Bloomberg News recently polled various economic policy makers regarding the future direction of the world’s economy. The result: economic policy makers are becoming discouraged:
Global Confidence Dips as Policy Makers Begin Exit Strategies Share Business Exchange
By Shamim Adam and Shobhana ChandraNov. 12 (Bloomberg) — Confidence in the world economy dipped in November as central banks’ actions to withdraw some emergency measures sparked concern about the strength of the recovery, a Bloomberg survey of users on six continents showed.
The Bloomberg Professional Global Confidence Index fell to 60.3 from 61.7 in October, the highest level in the series that began two years ago. The index exceeded 50 for a fourth month, which means there were more optimists than pessimists.
The survey follows steps by central banks including the Federal Reserve to start unwinding stimulus, seeking to avoid market distortions that may spur bubbles in assets from stocks and commodities to real estate. The shift comes at a time when job losses are still rising in the U.S. and Europe, threatening a nascent recovery as consumers limit spending.
If there is less stimulus – low cost cash loans and grants for finance – there will be no further recovery.
Yet … if there is continuing stimulus, low cost cash loans will start to become more and more expensive. Borrowing from our grandchildren acts in this way: they cannot deny us the loans but they can indeed refuse to pay them.
Finance claims the economy is fixed and markets have returned to rubust health. Finance also claims it is old and broken and needs continued help. Well … which is it?
Like all things financial, stimulus is an actor within a dynamic. The interest rate tension marks the evolution of this dynamic. The transformation is from the panic levels of cash lending during the height of the crisis to today’s increased desire for yield and the accompanying appetite for risk. The flood of stimulus was the policy response to the freezing of credit and the overpricing of repayment risk by the markets during last year’s hysteria. The immediate risk appeared to dissipate, instead it was pushed forward. There is the dawning realization that the flood of cash loans will reach a point where they can never be repaid. The evolution of the dynamic is from where we are now – at the glorious 60.3 level – to the period of default and repudiation, when we are flat- lining at a tepid 15 or so.
There is also the realization that the increase in derivative claims will never see conversion to cash. If the loans cannot be repaid 0r repaid in kind, why continue to lend?
What is interesting about this dialog is that the largest player in this Danse Macabre has lost control over its own destiny. The crisis emerged in the US – our appetite for fuel to waste is legendary. The American ‘waste crisis’ manifested itself in mortgage- backed securities. The establishment’s policy response has fixed itself around keeping intact offsetting hedges against increasing fuel costs. At issue is whether the rest of the world sees it in their interest to maintain the (futile) status quo in light of shrinking oil availability.
Is the rest of the world as unrealistic about US waste and energy consumption as is the US itself?
The rationalization the US offers up is that it consumes the world’s products and is therefore entitled to waste the world’s energy as part of the process. The US also claims entitlement to more and more stimulus from the rest of the world to facilitate that waste.
Unfortunately, other countries such as those in Europe not to mention up- and- coming neo- wasters such as Brazil and China also demand a share of the cornucopia. It is this demand that runs counter to finance’s desire for ever- greater stimulus. The concern grows that US stimulus requires parallel stimulus in all countries in order to maintain a level of competitive consumption.
If US customers require subsidy in order to buy goods and services, the rest of the world’s rising middle class requires equal subsidies as well. Fair is fair!
It is foolish therefore to ‘go long’ on the rest of the world forever subsidizing middle- class indulgences, particularly in one country. Americans at all economic levels have already come to this conclusion on their own and are cutting back. The cutback is reflected in the exorbitant interest rates being charged to unsecured consumer creditors. The solvent have no desire to borrow leaving only those who desperately need credit … and who lack the means to repay it.
It isn’t hard to make the connections between the insolvent consumer borrowers forcing credit costs higher and insolvent institutions doing the same on a larger stage. Repayment risk in the ‘future’ is becoming repayment risk of the now.
It appears that stimulus will not be available very much longer regardless of economic conditions or the desires of the finance community. Perhaps I am wrong, but – absent another deleveraging panic starting right about now – the trend in rates is beginning to pull upward. Money costs will rise to accurately reflect the ‘hard’ input costs of stimulus’.
Another way to view stimulus is to consider when the market begins to discount it. At that point, it becomes more expensive.
The cost of money relates directly to the cost of oil in dollars. In 2004 the US Fed had little choice but to raise rates responding to steady increases in oil price. For a refresher, please read ‘Further Evidence of the Influence of Energy on the U.S. Economy’
Increasing oil demand by commerce – here and abroad – pulls demand for cash funds away from finance. At some price level, funds are diverted to oil companies and national producers and away from securities and derivatives. Absent a ‘shock’ effecting oil supply such as a hurricane or military action, the contest between the demands of commerce on one hand and those of finance on the other can only be resolved by increasing money costs … so as to attract cash toward banks and money markets. Oil in turn becomes more pricey to pull funds back from finance and toward producers. The game becomes a tug- of- war. In 2004, the rise in oil prices forced money costs higher which in turn made mortgages more expensive. This shifted mortgage lending toward even higher cost products which, by design, were unaffordable. Mortgage borrowers defaulted and the increasing mortgage defaults made securities based on mortgages unprofitable. Businesses selling these mortgage products failed as a consequence.
There was a cascading decline in mortgage- derived values that has not ended. Relative to energy, finance products are worth less. This is our ‘crisis’ in eight words.
Since energy/gravity is attracting funds away from finance the upward pressure on rates is a reasonable consequence. There is little or aught for central banks to do but follow the trend or reinforce it and defend the higher rates at perhaps a lower level.
At a higher level than what finance would desire.
Keep in mind that while this interest rate arbitrage is taking place, the carry trade in dollars is accelerating; Ben Bernanke’s efforts to force all rates lower by open market activities, quantitative easing and purchases of GSE debt has made the US dollar the currency of choice for borrowing here and investing elsewhere. While funds flow into finance from governments and central banks, the actions of the Fed allows funds to flow right out again!
Way to go, Ben! Let’s all invest in America’s future by shorting the dollar and sending funds to Australia!
Regular citizens cannot avail themselves of this bonanza, only banks that have access to the near- zero Fed funds rate can afford this trade. The banks ‘invest’ (sell) the cheap dollars in securities issued in countries where interest rates are rising ahead of US rates. The fact of the flow of funds is revealing; the target countries are simply ahead of the same rate curve the US finds itself on; either the carry will assist in the decline in the dollar to the point where energy prices bolt or the US Fed itself and the bond market will price dollar rates higher. Either will end the carry trade.
This will be interesting, as in ‘learning experience’ interesting. The ‘lower’ the dollar is priced relative to other currencies, the more dollars will be borrowed and sold in an accelerating feedback loop. When rates finally rise, the dollar- short positions will have to be unwound and dollars returned to central banks from whence they were borrowed. Alternatively, dollars will be demanded from borrowers by central banks as margin calls. The consequence will be the ‘Mother of All Short Squeezes’. The dollar will become very much in demand while the now- lowly ‘risk assets’ will head for the drain in he middle of the floor.
Once started the tidal flow of deleveraging will be almost impossible to stop. This seems to be the inevitable outcome of the process that has just begun. Little wonder the world’s policy makers are stuck at 60.3!
The Fed cannot alter events that are unfolding; its expedients put into place over the past year and a half have reached their ‘half- life’. Other central banks will call in their dollar loans. Judging from Bloomberg’s poll, this process is starting to take place in a manner noticeable to finance’s big shots. Look for more dollar swaps to foreign central banks, but at some point – $85 a barrel? – it will be Ben Bernanke trying to command the tides.