Tuesday, 12 April 2016

Guess what? The Dutch turkeys did not vote for Christmas

The day after its referendum on the EU-Ukraine treaty tiny Holland was bestowed the honour of having Lionel Barber, editor of the FT, reflect on the negative outcome and put it in proper perspective. In case you haven’t seen his pearls of wisdom, here they are: Dutch abstention on Ukraine deal proves loudest message of all.
If you can’t be bothered to read it, here is a quote that illustrates the drift of it:
It was a Eurosceptic group calling itself GeenPeil (“Not a clue”) which amassed the signatures and selected the EU-Ukraine accord as the issue on which to make its stand.
Let me start with a brief lesson in Dutch for Mr Barber (and his fact checking colleagues). “GeenPeil” does not mean “Not a clue”. This translation is the fruit of the wishful imagination of someone who wants to marginalise those who voted against ratification of the EU treaty with the Ukraine *).

GeenPeil means “No level” or “No measure” in Dutch, just so you know.

Barber’s suggestive translation gives away what he tries to achieve in his column: depict the result of the Dutch referendum as the outcry of an unwashed and angry minority venting their frustration and narrow-mindedness, Trumpism in the Lowlands if you like. The referendum’s turnout of 32% is supposedly hardly representative and it is suggested that the 68% of the population that did not vote are probably mostly in favour of the treaty.

Well, I have news for Barber. The nationwide polls that were held prior to the election showed the same outcome of around 60% against. And the turnout of 32% is typical for a European election in the Netherlands, does that mean that elections for the European parliament are a joke as well? Remember that the previous referendum in 2005 on the Lisbon accord had a turnout of 63.3% while yielding a ‘No’ vote of 61.5%.

Not a clue, indeed.

*) Only "Geen Peil" when used in the Dutch expression “Geen peil op te trekken” comes close with a bit of imagination. It means that there is no knowing what will happen.

Saturday, 2 January 2016

A world coming apart at the seams, that is how we enter 2016

Let’s not fool ourselves. Asset bubbles and the return of banker wellbeing do not mean that prosperity (or even stability) is around the corner. The realities that matter more are crashing commodity prices, sticky high real unemployment rates, deteriorating terms of employment, declining disposable  incomes, double-digit inflation in the costs that matter most (housing, healthcare, education), and the gapping divide between haves and have-nots. Feudal times are here again, global corporations are our puppetmasters. That things are not as well as our officials would have us believe shows up in the increasing political instability all over the world.

Surprisingly, it does not seem that the obvious connection is made between political instability and the extreme monetary policies that continue to be pursued. Particularly the unmerited redistribution of wealth to those who were best-off to begin with while making it impossible for an ordinary saver to build a pension has caused a lot of resentment. Not to speak of malinvestments that can continue to distort markets as they are kept alive with cheap credit. Monetary manipulations have severe consequences by determining the winners and losers in our current society. The ignored reality is that central bank actions have political outcomes as the repercussions of their policies are not equally beneficial to different parts of society.

But even if it was recognised that continuously suppressing the price of risk and credit causes political mayhem in the end, we are way past the point of no return. The big bad choices have already been made in the past and admitting now that the current monetary policies are faulty is no longer an option. Central banks are condemned to generously keep printing money to keep the financial cuckoo alive until they no longer can’t. At that point they will have lost control and we will probably experience a period of hyperinflation before we agree on a radically different monetary system (yes, physical gold still makes sense as a hedge).

But until we get there it will be more of the same: financial repression, asset inflation, financialisation of anything that can be financialised, manipulated and broken markets, increasing wealth disparity, deflation from malinvestment and a lack of consumer spending power, more uncertainty and despair among the impoverished masses. And of course more political instability as the frustration of the many people who have lost their faith in the ruling elites expresses itself in aggressive calls for change.

Sadly, what the past teaches us about the situation we find ourselves in today is not very encouraging. With war historically used by a ruling class as a means to deal with internal political threats we should be very fearful of continuing along the current path. The Syrian proxy war, jihadism, fascism, nationalism, Trump, mass unemployment, hyperactive central banks: the echo of the 19thirties is loud and clear - the Spanish civil war, communism, Mussolini etc. There is a main difference but it is not a good one: nuclear bombs.

In order to have a better future we will have to clean up the systemic mess and make the necessary adjustments that work in the longer term.  Some form of honest capitalism has to be restored which means that real success is to be rewarded and failure has to have serious consequences: we have to take the crony out and replace it with actual meritocracy. Central banks should only have a price stability mandate with a wider definition of inflation than is currently being applied. Governments should not be overruled by corporations, and ensure that a level market playing field is enforced with enough competition to keep players honest. Nobody should be above the law and ‘affluenza’ should not be an excuse to get away with antisocial behaviour. In short, we have to put a halt to this Hunger Games world that is creeping up on us. More justifiable hope for a future that credibly involves a larger part of society (restoring the Capitalist Dream if you like) should save us from ourselves.

Greece was quite a telling event in 2015. Not because (unsurprisingly) in the end the creditors got their bailout, but because it was never heard of again. As if the Greek problems had been resolved which of course they weren’t (in fact, not at all). But the flow of information just stopped overnight: nothing to see there anymore people, please move on. It should make one wonder what other troubling information is being kept from the limelight. What the deafening Greek radio silence tells you is that you are probably not properly informed about anything that could disturb the cosy official narrative of economic recovery.

Greece should also remind us that democracy is increasingly only (sort of) applied at the moment of election, after overcoming that irritating formality the elected officials seem to feel unencumbered to do whatever suits a particular agenda. Like negotiating incisive international trade agreements in total secrecy without any public scrutiny whatsoever.

Let’s hope we make it safely to 2017

Wednesday, 29 July 2015


Flabbergasted. That is how I felt about the total capitulation of Greece to its creditors just days after their people’s protest vote. The Eurozone establishment had yet again managed to kick the can down the road and avoided a confrontation with reality. Germany had dropped any semblance of civility, took off its gloves, flexed its muscles, slammed the table, and, cheered on by the technocrats in Brussels, got the outcome it wanted with the ECB doing the dirty work as financial waterboarder. God knows what else was laid on poor Tsipras to break the man into such unconditional servility on the heels of a referendum that should have had the opposite effect, but the change in attitude was truly remarkable. Up until that moment, it had really seemed that Greece would chart its own course and do what made sense from their perspective. But it was not to be. Instead the creditors got their bailout and the bankrupt Greeks got saddled with even more unrepayable debt on top of losing their last bit of independence.

But in hindsight this outcome should not really surprise anyone since any deal that might actually work for Greece would have disturbed the illusion perception of systemic solvency that is the bedrock of the current status quo. The fragility of that status quo can easily be exemplified by bank leverage ratios still in excess of 20 to 1, and Portuguese 10 year yields at around 2.5% with a government debt to GDP ratio at 130% or Italian 10 year government bonds yielding below 2% with an even higher debt to GDP ratio. These examples hardly indicate a robust financial system that could weather nasty surprises, or that actual risks are even remotely reflected in bond prices.

When policymakers assured us some six years ago there would be ‘no more Lehmans’, what they actually meant was that another incident where the solvency of the system could be compromised was to be avoided at all cost – whatever it took. Remember that, as John Hussman pointed out again recently, markets only stabilized in March 2009 after a change in FASB rules lifted the requirement for banks to do mark-to-market accounting thereby allowing them to hide their solvency shortcomings.

Safeguarding an appearance of solvency has become the key to maintaining the financial and political peace across the world. This is why financial markets are increasingly orchestrated by central banks and governments, it is also the deeper motivation behind the wealth effect policies pursued by the Fed. By ensuring that assets keep their value relative to the liabilities on the other side of the ledger, any mark-to-market calculation has a reassuring outcome that prevents systemic upheaval. On top of that, rising asset values provide fresh collateral that allows for even more borrowing. Never mind that any honest clearing price of said collateral might be significantly lower than the debt it supports. This is how financial houses of cards are built.

If  accommodating more debt was the objective of policymakers for their active propping up of asset values (i.e. blowing bubbles) it has worked out splendidly. According to McKinsey, the world has added another whopping US$ 57 trillion in debt since the beginning of the global financial crisis in 2007, an increase of about 40% (per Q2 2014).

So here we are, stuck with an unsustainable combination of largely fabricated asset valuations and a massive debt pile that is growing much faster than the real economy. Central banks are already scraping the bottom of their tool boxes and the next cyclical downturn is knocking at the door. What will be next?

Well, if you extrapolate the policy responses of the past eight years and look at the Japanese struggle with circumstances that resemble much of what a big part of the world is facing today, my best guess is that we are heading for an apotheosis that was described perfectly by William White of the BIS in 2013:

There is little ammunition left if the system buckles again. “I don’t know what they will do: Abenomics for the world I suppose, but this is the last refuge of the scoundrel, “ he said.

And this brings me back to Greece. To undertake monetary policies that are truly ‘awesome’, a government and its central bank have to be in total cahoots with each other. Their mandates should be undisputed to give them the room to do whatever it takes to keep the solvency show on the road.  However, what the Greek saga has shown once more is that the Eurozone is built on political and economic quicksand resulting in division rather than unity. As the resentment builds among member countries, political unification is getting less likely with each single crisis. Without political unification and a full sharing of fiscal risks, it will be very difficult for the ECB to undertake the scale of debt monetisation that is likely to be needed further down the line. And even if a political union could be forged, it would be totally dominated by Germany, a country not exactly known for its love of ‘money printing to save overextended borrowers’. I wish the IMF good luck with selling QE 2.0 to Berlin.

Saturday, 14 February 2015

Troika against Greek rebels with a cause

I woke up this morning, you know... and the sun was shining, and it was nice, and all that type of stuff. And the first thing, I saw you, and, uh, I said, “Boy, this is gonna be one terrific day, so you better live it up, because tomorrow you’ll be nothing”.  
-James Dean, Rebel without a cause

The first time the current Greek minister of finance Yanis Varoufakis was ever mentioned in a piece about Greece in the FT was in a column by Wolfgang Munchau on April 13, 2014. Then nine months went by before he was mentioned again, this time in the newspaper’s main article presenting the freshly elected Greek government. These are the words that the FT used to describe him to their readership (me bold):

Greece’s radical leftist prime minister Alexis Tsipras announced his new cabinet on Tuesday, handing the top economic posts to a former communist politician and a popular leftwing blogger who has lambasted the austerity programme imposed by international creditors.

Yanis Varoufakis, an Athens university economics, prolific blogger and former economist-in-residence for a US online gaming company, was appointed finance minster. He will oversee public spending and revenue collection and represent the government at meetings of eurozone finance ministers.

Does that sound like the background of a Minister of Finance who can be taken seriously? Well, if your verdict is negative you have been successfully misled. Yanis Varoufakis was the authoritative blogger on Greece, read by anyone with a serious interest in the matter. Over the years his many quality insights established him as a competent original thinker with a sound understanding of the fundamental issues.

Particularly the FT’s emphasis on his online gaming involvement is suggestive. Varoufakis is better described as a mathematical economist and an expert in game and bargaining theory, an acknowledged academic field (sounds quite different doesn’t it?). He taught at Cambridge and Sydney university and is currently a visiting professor at the University of Texas. Far from being some flaky cyberspace cowboy, Varoufakis is a man who knows his stuff, probably a lot better than most of the people he currently faces at the other side of the negotiation table.

But what makes Varoufakis a particularly tricky man to deal with for the likes of Jean-Claude Juncker are his strong convictions. He comes across as a principled man on a mission to give (his) Greek people some future perspective. He doesn't not seem to be in politics for personal gain and suggests to have the integrity of a true representative of the people, someone who genuinely works for the benefit of the collective and therefore has the people's trust to make tough decisions if needed. For reference I am thinking of Paul Volcker and, yes, also Angela Merkel (in her careful way within the limitations of her function).

In short, Yanis Varoufakis is the European establishment’s worst nightmare: a knowledgeable outsider who can no longer be ignored and who cannot be corrupted. Probably Alexis Tsipras, the prime minister, is of the same calibre, I just don’t know enough about him.

The current stand-off between the new Greek government and the European status quo defenders is often described as a chicken race where the side who gives in first will have lost. Of course this is nonsense. A chicken race requires two parties with something at stake, it needs certain symmetry. That does not apply to Greece versus Brussels with Greece having nothing left to lose. The country might prefer a deal with its creditors over leaving the Eurozone but anything close to the current state of affairs will not be acceptable.

When Yanis Varoufakis says that his humiliated nation is already bankrupt and that the current austerity program offers zero prospect of coming out of debtor’s prison he totally means it (I can safely say that as a faithful reader of his columns). For Varoufakis there are only two acceptable ways forward: either Greece gets meaningful concessions from its creditors or the country will leave the Eurozone.

For the people at the other side of the table this means that there is no outcome possible that is favourable to them. Giving Greece any meaningful relief will be impossibly difficult to sell to a sceptical audience in Northern Europe. Given the primitive way in which the Greek bailout program has been politically spun, any concession to the Greeks will be perceived as caving in to blackmail by an ungrateful and unreasonable Greek government. Plus it will inspire requests by other countries for a similar treatment. However, if Greece decides to leave the Eurozone it will be Lehman 2.0. The choice for Brussels is between a shit sandwich and a sandwich with shit.

But no matter what comes out in the end, one thing seems very likely to happen: at some point there will be happy Greeks appearing on televisions all over Europe. They will either have won from Brussels or they will be freed from Brussels. This Greek joy might be unjustified and short lived, but the ray of light the Greek people will see in their darkness will be an inspiration for the other suffering citizens of Southern Europe. In Northern Europe, celebrating Greeks will either remind people of the fragility of the Eurozone or make them feel betrayed and taken advantage of. Unfortunately for the technocrats in Brussels, an accord on sentiment is not possible.

And the markets? They are oblivious to all of this, undisturbedly moving on to ever higher highs.

Ewald Engelen, if you read this, please be inspired by Yanis Varoufakis. I can’t wait to see you quoted in het FD for the very first time. You will have my vote.

Tuesday, 27 January 2015

The dire political consequences of the Draghi promise

So did we finally get QE by the ECB last Thursday? ‘JEIN’ a German might say, yes and no. ‘Yes’ because a significant asset buying effort was indeed announced. ‘No’ because there will only be 20 percent of risk sharing between the members of the Eurozone. This neutered operation by the ECB might therefore be good news for the owners of European assets in the short term (troubled banks and hedge funds in particular), but it is a big setback when it comes to the credibility of the ECB and the cohesion of the Eurozone. It was a rare moment of truth with the European monetary union failing the litmus test of having a fully functional common currency.

QE without risk sharing is the opposite of what is needed to fundamentally stabilise the Eurozone as it exposes the Achilles heel of the whole Euro project. The big speculative illusion assumption that justifies current market prices, namely that if need be Germany-Netherlands-Finland will chip in for the weaker members of the club, is the key underpinning of current ass-tight credit spreads between member countries. When meaningful risk sharing is taken of the table, the cheap funding cost of the periphery is unlikely to hold for very long if the ECB stops monetising.  

Even with the strong Northern European objections against QE, Mario Draghi really had no other option last week than to deliver since he had effectively launched the program already on July 26, 2012 when he promised to do whatever it takes. The massive frontrunning by investors that started after that faithful day left the ECB no other choice than to live up to market expectations. With QE already discounted in the absurdly low bond yields of the weaker members of the Eurozone, any backing down by the ECB would have released the hounds of bondmarket hell as the whole yield convergence play in recent years would have reversed and then some (Mayfair thanks you so much Mario!).

But by delivering on his promise Super Mario may have bitten off more than he can chew. What makes the loud protestations against QE different from any other ‘anti –European’ criticism is that they are coming from core members of the Northern European intellectual and political establishment (including Angela Merkel). This is far more dangerous for the ECB and the apparatchiks in Brussels than any pushback coming from some ‘local clown’ with no standing who ’just doesn’t get it’.  In the Dutch parliament, four political parties filed motions questioning the ECB decision including one from the VVD who are the governing party of Mark Rutte. Fighting a central bank is never a good idea, but fighting the Bundestag is definitely a worse one - pick your battle.

What Draghi may not appreciate enough is that massive money printing is seen as cursing in church in Northern Europe. Combine this deeply felt apprehension with the growing sensitivities about the gap between rich and poor (Piketty), revulsion about more bank bail-outs and doubts about the political ethics in Southern Europe, and you have the perfect recipe for a political Molotov cocktail that can render Mario’s bazooka into a limp peashooter at any time.

Can the Eurozone survive a growing distrust of ECB policies among Northern European policymakers? Well, the official retort is always that the Eurozone has passed the point of no return and that the countries of the Eurozone will have to make it work one way or the other. Of course in reality that is not the case as long as there has been no political unification and each individual country can still quite easily return to full sovereignty. In November of last year the Dutch minister of finance Jeroen Dijsselbloem surprised a Dutch audience by revealing that, despite the fact that the government at the time had always adamantly maintained that dropping the euro was not an option, a full plan for the re-introduction of the Guilder was ready to be implemented in 2012 when Eurozone tensions were at their highest. It would be very naive to assume that today no alternative scripts have been prepared (the refreshingly fortright Dijsselbloem mentioned in another interview that the main benefit of QE will be the reparation of bank balance sheets).

What could restore Northern Europe’s dented faith in the ECB? Only if its QE program is validated by improving growth dynamics in the Eurozone in the not too distant future. However, it is highly doubtful that massive monetisation is going to have a meaningful positive impact on the real economy of Europe other than to keep bond yields low. Given the saving cult in Northern Europe, desperate money printing is not going to do much for consumer and business confidence. Moreover, lower rates may actually induce people to save even more to deal with an even less certain future. Debt write-offs and higher rates to restore the balance between debtors and savers might actually work better. This is what Raul Ilargi Meijer had to say about it at Zerohedge:
The problem with Europe’s economy, what drives it into high unemployment and deflation, is that people are not spending. If QE would really be aimed at reviving the economy, or at battling deflation, it would need to assume that people will start borrowing on a massive scale just because Draghi buys bonds – and soon perhaps even stocks – from bankers. There simply is no logic in that. The stated goals, pro-growth and anti-deflation, are not true. It’s a sleight of hand.
In order to achieve the stated goals, money would have to reach the real economy. As it stands, the best Draghi can do is to ‘hope’ it will. That’s not enough by a mile. This is not about doubts over its effectiveness, that’s baloney, we know it’s not effective when it comes to the stated goals. It will still leave Europe with no growth, and deeper deflation, and now €1.1 trillion deeper in debt. While banks can grow their reserves.
The most generous defence of the ECB decision in the Dutch media and by politicians was that one should never meddle with the independence of a central bank. That might be true if constituents and central bank are all in the same political boat like in the US, UK and Japan. In the case of the Eurozone the boat is still being built and the key question is therefore overlooked: can the ECB be independent without political unification? Of course not.

Mayo42 signing off.

Sunday, 28 December 2014

Lazy 2015 forecasting

At least every cloud still has a silver lining. Thanks to the always investor-friendly Fed it has never been simpler to make a new year's forecast. Jim Reid of Deutsche Bank worded it perfectly already in his Credit Outlook 2015:

If it was a free market and central banks were not allowed to intervene anymore then we would be very bearish as the global financial system is still extremely fragile and not sustainable. Clearly this won't happen but illustrates our default position ex-intervention.

There you go, that was easy. Not much to add other than that I do not expect the Fed to raise rates in 2015 with a high likelihood of a renewed QE effort (but not by the ECB on any large scale).

Having said that, the juggling act by central banks will start to look impossibly desperate in the course of the year as it becomes evident that not all problems can be solved with fresh liquidity and more debt. Borrowed time is running out and we are getting near the point where weak fundamentals will translate into a general repricing of risk. Jeremy Grantham gives it until 2016 for the inevitable reset. Seems fair to me although I expect it sooner rather than later.

From my Amsterdam perspective I say Nastrovja! to the frenemies in the east and Chinchin! to the frenemies in the west. With a friendly request to both east and west to please pretty please with sugar on top: be careful with the proxy-conflicts in 2015 guys, don't be silly.

I hope you will enjoy the last bits of 2014, may the next year treat you kindly.

Mayo42 signing off.

Saturday, 29 November 2014

Somebody slay the financial cuckoo before it swallows us whole

People of privilege will always risk their complete destruction rather than surrender any material part of their advantage. Intellectual myopia, often called stupidity, is no doubt a reason. But the privileged also feel that their privileges, however egregious they may seem to others, are a solemn, basic, God-given right. The sensitivity of the poor to injustice is a trivial thing compared with that of the rich.   
- John Kenneth Galbraith, The Age of Uncertainty (1977)

The quote reminds me of Lloyd Blankfein doing God’s work, but I digress already..

About a year ago, at about the same time when I folded on frequent blogging, there were two prominent investors who drastically changed their views on equity values as they switched from a fundamentally negative to a much more optimistic stance. These investors were Jeremy Grantham (legendary ‘value investor’ who had been biding his time expecting better entry levels) and Hugh Hendry (an outspoken contrarian who had bet on a major market reset on the basis of unsustainable fundamentals). Their dramatic pivot was jubilantly interpreted by the sell-side as a surrender to the bullish narrative and an acceptance that monetary policies had been effective. The lonely bears that stayed behind felt somewhat betrayed, particularly as fundamentals had not significantly improved (if anything, they had gotten worse).

What may not have been fully appreciated at the time, was that both Hendry and Graham did not really change their views, they just acknowledged that economic and political realities no longer mattered and that central bank policy and price momentum were the only games in town. They resigned to the fact that markets were broken and that the only way to stay in the business of money management was to go along with central banks that would go to extremes to avoid a downdraft in asset values. Both men still strongly believed in an eventual collapse, just not in the immediate future.

Grantham and Hendry had both concluded that the real world and financial markets were increasingly operating in separate universes. After hapless politicians had missed the golden opportunity in 2008-9 to reign in a financial industry that had run amok with devastating effects for society at large, the financial establishment had quickly regained their upper hand in policymaking, becoming more overpowering, untouchable and ‘important’ than ever before. The financial sector could be expected to continue to look after its own (short term) interests and would ensure that the credit bubble was kept whole. There would be no private absorption of losses and no meaningful correction in the massive misallocation of capital that had taken place. Importantly,  Grantham and Hendry realized that the world’s central banks would do practically anything to keep the insatiable cuckoo in their nest fat and happy.

Now, a year later, with a continuing increase in equity values against a dismal economic and political background, both men are completely confirmed in the wisdom of their pragmatic adjustment and are to be applauded for the flexibility in their thinking. Because, sadly, they were totally correct. We currently have markets in which, as David Stockman recently described it, the relentless expansion of the bubble has killed off the bears, the skeptics, the prudent and even the militantly incredulous. A world in which sound arguments against the policies being pursued, even when coming from key institutions such as the BIS, can be completely ignored by the people in charge. A world in which redistributive monetary choices with enormous social implications are presented as if they are the inevitable outcomes of some ‘law’ of ‘economic science’. A world where any setback in equity values is countered by a central banker stepping up to the plate providing or promising even more liquidity.

Never mind that six years of massive expansions in central bank balance sheets and interest rates at zero have done very little for actual economic growth (real wealth) and have mainly benefited the financial sector (phantom wealth). The official narrative is maintained that extreme monetary policies have been successful and, in fact, they could have been even more successful had central banks been even more aggressive. Stock markets at record highs are presented as proof that we are on the right track with a return to normalcy in sight (Japan finally doing the right thing, the Fed on the verge of raising rates, the ECB about to go all-in, yada yada yada). 

Leave it to the eloquent people at GMO, Jeremy Grantham’s firm, to throw some frozen water on the false message that we have the worst behind us because asset values are doing so well. The way GMO looks at it, there are only two alternative scenarios from the current overstretched valuations (that is, if you are looking for a meaningful pension). Both scenarios are bad but rather than saying that most people are currently screwed one way or the other, they use the words ‘hell’ and ‘purgatory’.  Either interest rates stay at current levels indefinitely which means that you will be unable to build a large enough nest egg to retire (‘hell’), or interest rates normalize in the coming years which means that you will see a very significant downward correction in asset values before you can start (re)building your pension (‘purgatory’).  If you care, here’s their sobering arithmetic. Purgatory would obviously be better for those who haven’t saved much yet (such as young people) but devastating for almost everyone else. Pick your poison, it is the price you (will) pay for saving Jamie Dimon’s ass: the ongoing bail-out of the financial sector means that a dignified retirement will be almost unattainable. And that is without considering the challenge of just making a decent living in this environment. Meanwhile, on Wall Street..

The most depressing thing about GMO’s analysis is that there is really no escape, the bad choices have already been made in the past and all we can do now is deal with the consequences. Even if economic growth would exceed the already rosy forecasts, the math hardly changes. It’s all about discount rates being applied to future earnings and what is reflected in current market prices. In other words, the trees have already grown all the way to heaven and there is hardly anything left to capture (other than even more asset inflation from central bank actions). The only way to get a better return for the individual investor would be to time the market’s ebbs and flows - good luck with that! And even if that strategy succeeds, the world’s aggregate performance does not change since somebody has to own its assets at any point in time.

Taking GMO’s two scenarios, it is clear that the central banks prefer to stay in hell whilst trying to avoid purgatory at all cost. The recipe is to boil the frog saver slow enough that by the time the unwashed masses fully realize what has been happening and the mother of all popular furies is unleashed, today’s financial cooks will be resting on their laurels in a save place far away from the firing line (might that be why they could only find an ancient lady to head the Fed? – but I digress again). Our central bankers know full well that one day the music will stop so ideally all their peers follow the same dubious policies - group guilt means no individual accountability, see? That might be one reason why Germany and its Bundesbank are getting so much heavy flak for preventing the ECB from joining the quantitative easing orgy.

The growing frustration with Germany’s attitude seems particularly felt by the Anglo -Saxon banking cabal, a recent example of this being an FT column by Wolfgang Munchau with the ‘catchy’ title ‘The Wacky Economics of Germany’s Parallel Universe’. In this scathing piece German economic thinking is depicted as inconsistent and narrowminded with ‘local’ economists refusing or unable to be enlightened by God Keynes. While this broad-brushed condemnation of non-Keynesian beliefs feeds the idea that the FT is increasingly becoming a mouthpiece for the monetary establishment with diminishing returns room for dissenting views, it also reeks of misguided snobbism. Although far from being perfect, Germany is the only large economy in the world that is still in reasonably good shape, both financially and from a societal cohesion perspective. Oh wait, Munchau has thought about that as well as he ‘suspects that the country’s economic success is due mostly to technology, high skills and the presence of some excellent companies, rather than to economic policy’. Yeah right.

The Germans understand that the ECB opening the monetary spigots even wider will not solve the underlying global problem of misallocated capital, debt saturation and, mostly as a result of that, insufficient growth. We are deeply embroiled in what Richard Koo calls a balance sheet recession and more blunt QE will just add to the misallocation problem and get in the way of the necessary sanitization of sickly balance sheets. To really improve our economic prospects in the longer term other initiatives such as the recently announced European investment fund make a lot more sense (selective Keynesianism if you like). In the long run we are all dead Keynes said, which was easy for him to say since he, of course, had no offspring. Delaying and obstructing any serious tackling of our current problems just to safeguard an 'aggregate demand' that is financed and construed in an unsustainable manner, thereby making those problems even larger than they already are, is a generational crime.

The way I see it, Germany is the only thing standing between me, an ordinary Dutch saver with children, and a pack of intellectually myopic self-serving Keynes-abusing scientologists looking after their own debt-addicted parish. Ich bin ein Berliner and I support Wackonomics. Translation: I am a doughnut (get it?) and I know nothing about economics. But I do understand self-interest.

Mayo42 signing off.

For aficionados, a few more relevant pearls from J.K. Galbraith:

Do not be alarmed by simplification, complexity is often a device for claiming sophistication, or for evading simple truths.

This is what economics now does. It tells the young and susceptible (and also the old and vulnerable) that economic life has no content of power and politics because the firm is safely subordinate to the market and the state and for this reason it is safely at the command of the consumer and citizen. Such an economics is not neutral. It is the influential and invaluable ally of those whose exercise of power depends on an acquiescent public. If the state is the executive committee of the great corporation and the planning system, it is partly because neoclassical economics is its instrument for neutralizing the suspicion that this is so.

The enemy of the conventional wisdom is not ideas but the march of events.

Friday, 24 October 2014

Could it be that Mr Market still gets it right?

There is this old saying in the investment business: ‘The Market is Always Right’. The question is whether today, in that new normal universe of central bank extremism, expedient policy spin and slippery data, the Market is still capable of reflecting some of that wisdom of the crowd.

For many pundits it is obvious that asset markets are broken. Particularly the conflicting signals coming from overpriced equities (signaling nominal growth) and ultra-low bond yields (signaling deflation) lead many to conclude that markets must be truly FUBAR since one of the two valuations cannot be right. However, could it be that we are so deep into uncharted territory that the historical relationship between bonds and equities no longer applies? Could it be that both equity and bond markets are rationally 'overpriced' at the same time and that there is one coherent signal to be derived from the complete picture?

Floored bond yields and sky-high P/E’s can be two sides of the same coin since (asset)hyperinflation and debt-deflation are both outcomes of the same phenomenon: a credit collapse.  And considering that our collective mountain of debt is still getting bigger and bigger in relation to our income (OK, with the exception of Germany but for some that is a problem in itself), such a calamity is not entirely implausible.

What characterizes today’s financial markets? They are mostly one-sided (long-only) with limited true price-finding as a consequence of being shackled by policy makers. Shorting any asset market has been the mother of all widow maker trades in the past five years. But, despite all that, investors still have the choice to be either in or out and, if in, they can make a considered decision about which assets to own. In other words, investors can still vote with their feet.

Seen in this light, the fact that both bonds and equities continue to be owned at excessive and contradictory valuations should scare the pants of us: these contradictory valuations suggest that investors are expecting an extreme outcome either way. They signal that the credit bubble will eventually burst and that one of the two fat tail scenarios will become a nasty reality (debt-deflation or hyperinflation). Since the actual outcome largely depends on monetary policy responses that cannot be known (will it be restraint, infinite QE, money drops?), for the time being both outcomes are bought with exuberance.

Brrrrrrrr! Mayo42

Saturday, 30 August 2014

Do you feel lucky? Well do ya, punter?

I know what you're thinking. You're thinking "can the Fed reflate one more time if things go awry again or have they reached the limit of what monetary policy can achieve?" Now to tell you the truth, Janet doesn’t know herself as she is blinded by her own official storyline about the Fed's ‘successful’ policies. But she does have this exceptional authority, barely checked by outsiders, to create unlimited liquidity at the push of a button. It is the most powerful monetary weapon in the world and it can blow up asset values regardless of the real economic fundamentals. So, you've gotta ask yourself the question: "Will Janet print even more when the cycle turns or will she hold back? Is it safe to be long? Well, is it, punter?”

Welcome to the new normal of no volatility and big fat tails on either side. Yes, that looks like a smile, and yes, Candid Camera is also a tempting metaphor.

Mayo42 freestylin'

Wednesday, 23 July 2014

The truth about MH17 could be inconvenient to all

We have learnt that you can’t divide the parties in Bosnia into “good guys” and “bad guys”’.
Thom Karremans, Dutchbat commander in Srebrenica

Being an Amsterdammer I have quickly developed an insatiable appetite for any news about Malaysian Airways flight MH17. Although I am aware that in such a high stake case it is totally impossible for an outsider to distinguish fact from fantasy and propaganda, I can’t keep myself from over-eating at the vast buffet of (dis)information that is being dished out non-stop by the media. Now, getting close to the point of saturation, I need to line up my thoughts and bring some order to the information overload in my mind.

So here goes: in the past days my train of thought has followed the following trajectory and taken me to an (intermediate?) station at the end.

Given that the downing of MH17 happened over an area closely watched by some of the world’s militarily most sophisticated parties - the US and Russia - it seems implausible that neither side is able to present conclusive evidence about what has actually happened and use such evidence to ‘smoke’ the ‘enemy’.

What would stop both the US and Russia from presenting evidence that would secure the win in their relentless war of words? Could it be that the naked truth about the downing of MH-17 is inconvenient or embarrassing to both parties?

What truth would be inconvenient to both the US and Russia? This would have to be any scenario that includes Kiev as a less than innocent party, either by setting up MH17 as bait for the separatists to shoot at or shooting down the plane themselves using, of course, a Russian-made missile (can anyone tell a BUK from a BUK?). Why such a reality would be inconvenient for the West is obvious enough but, if you think about it, it could also not suit Russia’s agenda.

Whoever pulled the trigger, Russia will be seen as responsible for the situation in the Ukraine by the West. It has no hope of redeeming itself unless it raises a big white flag and fully surrenders the Ukraine to the “international community”. But it could still get worse for Russia: identifying Kiev as a culprit in the downing of MH17 beyond any reasonable doubt, thereby cutting off the Ukrainians from Western aid, might cause a lot more instability in the region than Russia bargains for. For starters, who would then pay Kiev's Gazprom bills?

How likely is it that Kiev has played a dirty role? Ask two additional questions and you have a plausible answer.  Firstly, why was MH-17 put at such risk, re-directed north from its normal flight path and instructed to fly at an altitude just skirting the restricted (hence dangerous) airspace? And the other question is of course the eternal ‘Cui bono?’ (which is clearly not Russia). Here is an interesting perspective from ZH based on info from the WSJ.

My hopeful eyes are now fixated on the Dutch leadership to see whether an independent inquiry will dig up the ‘smoking gun’ that is surely buried somewhere. If the propaganda war continues indefinitely without a knock-out finish, it will be because both the West and Russia prefer it that way. No good guys, no bad guys, no satisfaction.

Mayo42 signing off.

Sunday, 25 May 2014

A vote for a Europe that has a chance

Last Thursday the Dutch election for the European parliament took place. Outcome: the ruling parties (VVD and PvdA) more or less survived this popularity contest intact although the winners were the opposition. The big surprise was the defeat of the PVV of ‘funny’ Geert Wilders that looked like it was going to lose 40 percent of its European representation – Wilders’ unhelpful extremism seems to be losing ground. However, putting this result in perspective, only 37% of Dutch voters had bothered to turn up…

I was part of the 63% of the Dutch population who decided they had better things to do on Thursday. It was the first time in my life that I didn’t vote and it had been a deliberate choice: non-voting out of love for Europe. Fearing that ‘more Brussels’ being force-fed to the public would eventually lead to less Europe than we had to begin with had me wanting to vote for a change in course. Sadly, none of the mainstream parties were either sufficiently critical of the current maneuvers at the European front or credible in their tough rhetoric that smacked of electoral opportunism. D66, the party I had voted for in the last local elections, turned out to be, to my shock and horror, the most unreservedly pro Federal Europe party of them all.

After D66 was declared the biggest winner late Thursday night, the outcome was immediately spun by the pro-Brussels camp as a huge victory for Europe. Hmm..  I had boycotted these elections not only because of the lack of palatable alternatives but also because I didn’t want to support the democratic farce that Brussels currently represents. Remembering that my vote in 2005 against the proposed European constitution (together with a significant majority of the Dutch population - 62 percent NO, 63 percent turmout) had largely been ignored, I got a sinking feeling when D66 leader Alexander Pechtold declared the Netherlands to be politically cleansed and happily Europhile. That meant exit D66 for me, also for the foreseeable future I am afraid.

After waking up the next morning feeling politically orphaned and suffering from quite a mental hangover, a small miracle happened when I turned on the TV and nonchalantly zapped into the light-hearted breakfast show WNL. One of the guests on the show was Carola Schouten, a member of parliament for the niche Christian party CU. Her hair was nice, her dress was nice, she wore killer heels, and she made a lot of sense, talking with sound judgment and integrity about some of the larger European issues. Here’s the show in case you missed it (from 8:55 in Part 1)

Her vision totally revived me, an unexpected light at the end of the tunnel, offering shelter for my orphan vote. As an antidote against blunt nationalism and technocratic bliss maybe some biblical insights can provide the wisdom we need to solve the complex European puzzle and achieve a form of co-operation that will be sustainable in the long run. And harness us against opportunistic political spin and cynical snakes. Plus ça change, plus c'est la même chose - particularly in Europe, lest we forget.

Mayo42 signing off.

Wednesday, 16 October 2013

Keep the faith

With financial markets that are totally captured by central banks and politicians who can be captured by their own ego, money and dubious special interests, I needed some remedial soulfood to re-light my fire. Maybe it works for you too.

Tuesday, 1 October 2013

Taking the measure of Dutch European guarantees

The Netherlands Court of Audit (‘De Algemene Rekenkamer’) has already been fretting for some time about the rapidly increasing risks that the Netherlands are taking on a European level and how these risks are being recorded, reported and managed. Yesterday, they issued another critical report titled Financial risks to the Netherlands of international guarantees.

This is how the conclusions of the report are presented in English on their website (emphasis added):

The financial volume of the guarantees and interests that the Netherlands has given to the eight institutions audited has increased more than tenfold from €18.5 billion in 2008 to approximately €201 billion in 2012. This substantial rise has been accompanied by an increase in the lending capacity – and thus risk-taking – of the international institutions. The risks may ultimately be passed on to the countries that have given guarantees, such as the Netherlands. We therefore think it is important that parliament has a realistic insight into the risks that are being run, the measures taken by the institutions to mitigate them, the institutions' capital buffers to cushion losses and the size of the risks to the Netherlands. Since this information is not yet available in an orderly and comparable fashion, the report provides the following information on eight international institutions:

·         the institutions' financial ties with the Netherlands;
·         the institutions' financial profiles;
·         the institutions' risk mitigation measures.

Information on an institution's risk profile is necessary when a guarantee is given or amended because a guarantee may have to be honoured. We analysed three recent cases in which a guarantee was given to an institution or amended. The Minister of Finance could have informed the House of Representatives more specifically and concretely about the purpose, term and risks of the new or amended guarantees. This would be in keeping with the recommendations made by the Risk Arrangements Committee that the House be pro-actively informed and receive appropriate and concrete policy explanations of such guarantees.

The Court is a constitutionally independent body that audits the Dutch government’s financial housekeeping, its compliance to budgets, rules and regulations, as well as the effectiveness of the policies being undertaken. In short, they are well-informed people that have to be taken very seriously when they issue a warning.

The eight international institutions reviewed by the Court are the EFSF, the ESM, the EFSM, the Balance of Payments program, the EIB, the EBRD, the Euro system (the ECB and the NCB’s), and the IMF. Although the guarantees to these institutions represented only 8 per cent of Dutch GDP in 2008, this had increased to 33 per cent of GDP at the end of 2012. 

In its report, the Court provides detailed fact sheets (handy!) about the risk profiles of the eight institutions and their link to the NL. Five of them do not provide information regarding the risks they are taking (EFSF, ESM, EFSM, BoP program, the IMF) and three do not have any risk-bearing capital of their own (EFSF, EFSM, BoP program).

At the risk of being called a chauvinist, I rate the NL pretty high when it comes to financial thoroughness. After seeing the known unknowns identified in this report (and, who knows, the unmentionable unknown unknowns) I wonder whether anybody in Europe has a real grasp of the sovereign risks. Safe assumption: nobody does.

Mayo42 signing off.

Saturday, 28 September 2013

Next time we will need an even bigger boat

Thankyous to Tyler Durden for taking me to an interesting address on Memory Lane: on September 23 it was fifteen years ago that LTCM was rescued by a consortium of financial institutions that had been rounded up by the New York Fed. This emergency refunding arguably set the stage for the massive bail-outs that were to follow ten years later.

This is how the LTCM operation was described by Roger Lowenstein in his book When Genius Failed (emphasis added):

On September 23, 1998, Goldman Sachs, AIG, and Berkshire Hathaway offered then to buy out the fund's partners for $250 million, to inject $3.75 billion and to operate LTCM within Goldman's own trading division. The offer was stunningly low to LTCM's partners because at the start of the year their firm had been worth $4.7 billion. Warren Buffett gave Meriwether less than one hour to accept the deal; the time period lapsed before a deal could be worked out.

Seeing no options left the Federal Reserve Bank of New York organized a bailout of $3.625 billion by the major creditors to avoid a wider collapse in the financial markets. The principal negotiator for LTCM was general counsel James G. Rickards. The contributions from the various institutions were as follows:

·         $300 million: Bankers Trust, Barclays, Chase, Credit Suisse First Boston, Deutsche Bank, Goldman Sachs, Merrill Lynch, J.P.Morgan, Morgan Stanley, Salomon Smith Barney, UBS
·         $125 million: Société Générale
·         $100 million: Lehman Brothers, Paribas
·         Bear Stearns declined to participate.

Old dog that I am, reading this little text got me a bit nostalgic, longing for them good old days. LTCM happened only 15 years ago, and the amounts for such a systemically crucial rescue are trivial in comparison with the staggering numbers we are dealing with today. It required only $3.6 billion to save the whole system from collapsing (how ‘pathetic’) and the individual contributions by the banks are a modest bonus for your average financial honcho today. Then there is that ‘shocking’ loss for the LTCM partners: a measly $4.3 billion drawdown from the top (LTCM's partners received a 10 per cent stake still worth $ 400 million in the recap, their original investment was $1.9 billion). Those were the days. Think of the kind of money it would take in 2013 to rock the financial system in a similar way. If LTCM happened tomorrow, it would get mentioned on page three. That’s progress I suppose.

Fast forward ten years and we have AIG, one of the prospective saviors of LTCM, itself needing to be rescued to prevent another systemic collapse. This time the amounts are of a different order: an initial $85 billion loan by the Fed soon becomes a $150 billion rescue package in a complicated deal that involves the Treasury Department.

This ‘improvement’ in our systemic robustness can be better appreciated when putting these bail-outs in the context of their GDP at the time. According to the Worldbank, in 1998 US GDP amounted to $8,741 billion which grew to $14,219 billion in 2008, an increase of 1.6 times. Compare this to the size of a systemic rescue increasing by 42 times (from $3.6 billion to $150 billion - if you take into account the full $700 billion of the Troubled Asset Relief Program, the increase is, of course, even more awesome). Good news or bad news? Well, on the one hand the size of GDP in relation to financial rescues is getting a lot smaller, which is bad, on the other hand the financial system could now easily withstand the blow-up of an entity the size of LTCM (around $6.4 billion - the $3.6 billion adjusted for growth in GDP to 2012).

As far as systemic relevance goes, over a period of fifteen years we have moved from thinking in clips of $5 billion to thinking in clips of at least $50 billion. These days, a fine settlement of, say, $11 billion might be an embarrassing nuisance for a decent bank but hardly a life threatening event. Asset inflation? Only a figment of our imagination according to the Fed and the economic orthodox church. However, bail-out inflation seems only too real - the B in TBTF is getting bigger as we speak. In a post earlier this year, I referred to a study by consultants Bain & Co with the title A World Awash in Capital. The financial ´wealth´ that we are creating in relation to actual economic activity was illustrated by the inverted pyramid scheme above. Let´s hope that this bloating thing never topples but when it does, better pray that our boat GDP will be big enough to handle it.

May42 signing off.

Monday, 23 September 2013

The Fed is baking the mother of all soufflés

If there was any confidence that ‘forward guidance’ was a viable tool for managing interest rate expectations by a central bank, the Fed’s surprise decision not to cut back on Large Scale Asset Purchases (QE) should have taken care of that. Contrary to its earlier indications, QE was not reduced last week, not even by a little bit. The other big surprise was that the candidate most likely to succeed Ben Bernanke, the QE-skeptic Larry Summers, withdrew his candidacy. What we are left with is a Fed with dented credibility, more uncertainty when/if QE will be reduced, and the prospect of a dovish Janet Yellen at the helm of the world’s key central bank. When appointed, she will be leading the Fed’s battle against unemployment which is taking place in a setting of over-heating asset values, rising debt levels, insufficient growth and declining real incomes.

The Fed seems to have concluded that the US economy cannot (yet) support higher interest rates. Fair enough, but the big question remains whether continuing QE can lift the US economy to a healthier state able to withstand tighter monetary conditions. After five years of massive asset buying, not only is it doubtful whether QE has a meaningful positive impact on growth, the policy’s various negative side-effects could also be preventing a self-sustaining economic recovery from ever happening. Since that is a distinct possibility, a Fed stubbornly sticking to its conviction that QE works and, if it doesn’t work yet, it will just keep doing it until it does, is getting increasingly scary. The Fed’s firm belief (yep, yet another one..) that asset bubbles cannot be identified before they pop is all fine and dandy when you have the monetary leeway to deal with a messy aftermath, but at this stage in the game the Fed is running out of room to maneuver. If there ever was a monetary all-in, a betting the farm by a central bank, the current state of affairs in the US is beginning to look like it (Japan doesn’t count since they had no other choice). One more big reflation effort by the Fed when the next asset bubble bursts and the US will be flirting with hyperinflation.

Some of the official rhetoric surrounding the Fed’s unexpected decision was quite telling - although I am not sure whether it revealed dishonesty by the Fed to itself or to the public. Ben Bernanke mentioned several times in his press conference that the drop in unemployment is proof that QE is working while barely acknowledging that the US’ labor participation rate is at the lowest level since the late 1970’s which looks even worse when you take into account the poor quality of new jobs created (temporary, part-time, low paying service sector).  Another, almost hilarious line was used by Ben Bernanke and his colleague Esther George who both said that ‘the FOMC cannot let markets dictate policy’. Are you kidding? Fed policy is mostly about the markets and that’s a big part of the current problems. Not only has Alan Greenspan openly admitted that the stock market was a favorite target of his, the Fed’s ‘wealth’ objective is totally about juicing asset values. Why is QE not curtailed at this point? Mainly because rising rates in the bond market are threatening the values in US housing market. QED.

Graph via The Telegraph

With an economy that won’t be able to deal with higher interest rates in the foreseeable future, it will be interesting to see what the Fed will do if long rates keep creeping up despite its QE continuing at full blast. If suppressing long interest rates is such a key necessity for US economic wellbeing, the Fed might feel compelled to expand its buying program in the future. Not only would that completely suck all liquidity from the Treasury market (the little that’s left), at some point investors could get nervous from such a hyper-active Fed that cannot stop growing its balance sheet. When that happens and the vast ‘stock’ of outstanding US government debt starts shifting, it will be game over pretty quickly considering the huge volumes involved (USD 12 trillion held by the public of which 5.6 trillion sits with foreign investors). Foreign holders dumping a whopping  USD 40.8 billion in long-term Treasurys in June, a record amount according to data going back to 1977, and a dollar not strengthening on the taper talk could be early warning signs that the Fed can expand its balance sheet only so far without some unpleasant repercussions.

The many proponents of QE among economists are of the opinion that it is better to keep blowing bubbles than the alternative of deflationary hell from an ‘Austrian liquidation’. A good example is Ambrose Evans-Pritchard who strongly supported the Fed’s decision while offering some more radical monetary alternatives that could circumvent some of QE’s shortcomings. This is how AEP finished his article last week in The Telegraph:

My point is not to endorse Lord Turner's plan, or the Chicago plan, or any other particular plan, but simply to say that fear of asset bubbles is not a good reason to shut off monetary stimulus prematurely, if the economy still needs it.

Whether the Fed or the US policy establishment is willing to think so far out of the box remains to be seen. At least it has backed away from a repeat of the great 1937 error of premature tightening. There is slightly less risk that it will tip us back into another leg of the Long Slump. We have dodged a bullet.

In all fairness, AEP’s piece is as always well-balanced and he does look at the various issues very open-mindedly. In another article the previous week, AEP discusses the dire warnings coming from the BIS regarding the current monetary predicament we are in. Particularly BIS-guru William White, who unfortunately has been very right in the past, gets a lot of attention (emphasis added):

Mr White said the five years since Lehman have largely been wasted, leaving a global system that is even more unbalanced, and may be running out of lifelines. “The ultimate driver for the whole world is the US interest rate and as this goes up there will be fall-out for everybody. The trigger could be Fed tapering but there are a lot of things that can go wrong. I very am worried that Abenomics could go awry in Japan, and Europe remains exceedingly vulnerable to outside shocks.”

Mr White said the world has become addicted to easy money, with rates falling ever lower with each cycle and each crisis. There is little ammunition left if the system buckles again. “I don’t know what they will do: Abenomics for the world I suppose, but this is the last refuge of the scoundrel,” he said.

As if to prove Mr White’s point, the Fed strategy has moved from ascertaining that bubbles can only be identified in hindsight and dealing with them after they pop, to actively blowing bubbles and then preventing them from popping at all. Is it a viable strategy? I doubt it. So what now, little man?

Mayo42 signing off.

Wednesday, 11 September 2013

Asset buying talks, forward guidance walks

Numerous commentators have remarked that financial markets are broken after years of relentless bond buying by the Fed. Quantitative easing has destroyed any appetite to go against the tide of the Fed inflating assets to achieve a ‘wealth effect’. Given that hedge funds (a sector inhabited by contrarians rather than index-huggers) have consistently underperformed the S&P500 in the past 5 years, these observers may have a point. But this being the case, are markets so deeply broken that they will obediently follow the Fed in its efforts to suppress long term interest rates through ‘forward guidance’ or will they resume their independent value discovery role once quantitative easing will be cut back?

Graph via Zerohedge

Erik Nielsen, the global Chief Economist at UniCredit, recently discussed the practical problems with forward guidance in this excellent FT op-ed. He points out that if forward guidance is too non-committal (too ‘soft’ in the jargon), it doesn’t add much since it just confirms what you would expect a central bank to do i.e. policy making that is data dependent. On the other hand, if the guidance is too committal (or ‘hard’), it undermines the credibility of a central bank since it commits to interest rates that might be inappropriate for what the future will bring. His analysis suggests that forward guidance needs a broken market (i.e. a market that doesn’t make up its own mind any more) to be effective if actual economic developments diverge from the scenario that the central bank has in mind.

In another FT piece (sorry, I do read other publications as well), David Rosenberg points out that of the Fed’s two main objectives, an unemployment rate at 6.5 per cent and expected inflation at around 2.5 per cent, the latter is the most achievable with the tools at its disposal. When (not 'if') the Fed succeeds and inflation starts heading towards 2.5 per cent with only forward guidance to keep the treasury market in check, it is highly likely that long rates will go (at least) to their historical level of inflation plus a premium of 1-2 per cent. Should that scenario unfold, we are facing a combination of a Fed wearing a forward guidance straightjacket, inflation increasing, and only modest economic growth. Good luck with that.

Picture the Market as a zebra and the Fed as a trainer who wants to tame this wild animal and ride it like a donkey. The trainer gets the zebra to tolerate him on its back by feeding it regular portions of qat, an African herb that is, apparently, delightfully mind numbing. Over time, the zebra learns to accept the trainer’s weight and it even nods its head complacently when he tells it 'I have your back'. A few years of conditioning go by and the trainer feels quite satisfied about the good rapport he has with the animal and its obedient behavior. So much so, that he thinks that the qat is no longer needed, just soothing words and the promise of more qat should do the trick. Although taking away the qat is a bit of a gamble, the trainer actually has little choice in the matter - his qat bills are piling up and he gets increasingly harassed by drug addicts who also want some of the stuff.

Will the zebra stay docile as its QE qat is steadily being replaced by mere words and promises or will it buckle to reclaim its freedom and throw off its rider? The recent jitters in the bond markets and declining asset values in emerging markets suggest that the term ‘broken’ (as in subdued totally; humbled: a broken spirit) only referred to a temporary condition. I guess that’s somewhat of a relief, although relief….what we’ve seen so far was only the reaction of the beast to the message, its diet still has to be trimmed.

If forward guidance actually works, markets are truly broken – not good if you are a serious investor, not good for real returns in the bond market (returns after adjusting for inflation), and not good for overall confidence (see a previous post on QE). If forward guidance doesn’t work ('Don’t fight the Fed' turning into 'Don’t fight Mr. Market'), we will get seriously positive real rates in the treasury market – not good for economic growth and not good for dealing with the debt overhang. Either way, bonjour stagflation.

Mayo42 signing off.