China's Bond Market Faces Turmoil Amid Maturity Deluge

While the US bond market has had its share of harrowing slumps and vomit-inducing short squeezes in the past year as consensus shifted from one of "the neutral rate is far away" to "here comes NIRP", China's bonds have been a bastion of stability, trading in a tight range between 3% and 3.50% for the past year.

hat may be about to change.

The reason: a wall of bond maturities is about to flood across China’s sovereign-bond market, which in the past three months has already been reeling from a global sell-off and rising inflation.

According to Bloomberg, more than 2 trillion yuan ($283 billion) of local-government notes will mature in 2020, a record and 58% more than this year’s level. This means fresh debt to refinance upcoming maturities will start hitting the market soon, with a the southern province of Guangdong expected to sell notes as early as November.

This is happening as China's 10-year yield rose 3 basis points to 3.31%. the highest since late May, while the cost on 12-month interest rate swaps jumped 5 basis points to 2.92%. The yield on China Development Bank’s 3-year bonds due January 2022 rose 10 basis points to 3.25%.

Despite trading in a narrow range, China’s government bonds have been sliding for nearly two months, starting around the time a "growth shock" hit US rates and sparked the infamous quantastrophe, with the 10-year yield hitting the highest since May as selling momentum accelerated. Naturally, a flood of new supply will only exacerbate the weakness, especially as real, inflation-adjusted yields are barely above zero, a rarity for emerging markets.
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U.S. Shale Braces For Brutal Earnings Season

The timing comes as the shale sector is facing somewhat of a reckoning. After years of price volatility – with more downs than ups – oil prices have failed to return even remotely close to pre-2014 levels. For several years, shale E&Ps took on debt and issued new equity, promising investors that they would profit both from a rebound in prices and from rapid production growth.

They delivered on gains to output, but not on profits. At some point in the last year, investors really began to lose faith. Oil stocks have been the worst performers in the S&P 500 this year.

The latest release of earnings will probably do little to quell unease from big investors. Oil and natural gas prices have dropped this year, by about 17 percent and 31 percent, respectively. Job cuts have returned and bankruptcies are on the rise again.

The oil majors are pressing forward with their aggressive shale development plans. That may prevent a noticeable decline in production. But their earnings – many of the majors report this week – are expected to be down roughly 40 percent from a year ago, which will raise some tough questions.

Some of the largest banks have slashed their credit lines to smaller shale E&Ps. According to Reuters, JPMorgan Chase, Wells Fargo and the Royal Bank of Canada are among some of the lenders that have reduced the amount of credit they are offering to drillers.

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Texas Could Be The Epicenter Of The Next Subprime Auto Crisis

In a recent report, we outlined how the largest subprime auto lender, Santander, is currently experiencing one of the most significant accelerations in subprime auto loan delinquencies, not seen since the dark days of 2008. Now, in a separate report via the Federal Reserve Bank of Dallas, there is new evidence that the epicenter of the next auto loan meltdown could start in Texas.  

The Texas auto subprime market began experiencing a troughing event in serious auto delinquencies in 2015, with a rapid turn up in 2016. By the end of 2018, the serious auto delinquency rate was at 16.7%, approaching 2010 levels of 18.2%. Despite the "greatest economy ever," the Dallas Fed admits rising wealth inequality could be responsible for the growing delinquencies in Texas. 

"It's clear something is going on," said Emily Ryder Perlmeter, an adviser for the Dallas Fed and one of the report's authors. "The economy may not be working as well for everyone."

Michael Carroll, an economist at the University of North Texas, suggests the report is a clear indication that consumers in easy money times took on too much auto debt. Carroll also said consumer distress in Texas could be a bellwether for the broader economy and a warning sign that the consumer is weakening. 

Perlmeter said rising auto loan delinquencies across the country is a severe problem, but the meltdown unfolding in Texas is much worse than any other major metropolitan area. 

The Dallas Morning News noted the average auto loan in the state is $23,500 as of late 2018. 

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Innovation BIS 2025: A Stepping Stone Towards An Economic "New World Order"

The IMF’s annual meetings held in Washington DC last week demonstrated that when the institution issues new economic projections or warnings of a downturn, the mainstream press are not averse to giving them prominent coverage. After the Fund was founded in 1944 (off the back of World War Two), it became part of what internationalists call the ‘rules based global order‘. For 75 years, the IMF has been regarded by the political establishment and banking elites as a lynch pin of the world financial system.

Contrary to what some may believe, the IMF was not the first global monetary institution.

That accolade belongs to the Swiss based Bank for International Settlements, which predates the IMF by fourteen years. Its creation in 1930 was, according to the BIS, primarily to settle reparation payments ‘imposed on Germany following the First World War‘. Without WWI – a major crisis event – there would have been no mandate for the BIS to exist. Much as there would have been no mandate for the IMF to exist were it not for the spectre of WWII.

As well as settling German reparation payments, the BIS was also recognised from the outset as a forum for central bankers – the first of its kind – where they could speak candidly and direct the course of global monetary policy.

The board of directors at the BIS is taken up predominantly by the heads of the leading central banks in the world. Right now the governor of the German Bundesbank Jens Weidmann is chairman of the board. As public servants they gather in Basel every eight weeks or so for a series of bimonthly meetings, the discussions from which ordinary citizens are not privy to.

In 2013 author Adam Labor published a book called ‘The Tower of Basel‘ which analysed certain key figureheads behind the early years of the BIS. What Labor detailed is how many of them were integral members of the Nazi regime.



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Don't Blame The Global Slowdown On Trump's Trade War

Ever since last year, nothing has grabbed economists' attention as much as the whipsawing evolution of the US-China trade war. Just last week, the IMF downgraded its global growth forecast for 2020, citing trade and geopolitical tensions.

But economic forecasters are misunderstanding the primary cause of the current global slowdown, which means that they'll also miss what's coming next.

In hindsight, it's clear that actual global industrial production growth started slowing at the end of 2017. In other words, the year-over-year pace of increase in the world's total industrial output began a sustained decline in late 2017. That's the definition of a global industrial slowdown.

Most analysts focus on the global purchasing managers' index (PMI) data for their read on global growth because it's published each month about a month and a half before the actual production data. While the global PMI generally has a positive correlation with global industrial production growth, it doesn't measure actual industrial production, as it's based on a survey of purchasing executives about conditions facing their companies. It's really a proxy for industrial production growth, which measures real output for all companies within the manufacturing, mining and utilities industries.

In this case, while the global manufacturing PMI also started easing at the end of 2017, its decline didn't become evident until a few months into 2018, when the sustained nature of the downturn became increasingly difficult to dismiss as meaningless "noise." Coincidentally, that's just about when President Trump began his trade war, slapping tariffs on washing machines and steel and aluminum imports. Because the trade war was front and center, economists thought it was to blame for the drop in PMI and global industrial growth.

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China's Growth Much Worse Than Reported, What About The US?

China doubles value of infrastructure project approvals to stave off economic slowdown amid trade war.

The South China Morning Post reports China Doubles Value of Infrastructure Project Approvals to Stave Off Slowdown.

The National Development and Reform Commission (NDRC) has approved 21 projects, worth at least 764.3 billion yuan (US$107.8 billion), according to South China Morning Post calculations based on the state planner’s approval statements released between January and October this year.

The amount is more than double the size of last year’s 374.3 billion yuan (US$52.8 billion) in approvals recorded over the same period, which included 11 projects such as railways, roads and airports.

Local governments have been under increasing pressure from Beijing to support the economy, but they have less budget room due to lower tax revenues after the central government over the past year ordered individual and business tax cuts.

To fill the gap, Beijing has allowing local governments to sell more special purpose bonds, whose proceeds can only be used to fund infrastructure projects. At the beginning of this year, the Ministry of Finance raised the quota for special bonds to 2.15 trillion (US$302 billion) from 1.35 trillion (US$190 billion) last year. And when local governments came close to exhausting their annual quota set this autumn, the central government brought forward a portion of their 2020 quota so they could continue to raise funding for new projects.

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China Just Injected The Most Liquidity Since January... And It's Not Enough

Just days after China's GDP unexpectedly dropped to a sub-consensus 6.0%, the lowest in three decades (with Beijing now set to reveal a 5-handle GDP in the coming months), China watchers were convinced that this week would start with Beijing again lowering its "Libor rate", i.e., the previously discussed Loan Prime Rate, especially with the Fed expected to cut rates once again next week. However, that did not happen as China kept its one-year prime rate for new corporate loans unchanged in October, at 4.2%, and above the 4.15% consensus estimate. The five-year benchmark was also kept unchanged at 4.85%.

As we reported previously, the Loan Prime Rate, also called China's "Libor", is a revamped market indicator of the price that lenders charge clients for new loans, and is linked to the rate at which the central bank will lend financial institutions cash for a year. The rate, which is updated once a month, is made up of submissions from a panel of 18 banks, although ultimately it is Beijing that sets the final rate.

Analysts were quick to step in and "explain" away the unexpected move: Commerzbank's Zhou Hao said that a static one-year rate shows China “may be trying to balance the shrinking margins of banks with support to the real economy,” adding that "the PBOC remains restrained on policy easing.”

The market, however, was less sanguine, as the PBOC's lack of easing was promptly taken as an ill-omen: China's government bonds dropped while money-market rates climbed, amid bets that the policy makers are not in a rush to loosen monetary policy (why? perhaps China's gargantuan debt load and rapidly devaluing currency have something to do with it). On Monday, the yield on 10-year sovereign notes rose three basis points to 3.22%, the highest since July 1, while the costs on 12-month interest-rate swaps advanced to the highest level since late May.

While the Chinese economy has been under pressure amid a prolonged trade dispute with the US, many have expected that the central bank would match the Fed's easing and lower corporate borrowing costs and further cut bank reserve ratios. However, so far the PBOC hasn’t embarked on an aggressive stimulus program as some market watchers had hoped.

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"We're Being Robbed" - Central Bank 'Stimulus' Is Really A Huge Redistribution Scheme

When an economy turns from expansion to contraction there is an order of events. The first signs are an unexpected increase in inventories of unsold goods, both accompanied with and followed by business surveys indicating a general softening in demand. For monetarists, this is often confirmed by an inverting yield curve, which tells them that at the margin the short-term rates set by the central bank are becoming too high for business conditions.

That was the position for the US 10-year bond less the 2-year bond very briefly at the end of August, since when this measure, which is often taken to predict recessions, has turned mildly positive again. A generally negative sentiment, fueled mainly by the escalating tariff war between America and China, had earlier alerted investors to an international trade slowdown, expected to undermine the American economy in due course along with all the others. It stands to reason that backward-looking statistics have yet to reflect the global slowdown on the US economy, which is still buoyed up by consumer credit. The German economy, which is driven by production rather than consumption is perhaps a better guide and is already in recession.

After an initial hit, a small recovery in investor sentiment is understandable, with the negative outlook perhaps having got ahead of itself. But we must look beyond that. History shows the combination of a peak in the credit cycle and tariffs can be economically lethal. A brief return to a positive yield curve achieves little more than a sucker rally. It may be enough to put further monetary expansion on pause. But when that is over, and jobs begin to be threatened, there can be no doubt that central banks will ramp up the printing presses.

So reliant have markets become on monetary expansion that the default assumption is that an economy will always be rescued from recession by an easing of monetary policy, and furthermore that monetary inflation will prevent it from being any more than mild and short. We see this in the performance of stock market indices, which reflect perpetual optimism.

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Here Is The Real Reason The Fed Restarted QE

In the past month, a feud has erupted in the financial media and across capital markets between defenders of the Fed, who praise the return of its unprecedented easing in the form of $60BN in monthly T-Bill purchases, by refusing to call it by its real name, and instead the Fed's fanclub calls it "not QE" (just so it doesn't appear that ten years after the Fed first launched QE, we are back to square one), and those who happen to be intellectually honest, and call the largest permanent expansion in the Fed's balance sheet, meant to ease financial conditions and boost liquidity across the financial sector, for what it is: QE.

It is this same "not QE" that has boosted the Fed's balance sheet by $200BN in one month, the fastest rate of increase since the financial crisis.

Yet while the Fed's desire to purchase Bills instead of coupon Treasuries was dictated by its superficial desire to distinguish the current "Not QE" from previous "True QEs", even though both tends to inject the same amount of liquidity into the system, which as a reminder is what the Fed's bailout role in the past 11 years has all been about, and only true Fed sycophants are unable to call a spade a spade, the Fed's choice raises a rather thorny question of where the Fed will source those T-bills, because as JPMorgan calculates, the net supply of Bills in 4Q19 and 1Q20 is around $115-$130bn while JPM's economists estimate that at least $200-$250bn of purchases could be required to return reserves to around $1.5tr where they were in early September this year.

That means the Fed might need to source purchases from money-market funds and foreign central banks - which paradoxically would serve to further drain liquidity out of the system. As such, given the limited alternatives, JPM's Nikolas Panagirtzoglou believes that the Fed may be reluctant to do so and if they do, some may chose to leave cash in the Fed’s ON RRP facility which would represent a drain on reserves and make T-bills a less efficient vehicle for reserve creation.

Another key question: what if just returning to the previous reserve baseline is not sufficient, and the Fed needs to return reserves to a higher level than $1.5tr? Indeed, with close to $200bn of reserves injected via overnight and term repos for much of this week...

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HSBC Considers Slashing Equity Desks In London, New York, Germany

A mass exodus could be developing among major financial institutions, who seek to divest their equity sales and trading units.

Deutsche Bank and Nomura have already made it clear that they're reviewing their trading cash equities units because of profitability concerns.

Now HSBC might follow suit, sources told Bloomberg, adding that the bank could exit stock trading in Western markets as part of a significant overhaul program.

HSBC could slash trading units in the U.S., U.K., Germany, and France, in the near term, the source said. The bank's Asian equities operations wouldn't be affected by the overhaul.

HSBC will concentrate on the Greater China region, rather than Western markets in the 2020s, another source explained.

HSBC Chairman Mark Tucker has spent the last several years restructuring the bank. He appointed Noel Quinn, the interim chief executive, in August, as a push to continue strengthening the bank through new, innovative cost-cutting measures.

The strategy by HSBC could cut at least 45 traders in New York.

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High-Income Millennials Say They'll "Need To Work Forever" Due To Lack Of Savings

The economy isn't even in a full-blown recession yet, but nearing one, and high-income millennials are already saying they'll need to work "forever" because they don't have enough savings, stated a new study via Spectrem Group, a wealth advisory company, first reported by Bloomberg. It certainly seems that after the financial crash of 2008/09, the economic environment for millennials ages 30 to 34 changed for the worst. 

High-income millennials as a whole are maxed out on credit cards, student loans, auto loans, and if they're fortunate enough, have insurmountable mortgage debts. Their debt servicing payments have left many of them without savings, but it depends on which millennials you ask. 

The study says 50% of high-income millennials ages 30 to 34 feel that they will work forever because their savings are depleted.

Meanwhile, younger millennials, 29 or less, ones who graduated college after the financial crash, so the economy was already in an upswing, are more optimistic in retiring. Only 25% of them say they will need to work forever because of savings issues. 

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Shanghai Housing Sales Plunge 86% In Golden Week

Golden Week, a seven-day Chinese holiday, is traditionally a peak period for home sales.

This year, sales plummeted.

The South China Post reports ‘Golden Week’ Property Sales Plunge in Major Chinese Cities.

Property sales in China’s major cities saw one of their worst “golden week” holidays in years, as buyers held back amid a slowing economy and tight restrictions on mortgage loans.

Sales of new homes in Beijing dropped to their lowest level since 2014 during the week following the National Day holiday, according to data from the property information portal Zhuge.com.

By area, sales of new homes in Shanghai plummeted 86 per cent to 5,000 square metres, while the capital saw a 92 per cent plunge to 2,000 sq metre, according to data from Centaline Property.

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The Biggest Problem For The Aramco IPO

From almost the very moment in 2016 when Saudi Arabia first announced that it was to float its state-owned oil and gas behemoth, Saudi Aramco, in a dual domestic and international listing, the pool of possibilities for the foreign side of the initial public offering (IPO) has steadily reduced. This has been a result of a simple equation: the more that would-be investors know about Saudi Arabia and Aramco the less appealing the prospect of having anything to do with them becomes. However, because Crown Prince Mohammed bin Salman (Mbs) has staked his personal reputation – and his political future – on the Aramco IPO going ahead in some form, he and his bankers are currently rooting around for at least one international bourse upon which to execute the foreign listing part of the omni-toxic Aramco.

The New York Stock Exchange (NYSE) was one of the original top-two favored candidates, alongside the London Stock Exchange (LSE), as these two bourses are rightly seen as the most liquid, most traded, and most prestigious stock exchanges in the world. Early on, though, a number of major problems began to bubble up for a listing of any Saudi company and particularly Aramco in the U.S. Aside from the usual farrago of lies from Saudi about oil reserves, spare capacity, tax rates, concessions, non-hydrocarbons activities and so on with which investors have now become familiar, a key early sticking point was Saudi Arabia’s perceived links with the ‘9/11’ terrorist attacks.

Of the 19 terrorists who hijacked planes on ‘9/11’, no less than 15 were Saudi nationals. Following the overriding by the U.S. Congress of former President Barack Obama’s veto of the ‘Justice Against Sponsors of Terrorism Act’, making it possible for victims’ families to sue the government of Saudi Arabia, at least seven major lawsuits alleging Saudi government support and funding for the ‘9/11’ terrorist attack have so far landed in federal courts. As one New York-based chief executive officer of a major commodities hedge fund told OilPrice.com:

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Central Bank Issues Stunning Warning: "If The Entire System Collapses, Gold Will Be Needed To Start Over"

It's not just "tinfoil blogs" who (for the past 11 years) have been warning that a monetary reset is inevitable and the only viable fallback option once trust and faith in fiat is lost, is a gold standard (something which even Mark Carney hinted at recently): central banks are joining the doom parade now too.

An article published by the De Nederlandsche Bank (DNB), or Dutch Central Bank, has shocked many with its claim that "if the system collapses, the gold stock can serve as a basis to build it up again. Gold bolsters confidence in the stability of the central bank's balance sheet and creates a sense of security."

While gloomy predictions of a monetary reset are hardly new, they have traditionally been relegated to the fringe of mainstream financial thought - after all, as Mario Draghi stated on several occasions in recent years, the mere contemplation of a "doomsday scenario" is enough to create the self-fulfilling prophecy which materializes it. As such, it is stunning to see a mainstream financial institution open up about the superior value of limited supply, non-fiat, sound money assets. It is also hypocritical given the diametrically opposed Keynesian practices regularly engaged in by central banks and official institutions worldwide: after all, just a few months back, the IMF published a paper bashing Germany's adoption of the gold standard in the 1870s as the catalyst for instability in the global monetary system.

Fast forward to today, when the Dutch Central Bank is admitting not only did gold not destabilize the monetary system, but it will be its only savior when everything crashes.

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After Unveiling 'NotQE', Fed Eases Liquidity Rules For Foreign Banks (Rescues Deutsche)

Having cracked down on Deutsche Bank in the past, The Fed appears to be playing good-regulator/bad-regulator as The FT reports that Deutsche is expected to benefit most from an imminent change in The Fed's liquidity rules.

Specifically, US banking regulators have dropped an idea to subject local branches of foreign banks to tough new liquidity rules (forcing US branches of foreign banks to hold a minimum level of liquid assets to protect them from a cash crunch).

As The FT further details, people familiar with his thinking say Randal Quarles, the vice-chair for banking supervision at the Fed, accepts the banks’ argument that any liquidity rules on bank branches should only be imposed in conjunction with foreign regulators.

“Without some international agreement, we could have the situation where each country is trying to grab whatever isn’t nailed down if there is another scare.”

And Deutsche Bank benefits most (or rescued from major liquidity needs) since it has by far the largest assets in US branches...

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Debt Market Suffering "Quiet Meltdown" As Billions In Loans Are Suddenly Crashing

The exponential growth in the leveraged loan market, in the last several years, created an enormous excess accumulation of sub-investment grade loans that are a ticking time bomb when the next recession strikes.

Late last year, leveraged loan markets froze, for at least a month, as Treasury yields dropped, due to the increasing threat of a global recession. An abundance of fake trade news and central bank easing throughout 2019 saved Wall Street and reopened the leveraged loan market earlier in the year, but it seems that cracks are starting to develop again with recession threats building for 2020. 

Bloomberg reports that 50 companies that have at least $40 billion of loans have lost about ten percentage points of face value in the last three months. 

An exodus of investors has been seen in the leveraged loan market late-summer into early fall as liquidity dries up. It's mostly due to Treasury yields sinking, and end of cycle fears increasing, as a recession could emerge next year.

Some of the hardest-hit companies in the loan space in the last three months have been Amneal Pharmaceuticals, whose $2.7 billion loan due 2025 plunged about 80 cents on the dollar, and Seadrill Operating whose $2.6 billion loan maturing in 2021 only commands 53 cents on the dollar, said Bloomberg.

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The Surge In "Surprise" Medical Bills Bankrupting Americans Can Be Blamed On Private Equity

Surging "surprise" medical bills in the U.S. are private equity's fault, a new FT opinion piece claims. 

These "surprise" medical bills continue to be a major talking point in the U.S. and are likely to be a key issue during the upcoming 2020 Presidential race. The term refers to invoices that are generated after a patient is admitted to the hospital and treated, without their knowledge, by someone not in their insurance plan. 

And a recent Stanford study shows that these "surprise" bills continue to become more ubiquitous. They are up from about 33% of visits in 2010 to almost 43% in 2016. For inpatient stays, the number is even more alarming: the jump goes from 26% to 42%, with the average cost per patient rising from $804 to $2,040. It's an issue that only adds to the overwhelming debt bubble we have again created in the U.S. 

The opinion piece notes that these rising costs come not from hospitals, but rather from the "backwaters of the financial markets":

The prices of junk bonds issued by “physician services companies” have been sliding in the past month as their owners weigh the possibility and costs of political intervention. These point to the real source of the problem: private equity’s silent colonisation of parts of the healthcare profession.

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"Paper Money Systems Have Always Wound-Up With Collapse And Chaos", Buffett Senior

Warren himself acquired a record-setting 128 million ounces of silver back in the late 1990s… which he later sold at a profit in the early 2000s.

But to listen to him talk about precious metals these days, he’s always negative.

Buffett often quips that if you took the world’s entire supply of gold and melted it together, it would form a cube of about 68 feet (~21 meters) per side and be worth around $9 trillion.

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With that same $9 trillion, you could buy every share of Apple, Disney, Google, Microsoft, JP Morgan, Exxon Mobil, all the farmland in the United States, all the developable land in Manhattan, and still have more than a trillion dollars left over.

This is Buffett’s central argument: gold doesn’t produce anything. So it’s much better to invest in a productive asset like a business, farmland, etc.

Sure, I’d rather own a profitable, productive asset than a pile of metal.

But Buffett is completely wrong to compare gold to productive assets… they’re apples and oranges.

Gold isn’t an ‘investment’. It’s an insurance policy against paper currencies will lose value over time. So a MUCH better comparison for gold is CASH.

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The Repo Market Incident May Be The Tip Of The Iceberg

The Federal Reserve has injected $278 billion into the securities repurchase market for the first time. Numerous justifications have been provided to explain why this has happened and, more importantly, why it lasted for various days. The first explanation was quite simplistic: an unexpected tax payment. This made no sense. If there is ample liquidity and investors are happy to take financing positions at negative rates all over the world, the abrupt rise in repo rates would simply vanish in a few hours.

Let us start with definitions. The repo market is where borrowers seeking cash offer lenders collateral in the form of safe securities.  Repo rates are the interest rate paid to borrow cash in exchange for Treasuries for 24 hours.

Sudden bursts in the repo lending market are not unusual. What is unusual is that it takes days to normalize and even more unusual to see that the Federal Reserve needs to inject hundreds of billions in a few days to offset the unstoppable rise in short-term rates.

Because liquidity is ample, thirst for yield is enormous and financial players are financially more solvent than years ago, right? Wrong.

What the Repo Market Crisis shows us is that liquidity is substantially lower than what the Federal Reserve believes, that fear of contagion and rising risk are evident in the weakest link of the financial repression machine (the overnight market) and, more importantly, that liquidity providers probably have significantly more leverage than many expected.

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Will The Drive To Devalue The Dollar Lead To A Plaza Accord 2.0?

The Lead-Up to the Plaza Accord

To understand the Plaza Accord, one has to look back to August 15, 1971. On this day Richard Nixon closed the gold window. This step de facto ended the Bretton Woods system, which had been created in 1944 in the New Hampshire town of the same name and was formally terminated in 1973. The era of gold-backed currency was well and truly over; the era of flexible exchange rates had begun. Without a gold anchor, the exchange rate of every currency pair was supposed to be driven exclusively by supply and demand. National central banks — and indirectly governments as well — were at liberty to make their own decisions, free of the tight restrictions imposed by a gold standard, but they had to bear the costs of their decisions in the form of the devaluation or appreciation of their currencies. While a gold-backed currency aims to impose discipline on nations, a system of flexible exchange rates enables national idiosyncrasies to be preserved, with the exchange rate serving as a balancing mechanism.

However, unlike any other currency system, the system of free-floating currencies invites governments and central banks to manipulate exchange rates practically at will. Without reciprocal agreements, which can provide planning security to export-oriented companies in particular, the danger of international chaos is very high, as the system of flexible exchange rates lacks an external anchor.

In order to prevent this chaos, a repetition of the traumatic devaluation spiral of the 1930s, and the resulting disintegration of the global economy, IMF member nations agreed in 1976 at a meeting in Kingston, Jamaica, that “the exchange rate should be economically justified. Countries should avoid manipulating exchange rates in order to avoid the need to regulate the balance of payments or gain an unfair competitive advantage." And in this multilateral spirit — albeit under an US initiative that was strongly tinged by self-interest — an agreement was struck nine years later that has entered the economic history books as the Plaza Accord.

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We Finally Understand How Destructive Negative Interest Rates Actually Are

We are in the midst of a strange economic experiment. Vast quantities of negative-yielding debt are currently sloshing around the global economy. While the amount of negative-yielding bonds has dropped recently from a mind-boggling number in excess of $17 trillion, reinvigorated central bank easing across the globe ensures that this reduction is only temporary.

We are slowly starting to understand how destructive negative interest rates actually are. Central banks control short-term interest rates in an economy by setting the rate banks receive on their deposits, that is, on the reserves they hold at the central bank. A new development is the control central banks now exert over long-term rates through their asset purchase, or “QE” programs.

Banks profit from the interest rate differential between “lending long” but “borrowing short”. Essentially, the difference between lending and deposit rates determine a bank’s profitability. However, with today’s very low interest rates, this difference becomes almost non-existent, and with negative rates, inverts completely.

When a central bank pushes rates to negative, banks need to pay interest on the reserves they hold there. But they are not relieved of the obligation they have to pay interest on customer deposits, who are understandably reluctant to pay interest on money they place at a bank. Consequently, the whole earnings logic of banking goes haywire if banks are required to pay interest on loans and receive interest on deposits. As profit margins of banks are squeezed, profitability falls and lending activities suffer.

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Japan Hikes National Sales Tax Despite Recession Fears

Japan has increased its national sales tax to 10% from 8% on Tuesday, a significant policy change that could tilt the world's third-largest economy into recession by depressing consumer sentiment, reported Market Watch.

The last two times policymakers increased the sales tax, 2-point rise to 5% in 1997 and another to 8% in 2014, an economic contraction shortly followed.

Prime Minister Shinzo Abe twice delayed the tax hike in recent years.

Abe has indicated the tax is now unavoidable given the demographic challenges in the aging country. He said the tax would help pay down the enormous national debt, and position the country towards more financial responsibility in balancing the budget by 2025. But taxing the consumer as the economy is deteriorating could be a recipe for economic disaster in 2020.

Japan's GDP expanded at an annual pace of 1.8% over the summer. The economy is quickly slowing into fall, thanks to the trade war between the US and China. Global trade volumes are plummeting through 2H19, has taken a toll on Japan's exports. The tax will likely sideline the consumer in 2020, force them into a savings pattern that could tilt the economy into a recession next year, similar to the tax increase in 2014.

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"It’s Almost Impossible To Buy": Japanese Bond Crash, Margin Call Send Shockwaves Around The Globe

For a dramatic preview of what will happen in a flash to all those record low interest rates without the backstop of central banks and ravenous pension fund, look no further than what happened in Japan overnight, where bond futures suffered the biggest one-day crash since August 2, 2016, sliding as much as 0.97 yen to 154.05, and triggering margin calls for investors after the worst 10-year debt auction in three years.

More ominously, once the rout started it quickly spread outside of Japan, because as yields jumped, the sell-off spilled into US Treasuries and European debt.

There were three things behind the swift collapse: the first catalyst was the Bank of Japan’s Monday decision to slash bond purchases in October for the four major maturity buckets in order to steepen the curve and avoid further flattening which Kuroda has repeatedly expressed concern about in the past; the BOJ had indicated it may even stop buying debt of more than 25 years. It also sought to anchor yields from the one-to-three year zone by raising purchases in a regular operation earlier in the day and lifting the purchase band for the sector in October.

"The BOJ is showing its clear intention to correct distortions in the curve through flexible adjustments in market operations,” said Mari Iwashita, chief market economist at Daiwa. "While cutting the lower end of purchases in bonds maturing over 25 years to zero looks shocking, the BOJ will probably cut buying in this zone slowly."

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