By The Automatic Earth
Jack Delano Dear Folks … Greenville, SC. Air Service Command July 1943
U.K. Prime Minister David Cameron risked deeper isolation in the European Union as his party was drawn into a political alliance with an upstart German group that opposes Chancellor Angela Merkel. Cameron’s Conservatives will sit in the European Parliament alongside the “Alternative for Germany,” an anti-euro party which assails Merkel for wasting taxpayers’ money on bailing out southern European economies during the sovereign debt crisis. The outcome, announced today, alienates Britain’s key European ally at a time when Cameron is counting on Merkel to help keep the U.K. in the EU. The prime minister needs German help to shift the bloc toward freer trade and less regulation, while backing his drive to win back powers from Brussels. Cameron “is putting that key relationship at huge risk,” said Pawel Swieboda, head of the Warsaw-based Center for European Strategy.
Yesterday, Ambrose Evans-Pritchard wrote in There Is Life After Europe, But Let Us Stop The Triumphalism that there is only one way forward for those who want to keep the EU going, which is ever closer centralization, and since that is, will be and always was unacceptable for Britain, why not cut the umbilical cord right here and now and get it over with? In my view, he’s spot on in that one. I just wish Italy, Greece and Spain would draw the same conclusion. Britain has a referendum on EU membership soon, and as if that’s not bad enough for the establishment, first they have one on Scotland becoming independent. I tell ya, this will be the theme: people wanting independence. There was a line of people many miles long in Basque country this week to claim independence, Catalunya still wants it, there are dozens of movements across Europe who want it, and with zero chance the EU center will hold politically, many of them will get what they want in the rubble of the Union falling to pieces.
Let’s move to central banks. A very interesting piece at MarketWatch describes how politics decide policies at the supposedly independent (there’s that word again) ECB. the gist of the story: ECB head Mario Draghi is set to succeed Italian president Napolitano at around the latter’s 90th birthday (soon), Bundesbank head Jens Weidmann will succeed Draghi, and last week’s oh-so dramatic and historic ECB moves were the last there will be for now. No all-out bond buying that the markets desire.
The Bundesbank’s approval for last week’s European Central Bank package of liquidity measures and interest-rate cuts into negative territory appears to be part of a wider-ranging realignment of responsibilities on the European scene. A series of interlinked initiatives could consolidate the position of reform-minded leaders in key areas of European policy-making, reinforcing economic and monetary union by eventually installing a German leader at the helm of the ECB. By limiting the cut in the ECB’s main interest rates to only 0.10%, and agreeing that rates have now reached their floor in Europe, Mario Draghi and Jens Weidmann, the presidents of the ECB and the Bundesbank, have effectively ended sporadic skirmishing that erupted after they took their jobs in 2011.
What Merkel and Weidmann may still allow before taking over full control of EU finances is buying up some the European too big to fail banks’ used toilet paper:
European Union banks are set to win the right to use a wider range of asset-backed debt to meet their liquidity requirements as the bloc hunts for ways to boost the market for such securities. The European Commission is advocating that securitizations of loans to small businesses and consumers including car buyers should be allowed to count for as much as 15% of the buffers banks will be required to hold under the rule, according to an EU document obtained by Bloomberg News. Limits to the asset-backed debt that will be allowed would include that it must be from the “most senior tranche” of the securitization, that the instruments must have an issue size of at least $135 million and that the “remaining weighted average time to maturity is 5 years or less,” according to the document, prepared for a June 16 meeting with national experts.
Not just a minor detail, but still a sign the central bank policies have no – coordinated – center left to hold on to. Europe doesn’t want QE, but will go a ways to do what it can other than that to at least create the impression it seeks to ward off deflation. The Fed threatens to go the opposite way, says for instance Scotiabank:
The FOMC should (and might) accelerate the pace of QE reductions to $15 billion on Wednesday (June 18th). Furthermore, at its meeting on July 30th, the FOMC could – and should -announce a similar-sized reduction for the subsequent two months. Hence, the Fed would not have to wait until its September 17th meeting to announce the final leg. QE would then end two months earlier at the end of August rather than the end of October as markets currently expect. Such a path would generally afford the FOMC more freedoms, particularly at the September 17th press conference meeting. [..]
The Fed has indicated that it is “not of a pre-set course”. There are advantages of keeping investors on their toes and having them believe that the FOMC is nimble and flexible. In addition, it is likely that the Fed does not want to make the same mistakes made from 2004-2006 when it had become too predictable. The Fed should accelerate the QE withdrawal not just because it is currently being provided with the economic, geo-political, and market cover to do so, but also because the risks to financial stability are intensifying with the rise in the size of its balance sheet. Central bank-induced moral hazard continues to motivate risk-seekers and fuel asset inflation.
And Yellen et al think they have found the antidote to halting the stimulus too:
Federal Reserve officials, concerned that selling bonds from their $4.3 trillion portfolio could crush the U.S. recovery, are preparing to keep their balance sheet close to record levels for years. Central bankers are stepping back from a three-year-old strategy for an exit from the unprecedented easing they deployed to battle the worst recession since the Great Depression. Minutes of their last meeting in April made no mention of asset sales. Officials worry that such sales would spark an abrupt increase in long-term interest rates, making it more expensive for consumers to buy goods on credit and companies to invest, according to James Bullard, president of the Federal Reserve Bank of St. Louis. That “is a widespread view in parts of the Fed, I think, and in financial markets,” Bullard said in an interview last week. While he disagrees with that perspective, it “won the day.”
The Fed is testing new tools that would allow it to keep a large balance sheet even after it raises short-term interest rates, a step policy makers anticipate taking next year. They would use these tools to drain excess reserves temporarily from the banking system. “It is pretty clear they are anticipating operating in a situation with a lot of reserves and a high balance sheet for a long time,” said former Fed governor Laurence Meyer, co-founder of Macroeconomic Advisers. The strategy, which would make the Fed one of the biggest players in money markets, carries risks. In a time of crisis, investors could flock to safe short-term instruments created by the Fed, potentially starving the rest of the financial system of funding. “The whole situation has created a lot of uncertainty,” said Karl Haeling at Landesbank Baden-Wuerttemberg in New York. “The Fed is increasingly stepping into what had been a private-sector function.”
The Fed’s asset purchases have expanded its balance sheet to 25% of gross domestic product from 6% at the start of 2007. Central banks from Japan to the U.K. also will have to develop strategies for operating with large portfolios. For example, the Bank of England’s is 24% of GDP, up from about 6% in 2007. “Ambitious use of a central bank’s balance sheet to channel credit to particular economic sectors or entities threatens to entangle the central bank in distributional politics and place the bank’s independence at risk,” Richmond Fed president Jeffrey Lacker, one of the biggest internal critics of the policy, said in a May 13 speech. The Fed’s purchases created $2.54 trillion of bank reserves in excess of what lenders are required to hold against deposits. The central bank needs to tie up or extinguish that money to raise the short-term interest rate above its current range of zero to 0.25%.
When I read stuff like that, I think the galls and guys at the Fed think they still rule the world. But I don’t think so, and maybe the best proof of that is that the Bank of Japan has eerily similar ideas:
Bank of Japan officials are considering maintaining a large balance sheet for the central bank even after it achieves its inflation target, reducing the risk of a surge in long-term bond yields, according to people familiar with the discussions. Under the potential strategy, the BOJ would use cash from maturing securities in its portfolio to buy long-term government debt, the people said, asking not to be named as the talks are private. Governor Haruhiko Kuroda and his colleagues have yet to meet their inflation target, and pledge to continue asset purchases until consumer prices are rising at a 2% pace.
The possibility of permanently large balance sheets – in Japan’s case, now amounting to more than half the size of the economy – may become a global legacy of unprecedented stimulus measures. “There’s no need for the BOJ balance sheet to go back to where it was,” said Hiromichi Shirakawa, chief Japan economist at Credit Suisse in Tokyo and a former central bank official. “It’s a realistic approach to keep the size of the balance sheet large for a while to avoid a spike in yields.” Any abrupt end to government bond purchases by Japan’s central bank could send borrowing costs soaring, because the BOJ currently purchases the equivalent of about 70% of the new securities issued.
These people think they own the planet. My one big issue with all these bloated balance sheets held forever is that is they work so well, why do the present leadership think their predecessors never went down that road? Do they think they’re that much smarter? Does Yellen see herself miles above Paul Volcker? The idea in Japan seems to be that buying up whatever you can while hugely increasing the money supply is the way to go if you want to beat down deflation. But without increase spending, velocity of money, you’re just going to create mayhem and uncertainty, will push velocity down, not up. As we saw yesterday, the Japanese are so stretched they’re using their savings on a massive scale just to keep their heads above water. But Shinzo Abe has his career all on red, so he must be ready to go down with his bet. And he will. And drag millions of elderly Japanese with him as he uses their pensions in a final and fatal bid to buy stocks from domestic businesses that have seen people buy less of their products for 20 years or more now. There are limits in the extent to which you can distort an economy, but central bankers are too megalomaniac too see them. Take China:
China’s central bank said on Wednesday it will keep monetary policy steady in 2014, even as the finance ministry said fiscal spending had surged nearly 25% in May from a year earlier, highlighting government efforts to energize the slowing economy. Total fiscal spending in May rose to 1.3 trillion yuan ($208.75 billion), quickening sharply from a 9.6% rise in the first four months of the year. China’s cabinet also revealed on Wednesday that it was now planning more big infrastructure projects, including highways, train networks and oil and gas distribution and storage facilities … The higher spending comes after the world’s second-biggest economy got off to a soft start to the year, growing at its slowest pace in 18 months in the first quarter. [..] … the recovery appears patchy and analysts do not rule out further stimulus measures, especially if the cooling property market starts to deteriorate rapidly.
Fiscal revenues rose 7.2% in May from the same month last year, slowing from a 9.2% rise in April. The ministry attributed the slower revenue growth in May to the slowdown in the economy and falling property transactions. [..] The PBOC’s pursuit of stable monetary policy contrasts strongly with the finance ministry’s mini-stimulus, which saw total fiscal spending rise 24.6% to 1.3 trillion yuan ($208.75 billion) in May as it brought forward spending sharply, from growth of 9.6% in the first four months of the year. Stimulus measures taken so far by Beijing include speeding up the construction of railway projects and public housing, as well as orders to local governments to fast-forward their fiscal spending to prime the economy for growth. Central government spending rose 15.8% in May from a year earlier while local government expenditure soared 26.9%, the finance ministry said.
The ECB is doing the watch the hand thing. Big words without much moolah behind them. The Fed looks so divided that a QE wind-down, probably an accelerated one, seems cast in stone, and the one thing that gets a majority of the votes is to hold what’s there until hell freezes over. But China and Japan don’t have the luxury of thinking that they’re doing relatively well – whether that thought is accurate or not -. They think that printing can make – make that force – people spend their money. Whether they have it or not. The US economy is being held up a bit by an increase in credit card debt. The EU focuses on Germany, attempts to ignore the PIIGS numbers, and finds itself in a German induced stalemate at least until Draghi’s gone. While at the same time ignoring separatist voices that are a much bigger threat to Brussels than the powers that be allow themselves to realize.
In China and Japan, the leadership finds itself in a struggle for bare survival. That’s a whole other story, and it will lead to whole other, and increasingly different, central bank policies, this year and next and next. That should be fun to watch. Perhaps the following example will make someone somewhere take a second look:
New Zealand’s central bank delivered its third consecutive rate hike on Thursday, and it’s likely to make that four in a row judging by hawkish comments, some analysts say. The Reserve Bank of New Zealand (RBNZ) lifted its key interest rate by 25 basis points to 3.25%. While that move was not a surprise, analysts had expected the central bank to suggest a slowdown in the pace of monetary tightening. Instead policy makers said further rate increases would be needed to curb inflation in a robust economy. “Effectively, the RBNZ is a lot more focused on domestic mortgage rates. There’s been a lot of competition in the domestic mortgage market in New Zealand which has been pushing rates down,” said Robert Rennie, the global head of foreign exchange strategy at Westpac Bank in Sydney. “The RBNZ is unhappy with that and there is a risk that we see another rate hike in July, which would make it four in a row,” he added.
New Zealand is the only developed economy in the world raising interest rates in the current economic cycle. Last week, the European Central Bank cut its key interest rate to a record low of 0.15%; the Bank of Japan continues to pump money into the economy in a fight against deflation. The U.S. Federal Reserve meanwhile is unwinding its asset-purchasing program but continues to keep its key rate at zero%. “Some of these economies in Asia are doing better so it makes sense for them to be raising rates,” Nariman Behravesh, chief economist at IHS, told CNBC. Consumer prices in New Zealand rose an annual 1.5% in the first in the year to March 31, down from 1.6% in the fourth quarter of 2013.
The Second Coming
Turning and turning in the widening gyre
The falcon cannot hear the falconer;
Things fall apart; the centre cannot hold;
Mere anarchy is loosed upon the world,
The blood-dimmed tide is loosed, and everywhere
The ceremony of innocence is drowned;
The best lack all conviction, while the worst
Are full of passionate intensity.
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