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Is Yellen About To Shock Everyone: Goldman Says The "Fed Should Think About Easing"
Submitted by Tyler D.
09/12/2015 19:58 -0400

What a difference a little over a year makes.

Back in January 2014, just after the Fed announced the tapering of QE (because, you know, the "date-dependent" Fed would never be tapering if the economy wasn't improving, right?) the propaganda machine went into overdrive, with Wall Street's pet economist, not to mention the NY Fed's key "outside advisor", Goldman Jan Hatzius preaching that the long awaited recovery had finally arrived.

This is how the tabloid pseudo-finance website Business Insider characterized his call at the time: "Goldman's top economist, Jan Hatzius, just said the words we've been wanting to hear for five years. He believes the economy is now growing at an above-trend pace."

What exactly did he say? This:

Despite the 1% drop in real GDP in the first quarter, we believe that the US economy is now growing at an above-trend pace. The best way to see this is via our current activity indicator (CAI), which grew at an annualized rate of 3.4% in May, similar to the average of the prior two months. Although an estimated ½ percentage point of this sequential growth is due to a bounceback from the weather distortions of the first quarter, even the year-on-year CAI now stands at 2.7%, the fastest pace of the expansion so far and above our estimate of potential growth of 2%-2½%. In our view, the CAI is a far more reliable indicator of economic activity than real GDP because it is more timely, more broadly based, less noisy, and less subject to revision. One key reason why we expect a further pickup in the underlying growth pace to 3%+ is an improvement in the housing sector.

To be sure, the US economy would have literally cratered just a year later after another first quarter debacle was blamed on cold weather, and only a double seasonal adjustment saved what little was left of "growth" purely on the back of an absolute whopper in record inventory accumulation.

Back then, Joseph Wisenthal, then with Business Insider, and currently in charge of Bloomberg's hyperbole division, said "For what it's worth, we agree with Hatzius."

For what it was worth, we disagreed with Hatzius, noting that this would simply be the second time in five years Goldman has jumped the "recovery" shark after its dramatic reversal in December 2010 when as QE 2 was ending, Goldman once again sought to boost wholesale confidence by going fundamentally bullish and saying "This outlook represents a fundamental shift in the thinking that has
governed our forecast for at least the last five years."

Fast forward a little over a year when we learn that Goldman was once again wrong (for what it's worth, naturally Business Insider was too).

First it was in April of 2015 - some 16 months after his "bold" prediction - that the same "above trend growth"-forecasting Hatzius said we "do not have much confidence in the inflation outlook and believe that the right policy would be to put hikes on hold for now."

But... what happened to above trend growth?

Then in the first week of June, Hatzius once again hedged saying "Our forecast remains that the Fed policy committee will hike rates at the September meeting, but ...this remains a close call. There is a strong risk management case for delaying liftoff." In other words, the market determines Fed policy, not the economy, despite the reflexive lies to the opposite.

Then just two weeks later, on June 18, Hatzius having long given up on his "above trend growth" forecast changed his tune again, and now said he expected a December rate hike instead.

"In large part this reflects the fact that seven FOMC participants are now projecting zero or one rate hike this year, a group that we believe includes Fed Chair Janet Yellen.... We had viewed a clear signal for a September hike at the June meeting as close to a necessary condition for the FOMC to actually hike in September, because we did not believe that the FOMC would want to surprise markets on the hawkish side when they raise the funds rate."

Of course, if the economy had grown at an "above trend pace" since his January 2014 call, the Fed would have to be at 1% or higher by now.

Just to make sure nobody is surprised next week when Yellen does not hike and unleashes a massive relief rally, Hatzius added that a September rate hike announcement this Thursday "shouldn't be close", and as we showed previously, unveiled 7 reasons why. Amazing how Goldman's narrative changes with every month.

And then, the humiliation was complete last night when the same Jan Hatzius, having long-forgotten his January 2014 prediction, in a note previewing the US economy in "September and Beyond" had this to say:

In our view, the recent events have largely sealed the case against a rate hike next week. Fed officials have made clear that “data dependent” policy refers to incoming economic news as well as factors that could impinge on the outlook—including changes in financial conditions.... The news on wage and price inflation, however, has been softer than generally expected a few months ago.... most of the inflation shortfall relative to the Fed’s 2% target is due to more persistent factors, including continued labor market slack.



...



We expect modest downward revisions to GDP growth in 2016 and 2017 in light of tighter financial conditions.

Hm... maybe Jan meant below-trend growth?

And here we get to the punchline, because Goldman which originally expected a September rate hike, then pushed it to December in June, is now fairly confident that there may not be a 2015 rate hike at all!

Perhaps the biggest question for next week’s meeting will be whether Chair Yellen continues to signal rate hikes later this year, or whether she hints at a lengthier delay.



We see two arguments for why the first rate hike may be delayed beyond December. First, the Taylor rules above do not take into account risk management considerations. We have long seen a persuasive case for delaying rate increases until 2016 on risk management grounds, and recent communication suggests this may be weighing more heavily on Fed officials’ thinking.

That's that phrase again: just like in June, by "risk management" Hatzius simply means not to crash the market.

And then, now that a September rate hike has been made painfully clear will not be coming (trade accordingly), Goldman pulls out a whopper of an Easter egg:

Although the purpose of raising the funds rate is to tighten financial conditions, markets have already done much of the Fed’s “dirty work.” Indeed, our latest analysis suggests that the recent tightening—if maintained going forward—would be equivalent to around three hikes in the funds rate. Similarly, the GSFCI is now much too tight relative to our “FCI Taylor Rule”, which compares the current level of financial conditions with the “appropriate” level based on inflation and job market slack (Exhibit 11). The easiest way to ease financial conditions—and thereby better align the stance of policy with the dual mandate objectives—would be to signal a later liftoff than markets currently expect.

* * *

we may hear a bit more about risk management in the press conference, and Chair Yellen may make it clear that financial conditions need to improve for the committee to actually hike this year.

The punchline comes from Goldman's Financial Conditions Index which is now screaming for QE4 or NIRP, pick one:

And there you have it: the "above trend growth" is dead and buried - because 24 months after Goldman's prediction that the economy is now roaring, Goldman admits the Fed can't hike even 25 bps.

Which is why one can, and should, ignore all Goldman forecasts about the economy.

What one should most certainly pay attention to, however, is what Goldman says the Fed will do - you know, for "risk management" purposes - because as we have shown countless times in the past, Goldman runs the Fed.

As such, forget a September rate hike. Or perhaps Yellen will listen too carefully to Hatzius and instead of a rate hike, shock absolutely everyone, and instead of a rate hike the Fed will join the ECB, SNB and Riksbank in the twilight zone of negative rates. That, or QE4.

And why not: after both the Swiss National Bank and the Chinese central bank crushed investors who thought the banks would never surprise them, why should the Fed not complete the 2015 trifecta of central bank turmoil? After all, the money printers are already running on "faith" and credibility fumes. Might as well go out with a bang.

[Fenix]

Bank Caught Using Fake Gold As Reserve Capital In Russia
Submitted by Tyler D.
09/12/2015 14:54 -0400

Over the past several years, incidents involving fake gold (usually in the form of gold-plated tungsten) have emerged every so often, usually involving Manhattan's jewerly district, some of Europe's bigger gold foundries, or the occasional billion dealer. But never was fake gold actually discovered in the form monetary gold, held by a bank as reserve capital and designed to fool bank regulators of a bank's true financial state. This changed on Friday when Russia's "Admiralty" Bank, which had its banking license revoked last week by Russia's central bank, was reportedly using gold-plated metal as part of its "gold reserves."

According to Russia's Banki.ru, as part of a probe in the Admiralty bank, the central bank regulator questioned the existence of the bank's reported quantity of precious metals held in reserve. Citing a source, Banki.ru notes that as part of its probe, instead of gold, the "regulator found gold-plated metal."

The Russian website further adds that according to "Admiralty" bank's financial statements, as of August 1 the bank had declared as part of its highly liquid assets precious metals amounting to 400 million roubles. The last regulatory probe of the bank was concluded in the second half of August, said one of the Banki.ru sources. Another source claims that as part of the probe, the auditor questioned the actual availability of the bank's precious metals and found gold-painted metal.

The website notes that shortly before the bank's license was revoked, the bank had offered its corporate clients to withdraw funds after paying a commission of 30%. This is shortly before Russia's central bank disabled Admiralty's electronic payment systems on September 7.

Admiralty Bank was a relatively small, ranked in 289th place among Russian banks in terms of assets. On August 1 the bank's total assets were just above 8 billion roubles, while the monthly turnover was in the order of 40-55 billion rubles. The balance of the bank's assets was poorly diversified: two-thirds of the bank's assets (4.9 billion rubles) were invested in loans. The rest of the assets, about 30%, were invested in highly liquid assets.

Or at least highly liquid on paper: according to Banki.ru the key reason for the bank's license revocation was the central bank's insistence that the bank had insufficient reserves against possible loan losses.

The Russian central bank has not yet made an official statement.

The first question, obviously, is if a small-to-mid level Russian bank was using gold-plated metal to fool the central bank about the quality of its "gold-backed" reserves, how many other Russian banks are engaged in comparable fraud. The second question, and perhaps more relevant, is how many global banks - especially among emerging markets, where gold reserves remain a prevalent form of physical reserve accumulation - are engaging in comparable fraud.

Finally, what does this mean for gold itself, whose price on one hand is sliding with every passing day (thanks in part to what is now a record 228 ounces of paper claims on every ounce of physical gold as reported before), even as it increasingly appears there is a major global physical shortage. If the Admiralty bank's fraud is found to be pervasive, what will happen to physical gold demand as more banks are forced to buy the yellow metal in the open market to avoid being shuttered and/or prison time for the executives?

[Fenix]

A Major Bank Just Made Global Financial "Meltdown" Its Base Case: "The Worst The World Has Ever Seen"
Submitted by Tyler D.
09/12/2015 19:13 -0400

When it comes to the epic bubble in China's economy, it really boils down to one - or rather two - things: a vast debt build up (by now everybody should be familiar with McKinsey's chart showing China's consolidated debt buildup) leading to a just as vast build up of excess capacity, also known as capital stock accumulation. And/or vice versa.

It is how China resolves this pernicious, and self-reinforcing feedback loop, that is a far greater threat to the global economy than even what happens to China's bad debt (China NPLs are currently realistically at a 10-20% level of total financial assets) or whether China successfully devalues its currency without experiencing runaway capital flight and a currency crisis.

One bank that is now less than optimistic that China can escape a total economic meltdown is the Daiwa Institute of Research, a think tank owned by Daiwa Securities Group, the second largest brokerage in Japan after Nomura.

Actually, scratch that: Daiwa is downright apocalyptic.

In a report released on Friday titled "What Will Happen if China's Economic Bubble Bursts", Daiwa - among other things - looks at this pernicious relationship between debt (and thus "growth") and China's capital stock. This is what it says:

The sense of surplus in China’s supply capacity has been indicated previously. This produces the risk of a large-scale capital stock adjustment occurring in the future.



Chart 6 shows long-term change in China’s capital coefficient (= real capital stock / real GDP). This chart indicates that China’s policies for handling the aftermath of the financial crisis of 2008 led to the carrying out of large-scale capital investment, and we see that in recent years, the capital coefficient has been on the rise. Recently, the coefficient has moved further upwards on the chart, diverging markedly from the trend of the past twenty years. It appears that the sense of overcapacity is increasing.



Using the rate of divergence from past trends in the capital coefficient, we can calculate the amount of surplus in real capital stock. This shows us that as of the year 2013, China held a surplus of 19.4 trillion yuan in capital stock (about 12% of real capital stock).



Since China is a socialist market economy, they could delay having to deal directly with the problem of capital stock surplus for 1-2 years through fiscal and financial policy. However, there is serious risk of a large-scale capital stock adjustment occurring in the mid to long-term (around 3-5 years).




Daiwa then attempts to calculate what the magnitude of the collapse of China's economic bubble would be. Its conclusions:

Even in an optimum scenario China’s economic growth rate would fall to around zero

We take a quantitative look at the potential magnitude of the collapse of China’s economic bubble to ensure that we can get a good grasp of the future risk scenario. If a surplus capital stock adjustment were to actually occur, what is the risk for China and how far would its economy fall?



Chart 7 shows a factor analysis of China’s potential growth rate. The data here suggests that (1) China’s economy has gradually matured in recent years, and this has slowed progress in technological advancement, (2) Despite this fact, it has continued to depend on the accumulation of capital mainly from public spending to maintain a high economic growth rate, and (3) As a result, this has done more harm than good to technological advancement. Between the years 2012-15 China’s economy declined, yet still was able to maintain a high growth rate of over 7%. However, 5%pt of the growth rate was due to the increase in capital stock. Labor input and total factor productivity contributed only 2%pt.



The major decline in the rate of contribution from total factor productivity is especially noteworthy, as it had maintained an annualized rate of 5% for thirty years straight since the introduction of the reform and opening-up policy and on through the era of rapid globalization.



According to a DIR simulation, if a capital stock adjustment were to occur under such circumstances, China’s potential growth rate would fall to around 4% at best. This adjustment process is shown in the bottom left Chart 7. As far as can be determined from the capital stock circulation diagram, capital spending at the level seen in 2014 should not have been allowable without an expected growth rate of over 10%. Hence if adjustment progresses to the point where the potential growth rate is only 4%, the situation for capital spending will continue to be harsh. If the adjustment process lasts from the year 2016 to 2020, capital spending will likely continue in negative numbers on a y/y basis. If this scenario becomes a reality, the real economic growth rate will hover at around zero as is shown in the lower right portion of Chart 7.



All of this is well-known by most (or at least those who are willing to accept reality at face value instead of goalseeking it away with Keynesian theories that serve to merely perpetuate fallacious groupthink). It does, however, underscore the severity of China's economic situation and the follow-through linkages to the rest of the world.

But where the Daiwa stands out from every other report we have read on this topic, and where it truly goes where no other research has dared to go before, is quantifying the probability of China's worst case scenario. Here is what it says:

Meltdown scenario: World economy sent into a tailspin

We have already stressed that the scenario discussed in the previous section is the optimum or bestcase scenario. What is just as likely or possibly more likely to occur is the following. If the expected growth rate declines and the progress of the capital stock adjustment causes the bad debt problem to become even more serious, the economy could spiral out of control, lapsing further into a meltdown situation.

The stunning punchline:

"Of all the possible risk scenarios the meltdown scenario is, realistically speaking, the most likely to occur. It is actually a more realistic outcome than the capital stock adjustment scenario. The point at which the capital stock adjustment is expected to hit bottom is at a much lower point than in the previously discussed capital stock adjustment scenario (see Chart . As shown in the bottom right portion of this chart, the actual economic growth rate will continue to register considerably negative performance. If China’s economy, the second largest in the world, twice the size of Japan’s, were to lapse into a meltdown situation such as this one, the effect would more than likely send the world economy into a tailspin. Its impact could be the worst the world has ever seen."



Translated: Daiwa just made a Chinese "meltdown" and global economic "tailspin" its "realistically speaking, the most likely", base case scenario.

And here we were thinking our calls (since 2011) that China's debt and excess capacity bubble would negatively impact global growth, are audacious.

The question, now that Daiwa has broken the seal on Chinese and global doomsday scenarios, is whether and how soon other banks will follow in Daiwa's path, and predict an armageddon scenario which sooner or later, becomes a self-fulfilling prophecy even without the help of China's increasingly clueless micromanagers.

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