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Sunday, May 7, 2017

Economic Crisis: Central Banks Injected A Record $1 Trillion In 2017... It's Not Enough

Economic Crisis: Central Banks Injected A Record $1 Trillion In 2017... It's Not Enough
The latest economic crisis news...
Two weeks ago Bank of America caused a stir when it calculated that central banks (mostly the ECB & BoJ) have bought $1 trillion of financial assets just in the first four months of 2017, which amounts to $3.6 trillion annualized, "the largest CB buying on record." 


BofA's Michael Hartnett noted that supersized central bank intervention which he dubbed a "liquidity supernova" is "the best explanation why global stocks & bonds both annualizing double-digit gains YTD despite Trump, Le Pen, China, macro..."
To be sure, Hartnett's "discovery" did not come as a surprise to regular readers: back in October 2014, Citi's Matt King calculated that it costs central banks $200 billion per quarter to avoid a market crash, or as he put it:
For over a year now, central banks have quietly being reducing their support. As Figure 7 shows, much of this is down to the Fed, but the contraction in the ECB’s balance sheet has also been significant. Seen from this perspective, a negative reaction in markets was long overdue: very roughly, the charts suggest that zero stimulus would be consistent with 50bp widening in investment grade, or a little over a ten percent quarterly drop in equities. Put differently, it takes around $200bn per quarter just to keep markets from selling off.

Today we showed just what central bank buying looks like in practical terms when we demonstrated that the Swiss national Bank had purchased a record $17 billion in US equities in just the first quarter, bringing its total US equity long holdings to an all time high above $80 billion...

... in the process soaking up nearly 4 million AAPL shares in the first 3 months of the year.

On the surface, these sums appear vast; however in the latest weekly report by Deutsche's Dominic Konstam, the credit strategist finds something even more troubling: $1 trillion in central bank liquidity YTD - or roughly $250 billion per month -  is not enough.
The reason is two-fold: on one hand there is the stock of existing central bank assets that keeps growing at an exponential pace, which implies that central banks have to monetize ever more assets just to keep the system from becoming unstable, or "running to stand still" as Citi recently framed the growing problem; on the other hand, offsetting the "organic" expansion of central bank balance sheets is the decline in FX reserves among liquidity managers, the most famous recent episode of which is China's $1+ trillion drop in reserves which started in mid-2014 and has yet to conclude. Recall that global liquidity is defined in dollar terms "as the sum of all FX reserves, the fed’s balance sheet and the central bank balance sheets of the Eurozone, Japan, UK, China, India, Russia, Saudi, South Africa and Brazil."
So what happens when in addition to central bank liquidity one adds various other global liquidity components? Here is Konstam's troubling discovery:
Having accelerated for four straight quarters from 2015q4 to a local peak of +5.0 percent in 20167q4, q1 saw the first slowing to a year over year growth rate of just 2.23 percent. In absolute terms it was $29.5 trillion, almost unchanged from 2016q3. The main culprit (again) was FX reserves that sharply dropped by almost 1 percent versus a year ago, based on February data.
Worse, the Deutsche Banker forecasts that "the weak patch for global liquidity growth is likely to extend through to 2017q4 where even based on flat FX reserves ahead of ECB or Fed balance sheet changes, the current rate of ex Fed central bank liquidity growth should lift liquidity growth back to slightly over 5 percent year over year."
This is a problem because "5 percent is not a lot at a global level. It doesn’t accommodate faster nominal growth. And as the chart below indicates is consistent with relatively subdued bond yields. In 5y5y US Treasury terms a 3 percent rate seems a little elevated as is and is pretty much discounting liquidity growth closer to 10 percent, a level last seen in 2013."
But the biggest disconnect between liquidity and implied "fair value" is once again to be found in stocks:
Global equities tell a similar story but even more starkly; they appear to be discounting liquidity growth over 10 percent. This is another example of how the equity market seems to be discounting something very different from the bond market.

Why did Konstam make this analysis? Because, as he writes in his intro, "more than ever before in this tightening cycle we would suggest that the Fed faces the most delicate of balancing acts. There seems to be an almost automatic convergence on a June tightening with September also a possibility and then some kind of balance sheet adjustment. The ECB is widely viewed to be not far behind in terms of another taper and the possibility of an eventual depo rate increase (we think 15 bps priced by August 2018) as a quid pro quo for QE extension."
In other words, just like Hans Lorenzen from Citi warning one week ago, the market is blissfully ignorant of the threat that imminent global central bank tightening poses on risk assets, a risk neither ETFs, nor algos, nor CTA have considered.
Konstam's conclusion is that there are two outcomes: either asset prices drops, or central banks will ultimately be forced to inject even more liquidity. Here is his take on the former:
There are a couple of ways in which these disconnects can be resolved. But until they are, global central banks need to tread warily. One resolution is of course equities retreat and yields decline, recognizing the dearth of liquidity. Recently we have used broader liquidity indicators in the context of nominal output for the US, Europe, China and OECD in general to demonstrate that there is falling “excess” liquidity that always implies some kind of loss in real output momentum with a lag. This doesn’t necessarily mean outright declines in output growth but it would, for example, be consistent with weaker PMIs and typically puts a ceiling of where longer term yields can rise to. Specifically we find that yield momentum tends to decline implying, specifically for the US that 10s might be capped around the 2 ½ percent level with downside potential closer to 2 percent on a moderate loss of upward yield momentum.
And then the latter, which can be resolved by either QE4 (or more) or a sharp drop in the USD.
Another way we could see resolution would be an accelerated move higher in liquidity. This seems unlikely in terms of positive new accommodation by central banks, absent deterioration in observed growth or inflation. However it is possible if the dollar were to weaken which would reflate the dollar value of existing liquidity but also probably contribute to a faster recovery in FX reserves. The problem is that dollar rate correlation has remained stubbornly tight although as we have argued since Trump’s election, one senses that that correlation is less assured.... Recent weakness in the likes of iron ore, copper and oil are concerning. The weakness that we have seen in DXY, especially reflecting the European currencies, seems more to do with better growth expectations in Europe and relief around France politics. This will help global liquidity at the margin but Europe can ill afford a very strong euro and we think of this as more an idiosyncratic adjustment to the dollar rather than a US policy induced regime shift that sustains higher inflation."
The bottom line, however, boils down to the following chart first shown by Citi last September, demonstrating that the marginal cost of central bank liquidity injection is now negative...

... and is located in the lower right quadrant, something both markets and policy makers realize.
Which means that when stocks realize just how insufficient the record $1 trillion in central bank liquidity has become, central banks - which have stepped into every single market correction over the past 7 years with some "liquidity supernova" - will, for the first time since the financial crisis - be out of tools... something Janet Yellen appears to have realized some time ago.

How Governments Outlaw Affordable Housing

Authored by Ryan McMaken via The Mises Institute,
It's no secret that in coastal cities - plus some interior cities like Denver - rents and home prices are up significantly since 2009. In many areas, prices are above what they were at the peak of the last housing bubble. Year-over-year rent growth hits more than 10 percent in some places, while wages, needless to say, are hardly growing so fast. 
Lower-income workers and younger workers are the ones hit the hardest. As a result of high housing costs, many so-called millennials are electing to simply live with their parents, and one Los Angeles study concluded that 42 percent of so-called millennials are living with their parents. Numbers were similar among metros in the northeast United States, as well.

Why Housing Costs Are So High

It's impossible to say that any one reason is responsible for most or all of the relentless rising in home prices and rents in many areas. 
Certainly, a major factor behind growth in home prices is asset price inflation fueled by inflationary monetary policy. As the money supply increases, certain assets will see increased demand among those who benefit from money-supply growth. These inflationary policies reward those who already own assets (i.e., current homeowners) at the expense of first-time homebuyers and renters who are locked out of homeownership by home price inflation. Not surprisingly, we've seen the homeownership rate fall to 50-year lows in recent years. 
But there is also a much more basic reason for rising housing prices: there's not enough supply where it's needed most. 
Much of the time, high housing costs come down to a very simple equation: rising demand coupled with stagnant supply leads to higher prices. In other words, if the population (and household formation) is growing quickly, then the housing supply must also grow quickly — or rents will rise.
Moreover, where the housing gets built is a key factor. We cannot speak of housing supply for an entire metropolitan area. Metro areas are composed of a wide variety of employment centers and neighborhoods. The mix of employers and workers varies from place to place depending on tolerable commute times, local industries, and geography.
In an unhampered market, of course, as rents rise, housing developers will respond by building more housing where it's needed most — and thus potential prices are highest. Rents will then fall in those areas and developers will stop building housing — or build in other places — until rents rise again. Or, in response to rising rents, current homeowners will turn their homes into boarding houses. Others may build so-called mother-in-law suites over their garages. The number of ways to expand housing is actually quite long.
But, as everyone who's ever tried to do any of these things knows, we most certainly do not live in an unhampered market. In fact, the production of housing is one of the most regulated and micro-managed industries in the industrialized world.
City planners control what sort of housing can be built - and where - through zoning and land-use laws. These central planners tell us where housing must be single-family or multi-family. They tell us if you're allowed to rent out one of your bedrooms to a non-relative. They tell us if you can build an auxiliary housing unit on your property. 
With so much government planning at work, the effect has been rising home prices and a higher cost of living. And again, those who suffer the most tend to be those with the lowest incomes.
This is then made even worse by "urban renewal" schemes in which privately owned low-cost housing is bulldozed by governments to make room for trendy shopping districts or for government-owned or subsidized housing.

The Rise of Zoning and Land-Use Laws 

Prior to the rise of widespread zoning laws — which became especially popular after the Second World War — housing production was far more responsive to market demand. In areas where there was a housing shortage, many families rented out rooms to what was a booming industry of boarding houses in the nineteenth century and early twentieth century. Residential hotels were popular among the elderly and those living alone.
Over the past 100 years or so, thanks in part to control-freak Progressives who demanded "communistic" boarding houses be shut down, cities began to take over as planners who decided what sort of housing people were allowed to live in. 
Over time, this newfangled method of central planning has become immensely popular, and we can no longer say that city planners and local governments are forcing their vision on a disgruntled and resistant public.

Government Controls on Housing Are Very Popular 

Indeed, in many areas, it is the private-sector homeowners who most demand that every new townhouse, every new apartment building, and every new storefront be controlled, evaluated, and ultimately controlled by government bureaucrats.
Modern outer suburbs in most metro areas are notable for extremely detailed zoning. But even in traditionally more laissez faire inner areas (laissez-faire in terms of zoning) communities have been moving toward even more stringent zoning laws to prevent diversity and decentralization in land use.
We've all seen it at work over and over again in many of these older inner suburbs: A landowner realizes the housing demand has increased in the area and attempts to put a four-unit building where a single-family home once stood.
Naturally, this change will create more housing, bring down rents, and, of course, allow a private-property owner to exercise his rights as an owner. 
But, in many cases, the private-property owner quickly finds he has no such rights. 
The neighbors, who don't want to live near a row of townhouses or have more cars parked on the street will protest to the city government, demand a zoning hearing, and fight to ensure that only a single-family unit is allowed on the lot. In many cases, they'll use the increasingly-popular tactic of "downzoning" in which people who earlier bought property with the hope of developing it later will be robbed of their property rights. They'll be told: "sorry, that thing we once said you could do with your property — you can't do that anymore." This is done so that the community's other residents can maintain the status quo in that neighborhood until the end of time.
At the same time, employment continues to expand in nearby commercial areas, so employees — instead of living in inner suburbs — must move further and further outside the urban area and commute on taxpayer-funded roads. 
Nor is this problem limited to what many view as primarily residential areas. Even on major thoroughfares, nearby residents will protest new apartment buildings because they are believed to be unsightly, or will create more local traffic, are are simply something different they don't like.
The "solution" in this case is to shift traffic somewhere else — to the suburban freeways, for example — and shift the cost to statewide taxpayers who now must foot the bill for extending infrastructure ever further outward.
In all these cases, one group of voters uses the power of government to force costs onto some other group of voters in some other area — and onto the workers who must live further and further from employment. This is all done to save the "character" of the neighborhood. But it's really done because many homeowners have no qualms about using the power of the state to prevent other property owners from using their own property as they see fit. 

The Band-Aid: Subsidized Housing and Inclusionary Zoning 

Often, many residents who fight tooth and nail to prevent any increases in housing density or creation of more housing are the same people who say that "something must be done" to make housing more affordable.
Having caused the shortage of housing in places where people actually want to live, our "progressive" advocate for low density and exclusionary zoning may then attempt to sooth his conscience by advocating for a small number of subsidized housing units nearby. Or, he may demand "inclusionary zoning" which mandates that developers set aside a certain percentage of all new units as "affordable" units with legally-imposed limits on how high prices can go.
This, of course, does precious little to solve the problem. The subsidized units that get built are usually very small in number, and only get built after years of winding their way through the zoning and approval process. The inclusionary zoning tactic is even worse because the mandate for low-rent units discourage developers from building anything at all in that jurisdiction.
Thus, new production of housing continues to fall behind regional population growth, and rents and home prices continue to rise.

We Need More Housing of All Types 

The solution to this is more housing. Not more "affordable" housing and not necessarily more "high density" housing. Housing, after all, is extremely heterogeneous. Indeed, two identical houses built a block apart are not the same — thanks to differences in location. But types of housing vary widely in nature. There are high-rise apartment buildings, single-family homes, duplexes, boarding houses, and townhouses.
Which is the best type of housing to build in any given location? Thanks to the immense diversity of renters, homeowners, locations, neighborhoods, and unit types, no person can say. In fact, it's impossible to know the answer without allowing property owners and consumers to function within the marketplace. Property owners will attempt to build housing where they feel it will best satisfy market desires. Consumers will attempt to move where housing best suits their desired lifestyle.
City planners would have us believe they can figure this all out ahead of time. 
They can't. 
Nor should we trouble ourselves with mandating that builders create housing that caters to low-income houses. The problem isn't too little low-income housing, per se. The problem is too little housing overall.
After all, for every new unit built — even if it's a luxury unit — the housing supply increases, prices will fall ever so slightly, all else being equal. Over time, the cumulative effect of new units built for a wide variety of price levels will be to bring housing prices down overall. As new luxury units are built, the wealthiest renters and homeowners will tend to move into newer and fancier units. The older now-less-demanded units will fall in price making them more affordable to lower-income buyers and renters.
Today's luxury units are tomorrow's affordable housing. 
Unfortunately, thanks to the continuing role of government in housing production, attempting to meet the needs of renters and buyers continues to be an exhausting quest to deal with an endless assortment of ordinances, mandates, regulations, and plans. The current planners don't want more housing. The government planners only want a certain type of housing. Meanwhile, the renters live in smaller and smaller units, and drive further and further.

The Fed Confirms, Next Economic Crisis Massive Stimulus Planned