MoneyRiskAnalysis – Borsadocchiaperti

Visto il successo riscosso dal post “Ormai siamo in trappola” abbiamo pensato di renderlo disponibile anche in inglese. Abbiamo fatto del nostro meglio per cercare di fare una traduzione che fosse in un inglese corretto e contemporaneamente mantenesse il senso. Ci scusiamo per eventuali italianismi o per errori. Come al solito se avete consiglio e/o suggerimenti siamo ben contenti di riceverli con un’accortezza in questo caso: se sono commenti sui contenuti fateli pure nel blog, se sono commenti sulla forma o sull’inglese vi preghiamo di scriverci a borsaocchiaperti AT gmail DOT com. Saremo felici di leggerli e migliorare.

We are in a trap!

(To English reader: it’s our first english post, be patient. Thank you 🙂 ).

Someone has probably  noticed how market ways  have changed about  global market data.
If economy sees a decrease, markets are often bullish, as they are confident that central banks will probably push more money on the financial systems.
On the contrary, when economy wakes up, markets are bearish, thinking that central banks will stop QE or economic stimulus.
Since this  new dynamic started a few months ago  investors need to change their strategies and recalibrate their risk/reward targets.
Probably, investors’ change in risk/reward strategies is  the central bank’s final goal.
It’s surprising how investor are confident about unlimited central banks’ power! If you have any doubts, then you could think about how investors react to  Bernanke’s words or Draghi’s omt or Abe’s QE that removes Nikkei’s gravity.

Rarely we can find economists talking about new and unexplored monetary policy by USA and JPN, how they are effective and how they will change markets’ mind, financial strategies and economy.
Before going deep inside my analysis, it’s important to analyze why we are in that situation.

In the end of 2008 the financial world was near bankrupt, after Lehman crash and after loan bubble explosion.  Fed interest rates were near zero. So Bernanke started QE1 to save USA from liquidity trap. QE is a strong purchase of Government Bonds and mortgage subprime. The First QE saved the bank system and the entire economy.
But, what is a liquidity trap? The phenomenon when monetary policy cannot influence consumer demand and neither economy. Keynes created the definition of “liquidity trap” and he found a solution: an increase in public expenditure.

In 2008, Fed and some worlds’ central bank started new monetary policies, because interest rates were near to zero thus enable to influence consumer demand. In some countries (USA and Japan), Governments started Keynes therapy, spending more but with an already high starting public debt.
QE policy did really well during phase 1 (2008), but during the next phases it was progressively softer.
First year of QE, as we said, credit machine restarted, but bond rates collapsed near to zero or about by enormous amount of liquidity pumped in financial world. We need to investing more deep this situation. We can analyze a mid class USA citizen that before QE1 is confident about capital gain and coupon. The middle class citizen can beneficiate from bond rates reduction by capital gain as an anticipation of future coupons.

He can also spend more with this gain, so economy raise. But if it reinvest money, it will have a reduced coupon so he is more rich, but it will be less rich with the same inflation.
Another drawback is about wages. QE1 stopped or reduced middle class’ wages because of more competition. Business reduced wages because they can touch world economy’s vulnerability and volatility quarter by quarter. But, this isn’t true for managers. Managers’wages growth is exponential and the gap between manager salary and base salary is growing more and more.

Managers’s wages VS Base sale Wages

So, middle class citizen can benefits from first QE, but after that he probably stays worse.
Before first QE he could consider salary and coupon and interest rates has income, after QE1 he can only consider salary, which is now reduced because of competivity.

MONEY WORLD REDISTRIBUTION

This graph highlights in gray how much percentage of actual financial wealth belongs to  a 20% of the population (almost 85%), as that perceived and what the ideal. And ‘interesting to note is that perceived wealth is far from reality. Not to mention its ideal redistribution.

However , Fed monetary policy allowed more public spending. An increase in public expenditure helped people that were in trouble with mortgages.

I’m not saying that QEs’ central banks it’s wrong, I’m only analyzing the consequences.
When I’m talking about income, fixed rate, also, I am not referring to a small amount of world investments, but at a future value representing 60% of the world’s financial wealth. A figure well in excess of 40 thousand billion.

Well, now, these 40 thousand billion dollars, have a negative real yield. Therefore those gains are not present anymore, gains that were reused in some way in the economic cycle.

Image: This diagram shows asset class in the world. Adding together all the components of bond arrive at over 45 trillion dollars, equal to the size of world GDP. This pie chart does not include current accounts and savings account, which still represent a voice in the capital account that can generate income, at least until rates were above zero.

Providing more liquidity cannot obtain the same results as in the first QE phase. Now it would really be less effective because of interest rates and because of a decrease in public spending, much like what’s happening in Japan with Abenomics.

Central Banks QEs instead of incentivize economy growth, they are only replacing savers in the process of governments bond purchase. Savers are migrating from more secure assets to more risky assets to gain some earnings. This situation has zero growth impact and it will redistribute money in favour of rich people. The gap between finance and real economy is increasing.

Japan, as we mentioned, tried to escape from a 20 years old liquidity trap printing money and JPN central bank indicate Nikkei target. To what end? Why? Japan needs to print money because other monetary policy would have no effect. This is a bubble that generates distance between finance and real economy. This gap will reduce sooner or later.
Therefore it’s legitimate to ask whether, monetary dynamics seen in the last four years is leading to a radical transformation of the capitalist system, or this will lead to its fall.
Often we refuse to admit that the real cause of the crisis ,which began in 2007, is  to be found in wages. The loss of their purchasing power, the result of misguided policies ever since the Reaganomic, led the average consumer to borrow beyond measure in order to keep up, to the point of being in a situation no longer sustainable.

So, salary are reducing, in the other hand States search reflaction because liquidity trap is more evident. Germany  Is alone to fight this monetary politics. It searches for more competitiveness and it fights to preserve consumer purchasing power.
As mentioned several times, Japan (who could not do otherwise, since the alternative was to give up in front of a debt of 240%) is becoming “the canary in the mine” sent on a mission to explore the unknown. In the case of an implosion of the Japanese monetary system (probable) the other countries will look into something else. On the contrary they would pass to the next step, firing an atomic QE, thus enlarging more and more the gap between the real economy and the financial economy, which, as mentioned, sooner or later will clash.

So, to close.
Qe allowed to close the abyss created by the bank system and to accelerate public expenditure in order to save the economy.

QE reached its target, however a few years later we see a disappearance of income, due to the persistence of strongly negative real interest rates, while at the same time public deficits are intended to fall through a reduction in expenditure. Therefore less income for consumption, both public and capital gains. The revaluation  of equity assets applies only to a minority of the population, which represents a minimum slice in the pie of global consumption.

The liquidity trap seems to become increasingly important, as today, the unconventional monetary policies seem only to aid  public debt, without giving an acceleration of growth. At the same time no one is working on a growth for real wages, which in my opinion would be the only variable to put the economy on a virtuous circle. Wage growth that should always be followed by respect of legislation. For this reason countries should protect the rights otherwise they would not even have a reason to exist.
Earnings of listed corporation have never been so high, just because one side has artificially stimulated demand, while the other has put pressure on wages, through unbridled globalization. It’s clear that this trend is unsustainable.

Central banks are blind in front of all this, they continue to fight liquidity trap, with unconventional ad more aggressive policy, resulting in a distortion even of  the concept of the free market. This also results in the increase in the gap between real and financial  economy, that as noted, has to be filled sooner or later.
In the meantime, all we are left waiting for the outcome of the Japanese test subject, if it experienced positive consequences after this unknown mesures. Eventually if they fail, we will be here trying to comment on the metamorphosis of an economic system now distorted.

Dai un contributo all’Informazione Libera di Borsadocchiaperti