Notes From Underground: Further Into the Fray

On Tuesday the news was filled with the release of an analysis by the research combine at Goldman Sachs warning about the negative outcomes from the increasing amount of debt as interest rates rise, lifting the negative percentage of interest payments relative to GDP. (See the CNBC story, “Goldman Sachs Sees Red Ink Everywhere,Warns U.S. Spending Could Push Up Rates and Debt Levels.”) This is another voice warning about the ill-timed fiscal stimulus and budget deficit increase late in the economic cycle. In an interesting juxtaposition, the WSJ had an article published last week titled, “Cohn Downplays Concerns Over Rising Inflation, Bond Yields.” Speaking in his position as Trump’s top economic advisor, Cohn maintained that the White House is not worried about an overheating economy. Cohn emphasized, “We know how to deal with inflation. We don’t know how to deal with deflation in this country.”

Sorry Mr. Cohn but the deflation boogeyman departed when Bernanke opened the flood gates of liquidity with “his courage to act.” As the FED has raised rates and begun the unraveling of its massive balance sheet the concern is certainly not deflation. Really?? You were under consideration for Fed chairman? It is scary that the chief economic adviser is speaking of deflation while the FOMC is supposed to be concerned with rising wage pressure. Also, in an effort to fight inflation the FOMC would have to raise interest rates to a high enough level that it could crush a global economy saddled with record amounts of debt.

Peter Boockvar has continually raised the issue of the huge amount of corporate debt that is tied to LIBOR and so any FED action increases the interest rate expense.Yes,Volcker taught the world that the FED‘s reaction function to inflation is to raise rates high enough to send the economy into a recession. Mr. Cohn, is this what you are suggesting for we certainly are not in a deflationary situation so why even bring the concept to the fore. The WSJ article raises the key point to the present deficit dilemma: It has risen from 2.4% of GDP to 3.4% over the last year even as the economy has experienced increased growth.

Next year the budget deficit is projected to reach 5.4% as the tax cuts and recent spending deal are realized. In a moment of great candor, Cohn supports the argument I raised yesterday: “Mr. Cohn said the White House pays close attention to deficits but said higher spending was necessary to secure new defense investments. The administration had to agree to non-defense spending increases to secure votes for the extra Pentagon funding, he said.” Deficits don’t matter until they do. GUNS and BUTTER indeed. Goldman Sachs is correct: RED INK EVERYWHERE.

***On Tuesday I chatted with Rick Santelli on CNBC. The video is not available as of yet but I discussed an important article from the Project Syndicate by former Bundesbank Vice President Jurgen Stark, titled, “The Irresponsible ECB.” The story is important because Mr. Stark is one of the most highly respected economists in Germany on a level with Otmar Issing and Axel Weber. (Mr. Stark was a member of the ECB Executive Board under Jean Claude Trichet but resigned in September 2011 because of a disagreement over the BOND PURCHASE PROGRAM.) Key points from the Stark piece:

  1. Federal Reserve policy, although not expansionary, is still far from NORMAL considering the “advanced stage of the economic cycle.” The FED is behind the curve;
  2. While criticizing the ECB and BOJ for its maintenance of an absurdly low interest policy to fight deflation “the truth is that the risk of ‘bad’ deflation–that is a self-reinforcing downward spiral in prices, wages, and economic performance–has never existed for the eurozone as a whole. It has been obvious since 2014 that the sharp reduction in inflation was linked to the decline in the prices of energy and raw materials.” Stark criticizes the ECB’s inflation target as violating the intentions of the ECB Governing Council in 1998 since “a central bank cannot control inflation with enough precision to establish a specific rate.”
  3. A consequence of the ECB’s policy is that interest rates have lost their “steering and signaling functions. Another is that risks are no longer appropriately priced, leading to the misallocation of resources and zombification of banks and companies, which has delayed deleveraging.”

The bottom line for Stark is that monetary policy is held captive by politicians seeking to keep borrowing costs very low in an effort to keep budgets under control. Italian two-year notes at NEGATIVE 20 basis points allows the interest rate costs of the Italian government to be held artificially low. But monetary policy is fiscal policy. The narrative that has been controlled through central bank forward guidance is coming under heavy criticism creating an environment for increased volatility. Now that a Spaniard has been named to be ECB vice president, is the road being paved for Jens Weidmann to ride into the ECB presidency when Draghi’s term ends in a year? The German hard-money voices are striving to be heard creating ever more uncertainty for the global financial system.

***Wag the Dog. Now that the Russians are under pressure from the U.S. Justice Department, and the Trump White House is under siege from the media, and Congress is looking to punish Putin and his cronies, watch for the Russians to ramp up activity in Syria. The current situation has the Russians with the upper-hand in Syria. With tensions high between the Assad forces, the Kurds, the Iranian proxy armies and Erdogan’s Turkey the toxic brew plays to Putin’s desire to create mischief and deflect pressure from the Kremlin. Remember that Putin has used the distraction of the Olympics (think Georgia invasion in 2008, Crimea in 2014) so be aware of Russian military actions in Syria, especially to exact some concessions from the U.S. White House and State Department. Wag the dog indeed.

Tags: , , , , , , ,

16 Responses to “Notes From Underground: Further Into the Fray”

  1. asherz Says:

    Many politicians and Central Bankers seem to forget that debt service takes priority over entitlements, military expenditures and yes, politician’s salaries ( unless of course you were a Chrysler bond holder). This blog has seen warnings of impending doom when, not if, interest rates eventually rise to their free market levels. With global debt/GDP at about 320%, the outcome is preordained.
    When the proverbial turd hits the fan, one can surmise that the money printers will again turn on the money spigot to lower interest rates with renewed QE vigor, leaving QT and a deleveraging balance sheet in the dust. Hyperinflation will ensue followed by, yes,
    DEFLATION, by virtue of a debt laden sovereign, corporate, Central Bank and individual balance sheets. Borrowing from our grandchildren to pay for our present needs never was a good prescription for financial sanity.
    In our security analysis classes many years ago we were taught to look at the balance sheet with notes before examining the income statement. Unfortunately the decision makers will learn that lesson in the not very distant future.

    • yra harris Says:

      Asherz –well presented and yes we can see the outcome unless some significant change were to commence–doubtful as even the freedom caucus went quietly into the good night as defense spending was ramped up.Cohn’s candor on the breaking the sequester compromise should have been headlines in every quality news sorts but as in the times of LBJ–nothing like butter to lubricate the arsenal of democracy.

  2. Peter M Todebush Says:

    The Russian Attack Against America You Didn’t Hear About
    19 February 2018 Michael J Totten
    You probably didn’t hear this because few media organization have even mentioned it, but Russia committed an act of war against the United States a little more than a week ago. No, this is not about more social media and election shenanigans. Russia mounted an armed assault against American soldiers and our allies in Syria, including Kurdish security forces affiliated with the People’s Protection Units, or YPG, at a military base in the city of Deir Ezzor, the largest in eastern Syria. Russian combatants fought alongside Assad regime fighters and Shia militias armed, funded and directed by Iran.

    Both the Pentagon and the Kremlin are going out of their way to keep this as quiet as possible. If you only read the New York Times story about the incident on February 13, you’d have to squint and zero in on the subtext. After the United States used air and drone strikes to obliterate incoming assailants, including dozens of Russians, American military spokespeople assured the press in calm tones that there was never any chance that Russian and American forces would clash directly in Deir Ezzor or anywhere else. The Kremlin, for its part, said any Russians who might have participated in the assault were mercenaries unaffiliated with the Russian armed forces.

    The problem with the Kremlin statement is that Russian mercenaries in Syria are employed by the Wagner Group, which works for the Russian government, and specifically for Russia’s Ministry of Defense, not for the Syrian or Iranian governments. And the problem with the American statement is that the Pentagon is asking us to assume that dozens of Russians were killed not by the bombs it had just dropped but by somebody else…or perhaps by spontaneous heart attacks or a catastrophic series of vehicle accidents.

    Some fine reporters at Bloomberg News dug a bit deeper. First, on February 14, Henry Meyer and Stepan Kravchenko reported that wounded Russians were flown from the battlefield to hospitals administered by the Ministry of Defense in Moscow and St. Petersburg, belying the claim that they were freelancing for somebody else.

    Second, Eli Lake reported on February 16 that several US officials confirmed that the Russian government understood perfectly well what was going on in Deir Ezzor—thanks to the so-called “deconflicting” agreements in place to prevent American and Russian soldiers from accidentally shooting each other. He also helpfully pointed out that one of the leaders of the Wagner Group, Dmitry Utkin, is closely linked to Yevgeny Prigozhin (aka “Putin’s chef”), one of the 13 Russian nationals whom FBI Special Counsel Robert Mueller just indicted for information warfare during the 2016 presidential election. The Wagner Group is also, by the way, responsible for the out-of-uniform Russians dubbed the “little green men” fighting in Ukraine in 2014, and the Washington Free Beaconobtained a photograph taken in 2016 that shows some of these mercenaries given medals by Vladimir Putin himself.

    Take a look at how carefully Secretary of Defense James Mattis describes what happened in Deir Ezzor. “I have no idea why [the Russians] would attack there,” he told reporters after the incident. “The forces were known to be there, obviously the Russians knew. We have always known that there are elements in this very complex battle space that the Russians did not have, I would call it, control of.” He’s going along with the story that the Russian government has “no control” over the Wagner Group, which clearly isn’t the case.

    And why would he do that? Lake thinks Mattis is committing a “noble lie” for the common good in both countries. “If Mattis acknowledges the obvious,” he writes, “that the Kremlin authorized a direct assault on a U.S.-sponsored base by non-uniformed personnel — he risks an escalation spiral in Syria. Better to express bewilderment and give Russian President Vladimir Putin a chance to back down and deny culpability, which he ended up doing despite the heavy casualties suffered by his mercenaries.”

    Aside from the stories I’ve cited above, this incident has received almost no media coverage in the United States. Perhaps it’s because Americans suffered no casualties while, according to numerous Russian media accounts, as many as 200 Russians were killed, and three separate sources told Reuters that Russia suffered as many as 300 killed and injured. Maybe it’s also because during what would have been this story’s news cycle, Americans were transfixed by yet another bloody massacre at a high school, this time in Parkland, Florida. Another possibility is that, in this inward-looking and tribal partisan time in American history, a botched Russian attack doesn’t neatly fit into one of our pre-existing media narratives, where the Democratic Party is focused on Russian election meddling and the Republican Party would rather talk about almost anything except the Kremlin’s malfeasance.

    Whatever the reason or reasons, Americans have missed an opportunity to take stock of a terrible fact—that Russia is an outright enemy of the United States that just committed an act of war against us in the Middle East. Unless Vladimir Putin has suddenly and silently been deterred—fat chance of that being the case—something else will have to happen to get our attention. Something bigger, something worse, something more dangerous.

    • yra harris Says:

      Peter—just a marvelous post and informs readers to why it is critical to explore beyond the narrative of the Mainstream.Syria is a powder keg and although the attack was defeated article 5 of NATO exposes the U.S. to significant risk via the hand of Erdogan and Putin certainly knows this well–again thank you for this important post

  3. Trader 1 Says:


    In an interview Italian Five Star Party Luigi Di Maio suggested they will want EU Italian debt restructuring.

    Wont this bring into full force your question of “who guarantees the ECB balance sheet”??

    And wouldn’t this unleash massive deflation in EU land??

    • yra harris Says:

      Trader 1–I have that piece sitting in my pile of issues to discuss and I believe you are quite correct—again this is a narrative that few want to discuss but it is a live as Draghi has to confront the Frankenstein of a massive balance sheet constructed without a harmonized financial authority–can Italy be responsible for its percentage of the financial edifice of the EU based on its % GDP or what the ECB refers to as its capital key

  4. Trader 1 Says:


    Thanks for Five Star Italian debt reply.

    Using Rotten Heart of Europe as the template + modern day Draghi debt buying $ binge loading up EU balance sheet:

    Do you have any thoughts on what the end game of this EU mess looks like??

  5. Stefan Jovanovich Says:

    Let me see if I understand things properly. Europe, China, North America and Japan have all agreed that the combined cash flows of employment and welfare have to be large enough satisfy the groups that matter. If this requires the central banks to provide SOEs and national Treasuries enough credit to make up the short-falls in tax collections, then the central banks will do that. If this requires the collective debts to be handled so that the accounts balance, then the national Treasuries and international finance agencies will agree that the accounts balance. Meanwhile, President Trump had managed to get Congress to enact a tax bill and adopt a budget that shifts U.S. internal cash flows slightly in favor of the employed. This relatively small adjustment is cause for universal alarm because at the same time (1) the Federal Reserve is shifting its buying to shorter maturities and no longer guaranteeing to be the buyer of first resort for all Treasury borrowing and (2) this year’s litter of dogs being raised in the kennel of a half century of Hobbesian war in the Levant has a slightly different colored tail. Got it.

  6. Chicken Says:

    And to think we were promised some “Peace Dividends”.

    I want my price of admission refunded.

  7. David Richards (@djwrichards) Says:

    Some points of interest recently observed:

    1) The Citi economic surprise index for Europe has suddenly deteriorated to historic lows, as European economic data has mostly disappointed expectations in 2018, foretelling that the European economy could falter.

    2) With the long-plunging USD, emerging markets have been gorging on huge amounts of USD-denominated debt. This has helped to push the dollar down even more against many EM FX (which have extended gains against the dollar, unlike european currencies of late). But have they forgotten about the crisis of 1997-98 when their currencies fell and they were unable to repay their dollar-denominated debt?

    3) US stocks closed the week above the weekly ascending channel, reinforcing the view that record highs lie ahead. The correction, even if it’s not over, is just that, a correction before new highs later.

    • Stefan Jovanovich Says:

      An idiot question: how does the increase in USD borrowing by EM countries push the FX exchange rate DOWN?

      • David Richards (@djwrichards) Says:

        Not at all idiotic. When foreigners choose to borrow dollars or issue dollar bonds, they usually convert the dollars to their own currency for their own purposes. That conversion, if widespread enough, can create enough dollar selling to push the dollar down relative to the other currency. The borrower is essentially short dollars and wins if the dollar depreciates over the term of the loan and/or the dollar interest rate is lower than their local interest rate. Speculators look for such a situation and then borrow in low-interest, depreciating currencies to buy higher yielding appreciating currencies. For example, the legendary Ms Watanabe, the Japanese housewives who borrowed falling yen at 0% to buy rising Aussie dollars that paid 4.5%. On the other hand, if the yen rises, then Ms Watanabe could go insolvent. And if the dollar surges, then the EM dollar-borrowers are in trouble. This is a big reason why a rising dollar can bode ill for the global economy, and a collapsing dollar juices it. It’s probably the #1 reason why the global economy has been increasingly strong for over a year. But this shall pass. The seeds of the next currency crisis & global economic meltdown are being sewn right now with all this foreign dollar borrowing, and when the tide goes out (read when the dollar next spikes on a major episode of risk aversion), then we’ll see who’s swimming naked.

      • Stefan Jovanovich Says:

        Thx, David. What confused me was my assumption that the borrowed dollars would be deposited with the EM central bank and domestic currency would be issued by the CAB against the dollar reserve. The “sale” of dollars would then be “sterilized”. These were the terms of the rescue plans (Dawes put forward as solutions to the collapse of Italy and the Entente empires after WW 1. As a result the gold pledged as loans did not leave the vaults in the U.S. and the countries’ currencies were not redeemable in coin as they had been before 1914.

      • yra harris Says:

        Stefan/David a very good dialouge and David hit it exactly correct.The perfect currency play for any investor is borrowing a currency at low interest rates that is depreciating for a multitude of reasons.It worked great for the East Europeans by borrowing in swiss francs until the Swiss pulled the plug on the PEG at 1.20 Eur/Chf then massive losses were inflicted on the borrowers

Leave a Reply to Stefan JovanovichCancel reply

%d bloggers like this: