Even during the height of economic crises, we have rarely seen such a wide divergence in opinion in modern history, whether it involves a diagnosis of the economy, the near-term direction of interest rates and stock markets or measures to be taken, and they are all reduced to a "theological" schism between the Keynesians and the Chicago Boys.
But what is most shocking is the lack of coherency in the comments made by key officials, which can only muddy the debate about a solution which is not as complicated as all that.
BIS's comments off the wall
Let's take a look at a study published by the Bank for International Settlements, which I had the pleasure of reading this weekend: The future of public Debt: prospects and implications..
Aside from the fact that the above report further nourishes general fears of a hike in long-term government interest rates, due to huge budget deficits far into the future, including off-balance sheet commitments (retirement) and the temptation to monetarize debt (also see Interest Rates Have Nowhere to Go but Up in the Saturday edition of the NYT), the really striking thing about this report is that it offers no solution. Moreover, its theoretical foundations are more than debatable, which is disappointing for an institution of its stature.
Check out these revealing excerpts (emphasis mine).
After defending in the opening paragraphs the decisions to dramatically increase the budget deficits of OECD countries in the past 24 months (decline in tax receipts and counter-cyclical actions), the writers affirm:
This leads us to conclude that the question is when markets will start putting pressure on governments, not if.
When, in the absence of fiscal actions, will investors start demanding a much higher compensation for the risk of holding the increasingly large amounts of public debt that authorities are going to issue to finance their extravagant ways?
While providing little evidence to support their case, they merrily present a hike in long-term rates as inevitable ("when, not if"), due to budget deficits, while leaving aside Japan's example.
And after explaining the need for such deficits earlier in the report, they refer to the government's "their extravagant ways"! Given this disdainful characterisation of the counter-cyclical budget measures used to fight the depressive fall-out from the Great Financial Crisis, the reader is left with little doubt as to the direction of the rest of the study.
It follows that the fiscal problems currently faced by industrial countries need to be tackled relatively soon and resolutely.
Failure to do so will raise the chance of an unexpected and abrupt rise in government bond yields at medium and long maturities, which would put the nascent economic recovery at risk.
It will also complicate the task of central banks in controlling inflation in the immediate future and might ultimately threaten the credibility of present monetary policy arrangements.
So they would have us believe that we must immediately attack the budget deficits, at the risk of provoking a double dip; otherwise we may see an "unexpected and abrupt rise" in long-term government bond yields.
Feeling no need to explain cases contradicting their assertion, they appear quite sure of themselves!
While making short shrift of the problems this would create for central bank efforts to control inflation, their contention cannot stand up to the Japanese example, which, on the contrary, has proven unable to control … deflation.
While fiscal problems need to be tackled soon, how to do that without seriously jeopardising the incipient economic recovery is the current key challenge for fiscal authorities.
In this paper, we do not address this issue, but we note that, in our view, an important part of any fiscal consolidation programme is measures to reduce future liabilities such as an increase in the retirement age.
They are kind enough to admit that an immediate and steep reduction in the budget deficit would imperil the nascent economic recovery, but the offer no path to accomplish such budget cuts!
All in all, the only positive point about this report is its emphasis on the need to deal with the retirement, an issue we will discuss later, but one has to ask what good their alarmist about long-term rates will have.
In Japan, still stuck in the Deflation Trap
We see another illustration of the prevailing confusion with last night's statement by Japanese Finance Minister Naoto Kan who, feeling the heat from a more restrictive central bank than is generally realised, came out with a hilarious idea for pulling his country out of the deflation trap:
The biggest reason why Japan has been mired in stagnation and deflation in the past 20 years is that "money is not circulating" since the asset bubble of the late 1980s was burst.
Within the government, we agree that in order to close the (negative) output gap, some fiscal spending is needed, but there is no consensus as to whether it should be financed solely by issuing government bonds or also using tax reform
A tax hike could actually help us overcome deflation if you spend (the higher tax revenue) in the right way... if it helps circulate money,
If this gentleman can come up with a way of hiking taxes so as to increase money circulation (?!), without sending his country into the economic pits, like during the sad case of the VAT hike in 1997, all I can say is bravo!
In the meantime, our favourite Post-Keynesian and as infallible as ever indicator, the volume of outstanding bank loans in the economy, posted a new contraction, this time by 1.8% y-o-y in March, the steepest annual decline in four years! Japan's March Bank Loans Fall Most in 4 Years.
And yet, the BoJ continues to drag its feet, with its still incomprehensible rigidity on a QE, which causes it to limit the amount of JGB to buy to the amount of bank notes in circulation!
This reminds me of the deflationist wave created by some countries' blind adherence to the Gold Standard in the 1920s. Take a look at this very good text on this topic by Nobel Economist Robert A Mundell which I believe should get a lot more attention : Mismanagement of the gold standard.
This sadly recalls the comments by Patricia Hagan Kuwayama at the Columbia University Center on Japanese Economy and Business and J.P. Morgan in 1997, “Comments on Japanese Economic Policy” :
Monetary policy is at its easiest setting ever, and everyone knows it must be "normalized" before long.
Timing a rate hike is a tough judgment call: Industry is well on with recovery ...
In Europe, is the Greek tragedy truly solved?
The information revealed this weekend by the EU about the loan amount and terms to be granted Greece is good news, although we remain doubtful about what are still usurious interest rates (5% for 3 years) for an economy in the throes of Debt Deflation when the main creditor, Germany, is paying 1.40% during the same period.
But the most troubling part of this agreement is that to activate the loan, it will require unanimous support from eurozone member states which, considering the reactions in Germany following the plan's announcement, remains a big question mark:
Finance Ministry spokesman Michael Offer:
There is “no automatic link” between yesterday’s “technical agreement” and Greece getting aid.
Frank Schaeffler, deputy finance spokesman for Merkel’s Free Democrat junior coalition partners:
Germany buckled under the pressure -- we shouldn’t kid ourselves that such loans are anything but subsidies.
The loans would hurt the euro, help Greece only temporarily. We would be standing on very thin ice, legally, economically.
And this morning, German government spokesman, Christoph Steegmans, chimed in:
Greece will only receive financial aid from its Eurozone peers if it cannot meet its funding needs on financial markets anymore.
This decision position remains unchanged
No activation of Greece aid for now.
Greece aid requires EU leaders decision.
Nothing decided on likehood of Greece aid.
This raises the question as to what the Germans really want at this time, if we assume that the have a coherent and stable view of the problems and solutions with which Europe must contend?
In the United States, some weird figures…
Regular readers here know how seriously we take the study of changes in the bank lending to the economy, particularly the statistical series dealing with commercial and industrial loans (BloombergALCBC&IL) granted by American banks which, as we have constantly pointed out, have been continuously contracting in the past 18 months, in line with the debt deflation process dear to Irving Fisher.
Commercial and industrial loans: 2001-2010
But what really shocked me is that, after coming across the following text:
Commercial and industrial loans at U.S. commercial banks in March fell at a 17.9 percent annual rate, the Federal Reserve said in release today.
In February, the business loans, considered a gauge of economic activity, declined at a 16.4 percent rate.
The decline in commercial and industrial lending has slowed in recent months, the figures showed. In December and January they declined by 20.1 percent and 27.6 percent respectively.
I then went to check out these changes in absolute as opposed to percentage terms, given the deforming base effects we have seen in these statistical series in the past 18 months.
The first surprising observation is that there was a real rebound in this credit category (seen in circle in graph) in the last week of March, which I would tend to view as good news to be viewed in light of the "improvement" on the employment market and other assorted greenshoots.
Commercial and industrial loans: 2008-2010
Given my propensity to dig a little deeper into this sort of "recovery" statistics, my second surprise was the to note the incredible rebound in total credit granted by American banks, as described by the Bloomberg ticker, ALCBBKCR.
Total bank credit in the US: incredible rebound??
This hike seems impossible, unless the American bank balance sheets have grown $420bn in a single week.
After digging a little deeper, I came across my third surprise: this hike is mainly due to a third loan category, those for consumption (ALCBLLCN), which surged $370bn in one week, up 44.7%!
And, finally, after digging even deeper into this rabbit hole, I found the icing on the cake:
the 98.50% surge in credit card loans totalling $328bn in a single week! (ALCBLLCC)
As if total credit card loans in the US could double from one week to the next, when a 10% rise for the year is already enormous!
Consumer credit and credit cards: really?
I think it has been hard enough to project the course of the economy in recent months without having to contend with such weird figures. I can only wonder what's on the other side of the mirro?
The worst of it is that these figures come straight from the Fed's site: Publication of Percent Changes on the H.8 Release.
I have asked for more information but have not received a reply for the time being.
If someone can provide an explanation which holds up to scrutiny (aside from statistical error by the Fed or a conspiracy theory), he wins a year's free subscription to the Thaler's Corner. J
And too late, I have just learned that the balance sheets of the remaining SIV banks have been integrated via the adoption of new FASB rules 166 AND 167 (see link below)!
The Death of Securitisation will continue for some time to come.
As for the $23bn rebound in commercial and industrial loans, the most important point is that, once you remove the $32.3bn in loans for SIVs, which in no way constitute the creation of new loans, these loans in fact contracted again, this time by $9.3bn.
This amounts to about a 30% y-o-y decline in March, which is really a bad number!
Have a good day.
Asset allocation biases:
- Interest rates : We consider that history is still on the side of flattening, and our choices in maturities and structures, below, brings an added measure of protection, as long as German government spokesmen can keep their mouths shut for a while.
- Equities: Sorry about the still murky stock markets which, on the other hand, can be seen in the very low implied volatility levels of Eurostoxx options. The opportunist switches (long or short) against long option positions (calls or puts), carried out in recent days, are working out very well (gamma + Véga)!
Disclosure: Long 20 years OAT and 30 years BTP Zero Coupons, EDF Corp 5 Years 4.5%, Grece 2 Y and 10 Y bonds