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When You Aren’t Actually A Central Bank, Part 2: The Stubborn Deflation

Ever since March 2020, GFC2, Federal Reserve officials from Jay Powell on down have been busy patting themselves on the back for their splendid performance during last year’s big event. Again, market-of-last-resort. It would’ve been much worse, they…

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Ever since March 2020, GFC2, Federal Reserve officials from Jay Powell on down have been busy patting themselves on the back for their splendid performance during last year’s big event. Again, market-of-last-resort. It would’ve been much worse, they claim, particularly given what happened in the Treasury market itself which we are supposed to believe QE bailed out just in the nick of time. But when you review what actually happened, what you find is instead, as GFC1, the janitor who celebrates skillful broom-work amidst widespread flaming debris rather than successfully having thwarted even limited damage as any effective central bank might. Though officials repeatedly refer to this Treasury market “breakdown” not once have I witnessed a thorough explanation for what they believe this was. Instead, they quite purposefully begin in the middle with foreigners selling mostly off-the-run UST notes and bonds to US-based dealers. These are facts, just not arranged in the right order (see: below). Dealers were “forced”, in a way, to accept these sales because they were foisted upon them largely by large foreign customers, including those from overseas reserve managers at the direction of local big wigs. Since typically dealers fund their purchases in repo, pledging the assets as repo collateral, the flood of foreign UST sales purportedly “clogged” the repo market. This story leaves out many crucial details about what truly happens in these situations, including, importantly, the distinction between off-the-run (OFR) UST collateral and on-the-run (OTR). I wrote last Friday in detail about them here. It’s not absolutely essential that you read my (lengthy) description first, but it would help you understand what’s coming next (and then much of what follows from it) and what it all really means. For now, the short version:
Unwilling, likely unable, to upset a custodial relationship of such substantial potential revenue, the dealer dutifully obeys and takes the illiquid OFR asset off the Reserve Manager’s hands and crediting its account with some form of “cash”; which does deserve the quotation marks. Where does our harried primary dealer get such “cash” in order to purchase this foreign-reserve OFR UST? It could, in theory, adopt several postures but for now we’ll assume it would stick to what is very common practice: repos, reverse repos, likely some securities lending/swaps/transformations and a literally insane use of badly outdated accounting provisions.
But to our system janitors, all they know is the repo market is “clogged” and it has led to a flood of distressed sales in an increasingly illiquid part of the already less-liquid OFR Treasury market. From this view, the job of any monetary custodian is quite simple: market-of-last-resort, just start buying up a bunch of these illiquid Treasuries. Thus, QE6 and its enormous proportions given that function in the OFR Treasury market had become just so badly impaired. Following this new monetary doctrine, Powell’s Fed absorbs much (or all?) of the distressed selling from the private marketplace, which then, according to this new conventional viewpoint, restored market function therefore limiting economic damage (tons of jobs saved). Having established what seems to be an easy and straightforward even linear chain of cause and effect, the Federal Reserve’s actions stood seemingly as a solid firewall against any worse conflagration spreading much further. Ever since, it has been using this view to fortify the new dogma by courting public opinion purposefully focused on only the last parts in its carefully cultivated chain. All hail the janitor! This market-of-last-resort diction, however, curiously leaves unanswered more than a few self-evidently key questions. One of those, which probably immediately sprung to your mind, was this otherwise decently annoying query looking back toward the unpictured beginning rather than much at all about what happened toward the end of the process. Why the hell was there so much foreign UST selling – all at once, no less – in the first place? Seems like a vitally important detail to just leave out of this, hoping everyone just shrugs and says, well, COVID. Already thinking this way, it’s unnerving how there is even now no answer from the official standpoint. If you’ve read my last Friday’s column, I’ve already spelled it out as well as having written about it repeatedly (including here in GFC2’s immediate aftermath, as well as here during the event itself). Back to last week’s chronicle:
On net: the Treasury market appears to break down when in fact it isn’t the Treasury market what’s failing at all. Because of these repo complications, as well as others not discussed here, massive OFR dysfunction simply herds more and more participants toward the only parts of “the” market still available: OTR. Bills, mostly. Remember what bill yields were doing last March.
So, let’s go back and start from the beginning employing a realistic review of what happened, one actually backed up by evidence in markets and data, as well as, embarrassingly, the FOMC’s own publicly stated words. There was no separation foreign selling from repo “clogging”; in other words, the repo problems didn’t develop as a consequence of the overseas selling. On the contrary, those two things happened simultaneously, at the least, with a great deal of evidence the repo problems actually predated the overseas OFR deluge, meaning dealers were already managing repo difficulties as that UST selling complicated them so much more. This matters a great deal. Either way, these were concurrent manifestations or reactions to the same preceding factor/reason (which I’ll get to in a moment). Because of the repo market impairment, this led to distressed sales in OFR UST’s at the same time dealers unwilling (or unable) to take losses on customer books sought out each and every possible way of avoiding that situation. This meant, in addition to selling OFR’s, a stampede toward collateral that was still negotiable and usable: OTR Treasuries, especially bills (again, remember what bill yields were doing during this “Treasury market” breakdown). Therefore, when the Fed came in with first “repo operations” before finally QE6, these were unhelpful to the point of distraction. Neither did a thing about the developing bottleneck more destructively limiting the availability of usable collateral. Instead, the Fed focused almost exclusively upon the one problem in OFR Treasury because that’s the only place market-of-last-resort could have been applied. And it was with exclusively bank reserves initially; even QE6 didn’t show up until late on Sunday March 15! See what I mean about the janitor who comes in only at the end and tries to pass off a partial job as some full one? This is why the entire global financial space was rocked continuously by a global bout of serious inelasticity – in US$’s, nonetheless. The result hadn’t been a successful interruption or even a fruitful deployment of market-of-last-resort policies. The dollar surge/shortage had already become self-reinforcing such that no matter what of the mess the janitor attempted to sweep up all these breakdowns of elasticity contributed back to more of the same. Rinse. Repeat. All throughout the first twenty-some days of March (as well as late February) no matter what “repo operations” or initial QE6 purchases. And, of course, this would bring the public’s attention rather than focused like a laser on the ends of the process back to where it truly belonged the entire time: in realizing that our central bank is not a central bank, and this janitor stuff, or market-of-last-resort, truly amounts to a stunning admission of dereliction given the underlying facts of this money-less monetary policy. The Treasury market didn’t just out-of-the-blue break down because overseas accounts suddenly, for COVID pandemic reasons, began selling illiquid Treasuries in a tidal wave; on the contrary, the growing inelasticity in the true global monetary system (eurodollar) had first caused all those things. It’s always the first domino (balance sheet capacity). Global dollar shortage. Likewise, the accidental delivery of collateral elasticity in the form of T-bill supply issuance (among other things) had broken the cycle of financial violence but not before a tremendous and as-yet uncounted amount of permanent economic damage had been committed globally (long run demand destruction that is more visible and apparent outside the US than immediately inside). The central bank model envisioned in Bernanke’s long ago promise to Milton Friedman had already been erased, and because it had, that plus the pre-2008 arrogance has pushed the post-crisis version of the central bank to essentially admit in practice it isn’t actually a central bank. The Fed’s your financial janitor; and not an especially good one, either. Elasticity, especially in collateral, remains a full problem and that, dear friends, explains much about how the world since August 2007 had gotten this way as well as even inflation/deflation today. While the public may not have noticed or accounted for any of these things, you better believe participants within the system itself have and continue to do so – at our expense.

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Baltimore City Responds After Dozens Of Businesses Threaten Not To Pay Taxes

Baltimore City Responds After Dozens Of Businesses Threaten Not To Pay Taxes

This weekend, the Baltimore Police Department (BPD) closed down multiple city streets around the Inner Harbor, in a stretch called "Fells Point," after dozens…

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Baltimore City Responds After Dozens Of Businesses Threaten Not To Pay Taxes

This weekend, the Baltimore Police Department (BPD) closed down multiple city streets around the Inner Harbor, in a stretch called "Fells Point," after dozens of local businesses threatened the new city government, run by Mayor Brandon Scott, to not pay taxes because they're "fed up and frustrated" with the outburst of violence. 

Last week, 37 restaurants and small businesses sent a letter to the mayor's office titled "Letter to City Leaders From Fells Point Business Leaders." They threatened to stop paying city taxes and other fees until "basic and essential municipal services are restored." This comes as Madam State's Attorney Marilyn Mosby halted petty crimes during the pandemic and made such a measure permanent - the idea was to decrease violent crime, but that seems to have severely backfired.

What's happened in the historic bar strict is absolute mayhem at night, transformed into a dangerous area where violent and rowdy crowds have ruined the once pleasant atmosphere along with multiple shootings. 

So this weekend, BPD closed down streets around Fells Point, which includes parts of Aliceanna, Thames, and Bond streets.

In addition, Maryland State Police will conduct sobriety checkpoints in Fells Point. 

Local news WJZ13's Mike Hellgren tweets a couple of images of the increased police presence across Fells Point.

One of the 37 concerned business owners on the list is Bill Packo, who owns Barley's Backyard and has been operating in Fells Point for three decades. He spoke with WJZ13 about the out of control violence and public drunkenness:

"It's a shame. What they're letting happen to Fells Point is what they let happen in the Inner Harbor, and now it has made its way here," Packo said. "There's alcohol being sold by individuals out there, drugs, and clearly we all know about the shootings that took place last weekend. But there needs to be some control out there. There is none whatsoever."

BPD's mobile police command was spotted outside another shop in the bar district. It looks very dystopic. 

Meanwhile, Scott, who was newly elected, skipped out on the virtual community town hall meeting on Thursday at 7 p.m that was to address the issues in Fells Point. 

Packo called out Scott for not attending the meeting: 

"It's an embarrassment to the city. It's an embarrassment to the mayor no matter what the schedule was," he said.

Again, as we've said before, the chaos in Fells Point comes as the city descends into what could be the most violent period ever. Mosby has halted police officers going after petty crimes that have inadvertently backfired. Another liberal-run town with good intentions in policies not exactly panning out as they thought. 

Local news WMAR2's Eddie Kadhim interviewed a man who summed up the city's response in Fells Point: 

Another man said the violent crime in low-income neighborhoods is just spilling over into the downtown area. 

Tyler Durden Sat, 06/12/2021 - 15:00

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Visualizing The History Of US Inflation Over 100 Years

Visualizing The History Of US Inflation Over 100 Years

Is inflation rising?

The consumer price index (CPI), an index used as a proxy for inflation in consumer prices, offers some answers. In 2020, inflation dropped to 1.4%, the lowest rate..

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Visualizing The History Of US Inflation Over 100 Years

Is inflation rising?

The consumer price index (CPI), an index used as a proxy for inflation in consumer prices, offers some answers. In 2020, inflation dropped to 1.4%, the lowest rate since 2015. By comparison, inflation sits around 5.0% as of June 2021.

Given how the economic shock of COVID-19 depressed prices, rising price levels make sense. However, as Visual Capitalist's Dorothy Neufeld notes, other variables, such as a growing money supply and rising raw materials costs, could factor into rising inflation.

To show current price levels in context, this Markets in a Minute chart from New York Life Investments shows the history of inflation over 100 years.

U.S. Inflation: Early History

Between the founding of the U.S. in 1776 to the year 1914, one thing was for sure - wartime periods were met with high inflation.

At the time, the U.S. operated under a classical Gold Standard regime, with the dollar’s value tied to gold. During the Civil War and World War I, the U.S. went off the Gold Standard in order to print money and finance the war. When this occurred, it triggered inflationary episodes, with prices rising upwards of 20% in 1918.

However, when the government returned to a modified Gold Standard, deflationary periods followed, leading prices to effectively stabilize, on average, leading up to World War II.

The Move to Bretton Woods

Like post-World War I, the Great Depression of the 1930s coincided with deflationary pressures on prices. Due to the rigidity of the monetary system at the time, countries had difficulty increasing money supply to help boost their economy. Many countries exited the Gold Standard during this time, and by 1933 the U.S. abandoned it completely.

A decade later, with the Bretton Woods Agreement in 1944, global currency exchange values pegged to the dollar, while the dollar was pegged to gold. The U.S. held the majority of gold reserves, and the global reserve currency transitioned from the sterling pound to the dollar.

1970’s Regime Change

By 1971, the ability for gold to cover the supply of U.S. dollars in circulation became an increasing concern.

Leading up to this point, a surplus of money supply was created due to military expenses, foreign aid, and others. In response, President Richard Nixon abandoned the Bretton Woods Agreement in 1971 for a floating exchange, known as the “Nixon shock”. Under a floating exchange regime, rates fluctuate based on supply and demand relative to other currencies.

A few years later, oil shocks of 1973 and 1974 led inflation to soar past 12%. By 1979, inflation surged in excess of 13%.

The Volcker Era

In 1979, Federal Reserve Chair Paul Volcker was sworn in, and he introduced stark changes to combat inflation that differed from previous regimes.

Instead of managing inflation through interest rates, which the Federal Reserve had done previously, inflation would be managed through controlling the money supply. If the money supply was limited, this would cause interest rates to increase.

While interest rates jumped to 20% in 1980, by 1983 inflation dropped below 4% as the economy recovered from the recession of 1982, and oil prices rose more moderately. Over the last four decades, inflation levels have remained relatively stable since the measures of the Volcker era were put in place.

Fluctuating Prices Over History

Throughout U.S. history. there have been periods of high inflation.

As the chart below illustrates, at least four distinct periods of high inflation have emerged between 1800 and 2010. The GDP deflator measurement shown accounts for the price change of all of an economy’s goods and services, as opposed to the CPI index which is a fixed basket of goods.

It is measured as GDP Price Deflator = (Nominal GDP ÷ Real GDP) × 100.

According to this measure, inflation hit its highest levels in the 1910s, averaging nearly 8% annually over the decade. Between 1914 and 1918 money supply doubled to finance war efforts, compared to a 25% increase in GDP during this period.

U.S. Inflation: Present Day

As the U.S. economy reopens, consumer demand has strengthened.

Meanwhile, supply bottlenecks, from semiconductor chips to lumber, are causing strains on automotive and tech industries. While this points towards increasing inflation, some suggest that it may be temporary, as prices were depressed in 2020.

At the same time, the Federal Reserve is following an “average inflation targeting” regime, which means that if a previous inflation shortfall occurred in the previous year, it would allow for higher inflationary periods to make up for them. As the last decade has been characterized by low inflation and low interest rates, any prolonged period of inflation will likely have pronounced effects on investors and financial markets.

Tyler Durden Sat, 06/12/2021 - 19:00

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Visualizing The Biggest Companies In The World In 2021

Visualizing The Biggest Companies In The World In 2021

Since the COVID-19 crash, global equity markets have seen a strong recovery. The 100 biggest companies in the world were worth a record-breaking $31.7 trillion as of March 31 2021,…

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Visualizing The Biggest Companies In The World In 2021

Since the COVID-19 crash, global equity markets have seen a strong recovery. The 100 biggest companies in the world were worth a record-breaking $31.7 trillion as of March 31 2021, up 48% year-over-year. As a point of comparison, the combined GDP of the U.S. and China was $35.7 trillion in 2020.

In today’s graphic, Visual Capitalist's Jenna Ross uses PwC data to show the world’s biggest businesses by market capitalization, as well as the countries and sectors they are from.

The Top 100, Ranked

PwC ranked the largest publicly-traded companies by their market capitalization in U.S. dollars. It’s also worth noting that sector classification is based on the FTSE Russell Industry Classification Benchmark, and a company’s location is based on where its headquarters are located.

Within the ranking, there was a wide disparity in value. Apple was worth over $2 trillion, more than 16 times that of Anheuser-Busch (AB InBev), which took the 100th spot at $128 billion.

In total, 59 companies were headquartered in the United States, making up 65% of the top 100’s total market capitalization. China and its regions was the second most common location for company headquarters, with 14 companies on the list.

Risers and Fallers

What are some of the notable changes to the biggest companies in the world compared to last year’s ranking?

Tesla’s market capitalization surged by an eye-watering 565%, temporarily making Elon Musk the richest person in the world. Food delivery platform Meituan and PayPal benefited from growing e-commerce popularity with their market capitalizations growing by 221% and 151% respectively.

Tech companies TSMC and ASML Holdings were also among the top 10 risers, thanks to a shortage of semiconductor chips and growing demand.

On the other end of the scale, Swiss companies Nestlé, Novartis, and Roche Holding were all among the bottom 10 companies by market capitalization growth. China Mobile was the only company to decline with a -12% change. The company was delisted from the New York Stock Exchange as a result of an executive order issued by former president Donald Trump, and recently announced its intention to list on the Shanghai Stock Exchange.

A Sector View

Across the 100 biggest companies in the world, some sectors had higher weightings.

Technology had the highest market capitalization and was also the most common sector, with Big Tech dominating the top 10. Companies in the consumer discretionary, financials, and health care sectors also had a strong representation in the ranking.

Despite having only five companies on the list, the energy sector amounted to almost 10% of the top 100’s market capitalization, mostly due to Saudi Aramco’s whopping valuation.

An Uncertain Recovery

From near market lows on March 31, 2020, all sectors saw increases in their market capitalization. However, top 100 companies in some sectors outperformed their respective industry index, while others did not.

Basic materials and industrials, both cyclical sectors, were high performers in the top 100 and outperformed their respective industry indexes. Technology companies also outperformed, and accounted for $255 billion or 31% of all shareholder distributions by the top 100, far more than any other sector. Apple alone spent $73 billion on share buybacks and $14 billion in dividends in the 2020 calendar year.

On the other hand, the worst-performing sectors in the top 100 were health care, utilities, and energy. While the index performance for health care and utilities was also relatively poor, the wider energy sector performed fairly well.

It’s perhaps not surprising that all sectors saw positive returns since their low levels in March 2020, buoyed by fiscal stimulus and central bank policies. As countries begin to reopen, will the value of the biggest companies in the world continue to climb?

Tyler Durden Sat, 06/12/2021 - 23:00

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