ECB APRIL MEETING - No Easing

SIGNALS:

• Negative Deposit rates (likely FIRST STEP- They are currently zero)
• Large-scale bond purchases (we anticipate this to be UST's if it happens)
• Key measure is inflation which is too low at 0.5% versus 2% EU target.

The governing Council pointed to the economic recovery to justify inaction.

• The first reading on the composite PMI survey for the monetary union remained buoyant at 53.2 in March.
• The decline in the unemployment rate provides additional evidence of economic growth. It fell to 11.9 percent in February from 12 percent in January

LIKELY REAL REASON FOR DEALY

Draghi said the 24-member board—which includes Germany's ultracautious Bundesbank—was "unanimous in its commitment" to deploy "unconventional instruments" at its disposal if inflation stays too low for too long.

Mr. Draghi "has elevated the threat level about further action. "I don't think you can be any more dovish without actually doing something" said Nick Matthews, economist at Nomura International."

No ECB easing despite fear of stagnation Danske Bank

 Mario Draghi’s biggest fear for the euro area is protracted stagnation. Nevertheless, the ECB did not ease today.

 An interesting part of today’s ECB meeting was that the Governing Council discussed a quantitative easing (QE) programme. Last month , Draghi slightly opened the door for this, as he mentioned QE while listing a number of easing measures. Today , he was much more direct and said the Council is ‘unanimous on unconventional tools’.

 The ECB also discussed negative deposit rates as well as

• A narrowing of the rate corridor and related to this Draghi said that
• ‘the ECB has not yet finished with conventi onal measures’.

 Hence, it seemed that Draghi tried to use his old strategy of verbal intervention but it had only a marginal market influence. Could it be that markets are starting to get tired of soft words and now want action?

 At the latest meeting , Draghi focused on the recovery and how things had start ed to look better but today focus was back on inflation. The message from Draghi seems to be that another negative surprise on inflation w ou l d lead to more easing , as this is very likely to change the ECB’ s outlook for inflation. So far , it i s too early for the ECB to conclude whether the outlook has changed and i t maintained its wait - and - see approach.

 In our view , the ECB is too optimistic on inflation and we will get more negative surprises. Based on Drag hi’s communication today, we expect th is to lead to further easing.

 In our view the timing is still very unsure. We think the ECB’s inflation forecast is too optimistic for Q2 but in coming months base effects are likely to lead to higher inflation, which would buy the ECB some time. Hence , it could be that the ECB will remain on hold until H2. Moreover, the tool is also very uncertain. Although the Governing Council is now considering a QE programme , it looks as though it has not found a preferred tool to use in fighting low inflation.

 As expectations going into today’s meeting were lighter than previous meetings in 2014, the disappointment o f unchanged policy has not had a great influence o n the fixed income market. German 10Y moved marginally during the E CB meeting and most selling pressure was observed at the front of the Euribor and Eonia curve, as we now h av e confirmation of unchanged liquidity dynamics in the next maintenance period , including the usual volatile period of Easter. However, as QE was a m ore explicit subject at today’s meeting , peripheral spreads are tighter on the day.

Draghi: ECB Open to Further Easing 04-03-14 WSJ

Euro Weakens After Central Bank Chief Says Officials Discussed Possibility of Asset Purchases

FRANKFURT—The European Central Bank opened the door Thursday to the kind of extraordinary stimulus measures it has long resisted, even as its counterparts in the U.S. and elsewhere are winding down theirs, reflecting mounting fears about threats to Europe's economic recovery.

President Mario Draghi's revelation that the central bank had discussed negative interest rates and large-scale bond purchases—if needed to keep persistently low inflation from undermining growth—caught financial markets by surprise.

The ECB, as expected, held its main lending rate at the record low of 0.25%, where it has been since November. But the euro weakened at the ratcheting up of the rhetoric concerning the possibility of action as early as next month.

Mr. Draghi said officials had discussed asset purchases, known as quantitative easing, as well as setting a negative rate on bank deposits parked at the ECB—moves that could help bolster the economic recovery and push up prices. The annual inflation rate in the euro zone is just 0.5%, far below the bank's target of just under 2%.

"We don't exclude further monetary-policy easing," Mr. Draghi said at his monthly news conference. He also peppered his comments with much more aggressive language than he has used in recent month.

The ECB is "resolute" in its determination to keep its easy-money policies in place, he said, and "to act swiftly if required."

And whereas a handful of ECB members have signaled an openness to more action in recent days, Mr. Draghi put the weight of the full ECB behind it.

He said the 24-member board—which includes Germany's ultracautious Bundesbank—was "unanimous in its commitment" to deploy "unconventional instruments" at its disposal if inflation stays too low for too long.

After he spoke, Spanish and Italian government bonds extended their recent rallies, with Italy's 10-year bond yields falling to an eight-year low.

Mr. Draghi "has elevated the threat level about further action," said Nick Matthews, economist at Nomura International. "I don't think you can be any more dovish without actually doing something," he said. "Dovish" is used to describe central bankers who are more worried about weak growth than they are about inflation.

Mr. Draghi's comments suggest reducing interest rates would be a first step.

A negative deposit rate—it is currently zero—would force financial institutions to pay to park their excess funds at the ECB, which may encourage them to lend more to the private sector. Denmark has deployed negative rates since 2012, but it would be largely unchartered territory for a major central bank such as the ECB.

Quantitative easing is more complicated in the euro zone than in the U.S., where the Federal Reserve has deployed the policy and continues to do so, albeit at a scaled-back pace. Asset purchases in the U.S. filter quickly to its economy because relatively more borrowing there is done through the capital markets, Mr. Draghi noted.

The Bank of England has accumulated about £375 billion ($622 billion) in government bonds since 2009, but hasn't made any new purchases since November 2012. The U.K. economy has expanded much more vigorously than the euro zone's in recent years, and inflation is significantly higher.

But the euro zone has 18 national bond markets to deal with, making it hard to design a policy for the entire region. And the euro bloc is much more reliant on bank lending than the U.S., meaning that even if the ECB bought private and public debt, this may not be quickly transmitted to the economy.

Still, the ECB had a "rich and ample discussion" on quantitative easing and other measures, Mr. Draghi said, and will continue to study it.

Pressure on the ECB to act has grown since a report released Monday showed that inflation softened to just 0.5% in March, a more than four-year low.

A surprisingly weak inflation figure of 0.7% in October triggered the ECB rate cut last November. But Mr. Draghi said the central bank wants more time this time to gauge the longer-term outlook.

He noted that Easter occurs later this year than in 2013. That means typical price rises for such things as holiday-related travel will occur in April rather than March. Officials are also eyeing the effect of the relatively strong euro on consumer prices, he said.

This sets up the April inflation report as a key one for the ECB, analysts said.

ECB Vice President Vitor Constancio said on Tuesday that the central bank expects "that the low figure of inflation in March will be corrected" in April.

If that fails to happen, however, the ECB may move as early as next month, Mr. Matthews said.

The Organization for Economic Cooperation and Development reported Thursday that deflation risks in the euro area have risen, with Greece, Cyprus and Spain already suffering from it. The Paris-based think tank called on the ECB to consider "additional nonconventional measures" if the problem intensified.

Typically, low inflation is a good thing. It keeps long-term interest rates anchored and provides a stable environment for households and business to spend and invest.

But when it is too weak, consumers may put off purchases, hoping they will get a better deal if they wait. It also makes it harder for households, firms and governments to service their debts, because wages and tax revenue don't rise as much.

These risks intensify when prices fall outright for a prolonged stretch, known as deflation. Japan has struggled with these effects for two decades.

Mr. Draghi rejected, as he has numerous times before, fears of deflation in Europe.

Still, even too-low inflation carries risks. The closer inflation is to zero, the easier it is for an adverse shock from the economy or geopolitical uncertainty to push the rate into negative territory.

For this reason, major central banks such as the ECB and Fed aim to keep inflation around 2%.

So far, the euro zone has seen little ill effect from low inflation and the recent high value of the euro. The economy has expanded, if slowly, since exiting a lengthy recession last spring.

Business surveys and consumer spending reports suggest the recovery gathered some pace during the first quarter, led by Europe's largest economy, Germany.

Still, Mr. Draghi cited the economy as his biggest fear, and emphasized the need for government efforts to make labor markets more flexible. The longer high unemployment persists, the greater the chances that it will become structural rather than temporary, he said.

"The protracted stagnation…even right now it's pretty severe," he said.

CHINA -

What Happens After the Low-Hanging Fruit Has Been Picked? 04-02-14 Charles Hugh Smith

Right now China is at the top of the S-Curve, and the problems of stagnation are still ahead.

What happens after all the low-hanging fruit has been picked? 

USA: Why the global financial meltdown occurred in 2008

HOUSING

• In the U.S. housing market, there was nobody left to buy an overpriced house with a no-document liar loan because everyone who was qualified to buy a McMansion in the middle of nowhere had already bought three and everyone who wasn't qualified had purchased a McMansion to flip with a liar loan.
• Once the pool of credulous buyers evaporated, the dominoes fell, eventually circling the globe.

CHINA:

• China has led the world's growth for the better part of two decades, and now the growth story has entered a new phase.
• China is weakening its currency (renminbi/yuan), and trying to throttle its vast credit/shadow banking expansion even as Chinese officials claim
• China's economy is still expanding at a phenomenal clip (7+% annually).

I think we can shed some insightful analytic light by saying that the low-hanging fruit in China has all been plucked, and this creates an entirely new set of problems and challenges.

• Mathematical impossibility of continued break-neck growth 
• When China's economy (in purchasing power parity (PPP) or nominal dollars) GDP was $500 billion, an expansion of $50 billion equated to 10% a year.
• Now that China's PPP gross domestic product is around $13 trillion, a 10% growth rate would require an expansion of $1.3 trillion--roughly the entire GDP of Spain or Canada.
• Obviously, fast growth is easy when the low-hanging fruit are abundant, and it becomes progressively more difficult to maintain as the economy expands.

This pattern of rapid growth, maturity and stagnation can be seen in the S-Curve, a pattern that natural and human-made systems alike track.

• When a country lacks infrastructure, or the infrastructure has been destroyed by war, then building infrastructure is the dominant activity in the low-hanging fruit/fast growth phase.
• Nations such as Japan and Germany experienced rapid growth after World War II for much the same reason China has boomed: infrastructure.
• China has reached the maturity phase of the S-Curve in a mere 20 years
  • every major city has a subway system,
  • thousands of miles of rail and highways have been laid,
  • tens of millions of housing units have been built, and so on.
  • As a result of this single-minded pursuit of building, China now sports nearly empty cities, train stations, malls and highrise residential towers.

In other words, all the low-hanging fruit of infrastructure have been picked.

HOUSING

1. Observers in Beijing see endless growth of housing, due to strong demand. But this rosy view overlooks the fact that housing throughout China is out of reach not just of the millions of poorly paid migrant workers pouring into the cities but for college graduates--assuming they can even find a job (Chinese College Graduates Cannot Secure Jobs)
2. Even the cheapest condos cost well over $100,000 (in USD) in 3rd tier cities and much more in 1st and 2nd tier cities. The average starting salary for graduates is 2,000 to 3,000 yuan ($326) a month (roughly $4,000 to $6,000 a year), and salaries of around 50,000 yuan a year ($8,600) are considered good.
3. As a result, a double-income middle class household can only own a flat if the parents' savings are devoted to the down payment, which is usually 50% of the purchase price in China.
4. So all the stories of housing demand being permanent are misleading, because only a tiny sliver of the millions of people coming to cities can afford even the cheapest flat in the suburbs.

CREDIT EXPANSION & MARGINAL INVESTMENTS

The other problem is that the low-hanging fruit have all been stripped via an unprecedented expansion of credit.

Credit has a pernicious characteristic: it inevitably leads to diminishing returns as low-value,high-risk projects get funded in the rush to build anything and everything everywhere.

In other words, once the high-value low-hanging fruit has been picked, the sensible, high-value investment opportunities have all been taken and all that's left is marginal malinvestments.

1- SUSTAINING ASSUMPTION: Every Building Project will be Filled

In the U.S., this led to the famous McMansions in the middle of nowhere. In China, the general faith is that every building project, no matter how marginal, will soon be filled (and regardless of demand, the government will never let housing decline, even in ghost cities).

But as pointed out above, this presumes the millions of poorly educated rural migrants and the 7 million students graduating from college every year will soon be earning upper-middle-class incomes. Once the fast growth phase has ended, this becomes much more problematic. And indeed, reports of unemployed college graduates are now the norm (see below). As for migrants, most toil in very marginal jobs with low, insecure pay.

2- SUSTAINING ASSUMPTION: Expectations of Future Prosperity

Another systemic problem arises when the low-hanging fruit have been picked:expectations of future prosperity have been pushed into the stratosphere, and these expectations will inevitably be disappointed as growth slows.

Rapid industrialization leads to rampant pollution. China has spent very little of its GDP on environmental investments, and now the bill is coming due. It is mathematically impossible for China to spend what needs to be spent (say, 5% of GDP for a decade) on cleaning up the environment and maintaining 7.5% annual growth. Promising people both will only set up a profound disappointment as neither goal can possibly be met.

3- SUSTAINING ASSUMPTION: Excess is Built Into the Culture Fabric

Lastly, China lacks the cultural capital of maintaining infrastructure. In the 20 years of picking low-hanging fruit, buildings have been routinely torn down and replaced. The idea that a building will have to last 50 years, never mind 100 years, does not compute: if a building shows signs of aging, the solution for the past 20 years has been to tear it down and replace it with something grander.

This was possible in the fast-growth phase, but it is impossible in the stagnation phase for the same reason noted above: it's possible to tear down and replace 1,000 major buildings a year in the early years, but it becomes physically and financially impossible to replace millions of aging housing units.

Those familiar with construction and this lack of infrastructure to oversee and fund maintenance foresee tens of thousands of buildings that will slowly but surely become uninhabitable as elevators break down, pumps stop working, leaks cause concrete to spall, etc.

Anyone with even modest construction experience can see that the foundation beneath the toppled 13-story building is not even remotely adequate; the slightest temblor will destabilize all such buildings, and such feeble footings built directly on grade will lead to cracked pipes and a host of other impossible-to-fix problems.

REALITIES

Right now China is at the top of the S-Curve, and these problems of stagnation are still ahead. The most severe challenge in my view is not material or fiscal, it's psychological: when sky-high expectations crash to earth, social discord starts its own S-Curve of rapid growth.

Chinese College Graduates Cannot Secure Jobs: 28% Of Beijing's 2013 Graduates And 44% Of Shanghai's Have Found A Job:

This year a total of 6.99 million students graduated with a master's, bachelor's or technical college degree in China, an increase of 190,000 from 2012. In contrast, the number of jobs available decreased by 15 percent compared with 2012, according to China Youth, a state-run youth newspaper. Combined, these statistics mean a large portion of graduates will not have a job coming out of school.

Making matters worse for graduates, the "lucky" ones with jobs can expect an average salary of 3,000 yuan per month ($487.89). Netizens have calculated that at this rate, a 2013 graduate will have enough money to purchase a bathroom in the suburbs of Beijing in 10 years, if she doesn’t eat and chooses to live on the street.

UKRAINE - BRICS Back Russia On Crimea

Why Did BRICS Back Russia On Crimea? 03-31-14 Zachary Zeck of The Diplomat, via ZH

There’s been no shortage of reports and commentaries on the crisis in Ukraine and Crimea, and Russia’s role in it. Yet one of the more notable recent developments in the crisis has received surprisingly little attention.

Namely, the BRICS grouping (Brazil, Russia, India, China, and South Africa) has unanimously and, in many ways, forcefully backed Russia’s position on Crimea. The Diplomat has reported on China’s cautious and India’s more enthusiastic backing of Russia before. However, the BRICS grouping as a whole has also stood by the Kremlin.

Indeed, they made this quite clear during a BRICS foreign minister meeting that took place on the sidelines of the Nuclear Security Summit in The Hague last week. Just prior to the meeting, Australian Foreign Minister Julie Bishop suggested that Australia might ban Russia’s participation in the G20 summit it will be hosting later this year as a means of pressuring Vladimir Putin on Ukraine.

The BRICS foreign ministers warned Australia against this course of action in the statement they released following their meeting last week. “The Ministers noted with concern the recent media statement on the forthcoming G20 Summit to be held in Brisbane in November 2014,” the statement said. “The custodianship of the G20 belongs to all Member States equally and no one Member State can unilaterally determine its nature and character.”

The statement went on to say, “The escalation of hostile language, sanctions and counter-sanctions, and force does not contribute to a sustainable and peaceful solution, according to international law, including the principles and purposes of the United Nations Charter.”As Oliver Stuenkel at Post Western World noted, the statement as a whole, and in particular the G20 aspect of it, was a “clear sign that [the] West will not succeed in bringing the entire international community into line in its attempt to isolate Russia.”

This was further reinforced later in the week when China, Brazil, India and South Africa (along with 54 other nations) all abstained from the UN General Assembly resolution criticizing the Crimea referendum. Another ten states joined Russia in voting against the non-binding resolution.

In some ways, the other BRICS countries’ support for Russia is entirely predictable. Thegroup has always been somewhat constrained by the animosities that exist between certain members, as well as the general lack of shared purpose among such different and geographically dispersed nations. BRICS has often tried to overcome these internal challenges by unifying behind an anti-Western or at least post-Western position. In that sense, it’s no surprise that the group opposed Western attempts to isolate one of its own members.

At the same time, this anti-Western stance has usually taken the form of BRICS opposition to Western attempts to place new limits on sovereignty. Since many of its members are former Western colonies or quasi-colonies, the BRICS are highly suspicious of Western claims that sovereignty can be trumped by so-called universal principles of the humanitarian and anti-proliferation variety. Thus, they have been highly critical of NATO’s decision to serve as the air wing of the anti-Qaddafi opposition that overthrew the Libyan government in 2011, as well as what they perceive as attempts by the West to now overthrow Bashar al-Assad in Syria.

However, in the case of Ukraine, it was Russia that was violating the sanctity of another state’s sovereignty. Still, the BRICS grouping has backed Russia. It’s worth noting that the BRICS countries are supporting Russia at potentially great cost to themselves, given that they all face at least one potential secessionist movement within their own territories.

India, for example, has a long history of fluid borders and today struggles with potential secessionist movements from Muslim populations as well as a potent security threat from the Maoist insurgency. China suffers most notably from Tibetans and Uyghurs aspiring to break away from the Han-dominated Chinese state. Even among Han China, however, regional divisions have long challenged central control in the vast country. Calls for secession from the Cape region in South Africa have grown in recent years, and Brazil has long faced a secessionist movement in its southern sub-region, which is dominated demographically by European immigrants. Russia, of course, faces a host of internal secessionist groups that may someday lead Moscow to regret its annexation of Crimea.

The fact that BRICS supported Russia despite these concerns suggests that its anti-Western leanings may be more strongly held than most previously believed. Indeed, besides backing Russia in the foreign ministers’ statement, the rising powers also took time to harshly criticize the U.S. (not by name) for the cyber surveillance programs that were revealed by Edward Snowden.

The BRICS and other non-Western powers’ support for Russia also suggests that forging anything like an international order will be extremely difficult, given the lack of shared principles to act as a foundation. Although the West generally celebrated the fact that the UN General Assembly approved the resolution condemning the Crimea referendum, the fact that 69 countries either abstained or voted against it should be a wake-up call. It increasingly appears that the Western dominated post-Cold War era is over. But as of yet, no new order exists to replace it.

US ECONOMY - Golden Era of the 1950s/60s Was an Anomaly, Not the Default Setting

The Golden Era of the 1950s/60s Was an Anomaly, Not the Default Setting 03-28-14 Charles Hugh Smith

The 1950s/60s were not "NORMAL"--they were a one-off, extraordinary ANOMALY.

Golden Era of the 1950s and 60s:

• ONE WAGE EARNER earned enough to support a middle-class lifestyle because everything was cheap. 
  • Food was cheap,
  • Land was cheap,
  • Houses were cheap,
  • College was cheap and
  • Oil was cheap (most importantly).

• "The rising tide raises all ships"
  • Essentially full employment,
  • A strong U.S. dollar,
  • Overseas demand for U.S. goods,
  • Rising wages with low inflation.

SITUATIONAL ANALYSIS

The 1950s/60s was wasn't normal--it was a one-off anomaly, never to be repeated.

Consider the backdrop of this Golden Era:

1. Our industrial competitors had been flattened and/or bled dry in World War II, leaving the U.S. with the largest pool of capital and intact industrial base. Very little was imported from other nations.

2. The pent-up consumer demand after 15 years of Depression and rationing during 1942-45 drove strong demand for virtually everything, boosting employment and wages.

3. The Federal government had put tens of millions of people to work (12 million in the military alone) during the war, and with few consumer items to spend money on, these wages piled up into a mountain of savings/capital.

4. These conditions created a massive pool of qualified borrowers for mortgages, auto loans, etc.

5. The Federal government guaranteed low-interest mortgages and college education for the 12 million veterans.

6. The U.S. dollar was institutionalized as the reserve currency, backed by gold at a fixed price.

7. Oil was cheap--incredibly cheap.

TRIFFINS PARADOX

All those conditions went away as global competition heated up and the demand for dollars outstripped supply. 

• In essence, the industrial nations flattened during World War II needed dollars to fund their own rebuilding.
• Printing their own currencies simply weakened those currencies, so they needed hard money, i.e. dollars.
• The U.S. funded the initial spurt of rebuilding with Marshall Plan loans, but these were relatively modest in size.
• Though all sorts of alternative global currency schemes had been discussed in academic circles (the bancor, etc.), the reality on the ground was the dollar functioned as a reserve currency that everyone knew and trusted.
• To fund our Allies' continued growth the U.S. had to provide them with more dollars--a lot more dollars. Federally issued Marshall Plan loans provided only a small percentage of the capital needed. As Triffin pointed out, the "normal" mechanism to provide capital overseas is to import goods and export dollars, which is precisely what the U.S. did.
• This trend increased as industrial competitors' products improved in quality and their price remained low in an era of the strong dollar.

EXPORT LED TO IMPORT (CONSUMPTION) LED 

• As the U.S. shifted (by necessity, as noted above) from an exporter to an importer, a percentage of those holding dollars overseas chose to trade their dollars for gold.
• That cycle of exporting dollars/importing goods to provide capital to the world would lead to all the U.S. gold being transferred overseas, so the dollar was unpegged from gold in 1971.
• Since then, the U.S. has attempted to square the circle: continue to issue the reserve currency, i.e. export dollars to the world by running trade deficits, but also compete in the global market for goods and services, which requires weakening the dollar to be competitive.

You can't issue a reserve currency, export that currency in size and peg it to gold.

LABOR ARBITRAGE

In a global marketplace for goods and services, all sorts of things become tradable, including labor. 

• The misty-eyed folks who are nostalgic for the 1950s/60s want a contradictory set of goodies: they want a gold-backed currency that is still the reserve currency, and they want trade surpluses, i.e. they want to export goods and import others' currencies.
• They want full employment, protectionist walls that enable high wages in the U.S. and they want to be free to export U.S. goods and services abroad with no restrictions.
• All those goodies are contradictory. You can't have high wages protected by steep tariffs and also have the privilege of exporting your surplus goods to other markets. That's only possible in an Imperial colonialist model where the Imperial center can coerce its colonial periphery into buying its exports in trade for the colonies' raw commodities.

CHEAP ENERGY

And very importantly, oil is no longer cheap. The primary fuel for industrial and consumerist economies is no longer cheap. That reality sets all sorts of constraints on growth that central states and banks have tried to get around by blowing credit bubbles. That works for a while and then ends very badly.

The 1950s/60s were not "normal"--they were a one-off, extraordinary anomaly.

US MONETARY - Why "Tapering" Is a Mirage and the Fed May Be Loosening Instead

Duration Risk: Why "Tapering" Is a Mirage and the Fed May Be Loosening Instead 06-27-14 Cris Sheridan FSN

John Butler made an interesting comment in his recent interview with the Financial Sense Newshour. He said, when you look at the Fed’s balance sheet, one can argue that the Fed really isn’t pulling back on its stimulus to the markets at all. In fact, Butler explained, it may actually be loosening instead:

“The Fed may be tapering its purchases in nominal dollar amounts but in terms of the amount of interest rate risk it is assuming vis-à-vis the private commercial banking system, actually the Fed is continuing to assume additional interest rate risk at an elevated rate. And so from a bank balance sheet or liquidity management perspective, Fed policy is no tighter today than it was last year. And I can’t stress this point enough: It’s just as loose today as it was pre-taper…and arguably looser depending on how you define interest rate risk.”

In case you don’t understand the above, what Butler is saying is that while the Fed is buying less and less debt each month in dollar terms, it is simultaneously buying a larger amount of long-dated bonds, which has the overall effect of keeping conditions loose.

Here’s a recent chart from the St. Louis Fed showing how they’ve ramped up their purchase of long-dated Treasuries (ten years or more) over the last few years, while pulling back on shorter maturities:

Source: St. Louis Federal Reserve

With the above in mind, Butler stated that tapering "is something of a mirage…as long as the Fed continues to absorb more and more long-dated bonds, the banks will have an incentive to increase lending and leverage, notwithstanding the ‘taper’.”

Via email, Butler explained in more detail why this is so:

Ever since the 'taper' talk began I have been making the point that by only looking at the face amounts of debt purchased by the Fed we do not get the full picture. Indeed, recall when the Fed made a big deal about long-maturity purchases in the first place? Well, they were doing so to emphasize that they still had massive firepower to stimulate credit by buying long-dated bonds. 'Duration' is a fancy word for 'maturity' which incorporates the specific coupon and principal repayment schedule of a given bond or portfolio of bonds. More subtle is the concept of 'convexity' risk, which is only significant in longer 10y+ maturity bonds as it increases non-linearly with maturity.

Consider what banks are: they are financial intermediaries that borrow short to lend long. This means they are exposed not only to the level of interest rates, but to the term structure. The Fed has the power, through debt purchases, to affect both. In short maturities, however, there is little 'duration' or 'convexity', so the nominal amount of debt the Fed purchases is a proxy for the amount of interest rate risk it assumes from the banks. The less risk, the more long-term lending the banks can make, and the greater the implied, potential 'money multiplier' they can generate.

In long maturities (beyond 10 years), the Fed takes far more 'duration' and 'convexity risk’ off the banks, yet the banks receive the new money and can lend it out nevertheless. So the risk/reward for banks can shift dramatically when the Fed purchases 10y+ bonds instead of, say, 1y bonds, and the flexibility here can easily compensate or even overcompensate for the 'taper' currently underway. And the data show the Fed is continuing to increase its purchases of 10y+ bonds, the ones that really take the bulk of interest rate risk off the banks.

So based on this, you can argue fairly that the 'taper' is something of a mirage. Bank risk and liquidity managers know this and they think in 'duration' and 'convexity' terms. As long as the Fed is continues to absorb more and more 10y+ supply, the banks will have an incentive to increase lending and leverage, notwithstanding the 'taper'.

I'm a bit surprised more has not been written about this. There was an article in the FT two years or so back making this point but now there is an odd silence. Has any US bank published on this? If not, why not? Do they not want to? Does the Fed not want them to? If the Congress or others learned that the 'taper' really isn't a 'taper' at all, would there be repercussions? I don't know, but if the 'taper' was a PR campaign [see story] rather than a true change in policy all along then this would make more sense.

In the FT article, Brian Sack, executive vice president of the Federal Reserve Bank of New York, explained how the Fed views this very process of increasing the duration risk of its portfolio as an important aspect of stimulus:

If economic developments lead the FOMC to seek additional policy accommodation, it has several policy options open to it... One option is to expand the balance sheet further through additional asset purchases, with the just-completed purchase program presenting one possible approach. Another option involves shifting the composition of the SOMA [System Open Market Account] portfolio rather than expanding its size. As noted earlier, a sizable portion of the additional risk that the SOMA portfolio has assumed to date came from a lengthening of its maturity, suggesting that the composition of the portfolio can be used as an important variable for affecting the degree of policy stimulus.

Later in the interview, Butler noted that the reason the market probably hasn't reacted that much to the "taper" so far is precisely for this reason:

"[Those] who have a direct line to the Fed, who are involved in the whole primary dealer liquidity distribution network for Treasury securities and swaps and everything else, these people are well aware that conditions have not materially tightened and their institutions can act accordingly when they receive those internal reports from people actually in the know. Say one thing, do another. That’s kind of the way the Fed is operating. And that may help to explain why the U.S. equity market has still been able to shrug off a lot of what’s been taking equity markets down elsewhere in the world.

Q1 EARNINGS - Scramble to Pre-Announce Earning Estmate Reductions

Q1 EARNINGS -

GLOBAL GDP ESTIMATE TAKEN DOWN

GDP estimates for 2014 of 2.78% which is a 15% shrinkage in expectations from one year ago.

US Q1 GDP ESTIMATE TAKEN DOWN DRAMATICALLY

US MACRO

Top-down economic data has plunged to its lowest in 19 months

EARNINGS TAKEN DOWN BY 5%

MID-TERM PRESIDENTIL ELECTION CYCLE

GOLD - The Only Long Term "Buy and Hold" Asset in a Fiat Currency Regime.

The chart below is in normalized terms courtesy of Bill King’s The King Report.

According to King, Gold has risen 37.43 fold since 1967. That is more than twice the performance of the Dow over the same time period (18.45 fold). So much for the claim that stocks are a better investment than Gold long-term.

Indeed, once Gold was no longer pegged to world currencies there was only a single period in which stocks outperformed the precious metal. That period was from 1997-2000 during the height of the Tech Bubble (the single biggest stock market bubble in over 100 years).

In simple terms, as a long-term investment, Gold has been better than stocks.

THE GLOABL ECONOMIC ENGINE - Has been Dismantled!

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