The year in focus – From doves to hawks, the story of central bankers, political silliness and the markets
The year began with Congressmen agreeing that there was no way they were going to agree, about funding, and delaying the key decision for another day.
One has to feel sorry for the can; never in the field of human affairs has one object been kicked by so many.
In January the debate on bonds and equities was in full flow
Here it was stated: “Apologies to your grandma, who I am quite sure is most adept at sucking eggs, but, just to remind you, back in the first half of the 20th Century the yield on bonds was lower than equity dividends. But ever since the late 1950s, the relationship has been the other way round. Inflation provides a partial answer. If you fear inflation, equities make sense as their dividends should rise with inflation, whereas the yield on bonds is fixed. On the other hand, if you fear deflation then bonds may make more sense.”
On the one hand, QE is pushing up on bonds, making equities look cheap. On the other hand, is QE just creating a bubble?
Just bear this in mind. There is an awful lot of cash sloshing around the economy that is not being spent – $1.5 trillion on US company balance sheets. This money is sloshing around, and ends up pushing up the price of bonds, and because governments are not spending the money the markets want to lend them, GDP is leaking out of the economy. QE is an attempt to reverse this.
Barroso says existential threat to the Euro is over
Did you know French seagulls are all existentialists? You know this because if you listen to them very carefully you can hear them squawk: “PourQUOI!? PourQUOI!?” Okay, that joke may not work when seen in the written form, but trying say it out loud, and try to sound like a seagull as you screech them.
It seems therefore that French seagulls will understand European Commission President José Manuel Barroso, who in January said that the existential threat to the Euro is over.
It is certainly the case that the euro seems less likely to fall apart now than it did two years ago.
But with certain euro countries still in depression, and with the euro not helping, it is tempting to ask: why is saving the euro such a good idea? But why? Why?
Monetise debt and the idea for a trillion dollar coin
So if it is the case that money that is saved but not invested just falls out of the economy, like a golden apple nugget bar from a bulging basket of fruit, then does it not make sense for central banks to print an amount of money equal to that which is disappearing, and hand it out to all.
And while US politicians failed to agree on US debt, one idea doing the rounds was for the US government to mint a one trillion dollar platinum coin – something which the US constitution appears to allow.
Can you imagine Barack and the boys in the White House feeling a bit peckish during one of those late night meetings. So they send Michele out to grab some pizzas. “Pick up some money from petty cash darling,” says Barack. So the first lady arrives at the pizza restaurant, and says to the cashier: “I hope you you’ve got lots of change by the way, I only have a trillion dollar coin.”
It turns out that this is not how it would have worked. Instead the idea is to deposit the coin with the Fed, and then the US government can withdraw money against it. So, by doing this, the US government would have created one trillion dollars to fund its spending, quite literally out of nothing.
Spain pulls out of recession, but PM denies bribery
In the third quarter of this year Spain grew by 0.1 per cent. Unemployment is awful, but at least the PMIs are improving, and now we know that Spain has exited recession.
But in February its Prime Minister Mariano Rajoy was accused of bribery. He denied everything, or sort of denied everything. He has been linked with a corruption scandal. He, along with numerous other members of Spain’s Popular Party, has been accused of accepting payments in return for supporting the award of state construction contracts to a Spanish construction company.
Mr Rajoy said: “Everything that refers to me, and that appears there, and to some of my fellow party members that appear there, is not right, except for something that the media has published.” Maybe it is just a translation problem, but it does feel a bit like saying all the accusations are false with the exception of those that are not false.
But then he was also quoted as saying: “Never, and I repeat, never have I received, nor distributed black money.” That seems pretty unambiguous, unless that is he added the suffix under his breath: “except for those occasions when I did.”
Draghi and the Maradona theory of interest rates
Somehow Mari Draghi has to persuade the markets that he is doing all that is necessary to stop the euro from rising, without actually doing anything.
These days many are saying that Mr Draghi practises what’s called the Maradona theory of interest rates. What’s that exactly?
Well here is what Mervyn King said on this topic, back in 2005.
“The great Argentine footballer, Diego Maradona, is not usually associated with the theory of monetary policy. But his performance against England in the World Cup in Mexico City in June 1986 when he scored twice is a perfect illustration of my point. Maradona’s first ‘hand of God’ goal was an exercise of the old ‘mystery and mystique’ approach to central banking. His action was unexpected, time-inconsistent and against the rules. He was lucky to get away with it. His second goal, however, was an example of the power of expectations in the modern theory of interest rates. Maradona ran 60 yards from inside his own half beating five players before placing the ball in the English goal. The truly remarkable thing, however, is that Maradona ran virtually in a straight line. How can you beat five players by running in a straight line? The answer is that the English defenders reacted to what they expected Maradona to do. Because they expected Maradona to move either left or right, he was able to go straight on.”
So there you have it. Mario Draghi does nothing, but the markets are so convinced he is going to act that they behave as if he is doing what they he should rather than what he does do. Roll on the Messi theory of interest rates, or the David Beckham theory of fiscal stimulus.
Russian billionaires wince
Russia seems to be in the ascendance, what with Putin supposedly having come out of the Syrian crisis smiling, being all nice and friendly to the Ukraine, and even, out of the kindness of his heart, giving a pardon to Mikkail Khodorkovsky.
But spare a thought for those who are still Russian billionaires. On the whole they are a nice bunch. They must be because they are partly funding the Russian winter Olympics.
But the cost is going up. Latest estimates are coming in at $50 billion. That seems a bit pricy. In comparison the London Olympics were a kind of bargain basement games. The last winter Olympics in Canada cost around $3.6 billion.
The thing is that the Russian government has made it known that it is in the interests of these billionaires to invest in the games. One contractor put it this way: they were told it would be a “good idea to help out.”
When Mr Putin suggests something is a good idea, it is usually considered to be a good idea to agree with him if you are Russian.
Does BP agree with that, do you think?
The AA Milne theory of the tiger economies
In March, they started to worry about Asia.
Back in the 1990s the talk was of the tiger economies. Then 1997 happened. They went from tiger to Tigger and then everything went to Pooh.
It all went wrong, when Alan Greenspan increased the US rate of interest in the mid-1990s. Money that had been flowing into Asia, so-called hot money, went into reverse.
The Asia crisis of 1997 was nasty. For us in the West it was like dry rehearsal of what happened in 2008. For those in Asia, 2008 was like a pale shadow of what happened in 1997.
But now the Fed is slowly moving to tightening. It may take a while, but rates will rise eventually. What will happen in Asia, and indeed across the emerging world?
India and Turkey seem to be getting investors worried. South East Asia is not safe, but bear in mind that Indonesia and the Philippines have very strong fundamentals.
EU wants to limit bonuses
A text book on business might say: bonuses good (because they are a variable cost); salaries bad (because they are fixed).
Except when it comes to bankers, bonuses seem to be more like a fixed cost.
The EU has this idea to limit bankers’ bonuses to no more than 100 per cent of salary. But will it lead to higher salaries, and thus overheads?
Boris Johnson was not so keen on the idea. But don’t you just love the way the ‘Sunday Times’ reported Johnson’s words: “Boris Johnson, London Mayor… said: ‘This is possibly the most deluded measure to come from Europe since Diocletian tried to fix the price of groceries across the Roman Empire.’”
So the paper felt the need to explain who Boris Johnson is, but not Diocletian. It recalls memories of of those instructions you get sometimes – you know, they go into minute detail about how to open the box, and then skate over the bit that is hard to understand.
Maybe it would have been more appropriate to say Boris Johnson, who studied classics at Oxford, said: “This is … the most deluded measure…from Europe….since Diocletian (a former Roman Emperor who tried but failed to tackle inflation via price controls) tried to fix the price of groceries across the Roman Empire.”
Abe’s three arrows
Japan’s prime minister Shinzo Abe has this plan involving three arrows.
Thwack, arrow one: fiscal stimulus. Thwack, arrow two: labour market reforms.
Thwack arrow three: massive monetary stimulus. And to help him Japan’s PM has enlisted Haruhiko Kuroda to head the country’s central bank.
Do you remember when Mario Draghi said: “We will do whatever it takes?” When the president of the European Central Bank said those words, the markets loved it. In fact Mr Draghi said: “Within our mandate, the ECB is ready to do whatever it takes to preserve the euro. And believe me, it will be enough.”
Mr Kuroda said at his confirmation hearing: “[We] must clearly send out the message… that it will do whatever it can to beat deflation.”
It has paid off, sort of. GDP has picked up, the Nikkei 225 has a very good run – up from 10,395 at the beginning of the year to 15,870 at the time of writing (24 December 2013).
But watch out for the arrow that may backfire, or is that a boomerang? 2014 will see Japan’s consumption tax shoot up. It may go some way to solving the Japanese government’s debt crisis, or it may send the economy back into recession.
Dow passes an all-time high
In March the Dow hit a new all-time high. It began the year at 13104, and at the time of writing stands at 16,221. But how much of this is down to QE?
In fairness, the US economy is growing at a pretty brisk pace (4.1 per cent annualised in Q3). At least some of the rises in the Dow seemed to be supported by fundamentals.
Italy enjoys good news, or is that good(ish) and only relatively?
News from March: The Italian economy contracted by 0.9 per cent in Q4 last year, but that is being hailed as good.
Household spending fell 0.7 per cent, which may not sound very good to you, but for Italy, that was in fact the smallest fall since the middle of 2011. Exports were up by 0.3 per cent.
At this rate Italy may be over the worst by the turn of the century.
Alas, the more timely surveys point to contraction as bad as ever.
Meanwhile, in France, industrial production was down 1.2 per cent in January, which was the fourth contraction in the last five months. You don’t need a Nobel Prize to see that France is entering a very tricky phase; you just need not to be French.
Latest news in Q1, Q2 and Q3 of this year:
Italy’s growth was -0.6, 0.03 and -0.1 per cent.
In France, growth was -0.1, 0.5 and -0.1 per cent.
In Spain, growth was -0.2, -0.4 and +0.1 per cent.
Mervyn King’s words
“I think that during the course of 2013 we will see the recovery come into sight,” said the Bank of England’s governor in March. During the latter period of his time as Bank of England’s governor, Mervyn King added: “If you take away what happened in the North Sea oil production and in construction, the UK economy last year grew by 1.5 per cent.”
Well he was right, but he understated it. The UK grew 1.9 per cent year on year in Q3.
In fact the Bank’s governor came pretty close to uttering those dangerous words: green shoots. Poor old Norman Lamont, he once used the that phrase to describe baby plants that are coloured a kind of bluish yellow as a metaphor for the economy, and his credibility was never the same again. Many years later, after the ONS had finished revising its data, Lamont was proven right, but by then no one cared, and the view that the former chancellor was hopelessly out of touch was permanently etched onto the British psyche.
Still, it didn’t prevent Norman becoming Baron Lamont of Lerwick. Do you think Mervyn King will become his lordship one day? His lordship, the King, they might say.
Cyprus bank bail-out
And so in March Cyprus nearly went bust. The EU said it would help, but only if depositors at banks took some of the pain.
That idea didn’t go down that well.
And eventually the plan was watered down so that only depositors with more than 20,000 euros had to take a hit.
And as the penny dropped that money in banks was not all that safe, some people said: ‘Maybe we need another type of penny.’
Enter stage right the Bitcoin.
It may be the biggest bubble since tulips, but it sure isn’t controlled by banks.
November 27: Bitcoin passes $1,000; in early 2011 they were trading at $2. By the end of the year they were trading at $30. Why didn’t you buy them at the beginning of this year, when they were trading at $13? Last night, their value passed $1,000. Of course, you might as well ask: why didn’t you choose the winning lottery tickets this week? The rise in value of bitcoins was obvious, but only after the event.
December: China’s central bank warned that Bitcoins carried substantial risk, and then the biggest Bitcoin exchange in China said it has stopped accepting new deposits. And, by the way, last week China’s central bank issued rules to stop financial institutions in China dealing with the so-called virtual currency.
$1.4 trillion sitting on US balance sheets
$1.4 trillion. That is how much cash is sitting on the balance sheets of companies across the US, or so Moody’s calculated in April. This cash mountain has grown by 10 per cent over the last year.
It’s a gross figure by the way – that’s cash, before taking off debt. But then Moody’s figures show that US companies have enough cash to meet all debt payments over the next five years.
Other might agree with the description that $1.4 trillion is gross, but have in mind a different meaning of the word gross.
Buffett and Soros: were they just lucky?
Talking of gross, Bill Gross had something interesting to say in April. He was using his investment outlook publication, which he rather introspectively calls ‘Man in the Mirror’, to make his pronouncement. “All of us,” he said, “even the old guys like Buffett, Soros, Fuss, yeah – me too, have cut our teeth during perhaps a most advantageous period of time, the most attractive epoch that an investor could experience…perhaps it was the epoch that made the man as opposed to the man that made the epoch.”
Gross is, of course, the bond king; Soros the king of shorting currencies; and Buffett… well, he is just the king, or perhaps the god emperor of finance. But Gross said: “There is not a Bond King or a Stock King or an Investor Sovereign alive that can claim title to a throne.”
Errors found in economic bible
Austerity economics has its bible, and now we have found out that this tome may not be gospel after all.
The book is called “This time is Different.” It was written by Carmen Reinhart and Kenneth Rogoff and is one of the most often quoted economics books published over the last decade or so. It has been referred to here many times.
The book looks back over what it calls eight centuries of financial folly, and draws one pretty unequivocal conclusion: whenever government debt rises over 90 per cent of GDP, growth is adversely affected.
Now a new paper by Thomas Herndon, Michael Ash, and Robert Pollin from the University of Massachusetts looking into the data contained within “This Time is Different” has questioned the accuracy of the data used. For one thing they say the data is weighted so that it puts more emphasis on a year of contraction than a year of growth. In other words, ignore all the good bits and things look really bad. For another thing, the data apparently misses out New Zealand from the equation, and New Zealand enjoyed both high growth and high government debt. For a third thing, they say that US growth after World War II fell for some pretty unusual reasons – women pulling out of the workforce being one, and therefore the link between government debt and GDP for this era may not be valid.
Put together all these apparent discrepancies, say the critics, and the premise that government debt over 90 per cent of GDP correlates to slower growth is no longer correct.
In May, Reinhart and Rogoff told the ‘FT’: “To be clear, no one should be arguing to stabilise debt, much less bring it down, until growth is more solidly entrenched.” They added: “A higher borrowing trajectory is warranted, given weak demand and low interest rates, where governments can identify high-return infrastructure projects. Borrowing to finance productive infrastructure raises long-run potential growth, ultimately pulling debt ratios lower. We have argued this consistently since the outset of the crisis.”
Bankers are not demons – May
This may come as a shock, but if you were to shave a banker’s scalp, the numbers 666 would not be revealed. At least that is the gist of what Mervyn King said.
“I would say to people though, don’t demonise individuals here. This wasn’t a problem of individuals; this was a problem of failure of a system. We collectively allowed the banking system to become too big, we gave them far too much status and standing in society, and we didn’t regulate it adequately by ensuring it had enough capital,” he said.
To some people, this may seem like a controversial thing to say because they reckon that eternal damnation is what bankers need.
It is a puzzle why no one has suggested throwing them in water, and to then observe whether individual bankers sink or swim, with sinking meaning they are innocent and swimming meaning they are witches.
The big grey thing is otherwise known as QE.
May 22 Bernanke in double hint
Early on in the day, 22 May, Fed Chairman Ben Bernanke had the air of a man in a dovish mood. By the end of the day the Fed had a distinctly hawkish look about it.
This is how the story unravelled.
First off, Mr Bernanke was having a jolly good natter with the congressional Joint Economic Committee. He acknowledged that “a long period of low interest rates has costs and risks,” but said “a premature tightening of monetary policy could lead interest rates to rise temporarily but would also carry a substantial risk of slowing or ending the economic recovery and causing inflation to fall further.” So that was Bernanke the dove.
Then the minutes from the latest Fed meeting – or FOMC which is the Fed’s equivalent of the Bank of England MPC – were revealed. The minutes stated that “despite some softness in recent economic data…a number [of FOMC members] expressed willingness to adjust the flow of purchases downward as early as the June meeting.”
Arch bear predicts equity bull run
Nouriel Roubini, also known as Doctor Doom and being famous for his bearishness – the economics professor who called the US sub-prime crisis pretty much spot on – has said the equity rally will continue for two more years.
“Let us be clear. We have intentionally blown the biggest government bond bubble in history. That’s where we are now. We have to be vigilant to the consequences of that bubble deflating.” And with those words Andrew Haldane made it official.
And if you are going to open a can of worms, why not open another one while you are at it. Mr Haldane also said that cyber security was a key issue for financial stability and that the Financial Policy Committee had lacked “clarity and decisiveness” when it initially made recommendations about bank capital. He said: “We should have done a better job of explaining the significance of this package.”
June 19, Bernanke in rate rise warning
Ben Bernanke said that if things continued to improve, the Fed will reduce QE later this year (September being the likely month), cease it altogether next year, and that interest rates may go up in 2015.
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