This is a very important week, not because of the stunningly strong US labour report on Friday, or because the dollar has begun to fight back a little, or because WTI has dropped back below US$50 again.
It is an important week because it marks the 10th anniversary of the beginning of the global financial crisis. In popular thinking the big anniversary will be September 15 2018, the 10th anniversary of the pirate ship Lehman Brothers but the starting gun went off on August 9 2007, when BNP Investment Partners froze three of its structured credit funds, explaining that the absence of liquidity for some of its sub-prime mortgage structures had evaporated and that it could therefore no longer value the funds.
What followed was a year of panic, driven by the implosion in trust in the solidity of leveraged counterparties in the money markets and with it came the end of Bear Stearns, Merrill Lynch and, ultimately, Lehman Brothers. Along the way the likes of IKB disappeared off the map and the last really big trade of the period, the ludicrously expensive acquisition of ABN AMRO by RBS and its megalomaniac CEO, Fred “The Shred” Goodwin. It also brought some terrible public market bailouts, such as Lloyds Bank absorbing the other Scottish flag carrier, the terminally toxic HBOS, or Bank of America taking over the cancerous mortgage lender Countrywide. Other great names such as Dresdner Bank were to disappear from the docket, as well as pretty much every Italian and Spanish regional bank name we’d grown up with.
Ten years on we are sitting on a construct that calls itself a financial market but that is in reality a dog’s breakfast of artificial money, manipulated interest rates, false currency parities and growth funded by debt, debt and more debt. All the while we are treated to a political elite and a fourth estate obsessed by not causing offence to anyone and therefore utterly incapable of facing up to the realities of a society living way beyond its means.
Is it over yet?
So the key question facing us is whether we are still in the financial crisis or whether we are out of it? How could Friday’s July non-farm payroll release of 209,000 jobs created against a consensus forecast of 180,000 and an upward revision of the already strong June number of 222,000 to 231,000 indicate anything other than a strong and healthy economy? Unemployment is at 4.3%, which surely signifies that all is well in the garden. Look at the Dow, it’s at over 22,000! Well, it might do if Fed Fund rates were not at 1%-1.25% and the Fed’s balance sheet were not at US$4.5trn. The patient might be breathing comfortably but what happens if one were to switch off the life-support machine?
The lack of inflation continues to be rolled out as an excuse for excessively easy monetary policy. I have argued in the past that low inflation might just as easily be seen as an effect of cheap money and if it is to be brought closer to target, that this might be achieved by raising rates while leaving reserve policy loose.
Enter, stage left, Alan Greenspan. He warns of the risks that are lurking around the corner once the central banks begin to withdraw some of the stimulus they have been showering upon us for a decade. Banks, so Greenspan says, have been overlending and the risks of this coming home to roost in a rising rate environment are increasing. He refers to a bubble in the bond markets. If Greenspan has only just noticed that, what planet has he been on for the past two or three years? Moreover, the risks are now not principally in the banking system but in the asset management space where huge swathes of questionable corporate lending is parked. Both the IMF and the IIF are looking in the same direction, cognisant of the build up of interest rate-sensitive credit risk. Although the most recent report on the subject pertains to Japan, the themes are now universal.
Expect much introspection during the coming week, the only conclusion of which can be that there is too much borrowing, too much lending and not enough by way of the productivity gains that are necessary to offset the debt pile. Thus we must conclude that the persistently low central bank rates, though justified by low inflation levels, are a sign of the fears harboured by central bankers about the effects monetary tightening might have on a debt-laden economy. This is the real elephant in the room.
Jackson Hole
This year’s Kansas City Fed-sponsored Jackson Hole Economic Symposium, which takes place August 24-26, is themed “Fostering a Dynamic Global Economy”. This comes after last year’s “ Designing Resilient Monetary Policy Framework for the Future” and “Inflation Dynamics and Monetary Policy” the year before. My guess, though, is that behind the scenes, in the bars and on the mountain trails, the conversations will be about how to liberate monetary policy decision taking from the piles of debt that have been run up since QE was launched and ZIRP and NIRP were spawned, the servicing cost of which will either kill corporate earnings and drive insolvencies or suck away ever increasing parts of governments’ fiscal revenues….or both.
Headline news over the weekend was a report in the Sunday Telegraph that tells us that the UK government is prepared to pay £36bn to Brussels in Brexit severance costs. This is a long way away from the €120bn-plus that had been bandied about in the Belgian and European capital. Exactly how this figure was arrived at escapes me but the question remains as to what the EU has been doing to adjust its own budgetary flights of fancy to the absence of the UK contribution. Even after Maggie Thatcher’s famous “We want our money back!” rebate, the UK contributes roughly 10% to the overall income pool.
Mario Draghi might have sniped over the weekend that the UK vastly underestimates the negative impact that the UK will suffer from Brexit but failing to face up to the costs for the union itself is not smart. The idea that the EU can handle the exit of the UK better than the UK itself can is not entirely true. If, as and when the ECB stops manipulating the euro to the lowest possible level – another synthetic market – German exports might dip and then, all of a sudden, many of the realities of the low productivity of the Eastern expansion might begin to rear its ugly head again. Greece remains Greece, even if it is planning to be back in the bonds market before long, and Poland, Bulgaria, Romania and others are still a long way behind producing what they’d like to be consuming.
Much thinking required this week. Have a good one, nevertheless.