GLOBAL ECONOMY – DOWNCLIMBING
IS MUCH MORE DANGEROUS THAN UPCLIMBING
JANET YELLEN IS RIGHT.
In “Global economy – Quagmire & Quicksand” published in
January 2015, http://www.tremeritus.com/2015/01/21/global-economy-quagmire-quicksand-part-13/
I warned
- of stormy global economy and financial markets looming ahead.
- The strength of US recovery is running out of stamina moderated by rising US dollar.
And despite the strength of the US dollar, I asked this
pertinent searching question in closing comment – why is gold price so strong?
This is now playing out to full
illumination – turmoil, fear and even panic, griped financial markets since the
beginning of 2016. Two sudden Chinese Yuan devaluations in August 2015 and the
bursting of the Chinese equity market bubble since last June set the triggers.
Sharks roaming financial markets smell blood in the water. In just over 3 weeks
since January, over $8 trillions of asset values were wiped out in global
equity market rout. http://www.reuters.com/article/us-usa-economy-recession-idUSKCN0V01IF . This
bloodbath is continuing. Bank of America Merrill Lynch warned of elevated risks
of another US recession looming.
In Congressional testimony on 10
February 2016, Fed Chairwoman, Janet Yellen, warned of these risks ahead for
the US economy – rising borrowing costs, plummeting stock prices waiting to
discover a bottom. http://money.cnn.com/2016/02/10/news/economy/janet-yellen-testimony-congress/index.html. In fact,
she spoke not once but twice on the subject-matter of risks adversity strength
of the US dollar undercutting the fragile US economy recovery. http://www.federalreserve.gov/newsevents/testimony/yellen20160210a.htm. Yellen’s cautionary
stance blamed “subdued foreign growth” and “appreciation of dollar restrained
net exports”. The Fed’s estimated US 2015 GDP growth at a tepid 1.75%.
Financial conditions within US have become “less supportive of growth”.
What most market analysts missed,
perhaps forgotten, (but not financial market traders who dashed for the “sell”
door) are these dreaded foreboding words of last September ...“slowing Chinese
growth” and depressing commodities prices could “trigger financial stresses in
commodities exporting economies, particularly in vulnerable emerging economies”...their
flow-on effects pose detrimental risks to US economy forward. This is precisely
what is already happening now. Yellen in Sept 2015 press conference after her
Congressional testimony – in refusing to raise US interest rate – spoke of
“China” 16 times in less than an hour. http://money.cnn.com/2015/09/18/news/economy/china-yellen-global-economy-worry What has changed since September 2015?
Arguably,
worsen global economic conditions after a baby-step hike in US Fed fund rate
last December. And the US Dollar index, DXY, actually hit exhaustion close to
100 after the fact of event. Coincidentally, spot gold closed at US$1,071.81 an
ounce, near its lowest 2015 levels, on the relevant market day – thus rising
from charred disenchantment & transforming itself into a raging bull. Was
that a mistake of US Fed monetary policy of Yellen’s first stumble on a
dangerous terrain? At minimum, she either lost track of her September 2015
Congressional testimony or now preferred silence of that when the she testified
slowing China’s growth prospect has become the epicenter of global growth
narrative within the Fed, IMF, OECD, World Bank etc. http://www.tremeritus.com/2015/10/20/china-bond-market-are-quicksands-part-1/ and http://www.tremeritus.com/2015/10/22/china-bond-market-are-quicksands-part-2/ and http://www.tremeritus.com/2015/10/23/china-bond-market-are-quicksands-part-3/. This is
the first time Yellen acknowledges
- Fragility and timidity of US economic recovery below trend line benchmarks
- China and emerging economies pivoting play and negative feedback loops from these economies will be central to the sustainability of US economic recovery
- leaving US to be the last remaining bastion of global economic fortress
- US economy decelerated rapidly in the December qtr, the Fed mostly treading on the quicksand of US dollar appreciation & navigating increased volatility in financial market against a background of persistent weakness abroad, exacerbated concerns about global growth outlook.
WHAT ARE THE REALITIES?
Yellen spoke of “higher borrowing rates for riskier
borrowers” in the US – it is NOT an entirely new phenomena. Nor is it unique to
the US. Take a look at US corporate BBB
grade investment bond yield – it has been rising for nearly a year now despite
ample availability of near zero interest rate liquidity. It is now slightly
higher than 4.46% compared to 3.4% in March 2015. https://ycharts.com/indicators/us_corporate_bbb_effective_yield. Zero interest
rate policy (ZIRP) has not worked and central banks, globally, are in damage
control. Chinese have slowed down their money printing of stimulus spending.
Chinese President Xi warned at year beginning that “economic stimulus is ‘not the answer to nation’s
challenges....... China cannot rely on extensive development and strong stimulus to achieve
these targets, otherwise the country will repeat the old path, and then create
new contradictions and problems. Expanding investment could help boost growth, but ineffective
investment that brought no returns would eventually become bad debts, posing
financial risks to corporations and fiscal risks to the country.”http://www.scmp.com/news/china/policies-politics/article/1897719/chinas-president-warns-economic-stimulus-not-answer
Janet Yellen has yet to find a more
confident footing in pushing for normalisation of the Fed’s monetary policy. Credit
is tightening in some sectors such as housing and energy and no one knows who
is lending what amount to emergent economies, big oil or mining houses as
commodities prices got crushed. Recent equities sell-off slammed European banks
particularly hard, with banking shares diving deeper relative to broad market
indices fall. The sell-off in financials reflects investor’s risks adversity
flight to safe havens - investors preferring preservation of capitals rather
than trying to catch the bounce of earnings which slow economic growth finds
hard to discover. The iTraxx
Senior Financials index tracks the cost of credit default swaps (CDS) has
risen steeply last week though not quite to the level of fear-grip panic seen
in the Euro crisis. http://blogs.wsj.com/moneybeat/2016/02/09/surging-credit-risk-for-banks-is-becoming-a-major-issue-in-european-markets/
CDS which protect the investors
buying them against a company’s default, and this will add to the costs of
equity for European financial institutions. In an environment of negative
interest rate for deposits with central banks, the earnings of European banks
will be crushed notwithstanding risks of lending expanding. The risk-return
trade-off paradigm weighs against return.
Negative
rate, set by central banks in Europe, has spread to Japan. Banks across the
globe suddenly woke up to the realities that instead of providing liquidity in
tough times, protecting their own equity and capital must now take priority. On
razor thin margin spread between deposits and lending rates, banks find their
margins squeezed further having to pay central bank negative interest rate
penalty for their reserves deposits. Before that, risk across all asset classes
is already mispriced in unprecedented accommodative monetary policy as money
influx from quantitative easing finds its way into stock markets and other asset
bubbles. Banks know they have no backstop protection from central bankers from
financial market volatility when bubbles deflate. Corporate bonds saw their
prices falling but safe-haven bonds issued by UK & US government found
support. Plenty of money around, but fear of capital loss overrides in a sea of
overpriced assets.
GOLD’S STELLAR SURPRISE SURGE
Gold turned up a euphoric
performance in the face of global volatility. My last check at goldprice.org as
of February 11, 2016 reveals the gold price performance in different currency
mixes.
Against the weakening US dollar, physical gold rose 17.7% since
January 3. The yellow metal climbed 20.9%, 18.1%, 18.7% and 12.4% against the
Australian, Canadian dollar, Chinese Yuan and even the stronger Euro
respectively. Gold stocks fared much better taking analysts and market punters
by surprise. A look at the price charts of this list of Canadian gold stocks
reveals a majority of gold stocks bottomed-out well before this 2016 price
spike. http://www.miningfeeds.com/gold-mining-report-canada. Financial markets have appetite for gold stocks LONG
BEFORE this sudden forceful upturn in the bullion market – the strength of gold
was something which I alerted to in Global Economy – Quagmire & Quicksand
some 12 months ago. This is something Janet Yellen kept silent on.
Fundamentals alone cannot justify bullish gold sentiment even as
World Gold Council reported 4% growth in consumer demand, central bank demand
up 25% in the December 2015 qtr and for the first time since 2008, gold
production has fallen. In prior years of 2014 and 2015, geopolitical events
underpinned rally in gold price in the first qtr before it fizzled out. We saw
Russia’s annexation of Crimea in 2014 and Greece’s brinkmanship of “Grexit” in
2015. In 2016, is it going to be flight to “safe haven” in gold as even the US
dollar wilting, stock indexes worldwide collapsing over the concerns of health
of the global economy, hints of banking systemic contagion spreading, and
safe-haven 10 yr US Treasury hitting their low since 2012?
Or there might be no safe haven at all – merely the rotational
play of asset bubble bursting might see gold as the last bet on the gambling
table evaporating of its euphoric spasm of stretched valuations as investors
adjust to the realities of global recession. Unlike oil and gas, gold
production can’t be escalated modestly to meet with sudden surge in its
underlying commodity price. Stock price surge among some Australian gold producers
appears to defy logic and explanation. Bullion rise is too fast, too steep of
climb and stands in polar contrast to base metals and energy. Question must be
asked – is this sustainable much longer from here?
If one is to believe oil price is a good predictor of gold price
but not vice versa, the scripture written on the wall says deflation pressure
is stronger than inflationary pressure. That is the gold price rise is
temporary and global economy is, more likely than not, walking down the pathway
of subdued economic activity. At 1.75% annual growth rate of the US economy, the
FOMC cannot be sanguine of its targeted annual inflation rate of 2% over the
medium term. There is no demand pressure and declining energy prices is another
drag on inflation expectation in the short-term. Yellen testified in her
Congressional testimony that the US labor market, though much-improved, is
still operating below potential and housing demand is still significantly short
of demographic prediction.
GLOBAL ECONOMY DECELERATING TOGETHER IN LAST QUARTER
Economy
activity in the world’s three largest economy decelerated in the final qtr of
2015 and it was second shrinkage in 3 qtrs for the Japanese economy. http://www.marketwatch.com/story/japans-economy-shrinks-again-abenomics-in-doubt-2016-02-14
. The economic credentials of “Abenomics” are in tatters. Shinzo Abe has been
monkeying around with his unorthodox economic policy construct since December
2012. Economists may point
to a “better” Eurozone growth of 1.5% last year compared to 2014 but that had
the benefit of weaker Euro/dollar exchange battering US exports and economy.
The Eurozone economy demonstrated no “escape velocity” of growth recovery long
past ECB President, M. Draghi’s brave threat in July 2012 of “Within our
mandate, the ECB is ready to do whatever it takes to preserve the euro. And
believe me, it will be enough” in dealing with the debt crisis and turning its
economy around. http://www.telegraph.co.uk/finance/financialcrisis/9428894/Debt-crisis-Mario-Draghi-pledges-to-do-whatever-it-takes-to-save-euro.html.
So there you have it – “Abenomics” is a failing demand-side
economic experiment since December 2012, moving into new experiment with
negative interest rate supply-side economics. And “Draghi-nomics” is sinking
with this admission to the European Parliament this week from its principal
architect, no less. http://www.kitco.com/news/2016-02-15/ECB-chief-parts-of-Europe-banking-system-face-challenges.html.
In a week of violent swings in the stock prices of major European banks
including Credit Suisse, Deutsche Bank and
Societe Generale, the European parliament was reminded that some EU banks are
still battling with challenges from litigation and restructuring costs as well
as working off soured investments. Of course, Draghi spoke nothing of rising
credit defaults swaps and market pressures on major EU banks to buy back their
“contingent convertible bonds (also known as “cocos”” bonds) underlining
investors’ growing fear of these banks lending exposures to commodities
business, commodities export-dependent emerging economies, financially-strapped
EU sovereigns and vulnerability to even risks of sell-off among sovereign
wealth funds of their investment holdings. I believe Draghi’s European
parliamentary testimony understated the extent and balance sheet risks of EU
banks’ exposure to “soured investments”.
Post the GFC
period, monetary policy from the ECB is the only truly stimulative policy over
the last 4 years – Draghi noted. And, in the case of the US and China, monetary
stimulus, prevailing over the last 7 years. Draghi was silent that monetary
stimulus is proven ineffectual of its intended objectives. Yet, he has already
hinted of even more dosage of quantitative stimulus in March in the face of
destabilised global stock market, Chinese slowdown and continued tumbling of
commodities prices. http://www.ft.com/cms/s/0/1bf80430-c03d-11e5-846f-79b0e3d20eaf.html#axzz40Kox5VMR. “We are not surrendering in front of
these global factors” evidenced how defensive ECB has become of a failed
macroeconomic policy construct. Meantime, Morgan Stanley warned that negative
interest rate experiment is dangerous. http://www.marketwatch.com/story/negative-interest-rates-are-a-dangerous-experiment-warns-morgan-stanley-2016-02-17?dist=beforebell
ANOTHER EUROPEAN BANKING CRISIS LOOMING?
Who knows if
another EU banking crisis is lurking on the horizon – no matter what the ECB
promises to do of “whatever it takes”? A little known besieged Portuguese bank,
Novo Banco, could have lit the proverbial prairie fire. With the ease of keyboard stroke precision, it
simply deleted the “pari passu” (equal footing) ranking of all creditors to
unilaterally decide who gets what back of its debt borrowing. http://www.derivalert.org/news/?Tag=Novo+Banco+SA . The fear that creates must be who are
the next “Lehman Brothers” ghosts of re-incarnation among EU banks. It is hard
to know who is exposed to who and what amount and “cocos bond” of European
banks might be just another worthless piece of sanitary paper i.e. the legal
document defining the terms of the bond issue might count for nothing – the
debtor decides the fate of all those who invested – just like Novo Banco’s fait
accompli. http://www.forbes.com/sites/petertchir/2016/02/06/what-is-happening-to-european-banks/#172f5cf05b2f
The GFC of 2008 tells us no bank
is too big to fall – the bigger the bank, the heavier of fall of impact,
perhaps.
The latest
dismal EU banking results speak volume of intense margin pressures and that
will intensified as negative interest rate set by central banks adding to their
woes. In distressed environment, EU banks are absorbing the cost of negative
interest rate - too fearful to pass on their increased costs of equity to
customers. Since February 2015, most highly-rated non-financial corporate like
Nestle can easily offer “negative yield” bond rather than seeking bank
financing. http://www.ft.com/intl/cms/s/0/4b5c16a8-abcb-11e4-b05a-00144feab7de.html#axzz40Kox5VMR
Over in the US, Anheuser-Busch InBevNV did a US$46 billion bond issue in January
2016. Apple plans to issue US$10 to US$12 billion to finance share buybacks and
dividends. http://www.marketwatch.com/story/apple-to-issue-10-billion-to-12-billion-of-bonds-to-finance-share-buybacks-dividends-2016-02-16
. Other corporate like IBM are next in the queue. The inevitable follows must be crushed earning for banks aggravated by
intensified risks lending to financially-weaker borrowers.
Negative interest
rate policy is a desperation “crisis policy” of paying your banker to save
because traditional tools of monetary policy no longer work.
By the end
of 2015, roughly one-third of the debts, some as long as 6 yrs duration, issued
by EU sovereigns had negative yield. http://www.bloombergview.com/quicktake/negative-interest-rates The Bank of Japan surprised the world on
January 29 by adopting a negative interest-rate strategy. It is uncharted
waters of monetary policy in experimentation. A sea change in the banking world
is evolving with commercial banks finding no support of refuge from central
banks navigating macroeconomic monetary policy of its sovereign in command.
Banks used to be a warehouse of assets (good, bad or doubtful values) and a
provider of liquidity in distressed financial market conditions but they can no
longer afford or able to – this is the ultimate damage of negative interest
rate strategy. EU banks might be too fearful to lend. http://www.smh.com.au/business/markets/what-the-experts-wont-tell-you-about-last-weeks-market-turbulence-20160213-gmtijz.html
With
investors’ support diminishing of prospective capital raisings of lower quality
bond issuers evaporating, which banker is stepping forward to fill this credit
shortage? And, after Nova Banco, who is going to be the next investor buying EU
banks’ next “cocos bond” offering, in distress of their collapsed share prices?
What if negative interest rate strategy backfires, sending EU banking system
into a tailspin and its economies tumbling into a deflationary spiral?
IS THE US
ECONOMY QUITE SOUND?
Janet Yellen
was more “confident” of survival probabilities statistical analysis on December
16, 2015 (when the Fed raised 25 basis points on its lending rate)…… “but
the underlying health of the U.S. economy I consider to be quite sound. I think
it’s a myth that expansions die of old age. I do not think that they die of old
age. So the fact that this has been quite a long expansion doesn’t lead me to
believe that it’s one that has—its days are numbered…….. a lot has changed
since pre–financial crisis in terms of the financial system…” http://www.federalreserve.gov/mediacenter/files/fomcpresconf20151216.pdf.
I didn’t see Yellen so confident on February 10, 2016, less than 2 months
later. What has changed?
For one thing, the sustainable long-term growth rate
pre-financial crisis is 3% GDP growth per annum, the US struggled to reach
1.75% in 2015. And the US economy quite sound if you believe the soothing assurances
of Yellen of December 16 last year? Lumber price is languishing at the bottom,
back to 2012 levels. http://www.nasdaq.com/markets/lumber.aspx?timeframe=7y.
Weyerhaeuser (WY) reported on February 5, 2016 a lower 2015 sales turnover and
forecasting a modest-to-lower outlook forward. http://investor.weyerhaeuser.com/2016-02-05-Weyerhaeuser-reports-fourth-quarter-full-year-results. WY is bellwether of US housing sector. https://www.youtube.com/watch?v=udjyZ9F6qn8
Toll Brothers Inc, the largest builder
of luxury homes in US, reported stagnant gross margin - excluding interest and impairments - was 25.9% in 2015,
compared to 25.3% for FY 2014. http://globenewswire.com/news-release/2015/12/08/793702/10158087/en/Toll-Brothers-Reports-4th-Qtr-and-FYE-2015-Results.html?parent=792696. There is no price leverage even for builders of
luxury homes. This is despite lower unemployment,
increasing home equity, rising real personal income attribution made by Janet
Yellen.
With US
nationwide housing starts currently running at 1.1 million units annually, it
is still a long way from historical past. http://www.federalreserve.gov/mediacenter/files/fomcpresconf20151216.pdf
Yellen is correct in February on
her assessment of the “progress” in US new homebuilding since pre-financial
crisis period .It “remains well
below the longer-run levels implied by demographic trends” she said.
Bank of
America analysts noted that the fourth-quarter earnings season, currently
wrapping up, is shaping to be the worst quarter for earnings growth since the
financial crisis. http://www.marketwatch.com/story/this-is-the-worst-quarter-for-company-earnings-since-2009-2016-02-16?dist=tbeforebell The recovery in US economy is feeble, shallow,
its interest-sensitive housing sector remains fragile and the strength of the
US dollar adding to external vulnerability more than the positive offset of
cheaper import prices including energy. Already, the 10-yr treasury yield is
flashing warning signs of a US looming deep recession – unless this security is
“significantly mispriced”. http://www.marketwatch.com/story/heres-why-the-fed-not-the-market-might-be-right-about-a-recession-2016-02-18. That is to say, the collective
financial market is wrong and the Fed’s (read Yellen’s) optimism is right.
GOLDMAN SACHS
– BETTING GOLD OR ECONOMY?
High profile
market watchers are rethinking their assumptions and reworking their economic
calculus of the US economy. Goldman Sachs (GS) for one is a case in point. GS
backs away from 5 of its 6 big market calls so early in the year. http://www.marketwatch.com/story/how-to-react-when-a-goldman-sachs-backs-away-from-its-big-calls-so-early-in-the-year-2016-02-10?siteid=bigcharts&dist=bigcharts
one need to remember GS had been over extended of its optimistic forecast on
the US economic recovery in both 2014 and 2015 – for two consecutive years.
Betting against gold in 2014, Jeffrey Currie, Global Head of GS commodities
research, confidently asserted... “Our view there really is driven by the expectation of the
U.S. economy reaching escape velocity.” http://www.cnbc.com/2014/01/13/gold-to-tank-in-2014-goldman-sachs.html In 2015, GS’s Jan Hatzius forecast a US GDP
growth of at least 3% “above trend” as the Fed moves to exit the economy’s
dependency on QE. http://qz.com/316118/macroeconomic-outlook-for-2015/. We know and Janet Yellen
have pencilled in a US GDP growth of 1.75% for 2015 – well below trend line.
GS
was bearish on gold in 2014/2015 but again both were “wrong” of its bearish
bias. The Crimean war in 2014 and “Grexit” down to the wire challenge defeated
GS’s bearish forecast. Of course, GS is still stoic of its bearish conviction
on gold in 2016. They are recently forecasting the Fed will raise interest rate
3X by 25 basis point each time and maintaining their analysts’ December 2015
forecast that bullion will trade at US$1,000 per oz by end of 2016. http://www.bloomberg.com/news/articles/2016-02-09/goldman-is-no-believer-in-gold-rally-as-fed-to-hike-three-times.
So far, up to the date of this writing, bullion staged an unprecedented
euphoric rise contrary to most high profile market watchers. Uncertainty of how
hawkish then of the Fed will be in raising interest rate sidelined confidence
in gold – warned Barrons on 2 January 2016. http://www.newsmax.com/Finance/StreetTalk/Barron-s-Gold-Likely-to-Stay-Tarnished-in-2016/2016/01/02/id/707918/
Many fast-paced traders short found themselves short-covering in panic and this
rally is without any help from any specific geopolitical event unlike 2014/2015
except the global stock market rout hitting hardest on banking stocks and what
appears to be a potential forming systemic crisis of confidence ravaging banks
in EU, US and parts of Asia. This turmoil is continuing.
Yet GS adamantly said this week yet again – sell gold now as
recent rally isn’t justified - of irrational fear entrapment. Its global head
of commodities, Jeffrey Currie, urged
- “As we maintain our view of rising U.S.
rates and hence lower gold prices with a 3-month target of $1,100 an ounce and
12-month target of $1,000 an ounce, we are recommending shorting gold,” – it is
fascinating. http://www.marketwatch.com/story/sell-gold-now-as-recent-rally-isnt-justified-says-goldman-sachs-2016-02-16?dist=lcountdown . This writer
took a quick check on VIX - CBOE volatility index – as a proxy barometer of
market fear factor – it has spiked up twice since December 2015 and has already
subsided. http://bigcharts.marketwatch.com/quickchart/quickchart.asp?symb=vix&insttype=&freq=1&show=&time=6.
Is GS too late of this gold (but not gold equities
apparently) shorting recommendation? The extreme price volatility of Australian
gold stocks in positive territory this morning (17 February, 2016) contrasting
the extreme negative volatility of Canadian gold stocks overnight speaks volume
of deep global divisions among gold equity investors in this narrow investing
space. Bullion price had declined 2.94% and silver fallen 3.45% overnight in
North American trading. It is to be remembered that bullion is “spot” trading
and gold equities investing discounts forward of much further outlook years out
of both gold price and the gold miners. Glencore recently raised over US$800
million in funding from Franco-Nevada selling its future precious metal streams.
http://www.mining.com/glencore-to-sell-gold-and-silver-to-franco-nevada-in-500-million-deal/ and
Evolution Mining (EVN) in its December qtr sold forward 726,394 oz of its 2016
budgeted 800,000 oz production at A$1,589 per oz contrasting last week’s peak
A$1,753 per oz. http://www.asx.com.au/asxpdf/20160127/pdf/434l5rdsj8gzrn.pdf. EVN’s
market capitalisation (exceeding a staggering A$3 billion last week) had been
rising strongly signalling that its buyers are expecting gold price to reach
beyond A$1,753 per oz (or US$1,245 per oz) in 2017 and beyond. St Barbara
Mines, unhedged of FY 2017 production and beyond, also showed up a stellar
performance despite having its share price already risen 20X since November
2014 without the benefit of any exploration success. https://sg.finance.yahoo.com/echarts?s=SBM.AX#symbol=SBM.AX;range=5y Either GS or
investors of gold equities in Canada and Australia are right of their gold
forecast but it can’t be both. Is GS betting on a stronger recovery despite turbulence
in destabilised financial markets and global economies decelerating in
synchronisation?
NEGATIVE INTEREST RATE POLICY – AN EXCHANGE RATE DISGUISED DEVALUATION?
Beyond GS’s pessimistic look at gold relative to global economy bet in
contrast, other bankers/economists are searching hard for angles to interpret
economic statistics. Intense deep division of conflicted opinions exists even
within same financial institution flood the debating space. Citigroup’s William
Lee, Head of North American economics, views any talk of possible US recession
is “ridiculous” as market, in his informed opinion, can no longer appropriately
allocate risks. https://sg.finance.yahoo.com/video/citigroups-lee-u-recession-fear-115734669.html;_ylt=AuqFPDSbBaGRsXA_drJF.
Only 5 days earlier, global strategists within Citigroup in contrast warned the
global economy seems trapped in a “death spiral”. http://www.cnbc.com/2016/02/05/citi-world-economy-trapped-in-death-spiral.html.
Jose Vinals, Director - monetary and capital markets – IMF told Bloomberg
news that negative rates could even go lower. http://www.bloomberg.com/news/videos/2016-02-11/imf-s-vinals-interest-rates-could-go-even-more-negative.
The danger is the spread of negative interest rate strategy degenerate into a
capricious tool of disguised competitive currency devaluations destabilising
global banking system. The impact of currency intervention via negative
interest rate policy tool is similar to monetary easing. As Jose Vinals warned
correctly it is a struggle of choice of two lesser evils – without quantitative
easing, we might not even have today’s global financial architecture though
barely working and with the accommodative monetary policies since post-financial
crisis, we now have to handle its unfathomable moving consequences in the
aftermath. There is big tantrum ahead looming for global financial stability –
EU, Japan, China and US included. http://journal.georgetown.edu/the-outlook-for-global-financial-stability-five-minutes-with-jose-vinals/
China is the key for the world, according to Jose Vinals.
2016 will be a challenging year for China – ardent China
bulls agree on this forecast even as they battle to outdo each other of
rationalising soapy sell of what is really a dismal outlook forward – their
colliding logic offered (to me at least) is as bewildering as unconvincing.
Look at this from Yale economist, Stephen Roach – “The
slowed growth rate is a reflection of the structure shift in the Chinese
economy, away from manufacturing and construction to services. For any economy,
it means a slower growth; China is not an exception........ The growing service
sector can't completely compensate the declining industry sector. The important
thing is service sector can compensate a large portion of reduced employment
from industry sector. It's more important than GDP”. http://en.ce.cn/main/latest/201602/13/t20160213_8825037.shtml.
As Stephen Roach acknowledged correctly, Chinese industry, being restructured,
had been hit by weak global demand and lagged impact of the Yuan’s appreciation.
Chinese exports to Australian, Canadian, Brazilian, S.African and even EU
markets are challenged by huge devaluations of these currencies relative to the
strong US dollar which Chinese currency closely pegged to.
In similar parallel of observations, Song Yu, Beijing-based chief China economist at Goldman Sachs Gao Hua
Securities - the best overall forecaster of China's economy according to
Bloomberg Rankings for the past two years - spoke of overvaluation of the
Chinese Yuan, predicting a 7% devaluation in 2016 and another incremental adjustment
of 0.3% for 2017. http://www.smh.com.au/business/markets/no-need-to-panic-as-china-growth-slows-says-goldman-20160217-gmwy6a.html
This writer is unconvinced of the
magnitude of the suggested slightly over 7% plus Yuan adjustments forward for
many reasons. Relative to major currencies, the US dollar have appreciated
close to 20% in two years as measured using the US Dollar Index. http://bigcharts.marketwatch.com/quickchart/quickchart.asp?symb=dxy&insttype=&freq=1&show=&time=9 . The Chinese has a lot of devaluation
catch-up to do to restore its former competitive equilibrium. Slump in
factory gate prices extends to record length of 47 months as China’s economy
slows. http://www.scmp.com/news/china/economy/article/1913819/slump-factory-gate-prices-extends-record-length-chinas-economy The alternative is Chinese industries,
going through restructuring, might collapse faster than the restructuring
process allows them of continued survival fight. The risk is incomplete
restructuring imbalance with grave enduring consequences for China and the rest
of global economy.
As if not
enough of complexity - to make the Chinese elephant rhythmically dancing
according to the restructuring tune of global economy in turmoil is a big
difficult ask. Like I often said in blog comment, completion of a successful
mammoth restructuring of this scale and complexity requires a deft hand of
economic expertise and a miracle global economy backdrop. http://www.tremeritus.com/2016/02/05/chinas-fall-and-the-hard-landing-in-singapore/.
The former I am less confident because of China’s lack of long experience in
full opening-up and Chinese comprehension of the intricate processes of
continual adjustment, integration and adaptation to a fast shifting globalized
economy. And the latter, a haunting ghost, in rebuke of what is really now a
world economy in violent turbulence. Negative interest rate, a giant monetary
experiment, is wreaking havoc to banking systems and global economy.
The pressure is right at the doorstep - as Chinese imports plunged 18.8 per
cent in January from a year earlier in US dollar terms and exports dropped
11.2 per cent. Song Yu confessed as much of difficult synchronisation of
structural re-balancing from industry/infrastructure dependency to a
consumption-led counterweight, and in Song Yu’s optimistic words - even though
full-year growth will drop to 6.4 per cent in 2016 as wages, employment and
consumption "take a hit" - but it won’t leave dire consequences. In
equal confidence, UBS’s Wang Tao poured cold waters on China’s “super bears” presumably
George Soros, Kyle Bass, Jim Chanos and the likes of those adherents shorting
the Chinese Yuan believing the gloomy predictions of impending collapse of the
Chinese banking system. Dr. Wang Tao, has this confident retort and prediction....... While we acknowledge the seriousness
of challenges facing the Chinese economy and exchange-rate regime currently, we
don't think it as bad as some believe. http://www.marketwatch.com/story/ubs-thinks-super-bears-are-wrong-about-china-2016-02-16.
Wang Tao’s bottom-line assurance to all grizzly bears – China, according to
her, will simply “muddle through” as its
economy slows but there won’t be a cataclysmic meltdown that some China bears
will be counting on will materialise. It is interesting that economist Wang Tao
also disputed the size of risks insolvency exposures within the Chinese banking
system – offering two divergent amounts of derivations. Dr Wang Tao also denied
the relevance of FX transaction should China’s need to use of its huge
financial reserves in bailing out its banking system.
Acknowledging these wide divergent
views, this writer does not comprehend why the Chinese foreign reserves
dwindled in recent months to US$3.23 trillion in January – it’s lowest since
2012. http://www.scmp.com/news/china/economy/article/1912819/central-bank-neither-god-nor-magician-chinas-central-bank-chief Haven’t PBOC been active,
selling its US treasuries and for whatever reason/s? If the Yuan is not
overvalued needing adjustment which Song Yu agrees with China bears, in
contrast, one would find it difficult of explanation of Chinese off-shore banking
activities in relation to supporting the Yuan exchange rate like this. https://www.bullionvault.com/gold-news/yuan-squeeze-020520161.
These defensive exercises, even if temporary, are expensive and pundits in the
gold market have noticed.
China face three bubbles – stock market bubble, real estate
bubble and a debt bubble infecting its banking system. The stock market bubble
has burst and another economist has this warning of real estate bubble
bursting. https://sg.finance.yahoo.com/video/chinas-economy-real-estate-export-100602943.html. Can the Chinese economy sustain a twin bubble
bursting in quick succession? As China's manufacturing sector
stalls, is the world's second-largest economy relying on a more dangerous
growth engine: debt? http://money.cnn.com/2016/02/17/investing/china-debt-gets-bigger/index.html?iid=obnetwork.
Piling debt on top of debt is easy upclimbing of fabricating a risks mountain
of glossy infrastructure and urbanized architecture but the deleveraging
downclimbing when the economy slows to grinding slowdown is far more dangerous
of risks consequences. You often can’t see the terrain and the bottom on the
way down except knowing the steep slope is likely to be treacherous. Is it
going to be as Dr Wang Tao put it – the art – of simply “muddling through” the
unknown and uncertainty?
Central Banks watch helplessly as global equity market rout intensified
since January – not even keeping the global financial system on an even keel if
it can’t solve economic woes. BOJ Governor, H. Kuroda called on major economies
to find ways to stabilize financial markets when they due to meet later this
month. http://www.marketwatch.com/story/bojs-kuroda-calls-for-global-action-on-volatility-2016-02-18.
In breaking his silence on Yuan’s external parity, PBOC Governor, Zhou Xiaochuan,
set the perspective right – central bank is neither god or a magician who can
turn uncertainties into certainty. Global growth in 2015 is at its weakest
growth in 5 years. http://business.financialpost.com/investing/oecd-downgrades-global-growth-says-worlds-economy-needs-urgent-fiscal-response-from-governments
Central banks cannot change the dynamics of business cycle
nor can government. Never mind the Keynesian economic corpses or the monetarist
“devils” or variants of those adherents, Professor Krugman’s “liquidity trap” formulation did captured how excessive debt leverage have
imprisoned the recovery of the Japanese economy for decades leaving a trail of
enduring damaging impact. http://www.marketwatch.com/story/2-things-we-havent-learned-since-the-2008-financial-crisis-2016-02-17.
Monetary policy just isn’t as powerful of macro-economic tools as many
economists once believe. We witnessed an unprecedented level of monetary
expansion post GFC. The result of this gigantic monetary experiment? A stagnant global economy and arguably the
most feeble, uneven, volatile recovery in modern economic history. In finality
of glaring clarity, the Fed and the ECB have been around for decades, haven’t
we seen enough of recessionary cycles in their presumed watchful nursing care?
THE PERILS OF NEGATIVE
INTEREST RATE POLICY
Stephen Roach wrote an incisive piece on how negative
interest rate policy is setting the stage for the next financial crisis. http://www.marketwatch.com/story/negative-interest-rates-set-stage-for-next-crisis-stephen-roach-says-2016-02-18.
In it, he itemised two serious complications.
- Central banks ignored the risks of financial instability
- Politicians drawing false comfort from frothy asset markets are less inclined to fiscal policy measures in supplement, closing the last escape route of failed accommodative monetary policy.
Central banking, having lost its way, is in crisis. Can the
world economy be far behind? He asked. I believe Stephen Roach have answered
his own question already. The world, in his words....
— remain
stuck in an eight-year quagmire of just 1.5% average real growth. Even worse is
the eurozone, where real GDP growth has averaged just 0.1% over the 2008-2015
period.
PUMPING OXYGEN TO RESUSCITATE A GLOBAL ECONOMIC CORPSE?
Are
central bankers pumping oxygen to resuscitate a global economic corpse? This
question crosses my mind for the following reasons.
- Negative interest rate policy and its spread are toxic.
- Sell-off of EU banking stocks is endangers the prospect of EU economic recovery.
- PBOC’s Governor, Zhou Xiaochuan publicly “threatened” no Chinese devaluation left me bewildered which central bank governor will publicly admit to impending market-driven devaluation.
- Accommodative monetary policy failure obscured structural economic imbalance not yet addressed in political governance but for how long more(?)
- The end of Merkel era and Presidential election due must mean at least a temporary loss of determining political will and direction in EU and US.
- Chinese addiction to debt-laden carbon-heavy growth needs to find a new engine beyond consumption spending, itself dependent on the former.
- Too many global investment banks have revised their 2016 gold price and global economic outlook forecast so fast and soon.
- Desperate, besieged and deeply divided central banks are discovering the tidal wave of massive liquidity flow after unprecedented accommodative monetary policy is proving unmanageable of risks containment.
- Negative interest rate is not yielding positive results in EU countries and already stumbled in Japan.
OMINOUS SIGNS OF DESPERATION
There are
ominous signs of desperation elsewhere. The inexplicable gold price surge,
perhaps its best since 2011 gold price decline, speaks loudly of financial
market instability risks, loss of confidence in the US dollar, and more
specifically loss of faith in central banks and their failed monetary policies
of gravitating from ZIRP, to quantitative easing to now negative interest rate
policy. Draghi’s stern public warning to market speculators that “we are not surrendering in front of these
global factors” found similar echo of desperation in PBOC’s Zhou Xiaochuan’s
promise that “China would not let the market sentiment be dominated by
these speculative forces.” Central bankers are besieged of solution wanting
when none is readily apparent or available, if negative interest rate policy
fails. A proxy currency war is now underway via negative interest rate but in
BOJ’s case it ended up in failure as the Yen surged instead. http://www.cnbc.com/2016/02/18/bojs-governor-kuroda-defends-negative-rates-says-weaker-yen-wasnt-the-aim.html
Most frightening of all is how violently the mobility of
massive flood of liquidity from accommodative monetary policy since the GFC is
coming back to haunt policy makers in the manner of incapacitating nightmare
that inflicts on central bankers i.e. its apparent intensity/ferocity of
reactions – totally unanticipated and perhaps yet incomprehensible to
governments. Before the GFC, the Fed fund rate was 5%, it fell to nearly zero
for 7 years and financial markets partied on a feast of cheap money not on
productive investment but casino bets on asset bubbles. And now, a mere lift of
only 25 basis point on December 16 changed the world completely even though
after this lift-off, interest rates is still in the extremity depth of low
relative to long historical past. The ominous hint of that is financial market
is addicted to the tiger of ZIRP. Ride this tiger and shift it a little, it
will bite back at you mercilessly and if you got off, you may be eaten alive
for a quick meal.
The global economy is plagued by paltry growth and unsettled
financial markets – that is the glass ceiling. BOJ invited itself on 29 January
2016 joining a failed ECB experiment right at its own critical moment of
failure of monetary experiment. H. Kuroda, BOJ Governor denied a lower Yen
exchange rate objective was the unspoken intent of Japan to lift its exports
and GDP growth. He got a huge slap as the Yen surged upwards instead, making
imports cheaper. The contagion systemic risks are now set to implode if either
one or both BOJ/ECB negative interest rate policy backfired if others come to
the same buffet. We are in uncharted water of financial risks experimentation –
big tantrums waiting, regardless.
WATCH OUT THE GOLD PRICE.
I made a reference to gold in my January 2015 publishing, and
I shall repeat it here again – why is gold suddenly so strong when energy and
base metals so weak? And, perhaps, is gold likely to be massively volatile
going forward from this point as one gold technical analyst forecasting?
http://www.marketwatch.com/story/expect-gold-prices-to-be-massively-volatile-2016-02-19 Or is physical
gold price evolving into a reliable contrarian forward indicator of global
economy outlook ahead as negative interest rate in recession-ridden economies
destabilises the global financial system?
Zhen He
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