The Central Banks can enrich themselves and large equity investors but who else?

We are in a period of heavy central bank action with the US Federal Reserve announcement last night as well as the BCB of Brazil and the Bank of England today. We are also in the speeches season for the European Central Bank or ECB. But they have a problem as shown below.

(Reuters) – London-listed shares tracked declines in Asian stock markets on Thursday as the lack of new stimulus measures by the U.S. Federal Reserve left investors disappointed ahead of a Bank of England policy meeting.

Is their main role to have equity markets singing along with Foster The People?

All the other kids with the pumped up kicks
You’d better run, better run, faster than my bullet
All the other kids with the pumped up kicks
You’d better run, better run, outrun my gun

We can continue the theme of central planning for equity markets with this from Governor Kuroda of the Bank of Japan earlier.

BOJ GOV KURODA: ETF PURCHASES ARE NOT TARGETING SPECIFIC STOCK MARKET LEVELS. ( @FinancialJuice )

In fact he has been in full flow.

BOJ’S GOV. KURODA: I DON’T SEE JAPAN’S STOCK MARKET GAINS AS ABNORMAL.  ( @FinancialJuice)

I suppose so would I if I owned some 34 Trillion Yen of it. We also have an official denial that he is aiming at specific levels. He might like to want to stop buying when it falls then. Some will have gained but in general the economic impact has been small and there are a whole litany of issues as highlighted by ETFStream.

Koll says the sheer weight of BoJ involvement is off-putting for others who might wish to get involved in the market. “When I go around the world, (the size of the BoJ’s holdings is) the single biggest push back about Japan from asset allocators,” he says. “This is the flow in the market.”

As the Bank of Japan approaches 80% of the ETF market I am sure that readers can see the problem here. In essence is there a market at all now? Or as ETFStream put it.

So how can the BoJ extricate itself from the ETF market without crashing the stock market?

Also it is kind of theme to back the long-running junkie culture theme of mine.

As it stands, the market has become as hooked as any addict.

You also have to laugh at this although there is an element of gallows humour about it.

The recent slackening off in ETF buying might be an attempt to end this cycle of dependency,

That was from February and let me remind you that so much of the media plugged the reduction line. Right into the biggest expansion of the scheme! As an example another 80 billion Yen was bought this morning to prevent a larger fall in the market. It was the fourth such purchase this month.

The US Federal Reserve

It has boxed itself in with its switched to average ( 2% per annum) inflation targeting and Chair Powell got himself in quite a mess last night.

Projections from individual members also indicated that rates could stay anchored near zero through 2023. All but four members indicated they see zero rates through then. This was the first time the committee forecast its outlook for 2023. ( CNBC )

This bit was inevitable as having set such a target he cannot raise interest-rates for quite some time. Of course, we did not expect any increases anyway and this was hardly a surprise.

With inflation running persistently below this longer-run goal, the Committee will aim to achieve inflation moderately above 2 percent for some time so that inflation averages 2 percent over time and longer-term inflation expectations remain well anchored at 2 percent. The Committee expects to maintain an accommodative stance of monetary policy until these outcomes are achieved. ( Federal Reserve)

So there is no real change but apparently it is this.

Powell, asked if we will get more forward guidance, says today’s update was ‘powerful’, ‘very strong’, ‘durable’ forward guidance. ( @Newsquawk).

He has boxed himself in. He has set interest-rates as his main measure and he cannot raise them for some time and the evidence is that negative interest-rates do not work. So all he can do is the “masterly inaction” of the apocryphal civil servant Sir Humphrey Applebym or nothing. Quite how that is powerful is anyone’s guess.

Brazil

The same illogic was on display at the Banco Central do Brasil last night.

Taking into account the baseline scenario, the balance of risks, and the broad array of available information, the Copom unanimously decided to maintain the Selic rate at 2.00% p.a.

They have slashed interest-rates to an extraordinary low level for Brazil and seem to think they are at or near the “lower bound” for them.

The Copom believes that the current economic conditions continue to recommend an unusually strong monetary stimulus but it recognizes that, due to prudential and financial stability reasons, the remaining space for monetary policy stimulus, if it exists, should be small.

But telling people that is a triumph?

To provide the monetary stimulus deemed adequate to meet the inflation target, but maintaining the necessary caution for prudential reasons, the Copom considered adequate to use forward guidance as an additional monetary policy tool.

Seeing as nobody is expecting interest-rate increases telling them there will not be any will achieve precisely nothing. Let’s face it how many will even know about it?

ECB

They too are indulging in some open mouth operations.

ECB’s Rehn: Fed’s New Strategy Will Inevitably Have An Impact On The ECB, “We Are Not Operating In A Vacuum”

Regular readers will recall him from back in the day when he was often telling the Greeks to tighten their belts and that things could only get better. Nobody seems to have told poor Ollie about the last decade.

ECB’s Rehn: There Is A Risk That Inflation Will Continue To Remain Too Low Sees Risk That Euro Zone Will Fall In A Trap Of Slow Growth And Low Inflation For A “Long Time”

So we see more ECB policymakers correcting ECB President Christine Lagarde on the issue of the exchange rate. Also as the news filters around there is this.

Three month Euribor fixes at -0.501% … below the ECB’s deposit rate for the first time! ( StephenSpratt)

He is a little confused as of course this has happened before but whilst it is a very minor move we could see another ECB interest-rate cut. It will not do any good but that has not stopped the before has it?

Bank of England

There is this doing the rounds.

LONDON (Reuters) – The Bank of England is expected to signal on Thursday that it is getting ready to pump yet more stimulus into Britain’s economy as it heads for a jump in unemployment and a possible Brexit shock.

Actually nothing has changed and the Bank of England is at what it has called the lower bound for interest-rates ( 0.1%) and is already doing £4.4 billion of bond buying a week.

Still not everybody is seeing hard times.

Former Bank of England (BoE) governor Mark Carney has joined PIMCO’s global advisory board, which is chaired by former Federal Reserve chairman Ben Bernanke.

Carney, who was appointed UN Special Envoy on climate action and finance in December 2019, is one of seven members of the global advisory board, alongside former UK Prime Minister and Chancellor Gordon Brown, and ex-president of the European Central Bank Jean-Claude Trichet. ( investmentweek.co.uk )

As Dobie Gray put it.

I’m in with the in crowd
I go where the in crowd goes
I’m in with the in crowd
And I know what the in crowd knows

Comment

We have arrived at a situation I have long feared and warned about. The central bankers have grandly pulled their policy levers and now are confused it has not worked. Indeed they have pulled them beyond what they previously thought was the maximum as for example the Bank of England which established a 0.5% interest-rate as a “lower bound” now has one of 0.1%. Now they are trying to claim that keeping interest-rates here will work when the evidence is that they are doing damage in more than a few areas. In terms of economics it was described as a “liquidity trap” and they have jumped into it.

Now they think they can escape by promising action on the inflation rates that as a generic they have been unable to raise since the credit crunch. Here there is an element of “be careful which you wish for” as they have put enormous effort into keeping the prices they can raise ( assets such as bonds,equities and houses) out of the inflation measures. So whilst they can cut interest-rates further and frankly the Bank of England and US Federal Reserve are likely to do so in any further downtown they have the problem highlighted by Newt in the film Aliens.

It wont make any difference.

That is why I opened with a discussion of equity purchases as it is more QE that is the only game in town now. Sooner or later we will see more bond purchases from the US Federal Reserve above the present US $80 billion a month. Then the only move left will be to buy equities. At which point we will have a policy which President Trump would set although of course he may or may not be President by them.

Oh and I have missed out one constant which is this sort of thing.

ECB Banking Supervision allows significant banks to temporarily exclude their holdings of banknotes, coins and central bank deposits from leverage ratio calculations until 27 June 2021. This will increase banks’ leverage ratios.

The Precious! The Precious!

 

 

 

The rise and rise of negative interest-rates

The modern era has brought something that has been in motion all my career, although there have been spells which did not feel like that. I am discussing bond yields which have been in a secular decline since the 1980s. Regular readers will be aware that back when I was new to this arena I asked Legal and General why they were buying a UK Gilt that yielded 15%? Younger readers please feel free to delete such a number from your memories if it is all too much. But there is another shift as back then the benchmark was 20 years and not 10. However you look at it from that perspective a world in which both the 2 and 5 year UK bond or Gilt yields were around -0.13% would have been considered impossible it not unpossible.

Germany

These have been the leaders of the pack in terms of negative bond yields. Last week Germany sold a benchmark 10 year bond with no coupon at all. We should take a moment to consider this as a bond is in theory something with a yield or coupon so as it does not have one we are merely left with money being borrowed and then repaid. Except there was a catch there too as not all of it will be repaid. The price paid was 105.13 on average and you will only get 100 back. Or if you prefer a negative yield of the order of 0.5% per year.

This year has brought something that in the past would have ended the situation as this.

The German Federal Government intends to issue fixed income Government securities with an aggregate volume of € 210 billion in 2020 to finance
the Federal Government budget and its special funds.

Became this.

The auction volume in the first two quarters of the current year amounted to € 97 billion for nominal capital market instruments (planned at the beginning of the year: € 78 billion) and € 87.5 billion for money market instruments (planned at the beginning of the year: € 31 billion)…….Due to the adjustments, the third quarter auction volume for nominal capital market instruments will total € 74 billion (planned at the beginning of the year: € 41 billion).

As you can see there were considerably more bonds on offer but it has made little or no difference to investors willingness to accept a maturity loss or negative yield. Oh and maybe even more bonds are on the way.

In non-regular reopenings on 1 and 16 April, a total amount of € 142 billion of already existing Federal securities was issued directly into the Federal government’s own holdings. These transactions created the possibility to react flexibly to short-term liquidity requirements.

So we learn that the previous reality that Germany was benefiting from its austere approach to public finances was not much of an influence. Previously it has been running a fiscal surplus and repaying debt.

Switzerland

The benchmark yield is very similar here as the 10 year yield is -0.49%. There are many similarities in the situation between Germany and Switzerland but one crucial difference which is that Switzerland has its own currency. The Swiss Franc remains very strong in spite of an interest-rate of -0.75% that has begun to look ever more permanent which is an irony as the 1.20 exchange-rate barrier with the Euro was supposed to be that. The reality is that the exchange-rate over five years after the abandonment of that is stronger at just below 1.08.

So a factor in what we might call early mover status is a strong currency. This also includes the Euro to some extent as we note ECB President Lagarde was on the wires over the weekend.

ECB Lagarde Says Euro Gains Have Blunted Stimulus Boost to Inflation … BBG

This allows us to bring in Japan as well as the Yen has remained strong in spite of all the bond buying of the Bank of Japan.

Safe Haven

The ECB issued a working paper on this subject in January.

There is growing academic and policy interest in so called “safe assets”, that is assets that have stable nominal payoffs, are highly liquid and carry minimal credit risk.

Notice the two swerves which are the use of “stable nominal payoffs” and “minimal credit risk”. The latter is especially noticeable for a place like the ECB which insisted there was no credit risk for Greece, which was true for the ECB but not everyone else.

Anyway it continues.

After the global financial crisis, the demand for safe assets has increased well beyond its supply, leading to an increase in the convenience yield and therefore to the interest that these assets pay. High demand for safe assets has important macroeconomic consequences. The equilibrium safe real interest rate may in fact decline well below zero.

They also note a feature we have been looking at for the best part of a decade now.

In this situation, one of the adjustment mechanisms is the appreciation of the currency of issuance of the safe asset, the so called paradox of the reserve currency.

Quantitative Easing

The problem for the theory above is that the central banks who love to push such theories ( as it absolves them of blame) are of course chomping on safe assets like they are their favourite sweets. Indeed there is a new entrant only this morning, or more accurately an expansion from an existing player.

The Executive Board of the Riksbank has decided to initiate purchases of corporate bonds in the week beginning 14 September 2020. The purchases will keep
companies’ funding costs down and reinforce the Riksbank’s capacity to act if the credit supply to companies were to deteriorate further as a result of the corona pandemic. On 30 June 2020, the Executive Board decided that, within its programme for bond purchases, the Riksbank would offer to purchase corporate bonds to a
nominal amount of SEK 10 billion between 1 September 2020 and 30 June 2021.

There are all sorts of issues with that but for today’s purpose it is simply that the push towards negative interest-rates will be added to. Or more specifically it will increasingly spread to higher risk assets. We can be sure however that should some of these implode it will be nobody’s fault as it could not possibly have been predicted.

Meanwhile ordinary purchases around the world continue including in my home country as the Bank of England buys another £1.45 billion of UK bonds or Gilts.

Comment

There are other factors in play. The first is that we need to try to look beyond the present situation as we note this from The Market Ear.

the feedback loop…”the more governments borrow, the less it seems to cost – giving rise to calls for still more borrowing and spending”. ( Citibank)

That misses out the scale of all the central bank buying which has been enormous and gets even larger if we factor in expected purchases. The US Federal Reserve is buying US $80 billion per month of US Treasuries but with its announcement of average inflation targeting seems likely to buy many more

Also the same Market Ear piece notes this.

The scalability of modern technology means that stimulus is going into asset price inflation, not CPI

Just no. What it means is that consumer inflation measures have been manipulated to avoid showing inflation in certain areas. Thus via Goodhart’s Law and/or the Lucas Critique we get economic policy based on boosting prices in these areas and claiming they are Wealth Effects when for many they are inflation.

We get another shift because if we introduce the issue of capital we see that up to know bond holders will not care much about negative yields as they have been having quite a party. Prices have soared beyond many’s wildest dreams. The rub as Shakespeare would put it is that going forwards we face existing high prices and low or negative yields. It used to be the job of central banks to take the punch bowl away when the party gets going but these days they pour more alcohol in the bowl.

Meanwhile from Friday.

UK SELLS 6-MONTH TREASURY BILL WITH NEGATIVE YIELD AT TENDER, FIRST TIME 6-MONTH BILL SOLD AT NEGATIVE YIELD ( @fiquant )

Podcast

 

 

 

 

How many central banks will end up buying equities?

Sometimes we can combine one of our themes with the news flow and today is an example of that. We can start with the role of central banks where what was considered extraordinary policy is now ordinary and frankly sometimes mundane. We have seen interest-rate cuts, then QE bond buying, then credit easing and of course negative interest-rates. Overnight even the home of the All Blacks has joined the latter party.

Some New Zealand wholesale rates fell below zero for the first time on Wednesday as investors increased bets on a negative policy rate. Two and three-year swap rates sank to minus 0.005%, as did the yield on the benchmark three-year bond. ( Bloomberg)

So we have negative bond yields somewhere else as the contagion spreads. Whilst it is only marginal the track record so far is that it will sing along with Madonna.

Deeper and deeper, and deeper, and deeper

Bloomberg thinks it is driven by this.

Most economists expect the RBNZ to cut its cash rate from 0.25% to minus 0.25% or minus 0.5% in April next year, and some see the chance of an earlier move.

However they seem to have missed the elephant in the room.

The Monetary Policy Committee agreed to expand the Large Scale Asset Purchase (LSAP) programme up to $100 billion so as to further lower retail interest rates in order to achieve its remit. The eligible assets remain the same and the Official Cash Rate (OCR) is being held at 0.25 percent in accordance with the guidance issued on 16 March. ( Reserve Bank of New Zealand 12 August)

So we are on the road to nowhere except according to Bloomberg it was a triumph in Sweden.

Negative rates were successful in Sweden because they achieved the aim of returning inflation to target without causing any significant distortions in the economy, said Lars Svensson, an economics professor in Stockholm and a former deputy governor at the Riksbank.

Only a few paragraphs later they contradict themselves.

Swedish mortgage rates dropped below 2%, causing house prices to surge to double-digit annual gains, but unemployment fell and the economy grew. Crucially, headline inflation rose steadily from minus 0.4% in mid-2015 to meet the central bank’s 2% target two years later. Inflation expectations also rose.

And again.

The Riksbank sent its policy rate into negative territory in early 2015, reaching a low of minus 0.5% before raising it back to zero late last year.

It worked so well they raised interest-rates in last year’s trade war and they have not deployed them in this pandemic in spite of GDP falling by 8%!

Oh and there is the issue of pensions.

In Sweden, the subzero-regime was advantageous for borrowers but brutal for the country’s pension industry, which struggled to generate the returns needed when bond yields turned negative.

So in summary we arrive at a situation where in fact even the Riksbank of Sweden has gone rogue on the subject of negative interest-rates. Going rogue as a central bank is very serious because they are by nature pack animals and the very idea of independent thought is simply terrifying to them.

Also the Riksbank of Sweden is well within the orbit of the supermassive black hole for negativity which is the European Central Bank or ECB. We learn much I think by the fact that in spite of economic activity being in a depression no-one is expecting an interest-rate cut from the present -0.5%. When we did have some expectations for that it was only to -0.6% so even the believers have lost the faith. This is an important point as whilst the Covid-19 pandemic has hit economies many were slowing anyway.

Policy Shifts

We are seeing central banks start to hint at ch-ch-changes.

Purchases of foreign assets also remain an option.

The Governor of the Bank of England Andrew Bailey has also been on the case and the emphasis is mine.

But one conclusion is that it could be preferable, and consistent with setting monetary conditions
consistent with the inflation target, to seek to ensure there is sufficient headroom for more potent expansion
in central bank balance sheets when needed in the future – to “go big” and “go fast” decisively.

He then went further.

That begs questions about when does the need for headroom become an issue? What are the limits? One
way of looking at these questions is in terms of the stock of assets available for purchase.

He refers to UK Gilts ( bonds) but he is plainly hinting at wider purchases.

Swiss National Bank

This has become something of a hedge fund via its overseas equity purchases. For newer readers this all started with a surge in the Swiss Franc mostly driven by the impact of the unwinding of the “Carry Trade” where investors had borrowed Swiss Francs. The SNB promised “unlimited intervention” before retreating and now as of the end of June had 863.3 billion Swiss Francs of foreign currency assets. It did not want to hold foreign currency on its own so it bought bonds. But it ended up distorting bond markets especially some Euro area ones so it looked for something else to buy. It settled on putting some 20% of its assets in equities.

Much of that went to the US so we see this being reported.

Swiss National Bank is one of the leading tech investors in the world. 28% of SNB’s Equity portfolio is allocated to tech stocks. Swiss CenBank has 17.4mln Apple shares worth $6.3bn or 538k Tesla shares worth $630mln. ( @Schuldenshelder )

So this is a complex journey on which we now note an issue with so-called passive investing. The SNB buys relative to market position but that means if shares have surges you have more of them each time you rebalance. So far with Apple that has been a large success as it has surged above US $2 trillion in market capitalisation as the recent tech falls are minor in comparison.But the 20% fall in Tesla yesterday maybe a sign of problems with this sort of plan. It of course has surged previously but it seems to lack any real business model.

The Tokyo Whale

The Bank of Japan bought another 80.1 billion Yen of Japanese equities earlier today as it made its second such purchase so far this month. As of the end of last month the total was 33,993,587,890,000 Yen. Hence its nickname of The Tokyo Whale.

Quite what good this does ( apart from providing a profit for equity investors) is a moot point? After all the Japanese economy was shrinking again pre pandemic and there was no sign of an end to the lost decades.

Comment

We find ourselves in familiar territory as central bankers proclaim the success of their polices but are always expanding them. If they worked it would not be necessary would it? For example the US Federal Reserve moving to average inflation targeting would not be necessary if all the things they previously told us would work, had. I expect the power grab and central planning to continue as they move further into fiscal policy via the sort of subsidies for banks provided by having a separate interest-rate for banks ( The Precious! The Precious!) like the -1% provided by the ECB. Another version of this sort of thing is to buy equities as they can create money and use it to support the market.

The catch of this is that they support a particular group be it banks or holders of assets. So not only does the promised economic growth always seem to be just around the corner they favour one group ( the rich) over another ( the poor). They have got away with it partly by excluding asset prices from inflation measures, but also partly because people do not fully understand what is taking place. But the direction of travel is easy because as I explained earlier central bankers are pack animals and herd like sheep. They will be along…..

Wages growth looks an increasing problem

Today gives us an opportunity to take a look at an issue which has dogged the credit crunch era. It is the (lack of) growth in wages and in particular real wages which has meant that even before the Covid-19 pandemic they had not regained the previous peak. That is one of the definitions of an economic depression which may well be taking a further turn for the worse. It has been a feature also of the lost decade(s) in Japan so we have another Turning Japanese flavour to this.

Japan

The Ministry of Labor released the July data earlier and here is how NHK News reported it.

New figures from the Japanese government show that both wages and household spending fell in July from a year earlier amid a resurgence in the coronavirus pandemic.

Labor ministry data show that average total wages were down 1.3 percent in yen terms from a year ago, to 3,480 dollars. It was the fourth straight monthly drop.

Overtime and other non-regular pay dropped nearly 17 percent, as workers put in shorter hours.

A ministry official says that despite some improvements, the situation remains serious because of the pandemic.

I find it curious that NHK switches from Yen to US Dollars but I suppose it has not been that volatile in broad terns in recent times. That is awkward for the Abenomics policy of Prime Minister Abe which of course may be on the way out. It was supposed to produce a falling Yen. Also it was supposed to produce higher wages which as you can see are falling.

The issue here is summarised by Japan Macro Advisers.

Wages in Japan have been decreasing relatively steadily since 1998. Between 1997-2019, wages have declined by 10.9%, or by 0.5% per year on average (based on the data before the revision).

The Abenomics push was another disappointment as summarised by this from The Japan Times in May 2019.

Japan’s labor market has achieved full employment over the past two years. Unemployment has declined over the past two years to below 3 percent—close to the levels of the 1980s and early 1990s—after peaking at 5.4 percent in 2012…………..The puzzling thing is why wage growth has been so sluggish despite the apparent labor shortage. It is true that average wages turned positive in 2014 and increased 1.4 percent in 2018. Nonetheless, regular pay, or permanent income, rose a paltry 0.8 percent in 2018. In real terms, average wage growth has failed to take off and recorded just 0.2 percent in 2018.

That is in fact a rather optimistic view of it all because if we switch to real wages we see that the index set at 100 in 2015 was 99.9 last year. So rather than the triumph which many financial news services have regularly anticipated it has turned out to be something of a road to nowhere. Any believers in “output gap” theories have to ignore the real world one more time.

The Japanese owned Financial Times has put its own spin on it.

“Buy my Abenomics!” urged Japanese prime minister Shinzo Abe in 2013. And we did.

No we did not. Anyway their story of triumph which unsurprisingly has quite a list of failures also notes this about wages.

Nor was this the only way Abenomics undermined its own credibility. For example, the government never raised public sector wages in line with the 2 per cent inflation target. Why, then, should the private sector have heeded Mr Abe’s demand for wage increases?

If only places like the FT had reported that along the way. But the real issue here for our purposes is that even in what were supposed to be good times real wages went nowhere. So now we are in much rougher times we see a year where they fall and we note that this adds to a fall last year. Indeed partly by fluke the fall for July is very similar to last year, but we look ahead nervously because if wages had already turned down we seem set for falls again.

Detail

In terms of numbers average pay was 369.551 Yen in July and a fair bit or 106.608 Yen is bonuses ( special cash earnings). The highest paid is the professional and technical one at 542,571 and the lowest is hotels and restaurants at 124,707 Yen. Sadly for the latter not only do they get relatively little it is also falling ( 7.3%)

Somewhat chilling is that not only is the real estare sector well paid at 481.373 Yen it is up 12.3% driven by bonuses some 30% higher. So maybe they are turning British. Also any improvement in the numbers relies on real estate bonuses.

The UK

The latest real wage numbers pose a question.

For June 2020, average regular pay, before tax and other deductions, for employees in Great Britain was estimated at £504 per week in nominal terms. The figure in real terms (constant 2015 prices) fell to £465 per week in June, after reaching £473 per week in December 2019, with pay in real terms back at the same level as it was in December 2018.

The real pay number started this century at £403 per week but the pattern is revealing as we made £473 per week on occasion in 2007 and 2008. So we were doing well and that ended.

Actually if we switch from the Office for National Statistics presentation we have lost ground since 2008. This is because the have flattered the numbers in two respects. One if the choice of regular pay rather than total pay and the other is the choice of the imputed rent driven CPIH inflation measure that is so widely ignored.

The US

There was something of a curiosity here on Friday.

In August, average hourly earnings for all employees on private nonfarm payrolls rose by 11
cents to $29.47. Average hourly earnings of private-sector production and nonsupervisory
employees increased by 18 cents to $24.81, following a decrease of 10 cents in the prior month.

If you do not believe tat then you are in good company as neither does the Bureau of Labor Statistics.

The large employment fluctuations over the past several months–especially in industries with
lower-paid workers–complicate the analysis of recent trends in average hourly earnings.

If we look back this from the World Economic Forum speaks for itself.

today’s wages in the United States are at a historically high level with average hourly earnings in March 2019 amounting to $23.24 in 2019 dollars. Coincidentally that matches the longtime peak of March 1974, when hourly wages adjusted to 2019 dollars amounted to exactly the same sum.

Comment

There has been an issue with real wages for a while as the US, UK and Japanese data illustrate.The US data aims right at the end of the Gold Standard and Bretton Woods doesn’t it? That begs more than a few questions. But with economies lurching lower as we see Japanese GDP growth being confirmed at around 8% in the second quarter and the Euro area at around 12%. Also forecasts of pick-ups are colliding with new Covid-19 issues such as travel bans and quarantines. So real wages look set to decline again.

The next issue is how we measure this? The numbers have been shown to be flawed as they do not provide context. What I mean by this is that we need numbers for if you stay in the same job and ones for those switching. If we look at the US we see recorded wage growth because those already having the disadvantage of lower wages not have none at all as they have lost their job. That is worse and not better. This opens out a wider issue where switches to lower paid jobs and lower real wages are like a double-edged sword. People have a job giving us pre pandemic low unemployment rates and high employment rates. But I would want a breakdown as many have done well but new entrants have not.

There has been a contrary move which has not been well measured which are services in the modern era which get heavy use but do not get counted in this because they are free. Some money may get picked up by advertising spend but to add to the problem we have we are also guilty of measuring it badly

Meet the new Inflation era same as the old inflation era….

Yesterday brought news about inflation targeting but before we get to what you might think is the headline act, it has been trumped by Prime Minister Abe of Japan. Before I get to that let me wish him well with his health issues. But he also said this in his resignation speech.

JAPAN PM ABE ON ECONOMIC POLICY: WE HAVE SUCCEEDED IN BOOSTING JOBS, ENDING 20 YEARS OF DEFLATION WITH THREE ARROWS OF ABENOMICS. ( @FinancialJuice)

You might think that this is almost at a comical Ali level of denial at this point. For those unaware this was the Iraqi information minister who denied Amercan soldiers were in Baghdad when well I think you have figured the rest. Even the BBC is providing an opposite view to that of Abe san.

The Japanese economy has shrunk at its fastest rate on record as it battles the coronavirus pandemic.

The world’s third largest economy saw gross domestic product fall 7.8% in April-June from the previous quarter, or 27.8% on an annualised basis.

Japan was already struggling with low economic growth before the crisis.

The current situation is bad enough but even if we give him a pass on that there is that rather damning last sentence. Let me give you some context on that. You could argue the 0.6% contraction in the Japanese economy was also Covid related but you cannot argue that the 1.8% contraction at the end of last year was. Indeed the quarter before that was 0%.

So Japan had not escaped deflation and in fact the problems at the end of last year were created by an Abenomics arrow missing the target. People forget now but the economic growth that Abenomics was supposedly going to create was badged as a cure for the chronic fiscal problem faced by Japan. In fact the lack of growth and hence revenue was a factor in the Consumption Tax being raised to 10%. Which of course gave growth another knock.

Inflation

Another arrow was supposed to lead to inflation magically rising to 2% per annum. How is that going? From the Statistics Bureau this morning.

 The consumer price index for Ku-area of Tokyo in August 2020 (preliminary) was 102.1 (2015=100), up 0.3% over the year before seasonal adjustment, and down 0.4% from the previous month on a seasonally adjusted basis.

So it has taken five years and not one to hit 2%. For newer readers that was also the pre pandemic picture in Japan and it has mostly been possible to argue that there is effectively no inflation because the low levels are within any margin for error.

Also as a point of detail there is even more bad news for inflationistas which is that something which they clain cannot happen with zero inflation has. If you look in the detail food prices have risen by 7% and the cost of education has fallen by 7%, so you can have relative price changes. Looking at the national numbers it has been a rough run for fans of Salmon and carrots as prices have risen by more than 50% over the past 5 years.

The US Federal Reserve

The speech by Chair Powell opened with what may turn out to be an unfortunate historical reference.

Forty years ago, the biggest problem our economy faced was high and rising inflation. The Great Inflation demanded a clear focus on restoring the credibility of the FOMC’s commitment to price stability.

It is hard to know where to start with this bit.

Many find it counterintuitive that the Fed would want to push up inflation. After all, low and stable inflation is essential for a well-functioning economy. And we are certainly mindful that higher prices for essential items, such as food, gasoline, and shelter, add to the burdens faced by many families, especially those struggling with lost jobs and incomes.

I will simply point out that I am pleased to see a recognition that what are usually described by central bankers as “non-core” such as food and energy are suddenly essential. Perhaps the threats ( from The Donald) about him losing his job have focused his mind, although he would remain an extremely wealthy man.

He then got himself into quite a mess.

 Our statement emphasizes that our actions to achieve both sides of our dual mandate will be most effective if longer-term inflation expectations remain well anchored at 2 percent. However, if inflation runs below 2 percent following economic downturns but never moves above 2 percent even when the economy is strong, then, over time, inflation will average less than 2 percent. Households and businesses will come to expect this result, meaning that inflation expectations would tend to move below our inflation goal and pull realized inflation down.

This really does come from the highest of Ivory Towers where the air is thinnest. Many households and businesses will not even know who he and his colleagues are! Let alone plan ahead on the basis of what they might do especially after the flip-flopping of the last couple of years. Even worse the 2% per annum target which was pretty much pulled out of thin air has become a Holy Grail.

This next bit was frankly not a little embarrassing.

In seeking to achieve inflation that averages 2 percent over time, we are not tying ourselves to a particular mathematical formula that defines the average. Thus, our approach could be viewed as a flexible form of average inflation targeting.

So it is an average but without the average bit?

Canada

This week the Bank of Canada inadvertently highlighted a major problem. It starts with this.

Deputy Governor Lawrence Schembri discusses the difference between how Canadians perceive inflation and the actual measured rate.

You see we are back to you ( and I mean us by this) do not know what you are paying and we ( central bankers know better). Except it all went wrong in a predictable area.

Over the last two decades, the price of houses has risen on average more than twice as fast as the price of housing, at a rate of 6 percent versus 2.5 percent.

There is the issue in a nutshell. Your average Canadian has to shell out an extra 6% each year for a house but according to Lawrence and his calculations it is only 2.5%. Someone should give him a pot of money based on his calculations and tell him to go and buy one.

The Euro area

We looked at variations in the price of Nutella recently well according to The Economist there are other issues.

 Three enormous boxes of Pampers come to €168 ($198) on Amazon’s Spanish website. By contrast, the same order from Amazon’s British website costs only €74. (Even after an exorbitant delivery fee is added, the saving is still €42.)

This happens even inside the Euro area.

The swankiest Nespresso model will set them back €460 on Amazon’s French website, but can be snapped up for €301 on the German version. They could then boast about their canny shopping on Samsung’s newest phone, which varies in price by up to €300 depending on which domain is used.

I point this out because official inflation measurement relies on “substitution” where if the price rises you switch to something similar which is cheaper. But if people do not do this for the same thing inn the real world we are back in our Ivory Towers again.

Comment

Firstly we can award ourselves a small slap on the back as we were expecting this. From the movements in the Gold price ( down) and bond yields (up) far from everybody was. If we note the latter there are two serious problems for Chair Powell. The first is that if there is a body of people on this earth who follow his every word it is bond traders and they were to some extent off the pace. Thus all exposition about expectations above is exposed as this.

Every man has a place, in his heart there’s a space,
And the world can’t erase his fantasies
Take a ride in the sky, on our ship fantasii
All your dreams will come true, right away ( Earth,Wind & Fire )

Next is that if you take the policy at face value bond yields should have risen by far more than the 0.1% the long bond did. They did not rise by the 0.5% to 1% you might expect for two possible reasons.

  1. Nobody expected the Fed to raise interest-rates for years anyway so what is the difference?
  2. If there is a policy change it is mostly likely to be more QE treasury bond purchases which will depress bond yields.

So back to the expectations we see that the Fed is responding to expectations it has created. What could go wrong? Putting it another way it is living a combination of Goodhart’s Law and the Lucas Critique.

I brought in the Japanese experience because it has made an extraordinary effort in monetary policy terms but the economy was shrinking before Covid-19 and there was essentially no inflation.

However the stock market ( Nikkei 225) has nearly trebled since Abenomics was seen as likely. Oh and the Bank of Japan has essentially financed the government borrowing.

Podcast

 

GDP in Japan goes back to 2010 in another lost decade

Today we get to look East to the land of the rising sun or Nihon as we note its latest economic output figures. According to the Japanese owned Financial Times we should look at them like this.

Japan’s GDP decline less severe than US and Europe

Of course as we are looking at a country where the concept of the “Lost Decade” began in 1990 and is now heading into number 4 of them we need to be careful about which period we are looking at.

Japan’s economy shrank by a record 7.8 per cent in the second quarter of 2020 as it outperformed the US and Europe but lagged behind neighbouring South Korea and Taiwan in its response to coronavirus.

Okay so better than us in the West but not as good as its eastern competitors. Also I note that it relies quite a bit on seasonal adjustment when we have just had an economic season unlike any other as without it GDP fell by 9.9%.

Returning to the seasonally adjusted data we see a consequence of being an exporter at a time like this.

A fall in private consumption accounted for 4.8 percentage points of the decline in Japan’s GDP as the state of emergency reduced spending in shops and restaurants, while a large drop in exports accounted for the remaining 3 percentage points.

This is because exports fell by 18.5% with imports barely affected ( -0.5%) so there was a plunge in exports on a scale large enough to reduce GDP by 3%. Actually let me correct the FT here as it was domestic demand which fell by 4.8% with private consumption accounting for 4.5% and investment for 0.2% and the government sector not doing much at all. You may be pleased to read that Imputed Rent had only a minor impact on the quarterly change.

A cautionary note is that Japanese GDP data is particularly prone to revision or as the FT puts it.

Business investment was surprisingly strong, however, and contributed just 0.2 percentage points to the overall decline in output. That figure is often revised in updates to the data, but if confirmed, it would suggest resilience in the underlying economy and potential for a strong rebound.

International Comparison

Regular readers will know that due to the extraordinary move in the UK GDP Deflator ( the inflation measure for this area) of 6.2% in a single quarter our GDP fall may well have been more like 15%. Somehow the FT which is often very enthusiatic about combing through UK data has missed this.

The second-quarter decline in Japan’s GDP was comparable to a 9.5 per cent fall in the US during the same period, or a 10.1 per cent drop in Germany. It was less severe than the drop of more than 20 per cent in the UK, which was late to act but then imposed a severe lockdown. However, Japan did worse than neighbouring South Korea, where output fell 3.3 per cent in the second quarter, or Taiwan, where GDP was down just 0.7 per cent. Both countries managed to control the virus without extensive lockdowns, allowing their economies to function more normally.

It is typical of a Japanese owned publication to trumpet a form of national superiority though.

Japan’s performance relative to other advanced countries highlights how the effectiveness of a country’s coronavirus response affects the economy, with Japan forced to close schools but able to avoid the strict lockdowns used in Europe.

However, only time will tell whether that was more of a tactical than a strategic success.

Japan is suffering an increase in infections, with new cases running at more than 1,000 a day, but it has not imposed a fresh state of emergency.

Let me wish anyone who is ill a speedy recovery.

Context

The initial one is the economic output has now fallen in the last 3 quarters. Following the rise in Consumption Tax from 8% to 10% a decline was expected but now.of course, it looks really badly timed. Although in the period of the Lost Decade there is a bit of a shortage of good times to do such a thing.

Japan has if we look at the seasonally adjusted series gone back the beginning of 2010 and the middle of 2011 which was the same level.It has never achieved the “escape velocity” talked about by former Bank of England Governor Mark Carney.

Bank of Japan

The problem for it is that it was already doing so much or as the Red Queen put it.

“My dear, here we must run as fast as we can, just to stay in place. And if you wish to go anywhere you must run twice as fast as that.”

I noted Bloomberg reporting that it owns so 44% of the Japanese Government Bond market these days. Although there is an element of Alice In Wonderland here as via its stimulus programmes the Japanese government will be issuing ever more of them.

In May, the Japanese government approved a second large-scale ¥117tn ($1.1n or 21% of Japan’s GDP) economic rescue package, matching the size of the first stimulus introduced in April. ( OMFIF).

So there will be plenty more to buy so we can expect full employment to be maintained for the bond buyers at the Bank of Japan.

On a gross basis, the government plans to issue close to ¥253tn ($2.3tn) in government bonds and treasury bills in fiscal year 2020 (ending March 2021). This amount combines issues under all three budgetary plans. Excluding refinancing bonds, the net issuance of government bonds is reduced to almost ¥145tn (about 27% of GDP). This includes close to 4% of front-loaded bond issues from future fiscal years and is the largest net issuance in the post-world war II era.

Next there is its role as The Tokyo Whale to consider.

This phase saw the Bank of Japan buy on up as well as down days and the index it looks to match is the Nikkei 400.

There is also the negative interest-rate of -0.1% which I do not think the Bank of Japan has ever been especially keen on which is why it is only -0.1%. After all the years of propping up the banks we can’t have them failing again can we.

The latest move as is so often the case has echoes of the past so let me hand you over to Governor Kuroda.

The first is the Special Program to support corporate financing. The total size of this program is about 120 trillion yen. It consists of purchases of CP and corporate bonds with the upper limit of about 20 trillion yen and the Special Funds-Supplying Operations, which can amount to 100 trillion yen. Through this operation, the Bank provides funds on favorable terms to financial institutions that make loans in response to COVID-19. This operation also includes a scheme in which the government takes the credit risk while the Bank provides liquidity, thereby supporting financing together.

Comment

Japan is a mass of contradictions as we note that annual GDP was higher in the mid 1990s than it is now. The first switch is that the position per head is much better although that is partly because the population is in decline. Of course in terms of demand for resources that is a good thing for a country which has so few of them. That is not so hot when you have an enormous national debt which will be getting a lot larger via the stimulus effort. There are roads where it will reach 300% of GDP quite soon.

So why have things not collapsed under the weight of debt? One reason is the size of the Bank of Japan purchases in what is mostly (90% or so) a domestic market. Then we also need to note that in spite of it being official policy to weaken the Yen ( one of the arrows of Abenomics) it is at 106.4 versus the US Dollar looking strong in spite of all of the above. This is because even if the foreign investors started to leave the Japanese have large savings abroad and large reserves. As we stand they have had little success in pushing the Yen lower even with all the efforts of the Bank of Japan.

What is needed is some sustained economic growth but if Japan could do that the concept of the Lost Decade would have been consigned to the history books and it hasn’t. So we left with this thought by Graham Parker.

And there’s nothing to hold on to when gravity betrays you ( Discovering Japan)

Podcast on GDP measures

Is Japan the future for all of us?

A regular feature of these times is to compare our economic performance with that of Japan. That has propped up pretty regularly in this crisis mostly about the Euro area but with sub-plots for the US and UK. One group that will be happy about this with be The Vapors and I wonder how much they have made out of it?

I’m turning Japanese, I think I’m turning Japanese
I really think so
Turning Japanese, I think I’m turning Japanese
I really think so.

The two basic concepts here are interrelated and are of Deflation and what was called The Lost Decade but now are The Lost Decades. These matters are more nuanced that usually presented so let me start with Deflation which is a fall in aggregate demand in an economy. According to the latest Bank of Japan Minutes this is happening again.

This is because aggregate demand is
highly likely to be pushed down by deterioration in the labor market and the utilization rate of conventional types of services could decline given a new lifestyle that takes into
consideration the risk of COVID-19.

The latter point echoes a discussion from the comments section yesterday about an extension to the railway to the Scottish Borders. Before COVID-19 anything like that would come with a round of applause but now there are genuine questions about public transport for the future. There is an irony close to me as I have lived in Battersea for nearly 3 decades and a tube line there has been promised for most of that. Now it is on its way will it get much use?

This is a difficult conceptual issue because if we build “White Elephants” they will be counted in GDP ( it is both output and income), but if they are not used the money is to some extent wasted. I differ to that extent from the view of John Maynard Keynes that you can dig and hole and fill it in. If that worked we would not be where we are now. In the credit crunch we saw facets of this with the empty hotels in Ireland, the unused airport in Spain and roads to nowhere in Portugal. That was before China built empty cities.

Inflation Deflation

There is something of a double swerve applied here which I will illustrate from the Bank of Japan Minutes again.

Next, the three arrows of Abenomics should continue to be carried out to the fullest extent until the economy returns to a growth path in which the annual inflation
rate is maintained sustainably at around 2 percent.

A 2% inflation target has nothing at all to do with deflation and this should be challenged more, especially when it has this Orwellian element.

It is assumed that achievement of the price stability target will be delayed due to COVID-19
and that monetary easing will be prolonged further

It is not a price stability target it is an inflation rate target. This is of particular relevance in Japan as it has had stable prices pretty much throughout the lost decade period. It is up by 0.1% in the past year and at 101.8 if we take 2015 as 100, so marginal at most. The undercut to this is that you need inflation for relative price changes. But this is also untrue as the essentially inflation-free Japan has a food price index at 105.8 and an education one of 92.7.

Policy Failure

The issue here is that as you can see above there has been a complete failure but that has not stopped other central banks from speeding down the failure road. It is what is missing from the statement below that is revealing.

: the Special Program to Support Financing in Response to the Novel Coronavirus (COVID-19); an ample provision of
yen and foreign currency funds without setting upper limits; and active purchases of assets such as exchange-traded funds (ETFs).

No mention of negative interest-rates? Also the large-scale purchases of Japanese Government Bonds only get an implicit mention. Whereas by contrast the purchase of equities as in this coded language that is what “active purchases of assets such as exchange-traded funds (ETFs)” means gets highlighted. The 0.1% will be happy but as any asset price rise is omitted from the inflation indices it is entirely pointless according to their stated objective. No wonder they keep failing…

This matters because pretty much every central bank has put on their running shoes and set off in pursuit of the Bank of Japan. Ever more interest-rate cuts and ever more QE bond buying. Perhaps the most extreme case is the ECB (European Central Bank) with its -0.5% Deposit Rate and large-scale QE. On the latter subject it seems to be actively mirroring Japan.

The ECB may not need to use the full size of its recently expanded pandemic purchase program, Executive Board member Isabel Schnabel says ( Bloomberg)

This is a regular tactic of hinting at reductions whereas the reality invariably ends up on the Andrea True Connection road.

More! More! More!

Staying with the Euro area the ECB has unveiled all sorts of policies and has a balance sheet of 6.2 trillion Euros but keeps missing its stated target. We noted recently that over the past decade or so they have been around 0.7% per year below it and that is not getting any better.

In June 2020, a month in which many COVID-19 containment measures have been gradually lifted, Euro area annual inflation is expected to be 0.3%, up from 0.1% in May ( Eurostat )

Real Wage Deflation

This to my mind is the bigger issue. It used to be the case ( in what was called the NICE era by former Bank of England Governor Mervyn King) that wages grew faster than wages by 1-2% per annum. That was fading out before the credit crunch and since there have been real problems. The state of play for the leader of the pack here has been highlighted by Nippon.com.

Wage growth in Japan is also slow compared with other major economies. According to statistics published by the Organization for Economic Cooperation and Development, the average Japanese annual wage in 2018 was the equivalent of $46,000—a mere 0.2% increase on the figure for 2000 ($45,000).

They mean 2% and everyone else seems to be heading that way.

This increase is significantly smaller than those recorded in the same period in the United States ($53,900 to 63,100), Germany ($43,300 to 49,800), and France ($37,100 to 44,500).

The UK has gone from around $39,000 to the same as France at $44.500.

There is an obvious issue in using another currency but we have the general picture and right now it is getting worse everywhere.

Comment

The answers to the question in my title unfold as follows. In terms of central bank action we have an unequivocal yes. They have copied Japan as much as they can showing they have learnt nothing. We could replace them with an AI version ( with the hope that the I of Intelligence might apply). Related to this is the inflation issue where all the evidence is that they will continue to fail. We have here an example of failure squared where they pursue policies that do not work in pursuit of an objective which would make people worse rather than better off.

That last point feeds into the wages issue which in my opinion is the key one of our times. The Ivory Towers of the central banks still pursue policies where wages growth exceeds inflation and their models assume it. Perhaps because for them it is true. But for the rest of us it is not as real wages have struggled at best and fallen at worst. This is in spite of the increasingly desperate manipulation of inflation numbers that has been going on.

So we see different elements in different places. The Euro area is heading down the same road as Japan in terms of inflation and apart from Germany wages too. The UK is an inflation nation so that part we are if not immune a step or two away from, but that means our real wage performance is looking rather Japanese.

There is also another sub-plot.

30y gilt yield < 30y JGB yield ( Divyang Shah )

The Investing Channel

 

How much do the rising national debts matter?

Quote

A symptom of the economic response to the Covid-19 virus pandemic is more government borrowing. This flows naturally into higher government debt levels and as we are also seeing shrinking economies that means the ratio between the two will be moved significantly. I see that yesterday this triggered the IMF (International Monetary Fund) Klaxon.

This crisis will also generate medium-term challenges. Public debt is projected to reach this year the highest level in recorded history in relation to GDP, in both advanced and emerging market and developing economies.

Firstly we need to take this as a broad-brush situation as we note yet another IMF forecast that was wrong, confirming another of our themes.

Compared to our April World Economic Outlook forecast, we are now projecting a deeper recession in 2020 and a slower recovery in 2021. Global output is projected to decline by 4.9 percent in 2020, 1.9 percentage points below our April forecast, followed by a partial recovery, with growth at 5.4 percent in 2021.

It is hard not to laugh. At the moment things are so uncertain that we should expect errors but the issue here is that the media treat IMF forecasts as something of note when they are regularly wrong. Be that as it may they do give us two interesting comparisons.

These projections imply a cumulative loss to the global economy over two years (2020–21) of over $12 trillion from this crisis………Global fiscal support now stands at over $10 trillion and monetary policy has eased dramatically through interest rate cuts, liquidity injections, and asset purchases.

Being the IMF we do not get any analysis on why we always seem to need economic support.

What do they suggest?

Here come’s the IMF playbook.

Policy support should also gradually shift from being targeted to being more broad-based. Where fiscal space permits, countries should undertake green public investment to accelerate the recovery and support longer-term climate goals. To protect the most vulnerable, expanded social safety net spending will be needed for some time.

Readers will have differing views on the green washing but that is simply an attempt at populism which once can understand. After all if you has made such a hash of the situation in Argentina and Greece you would want some PR too. That leads me to the last sentence, were the poor protected in Greece and Argentina under the IMF? No.

The IMF has another go.

Countries will need sound fiscal frameworks for medium-term consolidation, through cutting back on wasteful spending, widening the tax base, minimizing tax avoidance, and greater progressivity in taxation in some countries.

Would the “wasteful spending” include the part of this below that props up Zombie companies?

and impacted firms should be supported via tax deferrals, loans, credit guarantees, and grants.

Now I know it is an extreme case but this piece of news makes me think.

BERLIN (Reuters) – German payments company Wirecard said on Thursday it was filing to open insolvency proceedings after disclosing a $2.1 billion financial hole in its accounts.

You see the regulator was on the case but….

German financial watchdog #Bafin last year banned short selling in its shares, and filed a criminal complaint against FT journalists who had written critical pieces. .. ( @BoersenDE)

Whereas now it says this.

The head of Germany’s financial watchdog says the Wirecard situations is “a disaster” and “a shame”. He accepts there have been failings at his own institution. “I salute” those journalists and short-sellers who were digging out inconsistencies on it , he says. ( MAmdorsky )

As you can see the establishment has a shocking record in this area and I have personal experience of it blaming those reporting financial crime rather than the criminals. I raise the issue on two counts. Firstly I am expecting a raft of fraud in the aid schemes and secondly I would point out that short-selling has a role in revealing financial crime. Whereas the media often lazily depict it as being a plaything of rich financiers and hedge funds. Returning directly to today’s theme the fraud will be a wastage in terms of debt being acquired but with no positive economic impulse afterwards.

Still I am sure the Bank of England is not trying to have its cake and eat it.

Join us on 30 June for an interactive webinar with restaurateur, chef and The Great British Bake Off judge, @PrueLeith . Find out more and register for your place here: b-o-e.uk/2CsGokX

Debt is cheap

The IMF does touch on this although not directly.

monetary policy has eased dramatically through interest rate cuts, liquidity injections, and asset purchases.

It does not have time for the next step, although it does have time for some rhetoric.

In many countries, these measures have succeeded in supporting livelihoods and prevented large-scale bankruptcies, thus helping to reduce lasting scars and aiding a recovery.

Then it tip-toes around the subject in a “look at the wealth effects” sort of way.

This exceptional support, particularly by major central banks, has also driven a strong recovery in financial conditions despite grim real outcomes. Equity prices have rebounded, credit spreads have narrowed, portfolio flows to emerging market and developing economies have stabilized, and currencies that sharply depreciated have strengthened.

Let me now give you some actual figures and I am deliberately choosing longer-dated bonds as the extra debt will need to be dealt with over quite a period of time. In the US the long bond ( 30 years) yields 1.42%, in the UK the fifty-year Gilt yields 0.43%, in Japan the thirty-year yield is 0.56% and in Germany it is -0.01%. Even Italy which is doing its best to look rather insolvent only has a fifty-year yield of 2.45%

I know that it is an extreme case due to its negative bond yields but Germany is paying less and less in debt interest per year. According to Eurostat it was 23.1 billion in 2017 but was only 18.5 billion in May of this year. Care is needed because most countries pay a yield on their debt but presently the central banks have made sure that the cost is very low. Something that the IMF analysis ( deliberately ) omits.

Comment

So we are going to see lots more national debt. However the old style analysis presented by the IMF has a few holes in it. For a start they are comparing a stock (debt) with an annual flow (GDP). For the next few years the real issue is whether it can be afforded and it seems that central banks are determined to make it so. Here is yet another example.

Brazil may experiment with negative interest rates to combat a historic recession, says a former central bank chief who presided over some of the highest borrowing costs in the country’s recent history ( @economics)

That is really rather mindboggling! Brazil with negative interest-rates? Anyway even the present 2.25% is I think a record low.

If we go back to debt costs then we can look at the Euro area where they were 2.1% of GDP in 2017 but are expected to be 1.7% over the next year. Now that does not allow for the raft of debt that will be issued but of course a few countries will be paid to issue ( thank you ECB!). The outlier will be Italy.

Looking further ahead there is the capital issue as this builds up. I do not mean in terms of repayment as not even the Germans are thinking of that presently. I mean that as it builds up it does have a psychological effect which is depressing on economic activity as we learnt from Greece. Which leads onto the final point which is that in the end we need economic growth, yes the same economic growth which even before the pandemic crisis was in short supply.

 

Why are central bankers so afraid of the truth?

We find ourselves in an era where central bankers wield enormous power. There is something of an irony in this. They were given the ability to set monetary policy as a way of taking power out of the hands of politicians.This led to talk of “independence” as they set interest-rates to achieve an inflation target usually but not always of 2% per annum. Actually this is the first falsehood because we are regularly told this.

The ECB has defined price stability as a year-on-year increase in the Harmonised Index of Consumer Prices (HICP) for the euro area of below 2%

They could also tell me the moon is full of cheese but I would not believe that either. I am amazed how rarely this is challenged but price stability is clearly an inflation rate of 0%, The usual argument that this stops relative price shifts collapsed when the oil price fall of 2015/16 gave us inflation of around 0% as plainly there was a relative price shift for oil and indeed other goods. Perhaps the shrieks of “Deflation” were a type of distraction.

Next has come the way that claimed independence has morphed into collusion with the political establishment. This moves us away from the original rationale which was to take monetary policy power out of the hands of politicians to stop them manipulating it for the electoral cycle. What had apparent success which was technocratic control of interest-rates has morphed into this.

  1. Interest-Rates around 0%
  2. Large-Scale purchases of sovereign bonds
  3. Large-Scale purchases of private-sector bonds
  4. Credit Easing
  5. Purchases of equities ( for monetary policy and as a consequence of exchange-rate policy)
  6. Purchases of commercial property so far via Exchange-Traded Funds or ETFs

Not all central banks have gone all the way down the list with the Bank of Japan being the leader of the pack and who knows may go even further overnight at its unscheduled meeting? I should add as people regularly look at my back catalogue that by the time anyone in that category reads this we may see many central banks at step 6 and maybe going further. But back to my collusion point here is some evidence.

I also confirm that the Asset Purchase Facility will remain in place for the financial year 2020-21.

This is almost a throwaway sentence in the inflation remit from the Bank of England but it is in fact extremely important in two ways, and in tune with today’s theme neither of which are mentioned. The Chancellor Rishi Sunak is reaffirming that Her Majesty’s Treasury is backing the QE ( Quantitative Easing ) policies of the Bank of England which currently are steps 2 to 4 above. Next comes the issue of the amount which is huge even for these times.

The Committee voted by a majority of 7-2 for the Bank of England to continue with the programme of £200 billion of UK government bond and sterling non-financial investment-grade corporate bond purchases, financed by the issuance of central bank reserves, to take the total stock of these purchases to £645 billion.

The 2 dissenters voted for “More! More! More!” rather than less and I expect the extra £100 billion they voted for to be something sung about by The Undertones.

Happens all the time
Its going to happen – happen – till your change your mind
Its going to happen – happen – happens all the time

So we have a doom loop for supporters of independence as the politicians via backing any losses from QE become the masters again and the central bankers become marionettes. As so often we see Japan in the van by the way the Abenomics of Shinzo Abe appointed Governor Kuroda to the Bank of Japan pretty much as they would appoint a minister. It is the most exposed in terms of monetary policy via its 31.4 trillion Yen of equity holdings with a break-even it estimates at around 19,500 in terms of the Nikkei 225 index. Also of course an individual company in which it holds shares could fold.

Forward Guidance

This had a cacophony of falsehoods as we were promised interest-rate rises which failed to happen. In my own country it became laughable as an unemployment rate of 7% was highlighted and then unemployment rates of 6% and 5% were ignored. Then at Mansion House in June 2014 Governor Mark Carney said this.

There’s already great speculation about the exact timing of the first rate hike and this decision is becoming
more balanced.
It could happen sooner than markets currently expect.

In fact a bit over 2 years later he cut them whilst promising to reduce them further than November to 0.1% before economic reality even reached Threadneedle Street and the latter was redacted. It is hard to believe now but many were predicting interest-rate rises by the ECB in 2019 based on Forward Guidance. Of course the US Federal Reserve did actually give it a go before retreating like Napoleon from Moscow and as we recall the role of President Trump in this I would remind you of my political collusion/control point above.

Negative Interest-Rates

This area is littered with falsehoods. In Beatles terms it took only a week for this.

Bank of Japan Governor Haruhiko Kuroda said he is not thinking of adopting a negative interest rate policy now,

to become this.

The Bank will apply a negative interest rate of minus 0.1 percent to current accounts that financial institutions hold at the Bank.1 It will cut the interest rate further into negative territory if judged as necessary.

As Hard-Fi put it.

Can’t believe it
You’re so hard to beat
Hard to beat

The new Governor of the Bank of England seems to be on the same road to Damascus. From Sky News yesterday.

Mr Bailey told MPs it was now studying how effective that cut had been as well as “looking very carefully” at the experience of other countries where negative rates had been implemented.

On the prospect of negative rates, he said: “We do not rule things out as a matter of principle.

Curious because that is exactly what people had thought he had done several times in this crisis.

Comment

There are other areas I could highlight as for example there is the ridiculous adherence to the output gap philosophy that has proved to be consistent only in its failures. But let me leave you via the genius of Christine McVie the central bankers anthem.

Tell me lies
Tell me sweet little lies
Tell me lies, tell me, tell me lies
Oh, no, no, you can’t disguise
(You can’t disguise, no, you can’t disguise)
Tell me lies
Tell me sweet little lies

Me on The Investing Channel

 

The central banking parade continues

The last 24 hours have seen a flurry of open mouth operations from the world’s central bankers. There are a couple of reasons for this of which the first is that having burst into action with the speed of Usain Bolt they now have little to do. The second is that they have become like politicians as they bask centre stage in the media spotlight. The third is that their policies require a lot of explaining because they never achieve what they claim so we see long words like “counterfactual” employed to confuse the unwary.

The land of the rising sun

Let us go in a type of reverse order as Governor Kuroda of the Bank of Japan has been speaking this morning and as usual has uttered some gems.

BoJ Gov Kuroda: Repeats BoJ Would Not Hesitate To Add Additional Easing If Needed -BoJ Has Several Tools And Measures To Deploy If Required ( @LiveSquawk )

This is something of a hardy perennial from him the catch though comes with the “if required” bit. You see the April Economic Report from the Ministry of Finance told us this.

The Japanese economy is getting worse rapidly in an extremely severe situation, due to the Novel Coronavirus…….Concerning short-term prospects, an extremely severe situation is expected to remain due to the influence of the infectious disease. Moreover, full attention should be given to the further downside risks to the domestic and foreign economy which are affected by the influence of the infectious disease.

So if not now when? After all the Japanese economy was already in trouble at the end if 2019 as it shrank by 1.8% in the final quarter. Actually he did kind of admit that.

BoJ’s Kuroda: Japan’s Economy To Be Substantially Depressed In Q2

Then looking at his speech another warning Klaxon was triggered.

In the meantime, it expects short- and long-term policy interest rates to remain at their present
or lower levels.

This raises a wry smile because in many ways the Bank of Japan is the central bank that likes negative interest-rates the least. Yes it has one of -0.1% but it tiptoed into it with the minimum it felt it could and stopped, unlike in other easing areas where it has been happy to be the leader of the pack. Why? Well after nearly 30 years of the lost decade it still worries about the banking sector and whether it could survive them and gives them subsidies back as it is. Frankly it has been an utter disaster and shows one of the weaknesses of the Japanese face culture.

Oh and as we mull the couple of decades of easing we got this as well.

KURODA: RECENT EASING ACTION INCLUDING MORE ETF PURCHASES IS TEMPORARY ( @DeltaOne)

This morning there was just over another 100 billion Yen of equity ETF purchases as we mull another refinement of the definition of temporary in my financial lexicon for these times. It appears to mean something which keeps being increased and never ends.

The Bank of England

The new Governor Andrew Bailey gave an interview to Robert Peston of ITV last night which begged a few questions. The first was how its diversity plans seem to involve so much dealing with the children of peers of the realm and Barons in particular? This of course went disastrously wrong with Deputy Governor Charlotte Hogg who seemed to know as little about monetary policy as she did about the conflict of interest issue which led to her departure. During the interview Robert Peston seemed to be exhibiting a similar degree of competence as I pointed out on social media.

@Peston  now says that buying hundreds of billions of debt is different to a decade ago when the Bank of England bought er hundreds of billions of debt. It is frightening that this man was once BBC economics editor.

There was a policy element although it was not news to us I am sure it was to some.

Governor of the Bank of England Andrew Bailey has told ITV’s Peston show that one of the main purposes of the Bank buying £200bn of government debt – and probably more over the course of the Covid-19 crisis – is to “spread the cost of this thing to society” and help the government avoid a return to austerity. ( ITV)

To the extent that there was a policy announcement the whole interview was very wrong as it should be on the Bank of England website for all to see rather than boosting the career of one journalist and network. As I note how that person’s career had been under pressure we see the UK establishment in action. I also note that two subjects were not mentioned.

  1. The apparent dirty protest at the FCA on Andrew Bailey’s watch
  2. The doubling of overdraft interest-rates after a botched intervention by the FCA on Andrew Bailey’s watch.

The United States

Something rather ominous happened last night as The Hill reports.

“He has done a very good job over the last couple of months, I have to tell you that,” Trump told reporters during a meeting with the governors of Colorado and North Dakota. “Because I have been critical, but in many ways I call him my ‘MIP.’ Do you know what an MIP is? Most improved player. It’s called the Most Improved Player award.”

We noted back in November 2018 that The Donald was taking charge of US monetary policy and that Jerome Powell had become something of a toy. Indeed there was more.

The president said he still is at odds with Powell over his stance on negative interest rates. Trump has for months pushed negative interest rates, arguing the U.S. is on an unfair playing field if other countries have negative rates.

Whilst I disagree with The Donald on negative interest-rates he is at least honest and we know where he stands. Whereas Chair Powell said this.

Speaking to the Peterson Institute for International Economics, Powell said negative interest rates are “not something that we’re looking at,” ( Forbes)

Is that an official denial? Anyway it does not go that well with this.

The economic toll has taken an outsized toll on lower-income households, Powell said, with 40% of those employed in February and living in a household that makes less than $40,000 a year losing their job in March.

Conceptually this is a real issue for the US Federal Reserve as such people are unlikely to have many holdings ( or indeed any…) of the assets it keeps pumping up the price of.

Comment

As we survey the scene some of it is surreal. I noted on Tuesday that the US had already seen two examples of negative interest-rates and one has deepened in the meantime. US Feds Funds futures have moved as high as 100.025 for the summer of 2021 and 100.05 for the autumn. Now -0.05% is not a lot but these things have a habit of being like a balloon that is about to be inflated.

You may also note that those who have claimed central banks are independent of government have been silent recently.Perhaps they are busy redacting past comments?

Missing for today’s update so far has been the European Central Bank or ECB. This is because it is involved in something of an internal turf war.

The shock at the ruling is palpable in the corridors of power in Berlin as Karlsruhe’s three-month deadline runs down.

Officials are trying to work out a way of satisfying the court without eroding the independence of the ECB, which has kept the euro zone intact through a decade of crises.

One lawmaker described feeling like a bomb disposal expert, “because the Constitutional Court has put an explosive charge under the euro and the EU”. ( Reuters)

Hang on! Someone still thinks central banks are independent…….