The Mystery Of The "Missing Inflation" Solved, And Why The US Housing Crisis Is About To Get Much Worse

Over the past few months (not to mention last 7 years), the topic of America's "missing inflation" has gained major prominence, because while supposedly every other aspect of the economy is humming along (which really just means that record numbers of waiters, bartenders and temp workers are hired and collect minimum wage salaries), CPI remains so low it (together with China to a lesser extent) was used as justification by the Fed to not hike rates for 55th consecutive FOMC meeting, even though 75% of polled economists said, after 9 years of ZIRP, Fed lift off would take place last week.

One problem with the Fed's measures of inflation, as we have documented in the past, is that they are wrong, if not with malicious intent, then purely due to definitional purposes. Recall our July comparison between CPI and PCE and our warning that "With The Spread Between CPI And PCE Blowing Out The Most Since 2009, Is The Fed Making A Big Mistake" in which we warned that "with a rate hike, as small as [25 bps] the Fed can and will almost certainly start a chain of events that results in the "ghost of 1937" waking up. We don't know if, like during the first Great Depression, it leads to a 50% plunge in stocks, but for those long risk here, it hardly makes sense to stick around and find out."

The Fed did not hike.

But a bigger problem for the the Fed's measures of how the overall economy is doing (and/or overheating) is that the Fed telling the vast majority of Americans that inflation is negligible, leads to riotous laughter.

The reason for this is a simple, if dramatic, one: the U.S. transformation from a homeownership society, to one of renters.

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Bankers Threaten Fed with Layoffs if it Doesn’t Raise Rates

Say the Fed wanted to raise short-term interest rates to 1 percent, meaning that it did not want banks to lend at lower rates. Because the glut of reserves is so great, the Fed could not easily raise rates by reducing the availability of money. Instead, the Fed plans to pre-empt the market, paying banks 1 percent interest on reserves in their Fed accounts, so banks have little reason to lend at lower rates. “Why would you lend to anyone else when you can lend to the Fed?” Kevin Logan, chief United States economist at HSBC, asked rhetorically.

This is not a cheap trick. Since the crisis, the Fed has paid banks a token annual rate of 0.25 percent on reserves. Last year alone, that cost $6.7 billion that the Fed would have otherwise handed over to the Treasury. Paying 1 percent interest would cost four times as much. The Fed has sent roughly $500 billion to the Treasury since 2008. As the Fed raises rates, some projections show that it may not transfer a single dollar in some years. Instead, the Fed will pay banks tens of billions of dollars not to use the trillions it paid them previously.

It’s also worth pointing out that financial firms historically have been losers in tightening cycles because they hold inventories of securities which fall in value as interest rates rise. In the past, they were inevitably net long. There simply was not enough hedging capacity for big dealers to go net short or simply flatten their positions. But Dodd Frank has forced dealers to cut their positions considerably, so the banks may feel they can make enough profit on having customers rearrange their lives (as in taking advantage of volatility) to offset losses on their OTC trading positions. i’d be curious to get informed reader views.

Now the Fed could use its reverse repo facility too, as reader craazyboy pointed out. But the Fed is already accounting for a significant portion of that market and may not want to become the repo market. Hence interest payments on reserves could be the Fed’s first line of intervention.

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Contemporary Capitalism: Neoliberal Capitalism, Financialized Capitalism, or Globalized Capitalism?

While it is widely agreed that capitalist economies underwent significant change after around 1980, there are different interpretations of the new form of capitalism that emerged. There is no agreement about the best organizing concept for post-1980 capitalism. Some view it as financialized capitalism, some as globalized capitalism, and some as neoliberal capitalism. These different conceptions of contemporary capitalism have implications for our understanding of the problems it has produced, including the financial and economic crisis that emerged from it in 2008. Focusing on the U.S. economy, I presented a case in part 1 that “neoliberal capitalism” is the best overall concept for understanding the form of capitalism that arose around 1980. Here, I deal more specifically with the shortcomings of alternative interpretations – focused on the concepts of “financialization” and “globalization,” respectively.

Why Not “Financialization”?

Some economists view “financialization” as the best overall concept for understanding contemporary capitalism. Financialization can best be understood, however, as an outgrowth of neoliberal capitalism. The rise in financial profit, which gave the financial sector a place of growing importance in the economy, came quite late in the neoliberal era. As figure 2 shows, only after 1989 did financial profit begin a long and steep climb, interrupted by a fall in the mid 1990s, and then a sharp rise to a remarkable 40% of total profit in the early 2000s. It was only in the 2000s that financialization fully blossomed. At that time, commentators noted, Wall Street was beginning to draw a large percentage of elite college graduates.

The “financialization” of the U.S. economy in recent decades, important though it is, was itself driven by neoliberal restructuring. The neoliberal institutional structure, including financial deregulation, enabled financial institutions to appropriate a growing share of profits. Furthermore, financialization cannot account for many of the most important economic developments in contemporary capitalism. It cannot explain the dramatic shift in capital-labor relations from acceptance of compromise by the capitalists to a striving by capitalists to fully dominate labor.. It cannot explain the sharp rise in inequality. And it cannot explain the deepening globalization of capitalism.

Why Not “Globalization”?

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The Real Reasons Why The Fed Will Hike Interest Rates

For the past several months, the chorus of voices crying out over the prospect of a Federal Reserve interest rate hike have all been saying essentially the same thing – either they can’t do it, or they simply won’t do it. This is the same attitude the chorus projected during the initial prospects of a QE taper. Given the trends and evidence at hand I personally will have to take the same position on the rate hike as I did with the taper – they can do it, and they probably will do it before the year is over.

I suppose we may know more after the conclusion of the Fed meeting set for the 16^th and 17^th of this month. August retail sales data and industrial production numbers have come in, and they are not impressive even with the artificial goosing such stats generally receive. However, I do not expect that they will have any bearing whatsoever on the interest rate theater. The Fed’s decision has already been made, probably months in advance.

The overall market consensus seems to be one of outright bewilderment, so much so that markets have reentered the madness of "bad news is good news" as stocks explode on any negative data that might suggest the Fed will delay. The so-called experts cannot grasp why the Fed would even entertain the notion of a rate hike at this stage in the game. Hilariously, it is Paul Krugman who is saying what I have been saying for the past year when he states:

"I really find it quite mysterious that the Fed is eager to raise rates given that, they’re going to be wrong one way or the other, we just don’t know which way. But the costs of being wrong in one direction are so much higher than the costs of being the other."

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Head Of China's 'Goldman Sachs' Probed For Insider Trading As "Market Purification" Continues

Imagine for a moment the sentiment shock for mainstream Americans if Goldman Sachs' Lloyd Blankfein was probed for insider-trading and publicly scapegoated for causing a nation's equity market (and economy) to collapse. While it may be true, it would never happen in America... But in China, as part of what authorities call "purifying the markets," the president of China’s biggest brokerage has been swept up in a widening campaign to root out financial wrongdoing and assign blame for the nation’s $5 trillion stock rout. As Bloomberg notes, shares are falling further in today's markets as the probe of Citic Securities President Cheng Boming comes after the state-run Xinhua News Agency reported last month that four executives at Citic had admitted to so-called insider trading.

Since the market crash, China’s targets have ranged from so-called “malicious” short sellers to a journalist from business magazine Caijing whose report was alleged to have caused market panic. Authorities say they want to “purify” the market.

“There does seem to be a bit of a witch hunt for a scapegoat at the moment, but I think this is mostly signaling by the authorities that they will not tolerate what they perceive as ‘unhelpful’ selling in the market,” Tony Hann, a London-based money manager at Blackfriars Asset Management, which oversees about $350 million, said in an e-mail.

Citic confirmed the police investigation of Cheng in a statement to Shanghai’s stock exchange. A brokerage spokeswoman declined to comment further.

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To Understand The Oil Story, You Need To Understand Exports

Despite the attention-grabbing economic volatility that is dominating headlines, it's important to keep our eye on the energy story firmly in focus. This is especially true as the headlines we regularly read about Peak Oil being dead " are "manifestly false" according to this week's podcast guest, petroleum geologist Jeffrey Brown. 

As concerning as the fact that global oil production has plateaued over the past decade, despite trillions invested in trying to goose it higher, are Brown's forecasting model for oil exports. His Export Land Model shows how rising internal consumption can swing (and has swung) countries from major exporters to permanent importers within a dizzyingly short period of time:

The crucial issue to understand about what has happened after 2005 is that we’ve had a very large increase in global gas production and natural gas liquids, but a much slower increase in crude plus condensate.

So, what I think has happened is the actual crude oil production has basically flatlined while the liquids associated with natural gas production, condensate and natural gas liquids, have continued to increase. So, we ask for the price of oil, we get the price of Brent or WTI; but when you ask for the volume of oil, you get some combination of crude, condensate, natural gas liquids, biofuels. So, the fact is that substitution has worked and is working in that they’re bringing on alternative substitutes, but they're only partial substitutes. The actual, physical volume of crude oil production has probably been flat to down since 2005. Over the past ten years, it has taken us trillions of dollars, basically, to keep us on an undulating plateau in actual crude oil production. What happens going forward?

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What Happens When Central Banks Hike Rates In The "New Normal"

Ten days ago, using Bank of America data, we summarized what it means to live in the New Normal: "In the 110 months [since the last Fed hike] global central banks have cut interest rates 697 times, central banks have bought $15 trillion of financial assets, zero [or negative] interest rates policies have been adopted in the US, Europe & Japan. And, following the Great Financial Crisis of 2008, both stocks and corporate bonds have soared to all-time highs thanks in great part to this extraordinary monetary regime."

Indeed, what has happened in the past 7 years is nothing short of the greatest attempt ro reflate asset prices (if not so much the economy - that will come when the helicopters start paradropping bags of cash) the world has ever seen, driven entirely by the central banks and China. In fact, it is now so obvious even JPM finally figured it out.

However, while the desperate attempt to monetize a quarter of global GDP in tradable assets just to boost the confidence (and wealth) of the "1%" is no longer lost on anyone, the reality is that some banks did try to tighten monetary conditions and hike rates.

This is how they fared. According to the WSJ: "In the seven years since the world’s central banks responded to the financial crisis by slashing interest rates, more than a dozen banks in the advanced world have tried to raise them again. All have been forced to retreat."

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Why Are Fannie and Freddie Raising Their Foreclosure Timeline?

One of the major fallacies skillfully employed by the lending industry since the foreclosure crisis is that the meddling defense attorneys and pro se litigants were clogging the courts with their dilatory motions and challenges, unnecessarily prolonging the foreclosure process, creating neighborhood blight and costing homeowners billions in property values by preventing “market clearing.” This was presented to state lawmakers as a rationale to tighten the rules on foreclosure challenges and eliminate consumer protections, ensuring that lenders could bulldoze their way through the courts.

It never appeared to be true, however, given that plaintiff’s attorneys routinely allowed cases to rot, filed motions to delay, withdrew cases at the last minute and so on. Some of this was due to problems with documents and procedure, some of it was inscrutable, some of it maybe even based on squeezing more money from investors. But the main investor in mortgages, the GSEs, continue to play along, whether wittingly or not.

Last week, Fannie Mae and Freddie Mac, in successive days, extended their foreclosure timelines in a majority of the states where they own mortgages. The timeline is a guidance for how long a foreclosure is supposed to take, from the initial delinquency to the foreclosure sale. This includes the timeline for an uncontested foreclosure proceeding.

In theory, if servicers go beyond the timeframe they get fined a “compensatory fee,” which they pass on to the foreclosure mill law firms to get them to hurry up. But servicers can provide “reasonable explanations” to waive the fee, like bankruptcy, probate or an active trial modification. There’s also a compensatory fee moratorium for Washington D.C., Massachusetts, New York and New Jersey, which presumably is related to their more stringent foreclosure laws.

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This Is EXACTLY What The Early Phases Of A Market Meltdown Look Like

There is so much confusion out there.  On the days when the Dow goes down by several hundred points, lots of people pat me on the back and tell me that I “nailed” my call for the second half of this year.  But on the days when the Dow goes up by several hundred points, I get lots of people contacting me and telling me that they are confused because they thought the stock market was supposed to go down.  Well, the truth is that if there is going to be a full-blown market meltdown, we would expect for there to be wildly dramatic swings in the market both up and down.  A perfect example of this is what we experienced during the financial crisis of 2008.  9 of the 20 largest single day declines in stock market history happened that year, but 9 of the 20 largest single day increases in stock market history also happened that year.  If we are moving into another great financial crisis, there should be massive ups and massive downs, and that is precisely what we are witnessing right now.

On Tuesday, the Dow surged several hundred points.  There was much celebrating in the mainstream media over this, but what they failed to realize was that this was another big red flag.  And we saw this volatility carry over into Wednesday.  The Dow was up 171 points early in the day before ending down 239 points.

By themselves, those two days don’t mean a whole lot.  The key is to look at them in context.  And in context, we have already witnessed the most dramatic stock market crash since the last financial crisis.

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"August Sucks" MIT Quant Warns New Strategies "Are Creating Volatility"

"August Sucks," concludes MIT Quant guru Andrew Lo, reflecting on the systematic-trading strategy effects on markets, and it's not going to get better any time soon. As he explains to Bloomberg, "algorithmic trading is speeding up the reaction times of these participants, so that’s the choppiness of the market. Everybody can move to the left side of the boat and the right side of the boat now within minutes as opposed to hours or days." As we have noted many time, Lo explains how "crowded trades have got to the point of alpha becoming beta," warning that volatility-targeting strategies (such as Risk-Parity) are not only "exaggerating the moves," but he cautions omniously reminiscent of the August 2007 quant crash, "I think they are creating volatility of volatility."

Bloomberg interviews MIT Quant guru and Chairman of AlphaSimplex Group LLC, Andrew Lo...

Question: What does this volatility look like to you? Is this another quant meltdown?

Lo: I’m not sure I’d characterize it as just a quant meltdown. I think that makes it a little bit too cut and dried. Probably there are a number of different factors, including algorithmic trading, that plays into it. We have a number of different forces that are all coming to a head. And because of the automation of markets and the electronification of trading, we’re seeing much choppier markets than we otherwise would have five or 10 years ago. But it’s many forces operating at different time scales, all coming to a head.

Question: Is systematic trading exaggerating the moves?

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The Numbers Are In: China Dumps A Record $94 Billion In US Treasurys In One Month

Shortly after the PBoC’s move to devalue the yuan, we noted with some alarm that it looked as though China may have drawn down its reserves by more than $100 billion in the space of just two weeks. That, we went on the point out, would represent a stunning increase over the previous pace of the country’s reserve draw down, which we began documenting months ahead of the devaluation (see here, for instance). We went on to estimate, based on the projected size of the RMB carry trade unwind, how large the FX reserve liquidation might need to be to offset capital outflows and finally, late last week, we suggested that China’s official FX reserve data was set to become the new risk-on/off trigger for nervous, erratic markets. In short, the pace at which Beijing is burning through its USD assets in defense of the yuan has serious implications not only for investors’ collective perception of market stability, but for yields on core paper, for global liquidity, and for US monetary policy. 

On Monday we got the official data from China and sure enough, we find out that the PBoC liquidated around $94 billion in reserves during the month of August to $3.557 trillion (the lowest since September 2013)... 

... and as Goldman argues (see below), the "real" figure might have been closer to $115 billion. Whatever the case, it’s a staggering burn rate and needless to say, were the PBoC to continue to liquidate its assets at this pace, it would necessitate a raft of RRR cuts and hundreds of billions in short-term liquidity ops to ensure that money markets don’t seize up in the face of the liquidity drain.

Here’s some commentary from across sellside desks on the official numbers:

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The IMF Just Confirmed The Nightmare Scenario For Central Banks Is Now In Play

The most important piece of news announced today was also, as usually happens, the most underreported: it had nothing to do with US jobs, with the Fed's hiking intentions, with China, or even the ongoing "1998-style" carnage in emerging markets. Instead, it was the admission by ECB governing council member Ewald Nowotny that what we said about the ECB hitting a supply brick wall, was right. Specifically, earlier today Bloomberg quoted the Austrian central banker that the ECB asset-backed securities purchasing program "hasn’t been as successful as we’d hoped."

Why? "It’s simply because they are running out. There are simply too few of these structured products out there."

So six months later, the ECB begrudgingly admitted what we said in March 2015, in "A Complete Preview Of Q€ — And Why It Will Fail", was correct. Namely this:

... the ECB is monetizing over half of gross issuance (and more than twice net issuance) and a cool 12% of eurozone GDP. The latter figure there could easily rise if GDP contracts and Q€ is expanded, a scenario which should certainly not be ruled out given Europe’s fragile economic situation and expectations for the ECB to remain accommodative for the foreseeable future. In fact, the market is already talking about the likelihood that the program will be expanded/extended.

... while we hate to beat a dead horse, the sheer lunacy of a bond buying program that is only constrained by the fact that there simply aren’t enough bonds to buy, cannot possibly be overstated.

Among the program’s many inherent absurdities are the glaring disparity between the size of the program and the amount of net euro fixed income issuance and the more nuanced fact that the effects of previous ECB easing efforts virtually ensure that Q€ cannot succeed. 

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Russia Is Going To Pass A Law Formally Dumping The U.S. Dollar

Russian President Vladimir Putin has introduced legislation that would deal a tremendous blow to the U.S. dollar.  If Putin gets his way, and he almost certainly will, the U.S. dollar will be eliminated from trade between nations that belong to the Commonwealth of Independent States.  In addition to Russia, that list of countries includes Armenia, Azerbaijan, Belarus, Kazakhstan, Kyrgyzstan, Moldova, Tajikistan and Uzbekistan.  Obviously this would not mean “the death of the dollar”, but it would be a very significant step toward the end of the era of the absolute dominance of the U.S. dollar.  Most people don’t realize this, but more U.S. dollars are actually used outside of the United States than are used inside this country.  If the rest of the planet decides to stop accumulating dollars, using them to trade with one another, and loaning them back to us at ultra-low interest rates, we are going to be in for a world of hurt.  Unfortunately for us, it is only a matter of time until that happens.
When I first read the following excerpt from a recent RT article, I was absolutely stunned…

Russian President Vladimir Putin has drafted a bill that aims to eliminate the US dollar and the euro from trade between CIS countries. 

This means the creation of a single financial market between Russia, Armenia, Belarus, Kazakhstan, Kyrgyzstan, Tajikistan and other countries of the former Soviet Union. 

“This would help expand the use of national currencies in foreign trade payments and financial services and thus create preconditions for greater liquidity of domestic currency markets”, said a statement from Kremlin.

For a long time, tensions have been building between the United States and Russia over Syria, Ukraine, the price of oil and a whole host of other issues.  But I didn’t anticipate that things would get to this level quite yet.  It is expected that Putin’s new bill will become law, and this is only one element of a much larger trend that is now developing.

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Heresy! China Won't Stick To IMF, World Bank Lending "Religion" With AIIB

Back in April, China was flying high. The stock market had reached dizzying heights on the back of an unprecedented surge in margin debt, creating billions in paper profits for millions of farmers and housewives turned day traders. Around the same time, Beijing had accidentally pulled off a major diplomatic coup. The China-led Asian Infrastructure Investment bank had just wrapped up a wildly successful membership drive after a surprise decision by the UK to back the new venture opened the floodgates and emboldened other US allies who, despite Washington’s best efforts to convince them otherwise, decided to join up.

The effort to recruit members was in fact so successful, that Beijing went out of its way to dispel the notion that the new bank represented an attempt on China’s part to usher in a new era of yuan hegemony and rewrite the rules of the post-War global economic order. 

Despite the Politburo’s best efforts to toe the line between acknowledging the bank’s early success and unnerving Western members who, although happy to participate, are still acutely aware that a dying hegemon is still a hegemon and therefore would prefer it if Beijing didn’t rub the whole thing in Washington’s face, it was abundantly clear to everyone involved that the AIIB represented no less than a changing of the guard and a revolution against the US-dominated multilateral institutions that many emerging countries believe have failed to respond to seismic shifts in the global economy. 

Unfortunately for China, the AIIB was forced to take a back seat in terms of media coverage to the country’s dramatic equity market meltdown and, subsequently, to the devaluation of the yuan which, you’re reminded, will play an outsized role in any financing extended by the new lender. But as the carnage in financial markets grabs the headlines, the AIIB is quietly making preparations to officially commence operations and as Reuters notes, China is set to “rewrite the unwritten rules of global development finance” by doing away with certain conditionalities required by Western multilateral lenders. Here’s Reuters with the story:

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The "Great Accumulation" Is Over: The Biggest Risk Facing The World's Central Banks Has Arrived

To be sure, there’s been no shortage of media coverage regarding the collapse in crude prices that’s unfolded over the course of the past year. Similarly, it’s no secret that commodity prices in general are sitting near their lowest levels of the 21st century. 

When Saudi Arabia, in an effort to bankrupt the US shale space and tighten the screws on a recalcitrant Moscow, endeavored late last year to keep oil prices suppressed, the kingdom killed the petrodollar, a move we argued would put pressure on USD assets and suck hundreds of billions in liquidity from global markets. 

Thanks to the fanfare surrounding China’s stepped up UST liquidation in support of the yuan, the world is beginning to understand what we meant. The accumulation of USD assets held as FX reserves across the emerging world served as a source of liquidity and kept a bid under things like US Treasurys. Now that commodity prices have fallen off a cliff thanks to lackluster global demand and trade, the accumulation of those assets slowed, and as a looming Fed hike along with fears about the stability of commodity currencies conspired to put pressure on EM FX, the great EM reserve accumulation reversed itself. This is the environment into which China is now dumping its own reserves and indeed, the PBoC’s rapid liquidation of USTs over the past two weeks has added fuel to the fire and effectively boxed the Fed in.

On Tuesday, Deutsche Bank is out extending their "quantitative tightening" (QT) analysis with a look at what’s ahead now that the so-called "Great Accumulation" is over. 

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