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Harold James examines the real story behind the international response to the near-meltdown in 2008. – Project Syndicate

Harold James examines the real story behind the international response to the near-meltdown in 2008. – Project Syndicate.

The Secret History of the Financial Crisis

PRINCETON – Balzac’s great novel Lost Illusions ends with an exposition of the difference between “official history,” which is “all lies,” and “secret history” – that is, the real story. It used to be possible to obscure history’s scandalous truths for a long time – even forever. Not anymore.

Nowhere is this more apparent than in accounts of the global financial crisis. The official history portrayed the US Federal Reserve, the European Central Bank, and other major central banks as embracing coordinated action to rescue the global financial system from disaster. But recently published transcripts of 2008 meetings of the Federal Open Market Committee, the Fed’s main decision-making body, reveal that the Fed has effectively emerged from the crisis as the world’s central bank, while continuing to serve primarily American interests.

The most significant meetings took place on September 16 and October 28 – in the aftermath of the collapse of the US investment bank Lehman Brothers – and focused on the creation of bilateral currency-swap agreements aimed at ensuring adequate liquidity. The Fed would extend dollar credits to a foreign bank in exchange for its currency, which the foreign bank agreed to buy back after a specified period at the same exchange rate, plus interest. This gave central banks – especially those in Europe, which faced a dollar shortage as US investors fled – the dollars they needed to lend to struggling domestic financial institutions.

Indeed, the ECB was among the first banks to reach an agreement with the Fed, followed by other major advanced-country central banks, including the Swiss National Bank, the Bank of Japan, and the Bank of Canada. At the October meeting, four “diplomatically and economically” important emerging economies – Mexico, Brazil, Singapore, and South Korea – got in on the action, with the Fed agreeing to establish $30 billion swap lines with each of their central banks.

Though the Fed acted as a kind of global central bank, its decisions were shaped, first and foremost, by US interests. For starters, the Fed rejected applications from some countries – whose names are redacted in the published transcript – to join the currency-swap scheme.

More important, limits were placed on the swaps. The essence of a central bank’s lender-of-last-resort function has traditionally been the provision of unlimited funds. Because there is no limit on the amount of dollars that the Fed can create, no market participant can take a speculative position against it. By contrast, the International Monetary Fund has finite resources provided by member countries.

The Fed’s growing international role since 2008 reflects a fundamental shift in global monetary governance. The IMF emerged at a time when countries were routinely victimized by New York bankers’ casual assumptions, such as J.P. Morgan’s assessment in the 1920’s that Germans were “fundamentally a second-rate people.” The IMF was a critical feature of the post-WWII international order, intended to serve as a universal insurance mechanism – not one that could be harnessed to advance contemporary diplomatic interests.

Today, as the Fed documents clearly demonstrate, the IMF has become marginalized – not least because of its ineffective policy process. Indeed, at the outset of the crisis, the IMF, assuming that demand for its resources would remain low permanently, had already begun to downsize.

In 2010, the IMF made a play for resurrection, presenting itself as central to solving the euro crisis – beginning with its role in financing the Greek bailout. But here, too, a secret history has been revealed – one that highlights just how skewed global monetary governance has become.

The fact is that only the US and the massively over-represented countries of the European Union supported the Greek bailout. Indeed, the major emerging economies all strongly opposed it, with the Brazilian representative calling it “a bailout of Greece’s private debt holders, mainly European financial institutions.” Even the Swiss representative condemned the measure.

As fears of a sudden collapse of the eurozone have given way to a prolonged debate about how the costs will be met through bail-ins and write-offs, the IMF’s position will become increasingly convoluted. Though the IMF is supposed to have seniority over other creditors, there will be demands to write down a share of the loans that it has issued. Poorer emerging-market countries would resist such a move, arguing that their citizens should not have to foot the bill for fiscal profligacy in much wealthier countries.

Even the original advocates of IMF involvement are turning against the Fund. EU officials are outraged by the IMF’s apparent effort to gain support in Europe’s debtor countries by urging write-offs of all debt that it did not issue. And the US Congress has refused to endorse the expansion of IMF resources – part of an international agreement brokered at the 2010 G-20 summit.

While the outrage that followed the appointment of another European as IMF Managing Director in 2011 is likely to ensure that the Fund’s next head will not hail from Europe, the IMF’s fast-diminishing role means that it will not matter much. As 2008’s secret history shows, what matters is who has access to the Fed.

Read more at http://www.project-syndicate.org/commentary/harold-james-examines-the-real-story-behind-the-international-response-to-the-near-meltdown-in-2008#EYtp3dyZ7LsmTwgc.99

No, Deflation is Not a ‘Danger’ |

No, Deflation is Not a ‘Danger’ |.

March 7, 2014 | Author 

The ‘Deflation Danger’ Should Abate …

What is it with this perennial fear the chief money printers have of falling prices? Not that we are likely to see it happen, but if it does, what of it? Bloomberg reports on the recent ECB decision with the following headline: Draghi Says Deflation Danger Should Abate as Economy Revives

The headline alone is a hodge-podge of arrant nonsense. First of all, ‘deflation’ (this is to say, falling prices), is not a ‘danger’. Speaking for ourselves and billions of earth’s consumers: we love it when prices fall! It means our incomes go further and our savings will buy more as well. What’s not to love?

The problem is of course that when prices decline, the ‘wrong’ sectors of society actually benefit, while those whose bread is buttered by the inflation tax would no longer benefit at the expense of everybody else. But they never say that, do they? Has Draghi ever explained why he believes deflation to be a danger? No, we are just supposed to know/accept that it is.

Secondly, the ‘as economy revives’ part makes no sense whatsoever. Why and how should a genuinely reviving economy produce inflation? Economic growth occurs when more goods and services are produced. Their prices should, ceteris paribus, fall (of course, we are not supposed to inquire too deeply into which ceteris likely won’t remain paribus if Draghi gets his wish).

From Bloomberg:

“ European Central Bank President Mario Draghi signaled that deflation risks in the euro region are easing for now after new forecasts showed that inflation will approach their target by the end of 2016.

The news that has come out since the last monetary policy meeting are by and large on the positive side,” he told reporters in Frankfurt today after the central bank kept itsmain interest rate at 0.25 percent. He also indicated that money markets are under control at the moment, lessening the need for emergency liquidity measures.

Draghi is facing down the threat of deflation in an economy still recovering from a debt crisis that threatened to rip it apart less than two years ago. New ECB forecasts today underscore his view that the 18-nation bloc will escape a Japan-style period of falling prices as momentum in the economy improves.”

(emphasis added)

We have highlighted the sentence above because we keep reading about the ‘Japan-style deflation trap’ for many, many years now. You would think that Japan was a third world country by now the way this keeps being portrayed as a kind of monetary evil incarnate that destroys the economy. Of course, nothing could be further from the truth.

Inflation is Not Equivalent to Economic Growth

‘Inflation’ is not the same as ‘economic growth’ – on the contrary, it both causes and frequently masks economic retrogression. How much inflation has there been in the euro area over time? Let’s have a look.


Euro Area TMS-a

The euro area’s true money supply since 1980. One can only shudder at this depiction of ‘deflation danger’ in action – click to enlarge.


What about prices though? Let’s have a look-see:


HCPI-LT-wow chartSince 1960, there was exactly one year during which prices according to the ‘CPI’ measure actually fell, namely in 2009, by a grand total of 0.5% – click to enlarge.

As Austrian economists have long explained, it is simply untrue that prices must rise for the economy to grow. Consumersobviously benefit from falling prices (only Keynesian like Paul Krugman don’t realize that, as their thought processes are evidently unsullied by logic and/or common sense). All of us can easily ascertain how beneficial the decline in computer prices, cell- and smart phone prices, prices for TV screens, etc. is. Naturally, it would be even better if all prices fell, not only those on a select group of consumer goods.

What about producers? Won’t they suffer? By simply looking at the share prices and earnings of the companies that make all the technological gadgets the prices of which have been continually declining for decades, everybody should realize immediately that the answer must be a resounding NO. This is by the way not only true of the firms that are in the final stages of the production process, i.e. the stages closest to the consumer. It is obviously also true for the firms in the higher stages of the capital structure. But why? It is quite simple actually: prices are imputed all along the chain of production. What is important for these companies to thrive are not the nominal prices of the products they sell, but the price spreadsbetween their input and output.

In fact, the computer/electronics sector is the one that comes closest to showing us how things would likely look in a free, unhampered market economy.

Of course, in said free, unhampered market economy, Mr. Draghi and a host of other central planners would have to look for a new job.

Charts by: ECB


No, Deflation is Not a ‘Danger’ |

No, Deflation is Not a ‘Danger’ |.

March 7, 2014 | Author 

The ‘Deflation Danger’ Should Abate …

What is it with this perennial fear the chief money printers have of falling prices? Not that we are likely to see it happen, but if it does, what of it? Bloomberg reports on the recent ECB decision with the following headline: Draghi Says Deflation Danger Should Abate as Economy Revives

The headline alone is a hodge-podge of arrant nonsense. First of all, ‘deflation’ (this is to say, falling prices), is not a ‘danger’. Speaking for ourselves and billions of earth’s consumers: we love it when prices fall! It means our incomes go further and our savings will buy more as well. What’s not to love?

The problem is of course that when prices decline, the ‘wrong’ sectors of society actually benefit, while those whose bread is buttered by the inflation tax would no longer benefit at the expense of everybody else. But they never say that, do they? Has Draghi ever explained why he believes deflation to be a danger? No, we are just supposed to know/accept that it is.

Secondly, the ‘as economy revives’ part makes no sense whatsoever. Why and how should a genuinely reviving economy produce inflation? Economic growth occurs when more goods and services are produced. Their prices should, ceteris paribus, fall (of course, we are not supposed to inquire too deeply into which ceteris likely won’t remain paribus if Draghi gets his wish).

From Bloomberg:

“ European Central Bank President Mario Draghi signaled that deflation risks in the euro region are easing for now after new forecasts showed that inflation will approach their target by the end of 2016.

The news that has come out since the last monetary policy meeting are by and large on the positive side,” he told reporters in Frankfurt today after the central bank kept itsmain interest rate at 0.25 percent. He also indicated that money markets are under control at the moment, lessening the need for emergency liquidity measures.

Draghi is facing down the threat of deflation in an economy still recovering from a debt crisis that threatened to rip it apart less than two years ago. New ECB forecasts today underscore his view that the 18-nation bloc will escape a Japan-style period of falling prices as momentum in the economy improves.”

(emphasis added)

We have highlighted the sentence above because we keep reading about the ‘Japan-style deflation trap’ for many, many years now. You would think that Japan was a third world country by now the way this keeps being portrayed as a kind of monetary evil incarnate that destroys the economy. Of course, nothing could be further from the truth.

Inflation is Not Equivalent to Economic Growth

‘Inflation’ is not the same as ‘economic growth’ – on the contrary, it both causes and frequently masks economic retrogression. How much inflation has there been in the euro area over time? Let’s have a look.


Euro Area TMS-a

The euro area’s true money supply since 1980. One can only shudder at this depiction of ‘deflation danger’ in action – click to enlarge.


What about prices though? Let’s have a look-see:


HCPI-LT-wow chartSince 1960, there was exactly one year during which prices according to the ‘CPI’ measure actually fell, namely in 2009, by a grand total of 0.5% – click to enlarge.

As Austrian economists have long explained, it is simply untrue that prices must rise for the economy to grow. Consumersobviously benefit from falling prices (only Keynesian like Paul Krugman don’t realize that, as their thought processes are evidently unsullied by logic and/or common sense). All of us can easily ascertain how beneficial the decline in computer prices, cell- and smart phone prices, prices for TV screens, etc. is. Naturally, it would be even better if all prices fell, not only those on a select group of consumer goods.

What about producers? Won’t they suffer? By simply looking at the share prices and earnings of the companies that make all the technological gadgets the prices of which have been continually declining for decades, everybody should realize immediately that the answer must be a resounding NO. This is by the way not only true of the firms that are in the final stages of the production process, i.e. the stages closest to the consumer. It is obviously also true for the firms in the higher stages of the capital structure. But why? It is quite simple actually: prices are imputed all along the chain of production. What is important for these companies to thrive are not the nominal prices of the products they sell, but the price spreadsbetween their input and output.

In fact, the computer/electronics sector is the one that comes closest to showing us how things would likely look in a free, unhampered market economy.

Of course, in said free, unhampered market economy, Mr. Draghi and a host of other central planners would have to look for a new job.

Charts by: ECB


Welcome to the Currency War, Part 12: Bankrupt Rome and Soaring Euro-Bonds

Welcome to the Currency War, Part 12: Bankrupt Rome and Soaring Euro-Bonds.

by John Rubino on February 28, 2014 · 14 comments

Only in a world totally corrupted by easy money could the following two things be announced on the same day. First:

 

European Bonds Surge as ECB Stimulus Confines Crisis to Memory

Yields on the euro area’s government bonds have never been lower as the potential for extended European Central Bank stimulus helps exorcise memories of the region’s sovereign debt crisis. 

The bond-market rally is broad based, encompassing both core economies such asFrance and also peripheral markets including Greece, which was pushed to the brink of exiting the currency bloc during the region’s financial woes. Another of those nations, Portugal, took a step toward exiting an international bailout program today as it bought back bonds, while Italy, supported in the turmoil by ECB bond purchases, sold five-year notes at a record-low rate.

“Investors are starting to look at the non-core European bond markets as a viable investment alternative again,” said Jussi Hiljanen, head of fixed-income research at SEB AB inStockholm. “Further ECB actions have the potential to maintain the tightening bias on those spreads,” he said, referring to the yield gap between core nations and the periphery.

The average yield to maturity on euro-area bonds fell to a record 1.6343 percent yesterday, according to Bank of America Merrill Lynch indexes. It peaked at more than 6 percent in 2011, the data show.

Italy’s 10-year yield fell seven basis points to 3.47 percent after touching 3.46 percent, a level not seen since January 2006. Portugal’s 10-year yield dropped four basis points to 4.81 percent and touched 4.78 percent, the least since June 2010, while Ireland’s two-year note yield and Spain’s five-year rates dropped to records.

Then, at about the same time:

 

Rome days away from bankruptcy

Eternal city warns it will go bust for the first time since it was destroyed by Nero 

Matteo Renzi, the Italian prime minister, came under pressure on Thursday as the city of Rome was on the brink of bankruptcy after parliament threw out a bill that would have injected fresh funding.

Ignazio Marino, Rome mayor, said city services like public transport would come to a halt and that he would not be a “Nero” – the Roman emperor who, legend has it, strummed his lyre as the city burnt to the ground.

Marino said that Renzi, a centre-left leader and former mayor of Florence who was only confirmed by parliament this week, had promised to adopt urgent measures to help the Italian capital at a cabinet meeting on Friday.

The newly-elected mayor faces a budget deficit of 816 million euros ($1.1 billion) and the city could be placed under administration if he does not manage to close the gap with measures such as cutting public services.

“Rome has wasted money for decades. I don’t want to spend another euro that is not budgeted,” Marino said, following criticism from the Northern League opposition party which helped shoot down the bill for Rome in parliament.

The draft law would have included funding for Rome from the central government budget as a compensation for the extra costs it faces because of its role as the capital including tourism traffic and national demonstrations.

Other cash-strapped cities complained it was unfair. But Marino warned there could be dire consequences. “We’re not going to block the city but the city will come to a standstill. It will block itself if I do not have the tools for making budget decisions and right now I cannot allocate any money,” he told the SkyTG24 news channel.

Marino said that buses may have to stop running as soon as Sunday because he only had 10 percent of the money required to pay for fuel in March.

He added: “With the money that we have in the budget right now, I can do repairs on each road in Rome every 52 years. That’s not really maintenance.”

How is it that Italy is able to borrow money at low and falling rates – which indicates that borrowers are confident of its ability to pay its bills – while its major city, far more important to that country than New York or Los Angeles is to the US, slides into bankruptcy?

The answer is that Rome is irrelevant in comparison with two other facts. First, Europe is slipping into deflation, which generally leads to lower bond yields. Second, the European Central Bank is virtually guaranteed to respond to fact number one with quantitative easing on a vast scale.

So the bond markets, far from rallying on the expectation of a eurozone recovery, are rising in anticipation of the opposite: a new round of recession/deflation/instability that forces the abandonment of even the pretense of austerity and the adoption of aggressively easy money.

In this scenario, a Roman bankruptcy is actually a good thing because it pushes the ECB, Bundesbank, Bank of Italy and the other relevant monetary entities to stop dithering and start monetizing debt in earnest. Once it gets going, the goal of the program will be to refinance everyone’s debt at extremely low rates, push down the euro’s exchange rate versus the dollar, yen and yuan, and shift the currency war front from Europe to the rest of the world. The race to the bottom continues.

The rest of this series is available here.

European Banking Crisis: the calm before the storm ? | The Cantillon Observer

European Banking Crisis: the calm before the storm ? | The Cantillon Observer.

Austrian business cycle theory explains that the “bust” phase of that cycle is created by extension of cheap and plentiful credit by a fractional reserve banking (FRB) system.  A FRB  system is inherently fragile during the bust phase as its’ leverage(lending as % of own capital) exposes the banks to the emerging tsunami of non-performing loans and impaired collateral that are the manifestations of malinvestment.

Yet, in today’s  protected and regulated banking industry, the “bust” phase of the cycle is delayed and distorted by the wide-ranging interventionism of regulators, central banks and governments. The ongoing crisis in the European banking sector is evidence of this. Its’ problems of insolvency are unresolved. The ECB is at the centre of interventionist efforts to stall and mitigate a European  banking sector collapse that looks increasingly likely within the next 18 months. 1/

Last week the ECB kept interest rates unchanged at 0.25 %. The exchange value of the euro rose and the mainstream media and  financial industry pundits  all bemoaned Mr Draghi’s immobilism in the face of worsening price deflation 2/. As my November 2013 commentary indicated 3/, there is growing political pressure on the ECB from southern European governments to launch a new round of Eurozone members’ sovereign  bond purchases.4/ , as public debt to GDP ratios are increasing for countries on the periphery; and menacingly high too even for some core member countries.

So why has the ECB President kept his powder dry, and is the European banking crisis contained or still perilously at risk ?

Mr Draghi diplomatically hedged at a press conference, claiming that the data available failed to show definitively a confirmed deflationary trend  and that though officially measured price inflation at 0.8% was below the Bank’s mandated target 2%, there was no convincing evidence of a Japanese-style deflation in the Eurozone.

The Bank President’s words are meant to buy time, while two related processes –  one political, the other regulatory – play out.

The political process is to determine the how Eurozone governments proceed  (attempting) to manage the twin crises of growing sovereign debts and growing systemic insolvency risk in the banking sector.  The latest event in that process is the  German Constitutional Court’s ruling last week that it does not consider that the ECB has been acting within its mandate when conducting debt monetisation  – thus allying itself to the view of Jens Wiedmann the Bundesbank President – although it did not explicitly rule that the ECB broke the German Constitution, preferring to pass the parcel on to the European Court of Justice for a definitive ruling.

These legal challenges are a mere proxy war for the real political one between the “Teutonic” bloc led by  Germany and the “Club Med” periphery which currently also includes France.

Which returns us to the ECB, whose Governing Council members are composed of a clear majority from the “Club Med” faction.  Knowing he has this majority ready to vote eventually for a new round of asset purchases, Mr Draghi is playing a long game.

With ECB benchmark rates already negative in real terms, he is well aware that reducing nominal rates further does little to encourage bank lending. Even with effectively “free” credit, bank lending to businesses is down; as is inter-bank lending.  This lack of lending has multiple proximate  reasons, but the fundamental one is banks’ own continuing struggle to remain solvent since the onset of the financial crisis in 2007/08.  This is where the newest regulatory process comes in.

The ECB is soon to take on so-called “macroprudential” oversight of the Eurozone banking system – a new interventionist approach championed by the G20, IMF and Bank of International Settlements’ (BIS) to reduce risks of failure in the banking system by imposing higher core capital ratios.

Complementary to the EU Commission’s plans to establish a Banking Union (including a Special Resolution Mechanism –SRM – for “bailing in” failing banks), and the BIS’s  work to revise and tighten the Basel Rules on bank capital, the ECB is about to embark upon a massive exercise of stress testing all European banks. 5/ A previous round of such tests in 2010 was ridiculed as far too lax.  This time the bar has been set higher. It is expected  that some banks will fail the stress test, and interested parties are already speculating which, and attempting to guestimate the likely outcome in terms of new capital requirements . 6/

How rigorous these stress tests are is a critical matter for the ECB. Its’ supervisory responsibility for all Eurozone banks enters in force once the SRM measure is finalised later this year . The benchmarks applied for the tests are themselves partly derived from the work of the Basle Committee on Banking Supervision in defining banks’ permitted  leverage ratio. Mr Draghi is the chairman of the Group of Governors and Heads of Supervision which oversees these Basle regulators. Interestingly, they recently relaxed the rules on the definition of banks’ leverage, following feedback from the industry that the new rules would entail banks having to raise at least $200 billion in new capital to comply.  7/

The challenge that these regulatory initiatives attempt to address is the massive build-up of leverage in the banking system as a whole. The Eurozone’s banks are the most vulnerable, but the problem is global. Hence the pivotal role of the BIS in defining a common approach.

What has to be factored in here is not simply banks’ traditional business and real estate lending, important though those are to understanding actual and potential loan losses. Far bigger in scale are the  banks’ exposures to the shadow banking sector; their off balance sheet losses; and the recent likely losses on FX futures contracts and interest rate swaps caused by the sell off in Emerging Markets.

Derivatives positions in FX and interest rate swaps are staggering and the total derivatives market is estimated at $700 trillion. Amongst large European banks, Deutsche Bank is said to have Euro 55.6 trillion of gross notional derivatives exposure on its books.  This figure is some 200%+ greater than Germany’s annual GDP !  8/ Note, these are not losses, just exposures. Nevertheless, it would take only a very small proportion of these contracts to turn sour for Deutsche Bank’s entire core capital to be wiped out.

The BIS-defined leverage ratio  aims to limit banks’ reliance on debt, using a minimum standard for how much capital they must hold as a percentage of all assets on their books. However, the BIS found that “a quarter of large global lenders would have failed to meet a June version of the  leverage limit had it been in force at the end of 2012.” 9/

There is a perfect storm developing then in the European banking sector.

First, there is the increasing likelihood that the ECB will unleash a new round of asset purchases from the banks to flood them with the liquidity they need to buy up their respective national governments’ sovereign bonds and so hold bond yields down.

Second, there is a Eurozone-wide regulatory initiative to recapitalise the banks likely, following on from the results of the ECB’s bank stress tests. Third, there is an increasing chance of a deep stock market correction happening this summer. All three, taken collectively,  could trigger a crisis of confidence in the  banking sector. An  insolvency crisis too should not be ruled out in the event of some large banks failing to recover from derivatives markets exposures in an increasingly volatile currency, interest rate and stock markets environment.

_______________________________________________________________________________

NOTES/REFERENCES

1/ Using technical analysis and Austrian economic theory, it is being predicted that a stock market “crack up boom” is due some time near Christmas 2014, followed by a fiat currency collapse. Before that, a deep market correction is foreseen starting by the summer. see“The Globalisation Trap: full report”, Gordon T Long.com, 2014 01 15

2/ “Split ECB paralysed as deflation draws closer” A. Evans Pritchard, DailyTelegraph.co.uk,7th  February 2014

3/ “Eurozone’s Debt Crisis: is the next phase of the ECB’s “large scale asset purchases” imminent ?” November 2013, mises.org

4/ A few days after my commentary was published, the ECB’s executive board member Peter Praet let markets know that stimulus measures were on the menu via comments in a November 13th Wall Street Journal interview. “ ECB Bank Stress Tests: Catalyst Of The Final EU Crisis?”, SeekingAlpha.com, 2013 11 17

5/ “ECB Bank stess tests: catalyst of the final EU crisis ?” SeekingAlpha.com, 2013 11 17

6/  “Eurozone banks face £42bn ‘capital black hole’”, Kamal Ahmed, DailyTelegraph.co.uk, 8th February 2014

7/“Basel Regulators Ease Leverage-Ratio Rule for Banks”, Jim Brunsden , Bloomberg .com,   2014 01 13

8/ “On Death and Derivatives”, 29 January 2014, Golemxiv.co.uk

9/ op. cit., Bloomberg .com,   2014 01 13

Greece Is Still Bankrupt |

Greece Is Still Bankrupt |.

February 6, 2014 | Author 

A ‘Flood of Good News’

As der Spiegel recently reported, the Greek government is intent on smothering its reluctant creditors with good news (in order to be able to accumulate a reasonable amount of such, the last ‘troika’ assessment has apparently been subject to numerous delays):

“A SPIEGEL report that German Finance Minister Wolfgang Schäuble is considering a third rescue package for Greece has electrified the struggling nation. Athens wants to impress its creditors with a stream of good news. But it still has a long list of unkept promises. New loans are welcome, but don’t ask us for any new austerity measures. This pretty much sums up Athens’ reaction to Germany’s reported willingness to approve further loans to Greece to cover the country’s multi-billion euro projected financing gap in 2015-2016.

Although there was no official reaction to SPIEGEL’s report, published on Monday, government sources say that Berlin’s intentions were known to Prime Minister Antonis Samaras, adding that Germany will not pull the rug from under Greece’s feet, especially with the European election due in May.

But the Greek government has also made clear that it will not accept a new round of measures or a continuation of what are perceived by many in Greece as the asphyxiating and humiliating controls by the troika of European Commission, European Central Bank and International Monetary Fund.

Finance Minister Yannis Stournaras is preparing Greece’s position ahead of the troika’s arrival. With a fresh round of bargaining looming on the new loans, he promised an avalanche of “impressively good news” in the coming days to show that Greece doesn’t need any further belt-tightening. It only needs to press on with its structural reforms, he said.

According to a Greek Finance Ministry official, the good news will include the first increase of retail sales in 43 months, and the first rise in the purchasing managers’ index in 54 months. The “super-weapon” in Stournaras’ arsenal, however, is the hefty 2013 primary budget surplus, now estimated at €1.5 billion, well above the official budget forecast of €812 million.

The same official said the expected good news was the reason why Athens doesn’t want the troika to return earlier to conclude a much-delayed round of inspections that started in the autumn.Stournaras is expected to present Greece’s accomplishments to German officials when he visits Berlin later this week. The final details of his trip are still being worked out. Athens also plans a return to the markets by the end of 2014 in what it believes will be a definitive sign that the Greek economy is out of the woods.

With the leftist opposition alliance Syriza leading most opinion polls, some observers say the Greek government needs to be able to show success soon. Athens was therefore quick to react to the reports about new loans, telling the public it should not fear a new wave of measures.

(emphasis added)

By all accounts SYRIZA would indeed win elections if they were held today – by a solid margin of almost 8% over its nearest rival New Democracy, the party of current prime minister Antonis Samaras. Electoral support for his coalition partner PASOK – for a long time the ruling party in Greece – has all but disappeared. Even the Stalinist KKE is set to grab a bigger share of the vote.

The upcoming European as well as municipal elections in Greece are bound to see SYRIZA winning comfortably. Meanwhile, the coalition’s majority in parliament has shrunk to a mere three MPs. It won’t take much to topple it, hence all the frantic activity described above.

Greetings from Charles Ponzi

So what’s the problem if there are all those good news, including a ‘hefty primary surplus’? As an aside, said surplus is already greedily eyed by various Greek bureaucrats who have suffered salary cuts which they are currently challenging in court. As the WSJ recently reported, a few European finance ministers held a ‘private meeting’ over Greece recently, to which their Greek colleague wasn’t invited. The problem? The month of May:

“Top officials peeled away from colleagues after a gathering of euro-zone finance ministers in Brussels on Monday evening for a private meeting to discuss mounting concerns over Greece’s bailout. Greek Finance Minister Yiannis Stournaras, who was briefing the press in a building across the street at the time, wasn’t invited.

High-level officials from the International Monetary Fund, the European Commission, and the European Central Bank, as well as senior euro-zone officials and the German and French finance ministers were present.

The meeting reflects anxiety that Greece could yet disturb the relative calm in euro-zone financial markets. But the issue is unlikely to come to a head until May when Greece needs to repay some €11 billion ($14.85 billion) of maturing government bonds.

The private meeting, confirmed by several people with direct knowledge of the talks, comes as Athens struggles to meet some of the conditions set by its official creditors for further payouts from bailout funds. The Monday meeting was held to discuss how to press Athens to forge ahead with unpopular reforms to its labor and product markets, and how to scramble together extra cash to cover a shortfall in the country’s financing for the second half of the year that is estimated at €5 billion to €6 billion.The meeting was inconclusive, people familiar with the situation said.

(emphasis added)

An € 11 billion bond repayment and a shortfall of  € 5 to 6 billion? Oh well, that’s why it’s called a “primary surplus” instead of just a “surplus”. “Primary” means it’s not really a surplus – only that it would be one, if not for the debtberg Greece must service. However, if servicing said debtberg costs more than Greece’s government can actually bring in, then its entire debt edifice remains a Ponzi scheme. Only, contrary to other governments that are able to finance their own Ponzi debt schemes in the markets, Greece needs Ponzi financing from elsewhere, or to be precise, from unwilling tax cows residing elsewhere. That is currently the main difference. The problem for all the other States is that it is important that people don’t start thinking too much about the essential Ponzi nature of government debt. If they do, then there might be another debt crisis. After all, nearly the entire euro zone sports a lot more debt today (both absolute and relative to GDP) than at any time during the most severe crisis months. That fact in turn means that the current calm in the markets really hangs by the thinnest of threads, propped up by misplaced confidence alone. Meanwhile, the much-lamented ‘banks-sovereigns doom loop’ has become worse by almost an order of magnitude in countries like Italy and Spain.

On the other hand, selling yet another bailout of Greece to the voters in creditor countries is quite a tall order at this stage, with the eurocracy already being subject to much scorn and revulsion (all of it well deserved).

What to do?


trojan-horse-239x300Helloooo, ‘European partners’ … thinking about me lately?

(Image source: The Web / Author unknown)


Let Us ‘Stipulate For All Times to Come’

Ludwig von Mises once wrote with regard to the inexorably growing mountains of government debt around the world:

“The long-term public and semi-public credit is a foreign and disturbing element in the structure of a market society. Its establishment was a futile attempt to go beyond the limits of human action and to create an orbit of security and eternity removed from the transitoriness and instability of earthly affairs. What an arrogant presumption to borrow and to lend money for ever and ever, to make contracts for eternity, to stipulate for all times to come!”

In the case of Greece, the eurocrats seem to have precisely such an arrogant presumption in mind:

“The next handout to Greece may include extending the maturity on rescue loans to 50 years and cutting the interest rate on some previous aid by 50 basis points, according to two officials with knowledge of discussions being held by European authorities.

The plan, which will be considered by policy makers by May or June, may also include a loan for a package worth between 13 billion euros ($17.6 billion) and 15 billion euros, another official said.Greece, which got 240 billion euros in two bailouts, has previously had its terms eased by the euro zone and International Monetary Fund amid a six-year recession.

“What we can do is to ease debt, which is what we have done before through offering lower interest or extending the maturity of loans,” Dutch Finance Minister Jeroen Dijsselbloem, who heads the group of euro finance chiefs, said yesterday on broadcaster RTLZ. “Those type of measures are possible but under the agreement that commitments from Greece are met.”

(emphasis added)

Good luck with that last one boys. Greece is still the same over-bureaucratized corrupt swamp it was prior to the bailouts. There will be a deep freeze in hell before the ‘commitments are met’.

Since we mentioned the banks earlier, here is the next non-suprise:

“As Greece seeks to meet its aid conditions and unlock more money from its existing bailouts, it’s also looking for ways to make the most of 50 billion euros that was set aside for bank recapitalization. The country had hoped some money might be left over for other financing needs. That now looks less likely because the Greek banks will need more capital, according to an EU official close to the bailout process.”

(emphasis added)

You really couldn’t make this sh*t up.

Conclusion:

This is what happens when unsound debt is artificially propped up instead of being liquidated. Now there is a never-ending drama. Creditors keep throwing good money after bad, into what appears to be a kind of financial black hole – money falls inside, but it looks like it will never come back. Meanwhile, the population of Greece has been so thoroughly ground into the dirt by the crisis that it is prepared to rather vote for Nazis and communists than continue with the situation as is. What a great accomplishment!


broken-euroQuick, this thing still needs some more glue …

(Image source: The Web / Author unknown)

Moneyness: Who signs a country’s banknotes?

Moneyness: Who signs a country’s banknotes?.

2010 Bank of England note signed by Andrew Bailey, former Chief Cashier of the Bank.

A few years ago, Peter Stella and Åke Lönnberg conducted a study that classified national banknotes by the signatories on that note’s face. They found some interesting results. Of the world’s 177 banknotes with signatures (10 had no signature whatsoever), the majority (119) were signed by central bank officials only. Just four countries issue notes upon which the sole signature was that of an official in the finance ministry: Singapore, Bhutan, Samoa, and (drum roll) the United States.

Stella and Lönnberg hypothesize that the signature(s) on a banknote indicate the degree to which the issuing central bank’s is financially integrated with its government. The lack of a signature from a nation’s finance ministry might be a symbol of a more independent relationship between the two, the central bank’s balance sheet being somewhat hived off from the government’s balance sheet and vice versa. The presence of a finance minister’s signature would indicate the reverse, that both the treasury and central bank’s balance sheets might be best thought of as one amalgamated entity.

The nature of this arrangement is significant because if something disastrous were to happen to an independent central bank’s financial health, say its assets were destroyed and all hope of profits dashed for eternity, the central banker should not necessarily expect support from his/her government. Lacking in resources, monetary policy could go off the rails. (Why would it go off the rails? Here I go into more detail).

On the other hand, should it be established by law that a government is to backstop its central bank, that same disaster would pose a smaller threat to monetary policy since the nation’s finance minister, his John Hancock affixed to the nation’s notes, would presumably come to the central bank’s rescue.

These ideas are similar to Chris Sims’s classification of type F and type E central banks (alternative link). One of the features of type F banks (like the Fed) is that “there is no doubt that potential central bank balance sheet problems are nothing more than a type of fiscal liability for the treasury.” On the other hand, with type E banks (like the ECB) “it is not obvious that a treasury would automatically see central bank balance sheet problems as its own liability.”

So is it the case that the Federal Reserve is actually more fused with the U.S. Treasury than other central banks are? One reading of the Federal Reserve Act might indicate yes. Section 16.1 stipulates that Federal Reserve notes are ultimately obligations of the US government:

Federal reserve notes, to be issued at the discretion of the Board of Governors of the Federal Reserve System for the purpose of making advances to Federal reserve banks through the Federal reserve agents as hereinafter set forth and for no other purpose, are hereby authorized. The said notes shall be obligations of the United States and shall be receivable by all national and member banks and Federal reserve banks and for all taxes, customs, and other public dues.

The language in the above phrase would seem to indicate that should the Fed find itself incapable of exercising monetary policy (Stella and Lönnberg  use the term policy insolvency), the US government is obliged to step in and make good on the Fed’s promises, however those promises might be construed. The fact that Treasury Secretary Jacob Lew’s signature appears on all paper notes, as does that of U.S. Treasurer Rosa Gumataotao Rios, can perhaps be taken as an indication of this guarantee.

Bank of Canada notes, on the other hand, are signed by the Governor of the BoC and his deputy. Finance Minister Flaherty’s signature is nowhere in sight. This jives well with a quick reading of the Bank of Canada Act, which stipulates that though notes are a first claim on the assets of the Bank of Canada, the government itself accepts no ultimate obligation to make good on banknotes. In theory, should the Bank of Canada cease to earn a profit from now to eternity, Canadian monetary policy could go haywire—American monetary policy, backstopped by the Treasury, less so.

Other central banks go even further in formalizing this separation. In Lithuania, for instance, the law states that: “The State of Lithuania shall not be liable for the obligations of the Bank of Lithuania, and the Bank of Lithuania shall not be liable for the obligations of the State of Lithuania.” Should Leituvos Bankas hit a rough patch, so will its monetary policy.

Stella and Lönnberg correlate the rise of independent central banking with a movement away from the printing of finance minister signatures on notes. For instance, the sole signature on Euro banknotes is that of the President of the ECB, Mario Draghi. Two of the currencies replaced by the Euro, the Irish punt and the Luxembourg franc, which had carried signatures of finance department officials, no longer exist, symbolic evidence of the Euro project’s dedication to central bank independence.

Sims uses the ECB as an exemplar of type E central banks because “the very fact that there is a host of fiscal authorities that would have to coordinate in order to provide backup were the ECB to develop balance sheet problems suggests that such backup is at least more uncertain than in the US.” For evidence, he points to the fact that the Fed carries just 1.9% of its balance sheet in capital and reserves while the ECB holds 6.7%.

Stella and Lönnberg hint at the prevalence of a “rather singular U.S. view of central bank and treasury relations.” My interpretation of this is that most conversations about central banking are inherently conversations about the the world’s dominant monetary superpower, the Federal Reserve. This is surely evident in the blogosphere, where we mostly talk as-if we were Bernanke, not Carney or Poloz or Ingves (Lars Christensen is a rare counter-example who is fluent in multiple “languages”). In the same way that all Americans only understand English while all foreigners are conversant in English and their native tongue, non-American commentators like me can’t talk solely in terms of our own central bank (in my case the Bank of Canada) lest we fall out of the conversation. The Fed becomes our focal point.

Yet among central banks, the Fed is an odd duck, since the wording in the Federal Reserve Act and the signature on its notes would indicate a more well-integrated financial relationship between central bank and treasury than most. The upshot is that popular conceptions of the central banking nexus will often be wrong as they will be couched in terms of the U.S.’s integrated viewpoint, whereas most of the world’s central banks are not structured in the same way as the U.S. A deterioration of the Fed’s balance sheet would likely be neutral with respect to monetary policy, but for many of the world’s nations this simply isn’t the case.

On a totally unrelated side note, I found it interesting that Bank of England notes stand out as being signed by the Chief cashier of the Bank, not the governor. When the BoE opened its doors for business in 1694, the banknotes it issued were written on blank sheets of paper, often for unusual quantities (standardized round numbers were not introduced till the 1700s). The bank’s directors and its governor, usually well-established bankers who simultaneously ran their family business, were not responsible for the BoE’s day-to-day operations, this being devolved to the bank’s cashiers who were given the repetitive task of signing each note by hand. Even when the ability to print signatures directly on to notes was developed in the 1800s, the practice of affixing the cashier’s signature continued, despite the fact that mechanical process would make it easy for the higher-ranked governor to get his name on each note.

So while Mark Carney’s route from the BoC to the BoE got him a higher salary, more prestige, and posher digs, in one respect his standing has deteriorated: there are no longer millions of bits of paper circulating with his name on them. Chief cashier Chris Salmon has that distinction.

Here it comes– more leading economists call for capital controls

Here it comes– more leading economists call for capital controls.

As the saying goes, ‘desperate times call for desperate measures.’

The phrase is bandied about so frequently, it’s generally accepted truth. But I have to tell you that I fundamentally disagree with the premise.

Desperate times, in fact, call for a complete reset in the way people think. Desperate times call for the most intelligent, effective, least destructive measures. But these sayings aren’t as catchy.

This old adage has become a crutch– a way for policymakers to rationalize the idiotic measures they’ve put in place:

  • Inflation-adjusted interest rates that are… negative.
  • Trillion dollar deficits.
  • Endless wars and saber-rattling
  • Unprecedented expansion of central bank balance sheets.
  • DIRECT CONFISCATION of people’s bank accounts.

But hey… desperate times call for desperate measures. I guess we’re all just supposed to be OK with that.

One of those desperate measures that’s been coming up a lot lately is the re-re-re-introduction of capital controls.

It started in late 2012, when both the European Central Bank and the International Monetary Fund seperately endorsed the use of capital controls.

For the IMF, it was a staunch reversal of its previous position, and Paul Krugman lauded the agency’s “surprising intellectual flexibility” a few days later.

The IMF then followed up in 2013 with another little ditty proposing a global wealth tax. The good idea factory is clearly working ’round the clock over there.

Lately, two more leading economists– Harvard professors Carmen Reinhart and Ken Rogoff– have joined the debate.

In a speech to the American Economic Association earlier this month, the pair suggested that rich economies may need to resort to the tactics generally reserved for emerging markets.

This is code for financial repression and capital controls.

The idea behind capital controls is simple: create barriers to restrict the free flow of capital. And if you’re on the receiving end, capital controls can be enormously destructive.

But for politicians, capital controls are hugely beneficial; once they trap funds within their borders, the money can be easily taxed, confiscated, or inflated.

Historically, capital controls have been used in ‘desperate times’. Too much debt. Too much deficit spending. Wars. Huge trade deficit. Intentional currency devaluation. Etc.

Does any of this sound familiar? It’s no surprise that policymakers have once again turned to this ‘desperate measure’. They’re already here.

Iceland has capital controls, over five years after its spectacular meltdown. We can also see capital controls in Cyprus, India, Argentina, etc.

I’ve been writing for years that capital controls are a foregone conclusion. This is no longer theory or conjecture. It’s happening. And every bit of objective evidence suggests that the march towards capital controls will quicken.

This is a HUGE reason to consider holding a portion of your savings overseas in a strong, stable foreign bank where your home government won’t as easily be able to trap your savings.

Other options including storing physical gold (even anonymously) at an overseas depository. Or if you’re inclined and tech savvy, you can also own digital currency.

But perhaps the best way to move some capital abroad is to own foreign real estate, especially productive land.

Foreign real estate is not reportable. It’s a great store of value. It generates both financial profits and personal resilience. It’s a LOT harder to forcibly repatriate. And it ensures that you always have a place to go in case you need to get out of Dodge.

Even if nothing ‘bad’ ever happens, you won’t be worse off for owning productive land in a thriving economy.

Like I said– desperate times don’t call for desperate measures. More than ever, it’s time for a complete reset in the way we look at the most effective solutions. These options are certainly among them.

by Simon Black

Simon Black is an international investor, entrepreneur, permanent traveler, free man, and founder of Sovereign Man. His free daily e-letter and crash course is about using the experiences from his life and travels to help you achieve more freedom.

ECB Sees Bad-Debt Rules as Threat to Credible Bank Review – Bloomberg

ECB Sees Bad-Debt Rules as Threat to Credible Bank Review – Bloomberg.

The European Central Bank is concerned that national differences in how bad debt is classified could cripple its probe into the health of euro-area banks, according to an internal ECB document.

Bad-debt classification practices across Europe show “material differences that, if not considered, would severely affect the consistency and credibility of the exercise,” according to the undated document obtained by Bloomberg News. A person familiar with the text said it was drawn up in late November and contains the ECB’s latest thinking on the subject. An ECB spokeswoman declined to comment.

Zombie Banks

The Frankfurt-based ECB is conducting a three-stage assessment of bank assets before it assumes oversight of about 130 lenders across the 18-member euro area this November. Using a strict definition of bad debt could threaten banks in countries hit hardest by Europe’s debt crisis, while a laxer rule may not reveal the true condition of the region’s financial system.

“A more ambitious definition would be consistent with the need to convey to external observers that the AQR is a thorough exercise,” the document said, referring to the Asset Quality Review stage of the Comprehensive Assessment. That’s set to culminate with a stress test run in cooperation with the European Banking Authority before October this year.

Photographer: Ralph Orlowski/Bloomberg

The headquarters of the European Central Bank (ECB) stands illuminated at night in Frankfurt.

Credit Quality

The ECB document said that not all countries may be able to comply with simplified definitions of non-performing loans set out in October by the London-based EBA, the EU’s top bank regulator, while saying that alignment to those rules is “of the essence.”

European banks’ bad loans are classified according to a variety of national rules, which makes a comparison among lenders difficult. The European Central Bank is struggling to harmonize the definition of non-performing loans so that it can give more credibility to its assessment of the credit quality of the region’s lenders.

In the first half of last year, total doubtful and non-performing loans as a proportion of lending calculated according to national rules exceeded 21 percent in Greece and were less than 1 percent in Sweden, ECB data show.

“It’s crucial to find common rules and a shared vision to overcome the national lobbies,” Karim Bertoni, a senior analyst on European equities at de Pury Pictet Turrettini & CIE SA in Geneva, said by telephone. “This is the main challenge for the ECB, which would allow a better management of banks and risk control.”

Simplified Definition

The ECB signaled it would apply the EBA’s simplified definition as a minimum, and where possible increase the level of detail on loans made by banks. The EBA sets financial standards for the 28 nations in the European Union, and is working with the ECB on the final part of the Comprehensive Assessment.

That minimum means the ECB would define as non-performing all exposures, including loans, debt securities, financial guarantees and other commitments, which are past due for more than 90 days. That differs from final, more complex, standards, due to be implemented by EBA by the end of this year, that include data on the likelihood of the borrower repaying. Only half of the countries examined could supply that data, according to the ECB report, while limiting the definition to the 90-day rule “seems feasible for the majority of countries.”

Financial Turmoil

Euro-area lenders from Banco Santander SA (SAN) in Spain to Alpha Bank SA (ALPHA) in Greece will come under ECB supervision, with oversight forming the first pillar of a nascent banking union designed to mitigate future financial turmoil.

ECB policy makers have said the central bank will provide more information on the treatment of non-performing loans and the parameters of the concluding stress test by the end of January.

While the simplified EBA rules should be adhered to in the Comprehensive Assessment as a minimum, adding further detail to the assessment could be possible since ECB officials will already be in contact with bank staff, the document said.

“Given the possibility to perform more granular analysis during the on-site visits, it is proposed that this analysis takes into account a more ambitious definition including the unlikeliness to repay criterion,” according to the document.

The ECB said that as there are so many variations between countries on the definition of forbearance — where banks shift the terms of a loan to account for a change in the debtor’s own income — the only possibility is to accept national definitions where they exist, as well as loans that were considered in that category until the end of 2012 but have since been recategorized.

For countries where no standard definition exists, the ECB said it may ask states to report all loans for which concessions have been granted as forborne.

To contact the reporters on this story: Sonia Sirletti in Milan at ssirletti@bloomberg.net; Jeff Black in Frankfurt at jblack25@bloomberg.net

To contact the editors responsible for this story: Craig Stirling at cstirling1@bloomberg.net; Frank Connelly at fconnelly@bloomberg.net

China Bond Yields Soar To 9 Year Highs As It Launches Crackdown On “Off Balance Sheet” Credit | Zero Hedge

China Bond Yields Soar To 9 Year Highs As It Launches Crackdown On “Off Balance Sheet” Credit | Zero Hedge.

As we showed very vividly yesterday, while the world is comfortably distracted with mundane questions of whether the Fed will taper this, the BOJ will untaper that, or if the ECB will finally rebel against an “oppressive” German regime where math and logic still matter, the real story – with $3.5 trillion in asset (and debt) creation per year, is China. China, however, is increasingly aware that in the grand scheme of things, its credit spigot is the marginal driver of global liquidity, which is great of the rest of the world, but with an epic accumulation of bad debt and NPLs, all the downside is left for China while the upside is shared with the world, and especially the NY, London, and SF housing markets. Which is why it was not surprising to learn that China has drafted rules banning banks from evading lending limits by structuring loans to other financial institutions so that they can be recorded as asset sales,Bloomberg reports.

Specifically, China appears to be targeting that little-discussed elsewhere component of finance, shadow banking. Per Bloomberg, the regulations drawn up by the China Banking Regulatory Commission impose restrictions on lenders’ interbank business by banning borrowers from using resale or repurchase agreements to move assets off their balance sheets. Banks would also be required to take provisions on such assets while the transactions are in effect. Ironically, it may be that soon China will be more advanced in recognizing the various exposures of shadow banking than the US, which is still wallowing under FAS 140 which allows banks to book a repo as both an asset and a liability.

Recall from a Matt King footnote in his seminal “Are the Brokers Broken?”

Quite apart from the fact that FAS 140 contradicts itself (with paragraph 15 (d) making borrowed versus pledged transactions off balance sheet, and paragraph 94 making them on balance sheet, a topic complained about by many broker-dealers immediately after its issue), there seems to be little consensus as to who is the borrower and who is the lender. As far as we can tell, terms like ‘borrower’ and ‘lender’ are used in exactly the opposite sense in the accounting regulations relative to standard market practice. The description above follows common market practice. The accounting documents seem to refer to this the other way around, a source of confusion commented upon in some of the accounting literature

So while in the US one may be a borrower or a lender at the same time courtesy of lax regulatory shadow banking definition (depending on how much the FASB has been bribed by the highest bidder), in China things will very soon become far more distinct:

The rules would add to measures this year tightening oversight of lending, such as limits on investments by wealth management products and an audit of local government debt, on concerns that bad loans will mount. The deputy head of the Communist Party’s main finance and economic policy body warned last week that one or two small banks may fail next year because of their reliance on short-term interbank borrowing.

“China’s banks and regulators are playing this cat-and-mouse game in which the banks constantly come up with new gimmicks to bypass regulations,” Wendy Tang, a Shanghai-based analyst at Northeast Securities Co., said by phone. “The CBRC has no choice but to impose bans on their interbank business, which in recent years has become a high-leverage financing tool and may at some point threaten financial stability.”

Cutting all the fluff aside, what China is doing is effectively cracking down on the the wild and unchecked repo market, and specifically re-re-rehypothecation, which allows one bank to reuse the same ‘asset’ countless times, and allow it to appear in numerous balance sheets.

The proposed rules target a practice where one bank buys an asset from another and sells it back at a higher price after an agreed period.

The reason why China is suddenly concerned about shadow banking is that it has exploded as a source of funding in recent years:

Mid-sized Chinese banks got 23 percent of their funding and capital from the interbank market at the end of 2012, compared with 9 percent for the largest state-owned banks, Moody’s Investors Service said in June. The ratings company forecast a further increase in non-performing loans as weaker borrowers find it hard to refinance.

And while we are confident Chinese financial geniuses will find ways to bypass this attempt to curb breakneck credit expansion in due course, in the meantime, Chinese liquidity conditions are certain to get far tighter.

This is precisely the WSJ reported overnight, when it observed that yields on Chinese government debt have soared to their highest levels in nearly nine years amid Beijing’s relentless drive to tighten the monetary spigots in the world’s second-largest economy. “The higher yields on government debt have pushed up borrowing costs broadly, creating obstacles for companies and government agencies looking to tap bond markets. Several Chinese development banks, which have mandates to encourage growth through targeted investments, have had to either scale back borrowing plans or postpone bond sales.”

This should not come as a surprise in the aftermath of the recent spotlight on China’s biggest tabboo topic of all: the soaring bad debt, which is the weakest link in the entire, $25 trillion Chinese financial system (by bank assets). So while the Fed endlessly dithers about whether to taper, or not to taper, China is very quietly moving to do just that. Only the market has finally noticed:

The slowing pace of bond sales from earlier in the year is reviving worries of reduced credit and soaring funding costs that were sparked in June, when China’s debt markets were rattled by a cash crunch.

The rise in borrowing costs and shrinking access to credit could undercut the recent uptick in China’s economy that global investors in stock, commodity and currency markets have cheered. Wobbly growth in China could undermine economic recovery in the rest of the world.

“If borrowing costs don’t fall in time, whether the real economy could bear the burden is a big question,” said Wendy Chen, an economist at Nomura Securities.

Chinese bond yields are rising amid a lack of demand among the big banks, pension funds and other institutional money managers, analysts say. These investors, traditionally the heavyweights in China’s bond market, have seen their funding costs rise in tandem with interbank lending rates, which are controlled by China’s central bank. The country’s bond market is largely closed to foreign investors.

The yield on China’s benchmark 10-year government bond was at 4.65% Monday, down from 4.71% Friday. Last Wednesday’s 4.72% was the highest since January 2005, according to data providers WIND Info and Thomson Reuters. The record is 4.88% set in November 2004. Bond yields and prices move in opposite directions.

“The recent sharp rise in bond yields was mostly due to worsening funding conditions and growing expectations for a tighter monetary policy as Beijing seeks to deleverage the economy,” said Duan Jihua, deputy general manager at Guohai Securities.

As government-bond yields have risen, the average yield on debt issued by China’s highest-rated companies rose to 6.21% as of Friday—the highest since 2006, when WIND Info began compiling the data.

In conclusion, it goes without saying that should China suddenly be hit with the double whammy of regulatory tightening in both shadow and traditional funding liquidity conduits, that things for the world’s biggest and fastest creator of excess liquidity are going to turn much worse. We showed as much yesterday:

If the Chinese liquidity spigot – which makes the Fed’s and BOJ’s QE both pale by comparison – is indeed turned off, however briefly, then quietly look for the exit doors.

 

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