The World's Troubled Currencies

By: Steve_H_Hanke

For academics, the term "troubled currency" might be a term of art. But for people who are faced with such a currency, they know a troubled currency when they see one. Today, this is the case for millions of people around the world — most notably in Iran, North Korea, Argentina, Venezuela, Egypt and Syria.

A troubled currency is one in which users have lost confidence. When users no longer think a currency will retain its purchasing power, they attempt to dump it for a stable foreign currency (or commodities). As the demand for the troubled currency evaporates, its value vis-á-vis stable foreign currencies collapses, and prices for goods and services sold in the troubled currency soar. As this process develops, expectations about the currency’s ability to retain its purchasing power deteriorate, and a doom loop ensues. At the extreme, doom loops can culminate in hyperinflation — an inflation rate of over 50% per month. This, however, is rare. Indeed, there have only been 56 cases of hyperinflation.

Troubled Currencies in History — The Indonesian Rupiah

The Asian financial crisis of the late 1990s gave rise to several troubled currencies. The Indonesian rupiah was one currency that entered such a doom loop. On August 14, 1997, shortly after the collapse of the Thai baht, Indonesia floated the rupiah — on ill-conceived instructions from the International Monetary Fund (IMF).

Contrary to the IMF’s expectations, the rupiah did not float on a sea of tranquility. Its value plunged from 2,700 rupiahs per U.S. dollar at the time of the float to lows of nearly 16,000 rupiahs per U.S. dollar in 1998. Indonesia was caught up in the maelstrom of the Asian crisis. By late January 1998, President Suharto realized that the IMF medicine was not working and sought a second opinion. I was invited to offer that opinion and began to operate as Suharto’s Special Counselor. I proposed replacing Indonesia’s troubled rupiah with a stable rupiah anchored to an orthodox currency board system. On the day that news hit the street, the rupiah appreciated by 28% against the U.S. dollar (see the accompanying chart).

In a sense, the case of Indonesia was unique — the rupiah traded freely on the foreign exchange market, with a floating exchange rate. More often, severe currency problems arise under monetary systems that restrict the convertibility of their currency and/or employ a pegged official exchange rate that overvalues the currency. These circumstances typically give rise to a black market for foreign exchange, where the domestic currency is freely traded at a market determined exchange rate.

What’s more, the Suharto government continued to publish economic data after the rupiah became a troubled currency. In many countries with troubled currencies, however, this is not the case. Indeed, regimes in countries undergoing severe inflation have a long history of hiding the true extent of their inflationary woes. Often, governments fabricate inflation statistics to hide their economic problems. In the extreme, countries simply stop reporting inflation data. Yes, official economic data from countries with troubled currencies often amount to nothing more than lying statistics and should be treated as such.

How can this problem be overcome? At the heart of the solution is the exchange rate. If free market exchange-rate data (usually black-market data) are available, a reliable estimate of an inflation rate can be determined. The principle of purchasing power parity (PPP), which links changes in exchange rates and changes in prices, allows for reliable inflation estimates during periods of elevated inflation. Indeed, PPP simply states that the exchange rate between two countries is equal to the ratio of their relative price levels. Accordingly, to calculate the inflation rate in countries with troubled currencies, a rather straightforward application of standard, time tested economic theory is all that is required.

Troubled Currencies Today

For the past year, I have been collecting black market exchange-rate data from various countries — namely Iran, North Korea, Argentina, Venezuela, Egypt and Syria — and using them to calculate implied inflation rates. While I have published a number of articles and blogs containing information and data on countries with troubled currencies, I have come to realize that there exists no centralized location where black-market exchange-rate and inflation data can be found for such countries.

To remedy this, I established the Troubled Currencies Project — a collaboration between the Cato Institute and the Johns Hopkins University. The Troubled Currencies Project hosts a website, regularly updated with the latest black-market exchange-rate and implied inflation rate data on countries with troubled currencies. What follows is a snapshot of the countries that the Troubled Currencies Project currently studies and a more detailed explanation of the circumstances surrounding each troubled currency.

Iran

The idea for the Troubled Currencies Project arose out of Iran’s inflation crisis in the fall of 2012. The Iranian rial’s exchange rate tells the tale of the effect that Western sanctions have had on Iran’s economy. When U.S. President Barack Obama signed the Comprehensive Iran Sanctions, Accountability, and Divestment Act in July 2010, the official exchange rate for the rial to the U.S. dollar was very close to the black market rate. Since those new sanctions took effect, however, the official and black market rates have increasingly diverged (see the accompanying chart).

The sanctions began to bite especially hard in early September 2012, and the slide in the value of the rial began to accelerate. The slide was punctuated by two dramatic collapses in the demand for the Iranian currency — the first was in early September 2012, and the second occurred in mid- October 2012, when Iran’s inflation rate reached hyperinflation levels (greater than 50% per month). With each collapse, there was something akin to a ‘bank run’ on the rial — a sharp rise in the black market (read: free market) IRR/USD exchange rate.

Since then, the rial has stabilized somewhat, but inflation remains elevated. Currently, Iran’s implied annual inflation rate sits at 74.2% (see the accompanying chart).

North Korea

For years, North Korea’s currency, the won, has been officially pegged to the U.S. dollar. That said, exchange controls and a plethora of associated regulations and harsh penalties have rendered the won inconvertible. This, of course, has given rise to a healthy black market for foreign currency.

North Korea’s monetary dysfunction has been accompanied by severe inflation problems. In 2009, the North Korean government attempted to address the won’s problems by implementing a phony currency "reform" program, which it promptly bungled. The so-called reform was actually just a currency redenomination program, which arbitrarily lopped two zeros off every won note.

North Koreans were given less than two weeks to exchange all of their won for new notes. And, the government set limits on the quantity of old won a family could exchange for new won. For those North Koreans who had saved a few too many won, the redenomination program was effectively a wealth tax program.

It should come as little surprise that Pyongyang’s botched currency reform sparked a panic in North Korea’s primitive, underground markets for goods and services. With the currency reform, the demand for foreign currency accelerated, as more and more merchants in the underground markets required transactions to be conducted in hard currency. In consequence, the value of the won plummeted on the black market (see the accompanying chart).

So, what happened to the overall price level in North Korea in the wake of the currency reform? Well, black-market exchange rate data allow us to reach a reliable estimate of North Korea’s inflation rate. As the accompanying chart shows, the 2009 panic sparked an inflation surge in North Korea.

Argentina

Argentina is once again wrestling with its long-time enemy, inflation. Now, it appears history may soon repeat itself, as Argentina teeters on the verge of another currency crisis. Capital controls and a deteriorating current account balance — coupled with a number of anti-business policies — have put the squeeze on the Argentine peso (see the accompanying chart).

Currently, the peso’s black-market U.S. dollar exchange rate sits at 8.2 pesos per dollar, putting the peso’s value 34% below the official exchange rate. This yields an implied annual inflation rate of 24.8% (see the accompanying chart).

For now, the effects of this elevated inflation rate have been officially hidden by Argentina’s massive price control regime. But these price controls are not sustainable in the long term. Indeed, these short-term "lying prices" only distort economic reality, ultimately leading to scarcity.

Venezuela

Venezuela has also relied on price controls in an attempt to suppress its inflation problems, with the same miserable results. Despite the country’s oil wealth, the massive Chavez-era social spending program continues to eat into the government’s primary balance, as well as dollar denominated revenues of the state oil company, PDVSA. To fill this void, Venezuela’s central bank has been running the money pumps at full steam, eroding the value of the country’s currency, the bolivar (see the accompanying chart).

This has brought about an inflation surge — in a country which was already no stranger to high inflation. Currently, the bolivar’s black-market U.S. dollar exchange rate sits at 34.42 bolivars per dollar, putting the bolivar’s value 80.6% below the official exchange rate. This yields an implied annual inflation rate of 249.3% (see the accompanying chart).

Egypt

Under the direction of President Morsi and the Muslim Brotherhood, economic conditions in Egypt have gone from bad to worse. Price and capital controls have caused shortages and a substantial slide in the value of the Egyptian pound. In consequence, Egyptians have watched inflation destroy their standard of living. Additionally, controls have delivered shortages of foreign exchange and many goods, like gasoline. In the face of the Brotherhood’s wrongheaded economic policies, official inflation and price statistics took leave of reality, and the black market quickly became a source of material support that the Muslim Brotherhood’s government could not provide.

Yes, as the accompanying charts illustrate, the story of a failing Egyptian economy is one of a troubled Egyptian pound — and of the inflation troubles that accompanied it. Indeed, as of July 1, 2013 (shortly before Morsi’s ouster), Egypt’s implied annual inflation rate was 27.1%. That’s over three times higher than the last reported official annual inflation rate (see the accompanying charts).

Syria

Finally, we turn to Syria, where civil war and economic sanctions have shattered the country’s economy. In an attempt to beat Western sanctions and halt the fall in the Syrian pound, the Assad regime — with the help of Iran, Russia, and China — has begun conducting all of its business in rials, rubles, and renminbi. This decision supplements other existing arrangements between Syria and its allies that are keeping the Syrian economy on life-support. These include transfers of $500 million per month in oil and an unlimited credit line with Tehran for food and oil-product imports.

According to Kadri Jamil, Syria’s prime minister for the economy, this life support is necessary because Syria’s devastated economy is the target of an elaborate plot, hatched by the U.S. and Britain, to "sink the Syrian pound."

In a desperate, wrongheaded attempt to save its troubled currency, the Assad regime has imposed harsh penalties for currency trading on the black-market. This strategy proved wildly unsuccessful when it was utilized by Iran in October of 2012. Indeed, as was the case in Iran, attempts to suppress currency exchange have sparked a panic — a run on the Syrian pound. As of 10 July 2013, the value of the Syrian pound on the black market has hit an all time low, with the current black-market exchange rate now sitting at 265 SYP/USD (see the accompanying chart).

The rout of the Syrian pound has been widely reported in the press. But, Syria’s inflation problems that have accompanied the collapse of the pound have gone largely unreported. That’s because, beyond the occasional bits of anecdotal evidence, there has been nothing to report by way of reliable economic data.

To fill that void, I employ standard techniques to estimate Syrian’s current inflation — an implied annual inflation rate of 291.1% (see the accompanying chart).

Accordingly, Syria is now experiencing a monthly inflation rate of 68.0%. This means that Syria has exceeded the threshold for hyperinflation (an inflation rate of 50% per month). Only time will tell if this run on the Syrian pound will continue. But, for the time being, we can be sure that the Syrian pound will remain a troubled currency.

The Troubled Currencies Project

A casual glance at the front page of any reputable newspaper will tell you that the current set of countries with troubled currencies are those that comprise many of the main "hot spots" of international conflict. Indeed, currency problems can often be a good leading indicator of other problems with a regime. For anyone involved in or monitoring international conflicts, reliable economic intelligence is absolutely essential. The data and charts contained in this column are now available on the Troubled Currencies Project page. The page also contains the following table, which I will update regularly with the latest black-market exchange-rate and implied-inflation-rate data.

See the original article >>

Stock Market Trendline Violation

By: Anthony_Cherniawski

The hourly SPX chart now shows the lower trendline of the Ending Diagonal is broken. This is the earliest and best warning. We may see the SPX drop to or below the hourly Cycle Bottom at 1584.84 before a bounce occurs. The decline may take a couple days, but it should wipe out the entire month-long rally.

From ZeroHedge, Thanks to a total and utter collapse in new order volume (from +9 to -15 - worst in 2 years) and order backlog (-1 to -24), the Richmond Fed manufacturing survey just printed at -11 (against expectations of an exuberant +8). This is the biggest miss since May 2006. Wages plunged; the average work-week plunged; capacity utlization plunged; but on the bright-side, the number of employees was flat (at 0). Perhaps more concerning is the outlook that sees prices paid rising notably more than prices received and capacity ultization dropping notably.

VIX made a very slight throw-under beneath its lower trendline and made an unmistakable reversal. The upper trendline is at 13.50, which will confirm the change in trend. VIX just completed a 243-day Master Cycle B. However, it went 130 days in Master Cycle A, just beyond the half-cycle turn which usually falls between days 120 and 129. The VIX cycles, which had been out-of-sync with one another, are getting back in sync. By the looks of things, we may expect to see VIX peak out by mid-November.

See the original article >>

Bankers Own the World

by Chris Martenson

In every era, there are certain people and institutions that are held in the highest public regard as they embody the prevailing values of society. Not that long ago, Albert Einstein was a major public figure and was widely revered. Can you name a scientist that commands a similar presence today?

Today, some of the most celebrated individuals and institutions are ensconced within the financial industry; in banks, hedge funds, and private equity firms. Which is odd because none of these firms or individuals actually make anything, which society might point to as additive to our living standards. Instead, these financial magicians harvest value from the rest of society that has to work hard to produce real things of real value.

While the work they do is quite sophisticated and takes a lot of skill, very few of these firms direct capital to new efforts, new products, and new innovations. Instead they either trade in the secondary markets for equities, bonds, derivatives, and the like, which perform the 'service' of moving paper from one location to another while generating 'profits.' Or, in the case of banks, they create money out of thin air and lend it out – at interest of course.

Banking was conceived in iniquity and was born in sin. The bankers own the earth. Take it away from them, but leave them the power to create money, and with the flick of the pen they will create enough deposits to buy it back again. However, take away from them the power to create money, and all the great fortunes like mine will disappear, and they ought to disappear, for this would be a happier and better world to live in. But, if you wish to remain the slaves of bankers and pay the cost of your own slavery, let them continue to create money.

~ Josiah Stamp – Bank of England Chairman, 1920s

Because these institutions and individuals accumulate vast sums of money for their less-than-back-breaking efforts, they are well respected if not idolized by most. Many of the most successful paper-accumulators are household names. They get invited to the best parties, are lured by major networks to appear on their shows, speak at the biggest conferences, and their views and words find an easy path to the ears of millions.

But this is more than just an idle set of observations for the curious. It's actually a critically important phenomenon to be aware of. For the current configuration of financially powerful entities has, at the tail end of a decades-long debt-based money experiment, achieved an astonishing concentration of power, money, and influence.

We raise this topic because our work centers on changing the conversation towards the things that really matter while there is still time to engineer a better outcome, and that requires illuminating the status quo and having a conversation about whether it needs to be modified. Unfortunately, those at the center of the status quo are not at all interested in having any such conversation, because all of their accumulated power depends on maintaining things as they are.

Money is power.

And history has shown that power is never ceded spontaneously or willingly.

The Network That Runs the World

A couple of years ago, I came across a study that has stuck with me ever since and I want to share it with you. It's really important if we want to understand the likelihood of a graceful transition for our current society into a future of prosperity.

Unlike prior studies seeking to quantify the degree of concentration of wealth and influence, this study simply pored through all of the available public data to build an empirical map of the network of power. Its findings are quite startling and deserve a bit of pondering:

Revealed – the capitalist network that runs the world

Oct 2011

AS PROTESTS against financial power sweep the world this week, science may have confirmed the protesters' worst fears. An analysis of the relationships between 43,000 transnational corporations (TNCs) has identified a relatively small group of companies, mainly banks, with disproportionate power over the global economy.

(...)

Previous studies have found that a few TNCs own large chunks of the world's economy, but they included only a limited number of companies and omitted indirect ownerships, so could not say how this affected the global economy - whether it made it more or less stable, for instance.

The Zurich team can. From Orbis 2007, a database listing 37 million companies and investors worldwide, they pulled out all 43,060 TNCs and the share ownerships linking them. Then they constructed a model of which companies controlled others through shareholding networks, coupled with each company's operating revenues, to map the structure of economic power.

The work, to be published in PLoS One, revealed a core of 1318 companies with interlocking ownerships (see image). Each of the 1318 had ties to two or more other companies, and on average they were connected to 20.

What's more, although they represented 20 per cent of global operating revenues, the 1318 appeared to collectively own through their shares the majority of the world's large blue chip and manufacturing firms - the "real" economy - representing a further 60 per cent of global revenues.

When the team further untangled the web of ownership, it found much of it tracked back to a "super-entity" of 147 even more tightly knit companies - all of their ownership was held by other members of the super-entity - that controlled 40 per cent of the total wealth in the network. "In effect, less than 1 per cent of the companies were able to control 40 per cent of the entire network," says Glattfelder. Most were financial institutions. The top 20 included Barclays Bank, JPMorgan Chase & Co, and The Goldman Sachs Group.

Just 147 companies control over 40% of the wealth of the entire network of companies. It should be pointed out that such a network does not have any borders and operates on a global basis, meaning that regional analyses – such as how Germany compares with the U.S. – might be less relevant than typically portrayed.

After all, if decisions being made by a tightly knit group of companies are being made to benefit a network that has no borders, then actions by the German or U.S. governments are only a part of the story. And perhaps a minor one, compared to those made the entities that actually control the real wealth of each nation.

It wasn't that many decades ago that a list of the top companies with the most wealth and influence would have been dominated by companies that produced real, tangible products – that is, those that created wealth by adding value to goods by transforming resources into products. Companies like GE, GM, IBM, Exxon, and other industrial giants would have been the wealthiest, because, well, they create actual wealth.

Today the top fifty companies in the 'super-entity' list of 147 from the above study is concerning. Out of the fifty, 17 are banks, 31 are an assortment of investment, insurance, and financial services companies, and only 2 are non-financial companies (Walmart and China Petrochemical)

The top 50 of the 147 superconnected companies

1. Barclays plc
2. Capital Group Companies Inc (Investment Management)
3. FMR Corporation (Financial Services)
4. AXA (Investments & Life Insurance)
5. State Street Corporation (Investment Management)
6. JP Morgan Chase & Co (Bank)
7. Legal & General Group plc (Investments & Life Insurance)
8. Vanguard Group Inc (Investment Management)
9. UBS AG (Bank)
10. Merrill Lynch & Co Inc (Bank)
11. Wellington Management Co LLP (Investment Management)
12. Deutsche Bank AG (Bank)
13. Franklin Resources Inc (Investment Management)
14. Credit Suisse Group (Bank)
15. Walton Enterprises LLC
16. Bank of New York Mellon Corp (Bank)
17. Natixis (Investment Management)
18. Goldman Sachs Group Inc (Bank)
19. T Rowe Price Group Inc (Investment Management)
20. Legg Mason Inc (Investment Management)
21. Morgan Stanley (Bank)
22. Mitsubishi UFJ Financial Group Inc (Bank)
23. Northern Trust Corporation (Investment Management)
24. Société Générale (Bank)
25. Bank of America Corporation (Bank)
26. Lloyds TSB Group plc (Bank)
27. Invesco plc (Investment mgmt) 28. Allianz SE 29. TIAA (Investments & Insurance)
30. Old Mutual Public Limited Company (Investments & Insurance)
31. Aviva plc (Insurance)
32. Schroders plc (Investment Management)
33. Dodge & Cox (Investment Management)
34. Lehman Brothers Holdings Inc* (Bank)
35. Sun Life Financial Inc (Investments & Insurance)
36. Standard Life plc (Investments & Insurance)
37. CNCE
38. Nomura Holdings Inc (Investments and Financial Services)
39. The Depository Trust Company (Securities Depository)
40. Massachusetts Mutual Life Insurance
41. ING Groep NV (Bank, Investments & Insurance)
42. Brandes Investment Partners LP (Financial Services)
43. Unicredito Italiano SPA (Bank)
44. Deposit Insurance Corporation of Japan (Owns a lot of banks' shares in Japan)
45. Vereniging Aegon (Investments & Insurance)
46. BNP Paribas (Bank)
47. Affiliated Managers Group Inc (Owns stakes in 27 money management firms)
48. Resona Holdings Inc (Banking Group in Japan)
49. Capital Group International Inc (Investments and Financial Services)
50. China Petrochemical Group Company

(Source)

How is it that companies that produce nothing and only move digital representations of money from point to point now control far more wealth than the companies that actually produce the things that makes money useful at all?

Well, that's just how the system works. And this is something that nobody in power wants to talk about.

While we may decide that such as system is just, or unjust, or evil, or good, such judgments are merely the emotionally laden descriptors we might assign to a system that – by its very design – accumulates wealth from the many to the few.

This is why compound money systems have been tried and tried again, yet have never proved sustainable. Even ancient religious texts described them as requiring a Jubilee every 7 periods of 7, or 49 years. The Jubilee, of course, was a reset mechanism that wiped out the inevitable concentration of wealth so that things could start all over again with a fresh slate.

An imbalance between rich and poor is the oldest and most fatal ailment of all republics.

~ Plutarch

So it really should not be any surprise that banks, in particular – with their extraordinary power to lend money out of thin air (that's what 'fractional reserve' allows) and their unlimited-duration corporate lives – are able over time to accumulate, accumulate some more, and finally end up owning everything.

While we're not quite there yet, we are well on the way.

A few are beginning to notice the seeming unfairness of it all, such as the author of this recent article in The New Yorker:

The Problem with Record Bank Profits

July 16, 2013

What do these large dollar numbers have in common: $6.5 billion, $5.5 billion, $4.2 billion, and $1.9 billion? They represent the latest quarterly net profits made by too-big-to-fail banks—in order, JPMorgan Chase, Wells Fargo, Citigroup, and Goldman Sachs, the last of which reported its second-quarter figures before the market opened on Tuesday.

Five years after being bailed out by the federal government, the U.S. banking system hasn’t merely recovered from the financial crisis that brought it to the brink of collapse. It is generating record profits—the sorts of figures usually associated with oil giants like ExxonMobil and Royal Dutch Shell. During the past twelve months, for example, JPMorgan, the country’s biggest bank, has earned $24.4 billion in net income.

Let’s begin with trading. In the aftermath of 2008, there was much talk of banks getting back to basics, which meant concentrating on lending to businesses and households, and jettisoning many of their investment bankers, whose generously remunerated antics had helped to bring on the financial crisis. (...) In the latest quarter, Citigroup’s investment-banking arm generated more than sixty per cent of the bank’s net profits, and JPMorgan’s investment bank generated more than forty per cent of the firm’s net profits.

What exactly did JPM do to 'earn' more than $24 billion over the past 12 months? Did they build millions of appliances? Install thousands of critical power systems? Build and install high-definition CT scanners?

In fact they did none of these things, which are just three out of hundreds of accomplishments of GE, which reported a 12-month net profit of just $17 billion  while employing over 300,000 workers.

What JPM did was: trade on the markets, lend to speculators, and use its inside advantage to skim what it could off of the Fed's monthly $85 billion of free money. Not that there's anything illegal with that, but perhaps we should really be asking ourselves if this truly serves our society to anoint financial players with the privilege of walking off with the vast majority of our total national and global income.

Unsustainable Systems Ultimately End

The alarming growing wealth gap in developed nations is a predictable indicator of the obvious inequities involved in this system. Those not in the top 1% are finding themselves as modern-day feudal subjects – bound by debt or lack of property – to a global corporatocracy (corporations being the new aristocrats).

But the stability of this parasitical system begins to weaken quickly when the lifeblood it depends on begins to dry up. And that's when things can begin to go south in a hurry: a crack-up of the financial system, civil unrest, government breakdown – that kind of scary strife.

In Part II: The Indicators of Instability to Watch For, we discuss the 3 most important danger indicators to monitor. These are the areas where the cracks will first appear, and will give those watching closely advance warning to adopt extremely defensive financial, physical, and emotional positions.

The vast concentration of wealth into so few hands is creating systemic instability, and if it continues long enough, it will prove to be a fatal ailment of not just any one particular republic, but all of them.

See the original article >>

Global PMI Surveys – Mixed Signals

by Pater Tenebrarum

Weak Data Follow on the Heels of Declining Confidence, Which Follows on Slowing Money Supply Growth Rates …

We recently noted that global business confidence has declined sharply in June to a new post 2008 crisis low. The biggest declines were recorded in China, and oddly, in the US. European confidence data were weak, but showed relative improvement to earlier surveys. We assume that the ups and down in these data points are directly related to slowdown and acceleration phases in money supply growth, which are not synchronous in these regions. While US and Chinese money supply growth rates have in recent months slowed from previously very high growth rates, they have accelerated markedly in the UK and Europe from previously very low growth rates (in the UK money supply growth still recorded negative year-on-year growth in the middle of last year. It has since then moved explosively higher).

No Fun in Richmond

Promptly we now get a bit of corroboration of all this from actual economic data (even though we must stress that one should always take such 'empirical confirmations' with a big grain of salt).  US housing data for instance delivered a negative surprise, with existing home sales dipping in spite of the recent investor-driven buying frenzy.

Then the Richmond Fed's manufacturing business survey was published, showing a rather outsized disappointment, with new orders free-falling. The service sector survey wasn't all that great either, with service revenues diving (admittedly this series is quite volatile, but one cannot fail to notice the overall 'weak recovery' trend compared to the pre-crisis era):

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Richmond service sector revenues - click to enlarge.

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Richmond survey manufacturing activity – the dips are regularly more pronounced than the recoveries – click to enlarge.

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It should be pointed out that a number of other regional US surveys released last week delivered positive surprises, so one cannot just point to the Richmond data and make a mountain out of what may turn out to be a molehill. However,  monetary developments exhibit varying lead times relative to real economic developments, so it is quite possible that the slowdown in money supply growth is just beginning to be felt.

Accelerated Slowdown in China

In China the issue is perhaps not so much the fact that money supply growth is now far lower than during the heady post 2008 crash stimulus orgy, but that China's government is rumored to be rationing credit to certain industries. Apparently the goal is to starve industries which have 'overcapacity' (really: industries in which gobs of capital have been malinvested).

Whether or not there is such precise targeting of credit distribution by the planners, we know there have recently been signs of stresses in China's interbank lending markets – which have also been blamed on deliberate action on the part of the PBoC.

Overnight, the latest Markit Flash PMI for China was released, showing a further weakening of economic activity. It is important to remember here that such data tell us nothing about whether this is good or bad. If, as seems likely,  malinvested capital and the associated bubble activities are in the process of being liquidated, then the long term outlook will be improved. However, given the sheer size of bubble activities in China, this could entail very considerable short to medium term pain.

This is of course also leaving aside for the moment that we don't really trust the mandarins to get all that planning right, including the rationing of credit.

As we have always maintained over the years, China's economic success since Deng's reforms is owed entirely to the extent to which it has moved away from central planning. In short, its economy has grown a lot in spite of the fact that the remnants of central planning retain a very strong influence. However, it seems possible that a threshold has finally been crossed and that many of the wealth destroying activities that have been undertaken due to the misguided incentives  created by the country's mercantilistic  planners (China's equivalent to pyramid building), are now coming home to roost in what could turn into a sizable bust.

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China Flash PMI, via HSBC/Markit – click to enlarge.

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The entire report can be downloaded here (pdf). There is really not much need to comment further on this, although we would like to quote Mish's comment regarding the alleged need for the planners to 'engage in more fine-tuning to stabilize growth' as HSBC's chief economist maintains.

Says Mish: “We do not need fine tuning, we need to eliminate fine tuners.”

We agree, although we imagine the fine-tuners won't.

European PMI's Improve Somewhat

At the time of writing, only the German (pdf) and the French Flash PMI (pdf) have been released (the remaining euro area PMIs will be released over coming days, and can be found here; we may comment if it anything unusual transpires).

As can be seen there, the data in the euro area's two 'core' nations have clearly improved, with Germany once again the positive standout, actually showing expansion. France can merely boast of a slowing in its ongoing manufacturing contraction.

As already indicated further above, similar to the UK, where both sentiment and economic activity have recently been on an upswing as well, we think monetary factors are the decisive driver of this improvement. Again, if one thinks these things through properly, then it should be clear that none of this has anything to do with genuine wealth creation, or rather, it is impossible to say how much activity is owed to genuine wealth creation and how much is owed to capital consuming bubble activities.

We do however know that given the leads and lags between monetary and credit expansion and business activity, the mirage of 'things are getting better' regularly follows in the wake of credit expansion, even if it is ultimately an illusion and turns out to be detrimental to the accumulation of real wealth.

Finally, here is a chart showing European government debt to GDP data comparing 2011 to 2012. Again, it is hardly worth commenting on this – as we have recently pointed out, they all keep spending like drunken sailors. There are the odd exceptions – e.g. Greece (to the far right) had little choice – but overall, the 'fiscal targets' of whatever 'pact' or 'compact' is in force at any given time, continue to recede further and further into the distance (eventually they will reach the edge of the world and fall off). 'Austerity' is a slogan, a meme, a promotion. It is not the reality, at least not for governments. There is of course plenty of austerity for the private sector, which has been burdened with innumerable additional impositions, from taxes to regulations.

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Debt-to-GDP ratios of European sovereigns, 2011 vs. 2012. All that austerity must really hurt – click to enlarge.

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QE, The Velocity of Money And Dislocated Gold

 

From time to time, it's nice to look at a series of graphs, and let them tell their thousand words worth - each - of stories. In this case, I started out looking at US monetary base at the St.Louis Fed website and it sort of went from there. Curious trends and intriguing numbers, beyond what I would have thought. To refresh memory and avoid confusion, first a few definitions:

The monetary base - base money, money base - is the sum of currency circulating in the public and commercial banks' reserves with the central bank. The money supply - money stock -, on the other hand, is the sum of currency circulating in the public and non-bank deposits with commercial banks, a.k.a. the total amount of monetary assets available in an economy at any given time.

Some additional useful definitions from Wikipedia:

" ... the ratio of [the monetary base and the money supply] is referred to as the money multiplier. If one excludes currency from the definitions, the monetary base is not a subset of the money supply - rather, the two are disjoint sets. On the commercial banks' balance sheets, the former belongs to the assets whereas the latter belongs to the liabilities.

• M1: The total amount of M0 (cash/coin) outside of the private banking system plus the amount of demand deposits, travelers checks and other checkable deposits

• M2: M1 + most savings accounts, money market accounts, retail money market mutual funds, and small denomination time deposits (certificates of deposit of under $100,000).

Ironically, Wikipedia also states: "Normally, the money supply exceeds the monetary base by far...". Well, we're not in Kansas anymore.

Two M1 graphs that I posted before in Deflation By Any Other Name Would Smell As Foul tell a first part of the story:

Of course, more information than from just M1 can be derived from M2, where the money supply looks different (no sudden shrinkage):

But the velocity does not (Do note the different time scales for these and other graphs):

Even more interesting than the money supply, however, is the monetary base (I used a very long timeline to show how out of - historical - proportion it has gotten):

And it gets real curious when we put monetary base and M2 Velocity together:

Velocity rose like crazy in the '90s. Ever since, the Fed, the government and the entire economy have basically been pushing on a string (or have they?). Velocity hasn't been this low in 50-odd years, since it started being recorded (and that included quite a few other crises). But $2.2 trillion in stimulus, much of it QE, has found its way from the Fed into the reserve accounts the major global banks have with the same Fed. And it's not moving one inch. Indeed, these banks, who got the funds from the Fed, are receiving interest payments on them from that very same Fed.

So has Bernanke been pushing on a string? Well, if and when the velocity of money plummets the way the graphs show, it's obvious nothing is helping to get the QE funds into the real economy. Bernanke knows this, and he too has seen the graphs and the trendlines. But he still continues to pour $1 trillion per year into this same sinkhole. What it then comes down to may be that while the Fed can claim innocence and say it only tried to energize the economy, that is all just sleight of hand. Because this looks a lot like one huge money transfer from the public to the private sector, and one that has little to no chance of achieving the advertised goals.

The net effect, if this continues, will be to further bankrupt an already bankrupt society. If you look at it that way, it no longer appears so innocent. If anything, it looks an awful lot like Japan. And that means all the news reports that suggest an improving US economy need to be taken with a whole lot of roadsalt: there can be no economic recovery with a plunging money velocity. And whatever Bernanke may claim he has done about that, even if he actually tried, nothing has worked.

Another way to look at it is through this H.8;Zero Hedge graph, which compares total bank deposits with loans (left scale). Until 2008, they ran together, but ever since, a $2 trillion gap was established (right scale). Take it one step further and you could say that with a 10% reserve requirement, banks could potentially lend out $20 trillion. But they don't. Moreover, unless deposits include the QE money banks have parked at the Fed (but that would be weird), they've not just seen the deposits/loans gap grow by $2 trillion, they also acquired another $2 trillion in QE from the Fed. $4 trillion available, but no change in credit for the real economy. What do you call that, nice job if you can get it?! Or is it something worse?

The dislocation between loans and deposits is not the only one of its kind. Another thing that struck me when flipping through these graphs concerns the "dislocation" between the monetary base and gold prices. The graph below (I forget where I found it) shows the tight correlation between the two from 2008 until 2012 (and a somewhat looser correlation before).

But if we look once more at the monetary base graph from before, we see it surged a lot more from where the graph just above left off (early 2012):

While gold has moved sharply in the opposite direction:

I don't claim to know exactly what this gold/monetary base dislocation is telling us, but it does look significant. Did central banks sell off gold, in which case it's pretty straightforward, or was it someone else? We do know that wherever the difference went, it wasn't stocks or bonds. Nor is there any other obvious place it went to. It may well have simply vanished, in a strong bout of deleveraging (debt deflation).

What I think should be crystal clear is that Ben Bernanke must be forced to stop his QE policies. It is abundantly obvious that none of it helps the real economy one iota, and if it doesn't help, it hurts. I've read it estimated that 86% of QE has so far ended up in banks' reserves with the Fed, and for all I can see it may be even worse. That is not an economic stimulus, it's something entirely different. If only 1 in 7 dollars spent has any effect on Main Street at all, it is at best the proverbial "throw it at the wall and see what sticks".

Lest we forget, consumers still make up 70% of GDP, and if you want to know how that is going, you need look no further than the stats on the velocity of money. Ben Bernanke and his Fed must be aware of this, which means that what they have been doing for the past five years is either very dumb or very devious. Take your pick.

- See more at: http://theautomaticearth.com/Finance/qe-the-velocity-of-money-and-dislocated-gold.html#sthash.t00HVY3M.dpuf

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A Tour Of The Post-Crisis World Economy In 10 Easy Charts

by Tyler Durden

How far has the global economy come in its recovery from the financial crisis? Citi's ten-chart tour highlights that even now, six years after the financial crisis first erupted, the global recovery continues to face some very powerful headwinds. Among the most notable are drag associated with ongoing efforts to consolidate private-sector balance sheets, challenges with managing high levels of public debt and the eventual unwinding of central bank balance sheets, the still-incomplete pattern of adjustment in Europe, and deteriorating demographics across the advanced economies. We see these challenges as being mainly lodged in the advanced economies, where the global financial crisis raged most intensively. But the resulting softness of advanced-economy demand has become an increasing obstacle for growth in the emerging markets. The bottom line is that investors, central planners, and politicians alike are frustrated by the slow pace of global recovery.

Via Citi,

Stated bluntly, our ten-chart tour provides substantially more reasons for concern about the global recovery than for comfort.

The recent growth performance of the world economy has been disappointing. Global trade volumes have moved sideways over the past 18 months, and purchasing managers indexes (PMIs) for global manufacturing point to stagnation in the sector. In addition, growth in the advanced economies is well below our estimated stall speed, suggesting vulnerability in the event of renewed shocks. Performance in the emerging market economies is somewhat more encouraging but hardly robust, and these economies face a daunting set of headwinds.

Balance sheet consolidation by households and firms has been a notable drag on growth in the advanced economies in the years since the financial crisis. Accordingly, private non-financial debt ratios have leveled out or declined, which is a promising development, but it is still too early to declare the deleveraging process complete. Indeed, in the aftermath of the bursting of Japan’s asset bubble in the 1990s, it took five years before the massive deleveraging of the country’s corporate sector gained momentum.

In the years following the onset of the crisis, policymakers moved aggressively to support demand through stimulative monetary and fiscal policies. These efforts prevented even more severe outcomes for the global economy, but have left governments with heavy debt burdens and central banks with bulging balance sheets. In the period after World War II, the U.S. achieved a smooth deleveraging of its sizable public debt, but we are skeptical that the forces which produced that outcome will operate in a similar fashion in the years ahead. We fear that high levels of public debt are likely to become the “new normal” for many advanced economies, with heightened vulnerability to shifts in market conditions and borrowing rates.

Lest we seem overcome by anxieties, our survey of the economic horizon also uncovers two notable positive developments.

First, we find indications of meaningful adjustment in external imbalances. For example, China’s ratio of exports to GDP has stepped down, and some of the euro-area peripheral countries are making progress toward improved international competitiveness. In contrast, Germany’s trade surplus is again widening.

Second, we see signs that the U.S. manufacturing sector may be poised for better performance in the years ahead. More generally, we read the recent data in the United States as pointing to a strengthening recovery. The discussion in the previous bullets underscores, however, that this recovery is unlikely to receive much support from the global economy.

Finally, looking well beyond the current recovery, we consider the prospects for growth in the United States, the euro area, and Japan through the next twenty years. Over this horizon, we see these economies as likely to struggle with the challenges of aging populations. But we expect that labor productivity will hold up relatively well. Japan’s experience suggests that an aging population tends to mean a lower quantity of labor input, but the quality of Japanese labor has remained favorable. We also see scope for substitution toward more capital-intensive technologies and industries and for innovations that will allow labor to be used more efficiently.

All told, our global tour highlights that even now, six years after the financial crisis first erupted, the world economy continues to struggle with a range of challenges and imbalances that are restraining recovery. Conceptually, these issues can be grouped into three separate categories:

First, some of the imbalances that triggered the global financial crisis and the subsequent disruptions in Europe still have not been fully worked off. High private-sector debt levels in a number of countries, as well as Germany’s persistent current account surpluses, fall into this category.

Second, other difficulties that policymakers now face are the consequence of necessary efforts to fight the financial crisis. This category includes, most notably, high public debt levels and challenges associated with managing central bank balance sheets.

Third, a number of countries are now facing a new set of structural problems related to population aging and deteriorating demographics. Japan has grappled with these issues for two decades, but other countries are starting to feel such effects as well.

We see these challenges as being lodged primarily in the advanced economies, likely reflecting that this is where the global financial crisis was most intense. But the resulting softness of demand in the advanced economies has, in turn, become an increasing impediment to growth in the emerging markets. Through the years of the financial crisis, many of the emerging market economies shifted the focus of their policies toward domestic demand and away from external demand. However, with business cycles in these economies now reaching maturity, the lack of solid demand from the advanced countries, along with the tepid performance of commodity markets and ongoing signs of softening in China, are increasingly restraining the prospects for the emerging markets.

Chart 1 - Stagnant Global Trade and Production

Chart 2 - Is The global Economy Approaching Stall Speed? Yes

Chart 3 -Balance Sheet Consolidation in the Private Sector has been an important headwind contributing to the soft performance of the advanced economies in recent years.

Chart 4 - The Public Sector to the Rescue? have left governments with heavy debt burdens and...

Chart 5 - Central Banks With Bulging Balance Sheets... but we continue to worry about unintended consequences of these policies.

Chart 6 - Global Imbalances - Current Account Performance: Germany vs. the Peripherals
Since the financial crisis erupted, three major developments have been observed. First, the euro area as a whole has swung into more sizable external surplus. Second, France’s deficit has widened further. At the time of the introduction of the euro, France was a surplus country—and remained so through the middle of the last decade. But in recent years, France has recorded a growing deficit, as its competitiveness has slipped and its unit labor costs have marched steadily upward. We see this as an important cautionary tale for the country’s policymakers. Structural reforms to improve competitiveness seem unavoidable. Third, and equally striking, deficits in the peripheral countries have closed, as these countries have made progress in strengthening their external competitiveness.

Chart 7 - Global Imbalances - Current Account Performance: Germany vs. China
The improved external performance of the peripherals is encouraging. But what about the other side of the coin? Are we seeing meaningful adjustment in Germany? We believe that both of these observations may have worrisome implications for the global economy. For Germany, the country’s continued reliance on external demand is problematic. German policymakers should put efforts to stimulate domestic demand at the top of their policy agendas.

Chart 8 - U.S. Recovery Prospects: Thoughts on Small Firms
Since early 2010, small firm employment has rebounded but has not yet come close to reversing the job losses sustained during the financial crisis. This is an issue that we are watching as a key indicator of the cyclical performance of the U.S. economy. Another concerning development is the steady decline since the early 1980s in the rate at which small businesses are being established.

Chart 9 - U.S. Recovery Prospects: Thoughts on Manufacturing
Labor’s share of value added (i.e., aggregate payments to workers relative to manufacturing value added) has declined from about 65 percent as recently as a decade ago to just a bit above 50 percent at present. Workers in other U.S. industries have not seen a similar decline.

Chart 10 - Projections for Long-term Growth
Our view is economic activity in the decades ahead is likely to be shaped by ongoing challenges posed by aging demographics. Aging can weigh on growth through a number of channels. First, accelerated aging means rising elderly dependency ratios and likely a declining share of workers relative to the overall population. Second, aging also means that the average worker who remains in the labor force is older than was the case a decade or two before, and older workers have typically chosen to work fewer hours than their younger counterparts. Third, meeting the needs of aging populations is already exerting stresses on government budgets and raising concerns about medium-term debt sustainability.

Our ten-chart tour highlights that the global recovery continues to face some very powerful headwinds. Among the most notable are ongoing efforts to consolidate private-sector balance sheets, challenges with managing the eventual unwinding of central bank balance sheets and high levels of public debt, the still-incomplete pattern of adjustment in Europe, and deteriorating demographics in the advanced economies. The genesis of these challenges has varied, with some having plagued the global economy since the financial crisis, others being the unavoidable side-effects of the policies required to fight the financial crisis, and still others coming as largely new developments. Whatever their sources, these impediments to growth have been—and are likely to remain—a significant drag on global activity.

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