What Does the World Do - When Monetary Policy Does NOT Work?

Central banks around the world have driven interest rates to historical lows, and even negative in some cases.

"Imagine a bank that pays negative interest. Depositors are actually charged to keep their money in an account. Crazy as it sounds, several of Europe’s central banks have cut key interest rates below zero."

The problem is that low interest rates are NOT having the stimulative impact we need.  Demand for capital is not triggering lending and consumers seem are uncharacteristically withdrawn.  Corporations are holding their cash, acquiring their competitors, buying back their stock, and only becoming more efficient with technology and improved business processes.  None of this behavior is promoting the spending and demand that the world's economy needs to counter deflation. 

More money has been printed over the last 5 years than all of history.  All in a futile attempt to increase inflation and stimulate demand.  But it's not good enough.  Fears of a rise in anti-competitive behaviors (tariffs, currency manipulation, governments using laws to hurt multinationals, etc.), political upheaval over reforms, and nationalism/imperialism are present, all because monetary policy is not having the desired effects.  What's the answer?

Some believe it's time for the USA to raise rates.  That's makes no sense with our dollar already rising more rapidly than ever and tons of corporations warning about exchange rate headwinds damaging earnings.  Besides, since when do you fight Deflation by raising rates?!  

By the same token, super low and negative interest rates are distorting investor and saver behaviors who are forced to chase yields from more risky investments.   The potential for very negative consequences can not be underestimated.  We need a better way.  And we have it.  

A better way was presented by British economist John Maynard Keynes wrote about in his book, The General Theory of Employment, Interest, and Money published in 1936 during the Great Depression, in contrast to his a previous works on aggregate supply-focused 'classical' economics.  Unfortunately, back then, Keynesian stimulus came in the form of WWII.  

A massive military expansion has its appeal for some.  And given the threats around the world, we are already seeing it in countries like China, Russia, India, Saudia Arabia, and other areas.  Fortunately, thanks to the "Sequester" that went into place here in the USA as a result of unresolved national debt ceiling negotiations, the USA is not going down the same military build up path.  Surely the hungry arms industry, congressional hawks, and warmongers would if they could. 

What we need is some Keynesian stimulus in the form of infrastructure spending.  Heaven knows we have enough need for it!  Time has come for a new approach to monetary stimulus.  Let's stop paying banks interest on reserves and start investing in the USA!

"All In" - What do you have?

The monetary standoff between Greece and Germany, being played out by the ECB, took a turn for the worse yesterday (2/4/15). Battle lines have been drawn. Greece has moved all their chips in with a creative debt restructuring plan, under which for all practical purposes they will never pay most of it back. Give them two points for not using the words - write down.

Who is going to be the winner? It won't be Germany. For some reason, their hardliners have no memory ... because if any country should understand the need to write down debt it is Germany! They received a huge write down after WW2. But all they can think about is the austerity rules they expect Greece to live up to.

Well Germany, you can forget about it. Greece elected a President, Party, and new finance minister because they said they will break the rules. At least the Greek leaders are being polite as they essentially tell the Germans to fuck off. The Greeks may have under estimated the price for that. Or the Germans may be under estimating the price for holding Greece to wall. Or BOTH! The big winner will be France, Italy, and Spain! Here is why I believe so.

Greece holds out. Time is ticking on a big debt payment and they will all go to the bell. Each with the position that they get it their way. Which amounts to either a creative way of getting a giant debt haircut, or Greece defaults. If this were poker, Greece has just gone all in on a losing hand. Germany calls the bluff. Game over. Say goodnight Greece. Have a nice new day, and good luck starting over. So what are they to do?

They can say, "Welcome back" to the drachma. And after some new currency laws, all the Greek citizens who ran the banks, only to find that only the firsts in line got any Euros, will now be proud to accept drachma instead. And for the rest of us, get ready for the best tourism packages we've seen in a long time, after the riots are over in about a year.

Meanwhile, what did Germany win in this poker game. A big fat bad debt write off. Along with France, Italy, Spain, and everyone else with any skin in the Euro. It is starting to look real bad for everyone at Euro party, I mean pact. Coming apart at the seems? Maybe, but I think not. Too much to lose. Funny how it is when you are standing at the edge of a cliff you get a fresh perspective. And what do they see? They realize that Greece was on to something! Default is such a messy thing. There has to be a better way.  Enter ECB, wait, let's just call the debt problem we have, Hmmm, what did Greece call it, we can't use that name, but .... what ever name they can come up with that will make a whole bunch of trillions in debt go away for so long that two generations from now nobody will remember where it came from.

The newly elected Claude Junker of the Economic Union will show up in the picture too, with fresh ideas for brand new debt.  After all, now that they've just freed up so much borrowing power, thanks to the power of the printing press and the fact that they just shoved so much of the old debt out of the way, they can practically start borrowing money all over again.  But this time is different!!  Yeah, right.  Well, at least for a while.  Long enough to stimulate the economy a "new way" with serious infrastructure spending.  (At least that's what I'm hoping for.)

And as the Europeans and the ECB applaud their own brilliance for saving the Euro, will they thank the Greeks for their great idea on how to handle debt that can't possibly be repaid? Of course not!  But the least they can all do in Europe is vacation on the Greek Islands! (But, people from Germany, suggest you find a way to lose the accent. Otherwise don't be surprised if you get very sick from from every Greek meal you eat.)

OR, Plan B, for the 12th time.  GREECE CAVES and swaps a "kick the can offer" for a "stay in the Euro" deal.


UPDATE: 4/27/15:
Since I published my blog post in February, the notion of bankruptcy and an exit have been trending.  It appears to me that the leaders in Europe are foreshadowing the future in an effort to give banks and the markets and finance ministers time to get ready.  At some point the expectation may be so much in the market that the actual announcement can come as welcome news and even has the potential of bringing a relief rally.  Here's an article which posits the position I have had for quite some time.  "We should let Greece to bankrupt." 

New Image Emerging

The sands are shifting.  The status-quot is giving way to market forces.   

Greece is going socialist or Marxist - and the economy is destroyed.  Germany and the ECB will use them to set an example. Venezuela - has imploded, but just needs a bit more time to collapse.  Russia is sinking - while it hopelessly uses its massive reserves to breath.  They're losing their world power status and rebuilding can't begin until Putin takes a long holiday - for good.  Oligarchs will buy his ticket and help him on the plane. 

The debts of both Greece and Venezuela have to be written down, by way of a default or some back door deal.  Either way, capital (money and talent) leaves, their markets are crushed.  Banks are run.  Game over.  But the phoenix will rise.  As it is finally going to do in Cuba.  

Spain, France and Italy look at the carnage and are determined to take a different path.  ECB draws the line and "does whatever it takes" to restructure their debts.  Seeing how turning back from reforms has hurt Greece, the ECB uses this as leverage to force faster progress on reforms but makes the pill more easy to swallow by using the printing press.  Together with Junker and the Economic Union, a new growth strategy is introduced.  It  involves reforms coupled with development funding.  In combination with low interest rates and E-QE, Europe takes a turn and their currency strengthens - at least it stops weakening.  This puts a floor under USA equities whose earnings are to hard to hedge otherwise with such a weak Euro. 

USA firms see the potential in Europe and put their reserve capital to work overseas. Plus, this works as another form of hedge to exchanges. Look at the difference this made for Ford who manufacturers in the region.  Rather than bringing reserves home, USA firms decide it is time to invest in Europe.  The Federal Reserve and Congress encourage USA investment in Europe. 

America's picture is changing.  Exchange rates are hurting earnings.  And, the oil industry is costing jobs faster than they're being created by the stimulus of low energy costs.  In an effort to curb costs, there is further downward pressure on expenses, which doesn't help USA growth. Raising rates is a non-starter until late 2015 at the earliest. More patience becomes the new operative way of thinking.  But we still need a new catalyst for growth in the USA!  Something has to come out of congress that is positive for growth.  Low rates, low energy help, but there needs to be a new picture that emerges for prosperity. I'm convinced it needs to be infrastructure - of all kinds - transportation, energy distribution (electric, natural gas and hydrogen), and a more secure Internet.

Along comes India.  Cuba might have been enough of a boost to our economy, had it not been for all the other negative shots. But new hope for the world economy, including China, is going to have the taste of curry.  I love curry!  Bring it on!!  They can take up some of the slack in materials - just in time to save miners from supply destruction.  Same to be said of shipping!  

I have to say, my compass has been spinning around trying to find North since 3Q 2014.  And, I'm still working this out in my head.  My investing starts with a macro-picture, so I've been having a very hard time lately with my compass spinning around looking for north.   Frankly, if I had just followed the plan that I blogged about months ago and gone to mostly cash, I'd be a lot happier at this moment. Costly lessons, hopefully learned!  At least it might be said that equities are looking more reasonably priced at this point.  That is unless you think we're entering a bear market.  

Do we need more capitulation before there is a massive turn?  Or is there a lot more pain to come first?  Couldn't tell you.  Only the market can answer that for sure.  Gotta love the intelligence of markets and chaos!  That's one of the things I love most about capitalism.

It appears tensions are building in the bond market for some sort of big turn.  It seems to me that another long super cycle of debt is coming to a head.  The sub-prime and US mortgage debt bust triggered the last financial crisis, and the solutions for that bought some time, while simultaneously contributing to the much greater super cycle of sovereign debt - national debt.  While the last crisis started in the USA, where we had the ability to move quickly and formulate a response, the next and larger crisis begins offshore.  And by the time it arrives here the worldwide damage will already be so enormous that a USA response will be like one plane attacking King Kong or Godzilla.

Of course there must be a response.  Mankind made this problem, so mankind can fix it.  It is in our DNA to try!  Maybe QE becomes QF.  E does follow F.  So maybe easing is followed by forgiveness.   After all, what's the real difference between debt which Greece can't possibly pay back and debt it doesn't have to?  In a word - inflation.  Hmmm, now isn't that the solution everyone is looking for anyway?!!

Now OR Never for Mario Draghi

With European inflation at .3% versus the 2% target, the ECB head Mario Draghi had better start using actions versus words to stimulate growth in Europe.  My belief is that he knows his rhetoric and promises have lost their effect.

But I also believe Drahgi's been looking a better means of delivering financial stimulus than the traditional sovereign debt purchases the the ECB has used thus far.  To this point, QE has just been an enabler for the governments to continue with their old ways.

Draghi has pushed politicians to make the kinds of systemic changes to the conditions that have bogged down Europe - heavy regulation, businesses burdened with workplace rules and limited by Unions to restructure in order to be more competitive.

The strong dollar against the weaker Euro is giving European businesses a strong pricing tailwind, which should help them.  And a dramatic drop in oil is leaving more money for consumers.  But ultimately, more aggressive monitory policy is needed to really get the engine revving.  Especially, now with the drag that a slowing China and Russia's collapsing economy will have on Europe.

The solution Draghi has been waiting for has come in the form of the newly elected European Union President, Juan Claude Junker.  He's got the right ideas if you ask me.  Firstly, Junker's stated number one priority is

"... getting Europe growing again and getting people back to work. "

Those words could have been delivered by any politician, but Junker thinks more like a capitalist than the socialists who have kept Europe in the grips of terrible economy for decades!  Since taking office Dec. 10, 2014, Junker has listed clear objectives including "freeing small and medium-sized businesses from red tape, to promote entrepreneurship and job creation."  He wants the commission to "focus on cutting regulation, making smarter use of existing financial resources, and making flexible use of public funds - to provide up to 300 billion Euro in additional public investment over the next three years."

Here is list of ways Junker wants this investment to be targeted:

• Infrastructure – broadband, energy networks and transport infrastructure
• Education, research and innovation
• Renewable energy and energy efficiency
• Projects to help young people find work (building on the Youth Guarantee scheme).

At a recent December press conference, Mario Drahgi announced that the ECB has just agreed to prepare "for further measures."  The pundits, and even those who initially believed in Draghi seem to have written off Draghi's comments has more of the same "talk."  I'm not so sure.  Draghi, who earned his Doctorate in Economics at MIT, is smart enough to know when time as run out on rhetoric.  Drahgi's been waiting for a man like Junker - and now he has him!  

New Year's Call

One of the things I like about New Year's day is how it causes us to forward think. 

A thesis is forming in my mind. It goes like this. Commodity deflation leads to both producer cost deflation, consumer buying power AND consumer consumption. That leads to both rising corporate profits AND inventory draw down. That leads to increased productivity, hiring, and wage inflation. Which in turn leads to work force expansion, and with that comes greater household formation. The stage is now set for a surge in larger durable orders and new home purchases. Consumer borrowing and spending increase quite a bit. The economy moves into a stronger period of back to back hirer GDP quarters. Finally, the fears of deflation are whipped around and the Fed finds sufficient reason to let interest rates gradually tick up. Stocks enjoy this.

Russia can still spoil the party. The Euro can still unravel. Both would likely happen together. If so, that would be more than markets can handle = big sell off. 

Time will tell ... It always does. As we appreciate especially on New Years.

Going on the Record for 2015

The last time I went on the record with my economic predictions was in August of this year.  It's that time ... year end ... time to look ahead to next year ... and to go on the record about what I think the macro picture will look like in 2015.   Here it goes:

Finally.  It took long enough.  But I believe 2015 is finally the year when the economy truly and undeniably breaks out.  Here's my big seven reasons why:

1. Up till now the economy did well in spite of congress.  In 2015, I think it's going to do better thanks to congress.  Look for the possibility of:
    - corporate tax reform including a means for repatriating overseas cash
    - natural gas exports and the Keystone pipeline
    - compromises on immigration with a path to citizenship
    - a way to reduce college debt
(Notice I said "possibility," not "passage.)

2. Innovations take hold across numerous industries bringing about compelling reasons to replace most everything, from cars to hips, and invest to improve your business and your life.

3. Low cost energy continues to drive USA industry.  Lower costs factors on everything, from transportation to petroleum based products, save consumers, businesses, and government an enormous amount of money which provides massive stimulus.  (The flip side of this would be the negative effects caused by an even more severe decline in oil, below $70K a barrel.  If that happens, bankruptcies and slow downs in the industries built around exploration and production, and their suppliers, which would also put a strain on investors and financial markets.  Of greater concern is the potential crisis triggered in countries such as Venezuela, Russia, Iran, etc.  How that plays out can be very risky and unsettling.  Especially with Russia already under major strain from sanctions.)

4.  Low interest rates combined with low cost steel and energy costs to make this the time to do historic levels of investment in USA roads, bridges, and rail.  We're going to need those "illegal" immigrants!  I say let them earn their citizenship by rebuilding America's infrastructure!  (It's been done before during the war!)

5. Wage growth and the work force size both jump in 2015.  This is a double dose of GDP!

6. The consumer and business confidence lead to a spending spree.  Retail comes alive - just in the (saint) nic of time!

7. HOPEFULLY the Federal Reserve stops paying interest on reserves and some of the regulation that's been discouraging banks to lend will lighten up.  Equity markets are hot enough, we need the banks to get back into the business of lending!

Need I say ... all this is good for equities!

It also goes without saying that all these ideas can go out the window at any time by some unforeseen major event.  But I learned a few years back not to speculate.  At least not about "black swains."

One Man's Ceiling Is Another Man's Floor .... Until That Other Man Take the Stairs!

With all the talk of the recent stock market highs being a bubble, I submit an alternate view.  Suppose instead that we may be about to form new support.  I think it is possible that the highs on the S & P and the Dow will turn from being a ceiling to a strong floor.

This week is not our first run at the highs, as we keep testing resistance, and once we've broken through we will no doubt test these levels from the other side.  (Old resistance becomes new support.)  If the highs hold, I can envision a chart forming a floor with strong technical support at 2000 on the S&P and 17,000 on the DOW.  Large round numbers with lots of zeroes offer a strong psychological effect - drawing you in and then holding you above.

Literally speaking, the ceiling becomes the floor once you take the stairs.  And if the animal spirits, the technicians, and traders, all start to view these historic market numbers as support, rather than resistance, this is a powerful paradigm shift.  Which would draw substantial new money into the market and squeeze out the shorts. And if volumes are good to boot, such positive market action bodes well for adding to the averages.  Focus would then shift from the fear of an imminent correction in the near term, to a renewed sense that the risk is to the upside.  Then the stage is set for a new leg up!

If this is supported with fundamentals including broad sentiment from economists, consumer & business surveys, combined with acceleration in the economy and earnings, then the ripple effects of consumer spending, CapEx, hiring, wage growth, etc. will all provide a credible basis for unseen new highs in the market - just waiting for final corroboration by the NASDAQ as it too returns to its all time record high of 5,048 reached on March 10, 2000.

And, as we shift focus from the 4Q to 2015 forward earnings, and the market starts to calculate in price multiplier expansion, there will be less justification for calling the market overpriced.  Again, corroborating the market's strength.

By the same token, some stocks have high expectations already baked into their prices, and could even pull back as the market moves higher.  Other stocks, have plenty of room to run and/or have lagged the market and are undervalued.   A classic rotation, which is healthy.  Stock pickers love markets like this!

At some point we are due for a healthy correction. Nothing to suggest that the secular bull is over, but more than the short little dips we've been having. A good 8-12% drop would shake out the loose hands and take some froth out of stocks that got ahead of themselves. There have been plenty of calls for this to happen, and it will.  But I think we get it from a higher level. I am moving to the side as we approach 2050-2090 on the S & P to let the bears have a little party. What's going to hurt most is the tax consequences from selling winners, but the opportunity to buy on this correction once it settles down will make it worth while! I definitely want to exit my losers before then because tax selling on those is going to really put them in tank!

Of course, some massive Geo-political event, such as the unraveling of the Russian economy, a new regional military action, boiling over civil unrest in Europe, or even a large consequential natural disaster such as the likes of the tsunami that brought down Fukushima, could rock the boat. But there is always a potential "Black Swan" out there and it doesn't need the stock market to tell it when to strike.

As negative as things are in Europe, the ECB has been much slower than the USA or Japan to implement major quantitative easing and monetary stimulus.  With risks of deflation and a recession looming over Europe, Mario Drahgi and the ECB are becoming increasingly dovish.  If Drahgi were to go forward with some monetary "shock & awe" to kick start inflation and the European economy, then Europe would go from being a headwind on USA GDP to a tailwind.  Put that together with a long awaited housing boom and consumers heading back into the stores and things get extremely interesting for equities!  Especially, if inflation in the USA continues to hold to its low pace.

And, once the Federal Reserve ends its asset purchases in October as scheduled, and we find that the economy can stand on its own. That will send an extremely positive message to the street!  Skeptics needs to see that the markets can withstand the punch bowl being pulled away. 

Keep in mind that we've had one of the slowest recoveries on record, so just maybe it's time for this economy to finally breakout.  And, if/when it does, the most hated stock market rally in decades may give the naysayers even more reasons to hate it.  Or, better yet, maybe the hold-outs will take the stairs and join us on the new floor!