Harris&Ewing F Street N.W., Washington, DC 1918
“..selective mass blindness prevents the economics profession answering the question posed by Queen Elizabeth II to the London School of Economics “Why did nobody notice it (the GFC)?”
• Has The Fed Got A Grasp On Economic Reality? (Gambles)
History shows us that the U.S. Federal Reserve’s grasp on economic reality hasn’t been anywhere near as strong as you might hope or expect, so maybe it’s time it used a new economic model. Back in 2011, CNBC’s Karen Tso asked me how I could be so critical of Yellen’s predecessor, Ben Bernanke, an acknowledged academic expert on the Great Depression. My answer was that Bernanke, his predecessor, Alan Greenspan, and many others in the economic establishment are associated with a single strand of economic thinking, neo-classical (and more specifically, monetarist) economics. Although this approach is being increasingly discredited, in practice it remains despite its utter failure to anticipate the global financial crisis (GFC) — or indeed just about any other significant financial crisis- the dominant school of economic thinking.
Professor Steve Keen, my advisory board colleague of economics think tank IDEA Economics, has stridently criticized the group-think of Bernanke including Larry Summers, Ken Rogoff, Paul Krugman and the IMF’s Olivier Blanchard, who all studied the same courses taught by Stanley Fischer at the Massachusetts Institute of Technology. The group’s views aren’t entirely uniform; but are informed by a uniform economic framework. Differences in opinion tend to be about details rather than fundamentals. Hence selective mass blindness prevents the economics profession answering the question posed by Queen Elizabeth II to the London School of Economics “Why did nobody notice it (the GFC)?” The answer is that quotations by leading economists about the apparently rude health of the US and global economies in 2007-08 would fill volumes.
They tend to range from Bernanke waxing lyrical about “the Great Moderation” to Blanchard telling us, as late as August 2008, “The state of macro is good”. Tempting as it may be, I’m not poking fun at high-profile individuals’ shortcomings, so much as diagnosing widespread institutional failure. While the GFC has been put behind us, the lack of any better understanding of its causes among most influential mainstream economists and policymakers remains a cause for concern. They tend to believe debt is merely a liquidity preference; one wealthy retiree’s deposits fund, via bank intermediation, is another borrower’s home or business loan. This ignores the fact that in the USA or the U.K. over 95% of ‘money’ is simply created by bank lending.
Long as they’re not called ‘innocent bystanders’.
• Global Inflation Mystery Risks Making Central Bankers Bystanders (Bloomberg)
Janet Yellen’s Federal Reserve is “reasonably confident” it can drive up consumer prices. Mario Draghi says his ECB’s stimulus has already “proven so far to be potent.” The Bank of England reckons inflation is “likely to return” to its target within two years. While not quite declarations of victory, such statements show policy makers’ optimism that record-low interest rates and bond-buying will be enough to return inflation to the 2% range most of them eye. Yet, central banks have repeatedly overestimated inflation since the middle of 2011, according to Marvin Barth at Barclays in London. To him, a mounting concern is that about a third of the decade-long decline in worldwide inflation is potentially inexplicable.
If he’s right then what he calls “global missingflation” threatens the ability of Yellen and company to push up prices and raises questions over whether they will ever be able to declare mission accomplished and truly end their use of easy stimulus. “‘Global missingflation’ likely will keep central banks nervous and should give pause to those who think downside risks to inflation are no longer a risk,” Barth, a former U.S. Treasury official, said in a report to clients on Wednesday. “It also should instill greater caution in market participants who think that ‘lowflation’ or deflation are receding risks.” To make his case, Barth studied 27 economies to identify why consumer prices outside of food and energy dropped 0.46 percentage point in industrial nations in the decade up to December 2014 and 0.74 percentage point in emerging markets.
Once he allowed for traditional drivers of prices such as demand or productivity, he found 35% of the slide in global inflation hard to pin down. Among the possible reasons could be deleveraging, technological progress, globalization, aging populations or China’s deflationary impulse. Whatever the explanation, the inflation puzzle is a reason for central banks to worry about the power of policy and may leave them reliant on factors over which they have less control such as commodities, currencies or wages to propel prices. Worse still is the risk that financial markets and the public lose faith in policy makers to control inflation. The inflation expectations of both over the next five years may start to suggest such doubts.
You betcha. They won’t be investors anymore.
• Investors Need To Face The Possibility Of A ‘Great Reset’ (MarketWatch)
Watch out if corporate-profit margins narrow to their long-term average share of GDP. If so, the S&P 500 Index would trade at less than 1,700 in five years, a decline of more than 20%. I’m not necessarily forecasting such a dismal eventuality, though it’s in the realm of possibility. I merely point it out to illustrate how dependent the stock market is on wide profit margins. Few seem to be focusing on this vulnerability. Take the discussion about George Mason University professor Tyler Cowen’s Friday column in The New York Times. Cowen discusses the possibility of a “Great Reset” as it collectively dawns on us that what workers in the future will earn a lot less than they did in the past. Yet I’ve not seen any mention in these discussions about Wall Street, where corporate profitability has been soaring even as wages struggle.
Wall Street needs to squarely face the possibility of a Great Reset of its own. If corporate-profit margins shrink even halfway to their long-term average, investors would suffer significant losses in coming years. There is more than one way of calculating the average profit margin of corporate America, and each approach has defects. For the chart at the top of this column, I used a simple ratio of corporate-after-tax-profits to GDP, which shows the latest profit margin to be 8.7%. Though lower than 10.1% from a couple of years ago, the current level is still two standard deviations above the six-decade average of 6.3%. To calculate what would happen if corporate profitability falls back to that average, I made a number of assumptions. For example, I assumed that this return to average takes five years.
I also assumed that the S&P 500’s price-to-earnings ratio stays constant, which is a generous assumption since the market’s current P/E is 30% above its 130-year average. I also had to assume a sales growth rate. I chose 4.2% annualized, which is how fast per-share sales for S&P 500 companies have grown since the economy emerged from the 2008-2009 recession. Notice that this generously assumes there will be no recession between now and May 2020. Even with those assumptions, however, the S&P 500 in May 2020 would be trading at 1,683 if corporate-profit margins revert to their historical average.
What an incredible disgrace. When did we start accepting this as normal? When did we start accepting this, period?
• Guilty Pleas and Heavy Fines Seem to Be Cost of Business for Wall St. (NY Times)
Even as five big banks plead guilty to felonies and paying out billions of dollars, the question remains whether top executives will shrug off the penalties as just an average cost of doing business. The Justice Department hailed the guilty pleas by JPMorgan Chase, Citigroup, Barclays, UBS and the Royal Bank of Scotland to foreign exchange and Libor manipulation charges as a victory for discouraging corporate misconduct. Attorney General Loretta E. Lynch said that the penalty of more than $5 billion that the banks agreed to pay, including $2.5 billion in criminal fines, “should deter competitors in the future from chasing profits without regard to fairness, to the law, or to the public welfare.”
Whether traders will ever be dissuaded from seeking out ways to gain any edge possible in financial dealings is an open question. The watchword for prosecutors and regulators these days in dealing with multinational businesses is “cooperation.” Last week, officials at both the Justice Department and the Securities and Exchange Commission emphasized that corporations and individuals would receive consideration if they were forthcoming about known violations. The price will be much steeper if they choose not to tell everything they know as early as possible. Yet even as penalty after penalty is paid by big banks in various cases, it seems as though the same cast of corporate characters keeps reappearing. It makes you wonder whether the global banks are acting like teenagers who find it easier to beg forgiveness than actually change their behavior.
The guilty pleas are noticeably tougher than the enforcement actions of just a few years ago, when virtually every case involving violations in the financial sector resulted in only a deferred or nonprosecution agreement. To send a message that repeat offenders will now pay a price, the Justice Department took the additional step of tearing up the 2012 nonprosecution agreement with UBS, which had resolved the investigation of its manipulation of the London interbank offered rate, or Libor. Now, UBS is pleading guilty and paying an additional $203 million fine. The bank had no defense to the Libor charges because its admissions could be used against it once the government found that it breached a provision of the nonprosecution agreement that promised it would not commit any more crimes.
I smell collapse.
The bad news is that we are investing in a world where Graham and Dodd’s “Security Analysis” has become a quaint relic of simpler times, when the nuts and bolts of a company’s fundamental were meant to motivate how analysts viewed its prospects. Now we have QE and buybacks. We live in a world where good Keynesians Tobin and Brainard’s work on valuation (which led to Tobin’s q test) was meant to remind investors that markets needed to be grounded in some form of reality. (Interestingly, as an aside, William Brainard was strongly in favor of Janet Yellen being appointed to the Fed Chair). Today we read that equities are at all-time highs because weak economic numbers may keep the Fed on hold longer. The good news is that investing is a lot easier if you have central banks on your side.
Central bankers admit they follow the markets, as they should. What has evolved in this world of activist central banks as proxy sovereign wealth funds are policy makers who watch, care and try to manage price levels in markets, rather than managing liquidity and continuous pricing. Front-running mutual funds used to be something of a skill and art. Front-running central banks merely requires not losing sight of the bigger picture and managing your positions. Oddly enough, skill at the latter is what old-fashioned traders, who are in the process of being killed off by boxes, were actually most prized for. In today’s world, negative rates are argued to be realistic. Markets that go up 100% in a year are prescient.
Markets that go down are described as killing wealth, not, perhaps, normalizing in the face of better numbers. Economists extol the value of the “wealth effect” on economic prospects. Translated that means central banks should be in the business of helping markets along. We are all meant to be on the same side here, right? European bonds have sold off in response to better numbers. Cruising speed. Cue the ECB’s Coeure to announce bigger buying of bonds now. He assured us this had nothing to do with the recent back-up in yield but rather prudent liquidity management. Europe does treasure the summer holidays after all.
And it ain’t only developed markets. After a nasty sell-off last week, Egypt’s EGX30 index is up over 9% this week as the government “postponed” the widely-praised capital gains tax on equities. For those gregarious enough to trade this market, watch the key 9000 level which held as resistance today This morning, everything German responded favorably to the QE-steroid announcement. Later in the session, the ZEW was released and was horrid on its face. Immediate reaction? Profit-taking. Gives you a good example of what is driving things.
Howard’s back!
• Record Number of American Stores, Malls Closing: Davidowitz (Bloomberg)
Davidowitz & Associates Chairman Howard Davidowitz discusses the U.S. retail industry and economy.
“Pensions have already been cut by 44pc, and 48pc for public sector workers, and these stipends are the final safety net for Greek society. The recipients are literally feeding their children and grandchildren and extended kin. ”
• Defiant Greeks Force Europe To Negotiating Table As Time-Bomb Ticks (AEP)
Europe’s creditor powers have started to wobble. Berlin, Paris and Brussels are coming to the grim conclusion that Greece may not capitulate as expected, and time is running out fast. Athens is now warning openly that the “moment of truth” will come on June 5, when the country faces default on a €300m payment to the IMF, unless the EU authorities hand over the next tranche of bail-out cash. It would be hazardous to bet the integrity of monetary union on the assumption that this is just a bluff. For the past four months the creditor bloc has been dictating terms, mechanically repeating the same demand that Alexis Tsipras and his Syriza rebels deliver on an austerity contract that they vowed to repudiate and which the previous conservative government was unable to implement.
EMU leaders have never at any moment acknowledged that the extra loans imposed on a bankrupt Greek state in 2010 were chiefly designed to save the euro and stem a European-wide banking crisis at a time when the eurozone had no defences against contagion. They have yielded slightly on Greece’s primary budget surplus but are still insisting on fiscal targets that can only trap Greece in a vicious circle of low growth and under-investment. Such a regime would leave the country just as bankrupt in the early 2020s as it was when the traumatic ordeal began, with nothing to show for so many cuts and a decade of depression. They are still pushing Greece to sell off state assets for a pittance to the same old oligarchy, further entrenching the deformities of the Greek economy, presumably – for there is no other urgent imperative – so that they can collect their debts.
Yet creditor bluster has reached its limits. It is by now clear that Syriza is so angry, and so driven by a sense of injustice, that it may be willing to bring the whole temple of monetary and political union crashing down on everybody’s heads, if pushed to the brink. Mr Tsipras spent five hours trying to calm the party leadership on Tuesday as a mutinous caucus on the hard-Left, but not only them, berated him furiously for raiding reserve funds to pay off creditors. Better to default and be done with it. The mood was already clear at a “war cabinet” 10 days ago when all wings of the party agreed that they would stand and fight – whatever the consequences – rather than submit to demands for a further cut in wages and pensions, or accept any deal that fails to offer debt relief and imposes a primary surplus above 1pc of GDP.
Pensions have already been cut by 44pc, and 48pc for public sector workers, and these stipends are the final safety net for Greek society. The recipients are literally feeding their children and grandchildren and extended kin. More than 900,000 registered unemployed – or 86pc of the total – receive no benefits. The Greek drama has, in any case, escalated to a higher level. Washington has brought to bear its immense diplomatic power, warning Germany ever more insistently that it would be a geo-strategic disaster of the first order if an embittered Greece were to spin out of control and into the orbit of Vladimir Putin’s revanchist Russia. Wiser heads in Berlin need no persuasion. Vice-Chancellor Sigmar Gabriel, the Social Democrat leader, clenches his teeth with exasperation when told that Europe can safely handle a €315bn default and a Greek ejection from the euro. “It is extremely dangerous politically. Nobody would have any more faith in Europe if we break apart in the first big crisis,” he said.
Yes, that’s the same pensions that have already been cut by 48% for public sector workers.
• Greek Pensions Said To Be In Creditor Crosshairs (Bloomberg)
Greece’s creditors are making pension reforms a top priority, leaving the door open to compromises on other issues like the country’s minimum wage proposals. Greek negotiators are meeting Wednesday with the so-called Brussels Group as efforts continue to reach a deal by month-end, according to two officials close to the talks. If Prime Minister Alexis Tsipras can offer sufficient pledges to overhaul Greece’s retirement program – one of the nation’s biggest hurdles to qualifying for IMF aid – creditors might offer leniency on their demands to restrict increases to the minimum wage. “The pension system looks unsustainable and needs reform,” said Guntram Wolff, director of the Brussels-based Bruegel group.
“If you don’t reform it and want debt relief, you’re essentially asking your partners to fund an unsustainable pension system.” The debate over pensions, wages and other contentious points delves into details as some European policy makers strike a more optimistic tone that a deal to unlock bailout aid can be reached. An agreement is possible in the coming weeks, EU Economic Commissioner Pierre Moscovici told the French Senate Wednesday, the day after German Chancellor Angela Merkel said Greece had until the end of the month to reach a resolution. Creditors won’t accept raising the Greek minimum wage back to its pre-2012 level, according to one of the officials.
At the same time, they might be open to a more gradual increase that takes into account the impact of higher wage requirements on unemployment and the overall economy, the official said. An acceptable deal with Greece may comprise as little as a third of the country’s previous commitments for economic policy changes, according to a German government official who asked not to be identified. A second German official said an agreement that rolls back minimum-wage pledges would wipe out about three quarters of what the Greeks had initially promised to deliver. Taken together, the comments suggest a minimum-wage compromise is not ruled out if there is no other alternative. The officials reiterated Germany’s view that Greece needs to live up to its bailout promises if it wants to get the rest of its money owed under the program.
Bit weak for a ‘think tank’.
• Giving Greece a Chance (Bruegel)
The Greek tragedy must not go on. Europe’s growing frustration with the new Greek government has triggered calls for stopping negotiations and even accepting “Grexit”, Greece’s exit from the euro. We believe that this would be a mistake. Grexit would be a collective political failure. Above all, it would cause a social and economic catastrophe for Greek citizens. However, keeping Greece in the euro area at the cost of citizens of other countries, without a serious and credible commitment by the Greek government to reform its economy and its institutions, would be a collective political failure as well. It would not only erode further the credibility of Europe’s institutions and its architecture, but as well the roots of European integration, which was based from the beginning on the respect of common rules.
The national sovereignty of each member state must be respected. But in a deeply integrated Europe, sovereignty is increasingly shared, rather than national. Time is running out quickly for the Greek government. It needs to decide now whether to get serious about reforming the country. It continues to have one major advantage, namely a clear mandate for a fresh start for Greece, not relying on the old elites who ruined the country. But it has also one serious challenge: the fact that it won its political mandate based on contradictory promises that it could not fulfil under any circumstances. The idea to call for a referendum in Greece should therefore not be regarded as a threat, but as an opportunity.
If Greek voters decide in a referendum to follow through with a serious programme of economic and institutional transformation, the new Greek government would obtain the necessary legitimacy to adjust its agenda. If Greek citizens decide otherwise, they will do so in the full knowledge of the implications, including the possibility of Greece’s exit from the euro. However, a Greek referendum will not exonerate Europe from its responsibilities. We need to acknowledge that the two support programmes for Greece were a colossal bail-out of private creditors, not least those based in France and Germany, at the expense of European taxpayers.
The optimism of the two programmes regarding Greece’s ability to reform and its debt sustainability was deeply flawed. Yet we should also honour our historic responsibility in stabilizing a continent in a peaceful common union. And we should accept that every European country in such a deep crisis, as Greece is in today, deserves solidarity and continued support.[..] In addition, European taxpayers would pay a high price, as loans to the Greek government could no longer be repaid. The combined official exposure of Germany and France to Greece amounts to close to €160 billion, or around €4350 for a German or French family of four.
Important: “Default but no Grexit cannot be a stable equilibrium..”
• Investors And Policy Makers Eye Consequences Of Greek Default (FT)
With Greece fast running out of cash, investors and policy makers have begun contemplating the possibility of a default and its consequences. The question they are asking is whether it is possible to keep Athens in the eurozone even if it failed to repay some of its creditors, thereby sparing the global economy renewed uncertainty. Our base-case scenario remains that Greece and its international partners will reach an agreement, wrote Reinhard Cluse, an economist at UBS, in a research note. Nevertheless .. the risk of failure and eventual Grexit [Greek exit from the currency bloc] should not be underestimate . The cash position of the Greek government is extremely murky, making it hard to assess when exactly Athens might be forced to renege on its obligations.
Silvia Merler, an economist at European think-tank Bruegel, has calculated that the government is running a better than expected primary surplus. However, this is largely the result of a severe squeeze on public spending, which is partly due to delayed supplier payments. Athens faces a challenging debt redemption schedule during the summer with about €2bn due to the INF and €6.5bn to the ECB and other eurozone central banks between June and August. The Greek government also has to pay its civil servants and pensioners, while the existing, stalled bailout programme with the eurozone terminates at the end of June. Athens is adamant that an agreement is in sight but the possibility of an accident remains.
While a default need not necessarily lead to a Grexit economists warn that it would substantially increase the risks of a departure. Default but no Grexit cannot be a stable equilibrium, Mr Cluse said. The short-term consequences of a default may depend on who exactly the Greek government fails to pay, as well as on the reaction by creditors — in particular depositors and the ECB. A default by Athens on domestic payment obligations, in the form of IOUs to pensioners and civil servants, would probably be the least risky. While such a move would almost certainly be challenged in court — as well as creating substantial political problems for the government — any ruling would be delayed.
A default on IMF loans would look politically ugly, as Greece would indirectly be refusing to repay some of the poorest countries in the world who contribute to the institution’s coffers. However, it is generally seen as less risky than a default to the ECB. The fund’s executive board would only be notified a month after Greece had not met its obligations and it would take several months before any concrete steps, which could go as far as excluding Greece from the IMF, were taken. Refusing to pay the IMF would be unlikely to trigger an automatic cross-default on other obligations. For example, the European Financial Stability Facility, the eurozone rescue fund, would need to decide if Greece was in default, leaving room for discretion among other European governments.
“Greece is the testing ground and everybody is watching very carefully…”
• Europe Faces 2nd Revolt As Portugal’s Ascendant Socialists Spurn Austerity (AEP)
Europe faces the risk of a second revolt by Left-wing forces in the South after Portugal’s Socialist Party vowed to defy austerity demands from the country’s creditors and block any further sackings of public officials. “We will carry out a reverse policy,” said Antonio Costa, the Socialist leader. Mr Costa said a clear majority of his party wants to halt the “obsession with austerity”. Speaking to journalists in Lisbon as his country prepares for elections – expected in October – he insisted that Portugal must start rebuilding key parts of the public sector following the drastic cuts under the previous EU-IMF Troika regime. The Socialists hold a narrow lead over the ruling conservative coalition in the opinion polls and may team up with far-Left parties, possibly even with the old Communist Party.
“There must be an alternative that allows us to turn the page on austerity, revive the economy, create jobs, and – while complying with euro area rules – restore hope to this county,” he said. While the Socialist Party insists that it is a different animal from the radical Syriza movement in Greece, there is a striking similarity in some of the pre-electoral language and proposals. Syriza also pledged to stick to EMU rules, while at the same time campaigning for policies that were bound to provoke a head-on collision with creditors. Mr Costa accused the Portuguese government of launching a blitz of privatisations in its dying days, signalling that the Socialists will either block or review the sale of the national airline TAP, as well as public transport hubs and water works.
His harshest language was reserved for the IMF but this reflects the cultural milieu of the Portuguese Left. In reality the IMF was the junior partner in the Troika missions. Mr Costa unveiled a package of 55 measures in March, led by a wave of spending on healthcare and education that amounts to a fiscal reflation package. The party would also roll back labour reforms and make it harder for companies to sack workers. The plan would appear entirely incompatible with the EU’s Fiscal Compact, which requires Portugal to run massive primary surpluses to cut its public debt from 130pc to 60pc of GDP over 20 years under pain of sanctions.
The increasingly fierce attacks on austerity in Lisbon are likely to heighten fears in Berlin that fiscal and reform discipline will break down altogether in southern Europe if Greece’s rebels win concessions. Worry about political “moral hazard” is vastly complicating the search for a solution in Greece. “Greece is the testing ground and everybody is watching very carefully. That is why the Spanish and Portuguese prime ministers have been so hawkish,” said Vincenzo Scarpetta, from Open Europe.
It’s not just the Socialist Party either.
• Portuguese Politicians Turn a Deaf Ear to IMF (WSJ)
Five months ahead of a general election, the Portuguese government and the main opposition Socialist Party can agree with one thing: the IMF no longer has a say here. Earlier this week, the IMF, which along with the European Union bailed out Portugal in 2011 with a €78 billion loan, issued a staff report. Portugal, it wrote, is still far from achieving significant growth levels, having failed to implement all the necessary reforms to make its economy more competitive. In addition, it warned that while the country’s current account has turned positive, a fall in imports—not a rise in exports–has played an important role in fixing external imbalances. And as imports pick up along with the economy, the current account could revert to a deficit.
On Wednesday, Finance Minister Maria Luis Albuquerque largely dismissed the IMF assessment, saying the report “has a very distorted view related to a series of issues.” “The big difference [between now and under the bailout] is that today we can disagree, because we gained that right,” Ms. Albuquerque, who oversaw Portugal’s exit from the bailout program a year ago, said. Portugal’s vocal opposition to the IMF represents a major U-turn. At least in public, the government spent its bailout years picturing itself as a poster child to the austerity drive in the eurozone.
For its part, the Socialist Party, which is currently slightly ahead in the polls, has called the bailout program, designed by the IMF and the EU and implemented by the government, a mistake. The party, which released its campaign program Wednesday, said it can keep fiscal targets in check by rebalancing spending and revenue. Ultimately, it believes that raising family incomes will lead to higher consumption and a needed pick-up in the economy. With that goal, the party has promised to cut taxes, which were sharply raised over the past three years, and reverse the salary cuts in the public sector.
Superficial long piece. Revelation: Yanis taped Riga meeting(s).
• A Finance Minister Fit for a Greek Tragedy? (NY Times Magazine)
Varoufakis is neither a politician nor a banker by training. He has been one of the most visible and vociferous critics of the Greek government, the European establishment and the Greek-European bailout. Imagine that President Obama had, instead of picking Timothy Geithner to be his Treasury secretary in the midst of the financial crisis, appointed a progressive academic economist like Paul Krugman or Joseph Stiglitz, only edgier and funnier, someone who had spoken out scathingly against bank bailouts, freely expressing himself however he wanted on television and in public debates because he wasn t running for office. His popularity was undeniable, though. When Syriza did put Varoufakis on the ballot for Parliament in January, despite the fact that he was living in Austin, Tex., at the time, he won more votes than any other candidate.
Four months into his political tenure, Varoufakis is at the center of a contest that could determine the entire Continent’s future. No deal between Greece and the domineering center of European authority has been reached. Varoufakis finds himself struggling to hold on to his principles, what he calls the red lines that prevent him, in his mind, from becoming like every other Greek politician before him. Those ideals risk bringing more hardship to Greece, but Varoufakis has staked his academic integrity on a particular economic and moral critique of the crisis. To what, to whom, does he presently owe his ultimate responsibility? For the people who are now 15, 16, 17 years old, to have a chance by the time they are 20 this is what matters, he told me this month.
There’s no doubt that this economy now is far worse off in the last two months as a result of our hard bargaining. He described that change as a trade-off, an investment in a better future. And an investment always involves a short-term cost, he said. I asked him about that short-term cost. Is he worried about the Greek economy today? Terrified, he said. Terrified and aghast.
“Remember: cash is King, Queen and Prince in a deflationary environment.”
• UK Enters Era Of Deflation With CPI At Minus 0.1% (EI)
According to the latest figures from the Office of National Statistics, the Consumer Price Index (CPI) fell by 0.1% in the year to April 2015, making it the first time in the past 55 years that the UK has experienced deflation on this measure. There has been a lot of talk about how falling prices are good for consumers. However, what is hardly reported is the effect deflation has on those with debts. If we enter a period of sustained deflation, as predicted by some economists such as Professor Steve Keen – the so-called Japan-like scenario – the burden of paying everything from your credit card bill to your mortgage will become a lot more onerous. On this basis, house prices will likely fall quite a long way.
The UK recovery seems to have been based on debt financing, everything from 30-year mortgages for first time buyers to people taking advantage of ostensibly cheap car finance. Inflation shrinks debts but deflation will mean it takes much, much longer to pay that debt off. This is because deflation increases the real value money and the real value of debt. The overall economy will also suffer. With shrinking prices will come shrinking sales, leading to falling corporate profits. They’re will inevitably be less investment and spending as a result. Most workers can forget about pay rises, indeed pay cuts may become the norm. After all, in an era of atomised, non-unionised workforces on short-term and zero hour contracts people will be in no position to argue.
Just as worrying will be the effect of deflation on government finances. With falling sales and more caution on the part of indebted consumers struggling to service their debts, national GDP will shrink. Thus the debt-to GDP figures will increase. Just ask any ordinary Greek what this scenario will feel like. For investors in such a scenario, it makes sense to steer clear of some of the behemoths exposed to the consumer side and instead invest more in high growth small caps – although this is an area where you need to take extreme care. Remember: cash is King, Queen and Prince in a deflationary environment. Its buying power will increase, other things being equal.
All of Britain will be owned by private investors. Sovereign country?
• Osborne Plans For Biggest Sell-Off Of British Public Assets (ITV)
George Osborne has set out his plans to help restore Britain’s economy by staging the biggest ever sell-off of government and public owned corporate and financial assets this year. The Chancellor will create a new government-owned company who will be in charge of the sales, which are expected to be worth £23 billion. UK Government Investments (UKGI) will sell shares in Lloyds Banking Group, UK Asset Resolution assets, Eurostar and the pre-2012 income contingent repayment student loan book. It is part of plans to cut spending by £13 billion by 2017/18.
Speaking at the Confederation of British Industry (CBI), Osborne said: “If we want a more productive economy, let’s get the government out of the business of owning great chunks of our banking system – and indeed other assets that should be in the private sector.” A “plan to make Britain work better” will be published over the next few weeks, setting out proposals to improve transport, broadband, planning, skills, ownership, childcare, red tape, science and innovation. Osborne also addressed the issue of the EU referendum saying he will be “fighting to be in Europe but not run by Europe”.
This is not less growth, this is contraction.
• China’s Factory Activity Contracts For Third Month (CNBC)
China’s manufacturing sector contracted for a third straight month in May as output shrank at the fastest rate in a year, a private survey showed on Thursday. The HSBC flash Purchasing Managers’ Index (PMI) came in at 49.1, weaker than the 49.3 print forecast by Reuters but better than the 48.9 final showing in March. A reading below 50 indicates contraction. “Softer client demand, both at home and abroad, along with further job cuts indicate that the sector may find it difficult to expand, at least in the near-term, as companies tempered production plans in line with weaker demand conditions,” said Annabel Fiddes, an economist at Markit. “On a positive note, deflationary pressures remained relatively strong, with both input and output prices continuing to decline, leaving plenty of scope for the authorities to implement further stimulus measures if required.”
The sub-index on new exports orders fell to a 23-month low of 46.8 in May, while overall new orders shrank for the third straight month, albeit at a slower pace. The output sub-index contracted for the first time this year, to a 13-month low of 48.4, while the employment sub-index showed manufacturers shed jobs for the 19th month in a row. The Shanghai Composite initially turned negative on the news, before recovering to trade about 0.5% higher. The Australian dollar trimmed gains by nearly 0.1% to $0.7877 against the U.S. dollar. “I think we’re still quite far away from where we should be in a recovery. Last month was a really poor… a one year low. So you would expect that the number would improve a little bit,” said Julia Wang, Greater China Economist at HSBC.
“But I think that this number coming in a little bit below than medium forecast shows that the strength of the economy is still not as good as people expected even though expectations have been scaled back continuously in 2015,” she added. The data is the latest in a string of downbeat indicators from China, and reinforces the view that policymakers will be unleashing further stimulus to reach its 7% growth target for 2015. The People’s Bank of China has cut interest rates three times since November, and lowered the reserve requirement ratios (RRR) – the cash banks must hold as reserves -twice. The moves aim to reduce companies’ borrowing costs and boost lending.
Local government liabilities could be $6-7 trillion.
• China Province Completes Landmark Bond Sale (FT)
The Chinese province of Jiangsu completed a landmark bond sale on Monday that marks the start of a massive local government debt bailout that some have described as quantitative easing with “Chinese characteristics”. After an initial failure in April that forced the province to postpone its bond sale, the central government issued administrative orders, guarantees and preferential policies to convince state-owned banks to buy the bonds, the first in a wider Rmb1tn ($161bn) local government debt swap. On Monday Jiangsu sold Rmb52.2bn with a coupon rate only slightly higher than equivalent sovereign Treasury rates, after the central bank capped the premium local governments could offer.
The plan is aimed at reducing the interest burden for debt-laden local governments, which have all borrowed heavily in recent years to pay for the enormous government construction boom unleashed to prop up the economy following the 2008 global financial crisis. The Jiangsu government estimated that Monday’s bond sale would reduce its interest burden by about half, since most of the proceeds would be used to repay expiring short-term bank loans with interest rates of 7-8%. The three, five, seven and 10-year bonds are sold at rates ranging from 2.94% to 3.41%, only slightly higher than China’s Treasury bond rates, which ranged from 2.77% to 3.39% for 10-year notes on Monday.
Not even Beijing seems to know the true scale of local government borrowing in recent years since much of the debt was taken on by off-balance sheet “local government financing vehicles” that allowed provincial authorities to skirt rules banning them from running deficits. In mid-2013 Beijing estimated that local governments had direct and indirect liabilities of nearly Rmb18tn, but they have continued to borrow heavily since then and some analysts believe the actual amount could be more than double that.
There go the Chinese markets.
• Goldin Group Losses Wipe $25 Billion Off Market Cap In One Day (FT)
A day after Hanergy Thin Film shares plunged 47% and were suspended, the two listed units of Goldin Group, the Hong Kong real estate, horse-breeding and electronics conglomerate, have suffered their biggest losses on record. A steep sell-off continued on Thursday afternoon in Hong Kong for Goldin’s two units, having collectively lost more than $25bn from their market capitalisations in fewer than two days. Since the Hong Kong market’s opening on Wednesday, Goldin Properties’ market capitalisation declined from $12.7bn to as low as $5.2bn, while Goldin Financial slid from $29.9bn to $11.3bn. Each stock fell as much as 60% on Thursday alone, and trading continues. As of 1pm in Hong Kong, Goldin Properties shares were down 45%, whilst Goldin Financial stock was 57 lower on the day.
The listed subsidiaries each issued “unusual price and trading volume” announcements to the Hong Kong stock exchange, but did not offer a reason for the losses. “The board confirms that it is not aware of any reasons for these movements or of any information that must be announced to avoid a false market in the company’s securities or of any inside information that needs to be disclosed,” both Goldin subsidiaries said. The Securities and Futures Commission warned in mid-March that Goldin Financial shares “could fluctuate substantially” given the high concentration of ownership. Just 20 shareholders owned almost 99% of the company’s shares, as of March 4, including Pan Sutong, chairman, who held a 70.3% stake.
The main shareholders lost billions in mere minutes.
• Hanergy Shares Suspended After 47% Plunge Wipes $19 Billion Off Market Cap (FT)
Almost $19bn was wiped off the value of Hanergy Thin Film Power on Wednesday when the Hong Kong-listed solar equipment supplier’s shares plunged 47%, on the same day as its chairman failed to turn up at its annual meeting. Li Hejun, chairman of HTF and its Chinese parent Hanergy group, has become one of China’s richest men as the Hong Kong-listed subsidiary’s shares surged about 600% over the past two years. In recent months, an investigation by the Financial Times has raised questions over HTF’s business model and trading patterns in its shares. HTF’s stock was suspended on Wednesday, about 30 minutes after the share price drop, pending an announcement by the company. No other information was given.
Hong Kong’s markets regulator has recently been probing trading in HTF shares, sending written requests for information and meeting investment groups and brokers who have bought and sold stock in the company, according to people familiar with the matter. The Securities and Futures Commission declined to comment. HTF’s public relations company confirmed that Mr Li, who is the controlling shareholder at both Hanergy group and its Hong Kong-listed subsidiary, did not attend Wednesday’s annual meeting. HTF managers, including Frank Dai Mingfang, chief executive, and Eddie Lam, finance director, were present.
China’s started bailing out real estate.
• The Weight Of Chinese Money Adds To The Cost Of Australian Housing (SMH)
The Evergrande Real Estate Group in China recently received a $20 billion bailout (US$16.2 billion) from a group of state-controlled banks which extended it a line of credit to protect the company from insolvency. That’s $20 billion, not million. The chairman of Evergrande is Xu Jiayin, also known as Hui Ka Yan, regarded as the biggest home-builder in China, has a troubled Australian connection. Last November, Xu paid $39 million for Point Piper mansion Villa del Mare, a transaction made via a series of shelf companies to avoid the foreign ownership laws. The federal government examined the high-profile purchase, found it contravened the law on foreigners buying residential property, and ordered the Sydney mansion sold within 90 days.
It only took 60 days to find another Chinese buyer willing to pay $40 million for the property. It sold last week to a Sydney resident with extensive business links in China. Meanwhile, back at Evergrande, big-spending Xu’s real estate empire is so stretched, in a nationally contracting housing market, that the government, via surrogates, is keeping it solvent. Beijing doesn’t want a contagion from the mayhem enveloping another nationally important property developer, Kaisa, which has achieved the negative trifecta of financial distress, a plunging share price and a corruption scandal. The Kaisa scandal coincides with a nationwide anti-corruption drive, instigated by President Xi Jinping, which has enmeshed hundreds of thousands of government officials. It has precipitated a recession in the gambling centre of Macao, a honeypot for laundering money in the grey economy.
The crackdown has caused capital flight, with many Chinese keen to place assets out of the sight and reach of the government. Australia has long been seen as a safe haven for Chinese investors, especially real estate in Sydney and Melbourne, and the local property industry has been a sieve for investments that would not pass the Foreign Investment Review Board guidelines if investigated. As the $20 billion bailout for Evergrande shows, the amount of money sluicing through the volatile Chinese real estate sector is enormous, at a time when the Australian government is looking for more investment from China.
Russia’s had enough.
• Moscow Says It Will Retaliate If Ukraine Hosts US Anti-Missile Defenses (RT)
Russia will take retaliatory measures to protect itself if Ukraine decides to station US anti-missile defense systems in its territory, a Kremlin spokesman told the media. “Concerning Ukraine’s plan to house anti-missile systems in its territory, we can only perceive it negatively,” Dmitry Peskov said Wednesday. “Because it will be a threat to the Russian Federation. In case there are missile defense systems stationed in Ukraine, Russia will have to take retaliatory measures to ensure its own safety.” He was commenting on a recent statement by the head of Ukraine’s Security Service, Aleksandr Turchinov, which claimed that Ukraine faces a “Russian nuclear threat.”
In an interview-structured statement published by the Ukrainian Security Council’s website, Turchinov claims Russia has stationed nuclear missiles on the Crimean peninsula. “Nuclear weapons in Crimea will be targeted, first and foremost, at European countries. There is also real danger for Turkey, which is, by the way, a NATO member,” Turchinov said. “To protect ourselves from the nuclear threat, we may have to hold consultations about stationing components of an anti-missile defense system in Ukraine,” Turchinov said in his statement.
The statement also calls for additional international sanctions against Russia, including blocking the Bosphorus strait from Russian navy vessels and shutting Russia off from the international SWIFT financial transfer system. When asked about Turchinov’s statements on hosting anti-missile defense, a NATO representative told the RIA Novosti news agency he could not comment, saying only that the alliance was “responsible for protecting its member states from missile threats.” Although NATO leaders have expressed support for Ukraine, it is not a member of the alliance. Russia has already rebuffed the idea, with Foreign Minister Sergey Lavrov saying that Turchinov’s statements are “hot air” and “have no prospects.”
Russia will not give in on this.
• Russia Will Take Ukraine to Court If June Coupon Payment Missed (Bloomberg)
Russia said it will take Ukraine to court if the government in Kiev fails to make its next coupon payment after passing a law allowing it to stop servicing its debt. “In June, a $75 million payment is due,” Finance Minister Anton Siluanov told reporters in Moscow on Wednesday. “We’ll see, if they miss the payment, we will use our right to go to court.” Ukraine has failed to bring Russia to the table as it begins negotiating with creditors to reduce its $23 billion of international debt. Russia says the $3 billion bond that comes due in December shouldn’t be included in the restructuring because it was bought from the regime of former Ukrainian President Viktor Yanukovych as part of a government aid agreement.
Ukraine raised the pressure on creditors to accept a writedown on their holdings on Tuesday when it passed a bill enabling the government to halt payments if it can’t reach agreement with bondholders by its June 15 target. Failure to cut a deal risks future tranches of a $17.5 billion IMF loan that Ukraine needs after a conflict with pro-Russian separatists pushed it into the worst recession since 2009. “If Russia takes Ukraine to court, that might be an incentive for other creditors to go down the same route,” Jakob Christensen at Exotix Partners in London, said by phone on Wednesday. “I would wait until after June 20 to go forward with” any moratorium, he said.
Ukraine’s sovereign bonds advanced on Wednesday after falling the most in two months yesterday. The nation’s debt levels are “unsustainable” and there is “no alternative” for creditors but to accept maturity extensions, coupon reductions and principal writedowns on their holdings, Finance Minister Natalie Jaresko said on Tuesday. “I wouldn’t assume that Ukraine is not willing to default on the Russia bond,” Anna Gelpern, a Georgetown University law professor and fellow at the Peterson Institute for International Economics, said by phone on Tuesday. “They’ve said that they want to restructure them on the same terms as everybody else.”
Scary numbers.
• In America, Inequality Begins In The Womb (PBS)
The womb is a miraculous tiny organ prior to pregnancy — not greater than a medium-size orange; its sole purpose is to nurture and protect the fetus until it is expelled into the world. Though small, its impact is gigantic: the nature of its environment during the short period between conception and birth has lifelong consequences on the fetus. For instance, babies born prior to the 37 weeks of gestation or weighing less than 5.5 pounds will be disadvantaged for the rest of their lives in just about everything including their lifetime earnings. Fetuses exposed to toxins or infections will be irreparably damaged. The elephant in the room that we’ve been ignoring for the most part is that inequality — the big social issue of our time — begins amazingly during those 37 weeks.
Sadly, zip codes of birth do matter in the U.S. and they matter more than we think. If the fetus happens to find itself in a womb at 10104 (sandwiched between 5th Avenue and the Avenue of the Americas between W. 51st and 52nd Streets) with an average annual income of an unbelievable $2.9 million, it’ll surely enjoy the best nutrition imaginable: no toxins, no infections, certainly no shortage of micronutrients, and a stupendous team of doctors will make sure that it sees the light of day with optimal weight under optimal circumstances. Those in zip-code 10112 (near Rockefeller Center), who have to make do with $700,000 less, would not be bad either.
However, should the fetus have somehow used an inaccurate GPS and landed in the Melrose-Morrisania neighborhood of the South Bronx — a small mix-up measured in miles — where in some housing projects half the households have less than $9,000 (no, not per month but per year) the fetus’ environment surely would be like on another continent. The kind of inhumane deprivation that exists in the dysfunctional low-income crime-ridden environment that is colloquially called a slum and which the federal government refers euphemistically as “targeted census tracts,” leads to stress, anxiety, abuse, poor nutrition, infrequent doctor visits or no visits at all until the time of delivery, because of lack of money and lack of health insurance.