#banks

The Fed firemen are also the arsonists

Jim Grant of Grant’s Interest Rate Observer has a great article pointing out the irresponsibility of the US Fed. It criticises the very conditions that made the outcomes of coronavirus way worse than had they administered sensible monetary policies decades ago. FNF Media has been saying this for years. Now we are facing long overdue nemesis. It is true of the overwhelming majority of unimaginative MMT ‘me too’ central banks.

Grant wrote,

It took a viral invasion to unmask the weakness of American finance. Distortion in the cost of credit is the not-so-remote cause of the raging fires at which the Federal Reserve continues to train its gushing liquidity hoses…But the firemen are also the arsonists. It was the Fed’s suppression of borrowing costs, and its predictable willingness to cut short Wall Street’s occasional selling squalls, that compromised the U.S. economy’s financial integrity.

FNF Media keeps on hearing tales about the failure of evil capitalism. When the actions of central banks stifle the free market from achieving price discovery, distorted capitalism will inevitably backfire.

From hereon, sharp pain will be the only effective – and quickest – way to resolve this mess. Governments need to ensure bad companies go bankrupt by rejecting bailout money to zombie companies that will just be a drag on the economy.

Instead of doling out tax dollars, the government should take equity in any business that receives money. Taxpayers deserve a return and by this methodology, it will enforce a mindset that always rejects propping up companies with failed business models. Instead of the government calling the shots, the expertise of commercial lenders should be tapped, a valid point made by Jonathan Rochford.

Unfortunately, this will cause huge short-term disruption and impact large swathes of the community but it will allow markets to clear and provide a platform for risk to be priced appropriately. It is like yanking off a Band-Aid. It stings at first but the recovery becomes far more sound, based on rational economics. Failure to do so will just lead to a protracted Frankenstein economy which will frustrate the majority.

The sad reality will be that Western governments will try to emulate Japan’s lost two decades by crawling on our belly making marginal inches forward. This is somehow seen as superior to hitting the giant “reset” button.

The only major difference being that the Japanese monoculture is experienced and better suited than any other nation to share grief. Western cultures are not remotely close to being able to tolerate such conformity. Japan is not capitalism with warts. It is socialism with beauty spots. It will pay to remember this. In the West, we will demand that others atone for our mistakes. Moral hazard will be the order of the day. This mentality must be stopped dead in its tracks.

Grant reinforced our long-held view on distorting capital markets with this,

The Fed commandeered investment values into the government’s service. It seeded bull markets in the public interest…But investment valuations don’t exist to serve a public-policy agenda. Their purpose is to allocate capital. Distort those values and you waste not only money but also timeLike a shark, credit must keep moving. Loans fall due and must be repaid or rolled over (or, in extremis, defaulted on). When the economy stops, as the world has effectively done, lenders are likely to demand the cash that not every borrower can produce.

We must not forget that post-GFC authorities have been asleep at the wheel even after the introduction of poorly thought out red tape designed to protect us.

Right before the regulators’ eyes, so many blue-chip corporations (e.g. Boeing, GE) binged on ultra-cheap debt to buy back their own shares just to chase short term performance incentives. In recent years, companies like Boeing and GE spent around $45 billion each aggressively buying back their own stock despite being in the midst of severe balance sheet deterioration. Both are trading in a state of negative equity today.

Ford Motor has a junk credit rating. GE & Boeing won’t be far behind them. Over 50% of US corporates are trading one-two notches above junk.

IMG_0523.PNG

The financial community has merely taken advantage of all of this short-termism. Where were the financial analysts doing forensic work on companies? All of this balance sheet deterioration was plain to see.  Why couldn’t they see the obvious long term deterioration in cash conversion cycles? How could they miss that aggregate corporate after-tax profitability has been trending sideways since 2012? Where were the biopsies? We will be witness to plenty of autopsies that were preventable.

Corp Profits After Tax

For Australia’s part, 28 years of unfettered economic growth has bred untold complacency. Only now will we realise the conceited arrogance of government and industry alike. One day we will realise that all of the onerous regulations dripping in ideology (e.g. climate/environment) to confound foreign investment will blow up in our faces. They will not have forgotten that Australia is an unfriendly place to conduct business.

Australia has behaved like a bloated drunk bishop looking down upon his destitute disciples climbing the stairs on hands and knees putting what is left of their pitiful savings into the collection tin. From now, the roles will be reversed at prices that will be highly unfavourable such will be our desperation. Not to mention our currency could well depreciate to a degree which makes us even more vulnerable to foreign predators. Setting our FIRB at $0 will be irrelevant if we fold to the whims of the first suitor that shows interest. The show will be on the other foot.

In press conference after press conference, we continue to be told that hibernating companies will spring back to life and it will all be a case of ‘keep calm and carry on!’We hate to sound negative here.

However, we believe that we are merely being realistic about what is to unfold. The coming depression will force us to become truly appreciative about just how well we have had it while governments have distorted our markets. Had we truly reflected on decades of prosperity instead of wailing about how life has never been worse, things might have turned out differently. We are about to get a true taste of the latter.

On reflection, some positives will come out of this tragedy because we will focus on things that matter rather than getting enmeshed in the theatre of the absurd – identity politics and the cancel culture.

Coronavirus might be a black swan event to the global economy but we have been complicit by allowing our lawmakers and regulators to play slalom with the icebergs. We all knew our overloaded ship was in danger of listing before we left the safe harbour but it was simpler to be suckered into the weather forecasts that predicted endless sunshine and eternal millponds. The engines have now stalled because the tanks are empty. We find ourselves in the middle of a pitch-black, stormy night with howling gale-force winds and a 40-foot swell. Some continue to cling on to the blind hope that the incumbent crew can bail fast enough to avoid the economy capsizing.

It will be all in vain because the ship’s crew left a tape recorder playing on a loop over the tannoy promising passengers to stay in their cabins while they secretly slipped away in the early hours on the only lifeboats available.

Central banks had one mission – create confidence. They have been complicit in the failure. They doubled down on all of the same policies that got them in trouble in the lead up to GFC. They had a simple task of telling governments to embark on structural and tax reform. Instead, they appeased their masters by endlessly cutting rates.

Never again must central banks be allowed to use QE to rescue the economy in a downturn. Central bank balance sheets should be forced to unwind all QE assets. Interest rates must be allowed to set at normalised rates which allow positive returns but avoid reckless borrowing.

While a lot of this piece might sound pessimistic we simply view it as being a realist with experience.

Only one you can’t stop crashing at your place during COVID19 is the economy

Warning Signs Investors Ignored Before the 1929 Stock Market Crash ...

Brace yourself.

COVID19 will be defeated but the cure is turning out to be way worse than the disease.

Unfortunately, the sad reality is that at the rate governments are tightening legislation to keep us in shut down mode, we are day-by-day staring at a great depression.

While some will praise governments for throwing the kitchen sink at the economy with all manner of stimulus packages, the relief will be temporary because all of the ammunition for a sustainable recovery had been depleted years earlier. It is like supplying an alcoholic on rehab with an all-you-can-drink open bar.

Our feckless RBA has just embarked on QE, a mission that has failed every other central bank that has tried it. The velocity of money has been falling for decades. Who will be given access to borrowing at zero interest rates when the economy is in freefall? Which banks will lend against properties that will likely implode in value? 50% down? To think of all the reckless “first home buyer” schemes that loaded young people at the top of the property market. The RBA has been complicit. Not wanting to put pressure on the government to reform, it just kept cutting rates to keep housing afloat. It was totally negligent in its duty even though it will signal its role as a rescuer of last resort.

When will banks be forced to mark to book the value of mortgages on their balance sheet? Equity is thin as it is. 15-20% equity buffer to mortgages is pretty wafer-thin. They need to do this immediately so we can properly assess risk. Forget stress tests by APRA. They’re meaningless. Our housing market will collapse with higher unemployment. 50% falls from here are possible. Remember there will be hardly any buyers. Prices fell up to 90% in Japan after its property bubble popped.

Worse our regulators have been asleep at the wheel chasing financial institutions on their commitment to climate change, the absolute least relevant metric to save them from here. It shows how complacent they became.

Australia has made some interesting crisis policy choices. For instance, PM Scott Morrison is trying to pass rent moratoriums where landlords suspend payments from tenants until things return to normalcy. It is not enshrined in law yet. In principle that is a nice gesture even if the government is subsidizing the banks for forgone interest due to short term loan repayment moratoriums. Let’s assume this continues for 6 months. Apart from the astronomical size of the subsidy, who will ultimately end up sacrificing the 6 months? Landlords? It won’t be the tenants.

Shouldn’t landlords be free to choose whether they are prepared to forgo rent or not as a purely rational business proposition? Shouldn’t a landlord be free to enforce a rental agreement? Will contracts matter anymore?

At some stage, the free market must be allowed to function and the government will hit a tipping point of weighing stopping economic armageddon by allowing businesses to function and the marginal risk of infections. The people will be crying for this if shutdowns remain.

Landlords may be labelled un-Australian or worse but in 6 months time, if unemployment has surged to nose bleed levels well above the 6% we saw during GFC at what point will disposable income be able to support a daily coffee at a cafe?

A cafe might soldier on for a further 3 months on skeleton staff before realising that they can’t cover costs. A landlord would be well within reason to demand that early cancellation clauses and fees are enforced.

Then what of all the invoices to coffee suppliers, bakeries who provide muffins and croissants and utilities? Who misses out? What about the invoices of the coffee supplier? Will the bakery get called on by its flour supplier to pay upfront for future deliveries when it has no operating cash flow, instead of the long-standing 60-90 day terms? That happens overnight. It isn’t a managed outcome. Cash is king.

The question is why hasn’t the government taken advice from the banks on business lending so it can better assess the risks involved from those that deal every day with small companies?

We can’t just shut an economy down for 6 months and expect a return to normal when it is all over. Unemployment rates are likely to surge well above 10%.

As we wrote in an earlier piece, there are 13.1 million Australians employed as of February 2020. Full-time employment amounted to 8,885,600 persons and part-time employment to 4,124,500 persons. Retail trade jobs come in at a shade over 1.2 million jobs. Construction at 1.15 million. Education 1.1 million. Accommodation/restaurants /bars etc at 900,000. Manufacturing another 900,000. Noticing a trend in our employment gearing?

We can fudge the unemployment figures however we like. We can pay $1,500 a fortnight for 6,000,000 workers to pretend they still have a job. That is $18bn a month. The PM can talk about how this will help us bounce on the other side. If it continues for just over 6-months can the budgeted $130 billion will be spent. This is separate to NewStart payments too.

Yet, will people lavishly spend or pay down debt and economise as best they can? We think the latter unless moral hazard has truly sunk in.

What people need to understand is that our Treasury expects to raise $472.8 billion in taxes for FY2019-20. Throw in sales of services, interest and dividend income and that climbs to a total of $511 billion. Expenses are forecast at $503 billion. In the following three years Treasury anticipates $490.0 billion,  $514.4 billion and $528.9 billion in taxes. Expect those totals to be cut significantly.

So if ScoMo’s JobKeeper rescue package for workers goes beyond 6 months, that is equivalent to 27% of annual tax revenues. That doesn’t take into account the slug to tax collections of lower GST and vastly lower income tax for individuals and corporates. That is just at the federal level.

Note, states such as NSW have recently waived payroll taxes for small businesses in a  $2.3bn stimulus package. We shouldn’t forget that the NSW Government is the largest employer in the Southern Hemisphere at 327,000 staff.

We remind readers that according to the RBA small businesses employ 47% of the workforce. Medium enterprises employ 23%. That is 70% of the entire workforce who are most at risk from a slowdown.

In 2019-20 income tax collections will make up $220 billion. Company tax was forecast to generate $99.8 billion. GST $67.2 billion. Excise taxes (petrol, diesel, tobacco etc) $44.7 billion. This data can be found on page 21 here.

Local cafes are reporting a 60~80% fall in revenue. Pretty much all casuals have been let go. It is a bit hard to survive on coffee when a lot of stores aren’t stocking pastries for fear of spoilage.

It is not hard to assume a scenario where government income taxes fall to $160 billion (-28%) due to mass layoffs. One assumes many people will be able to get a tax rebate come June 30th. So this number may end up being conservative on an annualised basis.

Company tax could plunge to $40 billion annualised due to the drastic fall in revenues as customers change the manner of contracts and reign in their own spending. Anyone that thinks that business will resume as normal is crazy. The ripple effects will be huge.

Excise taxes may drift to $35 billion as people cut back on drink (currently $7bn in tax revenue), are limited in places to drive negating the need to fill up (currently $18bn in total tax take). The $17 billion in tobacco excise may weather the storm better than most.

GST could fall to $50 billion. People just aren’t spending much outside of food. Massive retail discounts will not make much difference. GST will be the best indicator of how much the economy has slowed. Even if we start to see a massaging of the GDP numbers, GST won’t lie. It will be the safest indicator.

If our assumed tax revenue sums to $285 billion annualised from the budgeted $472 billion that equates to a 40% haircut.

Trim the ‘other revenue’ column to $30 billion from $39 billion and we have $315bn. Will the government then chop away at the $503 billion in expenses? All of the stimuli doesn’t arrive at once but a lot of it in relatively short order. Surely a $300~400 billion deficit is a fait accompli?

We should also anticipate forward year tax revenues be cut c.30% for several years after. The question is when does the government realise that it must cut the public service and scrap wasteful projects like French submarines and other nice-to-have quangos? We won’t see a budget surplus for decades.

We must careful not to fall into the trap Japan finds itself in. It has a US$1 trillion budget funded by US$600bn in taxes and US$400bn in JGB issuance. Every. Single. Year.

Nothing short of drastic tax and structural reform will do. Instead of behaving more prudently by cutting budgets when we had the chance, instant gratification created by governments desperate to stay in power has only weakened our relative position. Since 2013, the Coalition has been responsible for 46% of the total amount of all debt issued since 1854.

States should quickly realise that the $118 billion in federal grants going forward will also be curtailed. NSW will likely fare the worst because its financial position is by far the best.

If the government had a proper plan, it would be looking to what essential industries have been given up to the likes of China that we need to onshore. Medical equipment, masks or sanitiser. For cricketer Shane Warne to be converting his Seven Zero Eight gin factory to produce hand sanitiser shows how much of a joke our local manufacturing has become.

We must never forget that a Chinese government-owned company displayed the Communist Party’s mercenary credentials by (legally) buying 3,000,000 surgical masks, 500,000 pairs of gloves and bulk supplies of sanitiser and wipes. So not only was it responsible for covering up the truth surrounding the virus in the early stages of the pandemic, we openly let it compromise our ability to combat the virus when it hit our shores.

China has shown it doesn’t give a hoot for ordinary Australians. So why should we continue to fold to its whims and cowardly surrender our industries for fear it’ll stop dealing with us? It is nonsense. We have some of the highest quality mineral resources which it depends on. We can bargain. We have chosen to appease a bully.

Our Foreign Investment Review Board (FIRB) needs to be far more vigilant to prevent takeovers by Chinese businesses. We should openly accept the way China conducts business practices and recognise that it is often incompatible with ours when national security is at stake. Surely this crisis has highlighted the true colours of the political system in Beijing.

That leads us to Japanese companies. Many are seriously cashed up, have a favourable exchange rate and have a long-standing history of partnering with local businesses. We should be prioritising our relationship with Japan and look to have them invest in our inevitable capital works programs – specifically high-speed rail. It is the type of project that has meaning for the future and a long enough timeline to turn an economy around.

People need to be prepared for the reckoning. There is no point softening the blow. The brutal truth will eventually arrive and we will have only put ourselves in an even weaker position with the policy suite enacted so far. Time to be rational about risk/reward. Whether we like it or not, the minimum wage will need to be cut substantially in order to get the jobs market alive again. Don’t worry, unemployment will be so high that people will demand minimum wages are cut because it is far superior to the alternative!

(Time to ditch your industry super and start shovelling your superannuation into gold)

From a Gold Bullion dealer in Sydney

Gold

This is the latest update from Australia’s largest gold bullion dealer today:

In the past few days, both Royal Canadian Mint and PAMP have announced temporary closures due to unprecedented demand and Coronavirus. As a result, ABC Bullion will no longer be taking new orders for Royal Canadian Mint and PAMP (Swiss) product and will continue to fulfil existing orders for these products from our existing inventory and incoming deliveries.

ABC Refinery remains open processing gold and silver from our mining clients and manufacturing ABC Bullion brand cast bars.

For the health and safety of our clients and staff, ABC Bullion is prioritising metal collection and buyback transactions at its retail office on 88 Pitt Street and requests clients open new accounts and make purchases via https://www.abcbullion.com.au/, email comms@abcbullion.com.au or telephone 1300 361 261.

Due to unprecedented demand, we are backlogged on making deliveries and we appreciate your patience as we catch up.

Unlimited QE and a reminder of discontinued series

Just when you thought it couldn’t get crazier, the Fed has announced that it will buy unlimited sizes of treasuries, mortgage-backed securities and corporate bonds. Recall our comments in 2018 when the Fed discontinued its reporting of assets. We noted that the Fed discontinued M3 money stock in 2006, two years before the GFC. Coincidence?

We were always struck by former Fed Chair Janet Yellen’s comments in 2016:

Monetary and fiscal policy is far better prepared for large positive shocks than negative ones

and 2017:

Don’t expect another financial crisis in our lifetime

The only thing left is to buy equities outright which would require an act of Congress. Such moves once again only highlight just how bad the situation has become. The Bank of Japan can hardly be credited with success over its ETF based equity purchases. It has now lost $30bn in this recent market rout. We should mention that the BoJ is a top 10 shareholder in almost 50% of listed stocks, creating an overhang of epic proportions should it ever announce it wants to reduce holdings. It now owns $300bn and due to be $400bn by year-end.

A gem on how to work our way out of the coming economic crisis

Image result for truck nitroglycerin movie

Jonathan Rochford of Narrow Road Capital has written a gem on the role of central banks in spawning this current crisis. An excerpt here:

The rapid and widespread sell-off over the last four weeks is a textbook systemic deleveraging. Whilst the culprits are many; hedge funds, risk parity strategies and investors using margin loans have all been caught out, the underlying cause is excessive leverage across the economy and particularly the financial system. The timing of the unwind and the economic damage from the Coronavirus wasn’t predictable, but such a highly leveraged system was like a truck loaded with nitroglycerin driving down a road dotted with landmines.

Frustratingly, this inevitable deleveraging was clearly predicted. Rather than act to reduce systemic risks central banks encouraged governments, businesses and investors to increase their risk tolerances and debt levels.

Naturally, it fits our own long-held view on central banks.

Jonathan adds some sensible actions which are contained in this link. The question remains whether governments will put principle ahead of expediency in the cleanup?

MSM relishes trade of economic depression via pandemic over Trump as POTUS w/ no virus

Trump Derangement Syndrome (TDS) knows no bounds. Yes, the mainstream media (MSM) is celebrating the milestone that the Dow is below the level when Donald Trump was inaugurated.

We have always said that if Trump continued to boast about market gains he would have to wear it on the downside too. Alas, he is being hoisted by his own petard.

Sadly, as much as CNN and others relish the though of Trump out of office, we sincerely doubt the vast majority of Americans would trade a pandemic with catastrophic unemployment over business as usual before the WuFlu with a Trump at the helm.

Markets are forward looking. They anticipate where corporate earnings are likely to be. This market rout has little to do with Trump’s policies in isolation.

We’ve said repeatedly that global central banks have created a debt bomb through reckless monetary policies over the last two decades. They have proved just how little impact cutting rates to zero or throwing $850bn in handouts has on markets. They’re out of ammunition. Confidence is shot. We’re in uncharted territory.

Boeing is the perfect canary in the coal mine. The 737MAX debacle which is imminently due to be on sale again to a market that has effectively vanished. Airlines are cutting routes and it will be up to the zombie lending cycles of aircraft leasing companies to renegotiate rates so they can keep the patient alive. Airlines will push out deliveries.

However before Boeing’s core business troubles, the management embarked on short term incentive chasing buybacks to the tune of $43bn since 2013. The company is trading negative equity and has drawn down ALL of its credit lines ($13.8bn) and now wants a handout.

All of this is the product of two decades of mindless expediency. Governments are just as culpable for allowing greed to override common sense. No lessons have been learnt since 2000 and especially 2008. Blue chips like Boeing and GE are now heading to record lows because of it. Ford Motor is rated junk. How long before Boeing and GE fall foul of the same problem?

We are particularly interested in the next set of results from Parker Hannifin. It is like the global industrial hardware store. All of the major manufacturers use Parker for parts – pumps, hydraulics, pneumatics, valves, hoses etc. When we see Parker’s upcoming report on order flows we can gauge how bad it is at the manufacturing coal face.

This time we are staring at a “global depression” and it would be nice to think the MSM would try to put some context around the ramifications of this virus and the raft of economy killing policies governments around the world are introducing instead of just blaming Trump. Yes, he’s been his normal self during this but is he responsible for the actions of other countries going into shutdowns? Seriously? Do the US Coronavirus stats stack up poorly vs countries like Italy on a relative or absolute basis? No. Moreover COVID-19 cases in the US are a mere fraction of H1N1 swine flu cases which the media made nowhere near the level of hysteria as now. It’s a disgrace how far the media will go for clickbait.

Had the world’s central banks behaved sensibly to stop excessive debt and allowed markets to function freely, this pandemic would have had far less effect than it is now because we would have had the ammunition to fight this war of attrition. Now all our governments and regulators are doing is moving phantom armies across maps trying to stop economic Armageddon.

Let shareholders burn

We buy shares because we expect to gain a return. We all know there are risks attached. As we wrote yesterday on Boeing, it has embarked on reckless buybacks which have compromised the balance sheet. The company has drawn down all of its $13.8bn in credit lines from banks overnight. It is panic stations. It was completely avoidable.

How ironic that companies which are among those that splurged $4.5 trillion on share buybacks just to chase short term management incentives will be the first lining up for taxpayer support to save them from negligent governance.

We say shareholders should suffer the downside of that investment choice. They had the power to remove officers from the companies they entrusted management to. If a company goes belly up, let other players in the market pick up the spoils for fire sale prices.

The Wolf Street correctly noted,

The Trump administration is putting together a rumored $850-billion stimulus package that will include taxpayer funded bailouts of Corporate America, according to leaks cited widely by the media. Trump in the press conference today singled out $50 billion in bailout funds for US airlines alone. A bailout of this type is designed to bail out shareholders and unsecured creditors. That’s all it is. The alternative would be a US chapter 11 bankruptcy procedure which would allow the company to operate, while it is being handed to the creditors, with shareholders getting wiped out.”

All this Trump package will do is encourage the same bad behaviour. We think this is nothing more than trebling down on the problems that hit us in 2008. But hey, it’s an election year!! Reckless.

As usual, the SEC has been asleep at the wheel. Same as in the lead up to 2008. This is what happens when regulators hire clueless lawyers who don’t have a clue about how markets operate. Therefore they miss crucial events.

As for shareholders – you earned it.

The only upside to this market volatility is that no one has talked about climate change for weeks! Probably because when people are about to lose their livelihoods, all of a sudden virtue signaling is worthless. That goes for diversity and inclusion too. Every cloud has a silver lining.