Figuring out the public’s expectations of future
inflation—and trying to influence them—is core to any central banker’s work.
Yet Japan shows how hard that becomes when many people barely grasp the concept
of steadily rising prices.
“Those who were born in the 1980s and 1990s almost
have no experience of inflation. So even if they were told inflation was
coming, they didn’t believe it,” said Tsutomu Watanabe, a Tokyo University
professor and former central banker.
A 20-year-old in Japan today has
experienced average inflation of 0.1% over his or her lifetime. No wonder Bank of Japan Gov. Haruhiko Kuroda’s repeated vows to reach 2% inflation haven’t worked out.
The Federal Reserve, like the Bank of Japan, seeks 2%
inflation because it sees that level as consistent with a healthy economy. U.S.
inflation has held close to but below the target for years, and Fed officials
are reviewing their inflation targeting framework to avoid succumbing to the
low-inflation trap that has bedeviled Japan. Among the options under
consideration are approaches that would more explicitly allow or even encourage
inflation above 2% in hopes of lifting inflation expectations.
The problem, central bankers believe, is that
low-inflation expectations can be self-fulfilling if they cause consumers to
balk at higher prices and businesses to refrain from raising prices and wages.
“Inflation that runs persistently below our objective
can lead to an unhealthy dynamic in which longer-term inflation expectations
drift down, pulling actual inflation even lower,” Fed Chairman Jerome Powell
said at a Dec. 11 news conference.
In recent years, Mr. Kuroda has pointed to research
suggesting inflation expectations are adaptive: People predict future prices
based on what they have seen in recent years. In practice, that means Japanese
consumers have accustomed themselves to seeing everyday goods at low
prices and punish any retailer that tries to raise them.
Even consumers old enough to remember inflation might
not share a central banker’s 21st century perspective on it. To Messrs.
Powell and Kuroda, achieving modest, steady inflation of around 2% keeps a
nation away from a negative spiral of falling prices, declining wages and weak
demand. But to the average person, rising prices sound like a bad deal.
“When oil collapsed in 2014 under the weight of US shale production, it ushered in a new-found belief that prices would remain ‘lower for longer’.”
“The rampant new source of crude supplies was seen to be capable of meeting rising world demand almost single-handedly, obviating the need for extra Opec barrels ever again.”
“As such, the concept of a ‘shale price band’ emerged of roughly $40 to $55 per barrel, reflecting the range within which the majority of US shale producers could turn a profit without the risk of the industry growing so fast that it would again flood the market. And for the better part of three years, from 2015 to 2017, oil prices traded in this range.”
“But in 2018, this narrative has been slowly picked apart and is now in the process of disintegrating.”
“While there has been breathless attention paid to prompt Brent prices climbing to $80 a barrel for the first time since 2014, what has received less attention is that the entire Brent forward curve is now trading above $60, including contracts for delivery as far out as December 2024.”
“This development is an important psychological milestone for the oil market. The market is, in effect, saying that ‘lower for longer’ is dead.”
“The reality is that US shale has been unable to meet rising global oil demand, which has averaged 1.7m b/d per year since 2014 — double the level at the start of this decade — and inventories have drawn down as a consequence, eliminating the buffer that had been built up.”
“This inventory fall has been helped by strong demand growth and the Opec/non-Opec deal to curtail output since January 2017, which has since been superseded by rapid declines in Venezuelan and Angolan production and, more recently, non-Opec production outside of the US.”
“The inevitable supply deficit is very worrying, with very limited spare production capacity available globally.”
“Two main themes are now starting to impact investor thinking and drive the new-found interest in exposure to energy.”
“First, recent supply data are finally reflecting the ill effects from under-investment due to the collapse in capital expenditure since 2015. The data are now showing accelerating decline rates across important suppliers such as Brazil, Norway and Angola.”
“Second, the impressive strength in demand has been overshadowed in the past two years by the narrative dominated by electric cars.”
“But slowly this has given way to a recognition that while electric cars will undoubtedly alter the trajectory for global oil demand in the long term, this trend will not reach critical mass in the medium term (the next five years) to sufficiently make up for the expected fall in oil supplies due to the lack of investment.”
“So, even though expectations are for oil demand growth to slow from current levels, consumption will still be robust enough that — barring a major recession — the market will need new supplies to meet that growth.”
“The physical oil market is only going to face greater strain ahead of the marine fuel specification change in 2020, which is set to boost demand for products such as diesel and ultra-low sulphur fuel oil by 2m to 3m b/d.”
“As a result, we believe that oil prices may spike to above $100 per barrel, a price forecast we have held for the latter half of 2019 for three years now.”
“The shale price band has been decisively broken and 2018 will be a watershed year: the market will realize that US shale alone cannot meet the world’s incremental demand growth and future prices must rise to re-incentivize long-cycle investments (or curtail demand).”
“Nothing ever moves in a straight line, but the broader oil market is perhaps not prepared for what will happen to oil prices over the next couple of years.”
“The age of the unicorn likely peaked a few years ago. In 2014 there were 42 new unicorns in the United States; in 2015 there were 43. The unicorn market hasn’t reached that number again. In 2017, 33 new U.S. companies achieved unicorn status from a total of 53 globally. This year there have been 11 new unicorns, according to PitchBook data as of May 15, but these numbers tend to move around, and I believe the 279 unicorns recorded globally in late February by TechCrunch was the peak, where the start-up bubble was stretched to its limit.”
“A recent study by the National Bureau of Economic Research concludes that, on average, unicorns are roughly 50% overvalued. The research, conducted by Will Gornall at the University of British Columbia and Ilya Strebulaev of Stanford, examined 135 unicorns. Of those 135, the researchers estimate that nearly half, or 65, should be more fairly valued at less than $1 billion.”
“Don’t let the few recent successes in the 2017 IPO market fool you. After two years of stagnation in terms of the number of IPOs being filed in the United States — 275 IPOs (2014), 170 IPOs (2015) and 105 IPOs (2016) — deal counts have dropped to their lowest figure since 2012.”
“Seventy-six percent of the companies that went public last year were unprofitable on a per-share basis in the year leading up to their initial offerings, according to data compiled by Jay Ritter, a professor at the University of Florida’s Warrington College of Business, and recently featured in The New York Times. This is the largest number since the peak of the dot-com boom in 2000, when 81% of newly public companies were unprofitable.”
“The current volatility and correction evolving in the private market will be amplified for companies that have yet to make money and are burning cash faster than they’re bringing it in. Growth at all costs will not weather an economic storm.”
“Since the Snap IPO in March 2017 at $17 a share, when its shares surged 44% during its first day of trading, they have now declined to $11. Dropbox also went public. It had a first-day pop of 36%; however, with only 200,000 paying customers compared to its 500 million users, I would be hesitant to rush in to buy, even as it comes off that year-to-date high considerably. Another highly valued start-up, Blue Apron, went public at $10 a share in June and is now trading at $3. Remember Fitbit was a $45 stock in 2015 — it’s currently trading at just over $5.”
“Multiple signs of inflation in freight-related industries are at or near historical highs, in what could be an early sign that price pressures are building and ready to reverberate around the economy.”
“Freight marketplace DAT keeps track of supply and demand in the freight industry through a bulletin board that matches companies with loads to be delivered to the vehicles that will take the goods to the marketplace. The measures are in the spot market, where vendors that don’t contract their deliveries find drivers for their products.”
“Recent readings show demand for vehicles skyrocketing, a sign that generally points to inflationary pressures building up in the supply chain.”
“Loads on the spot market in general are up 100% from the same period a year ago. Another measure, the flatbed load-to-truck comparison, which tracks the amount of vendors looking for flatbeds and is generally the highest of all truck types, is up 142%.”
“The numbers by themselves, though, don’t indicate that inflation is ready to strike soon. Indeed, the most recent readings, such as the consumer and producer price indexes, show inflation pressures rising though relatively benign.”
“But they do jibe with some other indicators showing inflation is rising beneath the surface.”
“The US’s banks have largely sat out the mergers and acquisitions wave of recent years. While deal records have fallen in almost every other sector, big banks have done almost nothing, shrinking rather than expanding. And merger activity among small and mid-sized banks — some 5,607 of them, at last count — has been subdued.”
“But when Fifth Third Bancorp of Cincinnati revealed its $4.7bn swoop for Chicago’s MB Financial on Monday morning, shares in other Chicago-area banks began to move, too. Wintrust, a similar-sized bank based in Rosemont, Illinois, ended the day up almost 4%, while First Midwest of Itasca closed up 3%.”
“The implications were obvious: after years of thin activity in bank M&A, this deal could mark a turn.”
“The conditions for dealmaking look better than at any time since the financial crisis. Higher interest rates and lower taxes have pumped up bank profits, giving management teams stronger platforms from which to contemplate doing something radical.”
“Oil has had a leading role in geopolitics over the past 100 years, sucking western powers into an often disastrous dependence on the Middle East.”
“While black gold, as oil is sometimes known, is not always the overt cause of conflict, it is linked to between one quarter and a half of all interstate conflicts globally between 1973 and 2012, according to a 2013 study by Jeff Colgan of Brown University.”
“But it would be a mistake to assume that geopolitical tensions will miraculously ease in a future in which renewable energy sources dominate. Building wind turbines and creating lithium-ion batteries requires metals and raw materials from those countries which are blessed, or potentially cursed, with them.”
“And for some of these commodities, their high concentration in particular parts of the world sharpens the risks.”
“A clean energy economy will require a staggering volume of metals to be prized from the ground.”
“For example, Olivier Vidal of the University Grenoble Alpes estimates that to build the infrastructure for clean energy the amount of copper needed amounts to almost half the total mined since 1900.”
“There is also the real risk that the age of the electric car will generate corporate monopolies, echoing those of Standard Oil whose founder John D Rockefeller cornered the oil market more than a century ago as the combustion engine took off.”
“Glencore, the Switzerland-based and London-listed miner, is expanding its production of cobalt which is set to give it a 40% share of global supply by 2020.”
“The production of lithium, a key ingredient for batteries in electric cars as well as smartphones, is controlled by just five companies.”
“However, rather than tensions with the Middle East, the advent of the electric car will usher in greater friction with China. Beijing’s ambitions in clean energy are enormous.”
“As part of the ‘Made in China 2025’ plan to advance high-end manufacturing, the government wants to establish a grip on the production of electric cars and clean energy technology.”
“The rest of the year will provide further signs of the capital and scale that China is bringing to this competition.”
“No one is giving China a free run at the metals that have emerged as central to electric cars.”
“Trade tensions with US President Donald Trump are already brewing. This month his administration released a list of 35 minerals, including lithium and cobalt, that are ‘considered critical to the economic and national security of the United States.’”
“Chile, which has the world’s largest lithium reserves, is looking to build battery components, while South Africa, a producer of vanadium, wants to produce electrolytes for vanadium batteries, which are used to store energy for the electric grid.”
“Europe, too, is beginning to build its own giant battery factories to supply Germany’s car companies and the UK’s innovation agency has backed a study that uses satellites to look for lithium in Cornwall.”
“The geopolitics of the era of the electric car are in their infancy. While it is unlikely to lead to military conflict, the tensions, especially with China, over who will control the resources and technologies that will underpin electric cars will be heightened.”
“Over the long term, the winners are likely to be those countries and companies that can develop battery technology that relies on materials that are abundant rather than scarce. It might even help make the geopolitics a little less fraught.”
“Malaysia has paid almost RM7bn ($1.8bn) to service debt owed by 1MDB, the south-east Asian nation’s finance ministry said on Tuesday, as investigators ratcheted up their probe into the state investment fund from which $4.5bn is alleged to have gone missing.”
“Two weeks after voters ousted the government of Najib Razak, the finance ministry said it had been ‘bailing out’ the 1Malaysia Development Berhad fund since April 2017, adding that another RM144m interest payment was due on May 30.”
“The revelation ‘confirms the public suspicion that 1MDB had essentially deceived Malaysians by claiming that [the payments] have been paid via a ‘successful rationalization exercise’,’ the ministry said in a statement. ‘All the while it has been the MoF [ministry of finance] who has bailed out 1MDB.'”
“Earlier on Tuesday, Malaysia’s new anti-corruption chief said he had been harassed and received a death threat after he pursued a 2015 investigation into 1MDB.”
“In 2016 — as global crude oil prices fell to about $40 per barrel — India, which imports nearly 80% of its petroleum, levied new excise duties on petrol and diesel to stabilize prices and prevent a surge in demand.”
“Since then, New Delhi has come to depend heavily on those revenues to shore up its fragile public finances, especially as receipts from the goods and services tax introduced last year have failed to stabilize at expected levels.”
“But after global crude oil prices hit a four-year high of more than $80 per barrel last week, India’s fuel pump prices — for decades subsidized by the government and held artificially low — have jumped to among the highest in south Asia.”
“Industry groups are pressing New Delhi to pare back excise duties on fuel, warning that the high prices will undermine an economy only now recovering from the successive disruption of a dramatic cash ban and the introduction of the goods and services tax.”
“But any meaningful rollback to ease pressure on consumers will raise doubts over the ability of Mr Modi’s administration to meet its target of cutting the fiscal deficit to just 3.3% of gross domestic product.”
“’India’s reliance on oil revenue has now surpassed the Malaysian government’s reliance on oil revenues — and Malaysia is an oil exporter,’ said Vikas Halan, senior vice-president at Moody’s Investors Service, the rating agency. ‘The government can always roll back excise duty — there is no one stopping them — but the issue is, how will they compensate for the loss of revenue?’”
“Last year, excise duties on petroleum products, which are about a quarter of the retail price of petrol and diesel, accounted for 17% of New Delhi’s total revenue collection. For every R1 that the government pares back these excise duties, it will lose an estimated $1.8bn in revenues, or about 0.1% of annual GDP.”
“Adding to the overall pressure is the recent weakening of the Indian rupee, which has fallen 6% this year to a 16-month low of Rs68.1 per dollar. Further depreciation will mean even higher local fuel prices. Bond markets are also jittery, with yields rising.”
“Spaniards have become richer than Italians — a heartening indication of Spain’s economic revival but a worrying sign for Italy, the eurozone’s third-largest economy, which is stuck in political gridlock.”
“Spain’s per capita gross domestic product exceeded that of Italy in 2017, according to IMF data published this week that compare countries on a so-called ‘purchasing power parity’ basis. The IMF also forecast that Spain would become 7% richer than Italy over the next five years. A decade ago Italy was 10% richer on the same basis.”
“By 2023 some former Soviet bloc countries, including Slovakia and the Czech Republic, are also expected to become richer than Italy on a per capita basis, the IMF forecasts show.”
“Italy’s stagnation is one of the main causes of the country’s increasingly bitter political divisions, with the electorate losing faith in the ability of its traditional parties to create jobs and restore growth. Anti-establishment and protest parties emerged as the big winners of Italy’s inconclusive general election last month, where voters deserted more moderate center-left and center-right forces.”
“Italy’s underperformance — and in particular any threat to its ability to service its debt, the largest in the eurozone after Greece’s relative to the size of the economy — is also seen as one of the biggest risks for the single-currency area.”
“The fact that Spain has overtaken Italy owes more to Italy’s problems than Spain’s economic progress, which has only recently gathered pace.”
“At the end of the 1990s, Italy — which now has almost 15m more people than Spain — had an economy twice as large as that of Spain. It is now only 50% larger and the difference is expected to shrink even further in the next five years.”
“Back in 1997, Italy was the 18th richest economy on a per capita basis among the countries for which the IMF has a complete data set. After 10 years, its ranking dropped 10 positions — and it has now slipped five more positions in the decade to 2017.”
“By 2023 Italy is expected to be only the 37th richest country on a per capita basis.”
For the world to attain lower carbon dioxide emissions, the oil majors will need to be leaders in this initiative. They’ve taken on the charge to some degree committing larger sums to renewable energy sources; however, it’s hard when they’re so good at making money with carbon dioxide emitting sources.
“Assets managed by SWFs globally reached $7.45tn spread across 78 funds as at March 2018, an increase of $866bn, or 13%, over the past 12 months, according to data provider Preqin.”
“A recovery in oil prices and strong gains for equity markets drove the increase in assets, which will come as welcome news to investment managers as SWFs are among their most prestigious clients. SWFs pulled about $85bn from asset managers over the 24 months ending on December 16 as low oil prices forced governments in the Middle East to raid these rainy-day funds to prop up public spending.”
“Opinions differ on the exact nature of Tesla, ranging from struggling car manufacturer to tech pioneer to something akin to the second coming. Regardless, it is undoubtedly one thing: a money machine.”
“I don’t mean that in the sense of Tesla making a lot of money; more that it is a machine for the raising and consumption of money.”
“All companies are this to one degree or another, of course; it’s just that Tesla Inc. is more at the ‘another’ end of things. Reliably negative on free cash flow, Tesla depends on a smorgasbord of external funding, from equity raising to vehicle deposits to high-yield bonds to securitized leases to negative working capital. And that smorgasbord rests, of course, on Tesla’s famously gravity-defying stock price and faith in CEO Elon Musk.”
“Which is why these four charts deserve more than a glance from even the most ardent Muskovite:”
“We’re just over a week away from knowing whether or not Tesla has hit its (much reduced) target for producing 2,500 Model 3s per week by the end of the first quarter. The signs thus far aren’t good, which also raises doubts about the 5,000-a-week target for the end of June.”
“Hitting these targets matters for the Tesla money machine on three fronts.”
“First, reducing that risk-laden reliance on negative working capital and getting a return on the money already spent on production lines relies on producing more cars. Second, analysts currently expect Tesla to burn through $2.7 billion of cash this year — and analysts tend to be optimistic on this stuff. Third, when Moody’s rated that bond Tesla sold last August, it was assuming 300,000 Model 3 deliveries this year, which now looks far out of reach.”
“In other words, Tesla’s money machine will almost certainly need to raise more this year due to the Model 3’s problems — but those same problems undermine the pitch for selling more equity or debt.”
“This is happening against a backdrop of rising interest rates. Tesla’s debt has jumped in recent years, especially after it took on SolarCity Corp.’s obligations. Interest expense more than doubled in 2017 and reached the astounding level of one-third of gross profit in the final quarter of 2017:”
“At the same time, Tesla is moving closer to a maturity wall, with $3.7 billion of bonds and credit lines needing refinancing by the end of 2020.”
“Some $1.7 billion of that consists of three convertible bonds falling due between this coming November and the next one. Almost half of it — inherited from SolarCity — is hopelessly out of the money, with conversion prices starting at $560 (Tesla closed Thursday at $309 and change). The rest of it, a $920 million convertible due next March, sports a conversion price of just under $360; still underwater but within sight of the surface.”
“Converting that last one to equity would dilute Tesla’s free float by 2%. But that could be more palatable than the alternative of replacing it with a straight bond.”
“As of now, those three bonds pay a weighted-average coupon of just over 1%, or about $18 million a year. All else equal, assuming they were all refinanced at spreads similar to where Tesla’s 2025 bonds trade now, but factoring in the forecast increase in Treasury yields, that would jump to 7%, or $120 million. Putting that in context, Tesla’s entire interest expense last year was $471 million.”
“A rebound in the stock price would take much of this pain away, of course.”
“Today, established carmakers flaunt their ability to manufacture all kinds of models, from hatchbacks to sport utility vehicles, on a single production line. Their challenge is to revamp these operations to produce electric vehicles in high volumes, reinforcing barriers to entry in an industry under siege from technology companies and start-ups.”
“Instead of coming out with an array of unprofitable electric cars today, the incumbents are putting the bulk of resources into production facilities that will mass-produce models from 2020, once battery costs fall and economies of scale kick in. Analysts suggest this approach leaves the impression the incumbents are lagging far behind Tesla. But once the game actually starts, say experts, the carmakers will be in a strong position to dominate the market.”
“’None of the traditional car manufacturers will have problems scaling up electric vehicle production,’ says Klaus Stricker, co-head of the global automotive practice at Bain & Company. ‘That’s exactly what they do best’.”
“Yet if the stock market is any guide, investors are more skeptical. Valuations of the big carmakers are among the most depressed on the S&P 500, Germany’s DAX and Japan’s Nikkei indices, according to Bernstein. Yet Tesla is valued like its products are set to dominate the car market the way Apple conquered mobile phones.”
“Tesla’s market value of $55bn is about $2.3bn more than GM’s, though for every car it built last year the latter group produced 100.”
“Tesla’s production troubles are a reminder that in automotive history, it is how to build cars, rather than the merits of any particular model, that is key to success. After Ford displaced craft production with mass assembly in 1908, it was overtaken by GM in the 1920s with ‘flexible mass production’ that could produce an array of models, from entry-level to luxury brands, and respond to customer preferences. In the 1980s, both companies were disrupted by Honda and Toyota’s methods of lean production. The Japanese groups outsourced a majority of tasks previously considered critical. With parts arriving ‘just in time’ on the assembly line, they largely did away with inventories.”
“The success of German manufacturers, whose volumes more than trebled from 4m units in 1990 to 15m last year, was largely based on ‘platform sharing’ that let multiple models use the same design underpinnings. VW Group, the world’s largest carmaker, uses common building blocks under ‘the Lego principle’ to share engines, transmissions and components across its 12 brands.”
“These progressive changes were all based on superior methods of producing cars, forcing rivals to adapt or die. ‘Efficiency was always the cornerstone of success in the automotive industry,’ says Oliver Zipse, head of production at BMW. ‘As soon as you were not able to produce in a particular cost frame, you were out of the market’.”
“All of this suggests that average debt depends more on an individual’s choices than where he or she lives. People can achieve extremely low debt levels if they are in expensive urban areas or rural towns. If both the bureaucrats in Washington, DC and frontiersmen in Alaska can do it, then we bet you can too.”
Unless of course you live in Hawaii where the incomes are low and the cost of housing is high…
“You did not have to be a technophobe to worry that the virtual-currency boom of the past year papered over plenty of problems.”
“The scale of those problems is starting to become clear as digital tokens have slid more than 50% in value from their peaks in early January, with steep drops on Monday pushing the value of Bitcoin specifically below $7,000.”
“Hackers draining funds from online exchanges. Ponzi schemes. Government regulators unable to keep up with the rise of so-called cryptocurrencies. Signs of trouble have appeared at nearly every level of the industry, from the biggest exchanges to the news sites and chat rooms where the investment frenzy has been discussed.”
“’Cryptocurrencies are almost a perfect vehicle for scams,’ said Kevin Werbach, a professor at University of Pennsylvania’s Wharton School. ‘The combination of credulous buyers and low barriers for scammers were bound to lead to a high level of fraud, if and when the money involved got large. The fact that the money got huge almost overnight, before there were good regulatory or even self-regulatory models in place, made the problem acute.’”
“The fall from the peaks of early January has been dizzying. The value of all outstanding virtual currencies has been cut by more than half, down over $400 billion as of Monday, according to the website Coinmarketcap.com.”
“Government agencies in the United States have shut down a few notable frauds. Early last month, securities regulators in Texas and North Carolina issued cease-and-desist orders to BitConnect, an operation that had grown to be worth $3 billion.”
“But those moves only came after BitConnect had operated openly for months, collecting hundreds of millions of dollars from people around the world despite being labeled a Ponzi scheme by many prominent people in the virtual currency industry. BitConnect offered tokens on a decentralized network, similar to Bitcoin, but promised regular payouts to coin holders.”
“But regulators have not gotten near most of the brazen schemes that have popped up in the past year, many of which had been attacked by hackers first, or simply shut down by their operators after money had been raised.”
“A new virtual currency, Proof of Weak Hands Coin, whose creators referred to it as a Ponzi scheme on Twitter and use a pyramid as a website logo, raised $800,000 before hackers got into its systems last week and drained its funds.”
“One challenge facing regulators is that it is unclear how much of the deceptive activity they can legally control.”
“Some online groups openly try to manipulate the prices of digital tokens in what are known as pump-and-dump schemes. Similar schemes involving stocks are illegal, but people operating the groups recently told BuzzFeed that they did not think the same rules applied to virtual currencies.”
“Many schemes have been able to expand quickly because they do not use bank accounts and therefore do not have to win approval from established institutions. Instead, they are able to use virtual currency ‘wallets’ without any approvals. And virtual currency transactions cannot be reversed like normal bank or even PayPal transfers.”
“Traders have been particularly worried about the largest Bitcoin exchange in the world, Bitfinex, an unregulated operation that has provided few details about its operations, raising concerns about whether it is insolvent or involved in price manipulation.”
“But the biggest number of incidents have cropped up around so-called initial coin offerings, in which entrepreneurs sell custom virtual currencies to investors to raise money for software they are building. About 890 projects raised over $6 billion last year, a 6,000% increase over the year before, according to Icodata.io, which tracks the offerings.”
“The $240 million raised through one of the most successful initial coin offerings last year, Tezos, is already frozen in a dispute between the founders of the project and the board they created in Switzerland.”
“’It is a perfect storm for the kind of scammy activity we are seeing, and it’s not obvious to me how that is easily removed,’ said Fred Wilson, a partner at the venture capital firm Union Square Venture and one of the earliest advocates of Bitcoin in Silicon Valley. ‘Regulation, ideally prudent and informed regulation, can help. But we may also need to have a big correction to really clean things up’.”
Ms. Webb offers an interesting perspective at why inflation may not be that far away. Why…because the primary source of deflation – China – appears to have changed tact.
“For years, party officials have been incentivized to force growth out of their regions, regardless of the effects on prices, global macroeconomics or, for that matter, pollution. But in the party conference in October, Xi Jinping shifted emphasis.”
“Instead of focusing on growth, China’s leader talked of ‘three tough battles’: against preventing major risks (mainly financial — the new target is to be ‘further deleveraging’); poverty (Xi fancies a ‘moderately prosperous society’ in all respects); and pollution (he wants to see the sky blue again).”
“The result has been pretty instant. Almost as the delegates headed home, say the analysts at Gavekal, prices of natural gas (a ‘clean fuel’) doubled; steel output stalled; and cement sector output actually fell even as demand for it and hence prices rose. China doesn’t seem to be adding new capacity to the global economy in the way that it was and that should mean it isn’t exporting deflation to the rest of the world any more either.”
“That is a dynamic that is arguably beginning to show up everywhere else. The slack is disappearing. There is no spare capacity left in Japan (or you would see new cuts to it). Industrial production in the US hit a record high in December, despite the US being too busy with buybacks and financial engineering over the past decade to build new capacity. Manufacturing output in the UK is at its highest in 10 years.”
“This could all lead us to several interesting conclusions. The first, highlighted by Gavekal, is that it is an explanation for the way stock markets in countries that have been hampered with too much productive space in the past are suddenly breaking out. See China, Japan and Korea — markets you might want to stick with for a bit.”
“The second is that, guess what, the boom in the US might not be entirely down to Donald Trump’s policies. The factories could be humming because global capacity constraints are being hit rather than because he’s the best economic manager ever. And the third is that the real inflation our great leaders (the central banks) think is impossible however much they might print, isn’t impossible at all.”
“Just before payday, an email went out to employees from top executives: Give us your money, and we’ll make it worth your while.”
“It was one of many pitches by HNA Group, a Chinese conglomerate struggling under an estimated $90 billion in debt accumulated during a global shopping spree that included buying stakes in multinationals like Hilton Hotels and Deutsche Bank.”
“The company, in an email, advertised an ’employee treasure’ product with an 8.5% return if workers handed over $1,500. A similar one dangled 9%. A third mentioned a return as high as 40% if employees ponied up $15,000.”
“These pitches, more than a dozen of which were reviewed by The New York Times, were not part of an employee stock program. Instead, they appear to be high interest loans, with the company as borrower and its workers as lenders.”
“The conglomerate has seen its borrowing costs rise sharply on the global bond market in recent months, an indication that some investors are increasingly worried about the company’s ability to pay its debts. Seven public companies under the umbrella of HNA have suspended trading of their stock, suggesting that big announcements that could affect key businesses are in the works. The company is also starting to sell assets.”
“It is unclear how much money HNA has raised from employees. The company has long offered such investments to its employees as a way to incentivize them and to share in the company’s success, Thomas A. Clare, an attorney for HNA, said in an email.”
“Companies around the world allow employees to buy stock or provide other ways for workers to invest in the business. But the HNA pitches do not offer direct ownership stakes in the business.”
“The offers reviewed by The Times had similar hallmarks, namely high returns for funding certain operations.”
“Chinese companies have often turned to individual investors or their own workers to raise money. But such moves, according to some China finance experts, can signal problems.”
“’It’s a desperation measure when companies really have no other source of financing and they are stuck,’ said Anne Stevenson-Yang, co-founder of J Capital Research, a corporate research firm.”
“A small company in the southeastern Chinese city of Wenzhou called Wenzhou Liren Educational Group made national news in 2011 after it went bankrupt and was unable to pay nearly $790 million it borrowed from employees and local residents. In 2015, an online peer-to-peer platform called Great Group pressured employees to buy investments in order to raise funds when it found itself in a financial bind, the Chinese news media widely reported. The two companies did not respond to requests for comment.”
“As HNA has faced more questions about its operations by both the local and foreign media, the company has issued groupwide emails urging employees to not speak to reporters. In January, HNA’s human resources department told employees they would be required to take a test on how to deal with the news media, according to an internal document reviewed by The Times.”
“Suncor Energy Inc said on Wednesday that it expected to cut some 400 heavy-equipment operator positions over the next six years as it rolls out a fleet of self-driving trucks at its Canadian oil sand mining operations.”
“There’s usually two forms of ideological rhetoric that accompany low interest rates. The first is that the Fed has ‘manipulated’ interest rates lower. And the second is that the Fed is ‘punishing savers’. These myths have scared people away from stocks and bonds and left them frozen in cash or worse, chasing commodities and gold. So let’s take a look at each of these ideas because some clarity might help put things in a more practical perspective.”
“The US government bond market has further soured this week, with Treasuries selling off across the spectrum. When bond prices fall, yields rise. For example, the two-year Treasury yield rose to 2.06% on Friday, the highest since September 2008.”
“In the chart, note the determined spike of 79 basis points since September 8, 2017. That was the month when the Fed announced the highly telegraphed details of its QE Unwind.”
“The ten-year yield – the benchmark for financial markets that most influences US mortgage rates – jumped to 2.66% late Friday.”
“This is particularly interesting because the 10-year yield had declined from March 2017 into August despite the Fed’s three rate hikes last year, and rising short-term yields.”
“At 2.66%, the 10-year yield has reached its highest level since April 2014, when the ‘Taper Tantrum’ was winding down. That Taper Tantrum was the bond market’s way of saying ‘we’re shocked and appalled,’ when Chairman Bernanke dropped hints the Fed might eventually begin tapering what the market had called ‘QE Infinity’.”
“The 10-year yield has now doubled since the historic intraday low on July 7, 2016 of 1.32% (it closed that day at 1.37%, a historic closing low):”
“Friday capped four weeks of pain in the Treasury market. But it has not impacted yet the corporate bond market, and the spread in yields between Treasuries and corporate bonds, and particularly junk bonds, has further narrowed. And it has not yet impacted the stock market, and there has been no adjustment in the market’s risk pricing yet.”
“But it has impacted the mortgage market. On Friday, the average 30-year fixed-rate mortgage with conforming loan balances ($417,000 or less) for top-tier borrowers, according to Mortgage News Daily, ended at 4.23%, the highest in nine months.”
“But historically, 4.25% is still very low. And likely just the beginning of a long, uneven climb higher.”
“And the impact on mortgage payments can be sizable. When rates rise for example from 3.5% to 4.5%, the payment for a $250,000 mortgage jumps by $144 to $1,267 a month (a 13% increase).”
“A one-percentage-point increase takes on larger proportions in a place like San Francisco, where it might take a mortgage of $1.25 million to buy a median home. At 3.5%, the monthly payment is $5,613. At 4.5%, it jumps to 6,334, an increase of $721 a month and an increase of $8,652 a year.”
“A mortgage rate of 4.5% is still very low! And it is likely headed higher.”
“Since the Financial Crisis, the ultra-low mortgage rates were among the factors that have caused home prices to soar. But as rates are heading higher, the housing market is in for a big rethink. These higher rates are going to be applied to the now prevailing sky-high home prices.”
“There’s another aspect to this equation: Homebuyers who are willing and able to stretch to cough up those higher mortgage payments can’t spend this money on other things. Falling mortgage rates gave a huge boost to home prices and to the entire economy in numerous ways. But that process will go into reverse.”
“The city set a value of $1.26 trillion for its more than one million properties for the fiscal year beginning in July, an increase of 9.4% over the previous period that promises to boost the government’s tax collections.”
“Residential and commercial property value in Brooklyn rose 12%, the most of New York’s five boroughs, to $335.5 billion, according to the city’s finance department. Manhattan property rose 7.3% to $483.6 billion, the slowest growth.”
We’ll see if the values hold up in Brooklyn as rents – hence revenues – soften; see below.
“’It’s the greatest shock to the affordable-housing system since the Great Recession,’ said Michael Novogradac, managing partner of Novogradac & Company, a national accounting firm based in San Francisco.”
“According to an analysis by his firm, the new tax law will reduce the growth of subsidized affordable housing by 235,000 units over the next decade, compounding an existing shortage.”
“Chinese house prices have been booming for two years and shares of the country’s home builders—which have made big leveraged bets on the market—have likewise been on a tear. The question now, as the market shows signs of cooling, is: Should they hold or fold?”
“Some of the sector’s best performers are also the most indebted. Shares in China Evergrande, which sits on net debt of $63 billion, have surged nearly six times in value since the beginning of 2017 (this has led to the company’s chairman – Hui Ka Yan – becoming the wealthiest person in China). Likewise, Sunac China’s shares have risen more than five times in the same period. Its net debt is equivalent to four times its equity, while the ratio is 240% for Evergrande. The average for U.S. real-estate firms, by contrast, is 96%, according to S&P Global Market Intelligence.”
“There have been signs of developers deleveraging. Evergrande raised a total of $20 billion last year by selling about a third of its property business in three rounds—the latest in November. Sunac raised $1 billion from issuing new shares last month.”
“More remedial action will be needed if the cooling of China’s housing market continues. Data this week showed housing prices in China ticked up slightly in December; but growth is much slower now than a year ago, and prices are heading down in major markets such as Beijing. Lower revenues mean developers will have to reduce their already sky-high debt-servicing costs: Evergrande’s interest bill in the first half of last year was equal to about half its operating profit, for example. The company has reported negative operating cash flow ever since it was listed in 2009.”
“Digital currencies and the software developed to track them have become attractive targets for cybercriminals while also creating a lucrative new market for computer-security firms.”
“In less than a decade, hackers have stolen $1.2 billion worth of Bitcoin and rival currency Ether, according to Lex Sokolin, global director of fintech strategy at Autonomous Research LLP. Given the currencies’ explosive surge at the end of 2017, the cost in today’s money is much higher.”
“Blockchain records are shared, making them hard to alter, so some users see them as super-secure. But in many ways they are no safer than any other software, Matt Suiche, who runs the blockchain security company Comae Technologies, said in a phone interview.”
“And since the market is immature, blockchains may even be more vulnerable than other software. There are thousands of them, each with its own bugs. Until the field is winnowed to a few favorites, as happened with web browsers, securing them all will be a challenge.”
“Many blockchains started as forks that diverged from existing crypto ledgers, and as Taiwanese security researchers have pointed out, every fork gives hackers a new way to try to falsify data.”
“In a Dec. 25 paper, researchers at the Institute of Electrical and Electronics Engineers outlined ways hackers can spend the same Bitcoins twice, the very thing blockchains are meant to prevent. In a Balance Attack, for instance, hackers delay network communications between subgroups of miners, whose computers verify blockchain transactions, to allow for double spending.”
“In short, a water crisis — whether caused by nature, human mismanagement, or both — can be an early warning signal of trouble ahead. A panel of retired United States military officials warned in December that water stress, which they defined as a shortage of fresh water, would emerge as ‘a growing factor in the world’s hot spots and conflict areas’.”
“’With escalating global population and the impact of a changing climate, we see the challenges of water stress rising with time,’ the retired officials concluded in the report by CNA, a research organization based in Arlington, Virginia.”
“Crude oil production fell 12% in December from the month before, according to government figures released Thursday. Over all of 2017, output was down 29%, among the steepest national declines in recent history, driven by mismanagement and under investment at the state oil company, say industry observers and oilmen.”
“The drop is deeper than that experienced by Iraq after the 2003 war there—when the amount of crude pumped fell 23%—or by Russia during the collapse of the Soviet Union, according to data from the Organization of the Petroleum Exporting Countries.”
“’In Venezuela, there is no war, nor strike,’ said Evanán Romero, a former director of government-run Petróleos de Venezuela SA. ‘What’s left of the oil industry is crumbling on its own’.”
It appears there is no “too big to fail” in South Korea. US inflation coming only from a few unproductive sectors. China’s credit hose targeted at housing.
Headlines
NYT – Oceans Are Absorbing Almost All of the Globe’s Excess Heat 9/12. “Since 1955, more than 90% of the excess heat retained by the Earth as a result of increased greenhouse gases has been absorbed by the oceans, leaving ocean scientists like Eric Leuliette at the National Oceanic and Atmospheric Administration feeling that 90% of the climate change story is being ignored.”
“Yields on “junk”-rated euro-denominated debt hit a record low of 3.35% last week.”
“Traditional signals of risk aren’t as reliable as they might be in markets that have been so distorted by central-bank policies.”
“Take the developments in junk bonds. Ultralow yields and issuance of PIK (payment-in-kind) notes might usually suggest a market that is too bullish for its own good. Demand was so strong for Schaeffler’s (bearings maker) sale that it was able to sell €3.6 billion of debt in euros and dollars, versus an originally planned €2.5 billion; in the process it refinanced debt that carried rates ranging from 5.75% to 6.875% with notes paying from 2.75% to 4.75%. Moreover, it Ardagh’s (packaging group) case, some of the proceeds were used to pay a dividend to shareholders, another sign that borrowers have the upper hand.”
“Retail sales in Hong Kong fell by 10% in the first seven months of the year, compared with the same period in 2015, with purchases of jewelry and watches declining by 22%.”
“‘Our customer flow has dropped 60-70%’ since the peak of Chinese luxury spending in 2013, says manager (Kingdom Jewelry) Jacky Sze. ‘I don’t have much hope for the rest of this year, or next.'”
First there was the failed coup d’etat on President Recep Tayyip Erdogan, now there is the purge of detractors and then sum…
For those not familiar, the coup is being blamed on the Gulen community, aka the cemaat, an Islamist sect that promotes an interchange/dialogue with science. The imam that founded the movement is Fethullah Gulen who now lives in Pennsylvania.
Over 100,000 Gulen sympathizers have been rounded up so far.
“According to one minister, the state has seized more than $4 billion-worth of Gulenist assets.”
And following on the maxim to ‘never waste a good crisis.’ President Erdogan is also targeting Kurdish minorities.
However, for a little bit of context, the “secular Turks (of which President Erdogan is one) have no love for the Gulenist, who targeted them in their own purges in the 2000s.”
“Of the biggest 12 shipping companies that have published results for the past quarter, 11 have announced huge losses. Several weaker outfits are teetering on the edge of bankruptcy.”
“The industry could lose as much as $10 billion this year on revenues of $170 billion, reckons Drewry, a consultancy.”
Essentially, two primary forces are at play 1) world trade is down/slowing and many multinationals are creating manufacturing operations near their customers, and 2) there is overcapacity in the industry from the recent commodity boom.
As a result, “sending a container from Shanghai to Europe now costs half of what it did in 2014.”
“All told, the primary effect of monetary policy since 2008 has been to transfer wealth to those who already hold long-term assets – both real and financial – from those who now never will. This week’s debt sale reinforces this. Henkel and Sanofi are not borrowing at negative interest rates to invest in new productive facilities. Both companies have large cash piles, and the cash generated from their operations far exceeds their investment needs.”
“Mongolia was a darling among emerging markets during the commodities boom. Foreign miners flocked to exploit the mineral wealth under its grasslands and deserts, pushing up growth in gross domestic product by 17% in 2011. But after a debt-fueled spending spree at the peak of the cycle, the landlocked country is now one of the worst hit by the downturn.”
“Mongolia’s efforts to extricate itself highlight the dangers of the ‘resource curse’ – the notion that countries blessed with tremendous natural resources find themselves at the mercy of wealth-destroying boom-bust cycles.”
“Hanjin’s move to seek bankruptcy protection last month was the first time a big container shipping line had done so for 30 years, and it caught out many in the industry. As recently as a couple of months ago, shipping executives considered the failure of Hanjin Shipping – the world’s seventh-largest container line and South Korea’s largest – unthinkable.”
“Hanjin Shipping and its rival Hyundai Merchant Marine handled the bulk of South Korea’s exports, which account for more than half of the country’s $1.4tn economy.”
“Until now, Seoul has spent decades keeping lossmaking companies afloat with cheap state loans. In the case of its embattled shipbuilders, it has injected billions of dollars, despite next to no progress in turning them around.”
“How Seoul ultimately handles Hanjin Shipping’s collapse will set the tone for future restructuring of Korea Inc.”
“Many of the country’s smokestack industries – including steel, chemicals and construction – are similarly suffering from overcapacity.”
“The government has set up the principle that it will no longer support ailing companies with taxpayers’ money just because they are too big.” – Yoo Il-ho, South Korea’s finance minister
Since 1990 “…the bulk of the growth in employment can be attributed to a few sectors where productivity is either low or unmeasurable, a whopping 88% of the total rise in the price level boils down to four sectors of the US economy.”
“In January 1990, those four product categories only accounted for 30% of the money spent on consumption by the average American.”
And within education the main culprit has been the textbook. Akin to prescription drugs, supply in both industries is tightly controlled by regulation.
“By contrast, thanks to astounding technological innovation, television prices have plunged at an average rate of 12% each year since 1990 and computer prices have fallen more than 18% per year.”
“In general, the prices of durable goods are about a third lower now than in 1990, while the prices of nondurable goods excluding commodity products (food, drinks, and fuel, which tend to rise at the same rate as the broader price level over time) and excluding prescription drugs, have also fallen, albeit not by as much. Inflation outside of healthcare and education has generally been modest, with the notable exception of a few small professional services such as tax preparation, lawyers, and funeral homes.”
“More than 70% of new loans in August were to households, much of that in the form of mortgages, going by historical averages, a remarkable shifting of the fire hose of credit. It also helps explain why China’s property market has raced higher despite broader economic worries.”
“China’s stock of mortgages stood at 16.9 trillion yuan ($2.5 trillion) as of June 30. Almost a quarter of that was built up in just the past year, according to ANZ. Mortgage loans outstanding now account for 18% of total loans, the highest since at least 2008.”
“Local regulators are imposing clampdowns on mortgage lending and property speculation in the hottest cities such as Shanghai and Shenzhen. They are right to do so, as this leg of China’s multi-decade property bubble is clearly being fueled by leverage in a way that it wasn’t in the past.”
