The Counter-Attack on Irrational Exuberance May Be Beginning in Merrie Olde England

Back to basics from at least one part of the Bank of England?  (LINK):

BOE Says Investors May Be Taking ‘Too Rosy’ a View of Stress 

The Bank of England said rising equity markets don’t reflect the underlying economic situation and warned that investors may be underestimating risks in the financial system. 

Gains by equities since mid-2012 “in part reflected exceptionally accommodative monetary policies by many central banks,” the BOE’s Financial Policy Committee said today in London in the minutes of its March 19 meeting. “It was also consistent with a perception among some contacts that the most significant downside risks had attenuated. But market sentiment may be taking too rosy a view of the underlying stresses.”... 

The FPC’s comments on the advance in equity markets echo remarks last month by UBS AG Chairman Axel Weber, who said the economy hasn’t kept up with investor sentiment. 

“I fear the recent rally in financial markets could be a misleading signal,” Weber, a former European Central Bank Governing Council member, said at an event in London with BOE Governor Mervyn King and Federal Reserve President Ben S. Bernanke. “We’re not really out of the woods yet.”...

They focus on the US :

“This was evident in the re-emergence of some elements of behavior in financial markets not seen since before the financial crisis, including a relaxation in some U.S. credit markets of non-price terms and increased issuance of synthetic products,” the committee said. “At this stage, they did not appear indicative of widespread exuberance in markets. But developments would need to be monitored closely.”

And on the UK.  Fractionally-reserved banking remains risky under all current proposed capital regimes:

The FPC also said that banks’ leverage ratios, a measure of their debt to equity level, would remain “very high” even after the new recommendations were met. It said there would be “little margin for error against a backdrop of low growth in the advanced economies.”

There's not a lot to argue with in the above.  Though one might quibble with Dr. Weber.  What stocks are doing is rational.  They are rising in price as the quantity of currency units in which corporations do business increases rapidly.  The major risk to this market view is that these currency units are debt-based.  Their underlying value is based on confidence, which can change.

Unfortunately, this statement out of the MPC comes in March 2013, not March 2009.  And it's a bit of a damp squib for any dreamer who thinks there's any near-term hope of a seriously sound, unleveraged financial system.  But better late that they say this than never.

Evidence of Slowing Growth Momentum

Bloomberg.com has 3 articles on its front page pointing in the same direction of decline in the rate of growth, which is generally not good for stock prices:

U.S. Trade Deals Falter as Unemployment, Democrats Mute Obama;

Credit-Default Swaps Rising to Five-Week High ;

Stocks, Commodities Fall as China Curbs Lending; Dollar Rises.

Then you have what has become the typical incoherence out of Washington with the following two offsetting headlines:

Senate Democrats Said to Consider $80 Billion Jobs Legislation

Obama to Call for Three-Year Freeze on Some Federal Spending.

In addition, BB reports a marginal GDP change in Britain for Q4 last year:

Jan. 26 (Bloomberg) -- The U.K. economy resumed growth by less than economists forecast in the fourth quarter as service industries and manufacturing expanded just enough to pull Britain out of its longest recession on record.

Gross domestic product rose 0.1 percent from the third quarter, the Office for National Statistics said today in London. The median forecast in a Bloomberg News survey of 33 economists was for a 0.4 percent increase and the lowest prediction was for a result of 0.2 percent. . .

“It’s clearly disappointing,” Simon Hayes, chief U.K. economist at Barclays Capital and a former Bank of England official, said in a telephone interview. “The recovery is going to be uneven. I think the Bank of England will halt quantitative easing in February, but if we don’t see sustained growth it’s likely we may see them extend it in the middle of the year.” . . .

The recession, which lasted for six consecutive quarters, has shaved 6 percent off GDP, the statistics office said. The economy shrank 4.8 percent in 2009, the biggest annual drop since records began in 1949, officials said.

The economy contracted 3.2 percent from a year earlier in the fourth quarter, compared with a median decline of 3 percent forecast in a Bloomberg News survey of 30 economists.

The evidence is growing that in the developed countries, we have reach a period where simply fiddling with the cost and quantity of borrowed funds is not enough to have a big effect on the economy. It now takes special giveaways such as were embodied in cash-for-clunkers and a first-time home buyers credit to goose sales; but these largely simply bring demand forward.

I do not believe that the credit crisis is finished.

Those who cheerlead for Ben Bernanke should consider the following analogy.

Dr. Bernanke committed malpractice by not treating the risk factors for an economic heart attack, instead encouraging the patient to smoke and eat rich, sugary foods. He did not order an angiogram when angioplasty or a bypass might have prevented a heart attack. When the heart attack arrived, he was part of a team that threw everything modern medicine had, and the patient suffered a cardiac arrest as part of the event but survived. The patient is now engaged in a prolonged recovery with uncertain prospects and has resumed his bad lifestyle habits, having resumed smoking and eating the wrong foods, without the doctor's opposition. The doctor is continuing intravenous therapy long after the event, which is a sign of weakness in the patient's condition.

Meanwhile, on CNBC today, the commentators were dismissive of the opposition to the doctor staying on the case. "Fringe" was Joe Kernan's characterization of the opposition.

It's time for a change at the Fed. It's also time for a true Straight Talk Express to advise the American people that an equity culture trumps a credit-based one. The focus needs to be on a truly sustainable economy.

As the above Bloomberg headlines demonstrate, monetary policy cuts both ways. It in fact may be in the government's interest for stocks to fall so that people get scared and rush to the "safety" of Federal debt so that the massive deficits can continue to be financed cheaply, a la Japan (which is on its way to be rated not much above California if above it at all).

These are truly unprecedented times, with the over 400-year old Bank of England having its lowest borrowing rates in its entire history (see EBR's 1694 and all that from one year ago).

Thus the past is an uncertain guide to the future. As with a frail patient, even a small gust of wind can cause a fall.

Thus the emphasis at EBR on high-quality assets.

Copyright (C) Long Lake LLC 2010

Ouptut Gap? No, Common Sense Gap

Bloomberg.com is reporting that the Bank of England just can't stand some unused industrial capacity in BOE Stoking ‘Boom’ to Retrieve Lost Output, Citigroup Says:

Bank of England Governor Mervyn King said in London today he has an “open mind” on whether a 200 billion-pound ($332 billion) bond-purchase plan should be expanded, signaling officials aren’t ready to withdraw stimulus even as the economy recovers. Saunders (a Citigroup economist) says International Monetary Fund figures indicate the so-called output gap will close by the end of 2012 if the Bank of England’s new forecasts are correct.

The Bank of England said in its quarterly Inflation Report that it expects growth to reach around 4 percent in late 2010 and early 2011 if rates rise as investors expect. It took seven years for the economy to recover from the two previous recessions, Citigroup says.

“These are the strongest growth forecasts the MPC has ever published and far above consensus,” Saunders said. “The Inflation Report emphasizes the extent of the Monetary Policy Committee’s commitment to a reflationary bias.”

The output gap is a measure of the difference between the actual production of an economy and the capacity it could achieve based on its full potential. (Emph. added)

The idea of an output gap is beyond silly. There is a four-burner stove plus an oven in my kitchen. Presumably I should be cooking more foods. There is room for far more than two people in my house. Perhaps we should adopt?

When the horseless carriage started coming into fashion, there was likely spare capacity at carriage manufacturers and the like.

Sometimes homes, toasters, computers, oil, guns, etc. just get overproduced and spare capacity needs to be retired rather than utilized. The sort of output gap that needs to be filled is of new, better technologies. Think building factories to make semiconductors, Internet switching stations, etc. This is called new investment with a strong return on invested capital.

I have no idea if the policy makers in charge at the BofE and Team Obama/Team Bernanke are unimaginative, in thrall to various industries, or something else.

I just wish they would stick to traditional central banking, and to avoid central planning. I thought that the free market side won the Cold War.

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Bank of England Loves Inflation

This is a bit scary from the Bank of England today:

In the light of the Committee’s latest Inflation Report projections and in order to keep inflation on track to meet the 2% inflation target over the medium term, the Committee judged that maintaining Bank Rate at 0.5% was appropriate. In the light of that outlook, the Committee also agreed that it should extend its programme of purchases of government and corporate debt to a total of £175 billion, financed by the issuance of central bank reserves. The Committee expects the announced programme to take another three months to complete. The scale of the programme will be kept under review.

The Committee noted that the increase in the scale of the programme would necessitate an increase in the range of maturities of government debt that the Bank was willing to purchase. That is explained in an accompanying market notice.

It's news to me that the BofE, and therefore likely the Fed, is so committed to non-deflation that it will print money--debasing the currency-- at a time when inflation was 1.8% (per the statement). Does anyone really think that in a large complex economy such as Britain's, it is possible to measure the inflation rate with such great precision? Worse, what's wrong with letting savers actually have a positive return on their savings?

The Bank of England should stop manipulating interest rates to pump up the credit bubble again, and so should the Fed.

Copyright (C) Long Lake LLC 2009

Uninspiring Stability Breaking Out All Over?

We reported very recently that a GE Vice President reported no green shoots hanging around GE's neighborhood. Yesterday, Warren Buffett gave an interview to GE's subsidiary network CNBC stating that he receives daily updates on about 70 businesses, that the economy in the U. S. is in "shambles", and that there is no economic improvement visible. He did express optimism that on a 10-year basis, the stock market will beat the Treasury bond market. Uncle Warren said he has NO fear of deflation, just inflation on a 2-year horizon and beyond.

EBR believes that Mr. Buffett is making the wrong comparison between stocks and Treasury bonds. One buys Treasuries for security, not to "beat" stocks. The correct comparison is between stocks and corporate bonds. On that basis, corporate bonds are strong competition for stocks on a risk-reward basis.

Further in the anti-green shoots meme, we can point to Mervyn King, head of the Bank of England, who is bearish on the U. K. economy; the American Automobile Association, which has downgraded its estimate of the number of drivers to hit the roads this season; Johnson Redbook, which recorded below expectation retail sales, and others. On the other hand, Nouriel Roubini appears to grudgingly accept that matters are "stabilizing". For him, that's wildly bullish. And of course, the ECRI has "pounded the table" that recovery is certain this summer.

I feel like a religious agnostic. I can believe that all points of view and predictions are correct, but just not all at the same time. Inflation? For sure, but when. Bonds: they make sense with slack in the economy and perhaps chastened consumers for years to come. Cash: sounds good; keeps your powder dry to jump in the correct direction. Gold: for sure, but too many true believers have kept it churning. Stocks: primarily as income vehicles to compete with cash; and, the right tech stocks, which sat out the last cycle, are due to have their day.

One good rule of life: the future is more like today and yesterday than one thinks. If GE, Berkshire Hathaway and the Bank of England see no green shoots growing, why should tomorrow suddenly burst out with wild and crazy growth or sudden inflation? Anything is possible, but I wouldn't bet on it.

Copyright (C) Long Lake LLC 2009

Looking for Good Sense in All the Wrong Places

It appears to be back to the 1960s and 1970s in Britain, laboring under the delusion that printing money can revive prosperity more than briefly, as noted tonight on Bloomberg.com in King’s BOE May Keep Up Money-Printing Plan as Economy Revives. Here is the opening of the article:

The Bank of England may keep up the pace of bond purchases today as officials weigh whether they are already printing enough money to revive the British economy. (Emph. added: hard to believe people are saying this sort of stuff.)

Governor Mervyn King’s forecasts last month showed it needs to spend 125 billion pounds ($207 billion) of newly printed money in U.K. debt markets to fight off the recession.

In the U. S., you have Mish leading me to this "marvelous" quote from MarketWatch in It's your problem, Bernanke tells Congress:

For its part, the Fed also faces having to make some tough choices. The U.S. central bank has lowered interest rates substantially and has expanded its balance sheet by about $1.2 trillion, effectively flooding the banking system with cash to keep the economy from collapse.

Once the economy can stand on its own, all that cash will have to be drained away.

Everyone knows this and accepts it in principle -- but in practice, it will come down to knowing when to let go.

DoctoRx here. Where does MarketWatch acquire the right to assert that "everyone" accepts "it" in principle? Forgetting the grammatical question of what "it" precisely refers to, I for one disagree that "cash" was in fact infused into the banking system or any other system. Credit hardly cash, and the wholesale granting of credit by the Fed to insolvent, poorly run companies was a mistake. Also, the lowering of consumer interest rates to virtually zero is unfair and another mistake, as it encourages speculation.

In interpreting the above, please remember that the Bank of Japan has not prevented chronic deflation and recurrent recessions despite buying massive amounts of Japanese Government bonds. The more our and the British Governments demonstrate both incompetence and unfair favoritism toward bankers, more and more people will lose faith in the future and may emulate the Japanese people and become more and more desirous of preserving their capital in the bank.

Copyright (C) Long Lake LLC 2009

Oh! Darling

March 3 (Bloomberg) -- Chancellor of the Exchequer Alistair Darling suggested the Bank of England could start printing money as soon as this week to help revive the economy as interest rates lose their potency.

DoctoRx here.  The "We are Japan" hypothesis is now ratified.  Presumably the Fed and Treasury will come clean about printing money in the U.S. as well.

The only reason to print money is because there is not enough economic vitality for a natural recovery to occur.

Short-term, gold is selling off in the pattern of this bear market, where it shows relative strength but then dives as the selling climaxes.  Yet it retains a strong long-term chart pattern.  So do Treasuries, but now that the money-printing policy has officially begun, I would want to be a seller into strength of longer-dated Treasuries.  

The stock market is, for now, irrelevant in the face of more important matters.  Barack Obama and Ben Bernanke- the current Masters of the (financial) Universe, have more important issues.  They are fighting for the Hamiltonian principle of banking uber alles.

Copyright (C) Long Lake LLC 2009

 

Alma Mater: There Will Always Be an England

Alma Mater: From the Latin, "fostering mother".

Charles Bean, Deputy Governor for Monetary Policy at the Bank of England, spoke today at the National Farmers' Union Conference in Birmingham on 'The Economic Outlook'.

When one reads this, one thinks: only a Brit could speak so beautifully about this crisis.

The BOE tries to be upbeat, though it manages to spit out on page 6 that the risks to their sanguine outlook are weighted 3 to 1 to the downside.

One asks, why not pick a "central" forecast that weights the risks at least evenly to the upside vs. the downside. Or, since this is the crisis of the era, why not be conservative and come up with a forecast where one can state that this forecast is nearly a worst case scenario, so don't worry chaps, all shall be well and all manner of things shall be well, each in its season?

In any case, the document is in PDF form and cannot be easily copied. The document reads easily; there are easily-digestible graphs at the end.

It feels fitting to end the President's Day blogging by referring to the country for which George Washington fought in the 1760's and which he fought against in subsequent decades, and with which he then was an important part of reconciliation.

Time heals many wounds.

Copyright (C) Long Lake LLC 2009

UK and US Play Leapfrog in Making New Mistakes

Per Bloomberg.com:

U.K. to Announce Mortgage, Loan Guarantees to Encourage Lending

" . . . the government will offer to swap its preference shares for ordinary shares to give the banks more cash, according to the Sunday Telegraph. This may lead to the government increasing its holding to 70 percent in Royal Bank of Scotland Group Plc and 50 percent in Lloyds Banking Group, the newspaper said."

DoctoRx here: If you were a British financial institution, how would you like to depend on a fair playing field when you are competing with giant institutions in which your Government owned a controlling interest not just in preference stock but the common stock?

"The Treasury is offering to ditch its preference shares because it is concerned they are choking banks preventing them from lending. Royal Bank of Scotland Group, Lloyds and HBOS Plc agreed to pay a dividend of about 12 percent as part of the government bailout, eight times the Bank of England’s benchmark lending rate."

DoctoRx again. The banks can't lend because they are insolvent. Also, the economy is imploding. Those who are safe to lend to don't need to borrow, because they are also hoarding cash.

I would also note that unlike in the U.S., at least the Brits extracted a punitive lending rate for saving the banks (as prescribed many years ago by Mr. Bagehot).

The Brits appear to be leapfrogging the U.S. by going to common stock ownership. All this is for the wrong cause. The cause should be to discourage borrowing and encouraging true ownership.
An ownership society is a good thing. These Governmental contortions, extortions, and distortions are not only unseemly but miss the mark.

Copyright (C) Long Lake LLC