GROWTH - US GDP Forecasts

Since expectations of Q3's GDP growth began to get ratcheted lower with reality (in March), 'economists' have banked on Q4's fiscally-dragless-renaissance to fill the wedge between equity prices and fundamentals. That 'hope' has been dashed (once again) on the shores of QE insanity as Q4 2013 expectations have collapsed 30% in 2 months to only 1.8%... but 'hope' and 'faith' remain as Q1 2014 will save the day.

SENTIMENT - Percentage Bears As Financial Repression Forces Risk Taking

FINANCIAL REPRESSION - The Bank Interest Scam

Default, Deflation and Financial Repression 11-28-13 rcwhalen's blog

Back in March 2011, author Carmen Reinhart wrote a comment in Bloomberg describing the term “financial repression.”  She wrote:

“As they have before in the aftermath of financial crises or wars, governments and central banks are increasingly resorting to a form of “taxation” that helps liquidate the huge overhang of public and private debt and eases the burden of servicing that debt."

Such policies, known as financial repression, usually involve a strong connection between the government, the central bank and the financial sector. In the U.S., as in Europe, at present, this means consistent negative real interest rates (yielding less than the rate of inflation) that are equivalent to a tax on bondholders and, more generally, savers.”

http://www.bloomberg.com/news/2012-03-11/financial-repression-has-come-b...

In the FDIC data released this week, the financial repression imposed by Ben Bernanke, Janet Yellen and the rest of the Federal Open Market Committee over the past five years is very apparent.  Chief among the data points to be noted is that net interest expense, which is the money paid to depositors at banks, continues to fall.  While all banks earned about $118 billion in interest income last quarter, they paid just $13 billion to depositors, a graphic example of the “financial repression” used by the Fed to subsidize the US banking industry.

http://www2.fdic.gov/qbp/qbpSelect.asp?menuItem=QBP

Notice that while the Fed has maintained the net interest income to banks, the earnings of depositors have fallen more than 90% since 2008.  Via QE, the Fed is subsidizing all banks to the tune of over $100 billion per quarter in artificially depressed interest cost and income to depositors of all stripes. By robbing consumers and all savers of income, the FOMC is in fact feeding deflation and hurting growth and employment.  The chart below using data from the FDIC shows the interest earnings, expenses and net interest income through the end of September 2013 for all US banks.

Prior to the 2007 financial crisis, total interest expense for all US banks was over $100 billion every three months and interest income was almost $200 billion.  In order to maintain the net interest margin for banks at +/- $100 billion per quarter, the Fed is confiscating income of US savers, including companies, investors and the elderly, of almost the same amount each quarter.  This badly needed income is transfered from savers to the banks and is not available to support consumption.  This data graphically illustrates the deflationary nature of current Fed interest rate policies and why Janet Yellen and the Federal Open Market Committee need to raise interest rates soon.  But when rates rise, the next phase of the economic crisis will begin.

In a paper published this month by Carmen Reinhart and Ken Rogoff, the authors argue that financial repression is a necessary part of the adjustment process for heavily indebted nations, even the advanced nations.  The Guardian reports: “They say that if history is any guide countries will not be able to return to more sustainable levels of public debt through a combination of austerity and growth. They cite Europe, where the assumption is that normality can be restored by a combination of belt-tightening, forbearance and rising output, as an example of Panglossian thinking.”

http://www.theguardian.com/business/economics-blog/2013/nov/20/reinhart-...

Say Reinhart and Rogoff:   "The claim is that advanced countries do not need to apply the standard toolkit used by emerging markets, including debt restructurings, higher inflation, capital controls and significant financial repression. Advanced countries do not resort to such gimmicks, policy makers say."

The Guardian:  “Historically, this is poppycock according to Reinhart and Rogoff. Rich countries, when faced with high levels of debt in the past have been more than happy to default, inflate away their debts or indulge in financial repression (capping interest rates or putting pressure on savers to lend to the government).”

The current policy mix in the US certainly shows this tendency to resort to financial repression, but the real question is whether current Fed policy has not resulted in a deflationary trap, with falling income driving consumption, jobs and economic activity lower. Taking $100 billion in income away from savers each quarter does not seem to be a recipe for economic growth. 

But as Reinhart and Rogoff document well, there is no easy solution available for the US, EU, Japan and other heavily indebted developed nations.  Once interest rates start to rise, the necessity of debt restructuring in Europe, Japan and even the US will become more apparent.  There is no free lunch.  Either we kill growth via financial repression of savers or we embrace the painful process of debt restructuring for the major industrial nations.

www.rcwhalen.com

MACRO MONETARY - ECB Version of QE Likely

ECB May Be Pushed toward Asset-Purchase Program 11-27-13 Bloomberg Brief

The ECB will probably have to find a way to lower or offset the monetary union’s large current-account surplus if it wants to weaken the euro. Quantitative easing may be the best option.

The current-account surplus of the euro area remains high. The 12-month average hit a new record of 16 billion euros in September, according to bloomberg brief calculations based on balance-of-payments data from the ECB. That was more than double the record high registered prior to the recent trend increase. That number was 5.1 billion euros in December 2004.

The surplus can be narrowed or offset by several avenues. It could be lowered by:

IMPORTS

Countries with current-account surpluses would lower them through an increase in imports in an ideal world. Germany is the largest generator of those surpluses. The ECB appears unlikely to try to stimulate demand for imports in Germany. The central bank’s policy makers already face criticism for running a monetary policy that is too loose for the largest economy of the euro area.

A Taylor rule model, based on coefficients estimated by the Federal reserve bank of San Francisco, suggests the main policy rate for Germany should be 3.75 percent. That compares with the one-week refinancing rate of the ecb of 0.25 percent.

EXPORTS

A decline in exports is unlikely to appeal to the central bankers. They will want to refrain from policies that increase unemployment.

INCOME ASSETS

The ECB is largely unable to affect the income on previously purchased euro-area assets. The yields of pre-existing bonds would be unaffected by any future decline in borrowing costs. The ECB has no control over yields on foreign assets held by euro-area residents.

FDI

A policy to decrease foreign direct investment in the euro area would be unattractive even if some way of doing that existed. The ecb would probably like to encourage foreigners to invest in the monetary union to increase the economy’s productive capacity in the future. In any case, net FDI flows are already low. The 12-month average registered negative 9.8 billion euros in September. The ECB has little control over the foreign direct investment of euro-area residents.

REDUCED PORTFOLIO FLOWS

That leaves reducing portfolio flows into the euro area as one of the remaining options. Those purchases break down to the categories of equities and bonds. The ECB has little control over the purchase of foreign securities by euro-area residents. The ECB would probably see no advantage in reducing foreign purchases of equities even if some way of doing that existed. The resultant decline of the equity market – in the absence of the ECB buying stocks like the boJ – could reduce consumption through the wealth effect.

The most attractive option may be to decrease foreign demand for euro-area bonds. That would have to be achieved through central-bank purchases of corporate or sovereign debt – a form of quantitative easing – to reduce the yields and by extension their attraction to foreign investors looking to increase income.

That policy would have the added benefit of lowering corporate borrowing costs. The purchase of euro-area assets by the ECB may be more acceptable than the purchase of foreign assets to lower the exchange rate. The major trading partners of the euro area would probably loudly protest the attempt of a central bank that presides over the second-largest economy in the world to blatantly weaken its currency as the SNB did.

Direct intervention in the currency market is unlikely to have much effect. Speculators held a net long position in the euro of only 9,049 contracts in the week ended Nov. 19.

The ECB may eventually be pushed into a policy of quantitative easing

MACRO MONETARY - ECB Version of QE Increasingly Likely

There Is Just No Escape From Mario Draghi's Monetary Zombie Nightmare 11-28-13 SocGen via ZH

On November 7, when the ECB announced a "surprising" rate cut, 67 out of 70 economists who never saw it coming, were shocked. We were not. As we observed ten days prior, Europe had just seen the latest month of record low private sector loan growth in history. Or rather contraction. Back than we said that "one of our favorite series of posts describing the "Walking Dead" monetary zombie-infested continent that is Europe is the one showing the abysmal state Europe's credit creation machinery, operated by none other than the Bank of Italy's, Goldman's ECB's Mario Draghi, finds itself in." We concluded: "we now fully expect a very unclear Draghi, plagued by monetary zombie dreams, to do everything in his power, even though as SocGen notes, he really has no power in this case, to show he has not lost control and start with a rate cut in the November ECB meeting (eventually proceeding to a full-blown QE) to do all in its power to boost loan creation." Less than two weeks later he did just that. The problem, as the ECB reported today, is that both M3 declined once more, to 1.4% or the slowest pace in over 2 years, but more importantly lending to companies and households shrank 2.1% in October - the biggest drop on record! Draghi's monetary zombies are winning.

This is what Europe's monetary pipeline zombies look like:

From SocGen:

The European Central Bank reported that money supply growth (M3) in the euro area decelerated further in October, dropping to an annual rate of 1.4% – the slowest pace of increase in two years – well below the ECB’s 4.5% reference target. The flow of credit to the private sector dropped by 1.7% yoy (adjusted for securitization and sales), down from 1.6% in September.

While the credit impulse to households remains low but positive (0.1% yoy), the fall of credit to corporates (-3.7% yoy) confirms that we are heading towards a creditless recovery, where investment will not be an engine of growth. Of note, the picture is once again one of fragmentation. While the French corporate sector proved rather resilient to credit crunch, the total amount of loans  to corporates plunged by 5.7% yoy in Italy, 6.6% in Portugal, and 19.3% in Spain.

Buzzzz, wrong. In a Keynesian world there is no such thing as a creditless recovery: something Goldman's operative in the ECB knows well, and why the ECB may truly use the nuclear option, and opt for negative deposit rates probably after a conditional LTRO or another 15 bps repo rate cut, but potentially as soon in the next month or two, as it has tried everything else, aside from outright QE, which however would mostly benefit Germany's asset holders and do nothing to stimulate credit growth (see the US for 5 years worth of proof).

As for the European fragmentation in the loan creation department, our condolences to Spain because no amount of employment data falsification or Rajoy propaganda can undo the devastation left from an ongoing 20% crash in credit creation.

In conclusion, even SocGen is now pessimistic that anything the ECB does will have much of an impact on the credit implosion that is Europe: "Yet, it is not clear to us how a movement in overnight deposits would be such as to stimulate investment. What we rather see is that the flow of credit remains negative, which suggests that the strong recovery in investment everyone expects is unlikely to happen for, at least, six to nine more months."

How surprising: "everyone" as usual has zero understanding of how money and credit creation truly work, and just regurgitates whatever the guy next door has said. Alas, that will not help Draghi in his fight against monetary zombocalypse.

CHINA - Launches Crackdown On "Off Balance Sheet" Credit

China Bond Yields Soar To 9 Year Highs As It Launches Crackdown On "Off Balance Sheet" Credit 11-26-13 Zero Hedge

As we showed very vividly yesterday, while the world is comfortably distracted with mundane questions of whether the Fed will taper this, the BOJ will untaper that, or if the ECB will finally rebel against an "oppressive" German regime where math and logic still matter, the real story - with $3.5 trillion in asset (and debt) creation per year, is China. China, however, is increasingly aware that in the grand scheme of things, its credit spigot is the marginal driver of global liquidity, which is great of the rest of the world, but with an epic accumulation of bad debt and NPLs, all the downside is left for China while the upside is shared with the world, and especially the NY, London, and SF housing markets. Which is why it was not surprising to learn that China has drafted rules banning banks from evading lending limits by structuring loans to other financial institutions so that they can be recorded as asset sales, Bloomberg reports.

Specifically, China appears to be targeting that little-discussed elsewhere component of finance, shadow banking. Per Bloomberg, the regulations drawn up by the China Banking Regulatory Commission impose restrictions on lenders’ interbank business by banning borrowers from using resale or repurchase agreements to move assets off their balance sheets. Banks would also be required to take provisions on such assets while the transactions are in effect. Ironically, it may be that soon China will be more advanced in recognizing the various exposures of shadow banking than the US, which is still wallowing under FAS 140 which allows banks to book a repo as both an asset and a liability. 

Recall from a Matt King footnote in his seminal "Are the Brokers Broken?"

Quite apart from the fact that FAS 140 contradicts itself (with paragraph 15 (d) making borrowed versus pledged transactions off balance sheet, and paragraph 94 making them on balance sheet, a topic complained about by many broker-dealers immediately after its issue), there seems to be little consensus as to who is the borrower and who is the lender. As far as we can tell, terms like ‘borrower’ and ‘lender’ are used in exactly the opposite sense in the accounting regulations relative to standard market practice. The description above follows common market practice. The accounting documents seem to refer to this the other way around, a source of confusion commented upon in some of the accounting literature

So while in the US one may be a borrower or a lender at the same time courtesy of lax regulatory shadow banking definition (depending on how much the FASB has been bribed by the highest bidder), in China things will very soon become far more distinct:

The rules would add to measures this year tightening oversight of lending, such as limits on investments by wealth management products and an audit of local government debt, on concerns that bad loans will mount. The deputy head of the Communist Party’s main finance and economic policy body warned last week that one or two small banks may fail next year because of their reliance on short-term interbank borrowing.

“China’s banks and regulators are playing this cat-and-mouse game in which the banks constantly come up with new gimmicks to bypass regulations,” Wendy Tang, a Shanghai-based analyst at Northeast Securities Co., said by phone. “The CBRC has no choice but to impose bans on their interbank business, which in recent years has become a high-leverage financing tool and may at some point threaten financial stability.”

Cutting all the fluff aside, what China is doing is effectively cracking down on the the wild and unchecked repo market, and specifically re-re-rehypothecation, which allows one bank to reuse the same 'asset' countless times, and allow it to appear in numerous balance sheets.

The proposed rules target a practice where one bank buys an asset from another and sells it back at a higher price after an agreed period.

The reason why China is suddenly concerned about shadow banking is that it has exploded as a source of funding in recent years:

Mid-sized Chinese banks got 23 percent of their funding and capital from the interbank market at the end of 2012, compared with 9 percent for the largest state-owned banks, Moody’s Investors Service said in June. The ratings company forecast a further increase in non-performing loans as weaker borrowers find it hard to refinance.

And while we are confident Chinese financial geniuses will find ways to bypass this attempt to curb breakneck credit expansion in due course, in the meantime, Chinese liquidity conditions are certain to get far tighter.

This is precisely the WSJ reported overnight, when it observed that yields on Chinese government debt have soared to their highest levels in nearly nine years amid Beijing's relentless drive to tighten the monetary spigots in the world's second-largest economy. "The higher yields on government debt have pushed up borrowing costs broadly, creating obstacles for companies and government agencies looking to tap bond markets. Several Chinese development banks, which have mandates to encourage growth through targeted investments, have had to either scale back borrowing plans or postpone bond sales."

This should not come as a surprise in the aftermath of the recent spotlight on China's biggest tabboo topic of all: the soaring bad debt, which is the weakest link in the entire, $25 trillion Chinese financial system (by bank assets). So while the Fed endlessly dithers about whether to taper, or not to taper, China is very quietly moving to do just that. Only the market has finally noticed:

The slowing pace of bond sales from earlier in the year is reviving worries of reduced credit and soaring funding costs that were sparked in June, when China's debt markets were rattled by a cash crunch.

The rise in borrowing costs and shrinking access to credit could undercut the recent uptick in China's economy that global investors in stock, commodity and currency markets have cheered. Wobbly growth in China could undermine economic recovery in the rest of the world.

"If borrowing costs don't fall in time, whether the real economy could bear the burden is a big question," said Wendy Chen, an economist at Nomura Securities.

Chinese bond yields are rising amid a lack of demand among the big banks, pension funds and other institutional money managers, analysts say. These investors, traditionally the heavyweights in China's bond market, have seen their funding costs rise in tandem with interbank lending rates, which are controlled by China's central bank. The country's bond market is largely closed to foreign investors.

The yield on China's benchmark 10-year government bond was at 4.65% Monday, down from 4.71% Friday. Last Wednesday's 4.72% was the highest since January 2005, according to data providers WIND Info and Thomson Reuters. The record is 4.88% set in November 2004. Bond yields and prices move in opposite directions.

"The recent sharp rise in bond yields was mostly due to worsening funding conditions and growing expectations for a tighter monetary policy as Beijing seeks to deleverage the economy," said Duan Jihua, deputy general manager at Guohai Securities.

As government-bond yields have risen, the average yield on debt issued by China's highest-rated companies rose to 6.21% as of Friday—the highest since 2006, when WIND Info began compiling the data.

In conclusion, it goes without saying that should China suddenly be hit with the double whammy of regulatory tightening in both shadow and traditional funding liquidity conduits, that things for the world's biggest and fastest creator of excess liquidity are going to turn much worse. We showed as much yesterday:

If the Chinese liquidity spigot - which makes the Fed's and BOJ's QE both pale by comparison - is indeed turned off, however briefly, then quietly look for the exit

CHINA - China's Stunning $15 Trillion In New Liquidity - Part II

How In Five Short Years, China Humiliated The World's Central Banks 11-26-13 Zero Hedge

The concept of the "liquidity trap" is well-known to most: it is that freak outlier in an otherwise spotless Keynesian plane, when due to the need for negative interest rates to boost the economy (usually resulting from that other inevitable Keynesian state: the bursting of an asset bubble) - a structural impossibility according to most economists although an increasingly more probable in Europe - central banks have no choice but to offset a deleveraging private banking sector and directly inject liquidity into the banking sector with the outcome being soaring asset prices, and even more bubbles which will eventually burst only to be replaced with even more failed attempts at reflation. Sadly, very little of this liquidity makes its way to the broad economy as the ongoing recession in the developed world has shown for the 5th year in a row, which in turn makes the liqudity trap even worse, and so on in a closed loop.

Since there is little else in the central bankers' arsenal that is as effective in boosting the "wealth effect" - which is how they validate their actions to themselves and other economists and politicians - they continue to do ever more QE. And since banks are assured at generating far greater returns on allocated capital in the markets, where they can use the excess deposits they obtain courtesy of the Fed's generous reserve-a-palooza as initial margin for risk-on trades, the liquidity pipelines remain stuck throughout the world, and loan creation - that traditional money creation pathway - is permanently blocked (as is the case empirically in both the US and Europe, where private-sector loan creation is declining at a record pace).

Everywhere except the one place that has yet to actually engage in conventional quantitative easing: China. At least explicitly, because loan creation by China's state-controlled entities and otherwise government backstopped banks, is anything but conventional money creation. One can, therefore, claim that China's loan creation is a form of Quasi-QE whereby banks, constrained from investing in a relatively shallow stock market, and unable to freely transfer the CNY-denominated liquidity abroad, are forced to lend it out knowing that if things turn soure at the end of the day, the PBOC will bail them out. Paradoxically, this "non-QE" is exactly how QE should work in the US and other developed markets.

That's the long story.

The short story is far simpler.

In order to offset the lack of loan creation by commercial banks, the "Big 4" central banks - Fed, ECB, BOJ and BOE - have had no choice but the open the liquidity spigots to the max. This has resulted in a total developed world "Big 4" central bank balance of just under $10 trillion, of which the bulk of asset additions has taken place since the Lehman collapse.

How does this compare to what China has done? As can be seen on the chart below, in just the past 5 years alone, Chinese bank assets (and by implication liabilities) have grown by an astounding $15 trillion, bringing the total to over $24 trillion, as we showed yesterday. In other words, China has expanded its financial balance sheet by 50% more than the assets of all global central banks combined!

And that is how - in a global centrally-planned regime which is where everyone now is, DM or EM - your flood your economy with liquidity. Perhaps the Fed, ECB or BOJ should hire some PBOC consultants to show them how it's really done.

CHINA - China's Stunning $15 Trillion In New Liquidity

How China's Stunning $15 Trillion In New Liquidity Blew Bernanke's QE Out Of The Water 11-25-13 Zero Hedge

Much has been said about the Fed's attempt to stimulate inflation (instead of just the stock market) by injecting a record $2.5 trillion in reserves into the US banking system since the collapse of Lehman (the same goes for the ECB, BOE, BOJ, etc). Even more has been said about why this money has not been able to make its way into the broader economy, and instead of forcing inflation - at least as calculated by the BLS' CPI calculation - to rise above 2% has, by monetizing a record amount of US debt issuance, merely succeeded in pushing capital markets to unseen risk levels as every single dollar of reserves has instead ended up as assets (and excess deposits as a matched liability) on bank balance sheets.

Much less has been said that of the roughly $2 trillion increase in US bank assets, $2.5 trillion of this has come from the Fed's reserve injections as absent the Fed, US banks have delevered by just under half a trillion dollars in the past 5 years. Because after all, all QE really is, is an attempt to inject money into a deleveraging system and to offset the resulting deflationary effects. Naturally, the Fed would be delighted if instead of banks being addicted to its zero-cost liquidity, they would instead obtain the capital in the old-fashioned way: through private loans. However, since there is essentially no risk when chasing yield and return and allocating reserves to various markets (see JPM CIO and our prior explanation on this topic), whereas there is substantial risk of loss in issuing loans to consumers in an economy that is in a depressionary state when one peels away the propaganda and the curtain of the stock market, banks will always pick the former option when deciding how to allocated the Fed's reserves, even if merely as initial margin on marginable securities.

However, what virtually nothing has been said about, is how China stacks up to the US banking system when one looks at the growth of total Chinese bank assets (on Bloomberg: CNAABTV Index) since the collapse of Lehman.

The answer, shown on the chart below, is nothing short of stunning.

Here is just the change in the past five years:

You read that right: in the past five years the total assets on US bank books have risen by a paltry $2.1 trillion while over the same period, Chinese bank assets have exploded by an unprecedented $15.4 trillion hitting a gargantuan CNY147 trillion or an epic $24 trillion - some two and a half times the GDP of China!

Putting the rate of change in perspective, while the Fed was actively pumping $85 billion per month into US banks for a total of $1 trillion each year, in just the trailing 12 months ended September 30, Chinese bank assets grew by a mind-blowing $3.6 trillion!

Here is how Diapason's Sean Corrigan observed this epic imbalance in liquidity creation:

Total Chinese banking assets currently stand at some CNY147 trillion, around 2 ½ times GDP. As such, they have doubled in the past four years of increasingly misplaced investment and frantic real estate speculation, adding the equivalent of 140% of average GDP – or, in dollars, $12.5 trillion - to the books. For comparison, over the same period, US banks have added just less than $700 billion, 4.4% of average GDP, 18 times less than their Chinese counterparts – and this in a period when the predominant trend has been for the latter to do whatever it takes to keep commitments off their balance sheets and lurking in the ‘shadows’!

Indeed, the increase in Chinese bank assets during that breakneck quadrennium is equal to no less than seven-eighths of the total outstanding assets of all FDIC-insured institutions! It also compares to 30% of Eurozone bank assets.

Truly epic flow numbers, and just as unsustainable in the longer-run.

But what does this mean for the bigger picture? Well, a few things.

For a start, prepare for many more headlines like these: "Chinese buying up California housing", "Hot Money’s Hurried Exit from China", "Following the herd of foreign money into US real estate markets" and many more like these. Because while the world focuses and frets about the Fed's great reflation experiment (which is only set to become bigger not smaller, now that the Fed has thrown all caution about collateral shortage to the wind and will openly pursue NGDP targeting next), China has been quietly injecting nearly three times in liquidity into its own economy (and markets, and foreign economies and markets) as the Fed and the Bank of Japan combined!

To be sure, due to China's still firm control over the exchange of renminbi into USD, the capital flight out of China has not been as dramatic as it would be in a freely CNY-convertible world, although in recent months many stories have emerged showing that enterprising locals from the mainland have found effective ways to circumvent the PBOC's capital controls. And all it would take is for less than 10% of China's new credit creation to "escape" aboard from the Chinese banking system, the bulk of which is quasi nationalized and thus any distinction between prive and public loan creation is immaterial, for the liquidity effect to be as large as one entire year of QE. Needless to say, the more effectively China becomes at depositing all this newly created liquidity, the faster prices of US real estate, the US stock market, and US goods and services in general will rise (something the Fed would be delighted with).

However, while the Fed certainly welcomes this breakneck credit creation in China, the reality is that the bulk of these "assets" are of increasingly lower quality and generate ever lass cash flows, something we covered recently in "Big Trouble In Massive China: "The Nation Might Face Credit Losses Of As Much As $3 Trillion." It is also the reason why China attempted one, promptly aborted, tapering in the summer of 2013, and why the entire third plenum was geared toward economic reform particularly focusing on the country's unsustainable credit (and liquidity) creation machine.

The implications of the above are staggering. If the US stock, and especially bond, market nearly blew a gasket in the summer over tapering fears when just a $10-20 billion reduction in the amount of flow was being thrown about, and the Chinese interbank system almost froze when overnight repo rates exploded to 25% on even more vague speculation of a CNY1 trillion in PBOC tightening, then the world is now fully addicted to about $5 trillion in annual liquidity creation between just the US, Japan and China alone!

Throw in the ECB and BOE as many speculate will happen eventually, and it gets downright surreal.

But more importantly, as with all communicating vessels, global liquidity is now in a constant state of laminar flow - out of central banks: either unadulterated as in the US, Japan, Europe and the UK, or implicit, when Chinese government-backstopped banks create nearly $4 trillion in loans every year. If one issuer of liquidity "tapers", others have to step in. Indeed, as we suggested a few weeks ago, any possibility of a Fed taper would likely involve incremental QE by the Bank of Japan, and vice versa.

However, the biggest workhorse behind the scenes, is neither: it is China. And if something happens to the great Chinese credit-creation dynamo, then we see no way that the rest of the world's central banks will be able to step in with low-powered money creation, to offset the loss of China's liquidity momentum.

Finally, when you lose out on that purchase of a home to a Chinese buyer who bid 50% over asking sight unseen, with no intentions to ever move in, you will finally know why this is happening.

VALUATIONS - Will Eventually Be Shown to Have Been a Monetary Policy Induced Bubble

Why The Fed Can't See A Bubble In Equity Valuations 11-24-13 John Hussman via ZH

In 'An Open Letter To The FOMC' John Hussman lays out in detail the true state of the world that asset-gatherers and Fed members alike seem blinded to. The intent of his letter is not to criticize, but hopefully to increase the mindfulness of the FOMC as to historical evidence, the strength of various financial and economic relationships, and the potentially grave consequences of further extreme and experimental monetary policy. Crucially, as we have heard numerous times in the last few weeks, the Fed sees no bubble, and so, a courtesy to both the investing public and the gamblers at the Fed, Hussman explains the reason that the Fed does not see an “obvious” stock market bubble (to use a word regularly used by Governor Bullard, as if to imply that misvaluations cannot exist unless they smack their observers with a two-by-four).

Excerpted from John Hussman's "Open Letter To The FOMC",

...

The reason that the Fed does not see an “obvious” stock market bubble (to use a word regularly used by Governor Bullard, as if to imply that misvaluations cannot exist unless they smack their observers with a two-by-four) is because while price/earnings multiples appear only moderately elevated, those multiples themselves reflect earnings that embed record profit margins that stand about 70% above their historical norms.

We can demonstrate in a century of evidence that

a) profit margins are mean-reverting and inversely related to subsequent earnings growth,

b) margin fluctuations are largely driven by cyclical variations in the combined savings of households and government, and importantly,

c) valuation measures that normalize or otherwise dampen cyclical variation in profit margins are dramatically better correlated with actual subsequent outcomes in the equity markets.

[ZH: READ THAT AGAIN!!]

A few additional charts will drive this point home. The chart below shows the S&P 500 price/revenue ratio (left scale) versus the actual subsequent 10-year nominal total return of the S&P 500 over the following decade (right scale, inverted). Market valuations on this measure are well above any point prior to the late-1990’s market bubble. Indeed, if one examines the stocks in the S&P 500 individually, the median price/revenue multiple is actually higher today than it was in 2000 (smaller stocks were more reasonably valued in 2000, compared with the present). This is a dangerous situation. In this context, the dismissive view of FOMC officials regarding equity overvaluation appears misplaced, and seems likely to be followed by disruptive financial adjustments.

One obtains a similar view, with equal historical reliability, from the ratio of nonfinancial equity capitalization to nominal GDP, using Federal Reserve Z.1 Flow of Funds data. On this measure, equities are already beyond their 2007 peak valuations, and are approaching the 2000 extreme. The associated 10-year expected nominal total return for the S&P 500 is negative.

The unfortunate situation is that while the required financial adjustment may or may not be as brutal for investors as in 2007-2009, or 2000-2002, or 1972-1974, when the stock market lost half of its value from similar or lesser extremes, the consequences of extremely rich valuation cannot be undone by wise monetary policy. The Fed has done enough, and perhaps dangerously more than enough. The prospect of dismal investment returns in equities is an outcome that is largely baked-in-the-cake. The only question is how much worse the outcomes will be as a result of Fed policy that has few economic mechanisms other than to encourage speculative behavior.

And of course this speculative behavior ends with only one feature - bubble risk...

A discussion of bubble risk would be incomplete without defining the term itself. From an economist’s point of view, a bubble is defined in terms of differential equations and a violation of “transversality.” In simpler language, a bubble is a speculative advance where prices rise on the expectation of future advances and become largely detached from properly discounted fundamentals. Put another way, a bubble reflects a widening gap between the increasingly extrapolative expectations of market participants and the prospective returns that can be estimated through present-value relationships linking prices and likely cash flows.

As economist Didier Sornette observed in Why Markets Crash, numerous bubbles in securities and other asset markets can be shown to follow a “log periodic” pattern where the general advance becomes increasingly steep, while corrections become both increasingly frequent and gradually shallower. I’ve described this dynamic in terms of investor behavior that reflects increasingly immediate impulses to buy the dip.

Along with this pattern, which has emerged with striking fidelity since 2010, we observe a variety of other features typically associated with dangerous extremes:

• unusually rich valuations on a wide variety of metrics that actually have a reliable correlation with subsequent market returns; margin debt at the highest level in history and representing 2.2% of GDP (eclipsed only briefly at the 2000 and 2007 market extremes);
• a blistering pace of initial public offerings - back to volumes last seen at the 2000 peak - featuring “shooters” that double on the first day of issue;
• confidence in the narrative that “this time is different” (in this case, the presumption of a fail-safe speculative backstop or “put option” from the Federal Reserve); lopsided bullish sentiment as the number of bearish advisors has plunged to just 15% and bulls rush to one side of the boat;
• record issuance of covenant-lite debt in the leveraged loan market (which is now spreading to Europe);
• and a well-defined syndrome of “overvalued, overbought, overbullish, rising-yield” conditions that has appeared exclusively at speculative market peaks – including (exhaustively) 1929, 1972, 1987, 2000, 2007, 2011 (before a market loss of nearly 20% that was truncated by investor faith in a new round of monetary easing), and at three points in 2013: February, May, and today (see A Textbook Pre-Crash Bubble).

Many of us in the financial world know these to be classic features of speculative peaks, but there is career risk in responding to them, so even those who view the situation with revulsion can't seem to tear themselves away.

While I have no belief that markets follow any mathematical trajectory, the log-periodic pattern is interesting because it coincides with a kind of “signature” of increasing speculative urgency, seen in other market bubbles across history. The chart above spans the period from 2010 to the present. What’s equally unsettling is that this speculative behavior is beginning to appear “fractal” – that is, self-similar at diminishing time-scales. The chart below spans from April 2013 to the present. On this shorter time-scale, Sornette’s “finite time singularity” pulls a bit closer – to December 2013 rather than January 2014, but the fidelity to this pattern is almost creepy. The point of this exercise is emphatically not to lay out an explicit time path for prices, but rather to demonstrate the pattern of increasingly urgent speculation – the willingness to aggressively buy every dip in prices – that the Federal Reserve has provoked

VALUATIONS - EBIT is Where You Look - Not the Manipulated NBT

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