DiMartino Booth, Fed Up, Will Corporate Bonds Cross Over?

Will Corporate Bonds Cross Over?

It started out kinda ‘Crazy,’ in 1961 to be exact. A 20-something-year-old bass player by the name of Willie Nelson had written a song which he generously offered up to country singer Billy Walker. Walker, however, perceived the lilting lyrics to be a bit too feminine, so he passed. The late Patsy Cline would be forever grateful to Willie for ‘Crazy,’ which she sultrily sang to stardom, and in doing so, founded a movement.

We’re familiar with what followed, from the hobo portrayed as ‘King of the Road’ to the petulant moment, ‘The day my momma socked it to the Harper Valley PTA.” Even the most vacuous pop music acolytes couldn’t help but to let Olivia Newton John know they loved her. Did they ever let her know! And who didn’t want to emulate Glenn Campbell? Even those 1975 disco divas velvet-roping at Studio 54 dreamed of landing the perfect Rhinestone Cowboy.

Year in and year out, Crossover Country hits made traitors of pop purists. Even Willie finally got his mainstream due, with 1982’s No. 5 pop chart hit, “Always on my Mind.” It wasn’t until 1983, when Dolly Parton & Kenny Rogers met on “Islands in the Stream,” taking the hit all the way to No. 1 on the charts, that crossover crossed back over to strictly Country terrain.

And now there is Sam Hunt. Never heard of him? Chances are you can recite a line or two from ‘Body Like a Back Road,’ Hunt’s Crossover Country megahit that recently landed at No. 6 on the Billboard 100. Even if you choose to be obtuse about what the song is about, you can’t help but roll the windows down and sing about “Doin’ 15 in a 30.”

That is, unless you’ve recently hit our country’s byways and all but screamed at that infuriating Sunday driver who only adheres to half the law, that is, doesn’t comprehend Slower Traffic Keep Right (!)

Unbeknownst to unassuming corporate bond holders, they too will soon be forced into the slow lane. For the moment, the vast majority fancy themselves that equally exasperating driver who won’t get out of the fast lane, determined to bully their way to their damned destination. As for the perils of tailgating, they’re for the other guy, the less agile driver with rubbery reflexes.

That’s all good and well and has been for many years. Bond market fender benders are nearly nonexistent. The question is: Will central bankers worldwide turn placid parkways into highways to hell as they ‘remove accommodation,’ to borrow from their gently genteel jargon? That’s certainly one way to interpret Federal Reserve Chair Janet Yellen’s latest promise to shrink the balance sheet ‘appreciably.’

Care for a translation? How easily does “Aggressive Quantitative Tightening” roll off the tongue? Perhaps you’ve just bitten yours instead.

Enter the International Monetary Fund (IMF), The Institute of International Finance (IIF), The Bank of International Settlements (BIS), and by the way, the Emerging Markets complex including and especially China.

As a former central banker, it is with embarrassing ease yours truly can bandy about fantastic figures. No surprise that nary an eyebrow was raised at the latest figures out of the IIF that aggregate global debt is closing in on $220 trillion, as touched on last week. Consider that to be the broad backdrop.

Now, narrow in on the IMF’s concerns that financial stability could be rocked by a rumble in US corporate debt markets. Using firms’ capacity to service their debts from current earnings as a simple and elegant yard stick, the report warned that one in ten firms are failing outright.

The last two years of levering up have exacted rapid damage: earnings have fallen to less than six times interest expense, this during an era of unprecedented low interest rates. And as record non-financial debt as a percentage of GDP quickly approaches 50 percent, the share of income required to service this mountain is at a seven-year high. Should financial conditions tighten (the report was published in April prior to the Fed’s June rate hike), one-in-five firms are likely to default, which rises to 22 percent if rates continue to rise.

A separate signal of distress flickers into focus when one considers the sectors most at risk. Add up energy, real estate and utilities and you get to about half of the at-risk debt. And we wonder why Boston Fed President Eric Rosengren is perturbed about commercial real estate (CRE) and the risks it poses to the banking system.

A few bullets on CRE:

  • Smaller banks with less than $50 billion in assets hold $1.2 trillion of the $3.8 trillion in outstanding CRE debt. Larger banks are relatively less exposed, with $767 billion. This begs the question why the Fed chose this year to not stress test the smaller banks?
  • Bank holdings of CRE have risen nine percent over the last year; multifamily is up 12 percent.
  • Despite skyrocketing rents, multifamily prices have risen so much faster that “cap” rates (net operating income divided by the property price) have sunk to a 16-year low.

Why deviate to a CRE chit-chat in the middle of a corporate bond discussion? In so many words, financing is financing. Whether it’s the capital markets the Fed has kept wide open or banks, companies need access to sources of leverage, especially in times of need and extra especially in times of illiquidity. Stressed smaller banks in particular will be inhibited in their ability to extend lifelines to smaller companies in the coming years.

Speaking of illiquidity but not of small banks, over the past seven years, assets on the biggest banks’ balance sheets have fallen from $5 trillion to $3 trillion. Zero in on corporate bond inventories and you find that dealer holdings have collapsed by 75 percent since the onset of the financial crisis.

Who’s taken up the slack? Whom, pray tell, do you, Joe Q Bond Fund Manager, ping when you need to offload a few billion in bonds? Let’s just say the nontraditional entrants who provide bond market liquidity during the next rout won’t be nearly as polite when it comes to maintaining market stability and pricing. They might even behave a bit like vultures. The more you need to sell, the lower the price.

For this neat noose secured round our necks, we have the regulators to thank. Will bond investors sing along to the greatest hit that has yet to be released by those Rocking Regulatory trio of Dodd, Frank & Basel? Tossing tomatoes onto the stage will more likely be the case.

In the event you’ve begun to sweat, you might want to reach for more than a Kleenex. In a normal world, the bulk of the risk inherent in owning bonds was credit-related. But years of distortive low-interest rate policy have flipped bonds’ risk/return dynamic on its head. Using Barclays US-dollar Aggregate Corporate Bond Index, ‘duration’ now accounts for 90 percent of the risk of holdings bonds, with the balance related to credit; that’s up from 37 percent in 2013. Think of duration as your bonds’ sensitivity to interest rate risk. Kind of gives a whole new meaning to no sudden moves.

Thank heavens for geographic diversification? Ah, you must refer to those essential emerging markets (EM) bond holdings, a must have for any discerning investor. No doubt, they’re the ‘it’ girl. Dollar-denominated EM debt sales were already up 160 percent through May over 2016 to $160 billion, marking the fastest annual start to the year since 1999.

Let’s just say the Bank of International Settlements (BIS) isn’t quite so enthusiastic. The BIS is often referred to as the central bank to central banks. In its estimation, there is a total of $3 trillion in dollar-denominated EM credit worldwide. The BIS’ chief economist Claudio Borio warned in the BIS’ recently released annual report that, “dollar funding remains a potential pressure point in the international monetary and financial system.”

The IMF concurred, warning that in a tightening environment, “the weak tail of emerging economy firms” would be highly vulnerable. The report added that, “A sustained reversal of capital inflows would put pressure on countries with high external financing and/or low reserve adequacy.”

At least China’s got that going for it, as in $3 trillion in foreign reserves. The problem is that only a trillion is considered to be truly liquid, while another trillion is earmarked to build that expanse of infrastructure connecting China to the western world once and for all. After all, you don’t become dominant by being isolationists. Oops, well you get the point.

The BIS estimates that Chinese corporate debt is 169 percent of its GDP. Would you believe that eye-watering and disconcerting figure is realistically on the light side? My good friend Leland Miller sagely suggests one apply the apropos grain of salt to what Chinese statisticians generously refer to as ‘GDP.’ So round down the denominator, way down. Add in the fact the corporations might not be fessing up to what their liabilities really are (who wants to be Debbie Downer?) and or never repay it so why report it? So round up the numerator, way up.

And, you guessed it, who in the world can say with any authority how buried in debt Chinese corporations are? So there’s that lovely black box to ponder.

The takeaway is that ‘bonds’ just ain’t what they used to be. Don’t be comforted by your broker telling you they help you diversify or that they carry bullet proof credit ratings. Sit him or her down instead and warn of the real risks of swollen durations, of bonds of all stripes slipping into rusty junkyards, of our portfolios’ safest holdings crossing over, and not in the good way those country hits do for us pop enthusiasts.

Do yourself a favor. Have a listen to Body like a Back Road. It’s easy enough to find in your car, on that mean machine at the gym, or wherever you prefer to slow down and have a listen. You’ll be grateful you did as summer drags on, closing your eyes and imagining the luxury of going 15 in a 30. It beats the heck out of what your bonds are apt to do when inclement weather hits, which will feel more like going 100 in a 50 on bald tires. And who wants to listen to that?

In Case You Missed It — July 10, 2017

Dear friends,

It is my hope that you received an email that looked like what I’ve pasted below. While it doesn’t resemble the communique you normally receive from me, I assure you I am the sender. Please login as directed and you will transition yourself onto new platform.

 

On 07/6/2017, you successfully activated your trial subscription to Money Strong written by Danielle Dimartino Booth. During your trial subscription, you will receive an email containing a link to the most recent issue of Money Strong published every Wednesday. You may also view recently archived issues of Money Strong at the subscriber website (Subscribers Home).

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In the meantime, we’ve got one more payroll report under our belt. The headlines made a splash with job growth appreciably stronger than expected as a surge of sidelined laborers rejoined the workforce. Wages remain soft, which is intuitive given the type of jobs created – home health care workers led the month’s gains, a demographic sign of the times we are in.

For more on the outlook for baby boomers’ retirements, please have a look at my latest Bloomberg column, which focuses on the implications of boomers’ increasing exposure to passive and so-called ‘alternative investments.’ Below the Blomberg piece are three of my earlier missives on the implications of the tremendous build in private equity dry powder and pensions’ prospects. Hard to believe I started writing on this subject two years ago.

 

Private Equity and Passive Investors Are on a Collision Course

Bloomberg View — Danielle DiMartino Booth, July 6, 2017

Money Strong Archive Pull

The Smell of Dry Powder in the Morning 

What if Charlie Munger is Right?

The Smell of Dryer Powder in the Morning

In other In Case You Missed It

The Lance Roberts Show — July, 6, 2017

FED Players Receive Special Treatment

FX Street — EUR/USD and Fed: Levels, Ranges, Targets

As many of you hit the road back home, wishing you well,

 

Danielle

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Central Banks to Investors: I Know Nothing

Central Banks to Investors: “I Know Nothing!”

“I know nothing! I see nothing! I hear nothing!”

So light was Hogan’s Heroes, one could easily forget the sitcom, which debuted September 17, 1965, was set in a Nazi P.O.W. camp. More than any one character, Sergeant Schultz deserves credit for the show’s laughable levity. His gregarious girth, sincere sympathy and wonderful weakness for tempting treats — let’s just say Shultz had anything but steely resolve, convincing affable audiences that war could be whimsical. For the prisoners of the Luft Stalag 13, Schultz made an ideal witness to their eternal escape endeavors. His robustly repeated response, “I know nothing!” faithfully failed to fulfill his German superiors’ suspicions.

One can only imagine the proliferation of late 1960s era’s pretentious political philosophers chafing at the bemusement beckoned by Schultz’s channeling Socrates. The Socratic paradox, “I know that I know nothing,” back-translated to Katharevousa Greek, was relayed by Plato in Apology.

Apparently, Socrates attributed his wisdom to not imagining that he knows what he does not. At the intersection of Schultz and Socrates, humility and hilarity collide.

It was neither humor nor humbleness, but rather hubris, being highlighted in London on June 27, 2017 when Federal Reserve Chair Janet Yellen managed to make light of a heavy subject in a live televised Q&A with British Academy President Lord Nicholas Stern. Chuckling in response to one query, Yellen offered up the following on our collective financial future:

“Would I say there will never, ever be another financial crisis? You know probably that would be going too far. But I do think we’re much safer and I hope that it will not be in our lifetimes, and I don’t believe it will be.

It was these last few words that ignited the ire of so many central banking detractors. Was she hoping we’d come to see the softer side of central banking?

Clearly, she takes faith in the radiation detection facilities the Fed has installed in the years since the worst of the financial crisis engulfed the global financial system. If not, why would she have also offered up these words of reassurance, that those at the Fed, “are doing a lot more to try to look for financial stability risks that may not be immediately apparent … in order to try to detect threats to financial stability that may be emerging.”

Though this particular quote got much less in the way of play in the media, marrying the two threads of thought helps explain why Yellen, who no doubt means well, was able to strike a jovial tone at the prospect of future financial crises. Blind faith in those who’ve been assigned tasks has long handicapped Fed leadership.

On a deeper level, one has to question the qualifications of the architects who’ve built out the risk monitoring system in recent years. The February 2015 McKinsey report Debt and (Not Much) Deleveraging did not gain the rank of ‘seminal’ without captivating most front-line veterans of the financial crisis.

The study’s findings were startling in their simplicity: Rather than address the underlying over-indebtedness that detonated systemic risk and culminated in a full-blown catastrophe, policy had simply catalyzed further indebtedness.

The numbers, with which we are all familiar, are as follows. From a starting point of the end of 2007 through mid-year 2014, global debt rose by $57 trillion to $199 trillion. As a percentage of global gross domestic product (GDP), global debt had risen to 286 percent from 269 percent.

Though deleveraging had indeed occurred in some corners (referred to in America as defaulted mortgages), the overabundance of liquidity generated by central banks’ machinations had simply found new places to stoke unquantifiable risks. In the case of the seven years through 2014, some usual suspects made their presence known on the leveraging-up-to-their-eyeballs scale such as Greece and Ireland.

But it was China that stood out in the McKinsey study, specifically, “the quadrupling of China’s debt, fueled by real estate and shadow banking, in just seven years.”

McKinsey was also kind enough to offer a bit more historic perspective for those of us rookies who might have thought this type of perverse approach to treat over-indebtedness novel. It all started at the end of 2000, just about the time investors were reeling from Internet bubble implosion portfolio losses. In the seven ensuing years, global debt rose to $142 trillion from $87 trillion. As a percentage of global GDP, debt had grown ‘smartly,’ to 269 percent from 249 percent. (Lest you’ve forgotten the name of that starlet in the annals of dumb debt, it was referred to as the subprime housing bubble).

Conclusion: Do NOT attempt to resolve over-indebtedness by applying more debt to the problem.

Presumably the task force monitoring the global financial system for signs of building dangers was armed with this simple guiding tenet.

It follows that our protectors were blindsided by yet another report released the very same day Yellen made her fate-tempting London remarks about how much safer we are.

The Institute of International Finance (IIF) is a Washington, DC-based global tracker of capital flows with a stellar reputation for sniffing out risks. In its newest report, the IIF warned of the risks posed by global debt levels that had ballooned to $217 trillion. In the event you are about keeping score, the math works out to 327 percent of global GDP.

The good news:  Developed economies continue to delever; in the past year, they’ve offloaded some $2 trillion in debts. The not-so-good news:  Central banks’ manning the printing presses 24/7 necessitate their crisp, fresh product find a home, fungible as global quantitative easing has proven to be. Enter developing countries, where debt has grown by $3 trillion over the past year to a new record of $56 trillion.

Filling in the blank with the main driver is akin to gaming a multiple-choice test for which you’ve not studied. When in doubt, choose ‘C,’ as in China, which accounted for 2/3rds of last year’s debt growth. Chinese debt now stands at $33 trillion. This most recent spurt of growth has been led both by households and companies.

At least Uncle Sam has that in common with his Red Dragon counterpart. Household debt has recaptured its record high levels led by unsecured debt (lovely). And corporate debt stateside is now at record levels, even when compared to earnings and cash flow, which remain strong. (Note to Fed: tightening into a weakening economy when debt burdens are at record highs has yet to end well.)

The IIF shrewdly expressed unease that all of this debt could pose “headwinds for long-term growth and eventually pose risks for financial stability.” Party poopers.

For good measure, the International Monetary Fund and Bank of International Settlements share the IIF’s concerns. But what do they know?

In the event you sense tongue squarely in cheek, hence the cheekiness, you are correct.

Either you laugh and channel Sargent Schultz. “In (currency) wars, I do not take sides! I see nothing! I know nothing! I didn’t even wake up this morning!” You pray God central bankers are making the best of a gravely unstable situation by making light of it to calm the masses. If you present a strong face, the minions will hopefully buy into your outward confidence.

Well played? Consider the alternative.

What’s worse than the monetary myopia that’s blinded central bankers into believing moral suasion can resolve the teensiest $217 trillion problem?

What if they believe what they are saying in the face of irrefutable evidence to the contrary? Socrates’ self-discovery followed a journey wherein he tried to find a wiser man than himself, whether it be politician, poet or craftsman. His findings were as follows: Politicians boast wisdom without knowledge (some things never change). Poets, for their part, touch people with their words, but don’t grasp their meaning. Finally, craftsmen claim knowledge but it is restricted to too narrow a field.

Socrates concluded that there was no such thing as indelible intellect, but rather ingrained ignorance. Recognizing your fallibility was thus the secret to achieving greatness, to know in your very soul, “I know that I know nothing.”

Future generations across the globe would be well served by central bankers of the strongest constitutions, those who are neither politicians, nor poets, nor craftsmen who bow to econometric models that have scant application outside tight academic circles. May they rather live by Socrates’ humble mantra, may they know they know nothing, and nothing more.

Will US Drillers Drive Oil Prices into the Ground?

Asian Fusion’s got nothin’ on Chef Caveman.

At least Stone Age culinary connoisseurs knew enough to grease rocks before using them as cooking apparatus. You might concur that logical leap would make hot-rock table-cooking tuna a might bit easier. The question is, would you have ordered what was on the menu back then? The main ingredients alone might give you pause. A fine flour ground from ferns and cattails? A touch of water for that just-so batter consistency? Maybe it was the grease that made the difference. If that’s the case, it’s true — some things never change.

Some 30,000 years on, pancakes remain a hot hit with a hip history. In Neolithic times, einkorn wheat was all the rage in the Italian Alps. The Ancient Greeks added sweets, as in honey, to augment the allure. The French put pancakes on a diet; their “panne-quaiques” required thinning the batter, and voila, thus was created the crepe. As for us red-blooded Americans, let’s just say we rejected fancy flapjacks for puffier pancakes, preferably piled one on top of each other, slathered in melting butter and smothered in sticky syrup.

The Saudis are discovering the hard way that we also prefer our shale formations to be served up in tall stacks. Just a guess here, but there might even be a pattern: the taller the shale stack, the shorter the store of OPEC’s patience. It turns out that strong-mouthing oil prices upwards in crude form, the old-fashioned way, by announcing pared production, isn’t nearly as efficacious when those other announcements, that of deep discoveries, outweigh output cuts.

One can only imagine the dismay at the Wolfcamp Shale’s shooting to stardom last November. Though the formation is not a new discovery per se, the statistics released by the U.S. Geological Survey obliterated precedent. At 20 billion barrels, the recoverable oil is nearly three times that of the Bakken-Three Forks formations, which catapulted North Dakota into the energy hall of fame.

As one gourmet geologist explained: Think of a typical shale formation as a short stack of layers that can be drilled horizontally. The Wolfcamp lies at the outer edge of petroleum potential; it’s such a tall stack, the layers could number into the double digits.

The relationship between supply and demand has a funny habit of holding true to form. Though a matter of pure coincidence, it is telling that the Wolfchamp news roughly coincided with oil price’s most recent peak. Since then, its per-barrel price has fallen by about a fifth to $44-ish despite the Saudi’s best efforts to push the price back towards $60, which is still down 60 percent from 2014 highs.

It’s fair to ask if $60 is an arbitrary target? Think of it as the least sweet, sweet spot that enables the planned initial public offering of state-owned Saudi Arabian Oil (Aramco) to well, work, mathematically-speaking. You can bet your bottom petrodollar the very idea of taking the crown jewel public stirred a bit of controversy.

Consider Aramco’s IPO the brain child of 31-year old Mohammed bin Salman. By relative ruling royals’ age standards, the newly elevated crown prince is literally a child. That’s a good thing as he’ll need youthful verve and more to implement his ambitious plans to diversify the Saudi economy away from its oil dependence, the seed money for which is the planned proceeds of the IPO.

A little economic diversification could go a long way for Saudi Arabia, the region’s largest economy whose GDP is forecast to barely register in the positive this year. That’s a far cry from Iran, its geopolitical nemesis that’s expected to generate economic growth north of four percent this year.

Oil’s stubborn refusal to stage a compliant rebound is partially responsible for the accelerated announcement that Prince Mohammed would succeed his father to the throne. In his prior role as chairman of the country’s Council for Economic and Development Affairs, he pushed against his elders, jockeying for the IPO to be listed expeditiously exhibiting an appreciation for how fickle markets can be.

Of course, demographic challenges and political posturing with neighboring nations that support the Saudi’s enemies are also at work. But it’s hedge funds that could pose the greatest impediment to Saudi Arabia’s aspirations. Some of those cowboys manning their screens are a might bit more piqued than even the Saudis at crude’s refusal to rebound to even half its peak.

As reported by the Financial Times, hedge funds’ patience with OPEC’s assurances that prices will rise is effectively tapped out. Short positions that profit as oil prices fall stand near record highs, equivalent to 162 million barrels. (A word of caution to the shorts: Squeeze hurts. See 6/27/17 trading if you harbor doubts.)

Unlike prior episodes of bait and switch, though, OPEC has stood and largely delivered. It must be salt in the wound to trim two percent of global supply out of production and not even get a rise out of prices.

Afraid that’s just the way things go in a world saturated with supply, supply that keeps building despite OPEC’s opposite obstruction. Exempted OPEC members Nigeria and Libya have tacked on some 600,000 barrels-per-day (b/d) to supplies since the fourth quarter. And US-based shale producers look to drive another 700,000 b/d by this time next year, pushing total production to a record 10 million b/d. Yours truly was all of three months old when the last record of 9.94 million b/d was set in December 1970. Imagine that.

Tack on prospects for natural gas production and growing export activity and the US looks prime to dominate on the production stage for the foreseeable future. The question is at what price?

While it’s true, that some existing wells in the Permian Basin can break even with oil barely above $20 a barrel, even the leanest frackers would prefer a price with a $50-handle. That makes it much more attractive to tap new wells, which typically begin to break even when oil prices cross the $50 threshold.

Perhaps the most problematic platitude, for those who recall all too vividly the last time prices were this low, is that the current rut is a pure supply story and therefore none too knotty for the financial markets. OK, so developed world inventories are nearly 300 million barrels above their five-year average. And, yes, Europe and Japan are not in economic sinkholes. And, no, the Chinese economy has not withstood a hard landing (do they even allow that?). Still, there’s just something about conventional wisdom that never sits right…

It may not feel like it but there have been 225 bankruptcy filings in the oil patch since 2015. According to the theme of the recent Wall Street Journal story that featured that stat, energy producers have “adapted” to the new low-price world. “Companies say they are focused on living within their means at even this price,” so says the Journal.

There’s no doubt operators are lean. But does that alone justify their share prices trading close to where they were from 2011 to 2014, when oil traded north of $100 a barrel? Apparently so. As the article went on to say, “Companies have driven down costs by squeezing suppliers and contractors, trimmed less profitable projects and tackled a once spendthrift culture.” Heck, they don’t even want to see triple-digit prices again. (Can someone please cue an eyebrow lift??)

Maybe we’d best not use the stock market as a guiding light, which leads us to bonds. As awash as the world is in oil, its oversupply has nothing on the mountains of private equity dry powder that have piled up. The overabundance of capital looking for a home helps explain why there were so few – yes, few – bankruptcies across the energy sector. No doubt, fresh debt infusions have bought many flailing companies a lifeline. That’s a great thing if they’ve become more efficient and profitable operators as a result.

But it’s dangerous to assume all will be well regardless of how low oil prices go, which the high yield market has already refuted. Deutsche Bank’s Oleg Melentyev is a veteran of bond cycles and an authority on when break evens break down, leading to break points. He’s also a great friend whose guidance has yet to fail.

In Oleg’s estimation, debt levels among high yield energy issuers have yet to present a challenge. So long as oil stays above $40 a barrel, some form of stasis will prevail, albeit with the prospect that yields continue to rise. Appreciate that you know this, so consider the following public service announcement to be Pavlovian after years of writing Federal Reserve briefing documents: Bond yields move opposite price. There, said it.

Should that old West Texas Intermediate drop below $40, or worse, flirt with $35 a barrel…well then, things could get testy, shall we say. For the moment, the not-transitory decline in oil has acted as a deterrent against sudden moves by hawkishly-inclined central bankers. In other words, more justification yet for the complete complacency that’s comatosed the markets.

If there’s one quibble with Oleg’s observations, it’s that we’re now in the process of double-netting-out. Like it or not, “ex-energy” is back. Listen, it’s the bulls’ jobs to net out nastiness; they invented one-time charges that recur in perpetuity. The fact that they quit reporting all that netting when the skies clear is also what makes them bulls, or possibly full of bull. Besides, who wants to know what S&P 500 earnings growth would be if you netted out the massive rebound in energy shares?

So you’re down with the vernacular: “ex-energy.” But what about “ex-energy and ex-retail”? You’d better get used to it as the retail sector is in deeper distress in junk bond land than energy. “Of course ex-energy and ex-retail, the high yield market has nary felt a flutter over the last two weeks!” How’s that working for you?

For the time being, the hope is US oil supplies will stabilize, relieving the downward pressure on prices. A pause would certainly mark a shift after a frenetic year at the drill bit: Total rig count in North America – the US and Canada – ended the week of June 23rd at 1,111, more than double the count from a year ago of 487. The rig count has risen for a remarkable 23 consecutive weeks.

It could be a novel approach is what’s needed to stabilize prices at a level that allows bond investors and so many other interested parties to sleep at night. Maybe the solution is moving up Shrove Tuesday. As of now the calendar calls for the day, also known as Pancake Day, to arrive on February 13, 2018, the day before Ash Wednesday. Why not hit the confessional early, deplete all those fattening ingredients from the cupboard as was customary among the old English, and call a moratorium on drilling? Think of it as the oil market’s answer to Lent, That is unless you’d prefer oil prices continue to fall. It all depends on the position you’ve assumed and whose side you’re on.

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ICYMI.ddb, In Case You Missed It — August 4, 2017

In Case You Missed It — June 23, 2017

Dear friends,

It may be summer, but things are hopping hot. Welcome but unexpected gifts have crossed my screen in recent days – Fed Up book reviews, feature interviews, speech recaps. Knowing you know that I’m judicious with the number of emails I send, I provide for you below links to what you might have missed knowing there’s a risk your inbox won’t be checked until Monday.

In that vein, why not unplug? I hear it’s the ultimate liberator. Why not dig your toes in the sand and forget life for a while? In the event you prefer a bit of light mental intake, please enjoy:

THE WRITTEN WORD:

The Fed Needs to Acknowledge Slowing Economy – Too much debt is putting a strain on car sales, retail and commercial real estate.
June 23, 2017 – Danielle DiMartino Booth via Bloomberg Prophets

FED UP… An Insider’s Take On Why The Federal  Reserve Is Bad For America 
June 22, 2017 – Richard Bowen  of RichardBowen.com

Danielle DiMartino Booth is Spreading Financial Literacy by Speaking the Truth Few on Wall Street Would Dare
June 14, 2017 –  Elaine Rau of Ladybossblogger.com 

Cassandra of the Crash: An Interview With Former Dallas Fed Researcher Danielle DiMartino Booth
July 2017 issue Digital Edition, Reason.com

11 Takeaways from Danielle Dimartino Booth 
June 09, 2017 – Cole Henson, Architect, GFF of TREC Wire via Recouncil.com

THE SMALL SCREEN:

What Would America Look Like if…The Glenn Beck Program 
June 21, 2017 –   Danielle DiMartino-Booth Joins  Glenn

Larry Berman: Why the Federal Reserve is bad for America
Jun 19, 2017 –  BNN.com

Fed Trying to Cripple Trump Economy  
June 21, 2017 – Greg Hunter’s USAWatchdog

Hoping you enjoy the beach for me, and wishing you well,

Danielle

Danielle DiMartino Booth, Money Strong, Woman on Fire, Fed Up

Woman on Fire

There is a delicious liberation in having nothing to lose.

That profound realization quickly comes into focus for those who can bear the brutality that one man is capable of unleashing in Man on Fire.

Set in Mexico City, the casting and filming of the 2004 film are flawless. Though the supporting cast is critical to the film’s eventual success, its two main characters are key to the crossing of the film into the realm of sublime. Denzel Washington as “John Creasy,” a former CIA operative and Recon Marine officer turned mercenary, portrays to perfection a man whose heart had long since turned to stone. The on-air chemistry between Creasy and his nine-year old charge, “Lupita,” elevated the movie to greatness. A young Dakota Fanning nearly stole the show.

As shocked as he was to learn he still had the capacity to love, Creasy was all the more moved to hatred when told the girl, whose kidnappers had nearly killed him, had been murdered. With that his soul followed his heart into darkness.

Creasy avenged an evil as only a man with nothing to lose can. “Revenge is a meal best served cold,” he observed. And serve up vengeance Creasy did, to the powerfully protected “La Hermandad,” the corrupt brotherhood of police officers responsible for unspeakable crimes against the innocents.

Whether it was serendipity or fate that drew me to immerse myself in this film as I reflected upon the two years that have passed since I left the Federal Reserve will remain an unknown. Regardless, the resonance made its mark as I digest the latest headlines, warning that the new guard at the Federal Reserve will be much the same as the old, if not replicated down to the very same cast of characters.

Many readers who’ve journeyed with me these past two years have asked whether this spirit-sapping news will cause me to lay down my arms, to give the mission of reforming the Fed up to a higher being.

The answer is simple. Why come this far just to give up? I had no agenda, nothing to lose, the day I set foot inside the Fed. And I had nothing to lose the day I walked out its doors, determined to shine a light on an institution that is not so mysterious, as it is myopic, to the detriment of its own charges, We the People.

It is for the little guy that I will go on fighting the good fight. It is for the abandoned masses I will continue to make a stand against central banking’s answer to La Hermandad.

Did you miss the news, you might be asking? Have nominees to fill those three vacancies at the Federal Reserve Board been named? Has Janet Yellen been re-nominated to continue chairing the Fed? Well, no.

But Gary Cohn has told us we need not concern ourselves with change at the world’s most powerful central bank. As was reiterated in a deliberately timed and placed story in the Wall Street Journal last Wednesday, the very day the Fed met and raised interest rates,

“The Fed will do what they need to do, and we respect the powers of the Fed.”

Note two things: Cohn first spoke these words in an interview aired in March on Fox News. That his words were reprinted two months later under a front-page headline that read, “Search for Fed Chief Begins, Led by Goldman Veteran” was no coincidence. Consider the story’s emphasis on Cohn’s, “appreciation for the power of the Fed during his long career on Wall Street and for the institution’s relative freedom during his current stint in Washington,” to be the icing on the cake.

In the event you sense some sort of conspiracy at hand, stop it. It’s not sinister. It’s strategic. It’s how the establishment becomes entrenched. It’s how wrong becomes the accepted right.

Speaking of wrongs, a recent Economist story, cleverly titled, “How to be wrong,” offered a rude reminder to all of us who’d prefer to think we’re above fallibility. Two years on, and 127 missives later, I’d be remiss to park myself in the deity department. Rather, let me count the ways I have been wrong…

For starters, risky asset prices have gone from being rich to richer. As much as I’d like to brag on a different outcome, one that would have hit the reset button long ago, the stock market hasn’t fallen out of bed, bonds of all ilk remain buoyant and real estate roars on.

Rather than claim post-traumatic stress disorder resulting from too many years on the inside, take the words of Bernard Baruch, who once said, “The main purpose of the stock market is to make fools of as many men as possible.” Today, our upside-down existence dictates we flip his reasoning on its head. To that end, “The main purpose of a stock market in the modern age of central banking is to make fools of as many skeptics as possible.”

Did someone mention carnage in the junk bond market? Mea culpa again. Crude prices being closer to $30-something than $50-something looked to herald unprecedented losses in high yield bonds. What do we have instead, thanks to the bottomless pockets of those who ply in dry powder? That would be the leanest domestic energy industry on Planet Earth, which takes us one step closer to energy independence, an unequivocal best-case scenario result.

As for all those share buybacks I contended were the stock market’s sole prop, guess what? In the year through March 2017, the percentage of Standard & Poor’s 500 companies that have reduced their share count by four percent or more has halved to 14 percent from a high of 28 percent. Firms are being run as cost-effectively as ever and throwing off cash flow as never before.

Have faith the baring of these revelations that run contrary to my grave predictions has not been an enjoyable exercise. Nor was it supposed to be. But integrity demands it of the lowliest of us. Consider the alternative to fessing foibles, to acquiescing to necessary and yes, exhilarating, exercises in humility.

Perhaps you’ve noticed the belligerence of the bulls of late? How they all seemed to have lost any manners they should have gleaned from their upbringings in catty concert?

According to the Economist, “groupthink is highest when people within groups face a shared fate.” Well that explains a lot. “Even as the facts on a particular issue converge in one direction, parties can still become increasingly polarized around starkly different belief sets. That, in turn can make it harder still for a member of one party to derive any benefit from breaking ranks (emphasis mine).”

As little breaking bad as there is among the bullish herd, there’s even less among economists. For their sake, it’s a good thing Citigroup waves investors off viewing its proprietary Economic Surprise Index in isolation. The gauge, which tracks the pace at which economic indicators are beating estimates, has hit its lowest level in six years. You remember the summer of 2011, don’t you, when Uncle Sam was about to get slapped with a ratings downgrade? That said, once economists ratchet back their growth projections, this self-correcting index will pop back into positive territory.

As the New York Fed’s Bill Dudley himself has foreseen, it’s a matter of perspective and relativity. In his estimation, the overall outlook today is “pretty good.” As for what’s to come, forget the message in that old bond market. Things are apt to be smoking hot before we know it, hence the need to keep tightening.

“If we were not to withdraw accommodation,” Dudley said twisting his words as only economists can, “the risk would be that the economy would crash to a very, very low unemployment rate and generate inflation.” Follow? “Then the risk would be that we would have to slam on the brakes and the next stop would be recession.” Got it? The Fed is tightening so they don’t have to tighten. Right.

Dudley is right on one count. We could well see an overshoot on the unemployment rate. By the same token, the Fed wrote the rules on which economic indicators lead, and which lag. The caboose, if you will, is the unemployment rate.

What’s driving the train? What will lead the economy in its next direction? Hmmm. While earnings growth is all good and well, sales can’t seem to pick themselves off the floor and we’re talking the full spectrum, from the smallest to the biggest businesses. What else? There is that crude oil thing that’s looking less ‘transitory’ by the day and promises to bleed into inflation for months to com. As for the cars that have literally driven the current recovery? Maybe it’s best we not bring up the subject and leave it at that. You know how ugly it’s become in that space.

And finally, there’s this little thing called the commercial real estate market, which is taking daily body blows as valuations overheat in the face of a blindsiding barrage of supply emanating from retail, and soon to be restaurants.

Yep, that about sums it up if you’re into looking ahead as opposed to making monetary policy using only what you see in the rearview mirror to guide you.

To be fair, there are two voices of reason on the Fed. The Boston Fed’s Eric Rosengren has risen in stature as he refuses to back down on the potential for commercial real estate to spread to the macroeconomy.

And then there’s Vice Chair Stanley Fischer who just this week warned that house prices in a multitude of spots around the globe are a wee bit too high, “perhaps as a result of extended periods of low interest rates.” Imagine that. On the other hand, a $664,000 price tag for a parking spot in Hong Kong does seem a bit off (the Richter Scale).

If only, the lament goes, policymakers had a reliable inflation metric that correctly captured that darned asset price inflation! So we have whined for years and years…until now.

I wish I could take credit. Alas, the acclaim goes to a fishing buddy of mine who saw fit to put his mind to the grindstone for the cause of us wee souls who’ve been exhausted by “brilliant” central bankers who’ve yet to exemplify the capacity to come up with a new inflation mouse trap that incorporates real estate and asset price inflation. To think they defer to each other deferentially as “Doctor.”

For the time being, credit will have to sit with Brent Donnelly, or plain old Mister Donnelly if you insist on being formal, for taking a stab at reading reality.

Gourmand snobs in the audience will likely demand the details. To wit, Donnelly started with year-on-year figures for consumer prices (as per CPI), home prices and the Nasdaq. He then adjusted for volatility using the CPI as the baseline: he divided the CPI by itself; home prices by 1.64 and the Nasdaq by 11 (as it’s 11 times more volatile than the CPI). Is it me, or is it so far, so painfully intuitive?

The new and seriously improved metric goes by the ingenious acronym of the CAPI – the US Consumer and Asset Price Inflation. Maestro, can we please get a “Ta-Da?!” (Didn’t some central banker once go by that nickname? I digress…)

At the risk of Donnelly being drawn and quartered, I regret not being able to share the data and the glorious chart it produces that depicts this comprehensive metric all the way back to 1998, before the Original Sin of (inflation) omission was committed by Alan Greenspan.

Take my word for it, central bankers worth their weight in salt (gold is so passé!) would easily gather from a first blush glance that the line of demarcation between tamed inflation (the real and inclusive CAPI deal) and inflation run wild is seven percent…if they actually had to exist in a world that captured inflation in the aggregate.

In continuing on the theme of the data humbling any preconceived conclusions, in the here and now, the CAPI has just crossed up and over the seven-percent line. Inflation, measured wholly and holistically, is in true Goldilocks fashion, neither too hot nor too cold. The current equilibrium compares ever so favorably to early 2000, when the CAPI was double its current level, and 2007, when the index hit 10 percent.

Hate to break it to you, folks. Wherever “there” is, we haven’t arrived at “Destination No Looking Back.”

Bubbles, especially those that chip away at our intellect, wearing us down with their endless build-ups and messy aftermaths, are cruel, mean bitches that refuse to slink silently into any night. We may have a tornado in commercial real estate. We most certainly have a volcano building to eruption in the bond market. But we don’t have whatever it is that happens when a tornado meets a volcano in the risky asset marketplace that determines the fate of our financial livelihood.

And so, the Fed will once again appear to rise above the fray of so many naysayers, sloughing off worrywarts as Cassandras. The bulls will have their heroes and heroines to indemnify their vitriol. And the new administration will bask in the glory of being on the right side of the trade for the time being.

I refer back to the conclusion of the Economist’s lesson in fessing up to one’s ineptitudes to find a pathway to intellectual salvation, in the beauty of life’s eventually being allowed to be life: “It is rarely in the interests of those in the right to pretend they are never wrong.”

Should you choose to dwell in the land of central bank denialists, you too can dismiss the fifth largest state in our country being a stone’s throw from a junk bond rating. But first, ask yourself if an avalanche of states and municipalities will follow in Illinois’ wake when the markets correct despite the Fed’s delusions as to an otherwise out-worldly outcome?

Insist if you will that the Fed’s second mandate of maximum employment has not bastardized its originally intended role of safeguarding the value of the dollar in our wallets and stepping in as lender of last resort in times of extreme duress when the private sector is on its knees. Has the dual employment mandate not invited Mission Creep of the most nefarious sort?

Ignore if you must the flattest yield curve since the dark days of 2007 that preceded the financial crisis we crowned, “Great” for less than ignoble reasons; that flattening fast figment of our collective imagination is just that, a phantom in plain sight.

As for me, there’s a good chance I’m still Fed Up. There’s a high probability I’m more Fed Up than ever on behalf of you and you and you, that Twitter follower who recently remarked with deserved cynicism that “economic expansion” was defined as the rich getting more and the rest getting less.

More often than not, we forget the etymological wonders proffered by the Greeks. For shame. It is to those very ancient Greeks we are forever indebted for words such as “evangelize,” the literal translation of which is “to share the good news.”

There will indeed be good news to share and spread widely one day when the people take back what it rightfully theirs, their right to financial freedom. Until that splendid time arrives, have faith that I will carry the torch for one and all.

As for those who refuse to stop lying to us, the little people, the central bankers who continue to shush us, insisting they know better on all our behalf, be they ware, I remain steadfast to my committed cause. I still have no agenda, nothing to lose. I am now, more than ever, a Woman on Fire.

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DiMartino Booth, Housing in America: Movin’ on Up

Housing in America: Movin’ on Up

While exceptional exceptions exist, history’s shown superb sitcom sequels to be scant.

With any luck, you’ve long since forgotten the abysmal attempts of “AfterMASH,” “The Brady Brides,” “The Love Boat: The Next Wave,” and possibly the worst of the bunch, “Jonie Loves Chachi.” These small screen sideshows failed to give us Good Times, nor did they endear us to characters we still hold dear – Benson, Frasier, Laverne, Shirley, Maude, Mork and the lovely Mindy.

These disastrous debacles did anything but invite us to sing along to their opening songs. There was no, Movin’ on Up to the east side, to a deluxe apartment in the sky. Ah, The Jeffersons, which premiered in 1975 and ran for 11 seasons. Rolling Stone Magazine ranked it the fifth-best TV spin-off of all time. Think of it as the gift that All in the Family kept giving as only the brilliant creator of both George and Archie, Norman Lear, could deliver.

The beauty of The Jeffersons was the ease with which its characters elicited laughter. No longer was it 1971, when Archie Bunker’s angry sarcasm resonated so clearly with American viewers, whose own tempers were still flaring from the searing ‘60s. By 1975, we were all in the need of George Jefferson’s victory walk across the screen and the derision it elicited from Florence, the housekeeper who gave new meaning to cynically caustic comebacks.

It’s worth asking how valid the premise of The Jeffersons would be today. What are the odds a successful, entrepreneurial dry cleaner from Queens could pull up stakes and relocate to a luxury apartment at 185 East 85th Street in the Park Lane Towers? You tell me: units are available in the building with monthly rents starting at a cool $18,200.

Granted, this is an extreme example. According to Axiometrics, the national average annual rental rate is $1,304. While that figure is a record in dollar terms, there is much better news in the underlying trend of rental inflation. In May, effective annual rent growth rate was 2.2-percent, a level that’s held steady for the past six months. Critically, the rate has more than halved since its record pace of 5.2-percent was clocked in September 2015.

Chances are we will see a continued leveling off in rental inflation. Apartment construction is running at its highest level in at least 25 years. Nearly 600,000 units are currently under construction nationwide. Deliveries are forecast to be 102,000 in the third and fourth quarters, up appreciably from the average 82,000 per quarter in 2016 and early 2017. Looking out over the horizon, one million units will hit the market in the next three years.

This should be welcome news for renters. (Do you sense a however coming your way?) However, the vast majority of new construction in recent years has been in luxury units. That helps explain why half of would-be renters cannot afford to set out on their own – that $1,300-plus monthly pill is too big to swallow based on the affordability standard of 30 percent of income.

That’s assuming, mind you, you draw a decent salary. According to a recent report detailed in the Washington Post, no city in America has low enough rents on two-bedroom apartments for someone earning minimum wage to call home. All of 12 counties nationwide boast rents low enough for minimum-wage earners to let, that is if they can confine their belongings into a one-bedroom unit.

If you thought location mattered most when it came to buying, think again; it’s an even more critical determinant of rents. The minimum hourly wage you’d need to afford to rent in some counties in Georgia is $11.46. Meanwhile, across the country in the San Francisco Bay Area, you’d need to be raking in $58.04 an hour. Good luck with that commute teachers and nurses!

The report went on to say that things have only gotten worse since the Great Financial Crisis. In the eight years through 2015, average inflation-adjusted apartment rents rose by six percent while that of real wages fell by four percent. The upshot: some 11.2 million US households spend over half their income just to put a roof over their heads.

As big as that ‘however’ was, there’s an even bigger caveat that follows: Demographics suggest demand for apartments will only continue to increase in the coming years. Some 4.6 million MORE apartments will need to come online between now and 2030. That’s according to a fresh study jointly commissioned by the National Multifamily Housing Council and the National Apartment Association (Caution: Always consider potential bias of source).

It’s helpful to provide some context. The 4.6-million-unit figure is not altogether shocking against the backdrop of the million new renter households that have formed in every single one of the last five years, a record run rate as coming-of-age Millennials competed with downsizing Baby Boomers for apartments.

The question comes down to whether this momentum can be sustained. Will we really see annual construction of at least 325,000 new apartments for the next 12 years to satisfy this forecasted demand? It’s highly doubtful. It would require the massive imbalance that’s favored apartments over single-family construction to persist, which we know won’t be the case as the homeownership rate appears to have finally bottomed and begun to recover.

More to the point, Baby Boomers’ vacated homes don’t magically vanish into thin air keeping supply and demand in some beautiful balance only a realtor’s imagination could conjure. Every one of their homes sold adds to the supply that’s been ‘depleted’ in recent years by deep-pocketed private equity buyers who’ve swarmed markets from coast to coast to find a home for all that dry powder in their kegs.

Let’s be clear, Boomers have clearly indicated they’d prefer to sit tight, to age in their home sweet homes. Buy Home Depot stock and call it a day? That tall ‘buy’ order requires suspended animation, as in the presumption that recession will be held at bay indefinitely.

The reality of Boomer home sales won’t come into full view until we’re bearing the brunt of the next downturn. That cataclysmic catalyst will kill the optionality of aging in home. Millions of retirees on fixed incomes will buckle under the strain of their deflating retirement savings and skyrocketing property taxes, forced up to stem the bleed of underfunded pensions, which will also blow up at the intersection of Demographics and Recession Boulevards.

Wait. Go back to that part about private equity and their massive inventories of also-aging single-family rentals. Rest assured, these fly boys are not in it for the long haul despite what their propaganda purports. It’s just not in their DNA. Yes, the single-family-rental business is established. Heck, they’ve got bonds backed by these investment-cum-income properties that trade in the secondary market.

That’s all good and well until surging supply corrodes the collateral backing those securities. At that point, the big boys will do what they do best at the first whiff of a sell signal. They’ll hit the bid and hit it again to liquidate their portfolios ahead of the little guys who unwittingly followed them into the next-best-thing business.

So you’ve got supply conjuring more supply yet…which brings us back to apartment rents and some good news for that ‘lost’ generation, the Millennials. Believe it or not, these no-longer-youngsters will procreate. Furthermore, they will not cotton to raising their families in apartments, even of the George and “Weezie” Jefferson deluxe variety.

So there is good news in the making, if you can indulge one more ‘however’. At last check, student loans had not been forgiven in wholesale fashion. Top this with the fact that the average new home sales price hit $351,000 in 2015, a neat 40 percent rise from 2009. Holding hands with this dynamic household budget-buster duo is mortgage lending standards, which have been too tight for far too long. Taken together, Millennials could no sooner afford Boomers’ McMansions than a man in the moon.

That is, unless Millennials are in a position to leap frog prior generations and jump right in to move-up market. How so?  Despite what the realtors tell you, there will be ramifications that emanate from the largest age cohort in America failing to fulfill their designated role as first-time homebuyers in the current recovery. Millennials’ power-in-numbers will force the closure of the price gap between entry-level, move-up-to-after-second-child-born, and die-in homes.

You might be thinking the resurgence of affordability (Yes, Virginia, that is good news), and the home-price and rent declines it necessitates, will not be welcome news all around. Lower selling prices will obviously sting sellers.

The only advice on offer:  write in a complaint to your local Federal Reserve representative. It was failed Fed policy that created this fine mess in the first place.

Don’t see the connection?

Do any of us truly buy into the notion that private equity could have assumed the role of buyer of first resort had the Fed not lingered too long in its capacity of lender of last resort? Of course not! As for all of that luxury apartment construction, you try making the IRR work out for low-yielding properties in a zero-interest-rate environment.

The sad fact is buying and renting have never been so prohibitively, preciously priced. We can safely add that to the laundry list of obscene outgrowths of too-low-for-too-long monetary policy. You know, it sure would be nice if some Fed staffer could concoct a convincing model that shows how detrimental income inequality is to long-term macroeconomic growth prospects. Is it too intuitive for intellectuals to infer that housing is the biggest line item in an average household’s budget?

There is one last ‘however’ before we turn our attention to counting the words in today’s Fed statement.

As the headlines have heralded, one-percent down payments and subprime mortgage lending have finally staged a comeback. While such news is no doubt a relief to the politicians who are already agitating about the midterm elections (homeownership trumps baby-kissing every day of the week), easing lending standards should not be viewed as a palliative at this stage in the cycle, before prices come off their high boil.

We still have millions of conscientious subprime-mortgage homeowners who have never missed a payment in our midst, millions who are still underwater over a decade after home prices peaked the last time around, millions who remain imprisoned in homes they should have never qualified to buy. As they’ve learned the hard way, it’s impossible to Move on Up if you Dig in Too Deep.

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UK ELECTION, DiMartinoBooth

The U.K. Election: An Outsider Looking In

Talk about making hay if the sun shines through and through.

In 1696, William III introduced the ‘window tax.’ It was crystal clear that this dark tax was viewed with great disfavor being as it was based on the number of windows in a given home. Think of it as a first-generation progressive tax, which suited the extravagant era’s buildout of country estates. The more windows in a home, the wealthier the ostentatious occupants were, to say nothing of cheerier and healthier (did Vitamin D supplements exist back then?). So why not pony up more in taxes to help your sovereign offset the scourge of coin clipping?

Coin what?

Back in the day, coins were minted in pure precious metals. This prompted petty pilfers to shave, file and clip the edges off those coveted coins. Combine enduring effort with a red-hot melting pot and voila, fraudulent fortunes followed. The pinchers’ progeny were no doubt among the pioneers committing counterfeit currency capers.

These days we embrace the despicable denigration of our currencies. We go so far as to lavish the loftiest positions in the modern world on those whose most lauded accomplishments have been earned in laureates, not the legal authority to levy, well, anything.

‘Tis true, central bankers have assumed more power than our politicians. The question is where this will lead us all against the backdrop of a world where inequality has boiled over into illegality and depravity for our fellow man.

As all market watchers are aware, the British general elections are to be held Thursday. Intriguingly, some three million newly-registered voters will cast their calls for the first time. This should be a worrying factoid for Theresa May; the UK’s youngest voters were largely opposed to exiting the European Union last June.

The arguably inconsistent and unreliable polls will have certainly given Prime Minister Theresa May pause. One June 4th, May’s Conservative party looked to secure 354 seats, above and beyond the 326 needed for a Parliamentary majority. By Tuesday, other polls showed her party’s prospects had dwindled to 305 seats.

Intuition suggests Saturday night’s horrific terrorist attacks on London Bridge (pictured front and center in this week’s image) and a nearby neighborhood would have solidified Conservative’s lead. But the polls counterintuitively indicate a move in the opposite direction. Though impossible to predict, the least hyperbolic within the political analyst arena give the Conservatives better than even odds of winning a majority, or at the very least forming a coalition that accomplishes the next best thing.

It’s notable that May’s lead did not initially narrow based solely on events that were out of her control, as in three terrorist attacks in three months. Rather, it was her vow to make pensioners’ benefits progressive (just took a huge amount of license in simplifying her proposal) — as in those who have more can expect to collect less from the state – was met with about as much derision as William III’s window tax.

While it’s never wise to judge from the outside, some of the wisest and most patriotic suggestions floated in the United States have been from wealthy retirees who’ve suggested they need not collect Social Security to help balance the nation’s books. Moreover, May was magnanimous in her aim; she intends to use the saved state expenditures to funnel funds into raising productivity by closing the skills gap that has crippled the economy (sound familiar?)

Somehow the liberal media managed to paint May as a pariah (is it yours truly, or are the parallels multiplying?)

In one of May’s latest interviews, she reiterated her focus on what she hopes is to come: “It’s about young people’s future, it’s about ensuring we take the opportunities that will be opened up to us when we leave the EU to be a really global nation bringing more jobs, more investment into the UK. I want to see proper technical education for the first time for young people for whom that’s right.”

Connecting warm bodies with much-needed skills sets to UK’s corporate sector could well do the economy some good. Let’s hope she has wise economic counsel to help her execute her plan if the Conservatives prevail at the polls.

Luckily, one of Britain’s savviest economists is free to pursue his next career gig. Of course, the reference is to Andy Haldane, the Bank of England’s chief economist, whose term technically ended May 31st (he will remain at his post until his replacement is secured.)

How to sum up Haldane? A central banker who gets it right half the time is about as close to genius as you can ever hope for in the field given the de facto requirement that Keynesian Kool-Aid be drank before the threshold is crossed into the inner sanctum sanctorum. That applies whether you refer to the Bank of England, the Reserve Bank of Australia, the European Central Bank, the Bank of Japan or especially the Federal Reserve (though hawks may just get their chance to storm the temple – stay tuned on that count).

Of punk UK productivity, for one, Haldane has this to say in a recent speech: It wasn’t low interest rates that kept middling companies in business since the crisis hit, but rather delusions of operational grandeur. Haldane prodded the UK government to provide global benchmarks to UK firms so they could better appreciate their standing among their international peers.

“As Olympic athletes have shown, marginal improvements accumulated over time can deliver world-beating performance,” Haldane said. “Applying those marginal gains to the population of UK companies could significantly improve UK living standards.”

Sounds like May and Haldane are on the same page, though it goes without saying that low interest rates assisted in keeping ‘zombie’ companies alive in addition to an abject denial of mediocrity.

Most importantly for May, if she’s in the market for an economic advisor, Haldane is not beholden to the modern-day economics profession. Haldane likened economists’ failure to foresee the financial crisis to a, “Michael Fish moment.” Fish, for you non-Anglophiles, dismissed the chances that a massive hurricane would hit southern England in 1987. You know how this story ends. The Great Storm did indeed hit and how, wreaking mass destruction and casualties.

After describing his profession as being in, “some degree of crisis,” Haldane went on to suggest that his peers abandon their, “narrow and fragile” models in favor of a broader analysis that incorporated the perspectives of other disciplines. Hear, hear!

To be fair, Haldane went on to say that Brexit would crash the UK economy but with a lag, hence the above-referenced only ‘gets it right half the time’ bit.

If providence is propitious, May is also channeling the ghost of Margaret Thatcher, who made all manner of enemies going against the conventional wisdom of her day, especially as it pertained to the economy. No doubt it will take radical ideas to cure what ails the UK economy today.

In what can only be described as twisted irony, Mark Carney’s Bank of England (BoE) was recently taken to task for the pay raises recently ‘awarded’ to his employees which failed to keep pace with inflation. At around one percent, the most recent annual BoE employee pay raise is a pittance of the current 2.7 percent inflation rate. The average British worker bested that, with average wages increasing by 2.4 percent, which still fails to keep pace with the rising cost of living.

And yet, as is the case with his European and American counterparts, Carney is more likely to get caught out gnashing his teeth about inflation being too low, despite it clearly being too high for the average working man and woman.

The fact is Carney’s in a mighty tight corner with inflation running too hot, wages running too cold and a corporate sector petrified at the potentially poisonous ramifications of Brexit. For the moment, exports are a relative outperformer with a big boost from the weaker pound. It’s the ‘what’s next’ that matters most though — the impossible tradeoff between raising interest rates and the higher real wages that would follow, or lower for longer and the boost to short-term growth prospects too offset any Brexit fallout.

And that’s just for starters when it comes to threading needles on Threadneedle Street. As has been the case in Australia and Canada, residential real estate prices have run wild since quantitative easing unleashed animal spirits in the aftermath of the financial crisis. As a result, British households’ debt loads vis-à-vis the size of the economy have made a full round trip to record highs. But here’s the wrinkle:  mortgages in the UK tend to be of the variable rate variety, In other words, Carney has to tread more lightly than his counterpart Janet Yellen if he’s inclined to tighten.

And so they straddle the Atlantic, both weighed by impossible choices, rendered more intractable yet by their own misguided foregone follies that insisted more was more, lower was better. What good has that done? To add to their intellectual egos’ injuries, both Carney and Yellen have to contend with political leaders who’ve neither the appetite nor the intent to compromise, much less kowtow, to their theoretical end games.

Looking back, it’s hard to believe the window tax withstood its own political backlash for over 150 years. But believe you me, the tax was not abolished until 1851. By then, so despised was the levy, it had assumed a new name — Daylight Robbery. Is it so hard to see that the current crop of central bankers has also managed to destroy the vista, to suck the oxygen out of the world economy as closed up homes did back then, albeit with much more sophisticated means? We can only hope our elected leaders don’t have to wait another 150 years to see the light.

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The Demographic Divide: A Police State of Mind

The Demographic Divide: A Police State of Mind

Fake news is so old.

How else did, “I am prepared to veto any bill that has as its purpose a federal bailout of New York City to prevent a default,” become, “DROP DEAD” way back in October, 1975? Oh, those hellbent headline writers. Whatever will they think of next? Besides, the Daily News headline worked wonders, if infuriating die hard New Yorkers was the objective.

The insult so unhinged one William Martin Joel that he soon found himself saying goodbye to Hollywood and headed back to his native New York by way of a Greyhound bus on the Hudson River Line. Had the songwriter and singer we’ve all come to know and love as Billy Joel not been on that bus, he’d have never been inspired to pen the classic New York State of Mind, an anthem to the City only Sinatra himself can claim to have bested in his time.

So thank you, President Ford for refusing to treat the “insidious disease.” At least that’s how he characterized New York’s profligate spending ways. Without the media’s dramatization of Ford’s ire, the world would have been robbed of some of the most poetic lyrics ever written. And, by the way, a feasible blueprint for the years to come as some budget-strapped cities run their tills dry.

In the unique case of New York City in the late 1970s, federal assistance accompanied fiscal reforms. The details of the détente should thus be de rigueur study materials for the judicial and legislative arms of so many at-risk municipalities nationwide.

At the risk of feigning any pretense of legal expertise, municipal bankruptcies come down to the limitations of the federal government’s power to provide relief to ‘units of states,’ whether they be cities, counties, taxing authorities, municipal utilities or school districts.

Though a variety of other state-led interventions have been successfully deployed, many of us are most familiar with voluntary Chapter 9 bankruptcy filings, permitted by half the states and employing the powers of the judiciary in conjunction with creditor workouts. Jefferson County, Alabama and Stockton, California may ring mental bells. But it is 2013’s record $18 billion Detroit, Michigan Ch. 9 filing that reset precedent on how engaged the bankruptcy courts can be.

Suffice it to say, default via the court system is a lengthy process and most lucrative for the lawyers retained. In relative terms, New York City’s effective default occurred in a New York Minute. After the banks cut off New York City in the spring of 1975, the State created an emergency financial control board and a borrowing entity to provide immediate relief to the city. Rather than “default,” the city declared a “moratorium” on $1.6 billion in obligations, a hotly debated designation. A thorny rose it nevertheless was.

In December 1975, with the financial management wrested out of the city’s control, Congress passed and Ford signed into law legislation allowing the Treasury to extend loans to the city to keep it up and running. Future New York state and city revenues were promised to repay the loans and spending reforms that had been intractable were implemented by force.

Looking back at the 40th anniversary of the extraordinary federal-led intervention, American Enterprise Institute’s Alex Pollock applauded Ford’s staunch stance: “That’s what happens when you run out of money and the music stops. Intensely needed reforms of the city’s spending and financial controls actually did follow.”

Why raise the specter of federal assistance if it’s patently apparent other means can be deployed in today’s modern municipal era? The crush of retiring Baby Boomers will keep Uncle Sam up at night for years as he struggles to keep federal entitlements solvent. Why even consider federal involvement in municipal pensions that are at least backed by some semblance of assets? The answer comes down to demographics.

Forty years ago, Baby Boomer were entering their prime earning years. Opportunity in the land of America was expanding at a rapid clip. The level of education was rising among those entering the workforce vis-à-vis their older counterparts at the same time women were growing the overall workforce (just under half of women worked then; today it’s 70 percent). In the simplest terms, the size of the pie was growing.

Today, roughly 10,000 Boomers exit the workforce every day, which should present an opportunity in and of itself for Millennials to backfill the depleting workforce. Census data tell a different story. In 2016, median personal income for workers aged 24 to 34 was $35,000. In modern dollar terms, that same age cohort was earning $37,000 in 1975.

It’s difficult to square lower earnings with the educational makeup of the labor force. In 1975, 23 percent of young workers had earned a bachelor’s degree. Forty years on, 37 percent have achieved the same. Shouldn’t that improvement have lifted per capita earnings?

It comes down to comparative advantage. Back then, it was easy enough for a younger, better-educated worker to displace an older, less-educated and therefore less-qualified older worker. Today’s workforce is largely educated and intent on working longer; it’s stickier and less tractable. At the same time, the double governors of technological innovation and globalization have reduced the aggregate demand for warm bodies.

At the risk of getting buried in the weeds, there are more workers exiting the workforce than there are those joining it. Those making way for the exits are otherwise known as ‘retirees.’ It is at this critical juncture that municipal finance re-enters the picture.

As has been written on these pages, over the past few years, public pensions have been reducing the stated returns they anticipate their portfolios generating on investments. These reduced expectations necessarily trigger the need for higher contributions on the part of state and local governments.

That’s exactly what took place last year. The Census’ 2016 Annual Survey of Public Pensions found that state and local government contributions rose by 6.5 percent to $191.6 billion from 2015’s $179.7 billion. By contrast, earnings on investments, which include both realized and unrealized gains, tumbled 67.9 percent to $49.9 billion from $155.5 billion in 2015.

Meanwhile, the number of pensioners collecting checks marched upwards to 10.3 million people, up 3.3 percent over 2015. The benefits they received last year rose even more, by 5.4 percent to $282.9 billion from $268.5 billion in 2015. And finally, total pension assets fell 1.6 percent to $3.7 trillion from $3.8 trillion the prior year.

In the event you sense you’ve been felled by death by numbers, back out to the big picture. Paid benefits exceeded contributions to the tune of $40 billion in 2016 against the relentless backdrop of an increasing number of Boomers retiring (in 2014, there were 9.9 million receiving benefits).

Microcosm this demographic dynamic to the extreme example of Chicago. In 2015, the latest year for which we have full data, some $999 million was paid out to 29,296 recipients. That compares to the $90 million in investment income generated by the two employee pension funds that year. Back out the timeline a decade – in 2006, these two pensions held a combined $8.5 billion in assets. Since then the two funds have generated $3.1 billion in investment returns but paid out $8.511 billion to retirees.

Chicago Mayor Rahm Emanuel recently proposed raising new city employees’ contribution to help fill the gulf of underfunding but Illinois’ Governor quickly vetoed the measure declaring Emanuel was, “trying to fix a drought with a drop of rain.”

Projections suggest that one of the two funds will be cash flow negative by 2023; the other will run short by 2025. If all else remains the same, a big IF with risky asset prices trading at frothy high valuations, property taxes would need to be doubled to cover the coming shortfalls.

Many Cook County taxpayers are forsaking a wait-and-see approach. Chicago was the only large city in America to lose population last year, its resident count dropped at nearly double the rate of 2015.

As convenient as it might seem to excoriate the Windy City, there are plenty of other major cities deep in hock. According to a Moody’s report, though Chicago does indeed top the list, Dallas is the second-most underfunded city followed by Phoenix, two magnets for nomads in search of lower costs of living. Rounding out the top ten list are Houston, Los Angeles, Jacksonville, Detroit, Columbus, Austin and Philadelphia.

In other words, running and hiding in lower tax haven hamlets will be even more challenging in coming years. According to a Milliman report, 2015 marked the first time retirees outnumbered active employees in the nation’s 100 largest public pensions; there were 12.6 million retirees covered by the toils of 12.5 million workers.

Look back no further than 2012 to appreciate how the trend has accelerated; in that year retirees numbered 10.5 million vs. 12.3 million active employees. Absent a surge in state and local payrolls, further fiscal deterioration is poised to persist.

To take the case of the case of the country’s largest pension, the California Public Employees’ Retirement System, in 20 years’ time, retirees supported by the plan will be roughly double the number of active workers. CalPERS won’t be alone in this predicament.

Again, it comes down to the demographic divide that’s opened up since President Ford was in office. In the 1970s, the typical public pension’s active employees outnumbered retirees by a factor of four-to-five times; today that ratio is 1.5-to-1 and continues to fall as Boomers retire in droves and Millennials fail to fill the yawning gap.

After a grisly year that ended with a tally of 4,000 homicides, Chicago has begun to coordinate with federal authorities to control a crime wave driven by gangs’ unencumbered access to firearms. The last thing the city can withstand is further cuts to public service funding. By the same token, taxpayers have already begun to vote with their feet as rising taxes and foundering pensions promise to beget more tax hikes to come.

It’s plain that the last thing any of us want to see is a Police State of any kind. But the growing risk is that the next recession and deflating asset prices could well alter the rules of engagement between federal and state authorities on more levels than any of us care to envision.

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Danielle DiMartino Booth, Central Bankers, Money Strong LLC, Federal Reserve, Debt, Trojan Horse, Fed Up,

Beware of Central Bankers Bearing Gifts

Ulysses’s reputation preceded him.

   ‘O unhappy citizens, what madness?

Do you think the enemy’s sailed away? Or do you think

any Greek gift’s free of treachery? Is that Ulysses’s reputation?

Either there are Greeks in hiding, concealed by the wood,

or it’s been built as a machine to use against our walls,

or spy on our homes, or fall on the city from above,

or it hides some other trick: Trojans, don’t trust this horse.

Whatever it is, I’m afraid of Greeks even those bearing gifts.’

Virgil, The Aeneid Book II

So warned Laocoön to no avail, and that was with Cassandra’s corroboration. As reward for his prescient prudence, the Trojan priest and his twin sons were crushed to death by two sea serpents. It would seem the Greeks had no intention of relinquishing hold of ancient Anatolia, a critical continental crossroad where Europe and Asia’s borders meet, a natural target for conquering civilizations.

Thankfully, history has made history of menacing machinations crafted with the aim of undermining the opposition. If only… History is rife with exceptions starting with most politicians on Planet Earth and more recently, central bankers.

In what can only be characterized as Mission Creep raised to the power of infinity, the Federal Reserve’s last Federal Open Market Committee Minutes warned that “equity prices are quite high relative to standard valuation measures.”

Let’s see. Where does the stock market fit into Congress’ statutory requirements that the Fed’s objectives be: “maximum employment, stable prices and moderate long-term interest rates”? You neither, huh?

The Minutes also indicated that, “equity price indexes increased over the intermeeting period.” Is it the slightest bit alarming that monetary policymakers are nodding to a phenomena that’s been in place since March 2009 as having just occurred to them? Are we pondering pure coincidence or is this exactly what it appears to be — political pandering?

This from CNBC:  FOMC Minutes have unleashed the word “valuation’ as it pertains to equities six times since Alan Greenspan, a self-described obsessive observer of the stock market, first uttered the words, “irrational exuberance.” In every instance, stocks were hit over the next 12 months.

Could it be that Janet Yellen, who in 2008 said the Minutes should be used, “to provide quantitative information on our expectations” knew exactly what she was doing, that she planted the word ‘valuation’ to send the President a pointed message with nothing less than perfect precision?

You may be thinking our new leader has more than enough on his agenda to be worried about a threat to the stock market from the likes of academics he not so long ago publicly derided. If Trump cares about staying in the good graces of those who put him in office, he will fight the temptation to pivot on the Fed. He’s been in office long enough to have made a move to begin filling the three open seats on the Federal Reserve Board.

More to the point, in the event Trump hasn’t been apprised, the Fed has the economy by the short hairs. And, yes, it was, is, and will be about the economy, at least among those who voted him into office, many of whom remain angry and anxious, but not stupid.

They are still waiting for an advocate who sees through the average data right through to the galling truth that absent executive pay, incomes remain in decline. They pine for a leader who can like debt all he wants to get deals done, but doesn’t force it down the economy’s throat to generate economic growth of the most fleeting nature. They may not be able to identify the enemy within by name but they have every right to expect their President does, that he has the gumption to stand up to the Fed and deliver his People from the shackles of indentured servitude.

It might even be a good thing, for working Americans who’ve long sensed the economy has abandoned them, that Trump has a beef with the media and two savvy guys from Goldman Sachs helping steer the economy. Together they should be able to glean the facts from the data the Fed insists are so much “good news.”

Consider, if you will, a fresh report on the state of consumer finance released by the New York Fed. At $12.73 trillion, household debt sits at a record high. We’re told to look the other way, that it’s a nominal figure and more importantly that debt as a percentage of gross domestic product (GDP) is nowhere near where it was back in the bad old days of 2007.

‘Tis true that household debt is no longer 95 percent of GDP which was the case when it peaked in the fourth quarter of 2007. Before resuming its climb to its current 80-percent level, it got as low as 78 percent of GDP.  But let’s hold off on the austerity bubbly for the moment. Since record keeping began in 1952, when the record low of 23 percent was recorded, debt-to-GDP has averaged 56 percent.

As for the red herring that households have tightened their belts, while that is the case for a minority, the bulk of deleveraging that’s taken place has been the result of the past decade’s 10 million and counting foreclosures. (For those of you still keeping count, some 91,000 individuals had ‘foreclosure’ added to their credit reports in the first three months of this year, an uptick from 2016’s fourth quarter.)

The deleveraging, by the way, ended years ago. Aggregate household debt is 14 percent above the low it hit in the second quarter of 2013. And we’re not talking about mortgages here.

Drawing hard conclusions is a bit of a stretch as it really depends on your perspective. You make the call. How secured by anything of value is the type of debt households have taken on since mortgage lending standards tightened like a vise on would-be homebuyers? Credit card debt is an easy enough call. But what about that car loan? Checked your trade-in value lately? (Not recommended if you’ve had a bad day.) As for that festering $1.3 trillion mountain of student debt? Did someone say ‘perspective’?

The bottom line is we still have too much debt and precious little to show for it.

In return, we get this from the NY Fed’s President Bill Dudley: “Homeownership represents an important means of wealth accumulation, with housing equity being the principal form of wealth for most households.” (Isn’t that a good thing?)

He goes on to observe that, “Changes in the way we finance higher education, with an increased reliance on student debt, may have important implications for the housing market and the distribution of wealth.” (You think?)

And finally, out of the other side of his mouth, he has this gem of a recommendation to kick start the economy: “Whatever the timing, a return to a reasonable pattern of home equity extraction would be a positive development for retailers and would provide a boost to economic growth.” (Wait, wasn’t all that home equity borrowing what pushed debt up to its record highs and drove the economy into the Great Financial Crisis?)

It’s critical to note that Corporate America is also drowning in record levels of debt – nonfinancial corporate debt within a hair of $6 trillion. And though it was nary mentioned in the campaign by either party, at $20 trillion, Uncle Sam himself is up to his eyeballs in hock.

Hopefully you can see Trump’s once in a century chance to reshape the warped thinking inside the Fed. He has the tremendous power to redirect the meme by draining the debt swamp that makes our government beholden to foreign lenders, our corporations less competitive on the global stage and our households seething at their inhibited upward mobility. Talk about Making America Great Again, for ALL Americans.

Without a doubt, this will be one of Trump’s toughest tests, and yes, the Fed can easily take down the stock market in retaliation; they could even follow through on threats to shrink the balance sheet. It would be as if someone flipped a switch and we veered from Quantitative Pleasing to Quantitative Plaguing.

And what politician in their right mind wants plague visited upon their economy on their watch? Ask any of Trump’s predecessors and they’ll shoot you straight. Passing legislation with ultra-easy monetary policy and fluffy stock prices on your side sure as heck beats the alternative.

But in the end, it just buys time, not Greatness.

Artificially low interest rates might be as alluring as that Trojan Horse was to the people of Troy. But let’s put their experience to better use and not dismiss Laocoön’s words as the tragic Trojans did. Let us all Beware of Central Bankers Bearing Gifts.

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