Doug Noland: A True Central Banker

By Doug Noland on October 23, 2021

Doug tells us about German Central Bank President who is resigning and some of his sage advice. He lost the battle of protecting the value of money to the pollical elite and is tired and does not want to be associated with the reckoning.

Doug also gives us an update on China and this one paragraph sums up the disaster awaiting China. I also learned this week that all those unoccupied apartments are in fact owned by people who had to pay before they were built. It is not the builder on the hook. It is the owners of each apartment and the banks they borrowed money from.

China Watch

The key data point: Existing apartment sales were down 63% y-o-y during the first half of October. And nuggets from the Financial Times (see China Watch): “…A property sector that represents 29% of Chinese gross domestic product and is more than $5tn in debt. Some 41% of the Chinese banking system’s assets are associated with the property sector, and 78% of the invested wealth of urban Chinese is in housing.”

Which brings us to a couple of quotes from a “true” but consistently ignored Central Banker Jens Weidmann who is stepping down in Germany:

“The side effects of low interest rates. Research has found that risk-taking becomes more aggressive when central banks apply unconditional monetary accommodation in order to counter a correction of financial exaggeration, especially if monetary policy does not react symmetrically to the build-up of financial imbalances. In the end, putting too much weight on countering immediate risks to financial stability will create even greater risks to financial stability and price stability in the future.” Jens Weidmann: Economics Club of New York, April 23, 2012

“The mandate to safeguard the value of money, in order to explicitly keep the government from co-opting monetary policy.”

“The independence of central banks is an extraordinary privilege… its primary purpose is to use its credibility to ensure that monetary policy can focus unhindered on preserving the value of money.”

“In the end, putting too much weight on countering immediate risks to financial stability will create even greater risks to financial stability and price stability in the future.”

And from his resignation letter, “A stability-oriented monetary policy will only be possible in the long run if the framework of the monetary union ensures the unity of action and liability, monetary policy respects its narrow mandate and does not get caught in the wake of fiscal policy or the financial markets.”

Way too late.

The President of the ECB, which Weidmann battled, is now a very political lawyer. Not a business person nor banker. Monetary policy is being run for the financial markets which is the economy of the top – the financial economy – and they are using this power in Europe for political means.

I believe central bankers see themselves as a form of government today. They have moved away from protecting the value of money to discussing how they can affect climate change, health and the inequality that their policies have created. The unelected ruling class – the top.

A True Central Banker

by Doug Noland

Who can blame him? Certainly not me.

October 20 – Financial Times (Martin Arnold and Guy Chazan): “Jens Weidmann has decided to step down after a decade as head of Germany’s central bank, only weeks after the country’s general election and shortly before a crucial decision on the future of eurozone monetary policy. The president of the Bundesbank has been one of the most vocal critics of the ultra-loose monetary policy pursued by the European Central Bank, where he fought an often lonely battle against its bond buying and negative interest rate policies. The 53-year-old said… he was leaving for ‘personal reasons’. But colleagues said he was tired of opposing ECB policies and expected these frustrations to increase as the economy recovers, inflation rises and the ECB’s generous stimulus becomes harder to justify.”

Jens Weidmann fought the good fight – a superior intellectual warrior overwhelmed by the onslaught of rank inflationism. He is a statesman in an age of few, a too often lone voice for sanity in a world of monetary absurdity. The foundation of Weidmann’s analytical framework rests on the profound importance of two simple words (you won’t hear uttered by a U.S. central banker): “stable money.”

Weidmann’s plight is testament to why virtually every central banker falls in line. From the FT: “Labelled by former ECB president Mario Draghi as nein zu allem, no to everything, Weidmann articulated the view of monetary hawks…” While Weidmann resigns with scant fanfare, inflationist extraordinaire “Super Mario” governs as Italy’s Prime Minister. As for U.S. inflationism luminaries, while it’s unclear if Ben Bernanke still collects millions from lunch dates and appearances ($250k for 40 minutes in Abu Dhabi! ), collaborator Janet Yellen runs the U.S. Treasury.

I can only imagine how deeply frustrating the past decade has been for Weidmann. To know you’re right on such critical analysis, but to see it not matter – year after year. Fighting to safeguard humanity from The Scourge of Monetary Disorder and Inflationism, only to be designated the merciless villain. To repeatedly have no choice but to compromise, while recognizing that the slippery slope of inflationism ensures ever greater concessions culminating in future catastrophe. And to witness your analytical adversaries transformed into public heroes, understanding it’s all a sham – an Inflationary Mirage. With contemporary central banking now taking on water, I don’t fault Weidmann for jumping ship.

We should hope Weidmann continues to speak and write. We’ll need his deep insight and sound intellectual framework, especially when the loss of credibility leaves central bankers scrambling to resurrect more traditional doctrine and policies.

“Central banks create money by granting commercial banks credit against collateral or by buying assets such as bonds. The financial power of a central bank is unlimited in principle; it does not have to acquire beforehand the money it lends or uses for payments, but can basically create it out of thin air. The printing of money is an appropriate image here; from an economic perspective, the printing press is not necessary, as the creation of money primarily shows up on the central bank’s balance sheet, on its accounts…

If central banks can potentially create an unlimited amount of money out of thin air, how can we ensure that money remains sufficiently scarce to preserve its value? Does this ability to create money more or less at will not create the temptation to take advantage of this instrument to create additional leeway short term, even at the risk of highly probable long-term damage? Yes, this temptation certainly does exist, and many in monetary history have succumbed to it. Taking a look back in time, this was often the reason for establishing a central bank: to provide those in power with free access to seemingly unlimited financial resources. However, such government interference in central banking, combined with the government’s large demand for funding, often led to a strong expansion in the volume of money in circulation, causing it to lose value through inflation. In light of this experience, central banks were subsequently established as independent institutions, with the mandate to safeguard the value of money, in order to explicitly keep the government from co-opting monetary policy.

The independence of central banks is an extraordinary privilege – it is, however, not an end in itself. Instead, its primary purpose is to use its credibility to ensure that monetary policy can focus unhindered on preserving the value of money. Independent monetary policy combined with policymakers with a well-functioning, stability-oriented compass are a necessary – but not a sufficient – condition for preserving the purchasing power of money as well as public confidence in it. Of course, it is important that central bankers, who are in charge of a public good – in this case, stable money – bolster public confidence by explaining their policies. The best protection against temptation in monetary policy is an enlightened and stability-oriented society.” Jens Weidmann: Money Creation and Responsibility, September 18, 2012

“The mandate to safeguard the value of money, in order to explicitly keep the government from co-opting monetary policy.” “The independence of central banks is an extraordinary privilege… its primary purpose is to use its credibility to ensure that monetary policy can focus unhindered on preserving the value of money.” “In the end, putting too much weight on countering immediate risks to financial stability will create even greater risks to financial stability and price stability in the future.” And from his resignation letter, “A stability-oriented monetary policy will only be possible in the long run if the framework of the monetary union ensures the unity of action and liability, monetary policy respects its narrow mandate and does not get caught in the wake of fiscal policy or the financial markets.” A True Central Banker.

In the euro zone, the U.S. and globally, monetary policy has ventured recklessly away from its narrow mandate and is today trapped in the wake of fiscal policy and financial market dictate. Surely Weidmann sees the writing on the wall – and it would be too much to endure operating in the type of crisis backdrop he has worked so diligently to guard against. As the President of Germany’s Bundesbank, he understands that once the forces of monetary inflation have been unleashed, they become almost impossible to repress. Moreover, those seeking to ward off monetary disaster will be villainized and blamed for the bust. (On a personal basis, having warned for more than two decades of inflationism’s eventual peril, I dread the prospect of chronicling the unfolding debacle.)

October 22 – Bloomberg (Thomas Mulier): “Consumers around the world are about to get socked with even higher prices on everyday items, companies from food giant Unilever Plc to lubricant maker WD-40 Co. warned this week as they grapple with supply difficulties. The maker of Dove soap and Magnum ice-cream bars jacked up prices by more than 4% on average last quarter, the biggest jump since 2012, and signaled elevated pricing will continue into next year. A similar refrain came from Nestle SA, Procter & Gamble Co. and Danone SA, whose products dominate supermarket aisles and kitchen cupboards. ‘We’re in for at least another 12 months of inflationary pressures,’ Unilever CEO Alan Jope said… ‘We are in a once-in-two-decades inflationary environment.’”

U.S. society is receiving an education in rising prices. The New York Fed’s one-year inflation expectations reading rose to 5.3%, the high for data going back eight years. Excluding the summer of 2008, the University of Michigan one-year consumer inflation expectations (4.8%) were the highest since 1982. The five-year Treasury “break even” inflation rate this week jumped 15 bps (23bps in two weeks!), surpassing 2.9% for the first time in at least two decades.

Major U.S. equities indices this week rallied to all-time highs. Evergrande apparently made a delinquent bond payment thus, for now, avoiding default. Yet the air of unfolding global crisis remains. A three-percent Friday afternoon rally cut Brazilian equities losses for the week to 7.3%. Brazil’s currency sank 3.6%, increasing 2021 losses to 8.0%. Brazil’s local currency bond yields surged 78 bps to a near-five-year high 12.40%. Meanwhile, Turkey is stuck in their own political and monetary muck, with the lira’s 3.6% weekly drop boosting y-t-d losses to 22.6%. Turkish local currency yields jumped 70 bps to a near-five-year high 19.39%.

WTI crude’s 1.8% rise pushed 2021 gains to 73%. Fearing transitory is morphing into chronic inflation, global central bankers and bond markets are taking notice. Jumping another nine basis points to 2.12%, benchmark U.S. MBS yields are back to highs since March 2020. Also trading to pandemic highs, two-year Treasury yields rose six bps this week to 0.46%.

October 18 – Financial Times (Madison Darbyshire): “Nearly 900,000 individual accounts traded shares of GameStop in a single day after a 90-fold increase at the height of the ‘meme stock’ craze, according to a report by the US securities regulator. GameStop, a struggling video games retailer, became an emblem of the mania that gripped markets in January when its shares surged by 2,700% in less than three weeks. Individual traders organised on online message boards and collectively unleashed furious rallies in certain stocks. The US Securities and Exchange Commission studied the events and… released a report that offered a first glimpse into the true scale of the phenomenon. For GameStop, the number of individual accounts trading its shares rose from about 10,000 a day at the start of the year to nearly 900,000 at the peak on January 27.”

900,000 individual accounts trading GameStop in a single session. I’ll add this fun fact to my list of evidence of a full-fledged mania. As a mania, we should not expect the U.S. equities market to behave normally. Not that 2007 was normal, yet recall that stocks in October surged to record highs despite the faltering mortgage finance Bubble.

Buying every dip has been too easy. Ditto for squeezing the shorts. Yet the biggest fun and games are thriving throughout derivatives markets, where those buying protection repeatedly watch their hedges collapse in value. With yields rising and China’s Bubble faltering, there has been ample justification over recent weeks to hedge market risk. And when markets reverse higher, the unwind of hedges and bearish positions helps propel market rallies. In a historic speculative Bubble, shenanigans will work great until they don’t.

October 15 – CNN (Michelle Toh): “Evergrande’s unraveling is still commanding global attention, but its troubles are part of a much bigger problem. For weeks, the ailing Chinese real estate conglomerate has made headlines as investors wait to see what will happen to its enormous mountain of debt. As the slow-moving crisis unfolds, analysts are pointing to a deeper underlying issue: China’s property market is cooling off after years of oversupply… Mark Williams, chief Asia economist at Capital Economics, estimates that China still has about 30 million unsold properties, which could house 80 million people… On top of that, about 100 million properties have likely been bought but not occupied, which could accommodate roughly 260 million people, according to Capital Economics estimates. Such projects have attracted scrutiny for years, and even been dubbed China’s ‘ghost towns.’”

I’m convinced China’s Bubble is a disaster in the making. Things will likely prove even worse than expected. According to Capital Economics, the number of unoccupied Chinese apartment units is up to 130 million – 30 million unsold and 100 million purchased but not occupied.

October 20 – Bloomberg: “China’s housing market slump has intensified in recent weeks as sales plunge and more developers default on their debt. Now the downturn has reached another milestone: home prices have begun falling for the first time in six years. The 0.08% drop in new-home prices across 70 cities in September may be small, but it poses a potentially big blow for an economy that counts on property-related industries for almost a quarter of output. Homebuyer sentiment is evaporating as a crisis at China Evergrande Group ripples through the industry… September is traditionally a peak season for the home market. Yet residential sales tumbled 17%, investments slid for the first time since early 2020, and the rate of failed land auctions climbed to the highest since at least 2018 — potentially hurting local government coffers… The downturn has continued into this month. Existing-home sales plunged 63% from a year earlier in the first 17 days of October, according to a Nomura Holdings Inc. note…”

October 19 – Bloomberg: “China’s cash-strapped developers are becoming reluctant to bid for land during the nation’s property slump, threatening to undermine a $1 trillion revenue source for local governments and deepen the economic slowdown. About 27% of land parcels offered by local governments went unsold in September as no developer submitted bids — the highest rate since at least 2018… Proceeds from land auctions across the country plunged 18% in August from a year earlier, the biggest decline in almost three years… Faced with weakening funding access and rising borrowing costs amid the deepening crisis at China Evergrande Group, many developers have been refraining from replenishing their land holdings. In one sign of how tight financing has become, the industry’s borrowings from banks dropped 8.4% last month, the most since 2016… ‘Developers are hoarding cash to avoid becoming the next Evergrande,’ said Larry Hu, head of China economics at Macquarie Securities Ltd. ‘The contagion risk is real.’”

The consensus view holds that the so-called “great financial crisis” could have been avoided, had only the Fed bailed out Lehman. Surely the great Beijing meritocracy is smart enough to avoid such a disastrous blunder. But I just don’t believe a Lehman bailout would have changed much. There was too much Bubble-related financial rot and economic maladjustment. Crisis was unavoidable, as it is today in China.’’

There’s always an ebb and flow to Crisis Dynamics. Especially in major Bubbles, the specter of devastating collapse will have desperate policymakers employing extraordinary measures to hold crisis at bay. There will be relief rallies, along with bouts of optimism that government efforts are working to resolve systemic fragilities. Short squeezes and the unwind of hedges temporarily bolster market confidence.

Over time, however, fundamental deterioration takes an increasing toll – chipping away at increasingly fragile confidence. At some point, with the catalyst clear only in hindsight, there is a flash realization that the authorities do not, in fact, have the situation under control: “Lehman Moment.”

China’s faltering Bubble creates a unique situation. Beijing has enormous resources available to deploy. They can withhold information from their citizens. They can obfuscate and manipulate. They will initially ring-fence their banking system.

But I am skeptical they can sustain ridiculously overvalued apartments often of suspect quality. And it will be impossible to suppress news of sinking apartment prices. Word will travel quickly for subject matter of such keen national interest. How owners of depreciating apartments react is a huge unknown. Will millions of units hit the market, with panicked sellers willing to accept steep discounts? Will owners of unoccupied apartments mail keys to their banks and stop making payments? National protests and resulting government crackdowns? Darkening public moods for apartment speculation, the economy, the communist party and the world?

I am also skeptical that, short of stringent capital controls, Beijing will be able to suppress financial outflows. And as Crisis Dynamics unfold, Beijing will be challenged to control de-risking/deleveraging dynamics. How much speculative leverage has accumulated over this incredible cycle remains the $64 TN question.

But we’re so early in the process, and it’s not fruitful to jump too far forward. After trading to 75% earlier in the week, Evergrande bond yields dropped to 67.4% after holding default at bay. An index of Chinese high-yield dollar bond yields dropped from 20% to 17.8%, after beginning September at 12%. China’s sovereign CDS fell from 49 to 46.5 bps, with most Chinese bank CDS also declining moderately.

Despite the modest Chinese Credit relief rally and record U.S. stock prices, an index of Emerging Market CDS ended the week higher. Brazil’s sovereign CDS surged 34 bps to a 13-month high 236 bps. Turkish CDS jumped 11 to 470 bps, the high since March. And local currency bond yields continue their upward march, with yields rising 28 bps in Russia (high since March ’20), 13 bps in the Czech Republic (high since 2012), 10 bps in South Africa (17-month high), 10 bps in Mexico (high since March ’20), and eight bps in Poland (high since May ‘19). Despite ongoing “developed” central bank QE liquidity injections, global financial conditions have begun to tighten. The extraordinary confluence of surging inflation, spooked central bankers and a faltering Chinese Bubble creates momentous risks for a highly levered world.

Original Post 23 October 2021

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