Submitted by David Stockman – The Contra Corner Blog
This week brought another reason to get out of the casino, and to sell it short if you can tolerate some volatility.
On Friday the Japanese stock market ripped 6% higher and the European bourses were up 5% because their respective central bankers emitted some hints of more easing just ahead. Even the US market managed to find green for the week.
Apparently, the day traders and robo-machines think BTFD still works. But they are going to be sorely disappointed——just as they have been for nearly 700 days running.
Like the bloody trenches of World War I, the movement back and forth in “no man’s land” on the chart above has been pointless. At some juncture in the not too distant future, the stock averages are going to break this trading range, and plunge back down to earth.
In the meantime, you can’t blame the punters for trying. This week they succumbed once again to the BTFD delusion undoubtedly because the “moar money” chorus grew ever louder as Friday approached.
That baleful refrain was led this time around by no less than the posse of oligarchs and apparatchiks assembled at Davos. Thus, when Mario Draghi, the world’s most ludicrous monetary dunce, let on that there were “no limits” on how much fraudulent credit could be emitted by the ECB’s printing press, he surely spoke a frightening truism.
Yet the world largest asset gather, Larry Fink, founder of $3 trillion Black Rock, gushed with an endorsement of what was pure monetary crack pottery:
“We’ve seen over the last few years you have to trust in Mario,” Laurence Fink, chief executive officer of BlackRock Inc., said in Davos. “The market should never, as we have seen now, the market should not doubt Mario.”
That’s right. You can’t make this baloney up. As Jeffery Snider shows in a nearby post, the massive ECB exercise in QE, which has already emitted some $700 billion in printing press airballs, has had no impact at all on its ostensible targets. Namely, the generation of a burst of private borrowing in order to stimulate spending and inflation.
In fact, European bank lending has been on the flat-line for 7 years and neither the ECB’s massive LTRO of 2012 or the QE explosion during 2015 has changed this trend. That’s because Europe is at “peak debt” and has been so ever since the original single currency borrowing binge peaked in 2008 (bottom panel).
Surely, Larry Fink knows that QE has been a failure in Europe, the US and everywhere else it has been tried. To wit, when the household and business sectors are at “peak debt” central bank money printing amounts to pushing credit on a credit string. It does nothing except inflate the value of existing financial assets and provides cheap carry trade funding for speculators.
That is actually the point, of course. Contemporary central bankers function like a team of monetary wranglers, herding the retail cattle toward the asset gathers. And the latter always and everywhere manage to scalp a fee from investor portfolios being inflated by central bank action. It’s the modus operandi of our regime of bubble finance.
So the Larry Fink’s of the world have become cynical advocates for monetary policies that any half-wit can see amount to gibberish. Here is what the ECB said a year ago when it launched into it $1.4 trillion QE program:
The Governing Council took this decision in a situation in which most indicators of actual and expected inflation in the euro area had drifted towards their historical lows. As potential second-round effects on wage and price-setting threatened to adversely affect medium-term price developments, this situationrequired a forceful monetary policy response.
Asset purchases provide monetary stimulus to the economy in a context where key ECB interest rates are at their lower bound. They further ease monetary and financial conditions, making access to finance cheaper for firms and households.This tends to support investment and consumption, and ultimately contributes to a return of inflation rates towards 2%. [emphasis added]
Needless to say, the first paragraph above is errant nonsense. The idea that Europe was suffering from a dearth of inflation is essentially Keynesian newspeak. What these monetary cranks were talking about as requiring a “forceful monetary policy response” was the tiny area of relatively benign consumer inflation shown in the circle.
Even then, the 26-year average rate of consumer inflation shown above was 2.1%. By contrast, the slight relief experienced by wage earners and savers in recent months is entirely due to the great oil and commodity deflation now washing through the world economy.
Yet since the Eurozone produces virtually no fossil energy or industrial raw materials (even most of the coal is produced in Poland which is not in the euro area), it’s a wonderful thing; it results in higher real wages and more real output and wealth.
In fact, after years of deteriorating terms of trade with the rest of the world due to the China driven commodity bubble, the pendulum is swinging favorably in Europe’s direction. But its self-serving monetary central planners and financial class have managed to turn an unequivocal good into an entirely contrived problem——as in the specious claim that “potential second-round effects on wage and price-setting threatened to adversely affect medium-term price developments”.
That is gibberish. So what if stronger real wages and better purchasing power on global commodity markets result in a lower trend of nominal wages and prices in Europe. For 200 years until about 2009, most economists thought that was a very good thing.
And virtually none of them believed in “inflation targeting”, let alone a magic threshold of 2%. That was the half-baked theory of Ben Bernanke and a small posse of second rate academics like Frederic Mishkin of Columbia Business School, who published indecipherable papers in Ben’s forgettable books.
Simply put, there is no logic or empirical evidence whatsoever that supports the idea that 2.00% consumer inflation is better for economic growth and improvements in real productivity and living standards than is 1.22% or 0.02% consumer inflation.
This is just a postulate made-up from wholecloth that justifies massive central bank intrusion in the financial system and constant efforts to falsify and inflate the prices of financial assets. Since the annual Davos confab has increasingly become the equivalent of an asset gathers ball, it is not uprising that it has become a loud lobby in favor of moar central bank monetary fraud.
Nor were the BOJ and ECB the only source of renewed hope for monetary ease. Davos based whispers that the Fed’s expected March raise would be taken off the table quickly flooded the canyons of Wall Street. In no time flat the dip buyers were back in force.
But let me pick out Ray Dalio for special mention in the roll call of shame. The founder of the $200 billion Bridgewater complex of hedge funds was talking his book like there was no tomorrow on the sidelines at Davos, assuring the world’s punters that Q4 is just around the corner:
“I think a move to a quantitative easing would bolster psychology,” he told CBBC’s “Squawk Box: at the so-called World Economic Forum at Davos…..This will be a negative for the economy, this market movement. The Fed should remain flexible. It’s shouldn’t be so wedded to a path……. “The risks are asymmetric on the downside, because asset prices are comparatively high at the same time there’s not an ability to ease,” he said. “That asymmetric risk exists all around the world. So every country in the world needs an easier monetary policy.”
You can listen to the whole interview if you can manage your blood pressure, but it amounts to this. Dalio’s $80 billion “All Weather” portfolio is in deep trouble because his fabled “risk parity trade” is in danger of puking big time.
So he urges the central banks to plunge into another fit of destructive money printing, and thereby keep tens of millions of ordinary savers and retirees impaled on the economic torture racks of ZIRP. Worse still, without a trace of compunction or embarrassment he urges the retail sheep back to the stock market slaughter for the bald faced reason that he needs to nix the VIX.
Let me explain. Dalio ended up a billionaire not because he created a lot of economic value added or societal wealth gains as did Bill Gates, Steve Jobs, Sam Walton or even Jeff Bezos. The latter’s stock is way over-valued, but the immense gains he has delivered to tens of millions of consumers cannot be gainsaid.
By contrast, Dalio did little more than stumble on a Wall Street gambling formula that would be absolutely bogus without the perverted “wealth effects” policies of today’s Keynesian central bankers.The turbo-charging effect of Wall Street’s fast money traders and robo-machines piling on for the ride only makes Dalio’s rent scalping even more lucrative.
They call the underlying dynamic “risk-on/risk-off” on bubblevision, but it amounts to this. In a rigged financial market in which stock and bond prices are continuously rising over time owing to systematic falsification of financial asset prices by the central banks, you can make tons of money being long. Yet there is even more megatons of windfall gains to be harvested if you add Dalio’s secret sauce, as I explained in a post a few months ago:
Indeed, never in all of history have a few ten thousand punters made so many trillions in return for so little economic value added. But what Dalio did in this context was to invent an even more efficient machine to strip-mine the Fed’s monumental largesse.
To wit, Bridgewater’s computers buy more stocks on the “rips”, when equity volatility is falling and prices are rising; and then on the “dips” they rotate funds into more bonds when equity volatility is rising and the herd is retreating to the safe haven of treasuries and other fixed income securities, thereby causing the price of the latter to rise.
In short, there is a payday in every type of short-run financial weather because Bridgewater’s computers are monetary sump pumps; they constantly purge volatility from the portfolio.
But here’s the thing. The “risk parity trade” could never exist in an honest free market.
You couldn’t create algorithms to safely pump out volatility and milk the market on alternating strokes because the regularity of the waves on which it is based are not natural; they are the handiwork a central bank that has been taken hostage by the casino gamblers.
Nor is “hostage” too strong a word. In the days of Paul Volcker and William McChesney Martin anybody who even speculated about 80 months of ZIRP would have been assigned to the William Jennings Bryan school of monetary crankery.
The occasion for these musings was the August market swoon, which was triggered by the initial financial shock waves from the fracturing Red Ponzi of China. This caused something to happen which violated the rules generated by the 29-year regime of Bubble Finance inaugurated by Alan Greenspan in October 1987 when the stock market plunged on Black Monday.
To wit, when stock prices fell by 12% during late August to the 1870 low on the S&P 500, bond prices did not surge owing to risk-off clamoring by the market herd. Accordingly, Bridgewater’s risk party portfolio became swamped with too much volatility on both the bond and equity side of Dalio’s big boat. So the algorithmic sump pumps went into over-time dumping stocks in order to drain the ship.
Consequently, Bridgewater wiped out its entire profits for the year in a few days during August. This spasmodic stock selling, in turn, pushed the casino’s plain vanilla momo chasers and robo-machines into the drink in the process. Needless to say, the capsizing Big Boats in the casino were soon firing at each other in public, but also lining-up for a full court press at the Eccles Building.
Here’s the reason. In an honest financial market in which debt is priced by the willingness of savers to forego current use of their money, there could be no “risk parity” trade because the price of stocks and bonds would not be inversely correlated. Indeed, the price of government bonds and blue chips corporates would fluctuate only modestly over time owing to secular changes in the propensity to save, but they would absolutely not vary inversely to the stock average on a short and mid-term basis.
The graph below, therefore, is a pure product of central bank driven bubble finance. The stock index rose by 11X on a trend basis over the last three decades even as national income (GDP) rose by only 3X. That yawning gap was due to the Fed’s massive financial repression which subsidized the flow of speculative capital into the stock markets.
At the same time, the yield on the 10-year treasury note dropped from 9% to 2%, meaning that the price of the risk free benchmark bond surged by order of magnitude over the period.
So risk parity really worked only because in two stroke engine fashion it deftly moved short-term trading positions back and forth along the rising trend lines of the stock and bond markets, while minimizing the setbacks owing to occasional downward price corrections in both markets.
The rub, of course, is that in an a classic world of independent economies and central banks, even Dalio’s two stroke engine would not work. That’s because in response to the egregious money printing of the Bubble Finance era—-the Fed’s balance sheet rose from $200 billion to $4.5 trillion or 22X during the last three decades—-the US dollar’s exchange rate would have collapsed, causing a surge of domestic inflation and a 1970s style crash of bond prices.
So enter the Red Ponzi of China and the linked and derivative mercantilist central banking policies of its EM supply chain and the petro-states which, on the margin, literally fueled the world’s explosive growth between 1992 and 2014
As it happened, however, in the last few months the long reign of the global money printers has begun to sprout fractures. Over on the other side of the earth in China what had become a 20-year long $4 trillion cumulative “bid” for US treasuries and other DM fixed income securities has gone serious “offers”.
This will prove to be one of the great financial pivots of history. During the course of their stupendous inflation of China’s $28 trillion Credit Ponzi, the red suzerains of Beijing bought treasuries hand over fist and thereby kept their price rising and the volatility of the world bond market falling.
To be sure, this wasn’t charity for America’s debt besotted shoppers and governments. It was done in order to peg the RMB exchange rate and thereby keep its mercantilist export machine humming and the people grateful to their beneficent communist party rulers.
But at length it became too much of a good thing because every time the Peoples Bank Of China (PBOC) bought Uncle Sam’s debt it similtaneously expanded the internal banking system and supply of RMB credit. Moreover, after Beijing launched its madcap infrastructure building campaign in response to the the 2008 financial crisis the phony construction and investment boom which ensued attracted increasing waves of hot money from abroad, thereby inflating the domestic Chinese economy to a fever pitch.
In fact, the PBOC was forced to let the RMB slowly rise against the dollar to keep its banking system from becoming a financial runaway. But the steadily rising RMB drastically accelerated the inflow of foreign capital and speculative funds into the Chinese economy, thereby filling the vaults of the PBOC to the brim at more than $4 trillion early this year compared to a few hundred billion at the turn of the century.
But these weren’t monetary reserves in any meaningful or historic sense of the term; they were the fruits of an utterly stupid mercantilist trade policy and the conversion of a naïve old man, and survivor of Mao’s depredations, to the view that communist party power could be better administered from the end of a printing press than from the barrel of a gun.
But Mr. Deng merely unleashed a Credit Monster that sucked in capital and resources from all over the globe into a domestic whirlpool of digging, building, borrowing, investing and speculation that was inherently unstable and incendiary. It was only a matter of time before this edifice of economic madness began to wobble and sway and to eventually buckle entirely.
That time came in 2015—-roughly 30 years after Mr. Deng proclaimed it is glorious to be rich. So saying, he did not have a clue that a credit swollen simulacrum of capitalism run by communist apparatchiks was a doomsday machine.
In any event, what is happening in China now amounts to the end of the risk parity trade. Because China’s state economic prison is not escape proof, it is now experiencing massive, unrelenting capital flight. That means that is will be forced to sell dollar and euro bonds and thereby choke its own banking system and domestic economy.
As we pointed out in a post earlier this week, China’s faltering industrial economy was more than evident in the 10% decline in freight volume it recorded during 2015——an outcome its has not experienced since Mr. Deng’s proclamation.
But this means its oil consumption will soon stop growing, and actually already has once you set aside its purchases for the strategic reserves’, which are now full.
Needless to say, sinking global oil demand from China and the EM means that oil prices will remain trapped in the $20s and the petro states will be forced to dump growing portions of their $7 trillion in sovereign wealth funds, driving both stock and bond markets lower.
That’s why Ray Dalio is so very afraid. It is only a matter of time before the risk parity machines and their imitators and confederates trigger a selling crescendo like that of October 1987.
But this time there can be no central bank rescue. The latter have already shot their wad—–expanding their collective balance sheet from $2 trillion in the mid-1990s to $21 trillion today.
But since the global economy has had its artificial boom and CapEx frenzy already, years of deflationary liquidation and correction lie ahead. Money printing has failed. Any effort by the central banks to double down on another $20 trillion of bond purchases would blow the world’s financial casinos sky high.
At the end of the day, the asset gathers will profoundly regret what they are clamoring for.