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Your Front Row Seat To Argentina’s (Latest) Currency Collapse | Zero Hedge

Your Front Row Seat To Argentina’s (Latest) Currency Collapse | Zero Hedge.

UPDATE: The Argentine Trade Balance missed surplus expectations by the most in 3 years (and 2nd most on record).

As those who follow Zero Hedge on twitter know, we have recently shown a keen interest in the collapse of the Argentine currency reserves – most recently at $29.4 billion – which have been declining at a steady pace of $100 million per day over the past week, as the central bank desperately struggles to keep its currency stable. Actually, make that struggled. Here is what we said just yesterday:

The decline continues: ARGENTINA’S RESERVES FELL $80M TODAY TO $29.4B: CENTRAL BANK

— zerohedge (@zerohedge) January 22, 2014

As of today it is not just the collapse in the Latin American country’s reserves, but its entire currency, when this morning we woke to learn that the Argentina Peso (with the accurate identifier ARS), had its biggest one day collapse since the 2002 financial crisis, after the central bank stopped intervening in currency markets. The reason: precisely to offset the countdown we had started several days back, namely “an effort to preserve foreign exchange reserves that have fallen by almost a third over the last year” as FT reported.

As the chart below shows, the official exchange rate cratered by over 17% when the USDARS soared from 6.8 to somewhere north of 8.

But as most readers know, just like in Venezuela, where the official exchange rate is anywhere between 6.40 and 11, and the unofficial is 78.85, so in Argentina the real transactions occur on the black market, where they track the so-called Dolar Blue, which as of this writing just hit an all time high of 12.90 and rising fast.

What happens next? Nothing good. “The risk of capital flight is rising by the minute. This will be very hard to control,” wrote Dirk Willer, strategist at Citigroup, adding that liquidity had “largely disappeared” with a risk of Venezuela-style capital controls. Ah Venezuela – that socialist paradise with a soaring stock market… even if food or toilet paper are about to become a thing of the past.

Some other perspectives via the FT:

Siobhan Morden of Jeffries said: “This is not an administration that respects or understands market pressure. They have been in the early stages of currency crisis since December, and yet their main strategy has been to pay off arrears and try to attract foreign direct investment.”

Luis Secco, Buenos Aires economist, said “It is hard to figure out what is the logic behind the authourities decision to let the peso so abruptly, without any other accompanying macroeconomic policy. It’s possible that the authorities would rather see a strong rise in the dollar, than lose, again, a large quantity of reserves.”

It is a potentially dangerous situation…not least because it could give the impression that the authorities don’t have a very clear idea of how to manage the situation.”

Ricardo Delgado, Buenos Aires economist, said on Wednesday: “The government faces a dilemma. It wants to stop reserves from falling. But that means less imports and thus lower growth, as the economy is very dependent on imports. So the question is: do you want more growth, or higher foreign reserves.“

However, with the “currency run” having once again begun, absent a wholesale bailout and/or backstop by “solvent” central banks of Argentina, a country which has hardly been on good speaking terms with the western central banks, there is little that the nation can do.

So for all those morbidly curious individuals who are curious what the slow-motion train wrecked death of yet another currency will look like, below is a link to the DolarBlue website, aka the front row seats where the true level of the Argentina currency can be seen in real time. If and when this number takes off parabolically, that’s when the panic really begins – first in Argentina, then elsewhere.

Of course, it’s not just Argentina – most of the world’s emerging market FX is getting hammered year-to-date…

The New Normal Paradox: All The Job Gains With Half The Hiring? | Zero Hedge

The New Normal Paradox: All The Job Gains With Half The Hiring? | Zero Hedge.

While everyone obsesses over the monthly payrolls report, which on a trailing 12 month basis is once indicating the creation of roughly 2 million jobs each year, or roughly where it was before the crisis (red line chart below), one aspect that is largely ignored is the amount of hiring.

Why is hiring important?

Because that is the actual process by which those without a job end up with a job. And as we just learned today after the latest JOLTS release, which showed that there were over 4 million job openings (4,001 to be precisely) for the first time since 2008, a far more important number is the update on Hires which at 4.5 million barely changed from last month, but more importantly, is barely a fraction of where it should be based on the number of job gains reported by the BLS monthly. The chart below confirms this stunning discrepancy: a surge in jobs with barely half the pre-recession hiring?

 

How does one explain this discrepancy in which the US economy supposedly is growing at its historic peak pace while hiring is at half the peak pace? Simple: the gains in nonfarm payrolls are due a decline in layoffs and other separations, not an increase in hirings: i.e., normal labor demand driven growth.

Which means that anyone hoping for a brisk increase in wages, i.e. worker leverage, is in for a prolonged shock.

The chart above simply shows that the leverage is and continues to be with the employers – instead of letting people go (or workers quitting at their volition) at anything close to a traditional pace, employers have a huge bargaining chip – a job. Because if a worker does not want to perform a job, tough: there are about 3 people willing to fight for every job opening. It also means that those who lose their job will find it doubly more difficult time to reenter the workforce as there simply is not enough hiring.

Which means that wage deflation, at least among prevailing jobs, will continue leading to declining real disposable income, a declining in personal savings and the continued use of “student loans” (since credit card deleveraging continues) to fund everyday lifestyles, at least until such time as the hiring trend has normalized.

The really bad news: while such a normalization will eventually happen, according to our back of the envelope calculations, it will take place some time in… 2020.

Bernanke reflects on ‘trying to avoid going off the bridge’ – Business – CBC News

Bernanke reflects on ‘trying to avoid going off the bridge’ – Business – CBC News.

Ben S. Bernanke likened the financial crisis to a car crash in his final public comments as head of the Federal Reserve Thursday.Ben S. Bernanke likened the financial crisis to a car crash in his final public comments as head of the Federal Reserve Thursday. (Bloomberg)

In his final public appearance as chairman of the Federal Reserve, Ben Bernanke took a moment to reflect on the 2008 financial crisis and compared it to surviving a bad car crash.

During an interview Thursday at the Brookings Institution, Bernanke recalled some “very intense periods” during the crisis, similar to trying to keep a car from going over a bridge after a collision.

The government had just taken over mortgage giants Fannie Mae and Freddie Mac. Lehman Brothers had collapsed. He recalled some sleepless nights working with others to try and contain the damage.

“If you’re in a car wreck or something, you’re mostly involved in trying to avoid going off the bridge. And then, later on, you say, ‘Oh my God!”‘ Bernanke said.

Term ends January 31

Bernanke will leave the Fed on Jan. 31 after eight years as chairman. His successor, Janet Yellen, will take over on Feb. 1.

In his appearance, Bernanke defended the Fed’s efforts during the crisis, which included massive purchases of Treasury bonds to push long-term interest rates lower and forward guidance to investors about how long the Fed plans to keep short-term interest rates near zero.

Critics have warned that those efforts pose great risks for higher inflation or future financial market turmoil.

But Bernanke says there has not been a problem with inflation, which is still running well below the Fed’s 2 per cent target.

Should inflation start to be a problem as the economy starts growing at faster rates, the Fed “has all the tools we need to manage interest rates” to keep inflation from getting out of hand, he said.

“Inflation is just not really a significant risk” from the bond purchases, Bernanke said.

Bernanke said the central bank was aware of potential threats to financial market stability from its massive bond holdings and is monitoring markets very closely to spot any signs of trouble. He said this threat was the one “we have spent the most time thinking about and trying to make sure that we can address” should the need arise.

But he said any concerns about financial stability did not outweigh the need to keep providing support to the economy.

The Fed announced last month that it would slightly reduce the size of its bond purchases in January from $85 billion per month down to $75 billion. And it said it would likely make further reductions at upcoming meetings, if the economy keeps improving.

The Greatest Myth Propagated About The FED: Central Bank Independence (Part 1) | New Economic Perspectives

The Greatest Myth Propagated About The FED: Central Bank Independence (Part 1) | New Economic Perspectives.

By L. Randall Wray

It has been commonplace to speak of central bank independence—as if it were both a reality and a necessity. Discussions of the Fed invariably refer to legislated independence and often to the famous 1951 Accord that apparently settled the matter. [1] While everyone recognizes the Congressionally-imposed dual mandate, the Fed has substantial discretion in its interpretation of the vague call for high employment and low inflation. For a long time economists presumed those goals to be in conflict but in recent years Chairman Greenspan seemed to have successfully argued that pursuit of low inflation rather automatically supports sustainable growth with maximum feasible employment.

In any event, nothing is more sacrosanct than the supposed independence of the central bank from the treasury, with the economics profession as well as policymakers ready to defend the prohibition of central bank “financing” of budget deficits. As in many developed nations, this prohibition was written into US law from the founding of the Fed in 1913. In practice, the prohibition is easy to evade, as we found during WWII in the US when budget deficits ran up to a quarter of GDP. If a central bank stands ready to buy government bonds in the secondary market to peg an interest rate, then private banks will buy bonds in the new issue market and sell them to the central bank at a virtually guaranteed price. Since central bank purchases of bonds supply the reserves needed by banks to buy bonds, a virtuous circle is created so that the treasury faces no financing constraint. That is what the 1951 Accord was supposedly all about—ending the cheap source of US Treasury finance.

Since the Global Financial Crisis hit in 2007 these matters have come to the fore in both the US and the European Monetary Union. In the US, discussion of “printing money” to finance burgeoning deficits was somewhat muted, in part because the Fed purportedly undertook Quantitative Easing to push banks to lend—not to provide the Treasury with cheap funding. But the impact has been the same as WWII-era finances: very low interest rates on government debt even as a large portion of the debt ended up on the books of the Fed, while bank reserves have grown to historic levels (the Fed also purchased and lent against private debt, adding to excess reserves). While hyperinflationists have been pointing to the fact that the Fed is essentially “printing money” (actually reserves) to finance the budget deficits, most other observers have endorsed the Fed’s notion that QE might allow it to “push on a string” by spurring private banks to lend—which is thought to be desirable and certainly better than “financing” budget deficits to allow government spending to grow the economy. Growth through fiscal austerity is the new motto as the Fed accumulates ever more federal government debt and suspect mortgage-backed securities.

The other case is in the EMU where the European Central Bank had long been presumed to be prohibited from buying debt of the member governments. By design, these governments were supposed to be disciplined by markets, to keep their deficits and debt within Maastricht criteria. Needless to say, things have not turned out quite as planned. The ECB’s balance sheet has blown up just as the Fed’s did—and there is no end in sight in Euroland even as the Fed has begun to taper. It would not be hyperbole to predict that the ECB will end up owning (or at least standing behind) most EMU government debt as it continues to expand its backstop.

It is, then, perhaps a good time to reexamine the thinking behind central bank independence. There are several related issues.

First, can a central bank really be independent? In what sense? Political? Operational? Policy formation?

Second, should a central bank be independent? In a democracy should monetary policy—purportedly as important as or even more important than fiscal policy—be unaccountable? Why?

Finally, what are the potential problems faced if a central bank is not independent? Inflation? Insolvency?

While this two part piece will focus on the US and the Fed, the analysis is relevant to general discussions about central bank independence. We will limit our analysis to the questions surrounding what we mean by central bank independence. We leave to other analyses the questions surrounding the wisdom of granting independence to the Fed, democratic accountability, and potential problems. We will argue here that the Fed is independent only in a very narrow sense. We have argued elsewhere that the Fed’s crisis response during the global financial crisis does raise serious issues of transparency and accountability—issues that have not been resolved with the Dodd-Frank legislation.[2] Finally, it will become apparent that we do not believe that lack of central bank independence raises significant problems with inflation or insolvency of the sovereign government.

For the US case we will draw on an excellent study of the evolution of governance of the Fed by Bernard Shull, one of the foremost authorities of the history of the Fed.[3] As we will see, the dominant argument for independence throughout the Fed’s history has been that monetary policy should be set to promote the national interest. This requires that it should be free of political influence coming from Congress. Further, it was gradually accepted that even though the Federal Open Market Committee includes participation by regional Federal Reserve banks, the members of the FOMC are to put the national interest first. Shull shows that while governance issues remain unresolved, Congress has asserted its oversight rights, especially after economic or financial crises.

I’ll also include summaries of the arguments of two insiders—one from the Treasury and the other from the Fed—that also conclude that the case of the Fed’s independence is frequently overstated. The former Treasury official argues that at least within the Treasury there is no presumption that the Fed is operationally independent. The Fed official authored a comprehensive statement on the Fed’s independence, arguing that the Fed is a creature of Congress. More recently, Chairman Bernanke has said that “of course we’ll do whatever Congress tells us to do”:  if the Congress is not satisfied with the Fed’s actions, the Congress can always tell the Fed to behave differently.[4]

In the aftermath of the GFC, Congress has attempted to exert greater control with its Dodd-Frank legislation. The Fed handled most of the US policy response to the Great Recession (or, GFC). As we have documented, most of the rescue was behind closed doors and intended to remain secret. (See Felkerson 2012; and Wray 2012)[5]  Much of it at least stretched the law and perhaps went beyond the now famous section 13(3) that had been invoked for “unusual and exigent” circumstances for the first time since the Great Depression. Congress has demanded greater transparency and has tightened restrictions on the Fed’s future crisis response. Paradoxically, Dodd-Frank also increased the Fed’s authority and responsibility. However, in some sense this is “deja-vu” because Congressional reaction to the Fed’s poor response to the onset of the Great Depression was similarly paradoxical as Congress simultaneously asserted more control over the Fed while broadening the scope of the Fed’s mission.

INDEPENDENT OF WHAT?

Most references to central bank independence are little more than vague hand-waves. In the US, the Fed is a “creature of Congress”, established by the Federal Reserve Act of 1913, which has been modified a number of times. Elected officials play a role in selecting top Fed officials. And while the Fed is nominally owned by share-holding banks, and while the Fed’s budget is separate, profits above 6% on equity are returned to Treasury. Congress also has asserted its authority to mandate that the Fed release detailed information on its operations and budget—and there seems to be nothing but Congressional timidity to stop it from demanding more control over the Fed (indeed, Dodd-Frank sanctions many of the actions taken by the Fed during the GFC, now requiring prior approval by the President, the Treasury Secretary, and/or Congress for various interventions). Further, as we will see, the Fed’s operations are necessarily closely coordinated with the Treasury’s; the Fed, after all, functions as the Treasury’s bank. Finally, as everyone knows, Congress has provided a dual mandate to guide Fed policy although one could easily interpret Congressional will as consisting of four (at least some of which are related) mandates: high employment, low inflation, acceptable growth, and financial stability.

Above I have argued that the Fed is a creature of Congress. MacLaury has put the relationship this way:

Ultimately the [Federal Reserve] System is accountable to congress, not the executive branch, even though Reserve Board members and the chairman are president-appointed. The authority and delegated policy powers are subject to review by the congress not the president, the Treasury Department, nor by banks or other interests. (p. 4)

While many supporters and critics alike have stressed the Fed’s nominal ownership by member banks as evidence that it is somehow independent of government, the Fed’s Bruce MacLaury interprets the independence as follows[6]:

First, let’s be clear on what independence does not mean. It does not mean decisions and actions made without accountability. By law and by established procedures, the System is clearly accountable to congress—not only for its monetary policy actions, but also for its regulatory responsibilities and for services to banks and to the public. Nor does independence mean that monetary policy actions should be free from public discussion and criticism—by members of congress, by professional economists in and out of government, by financial, business, and community leaders, and by informed citizens. Nor does it mean that the Fed is independent of the government. Although closely interfaced with commercial banking, the Fed is clearly a public institution, functioning within a discipline of responsibility to the “public interest.” It has a degree of independence within the government—which is quite different from being independent of government. Thus, the Federal Reserve System is more appropriately thought of as being “insulated” from, rather than independent of, political—government and banking—special interest pressures. Through their 14-year terms and staggered appointments, for example, members of the Board of Governors are insulated from being dependent on or beholden to the current administration or party in power. In this and in other ways, then, the monetary process is insulated—but not isolated—from these influences. In a functional sense, the insulated structure enables monetary policy makers to look beyond short-term pressures and political expedients whenever the long-term goals of sustainable growth and stable prices may require “unpopular” policy actions. Monetary judgments must be able to weigh as objectively as possible the merit of short-term expedients against long-term consequences—in the on-going public interest.

We can take that as our starting point: the Fed is part of government–a public institution–but is insulated from day-to-day politics and other types of special interest pressures. Let’s explore this independence in more detail, beginning with an historical perspective.

Fed Governance: Historical Perspective

Shull[7] (2014) offers a detailed history of the evolution of Fed governance. He notes that the Fed is an independent government agency like the Federal Trade Commission, the National Labor Relations Board, and the Securities and Exchange Commission. Each of these has substantial discretion in implementing laws through rules and regulations and in formulating policies. Most independent agencies have an Inspector General and are subject to Congressional oversight. The Fed is somewhat unusual in that it is self-financing and in that there is a widely held belief that if its formulation of monetary policy were not independent, the policy outcome would be worse. In other words, good monetary policy supposedly depends on independence (from Congress and the Administration).Thus, the Fed’s monetary policy is not subject to audit by the General Accountability Office—and courts have refused to hear suits that accuse the Fed of policy mistakes. In recent decades, the Administration has been reluctant even to criticize the Fed’s monetary policy. However, as we will see, that has not always been the case.

The movement to create a central bank strengthened after the Panic of 1907. Rival plans were put forward, which ranged from a bank-supported plan which would create a privately-owned central bank (like the Bank of England), to a proposal to house the US central bank within the Treasury. The Glass-Owen bill split the difference, with private ownership and a decentralized system, but with the Treasury Secretary and the Comptroller of the Currency sitting on the Board. The decentralized system was supposed to ensure “fair representation of the financial, industrial and commercial interests and geographic divisions of the country,” (quoted in Shull p. 4). The Board was to be “a distinctly nonpartisan organization and was to be wholly divorced from politics.” (ibid p. 5) According to Paul Warburg, governance was to be maintained by a “system of checks and counter-checks— a paralyzing system which gives powers with one hand and takes them away with the other.” (ibid) In other words, the idea was that by ensuring broad representation of interests, the Fed would be stymied by a “clash of interests” that would reduce the damage it might do; as Shull puts it, “The checks and balances thus constituted a form of internal governance.” (ibid p. 5) That of course sounds somewhat familiar as a typically American approach to governance.

When WWI came along, however, the Fed turned its attention to supporting the Treasury’s debt issue. In the inflationary period at the end of the war, the regional Feds raised discount rates sharply (up to 85%) and a deep retraction followed that led to deflation of farm prices. Congress revisited the governance issue as some critics wanted to force the Fed to seek Congressional approval in advance of future rate hikes. One of the Board members, Adolph Miller, understood the implication:

“The American people will never stand contraction if they know it can be helped. Least of all will they stand contraction if they think it is contraction at the instance, or with the consent of an institution like the Federal Reserve System….The Reserve System cannot ‘make’ the business situation but it can do an immense deal to make its extremes less pronounced and violent….Discount policy…should always address itself to the phase of the business cycle through which the country happens to be passing.” (quoted in Shull, p. 7)

As Shull argues, the governance by paralyzing checks and balances conflicted with the need to cooperate to use monetary policy to stabilize the economy. Congress tightened the reins on the Fed but also centralized decision-making at the Board in Washington. The GAO began to audit the Board and there were a number of Commissions and Committees that investigated new guidelines to control the Fed. However, the 1927 Pepper-McFadden Act replaced the Fed’s original 20 year charter with an indefinite charter, and a Congressional report at the time declared that the Fed had demonstrated its usefulness. In the end, Congressional anger dissipated and not much was done to constrain the Fed’s discretion.

Governance issues again came to the forefront during the Great Depression, with serious consideration given to government ownership of the Fed, to be housed in the Treasury. President Roosevelt (who seemed to have supported such a move) as well as many in Congress were concerned that the Fed was not sufficiently attune to the national interest. Title II of the Banking Act of 1935 was a compromise that preserved private ownership but moved to ensure the Board would be more responsive, focusing on the national interest. (Shull, p. 10)  As power was further centralized in Washington, the “checks-and-balances” approach to governance continued to fade.

As in WWI, WWII saw the Fed cooperating with Treasury, in the national interest to keep rates on national debt low. That ended in the famous Accord of 1951, restoring “independence” of the Fed to formulate monetary policy. However, policy was still to be undertaken in the national interest, with the Fed keeping rates very low until the mid 1960s; the Fed mainly operated in short-term Treasury bills so as to have minimum effects on other financial markets. Monetary policy remained on the backburner until the inflation-recession cycle of the early 1970s. In 1975, Congress decided to exert greater control, in House Resolution 113.

In the Federal Reserve Reform Act of 1977, the Senate insisted on the requirement that it confirm the President’s appointment of the Fed’s chairman and vice-chairman. In addition Congress required that Class B Reserve bank directors had to be “elected to represent the public”. (Shull p. 12) The 1978 Humphrey-Hawkins full Employment and Balanced Growth Act clarified the Fed’s mandates and required semi-annual reports to both the Senate and the House. Later, after Chairman Greenspan got caught in “white lies” provided to Chairman Gonzalez, the Fed was required to release its transcripts of FOMC meetings (albeit with a five year lag).[8] The Fed also voluntarily agreed to measures designed to increase transparency (including announcing its explicit interest rate target).

The final big changes to governance occurred after the GFC, when Dodd-Frank tightened limits on what the Fed can do in response to a crisis. This was a surprising turn of events, as Chairman Greenspan had become the darling of Congress and the media and his replacement, Chairman Bernanke, had declared the era of the New Moderation in which central bankers could do nothing wrong. However, in the aftermath of the crisis, many elected representatives as well as the media and the population at large blamed the Fed for the crisis and for bungling a response that made the downturn worse than it should have been. As we’ve argued elsewhere, even many of those directly involved agreed that the Fed’s crisis response “stunk” and that it should never be repeated.[9] The Dodd-Frank legislation was designed in part to ensure it would not happen again.

However, yet again, Congress actually extended Fed responsibility, to include authority over large, systemically important non-bank financial institutions. Still, the Act restricted application of Section 13(3) in future crises, and for some actions required approval from the Treasury. It also mandated increased transparency (including a review by the GAO of all the Fed’s emergency assistance after the GFC). Congress also created the Financial Stability Oversight Council that is chaired by the Treasury Secretary and includes heads of agencies involved in overlooking the financial sector—including the Fed. In that manner it diluted the Fed’s power somewhat. Exactly what difference all this will make for the response in the next crisis cannot be foreseen in advance.

Next time, in Part 2, we look at the Fed’s supposed independence from our elected representatives. We’ll see that that is a fabricated myth.

 


[1] Thorvald Moe examines the role of Marriner Eccles and the discussions and events that led up to the 1951 Accord. Eccles was a dominant figure in the transformation of the Fed from the relatively weak and decentralized institution that had been created in 1913 to the modern central bank we know now. Moe makes a strong case that the vision of Eccles was instrumental in that evolution; as we will see, modern theories of central banks, however, deviate sharply from the Eccles vision in quite illuminating ways. See: Thorvald Grung Moe “Marriner S. Eccles and the 1951 Treasury – Federal Reserve Accord: Lessons for Central Bank Independence” Working Paper No. 747, Levy Economics Institute of Bard College January 2013.

[2] See two annual reports of research conducted with the support of Ford Foundation Grant no. 1110-­‐0184, administered by the University of Missouri–Kansas City. See: L. Randall Wray, 2012. “Improving Governance of the Government Safety Net in Financial Crises,” Research Project Report, April 9.http://www.levyinstitute.org/pubs/rpr_04_12_wray.pdf; and L. Randall Wray, 2013. “The Lender of Last Resort: A Critical Analysis of the Federal Reserve’s Unprecedented Intervention after 2007”, Research Project Report, April http://www.levyinstitute.org/publications/?docid=1739.

[3] Bernard Shull, who made a great presentation at the annual ASSA meetings in Philadelphia. His paper, “Financial crisis resolution and Federal Reserve governance: economic thought and political realities”, Jan 4 2014, is forthcoming as Levy Institute Working Paper.

[4] See his statement here: http://www.youtube.com/watch?v=a7XV3vS1hAM.

[5] See James A. Felkerson, 2012 “A Detailed Look at the Fed’s Crisis Response by Funding Facility and Recipient.” Public Policy Brief No. 123. Annandale-on-Hudson, NY: Levy Economics Institute of Bard College.http://www.levyinstitute.org/pubs/ppb_123.pdf; and L. Randall Wray, 2012. “Improving Governance of the Government Safety Net in Financial Crises,” Research Project Report, April 9.http://www.levyinstitute.org/pubs/rpr_04_12_wray.pdf.

[6] See Bruce K. MacLaury; “Perspectives on Federal Reserve Independence – A Changing Structure for Changing Times”;  Published January 1, 1977, The Federal Reserve Bank of Minneapolis, Annual Report 1976, http://www.minneapolisfed.org/publications_papers/pub_display.cfm?id=690, which examines Fed independence with respect to Congress, the Executive branch (including the Treasury), member banks, and within itself (ie, for example relations between the Board of Governors in Washington and the District banks). I will use several quotes from this comprehensive survey.

[7] Bernard Shull, “Financial crisis resolution and Federal Reserve governance: economic thought and political realities”, Jan 4 2014, forthcoming as Levy Institute Working Paper.

[8] See L. Randall Wray, “The Fed and the New Monetary Consensus: The Case for Rate Hikes, Part Two”, Public Policy Brief No. 80, December 2004, p. 14 for a discussion of this episode.

[9] See Wray 2013, the second report of this Ford Foundation-funded project, cited above.

The Prosperity Illlusion Part 1

The Prosperity Illlusion Part 1.

Gonzalo Lira: The Fed Is Playing Global Pump-and-Dump

Gonzalo Lira: The Fed Is Playing Global Pump-and-Dump.

The Fed Is Playing Global Pump-and-Dump

People often criticize me for objecting to the Federal Reserve’s Quantitative Easing (QE) and Zero Interest-Rate Policy (ZIRP) on the grounds that they are setting the stage for hyperinflation and a dollar collapse. Since neither has arrived—yet—people mock me, often pretty badly: “Hey Lira! How’s that 2% ‘hyperinflation’ working out for ya!

“The left side reminds me of Dow Jones.”
“Hmm! There does seem to be
a family resemblance . . .”

Funny-funny hardy-har-har.

.!..

But even if you don’t buy that QE and ZIRP will lead to a dollar collapse, you do have to admit that these Fed policies have severely brainwashed investors.

Why ‘brainwashed’? Because today, due to the Fed’s policies, stock prices are booming—we’re about to crack 16,500 on the Dow Jones, NASDAQ is well on its way to 4,200, and the S&P is close to 1,850—all record highs.

What’s wrong with record highs? What’s wrong with booming stock prices? Absolutely nothing—unless you look at the two-year charts and realize that these three indices are not reflecting a robust, booming economy. Rather, they have had unrelenting climbs that have been openly—and exclusively—caused by QE and ZIRP.

Which has brainwashed investors into dismissing value. Today,all investors are momentum-chasing pump-and-dumpers who are not worrying about fundamentals, or worrying about the long-term health and well-being of a company.

All they have been brainwashed into caring about is the rise in a stock’s price.

Which is pretty funny, if you think about it: These investors might shun penny-stocks, they might buy and sell stocks by way of “respectable” brokerage houses—but these investors are behavingexactly like the suckers taken for a ride by sketchy boiler rooms operating out of north Jersey.

And we all know how those poor saps usually end up: Broke, holding on to worthless stock certificates not worth the paper they’re printed on.

Why is this happening? Easy, because of the Fed’s QE and ZIRP have so flattened the yield curve across Treasuries and the rest of the bond markets, that anything yielding better than 5%—in anyasset class, not just bonds—quickly gets priced up.

They call Treasuries the “benchmark” for a reason: As the (supposedly) safest asset class, they set the yield curve for allassets in all classes—not just in other bonds, but in equities and real estate as well. If Treasury yields are minimal, then a “normal” yield in a riskier asset class will also be minimal.

Look at the following chart:

Click to enlarge.

These are the Top 20 Dow Jones stock as measured by expected stock dividend yields for 2014. The mean of these Top 20 is 3.16%, the average 3.28%.

Now, these are the bluest of the blue-chips—repeat, the Top 20 as measures by yield. If you get dividends of 3.28% on these blue-chip stocks, and pay an income tax rate of say 35% combined State and Federal, you’re looking at a yield of 2.13%.

That’s yearly. That’s less than inflation.

So why are the yields on these oh-so-blue-chips so low? Because of QE and ZIRP’s unrelenting asset price inflation. That’s why you have companies like twitter—which does not have any income to speak of—with a market valuation of $38 billion or whatever.

Since nothing yields a healthy 6% or better, the only thing investors care about today is whether the price of the asset they “invest in” will rise within the year—so that they can sell it at a profit.

That’s not investing—that’s speculating.

By the way, unrelenting asset price inflation was the whole point of the Federal Reserve’s policies. Yeah, I know I went overboard with the combined bold-italics-underlined thing, but I just wanted to emphasize that point, and one other:

The Federal Reserve is the boiler room operation that has pumped up the equities market by way of QE and ZIRP. You are investing in a pump-and-dump scam. And like in all such scams, you will lose. 

Clear enough for ya?

Crazy as this may sound, when you look at those measely yields for the Top 20 performer, you realize that investors for the time being are acting rationally: Since yields are minimal—in fact negative, after you factor in income tax and inflation—it pays investors to speculate, rather than to properly invest. Not only are the Fed’s policies goosing the equities markets, the tax code privileges speculators as well, by way of a capital gains tax rate which is lower than the income tax rate. You pay less taxes if you speculate than if you invest responsibly. (!)

Thus both the Federal Reserve and the IRS are encouragingspeculation. That’s how investors have become brainwashed: They think that this low-yield, high-asset price inflation, low-capital gains tax environment is the way things ought to be.

But even though the Fed is deliberately, openly goosing the market, no different from a Jersey boiler room operation, nobody’s complaining—or even realizing it—because at this time, investors are making money with this Global Pump-and-Dump.

It ought to be beautiful, right? Everybody making money, all happy in the world. Only problem is, these pump-and-dum scams always end. When do they end? When people stop believing in the hype. When people realize that the global economy is in the toilet, companies are not booming but barely getting by, and there’s nothing on the horizon which will restart the economy. When people—and not a lot of people, mind you, just a tipping point estimated at about 10%—realize that this game that the Fed is playing with QE and ZIRP is a game of musical chairs.

That’s when the Fed’s Global Pump-and-Dump Scam will blow up.

You don’t think as I do that QE and ZIRP will lead to hyperinflation and dollar collapse? Fine, that’s cool—but admit that these Fed policies are skewing the market: They are turning investors into speculators—scratch that, brainwashing them intogamblers.

And it will all end in tears—these schemes usually do. I for one am keeping an ear on this game of musical chairs, trying to anticipate when the music will stop.

Inflation Vs Deflation – The Ultimate Chartbook Of ‘Monetary Tectonics’ | Zero Hedge

Inflation Vs Deflation – The Ultimate Chartbook Of ‘Monetary Tectonics’ | Zero Hedge.

Financial markets have become increasingly obviously highly dependent on central bank policies. In a follow-up to Incrementum’s previous chartbook, Stoerferle and Valek unveil the following 50 slide pack of 25 incredible charts to crucially enable prudent investors to grasp the consequences of the interplay between monetary inflation and deflation. They introduce the term “monetary tectonics’ to describe the ‘tug of war’ raging between parabolically rising monetary base M0 driven by extreme easy monetary policy and shrinking monetary aggregate M2 and M3 due to credit deleveraging. Critically, Incrementum explains how this applies to gold buying decisions as they introduce their “inflation signal” indicator.

GoldSilverWorlds.com has done a great job of summarizing the key aspects (and the full chartbook is below)…

The authors introduce the term “monetary tectonics” as a metaphor for this war. Similar to tectonic plates under a volcano, monetary inflation and deflation is currently working against each other:

  • Monetary inflation  is the result of a parabolically rising monetary base M0 driven by the central bank monetary easing policy.
  • Monetary deflation is the result of shrinking monetary aggregates M2 and M3 because of credit deleveraging.

The following chart clearly shows that 2013 was a pivot year in which the monetary base M0 grew exponentially while net M2 (expressed on the chart line as M2 minus M0) declined significantly.

deflating credit vs inflating monetary base 2000 2013 money currency

The chartbook shows several trend which confirm the deflationary monetary pressure:

  • Total credit market debt as a % of US GDP has been shrinking since 2007 (“debt deleveraging”).
  • US bank credit of all commercial banks is stagnating (close to negative growth), similar to the period 2007/2008. See first chart below.
  • Money supply growth in the US and the Eurozone is trending lower. See second chart below.
  • Personal consumption expenditures are exhibiting disinflation .
  • The gold/silver-Ratio is declining. Gold tends to outperform silver during disinflationary and/or deflationary periods.
  • The gold to Treasury ratio is declining. See third chart below.
  • The Continuous Commodity Index (CCI) has been in a steep decline since the fall of 2011.

US bank credit commercial banks growth 1974 till 2013 money currency

money supply growth M2 vs M3 1991 till 2013 money currency

gold to bond ratio 2002 2013 money currency

On the other hand, inflationary pressure is present through the following trends:

  • An explosion of the monetary base M0. See first chart below.
  • US households show signs of stopped deleveraging. See second chart below.
  • The currency in circulation keeps on expanding.
  • Commercial banks have piled up an enormous amount of excess reserves which, in case of a rate hike by central planners, could flood the market through lending in the fractional banking system. See thrid chart below.

US monetary base since 1918 money currency

US households stop deleveraging 1971 2013 money currency

excess reserves 2000 2013 money currency

How is gold impacted in this inflation vs deflation war? The key conclusion of the research is that, due to the fractional reserve banking system and the dynamics of the ‘monetary tectonics’, inflationary and deflationary phases will alternate in the foreseeable future. Gold, being a monetary asset in the view of Austrian economics, tends to rise in inflationary periods and decline during times of disinflation.

The key take-away for investors is to position themselves accordingly and consider price declines as buying opportunities for the coming inflationary period. How comes one can be so sure that inflation is coming? Consider that the government must avoid deflation; it is a horror scenario for the following reasons:

  • Price deflation results in a real increase in the value of debt and a nominal decline in asset values. Debt can no longer be serviced.
  • Price deflation would lead to massive tax revenue declines for the government due to a declining taxable base.
  • Deflation would have fatal consequences for large parts of the banking system.
  • Central banks also have the mandate to ensure ‘financial market stability‘

inflation deflation US Fed 200 years money currency

Interesting to know, Stoeferle and Valk developed the “Incrementum Inflation Signal,” an indicator of how much monetary inflation reaches the real economy based on market and monetary indicators. According to the signal, investors should take positions according to the the rising, neutral or falling inflation trends.

monetary seismograph incrementum inflation signal 2013 money currency

Monetary Tectonics Inflation vs Deflation Chartbook by Incrementum

Is Inflation Understated? | Zero Hedge

Is Inflation Understated? | Zero Hedge.

Submitted by Shane Obata-Marusic,

It’s ironic that in a day and age where Keynesian economics is the “accepted view” we still don’t pay enough attention to what Keynes said about inflation.

By a continuing process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens. By this method they not only confiscate, but they confiscate arbitrarily; and, while the process impoverishes many, it actually enriches some… Those to whom the system brings windfalls,…become “profiteers,” who are the object of the hatred… the process of wealth-getting degenerates into a gamble and a lottery… Lenin was certainly right. There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose.”

Keynes On Inflation

The problem today is that some people believe inflation is lower than it actually is.

The Consumer Price Index CPI is used to measure the cost of maintaining a certain standard of living. Now it measures the cost of maintaining a certain level of satisfaction.

1. VESTED INTERESTS

In reality, the purchasing power of the consumer dollar is tanking and the prices of many goods, services, and assets are increasing in price. The end result is that the consumer is suffering. By creating incredible amounts of money, the central banks of the world are debasing the currencies that they issue. In other words, the value of all of existing dollars is reduced when new dollars are supplied.

This is translating to a lower quality of life for more Americans. When one examines real median household income – which was down to $51 ,000 in 201 2 from $56,000 in the year 2000 – this becomes evident.

Before we continue, let’s make something clear. The year over year rate of increase in inflation has been in a downtrend for some time. Therefore, it’s reasonable to conclude that disinflation is a real risk.

That said, because of the presence of the central banks, it’s unlikely that deflation will become a real problem.

The CPI affects the economy because cost of living adjustments to social security, federal civilian and military retirement, and supplemental security income are tied to it. It’s also used to index income tax parameters, TIPS, and some federal contracts.

If the CPI is so important then why does it understate inflation?

That question brings us to the government’s “inflation dilemma”. The US government has 1 of 2 choices: either it can 1 ) mislead its citizens by understating inflation or 2) release accurate inflation data thereby increasing social benefit obligations. This is a lose-lose situation because, unfortunately, both choices only serve to perpetuate an already insurmountable debt problem.

So why is it important to know that inflation is understated? Because, as Keynes said in the opening quote, inflation is essentially a means by which wealth – in the form of real assets such as real estate, businesses, stocks, and bonds – is transferred from the poor and the middle class to the rich. As asset prices inflate, the rich get richer. This allows them to purchase even more assets. At the same time, the poor and middle class become worse off because they have fewer assets and more debt.

Due to the fact that the CPI understates actual inflation, low and middle income individuals are struggling to keep up with the rising costs of living. As a result, more and more people are relying on the government for support.

Inflation is only “low” because of how it’s calculated. Since the 1980s, the US government has made many changes to how the CPI is calculated. These changes have resulted in an index that no longer accurately represents how expensive it is for people to live.

The Way The Politicians Wanted It

 

In the early-1990’s, political Washington moved to change the nature of the CPI. The contention was that the CPI overstated inflation (it did not allow substitution of less-expensive hamburger for more-expensive steak). Both sides of the aisle and the financial media touted the benefits of a “more-accurate” CPI, one that would allow the substitution of goods and services.

 

The plan was to reduce the cost of living adjustments for government payments to Social Security recipients, etc. The cuts in reported inflation were an effort to reduce the federal deficit without anyone in Congress having to do the politically impossible: to vote against Social Security. The inflation-calculation changes had the further benefit to government fiscal conditions of pushing taxpayers artificially in to the higher tax brackets, thus increasing tax revenues. The changes afoot were publicized, albeit under the cover of academic theories. Few in the public paid any attention.

 

Federal Reserve Chairman Alan Greenspan and Michael Boskin, then chairman of the Council of Economic Advisors, were very clear as to how changing or “correcting” the CPI calculations would help to reduce the deficit. As described at the time by Robert Hershey of the New York Times, “Speaker Newt Gringrich, Republican of Georgia, suggested this week that fixing the [CPI] index, with its implications for lower spending [Social Security, etc.] and higher revenue [tax bracket adjustments], would provide maneuvering room for budget negotiators…”

 

John Williams’
Shadow Governement Statistics

The Boskin Commission estimates that the cumulative effects of a 1% bias (to the upside) would have added 1 trillion dollars to national debt in between 1997-2008; clearly, this was an incentive to lower the reported state of inflation.

2) PROBLEMS WITH THE CPI

If the CPI understates inflation then why is it so widely used and referred to? Probably because it’s accepted as “the best measure of inflation that exists”.

In terms of measurement, the CPI has 3 main problems: 1 ) hedonics, 2) substitution, and 3) understated costs.

1 ) Hedonic Adjustments are meant to account for changes in the quality of goods and services. The concept of adjusting prices for changes in quality makes sense. That said, the process is too subjective and is far from perfect.

Some examples:

New computer features were deemed quality improvements, with downside price adjustments made in the CPI for the changes, even though a consumer may not have wanted or used the features

 

The consumer still had to buy those features and pay full cost out-of-pocket, irrespective of what the government determined those products were generating in purported hedonic quality benefits that the consumer was not considering or using.

 

John Williams’
Shadow Governement Statistics

More issues related to subjectivity:

  • where does a good stop being a variety of a given product class and become a product on its own? – ex: Toyota corollas and Toyota camrys.
  • when it comes to a good or service’s characteristics, who’s judging their utility? The consumer or the producer or both?
  • how can someone accurately determine the “quality” of novel or intangible items?
  • what if the ratio of prices does not = the ratio of qualities?

Examples:

  1. if an old product is discounted and a new product is introduced at an unusually high price
  2. if an item is introduced into the market at an unreasonably low price in order to induce demand and then subsequently increases in price during a return to normal market conditions
  3. when a new item is not comparable to an old item

and one final comment on inflation:

The take away point here is not that hedonics is a bad concept but that a lot of subjectivity is involved in calculating hedonic adjustments. I t’s a conflict of interest for the Bureau of Labor Statistics (BLS) to calculate the CPI because it’s in the government’s interest to lower social benefit payments. As a result, the BLS’s inflation data are questionable.

2) Substitution may reflect changes in consumption patterns. That said, the concept of substitution invalidates the CPI as a measure of the cost to maintain a certain standard of living. Ex: if Bob eats steak every day for a year but is then forced to switch to chicken because of rising beef costs then it’s plausible to think he’s maintained the same level of utility. That said, one cannot argue that he’s maintained the same standard of living if he’s forced to substitute steak for a lesser alternative.

BLS introduced: More frequent re-weightings of the CPI index from every ten years to every two years, which moved the CPI closer to a substitution-based index, but the change was not considered a change in methodology.

 

BLS introduced: On-going re-weightings of sales outlets (discount/mass-merchandisers versus Main Street shops), also moving closer to a substitution-based index and creating other constant-standard-of-living issues.

3) If the BLS was actually trying to measure the cost of home ownership then their measure of housing inflation – the Owner’s Equivalent Rent (OER) – would include property taxes, maintenance costs, and insurance. The next best option would be to use the actual price of home. The OER is even less realistic as it measures “how much someone’s house would rent for monthly, unfurnished and without utilities.

“the problem with this hypothetical approach to measuring a significant portion ofCPI is obvious at best. At worst, it’s somewhat disturbing in today’s information age where actual home price data are readily-available at the mere stroke of a key. The “corrected” CPI measure clearly failed to predict an incredible amount of home price inflation which ultimately led to the biggest housing bubble in the history of the world.”

A lower OER leads to a lower CPI . This in turn leads to lower rates which lead to an even lower rate of growth in OER; it’s a negative feedback loop. What’s more is that the OER is the single largest component of the CPI”

The CPI also fails to reflect higher costs in other areas such as energy, tuition, medical care, and food and beverages. Here is a chart that demonstrates how the CPI underestimates inflation:

Lastly, it’s important to the note that the CPI doesn’t include taxes – which have grown from 5% in 1 91 3 to over 30% in 201 3. I t doesn’t make sense that the CPI doesn’t include such a significant expense. Thus, the CPI is flawed as a measure of maintaining a certain standard of living.


3) ALTERNATIVES TO THE CPI

The following section will examine multiple alternative measures of inflation. I t is not that any or all of these measures are perfect, it’s that the actual rate of inflation is higher than the CPI says it is. As a reminder, at its current levels, the CPI indicates that inflation is running at around 1% year over year.

1 ) Shadow Stats:

According to Shadow Stats, the CPI understates inflation by around 3% and 7% for the 1990s and 1980s based shadow stats alternatives respectively.

CPI Year-to-Year Growth The CPI -U (consumer price index) is the broadest measure of consumer price inflation for goods and services published by the Bureau of Labor Statistics (BLS).

While the headline number usually is the seasonally-adjusted month-to-month change, the formal CPI is reported on a not seasonally-adjusted basis, with annual inflation measured in terms of year-to-year percent change in the price index.

In the charts above we show two SGS-Alternate CPI estimates: One based on the pre-1990 official methodology for computing the CPI -U, and the other based on the methodology which was employed prior to 1980.

2) Chapwood index:

In 2012, the average inflation rate for the top 30 cities – ranked by population – was approximately 11% – or more than 3x higher than what the CPI was.

3) The EPI (Every day Price Index):

As you can see in the following chart, the CPI and EPI tracked relatively closely until the early 2000s. At that point in time, the 2 measures began to diverge. Since 1 987, the EPI and CPI have increased by approximately 1 40 and 1 1 0 percent respectively. In other words, the EPI suggests that cumulative inflation from 1 987 to the present is 30% higher than the CPI would suggest.

4) CONCLUSION

Inflation is higher than the CPI says that it is and most people are aware of that. I f you ask your friends and family whether or not they’ve noticed a general increase in prices then they’ll say yes. As noted above, both food and beverages and energy costs have risen in price dramatically. Why is that important? Because the majority of people are exposed to one or both of those costs on a regular basis.

You can argue the magnitude of the inflation understatement but you can’t argue that the official numbers are accurate.

Under reporting inflation has led to many predictable outcomes.

Americans are accumulating debt, reducing their spending, relying on government transfers, and searching for yield because the cost of living is going up.

A repressed CPI also has many effects on the financial markets.
1) It provides justification for artificially low interest rates and QE
2) It leads to the perception that the USD is holding its value and
3) It leads to overstated real returns in stocks and especially bonds

In conclusion, inflation is the means and a wealth transfer from poor and the middle class
to the rich is the end.

Don’t be fooled by people who claim that there’s no inflation.

Although disinflation is – at present – a real risk, cumulative inflation is still drastically reducing the consumer’s purchasing power.

Bond Tab for Biggest Economies Seen at $7.43 Trillion in ’14 – Bloomberg

Bond Tab for Biggest Economies Seen at $7.43 Trillion in ’14 – Bloomberg.

The world’s biggest economies will need to refinance $7.43 trillion of sovereign debt in 2014 as bond yields begin to climb from record lows, threatening to raise borrowing costs while nations struggle to bring down elevated budget deficits.

The amount of bills, notes and bonds coming due for the Group of Seven nations plus Brazil, Russia, India and China is little changed from 2013 after dropping from $7.6 trillion in 2012, according to data compiled by Bloomberg. At $3.1 trillion, representing a 6 percent increase, the U.S. faces the largest tab. Russia, Japan and Germany will see refinancing needs drop, while those of Italy, France, Britain, China and India increase.

While budget deficits in developed nations have fallen to 4.1 percent of their economies from a peak of 7.8 percent in 2009, they remain about double the average in the decade before the credit crisis began. The cost for governments to borrow may rise further after average yields last year rose the most since 2006, as the global economy shows signs of improving and the Federal Reserve pares its unprecedented bond buying.

“Refinancing needs remain elevated in many developed nations, particularly the U.S.,” Luca Jellinek, the London-based head of European rates strategy at Credit Agricole SA, said in a Dec. 30 telephone interview. “The key here is demand rather than supply. If demand drops as growth picks up, and we expect it will, that could put pressure on borrowing costs.”

Photographer: Brent Lewin/Bloomberg

A man is silhouetted against the sun as he walks his bicycle down a flight of stairs in…Read More

Debt as a proportion of the economies of the 34 members of the Organization for Economic Cooperation and Development will rise to 72.6 percent this year from 70.9 percent last year and 39 percent in 2007, according to the group’s forecasts.

Deficit Spending

The amount of government debt obligations contained in a benchmark Bank of America Merrill Lynch index has more than doubled to $25.8 trillion since the end of 2007 as countries from the U.S. to Japan financed increased spending to counter the worst economic crisis since the Great Depression.

After interest-rate cuts around the world and the Fed’s bond purchases pushed down average yields on government notes to an all-time low of 1.29 percent in May, borrowing costs have since jumped, according to the Bank of America Merrill Lynch Global Broad Market Sovereign Plus Index.

Yields climbed to 1.84 percent by the end of December, making the 0.41 percentage point increase in 2013 the biggest in seven years, the data show. That represents an extra $4.1 billion in annual interest on every $1 trillion borrowed.

Bond buyers are demanding more compensation as the Fed plans to scale back its own monthly debt purchases in January to $75 billion from $85 billion and the U.S.-led recovery prompts investors to seek assets with higher returns such as equities.

Risk Premium

Government debt lost an average 0.36 percent worldwide last year, the first decline since 1999.

Based on 41 economists surveyed by Bloomberg on Dec. 19, the Fed will reduce its buying by $10 billion in each of the next seven meetings before ending its stimulus in December.

The U.S., the world’s largest economy, will expand 2.6 percent this year after 1.7 percent growth in 2013 and accelerate 3 percent in 2015, which would be the fastest in a decade, according to economists surveyed by Bloomberg. With Europe and Japan also forecast to grow, the three economies will all expand for the first time since 2010.

“With the Fed pulling back on bond purchases and growth picking up, bond investors will demand higher yields to justify investment,” Mohit Kumar, a money manager at GLG Partners, a hedge-fund unit of Man Group Plc, said by telephone from London. “We need to price in higher risk premium in an environment where rates and market volatility are likely to increase.”

Debtor Nations

Even as faster growth helps increase tax revenue, higher refinancing costs may squeeze governments that are still contending with fiscal deficits. Spending will outstrip revenue in the world’s largest economies by 3.3 percent of their gross domestic product this year, versus an average of 1.75 percent in the 10 years through 2007, data compiled by Bloomberg show.

In the U.S., the world’s largest debtor nation with $11.8 trillion of marketable debt obligations, the amount due this year will increase by about $187 billion, data compiled by Bloomberg show. France, faced with an economy that has barely grown in two years, will see the amount of debt securities due this year rise by 15 percent to $410 billion.

China will lead emerging-market economies with the amount of maturing bonds increasing by 12 percent to $143 billion.

Japan will have $2.38 trillion of bonds and bills to refinance this year, 9 percent less than in 2013, while the amount of German debt maturing this year will decrease by about 5.3 percent to $268 billion.

Public Debt

Including interest payments, the amount of debt that needs to be refinanced by the G-7 countries plus the BRIC nations this year increases by about $712 billion to $8.1 trillion, according to data compiled by Bloomberg.

“There has been a shift of a significant amount of debt” into the public sector during the crisis, saidNicholas Gartside, London-based international chief investment officer for fixed-income at J.P. Morgan Asset Management, which oversees $1.5 trillion. “Despite some improvement on the debt front, there is still a lot of deleveraging to go. The process is still ongoing and will continue for many years.”

Forecasters are overestimating the likelihood government debt costs will increase because the global economic recovery remains fragile and disinflation is starting to emerge, according toSteven Major, head of global fixed-income research at HSBC Holdings Plc, Europe’s largest bank.

The world economy will to expand 2.83 percent this year, according to forecasts compiled by Bloomberg, slower than the average 3.43 percent during the five-year span between the end of the dot-com bust in 2002 and the start of the credit crisis.

Consumer Prices

Slowing inflation also preserves the purchasing power of fixed-rate interest payments, which may support demand for bonds. Consumer prices in the U.S. will rise less than 2 percent in 2014 for a second straight year, which has only happened one other time in the last half century, data compiled by Bloomberg and the Bureau of Labor Statistics show.

In the 18 nations that share the euro, the inflation rate will be 1.2 percent, the lowest in five years.

“Growth may have picked up but it’s still pretty weak compared to previous cycles,” Major said in a telephone interview on Dec. 31. “Inflation is falling in many developed countries. Central banks should be worried about disinflation rather than inflation. It’s hard for me to imagine that bond yields will rise much against this backdrop.”

Some nations are starting to rein in spending, which may help contain borrowing costs. Government bond sales in the euro area, excluding issuance used to refinance maturing debt, will decline to 215 billion euros ($293 billion), the least since 2009, Morgan Stanley predicted.

Bond Sales

Germany said in December that it plans to curb bond and bill sales this year by 17 percent to 205 billion euros as tax revenue rises and Chancellor Angela Merkel seeks to end net new borrowing by 2015. In the U.S., the budget deficit will drop to to 3.4 percent of the economy this year, versus 10 percent five years ago, economist forecasts compiled by Bloomberg show.

Demand at U.S. government debt auctions remained stronger than before the financial crisis as investors bid for 2.87 times the amount sold last year, the fourth-highest ratio on record and surpassed only in the the prior three years.

Buying of Japanese debt was underpinned by the Bank of Japan’s commitment to buy 7 trillion yen ($71 billion) a month of bonds, a pace that would equal more than 50 percent of the 155 trillion yen in notes that Japan plans to sell this year.

Yield Forecasts

“Investors should not and will not be concerned about the supply picture,” said Major, who predicts that yields on the benchmark U.S. 10-year note will decrease to 2.1 percent by year-end from 2.99 percent last week.

His estimate conflicts with the majority of forecasters in a Bloomberg survey who say U.S. borrowing costs will increase. They anticipate yields on the 10-year notes, which rose 1.27 percentage points last year to 3.03 percent, the highest since 2011, will climb to 3.38 percent on average. No one in the survey projected yields falling below 2.5 percent. The yield was at 2.98 percent as of 9:56 a.m. London time.

Borrowing costs in all the G-7 nations are all poised to increase in 2014, based on the estimates. Yields on German bunds will increase to 2.28 percent by year-end, while those for similar-maturity U.K. gilts will end the year at 3.36 percent. That would be the highest for both nations since 2011.

Among the BRIC nations, only bond yields in India and China are poised to drop, the data show.

With global growth picking up, investors such as Standard Life Investments predict government bonds will underperform this year and are holding a greater proportion of equities than their benchmarks used to measure performance.

“We are not enthusiastic about government bonds,” Frances Hudson, a strategist at Standard Life in Edinburgh, which oversees $294 billion, said in an telephone interview on Jan. 2. “It’s reasonable to expect bond yields to rise from record lows as recovery gains momentum.”

Following is a table of projected bond and bill redemptions and interest payments in dollars for 2014 for the Group of Seven countries, Brazil, China, India and Russia using data compiled by Bloomberg as of Dec. 30:

To contact the reporter on this story: Anchalee Worrachate in London ataworrachate@bloomberg.net

Top 10 Global Risks for 2014 | Zero Hedge

Top 10 Global Risks for 2014 | Zero Hedge.

With another new year upon us mortals, we thought it is time again to check out the top 10 global risks ranked by Oxford Analytica.  Not surprisingly, from a geographical perspective, a majority of the top global risks come from the Middle East region (at 40%) and the Asia-Pacific region, specifically China, and North Korea (at 30%).  U.S., Europe, and Russia round out the rest.

 

 

Source: Oxford Analytica

 

The ranking is mostly based on the potential size of global impact.  However, putting them under the lens of probability, a difference picture emerges (see graph below)

 

Chart Source: Oxford Analytica

While the economic related risks such as a sharp slowdown in China, EU disintegration, and deflation in the U.S may rein supreme in terms of global impact, the probability of them materializing is actually less likely than the geopolitical risk in the Middle East (Syria, Iran, Pakistan and Afghanistan), and Asia (China, North Korea).

 

In terms of the type of risk, seven out of the top 10 risks are geopolitical, while only three are financial or economic.  So if we look at probability from this perspective, we are more likely to see a war or regime topple before another financial crisis rippling through the world again.

 

Regarding the ‘U.S. Deflationary Trap’, the Fed said last month it would reduce its monthly asset purchases by $10 billion to $75 billion, while also expressed worries about inflation.  Meanwhile, Fed’s balance sheet has ballooned to $4 trillion, we seriously doubt the U.S. deflationary scenario after Fed’s helicoptered five years worth of QEs.

 

 

At this point, we at EconMatters believe that the Federal Reserve removing the Liquidity Punchbowl not because everything is fixed with the US economy, and we have fully recovered from the financial crisis of 2007, but because they have no other choice in the matter given the obvious asset bubbles they have created in the credit, bond and equity markets.

 

For now, the inflationary effect from QEs is mostly trapped in the stock and commodity markets (i.e. enriching the 1%), but inevitably it will manifest and spill over to the consumer side of things hitting hard on the 99%.  The removal of this liquidity, the resultant implications for financial markets, and potential future inflationary consequence of Fed’s QEs remain an under appreciated risk to the global economy in our humble opinion.

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