Notes From Underground: The Chinese Cite Hyman Minsky

First a few jokes: My sources tell me that the new Fed Chairman will be Marc Faber; second, as Lloyd Blankfein is chirping about Brexit and Goldman moving to Frankfurt, Germany, he opined several years ago that Goldman was doing God’s work. Well, being the cyclical time in the Jewish Torah of the reading of NOAH, I remind Blankfein that Noah was also part of God’s work. (Pour a scotch and laugh).

The world was shaken last night when the People’s Bank of China (PBOC) Governor raised one of our favorite themes at NOTES: The rise of complacency in the financial markets due to the low volatility generated in markets. The more complacent the market, the higher the P/E valuations as RISK PREMIUMS get squashed. Governor Zhou said, “If we’re too optimistic when things go smoothly, tensions build up, which could lead to a sharp correction, what we call a Minsky Moment. That’s what we should particularly defend against.” This is an amazing comment coming from the second-most important central banker in the world. In the global financial markets, equities sold off, bonds rallied and the U.S. Dollar initially rallied as the algos drove flows to havens. The equity markets returned to bullish sentiment by the afternoon in the United States, but Governor Zhou’s comments should not be readily dismissed.

Treasury Secretary Mnuchin may believe his threats to Congress about the need to pass TAX REFORM/CUT or suffer a sharp correction in U.S. and global equity markets, but I would argue that the Chinese will have a far greater impact upon the global economy than the U.S. tax plan. A U.S. tax cut will have far less impact on equity markets unless it is accompanied with GENUINE TAX REFORM. It is a mistake for a U.S. Treasury Secretary to air concerns about the equity markets. It is almost as ill-advised as a U.S. president who touts every new S&P high high at press conferences. Smart politicians realize that markets rally and markets break due to variables beyond their control. As Peter Boockvar has written, “EQUITY MARKETS ARE DRUNK ON TAX REFORM.” This should make policy makers leery of accepting responsibility for increased stock values.

If you don’t believe this reread the comments from the PBOC. As Governor Zhou warned on Sunday in Washington, “Chinese companies have taken on too much debt and there needs to be less financial leverage. The country’s total debt is already two and a half times the size of the economy.” Some opinions carry more weight than others. Zhou or Mnuchin? The theory of Hyman Minsky are nothing to be complacent about.

***Yield curves. The 5/30 has broken below 10-year lows as the flattening continues in the face of the FED raising short term rates (and even as the BOJ and ECB continue purchasing assets in an effort to maintain their QE programs). The U.S. 2/10 is pressing the previous lows of 74 basis points as it currently sits at 76.6 basis points. Is the FED‘s failure to understand the inflation dynamics of its own models causing investors to hedge themselves with bond purchases? We just don’t know because the QE policies have broken the traditional signaling mechanism of bond markets. But the curves are flattening and we continue to pay attention, especially since tomorrow is Friday and weekly closes have greater significance. But be very attentive especially in light of PBOC Governor Zhou’s comments.

***On Monday Bloomberg reported the Japan Post will shift billions of dollars into yen-based domestic large-capitalization stocks. This reallocation to equities from bonds comes as the Nikkei index is making 21-year highs. Japan Post is one of the largest investors in the world as it controls a huge amount of the savings of Japanese retail pensioners.

This Sunday Japan goes to the polls and it appears that Prime Minister Abe will prevail and not suffer any significant parliamentary losses. The YEN has held steady, even as the NIKKEI has continued to rally which reflects a weakening in its long-established negative correlation. The Nikkei has generally rallied when the yen weakened as a weaker currency was deemed to be supportive of corporate profits. This breakdown reflects the beginning of a change as long-held correlations are negating long-established relationships.

***Thursday, Bloomberg News had an article titled, “Conservatives Campaign Against Yellen’s Reappointment to Fed.” In my last blog post, I suggested that President Trump would use the FED chair selection as a bargaining chip with Congressional Democrats and article gives strength to that notion. The House Freedom Caucus has cited concerns over excessive use of regulatory powers to influence things outside the issues of monetary policy (essentially overreach of mandated powers). The HOUSE OF REPRESENTATIVES has no power over the FED pick but the concerns of House Republicans can provide leverage for Trump in his negotiations with Congress over tax reform.

The article quotes Andrew Surabian of the Great America Alliance (a Bannon-associated Super PAC), who said, “Americans deserve a true outsider at the FED and not another insider in the pocket of the financial of the financial elites.” This sentiment provides Trump with the flexibility to craft a tax deal with the Democrats. If DJT reaches across the aisle to get a deal with the likes of Senator Chuck Schumer, he would readily support the reappointment of Chair Janet Yellen. The insiders keep talking about a White House short-list for Fed Chair. A list devoid of politics is not a narrative I am willing to accept.

***Market perspective. The precious metals have  declined this week as the strong economic data and equity market strength have provided a backdrop to an increased probability of the FOMC raising rates in December. Coupled with this view are rumors of the ECB cutting QE purchases by 50% (60 billion to 30 billion) while extending the duration of its large asset purchase calendar. The ECB meeting is Thursday, October 26 so markets will be cautious about any ECB quantitative tightening (QT). What will be critical for me will be the GOLD/EURO relationship, which is currently trading at 1083.27 euros to an ounce of GOLD. The 200-week moving average resides at 1057.9 euros/gold so this will be a support area.

The Chinese overnight statement did contribute to a GOLD and SILVER with a rally as fears rose about global finances is down 1% on the week even with today’s rally. Silver is flirting with its 200-day and 200-week moving averages. In the time of COMPLACENCY there are divergences that warrant our attention.



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10 Responses to “Notes From Underground: The Chinese Cite Hyman Minsky”

  1. kevinwaspi Says:

    From Grant’s Interest Rate Observer today, another pearl. “In addition to the 1987 swan-dive, October 19 also marks another financial anniversary, that of the 1955 “punch bowl” speech from then-Fed Chair William McChesney Martin, Jr:

    “”In the field of monetary and credit policy, precautionary action to prevent inflationary excesses is bound to have some onerous effects–if it did not it would be ineffective and futile. Those who have the task of making such policy don’t expect you to applaud. The Federal Reserve, as one writer put it, after the recent increase in the discount rate, is in the position of the chaperone who has ordered the punch bowl removed just when the party was really warming up.””

    Gone are the days, indeed. “

    • David Richards (@djwrichards) Says:

      Came back to reread this because it’s such a fascinating contrast to now. Thank you for the education. Why isn’t Mr Grant being talked about for a Fed position? Must we first suffer another crisis exacerbated by poor policy?

  2. Asherz Says:

    Zhou Xiaochuan was a visiting scholar at the University of California 30 years ago. Minsky’s ideas must certainly have been part of what he learned while teaching here. His cautioning on high corporate and household debt stems from the understanding of Hyman Minsky’s theory. The rank speculation financed by the QE printing press has continued for so long, because debt service is facilitated by low interest rates. We are witnessing a textbook example of what Minsky warned about.
    Daily self back-patting by members of the administration of new Dow highs, will one day return with bites in the back. It would be more prudent to warn investors of the great risks that exist in the markets as the VIX makes lows.
    The wealth effect effects primarily the wealthy. The middle class is largely living hand to mouth with a decade of meager wage increases. Those who are fortunate to have a 401K or increase in their home if they own one, don’t spend the higher current valuations in the super market. And when the inevitable bust finally comes as per Minsky, the debt will still be there. and that may be why inflation remains subdued. Inflation/disinflation/deflation is forward looking and not perceived from the rear view mirror.

    • Yra Says:

      Asherz–really good points .And it is refreshing to me that the chief of the PBOC issues forth such a viewpoint.I am sure the policy point coming at the time of the 19th Plenum –the face is Zhou but the words are Xi—I believe we should all be attentive to this pronouncement.It is as always not mere ramblings but a voice of concern.

      • Asherz Says:

        Xi has 5 more years, the 20th plenum, until he will be required to retire because of age. In the global competition with the US superpower, Xi seeks to elevate the standing of the yuan which he hopes will one day remove the dollar as the sole reserve currency, having a yuan priced crude oil future backed by gold as the first big step. Bretton Woods made the gold backed dollar the currency of choice in 1944 as the war ravaged Europe turned to the US for help. With the Nixon act of breaking the dollar from its gold backing in 1971, another area of dollar demand was necessary. The petrodollar came into existence in 1973 and as demand for oil increased, the demand for the dollar increased despite the lack of gold backing.
        Watch for a gold backed petroyuan to become a key factor in the race for global power.
        And that is why bringing up the Minsky Moment at the 19th plenum is important, as the Chinese Debt/GDP ratio approaches 300%.

    • David Richards (@djwrichards) Says:

      In addition, the Minsky remark isn’t too surprising coming from the head of an org like the PBOC which is staffed with experienced traders rather than lawyers and boot-licking Wall Street wannabes.

  3. Chicken Says:

    1st joke was best, IMO.

    Perhaps while running their greasy mouths they’re counting on the shortness of memory people have.

    Proof of concept; Mitt Romney delivered on his promise of low gasoline prices, despite losing the election.

    It’s a given, asset strippers are no more feminist than sex workers.

  4. Alan Cahn Says:

    Yra Harris’ analysis is brilliant for his understanding of political economics

  5. David Richards (@djwrichards) Says:

    Re the curves, Bretton Howard is reportedly starting up the first ever single purpose hedge fund to bet on a steepening.

    In a nutshell I think their thought is that Central Banks desperately need monetary inflation as governments are faced with increasingly onerous debts and disillusioned citizens, while printing and spending their way out of this problem is cheap at historically low interest rates. So more printing ahead (witness Jerome Powell and the other Big 3 central banks).

    The printing will cause long term rates to move higher as these rates discount future inflationary expectations. Any shrinkage of CB balance sheets will place further upward pressure on long-term rates. But short-term rates won’t be hiked much because doing so would bankrupt their over-leveraged citizens and massively indebted governments, both of whom have heavily borrowed on the short end. Thus the steepening to come. We’ll see. As usual, timing is key. Possibly yield flattening to precede widening, as the deflation (already seen) precedes the inflation (early but already increasing). In the less likely alternative, if inflation doesn’t materialize, the economy rolls over in deflation and the curve steepens anyway.

    More interesting is that the yield curve steepener trade is a way to bet & profit on the view that Central Banks will lose control of the bond market. This could be the source of the next (bigger) financial crisis – a bond market crash, rather than a mortgage-meltdown induced crash of the equity market like last time, the tech wreck before that and the EM crash before that. As history rhymes rather than repeats.

  6. Rob Syp Says:

    Even our old pal Phil Flynn hopin on the Minsky moment..

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