The Central Planning Gambit: Can Central Banks Avoid a Crash?

The Bank for International Settlements put out its annual report on June 29. It says that the recovery is driven primarily by new fiat money generated by central banks. As a result, the pricing of capital assets is badly distorted. The overall theme is Austrian, not Keynesian.

Here is the summary:

A new policy compass is needed to help the global economy step out of the shadow of the Great Financial Crisis. This will involve adjustments to the current policy mix and to policy frameworks with the aim of restoring sustainable and balanced economic growth.

The global economy has shown encouraging signs over the past year but it has not shaken off its post-crisis malaise. Despite an aggressive and broad-based search for yield, with volatility and credit spreads sinking towards historical lows, and unusually accommodative monetary conditions, investment remains weak. Debt, both private and public, continues to rise while productivity growth has extended further its long-term downward trend. There is even talk of secular stagnation. Some banks have rebuilt capital and adjusted their business models, while others have more work to do.

To return to sustainable and balanced growth, policies need to go beyond their traditional focus on the business cycle and take a longer-term perspective — one in which the financial cycle takes centre stage. They need to address head-on the structural deficiencies and resource misallocations masked by strong financial booms and revealed only in the subsequent busts. The only source of lasting prosperity is a stronger supply side. It is essential to move away from debt as the main engine of growth.

Resources have been grossly misallocated by these interventions. Chapter VI begins with the following observations:

Nearly six years after the apex of the financial crisis, the financial sector is still coping with its aftermath. Financial firms find themselves at a crossroads. Shifting attitudes towards risk in the choice of business models will influence the sector’s future profile. The speed of adjustment will be key to the financial sector again becoming a facilitator of economic growth.

The banking sector has made progress in healing its wounds, but balance sheet repair is incomplete. Even though the sector has strengthened its aggregate capital position with retained earnings, progress has not been uniform. Sustainable profitability will thus be critical to completing the job. Accordingly, many banks have adopted more conservative business models promising greater earnings stability and have partly withdrawn from capital market activities.

Looking forward, high indebtedness is the main source of banks’ vulnerability. Banks that have failed to adjust post-crisis face lingering balance sheet weaknesses from direct exposure to overindebted borrowers and the drag of debt overhang on economic recovery (Chapters III and IV). The situation is most acute in Europe, but banks there have stepped up efforts in the past year. Banks in economies less affected by the crisis but at a late financial boom phase must prepare for a slowdown and for dealing with higher non-performing assets.

Then it discusses commercial banks — they are relying on the low interest rate environment to keep submarginal borrowers afloat. This is postponing inevitable losses.

In the United States, non-performing loans tell a different story. After 2009, the country’s banking sector posted steady declines in theaggregate NPL ratio, which fell below 4% at end-2013. Coupled with robust asset growth, this suggests that the sector has madesubstantial progress in putting the crisis behind it. Persistent strains on mortgage borrowers, however, kept the NPL ratios of the two largest government-sponsored enterprises above 7% in 2013.Enforcing balance sheet repair is an important policy challenge in the euro area. The challenge has been complicated by a prolonged period of ultra-low interest rates. To the extent that low rates support wide interest margins, they provide useful respite for poorly performing banks. However, low rates also reduce the cost of – and thus encourage – forbearance, ie keeping effectively insolvent borrowers afloat in order to postpone the recognition of losses. The experience of Japan in the 1990s showed that protracted forbearance not only destabilises the banking sector directly but also acts as a drag on the supply of credit and leads to its misallocation (Chapter III). This underscores the value of the ECB’s asset quality review, which aims to expedite balance sheet repair, thus forming the basis of credible stress tests.

The holy grail of central banking is this: shrink asset bubbles without crashing the economy.

No central bank has ever accomplished this. Yet monetary central planners have big egos — they think they are the smartest people in the entire universe. Right now, they think they have the economy under their control — unemployment slowly falling, economic activity slowly improving, and consumer price inflation is nowhere in sight.

Business cycle “recovery” phases (even weak ones) can’t last forever. The question is, can they pull off their ultimate gambit?

If central banks can unwind the massive increases to their balance sheets without causing recessions, it will show that Keynesian economics works. It will be nothing short of a miracle.

Do you believe in miracles?

Bank of Canada Has More Assets Than Ever

The Bank of Canada’s balance sheet is now bigger than ever. The central bank grows fat on the debts created by Ottawa.

boc may14

The rate of growth had slowed a bit in recent months, but the latest data tells us that Governor Poloz really doesn’t know what to do other than create new money and buy stuff. This is exasperating the business cycle and driving down the price of the Canadian dollar.

The Bank of Canada’s assets are 99% Canadian government bills and bonds. Buying more of these bids up their prices and pushes interest rates lower than they would be otherwise.

The newly created money enters the capital markets, and begins distorting the market’s allocation of resources. This is the cause of business cycles.

Interestingly, rates are so low in Canada that capital is nearly free, but the Eastern economy is still a mess. According to Keynesianism, the entire country should be on the verge of Utopia.

The aggressive monetary policy was kicked off by Carney, shortly after selling off the Bank’s emergency acquisitions of the financial crisis. Poloz is continuing this policy. He is trying to juice the Canadian economy by driving down the value of the Canadian dollar, thereby increasing exports, as he told us in his April 16 rate decision. This kind of short-sighted and special-interest-serving policy is to be expected from central bankers, particularly ones who that worked Export Development Canada for more than a decade, like Poloz.

Hilariously, a few days ago the mainstream media churned out a puff piece about how Poloz is the “king” of central bankers and other central bankers want to be like him. The article presents Poloz as a really cool dude because when he says something, the Canadian dollar’s value is more greatly affected than the value of other currencies when their central bankers talk.

It never seems to occur to anyone that this is a horrible, horrible thing. It shows that the dollar is dangerously sensitive to the whims of central bankers, and that is not healthy for an economy. Uncertainty due to regulatory hazard is destructive to economic opportunity.

But of course, words are one thing, and the biggest impact on the economy emerges from the BoC’s actions — i.e. printing money. And as we can see, the Bank of Canada still going full steam ahead with that plan.

Bank of Canada’s Balance Sheet: Still Trending Higher

The Bank of Canada has somewhat arrested the rate of growth on its balance sheet. The monetary base has reached a bit of a “plateau” for now, very close to all-time highs from December 2013 ($91.045 billion on the books as of April 30 2014).

It seems Poloz is trying to follow along with the general “tapering” strategy of the Fed. In order to maintain the “boom” of this business cycle (as lame a boom as it might be), the balance sheet’s size must continue to trend higher. But the flattening of the curve means that the BoC’s purchases are slowing. This will tend to push down asset prices.

boc april14

A Billion Barrels of Bakken Oil: So What?

The headline says: “BAKKEN OIL FIELDS MARK BILLIONTH BARREL OF OIL.”

Wow, sounds impressive. But how impressive is it really?

oil consumption

The world consumes 87 million barrels of oil per day. A billion barrels of oil is merely 11.5 days worth of global oil consumption.

Well, okay, but that’s still pretty good, right? After all, 11.5 days of oil is 11.5 days of oil. But then we read:

Drillers first targeted the Bakken in Montana in 2000 and moved into North Dakota about five years later using advanced horizontal drilling and hydraulic fracturing techniques to recover oil trapped in a thin layer of dense rock nearly two miles beneath the surface.

Oh, darn.

In comparison, Alberta produces about 2.1 million barrels per day. That’s roughly a billion barrels every 16 months.

A billion barrels is just a drop in the bucket of world oil consumption, especially when you’re talking about production since 2005 and the oil is extremely challenging to actually get out of the earth.

– Read more at Yahoo News

Lessons in Secession for the Quebec Election

Separatism was a hot topic for the latest Quebec election. Quebec’s separatist party was defeated, but regardless of the outcome secession will remain one of the most important controversies underlying Canadian confederacy.

Hoppe writes:

Secession increases ethnic, linguistic, religious, and cultural diversity, while in the course of centuries of centralization hundreds of distinct cultures were stamped out.

There are also economic reasons to favor secession. Although Quebec receives transfer payments from Ottawa, these ultimately make Quebec’s economy weaker. This kind of provincial welfare creates an environment where people have stronger incentives to get money from the government (because there is more loot up for grabs), either through welfare or cronyism, rather than serving one’s fellow man in the market and truly benefiting society.

Furthermore, smaller countries have a stronger incentive to favor free trade, and reject protectionism. It is surely correct that if Quebec maintained its same economic policies post-separation, it would be a disaster for the citizens. But there would be far greater pressure to actually liberalize the economy if there was less subsidization available. Additionally, any of Quebec’s wealth that is currently sucked into the black hole of Ottawa would remain in Quebec.

It would be an advance in Canadian civilization for the country to split. But it would not be enough to stop there — there should be hundreds, or thousands of Canadas, which would create a land of amazing prosperity and happy coexistence. There can still be a “Canada” — but Canada should be a coalition of cooperating territories, not a exploitative system where some groups use Ottawa to rip off other groups.

Is the Taper a Big Lie?

(UPDATED! See below.)

The much-talked-about taper could be nothing more than a big joke. Where is the statistical evidence of the taper?

Let’s look at the last 10 years of the Federal Reserve’s balance sheet.

Here you can see all three QEs laid out nicely.

Let’s “zoom in” and look at just the last year.

 

The rate of growth briefly slowed then picked right back up. Other purchases appear to be offsetting the taper, at least so far.

Meanwhile, despite media reports and promises from European central bankers that they will inflate to prevent recession, the ECB is engaged in a deflationary policy, and has been for nearly a year.

Sometimes the official central bank statistics don’t match their words.

The Fed has been saying it will not let interest rates rise, yet at the same time it will slow its rate of purchasing assets. I don’t know how that is supposed to work, since regardless of the Federal Funds target rate, the market sets the real Federal Funds rate. Yet it almost makes sense if you assume while they might buy less crap via QE3, they will balance that with more purchases of different crap.

UPDATE: The updated Fed charts show the taper kicking in more. Unless excess reserves start to get unloaded, recession will follow. We cannot say when, but we know from business cycle theory that it is inevitable.

Did Canada’s Housing Bubble Just Get Popped?

Canada’s housing market has soared while the US market crashed.

-

Canada has the most overvalued housing market in the world:

-

The WSJ recently commented:

Canada, for example, is very open to foreign investors, which means that in an age of unprecedented global liquidity cash-rich wealthy individuals who are looking for places to park their excess funds can do so in its housing market far more easily than in Japan, with its closed system.

Now, the Canadian government is eliminating “its controversial investor Visa scheme, which has allowed waves of rich Hongkongers and mainland Chinese to immigrate since 1986.”

The story continues in The South China Morning Post:

Canada’s government has announced that it is scrapping its controversial investor visa scheme, which has allowed waves of rich Hongkongers and mainland Chinese to immigrate since 1986.

The surprise announcement was made in Finance Minister Jim Flaherty’s budget, which was delivered to parliament in Ottawa on Tuesday afternoon local time. Tens of thousands of Chinese millionaires in the queue will reportedly have their applications scrapped and their application fees returned.

The decision came less than a week after the South China Morning Post published a series of investigative reports into the controversial 28-year-old scheme.

The Post revealed how the scheme spun out of control when Canada’s Hong Kong consulate was overwhelmed by a massive influx of applications from mainland millionaires. Applications to the scheme were frozen in 2012 as a result, as immigration staff struggled to clear the backlog.

In recent years, significant progress has been made to better align the immigration system with Canada’s economic needs. The current immigrant investor program stands out as an exception to this success,” Flaherty’s budget papers said.

For decades, it has significantly undervalued Canadian permanent residence, providing a pathway to Canadian citizenship in exchange for a guaranteed loan that is significantly less than our peer countries require,” it read.

Under the scheme, would-be migrants worth a minimum of C$1.6 million (HK$11.3 million) loaned the government C$800,000 interest free for a period of five years. The simplicity and low relative cost of the risk-free scheme made it the world’s most popular wealth migration program.

A parallel investor migration scheme run by Quebec still remains open. Many Chinese migrants use the alternative scheme to get into Canada via the French-speaking province and then move elsewhere in Canada. The federal government has previously pledged to crack down on what it said was a fraudulent practice.

Flaherty also announced yesterday the scrapping of a smaller economic migration scheme for entrepreneurs.

All told, 59,000 investor applicants and 7,000 entrepreneurs will have their applications returned, Postmedia News reported. Seventy per cent of the backlog, as of last January, was Chinese, suggesting more than 46,000 mainlanders will be affected by yesterday’s announcements.

The Immigrant Investor Program, which has brought about 185,000 migrants to Canada, was instrumental in facilitating an exodus of rich Hongkongers in the wake of the 1989 Tiananmen massacre and in the run-up to the handover. More than 30,000 Hongkongers immigrated using the scheme, though SAR applications have dwindled since 1997.

The investor visa plan is truly stupid and should be eliminated. The idea of requiring loans to the government in exchange for citizenship is incredibly perverse. All money lent to the government is wasted and hurts the economy. The Chinese and Hongkongers who participated in this program could have really invested that money in productive endeavors instead. But this is a double-whammy to the Canadian economy, because to pay back those loans the Canadian state must tax its citizens, which hurts the economy even more.

But what effect will this have on Canada’s housing bubble? It will reduce demand for Canadian real estate. That obviously doesn’t help keep prices high.

Yet the really critical factor is central bank policy. The Bank of Canada is not up to date on its financial statements, but as of November it held more assets than ever. I am interested to see whether Poloz will “taper” with his American counterparts.

My intuition says that he won’t. Poloz wants to keep down the Canadian dollar and subsidize exports.  The Bank of Canada has been expanding its balance sheet since mid-2010. Canada’s M1 money supply has grown dramatically. Canada’s housing prices are high. Canada’s interest rates are low. Yield on Canadian government bonds have fallen below American bonds. Yet consumer prices are not rising quickly, so the Bank of Canada sees its policy as an epic success so far.

– Read more at zerohedge

Follow

Get every new post delivered to your Inbox.

Join 69 other followers

%d bloggers like this: