Monday, July 30, 2012 – A Convergence of Central Bankers

A Convergence of Central Bankers
-by Sinclair Noe

DOW – 2 = 13,073
SPX – 0.67 = 1385
NAS – 12 = 2945
10 YR YLD -.05 = 1.50%
OIL – .11 = 89.95
GOLD – 1.70 = 1622.90
SILV +.39 = 28.28
PLAT + 5.00 = 1422.00

This week features a convergence of central bankers: the ECB, the BOE, and the Fed; toss in a jobs report to finish the week and the fate of the global economy hangs in the balance. Maybe, maybe not;what we can say is that the game of kick the can down the road is running out of road. A quarter point rate cut from the ECB will not satisfy anybody. ECB President Mario Draghi has promised to do whatever it takes; now he is being put to the test. Germany will be required to step up; the ECB will be required to function as a global central bank and throw off its limitations. If Draghi and the ECB can’t control the downward spiral of the debt debacle in Spain and Italy, the entire global economy could start to crumble. Too dramatic? Consider China, India and Brazil are facing slower economic growth and a broken credit cycle; the US is facing the prospect of a fresh round of QE or some other tool to lift us out of a downturn – and let’s not even spend time today on the fiscal cliff. 

The International Monetary Fund issued this warning:  “the euro area crisis has reached a new and critical stage … raising questions about the viability of the monetary union itself. The adverse links between sovereigns, banks, and the real economy are stronger than ever.”

So far, we’ve seen the playbook of how not to rescue the Euro-zone. Draghi tried a trillion dollar lending program directly to the banks; the idea was for the banks to buy sovereign debt; the results resembled a drowning man flailing in the water and dunking the lifeguard sent to rescue him. The ECB has set up various funds, such as the ESM and the EFSF but those bailout funds haven’t been funded; it is hard to take them seriously. Hedge funds know how much funding the rescue funds hold, and they are willing to push the limits. Underfunding is just like handing over a bet to the hedge funds. So, one idea is to really fund the rescue funds. We’ll see. 

Spain and Italy will need about $1.5 trillion dollars over the next couple of years but the problem is that the money doesn’t really exist. Germany will be asked to step up but there might be some hesitation; call it bailout fatigue in Germany, Holland and France. Germans would not have joined the EU without assurances that their hard-won prosperity would remain in their control. The idea of a “transfer union” has loomed large in the German psyche for years, and not in a good way. Likewise, there are limits to the discipline Spain and Italy might be willing to accept from the German paymasters; Greece has already reached its limits. 

Today, US Treasury Secretary Tim Geithner met with German Finance Minister Wolfgang Schauble and then they issued a statement: Both expressed confidence in Euro area member states’ efforts to reform and move towards greater integration. They discussed the considerable efforts undertaken by Spain and Italy, to pursue far-reaching fiscal and structural reforms. 

Both the ECB and BOE will release their policy prescriptions Thursday. Draghi has promised he’ll do whatever it takes. He has vowed that action is coming and we should believe him – it will be enough. Now we hear that whatever Draghi up his sleeve will likely take a while to implement, at least a month, maybe more. And we’re most likely talking about bond purchases; which does nothing to solve the fundamental economic problems. Spain has unemployment of more than 25%.  Bond purchases will not create new jobs. Draghi has done better at resisting the austerity hawks than his predecessors. Europe needs to reverse its austerity policies, to take shared responsibility for dealing with the legacy debt of its weaker members, and to turn the ECB into a true central bank. None of this is likely to happen. Draghi does not have the leverage or the will to reverse Europe’s larger economic systemic flaws and prevent a slide into depression.

What this means is that the Euro probably won’t disintegrate this week. The central bankers have an uncanny ability to kick the can down the road for much longer than it seems possible – it’s what they do.

And then on Friday, we get the monthly jobs report. Net hiring likely rose by about 110,000 last month. It is modest but it is still a positive number. The biggest source of economic growth is consumer spending, but Americans have cut back over the past few months. The latest reading on personal spending and income, released Tuesday, is expected to show barely any increase at all in July. The economy cannot grow much faster until businesses step up hiring, but companies won’t add workers unless customers boost purchases of their goods and services. The result: a shackled economy unable to break free and expand rapidly and unemployment hovering around 8.2%. 

Of course, part of the Federal Reserve’s mandate is for maximum employment. So, what is the Fed going to do to help the jobs picture? The Federal Reserve is holding a two day meeting this week. Will they make some announcement, such as a reduction in what they pay member banks to park excess reserves? How about a pledge to keep rates in the zero range until the cows come home? Will that be enough? Will it actually change the jobs picture? Probably not. So the Fed will likely hold off on major stimulus such as more asset purchases, to get a better sense of whether the economy is in a soft patch or in deeper trouble.

There is no clear consensus on how the central bankers will respond. It seems increasingly likely that the ECB and the Fed will not act with bold moves and only the disappointment will be big.  Policy makers are predisposed to incrementalism. Most problems will fade away or self-correct if they are ignored. Policy makers always assume that they can do more if needed, but they can never undo what they’ve already set in motion. The IMF says the problems in Europe will be prolonged and costly – in other words, the banks will be sucking money out of the economy for as long as they can get away with it.  Political compromise naturally leads to small steps. That is usually true, remarkably and infuriatingly true – right up until the instance it fails. 

It is my sincere hope that one day we will be able to see the banksters repent for the wrongs they have committed and then go forth and sin no more. Today, the Hong Kong and Shanghai Banking Company was repenting. HSBC apologized for  “shameful” systems breakdowns that failed to stop the bank from laundering money for terrorists and drug barons as it set aside $700 million for potential fines in the US and another $1.3 billion for mis-selling financial products in the UK.

The bank insisted that those responsible for the rule breaches in the US and Mexico had left the business and that bonuses had been clawed back from staff who allowed billions of illegal dollars to be funneled through the financial system. The bank is also caught up in the Libor rigging scandal but did not make a provision for any potential fine or legal cases.

Edward Yardeni of Yardeni Research in this week’s Barron’s:
“The problem with banks is that they tend to blow up on a regular basis. That’s because bankers are playing with other people’s money (OPM). They consistently abuse the privilege and shirk their fiduciary responsibilities. Whenever they get into trouble, government regulators scramble to bail them out first and then scramble to regulate them more strictly. Without fail, the bankers respond to tougher rules by using some of the OPM to hire financial engineers and political lobbyists to figure out ways around the new regulations.

“…banks are the Achilles’ heel of capitalism. They really do need to be regulated like utilities if their liabilities are either explicitly or implicitly guaranteed by the government, i.e., by taxpayers. Banks should be permitted to earn a very low utility-like stable return. Bankers should receive compensation in the middle of the pay scale for government employees, somewhere between the pay of a postal worker and the head of the FDIC. It should be the capital markets, hedge funds, and private-equity investors that provide credit to risky borrowers instead of the banks.”

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