Worldwide Incongruities: Rising Monetary Bases, Decreasing Prices

Gary North - December 03, 2014

Doug Nolan writes the Prudent Bear column. In his column for November 28, he summarized today's worldwide insanity.

First, the fall in the price of oil.

On the back of OPEC's failure to cut production, crude this week sank $10.36, or 13.5%, to the lowest price since May 2010. The Goldman Sachs' Commodities Index (GSCI) dropped 8.2%, to the low since September 2010. It's worth noting that Copper dropped 6% this week to the lowest level since July 2010.

This indicates that a recession has arrived in much of the world.

Then there are the currencies of developing nations.

On the currency front, this week saw Russia's ruble slammed for 7.3% to a record low. Brazil's real dropped 1.9%, the Colombian peso 3.2%, and the Chilean peso 2.3%. The Mexican peso fell 1.9% to the lowest level since the tumultuous summer of 2012. The South African rand declined 1.1%. And despite losing a little ground to the euro this week, the U.S. dollar index traded to the highest level since June 2010.

This has led to huge increases in the interest rates demanded by -- and accepted by -- international lenders.

At the troubled "Periphery of the Periphery," Russia's 10-year yields jumped 43 bps to 10.53%. Ukraine 10-year yields surged 297 bps to a record 19.49% (Bloomberg: "worst week on record"). Venezuela CDS jumped 188 bps to 2,292. Greek 10-year yields surged 42 bps to 8.35%.

Meanwhile, the opposite effect is happening in the West.

The melt-up in global "developed" bond markets is nothing short of incredible. German (0.70%), French (0.97%), Italian (2.03%), Spanish (1.90%), Portuguese (2.84%), Austrian (0.84%), Belgian (0.92%), Irish (1.38%) and Dutch (0.82%) yields all traded to record lows this week. With GDP surpassing 130% of GDP, Italian 10-year yields at 2%? French yields below 1% - with a huge debt load and big deficits as far as the eye can see? Japanese yields at a record low 0.41% (federal debt-to-GDP exceeding 250%)? What on earth have central bankers done to global markets? It's worth noting that U.S. long-bond yields Friday fell below the October 15th "panic low" level, closing at a 19-month low 2.89%.

U.S. stocks rose.

Market divergences have turned only more extreme. This week saw the S&P500 trade to another all-time high. The Dow Jones Transports jumped 1.1% this week to a record high. Gaining 2.0%, the Nasdaq 100 traded to the highest level since that fateful month, March 2000. Biotech stocks traded to a record high. The Morgan Stanley Retail Index jumped 2.0% this week to close at a record high. Standard & Poor's Supercomposite Restaurants Index gained 1.3% to also close at an all-time high.

The same was true in Asia.

In ("Core") EM, the Shanghai Composite traded to a three-year high, while Indian stocks closed Friday at a record high.

What about oil's price in relation to central bank holdings of government debt?

It's worth noting that the last time crude, the GSCI and copper traded at today's levels the Fed's balance sheet was about half its current size. Ditto for Bank of Japan assets. China's International Reserve holdings have increased more than 70% since June 2010 (to $3.888 TN). Total Chinese system Credit has almost doubled in five years. Debt has exploded throughout EM, with too much denominated in dollars.

The world is now six years into history's greatest concerted monetary inflation. Unprecedented policy measures have incited an unmatched global speculative Bubble. There is the ongoing global securities market Bubble that inflates on the back of central bank liquidity pumping and market backstops. This week, however, provided added confirmation of the ongoing deflation of the "Global Reflation Trade." I believe history will look back on the crude, commodities and EM currency collapses as warnings that went unheeded in manic securities markets. In the worst-case scenario, the faltering of the global Bubble at the Periphery ensures that central bank liquidity stokes "Terminal Phase" excess at the Core. The global monetary experiment is failing spectacularly, though over-liquefied securities markets remain in denial.

My view: the experiment is creating anomalies that cannot be sustained. Yet China's bubble has been sustained for a decade. This seems impossible. But all good things must come to an end.

November 28 -- Financial Times (Jamil Anderlini): "'Ghost cities' lined with empty apartment blocks, abandoned highways and mothballed steel mills sprawl across China's landscape -- the outcome of government stimulus measures and hyperactive construction that have generated $6.8tn in wasted investment since 2009, according to a report by government researchers. In 2009 and 2013 alone, 'ineffective investment' came to nearly half the total invested in the Chinese economy in those years, according to research by Xu Ce of the National Development and Reform Commission, the state planning agency, and Wang Yuan from the Academy of Macroeconomic Research, a former arm of the NDRC. China is this year on track to grow at its slowest annual pace since 1990, and the report highlights growing concern in the Chinese leadership about the potential economic and social consequences if wasteful investment leaves projects abandoned and bad loans overloading the financial system. The bulk of wasted investment went directly into industries such as steel and automobile production that received the most support from the government following the 2008 global crisis…"

What is China's central bank doing now? Inflating.

November 23 -- Reuters (Kevin Yao): "China's leadership and central bank are ready to cut interest rates again and also loosen lending restrictions, concerned that falling prices could trigger a surge in debt defaults, business failures and job losses, said sources involved in policy-making. Friday's surprise cut in rates, the first in more than two years, reflects a change of course by Beijing and the central bank… Economic growth has slowed to 7.3% in the third quarter and policymakers feared it was on the verge of dipping below 7% - a rate not seen since the global financial crisis. Producer prices, charged at the factory gate, have been falling for almost three years, piling pressure on manufacturers, and consumer inflation is also weak. 'Top leaders have changed their views,' said a senior economist at a government think-tank involved in internal policy discussions. The economist… said the People's Bank of China had shifted its focus toward broad-based stimulus and were open to more rate cuts as well as a cut to the banking industry's reserve requirement ratio (RRR)…"

China has been somewhat off the markets' radar of late. The People's Bank of China has been injecting large amounts of liquidity and, last week, cut interest-rates. Chinese stimulus these days feeds the bullish imagination. Chinese equities have rallied sharply (short squeeze?), and the bulls view this as confirmation that China's policymakers have everything under control.

It never ends. The PBOC always inflates. But commodity prices are falling.

At this point, I view China as a real near-term wildcard. Inarguably, both Chinese end demand and finance were integral to the "Global Reflation Trade." Supposedly, the Chinese boom was to provide robust commodities demand for years to come. Chinese companies have scoured the world for commodities-related investment. At the same time, the Chinese financial system played a major role in global commodities financing. What does the commodities collapse mean for Chinese financial stability, especially with stability already challenged by serious domestic issues.

I find it intriguing that Chinese policymakers have apparently turned much more concerned about the economy (see Reuters excerpt above). And a report (see FT above) from government researchers has admitted that "government stimulus measures and hyperactive construction… have generated $6.8tn in wasted investment since 2009"? Wow. I'll assume that Chinese officials are now in intense discussions as to how to respond to a bevy of pressing issues, including sinking commodities, heightened global disinflationary forces, king dollar, significant currency devaluation from the Japanese, Europeans, South Koreans and others, and overall mounting financial and economic risks.

China's central bank has mimicked the Federal Reserve. The yuan is a rigged currency. The PBOC inflates.

Over the past six years, respective U.S. and Chinese Credit Bubbles have been engaged in somewhat of a mirror image dynamic. With U.S. federal debt up 150% in six years and the Fed's balance sheet inflating 400%, surfeit dollar balances flooded into the PBOC. In the process, the People's Bank of China accommodated a historic expansion of Chinese domestic Credit. This Credit fueled historic booms in manufacturing capacity and Chinese housing (apartments). This Credit Bubble was also fundamental to the greater EM Bubble that saw virtually unlimited cheap finance spur booms throughout the commodity-related economies.

We are in the midst of central bank panic. The central bankers have only two tools, as Franklin Sanders says: inflation and blarney. They have used both.

The world is in the midst of a monetary base explosion, yet commodity prices are now falling, especially the two bellwethers: oil and copper.

The Federal Reserve is contracting the money supply. Were it not for a decrease in excess reserves by commercial banks, this action would guarantee a recession. It probably will come, but delayed. I think it will come in Europe first.

Nolan's concerns are echoed by John Rubino.

Last week saw the global financial system tip from delusion -- where it had happily drifted for several years -- into chaos. Consider the following more-or-less randomly chosen data points:

French unemployment hits record high

Italian unemployment hits record high

Oil's price falls by $10.36/bbl, or 13.5%, in a single day, to its lowest price since 2010.

Copper falls by 6% to $2.86/lb, 25% below its 2013 high.

European bond yields fall to record lows. Even Italy, with government debt exceeding 130% of GDP, can now borrow for around 2%. Japan, meanwhile, issues bonds with negative interest rates.

European inflation approaches zero, with several member states apparently already in deflation.

Emerging markets see the opposite trend, as a soaring dollar causes their currencies to fall and inflation to spike. The Russian ruble falls by 7.3% to a record low, while the currencies of Brazil, Colombia, Mexico and Chile drop by at least 1.9%. See Brazil's Rousseff vows immense effort to slow inflation.

Chinese malinvestment, a topic of conversation ever since those ghost city pictures started circulating, is pegged at $6.8 trillion, or about 70% of China's entire economy.

The financial media have not connected the dots. These are frightening dots to connect if you are a central banker.

Humpty-Dumpty is being placed on an ever higher wall. Central bankers have created the conditions for another 2008.