Jun 012018
 
 June 1, 2018  Posted by at 1:01 pm Finance Tagged with: , , , , , , , , , , , , ,  


Nikolay Dubovsky Became Silent 1890

 

“European Stocks Surge Celebrating New Spanish, Italian Governments”, says a Zero Hedge headline. “Markets Breathe Easier As Italy Government Sworn In”, proclaims Reuters. And I’m thinking: these markets are crazy, and none of this will last more than a few days. Or hours. The new Italian government is not the end of a problem, it’s the beginning of many of them.

And Italy is far from the only problem. The new Spanish government will be headed by Socialist leader Pedro Sanchez, who manoeuvred well to oust sitting PM Rajoy, but he also recently saw the worst election result in his party’s history. Not exactly solid ground. Moreover, he needed the support of Catalan factions, and will have to reverse much of Rajoy’s actions on the Catalunya issue, including probably the release from prison of those responsible for the independence referendum.

Nor is Spain exactly economically sound. Still, it’s not in as bad a shape as Turkey and Argentina. A JPMorgan graph published at Zero Hedge says a lot, along with the commentary on it:

The chart below, courtesy of Cembalest, shows each country’s current account (x-axis), the recent change in its external borrowing (y-axis) and the return on a blended portfolio of its equity and fixed income markets (the larger the red bubble, the worse the returns have been). This outcome looks sensible given weaker Argentine and Turkish fundamentals. And while Cembalest admits that the rising dollar and rising US rates will be a challenge for the broader EM space, most will probably not face balance of payments crises similar to what is taking place in Turkey and Argentina, of which the latter is already getting an IMF bailout and the former, well… it’s only a matter of time.

 

And now Erdogan has apparently upped the ante once more yesterday. Last week he called on the Turkish population to change their dollars and euros into lira’s, last night he ‘suggested’ they bring in their money from abroad (to profit from ‘beneficial tax rules’). Such things have, by and large, one effect only: the opposite of what he intends. He just makes his people more nervous than they already were.

It’s June 1, and the Turkish elections are June 24. Will Erdogan be able to keep things quiet enough in the markets? It’s doubtful. He has reportedly already claimed that the US and Israel are waging an economic war on Turkey. And for once he may be right. A few weeks ago Erdogan called on all member states of the Organisation of Islamic Cooperation to boycott all Israeli products (and presumably America products too).

On April 30, the IMF warned that the Turkish economy is showing “clear signs of overheating”. On May 1, Standard & Poor’s downgraded the Turkish economy to double-B-minus. Economic war? Feels a bit more like a political war. Erdogan has three weeks left to win that election. Don’t expect things to quieten down before then. But as the graph above shows, Turkey itself is the problem here first and foremost.

Expect Erdogan to say interest rates -usury- are immoral in Muslim countries. Expect much more pressure from the west on him. Erdogan has also been busy establishing Turkish ‘enclaves’ in Syria’s Afrin territory (where he chased out the original population) and in the Turkish-occupied northern part of Cyprus (where he added 100s of 1000s of Turks).

No, the West wouldn’t mourn if the man were defeated in the vote. They can add a lot more pressure in three weeks, and they will. Will it suffice? Hard to tell.

 

Back to Italy. Where the optimism comes from, I can’t fathom. The M5S-Lega coalition has never made a secret of its program and/or intentions. Just because pronounced eurosceptic Paolo Savona was shifted from Finance to EU minister doesn’t a summer make. New Finance minster Tria may be less outspoken than Savona, but he’s no europhile, and together the two men can be a woeful pain in Europe’s behind. This is Italy. This is not Sparta.

The essence of the M5S-Lega program is painfully simple: they reject austerity as the basics of economic policy. And austerity is all that Europe’s policy has been based on for the past decade at least. That spells collision course. And there is zero indication that the new coalition is willing to give an inch on this. Tsipras may have in Greece, but Italy’s sheer size means it has a lot more clout.

To begin with, the program wants to do away with the Eurozone’s 3% deficit rule. It speaks of a 15-20% flat tax, and a €780 basic income. These two measures would cost between €109 billion and €126 billion, or 6 to 7% of Italian GDP. As Italy’s public debt stand at €2.4 trillion, 132% of GDP.

“The government’s actions will target a programme of public debt reduction not through revenue based on taxes and austerity, policies that have not achieved their goal, but rather through increased GDP by the revival of internal demand,” the program says. Yes, that is the opposite of austerity.

The parties want a roll-back of previously announced pension measures to a situation where the sum of a person’s age and years of social security contributions reach 100. If someone has worked, and contributed to social security for 40 years, they will be able to retire at 60, not at 67 as the present plans demand.

In an additional plan that will make them very popular at home amongst the corrupt political class, the parties want to slash the number of parliamentarians to 400 MPs (from 630) and 200 senators (from 318). They would be banned from changing political parties during the legislature.

 

And then there are the mini-Bots, a parallel currency system very reminiscent of what Yanis Varoufakis proposed for Greece. Basically, they would allow the government to pay some of its domestic obligations (suppliers etc.) in the form of IOUs, which could then in turn be used to pay taxes and -other- government services. They would leave what is domestic, domestic.

There’s a lot of talk about this being a first step towards leaving the euro, but why should that be so? The main ‘threat’ lies in the potential independence from Brussels it may provide a country with. But it’s a closed system: you can’t pay with mini-Bots for trade or other international obligations.

Italy, like an increasing number of Eurozone nations, is looking for a way to get its head out of the Brussels/Berlin noose that’s threatening to suffocate it. If the EU doesn’t react to this, and soon, and in a positive manner it will blow itself up. Yes, if Italy started to let its debt balloon, the European Commission could reprimand it and issue fines. But the Commission wouldn’t dare do that. This is Italy. This is not Sparta.

Anyway, risk off, as the markets suggest(ed) this morning? Surely you’re joking. And we haven’t even mentioned Trump’s trade wars yet. Risk is ballooning.

 

 

Jan 072018
 
 January 7, 2018  Posted by at 10:43 am Finance Tagged with: , , , , , , , , ,  


Edward Hopper Gloucester Beach, Bass Rocks 1924

 

UPDATE: There still seems to be a problem with our Paypal widget/account that makes donating -both for our fund for homless and refugees in Greece, and for the Automatic Earth itself- hard for some people. What happens is that for some a message pops up that says “This recipient does not accept payments denominated in USD”. This is nonsense, we do. We notified Paypal weeks ago.

We have no idea how many people have simply given up on donating, but we can suggest a workaround (works like a charm):

Through Paypal.com, you can simply donate to an email address. In our case that is recedinghorizons *at* gmail *com*. Use that, and your donations will arrive where they belong. Sorry for the inconvenience.

 

 

 

Everyone Knows Pensions Are Screwed (Felder)
Shares Have Gone Through The Roof: Could They Possibly Go Even Higher? (G.)
States Threaten “Economic Civil War” On Washington (ZH)
UK Companies Will Face Huge New VAT Burden After Brexit (G.)
China To Move Millions Of People From Homes In Anti-Poverty Drive (G.)
Trump Takes Credit For Olympics Talks Between North and South Korea (G.)
11 Saudi Princes Sent to Maximum-Security Prison After Protesting Utility Bills
Scientists Lament The Likely Loss Of ‘Most Of The World’s Coral Reefs’ (Grist)

 

 

So Why Are They Investing In The Exact Same Fashion?

Everyone Knows Pensions Are Screwed (Felder)

The average pension fund assumes it can achieve a 7.6% rate of return on its assets in the future. As noted in Monday’s Wall Street Journal, the majority of these assets are invested in the stock market. The rest are invested in bonds, real estate and alternatives. An aggregate bond index fund yields 2.5% today. Real estate investment trusts, as a group, yield nearly 4%. Alternatives are a mixed bag but the point is that, in order for pensions to meet this 7.6% rate of return they require that stocks (and, to a much lesser degree, alternatives) do far better than even that optimistic assumption because the balance of the portfolio is nearly guaranteed to fall short of that mark. The trouble is that for stocks to return anywhere near 8% they would need to fall more than 50% first.

Warren Buffett famously said, “the price you pay determines your rate of return.” John Hussman puts an even finer point on it this week showing that if you want an 8% rate of return over the coming 12 years you should not be willing to pay more than 1,281 for the S&P 500 today. Currently, the index trades at roughly 2,690 thus it would take a major stock market crash for investors to have the opportunity to invest at a level that would enable them to achieve anything close to what pensions now require. But if stocks were to crash again, as they did after the last two times valuations reached current extremes, that would obviously create other problems for pensions that are now fully invested in risk assets and already underfunded to the tune of several trillion dollars.

Even if they don’t crash, however, it is now almost inevitable that pensions will face a massive crisis sometime over the next decade or so. Still, it’s fascinating to note that even though this issue is common knowledge today, investors as a group have decided to ensure they will come to the very same fate. Passive investing, which has exploded in popularity in recent years, is essentially a way for individual investors to model pension investing, typically with an even greater exposure to equities.

Read more …

Of course they could. But Jeremy Grantham’s ‘Melt-Up’ is being criticized by quite a few voices. The question is not ‘could they rise’, but ‘how long until they will plunge’?

Shares Have Gone Through The Roof: Could They Possibly Go Even Higher? (G.)

Shares are expensive – keep buying them. That appears to be investors’ consensus view. The storming run for stock markets in 2017 seemed almost too good to be trusted, but 2018 has started in similar style. In the US, the Dow Jones industrial average soared past 25,000 last week, almost exactly 12 months after 20,000 was achieved. In the UK, the FTSE 100 index stands at a record high. Even the Japanese market, for years an international laggard, is back at a 26-year high. Last year the MSCI World index – a proxy for a global stock market – delivered a return of 20.1%. Optimists expect more of the same. The other camp warns that a dangerous bubble is about to burst. Both sides could probably agree that the recent run in stock markets has been astonishing.

Or, rather, the truly remarkable feature has been the steady and unbroken pace of the march upwards. Stock markets, we used to think, offered thrills, spills and rollercoaster rides. Individual shares still provide such excitement, of course, but the overall market seems bizarrely free of stress. Andrew Lapthorne, who crunches the market numbers for French bank Société Générale, called 2017 “the year volatility died” in his end-of-year round-up. He wrote: “Those of us expecting greater market turbulence in 2017 could not have been more wrong. Not only did global equity markets perform well, but they did so with such low volatility and consistency that, if this were a fund, it would perhaps merit a visit from the authorities to check exactly what you were up to.”

What happened? First, investors seem to have decided that rising interest rates in the US, a big worry a year ago, are not the bogeyman they seemed. The US Federal Reserve has been a protective nurse. Rate rises have been gradual, and ultra-cheap money has been followed by very cheap. A US rate of 1.5% ain’t so bad. Second, President Donald Trump’s administration, amid its chaos and crises, has delivered the policy investors in companies cared about most: corporate tax cuts. Maybe a growth-generating splurge on infrastructure, the second part of his economic agenda, will follow.

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More of a partisan thing.

States Threaten “Economic Civil War” On Washington (ZH)

The new year has only just begun, but already Democratic politicians in the country’s largest high-tax states are threatening lawsuits and publicly touting proposed workarounds to help compensate tax payers for the elimination of the state and local tax (SALT) deductions which were dramatically rolled back, along with deductions for mortgage interest, as part of the White House’s tax reform plan. During his state of the state address earlier this week, New York Mayor Andrew Cuomo threatened to sue the federal government over the tax bill, claiming that the plan is unconstitutional and overly burdensome to New Yorkers. Cuomo said that the new law could raise some families’ taxes by as much as 25% and said the plan amounted to “double taxation.”

He later accused President Donald Trump of waging “economic civil war” on states that didn’t back him during the election, and promised to consider workarounds that would help lower residents’ federal tax bills, according to Bloomberg. Then, on Thursday, California Senate President Pro Tempore Kevin de Leon introduced a bill that the Washington Post said could become a model for how blue states push back against the Trump tax plan. According to the Trump tax plan, which took effect in January, taxpayers can only deduct up to $10,000 in state and local taxes when they file their federal return.

“De Leon’s bill, if it became law, would essentially allow Americans to deduct much more than the $10,000 limit by redirecting state tax payments into a type of charitable contribution that would be later redirected to the state. The new federal tax law, which was supported only by Republicans, went into effect in January and does not include any caps on charitable deductions. “The Republican tax plan gives corporations and hedge-fund managers a trillion-dollar tax cut and expects California taxpayers to foot the bill,” de León said in a statement. “We won’t allow California residents to be the casualty of this disastrous tax scheme.” Several states have said they are looking for ways to challenge or work around the law, particularly states such as California and New York where residents pay a higher level of local taxes that they have traditionally been able to deduct without any limits. New York Gov. Andrew M. Cuomo (D) has said he is looking at a way of challenging the new law in court.”

Then on Friday, incoming New Jersey Gov. Democrat Phil Murphy said he’s working on a plan similar to California’s that would allow taxpayers to pay a percentage of their state income taxes as if they were a charitable donation. The money will eventually be redirected to the state. And there’s nothing in the Republican tax plan that limits charitable deductions. Predictably, the White House has threatened to push back against these strategies. During a televised interview this week, Gary Cohn said the administration would be looking into ways to stop states from implementing these work-arounds.

Read more …

Seems easy to avoid.

UK Companies Will Face Huge New VAT Burden After Brexit (G.)

More than 130,000 UK firms will be forced to pay VAT upfront for the first time on all goods imported from the European Union after Brexit, under controversial legislation to be considered by MPs on Monday. The VAT changes spelled out in the taxation (cross-border trade) bill – one of a string of Brexit laws passing through parliament – are causing uproar among UK business groups, which say that they will create acute cashflow problems and huge additional bureaucracy. Labour and Tory MPs and peers said that the only way to avoid the VAT Brexit penalty would be to stay in the customs union or negotiate to remain in the EU-VAT area. On Sunday night the Tory chair of the all-party Treasury select committee, Nicky Morgan, said the committee would launch an urgent investigation.

She also said she would be writing to the head of HM Revenue and Customs to see what contingency plans were being made to avoid hitting UK firms. The bill, which has its second reading in the Commons on Monday, spells out clearly how VAT would have to be paid upfront by companies. The government’s own explanatory notes on the bill say the existing regime will end “so that import VAT is charged on all imports from outside the UK”. The Labour MP and former minister Chris Leslie said that the VAT hit to firms was “yet another aspect of Brexit that the Leave campaign failed to inform the public about”. He added that he would be tabling urgent amendments to ensure the UK remained in the EU VAT area – a move that would enrage pro-Brexit MPs.

UK companies that import machine parts or goods ready for sale from the EU can currently register with HMRC to bring them into the UK free of VAT. They register the VAT charge and reclaim it later, all as a paper exercise. VAT is added to the price of the product whenever it is sold to the final customer. Without a VAT deal with Brussels, importers will have to pay the VAT upfront in cash and then recover the money later, creating a huge outflow of funds before they can be recouped.

Read more …

“Once made, a promise is as weighty as a thousand ounces of gold..”

China To Move Millions Of People From Homes In Anti-Poverty Drive (G.)

Over the next three years Xi Jinping’s anti-poverty crusade – which the Communist party leader has declared one of the key themes of his second five-year term – will see millions of marginalised rural dwellers resettled in new, government-subsidised homes. Some are being moved to distant urban housing estates, others just to slightly less remote or unforgiving rural locations. Other poverty-fighting tactics – including loans, promoting tourism and “pairing” impoverished families with local officials whose careers are tied to their plight – are also being used. By 2020, Beijing hopes to have helped 30 million people rise above its official poverty line of about 70p a day while simultaneously reinforcing the already considerable authority of Xi, now seen as China’s most powerful ruler since Mao Zedong.

China’s breathtaking economic ascent has helped hundreds of millions lift themselves from poverty since the 1980s but in 2016 at least 5.7% of its rural population still lived in poverty, according to a recent UN report, with that number rising to as much as 10% in some western regions and 12% among some ethnic minorities. A recent propaganda report claimed hitting the 2020 target would represent “a step against poverty unprecedented in human history”. In his annual New Year address to the nation last week Xi made a “solemn pledge” to win his war on want. “Once made, a promise is as weighty as a thousand ounces of gold,” he said. The current wave of anti-poverty relocations – a total 9.81 million people are set to be moved between 2016 and 2020 – are taking place across virtually the whole country, in 22 provinces.

[..] Mark Wang, a University of Melbourne scholar who studies Beijing’s use of resettlements to fight poverty, attributed Xi’s focus on the issue partly to the seven years he spent in the countryside during Mao’s Cultural Revolution. Xi was born into China’s “red aristocracy” – the son of the revolutionary elder Xi Zhongxun – but was exiled to the parched village of Liangjiahe in the 1960s after his father strayed to the wrong side of Mao. Wang claimed those years of rural hardship continued to shape Xi’s political priorities: “From the bottom of his heart he knows the Chinese farmers … He understands what they want … He even knows the dirty language the people use in the fields when they are farming.”

But hard-nosed political calculations also explained Xi’s bid to paint himself as a champion of the poor – an effort undermined by a recent crackdown on migrants in Beijing which has reportedly seen tens of thousands of poor workers forced from the capital. “How can you make sure a billion people trust you and say: ‘This is our strong leader?’” asked Wang, who argued one answer was waging war on poverty.

Read more …

Dunk.

Trump Takes Credit For Olympics Talks Between North and South Korea (G.)

Donald Trump said on Saturday he was open to talking to Kim Jong-un and hoped good could come from negotiations between North and South Korea over this year’s Winter Olympics in Pyeongchang. The US president also took credit for those talks, saying: “If I weren’t involved they wouldn’t be talking about Olympics right now. They’d be doing no talking or it would be much more serious.” North and South Korea have agreed to discuss cooperation on the games as well as other issues in rare meetings set to begin on Tuesday in Panmunjom, a village that straddles the demilitarised zone between the two countries. Amid international concern over Pyongyang’s ballistic missile and nuclear programmes, the talks will be the first staged since December 2015. The discussions will be held at the Peace House on the South Korean side of Panmunjom.

[..] Speaking to reporters at Camp David in Maryland on Saturday, at the end of a week marked by the publication of an explosive book about his administration and his mental capacity for his job, the president was asked if he would speak to Kim on the telephone. “Sure, I believe in talking,” he said. “… Absolutely I would do that, no problem with that at all.” Asked if that meant there would be no prerequisites for such talk, the president said: “That’s not what I said at all.” Trump added: “[Kim] knows I’m not messing around, not even a little bit, not even 1%. He understands that. “At the same time, if we can come up with a very peaceful and very good solution, we’re working on it with [secretary of state] Rex [Tillerson], we’re working on it with a lot of people. “If something good can happen and come out of those talks it would be a great thing for all of humanity. That would be a great thing for the world. Very important.”

Read more …

Prines have been arrested, tortured, forced to sign away their fortunes. But now they protest over water bills? And think they’ll win that one?

11 Saudi Princes Sent to Maximum-Security Prison After Protesting Utility Bills

Saudi authorities made a fresh round of arrests of royal-family members as a group of princes staged a palace protest in the capital over the non-payment of their electricity and water bills. Security services on Thursday arrested the 11 princes after they refused to leave Qasr Al-Hokm in Riyadh, Saudi Arabia’s Attorney General, Sheikh Saud Al Mojeb, said in an emailed statement. The princes, who objected to a decree that ordered the state to stop paying their utility bills, will be held at al-Ha’er prison pending their trial, Al Mojeb said. “No one is above the law in Saudi Arabia, everyone is equal and is treated the same as others,” Al Mojeb said. “Any person, regardless of their status or position, will be held accountable should they decide not to follow the rules and regulations of the state.”

In November, authorities swept up dozens of Saudi Arabia’s richest and most influential people, including princes and government ministers, and detained them at the Ritz-Carlton in Riyadh. The arrests were ordered by a newly established anti-corruption committee, headed by Crown Prince Mohammed bin Salman. The prince’s anti-graft drive appeared designed to tap into a popular vein among young Saudis who are bearing the brunt of low oil prices and complaining, privately and on social media, that the kingdom’s elite were above the rule of law. King Salman on Saturday ordered extra pay for Saudi government workers and soldiers this year after the implementation of value-added taxation and a surge in fuel prices stirred grumbling among citizens, highlighting the kingdom’s struggle to overhaul its economy without risking a public backlash.

The handouts will cost the state more than 50 billion riyals ($13.3 billion), Saud Al-Qahtani, an adviser to the royal court, said on his Twitter account. The princes arrested at the palace were also seeking compensation for a death sentence that was issued against one of their cousins, who had been convicted of killing another man and executed in 2016, according to Al Mojeb’s statement. Earlier Saturday, the Jeddah-based newspaper Okaz reported the princes had been arrested. The Al-Ha’er facility south of Riyadh is one of Saudi Arabia’s maximum-security prisons. Many of Saudi Arabia’s Islamic militants who have fought abroad are held there.

Read more …

That’s where the life is.

Scientists Lament The Likely Loss Of ‘Most Of The World’s Coral Reefs’ (Grist)

“Before the 1980s, mass bleaching of corals was unheard of,” Terry Hughes, a coral scientist at Australia’s James Cook University and lead author of the new study, said in a statement. Hughes personally surveyed thousands of miles of the Great Barrier Reef during the 2015 and 2016 bleaching. “It broke my heart,” he told the Guardian last year. The new study finds that 94% of surveyed coral reefs have experienced a severe bleaching event since the 1980s. Only six sites surveyed were unaffected. They are scattered around the world, meaning no ocean basin on Earth has been entirely spared. The implications of these data in a warming world, taken together with other ongoing marine stressors like overfishing and pollution, are damning.

“It is clear already that we’re going to lose most of the world’s coral reefs,” says study coauthor Mark Eakin, coordinator of the National Oceanic and Atmospheric Administration’s Coral Reef Watch program. He adds that by 2050, ocean temperatures will be warm enough to cause annual bleaching of 90% of the world’s reefs. For conservation biologists like Josh Drew, whose work focuses on coral reefs near Fiji, that loss of recovery time amounts to a “death warrant for coral reefs as we know them.” “I’m not saying we’re not going to have reefs at all, but those reefs that survive are going to be fundamentally different,” says Drew, who is not affiliated with the new study. “We are selecting for corals that are effectively weedy, for things that can grow back in two to three years, for things that are accustomed to having hot water.”

Reefs are incalculably important not only as a harbor for life — they shelter about one-quarter of all marine species in just a half-percent of the ocean’s surface area — but also for human nutrition and many nation’s economies.

Read more …

Oct 032017
 
 October 3, 2017  Posted by at 9:28 am Finance Tagged with: , , , , , , , ,  


Fan Ho Obsession 1964

 

Who Will Be There To Buy When Everyone Wants To Sell? – Howard Marks (FuW)
The Pricing of Risk is Kaput (WS)
Art Cashin: “I’ve Never Seen Anything Like Today’s Market Before” (ZH)
What You Are Not Being Told About The Economy – Steve Keen (RT)
An Accountant Smells a Rat in Our Global Credit Bubble (WS)
26 Recession-Free Years Hide a Darker Picture for Australia (BBG) >
Russia’s Rush For Gold Sees Record Reserves For Putin Era (II)
Fall of the Great Pumpkin (Jim Kunstler)
Spain’s Crisis Deepens as Catalonia Secession Clock Ticks Down (BBG)
Catalonia Set For General Strike Over Independence Poll Violence (AFP)
100,000s Of Puerto Ricans To Flee To Florida, New York (ZH)

 

 

 

 

A point I made again recentlly “It will continue to go up, but I will get out in time.» People overestimate their ability to get out in time. Who will be there to buy when everyone wants to sell? That’s wishful thinking.”

Who Will Be There To Buy When Everyone Wants To Sell? – Howard Marks (FuW)

It would be a dangerous bet to say interest rates are going to stay low forever, but I don’t see many people taking that bet. And you see, even if interest rates were to stay where they are, that would argue for P/E ratios to stay where they are. And if they do, then stocks will only appreciate at the same rate as earnings, which is not really fast; there would be no multiple expansion. This market is not built on some euphoric view of the future, but mainly on the unwillingness to accept zero or negative returns on cash and safe instruments. It’s based on the view that there is no alternative: people are afraid to be out of the market. But then again, a perceived lack of alternatives is not a good argument for chasing yield and taking big risks. That’s why I think this is the time to turn cautious.

It’s not smart, but people think that’s what they have to do now. You remember Chuck Prince, the CEO of Citigroup, who in July of 2007 said «when the liquidity dries up, this will end badly, but as long as the music is playing, you have to dance?» What does that even mean? People always say they’ll stay in the market, thinking it has further to go, but if it starts to turn down they will get out. Maybe that’s what people are thinking in today’s stock market: «It will continue to go up, but I will get out in time.» People overestimate their ability to get out in time. Who will be there to buy when everyone wants to sell? That’s wishful thinking.

[..] I see a lot of worries. One example: What’s going to happen when central banks start unwinding their balance sheets? We have no clue. There is no historical precedent for the measures they used to stimulate the economies in the past years, so we don’t know what will happen when they unwind them. If QE was stimulative, won’t the unwinding of it be the opposite of stimulative? I don’t know where the money came from for the QE programs, and I don’t know where the money will go to next. We don’t know what it will mean for interest rates and inflation.

Another worry is the low economic growth, combined with politics. All these right-wing populist movements – what are the implications of that? This is not imaginary. Where will the person with a low education level get a job in ten or twenty years, when all the cars are self-driving and all the stores have no clerks? I don’t know what the solution is. But I see a lack of political leadership around the world. Another worry concerns our pension systems. In the US and in other countries, defined benefit systems are hundreds of billions of dollars in the red. What’s going to happen to the people who expect to get their promised retirement payments? But today, nobody’s talking about the problems in our pension systems.

Read more …

“..when markets can no longer price risks, they cannot price anything at all because the price of risk underlies all prices in the financial markets.”

The Pricing of Risk is Kaput (WS)

US Treasury Securities with longer maturities fell this morning, with the 10-year Treasury yield rising above 2.37% early on and currently trading at 2.34%. This is still low by historical standards, and it’s still in denial of the Fed’s monetary tightening: Four rate hikes since it started this cycle, and the QE unwind has commenced as of today. But it cannot hold a candle to the Draghi-engineered negative-yield absurdity still unfolding in the Eurozone. The average yield of junk bonds denominated in euros hit a new all-time record low at the close on Friday of 2.30%. Let that sink in a moment. These euro corporate bonds are rated below investment grade. Companies, unlike the US, cannot print their own money to prevent default.

There is little liquidity in the junk bond market, and selling these bonds when push comes to shove can be hard or impossible. The reason they’re called “junk” is because of their high risk of default. And yet, prices of these junk bonds have been inflated by the ECB’s policies to such a degree that their yield, which falls as prices rise, is now lower than that of 10-year US Treasury securities that are considered the most liquid securities with the least credit risk out there. The average yield of the euro junk bonds is based on a basket of below-investment-grade corporate bonds denominated in euros. Issuers include junk-rated American companies with European subsidiaries – in which case these bonds are called “reverse Yankees.”

They include the riskiest bonds. Plenty of them will default. Losses will be painful. Investors know this. It’s not a secret. But they don’t mind. They’re institutional investors plowing other people’s money into these bonds, and they don’t need to mind, but they have to buy these bonds because that’s their job. This chart, based on BofA Merrill Lynch Euro High Yield Index Effective Yield via the St. Louis Fed, shows that the average euro junk bond yield is on the way to what? Zero?

During the peak of the Financial Crisis, the average junk bond yield hit 25%. During the dog days of the euro debt crisis in the summer of 2012, when Draghi pronounced the magic words that he’d do “whatever it takes,” these bonds yielded about 9%. The yield dropped below 5% in October 2013, for the first time ever. This juxtaposition of the already low 10-year US Treasury yield and the even lower euro junk bond yield creates one of the most fascinating WTF-charts for our amusement at central-bank absurdist policies – and we’d be laughing at these bond investors gone nuts, if it weren’t so serious:

.. this is Draghi’s ultimate accomplishment in his nutty bailiwick: The total destruction of the market’s risk-pricing mechanism at the expense of other people’s money – this includes pension funds and life insurance companies that play a large role in Europe’s private pension system. They have to buy corporate bonds. Their beneficiaries that paid into the systems will have to bear the costs in future years. And then there’s the comforting thought that when markets can no longer price risks, they cannot price anything at all because the price of risk underlies all prices in the financial markets.

Read more …

“..when we had the taper tantrum they hadn’t even done anything yet, they’d just threatened to taper..”

Art Cashin: “I’ve Never Seen Anything Like Today’s Market Before” (ZH)

Market veteran Art Cashin, the head of NYSE floor operations for UBS, made an interesting observation earlier today just minutes before the close, as US stocks headed for another record finish after shrugging off the worst mass shooting in US history. Asked by CNBC’s Kelly Evans to explain how US stocks have continued to outperform while the 10-year Treasury yield has remained anchored below 2.5%, Cashin acknowledged that, during a career that’s spanned more than six decades, he’s never seen anything like today’s market. “I’ve been doing this for over 50 years and I’ve never seen anything like it so it is rather odd.” And given global stocks’ strong performance this year, with markets weathering a series of political crises, natural disasters, terror attacks and other nominally destabilizing events (with a little help from central banks, of course) – Cashin says the outlook isn’t as dire as some would believe.

“Right now, Europe’s doing all right emerging markets are okay, and maybe they’re not going to take away the punchbowl that quickly – so we’ll see,” Cashin said. In September, the Fed suggested that while it would likely raise interest rates more quickly than previously believed during the coming quarters, median forecasts for the Fed funds rate in 2019, as well as the longer-run median target, declined compared with a set of forecasts released in July. Looking ahead to the fourth quarter, the most pressing questions that investors should be asking themselves is ‘is this the quarter where tapering – or the expectation of further tapering – finally triggers a market correction.

“What’s really going to be interesting to watch in this final quarter, is will there be an impact of quantitative tightening. As Peter Boockvar points out…it’s only going to be a token amount. But when we had the taper tantrum they hadn’t even done anything yet they’d just threatened to taper. When asked what it would take to spark a meaningful correction in stocks, Cashin said he expects investors will take notice once the 10-year yield climbs above 3%. “I think we’ve got to get a bit higher. Probably up around 3% you start to get everybody’s attention and you’ll start to hear that in the conversation more and more.”

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Are you rational? Economics is not.

What You Are Not Being Told About The Economy – Steve Keen (RT)

As Karl Marx’s ‘Das Kapital’ turns 150 and the global financial crisis enters its tenth year, we ask why it is that we are still no closer to creating an economy that actually works. Perhaps more importantly, why do mainstream economists continue to miss the fundamental drivers of financial instability? Host Ross Ashcroft talks about what’s next for the global economy with Professor Steve Keen, an economist who correctly predicted the financial crisis and the author of ‘Debunking Economics.’

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“Economists can’t see it. They can’t model money and credit. ”

An Accountant Smells a Rat in Our Global Credit Bubble (WS)

Twenty years ago Doug Noland was so worried about imbalances surrounding the dot.com boom that he began to title his weekly reports “The Credit Bubble Bulletin. Years later, he warned the world about the impending 2008 crisis. However a coming implosion, he says, could be the biggest yet. “We are in a global finance bubble, which I call the grand-daddy of all bubbles,” said Noland. “Economists can’t see it. They can’t model money and credit. However, to those outside the system, the facts are increasingly clear.” Noland points to inflating real estate, bond and equity prices as key causes for concern. According to the Federal Reserve’s September Z.1 Flow of Funds report, the value of US equities jumped $1.5 trillion during the second quarter to $42.2 trillion, a record 219% of GDP.

Noland may be right. A report by the International Institute of Finance released in June estimated that global government, business and personal debts totaled $217 trillion earlier this year. That’s more than three times (327%) higher than global economic output. Adding to the complexity is the fact that not all debts are fully recorded. For example, according to a World Economic Forum study, the world’s six largest pension saving systems – the US, UK, Japan, Netherlands, Canada and Australia – are expected to experience a $224 trillion funding shortfall by 2050. Noland’s warnings come during a time of exceptional public trust in governments, central banks, regulators and other institutions. Market volatility is trending at near record lows. In June, Federal Reserve Chair Janet Yellen spoke for many when she said that she did not see a financial crisis occurring “in our lifetimes.”

So why would Noland, who during his day job runs a tactical short book at McAlvany Wealth Management, see things that government, academic, and central bank economists don’t? One possibility is because Noland, who studied accounting and finance in college and began his career as a CPA at Price Waterhouse, is not an economist. He is thus not burdened with the “dismal science’s” limitations. Although Noland eventually completed an MBA and some doctoral studies, he was never forced to buy into the econometrics groupthink that plagues the profession. Noland is thus free to incorporate historical, financial, geographical and other data into his analyses. Another possible reason is that Noland (unlike almost all professional economists who missed both major market implosions/recessions of the last two decades) doesn’t hide it when he makes a bad call.

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But Australians won’t believe it until it hits them in the head.

26 Recession-Free Years Hide a Darker Picture for Australia (BBG)

The global crown for the longest stretch of uninterrupted economic growth is within sight for Australia. But it’s limping to the line as policy paralysis weighs on the nation’s prospects. Twenty-six years without recession have put Australia within two years of overtaking the Netherlands’ record growth streak and government, central bank and economist forecasts all suggest it’ll take the mantle. After all, the economy has a head start with 2.5% growth virtually baked in – 1.5% from population gains that are among the developed world’s quickest and 1% from resource exports feeding Asia’s giant economies. Yet the reliance on rapid immigration is straining infrastructure, while mining profits fuel riches for stakeholders but do little for the vast majority of Australians living in major cities.

Meantime, wages are barely growing, households carry some of the world’s heaviest debt loads, and productivity gains from the economic reforms of the 1980s and early 1990s have petered out. There’s been no major economic reform since the turn of the century, with just about every attempt reversed or cannibalized by toxic politics. And the impact is starting to show. Just when the economy needs growth drivers outside of mining, a slide in global rankings for innovation and education suggest living standards could decline. The miracle economy that shrugged off the global recession is turning mediocre. “Now that we don’t have the benefit of the mining boom, there’s nothing really that replaces it in terms of driving economic activity,” said Jeremy Lawson, chief economist at Aberdeen Standard Investments in Edinburgh and a former Reserve Bank of Australia economist.

“The really big task of governments over the next 5 to 10 years is to deal with these big structural issues that Australia is facing. Potential growth is relatively weak.” A decade of political infighting has seen the nation change prime ministers five times since 2007 and sidelined substantive policy debate. Meanwhile, attempts at reform have been held hostage by populists and single-issue parties who’ve harnessed voter frustration with mainstream politicians to take the balance of power in parliament’s upper house. That political dysfunction is threatening the nation’s prospects. A policy vacuum around energy has seen electricity prices surge to among the highest in the world, despite Australia holding some of the largest coal and gas reserves on the planet.

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“The gold rush is allowing the Bank of Russia to continue growing its reserves while abstaining from purchases of foreign currency for more than two years. ”

Russia’s Rush For Gold Sees Record Reserves For Putin Era (II)

Vladimir Putin is doing his part to keep the upswing in gold alive. Since the Russian president went on a geopolitical offensive in Ukraine in 2014, the haven asset had its first annual gain in four years in 2016 and is on track for another in 2017. A beneficiary of economic and political perils from North Korea to Brexit, it’s among the top-performing commodities this year. Meanwhile, the Bank of Russia has more than doubled the pace of gold purchases, bringing the share of bullion in its international reserves to the highest of Mr Putin’s 17 years in power, according to World Gold Council data. In the second quarter alone, it accounted for 38pc of all gold purchased by central banks. The gold rush is allowing the Bank of Russia to continue growing its reserves while abstaining from purchases of foreign currency for more than two years.

It’s one of a handful of central banks to keep the faith as global demand for the precious metal fell to a two-year low in the second quarter. But what may matter most is that gold is as geopolitics-proof an investment as any in the age of sanctions and a deepening rift with the US. “Gold is an asset that is independent of any government and, in effect, given what is usually held in reserves, any Western government,” said Matthew Turner, metals analyst at Macquarie Group in London. “This might appeal given Russia has faced financial sanctions.” Besides being the largest official buyer of gold, Russia is also among the world’s three biggest producers, with the central bank purchasing from domestic miners through commercial banks and not in the open market. Since starting to accelerate bullion purchases in 2007, Russia’s holdings have more than quadrupled to 1,556 tonnes at the end of June, just behind China and more than Turkey, India and Mexico combined, bringing its share in Russia’s $427bn (€361bn) reserves to near 17pc.

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“Trump travels there this week. That may be exactly the moment that the Deep State moves to take him down.”

Fall of the Great Pumpkin (Jim Kunstler)

Welcome to the witching month when America’s entropy-fueled death-wish expresses itself with as much Halloween jollity and merriment as the old Christmas spirit of yore. The outdoor displays alone take on a Babylonian scale, thanks to the plastic factories of China. I saw a half-life-size T-Rex skeleton for sale at a garden shop last week surrounded by an entire crew of moldering corpse Pirates of the Caribbean in full costume ho-ho-ho-ing among the jack-o-lanterns. What homeowner in this sore-beset floundering economy of three-job gig-workers can shell out four thousand bucks to decorate his lawn like the set of a zombie movie? The overnight news sure took on that Halloween tang as the nation woke up to what is probably a national record for a civilian mad-shooter incident.

So far, fifty dead and two hundred wounded at the Las Vegas at the Route 91 Harvest Festival (one up in fatalities from last year’s Florida Pulse nightclub massacre, and way more injured this time). The incident will live in infamy for maybe a day and a half in the US media. Stand by today as there will be calls far and wide, by personas masquerading as political leaders, for measures to make sure something like this never happens again. That’s rich, isn’t it? Meanwhile, the same six a.m. headlines declared that S &P futures were up in the overnight markets. Nothing can faze this mad bull, apparently. Except maybe the $90 trillion combined derivatives books of CitiBank, JP Morgan, and Goldman Sachs, who have gone back whole hog into manufacturing the same kind of hallucinatory collateralized debt obligations (giant sacks of non-performing loans) that gave Wall Street a heart attack in the fall of 2008.

Europe’s quaint doings must seem dull compared to the suicidal potlatch of life in the USA, but, believe me, it’s a big deal when the Spanish authorities start cracking the heads of Catalonian grandmothers for nothing more than casting a ballot. The video scenes of mayhem at the Barcelona polls looked like something out of the 1968 Prague uprising. And now that the Catalonia secession referendum passed with a 90% “yes” vote, it’s hard to imagine that a good deal more violent mischief will not follow. So far, the European Union stands dumbly on the sidelines. (For details, read the excellent Raul Ilargi Meijer column on today’s TheAutomaticEarth.)

[..] Finally — well, who know what else may pop up now — there is the matter of Puerto Rico. Halloween there is not like New England, with our nippy fall mornings, steaming mugs of hot cider, and quickening fall color. It will remain 90-degrees-plus down there in the fetid, stinking ruins, with lots of still-standing water, broken communications, shattered supply lines, and very little electricity. FEMA and the US Military may be doing all they can now, but they must be on watch for the ominous blossoming of tropical disease epidemics. The story there is far from over. Trump travels there this week. That may be exactly the moment that the Deep State moves to take him down.

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Catalonia wants to talk. But it will no longer accept many of the things it would have before Sunday.

Spain’s Crisis Deepens as Catalonia Secession Clock Ticks Down (BBG)

In Madrid, Barcelona, Bilbao and beyond, the question is the same: Now what? Sunday’s vote for independence in Catalonia, one of Spain’s most populous and prosperous regions, has thrust the country into its gravest political crisis since the days of the dictator Francisco Franco. Few see an easy way out. The results of the referendum give Prime Minister Mariano Rajoy stark choices – try to deal a blow to the independence movement by suspending Catalonia’s semi-autonomous status, or meet the secessionists halfway and start talks with Catalan President Carles Puigdemont. Puigdemont said the vote, rejected by the central government as illegal, justifies a unilateral declaration of independence. That could come by the end of the week, if the regional parliament agrees.

The European Union refused to recognize the rebel region’s bid, but Spanish bonds and stocks fell Monday as the risks of a breakaway rose. The clash puts Rajoy in a tight corner. Head of a minority government that relies on support from regional parties to rule, he has pledged to protect Spain’s territorial integrity. His main ally in parliament, Ciudadanos party leader Albert Rivera, called on the prime minister to invoke a never-before-used article of the 1978 constitution and pull Catalonia’s special regional standing, which gives it certain administrative powers. “It’s the moment to act with calm but with firmness,” said Rivera, who is Catalan, after meeting with Rajoy on Monday. Rivera said an independence declaration may be 72 hours away and suggested invoking Article 155 would cut off any attempt to make such a move.

But Pedro Sanchez, head of the main Socialist opposition party, said after his own meeting with Rajoy that the central government should hold talks with the secessionists. While Sanchez made no mention of Article 155 in the statement he issued, socialists in Catalonia said the party wouldn’t support the prime minister taking that step. That means Rajoy will have little political cover if he opts to suspend Catalan self-government – the most powerful card he has left. The crisis has already caused him problems: Last week, he had to withdraw plans to present his 2018 budget after allies in the Basque PNV party withheld their support as they criticized his position on Catalonia.

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The Guardia Civil will have to leave Catalonia at some point. And what then?

Catalonia Set For General Strike Over Independence Poll Violence (AFP)

Large numbers of Catalans are expected to observe a general strike on Tuesday to condemn police violence at a banned weekend referendum on independence, as Madrid comes under growing international pressure to resolve its worst political crisis in decades. Flights and train services could be disrupted as well as port operations, after unions called for the stoppage to “vigorously condemn” the police response to the poll, in which Catalonia’s leader said 90% of voters backed independence from Spain. Barcelona’s public universities are expected to join the strike, as is the contemporary art museum, football club FC Barcelona and the Sagrada Familia, the basilica designed by Antoni Gaudi and one of the city’s most popular tourist sites. “I am convinced that this strike will be widely followed,” Catalan leader Carles Puigdemont said ahead of the protest.

The central government has vowed to stop the wealthy northeastern region, which accounts for a fifth of Spain’s GDP, breaking away from Spain and has dismissed Sunday’s poll as unconstitutional and a “farce”. Violent scenes played out in towns and cities across the region on Sunday as riot police moved in on polling stations to stop people from casting their ballots, in some cases charging with batons and firing rubber bullets to disperse crowds. UN rights chief Zeid Ra’ad Al Hussein said he was “very disturbed” by the unrest while EU President Donald Tusk urged Madrid to avoid “further use of violence”. The European Parliament will hold a special debate on Wednesday on the issue. “We call on all relevant players to now move very swiftly from confrontation to dialogue. Violence can never be an instrument in politics,” European Commission spokesman Margaritis Schinas said, breaking weeks of virtual EU silence on the Catalan issue.

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“Florida Gov. Rick Scott has declared a state of emergency in Florida..”

100,000s Of Puerto Ricans To Flee To Florida, New York (ZH)

As mayors of cities with large Puerto Rican populations continue to advocate for federal assistance to help with the resettlement of hundreds of thousands of Puerto Ricans who are expected to temporarily seek shelter with friends and families in the US, Florida Gov. Rick Scott has declared a state of emergency in Florida, allowing state agencies to take extraordinary measures to assist families that will soon be arriving in droves to cities like Orlando and Miami, both of which feature large Puerto Rican populations. The Orlando Sentinel reports that Scott announced that disaster relief centers will be set up at Orlando International Airport and in Miami to help those seeking refuge in Florida. “Puerto Rico is absolutely devastated and so many families have lost everything,” Scott said in a released statement.

“Our goal is to make sure that while [Puerto Rican] Governor [Ricardo] Rosselló is working to rebuild Puerto Rico, any families displaced by Maria that come to Florida are welcomed and offered every available resource from the state.” The relief center at OIA, and two others at Miami International Airport and the Port of Miami, open Tuesday, according to a release from Scott’s office, just days after Puerto Rican airports reopened following the devastation caused by Hurricane Maria. [..] Scott’s emergency order will allow state agencies broad autonomy to waive regulations and do whatever is necessary to help Puerto Ricans. Importantly, it could also help bring more federal funding to help the state cope with aid efforts.

State lawmakers have said they expect at least 100,000 Puerto Ricans to flee to Florida because of Maria, forcing the state to step up its education, housing and job-placement offerings. It’s expected that some of those displaced by the storm could resettle permanently, as the reconstruction effort in Puerto Rico is expected to take months, if not years. State Rep. Carlos Guillermo Smith, D-Orlando, said the Legislature should hold a special session, as he estimates hundreds of thousands of Puerto Ricans are coming to Florida. The 2018 regular session starts in January. “FL needs 2 deal w/humanitarian crisis + over 100K Boricuas who’ll seek refuge here right now, not in Jan.,” he tweeted.

We now wait to hear from New York Gov. Andrew Cuomo and New York City Mayor Bill De Blasio. NYC officials have said more than 100,000 Puerto Ricans could arrive in NYC alone.

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Sep 112016
 
 September 11, 2016  Posted by at 1:20 pm Finance Tagged with: , , , , , , , , , ,  Comments Off on Negative Interest Rates and the War on Cash (Full Article)


The Statue of Liberty at the 1878 Paris World’s Fair

 

 

This article by Nicole Foss was published earlier at the Automatic Earth in 4 chapters.

Part 1 is here: Negative Interest Rates and the War on Cash (1)

Part 2 is here: Negative Interest Rates and the War on Cash (2)

Part 3 is here: Negative Interest Rates and the War on Cash (3)

Part 4 is here: Negative Interest Rates and the War on Cash (4)

 

 

Nicole Foss: As momentum builds in the developing deflationary spiral, we are seeing increasingly desperate measures to keep the global credit ponzi scheme from its inevitable conclusion. Credit bubbles are dynamic — they must grow continually or implode — hence they require ever more money to be lent into existence. But that in turn requires a plethora of willing and able borrowers to maintain demand for new credit money, lenders who are not too risk-averse to make new loans, and (apparently effective) mechanisms for diluting risk to the point where it can (apparently safely) be ignored. As the peak of a credit bubble is reached, all these necessary factors first become problematic and then cease to be available at all. Past a certain point, there are hard limits to financial expansions, and the global economy is set to hit one imminently.

Borrowers are increasingly maxed out and afraid they will not be able to service existing loans, let alone new ones. Many families already have more than enough ‘stuff’ for their available storage capacity in any case, and are looking to downsize and simplify their cluttered lives. Many businesses are already struggling to sell goods and services, and so are unwilling to borrow in order to expand their activities. Without willingness to borrow, demand for new loans will fall substantially. As risk factors loom, lenders become far more risk-averse, often very quickly losing trust in the solvency of of their counterparties. As we saw in 2008, the transition from embracing risky prospects to avoiding them like the plague can be very rapid, changing the rules of the game very abruptly.

Mechanisms for spreading risk to the point of ‘dilution to nothingness’, such as securitization, seen as effective and reliable during monetary expansions, cease to be seen as such as expansion morphs into contraction. The securitized instruments previously created then cease to be perceived as holding value, leading to them being repriced at pennies on the dollar once price discovery occurs, and the destruction of that value is highly deflationary. The continued existence of risk becomes increasingly evident, and the realisation that that risk could be catastrophic begins to dawn.

Natural limits for both borrowing and lending threaten the capacity to prolong the credit boom any further, meaning that even if central authorities are prepared to pay almost any price to do so, it ceases to be possible to kick the can further down the road. Negative interest rates and the war on cash are symptoms of such a limit being reached. As confidence evaporates, so does liquidity. This is where we find ourselves at the moment — on the cusp of phase two of the credit crunch, sliding into the same unavoidable constellation of conditions we saw in 2008, but on a much larger scale.

 

From ZIRP to NIRP

 

Interest rates have remained at extremely low levels, hardly distinguishable from zero, for the several years. This zero interest rate policy (ZIRP) is a reflection of both the extreme complacency as to risk during the rise into the peak of a major bubble, and increasingly acute pressure to keep the credit mountain growing through constant stimulation of demand for borrowing. The resulting search for yield in a world of artificially stimulated over-borrowing has lead to an extraordinary array of malinvestment across many sectors of the real economy. Ever more excess capacity is being built in a world facing a severe retrenchment in aggregate demand. It is this that is termed ‘recovery’, but rather than a recovery, it is a form of double jeopardy — an intensification of previous failed strategies in the hope that a different outcome will result. This is, of course, one definition of insanity.

Now that financial crisis conditions are developing again, policies are being implemented which amount to an even greater intensification of the old strategy. In many locations, notably those perceived to be safe havens, the benchmark is moving from a zero interest rate policy to a negative interest rate policy (NIRP), initially for bank reserves, but potentially for business clients (for instance in Holland and the UK). Individual savers would be next in line. Punishing savers, while effectively encouraging banks to lend to weaker, and therefore riskier, borrowers, creates incentives for both borrowers and lenders to continue the very behaviour that set the stage for financial crisis in the first place, while punishing the kind of responsibility that might have prevented it.

Risk is relative. During expansionary times, when risk perception is low almost across the board (despite actual risk steadily increasing), the risk premium that interest rates represent shows relatively little variation between different lenders, and little volatility. For instance, the interest rates on sovereign bonds across Europe, prior to financial crisis, were low and broadly similar for many years. In other words, credit spreads were very narrow during that time. Greece was able to borrow almost as easily and cheaply as Germany, as lenders bet that Europe’s strong economies would back the debt of its weaker parties. However, as collective psychology shifts from unity to fragmentation, risk perception increases dramatically, and risk distinctions of all kinds emerge, with widening credit spreads. We saw this happen in 2008, and it can be expected to be far more pronounced in the coming years, with credit spreads widening to record levels. Interest rate divergences create self-fulfilling prophecies as to relative default risk, against a backdrop of fear-driven high volatility.

Many risk distinctions can be made — government versus private debt, long versus short term, economic centre versus emerging markets, inside the European single currency versus outside, the European centre versus the troubled periphery, high grade bonds versus junk bonds etc. As the risk distinctions increase, the interest rate risk premiums diverge. Higher risk borrowers will pay higher premiums, in recognition of the higher default risk, but the higher premium raises the actual risk of default, leading to still higher premiums in a spiral of positive feedback. Increased risk perception thus drives actual risk, and may do so until the weak borrower is driven over the edge into insolvency. Similarly, borrowers perceived to be relative safe havens benefit from lower risk premiums, which in turn makes their debt burden easier to bear and lowers (or delays) their actual risk of default. This reduced risk of default is then reflected in even lower premiums. The risky become riskier and the relatively safe become relatively safer (which is not necessarily to say safe in absolute terms). Perception shapes reality, which feeds back into perception in a positive feedback loop.

 

 

The process of diverging risk perception is already underway, and it is generally the states seen as relatively safe where negative interest rates are being proposed or implemented. Negative rates are already in place for bank reserves held with the ECB and in a number of European states from 2012 onwards, notably Scandinavia and Switzerland. The desire for capital preservation has led to a willingness among those with capital to accept paying for the privilege of keeping it in ‘safe havens’. Note that perception of safety and actual safety are not equivalent. States at the peak of a bubble may appear to be at low risk, but in fact the opposite is true. At the peak of a bubble, there is nowhere to go but down, as Iceland and Ireland discovered in phase one of the financial crisis, and many others will discover as we move into phase two. For now, however, the perception of low risk is sufficient for a flight to safety into negative interest rate environments.

This situation serves a number of short term purposes for the states involved. Negative rates help to control destabilizing financial inflows at times when fear is increasingly driving large amounts of money across borders. A primary objective has been to reduce upward pressure on currencies outside the eurozone. The Swiss, Danish and Swedish currencies have all been experiencing currency appreciation, hence a desire to use negative interest rates to protect their exchange rate, and therefore the price of their exports, by encouraging foreigners to keep their money elsewhere. The Danish central bank’s sole mandate is to control the value of the currency against the euro. For a time, Switzerland pegged their currency directly to the euro, but found the cost of doing so to be prohibitive. For them, negative rates are a less costly attempt to weaken the currency without the need to defend a formal peg. In a world of competitive, beggar-thy-neighbour currency devaluations, negative interest rates are seen as a means to achieve or maintain an export advantage, and evidence of the growing currency war.

Negative rates are also intended to discourage saving and encourage both spending and investment. If savers must pay a penalty, spending or investment should, in theory, become more attractive propositions. The intention is to lead to more money actively circulating in the economy. Increasing the velocity of money in circulation should, in turn, provide price support in an environment where prices are flat to falling. (Mainstream commentators would describe this as as an attempt to increase ‘inflation’, by which they mean price increases, to the common target of 2%, but here at The Automatic Earth, we define inflation and deflation as an increase or decrease, respectively, in the money supply, not as an increase or decrease in prices.) The goal would be to stave off a scenario of falling prices where buyers would have an incentive to defer spending as they wait for lower prices in the future, starving the economy of circulating currency in the meantime. Expectations of falling prices create further downward price pressure, leading into a vicious circle of deepening economic depression. Preventing such expectations from taking hold in the first place is a major priority for central authorities.

Negative rates in the historical record are symptomatic of times of crisis when conventional policies have failed, and as such are rare. Their use is a measure of desperation:

First, a policy rate likely would be set to a negative value only when economic conditions are so weak that the central bank has previously reduced its policy rate to zero. Identifying creditworthy borrowers during such periods is unusually challenging. How strongly should banks during such a period be encouraged to expand lending?

However strongly banks are ‘encouraged’ to lend, willing borrowers and lenders are set to become ‘endangered species’:

The goal of such rates is to force banks to lend their excess reserves. The assumption is that such lending will boost aggregate demand and help struggling economies recover. Using the same central bank logic as in 2008, the solution to a debt problem is to add on more debt. Yet, there is an old adage: you can bring a horse to water but you cannot make him drink! With the world economy sinking into recession, few banks have credit-worthy customers and many banks are having difficulties collecting on existing loans.
Italy’s non-performing loans have gone from about 5 percent in 2010 to over 15 percent today. The shale oil bust has left many US banks with over a trillion dollars of highly risky energy loans on their books. The very low interest rate environment in Japan and the EU has done little to spur demand in an environment full of malinvestments and growing government constraints.

Doing more of the same simply elevates the already enormous risk that a new financial crisis is right around the corner:

Banks rely on rates to make returns. As the former Bank of England rate-setter Charlie Bean has written in a recent paper for The Economic Journal, pension funds will struggle to make adequate returns, while fund managers will borrow a lot more to make profits. Mr Bean says: “All of this makes a leveraged ‘search for yield’ of the sort that marked the prelude to the crisis more likely.” This is not comforting but it is highly plausible: barely a decade on from the crash, we may be about to repeat it. This comes from tasking central bankers with keeping the world economy growing, even while governments have cut spending.

 

Experiences with Negative Interest Rates

 

The existing low interest rate environment has already caused asset price bubbles to inflate further, placing assets such as real estate ever more beyond the reach of ordinary people at the same time as hampering those same people attempting to build sufficient savings for a deposit. Negative interest rates provide an increased incentive for this to continue. In locations where the rates are already negative, the asset bubble effect has worsened. For instance, in Denmark negative interest rates have added considerable impetus to the housing bubble in Copenhagen, resulting in an ever larger pool over over-leveraged property owners exposed to the risks of a property price collapse and debt default:

Where do you invest your money when rates are below zero? The Danish experience says equities and the property market. The benchmark index of Denmark’s 20 most-traded stocks has soared more than 100 percent since the second quarter of 2012, which is just before the central bank resorted to negative rates. That’s more than twice the stock-price gains of the Stoxx Europe 600 and Dow Jones Industrial Average over the period. Danish house prices have jumped so much that Danske Bank A/S, Denmark’s biggest lender, says Copenhagen is fast becoming Scandinavia’s riskiest property market.

Considering that risky property markets are the norm in Scandinavia, Copenhagen represents an extreme situation:

“Property prices in Copenhagen have risen 40–60 percent since the middle of 2012, when the central bank first resorted to negative interest rates to defend the krone’s peg to the euro.”

This should come as no surprise: recall that there are documented cases where Danish borrowers are paid to take on debt and buy houses “In Denmark You Are Now Paid To Take Out A Mortgage”, so between rewarding debtors and punishing savers, this outcome is hardly shocking. Yet it is the negative rates that have made this unprecedented surge in home prices feel relatively benign on broader price levels, since the source of housing funds is not savings but cash, usually cash belonging to the bank.

 

 

The Swedish property market is similarly reaching for the sky. Like Japan at the peak of it’s bubble in the late 1980s, Sweden has intergenerational mortgages, with an average term of 140 years! Recent regulatory attempts to rein in the ballooning debt by reducing the maximum term to a ‘mere’ 105 years have been met with protest:

Swedish banks were quoted in the local press as opposing the move. “It isn’t good for the finances of households as it will make mortgages more expensive and the terms not as good. And it isn’t good for financial stability,” the head of Swedish Bankers’ Association was reported to say.

Apart from stimulating further leverage in an already over-leveraged market, negative interest rates do not appear to be stimulating actual economic activity:

If negative rates don’t spur growth — Danish inflation since 2012 has been negligible and GDP growth anemic — what are they good for?….Danish businesses have barely increased their investments, adding less than 6 percent in the 12 quarters since Denmark’s policy rate turned negative for the first time. At a growth rate of 5 percent over the period, private consumption has been similarly muted. Why is that? Simply put, a weak economy makes interest rates a less powerful tool than central bankers would like.

“If you’re very busy worrying about the economy and your job, you don’t care very much what the exact rate is on your car loan,” says Torsten Slok, Deutsche Bank’s chief international economist in New York.

Fuelling inequality and profligacy while punishing responsible behaviour is politically unpopular, and the consequences, when they eventually manifest, will be even more so. Unfortunately, at the peak of a bubble, it is only continued financial irresponsibility that can keep a credit expansion going and therefore keep the financial system from abruptly crashing. The only things keeping the system ‘running on fumes’ as it currently is, are financial sleight-of-hand, disingenuous bribery and outright fraud. The price to pay is that the systemic risks continue to grow, and with it the scale of the impacts that can be expected when the risk is eventually realised. Politicians desperately wish to avoid those consequences occurring in their term of office, hence they postpone the inevitable at any cost for as long as physically possible.

 

The Zero Lower Bound and the Problem of Physical Cash

 

Central bankers attempting to stimulate the circulation of money in the economy through the use of negative interest rates have a number of problems. For starters, setting a low official rate does not necessarily mean that low rates will prevail in the economy, particularly in times of crisis:

The experience of the global financial crisis taught us that the type of shocks which can drive policy interest rates to the lower bound are also shocks which produce severe impairments to the monetary policy transmission mechanism. Suppose, for example, that the interbank market freezes and prevents a smooth transmission of the policy interest rate throughout the banking sector and financial markets at large. In this case, any cut in the policy rate may be almost completely ineffective in terms of influencing the macroeconomy and prices.

This is exactly what we saw in 2008, when interbank lending seized up due to the collapse of confidence in the banking sector. We have not seen this happen again yet, but it inevitably will as crisis conditions resume, and when it does it will illustrate vividly the limits of central bank power to control financial parameters. At that point, interest rates are very likely to spike in practice, with banks not trusting each other to repay even very short term loans, since they know what toxic debt is on their own books and rationally assume their potential counterparties are no better. Widening credit spreads would also lead to much higher rates on any debt perceived to be risky, which, increasingly, would be all debt with the exception of government bonds in the jurisdictions perceived to be safest. Low rates on high grade debt would not translate into low rates economy-wide. Given the extent of private debt, and the consequent vulnerability to higher interest rates across the developed world, an interest rate spike following the NIRP period would be financially devastating.

The major issue with negative rates in the shorter term is the ability to escape from the banking system into physical cash. Instead of causing people to spend, a penalty on holding savings in a banks creates an incentive for them to withdraw their funds and hold cash under their own control, thereby avoiding both the penalty and the increasing risk associated with the banking system:

Western banking systems are highly illiquid, meaning that they have very low cash equivalents as a percentage of customer deposits….Solvency in many Western banking systems is also highly questionable, with many loaded up on the debts of their bankrupt governments. Banks also play clever accounting games to hide the true nature of their capital inadequacy. We live in a world where questionably solvent, highly illiquid banks are backed by under capitalized insurance funds like the FDIC, which in turn are backed by insolvent governments and borderline insolvent central banks. This is hardly a risk-free proposition. Yet your reward for taking the risk of holding your money in a precarious banking system is a rate of return that is substantially lower than the official rate of inflation.

In other words, negative rates encourage an arbitrage situation favouring cash. In an environment of few good investment opportunities, increasing recognition of risk and a rising level of fear, a desire for large scale cash withdrawal is highly plausible:

From a portfolio choice perspective, cash is, under normal circumstances, a strictly dominated asset, because it is subject to the same inflation risk as bonds but, in contrast to bonds, it yields zero return. It has also long been known that this relationship would be reversed if the return on bonds were negative. In that case, an investor would be certain of earning a profit by borrowing at negative rates and investing the proceedings in cash. Ignoring storage and transportation costs, there is therefore a zero lower bound (ZLB) on nominal interest rates.

Zero is the lower bound for nominal interest rates if one would want to avoid creating such an incentive structure, but in a contractionary environment, zero is not low enough to make borrowing and lending attractive. This is because, while the nominal rate might be zero, the real rate (the nominal rate minus negative inflation) can remain high, or perhaps very high, depending on how contractionary the financial landscape becomes. As Keynes observed, attempting to stimulate demand for money by lowering interest rates amounts to ‘pushing on a piece of string‘. Central authorities find themselves caught in the liquidity trap, where monetary policy ceases to be effective:

Many big economies are now experiencing ‘deflation’, where prices are falling. In the euro zone, for instance, the main interest rate is at 0.05% but the “real” (or adjusted for inflation) interest rate is considerably higher, at 0.65%, because euro-area inflation has dropped into negative territory at -0.6%. If deflation gets worse then real interest rates will rise even more, choking off recovery rather than giving it a lift.

If nominal rates are sufficiently negative to compensate for the contractionary environment, real rates could, in theory, be low enough to stimulate the velocity of money, but the more negative the nominal rate, the greater the incentive to withdraw physical cash. Hoarded cash would reduce, instead of increase, the velocity of money. In practice, lowering rates can be moderately reflationary, provided there remains sufficient economic optimism for people to see the move in a positive light. However, sending rates into negative territory at a time pessimism is dominant can easily be interpreted as a sign of desperation, and therefore as confirmation of a negative outlook. Under such circumstances, the incentives to regard the banking system as risky, to withdraw physical cash and to hoard it for a rainy day increase substantially. Not only does the money supply fail to grow, as new loans are not made, but the velocity of money falls as money is hoarded, thereby aggravating a deflationary spiral:

A decline in the velocity of money increases deflationary pressure. Each dollar (or yen or euro) generates less and less economic activity, so policymakers must pump more money into the system to generate growth. As consumers watch prices decline, they defer purchases, reducing consumption and slowing growth. Deflation also lifts real interest rates, which drives currency values higher. In today’s mercantilist, beggar-thy-neighbour world of global trade, a strong currency is a headwind to exports. Obviously, this is not the desired outcome of policymakers. But as central banks grasp for new, stimulative tools, they end up pushing on an ever-lengthening piece of string.

 

 

Japan has been in the economic doldrums, with pessimism dominant, for over 25 years, and the population has become highly sceptical of stimulation measures intended to lead to recovery. The negative interest rates introduced there (described as ‘economic kamikaze’) have had a very different effect than in Scandinavia, which is still more or less at the peak of its bubble and therefore much more optimistic. Unfortunately, lowering interest rates in times of collective pessimism has a poor record of acting to increase spending and stimulate the economy, as Japan has discovered since their bubble burst in 1989:

For about a quarter of a century the Japanese have proved to be fanatical savers, and no matter how low the Bank of Japan cuts rates, they simply cannot be persuaded to spend their money, or even invest it in the stock market. They fear losing their jobs; they fear a further fall in shares or property values; they have no confidence in the investment opportunities in front of them. So pathological has this psychology grown that they would rather see the value of their savings fall than spend the cash. That draining of confidence after the collapse of the 1980s “bubble” economy has depressed Japanese growth for decades.

Fear is a very sharp driver of behaviour — easily capable of over-riding incentives designed to promote spending and investment:

When people are fearful they tend to save; and when they become especially fearful then they save even more, even if the returns on their savings are extremely low. Much the same goes for businesses, and there are increasing reports of them “hoarding” their profits rather than reinvesting them in their business, such is the great “uncertainty” around the world economy. Brexit obviously only added to the fears and misgivings about the future.

Deflation is so difficult to overcome precisely because of its strong psychological component. When the balance of collective psychology tips from optimism, hope and greed to pessimism and fear, everything is perceived differently. Measures intended to restore confidence end up being interpreted as desperation, and therefore get little or no traction. As such initiatives fail, their failure becomes conformation of a negative bias, which increases the power of that bias, causing more stimulus initiatives to fail. The resulting positive feedback loop creates and maintains a vicious circle, both economically and socially:

There is a strong argument that when rates go negative it squeezes the speed at which money circulates through the economy, commonly referred to by economists as the velocity of money. We are already seeing this happen in Japan where citizens are clamouring for ¥10,000 bills (and home safes to store them in). People are taking their money out of the banking system to stuff it under their metaphorical mattresses. This may sound extreme, but whether paper money is stashed in home safes or moved into transaction substitutes or other stores of value like gold, the point is it’s not circulating in the economy. The empirical data support this view — the velocity of money has declined precipitously as policymakers have moved aggressively to reduce rates.

Physical cash under one’s own control is increasingly seen as one of the primary escape routes for ordinary people fearing the resumption of the 2008 liquidity crunch, and its popularity as a store of value is increasing steadily, with demand for cash rising more rapidly than GDP in a wide range of countries:

While cash’s use is in continual decline, claims that it is set to disappear entirely may be premature, according to the Bank of England….The Bank estimates that 21pc to 27pc of everyday transactions last year were in cash, down from between 34pc and 45pc at the turn of the millennium. Yet simultaneously the demand for banknotes has risen faster than the total amount of spending in the economy, a trend that has only become more pronounced since the mid-1990s. The same phenomenon has been seen internationally, in the US, eurozone, Australia and Canada….

….The prevalence of hoarding has also firmed up the demand for physical money. Hoarders are those who “choose to save their money in a safety deposit box, or under the mattress, or even buried in the garden, rather than placing it in a bank account”, the Bank said. At a time when savings rates have not turned negative, and deposits are guaranteed by the government, this kind of activity seems to defy economic theory. “For such action to be considered as rational, those that are hoarding cash must be gaining a non-financial benefit,” the Bank said. And that benefit must exceed the returns and security offered by putting that hoarded cash in a bank deposit account. A Bank survey conducted last year found that 18pc of people said they hoarded cash largely “to provide comfort against potential emergencies”.

This would suggest that a minimum of £3bn is hoarded in the UK, or around £345 a person. A government survey conducted in 2012 suggested that the total number might be higher, at £5bn….

…..But Bank staff believe that its survey results understate the extent of hoarding, as “the sensitivity of the subject” most likely affects the truthfulness of hoarders. “Based on anecdotal evidence, a small number of people are thought to hoard large values of cash.” The Bank said: “As an illustrative example, if one in every thousand adults in the United Kingdom were to hoard as much as £100,000, this would account for around £5bn — nearly 10pc of notes in circulation.” While there may be newer and more convenient methods of payment available, this strong preference for cash as a safety net means that it is likely to endure, unless steps are taken to discourage its use.

 

 

 

Closing the Escape Routes

 

History teaches us that central authorities dislike escape routes, at least for the majority, and are therefore prone to closing them, so that control of a limited money supply can remain in the hands of the very few. In the 1930s, gold was the escape route, so gold was confiscated. As Alan Greenspan wrote in 1966:

In the absence of the gold standard, there is no way to protect savings from confiscation through monetary inflation. There is no safe store of value. If there were, the government would have to make its holding illegal, as was done in the case of gold. If everyone decided, for example, to convert all his bank deposits to silver or copper or any other good, and thereafter declined to accept checks as payment for goods, bank deposits would lose their purchasing power and government-created bank credit would be worthless as a claim on goods.

The existence of escape routes for capital preservation undermines the viability of the banking system, which is already over-extended, over-leveraged and extremely fragile. This time cash serves that role:

Ironically, though the paper money standard that replaced the gold standard was originally meant to empower governments, it now seems that paper money is perceived as an obstacle to unlimited government power….While paper money isn’t as big impediment to government power as the gold standard was, it is nevertheless an impediment compared to a society with only electronic money. Because of this, the more ardent statists favor the abolition of paper money and a monetary system with only electronic money and electronic payments.

We can therefore expect cash to be increasingly disparaged in order to justify its intended elimination:

Every day, a situation that requires the use of physical cash, feels more and more like an anachronism. It’s like having to listen to music on a CD. John Maynard Keynes famously referred to gold (well, the gold standard specifically) as a “barbarous relic.” Well the new barbarous relic is physical cash. Like gold, cash is physical money. Like gold, cash is still fetishized. And like gold, cash is a costly drain on the economy. A study done at Tufts in 2013 estimated that cash costs the economy $200 billion. Their study included the nugget that consumers spend, on average, 28 minutes per month just traveling to the point where they obtain cash (ATM, etc.). But this is just first-order problem with cash. The real problem, which economists are starting to recognize, is that paper cash is an impediment to effective monetary policy, and therefore economic growth.

Holding cash is not risk free, but cash is nevertheless king in a period of deflation:

Conventional wisdom is that interest rates earned on investments are never less than zero because investors could alternatively hold currency. Yet currency is not costless to hold: It is subject to theft and physical destruction, is expensive to safeguard in large amounts, is difficult to use for large and remote transactions, and, in large quantities, may be monitored by governments.

The acknowledged risks of holding cash are understood and can be managed personally, whereas the substantial risk associated with a systemic banking crisis are entirely outside the control of ordinary depositors. The bank bail-in (rescuing the bank with the depositors’ funds) in Cyprus in early 2013 was a warning sign, to those who were paying attention, that holding money in a bank is not necessarily safe. The capital controls put in place in other locations, for instance Greece, also underline that cash in a bank may not be accessible when needed.

The majority of the developed world either already has, or is introducing, legislation to require depositor bail-ins in the event of bank failures, rather than taxpayer bailouts, in preparation for many more Cyprus-type events, but on a very much larger scale. People are waking up to the fact that a bank balance is not considered their money, but is actually an unsecured loan to the bank, which the bank may or may not repay, depending on its own circumstances.:

Your checking account balance is denominated in dollars, but it does not consist of actual dollars. It represents a promise by a private company (your bank) to pay dollars upon demand. If you write a check, your bank may or may not be able to honor that promise. The poor souls who kept their euros in the form of large balances in Cyprus banks have just learned this lesson the hard way. If they had been holding their euros in the form of currency, they would have not lost their wealth.

 

 

Even in relatively untroubled countries, like the UK, it is becoming more difficult to access physical cash in a bank account or to use it for larger purchases. Notice of intent to withdraw may be required, and withdrawal limits may be imposed ‘for your own protection’. Reasons for the withdrawal may be required, ostensibly to combat money laundering and the black economy:

It’s one thing to be required by law to ask bank customers or parties in a cash transaction to explain where their money came from; it’s quite another to ask them how they intend to use the money they wish to withdraw from their own bank accounts. As one Mr Cotton, a HSBC customer, complained to the BBC’s Money Box programme: “I’ve been banking in that bank for 28 years. They all know me in there. You shouldn’t have to explain to your bank why you want that money. It’s not theirs, it’s yours.”

In France, in the aftermath of terrorist attacks there, several anti-cash measures were passed, restricting the use of cash once obtained:

French Finance Minister Michel Sapin brazenly stated that it was necessary to “fight against the use of cash and anonymity in the French economy.” He then announced extreme and despotic measures to further restrict the use of cash by French residents and to spy on and pry into their financial affairs.

These measures…..include prohibiting French residents from making cash payments of more than 1,000 euros, down from the current limit of 3,000 euros….The threshold below which a French resident is free to convert euros into other currencies without having to show an identity card will be slashed from the current level of 8,000 euros to 1,000 euros. In addition any cash deposit or withdrawal of more than 10,000 euros during a single month will be reported to the French anti-fraud and money laundering agency Tracfin.

Tourists in France may also be caught in the net:

France passed another new Draconian law; from the summer of 2015, it will now impose cash requirements dramatically trying to eliminate cash by force. French citizens and tourists will only be allowed a limited amount of physical money. They have financial police searching people on trains just passing through France to see if they are transporting cash, which they will now seize.

This is essentially the Shock Doctrine in action. Central authorities rarely pass up an opportunity to use a crisis to add to their repertoire of repressive laws and practices.

However, even without a specific crisis to draw on as a justification, many other countries have also restricted the use of cash for purchases:

One way they are waging the War on Cash is to lower the threshold at which reporting a cash transaction is mandatory or at which paying in cash is simply illegal. In just the last few years.

  • Italy made cash transactions over €1,000 illegal;
  • Switzerland has proposed banning cash payments in excess of 100,000 francs;
  • Russia banned cash transactions over $10,000;
  • Spain banned cash transactions over €2,500;
  • Mexico made cash payments of more than 200,000 pesos illegal;
  • Uruguay banned cash transactions over $5,000

Other restrictions on the use of cash can be more subtle, but can have far-reaching effects, especially if the ideas catch on and are widely applied:

The State of Louisiana banned “secondhand dealers” from making more than one cash transaction per week. The term has a broad definition and includes Goodwill stores, specialty stores that sell collectibles like baseball cards, flea markets, garage sales and so on. Anyone deemed a “secondhand dealer” is forbidden to accept cash as payment. They are allowed to take only electronic means of payment or a check, and they must collect the name and other information about each customer and send it to the local police department electronically every day.

The increasing application of de facto capital controls, when combined with the prevailing low interest rates, already convince many to hold cash. The possibility of negative rates would greatly increase the likelihood. We are already in an environment of rapidly declining trust, and limited access to what we still perceive as our own funds only accelerates the process in a self-reinforcing feedback loop. More withdrawals lead to more controls, which increase fear and decrease trust, which leads to more withdrawals. This obviously undermines the perceived power of monetary policy to stimulate the economy, hence the escape route is already quietly closing.

In a deflationary spiral, where the money supply is crashing, very little money is in circulation and prices are consequently falling almost across the board, possessing purchasing power provides for the freedom to pursue opportunities as they present themselves, and to avoid being backed into a corner. The purchasing power of cash increases during deflation, even as electronic purchasing power evaporates. Hence cash represents freedom of action at a time when that will be the rarest of ‘commodities’.

Governments greatly dislike cash, and increasingly treat its use, or the desire to hold it, especially in large denominations, with great suspicion:

Why would a central bank want to eliminate cash? For the same reason as you want to flatten interest rates to zero: to force people to spend or invest their money in the risky activities that revive growth, rather than hoarding it in the safest place. Calls for the eradication of cash have been bolstered by evidence that high-value notes play a major role in crime, terrorism and tax evasion. In a study for the Harvard Business School last week, former bank boss Peter Sands called for global elimination of the high-value note.

Britain’s “monkey” — the £50 — is low-value compared with its foreign-currency equivalents, and constitutes a small proportion of the cash in circulation. By contrast, Japan’s ¥10,000 note (worth roughly £60) makes up a startling 92% of all cash in circulation; the Swiss 1,000-franc note (worth around £700) likewise. Sands wants an end to these notes plus the $100 bill, and the €500 note – known in underworld circles as the “Bin Laden”.

 

 

Cash is largely anonymous, untraceable and uncontrollable, hence it makes central authorities, in a system increasingly requiring total buy-in in order to function, extremely uncomfortable. They regard there being no legitimate reason to own more than a small amount of it in physical form, as its ownership or use raises the spectre of tax evasion or other illegal activities:

The insidious nature of the war on cash derives not just from the hurdles governments place in the way of those who use cash, but also from the aura of suspicion that has begun to pervade private cash transactions. In a normal market economy, businesses would welcome taking cash. After all, what business would willingly turn down customers? But in the war on cash that has developed in the thirty years since money laundering was declared a federal crime, businesses have had to walk a fine line between serving customers and serving the government. And since only one of those two parties has the power to shut down a business and throw business owners and employees into prison, guess whose wishes the business owner is going to follow more often?

The assumption on the part of government today is that possession of large amounts of cash is indicative of involvement in illegal activity. If you’re traveling with thousands of dollars in cash and get pulled over by the police, don’t be surprised when your money gets seized as “suspicious.” And if you want your money back, prepare to get into a long, drawn-out court case requiring you to prove that you came by that money legitimately, just because the courts have decided that carrying or using large amounts of cash is reasonable suspicion that you are engaging in illegal activity….

….Centuries-old legal protections have been turned on their head in the war on cash. Guilt is assumed, while the victims of the government’s depredations have to prove their innocence….Those fortunate enough to keep their cash away from the prying hands of government officials find it increasingly difficult to use for both business and personal purposes, as wads of cash always arouse suspicion of drug dealing or other black market activity. And so cash continues to be marginalized and pushed to the fringes.

Despite the supposed connection between crime and the holding of physical cash, the places where people are most inclined (and able) to store cash do not conform to the stereotype at all:

Are Japan and Switzerland havens for terrorists and drug lords? High-denomination bills are in high demand in both places, a trend that some politicians claim is a sign of nefarious behavior. Yet the two countries boast some of the lowest crime rates in the world. The cash hoarders are ordinary citizens responding rationally to monetary policy. The Swiss National Bank introduced negative interest rates in December 2014. The aim was to drive money out of banks and into the economy, but that only works to the extent that savers find attractive places to spend or invest their money. With economic growth an anemic 1%, many Swiss withdrew cash from the bank and stashed it at home or in safe-deposit boxes. High-denomination notes are naturally preferred for this purpose, so circulation of 1,000-franc notes (worth about $1,010) rose 17% last year. They now account for 60% of all bills in circulation and are worth almost as much as Serbia’s GDP.

Japan, where banks pay infinitesimally low interest on deposits, is a similar story. Demand for the highest-denomination ¥10,000 notes rose 6.2% last year, the largest jump since 2002. But 10,000 Yen notes are worth only about $88, so hiding places fill up fast. That explains why Japanese went on a safe-buying spree last month after the Bank of Japan announced negative interest rates on some reserves. Stores reported that sales of safes rose as much as 250%, and shares of safe-maker Secom spiked 5.3% in one week.

In Germany too, negative interest rates are considered intolerable, banks are increasingly being seen as risky prospects, and physical cash under one’s own control is coming to be seen as an essential part of a forward-thinking financial strategy:

First it was the news that Raiffeisen Gmund am Tegernsee, a German cooperative savings bank in the Bavarian village of Gmund am Tegernsee, with a population 5,767, finally gave in to the ECB’s monetary repression, and announced it’ll start charging retail customers to hold their cash. Then, just last week, Deutsche Bank’s CEO came about as close to shouting fire in a crowded negative rate theater, when, in a Handelsblatt Op-Ed, he warned of “fatal consequences” for savers in Germany and Europe — to be sure, being the CEO of the world’s most systemically risky bank did not help his cause.

That was the last straw, and having been patient long enough, the German public has started to move. According to the WSJ, German savers are leaving the “security of savings banks” for what many now consider an even safer place to park their cash: home safes. We wondered how many “fatal” warnings from the CEO of DB it would take, before this shift would finally take place. As it turns out, one was enough….

….“It doesn’t pay to keep money in the bank, and on top of that you’re being taxed on it,” said Uwe Wiese, an 82-year-old pensioner who recently bought a home safe to stash roughly €53,000 ($59,344), including part of his company pension that he took as a payout. Burg-Waechter KG, Germany’s biggest safe manufacturer, posted a 25% jump in sales of home safes in the first half of this year compared with the year earlier, said sales chief Dietmar Schake, citing “significantly higher demand for safes by private individuals, mainly in Germany.”….

….Unlike their more “hip” Scandinavian peers, roughly 80% of German retail transactions are in cash, almost double the 46% rate of cash use in the U.S., according to a 2014 Bundesbank survey….Germany’s love of cash is driven largely by its anonymity. One legacy of the Nazis and East Germany’s Stasi secret police is a fear of government snooping, and many Germans are spooked by proposals of banning cash transactions that exceed €5,000. Many Germans think the ECB’s plan to phase out the €500 bill is only the beginning of getting rid of cash altogether. And they are absolutely right; we can only wish more Americans showed the same foresight as the ordinary German….

….Until that moment, however, as a final reminder, in a fractional reserve banking system, only the first ten or so percent of those who “run” to the bank to obtain possession of their physical cash and park it in the safe will succeed. Everyone else, our condolences.

The internal stresses are building rapidly, stretching economy after economy to breaking point and prompting aware individuals to protect themselves proactively:

People react to these uncertainties by trying to protect themselves with cash and guns, and governments respond by trying to limit citizens’ ability to do so.

If this play has a third act, it will involve the abolition of cash in some major countries, the rise of various kinds of black markets (silver coins, private-label cash, cryptocurrencies like bitcoin) that bypass traditional banking systems, and a surge in civil unrest, as all those guns are put to use. The speed with which cash, safes and guns are being accumulated — and the simultaneous intensification of the war on cash — imply that the stress is building rapidly, and that the third act may be coming soon.

Despite growing acceptance of electronic payment systems, getting rid of cash altogether is likely to be very challenging, particularly as the fear and state of financial crisis that drives people into cash hoarding is very close to reasserting itself. Cash has a very long history, and enjoys greater trust than other abstract means for denominating value. It is likely to prove tenacious, and unable to be eliminated peacefully. That is not to suggest central authorities will not try. At the heart of financial crisis lies the problem of excess claims to underlying real wealth. The bursting of the global bubble will eliminate the vast majority of these, as the value of credit instruments, hitherto considered to be as good as money, will plummet on the realisation that nowhere near all financial promises made can possibly be kept.

Cash would then represent the a very much larger percentage of the remaining claims to limited actual resources — perhaps still in excess of the available resources and therefore subject to haircuts. Not only the quantity of outstanding cash, but also its distribution, may not be to central authorities liking. There are analogous precedents for altering legal currency in order to dispossess ordinary people trying to protect their stores of value, depriving them of the benefit of their foresight. During the Russian financial crisis of 1998, cash was not eliminated in favour of an electronic alternative, but the currency was reissued, which had a similar effect. People were required to convert their life savings (often held ‘under the mattress’) from the old currency to the new. This was then made very difficult, if not impossible, for ordinary people, and many lost the entirety of their life savings as a result.

 

A Cashless Society?

 

The greater the public’s desire to hold cash to protect themselves, the greater will be the incentive for central banks and governments to restrict its availability, reduce its value or perhaps eliminate it altogether in favour of electronic-only payment systems. In addition to commercial banks already complicating the process of making withdrawals, central banks are actively considering, as a first step, mechanisms to impose negative interest rates on physical cash, so as to make the escape route appear less attractive:

Last September, the Bank of England’s chief economist, Andy Haldane, openly pondered ways of imposing negative interest rates on cash — ie shrinking its value automatically. You could invalidate random banknotes, using their serial numbers. There are £63bn worth of notes in circulation in the UK: if you wanted to lop 1% off that, you could simply cancel half of all fivers without warning. A second solution would be to establish an exchange rate between paper money and the digital money in our bank accounts. A fiver deposited at the bank might buy you a £4.95 credit in your account.

 

 

To put it mildly, invalidating random banknotes would be highly likely to result in significant social blowback, and to accelerate the evaporation of trust in governing authorities of all kinds. It would be far more likely for financial authorities to move toward making official electronic money the standard by which all else is measured. People are already used to using electronic money in the form of credit and debit cards and mobile phone money transfers:

I can remember the moment I realised the era of cash could soon be over. It was Australia Day on Bondi Beach in 2014. In a busy liquor store, a man wearing only swimming shorts, carrying only a mobile phone and a plastic card, was delaying other people’s transactions while he moved 50 Australian dollars into his current account on his phone so that he could buy beer. The 30-odd youngsters in the queue behind him barely murmured; they’d all been in the same predicament. I doubt there was a banknote or coin between them….The possibility of a cashless society has come at us with a rush: contactless payment is so new that the little ping the machine makes can still feel magical. But in some shops, especially those that cater for the young, a customer reaching for a banknote already produces an automatic frown. Among central bankers, that frown has become a scowl.

In some states almost anything, no matter how small, can be purchased electronically. Everything down to, and including, a cup of coffee from a roadside stall can be purchased in New Zealand with an EFTPOS (debit) card, hence relatively few people carry cash. In Scandinavian countries, there are typically more electronic payment options than cash options:

Sweden became the first country to enlist its own citizens as largely willing guinea pigs in a dystopian economic experiment: negative interest rates in a cashless society. As Credit Suisse reports, no matter where you go or what you want to purchase, you will find a small ubiquitous sign saying “Vi hanterar ej kontanter” (“We don’t accept cash”)….A similar situation is unfolding in Denmark, where nearly 40% of the paying demographic use MobilePay, a Danske Bank app that allows all payments to be completed via smartphone.

Even street vendors selling “Situation Stockholm”, the local version of the UK’s “Big Issue” are also able to take payments by debit or credit card.

 

 

Ironically, cashlessness is also becoming entrenched in some African countries. One might think that electronic payments would not be possible in poor and unstable subsistence societies, but mobile phones are actually very common in such places, and means for electronic payments are rapidly becoming the norm:

While Sweden and Denmark may be the two nations that are closest to banning cash outright, the most important testing ground for cashless economics is half a world away, in sub-Saharan Africa. In many African countries, going cashless is not merely a matter of basic convenience (as it is in Scandinavia); it is a matter of basic survival. Less than 30% of the population have bank accounts, and even fewer have credit cards. But almost everyone has a mobile phone. Now, thanks to the massive surge in uptake of mobile communications as well as the huge numbers of unbanked citizens, Africa has become the perfect place for the world’s biggest social experiment with cashless living.

Western NGOs and GOs (Government Organizations) are working hand-in-hand with banks, telecom companies and local authorities to replace cash with mobile money alternatives. The organizations involved include Citi Group, Mastercard, VISA, Vodafone, USAID, and the Bill and Melinda Gates Foundation.

In Kenya the funds transferred by the biggest mobile money operator, M-Pesa (a division of Vodafone), account for more than 25% of the country’s GDP. In Africa’s most populous nation, Nigeria, the government launched a Mastercard-branded biometric national ID card, which also doubles up as a payment card. The “service” provides Mastercard with direct access to over 170 million potential customers, not to mention all their personal and biometric data. The company also recently won a government contract to design the Huduma Card, which will be used for paying State services. For Mastercard these partnerships with government are essential for achieving its lofty vision of creating a “world beyond cash.”

Countries where electronic payment is already the norm would be expected to be among the first places to experiment with a fully cashless society as the transition would be relatively painless (at least initially). In Norway two major banks no longer issue cash from branch offices, and recently the largest bank, DNB, publicly called for the abolition of cash. In rich countries, the advent of a cashless society could be spun in the media in such a way as to appear progressive, innovative, convenient and advantageous to ordinary people. In poor countries, people would have no choice in any case.

Testing and developing the methods in societies with no alternatives and then tantalizing the inhabitants of richer countries with more of the convenience to which they have become addicted is the clear path towards extending the reach of electronic payment systems and the much greater financial control over individuals that they offer:

Bill and Melinda Gates Foundation, in its 2015 annual letter, adds a new twist. The technologies are all in place; it’s just a question of getting us to use them so we can all benefit from a crimeless, privacy-free world. What better place to conduct a massive social experiment than sub-Saharan Africa, where NGOs and GOs (Government Organizations) are working hand-in-hand with banks and telecom companies to replace cash with mobile money alternatives? So the annual letter explains: “(B)ecause there is strong demand for banking among the poor, and because the poor can in fact be a profitable customer base, entrepreneurs in developing countries are doing exciting work – some of which will “trickle up” to developed countries over time.”

What the Foundation doesn’t mention is that it is heavily invested in many of Africa’s mobile-money initiatives and in 2010 teamed up with the World Bank to “improve financial data collection” among Africa’s poor. One also wonders whether Microsoft might one day benefit from the Foundation’s front-line role in mobile money….As a result of technological advances and generational priorities, cash’s days may well be numbered. But there is a whole world of difference between a natural death and euthanasia. It is now clear that an extremely powerful, albeit loose, alliance of governments, banks, central banks, start-ups, large corporations, and NGOs are determined to pull the plug on cash — not for our benefit, but for theirs.

Whatever the superficially attractive media spin, joint initiatives like the Better Than Cash Alliance serve their founders, not the public. This should not come as a surprise, but it probably will as we sleepwalk into giving up very important freedoms:

As I warned in We Are Sleepwalking Towards a Cashless Society, we (or at least the vast majority of people in the vast majority of countries) are willing to entrust government and financial institutions — organizations that have already betrayed just about every possible notion of trust — with complete control over our every single daily transaction. And all for the sake of a few minor gains in convenience. The price we pay will be what remains of our individual freedom and privacy.

 

 

 

Promoters, Mechanisms and Risks in the War on Cash

 

Bitcoin and other electronic platforms have paved the way psychologically for a shift away from cash, although they have done so by emphasising decentralisation and anonymity rather than the much greater central control which would be inherent in a mainstream electronic currency. The loss of privacy would no doubt be glossed over in any media campaign, as would the risks of cyber-attack and the lack of a fallback for providing liquidity to the economy in the event of a systems crash. Electronic currency is much favoured by techno-optimists, but not so much by those concerned about the risks of absolute structural dependency on technological complexity. The argument regarding greatly reduced socioeconomic resilience is particularly noteworthy, given the vulnerability and potential fragility of electronic systems.

There is an important distinction to be made between official electronic currency – allowing everyone to hold an account with the central bank — and private electronic currency. It would be official currency which would provide the central control sought by governments and central banks, but if individuals saw central bank accounts as less risky than commercial institutions, which seems highly likely, the extent of the potential funds transfer could crash the existing banking system, causing a bank run in a similar manner as large-scale cash withdrawals would. As the power of money creation is of the highest significance, and that power is currently in private hands, any attempt to threaten that power would almost certainly be met with considerable resistance from powerful parties. Private digital currency would be more compatible with the existing framework, but would not confer all of the control that governments would prefer:

People would convert a very large share of their current bank deposits into official digital money, in effect taking them out of the private banking system. Why might this be a problem? If it’s an acute rush for safety in a crisis, the risk is that private banks may not have enough reserves to honour all the withdrawals. But that is exactly the same risk as with physical cash: it’s often forgotten that it’s central bank reserves, not the much larger quantity of deposits, that banks can convert into cash with the central bank. Both with cash and official e-cash, the way to meet a more severe bank run is for the bank to borrow more reserves from the central bank, posting its various assets as security. In effect, this would mean the central bank taking over the funding of the broader economy in a panic — but that’s just what central banks should do.

A more chronic challenge is that people may prefer the safety of central bank accounts even in normal times. That would destroy private banks’ current deposit-funded model. Is that a bad thing? They would still have a role as direct intermediators between savers and borrowers, by offering investment products sufficiently attractive for people to get out of the safety of e-cash. Meanwhile, the broad money supply would be more directly under the control of the central bank, whereas now it’s a product of the vagaries of private lending decisions. The more of the broad money supply that was in the form of official digital cash, the easier it would be, for example, for the central bank to use tools such as negative interest rates or helicopter drops.

As an indication that the interests of the private banking system and public central authorities are not always aligned, consider the actions of the Bavarian Banking Association in attempting to avoid the imposition of negative interest rates on reserves held with the ECB:

German newspaper Der Spiegel reported yesterday that the Bavarian Banking Association has recommended that its member banks start stockpiling PHYSICAL CASH. The Bavarian Banking Association has had enough of this financial dictatorship. Their new recommendation is for all member banks to ditch the ECB and instead start keeping their excess reserves in physical cash, stored in their own bank vaults. This is officially an all-out revolution of the financial system where banks are now actively rebelling against the central bank. (What’s even more amazing is that this concept of traditional banking — holding physical cash in a bank vault — is now considered revolutionary and radical.)

There’s just one teensy tiny problem: there simply is not enough physical cash in the entire financial system to support even a tiny fraction of the demand. Total bank deposits exceed trillions of euros. Physical cash constitutes just a small percentage of that sum. So if German banks do start hoarding physical currency, there won’t be any left in the financial system. This will force the ECB to choose between two options:

  1. Support this rebellion and authorize the issuance of more physical cash; or
  2. Impose capital controls.

Given that just two weeks ago the President of the ECB spoke about the possibility of banning some higher denomination cash notes, it’s not hard to figure out what’s going to happen next.

Advantages of official electronic currency to governments and central banks are clear. All transactions are transparent, and all can be subject to fees and taxes. Central control over the money supply would be greatly increased and tax evasion would be difficult to impossible, at least for ordinary people. Capital controls would be built right into the system, and personal spending information would be conveniently gathered for inspection by central authorities (for cross-correlation with other personal data they possess). The first step would likely be to set up a dual system, with both cash and electronic money in parallel use, but with electronic money as the defined unit of value and cash subject to a marginally disadvantageous exchange rate.

The exchange rate devaluing cash in relation to electronic money could increase over time, in order to incentivize people to switch away from seeing physical cash as a store of value, and to increase their preference for goods over cash. In addition to providing an active incentive, the use of cash would probably be publicly disparaged as well as actively discouraged in many ways. For instance, key functions such as tax payments could be designated as by electronic remittance only. The point would be to forced everyone into the system by depriving them of the choice to opt out. Once all were captured, many forms of central control would be possible, including substantial account haircuts if central authorities deemed them necessary.

 

 

The main promoters of cash elimination in favour of electronic currency are Willem Buiter, Kenneth Rogoff, and Miles Kimball.

Economist Willem Buiter has been pushing for the relegation of cash, at least the removal of its status as official unit of account, since the financial crisis of 2008. He suggests a number of mechanisms for achieving the transition to electronic money, emphasising the need for the electronic currency to become the definitive unit of account in order to implement substantially negative interest rates:

The first method does away with currency completely. This has the additional benefit of inconveniencing the main users of currency-operators in the grey, black and outright criminal economies. Adequate substitutes for the legitimate uses of currency, on which positive or negative interest could be paid, are available. The second approach, proposed by Gesell, is to tax currency by making it subject to an expiration date. Currency would have to be “stamped” periodically by the Fed to keep it current. When done so, interest (positive or negative) is received or paid.

The third method ends the fixed exchange rate (set at one) between dollar deposits with the Fed (reserves) and dollar bills. There could be a currency reform first. All existing dollar bills and coin would be converted by a certain date and at a fixed exchange rate into a new currency called, say, the rallod. Reserves at the Fed would continue to be denominated in dollars. As long as the Federal Funds target rate is positive or zero, the Fed would maintain the fixed exchange rate between the dollar and the rallod.

When the Fed wants to set the Federal Funds target rate at minus five per cent, say, it would set the forward exchange rate between the dollar and the rallod, the number of dollars that have to be paid today to receive one rallod tomorrow, at five per cent below the spot exchange rate — the number of dollars paid today for one rallod delivered today. That way, the rate of return, expressed in a common unit, on dollar reserves is the same as on rallod currency.

For the dollar interest rate to remain the relevant one, the dollar has to remain the unit of account for setting prices and wages. This can be encouraged by the government continuing to denominate all of its contracts in dollars, including the invoicing and payment of taxes and benefits. Imposing the legal restriction that checkable deposits and other private means of payment cannot be denominated in rallod would help.

In justifying his proposals, he emphasises the importance of combatting criminal activity…

The only domestic beneficiaries from the existence of anonymity-providing currency are the criminal fraternity: those engaged in tax evasion and money laundering, and those wishing to store the proceeds from crime and the means to commit further crimes. Large denomination bank notes are an especially scandalous subsidy to criminal activity and to the grey and black economies.

… over the acknowledged risks of government intrusion in legitimately private affairs:

My good friend and colleague Charles Goodhart responded to an earlier proposal of mine that currency (negotiable bearer bonds with legal tender status) be abolished that this proposal was “appallingly illiberal”. I concur with him that anonymity/invisibility of the citizen vis-a-vis the state is often desirable, given the irrepressible tendency of the state to infringe on our fundamental rights and liberties and given the state’s ever-expanding capacity to do so (I am waiting for the US or UK government to contract Google to link all personal health information to all tax information, information on cross-border travel, social security information, census information, police records, credit records, and information on personal phone calls, internet use and internet shopping habits).

In his seminal 2014 paper “Costs and Benefits to Phasing Out Paper Currency.”, Kenneth Rogoff also argues strongly for the primacy of electronic currency and the elimination of physical cash as an escape route:

Paper currency has two very distinct properties that should draw our attention. First, it is precisely the existence of paper currency that makes it difficult for central banks to take policy interest rates much below zero, a limitation that seems to have become increasingly relevant during this century. As Blanchard et al. (2010) point out, today’s environment of low and stable inflation rates has drastically pushed down the general level of interest rates. The low overall level, combined with the zero bound, means that central banks cannot cut interest rates nearly as much as they might like in response to large deflationary shocks.

If all central bank liabilities were electronic, paying a negative interest on reserves (basically charging a fee) would be trivial. But as long as central banks stand ready to convert electronic deposits to zero-interest paper currency in unlimited amounts, it suddenly becomes very hard to push interest rates below levels of, say, -0.25 to -0.50 percent, certainly not on a sustained basis. Hoarding cash may be inconvenient and risky, but if rates become too negative, it becomes worth it.

However, he too notes associated risks:

Another argument for maintaining paper currency is that it pays to have a diversity of technologies and not to become overly dependent on an electronic grid that may one day turn out to be very vulnerable. Paper currency diversifies the transactions system and hardens it against cyber attack, EMP blasts, etc. This argument, however, seems increasingly less relevant because economies are so totally exposed to these problems anyway. With paper currency being so marginalized already in the legal economy in many countries, it is hard to see how it could be brought back quickly, particularly if ATM machines were compromised at the same time as other electronic systems.

A different type of argument against eliminating currency relates to civil liberties. In a world where society’s mores and customs evolve, it is important to tolerate experimentation at the fringes. This is potentially a very important argument, though the problem might be mitigated if controls are placed on the government’s use of information (as is done say with tax information), and the problem might also be ameliorated if small bills continue to circulate. Last but not least, if any country attempts to unilaterally reduce the use of its currency, there is a risk that another country’s currency would be used within domestic borders.

Miles Kimball’s proposals are very much in tune with Buiter and Rogoff:

There are two key parts to Miles Kimball’s solution. The first part is to make electronic money or deposits the sole unit of account. Everything else would be priced in terms of electronic dollars, including paper dollars. The second part is that the fixed exchange rate that now exists between deposits and paper dollars would become variable. This crawling peg between deposits and paper currency would be based on the state of the economy. When the economy was in a slump and the central bank needed to set negative interest rates to restore full employment, the peg would adjust so that paper currency would lose value relative to electronic money. This would prevent folks from rushing to paper currency as interest rates turned negative. Once the economy started improving, the crawling peg would start adjusting toward parity.

This approach views the economy in very mechanistic terms, as if it were a machine where pulling a lever would have a predictable linear effect — make holding savings less attractive and automatically consumption will increase. This is actually a highly simplistic view, resting on the notions of stabilising negative feedback and bringing an economy ‘back into equilibrium’. If it were so simple to control an economy centrally, there would never have been deflationary spirals or economic depressions in the past.

Assuming away the more complex aspects of human behaviour — a flight to safety, the compulsion to save for a rainy day when conditions are unstable, or the natural response to a negative ‘wealth effect’ — leads to a model divorced from reality. Taxing savings does not necessarily lead to increased consumption, in fact it is far more likely to have the opposite effect.:

But under Miles Kimball’s proposal, the Fed would lower interest rates to below zero by taxing away balances of e-currency. This is a reduction in monetary base, just like the case of IOR, and by itself would be contractionary, not expansionary. The expansionary effects of Kimball’s policy depend on the assumption that households will increase consumption in response to the taxing of their cash savings, rather than letting their savings depreciate.

That needn’t be the case — it depends on the relative magnitudes of income and substitution effects for real money balances. The substitution effect is what Kimball has in mind — raising the price of real money balances will induce substitution out of money and into consumption. But there’s also an income effect, whereby the loss of wealth induces less consumption and more savings. Thus, negative interest rate policy can be contractionary even though positive interest rate policy is expansionary.

Indeed, what Kimball has proposed amounts to a reverse Bernanke Helicopter — imagine a giant vacuum flying around the country sucking money out of people’s pockets. Why would we assume that this would be inflationary?

 

 

Given that the effect on the money supply would be contractionary, the supposed stimulus effect on the velocity of money (as, in theory, savings turn into consumption in order to avoid the negative interest rate penalty) would have to be large enough to outweigh a contracting money supply. In some ways, modern proponents of electronic money bearing negative interest rates are attempting to copy Silvio Gesell’s early 20th century work. Gesell proposed the use of stamp scrip — money that had to be regularly stamped, at a small cost, in order to remain current. The effect would be for money to lose value over time, so that hoarding currency it would make little sense. Consumption would, in theory, be favoured, so money would be kept in circulation.

This idea was implemented to great effect in the Austrian town of Wörgl during the Great Depression, where the velocity of money increased sufficiently to allow a hive of economic activity to develop (temporarily) in the previously depressed town. Despite the similarities between current proposals and Gesell’s model applied in Wörgl, there are fundamental differences:

There is a critical difference, however, between the Wörgl currency and the modern-day central bankers’ negative interest scheme. The Wörgl government first issued its new “free money,” getting it into the local economy and increasing purchasing power, before taxing a portion of it back. And the proceeds of the stamp tax went to the city, to be used for the benefit of the taxpayers….Today’s central bankers are proposing to tax existing money, diminishing spending power without first building it up. And the interest will go to private bankers, not to the local government.

The Wörgl experiment was a profoundly local initiative, instigated at the local government level by the mayor. In contrast, modern proposals for negative interest rates would operate at a much larger scale and would be imposed on the population in accordance with the interests of those at the top of the financial foodchain. Instead of being introduced for the direct benefit of those who pay, as stamp scrip was in Wörgl, it would tax the people in the economic periphery for the continued benefit of the financial centre. As such it would amount to just another attempt to perpetuate the current system, and to do so at a scale far beyond the trust horizon.

As the trust horizon contracts in times of economic crisis, effective organizational scale will also contract, leaving large organizations (both public and private) as stranded assets from a trust perspective, and therefore lacking in political legitimacy. Large scale, top down solutions will be very difficult to implement. It is not unusual for the actions of central authorities to have the opposite of the desired effect under such circumstances:

Consumers today already have very little discretionary money. Imposing negative interest without first adding new money into the economy means they will have even less money to spend. This would be more likely to prompt them to save their scarce funds than to go on a shopping spree. People are not keeping their money in the bank today for the interest (which is already nearly non-existent). It is for the convenience of writing checks, issuing bank cards, and storing their money in a “safe” place. They would no doubt be willing to pay a modest negative interest for that convenience; but if the fee got too high, they might pull their money out and save it elsewhere. The fee itself, however, would not drive them to buy things they did not otherwise need.

People would be very likely to respond to negative interest rates by self-organising alternative means of exchange, rather than bowing to the imposition of negative rates. Bitcoin and other crypto-currencies would be one possibility, as would using foreign currency, using trading goods as units of value, or developing local alternative currencies along the lines of the Wörgl model:

The use of sheep, bottled water, and cigarettes as media of exchange in Iraqi rural villages after the US invasion and collapse of the dinar is one recent example. Another example was Argentina after the collapse of the peso, when grain contracts priced in dollars were regularly exchanged for big-ticket items like automobiles, trucks, and farm equipment. In fact, Argentine farmers began hoarding grain in silos to substitute for holding cash balances in the form of depreciating pesos.

 

 

For the electronic money model grounded in negative interest rates to work, all these alternatives would have to be made illegal, or at least hampered to the point of uselessness, so people would have no other legal choice but to participate in the electronic system. Rogoff seems very keen to see this happen:

Won’t the private sector continually find new ways to make anonymous transfers that sidestep government restrictions? Certainly. But as long as the government keeps playing Whac-A-Mole and prevents these alternative vehicles from being easily used at retail stores or banks, they won’t be able fill the role that cash plays today. Forcing criminals and tax evaders to turn to riskier and more costly alternatives to cash will make their lives harder and their enterprises less profitable.

It is very likely that in times of crisis, people would do what they have to do regardless of legal niceties. While it may be possible to close off some alternative options with legal sanctions, it is unlikely that all could be prevented, or even enough to avoid the electronic system being fatally undermined.

The other major obstacle would be overcoming the preference for cash over goods in times of crisis:

Understanding how negative rates may or may not help economic growth is much more complex than most central bankers and investors probably appreciate. Ultimately the confusion resides around differences in view on the theory of money. In a classical world, money supply multiplied by a constant velocity of circulation equates to nominal growth.

In a Keynesian world, velocity is not necessarily constant — specifically for Keynes, there is a money demand function (liquidity preference) and therefore a theory of interest that allows for a liquidity trap whereby increasing money supply does not lead to higher nominal growth as the increase in money is hoarded. The interest rate (or inverse of the price of bonds) becomes sticky because at low rates, for infinitesimal expectations of any further rise in bond prices and a further fall in interest rates, demand for money tends to infinity.

In Gesell’s world money supply itself becomes inversely correlated with velocity of circulation due to money characteristics being superior to goods (or commodities). There are costs to storage that money does not have and so interest on money capital sets a bar to interest on real capital that produces goods. This is similar to Keynes’ concept of the marginal efficiency of capital schedule being separate from the interest rate. For Gesell the product of money and velocity is effective demand (nominal growth) but because of money capital’s superiority to real capital, if money supply expands it comes at the expense of velocity.

The new money supply is hoarded because as interest rates fall, expected returns on capital also fall through oversupply — for economic agents goods remain unattractive to money. The demand for money thus rises as velocity slows. This is simply a deflation spiral, consumers delaying purchases of goods, hoarding money, expecting further falls in goods prices before they are willing to part with their money….In a Keynesian world of deficient demand, the burden is on fiscal policy to restore demand. Monetary policy simply won’t work if there is a liquidity trap and demand for cash is infinite.

During the era of globalisation (since the financial liberalisation of the early 1980s), extractive capitalism in debt-driven over-drive has created perverse incentives to continually increase supply. Financial bubbles, grounded in the rediscovery of excess leverage, always act to create an artificial demand stimulus, which is met by artificially inflated supply during the boom phase. The value of the debt created collapses as boom turns into bust, crashing the money supply, and with it asset price support. Not only does the artificial stimulus disappear, but a demand undershoot develops, leaving all that supply without a market. Over the full cycle of a bubble and its aftermath, credit is demand neutral, but within the bubble it is anything but neutral. Forward shifting the demand curve provides for an orgy of present consumption and asset price increases, which is inevitably followed by the opposite.

Kimball stresses bringing demand forward as a positive aspect of his model:

In an economic situation like the one we are now in, we would like to encourage a company thinking about building a factory in a couple of years to build that factory now instead. If someone would lend to them at an interest rate of -3.33% per year, the company could borrow $1 million to build the factory now, and pay back something like $900,000 on the loan three years later. (Despite the negative interest rate, compounding makes the amount to be paid back a bit bigger, but not by much.)

That would be a good enough deal that the company might move up its schedule for building the factory. But everything runs aground on the fact that any potential lender, just by putting $1 million worth of green pieces of paper in a vault could get back $1 million three years later, which is a lot better than getting back a little over $900,000 three years later.

This is, however, a short-sighted assessment. Stimulating demand today means a demand undershoot tomorrow. Kimball names long term price stability as a primary goal, but this seems unlikely. Large scale central planning has a poor track record for success, to put it mildly. It requires the central authority in question to have access to all necessary information in realtime, and to have the ability to respond to that information both wisely and rapidly, or even proactively. It also assumes the ability to accurately filter out misinformation and disinformation. This is unlikely even in good times, thanks to the difficulties of ‘organizational stupidity’ at large scale, and even more improbable in the times of crisis.

 

 

 

Financial Totalitarianism in Historical Context

 

In attempting to keep the credit bonanza going with their existing powers, central banks have set the global financial system up for an across-the-board asset price collapse:

QE takes away the liquidity preference choice out of the hands of the consumers, and puts it into the hands of central bankers, who through asset purchases push up asset prices even if it does so by explicitly devaluing the currency of price measurement; it also means that the failure of NIRP is — by definition — a failure of central banking, and if and when the central bank backstop of any (make that all) asset class — i.e., Q.E., is pulled away, that asset (make that all) will crash.

It is not just central banking, but also globalisation, which is demonstrably failing. Cross-border freedoms will probably be an early casualty of the war on cash, and its demise will likely come as a shock to those used to a relatively borderless world:

We have been informed with reliable sources that in Germany where Maestro was a multi-national debit card service owned by MasterCard that was founded in 1992 is seriously under attack. Maestro cards are obtained from associate banks and can be linked to the card holder’s current account, or they can be prepaid cards. Already we find such cards are being cancelled and new debit cards are being issued.

Why? The new cards cannot be used at an ATM outside of Germany to obtain cash. Any attempt to get cash can only be as an advance on a credit card….This is total insanity and we are losing absolutely everything that made society function. Once they eliminate CASH, they will have total control over who can buy or sell anything.

The same confused, greedy and corrupt central authorities which have set up the global economy for a major bust through their dysfunctional use of existing powers, are now seeking far greater central control, in what would amount to the ultimate triumph of finance over people. They are now moving to tax what ever people have left over after paying taxes. It has been tried before. As previous historical bubbles began to collapse, central authorities attempted to increase their intrusiveness and control over the population, in order to force the inevitable losses as far down the financial foodchain as possible. As far back as the Roman Empire, economically contractionary periods have been met with financial tyranny — increasing pressure on the populace until the system itself breaks:

Not even the death penalty was enough to enforce Diocletian’s price control edicts in the third century.

Rome squeezed the peasants in its empire so hard, that many eventually abandoned their land, reckoning that they were better off with the barbarians.

Such attempts at total financial control are exactly what one would expect at this point. A herd of financial middle men are used to being very well supported by the existing financial system, and as that system begins to break down, losing that raft of support is unacceptable. The people at the bottom of the financial foodchain must be watched and controlled in order to make sure they are paying to support the financial centre in the manner to which it has become accustomed, even as their ability to do so is continually undermined:

An oft-overlooked benefit of cash transactions is that there is no intermediary. One party pays the other party in mutually accepted currency and not a single middleman gets to wet his beak. In a cashless society there will be nothing stopping banks or other financial mediators from taking a small piece of every single transaction. They would also be able to use — and potentially abuse — the massive deposits of data they collect on their customers’ payment behavior. This information is of huge interest and value to retail marketing departments, other financial institutions, insurance companies, governments, secret services, and a host of other organizations….

….So in order to save a financial system that is morally beyond the pale and stopped serving the basic needs of the real economy a long time ago, governments and central banks must do away with the last remaining thing that gives people a small semblance of privacy, anonymity, and personal freedom in their increasingly controlled and surveyed lives. The biggest tragedy of all is that the governments and banks’ strongest ally in their War on Cash is the general public itself. As long as people continue to abandon the use of cash, for the sake of a few minor gains in convenience, the war on cash is already won.

Even if the ultimate failure of central control is predictable, momentum towards greater centralisation will carry forward for as long as possible, until the system can no longer function, at which point a chaotic free-for-all is likely to occur. In the meantime, the movement towards electronic money seeks to empower the surveillance state/corporatocracy enormously, providing it with the tools to observe and control virtually every aspect of people’s lives:

Governments and corporations, even that genius app developer in Russia, have one thing in common: they want to know everything. Data is power. And money. As the Snowden debacle has shown, they’re getting there. Technologies for gathering information, then hoarding it, mining it, and using it are becoming phenomenally effective and cheap. But it’s not perfect. Video surveillance with facial-recognition isn’t everywhere just yet. Not everyone is using a smartphone. Not everyone posts the details of life on Facebook. Some recalcitrant people still pay with cash. To the greatest consternation of governments and corporations, stuff still happens that isn’t captured and stored in digital format….

….But the killer technology isn’t the elimination of cash. It’s the combination of payment data and the information stream that cellphones, particularly smartphones, deliver. Now everything is tracked neatly by a single device that transmits that data on a constant basis to a number of companies, including that genius app developer in Russia — rather than having that information spread over various banks, credit card companies, etc. who don’t always eagerly surrender that data.

Eventually, it might even eliminate the need for data brokers. At that point, a single device knows practically everything. And from there, it’s one simple step to transfer part or all of this data to any government’s data base. Opinions are divided over whom to distrust more: governments or corporations. But one thing we know: mobile payments and the elimination of cash….will also make life a lot easier for governments and corporations in their quest for the perfect surveillance society.

Dissent is increasingly being criminalised, with legitimate dissenters commonly referred to, and treated as, domestic terrorists and potentially subjected to arbitrary asset confiscation:

An important reason why the state would like to see a cashless society is that it would make it easier to seize our wealth electronically. It would be a modern-day version of FDR’s confiscation of privately-held gold in the 1930s. The state will make more and more use of “threats of terrorism” to seize financial assets. It is already talking about expanding the definition of “terrorist threat” to include critics of government like myself.

The American state already confiscates financial assets under the protection of various guises such as the PATRIOT Act. I first realized this years ago when I paid for a new car with a personal check that bounced. The car dealer informed me that the IRS had, without my knowledge, taken 20 percent of the funds that I had transferred from a mutual fund to my bank account in order to buy the car. The IRS told me that it was doing this to deter terrorism, and that I could count it toward next year’s tax bill.

 

 

The elimination of cash in favour of official electronic money only would greatly accelerate and accentuate the ability of governments to punish those they dislike, indeed it would allow them to prevent dissenters from engaging in the most basic functions:

If all money becomes digital, it would be much easier for the government to manipulate our accounts. Indeed, numerous high-level NSA whistleblowers say that NSA spying is about crushing dissent and blackmailing opponents. not stopping terrorism. This may sound over-the-top. but remember, the government sometimes labels its critics as “terrorists”. If the government claims the power to indefinitely detain — or even assassinate — American citizens at the whim of the executive, don’t you think that government people would be willing to shut down, or withdraw a stiff “penalty” from a dissenter’s bank account?

If society becomes cashless, dissenters can’t hide cash. All of their financial holdings would be vulnerable to an attack by the government. This would be the ultimate form of control. Because — without access to money — people couldn’t resist, couldn’t hide and couldn’t escape.

The trust that has over many years enabled the freedoms we enjoy is now disappearing rapidly, and the impact of its demise is already palpable. Citizens understandably do not trust governments and powerful corporations, which have increasingly clearly been acting in their own interests in consolidating control over claims to real resources in the hands of fewer and fewer individuals and institutions:

By far the biggest risk posed by digital alternatives to cash such as mobile money is the potential for massive concentration of financial power and the abuses and conflicts of interest that would almost certainly ensue. Naturally it goes without saying that most of the institutions that will rule the digital money space will be the very same institutions….that have already broken pretty much every rule in the financial service rule book.

They have manipulated virtually every market in existence; they have commodified and financialized pretty much every natural resource of value on this planet; and in the wake of the financial crisis they almost single-handedly caused, they have extorted billions of dollars from the pockets of their own customers and trillions from hard-up taxpayers. What about your respective government authorities? Do you trust them?…

….We are, it seems, descending into a world where new technologies threaten to put absolute power well within the grasp of a select group of individuals and organizations — individuals and organizations that have through their repeated actions betrayed just about every possible notion of mutual trust.

Governments do not trust their citizens (‘potential terrorists’) either, hence the perceived need to monitor and limit the scope of their decisions and actions. The powers-that-be know how angry people are going to be when they realise the scale of their impending dispossession, and are acting in such a way as to (try to) limit the power of the anger that will be focused against them. It is not going to work.

Without trust we are likely to see “throwbacks to the 14th century….at the dawn of banking coming out of the Dark Ages.”. It is no coincidence that this period was also one of financial, socioeconomic and humanitarian crises, thanks to the bursting of a bubble two centuries in the making:

The 14th Century was a time of turmoil, diminished expectations, loss of confidence in institutions, and feelings of helplessness at forces beyond human control. Historian Barbara Tuchman entitled her book on this period A Distant Mirror because many of our modern problems had counterparts in the 14th Century.

Few think of the trials and tribulations of 14th century Europe as having their roots in financial collapse — they tend instead to remember famine and disease. However, the demise of what was then the world banking system was a leading indicator for what followed, as is always the case:

Six hundred and fifty years ago came the climax of the worst financial collapse in history to date. The 1930’s Great Depression was a mild and brief episode, compared to the bank crash of the 1340’s, which decimated the human population. The crash, which peaked in A.C.E. 1345 when the world’s biggest banks went under, “led” by the Bardi and Peruzzi companies of Florence, Italy, was more than a bank crash — it was a financial disintegration….a blowup of all major banks and markets in Europe, in which, chroniclers reported, “all credit vanished together,” most trade and exchange stopped, and a catastrophic drop of the world’s population by famine and disease loomed.

As we have written many times before at The Automatic Earth, bubbles are not a new phenomenon. They have inflated and subsequently imploded since the dawn of civilisation, and are in fact en emergent property of civilisational scale. There are therefore many parallels between different historical episodes of boom and bust:

The parallels between the medieval credit crunch and our current predicament are considerable. In both cases the money supply increased in response to the expansionist pressure of unbridled optimism. In both cases the expansion proceeded to the point where a substantial overhang of credit had been created — a quantity sufficient to generate systemic risk that was not recognized at the time. In the fourteenth century, that risk was realized, as it will be again in the 21st century.

What we are experiencing now is simply the same dynamic, but turbo-charged by the availability of energy and technology that have driven our long period of socioeconomic expansion and ever-increasing complexity. Just as in the 14th century, the cracks in the system have been visible for many years, but generally ignored. The coming credit implosion may appear to come from nowhere when it hits, but has long been foreshadowed if one knew what to look for. Watching more and more people seeking escape routes from a doomed financial system, and the powers-that-be fighting back by closing those escape routes, all within a social matrix of collapsing trust, one cannot deny that history is about to repeat itself yet again, only on a larger scale this time.

The final gasps of a bubble economy, such as our own, are about behind-the-scenes securing of access to and ownership of real assets for the elite, through bailouts and other forms of legalized theft. As Frédéric Bastiat explained in 1848,

“When plunder becomes a way of life for a group of men in a society, over the course of time they create for themselves a legal system that authorizes it and a moral code that glorifies it.”

The bust which follows the last attempt to kick the can further down the road will see the vast majority of society dispossessed of what they thought they owned, their ephemeral electronic claims to underlying real wealth extinguished.

 

The Way Forward

 

The advent of negative interest rates indicates that the endgame for the global economy is underway. In places at the peak of the bubble, negative rates drive further asset bubbles and create ever greater vulnerability to the inevitable interest rate spike and asset price collapse to come. In Japan, at the other end of the debt deflation cycle, negative rates force people into ever more cash hoarding. Neither one of these outcomes is going to lead to recovery. Both indicate economies at breaking point. We cannot assume that current financial, economic and social structures will continue in their present form, and we need to prepare for a period of acute upheaval.

Using cash wherever possible, rather than succumbing to the convenience of electronic payments, becomes an almost revolutionary act. So other forms of radical decentralisation, which amount to opting out as much as possible from the path the powers-that-be would have us follow. It is likely to become increasingly difficult to defend our freedom and independence, but if enough people stand their ground, establishing full totalitarian control should not be possible.

To some extent, the way the war on cash plays out will depend on the timing of the coming financial implosion. The elimination of cash would take time, and only in some countries has there been enough progress away from cash that eliminating it would be at all realistic. If only a few countries tried to do so, people in those countries would be likely to use foreign currency that was still legal tender.

 

 

Cash elimination would really only work if it it were very broadly applied in enough major economies, and if a financial accident could be postponed for a few more years. As neither of these conditions is likely to be fulfilled, a cash ban is unlikely to viable. Governments and central banks would very much like to frighten people away from cash, but that only underlines its value under the current circumstances. Cash is king in a deflation. The powers-that-be know that, and would like the available cash to end up concentrated in their own hands rather than spread out to act as seed capital for a bottom-up recovery.

Holding on to cash under one’s own control is still going to be a very important option for maintaining freedom of action in an uncertain future. The alternative would be to turn to hard goods (land, tools etc) from the beginning, but where there is a great deal of temporal and spatial uncertainty, this amounts to making all one’s choices up front, and choices based on incomplete information could easily turn out to be wrong. Making such choices up front is also expensive, as prices are currently high. Of course having some hard goods is also advisable, particularly if they allow one to have some control over the essentials of one’s own existence.

It is the balance between hard goods and maintaining capital as liquidity (cash) that is important. Where that balance lies depends very much on individual circumstances, and on location. For instance, in the European Union, where currency reissue is a very real threat in a reasonably short timeframe, opting for goods rather than cash makes more sense, unless one holds foreign currency such as Swiss francs. If one must hold euros, it would probably be advisable to hold German ones (serial numbers begin with X).

 

US dollars are likely to hold their value for longer than most other currencies, given the dollar’s role as the global reserve currency. Reports of its demise are premature, to put it mildly. As financial crisis picks up momentum, a flight to safety into the reserve currency is likely to pick up speed, raising the value of the dollar against other currencies. In addition, demand for dollars will increase as debtors seek to pay down dollar-denominated debt. While all fiat currencies are ultimately vulnerable in the beggar-thy-neighbour currency wars to come, the US dollar should hold value for longer than most.

Holding cash on the sidelines while prices fall is a good strategy, so long as one does not wait too long. The risks to holding and using cash are likely to grow over time, so it is best viewed as a short term strategy to ride out the deflationary period, where the value of credit instruments is collapsing. The purchasing power of cash will rise during this time, and previously unforeseen opportunities are likely to arise.

Ordinary people need to retain as much of their freedom of action as possible, in order for society to function through a period of economic seizure. In general, the best strategy is to hold cash until the point where the individual in question can afford to purchase the goods they require to provide for their own needs without taking on debt to do so. (Avoiding taking on debt is extremely important, as financially encumbered assets would be subject to repossession in the event of failure to meet debt obligations.)

One must bear in mind, however, that after price falls, some goods may cease to be available at any price, so some essentials may need to be purchased at today’s higher prices in order to guarantee supply.

Capital preservation is an individual responsibility, and during times of deflation, capital must be preserved as liquidity. We cannot expect either governments or private institutions to protect our interests, as both have been obviously undermining the interests of ordinary people in favour of their own for a very long time. Indeed they seem to feel secure enough of their own consolidated control that they do not even bother to try to hide the fact any longer. It is our duty to inform ourselves and act to protect ourselves, our families and our communities. If we do not, no one else will.

 

 

This article by Nicole Foss was earlier published at the Automatic Earth in 4 chapters.

Part 1 is here: Negative Interest Rates and the War on Cash (1)

Part 2 is here: Negative Interest Rates and the War on Cash (2)

Part 3 is here: Negative Interest Rates and the War on Cash (3)

Part 3 is here: Negative Interest Rates and the War on Cash (4)

 

 

 

 

Sep 082016
 
 September 8, 2016  Posted by at 12:55 pm Finance Tagged with: , , , , , , , , , ,  


AlfredEisenstaedt View of Midtown Manhattan NYC 1939

 

 

This is part 4 of a 4-part series by Nicole Foss entitled “Negative Interest Rates and the War on Cash”.

Part 1 is here: Negative Interest Rates and the War on Cash (1)

Part 2 is here: Negative Interest Rates and the War on Cash (2)

Part 3 is here: Negative Interest Rates and the War on Cash (3)

We will soon publish the entire piece in one post.

Here is Nicole:

 

 

 

Financial Totalitarianism in Historical Context

 

Nicole Foss: In attempting to keep the credit bonanza going with their existing powers, central banks have set the global financial system up for an across-the-board asset price collapse:

QE takes away the liquidity preference choice out of the hands of the consumers, and puts it into the hands of central bankers, who through asset purchases push up asset prices even if it does so by explicitly devaluing the currency of price measurement; it also means that the failure of NIRP is — by definition — a failure of central banking, and if and when the central bank backstop of any (make that all) asset class — i.e., Q.E., is pulled away, that asset (make that all) will crash.

It is not just central banking, but also globalisation, which is demonstrably failing. Cross-border freedoms will probably be an early casualty of the war on cash, and its demise will likely come as a shock to those used to a relatively borderless world:

We have been informed with reliable sources that in Germany where Maestro was a multi-national debit card service owned by MasterCard that was founded in 1992 is seriously under attack. Maestro cards are obtained from associate banks and can be linked to the card holder’s current account, or they can be prepaid cards. Already we find such cards are being cancelled and new debit cards are being issued.

Why? The new cards cannot be used at an ATM outside of Germany to obtain cash. Any attempt to get cash can only be as an advance on a credit card….This is total insanity and we are losing absolutely everything that made society function. Once they eliminate CASH, they will have total control over who can buy or sell anything.

The same confused, greedy and corrupt central authorities which have set up the global economy for a major bust through their dysfunctional use of existing powers, are now seeking far greater central control, in what would amount to the ultimate triumph of finance over people. They are now moving to tax what ever people have left over after paying taxes. It has been tried before. As previous historical bubbles began to collapse, central authorities attempted to increase their intrusiveness and control over the population, in order to force the inevitable losses as far down the financial foodchain as possible. As far back as the Roman Empire, economically contractionary periods have been met with financial tyranny — increasing pressure on the populace until the system itself breaks:

Not even the death penalty was enough to enforce Diocletian’s price control edicts in the third century.

Rome squeezed the peasants in its empire so hard, that many eventually abandoned their land, reckoning that they were better off with the barbarians.

Such attempts at total financial control are exactly what one would expect at this point. A herd of financial middle men are used to being very well supported by the existing financial system, and as that system begins to break down, losing that raft of support is unacceptable. The people at the bottom of the financial foodchain must be watched and controlled in order to make sure they are paying to support the financial centre in the manner to which it has become accustomed, even as their ability to do so is continually undermined:

An oft-overlooked benefit of cash transactions is that there is no intermediary. One party pays the other party in mutually accepted currency and not a single middleman gets to wet his beak. In a cashless society there will be nothing stopping banks or other financial mediators from taking a small piece of every single transaction. They would also be able to use — and potentially abuse — the massive deposits of data they collect on their customers’ payment behavior. This information is of huge interest and value to retail marketing departments, other financial institutions, insurance companies, governments, secret services, and a host of other organizations….

….So in order to save a financial system that is morally beyond the pale and stopped serving the basic needs of the real economy a long time ago, governments and central banks must do away with the last remaining thing that gives people a small semblance of privacy, anonymity, and personal freedom in their increasingly controlled and surveyed lives. The biggest tragedy of all is that the governments and banks’ strongest ally in their War on Cash is the general public itself. As long as people continue to abandon the use of cash, for the sake of a few minor gains in convenience, the war on cash is already won.

Even if the ultimate failure of central control is predictable, momentum towards greater centralisation will carry forward for as long as possible, until the system can no longer function, at which point a chaotic free-for-all is likely to occur. In the meantime, the movement towards electronic money seeks to empower the surveillance state/corporatocracy enormously, providing it with the tools to observe and control virtually every aspect of people’s lives:

Governments and corporations, even that genius app developer in Russia, have one thing in common: they want to know everything. Data is power. And money. As the Snowden debacle has shown, they’re getting there. Technologies for gathering information, then hoarding it, mining it, and using it are becoming phenomenally effective and cheap. But it’s not perfect. Video surveillance with facial-recognition isn’t everywhere just yet. Not everyone is using a smartphone. Not everyone posts the details of life on Facebook. Some recalcitrant people still pay with cash. To the greatest consternation of governments and corporations, stuff still happens that isn’t captured and stored in digital format….

….But the killer technology isn’t the elimination of cash. It’s the combination of payment data and the information stream that cellphones, particularly smartphones, deliver. Now everything is tracked neatly by a single device that transmits that data on a constant basis to a number of companies, including that genius app developer in Russia — rather than having that information spread over various banks, credit card companies, etc. who don’t always eagerly surrender that data.

Eventually, it might even eliminate the need for data brokers. At that point, a single device knows practically everything. And from there, it’s one simple step to transfer part or all of this data to any government’s data base. Opinions are divided over whom to distrust more: governments or corporations. But one thing we know: mobile payments and the elimination of cash….will also make life a lot easier for governments and corporations in their quest for the perfect surveillance society.

Dissent is increasingly being criminalised, with legitimate dissenters commonly referred to, and treated as, domestic terrorists and potentially subjected to arbitrary asset confiscation:

An important reason why the state would like to see a cashless society is that it would make it easier to seize our wealth electronically. It would be a modern-day version of FDR’s confiscation of privately-held gold in the 1930s. The state will make more and more use of “threats of terrorism” to seize financial assets. It is already talking about expanding the definition of “terrorist threat” to include critics of government like myself.

The American state already confiscates financial assets under the protection of various guises such as the PATRIOT Act. I first realized this years ago when I paid for a new car with a personal check that bounced. The car dealer informed me that the IRS had, without my knowledge, taken 20 percent of the funds that I had transferred from a mutual fund to my bank account in order to buy the car. The IRS told me that it was doing this to deter terrorism, and that I could count it toward next year’s tax bill.

 

 

The elimination of cash in favour of official electronic money only would greatly accelerate and accentuate the ability of governments to punish those they dislike, indeed it would allow them to prevent dissenters from engaging in the most basic functions:

If all money becomes digital, it would be much easier for the government to manipulate our accounts. Indeed, numerous high-level NSA whistleblowers say that NSA spying is about crushing dissent and blackmailing opponents. not stopping terrorism. This may sound over-the-top. but remember, the government sometimes labels its critics as “terrorists”. If the government claims the power to indefinitely detain — or even assassinate — American citizens at the whim of the executive, don’t you think that government people would be willing to shut down, or withdraw a stiff “penalty” from a dissenter’s bank account?

If society becomes cashless, dissenters can’t hide cash. All of their financial holdings would be vulnerable to an attack by the government. This would be the ultimate form of control. Because — without access to money — people couldn’t resist, couldn’t hide and couldn’t escape.

The trust that has over many years enabled the freedoms we enjoy is now disappearing rapidly, and the impact of its demise is already palpable. Citizens understandably do not trust governments and powerful corporations, which have increasingly clearly been acting in their own interests in consolidating control over claims to real resources in the hands of fewer and fewer individuals and institutions:

By far the biggest risk posed by digital alternatives to cash such as mobile money is the potential for massive concentration of financial power and the abuses and conflicts of interest that would almost certainly ensue. Naturally it goes without saying that most of the institutions that will rule the digital money space will be the very same institutions….that have already broken pretty much every rule in the financial service rule book.

They have manipulated virtually every market in existence; they have commodified and financialized pretty much every natural resource of value on this planet; and in the wake of the financial crisis they almost single-handedly caused, they have extorted billions of dollars from the pockets of their own customers and trillions from hard-up taxpayers. What about your respective government authorities? Do you trust them?…

….We are, it seems, descending into a world where new technologies threaten to put absolute power well within the grasp of a select group of individuals and organizations — individuals and organizations that have through their repeated actions betrayed just about every possible notion of mutual trust.

Governments do not trust their citizens (‘potential terrorists’) either, hence the perceived need to monitor and limit the scope of their decisions and actions. The powers-that-be know how angry people are going to be when they realise the scale of their impending dispossession, and are acting in such a way as to (try to) limit the power of the anger that will be focused against them. It is not going to work.

Without trust we are likely to see “throwbacks to the 14th century….at the dawn of banking coming out of the Dark Ages.”. It is no coincidence that this period was also one of financial, socioeconomic and humanitarian crises, thanks to the bursting of a bubble two centuries in the making:

The 14th Century was a time of turmoil, diminished expectations, loss of confidence in institutions, and feelings of helplessness at forces beyond human control. Historian Barbara Tuchman entitled her book on this period A Distant Mirror because many of our modern problems had counterparts in the 14th Century.

Few think of the trials and tribulations of 14th century Europe as having their roots in financial collapse — they tend instead to remember famine and disease. However, the demise of what was then the world banking system was a leading indicator for what followed, as is always the case:

Six hundred and fifty years ago came the climax of the worst financial collapse in history to date. The 1930’s Great Depression was a mild and brief episode, compared to the bank crash of the 1340’s, which decimated the human population. The crash, which peaked in A.C.E. 1345 when the world’s biggest banks went under, “led” by the Bardi and Peruzzi companies of Florence, Italy, was more than a bank crash — it was a financial disintegration….a blowup of all major banks and markets in Europe, in which, chroniclers reported, “all credit vanished together,” most trade and exchange stopped, and a catastrophic drop of the world’s population by famine and disease loomed.

As we have written many times before at The Automatic Earth, bubbles are not a new phenomenon. They have inflated and subsequently imploded since the dawn of civilisation, and are in fact en emergent property of civilisational scale. There are therefore many parallels between different historical episodes of boom and bust:

The parallels between the medieval credit crunch and our current predicament are considerable. In both cases the money supply increased in response to the expansionist pressure of unbridled optimism. In both cases the expansion proceeded to the point where a substantial overhang of credit had been created — a quantity sufficient to generate systemic risk that was not recognized at the time. In the fourteenth century, that risk was realized, as it will be again in the 21st century.

What we are experiencing now is simply the same dynamic, but turbo-charged by the availability of energy and technology that have driven our long period of socioeconomic expansion and ever-increasing complexity. Just as in the 14th century, the cracks in the system have been visible for many years, but generally ignored. The coming credit implosion may appear to come from nowhere when it hits, but has long been foreshadowed if one knew what to look for. Watching more and more people seeking escape routes from a doomed financial system, and the powers-that-be fighting back by closing those escape routes, all within a social matrix of collapsing trust, one cannot deny that history is about to repeat itself yet again, only on a larger scale this time.

The final gasps of a bubble economy, such as our own, are about behind-the-scenes securing of access to and ownership of real assets for the elite, through bailouts and other forms of legalized theft. As Frédéric Bastiat explained in 1848,

“When plunder becomes a way of life for a group of men in a society, over the course of time they create for themselves a legal system that authorizes it and a moral code that glorifies it.”

The bust which follows the last attempt to kick the can further down the road will see the vast majority of society dispossessed of what they thought they owned, their ephemeral electronic claims to underlying real wealth extinguished.

 

The Way Forward

 

The advent of negative interest rates indicates that the endgame for the global economy is underway. In places at the peak of the bubble, negative rates drive further asset bubbles and create ever greater vulnerability to the inevitable interest rate spike and asset price collapse to come. In Japan, at the other end of the debt deflation cycle, negative rates force people into ever more cash hoarding. Neither one of these outcomes is going to lead to recovery. Both indicate economies at breaking point. We cannot assume that current financial, economic and social structures will continue in their present form, and we need to prepare for a period of acute upheaval.

Using cash wherever possible, rather than succumbing to the convenience of electronic payments, becomes an almost revolutionary act. So other forms of radical decentralisation, which amount to opting out as much as possible from the path the powers-that-be would have us follow. It is likely to become increasingly difficult to defend our freedom and independence, but if enough people stand their ground, establishing full totalitarian control should not be possible.

To some extent, the way the war on cash plays out will depend on the timing of the coming financial implosion. The elimination of cash would take time, and only in some countries has there been enough progress away from cash that eliminating it would be at all realistic. If only a few countries tried to do so, people in those countries would be likely to use foreign currency that was still legal tender.

 

 

Cash elimination would really only work if it it were very broadly applied in enough major economies, and if a financial accident could be postponed for a few more years. As neither of these conditions is likely to be fulfilled, a cash ban is unlikely to viable. Governments and central banks would very much like to frighten people away from cash, but that only underlines its value under the current circumstances. Cash is king in a deflation. The powers-that-be know that, and would like the available cash to end up concentrated in their own hands rather than spread out to act as seed capital for a bottom-up recovery.

Holding on to cash under one’s own control is still going to be a very important option for maintaining freedom of action in an uncertain future. The alternative would be to turn to hard goods (land, tools etc) from the beginning, but where there is a great deal of temporal and spatial uncertainty, this amounts to making all one’s choices up front, and choices based on incomplete information could easily turn out to be wrong. Making such choices up front is also expensive, as prices are currently high. Of course having some hard goods is also advisable, particularly if they allow one to have some control over the essentials of one’s own existence.

It is the balance between hard goods and maintaining capital as liquidity (cash) that is important. Where that balance lies depends very much on individual circumstances, and on location. For instance, in the European Union, where currency reissue is a very real threat in a reasonably short timeframe, opting for goods rather than cash makes more sense, unless one holds foreign currency such as Swiss francs. If one must hold euros, it would probably be advisable to hold German ones (serial numbers begin with X).

 

US dollars are likely to hold their value for longer than most other currencies, given the dollar’s role as the global reserve currency. Reports of its demise are premature, to put it mildly. As financial crisis picks up momentum, a flight to safety into the reserve currency is likely to pick up speed, raising the value of the dollar against other currencies. In addition, demand for dollars will increase as debtors seek to pay down dollar-denominated debt. While all fiat currencies are ultimately vulnerable in the beggar-thy-neighbour currency wars to come, the US dollar should hold value for longer than most.

Holding cash on the sidelines while prices fall is a good strategy, so long as one does not wait too long. The risks to holding and using cash are likely to grow over time, so it is best viewed as a short term strategy to ride out the deflationary period, where the value of credit instruments is collapsing. The purchasing power of cash will rise during this time, and previously unforeseen opportunities are likely to arise.

Ordinary people need to retain as much of their freedom of action as possible, in order for society to function through a period of economic seizure. In general, the best strategy is to hold cash until the point where the individual in question can afford to purchase the goods they require to provide for their own needs without taking on debt to do so. (Avoiding taking on debt is extremely important, as financially encumbered assets would be subject to repossession in the event of failure to meet debt obligations.)

One must bear in mind, however, that after price falls, some goods may cease to be available at any price, so some essentials may need to be purchased at today’s higher prices in order to guarantee supply.

Capital preservation is an individual responsibility, and during times of deflation, capital must be preserved as liquidity. We cannot expect either governments or private institutions to protect our interests, as both have been obviously undermining the interests of ordinary people in favour of their own for a very long time. Indeed they seem to feel secure enough of their own consolidated control that they do not even bother to try to hide the fact any longer. It is our duty to inform ourselves and act to protect ourselves, our families and our communities. If we do not, no one else will.

Sep 072016
 
 September 7, 2016  Posted by at 1:03 pm Finance Tagged with: , , , , , , , , , ,  


Lou Stoumen Going to work 8am Times Square, NYC 1940

 

 

This is part 3 of a 4-part series by Nicole Foss entitled “Negative Interest Rates and the War on Cash”.

Part 1 is here: Negative Interest Rates and the War on Cash (1)

Part 2 is here: Negative Interest Rates and the War on Cash (2)

Part 4 will follow soon, and at the end we will publish the entire piece in one post.

Here is Nicole:

 

 

 

Promoters, Mechanisms and Risks in the War on Cash

 

Nicole Foss: Bitcoin and other electronic platforms have paved the way psychologically for a shift away from cash, although they have done so by emphasising decentralisation and anonymity rather than the much greater central control which would be inherent in a mainstream electronic currency. The loss of privacy would no doubt be glossed over in any media campaign, as would the risks of cyber-attack and the lack of a fallback for providing liquidity to the economy in the event of a systems crash. Electronic currency is much favoured by techno-optimists, but not so much by those concerned about the risks of absolute structural dependency on technological complexity. The argument regarding greatly reduced socioeconomic resilience is particularly noteworthy, given the vulnerability and potential fragility of electronic systems.

There is an important distinction to be made between official electronic currency – allowing everyone to hold an account with the central bank — and private electronic currency. It would be official currency which would provide the central control sought by governments and central banks, but if individuals saw central bank accounts as less risky than commercial institutions, which seems highly likely, the extent of the potential funds transfer could crash the existing banking system, causing a bank run in a similar manner as large-scale cash withdrawals would. As the power of money creation is of the highest significance, and that power is currently in private hands, any attempt to threaten that power would almost certainly be met with considerable resistance from powerful parties. Private digital currency would be more compatible with the existing framework, but would not confer all of the control that governments would prefer:

People would convert a very large share of their current bank deposits into official digital money, in effect taking them out of the private banking system. Why might this be a problem? If it’s an acute rush for safety in a crisis, the risk is that private banks may not have enough reserves to honour all the withdrawals. But that is exactly the same risk as with physical cash: it’s often forgotten that it’s central bank reserves, not the much larger quantity of deposits, that banks can convert into cash with the central bank. Both with cash and official e-cash, the way to meet a more severe bank run is for the bank to borrow more reserves from the central bank, posting its various assets as security. In effect, this would mean the central bank taking over the funding of the broader economy in a panic — but that’s just what central banks should do.

A more chronic challenge is that people may prefer the safety of central bank accounts even in normal times. That would destroy private banks’ current deposit-funded model. Is that a bad thing? They would still have a role as direct intermediators between savers and borrowers, by offering investment products sufficiently attractive for people to get out of the safety of e-cash. Meanwhile, the broad money supply would be more directly under the control of the central bank, whereas now it’s a product of the vagaries of private lending decisions. The more of the broad money supply that was in the form of official digital cash, the easier it would be, for example, for the central bank to use tools such as negative interest rates or helicopter drops.

As an indication that the interests of the private banking system and public central authorities are not always aligned, consider the actions of the Bavarian Banking Association in attempting to avoid the imposition of negative interest rates on reserves held with the ECB:

German newspaper Der Spiegel reported yesterday that the Bavarian Banking Association has recommended that its member banks start stockpiling PHYSICAL CASH. The Bavarian Banking Association has had enough of this financial dictatorship. Their new recommendation is for all member banks to ditch the ECB and instead start keeping their excess reserves in physical cash, stored in their own bank vaults. This is officially an all-out revolution of the financial system where banks are now actively rebelling against the central bank. (What’s even more amazing is that this concept of traditional banking — holding physical cash in a bank vault — is now considered revolutionary and radical.)

There’s just one teensy tiny problem: there simply is not enough physical cash in the entire financial system to support even a tiny fraction of the demand. Total bank deposits exceed trillions of euros. Physical cash constitutes just a small percentage of that sum. So if German banks do start hoarding physical currency, there won’t be any left in the financial system. This will force the ECB to choose between two options:

  1. Support this rebellion and authorize the issuance of more physical cash; or
  2. Impose capital controls.

Given that just two weeks ago the President of the ECB spoke about the possibility of banning some higher denomination cash notes, it’s not hard to figure out what’s going to happen next.

Advantages of official electronic currency to governments and central banks are clear. All transactions are transparent, and all can be subject to fees and taxes. Central control over the money supply would be greatly increased and tax evasion would be difficult to impossible, at least for ordinary people. Capital controls would be built right into the system, and personal spending information would be conveniently gathered for inspection by central authorities (for cross-correlation with other personal data they possess). The first step would likely be to set up a dual system, with both cash and electronic money in parallel use, but with electronic money as the defined unit of value and cash subject to a marginally disadvantageous exchange rate.

The exchange rate devaluing cash in relation to electronic money could increase over time, in order to incentivize people to switch away from seeing physical cash as a store of value, and to increase their preference for goods over cash. In addition to providing an active incentive, the use of cash would probably be publicly disparaged as well as actively discouraged in many ways. For instance, key functions such as tax payments could be designated as by electronic remittance only. The point would be to forced everyone into the system by depriving them of the choice to opt out. Once all were captured, many forms of central control would be possible, including substantial account haircuts if central authorities deemed them necessary.

 

 

The main promoters of cash elimination in favour of electronic currency are Willem Buiter, Kenneth Rogoff, and Miles Kimball.

Economist Willem Buiter has been pushing for the relegation of cash, at least the removal of its status as official unit of account, since the financial crisis of 2008. He suggests a number of mechanisms for achieving the transition to electronic money, emphasising the need for the electronic currency to become the definitive unit of account in order to implement substantially negative interest rates:

The first method does away with currency completely. This has the additional benefit of inconveniencing the main users of currency-operators in the grey, black and outright criminal economies. Adequate substitutes for the legitimate uses of currency, on which positive or negative interest could be paid, are available. The second approach, proposed by Gesell, is to tax currency by making it subject to an expiration date. Currency would have to be “stamped” periodically by the Fed to keep it current. When done so, interest (positive or negative) is received or paid.

The third method ends the fixed exchange rate (set at one) between dollar deposits with the Fed (reserves) and dollar bills. There could be a currency reform first. All existing dollar bills and coin would be converted by a certain date and at a fixed exchange rate into a new currency called, say, the rallod. Reserves at the Fed would continue to be denominated in dollars. As long as the Federal Funds target rate is positive or zero, the Fed would maintain the fixed exchange rate between the dollar and the rallod.

When the Fed wants to set the Federal Funds target rate at minus five per cent, say, it would set the forward exchange rate between the dollar and the rallod, the number of dollars that have to be paid today to receive one rallod tomorrow, at five per cent below the spot exchange rate — the number of dollars paid today for one rallod delivered today. That way, the rate of return, expressed in a common unit, on dollar reserves is the same as on rallod currency.

For the dollar interest rate to remain the relevant one, the dollar has to remain the unit of account for setting prices and wages. This can be encouraged by the government continuing to denominate all of its contracts in dollars, including the invoicing and payment of taxes and benefits. Imposing the legal restriction that checkable deposits and other private means of payment cannot be denominated in rallod would help.

In justifying his proposals, he emphasises the importance of combatting criminal activity…

The only domestic beneficiaries from the existence of anonymity-providing currency are the criminal fraternity: those engaged in tax evasion and money laundering, and those wishing to store the proceeds from crime and the means to commit further crimes. Large denomination bank notes are an especially scandalous subsidy to criminal activity and to the grey and black economies.

… over the acknowledged risks of government intrusion in legitimately private affairs:

My good friend and colleague Charles Goodhart responded to an earlier proposal of mine that currency (negotiable bearer bonds with legal tender status) be abolished that this proposal was “appallingly illiberal”. I concur with him that anonymity/invisibility of the citizen vis-a-vis the state is often desirable, given the irrepressible tendency of the state to infringe on our fundamental rights and liberties and given the state’s ever-expanding capacity to do so (I am waiting for the US or UK government to contract Google to link all personal health information to all tax information, information on cross-border travel, social security information, census information, police records, credit records, and information on personal phone calls, internet use and internet shopping habits).

In his seminal 2014 paper “Costs and Benefits to Phasing Out Paper Currency.”, Kenneth Rogoff also argues strongly for the primacy of electronic currency and the elimination of physical cash as an escape route:

Paper currency has two very distinct properties that should draw our attention. First, it is precisely the existence of paper currency that makes it difficult for central banks to take policy interest rates much below zero, a limitation that seems to have become increasingly relevant during this century. As Blanchard et al. (2010) point out, today’s environment of low and stable inflation rates has drastically pushed down the general level of interest rates. The low overall level, combined with the zero bound, means that central banks cannot cut interest rates nearly as much as they might like in response to large deflationary shocks.

If all central bank liabilities were electronic, paying a negative interest on reserves (basically charging a fee) would be trivial. But as long as central banks stand ready to convert electronic deposits to zero-interest paper currency in unlimited amounts, it suddenly becomes very hard to push interest rates below levels of, say, -0.25 to -0.50 percent, certainly not on a sustained basis. Hoarding cash may be inconvenient and risky, but if rates become too negative, it becomes worth it.

However, he too notes associated risks:

Another argument for maintaining paper currency is that it pays to have a diversity of technologies and not to become overly dependent on an electronic grid that may one day turn out to be very vulnerable. Paper currency diversifies the transactions system and hardens it against cyber attack, EMP blasts, etc. This argument, however, seems increasingly less relevant because economies are so totally exposed to these problems anyway. With paper currency being so marginalized already in the legal economy in many countries, it is hard to see how it could be brought back quickly, particularly if ATM machines were compromised at the same time as other electronic systems.

A different type of argument against eliminating currency relates to civil liberties. In a world where society’s mores and customs evolve, it is important to tolerate experimentation at the fringes. This is potentially a very important argument, though the problem might be mitigated if controls are placed on the government’s use of information (as is done say with tax information), and the problem might also be ameliorated if small bills continue to circulate. Last but not least, if any country attempts to unilaterally reduce the use of its currency, there is a risk that another country’s currency would be used within domestic borders.

Miles Kimball’s proposals are very much in tune with Buiter and Rogoff:

There are two key parts to Miles Kimball’s solution. The first part is to make electronic money or deposits the sole unit of account. Everything else would be priced in terms of electronic dollars, including paper dollars. The second part is that the fixed exchange rate that now exists between deposits and paper dollars would become variable. This crawling peg between deposits and paper currency would be based on the state of the economy. When the economy was in a slump and the central bank needed to set negative interest rates to restore full employment, the peg would adjust so that paper currency would lose value relative to electronic money. This would prevent folks from rushing to paper currency as interest rates turned negative. Once the economy started improving, the crawling peg would start adjusting toward parity.

This approach views the economy in very mechanistic terms, as if it were a machine where pulling a lever would have a predictable linear effect — make holding savings less attractive and automatically consumption will increase. This is actually a highly simplistic view, resting on the notions of stabilising negative feedback and bringing an economy ‘back into equilibrium’. If it were so simple to control an economy centrally, there would never have been deflationary spirals or economic depressions in the past.

Assuming away the more complex aspects of human behaviour — a flight to safety, the compulsion to save for a rainy day when conditions are unstable, or the natural response to a negative ‘wealth effect’ — leads to a model divorced from reality. Taxing savings does not necessarily lead to increased consumption, in fact it is far more likely to have the opposite effect.:

But under Miles Kimball’s proposal, the Fed would lower interest rates to below zero by taxing away balances of e-currency. This is a reduction in monetary base, just like the case of IOR, and by itself would be contractionary, not expansionary. The expansionary effects of Kimball’s policy depend on the assumption that households will increase consumption in response to the taxing of their cash savings, rather than letting their savings depreciate.

That needn’t be the case — it depends on the relative magnitudes of income and substitution effects for real money balances. The substitution effect is what Kimball has in mind — raising the price of real money balances will induce substitution out of money and into consumption. But there’s also an income effect, whereby the loss of wealth induces less consumption and more savings. Thus, negative interest rate policy can be contractionary even though positive interest rate policy is expansionary.

Indeed, what Kimball has proposed amounts to a reverse Bernanke Helicopter — imagine a giant vacuum flying around the country sucking money out of people’s pockets. Why would we assume that this would be inflationary?

 

 

Given that the effect on the money supply would be contractionary, the supposed stimulus effect on the velocity of money (as, in theory, savings turn into consumption in order to avoid the negative interest rate penalty) would have to be large enough to outweigh a contracting money supply. In some ways, modern proponents of electronic money bearing negative interest rates are attempting to copy Silvio Gesell’s early 20th century work. Gesell proposed the use of stamp scrip — money that had to be regularly stamped, at a small cost, in order to remain current. The effect would be for money to lose value over time, so that hoarding currency it would make little sense. Consumption would, in theory, be favoured, so money would be kept in circulation.

This idea was implemented to great effect in the Austrian town of Wörgl during the Great Depression, where the velocity of money increased sufficiently to allow a hive of economic activity to develop (temporarily) in the previously depressed town. Despite the similarities between current proposals and Gesell’s model applied in Wörgl, there are fundamental differences:

There is a critical difference, however, between the Wörgl currency and the modern-day central bankers’ negative interest scheme. The Wörgl government first issued its new “free money,” getting it into the local economy and increasing purchasing power, before taxing a portion of it back. And the proceeds of the stamp tax went to the city, to be used for the benefit of the taxpayers….Today’s central bankers are proposing to tax existing money, diminishing spending power without first building it up. And the interest will go to private bankers, not to the local government.

The Wörgl experiment was a profoundly local initiative, instigated at the local government level by the mayor. In contrast, modern proposals for negative interest rates would operate at a much larger scale and would be imposed on the population in accordance with the interests of those at the top of the financial foodchain. Instead of being introduced for the direct benefit of those who pay, as stamp scrip was in Wörgl, it would tax the people in the economic periphery for the continued benefit of the financial centre. As such it would amount to just another attempt to perpetuate the current system, and to do so at a scale far beyond the trust horizon.

As the trust horizon contracts in times of economic crisis, effective organizational scale will also contract, leaving large organizations (both public and private) as stranded assets from a trust perspective, and therefore lacking in political legitimacy. Large scale, top down solutions will be very difficult to implement. It is not unusual for the actions of central authorities to have the opposite of the desired effect under such circumstances:

Consumers today already have very little discretionary money. Imposing negative interest without first adding new money into the economy means they will have even less money to spend. This would be more likely to prompt them to save their scarce funds than to go on a shopping spree. People are not keeping their money in the bank today for the interest (which is already nearly non-existent). It is for the convenience of writing checks, issuing bank cards, and storing their money in a “safe” place. They would no doubt be willing to pay a modest negative interest for that convenience; but if the fee got too high, they might pull their money out and save it elsewhere. The fee itself, however, would not drive them to buy things they did not otherwise need.

People would be very likely to respond to negative interest rates by self-organising alternative means of exchange, rather than bowing to the imposition of negative rates. Bitcoin and other crypto-currencies would be one possibility, as would using foreign currency, using trading goods as units of value, or developing local alternative currencies along the lines of the Wörgl model:

The use of sheep, bottled water, and cigarettes as media of exchange in Iraqi rural villages after the US invasion and collapse of the dinar is one recent example. Another example was Argentina after the collapse of the peso, when grain contracts priced in dollars were regularly exchanged for big-ticket items like automobiles, trucks, and farm equipment. In fact, Argentine farmers began hoarding grain in silos to substitute for holding cash balances in the form of depreciating pesos.

 

 

For the electronic money model grounded in negative interest rates to work, all these alternatives would have to be made illegal, or at least hampered to the point of uselessness, so people would have no other legal choice but to participate in the electronic system. Rogoff seems very keen to see this happen:

Won’t the private sector continually find new ways to make anonymous transfers that sidestep government restrictions? Certainly. But as long as the government keeps playing Whac-A-Mole and prevents these alternative vehicles from being easily used at retail stores or banks, they won’t be able fill the role that cash plays today. Forcing criminals and tax evaders to turn to riskier and more costly alternatives to cash will make their lives harder and their enterprises less profitable.

It is very likely that in times of crisis, people would do what they have to do regardless of legal niceties. While it may be possible to close off some alternative options with legal sanctions, it is unlikely that all could be prevented, or even enough to avoid the electronic system being fatally undermined.

The other major obstacle would be overcoming the preference for cash over goods in times of crisis:

Understanding how negative rates may or may not help economic growth is much more complex than most central bankers and investors probably appreciate. Ultimately the confusion resides around differences in view on the theory of money. In a classical world, money supply multiplied by a constant velocity of circulation equates to nominal growth.

In a Keynesian world, velocity is not necessarily constant — specifically for Keynes, there is a money demand function (liquidity preference) and therefore a theory of interest that allows for a liquidity trap whereby increasing money supply does not lead to higher nominal growth as the increase in money is hoarded. The interest rate (or inverse of the price of bonds) becomes sticky because at low rates, for infinitesimal expectations of any further rise in bond prices and a further fall in interest rates, demand for money tends to infinity.

In Gesell’s world money supply itself becomes inversely correlated with velocity of circulation due to money characteristics being superior to goods (or commodities). There are costs to storage that money does not have and so interest on money capital sets a bar to interest on real capital that produces goods. This is similar to Keynes’ concept of the marginal efficiency of capital schedule being separate from the interest rate. For Gesell the product of money and velocity is effective demand (nominal growth) but because of money capital’s superiority to real capital, if money supply expands it comes at the expense of velocity.

The new money supply is hoarded because as interest rates fall, expected returns on capital also fall through oversupply — for economic agents goods remain unattractive to money. The demand for money thus rises as velocity slows. This is simply a deflation spiral, consumers delaying purchases of goods, hoarding money, expecting further falls in goods prices before they are willing to part with their money….In a Keynesian world of deficient demand, the burden is on fiscal policy to restore demand. Monetary policy simply won’t work if there is a liquidity trap and demand for cash is infinite.

During the era of globalisation (since the financial liberalisation of the early 1980s), extractive capitalism in debt-driven over-drive has created perverse incentives to continually increase supply. Financial bubbles, grounded in the rediscovery of excess leverage, always act to create an artificial demand stimulus, which is met by artificially inflated supply during the boom phase. The value of the debt created collapses as boom turns into bust, crashing the money supply, and with it asset price support. Not only does the artificial stimulus disappear, but a demand undershoot develops, leaving all that supply without a market. Over the full cycle of a bubble and its aftermath, credit is demand neutral, but within the bubble it is anything but neutral. Forward shifting the demand curve provides for an orgy of present consumption and asset price increases, which is inevitably followed by the opposite.

Kimball stresses bringing demand forward as a positive aspect of his model:

In an economic situation like the one we are now in, we would like to encourage a company thinking about building a factory in a couple of years to build that factory now instead. If someone would lend to them at an interest rate of -3.33% per year, the company could borrow $1 million to build the factory now, and pay back something like $900,000 on the loan three years later. (Despite the negative interest rate, compounding makes the amount to be paid back a bit bigger, but not by much.)

That would be a good enough deal that the company might move up its schedule for building the factory. But everything runs aground on the fact that any potential lender, just by putting $1 million worth of green pieces of paper in a vault could get back $1 million three years later, which is a lot better than getting back a little over $900,000 three years later.

This is, however, a short-sighted assessment. Stimulating demand today means a demand undershoot tomorrow. Kimball names long term price stability as a primary goal, but this seems unlikely. Large scale central planning has a poor track record for success, to put it mildly. It requires the central authority in question to have access to all necessary information in realtime, and to have the ability to respond to that information both wisely and rapidly, or even proactively. It also assumes the ability to accurately filter out misinformation and disinformation. This is unlikely even in good times, thanks to the difficulties of ‘organizational stupidity’ at large scale, and even more improbable in the times of crisis.

Sep 052016
 
 September 5, 2016  Posted by at 1:16 pm Finance Tagged with: , , , , , , , , , ,  


Berenice Abbott Broad St., NYC 1936

 

 

This is part 2 of a 4-part series by Nicole Foss entitled “Negative Interest Rates and the War on Cash”.

Part 1 is here: Negative Interest Rates and the War on Cash (1)

Parts 3 and 4 will follow in the next few days, and at the end we will publish the entire piece in one post.

Here, once again, is Nicole:

 

 

 

Closing the Escape Routes

 

Nicole Foss: History teaches us that central authorities dislike escape routes, at least for the majority, and are therefore prone to closing them, so that control of a limited money supply can remain in the hands of the very few. In the 1930s, gold was the escape route, so gold was confiscated. As Alan Greenspan wrote in 1966:

In the absence of the gold standard, there is no way to protect savings from confiscation through monetary inflation. There is no safe store of value. If there were, the government would have to make its holding illegal, as was done in the case of gold. If everyone decided, for example, to convert all his bank deposits to silver or copper or any other good, and thereafter declined to accept checks as payment for goods, bank deposits would lose their purchasing power and government-created bank credit would be worthless as a claim on goods.

The existence of escape routes for capital preservation undermines the viability of the banking system, which is already over-extended, over-leveraged and extremely fragile. This time cash serves that role:

Ironically, though the paper money standard that replaced the gold standard was originally meant to empower governments, it now seems that paper money is perceived as an obstacle to unlimited government power….While paper money isn’t as big impediment to government power as the gold standard was, it is nevertheless an impediment compared to a society with only electronic money. Because of this, the more ardent statists favor the abolition of paper money and a monetary system with only electronic money and electronic payments.

We can therefore expect cash to be increasingly disparaged in order to justify its intended elimination:

Every day, a situation that requires the use of physical cash, feels more and more like an anachronism. It’s like having to listen to music on a CD. John Maynard Keynes famously referred to gold (well, the gold standard specifically) as a “barbarous relic.” Well the new barbarous relic is physical cash. Like gold, cash is physical money. Like gold, cash is still fetishized. And like gold, cash is a costly drain on the economy. A study done at Tufts in 2013 estimated that cash costs the economy $200 billion. Their study included the nugget that consumers spend, on average, 28 minutes per month just traveling to the point where they obtain cash (ATM, etc.). But this is just first-order problem with cash. The real problem, which economists are starting to recognize, is that paper cash is an impediment to effective monetary policy, and therefore economic growth.

Holding cash is not risk free, but cash is nevertheless king in a period of deflation:

Conventional wisdom is that interest rates earned on investments are never less than zero because investors could alternatively hold currency. Yet currency is not costless to hold: It is subject to theft and physical destruction, is expensive to safeguard in large amounts, is difficult to use for large and remote transactions, and, in large quantities, may be monitored by governments.

The acknowledged risks of holding cash are understood and can be managed personally, whereas the substantial risk associated with a systemic banking crisis are entirely outside the control of ordinary depositors. The bank bail-in (rescuing the bank with the depositors’ funds) in Cyprus in early 2013 was a warning sign, to those who were paying attention, that holding money in a bank is not necessarily safe. The capital controls put in place in other locations, for instance Greece, also underline that cash in a bank may not be accessible when needed.

The majority of the developed world either already has, or is introducing, legislation to require depositor bail-ins in the event of bank failures, rather than taxpayer bailouts, in preparation for many more Cyprus-type events, but on a very much larger scale. People are waking up to the fact that a bank balance is not considered their money, but is actually an unsecured loan to the bank, which the bank may or may not repay, depending on its own circumstances.:

Your checking account balance is denominated in dollars, but it does not consist of actual dollars. It represents a promise by a private company (your bank) to pay dollars upon demand. If you write a check, your bank may or may not be able to honor that promise. The poor souls who kept their euros in the form of large balances in Cyprus banks have just learned this lesson the hard way. If they had been holding their euros in the form of currency, they would have not lost their wealth.

 

 

Even in relatively untroubled countries, like the UK, it is becoming more difficult to access physical cash in a bank account or to use it for larger purchases. Notice of intent to withdraw may be required, and withdrawal limits may be imposed ‘for your own protection’. Reasons for the withdrawal may be required, ostensibly to combat money laundering and the black economy:

It’s one thing to be required by law to ask bank customers or parties in a cash transaction to explain where their money came from; it’s quite another to ask them how they intend to use the money they wish to withdraw from their own bank accounts. As one Mr Cotton, a HSBC customer, complained to the BBC’s Money Box programme: “I’ve been banking in that bank for 28 years. They all know me in there. You shouldn’t have to explain to your bank why you want that money. It’s not theirs, it’s yours.”

In France, in the aftermath of terrorist attacks there, several anti-cash measures were passed, restricting the use of cash once obtained:

French Finance Minister Michel Sapin brazenly stated that it was necessary to “fight against the use of cash and anonymity in the French economy.” He then announced extreme and despotic measures to further restrict the use of cash by French residents and to spy on and pry into their financial affairs.

These measures…..include prohibiting French residents from making cash payments of more than 1,000 euros, down from the current limit of 3,000 euros….The threshold below which a French resident is free to convert euros into other currencies without having to show an identity card will be slashed from the current level of 8,000 euros to 1,000 euros. In addition any cash deposit or withdrawal of more than 10,000 euros during a single month will be reported to the French anti-fraud and money laundering agency Tracfin.

Tourists in France may also be caught in the net:

France passed another new Draconian law; from the summer of 2015, it will now impose cash requirements dramatically trying to eliminate cash by force. French citizens and tourists will only be allowed a limited amount of physical money. They have financial police searching people on trains just passing through France to see if they are transporting cash, which they will now seize.

This is essentially the Shock Doctrine in action. Central authorities rarely pass up an opportunity to use a crisis to add to their repertoire of repressive laws and practices.

However, even without a specific crisis to draw on as a justification, many other countries have also restricted the use of cash for purchases:

One way they are waging the War on Cash is to lower the threshold at which reporting a cash transaction is mandatory or at which paying in cash is simply illegal. In just the last few years.

  • Italy made cash transactions over €1,000 illegal;
  • Switzerland has proposed banning cash payments in excess of 100,000 francs;
  • Russia banned cash transactions over $10,000;
  • Spain banned cash transactions over €2,500;
  • Mexico made cash payments of more than 200,000 pesos illegal;
  • Uruguay banned cash transactions over $5,000

Other restrictions on the use of cash can be more subtle, but can have far-reaching effects, especially if the ideas catch on and are widely applied:

The State of Louisiana banned “secondhand dealers” from making more than one cash transaction per week. The term has a broad definition and includes Goodwill stores, specialty stores that sell collectibles like baseball cards, flea markets, garage sales and so on. Anyone deemed a “secondhand dealer” is forbidden to accept cash as payment. They are allowed to take only electronic means of payment or a check, and they must collect the name and other information about each customer and send it to the local police department electronically every day.

The increasing application of de facto capital controls, when combined with the prevailing low interest rates, already convince many to hold cash. The possibility of negative rates would greatly increase the likelihood. We are already in an environment of rapidly declining trust, and limited access to what we still perceive as our own funds only accelerates the process in a self-reinforcing feedback loop. More withdrawals lead to more controls, which increase fear and decrease trust, which leads to more withdrawals. This obviously undermines the perceived power of monetary policy to stimulate the economy, hence the escape route is already quietly closing.

In a deflationary spiral, where the money supply is crashing, very little money is in circulation and prices are consequently falling almost across the board, possessing purchasing power provides for the freedom to pursue opportunities as they present themselves, and to avoid being backed into a corner. The purchasing power of cash increases during deflation, even as electronic purchasing power evaporates. Hence cash represents freedom of action at a time when that will be the rarest of ‘commodities’.

Governments greatly dislike cash, and increasingly treat its use, or the desire to hold it, especially in large denominations, with great suspicion:

Why would a central bank want to eliminate cash? For the same reason as you want to flatten interest rates to zero: to force people to spend or invest their money in the risky activities that revive growth, rather than hoarding it in the safest place. Calls for the eradication of cash have been bolstered by evidence that high-value notes play a major role in crime, terrorism and tax evasion. In a study for the Harvard Business School last week, former bank boss Peter Sands called for global elimination of the high-value note.

Britain’s “monkey” — the £50 — is low-value compared with its foreign-currency equivalents, and constitutes a small proportion of the cash in circulation. By contrast, Japan’s ¥10,000 note (worth roughly £60) makes up a startling 92% of all cash in circulation; the Swiss 1,000-franc note (worth around £700) likewise. Sands wants an end to these notes plus the $100 bill, and the €500 note – known in underworld circles as the “Bin Laden”.

 

 

Cash is largely anonymous, untraceable and uncontrollable, hence it makes central authorities, in a system increasingly requiring total buy-in in order to function, extremely uncomfortable. They regard there being no legitimate reason to own more than a small amount of it in physical form, as its ownership or use raises the spectre of tax evasion or other illegal activities:

The insidious nature of the war on cash derives not just from the hurdles governments place in the way of those who use cash, but also from the aura of suspicion that has begun to pervade private cash transactions. In a normal market economy, businesses would welcome taking cash. After all, what business would willingly turn down customers? But in the war on cash that has developed in the thirty years since money laundering was declared a federal crime, businesses have had to walk a fine line between serving customers and serving the government. And since only one of those two parties has the power to shut down a business and throw business owners and employees into prison, guess whose wishes the business owner is going to follow more often?

The assumption on the part of government today is that possession of large amounts of cash is indicative of involvement in illegal activity. If you’re traveling with thousands of dollars in cash and get pulled over by the police, don’t be surprised when your money gets seized as “suspicious.” And if you want your money back, prepare to get into a long, drawn-out court case requiring you to prove that you came by that money legitimately, just because the courts have decided that carrying or using large amounts of cash is reasonable suspicion that you are engaging in illegal activity….

….Centuries-old legal protections have been turned on their head in the war on cash. Guilt is assumed, while the victims of the government’s depredations have to prove their innocence….Those fortunate enough to keep their cash away from the prying hands of government officials find it increasingly difficult to use for both business and personal purposes, as wads of cash always arouse suspicion of drug dealing or other black market activity. And so cash continues to be marginalized and pushed to the fringes.

Despite the supposed connection between crime and the holding of physical cash, the places where people are most inclined (and able) to store cash do not conform to the stereotype at all:

Are Japan and Switzerland havens for terrorists and drug lords? High-denomination bills are in high demand in both places, a trend that some politicians claim is a sign of nefarious behavior. Yet the two countries boast some of the lowest crime rates in the world. The cash hoarders are ordinary citizens responding rationally to monetary policy. The Swiss National Bank introduced negative interest rates in December 2014. The aim was to drive money out of banks and into the economy, but that only works to the extent that savers find attractive places to spend or invest their money. With economic growth an anemic 1%, many Swiss withdrew cash from the bank and stashed it at home or in safe-deposit boxes. High-denomination notes are naturally preferred for this purpose, so circulation of 1,000-franc notes (worth about $1,010) rose 17% last year. They now account for 60% of all bills in circulation and are worth almost as much as Serbia’s GDP.

Japan, where banks pay infinitesimally low interest on deposits, is a similar story. Demand for the highest-denomination ¥10,000 notes rose 6.2% last year, the largest jump since 2002. But 10,000 Yen notes are worth only about $88, so hiding places fill up fast. That explains why Japanese went on a safe-buying spree last month after the Bank of Japan announced negative interest rates on some reserves. Stores reported that sales of safes rose as much as 250%, and shares of safe-maker Secom spiked 5.3% in one week.

In Germany too, negative interest rates are considered intolerable, banks are increasingly being seen as risky prospects, and physical cash under one’s own control is coming to be seen as an essential part of a forward-thinking financial strategy:

First it was the news that Raiffeisen Gmund am Tegernsee, a German cooperative savings bank in the Bavarian village of Gmund am Tegernsee, with a population 5,767, finally gave in to the ECB’s monetary repression, and announced it’ll start charging retail customers to hold their cash. Then, just last week, Deutsche Bank’s CEO came about as close to shouting fire in a crowded negative rate theater, when, in a Handelsblatt Op-Ed, he warned of “fatal consequences” for savers in Germany and Europe — to be sure, being the CEO of the world’s most systemically risky bank did not help his cause.

That was the last straw, and having been patient long enough, the German public has started to move. According to the WSJ, German savers are leaving the “security of savings banks” for what many now consider an even safer place to park their cash: home safes. We wondered how many “fatal” warnings from the CEO of DB it would take, before this shift would finally take place. As it turns out, one was enough….

….“It doesn’t pay to keep money in the bank, and on top of that you’re being taxed on it,” said Uwe Wiese, an 82-year-old pensioner who recently bought a home safe to stash roughly €53,000 ($59,344), including part of his company pension that he took as a payout. Burg-Waechter KG, Germany’s biggest safe manufacturer, posted a 25% jump in sales of home safes in the first half of this year compared with the year earlier, said sales chief Dietmar Schake, citing “significantly higher demand for safes by private individuals, mainly in Germany.”….

….Unlike their more “hip” Scandinavian peers, roughly 80% of German retail transactions are in cash, almost double the 46% rate of cash use in the U.S., according to a 2014 Bundesbank survey….Germany’s love of cash is driven largely by its anonymity. One legacy of the Nazis and East Germany’s Stasi secret police is a fear of government snooping, and many Germans are spooked by proposals of banning cash transactions that exceed €5,000. Many Germans think the ECB’s plan to phase out the €500 bill is only the beginning of getting rid of cash altogether. And they are absolutely right; we can only wish more Americans showed the same foresight as the ordinary German….

….Until that moment, however, as a final reminder, in a fractional reserve banking system, only the first ten or so percent of those who “run” to the bank to obtain possession of their physical cash and park it in the safe will succeed. Everyone else, our condolences.

The internal stresses are building rapidly, stretching economy after economy to breaking point and prompting aware individuals to protect themselves proactively:

People react to these uncertainties by trying to protect themselves with cash and guns, and governments respond by trying to limit citizens’ ability to do so.

If this play has a third act, it will involve the abolition of cash in some major countries, the rise of various kinds of black markets (silver coins, private-label cash, cryptocurrencies like bitcoin) that bypass traditional banking systems, and a surge in civil unrest, as all those guns are put to use. The speed with which cash, safes and guns are being accumulated — and the simultaneous intensification of the war on cash — imply that the stress is building rapidly, and that the third act may be coming soon.

Despite growing acceptance of electronic payment systems, getting rid of cash altogether is likely to be very challenging, particularly as the fear and state of financial crisis that drives people into cash hoarding is very close to reasserting itself. Cash has a very long history, and enjoys greater trust than other abstract means for denominating value. It is likely to prove tenacious, and unable to be eliminated peacefully. That is not to suggest central authorities will not try. At the heart of financial crisis lies the problem of excess claims to underlying real wealth. The bursting of the global bubble will eliminate the vast majority of these, as the value of credit instruments, hitherto considered to be as good as money, will plummet on the realisation that nowhere near all financial promises made can possibly be kept.

Cash would then represent the a very much larger percentage of the remaining claims to limited actual resources — perhaps still in excess of the available resources and therefore subject to haircuts. Not only the quantity of outstanding cash, but also its distribution, may not be to central authorities liking. There are analogous precedents for altering legal currency in order to dispossess ordinary people trying to protect their stores of value, depriving them of the benefit of their foresight. During the Russian financial crisis of 1998, cash was not eliminated in favour of an electronic alternative, but the currency was reissued, which had a similar effect. People were required to convert their life savings (often held ‘under the mattress’) from the old currency to the new. This was then made very difficult, if not impossible, for ordinary people, and many lost the entirety of their life savings as a result.

 

A Cashless Society?

 

The greater the public’s desire to hold cash to protect themselves, the greater will be the incentive for central banks and governments to restrict its availability, reduce its value or perhaps eliminate it altogether in favour of electronic-only payment systems. In addition to commercial banks already complicating the process of making withdrawals, central banks are actively considering, as a first step, mechanisms to impose negative interest rates on physical cash, so as to make the escape route appear less attractive:

Last September, the Bank of England’s chief economist, Andy Haldane, openly pondered ways of imposing negative interest rates on cash — ie shrinking its value automatically. You could invalidate random banknotes, using their serial numbers. There are £63bn worth of notes in circulation in the UK: if you wanted to lop 1% off that, you could simply cancel half of all fivers without warning. A second solution would be to establish an exchange rate between paper money and the digital money in our bank accounts. A fiver deposited at the bank might buy you a £4.95 credit in your account.

 

 

To put it mildly, invalidating random banknotes would be highly likely to result in significant social blowback, and to accelerate the evaporation of trust in governing authorities of all kinds. It would be far more likely for financial authorities to move toward making official electronic money the standard by which all else is measured. People are already used to using electronic money in the form of credit and debit cards and mobile phone money transfers:

I can remember the moment I realised the era of cash could soon be over. It was Australia Day on Bondi Beach in 2014. In a busy liquor store, a man wearing only swimming shorts, carrying only a mobile phone and a plastic card, was delaying other people’s transactions while he moved 50 Australian dollars into his current account on his phone so that he could buy beer. The 30-odd youngsters in the queue behind him barely murmured; they’d all been in the same predicament. I doubt there was a banknote or coin between them….The possibility of a cashless society has come at us with a rush: contactless payment is so new that the little ping the machine makes can still feel magical. But in some shops, especially those that cater for the young, a customer reaching for a banknote already produces an automatic frown. Among central bankers, that frown has become a scowl.

In some states almost anything, no matter how small, can be purchased electronically. Everything down to, and including, a cup of coffee from a roadside stall can be purchased in New Zealand with an EFTPOS (debit) card, hence relatively few people carry cash. In Scandinavian countries, there are typically more electronic payment options than cash options:

Sweden became the first country to enlist its own citizens as largely willing guinea pigs in a dystopian economic experiment: negative interest rates in a cashless society. As Credit Suisse reports, no matter where you go or what you want to purchase, you will find a small ubiquitous sign saying “Vi hanterar ej kontanter” (“We don’t accept cash”)….A similar situation is unfolding in Denmark, where nearly 40% of the paying demographic use MobilePay, a Danske Bank app that allows all payments to be completed via smartphone.

Even street vendors selling “Situation Stockholm”, the local version of the UK’s “Big Issue” are also able to take payments by debit or credit card.

 

 

Ironically, cashlessness is also becoming entrenched in some African countries. One might think that electronic payments would not be possible in poor and unstable subsistence societies, but mobile phones are actually very common in such places, and means for electronic payments are rapidly becoming the norm:

While Sweden and Denmark may be the two nations that are closest to banning cash outright, the most important testing ground for cashless economics is half a world away, in sub-Saharan Africa. In many African countries, going cashless is not merely a matter of basic convenience (as it is in Scandinavia); it is a matter of basic survival. Less than 30% of the population have bank accounts, and even fewer have credit cards. But almost everyone has a mobile phone. Now, thanks to the massive surge in uptake of mobile communications as well as the huge numbers of unbanked citizens, Africa has become the perfect place for the world’s biggest social experiment with cashless living.

Western NGOs and GOs (Government Organizations) are working hand-in-hand with banks, telecom companies and local authorities to replace cash with mobile money alternatives. The organizations involved include Citi Group, Mastercard, VISA, Vodafone, USAID, and the Bill and Melinda Gates Foundation.

In Kenya the funds transferred by the biggest mobile money operator, M-Pesa (a division of Vodafone), account for more than 25% of the country’s GDP. In Africa’s most populous nation, Nigeria, the government launched a Mastercard-branded biometric national ID card, which also doubles up as a payment card. The “service” provides Mastercard with direct access to over 170 million potential customers, not to mention all their personal and biometric data. The company also recently won a government contract to design the Huduma Card, which will be used for paying State services. For Mastercard these partnerships with government are essential for achieving its lofty vision of creating a “world beyond cash.”

Countries where electronic payment is already the norm would be expected to be among the first places to experiment with a fully cashless society as the transition would be relatively painless (at least initially). In Norway two major banks no longer issue cash from branch offices, and recently the largest bank, DNB, publicly called for the abolition of cash. In rich countries, the advent of a cashless society could be spun in the media in such a way as to appear progressive, innovative, convenient and advantageous to ordinary people. In poor countries, people would have no choice in any case.

Testing and developing the methods in societies with no alternatives and then tantalizing the inhabitants of richer countries with more of the convenience to which they have become addicted is the clear path towards extending the reach of electronic payment systems and the much greater financial control over individuals that they offer:

Bill and Melinda Gates Foundation, in its 2015 annual letter, adds a new twist. The technologies are all in place; it’s just a question of getting us to use them so we can all benefit from a crimeless, privacy-free world. What better place to conduct a massive social experiment than sub-Saharan Africa, where NGOs and GOs (Government Organizations) are working hand-in-hand with banks and telecom companies to replace cash with mobile money alternatives? So the annual letter explains: “(B)ecause there is strong demand for banking among the poor, and because the poor can in fact be a profitable customer base, entrepreneurs in developing countries are doing exciting work – some of which will “trickle up” to developed countries over time.”

What the Foundation doesn’t mention is that it is heavily invested in many of Africa’s mobile-money initiatives and in 2010 teamed up with the World Bank to “improve financial data collection” among Africa’s poor. One also wonders whether Microsoft might one day benefit from the Foundation’s front-line role in mobile money….As a result of technological advances and generational priorities, cash’s days may well be numbered. But there is a whole world of difference between a natural death and euthanasia. It is now clear that an extremely powerful, albeit loose, alliance of governments, banks, central banks, start-ups, large corporations, and NGOs are determined to pull the plug on cash — not for our benefit, but for theirs.

Whatever the superficially attractive media spin, joint initiatives like the Better Than Cash Alliance serve their founders, not the public. This should not come as a surprise, but it probably will as we sleepwalk into giving up very important freedoms:

As I warned in We Are Sleepwalking Towards a Cashless Society, we (or at least the vast majority of people in the vast majority of countries) are willing to entrust government and financial institutions — organizations that have already betrayed just about every possible notion of trust — with complete control over our every single daily transaction. And all for the sake of a few minor gains in convenience. The price we pay will be what remains of our individual freedom and privacy.

Sep 042016
 
 September 4, 2016  Posted by at 1:16 pm Finance Tagged with: , , , , , , , , , ,  


Irving Underhill City Bank-Farmers Trust Building, William & Beaver streets, NYC 1931

 

 

It’s been a while, but Nicole Foss is back at the Automatic Earth -which makes me very happy-, and for good measure, she starts out with a very long article. So long in fact that we have decided to turn it into a 4-part series, if only just to show you that we do care about your health and well-being, as well as your families and social lives. The other 3 parts will follow in the next few days, and at the end we will publish the entire piece in one post.

Here’s Nicole:

 

 

Nicole Foss: As momentum builds in the developing deflationary spiral, we are seeing increasingly desperate measures to keep the global credit ponzi scheme from its inevitable conclusion. Credit bubbles are dynamic — they must grow continually or implode — hence they require ever more money to be lent into existence. But that in turn requires a plethora of willing and able borrowers to maintain demand for new credit money, lenders who are not too risk-averse to make new loans, and (apparently effective) mechanisms for diluting risk to the point where it can (apparently safely) be ignored. As the peak of a credit bubble is reached, all these necessary factors first become problematic and then cease to be available at all. Past a certain point, there are hard limits to financial expansions, and the global economy is set to hit one imminently.

Borrowers are increasingly maxed out and afraid they will not be able to service existing loans, let alone new ones. Many families already have more than enough ‘stuff’ for their available storage capacity in any case, and are looking to downsize and simplify their cluttered lives. Many businesses are already struggling to sell goods and services, and so are unwilling to borrow in order to expand their activities. Without willingness to borrow, demand for new loans will fall substantially. As risk factors loom, lenders become far more risk-averse, often very quickly losing trust in the solvency of of their counterparties. As we saw in 2008, the transition from embracing risky prospects to avoiding them like the plague can be very rapid, changing the rules of the game very abruptly.

Mechanisms for spreading risk to the point of ‘dilution to nothingness’, such as securitization, seen as effective and reliable during monetary expansions, cease to be seen as such as expansion morphs into contraction. The securitized instruments previously created then cease to be perceived as holding value, leading to them being repriced at pennies on the dollar once price discovery occurs, and the destruction of that value is highly deflationary. The continued existence of risk becomes increasingly evident, and the realisation that that risk could be catastrophic begins to dawn.

Natural limits for both borrowing and lending threaten the capacity to prolong the credit boom any further, meaning that even if central authorities are prepared to pay almost any price to do so, it ceases to be possible to kick the can further down the road. Negative interest rates and the war on cash are symptoms of such a limit being reached. As confidence evaporates, so does liquidity. This is where we find ourselves at the moment — on the cusp of phase two of the credit crunch, sliding into the same unavoidable constellation of conditions we saw in 2008, but on a much larger scale.

 

From ZIRP to NIRP

 

Interest rates have remained at extremely low levels, hardly distinguishable from zero, for the several years. This zero interest rate policy (ZIRP) is a reflection of both the extreme complacency as to risk during the rise into the peak of a major bubble, and increasingly acute pressure to keep the credit mountain growing through constant stimulation of demand for borrowing. The resulting search for yield in a world of artificially stimulated over-borrowing has lead to an extraordinary array of malinvestment across many sectors of the real economy. Ever more excess capacity is being built in a world facing a severe retrenchment in aggregate demand. It is this that is termed ‘recovery’, but rather than a recovery, it is a form of double jeopardy — an intensification of previous failed strategies in the hope that a different outcome will result. This is, of course, one definition of insanity.

Now that financial crisis conditions are developing again, policies are being implemented which amount to an even greater intensification of the old strategy. In many locations, notably those perceived to be safe havens, the benchmark is moving from a zero interest rate policy to a negative interest rate policy (NIRP), initially for bank reserves, but potentially for business clients (for instance in Holland and the UK). Individual savers would be next in line. Punishing savers, while effectively encouraging banks to lend to weaker, and therefore riskier, borrowers, creates incentives for both borrowers and lenders to continue the very behaviour that set the stage for financial crisis in the first place, while punishing the kind of responsibility that might have prevented it.

Risk is relative. During expansionary times, when risk perception is low almost across the board (despite actual risk steadily increasing), the risk premium that interest rates represent shows relatively little variation between different lenders, and little volatility. For instance, the interest rates on sovereign bonds across Europe, prior to financial crisis, were low and broadly similar for many years. In other words, credit spreads were very narrow during that time. Greece was able to borrow almost as easily and cheaply as Germany, as lenders bet that Europe’s strong economies would back the debt of its weaker parties. However, as collective psychology shifts from unity to fragmentation, risk perception increases dramatically, and risk distinctions of all kinds emerge, with widening credit spreads. We saw this happen in 2008, and it can be expected to be far more pronounced in the coming years, with credit spreads widening to record levels. Interest rate divergences create self-fulfilling prophecies as to relative default risk, against a backdrop of fear-driven high volatility.

Many risk distinctions can be made — government versus private debt, long versus short term, economic centre versus emerging markets, inside the European single currency versus outside, the European centre versus the troubled periphery, high grade bonds versus junk bonds etc. As the risk distinctions increase, the interest rate risk premiums diverge. Higher risk borrowers will pay higher premiums, in recognition of the higher default risk, but the higher premium raises the actual risk of default, leading to still higher premiums in a spiral of positive feedback. Increased risk perception thus drives actual risk, and may do so until the weak borrower is driven over the edge into insolvency. Similarly, borrowers perceived to be relative safe havens benefit from lower risk premiums, which in turn makes their debt burden easier to bear and lowers (or delays) their actual risk of default. This reduced risk of default is then reflected in even lower premiums. The risky become riskier and the relatively safe become relatively safer (which is not necessarily to say safe in absolute terms). Perception shapes reality, which feeds back into perception in a positive feedback loop.

 

 

The process of diverging risk perception is already underway, and it is generally the states seen as relatively safe where negative interest rates are being proposed or implemented. Negative rates are already in place for bank reserves held with the ECB and in a number of European states from 2012 onwards, notably Scandinavia and Switzerland. The desire for capital preservation has led to a willingness among those with capital to accept paying for the privilege of keeping it in ‘safe havens’. Note that perception of safety and actual safety are not equivalent. States at the peak of a bubble may appear to be at low risk, but in fact the opposite is true. At the peak of a bubble, there is nowhere to go but down, as Iceland and Ireland discovered in phase one of the financial crisis, and many others will discover as we move into phase two. For now, however, the perception of low risk is sufficient for a flight to safety into negative interest rate environments.

This situation serves a number of short term purposes for the states involved. Negative rates help to control destabilizing financial inflows at times when fear is increasingly driving large amounts of money across borders. A primary objective has been to reduce upward pressure on currencies outside the eurozone. The Swiss, Danish and Swedish currencies have all been experiencing currency appreciation, hence a desire to use negative interest rates to protect their exchange rate, and therefore the price of their exports, by encouraging foreigners to keep their money elsewhere. The Danish central bank’s sole mandate is to control the value of the currency against the euro. For a time, Switzerland pegged their currency directly to the euro, but found the cost of doing so to be prohibitive. For them, negative rates are a less costly attempt to weaken the currency without the need to defend a formal peg. In a world of competitive, beggar-thy-neighbour currency devaluations, negative interest rates are seen as a means to achieve or maintain an export advantage, and evidence of the growing currency war.

Negative rates are also intended to discourage saving and encourage both spending and investment. If savers must pay a penalty, spending or investment should, in theory, become more attractive propositions. The intention is to lead to more money actively circulating in the economy. Increasing the velocity of money in circulation should, in turn, provide price support in an environment where prices are flat to falling. (Mainstream commentators would describe this as as an attempt to increase ‘inflation’, by which they mean price increases, to the common target of 2%, but here at The Automatic Earth, we define inflation and deflation as an increase or decrease, respectively, in the money supply, not as an increase or decrease in prices.) The goal would be to stave off a scenario of falling prices where buyers would have an incentive to defer spending as they wait for lower prices in the future, starving the economy of circulating currency in the meantime. Expectations of falling prices create further downward price pressure, leading into a vicious circle of deepening economic depression. Preventing such expectations from taking hold in the first place is a major priority for central authorities.

Negative rates in the historical record are symptomatic of times of crisis when conventional policies have failed, and as such are rare. Their use is a measure of desperation:

First, a policy rate likely would be set to a negative value only when economic conditions are so weak that the central bank has previously reduced its policy rate to zero. Identifying creditworthy borrowers during such periods is unusually challenging. How strongly should banks during such a period be encouraged to expand lending?

However strongly banks are ‘encouraged’ to lend, willing borrowers and lenders are set to become ‘endangered species’:

The goal of such rates is to force banks to lend their excess reserves. The assumption is that such lending will boost aggregate demand and help struggling economies recover. Using the same central bank logic as in 2008, the solution to a debt problem is to add on more debt. Yet, there is an old adage: you can bring a horse to water but you cannot make him drink! With the world economy sinking into recession, few banks have credit-worthy customers and many banks are having difficulties collecting on existing loans.
Italy’s non-performing loans have gone from about 5 percent in 2010 to over 15 percent today. The shale oil bust has left many US banks with over a trillion dollars of highly risky energy loans on their books. The very low interest rate environment in Japan and the EU has done little to spur demand in an environment full of malinvestments and growing government constraints.

Doing more of the same simply elevates the already enormous risk that a new financial crisis is right around the corner:

Banks rely on rates to make returns. As the former Bank of England rate-setter Charlie Bean has written in a recent paper for The Economic Journal, pension funds will struggle to make adequate returns, while fund managers will borrow a lot more to make profits. Mr Bean says: “All of this makes a leveraged ‘search for yield’ of the sort that marked the prelude to the crisis more likely.” This is not comforting but it is highly plausible: barely a decade on from the crash, we may be about to repeat it. This comes from tasking central bankers with keeping the world economy growing, even while governments have cut spending.

 

Experiences with Negative Interest Rates

 

The existing low interest rate environment has already caused asset price bubbles to inflate further, placing assets such as real estate ever more beyond the reach of ordinary people at the same time as hampering those same people attempting to build sufficient savings for a deposit. Negative interest rates provide an increased incentive for this to continue. In locations where the rates are already negative, the asset bubble effect has worsened. For instance, in Denmark negative interest rates have added considerable impetus to the housing bubble in Copenhagen, resulting in an ever larger pool over over-leveraged property owners exposed to the risks of a property price collapse and debt default:

Where do you invest your money when rates are below zero? The Danish experience says equities and the property market. The benchmark index of Denmark’s 20 most-traded stocks has soared more than 100 percent since the second quarter of 2012, which is just before the central bank resorted to negative rates. That’s more than twice the stock-price gains of the Stoxx Europe 600 and Dow Jones Industrial Average over the period. Danish house prices have jumped so much that Danske Bank A/S, Denmark’s biggest lender, says Copenhagen is fast becoming Scandinavia’s riskiest property market.

Considering that risky property markets are the norm in Scandinavia, Copenhagen represents an extreme situation:

“Property prices in Copenhagen have risen 40–60 percent since the middle of 2012, when the central bank first resorted to negative interest rates to defend the krone’s peg to the euro.”

This should come as no surprise: recall that there are documented cases where Danish borrowers are paid to take on debt and buy houses “In Denmark You Are Now Paid To Take Out A Mortgage”, so between rewarding debtors and punishing savers, this outcome is hardly shocking. Yet it is the negative rates that have made this unprecedented surge in home prices feel relatively benign on broader price levels, since the source of housing funds is not savings but cash, usually cash belonging to the bank.

 

 

The Swedish property market is similarly reaching for the sky. Like Japan at the peak of it’s bubble in the late 1980s, Sweden has intergenerational mortgages, with an average term of 140 years! Recent regulatory attempts to rein in the ballooning debt by reducing the maximum term to a ‘mere’ 105 years have been met with protest:

Swedish banks were quoted in the local press as opposing the move. “It isn’t good for the finances of households as it will make mortgages more expensive and the terms not as good. And it isn’t good for financial stability,” the head of Swedish Bankers’ Association was reported to say.

Apart from stimulating further leverage in an already over-leveraged market, negative interest rates do not appear to be stimulating actual economic activity:

If negative rates don’t spur growth — Danish inflation since 2012 has been negligible and GDP growth anemic — what are they good for?….Danish businesses have barely increased their investments, adding less than 6 percent in the 12 quarters since Denmark’s policy rate turned negative for the first time. At a growth rate of 5 percent over the period, private consumption has been similarly muted. Why is that? Simply put, a weak economy makes interest rates a less powerful tool than central bankers would like.

“If you’re very busy worrying about the economy and your job, you don’t care very much what the exact rate is on your car loan,” says Torsten Slok, Deutsche Bank’s chief international economist in New York.

Fuelling inequality and profligacy while punishing responsible behaviour is politically unpopular, and the consequences, when they eventually manifest, will be even more so. Unfortunately, at the peak of a bubble, it is only continued financial irresponsibility that can keep a credit expansion going and therefore keep the financial system from abruptly crashing. The only things keeping the system ‘running on fumes’ as it currently is, are financial sleight-of-hand, disingenuous bribery and outright fraud. The price to pay is that the systemic risks continue to grow, and with it the scale of the impacts that can be expected when the risk is eventually realised. Politicians desperately wish to avoid those consequences occurring in their term of office, hence they postpone the inevitable at any cost for as long as physically possible.

 

The Zero Lower Bound and the Problem of Physical Cash

 

Central bankers attempting to stimulate the circulation of money in the economy through the use of negative interest rates have a number of problems. For starters, setting a low official rate does not necessarily mean that low rates will prevail in the economy, particularly in times of crisis:

The experience of the global financial crisis taught us that the type of shocks which can drive policy interest rates to the lower bound are also shocks which produce severe impairments to the monetary policy transmission mechanism. Suppose, for example, that the interbank market freezes and prevents a smooth transmission of the policy interest rate throughout the banking sector and financial markets at large. In this case, any cut in the policy rate may be almost completely ineffective in terms of influencing the macroeconomy and prices.

This is exactly what we saw in 2008, when interbank lending seized up due to the collapse of confidence in the banking sector. We have not seen this happen again yet, but it inevitably will as crisis conditions resume, and when it does it will illustrate vividly the limits of central bank power to control financial parameters. At that point, interest rates are very likely to spike in practice, with banks not trusting each other to repay even very short term loans, since they know what toxic debt is on their own books and rationally assume their potential counterparties are no better. Widening credit spreads would also lead to much higher rates on any debt perceived to be risky, which, increasingly, would be all debt with the exception of government bonds in the jurisdictions perceived to be safest. Low rates on high grade debt would not translate into low rates economy-wide. Given the extent of private debt, and the consequent vulnerability to higher interest rates across the developed world, an interest rate spike following the NIRP period would be financially devastating.

The major issue with negative rates in the shorter term is the ability to escape from the banking system into physical cash. Instead of causing people to spend, a penalty on holding savings in a banks creates an incentive for them to withdraw their funds and hold cash under their own control, thereby avoiding both the penalty and the increasing risk associated with the banking system:

Western banking systems are highly illiquid, meaning that they have very low cash equivalents as a percentage of customer deposits….Solvency in many Western banking systems is also highly questionable, with many loaded up on the debts of their bankrupt governments. Banks also play clever accounting games to hide the true nature of their capital inadequacy. We live in a world where questionably solvent, highly illiquid banks are backed by under capitalized insurance funds like the FDIC, which in turn are backed by insolvent governments and borderline insolvent central banks. This is hardly a risk-free proposition. Yet your reward for taking the risk of holding your money in a precarious banking system is a rate of return that is substantially lower than the official rate of inflation.

In other words, negative rates encourage an arbitrage situation favouring cash. In an environment of few good investment opportunities, increasing recognition of risk and a rising level of fear, a desire for large scale cash withdrawal is highly plausible:

From a portfolio choice perspective, cash is, under normal circumstances, a strictly dominated asset, because it is subject to the same inflation risk as bonds but, in contrast to bonds, it yields zero return. It has also long been known that this relationship would be reversed if the return on bonds were negative. In that case, an investor would be certain of earning a profit by borrowing at negative rates and investing the proceedings in cash. Ignoring storage and transportation costs, there is therefore a zero lower bound (ZLB) on nominal interest rates.

Zero is the lower bound for nominal interest rates if one would want to avoid creating such an incentive structure, but in a contractionary environment, zero is not low enough to make borrowing and lending attractive. This is because, while the nominal rate might be zero, the real rate (the nominal rate minus negative inflation) can remain high, or perhaps very high, depending on how contractionary the financial landscape becomes. As Keynes observed, attempting to stimulate demand for money by lowering interest rates amounts to ‘pushing on a piece of string‘. Central authorities find themselves caught in the liquidity trap, where monetary policy ceases to be effective:

Many big economies are now experiencing ‘deflation’, where prices are falling. In the euro zone, for instance, the main interest rate is at 0.05% but the “real” (or adjusted for inflation) interest rate is considerably higher, at 0.65%, because euro-area inflation has dropped into negative territory at -0.6%. If deflation gets worse then real interest rates will rise even more, choking off recovery rather than giving it a lift.

If nominal rates are sufficiently negative to compensate for the contractionary environment, real rates could, in theory, be low enough to stimulate the velocity of money, but the more negative the nominal rate, the greater the incentive to withdraw physical cash. Hoarded cash would reduce, instead of increase, the velocity of money. In practice, lowering rates can be moderately reflationary, provided there remains sufficient economic optimism for people to see the move in a positive light. However, sending rates into negative territory at a time pessimism is dominant can easily be interpreted as a sign of desperation, and therefore as confirmation of a negative outlook. Under such circumstances, the incentives to regard the banking system as risky, to withdraw physical cash and to hoard it for a rainy day increase substantially. Not only does the money supply fail to grow, as new loans are not made, but the velocity of money falls as money is hoarded, thereby aggravating a deflationary spiral:

A decline in the velocity of money increases deflationary pressure. Each dollar (or yen or euro) generates less and less economic activity, so policymakers must pump more money into the system to generate growth. As consumers watch prices decline, they defer purchases, reducing consumption and slowing growth. Deflation also lifts real interest rates, which drives currency values higher. In today’s mercantilist, beggar-thy-neighbour world of global trade, a strong currency is a headwind to exports. Obviously, this is not the desired outcome of policymakers. But as central banks grasp for new, stimulative tools, they end up pushing on an ever-lengthening piece of string.

 

 

Japan has been in the economic doldrums, with pessimism dominant, for over 25 years, and the population has become highly sceptical of stimulation measures intended to lead to recovery. The negative interest rates introduced there (described as ‘economic kamikaze’) have had a very different effect than in Scandinavia, which is still more or less at the peak of its bubble and therefore much more optimistic. Unfortunately, lowering interest rates in times of collective pessimism has a poor record of acting to increase spending and stimulate the economy, as Japan has discovered since their bubble burst in 1989:

For about a quarter of a century the Japanese have proved to be fanatical savers, and no matter how low the Bank of Japan cuts rates, they simply cannot be persuaded to spend their money, or even invest it in the stock market. They fear losing their jobs; they fear a further fall in shares or property values; they have no confidence in the investment opportunities in front of them. So pathological has this psychology grown that they would rather see the value of their savings fall than spend the cash. That draining of confidence after the collapse of the 1980s “bubble” economy has depressed Japanese growth for decades.

Fear is a very sharp driver of behaviour — easily capable of over-riding incentives designed to promote spending and investment:

When people are fearful they tend to save; and when they become especially fearful then they save even more, even if the returns on their savings are extremely low. Much the same goes for businesses, and there are increasing reports of them “hoarding” their profits rather than reinvesting them in their business, such is the great “uncertainty” around the world economy. Brexit obviously only added to the fears and misgivings about the future.

Deflation is so difficult to overcome precisely because of its strong psychological component. When the balance of collective psychology tips from optimism, hope and greed to pessimism and fear, everything is perceived differently. Measures intended to restore confidence end up being interpreted as desperation, and therefore get little or no traction. As such initiatives fail, their failure becomes conformation of a negative bias, which increases the power of that bias, causing more stimulus initiatives to fail. The resulting positive feedback loop creates and maintains a vicious circle, both economically and socially:

There is a strong argument that when rates go negative it squeezes the speed at which money circulates through the economy, commonly referred to by economists as the velocity of money. We are already seeing this happen in Japan where citizens are clamouring for ¥10,000 bills (and home safes to store them in). People are taking their money out of the banking system to stuff it under their metaphorical mattresses. This may sound extreme, but whether paper money is stashed in home safes or moved into transaction substitutes or other stores of value like gold, the point is it’s not circulating in the economy. The empirical data support this view — the velocity of money has declined precipitously as policymakers have moved aggressively to reduce rates.

Physical cash under one’s own control is increasingly seen as one of the primary escape routes for ordinary people fearing the resumption of the 2008 liquidity crunch, and its popularity as a store of value is increasing steadily, with demand for cash rising more rapidly than GDP in a wide range of countries:

While cash’s use is in continual decline, claims that it is set to disappear entirely may be premature, according to the Bank of England….The Bank estimates that 21pc to 27pc of everyday transactions last year were in cash, down from between 34pc and 45pc at the turn of the millennium. Yet simultaneously the demand for banknotes has risen faster than the total amount of spending in the economy, a trend that has only become more pronounced since the mid-1990s. The same phenomenon has been seen internationally, in the US, eurozone, Australia and Canada….

….The prevalence of hoarding has also firmed up the demand for physical money. Hoarders are those who “choose to save their money in a safety deposit box, or under the mattress, or even buried in the garden, rather than placing it in a bank account”, the Bank said. At a time when savings rates have not turned negative, and deposits are guaranteed by the government, this kind of activity seems to defy economic theory. “For such action to be considered as rational, those that are hoarding cash must be gaining a non-financial benefit,” the Bank said. And that benefit must exceed the returns and security offered by putting that hoarded cash in a bank deposit account. A Bank survey conducted last year found that 18pc of people said they hoarded cash largely “to provide comfort against potential emergencies”.

This would suggest that a minimum of £3bn is hoarded in the UK, or around £345 a person. A government survey conducted in 2012 suggested that the total number might be higher, at £5bn….

…..But Bank staff believe that its survey results understate the extent of hoarding, as “the sensitivity of the subject” most likely affects the truthfulness of hoarders. “Based on anecdotal evidence, a small number of people are thought to hoard large values of cash.” The Bank said: “As an illustrative example, if one in every thousand adults in the United Kingdom were to hoard as much as £100,000, this would account for around £5bn — nearly 10pc of notes in circulation.” While there may be newer and more convenient methods of payment available, this strong preference for cash as a safety net means that it is likely to endure, unless steps are taken to discourage its use.

Mar 202016
 
 March 20, 2016  Posted by at 9:50 am Finance Tagged with: , , , , , , , , ,  


NPC Kidwell’s Market on Pennsylvania Avenue, Washington DC 1920

World Is ‘Overloaded On Monetary Policy’, Says OECD (Tel.)
Central Banks Are Already Doing The Unthinkable – You Just Don’t Know It (Tel.)
Helicopter Drops By Stealth (Tel.)
Buyback Blackout Period Starts Monday (ZH)
Another False Oil Price Rally: Crossing A Boundary (Berman)
China’s Property Rally Has ‘Reached A Tipping Point’ (Forbes)
China’s Bottom Line to Avoid Systemic Risks, Vice Premier Says (BBG)
China Top Planner Promises Foreign Companies Access To Markets (WaPo)
Why Are There Doubts Over China’s Growth Rate? (Forbes)
Support For Impeaching Brazil’s President Rises To 68% (Reuters)
German Right Wing Demands Referendum on EU, Refugee Crisis (Express)
Greece Delays Sending Refugees Back To Turkey Under EU Deal (AFP)
EU-Turkey Deal: Officials Left In The Dark As Deadline Looms (Tel.)
Don’t Make Us Ashamed To Be European (3 Mayors)

One trick ponies.

World Is ‘Overloaded On Monetary Policy’, Says OECD (Tel.)

Central banks cannot haul economies out of stagnation on their own, the OECD has warned. Catherine Mann, chief economist at the Paris-based think-tank, said countries were now “overloaded on monetary policy” as she described the use of negative interest rates as “a reaction of central banks trying to meet the objective of raising inflation and fostering growth alone”. Ms Mann said banks faced being “squeezed” by the unintended consequences of sub-zero rates in an environment where demand remained subdued. The OECD has repeatedly warned that fiscal policy and structural reforms are needed to ensure recoveries are self-sustaining. “In the economies where negative interest rates are most deployed, the credit channel is particularly important, and this is impaired. Banks in Europe for example have not deleveraged and they as a result are not in a position to effectively lend credit,” said Ms Mann.

“They are also squeezed in the middle between negative interest rates on the one hand and very soft economic activity on the other. So negative interest rates are tough. It’s a tough policy to use.” Mark Carney, the Governor of the Bank of England, has warned that negative interest rates could do more harm than good by eating into banks and building societies’ profits and pushing up consumer charges. Earlier this month, the ECB stepped up efforts to reflate the eurozone. Policymakers slashed its deposit rate deeper into negative territory and beefed-up its quantitative easing programme. In a bid to spur credit growth, the ECB sweetened its incentive for banks to lend by revamping its targeted longer-term refinancing operations (TLTROs).

From this June, banks that lend more will be paid as much as 0.4pc to borrow from the ECB. Ms Mann said the ECB’s actions were welcome, but would not get Europe “back on track” on their own. “The ECB has done a lot, but the effective way to enhance economic activity in the euro area is a three-legged stool: fiscal, monetary and structural. What [Mario] Draghi [the president of the ECB] has done is make the monetary leg of the stool even longer, so we’re not there yet with the recipe we need in order to get Europe back on track.” Some experts argue that central banks will be forced to inject money directly into the economy through so-called “helicopter drops” in order to boost flagging nations.

Read more …

The road to helicopter money.

Central Banks Are Already Doing The Unthinkable – You Just Don’t Know It (Tel.)

The lords of finance are losing their touch. Institutions which dragged the world from its worst depression since the early 20th century are finally seeing their magic desert them, if conventional wisdom is to be believed. Eight years on the from the Great Recession, voices as authoritative as the IMF and the BIS – dubbed the ‘central bank of central banks’ – have called time on the era of extraordinary monetary policy. Having hoovered up $12.3 trillion in financial assets and carried out 637 interest rate cuts since 2008, central banks have been stunned back into action in the last six weeks. The Bank of Japan kicked off a new round of global easing with its decision to cross the rubicon into negative interest rate territory on January 29.

Eurozone policymakers followed suit earlier this month with a triple whammy of interest rate cuts, €20bn in additional asset purchases a month, and an unprecedented move to allow commercial banks to borrow money at negative rates. The Federal Reserve has also taken its foot off the pedal by slashing its expected interest rate hikes from four a year to just two. But the new wave of policy accommodation has ushered in fresh panic that monetary policy is suddenly subject to dwindling returns. Instead, talk has turned to governments finally pulling their weight to support the shaky global recovery. Fiscal policy has been largely dormant in the wake of the crisis as countries have concentrated on bringing down debt and deficits levels, binding themselves to stringent spending rules in the process.

Without tax breaks and greater state investment, the world is at risk of another “economic derailment”, the IMF has warned. The latest G20 communique has paid lip service to the idea that global governments will adopt policies to “strengthen growth, job creation and confidence”. In reality, there are little signs that politicians are ready to jettison their fixations on low debt and balanced budgets to support global growth.

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Part 2 of the long article above that takes a while getting to the point.

Helicopter Drops By Stealth (Tel.)

For some observers, the next phase in extraordinary central bank action has already arrived, and it is Japan which is leading the way. The Bank of Japan’s move to impose a three tiered deposit rate on banks this year can be seen as a covert attempt to transfer funds to the private sector, argues Eric Lonergan, economist and hedge fund manager. He notes that the BoJ’s decision to exempt some reserves from the negative rate represents a transfer of cash to commercial lenders at rate of 0.1pc. The system “separates out the interest rate on reserves from that which affects market rates”, says Lonergan. “It is taking the first step along the journey towards helicopter money and opens up a whole new avenue of stimulus”. In the same vein, the ECB has also signaled its intention to move away from endless interest rate cuts towards targeted attempts to boost private sector credit demand.

From June, eurozone banks will be paid as much as 0.4pc to borrow from the ECB for four years – a scheme dubbed ‘Targeted Long-Term Refinancing Operations’ (TLTRO’s). Lenders who do the most to pass on cheap loans to customers will be rewarded with the most favourable rates. “I wish they’d done it an awful lot sooner”, says Lonergan, who notes that for all its institutional constraints, the ECB still boasts a number of tools to boost bank lending. With government borrowing costs at rock bottom across the eurozone, even more QE would be unnecessary at this stage, he says. TLTRO’s however, “open the possibility of two different rates where you can leave the policy rate unchanged but lend to banks at lower and lower rates contingent on them lending to the real economy” he adds. “It is much cleverer way of doing things because savers do not suffer.”

But central bank ingenuity – however welcome – raises separate concerns about the accountability of institutions whose independence is sacrosanct but where decision-making is often insulated from public view. Lord Adair Turner, a former chairman of the Financial Services Authority, and one of the earliest advocates of helicopter money, calls for more transparency in a bid to finally smash the taboos around injecting money straight into the hands of consumers or governments. “I think it is more dangerous for central banks to forever denying what they are doing,” says Lord Turner. He calls Japan’s move to issue government debt at a rate of 40 trillion yen, while the central bank expands its balance sheet at a rate of 80 trillion yen a year, “a de facto debt monetisation”. “You are effectively replacing government debt with central bank money,” says Lord Turner. “It would be better for authorities to publish a statement, laying out the rules and assuring the world it is not too much.”

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It’s been all buybacks, so this should scare you.

Buyback Blackout Period Starts Monday (ZH)

Last week, one day before the Fed unleashed a statement that stunned Wall Street by its dovishness and admission that the Fed had been far too optimistic on the state of the US (and global) economy, when it slashed its forecast on the number of rate hikes from 4 to 2, we said that “while everyone’s attention is on the Fed, the biggest danger to the S&P500 has little to do with what Janet Yellen may say tomorrow, and everything to do with the marginal buyer of stocks being put into a state of forced hibernation”, namely the start of the stock buyback blackout period during Q1 earnings session.

As a reminder, even Bloomberg recently acknowledged the unprecedented role corporate stock repurchases play in the current market when it penned “There’s Only One Buyer Keeping S&P 500’s Bull Market Alive.” Of course,  our readers have known the identity of the “mystery, indescriminate buyer” for two years.

Today, it is Deutsche Bank’s turn to warn about the imminent end of buybacks for the next 6 weeks. From Parag Thatte’s latest Asset Allocation and Flows report:

Buyback blackout period starts Monday. An increasing number of S&P 500 companies will enter into their blackout period starting next week, about a month before the earnings season kicks into high gear in the third week of April

Deutsche Bank tries to spin it as not necessarily a source of downside:

The blackout period means a slowing in the pace of buybacks which leaves equities vulnerable to negative catalysts. However it does not automatically imply downside and as we have emphasized before it is the total demand-supply gap that is key. So flows are critical and data surprises suggest the recent flow rotation into US equities can go further

There are two problems with this assessment. First. as DB’s own chart below shows, traditionally US equity flows have seen substantial and sharp declines during the buyback blackout period during the past three calendar years. It is unclear why this time will be any different.

Second, and more important, is that as Bank of America reported earlier this week, in the latest week “during which the S&P 500 climbed 1.1%, BofAML clients were net sellers of US stocks for the seventh consecutive week. Net sales of $3.7bn were the largest since September and led by institutional clients (where net sales by this group were the second-largest in our data history). Hedge funds and private clients were also net sellers, as was the case in each of the prior two weeks, but a different group has led the selling each week. Clients sold stocks across all three size segments, and net sales of mid-caps were notably the largest since June ’09.”

BofA’s summary: “clients don’t believe the rally, continue to sell US stocks” and they were selling specifically to corporations whose repurchasing activity is near all time highs: “buybacks by corporate clients accelerated for the third consecutive week to their highest level in six months, which is also above levels at this time last year.

Next week this “accelerating” buyback activity ends, and the question will be whether the S&P at a high enough level to give institutional investors comfort that without the buyback bid, in fact the only bid for the past seven weeks, they should now buy on their own, or will the selling, which took place as the market has soared from its recent lows in its biggest quarterly comeback ever…

 

… continue, only this time with a cheap debt-funded, price indiscriminate buyer on the other side to absorb all the selling. We will have the answer in just about one week’s time.

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Keep your eyes on the dollar.

Another False Oil Price Rally: Crossing A Boundary (Berman)

The oil-price rally that began in mid-February will almost certainly collapse. It is similar to the false March-June 2015 rally. In both cases, prices increased largely because of sentiment. As in the earlier rally, current storage volumes are too large and demand is too weak to sustain higher prices for long. WTI prices have increased 47%  over the past 20 days from $26.21 in mid-February to $38.50 last week (Figure 1).

Figure 1. NYMEX WTI futures prices & OVX oil-price volatility, 2015-2016. Source: EIA, CBOE, Bloomberg and Labyrinth Consulting Services, Inc. (click image to enlarge).

 

A year ago, WTI rose 41% in 35 days from $43 to almost $61 per barrel. Like today, analysts then believed that a bottom had been reached. Prices stayed around $60 for 37 days before falling to a new bottom of $38 per barrel in late August. Much lower bottoms would be found after that all the way down to almost $26 per barrel at the beginning of the present rally.

Higher prices were unsustainable a year ago partly because crude oil inventories were more than 100 mmb (million barrels) above the 5-year average (Figure 2). Current inventory levels are 50 mmb higher than during the false rally of 2015 and are they still increasing.

Figure 2. U.S. crude oil stocks. Source: EIA and Labyrinth Consulting Services, Inc. (click image to enlarge).

 

International stocks reflect a similar picture. OECD inventories are at 3.1 billion barrels of liquids, 431 mmb more than the 2010-2014 average and 359 mmb above the 2015 level. Approximately one-third of OECD stocks are U.S. (1.35 billion barrels of liquids).

For 2015, U.S. liquids consumption shows a negative correlation with crude oil storage volumes (Figure 3). During the 2015 false price rally, consumption began to increase in April and May following the lowest WTI oil prices since March 2009–response lags cause often by several months. First quarter 2015 prices averaged $47.54 compared to an average price of more than $99 per barrel from November 2010 through September 2014 (44 months).

Figure 3. U.S. liquids consumption, crude oil stocks and WTI price. Source: EIA, Bloomberg and Labyrinth Consulting Services, Inc. (click image to enlarge).

 

This coincided with the onset of declining U.S. crude oil production after April 2015 (Figure 4).

Figure 4. U.S. crude oil production and forecast. Source: EIA March 2016 STEO and Labyrinth Consulting Services, Inc. (click image to enlarge).

 

Net withdrawals from storage continued until consumption fell in July in response to higher oil prices that climbed to $60 per barrel in June. Production increased because of higher prices from July through November before resuming its decline after prices fell again, this time, far below previous lows. This complex sequence of market responses shows how sensitive the current market is to relatively small changes in price, production and consumption.

Most importantly, it suggests that a price variation of only $15 per barrel was enough to depress consumption a year ago. That has profound implications for the present price rally that is now $12 per barrel above its baseline and has already increased by a greater percentage than the 2015 rally.

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“For homebuyers, it is easier than ever to get mortgages.” But more important, the downpayment itself is today often being financed through peer-to-peer lending channels, [..] basically another form of high-interest “loan shark.”

China’s Property Rally Has ‘Reached A Tipping Point’ (Forbes)

The real estate market in China is once again burning hot. Home prices in Beijing, Shanghai and Shenzhen have surged by 20-30% since the Lunar New Year in February, according to state-controlled media. In Shenzhen, prices have increased by more than 70% over the past 12 months. “The makings of this rally started more than a year ago and have reached a tipping point,” says Steven McCord at JLL North China. “Policies are looser than at any time in history in the last ten years, including the major policy rollbacks of 2009.” This is not the first time China is facing a property bubble. But one thing makes this time around different – unregulated lending. Previous upswings were not driven by leverage, McCord explains. The norm was that people did not finance the maximum allowable level.

They financed, on average, half of the cost – even if 70% or 80% was allowed. Therefore, mortgages did not play a role in driving up demand or prices. “Now, we believe there are more buyers using the maximum available leverage,” he says. “For homebuyers, it is easier than ever to get mortgages.” But more important, McCord adds, the downpayment itself is today often being financed through peer-to-peer lending channels. “This is not the norm yet, but it’s appearing and it makes us uncomfortable,” he says. “This means some buyers are buying with zero down.” In his view, peer-to-peer lenders are basically another form of high-interest “loan shark.” Hong Kong Economic Journals recently reported that some 900 peer-to-peer lending platforms went belly up last year, three times the number in 2014.

While some bankruptcies were due to poor management, many companies folded after the owner or operator took the money and disappeared. “Unregulated lending adds fuel to the fire of any bubble, and this could be a real problem if it becomes common,” McCord said. Chen Zhenggao, Minister of Housing and Urban-Rural Development, said earlier this week that China’s real estate market would not collapse. “It is not appropriate to compare the real estate market in China with that of Japan in the 1990s, as the two countries are in different stages of economic development and urbanization. We also have different macro policies to control the situation,” Chen said at a news conference.

Read more …

Really?

China’s Bottom Line to Avoid Systemic Risks, Vice Premier Says (BBG)

China will do what it needs to tamp down risks to the stocks, bonds, foreign-exchange and property markets as economic growth slows, Vice Premier Zhang Gaoli said in a speech. The economy faces “relatively large” downward pressure, said Zhang, who is one of seven members of the ruling Communist Party’s top decision-making body, the Politburo Standing Committee. He said plans for a 3% fiscal deficit, outlined in Premier Li Keqiang’s March 5 report to the national legislature, are meant to ease the burden on business. “There will be no systemic risks – that’s our bottom line,” Zhang told the China Development Forum, an annual gathering of global business leaders and Chinese government officials. Zhang’s remarks echoed recent comments from top officials, including the chairman of the securities regulator, that the government would act swiftly to stop the sort of market turmoil that led to a $5 trillion stock-market wipeout last August.

Premier Li Keqiang told his annual news conference on March 16 that China needs to be on the lookout for financial-market risks with “golden-gaze fiery eyes.” Speaking earlier Sunday, IMF Managing Director Christine Lagarde said China is in the middle of a historic transition that’s “good for China and good for the world.” “We should expect that, like any major transition, it will at times be bumpy,” Lagarde said, according to her prepared remarks. “A delicate balance needs to be struck between shifting to a relatively slower but more sustainable pace of growth, and advancing much-needed structural reforms.” Zhang said the government plans to cut overcapacity, especially in the steel and coal sectors. China’s 13th Five-Year Plan, unveiled during the legislative session that ended March 16, said the government will reduce as much as 150 million tons of steel capacity.

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After they’ve collapsed.

China Top Planner Promises Foreign Companies Access To Markets (WaPo)

China’s top planner tried to reassure foreign companies they are welcome in its slowing, state-dominated economy in a speech Sunday aimed at dispelling growing anxiety Beijing is squeezing them out of promising industries. Speaking to an audience that included executives of top global companies at a government-organized conference, Xu Shaoshi pledged to “promote two-way opening up and liberalization.” Xu promised foreign companies equal treatment with local enterprises as Beijing carries out a sweeping overhaul aimed at promoting self-sustaining growth based on domestic consumption and making state companies that dominate a range of industries more competitive and efficient. “We are ready to share these growth opportunities with you,” said Xu, chairman of the Cabinet’s National Reform and Development Commission.

The China Development Forum 2016 is being closely watched by global companies because it comes at the start of the ruling Communist Party’s latest five-year development plan that runs through 2020. Executives are eager to learn details of how the party might carry out pledges to make the economy more competitive, open more industries to private and possibly foreign competitors and to shrink bloated, money-losing industries including coal, steel and cement. The guest list for the weekend conference at a government guesthouse in the Chinese capital included executives of U.S., European and Asian banks, manufacturers, Internet and other companies.

The ruling party’s plan promises to give the private sector a bigger economic role, but business groups say regulators are trying to shield Chinese rivals from competition or compel foreign companies to hand over technology in exchange for market access. Business groups say Beijing has yet to carry out most of the reforms promised in a separate 2013 plan that called for giving market forces a “decisive role” in the economy. They point to limits on foreign ownership in an array of industries and say in some areas such as information security technology for banks regulators are reducing or blocking market access.

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“Examining a range of indicators from VAT rates to steel production volumes, and comparing the results to estimates of the government deficit, produces the startling suggestion that “the real economy in China probably isn’t growing at all.”

Why Are There Doubts Over China’s Growth Rate? (Forbes)

China’s growth rate has been in the spotlight ever since Li Keqiang – China’s Premier – signalled the arrival of a ‘new normal’ in May 2015. Before then, headline rates routinely in excess of 8%, even rising above 14% in 2007, meant the detail was not scrutinised so closely. Now, however, with growth forecast between 6.5% and 7% for the period to 2020, the decimal points are beginning to matter. For China, the growth rate indicates the continuing success of their economic development, and measures their progress towards prosperity. For the rest of the world, Chinese growth has become a crucial source of global demand, driving expansion – and revenue streams – everywhere. There is, therefore, no exaggerating the significance of the number, both in fact and in appearance.

But increasing doubts are being raised. A recent article in Foreign Affairs raised the possibility that, despite a headline growth figure of 6.9% for 2015, China’s economy may not be growing at all. Examining a range of indicators from VAT rates to steel production volumes, and comparing the results to estimates of the government deficit, produces the startling suggestion that “the real economy in China probably isn’t growing at all. It may even be shrinking.” Doubts about the official figures are not new of course, but the difference between 6.9% and 0.0% is pretty striking nonetheless. And what often goes unsaid is that the official estimates are always at the high end of expectations. As a follow up, Foreign Affairs published a more optimistic account just a few weeks later.

According to this version of events, the ‘Li Keqiang’ index is out of date, reflecting the sort of industrially focussed economy that China was 10 years ago. But even this measure has different methods of calculation, producing results which vary between 2.9% and 5% for 2015. This account, however, also implies the official figures are not very precise estimates. The main argument is that the Chinese economy has changed and now shows significant growth in the service sector, as opposed to the industrial and manufacturing sector.

Read more …

Zika, poisoned water, riots and impeachment: here come the Olympics.

Support For Impeaching Brazil’s President Rises To 68% (Reuters)

A growing majority of Brazilians favor impeachment of President Dilma Rousseff or her resignation, according to a survey released on Saturday by polling firm Datafolha. The poll showed 68% of respondents favor Rousseff’s impeachment by Congress, while 65% think the president should resign. The president’s approval ratings have been hammered by Brazil’s worst recession in decades and its biggest ever corruption probe. Rousseff’s popularity also fell, with 69% of respondents rating her government negatively. The current%age is close to the president’s lowest ratings on record, in August 2015, when 71% of respondents rated the government negatively.

The poll also showed that rejection levels for former President Luiz Inacio Lula da Silva, who was named as Rousseff’s chief of staff on Wednesday, rose to a record 57%. That is far higher than the previous high of 40% in September 1994, before his 2003-2010 presidency. A Supreme Court judge suspended Lula’s appointment on Friday, saying it might interfere with an investigation by prosecutors, who have charged him with money laundering and fraud, as part of the probe into political kick back scheme at state oil company Petrobras. Even if Brazilians support Rousseff’s ouster, voters are not enthusiastic about a government led by vice-president Michel Temer. Some 35% of respondents say his government would be “bad” or “terrible”. Datafolha surveyed 2,794 people on March 17 and 18.

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A Europe-wide idea.

German Right Wing Demands Referendum on EU, Refugee Crisis (Express)

Alternative fur Deutschland, formed in 2013, shocked the German establishment last week with huge gains in state elections. The results have placed it in prime position to challenge Mrs Merkel’s CDU/CSU coalition in next year’s general election. Speaking exclusively to the Sunday Express last night, party leaders shared their envy of Britain’s forthcoming EU referendum on June 23, and confirmed they would be pushing for a similar move in Germany. “I want every member state to decide what is better for them, and the only way we can really do that is to have a referendum, like the UK.” said deputy chairman Beatrix von Storch MEP. “Schengen has collapsed already. Under Schengen Europe’s borders are supposed to be protected. They’re not.

“A referendum is the only way German people can truly express if they want to stay in the EU, if they want to stay in the Euro, if they want to reform border controls to deal with the migrant crisis. They should be given a voice. They must be asked what they want.” Angela Merkel last week refused to back down on her policy not to cap the number of refugees given asylum in Germany. Over the last 12 months, more than 1.1 migrants have crossed Germany’s borders with 300,000 granted asylum. The policy will cost German taxpayers £36bn by 2017, according to a recent report. AfD won an extraordinary 61 seats in 3 regional parliaments last week, coming second with 24% of the votes in Saxony-Anhalt. “We’re still a very young party so it’s a huge success,” said Ms von Storch.

“What’s even more important is the result in Baden-Wuertemberg, where we overtook the SDP, a ruling coalition party, to gain 15% of the votes. “Our success shows that the people are no longer supporting the politics of our Chancellor and all the other parties who back her. “We are the only ones arguing that the only way for Germany to fight the refugee and migrant crisis is to close our borders.”

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The 2,300 ‘experts’ promised -and needed- for the deal are not available. It’ll take weeks for them to get to the islands. What happens to new arrivals in the meantime?

Greece Delays Sending Refugees Back To Turkey Under EU Deal (AFP)

Greece will not be able to start sending refugees back to Turkey from Sunday, the government said, as the country struggles to implement a key deal aimed at easing Europe’s migrant crisis. Under the agreement clinched between Brussels and Ankara last week, migrants who reach the Greek islands will be deported back to Turkey. For every Syrian returned, the EU will resettle one from a Turkish refugee camp. The deal aims to strangle the main route used by migrants travelling to the EU and discourage people smugglers, but it has faced criticism from rights groups and thousands took to the streets of Europe in protest. Greek premier Alexis Tsipras told his ministers on Saturday afternoon to be ready to begin deporting people the following day, as agreed, but officials said afterwards they needed more time to prepare.

“The agreement to send back new arrivals on the islands should, according to the text, enter into force on March 20,” the government coordinator for migration policy (migration coordination agency) spokesman Giorgos Kyritsis told AFP. “But a plan like this cannot be put in place in only 24 hours.” Around 1,500 people crossed the Aegean to Greece’s islands Friday before the deal was brought in, officials said – more than double the day before and compared with several hundred a day earlier this week. A four-month-old baby drowned when a migrant boat sank off the Turkish coast Saturday hours before the deal came into force, Turkey’s Anatolia agency reported. Hundreds of security and legal experts – 2,300 according to Tsipras – are set to arrive in Greece to help enforce the deal, described as “Herculean” by EC chief Jean-Claude Juncker.

Paris and Berlin have pledged to send 600 police and asylum experts to Greece, according to a joint letter seen by AFP. But Greek officials said they were still waiting for the extra personnel, and without them they would struggle to enforce the new accord. “We still don’t know how the deal will be implemented in practice,” a police source on the island of Lesbos told AFP. “Above all, we are waiting for the staff Europe promised to be able to quickly process asylum applications – translators, lawyers, police officers – because we cannot do it alone.” Realistically, migrants will likely not start being returned to Turkey until April 4, according to German Chancellor Angela Merkel, a key backer of the scheme. The numbers are daunting: officials said as of Saturday there were 47,500 migrants in Greece, including 8,200 on the islands and 10,500 massed at the Idomeni camp on the Macedonian border.

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“If they told me I had to go back, I would drown myself in the sea.”

EU-Turkey Deal: Officials Left In The Dark As Deadline Looms (Tel.)

Europe’s refugee resettlement programme with Turkey appeared to be descending into farce last night as officials on the Greek island of Lesbos reported they had received no instructions from the EU authorities on how to proceed. As the midnight deadline approached for the EU’s new deportation regime with Turkey, organisations and local authorities on Lesbos, where the majority of boats land, said not a single new staff member had arrived and no information had been received. “We don’t know anything,” said Marios Andriotis, advisor to the mayor of Lesbos. “We have received many officers from [the EU border agency] Frontex et cetera over the past year but no one new since Friday. And nobody told us to prepare anything or do anything differently.”

“We have taken note of the deal but we are not privy to details of the implementation,” said Boris Cheshirkov, a spokesman for the United Nations Refugee Agency (UNHCR). Jean-Claude Juncker, the president of the European Commission described the controversial plan as last week as a “Herculean task” that will present “the biggest challenge the EU has ever faced”, but there was no sign last night on Lesbos of even a symbolic show of intent. Under the terms of the deal agree last Friday, some 4,000 extra staff have been promised to process all new arriving refugees who will be deported back to Turkey after undergoing fast-track asylum processing. The first deportations are scheduled for April 4. The Greek authorities said yesterday there are now 47,500 migrants in the country, of which 8,200 were on the islands and some 10,500 massed at Idomeni, on the closed border with Macedonia.

NGO workers and volunteers in reception camps on Lesbos, which will serve as detention camps for migrants and refugees waiting to be returned to Turkey, shook their heads when asked about the implementation of the deal. “Like the husband of an unfaithful wife, we will always be the last to know anything about Europe’s deals,” said a UNHCR worker in Kara Tepe camp, where 1,500 Syrians and Iraqis are currently staying. “Really, we have no information.” Refugees in the camp called the idea of being returned “inhumane”, while Amnesty International has called the deal a “historic blow to human rights” raising the prospect of future legal challenges to the deal. The EU insists the deal is lawful.

Those that are now on Lesbos will not be sent back, though with Macedonia’s border still closed, they face an uncertain road ahead. “There is nothing for us in Turkey. No life, no work. I worked bad jobs for 700 lira (£170) a month, I could not put a roof over my family’s head,” said Samir, a teacher from Damascus who had been in the camp for five days. “If they told me I had to go back, I would drown myself in the sea.” In nearby Moria camp hundreds of mainly Pakistani migrants are housed in tents pitched on a muddy field outside the sealed-off EU “hotspot”, the official reception camp. Camp volunteers debated how to break the news of the returns to tomorrow’s arrivals. “They’ll just try again,” said Emma Kriss, an American volunteer. “I don’t think people will give up.”

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Article by Ada Colau, Mayor of Barcelona, Giuseppina Nicoli, Mayor of Lampedusa, and Spyros Galinos, Mayor of Athens

Don’t Make Us Ashamed To Be European (3 Mayors)

Two and a half thousand years ago, the islands of the Western Mediterranean were the cradle of the sciences, the arts and democracy. Today, they’re where the survival of Europe is at stake. We find ourselves facing a dilemma: either we assume our responsibility and strengthen the founding principles of the European project or we allow it to sink irreversibly. There is hope. Over recent months we’ve seen thousands of citizens, volunteers and aid workers working to save lives by helping those fleeing from war. We’ve seen local governments with hardly any legal powers carry out herculean tasks to receive refugees, investing the resources that state governments have refused.

Nevertheless, we’ve also observed, with sadness, not just the inability of European states to offer a dignified solution to the humanitarian crisis, but also transit routes being choked off; increasing border controls and repression, and the aberration of a deal with Turkey that contravenes all international law regarding asylum and fundamental rights. Local initiatives stand in stark contrast to the lack of sensitivity demonstrated by European states. While state governments haggle quotas, we cities make contingency and awareness-raising strategies that, with adequate resources, we have a greater capacity to take in refugees than has been recognized. While state governments agree to repressive measures, we municipalities are working in networks to reach deals, like the agreement between Lesbos, Lampedusa and Barcelona that will allow the exchange of knowledge, resources and solidarity between the three cities.

With state governments are incapable of thinking beyond their national context, Barcelona and Athens city halls are working together to put pressure on them to meet their ethical and legal obligations. We, the cities of the Mediterranean, urgently call for other European cities to put an end to the inhumane policies of state governments and to force them to change course in response to the greatest humanitarian crisis since the end of the Second World War. The families that have lost their homes will not rest in pursuit of a place to live in peace, however many obstacles are put in their way. Each new impediment will simply increase the risks to human life and be another incentive for those wishing to profit from people-trafficking. We call for the rejection of the deal with Turkey, which flouts international law and fundamental rights.

Human lives cannot be traded for economic and commercial agreements. The right to asylum is a basic human right that cannot be subject to discounts and bartering. We also call for an end to the criminalization of refugees, and of the aid workers and volunteers collaborating in their reception. Their work should be a source of pride, and be supported and incentivised by public institutions. Events in recent days at the border of the Former Yugoslav Republic of Macedonia, the xenophobic rallies seen in various European countries, and their subsequent electoral exploitation, are a display of indecency that should embarrass us as European citizens and as human beings.

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Feb 102016
 
 February 10, 2016  Posted by at 10:20 am Finance Tagged with: , , , , , , , , , ,  


Arthur Rothstein Scene along Bathgate Avenue in the Bronx 1936

Europe’s Dead Cats Bounce, Deutsche Up 10% (BBG)
Surging Credit Risk for Banks a Major Issue in European Markets (WSJ)
Banks Eye More Cost Cuts Amid Global Growth Concerns (Reuters)
Europe Banks May Face $27 Billion Energy-Loan Losses (BBG)
European Banks: Oil, Commodity Exposure As High As 160% Of Tangible Book (ZH)
Europe’s ‘Doom-Loop’ Returns As Credit Markets Seize Up (AEP)
Options Bears Circle Nasdaq (BBG)
Deutsche Bank’s Big Unknowns (BBG)
The Market Isn’t Buying That Deutsche Bank Is ‘Rock Solid’ (Coppola)
Deutsche Considers Multibillion Bond Buyback (FT)
Distillates Demand Signals US Recession Is Imminent (BI)
US Oil Drillers Must Slash Another $24 Billion This Year (BBG)
Five Reasons Behind US Bank Stocks Selloff (FT)
10-Year Japanese Government Bond Yield Falls Below Zero (FT)
EU Probes Suspected Rigging Of $1.5 Trillion Debt Market (FT)
Italy, A Ponzi Scheme Of Gargantuan Proportions (Tenebrarum)
Maersk Profit Plunges as Oil, Container Units Both Suffer (BBG)
Australia Admits Recent Stellar Job Numbers Were Cooked (ZH)
Pentagon Fires First Shot In New Arms Race (Guardian)
NATO Weighs Mission to Monitor Mediterranean Refugee Flow (BBG)
Border Fences Will Not Stop Refugees, Migrants Heading To Europe (Reuters)

Brimming with confidence. Deutsche buying back its debt at this point in the game screams EXIT.

Europe’s Dead Cats Bounce, Deutsche Up 10% (BBG)

European stocks rebounded from their lowest level since October 2013 as investors assessed valuations following seven days of declines. A measure of lenders posted the best performance of the 19 industry groups on the Stoxx Europe 600 Index, with Deutsche Bank rising 10% as a person familiar with the matter said the German bank is considering buying back some of its debt. Commerzbank climbed 6%. Greece’s Eurobank Ergasias recovered 11% after falling to its lowest since at least 1999 on Tuesday, and Italy’s UniCredit SpA gained 10%. The Stoxx 600 advanced 1.6% to 314.39 at 9:27 a.m. in London, moving out of so-called “oversold” territory.

Global equities have been battered in 2016 in volatile trading amid investor concern over oil prices, earnings, the strength of the U.S. and Chinese economies, as well as the creditworthiness of European banks. The Stoxx 600 now trades at 13.9 times estimated earnings, about 20% below its April 2015 peak. A gauge tracking stock swings has jumped 47% this year. “When it feels this bad, it’s usually a good buying opportunity,” said Kevin Lilley at Old Mutual Global Investors in London. “But we’ve just been through a huge crisis of confidence and I think a long-term rebound is still very dependent on central-bank policy and global macro data. You’re fighting negative newsflow with very low valuations at the moment, and that’s the trade off.”

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Not just in Europe either.

Surging Credit Risk for Banks a Major Issue in European Markets (WSJ)

If there’s one thing on the mind of analysts and investors in Europe right now, it’s credit risk. The recent selloff in equities has sparked questions over whether a similar bearishness on credit is justified, particularly among European banks that have been slammed in stock markets over the last month. The iTraxx Senior Financials index tracks the cost of credit default swaps, which protect the investors buying them against a company’s default, for major financial institutions in Europe. More credit risk means pricier CDS, and the cost of European bank CDS has taken off. The index is still far from the extremely elevated levels reached in 2012, during the dismal days of the euro crisis.

Some of the latest analysts to weigh in on the subject come from Bank of America Merrill Lynch. In a research note out on Monday titled “the tide has turned,” analysts Ioannis Angelakis, Barnaby Martin and Souheir Asba argue that risk is becoming more systematic. The authors go on: “Risks are not contained any more within the EM/oil related names. Global growth outlook fears and risks of quantitative failure have led to weakness into cyclical names. Add also the recent sell-off in financials and you have the perfect recipe for a market sell-off that looks and feels systemic.” Within the last week we’ve spoken to analysts and investors that disagreed, suggesting that European bank credit was quite secure. Either way, it’s clear that the worries about credit risks have become heightened. How far the threat to balance sheets now goes is one of the biggest questions in European markets right now.

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The more you try to look confident, the less you do.

Banks Eye More Cost Cuts Amid Global Growth Concerns (Reuters)

Goldman Sachs and other U.S. banks are looking at ways to slash expenses further this year as market turmoil, declining oil prices and concerns about Germany’s Deutsche Bank have sent the sector’s shares down sharply. “We can absolutely do a lot more on the cost side if we have to, especially now, when you have to deliver a return,” Goldman Chief Executive Officer Lloyd Blankfein said on Tuesday at the Credit Suisse financial services forum in Miami. “We take a particular and energetic look at continued cost cuts when revenues are stalled,” he said. ” … Necessity is the mother of invention.” U.S. Bancorp CFO Kathy Rogers echoed Blankfein’s comments at a separate panel, saying her bank would continue cutting costs this year. She cited a smaller chance that interest rates would rise, which would have indicated a stronger economy and more revenue for the bank.

As executives were speaking at the conference, Deutsche Bank shares hit a record low, following their 9.5% plunge on Monday. Although the bank has said it has sufficient reserves, investors have worried that it will not be able to repay some bonds that are coming due. The bonds, called AT1 securities, convert into equity in times of market stress. Deutsche Bank’s woes reflect broader concerns about the health and profitability of euro zone banks. Last week, for instance, Sanford Bernstein analyst Chirantan Barua said Barclays should spin off its investment bank in an effort to revive its core UK retail and commercial business. Major Wall Street banks have also had a brutal start to 2016, with the KBW Nasdaq Bank index down nearly 20% on concerns about profitability.

Since demand for U.S. bank shares began to weaken in late November, the sector’s top five stocks have lost 20% of their market capitalization, or around $120 billion. Almost 70% of the banks deemed globally significant are trading below their tangible book values, or what they would be worth if liquidated. Analysts say if this continues, banks may have to restructure more drastically to cut costs. Investors said bank executives would need to look at other ways to boost profitability now that hopes for further interest rates hikes have faded. “They’re going to have to come up with other levers to pull, whether it is investing in technology or reducing headcount,” said John Fox at Feinmore Asset Management, which invests in financials. “There will be more pressure on expenses because of the interest rate environment.”

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Bloomberg lowballing.

Europe Banks May Face $27 Billion Energy-Loan Losses (BBG)

European banks face potential loan losses from energy firms of $27 billion, or about 6% of their pretax profit over three years, according to analysts at Bank of America. “We believe European banks with large exposures to energy and commodities lending will be increasingly challenged over these positions by shareholders,” analysts Alastair Ryan and Michael Helsby wrote in a note to clients on Tuesday. “While long-term oil- and metal-price forecasts are well above current levels, we expect the equity market to continue to stress exposures to current market prices and deduct potential losses from the earnings multiple of the banks.”

The $27 billion estimate is “potentially a smaller figure than is implied in the share prices of a number of banks,” and lenders’ potential losses aren’t a threat to the capitalization of the banking system or its ability to provide credit to the economy, they wrote. European banks are getting walloped by the global market rout and plunge in global oil prices while struggling to bolster their capital buffers amid record low interest rates in the euro zone. The 46-member Stoxx Europe 600 Banks Index has lost about 27% this year, outpacing the 15% drop by the wider Stoxx 600.

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Tyler Durden doesn’t lowball.

European Banks: Oil, Commodity Exposure As High As 160% Of Tangible Book (ZH)

[..] Morgan Stanley writes, “Europeans have not typically disclosed reserve levels against energy exposure, making comparison to US banks challenging. Moreover, quality of books can vary meaningfully. For example, we note that Wells Fargo has raised reserves against its US$17 billion substantially non-investment grade book, while BNP and Cred Ag have indicated a significant skew (75% and 90%, respectively) to IG within energy books. Equally we note that US mid-cap banks typically have a greater skew to higher-risk support services (~20-25%) compared to Europeans (~5-10%) and to E&P/upstream (~65% versus Europeans ~10-20%).” Morgan Stanley then proceeds to make some assumptions about how rising reserves would impact European bank income statements as reserve builds flow through the P&L: in some cases the hit to EPS would be .

A ~2% reserve build in 2016 would impact EPS by 6-27%, we estimate:We believe noticeable differences exist between US and EU banks’ portfolios in terms of seniority and type of exposure. As such, applying the assumption of a ~2% further build in energy reserves in 2016, versus ~4% assumed for large US banks, we estimate that EPS would decline by 6-27% for European-exposed names (ex-UBS), with Standard Chartered, Barclays, Credit Agricole, Natixis and DNB most exposed. [..] But the biggest apparent threat for European banks, at least according to MS calulcations, is the following: while in the US even a modest 2% reserve on loans equates to just 10% of Tangible Book value…

… in Europe a long overdue reserve build of 3-10% for the most exposed banks, would immediately soak up anywhere between 60 and a whopping 160% of tangible book!

Which means just one thing: as oil stays “lower for longer”, and as many more European banks are forced to first reserve and then charge off their existing oil and gas exposure, expect much more diluation. Which, incidentlaly also explains why European bank stocks have been plunging since the beginning of the year as existing equity investors dump ahead of inevitable capital raises. And while that answers some of the “gross exposure to oil and commodities” question, another outstanding question is what is the net exposure to China. As a reminder, this is what Deutsche Bank’s credit analyst Dominic Konstam said in his explicit defense of what needs to be done to stop the European bloodletting:

The exposure issue has been downplayed but make no mistake banks are heavily exposed to Asia/MidEast and while 10% writedown might be worst case for China but too high for the whole, it is what investors shd and do worry about — whole wd include the contagion to banking hubs in Sing/HKong

Ironically, it is Deutsche Bank that has been hit the hardest as the full exposure answer, either at the German bank or elsewhere, remains elusive; it is also what has cost European banks billions (and counting) in market cap in just the past 6 weeks.

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“..Liquidity is totally drained and it is very difficult to exit trades. You can’t find a buyer..”

Europe’s ‘Doom-Loop’ Returns As Credit Markets Seize Up (AEP)

Credit stress in the European banking system has suddenly turned virulent and begun spreading to Italian, Spanish and Portuguese government debt, reviving fears of the sovereign “doom-loop” that ravaged the region four years ago. “People are scared. This is very close to a potentially self-fulfilling credit crisis,” said Antonio Guglielmi, head of European banking research at Italy’s Mediobanca. “We have a major dislocation in the credit markets. Liquidity is totally drained and it is very difficult to exit trades. You can’t find a buyer,” he said. The perverse result is that investors are “shorting” the equity of bank stocks in order to hedge their positions, making matters worse. Marc Ostwald, a credit expert at ADM, said the ominous new development is that bank stress has suddenly begun to drive up yields in the former crisis states of southern Europe.

“The doom-loop is rearing its ugly head again,” he said, referring to the vicious cycle in 2011 and 2012 when eurozone banks and states engulfed in each other in a destructive vortex. It comes just as sovereign wealth funds from the commodity bloc and emerging markets are forced to liquidate foreign assets on a grand scale, either to defend their currencies or to cover spending crises at home. Mr Ostwald said the Bank of Japan’s failure to gain any traction by cutting interest rates below zero last month was the trigger for the latest crisis, undermining faith in the magic of global central banks. “That was unquestionably the straw that broke the camel’s back. It has created havoc,” he said. Yield spreads on Italian and Spanish 10-year bonds have jumped to almost 150 basis points over German Bunds, up from 90 last year.

Portuguese spreads have surged to 235 as the country’s Left-wing government clashes with Brussels on austerity policies. While these levels are low by crisis standards, they are rising even though the ECB is buying the debt of these countries in large volumes under quantitative easing. The yield spike is a foretaste of what could happen if and when the ECB ever steps back. Mr Guglielmi said a key cause of the latest credit seizure is the imposition of a tough new “bail-in” regime for eurozone bank bonds without the crucial elements of an EMU banking union needed make it viable. “The markets are taking their revenge. They have been over-regulated and now are demanding a sacrificial lamb from the politicians,” he said.

Mr Guglielmi said there is a gnawing fear among global investors that these draconian “bail-ins” may be crystallised as European banks grapple with €1 trillion of non-performing loans. Declared bad debts make up 6.4pc of total loans, compared with 3pc in the US and 2.8pc in the UK.

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Pop some more.

Options Bears Circle Nasdaq (BBG)

Options traders are betting the pain is far from over in the Nasdaq 100 Index. Unconvinced a two-day decline of 5% found the bottom, they’re loading up on protection in the technology-heavy index, pushing the cost of options on a Nasdaq 100 exchange-traded fund to the highest in almost two years versus the Standard & Poor’s 500 Index, data compiled by Bloomberg show. It’s the latest exodus from risk in the U.S. equity market, with selling that started in energy shares spreading to everything from health-care to banks. Technology companies, which until recently had been spared because of their low debt burden and rising earnings, joined the rout as investors focus on elevated valuations among the industry’s biggest stocks.

“Exuberance has turned to panic pretty quickly,” said Stephen Solaka at Belmont Capital. “Technology stocks have had quite a run, and now they’re seeing momentum the other way.” The S&P 500 slipped less than 0.1% to 1,852.21 at 4 p.m. in New York, extending its three-day decline to 3.3%. The Nasdaq 100 lost 0.3%. Options are signaling more trouble ahead just as professional speculators dump bullish wagers on the group. Hedge funds and large speculators have pared back their long positions on the Nasdaq 100 for a fourth week out of five, data from the Commodity Futures Trading Commission show. Investors were dealt a blow on Friday when disappointing results from LinkedIn and Tableau sent both companies down more than 40%.

The selloff has been heaviest in a handful of momentum stocks that boosted returns in the Nasdaq 100 last year, sending the gauge’s valuation to a one-year high versus the S&P 500’s in December. Since then, the Nasdaq multiple has tumbled faster than the S&P 500’s, dropping 20% versus 13%, as stocks from Amazon to Netflix faced scrutiny from investors amid broader economic concerns. Even after a 16% plunge from a record in November, Nasdaq 100 companies still trade at 16.3 times projected profits, higher than the S&P 500’s 15.4 ratio. Scott Minerd at Guggenheim Partners said in an interview that technology stocks will tumble even further this year as investors flee to safety and buyers stay on the sidelines.

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Tick. Tock.

Deutsche Bank’s Big Unknowns (BBG)

Regulation is forcing banks to retrench from some previously lucrative businesses. Lacklustre economic growth and low interest rates are stymieing profit growth in other areas. Concerns about China’s economy and the energy industry are rippling through markets, reducing activity among bank clients.There are specific concerns about Deutsche Bank. Cryan is trying to reshape the business while facing these ominous economic and market headwinds. There’s still a slew of litigation costs to be settled. And he’s trying to offload parts of the bank that don’t fit any more, including Postbank, the domestic German retail unit. The announced full-year net loss of €6.8 billion darkened the mood.

The bank’s shares now trade at about 35% of the tangible book value of the bank’s assets, partly because equity investors can’t get a clear handle on what lies ahead. In the credit market, concerns were fueled Monday by a note from CreditSights analyst Simon Adamson that spelled out “a base case” for Deutsche Bank to pay AT1 coupons this year and next year. But there is a caveat – a bigger than expected loss this financial year, because of a major fine or other litigation cost, could wipe out the bank’s capacity to pay. In other words, what happens if a big unknown strikes? Deutsche Bank, for its part, made the case that it has more than enough capacity for the 2016 payment due in April – 1 billion euros of capacity compared with coupons of about €350 million.

The bank says it estimates it has €4.3 billion of capacity for the April 2017 payment, partly driven by the proceeds from selling its stake in a Chinese lender. That sale is still pending regulatory approval but should go through in coming months. So, Deutsche Bank ought to have enough to make its payments and will be desperate to do so. Can pay, will pay. Unless, the bank is hit with a big shock, like a major, unforeseen litigation cost. Nervous investors await further communication.

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“I have said before that Deutsche Bank should be broken up. Now is the time to do it.”

The Market Isn’t Buying That Deutsche Bank Is ‘Rock Solid’ (Coppola)

This has been a terrible day for Deutsche Bank. The stock price has collapsed, and shares are now trading lower than they were in the dark days of 2008 after the fall of Lehman. Yields on CoCos and CDS are spiking too. Despite a reassuring statement from the German Finance Minister that he had “no concerns” about Deutsche Bank, markets are clearly worried that Deutsche Bank may be in serious trouble. And when “serious trouble” means that shareholders, subordinated debt holders and even senior unsecured bondholders could lose part or all of their investment, because of the bail-in rules under the EU’s Bank Recovery and Resolution Directive (BRRD), it is hardly surprising that investors are running for the hills. Even if Deutsche Bank were not in trouble before, it is now.

Unsurprisingly, the CEO, John Cryan, is upbeat about it. Today he issued a statement to staff advising them how to address the concerns of clients:

Volatility in the fourth quarter impacted the earnings of most major banks, especially those in Europe, and clients may ask you about how the market-wide volatility is impacting Deutsche Bank. You can tell them that Deutsche Bank remains absolutely rock-solid, given our strong capital and risk position. On Monday, we took advantage of this strength to reassure the market of our capacity and commitment to pay coupons to investors who hold our Additional Tier 1 capital. This type of instrument has been the subject of recent market concern. The market also expressed some concern about the adequacy of our legal provisions but I don’t share that concern. We will almost certainly have to add to our legal provisions this year but this is already accounted for in our financial plan.

I reviewed Deutsche Bank’s financial position as stated in their interim results last week. My findings do not support John Cryan’s statement that the bank is “rock solid”. Its capital and leverage ratios were not particularly strong by current standards, and have deteriorated since the full-year results. More worryingly, I found evidence that profits in two of the four divisions were only achieved by risking-up: the other two divisions were loss-making. Risking-up to generate profits would, if sustained over the medium-term, require substantially more capital than Deutsche Bank currently has. For two divisions of a bank that is currently delivering NEGATIVE return on equity to adopt strategies which would in due course require more capital does not appear remotely sensible.

Though I suppose actually admitting that the bank cannot generate anything like a reasonable return for shareholders without taking significantly more risk would be even worse. I also share the market’s concern about lack of legal provisions. A large part of the write-off of 5.2bn Euros due to litigation costs and fines in the interim results arose from cases already settled, particularly the record multi-jurisdictional fine for benchmark rate rigging in April 2015, though it also includes the 1.3bn Euros increase in provisions announced in October 2015 to cover charges potentially arising from the investigation of Deutsche Bank’s Russian operation for money laundering. But since these provisions seem light for what is a serious offense, and Deutsche Bank faces other potentially very expensive regulatory investigations and legal cases, I do not consider this write-off adequate.

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They’re so f**ked. Biggest bank, biggest derivatives portfolio. Run for the hills. When you even need your finance minister to do a reassurance call, you know you’re cooked.

Deutsche Considers Multibillion Bond Buyback (FT)

Deutsche Bank is considering buying back several billion euros of its debt, as Germany’s biggest bank steps up efforts to shore up the tumbling value of its securities against the backdrop of a broader rout of financial stocks. After European banks suffered a second consecutive day of sharp falls, Deutsche Bank is expected to focus its emergency buyback plan on senior bonds, of which it has about €50bn in issue, according to the bank. The move was unlikely to involve so-called contingent convertible bonds which, along with the bank’s shares, have been the butt of a brutal investor sell-off in recent days, people briefed on the plan said. The news came as Germany’s finance minister Wolfgang Schäuble and Deutsche CEO John Cryan both sought to assuage market fears.

Mr Schäuble said he had “no concerns” about the bank, while Mr Cryan insisted Deutsche’s position was “absolutely rock-solid”. The bank’s shares still fell 4%, taking the decline since the start of the year to 40%. Other European banks fared even worse on Tuesday, with Credit Suisse falling 8% and UniCredit 7%, as investor nervousness intensified over the relative weakness of European bank capital and earnings amid broader market turmoil. US banks, which have been hit hard in recent weeks, too, were only marginally weaker at lunchtime on Tuesday. Investors have also been rattled by the prospect of negative interest rates spreading across the developed world.

On Tuesday Japan became the first major economy with a sub-zero borrowing rate for 10-year debt as the total of government bonds trading with negative yields climbed to a new peak of $6tn. Concern about the solidity of bank debt — principally European bank cocos, which can suspend coupons and may convert into equity in a crisis — has prompted an investor dash to buy protection. A popular credit derivatives index that tracks the likelihood of default of investment-grade debt of European companies and banks was trading at 119 basis points on Tuesday, near its highest level since June 2013. Broader investor concerns about the health of the financial sector have coincided with more specific questions about Deutsche’s nascent restructuring programme.

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Ouch. Peddling fiction, sir?

Distillates Demand Signals US Recession Is Imminent (BI)

The US economy is flashing warning signs, particularly the industrial and manufacturing sectors. Demand for oil, and particularly so-called distillates – which are refined oil products such as jet fuels and heating oils – is crashing. Here’s the Barclays commodities team on the indicator:

January US demand for the four main refined products came in at -568k b/d (-3.9% y/y), compared with January 2015. Distillates were the weakest sector, down 18% y/y. Whether or not the data itself point to much weaker underlying growth in the US economy is still open to question, but not much. As illustrated in Figure 4, the scale of the decline in distillates demand in January has only ever been seen before during full-blown US recessions.

And here’s that chart:

Barclays does cite some mitigating factors, such as unusually warm winter weather and the fact this is based on preliminary data that may get revised upward later on. But it doesn’t look great.

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And counting.

US Oil Drillers Must Slash Another $24 Billion This Year (BBG)

North American oil and natural gas drillers will need to cut an additional 30% from their capital budgets to balance their spending with the cash coming in their doors even if crude rises to $40 a barrel, according to an analysis by IHS Inc. A group of 44 North American exploration and production companies are planning to spend $78 billion on capital projects this year, down from $101 billion last year. Those companies need to cut another $24 billion this year to get their spending in line with a historical 130% ratio of spending to cash flow, IHS said Monday.

“These spending cuts will be particularly troublesome for the highly leveraged companies,” said Paul O’Donnell at IHS Energy. “These E&Ps are torn between slashing spending further to avoid additional weakening of their balance sheets, and the need to maintain sufficient production and cash flow to meet financial obligations.” The analysis is based on IHS’s low-case price scenario of $40-a-barrel oil and $2.50-per-million-cubic-feet natural gas prices. IHS cited Concho Resources, Whiting Petroleum, WPX Energy, and PDC Energy. as examples of companies displaying the best spending discipline.

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“..“There is not any kind of imaginary line where you can say, ‘OK this has gone down enough,’ and it’s now a recovery play or a turnround play. They just go down more, until they are done going down..”

Five Reasons Behind US Bank Stocks Selloff (FT)

US bank stocks have suffered a brutal start to 2016. Out of the 90 stocks on the S&P financials index, just eight were in positive territory for the year at mid-morning on Tuesday. Two of the biggest losers, Bank of America and Morgan Stanley, are down 27% and 28% respectively. Citigroup, also down 27%, is now trading at just 6.5 times earnings, not far off its post-crisis trough of 5.9 times, reached during the depths of the European debt crisis five years ago.

• Collapsing expectations of US interest rate rises Analysts offer a lot of different reasons for the big sell-off, but on this they agree. “Lift-off” in December was supposed to usher in an era of higher interest rates — which are always good news for the banks. In previous rate-raising cycles, assets have always re-priced faster than liabilities, earning banks a bigger spread between the yields on their loans and the cost of their funds. But worsening data since then from big economies, notably China, has investors worried that the world economy is a lot sicker than they had assumed. Expectations of another three rate rises from the Fed this year have collapsed in a matter of weeks. Talk of a rate cut, or even a move to negative rates, is entering the picture.

• Worsening credit quality In itself, a lower oil price will not do much direct damage to the big banks’ balance sheets, say analysts. Total energy exposures amount to less than 3% of gross loans at the big banks, which have mostly investment-grade assets, and which have already pumped up reserves. Perhaps more worrying are the second-round effects: if weakness in oil-dependent communities begins to spill into commercial real estate loan books, say, or if consumers find they cannot afford repayments on loans for their new gas-guzzling cars. In an environment of precious little growth — the big six US banks produced exactly the same amount of revenue last year as they did in 2014 — rising credit costs are likely to lead to lower profits.

• Deutsche Bank Every sell-off needs a point of focus and in recent days it has been Deutsche Bank. The contortions of the Frankfurt-based lender weighed on the entire banking sector on Monday, as it fought to dispel fears that it could not pay a coupon on a bond. “I think maybe counterparty risk is emerging,” says Shannon Stemm at Edward Jones in St Louis. “At the root, are some of these [European] banks as well capitalised as the US banks? Probably not. Can they continue to build capital in an environment where there is not a lot of revenue growth, and a lot of expenses have already been taken out of the business?”

• Banks are banks These are confidence stocks. When markets are doing well, banks tend to do well, as companies feel better about doing deals and raising money, investors put on a lot of trades, and asset management arms benefit from big inflows. But when confidence disappears, banks tend to bear the brunt of the sell-off. Matt O’Connor at Deutsche Bank notes that in 15 corrections going back to 1983, the US banks sector has been hit roughly twice as hard as the rest of the market — regional banks about 1.8 times worse, and capital markets-focused banks about 2.3 times worse. “At the end of the day when markets get scared, banks go down more, that is just what happens,” he says. “There is not any kind of imaginary line where you can say, ‘OK this has gone down enough,’ and it’s now a recovery play or a turnround play. They just go down more, until they are done going down or markets feel better about macro conditions.”

• Bank stocks were not cheap before the slide At the peak last July, the S&P 500 was trading about 20% above historical levels, and bank stocks were up to 25% higher than their historical averages, based on multiples of estimated earnings.* But none of these reasons is providing much comfort to investors at the moment. At Edward Jones, Ms Stemm is recommending clients ride out the turmoil by switching big global universal banks for steadier, US-focused lenders such as Wells Fargo and US Bancorp. “If there are global macro concerns, if recession concerns really are on the table, investors would rather get out than wait to see what happens,” she says.

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Japan is getting cooked. Fried. Roasted. Torched.

10-Year Japanese Government Bond Yield Falls Below Zero (FT)

The universe of government bonds trading with negative yields climbed to a new peak of $6tn on Tuesday as Japan became the first major economy with a sub-zero borrowing rate for 10-year debt. Benchmark bonds issued by the world’s third-largest economy dropped to a yield of minus 0.05%, as investors sought shelter from market convulsions triggered by sliding oil prices, concern for the health of the global economy and mounting fears over parts of the financial system. Japan’s recent decision to introduce a charge on new reserves parked with the central bank has rippled out across global government bond markets as investors expect central banks in Europe to push their overnight borrowing rates further into negative territory. That has spurred strong buying of positive yielding government debt across the eurozone, US and UK markets, while also bolstering other havens such as gold and the yen.

“The bear market in risk assets is evolving very quickly,” said Andrew Milligan at Standard Life. “A month ago the focus was China, then oil, then the prospect of US recession, now it is European financial companies.” The move comes just 11 days after the Bank of Japan’s surprise decision to follow in the footsteps of Switzerland, Denmark, Sweden and the eurozone by adopting negative interest rates, raising fresh concern about the side-effects of ultra-loose monetary policy by central banks. The growing trend of negative yields within the $23tn universe of developed world government debt tracked by JP Morgan has also sapped sentiment for financial shares and bonds, intensifying the demand for havens, as investors reassess their holdings of equities and corporate bonds. David Tan at JPMorgan said negative interest rates were being viewed as negative for bank earnings.

“The principal driver of negative JGB yields was the Bank of Japan’s deposit rate cut to -10bp, and the market now expects additional cuts during this year starting from as soon as the next Bank of Japan meeting,” he said. “This has contributed to a sell-off in banking stocks and a renewed flight to safety into government bonds.” Leading the slide among financials has been Deutsche Bank, with investors worried that it may have trouble repaying its debts. David Ader, CRT Investment Banking bond strategist, said market skittishness was understandable, if not expected. “The European banking system clearly remains a meaningful concern and memories of the credit crisis in the sector are still fresh,” he said.

For Japan’s government, the appreciating yen looms as an uncomfortable development. A weak currency is one of the major hallmarks of Prime Minister Shinzo Abe’s economic revival plan, dubbed Abenomics. Investors now suspect Japan Inc’s assumptions of an average rate of Y117.5 against the dollar during 2016 could leave companies missing profit forecasts and force the BoJ and government into fresh action — if more is possible. “If a 20 basis points cut won’t stop the yen rising, what can the Japanese authorities do? That is the question the market is asking,” said Shusuke Yamada at Bank of America. Investors, especially foreign funds that poured into the Japanese stock market during 2013, are increasingly taking the view that the magic of the “Abenomics” growth programme has worn off. Foreigners sold a net Y1.66tn of Japanese equities in January, according to official figures.

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Why not have another one of these scams?

EU Probes Suspected Rigging Of $1.5 Trillion Debt Market (FT)

European regulators have opened a preliminary cartel investigation into possible manipulation of the $1.5tn government-sponsored bond market, in the latest efforts to root out rigging involving financial traders. The European Commission’s early-stage inquiry comes amid revelations that the US Department of Justice and the UK’s Financial Conduct Authority are also investigating the market. The investigations are part of a campaign by antitrust regulators to root out collusion in financial markets following revelations that groups of traders worked together to manipulate Libor, a key rate that underpins the price of loans around the world. Further allegations followed that traders colluded to rig foreign exchange markets.

The commission’s powerful competition department has sent questionnaires to a number of market participants as part of an early-stage probe into possible manipulation of the price of supranational, subsovereign and agency debt, known as the SSA market. This market covers a diverse range of debt issuers including organisations such as the European Bank for Reconstruction and Development and regional borrowers like Germany’s Länder. A common feature is that the bonds often have a form of implicit or explicit state guarantee. Banks and interdealer brokers have so far been fined around $20bn by authorities around the world in response to the Libor and foreign exchange rate scandals which saw over a dozen leading financial institutions investigated by antitrust authorities.

The findings also led to criminal prosecutions of individual traders, and spurred investigations into other markets such as derivatives trading. The Financial Times reported last month that Crédit Agricole, Nomura and Credit Suisse are among a number of banks being investigated by the DOJ as part of its investigation into possible manipulation of SSA markets. London-based traders at these three banks, in addition to another trader at Bank of America, have been put on leave in response to the DOJ investigations, according to people familiar with the matter. It is understood that the commission’s inquiry started around the same time as the DoJ probe.

The commission’s enquiries concern a possible cartel or “concerted practice” according to the person familiar with the investigation, who did not provide further details. The questionnaires will help Margrethe Vestager, the commission’s competition chief, decide whether there are the grounds to launch a formal probe. Complex cartel cases typically take a minimum of four years to complete and are usually based on evidence from tip-offs provided by whistleblowers. The commission can fine a company involved in a cartel up to 10% of its global turnover.

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I picked one detail from the longer article on eurozone banks.

Italy, A Ponzi Scheme Of Gargantuan Proportions (Tenebrarum)

Ever since the ECB has begun to implement its assorted money printing programs in recent years – lately culminating in an outright QE program involving government bonds, agency bonds, ABS and covered bonds – bank reserves and the euro area money supply have soared. Bank reserves deposited with the central bank can be seen as equivalent to the cash assets of banks. The greater the proportion of such reserves (plus vault cash) relative to their outstanding deposit liabilities, the more of the outstanding deposit money is in fact represented by “covered” money substitutes as opposed to fiduciary media.


Euro area true money supply (excl. deposits held by non-residents) – the action since 2007-2008 largely reflects the ECB’s money printing efforts, as private banks have barely expanded credit on a euro area-wide basis since then.

Many funny tricks have been employed to keep euro area banks and governments afloat during the sovereign debt crisis. Essentially these consisted of a version of Worldcom propping up Enron, with the central bank’s printing press as a go-between. As an example here is how Italian banks and the Italian government are helping each other in pretending that they are more solvent than they really are: the banks buy government properties (everything from office buildings to military barracks) from the government, and pay for them with government bonds. The government then leases the buildings back from the banks, and the banks turn the properties into asset backed securities. The Italian government then slaps a “guarantee” on these securities, which makes them eligible for repo with the ECB. The banks then repo these ABS with the ECB and take the proceeds to buy more Italian government bonds – and back to step one.

Simply put, this is a Ponzi scheme of gargantuan proportions. Still, in view of these concerted efforts to reliquefy the banking system, one would expect that European banks should be at least temporarily solvent, more or less. Since they have barely expanded credit to the private sector, preferring instead to invest in government bonds, the markets should in theory have little to worry about.

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Overinvested.

Maersk Profit Plunges as Oil, Container Units Both Suffer (BBG)

A.P. Moeller-Maersk A/S reported an 84% plunge in 2015 profit after its oil unit was hit by lower energy prices and its container division got squeezed between sluggish trade growth and overcapacity. Maersk said net income was $791 million last year compared with $5.02 billion in 2014. The result includes a writedown in the value of Maersk’s oil assets by $2.6 billion, the Copenhagen-based company said. “Given our expectation that the oil price will remain at a low level for a longer period, we have impaired the value of a number of Maersk Oil’s assets,” CEO Nils Smedegaard Andersen said in the statement. “We will continue to strengthen the Group’s position through strong operational performance and growth investments.”

In October, Maersk started cost cut programs for both of its two biggest units to address what analysts have described as a perfect storm for the conglomerate, which historically has found support from positive market conditions for at least one the two divisions. Maersk said Wednesday that 2016’s underlying profit will be “significantly below” last year’s $3.1 billion. The Maersk Line unit’s profit will also be “significantly below” 2015’s level, which was $1.3 billion. Maersk Oil will report a loss this year, it said. The unit currently breaks even when oil prices are in a range of $45 to $55 a barrel, the company said.

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“..with the Australian economy suddenly desperate for lower rates from the RBA, one can ignore the propaganda lies, and focus once again on the far uglier truth…”

Australia Admits Recent Stellar Job Numbers Were Cooked (ZH)

Two months ago the Australian media, which unlike its US counterpart refuses to be spoon fed ebullient economic propaganda, called bullshit on the spectacular October job numbers, when instead of adding 15,000 jobs as consensus expected, Australia’s Bureau of Statistics reported that a whopping 58,600 jobs had been added. [.] One month later, the situation got even more ridiculous, when instead of the expected 10,000 drop in November, the “statistical” bureau announced that 71,400 jobs had been added, the most in 15 years, and the equivalent of 1 million jobs added in the US. Once again the local media cried foul.

Two months later we find that the media, and all those mocking the government propaganda apparatus, were spot on, because moments ago today, Australia Treasury Secretary John Fraser, during testimony to parliamentary committee, admitted that jobs growth for the two months in question “may be overstated.” What’s the reason? The same one the propaganda bureau always uses when its lies are exposed: “technical issues”, the same explanation the Atlanta Fed used in its explanation for a strangely belated release of its GDP Now estimate one month ago. Here’s Bloomberg with more:

Australia has had some technical issues with its labor data, which “look a little bit better” than would otherwise have been the case, the secretary to the Treasury said, commenting on record employment growth in the final quarter of 2015. John Fraser, the nation’s top economic bureaucrat, told a parliamentary panel in Canberra Wednesday that he held discussions on the employment figures with the chief statistician this week. He didn’t elaborate on the meeting but said the recent strength in the jobs market is encouraging.

There were some “technical issues” in October and November that may have made the employment figures “look a little bit better than otherwise would be the case,” he said. The technical issues relate to “rolling off” of participants in the labor survey. Australia’s economy added 55,000 jobs in October and a further 74,900 in November, before shedding 1,000 in December to produce the record quarterly gain. Questions regarding the accuracy of the data have been raised following acknowledgment by the statistics agency in 2014 of measurement challenges.

Why the sudden admission it was all a lie? Simple: weakness in commodity prices “is far greater than people had been expecting,” Fraser said in earlier remarks to the panel. Australia is now “swimming against the tide” because of uncertainties in the global economy, he added. Translation: “we need more easing, and to do that, the economy has to go from strong to crap.” And with the Australian economy suddenly desperate for lower rates from the RBA, one can ignore the propaganda lies, and focus once again on the far uglier truth.

Which makes us wonder: with the Yellen Fed in desperate need of political cover for relenting on its terrible rate hike strategy, and once again lowering rates to zero or negative, a recession – something JPM hinted at yesterday – will be critical. And what better way to admit the US has been in one for nearly a year than to drastically revise all the exorbitant labor numbers over the past 12 months. You know, for “technical reasons”…

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The crazies are in charge: “Ash Carter said he would ask for spending on US military forces in Europe to be quadrupled in the light of “Russian aggression”. The allocation for combating Islamic State, in contrast, is to be increased by 50%.”

Pentagon Fires First Shot In New Arms Race (Guardian)

As the voters of New Hampshire braved the snow to play their part in the great pageant of American democracy on Tuesday, the US secretary of defence was setting out his spending requirements for 2017. And while the television cameras may have preferred the miniature dramas at the likes of Dixville Notch, the reorientation of US defence priorities under the outgoing president may turn out to exert the greater influence – and not in a good way, at least for the future of Europe. In a speech in Washington last week, previewing his announcement, Ash Carter said he would ask for spending on US military forces in Europe to be quadrupled in the light of “Russian aggression”. The allocation for combating Islamic State, in contrast, is to be increased by 50%. The message is unambiguous: as viewed from the Pentagon, the threat from Russia has become more alarming, suddenly, even than the menace that is Isis.

If this is Pentagon thinking, then it reverses a trend that has remained remarkably consistent throughout Barack Obama’s presidency. Even before he was elected there was trepidation in some European quarters that he would be the first genuinely post-cold war president – too young to remember the second world war, and more global than Atlanticist in outlook. And so it proved. From his first day in the White House, Obama seemed more interested in almost anywhere than Europe. He began his presidency with an appeal in Cairo addressed to the Muslim world, in an initiative that was frustrated by the Arab spring and its aftermath, but partly rescued by last year’s nuclear agreement with Iran. He had no choice but to address the growing competition from China, and he ended half a century of estrangement from Cuba.

But Europe, he left largely to its own devices. When France and the UK intervened in Libya, the US “led from behind”. Most of the US troops remaining in Europe, it was disclosed last year, were to be withdrawn. Nor was such an approach illogical. Europe was at peace – comparatively, at least. The European Union was chugging along, diverted only briefly (so it might have seemed from the US) by the internal crises of Greece and the euro. Even the unrest in Ukraine, at least in its early stages, was treated by Washington more as a local difficulty than a cold war-style standoff. Day to day policy was handled (fiercely, but to no great effect) by Victoria Nuland at the state department; Sanctions against Russia were agreed and coordinated with the EU. All the while – despite the urging of the Kiev government – Obama kept the conflict at arm’s length.

Congress agitated for weapons to be sent, but Obama wisely resisted. This was not, he thereby implied, America’s fight. In the last months of his presidency, this detachment is ending. The additional funds for Europe’s defence are earmarked for new bases and weapons stores in Poland and the Baltic states. There will be more training for local Nato troops, more state-of-the-art hardware and more manoeuvres. Now it is just possible that the extra spending and the capability it will buy are no more than sops to the “frontline” EU countries in the runup to the Nato summit in Warsaw in July, to be quietly forgotten afterwards. More probably, though, they are for real – and if so the timing could hardly be worse. Ditto the implications for Europe’s future.

By planning to increase spending in this way, the US is sending hostile signals to Russia at the very time when there is less reason to do so than for a long time. It is nearly two years since Russia annexed Crimea and 18 months since the downing of MH17. The fighting in eastern Ukraine has died down; there is no evidence of recent Russian material support for the anti-Kiev rebels, and there is a prospect, at least, that the Minsk-2 agreement could be honoured, with Ukraine (minus Crimea) remaining – albeit uneasily – whole.

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These people are inventing a entire parallel universe, and nobody says a thing. NATO to patrol the Med on refugee streams? NATO is an aggression force, an army way past its expiration date. It has zero links to refugees. There is no military threat there. Oh, but then we bring in Russia.. “Stoltenberg said naval patrols would fit into “reassurance measures” to shield Turkey from the war in neighboring Syria..” ‘We’ have lost our marbles. ‘We’ are on the war path.

NATO Weighs Mission to Monitor Mediterranean Refugee Flow (BBG)

NATO will weigh calls for a naval mission in the eastern Mediterranean Sea to police refugee streams as a fresh exodus from Syria adds to European leaders’ desperation. Such a mission, proposed by Germany and Turkey, would thrust the 28-nation alliance into the humanitarian trauma aggravated by the Russian-backed offensive by Syrian troops that drove thousands out of Aleppo and toward Turkey. “We will take very seriously a request from Turkey and other allies to look into what NATO can do to help them cope with and deal with the crisis,” NATO Secretary General Jens Stoltenberg told reporters in Brussels on Tuesday. NATO is confronted with Russian intervention in the Middle East – including airspace violations over Turkey, an alliance member – after reinforcing its eastern European defenses in response to the Kremlin’s annexation of Crimea and fomenting rebellion in Ukraine in 2014.

Allied warships now on a counter-terrorism mission in the Mediterranean and anti-piracy patrols off the coast of Somalia could be reassigned to monitor and potentially go after human traffickers in the Aegean Sea between Greece and Turkey. A naval mission, to be discussed Wednesday and Thursday at a meeting of defense ministers in Brussels, is controversial. It could produce unpleasant images of NATO sailors and soldiers herding refugee children behind barbed wire, handing a propaganda victory to Islamic radicals and the alliance’s detractors in the Kremlin. With her political standing in jeopardy as German public opinion turns against her open-arms approach, German Chancellor Angela Merkel went to Ankara on Monday with limited European leverage to persuade Turkey to house more refugees on its soil instead of pointing them toward western Europe.

Stoltenberg said naval patrols would fit into “reassurance measures” to shield Turkey from the war in neighboring Syria that already include Patriot air-defense missiles and air surveillance over Turkish territory and the coast. U.S. Ambassador to NATO Douglas Lute called on European Union governments to take the lead on civilian emergency management, with the alliance confined to offering backup. He said military planners will draw up options. “This is fundamentally an issue that should be addressed a couple miles from here at EU headquarters, but it doesn’t mean NATO can’t assist,” Lute told reporters.

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I could have spared them the research.

Border Fences Will Not Stop Refugees, Migrants Heading To Europe (Reuters)

Efforts by European countries to deter migrants with border fences, teargas and asset seizures will not stem the flow of people into the continent, and European leaders should make their journeys safer, a think-tank said on Wednesday. The Overseas Development Insitute (ODI) said Europe must act now to reduce migrant deaths in the Mediterranean, where nearly 4,000 people died last year trying to reach Greece and Italy, and more than 400 have died so far this year. European governments could open consular outposts in countries like Turkey and Libya which could grant humanitarian visas to people with a plausible asylum claim, the think-tank said. Allowing people to fly directly to Europe would be safer and cheaper than for them to pay people smugglers, and would help cripple the smuggling networks that feed off the migrant crisis, the London-based ODI said.

More than 1.1 million people fleeing poverty, war and repression in the Middle East, Asia and Africa reached Europe’s shores last year, prompting many European leaders to take steps to put people off traveling. But the ODI said new research showed such attempts either fail to alter people’s thinking or merely divert flows to neighboring states. Researchers interviewed 52 migrants from Syria, Eritrea and Senegal who had recently arrived in Germany, Britain and Spain. Their journeys had cost an average 2,680 pounds ($3,880) each. More than one third had been victims of extortion, and almost half the Eritreans had been kidnapped for ransom during their journey. Researchers said that, contrary to popular perception, many migrants left home without a clear destination in mind. Their experiences along the way and the people they met informed where they would go next.

Information from European governments was unlikely drastically to alter migrants’ behavior, the ODI said. “Our research suggests that while individual EU member states may be able to shift the flow of migration on to their neighbors through deterrent measures such as putting up fences, using teargas and seizing assets, it does little to change the overall number … coming to Europe,” said report co-author Jessica Hagen-Zanker. “As one of the people we interviewed put it ‘When one door shuts, another opens’.”

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