One of the gems of net-borne financial journalism is the FT's Short View currently assembled by John Authers. A couple of days ago he did a piece called Gold glitters once more in which this chart appears:



Now, inflation vs deflation is one of those debates occupying many minds; and easily one of the best discussions I have read is to be found in two blogs at Cassandra Does Tokyo (including the comments). By contrast this post is semantic, not strategic.

One funny thing with data relationships during crises is that many of them break down: chaos and linearity are generally incompatible bedfellows. The TIPS break even spread, I would suggest, is such a linear relationship that has become somewhat confused the deeper the financial chaos becomes.

The nominal 10 year US bond market is highly liquid. The inflation protected equivalent less so. Investors pay a premium for that feature of the nominals meaning their yield, other things being equal, is relatively smaller than those of the TIPS. Even in "regular" times the derived real inflation measure is therefore "artificially" low. In times of panic the effect is exaggerated. Hence, I think, that deflationary point on the chart.

Anoraks will tell you that there is also an inflation premium built into the nominals mitigating this effect. That's true (the Cleveland Fed has a full explanation here and a further background paper from the KC Fed is here). But during crises the magnitudes are not, probably, comparable.

That suggests that the unadjusted-for-these-effects Short View chart underestimates real inflation expectations and is more a demonstration of the extent of the flight-to-liquidity panic. The recent upturn possibly reflects this overshoot as well as the (consequent) growing enthusiasm for TIPS, led most notably by Bill Gross, as many persuade themselves that the deflation threat is overstated.

Course, those are opinions and all nuance is lost without discussion of timing and lags: just because deflation may be an exaggeration at this stage does not mean it will remain so.

Nonetheless, it used to be that such views as Mr Gross' could be tested (somewhat) using an adjusted TIPS measure conveniently provided by the Cleveland Fed. Guess what the Cleveland Fed has to say about it today:

"We have discontinued the liquidity-adjusted TIPS expected inflation estimates for the time being. The adjustment was designed for more normal liquidity premiums. We believe that the extreme rush to liquidity is affecting the accuracy of the estimates." (link)

Still, so what? Between adjusted and unadjusted it's all a question of magnitude not direction - isn't it? Well, it wasn't back in May the last time, unfortunately, I had a look at adjusted vs unadjusted US inflation expectations (chart below):


At the time mainstream commentators overlooked this divergence since not many were aware of the adjusted series. Which does not mean by any stretch, given what subsequently happened, that the adjusted model was in whack. But somewhere there is still a place for the point that what seems obvious isn't (maybe) always. In a chaotic crisis this is even more true.

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A day after referring here to Goodhart and Persaud the great Vox puts this up. Preliminary conclusions (page 59):

  1. Regulation (external intervention) should always be capable of justification as a consequence of some specified market failure
  2. The main cause of externalities arises because the social cost of systemic financial collapse exceeds the private cost to the individual financial institutions (and markets). A collapse of a financial institution causes risk spillovers. Effective regulation should provide incentives for financial institutions to internalize these externalities (risk spillovers).
  3. The main cause of systemic collapse is endogenous risk, the likelihood of self-amplifying spirals like the loss and margin spiral.
  4. Stress tests examine the responses of banks to exogenous risks. By construction they do not incorporate endogenous risk. Completely new techniques, perhaps based on models and endogenous risk-spillover measures, like CoVaR, need to be devised to explore the implications of endogenous risk for the system.
  5. Requirements based on minimum capital ratios do not provide resilience, since they cannot be breached. They represent a tax, not a source of strength.
  6. Requirements should, instead, be normally restated in terms of higher target levels of capital, with a specific, statutory (i.e. not discretionary) and forceful ladder of increasing sanctions. This ladder should have a minimum point at which either the deficiency is satisfactorily redressed, or the institution is shut down, i.e. prompt corrective action, p.c.a.
  7. The response to the current crisis has led in several countries to a further concentration of the banking system and, perhaps, elsewhere amongst hedge funds. Greater intervention to encourage competition and to prevent oligopolistic behaviour may well be warranted.

Full draft available by clicking through the image below:

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Like a flea implausibly claiming ownership of a dog UK Prime Minister Brown is today reported as saying it's now been a decade that he has been calling for an "early warning system so that international financial flows are properly monitored". This, along with his frequent (ever more so as the UK tanks) call for "a truly international" approach (which sounds much like a get out clause) is part of the Labour case for its own economic competence.

Not that this might be morphed into an argument for the Tories. Shadow Chancellor George Osborne is today, say the Telegraph, to make a "major economic speech at the Institute of Chartered Accountants" whose centerpiece, it appears, is the notion that senior civil servants be punished if they fritter away taxpayer funds.

Forget the purpose of the National Audit Office. Leave aside the existence of all those watchdog divisions in the Treasury monitoring spending departments. Just wonder why, in a week when the opposition were prepared to aid and abet (allegedly) the government by abstaining on legislation that would have revealed their own expenses, Mr Osborne chooses this moment to raise more questions as to his political nous.

But back to Mr Brown. According to the Times he has a number of ideas including:

  • "ensuring national financial regulators stay in close touch with their counterparts in other countries;
  • setting standards for all financial institutions around the world on transparency and corporate governance;and
  • Reforming bankers' pay and rewards to encourage responsible, long-term risk-taking rather than quick profit.

Public hanging and quartering of financiers is a politically attractive, additional option. And anyone with a passing familiarity with financial crises will hear Mr Brown's calls echoing down through the ages. There is no need to trawl the archives to prove this. Just start in the recent past from, say, 1997 and the Asian crisis. Move through the corporate frauds at Enron, Tyco, Worldcom et al. End post tech wreck. Law codes around the world are subsequently all much, much heavier. Yet crises persist worse than ever. There are many views as to why. But key is that the cycle cannot be eliminated - only mitigated. So why not focus on that?

Avinash Persaud and Charles Goodhart published a piece in the Financial Times last June in this regard that does not appear to have found favour anywhere it might matter. That's a shame. Once again it looks as though the politically loud will prevail over the thoughtful and knowledgeable.

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Restricted


SUBJECT: CIVIL SERVICE HEADCOUNT
FROM: PSG
TO: CHANCELLOR
CC: BTW, IF, MFP, CABINET OFFICE


You asked for the latest data following Lord Jones' Digby-gate utterances. Provisional headcount figures are graphed below:



LINE(S) TO TAKE:
Presentationally there are seven lines to take explaining away the fact that public sector numbers (and, when the time comes, public sector debt) may well double in short order.

  1. Private sector headcount systems are different
  2. Emergency situation makes comparables invalid
  3. The extra capital injections for banking would have taken the form of special supra budgetary expenditures before the next election had this crisis not occurred. In other words, we have simply brought forward spending thereby making this intervention budget neutral
  4. It may turn out to be the wisest and most profitable public investment ever made - as well as save the world
  5. We have not quantified the cost to taxpayers in order to prevent the type of wildy inconvenient inaccurate cost per taxpayer press estimates produced after last October's injection to the banking sector
  6. Unforeseen but important cyclical rises in unemployment elsewhere mean this expenditure is needed in marginal constituencies
  7. The Government has made consistent contra-cyclical economies during its tenure due to its breaking of the boom-bust syndrome. This has created the financial headroom to cope with today's extraordinary crisis brought on solely by irresponsible bankers. Our capacity to spend these sums is in many ways, therefore, testament to our prudent stewardship of the UK economy


NB: with apologies to Yes, Minister - The Economy Drive
NB1: Graph source - Office for National Statisitics data (erm, mostly)

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Feeling an obligation, here, to balance prior downbeat coverage of money market spreads. The latest picture is this:


(Chart source: Bloomberg)

Which is quite a change and what Baroness Vadera, working in a role titled "Business Minister" in the UK, claimed to be referring to a couple of days ago when she admitted seeing "little green men" "green shoots" of recovery (interview here plus entertaining video report on it here).

Never likely to be confirmed suspicions suggest that Prime Minister Brown immediately requested the Baroness reduce her daily intake of seven cups of coffee. Which may prove a challenge for someone with 14 years experience of the hallucinatory UBS culture, a suspected stronghold of excessive caffeine inbibation.

But back on track, and keeping with the theme of the previous post, the picture looks more stable than before thanks to central bank interventions. Or it does in relative terms. Yet compared to pre-summer 2007 normalcy it is not. Still, other things being equal, a smaller spread means perceived default risk is dropping.

However, do you not wonder - given those same central bank actions - that because wholesale money markets are surviving on public finance life support systems that the risk such spreads once measured has not declined (or not by as much as the graph suggests) but merely been steadily transferred...elsewhere?

In the same way the Baltic Dry Index lost proxy status for global sea-borne trade once China started flooding the world with steel from 2006, the TED and Libor/OIS spreads are, perhaps, less informative risk indicators than before. The urgency with which capital raising continues alongside further mooted injections of taxpayer money into banks, anecdotally at least, may also be suggesting as much.

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A tidy round-up in Global Finance magazine (free subscription here) on the "Shortage of dollars" hit my snail-mail box a couple of days ago.

The "credit crunch" by another name, the shortage began in earnest, as everyone knows, when free lunches were removed and Lehman went down. Serious dollar hoarding followed amongst banks and money market funds (a key source of dollar finance to non-US banks). BRIC countries are at it too as they look to rebuild dollar reserves dropping precipitously - October ’08 saw these fall by $140bn, a monthly record.

Though the article ignores the additional dollar-supportive role of deleveraging by non-US banks, in visual form - and taking last Spring as the starting point - it all adds up to something like this:

US Dollar index, weekly:

(Chart source, Marketclub)

Quite surprising for a currency whose central bank seems to be bent on printing money willy-nilly since its November $500bn purchase of Fannie Mae, Freddie Mac and Ginnie Mae mortgage backed securities (plus the additional liquidity programme of $100m). And there is the doubling (to over $600bn) of Federal Reserve swap lines to the European Central Bank (and others), mitigating the aforementioned money market hoarding, to bear in mind too.

This shift to a "creation of money’" policy in harness with the previous stand alone "price of money" stance is the crux of the deflation/inflation debate so much cyber and real ink is being spilt over. Toss in the financing form of the bigger-every-day Obama fiscal package - Treasury sale vs reserve creation by the Fed – and watch it run and run.

Then, yesterday as I confessed (without irony or basis) to coveting the credit for her post Ethics Exam, Cassandra Does Tokyo sent me this link to an excellent Econobrowser post and highlighted the comment below from Professor Perry Mehrling of Columbia University:

"It seems to me that what we are seeing is simply the balance sheet consequences of the Fed's decision to take the wholesale money market onto its own balance sheet…In this view, inflation seems much less likely. Why not? If the original wholesale money market borrowing and lending was not inflationary, then why should its substitute be inflationary? Indeed, the real question is whether the expansion of the Fed's balance sheet is keeping pace with the contraction of money market credit more generally. If not, then the consequence may be deflationary."

That elevates the discussion, I think, to one about the health and future structure of the wholesale money market. Is it a salvage and rebuild job? Or does it only need time to heal itself back to normal (at which point, ZIRP and money creation will be revealed as excessive and bite back)?

An era of salvage, reconstruction and enduring deflation is what is very clearly signposted currently - including the impact of today's ongoing policy responses. But, citing from a Bloomberg appearance by Bill Poole a few days ago, "shit happens".

Which is econ speak for "beware the lags".

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How would you like to have to explain to your clients that, acting on buyout news, you went in hard and heavy on the target (ie $millions) and got in ahead of the crowd morons to lock in gains. The price went up over 200% from its overnight close and you nailed down more than half of that ahead of what was rapidly shaping up to be a weekend of wild debauch.

Then, in a sickening moment of realisation reminiscent of the time you locked yourself out of the motel room with only a head full of shampoo for company and a woman (not your wife) passed out drunk in bed on the other side, you recognise that...you bought the wrong freaking stock! Master of the Universe Friday morning you now have the entire weekend to think about it and formulate lines to take for the boss/clients come Monday morning.

This explanation (less embellishments) for unusual movement in the company Allied Motion comes from the not always entirely trustworthy Yahoo message boards. Yet it does have a plausible ring to it and visually looks (allegedly) like this:

(Chart source: Market Club)


Allied Motion trades under the symbol AMOT. The genuine bid target was Advanced Medical Optics whose logo is:
And who refer to themselves in literature as "Advanced Medical Optics (AMO) [NYSE:EYE]". Confused? Me neither. If you got it right the transaction looks thus:

(Chart source: Market Club)

Not Kerviel's league. But still highly amusing.


Postscript freebie
Ironically, Allied Motion (which I do not own) is itself a very tempting small cap enterprise - free cash flow yield over 20%, low debt, strong Altman Z and Piotroskis, a ridiculous PE and all the signs of being able to weather the storm with something in hand. But nonetheless not about to get bought for a 10 times premium.

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Assume no bond bubble for a moment. Which assumes also that investment grade (IG) bonds are not ridiculously cheap. Which assumes default rates really are/will be diabolical (and Dow Chemical’s travails with Kuwait as they relate to the group's financing of the Rohm & Haas transaction illustrate the problems that can touch relatively sound IG). Which assumes a near ZIRP will not kick in violently but fitfully and slowly, Japanese-style (Ed: did they recover?). Which assumes continued risk aversion to the benefit of US long bonds. Which assumes China does not have an economic death-wish and will not stop buying. Etc etc.

There are some great articles covering bubble vs no bubble. One, two and three for example.

A further consideration, perhaps, is the effect on sentiment that the impact of the recession cum systemic crisis is having on the US tax base. The following graph is through Q2 2008.



Another cut of the same thing:



(St Louis Fed FRED data)


The position is deteriorating badly and likely is set to continue at both ends, tax receipts and expenditure, if the shape of the fiscal debate in Washington and the continuing macro malaise are reference points.

Sovereign default is an unlikely issue: the US economy doubtless can handle the debts it is taking on immense though they may be. But one does still wonder as worse data trickles out if the growing gap between income and expenditure – and draining faith in the direction of policy - might act as the catalyst bubble theorists fear.


*Title a reference, of course, from the well-worn economic joke

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There are 14 lines in a sonnet. I have completed just two in a work begun a couple of years ago. The opener:

Oh, fractional reserve banking, made in heaven! Oh, fractional reserve banking chaste and so pure!*

I know! "Chaste" and "pure"?! Inspired - and great hooks in these times of vast money creation.

Curiously, next it was the concluding 14th line that came to me:


Tho’ currencies be debauched, the battle is won!

Quite sublime stuff. But since the top and tail? Sweet FA. I had expected the cheese for this bun to dialogue luxuriantly like a rich strand of fondue through and around the story: the threat to chastity from investors, the bitter struggle with savers and the final emergence, with a large chunk of public investment, honour (and method) intact. Oh, chaste and pure banking system!

Yet, inexplicably, it is these middle 12 lines I have been having trouble with. Possibly something about the gold standard? Maybe a Keynes/brains combo couplet? Reference to the politically inspired but limp reflexive regulatory impulses sure to follow, like those littering the wake of every prior crisis (“dynamic provisioning, thou art but a dream”)? And is it possible to use the phrase “sterilised intervention” without losing some resonance?

In this inspirational desert any muse remains but a mirage.

So I thought, “what the hell, try turning the 14th around”:


Tho’ the battle may be lost, the currencies are sound!

The great thing about this line(s) is its versatility. And its sonority. And the implication of a greater war to be won. OK, so the meaning appears diametrically altered. Ambiguity is part of the beauty of verse.

Unfortunately, still inspiration remains illusionary. The fondue is cooling prematurely into a coagulated greasy mish-mash of illogical and clumsily linked words. There have been endless re-writes until continuity, logic and result - like some wild, on the fly, fire fighting regulatory policy - have become a hopeless dream.

Still, mustn’t grumble.


*With apologies to Machado de Assis

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If you saw the FT Alphaville post on this you may also have seen that the link to the paper itself was broken. Here it is.

There are several dispiriting charts for optimists in the paper with the one below, for example, not suggesting encouraging odds on an imminent reversal of property price declines:


Another similar chart has relatively better (but hardly marvellous) news on the equity front:


The authors background paper, Banking Crises: An Equal Opportunity Menace, is also recommended reading. It too has a collection of lovely charts this one of which may (hopefully) interest policy makers:


No free lunch, globalisation.

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New year, old news, turn the page etc etc. Or at least you'd think so counting the number of "declined to comment" positions from those involved in this brilliant piece of triple-A rated financial engineering that settled (net) around $0.15 on the dollar.



This fine WSJ article accompanies vid above.

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New Year, new hope.

The title of this post comes from that of a French fashion line (they are not all out of business) and a play on the words in "deux mille neuf" where "meufs" is slang (verlan) for the ladies. That is, it is fantasy time.

Fantasies can come true, of course. Except, to my knowledge (and experience), those involving 2009 nubiles. But in equity markets one realisable fantasy envisages a poor equity market in the first half followed by a decent pick up in the second as the volume of free money seeded by central banks eventually finds purchase in thin credit market soils.

Already, in sympathy with this view, there is a certain amount of egging-on detectable amongst institutions. I received this from ING:

La chute des cours de la Bourse présente aujourd'hui une belle opportunité d'investissement: se placer sur les marchés financier à des conditions avantageuses. Alors pourquoi ne pas le saisir?

Which, freely translated, means "don't be stupid, send us money to buy equities".

Similarly, it has been possible on Bloomberg to hear things like "I like the Indian rupee" which on one level is actually a plea for company on the meuf chat-up circuit. Career-wise, you get to keep your job if you were rejected by a (for example) BRIC beauty at the same time as everyone else.

Adds up to self-fulfilling stuff (and probably with the rise in the first half) whilst the world awaits sufficient trickles of "real" economic data to support - or reject - the assumption that policy is aggressive enough to reverse current growth trends this year. The effect of fiscal stimuli and near-free money on job and house price data, in particular, looks key.

Happy New Year and stay nimble!

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