Massive Liquidity Injections
Starting on December 22, 2011, there has been but one force driving markets - money printing. On that date, the European Central Bank (ECB) announced the details of its Long Term Refinancing Operation (LTRO). The ECB lent 489 billion euros to 523 European banks for three years at a rate of 1%. This move was made to ensure that European banks had enough cash to pay the 200 billion in Euro-denominated debt due to be repaid in the first three months of 2012. Also, if European banks no longer had to worry about meeting their debt obligations, it would free up capital to lend to European businesses, avoiding a credit crunch and the corresponding economic disaster.
On February 29, the ECB announced LTRO 2, where we learned 800 European banks took another 529.5 billion euros in 1% 3-year loans. So, at least 800 banks have been lent more than a trillion euros since December 22. That's $750 billion.
The LTRO is a special case. No other central bank operates this way. Other central banks can simply print money, but the ECB is prohibited from doing so. So while they can't "give" their banks money to lend, they can lend banks money to lend. Of course, the European banks are not required to lend the money, but that is the hope of the ECB.So what about the Fed and the lingering rumors of a third quantitative easing program? We would argue that 2011 saw the other major central banks (particularly the ECB) of the world take the torch from the Fed eliminating the immediate need for a Fed-engineered QE 3.0. Consider the following chart:
The six major central banks: Bank of Japan, Swiss National Bank, Bank of England, People's Bank of China, the Fed and the ECB have increased the assets on their balance sheet – and that is what quantitative easing is – at an unprecedented rate. So the question is not whether the Fed will implement another quantitative easing program. The question is when will global quantitative easing end?
As much as our economy in the US has gotten off of the mat just prior to the standing eight-count, it has not exactly come back fighting. The growth in various risk asset markets around the world like stocks, high yield bonds, gold and other commodities can be almost entirely attributed to liquidity injections. Consider the following chart:
Much has been made of the Dow crossing 13,000 over the past couple of weeks. So far it has yet to hold that level, but every time it crossed above 13,000 CNBC stopped the presses to give a live "look-in." They were anxious to remind us that the Dow has not been 13,000 since May 2008. But priced in gold, the Dow is now 50% below where it was in May of 2008. Proof positive that the only thing driving the stock market right now is currency debasement, which is picked up most effectively in the price of gold.
Consider this statistic. Retail sales in the US totaled $2.0 trillion in 1992. By the end of 2011, they had grown to $4.7 trillion. That sounds like reasonable growth, right? But retail sales are priced in current dollars. If you adjust the value of these sales for inflation using the Consumer Price Index (CPI), we find that over 60% of this growth is due to inflation alone. And if we apply the CPI as it was calculated prior to 1980 (when we first started changing how that index is constructed), we can attribute the entire growth in retail sales to inflation. And since 1992, the US population has grown 23% - from 255 million people to 313 million. So, on a per capita basis, the numbers are even worse. Have investment markets forgotten about the difference between nominal and real values? Perhaps "willful ignorance" is a better characterization. What this statistic really makes clear is that the US deleveraging process has been effectively pushed down the road because given these numbers, much more deleveraging awaits us.
As Lakshman Achuthan of ECRI points out, US industrial production growth is now at a 22 month low, and not surprisingly, the ECRI Coincident Index growth is now at a 21-month low.
Real personal incomes have deteriorated, real personal consumption has deteriorated, S&P 500 earnings have had their worst quarter since 2008, and yet, the Dow flirts with a four-year high. It can only be the massive and global liquidity injections unleashed in the last several years, but particularly in 2011 and the beginning of 2012. When there is no fundamental economic reason for asset market behavior, that behavior tends to reverse. When is that likely to occur? That is the question, but it is difficult to call. We are in an unprecedented period of immense liquidity and therefore, have no way of telling. Again, there are pockets of strength in this economy. Things look better than they did in August. Just not enough to warrant equity market jubilation. We can only urge caution and dexterity.
Perhaps one of the triggers that will bring asset markets more in line with economic reality is oil prices. Interestingly, part of the run-up in oil to $110 per barrel in the US is due to excess liquidity. However, much of the price run is also due to an exogenous supply shock as the market discounts Iran's oil supply should war between Iran and any other party become a reality. Still, it does not matter why oil prices are high. The corresponding rise in gasoline prices hurts the global economy, regardless the reason.
Will gas prices hurt the US economy during this most recent oil price spike? Not if disposable incomes in the US start to increase. On a real basis, disposable incomes are already trending down amid what were stable gas prices. Higher gas prices will almost assuredly start to work themselves into consumer sentiment. January set a record high price for gasoline for the month of January. In other words, no prior January in the US saw the average gasoline price higher. And then we set another record for February. That was difficult enough for our economy to handle but now we must consider that on a seasonal basis, gasoline prices see their sharpest demand-driven price increase from January to May. So gas prices may very well move higher from here. In fact, that is what the futures market is telling us - $4 per gallon gas for the entire nation (and higher on the coasts) by summer.
And when you consider that every $10 increase in the price of a barrel of oil takes 1% from GDP, it makes the following news even more disappointing. After a week of weaker-than-expected economic releases, Goldman Sachs cut their US GDP estimates for the first quarter of 2012. Going into Thursday, Goldman expected Q1 GDP to be 2.3%. They cut it to 2.0% after the weak consumer spending data. Then they cut it again to 1.9% following the drop in the ISM Manufacturing Survey. Bank of America followed suit, lowering its estimate from 2.2% to 1.8%. And all of this after a Goldman study which found that unusually warm weather is actually propping up the economic numbers for the months of January and February.
It would be a shame, but certainly not surprising, if we were to find that the attempt to prop up global financial systems through massive liquidity injections had the unintended consequence of propping up energy prices to the point where they forced the globe into an economic slow-down or recession.
Until the markets start to recognize that while things are better, but certainly not good, the fiat money of the world will continue to prop up risky assets. We would urge caution as there seems to be a disconnect from economic reality and the "reality" the markets see through their liquidity-fogged lenses.