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Consensus that the Fed would extend its $10bn taper from December with a further $10 bn taper today (reducing the monthly flow to a ‘mere’ $65 billion per month – $30bn MBS, $35bn TSY) was spot on. We suspect the view, despite the clear interconnectedness of markets (and flows), of the FOMC is that “it’s not our problem, mate” when it comes to EM turmoil.
- *FED TAPERS BOND BUYING TO $65 BLN MONTHLY PACE FROM $75 BLN
- *FED SAYS LABOR MARKET `MIXED,’ `SHOWED FURTHER IMPROVEMENT’
Of course, “communication” was heavy with forward guidance on lower for longer stressed. We’ll see if the market buys the dichotomy of hawkish real tapering and dovish promises…remember “tapering is not tightening.”
Pre-FOMC: S&P Futs 1775, Gold $1267, 10Y 2.71%, 2Y 35.5bps, USDJPY 102, EM FX 85.67, WTI $97.35, IG 72bps, HY $106.35
Perhaps this chart from Saxo Capital Markets ( @saxomarkets ) sums up the world best for now…
Full redline below…
As Federal Reserve Chairman Ben S. Bernanke shuts the door to his office for a final time in two days, he can say he took actions that were the first or the biggest of their kind in the central bank’s 100-year history. Some will probably also be the last.
Bernanke was the first to devise a monetary policy that focused on lowering credit costs by suppressing longer-terminterest rates after the short-term policyrate hit zero. His strategy, involving direct purchases of agency mortgage-backed securities and longer-term Treasury debt, left the Fed with the biggest balance sheet in its history, $4.1 trillion.
He was the first chairman since the Great Depression to use emergency lending powers to rescue businesses in almost every corner of the financial system — from banks, to corporations, to bond dealers. And he might be the last: Congress, leery of the Fed’s sweeping powers, removed the central bank’s ability to loan to individuals, partnerships and non-bank companies.
“He was incredibly creative in the different steps and programs he took to prevent a free fall of the global economy,” said Kristin Forbes, a professor at Massachusetts Institute of Technology’s Sloan School of Management in Cambridge and a member of the White House Council of Economic Advisers under President George W. Bush. “During a crisis, you have to make decisions with highly imperfect information. He was willing to do that.”
The 60-year-old Bernanke leaves a Fed vastly different from the institution he took charge of on Feb. 1, 2006. At that time, the former Princeton University professor had a few goals. He said naming an inflation target would help boost accountability and policy effectiveness. He also wanted to push power out of the chairman’s office down into the policy-making Federal Open Market Committee, in effect, to dilute some of the mystique his predecessor Alan Greenspan created.
Eight years later, Bernanke achieved those goals. The Feddeclared an inflation target of 2 percent in 2012, and the FOMC is more democratic. The Fed chairman encouraged more open debate at policy meetings, allowing colleagues to interrupt the format if they wanted to make a point. Unlike Greenspan, Bernanke voices his policy view last.
Among other Bernanke innovations, central bankers publish their economic forecasts, including their outlook for the policy interest rate they set, four times a year. The chairman holds a press conference quarterly.
The crisis response also transformed the institution in ways that defy any near-term conclusion because nobody knows whether extraordinary actions, like purchasing $1.5 trillion in mortgage debt or creating $2.4 trillion in excess bank reserves, can be retracted, shrunk and unwound successfully.
The Fed is more extended politically as it engages in policies such as suppressing mortgage rates, and the size and influence of its open-market operations have involved it in financial markets as never before.
“The legacy is still open,” said Vincent Reinhart, a former top Fed official and now chief U.S. economist at Morgan Stanley in New York. “We survived. The question is what are the consequences?”
U.S. central bankers meeting today will probably announce a second $10 billion reduction in the pace of monthly bond purchases, bringing them down to $65 billion from an original $85 billion. That means Bernanke’s successor, current Fed vice chairman Janet Yellen, will inherit a balance sheet that is still growing.
Those purchases from Wall Street dealers add to the level of reserves in the banking system, requiring the Fed to plant a huge footprint in money markets to manage them. Yellen’s Fed will need to use new tools such as paying interest on these reserves or pulling them out of the banking system with reverse repurchase agreements. Otherwise, the central bank would have a difficult time stabilizing its policy interest rate as banks dumped reserves into the overnight market. That could lead to higher inflation.
“I think it is very intrusive,” Tad Rivelle, who oversees about $84 billion as chief investment officer for U.S. fixed-income securities at TCW Group in Los Angeles, said of the Fed’s operations under Bernanke. The outgoing chairman’s legacy “will ultimately be negative” as policies used during the crisis and slow recovery lead to future instability, he said.
That instability may be social and political as well as financial, he said. Banks are still wary lenders, so the Fed’s low-rate policies are providing what Rivelle calls “preferential access” to a privileged group of borrowers: the government, corporations and consumers with the highest credit scores.
The bond-buying policy, known as quantitative easing, has helped boost asset prices. The Standard and Poor’s 500 stock index rose 30 percent last year, and home prices rose a projected 11.5 percent in 2013, according to an index tracked by CoreLogic, an Irvine, California, data and analytics company. Yet earnings per hour for private-sector workers have climbed just 2 percent a year on average since 2011 compared with a 3.2 percent gain in 2007, the last year of the previous expansion. Adjusted for inflation, they’ve barely grown at all.
Meanwhile, the Fed’s retreat from quantitative easing is slowing capital flows to emerging markets, roiling local stock markets. The MSCI Emerging Markets Index is down 6.8 percent year-to-date.
The Fed’s rescues under Bernanke also left an expanded safety net around financial institutions and markets that Congress and regulators are busily trying to shrink.
Fed officials, such as Richmond Fed president Jeffrey Lacker, warn that if the perception of government guarantees against financial risk isn’t reduced, it will set the stage for another crisis. Richmond Fed economists estimate that the proportion of the total liabilities of U.S. financial firms covered by an implicit or explicit federal safety net increased by 27 percent over the past 12 years.
Bernanke helped increase the perception of government support by rescuing Bear Stearns Cos. and American International Group Inc. during the crisis. He further contributed to that notion when Goldman Sachs Group Inc. and Morgan Stanley came under speculative attack and he let them convert into banks, which granted them access to backstop credit from the Fed.
The bailouts triggered a backlash, stiffening resolve on Capitol Hill to prevent taxpayer support from helping Wall Street again.
Even one of Bernanke’s predecessors, former Chairman Paul Volcker, was surprised by the actions, which, he said in an April 8, 2008, speech before economists in New York, took the Fed “to the very edge of its lawful and implied powers.”
The 2010 Dodd-Frank Act, the most sweeping rewrite of financial rules since the 1930s, contains the phrase “to end too-big-to-fail” in its preamble, a message to regulators that no bank should be so big and risky that it would have to be saved again. To put a point on it, Congress limited the Fed’s power to lend emergency funds to non-bank corporations to a broad-based facility that could only be accessed by several institutions. The message was that singular bailouts of firms such as Bear Stearns were over.
Bernanke said in a hearing in February that regulators were “moving in the right direction” to end too-big-to-fail with the new tools given to them by the Dodd-Frank Act.
Phillip Swagel, who helped manage the government’s bank bailout fund known as the Troubled Asset Relief Program during the George W. Bush administration, said legislation is only part of the solution.
“We won’t know if too-big-to-fail has been solved until the next crisis,” said Swagel, now an economist at the University of Maryland in College Park. “The tools are there” to take down a troubled bank, he added. “The unknown is the will of the government.”
Among the unresolved questions as Bernanke exits: Can the Fed operate indefinitely with a multi-trillion-dollar balance sheet? Is the flow of credit to the economy constricted with the banking system under intense regulatory scrutiny? Has the economy downshifted to some slower pace of growth that the Fed can’t change?
“This is a Fed that’s intervening in the yield curve, it’s intervening in liquidity markets, it’s intervening in many asset classes,” said Julia Coronado, a former Fed board staff economist who is now chief economist for North America at BNP Paribas in New York.
“The book is still open, the last chapters have yet to be written, and it’s way too soon to say, ‘Ah, this is his legacy,’ because history is the judge, and there’s still a lot of risk.”
To contact the reporter on this story: Craig Torres in Washington at firstname.lastname@example.org
To contact the editor responsible for this story: Chris Wellisz at email@example.com
Is this how it starts?
The third great market crash of the 21st century?
At Ben Bernanke’s perhaps final public appearance at the Brookings Institution on January 16th, the beginnings of the 2008-2009 financial crisis were linked to the issues of a French bank in the summer of 2007, an incident little noticed at that point in time.
This time around will it be the currency problems of frontier and emerging markets? The default of a Chinese trust fund, discussed in some detail here atForbes? Or something else altogether, totally hidden at the moment? Or nothing at all?
With U.S. equity markets suffering their deepest losses since 2012, there were plenty of disparate concerns to go around this past week.
These included the fear of the Fed’s tapering ultimate timing and impact, weakening China growth, those currency devaluation jitters, a lackluster U.S. earnings season, perceived overheated equity market valuations, and that China trust fund, to mention a few. There was also the end of week concern that the selling could feed upon itself, as those market-makers selling puts on indices and calls on the VIX could get squeezed and have to hedge next week with more S&P futures selling.
On the week, the Dow gave up -3.5%, finishing below 16,000 for the first time since mid-December. The S&P 500 lost -2.6%, closing below the key 1800 level at 1790. And the NASDAQ fared the best, down “only” -1.7%, helped by the relative strength of some of its high-fliers. Notably, the VIX popped close to +46%, ending the week just above 18, although still far below panic levels.
It is a bit iffy to reconstruct the true narrative of the week, as things seemed to get rolling to the downside on Monday evening. Influential Fed watcher Jon Hilsenrath of the WSJ wrote of January FOMC tapering possibilities:
A reduction in the program to $65 billion a month from the current $75 billion could be announced at the end of the Jan. 28-29 meeting, which would be the last meeting for outgoing Chairman Ben Bernanke.
Coincidence or not, the next four trading days were all on the negative side of the ledger for the Dow, although the S&P hung in decently on Tuesday and Wednesday. But then China’s HSBC PMI numbers hit, indicating a drop in January to 49.6 from December’s final reading of 50.5, moving “below the 50 line which separates expansion of activity from contraction.” (Reuters).
This, combined with the currency devaluation news, with Venezuela, Argentina, and Turkey leading the headlines, seemed to fuel the overall“emerging market risk” theme which overwhelmed markets on Friday.
Not helping were some comments coming out of Davos. Larry Fink ofBlackRock BLK -3.95% said there was “too much optimism” in the markets. He added, according to Bloomberg , “The experience of the marketplace this past week is going to be indicative of this entire year. We’re going to be in a world of much greater volatility.”
This came on the heels of Goldman’s chief strategist, David Kostin, saying two weeks ago that market valuations are “lofty by almost any measure.”
But the real outlier came from Dr. Doom himself, NYU professor and head of Roubini Global Economics, Nouriel Roubini. Roubini seized on yet another global issue, tweeting:
@ Nouriel: “Japan-China war of words goes ballistic in Davos” and “A black swan in the form of a war between China & Japan?” along with various comments on the emerging market issues, saying, “Argentina currency crisis & contagion to other EM – on top of weak China PMI – suggests that some emerging markets are still fragile.”
The China/Japan “conflict” story was the shocker, and apparently goes back to some comments allegedly made by Japanese Prime Minister Shinzo Abewhich compared China/Japan tensions to those found between Germany and Britain prior to World War I. (CNBC) In an interview with Business Insider, Roubini called the events of last week “a mini perfect storm,” alluding to“weak data in China, fresh currency market turmoil in Argentina, and a worsening chaotic situation in the Ukraine.”
It is a bit amusing to note that while Mr. Roubini was serving on several panels at Davos, giving press interviews, and tweeting non-stop, he also found time (or one of his associates did) to post a ranking of “top Tweeters” from the World Economic Forum, showing himself in 5th place. (See Twitter imagehere.)
Let’s take a very quick look at a few of the other notable quotes from newsmakers this week:
–“I don’t think it (marijuana) is more dangerous than alcohol.” –President Obama in a New Yorker interview published last Sunday. The remark created a firestorm of controversy, including reportedly negative feedback from DEA Administrator Michele M. Leonhart and many others. (Huffington Post)
–Apple is “one of the biggest ‘no-brainers’ we have seen in five decades of successful investing.” –Fund manager and legendary investor Carl Icahn, in continuing to tout AAPL’s undervaluation and push for stock buybacks by the company. Forbes also noted that Icahn grabbed headlines last week for now getting involved with eBay and urging a spinoff of its PayPal holding.
–“Gross: PIMCO’s fully engaged. Batteries 110% charged. I’m ready to go for another 40 years” –PIMCO’s Bill Gross tweeting after the highly visible and speculation-provoking departure of Mohamed El-Erian. Mr. El-Erian reportedly said in a letter to PIMCO employees, “The decision to step down from PIMCO was not an easy one.”
–“It’s a very juicy target.” –Andrew Kuchins, Russia Program Director for CSIS, in commenting on the terrorist threats at the Sochi Olympics and the need for extensive security and preparedness planning. (USA Today)
–“It’s so easy to enter, a caveman could do it.” –Warren Buffett, a bit jokingly, in announcing his company’s sponsorship of a $1 billion March Madness challenge along with Quicken. (Fox Sports) The simple idea is that an absolutely perfect bracket will produce the billion-dollar winner, but the offer includes also some twenty $100,000 winners for the best, if imperfect, brackets. There is also a charity angle, but at something like 1 in 9.2 quintillion odds (we have seen varying estimates all over the place) Berkshire is likely not facing too much risk here.
–“A lot of people got dead in that one.” –retired NYC detective and now security consultant/media celebrity Bo Dietl on the Don Imus program, commenting on the history of the Lufthansa “Goodfellas” robbery and this week’s arrests in the case.
–And in another high profile criminal case, famed lawyer Roy Black said of client Justin Bieber, “I’m not going to make any comments about the case except to say Mr. Bieber has been released on bond and we agreed that the standard bail would apply in this case.” (CBS Miami)
–“We’ve lost some of our consumer relevance.” –McDonald’s CEO Don Thompson in a call after client traffic comps greatly disappointed in the recent earnings release. This was the flipside of Netflix, which surged dramatically after their latest numbers and user figures, with NFLX stock up some 17% despite the terrible market week.
–“We believe POS malware will continue to grow.”–The FBI in a statement on the troubling hacking of Target and other retailers, which was revealed in far greater detail this week, including the hacking intrusion of Neiman Marcus. (Yahoo)
–“It was so awesome!” –ESPN reporter Erin Andrews, in a slightly hard to believe remark on the antics of Seattle defensive back Richard Sherman after last week’s NFC title game. Her initial real-time reaction to the interview seemed at odds with that statement, as she stood in utter disbelief in the post-game situation. (seattlepi.com)
Let’s close it out there, as all eyes will be on the opening of foreign equity markets tonight and the U.S. futures trading. Well, maybe not all eyes, as the Grammy Awards also kicks off this evening. But the really big event of the week will be President Obama’s State of the Union address Tuesday evening. Presidential senior adviser Dan Pfeiffer predicted in an email of the upcoming SOTU address, according to Bloomberg:
Pfeiffer: ‘Three words sum up the president’s message on Tuesday night: opportunity, action, and optimism. The core idea is as American as they come: If you work hard and play by the rules, you should have the opportunity to succeed.’ While Obama ‘will seek out as many opportunities as possible to work with Congress in a bipartisan way,’ Pfeiffer said he ‘will not wait for Congress’ to act on some of his goals.’
Have a good week!
The Business Unit
Don Pittis has been a Fuller Brush man, a forest fire fighter and an Arctic ranger before discovering journalism. He was principal business reporter for Radio Television Hong Kong before the handover to China and has produced and reported for CBC and BBC News. He is currently senior producer at CBC’s business unit.
Janet Yellen, soon to be the new head of the world’s most powerful central bank, sure seems like a nice person. In some circles, being nice is an insult. Some Americans say Canadians are too nice – we even thank our bank machines, goes the joke. But despite all that, JanetYellen does seem nice.
Not that the outgoing chair of the U.S. Federal Reserve, Ben Bernanke, is a bad man. And surely the one before that, Alan Greenspan, meant well when he kept cutting interest rates to keep the stock and property boom alive – long past the moment when, most now agree, they should have been allowed to take a rest.
But Janet Yellen – soft-spoken, seemingly concerned about America’s disenfranchised as much as she is about stock market growth – exudes character. With Yellen assuming the role of Fed chair on Feb. 1, the question is, what does the character of a central banker mean for the economic future of the U.S., the world… and Canada?
- 5 key facts about incoming U.S. fed chair Janet Yellen
- Janet Yellen cleared to become next chair of U.S. Federal Reserve
For all the supposed clout of the U.S. central bank, the chair of the Fed does not have the power of a dictator. In a rare foray into central bank humour, comedian Rick Mercer reminds us that the levers of that power are subtle.
There is no question that Yellen is smart. That will count in her job of swinging the 19 members of the committee that makes interest rate decisions toward consensus. But it will also be helped by the feeling that she is motivated by the best intentions for the entire U.S.
Central bankers a product of their time
It may be that each of the recent central bankers was perfectly suited to their times. Greenspan, who trained at the knee of Ayn Rand, presided during the era of Greed Is Good, when everyone in the world was supposed to be fighting to get to the top of the heap.
When the house of cards suddenly collapsed, it was the turn of Ben Bernanke, a man who has made a career studying the economic mistakes that turned a 1929 market collapse into the Great Depression. He wanted to prevent the same thing from happening again, at all costs.
Now, we are in a different era. It appears that Bernanke’s strategy managed to avert a disruptive economic collapse. But one of the results of the Fed’s emergency measures was to give a giant handout to the people who Greenspan had allowed to climb to the top of the heap, creating a class divide not seen since before the Great Depression.
Like almost everyone else in the upper echelons of U.S. government, Yellen is elite, with elite friends. As she said in a revealing interview in the early 2000s with fellow University of California, Berkeley economist Kenneth Train, when she voted in favour of interest rate hikes in the 1990s, she says she felt pressure in social circles.
“Higher interest rates are things that people really don’t like,” she told Train. “I would go to parties and meet people [and people would say,] ‘I’m losing money because you’re raising interest rates and what you’re doing is harming me.'”
She goes on to say that while it drove home her personal responsibility for making rate decisions, she had to put the interests of the wider economy before those of her friends.
An easing of quantitative easing?
Yellen’s job now could have even more of an impact on her well-off friends. As I have said before, the distorting effect of Bernanke’s quantitative easing (or QE) – buying bonds to stimulate the economy when interest rates could go no lower – has been great for the stock market. But there are growing doubts that the extra injection of cash is making it into the hands of the poorer Americans who need it most.
Yellen knows she will have to cut QE eventually. But it is a scary process. You may argue whether or not QE really worked. But if buying bonds stimulated the economy, then ending the buying of bonds will definitely de-stimulate it. As with plans to halt fiscal spending in 2010,stopping a strong stimulant is effectively indistinguishable from taking a strong depressant.
As the Fed said in recently released minutes, even if reducing QE does not have a huge, direct impact on Main Street, it might cause an “unintended tightening of financial conditions if a reduction in the pace of asset purchases was misinterpreted as signaling that the Committee was likely to withdraw policy accommodation more quickly than had been anticipated.”
That’s Fed-speak for bond and mortgage markets taking fright, sending interest rates shooting up. It’s not just hypothetical. It happened once last year, just because people thought policy would change. And that wouldn’t just be bad for Americans. World bond and mortgage rates are set in the U.S., and the Canadian housing market might be severely hurt by such a shock.
If you believe, as I do, that QE is hurting a majority of Americans and Canadians, and maybe doing long-term damage to the entire society by increasing the disparity of rich and poor, Yellen has a balancing act ahead of her. Her feat must be to reduce QE as quickly as possible without scaring the markets into thinking she is doing it too quickly.
Thankfully, Yellen is appropriately humble.
“Macroeconomics, I think it’s a very useful set of tools for thinking about the economy,” she said in her interview with Train. “But in terms of our ability to know the future and forecast where things are going, that’s a very difficult thing to do. There are a lot of imponderables.”
If Yellen succeeds, it will not be a feat of strength. It will be a feat of wisdom. It will be a feat of experience. And it will depend on being nice. Nice as a Canadian. With luck, Yellen, like Greenspan and Bernanke, will be the right person for her time. The world needs a little nice.
The casino metaphor has been widely used as a part-description of the phenomenon of over-financialisation. It’s a handy pejorative tag but can it give us any real insights? This article pursues the metaphor to extremes so that we can file & forget/get back to the football or possibly graduate to next level thinking.
What is the Financialised Economy (FE) and how big is it?
The FE can be loosely described as ‘making money out of money’ as opposed to making money out of something; or ‘profiting without producing’ . Its primacy derives largely from two sources – the ability of the commercial banks to create credit out of thin air and then lend it and charge and retain interest; and their ability to direct the first use of capital created in this fashion to friends of the casino as opposed to investing it in real economy (RE) businesses. So the FE has the ability to create money and direct where it is used. Given those powers it is perhaps unsurprising that it chooses to feed itself before it feeds the RE. The FE’s key legitimate roles – in insurance and banking services – have morphed into a self-serving parasite. The tail is wagging the dog.
The FE’s power over the allocation of capital has been re-exposed, for those who were perhaps unaware of it, as we see the massive liquidity injected by the central banks via QE disappearing into the depths of bank balance sheets and inflated asset values leaving mid/small RE businesses gasping for liquidity.
By giving preferential access to any capital allocated to the RE to its big business buddies the FE enables those companies to take out better run smaller competitors via leveraged buy outs. By ‘investing’ in regulators and politicians via revolving doors and backhanders, it captures the legislative process and effectively writes its own rule book.
Five years after the 2008 crisis hit, as carefully catalogued by FinanceWatch , economies are more financialised than ever. If the politicians and regulators ever had any balls they have been amputated by the casino managers, under the anaesthesis of perceived self-interest. They have become the casino eunuchs. An apparent early consensus on the systemic problems of over financialisation has melted away into a misconceived search for ‘business as usual’.
Derivatives are one of the most popular games in the casino.
Over the counter derivatives, which are essentially bets on the performance of asset prices, stocks, indices or interest rates, have a nominal value (as of December 2012 ) of USD 632 trillion – 6% up from 2007 levels – and 9 times world GDP. If the world decided to stop living and buy back derivatives instead of food, energy, shelter and all the stuff we currently consume, it would take nine years to spend this amount.
OK – it’s a nominal value. Many observers believe (even hope) that its real value is a minute fraction of this, but the only way we will ever find out is if the derivative contracts unwind. That is, prompted presumably by some form of crisis, parties progressively withdraw from the contracts or fold. The regulators (and the FE itself of course) will do everything they can to prevent this from happening, including grinding the population into the dust via austerity, because while no-one knows who precisely holds the unwound risk, most will certainly belong to the FE’s top tier.
Many of these derivatives started life as sensible financial products. Businesses need to insure against an uncertain harvest, or hedge against uncertain currency movements. But only a small proportion of current holders now have an insurable risk. So whereas in the past you could say we insured against our own house burning down, now they bet on their neighbour’s house burning; whereas in the past we bet on our own life expectancy, they now bet on the deaths of others; whereas in the past we insured against currency losses we experienced in our own business transactions, now they bet on currency movements in general. What might be expected when there are incentives to burn your neighbour’s house down? Organisations have even purposely set up junk asset classes, had them AAA rated, sold them to outsiders and then bet on their failure.
Government & Politicians
Politics operates as a debating society in a rented corner of the casino. The rent is high but largely invisible to the populace. The debaters are themselves well off, at least in the U.S. they are .
Now the strange thing is that the government actually owns the casino, but they have forgotten this. For the last 40 years or so, they have asked the casino managers to issue all the chips. The government use the same chips to spend on public services, and require us all to pay taxes in those chips. Mostly they don’t have enough chips for all the services they provide, so they ask the casino managers for loans. The casino managers are happy with this, provided the government pay interest on the loan of chips. This hidden subsidy effectively funds the casino. It’s perverse because the government pays interest on money they could issue themselves debt-free.
It’s not entirely clear why the government thinks the casino managers are better at managing chips than they would be. Arguably the government is elected to carry out a programme and they should be the arbiters of the country’s strategic priorities, so there should be some strategic guidance over the way the chips are spent.
But the government is only here for five years, and the casino managers are here permanently. So perhaps they think it’s safer just to trust the casino managers to get on with it. When asked, the casino managers explain that they allocate chips according to ‘what the market needs’ and no-one quite understands why that doesn’t seem to include much real investment. In any case the government have forgotten that they could issue the chips themselves, and although prompted (e.g. ), have failed to show any interest in reclaiming that power. Occasionally they create a whole new batch of chips themselves (QE) – if they think the tables are quiet – but give them straight back to the casino managers. Maybe it’s too complicated for politicians. Many of them haven’t had proper jobs. There are a few civil servants who understand what’s happening, but most of them don’t want to rock the boat – they are here permanently too and have good pensions. They research for the debaters and have lunch with the casino managers. That keeps them quite busy enough, thank you.
The Real Economy
The Real Economy also operates from a corner of the casino. It’s hard to put an exact figure on it, but perhaps 3-5% of the overall floor space depending how you measure.
It’s a very important corner of the casino, but not for the reasons it should be. It should be important because it’s the place where food is grown, houses are built, energy for warmth and work is created and so on. But these precious things are taken for granted by the casino managers. They have always had enough chips to buy whatever they need – they issue them for God’s sake – and they think food, shelter and energy will always be available to them. Crucially though, they have also managed to financialise this remaining RE corner, and this ‘support’ is trotted out as a continuing justification for the FE’s central importance .
The RE corner has always included important social and cultural, non-GDP activities. The enormous real value of these activities is now being properly articulated and is spawning citizen-led initiatives (e.g. sharing economy approaches, basic unconditional income) but they are often presented as beggars who annoyingly keep petitioning for their ‘entitlements’ and generally clutter up this remote corner of the casino.
On the finance side, individuals and businesses are exploring ways of funding their future activity without going cap-in-hand to the casino managers. They are exploring peer-to-peer finance, crowdfunding, prepayment instruments and so on. What these initiatives have in common is the disintermediation of the casino. They provide ways for people to invest more directly and take more control over their savings and investments. Of course a new breed of intermediary is surfacing to broker and risk-insure these new models, and these new intermediaries can also be captured.
With transparency and short-circuit communication via social media though, there is definitely scope to do things differently. We must hope for progress because the casino managers have little interest in what’s going on outside.
The Planet – outside the casino
The planet outside is used by the casino in two ways – as a source of materials and as a dumping ground for waste.
The materials are not essential to the core FE which is all about making money out of money and needs nothing but ideas, a few arcane mathematical models to give spurious gravitas, and credulous or naive investors. But RE activity performs a valuable role for the casino managers – it provides them with an endless stream of innovative ways of using chips. The shale gas bonanza for example is apparently grounded in the real world need for energy, and is presented as such. Its significance to the FE is as another bubble based partly at least on land-lease ‘flipping’ .
Without an RE-related rationale/narrative, the FE might disappear up its own waste pipe as it re-invested/sliced-and-diced/marketised its own products to itself. So materials from outside the casino are important for the managers’ big corporate proxies in the RE.
FE-favoured RE activities also create lots of waste, some of which is toxic, and may eventually prove terminal, as it builds up. This fact is of little interest to the casino managers. There is a minor interest in waste-related financialised vehicles – carbon markets for example are a relatively new casino game – and in the slight impact on some of the FE’s RE-friends like big energy companies. But mostly the casino managers are too busy with their games and their chips. Occasionally a manager will wake up to the dangers and defect to the real world where they, somewhat perversely, carry more credibility because of their casino experience. A small minority of managers stay within the casino and try to gently modify its behaviour. This is portrayed as a healthy sign of openness; the casino is secure in the knowledge that their ways cannot easily be re-engineered.
Combating the casino’s influence
Essentially there would appear to be three possible lines of response for those who believe there should be more to life than casino capitalism. Marginalise, convert or destroy……
These approaches map on to the three ‘broad strategies of emancipatory transformation’ suggested by sociologist Erik Olin Wright  – interstitial, symbiotic and ruptural. I have a fourth suggestion/ variation of which more in a moment.
The challenge for interstitial initiatives is the sheer pervasiveness of the FE. There are few spaces left where the effects of the FE can be ignored. They may not be well understood, but whenever we pursue dreams, they pop up in front of us, usually as obstacles. Developments that are most heavily attacked by the FE establishment perhaps merit the most attention – community scale renewable energy, crypto currencies, co-ops, the sharing economy, and so on. The more these alternative directions are attacked as utopian or uneconomic the more we can be sure they offer promising interstitial opportunities.
Symbiotic opportunities may represent the triumph of hope over experience. Armed with the power of ideas, we back our ability to persuade policy makers and business leaders to change the game. The main challenges here are the arrogance of the powerful and the danger of being captured by supping with the devil. Vested interests generally feel secure enough that they don’t need to negotiate or even to spend brain power on listening and evaluating alternatives. If enough interest is manifested that symbiotic trial projects are begun, their champions can be captured by being made comfortable.
Ruptural alternatives come in a spectrum from those that would destroy business models to those that would destroy societies. They probably share the above analysis but differ in their degree of radicalism and disconnection from the main. The impact of FE-driven globalisation is beyond the scope of this article, save to note that its effects have unnecessarily radicalised whole populations making more measured responses more difficult to promote than they might have been.
The role of the internet and social media in progressing both interstitial and ruptural initiatives is significant. Most of the space to develop and assemble communities of interest and mission-partners is here, explaining why both are likely to experience increasingly determined attempts to capture.
The nature of one’s chosen response will be a matter of personal choice. We should not be judgemental of those who don’t have the will, energy or resourcefulness to play a more active role. We all suffer from our subservience to a dysfunctional system, some much more than others. The fourth response? Perhaps there’s some mileage in judo principles .
: http://rikowski.wordpress.com/2013/12/12/profiting-without-producing-how-finance-exploits-u s-all/
: “It seems fairly clear at this time that the land is the play, and not the gas. The extremely high prices for land in all of these plays has produced a commodity market more attractive than the natural gas produced.” Art Berman quoted athttp://theautomaticearth.blogspot.ie/2011/07/july-8-2011-get-ready-for-north.html
Featured image: Luxor, Las Vegas. Author: David Marshall jr. Source: http://www.sxc.hu/browse.phtml?f=view&id=90604
In his 712-page tour de force, The Great Deformation, David Stockman dissects America’s descent into the present era of “bubble finance.” He describes the housing bubble’s early stages as follows:
The American savings deficit was transparent after the turn of the century, but the Fed flat-out didn’t care. … Greenspan and his monetary central planners had a glib answer: do not be troubled, they admonished, the Chinese have volunteered to handle America’s savings function on an outsourced basis.
So instead of addressing the growing deformations of the American economy after the dot-com crash, the Fed chose to repeat the same failed trick; that is, it once again cranked up the printing presses with the intent of driving down interest rates and thereby reviving speculative carry trades in stocks and other risk assets.
Needless to say, it succeeded wildly in this wrong-headed game plan: by pushing interest rates down to the lunatic 1 percent level during 2003-2004, the Fed sent a powerful message to Wall Street that the Greenspan Put was alive and well, and that the carry trades now offered the plumpest spreads in modern history. Under the Fed’s renewed exercise in bubble finance, asset prices could be expected to rumble upward, whereas overnight funding costs would remain at rock bottom.
That is exactly what happened and the equity bubble was quickly reborn. After hitting bottom at about 840 in February 2003, the S&P 500 took off like a rocket in response to virtually free (1 percent) money available to fund leveraged speculation. One year later the index was up 36 percent, and from there it continued to steadily rise in response to reported GDP and profit growth, albeit “growth” that would eventually be revealed as largely an artifact of the housing and consumer credit boom which flowed from the very same money-printing policies which were reflating the equity markets.
In hindsight, it’s hard to refute Stockman’s perspective on the Fed’s role in the housing bubble. But that won’t stop some from trying, and especially the many academic economists beholden to the Fed. Research papers have stealthily danced around the Fed’s culpability for our crappy economy, as we discussed here.
More importantly, if Stockman is right about bubble finance, there’s more mayhem to come. Consider that denying failure and persisting with the same strategy are two sides of the same coin. Just as investors avoid the pain of admitting mistakes by holding onto losing positions, Fed officials who claim to have done little wrong are also more committed than ever to propping up asset markets with cheap money.
For those concerned about another policy failure, a key question is: “As of today, where do we stand with respect to bubbles and bubble finance?”
We’ll compare two indicators that may help with an answer:
- Stock valuation indicator: To eliminate the problem that price-to-earnings (P/E) multiples tend to skyrocket when earnings shrink in a recession, we use price-to-peak-earnings (P/PE). This is the S&P 500 (SPY) index divided by the highest earnings result from any prior 12 month period. (See here for further discussion.)
- Monetary policy indicator: We use the difference between Fed policy rates (the discount rate until 1954 and fed funds rate thereafter) and inflation, averaged over the prior two years. By taking a two-year average, we capture lags in the economic effects of rate changes (commonly estimated at up to 24 months), while also smoothing out anomalies.
Here’s the data:
The chart shows that it wasn’t until the Fed’s battle with the Internet bust – described above by Stockman – that policy rates were first lowered below inflation at the same time that stocks were “fully valued” (which we defined as a P/PE above 17). The Fed had never before allowed the policy/valuation mix to drift into the chart’s bolded, upper-left quadrant.
Today, we’re well into our second experiment with that quadrant, which is a precarious place to be. It doesn’t take much analysis to see that strong policy stimulus despite an elevated price multiple is a recipe for bubbles.
In other words, the chart suggests another reason to expect the next bear market to be severe, as we discussed in “P/E Multiples, Deleveraging and the Big Experiment: Sizing Up the Next Bear Market” and again in “Bubble or Not, U.S. Stocks Are Priced to Deliver Dismal Long-Term Returns .”
Worse still, we haven’t even contemplated the Fed’s preoccupations as we head into Janet Yellen’s reign. The next time you puzzle over the transparency of the forward guidance or the timing of the taper or the transparency of the guidance for the timing of the taper (you get the idea), we suggest coming back to the data above.
In the bigger picture, interest rates alone are enough to show that we’re back in the danger zone.
While the policy/valuation mix reached the chart’s bolded quadrant for the first time in 2003, you may wonder about close calls. Eliminating the bubble finance era, we find two:
The first occurred in late 1958 and 1959, and Fed Chairman William McChesney Martin met the challenge with aggressive increases in both interest rates and stock market margin requirements. Stockman discussed these policies in The Great Deformation, stressing that Martin responded to financial excess only four months after the end of a recession. Martin’s actions helped to slow lending growth while preventing asset bubbles.
The second close call occurred in 1972, when Fed Chairman Arthur Burns held the discount rate steady at a five-year low of 4.5%. Alongside President Nixon’s blunders, Burns’ dovish approach soon spawned double-digit inflation, a painful recession and a severe bear market.
Overall, four past chairmen faced a policy/valuation mix that was either headed toward or inside the bolded “danger zone” in our charts. Martin tightened preemptively and escaped unscathed. Burns and Greenspan will forever be seen to have lost the plot. The history books aren’t yet written for Ben Bernanke, but we don’t like his chances.
From Russ Certo, head of rates at Brean Capital
Two Roads Diverged
As we know, it has been a suspect week with a variety of earnings misses. Although I have been constructive on risk asset markets generally, equities anecdotally, as figured year end push for alpha desires could let it run into year end. New year and ball game can change quickly. Just wondering if a larger rotation is in order.
There is an overall considerable theme of what you may find when a liquidity tide recedes as most major crises or risk pullbacks have been precipitated by either combination of tighter monetary or fiscal policy. Some with a considerable lag like a year after Greenspan departed from Fed helm, or many other examples. I’m not suggesting NOW is a time for a compression in risk but am aware of the possibility, especially when Fed Chairs take victory laps, Bernanke this week. Symbolic if nothing more. Cover of TIME magazine?
I happen to think that 2014 is a VERY different year than 2013 from a variety of viewpoints. First, there appears to be a dispersion of opinion about markets, valuations, policy frameworks and more. This is a healthy departure from YEARS of artificiality. Artificiality in valuations, artificiality in market and policy mechanics and essentially artificiality in EVERY financial, and real, relationship on the planet based on central bank(s) balance sheet expansion and other measures intended to be a stop-gap resolution to tightening financial conditions, adverse expectations of economic activity, and the great rollover….of both financial and non-financial debt financing. Boy, what a week in the IG issuance space with over $100 billion month to date, maybe $35 billion on the week. Debt rollover on steroids.
Beneath the veneer of market aesthetics, I already see fundamental (and technical) relevance. This could be construed as an optimist pursuit or reality that markets are incrementally transcending reliance and/or dependence on the wings of central bank policy prerogatives. The market bird is trying to fly on its own with inklings of a return to FUNDAMENTAL analysis. A good thing, conceptually, and gradualist development of passing the valuation baton back to market runners. A likely major pillar objective of policy despite more than a few critics worried about seemingly dormant lurking imbalances created by immeasurable policy and monetary and fundamentally skewed risk asset relationships globally.
This exercise of summarization of ebb and flow and comings and goings of markets and policy naturally funnels a discussion to what stature of central bank policy currently or accurately exists? Current events. What is the accurate stage of policy?
I actually think this is a more delicate nuance than I perceive viewed in overall market sentiment. Granted, we have taken a major step for mankind, which is the topical engagement of some level of scope or reduction of liquidity provisioning,” not tightening.” Tip of the iceberg communique with markets to INTRODUCE the concept of stepping off the gas but not hitting the break. Reeks of fragility to me but narrative headed in right direction to stop medicating the patient, the global economy.
Some markets have logically responded in kind. The highest beta markets as either beneficiaries or vulnerable to monetary policy changes, the emerging markets, have reflected at least the optics of change with policy. More auditory than optics in hearing a PROSPECTIVE change in garbled Fedspeak. The high flyer currencies which capture the nominal flighty hot money flows globally affirmed the Fed message.
In literally the simplest of terms, the G7 industrialized, not peripheral; interest rate complex has simply moved the needle in form of +110 basis point higher moves in nominal sovereign interest rates. And there are a bevy of other expressions which played nicely and rightly conformed to the messages coming out of the central bank sandbox. But there are ALSO notable dichotomies, which send a different or even the opposite message.
I perceive a deviation in perception of message as some markets or market participants appear to be betting on taper or a return to normalcy in global growth or U.S. growth outcomes??? OR no taper, or conversely QE4 or whatever. Sovereign spreads have moved materially tighter vs. industrial and supposed risk free rates (Tsys, Gilts, Bunds) both last year and in the first three weeks of 2014. Something a new leg of QE would represent, not a taper. A different year!!!
There have been VERY reliable risk asset market beta correlations over the last 5 years and sovereign or peripheral spreads have been AS volatile and correlated as any asset class. These things trade like dancing with a rattle-snake. Greece, Spain, France etc. They can bite you with fangs. They have been meaningfully more correlated to high yield spreads and yields and to central bank balance sheet expansion as nearly any asset class. So, the infusion of central bank liquidity into markets has seen “relief” rallies in peripherals and one would think the converse would be true as well. The valuations have represented the flavor and direction of risk on/risk off or liquidity on/liquidity off reliably for many months/years.
But I THOUGHT markets were deliberating tapering views and expressions as validated by some good soldier markets BUT that is not necessarily what the rally in riskiest of sovereign “credits” is suggesting. The complex seems to be decoupling with Fed balance sheet correlation and message. Some are OVER 100 standard deviations from the mean! They are rich and could/should be sold. Especially if one was to follow the obvious correlation with the direction of central bank as stated.
But look to other arena’s like TIPS breakevens which also have been correlated with liquidity and risk on/off and central bank balance sheet expansion. Correlated to NASDAQ, HY, peripherals and the like. BUT this complex COUNTERS what peripherals are doing. They haven’t shown up to the punch bowl party yet. Not invited. This is a departure of markets that have largely and generally been in synch from a liquidity and performance correlation view.
Like gold and silver which got tattooed vis a vis down 35%+ performance last year MOSTLY, but not exclusively, due to perceptions of winds of central bank change. BUT even within a contrary, the fact that rallies in Spain, France, Greece, and Italy reflect more of central bank easing notions, the opposite of taper. In essence, the complex has gone batty uber-appreciation this year. Sure, many eyeball the Launchpad physical metals marginal stabilization no longer falling on a knife but the miner bonds and the mining stocks are string like bull with significant appreciation. This decidedly isn’t the stuff of taper which had the bond daddy’s romancing notions of 3% 10yr breaks, 40 basis point Green Eurodollar sell-offs, emerging market rinse, and upticks in volatility amongst other things.
Equity bourses appear to be changing hands between investors with oscillating rotations which mark the first prospective 3 week consecutive sell-off in a while. New year. This is taper light. Somewhere in between and further blurs the correlation metrics.
So, which is it? Are we tapering or not and why are merely a few global asset classed pointed out here, why are they deviating or arguably pricing in different central bank prospects or scenarios or outcomes?
I’m not afraid but I am intrigued as to the fact that there may some strong opinions within markets and I perceive a widely received comfortability with taper or tightening notions, negative leanings on interest rate forecasts, a complacency of Fed call if you will. And all of these hingings occur without intimate knowledge of the most critical variable of all, what Janet Yellen thinks? She has been awfully quiet as of late and there are many foregone conclusions or assumptions in market psyche without having heard a peep from the new MAESTRO.
Moreover, looking in the REAR view mirror within a week where multiple (two) Fed Governor proclamations, communicated and implicated notions which arguably would be considered radical in ANY other policy period of a hundred years. How to conduct “monetary policy at a ZERO lower bound (Williams) ” and “doing something as surprising and drastic as cutting interest on excess reserves BELOW zero (Kocherlakota).”
This doesn’t sound like no stinking taper? A tale of two markets. To be or not to be. To taper or not to taper. Two roads diverged and I took the one less traveled by, and that has made all the difference. Robert Frost.
Which is it? Different markets pricing different things. Right or wrong, the market always has a message; listen critically.
Paul Craig Roberts and Dave Kranzler
The deregulation of the financial system during the Clinton and George W. Bush regimes had the predictable result: financial concentration and reckless behavior. A handful of banks grew so large that financial authorities declared them “too big to fail.” Removed from market discipline, the banks became wards of the government requiring massive creation of new money by the Federal Reserve in order to support through the policy of Quantitative Easing the prices of financial instruments on the banks’ balance sheets and in order to finance at low interest rates trillion dollar federal budget deficits associated with the long recession caused by the financial crisis.
The Fed’s policy of monetizing one trillion dollars of bonds annually put pressure on the US dollar, the value of which declined in terms of gold. When gold hit $1,900 per ounce in 2011, the Federal Reserve realized that $2,000 per ounce could have a psychological impact that would spread into the dollar’s exchange rate with other currencies, resulting in a run on the dollar as both foreign and domestic holders sold dollars to avoid the fall in value. Once this realization hit, the manipulation of the gold price moved beyond central bank leasing of gold to bullion dealers in order to create an artificial market supply to absorb demand that otherwise would have pushed gold prices higher.
The evidence of gold price manipulation is clear. In this article we present evidence and describe the process. We conclude that ability to manipulate the gold price is disappearing as physical gold moves from New York and London to Asia, leaving the West with paper claims to gold that greatly exceed the available supply.
The primary venue of the Fed’s manipulation activity is the New York Comex exchange, where the world trades gold futures. Each gold futures contract represents one gold 100 ounce bar. The Comex is referred to as a paper gold exchange because of the use of these futures contracts. Although several large global banks are trading members of the Comex, JP Morgan, HSBC and Bank Nova Scotia conduct the majority of the trading volume. Trading of gold (and silver) futures occurs in an auction-style market on the floor of the Comex daily from 8:20 a.m. to 1:30 p.m. New York time. Comex futures trading also occurs on what is known as Globex. Globex is a computerized trading system used for derivatives, currency and futures contracts. It operates continuously except on weekends. Anyone anywhere in the world with access to a computer-based futures trading platform has access to the Globex system.
In addition to the Comex, the Fed also engages in manipulating the price of gold on the far bigger–in terms of total dollar value of trading–London gold market. This market is called the LBMA (London Bullion Marketing Association) market. It is comprised of several large banks who are LMBA market makers known as “bullion banks” (Barclays, Credit Suisse, Deutsche Bank, Goldman Sachs, HSBC, JPMorganChase, Merrill Lynch/Bank of America, Mitsui, Societe Generale, Bank of Nova Scotia and UBS). Whereas the Comex is a “paper gold” exchange, the LBMA is the nexus of global physical gold trading and has been for centuries. When large buyers like Central Banks, big investment funds or wealthy private investors want to buy or sell a large amount of physical gold, they do this on the LBMA market.
The Fed’s gold manipulation operation involves exerting forceful downward pressure on the price of gold by selling a massive amount of Comex gold futures, which are dropped like bombs either on the Comex floor during NY trading hours or via the Globex system. A recent example of this occurred on Monday, January 6, 2014. After rallying over $15 in the Asian and European markets, the price of gold suddenly plunged $35 at 10:14 a.m. In a space of less than 60 seconds, more than 12,000 contracts traded – equal to more than 10% of the day’s entire volume during the 23 hour trading period in which which gold futures trade. There was no apparent news or market event that would have triggered the sudden massive increase in Comex futures selling which caused the sudden steep drop in the price of gold. At the same time, no other securities market (other than silver) experienced any unusual price or volume movement. 12,000 contracts represents 1.2 million ounces of gold, an amount that exceeds by a factor of three the total amount of gold in Comex vaults that could be delivered to the buyers of these contracts.
This manipulation by the Fed involves the short-selling of uncovered Comex gold futures. “Uncovered” means that these are contracts that are sold without any underlying physical gold to deliver if the buyer on the other side decides to ask for delivery. This is also known as “naked short selling.” The execution of the manipulative trading is conducted through one of the major gold futures trading banks, such as JPMorganChase, HSBC, and Bank of Nova Scotia. These banks do the actual selling on behalf of the Fed. The manner in which the Fed dumps a large quantity of futures contracts into the market differs from the way in which a bona fide trader looking to sell a big position would operate. The latter would try to work off his position carefully over an extended period of time with the goal of trying to disguise his selling and to disturb the price as little as possible in order to maximize profits or minimize losses. In contrast, the Fed‘s sales telegraph the intent to drive the price lower with no regard for preserving profits or fear or incurring losses, because the goal is to inflict as much damage as possible on the price and intimidate potential buyers.
The Fed also actively manipulates gold via the Globex system. The Globex market is punctuated with periods of “quiet” time in which the trade volume is very low. It is during these periods that the Fed has its agent banks bombard the market with massive quantities of gold futures over a very brief period of time for the purpose of driving the price lower. The banks know that there are very few buyers around during these time periods to absorb the selling. This drives the price lower than if the selling operation occurred when the market is more active.
A primary example of this type of intervention occurred on December 18, 2013, immediately after the FOMC announced its decision to reduce bond purchases by $10 billion monthly beginning in January 2014. With the rest of the trading world closed, including the actual Comex floor trading, a massive amount of Comex gold futures were sold on the Globex computer trading system during one of its least active periods. This selling pushed the price of gold down $23 dollars in the space of two hours. The next wave of futures selling occurred in the overnight period starting at 2:30 a.m. NY time on December 19th. This time of day is one of the least active trading periods during any 23 hour trading day (there’s one hour when gold futures stop trading altogether). Over 4900 gold contracts representing 14.5 tonnes of gold were dumped into the Globex system in a 2-minute period from 2:40-2:41 a.m, resulting in a $24 decline in the price of gold. This wasn’t the end of the selling. Shortly after the Comex floor opened later that morning, another 1,654 contracts were sold followed shortly after by another 2,295 contracts. This represented another 12.2 tonnes of gold. Then at 10:00 a.m. EST, another 2,530 contracts were unloaded on the market followed by an additional 3,482 contracts just six minutes later. These sales represented another 18.7 tonnes of gold.
All together, in 6 minutes during an eight hour period, a total amount of 37.6 tonnes (a “tonne” is a metric ton–about 10% more weight than a US ”ton”) of gold future contracts were sold. The contracts sold during these 6 minutes accounted for 10% of the total volume during that 23 hours period of time. Four-tenths of one percent of the trading day accounted for 10% of the total volume. The gold represented by the futures contracts that were sold during these 6 minutes was a multiple of the amount of physical gold available to Comex for delivery.
The purpose of driving the price of gold down was to prevent the announced reduction in bond purchases (the so-called tapering) from sending the dollar, stock and bond markets down. The markets understand that the liquidity that Quantitative Easing provides is the reason for the high bond and stock prices and understand also that the gains from the rising stock market discourage gold purchases. Previously when the Fed had mentioned that it might reduce bond purchases, the stock market fell and bonds sold off. To neutralize the market scare, the Fed manipulated both gold and stock markets. (See Pam Martens for explanation of the manipulation of the stock market:http://wallstreetonparade.com/2013/12/why-didn’t-the-stock-market-sell-off-on-the-fed’s-taper-announcement/ )
While the manipulation of the gold market has been occurring since the start of the bull market in gold in late 2000, this pattern of rampant manipulative short-selling of futures contracts has been occurring on a more intense basis over the last 2 years, during gold’s price decline from a high of $1900 in September 2011. The attack on gold’s price typically will occur during one of several key points in time during the 23 hour Globex trading period. The most common is right at the open of Comex gold futures trading, which is 8:20 a.m. New York time. To set the tone of trading, the price of gold is usually knocked down when the Comex opens. Here are the other most common times when gold futures are sold during illiquid Globex system time periods:
– 6:00 p.m NY time weekdays, when the Globex system re-opens after closing for an hour;
– 6:00 p.m. Sunday evening NY time when Globex opens for the week;
– 2:30 a.m. NY time, when Shanghai Gold Exchange closes
– 4:00 a.m. NY time, just after the morning gold “fix” on the London gold market (LBMA);
– 2:00 p.m. NY time any day but especially on Friday, after the Comex floor trading has closed – it’s an illiquid Globex-only session and the rest of the world is still closed.
In addition to selling futures contracts on the Comex exchange in order to drive the price of gold lower, the Fed and its agent bullion banks also intermittently sell large quantities of physical gold in London’s LBMA gold market. The process of buying and selling actual physical gold is more cumbersome and complicated than trading futures contracts. When a large supply of physical gold hits the London market all at once, it forces the market a lot lower than an equivalent amount of futures contracts would. As the availability of large amounts of physical gold is limited, these “physical gold drops” are used carefully and selectively and at times when the intended effect on the market will be most effective.
The primary purpose for short-selling futures contracts on Comex is to protect the dollar’s value from the growing supply of dollars created by the Fed’s policy of Quantitative Easing. The Fed’s use of gold leasing to supply gold to the market in order to reduce the rate of rise in the gold price has drained the Fed’s gold holdings and is creating a shortage in physical gold. Historically most big buyers would leave their gold for safe-keeping in the vaults of the Fed, Bank of England or private bullion banks rather than incur the cost of moving gold to local depositories. However, large purchasers of gold, such as China, now require actual delivery of the gold they buy.
Demands for gold delivery have forced the use of extraordinary and apparently illegal tactics in order to obtain physical gold to settle futures contracts that demand delivery and to be able to deliver bullion purchased on the London market (LBMA). Gold for delivery is obtained from opaque Central Bank gold leasing transactions, from “borrowing” client gold held by the bullion banks like JP Morgan in their LBMA custodial vaults, and by looting the gold trusts, such as GLD, of their gold holdings by purchasing large blocks of shares and redeeming the shares for gold.
Central Bank gold leasing occurs when Central Banks take physical gold they hold in custody and lease it to bullion banks. The banks sell the gold on the London physical gold market. The gold leasing transaction makes available physical gold that can be delivered to buyers in quantities that would not be available at existing prices. The use of gold leasing to manipulate the price of gold became a prevalent practice in the 1990s. While Central Banks admit to engaging in gold lease transactions, they do not admit to its purpose, which is to moderate rises in the price of gold, although Fed Chairman Alan Greenspan did admit during Congressional testimony on derivatives in 1998 that “Central banks stand ready to lease gold in increasing quantities should the price rise.”
Another method of obtaining bullion for sale or delivery is known as “rehypothecation.” Rehypothecation occurs when a bank or brokerage firm “borrows” client assets being held in custody by banks. Technically, bank/brokerage firm clients sign an agreement when they open an account in which the assets in the account might be pledged for loans, like margin loans. But the banks then take pledged assets and use them for their own purpose rather than the client’s. This is rehypothecation. Although Central Banks fully disclose the practice of leasing gold, banks/brokers do not publicly disclose the details of their rehypothecation activities.
Over the course of the 13-year gold bull market, gold leasing and rehypothecation operations have largely depleted most of the gold in the vaults of the Federal Reserve, Bank of England, European Central Bank and private bullion banks such as JPMorganChase. The depletion of vault gold became a problem when Venezuela was the first country to repatriate all of its gold being held by foreign Central Banks, primarily the Fed and the BOE. Venezuela’s request was provoked by rumors circulating the market that gold was being leased and hypothecated in increasing quantities. About a year later, Germany made a similar request. The Fed refused to honor Germany’s request and, instead, negotiated a seven year timeline in which it would ship back 300 of Germany’s 1500 tonnes. This made it apparent that the Fed did not have the gold it was supposed to be holding for Germany.
Why does the Fed need seven years in which to return 20 percent of Germany’s gold? The answer is that the Fed does not have the gold in its vault to deliver. In 2011 it took four months to return Venezuela’s 160 tonnes of gold. Obviously, the gold was not readily at hand and had to be borrowed, perhaps from unsuspecting private owners who mistakenly believe that their gold is held in trust.
Western central banks have pushed fractional gold reserve banking to the point that they haven’t enough reserves to cover withdrawals. Fractional reserve banking originated when medieval goldsmiths learned that owners of gold stored in their vault seldom withdrew the gold. Instead, those who had gold on deposit circulated paper claims to gold. This allowed goldsmiths to lend gold that they did not have by issuing paper receipts. This is what the Fed has done. The Fed has created paper claims to gold that does not exist in physical form and sold these claims in mass quantities in order to drive down the gold price. The paper claims to gold are a large multiple of the amount of actual gold available for delivery. The Royal Bank of India reports that the ratio of paper claims to gold exceed the amount of gold available for delivery by 93:1.
Fractional reserve systems break down when too many depositors or holders of paper claims present them for delivery. Breakdown is occurring in the Fed’s fractional bullion operation. In the last few years the Asian markets–specifically and especially the Chinese–are demanding actual physical delivery of the bullion they buy. This has created a sense of urgency among the Fed, Treasury and the bullion banks to utilize any means possible to flush out as many weak holders of gold as possible with orchestrated price declines in order to acquire physical gold that can be delivered to Asian buyers.
The $650 decline in the price of gold since it hit $1900 in September 2011 is the result of a manipulative effort designed both to protect the dollar from Quantitative Easing and to free up enough gold to satisfy Asian demands for delivery of gold purchases.
Around the time of the substantial drop in gold’s price in April, 2013, the Bank of England’s public records showed a 1300 tonne decline in the amount of gold being held in the BOE bullion vaults. This is a fact that has not been denied or reasonably explained by BOE officials despite several published inquiries. This is gold that was being held in custody but not owned by the Bank of England. The truth is that the 1300 tonnes is gold that was required to satisfy delivery demands from the large Asian buyers. It is one thing for the Fed or BOE to sell, lease or rehypothecate gold out of their vault that is being safe-kept knowing the entitled owner likely won’t ask for it anytime soon, but it is another thing altogether to default on a gold delivery to Asians demanding delivery.
Default on delivery of purchased gold would terminate the Federal Reserve’s ability to manipulate the gold price. The entire world would realize that the demand for gold greatly exceeds the supply, and the price of gold would explode upwards. The Federal Reserve would lose control and would have to abandon Quantitative Easing. Otherwise, the exchange value of the US dollar would collapse, bringing to an end US financial hegemony over the world.
Last April, the major takedown in the gold price began with Goldman Sachs issuing a “technical analysis” report with an $850 price target (gold was around $1650 at that time). Goldman Sachs also broadcast to every major brokerage firm and hedge fund in New York that gold was going to drop hard in price and urged brokers to get their clients out of all physical gold holdings and/or shares in physical gold trusts like GLD or CEF. GLD and CEF are trusts that purchase physical gold/silver bullion and issue shares that represent claims on the bullion holdings. The shares are marketed as investments in gold, but represent claims that can only be redeemed in very large blocks of shares, such as 100,000, and perhaps only by bullion banks. GLD is the largest gold ETF (exchange traded firm), but not the only one. The purpose of Goldman Sachs’ announcement was to spur gold sales that would magnify the price effect of the short-selling of futures contracts. Heavy selling of futures contracts drove down the gold price and forced sales of GLD and other ETF shares, which were bought up by the bullion banks and redeemed for gold.
At the beginning of 2013, GLD held 1350 tonnes of gold. By April 12th, when the heavy intervention operation began, GLD held 1,154 tonnes. After the series of successive raids in April, the removal of gold from GLD accelerated and currently there are 793 tonnes left in the trust. In a little more than one year, more than 41% of the gold bars held by GLD were removed – most of that after the mid-April intervention operation.
In addition, the Bank of England made its gold available for purchase by the bullion banks in order to add to the ability to deliver gold to Asian purchasers.
The financial media, which is used to discredit gold as a safe haven from the printing of fiat currencies, claims that the decline in GLD’s physical gold is an indication that the public is rejecting gold as an investment. In fact, the manipulation of the gold price downward is being done systematically in order to coerce holders of GLD to unload their shares. This enables the bullion banks to accumulate the amount of shares required to redeem gold from the GLD Trust and ship that gold to Asia in order to meet the enormous delivery demands. For example, in the event described above on January 6th, 14% of GLD’s total volume for the day traded in a 1-minute period starting at 10:14 a.m. The total volume on the day for GLD was almost 35% higher than the average trading volume in GLD over the previous ten trading days.
Before 2013, the amount of gold in the GLD vault was one of the largest stockpiles of gold in the world. The swift decline in GLD’s gold inventory is the most glaring indicator of the growing shortage of physical gold supply that can be delivered to the Asian market and other large physical gold buyers. The more the price of gold is driven down in the Western paper gold market, the higher the demand for physical bullion in Asian markets. In addition, several smaller physical gold ETFs have experienced substantial gold withdrawals. Including the more than 100 tonnes of gold that has disappeared from the Comex vaults in the last year, well over 1,000 tonnes of gold has been removed from the various ETFs and bank custodial vaults in the last year. Furthermore, there is no telling how much gold that is kept in bullion bank private vaults on behalf of wealthy investors has been rehypothecated. All of this gold was removed in order to avoid defaulting on delivery demands being imposed by Asian commercial, investment and sovereign gold buyers.
The Federal Reserve seems to be trapped. The Fed is creating approximately 1,000 billion new US dollars annually in order to support the prices of debt related derivatives on the books of the few banks that have been declared to be “to big to fail” and in order to finance the large federal budget deficit that is now too large to be financed by the recycling of Chinese and OPEC trade surpluses into US Treasury debt. The problem with Quantitative Easing is that the annual creation of an enormous supply of new dollars is raising questions among American and foreign holders of vast amounts of US dollar-denominated financial instruments. They see their dollar holdings being diluted by the creation of new dollars that are not the result of an increase in wealth or GDP and for which there is no demand.
Quantitative Easing is a threat to the dollar’s exchange value. The Federal Reserve, fearful that the falling value of the dollar in terms of gold would spread into the currency markets and depreciate the dollar, decided to employ more extreme methods of gold price manipulation.
When gold hit $1,900, the Federal Reserve panicked. The manipulation of the gold price became more intense. It became more imperative to drive down the price, but the lower price resulted in higher Asian demand for which scant supplies of gold were available to meet.
Having created more paper gold claims than there is gold to satisfy, the Fed has used its dependent bullion banks to loot the gold exchange traded funds (ETFs) of gold in order to avoid default on Asian deliveries. Default would collapse the fractional bullion system that allows the Fed to drive down the gold price and protect the dollar from QE.
What we are witnessing is our central bank pulling out all stops on integrity and lawfulness in order to serve a small handful of banks that financial deregulation allowed to become “too big to fail” at the expense of our economy and our currency. When the Fed runs out of gold to borrow, to rehypothecate, and to loot from ETFs, the Fed will have to abandon QE or the US dollar will collapse and with it Washington’s power to exercise hegemony over the world.
Dave Kranzler traded high yield bonds for Bankers Trust for a decade. As a co-founder and principal of Golden Returns Capital LLC, he manages the Precious Metals Opportunity Fund.
This article first appeared at Paul Craig Roberts’ new website Institute For Political Economy. Paul Craig Roberts was Assistant Secretary of the Treasury for Economic Policy and associate editor of the Wall Street Journal. He was columnist for Business Week, Scripps Howard News Service, and Creators Syndicate. He has had many university appointments. His Internet columns have attracted a worldwide following.
Terrifying Technicals: This Chartist Predicts An Anti-Fed Revulsion, And A Plunge In The S&P To 450 | Zero Hedge
“Sooner or later everyone sits down to a banquet of consequences.”
– Robert Louis Stevenson
1. History is written as much by the unforeseen consequences of key events as by the events themselves. We prefer not to think in these terms, but history clearly reveals that the adverse consequences of well intended efforts often have a much more dramatic and lasting impact than the original efforts themselves.
2. In fact history suggests a law of adverse consequences where the more insistent and forceful the well intended effort, the more dramatic, powerful and harmful the blowback. In simple terms,attempts to force the world to improve have always ended badly.
3. This law of adverse consequences is a very common phenomena in medicine and is known by the euphemism of ‘side effects’. Adverse drug reactions to prescribed medications are the fourth leading killer in America, right after heart disease, cancer, and stroke. However this expression of the law of unintended consequences gets even less press than its expressions in human history. Neither is a popular topic.
4. One could easily write several volumes of history focused exclusively on the unwelcome repercussions from otherwise well-intended efforts. However as this is a subject that we would all rather avoid I suspect it would be a very difficult book to market.
5. Instead of a book I have opted for two pages of examples. The present situation strongly suggests that the high risk of unexpected blowback from current economic policies are much more deserving of our full attention than the past history of unwelcome consequences.
6. QE has already created what is arguably the most bullish market sentiment in history. And that extreme bullish sentiment has already driven most stock indices to new all time highs. So now would be a good time for some sober reflections on what could go wrong.
7. One sector that seems dangerously poised to go badly wrong are the junk and emerging bond markets. What will happen when Treasuries start yielding the same rates as previously issued junk debt? A massive exodus will happen. Junk bonds and emerging market debt will become a disaster area.
8. We already know how wildly successful Fed stimulus has been at creating speculative bubbles. Fed inflated bubbles that have already burst include a Dot-Com bubble, a credit bubble, a real estate bubble, and a commodity market bubble. The biggest bubble of them all is still inflating. That would be this stock market bubble.
9. There are now fewer banks than ever before in modern history. And the biggest banks are larger than ever before in history. The war against ‘too big to fail’ was lost before it began. Fewer, bigger banks means a more fragile financial system.
10. The worst of the bullish sentiment extremes of previous major stock market peaks have all returned. Analysts are positively gushing with ebullience. There is a competition to see who can come up with the highest targets for the various stock indices. No one sees any downside risk. All are confident that the Fed can and will fix anything. This is a situation ripe for adverse consequences. This is a market where blowback will be synonymous with blind-sided. No one will prepare for what they cannot see coming.
Comparing Costs: Major US Wars versus Quantitative Easing
The chart above suggests that the magnitude of the Federal Reserve economic stimulus program is only comparable to previous major war efforts. The dollar costs plotted here bears that out.
All of the war costs on the previous page were taken from one report dated 29 June 2010. That report was prepared by Stephen Dagget at the Congressional Research Service. I adjusted his numbers to 2013 dollars. You can find his report in PDF format on-line. However some further comments may be useful here.
The Civil War number combines the Northern or Union costs and the Southern or Confederate costs. In 2011 dollars the price of waging the war for the Union was $59.6 billion dollars and $20.1 billion for the Confederacy. I simply added these two numbers and then converted to 2013 dollars.
Post 9/11 Wars
Here I combined the costs of the Persian Gulf war, and Iraq war, and the war in Afghanistan into one category and then adjusted to 2013 dollars.
Sending a Man to the Moon
I thought it would be interesting to compare the costs of sending a man to the moon to the costs of QE. Most references to the cost of putting a man on the Moon only cite the Apollo project. But of course that is very wrong. Apollo arose from Gemini which grew out of Mercury. So for the true cost of sending a man to the Moon I included all costs for the Mercury missions, the Gemini program, the Lunar probes, the Apollo capsules, the Saturn V rockets, and the Lunar Modules. I relied on numbers gathered from NASA by the Artemis Project. I then converted those costs to 2013 dollars.
World War II versus Quantitative Easing
World War II transformed the United States from a sleepy agricultural enterprise into the world’s dominant economic super-power, and defeated both Nazi Germany and Imperial Japan at the same time. It may seem entirely callous to calculate US Dollar costs for a war that claimed 15,000,000 battle deaths, 25,000,000 battle wounded, and civilian deaths that exceeded 45,000,000 but there is a point to this exercise.
The second world war defeated the strategy of geographical conquest through militarism as a national policy. Of course WW II had it’s own undesirable blowback as anything on this gigantic a scale would. However it seems pretty clear that replacing fascism and militarism with democracy was a step of progress for mankind.
WW II and QE
Since the 1950’s many have argued that it took World War II to pull the world out of the Great Depression. As a life-long student of the Great Depression Bernanke must be aware of this debate. In terms of the dollar amounts involved, World War Two is the only project comparable in size to QE. So it seems reasonable to assume that Bernanke’s goal here is to have QE fulfill the economic role of a World War Three; a war-free method of pulling the world out of the Great Recession. However human history suggests that the sheer magnitude and forced nature of the QE program all but ensures serious, unexpected and adverse consequences.
Learning from History
I am not bearish on the human race. When I read history I see things getting better. When I read history I find the slow replacement of brutality with compassion. When I read history I find the long term trend to be the replacement of centralized authority with local self-determination. And I find that every single effort to fight these long term trends has failed. And as history continues to unfold the efforts to fight these trends tends to fail more quickly, more dramatically, and more decisively.
There is an ancient Chinese proverb that states “Plan too far ahead and nature will seem to resist.” That aphorism definitely resonates with my experience and observations. If there is something inherent in the flow of time that unfolds an improvement in the human condition, then there is also something in the nature of things that resists the application of force, whether well intended or not.
If all of the above is an accurate accounting of things, then the key issue for policy makers is finding the fine line that separates supporting the natural flow of human evolution from attempting to force change. The former will help while the later will end badly. The question today has to do with Quantitative Easing. Is QE a gentle nurturing of economic evolution or is it the next doomed attempt to force things to get better? The QE program is so enormous, and relentless, and insistent, that I fear it is the later. And if QE is a huge attempt to force the economy to improve, than we had better start bracing for the blowback.
QE: the blowback to come
What kind of blowback should we prepare for? The lesson of history is that trying to force things to get better does not merely create unwelcome repercussions. It does not merely slow the pace of natural evolution. Attempts to enforce a certain outcome always appears to create the opposite effect. We do not find a law of adverse consequences. We find a law of opposite impacts.
Let us review the sample examples from the previous charts. Every effort to jam an ideology or a plan down the throat of the world only creates the opposite of the intended effect. I would maintain that this is one of the few lessons from history that can be relied on.
If the Federal Reserve is trying to force feed us prosperity then the inevitable blowback will be adversity. If the Fed is trying to compel the most dramatic economic recovery in history, then the blowback may well be the deepest depression in history. If the Fed is trying to enforce confidence and optimism then the blowback will be fear and despair. If the Fed is trying to force consumers to spend then the blowback will be a collapse in consumer confidence.
I sincerely hope that I am completely wrong here, that I am missing something, that there is a flaw in my logic. However until I can locate such a flaw I must trust the technical case for treating this Fed force-fed rally in the stock market as something that will end badly.
Here’s how it plays out…
Europe is recovering, right? Wrong. As Nigel Farage raged last night, things are not what they seem and even the IMF is now beginning to get concerned again (especially after Lagarde’s call yesterday for moar from Draghi and every other central banker). As Bloomberg’s Niraj Shah notes, it’s not just the PIIGS we have to worry about (or not), Denmark, Finland, Norway and Poland have been added to the IMF’s list of countries with the potential to destabilize the global economy.
Via Bloomberg’s Niraj Shah ( @economistniraj ),
The IMF’s decision means the four nations will be subject to mandatory financial sector assessments. The total number of countries on the list has risen to 29 from 25. The IMF’s decision may further undermine the safe-haven status of the Nordic nations, where rising household debt imposes a financial risk.
Ballooning Household Debt
Household debt and government-imposed austerity measures are deterring consumers from spending in the Nordic region. Denmark’s financial regulator is considering curbing banks’ lending policies to address the record household debt load. Danish households owe creditors 321 percent of disposable income, the OECD says. Norway’s household debt reached a record 200 percent of disposable income in 2011.
Austerity Triggered by Rising Government Debt
Finland’s debt-to-GDP ratio will almost double to 60.5 percent by 2015 from 33.9 percent in 2008, the IMF forecasts. The fund estimates the Finnish economy shrank 0.65 percent last year. Polish government debt reached 57.6 percent of GDP last year. A clause in the country’s constitution states that breaching a 55 percent ceiling triggers mandatory austerity measures.
Competitiveness at Risk
Denmark has dropped to 15th place in the World Economic Forum’s global competitiveness report from third in 2008. Labor costs rose 9.1 percent between 2008 and 2012, compared with an EU average increase of 8.6 percent in the period. Norway has the highest labor costs in Europe at 48.3 euros per hour in 2012, compared with 30.4 euros in Germany. That may undermine competitiveness and the growth outlook.
Most Financially Interconnected Countries
The inclusion of three Nordic nations for mandatory assessment is the result of a new methodology by the IMF that gives more weight to financial interconnectedness. The U.K. is the most financially linked nation in the world, followed by Germany. Seven of the top 10 most interconnected financial nations are in the euro-area.
So as the world congratulates itself (most notably Ben Bernanke today), the IMF seems concerned that this could all get worse again very quickly. Think they are all too small to worry about? Remember Lehman?