Markets question central bank power as Great Reckoning nears

NYSE marginTimeTIME magazine covers often capture the mood of a moment.  And that was certainly true in February 1999, with their now famous cover picturing then US Federal Reserve Chairman, Alan Greenspan, under the heading “The Committee to SAVE the World“.

In a further sign of the times, Greenspan was flanked by the US Treasury Secretary and his Deputy, Robert Rubin and Lawrence Summers.  The message was clear – the central bank led, and the government followed.  And their remit was indeed global, as Time commented:

As volatility has upset foreign markets and economic models, the three men have forged a unique partnership to prevent the turmoil from engulfing the globe”.

The cover set the pattern for the next 15 years:

  “Dotcom crisis in 2000″ – call for Greenspan; “Subprime crisis in 2008″ – call for his successor, Bernanke
  Regional crises were the same. “Eurozone debt crisis in 2012” – call for ECB President, Draghi; Japanese deflation in 2013 – call for Bank of Japan Governor, Kuroda; “Brexit crisis in 2016″ – call for Bank of England governor, Carney

But now, it seems that its not just the UK markets that are losing faith in their former super-heroes:

  US 10 year rates have risen by a third from their July low to 1.8%
  German rates have gone from a negative 0.2% to a positive 0.06%
  Even Japanese rates have risen from a negative 0.3% to a negative 0.05%

These are major moves in such a short space of time, especially when one remembers these bonds are supposed to be “risk-free”.  Clearly markets are starting to worry that they may not be “risk-free” after all.

In the past, the central banks had made the task of managing the global economy seem very easy.  These incredibly powerful men (and today, one woman), seemed able to resolve any financial crisis with a nod and a wink to their friends in the markets, backed up by an interest rate cut and a round of money-printing.

And, of course, markets wanted to believe what they were being told.  After all, hadn’t Greenspan invented the “Greenspan put”?  This was a phrase derived from the Options market, which meant traders knew he would ride to the rescue if ever markets looked like falling out of bed.

It is true that sometimes (as with subprime) central banks appeared rather slow to realise that a crisis was brewing. But as soon as they did notice, they went straight into action to make sure prices went straight back up again, as Greenspan’s successors followed “The Master of the Universe’s” teaching.

His departure was followed by the “Bernanke put”, and then the “Yellen put”, when Janet Yellen took over at the Fed. Traders therefore learnt to borrow as much as possible after 2000, as Doug Short’s chart shows of margin debt on the New York Stock Exchange.  Being bold was best, when you knew the central bank would always cover your back.

But today, many traders worry that their super-heroes can’t actually create the promised growth?  They wonder how governments can pay back the vast sums of money they have borrowed for the monetary experiment?  How would markets react if, one day, a major economy proved unable or unwilling to pay its debts?

And they are not alone in worrying.  Even the IMF has woken up to the fact that borrowing has now doubled to $152tn since 2000, and is still rising.  15 years is, after all, a long time for an experiment to run, without producing the expected results.  At some point, the funding tap must be turned off.

This is the Great Reckoning in action.  Clearly some traders and investors now don’t believe that monetary policy can deliver the promised results.  And as I noted on Friday, even one of the US Federal Reserve Banks has now come close to accepting our argument that demographics – not central banks – really drive the global economy.


Markets doubt Carney’s claim to have saved 500k UK jobs

Brexit Oct16

Last week as the BBC reported, Bank of England Governor, Mark Carney, explained to an audience in Birmingham that the Bank had saved the UK economy after the Brexit vote in June:

Between 400,000 and 500,000 jobs could have been at risk if the Bank had not taken action after the referendum, he said.  ”We are willing to tolerate a bit of an overshoot [on inflation] to avoid unnecessary unemployment. We moved interest rates down to support the economy.”

Imagine that!  How wonderful, that one man and his Monetary Policy Committee could save “between 400,000 and 500,000 jobs“, just with a speech, an interest rate cut, and more money-printing.

There was only one problem, as the chart above shows.  Markets didn’t applaud by buying more UK government bonds and so reducing interest rates.  They sold off again (red line)*, panicked by the idea that debt was rising whilst growth was slowing and the currency falling (blue line):

  Interest rates had fallen after the June 23 vote, as traders bet that Carney would add more stimulus
  They fell to 1.09% on June 24, and then to 0.65% after his August confirmation that this was underway
  But then, in a departure from the Bank’s script, they bottomed at 0.53% a week later, and began to rise
  Premier Theresa May caused further alarm at the Conservative Conference, suggesting Brexit might be for real
  They closed on Friday after Carney’s speech at 1.1% – nearly twice the August level, and above the June 24 close

Over the weekend, traders were then able to read the previously unpublished comments of Foreign Secretary, Boris Johnson, on the implications of a Brexit vote:

There are some big questions that the “out” side need to answer. Almost everyone expects there to be some sort of economic shock as a result of a Brexit. How big would it be? I am sure that the doomsters are exaggerating the fallout — but are they completely wrong? And how can we know?

“And then there is the worry about Scotland, and the possibility that an English-only “leave” vote could lead to the break-up of the union. There is the Putin factor: we don’t want to do anything to encourage more shirtless swaggering from the Russian leader, not in the Middle East, not anywhere.

“And then there is the whole geostrategic anxiety. Britain is a great nation, a global force for good. It is surely a boon for the world and for Europe that she should be intimately engaged in the EU. This is a market on our doorstep, ready for further exploitation by British firms: the membership fee seems rather small for all that access.

“Why are we so determined to turn our back on it?”

Its just a pity that it was left until now for Johnson’s “alternative view” on Brexit to emerge.  It confirms my fear immediately after the Brexit vote, that Brexit will prove to be:

The canary in the coalmine.  It is the equivalent of the “Bear Stearns collapse” in March 2008, ahead of the financial crisis.    And as I have argued for some time, the global economy is in far worse shape today than in 2008, due to the debt created by the world’s major central banks.

The sad conclusion is that the world is now likely to suffer some very difficult years.  Markets will have to relearn their true role of price discovery, based on supply and demand fundamentals, rather than central bank money-printing.  On Wednesday, I will look at some of the wider implications for global interest rates.

* Bond prices move inversely to interest rates, so a higher rate means a lower price

My weekly round-up of Benchmark prices since the Great Unwinding began is below, with ICIS pricing comments:
Brent crude oil, down 50%
Naphtha Europe, down 48%.“Petrochemical demand high despite margin drop”
Benzene Europe, down 53%. “Prices have ebbed and flowed with the crude oil/energy market as well as market developments in the US”
PTA China, down 40%. “Bottle chip producers in China have been staying away from purchasing import cargoes, with traders describing demand for PET producers as ‘soft”
HDPE US export, down 31%. “The depreciation of Chinese Yuan dampened buying interest for import cargoes”
S&P 500 stock market index, up 9%


San Francisco Fed agrees ageing Boomers impact economy

YouTube Oct16Finally, one of the major Western central banks has agreed that the ageing of the BabyBoomers does indeed have an impact on the economy.  John Fernald of the San Francisco Federal Reserve Bank, wrote in a new paper this week:

“Estimates suggest the new normal for U.S. GDP growth has dropped to between 1½ and 1¾%, noticeably slower than the typical postwar pace. The slowdown stems mainly from demographics and educational attainment. As baby boomers retire, employment growth shrinks. And educational attainment of the workforce has plateaued, reducing its contribution to productivity growth through labor quality. The GDP growth forecast assumes that, apart from these effects, the modest productivity growth is relatively “normal”—in line with its pace for most of the period since 1973.”

SF Fed Oct16

The paper only takes a limited view of the impact, just focusing on the labour market implications, as the second chart shows.  This highlights, exactly as we discussed in Boom, Gloom and the New Normal; How the Western BabyBoomers are Changing Demand Patterns, Again, the enormous impact of the Boomers on the US labour force.  As Fernald rightly notes:

“In the 1950s and 1960s, population (yellow line) grew more rapidly than the working-age population ages 15 to 64 (blue line) or the labor force (red line). In contrast, in the 1970s and 1980s, the labor force grew much more rapidly than the population as the baby boom generation reached working age and as female labor force participation rose. Those drivers of labor force growth largely subsided by the early 1990s. Since then, the labor force, working-age population, and overall population have all seen slower growth rates.”

Hopefully, Fernald or his colleagues will now go on to look at the issue of demand patterns.  This is more critical than the labour issue in a consumer-based society such as the USA – where consumption is 70% of GDP.

As I noted in the Financial Times last year, those aged 55+ consume very much less than younger people, and essentially create demographic headwinds for the economy.  They already own most of what they need, and their incomes decline as they enter retirement.  So the Fed’s policy of printing money to boost demand is inevitably going to fail, as we have seen over the past decade.

But, after all these years, it is good that a start has been made, and that someone in a major central bank has recognised that the issue exists.  It is impossible to move forward when everyone is in denial. The fact that Fernald works for the San Francisco Fed may also be a hopeful sign, as this was formerly the home of the current Fed Chair, Janet Yellen.

The problem, of course, as I discuss in this new interview with Will Beacham, Deputy Editor of ICIS Chemical Business, is that much of the damage has already been done.  The chemical industry is the 3rd largest in the world after energy and agriculture, and it now faces major issues of over-capacity at a time of slowing (or perhaps even negative) demand growth.

The UK’s Brexit vote to leave the European Union has been the catalyst for a sudden realisation that all is not well in the global economy.  It seems likely that 2017 will prove to be a difficult year.  I hope that the interview may help you to prepare for this.

Central bankers create debt, not growth, by ignoring demographic reality

Japan Sept16The world’s 4 main central bankers love being in the media spotlight.  After decades climbing the academic ladder, or earning millions with investment banks, they have the opportunity to rule the world’s economy – or so they think.

But their background is rather strange preparation to take on this role – even if it was achievable:

  Janet Yellen, Chair of the US Federal Reserve, is a former academic
  Haruhiko Kuroda, Governor of the Bank of Japan, is a career civil servant
  Mario Draghi, President of the European Central Bank; and Mark Carney, Governor of the Bank of England, are former Goldman Sachs bankers

None of these roles are noted for their contact with ordinary people.  Nor does their habit of flying First Class and staying in top-class hotels, or being chauffeur-driven to meetings, help them to engage with the real world.  Mark Carney’s travel expenses currently average £100k/year ($130k), in addition to his £250k/year housing allowance.

But the main disadvantage is simply that common sense is not a core requirement for the job.  If it was, then none of the stimulus policies enacted since 2000 – subprime, QE, Abenomics etc – would ever have been considered.

Common sense would have told them that people create demand – not economic models or financial markets.  And anyone used to working with real people would know that the key to demand is (a) the existence of a “need”, or at least a “want” and (b) the ability to afford the purchase.

Last week’s announcements by the Federal Reserve and the Bank of Japan highlight the disconnect.  Unsurprisingly, Yellen and Kuroda’s stimulus policies have completely failed to create sustained demand.  Instead, they have destroyed price discovery in financial markets and created asset bubbles instead.

The above chart highlights the irrelevance of their current policies.  As Bloomberg comment in respect of Japan:

Japan’s economy has been in trouble for decades. Massive monetary and fiscal stimulus have so far failed to spur faster growth. (Last) week, the Bank of Japan met to decide whether to apply yet more economic shock therapy. Here’s the situation the country’s leaders face:

“Japan has the world’s oldest population, as well as a low birth rate and little immigration, but its growth problems go far deeper. In the early 1990s, the country’s postwar growth boom collapsed—decades of deflation followed and Japan started to suffer a shortage of workers….

“Japan’s debt burden far outstrips that of other countries, largely a result of the stimulus introduced to help fix the economy. Abenomics, Prime Minister Shinzo Abe’s rescue plan, has helped to weaken the yen and boost corporate profits but wages and domestic spending have remained fragile.

“Higher debt led the government to consider a sales tax increase for revenue. But the last time it was imposed in 2014, consumer spending and gross domestic product fell, sending the economy into a recession.”

The chart (interactive on Bloomberg itself) confirms this analysis:

  26% of Japan’s population is aged over-65.  And the OECD median is now 18%.  People of this age already own most of what they need or want, and their incomes are declining as they enter retirement
  Japan’s fertility rate is just 1.4 babies/woman, only 2/3rds of the 2.1 replacement level needed to maintain a stable population.  The OECD median is almost as low at 1.7 babies
  Immigration might just be a way of compensating for these factors, but only 1.6% of Japan’s population are immigrants.  The OECD median is also too low to really make a difference at just 12%
  Japanese government debt is more than twice GDP at 247%.  The OECD median is equally worrying at 82%: debt in the other G7 economies ranges from 82% (Germany) up to 156% for Italy.

Fertility Oct13Slowly but surely, the world is realising that central bank policies have been a disaster for the global economy.

Common sense tells us that simplistic “solutions”, such as printing money and lowering interest rates, will never succeed in creating sustainable economic growth.  The real need is for policy to address the cause of the growth slowdown – the impact of the 50% rise in global life expectancy since 1950, and the  50% fall in fertility rates.

Until discussion takes place around the implications of these key facts (highlighted in the second chart), nothing will change, and the debt will continue to rise.  And as the Financial Times commented at the weekend:

The problem with the authorities rigging the markets is it could be painful when they stop doing it.”


My weekly round-up of Benchmark prices since the Great Unwinding began is below, with ICIS pricing comments:
Brent crude oil, down 56%
Naphtha Europe, down 53%. “A build-up in products supply has punctured refiners’ margins, according to the International Energy Agency, which warned that global refinery runs are experiencing their lowest growth rates in a decade.”
Benzene Europe, down 54%. “A drop in consumption was felt by numerous players”
PTA China, down 41%. “Bearish demand for spot cargoes as endusers laid off buying due to the proximity to the upcoming week-long National Day celebrations in China”
HDPE US export, down 27%. “Weak overall demand in China weighed down on prices”
S&P 500 stock market index, up 11%

13m missing American workers highlight economic slowdown

US jobs Jun16There’s something very wrong with the US jobs market, as the slide above confirms.  Commentators professed to be surprised by the disappointing May report last Friday, but its hard to know why:

  • The overall participation rate has been in decline since July 1997, when it reached 68%: today it is only 62.7%
  • Male participation is at an all-time low of 69.1%; female participation is back at 56.8%, the 1988 level
  • The total civilian population was 253m, so 172m would be working today if the participation rate was still 68%
  • Instead, only 159m were working – 13m fewer people, over 5% of the civilian population

Equally worrying is that there is no sign of any improvement.  If we look at data for the month of May, it shows that overall and female participation has been in steady decline since 2008, when they were 66% and 59% respectively.  Every single year since then has seen a decline.  Male participation has seen almost exactly the same trend, with the exception of last year – when it rose by 0.3% to 69.5%.  This year, however, it fell to a new low.

The striking thing about the post-2008 downturn is that it parallels the launch of the US Federal Reserve’s major stimulus programmes.  The Fed has just two targets – employment and inflation.  It has boosted its balance sheet by over $4tn dollars since 2008 to try and meet these targets, and cut interest rates to near-zero.  But the policies have clearly failed, given the participation rate decline and that CPI inflation is virtually half the target level at 1.1%.

One might think that policymakers would feel some embarrassment about such a very expensive failure.  But it seems not:

  • Instead, they prefer to avoid focusing on these key trends.  Their focus is on indicators which disguise the key trends, such as the jobless rate.  This is a far less reliable indicator, as it only measures people actively looking for work, not those who have given up.  So it is always likely to give a more favourable view of the position.  Similarly, they prefer to talk about so-called “core inflation”, rather than the CPI itself
  • This self-delusion has a purpose, of course.  If they focused on the key data, they would soon have to explain why they were ignoring the demographic issues that are causing the participation rate to fall, and inflation to turn to deflation.  They would also be forced to have difficult discussions with the voters about the sheer unsustainability of current policies – which have failed to adapt to a world where the average 65-year old American now has 20 years’ life expectancy ahead of them

The simple fact is that an extra 13m people would be working today, if the participation rate had remained at 1997′s level.  There would then have been no need for the Fed to have created today’s vast debt levels.  And the whole world would be in a better state as a result.


Surplus chemical industry capacity reaches 26% as demand slows

ACC Prod May16Global demand is continuing to slow, yet chemical industry capacity is continuing to ramp up.  As a result, supply gluts are likely to appear in many key areas as we move into the second half of the year.  That is the key conclusion from the latest American Chemistry Council data for global chemical capacity and production.

“This cannot be true” will likely be your first reaction.  After all, margins have been strong so far this year.  But margins have been strong because the oil price has been rising – not because demand has been strong:

  • Rising oil prices always lull the industry into a state of complacency
  • Demand appears to increase as oil prices rise, and we assume this is because of a strengthening economy
  • But in fact, it is almost always due to buyers building stock ahead of future price rises
  • They know prices will be higher next month, so they rush to beat the inevitable increase

Oil prices have risen around 87% since mid-January, when Brent bottomed at $27/bbl.  So there has been an enormous incentive for buyers to build inventory.  But this rise has not been due to any shortages – inventories are in fact at near-record levels.  Instead, it has been due to pension/hedge fund speculation over the outlook for US interest rates and hence the value of the US$.

This highlights, as the chart above shows, how the global chemical industry has been fooled for the past 5 years by the central banks.  They have kept telling us that demand is about to return to previous SuperCycle levels:

  • The industry has therefore kept building new capacity at the same rate as in the SuperCycle
  • Capacity has therefore risen by around 15% since 2012
  • But demand has only risen by 8% over the same period

ACC Surplus May16

This means that H2 could be very difficult indeed, if the pension/hedge funds decide to reverse their strategies:

  • They guessed correctly the US Federal Reserve would give up on its promised interest rate rise in March
  • As a result, they made good profits by reverting to the post-2008  “store of value” trend
  • This involved selling the US$ and buying oil and other commodities on the futures markets

But now this game is likely over, as the Fed has recovered its nerve.  Fed Chair, Janet Yellen, gave strong hints on Friday that interest rates were likely to rise in June or July.  So we may well see the US$ rise again

In turn, buyers will then likely start to destock into the seasonally weak Q3 period, as oil and commodity prices fall.  Prudent companies urgently need to develop plans to mitigate the impact of this reversal.

But this will not be easy – as the second chart shows, surplus capacity was already at 25.9% in April – more than twice the average 9.6% level seen in the SuperCycle.


My weekly round-up of Benchmark prices since the Great Unwinding began is below, with ICIS pricing comments:
Brent crude oil, down 53%
Naphtha Europe, down 52%. “France refinery strike has minimal impact on naphtha”
Benzene Europe, down 57%. “A steady flow of imports combined with less consumption in May has seen prices move lower”
PTA China, down 41%. “Plants within 50km of G20 meetings in Hangzhou have been confirmed to be reducing run rates or shutting down their units during that period, while plants within 100km of the meeting locations, such as those in Ningbo or Dalian, continue to be in discussions with authorities on operating statuses. Those within 300km of the meeting locations will shut or reduce run rates for a shorter period of time”
HDPE US export, down 29%. “China’s imported prices were continuing to drop in the week”
¥:$, down 8%
S&P 500 stock market index, up 7%