One of the great movies of the 1960s asks who is more insane: Those in the asylum or those who create wars? The present state of central banking can lead one to ask the same question about the overseers of FIAT CURRENCY and those who make investment decisions based on the policies of those academics so in love with their economic models. As the Bernanke victory tour rolls on, the fallback position of the recent anointed savior of the global financial system poses the counter-factual of, “What if we hadn’t acted by embarking on a massive liquidity injection? Aren’t you all satisfied that the unemployment rate is hovering around the defined level of full-employment?”
My question back to Ben Bernanke is posed as another counter-factual. What if you had not MADE YOURSELF the only game in town? By preempting Congress and continually adding liquidity through large-scale asset purchases, didn’t you make it possible for Congress to do nothing since cheap money was providing the stimulus? It was Senator Chuck Schumer who called you the only game in town. But it was IMF chief economist Olivier Blanchard who wrote that the multiplier effect of infrastructure spending was a greater stimulus than mere provision of liquidity. The initial QE program was necessary to prevent the liquidation of assets but the continued efforts of QE2 and QE3 made it easy for Congress to DO NOTHING. Like the counter-factual put forward by Bernanke, the truth is we will never know the outcomes of either hypothesis.
However, the end result is that all the world’s central banks have pursued the Bernanke Doctrine and have built or are building massive balance sheets. The only result has been the continued elevation of risk assets as money crowds into a small pool of assets, especially as sovereign bonds are not available while the ECB, BOJ and the FED crowd out private investors. At the end of October, the fact that all developed country stock markets rallied in harmony reflects the power of the world’s central banks. Why should the SPOOS have been up as much as the European markets and Japan when the DOLLAR was up 1.5% for the month? Every CEO in the U.S. blamed their earnings shortfall on DOLLAR STRENGTH yet it’s actually lower since the end of the first quarter. Yes, the DOLLAR is up 6% on the year but most of that is against the EURO, which shouldn’t have led to a shortfall in all regions. If the DOLLAR was the main culprit, the U.S. equity markets OUGHT to have underperformed in October, except that wasn’t the case. The only reason seems to be that cheap money floats many boats.
Also, if the FED is going to raise rates when inflation rises close to the level of the dual mandate then it will be met with rising WAGES. A stronger dollar and increased wages resulting in an interest rate hike should be a drag on U.S. equities relative to the rest of the world. But with the world struggling to differentiate between the inmates and the decision makers it makes sense to party on.
In a further testimony to global financial insanity, the Financial Times had an article on its front page, “Beijing Comes to Aid of Eurozone QE Drive With Sales of German Bunds.” The problem for the Bundesbank and ECB is that there is not enough German debt to buy because Germany has been running budget surpluses and therefore not issuing enough bonds to meet the requirements of the ECB‘s QE program. The PBOC and SAFE (State Administration of Foreign Exchange) are selling German and other European sovereign bonds at artificially inflated prices and netting a nice profit at the expense of European taxpayers who will ultimately pay the price for the ECB‘s losses on its portfolio. The article said:
“The Bundesbank has scoured the world for sellers according to one person familiar with the matter, including SAFE. Under pressure to make a return on its reserves portfolio, SAFE has agreed to take advantage of the high prices on offer for low-yielding German Bonds.”
This is what has made the global sovereign bond markets a broken mechanism for pricing credit risk. The ECB keeps buying debt forcing even Italian two-year notes to a ZERO interest rate. The more the ECB buys, the lower rates go and it has a ripple effect all over the world, resulting in investors purchasing assets at artificial prices. The Chinese are wise to unload their vast reserves with the central banks providing the escape mechanism.
The ultimate effect of the ECB‘s actions is that the global credit become starved for GOOD COLLATERAL and the result of ECB action is to choke the channels of private credit creation. Also, it makes the European bond markets a trade and not an investment for it is too difficult to fight the ECB in an attempt to ascertain real value. And an important note, today is the first day of the month so the ECB has 60 billion euros to buy so be very cautious about any steep rise in yields. Who is insane in the global game of capital flows?
***Tonight the Reserve Bank of Australia (RBA) announces it interest rate decision. The consensus calls for no change and rates to be left at 2%. The recent weakness of the Aussie dollar versus the KIWI and other currencies may keep the RBA on hold but it is worth reading Governor Glenn Stevens statement about the condition of the Asian economies. The other day I made note of the technical importance of the Aussie/kiwi cross-rate at 1.0525. It violated that level in trading after the RBNZ rate decision last week but if the RBA were to CUT rates look for that level to retest. Recent data projects a 35% chance of a rate cut but again the recent AUSSIE weakness will PROBABLY keep the RBA on hold.
Also, the residential construction sector has held up well and the Aussie authorities have tried to slow housing by using macro-prudential tools. A rate cut would act to undermine those efforts.