Friday, May 22, 2015

My Weekly Commentary: Paying for the Past: Insight from Lindsey, Fisher and Greenspan

The Peterson Institute for International Economics this week held it’s sixth annual “Fiscal Summit,” a wide-ranging and critical discussion of issues facing our nation. I have highlighted comments from a panel discussion, “Paying for the Past: How Will Rising Interest Costs Affect Economic Growth?,” with former Fed governor Lawrence B. Lindsey, former Dallas Fed president Richard W. Fisher and former Fed chairman Alan Greenspan (moderated by Bloomberg’s Betty Liu).

Lawrence Lindsey: “We’re delaying a normalization of rates way, way beyond what is prudent. We have a monetary policy that’s now in place that was adopted for the crisis conditions of 2008 and 2009. This summer we’re going to be getting the seventh year of this recovery. It’s been a lousy recovery, but it’s still the seventh year of a recovery. That is totally inappropriate. The unemployment rate is essentially at what economists call “NAIRU” [Non-Accelerating Inflation Rate of Unemployment]… When I went to school, you’d be laughed out of the classroom if you said the right interest rate when unemployment rate was five four [5.4%] was zero - it was just the most preposterous thing you could imagine. Or that the Fed should have quintupled its balance sheet in five years. We’re at the point of absurdity. Maybe it made sense when you had a crisis. It does not make sense now. At some point what is going to happen - and this gets to my eight or nine cataclysmic number [on a scale of 1 to 10] - is that we’re going to get a series of bad numbers - a little higher inflation, higher average hourly earnings or whatever - and the market is suddenly going to say, “Oh my God, they are so far behind the curve that they will never catch up.” And the market is going to force an adjustment on the Fed that will be wrenching. That’s the cataclysmic outcome. If the Fed were to get a little bit ahead of the curve - or even maybe move a little bit closer to the curve - that’s the best we can hope for - we would mitigate that.  We would phase into it gradually. And that’s why so much is at stake in the monetary policy that we adopt now…

“I used to think more highly of what they were going to do. And I’ve constantly been disappointed. So I certainly think they could mitigate it if we do very modest things now. I think the Fed will say, “Oh, we’re really serious.” When I talk to my clients, the Fed has almost no credibility when it comes to a sense that they will be able to stay on top of this ticking monetary bomb. Now, my clients are all making money. They are enjoying the party while it lasts. Nobody is complaining. That’s why things [the stock market] are going up. But they also know it will end. They don’t think the Fed is going to take it seriously. And so if you have an institution that’s lost credibility in the market, when the bad number comes in the market is going to take the Fed and the Treasury curve to task in a very painful way.”

Richard W. Fisher: “I may be the only FOMC member who would quote Van Morrison and his great song “Not Feeling it Anymore.” I just want to read you a couple lyrics: “When I was high at the party everything looked good. I was seeing through rose-colored glasses and not seeing the woods for the trees. I started out in normal operation but I just ended up in doubt.” I voted against QE3. There was a reason for it. First of all we were well on our way. In March 2009 the market started to take off. They’ve tripled…”

Alan Greenspan: “We don’t have the rest of the world out there all of the sudden saying “we’re doing far better than the United States and we will effectively succeed in moving you up.” The exchange rate tells us it’s not the case. Everyone is doing worse than we are. So we’ve got all sorts of problems which says that the sooner we come to grips with this [debt] problem - and we’re going to have to come to grips with it - or the markets will do it for us. And that is not going to be a very happy experience. The longer we wait… the more difficult it’s going to be to implement it. And there’s a presumption out there that central banks can do as they see fit. The ECB has got a problem in many respects more difficult than ours. Because if the Federal Reserve were ever to go bankrupt, we have the sovereign Credit of the United States standing behind it. But who stands behind the ECB. It’s got this other monetary transaction which has not been drawn upon, but some day it will be. And the question is if there’s a run on the European Central Bank, I’m not sure where they go. So when we talked this morning about all the problems that the United States has, we can match them abroad. And that is not a good message for the United States.”

Moderator Betty Liu: “When you see a chart like that [debt] and you see the trajectory, what do you do? How do you mitigate it?”

Lindsey: “Right now we’re artificially mitigating it through Fed purchases of bonds. That is not a sustainable proposition. So one of the things we should all be concerned about is that not only will we have to pay down that debt, but ultimately the Fed is going to have to dump the debt it now has onto the market. So there’s going to be a huge amount of supply coming on which is going to push up interest rates. We talk about 2060 and 2048 and things like that - just think about 2025. It the next President, if he or she serves two terms - will be submitting the 2025 budget. Now, interest costs, healthcare costs and Social Security will be 4.6% of GDP higher under current law than they are now in that budget if we do nothing - no increasing, nothing more generous. That’s the equivalent to a 20% across the board tax increase in all taxes. So the top tax rate would have to go from 40% to 48%. The Social Security tax rate would have to go from 15.3% to 18.3%. The corporate tax rate would have to go from 35% to 42% - just to hold things even with what’s automatically going to happen. Those are not the kind of taxes the economy can afford. So taxes are not the solution. In the end, we’re going to have to begin to attack the Social Security and healthcare cost problem and that’s going to be the ultimate way of holding down the interest costs in the debt.”

Fisher: “First, a little context: I went back and looked at what our total debt was as a nation the year that Alan Greenspan was born… In 1926, our total debt was $19.6 billion. I was born in 1949 and the total debt of the US government was $253 billion. Now if you add up the numbers - in terms of what’s held by the public and the intergovernmental holdings - we’re talking a number that’s pushing $18 Trillion. It does not include these unfunded liabilities of Medicare and Medicaid and Social Security. And also it does not include - which I believe it should - the ultimate obligation of these so-called called ‘agencies’ - Freddie, Fannie and Sallie Mae. So we’re talking about very big numbers. The real issue is what does interest do - and that chart shows - we’re going to get to a point… where interest eats up certainly as much as we spend on healthcare. If you look at the CBO’s [Congressional Budget Office] numbers and you project out forward not too far, interest and healthcare costs will be well over half the budget. In Pete’s [Peterson] opening letter… he points out that interest costs will exceed R&D, education and, very importantly, as Mike Bloomberg lectured us, infrastructure. So, we’ve put ourselves in a horrific position. And getting to the Federal Reserve - and I was part of that group, Alan [Greenspan] had exited a few years earlier - we had this huge rise while I was at the Fed from $7.7 Trillion to its current level of almost $18 Trillion. So that’s 2.5 times, a compound annual growth rate of 11% just over ten years… At some point, you have to pay the piper. The real issue is what happens when interest rates go up. CBO estimates have them just increasing gradually. Well, we’ve been suppressing the yield curve. Foreign buyers have been helping us suppress the yield curve. And I think this is the ticking time bomb of all.”

Greenspan: “We’re way underestimating our debt, as of now, largely because we are not including contingent liabilities… What is the probability, in today’s environment, that JPMorgan would be allowed to default? The answer is zero or less. Now that means that that whole balance sheet is a contingent liability. To be sure, that while it’s contingent there’s not interest payments. But ultimately that overhangs the structure, because we in so many different ways have guaranteed this, that and the other thing. It’s not only Fannie and Freddie, but it’s a whole series of financial institutions. And, regrettably, it’s also non-financial institutions. I was very much concerned when we started to guarantee everyone as being too big to fail. But at least it was in the financial area. As soon as we moved over into General Motors and various other non-financial organizations, I said what is the contingent liability of the United States… What the three of us are talking about, the path we are currently on is not going to be easily resolved. It’s going to be very difficult… The sooner we get to it the better. But I see no evidence that we’re moving in that direction.”

Lindsey: “It always ends this way. If you go back and you look at Rome. You look at the Ming Dynasty or you look at Zimbabwe - it always, always, always ends this way. And the question is how can you delay it… The end game we’re all talking about here is a very unpleasant one. It means that the financial arrangement that the state has created is no longer sustainable by society. And that’s how overly indebted societies end and they move on to a new type of arrangement. So it isn’t going to be a pretty change - if we get there. And that’s why it is so urgent that we act now. It is not just a matter of numbers. It’s a matter really of political liberty. Because the government will not voluntarily let itself go out of business. It will use all of its powers - I’m not talking about just our government but any government - will use all of its powers in order to fund itself… It isn’t hard to get the math to work for America to save itself - and that’s why I’m optimistic like my colleagues here that we could do it. But we’ve got to get on the wagon and get doing it soon because time is running out.”

My thoughts: The abhorrent dilemma facing our nation is becoming increasingly difficult to evade. As such, leading policy figures are becoming more outspoken – in some cases stunningly candid. And future readers of history will be left bewildered and appalled that key issues were in fact recognized yet policymakers lacked the fortitude to confront them.

The root cause of a complex predicament is actually rather uncomplicated: it’s called inflationism. And there’s a reason why I am not the least bit optimistic. Despite centuries of history, we’ve somehow bought into the fallacy that “money printing” can resolve structural issues (financial, economic and social). In the face of overwhelming contrary evidence, central bankers and their supporters have clung to the sophistry that they can raise prices levels – in the real economy and securities markets – and that such inflation supports system growth and stability. Central banks have overpromised and have been too content to feed fanciful notions of their omnipotence and overwhelming power. Progressively bolder “activist” central bankers were afforded way too much discretion to experiment. In the end, their inflationary policies primarily inflated asset prices and securities market speculative Bubbles. And each policy error – accommodating or, worse yet, orchestrating a new Bubble – invariably led to only bigger blunders. The greater the boom and bust the more outlandish the subsequent reflationary cycle and attendant Bubbles.

For today’s readers and for the reader in 2065, it is imperative to appreciate that the Fed (and global central bankers more generally) is today trapped. Borrowing from Larry Lindsey, “We’re at the point of absurdity.” Yet normalization from absurd rates and central bank monetization is indefinitely deferred because of fears of bursting Bubbles. The great danger of central bank controlled, market-based finance has come to fruition: central bankers see no alternative than to allow Bubbles to run wild. And unhinged markets will do what unsound markets do: go to self-reinforcing precarious excess.

The nature is unclear and the course always uncertain. The end game, however, is never in doubt. Inflationism is seductive – it sets an incredibly powerful trap. And it inevitably reaches the point of no return. If only the Fed would quickly mend its ways and begin normalizing rates. I very much wish it wasn’t too late. But these global Bubbles are not going to tolerate anything like normality.

For the Week:

The S&P500 added 0.2% (up 3.3% y-t-d), while the Dow slipped 0.2% (up 2.3%). The Utilities increased 0.3% (down 6.8%). The Banks gained 1.3% (up 2.5%), and the Broker/Dealers added 1.2% (up 5.0%). The Transports were hit for 2.3% (down 7.2%). The S&P 400 Midcaps gained 0.7% (up 6.1%), and the small cap Russell 2000 added 0.7% (up 3.9%). The Nasdaq100 rose 0.7% (up 6.9%), and the Morgan Stanley High Tech index increased 0.4% (up 3.9%). The Semiconductors advanced 1.5% (up 4.9%). The Biotechs surged 3.0% (up 21.0%). With bullion down $21, the HUI gold index fell 5.5% (up 4.4%).

Three-month Treasury bill rates ended the week at a basis point. Two-year government yields rose seven bps to 0.61% (down 6bps y-t-d). Five-year T-note yields jumped 10 bps to 1.56% (down 9bps). Ten-year Treasury yields gained seven bps to 2.21% (up 4bps). Long bond yields increased five bps to 2.98% (up 23bps).

Greek 10-year yields jumped 60 bps to 11.02% (up 128bps y-t-d). Ten-year Portuguese yields rose 14 bps to a three-month high 2.40% (down 22bps). Italian 10-yr yields gained nine bps to a 19-week high 1.85% (down 4bps). Spain's 10-year yields increased five bps to 1.77% (up 16bps). German bund yields slipped two bps to 0.60% (up 6bps). French yields declined a basis point to 0.89% (up 6bps). The French to German 10-year bond spread widened one to 29 bps. U.K. 10-year gilt yields rose five bps to 1.93% (up 18bps).

Japan's Nikkei equities index jumped 2.7% (up 16.1% y-t-d). Japanese 10-year "JGB" yields added a basis point to 0.41% (up 9bps y-t-d). The German DAX equities index rose 3.2% (up 20.5%). Spain's IBEX 35 equities index gained 2.1% (up 12.4%). Italy's FTSE MIB index increased 1.3% (up 25.1%). Emerging equities were mixed. Brazil's Bovespa index was slammed for 5.0% (up 8.7%). Mexico's Bolsa declined 1.0% (up 4.0%). South Korea's Kospi index jumped 1.9% (up 12%). India’s Sensex equities index advanced 2.3% (up 1.7%). China’s bubbling Shanghai Exchange surged 8.1% (up 44%). Turkey's Borsa Istanbul National 100 index declined 2.1% (unchanged). Russia's MICEX equities index fell 1.5% (up 19.3%).

Junk funds saw inflows of $445 million (from Lipper).

Freddie Mac 30-year fixed mortgage rates dipped a basis point to 3.84% (down 3bps y-t-d). Fifteen-year rates slipped two bps to 3.05% (down 10bps). One-year ARM rates gained three bps to 2.51% (up 11bps). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed rates up two bps to 4.03% (down 25bps).

Federal Reserve Credit last week expanded $4.0bn to $4.443 TN. Over the past year, Fed Credit inflated $166bn, or 3.9%. Fed Credit inflated $1.632 TN, or 58%, over the past 132 weeks. Elsewhere, Fed holdings for foreign owners of Treasury, Agency Debt gained $8.0bn last week to $3.325 TN. "Custody holdings" were up $31bn y-t-d.

M2 (narrow) "money" supply jumped $22.8bn to a record $11.913 TN. "Narrow money" expanded $629bn, or 5.6%, over the past year. For the week, Currency increased $0.5bn. Total Checkable Deposits dropped $52.5bn, while Savings Deposits surged $77.7bn. Small Time Deposits slipped $1.8bn. Retail Money Funds declined $1.1bn.

Money market fund assets rose $20.6bn to $2.610 TN. Money Funds were down $105bn year-to-date, while gaining $25.8bn y-o-y.

Total Commercial Paper contracted $28.3bn to a two and one-half year low $964bn. CP declined $73bn over the past year, or 7.0%.

Currency Watch:

The U.S. dollar index jumped 3.1% to 96.14 (up 6.5% y-t-d). For the week on the downside, the Norwegian krone declined 4.6%, the euro 3.8%, the Brazilian real 3.2%, the Swiss franc 3.0%, the Australian dollar 2.6%, the Swedish krona 2.5%, the Canadian dollar 2.2%, the New Zealand dollar 2.2%, the Japanese yen 1.9%, the Mexican peso 1.7% and the British pound 1.5%.

Commodities Watch:

The Goldman Sachs Commodities Index fell 2.0% (up 5.7% y-t-d). Spot Gold declined 1.7% to $1,204 (up 1.6%). July Silver dropped 2.9% to $17.05 (up 9%). June Crude was little changed at $59.72 (up 12%). June Gasoline added 0.5% (up 40%), while June Natural Gas was hit 3.9% (unchanged). July Copper sank 3.9% (down 1%). July Wheat increased 0.8% (down 13%). July Corn lost 1.5% (down 9%).

Fixed Income Bubble Watch:

May 17 – Bloomberg (Michelle Kaske and Bill Faries): “The sobering news arrived in San Juan via telephone from Washington. It was April 28, and U.S. Treasury Secretary Jacob J. Lew called to tell Puerto Rico officials they must confront one of the island’s gravest financial crises without a bailout. Saddled with $72 billion in debt, the commonwealth… needs a ‘credible’ plan, Lew said. The Caribbean island is hurtling toward the fiscal brink. After years of borrowing to paper over deficits, and with $630 million due to investors on July 1, Puerto Rico may confront the unthinkable: a default. The prospect has set Wall Street on edge as bond yields surpass those of Argentina and Greece; about half of municipal mutual funds hold commonwealth debt. Puerto Ricans across the political spectrum are alarmed at the scale of the crisis, Rafael ‘Tatito’ Hernandez, chair of the House Treasury Committee, said during a May 6 interview… Every mayor on the island will face angry constituents, he added, especially those whose work weeks may be cut to four days. ‘We used to have choices,’ Hernandez said… Now ‘people have to realize where we’re really at. It may be late, but that’s the reality.’”

May 19 – Bloomberg (Michelle Kaske): “Puerto Rico and its agencies have amassed $72 billion of debt as the junk-rated island's economy has shrunk every year but one since 2006. Investors bought the securities, which are tax-exempt in all U.S. states, for their relatively higher yields. There are fewer residents to help repay the obligations: The island's population has declined 7% in the past decade as residents moved to the U.S. mainland. That combination of rising debt, sluggish economy, and falling population has pushed yields on Puerto Rico debt above those of Greece. The securities have been trading at distressed levels for nearly two years as investors doubted the commonwealth's ability to repay its debt on time and in full. Puerto Rico warned in its latest quarterly filing that it may place a moratorium on debt payments in fiscal year 2016 if the government can't cut spending or raise enough revenue. The island's state-run power utility, Puerto Rico Electric Power Authority (Prepa) is currently negotiating with creditors to potentially reduce its nearly $9 billion debt load. Such a restructuring would be the largest ever in the $3.6 trillion municipal bond market.”

May 18 – Bloomberg (Lisa Abramowicz): “Don’t be surprised if you see a huge chunk of cash simply evaporate one day from your exchange-traded bond fund. There’s a good chance it’s just a hedge fund cashing in on a bet. An example of this can be found in BlackRock Inc.’s $5.1 billion long-term U.S. Treasuries ETF, which saw the greatest volume of withdrawals this year among similar funds. Among investors yanking cash was Passport Capital, the $4 billion hedge-fund firm run by John Burbank. The firm sold its entire $217 million stake in the ETF in the period ended March 31, about three months after purchasing the shares… It’s also notable because ETFs have traditionally been marketed to individuals as a quick, easy way to invest in debt. But that’s changing. These funds are increasingly being used by and advertised to big institutions, which are looking for the same efficiency as smaller investors at a time when it’s getting more difficult to execute big trades. Larger bond buyers are finding it easier to dash in and out of positions electronically with ETFs, rather than bonds that are traded over-the-counter in telephone calls and e-mails. Since 2008, trading volumes of the five-largest credit ETFs have grown 75-fold, according to a Greenwich Associates study…”

U.S. Bubble Watch:

May 20 – Bloomberg (Joseph Ciolli): “The $1 trillion U.S. companies are on track to return to shareholders this year will constitute the market’s entire return in 2015, according to Goldman Sachs… Dividends and buybacks will be responsible for supporting a market where the median stock in the Standard & Poor’s 500 Index is trading at 18.2 times earnings, putting it in the 99th percentile of historical valuation… Not only will dividends supply all the market’s upside, but companies that pay the most are poised to bounce back in 2015’s second half, analysts led by David Kostin wrote. Stocks with the biggest payouts relative to share prices from utilities to real-estate investment trusts have trailed the S&P 500 since January as higher bond yields lured investors. S&P 500 stock values ‘have limited scope for further upward expansion,’ a group of Goldman Sachs analysts including Kostin, the firm’s chief U.S. equity strategist, wrote…”

May 22 – Reuters (David Randall and Jessica Toonkel): “If you can't beat them, buy them. That's the theory underlying a move by a growing number of mutual fund managers… to slip shares of indexed exchange traded funds into their actively managed fund portfolios. Over the last five years - a period in which active fund managers have both underperformed and lost market share to ETFs - the number of actively-managed equity funds that hold ETFs in their top-10 holdings has jumped 174%, to a total of 148, according to Lipper… In the past year, the number of active equity funds with ETFs as a top-10 holding has risen more than 23%, to 120… Fund managers say that they are turning to low cost ETFs as a way to mitigate the effects of so-called cash drag - the underperformance that comes from the 3% to 5% of assets that a manager typically holds in cash to meet investor redemptions.”

May 20 – Wall Street Journal (Nick Timiraos): “American households across the wealth spectrum increasingly face sharp swings in monthly income and spending, a finding that underscores the unpredictability that has become a hallmark of the U.S. labor market since the recession. A J.P. Morgan… analysis of 100,000 of the bank’s customers found a large and diverse share of Americans with incomes that vary by more than 30% from one month to the next. The study… also found the bottom 80% of households by income lack sufficient savings to cover the type of volatility observed in income and spending. Income volatility ‘is not just a poor person’s problem,’ said Diana Farrell, chief executive of the J.P. Morgan Chase Institute… ‘This is a middle-income problem.’ In drawing attention to monthly income swings, the research shows a broader challenge for the economy: Insecurity isn’t driven just by unexpected events like losing a job. Instead, volatility has become ‘a normal part of a lot of folks’ lives given the way we’re earning today. Households are scrambling,’ said Jonathan Morduch, an economist at New York University who has done extensive research on the issue.”

May 20 – Bloomberg (Mark Niquette): “Six years after the recession ended, many U.S. states are hard pressed to balance budgets because of a sluggish recovery and their own policy decisions. The fiscal fragility raises questions about how they will weather the next economic downturn. A majority of states are making cuts, tapping reserves or facing shortfalls despite an improving national economy and stock markets at record levels, according to Standard & Poors and the Nelson A. Rockefeller Institute of Government. State revenue hasn’t rebounded to a prerecession peak adjusted for inflation, and other factors are putting pressure on budgets. Alaska, Oklahoma and energy-producing states saw receipts fall with global oil prices…‘The extent of the weakness is really impressive,’ said Donald Boyd, who tracks state finances at the Rockefeller Institute… ‘There’s a lot of pressure on governors and legislators.’ Thirty-two states faced budget gaps in fiscal 2015 or 2016 or both, according to an April 27 report by Standard & Poors… Not all states are struggling. California Governor Jerry Brown said last week that an expanding economy has allowed a boost in proposed spending next year to a record $115 billion.”

May 20 – Bloomberg (Kelly Gilblom): “At the height of the U.S. energy boom, Texas landowner John Baen received about $100,000 a month in royalty payments from companies producing oil and natural gas on his property. Now the checks are much smaller, and when he opens his mailbox each day, he’s afraid he’ll find yet another bankruptcy notice. So far, four of the producers sending him checks have caved in to rising debts as oil prices slumped, seeking court protection from their creditors. ‘I feel like crying because I know I’m going to get another 10 notices,’ said Baen, 67, who owns 10,000 acres of land and mineral rights on other property.”

May 20 – Bloomberg (Katya Kazakina and Mary Romano): “As spring auction sales wrapped up in New York at a record $2.7 billion last week, a slew of art fairs shared in the frenzied buying. Works at Frieze Art Fair went for as much as $4 million while smaller fairs sold art pinned to the walls of booths for less than $3,000. Among the shoppers were seasoned collectors including Peter Kraus, chief executive officer of AllianceBernstein Corp., and real-estate developer Jerry Speyer. ‘When you see the sensationalized prices, it’s good for the market,’ Steven Hartman, owner of Contessa Gallery… ‘Rising tides lift all boats. At every financial level in which collectors buy, they like to know the art market is doing well.”

Federal Reserve Watch:

May 19 – MarketWatch (Greg Robb): “The Federal Reserve risks another bond market tantrum if it continues to hold off on a rate hike, a former U.S. central banker said… Lawrence Lindsey, who served at the Fed in the 1990s before joining the George W. Bush White House, said the central bank had delayed normalization of rates ‘way beyond what is prudent.’ ‘You would have been laughed out of the classroom’ in graduate school if you proposed holding rates at zero with the unemployment rate at 5.4%, as the Fed is doing now, Lindsey said during a panel discussion on Fed policy at an event sponsored by the Peterson Foundation. ‘At some point we’re going to get a series of bad numbers, showing a little higher inflation and the market is going to say ‘on my god, we’re so far behind the curve’ and force an adjustment that is going to be wrenching,’ Lindsey said.”

May 16 – Wall Street Journal (Jon Hilsenrath): “A slew of recent soft economic data has fueled fresh expectations of dimmer U.S. growth, underscoring the already-anemic economy’s unusual vulnerability to even fleeting shocks. This softness—with output possibly flat for the first half of 2015—looks set to give Federal Reserve officials pause as they eye when to raise short-term interest rates from near zero. Fed officials see many indications of underlying strength: Companies are hiring, while incomes and wealth are rising. A variety of other indicators, though, tell a less upbeat story.”

Global Bubble Watch:

May 21 – Wall Street Journal (Simon Nixon): “Talk to almost any banker, investor or hedge-fund manager today and one topic is likely to dominate the conversation. It isn’t Greece, or the U.S. economy, or China, let alone the U.K.’s referendum on European Union membership. It is the lack of liquidity in the markets and what this might mean for the world economy—and their businesses. Market veterans say they have never experienced conditions like it. Banks have become so reluctant to make markets that it has become hard to execute large trades even in the vast foreign-exchange and government-bond markets without moving prices, raising fears investors will take unexpectedly large losses when they try to sell… Recent violent swings in European government-bond markets show what can happen when there is a shortage of capital to stabilize markets.”

May 20 – Bloomberg (Kyoungwha Kim): “Hong Kong’s best-performing stocks this year are tumbling even faster than they rallied. Goldin Financial Holdings Ltd. and Goldin Properties Holdings Ltd., controlled by billionaire Pan Sutong, plunged more than 60% in Hong Kong trading Thursday. There was no immediate explanation for the drop. Before the rout, the two stocks surged more than 300% in 2015… The tumble follows the mysterious 47% plunge in 24 minutes by Hanergy Thin Film Power Group Ltd. on Wednesday, which erased $19 billion in market value…”

May 20 – Bloomberg (David McLaughlin, Tom Schoenberg and Liam Vaughan): “Six of the world’s biggest banks will pay $5.8 billion and five of them agreed to plead guilty to charges tied to a currency-rigging probe as they seek to wind down almost half a decade of enforcement actions. Citicorp, JPMorgan Chase & Co., Barclays Plc and Royal Bank of Scotland Plc agreed to plead guilty to conspiring to manipulate the price of U.S. dollars and euros in settlements with the Justice Department… The main banking unit of UBS Group AG agreed to plead guilty to charges related to interest-rate manipulation… The four banks that agreed to plead guilty to currency charges are among the world’s biggest foreign-exchange traders. They were accused of colluding to influence benchmark rates by aligning positions and pushing transactions through at the same time. Traders who described themselves as members of ‘The Cartel’ used online chat rooms to discuss their positions in the minutes before the rates were set…”

May 20 – Bloomberg (Jeff Black and Anchalee Worrachate): “On Monday evening, Benoit Coeure told a room of bankers and hedge-fund managers in London that the European Central Bank will front load its asset-buying program before a summer lull. The next day, the rest of the market found out, irking investors from Edinburgh to Frankfurt who weren’t in the know as the euro dropped and bonds and stocks rallied. The ECB board member’s dinner speech at the Berkeley Hotel came at the end of an invitation-only conference featuring senior officials from at least five central banks, and which was organized by research groups including one financed by hedge fund Brevan Howard Asset Management. While such events allow the ECB and its peers to maintain a dialog with the investment community, they present a challenge in maintaining a level playing field.”

Central Bank Watch:

May 20 – Bloomberg (Sho Chandra and Sandrine Rastello): “Reserve Bank of India Governor Raghuram Rajan warned that unconventional monetary policies pose a ‘substantial risk’ to sustainable global growth. ‘It is not an industrial country problem, nor an emerging market problem, it is a problem of collective action,” he said in a speech… ‘We are being pushed towards competitive monetary easing.’ Rajan, a former International Monetary Fund chief economist, has been one of the most vocal critics of unprecedented monetary stimulus policies deployed by developed economies. He’s questioned their success and deplored the lack of coordination with developing counterparts. The tactics being deployed by some countries to boost growth also create risks in the financial industry, once the era of unconventional monetary policies ends, Rajan said… ‘I fear that in a world with weak aggregate demand, we may be engaged in a risky competition for a greater share of it,’ Rajan said… While some unconventional policies are justified to help mend markets that are ‘broken or grossly dysfunctional,’ the benefits becomes fuzzy when policies are prolonged, he said.”

Europe Watch:

May 22 – Bloomberg (Jonathan Stearns, Helene Fouquet and Arne Delfs): “German Chancellor Angela Merkel said that greater efforts are needed to unlock bailout funds for Greece after late-night negotiations with Greek Prime Minister Alexis Tsipras failed to yield any sign of a breakthrough. With time running out for a deal to free up the remaining 7.2 billion-euro ($8bn) tranche of aid, Merkel’s discussions in Latvia with Tsipras and French President Francois Hollande broke up in the early hours of Friday with an agreement only to keep talking. Tsipras talked of a resolution ‘soon,’ whereas Merkel said there’s ‘a whole lot to do.’”

May 18 – Reuters (John O’Donnell): “Greece's government should stick to earlier commitments and present reform proposals to help avoid the country becoming insolvent, Germany's central bank warned on Monday. In its monthly report, written by economists and officials at the bank, the Bundesbank used unusually frank language to describe what it called the ‘worrying’ situation in Greece. ‘The current Greek government is obliged to make appropriate proposals, to implement those agreements that have been reached and thereby do their part to avoid the insolvency of the state, with strong repercussions for Greece,’ officials wrote…‘A sustainable solution is not possible without substantial reform in Greece,’ the report said. ‘Financial help should be linked to the relevant preconditions,’ it added.”

China Bubble Watch:

May 18 – Financial Times (Gabriel Wildau): “Capital is flowing out of China at a record pace, sparking fears over financial stability and complicating efforts by the central bank to support a slowing economy with lower interest rates. China ran a balance of payments deficit of $80bn in the first three months of the year, the largest quarterly net outflow on record… The outflows are all the more striking because China’s trade surplus remained strong over the period. As falling commodity prices slashed the country’s import bill, it recorded a $79bn current-account surplus — the largest in nearly five years. But this was overwhelmed by outflows on the capital and financial accounts worth a record $159bn. The lure of China's surging stock market also failed to counter the outflow trend.”

May 18 – Reuters (Umesh Desai and Michelle Price): “As China's economy slows and Beijing becomes more relaxed about letting its companies fail, a rising number of foreign bondholders risk being caught up in the country's unpredictable court system. Last month, solar producer Baoding Tianwei Baobian Electric became China's first ever state-owned company to default on a bond coupon payment, showing Beijing's increasing willingness to let companies go bust in a bid to reform its corporate market. Also in April, Kaisa Group became the first Chinese property developer to fail to pay a coupon on its U.S. dollar bonds and Internet company Cloud Live Tech Group failed to repay nearly $40 million to bondholders. Although onshore and offshore bondholders have equal standing in China's bankruptcy law, lawyers and investors who have experienced corporate failures in China, say bankruptcy proceedings are subject to interference from local government officials who rarely prioritize offshore bondholders. ‘The courts can and do exercise wide discretion, and it's not always clear how that discretion is applied,’ said Mark Hyde, global head of the insolvency and restructuring practice at law firm Clifford Chance… who advised creditors in the 2014 bankruptcy of solar producer Chaori, China's first domestic bond default.”

May 15 – Wall Street Journal (Lingling Wei): “China is reversing course on a major effort to tackle its hefty local government debt problem, marking a setback for a priority reform aimed at getting its financial house in order. The move could provide the economy with some short-term help. But it restores a backdoor way that enabled local governments to load up on debt in recent years, providing a drag on growth at a time when Beijing is looking for ways to rekindle it. According to an announcement made Friday by the State Council, China’s cabinet, the authorities relaxed controls on the ability of local governments to raise money by allowing them to tap government-sponsored financing companies—the very entities that have been blamed for a rapid run-up in China’s local debt load over the past few years. The move undermines an October policy intended to prevent those financing firms from taking on new debt.”

May 18 – Wall Street Journal (Gregor Stuart Hunter): “Investment banks from Morgan Stanley to Citic Securities Co. Ltd. are on a hiring spree in Hong Kong and Shanghai for research analysts who can cover Chinese domestic stocks, banking on billions of dollars in funds descending on China’s capital markets. Among brokerage firms planning to ramp up the number of research analysts are a host of Wall Street banks: Morgan Stanley plans to hire more than 20, Barclays PLC is adding about a dozen analysts to cover as many as 100 stocks this year, Credit Suisse Group AG is hiring so it can increase coverage from 160 to 300 companies by the end of 2016, and HSBC Holdings PLC is adding up to 15 staffers…”

May 20 – Financial Times (Jamil Anderlini): “Last month more than 30 provincial taxi drivers drank poison and collapsed together on the busiest shopping street in Beijing in a dramatic protest against economic and working conditions in their home town. The drivers, who the police say all survived, were from Suifenhe, a city on the Russian border in the northeastern province of Heilongjiang. Such lurid acts of protest are an ancient tradition in China but the extremity of their action highlights one of the biggest problems facing Beijing as it tries to manage the worst economic slowdown in nearly three decades: a deepening provincial economic divide. An examination of regional growth rates across the country shows the slowdown has affected some areas far worse than others. Perhaps predictably, the worst-hit places are those that can least afford it.”

May 22 – Reuters (Brenda Goh): “The concrete building shells, attended by motionless cranes and piles of rubbish, were supposed to be an affordable housing project for nearly 40,000 Shanghai residents, but now stand testament to China's slowing economy. ‘Work has stopped for close to a year,’ said a man who described himself as the live-in caretaker for the site in the city's southern district of Minhang. ‘There's no more money. They stopped paying the construction workers,’ he said… Though China has since the start of last year given the green light to infrastructure projects worth nearly 2 trillion yuan ($320bn) to arrest its economic slowdown, projects where work has stalled or been delayed are common. With growth set to slip to its slowest in a quarter of century and financing becoming more difficult, the number of such projects is likely to grow.”

May 18 – Financial Times (Jamil Anderlini): “More than 100 top executives from some of China’s largest state-owned enterprises have been detained on suspicion of corruption since the start of last year, according to official statistics. Since the beginning of 2014, China’s anti-corruption authorities have publicly named 115 C-suite officials from state groups including global giants such as PetroChina, China Southern Airlines, China Resources, FAW and Sinopec, who have been placed under investigation for graft. Because virtually all of them are also senior Communist party officials, they have mostly disappeared into the feared system of internal party ‘discipline inspection’, where they can be held indefinitely without trial and where torture is believed to be rife. Since ascending to the top of the Chinese system in late 2012, Chinese President Xi Jinping has been engaged in a ferocious anti-corruption campaign that has already gone further and continued for longer than any other since the founding of the People’s Republic in 1949.”

EM Bubble Watch:

May 22 – Reuters (Daren Butler): “Turkish police launched an operation on Friday to detain dozens of people including businessmen perceived to be supporters of U.S.-based Muslim cleric Fethullah Gulen, President Tayyip Erdogan's ally-turned-foe, the Dogan news agency said. Moves against what Erdogan calls a ‘parallel structure’ within the state had until now focused on suspected members of Gulen's network in the police, judiciary, media and a bank founded by his followers.”

Brazil Watch:

May 21 – Bloomberg (Denyse Godoy): “Brazil’s disappointing jobs report added to speculation Latin America’s largest economy is heading to its deepest recession since 1990, sinking bank stocks. The unemployment rate… rose more than analysts forecast in April. Separately, a gauge of gross domestic product showed a bigger-than-estimated contraction. Companies that depend on domestic demand such as busmaker Marcopolo SA dropped, while Banco Bradesco SA paced losses among lenders. ‘The outlook for Brazil’s economy is very negative, so we should expect companies that sell in the domestic market to show weak results,’ Hersz Ferman, an economist at brokerage Elite Corretora, said…”

Geopolitical Watch:

May 20 – MarketWatch (Greg Robb): “Billionaire investor George Soros said flatly that he’s concerned about the possibility of another world war. Much depends on the health of the Chinese economy, Soros said in remarks at a Bretton Woods conference at the World Bank. If China’s efforts to transition to a domestic-demand led economy from an export engine falter, there is a ‘likelihood’ that China’s rulers would foster an external conflict to keep the country together and hold on to power. ‘If there is conflict between China and a military ally of the United States, like Japan, then it is not an exaggeration to say that we are on the threshold of a third world war,’ Soros said.”

May 21 – Reuters (Kanupriya Kapoor): “China's land reclamation around reefs in the disputed South China Sea is undermining freedom and stability, and risks provoking tension that could even lead to conflict, U.S. Deputy Secretary of State Antony Blinken told a conference… China claims 90% of the South China Sea, which is believed to be rich in oil and gas, its claims overlapping with those of Brunei, Malaysia, the Philippines, Vietnam and Taiwan… ‘As China seeks to make sovereign land out of sandcastles and redraw maritime boundaries, it is eroding regional trust and undermining investor confidence,’ Blinken said… ‘Its behavior threatens to set a new precedent whereby larger countries are free to intimidate smaller ones, and that provokes tensions, instability and can even lead to conflict.’”

May 22 – Reuters (Sui-Lee Wee): “China said on Friday it was ‘strongly dissatisfied’ after a U.S. military plane flew over part of the South China Sea near where China is building artificial islands, and called on the United States to stop such action or risk causing an accident. The Chinese navy issued eight warnings to the U.S. P8-A Poseidon, the U.S. military's most advanced surveillance aircraft, when it conducted the overflights on Wednesday… Foreign Ministry spokesman Hong Lei said the Chinese military drove away the U.S. aircraft, in accordance with relevant regulations, labeling the U.S. action a security threat to China's islands and reefs. ‘Such action is likely to cause an accident, it is very irresponsible and dangerous and detrimental to regional peace and stability. We express our strong dissatisfaction, we urge the U.S. to strictly abide by international law and international rules and refrain from taking any risky and provocative actions… China will continue to closely monitor the relevant area and take the necessary and appropriate measures to prevent harm to the safety of China’s islands and reefs as well as any sea and air accidents.’”

May 22 – Fox News: “The U.S. warned China Thursday against confronting U.S. aerial patrols over the South China Sea days after a verbal dispute between a Chinese military dispatcher and a U.S. Navy surveillance aircraft… Daniel Russel, the top U.S. diplomat for East Asia, said the flight of a U.S. reconnaissance plane in international airspace over the South China Sea was a regular and appropriate occurrence. He said the U.S. will seek to preserve the ability of not just the United States but all countries to exercise their rights to freedom of navigation and overflight. ‘Nobody in their right mind is going to try to stop the U.S. Navy from operating. That would not be a good step. But it's not enough that a U.S. military plane can overfly international waters, even if there is a challenge or a hail and query’ from the Chinese military, he said.”

May 21 – Bloomberg (Ian Wishart): “Russia has deployed equipment during the conflict in eastern Ukraine that can be used for nuclear weapons, NATO’s top military commander said. While there’s no ‘direct evidence’ that the Kremlin has made deployments of nuclear arms, U.S. Air Force General Philip Breedlove said on Thursday, ‘that does not mean that they may not have happened.’ ‘Lots of the systems that the Russians use to deliver nuclear weapons are dual-use systems -- they can be either conventional or nuclear -- and some of those systems are deployed,’ Breedlove said.”

Russia and Ukraine Watch:

May 19 – BBC: “Ukraine's president has told the BBC his country is now in a ‘real war’ with Russia - and that Ukrainians should prepare for a Russian offensive. President Petro Poroshenko told the BBC's Fergal Keane he did not trust his Russian counterpart, Vladimir Putin. However he said he had no option but to negotiate with Mr Putin…When asked whether he feared a summer offensive by Russia, Mr Poroshenko said: ‘I not fear anything [sic]. I believe they are preparing an offensive and I think we should be ready and I think that we do not give them any tiny chance for provocation. That will totally be their responsibility.’”

May 18 – Reuters (Sujata Rao): “Ukraine should prepare for default rather than repay ‘selfish and unconstructive’ creditors who oppose a debt writedown backed by the International Monetary Fund, former U.S. Treasury Secretary Lawrence Summers said. Writing in the Financial Times on Monday, Summers said the case for cutting Ukraine's debt burden was compelling, and failure to do so would confirm the view that ‘private financial interests disproportionately influence public policy’. Kiev, which is nearly bankrupt and fighting separatist rebels in eastern Ukraine, wants to restructure about $23 billion in bonds, as the contribution of private creditors to a $40 billion bailout. The IMF is providing $17.5 billion and is making loan disbursements conditional on a restructuring deal. But a creditor committee, comprising Franklin Templeton and four other anonymous funds, refuses to accept a writedown in the bonds' face value.”

May 19 – Bloomberg (Natasha Doff and Marton Eder): “Ukraine’s bonds may have a long way to fall even after the announcement of a possible moratorium on interest payments triggered the deepest selloff in two months. The debt slumped to 45 cents on the dollar on Tuesday. Prices could drop to below 40 cents if negotiations on restructuring the $23 billion of bonds drag on, according to Vadim Khramov, an economist at Bank of America Merrill Lynch… Ukraine has forced investors to weigh the risk of refusing to accept debt writedowns by passing a bill enabling the government to halt payments if it can’t reach agreement with bondholders by its June 15 target. The danger for Ukraine is that it won’t qualify for the next slice of a $17.5 billion International Monetary Fund bailout loan that it needs after a conflict with pro-Russian separatists reduced its reserves to a record amid the worst recession since 2009.”

Japan Watch:

May 18 – Wall Street Journal (Tatsuo Ito and Takashi Nakamichi): “The Bank of Japan appears to be relaxing its stance of doing whatever it takes to quickly reach its 2.0% inflation target, as it opts to wait for tightening labor conditions and higher economic growth to push up prices. The central bank’s at-all-costs approach was first introduced when it launched its aggressive monetary easing campaign in April 2013… While few private economists expect the BOJ to take extra stimulus steps when its policy board holds a regular two-day meeting later this week, a number of economists still see further action either in July or October because they don’t expect the inflation rate to resume rising later this year… But people familiar with the BOJ’s thinking say there is a growing sense among some officials that the BOJ won’t necessarily stick to its whatever-it-takes approach, particularly after the central bank in April pushed back the timing of achieving its price growth target by about six months as inflation decelerates. The BOJ’s all-out approach should be given up, one of those people said, expressing the view that monetary policy should be steered in a way that’s supportive of the economy.”