European Banking Crisis?

[JBTC]

JBTC I think we have been arguing at cross-purposes.  I agree with your post and wasn't trying to argue that foreign debt is the key problem (although it is a problem).

 

What I would question within your post is the continued competitiveness of Chinese manufacturing.  We know their currency has appreciated vs competitors, that salaries have risen fast, that urbanisation has reversed (indicating fewer manufacturing and other jobs in cities). 

 

My understanding is that the only reason the trade balance is OK is because imports are falling even faster than exports!  Jan -18% and -11% for example.  Neither looks good.

 

I agree. So China's manufacturing competitiveness has eroded somewhat compared to its past.

 

But it remains mostly competitive to both the DM countries (lower cost) and EM countries (unparalleled scale, supply chain, infrastructure, worker quality).

 

I suspect even taking out the benefit of lower commodities/oil, China will continue to run surplus.

 

 

[petec]

Other assets are not replacements for cash. You can buy stocks from me, but then I am stuck with the cash. I can buy a house, then the seller is stuck with cash. The cash has to be somewhere. If not in the bank, where?

 

 

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.

 

First of all, is it happening? As rates have come down, has money velocity gone up? I want to know.

 

Second, if it is and somehow causing inflation, that's great news isn't it? Because we can finally get rid of negative rates.

 

Back to normal - whew!

 

I actually don't completely discount the possibility of seeing inflation. Maybe that's the ultimate contrarian trade.

 

Call me biased but I don't quite like the negative rates death spiral seemingly unfolding before us...

 

No it is not happening - the question is, is that because it won't happen, or because -ve rates have not been passed on to depositors yet? 

 

BTW see my edited post above for idea about specialist firms setting up vaults - might answer your question!

 

Re inflation and therefore positive rates, I'm not so sure.  You'd get (even more) inflation in the prices of real assets; but would that get into CPI, which is what CBanks look at?  In other words, if it works NIRP just inflates the bubble further (remember that von Mises quote about needing to throw ever more fiduciary media on the fire to keep a bubble going) and if it doesn't it's actively contractionary and starts the bust.

 

That's my view so I don't like it either!

[petec]

JBTC I think we have been arguing at cross-purposes.  I agree with your post and wasn't trying to argue that foreign debt is the key problem (although it is a problem).

 

What I would question within your post is the continued competitiveness of Chinese manufacturing.  We know their currency has appreciated vs competitors, that salaries have risen fast, that urbanisation has reversed (indicating fewer manufacturing and other jobs in cities). 

 

My understanding is that the only reason the trade balance is OK is because imports are falling even faster than exports!  Jan -18% and -11% for example.  Neither looks good.

 

I agree. So China's manufacturing competitiveness has eroded somewhat compared to its past.

 

But it remains mostly competitive to both the DM countries (lower cost) and EM countries (unparalleled scale, supply chain, infrastructure, worker quality).

 

I suspect even taking out the benefit of lower commodities/oil, China will continue to run surplus.

 

Agreed.  The dollar-pegged yuan has been very strong against the major trading competition but it takes ages to re-orient a supply chain.  The bigger impact can be seen in the Chinese PPI figures - deflation there is keeping them in the game.  But that has to hit employment and creditworthiness internally.

[ni-co]

"Banks in Europe have started to pass on some of the cost of negative rates to big corporate depositors. Their only ready alternative to stashing large pots of cash is safe and liquid government bonds, whose yields have also turned negative, for terms of up to ten years in Switzerland. Rich personal-account holders are next. The boss of Julius Baer, a Swiss private bank, said this week that if interest rates in Europe go further into the red, it might have to charge depositors."

 

Which leads me right to the only real long investment (interest bearing asset) I want to make/have made for a few months (except some minor call LEAPs on LBTYA as a hedge): 30y US treasury bonds. Everywhere people are telling you that they are a very bad risk/reward bet at those low yields. Have they really thought about negative interest rates?

[Picasso]

I'm trying to figure out why investors on this board think a European financial crisis is looming or whatever.  I pulled up a total return index on Deutsche Bank since 1992 and I show a 14% nominal return when you include dividends.  Over that time frame the share count tripled so they just keep raising equity at the detriment to existing investors.  It's been an investing graveyard but we've gone through it many times and it's been fine.

 

How does that spell financial crisis?  A stock like DB continually round trips back and forth and as one of my friends who used to work there says, those guys are idiots who will lend to almost anything.  Worrying about stupid European bankers would have prevented you from investing in a lot of really good or inexpensive businesses/bonds for the past thirty years.  If some of these European stocks weren't trading crappy (as they've always done over history) I don't think people would come to the European crisis conclusions.  And if we didn't have 2008 fresh in our minds we would be even less likely to think that's around the corner. 

 

That's not to say these euro banks are not terrible investments.  But I don't see how we jump from crappy equity performance, crappy business models and write downs to financial crisis.  Investors in these banks will keep getting crappy returns just like they always have.  I don't think it's much more complicated than that. 

[Guest Grey512]

The way I see it, the thing that people are missing (ignoring?) here is the increasing probability of a global crisis of faith in central bankers' ability to steer the global economy / financial system. Again - bank equities are the ultimate reflexive asset class. Buying a bank stock is akin to going long on confidence in 'the system', which basically means Mario, Kuroda-san and Janet; this is similar to the idea that going long QQQ or long Google is to go long innovation.

 

The more people begin to doubt the central bankers' competence or power, the worse it is going to get for the banks. And this is before we even get to the whole 'the European Union is an unstable and unsustainable construct' argument (and I am firmly in that camp).

[Picasso]

Central banks are the nuclear option for problems the private market can't effectively solve on it's own without sending us back to the stone ages.  They're also supposed to smooth out the extreme of the economic cycles.  I don't think they're *supposed* to be effective at controlling the short term movements of the economy.  That's been sort of this new thing to combat slow growth which doesn't make a ton of sense to me.

 

I was telling someone that I'd rather pay 15% interest on a house that's undervalued than paying 0% on an asset which is way too expensive.  They seem to be driving people to buy up expensive assets regardless of their value and that's a problem.  Look at all the guys blown up on REIT's, MLP's, dividend stocks, etc.  You have to let the markets work out these problems, there isn't supposed to be an easy fix all the time.

 

I take the view that most bank equities are just a retarded investment regardless of what happens with the economy.  It's just classic tails you lose and heads the government wins and you still lose.  And central bank policy is just making it harder to be a bank so either they have to start making riskier loans or they'll be continually driven to less and less profits over time.  Why is the market just realizing this now and why do we jump to financial crisis conclusions?  There's too many variables before you get to that conclusion which makes it a very low outcome event imo.

[Picasso]

The way I see it, the thing that people are missing (ignoring?) here is the increasing probability of a global crisis of faith in central bankers' ability to steer the global economy / financial system.

 

I agree with this in that any equity market pops you get on central bank hope (new easing, lowering rates, etc.) should be shorted aggressively.  To me that's just weak money that's coming in on the tail end of the effective 2010-2014 policy.  I don't see how you can sustain any rallies on central bank easing versus real economic growth.  I don't think there's enough growth to justify a lot of valuations out there so it's a fairly safe short but I've been known to be wrong.

[ni-co]

The way I see it, the thing that people are missing (ignoring?) here is the increasing probability of a global crisis of faith in central bankers' ability to steer the global economy / financial system.

 

I agree with this in that any equity market pops you get on central bank hope (new easing, lowering rates, etc.) should be shorted aggressively.  To me that's just weak money that's coming in on the tail end of the effective 2010-2014 policy.  I don't see how you can sustain any rallies on central bank easing versus real economic growth.  I don't think there's enough growth to justify a lot of valuations out there so it's a fairly safe short but I've been known to be wrong.

 

And maybe there is your answer why it matters just now that European banks have a crappy business model and have never been recapitalized.

 

Why do we jump to crisis conclusions? Because we ran out of solutions for this banking problem. Central banks are pushing on a string. And the options that are discussed/applied now to "revitalize" the economy happen to be horrible for banks. At the same time, those banks have enormous balance sheets compared to their domestic economies. Is there even enough GDP in the EU to rescue all the large European banks?

 

Add to this that these banks are far too intertwined via swaps and derivatives with other banks worldwide to keep this just a Europe issue.

[Picasso]

If there's no growth, is that really the end of the world for European banks?  You could have made the same argument for Japanese banks for close to two decades before people gave up on that trade.  Except for Kyle Bass.  He decided to try his luck recently and get his ass kicked as well.  He looked at the leverage, low growth, bad demographics, low interest rates in Japan and came to the logical, first level thinking that JGB's were a short.  Well he got what he wanted out Japan (first sky rocketing oil + TEPCO + full on BOJ pushing on a string) and now rates are negative on those JGB's.  It's too hard to go from looking at this macro situation and making the bet to full financial crisis.  Guys like Kyle Bass or John Paulson had a once in a lifetime opportunity and everyone's now constantly trying to find the next one.  Hint: it'll be the thing people least expect.

 

As far as the exposure relative to the economy.  Well, isn't that the banks fault for taking on that kind of balance sheet?  No one is forcing them to do so.  If it ends up blowing up their institution then I'd expect the equity and preferred holders to eat it in the shorts.  In comparison 2008 happened too quickly (it went 0-60 faster than a La Ferrari), this is a slow moving train wreck that will be involve less lubricant and Netflix and chill before the action happens.  There's also 200 pages on the poor FNMA guys who are fighting against what happens when the government needs to step in and protect an asset when no one else has enough capital/courage to plug the hole.  Expect the ECB to change the rules mid-game, break up the offending banks in pieces that protect certain debt holders, screw the rest of the stakeholders, and do whatever is necessary now that they're pot committed with big central bank balance sheets.  They won't admit they made a mistake for a long time, this is just the path they've all chosen. 

 

If the relative size of these banks is problematic (seemingly every couple years these days) then they'll eventually be broken up, whether by force or necessity.  Let the crappy, more exposed banks take it in the shorts.  No one would really care about the bad bank spinoffs except the investors that were stuck holding the equity and debt of those banks.  And (in my opinion) that's their fault for still investing in these banks after we saw what happened in 2008 with FNMA and other entities.  It's not the end of the world and it doesn't need to create another financial crisis.  And it will take time to get to the point where the various governments would need to step in.  In the meantime these banks will earn whatever profit they can to offset the future losses that will prove once again that it makes no sense to invest in these institutions. 

 

The better short is probably the high yield debt in Europe.  It's going to catch up to the rest of the worlds high yield and there isn't a lot of liquidity in those bonds.  It was bid up on all this ECB easing but it doesn't mean it has the protection or lack of credit risk that the other EU member sovereign debt has.

 

Anyway I think there are other reasons to be negative on the market but financial crisis doesn't seem like one.  Maybe it's all too interconnected and it hits everyone but I think those types of events are once in a lifetime.  I'll have to give it to these central banks if they do it twice in less than ten years.  That would be quite the accomplishment worthy of a certificate of achievement.

[ni-co]

Maybe I didn't specify enough what I meant by financial crisis. I meant a crisis lead by financials, not a 1:1 repeat of 2007. I've been saying several times that "Japan" is the most likely outcome for Europe. In my mind, Japan has had a banking crisis for 30 years now and I don't think that you lost money by shorting Japanese banks… (Btw. I think Bass bought CDS on JGBs which didn't work out but at the same time he was massively short the yen – also saying that as long as JGBs don't implode the yen has to, which was correct – so I don't think he lost any money there though I'm not familiar with his performance numbers.)

[Picasso]

Last I looked his special Japan fund lost 80%.

 

I understand your viewpoint now. Thanks for clarifying. It seems like the downturn is being led by energy and maybe China more than the banking system. We won't know until we see some economic numbers in a year and by then prices will likely have adjusted to whatever reality is.

 

Edit: Some of the reports out there says he lost 61% the first year and then made 200% over the next couple years.  I don't know what to believe with Kyle Bass.  He's the kind of guy to go out and show the world how much he made on the trade if shorting Japan really made his investors over 200% but it could be possible, who knows.

[petec]

Picasso, I agree with most of what you've written.  But you ask why this structurally flawed banking system should be more prone to a crisis now than at any other time* and my answer is:

 

1. NIRP might cause a run on the banks. 

 

2. Global lending has run amok in the last 5 years so the probability of high loan losses is higher than normal.

 

These two could operate in a feedback loop - if NIRP causes loans to get called then banks can't extend-and-pretend.

 

More generally I would also point out that while overlevered and badly run banks usually avoid crises, banking crises do happen so it's not so odd to expect one where you can see all the warning signs!

 

*NB by now, I mean within the next 3-5 years.  That's about as good as I think you can get with macro timing.

[JBTC]

ni-co, great post.

 

A couple of questions:

 

1) So is this potential crisis being triggered mostly by negative interest rates, or are there other factors that have caused the kick-the-can-down-the-road approach by the Europeans to no longer work?

 

2) Assuming ECB knows what you know, is there anything they can do to forestall the crisis? Is there a way for us to tell if ECB sees what you see? I suppose they do talk to the banks they regulate.

 

Thanks for your insights.

 

So I asked this question a while back.

 

With the establishment already acknowledging the risk (head of OECD speaking on Bloomberg), what could /should/will the regulators and governments do?

 

The level 1 thinking is the negative rates are leading to a bank crisis.

 

The level 2 thinking may be 1) how much of this is reflected, when leading European bank stocks are at a 30-year low? 2) Could ECB etc do something to soften the crisis?

 

The longs need to ask the question, and the shorts need to think even harder about this.

 

 

[ni-co]

ni-co, great post.

 

A couple of questions:

 

1) So is this potential crisis being triggered mostly by negative interest rates, or are there other factors that have caused the kick-the-can-down-the-road approach by the Europeans to no longer work?

 

2) Assuming ECB knows what you know, is there anything they can do to forestall the crisis? Is there a way for us to tell if ECB sees what you see? I suppose they do talk to the banks they regulate.

 

Thanks for your insights.

 

So I asked this question a while back.

 

With the establishment already acknowledging the risk (head of OECD speaking on Bloomberg), what could /should/will the regulators and governments do?

 

The level 1 thinking is the negative rates are leading to a bank crisis.

 

The level 2 thinking may be 1) how much of this is reflected, when leading European bank stocks are at a 30-year low? 2) Could ECB etc do something to soften the crisis?

 

The longs need to ask the question, and the shorts need to think even harder about this.

 

1) OM posted a long list of possible drivers for this crisis. I think negative rates are the most important one because they take the last hope for European banks to grow their way out of their bad balance sheets.

 

2) I'm guessing that banks are top priority on the ECB list of issues and have been for quite some time because they are inextricably linked to Europe's sovereign debt problem. I don't see what the ECB can do long-term. Short-term they could buy the bank bonds, especially the hybrids. They could infuse equity. But everything they can do along those lines only lengthenes the malaise. I don't see how they can really restructure the banks. They try it with QE but I don't see how this could possibly be a long-term solution. Even if they could restructure the banks in US fashion I don't see how they can do it without effectively wiping out shareholders.

 

The longs have to 1) think of a long-term solution for Europe's sovereign debt problem, 2) have to be very positive about the effectiveness of QE and negative interest rates, and 3) offer even a short-term solution that doesn't lead to them being wiped-out (or at least hugely diluted).

 

As a short, I only have to pass this last hurdle. I don't think there is a short-term solution where shareholders won't be massively diluted.

 

So, when you, as a (potential) shareholder, are in danger of being wiped-out does it really matter that we are at 30 year lows? The way from here to zero is a 100% loss of your capital invested. People confuse the necessity of having banks and inevitability of "too big to fail" with the necessity of having them in their current form with their current shareholder base. Look at BAC or C – when you bought them before 2007, did it really help you as a shareholder that your bank was "rescued"? Sometimes the consensus is right and second or third level thinking ends at the same results like first level thinking. Obviously I could be completely wrong here but I wouldn't lose that much in this event. Risk/reward is skewed to the downside here.

[JBTC]

ni-co, great post.

 

A couple of questions:

 

1) So is this potential crisis being triggered mostly by negative interest rates, or are there other factors that have caused the kick-the-can-down-the-road approach by the Europeans to no longer work?

 

2) Assuming ECB knows what you know, is there anything they can do to forestall the crisis? Is there a way for us to tell if ECB sees what you see? I suppose they do talk to the banks they regulate.

 

Thanks for your insights.

 

So I asked this question a while back.

 

With the establishment already acknowledging the risk (head of OECD speaking on Bloomberg), what could /should/will the regulators and governments do?

 

The level 1 thinking is the negative rates are leading to a bank crisis.

 

The level 2 thinking may be 1) how much of this is reflected, when leading European bank stocks are at a 30-year low? 2) Could ECB etc do something to soften the crisis?

 

The longs need to ask the question, and the shorts need to think even harder about this.

 

1) OM posted a long list of possible drivers for this crisis. I think negative rates are the most important one because they take the last hope for European banks to grow their way out of their bad balance sheets.

 

2) I'm guessing that banks are top priority on the ECB list of issues and have been for quite some time because they are inextricably linked to Europe's sovereign debt problem. I don't see what the ECB can do long-term. Short-term they could buy the bank bonds, especially the hybrids. They could infuse equity. But everything they can do along those lines only lengthenes the malaise. I don't see how they can really restructure the banks. They try it with QE but I don't see how this could possibly be a long-term solution. Even if they could restructure the banks in US fashion I don't see how they can do it without effectively wiping out shareholders.

 

The longs have to 1) think of a long-term solution for Europe's sovereign debt problem, 2) have to be very positive about the effectiveness of QE and negative interest rates, and 3) offer even a short-term solution that doesn't lead to them being wiped-out (or at least hugely diluted).

 

As a short, I only have to pass this last hurdle. I don't think there is a short-term solution where shareholders won't be massively diluted.

 

So, when you, as a (potential) shareholder, are in danger of being wiped-out does it really matter that we are at 30 year lows? The way from here to zero is a 100% loss of your capital invested. People confuse the necessity of having banks and inevitability of "too big to fail" with the necessity of having them in their current form with their current shareholder base. Look at BAC or C – when you bought them before 2007, did it really help you as a shareholder that your bank was "rescued"? Sometimes the consensus is right and second or third level thinking ends at the same results like first level thinking. Obviously I could be completely wrong here but I wouldn't lose that much in this event. Risk/reward is skewed to the downside here.

 

I don't have any European bank shares, but the impending wipeout of US bank stocks, should negative rates come to the US, does worry me a little. I also own BRK, which would suffer badly given it's stuffed with bank shares.

 

But I feel the demand for the so-called long-term solutions for either European banks or sovereign debt (or frankly most important matters in the world) is misguided. The world's big problems are never solved in one go.

 

Right now, it feels like the crisis is mostly in investor confidence - we haven't seen any bank runs yet, have we? What the governments and central banks need to do is to provide a short-term solution and calm the markets.

 

If ECB does believe healthy banks are critical for the recovery in the European economy, maybe they could create new laws and regulations to allow the banks to gradually earn more profits and improve capital. Perhaps they could mandate certain bands between deposit and borrowing rates to make sure banks' NIM is wide enough. They could relax rules on how banks charge the customers on accounts and transactions.

 

The government's job is to maintain stability and growth, and to allocate resources between different sectors. If banks are essential for modern life, then it must support the banks by taxing other economic sectors.

 

I am not saying these are the steps to be taken. I have no clue. But I generally don't like the end of the world scenarios. If things are bad enough, solutions will come up.

 

 

[ni-co]

I don't have any European bank shares, but the impending wipeout of US bank stocks, should negative rates come to the US, does worry me a little. I also own BRK, which would suffer badly given it's stuffed with bank shares.

 

But I feel the demand for the so-called long-term solutions for either European banks or sovereign debt (or frankly most important matters in the world) is misguided. The world's big problems are never solved in one go.

 

Right now, it feels like the crisis is mostly in investor confidence - we haven't seen any bank runs yet, have we? What the governments and central banks need to do is to provide a short-term solution and calm the markets.

 

If ECB does believe healthy banks are critical for the recovery in the European economy, maybe they could create new laws and regulations to allow the banks to gradually earn more profits and improve capital. Perhaps they could mandate certain bands between deposit and borrowing rates to make sure banks' NIM is wide enough. They could relax rules on how banks charge the customers on accounts and transactions.

 

The government's job is to maintain stability and growth, and to allocate resources between different sectors. If banks are essential for modern life, then it must support the banks by taxing other economic sectors.

 

I am not saying these are the steps to be taken. I have no clue. But I generally don't like the end of the world scenarios. If things are bad enough, solutions will come up.

 

I wouldn't say that I disagree with you. The only thing I would add is that is this: What are they (politicians) going to do to make sure banks survive? Of course they could change the laws and let the banks earn more by making bank customers pay for it. But what this means politically is taking money from customers and giving it to 1) bankers and 2) current bank shareholders. How large are the probabilities for this policy change to happen?

[JBTC]

I don't have any European bank shares, but the impending wipeout of US bank stocks, should negative rates come to the US, does worry me a little. I also own BRK, which would suffer badly given it's stuffed with bank shares.

 

But I feel the demand for the so-called long-term solutions for either European banks or sovereign debt (or frankly most important matters in the world) is misguided. The world's big problems are never solved in one go.

 

Right now, it feels like the crisis is mostly in investor confidence - we haven't seen any bank runs yet, have we? What the governments and central banks need to do is to provide a short-term solution and calm the markets.

 

If ECB does believe healthy banks are critical for the recovery in the European economy, maybe they could create new laws and regulations to allow the banks to gradually earn more profits and improve capital. Perhaps they could mandate certain bands between deposit and borrowing rates to make sure banks' NIM is wide enough. They could relax rules on how banks charge the customers on accounts and transactions.

 

The government's job is to maintain stability and growth, and to allocate resources between different sectors. If banks are essential for modern life, then it must support the banks by taxing other economic sectors.

 

I am not saying these are the steps to be taken. I have no clue. But I generally don't like the end of the world scenarios. If things are bad enough, solutions will come up.

 

I wouldn't say that I disagree with you. The only thing I would add is that is this: What are they (politicians) going to do to make sure banks survive? Of course they could change the laws and let the banks earn more by making bank customers pay for it. But what this means politically is taking money from customers and giving it to 1) bankers and 2) current bank shareholders. How large are the probabilities for this policy change to happen?

 

If the alternative is not having a properly functioning banking industry, I have to say the probability of getting government support is 100%. That is their job.

 

If the banking industry's survival is threatened by negative rates, which is a result of central bank policy, of course central banks have every reason to support the banks.

 

This is entirely different from the last financial crisis, where the banks were regarded as the bad guys who caused the entire mess.

 

In fact, ECB could issue one sentence to completely reverse the market sentiment:

 

Given the importance of a well functioning banking industry, ECB is prepared to inject capital of whatever amounts required in the major financial institutions, in terms that are fair and supportive to all existing debt and stock holders.

 

If the purpose is not to punish the debt and stock holders, no one needs to be wiped out.

 

The crisis will be over after this statement.

 

 

[ni-co]

QE or negative rates?—Pick your poison.

 

The German Council of Economic Experts said negative rates are devastating for German savings banks, Landesbanken and credit cooperatives, which rely on interest income for almost 80pc of total earnings.

 

Morgan Stanley said that once negative rates fall below 0.2pc, the damage to bank earnings goes "exponential" and ultimately endangers the whole system of free banking in Europe that we take for granted.

 

The policy is a tax on excess bank reserves and "effectively a tax on QE itself". The more the ECB steps up QE, the more it increases those excess reserves and the greater the burden on banks caused by negative rates. The construction is becoming absurd.

 

Worse yet, negative rates are a creeping threat to civil liberties since the only way to enforce such a regime over time is to abolish cash, for otherwise people will move their savings beyond reach. Mao Zedong briefly flirted with the idea during the Cultural Revolution in his bid to destroy every vestige of China's ancient culture, but even he recoiled.

 

http://www.telegraph.co.uk/finance/economics/12160280/Negative-interest-rates-are-a-gigantic-fiscal-failure.html

[petec]

 

The crisis will be over after this statement.

 

Will it, though?  You have just created untold moral hazard and dramatically raised the probability of harmful inflation.

[JBTC]

 

The crisis will be over after this statement.

 

Will it, though?  You have just created untold moral hazard and dramatically raised the probability of harmful inflation.

 

By now you should know that the global governments are dying to get inflation. Getting sufficient inflation is the key central bank objective everywhere.

 

The question investors face is not what the central banks want - it's if they can eventually succeed.

 

For now the markets have decided that no matter what the central banks try to do, we will not get inflation; we will get deflation instead.

 

I keep an open mind and am keen to find out.

 

 

[petec]

JBTC,

 

I totally agree it's what central banks want.  What I am arguing is that it might feel like a crisis when we get it - although I accept your point that the central banks could stop a *banking* crisis that way, I'm saying I don't think they can stop an *economic* crisis that way. 

 

I very much doubt the markets have really decided we will get deflation.  The bond markets might have done but are hugely distorted by central bank policy; but I do not believe equities are pricing in *either* deflation or inflation over say 4%.

 

As you suggest, the future looks interesting!

[TwoCitiesCapital]

JBTC,

 

I totally agree it's what central banks want.  What I am arguing is that it might feel like a crisis when we get it - although I accept your point that the central banks could stop a *banking* crisis that way, I'm saying I don't think they can stop an *economic* crisis that way. 

 

I very much doubt the markets have really decided we will get deflation.  The bond markets might have done but are hugely distorted by central bank policy; but I do not believe equities are pricing in *either* deflation or inflation over say 4%.

 

As you suggest, the future looks interesting!

 

Markets are nowhere close to pricing in deflation. We'd see equity markets fall SIGNIFICANTLY more than we have if a deflationary scare was considered to be a credible threat. Further, there are market-based indicators of inflation expectations like TIPS breakevens (the differential between TIPS yields and nominal treasuries). 10-year breakevens in the U.S. are around 1.25%. That literally means the market is pricing in 1.25% in U.S. annual inflation for the next 10 years. That is the lowest since the inception of the TIPS market (if I'm not mistaken), but it's  FAR, FAR cry from pricing in actual deflation as I've seen many suggest.

 

For some reason, people seem to think a 15% decline in an equity index and a 50 basis point rally in bond yields suggests the markets have priced in a healthy amount of deflationary fears. In reality, we'd need something on par with 2008 for a deflationary episode to be truly priced in.

[ni-co]

JBTC,

 

I totally agree it's what central banks want.  What I am arguing is that it might feel like a crisis when we get it - although I accept your point that the central banks could stop a *banking* crisis that way, I'm saying I don't think they can stop an *economic* crisis that way. 

 

I very much doubt the markets have really decided we will get deflation.  The bond markets might have done but are hugely distorted by central bank policy; but I do not believe equities are pricing in *either* deflation or inflation over say 4%.

 

As you suggest, the future looks interesting!

 

Markets are nowhere close to pricing in deflation. We'd see equity markets fall SIGNIFICANTLY more than we have if a deflationary scare was considered to be a credible threat. Further, there are market-based indicators of inflation expectations like TIPS breakevens (the differential between TIPS yields and nominal treasuries). 10-year breakevens in the U.S. are around 1.25%. That literally means the market is pricing in 1.25% in U.S. annual inflation for the next 10 years. That is the lowest since the inception of the TIPS market (if I'm not mistaken), but it's  FAR, FAR cry from pricing in actual deflation as I've seen many suggest.

 

For some reason, people seem to think a 15% decline in an equity index and a 50 basis point rally in bond yields suggests the markets have priced in a healthy amount of deflationary fears. In reality, we'd need something on par with 2008 for a deflationary episode to be truly priced in.

 

I think what matters is direction and it's been going south for 40 years. Yes markets aren't pricing it in today but, as you said, once they price it in the game is over. The China debt bubble imploding has more than enough potential to drag the rest of the world into deflation. I also think that a lot of market participants (but not yet the majority) sense this.

[JBTC]

JBTC,

 

I totally agree it's what central banks want.  What I am arguing is that it might feel like a crisis when we get it - although I accept your point that the central banks could stop a *banking* crisis that way, I'm saying I don't think they can stop an *economic* crisis that way. 

 

I very much doubt the markets have really decided we will get deflation.  The bond markets might have done but are hugely distorted by central bank policy; but I do not believe equities are pricing in *either* deflation or inflation over say 4%.

 

As you suggest, the future looks interesting!

 

Markets are nowhere close to pricing in deflation. We'd see equity markets fall SIGNIFICANTLY more than we have if a deflationary scare was considered to be a credible threat. Further, there are market-based indicators of inflation expectations like TIPS breakevens (the differential between TIPS yields and nominal treasuries). 10-year breakevens in the U.S. are around 1.25%. That literally means the market is pricing in 1.25% in U.S. annual inflation for the next 10 years. That is the lowest since the inception of the TIPS market (if I'm not mistaken), but it's  FAR, FAR cry from pricing in actual deflation as I've seen many suggest.

 

For some reason, people seem to think a 15% decline in an equity index and a 50 basis point rally in bond yields suggests the markets have priced in a healthy amount of deflationary fears. In reality, we'd need something on par with 2008 for a deflationary episode to be truly priced in.

 

I think what matters is direction and it's been going south for 40 years. Yes markets aren't pricing it in today but, as you said, once they price it in the game is over. The China debt bubble imploding has more than enough potential to drag the rest of the world into deflation. I also think that a lot of market participants (but not yet the majority) sense this.

 

I really think we (investors/media) tend to over use the word "crisis", which implies the past was all piece and nice, which is just not the case. If you read history, the world appears to be in some sort of crisis all the time. It gets out of one, and gets in another. Life is messy, not just now, but always.

 

Regarding China, I humbly suggest that we are unlikely to see anything "imploding". China has deep problems. But the most likely outcome is stagnation - there will be no growth other than being reported. It may be a bit like Japan in the past few decades. But China has a much more powerful state, which can impose a lot more control on the economy. Of course that's not good, but don't hold your breath for a "Lehman" moment.

 

Much more importantly, we all agree the world has a debt problem, and we all fear deflation (even if it's not fully priced in). This is where our fear becomes slightly illogical.

 

This is because the deadly combo of debt plus deflation guarantees that debt grows faster and faster until the end of our civilization. So the society as a whole, which includes the central bankers, cannot allow this to happen.

 

The quickest way to deal with this is debt forgiveness. Greece and subprime borrowers no longer need to pay! For all sorts of reasons no one wants this to happen.

 

The only option left is to bring in inflation, which will gradually inflate the debt away and restore the world's balance sheet.

 

Dare I say that if this is indeed the only option facing the world, it has a decent chance of happening eventually?