domingo, 3 de mayo de 2015

domingo, mayo 03, 2015

Quasi-Capitalism and Crowded Trades

Doug Nolan

Friday, May 1, 2015

May 1 – Reuters (Jamie McGeever): “The calm on global financial markets masks a growing threat to their smooth functioning should shrinking liquidity morph into an outright crunch in response to a U.S. interest rate rise or some other shock. The price of German 10-year government bonds plunged this week, triggering the biggest rise in yield in over two years.
 
Some analysts blamed the sell-off on a lack of liquidity, with Commerzbank going so far as to call it a ‘flash crash’… Liquidity is an amorphous concept and impossible to measure accurately. Its scarcity is only exposed in times of crisis. But everyone agrees it is shrinking, and this could dramatically push up the cost of trading, widen bid-ask spreads and make it harder for traders to close out positions. As long as asset prices are rising, as most are thanks to super-easy global monetary policy, this isn't a problem. But it will be if there is a sudden reversal and traders are forced to offload assets only to discover there are no buyers.”

It was yet another week replete with Bubble Dynamics, indications of fragility and heightened market liquidity worries. There was more disappointing economic data, especially considering the extraordinary monetary and market backdrops. Festering social instability has again bubbled to the surface. And Dr. Bernanke was out defending his record/doctrine, this time taking a shot at The Wall Street Journal. All in all, there was again ample confirmation of the global government finance Bubble thesis.

In a December 2001 CBB, I introduced “Financial Arbitrage Capitalism.” This was an update of the great Hyman Minsky’s “stages of development of capitalistic finance”:

“To garner better understanding as to the causes and ramifications of recent financial and economic turmoil it is helpful to contemplate the nature of dominant financial entrepreneurs, institutions, relations and structures. Minsky saw in capitalist economies ‘at least four models of the structure of relations among business, households and finance… Although all four coexist in advanced capitalistic economies, they can be viewed as stages in the development of capitalist finance. These are (1) commercial, (2) financial (3) managerial and (4) money market capitalism. These stages are related to what is financed and who does the proximate financing.’”

In that same 2001 post, I noted a piece from The Wall Street Journal (Greg Ip and Jacob Schlesinger), “Did Greenspan Push US High-Tech Optimism Too Far?”:

“The article addressed a central issue: ‘The Fed’s growth debate amounts to an argument over what kind of economy America can look forward to once the recession ends: one of rapidly rising living standards, low inflation, low interest rates, and federal budgets in reasonable balance – like that in most of the 1950s and 1960s – or a much-less-robust version.’”

Thirteen years have passed and by now it seems the answer is rather obvious. Yet this critical debate is anything but resolved. Actually, as the issue becomes more acute the discussion turns only more muddled. Dr. Bernanke deflects responsibility for the boom and bust, the crisis and the weak and unbalanced recovery. He instead credits monetary policy for being “the only game in town.” I am again reminded of a central theme from “When Money Dies: The Nightmare of Deficit Spending, Devaluation, and Hyperinflation in Weimar Germany:” Weimar central bankers would not accept that their policies were the overriding problem. 


Rather, they believed they were responding to outside forces. Their responses only got bigger.

Key facets of Minskian analysis remain pertinent today: “Financial structure is a central determinant of the behavior of a capitalist economy.” There is a critical role played by the evolution of financial structures and institutions - and their effects on economic structure and performance. As they say, “You are what you eat”. An economy is how its Financial Sphere lends, invests and speculates. Monetary inflation is the root cause of disease, and I’ve been pounding on my Analytical Framework of late as the global system approaches a major inflection point.

In my terminology, economic prospects are only as favorable as the underlying finance is sound. After the bursting of the nineties “tech” Bubble, central bankers responded to stagnation by pushing monetary inflation even harder. The results were predictable: Only greater distortions to market incentives – more leverage, more financial speculation and an explosion of high-risk mortgage securities and derivatives.

The historic boom in high-risk debt issuance and leveraging - “Financial Arbitrage Capitalism” – played a prevailing role in economic development throughout the boom period. Today’s confluence of secular stagnation, unending extreme monetary measures and unstable global Bubble markets has its roots in nineties financial innovation and excess. And the more conspicuous policy shortcomings have turned, the more entrenched central bankers have become to a dangerously flawed inflationary doctrine.

The critical issue is neither inflation nor deflation. To be clear, the rapid expansion of non-productive Credit, speculative leveraging, risk-market distortions, Bubbles and attendant resource misallocation and wealth redistribution are the predominant risks. Deeply flawed monetary management is directly culpable – and has been for better than two decades.

I began chronicling the “global government finance Bubble” in 2009. In 2013, I again updated Minky’s “stages.” “Financial Arbitrage Capitalism” had been supplanted by “Government Finance Quasi-Capitalism (GFQC).”

From August 17, 2013 CBB: “The government now essentially determines market yields throughout the entire Credit system. The government now basically insures system mortgage Credit and sets mortgage borrowing costs. Massive federal deficits and low Fed-dictated borrowing costs sustain inflated corporate earnings and cash-flows. The Fed has come to believe it is within its mandate to inflate securities and asset prices. It has crushed returns on saving instruments. Amazingly, the Fed believes it is within its mandate to dictate that savers flee the safety of deposits and other “money” for the risk markets. “Government Finance Quasi-Capitalism” exacerbates fragilities. It fosters ongoing Credit excesses including a historic expansion of non-productive government debt. GFQC and the resulting flow of finance exacerbate imbalances and economic maladjustment. Accordingly, resulting financial and economic fragilities ensure an even bigger role for Washington in the real economy and for the Federal Reserve in the financial markets.”

I stick by this analysis. Appreciation of the ongoing evolution of finance, financial players, financial structures and financial/monetary policies has become critical. It’s a feeble debate that fixates on the timing of Fed “liftoff.” Of course, conventional analysis sees things conventionally bullish. My analytical framework sees unstable “money” and Credit, unstable financial structures and weak economic underpinnings, with desperate monetary policy on a global basis trying to ward off mounting systemic vulnerability.

A few “Government Finance Bubble Quasi-Capitalism” tenets are in order: After unprecedented “money” printing and market liquidity injections, it will not be possible for central bankers to extricate themselves from the Bubbles they’ve instigated. Government policies targeting higher securities prices are pro-market Bubbles; pro-resource misallocation; pro-wealth inequality; pro-economic imbalances and stagnation; and pro-social tension. Since Bubbles and wealth redistributions now thrive on an unprecedented global scale, the backdrop is exceptionally pro-geopolitical instability and risk. In a world of complexities, inconsistencies and contradictions, I believe this framework is especially germane.

I would strongly argue that Fragility and Illiquidity are integral and interminable to GFQC. 


Central bankers have inflated securities markets through the purchase of Trillions of sovereign debt, bonds and stocks. They have pledged liquid markets. Central banks have incentivized the flow of Trillions into global securities markets. Monetary policy has incentivized Trillions of leveraged speculation on a global basis. Government stimulus and market backstopping policies have been fundamental to a flourishing derivatives “insurance” marketplace.

GFQC has directly fostered a massive expansion of the global pool of trend-following and performance-chasing finance. At this point, a sustained bout of risk aversion would confront a dearth of buyers. Liquidity risks have become structural. This ensures that bolstering markets prevails as a policy priority even in the face of booming stocks and bonds. This only works to further distort securities markets, exacerbating the dominance of “Financial Sphere” returns over “Real Economy Sphere” profits.

The upshot is a further widening of the historic divergence between inflating securities markets and deflating real economy prospects. Moreover, the massive global pool of speculative finance has turned progressively unwieldy, held in check by extreme policy measures that perpetuate risk-taking and “bull market” confidence.

GFQC has fomented a problematic “Crowded Trade” dilemma on a global basis. There is way, way too much “money” (and leverage) chasing speculative securities and derivative market returns. This creates intractable stability issues that again raised their head this week. Crowding has altered the game of financial speculation.

Fundamentally, “Crowded Trades” Change the Risk vs. Reward Calculus. Too much “money” chasing limited returns ensures that opportunities are quick to disappear. Meanwhile, a potential Crowd rush for the exits equates to major liquidity risk. Sophisticated market operators well appreciate this dynamic. Yet surviving a prolonged Bubble backdrop entails joining the Crowd and the performance chase. For most professionals, not participating is not an option. These are all textbook elements for a financial crash – though central bankers have apparently banished panics and market dislocation.

The global leveraged speculating community has struggled for performance over recent years. I have posited that this creates susceptibility to market losses spurring redemptions and a self-reinforcing risk-off dynamic. Notably, the savior Mario Draghi’s QE/euro devaluation provided a huge boost to speculative returns. Ongoing BOJ QE and Fed Ultra-Dovisness have also supported the speculator community. More recently, fiscal and monetary stimulus out of China has provided major underpinning for global speculation.

A prolonged period of unabating policy moves has solidified the view of limitless measures available to sustain global market booms. I’ll throw out a counter-view: Highly speculative markets are again approaching a critical juncture. For the most part, “developed” policy rates are near zero, while Trillions of “developed” sovereign debt yield near or less than nothing. 


Furthermore, global markets have now largely priced in ongoing loose monetary policy.

Global markets now react with blistering speed. It took seemingly no time for European sovereign yields to collapse to historic lows. The euro sank from about 1.40 to 1.05 (vs. $) in ten months. European stocks surged almost 50% in six months. Notably, prospects for aggressive fiscal and monetary stimulus spurred a spectacular 90% six-month gain in the Shanghai Composite. Where is the next big move?

Wednesday was an intriguing session in the markets. In the face of weaker-than-expected Q1 GDP (0.2%), Treasury yields jumped to a six-week high. U.S. bond yields followed the big reversal in German bunds, and somewhat less dramatic jumps in European and Japanese sovereign yields.

Curiously, Treasury yields rose this week in the face of unstable equity markets. The dollar was also under pressure. Biotech stocks were slammed. Higher-yielding stocks were being sold. So-called “defensive” stocks were underperforming. Small caps were underperforming. Meanwhile, many heavily shorted stocks and sectors were outperforming. Copper surged 6.4%, as an almost 2% gain in the Goldman Sachs Commodities Index boosted 2015 gains to 6.1%. In short, Crowded Trades were causing a bit of angst. I’m not so sure Friday’s equity market rally rectified the situation.

Global bond markets are fully priced for QE and disinflation forever. This historic Bubble – with all the unknown leverage and unappreciated risks to sophisticated and unsophisticated alike – now confronts a major risk: China.

Chinese officials were too slow and timid in efforts to rein in their runaway Bubble. “Terminal Phase” excesses have been accommodated to the point where massive fiscal and monetary stimulus will surely be forthcoming. This creates major uncertainty for the global pricing backdrop – for commodities, for things and for bonds. And with even signs of life in Europe, there’s now a catalyst for a potential upside surprise in inflation “psychology”. As such, the risk vs. reward calculus for the Crowded global deflation bond trade is turning unattractive. Moreover, Treasuries - and government bonds generally – are losing their appeal as a reliable hedge against market risk.

Government finance has made such a mess of things. Global bonds have become a historic Crowded Trade. Long dollar (short euro, yen, commodity currencies, EM, etc.) is a huge Crowded Trade. If a Chinese move toward massive stimulus (in concert with ultra-loose policies everywhere) does begin to weigh on global bond markets, what might this mean for the currencies Crowd? How vulnerable is the dollar to a self-reinforcing decline, the mirror image of the king dollar melt-up. What would this mean to the Crowded commodities short trade? Commodities and commodity currencies have been trading more bullishly.

The unwind of the Crowded post-crisis Global Reflation Trade had potential to be quite destabilizing. For the most part, instability was held in check by zero rates; open-ended QE and a flood of global liquidity; and a seemingly indefatigable Chinese Bubble. Aggressive QE and devaluation from Draghi and Kuroda helped mobilize king dollar. This spurred a rush to establish positions short commodity-related and leveraged long bonds and stocks – the Global Deflation Trade. Throughout it all, the outcome was only more global speculative leveraging.

A buyer of 10-year German bunds last Friday was willing to accept an annual yield of 15 bps. That same buyer lost 210 bps of principal on those bonds this week, as yields surged 22 bps. At this point, I’ll assume most global “bond” investors have forgotten how quickly losses can be incurred. This week saw French yields surge 23 bps to 0.65%. UK bond yields jumped 19 bps this week to 1.84%. Japanese JGB yields rose seven bps to a five-week high 0.36%. Ten-year Treasury yields jumped 21 bps to a seven-week high 2.12%. Long-bond yields surged 22 bps to near four-month highs.

I won’t get too carried away by a one-week reversal in global bond yields and some recent outperformance by commodities and EM. But it’s worth pondering the ramifications of heightened instability for a number of Crowded Trades. It’s always been somewhat of a challenge to square aggressive open-ended monetary stimulus with ongoing global deflationary pressures. And just when the massive global pool of speculative finance became comfortably (heavily) overweight U.S. securities markets -American markets underperform. Government policies have spurred historic global financial flows.

There are huge unavoidable costs associated with flawed policies and flagrant inflationism. At this point, what more can policy measures do to promote additional speculative leveraging? If the answer is “perhaps not much,” then it’s worth pondering the possibility that ebullient global markets are nearing an inflection point. Liquidity issues are a serious problema.

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