Notes From Underground: May Day or Mayday Mayday Mayday?

On Friday the world “celebrated” May Day, when the red flags of the world’s workers united in solidarity are traditionally unfurled. The fall of the Berlin Wall unleashed the rush for economic development and a plethora of workers in search of capital to lift its productivity. And for the past 30 years have capital and wages have been elevated for the emerging economies yet stagnant for the developed region. It has been capital that has been the recipient of increased profits as global capital went to the lowest wage regions.

The Coronavirus pandemic may undo all of that as the large corporations are having to rethink supply chains and pay more in wages to build more efficient transport modes in order to prevent the breakdown seen during the past three months. Also, as the attacks on the Chinese mount for their lack of transparency in reporting the Corvid-19 pandemic global firms are going to be on the defensive, having to rebuild GOODWILL with its domestic populations.

There is great uncertainty about what this means for corporate profits going forward. As firms and consumers request debt forbearance political priorities will weigh heavily on domestic needs. If the democrats win the White House and both Houses of Congress what will be the impact on global business?

Changes are certainly afoot as all citizens have been asked to endure wartime conditions, especially the young (the under 35 crowd) for as Phil Ochs sang, “It’s always the OLD to lead us to the wars, it’s always the young to fall.” What will be the price of reparations on global capital?

***My father, who was a B-17 navigator during WWII, always stressed the distress call of mayday, mayday, mayday, which alerted the airfield to a plane in distress. It seems that the ECB and Federal Reserve press conferences were mayday calls from the cockpits of two major central banks.

Chairman Jerome Powell left no doubt that the U.S. central bank will been fighting the incendiary outcomes of a “DEFLATIONARY SPIRAL” for an extended period of time as rapid UNEMPLOYMENT continues to ravage debt repayments and more importantly, the fear of recently employed workers suffering a diminished skill set from being laid off. Powell went out his way to express great concern about Hispanic and African-American workers experiencing the best job market in decades losing that new found pride in work, especially experiencing higher wages and pride of place.

Looking out for the entire economy will keep the FED pinned at the zero lower bound for an indeterminate amount of time. Powell also explained that while the central bank announced its intention to buy high-yield ETFs to support fallen angel corporate bonds, the jawboning worked as the mere mention of purchases restored calm to the market. This was a page directly out of former ECB President Mario Draghi’s 2012 playbook when he announced the ECB would do whatever it takes to preserve the EURO with Outright Monetary Transactions.

The ECB never purchased one sovereign bond under OMT conditions but succeeded in saving the euro and reducing borrowing rates for EU countries. The Fed’s actions in March was a victory for the Powell Fed but I caution about considering it mission accomplished. Powell is well aware he was close to being legally challenged for the ETF /corporate bond purchases and walked back by clarifying that the FED going “where we have never been before and quite aggressively. Nonetheless these are lending powers. We can’t lend to insolvent companies. We can’t make grants.”

Liquidity additions can prevent the mass forced liquidation of assets in an effort to raise capital but if UNEMPLOYMENT and its cohort suppressed demand are prolonged, solvency will be the issue.

On Thursday, ECB President Christine Lagarde didn’t increase any of the ECB’s QE programs but did lower rates for banks needing to get loans to businesses suffering  short-term stress. Lagarde, like Powell, noted the negative feedback loop from increased UNEMPLOYMENT making it difficult to forecast outcomes “so we will of course err on the liquidity providing side.”

The new broadside from President Lagard was the twice iterated: “WE WILL NOT TOLERATE FRAGMENTATION.” This was a direct shot at those opposing any form of eurobonds. If no fragmentation will be tolerated then NO CAPITAL KEY will be followed and the ECB will buy unlimited amounts of any sovereign debt in trouble relative to the BUND. Watch the charts for yield differentials for that will be the mayday alert.

German/Italian spreads narrowed substantially but European debt markets were closed on Friday for the holiday. Unlimited purchases of Italian, Spanish, Portuguese and Greek debt accentuates the ECB’s synthetic eurobond. How could you possibly unwind the ECB balance as GDP/DEBT levels in several EU countries explode higher? To Jens Weidmann and the Hanseatic League, mayday mayday mayday.

***Please read the Financial Times piece by Rana Foroohar titled, “There Will Have to be Massive Debt Relief” and interview with Kiril Sokoloff. This is a high quality interview by the best of the FT’s columnist. I am sad to say I have been unaware of Mr.Sokoloff for he is somebody I would have admired for his deep analysis of markets through the tools of economic history. Arthur posted the interview in the comments section of the last post.

***This week the German High Court will again hear challenges to the ECB’s QE/Asset Purchase Programs and the possible violation of German legal system and the fiscal responsibility of the Bundestag. Be aware, especially as the EURO had a late week rally following on the back of Lagarde’s press conference.

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11 Responses to “Notes From Underground: May Day or Mayday Mayday Mayday?”

  1. Michael Temple Says:

    Yra
    Sounds rather bullish/constructive for USTs and USD.

    Best

    Mike

  2. Michael Temple Says:

    Yra
    You ask what the costs to business will be in the New Normal.

    Seems like very few people caught the Amazon statement that it expects to spend $300MM (I am assuming that is a 2020 figure) to be able to test its employees!!

    Yes, Amazon can afford the extra burden?

    Can F and GM afford it? How about all the white collar firms located in downtown office towers with hundreds/thousands of employees. Will they be able to absorb those extra costs of doing business without harming operating margins?

    Finally, Warren Buffett echoes Kiril Sokoloff’s skeptical tones this weekend. Sold all his airlines and has said he has no good feel for what the economic future/outcomes will be. Ergo, he bought not ONE investment in this Fed-inspired buying panic.

    Even though he hates cash, he is content to build his stash.

    Wonder if he could ever see bring himself to reject his lifelong investment principles and buy some gold. We know he once did
    buy a boat load of silver…..Imagine if he simply wanted to put 1% of his $135 BN cash position to work in silver.

    The mind boggles. But, I am sure Warren won’t go fishing in those waters. Gold, either

  3. Alex Says:

    Yra, an insightful post as always with much to think about! A bit off topic here, I’m curious do you still use the 2s10s spread to gauge risk appetite?

    • yraharris Says:

      Alex—the 2/10 is caught on the pincers of a Fed grabbing all it canin an effort to control the market—some will be jaw boned as Powell admitted the other will be actual Fed purchases—difficult at the moment to get any real sense of market temperment

  4. asherz Says:

    Yra,- “If the democrats win the White House and both Houses of Congress what will be the impact on global business?”, you ask.
    If the Democrats gain control of the government, we will have the US complete the transformation from entrepreneurship and free markets to big government and a Social Democracy. The Sanders/AOC wing will be calling the shots from health care, regulations, carbon foot prints, to open borders, etc.

    Sokoloff’s ideas are right on, some of which have been presented on this blog over the last few years.
    He quotes Montagu Norman of almost a century ago of the BOE on the failed monetary policy. He could just as easily have quoted our own Secretary of the Treasury Henry Morgenthau Jr. in 1939 saying after the massive New Deal spending, “We have tried spending money. We are spending more than we have ever spent before and it does not work.” Unemployment was higher in 1939 than in 1931.
    Too bad Bernanke, Powell and Co. didn’t learn from history. The only result of their Sikorsky lunacy will be the destruction of the dollar, Black Hawk down, a main part of the mandate they were charged to prevent.

  5. APH Says:

    Buffet WILL buy Gold if/when he feels the potential gain versus the risk is there.

    He’s a greedy **** and can’t resist the lure of profit and return on capital. So for him to perhaps see Gold at $4,000 when it’s now at $1800 and not be on that, especially when he’s got so much cash on hand, is ludicrous in my opinion.

    And he can still not like Gold as an investment. He’ll argue the Gold play is just that, a play.

    • yraharris Says:

      APH—i care much more what Munger thinks when it comes to global Macro—but remember that Mr.Buffet did very well on a silver trade years ago buying at $4.00 and selling out somewhere in the teens —-it may be a barbarous relic but it has proven a relevant and meaningful store of value in a world that thrives on the debasing /depreciating of fiat currency values as a way to ameliorate the effects of too much debt in a system that is totally dependent of low interest rates and the use of debt for any and all reasons

  6. Michael Temple Says:

    Yra
    Your comments apply to gold, but not to silver at this time.

    Silver may yet rise higher. But, it is gold that proves to be the antidote to reckless fiscal and monetary behavior.

    Now, if Buffett were to re-study his previous silver gambit, he might be able to grasp that the supply/demand curve for silver indicates that demand is growing way above current annual production.

    Moreover, roughly 60% of annual silver demand is industrial which is strangely a bullish argument for silver if you believe investors will soon value it as a monetary metal.

    Why? Let’s assume industry demand drops from 60% to 45% (nearly 25%) in 2020.

    Estimated 2020 production + scrap is 950MM Oz

    If 45% is spoken for by industry, that leaves supply at roughly 500MM Oz. At $15, that is just $7.5 BN left for investors to buy.

    Mighty small number in the multi trillion world of investable funds.

    Buffett could take 2% of his cash hoard of $135 BN and buy roughly 1/3 of that remaining supply.

    Of course, after he finishes buying up near $16/17, he can conveniently tell the world he now owns nearly 170MM ounces because he sees a big deficit in the market. I dare say silver would jump the same 10% that the airlines dropped today when he said he sold em all.

    But, that prospect and that day is way off in the future as the markets continue to treat silver with disdain, something as lethal as kryptonite.

    But, if some real market pros would simply study supply/demand dynamics of silver and embrace the view that, sometime down the road, more investors will embrace silver as “poor man’s gold, it is easy to see silver outperform gold, especially once gold makes new all time highs.

    But, for now, it is all about gold.

    • yraharris Says:

      Mike—I was only noting that he has made investments in the metals when he deemed they had value

      • Michael Temple Says:

        Yra
        I never recall gold, but yes to silver.

        Too bad he cannot show some intellectual flexibility and marvel at the FCF monsters that the miners have become.

        He says he hates cash for the long term.
        He equally despises bonds.
        Stocks look too rich for his blood.
        And the world’s CBs and governments are pumping out more fiat and stimulus than ever.

        In fact, look at the miners today. Most are at or making new 52 week highs. Gold price will soon follow suit.

        But, back to silver. Nobody in the financial world really seems to care, despite some very favorable supply/demand dynamics. Least of all Warren

      • yraharris Says:

        Mike—only one is Jimmy Rogers cousin of Roy and evidently friend of Clayton Moore

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