Doug Noland: Catastrophic Failures

Smart Bird: How many times do we need to be “close to catastrophic failure” before we ask what is underlying these failures – governance and oversight?

California Power Grid, Texas Power Grid, Total Stock Market Clearing House System with little Gamestock, the 2008 then the 2020 financial crisis caused then saved by the Federal Reserve, Democracy.

Doug does not provide his opinion on this, but I will. We have reached the point where either the financial system will fail or our money system. The financial system’s front end is the stock and bond markets. It is that which is hidden in the back end of the system in the derivates, the leverage and black pools of money that will implode the financial system. This is why wall street and the global financial system was bailed out in 2008 through 2013, this is why wall street and the global dollar system was bailed out in 2020. The distorted, corrupt financial system was too close to catastrophic failure.

The failures of crony capitalism, financialization and self-regulation do not appear until close to or during catastrophic failure. Then the real propaganda begins.

Wrecking Ball

by Doug Noland

I give it my best shot each week. My hope is to provide pertinent insight, though the overarching objective is to scrupulously chronicle this extraordinary period in history. Like other great Bubbles and manias, looking back at this era will leave most confounded. This week, in particular, I pondered how contemporaneous analysis might decades from now assist readers in comprehending today’s extraordinary dynamics. It was yet another alarmingly fascinating seven days.

February 18 – MarketWatch (Mark DeCambre): “That’s Thomas Peterffy, founder and chairman of Interactive Brokers Group Inc., detailing… the dire situation in which the market stood in late January as individual investors on social-media platforms banded together to send a handful of heavily shorted stocks, including bricks-and-mortar videogame retailer GameStop…, with shockwaves registering throughout the market. As Peterffy explained…, the so-called short squeeze that played out was rocking clearinghouses and forcing a number of brokerages to attempt to protect themselves by raising margin requirements and capping trading in select stocks to prevent wider-reaching chaos in markets… ‘So as the price goes higher, the shorts default on the brokers, the brokers now must cover themselves, [and] that puts the price further up, so the brokers default on the clearinghouse, and you end up with a complete mess that is practically impossible to sort out… So that’s what almost happened.’”

From CNBC: “‘We have come dangerously close to the collapse of the entire system and the public seems to be completely unaware of that, including Congress and the regulators,’ Peterffy said…”

Listening Thursday to the House Financial Services Committee’s “GameStop” hearing, it was clear Washington has little appreciation for the seriousness of structural deficiencies revealed by recent market mayhem. The focus was more on blasting predatory Wall Street and the hedge funds, while looking into the cameras to defend the defenseless small investor. The broader point of a historic mania and potentially catastrophic infrastructure shortcomings was completely neglected. Millions of unusually synchronized buy orders almost led to a cascading market accident. It seems rather obvious at this point that existing market infrastructure will buckle under tens of millions of synchronized sell orders.

On the subject of buckling infrastructure, the Texas power grid.

February 19 – Independent (Louis Hall): “The power grid in Texas was ‘seconds and minutes’ away from a catastrophic failure that could have led to months of blackouts, officials with the corporation that operates the grid have said. Officials with the Electric Reliability Council of Texas told The Texas Tribune… that the state was dangerously close to the worst-case scenario, forcing grid operators to order transmission companies to quickly reduce power. According to the report, operators had to make the quick decision to employ what was intended to be rolling blackouts amid signs that massive amounts of energy supply were dropping off the grid. ‘It needed to be addressed immediately,’ said Bill Magness, president of ERCOT, told the newspaper. ‘It was seconds and minutes [from possible failure] given the amount of generation that was coming off the system.’”

As a nation, we were woefully unprepared for the pandemic. The drought and summer fires exposed serious deficiencies in California’s power grid. Now a deep freeze sees the second largest state suffer a catastrophic power failure – that was apparently close to a complete breakdown that would have required months to repair.

Millions of Americans (mostly in Texas) suffered through several days of extreme cold without power. There was death and serious hardship. Many resorted to sleeping in their cars to stay warm. More than 14 million in Texas were by Friday either without or under orders to boil tap water. Some locations were facing food scarcity. Hours were spent waiting to purchase fuel to power generators. Many hospitals were operating without secure energy or water supplies. It is what one might expect from a third world country, not the powerhouse U.S. producer of energy products.

February 19 – Bloomberg (Leslie Patton): “Restaurants in Texas are throwing out expired food, grocery stores are closing early amid stock shortages and residents are struggling to find basic necessities as a cold blast continues to upend supply chains… The situation is so dire in Houston, a major city for dining out, some people have running lists of restaurants that are open and have food supplies… The challenges are further limiting residents’ access to food as grocery store shelves remain barren in many areas. Supermarket chains such as Kroger Co. have implemented purchase limits on items such as eggs and milk, while HEB Grocery Co. said the weather is causing ‘severe disruption in the food supply chain.’”

Some will blame climate change. Others will point to Texas’s fixation on independence and animus toward regulation. At this point, some Republican lawmakers must feel cursed.

Former Texas governor and U.S. Energy Secretary Rick Perry: “Texans would be without electricity for longer than three days to keep the federal government out of their business. Try not to let whatever the crisis of the day is take your eye off of having a resilient grid that keeps America safe personally, economically, and strategically.”

Reliable energy is a necessity – more now than ever. It is a critical basic utility that must be safeguarded with competence, foresight and intense focus. The risks associated with power system failure are so high that reliability even under unusual circumstances can’t be left to chance. It cannot be only about low cost. Politics and ideology are anathema.

Clearly, there are serious shortcomings in how Texas and our nation’s energy infrastructure are being managed. The Lone Star State experienced serious cold weather infrastructure issues in 1989 and again in 2011 – and yet the risk of grid failure under extreme cold was largely disregarded. The commitment remained to deregulated low-cost energy, avoiding the massive investment necessary to ensure stable energy output and delivery during outlier winter weather episodes.

There is understandable outrage. Hearings and reports will be forthcoming – and there will be political ramifications. A push toward reregulation would seem inevitable. Massive investment to winterize systems will be required. And whether it is extreme occurrences in weather, viruses, or market dislocations, we can no longer disregard what were previously dismissed as being highly unlikely. Similarly, as a society we need to come to grips with systemic propensities that seem to ensure a lack of planning and preparation. The consequences of resource misallocation and structural maladjustment were this week on full display.

Record stock prices. Less than two months into 2021, the small cap Russell 2000 has risen 14.8%, with the S&P400 Midcaps up 9.9%. The “average stock” Value Line Arithmetic Index enjoys a y-t-d gain of 11.8%. The Banks have jumped 16.4% and the Broker/Dealers 16.6%. Bitcoin has gained more than 90% so far this year to surpass $53,000.

Record IPO and SPAC issuance runs unabated. Full steam ahead for the historic corporate debt issuance boom, certainly including junk bonds. Seemingly any leveraged loan or merger/leveraged transaction enjoys the cheapest of financing costs. With a proposed $1.9 TN stimulus package, our federal government is poised for back-to-back $3 TN plus fiscal deficits. There is today unlimited finance available for about any zany idea imaginable. Indeed, we’re witnessing history’s greatest expansion of non-productive debt. I read this week that “Trillions” will be required to update our nation’s decrepit energy infrastructure. I appreciate there’s “money” slushing around everywhere – and Trillions more on the way. Yet, where will the money come from to modernize the national power grid?

There was reference to the spike in spot Texas electricity prices pushing the cost of recharging a Tesla from about $18 to $900. And while the price spike was fleeting, it does raise the broader issue of the disconnect between the push toward electrification and our woefully inadequate energy infrastructure. Who, after all, would invest in infrastructure when such incredible opportunities await in thousands of companies sporting breathtaking new technologies – EV and autonomous vehicles, AI, Cloud computing, Robotics, blockchain, cybersecurity, 5/6 G, the “genomic revolution”, Fintech, green technologies and on and on.

I’ll assume the Texas energy debacle will boost momentum for massive federal infrastructure spending. Let’s presume a Trillion dollar spending bill later in the year gets the ball rolling, ensuring another massive federal deficit next year – easily exceeding $2.0 TN. Several years of Trillion dollar annual infrastructure spending is not an unreasonable scenario. The power grid and energy infrastructure, highways, bridges, tunnels, rail, airports, etc. The green new deal. So, to answer the above question: our federal government will finance needed infrastructure through ongoing massive debt issuance – at least some of it conveniently monetized by the Federal Reserve. Between infrastructure investment and redistribution policies, multi-Trillion fiscal deficits as far as our eyes can see.

Ten-year Treasury yields rose another 14 bps this week to a one-year high 1.35%. After trading to a multiyear high 2.25% on Tuesday, the 10-year Treasury inflation “breakeven rate” ended the week at 2.12%. The Treasury yield curve (10 vs. 2yr) steepened another 13 bps this week to 123 bps, the widest in four years.

It’s worth noting the February Input Price component in the IHS Markit U.S. Manufacturing Purchasing Managers’ Index (PMI) survey surged eight points to an almost decade high 73.3. Output Prices jumped to the high since 2008. The Markit Services PMI Pricing component rose three points to 70.3, the high since October 2009. Elsewhere, the Producer Price Index jumped in January a much stronger-than-expected 1.3%, “the biggest gain since December 2009.” Notably, prices rose sharply for both Goods and Services components.

From CNBC (Diana Olick): “The median price of an existing home sold in January was $303,900, a 14.1% increase from January 2020. That is the highest January price that the Realtors have ever recorded.”

February 17 – Bloomberg (James Politi and Colby Smith): “Federal Reserve officials generally believe the threat posed by subdued inflation is greater than the danger of rapidly rising prices, as they begin to factor in the possible effect of President Joe Biden’s $1.9tn fiscal stimulus. The US central bank held an extensive discussion of inflationary trends last month in light of a possible acceleration in the economic recovery this year triggered by Biden’s stimulus package, according to minutes from the January meeting of the Federal Open Market Committee. ‘Participants generally viewed the risks to the outlook for inflation as having become more balanced than was the case over most of 2020, although most still viewed the risks as weighted to the downside,’ the FOMC minutes said.”

Fed officials this week seemed to be lined up to pacify the bond market with the view that heightened inflationary pressures were transitory and a non-issue. This should make bonds jittery. Traditionally, it was understood that central bank neglect in tamping down fledgling inflationary pressures risked a much more problematic tightening after inflation gained a foothold. The Fed is poised to disregard mounting inflation risk. It has painted itself into a corner with ill-conceived doctrine invoking above-target inflation to counter a previous period of below-target CPI.

Indicators of excessively loose monetary policy are everywhere – inflating asset prices, highly speculative securities markets, overheated housing markets, record trade deficits and, now even, heightened producer and consumer price pressures. Commodities prices have been surging. And this week JPMorgan boosted their forecasts for Q2 growth to 9.5% and the 2021 expansion to 6.4%.

At this point, the Fed should be in the process of rate normalization. Yet, contemplation of that move won’t begin until well after the winding down of QE. Amazingly, the Fed is sticking with its monthly $120 billion balance sheet expansion. At some point in the future, the Federal Reserve will telegraph its intention to begin some type of taper process. It will likely begin a cautious tapering some period following this signal – ensuring many months will pass before this round of QE has run its course. It is almost inconceivable that there will not be “taper tantrums” along the way that will further extend the Fed’s irrepressible “money printing” operations.

The point is the Fed is locked into the loosest and most asymmetric monetary policy imaginable. Slash rates to zero and inject Trillions of liquidity in days and weeks, while the return to any semblance of policy normalcy unfolds over quarters and years.

In a classic “careful what you wish for,” the Fed is going to get the massive fiscal stimulus it has beckoned for. And for some time to come, historic monetary and fiscal stimulus will support mounting inflationary pressures. I do not recall a period when the domestic environment was as ripe for inflationary pressures to gather momentum.

Importantly, the global backdrop is also highly conducive to upside inflation surprises. While generally not to the level of the U.S., nations around the world are running synchronized, dangerously loose monetary and fiscal policies. Reckless U.S. inflationism and resulting structural dollar weakness have afforded the entire world the leeway to inflate “money” and Credit. The upshot is a pool of dollar balances flooding the world coupled with rapidly inflating quantities of renminbi, euros, yen, pounds, “Aussie”, “kiwi” and “loonie” dollars, won, reals, pesos, rands, and scores of other currencies. The world is awash in liquidity and cheap “money” like never before. Global inflation risk is highly elevated.

Then why are 10-year Treasury yields today at only 1.34%? Because the current financial structure is unsustainable. U.S. equities and cryptocurrencies are in a historic mania. The U.S. corporate Credit boom is an accident in the making. Globally, precarious Bubble Dynamics encompass securities markets in about every nook and cranny. The degree of speculation and speculative leverage is unprecedented and unsustainable.

Meanwhile, mounting inflationary pressures pose a serious risk. Yet safe haven bonds, including Treasury, bunds and JGBs, are underpinned by the prospect of faltering global Bubbles and an associated “risk off” contraction of speculative Credit.

Global yields have moved meaningfully higher, and incipient forces of de-risking/deleveraging are emerging at the periphery. Local currency 10-year bond yields were this week up 87 bps in Lebanon (49.52%), 46 bps in Mexico (6.04%), 37 bps in Romania (3.13%), 31 bps in South Africa (8.86%), and 19 bps in Indonesia (6.50%). Over the past month, yields were up 53 bps in Russia, 35 bps in Slovakia, 34 bps in Brazil, and 26 bps in the Czech Republic.

While not as dramatic, dollar-denominated EM bonds have also been under pressure. This week saw Brazilian 10-year yields jump 16 bps, Mexico 14 bps, Indonesia 21 bps, and Peru 22 bps. Outside of EM, periphery European yields have reversed sharply higher. Ten-year yields jumped 20 bps this week in Spain, 15 bps in Italy, 15 bps in Portugal, and 14 bps in Greece. Bund yields rose 12 bps to negative 0.31%, the high since June 8th. Japanese 10-year yields rose four bps this week to 0.11%, the high going back to November 2018.

February 17 – Reuters (Marc Jones): “The COVID pandemic has added $24 trillion to the global debt mountain over the last year a new study has shown, leaving it at a record $281 trillion and the worldwide debt-to-GDP ratio at over 355%. The Institute of International Finance’s global debt monitor estimated government support programmes had accounted for half of the rise, while global firms, banks and households added $5.4 trillion, $3.9 trillion and $2.6 trillion respectively. It has meant that debt as a ratio of world economic output known as gross domestic product surged by 35 percentage points to over 355% of GDP. That upswing is well beyond the rise seen during the global financial crisis, when 2008 and 2009 saw 10 percentage points and 15 percentage points respective debt-to-GDP jumps.”

It’s frightening debt growth – with too little to show for. And no end in sight. Parabolic expansion of debt of increasingly poor quality. “Terminal Phase Excess” on an unprecedented global scale. Intensifying Monetary Disorder. Manic market Bubble Dynamics – and an ever-widening chasm between inflating asset prices (perceived wealth) and deflating global prospects. Record stock prices versus a near catastrophic collapse of Texas’s power grid. American society is taking too many blows. The Intensifying Drumbeat of a Wrecking Ball. If ramifications of a bursting Bubble are not worrying, you’re not paying attention.

Original Post 20 February 2021

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Categories: Doug Noland