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Broken Energy Markets and the Downside of Hubbert’s Peak

Dec 232014

December 23, 2014 Posted by Raúl Ilargi Meijer at 11:01 am Finance Tagged with: energy, gas, Hubbert, markets, oil, peak oil, Shale 16 Responses »

John Vachon Hull-Rust-Mahoning pit, largest open pit iron mine in the world, Hibbing, Minnesota Aug 1941

This is another entry by our friend Euan Mearns, orginally posted at Energy Matters.

Euan: A few commenters have mentioned peak oil recently. I am cautious about making forecasts and predictions and prefer instead to observe and document the data as the peak oil story unfolds. I have in fact published a couple of charts recently illustrating aspects of peak oil, one showing a possible peak in the rest of the world that excludes N America and OPEC (Figure 1). The other showing the undulating plateau in conventional crude + condensate that has persisted since 2005 (Figure 2). In my last post on oil price scenarios two of those showed global oil production capacity 1 to 2 Mbpd lower in 2016 than 2014. If that comes to fruition, will we have passed peak oil but does it matter?

Figure 1 Global oil production has been split into three geo-political categories: 1) USA and Canada, 2) OPEC and 3) the Rest of the World (RoW). RoW production bears the hallmarks of having peaked in the period 2005 to 2010 and this has consequences for oil prices, demand and prosperity in parts of the world, especially the OECD. Most of the growth in oil supply has been in the USA and Canada where the market has been flooded with expensive oil. Data are crude oil + condensate + natural gas liquids (C+C+NGL) and exclude biofuels and refinery gains that are included by the IEA in their total liquids number.

The current “low oil price crisis” is providing a clear and new perspective on the nature of the peak oil problem. If low price does indeed destroy high cost production capacity then this will raise the question if the high cost sources can ever be brought back? IF low price kills the shale industry can it come back from the dead?

Figure 2 Conventional crude oil + condensate production has been on an undulating plateau just over 73 million barrels per day (Mbpd) since May 2005, that is for almost 10 years and despite record high oil prices! Note that chart is not zero scaled in order to amplify details. Click chart for large version.

The response of the oil price to scarcity in the period 2002 to 2008 was for it to shoot up. And the response of the energy industries to scarcity and high price was to develop high cost sources of energy – shale oil and gas and renewables. The longevity and permanence of these new initiatives has always been dependent upon our ability and willingness to pay. Of course, most of us who have cars continued to use them but have perhaps subliminally modified our behaviour through driving less or buying more fuel efficient vehicles. OECD oil consumption has at any rate been in decline and robust economic growth has been elusive. Is this due to the peak oil story unfolding?

The global finance and energy system is unfortunately rather more complex than that. The creation and expansion of debt is of course central to creating demand for oil and other energy sources. Without QE the global economy may have died in 2009 and demand for oil with it. Gail Tverberg produced an interesting chart that may illustrate this point (Figure 3). However, back in 2008 / 09 OPEC trimmed 4 Mbpd from their production and this equally explains why the price rebounded so strongly then. The end of QE3 may have contributed to the recent fall in demand, but the price has fallen so precipitously because OPEC has not compensated by reducing production.

Figure 3 QE appears to have impacted demand for oil and may have created the lines of credit enabling energy companies to produce high cost gas and oil at a loss. But the oil price has been equally controlled by OPEC controlling supply. Chart by Gail Tverberg.

The big picture is made even more complex by climate concern and a growing raft of energy policies in Europe and the USA designed to reduce CO2 emissions while singularly failing to do so meaningfully. And so at a time when clear engineering thinking was required on how to tackle the potential impacts on society of energy scarcity in the global economy we got instead ‘Green Thinking’. Future generations will look back on this era with bewilderment.

Against this backdrop, I will now move on to the main topic of this post which is the concept of broken markets and Hubbert’s peak. For those who do not know, Hubbert’s peak is peak oil by another name and while wise guys may want to invent a multitude of definitions I will stick to the simple definition of the month or year when global oil production reached a maximum volume or mass and thereafter went into inexorable decline. The impact of this on Mankind is normally expected to be negative since oil is the lifeblood of the global economy. The reason for this happening could be because we discovered something better than oil that substituted oil out of existence (that wouldn’t be bad) or because of scarcity oil became too expensive to produce (perhaps where we are now) or because Greens in government like Ed Davey and Barack Obama set out to undermine the fossil fuel industries which just a few years ago I would have found impossible to believe. We live in interesting times.

The world economy as we know it runs on fossil fuels and in particular a relatively small number of truly gigantic fossil fuel reserves such as the Ghawar oil field in Saudi Arabia, the Black Thunder coal field in Wyoming and the Groningen gas field in The Netherlands. Both Ghawar and Groningen are showing signs of age, along with the hundreds of other super giant fossil fuel deposits. The stored energy in these deposits flows out at enormous rate and at little financial or energy cost. It is these vast energy supplies and surpluses that provide the global economy with economic surplus. It is indeed the lifeblood. But the world has run out of these super giant deposits to exploit and we are finding it increasingly difficult to find large enough numbers of their smaller cousins to keep the wheels of the global economy well oiled

The focus has thus turned to low grade resource plays. The resource plays offer near infinite amounts of energy but require large amounts of effort to gather that energy. The ERoEI is lower than what went before, perhaps much lower, but for so long as the energy return is positive, we have indeed learned that Man’s inventiveness and commitment can exploit these resources. One of the main questions I want to pose here is, is it possible for these resource plays to participate in the global economic system as it has existed for many decades that has become known to us as capitalism?

The first example of broken energy markets I want to look at is wind power. Both onshore and in particular offshore wind are expensive forms of intermittent electricity. Wind advocates will argue that the intermittency does not matter and will point gleefully to the low electricity prices achieved when the wind blows strongly across Europe resulting in over-supply that dumps the price. Wait a minute though, high cost and low price is a toxic mix that does not jive with capitalism. The more wind resource installed on the system the greater the size the unusable surplus and economic penalty becomes.

Why have the wind producers not gone out of business? It’s because the markets are rigged such the wind producers are given priority to market and receive a guaranteed price. This is a monopoly! The consumers don’t benefit because they have to pay the guaranteed price to the wind monopoly. The losses end up in the hands of the traditional generators who see their prices dumped and need to chew on the losses whilst providing the invaluable balancing services for free.

Providing back up services for when the wind doesn’t blow is another problem newly addressed in the UK with the new “capacity market”. The government is calling this a ‘market’ while it is in fact a component part of the wind monopoly. Companies are being paid to maintain generating capacity on stand by to cover periods when the wind doesn’t blow. Again the consumer has to foot the bill. One day quite soon, UK and other European governments are going to have to explain to their electorates why they have distorted the electricity market so badly, delivering a monopoly to wind producers, destroying the traditional market participants with the bill being met by the consumer who receives zero benefits. This can only be explained if it is underlain by rampant corruption or sheer stupidity.

The second example of a broken energy market I want to explore is the US shale industry. This shares certain characteristics with the wind industry in that it is a high cost but potentially very large resource. But the mechanism for integration of this resource into the market is rather different. The problem with shale gas is that over-supply has resulted in the US gas price being dumped below the level where many shale operators can make a profit. Consumers in this case benefit through getting both secure and low priced gas. But the shale operators have reportedly racked up large losses that have been covered by expanding debt. These losses may yet come home to roost with the consumer if debt defaults result in a new credit crunch where the debts are socialised via government bailouts of the banking sector.

If it were possible to produce shale gas at $1 / million btus then everyone would be happy. Consumers would be getting secure and cheap energy and producers would be making handsome profits to distribute to shareholders. That is how capitalism is supposed to work. The system as it has operated seems broken.

US Light tight oil (LTO) production appears now to have created the same problem for the liquids plays where the entrance of expensive liquids in the market have contributed to the crash in the oil price. This has created risks for the LTO operators. It remains to be seen if the LTO sector sees mass insolvencies and default on loans that may socialise these losses. The introduction of high cost LTO has also undermined the whole of the higher cost component of the conventional oil sector. If LTO could be produced in large quantities for $20 / bbl then there would be no problem since this source would go on to substitute for the higher cost conventional sources of supply. But with costs closer to $60-$80 this is not going to happen. The conundrum for capitalism is the introduction of large quantities of higher cost energy to the system.

At this point I have to admit that nuclear power may be subject to similar limitations. It is difficult to view the Hinkley Point new nuclear build in the UK as a triumph for the consumer or the country. A better way to manage such enormous capital expenditure on vital infrastructure is via the state. The costs may eventually be socialised to the tax payer, but at least the energy is reliable and amongst the safest forms of power generation ever developed and the taxation system distributes costs in an equitable way.

A form of society could undoubtedly exist powered by nuclear, wind and shale gas. But it would be a society supported by the state with far larger numbers working in the energy industries than now, producing lower surpluses, the energy production part perhaps running at a perennial loss. Those losses have to be covered by either higher price or via the taxation system. Either way, the brave new world that awaits us will be characterised as the time of less that will be in stark contrast to the time of plenty many of us enjoyed during the 20th Century.

Europe’s Fatal Flaw Laid Bare For All To See. Again.

Oct 172014

October 17, 2014 Posted by Raúl Ilargi Meijer at 9:07 pm Finance Tagged with: bond, ECB, EU, eurozone, Germany, Greece, markets, PIIGS, yield 5 Responses »

Marjory Collins Carpool for 3rd shift defense workers, midnight, Baltimore April 1943

Da markets today sort of refound their – shaky – feet, oil up a dollar, EU exchanges up 3% or so, Greece even over 7%, while interestingly gold didn’t move much at all during the wild week (no safe haven), and most movement was perhaps, through all the see-saw, in bonds. To sum up the week: panic followed by plunge protection teams. And now the ‘leaders’ hope plunge protection will save another day too.

And they may. Germany sinks a bit, but Germany is strong. US housing is at least not falling further, but US consumer spending stalls and drops. The deep dark weakness has not yet hit the big economies. But the nerves are back. Volatility is back with a vengeance. As it should. And that will paint the picture going forward, plunge protection or not. Da markets will come again and again and dare central banks to plunge protect.

Well, either that or more QE, but despite whatever Bullard says the Fed will go ahead with the taper – just listen to Yellen waxing dreamily about the US ‘expansion’ -, and the ECB won’t go full QE because the member states will never agree on anything. And Merkel feels the euroskeptics breathing down her neck as much as the ‘leaders’ of Britain, Italy, France et al.

But as we’ve seen today, there’s sufficient fire power left on both sides of the pond to survive one week of mayhem. But that’s not the main lesson on this Friday. The main lesson is that Europe’s Achilles heel has been laid bare, once more, in full sight, and Europe – re: Draghi, Merkel – thinks that denial is its best defense. Big mistake.

The lofty leaders at the ECB, and Berlin, Paris, Brussels, pretend they can make everything right that’s wrong inside their toy monetary union through asset purchases, sovereign bond purchases, and anything that falls in the ‘whatever it takes’ category. But it’s all just bluff. Because, what it all boils down to, they can’t keep buying Greek bonds with German taxpayer money until the end of time.

And the markets know this. And when they feel like it, for example because other profits (free QE funds) have dried up, the markets will call that bluff at craftfully chosen intervals. It’s the easiest thing in the world: they only need to bet against something they know is hollow gaping hot air to begin with. There’s no there there. Draghi cannot save Greece. Period. And if he can’t save Greece, he can’t save the euro. Period.

In Brussels, like in Washington, Tokyo, Beijing, only one thing really counts: they have to achieve economic growth, because if they do, all problems will vanish into thin air. Which is not only an idiotic notion, it’s been 7 years now and they still haven’t achieved even just that one thing they focus on. It’s exactly like converting to some religion because it promise that the deity of their choice will relieve you of all your troubles, only in modern economics the deity is growth. And its apostles are debt, debt and credit.

If it were you or me, we’d say: let’s try something else, go for some other approach, but not Brussels or Washington, they live in one dimension only, they lack every form of depth perspective, and they will keep pushing for growth until they die trying. And in the case of the ECB, drag Europe down with them, first of all the young people of Greece, Italy, Spain and Portugal.

The idea is that all problems will be solved by the return of growth, but how is Greece ever going to grow again when over 50% of its young people haven’t, for 6-7 years running now, ever worked a decent job in their lives, and those who are now 25-28 years old, and never had a shot at real work, despite college degrees, university degrees, face the competition of all graduating classes of those 6-7 years for the same jobs, which still don’t exist?!

It’s an impossibly dumb concept that can exist only in the minds of well-paid bureaucrats in both Athens and Brussels – and Rome and Madrid-. And it can lead to only one outcome: Greece will leave the EU. Because no matter what you think about the Greeks’ abilities to govern themselves, they couldn’t possibly do worse for themselves, for their young people, and thereby their entire economy, than the present system has done. What could possibly have been worse than this?

Greece wanted to join the EU because of the promise of added riches. Instead, they see their entire society dissolve through the EU ideal of lifting all Mediterranean boats to the level of Germany. It’s not like Germany wanted itself to become poorer, that was never their reason to set up the EU.

Berlin wanted Greece to become Germany, and Germany to become an economic Nirvana. They still do. Politicians know that to get (re-)elected they need to promise growth, they need to paint a rosier picture than people see around them today. As if we’re not rich enough yet. It’s not just the politicians who lack depth perspective, it’s their voters too. If you can choose between a promise of more or a threat of less, you know how you will vote.

What this turbulent week exposed was this: Greek 10-year bond yields rose to close to 9%. They’re back down to 7.8% as we speak, plunge protection. 7% is the major ‘sustainable’ level. Greece, just very recently, said they wanted to free themselves of the Troika. The financial markets have now let them know what they think of that.

First Greece, then Cyprus, and Spain, and Italy, and Portugal, and Ireland, will continue to be the targets of the global financial markets. And the EU can’t save them all. There will be more moments like the past week, and the ECB is powerless to stop them all, other than at such gigantic costs that the voters in the richer nations will move their support to other parties.

4-5 years ago, when the PIIGS crisis was at its height, Europe could have enabled the poorer countries to leave the euro straightjacket. Soon, it won’t be a question of enabling anymore, it will turn into a dogfight. The eurozone as a whole will never achieve growth anymore, but Germany and Holland and Finland might; at the cost of the PIIGS.

This will stop at some point, da markets will make sure it does. Achilles was a mighty warrior, with one fatal weakness. That weakness for the eurozone was laid bare this week in the Greek 10-year bond 9% yield. The only ways that exist to bring that back down are artificial: it’s not like Greece itself, with 25% unemployment and more than twice that among young people, can lift itself up by its hairs.

And still, no, it’s not Greece that is Europe’s Achilles heel. It’s the hubris and megalomania that has made Europe, Brussels, blind to its inherent weaknesses. If Greece, and perhaps Spain, Italy, Portugal, would have been allowed to leave the eurozone in 2008/9, they would all have done much better than they are now, and so would the richer core of the EU.

After all, how could the PIIGS possibly have done worse than the present 50%+ youth unemployment? Greece is not Germany, and never will be. Italy is not Helsinki, and never will be.

The peace ideals behind the European unification will, unless something changes very soon, turn into them’s fightin’ words. Because the hunger for power floated like so much excrement to the top of yet another supra-national organization that this world of ours should never have built. EU, World Bank, UN, IMF, NATO, you name them. They take on powers we never designed them for, and before we know it we can’t stop them anymore from accumulating ever more power.

The eurozone’s Achilles heel was there for everyone to see this week, and it’s fatal, lethal: Greek 10-year yields at 9%. That will end up killing the whole edifice. Unless Brussels comes up with a plan to let the PIIGS leave. Brussels won’t. The power hungry don’t give up power voluntarily. So we’ll fight. Suit yourself. But don’t think this will somehow turn out alright all by its smooth and easy self. Europe is on the verge of disintegration. For no reason at all, other than the power dreams of a bunch of borderline psychopaths.

Deflation Flirts With America

Oct 162014

October 16, 2014 Posted by Raúl Ilargi Meijer at 5:51 pm Finance Tagged with: consumer, deflation, Juncker, Keynes, markets, Merkel, Yellen 5 Responses »

Jack Allison Street scene, New York City Summer 1938

“When it becomes serious, you have to lie,” said brand-new EC head Jean-Claude Juncker back in May 2011. I’m thinking the last few days have been serious enough to warrant some real whoppers from Brussels. And beyond.

Yesterday, one hour after the S&P reached its low point, not only was it deemed necessary to bring out the Plunge Protection Team, Fed grey head Janet Yellen was trotted out as well to soothe the dark mood with rosy tales about the US economy.

A multi-day series of downturns got a temporary crescendo, with many of the richest stock European exchanges at 10-11% losses from recent highs. Many lost 3-3.5% for the day alone, with Greece down 6.25% (Athens is off some -25% in all), and having its bonds dumped while Germany et al see ‘investors’ fleeing into theirs. A new attack on Athens certainly looks possible. And where Greece goes, so go Italy and Spain, albeit a few mph slower.

Is this the end or the beginning? Well, as should have been clear for a very long time now, you cannot buy growth. And in ‘our’ efforts to buy growth instead of working for it, a lot of damage has been done. Which won’t all show up at once, but it will at some point. There will be many, and mighty, voices clamoring for more of the same, in more than one sense, as people seek to hold on to what looks familiar with additional debt injections in the by now 7 year-old tradition spirit of ‘stimulus’.

It’s become a new normal to claim the Germans must be insane not to follow the teachings of the Great Lord Keynes, with the huge success stories of the US and UK as ‘proof’ of just how wise he was. Then how come this kind of plunge is so predictable?

US stocks see their heaviest trading volume in 3 years. That takes liquidity. Dollars. But they are getting scarce. The ‘insanest’ amounts of free money, from China and America, are shrinking (Japan has become a story all of its own) and right away, panic ensues. Add the threat of higher rates and you get a sell-off. I see plenty ‘experts’ saying both Beijing and Washington will see the folly of their ways in time, but can they really do more of the same? And what would be the benefit vs the cost?

I remain solidly convinced that Yellen et al will suffocate QE, hike interest rates, and raise the dollar. Because that’s the triple that benefits big banks the most. And that’s also why she, yesterday, held that speech in which she ‘voiced confidence in the durability of the U.S. economic expansion’.

Yellen Voices Confidence in U.S. Economic Expansion

Federal Reserve Chair Janet Yellen voiced confidence in the durability of the U.S. economic expansion in the face of slowing global growth and turbulent financial markets at a closed-door meeting in Washington last weekend [..] Yellen told the Group of 30 that the economy looked to be on track to achieve growth of around 3%. She also saw inflation eventually rising back to the Fed’s 2% target as unemployment falls further… [..] Yellen’s reported remarks were roughly in line with the forecasts presented by Fed policy makers at their last meeting in September.

Not only did she, with the PPT, save the day on Wall Street, she also provided the reason why rates will rise, even if world markets have a high fever. In an aside, an Air France plane has been quarantined at Madrid airport just now with a Nigerian man with high fever and 182 other passengers. We can’t seem to get this right, can we?

Back to da mullah. Here’s a few interesting lines from Bloomberg yesterday afternoon:

U.S. Stocks Drop as Weakening Economic Data Fuel Selloff

The Chicago Board Options Exchange Volatility Index, the benchmark gauge of options prices known as the VIX, jumped 15% to 26.25, the highest level since 2012, amid demand for protection against losses in equities.

Almost 12 billion shares changed hands in the U.S., the most since October 2011. Stocks pared losses after the S&P 500 fell to its low of the day of 1,820.66 shortly before 1:30 p.m. in New York. About an hour later, Bloomberg News reported that Federal Reserve Chair Janet Yellen voiced confidence in the durability of the U.S. economic expansion in the face of slowing global growth and turbulent financial markets at a closed-door meeting in Washington last weekend.

Retail sales in the U.S. dropped more than forecast in September, decreasing 0.3% after a 0.6% gain in August that was the biggest in four months, Commerce Department figures showed. Another report today showed manufacturing in the Federal Reserve Bank of New York’s region slowed more than projected in October. The bank’s so-called Empire State index dropped to 6.2 this month from an almost five-year high of 27.5 in September.

That ‘demand for protection against losses in equities’ is a curious line. Can’t they let the PPT act in secret anymore? What else is its use? You can’t very well make it the Public Plunge Protection Team, nudge nudge…

But the big one is the drop in US retail sales. No harsh winter, no hurricanes, not even heavy rains. And the Empire State Index falling of a cliff. I know that today US industrial output came out looking like a harvest queen, and initial claims were down a bit, but I find the timing odd, and I can’t rhyme it with the heavy drop in that NY Fed index. Is it winter in Manhattan already? Or is it Juncker time?

It gets truly hilarious when you see things like this from Bloomberg. Pay special attention to Deutsche’s Joseph LaVorgna:

The $11 Trillion Advantage That Shields U.S. From Turmoil

Call it America’s $11 trillion advantage: Consumer spending is likely to steer the U.S. economy safely through the shoals of deteriorating global growth and turbulent financial markets. The combination of more jobs, falling gasoline prices and low borrowing costs will help lift household purchases. Such tailwinds probably matter more than Europe’s struggles or the slackening in emerging markets that caused the Dow Jones Industrial Average last week to erase its gains for the year.

“We’ve got a lot of things working in favor of the consumer right now,” said Nariman Behravesh, chief economist at IHS. “To have that kind of strength is the biggest asset for the U.S. It’s a pretty rock solid footing.” Household purchases make up almost 70% of the $16.8 trillion U.S. economy and have climbed an average 2% in the recovery that’s now in its sixth year. Spending growth will accelerate to 2.7% next year after 2.3% in 2014, according to the latest Bloomberg survey of economists.

The poll, taken from Oct. 3 to Oct. 8 in the midst of the meltdown in equities, showed little change in the median projections from the prior month. The economy is forecast to expand 3% in 2015 after 2.2% growth this year, according to the survey. “We’ve got the proverbial 800-pound gorilla – the consumer,” said Joseph LaVorgna, chief U.S. economist at Deutsche Bank Securities Inc. in New York. “Households are more fixated on the good news here, and a big part of that is the labor market. The U.S. is going to be pretty immune to the rest of the world.”

“The U.S. is going to be pretty immune to the rest of the world.” No, Joe, it’s not. The US is less vulnerable than most to lower oil prices and higher and scarcer dollars, true enough. But the US also still has a population in which labor participation is at a historic low, in which those who have jobs are paid less and get far fewer benefits, and which has huge levels of personal debt.

Ergo, the only way the US consumer can consume is by delving deeper into debt. They have to borrow before they can spend. Just like much of the rest of the world. Only, in the US consumer spending accounts for 70% of GDP (and it’s down); in other countries, it’s substantially lower.

A nice example of where the US stands at this point in time is here: German states ask Merkel for more infrastructure spending, which she refuses, while the US can’t even afford it own infrastructure anymore, because all the trillions the US spent (by expanding its central bank balance sheet), – and Germany did not -, went to Wall Street. And then you get this:

German States Join Ranks Pressing Merkel to Spur Spending

Germany’s state governments stepped up calls for infrastructure spending, adding another source of pressure on Chancellor Angela Merkel to boost investment as economic growth falters. Much like Merkel’s national government, the states are caught between a deteriorating growth outlook and the balanced-budget drive that Germany started in response to the euro area’s debt crisis.[..] A day after the German government lowered its growth outlook, proposals to spend more on projects such as highways in Europe’s biggest economy are on the table at a retreat of state premiers that Merkel plans to attend.

Merkel will let some projects be executed, but she won’t let her country sink into debt to do it. For America, that’s not even a choice anymore. It needs Chinese funny money now or bridges will crumble. A country with such a rich history of citizens chipping in to build bridges, roads and other infrastructure, what a remarkable turn-around this is. Only 100 years ago, a town that couldn’t afford to build its own bridges would have been ridiculed. And look now:

Crumbling US Fix Seen With Global Trillions of Dollars

[..] Former Indiana Governor Mitch Daniels said: “America needs the upgrade and modernization of our infrastructure, and I don’t think you’ll get there if you keep excluding, or at least discouraging, private capital.” President Barack Obama’s administration, which had resisted private financing of public works, is starting a new center to serve as a one-stop shop for bringing capital into government projects.

U.S. Treasury Secretary Jacob J. Lew said while direct federal spending is indispensable in such cases, tight budgets demand creative ways for unlocking private money.His cabinet colleague, Transportation Secretary Anthony Foxx, put it more bluntly when he announced the Build America Investment Initiative in July. “There will always be a substantial role for public investment,” Foxx said. “But the reality is we have trillions of dollars internationally on the sidelines that are not being put to work.”

Now, America must pay hefty interest rates to strangers on its own bridges. Or they won’t get built. That should hurt. No, it really should.

You can focus on the hosannah news that comes out about the US economy every single day, and on Janet Yellen’s confidence booster yesterday, or you can look at how car sales are deteriorating, after they were upbeat for a while only on subprime loans.
The biggest number for me, amid the global storm in stocks and bonds, and the renewed – very real – threat of financial markets targeting southern Europe, is that drop in US retail sales.

So industrial output was up 1%. So what? That’s not the 70% of your economy. Retail sales are though. And they are down. Because Americans borrowed less, for whatever reason. And what they can’t borrow, they can’t spend. Because they’re dead broke.

So how are you going to make them less broke? Those 92 million Americans who are no longer counted in the work force, how are you going to get them to increase their spending patterns? Or the millions more who are still ‘counted’ in the work force, but have no jobs? Or the fast rising number who have jobs that pay close to or below a living wage?

I say let them stocks plummet, and let’s get a glimpse of where the real economy is at. We’ve seen the fantasy one for 7 years now, and it gets old and bitter.

I see deflation flirting with America. Retail sales equals consumer spending equals velocity of money. And unless the money supply is rising, hardly likely in the taper, less spending is deflation by definition. Forget about PMI and all that kind of data, it’s much simpler than that. Central banks can do all kinds of stuff, but they can’t make us spend our money on things we don’t want or need. Let alone make us borrow to do so. And if we don’t, deflation is an inevitable fact. That doesn’t mean prices for some items won’t go up, but that’s not what counts. It’s about how fast we either spend the money we have – if we have any left – or how much we borrow. And if time is money, then borrowed money is borrowed time. So we really shouldn’t.

Debt Rattle Jun 16 2014: Central Banks Have Become The Markets

Jun 162014

June 16, 2014 Posted by Raúl Ilargi Meijer at 2:46 pm Finance Tagged with: central banks, markets 8 Responses »

Dorothea Lange Tobacco sharecropper, with baby on front porch. Person County, NC July 1939

The cluster, – or pride, or cabal – of global central banks, led by the Bank of Japan have come very close to strangling their respective bond markets to the point suffocation with ultra low interest rates, and therefore together moved $29 trillion they had ‘invested’ there into equity markets. Restoring the world’s $100 trillion bond markets to health, even ever, will be a task so daunting that it’s hard to see one single way it can be done. The Bank of Japan has become the de facto only buyer of its own government’s bonds, with the result that trading has ground to a halt, literally so for a number of days last week. Yields on global bonds have been manipulated down so much that not only pension funds and other traditional large-scale fixed-income buyers feel forced to move into stocks, it’s even come to the point where central banks themselves, too, make that move.

Bank of Japan’s Bond Paralysis Seen Spreading Across Markets

The Bank of Japan’s unprecedented asset purchase program has released a creeping paralysis that is freezing government bond trading, constricting the yen to the tightest range on record and braking stock-market activity. Historical price volatility on Japanese bonds slid to a 1 1/2-year low of 0.913% on June 13 and a lack of activity delayed trading at least four days last week. The yen has traded in a range of 4.68 per dollar since Jan. 1, the tightest since Japan ended currency controls four decades ago. Average trading on the Topix index is near its lowest level in more than a year. Asset purchases have not only made BOJ Governor Haruhiko Kuroda the biggest player in Japan’s $9.6 trillion bond market, they have also given him the most leverage over currency and equity markets in the world’s third-largest economy.

China’s State Administration of Foreign Exchange (or Safe), which is part of China’s central bank PBoC, has become “the world’s largest public sector holder of equities”, writes the Financial Times, which has seen an upcoming report by central bank research and advisory group Official Monetary and Financial Institutions Forum (Omfif) : “In a new development, it appears that PBoC itself has been directly buying minority equity stakes in important European companies,” Omfif adds.”The trend “could potentially contribute to overheated asset prices”:

Central Banks Shift $29 Trillion Into Equity As Low Rates Hit Revenues

Central banks around the world, including China’s, have shifted decisively into investing in equities as low interest rates have hit their revenues, according to a global study of 400 public sector institutions. “A cluster of central banking investors has become major players on world equity markets [..] Although scant details are available of their holdings Omfif’s first “Global Public Investor” survey points out they have lost revenues in recent years as a result of low interest rates – which they slashed in response to the global financial crisis. The report identifies $29.1 trillion in market investments, including gold, held by 400 public sector institutions in 162 countries. Central banks’ actions aimed at stimulating economies, including quantitative easing, have deliberately sought to push investors into riskier assets, and share prices have risen sharply since 2009 – leading to fears of stock market corrections if economic growth disappoints.

That “could potentially contribute to overheated asset prices” bit is a leading contender for understatement of the new millennium, of course; there’s nothing potential about it, the overheating is a done deal, and the people at Omfif know it. Between corporations utilizing their access to cheap QE related debt to buy back their own shares, and central banks using their own QE funds to first kill markets for their own government bonds and then prop up stock markets, it’s a miracle the latter have ‘only’ risen as high as they have. Because $29 trillion buys a lot of assets. But a behemoth-scale shift from bonds to stocks creates a lot of problems as well. Bloomberg hints at one:

Bond’s Liquidity Threat Is Revealed in Derivatives Explosion

The boom in fixed-income derivatives trading is exposing a hidden risk in debt markets around the world: the inability of investors to buy and sell bonds. While futures trading of 10-year Treasuries is close to an all-time high, bond-market volume for some maturities has fallen a third in the past year. In Japan’s $9.6 trillion debt market, the benchmark note didn’t trade until midday on two days last week. As a lack of liquidity in Italy caused transaction costs in the world’s third-largest sovereign bond market to jump last month, Lombard Odier Asset Management helped propel an eightfold surge in Italian futures by relying more on derivatives. The shift reflects an unintended consequence wrought by central banks, which have dropped interest rates close to zero and implemented policies such as buying debt to restore demand in economies crippled by the financial crisis.

Inefficiencies in the $100 trillion market for bonds may make investors more vulnerable to losses when yields rise from historical lows. “Liquidity is becoming a serious issue,” Grant Peterkin, a money manager at Lombard Odier, which oversees $48 billion, said in a June 11 telephone interview from Geneva. The worry is that when investors try to exit their positions, “there may be some kind of squeeze.” That concern has caused investors to pour into derivatives, which are contracts based on underlying assets that can provide the same exposure without tying up as much capital. As bond trading has slumped, the notional value of over-the-counter contracts soared fivefold in the past decade to a record $710 trillion, based on the latest data from the Bank for International Settlements compiled by Deutsche Bank.

There will be tons of pundits’ comments about how all this is a matter of ‘unintended consequences’, but we should not take that at face value. While QE was advertized as being aimed at reviving the real economy, the actual target from the start was always debt- and derivatives-laden Wall Street banks, and a switch from bonds to stocks fits in perfectly with that reality. The picture seen in the media all day long, every day of rising stock markets keeps a lot of – PR – trouble at bay, illusionary as it may be, and allows for many a trillion here, trillion there scheme to continue happening out of the public’s sight.

Central banks lose revenue because of the low interest rates they themselves engineered to allegedly “help the real economy”. In that same vein, as Tyler Durden notes:

“To summarize, the global equity market is now one massive Ponzi scheme in which the dumb money are central banks themselves, the same banks who inject the liquidity to begin with.”

If the Bank of Japan can become the only game in town for its ‘own’ bonds and kill the market for these bonds that way, what can we expect from central banks moving head first into stocks? What about a permanent high, or, to be precise, a permanent higher, as long as they keep buying, and after that a whole lot of nothing because all trade has been stifled? Why do we even still talk about bond ‘markets’ and stock ‘markets’? Doesn’t that imply there should be actual trading going on?

Central banks can’t cure the real economy with stimulus or illusions, but they can sure do it a lot of harm with both. Bernanke, Yellen, Kuroda and Draghi have dug themselves into a very deep hole, but they don’t care, because you will be counted on to dig them out. While bankers and large shareholders count their loot and their blessings.

• Central Banks Shift $29 Trillion Into Shares As Low Rates Hit Revenues (FT)

Central banks around the world, including China’s, have shifted decisively into investing in equities as low interest rates have hit their revenues, according to a global study of 400 public sector institutions. “A cluster of central banking investors has become major players on world equity markets,” says a report to be published this week by the Official Monetary and Financial Institutions Forum (Omfif), a central bank research and advisory group. The trend “could potentially contribute to overheated asset prices”, it warns. Central banks are traditionally conservative and secretive managers of official reserves. Although scant details are available of their holdings Omfif’s first “Global Public Investor” survey points out they have lost revenues in recent years as a result of low interest rates – which they slashed in response to the global financial crisis.

The report, seen by the Financial Times, identifies $29.1 trillion in market investments, including gold, held by 400 public sector institutions in 162 countries. Central banks’ actions aimed at stimulating economies, including quantitative easing, have deliberately sought to push investors into riskier assets, and share prices have risen sharply since 2009 – leading to fears of stock market corrections if economic growth disappoints. China’s State Administration of Foreign Exchange has become “the world’s largest public sector holder of equities”, according to officials quoted by Omfif. Safe, which manages $3.9tn, is part of the People’s Bank of China. “In a new development, it appears that PBoC itself has been directly buying minority equity stakes in important European companies,” Omfif adds.

A chapter in the report on Chinese foreign investment trends argues Safe’s interest in Europe is “partly strategic” because it “counters the monopoly power of the dollar” and reflects Beijing’s global financial ambitions. In Europe, the Swiss and Danish central banks are among those investing in equities. The Swiss National Bank has an equity quota of about 15%. Omfif quotes Thomas Jordan, SNB’s chairman, as saying: “We are now invested in large, mid- and small-cap stocks in developed markets worldwide.” The Danish central bank’s equity portfolio was worth about $500m at the end of last year. Overall, the Omfif report says “global public investors” have increased investments in publicly quoted equities “by at least $1 trillion in recent years” – without saying from what level, or how the figure is split between central banks and other public sector investors such as sovereign wealth funds and pension funds.

Growth in countries’ official reserves has increased fears about potential risks to global financial stability. In a contribution to the Omfif report, Ted Truman, a senior fellow at the Peterson Institute for International Economics, writes: “Reforms are urgently needed to enhance the domestic and international transparency and accountability for this activity – in the interests of a better-functioning world economy.” He adds: “Changes, real or rumoured, in the asset or currency composition of foreign exchange reserves have the potential to destabilise exchange rate and financial markets.” Central banks around the world have foregone between $200bn and $250bn in interest income as a result of the fall in bond yields in recent years, Omfif calculates, without giving details. “This has been partly offset by reduced payments of interest on the liabilities side of the balance sheets,” it adds.