The theater of the absurd became even more bizarre on Jan 22nd, when the European
Central bank <ECB,> desperate to extract the Euro-zone's economy from
the quagmire of deflation and stagnation, decided it would try its hand at
the magic elixir of "quantitative easing," (Q€). Starting on March 1st,
the ECB will inject €60-billion of liquidity into the Euro-zone's money
markets, each month until the end of Sept 2016. The ECB is the last of the
Big-4 central banks to unleash the nuclear option of central banking - QE,
- starting about six years after the Bank of England, the Bank of Japan, and
the Fed began flooding the world markets with $7-trillion of British pounds,
Japanese yen and US$'s.
Proponents of QE argue that the UK and US-economies are among the best performing
in the developed world today, and say the massive doses of money printing and
near zero interest rate policies (ZIRP) are the main reasons why. Opponents
of QE say the liquidity injections are mostly channeled into the bond and stock
markets, - enriching the owners of financial assets, and very little of the
QE-injections "trickle down" into the hands of the struggling masses. Instead,
thanks to QE and ZIRP, the net worth of the world's 400 wealthiest has mushroomed
to a cumulative $4.1-trillion. The Richest 85-billionaires now control more
wealth than half of the world's population combined, or 3.5-billion persons.
Many of the world's ultra-wealthy were in attendance at the World Economic
Forum in Davos, Switzerland this month, dining and conversing with the most
powerful central bankers and finance ministers from around the world, and getting
a few "hot tips." Also in attendance, was the Bank of Japan chief Haruhiko
Kuroda who welcomed the prospect of the upcoming "Tug-of-War" with the ECB
over the direction of the Euro /yen exchange rate. "We very much welcome this
QE action by the ECB," Kuroda said in Davos. "The decision could end deflationary
pressures and stimulate growth in Europe, which is good for the economies of
Japan and the world," Kuroda said.
However, when translating Kuroda's jargon into plain English, what he really
said to investors was; "The ECB's decision could end deflationary pressures
(ie; reduce selling pressure in the Euro-zone stock markets), and stimulate
growth in Europe (ie; inflate EuroStoxx valuations and P/E multiples), which
is good for Japan (ie; owners of Tokyo listed equities) and the world (ie the
Richest-1%). On October 31st, 2014, the BoJ jolted the world stock markets
sharply higher, when it stated its intention to buy ¥80-trillion of Japanese
government bonds over the next 12-months, which means the BoJ would soak up
all of the new bonds that the Ministry of Finance sells. The BoJ ramped-up
its QE operations the same day the Fed mothballed its QE-3 scheme.
The BoJ already holds about 20% of Japan's outstanding government bonds, and
if it continues to underwrite the entire deficits of the government, it could
end up owning half of the JGB market by as early as in 2018. BoJ chief Kuroda
says the massive printing of yen, - dubbed "QQE" in Japan is necessary to prevent
a reversal into a "deflationary mindset," that has stymied Japan's economy
for decades. "Countering such a trend is the most important thing we can do.
Whatever we can do, we will," Kuroda said. Reading between the lines, the "deflationary
mindset" that Kuroda aims to turn around is the Bearish psychology that has
plagued the Tokyo Stock Exchange for more than two decades. Since the BoJ unleashed
QQE in Dec '13, the Nikkei-225 stock index has doubled in value to above 17,500-points,
- thanks to a -50% devaluation of the Japanese yen versus the US$.
ECB Ups the Ante against the BoJ
For almost two years, inflation has been consistently below the ECB's target
rate of +2%, with each month showing a lower figure than the previous one.
More than six years after the collapse of Lehman Brothers and the start of
the "Great Recession," conditions are still at Depression-like levels in the
peripheral countries of Europe, with double-digit unemployment rates, and ever-lower
living standards and rising poverty that have become a permanent situation.
Reflecting the deeply entrenched trend of deflation, the yield on Germany's
5-year schatz turned negative on January 15th, to as low as -5-basis points
(bps), before rebounding to +1-bps today.
As such, the ECB unveiled its most aggressive effort to date to revive the
region's ailing economy (ie; inflate the EuroStoxx index) with a QE-scheme
to print 1.1-trillion Euros and purchase government and private bonds starting
in March. Thus, the BoJ and ECB will engage in hand to hand combat the Euro
/yen exchange rate in the year ahead. Initially, the BoJ gained the upper hand
over the Euro /yen exchange rate, when it struck first, with a surprise attack,
by expanding its QQE scheme to ¥80-trillion /year. That act of "shock and
awe" lifted the Euro to as high as ¥150 in December. However, the ECB quickly
retaliated by driving German T-bill rates to zero percent, and -16-bps below
Japanese T-bill rates. And of course, the ECB has upped the ante, by playing
the Q€1.1-trillion -Q€ card, and in turn, knocked the Euro sharply
lower to ¥130 last week.
German firms are competing head-to-head with Japanese firms in the $3.4-trillion
capital goods export market, and the central banks have the advantage of being
able to move quickly. Politicians always turn to central bankers and say, "Can
you fix it? Put some cheap money out there." Together, these two heavy weight
central banks are planning to inject a combined ¥10-trillion and €720-billion
into the world money markets in one year's time. But there is no quick fix.
Switzerland Stuns Markets by Giving Up on Currency Peg
On January 15th, the Swiss National Bank <SNB> shocked the markets,
in one of the most memorable days in the history of currency trading. The SNB
swept the rug from under the feet of currency, debt, and equity traders alike,
when it decided to abandon its defense of the Euro versus the Swiss franc.
The SNB's sudden withdrawal from the currency wars, sent the Swiss franc soaring
by +20% within a few minutes, a move that rippled through global markets and
wiped Sfr-155-billion off the value of the Swiss stock market.
The SNB scrapped its defense of the Euro at 1.20-Swiss franc, just days after
SNB officials said the currency peg was absolutely necessary, to fend off deflation
and a recession. SNB deputy Jean-Pierre Danthine said on Jan 12th that the
1.20 ceiling would remain a "pillar" of monetary policy. "We took stock of
the situation less than a month ago, we looked again at all the parameters
and we are convinced that the minimum exchange rate must remain the cornerstone
of our monetary policy," Danthine declared. Earlier, on Jan 5th, SNB chief
Thomas Jordan said the currency peg as "absolutely central."
Since introducing the currency peg in Sept '11, the SNB had printed roughly
Sfr-400-billion and used to buy Euros and US$'s. As of Jan 14th, its foreign
currency reserve had increased to a record Sfr-495-billion, or equal to 85%
of Switzerland's GDP. Then, the gig was up. The SNB realized it was not possible
to match the ECB's forthcoming €1.1-trillion Q€-printing spree. To
counter the ECB, the SNB would have to print Swiss francs equal to 2-times
the size of Switzerland's annual GDP.
In Zurich, the SNB's defense of the currency peg had in essence, become a
quasi QE-scheme. Much of the 400-billion of Swiss francs that were injected
into the foreign currency market, filtered into Swiss bonds, (pushing the Swiss
10-year yield below zero-percent last week), and into blue-chip Swiss stocks.
However, when the SNB suddenly went cold turkey on quasi-QE, and abandoned
the Euro /franc peg, it triggered an instant reaction of panic. The Swiss Market
Index <SMI> tumbled -15% lower to the 7,900-level. The two-day crash
was the biggest since "Black Monday" in October 1987, and wiped out around
155-billion francs in market value.
Morgan Stanley analysts wrote: "We estimate that 85% of SMI sales come from
overseas, and many of the large-cap names generate 90-95% of their revenues
from sales outside Switzerland. With the franc worth around +17% more than
it was a day and a half ago - the franc is now nearly at parity with the Euro.
Swiss companies must face the challenge of absorbing what amounts to a -17%
reduction in revenue on every item sold in the Euro-zone." The SNB's retreat
from quasi-QE also has far reaching consequences for 550,000 Poles, 150,000
Romanians, and many Croatians, who have mortgage debts denominated in Swiss
francs, and now face +17% increases in their interest and principal payments.
However, on Jan 18th, Switzerland's finance chief Eveline Widmer-Schlumpf
sought to reassure shell shocked investors that abandoning the currency peg
with the Euro would not destabilize the Swiss economy. She predicted the Euro
/ Swiss franc rate would eventually rebound to 1.10. "I'm confident that the
economy will be able to cope with this decision. Companies are in a far better
position than in 2011 when the cap was introduced," she told the SonntagsBlick
and Schweiz am Sonntag newspapers.
Sure enough, on Jan 27th, the SNB backed-up the finance chief, and issued
a warning that it is ready to intervene in the currency market to support the
Euro against the Swiss franc. "Giving up the cap means a tightening of monetary
policy. We accept this, but only up to a point. We are fundamentally prepared
to intervene in the foreign exchange market," warned SNB deputy Jean-Pierre
Danthine. He said it would take some time for the foreign exchange markets
to balance out, and declined to give exact levels, the SNB is aiming for the
Swiss franc versus the Euro and the US-dollar.
Already, signs of stability in the Euro's value at around parity with the
Swiss franc was enough of a signal for bargain hunters to pick-up battered
Swiss shares. With the SNB alerting traders that it is not completely walking
away from currency intervention, traders bid-up the SMI +5% higher to the 8,400-level
on Jan 27th, or +5% above the panic bottom lows. In turn, signs of stability
for the Euro /franc led speculators to dump Swiss T-bills. The yield on Switzerland's
3-month T-bill jumped to minus -118-bps on Jan 27th, from a record low of -260-bps
on Jan 23rd.
Still, the Swiss economy will have to deal with a "deflationary" shock, largely
as a result of the ECB's decision to launch Q€. The SNB might have to
widen the scope of bank deposits that are affected by negative rates in order
to weaken the Swiss franc, and unwind the deflationary pressures. The Swiss
consumer price index <CPI> fell -0.5% in December, and compared with
Dec '13, the CPI was -0.3% lower, compared with annualized rates of -0.1% in
Nov '14. In light of the Swiss franc's rapid appreciation against the US$ this
month, to around $1.100, the Continuous Commodity Index, including a basket
of 17-equally weighted commodities, is trading -16% lower compared with a year
ago, when measured in the Swiss franc. In turn, that could keep the Swiss CPI
in negative territory in the months ahead. And the ability of the SNB to support
the Euro /franc with sporadic rounds of interventions would be limited at best,
given the expected flow of €1.1-trillion from the ECBs printing press
thru Sept '16. In essence, the ECB is exporting the Euro-zone's deflation problem
to Switzerland.
Loss of Confidence in Euro sparks flight for Safety into Gold
Still, the ECB's belated Q€ scheme cannot disguise the fact that the
Euro-zone economy is based upon a one-size-fits-all monetary policy that is
fatally flawed. The economic divergence between Europe's wealthy core countries
and the weaker debt-saddled periphery continues to widen. On the fiscal side,
Berlin has insisted instead that the big debtors in the Euro-zone push through
painful spending cuts and tax increases to reduce their budget deficits, in
line with its own successful fiscal model. The Irish, Spanish, Italian, and
Portuguese are going along with these policies for now, but skeptics worry
that in the years to come this strategy will be exposed as deeply flawed and
result in long lasting stagnation and high levels of joblessness. Support for
political fringe parties that want to break-away from fiscal austerity, such
as in Greece, is also leading a growing numbers of citizens to conclude, that
they might be better off outside the currency union.
Who says interest rates can't go below zero-percent?
While yesterday's news centered on the fall in US 10-year Treasury yields
to as low as 1.75%, the bigger news is Germany's 5-year schatz is trading at
zero-percent. On Jan 15th, it briefly fell into negative territory at -0.05%.
Shorter-term German T-bill yields began to slip below zero percent in August
'14, and today, the 3-month German T-bill is yielding minus -17-basis points
(bps). But why would anybody lock in a yield of zero-percent for 5-years? Perhaps,
it's a low cost "option play" - and betting on the eventual break-up of the
Euro currency.
Although the Deutschemark is officially out of circulation, if in the event
that the Euro does break up into the former currencies of each member state,
then it would be a logical assumption that all securities would also be redenominated
in those original currencies. So German Bunds would be denominated in the Deutschemark.
That is one reason why the 5-year Schatz is yielding zero percent. And while
the investor that buys German T-bills or notes at less than zero-percent, pays
interest to Berlin, the expected payoff from big currency gains, due to the
potential break-up of the Euro would far exceed the costs. In that "Black Swan" scenario,
the currencies of the periphery, new Drachma, New Escudo, New Peseta and new
Irish Punt could be revalued far below the Deutschemark.
It's difficult to pinpoint exactly the reason for negative interest rates
in Germany, although it certainly deserves the lowest borrowing costs in the
Euro-zone. Germany balanced its federal budget for the first time in almost
half a century in 2014, and even managed to pay off old debts worth 2.5-billion
euros. Germany's finance chief Wolfgang Schaeuble says Berlin won't issue new
debt in 2015 and is aiming to generate a budget surplus in 2016 , helped by
soaring tax revenues and record low unemployment - and negative interest rates
resulting from its safe-haven status. Outside of Germany, however, there are
26-million people unemployed in the EU, including around one in every two young
people in Greece, Spain and parts of Italy and Portugal.
Another possible reason for the emergence of negative interest rates in Germany
is the possibility of a massive short squeeze in the German Bund market, once
the ECB begins to buy sovereign bonds. The amount of eligible Euro area government
bonds is €7-trillion and the estimated net government bond issuance is
around €90-billion in the year ahead. If correct, the ECB would soak-up
around 55% of the newly issued debts. The ECB would be reducing the amount
of German Bunds in circulation, with Berlin running a balanced fiscal budget
or even a small surplus.
Around €1.4-trillion of Euro area government bonds are already trading
with negative nominal yields, almost all of them up to 5-years maturity.
Whatever the reason for the emergence of negative interest rates in Europe,
it's suddenly made the Gold market more attractive, simply because the yellow
metal is yielding a higher rate of interest, or zero-percent. And with the
ECB is vowing to further dilute the value of the Euro against other paper
currencies, through its Q€ scheme, there has been a panicked flight
from the Euro and into safer havens. And there is another wildcard in play
that might explain Gold's sudden explosive +15% rally against the Euro in
the month of January '15, to as high as €1,150 this week. Most traders
to date have concluded that the cost of Greece exiting the Euro currency
union is so high that Athens would not contemplate it. However, the virtual
economic collapse and high poverty level in Greece that has led the left-wing
Syriza opposition party led by Alexis Tsipras to power have upset those calculations.
Greece, in effect, has a lot less to lose by leaving the Euro currency.
Greece's economy has shrunk by -25% since the onset of the "Great Recession." Thousands
of businesses have closed, wages and pensions have been slashed and more than
half of young people are unemployed. Half a million citizens have left the
country. At the same time, its massive public debt has climbed to €320-billion,
or 176% of GDP last year, the second highest in the world. Greece could declare
bankruptcy if a solution is not found. As such, there is a flight from Greek
bonds that has already doubled the yield on Greece's 10-year note since the
start of September to as high as 10.70% this week.
Yet Berlin believes that the rest of the Euro zone would be able to cope with
a Greece exit if that proved to be necessary, the Der Spiegel magazine reported
on Jan 3rd. Both German Chancellor Angela Merkel and Finance chief Wolfgang
Schaeuble believe the "danger of contagion is limited because Portugal and
Ireland are considered rehabilitated. In addition, the European Stability Mechanism
(ESM), the Euro zone's bailout fund, is an effective rescue mechanism and is
now available." According to the report, the German government considers a
Greece exit almost unavoidable if the leftwing Syriza opposition party led
by Alexis Tsiprasto tries to cancel austerity measures and a chunk of Greek
debt .
"If Alexis Tsipras of the Greek left party Syriza thinks he can cut back the
reform efforts and austerity measures, then the troika will have to cut back
the credits for Greece, " warned Merkel's chief advisor Michael Fuchs on January
3rd. "The times where we had to rescue Greece are over. There is no potential
for political blackmail anymore. Greece is no longer of systemic importance
for the Euro," he said. On the other hand, many traders are bidding up the
price of Gold and German bunds, fearful that a Grexit could open the way for
the eventual demise of the Euro and a return to the Deutsche Mark.
On the political front, the Greek election that brought Syriza to power highlights
the growing strength of anti-austerity and anti-Euro parties. It is perhaps
Spain which has the strongest parallels with Greece. The Spanish economy has
suffered a major economic downturn that has fuelled the rise of anti-establishment,
radical left party Podemos, only founded in 2014, which is currently neck and
neck in the polls with the ruling People's Party. Meanwhile, the long established
Socialist Party is trailing in third place, but might yet win power in coalition
with Podemos at the next election. So after 3 years of kicking the can and
pretending it is fixed, suddenly everything that is broken in the Euro-zone
threatens to float right back to the surface, and the ECB's QE-scheme might
only make matters much worse.
Ex-Finance chief Kudrin warns of "full-fledged crisis" in Russia
There is another currency war that is being fought in Europe, and this one
has all the makings of a great conspiracy novel. There is an uncanny sequence
of events that is unfolding before our eyes, that is threatening to topple
the world's 10th largest economy. For more than a decade, oil income and consumer
spending have delivered growth to Vladimir Putin's Russia. Not anymore. Russia's
economy is sliding into a severe recession. The Russian rouble has lost half
of its value against the US$ compared with a year ago, and with it the faith
of the country's businessmen. Banks have been cut off from Western capital
markets, and the price of oil, - Russia's most important export commodity has
plunged - 60%. Consumption, the main driver of growth in the previous decade,
is slumping. Money and people are leaving the country.
On Dec 22nd, Russia's former finance chief Alexei Kudrin warned of mounting
trouble that is spreading through the Russian economy, and what Economy Minister
Alexei Ulyukayev called a "perfect storm" of plummeting oil prices, EU & US-economic
sanctions related to its military action in Ukraine, and a $134-billion flight
of investors' capital last year. "Today, I can say that Russia's economy is
entering a real, full-fledged economic crisis. In 2015, we will feel it clearly," Kudrin
told a news conference on Dec 22nd. "The government has not been quick enough
to address the situation." Kudrin forecast a series of defaults among both
medium and large companies -- though he said banks would probably be supported
by the state -- which was likely to result in rating agencies downgrading Russia's
debt to "junk" status. The collapse of the Russian rouble will lift Russia's
inflation rate to +12% to +15% in 2015, Kudrin predicted. Russia imported $341-billion
last year, so a devalued rouble quickly stokes inflation.
Long before he annexed the Crimean peninsula and began backing pro-Russian
forces in eastern Ukraine, Russian kingpin Vladmir Putin created an economic
system that allowed a clique of Oligarchs to grow wealthy on Russia's vast
oil and gas reserves. He did little to diversify the economy or to make it
more resilient. As such, Kudrin's outlook for Russia's economy is bleak: "Even
if the price of Russia's Urals crude oil rebounds to $80 /barrel, gross domestic
product is still likely to fall by more than -2% in 2015, Kudrin predicted.
At $60 /barrel GDP would decline by -4% or more, he added.
The collapse of the Russian rouble is a mirror reflecting the crisis undermining
its entire economy, which has been devastated by the plunge in oil prices to
around $46.50 /barrel today. The Gazeta.ru newspaper said last month was "Black
December" in Russian history. According to the central bank, capital flight
amounted to $134-billion last year. Bank Rossi responded by tripling its key
overnight lending rate to 17%, after it burned through $113-billion of foreign
currency reserves.
On Dec 15th, nearly $10-trillion of foreign currencies traded hands in the
world markets, double the daily average, when the US$ suddenly surged +30%
higher to 80-roubles. Moscow reacted by ordering state-controlled exporters
to sell their holding of foreign currency, and briefly succeeded in knocking
the US$ down to 54-roubles a week later. On December 19th, Russian president
Vladimir Putin met with 41 of the leading Russian finance tycoons and Oligarchs,
and asked them to limit their sales of Russian roubles. The collapse of the
rouble and the Russian stock market has wiped out $73-billion of wealth of
the 20 richest Russians. The fortunes of some oligarchs have more than halved.
However, on January 27th, Standard & Poor's became the first of the big-three
ratings companies to strip Russia of its investment grade, citing weaker growth
prospects and a deterioration of fiscal buffers. Russia's debt rating was lowered
one notch to BB+ by S&P, while Moody's and Fitch cut Russia to one level
above junk this month. The country's debt will no longer be eligible for some
indexes that track investment-grade sovereigns if two of the three biggest
rating companies cut it to junk. The cost of insuring Russian debt against
default using credit-default swaps <CDS's> has soared to 600-bps this
week, and up sharply from around 95-bps in Dec '13
Russia may have to spend more than $40-billion of its dwindling FX-stash this
year in order to avert a banking crisis. Last month, the state spent 130-billion
roubles to bail out the first major bank to fall victim to the rouble crisis,
mid-sized lender Trust Bank, then ranked 15th biggest by retail accounts and
32ndby assets. If any of Top-30 banks get into trouble, the government will
have to save them at any price, as it could spark a crisis of confidence in
which the population withdraws deposits en masse and interbank lending rates
spike sharply higher.
Russia's finance ministry is warning of at least a $45-billion drop in revenues
this year, if the average oil price is $50 /barrel. Finance chief Anton Siluanov
said all state expenditure should be cut by -10% except defense, a priority
for President Vladimir Putin. "The state cannot have the kind of spending it
used to have with the oil price at $100 / barrel," Siluanov warned. Russia's
budget for 2015 was based on an oil price of $100 /barrel but prices are now
close to six-year lows at just above $46 /barrel . Siluanov said Russia needs
to conserve its foreign currency reserves to overcome difficulties as the price
of oil looked set to continue at low levels. "We think that with the average
oil price at $50 /barrel (in 2015), we will lose some 3-trillion roubles in
revenues," he said.
While Russia's sovereign debt is just $57-billion, many Russian banks and
corporations, including large oil and gas businesses, went on a borrowing spree.
They increased their foreign-currency debt by $170-billion in the past two
years, and are on the hook for a total of $614-billion in foreign currency
debt. Most of this debt was racked up by state owned corporations and national
energy companies, which gives it a quasi-sovereign status. And by the end of
2015, Russian firms will have to repay about $130-billion of foreign debt.
The -50% devaluation of the rouble makes the servicing of the foreign debt
twice as expensive. So instead of preparing itself for a crisis, Russia has
prepared a crisis for itself.
Rosneft, Russia's national oil company, run by Igor Sechin, Mr Putin's close
confidant, is already asking the Kremlin for a bailout, in part to help it
repay $30-billion of debt which it took on when buying a successful private
company, TNK-BP. If the price of crude oil stays below $50 /barrel for two
years, much of Russia's treasure chest of foreign currency reserves could become
depleted. As such, the ordinary Russian citizen is able to protect his /her
purchasing power by purchasing Gold, - a hedge against massive currency devaluation.
The price of Gold has nearly doubled since June '14 to above 87,000-roubles
per ounce this week. Interestingly enough, the Kremlin was the world's biggest
buyer of Gold in 2014, adding 150-tons to its hoard and catapulting its holdings
into the top five among nations. It stands at just shy of 1,170-tons, and worth
about $50-billion at today's prices.
Russia is facing its worst economic crisis since 1998, when the country devalued
the ruble and defaulted on its debt. Putin's popularity is partly based on
his reputation for providing prosperity and stability. And so, amid a double-digit
inflation rate, Russian kingdom Vladimir Putin has ordered his government to
rein in rising vodka prices. Under the Kremlin's new price control policy,
the cheapest half-liter legally available will continue to cost a minimum of
220 rubles ($4).
