Since the Great Financial Crisis started (in truth,
since well before), we have unwaveringly maintained three main tenets in
relation to how one should deal with the aftermath of a credit?driven, mass misallocation of resources.
Firstly, we have said that, even if we did accept, arguendo,
the trite macroeconomic mumbo?jumbo
of over?aggregation, that tired old, maintenance?of? spending?at?any?cost,
Keynesian game of trying to compensate for the overstretch of one particular
‘sector’ of the economy by passing ‘the bad, or
depreciating, half crown to the other fellow’
is most likely to tangle us in an inextricable knot of surindebtedness
if the ‘fellow’ is a governmental body. We say this, since the specious
initial advantage of the state’s temporary ability to ignore the
imperatives of accounting logic is doomed to be overwhelmed by the legal in? tractability associated with that same entity’s
even? tual financial
exhaustion. Furthermore, this mere procedural failing is always horribly
compounded by the dilution of the sense of direct responsibility which
accompanies its involvement in any plight in which the relevant country lands
Secondly, we have stood foursquare behind the idea that
all the losses are actually incurred during the heady euphoria of the Boom,
that the Bust is nothing more than the overdue recognition of those mistakes,
and that to procrastinate thereafter in their acknowledgement is not to avoid
the pain, but to exacerbate it in much the same way as a sufferer from a
cancer can do himself nothing but harm by trying to delay the awfulness of
the therapy which sadly must await
Thirdly, it has been our avowed belief that, contrary
to the accepted wisdom, there are very few useful macro solutions to such a
condition, but only micro ones; that recovery is built one job, one company
at a time, from the bottom up.
Therefore, the most beneficial role for Leviathan is
not some crazed, Frankenstein process of pulling levers and administering
potions in some swivel?eyed,
Gene Wilder fashion, but is one of expediting the renegotiation of now?unfulfillable contracts; of impartially overseeing a
just transfer of assets from the failed to the well?founded;
and of ensuring as few scarce resources as possible— in this time of
unexpected penury—are pre? empted
by the dead hand of the bureaucracy and, hence, are made available to the
putative builders of a new, more prosperous tomorrow.
In all of this, we have been generally cynical of the
ability of politicians to deny themselves the chance to carve their effigy on
an imaginary Mt Rushmore of interventionists. We have been even more
deprecatory of the nomenklatura of would?be Plato’s who
advise them, those ’socialists of the chair’ who blindly fill
their pink column inches with the ludicrous argument that the only remedy for
the failure of government interference is more interference. We have been
vehemently op? posed to the machinations of central bankers—the
ultimate succourers, when not the original seeders,
of the Boom—who continue to frame every response in terms of the
provision of liquidity to their precious cartel of institutionally parasitic,
fractional reserve banks.
Despite this, it has been hard to suppress the faint
fluttering of a hope lately freed from its hard chrysalis of doubt by the
integrity of some members of the northern European political class and their
nominees within the Heart of Darkness of the central bank itself.
Germany—with both tacit and expressed support
from among the Dutch, the Finns, the Slovaks, and others—has wrestled
itself close enough to doing the right thing—to writing off much of the
debt; to making the imprudent private owners and creditors face their
responsibilities; and to insisting on guarantees of future good housekeeping
from the incontinent debtors—to merit our applause, even if its courage
eventually fails it, or the temptation to take the road to hell along which
everyone else is frantically pointing finally proves too hard to resist.
However, any sense of the victory we entertain in this
critical war of ideas—albeit four years late and several trillion
dollars short—has to be tempered greatly by the awful truth that two of
the major central banks have already succumbed, once more, to their liquidity
fetish, while a third is patently ravening for the chance to overcome the
present domestic impediments to further action.
One of them, the ECB, is slowly transforming itself
into a Fed—over the careers of ex?Bundesbankers
perhaps, but nonetheless inexorably so.
Believe, if you will, that all such measures as those
announced this week are ‘temporary’ — only to be
countenanced for the duration of the emergency— and, as our New York
friends say, I have a bridge to sell you in Brooklyn.
Yes, it is true that interbank lending has frozen, that
the vast apparatus of sovereign finance is creaking alarmingly, and that real
money supply growth in the Zone is hovering just above the zero bound. Of
these, however, only the third is a potentially justifiable field for central
The first is a consequence of the long?suppressed mistrust of one another’s balance
sheets being expressed by the banks themselves; a fear which could be
dispelled overnight if they would each do no more than is required of any
public corporation, namely, to produce an honest set of accounts, even if
this would be to undertake an exercise in triage—of the merciless
sorting of the weak from the strong. To recognise
its origin is already to point to where the cure may be found—extended
repo operations and expanded bond purchases do not lie along that way.
The second handicap is the legacy of long years of
populist vote?buying whereby venal politicians have
far too liberally dispensed a morally corrupting patronage, not by having to
undertake the invidious task of clearly identifying the winning net
recipients of tax monies from the losing net payers standing beside them at
the hustings, but by recourse to the seemingly
painless expedient of borrowing funds which are never intended to be repaid
and which are, in great part, the result of inflationary credit creation on
the part of the same central and commercial banks who are now so threatened
by the fall of all these democratic Bourbons. Again, to make this diagnosis
is to indicate what form the remedy must take and to show that the
prostitution of the central bank, so as to maintain the status quo ante, will
prove futile, if not fatal, to the patient.
As for the Bank of England—well, yes again, real money
supply has been running at a negative rate in the UK for some good few months
past, dragging activity lower as it has. Yet a very good part of this real
contraction is because the Bank has also man? aged
to ignite a nasty rise in prices in violation of its rather open?ended mandate to moderate these over a self?determined and highly elastic ‘medium?term’.
As we have said before, the fact that the UK still
manages to run a near?record trade deficit amid a
severe recession and during an ostensible private sector credit crunch,
despite a 25% drop in sterling’s real effective exchange rate such as
to take it to a level only matched during the IMF crisis of the mid? 70s Labour administration, is testimony both to the fact that
the squeeze is not so intense as it seems and to the failure of all this macro?meddling to restore a
semblance of competitiveness to a hollowed?out
Where the leakage occurs, of course, is in the realm of
the state where, for all the gnashing of teeth and tearing of hair about the
‘austerity’ programme, spending
continues to rise, with the change in the state component of expenditures in
QII outstripping that of households for the fifth quarter out of the last
six. Total state outlays are still making new record highs, both outright and
as a proportion of non?state
GDP—that latter ratio now bumping up against the 60% mark, no less.
So it is all very well for Mervyn
King to bleat about facing the most severe financial crisis since the 1930s,
or to casually dismiss the cries of the thrifty that their livelihoods are
being crushed in the vice of rising prices and falling returns to capital,
but it is he and his predecessors, together with the political masters they
serve, who have led us into these straits, by dint of their unshrinking
embrace of a perverted orthodoxy of inflationary entitlement—of the
entitlement of welfare recipients to their doles, of office?seekers
to their votes, and of inveterate financial gamblers to their place at the
tables of the state?sponsored, state?regulated,
and state?underwritten casino.
Mr. King’s response to all this? Why, again to
make it easy for the state to spend more and difficult for many of the most
vulnerable elements of the nation to spend as much. Bravo, indeed!
So, while Chairman Bernanke can, for now, only threaten
to increase the disruption to the market’s pricing signals and to its
ability to allocate resources optimally over time, his peers are already at
work doing the same mischief.
Caught up with the demands of their real dual
mandate—that of keeping the ruling class happy while looking after the
interests of their cabal of big bankers—few of them will stop to listen
to what businessmen are telling them, though the message is being broadcast
in the most clarion of tones.
Take the most recent Duke University/CFO Magazine
quarterly survey of senior US executives as a case in point.
Asked to list external concerns in order of importance,
the perennial question of sufficient demand for the firm’s products
came top, but a clear second place was secured by the category ‘Federal
Government agenda/policies’ ? aka, REGIME
As for internal worries, the ability to maintain
margins was top, the cost of health care, second, and the ability to
forecast, third—over to you, Mssrs Bernanke
and Obama, once more, for creating and fostering such extreme REGIME and
And the result of all this? Exactly what we showed in
graphical form and briefly discussed in our last edition:?
“A third of CFOs say they will not deploy excess
cash this year, because they want to retain it should credit markets tighten.
Twenty?nine percent say they are hoarding cash due
to economic uncertainty, and 31% say they don?t
have any excess cash to spend.”
More worrying still for all those executives and traders
who keep telling us that while business in the Old World may be slow, Asia
will keep firing away and so save their bacon, the respondents from that
particular region also manifested an uncharacteristically subdued tenor.
We quote as follows:?
“Optimism about the regional economy in Asia (not
counting China) fell, with optimists and pessimists now evenly balanced. Last
quarter, optimists outnumbered pessimists by two to one. In China, 69 percent
of firms have grown more pessimistic about the economic outlook.”
“The top internal concern among Asian CFOs is
difficulty in planning due to extreme uncertainty, working capital management
and employee morale. The top external concerns in Asia are global financial
instability, intense pricing pressure and weak consumer demand. Chinese CFOs
also worry about government policies.”
But, carry on regardless! The present approach has been
so successful that while one in ten Americans with a full?time job lost it in the slump, barely one in six
of those unfortunates has found similar work since, leaving the total at 2000
levels and its fraction of the population at 1975 and 1983 recessionary
depths, despite the intervening incorporation of women into the workforce. As
for manufacturing— supposedly doing well on the cheapest dollar of the
modern era—almost one quarter of the hours worked here were lost from
the local maximum of 2006, of which, again, less than a sixth have since been
replaced, leaving total hours fully a third below the stationary average of
1984?2001, where they were in the 1940s!
Meanwhile, the 3mma of US NAPM new orders has dipped
below the 50 watershed for the first time since the crisis, an event which
has historically signalled a further deterioration
over the succeeding six months in 70% of cases, an ill omen we must interpret
in light of the fact that the last few months’ fall in this component
has only been exceeded three times in the past century—in 1974/5, 1980,
and in 2009 itself.
Even in Germany, the impressive growth in factory
orders has begun to peter out to the point that there has been little further
sustained growth so far this year. Meanwhile, at the other end of the world,
a PMI of Korean orders languishes at a 2?year low,
while exports of capital goods from Taiwan have not been this weak since
It may be too much to say that the wheels are coming
off the recovery, but they are certainly beginning to wobble.
Somewhat bereft of the opportunity to say much that is
positive about commodity markets at present and all too aware that they have
become correlated to—and hence unduly competitive with—equities,
much conversation has of late centred around their
near-term chances of doing less badly than their financial asset co-travellers in the portfolio.
One starting point is to consider the merits of
equities themselves and here we keep running into people who insist that
these are ‘cheap’ when what they really mean is that they are a
deal less expensive than they were before the rot set in and some of the
extreme optimism (as shown above in terms of the high levels of margin debt
and record low mutual fund liquid asset holdings which prevailed on the eve
of the sell-off) began to dissipate.
All we will say is that revenue growth appears to have
come to a halt and that, absent much topline growth, those elevated margin
levels will have to sustained simply in order to
stand still. We have seen that this is precisely what is worrying the boardroom,
leading to the drastic downward revision of earnings prospects seen over the
Secondly, balance sheets are still none too healthy in the aggregate, with
our overall estimate of the US non-financial Z-score barely moved from its
secular lows. Worse, with capital markets effectively shut these past few
months, the scope for boosting present returns on equity at the expense of a
potential impairment of future returns on capital can only have shrunk.
Thirdly, the plain truth is that price/book ratios (and
net worth in general) are being flattered by the inclusion of some very pricy
real estate among the assets—a situation which may belie some of that
property's productive utility, much less its realisable
Fourthly, the mispricing which has been partly due to
the reckless suppression of bond yields around the globe has pushed P/Es to the point where realized returns on equity lie
anomalously below trailing earnings yields. This is something which has
historically been followed by a long stretch of sub-par returns, and which
has typically required falls in the rate of price inflation to sustain
it—a condition whose fulfilment must be moot
indeed, given what our friends at the central banks and finance ministries
see as the solution to all our woes.
Under such circumstances, it seems a little foolhardy
to overcommit to the idea that equities, as a class, represent some sort of
But, if equities are not inarguably cheap, what are we
to say of commodities? Only that, at first, their early resilience during the
sell-off seems to have been anchored upon two main presuppositions.
Firstly, there is the idea that any exercise of the
Bernanke Put would benefit them disproportionately, as in fact was the case
during each of QE-prime, QE-China, QE-I and QE-II in spot terms, and for much
of the latter two episodes on a total return basis.
Secondly, there is the persistent faith that Asia will
continue to grow more, grow faster, and grow longer even if the West
continues to ail, and thus our Oriental friends will burn through just enough
of the main metals, fuels, foods, feeds, and fibres
to validate the unsullied optimism of the hungriest of asset-gatherers.
That this latter is indeed the case is best supported
by the slightly circumstantial evidence that commodity prices did not crack
until EM equities suddenly dropped vis-à-vis their developed world
counterparts in the second week of September, their currencies simultaneously
slumped versus the US dollar, and their CDS spreads blew out.
By ‘Asia’, what most in the market really mean is China, of course, and it has been ironical that
the holiday season there has more or less imposed a news blackout just when
we were most in need of a little reassurance. That silence will only be
broken next week, a period when we are also to be given some new substance on
which to chew by the imminent round of economic releases.
Tales of economic distress are becoming widespread but,
just as critically, these are still largely confined to the private and SME
sectors whose winnowing out can be seen as a
windfall for the well-connected SOE giants, as can any corresponding
difficulties in the underground lending market for the regular banks.
Meanwhile, with the People’s Daily running a front page story on how
inflation is causing real income to decline in several major cities, we are
not sure that the calculus has shifted away from the emphasis on a restraint
which has been partially vitiated by the leakage of credit from the official
channels into the shadowlands of lending and
A good deal of leverage has been shaken out of the system,
of that there can be little doubt. Markets became horribly oversold and are
now reacting accordingly and, in such conditions of these, when underlying
conviction is absent and the reservoirs of both financial and reputational
capital are so scanty, such reverses can be violent indeed, so being bearish
is not operationally straightforward, even if being bullish seems perverse .
Whether the present bounce is any more than a temporary
relief, must however, remain in doubt while the underlying weaknesses lie
unaddressed and the treatment prescribed for them are so palpably toxic in
At least we have the weekend to ponder it.