By Kevin Muir of the Macro Tourist
One of the biggest pushbacks about my theory that inflation is the real worry for the markets, not deflation, is the argument that there is no demand for credit, and therefore, inflation will never be able to take root. There can be no denying that Central Bankers throughout the world have had much more difficulty creating inflation than they would have ever guessed. Draghi and Kuroda would have never predicted it would take negative rates and doubling their balance sheets every couple of years to stabilize their economies, nevertheless, this is where they find themselves.
Take a moment to think about the insanity of their policies.
First look at Japan’s short term rates. Negative at the front of the curve, and pegged to zero at the 10 year mark.
Then, consider the rate of Bank of Japan balance sheet expansion.
When it comes to Europe, like Mike Myer’s Saturday Night Live skit “Sprockets”, the ECB has experimented with some pretty weird stuff, pushing short term rates to asinine negative levels.
And the ECB’s pace of balance sheet expansion over the past year, would even scare Sprockets’ host Dieter.
At this point my skeptics will say, so what? We have seen this movie before, and each time, the money has not made its way into the financial system, so it ends up sitting inert on the banks’ balance sheets. And these doubters would not be wrong. Ever since the 2008 Great Financial Crisis, monetary policy has been pushing on a string. As Central Banks have shoved credit into the economy, the velocity of money has sunk, keeping the money supply from expanding rapidly.
While many believe this has solely resulted from of a lack of demand for credit, I take the opposing view. After the 2008 crisis, regulators cracked down on banks. Determined to never let it happen again, government officials introduced an array of rules designed to limit banks’ ability to lend too aggressively. Whether it was stricter BIS Basel III rules or US regulatory crack downs, banks were under pressure everywhere to limit lending. Recall JP Morgan’s Jamie Dimon’s 2015 comments:
“Banks are under assault. We have five or six regulators coming at us on every issue… you have to ask how American that is.”
Although Jamie was complaining about the “American-ness” of this regulatory assault, it was by no means limited to the United States. Throughout the world, the mantra of “never again” limited the effectiveness of easier monetary policy.
And this tightening of the private sector’s ability to create credit was the main reason for the falling monetary velocity over the past decade. I understand that private sector demand for credit was shaken after the 2008 crisis, but countries whose banking system were less scarred (such as Canada and Australia), saw a tremendous willingness to borrow. And even in countries like the United States, areas of the economy where credit was extended, such as automobiles or student loans, have experienced plenty of borrowing.
Ironically, the desire to regulate and ensure the global economy would never suffer another crisis like 2008, forced the Central Banks to engage in the extraordinarily easy monetary policy. Had money velocity not fallen so precipitously, monetary policy would have been more effective, and therefore much less easing would have been necessary.
Now you might argue Central Banks should not have tried to goose the economy. That’s a perfectly valid point. But that means about much as the nice old lady in the supermarket checkout line telling you that she was once quite a dish. Sure, it might be true, but it doesn’t do much for you today.
What Central Banks should have done is completely irrelevant. If you want to argue about the theoretical best path for monetary policy, go find some economics professor’s blog. I am only interested in what was done, what will be done, and what that means for the market.
And it is quite obvious Central Banks are no longer afraid of expanding their balance sheet. They have decided they can always stop inflation later, but that deflation is the foe they need to fight today.
Which brings me back to my most cited criticism. Everyone, and I mean everyone, is convinced that between demographics, technological innovation and overbuilding of supply, there is zero chance inflation will return. But their main point is often, who is going to borrow?
Yeah, I understand their arguments. But this line of thinking reminds me what the famous chaos trader Dr. Ian Malcolm said in that great movie, Jurassic Park:
John, the kind of control you’re attempting simply is… it’s not possible. If there is one thing the history of evolution has taught us it’s that life will not be contained. Life breaks free, it expands to new territories and crashes through barriers, painfully, maybe even dangerously, but, uh… well, there it is.
Throw enough cheap money at the problem, and people will find a way. I can’t tell you where. I can’t tell you when. But I am confident that eventually, people will borrow.
Almost no one recognized the extent of the real estate problems in the 2000s until after the fact. Of course, now everyone thinks it was obvious, but it was anything but.
And the fact that everyone believes inflation will never return, is the very reason it will return. That complacency is why we can have such extreme monetary policies.
The other day, one of my readers, Mehul Daya from Nedbank CIB in South Africa, sent me a link to this terrific Bloomberg piece. I had missed it, and although it is a small article, I can’t stress enough how important it is. The article titled, “How China’s Biggest Bank Became Wall Street’s Go-To Shadow Lender” highlights the rise of Industrial & Commercial Bank of China as the biggest player in the US repo market.
High up in a New York City skyscraper, China’s biggest bank is playing in the shadows of American finance.
The prize for Industrial & Commercial Bank of China Ltd. isn’t stocks, bonds or currencies. It’s the grease in the wheels of all those markets: repurchase agreements.
By exploiting a loophole in rules intended to keep U.S. banks from getting “too big to fail,” the state-owned ICBC has become a go-to dealer in repos in just a few short years, alongside longtime powerhouses like Goldman Sachs Group Inc. The short-term loans allow investors to borrow money by lending securities, serving a vital role in day-to-day trading on Wall Street.
ICBC’s rise reflects not only China’s global ambitions in high finance, but also how post-crisis rules have let a whole host of new players profit from the murky world of shadow banking, largely beyond the reach of bank regulators. As big banks face tougher standards, they’re being replaced by brokers, asset managers and foreign firms like ICBC, which can use more leverage and take greater risks. That has some regulators worried non-bank lenders are once again emerging as a threat to financial stability, less than a decade after panic in the repo market wiped out Lehman Brothers.
“The concern is that non-bank dealers are becoming a larger part of the repo market,” said Benjamin Munyan, who specializes in shadow banking and regulation at Vanderbilt University’s Owen Graduate School of Management. “These intermediaries are outside the scope of our traditional Federal Reserve safety net.”
I am not suggesting that Chinese banks will fuel the next inflationary boom through a burgeoning repo book. I don’t know if they will or they won’t.
I just know that if the price of money is set too low, the private sector will find a reason to borrow. I don’t have a clue how they will do that. And I don’t know how low is too low, so it could be that we still aren’t there yet.
But I do know that Central Banks are intent on reflating the global economy, and that there will be many more stories such as “Chinese banks engaging in US repo to exploit regulatory constraints” in the future. I don’t buy the idea that Central Banks are incapable of stimulating the private sector to borrow. Like most things in life, it’s just a question of price, and these Central Banker knobs seem willing to pay whatever it takes.Subscribe to NFTRH Premium for your 40-55 page weekly report, interim updates and NFTRH+ chart and trade ideas or the free eLetter for an introduction to our work. Or simply keep up to date with plenty of public content at NFTRH.com and Biiwii.com. Also, you can follow via Twitter @BiiwiiNFTRH, StockTwits, RSS or sign up to receive posts directly by email (right sidebar).