petec

Ok. I understand. But I wasn’t discussing investment merits either… Instead, I am not sure I would say humanity at the stage of development it has reached today only benefits from what’s ‘necessary’… Imo the more technological progress goes on, the more humanity will benefit from ‘great’ products. In the past the onset of negative rates has led to wars, hasn’t it? War has historically succeeded in accelerating the deleveraging process through defaults, and in causing inflation (and interest rates) to rise again. Right? It might be just wishful thinking… But let’s hope this time the deleveraging process might proceed from the building of wealth, instead of the defaulting of debts. And to build wealth you ‘need’ great products! Cheers, Gio Ha - excellent post! However I fear we have already shown that growth won't dig us out of this hole. Deflation, default, and cleared markets may be the only way - not, I hope, aided by war.

What do you mean? Both Apple and Google are examples of companies which create wonderful products. Banks instead are very useful, I agree. But I would not define their products nor services wonderful. Therefore, I don’t see how a comparison between something that’s ‘necessary’ and something that’s ‘wonderful’ might make much sense… Cheers, Gio The statement I agreed with was "I am quite sure without banks our life will be more miserable than without Apple and Google combined". Take Apple and Google away and I can't call my mum or waste time on tinterwebs. Take the banks away and we're back in 1932. I know which would make me more miserable!

Well that's sort of my point: when no-one wants to hold cash, and passes it on to the next person as fast as possible, you get a rise in the money velocity and, all else equal, inflation. Which is what the central banks think they want. You're assuming the cash has to be parked somewhere. That's exactly what the central banks are trying to stop. They want it to go round and round.

ni-co, My understanding is much of Chinese debt is internal, meaning that it is borrowed from domestic savers, not from foreigners. A lot was also dollar based - borrow at 1% in the US, lend at >>1% in China, minimal fx risk because of the peg = nice carry. Chinese GDP is over USD10tn, and some people peg Chinese debt as much as 3x GDP, or USD30tn. Whatever your "a lot" is, it's likely small when measured in China's scale. Yes, but not necessarily small when compared to: 1. Chinese borrowers' ability to repay in dollars 2. Chinese capital and current account flows 3. Chinese bank equity. These are the things that matter when it comes to whether China will have to devalue (which I believe they will). Bottom line: all EM's are having moderately serious issues with $ debt. Exactly. The inflowing dollars were converted into yuan (in the end the PBoC bought those dollars with newly printed yuan and invested them into US treasuries held as reserves). The capital, in form of newly printed yuan, found its way – through the regular and the shadow banking system (multiplier effect!) – into the Chinese economy. A lot of yuan denominated loans are directly or indirectly dependent on those capital flows. Now the flows are in reverse-gear and the multiplier effect works in the other direction, tightening credit conditions. Even worse, by trying to stabilize the yuan against the dollar (selling USD and buying yuan), China is actually tightening domestic money supply as well, thereby making the problem worse. +1

ni-co, My understanding is much of Chinese debt is internal, meaning that it is borrowed from domestic savers, not from foreigners. A lot was also dollar based - borrow at 1% in the US, lend at >>1% in China, minimal fx risk because of the peg = nice carry. Chinese GDP is over USD10tn, and some people peg Chinese debt as much as 3x GDP, or USD30tn. Whatever your "a lot" is, it's likely small when measured in China's scale. Yes, but not necessarily small when compared to: 1. Chinese borrowers' ability to repay in dollars 2. Chinese capital and current account flows 3. Chinese bank equity. These are the things that matter when it comes to whether China will have to devalue (which I believe they will). Bottom line: all EM's are having moderately serious issues with $ debt.

1. Handelsbanken's AR suggests corporates are starting to pull deposits. 2. There are lots of options - bonds, stocks, real estate, gold etc. 3. Yes. One of the small Swiss banks already has I believe. 4. Yes - or raising borrowing costs which I believe has happened in Switzerland. Agreed re banks vs. Apple and Google! I don't think NIRP stops banks from functioning per se - but I do think it makes life very hard for them and crucially I think it has all sorts of unintended consequences. Perhaps most importantly it makes it abundantly clear that easy money hasn't created "escape velocity".

ni-co, My understanding is much of Chinese debt is internal, meaning that it is borrowed from domestic savers, not from foreigners. A lot was also dollar based - borrow at 1% in the US, lend at >>1% in China, minimal fx risk because of the peg = nice carry.

On a slightly different note I was reading Handelsbanken's annual report over the weekend and was struck by their 21% CT1 ratio and 27% total capital ratio. This is far higher than the banks I usually look at in the emerging markets. However, their assets/equity ratio is nearly 20x, which is far higher. Point being, the risk weights assigned to European bank assets are much lower - I'm not sure if this is still the case but a couple of years ago Greek government debt carried a 0% risk weight, which doesn't happen in EM even where the local government is far more creditworthy than Greece - making the capital ratios nonsensical. None of this is a knock on Handelsbanken which is an outstanding bank.

Two separate debates here IMHO. First, to prove the hollowing out thesis you would need to show that companies invest a smaller proportion of their cash flow into growth/maintenance capex than they used to. I believe I have seen this data, but I can't remember where. Either way, I would argue that there is a dangerous incentive at the moment for executives to issue themselves stock options, borrow cheaply to pump their stock, and take a whacking pay packet at a nice low capital gains tax rate. It would be very interesting to know how many of those same executives are taking out cheap loans *personally* (secured, perhaps, against their ill-gotten stock) to buy more equity. I'm guessing not many. Second, I would say that what caused the last two crashes (and the next one) was the bubble that preceded them, and that was caused by too-easy money. That has nothing to do with trying to grow, and everything to do with the rather strange idea that although prices of individual goods ought to be set in a free market of willing buyers and willing sellers, prices of goods in aggregate should be set by all-knowing, all-seeing bureaucrats in central banks. To put it another way: free markets incentivise a continual hunt for efficiency. That's a key part of how we make economic progress - we find out a way to do something using fewer resources, and direct the saved resources to something new. But if we are continually getting more efficient, shouldn't the price of a fixed basket of goods generally trend down over time? And if that is true, why do central banks target 2% inflation? And if they target inflation when there ought to be deflation, won't that mean that monetary policy is way too easy sometimes, and won't that create bubbles?

Nico my objections to that post are all on points of detail. I agree entirely with the general direction.

+1 Since it also fits this discussion I cross-link my thoughts on US banks from the BAC thread – apologies to those who follow them both because of the repetition: I completely agree with you on your big picture. What I'd point out – and I consider this as especially relevant for banks and their business model – is that cause of all this is the change in the long-term debt cycle. Debt is expanding and contracting in . At least since 2008, debt has been contracting all around the world, and all central banks (and governments) can do about it is trying to ease this contraction, which is what Ray Dalio has been saying – and been consistently right on – for many years now. It boggles my mind that he's been so spot-on with his model – correctly predicting the financial crisis, the CB action resulting from it, that QE wouldn't cause inflation, and now that CBs will be experiencing "pushing on a string" – and yet people are still blaming the CBs for everything that goes wrong (Dalio is literally the only fund manager out there who says that CBs are doing a good job. At the same time he is the most successful one – shouldn't this give people some pause?). If you take Dalio's model it's very clear that the banking business model is under siege. This is because of the long-term debt cycle contracting and this will remain the case for many years to come. So, NIM won't come back for a very long time. Of course, banks will always be needed and they will figure out how to do their business in a contracting debt cycle but this is going to be a very painful process. Against this background, being a bank shareholder seems to be a bad risk/reward proposition – even in the long term. In my view, people who are expecting BAC, or any other bank, to simply go back to normal like it was in the 1990s or early 2000s are delusional because they completely miss this big picture. The late 1930s and the 1940s provide a far better model to think about the challenges and risks that banks will be facing in the coming one or two decades. When you view the world through Dalio's eyes everything that's happening right now with banks is completely logical and not surprising in the least. Brushing this aside as "ZH talk" is ignorant at best. I don't say that you have to follow this model but at least acknowledge that it exists and that it provides what seems to be a logical explanation for what is going on right now. Since I am a value investor at heart it took me some time to internalize this model for the really big picture. But ever since, it has been extremely useful and rewarding. Ni-co, totally agree with the thrust of your post and the use of the 1930s as a model. Also interested by your last sentence, because I went down the same path from thinking macro was unpredictable and didn't matter to thinking it might, at this point in time, be the only thing that matters. What I don't agree with is the idea that debt has been contracting since 2008. That is true for the US consumer (though their debt levels remain fairly high). It is not true for just about anything else: DM governments and companies, and EM everything. The world is far more levered now than it was in 2008, and we have seen huge inflation as a result (mainly in asset prices but also in CPI if you use the 1980 method of calculating it - I'm not arguing that the method is correct, just that inflation compared with the past has been running much higher than we think www.shadowstats.com). What I fear is that world debt is *now* starting to contract, driven by natural debt limits and also by Fed tightening while the other major central banks (ECB, PBOC, BOJ) are easing - this is driving a huge carry trade unwind. That is deflationary, and so might the initial response (NIRP) be.

Fingers crossed - I imagine it'd still get caught up in a massive sell-off in which everything is liquidated indiscriminately, but the behavior we've seen YTD is suggesting this won't be a 2008 scenario where they're minting billions that you can buy for 50% off. Agreed. So far I've broken even (in sterling, not dollars) in this selloff because of Fairfax. I'm mildly nervous that won't continue.

Svenska Handelsbanken comes to mind. But personally I wouldn't touch a bank in a NIRP environment. Nor would I touch WFC because I think the risk of NIRP in the US is significant. Much as I love Wells.

Nah...he forgot to say "except Fairfax" ;)

LUK

Funny, I have been thinking about buying some barbarous relic for the first time.

Excellent summary of China from Kyle Bass: http://finance.yahoo.com/news/kyle-bass-china-running-money-202853355.html Conclusion (as you might have guessed) is that China has no choice but to weaken its currency, which will be very deflationary for the US and Europe.

Grey, do you have a summary of Euro banks leverage vs US banks? thanks Pete

Just trying to think the effects of -ve rates through further. I see several possibilities and none of them are good. 1. Banks earn a -ve spread and either have to raise fees or take losses which impair their capital ratios. 2. Banks pull reserves from the central bank and make loans, but the world is so leveraged that an unpleasantly high proportion will go bad, so the banks impair their capital ratios. 3. Banks pass -ve rates onto depositors which creates a bank run. This is a big assumption but it only takes a few withdrawals to start a run - and I'm sure that 2% or 4% or 6% of depositors will decide they have better options than paying the bank to guard their money. That's enough to start a run at the weaker banks - especially if the banks have to pull in nonperforming loans and take losses. This has the potential to trigger a deflationary crisis. What am I missing here? I'm deeply bearish and sceptical of central bankers but surely there is a more positive outcome that they are hoping for?! On a related topic, the US banking system looks pretty sturdy after 7 years of building deposits faster than loans. Where are the Europeans on this front?

Thanks. This man is fast becoming one of my heroes.

Petec, I'm not entitled to reply on behalf of SharperDingaan - he is certainly capable of doing that for himself. I'll just mention here, that personally I read SharperDingaan's last post in this topic as a reference to the terms of the bonds, that DB is rumored to be buying back at the moment [most likely at a loss for the sellers], compared to buying DB preferred - at an earlier moment. Oh so did I and I agree with everything he wrote. My point (poorly expressed perhaps) is that I see the extraordinary reaching for yield that drives demand for these daft securities (what SD referred to as desperation) as being purely down to some incredibly poor government/central bank policy. And yes, before anyone asks, that does mean I think we need to take some deflationary (in the broad bubble sense, not the narrow CPI sense) pain and central banks need to allow that.

Desperate? No, you just have to live in a world that's been really, really fucked up by central bankers out to prove pet theories.

If it is a significant amount and for a long time, 4% won't affect your eventual outcome.

Yes - having actually read the piece (sorry!) it's entirely about Hussman's model for predicting future returns and not about CAPE. CAPE is merely one possible input to that model.

Quite. It's absurd to believe that P/normalised earnings on an individual stock basis might be meaningful (and as value investors we all believe that) but P/normalised earnings for the market isn't.