The Beggar’s Opera

If we were to travel back in time and tell the inhabitants of a Mediaeval village whose windmill had burnt down and who had been cut off from their flocks all winter by the raging torrent dividing field from hut that their best means of overcoming these hardships was to bring out what few remaining stores of food and drink were left them and to indulge in a great, exhaustive feast, they would surely think us to be touched by madness.

If we had meanwhile issued our afflicted villagers with pieces of parchment, notionally ascribing to them command over all the missing goods and more, they would hardly revise their opinion of our folly since the grumbling of their bellies and nakedness of their backs would easily dispel the allure of such empty promises.

Yet, when we artful Moderns forcibly lock people in their homes, shutter their businesses, prevent their travel, and deny them the basic delights of friendship and family, we seem to imagine that we can make up for the loss by stuffing their bank accounts with monies conjured from nothingness and then enjoining them to rush out and spend them, whenever the ruling Pathocracy finally releases them from our captivity.

Australian Rules

A recent case in point was RBA Governor Philip Lowe who, this week, announced a further, vast addition to the already unprecedented levels of money creation his institution has undertaken.

Taking a cue from the Depression & Wartime Fed of Marriner S Eccles – as well as a few pointers from more contemporary Japanese central bankers – Friend Lowe proposes not just to continue with the A$100 billion already due to be pumped into the system between November and mid-April (a sum additional to the first, Covid-related slug of A$130 billion injected in the preceding eight months) but will now extend the programme by a further A$100 billion to bridge the gap between spring and autumn. Moreover, should even this effusion not be enough to peg 3-year government bonds at the desired yield of 0.1%, Mr. Lowe has avowed that he stands ready to do more.

How do we begin to get our head around such numbers? Well, note that the various governments of the ‘Lucky Country’ were a cool A$200 billion in the red during the second and third quarters of the year – a yawning gap which amounts to more than one-sixth of contemporaneous GDP and possibly as much as one-third of net private product.

And how was this mighty monetary chasm bridged? By the RBA, of course, the Bank stepping in to buy A$266bln in securities (around A$75bln of which were temporarily parked on deposit with that same, noble institution).

If we now extrapolate on towards the (currently envisaged) end-date for these ‘stimulus’ programmes, we find that – even allowing for some modest rebound in economic activity in the interim – the Reserve Bank’s provision of base money will balloon further from its long term norms of just under 5% of GDP to an unheralded 20%, the Bank’s total assets almost tripling likewise from under 9% to around 24% of annual output in the process.

As we have continued to emphasise for much of the past year, the fact that the possibilities for such monies to be put to use has been drastically curtailed throughout this largely man-made calamity – and hence that a goodly portion of these monies have piled up in people’s bank accounts in relative idleness – is no cause for complacency about what happens when the domestic dungeons are at last emptied and the erstwhile prisoners stumble, blinking, into the daylight.

Even if this rather miraculously does NOT translate into a classic, post-war inflation, it cannot be denied that an enormous transfer of resources must take place from creditors to debtors, from the private to the public sector (where support loans must be repaid or taxes levied), and from those industries denied permission to function as normal – or who suffer inordinate extra costs and inconvenience in the attempt to do so – to those which are far less radically constrained, now and in the future.

We must also note the sinister role of the central bank in both enabling and prolonging the present, unheard of degree of peacetime government coercion. Were the state to have struggled to fund its various support packages and ‘furlough’ payments by attracting private savings, its ability to recruit an army of stay-at-home, Lockdown Lotus-eaters would have been severely curtailed.

This, in turn, would have forced a much more rigorous examination of the likely costs and benefits associated with each so-called ‘non-pharmaceutical intervention’ than has ever actually taken place. By making evident the appalling cost of monomaniacal Coronaphobia, it would also likely have resulted in a swift, popular rejection of that policy’s more draconian iterations.

Just as the preceding 11 ½ years’ exercise in reinforcing the failures laid bare by the ‘Great Financial Crisis’ was carried out under the cover of ever-easier terms of finance – and hence was accompanied by ever more profound disruptions of economic and political calculation – so, too, has central bank hyperactivity greatly abetted the ongoing attempt by a largely discredited governing class to shore up its crumbling prestige and to secure its shaky grip on power by exploiting both the real – if arguably overblown – threat posed by the current epidemic and the far more imaginary one conjured up by the so-called ‘climate crisis’.

The Race to Zero

Nor has it been just the Australians who have given into this madness, of course. Across the Tasman Sea, the RBNZ has almost tripled its balance sheet in the past 12 months, taking it from a 15-year low of 30% to a modern era high 85% of GDP in a single bound.

The Antipodeans’ counterparts in the Mother Country have been every bit as bad, if not worse. In writing sufficient cheques to cover all the extra outlays of the awful technocratic Junta which rules by decree over the very home of parliamentary democracy, the Bank of England has managed to push real money supply growth up to levels not seen for at least the last 35 years and is on course to boost its balance sheet from a pre-GFC low of around 4% of GDP to an inordinate 50% – far more than double the ratio seen at any other point in the Bank’s 327 long years of existence.

Far across the storm-tossed Atlantic, meanwhile, the Bank of Canada has seen its footprint explode from ~4% of GDP to ~20% while, south of the Parallel, the Fed has sextupled its pre-Lehman size in those same relative terms to hit 35% of GDP.

Not to be outdone, that execrable, mission-creep, mandate-monger, the ECB, has gone from an already overlarge 15% of EU19 GDP to today’s 60%, with the entire ESCB burgeoning to over 90%. Testimony to the flawed nature of the entire construct, the various central banks have together expanded six times faster over their joint life than has the combined commercial bank network struggling under their misrule. Thus the central banks’ books have swollen in size from around 5% of the commercial banks’ total to today’s unhealthy 30%, with never a thought of when it might stop elbowing them progressively aside in the task of allocating the region’s credit.

As for China? Well, there the banks are effectively joined at the hip to the central bank – being subject to a long list often highly specific injunctions, exhortations, and prohibitions – so most of the action in the Middle Kingdom comes from proclamation, not the printing press.

Thus, if the PBOC itself only grew by 5% or so last year, its minions were nowhere near so reticent. If the latters’ expansion was not exactly out of the ordinary – at ‘only’ 10% of total assets – such is their already vast size that that still represented a hefty ~30% of a (suspiciously?) enlarged GDP.

All of which, of course, pales into insignificance beside the Big Daddy of Them All, the BOJ. A glance at the numbers shows that the Japanese GDP has fluctuated either side of Y550 trillion for much of the past five years, a period during which the central bank’s balance sheet has grown by 85% to jump from 70% to a mind-boggling 130% of that same national product.

We should just remind you here that central bank assets do not exactly correspond to changes in the monetary base and also re-emphasise that nor is that base mechanically ‘multiplied’ up into other aggregates in any fashion which is consistent across either jurisdictions or time. We should also repeat our frequent observation that such dramatic additions to the base as have become the norm this past decade may replace, rather than catalyse, other more commercially-driven means of creating transactional monies. To add to the confusion, the superabundance of reserves of which this hypertrophied base principally consists can even end up backing savings accounts in a world of ZIRP and NIRP and so indirectly replicate the War Bond drives of previous eras of fiscal freehandedness and consumer constraint.

The two measures – total assets and the monetary base – do, however, have the merit of being easier to track over long histories and they do provide a reliable, if sometimes overly broad gauge as to the magnitude of the central banks’ interference with voluntary economic activity.

In that light and given all the foregoing, what should we suppose remains of the concept of ‘price discovery’? What of ‘rational capital allocation’? And do we still dare talk of ‘free markets’? Quelle blague!

Dishonest money, to paraphrase the Evangelist, is the root of all evil. This much dishonest money cannot but give rise to evils on a truly awful scale.

Putting it to Work

And for those of you still beating out the funeral drumbeat of Deflation, clutching at the threadbare blanket of the as-yet modest impact on the official consumer price indices, and invoking the phantom of a lowered monetary ‘velocity’, we suggest you need to look a little more keenly about you.

After all, this is the world in which SPACs are launched with gay abandon – roughly $1bln a day so far in 2021, already outdoing the whole of 2018-19 combined and running at five times the pace of the record-beating full year of 2020.

This is the world in which LBO multiples hit a record 11.96 , a marker which also carried with it a new high debt multiple of 6.1 times EBITDA.

This is the world in which – despite street protests and a CCP crackdown in Hong Kong and the spread of coronavirus across the region – Sotheby’s contemporary art sales in Asia reached unheard-of levels while online auctions everywhere have been posting big numbers, too, in recent months.

This is a world where the annual Mecum classic car auction in Kissimmee, Florida smashed all previous records; where De Beers raised 44% more from its latest diamond ‘sight’ than during last year’s pre-epidemic equivalent; and where back-catalogue music rights, have been pushing to ever higher per-annum equivalents amid a veritable frenzy of bidding.

This is a world where there are widespread reports of sales of luxury homes rebounding strongly and even setting new highs across the globe: Dubai, Palm Beach, Wilmington, Las Vegas, Vancouver, Berlin, Seoul, Sydney – even Manhattan – being named among them.

This is a world in which many still deny that prices can undergo any appreciable rise and also one in which many of those supposedly charged with ensuring they do not are only too happy to accommodate their ascent.

It is, of course, still a world of bifurcations and large changes in relative prices and activity, too. Take the case of the US construction sector. 2020 closed out with a quarter in which residential spending was up 18.6% on the last three months of 2019 – the sector’s strongest performance in almost a decade. Non-residential, by contrast, was down 9.1% yoy – its worst showing since mid-2011 – meaning that the ratio between the latter and the former plunged an impressive 23.3% in what an Austrian might interpret as a classic, inflationary ‘shortening’ of activity.

Against this, much has been made of people’s apparently increased propensity to save and, yes, we have seen a remarkable build-up of partially idle deposits over the past year. But we must be careful not resurrect the fallacies of Bernanke’s mid-2000s ‘savings glut’ argument. As even the MMT Neanderthals are able to grasp, it is impossible to create liabilities in one place without generating the corresponding assets in another. The issue remains one of intent: of what the individual holders of those assets intend to do with them and when.

In the Eurozone, for example, households accumulated €535 billion in new deposits in the 10 months after the plague hit, while only taking out €160 billion in additional loans. Nor were non-financial corporates far behind – something which starkly highlights the contrast between the Lehman crisis and this latest period of economic disruption.

Back then, in the peak 10 months before the 2008 collapse, NFCs had borrowed €1/2 trillion gross, €430bln net, pushing their outstanding net obligation to the banks to a record €3 trillion. In these last 10 months, they have instead added €1/2 trillion to their deposit balance, saving up a net €310bln and so pushing their aggregate shortfall down to levels last seen way back in May 1999 and to half the pre-GFC peak.

Between them, the two sectors now have surplus funds at the bank of €650 billion – all of it acquired by dint of ECB largesse and governmental overspending. To complete the story of Then and Now, the ECB and its commercial bank satellites had monetized around €2.5 trillion of the Eurozone’s various government entities by the time the wheels fell off, 12 years ago: today the figure has grown to fast-approaching €6 trillion – with that intervening €3.5 trillion shift providing a neat counterpart to the private sector’s simultaneous reliquification.

Out of the Frying Pan

So what happens next? Well, if we make the rather less than bold assumption that the authorities will be in no rush to restore their finances by cutting spending and raising taxes but will instead double down on their aery schemes of restructuring vast swathes of industry and infrastructure, we can expect no absorption of the extra monies from this quarter.

To some limited extent, once the shackles are finally struck off, householders might use the surplus to reduce some of their other outstanding debts – though, so far, the evidence is that for every £1 lopped off their credit card balance, Britons are willing to contract getting on for £2 in new mortgage debt. Americans are presumably not that far behind for though they have added nothing to their total of outstanding revolving credit since the summer (having paid down a record $90-odd billion in April and May), they have not been so shy with regard to real estate loans, most recently having applied for 18% more mortgages for purchase of an average 8.5% larger dollar size than in the same week of 2020.

Ditto companies – especially those who have drawn on credit lines, the better to have them exercises than later retired by a bank grown duly cautious, or those which have some received temporary government assistance which must now be repaid. A further source of retrenchment may yet come from the inevitable rise in bankruptcies and other liquidations which will follow the ending of furlough and forbearance, given that these will probably necessitate some form of capital raising (and that not all of that will be financed by another bank, either directly or via repo, etc).

Be that as it may, the chances are elevated that the almost incomprehensible sums of ready money injected into the system at so many different locations will largely remain in being and therefore will eventually be put to use as its holders first chafe at the surplus and later start to fret that the results of their joint efforts to reduce it – namely, higher prices for goods and services – are eating into their reserves and hence that these need to be exchanged for even more goods and exchanged more rapidly, too.

We may be some way from seeing a global enactment of Mises famous analogy of the housewife and the frying pan – not least because, in many places, the pan is not on the list of the ‘essential’ goods the poor woman is permitted to buy – but it is not inconceivable that the curtain will soon go up on this Beggar’s Opera of monetary overkill.

Market Observations

Consolidation/pullback in agriculture was relatively short-lived. Remember that while most of us Westerners are fortunate enough not to have to spend large fractions of our income on staple foodstuffs, others are not so lucky. Notwithstanding that cushion, these are the items we purchase most often and hence the ones which tend to register with us most strongly.

If, to paraphrase Bonaparte’s quip about matériel and morale, ‘inflation’ is three parts money to one part perception, rising food prices usually help shape the latter.

Despite renewed or extended lockdowns, oil is trading strongly. As we know, the political winds are blowing very adversely for this sector, but demand is unlikely to tumble anywhere near as rapidly as supply may be impacted by such forces. Plus, OPEC + Russia seem to be sticking to their game-plan much more diligently than is usually the case. Through $60/bbl and $72 – even $80 – is a realistic prospect.

Rejection of the highs. Disarray among the Redditors. Was silver a spoof too far? Which is not to ignore the fact that this chart is not yet telling us that the medium term move is over. Projections to $36/oz and even $42/oz are conceivable as long as this correction doesn’t run TOO deep.

Gold, alas, has two – if not three – problems with which to contend. Risk On, rising yields, and a possible near-term low in the Greenback. Avoid until we see what happens around last November’s $1765 lows.

Say what you like about the front end of the curve, but long yields are still trending higher. 50% retracement the likelihood for the Long Bond.

Medium term targets achieved on the ‘average’ stock but impossible to rule out further, substantial gains. We old stagers get very nervous on one-way streets, all the same.

And the poster children of momentum over fundamentals in the Russell are looking particularly overstretched. How many of these stocks actually have earnings, by the way??

Trend channels are possibly THE most subjective of all chart patterns, being far too suggestive to a human brain desperate to make order out of chaos, but if Growth DOES wobble here, you could do worse than to play for a further rebalancing.

One place where even the authorities seem to have decided enough is enough is China. Hard to interpret anything until the Lunar New Year festivities are at an end, but the PBOC has seemingly been happy to allow short rates to rise into the holidays and there are scattered stories of ‘moral suasion’ being exerted to cool the overall enthusiasm. One to watch in the latter half of the month.

The US dollar has flirted with a major cyclical disaster in recent weeks – of a kind which would do wonders for generalised, global ‘reflation’ – but it has since pulled a little way back from the brink. The smart move would be to buy on the basis that the past ~6 years’ range will hold and that we therefore now rotate back towards its middle (as in the second of the next charts), but also to be prepared to reverse smartly (or to take some options protection aganst the move) if the January 2018 lows do ultimately give way.

Though we’d be far more convinced if that dollar rebound were to fizzle, note that EM currencies tend to be tightly coupled to commodity prices. If the latter can maintain their upward bent regardless of the dollar’s trajectory, EM FX should continue to prosper.