China Credit and Global Inflationary Dynamics

By Doug Noland

Credit Bubble Bulletin: China Credit and Global Inflationary Dynamics

February 14 – Bloomberg: “China added more credit last month than the equivalent of Swedish or Polish economic output, revving up growth and supporting prices but also fueling concerns about the sustainability of such a spree. Aggregate financing, the broadest measure of new credit, climbed to a record 3.74 trillion yuan ($545bn) in January… New yuan loans rose to a one-year high of 2.03 trillion yuan, less than the 2.44 trillion yuan estimate. The credit surge highlights the challenges facing Chinese policy makers as they seek to balance ensuring steady growth with curbing excess leverage in the financial system.”

Like so many things in The World of Finance, we’re all numb to Chinese Credit data: Broad Credit growth expanded a record $545 billion in the month of January, about a quarter above estimates. Amazingly, last month’s Chinese Credit bonanza exceeded even January 2016’s epic Credit onslaught by 8%. Moreover, as Bloomberg noted, “The main categories of shadow finance all increased significantly. Bankers acceptances — a bank-backed guarantee for future payment — soared to 613.1 billion yuan from 158.9 billion yuan the prior month.”

February 14 – Bloomberg: “China’s shadow banking is back in full swing. Off-balance sheet lending surged by a record 1.2 trillion yuan ($175bn) last month… Efforts by the People’s Bank of China to curb fresh lending may have prompted banks to book some loan transactions as shadow credit, according to Sanford C. Bernstein.”

Yet this was no one-month wonder. China’s aggregate Credit (excluding the government sector) expanded a record $1.05 TN over the past three months, led by a resurgence in “shadow” lending. According to Bloomberg data, China’s shadow finance expanded $350 over the past three months (Nov. through Jan.), up three-fold from the comparable year ago period.

Friday from Bloomberg: “White House Chaos Doesn’t Bother the Stock Market.” Many are confounded by stock market resilience in the face of Washington discord. Perhaps it’s because global liquidity and price dynamics are currently dictated by China, the BOJ and the ECB – rather than Washington and New York. Eurozone and Japanese QE operations continue to add about $150bn of new liquidity each month. Meanwhile, Chinese Credit growth has accelerated from last year’s record $3.0 TN (plus) annual expansion.

February 14 – Bloomberg (Malcolm Scott and Christopher Anstey): “Forget about Donald Trump. The global reflation trade may have another driver that proves to be more durable: China’s rebounding factory prices. The producer price index has staged a 10 percentage-point turnaround in the past 10 months, posting for January a 6.9% jump from a year earlier. Though much of that reflects a rebound in commodity prices including iron ore and oil, China’s economic stabilization and its efforts to shutter surplus capacity are also having an impact.”

China’s January PPI index posted a stronger-than-expected 6.9% y-o-y increase. A year ago – back in January 2016 – y-o-y producer price inflation was a negative 5.3%.  It’s worth noting that China’s y-o-y PPI bottomed in December 2015 at negative 5.9%, the greatest downward price pressure since 2009. In contrast, last month’s y-o-y PPI jump was the strongest since August 2011 (7.3%). China’s remarkable one-year inflationary turnaround was not isolated in producer prices. China’s 2.5% January (y-o-y) CPI increase was up from the year ago 1.8%, matching the peak in 2014.

There are two contrasting analyses of China’s record January Credit growth. The consensus view holds that Chinese officials basically control Credit growth, and a big January confirms that Beijing will ensure/tolerate the ongoing rapid Credit expansion required to meet its 6.5% 2017 growth target (and hold Bubble collapse at bay). This is viewed as constructive for the global reflation view, constructive for global growth and constructive for global risk markets. Chinese tightening measures remain the timid “lean against the wind” variety, measures that at this point pose minimal overall risk to Chinese financial and economic booms.

An opposing view, one I adhere to, questions whether Chinese officials are really on top of extraordinary happenings throughout Chinese finance, let alone in control of system Credit expansion. Years of explosive growth in Credit, institutions and myriad types of instruments and financial intermediation have created what I suspect is a regulatory nightmare. I seriously doubt that PBOC officials take comfort from $1.0 TN of non-government Credit growth over just the past three months.

Continue reading China Credit and Global Inflationary Dynamics

A Trade Deficit is Never a Problem

By Steve Saville

It’s not just Donald Trump. Many political leaders around the world operate under the misconception that a trade deficit is a problem to be reckoned with. This misconception has been the root of countless bad policies over the centuries.

Trade, by definition, is not an adversarial situation resulting in a winner and a loser. Rather, both parties believe that they are benefiting, otherwise the trade would not take place. Most of the time, both parties do benefit. In general, one side wants a particular product more than a certain quantity of money and the other side wants the quantity of money more than the product. When the exchange takes place, both sides get the thing to which they assign the higher value at the time.

All the hand-wringing about international trade deficits is based on the ridiculous notion that the side receiving the money is the winner and the side receiving the product is the loser, but how could this be? If the side receiving the product was losing-out then it wouldn’t enter into the trade. Furthermore, given that today’s money is created out of nothing, if a trade were to be viewed as a win-lose situation then surely it’s the side receiving the product that should be viewed as the winner.

That being said, I don’t want to confuse the argument by asserting that it makes sense to view the side receiving the product as the winner in the exchange of money for product. Both sides are winners, because both sides get what they prefer at the time of the exchange.

For example, if you shop at Wal-Mart then you run a trade deficit with Wal-Mart. Is this trade deficit a problem for you? Obviously not, otherwise you wouldn’t shop there. Would it make sense for the government to step in and slap a tax on all Wal-Mart products, thus forcing you to buy less products from Wal-Mart and thereby reducing your trade deficit with that company?

Some will claim that a trade deficit is only a problem when it happens between different countries, but countries aren’t entities that trade with each other. People trade with each other, and political borders don’t determine what is and isn’t economically beneficial. If John and Bill have been trading with each other for years to their mutual benefit within the same political region, placing a political border between them wouldn’t mysteriously alter the mutually-beneficial nature of their trading.

Another point that should be understood is that a “trade deficit” for a country results in an investment surplus for that country. The reason is that the monetary surplus on the trade account doesn’t disappear or get placed under a mattress, it gets invested in securities (stocks and bonds), real estate, businesses and projects. A trade deficit therefore isn’t associated with a net flow of money out of the economy, it is associated with a re-routing of money within the economy. There is no good reason to expect that this re-routing will lead to a net loss of jobs. In fact, the opposite is the case.

Unfortunately, while a so-called trade deficit is not a problem, the taxes, tariffs, subsidies and other government measures that are implemented to reduce a trade deficit definitely do cause problems.

Bubbles, Money and the VIX

By Doug Noland

Credit Bubble Bulletin: Bubbles, Money and the VIX

February 10 – Financial Times (John Authers): “The Importance of Bubbles That Did Not Burst:”

“Is there really such a thing as a market bubble? I feel almost heretical answering this question. I and most readers have lived through two decades that were dominated by two vast investment bubbles and the attempt to deal with their consequences when they burst. Getting into definitions is beside the point. As US Supreme Court Justice Potter Stewart once said to define pornography: ‘I know it when I see it.’ And there is no point in arguing that the dotcom bubble that came to a head in 2000, or the credit bubble that burst seven years later, were not bubbles. I know a bubble when I see one, and they were bubbles. For those of my generation, spotting bubbles before they get too big, and thwarting them, seems to be vital for regulators and investors alike.”

“But in a great new compendium on financial history, several writers make the same points. The number of bubbles in history is very small. That makes it hard to draw any valid inferences from them. Further, definition is a real problem, and not just one for linguistic nitpickers. History’s acknowledged bubbles all have one critical factor in common; they burst. But that gives us a one-sided view. We need to look at those bubbles that did not burst and the crises that did not happen.”

We’re at the stage where there’s impassioned pushback against the Bubble Thesis. To most, it’s long been totally discredited. Even those sympathetic to Bubble analysis now question why the current backdrop cannot be sustained. “The number of bubbles in history is very small.” Most booms did not burst. So why then must the current boom end in crisis – when most don’t? It has become fashionable for writers to try to convince us that such an extraordinary backdrop need not end extraordinarily.

There’s great confusion that I wish could be clarified. I define Bubbles generally as “a self-reinforcing but inevitably unsustainable inflation.” There are numerous types of Bubbles. Most definitions and research (as was the case with the analysis cited by the FT’s Authers) focus specifically on asset prices (“an extreme acceleration in share prices. In one version, [Yale’s Will Goetzmann] required them to double in a year — which excluded the dotcom bubble and the Great Crash of 1929. To keep them in, he also tried a softer version where stocks doubled in three years”).

Behind every consequential Bubble is an inflation in underlying Credit. My analysis focuses on the nature of the monetary expansion responsible for the asset inflation. I’m less concerned with P/E ratios and valuation than I am Credit expansions and the nature of risk intermediation. Earnings are important, but more critical to the analysis is the degree to which they (and “fundamentals” more generally) are being inflated by monetary factors – and whether such inflation is sustainable or susceptible.

Credit Dynamics are key. Mr. Authers refers to the “dot.com” and “Credit” Bubbles. Yet the nineties Bubble was fueled by extraordinary expansions in GSE Credit, securitizations and corporate debt. Internet stocks inflated spectacularly, but in the grand scheme of the Bubble were rather inconsequential. The Bubble faltered initially in 2000 with the sharp reversal in technology stocks. Less embedded in memory is the near breakdown in corporate Credit back in 2002. The resulting aggressive Fed-induced reflation then spurred a doubling of mortgage Credit in just over six years. The transformation of risky Credit into perceived safe money-like securities (“Wall Street Alchemy”) was integral to both “tech” and “mortgage finance” Bubble periods. The fact that dot.com price inflation and overvaluation greatly exceeded that of home prices is meaningless.

When I initially titled my weekly writings the “Credit Bubble Bulletin” back in 1999, I anticipated that “Bubble” would remain in the title only on a short-term basis. And indeed, I thought the Bubble had burst in 2000/2001 and then again in 2008. But in both instances Credit Dynamics and resurgent monetary inflation made it clear to me that a more powerful Bubble had reemerged. Whether one prefers to date the beginning of the Great Credit Bubble 1992, 1987 or even 1971, it’s been inflating now for quite a long time. Too be sure, the expansion of government Credit over the past eight years puts mortgage Credit and other excesses to shame. I would argue that price distortions and risk misperceptions similarly overshadow those from the mortgage finance Bubble period.

Of course, the vast majority have become convinced that the boom is sustainable. Indeed, analysis these days is eerily reminiscent of “permanent plateau” jubilation from 1929. The bullish perspective sees an improving global economy and a powerful pro-growth agenda unfolding in the U.S. Worries about debt, China and such matters have turned stale. A contrary argument focuses on Credit Dynamics and the unsustainability of today’s unique monetary and market backdrops.

Over the years, I’ve made the point that a Bubble financed by junk bonds would not create a systemic issue. There are, after all, limits to the demand for high-risk debt. Long before such a boom could go to prolonged and dangerous extremes (imparting deep structural maladjustment), investors would shy away from increasingly unattractive Credit issued in clear excess. The boom would lose its monetary fuel.

I define contemporary “money” as a financial claim perceived as a safe and liquid store of (nominal) value. Money these days is Credit, but a special type of Credit. Unlike junk bonds, “money” enjoys essentially insatiable demand. As such, a boom fueled by “money” is a quite different animal than our above junk bond example. I would posit that a prolonged inflation of perceived safe “money” by its nature ensures far-reaching risk distortions. For one, Bubbles fueled by “money” appear especially sustainable, while a prolonged inflation of “money” virtually ensures a destabilizing crisis of confidence. Governments throughout history have abused money. Contemporary central bankers took it to a whole new level.

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Slapped in the Face by the Invisible Hand

By Danielle DiMartino Booth

Slapped, Danielle Dimartino Booth, Fed Up: An Insider's Guide to why the Federal Reserve is Bad for AmericaFor those of you who subscribe to the Wall Street Journal, please link on to today’s story on the book: A teaser in the form of a quote from Richard Fisher who the Journal interviewed for the article. “The book’s greatest value is in describing ‘the hubris of Ph.D. economists who’ve never worked on the Street or in the City, as well as flagging the protected culture of Fed officials in Washington. Many central bankers are, ‘not going to like the book.”

Former Fed Staffer Says Central Bank Is Under the Thumb of Academics, Wall Street Journal

Not that Mr. Fisher asked for an answer. But to those who ‘don’t like it,’ I say, “So be it.” With that, please enjoy an excerpt from Fed Up, Chapter 11: Slapped in the Face by the Invisible Hand.


You want to put out the fire first and then worry about the fire code.”  — Ben Bernanke, December 1, 2008

Among the economists at the Dallas Fed, Bernanke’s optimism prevailed. The Bear Stearns rescue was the punctuation mark that ended the paragraph. Bernanke would trim the sails to right the foundering ship.

I disagreed. The demise of the Bear was a flashing red light that shouted “danger.” My colleagues rolled their eyes.

Rosenblum treated me with a new respect. The chain of events was playing out as I had predicted. He and I began collaborating on a paper on moral hazard. It would make Rosenblum no fans at the Board of Governors.

The bailout both relieved and alarmed the financial press.

The Economist wrote that the Fed was “taking the unprecedented (and, some say, disturbing) step of financing up to $30 billion of Bear’s weakest assets. This could cost the central bank several billion dollars if those assets fall in value.”

The fear of the unknown prompted the Fed, for the first time ever, to extend lending at its discount window to all bond dealers.

Under previous rules, only institutions offering depository insurance or under strict regulatory oversight were allowed to use the discount window, paying a penalty fee for the privilege. Now any distressed investment bank, broker, or commercial bank was allowed to come, hat in hand, to use the window.

The Economist expressed skepticism at this development, saying that fear persisted because the “new Fed window is untested and the very act of drawing on it could rattle markets.” No bank wanted to be perceived as the next sick buffalo.

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Solutions Require Good Data

By Jeffrey Snider of Alhambra

There were no surprises in the updated JOLTS estimates for December 2016, just more of the same sideways. The level of Job Openings was 5.501 million (SA), practically unchanged from November’s 5.505 million. The BLS estimates that Job Openings have been stuck at around that level since April 2015. In terms of Hires, that series, too, was practically unchanged in December from November (5.25 million vs. 5.21 million) and more or less sideways all the way back to October 2014.

From this data we can further assume that the near-recession in 2015-16 was as significant as the term sounds, as the actual economic process penetrated the BLS data in ways that the 2012 slowdown did not. Illustrating this difference in severity is the year-over-year comparison in the rate of monthly hiring activity.

December was the fourth consecutive month of comparatively lower levels, and five out of the last eight months. The 6-month average is down to near zero, suggesting that whatever happened overall in that period of “global turmoil” was enough to bring the US economy to a halt if not quite into full-blown contraction.

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U.S. Exorbitant Privilege at Risk?!

By Axel Merk

If the road to hell is paved with good intentions, American’s exorbitant privilege might be at risk with broad implications for the U.S. dollar and investors’ portfolios. Let me explain.

The U.S. was the anchor of the Bretton Woods agreement that collapsed when former President Nixon ended the dollar’s convertibility into gold in 1971. Yet even when off the remnants of the gold standard, the U.S. has continued to be the currency in which many countries hold their foreign reserves. Why is that, what are the benefits and what are the implications if this were under threat?

Let me say at the outset that the explanation I most frequently hear as to why the U.S. dollar is the world’s reserve currency – “it is because of tradition” – which is in my opinion not a convincing argument. Tradition only gets you so far – it ought to be policies and their implementation that guide investors.

Wikipedia’s definition of exorbitant privilege includes:

“The term exorbitant privilege refers to the alleged benefit the United States has due to its own currency (i.e., the US dollar) being the international reserve currency.[..]

Academically, the exorbitant privilege literature analyzes [..] the income puzzle [which] consists of the fact that despite a deeply negative net international investment position [NIIP], the U.S. income balance is positive, i.e. despite having much more liabilities than assets, earned income is higher than interest expenses.”

In the context of today’s discussion, I would like to focus on what I believe may be the most under-appreciated yet possibly most important aspect of the so-called exorbitant privilege: what makes the U.S. so unique is that it is de facto acting as the world’s bank. A bank takes on (short-term) deposits and lends long-term, capturing the interest rate differential.

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The Wrath

By Doug Noland

Credit Bubble Bulletin: The Wrath

It’s not the first time that a non-farm payrolls rally wiped away inklings of market anxiety. Coming early in the month – and on Fridays – the jobs report typically makes for interesting trading dynamics. By the end of another interesting week, the timely reemergence of “goldilocks” along with Trump The Deregulator were propelling stocks higher. Long forgotten were Monday’s “Stocks Fall Most in Month…” and “Trump Rally Hits Speed Bump on Immigration Concern.” Indeed, markets were grateful to let a number of developments slip from memory.

It’s still worth mentioning a few indicators that were beginning to lean away from “Risk On”. Prior to Friday’s jump, the powerful bank stock rally had stalled. The BKX was down almost 2% from Thursday to Thursday (Italian and Japanese banks down 3.4% and 2.9%). Small cap stocks have underperformed, with the Russell 2000 down slightly y-t-d as of Thursday’s close. Many “Trump Rally” stocks and trades have recently underperform. Equity fund flows were negative for three straight weeks. In high-yield debt, the rally had similarly lost momentum. Also noteworthy, Treasuries rallied only tepidly on Monday’s equity market selloff. European bonds continue to trade poorly (Greek yields up 33 bps; French spreads to bunds widened another 10bps). This week saw bullion jump $29. The dollar Index is now down 2.5% y-t-d.

The dollar/yen has for a while now been a key market indicator. After trading as low as 101.2 on election night market drama, Trump-induced king dollar euphoria had the dollar/yen surging to almost 119 by early January. The dollar/yen traded down to almost 112 on Thursday, to a two-month low. And similar to Treasuries, the dollar/yen these days struggles to participate during “Risk On” days. Trading slightly higher Friday, the yen jumped 2.2% against the dollar this week.

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The Three Ds That Spell Risk & Opportunity

By Capitalist Exploits

Yesterday we discussed the lurking dangers of a standard portfolio theory, when markets are mispricing assets.

Today, we’ll take an incisive look at the rapidly converging three “Ds” of risk, and the once in a lifetime opportunity they create:

Debts, Demographics, and Deflation.

Balloons:

Ever held a balloon underwater?

The further we push it down the greater the pressure.

As soon as you let it go we know what happens. The change in the size of the balloon is nonlinear and the balloon increases in size at an exponential rate.

The same thing happens when asset prices are artificially held either too low or too high. The asymmetry builds just as pressure inside the balloon builds.

The greater the mispricing of assets, the greater the asymmetry and the greater the risk to a standard portfolio theory approach. To say that assets are mispriced today would be like saying Godzilla is just a little monkey.

Global assets have never been more mispriced in history. This has to do with the fact they are priced off of benchmarks, the most notable being the US 10 year treasury. What’s important to understand is that the pricing of the US 10 year bond and in fact every sovereign bond cannot be the true market price.

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A Dubious Monetary Backdrop

By Doug Noland

Credit Bubble Bulletin: A Dubious Monetary Backdrop

Now that was one eventful week. President Trump wasted not a minute in making good on a series of campaign promises. A bevy of executive orders moved to rein in Obamacare, withdraw from Trans-Pacific Partnership (TPP) trade negotiations, tighten immigration, cut regulation and advance the Keystone Pipeline. No earth-shattering surprises there. Perhaps more startling, Team Trump had yet to even unpack before broaching radical notions such as abandoning America’s strong dollar policy, imposing a 20% border tax on imports from Mexico and opening direct confrontation with the media. Friday evening from the WSJ: “Trump’s First Week: Governing Without a Script.”

At least for this week, I’ll leave it to others to pontificate on the economic merits of Trump policymaking. Dow 20,000 is testament to the market’s ongoing fixation with tax reduction and reform, de-regulation and imminent fiscal stimulus. There were enough disquieting developments this week to dent confidence, though break-out bullish exuberance proved resilient. Unwavering faith in the course of central banking surely underpins the markets, confidence that I expect to be challenged in 2017.

My focus – one that the world now largely neglects – is on unsound global finance. It’s such an extraordinary backdrop – in all things monetary, in politics, geopolitics and the markets. Yet it is anything but a new experience for speculative markets to disregard latent financial fragilities. And we’ve witnessed in past episodes the capricious nature of market psychology. There’s something to glean from each one.

I think back to the summer of 1998. Markets were surging to record highs, led by monster advances in bank and financial stocks. The mantra was “the West will never allow Russia to collapse” – certainly not after the devastating Asian Tiger debacle. The simultaneous autumn implosions of Russia and LTCM not only punctured the financial Bubble, they almost brought down the global financial system.

Bolstered by “The Committee to Save the World” and all the Fed’s Y2K histrionics, powerful Bubble reflation saw Nasdaq almost double in 1999. Fear somehow just vanished as greed took full control. The U.S. was the indisputable leader of the free-world; there was an unassailable New Paradigm of technology-induced prosperity; America was the vanguard of technological revolution; and the dollar was unconditional king. With the clairvoyant Maestro leading U.S. and global central bankers, the New Millennium was destined to be the golden age of prosperity. Naysayers were tarred and feathered, yet that didn’t change the harsh reality that finance was fundamentally unsound.

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Bi-Weekly Economic Review

By Joseph Calhoun of Alhambra

Economic Reports Scorecard

Well it’s time to get back in the habit of doing this every two weeks. The schedule was interrupted over the holidays and then again by my annual outlook piece.

The economic data released over the last two weeks was not particularly inspiring, not that hard data is what has been egging on the old animal spirits. That’s a decidedly political phenomenon not to be found yet in the economic statistics. Whether the political rhetoric will ever translate to actual improved economic growth is something I can’t answer just yet because I have no idea what policy changes will make the cut. Whatever we see out of the data today – with the exception obviously of sentiment measures in all its varieties – is not anything that can be credited or blamed on the new administration.

But back to the data. We’ve been getting what I’ve called mixed data for several years now. Good reports contradicted by bad ones, sometimes within the same press release. That is a product of the long period we’ve had of sub-par growth, running a bit less than 2% currently. The last two weeks continues this dismal trend of two steps forward and two steps back. The Labor Market Conditions index returns to negative territory while jobless claims dip into territory not seen since bell bottoms were in vogue. The JOLTS report shows lots of job openings with apparently no one qualified to fill them. But there doesn’t seem to be a surge in wages – a small recent rise notwithstanding – to support the notion that companies are scrambling to fill positions. There’s no urgency there.

Whatever workers are finding in their pay packets, they don’t seem anxious to spend it; retail sales ex-autos and gas were reported as a big old goose egg, 0.0% month to month and a sub-3% yoy rate. That’s confirmed by rising inventories at the wholesale and retail levels and inventory to sales ratios ticking up a tenth. Inventory to sales numbers had been moderating since the summer but now may be starting to move in the wrong direction again. Q4 GDP may get a boost from that but Q1 will see the payback, same as it ever was, same as it ever was (HT: Talking Heads). Maybe the punk sales are because inflation continues to tick higher with both PPI and CPI up 0.3% on the month. CPI is now above the Fed’s 2% inflation target although they don’t use CPI so as far as they’re concerned we aren’t there yet.

At first glance Industrial Production looked like a positive note but a huge rise in utility output – cold weather – accounted for most of the gain of 0.8%. The improved sentiment we see in all the Regional Fed Surveys – Philly Fed and Empire State the most recent – doesn’t seem to be making it to the factory floor. Housing starts were much better than expected at 1.226M, up 11% from November. But then the details show the entire gain was in multi-family while single family starts were actually down. Housing has been going sideways for months and this report didn’t change it a bit. Again, sentiment, in the form of the Housing Market Index, is outpacing reality. One can’t help but wonder how long that particular bubble can last.

Continue reading Bi-Weekly Economic Review