Big Picture: Central Bank balance sheet growth accelerates YTD: Now at $21.4 trillion

A new flood of liquidity is being unleashed. Where will it go? (below is from the Bloomberg article)

Shakespeare's take on the Fed's failure to raise rates

Thus conscience does make cowards of us all,

And thus the native hue of resolution

Is sicklied o'er with the pale cast of thought,

And enterprise of great pith and moment

With this regard their currents turn awry

And lose the name of action.




(Hamlet, Act III, Scene 1)

Economist blames low capital spending on low interest rates.

In today's WSJ, we learn that economist Jason Thomas of Carlyle Group says that low interest rates are stimulating dividend increases and share buybacks at the expense of capital spending, which is expected to be negative in real terms in 2016. If he is right, then the Fed is preventing the very thing it seeks to achieve.

Here's how the article by Greg IP begins:

"One of the great mysteries of the recovery is why low interest rates have done so little to lift business investment.

"After all, that is supposed to be one of the ways monetary policy works: A lower cost of capital makes any project more viable. But what if lower interest rates are actually hurting investment by encouraging companies to pay dividends or buy back stock instead?

"That’s the theory advanced by economist Jason Thomas of private-equity giant Carlyle Group. It is at odds with conventional economics but has some intuitively appealing logic and supportive data.

"He calculates that since 2009, just after the Federal Reserve took interest rates to near zero, U.S. companies have boosted stock buybacks by 194% and dividends by 66.5%, but investment by 43%. Big energy companies have been slashing capital expenditures while boosting payouts. Even companies without the headwind of lower commodity prices are holding the line: McDonald’s Corp. and Eli Lilly & Co. are maintaining flat capital expenditures while raising dividends; Verizon Communications Inc. said it plans to trim its capital budget and has raised its dividend."

There's a great quote in the article:

Since 1976, higher-yielding stocks systematically outperform the overall market by 0.76 percentage point when inflation-adjusted interest rates fall 1 percentage point, Mr. Thomas finds. Moreover, the relationship becomes more extreme the lower rates go and the longer they stay low.

“John Bull can stand many things but he cannot stand two per cent,” Walter Bagehot, a 19th century editor of the Economist, once said, describing investors’ need for some minimum level of income.

It make sense to me.

Missing Fed gold found!

Ron Paul, Bernie Sanders and other conspiracy theorists have long suggested that the Fed has refused to audit its vaults since 1963 (?) because the gold simply isn't there. Today we saw the first pictorial evidence that Paul and Sanders are right when, in an unguarded moment, Fed Gov. Lael Brainard rested her chin in her hand.

Lincoln

Separated at birth: Russian gold reserves and Switzerland's 5000 franc bill

I recently read (WSJ, 2/23/16, C2) that demand for the CHF 1000 note, currently Switzerland's largest denomination, has been increasing as Swiss central bank rates have turned negative. This raises the fear that local depositors will soon be charged for storing their money in banks. There are now CHF 45.2 bn (US$45.7 bn) in circulation, a 17% increase in the last twelve months.

Two gnome-like parliamentarians from Zug, near Zurich zeroed in on this and proposed that the SNB also Issue CHF 5000 notes, arguing that "an individual's ability to keep wealth stockpiled in cash, and out of the reach of banks, digital payment systems or the government, is a fundamental right." (WSJ's paraphrase)

Meanwhile back in the Kremlin, Bank of Russia President Elvira Nabuillina, a Tartar and worthy scion of the Golden Horde, whom Euromoney has named Central Banker of the Year in 2015, is buying all the gold she can get her hands on. (Well, almost all) In the fourth quarter, the Bank was reportedly the world's largest single buyer of gold, and in January alone it added another 700,000 ounces ($840 mn). Russia's concern is that by holding dollars in reserve it risks having them effectively cancelled by denial of access to the international transfer system, which is the only way these ones and zeroes in the their computer have any value. It is interesting that the Zug solons also expressed concern for digital payment systems in arguing for the CHF 5000 bill. (By the way, one of the ideas discussed last year by the US authorities was to close the payment system to Russia to force them to default on their external debts, which are mainly corporate, thus strewing chaos; international creditors did not like this idea, however.)

Money is a means of exchange and a store of value. In the dollar world, both of these functions are available at the pleasure, and only at the pleasure of the Fed and the US Treasury. That is why politics worry some and "unconventional policies" worry others.

El-Erian fears doom, but hopes for the good enough

Mohammed El-Erian has just published a book, The Only Game in Town: Central Banks, Instability, and Avoiding the Next Collapse. He says the world economy is on a road heading for a "T junction," to use a British phrase. We must soon choose between the two roads. One leads to total destruction (depression, social disorder) and the other to some sort of survival. He assigns a 50% likelihood to each outcome. To achieve the latter somewhat better outcome, far-sighted, enlightened and public-spirited actions are required from our leaders. (It is unclear how he gets a 50% likelihood that this will happen. It's rather like Samuel Johnson's definition of a second marriage, "the triumph of hope over experience.")

As for the central banks, we have reached the point where a continuation of extraordinary measures (ZIRP, QE) is counterproductive, and even destructive. He goes so far as to say that apart from the emergency measures during the crisis, the central bank monetary manipulation experiment has not worked.

Yesterday my wife listened to El-Erian's hour-long interview on Tom Ashbrook's show "On Point" in the morning. She insisted I hear the replay in the evening, but I resisted as I was reading a book. I did, however, subsequently download and listen to the podcast. It is well worth hearing. It is anything but the party line.

The link: http://onpoint.wbur.org/2016/02/16/economic-market-crash-prediction


Yours truly,
Lincoln

Central bankers among the wolves

Last week Janet Yellen talked to Congress and on Monday Mario Draghi spoke to the European parliament. I happened to watch some of each on TV.

Janet Yellen probably regards her recent testimony to Congress as a low point, at least so far. Like Rodney Dangerfield, she got no respect. (“I come from a stupid family. During the Civil War my great uncle fought for the West!” – NB: I think that was said by Dangerfield, not Yellen.) Gone are the halcyon days of the representatives’ and senators’ groveling and obsequious boot-licking of Greenspan and Bernanke. The image that came to my mind was the movie scene where the caveman, or, in this case, cave-chair finds herself alone at night surrounded by a pack of hungry wolves held at bay only by the sputtering flames of a dying torch. The wolves respect the flames but not the chair, and they know the flames are dying. I was half expecting a band of loyal governors to rush into to hearing room at the last minute to rescue her, but they didn’t.

Mario Draghi looked more impressive, speaking with assuredness, surrounded by well-groomed advisors in Italian suits, until the Q&A, when the camera turned and revealed that the large parliamentary room was almost empty. Draghi gave his usual “we’ll do what it takes” and even boasted that half of the Eurozone’s growth has been from ECB actions. (The other half was, according to him, from low oil prices, leaving out government, policy, individual initiative, invention, and hard work, all of which are of no account, at least in Mario’s mind.) I couldn’t help thinking that he keeps saying he’ll do “whatever,” but in reality he does rather less than his words suggest. No doubt there are some puppet strings leading to the restraining hand of Wolfgang Schäuble, just offstage.

For several years at least, people have been reassured by the assumption that the central banks have matters under control. Now that doubt has crept in, who or what will be the new repository of hope? So far, the political leaders are AWOL and have been a long time. Nature abhors a vacuum. This has the makings of a crisis.