A Liquidity Crisis Hit The Banking System In September

Submitted by Tyler Durden on 10/03/2015

Global Dollar Funding Shortage Intesifies To Worst Level Since 2012

The Financialization of the Economy

Joan McCullough, Longford Associates
October 21, 2015

Yesterday, we learned that lending standards had eased and that there was increased loan demand from institutions and households, per the ECB’s September report. (Which was attributed to the success of QE and which buoyed the Euro in the process.)

This has been bothering me. Because it is a great example of the debate over “financialization” of an economy, i.e., is it a good thing or a bad thing?

The need to further explore the topic was provoked by reading this morning that one of the larger shipping alliances, G6, has again announced sailing cancellations between Asia and North Europe and the Mediterranean. This round of cuts targets November and December. The Asia-Europe routes, please note, are where the lines utilize their biggest ships and have been running below breakeven. So it’s easy to understand why such outsized capacity is further dictating the need to cancel sailings outright. G6 members: American President, Hapag Lloyd, Hyundai Merchant Marine, Mitsui, Nippon and OOCL. So as you can see from that line-up, these are not amateurs.

We have already discussed in the past in this space, the topic of financialization. But seeing as how the stock market keeps rallying while the economic statistics have remained for the most part, punk, time to revisit the issue once again. Is it all simply FED or no FED? Or is the interest-rate issue ground zero and/or purely symptomatic of the triumph of financialization over the real economy?

Further urged to revisit the topic by the seemingly contradictory developments of the ECB banks reportedly humming along nicely while trade between Asia and Europe remains obviously, significantly crimped.

Let’s make this plain English because it takes too much energy to interpret most of what is written on the topic.

Snappy version:

Definition (one of quite a few, but the one I think is accurate for purposes of this screed):

Financialization is characterized by the accrual of profits primarily thru financial channels (allocating or exchanging capital in anticipation of interest, divvies or capital gains) as opposed to accrual of profits thru trade and the production of goods/services.

Economic activity can be “creative” or “distributive”. The former is self- explanatory, i.e., something is produced/created. The latter pretty much simply defines money changing hands. (So that when this process gets way overdone as it likely has become in our world, one of the byproducts is the widening gap called “income inequality”.)

You guessed correctly: financialization is viewed as largely distributive.

So now we roll around to the nitty-gritty of the issue. Which presents itself when business managers evolve to the point where they are pretty much under the control of the financial community. Which in our case is simply “Wall Street”.

This is something I saved from an article last summer which ragged mercilessly on IBM for having kissed Wall Street’s backside ... and in the process over the years, ruined the biz.

... “And of course, it’s not just IBM. ... A recent survey of chief financial officers showed that 78 percent would ‘give up economic value’ and 55 percent would cancel a project with a positive net present value—that is, willingly harm their companies—to meet Wall Street’s targets and fulfill its desire for ‘smooth’ earnings....http://www.forbes.com/sites/stevedenning/2014/06/03/why-financialization-has-run-amok/

IBM is but one possible target in laying this type of blame where the decisions on corporate action are ceded to the financial community; the instances are innumerable.

You probably could cite the well-known example of a couple of years back when Goldman Sachs was exposed as the owner of warehouse facilities that held 70% of North American aluminum inventory. And how that drove up the price and cost end-users dearly. (Estimated as $ 5bil over 3 years’ time.)

First link: NY Times article from July of 2013, talking about the warehousing issue.

http://www.nytimes.com/2013/07/21/business/a-shuffle-of-aluminum-but-to-banks-pure-gold.html?pagewanted=all&_r=0

Second link: Senate testimony from Coors Beer, complaining about the same situation.

http://www.banking.senate.gov/public/index.cfm? FuseAction=Files.View&FileStore_id=9b58c670-f002-42a9-b673- 54e4e05e876e 

Well, here’s another from the same article which makes the point quite clearly:

... Boeing’s launch of the 787 was marred by massive cost overruns and battery fires. Any product can have technical problems, but the striking thing about the 787’s is that they stemmed from exactly the sort of decisions that Wall Street tells executives to make.

Before its 1997 merger with McDonnell Douglas, Boeing had an engineering-driven culture and a history of betting the company on daring investments in new aircraft. McDonnell Douglas, on the other hand, was risk-averse and focused on cost cutting and financial performance, and its culture came to dominate the merged company. So, over the objections of career-long Boeing engineers, the 787 was developed with an unprecedented level of outsourcing, in part, the engineers believed, to maximize Boeing’s return on net assets (RONA). Outsourcing removed assets from Boeing’s balance sheet but also made the 787’s supply chain so complex that the company couldn’t maintain the high quality an airliner requires. Just as the engineers had predicted, the result was huge delays and runaway costs. ... Boeing’s decision to minimize its assets was made with Wall Street in mind. RONA is used by financial analysts to judge managers and companies, and the fixation on this kind of metric has influenced the choices of many firms. In fact, research by the economists John Asker, Joan Farre-Mensa, and Alexander Ljungqvist shows that a desire to maximize short-term share price leads publicly held companies to invest only about half as much in assets as their privately held counterparts do.” ...

That’s from an article in the June, 2014, Harvard Business Review by Gautam Mukunda,“The Price of Wall Street’s Power” also cited in the Forbes article. This is the link; it is worth the read though you may not agree with parts of the conclusion:https://hbr.org/2014/06/the-price-of-wall-streets-power

The upshot to this type of behavior is that the balance of power ... and ideas ... then migrates into domination by one group.

Smaller glimpse: Over-financialization is what happens when a company generates cash then pays it to shareholders and senior management which m.o. also includes share buybacks and vicious cost cutting. This is one way, as you can see, in which the real economy is excluded from the party!

Part of the financialization process also includes ‘cognitive capture’ where the big swingin’ investment banking sticks have the ear of business managers.

And the business managers/special interest groups, in turn, have the ear of the federal government. See? The control by Wall Street is still there, but sometimes the route is a tad circuitous! The clandestine formulation of the TPP agreement is a perfect example of this type of dominance. (Congress shut out/ corporate lobbyists invited in.)

So the whole process goes to the extreme. Therein lies the rub: the extreme.

So that business obediently complies with the wishes of these financial wizards. Taken altogether, over time, our entire society morphs to where it assumes a posture of servitude to the interests of Wall Street.

An example of that? John Q.’s sentiment meter (a/k/a consumer confidence) is clearly known to be tied most of the time to the direction of the S&P 500. Which of course, is aided and abetted by the foaming-at- the-mouth Talking Heads who pretty much .... dictate to John Q. how he is supposed to be feeling.

Forty years on the Street, I am still agog at the increasing clout of the FOMC to the extent where we are now hostages to their infernal sound bites and communiqués. Another example of the process of creeping financialization? I’d surely say so!

This is not an effort to try and convict “financialization” as indeed it has its place. When it is used prudently. Such as to facilitate trade in the real economy! Sounds kind of Austrian, eh? You bet. The simplest example of this which is frequently cited is a home mortgage. The borrower exchanges future income for a roof via a bank note.

And so it goes. Financialization humming along nicely, facilitating trade in the real economy.

Unfortunately, along the line somewhere, it got out of hand. Which is where the World Bank comes in.

http://data.worldbank.org/indicator/FS.AST.PRVT.GD.ZS

As they have the statistics on “domestic credit to private sector (% of GDP)”

Why do we wanna’ look at that? Well the answer is suggested by yet another institution who has studied the issue. Correct. The IMF. Which espouses the notion that:

... ““the marginal effect of financial depth on output growth becomes negative ... when credit to the private sector reaches 80-100% of GDP ...

https://www.imf.org/external/pubs/ft/wp/2012/wp12161.pdf

Does the above sound familiar? Right. Too much financialization crimps growth.

That’s when we turn to the above-referenced World Bank table. Which shows the latest available worldwide statistics (2014) on domestic credit to private sector % of GDP.

Okay. Maybe we oughta’ read this bit from the World Bank before we get to the US statistic:

... “Domestic credit to private sector refers to financial resources provided to the private sector by financial corporations, such as through loans, purchases of nonequity securities, and trade credits and other accounts receivable, that establish a claim for repayment. ...

The financial corporations include monetary authorities and deposit money banks, as well as other financial corporations ...

Examples of other financial corporations are finance and leasing companies, money lenders, insurance corporations, pension funds, and foreign exchange companies.” ...

Clear enough. Again, the IMF suggests that 80 to 100% of GDP is where it gets dicey in terms of impact on growth:

In 2014, the US ratio stood at 194.8. In 1981 (as far back as the table goes), our ratio stood at 89.1.

For comparison, also in 2014, Germany stood at 80.0; France at 94.9. China at 141.8 and Japan at 187.6. Which is suggestive of what can be called “over-financialization”. So what’s the beef with that, you ask?

For all the reasons mentioned above which led to increasing dominance by the financial sector on corporate and household behavior, the emphasis leans heavily towards making money out of money. Which I’d like to do myself. You?

But when massaged into the extreme which is clearly, I believe, where we find ourselves now ... at the end of the day, we create nothing.

By creating nothing, the economy relies on the financialization process to create growth. But the evidence supports the notion that once overdone, financialization stymies growth.

“ ... The whole of economic life is a mixture of creative and distributive activities. Some of what we “earn” derives from what is created out of nothing and adds to the total available for all to enjoy. But some of it merely takes what would otherwise be available to others and therefore comes at their expense. Successful societies maximize the creative and minimize the distributive. Societies where everyone can achieve gains only at the expense of others are by definition impoverished. They are also usually intensely violent.” ... Roger Bootle quoted here: http://bilbo.economicoutlook.net/blog/?p=5537

In short, corporate behavior is dictated by Wall Street desire which in turn results in a flying S&P 500. Against a backdrop, say, of a record number of US workers no longer participating in the labor force.

So instead of cogitating the entire picture and all of its skanky details, we have so farbeen willing to accept a one-size fits all alibi for stock market action where financialization still dominates; the only choice is what financialization flavor will trump the other: “FED or no FED”.

I now wonder if when Bootle said a few years back ... “they are usually intensely violent”, if this wasn’t prescience. Which can be applied to the current political landscape in the US where the financialization of the economy has so excluded the average worker ... that he is willing to put Ho-Ho the Clown in the White House. Just to change the channel. And hope for relief.

Submitted by Tyler Durden on 10/26/2015

It's On: Obama Sends Destroyer To Chinese Islands, China Vows Military Response

Quarterly profits and revenue at big American companies are poised to decline for the first time since the recession, as some industrial firms warn of a pullback in spending.

From railroads to manufacturers to energy producers, businesses say they are facing a protracted slowdown in production, sales and employment that will spill into next year. Some of them say they are already experiencing a downturn.

“The industrial environment’s in a recession. I don’t care what anybody says,” Daniel Florness, chief financial officer of Fastenal Co., told investors and analysts earlier this month. A third of the top 100 customers for Fastenal’s nuts, bolts and other factory and construction supplies have cut their spending by more than 10% and nearly a fifth by more than 25%, Mr. Florness said.

Caterpillar Inc. last week reduced its profit forecast, citing weak demand for its heavy equipment, and 3M Co., whose products range from kitchen sponges to adhesives used in automobiles, said it would lay off 1,500 employees, or 1.7% of its total, as sales growth sagged for a wide range of wares.

The weakness is overshadowing pockets of growth in sectors such as aerospace and technology.

Industrial companies are being buffeted on multiple fronts. The slump in energy prices has gutted demand for drilling equipment and supplies. Economic expansion is slowing in China and major emerging markets such as Brazil, which U.S. companies have relied on for sales growth. And the dollar’s strength also has eroded overseas profits.

The drag on earnings and sluggish growth projections for next year come as the Federal Reserve considers raising interest rates for the first time in nine years, and could add momentum to those in favor of postponing any rate increase until next year.

Profit and revenue are falling in tandem for the first time in six years, with a third of S&P 500 companies reporting so far. Analysts expect the index’s companies to book a 2.8% decline in per-share earnings from last year’s third quarter, according to Thomson Reuters.

Sales are on pace to fall 4%—the third straight quarterly decline. The last time sales and profits fell in the same quarter was in the third period of 2009.

At some companies, foreign-currency effects hurt results significantly. Consumer-products maker Kimberly-Clark Corp. predicted that currency swings would slash earnings by 25% this year, while Johnson & Johnson said that the dollar’s moves would reduce sales growth by almost 7 percentage points this year, even without further fluctuations.

This week, another third of the S&P 500 are expected to report their results, including such giants as Apple Inc., United Parcel Service Inc. and Exxon Mobil Corp.

Much of the anticipated decline stems from the hard-hit energy industry, where sales are expected to drop by more than a third from a year earlier and profits are likely to plummet 65%, Thomson Reuters says, based on analysts’ estimates. Basic-materials companies face a 17% drop in profits, and industrial sales are expected to decline more than 5%.

United Technologies Corp., which makes Otis elevators and Carrier air conditioners, said it expects profits to be flat or down in three of its four operating segments next year, despite strength in its U.S. operations. Chief Financial Officer Akhil Johri told investors last week that the Otis division’s sales in China fell 19% in the third quarter as commercial construction slumped.

Other companies voiced similar concerns. “If you look at kind of the broad industrial-production index, you see industrial production sequentially coming down,” said Fredrik Eliasson, chief sales and marketing officer at railroad operator CSX Corp.

CSX is scaling back some operations in response to declining coal shipments as power plants switch fuels, eliminating nearly 500 jobs in Corbin, Ky., and Erwin, Tenn. In the current quarter, the company plans to reduce its average head count by 2% from the third-quarter level.

U.S. manufacturing production rose in September at its slowest pace in more than two years, the Institute for Supply Management reported earlier this month. Economic activity at 11 industries tracked by the group contracted during the month, while just seven reported growth. Meantime, manufacturers told ISM that customer inventories remained high, contributing to a slowdown in new orders.

Some investors and analysts worry that companies accustomed to boosting earnings by cutting costs, repurchasing shares and refinancing debt will soon have to face the reality of worsening sales. “The ability of corporations to take a 1% to 2% revenue line [gain] and turn it into 5% to 6% profit growth is waning,” said Charlie Smith, chief investment officer of Fort Pitt Capital Group. “They’ve run out of rabbits to pull out.”

Still, cost-cutting continues. Companies from Twitter Inc. and Biogen Inc. to Wal-Mart Stores Inc. and Monsanto Co. have announced job cuts in recent weeks. That could boost the U.S. unemployment rate, which ended September at 5.1%, its lowest point since April 2008.

“Things are definitely a bit shakier than they were several months ago,” said Joseph LaVorgna, chief U.S. economist at Deutsche Bank. But, he added, “the U.S. is fundamentally in decent shape.”

Indeed, low fuel prices have boosted U.S. car sales and buoyed airlines’ results, and the U.S. construction market remains robust. And, even among manufacturers, the aerospace industry is doing well. Technology giants Amazon.com Inc. and Microsoft Corp. posted strong results on Thursday, as did Google parent Alphabet Inc.

Such strength suggests that the broader economy is unlikely to succumb to the industrial sector’s gloom, especially given robust profit margins, said Jeremy Zirin, chief U.S. equity strategist for wealth management at UBS. “The broad mosaic of data suggests that the U.S. economy is still doing OK,” Mr. Zirin said. “This isn’t a very bullish view, it’s just saying things aren’t as bad as feared.”

Others worry that the slowdown is spreading to consumer businesses. Wal-Mart recently warned its sales this year are likely to be flat, down from projection of as much as 2% growth, and cut its earnings forecast for next year as it raises wages. The retailer blamed the strong dollar for the weakening sales growth.

And truckload carriers have warned that they aren’t witnessing the usual uptick in retailer demand as the holiday season approaches, thanks to stubbornly high inventories, said Alex Vecchio, a transportation analyst at Morgan Stanley. “Transportation companies are typically a leading indicator, and our data is not good,” Mr. Vecchio said.