'The historic mistake was to believe that aggressive monetary policy would reduce systemic Fragilities. Stimulation of economies and animal spirits, no doubt, but at the cost of mounting latent instability. It's the six-year anniversary of "whatever it takes;" approaching the 10-year anniversary of the financial crisis; and going on ten years since China's massive stimulus. This week provided further evidence of trapped central banks.''The ongoing "global government finance Bubble" is unique in history. Rarely has market intervention and manipulation been so widely championed. Never have governments and central banks on a concerted basis inflated government debt and central bank Credit. And almost a full decade since the crisis, the massive inflation of "money"-like government obligations runs unabated - across the continents.
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Extreme and protracted (fiscal and monetary) policy stimulus has indeed stimulated real economy expansion. Given sufficient scope and duration, stimulus will invariably fuel spending and investment. Unfortunately, the artificial boom is also not without myriad negative consequences. Is the boom sustainable? Have we today reached the point where economic growth is self-supporting? Or, instead, is the global boom vulnerable to the curtailment of aggressive stimulus measures? Has global government stimulus promoted a return to stability? Or has an almost decade of unprecedented measures only exacerbated Latent Fragilities?
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Despite GDP growth in the neighborhood of 6.0%, booming household borrowings, an unrelenting apartment Bubble and an ongoing Credit boom, China has once again been compelled to resort to aggressive stimulus in an attempt to hold its tottering Bubble upright. The Chinese economy's vulnerability to a U.S. trade war is generally offered as the impetus behind recently announced measures. Perhaps exposure to the faltering EM Bubble is also a pressing concern in Beijing.
July 22 - Wall Street Journal (Jeremy Page and Saeed Shah): "Pakistan's first metro, the Orange Line, was meant to be an early triumph in China's quest to supplant U.S. influence here and redraw the world's geopolitical map. Financed and built by Chinese state-run companies, the soon-to-be-finished overhead railway through Lahore is among the first projects in China's $62 billion plan for Pakistan. Beijing hoped the $2 billion air-conditioned metro, sweeping past crumbling relics of Mughal and British imperial rule, would help make Pakistan a showcase for its global infrastructure-building spree. Instead, it has become emblematic of the troubles that are throwing China's modern-day Silk Road initiative off course. Three years into China's program here, Pakistan is heading for a debt crisis, caused in part by a surge in Chinese loans and imports for projects like the Orange Line, which Pakistani officials say will require public subsidies to operate."
A few decades back it was Japanese Bubble Finance spreading its tentacles across the world. This week saw Japanese 10-year yields almost reach 11 bps, near the high going back to January 2016. It took two Bank of Japan (BOJ) interventions - offers to buy unlimited JGBs - to push yields back below 10 bps by Friday. There is considerable market focus on next week's BOJ policy meeting, along with heightened concerns in Japan for the sustainability of the BOJ's policy course. Holding "market" yields indefinitely at zero promotes distortions and imbalances. Various reports have the BOJ contemplating adjusting this policy. The bank may also adjust an ETF purchase program viewed as distorting the Japanese equities market.
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I believe we've reached the stage where a meaningful tightening of finance in Europe risks both acute bond market instability and even the entire euro experiment. For those believing this is hyperbole, allow me to phrase this differently: Italy and other "periphery" nations are one financial crisis away from demanding an alternative monetary regime.
A reasonable question: Why then is the euro not under more pressure? Well, Japan is only a meaningful tightening of financial conditions away from major bond market and financial system issues. The yen is a big wildcard. China is only a meaningful tightening away from major financial and economic issues. The renminbi is a big wildcard. The emerging markets are already suffering the effects of a tightening of financial conditions. Many EM currencies are in trouble.
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In the eyes of complacent markets, vulnerabilities - China, Japan, EM, Eurozone, UK, etc. - ensure the coterie of global central bankers remain trapped in aggressive stimulus. Yet there appears increasing recognition within the central bank community that further delays in the start of "normalization" come with mounting risks. That they have all in concert for far too long delayed getting the process started ensures great Latent Fragilities.
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The historic mistake was to believe that aggressive monetary policy would reduce systemic Fragilities. Stimulation of economies and animal spirits, no doubt, but at the cost of mounting latent instability. It's the six-year anniversary of "whatever it takes;" approaching the 10-year anniversary of the financial crisis; and going on ten years since China's massive stimulus. This week provided further evidence of trapped central banks.
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First it was the February blow-up of the "short vol" trade. Then instability engulfed the emerging currencies, debt and equities markets, followed by a destabilizing spike in Italian yields. The Chinese renminbi sinks a quick 5%. This week saw further weakness in the Chinese currency, along with hints of instability in Japanese and Italian bonds. Importantly, Beijing stimulus measures come with atypical currency vulnerability.
All in all, the Latent Fragility case is coming together. Financial conditions are tightening, and myriad Bubbles are showing the strain. And while the VIX traded below 12 this week (closing Friday at 13.03), my hunch would be that liquidity in the volatility markets has quietly receded. The next VIX spike could get interesting.'
- Doug Noland,
Latent Fragilities, July 28, 2018
Context'..market extremes..''..I’ve lost all respect for monetary economists..'End the Fed - 'Rarely do people ask what the fundamental source of instability really is.'((Hapto)praxeology) - '..Mises’s warning to the world .. not to suppress the market rate of interest in the name of creating prosperity.'History is Clear, Central Banks Fail to Assure Economic StabilityHuman action originates change.' - 'Repress change, and you repress all that it means. Repressing it is sheer hubris..'The Dangerous Delusion of Price Stability - William White'Deflation may actually boost output. Lower prices increase real incomes and wealth. And they may also make export goods more competitive.' - BIS(Banking Reform - Monetary Reform) - '..The Theory of Money and Credit .. an invaluable guide for ending the business cycles of our own time.'(Praxeology) - '..Menger’s experience stressed subjective factors..''..monetary knowledge .. of currency reform under difficult conditions you have to go to Carl Menger.'(Banking Reform - English/Dutch) '..a truly stable financial and monetary system for the twenty-first century..'