First, I would like to make a point about my apparently obsessive compulsive need to closely monitor the credit aggregates in the United States, European and Asia, sometimes to the consternation of some long-time Thaler's readers.
Everything always begins with the simple equation, MV=PQ, which we have used in recent years to construct our inflation and economic growth projections and, thus, our asset allocation scenarios.
As for this photo below, I couldn't resist this reference to the Cadillac purchased by Milton Friedman after he developed MV=PQ, seen on his license plate.
The big problem with this equation is the real time appreciation of V, money velocity, which the Malthusian monetarists have made the monumental mistake of generally considering as stable, which flies in the face of common sense.
Indeed, even if we exclude the desire for safety which pushes many to increase the cash component of their assets when interest rates are at their lowest levels since the beginning of the Great Financial Crisis, it serves as a strong incentive for investors to keep an even larger proportion of assets in cash.
The difference in yields between classical risk-free securities (money market funds at 0.10%, 2-year German Shatz at 0.50%) appears to be too low for the time being to warrant any conversion of this liquid cash into money market securities.
Cash is King takes on all its meaning when the economy is confronted with deflation to such an extent that the visibility of 0% interest rates encourages investors to farthest yield on the curve.
This explains why 10-year yields in Japan have been averaging 1.45% since 1998.
In the meantime, the concentration of assets in cash slows V, since money is now longer circulating.
Consequently, the stalling of V, which we have been monitoring for the past two years, has left the hyperinflation theories of the dollar printing presses paranoids in a shambles, and the consensus is struggling to recognise the strength of the real deflationary trends.
The concern is that, in practice, V is seen only a posteriori, via the inversion of the equation's variable: V = (PxQ)/M, i.e. GDP divided by money supply.
Given the hit to US GDP in 2008 and the Fed's subsequent stimulus to M2, it is easy to imagine the effect on V.
Calculated in this way, it has been fluctuating between 1.90 and 2.15 since 1993, and it is now just 1.70. A decline of around 15% on this variable is hardly insignificant.
With this time gap in mind, I have emphasized the importance of the credit aggregates, because they are the best way to gauge the real-time behaviour of V, with all the conclusions that may be drawn on P (inflation-deflation) and Q, (growth-recession).
We have received plenty of fresh data on these matters in recent days. I will thus provide you today with some graphs which (almost) speak for themselves.
Eurozone M3 + Core CPI + ECB Balance Sheet.
The lowest core CPI ever, with M3 growth still negative: unprecedented!
(Click to enlarge)
M3 money supply data in Europe were released this morning (-0.1% YOY, still declining), once again falling below ECB targets. I added in this graph the slope of the ECB, which indicates the degree of quantitative easing applied, although it refuses to use the term.
Since once does not a trend make, check out this delicious comment from the Bundesbank:
The inflation projections made on the basis of monetary data continue in the aggregate to indicate that there exists no pronounced danger for price stability in the euro area for the next three years.
I dare not imagine what the CPI curve would look like if the ECB had not applied unconventional measures (long-term refis, purchases of covered bonds and then government bonds). As such, this reinforces my opinion that, regardless of the cries of outrage by Weber and Stark, the ECB will go still farther and stronger.
The MR Draghi tries to burnish his image as a hawk in the midst of the campaign to replace Mr Trichet changes nothing. Just consider what ECB Governor and President of the Bank of Ireland Mr. Honohan has to say:
The bank’s government bond purchases as an “important” new weapon in its armory and said any risks associated with the policy are being managed.
- The decision “was exactly the right kind of prompt initiative” needed.
- It’s not in the normal course of the ECB’s traditional approach to a toolbox, but it’s not outside the range of the toolbox of standard central banking around the world in history.
Then consider Mr. Makuch, the Slovakian ECB member:
The euro is very close to fundamentals, it is a good exchange rate, supporting our exports.
I am happy with the rate.
And then a word from Mr. Trichet:
Sterilization of the interventions is meant to "guarantee" that the monetary policy stance of the ECB is not affected.
The weekly sterilisation announced with so much fanfare is nothing more than a political masquerade to reassure those who yearn for the Deutschmark; the sums injected by this bond buying programm would have been sterilised anyway, at lower cost, on the daily deposits of commercial banks at the ECB.
- The debt-purchasing program thus should not be confused with quantitative easing. In simple words: we are not printing money.
For once, I can only applaud this statement: The ECB is not printing money. The bonds purchased remain on the ECB's balance sheet; they pay coupons and will be paid at par value, excluding a sovereign accident, and even in such an extreme case, we will have even less to worry about inflation!
But the most important aspect of the data published yesterday is the behavior of credit -- ergo the headline to today's Thaler's Corner -- with the loans granted by eurozone commercial banks to non-financial businesses in the area.
Down another extra €14bn in April, or -2.6% YOY, that brings the correction for this credit category to 4.80% since January 2009, which is also unprecedented.
In order to make the transition with the same type of US data published this weekend, let's take a look at the graph, below, illustrating the change in these loans and their equivalent in the US, Commercial and Industrial loans.
Change from previous week: May-05 May 12 May 19 ($bn)
Large Domestic Bank Credit -17.5 11.2 -21.3
Commercial & Industrial Loans,Leases -4.0 -0.2 -2.3
Loans to the real economy in Europe and the US
Deleveraging in the US was much more brutal.
(Click to enlarge)
Moreover, the teeny weeny rebound in March 2010 was simply the result of the regulatory integration of some remaining SIVs in bank balance sheets.
In the graph below, we get a bird's eye view of these same C&I loans, but only those granted by commercial banks.
C&I Loans in the US and large Banks, according to recessions
The contraction today has been faster and harsher than those experienced in previous recessions.
(Click to enlarge)
Below, we have another stress factor in the United States, which played a role in the plunge in V: the interbank loans and repo operations carried out by American banks.
Interbank loans and Repos in the USA
We have reverted back 15 years, as banks do not lend and money does not circulate.
(Click to enlarge)
And, for the icing on the cake, the Money Multiplier, as defined by the St. Louis Fed:
The M1 multiplier is the ratio of M1 to the St. Louis Adjusted Monetary Base. The ratio is Seasonally Adjusted.
If the money multiplier is below one, that means that for each dollar increase in reserves, the money supply is increasing by less than one dollar.
Money Multiplier of the Saint Louis FED
A nightmare of inefficiency with respect to the money supply arm. What happened to V?
(Click to enlarge)
As such, we have no reason to be surprised by the latest comments by Chicago Fed President, Mr. Evans, in Seoul:
The Federal Reserve can maintain its effort to stimulate the U.S. economy and support the banking system through its "large" balance sheet for an extended period.
- A period that may be extended even more should the situation worsen.
- The situation in Europe is "a small additional uncertainty" that will mean US exports will be weaker than expected. That's going to dampen the recovery a little bit.
- Inflation in the US is under-running what I would term price stability.
And then we have the confirmation of this situation by the Bureau of Economic Analysis:
· The chain-type price index for personal consumption expenditures (PCE) core measure is up 1.2 percent year over year, the smallest annual increase in the series' 50-year history, save a matching data point in September 2001.
In Asia, Japan continues to be confronted by its deflationist demons, as reiterated this morning by BoJ Governor Masaaki Shirakawa:
Japan needs a combination of efforts on two fronts to beat deflation -- the BOJ will maintain its very easy monetary policy "persistently" and both the authorities and private-sector should work toward raising public expectations for higher economic growth.
· (I) reject the notion that expanding a central bank's balance sheet alone would push up prices
- Japan's own experience of conducting quantitative easing from 2001 till 2006 supported the banking sector but did not boost depressed prices.
- Japan's economy could decline if developments in fiscal conditions in Greece and other economies further intensify strains in international financial markets or exert downward pressure on the global economy.
- Also, the consequences of balance-sheet adjustments in the United States and Europe continue to demand vigilance.
And, to wrap up, only China is confronted by the opposite problem (for the time being), as authorities try to resolve their Minsky ladder problem by administrative means:
A number of commercial banks have temporarily suspended loans to local government finance vehicles, the official China Securities Journal reported Monday.
- China’s State Council said last week that it will step up control of local government financing vehicles amid concerns about the debt burden of local governments.
- No official figure has been published on total Chinese government debt from the central, provincial and local governments. However, Victor Shih, assistant professor of political science at North-western University in the United States, has estimated that the figure may total about CNY3.9 trillion by 2011, or approximately 96% of GDP.
Asset allocation biases and advised option strategies
- Our macro and thus long-term biases remain downward on government debt yields and negative on risky assets (equities and European real estate, commodities, etc.). This entails a deflation/depression scenario, which requires a lot more effort from the ECB than a shame-faced QE.
- Our short-term and thus more tactical biases are now neutralized, since the cacophony of ECB members…
Disclosure: Author long 20 years OAT and 30 years BTP Zero Coupons, EDF Corp 5 Years 4.5%, Grece 2 Y and 10 Y bonds