Mish's Global Economic Trend Analysis

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Biggest Bubble: Central Bank Credibility; Cautionary Tale of Global Gloom from Down Under Posted: 11 Jan 2015 09:28 PM PST Australian newspaper "The Age" has an interesting interview with Gerard Minack, former Morgan Stanley strategist. Minack is now out on his own, publisher of "Downunder Daily". Minack says "I deliberately decided when I left to keep it balanced, not to start writing like Zero Hedge." Nonetheless, Minack is a bear who thinks Australia is in for some tough times, the price of iron ore still has plenty of room to fall, and the most important monetary policy act of the last four years was European Central Bank president Mario Draghi's "whatever it takes" speech, but the eurozone will break up anyway. Finally Minack calls "central bank credibility" the biggest bubble. Let's take a look. Cautionary Tale of Global Gloom Please consider a few snips from The Bear is Back: A Cautionary Tale of Global Gloom. Fairfax Media: How do you think 2014 panned out in investment markets? Gerard Minack: People look at the S&P 500 and think it was a good year; it was a rubbish year for equities in US dollar terms. The S&P is the [2002 Olympics speed ice-skating gold medalist] Steve Bradbury of financial markets – the only one that has kept on skating while the others wobbled and fell over. Aussie shares are in a full-blown bear market, in US dollar terms. Credit markets are starting to wobble, commodities have been smoked. After two years of broad-based gains in risky assets, we're down to the last man standing. Fairfax: What has supported the strong gains in asset markets up to recently? GM: A couple of things. I think QE has been overrated, but six years of zero rates in the US is going to have an impact. But for me the most important monetary policy act of the last four years by a mile was [European Central Bank president Mario] Draghi's "whatever it takes" speech. In the two years before that, every time we hit a soft patch you reintroduced the tail risk of a systemic European banking crisis. And by taking that risk away all of a sudden the market became inured to macro weakness and started this two year re-rating. It was a pure valuation rally. From the late 2011 lows in global equities to early this year the MSCI All Country Index was up 65 per cent. Earnings over the same period were down, so we had a pure P/E-led rally. Fairfax: What about China as a potential source of returns this year? GM: There are structural problems there. You've had 30 years of great growth in China and lousy equity returns, and that's because they can't allocate their capital. If they improve their capital allocation they will be better over the medium term, but you want to see those reforms put in place first. The rest of Asia is an uneven story. Ultimately still a slow-growth world. If the US is growing at 2.5 per cent, and it's the world's locomotive, then you know the train is not moving very fast. Fairfax: What's your outlook for the iron ore price? GM: From here, iron ore will halve in US dollar terms, in my view. In the boom all the other commodities went up six- or seven-fold, while iron ore went up 15 times. So, sure, it's halved already, but it has further to go. Fairfax: How vulnerable is our housing market? GM: I don't think there's anything exceptional about our housing market, except that we've gone 23 years without a downturn. When we get across-the-board unemployment then we'll get an across-the-board downturn in house prices; it's just a matter of time. Fairfax: What are the big global risks you see out there in the coming few years? GM: The biggest bubble out there is central bank credibility. If Draghi was a stock he'd be on a P/E of 200! Yellen's on 100. When that bubble pops, all hell will break loose again, and there you really just want to be in cash. Fairfax: So the biggest risks are in Europe? GM: Yep. The problem is the next crisis will not be in the periphery and it will not be in the banks; it will be economic and it will be in the core. The big problem is the internal competitive imbalances in Europe. The problem's not [that] the euro is too high against the dollar, it's not that the euro is too high against the yen. The problem is that the French franc is too high against the deutschemark, and Mr Draghi can't fix that. From the resulting economic stress you're getting political blowback. You're getting fringe parties flourishing everywhere. There are whole landmines of elections coming up in the next 18 months, any one of which could throw up a result that could get the crisis back as front page news. Fairfax: So you still don't believe the euro can survive? GM: That's still the case. You can't restore your competitiveness in a fixed-exchange-rate regime. The solution is simple, and it's what the periphery has done: it's called having a depression. It's 20 per cent unemployment and large nominal wage cuts. The trouble is that the small economies can be bossed around, but you can't see the French taking the same medicine. In Agreement With slight differences on theoretical possibilities, Minack and I are in near-complete agreement. Eurozone: It's certainly possible to restore your competitiveness in a fixed-exchange-rate regime, but there's a snowball's chance in hell socialist France will do that. Otherwise, I have stated on numerous occasions the eurozone will break up or Europe will remain in a depression for over a decade. Productivity: The euro has many structural defects, including monetary policy that is absolutely not suitable for every country in the eurozone. Minack says "the problem is that the French franc is too high against the deutschemark, and Mr Draghi can't fix that." Correct. The ECB can't fix that. France could in theory fix the problem, but won't. Draghi: Without a doubt the most important monetary policy act of the last four years was Draghi's "whatever it takes" speech. That's something I have said that as well. Fringe Political Parties: We are certainly in agreement here, except I believe two of the alleged fringe parties are going to win the next election. Greece: Alexis Tsipras and the radical left in Greece (see Greek Polls Show Syriza on Cusp of Victory) Spain: Pablo Iglesias and his radical left Podemos party (see Podemos "Economic Manifesto" Calls for Debt Restructuring, Spain to Abandon the "Euro Trap"). Italy: Beppe Grillo's 5-Star Movement (see Beppe Grillo Seeks Referendum to Abandon Euro, "At War with ECB Scum, Not ISIS or Russia!") France: Marine Le Pen and her far right Front National party (see Rise of the Eurosceptics: Socialists Hammered in French Elections; Le Pen Surprises, Calls for "Alliance of Eurosceptics")  I expect wins by Podemos in Spain and Syriza in Greece. An outright win by the the 5 Star Movement in Italy is not out of the question. If you win, are you a fringe party?  Central Banks: Minack says "the biggest bubble out there is central bank credibility." On numerous occasions I have made similar statements. Please consider this reference from Sisyphean Fed Struggle to Create Inflation. Bubbles of Increasing Amplitude Via the moral hazard of bailouts, the Fed sponsors bubbles and crashes of increasing amplitude over time. But the biggest bubble of all is belief central banks will always be able to handle these busts. It's pretty rare for me to agree with someone on so many issues, especially an analyst (former in this case) at a big brokerage house, but there you have it. Further Reading Deflationary Spiral Nonsense; Keynesian Theory vs. Practice; Eurozone Policymakers Concerned About Falling Prices Challenge to Keynesians "Prove Rising Prices Provide an Overall Economic Benefit" "Will These Central Bank Morons Ever Learn?" asks Albert Edwards at Societe General James Grant Conference Video: Inflation Expectations, Growth, Policy Problems; Europe Has Become Japan. Mike "Mish" Shedlock http://globaleconomicanalysis.blogspot.com Mike "Mish" Shedlock is a registered investment advisor representative for SitkaPacific Capital Management. Sitka Pacific is an asset management firm whose goal is strong performance and low volatility, regardless of market direction. Visit http://www.sitkapacific.com/account_management.html to learn more about wealth management and capital preservation strategies of Sitka Pacific.

Illinois Governor Backs Away From No Tax Hike Pledge; Clueless Rauner Has Few Ideas Posted: 11 Jan 2015 01:12 PM PST It's par for the course for politicians to back away from campaign pledges. But one might have at least expected that Republicans would not consider tax hikes. Unfortunately, even that modest assumption is suspect as Governor Rauner Set to Inherit Illinois' Sea of Red Ink. Illinois faces a sea of red ink because shrinking income tax revenue will fail to keep pace with rising pension and health insurance costs, according to outgoing Gov. Pat Quinn's latest three-year budget forecast. The projections from the Office of Management and Budget warn that the estimated $4.1 billion bill backlog expected at the close of fiscal 2015 could grow to $9.9 billion in fiscal 2016, $15.7 billion in fiscal 2017, and reach $21.3 billion at the close of fiscal 2018. At the same time, a general funds deficit of $180 million this year will rise to more than $5 billion in the coming years. Quinn, as he unsuccessfully pressed lawmakers last year to make permanent the 2011 tax hike, warned lawmakers that years of progress would be reversed if they expired. Facing an election, lawmakers balked and adopted a fiscal 2015 budget that is now $750 million short of the actual funding needed to support costs. The task of balancing the current budget that runs through June 30 and dealing with skyrocketing red ink falls to Gov.-elect Bruce Rauner, who has warned that state finances are in even more dire shape than he thought. He has, at least temporarily, backed away from his campaign pledge not to extend the higher rates. Rauner, who defeated Quinn in November, takes office Monday and his budget is due Feb. 18 unless he asks for a delay. The Republican faces veto-proof Democratic majorities in the General Assembly. Rauner has so far offered only general ideas for balancing the state's books. A 10-point fiscal blueprint released during the campaign called for trimming $1 billion in spending, cutting state purchasing and cracking down on Medicaid eligibility, among other ideas. Clueless Rauner Has Few Ideas Clearly Rauner has few solid proposals. But instead of forcing Democrats to override his veto of a tax hike bill, Rauner appears ready to throw in the towel already. Reflections on "Progress" Former governor Pat Quinn "warned lawmakers that years of progress would be reversed if tax hikes expired." Progress for Illinois democrats is tax hikes, followed by tax hikes, followed by more tax hikes simply to cover inane benefits of public unions while taxpayers and businesses flee the state. And now Rauner appears ready to go along with tax hikes because "state finances are in even more dire shape than he thought." Pathetic. Our only hope is to shame Rauner into a position that displays a backbone rather than a wet noodle. Mike "Mish" Shedlock http://globaleconomicanalysis.blogspot.com Mike "Mish" Shedlock is a registered investment advisor representative for SitkaPacific Capital Management. Sitka Pacific is an asset management firm whose goal is strong performance and low volatility, regardless of market direction. Visit http://www.sitkapacific.com/account_management.html to learn more about wealth management and capital preservation strategies of Sitka Pacific.

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