Category Archives: The Fed

Unicorns

Recent and prospective IPOs:

Nothing to see here, move along. It’ll be fine. Really.

Are You Kidding Me?

Thanks to zero hedge.

Central Banks Rule

Why is the stock market so strong?

Very simple. China injected 5% of GDP in net new credit into its economy in one month.

Panic.

Woof!

Sadly, the last hope for avoiding financial catastrophe is disappearing as Powell steps back from reining in the credit bubble.

Caveat Emptor

Bond guru Jeff Gundlach observed that the stock market has become a market for high-risk CDO residuals.

I must admit that I had not thought about this but he is exactly correct. CDOs (Collateralized Debt Obligations) were at ground zero in the last financial crisis. A CDO is constructed from a collection of assets, for example mortgages, and is divided into slices (“tranches”) which receive income in a priority sequence, based on the cash flow the CDO collects from the pool of bonds or other assets it owns. So for example, if $100 comes in, then slice 1 may be entitled to the first $25, slice 2 the next $25 and so on. But if only $10 comes in, slice 1 gets it all and nobody else gets any money. The last or lowest priority slice is called the residual, which receives whatever is left over after the other slices with fixed entitlements have been satisfied.

Gundlach’s point is that companies which have bought back shares with debt now have a capital structure essentially identical to that of a CDO, where the debt obligations have first claim on the company’s income and the equity investors must be satisfied with the crumbs. They are in the same position as the owner of the residual tranche of a CDO. So long as earnings are high and interest rates are low, all is well and there will be yachts and jets. But when the tide goes out, there will be naked swimmers as the ugly side of leverage becomes visible. Read Jeff’s piece and be very very scared.

Same Old

The Fed is making clear that it is having a change of heart and rate increases are on hold for the time being.

Does this mean the all clear, the bull market can resume? No. This is not good news. It means that even the Fed can now see the recession coming and is trying to avoid the blame. The recession itself is inevitable. The light at the end of the tunnel is a train and no amount of panicking will change that.

Powell was the last hope for a truly independent Fed. Well forget that. It turns out he’s just another politician. Go back to your cherished memory of Paul Volcker and resume dreaming. I quote the IMF, which may not know economics but does know accounting:

“Global debt has reached an all-time high of $184 trillion in nominal terms, the equivalent of 225 percent of GDP in 2017. On average, the world’s debt now exceeds $86,000 in per capita terms, which is more than 2½ times the average income per-capita.”

This catastrophe belongs entirely to the world’s central bankers and the governments that have failed to constrain them.

Crispin’s Day (Not Henry V)

Crispin Odey, who runs the most bearish hedge fund and needless to say has done rather well this year, writes in his recent manager’s letter:

I have a lot of sympathy for your position, sitting on the other side of the desk.

This is late cycle economics. Consumers are sated and over-borrowed. Companies have extracted all the margin they can and have leveraged themselves as well. Cheap money has spawned competition. Populism risks playing about with prices and property ownership. Recessions will not be altogether unwelcome given that they deal with the problem of rich and poor and young and old. The rich lose money which pleases the poor. The old lose their jobs and the young are the first to be reemployed. Without recessions this redistribution has to be done through taxation and legal theft.

Too Tight?

Reportedly, President Trump is considering firing Fed chair Powell, blaming him for the recent stock market declines.

Ironically, in Sept 2016, Trump accused the the Fed of “keeping the rates artificially low so the economy doesn’t go down so that Obama can say that he did a good job. They’re keeping the rates artificially low so that Obama can go out and play golf in January and say that he did a good job. It’s a very false economy. We have a bad economy, everybody understands that but it’s a false economy.”

Of course, he then adopted the “false economy,” even though he apparently well knew that it was a bubble, going on to extend it with spending increases and tax cuts. Of course, this simply increased government’s value destruction and we will all reap the consequences. In my mind, this is the biggest disappointment of Trump’s presidency – that he knowingly continued to inflate the bubble.

Yellen was “too short.” It seems Powell is “too tight.” Firing Powell would probably precipitate a crash.

The right thing to do is to acknowledge that the Fed’s ability to control the economy is a myth. Their attempts just lead to an endless series of booms and busts, as anyone who has the least understanding of control systems theory could predict.

Here We Go Again

Recurring economic crises are nothing but the consequence of attempts, despite all the teachings of experience and all the warnings of the economists, to stimulate economic activity by means of additional credit. […]

And although the conclusion to which my investigations lead, that expansion of credit cannot form a substitute for capital, may well be a conclusion that some may find uncomfortable, yet I do not believe that any logical disproof of it can be brought forward.

— Ludwig von Mises, The Theory of Money and Credit, 1934, 2009 edition

Deflation Watch

ECRI chimes in – I told you so.

The plunge in oil prices, which dropped below $50 this week, blindsided many businesses and investors. But the inevitable decline was foreshadowed months ago by a downturn in commodity prices, as measured by ECRI’s Industrial Price Index (IPI) which was previously known as the JoC-ECRI IPI*…….

…..Oil price inflation has now plummeted to a 32-month low – its worst reading since early 2016 (bottom line). But industrial commodity price inflation, as measured by the IPI, has already dropped to a 33-month low, and is still falling (top line), signaling continued downside risk for oil price inflation.