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

 

In the future will all central banks buy equities?

As the weather shows a few signs of picking up in London it appears that one central banker at least has overheated listening to Glen Frey on the radio.

The heat is on, on the street
Inside your head, on every beat
And the beat’s so loud, deep inside
The pressure’s high, just to stay alive
‘Cause the heat is on

Yes it is our favourite “loose cannon on the decks” which is the Bank of England Chief Economist Andy Haldane. He has been quiet in recent times after his Grand Tour around the UK to take central banking to the people and get himself appointed as Governor was widely ignored. But he is back.

LONDON (Reuters) – The Bank of England is looking more urgently at options such as negative interest rates and buying riskier assets to prop up the country’s economy as it slides into a deep coronavirus slump, the BoE’s chief economist was quoted as saying.

The Telegraph newspaper said the economist, Andy Haldane, refused to rule out the possibility of taking interest rates below zero and buying lower-quality financial assets under the central bank’s bond-buying programme.

There is a lot going on there and certainly enough for him to be summoned to the Governor’s study to explain why he contradicted what the Governor had said only a few days before. Also as is his wont Andy had also contradicted himself.

“The economy is weaker than a year ago and we are now at the effective lower bound, so in that sense it’s something we’ll need to look at – are looking at – with somewhat greater immediacy,” he said in an interview. “How could we not be?”

So we have a lower bound for interest-rates but we are thinking of cutting below it? So it is not an effective lower bound then. I can help him out with just a couple of letters as calling it an ineffective lower bound would fix it. Of course Andy has experience of numbers slip-sliding away on his watch as the estimate of equilibrium unemployment has gone from 6.5% to around 4.25% ( it has got a bit vague of late) torpedoing his output gap theories. Even worse of course it will now be going back up. Time for him to move from Glen Frey to Kylie Minogue.

I’m spinning around
Move outta my way

Then there is Andy’s hint about buying equities.

buying lower-quality financial assets

He has a problem with those who recall him pointing out he does not understand pensions so he would not be a stock picker more a tracker man. Although of course in the UK in many ways that means the same thing. For example if we look at Astra Zeneca it was worth just under £108 billion at the beginning of this month and Royal Dutch Shell some £95 billion whereas if we those bandying for the number 100 slot we are between £3 and £3.5 billion. Then the FTSE 100 is over 80% of the all-share so by now I think you will have figured that yet again such a policy would benefit big business. Andy may not have done so as his “Sledgehammer QE” of 2016 dashed into such UK stalwarts as er Apple and Maersk. An error being repeated in the current operations.

Chair Powell

Chair Powell of the US Federal Reserve was interviewed on 60 Minutes yesterday which was likely to be more like 40 minutes when you allow for adverts. What did he say? Well after a really odd section on virology we got this burst of hype.

But I would just say this. In the long run, and even in the medium run, you wouldn’t want to bet against the American economy. This economy will recover. And that means people will go back to work. Unemployment will get back down. We’ll get through this. It may take a while. It may take a period of time. It could stretch through the end of next year. We really don’t know. We hope that it will be shorter than that, but no one really knows.

Eyes will have turned to the hint that it might be in 2022 as that begs a lot of questions as to what the Federal Reserve might do in the meantime. What about this for instance?

I continue to think, and my colleagues on the Federal Open Market Committee continue to think that negative interest rates is probably not an appropriate or useful policy for us here in the United States. ( Chair Powell)

“probably not” eh? That is leaving the door open to a change of mind. This is in spite of the fact that in central banking terms this is quite a damning critique ( as it involves an implicit criticism of other central banks).

The evidence on whether it helps is quite mixed.

Also as section which is just plain wrong.

PELLEY: So the banks would pay people to borrow money, essentially?

POWELL: Yes.

Let us now move onto what might be called the money shots.

POWELL: Well, there’s a lot more we can do. We’ve done what we can as we go. But I will say that we’re not out of ammunition by a long shot. No, there’s really no limit to what we can do with these lending programs that we have. So there’s a lot more we can do to support the economy, and we’re committed to doing everything we can as long as we need to.

The track record of central bankers using the phrase “no limit” is not good as the Swiss National Bank most famously found out. But there was more and the emphasis below is mine.

POWELL: Well, to begin, the one thing we can certainly do is we can enlarge our existing lending programs. We can start new lending programs if need be. We can do that. There are things we can do in monetary policy. There are a number of dimensions where we can move to make policy even more accommodative. Through forward guidance, we can change our asset purchase strategy. There are just a lot of things that we can do.

Comment

Central bankers are like gamblers on a losing streak desperately doubling down. You do not need to take my word for it as we can take a look at a country which has been enthusiastically buying equities for a while now, which is Japan. For example the Bank of Japan bought over 100 billion Yen’s worth as recently as Friday on its way to this.

The Bank will actively purchase ETFs and J-REITs for the time being so that their amounts outstanding will increase at annual paces with the upper limit of about 12 trillion
yen and about 180 billion yen, respectively.

As of the last update the Bank of Japan had bought some 31.4 trillion Yen of equity ETFs. How is that going?

Japan fell into a technical recession in the first quarter for the first time since 2015

That is from the Financial Times. If you think that does not do justice to an economy 2% smaller than a year ago and seeing nominal GDP declines with a large national debt, well the FT is Japanese owned these days. Meanwhile back in the real world the lost decade(s) carries on.

Why would you copy that? Yet we seem likely to do so…..

Podcast on the UK Gilt Market

 

Central Banks will demand even more powers in response to this crisis

Yesterday was quite something with the extraordinary oil price decline topped off by a more than 2000 point fall in the Dow Jones Industrial Average in the United States. I know that it is an outdated and flawed index but nonetheless it felt symbolic. So far today things are quieter with some bounce back in equity markets and the reverse in bond markets. But we have some familiar themes at play so let us get straight to them.

Japan

The Bank of Japan has been at the outer limit of monetary policy for some time now as The Mainichi pointed out earlier today.

The BOJ already owns around 50 percent of outstanding Japanese government bonds of about 1,000 trillion yen ($9.73 trillion), while pledging to buy 80 trillion yen of them per year. It has also bought nearly exchange traded funds.

Further cuts in the negative interest rate of minus 0.1 percent, which have pushed down longer-term interest rates for years, are expected to snap the profitability of the banking sector and hurt returns for insurers and pensions of private companies.

They have got a little excited on the issue of equity purchases as I am not sure what a nearly exchange traded fund is? Let me help out by pointing out that the Bank of Japan purchased some 101.4 billion Yen of equity ETFs both yesterday and today. Today’s purchases have a different perspective because the market closed higher, this is because the Bank of Japan has established a principle of only buying on down days. In this present crisis it has abandoned that twice so far. In addition its “clip size” has risen from 70.4 billion Yen to 101.4 billion. So far in March it has bought around 410 billion Ten of equities.

So Andrea True Connection continues to be playing from its loudspeakers.

More, more, more
How do you like it, how do you like it
More, more, more
How do you like it, how do you like it
More, more, more
How do you like it, how do you like it

It also buys commercial property ETFs although it is much less enthusiatic about this and has only bought 3.6 billlion Yen of them this month. Frankly I am not sure what these particular purchases are to achieve but they continue.

Fiscal Policy

I regularly point out that fiscal policy has been oiled and facilitated by the low level of bond yields. As The Mainichi points out above The Tokyo Whale has purchased half the Japanese bond market meaning that at many maturities Japan is being paid to borrow and even the thirty-year yield is a mere 0.3%. Thus it helps this.

President Donald Trump on Monday said he will be taking “major” steps to gird the U.S. economy against the impact of the spreading coronavirus outbreak, while Japan’s government plans to spend more than $4 billion in a second package of steps to cope with fallout from the virus. ( Reuters)

If we stay with Japan for now I note that as I looked this up there were references to a US $122 billion stimulus as recently as December. This is a problem as Japan keeps needing more fiscal stimuli and it is a particular issue right now. This is because last year’s rise in the Consumption Tax was supposed to improve the fiscal position whereas all we have seen since is stimuli or moves in the opposite direction.

This is a recurring theme in Japan as we mull the consequences of such extreme monetary action. Let me give you another example of a backwash for the control agenda. The policy of Yield Curve Control because it aims at a specific yield target for Japanese Government Bonds has been keeping yields up and not down in recent times.

The Euro area

It was only last week that I suggested the ECB could become the next major central bank to buy equities and thus I noted this overnight from a former Vice-President.

Should the central banks’ mandate be extended to explicitly include financial stability, giving them more instruments to try to contain asset prices booms instead of just “mopping-up after the crash”. Policy reviews are ongoing and everything must be on the table this time.

That is Vitor Constancio saying “everything must be on the table this time”.

I doubt he meant this but something has turned up today that will require ECB support.

ROME (Reuters) – Payments on mortgages will be suspended across the whole of Italy after the coronavirus outbreak, Italy’s deputy economy minister said on Tuesday.

“Yes, that will be the case, for individuals and households,” Laura Castelli said in an interview with Radio Anch’io, when asked about the possibility.

Italy’s banking lobby ABI said on Monday lenders representing 90% of total banking assets would offer debt moratoriums to small firms and households grappling with the economic fallout from Italy’s coronavirus outbreak.

Yesterday we noted that businesses were going to get a debt payment moratorium and today we see mortgages will also be on the list. This will immediately lead to trouble for the banks and of course the Italian banks were in enough trouble as it is. Even the bank considered the strongest Unicredit has a share price 23% lower than a year ago and of course there are all the zombies.

This also impacts at a time when Italian bond yields have risen albeit to a mere 1.3% for the ten-year benchmark. But even that leads to worries as Reuters point out.

Despite the introduction of tougher banking regulation and oversight in the wake of the euro zone debt crisis a decade ago, the doom loop remains.

Italian banks held 388.22 billion euros of Italian government bonds in their portfolios at the end of January, around a sixth of the country’s public debt.

“The feedback loop between the sovereign and banks in Italy is alive and well, and both sovereign and bank debt should trade in lock-step,” said Antoine Bouvet, senior rates strategist at ING.

Mentions of something that was in danger of being forgotten are on the rise so let me point out this from the ECB website.

The Governing Council will consider Outright Monetary Transactions to the extent that they are warranted from a monetary policy perspective as long as programme conditionality is fully respected, and terminate them once their objectives are achieved or when there is non-compliance with the macroeconomic adjustment or precautionary programme.

There are other issues here as plainly Italy is about to blast through the Stability and Growth Pact or Maastricht fiscal rules. Also I note that the European Stability Mechanism would be involved as why put things on balance sheet when you can tuck them away in a Special Purpose Vehicle or SPV? But the ECB will be busy and let me throw a snack into the debate, might it support bank shares?

Comment

There is quite a bit to consider here and the news keeps coming on this front.

#JAPAN SEEN MULLING EXPANSION OF ETF BUYING PROGRAM, KYODO SAYS – BBG ( @C.Barraud )

On and on it goes with so few ever questioning why it is always more needed? At some point you need an audit of progress so far and successes and failures. Whereas obvious failures get swept under the carpet. Let me give you an example of this from a Sweden which had negative interest-rates for several years but has now climbed back to the giddy heights of 0%. Yet Sweden Statistics reports this.

In recent years, households have made large net deposits in bank accounts despite low interest rates.

Then there is this as well.

Households’ net purchases of new tenant-own apartments amounted to SEK 21 billion in the fourth quarter of 2019, which is the highest value ever in a single quarter.

This returns us to the side-effects of such policies which is where we came in looking at Japan which has loads of them.

But ever quick to use a crisis to expand their powers the central bankers will be greedily using this crisis to do so. So we can expect more mortgage moratorium’s which of course will require even more help for “The Precious”.

Just as I was posting this it seems to be happening already.

BREAKING: RBS confirms it will give a three-month mortgage payment holiday to homeowners impacted by coronavirus. Follows Italy saying mortgage payments will be suspended. ( @gordonrayner )

I wonder if the Bank of England has been moving behind the scenes? Meanwhile it too moved on yesterday as one of the bonds it purchased in its Operation Twist QE purchases was at a negative yield.

Welcome to the oil price shock of 2020

Today is one where we are mulling how something which in isolation is good news has led to so much financial market distress overnight and this morning. So much so that for once comparisons with 2008 and the credit crunch have some credibility.

And I felt a rush like a rolling bolt of thunder
Spinning my head around and taking my body under
Oh, what a night ( The Four Seasons)

Just as people were getting ready for markets to be impacted by the lock down of Lombardy and other regions in Italy there was a Mexican stand-off in the oil market. This came on top of what seemed at the time large falls on Friday where depending on which oil benchmark you looked at the fall was either 9% or 10%.Then there was this.

DUBAI, March 8 (Reuters) – Saudi Arabia, the world’s top oil exporter, plans to raise its crude oil production significantly above 10 million barrels per day (bpd) in April, after the collapse of the OPEC supply cut agreement with Russia, two sources told Reuters on Sunday.

State oil giant Aramco will boost its crude output after the current OPEC+ cut deal expires at the end of March, the sources said.

Whilst they are playing a game of who blinks first the oil price has collapsed. From Platts Oil

New York — Crude futures tumbled roughly 30% on the open Sunday evening, following news that Saudi Aramco cut its Official Selling Prices for April delivery. ICE front-month Brent fell $14.25 on the open to $31.02/b, before climbing back to trade around $35.22/b at 2238 GMT. NYMEX front-month crude futures fell $11.28 to $30/b on the open, before rising to trade at around $32.00/b.

The Real Economy

Let us get straight to the positive impact of this because in the madness so many are missing it.

We find that a 10 percent increase in global oil inflation increases, on average, domestic inflation by about 0.4
percentage point on impact, with the effect vanishing after two years and being similar between advanced and developing economies. We also find that the effect is asymmetric, with positive oil price shocks having a larger effect than negative ones. ( IMF 2017 Working Paper )

There is plenty of food for thought in the reduced relative impact of lower oil prices for those who believe they are passed on with less enthusiasm and sometimes not passed on at all. But if the IMF are right we will see a reduction in inflation of around 0.6% should oil prices remain here.

As to the impact on economic growth the literature has got rather confused as this from the Bank of Spain in 2016 shows.

Although our findings point to a negative influence from oil price increases on economic growth, this phenomenon is far from being stable and has gone through different phases over time. Further research is necessary to fathom this complex relationship.

Let me give you an example of how it will work which is via higher real wages. Of course central bankers do not want to tell us that because they are trying to raise inflation and are hoping people will not spot that lower real wages will likely be a consequence. To be fair to the IMF it does manage to give us a good laugh.

The impact of oil price shocks, however,
has declined over time due in large part to a better conduct of monetary policy.

That does give us the next link in the story but before we get there let me give you two major problems right now which have links. The first is that the oil price Mexican stand-off has a silent player which is the US shale oil industry. As I have pointed out before it runs on a cash flow business model which has just seen likely future flows of cash drop by a third.

Now we get to the second impact which is on credit markets. Here is WordOil on this and remember this is from Thursday.

NEW YORK (Bloomberg) –Troubled oil and gas companies may have a hard time persuading their bankers to keep extending credit as the outlook darkens for energy, potentially leading to more bankruptcies in the already-beleaguered sector.

Lenders evaluate the value of oil reserves used as collateral for bank loans twice a year, a process that’s not likely to go well amid weak commodity prices, falling demand, shuttered capital markets and fears of coronavirus dampening global growth. Banks may cut their lending to cash-starved energy companies by 10% to 20% this spring, according to investors and analysts.

That will all have got a lot worse on Friday and accelerated today. I think you can all see the problem for the shale oil producers but the issue is now so large it will pose a risk to some of those who have lent them the money.

US oil/junk bonds: busts to show folly of last reboot ( FT Energy )

I am not sure where the FT is going with this bit though.

There will be no shortage of capital standing ready to recapitalise the energy sector….

Perhaps they have a pair of glasses like the ones worn by Zaphod Beeblebrox in The Hitch Hikers Guide to the Galaxy. Meanwhile back in the real world there was this before the latest falls.

More than one-third of high-yield energy debt is trading at distressed levels. Oil and gas producers with bonds trading with double-digit yields include California Resources Corp., Range Resources Corp., Southwestern Energy Co., Antero Resources Corp., Comstock Resources Inc., Extraction Oil & Gas Inc. and Oasis Petroleum Inc. ( World Oil)

Central Banks

As the oil price news arrived central bankers will have been getting text messages to come into work early. Let me explain why. Firstly we know that some credit markets were already stressed and that the US Federal Reserve had been fiddling while Rome burns as people sang along with Aloe Blacc.

I need a dollar, dollar a dollar is what I need
hey hey
Well I need a dollar, dollar a dollar is what I need
hey hey
And I said I need dollar dollar, a dollar is what I need.

Whoever decided to taper the fortnightly Repo operations to US $20 billion had enough issues when US $70 billion was requested on Thursday, now I guess he or she is not answering the phone. Anyway the role of a central bank in a crisis like this is to be lender of last resort and splash the cash. At the same time it should be doing emergency investigations to discover the true state of affairs in terms of solvency.

This is because some funds and maybe even banks must have been hit hard by this and may go under. Anyone long oil has obvious problems and if that is combined with oil lending it must look dreadful. If anyone has geared positions we could be facing another Long-Term Capital Management. Meanwhile in unrelated news has anyone mentioned the derivatives book of Deutsche Bank lately?

The spectre of more interest-rate cuts hangs over us like a sword of damocles. I type that because I think they will make things worse rather than better and central banks would be better employed with the liquidity issues above. They are much less glamorous but are certainly more effective in this type of crisis. Frankly I think further interest-rate cuts will only make things worse.

Comment

I have covered a lot of ground today but let me move onto home turf. We can also look at things via bond yields and it feels like ages ago that I marked your cards when it was only last Thursday! Anyway we have been on this case for years.

Treasury 10-Year Note Yield Slides Below 0.5% for First Time ( @DiMartinoBooth)

Yes it was only early last week that we noted a record low as it went below 1%. Meanwhile that was last night and this is now.

Overnight the US 10-year traded 0.33%, under 0.44% now. The longbond traded down to 0.70% overnight. The bond futures were up over 12 points. Now trading 0.85%. Note how “gappy” this chart is. Liquidity is an issue. ( @biancoresearch )

This really matters and not in the way you may be thinking. The obvious move is that if you are long bonds you have again done really well and congratulations. Also there is basically no yield these days as for example, my home country the UK has seen a negative Gilt yield this morning around the two-year maturity.

But the real hammer on the nail will not be in price ( interest-rates) it will be in quantity as some places will be unable to lend today. Some of it will be predictable ( oil) but in these situations there is usually something as well from left field. So let me end this part Hill Street Blues style.

Let’s be careful out there

Podcast

I have not mentioned stock markets today but I was on the case of bank shares in my weekly podcast. Because at these yields and interest-rates they lack a business model.

 

 

 

The madness of central bankers

Today will depending on what time you read this either have seen yet more monetary policy accommodation by the European Central Bank or be about to get it. It;s President Mario Draghi is too smooth an operator to so strongly hint at it for nothing to happen, especially as in my opinion he feels the need to set policy for the new incoming ECB President Christine Lagarde who he knows well. That is quite a damning critique of her abilities if you think about it which is in line with her track record. But as to the action further confirmation has been provided by the way that markets have been toyed with by leaks from what are known as official “sauces”.

For those unaware the “sauces” strategy is to suggest lots of action as I pointed out on the 16th of August.

Investors currently expect the ECB to cut its key interest rate to minus 0.7% and to hold rates below their current level through 2024, according to futures markets. Mr. Rehn said those market expectations showed that investors had understood the ECB’s guidance.

Actually even this position had its own contradictions.

So will he now be overshooting -0.5% or -0.7%? Actually it gets better as -0.6% is in there now as well.

Later we get told that much less will happen as we saw earlier this week as the last thing central bankers want to see on their big day is the word “disappointment”. So we get this.

Oh, the grand old Duke of York
He had ten thousand men
He marched them up to the top of the hill
And he marched them down again
And when they were up, they were up
And when they were down, they were down
And when they were only half-way up
They were neither up nor down

The whole plan here is under the category of “open mouth operations” which might serve the purposes of the ECB but anyone in the real economy is being actively misled. The only saving grace is that most people will be unaware but there have been real world effects on mortgage rates and the rates at which companies and countries can borrow.

Where are we now?

Joumanna Bercetche of CNBC has summarised the expected position.

Here’s what analysts are expecting:
1) Majority expect 10bps rate cut to -50bps (minority 20bps cut)
2) Tiering
3) Restart of Asset Purchases : sov +corp bonds of EUR 30bn x 12 months (risk of LESS given recent hawkish commentary)
4) Enhanced Fwd Guidance

Interest-Rates

Let us address this as it clearly fails Einstein’s definition of madness. As to doing the same thing and expecting a different result well how about cutting interest-rates by 0.1% four times as has happened to the Deposit Rate and then adding a fifth! Or adding another 0.1% ( or even 0.2%) to a sequence of cuts amounting to 3.65% so far and expecting a different result.

Oh and I see more than a few saying the ECB interest-rate is 0% as indeed one of its interest-rates is. However I use the Deposit Rate because the amount of money deposited with the ECB at this rate is some 1.9 trillion Euros.

Next there was a stage where the madness went even further and we were told that shifting the differences between the various ECB interest-rates was a big deal. For example the minimum lending rate has fallen by 4% so 0.35% more than the Deposit Rate. This has an influence for financial markets but little or no impact on the real economy.

It all seems rather small fry compared to this from President Trump.

The Federal Reserve should get our interest rates down to ZERO, or less, and we should then start to refinance our debt. INTEREST COST COULD BE BROUGHT WAY DOWN, while at the same time substantially lengthening the term. We have the great currency, power, and balance sheet………The USA should always be paying the the lowest rate. No Inflation! It is only the naïveté of Jay Powell and the Federal Reserve that doesn’t allow us to do what other countries are already doing. A once in a lifetime opportunity that we are missing because of “Boneheads.”

The problem for the Donald is that if negative interest-rates were any sort of magic elixir we would not be where we are.Sadly the ECB proves this as it ends up having to keep cutting to keep up what I have previously described as a type of junkie culture.

On the upside the “once in a lifetime” reference may mean he is also a Talking Heads fan.

Tiering

This is another sign of central banking madness where their policies are essentially always aimed at the banks. The interest-rate cuts and QE were to help bail them out but went so far that they now hurt the banks. For newer readers this is because the banks are afraid to pass on the negative interest-rates to ordinary depositors in case they withdraw their money.

So we seem likely to see an effort to shield the banks by some of their deposits at the ECB not having the full negative rate applied. The real economy gets no such sweetners.

Again if the policy of protecting “The Precious” worked these new policies would not be necessary would they?

QE

Exactly the same critique applies here. Up until now some 2.6 trillion Euros of bonds has been bought for monetary policy purposes or Quantitative Easing. So what difference will another 360 billion Euros make? Especially if we remind ourselves that the original programme only ended last December so even fans of it have to admit the sugar high went pretty fast.

There is a subtler argument here which is that the ECB is really oiling the wheels of fiscal policy by making debt cheap to issue for Euro area nations. But what difference has this made? Some maybe at the margins but the basic case of Germany is a fail. In spite of its ability to be paid to issue debt Germany still plans to run a fiscal surplus.

Enhanced Forward Guidance

in 2019 this led many ECB watchers to expect an interest-rate rise and instead we are getting a cut. I am not sure how you could enhance this unless they expect to do even worse!

Comment

My critique has so far looked mostly at the ECB but whilst in some areas it is the leader of the pack there are plenty of other signs of madness. After two “lost decades” the Bank of Japan cut interest-rates by 0.1% to -0.1%. Then it introduced Yield Curve Control which in recent times has been raising bond yields rather than cutting them in a complete misfire. In my home country the UK we saw the Bank of England plan to cut interest-rates by 0.15% in November 2016 before fortunately realising that it had misjudged the economy and abandoning the plan. They end up singing along with Genesis.

You know I want to, but I’m in too deep…

As to the situation the immediate one is grim as this from Eurostat today reminds us.

In July 2019 compared with July 2018, industrial production decreased by 2.0% in the euro area.

But this is a “trade war” issue which has very little to do with monetary policy. As to the domestic impulse the money supply figures have picked up in 2019 so the ECB may be easing at exactly the wrong moment just as it turned out it ended easing at the wrong moment. So let me end with the nutty boys.

Madness, madness, they call it madness
Madness, madness, they call it madness
It’s plain to see
That is what they mean to me
Madness, madness, they call it gladness, ha-ha

Number Crunching

This tweet has gained popularity.

“£4,563,350,000 of aggregate short positions on a ‘no deal’ Brexit have been taken out by hedge funds that directly or indirectly bankrolled Boris Johnson’s leadership campaign” ( Carole Cadwalladr)

I took a look at the article referred to in the Byline Times and if you read it then it conflates being short the UK Pound £ with being short individual shares which is bizarre. Next it has no mention at all of any long positions these companies may have.

Is this a reinvention of Bitcoin or just another passing phase?

Over the past few weeks there has been something of a rave from the grave going on in financial markets. If we look at the news then maybe John Lennon was partly right with his “About a lucky man who made the grade” if that man or indeed woman is a holder of Bitcoin. This is how @fastFT has reported it.

The price of bitcoin soared to its highest level since January 2018, as the cryptocurrency’s recent rally shows little signs of fizzling out. In Asian trading hours on Wednesday, the price of bitcoin traded on the Bitstamp exchange rose as much as 10 per cent to as high as $12,935.58, putting the digital currency on track for its biggest one-day jump in more than a month. Bitcoin’s price pulled back to just under $12,600 in afternoon trading.

So it is back at least for now and the June futures contract on the Chicago Mercantile Exchange is doing better than that because it is at US $12,990 as I type this and peaked at US $13,172.5 overnight. If we look back we see that it did not pass US $4000 until latish in March and US $6000 on the 9th of May. If we return to @fastFT we are told this.

Bitcoin’s value has now jumped for the last eight trading sessions in a row, bringing its overall return for the year to 250 per cent. Still, the digital currency remains some way below its peak of more than $19,000 reached at the end of 2017.

The current position provokes two thoughts. Firstly as a pure chart it reminds me of the “bowl theory” taught to me some years back by a colleague. It is not complex in that you simply draw a bowl shape around such a rise and it predicts that when any fall breaks the line you will see a sharp drop which is both fast and large. Putting it another way the rally needs to keep accelerating to survive as the bowl curve gets steeper.

On the other side of the coin the mention of the US $19,000 peak reminds me of this from the 11th of December 2017.

Bitcoin is in the “mania” phase, with some people even borrowing money to get in on the action, regulator Joseph Borg said. “We’ve seen mortgages being taken out to buy bitcoin. … People do credit cards, equity lines,” he said. Bitcoin has been soaring all year, starting out at $1,000 and rocketing above $19,000 on the Coinbase exchange last week. ( CNBC )

That “madness of crowds” phase when people borrowed to get in on the previous rise, which sadly was the time in fact to get out.

What has driven this?

One factor has been the turn in expectations for monetary policy around the world. We have seen some actual interest-rate cuts by the Reserve Banks of India, Australia and New Zealand as well as hints from the US Federal Reserve and the European Central Bank or ECB. The general expectation for the latter has moved to more QE being announced in September as well as a deposit rate cut. The latter may be more significant here because whilst only a small change of 0.1% is expected it will take it further into negative territory. That would be no surprise for us on here as we have been expecting another phase in the “war on cash” but I think the acceleration in Bitcoin has been affected by that view spreading. After all if we look back many “ECB Watchers” were telling us interest-rates would rise in 2019.

Whilst Bitcoin is priced in US Dollars and the explicit effect on it will be the fall in the US Treasury ten-year yield to 2% I also think that the emergence of this has had a strong impact.

GERMAN 10-YEAR BOND YIELD FALLS TO -0.330%, NEW RECORD LOW ( @DeltaOne)

For that we had to look all the way back to yesterday.

Oh and there is an odd link here because the countries which have cut interest-rates recently are the ones doing best in the cricket world cup.

The Libra Factor

The environment changed with this announcement from Facebook.

The mission for Libra is a simple global currency and financial infrastructure that empowers billions of people. Libra is made up of three parts that will work together to create a more inclusive financial system:

  1. It is built on a secure, scalable, and reliable blockchain;
  2. It is backed by a reserve of assets designed to give it intrinsic value;
  3. It is governed by the independent Libra Association tasked with evolving the ecosystem.

This shook things up in two main ways. Firstly in terms of psychology and awareness. Secondly that a big player in the online world was giving things a push. Of course, Facebook is not what it was ( if you have never seen the millennial job interview where she defines it as something her parents look at I recommend that you do….), but nonetheless it remains a significant player.

Back to the central banks

They have been quickly on the Libra case as this from Reuters highlights.

“A wider use of new types of crypto-assets for retail payment purposes would warrant close scrutiny by authorities to ensure that they are subject to high standards of regulation,” Quarles said ahead of a summit of Group of 20 countries in Japan this week.

Governor Carney of the Bank of England raised the topic at his Mansion House speech last week also.

As designed, Libra may substantially improve financial inclusion and dramatically lower the costs of
domestic and cross border payments.The Bank of England approaches Libra with an open mind but not an open door.

Much of that is public relations flim flam as a genuinely successful cryptocurrency would be like Kryptonite is to Superman for central banks. Not only would it challenge their monopoly over money it would further challenge the business model of “the precious” and frankly there is not much of it left as it is.

So they will be sitting in an ivory tower version of Mount Doom plotting to stop any version of their ring of power being thrown into the fire.

Comment

As we observe the situation we can learn a few lessons. For example I have seen some arguing that Bitcoin is a safe haven but that is only true on the rallies it has seen. In another form that relates to one of the functions of money which is to be a store of value. That is hard to argue if we look at the money chart below.

There are clear phases where it has destroyed value.

If we move to another function which is medium of exchange then the Libra plan offers clear hope for the future. Should Facebook push this then it could easily break new ground and get the cryptocurrency world into the ordinary persons life. Maybe it will help with it being a unit of account which is the area where most ground needs to be made.

So the outlook has brightened but there are two warning signs. Firstly the chart pattern and the bowl theory logic which suggests that the only way is not up. Next is the issue of past revolutions. For example the Victorians had a great success with railways leading to all sorts of things including proper timekeeping across the UK. But it is also true that many of the companies involved went bust.

Where next for the world of Bitcoin?

The world of Bitcoin and indeed all the other altcoins has seen quite a reversal as 2018 has progressed. The days of “free money” have gone and they have been replaced by this according to MarketWatch.

Bitcoin is breaking all sorts of records at the moment, most of them unwanted, and in a few days it will equal a milestone not matched in four years.

Not since October of 2014 has the price of bitcoin   seen four consecutive monthly declines, and a negative close for the month of November, which now seems a foregone conclusion, would match this feat having fallen every month since August, according to Dow Jones Market Data.

So a clear change although in the fast moving world of Bitcoin it is still over ten times higher than it was back then. If anything the fall seems to be picking up the pace.

After opening November above $6,500, bitcoin is down more than 40%, and since the four-month streak began on Aug. 1, the value of the world’s most famous digital currency has more than halved.

As I type this the Bitcoin price is at US $3763.7 which is down some US $282 or a bit under 7%. I note that just to add to the confusion there is also now a Bitcoin Cash. This was created by a fork out of Bitcoin.

Bitcoin cash was one of the marvels of the bitcoin bubble. It is a fork from bitcoin. A fork of a cryptocurrency takes place when someone, anyone declares that a blockchain is going to be transferred to a new set of rules and network infrastructure. ( Forbes)

It did lead to what was free money for a while.

When the fork came out, bitcoin did not fall and bitcoin cash went through the roof rising from the low hundreds to shoot quickly above $1,000. It was free money for bitcoin holders who could get their hands on their bitcoin cash by navigating the technical issues, which were mighty. ( Forbes)

But the gains were short-lived.

The central bankers revenge

From a central banking point of view the altcoin world is a disaster as they have no power to set interest-rates and no control over the total amount of it. Even worse it bypasses “the previous” and in the bull market days saw very heavy disinflation as the price of goods and services became much cheaper. At the limit it would make them be an anachronism and then irrelevant.

John Lewis of the Bank of England put it like this on the 13th of this month.

Existing private cryptocurrencies do not seriously threaten traditional monies because they are afflicted by multiple internal contradictions. They are hard to scale, are expensive to store, cumbersome to maintain, tricky for holders to liquidate, almost worthless in theory, and boxed in by their anonymity. And if newer cryptocurrencies ever emerge to solve these problems, that’s additional downside news for the value of existing ones.

There are of course issues there but being “almost worthless in theory” is a critique that could be pointed at central bank fiat currencies which also rely on an act of faith to have value. Also the bit about new companies would have applied to the proliferation of railway companies back in the day. Whereas we know that whilst many failed the railways are still with us. Those suffering commuters who use Southern Rail may wish that they didn’t but they do.

Let us look at his paradoxes or as he might have put it seven deadly sins.

The congestion paradox

But cryptocurrency platforms are different. Their costs are largely variable, their capacity is largely fixed. Like the London Underground in rush hour, crypto platforms are vulnerable to congestion: more patrons makes them *less* attractive.

The storage paradox

Each user has to maintain their own copy of the entire transactions history, so an N-fold increase in users and transactions, means an N-squared fold increase in aggregate storage needs.

The mining paradox

Rewarding miners with new units of currency for processing transactions leads to a tension between users and miners.  This crystalises in Bitcoin’s conflict over how many transactions can be processed in a block. Miners want this kept small………But users want the exact opposite: higher capacity, lower transactions costs and more liquidity, and so favour larger block sizes.

The concentration paradox

This starts in intriguing fashion.

 97% of bitcoin is estimated to be held by just 4% of addresses, and inequality rises with each block.

However this critique is also applicable to the central banking enthusiasm for higher house prices and the “wealth effects”

An asset is valued by the market price at which it changes hands. Only a fraction of the stock is actually traded at any point in time. So the price reflects the views of the marginal market participant.

You can’t all sell at once and certainly not at that price. The list below is somewhat breathtaking in the circumstances.

But for cryptos they are much larger because i)Exchanges are illiquid ii) Some players are vast relative to the market iii) There isn’t a natural balance of buyers and sellers iv) opinion is more volatile and polarised.

As central banks have sucked liquidity of out markets with their actions, for example the Japanese government bond market has often been frozen, the opening point is a bit rich. Ditto point ii) if we look at the size of central bank balance sheets and of course there was no natural balance between buyers and sellers when they surged into markets. For example some of the recent turmoil in the Italian government bond market has been caused by the “unnatural” buying of the ECB being reduced. As to the last point, well maybe, but so many things are polarised these days.

The valuation paradox

The puzzle in economic theory is why private cryptocurrencies have any value at all.

Fiat currencies anyone?

The anonymity paradox

The (greater) anonymity which cryptocurrencies offer is generally a weakness not a strength. True, it creates a core transactions demand from money launderers , tax evaders and purveyors of illicit goods> because they make funds and transactors hard to trace.

This is both true and an attempted smear. After all the recent money laundering spree undertaken in the Baltics by customers of Danske Bank seems to have been at 200 billion Euros or so much larger than the altcoin universe in total.

Of course for a central banker it needs central bankers.

 Keep a cryptocurrency far from regulated institutions and you reduce its value, because it drastically restricts the pool of willing transactors and transactions. Bring it closer to the realm of regulated financial institutions and it increases in value.

The innovation paradox

Perhaps the biggest irony of all is that the more optimistic you are about tomorrow’s cryptocurrencies, the more pessimistic you must be about the value of today’s.

Odd though that this sort of logic is not applied to forward guidance.

Expect it to be worthless in the future, and it becomes worthless now.

Comment

There is a lot to consider here and let me start by offering some sympathy for those who did this back in the day. From CNBC.

Bitcoin is in the “mania” phase, with some people even borrowing money to get in on the action, regulator Joseph Borg said. “We’ve seen mortgages being taken out to buy bitcoin. … People do credit cards, equity lines,” he said. Bitcoin has been soaring all year, starting out at $1,000 and rocketing above $19,000 on the Coinbase exchange last week. ( CNBC )

Hard to believe that was the 11th of December last year as it feels like a lifetime ago. Also yes I do feel sorry for them even though it was pretty stupid. A fortnight or so earlier we were looking at some of the issues above.

That statement is true of pretty much every price although of course some have backing via assets or demand. So often we see a marginal price used to calculate a total based on an average price that is not known………This leaves us with the issue of how Bitcoin functions as a store of money which depends on time. Today’s volatility shows that over a 24 hour period it clearly fails and yet if we extend the time period so far at least it has worked rather well as one.

As to the store of value function that still holds as early buyers have still done really rather well but more recent ones have taken a bath and a cold one at that. Looking ahead it does not look as though the market has capitulated enough to find the ground to rally, But in the background there are still flickers of good news.

Ohio appears set to become the first state to accept bitcoin for tax bills, a show of support for a technology that has garnered lots of hype but failed to gain traction as a form of payment. ( WSJ)