Have Central Banks Lost Credibility?Independent Trader
The beginning of 2019 supposed to be a period of “normalization” in terms of the central banks activities. However, nothing has changed and in reality we are still dealing with the persistent currency printing which is often hidden from the citizens.
Does the currency printing influence prices?
Before we move on to the largest central banks activities, it is worth to note one important issue. Using some sort of simplifcation. So called currency printing can be conducted by the central bankers in two ways:
a) By purchasing financial assets
Good example of that practice can be buying sovereign bonds by the FED, corporate bonds by the ECB or purchasing stock ETFs by the Bank of Japan. This type of money creation has been performed over last 10 years and till now had been regularly announced by the central banks. This purchase of assets has created speculative bubbles on the stock and bond markets. We have been writing about this close correlation between asset purchases of central banks and quotations of stocks and bonds many times. It is clearly shown on the chart below where the main stock market index in US is described by the red line and the total assets value owned by major central banks is showed as the blue line.
Looking deeper into it we can conclude that the purchase of financial assets means that new funds appear on the financial markets. The net effect is the inflation of stocks and bonds prices. However, the currency does not flow to the real economy and does not influence prices of goods and services. In addition, the purchase of assets helps growth of the small part of the people in the general wealth of the society – the richest. This is confirmed by the graph below:
The blue color indicates the share of 0.1% of the richest Americans in the US household wealth. For comparison, the red color determines the share of 90% of the poorest people. What is the relationship with the stock exchanges? It is significant. Since the prices of shares and bonds were pumped up, and real wages not risen, the richest part of the society has benefited the most from it. To be clear, poor people usually do not own securities.
b) By increasing the availiability of credit
It can happen in various ways. First, through the reduction of interest rates, which have been done by central banks during the recent financial crisis, initiating the era of “zero rates”. However, there are also other ways, such as special loans with low interest rates for companies (example of the ECB actions) or decreasing the level of reserves that commercial banks have to maintain (example of the Bank of China actions).
As a result of these activities the currency actually flows to the real economy. For instance, particular citizen gets a loan, buys a house, furniture and goes on vacation. The currency is circulating. Similarly, the company takes a loan and spends it on investments, while increasing employment . Therefore in this case, the appearance of the new currency in the economy ultimately contributes to the price inflation of goods and services.
As you can see, the money creation is not as straightforward as it seems. The other ways of currency printing apart from mentioned above, e.g. helicopter money (giving money away, which is actually giving away worthless notes) also exist. However, those two which we have mentioned are important because they are linked to the second part of the article.
No central bank in the world is as involved in events on financial markets as the Bank of Japan. BOJ’s share in Japanese bonds market is so large that it is virtually impossible to call it “the market” at all. Furthermore, the Bank of Japan is also the main player on the stock market owning huge amounts of japanese ETFs. As in the chart below, in mid-2018, the value of the Japanese ETF market was about 27 trillion yen, of which 20 trillion yen was the Bank of Japan’s share!
Along with the purchase of assets, BOJ for many years has been employing loose monetary policy by keeping their interest rates just below zero. During many of the conferences, the poeple in charge of BOJ explained that their aim is to reach the 2% inflation target.
The problem is that at least 40% of the data on which BOJ activities are based are simply false. This is not a rumour, this is the official fact which came from Japanese authorities. For example, the annual increase of wages in Japan has been overstated by 0.7 percentage points over the past year, which for Japan makes a significant difference.
In general, this scandal gives a lot of doubts whether it is worth to listening to any news from Japan, at least for now. To make it short, it can be said, that BOJ activities are based on distorted data, additionaly it conducts currency printing based on its’ own whim.
Due to the lack of transparency, Bank of Japan can become a very convenient liquidity provider to the financial markets. Ultimately, no one in the world will be outraged of their activities.
It is also worth noting that due to the course of events in Japan (strong growth before 1989, then stagnation and the highest debt in the world – in relation to GDP) it was the Bank of Japan who had the most time to prove that the policy of eternal currency printing will bring results. After all, considering the disappointing macroeconomic data in Japan, we believe that it is impossible to print the prosperity.
ECB have no choice
In December, the European Central Bank has announced the end of asset purchases. It is worth recalling that the ECB has been purchasing mainly corporate bonds without any specific criteria in terms of the selection of companies whose debt would be bought. This policy has given an ideal incentive for corruption because for each enterprise it was better financially to hand over a specific bribe in the exchange for reducing the company’s cost of debt.
After the announcement, speculation began how quickly the European Central Bank will follow the Federal Reserve and begins to raise interest rates. We were quite surprised because every reasonable analyst seeing the economics slowdown in the Eurozone and the dramatic situation of the banking sector knew that the ECB would soon return to the loose monetary policy rather than to the increase of the interest rates. In regards to this, we have written this article “Does the ECB really end up printing?” https://independenttrader.org/did-the-ecb-really-end-up-printing.html suggesting that the European Central Bank may soon consider another program of cheap loans available to enterprises (the so called TLTRO).
What do we know after a few weeks of 2019? First of all, we can forget about the increase of the interest rates. The market assumes that the first hike will take place in 2020, but we think that the interest rates will move in the opposite direction, despite the fact that they are already on zero level.
Low-interest loans for companies have been already discussed at the ECB meetings. It is assumed that Mario Draghi will talk about this issue in March and the loans will be made available in June. We think that it is a feasible scenario – the slowing Eurozone economy will certainly put pressure on the ECB to support the economy (regardless of whether the support works or not).
Moreover, considering the fact that the ECB supposed to finish the assets purchases in December, as a result the bank’s balance sheet should stabilize. However, in January we observed that it was still growing (green dotted line on the chart), which makes the ECB credibillity becoming similar to this of the Bank of Japan.
Just over four months ago, the sentiment on the American stock exchange was outstanding. Most investors were convinced that if somebody wants to invest, should do it in the US. Moreover, the FED chairman Jerome Powell firmly argued that he intends to continue raising interest rates and reducing the balance sheet and only the bad economic situation may change his attitude.
Three months of decreasing stock prices was sufficient to change the environment dramatically. Currently, market is pricing a rate cut more than the rate hike in 2019, and the FED itself capitulated saying that the end of the balance sheet reduction is possible. It is once again a confirmation that the central bankers pay a lot of attention to the quotations on the financial markets.
It looks like central banks are making great efforts to maintain good mood among investors. Unfortunately, this is not enough. Chinese economy is slowing down and the stock exchange is not performing well despite the loose monetary policy of the Bank of China. In Europe, we can officialy say that the recession has come to Germany and Italy, and more countries are waiting in the line. It is true that the economic situation affects the markets, so the banks’ stock prices are poor and corporate bonds are in a bad place. It is not even worth to mention Japan. Only the United States remain relatively solid, where the stock exchanges and the economy have both better and worse moments. On that basis can we say that if you want to invest, you should do it in the US?
Definitely not. United States assets in comparison to the other developed markets are overvalued the most since at least 70 years.
So what can we choose apart from sitting on cash and precious metals? We can only search for extremely undervalued assets, preferably which pays regular, decent dividends.
Why we do not suggest that a reasonable investor should limit his exposure only to metals, cash and possibly shorts? First things first, because of the unbelievable determination of bankers and politicians who will take a lot of steps towards ultra-loose monetary policy, as long as they do not experience a severe meltdown that will really annoy citizens. For now, the recession is looming on the horizon, so the central banks tend to avoid buying assets. However, when sharp drops occur, QE will return and financial assets will be pumped up again.
This is not everything yet. Over last few days, the promotion of negative interest rates in the news has begun. This is of course a separate theme, but it is worth noting that at February 4 an article appeared on the FED San Francisco website which proved that the negative rates should have been introduced in the US 10 years ago as the response to the financial crisis. In addition, IMF later on published a text in which the issue of negative interest rates and the possible separation between cash and electronic money was referred to.
For us, it has been all arranged in one scenario. Central banks are currently trying to fill financial holes with ad-hoc stimulus, in the same time acknowledging that no normalization of their policies will take place. When the economic slowdown hit the markets with more force, and the additional credit together with the fake news about US-China deal will not help, it will be decided to reduce interest rates just below zero. At the same time, the central banks, again will start the asset purchases. We do not want to whet our appetites, but it is really hard for us to imagine that with such a strong destruction of the currency, the precious metals prices will not shoot up.
Article by The Independent Trader