Posts Tagged ‘Reflexivity’
Thank You CTRL-P: Deposits Rise To Record $2.1 Trillion Over Bank Loans
Monday, 03 June 2013 09:56
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It may come as a surprise to some that the total level of commercial bank loans outstanding as of the most recent week, May 22, was “only” $7.303 trillion. We say only because this number is $20 billion less than the total commercial loans outstanding as of the weeks following the Lehman failure, just before the most epic deleveraging episode in recent US history began. It is also just $600 billion higher than the cyclical lows of $6.7 trillion (net of the February 2010 readjustment of the commercial loan terminology). (Read more…) Why do we bring this up? Because as is well-known, loans are the primary commercial bank system asset, and in a normally functioning financial system, loan creation leads to deposit growth (and vice versa: there is a certain element of reflexivity when it comes to money creation).

So does this mean that deposits in the US financial system have been unchanged in the past nearly 5 years? Not at all. As the chart below shows, while commercial loans have flatlined, deposits, which previously used to track loans on a dollar for dollar basis, took off, and are now at $9.4 trillion (as per the latest H.8), or $2.2 trillion more than the $7.2 trillion when commercial banks loan hits a record in October 2008, just after Lehman filed. What’s more notable, is that as of the latest week, the excess of deposits over loans just hit an all time record of $2.079 trillion (we exclude the one week outlier from March 27 as this was a seasonal adjustment aberration).

So what gives? Quite literally, the Fed.

Recall that in a fiat system, money is created either by commercial banks (mostly: but only when there is demand for money), or by the Federal Reserve, which creates money out of thin air (in the form of fungible reserves – a Fed liability), while purchasing “high-quality collateral” such as TSY or MBS as the corresponding asset. Indeed, the chart below shows the very close correlation between the deposit over loan excess since the Great Financial Crisis, and the total amount of reserves created, in this case represented by assets purchased by Bernanke.

The problem with the latter is that Fed money creation is a “supply-push” form of liquidity creation, unlike commercial loans which are “demand-pull” which means the Fed “shotgun” injects liquidity and hopes and prays it finds its way to a consumer who, however, has no monetary preference. Hence “trickle down” and why the bulk of the $2.5 trillion in money created by the Fed has ended up in the stock market (and quite levered at that).

It also means that banks, stuck with massive excess deposits on their books (recall “The “Big Three” Banks Are Gambling With $860 Billion In Deposits“) have no choice but to use this capital and gamble with risk assets. JPM publicly disclosed as much in the aftermath of the London Whale fiasco.

All of the above is important because there still is confusion about this process four years after QE began.

Only this past week, Steve Keen, an economist whose views we respect, wrote: “So the ‘printing money’ moniker that critics give to QE is misguided: it actually creates no additional money at all (outside of the gain banks will make on the repo deal). For money to really be created, QE would have to go directly to the Deposits of the public in the private banks, and that’s not what QE does.” Actually, that’s exactly what the evidence above shows QE has done.

The only difference is that in the absence of IRR>0 opportunities for entrepreneurs, and for capital allocators in the broader economy, not to mention a still pervasive distrust of the TBTF banking system, deposit holders (without prejudice for just who it is these deposits belong to) opt to keep their money in the banks in the form of increasingly more unsecured (see Cyprus) zero interest bearing deposits, instead of allocating it to various capital intensive projects. One need to only look at the collapse in CapEx (and the surge in the balance sheet gimmick of stock buybacks) to understand why this is happening from a corporate standpoint.

The irony is that the longer the Fed remains in the market, the greater the differential between loans and deposits will become, as lack of confidence in the system remains. It was none other than Seth Klarman who explained the simplicity of the reflexive popular thinking as follows:

Most people seem to viscerally recognize that the absence of an immediate crisis does not mean we will not eventually face one. They are wary of believing promises by those who failed to predict previous crises in housing and in highly leveraged financial institutions.

 

They regard with skepticism those who don’t accept that we have a debt problem, or insist that inflation will remain under control. (Indeed, they know inflation is not well under control, for they know how far the purchasing power of a dollar has dropped when they go to the supermarket or service station.)

 

When an economist tells them that growing the nation’s debt over the past 12 years from $6 trillion to $16 trillion is not a problem, and that doubling it again will still not be a problem, this simply does not compute. They know the trajectory we are on.

 

And when you tell the populace that we can all enjoy a free lunch of extremely low interest rates, massive Fed purchases of mounting treasury issuance, trillions of dollars of expansion in the Fed’s balance sheet, and huge deficits far into the future, they are highly skeptical not because they know precisely what will happen but because they are sure that no one else–even, or perhaps especially, the  policymakers—does either.

Indeed, the greater fool is long dead. And as long as the Fed remains actively involved, so will excess deposits – created indirectly by the Fed but parked at commercial banks – stay at these same banks, who see no need to create loans as they are already flooded with trillions of excess deposits which in a post-Volcker and post-London Whale world, they have increasingly fewer options to allocate.

It is only after the Fed exits, that these excess deposits have a chance of entering the economy and resulting in the much needed gradual inflation. Ironically, the longer the Fed remains, the greater the capital allocation preference will be by commercial banks to inject the fungible capital created from excess deposits into stocks.

Speaking of, has anyone seen the “inflation” in the S&P500 in the past several years?

    



 
New York Fed Sees Five More Years Of Stock Increases
Thursday, 09 May 2013 12:41
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Normally the New York Fed would not have to bother itself with such Series 7, 63-registration requiring, “financial advisor“-type things as predicting where the stock market will go, especially when it is its own trading desk that provides the impetus for more than 100% of the current equity rally. However, these are not normal times – they are New Normal. And as a result, Fed economists Fernando Duarte and Carlo Rosa have penned a “research” paper titled “Are Stocks Cheap?” in which they view the same reflexive “evidence” that Ben Bernanke himself used to answer a question during a recent press conference if he would still be buying stocks at record levels, namely the risk premium. This is what the NYFed’s economists say on the matter: “We surveyed banks, we combed the academic literature, we (Read more…) economists at central banks. It turns out that most of their models predict that we will enjoy historically high excess returns for the S&P 500 for the next five years.”

They find, not surprisingly, that based on various economist models, the risk premium has never been higher.

As a reminder, the equity risk premium is “expected future return of stocks minus the risk-free rate over some investment horizon.” It is this record high risk premium that leads the two to agree with Wall Street and to forecast that stocks have nothing but upside for half a decade more. Of course, what they try to not highlight is that the previous near all time high equity risk premium was seen in the days just before the Lehman collapse, when the same poll and the same models, would have predicted smooth sailing for a long, long time, instead of the 60% modest correction that transpired in the coming months, and which would have led to the end of the Western financial model as we know it if not for the same NY Fed injecting a little over $10 trillion into risk on short notice. But don’t worry, there is an economist “explanation” for this particular fly in the ointment: “It is difficult to argue that we’re living in rosy times, but we are surely in better shape now than then.“

Surely.

So assuming one buys into the explanation that this time it’s different and “we are in better shape now than then” (even if said shape is purely due to the trillions in excess liquidity injected by the world’s central banks over the past five years, something which is completely ignored by the very same Fed’s economists), here is how an economists goes about justifying an equity valuation:

Why is the equity premium so high right now? And why is it high at all horizons? There are two possible reasons: low discount rates (that is, low Treasury yields) and/or high current or future expected dividends. We can figure out which factor is more important by comparing the twenty-nine models with one another. This strategy works because some models emphasize changes in dividends, while others emphasize changes in risk-free rates. We find that the equity risk premium is high mainly due to exceptionally low Treasury yields at all foreseeable horizons. In contrast, the current level of dividends is roughly at its historical average and future dividends are expected to grow only modestly above average in the coming years.

 

In the next chart we show, in an admittedly crude way, the impact that low Treasury yields have on the equity risk premium. The blue and black lines reproduce the lines from the previous chart: the blue is today’s equity risk premium at different horizons and the black is the average over the last fifty years. The new purple line is a counterfactual: it shows what the equity premium would be today if nominal Treasury yields were at their average historical levels instead of their current low levels. The figure makes clear that exceptionally low yields are more than enough to justify a risk premium that is highly elevated by historical standards.

 

Keep the above bolded, underlined sentence in mind for a second.

So let’s fast forward to the authors’ summary:

At face value, this result means that the models are actually helpful in forecasting returns. However, we should keep in mind some of the limitations of our analysis. First, we have not shown confidence intervals or error bars. In practice, those are quite large, so even if we could have earned extra returns by using the models, it may have been solely due to luck. Second, we have selected models that have performed well in the past, so there is some selection bias. And of course, past performance is no guarantee of future performance.

Actually, at “face value” the models have been horribly wrong at forecasting returns especially in situations in which confidence in the entire system collapses, and as a result five years later, the Fed, and all its central bank peers, are forced to inject more and more liquidity to keep the house of cards: both the market and the economy from imploding.

Which actually is also the biggest failing of the paper.

Let’s go back to the bolded sentence above:

“The new purple line is a counterfactual: it shows what the equity premium would be today if nominal Treasury yields were at their average historical levels instead of their current low levels.”

Looking at the chart shows that the Risk Premium would be negative in a “normal” environment – or one where bonds were back at their historical averages, where even the Fed, not to mention Congress and the President, see them reverting to one day when the Fed supposedly exits the market.  And what is most stunning about this entire paper authored by Fed economists, is that the authors completely ignore that the only reason the Treasury yields are low is because of the Fed’s distortions of the bond market itself. In other words, nobody at the Fed has even the faintest understanding of recursive, circular logic, or what Soros famously pegged as reflexivity.

Which in turn means that the longer one chases stocks relative to a baseline “normal” risk free rate, the more negative the premium would be, and the greater the stock market fall, once things are allowed to normalize (if ever).

Perhaps, instead of coming up with this sad attempt at pitching stocks, the NY Fed were to come up with something relevant like where the 10 Year bond would be not only if the Fed was out of the market, but if it had never entered, the general public would have a sense of just how massively overvalued stocks truly are when factoring out the biggest artificial component to the “rally”, and also why, intuitively, virtually everyone hates what has become a daily no volume levitation on nothing but the expectation that i) the Fed will continue the liquidity tsunami indefinitely and ii) the Fed will not lose control of the market and the economy, as it did in 2008.

Is it any wonder why the occupation “economist” (not really a job, more of a clerical position) and especially one with a political bent, sent here from above to justify an ever-encroaching government, and a ruinous central planning regime that only serves to perpetuate capital misallocation and wealth transfer from the middle to the upper class, has become the most pejorative “four letter” word in existence?

    



 
Reuters Releases George Soros Obituary By Mistake: “Enigmatic Financier, Liberal Philanthropist Dies At XX”
Thursday, 18 April 2013 17:04
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Update – that didn’t take long:

Reuters erroneously published an advance obituary of financier and philanthropist George Soros. A spokesman for Soros said that the New York-based financier is alive and well. Reuters regrets the error.

(Read more…)

* * *

First CNN, then AP, now Reuters: the entire media is increasingly starting to look like amateur hour. Unless, of course, Soros is like Osama, and had several “reincarnated” body doubles, with the original specimen long gone.

Here is our suggestion for another prepared article: “Today after XX centuries of monetizing debt, the Emperor of the Galactic Central Bank, Gaius Maximus Printius Bernankius the DCLXVIth, ended QE in the year of the alien invasion, XXXXX. Bread costs XXXXXXXXXXX.”

Just out from Reuters, an article which will certainly be withdrawn in milliseconds. Intern heads will roll for this, although it would be truly “New Normal” if Soros were to have a heart attack upon reading news of his own death, and die from it.

George Soros, enigmatic financier, liberal philanthropist dies at XX
5:41pm EDT

By Todd Eastham

WASHINGTON, XXX (Reuters) – George Soros, who died XXX at age XXX, was a predatory and hugely successful financier and investor, who argued paradoxically for years against the same sort of free-wheeling capitalism that made him billions.

He was known as “the man who broke the Bank of England” for selling short the British pound in 1992 and helping force the United Kingdom to withdraw from the European Exchange Rate Mechanism, which devalued the pound and earned Soros more than $1 billion.

And his Soros Fund Management was widely blamed for helping trigger the Asian financial crisis of 1997, by selling short the Thai baht and Malaysian ringgit.

“Subsequently, Prime Minister Mahatir of Malaysia accused me of causing the crisis, a wholly unfounded accusation,” Soros wrote in The Crisis of Global Capitalism: Open Society Endangered,” in 1998.

“We were not sellers of the currency during or several months before the crisis; on the contrary … we were purchasing ringgits to realize profits on our earlier speculation.”

Still, economist Paul Krugman, was one of many observers who accused Soros of helping trigger the crisis.

In 1999, Krugman wrote that “nobody who has read a business magazine in the last few years can be unaware that these days there really are investors who not only move money in anticipation of a currency crisis, but actually do their best to trigger that crisis for fund and profit.”

Still, Soros has written extensively on the folly of what he has called free market “fundamentalism,” the belief of many conservative economists that markets will correct themselves with no need for government intervention.

In Soros’ view, markets and investors are subject to “mood” swings, or a prevailing positive or negative bias which can be exploited by savvy investors but which inevitably lead to damaging market bubbles and boom/bust cycles.

An enigma, wrapped in intellect, contradiction and money.

A Jew born in Hungary as the Nazis were gaining power in Germany, Soros survived World War Two and then emigrated to Great Britain, where he earned a degree from the London School of Economics in 1952, and landed his first job in the financial industry largely through pure stubborn chutzpah.

OPEN SOCIETY INSTITUTE

While at the London School, Soros studied under the economist and philosopher Karl Popper and a main vehicle for his philanthropy, the Open Society Institute, is named for Popper’s two-volume work, “The Open Society and Its Enemies.”

In that work, Popper develops the philosophy of reflexivity, a theory first articulated by William Thomas in the 1920s that posits that individual biases enter into market transactions, coloring the perception of economic fundamentals. Soros has attributed his own financial success in part to his understanding of the reflexive effect.

Key to understanding that effect is recognizing when markets are in a condition of near-equilibrium, or in disequilibrium. Soros has observed that when markets are rising or falling rapidly, they are typically marked by rising disequilibrium, and the dispassionate investor can capitalize on that recognition.

While Soros has benefited enormously from this understanding (Forbes put his wealth in 2013 at $19 billion, making him the world’s 30th richest person, not counting the roughly $8 billion he has given away through various charitable entities he controls), he has argued nevertheless for strong central government regulation to correct for and counterbalance the excesses of greed, fear and the free market.

Popper’s idea of fallibilism, which posits that anything one believes may in fact be wrong, is another key principle that has guided Soros in his career, and his philanthropy.

Soros’ philanthropy since the 1970s, when he began funding the studies of black students at the University of Cape Town in South Africa, has been marked as much by his personal journey as by the needs of the communities he has set out to serve.

His efforts through the Open Society Institute and the Soros Foundations have been skewed toward the effort to promote democratic values in the post-Soviet economies of Central and Eastern Europe, where he witnessed the rise of communism in Hungary after World War Two.

“The bulk of his enormous winnings (as an investor and speculator) is now devoted to encouraging transitional and emerging nations to become ‘open societies,’” former Federal Reserve Chairman Paul Volcker wrote in the foreword to Soros’ “The Alchemy of Finance” (2003).

“Open,” Volcker wrote, “not only in the sense of freedom of commerce but – more important – tolerant of new ideas and different modes of thinking and behavior.”

PHILANTHROPY, POLITICS

Soros also pledged $50 million in 2006 to the Millennium Promise, led by economist Jeffrey Sachs, to provide educational, agricultural and medical aid to help poor villages in Africa. And the Open Society Institute has expanded its giving to more than 60 countries around the world, giving away roughly $600 million a year.

Soros was an early supporter of the peaceful transformation of the Solidarity movement in Poland and Open Society Institute programs were considered by many Western observers to be a key factor in the success of the “Rose Revolution” in Georgia.

While his philanthropy has earned him friends around the world, his political giving has earned him both friends and enemies. Former President George W. Bush, who Soros blamed for turning the United States into “the main obstacle to a stable and just world order,” was perhaps the biggest single target of his political wrath.

“By declaring a ‘war on terror’ after Sept. 11, we set the wrong agenda for the world,” Soros told Newsweek magazine in a 2006 interview. “When you wage war, you inevitably create innocent victims.”

In a bid to stop Bush’s re-election, Soros donated $23.5 million to more than 500 liberal and progressive groups during the 2003-2004 U.S. election cycle.

Other causes that have attracted Soros’ generosity include drug policy reform. He donated $1.4 million to promote California’s Proposition 5 in 2008, a failed initiative that would have expanded drug rehabilitation programs as alternatives to prison for non-violent drug offenders, and $400,000 to the successful 2008 Massachusetts initiative to decriminalize possession of less than an ounce (28 grams) of marijuana.

He has also been a vocal supporter of the right to die in dignity, revealing in 1994 that he had offered to help his own mother, a member of the Hemlock Society, commit suicide.

While Soros’ life has been marked by remarkable success in his far-flung endeavors, it has not been without defeat. His investment in France’s Societe Generale following Jacques Chirac’s aggressive program of privatization led to charges of insider trading, which he disputed, and eventual conviction and the payment of a small penalty.

And he was a minority partner in a group that failed to acquire the Washington Nationals Major League baseball team.

But these failings stand out in the life of this remarkably successful Hungarian-American financier, philanthropist and thinker, in contrast to his stubborn refusal to fail in virtually every other venture.