% of money stock, a 75% increase. So each year, 3% of money stock is being reallocated from private domestic investment to corporate dividend payments. And make no mistake, dividend payments do not fuel the economy as some +90% are reinvested into the secondary market. An investment which provides almost no economic benefit (with the exception of very few secondary offerings that add cash to corporate balance sheets) as opposed to domestic fixed reinvestment which is pure economic fuel.
But let’s take a closer look at the moral hazard and its direct implication on the economy.
What we see by adding trendlines to both parametres is that very shortly after the US went to a pure fiat currency in 1971, domestic investment as a percentage of money stock began to drop, resulting in the secular deterioration in real GDP that continues today. I say resulting rather than mere correlation and let me explain.
Again the reality is that excess money stock is a drag on the economy because each unit of money stock necessarily has a unit of debt attached to it. Logically then, as the percentage of money stock allocated to investment (meaning potential positive net returns) declines the percentage of unpayable debt (attached to the uninvested money stock) requires the perpetual rolling over of ever more debt.
This results in massive drag on the economy because remember that mathematically debt used for consumption rather than investment is a net negative on medium and long term output. The implication is that while all debt gets included into current GDP (through its expenditure today), all consumed debt plus interest is removed (paid back) from output later on. This effect is not easily seen because the reduced medium and long term output is being continuously offset by even more consumer debt.
So what we’ve ended up with is a death spiral of economic prosperity dressed in sheep’s clothing. The above chart depicts that every worker in America today has increased their consumer debt levels by about 40% since the ‘end’ of the credit crisis. Think about that for a moment. Perhaps the most destructive economic collapse in history that was triggered by excessive credit has led American workers to take on 40% more consumer debt.
Allow me to digress for a moment about the concept of consumer debt and why if it is such a destructive thing policymakers would allow it to continue its record expansion. Think of it like this; where a purchase made with earned money is a two party transaction a purchase made on debt is a three party transaction. Essentially banks become a party to every consumer transaction that is done on debt. And so banks essentially are feeding off of every transaction between a consumer and a proprietor. In the natural world we call that a parasite. For the corporations the parasite is helpful because it magically turns the consumer’s debt into profit and so they don’t mind. However, for consumers, the transaction doesn’t end after they eat the candy bar. The debt not only remains, it builds, and so the parasite slowly deteriorates the consumer’s ability to prosper. But because the parasite controls the economic policies of the nation the policies actually drive the indebtedness that we see in the above chart which benefit both the banks’ and the corporations’ profits but to the detriment of the working class (discussion as to the borrowers’ responsibility in the matter won’t take place here but I will note the data today suggests more than ever consumer debt is being used on inflating staples – healthcare, food and rent – rather than discretionary purchases).
And yet we are told by the very elite PhD economists that the credit crisis ended back in 2009. And worse we are told that the expansion of excess credit will end differently this time around. And still worse, any Americans who actually have savings have been forced into bloating equity valuations (along with corporations for the same reason but from the other side of the coin) because interest rate securities have been set to return effectively nothing.
The above chart depicts income from private savings (using the 2 yr rate as a proxy, which is likely being generous today) has declined from about 2.0% of GDP in the early 1980’s to 0.6% in 2000 to around 0.2% today. And so while consumer borrowers have been forced into a state of perpetual borrowing, savers has been forced to lend money into secondary markets which will once again be transferred to the very few upon the inevitable next market crash. A crash that is already being signaled around the world.
So when we watch guys like Bernie Sanders get visibly angry at guys like Alan Greenspan it behooves all of us to go beyond the entertainment of it or some prima facie agreement and to truly understand why the anger is justified. When we do we will be asking why in the hell is no one yelling at Janet Yellen??
Economics has become hostage to academia where PhD’s want to ring fence the subject with statistics and calculus to ensure only those who have done the very narrow and otherwise irrelevant studies can play. But economics has very little to do with stats and calculus. Economics is a subject of interrelatedness based on logic with a little basic math thrown in.
If we were to all take the responsibility to understand the lifeblood of our American existence i.e. the economy, we will most certainly be moved to remove not only the policymakers but the system that together serve only those at the top of the economic food chain and at a cost to the rest of us. At the end of the day the system is a zero sum game in a monetary system that is based on trading a unit of currency for a unit of debt. There is no other end than a bad one and I’m sorry my friends but that is a (simple) mathematical certainty.
- Echoes Of 1997: China Devaluation "Rekindles" Asian Crisis Memories, BofA Warns
In “Currency Carnage: Gross Warns On ‘Fakers And Breakers’; Morgan Stanley Tells Asia To Watch Its REER,” we outlined which Asia ex-Japan economies faced the biggest risk from China’s decision to devalue the yuan.
Broadly speaking, a weaker yuan will likely cause regional economies to suffer a loss of export competitiveness in combination with decreased demand for their products on the mainland.
Even before the latest shot across the bow in the escalating global currency wars, EM FX was beset by falling commodity prices, stumbling Chinese demand, and a looming Fed hike.
Now, the situation is immeasurably worse.
We got a preview of what is perhaps in store when, on Tuesday, Indonesia reported that trade had collapsed in July, while Friday’s meltdown in the ringgit as well as Malaysian stocks and bonds underscored just how fragile the situation has become. And while, as Barclays notes, “estimating the global effects China has via the exchange rate and growth remains a rough exercise,” more than a few observers believe the effect may be to spark a Asian Financial Crisis redux.
For their part, BofAML has endeavored to compare last week’s move to the 1994 renminbi devaluation, on the way to drawing comparisons between what happened in 1997 and what may unfold in the months ahead.
“On 1 Jan 1994, China unified its exchange rate by bringing the official in line with swap market rate, devaluing the RMB official rate by nearly 50% (from 5.8 to 8.7 RMB/USD),” BofA reminds us, adding that because only a fifth of transactions occurred at the official rate, the effect was a devaluation on the order of 7%. Because the bank (and they aren’t alone here) ultimately sees the yuan weakening by 10% against the dollar this time around, “the magnitude of devaluation [will] effectively be larger than the 1994 move.”
As for the fallout, BofA is “concerned about the competitive impact from China’s devaluation on rest of Asia, as the devaluation comes on top of [1] China’s deflation; [2] China’s growing market share in key third markets; and [3] Asia’s sluggish exports.” As the following charts and subsequent commentary make clear, China was already taking share and now, that dynamic could accelerate and demand, already depressed, could be reduced further by the weaker yuan:
China’s market share of US and EU’s imports was already expanding, pre- devaluation (Chart 5 & Chart 6). China was already eating into rest of Asia’s market share, even with an anchored RMB. China’s market share of both US and Europe’s imports generally rose strongly from 2000 – 2010, before moderating during the GFC but has since picked up. China now accounts for about 20% of US imports and 7% of Europe’s imports. In contrast, ASEAN’s share of US imports has declined to 4.4% over 2011-14 from 7% in 2000, before recovering to about 5% in the first half of this year.
In Europe, ASEAN’s share has declined to about 1.8% in 2008 from 2.6% in 2000, before picking up to about 2.4% this year. The IMF Regional Outlook also highlights that China, a major player in Asian supply chains, is capturing an increasingly larger part of the chain as domestically sourced intermediates (from either locally owned producers or subsidiaries of foreign firms) increasingly replaced imported intermediate goods. China’s “on-shoring” is thus one more reason why rest of Asia’s exports is struggling.
Northeast Asia economies will likely face greater competitive pressures from China’s devaluation given stronger trade linkages and overlapping exports. Trade links with China are highest for the Northeast Asian economies: Taiwan (16% of GDP) and Korea (10%). More than a quarter of exports from Korea and Taiwan are destined for China. China’s lower tech exports also compete more closely with Korea and Taiwan. Almost a fifth of Japan’s exports are for China. For Southeast Asia, only 10% of exports go to China, with Malaysia and Singapore having a larger share. But ASEAN commodity exporters (Indo, Mal and Thai) will also be hit if China’s devaluation reduces import demand and intensifies the deflationary pressures on commodity prices.
BofAML’s conclusion is that China’s devaluation has added “another layer of risk and uncertainty for the rest of Asia, on top of the looming Fed funds rate hike cycle.”
“Asia,” the bank’s FX strategy team continues, “is already not in a good place (compared to past Fed rate hike episodes), as exports are contracting, domestic demand is sluggish and monetary policy is out of sync with the Fed,” which means that between the weaker RMB and a Fed that will eventually have to try and prove that contrary to what the St. Louis Fed’s Stephen Williamson says, an exit from ZIRP is actually possible, a 1997 replay may indeed be in the cards.
- Aug 20 – Fed Minutes: Conditions For Rate Hike Approaching Hike….
EMOTION MOVING MARKETS NOW: 11/100 EXTREME FEAR
PREVIOUS CLOSE: 14/100 EXTREME FEAR
ONE WEEK AGO: 10/100 EXTREME FEAR
ONE MONTH AGO: 36/100 FEAR
ONE YEAR AGO: 32/100 FEAR
Put and Call Options: EXTREME FEAR During the last five trading days, volume in put options has lagged volume in call options by 27.71% as investors make bullish bets in their portfolios. However, this is still among the highest levels of put buying seen during the last two years, indicating extreme fear on the part of investors.
Market Volatility: NEUTRAL The CBOE Volatility Index (VIX) is at 15.25. This is a neutral reading and indicates that market risks appear low.Stock Price Strength: EXTREME FEAR The number of stocks hitting 52-week lows is slightly greater than the number hitting highs and is at the lower end of its range, indicating extreme fear.
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MEME OF THE DAY – IT’S THE JERKS
UNUSUAL ACTIVITY
IDTI Vol weakness SEP 19 PUT ACTIVITY @$1.25 on offer 4500+ Contracts
SLB SEP 80 PUT ACTIVITY @$1.31 on offer 4000+ Contracts
PYPL SEP WEEKLY4 PUTS on the BID @$1.35 3700 Contracts
SPLS DEC 15 CALLS on the OFFER @$.90-.95 6000 Contracts
SEMI – CEO Purchased $300k+ total
AVHI Director Purchase 1,920 @$ 13.9989 Purchase 1,280 @$13.99
HEADLINES
Fed Minutes: Conditions for rate hike approaching hike, but not there yet
Fed’s Bullard says he Will argue for September liftoff
Fed’s Kocherlakota: Raising rates now would be a mistake
US CPI (MoM) Jul: 0.10% (est 0.20%; prev 0.30%)
US CPI (YoY) Jul: 0.20% (est 0.20%; prev 0.10%)
US CPI Core (MoM) Jul: 0.10% (est 0.20%; prev 0.20%)
US CPI Core (YoY) Jul: 1.80% (est 1.80%; prev 1.80%)
US Real Avg Weekly Earnings (YoY) Jul: 2.20% (prev 1.80%)
US MBA Mortgage Applications (14 Aug): 3.60% (prev 0.10%)
US DOE Crude Inventories (WoW) Aug-14: 2.62m (est -820K; prev -1682K)
WTI futures settle 4.3% lower at $40.80/barrel
ESM: Greece to receive EUR 13bln disbursement on Thursday
ESM: Greek debt relief to be considered in Oct-Nov
GOVERNMENTS/CENTRAL BANKS
Fed Minutes: ‘Approaching’ hike, not there yet –CNBC
Hilsenrath: Fed’s Signals Mixed on Rate Increase at September Meeting –WSJ
Fed’s Bullard says he Will argue for September liftoff –MNI
Fed’s Kocherlakota: Raising rates now would be a mistake –WSJ Op-Ed
Fed RRP (19 Aug): 31 bidders. $84.4bn (prev 34 bidders, $88.1bn)
PBOC’s Zhou urges ‘capital restraint’ over three policy banks –Caijing bia BBG
IMF: China won’t join SDR till Sept 2016 at earliest –FT
ECB: EZ excess liquidity rose to E472.92bn (prev E471.54bn) –Livesquawk
ECB: E781m borrowed using overnight loan facility, E156.8bn deposited –Livesquawk
Dutch defeats no-confidence motion in parliament –Rtrs
Ex-BoE Miles: Rates will rise pretty soon –BBC
GREECE
ESM: Greece to receive EUR 13bln disbursement tomorrow, –Livesquawk
ESM: Greek debt relief to be considered in Oct-Nov –Livesquawk
EG’s Dijsselbloem: IMF, euro zone can agree on Greek debt
Greek bailout moves ahead after German parliament backs programme –BBG
German FinMin Schaeuble rules out debt haircut for Greece –Rtrs
Schaeuble: IMF will join Greek deal if conditions met –ForexLive
Fitch Upgrades 2 Greek Banks’ State-Guaranteed Debt To ‘CCC’ On Sovereign Upgrade
GEOPOLITICS
OSCE not prepared to work in Gorlovka under fire
Poroshenko to discuss Ukraine situation with Hollande and Angela –Armenpress
Merkel calls summit over rising violence in Ukraine –FT
Reports of gunfire near Dolmabahce Palace in Istanbul –ForexLive
UN to let Iran inspect alleged nuke work site –AP
Iran boosting strategic defense production –PressTV
FIXED INCOME
U.S. Government Bonds Strengthen After Fed Minutes –WSJ
Norway SWF posts first decline in three years on bonds –BBG
Iraq courts investors before international debt sale –FT
Glencore bonds slump on poor earnings –IFR
FX
USD: Dollar dips after Fed minutes –FT
CNY: IMF says China won’t join SDR till Sept 2016 at earliest –FT
COMMODITY FX: Oil currencies under fire as WTI tumbles –FT
TRY: Turkish lira hits fresh record low –FT
ENERGY/COMMODITIES
WTI futures settle 4.3% lower at $40.80/barrel –Livesquawk
Brent futures settle 3.4% lower at $47.16/barrel –Livesquawk
DOE US Crude Oil Inventory Change (WoW) Aug-14: 2620k (est -820K; prev -1682K)
DOE US Distillate Inventory Change (WoW) Aug-14: 594K (est 1500K; prev 2994K)
DOE Cushing OK Crude Inventory Change (WoW) Aug-14: 326K (est 505K; prev -51K)
DOE US Gasoline Inventory Change (WoW) Aug-14: -2708K (est -1250K; prev -1251K)
DOE US Refinery Utilization (WoW) Aug-14: -1.00% (est -0.50%; prev 0.00%)
CRUDE: Oil down on surprise inventory build –ForexLive
CRUDE: EIA cuts WTI forecast for 2015, 2016 –FT
EQUITIES
EARNINGS: Glencore profits hit by oil and metal price slowdown –BBC
EARNINGS: Target raises 2015 earnings forecast for second time –Rtrs
EARNINGS: Staples reports profit decline as sales slide –MW
EARNINGS: Lowe’s earnings miss estimates –CNBC
M&A: AbbVie buys special review voucher for $350m –Rtrs
SALES UPDATE: Imperial Tobacco upbeat despite falling volumes –FT
TRADING: Short sellers target European luxury stocks –FT
JV: India’s Tata to invest almost $100m in Uber –FT
F&B: Carlsberg shareholders drown sorrows after warning –FT
F&B: Coke takes minority stake in organic juice maker Suja –CNBC
LEGAL: Citi to Pay $15m to Settle US Compliance Charges –FBN
Toyota to seek price cuts from suppliers –Nikkei via BBG
EMERGING MARKETS
FLOW: Investors pulled near $1trln from EMs –CNBC
CHINA: China stocks rebound, but who is buying?
CHINA: PBOC Confirms CNY110 Bln In Funding Ops Weds
- US Plans Dramatic Increase In Global Lethal & Surveillance Drone Flights By 2019
Submitted by Claire Bernish via TheAntiMedia.org,
As if in complete defiance of the extensive contention at home and abroad, the Pentagon announced plans this week to dramatically ramp up global drone operations over the next four years.
Daily drone flights will increase by 50% during this time, and will include lethal air strikes and surveillance missions to deal with the increase in global hot spots and crises, according to an unnamed (and unverified) senior defense official, as reported by The Wall Street Journal.
“We’ve seen a steady signal from all our geographic combatant commanders to have more of this capability,” said Defense Department spokesperson, Navy Captain Jeff Davis to reporters at the Pentagon.
Capacity for lethal airstrikes — despite the U.S.’ existent infamous reputation in its massive current program — will increase still further through a joint effort by the Air Force, Army, and Special Operations Command. Ironically, this news comes on the heels of a report that — because of what amounts to sibling rivalry — around $500 million has been wasted in attempts to bring the Air Force and Army into a combined drone purchasing program of the same Predator drones whose flights are now to be increased.
“The combatant commanders and the Department of Defense need to take a truly joint approach to delivering the kinds of capabilities that remotely piloted aircraft can provide,” said retired Air Force three-star general David Deptula. “I’m glad to hear they’re taking a more joint approach. That’ll be a great help right there.”
According to the unnamed official, intelligence surveillance and collection will be broadened in Iraq, Syria, Ukraine, North Africa, and the South China Sea, among other locations.
Overall, daily drone flights have exponentially increased over the past decade — from about five in 2004 to 61 today, and a goal of around 90 by 2019. That would amount to 32,850 a year if the goal is met. The latest expansion is the largest since 2011.
Part of the reason for expansion is the current use of military drone flights on behalf of the CIA — as many as 22 of the 61 daily flights are committed to CIA surveillance missions. Using military personnel, the agency essentially directs the missions and benefits from the surveillance, and though the military can use the agency’s information, it isn’t in command of those flights and thus loses that capacity while they are deployed that way.
No budget figures were immediately available, but once they are, they will be subject to congressional approval.
Nearly 5,500 people have been killed in U.S. drone strikes in Pakistan, Yemen, Somalia, and Afghanistan, alone — of which nearly 1,100 were civilian casualties, including over 200 children, according to the Bureau for Investigative Journalism. Now, there is no way to avoid an increase in the number of civilians who pay with their lives for being in the wrong place when the U.S. feels the need to carry out more strikes.
As former drone sensor operator Brandon Bryant disturbingly told RT, “There was no oversight. I just know that the inside of the entire program was diseased and people need to know what happens to those that were on the inside. People need to know the lack of oversight, the lack of accountability, that happen.”
But they hate us for our freedom. Right?
- U.S. Military Leaders Support Iran Deal
Scores of high-level American military leaders support the Iran deal. For example, the following 35 military officials – from the Army, Navy, Air Force and Marine Corps – signed a letter urging support for the deal:
- General James “Hoss” Cartwright, U.S. Marine Corps
- General Joseph P. Hoar, U.S. Marine Corps
- General Merrill “Tony” McPeak, U.S. Air Force
- General Lloyd W. “Fig” Newton, US. Air Force
- Lieutenant General Robert G. Gard, Jr., U.S. Army
- Lieutenant General Arlen D. Jameson, U.S. Air Force
- Lieutenant General Frank Kearney, U.S. Army
- Lieutenant General Claudia J. Kennedy, U.S. Army
- Lieutenant General Donald L. Kerrick, U.S. Army
- Lieutenant General Charles P. Otstott, U.S. Army
- Lieutenant General Norman R. Seip, U.S. Air Force
- Lieutenant General James M. Thompson, U.S. Army
- Vice Admiral Kevin P. Green, U.S. Navy
- Vice Admiral Lee F. Gunn, US. Navy
- Major General George Buskirk, US Army
- Major General Paul D. Eaton, U.S. Army
- Major General Marcelite J. Harris, U.S. Air Force
- Major General Frederick H. Lawson, U.S. Army Major General William L. Nash, U.S. Army
- Major General Tony Taguba, U.S. Army
- Rear Admiral John Hutson, U.S. Navy
- Rear Admiral Malcolm MacKinnon HI, US. Navy
- Rear Admiral Edward “Sonny” Masco, U.S. Navy
- Rear Admiral Joseph Sestak, U.S. Navy
- Rear Admiral Garland “Gar” P. Wright, US. Navy
- Brigadier General John Adams, US. Air Force
- Brigadier General Stephen A. Cheney, U.S. Marine Corps
- Brigadier General Patricia “Pat” Foote, U.S. Army
- Brigadier General Lawrence E. Gillespie, U.S. Army
- Brigadier General John Johns, U.S. Army
- Brigadier General David McGinnis, U.S. Army
- Brigadier General Stephen Xenakis, U.S. Army
- Rear Admiral James Arden “Jamie” Barnett, Jr., U.S. Navy
- Rear Admiral Jay A. DeLoach, U.S. Navy
- Rear Admiral Harold L. Robinson, U.S. Navy
- Rear Admiral Alan Steinman, U.S. Coast Guard
General Martin Dempsey – Chairman of the Joint Chiefs of Staff – agrees.
So does Admiral Cecil E.D. Haney, U.S. Navy, who is commander of the U.S. Strategic Command.
And Admiral Eric Olson, U.S. Navy, who was Commander of U.S. Special Operations Command.
- Secretary of Defense William Perry
- National Security Advisor Zbigniew Brzezinski
- National Security Advisor General Brent Scowcroft
- National Security Advisor Samuel Berger
- Secretary of State Madeline Albright
- Assistant Secretary of Defense and Chairman National Intelligence Council Joseph Nye
- Director for Iran, National Security Council and Deputy Coordinator for Sanctions Policy at the Department of State Richard Nephew
- National Security Council Member for Iran and the Persian Gulf Gary Sick
- Numerous additional high-level American defense, intelligence and diplomatic officials
Scores of top Israeli generals and intelligence chiefs endorse the deal as well.
So do 340 U.S. rabbis from across the political spectrum. And the majority of American Jews. And see this.
- The Next Leg Of The Commodity Carnage: Attention Shifts To Traders – Glencore Crashes, Noble Default Risk Soars
One month ago we asked:
Which will be first: Trafigura, Mercuria or Glencore
— zerohedge (@zerohedge) July 22, 2015
Today we got our answer.
Commodity trading giant Glencore may have top-ticked the commodity supercycle with its 2011 IPO, but it’s been downhill ever since (66% downhill to be precise if measured by the tumble in the stock price), culminating this morning when the Baar, Switzerland-based mining and commodity giant reported a first half net loss of $676 million, compared with net profit of $1.72 billion a year ago.
Revenue tumbled 25% to $85.7 billion after the company admitted China’s economic slowdown had caught the company “by surprise” and that no one in the mining industry “can read China” at the moment. The result: GLEN stock had plunged by 9% as of the last check, wiping out $3 billion in market value, and down a whopping 44% in the past three months, substantially underperforming its peers Rio Tinto (which Glencore once tried to acquire) and BHP Billiton.
In addition to the poor earnings, the company slashed both its operating outlook and its spending plans: Glencore said it expected trading, or what the company calls its marketing division, to post full-year earnings before interest and tax of $2.5 billion to $2.6 billion. Glencore Chief Executive Ivan Glasenberg had previously said he expected the trading division to generate $2.7 billion to $3.7 billion in full-year earnings before interest and tax “no matter what commodity prices are doing”.
It would appear what commodity prices are doing mattered after all.
Perhaps more concerning is that as a result of Glencore’s 29% EBITDA tumble to $4.6 billion the company’s default risk as measured by its CDS, had surged to the highest in over two years. The reason is that while the company has been deleveraging its debt load “somewhat” it appears not to be enough, and now fears have appeared that at this rate, Glencore may lose its investment grade rating soon. CEO Ivan Glasenberg hinted as much when during the conference call he said a a modest rating cut was manageable. “Even if we drop one notch, it isn’t a high cost to the company,” he said on the call. To many this sounded like a confirmation that a downgrade is imminent.
The company attempted to smooth over the damage when it said it lowered net debt by almost $1 billion to $29.6 billion, by reducing capital expenditure together with lower requirements for funding working capital at its trading business, adding that Glencore plans to reduce net debt to
$27 billion by the end of 2016, while maintaining its dividend-payment
plans.However, judging by the stock and CDS price chart below, it did not quite achieve the desired result.
The FT summarizes the company’s cap table, which is not pretty: “The value of the company’s shares has shrunk to £22bn, compared with net debt of $29.6bn excluding inventories of $17bn it says it can sell swiftly. Glencore aims to maintain dividends, which cost more than $2bn a year, alongside a ratio of net debt to earnings of under three times. At an estimated net debt level of $27bn, earnings of $9bn will be required in 2016.”
In other words, a dividend cut for Glencore now appears in the cards, and is virtually inevitable if copper, which is trading under $5000 at six year lows and is massively levered to how China’s economy dies, is unable to stage a bounce.That looks increasingly unlikely especially following the recent breach of copper’s 15 year support trendline:
Why copper? As Reuters reminds us, formerly just a commodities trader, Glencore merged with mining company Xstrata in 2013. The marketing business was seen as a plus in diversifying earnings of the combined company as its success was not so closely tied to commodity prices.
The price of copper, Glencore’s largest earner, is at six-year lows weighed down by a slowdown in China, one of the world’s biggest consumers of metals and other raw materials.
“We are still looking for growth in both copper and zinc production in the second half of 2015 and then continuing in 2016,” Kalmin told Reuters. “Those in particular are the two commodities that we see going forward fundamentally looking in much better shape than other commodities.”
Coal prices, another major commodity for Glencore, also show no sign of recovering due to a supply glut.
Yet despite the collapse in coal, copper and other commodity prices, Glencore has been slow to adjuts. Competitor Rio Tinto this month said it planned $1 billion in cost cuts this year and Anglo American is to cut thousands of jobs in the next few years and may sell assets. Analysts had expected deeper cost cuts by Glencore to ease the strain on its debt levels and protect its credit rating. However, perhaps in expecting yet another dead cat bounce, the Swiss company has so far avoided dealing with the looming commodity crunch. Its stock is reflecting that this morning.
Worst of all, however, is that while Glencore’s existing commodity exposure as a result of its miner “hybrid” nature may go up and down, its trading operation was supposed to be a natural hedge to deteriorating fundamentals: after all, commodity trading should be vibrant even when (and perhaps especially) prices drop. That also did not happen: the company’s trading division reported a 29% drop in first-half adjusted EBIT to $1.1 billion over the same period, lower than some analysts expected. According to the WSJ, the company blamed everything but itself for this disappointment:
Glencore blamed tough trading conditions, particularly in aluminum and nickel, as well as coal markets. A slowdown in Chinese economic growth caught the company by surprise, it said, restricting access to credit there and softening demand. All that squeezed trading profits.
The company’s agricultural-trading division also suffered, due in part to Russia’s unexpected imposition of a new Russian export tax in February. The only bright spot in trading was in energy, where volatility in the oil markets helped the company report a profit despite the slump in coal prices.
But the punchline came during the call when Glasenberg blamed “speculators”, not so much China, for the lower commodity prices. Of course, it goes without saying that when commodity prices were at record highs, it was all thanks to the fundamentals.
In any event, while the market remains focused on the miners, our warning from one month ago remains more relevant than ever: the real surprise will be the traders: the Glencores, Mercurias and Trafiguras of the world, who may indeed be quietly liquidating billions in paper commodity exposure.
And not just them: yesterday we noted the ongoing collapse in Asia’s largest commodity trader, Noble Group. This is the real canary in the Asian coal, and copper, mine. Judging by the ongoing blowout in Noble Group CDS, up another 48 bps since yesterday’s note…
… the pain in the commodity world may be about to get a whole lot worse especially if Noble Group suffer a liquidity/capitalization ‘event’ and is forced to liquidate any of its billions in commodity holdings.
It is at that point that we will see just how immune to the commodity carnage the US stock market truly is.
- ClusterF'ed: Bonds & Bullion Pumped While Stocks & Dollar Dumped
Seemed appropriate…
Let's start with a quick intraday across the major asset classes…
Surprise! Volume's back…
Quite a day for stocks… Something changed today!! No follow through on a post Fed pump…
Stocks on the week have been wild…
With all major cash indices red on the week…
Energy stocks atrting to catch down to reality…
VIX crashed to unchanged on the FOMC minutes only to rip back higher to 15…
Who could have seen this coming?
This is starting to worry us… Financials CDS is really starting to decouple…
The Treasury Complex was a mess – an inflation spike in yields after the CPI print, followed by a rally as stock dumped.. then a spike in yields on the leaked minutes followed by an aggressive bid…
The US Dollar held gains after the CPI print (after its flash crash) but started to wilt into the European close. The leaked minutes saw an itial pop then a big dump in the dollar (note the strength all day in Swissy)…
Commodities were very mixed. Silver screamed higher on the day and gold pushed on to new 1-month highs as Crude and Copper were crushed…
The October WTI contract was glued at the $40/$41 barrier intop the close after collapsing 4.7% on the day – its biggest drop in 7 weeks and lowest since March 2009 (when the Fed initiated QE1)
And Copper broke its 15-year trendline…
We leave you with the following from a St. Louis Fed vice President:
"A Taylor-rule central banker may be convinced that lowering the central bank's nominal interest rate target will increase inflation. This can lead to a situation in which the central banker becomes permanently trapped in ZIRP."
On that note…
Charts: Bloomberg
- The "Best Way To Play The Chinese Credit-Commodity Crunch" Is About To Pay Off Big
China’s upcoming (or already present) hard-landing and credit/commodity crunch should be no surprise to anyone: we have been previewing it since 2010, and – just like the upcoming crash in the S&P and all other “developed” mareets – was always just a question of when, not if.
However, knowing the endgame and trading it correctly, with the timing so uncertain, are two vastly different things.
To be sure, anyone who bet that the Chinese economic crash would lead to a plunge in the stock market, has long been bankrupted by China’s plunge protection aka “National” team, which unlike the Fed/Citadel spoofing/ETF buying joint venture, is hardly shy about making itself apparent.
Alternatively, playing the commodity crunch would have been a fool’s game until Saudi Arabia was politely asked by Kerry to crush Putin’s oil empire, and then decided to also destroy its biggest competitor, the marginal US shale producers, by fracturing OPEC and pumping so much oil that even the Saudis can no longer “make up for it with volume” and are now forced to issue debt to fund the country’s depleting fx reserves.
Which is why we remind readers that what may be best China crash trade, not only in terms of total possible profit, but the best trade in terms of upside/downside, was one we laid out in collaboration with Manal Mehta last March in an article titled, appropriately enough “Is This The Cheapest (And Most Levered) Way To Play The Chinese Credit-Commodity Crunch?”
Here are some excerpts of what we said 17 months ago in an article laying out Glencore CDS as the best way to trade the inevitable China blow up:
The economic slowdown in China is hammering prices of some raw materials, driving down industrial commodities from copper to iron ore and coal – exacerbated by the vicious cycle of credit-collateral-contraction. What is the cheapest way to play continued stress (with potentially limited downside)?
The diversified natural resources company Glencore has a huge $55 billion of debt, is drastically sensitive to copper (and other commodity) prices, and its CDS remains just off record tights.
Is Glencore the most exposed to a decline in commodities prices? – A trading giant rated BBB with over $55bn of debt and heavy exposure to commodities. A downgrade to below investment grade would be catastrophic to Glencore’s trading business.
Company’s 12/31/2013 presentation says a 10% decline in Copper Prices would reduce EBIT By $1.2bn!
As of 12/31/13, Glencore had $55.185 billion in Gross Debt.
By 3/12/2014, Copper has declined to a 44 month low, 12% decline in YTD 2014
Glencore reports Net Debt of $35.882bn, which is $55.2bn of gross debt minus $2bn of cash minus $16.4bn of “Readily Marketable Inventories.” Nowhere do they define what’s included in the Readily Marketable Inventories and whether or not the RMIs are hedged. The firm is still highly levered for investment grade even if RMIs can be converted into cash at stated value.
* * *
At 170bps and with 155bps as a floor for the last 6 months, it seems like a cheap protection play on further Chinese/Commodity contraction
To be sure, the fact that going long GLEN CDS had limited downside was by far the most appealing aspect of the trade. As for the maximum upside, well that’s the real question.
As we reported earlier today in “The Next Leg Of The Commodity Carnage: Attention Shifts To Traders – Glencore Crashes“, after sweeping the Chinese crisis under the rug, today – at long last – the first day of reckoning for Glencore emerged, leading to a 10% crash in the stock price following the company’s report of abysmal first half earnings and just as bad guidance.
But more importantly, after trading at what we postulated was the rough floor for the CDS at 150 bps for over a year, in the past month Glencore CDS have exploded higher, and at last check was trading 315 bps wide, about 150 wider from the March 2014 levels…
… with the likelihood of a major gap wider when the rating agencies downgrade the company from investment grade to junk, which in turn would trigger an unknown amount of cascading collateral calls and an accelerated liquidity depletion, which would then further hammer Glencore’s bonds, and as a result, send its default risk, and CDS, surging.
But even absent a credit-risk crashing downgrade, one can see that Glencore CDS is cheap when simply comparing it to the price of its most important commodity, copper.
As a reminder, and as we highlighted in 2014, a 10% drop in copper reduces Glencore’s EBIT by $1.2 billion. Copper, currently, is at six and a half year lows and has now broken its 15 year support line. What happens next for the “doctor” which has now lost all technical support is anyone’s guess.
But what is certain is that if the market realizes just how levered to copper Glencore truly is, and decides to price its bonds and CDS to account appropriately for the implied risk, then the one trade which over a year ago we said is the “cheapest and most levered” way to trade China’s “Credit-Commodity Crunch”, is about to pay off big as seen in the chart below.
So is 700 bps, or much wider, in the cards for Glencore CDS? We don’t know, but we would certainly take it.
- Keeping The Bubble-Boom Going
Submitted by Thorstein Pollett via The Mises Institute,
As The FOMC Minutes just showed, The US Federal Reserve is playing with the idea of raising interest rates, possibly as early as September this year. After a six-year period of virtually zero interest rates, a ramping up of borrowing costs will certainly have tremendous consequences. It will be like taking away the punch bowl on which all the party fun rests.
Low Central Bank Rates have been Fueling Asset Price Inflation
The current situation has, of course, a history to it. Around the middle of the 1990s, the Fed’s easy monetary policy — that of Chairman Alan Greenspan — ushered in the “New Economy” boom. Generous credit and money expansion resulted in a pumping up of asset prices, in particular stock prices and their valuations.
A Brief History of Low Interest Rates
When this boom-bubble burst, the Fed slashed rates from 6.5 percent in January 2001 to 1 percent in June 2003. It held borrowing costs at this level until June 2004. This easy Fed policy not only halted the slowdown in bank credit and money expansion, it sowed the seeds for an unprecedented credit boom which took off as early as the middle of 2002.
When the Fed had put on the brakes by having pushed rates back up to 5.25 percent in June 2006, the credit boom was pretty much doomed. The ensuing bust grew into the most severe financial and economic meltdown seen since the late 1920s and early 1930s. It affected not only in the US, but the world economy on a grand scale.
Thanks to Austrian-school insights, we can know the real source of all this trouble. The root cause is central banks’ producing fake money out of thin air. This induces, and necessarily so, a recurrence of boom and bust, bringing great misery for many people and businesses and eventually ruining the monetary and economic system.
Central banks — in cooperation with commercial banks — create additional money through credit expansion, thereby artificially lowering the market interest rates to below the level that would prevail if there was no credit and money expansion “out of thin air.”
Such a boom will end in a bust if and when credit and money expansion dries up and interest rates go up. In For A New Liberty (1973), Murray N. Rothbard put this insight succinctly:
Like the repeated doping of a horse, the boom is kept on its way and ahead of its inevitable comeuppance by repeated and accelerating doses of the stimulant of bank credit. It is only when bank credit expansion must finally stop or sharply slow down, either because the banks are getting shaky or because the public is getting restive at the continuing inflation, that retribution finally catches up with the boom. As soon as credit expansion stops, the piper must be paid, and the inevitable readjustments must liquidate the unsound over-investments of the boom and redirect the economy more toward consumer goods production. And, of course, the longer the boom is kept going, the greater the malinvestments that must be liquidated, and the more harrowing the readjustments that must be made.
To keep the credit induced boom going, more credit and more money, provided at ever lower interest rates, are required. Somehow central bankers around the world seem to know this economic insight, as their policies have been desperately trying to encourage additional bank lending and money creation.
Why Raise Rates Now?
Why then do the decision makers at the Fed want to increase rates? Perhaps some think that a policy of de facto zero rates is no longer warranted, as the US economy is showing signs of returning to positive and sustainable growth, which the official statistics seem to suggest.
Others might fear that credit market investors will jump ship once they convince themselves that US interest rates will stay at rock bottom forever. Such an expectation could deal a heavy, if not deadly, blow to credit markets, making the unbacked paper money system come crashing down.
In any case, if Fed members follow up their words with deeds, they might soon learn that the ghosts they have been calling will indeed appear — and possibly won’t go away. For instance, higher US rates will suck in capital from around the word, pulling the rug out from under many emerging and developed markets.
What is more, credit and liquidity conditions around the world will tighten, giving credit-hungry governments, corporate banks, and consumers a painful awakening after having been surfing the wave of easy credit for quite some time.
China, which devalued the renminbi exchange rate against the US dollar by a total of 3.5 percent on August 11 and 12, seems to have sent the message that it doesn’t want to follow the Fed’s policy — and has by its devaluation made the Fed’s hiking plan appear as an extravagant undertaking.
A normalization of interest rates, after years of excessively low interest rates, is not possible without a likely crash in production and employment. If the Fed goes ahead with its plan to raise rates, times will get tough in the world’s economic and financial system.
To be on the safe side: It would be the right thing to do. The sooner the artificial boom comes to an end, the sooner the recession-depression sets in, which is the inevitable process of adjusting the economy and allowing an economically sound recovery to begin.
- Momo No Mo' – BofAML Warns Stocks "Close To A Tipping Point"
Momentum traders – relying on the 'trend is your friend' theme – may have a rude awakening soon as momentum stocks trade at a stunning 50% premium to the market (vs an average 20%). As BofAML notes, high growth, high multiple names that have been leading the market over the past year are showing some signs suggest we are close to a tipping point. The growth-to-value spread is at its highest since the peak of the dotcom bubble in 2000 and, as Subramanian ominously notes, when momentum ends, it ends badly – with an average loss of 25% over the next 12 months.
Momentum stocks are now trading at about a 50% premium to the market, where the average has been closer to a 20% premium.
Via BofAML,
Mo’ and growth – are we done yet?
Of the factor groups we follow, price momentum and growth factors are outperforming by the widest margin this year, and are roughly neck and neck for the year – largely, because the two strategies represent the same stocks: high growth, high multiple names that have been leading the market over the past year. Some signs suggest we are close to a tipping point. Market breadth amongst the growth strategies we track is starting to narrow, with only one factor of five continuing to outperform in July. Valuations and flows, explored below, suggest further risks of a reversal. And it could be felt hard: as the market has narrowed, funds have doubled down on their winning bets, with the 10 biggest overweights now more overweight than ever.
Growth vs. value spread now highest since 2000
Another eerie sign that the end of momentum may be nigh: July’s outperformance of high secular growth names pushed the Growth / Value outperformance gap to 6.5ppt in the YTD, the widest gap for this point in the year since 2000, the year of the Tech Bubble peak. Meanwhile, buying inexpensive names has been a route to underperformance. July saw a further meltdown, with some valuation factors logging their worst returns this year: EV/EBITDA and Price/Book lost ~5% each and ranked in the bottom 5 screens.
When momentum ends, it ends badly: avg NTM loss of 25%
The outsized performance of 12-month momentum stocks has now pushed valuations of the winners to the highest levels we have seen since the financial crisis. Being priced for perfection renders the group even more vulnerable to a change in leadership. Momentum, by definition, tends to work very well until it breaks, but the magnitude of absolute and relative losses post-break has been extreme: from 1986 to now, cycle peaks in 12-month momentum have been followed by extremely weak momentum returns in the next twelve months: relative underperformance of 16ppt, and absolute losses of 25% on average.
Virtually nothing has worked better in this year's thinning equity market than momentum, where you load up on stocks that have risen the most in the past two to 12 months and hope they keep going up. Sent aloft by sustained rallies in biotech and media shares, concern is mounting that the trade has gotten too popular, setting the stage for sharper swings.
"In the past few years, including this year, there have been a lot of moments when trades have become crowded," said Arvin Soh, a New York-based fund manager who develops global macro strategies at GAM, which oversees $130 billion. "What's different is that the reversals that eventually come do tend to be more severe now than what we've seen over a longer-time horizon."
"The question is whether you're seeing the narrative change around biotech and it's causing that momentum trade to lose steam," said Grieves, a London-based portfolio manager at Miton, who runs the firm's U.S. Opportunities Fund. "The problem with momentum trades is that you have no margin of safety. When you get on the bandwagon, you shut your eyes to valuation."
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Crowded trades and thin liquidity… grab the popcorn…
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