FLOWS - Liquidity, Credit & Debt

The Global Liquidity Squeeze Has Begun 04-18-14 Submitted by Michael Snyder via The Economic Collapse blog,

Get ready for another major worldwide credit crunch.  Today, the entire global financial system resembles a colossal spiral of debt.  Just about all economic activity involves the flow of credit in some way, and so the only way to have “economic growth” is to introduce even more debt into the system.  When the system started to fail back in 2008, global authorities responded by pumping this debt spiral back up and getting it to spin even faster than ever.  If you can believe it, the total amount of global debt has risen by $35 trillion since the last crisis.  Unfortunately, any system based on debt is going to break down eventually, and there are signs that it is starting to happen once again.

For example,

1. Just a few days ago the IMF warned regulators to prepare for a global “liquidity shock“. 
2. On Friday, Chinese authorities announced a ban on certain types of financing for margin trades on over-the-counter stocks, and
3. We learned that preparations are being made behind the scenes in Europe for a Greek debt default and a Greek exit from the eurozone. 
4. On top of everything else, we just witnessed the biggest spike in credit application rejections ever recorded in the United States. 

All of these are signs that credit conditions are tightening, and once a “liquidity squeeze” begins, it can create a lot of fear.

Over the past six months, the Chinese stock market has exploded upward even as the overall Chinese economy has started to slow down.  Investors have been using something called “umbrella trusts” to finance a lot of these stock purchases, and these umbrella trusts have given them the ability to have much more leverage than normal brokerage financing would allow.  This works great as long as stocks go up.  Once they start going down, the losses can be absolutely staggering.

That is why Chinese authorities are stepping in before this bubble gets even worse.  Here is more about what has been going on in China from Bloomberg…

China’s trusts boosted their investments in equities by 28 percent to 552 billion yuan ($89.1 billion) in the fourth quarter. The higher leverage allowed by the products exposes individuals to larger losses in the event of stock-market drops, which can be exaggerated as investors scramble to repay debt during a selloff.

In umbrella trusts, private investors take up the junior tranche, while cash from trusts and banks’ wealth-management products form the senior tranches. The latter receive fixed returns while the former take the rest, so private investors are effectively borrowing from trusts and banks.

Margin debt on the Shanghai Stock Exchange climbed to a record 1.16 trillion yuan on Thursday. In a margin trade, investors use their own money for just a portion of their stock purchase, borrowing the rest. The loans are backed by the investors’ equity holdings, meaning that they may be compelled to sell when prices fall to repay their debt.

Overall, China has seen more debt growth than any other major industrialized nation since the last recession.  This debt growth has been so dramatic that it has gotten the attention of authorities all over the planet…

Wolfgang Schaeuble, Germany’s finance minister says that “debt levels in the global economy continue to give cause for concern.”

Singling out China in particular, Schaeuble noted that “debt has nearly quadrupled since 2007″, adding that it’s “growth appears to be built on debt, driven by a real estate boom and shadow banks.”

According to McKinsey’s research, total outstanding debt in China increased from $US7.4 trillion in 2007 to $US28.2 trillion in 2014. That figure, expressed as a percentage of GDP, equates to 282% of total output, higher than the likes of other G20 nations such as the US, Canada, Germany, South Korea and Australia.

This credit boom in China has been one of the primary engines for “global growth” in recent years, but now conditions are changing.  Eventually, the impact of what is going on in China right now is going to be felt all over the planet.

Over in Europe, the Greek debt crisis is finally coming to a breaking point.  For years, authorities have continued to kick the can down the road and have continued to lend Greece even more money.

But now it appears that patience with Greece has run out.

For instance, the head of the IMF says that no delay will be allowed on the repayment of IMF loans that are due next month…

IMF Managing Director Christine Lagarde roiled currency and bond markets on Thursday as reports came out of her opening press conference saying that she had denied any payment delay to Greece on IMF loans falling due next month.

Unless Greece concludes its negotiations for a further round of bailout money from the European Union, however, it is not likely to have the money to repay the IMF.

And we are getting reports that things are happening behind the scenes in Europe to prepare for the inevitable moment when Greece will finally leave the euro and go back to their own currency.

For example, consider what Art Cashin told CNBC on Friday…

First, “there were reports in the media [saying] that the ECB and/or banking authorities suggested to banks to get rid of any sovereign Greek debt they had, which suggests that maybe the next step will be Greece exiting,” Cashin told CNBC.

Also, one of Greece’s largest newspapers is reporting that neighboring countries are forcing subsidiaries of Greek banks that operate inside their borders to reduce their risk to a Greek debt default to zero…

According to a report from Kathimerini, one of Greece’s largest newspapers, central banks in Albania, Bulgaria, Cyprus, Romania, Serbia, Turkey and the Former Yugoslav Republic of Macedonia have all forced the subsidiaries of Greek banks operating in those countries to bring their exposure to Greek risk — including bonds, treasury bills, deposits to Greek banks, and loans — down to zero.

Once Greece leaves the euro, that is going to create a tremendous credit crunch in Europe as fear begins to spread like wildfire.  Everyone will be wondering which nation will be “the next Greece”, and investors will want to pull their money out of perceived danger zones before they get hammered.

In the past, other European nations have been willing to bend over backwards to accommodate Greece and avoid this kind of mess, but those days appear to be finished.  In fact, the finance minister of France openly admits that the French “are not sympathetic to Greece”…

Greece isn’t winning much sympathy from its debt-wracked European counterparts as the country draws closer to default for failing to make bailout repayments.

“We are not sympathetic to Greece,” French Finance Minister Michael Sapin said in an interview at the International Monetary Fund-World Bank spring meetings here.

“We are demanding because Greece must comply with the European (rules) that apply to all countries,” Sapin said.

Yes, it is possible that another short-term deal could be reached which could kick the can down the road for a few more months.

But either way, things in Europe are going to continue to get worse.

Meanwhile, very disappointing earnings reports in the U.S. are starting to really rattle investors.

For example, we just learned that GE lost 13.6 billion dollars in the first quarter…

One week following the announcement that it would dismantle most of its GE Capital financing operations to instead focus on its industrial roots, General Electric reported a first quarter loss of $13.6 billion.

The results were impacted by charges relating to the conglomerate’s strategic shift. A year ago GE reported a first quarter profit of $3 billion.

That is a lot of money.

How in the world does a company lose 13.6 billion dollars in a single quarter during an “economic recovery”?

Other big firms are reporting disappointing earnings numbers too…

In earnings news, American Express Co. late Thursday said its results were hurt by the strong U.S. dollar, which reduced revenue booked in other countries. Chief Executive Kenneth Chenault reiterated the company’s forecast that 2015 earnings will be flat to modestly down year over year. Shares fell 4.6%.

Advanced Micro Devices Inc. said its first-quarter loss widened as revenue slumped. The company said it was exiting its dense server systems business, effective immediately. Revenue and the loss excluding items missed expectations, pushing shares down 13%.

And just like we saw just before the financial crisis of 2008, Americans are increasingly having difficulty meeting their financial obligations.

For instance, the delinquency rate on student loans has reached a very frightening level…

More borrowers are failing to make payments on their student loans five years after leaving college, painting a grim picture for borrowers, according to the Federal Reserve Bank of New York.

Student debt continues to increase, especially for people who took out loans years ago. Those who left school in the Great Recession, which ended in 2009, had particular difficulty with repayment, with many defaulting, becoming seriously delinquent or not being able to reduce their balances, the New York Fed said today.

Only 37 percent of borrowers are current on their loans and are actively paying them down, and 17 percent are in default or in delinquency.

At this point, the American consumer is pretty well tapped out.  If you can believe it, 56 percent of all Americans have subprime credit today, and as I mentioned above, we just witnessed the biggest spike in credit application rejections ever recorded.

We have reached a point of debt saturation, and the credit crunch that is going to follow is going to be extremely painful.

Of course the biggest provider of global liquidity in recent years has been the Federal Reserve.  But with the Fed pulling back on QE, this is creating some tremendous challenges all over the globe.  The following is an excerpt from a recent article in the Telegraph…

The big worry is what will happen to Russia, Brazil and developing economies in Asia that borrowed most heavily in dollars when the Fed was still flooding the world with cheap liquidity. Emerging markets account to roughly half of the $9 trillion of offshore dollar debt outside US jurisdiction.

The IMF warned that a big chunk of the debt owed by companies is in the non-tradeable sector. These firms lack “natural revenue hedges” that can shield them against a double blow from rising borrowing costs and a further surge in the dollar.

So what is the bottom line to all of this?

The bottom line is that we are starting to see the early phases of a liquidity squeeze.

The flow of credit is going to begin to get tighter, and that means that global economic activity is going to slow down.

This happened during the last financial crisis, and during this next financial crisis the credit crunch is going to be even worse.

This is why it is so important to have an emergency fund.  During this type of crisis, you may have to be the source of your own liquidity.  At a time when it seems like nobody has any cash, those that do have some will be way ahead of the game.

FLOWS - Liquidity, Credit & Debt

"Biggest Worry" Is "Dramatic Decline" In Bond Market Liquidity, Prudential Says 04-14-15 Zero Hedge

It has now become fashionable in the world of high finance to express extreme consternation about reduced liquidity in the bond market. Last week, Jamie Dimon spelled out the problem as follows:

The likely explanation for the lower depth in almost all bond markets is that inventories of market-makers’ positions are dramatically lower than in the past. For instance, the total inventory of Treasuries readily available to market-makers today is $1.7 trillion, down from $2.7 trillion at its peak in 2007. Meanwhile, the Treasury market is $12.5 trillion; it was $4.4 trillion in 2007. The trend in dealer positions of corporate bonds is similar. Dealer positions in corporate securities are down by about 75% from their 2007 peak, while the amount of corporate bonds outstanding has grown by 50% since then.

Meanwhile, complacency in credit markets is building as the central bank-driven rally has left few opportunities in its wake, prompting DoubleLine to note that US corporate credit currently offers the most unpalatable risk/return proposition in history and leading some bond traders to turn Monday into “the new Friday.” Couple all of this with the fact that one “malfunction” by a “liquidity providing” algo could, at any given time, trigger a repeat of October’s Treasury flash crash sending ripples through credit markets at a time when nobody is home on the sell side (both figuratively in the form of dealer inventories and literally on “new Friday Mondays”) and you’ve got yourself a perfect storm. 

Given all of this it’s not surprising that yet another executive is out raising the liquidity red alert. Here’s Bloomberg:

Prudential Investment Management Chief Executive Officer David Hunt says the No. 1 concern among bond buyers globally is liquidity and its rapid disappearance.

“The biggest worry of the buy side around the world is that there has been a dramatic decline in liquidity from the sell side for many fixed income products,” said Hunt, 53, who heads Prudential Financial Inc.’s investment management unit, which had $934 billion in assets at the end of 2014. “I think it’s a big risk and is one of the unintended consequences” of regulators trying to prevent another financial crisis, he said.

Note the irony: the biggest risk to the global financial system stems from regulatory efforts to head off risks to the global financial system.

While the size of the U.S. bond market has swelled 23 percent since the end of 2007 through the end of last year, trading has fallen 28 percent in the period, Securities Industry & Financial Markets Association data show, as regulators, seeking to reduce risk, have made it less attractive for banks to hold an inventory of tradable bonds. JPMorgan Chase & Co. Chief Executive Officer Jamie Dimon warned in a report last week the next financial crisis could be exacerbated by a shortage of U.S. Treasuries.

“If we had a major political event or something that caused rates to spike and traders needed to get out of the current position they have, and there was a lot of people that wanted to do that, I think it would be quite difficult,” Hunt, in Tokyo last week for various management meetings, said. He declined to comment on what measures Prudential is taking to lower liquidity risk, saying that information was sensitive from a competitive perspective.

Once again, the writing is on the wall and as (another) reminder here is the problem:

1) demand for corporate credit is high thanks to the global hunt for yield occasioned by central bank easing,

2) corporates are thus issuing a lot of debt to tap into voracious demand before the Fed embarks on a rate hike cycle,

3) dealer books are shrinking thanks to regulations designed to limit prop trading,

4) and so the primary market is booming while no one is home in the secondary market.

We’ll close with what we said on Monday in “Human Bond Traders Barely Show Up To Work As Machines Take Control”: 

Meanwhile, the new regulatory regime has done an admirable job of making the system “safer” by encouraging dealers to shrink their inventories, meaning that while we’re all safe from evil prop traders (because we’re sure prop trading is dead and the Goldmans of the world didn’t find a way around Volcker the very instant it was proposed), secondary market liquidity has evaporated, meaning the door to the proverbial crowded theater is getting smaller even as the number of yield seekers inside is getting larger so when someone finally yells fire, well, let’s mix our metaphors here and say we’re all up a creek. 

 

BOND BUBBLE - The Last Time Bond Yields Crashed Like This

Guess What Happened The Last Time Bond Yields Crashed Like This...04-21-05 Michael Snyder via The Economic Collapse blog

If a major financial crisis was approaching, we would expect to see the “smart money” getting out of stocks and pouring into government bonds that are traditionally considered to be “safe” during a crisis.  This is called a “flight to safety” or a “flight to quality“.  In the past, when there has been a “flight to quality” we have seen yields for German government bonds and U.S. government bonds go way down.  As you will see below, this is exactly what we witnessed during the financial crisis of 2008.  U.S. and German bond yields plummeted as money from the stock market was dumped into bonds at a staggering pace.  Well, it is starting to happen again.  In recent months we have seen U.S. and German bond yields begin to plummet as the “smart money” moves out of the stock market.  So is this another sign that we are on the precipice of a significant financial panic?

Back in 2008, German bonds actually began to plunge well before U.S. bonds did.  Does that mean that European money is “smarter” than U.S. money?  That would certainly be a very interesting theory to explore.  As you can see from the chart below, the yield on 10 year German bonds started to fall significantly during the summer of 2008 – several months before the stock market crash in the fall…

So what are German bonds doing today?

As you can see from this next chart, the yield on 10 year German bonds has been steadily falling since the beginning of last year.  At this point, the yield on 10 year German bonds is just barely above zero…

And amazingly, most German bonds that have a maturity of less than 10 years actually have a negative yield right now.  That means that investors are going to get back less money than they invest.  This is how bizarre the financial markets have become.  The “smart money” is so concerned about the “safety” of their investments that they are actually willing to accept negative yields.  I don’t know why anyone would ever put their money into investments that have a negative yield, but it is actually happening.  The following comes from Yahoo…

The world’s scarcest resource right now is safe yield, and the shortage is getting more extreme. Most German government bonds that mature in less than 10 years now have negative yields – part of some $2 trillion worth of paper with yields below zero.

This is what happens when the European Central Bank begins a trillion-euro bond-buying binge with rates already miniscule.

Yesterday, ECB boss Mario Draghi – unfazed by the protest stunt at his press conference – reaffirmed his plan to keep bidding for paper that yields more than -0.2% – that’s minus 0.2%.

Yes, the ECB is driving a lot of this, but it is still truly bizarre.

So what about the United States?

Well, first let’s take a look at what happened back in 2008.  In the chart below, you can see the “flight to safety” that took place in late 2008 as investors started to panic…

And we have started to witness a similar thing happen in recent months.  The yield on 10 year U.S. Treasuries has plummeted as investors have looked for safety.  This is exactly the kind of chart that we would expect to see if a financial crisis was brewing…

What makes all of this far more compelling is the fact that so many other patterns that we have witnessed just prior to past financial crashes are happening once again.

Yes, there are other potential explanations for why bond yields have been going down.  But when you add this to all of the other pieces of evidence that a new financial crisis is rapidly approaching, quite a compelling case emerges.

For those that do not follow my website regularly, I encourage you to check out the following articles to get an idea of what I am talking about…

-“Guess What Happened The Last Time The Price Of Oil Crashed Like This?…”

-“Not Just Oil: Guess What Happened The Last Time Commodity Prices Crashed Like This?…”

-“10 Key Events That Preceded The Last Financial Crisis That Are Happening Again RIGHT NOW”

-“Guess What Happened The Last Time The U.S. Dollar Skyrocketed In Value Like This?…”

-“7 Signs That A Stock Market Peak Is Happening Right Now”

-“Guess What Happened The Last Two Times The S&P 500 Was Up More Than 200% In Six Years?”

Of course no two financial crashes ever look exactly the same.

The crisis that we are moving toward is not going to be precisely like the crisis of 2008.

But there are similarities and patterns that we can look for.  When things start to get bad, investors act in predictable ways.  And so many of the things that we are watching right now are just what we would expect to see in the lead up to a major financial crisis.

Sadly, most people are not willing to learn from history.  Even though it is glaringly apparent that we are in a historic financial bubble, most investors on Wall Street cannot see it because they do not want to see it.  They want to believe that somehow “things are different this time” and that stocks will just continue to go up indefinitely so that they can keep making lots and lots of money.

And despite what you may think, I actually want this bubble to continue for as long as possible.  Despite all of our problems, life is still relatively good in America today – at least compared to what is coming.

I like to refer to this next crisis as our “third strike”.

Back in 2000 and 2001, the dotcom bubble burst and we experienced a painful recession, but we didn’t learn any lessons.  That was strike number one.

Then came the financial crash of 2008 and the worst economic downturn since the Great Depression.  But we didn’t learn any lessons from that either.  Instead, we just reinflated the same old financial bubbles and kept on making the exact same mistakes as before.  That was strike number two.

This next financial crisis will be strike number three.  After this next crisis, I don’t believe that there will ever be a return to “normal” for the United States.  I believe that this is going to be the crisis that unleashes hell in our nation.

So no, I am not eager for that to come.  Even though there is no way that this bubble of debt-fueled false prosperity can last indefinitely, I would like for it to last at least a little while longer.

Because what comes after it is going to be truly terrible.

CHINA - Beginning to Panic!

China Easing to Combat The 'Darkest Period' of 2015 04-20-15 By EconMatters

PBOC Easing

China is now firmly in stimulus mode when PBOC announced on Sunday to cut the reserve-requirement ratio by 1% to 18.5% effective April 20.  This is the second reduction this year and the largest since November 2008 during the global financial crisis. The reserve-requirement ratio represents the minimum fraction of customer deposits and notes that each commercial bank must hold as reserves in cash.

The new 18.5% ratio required by China is still higher than the typical global standard and than the current 10% cap by the U.S. Federal Reserve.  The PBOC also announced an additional 100 bps cut for rural credit cooperatives and village banks, as well as a 200 basis point cut for the China Agricultural Development Bank.

1Q15 The 'Darkest Period'

Bloomberg quoted Larry Hu, head of China economics at Macquarie in Hong Kong call 1Q15 the “darkest period” this year for China's economy.  GDP was 7% in Q1, the slowest since 2009, while industrial production in March rose at the slowest rate since November 2008, and inflation turned negative for the first time since 2009. (Read: Bloomberg Analyst Returned From China 'Terrified for the Economy')

Hu now expects further easing with an interest-rate cut within a month (PBOC has already cut interest rates twice since November), increasing infrastructure spending and a relaxation of home-purchasing rules.

My contacts in China and Hong Kong indicated that the new crackdown by Xi on corruption and state largess has put a fairly large portion of the nation's businesses (in mainland and Hong Kong) once catering to the 'elite' rich class in China out of commission. This is one of the major contributing factors to the nation's slowing growth.

$100 Billion Liqudity
WSJ estimated that the reduction in bank reserve-requirement-ratio could freed up more than $100 billion for China's banks to lend.  This suggests increasing liquidity compounding the social economic issue of wealth gap (which should be Beijing's primary concern), similar to the 3 QE programs by the U.S. Fed.

CHINA - Skewed Heavily To The Downside," BNP Says

Chinese Economic Outlook "Skewed Heavily To The Downside," BNP Says 04-20-15 BNP via ZH

Over the past several months we’ve built on several narratives out of China certainly not the least of which is the idea that economic growth in the country is decelerating quickly at a time when accelerating capital outflows make devaluation an unpalatable (if inevitable) proposition. Signs of a dramatic slowdown were on full display earlier this month when GDP growth slipped to 7%, the slowest pace in six years, while key indicators such as rail freight volume have fallen completely off a cliff:

With the country’s tough transition to a service-based economy being made all the more difficult by the hit industrial production will likely take as Beijing ramps up efforts to fight a pollution problem that was thrust back into the spotlight early last month thanks to a viral documentary, it’s reasonable to suspect we’ll be seeing a lot more of the idle cranes, empty construction sites, and half-finished abandoned buildings that greeted Bloomberg metals analyst Kenneth Hoffman who returned from a tour of the country earlier this month. Ultimately, Hoffman’s assessment was that metals demand in China is collapsing and isn’t likely to pick back up for the foreseeable future. 

This is bad news for the Chinese economic machine and it’s also bad news for any iron ore miner out there whose marginal costs aren’t low enough to stay profitable in the face of a protracted downturn in prices because if you can’t convince the big guys that your price collusion idea will pass regulatory muster, well, they’ll likely take the opportunity to keep right on producing despite the slump and run you out of business. With the stage thus set, we bring you the following from BNP who explains why iron ore prices aren’t likely to rebound any time soon, and why the economic outlook for China is indeed “as bad as the data looks, if not worse” (to quote Mr. Hoffman).

Via BNP:

Global commodity prices have fallen sharply since last summer, dragged down by a cocktail of fading Chinese industrial demand, surging supply and a strong USD. Oil has inevitably garnered the majority of headlines but iron ore prices have fallen even further. Iron ore prices have collapsed by close to 50% since last July and over 65% since the beginning of 2014. Falls have accelerated in recent weeks, almost becoming a rout, with prices down over 30% year-to-date. 

The analogue of China’s unprecedented construction bonanza has been extraordinary levels of both cement and steel production and consumption. We have documented the epic nature of the former with China incredibly producing more than twice as much cement in the last five years than the United States managed in the previous century (China: Cementing The Bear Case).

The increases in China’s steel production and consumption post-GFC have been almost as, but inevitably not quite, so spectacular. Since the end of 2007, China’s steel production has leapt by over 300 million tonnes while production in the rest of the world has slightly slipped. As will be discussed below, China’s steel production has started to flatten out over the last 12-15 months but, at around 810 million tons over the last year, China’s steel production has now accounted for 50% of total global production..

The surge in Chinese steel production has inevitably required a counterpart in much higher rates of global iron ore production. China’s own, typically low grade iron ore production, has not been able to keep pace with demand growth, meaning huge increases in demand for iron ore from the rest of the world. This demand has been fed largely by huge increases in Australian supply and, to a lesser extent, Brazil...

The collapse in iron ore prices over the last 15 months or so reflects the interplay of a levelling off in Chinese demand in 2014 for the first time since the GFC and, given the inevitably long lags between investment decision and output, continued strong gains in global supply. Our calculations suggest that China’s apparent steel use grew by less than 3% in 2014; slower than even 2008’s 4% growth (Chart 5). The latest industrial production data suggest that downward pressure has intensified in the final months of 2014 and early 2015 with crude steel production down -1.5% y/y on average in January and February. 

On the supply side, optimistic assumptions over the potential for Chinese steel demand growth to continue strongly for the rest of the decade has led to steady increases in productive capacity which are forecast to come on line in the next few years. Australian iron ore production alone is expected to increase by a further 196 million tonnes between 2014 and 2018….

Even as the risks for global iron ore supply are strongly tilted to the upside for the time being, the outlook for Chinese demand, in contrast to optimistic forecasts of producers, is skewed heavily to the downside. The key downside risk is of course the prospect of a multi-year and deep correction in real estate investment. Given the epic nature of the ‘stock’ and ‘flow’ adjustment that China’s real estate market faces, the best case scenario is probably that real estate investment (c.151?2% of GDP), bolstered by considerable policy support, could achieve a soft landing with zero growth over the next 2-3 years…

The worst case is that increasingly entrenched deflationary dynamics and the unprecedented weight of excess supply (the value of unfinished real estate projects at market prices reached a mind-boggling 75% of GDP in 2014) mean the real estate sector is relatively impervious to stimulus and real estate investment likely to fall sharply for several years.

Another critical dimension is China’s increasingly unsustainable levels of air pollution which is generating mounting political pressure for sharp reductions in steel, cement and, of course, coal output. As with the real estate sector, the best that can be said is that China’s pollution problem has perhaps stopped getting worse over the last year. The tough decisions and the real economic pain continue to lie ahead, however, with some estimates finding that China’s industrial production might need to fall by as much as 40% to meet global pollution standards. 

As a reminder, here’s the graphic on the relationship between industrial production and efforts to remedy the country’s pollution problem:

China’s domestic steel prices have fallen to near record discount of c.25% vs. global prices. Meanwhile, China’s steel exports have soared by over 40 million tonnes over the last year; easily the biggest annual gain on record with growth of nearly 60%...

Chinese producers have been able to slash steel export prices (which appear to follow domestic prices with a lag of about five months) as the collapse in iron ore prices is (temporarily) boosting margins…

As already emphasized, there appears to be little to interrupt these strongly deflationary dynamics any time soon. With the large iron ore producers likely to keep increasing supply until prices fall to close to their estimated marginal cost of $35 per tonne, further falls in iron prices look inevitable. China’s continuing real estate correction and anti-pollution drive will continue to weigh on domestic demand although sharp reductions in domestic output ultimately required are likely to continue to be resisted in the short term by the authorities given their high cost in terms of output and employment.Domestic steel prices should fall sharply while China’s steel exports look set to continue soaring, procuring further strong downward pressure on global prices…

And that, ladies and gentlemen, is the decisively precarious situation that Beijing finds itself in as China attempts to project its economic and military prowess to the rest of the world. Call it the growing pains of a rising superpower, but don't call it an enviable position and don't be surprised to discover that contrary to what the Ministry of Finance steadfastly proclaims, there may indeed be such a thing as Chinese QE.

BOND BUBBLE - Credit Measures At Worst Levels Since The Crisis

Warning: This Measure Of Credit Is At Its Worst Level Since The Crisis 04-21-15 Zero Hedge

As we’ve pointed out on a number of occasions, there’s been no shortage of corporate debt issuance this year as high grade supply in the US hit a record $348 billion in Q1 helped by a blockbuster month in March which saw $143 billion in deals price. Meanwhile, high yield issuance came in at more than $90 billion for the period. Despite goldilocks (to use a financial market cliche) conditions characterized by the interplay between yield-starved investors, rock-bottom borrowing costs, and companies’ propensity to leverage their balance sheet in order to inflate earnings and underwrite their stock price, at least one leading indicator is flashing red. 

As UBS notes, trade credit indicators are now at their worst levels since the crisis and unfortunately for anyone piling money into junk bonds, tightening conditions in the financing of receivables and inventories turns out to be a very good predictor of where HY spreads are headed. Here’s more:

Credit is the lifeblood of the world economy, and we believe the retrenchment of lenders from extending new credit is a highly reliable leading indicator of future problems for borrowers and the economy at large. Lending conditions have hitherto remained acceptable, particularly in the IG & higher quality HY bond market, where issuers are churning out debt in near record amounts. However, recent monthly surveys from the National Association of Credit Management’s Credit Managers Index (CMI) paint a picture in stark contrast. Simply put, measures of trade credit (the financing of receivables and inventories) have deteriorated sharply from January to March and are at their worst level since the financial crisis. We believe this data point should not be dismissed, and is an indication of the negative credit ramifications from dollar strength and falling EM demand.

The CMI polls 1,000 trade credit managers across the US and asks respondents to qualitatively assess changes in lending conditions from prior months. The index constructed is a diffusion index, similar to PMI indices (any readings greater than 50 indicate an economy in expansion, any readings less than 50 indicate an economy in contraction). The index is split evenly between service and manufacturing firms, so it will pick up conditions impacting both domestic and international borrowers. The survey covers credit managers at companies and finance firms, rather than from banks. 

The latest March survey indicates sharply deteriorating conditions, which is a problem for credit investors, as the CMI has been a leading indicator of HY credit spreads in the past. Much of the weakness is being driven by lenders, rather than solely a tick-down in borrowing demand. The amount of credit extended fell precipitously and the number of credit applications rejected by lenders increased sharply last month. Dollar amounts beyond terms (the length of times it takes customers to pay) and dollar amounts of customer deductions (which measures the cash flow problems of customers) are also in contractionary territory. New credit applications did increase, but this is not necessarily a mitigating sign. It may indicate that stressed borrowers are reaching for a lifeline and getting rejected. This was seen during the financial crisis when demand for trade financing increased even as banks cut supply.

BOND BUBBLE - The Last Time Bond Yields Crashed Like This

Guess What Happened The Last Time Bond Yields Crashed Like This...04-21-05 Michael Snyder via The Economic Collapse blog

If a major financial crisis was approaching, we would expect to see the “smart money” getting out of stocks and pouring into government bonds that are traditionally considered to be “safe” during a crisis.  This is called a “flight to safety” or a “flight to quality“.  In the past, when there has been a “flight to quality” we have seen yields for German government bonds and U.S. government bonds go way down.  As you will see below, this is exactly what we witnessed during the financial crisis of 2008.  U.S. and German bond yields plummeted as money from the stock market was dumped into bonds at a staggering pace.  Well, it is starting to happen again.  In recent months we have seen U.S. and German bond yields begin to plummet as the “smart money” moves out of the stock market.  So is this another sign that we are on the precipice of a significant financial panic?

Back in 2008, German bonds actually began to plunge well before U.S. bonds did.  Does that mean that European money is “smarter” than U.S. money?  That would certainly be a very interesting theory to explore.  As you can see from the chart below, the yield on 10 year German bonds started to fall significantly during the summer of 2008 – several months before the stock market crash in the fall…

So what are German bonds doing today?

As you can see from this next chart, the yield on 10 year German bonds has been steadily falling since the beginning of last year.  At this point, the yield on 10 year German bonds is just barely above zero…

And amazingly, most German bonds that have a maturity of less than 10 years actually have a negative yield right now.  That means that investors are going to get back less money than they invest.  This is how bizarre the financial markets have become.  The “smart money” is so concerned about the “safety” of their investments that they are actually willing to accept negative yields.  I don’t know why anyone would ever put their money into investments that have a negative yield, but it is actually happening.  The following comes from Yahoo…

The world’s scarcest resource right now is safe yield, and the shortage is getting more extreme. Most German government bonds that mature in less than 10 years now have negative yields – part of some $2 trillion worth of paper with yields below zero.

This is what happens when the European Central Bank begins a trillion-euro bond-buying binge with rates already miniscule.

Yesterday, ECB boss Mario Draghi – unfazed by the protest stunt at his press conference – reaffirmed his plan to keep bidding for paper that yields more than -0.2% – that’s minus 0.2%.

Yes, the ECB is driving a lot of this, but it is still truly bizarre.

So what about the United States?

Well, first let’s take a look at what happened back in 2008.  In the chart below, you can see the “flight to safety” that took place in late 2008 as investors started to panic…

And we have started to witness a similar thing happen in recent months.  The yield on 10 year U.S. Treasuries has plummeted as investors have looked for safety.  This is exactly the kind of chart that we would expect to see if a financial crisis was brewing…

What makes all of this far more compelling is the fact that so many other patterns that we have witnessed just prior to past financial crashes are happening once again.

Yes, there are other potential explanations for why bond yields have been going down.  But when you add this to all of the other pieces of evidence that a new financial crisis is rapidly approaching, quite a compelling case emerges.

For those that do not follow my website regularly, I encourage you to check out the following articles to get an idea of what I am talking about…

-“Guess What Happened The Last Time The Price Of Oil Crashed Like This?…”

-“Not Just Oil: Guess What Happened The Last Time Commodity Prices Crashed Like This?…”

-“10 Key Events That Preceded The Last Financial Crisis That Are Happening Again RIGHT NOW”

-“Guess What Happened The Last Time The U.S. Dollar Skyrocketed In Value Like This?…”

-“7 Signs That A Stock Market Peak Is Happening Right Now”

-“Guess What Happened The Last Two Times The S&P 500 Was Up More Than 200% In Six Years?”

Of course no two financial crashes ever look exactly the same.

The crisis that we are moving toward is not going to be precisely like the crisis of 2008.

But there are similarities and patterns that we can look for.  When things start to get bad, investors act in predictable ways.  And so many of the things that we are watching right now are just what we would expect to see in the lead up to a major financial crisis.

Sadly, most people are not willing to learn from history.  Even though it is glaringly apparent that we are in a historic financial bubble, most investors on Wall Street cannot see it because they do not want to see it.  They want to believe that somehow “things are different this time” and that stocks will just continue to go up indefinitely so that they can keep making lots and lots of money.

And despite what you may think, I actually want this bubble to continue for as long as possible.  Despite all of our problems, life is still relatively good in America today – at least compared to what is coming.

I like to refer to this next crisis as our “third strike”.

Back in 2000 and 2001, the dotcom bubble burst and we experienced a painful recession, but we didn’t learn any lessons.  That was strike number one.

Then came the financial crash of 2008 and the worst economic downturn since the Great Depression.  But we didn’t learn any lessons from that either.  Instead, we just reinflated the same old financial bubbles and kept on making the exact same mistakes as before.  That was strike number two.

This next financial crisis will be strike number three.  After this next crisis, I don’t believe that there will ever be a return to “normal” for the United States.  I believe that this is going to be the crisis that unleashes hell in our nation.

So no, I am not eager for that to come.  Even though there is no way that this bubble of debt-fueled false prosperity can last indefinitely, I would like for it to last at least a little while longer.

Because what comes after it is going to be truly terrible.

BOND BUBBLE - Credit Measures At Worst Levels Since The Crisis

Warning: This Measure Of Credit Is At Its Worst Level Since The Crisis 04-21-15 Zero Hedge

As we’ve pointed out on a number of occasions, there’s been no shortage of corporate debt issuance this year as high grade supply in the US hit a record $348 billion in Q1 helped by a blockbuster month in March which saw $143 billion in deals price. Meanwhile, high yield issuance came in at more than $90 billion for the period. Despite goldilocks (to use a financial market cliche) conditions characterized by the interplay between yield-starved investors, rock-bottom borrowing costs, and companies’ propensity to leverage their balance sheet in order to inflate earnings and underwrite their stock price, at least one leading indicator is flashing red. 

As UBS notes, trade credit indicators are now at their worst levels since the crisis and unfortunately for anyone piling money into junk bonds, tightening conditions in the financing of receivables and inventories turns out to be a very good predictor of where HY spreads are headed. Here’s more:

Credit is the lifeblood of the world economy, and we believe the retrenchment of lenders from extending new credit is a highly reliable leading indicator of future problems for borrowers and the economy at large. Lending conditions have hitherto remained acceptable, particularly in the IG & higher quality HY bond market, where issuers are churning out debt in near record amounts. However, recent monthly surveys from the National Association of Credit Management’s Credit Managers Index (CMI) paint a picture in stark contrast. Simply put, measures of trade credit (the financing of receivables and inventories) have deteriorated sharply from January to March and are at their worst level since the financial crisis. We believe this data point should not be dismissed, and is an indication of the negative credit ramifications from dollar strength and falling EM demand.

The CMI polls 1,000 trade credit managers across the US and asks respondents to qualitatively assess changes in lending conditions from prior months. The index constructed is a diffusion index, similar to PMI indices (any readings greater than 50 indicate an economy in expansion, any readings less than 50 indicate an economy in contraction). The index is split evenly between service and manufacturing firms, so it will pick up conditions impacting both domestic and international borrowers. The survey covers credit managers at companies and finance firms, rather than from banks. 

The latest March survey indicates sharply deteriorating conditions, which is a problem for credit investors, as the CMI has been a leading indicator of HY credit spreads in the past. Much of the weakness is being driven by lenders, rather than solely a tick-down in borrowing demand. The amount of credit extended fell precipitously and the number of credit applications rejected by lenders increased sharply last month. Dollar amounts beyond terms (the length of times it takes customers to pay) and dollar amounts of customer deductions (which measures the cash flow problems of customers) are also in contractionary territory. New credit applications did increase, but this is not necessarily a mitigating sign. It may indicate that stressed borrowers are reaching for a lifeline and getting rejected. This was seen during the financial crisis when demand for trade financing increased even as banks cut supply.

FINANCIAL REPRESSION - Net Bank Interest

Financial Repression, Central Banks, Credit Expansion, and the Importance of Being Impatient 04-06-15 John Mauldin

We live in a time of unprecedented financial repression. As I have continued writing about this, I have become increasingly angry about the fact that central banks almost everywhere have decided to address the economic woes of the world by driving down the returns on the savings of those who can least afford it – retirees and pensioners.

This week’s Outside the Box, from my good friend Chris Whalen of Kroll Bond Rating Agency, goes farther and outlines how a low-interest-rate and massive QE environment is also destructive of other parts of the economy. Counterintuitively, the policies pursued by central banks are actually driving the deflationary environment rather than fighting it.

To further Chris’s point I want to share with you a graph that he sent me, from a later essay he wrote. It shows that the cost of funds for US banks has dropped over $100 billion since the financial crisis, but their net interest income is almost exactly the same. What changed? Banks are now paying you and me and businesses $100 billion less. The Fed’s interest-rate policy has meant a great deal less income for US savers.

It is of the highest irony that Keynesians wanted to launch a QE policy that would increase the value of financial assets (like stocks), which they claimed would produce a wealth effect. I made fun of this policy some five years ago by calling it “trickle-down monetary policy.” Subsequent research has verified that there is no wealth effect from QE. Well, it did make our stocks go up, on the backs of savers. We’ve transferred interest income from savers into the stock market. We’ve made retirement far riskier for our older pensioners than it should be.

As Chris Whalen writes:

Indeed, in the present interest rate environment, to paraphrase John Dizard of the Financial Times, it has become mathematically impossible for fiduciaries [brokers, investment advisors and managers of pension funds and annuities] to meet the beneficiaries’ future investment return target needs through the prudent buying of securities.

Everywhere I go I talk with investment advisors and brokers who are scratching their heads trying to figure out how to create retirement portfolios that provide sufficient income without significantly moving out the risk curve at precisely the wrong time in their client’s lives. It is a conundrum that has been made for more difficult by Federal Reserve policy.

Economics Professor Larry Kotlikoff (Boston University) and our mutual friend syndicated financial columnist Scott Burns came by to visit me last week. I have talked with Larry on and off over the last few years, and Scott and I go back literally decades. A few years ago, Scott and Larry wrote a very good book called The Clash of Generations. Now, Larry has branched off on his own and written a really powerful manual on Social Security called Get What's Yours: The Secrets to Maxing Out Your Social Security.

I will admit I have not paid much attention to Social Security. I just assumed I should start mine when I’m 70, as so many columns I have read suggested. Larry and I recently spent an hour discussing the Social Security system (or perhaps it would be better to call it the Social Security Maze). Three thousand pages of law and tens of thousands of regulations and so many nuances and “gotchas” that it is really difficult to understand what might be best in your particular circumstances. Larry asked me questions for about two minutes and then proceeded to make me $40,000 over the next five years. It turns out I qualify for an obscure (at least to me) regulation that allows me to get some Social Security income for four years prior to turning 70 without affecting my post-70 benefits. There are scores of such obscure rules.

Larry says it is more often the case than not that he can sit down with somebody and make them more money than they thought they were going to get. As one reviewer says:

This book is necessary for three reasons:

1. Social Security is not intuitive, and sometimes makes no sense at all.
2. Two, Americans act against their best interests, leaving all kinds of money on the table.
3. Three, there is usually a “however” with Social Security rules. Worse, Social Security is now up to three million requests every week, but Congress keeps cutting back budget, staff, hours and whole offices. Combine that with the complexity factor, and the authors conclude you cannot trust what Social Security advises. Great.

If you or your parents are on Social Security or you are approaching “that age,” you really should get this book. Did you know that if you are divorced you can get a check for half of your former spouse’s Social Security income without affecting their income at all? But you can’t know whether this is a good strategy unless you look at other options.

How many retirees or those nearing retirement know about such Social Security options as file and suspend (apply for benefits and then don’t take them)? Or start stop start (start benefits, stop them, then restart them)? Or– just as important – when and how to use these techniques? Get What’s Yours covers the most frequent benefit scenarios faced by married retired couples, by divorced retirees, by widows and widowers, among others. It explains what to do if you’re a retired parent of dependent children, disabled, or an eligible beneficiary who continues to work, and how to plan wisely before retirement. It addresses the tax consequences of your choices, as well as the financial implications for other investments.

The book is written in Larry’s usual easy-to-read style, and you can jump to the sections that might be most relevant to you. The book is $11 on Kindle and under $15 at Amazon. This might be some of the better financial advice that you get from reading my letter: go get a copy of Get What’s Yours.

I can’t guarantee it will make you $40,000 in five minutes, but it can show you how to navigate the system. Larry also has a website with some inexpensive software to help you maximize your own Social Security. Seeing as how Social Security is the largest source of income for most US retirees, this is something everyone should pay attention to.

It is time to hit the send button. Quickly, we finalized the agenda for the 2015 Strategic Investment Conference. You can see it by clicking on the link. Then go ahead and register before the price goes up. This really is the best economic conference that I know of anywhere this year.

Your wondering how long they’ll pay me Social Security analyst,

John Mauldin, Editor
Outside the Box[email protected]

This research note is based on the presentation given by Christopher Whalen, Kroll Bond Rating Agency (KBRA) Senior Managing Director and Head of Research, at the Banque de France on Monday, March 23, 2015, for an event organized by the Global Interdependence Center (GIC) entitled “New Policies for the Post Crisis Era.” KBRA is pleased to be a sponsor of the GIC.

Investors are keenly focused on the Federal Open Market Committee (FOMC) to see whether the U.S. central bank is prepared to raise interest rates later this year – or next. The attention of the markets has been focused on a single word, “patience,” which has been a key indicator of whether the Fed is going to shift policy after nearly 15 years of maintaining extraordinarily low interest rates. This week, the Fed dropped the word “patience” from its written policy guidance, but KBRA does not believe that the rhetorical change will be meaningful to fixed income investors. We do not expect that the Fed will attempt to raise interest rates for the balance of 2015.

This long anticipated shift in policy guidance by the Fed comes even as interest rates in the EU are negative and the European Central Bank has begun to buy securities in open market operations mimicking those conducted by the FOMC over the past several years. Investors and markets need to appreciate that, regardless of what the FOMC decides this month or next, the global economy continues to suffer from the effects of the financial excesses of the 2000s.

The decision by the ECB to finally begin U.S. style “quantitative easing” (QE) almost eight years after the start of the subprime financial crisis in 2007 speaks directly to the failure of policy to address both the causes and the terrible effects of the financial crisis. Consider several points:

• QE by the ECB must be seen in the context of a decade long period of abnormally low interest rates. U.S. interest rate policy has been essentially unchanged since 2001, when interest rates were cut following the 9/11 attack. The addition of QE 1-3 was an effort at further monetary stimulus beyond zero interest rate policy (ZIRP) meant to boost asset prices and thereby change investor tolerance for risk.
   
• QE makes sense only from a Keynesian/socialist perspective, however, and ignores the long-term cost of low interest rate policies to individual investors and financial institutions. Indeed, in the present interest rate environment, to paraphrase John Dizard of the Financial Times, it has become mathematically impossible for fiduciaries to meet the beneficiaries’ future investment return target needs through the prudent buying of securities. (See John Dizard, “Embrace the contradictions of QE and sell all the good stuff,” Financial Times, March 14, 2015.)
   
• The downside of QE in the U.S. and EU is that it does not address the core problems of hidden off- balance sheet debt that caused the massive “run on liquidity” in 2008. That is, banks and markets in the U.S. globally face tens of trillions of dollars in "off-balance sheet" debt that has not been resolved. The bad debt which is visible on the books of U.S. and EU banks is also a burden in the sense that bank managers know that it must eventually be resolved. Whether we talk of loans by German banks to Greece or home equity loans in the U.S. for homes that are underwater on the first mortgage, bad debt is a drag on economic growth.
   
• Despite the fact that many of these debts are uncollectible, governments in the U.S. and EU refuse to restructure because doing so implies capital losses for banks and further expenses for cash- strapped governments. In effect, the Fed and ECB have decided to address the issue of debt by slowly confiscating value from investors via negative rates, this because the fiscal authorities in the respective industrial nations cannot or will not address the problem directly.
   
• ZIRP and QE as practiced by the Fed and ECB are not boosting, but instead depressing, private sector economic activity. By using bank reserves to acquire government and agency securities, the FOMC has actually been retarding private economic growth, even while pushing up the prices of financial assets around the world.
   
• ZIRP has reduced the cost of funds for the $15 trillion asset U.S. banking system from roughly half a trillion dollars annually to less than $50 billion in 2014. This decrease in the interest expense for banks comes directly out of the pockets of savers and financial institutions. While the Fed pays banks 25bp for their reserve deposits, the remaining spread earned on the Fed’s massive securities portfolio is transferred to the U.S. Treasury – a policy that does nothing to support credit creation or growth. The income taken from bond investors due to ZIRP and QE is far larger.
   
• No matter how low interest rates go and how much debt central banks buy, the fact of financial repression where savers are penalized to advantage debtors has an overall deflationary impact on the global economy. Without a commensurate increase in national income, the elevated asset prices resulting from ZIRP and QE cannot be validated and sustained. Thus with the end of QE in the U.S. and the possibility of higher interest rates, global investors face the decline of valuations for both debt and equity securities.
   
• In opposition to the intended goal of low interest rate and QE policies, we also have a regressive framework of regulations and higher bank capital requirements via Basel III and other policies that are actually limiting the leverage of the global financial system. The fact that banks cannot or will not lend to many parts of society because of harsh new financial regulations only exacerbates the impact of financial repression. Thus we take income from savers to advantage debtors, while limiting credit to society as a whole. Only large private corporations and government sponsored enterprises with access to equally large banks and global capital markets are able to function and grow in this environment.

So what is to be done? KBRA believes that the FOMC and policy makers in the U.S. and EU need to refocus their efforts on first addressing the issue of excessive debt and secondly rebalancing fiscal policies so as to boost private sector economic activity. Low or even negative interest rate policies which punish savers in order to pretend that bad debts are actually good are only making things worse and accelerate global deflation. Around the globe, nations from China to Brazil and Greece are all feeling the adverse effects of excessive debt and the related decline in commodity prices and overall economic activity. This decline, in turn, is being felt via lower prices for both commodities and traded goods – that is, deflation.

In the U.S., sectors such as housing and energy, the effects of weak consumer activity and oversupply are combining into a perfect storm of deflation. For example, The Atlanta Fed forecast for real GDP has been falling steadily as the underlying Blue Chip economic forecasts have also declined. The drop in capital expenditures related to oil and gas have resulted in a sharp decline in related economic activity and employment. Falling prices for oil and other key industrial commodities, weak private sector credit creation, falling transaction volumes in the U.S. housing sector, and other macroeconomic indicators all suggest that economic growth remains quite fragile.

To deal with this dangerous situation, the FOMC should move to gradually increase interest rates to restore cash flow to the financial system, following the famous dictum of Adam Smith that the “Great Wheel” of circulation is the means by which the flow of goods and services moves through the economy:

“The great wheel of circulation is altogether different from the goods which are circulated by means of it. The revenue of the society consists altogether in those goods, and not in the wheel which circulates them” (Smith 1811: 202).

Increased regulation and a decrease in the effective leverage in many sectors of banking and commerce have contributed to a slowing of credit creation and economic activity overall. And most importantly, the issue of unresolved debt, on and off balance sheet, remains a dead weight retarding economic growth. For this reason, KBRA believes that investors ought to become impatient with policy makers and encourage new approaches to boosting economic growth.

• U.S. Real Estate Prices Show Signs of Rising Again (Published February 23, 2015)
   
• GSE Litigation Affirms that Fannie Mae and Freddie Mac are Sovereign Credits (Published February 19, 2015)
   
• Swiss Francs & Global Debt Deflation (Published January 21, 2015)

Analytical Contact: Christopher Whalen, Senior Managing Director [email protected], (646) 731-2366