ECB and BoE Fulfill Expectations, PBoC 'Surprises'

On Thursday we witnessed a veritable race to the bottom by various central banks. Mario Draghi in his press conference assured the assembled journalists that it was not 'coordinated action', but allowed that the central banks are 'exchanging views'.

Since we must assume that all of them are slightly alarmed by the slew of weakening economic data that has recently emerged world-wide, we can imagine the content of the exchanged views.

To this readers must keep in mind that manufacturing surveys are far more important as economic indicators as one would assume if one followed developments in the economy only superficially. For instance, it is an article of faith in the financial press that 'consumption represents 70% of the US economy'. Balderdash. The biggest sector of the US economy by gross output is actually the manufacturing sector.

The reason why the meme of the 'consumer representing 70%' has become so ingrained is based on how 'GDP' is calculated. The GDP should be renamed the 'NDP' (net domestic pruduct), since apart from investment spending on durable goods, it only counts consumer spending on final goods, government spending and net exports. What is conspicuously missing is practically the entire production structure – spending on raw and intermediate goods is entirely omitted, as is capital maintenance. If these activities were included, consumption spending would amount to no more than 35%-40% of GDP and the GDP total of e.g. the US would amount to $25 to $26 trillion instead of $15 trillion.

The point we wish to make here is mainly that manufacturing is far more important to the economy's health than its share in the official GDP data would suggest. Therefore, the fact that manufacturing PMI data (ISM in the US) have – with a few exceptions like e.g. in Canada – slipped into contraction territory is a serious development. Central bankers evidently are not prepared to ignore these developments – unfortunately. They feel compelled, in line with their statutory mission, to provide more easy money, in the mistaken assumption that this will 'fix' the economy.


The PBoC Rate Cut

The lead was taken by the Peoples Bank of China (PBoC), which decided on a 'surprise rate cut' (note here that moves on rates and reserve requirements by the PBoC are always 'surprises'; the People's Bank of China, as the presence of the term 'people' in its name suggests, is slightly less transparent than its Western counterparts. This is merely a general observation: every nation that has the 'people' in its name is as a rule autocratic).

The PBoC cut its one-year benchmark lending rate by 31bp to 6.0% and the one-year benchmark deposit rate by 25bp to 3.0%.

In its statement the PBoC specifically mentioned that restrictions on lending to the real estate sector are to remain in place so as to 'discourage speculative buying'.



China's administered interest rates versus the 1-year t-bill yield and 3m SHIBOR (Shanghai Interbank Offered Rate) – click chart for better resolution.



China's reserve requirement ratio, the main tool by which the PboC influences credit and money supply growth. It has been left unchanged on Thursday, but it is widely expected to be cut soon – click chart for better resolution.



BoE Adds to 'QE'

Next up to bat was the Bank of England, which resumed its totally ineffective and by now absurdly vast 'quantitative easing' program, raising it by yet another 50 billion pounds to 375 billion pounds in toto.

It's a case of 'let's do more what has utterly failed to work so far'. Even from the point of view of committed inflationists the program must be regarded a complete and utter failure, as it has failed to arrest and reverse a sharp decline in the rate of true money supply growth.

Here is a snip from the BoE's policy statement:


At its meeting today, the Committee agreed that the Funding for Lending Scheme, which would be launched shortly, was a welcome initiative. It also noted recent and prospective actions to ease liquidity constraints within the banking system. Taken together with reduced pressure on household real incomes, on the back of lower commodity prices, and the continued stimulus from past monetary policy actions, that should sustain a gradual strengthening of output growth.


But against the background of continuing tight credit conditions and fiscal consolidation, the increased drag from the heightened tensions within the euro area meant that, without additional monetary stimulus, it was more likely than not that inflation would undershoot the target in the medium term. The Committee therefore voted to increase the size of its programme of asset purchases, financed by the issuance of central bank reserves, by £50 billion to a total of £375 billion. The Committee also voted to maintain Bank Rate at 0.5%. The Committee expects the announced programme of asset purchases to take four months to complete. The scale of the programme will be kept under review.”


(emphasis added)

UK CPI 'inflation' has been 'above target' for several years now, but at a recent 2.8% was mired in a sharply declining trend from its previous high near 5%. According to accepted central bank lore, falling prices, or prices that are rising 'too slowly' are 'bad'. Every single consumer on the planet disagrees with this view, but consumers have no voice in these decisions and the accepted economic orthodoxy is that the purchasing power of money must decline, lest great travails will befall us. Since 2008 we have seen the end result of this orthodoxy manifest itself in its full glory, but no introspection on that point has as of yet occurred. Pity.

It is therefore a good thing that the BoE has been so singularly incapable of igniting monetary inflation thus far. Market forces have proven stronger than the central bank. Unfortunately that also means that the BoE is likely to become more 'creative' in the future, as evidenced by the above mentioned 'welcome initiative'.



Both broad money M4 and UK money TMS have failed to respond to the BoE's 'QE' exertions. As far as printing the shores of Albion back to prosperity goes, the BoE is literally a paper tiger (chart via Michael Pollaro – for full updates of TMS data, see the links to Michael's data on the sidebar) – click chart for better resolution.



For comparison purposes, the growth in BoE credit, which has now been boosted even further – click chart for better resolution.



ECB – Twilight Zone Reached

Then the ECB chimed in with a widely expected rate cut of 25 basis points to 0.75% in its main refinancing rate. This won't alter anything for Spain or Italy, but it is a record low in the ECB refi rate since the birth of the common currency. The 'marginal lending rate' (akin to the discount rate in the US) was also cut by 25 basis points.

More notable than the cut in the refi rate was however the decision to cut the ECB's deposit rate to zero – a possibility which we have previously discussed in these pages (scroll down to 'ECB – Departing Into the Twilight Zone' for details).

This concerns the interest rate the ECB pays to banks for keeping excess reserves on deposit with the central bank. We have previously pointed out that contrary to widespread lore, excess reserves on deposit with the central bank are not an obstacle to the creation of credit and deposits from thin air by the commercial banks (see 'Understanding the ECB's Balance Sheet Composition' for details). The liabilities side of the ECB's balance sheet would undergo a subtle change if the banks were to begin using their excess reserves to pyramid credit atop them, as a tiny percentage (1% to be precise) of every euro in new deposit money created would lead to a reclassification of 'excess' to 'required' reserves. If bank customers were to increasingly withdraw deposit money in the form of currency, then some of the excess reserves would become currency.

Still, for a variety of reasons, banks prefer not to create more credit at the moment, and would rather hang on to their excess reserves (if they have any – only certain banks are in fact depositing money with the ECB – most of the excess reserves are likely deposited by German banks, which are the recipients of a lot of deposit money fleeing from the periphery). After all, so the reasoning goes, if the crisis should worsen, interbank lending markets may freeze again completely, just as they have done in 2008. A cushion of excess reserves could come in handy at that point, as it serves as a buffer against bank runs.

Moreover, there is simply no reason to increase lending at this point. There is little credit demand on the part of creditworthy borrowers, and those who would need credit most urgently are mostly in dubious shape. An economic contraction is underway – as a result there is great interest in paying down debt, while taking on new debt is somewhat lower on the list of priorities. The desire to hold larger cash balances than usual as a precaution against an uncertain future extends to everyone in the economy – including the banks.

The ECB is cutting the deposit rate to zero in the hope that this will lead to more lending. The reasoning is fairly straightforward: at present, there are about €800 billion in excess reserves deposited with the ECB. Up until now, the central bank paid 25 basis points per annum in interest on these deposits. That's € 2 billion in interest earned per year – nothing to write home about considering the huge amount on deposit, but better than nothing, especially as these deposits are regarded as 100% safe.

By lowering the rate to zero it is reckoned that banks with excess reserves will have either an incentive to offer them in the interbank market or use them as the basis for throwing more fiduciary media on the loan market themselves.

We predict the failure of this stratagem and expect that eventually, the ECB will resort to imposing a penalty rate, or put differently, a negative interest rate. Not even that may be sufficient inducement at first: as we have pointed out in our previous missive on the topic, in Switzerland the entire yield curve from short term bills out to five year notes recently briefly went negative. This indicates that safety concerns may well trump the fact that negative rates amount to a guaranteed loss.



Excess reserves on deposit with the ECB (chart via CLSA) – click chart for better resolution.



National Bank of Denmark – Negative Deposit Rates Become Reality

The National Bank of Denmark (NBD) is showing the way – it went ahead and indeed imposed a negative interest rate on deposits commercial banks hold with it, while cutting its discount rate to zero. The NBD is worried about the Danish Krone being pushed up as a result of the euro area debt crisis and evidently intends to flood Denmark with liquidity to keep the currency's peg with the euro intact.

According to the WSJ:


Denmark's central bank cut its main interest rates Thursday, including slashing its deposit rate to a negative level for the first time, to prevent further appreciation pressure on the krone after the European Central Bank reduced its key borrowing costs to an historic low.

Nationalbanken lowered its deposit rate to a negative 0.2%, from 0.05%, while the key policy lending rate was also cut by a quarter of a percentage point, to 0.2%, from 0.45%.

The ECB earlier reduced its refinancing and deposit rates by 0.25 percentage point to 0.75% and zero, respectively, a move aimed at spurring economic growth in the euro area as it struggles with a deepening debt crisis.

The euro zone's financial turmoil has made the krone-denominated assets of this Nordic nation with a sound economy and low debt ratio an increasingly popular safe haven for investors concerned about the future of the euro. To relieve upward pressure on the krone, the central bank has intervened in markets to buy other currencies, resulting in the country's foreign reserves reaching a record high in June.

Denmark's central bank Thursday also cut its discount rate 0.25 percentage point to zero.

According to the Danish financial sector organization Finansraadet, banks will have to move quickly to seek alternative places to park the liquidity now to avoid significant losses.

While the negative deposit rate will help keep the euro peg in place, it could cost Danish banks between DKK400 million ($68 million) and DKK500 million in interest expenses, unless they shift the spare liquidity away from Nationalbanken's deposit facility, said Finansraadet Chief Economist Niels Storm Stenbaek.

Denmark's central bank also increased its current account limits to allow Danish banks to shift liquidity from the deposit account where they will now pay to park funds to a folio account, where the interest rate is zero.

The current account ceiling for day-to-day deposits will now climb to DKK69.70 billion, from DKK23.15 billion previously, the bank said on its web site.

Since mid-2011, the Nationalbanken has cut its main interest rate several times, both in alignment with and independently of the ECB, to stabilize the krone.

Danes rejected euro-zone membership in a referendum in 2000, but pegged the krone to the euro. The krone is allowed to sway 2.25% either side of the central rate of 746.038 krone per 100 euros.”


(emphasis added)

We would take issue with the alleged soundness of Denmark's economy. Not only is the nation a bastion of socialism, but it has gone through a significant mortgage credit and housing bubble. Denmark has the world's biggest public sector and its highest taxes (38% of the country's full time employees were employed by the government as of 2006, and tax revenue amounted to over 50% of GDP). Socialists islands can of course exist as long as there is still a market economy somewhere, but this does not strike us as sustainable model. As Per Henrik Hansen from the Copenhagen Business School pointed out in an article in 2003 (while slightly dated, we don't think that the basic facts have changed much):


Despite its reputation as a showcase of political utopia, 40 percent of its adult population live on government transfer income, full-time, all-year. A little more than a third of these people are pensioners and the rest are working age. About one third of the people who actually hold a job work for the government or government-owned companies. The effective tax level is around 70 percent, not the 50 percent that is usually reported (the lower figure comes about by disregarding the effects of the sales tax and excise taxes).”


Elsewhere he writes:


Danish politicians proudly proclaims that Denmark is the most egalitarian country in the world. They may be right. The obsession with equality delivers a crushing, daily blow to anyone with a new idea or the inkling to cultivate an ability that surpasses the norm. Young people have virtually no chance to improve their lot in life, to take risks, to make it big through innovation and entrepreneurship.

Excellent and hard work are not rewarded by a system that systematically levels the population into a huge homogenous middle class, whose standard of living advances only incrementally and in ways that flout economic priorities. A total tax level that approaches 70 percent is a relentless and debilitating reminder that this country desires no personal economic achievement and no accumulation of wealth.

And yet many people seem to be happy with this system, somewhat like the masses of Huxley's Brave New World. Of course it sets up a dynamic that harms everyone in the long run, but people don't seem to understand or care about this. Equality and stability are regarded as more important than progress and freedom.

A heritage of honesty and hard work are marvelous tools for papering over the failures of welfarism and subtle servitude. With the right attitude, even a prison population can settle into a comfortable and egalitarian existence, one that might even impress Queen Catherine passing by on a boat. But lacking energy, enterprise, entrepreneurship, and freedom, such systems of economic control exact a huge toll with the passage of time.”


As Dane-in-exile Michael Bach points out, it is a bit like a gilded prison, with the gold-plating slowly but surely peeling off the bars. There is not one aspect of life that is not regulated to the smallest detail it seems. One is even required to place a harness on one's dog and attach it to a seat belt when taking the animal along in a car. Failure to do so can result in a $200 fine. Bach, who these days lives in Mexico, has recently visited Denmark and come to this conclusion:


“You'd think with this socialist nanny state taking care of everyone they'd all be happy. But, Denmark is in the upper tier of suicide rates per country. It's no wonder to me after having been free for the last eight years and returning to what for all intents and purposes felt like a dark, cold prison.

As I got off the plane in Acapulco, felt the humid, warm air and realized the worst problem I had was that I had stupidly left my car parked under a mango tree for the last 6 weeks and it was covered in tropical fruit, I realized for the first time why exactly I enjoy living here so much… and why I can never see myself ever going back to Denmark to live.

Denmark is one of the last highly socialist states that communists keep pointing to as proof of the success of massive socialism. If that is success, they can have it. I love and miss my family but will never miss what I now see so clearly as being pure oppression and a life of monotonous misery.”


It is perhaps be no surprise that the planners at the country's central bank have now decided that the cost of capital should be between zero and negative. What is surprising is that investors think of Denmark as a safe haven. If anything , it shows us the degree of sheer desperation out there.


Sell the News

The sudden flurry of activity by various central bank busybodies has not had any discernible positive effect on asset markets yet. Rather, a 'sell the news' effect could be observed on Thursday. This was probably due to the fact that nothing truly unexpected or particularly radical happened. We would point out here that the recently 'saved' Spain and Italy have seen their bond yields rise again sharply after the initial bout of short covering following the euro-group summit. It seems the initial euphoria is beginning to wear off rather quickly this time, although no firm judgment can yet me made on this point. The need to constantly roll over massive amounts of debt leads to the usual 'auction discounts' in these markets. As we have pointed out previously, both Spain and Italy have enormous amounts of debt maturing this year, and there are obviously not a great many willing buyers for it.



Spain's 10 year government bond yield: back at 6.75% – click chart for better resolution.



Spain's 2 year yield has also taken back a good chunk of its recent decline, rising by more then 50 basis points in a single day – click chart for better resolution.



Italy's 10 year yield: also rising again and back above the 6% barrier – click chart for better resolution.



Addendum: What the President Can Do

Mish today had a report out on president Obama's score card with regards to his promise to 'double exports'. This prompted us to comment with the following bon-mot which readers may want to keep in mind for use at appropriate occasions:


A president can neither create jobs, no can he 'double exports'. All he usually does is devise ways to steal more creatively from the citizenry than his predecessor.”




Charts by:  BigCharts, CLSA, Michael Pollaro, Den Danske Bank/Reuters



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2 Responses to “Central Banks Resume Monetary Pumping”

  • ab initio:

    This is not the end of money printing by the central banks – not by any stretch of the imagination. Their argument is that inflation is trending down so all these fears of inflation as a consequence of printing are only hyperbole. Print away every time the equity markets hiccup is their motto. The ECB will get into this mode too, sooner rather later, with gusto. Clearly, markets no longer discount anything as the biggest money printers right now are rewarded by the bond market with low yields and the forex market with relatively strong currencies. When the bond market pendulum swings the other way is when the shit finally hits the fan! When, of course is the eternal question!

    Japan, has been a graveyard for bond bears for many years as their government debt keeps rising to now over 200% of GDP. Even super savvy billionaire investors like Kyle Bass have had their head handed to them betting on the resurgence of the Japanese bond bear. Ditto for Treasury and Gilt bears. The tide will turn as t always does. Identifying the trigger that can get one on that profitable ride will make many an investor.

    • Kyle bass is using Japan as a hedge. I think he has been in the trade for a year or so, CDS’s. Under 1%. Japan has a demographic problem.

      There seems to be some idea these idiots are getting away with destroying their currency. For one, most of this money is nothing but a swap of assets for cash that is on the side of the bank balance sheet that doesn’t represent public cash. That doesn’t mean the banks aren’t financing speculation, lending or buying something with the funds. But, if they keep on, the CB’s are going to finish their paper money. This stuff didn’t start out as paper money, but as notes for metalic money. I don’t believe any of it will be trusted for international trade if we continue to head toward the current conclusion.

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