Tag Archives: Deflation

Battle Of The ‘Flations’ Has Begun

Inflation? Deflation? Stagflation? Consecutively? Concurrently?… or from a great height.

We’ve reached a pivotal moment where all of the narratives of what is actually happening have come together. And it feels confusing. But it really isn’t.

How can we stuff fake money onto more fake balance sheets to maintain the illusion of price stability?

The consequences of this coordinated policy to save the banking system from itself has resulted in massive populist uprisings around the world thanks to a hollowing out of the middle class to pay for it all.

The central banks’ only move here is to inflate to the high heavens, because the civil unrest from a massive deflation would sweep them from power quicker.

For all of their faults leaders like Donald Trump, Matteo Salvini and even Boris Johnson understand that to regain the confidence of the people they will have to wrest control of their governments from the central banks and the technocratic institutions that back them.

That fear will keep the central banks from deflating the global money supply because politicians like Trump and Salvini understand that their central banks are enemies of the people. As populists this would feed their domestic reform agendas.

So, the central banks will do what they’ve always done — protect the banks and that means inflation, bailouts and the rest.

At the same time the powers that be, whom I like to call The Davos Crowd, are dead set on completing their journey to the Dark Side and create their transnational superstructure of treaties and corporate informational hegemony which they ironically call The Open Society.

This means continuing to use whatever powers are at their disposal to marginalize, silence and outright kill anyone who gets in their way, c.f. Jeffrey Epstein.

But all of this is a consequence of the faulty foundation of the global financial system built on fraud, Ponzi schemes and debt leverage… but I repeat myself.

And once the Ponzi scheme reaches its terminal state, once there are no more containers to stuff more fake money into the virtual mattresses nominally known as banks, confidence in the entire system collapses.

It’s staring us in the face every day. The markets keep telling us this. Oil can’t rally on war threats. Equity markets tread water violently as currencies break down technically. Gold is in a bull market. Billions flow through Bitcoin to avoid insane capital controls.

Any existential threat to the current order is to be squashed. It’s reflexive behavior at this point. But, as the Epstein murder spotlights so brilliantly, this reflexive behavior is now a Hobson’s Choice.

They either kill Epstein or he cuts a deal or stands trial and hundreds of very powerful people are exposed along with the honeypot programs that are the source of so much of the bad policy we all live with every day.

These operations are the lifeblood of the power structure, without it glitches in the Matrix occur. People get elected to power who can’t be easily controlled.

The central banks are faced with the same problem. To deflate is worse than inflating therefore there is no real choice. So, inflation it is. Inflation extends their control another day, another week.

Whenever I analyze situations like this I think of a man falling out of a building. In that state he will do anything to find a solution to his problem, grasp onto any hope and use that as a means to prolong his life and avoid hitting the ground for as long as possible.

Desperate people do desperate and stupid things. So as the mother of all Battles of the ‘Flations unfolds over the next two years, remember it’s not your job to take sides because they will take you with them.

This is not a battle you win, but rather survive. Like Godzilla and Mothra destroying the city. If Epstein’s murder tells you anything, there’s a war going on for control of what’s left of the crumbling power structure.

And since inflation is the only choice that choice will undermine what little faith there is in the current crop of institutions we’ve charged with maintaining societal order.

As those crumble that feeds the inflation to be unleashed.

For the smart investor, the best choice is not to play. Wealth preservation is the key to survival. That means holding assets whose value may fluctuate but which cannot be taken from you during a crisis.

It means having productive assets and being efficient with your time.

It means minimizing your counter-party risk. Getting out of debt. Buying gold and cryptos on program or on pullbacks. Most importantly, it means keeping your skills up to date and your value to your employer(s) high.

And if you’re really smart, diversifying your income streams to keep your options open.

Deflation and inflation are two sides of the same coin (or the same side of two coins). Both are just as destructive.

Source: by Tom Luongo, | ZeroHedge

What Turkey Can Teach Us About Gold

If you were contemplating an investment at the beginning of 2014, which of the two assets graphed below would you prefer to own?

https://www.zerohedge.com/sites/default/files/inline-images/1-gold.png?itok=RqzcFr6tData Courtesy: Bloomberg

In the traditional and logical way of thinking about investing, the asset that appreciates more is usually the preferred choice.

However, the chart above depicts the same asset expressed in two different currencies. The orange line is gold priced in U.S. dollars and the teal line is gold priced in Turkish lira. The y-axis is the price of gold divided by 100.

Had you owned gold priced in U.S. dollar terms, your investment return since 2014 has been relatively flat.  Conversely, had you bought gold using Turkish Lira in 2014, your investment has risen from 2,805 to 7,226 or 2.58x. The gain occurred as the value of the Turkish lira deteriorated from 2.33 to 6.04 relative to the U.S. dollar.

Although the optics suggest that the value of gold in Turkish Lira has risen sharply, the value of the Turkish Lira relative to the U.S. dollar has fallen by an equal amount. A position in gold acquired using lira yielded no more than an investment in gold using U.S. dollars.

https://www.zerohedge.com/sites/default/files/inline-images/2.1.png?itok=ZFZyUtVc
Data Courtesy: Bloomberg

This real-world example is elusive but important. It helps quantify the effects of the recent economic chaos in

This real-world example is elusive but important. It helps quantify the effects of the recent economic chaos in Turkey. Turkey’s economic future remains uncertain, but the reality is that their currency has devalued as a result of large fiscal deficits and heavy borrowing used to make up the revenue shortfall. Inflation is not the cause of the problem; it is a symptom. The cause is the dramatic increase in the supply of lira designed to solve the poor fiscal condition.

A Turkish citizen who held savings in lira is much worse off today than even two months ago as the lira has fallen in value. She still has the same amount of savings, but the savings will buy far less today than only a few weeks ago. Her neighbor, who held gold instead of lira, has retained spending power and therefore wealth. This illustration highlights the ability of gold to convey clear comparisons of various countries’ circumstances. It also illustrates the damage that imprudent monetary policy can inflict and the importance of gold as insurance against those policies.

Penalty

Using Turkey as an example also helps illustrate why we say that inflationary regimes impose a penalty on savers. Inflation encourages and even forces people to spend, invest or speculate to offset the effects of inflation. Investing and speculating entail risk, however, so in an inflationary regime one must assume risk or accept a decline in purchasing power.

Most people think of inflation as rising prices. Although that is the way most economists represent inflation, the truth is that inflation is actually your money losing value. Inflation is not caused by rising prices; rising prices are a symptom of inflation. The value of money declines as a result of increasing money supply provided by the stewards of monetary discipline, the Federal Reserve or some other global central bank.

This is difficult to conceptualize, so let’s bring it home in a simple example. If you live in a country where the annual inflation rate is a steady 2%, the value of the currency will decline every year by 2% on a compounded basis. At this rate, the purchasing power of the currency will be cut in half in less than 35 years.

Now consider a country, like Turkey, that has been running chronic deficits, printing money rapidly to make up a revenue shortfall, and begins to experience accelerating inflation. The annual inflation rate in Turkey is now estimated to be over 100% or 8.30% per month, a difficult number to comprehend. The value of their currency is currently falling at an accelerating pace so that what might have been purchased with 500 lira 9 months ago now requires 1,000 lira.

Put another way, for the prudent retiree who had 10,000 lira in cash stashed away nine months ago, the inflation-adjusted value of that money has now fallen to less than 5,000 lira.  If inflation persists at that rate, the 10,000 will become less than 1,000 in 29 months.

Believe it or not, Turkey is, so far, a relatively mild example compared to hyperinflationary episodes previously seen in Germany, Czechoslovakia, Venezuela, and Zimbabwe. These instances devastated the currencies and the wealth of the affected citizens. Fiscal imprudence is a real phenomenon and one that eventually destroys the financial infrastructure of a country. For more on the insidious role that even low levels of inflation have on purchasing power, please read our article: The Fed’s Definition of Price Stability is Likely Different than Yours.

Summary

There are over 3,800 historical examples of paper currencies that no longer exist. Although some of these currencies, like the French franc or the Greek drachma disappeared as a result of being replaced by an alternative (euro), many disappeared as a result of government imprudence, debauching the currency and hyperinflation. In all of those cases, persistent budget deficits and printed money were common factors. This should sound worryingly familiar.

Modern day central banks function by employing a steady dose of propaganda arguing against the risks of deflation and in favor of the benefits of a “modest” level of inflation. The Fed’s Congressional mandate is to “foster economic conditions that promote stable prices and maximum sustainable employment” but promoting stable prices evolved into a 2% inflation target. The math is not complex but it is difficult to grasp. Any number, no matter how small, compounded over a long enough time frame eventually takes on a parabolic, hockey stick, shape. The purpose of the inflation target is clearly intended to encourage borrowing, spending and speculating as the value of the currency gradually erodes but at an ever-accelerating pace. Those not participating in such acts will get left behind.

In the same way that rising prices are a symptom of inflation attributable to too much printed money in the system, deflation is falling prices due to unfinanceable inventories and merchandise pushed on to the market caused by too much debt. Contrary to popular economic opinion, deflation is not falling prices caused by a technology-enhanced decline in the costs of production – that is more properly labeled as “progress.” The Fed is either knowingly or unknowingly conflating these two separate and very different issues under the deflation label as support for their “inflation target”. In doing so, they are creating the conditions for deflation as debt burdens mount.

Gold, for all its imperfections, offers a time-tested, stable base against which to measure the value of fiat currencies. Accountability cannot be denied.  Despite the unwillingness of most central bankers to acknowledge gold’s relevance, the currencies of nations will remain beholden to the “barbarous relic”, especially as governments continue to prove feckless in their application of fiscal and monetary discipline.

Source: Authored by Michael Lebowitz via RealInvestmentAdvice.com| ZeroHedge

“It’s Foolish to Believe The Endgame is Anything But Inflation…”

Authored by Kevin Muir via The Macro Tourist blog,

I am going to break from regular market commentary to step back and think about the big picture as it relates to debt and inflation. Let’s call it philosophical Friday. But don’t worry, there will be no bearded left-wing rants. This will definitely be a market-based exploration of the bigger forces that affect our economy.

https://www.zerohedge.com/sites/default/files/inline-images/20180323-keith.png?itok=y_3ovh1C

One of the greatest debates within the financial community centers around debt and its effect on inflation and economic prosperity. The common narrative is that government deficits (and the ensuing debt) are bad. It steals from future generations and merely brings forward future consumption. In the long run, it creates distortions, and the quicker we return to balancing our books, the better off we will all be.

I will not bother arguing about this logic. Chances are you have your own views about how important it is to balance the books, and no matter my argument, you won’t change your opinion. I will say this though. I am no disciple of the Krugman “any stimulus is good stimulus” logic.

https://www.themacrotourist.com/img/posts/05/20180323-krugman.jpg

The broken window fallacy is real and digging ditches to fill them back in is a net drain on the economy. Full stop. You won’t hear any complaints from me there.

Yet, the obsession with balancing the government’s budget is equally damaging. In a balance sheet challenged economy the government is often the last resort for creating demand. Trying to balance a government deficit in this environment (like the Troika imposed on Greece during the recent Euro-crisis) is a disaster waiting to happen.

Have a look at these charts from the NY Times outlining the similarity of the Greece depression to the American Great Depression of the 1930s.

https://www.themacrotourist.com/img/posts/05/20180323-greece1.png

https://www.themacrotourist.com/img/posts/05/20180323-greece2.png

https://www.themacrotourist.com/img/posts/05/20180323-greece3.png

Now you might look at these charts and say, “Greece spent too much and suffered the consequences. Ultimately they will be better off taking the hit and reorganizing in a more productive economic fashion.” If so, you probably also still have this poster hanging in your room at your parent’s house where you grew up.

https://www.themacrotourist.com/img/posts/05/20180323-austrian.jpg

Personally, I don’t want to even bother discussing the possibility of this sort of Austrian-style-rebalancing coming to Western democracies. Yeah, it might be your dream, but it’s just a dream. I have Salma Hayek on my freebie list, but what do I think of my chances? About as close to zero without actually ticking at the perfect zero level. It’s not a “can’t happen,” but it’s certainly a “it’s not going to happen in a million years.”

Governments were faced with a choice during the 2008 Great Financial Crisis. Credit was naturally contracting, and the economy wanted to go through a cleansing economic rebalancing where debt would be destroyed through a severe recession. Yet, governments had practically zero appetite to allow this sort of cathartic cleansing to happen. Instead, they stepped up and stopped the credit contraction through government spending and quantitative easing.

I believe that government spending is not all bad, and at times, it plays an important role in our economy. I am a huge fan of Richard Koo’s work. When economies’ interest-rate policies become zero bound, governments are crucial in engaging in anti-cyclical spending. All debt is not bad. Take debt your company might issue for instance. Borrowing a million dollars to invest in capital equipment to make your firm more productive is a much different prospect than taking out a loan to engage in a Krugman-inspired-all-you-can-drink-party-headlined-by-the-Killers. Sure, the party sounds like fun, but it’s not going to benefit your firm past one night of excitement. Governments shouldn’t perpetuate unproductive pension grabs by workers, but instead actually spend money on infrastructure that will make the economy more productive. During the 1950s Eisenhower invested in the American highway system, helping America secure its place as the world’s most economically dominant country. Today that sort of infrastructure spending would be shouted down as irresponsible. Well, not continuing to invest in your country’s productive capacity is the irresponsible part.

The point is that not all spending is bad, but nor is all spending good. And even more importantly, government spending should be anti-cyclical. No sense spending more when your economy is rocking. Better to save the bullets to ebb the natural flow of the business cycle.

But I digress. Let’s get back to debt.

Creating debt is inflationary, while paying down debt is deflationary. That’s pretty basic.

The easiest way for me to demonstrate this fact is to look at an area where debt has been created for spending in a specific area. No better example than student loans.

Over the past fifteen years, inflation in college tuition has exploded. It’s been absolutely bonkers. Here is the chart of regular CPI versus tuition CPI.

https://www.themacrotourist.com/img/posts/05/20180323-cpi.png

But it should really be no surprise. If we add the student loan debt versus Federal debt series, it becomes clear that a tremendous amount of credit has been extended to students.

https://www.themacrotourist.com/img/posts/05/20180323-cpiversus.png

So let’s agree that credit creation is inflationary, and by definition, credit destruction should be deflationary.

Therefore when the market pundits that I like to affectionately call deflationistas argue that this next chart is ultimately deflationary, I understand where they are coming from.

https://www.themacrotourist.com/img/posts/05/20180323-percent.png

If you assume that this debt needs to be paid back, then it’s easy to understand their argument. When debt starts to contract and this chart heads lower, this will be deflationary. And if you assume that governments start to balance their books, then there is every reason to expect that future deflation is the worry, not inflation. After all, the money has already been spent. The inflation from that spending is already in the system.

I can already hear the deflationistas argument – over 100% of GDP is unsustainable therefore credit growth will at worst go sideways, but most likely actually contract in coming years.

Really? How about Japan?

https://www.themacrotourist.com/img/posts/05/20180323-japan.png

The same argument was made at the turn of the century when Japan was running a debt that was over 150% of GDP, yet they somehow managed to push that up another 80% to 230% without causing some sort of apocalyptic collapse.

Now before you send me an angry email about the moral irresponsibility of suggesting debt can go higher, save your clicks. I understand your argument. I am not interested in debating what should be done, but rather I am trying to determine what will be done. You might believe governments and Central Banks will gain religion and start conducting prudent and responsible policies. So be it. If you believe that, then by all means – load up on long-dated sovereign bonds as they will continue to be the trade of the century.

I, on the other hand, believe that Central Banks will continue printing until, as my favourite West Coast skeptic Bill Fleckenstein says, “the bond market takes away the keys.” And even when Central Banks are mildly responsible, politicians are sitting in the wings waiting to spend at any chance they get. Take Trump’s recent stimulus program. We are now more than eight years into an economic recovery, and he just pushed through one of the most stimulative fiscal policies of the past couple of decades. Regardless of where you stand politically regarding these tax cuts, there can be no denying they were much more needed in 2008 than today.

This is a long-winded way of saying that although I agree that the creation of debt is inflationary, and that the destruction of debt is deflationary, I don’t buy the argument that any sort of absolute amount of debt means the trend has to change. I don’t look at the 100% debt-to-GDP figure and worry that the US government will somehow institute deflationary policies to pay that back. Nope, I don’t see anything but a sea of growing deficits and debts. And in fact, the larger debts grow, the less likely they are to be paid back.

How will Japan pay back their debt that is 230% of GDP? The answer is that they can’t. It will be inflated away.

It’s foolish to believe that the end-game is anything but inflation. And even though increasing debt seems scary, if there is one thing that I am sure of, it’s that they will figure out a way to make even more of it.

Rant over. And no more big picture philosophy for a while – I promise.

Black Pilled Channel

Source: ZeroHedge

The ‘Dilemma From Hell’ Facing Central Banks

We present some somber reading on this holiday season from Macquarie Capital’s Viktor Shvets, who in this exclusive to ZH readers excerpt from his year-ahead preview, explains why central banks can no longer exit the “doomsday highway” as a result of a “dilemma from hell” which no longer has a practical, real-world resolution, entirely as a result of previous actions by the same central bankers who are now left with no way out from a trap they themselves have created.

* * *

It has been said that something as small as the flutter of a butterfly’s wing can ultimately cause a typhoon halfway around the world” – Chaos Theory.

There is a good chance that 2018 might fully deserve shrill voices and predictions of dislocations that have filled almost every annual preview since the Great Financial Crisis.

Whether it was fears of a deflationary bust, expectation of an inflationary break-outs, disinflationary waves, central bank policy errors, US$ surges or liquidity crunches, we pretty much had it all. However, for most investors, the last decade actually turned out to be one of the most profitable and the most placid on record. Why then have most investors underperformed and why are passive investment styles now at least one-third (or more likely closer to two-third) of the market and why have value investors been consistently crushed while traditional sector and style rotations failed to work? Our answer remains unchanged. There was nothing conventional or normal over the last decade, and we believe that neither would there be anything conventional over the next decade. We do not view current synchronized global recovery as indicative of a return to traditional business and capital market cycles that investors can ‘read’ and hence make rational judgements on asset allocations and sector rotations, based on conventional mean reversion strategies. It remains an article of faith for us that neither reintroduction of price discovery nor asset price volatility is any longer possible or even desirable.

However, would 2018, provide a break with the last decade? The answer to this question depends on one key variable. Are we witnessing a broad-based private sector recovery, with productivity and animal spirits coming back after a decade of hibernation, or is the latest reflationary wave due to similar reasons as in other recent episodes, namely (a) excess liquidity pumped by central banks (CBs); (b) improved co-ordination of global monetary policies, aimed at containing exchange rate volatility; and (c) China’s stimulus that reflated commodity complex and trade?

https://i2.wp.com/www.zerohedge.com/sites/default/files/images/user5/imageroot/2017/11/07/macquarie%20central%20banks.jpg

The answer to this question would determine how 2018 and 2019 are likely to play out. If the current reflation has strong private sector underpinnings, then not only would it be appropriate for CBs to withdraw liquidity and raise cost of capital, but indeed these would bolster confidence, and erode pricing anomalies without jeopardizing growth or causing excessive asset price displacements. Essentially, the strength of private sector would determine the extent to which incremental financialization and public sector supports would be required. If on the other hand, one were to conclude that most of the improvement has thus far been driven by CBs nailing cost of capital at zero (or below), liquidity injections and China’s debt-fuelled growth, then any meaningful withdrawal of liquidity and attempts to raise cost of capital would be met by potentially violent dislocations of asset prices and rising volatility, in turn, causing contraction of aggregate demand and resurfacing of disinflationary pressures. We remain very much in the latter camp. As the discussion below illustrates, we do not see evidence to support private sector-led recovery concept. Rather, we see support for excess liquidity, distorted rates and China spending driving most of the improvement.

We have in the past extensively written on the core drivers of current anomalies. In a ‘nutshell’, we maintain that over the last three decades, investors have gradually moved from a world of scarcity and scale limitations, to a world of relative abundance and an almost unlimited scalability. The revolution started in early 1970s, but accelerated since mid-1990s. If history is any guide, the crescendo would occur over the next decade. In the meantime, returns on conventional human inputs and conventional capital will continue eroding while return on social and digital capital will continue rising. This promises to further increase disinflationary pressures (as marginal cost of almost everything declines to zero), while keeping productivity rates constrained, and further raising inequalities.

The new world is one of disintegrating pricing signals and where economists would struggle even more than usual, in defining economic rules. As Paul Romer argued in his recent shot at his own profession, a significant chunk of macro-economic theories that were developed since 1930s need to be discarded. Included are concepts such as ‘macro economy as a system in equilibrium’, ‘efficient market hypothesis’, ‘great moderation’ ‘irrelevance of monetary policies’, ‘there are no secular or structural factors, it is all about aggregate demand’, ‘home ownership is good for the economy’, ‘individuals are profit-maximizing rational economic agents’, ‘compensation determines how hard people work’, ‘there are stable preferences for consumption vs saving’ etc. Indeed, the list of challenges is growing ever longer, as technology and Information Age alters importance of relative inputs, and includes questions how to measure ‘commons’ and proliferating non-monetary and non-pricing spheres, such as ‘gig or sharing’ economies and whether the Philips curve has not just flattened by disappeared completely. The same implies to several exogenous concepts beloved by economists (such as demographics).

The above deep secular drivers that were developing for more than three decades, but which have become pronounced in the last 10-15 years, are made worse by the activism of the public sector. It is ironic that CBs are working hard to erode the real value of global and national debt mountains by encouraging higher inflation, when it was the public sector and CBs themselves which since 1980s encouraged accelerated financialization. As we asked in our recent review, how can CBs exit this ‘doomsday highway’?

Investors and CBs are facing a convergence of two hurricane systems (technology and over-financialization), that are largely unstoppable. Unless there is a miracle of robust private sector productivity recovery or unless public sector policies were to undergo a drastic change (such as merger and fiscal and monetary arms, introduction of minimum income guarantees, massive Marshall Plan-style investments in the least developed regions etc), we can’t see how liquidity can be withdrawn; nor can we see how cost of capital can ever increase. This means that CBs remain slaves of the system that they have built (though it must be emphasized on our behalf and for our benefit).

If the above is the right answer, then investors and CBs have to be incredibly careful as we enter 2018. There is no doubt that having rescued the world from a potentially devastating deflationary bust, CBs would love to return to some form of normality, build up ammunition for next dislocations and play a far less visible role in the local and global economies. Although there are now a number of dissenting voices (such as Larry Summers or Adair Turner) who are questioning the need for CB independence, it remains an article of faith for an overwhelming majority of economists. However, the longer CBs stay in the game, the less likely it is that the independence would survive. Indeed, it would become far more likely that the world gravitates towards China and Japan, where CB independence is largely notional.

Hence, the dilemma from hell facing CBs: If they pull away and remove liquidity and try to raise cost of capital, neither demand for nor supply of capital would be able to endure lower liquidity and flattening yield curves. On the other hand, the longer CBs persist with current policies, the more disinflationary pressures are likely to strengthen and the less likely is private sector to regain its primacy.

We maintain that there are only two ‘tickets’ out of this jail. First (and the best) is a sudden and sustainable surge in private sector productivity and second, a significant shift in public sector policies. Given that neither answer is likely (at least not for a while), a coordinated, more hawkish CB stance is akin to mixing highly volatile and combustible chemicals, with unpredictable outcomes.

Most economists do not pay much attention to liquidity or cost of capital, focusing almost entirely on aggregate demand and inflation. Hence, the conventional arguments that the overall stock of accommodation is more important than the flow, and thus so long as CBs are very careful in managing liquidity withdrawals and cost of capital raised very slowly, then CBs could achieve the desired objective of reducing more extreme asset anomalies, while buying insurance against future dislocation and getting ahead of the curve. In our view, this is where chaos theory comes in. Given that the global economy is leveraged at least three times GDP and value of financial instruments equals 4x-5x GDP (and potentially as much as ten times), even the smallest withdrawal of liquidity or misalignment of monetary policies could become an equivalent of flapping butterfly wings. Indeed, in our view, this is what flattening of the yield curves tells us; investors correctly interpret any contraction of liquidity or rise in rates, as raising a possibility of more disinflationary outcomes further down the road.

Hence, we maintain that the key risks that investors are currently running are ones to do with policy errors. Given that we believe that recent reflation was mostly caused by central bank liquidity, compressed interest rates and China stimulus, clearly any policy errors by central banks and China could easily cause a similar dislocation to what occurred in 2013 or late 2015/early 2016. When investors argue that both CBs and public authorities have become far more experienced in managing liquidity and markets, and hence, chances of policy errors have declined, we believe that it is the most dangerous form of hubris. One could ask, what prompted China to attempt a proper de-leveraging from late 2014 to early 2016, which was the key contributor to both collapse of commodity prices and global volatility? Similarly, one could ask what prompted the Fed to tighten into China’s deleveraging drive in Dec ’15. There is a serious question over China’s priorities, following completion of the 19th Congress, and whether China fully understands how much of the global reflation was due to its policy reversal to end deleveraging.

What does it mean for investors? We believe that it implies a higher than average risk, as some of the key underpinnings of the investment landscape could shift significantly, and even if macroeconomic outcomes were to be less stressful than feared, it could cause significant relative and absolute price re-adjustments. As highlighted in discussion below, financial markets are completely unprepared for higher volatility. For example, value has for a number of years systematically under performed both quality and growth. If indeed, CBs managed to withdraw liquidity without dislocating economies and potentially strengthening perception of growth momentum, investors might witness a very strong rotation into value. Although we do not believe that it would be sustainable, expectations could run ahead of themselves. Similarly, any spike in inflation gauges could lift the entire curve up, with massive losses for bondholders, and flowing into some of the more expensive and marginal growth stories.

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While it is hard to predict some of these shorter-term moves, if volatilities jump, CBs would need to reset the ‘background picture’. The challenge is that even with the best of intentions, the process is far from automatic, and hence there could be months of extended volatility (a la Dec’15-Feb’16). If one ignores shorter-term aberrations, we maintain that there is no alternative to policies that have been pursued since 1980s of deliberately suppressing and managing business and capital market cycles. As discussed in our recent note, this implies that a relatively pleasant ‘Kondratieff autumn’ (characterized by inability to raise cost of capital against a background of constrained but positive growth and inflation rates) is likely to endure. Indeed, two generations of investors grew up knowing nothing else. They have never experienced either scorching summers or freezing winters, as public sector refused to allow debt repudiation, deleveraging or clearance of excesses. Although this cannot last forever, there is no reason to believe that the end of the road would necessarily occur in 2018 or 2019. It is true that policy risks are more heightened but so is policy recognition of dangers.

We therefore remain constructive on financial assets (as we have been for quite some time), not because we believe in a sustainable and private sector-led recovery but rather because we do not believe in one, and thus we do not see any viable alternatives to an ongoing financialization, which needs to be facilitated through excess liquidity, and avoiding proper price and risk discovery, and thus avoiding asset price volatility.

Source: ZeroHedge

What Does The Bank Of Canada Know That We Don’t?

“Unprecedented deflation are pushing rates down. However, investors are holding 1/3 outstanding shares of ETF | TLT short: Betting that rates will go up.”

Article and video commentary by Christine Hughes

In a totally unexpected move, the Bank of Canada cut the overnight interest rate by 25 basis points on Wednesday. This of course should make you wonder what the Bank of Canada knows that the rest of us don’t! I mean usually the Bank indicates a bias towards cutting interest rates, but this was just out of the blue. It signals that the oil shock on the economy is going to be a lot more significant than anyone expected.

The Canadian dollar dropped vs. the US dollar thanks to the surprise move. Gold and silver prices climbed on safe-haven demand. Canadian bond yields plunged. As per Bloomberg: “’It’s a big shock,’ David Doyle, a strategist at Macquarie Capital Markets, said by phone from Toronto. “They’re going to try to provide the necessary medicine here for the soft landing from slowing debt growth, from slowing investment in the oil sands, and I think they thought it needed some stimulus here.”

No one probably stands to hurt more from plunging oil prices than Alberta.

Energy companies have started cutting capital expenditure, and this means job losses, which means a slowing housing market. In fact, plunging oil prices have seen home sales in Calgary tumble 37% in the first half of January, compared to a year earlier. Prices dropped 1.5%. And active listings soared by nearly 65%.

As you can see in the chart below, while you may have thought Toronto was a hot housing market these past several years, you’d be wrong. It was Calgary.
jan21
What’s the most worrisome about this is that everyone thinks Canada’s mortgages are different than what caused the US housing market to blow up. Well, not exactly. See, mortgage standards vary by province, and things in Alberta don’t look good.

There are two types of mortgages Alberta can issue: recourse and non-recourse. In a recourse mortgage, the bank can cease your house, sell it, and you will still owe the remaining balance of your mortgage. In a non-recourse mortgage, the bank can seize your house, and you the borrower can walk away. If the asset doesn’t sell for at least what you owe, then the bank has to absorb the loss.

Below is a chart, courtesy of RBC Capital Markets, which outlines that 35% of all Alberta mortgages (by the big 6 banks) are non-recourse. They can walk away!  Pay attention to Royal Bank especially:
jan21
There’s definitely a reason why the Bank of Canada is very concerned! By Christine Hughes

  • If things are getting better, why do global rates keep falling?
  • To much debt is causing deflation.
  • US has the highest relative rates, hence where everybody wants to invest.