Has Australia hit the floor with interest rates?

Izabella Kaminska made a strong argument on FT Alphaville last year for the RBA to lower interest rates and weaken the Australian Dollar to protect manufacturing and export industries:

Australia’s current account deficit coupled with a deeply negative net external debt position both provide strong fundamental impetus for currency weakening. Should the RBA want to engineer currency depreciation, lower interest rates are likely to be more than enough. Indeed, even if interest rates decline only gradually to reflect a structurally slowing economy there are plenty of fundamental reasons for the Australian dollar to weaken.

The case for lower interest rates still holds true but the RBA is obviously concerned by signs of recovery in housing prices that could exacerbate the existing property bubble. Robert Gottliebsen at Business Spectator reports:

In less than three months the market price of a bottom of the range Meriton inner-Sydney apartment has risen 6 per cent from about $500,000 to around $530,000……According to Meriton’s Harry Triguboff, local buyers have jumped from 15 to 40 per cent of the market.

There is a solution. The RBA can lower interest rates provided it simultaneously introduces macroprudential steps similar to those being considered by the RBNZ: increase the amount of capital banks must set aside to cover potential losses from high loan to valuation ratio (LVR) home loans. That would make high LVR loans more expensive and discourage property speculation, taking some of the heat out of the housing market.

Mongolia needs better roads, schools and hospitals: so why all this talk about saving for the future? | Making development work for all

Australia could also learn from the Chilean experience of resources boom-bust cycles and adopt similar policies to those being considered by Mongolia. Gregory Smith explains:

Eric Parrado, former head of the Chilean ‘Economic and Social Stabilization Fund’, tells us that “if natural resource booms are well managed they can be a blessing” and that “an important general lesson is that governments should avoid temptation to spend significant temporary surpluses”.

Read more at Mongolia needs better roads, schools and hospitals: so why all this talk about saving for the future? | Making development work for all.

When You Weren’t Looking, Democrat Bank Stooges Launch Bills to Permit Bailouts, Deregulate Derivatives « naked capitalism

Yves Smith reports on attempts to undermine the Volcker Rule and why the rule is so important:

In the US, depositors have actually been put in a worse position than Cyprus deposit-holders, at least if they are at the big banks that play in the derivatives casino. The regulators have turned a blind eye as banks use their depositaries to fund derivatives exposures. And as bad as that is, the depositors, unlike their Cypriot confreres, aren’t even senior creditors. Remember Lehman? When the investment bank failed, unsecured creditors (and remember, depositors are unsecured creditors) got eight cents on the dollar. One big reason was that derivatives counterparties require collateral for any exposures, meaning they are secured creditors. The 2005 bankruptcy reforms made derivatives counterparties senior to unsecured lenders.

Read more at When You Weren’t Looking, Democrat Bank Stooges Launch Bills to Permit Bailouts, Deregulate Derivatives « naked capitalism.

‘Most of the banks are zombie banks’ | Het Financieele Dagblad

Translation from an interview by Marcel de Boer & Martin Visser with Willem Buiter, chief economist at Citgroup:

Is Europe creating zombie banks?

These already exist. Most of the banks are zombie banks. There is little new lending to businesses and households. Zombie banks will not offer credit even on good projects — that is already evident on a large scale.

Full article (in Dutch) at ‘De meeste banken zijn zombiebanken’ | Het Financieele Dagblad.

S&P 500: Any gas left in the tank?

The S&P 500 managed to close at a new high, with most fund managers reporting good results for the quarter, but does this signal a new bull market or a last-gasp effort to lock in performance bonuses before the market subsides into a correction?

While markets may be rising, there is strong risk aversion.

This is definitely not a classic bull market.

One also needs to be wary of September and March quarter-ends. They often represent significant turning points, with new highs (red arrows) and new lows (green arrows) frequently proving unsustainable.

S&P 500 Index

* Target calculation: 1530 + ( 1530 – 1485 ) = 1575

While there is no sign of divergence on 13-week Twiggs Money Flow, which would indicate unusual selling pressure, it is important to remain vigilant over the next quarter rather than blindly follow the herd. Bearish (TMF) divergence or reversal of the S&P 500 below 1500 would warn of a correction.

Forget too-big-to-fail: Kill the fractional reserve banking system

Interesting discussion on Bloomberg about currency-backed deposits and equity-funded loans.

The fractional reserve banking system is the primary cause of instability and asset bubbles in the global economy, allowing banks to create money out of thin air. Credit expansion above the rate of real GDP growth has only two possible consequences: inflation or asset bubbles. Both do serious long-term damage to the economy.

Under the current system, banks create new money by making loans where they don’t have deposits. The recipient of the loan generally deposits the money back in the banking system, allowing banks to fund newly-created loans with newly-created deposits. The fractional reserve system enables banks to rapidly expand credit as demand grows, but at the risk of creating a bubble.

Requiring banks to hold 100% reserves against deposits — either government bonds and short-term bills or central bank deposits — would remove the risk of bank runs and the need for deposit insurance. It would also eliminate bank bailouts and the subsidy of too-big-to-fail banks by the taxpayer. Volcker rule restrictions on proprietary trading would become unnecessary, with banks no longer able to bet with their customers’ money.

Credit would be equity-funded rather than deposit funded. While this model may seem strange to the reader, it was successfully used by German banks to fund Germany’s industrial expansion in the early 20th century and is still employed by investment banks and private equity funds to finance major ventures today. Islamic banks follow similar principles.

It would be a fairly simple exercise to structure different tiers of equity — with commensurate returns — that participate in different levels of risk. Banks would not be restricted from issuing bonds, but the ratio of debt to equity and access to the retail market could be strictly controlled by regulators.

Fractional reserve banking is not an essential component of capitalism. All that we need is an efficient financial intermediary to channel savings into capital investment. When one considers the costs of the present system — especially the massive wealth destruction wrought by an unstable banking system — the alternative is a lot more appealing.

The Dijsselbloem Principle | Felix Salmon

Felix Salmon makes this succinct observation:

If a gaffe is what happens when a politician accidentally tells the truth, what’s the word for when a politician deliberately tells the truth? Dutch finance minister Jeroen Dijsselbloem, the current head of the Eurogroup, held a formal, on-the-record joint interview with Reuters and the FT today, saying that the messy and chaotic Cyprus solution is a model for future bailouts.

Those comments are now being walked back, because it’s generally not a good idea for high-ranking policymakers to say the kind of things which could precipitate bank runs across much of the Eurozone. But that doesn’t mean Dijsselbloem’s initial comments weren’t true; indeed, it’s notable that no one’s denying them outright…..

Read more at The Dijsselbloem Principle | Felix Salmon.

RBNZ steps closer to macroprudential | MacroBusiness

Houses & Holes at Macrobusiness reports on macroprudential steps being considered by the RBNZ. Macroprudential regulation are measures aimed to mitigate the risk of the financial system as a whole, or systemic risk, as opposed to the risk to individual participants.

The [Reserve Bank of New Zealand] says it wants to increase the amount of capital the country’s big four banks must set aside to cover potential losses from high loan to valuation ratio (LVR) home loans. Such a move would, in theory at least, make such lending more expensive for the banks.

Read more at RBNZ steps closer to macroprudential | | MacroBusiness.

S&P 500 tests 2007 high

The S&P 500 continues to find support above 1540 on the daily chart. Breakout above 1565 would signal another advance. A higher trough on 21-day Twiggs Money Flow would indicate medium-term buying pressure. Breach of the rising trendline is unlikely at present but would warn of a correction. Target for the current advance is 1600*.

S&P 500 Index

* Target calculation: 1530 + ( 1530 – 1485 ) = 1575

VIX Volatility Index remains near its 2005 lows at 0.10. This does not offer much reassurance as volatility can rapidly spike. Breakout above the quarterly high at 0.20 would be a warning sign.
VIX Index
Bellwether transport stock Fedex dipped below $100 after an earnings disappointment. Reversal below the rising trendline at $85 would warn that the broader economy is slowing.
Fedex
The Nasdaq 100 continues to struggle with resistance at 2800. Declining relative strength against the S&P 500 illustrates how blue chips are being favored over tech stocks. Bearish divergences on both 13-week Twiggs Momentum and 13-week Twiggs Money Flow warn of another correction. Reversal below the latest rising trendline would strengthen the signal. Follow-through above 2900 is unlikely at present, but would signal an advance to 3300*. Only breach of primary support at 2500 would signal a reversal.
Nasdaq 100 Index

* Target calculation: 2900 + ( 2900 – 2500 ) = 3300

While there are structural flaws in the US economy, the market is gaining momentum and the current advance shows no signs of ending.

Cyprus: The Operation Was a Success. Shame the Patient Died. | Some of it was true…

Pawelmorski (pseudonym for a london-based fund manager) gives this opinion of the EU ‘rescue’ of Cyprus :

How bad is the damage?

Bloody appalling…… Take a moment to realise the scale of what’s been done here. No human agency has achieved so much economic destruction in such a short time without the use of weapons. The combination of laying waste to the financial sector and tearing up the savings of thousands of residents means that Cyprus won’t return to current levels of output for a decade, a funeral pyre which bears comparison only with Greece. There are four shocks happening at once; the bog-standard austerity shock; the trauma of bank withdrawal controls; the wealth shock; and the structural shock of wiping out the financial sector. The bailout bill is certainly going to get a lot higher too, as a larger amount of debt is piled onto a smaller economy.

Read more at Cyprus: The Operation Was a Success. Shame the Patient Died. | Some of it was true….