Moral Hazard Quagmire

By Doug Noland via creditbubble buletein

The Nasdaq100 (NDX) jumped another 3.5% this week, increasing 2020 gains to 32.3%. Amazon gained 4.3% during the week, boosting y-t-d gains to 77.8% – and market capitalization to $1.626 TN. Apple surged 8.2% this week, increasing 2020 gains to 69.4%. Apple’s market capitalization ended the week at a world-beating $2.127 TN. Microsoft rose 2.0% (up 35.1% y-t-d, mkt cap $1.612 TN). Google rose 4.8% (18.2%, $1.073 TN), and Facebook gained 2.2% (30.1%, $761bn). The NDX now trades with a price-to-earnings ratio of 37.4.

This era will be analyzed and debated for decades to come – if not much longer. Market Bubbles, over-indebtedness, inequality, financial instability and economic maladjustment – festering for years – can no longer be disregarded as cyclical phenomena. Ben Bernanke has declared understanding the forces behind the Great Depression is the “Holy Grail of economics”. It’s ironic. That the Fed never repeats its failure to aggressively expand the money supply in time of crisis is a key facet of the Bernanke doctrine – policy failing he asserts was a primary contributor to Depression-era financial and economic collapse. Yet this era’s unprecedented period of monetary stimulus is fundamental to current financial, economic, social and geopolitical instabilities.

August 18 – Bloomberg (Craig Torres): “The concentration of market power in a handful of companies lies behind several disturbing trends in the U.S. economy, like the deepening of inequality and financial instability, two Federal Reserve Board economists say in a new paper. Isabel Cairo and Jae Sim identify a decline in competition, with large firms controlling more of their markets, as a common cause in a series of important shifts over the last four decades. Those include a fall in labor share, or the chunk of output that goes to workers, even as corporate profits increased; and a surge in wealth and income inequality, as the net worth of the top 5% of households almost tripled between 1983 and 2016. This fueled financial risks and higher leverage, the economists say, as poorer households borrowed to make ends meet while richer ones shoveled their wealth into bonds… ‘The rise of market power of the firms may have been the driving force’ in all of these trends, Cairo and Sim write in the paper.”

My analytical framework’s “money” and Credit focus is at times lacking in capturing non-monetary macro factors. To blame the Fed and global central banks for all that ails the world (while a valid starting point) represents a too simplified view of complex dynamics. To be sure, technological innovation and advancement along with “globalization” continue to exert momentous influence – arguably at an accelerated pace. Indeed, analysis with technological and globalization trends at its focal point could offer a plausible explanation of many macro developments – to the exclusion of policymaking and finance. As the above Fed research asserts, it is increasingly tempting to deflect blame for inequality upon monopoly power.

Isabel Cairo and Jae Sim’s Fed research paper, “Market Power, Inequality, and Financial Instability,”is a technical research piece: “A few secular trends have emerged in the U.S. economy over the last four decades… First, real wage growth has stagnated behind productivity growth over the last four decades and, as a result, the labor income share has steadily declined… Second, the before-tax profit share of U.S. corporations has shown a dramatic increase in the last few decades… Third, income inequality has been exacerbated over the last four decades… Fourth, wealth inequality has also been exacerbated during the last four decades… Finally, the rising household sector leverage has been coupled with rising financial instability…” “We develop a real business cycle model and show that the rise of market power of the firms in both product and labor markets over the last four decades can generate all of these secular trends.”

“In this paper, we quantitatively investigate the role of rising firms’ market power in both product and labor markets in explaining the six secular trends. In so doing, we are inspired by Kalecki (1971), who… predicted that the market power of the firms would increase over time and consequently, labor share would fall in the long-run.”

Understandably, Amazon lost money in its initial years. Losses mounted steadily from 1995, jumping to $720 million by 1999, $1.4 billion in the year 2000 and $567 million in 2001. The company posted a 2003 profit of $35 million on revenues of $5.3bn. Net Income jumped to $589 million in 2004 (pre-tax $365 million), earnings not exceeded until 2008’s $645 million (on revenues of $19.2bn). Amazon reported Net Income last year of $13.18 billion on Revenues of $280.5bn.

What impact did loose monetary policies have on Amazon’s evolution to an online retail juggernaut, crushing traditional retailers and online competitors alike? Enjoying limitless access to virtually free finance, there were no constraints on investment spending (or acquisitions). And as competitors increasingly struggled to retain profitability and affordable finance, there was nothing holding back Amazon’s rein of dominance.

Tesla’s stock price closed the week at $2,050, up almost 400% y-t-d, with a market capitalization of $390 billion, exceeding the combined capitalization of five global auto heavyweights (Ford $26.7bn, GM $41.0bn, Toyota $218bn, Honda $45.3bn, and Daimler $51.8bn). Tesla reported losses of $725 million in 2016, $1.8bn in 2017, $742 million in 2018 and $629 million in 2019. After reporting cumulative profits of about $450 million over the past four quarters, Tesla’s stock currently trades with a price/earnings ratio of 895.

How would Tesla appear these days if not for ongoing aggressive Federal Reserve stimulus and the resulting loosest financial conditions imaginable? Would it have survived? I’m all for zero emissions vehicles – as well as a proponent for Schumpeter’s “creative destruction.” But zero rates, QE, mispriced finance and market Bubbles have created financial and economic distortions with momentous consequences. Years of ultra-cheap finance, booming securities markets, and a most elongated business cycle have created powerful industry behemoths. Pandemic crisis measures now cement monopoly power.

To be sure, whether it is Amazon, Tesla, Netflix, Apple, Microsoft, Google, Facebook or scores of other market darlings, a hot stock price is essential to achieving market dominance. For one, it provides a currency for acquisitions, purchases that often include fledgling competitors. And as these companies grow increasingly dominant in both the markets and real economy, surging stock prices ensure these heavyweights attract and retain the best and brightest talent (further cementing competitive advantage).

There is today no more powerful factor in exacerbating inequality than the stock market. A position (with stock grants) at one of the hundreds of market darlings is today a ticket to extraordinary riches. While tens of millions have lost their jobs and financial security over recent months, those fortunate to be riding the bull market wave have enjoyed spectacular wealth gains.

August 20 – Bloomberg (Liz Capo McCormick): “The unprecedented speed and scale of the Federal Reserve’s buying of Treasuries and mortgage debt to aid a severely impaired bond market has accomplished that without raising the specter of moral hazard, Federal Reserve Bank of New York researchers wrote… Pandemic-sparked volatility in March caused liquidity in the world’s biggest bond market to plunge to its worst since the 2008 financial crisis. The Fed responded with purchases of Treasuries and mortgage securities that peaked at more than $100 billion a day combined. It’s still soaking up about $80 billion of Treasuries and at least $40 billion of mortgage securities a month, and some bond veterans warn that the central bank’s involvement in the market could potentially be encouraging risky behavior, such as excessive borrowing. But a post… in the New York Fed’s Liberty Street blog argued against that. ‘The magnitude of the Desk’s purchase program in 2020 ‘to support the smooth functioning’ of the Treasury and agency MBS markets marked those purchases as highly unusual,’ wrote Kenneth Garbade, a senior vice president in the New York Fed’s Research and Statistics Group, and Frank Keane, a senior policy advisor. But they also say that the tool has been used before and ‘the infrequency of Federal Reserve intervention suggests that relying on the Fed on those rare occasions when markets are in extremis has not materially exacerbated moral hazard.”

The Fed’s stunning pandemic response has greatly exacerbated at least two pernicious dynamics – Inequality and Moral Hazard. Only Fed economists could argue the Federal Reserve’s crisis response measures haven’t stoked risk-taking throughout the markets (and in the real economy). Indeed, any doubt that the Fed would invoke “whatever it takes” to support the securities markets has been allayed.

It is strangely flawed analysis deserving of a response. “The magnitude of the Desk’s purchase program in 2020 ‘to support the smooth functioning’ of the Treasury and agency MBS markets marked those purchases as highly unusual. From an operational perspective the speed and size of the program were unprecedented, yet as a policy response, as the three episodes discussed here show, it was not unique.”

The Fed economists point to three episodes as evidence recent Fed crisis measures were not unique: 1) Fed purchases of $800 million of Treasuries during September 1939, at the start of WWII. 2) Several hundred million Treasury purchases in response to disorderly markets in July 1958. 3) The buying of several billion Treasury securities in May 1970, in response to disorderly markets after President Nixon announced a military escalation with large-scale operations in Cambodia – along with anti-war protests and the Kent State tragedy. The analysis concludes with a bold assertion: “…The infrequency of Federal Reserve intervention suggests that relying on the Fed on those rare occasions when markets are in extremis has not materially exacerbated moral hazard.”

Arguably, the three highlighted historical interventions have little or no bearing whatsoever on today’s Moral Hazard Quagmire.

I would point to more than three decades of serial – and escalating – market interventions and bailouts – including Greenspan’s 1987 post-crash liquidity assurances; early ‘90’s aggressive rate cuts and yield curve manipulation; 1994 GSE quasi-central bank liquidity operations; the 1995 Mexican bailout; Greenspan’s pro-markets “asymmetric” policy responses; the ’98 LTCM bailout to safeguard global derivatives markets; Bernanke’s 2002 “helicopter money” and “government printing press” speeches; the Fed’s post-tech Bubble accommodation of rapid mortgage Credit growth as the primary system reflation mechanism – and the subsequent blatant disregard for mortgage finance and housing excesses; the post-Bubble $1 TN QE program, bailouts and various extraordinary crisis measures in 2008/09; the Bernanke Fed’s coercion of savers into the debt and equities markets; Draghi’s “whatever it takes” 2012 crisis response; Bernanke’s 2013 assurance that the Fed would “push back” against any market tightening of financial conditions (i.e. market corrections); the Bernanke and Yellen Feds’ decade-long aversion to policy normalization; the Powell Fed’s abrupt market instability-induced December 2018 abandonment of policy “normalization”; the September 2019 “insurance” rate cut and QE in the face of record stock prices and generally overheated securities markets.

“Moneyness of Credit” was an analytical focus of mine during the mortgage finance Bubble period. It was a historic Moral Hazard episode, with the government-sponsored enterprises, the Treasury and Federal Reserve all contributing to the perception that federal backing insured mortgage finance would remain safe and liquid (money-like) – irrespective of the risk profile of the underlying mortgages. The view that Washington would never allow a housing (or mortgage finance) bust was fundamental to egregious risk-taking and excess (in both the Real Economy and Financial Spheres).

I coined “Moneyness of Risk Assets” in 2009 upon recognizing that Bernanke was targeting rising equities and corporate Credit markets as the primary mechanism for post-Bubble system reflation. Epic Moral Hazard was unleashed. Markets accurately assumed the Fed had taken a giant leap with respect to market intervention and support – with the greater the degree of Bubble excess the more confident the marketplace became that the Fed wouldn’t risk pulling back.

In the realm of Moral Hazard, last autumn’s “insurance” monetary stimulus was a catastrophic policy blunder. Stress was building in leveraged speculation and within global derivatives markets – air was beginning to leak from the global financial Bubble. The Fed’s aggressive measures quashed the incipient market correction and stoked only greater speculative excess. This ensured the acute market fragility that contributed to March’s near-financial meltdown.

And the financial crisis spurred an unprecedented $3 TN expansion of Fed market liquidity. M2 money supply surged an unparalleled $2.9 TN in only six months, in an ongoing episode of historic Monetary Disorder. And when it comes to Moral Hazard, one cannot overstate the significance of the Fed’s giant leap to purchasing corporate bonds and even ETFs that hold junk bonds. With rates back to zero and the Fed now directly backstopping corporate Credit, “money” has flooded into perceived safe and liquid bond ETFs (in the face of the steepest economic downturn in decades). A debt issuance bonanza ensued.

Once more for posterity: “…The infrequency of Federal Reserve intervention suggests that relying on the Fed on those rare occasions when markets are in extremis has not materially exacerbated moral hazard.”

Rather than infrequent, Fed intervention has become incessant. Market “extremis” has turned commonplace. And any assertion that Fed policies have not materially exacerbated Moral Hazard completely lacks credibility. In fact, it’s foolish.

Friday afternoon from Bloomberg (Lu Wang): “Bears Are Going Extinct in Stock Market’s $13 Trillion Rebound.” “Skeptics are a dying breed in American Equities.” “Going by the short positions of hedge funds, resistance to rising prices is the lowest in 16 years… At the start of August, the median S&P 500 stock had outstanding short interest equating to just 1.8% of market capitalization, the lowest level since at least 2004…” “At 26 times forecast earnings, the S&P 500 was trading at the highest multiple since the dot-com era.” “Consider the internet frenzy 20 years ago. Back then, large speculators, mostly hedge funds, were net short on S&P 500 futures in all but five weeks in 1998 and 1999. Those mostly losing bets were completely squeezed out in 2000. That’s when the crash came.”

http://creditbubblebulletin.blogspot.com/2020/08/weekly-commentary-moral-hazard-quagmire.html

What a move toward de-globalization means for companies and investors- BOFA

Before the world had even heard of the coronavirus, the intricate transnational trade networks that feed the modern factory already appeared vulnerable. A wide range of forces are responsible: From trade disputes to national security concerns to climate change and the rise of automation and robots. “It’s not just one factor but many,” says Candace Browning, head of BofA Global Research. “And what’s remarkable is that they’re all happening at the same time.” The result? A fundamental—and accelerating—shift toward de-globalization, as more and more companies are bringing supply chains, manufacturing and jobs closer to home, according to a report from BofA Global Research, titled Tectonic Shifts in Global Supply Chains.

What does this mean for the U.S. and global economies? How might companies best adapt to the changing environment, and could this present new opportunities for investors? Co-authors Browning and Ethan Harris, head of Global Economics for BofA Global Research, share their thoughts on this evolving trend and the seismic changes it represents.

What ignited your sense of urgency around the changes that may be underway in the global economy?

Candace Browning: We’re always looking beyond daily events at bigger economic trends affecting the United States and the world. We’d heard that companies were thinking more locally but wanted to gauge whether it was myth or reality. So, we surveyed our international team of equity analysts—who together cover some 3,000 global companies—and were struck by what we found. Across 12 industries ranging from semiconductors to capital goods, companies in more than 80% of those industries are rethinking, or plan to rethink, at least some of their supply chains. We weren’t surprised that companies are shifting from China towards lower labor costs in Southeast Asia and India. What really did surprise us was the number of companies, particularly in North America and Asia, that intend to “reshore” supply chains to their own country or region. Firms in almost all industries plan to make the transition work using robots and automation. Our forecast that industrial robots will double to 5 million units by 2025 may be conservative—and the cost of automation and robots keeps going down.

“What really did surprise us was the number of companies, particularly in North America and Asia, that intend to ‘reshore’ supply chains to their own country or region.”

– Candace Browning, Head of BofA Global Research

What exactly are supply chains, and why is this shift so significant?

Ethan Harris: For 60 years after World War II we witnessed a steady rise in international trade and revolutionary changes in how products are made and sold. Today, through complex networks of suppliers, a single smart phone or appliance contains parts sourced from many countries. In the last decade, though, international trade has leveled off, and our new findings suggest that what had seemed a relentless march toward globalization may now be reversing. Of course, that doesn’t mean that international trade will end. But when you consider that the companies in the 12 global industries we cover represent $22 trillion in combined market value, even incremental shifts toward “de-globalization” could have major implications for economies, jobs and consumers.

Why now? What’s driving this trend?

Browning: Higher wages in the developing world and advances in automation are reducing some of the cost benefits that have long made overseas suppliers so attractive. Another factor is ongoing trade tensions, even taking into account the new Phase-1 trade deal between the United States and China. National security is a growing concern as countries seek to protect their technologies. From an environmental, social and governance perspective, sourcing parts locally may leave a smaller carbon footprint and help companies ensure that suppliers treat employees well. It’s too early to know which of these forces will play the most important roles in de-globalization, but we’ll be watching developments closely.

Who might the beneficiaries be, and where are the challenges?

Harris: U.S. companies seem most ready to embrace automation and its cost savings. Technology companies and their suppliers could benefit as demand for robots rises. Generally, larger companies tend to have multiple suppliers and their scale may give them greater flexibility to adjust supply chains. China faces perhaps the greatest challenges. The underlying story is positive, with a rising middle class earning more money. But that means China needs to speed up its effort to depend less on exports and more on domestic consumers and services. The coronavirus, which has forced a number of Chinese factories to slow down or stop production altogether, contributes to these pressures.

Browning: Small U.S. businesses may also benefit as part of industrial “clusters” that develop when large manufacturers move into an area. Manufacturers spend 5.5% of domestic net sales on research and development, compared with 3.6% for non-manufacturers, so that, too, creates opportunities for companies that support them.1 In some cases, reshoring will mean moving supply chains to nearby developing countries. So Mexico is likely to benefit from reshoring of U.S. companies, for example.

What does all this mean for workers and consumers now?

Browning: Some 400,000 U.S. factory jobs are currently unfilled, and companies are going out of their way to lure job seekers with higher wages, signing bonuses and other benefits. Moving supply chains closer to home will increase the demand for skilled workers such as welders, engineers and machine programmers—and manufacturing jobs already pay 15% more in total compensation than nonmanufacturing jobs.2 So, wages are likely to grow. But jobs, too. Ten years ago, conventional wisdom held that workers were all going to be replaced by robots. Yet while automated factories do require fewer employees, every new manufacturing job generates an estimated six additional jobs indirectly.

The benefits may be less pronounced among service companies, and unskilled workers will face steeper challenges. So companies and policymakers alike will have to emphasize retraining and other programs to help give workers the skills they need for the new manufacturing landscape.

Harris: For consumers, a lot depends on what the major forces behind de-globalization turn out to be. If it’s mostly about trade barriers, consumers will pay higher prices, which is obviously not good for them. But if it’s because companies find greater efficiency through automation and lower shipping costs, that’s good news for everyone. That story is still unfolding.

What risks does de-globalization present?
Harris: Protectionism or national security could prompt government anti-trade policies that make this process happen much too quickly. In the technology sector, for example, different countries have developed very different capabilities. Forcing everyone to suddenly shift to local supply chains would be incredibly expensive and quite disruptive. One of the toughest challenges for governments will be finding ways to address national security concerns while minimizing those disruptions.

“We’re calling this a ‘tectonic’ shift because we expect things to move slowly but persistently over the next five or 10 years. It won’t happen overnight, but some of the forces seem unstoppable.” –

Ethan Harris, Head of Global Economics, BofA Global Research

How quickly do you expect these changes to take place—and what should investors watch for?
Harris: We’re calling this a “tectonic” shift because we expect things to move slowly but persistently over the next five or 10 years. It won’t happen overnight, but some of the forces seem unstoppable. National security and protectionist concerns aren’t going away. Automation’s not going away. Labor costs in China aren’t going to suddenly drop.

Browning: While de-globalization is likely to play out over a number of years, a look at market values and fund investments tells us that investors may not be fully prepared for a sustained recovery in manufacturing that could begin by mid-2020. We see opportunities ahead for industries ranging from automation to industrials to the banks that will help finance changes in supply chains. For these reasons, we believe investors should start thinking now about the implications for their portfolios, and how they can prepare for the global shift.

Uday Kotak deconstructs the story behind China’s slow, systematic capture of India’s markets

Uday Kotak, Asia’s richest banker and one of India’s premier industry captains, has laid bare the inner workings of the playbook China uses to give effect to its slow but certain capture of the Indian market.

To get an idea of the extent of Chinese industry’s reach, one needs only look at the size of India’s imports from China which currently stands at $60 billion, Kotak said in an interview with ET Now.

China has not only become the world’s factory in the last one decade or two, it has also seized large swathes of many countries’ local markets including India’s, data shows.

During the time China was rising to become a trade powerhouse, could Indian industry have done things differently?

In his exposition, the Kotak Mahindra Bank CMD shed light on how Chinese industry aced the global game while Indian industry was left languishing with the exception of a few sectors.

He brought up pricing to explain this: there is emerging a clear possibility that manipulative pricing by Chinese players may have long loaded the dice against Indian factories.

According to Kotak, if this actually was the case, it would then be grossly unfair to blame Indian businesses for failing to stand up to Chinese competition adequately, because they simply were not left with the wherewithal.

In the interview, Kotak further decoded the raw deal domestic businesses got from China: in sector after sector, segment after segment, China was able to dramatically under-price its goods, with the result that many Indian manufacturers went out of business.

And once Chinese suppliers captured the market this way, many of them could raise prices at will because there was no strong local competitor left.

Manipulative pricing is exactly the reason behind the raging US-China trade war, and India must put a premium on getting stronger so that such unfair competition could be kept at bay, Kotak cautioned.

Focus on execution is the the most critical need of the hour for India, and the government must focus on getting its policies right and making sure that they showed results on the ground, he added.

Execution is going to have major implications for Modi’s pet Atmanirbharta push too, Kotak insisted. India will need two Es to make itself truly self-reliant, exports being the other E apart from execution, he said.

How to grow net exports and how to cut down the time for policy execution — these two questions are going to decide the success or failure of India’s self-reliance mission, he added.

India must do whatever it takes to strengthen its exports because that is the true proof of a country’s ability to be competitive, and the government must send out a consisent message that it is willing to walk the talk on this, Kotak offered, along with the reminder that delay in payments or incentive by the government could hinder the export push seriously.

Kotak thinks that this government is largely on the right track so far, given Modi’s focus on infrastructure and the integrated — as opposed to bits and pieces — approach that he opted for. He reckons that with Rs 110 lakh crore to be spent in the next few years, there will be major job creation and demand stimulus.

Kotak points out two things that Modi government must tackle urgently — a) lockdown-related uncertainties have to end, and states must not leave a growth turnaround solely to the Centre; and b) India may not have enough supply, which will cause major problems with the eventual return of demand, much of which (70-80%) is already back.

“I genuinely believe we are no longer moving to a new normal, we are moving to a world in finance, technology and business to a never normal world,” he said

Link – https://economictimes.indiatimes.com/news/economy/foreign-trade/uday-kotak-deconstructs-the-story-behind-chinas-slow-systematic-capture-of-indias-markets/articleshow/77587935.cms?from=mdr

Washington Consensus to Buenos Aires Consensus

Summary- Real Vision interview

Marko Papic and Mike Green — The Next Decade for Geopolitics and Markets

Geopolitical activities will be a cause for concern. But, the major driver is going to be domestic politics in US, China, Europe and around the globe. The reason is low growth, secular stagnation compounded by Covid-19.

The Great financial crisis was not like the great depression as post the depression, debt levels did not fall dramatically now were there high number of defaults. The 2008 seems more like the 1920s where it was a big financial crisis.

Investing based on macro means how would one look at today’s scenario 10 years from now. It all depends on the chart of the year and its directionality. So, we have covid 19 which lead to wartime level spending but no war.

Most important trend is shifting away from the 40 year old Washington consensus. The transition is happening towards a new consensus at a rapid speed. Investors who were bearish thought a great depression was coming. Great Depression was about policy. It was about going into a crisis. As Treasury Secretary Mellon said, liquidating everything. It’s like tightening the screws of pain on the American economy so as to cleanse the system. That was the obsession they had at the time. The recession was tackled with austerity and lowered government spending in the early years of the depression.

But, we have an extraordinary fiscal response which requires a new framework of thinking about politics. We are transitioning from Washington consensus to Buenos Aires consensus.

Washington consensus were about free trade, privatization, central bank independence, fiscal prudence and fiscal policy becoming apolitical.

Buenos Aires consensus is the opposite, it’s about democratizing the institutions related to Washington consensus. It means basically short term gain, long term pain.

Fiscal policy was not in the limelight a lot except for the 2013 fiscal cliff. While the federal reserve monetizing the debt is important whats different this time is that the previous we had a stimulus it was five months into the crisis to the tune of $850 billion and was passed completely along party lines.

After that within 18 months in wake of the 2010 midterm election, we had the tea party revolution where there was talk of usa ending up like Greece. The political revolution was based on fiscal prudence and austerity became the guardrails of monetary stimulus. If you’re going to stimulate fiscally, we’re going to pull back monetary support. You’re going to have huge monetary stimulus, we’re going to pull back fiscal.The reasons we did not have inflation was other than the balance sheet recession , it was the lack of fiscal policy. From 2010 to 2016, US had the most longest and deepest self imposed austerity, basically government was not contributing to GDP growth.

There is a revolt inside the republican party with regards to the tepid $1 trillion package passed. It doesn’t mean that Mitch McConnell or Rand Paul, or Republican senators whose constituencies might be still fiscally conservative, it doesn’t mean that they’re not going to put up a fight, but they’re going to lose.

Nancy Pelosi has sniffed out where the Median voter is in this country which is in favor of left leaning policies. What Nancy Pelosi did is she drove this incredible strategy of just saying more and more stimulus to trump to the extent that we now have trump campaigning against her.

If Mitch McConnell does not allow the stimulus to happen the unrelenting ads against trump regarding him cutting their unemployment benefits will cause him to lose massively.  If Joe Biden wins, he is not going to allow a fiscal cliff to happen as he just now won because of these left leaning policies.

This is the mechanism by which we end up in the new consensus where the size of fiscal stimulus is bid up. The new administration that comes into power next year will say if I stimulated earlier why can’t I stimulate again to avoid a fiscal cliff.

This is why the market is not worried about a blue wave, as a democrat next year would mean that capital gains and corporate taxes are going up. But the market is overlooking the tax and regulatory changes because of its addiction to fiscal policy.

Politicians don’t care about ideals only they just try to win, they feel if they win they can pursue their ideals. Therefore, the median voter is the price maker in the political marketplace and the politician is the price taker.

The great recession in 2008 exacerbated the inequalities, US has a very high median income but middle income as share of total population , but it is very low.

For the first time in history the millennial voter is the median voter and millennials and Gen Z cohort are the ones worst affected by this crisis. Policy makers will simply respond to their policy preferences and if they don’t. They are going to compete against someone who does respond to the policy preferences of the millennial. Last time there was the tea party revolution this time there wont be one.

Now, if US which is the bulwark of the Washington consensus does not back it up, everyone around the world will also abandon it and politicians all around the world are going to surprise us. The fiscal situation is going to last longer than people think and inflationary pressures will build up.

Shifting focus towards Europe , the perception that Europe wants to create a super state to rival US is overblown but so is the narrative that it is going to subjugate the common man to supranational sovereignty. The European union is uniting not out of arrogance or strength but weakness. This is a world in which European countries actually have a geopolitical imperative to continue to integrate. In a world of large states that protect their markets, suddenly scale really does matter. European Union is a protectionist economic bloc that has a geopolitical logic and that logic is strengthening not weakening.

Italy may have a bout of populism in the next 5 to 6 years, which will be an opportunity to buy risk assets as the Italians will renegotiate rather than leave. Long term Europe will stay together, so with china stimulating Europe is ahigh beta play. Euros role as the reserve currency could go from 20% to around 25 to 30%. But EU is not going to be the next global power. Europe is going to do well and one should have a skew towards cyclicals when investing. As Manufacturing shifts from china to Vietnam, Malaysia, Indonesia, East Africa they will need infrastructure and factory building which they will acquire from Europe. Europe probably stands to benefit from deglobalization because it gets to play both sides, and it’s going to be very difficult for the United States to enforce European compliance to its position on China. So, Europe will benefit from Chinese demand or the rewiring of supply chains that will again require some of these cyclical companies to get revenue from the rewiring. Rewiring of supply chains is not all negative for everyone. The last time in 2001-2008, when China entered the WTO, that was hugely beneficial for Europe, emerging markets and other cyclicals and commodities, the industrialization of China and the rewiring of supply chains to include China as a central cog in supply chains. Rewiring of supply chain may hurt S&P 500 as they will have to dip into the revenues profit margins to rewire their own supply chains. That’s not bad for Europe, which could participate in the rewiring.

A lot of countries took the last decade to be the decade of American decline. I think that there is something to say that China moved too quickly. There seems to a policy setting in China to not to respond to the Trump administration with any real increase in tensions. So, while there is the tit for tat policy occurring, its complying as much as it can to the phase one trade deal. China is opening up its domestic economy because it needs foreign investors to go in and professionalized capital markets. If that setting of Chinese policy persists most people will be surprised by how muted Chinese policy will be with respect to united states.

There are red lines like Hong Kong , Taiwan which they are not going to compromise on , but they are opening up to foreign investment. We are in a world that is not going to clearly bifurcate and instead we are entering a 19th century world where there’s still investment and trade going on between great powers. Most people think in terms of the us vs ussr cold war but that era was different as you had only two clear powers. Instead we are in this multipolar world. That multipolar context has real implications for how the enmity between China and the US will articulate itself from an investment perspective.

After 28 July and Mike Pompeo’s historical speech , the Australian delegation visited and while they were with us on some issues but they will keep trading with china. However, it requires American defense in order to properly protect its sovereignty given its close linkages with China. This is really important, because if America can’t keep its allies in line, it means that they will stab the US in the back in order to get revenues from China, Airbus will pick up the slack that Boeing leaves on the table by pulling out of China. the real critical issue because what we know from history is that when you have this multipolar context, where allies can’t keep each other in line, they capitulate and they trade with the enemy. The one from the 19th century shows that the United Kingdom traded with Germany right up until the start of World War I. I could have also shown you French trade with Germany, Russian trade with Germany. These were three countries , the triple entendre. They were allied defensively against Germany, and they all expected for 20 years before World War I that there would be a war. But , they still traded because if one partner like UK didn’t protect its commercial interests , then France would pick up the revenue left on the table. It’s going to be very difficult for the US to disentangle from China, because he can’t control its allies the way it did in a bipolar context. However, the probability of conflict in south china sea over Taiwan is a clear threat, but this is going to be a multi decade rivalry and that should not be a reason to stay way from S&P 500. However, because there are chances of conflict one needs to position themselves defensively and be in gold and defense stocks.

Source : Real Vision Interview

The moment of Truth for Markets

There was a moment of panic in markets today ( with EUR/USD down 50 pips, gold down 30 and Dow jones down 150 in minutes ) when US 30 year bond auction result came out. I have attached bloomberg chart for reference

After the stellar, record-sized 3Y and 10Y auctions earlier this week, moments ago the Treasury concluded refunding week with another record auction, this time in the form of an all time high $26BN in 30Y bonds.

However besides the record auction size, today’s 30Y sale had nothing in common with this week’s prior coupon auctions both of which passed with flying colors, as this was without doubt the ugliest 30Y auction in years.

Pricing at a high yield of 1.406%, this was a 2.4bps tail to the 1.382 When Issued – the biggest tail since last July – and well above last month’s 1.357%.

The other metrics were far worse, however, with the Bid to Cover plunging from 2.50 to just 2.136, the lowest since July 2019 and one of the lowest on record.

The internals were even uglier, with Indirects plunging from 72% to 59.8%, the lowest since November and well below the 66.2% six-auction average. And with Directs taking down just 11.9%, it left Dealers holding a whopping 28.3% of the sale, the most since July 2019. 

I believe that investors have started asking for a higher premium to invest in long term US treasuries and today was just a glimpse.

If US treasuries gives market related yields at auction then the yields will blow out

If US treasuries does not want to give higher cutoff yield then Fed will have to buy the bonds by capping the yield curve and Dollar will tank

We are nearing the moment of truth because if Fed does not come to rescue all markets except US dollar will have a meltdown together