The Central Bankers Dilemma

We are playing with fire. 

How quickly we forget about the power of compounding interest - in reverse. 

The world is limping along at ultra-low interest rates. Otherwise benign movements from such extreme lows are magnified beyond comprehension. An equivalent interest rate move up from 10% has a tiny overall effect, compared with the same move up from lower rates.

Human perception struggles with the non-linear. 

Again, when rates are 10%, a 100 basis point move is only 10%. When rates are 2%, a 100 basis move is 50%…

What we see in China and Greece, along with untold others, are mere nodal points in a complex and fragile daisy chain  - held together by quadrillions of dollars in derivatives and ultimately promises backed by faith.

The point is that small changes at these extremes can be dangerous. They can result is ripples that spread out much further than rationally imagined. 

This perpetual state leads to a constant and evermore desperate attempt to rationalize faith by referencing periods of time where things seemed better.

That this faith is held together by an ever-shifting set of legal and accounting classifications is another matter. At this point, these are ‘laws of the jungle’ and no longer ‘laws of the land’. 

The following is a must read perspective about central bank omnipotence, written by Mark St. Cyr

The Central Bankers Dilemma: The Pendulum’s Back Swing

Today, July 5th, a referendum is to be voted on in Greece as to whether they should vote “Yes” for the austerity measures demanded by the bankers of the Euro Zone (EZ.) Or, vote “No” against such demands. Where a “no” vote will in effect all but ensure an exit from it (whether voluntarily or not.) How this vote will come down no one knows. For when a populace is scared, many times they’ll vote blindly for what they perceive in the present as the lesser of two evils, and let longer term consequences be damned.

On the other hand, when a populace is both scared and mad – what was at first thought to be implausible (i.e., against what many outsiders may perceive as in their best interest) within the confines and privacy of the voting booth. Anger, as well as a disgust for the present can over-rule. Where it’s the consequences of the moment that will be damned. Where an overwhelming affinity for the possible future suddenly reins supreme. Whether realistic or not.

It is this latter point that catches most (i.e., outsiders looking in) flat-footed. Especially those that tend to think everything is based only in numbers, models, or rationality, and it’s ultimately controllable. This form of thinking implies: If you control the numbers, and can interpret the models – you can control the rationale, as well as an outcome.

Not only is line of thinking rampant throughout academia. It is followed with a near religious zeal. However, there’s the inherent problem: Yes you can – till you can’t. And that’s where the most critical issue fails within Ivory Tower thinking. For they don’t ever contemplate, or anticipate the “till you can’t” part. For them it shouldn’t exist. Therefore – it mustn’t.

Yet, anyone with just a modicum of business acumen knows all too well: More often than not what you’re convinced won’t happen; is exactly what will. Usually – at the most inopportune of times.

Here is where we find many of the Central Bankers today. Suddenly their implied omnipotence is being turned on its head from “omnipotent” to “oppressive.” From “rescuer” of an economy to “destroyer.” And the distaste as well as grumblings against this Central authority is growing. Why? As I stated before: Central Banks are now perceived as “the body politic.” No-matter how much they rail against the inclusion. And the vitriol (as well as the impending implications) are just getting started in my opinion.

Over the last week the IMF dropped what was for all intents and purposes a bombshell of a revelation. It stated (I’m paraphrasing) that Greece was indeed in need of a debt reduction (i.e., write-offs) just as much as it was in need of restructuring of those said debts. Otherwise, it would all be for naught because Greece would never be able to surmount them.

This singular point has been at the heart of all Greece’s arguments. However, what has been argued back to Greece by the Troika has been nothing less than “Tough – deal with it. That’s your problem – not ours.” Well, it seems that’s not so much the case anymore. Regardless of which way the vote goes, it is the Troika itself that may find the problems are just beginning. And those problems are theirs.

In a previous post I drew an analogy from the Iron Man 2 movie. The premise was: If one can make the gods bleed, no matter how small, people will not only will lose faith, but will turn on them. It seems Greece did in fact strike the first in what might be a mortal blow. Not so much with the degree of the initial cut, but with the ever-growing infectious nature to follow.  Even if Greece votes “yes” this Sunday – the damage has already been done to the EZ as well as the central banks within. While quite possibly to Central Banks everywhere.

The revelation that the IMF concurred in secret with what Greece was proclaiming all along; while demanding the opposite; siding with the more austerity demands by their fellow members; as not only the people suffered but as the politicians themselves (i.e., ridiculed or voted out) will not be lost on Italy, Spain, Portugal, ____________ (fill in the blank.)

Yet, as damaging as it is to have one of the three parts (e.g., Troika) acknowledging what Greece has been insisting was needed all along via a leaked document. To now have it leaked that all three were of the same conclusion yet: wouldn’t budge or acknowledge it? This is quite another, and will be used by any and all as an excuse (whether rightly or wrongly) to demand new terms. Or worse, like Greece – just refuse to pay until the bargaining table is reopened.

Suddenly it’s not the borrowers that have a problem. Rather; it’s the other way around. And it’s only been days since these revelations. Yet, there’s now “blood” in this ever-growing pool. And that’s a problem no “bazooka” or “printing press” may be able to overcome. However, this is just Europe…

In China the financial markets are tumbling faster than any other time in history since 2007. What many forget (and what the main stream financial media will not speak of) is that right before the financial crisis took hold here in the U.S., It was none other than China’s Shanghai Composite Index that was the harbinger of what lay ahead as it tumbled from that meteoric rise in ’07 to within a year – it would go on to lose some two-thirds of its value.

Right before the crash the Chinese markets were assumed “unstoppable” (sound familiar?) as they went parabolic to near vertical assent when viewed on a chart. Then: they fell in spectacular fashion entering “bear market” statistical valuations in mere weeks (i.e., losing 20%.) This had never been seen since. That is – until now.

Suddenly there are reports of extraordinary measures being allocated behind the scenes by China’s central banking authorities. The problem? So far, by all accounts – it ain’t working. The index continues to fall. Many of the components (I would like to say businesses however, there are far too many reports these “businesses” are in name only) that make up these composites are opening up daily to “limit down” selling pressures with no relief in sight.

So much so it has been reported the only way for this rout to be reeled in is for the PBoC to directly “buy the market” in one form or another. Yet, the rout is so wide-spread, and so fierce (imagine 10’s of millions of first time traders all heading for the one and only exit door – all at the same time) that it is being openly questioned if the PBoC itself has the monetary firepower to overcome it. And just for perspective, China’s market isn’t some backwards market in size or scope those in the “general public” might think of when they first hear. For those not familiar: China’s market is number 2 in the world, right behind the U.S. And last time such a thing happened the contagion effects were here seemingly overnight – and the great financial meltdown of the U.S. markets were upon us.

Is “this time it’s different?” Who knows, but one thing is for sure: The general public today is still enamored with the main stream media’s push that whatever “bad” happens in the world or markets: “The Fed. has their back,” or “The ECB” or “China’s growth will solve our malaise” or ______________(fill in the blank.)

Today one thing is more certain than any other time before. With the Federal Reserve’s unwillingness to allow the markets to stand on their own feet, and not be so dependent on their interventionism with QE for years, and Zero interest rates for the same – the tool box may in fact be empty – at the most inopportune time.

So here we are, once again, waiting or watching for what could possibly be the start of another contagion effect to ripple through the markets that has the potential of resembling 2008, or worse.  And the only thing to stand in its way will be the faith and/or belief in their omnipotence. 

For it seems – that’s all they have left. All while we watch the same crumble in the eyes of others across the waters as their Central Banks are being perceived daily more as villains or worse – inept.

I’ve stated many times in what I’ve coined “the pendulum rule.” It’s not the first swing that can ruin you. It’s when you get up thinking you’ve dodged a one-time fatal blow and act as if it can’t happen again. You don’t prepare. You don’t harden your resources. You act as if it were a one-time only thing. And just when you’re at your most vulnerable – the back swing is what takes you out.

It would seem the pendulum is indeed still swinging. What transpires from here once again – is anyone’s guess.