After two weeks pondering money aspects of economic theory, it’s time to review where we stand in the global panorama. These are, in a perverse chinese sense, interesting times. And things keep moving under the seemingly calm surface. So this post intends to be something like the annual presidential overview in the USA: the state of the Union address.
I am aware of some facts. First, I am not the president of anything, not to mention the USA; my opinion is highly irrelevant. I hope my thinking is better rated. Second, it is a little early as it should come well after Christmas. No problem; the early bird gets the worm. And third, the world is nowadays a civilized disunion of countries desperate for economic survival, so we can hardly talk about the global picture with a “union” characterization in the concept. So I renamed the address. After the brotherly G20 communiqué, a trace of realism is what the doctor ordered.
When you write, you have certain advantages over the reader. But he can read you in the comfort of his sofa, and backtest what you say, particularly with the benefit of time. Once you assume the challenge, it is all downhill pedaling. Everything else is up to you. You run the show.
So, in use of that capacity, I determine to focus on two pressing matters.
1.- Update on money printing and its actual practical effects in financial markets (no economic theory today). We use US markets as a proxy for the rest. The situation is very similar in all the developed world.
2.- A long hard look at income distribution. Where we come from, and where it’s going to take us.
Money printing and financial market prices.
The issue of money printing has been debated in these posts to the point of exhaustion. The reader already knows what I think. He now wants to check my views against future outcomes. He’s not to blame for that, specially after reading tons of material -with the entirely opposite views- sustaining Saxonomics, Helinomics, Abenomics, and now Draguinomics. I lack the institutional back up to enhance the credibility of my line of thinking. Time will tell. In the meantime, I am 100% certain of the validity of my thinking in this matter. For what it’s worth.
I keep on gathering evidence wherever I find it. Not trying to prove anything. Just checking the validity of my thinking daily. Doing my homework, I stumbled upon a few charts included in a Tyler Durden post in Zero Hedge last saturday. Correlation is certainly not causation. But if you look at them for a while, they certainly seem to fit the wording I have used in past posts to characterize the incidence of money printing in financial markets.
They also seem to corroborate Cantillon’s conclusion that money printing affects the equilibrium between asset prices and consumption pricing. Once aggregate supply became plentiful (with globalization), money creation ceased to generate consumer price inflation. Money went directly into investment assets (financial markets), with scarce and decreasing spillover into the real economy.
Globalization is not the agent of the actual economic malaise; it has simply allowed insane central bankers to continue their printing game for ever, because it effectively provided near unlimited supply of most products. After Globalization, aggregate demand is local but supply is global. Prices will remain reasonably near marginal costs for as long as supply is perfectly elastic.
Central Bankers had been taught that they were there to target an specific inflation figure, and (explicitly in the US, or implicitly in the other countries) use whatever leeway was left, to stimulate economies with as easy money as possible. Consumer inflation is undoubtedly a monetary phenomenon, but not the only variable to watch. Easy monetary policy produces other side effects. An uninflationary environment is not an ecstatic situation that allows you to write checks for free. It’s not only about inflation Mrs. Yellen!
Another way to show that it’s money debasement (and no other relevant factor) that moves asset prices. Again from Tyler at Zero Hedge, using a Citibank graph.
Market Capitalization or house pricing show a disturbing logic, when put in contrast with the main money aggregates, be it base money, or M2. In different countries. There could be other explanations of course, but according to Ockhams razor principle, this is “the explanation”. It is certainly the simplest and most direct cause-effect for achieving the actual market price level.
If we take the monetary debasement out of the picture, things certainly look different. See how the next two charts show an outlier.
Of course, the conventional explanation for the two previous charts considers any correlation of asset prices with the monetary variables as purely casual. Actual pricing is instead solid, and based both, on profit growth over the last decade, and low or nonexistent interest rates used to discount future cash flows.
Two unreliable pillars in truth. Profits are linked to the subsidies and public deficit policies used to support aggregate demand (see previous post on the Kalecki profit equation). Interest rates are not the foolproof support people think of. If something, ultralow interest rates are a whistle for caution, because a one off event cannot be cushioned with interest rates.
Rates are not all that relevant. When compared to money printing and credit, their incidence in financial pricing is hardly negligible, but not assured any more. Rates used to guide markets in the past, because they coexisted with stable underlying money aggregates. Not any more. And the incidence of the real underlying economic situation has also become modest. The next chart makes it obvious. Markets have been up when raising rates, and down when they were falling.
It’s not that economic theory is wrong, its about the pure power of money printing marginalizing any other effect.
Ok. Enough is enough. Actually, whether or not, easy money is a direct input in the actual pricing level is an irrelevant discussion. I don’t care if it works its way through the real economy, and finally shows itself in asset pricing (Central Bank and mainstream thesis), or if, as I believe, it is mostly a direct input in asset pricing, with little or no effect on the real economy. What is indeed relevant is:
- Can this go on for long enough to allow the economy to self heal?
- Can we continue with this, and maintain financial stability using mainly, if not solely, the hyperactive POMO desks of the Central Banks?
- Will more easy money continue to have the same effects on the economy?
My own answers are: no, I don’t know (but it’s risky), and no. First, the economy will not place itself in autohealing mode with a Central Bank directory upsetting market equilibrium pricing. Not a chance; we need serious surgery. Second, Financial Stability will be a permanent and increasing concern. and any unexpected incident can crash the entire system.
Third and crucial, money printing is already less effective by the day. The Chinese government is terrified of the consequences of this third factor. Just look at this chart. Steve Keen has produced a similar chart related to the Australian economy. Money printing effects are decreasing over time.
This law of decreasing effectiveness of monetary stimulus implies the Chinese Economy being close to falling of the cliff. The last G20 meeting was, as expected, oblivious to this risk factor. Beware: if China doesn´t grow, their credit mess is going to be staggering.
Back to the global panorama. Of course, the prospective outcome for the world economy, is entirely different depending on the printing presses being shut down, or kept working until the system implodes (see “timing the top”). If printing presses stop, that’s it. The end. Every man/woman for himself.
If they keep going, there is two factors that can rock the boat, but will not sink it: central bank short end interest rates coming up, or inflation. They won’t prick the bubble. As I have said many times before, I think inflation is not an inmediate concern. Take a look at the next chart from Cullen Roche at pragcap.com. It endorses my long time held view about inflation not being the likely catalyst for disaster. Do you see the blip in Japan (thanks to Abenomics)?
Same thing for interest rate rises. I doubt they will substantially alter the “base-money market-cap” correlation. The Oppenheimer chart shown before, supports this view. And timing wise they will come well after money printing is finished. Allocating time and resources to timing the US interest rate rise, misses the point.
A credit cycle of this intensity can only be ended with one of two main catalysts.
The first option is financial instability tipping the boat. It could be a major default, or a yen collapse, a Chinese melt down, or a market panic for whatever reason. POMO desks will be watchful to abort any symptoms in the early stages, as they appear. And they are powerful. I’ve been beaten up by them in the past. Not nice. It still hurts.
The second catalyst is well known. Credit quality concerns ended the real state bubble in 2007. Provided money printing continues unabated, I think it will be the same factor this time around. The “100 trillion plus” dominant, central bank induced, misjudgment, is that debt will be payed. Credit quality has been inferred by the global financial market, because of the missionary role of the central banks. It won’t. It will be sovereign risk or high yield that breaks up first.
All this obsession of late with growth (both in Europe and the G20), brings to light the fragility of actual conditions. Governments and politburós need to achieve money induced growth, to soothe debt sustainability concerns that will appear over time (they should be here already).
Sovereign debt accumulation is a time ticking bomb, particularly wiith low nominal GDP growth. Growth is a must. If more money is unable to launch growth, and people sense it, the end will be near: tic toc tic toc
Lets remain focused: it’s all about printing. We have four printing presses running. Let’s see how they are doing.
- The “Kuroda brand” money printers.– If the yen enters free fall mode, money printing could stop all of a sudden. As Iwata (ex BOJ deputy) warns, “beggar thy neighbour “could easily evolve into “beggar thyself”. Current yen weakness (near 109 vs USD) is excessive for everybody. POMO desks are sure to intervene soon. Abenomics is a very delicate balancing act. Yen shorts: don’t turn around but keep on your toes.
- Yuan printers.– I don´t think printing (or credit growth) will stop in China (80 billion USD are the last injection). Lack of growth will tilt the balance in China, but monetary support will be maintained. They’ve run out of alternative options. Soft landing is a delusion.
- Europe will continue to print, but QE might be bypassed using what they could call “outright forex reserve accumulation”. They really want to push the euro down, at they are excellent at branding acronyms for the various types of market manipulation. The ECB balance sheet will expand for certain. Could be done buying ABS, or buying foreign currency in real swiss “rosti” style.
- The US will not go back to printing (well, “never say never again”, but it is highly unlikely).
The income distribution disaster.
This issue is a major concern. If actual trends do not reverse relatively fast, we are all going to join central bankers in the big bazooka business (superMario will be happy: it’s his favourite toy). Only this time around, it will not be a shock and awe monetary bazooka, but a real one, the kind that hurts. And I am hopeless with arm handling. The minute arm handling is the leading science for survival, I have to shut down this blog. Thinking will not make sense any more.
Some charts from different authors will do the talking here. The first chart, from the Levy institute, is for grandma Janet. It was only last week she was lecturing the poor on “how important it is to promote asset-building, including saving for a rainy day, as protection from the ups and downs of the economy,” Hilarious. Bad if she’s dumb, worse if she is dishonest.
The next charts (John Hussman/Jeffrey Gundlach) show the virtues of socialism. Money is extorted from workers, and then redistributed through subsidies funded by governments with taxes and issuing debt for future generations. Idiotic. If we pay the factors of production properly, we won´t need a huge government to redistribute. We have to distribute properly, not redistribute. Sound simple? It is.
Let’s zoom in to what’s been going on in since 2007. Not pretty. Things are getting worse, not better.
I fully understand that income inequality has different roots. The Cantillon effect is one. Too big to fail multinationals is another. Zero interest rates for savers adds to the problem. Corrupt government cartels with large caps also weigh in. It’s complex. Robotics. Inadequate population schooling. But we have to turn that around.
This next chart comes to prove that it’s not management expertise that is enabling multinationals to increase profit share of GDP. They are crushing the employed population to maximize profit. Anybody with an IQ of 100 can do it. You don´t have to pay a CEO thirty million dollars a year to squeeze the blood out of the company employees. John Hussman at work again, built the following chart.
Testimony of the limited power of average human brain capabilities, everybody thinks this trend is sustainable. With actual dividend yields, equity duration sums up to roughly 50 years. Anybody seriously for this going on for that long?
Another way to see this. As the next chart shows, wealth transfer between workers and corporations is mindblowing, and has been going on for decades now. Wages are a disaster. Equities have been the superior investment. Is it sustainable?
Wage wealth transfer wasn’t enough to pay for the latest technology superyachts. With the Bernanke introduction of utmost (the SNBs favourite word) financial repression in 2009, now savers are also enduring their own wealth transfer to debtors and governments. ZIRP and NIRP will help corporations make more money, and allow governments to pay out welfare, so they can hopefully surf the social waves of extreme unrest. Awesome.
Welcome to the new economy, where the winner takes it all. Very much like the traditional America’s Cup sailing championship: “your majesty, there is no second”. Never mind the other seven billion people, there is no second! It won’t last. Nothing springs eternal save for love (the real kind), and hope. And both are highly inadequate investment policies.
Aggregate demand will not recover. The triple effect of distorted income distribution (as shown), the actual level of debt over GDP, and serious structural unemployment (on top of the crisis related unemployment surge), make it unfeasible. Without stable aggregate demand, subsidies will continue to support the economy only for as long as we don’t run out of other peoples money, and we can continue to place debt in primary markets.
So we can print money, and subsidize the poor for as long as possible. But we will not fix the problem. Fresh money has been failing to move inflation for a decade or more. Now it increasingly fails to move nominal GDP as well. The next combined graph from Citi shows it clearly.
The monetary show is nearly over for the real economy, but it can still make financial assets float. I can already smell the rot. Wall street may be glamorous, but Main Street stinks. Ain’t it obvious?
“There is no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as the result of voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved.”
Ludwig Von Mises, Human Action, 1949
PD. Well, this hasn’t been short once again. My apologies. Next posts on the “new taxation” required by the actual economy, and the “small is beautiful” concept.