Archive
August Hangover
Don’t begin to worry, just yet, about the continued low volumes. It isn’t unusual, following a long weekend, for the first day back to still be sluggish. People are catching up with e-mail, greeting friends (friends which, in Europe at least, they may not have seen for a month or more), and so on.
And anyway, we should put today’s light volume – 599 million shares on the NYSE – in context. The average for all of last month was only 581 million shares, and only 544 million for the last half of the month. Only eight days in August were busier than today’s total, and three of those were the FOMC meeting day, the last day of the month, and Employment day. That’s slim solace if you’re a broker, I am sure, but brighter and busier days are ahead. In fact, proximately ahead.
European bonds rallied strongly as details of the ECB’s plan to buy Eurozone bonds were leaked; ECB President Draghi told the European Parliament in a “closed door” (but apparently open-mic) session that the ECB simply must buy bonds because the traditional instruments of monetary policy are ineffective. “We cannot pursue price stability now with a fragmented euro area because changes in interest rates affect only one country, or two countries at most. They have no importance whatsoever in the rest of the euro area.” It is true that to a man with a hammer, everything looks like a nail, but Draghi was essentially arguing that in want of a hammer, anything that will pound a nail will do. In short, because the traditional tools don’t work, Draghi claims that anything else which accomplishes the same ends is allowed.
The Bundesbank will not agree.
But Draghi claims the Euro’s survival depends on his being allowed to buy bonds under 3 years to maturity (why there is a limit at 3 years is unclear to me; if it was necessary to extend the program to 5 years because buying everything less than 3 years wasn’t working, why won’t the same argument work?), and it seems unlikely that there will be enough opposition to dissuade him from this action. It is one thing to ask legislatures to write a check, but the costs of profligate monetary policy (as we have seen) are not as apparent and not as immediate; and anyway, the politicians can campaign later on the need to have them around to fix whatever new problem that is created as a result.
The continuing question should be – if there is no cost to buying huge numbers of bonds, then why should the central banks ever have eschewed that action? Of course, there is no such free lunch, as William White wrote last week. But from the standpoint of a politician, it’s almost a free lunch. “I’ll glad you pay you next election cycle for a hamburger today,” as Popeye’s pal Wimpy might have said.
Or, better yet, chastise the monetary policymakers for not foreseeing the true cost of that hamburger today!
One more comment on that William White piece. In it, he discusses among other things the many ways in which overcapacity has developed last couple of decades in many countries and many industries. He does this to illustrate the concept of “malinvestment,” which mainstream economists these days pooh-pooh but which many Nobel Laureate economists (such as Hayek) did not.
However, like many of those earlier authors, White seems to take the existence of overcapacity as implying that deflation is a serious risk. I think this is based on a misunderstanding and misapplication of the original concept of malinvestment. Overcapacity implies that resources have been mis-allocated in the past, and this creates a cost in the future – but it only implies deflation in the presence of traditional monetary response (which, let’s remember, we haven’t had in a decade or more). Overcapacity implies declining real prices, and declining real returns to property, plant, and equipment relative to labor – and that is good news for consumers. But, if this overcapacity is coupled with ample money printing, this is not inconsistent with rising, rather than falling, price levels.
Remember that the original Keynesians and Austrians were writing in a period during which most of the historical record involved a money supply effectively, if not explicitly, limited by linkage to gold. In the presence of a fixed money supply, overcapacity most assuredly leads to deflation. But in the presence of a rising money supply, these are no longer automatically connected concepts: overcapacity is a statement of investments and returns in real space, while inflation measures a change in nominal prices.
And that’s why the malinvestment of the 1990s and 2000s need not lead to the same end result as the malinvestment of the 1920s. Indeed, unless something very odd happens – and I gave the parameters I would consider odd last week – deflation, with or without the hangover effects of prior malinvestment, isn’t going to happen.
The next few weeks will be more increasingly more active, to a degree that we may long for the quiet days of August. Keep in mind that it is a very strong time of the year for bonds, seasonally speaking, and a weak one (although not as consistently so) for stocks. But I wouldn’t try to play those zig-zags. The DJ-UBS index reached a 6-month high this morning, before backing off; that’s where I would have (and do have) my money.
It’s In ‘The Hole’
As the end of August approaches, the somnambulation of the markets should be slowly diminishing. Events are still proceeding in slow-motion, but investors will gradually wake up and re-assess their surroundings in the days remaining before the Jackson Hole colloquium that represents the next major scheduled event on the domestic calendar.
But even in the dog days of August, governments borrow and spend money, and sometimes they even have to pay it back. Today, the emerging market of Belize missed a bond payment as its deficit swelled to a level of (gasp!) 2.5% of GDP, and the Prime Minister declared a restructuring is needed since the country simply doesn’t have the ability to pay the 8.5% coupon on its superbond. Isn’t it nice to be a superpower? The U.S. runs a deficit of around 8% of GDP, and our creditors seem to have no quarrels with us – at least, for now.
Of course, we’re too busy to worry about Belize when Greece beckons. Greek Prime Minister Samaras is asking for a two-year extension of the deadline for deep spending cuts and tax increases, but German Financial Minister Schaeuble (among others) said over the weekend that “It can’t be helped – we can’t make yet another new program. There are limits.” http://economywatch.nbcnews.com/_news/2012/08/20/13377541-germany-forcing-greeces-day-of-reckoning Certainly, the suggestion that there are limits to European largesse in the case of Greece is not a new one; the appearance of actual limits is still what all parties are waiting for. We are approaching the next showdown, surely.
More stirring was the report over the weekend in Der Spiegel that the ECB is considering a program to ‘cap’ European rates versus Bunds, such that they would determine an “appropriate” spread (appropriate in a cosmic justice sense, one supposes, not in a ‘market clearing’ sense) and then buy unlimited quantities of bonds of countries whose yields strayed above the cap. The idea, surely, is to make the cap unnecessary, since rational (and, it should be pointed out, credulous) investors would buy unlimited amounts of bonds just shy of the cap, knowing they had a much higher upside than downside, guaranteed. But ask Soros and the Bank of England how that works, when the economics aren’t there.
The Bundesbank, predictably, came out with immediate criticism of such a plan, which isn’t surprising since they had previously spanked Draghi for suggesting that the ECB would do “whatever it takes” to preserve the Euro. The ECB promptly hove to today, as well, muttering something about how it’s “misleading to report on decisions, which have not yet been taken and also on individual views, which have not yet been discussed by the ECB’s Governing Council, which will act strictly within its mandate.” And, of course, that begs the question of why they leaked the notion in the first place. Who’s in charge over there, anyway?
It also was unclear if the idea of an automatic cap replaced the prior assertion that the countries themselves must formally request help, or was in addition to that requirement.
All in all, it should be an interesting autumn.
But I nevertheless contend that the first really important event for the market is going to be the Bernanke speech at Jackson Hole on August 31st. The machine is already at work, setting up the arguments so that Bernanke need only nod in the general direction of what the Fed is going to do. An article on Bloomberg yesterday was entitled “No Inflation Proves Critics of Fed’s Bernanke Wrong.” The content of the refutation is essentially that it’s obvious that Bernanke was right, all of those opposed are just ‘haters, and clearly the money-printing didn’t cause inflation.
However, since the money-printing also didn’t evidently cause unemployment to improve very much, we are left with this: either monetary policy simply doesn’t matter, and affects neither inflation nor growth in any important degree (in which case we can safely disband the Fed since it’s just an economist-employment project), or it does matter, and it’s too early to judge the effects of a rapidly-expanding money supply which, until one month ago was still expanding at better than 10% per annum. After all, along with that expanding money supply we did, until three months ago, have core inflation that was accelerating every month, so that’s hardly an open-and-shut case in favor of the notion that large amounts of money don’t cause inflation. Moreover, clearly the Fed itself believes that QE causes inflation, or it wouldn’t have cited the possibility of deflation as a key reason for QE1! They seem to want it both ways: money-printing causes dis-deflation, but doesn’t cause inflation above target.
In my view, it is very premature to declare victory over core inflation merely because we have had a couple of months where core inflation went sideways – mostly due to base effects.
But as investors, what is more important in the near-term is that this argument is silly to make now, when its veracity won’t be judge-able for at least a year or two, unless the purpose of the argument is to encourage additional monetary easing.
Perhaps you may think that my cynicism knows no bounds. This may well be true, but is not relevant at the nonce. Consider that the Fed also has just released a study (summarized here) that argues there is much more ‘cyclical’ unemployment left from the recession that can yet be reversed. This tends to mean (according to the Bloomberg article) that more can be done on the employment front without spurring inflation. Other economists cited in the Bloomberg piece, who think structural unemployment is higher, figure that if the unemployment falls too fast it could spell inflation.
I have pointed out here a number of times that there is no strong relationship between unemployment and overall inflation, although there is a decent relationship between unemployment and wages (see this article for some pretty charts). Lower unemployment would mean higher wages, and probably higher real wages, but it doesn’t necessarily mean broad inflation (consider the late 1990s).
So we have an argument that inflation is tamed and Bernanke was right, and we have an argument that there is still more room for policy to lower unemployment without triggering inflation. Yes, I am cynical, but as investors it sometimes pays to be that way. If I were looking to push further unprecedented monetary policy on a suspicious investor community, these are just the sort of articles and studies I would like to see floated.
Bundespanked
Draghi’s celebrated, chest-thumping, “whatever it takes” to preserve the Euro was apparently…nothing. The ECB did nothing. Perhaps he meant the value of the Euro, not its existence, and they would preserve it like the Bundesbank wants to, by controlling its supply? Yet, in his press conference he seemed to make clear that he meant the ECB would go to bat for European union, as he said the “Euro is irreversible.”
Actually, Mario, that’s precisely the question at hand!
Also, like a true central planner, he intoned that “high yields [for peripheral countries] are unacceptable.” At least, I assume he means for the peripheral countries, although it was not so long ago that 7% was considered a sustainable yield. At some level of debt, I suppose that even 2% is unsustainable! But this isn’t the point. The point is that it isn’t up to Draghi to “accept” high yields. It isn’t his market to arrange. The market itself makes the decision about what yields are “acceptable,” given the risk. I think he means the same thing my daughter means when she stamps her 5-year-old foot and declares something “unacceptable.” What she means is, she doesn’t like it. Just like with her, the answer to Draghi is “too bad.”
The Fed’s inaction was surprising (to me), but justifiable with the ECB up the following day. The inaction of the ECB is much harder to fathom in the context of President Draghi’s boast of only a few days past. A lot of theories about future paths of policy have now been thrown somewhat into question, for the ECB appears to have been Bundespanked.
Are monetary policymakers maybe finally growing concerned about money? They haven’t been for a long time; Daniel Thornton, a senior economist at the St. Louis Fed, has been fairly in the wilderness with his publications exhorting economists to actually look at the data again. His latest piece, “Monetary Policy: Why Money Matters and Interest Rates Don’t”, likely will get no more read inside the Fed than his other pieces have, more’s the pity.
Now Draghi did say in the Q&A part of his press conference that we shouldn’t assume the ECB “will or will not sterilize” any bond purchases that happen. Since always previously the ECB has claimed it was sterilizing purchases (which means they soaked up the money that they were inserting with the purchases), this would represent a weakening of hard-money resolve…if it were actually going to happen. I rather wonder if he didn’t say that just to tweak the Bundesbank. Anyway, he says that “details [are] to come in the next weeks,” which was enough to save markets from a pure meltdown.
Strangely, the Euro weakened along with stock markets in the U.S. (S&P -0.7%) and in Europe (Eurostoxx -3.0%). The Euro ought to be strengthening if investors thought that the ECB just got monetary policy religion and so would restrict the money-printing activities everyone was assuming would happen. Unless, that is, investors are selling Euro-denominated issues because they think the union will break up due to ECB inaction.
My head hurts.
What seems clear enough is that for at least a month or two, the markets are on their own. I don’t know how that’s going to work, when Greece is due to borrow money from the ECB to pay off maturing bonds in only 3 weeks. Conventional wisdom is that the ECB will advance the money, since the ECB holds most of the debt that will be paid off, but I’m no longer so sure of anything.
I do know that we have Payrolls tomorrow morning, and expectations are justifiably low. Consensus expectations are for 100k in nonfarm payrolls and an unchanged 8.2% Unemployment Rate. Payrolls over the last three months have been, after revisions, 68k, 77k, and 80k respectively. The market likely reacts to a very weak number in a positive way, because the conventional wisdom seems to be that the Fed will surely ease at the next meeting if the data remains this weak. But what do we do with a strong number that throws the Fed’s immediate next move into doubt? My guess is that something in the high 100s (175k, 190k, etc) is taken as bearish equities, bullish bonds for this reason, while much above that it all becomes confusing because it won’t be clear whether the first three months of the year were the aberration (the operating hypothesis) or the last three months were.
The only clear investment to me remains commodities, which corrected strongly today , down around 1.25-1.50% ex Nat Gas, which plummeted nearly 8%. Gasoline, however, rallied another three cents. If the central banks abruptly started to control money supply growth and shrink central bank balance sheets – a prospect that I give about a 20% chance to – then the future returns to commodities would be less than I expect. But they’re still undervalued with respect to the current money supply, so even in this case I’d expect solidly positive 5-year real returns.
And if the Bundespanking wears off (and as a father I can tell you, they tend to wear off very quickly), the near-term returns to commodities will continue to look great as well.
