Earlier in the week I examined whether the Twilight Zone is back. Is bad news good news for the stock market thanks to the increased likelihood of a government or central bank intervention?
Well Mr Market gave us a decisive answer since I posed the question. Markets went back to toppling… until this morning when the UK’s GDP came in as expected at 0.5% growth. The FTSE 100 popped almost 2%.
But the UK’s big rally is an exception these last few days. Oil exporting countries belittled plans to stabilise production, causing oil to fall. Iffy economic data on manufacturing and services from China left stocks there plummeting and they continued down overnight. Bank stocks around the world continued their decline on problems with bad debt. The rally of recent weeks looks doomed.
So bad news is still bad… for now
At some point things will get bad enough for central bankers and governments to get back in the market with enough gusto to put a floor under the stocks. They’re keeping investors guessing though. How low will we go before stocks don’t have permission from central bankers to fall any further?
Meanwhile the world’s meddle-o-maniacs have a problem. Two of their trademark polices are creating a contradiction. On the one hand you have the war on cash. On the other you have the need to stimulate the economy with negative interest rates.
You might think these two go hand in hand, as you read about in past Capital & Conflicts. Negative interest rates are designed to stimulate the economy by forcing spending over saving, and the war on cash makes it easier for the government to force that spending because it’s harder to escape the negative rates by cashing out of your bank account. Keeping money in the bank also props up the banking system because there can’t be a run on the banks if you can’t cash out.
But all government policies have unintended consequences
These are usually blindingly obvious in advance, if you’ve read any economics book that’s too politically incorrect to be found in a university library. The good ones, in other words. But sometimes the unintended consequences are amusingly surprising.
It looks like negative interest rates are proving dangerous for the very banking system that the war on cash is trying to protect. And wobbling banks have become a big obstacle to global growth, which negative interest rates are supposed to create. The governments’ policies are counteracting each other. And leaving a messed up banking system in their wake.
US investment bank Morgan Stanley just joined Deutsche Bank in complaining about the consequences of negative interest rates. It’s causing distortions that banks are struggling to deal with. Especially because the Federal Reserve isn’t keeping pace with the negative rates in Europe and Japan. This ruins the trading revenue of European banks by crushing commodity prices, causing inflows into bonds at the expense of stocks and it also pressures China’s trade flows and currency peg. (Charlie Morris is warning his subscribers about the hidden dangers of this peg in The Fleet Street Letter.)
Tracking Lehman Brothers’
All eyes are on Deutsche Bank, which is reliant on those three sources of revenue – equities, commodities and China. The Deutsche Bank share price has been tracking Lehman Brothers’ 2007 share price performance rather closely of late. And the price of credit default swaps (CDSs) on Deutsche jump each time the European Central Bank (ECB) looks more likely to push rates further down, suggesting the risk of default by Deutsche rises as the ECB “stimulates”.
The thing is, Deutsche is far larger and more important than Lehman was. In fact, in terms of its total derivatives exposure, it’s the biggest bank in the world. If Deutsche is in trouble, all the world’s derivative markets are because it’s a counterparty to so many contracts.
The markets are especially worried about 10 March, when the ECB is expected to announce even more weird and wonderful policies involving negative rates. European banks are getting thumb screwed by their own central bank.
All this has played out before. Japan has been fiddling away with dangerously low interest rates and a rotten banking system for decades.
Tim Price, editor of the London Investment Alert, explained this in an interview with Dan Denning recently. If you want to know what’s happening, just check out what happened in Japan says Tim.
How you will pay for your money
In the second part of the interview Dan focuses on how Tim saw the war on cash coming. He managed to polish up a book about it before the story really went mainstream.
But even Tim was surprised about just how the government might impose itself. Here’s an excerpt from the interview between Dan Denning and Tim Price:
DD: Here’s what [Bloomberg’s editorial board] said: “For much of the past decade, central banks in the rich world have been hampered by what economists call the zero lower bound or the inability to impose significantly negative interest rates. Persistent low demand and high unemployment may sometimes require interest rates be pushed below zero, but why keep money in a deposit whose value keeps shrinking when you can hold cash instead. With rates near zero, that conundrum has led policy makers to a novel and unpredictable method of stimulating the economy, such as large-scale bond buying.”
Here’s where it gets interesting: “A digital legal tender could resolve this problem. Suppose the central bank charged the banks that deal with it a fee for accepting paper currency. In that way, it could set up an exchange rate between electronic and paper money, and by raising the fee it would cause paper money to depreciate against the electronic standard. This would eliminate the incentive to hold cash rather than digital money, allowing the central bank to push the interest rate below zero and, thereby, boost consumption and investment. It would be a big step toward doing without cash altogether.”
I mean, that is our worst…
TP: I can’t believe I’m hearing this. It’s, like, is it April the first?
DD: Yes, well, it’s hard to know which part of this is more shocking, but, one, the policy is driven by what’s good for the central bank, not what’s good for savers, good for people nearing retirement who have money in the bank, and that this method of setting up an exchange rate between digital cash and physical cash is a way to punish people for owning physical cash.
So, when you wrote this, I mean, did you have any of your colleagues in the city or the professional world say, what are you doing? I mean, are you serious? Did people, did you lose credibility for making that claim six months ago?
TP: People have viewed me as, sort of, a voice crying in the wilderness for so long, I don’t really care anymore, so…
DD: Do you feel vindicated though when you see that?
TP: I will put it this way: I think if expressing concern about a war on cash was deemed to be a weird minority view last year, I think it’s becoming increasingly mainstream now.
So the plan is to charge you to use cash, and charge you to have deposits in the bank at the same time. Things are not looking good for savers. The famous investor Jim Rogers has the summary:
“This is the first time in recorded history where you have Central Banks & governments setting out to destroy the people who save & invest.”
Tim does have a plan of action for you to avoid this mess. But things are getting frighteningly bizarre.
The Germans are coming for your stock exchange
Just when the Brexit debate really kicked off, with London’s financial prowess at the centre of the debate, Britain and Germany’s stock exchanges announced a merger.
The Germans are coming for your stock market. I asked long-time fund manager Charlie Morris for his take on what’s going on and whether this move is politically motivated given its timing. Here’s his reply:
Deutsche Bourse (DB) and the London Stock Exchange (LSE) first had merger talks in 2000 that came to nothing. The LSE then decided to float in 2001 only to be approached once again by DB in 2004. The offer to buy the LSE was for ÂŁ1.35 bn.
DB is worth ÂŁ13.8 bn while the LSE is worth ÂŁ9.2 bn. DB makes roughly three times the profits of the LSE, despite having a smaller stock market. DB has been more aggressive in achieving revenue growth via launching innovative products and services. The LSE oversees a larger market but has done less with it. If the deal were to go ahead it would create one of the largest exchanges in the world.
But what about the timing of the deal? Is Brexit relevant and is this politically motivated? I don’t think so. DB has had its eyes on the LSE for years and consolidation is the general trend in the industry. Perhaps more importantly, it demonstrates that Brexit doesn’t mean Britain is cut off. We will still be integrated. Investors will continue to engage in cross border activities. The city will continue to thrive. The Germans wouldn’t be making such a generous offer if they believed Brexit would sink the value of their prize.
We shouldn’t be emotional about it either
The real value is in the City of London. Buying the exchange doesn’t mean kidnapping the customers and moving them to Germany. This will provide a bigger and deeper market for all investors. That’s a win for both the British and the Germans – and capital markets in general. It also makes sense in a historical context.
There used to be regional stock exchanges. By 1914 there were 22 across the UK, including exchanges in Bristol, Cardiff, Halifax, Liverpool, Sheffield and Swansea. Many of these continued to operate until the 1970s. London then became dominant as computers and communications improved. It made sense to improve liquidity in one place so that it was easier for buyers and sellers to find one another.
The LSE used to be mutually owned by its member firms. Each was limited to a 4.9% shareholding so no one could monopolise it. The Big Bang came along in 1986 whereby trading was deregulated. Prior to that, dealing commissions were fixed at 1.5%. That’s expensive, and ever since commissions have collapsed. An institution could now pay as little as 0.03% to trade. As a result transactions have ballooned yet revenue from share transactions only accounts for 10% of the total for major exchanges.
Global consolidation has been frantic, and the world will see just a handful of exchanges in the future. This is linked to the continued improvements in technology and the need for fewer and larger liquidity pools. In addition, regulatory capital requirements mean that large sums must be deposited with each exchange to manage risk in order to transact in those markets. Fewer exchanges would reduce the margin requirement for investors. In this sense, bigger is better.
More recently, the real money for stock exchanges is made from derivatives, data, clearing, asset management and information technology. While trading commission has collapsed, data fees defy gravity. It could cost several thousand pounds each year to receive live prices for a fund manager watching global markets. Fewer exchanges mean less competition. Prices can only rise.
So it looks like the merger is a pretty wise business decision. But good luck convincing me the timing is a coincidence. We Germans are too crafty for that. The Bremain campaign will make hay out of this one by suggesting we can’t put business deals like this at risk.
Category: Central Banks