November 3, 2014

Staying ahead of the economic curve

Posted in Sunday Business Post · 44 comments ·

You know the sporting expression “he reads the game well”? It is usually applied to great players who know where the ball is going. It was often applied to the two men whose books are just out, Keano and Drico. It is the ultimate compliment for any player because it suggests he has almost a sixth sense that is invaluable. Wayne Gretzky, the brilliant Canadian ice hockey star, summed it up when he said: “A good hockey player plays where the puck is. A great hockey player plays where the puck is going to be.”

Economics is, in a sense, like sport. It is all about looking forward, moving on and dealing with new challenges. Because the world we live in changes so much, some things which had been anticipated as being hugely important can be overtaken by events and become much less significant by the time they come to pass.

Last week two major events – both bank related – which had been billed as hugely important, almost cataclysmic, passed off without as much as a whimper.

The first was the much-awaited ECB bank stress tests and the second was the ending of Quantitative Easing (QE) in America.

The common thread running through both events is the recovery in asset prices all around the globe. In the same way as falling asset prices dramatically increase bad loans and can destroy a bank’s balance sheet overnight, rising asset prices do the opposite. Rising assets prices are a soothing financial balm that can repair even the most damaged balance sheet very quickly – and this is what is happening.

It is a development that we should all be aware of.

In Europe, of the 130 banks stress-tested, 105 passed, 25 didn’t. The ones that didn’t, like Permanent TSB, have to raise capital in the next nine months or face being shut down. However, the amounts in most cases are small.

Had the bank stress tests been last year, the results would have been much more calamitous. We can see this reversal of fortune clearly in the performance of Irish banks.

Take Ulster Bank. Last week RBS – the parent – announced that Ulster was part of its core business. Six months ago RBS was trying to flog Ulster to whoever would buy it for any price, yet today it’s part of its core business. How can this be?

The turnaround, in the case of Ulster, is driven by the recovery in Irish property prices – both residential and commercial. The upswing dramatically improves the amount of non-performing loans on the balance sheet. This process moves a bank from bankruptcy to solvency without the management having to do anything.

The snag is that bank capital is only the difference in the value of the banks’ liabilities and the banks’ assets at a moment in time.

Therefore if asset prices are rising, bank capital rises magically. Clearly the implication is that the opposite can also occur, but for now, asset prices are going in the right direction and banks are benefiting, but for how long? And if there is a wobble in asset prices, what will the ECB do?

Buoyant asset prices are also why large banks around the continent have been able to raise capital quite easily – something that would have been unthinkable a few years, even months, ago.

Thus, the big event that many people feared would lead to a renewed banking crisis has hardly registered a blip.

Some might say that we shouldn’t be so sanguine and we would be wise to apply the Mandy Rice-Davies test to the ECB. “It would say that, wouldn’t it?”

Cynics argue that, in much the same way as John Profumo had an incentive to say that he’d never slept with the call girl Christine Keeler, the ECB has the incentive to pass loads of banks even if they are dodgy because the last thing the ECB wants now is another banking crisis – this time self inflicted.

However, I doubt this because from January 1, the ECB itself is responsible for the banks and it would be unusual to say the least for an institution to pile future woes upon itself when it doesn’t have to.

It is true that the ECB didn’t stress test the banks for deflation in the eurozone – which is a real threat – and it only tested banks in the event of a 10 per cent fall in house prices, which we know is an underestimate of what can happen. It also didn’t entertain a new sovereign bond crisis in its estimates, nor a renewed flare up in Ukraine.

These events could happen, and the ECB has another weapon up its sleeve which I imagine it will unleash in time.

Remember the aim of policy is to keep asset prices high for long enough for the banks to deal with bad debts because rising asset prices solve a multitude of problems for banks.

This is where the second event, the end of American QE, comes in. For years, people have argued that the end of QE would lead to a massive collapse in liquidity and a sharp fall in asset prices. This hasn’t happened. Yet again, an event that was widely thought to be massively significant has passed off without incident.

Maybe the reason for this is that QE isn’t printing money – as we know. It is the central bank swapping low liquidity instruments (bonds) on the bank balance sheet (which the banks can’t turn into loans easily) with high liquidity ones (cash reserves which can be lent out immediately).

These new cash reserves are available to banks for lending – which drives investment, spending and consumption – or they can be invested, which drives the capital markets higher. The latter is what has occurred in the US.

Now think about what is happening and the impact on the general economy.

The way in which the world’s central banks have dealt with the recession is by driving up asset prices; they hope that the people who are made rich by asset price rises spend more.

This is not just trickle-down economics, it’s hyper-trickle-down economics and is hardly the most equitable way to go about managing the economy, but it is the undisputed policy worldwide right now. In fact last Friday, Japan announced more QE. Is it any wonder that inequality is rising when rising inequality isn’t just the by-product of policy, but its aim ?

Getting back to Europe and what is coming down the tracks, the stress tests were successful because asset prices were buoyed up by the threat of the ECB introducing QE. In time, it probably will have to stop threatening and start acting.

This is, like it or not, where the puck is going.

Like the great Gretzky, do we want to be where the puck is now or where it is going? The ECB will open up the floodgates for as long as it takes. This is why the stress tests were successful.

There will be no shortage of credit in Europe, and this will apply to Ireland too.

  1. “The upswing dramatically improves the amount of non-performing loans on the balance sheet. This process moves a bank from bankruptcy to solvency without the management having to do anything.”

    I don’t get this bit – maybe I’m reading it wrongly. How does this work?

    • jwtralee

      Hi Adam, When asset prices were falling, many people with mortgages were in negative equity (i.e. The value of their property was less than what they owed to the bank). This causes a problem for the banks and they increase loan loss provisions anticipating that some people will default on their mortgages and loans. When asset prices rise, the opposite happens. The number of people in negative equity positions fall, and the banks can reduce loan loss provisions, making their financials look more healthy. What was a vicious cycle on the way down, can become a virtuous cycle on the way back up…. Until it turns again, of course. This is partly why the world fears deflation so much. Deflation would result in falling asset prices, trouble for banks and give people a reason to stop spending because who wants to buy anything today if the price is going down tomorrow? Hope that explains it. Have a nice day!

      • Yes thanks jwtralee, I understand the general idea, but maybe it’s just the way David phrased it.

        “The upswing dramatically improves the amount of non-performing loans on the balance sheet.”

        You would think it should say ‘decreases’ rather than ‘improves’. Or ‘performing’ rather than ‘non-performing’.

    • michaelcoughlan

      Well done Adam. Very insightful question. The statement made by McWilliams hasn’t been though out fully so let me try and complete it.

      The non performing loans result from an inability to pay the mortgage as it falls due. If you can pay the mortgage even if you are in negative equity the loan which is an asset on the balance sheet of the bank will still have its value even if the value of the house is lower than the mortgage on it.

      When prices fall the trouble for the bank is that its lTV capital ratios go negative hindering its capacity to borrow on the wholesale markets causing its cash flow and working capital to dry up. The same effect happens to the home owner and as their cash flow drys up they cant pay the mortgage which devalues the loan as the customer is in default.

      I hope I haven’t made an error. If I have someone point it out thanks.


    • Mike Lucey

      @Adam – ‘How does this work?’

      It doesn’t in sound reality. Its only a fuzzy illusion that works for a while longer. It looks that the BRICS, Iran and the Saudis will be throwing a huge spanner in the works shortly, backed by ‘real money’ (Gold / Silver) very soon that will de-throne the US dollar as the WRC which is backed by aircraft carriers alone since the 70′s.

      I would not be surprised the see the fun and games happening within a year if the signs are anything to go by.

  2. HubblyJubbly

    I the words of Mr. Byrne “Subscribe”……..and Father Les Costello, former Assistant Captain with the Toronto Maple Leafs (a.k.a. Toronto Maple Laughs)was a much better role model than Gretzky. He was a professional ice hockey player on the 1948 winning Stanley Cup team, gave all that up and then became a Catholic Priest in Timmins Ontario, a champion for the poor and a tremendous charity worker. A credit to all Irish Canadians. Coincidently the famous director Martin Scorcese wanted to make a film about the now deceased Father Les with Gretzky playing the leading role.

  3. Troika

    We have Keano and Drico and on this site we have Davo who always knows where the ball will be when it matters economically speaking .

  4. Adelaide

    Monetarist madness is now the norm. Destructive sociopaths pull the levers of power. Deliberate impoverishment of the masses through debasement of their money may temporarily proffer asset bubbles for the rich but this sorry saga will crash inevitably.

    On a side note, heartening to see the impressive protests on Saturday, I was at the Cavan march myself where 3000 turned up, in awful weather, and the general consensus there was Wow! They were expecting perhaps 500.

  5. michaelcoughlan


    “For years, people have argued that the end of QE would lead to a massive collapse in liquidity and a sharp fall in asset prices. This hasn’t happened”

    No it hasn’t but QE HASN’T ENDED. At the same time Mrs. Yellen announces the end of FED directed QE in the US right on queue the Japs pick up where the yanks ease off. Coincidence or what? And of course since the markets can borrow Jap money to buy US securities then UP go the financial markets in the US. Oh deary me David.

    “they hope that the people who are made rich by asset price rises spend more”

    No they don’t they are scared shitless that the bubble is going to blow up all over them bringing down the banks.

    Your article in the SBP said the powers that be are scared of deflation. That’s true but it’s not because they give a shit about the people because they don’t. What the world is experiencing is biflation;

    Your final analysis is something I share. Europe will enter into a sustained period of Japanese style deflation with massive inflation for the foreseeable future in equity markets.

    Working people from the middle classes working classes and the working poor will continue to be subjected to one massive club sandwich of deflation in wages and other assets, low interest rates on savings, continued reduction in the purchasing power of the currency in their pockets etc. Maybe the Russians led by Gladheshere not Pukin will have the stomach to face down the monetary madness.



    • michaelcoughlan


      The following link shows how hyperinflation in stock market takes place as the curerncy drops in value in this case Zimbabwe;

      With biflation the inflation in the west is predominately confined to the stock markets but as taxes rise to pay the coupons on the govt bonds issued in exchange for loans from the various central banks then the money supply in the economy is reduced causing deflation in the real economy. This deflation in the real economy is NOT THE RESULT OF PEOPLE POSTPONING PURCHASE NOW TO GET A BETTER DEAL LATER ITS BECAUSE PEOPLE HAVE REDUCED SPENDING POWER DATHI.

      You might consider telling Hobbs this also as he seems to have the same view as you re delayed purchases from his article in the SBP.


  6. Pat Flannery

    Growing business confidence in the U.S. has allowed the Fed to end QE. QE caused an increase of between $4 and $5 trillion in the Feds asset base, from a mere $1 trillion in 2007. Nobody yet knows (not even Tony Brogan) whether that is a good thing or a bad thing. Will it come back to haunt us? Our Central Banks’ balance sheets are the tracks upon which our capitalist system runs. There is no other in sight.

    Looking down those tracks, one thing seems certain: low borrowing rates for businesses will continue well into the future. That forward-looking observation by the corporate economists seems to be what is driving the current business confidence in the corporate board rooms.

    One other thing: it is misleading to see the present system as a Zero-sum game between rich and poor individuals locked in an ever-widening debt spiral. Many commentators see this asset/debt equation as greedy drone-like individual bondholders on one hand and impoverished debt-ridden working individuals on the other. It is more complicated than that.

    Much of the bond debt is held by mutual funds and pension funds owned by the “impoverished debt-ridden working individuals” themselves e.g. public sector workers, trade unionists etc., anybody who is paying into an “entitlement” fund of any kind, even Social Security. The present system seems to be the only alternative to Communism, which we tried and found it wanting.

    • Adelaide

      “The present system seems to be the only alternative to Communism, which we tried and found it wanting.”

      Pat, you can do better than that. Then again it is Monday morning.

      • Pat Flannery

        If I were Mario Draghi or Janet Yellen this wet Monday morning I’m not sure I could think of any way of keeping the train on the rails other than how they are respectively doing it right now. Each must react to the vagaries of the track they are on, which was laid down by previous generations of their respective countrymen.

        Yellen has slightly better options than Draghi because the American economic indicators are stronger, neither of which are ideal. In our present system the capital markets are the engines of our economies, whether we like it or not and they require more and more fuel in the form of central bank money. It is a crazy system but it seems to work.

        Is it a bubble? Probably.

        But bubbles seem to be integral to our system. We love them. Perhaps we should accept it and start calling our various currencies “Bubbles” e.g. the U.S. Bubble, the EU Bubble, the Chinese Bubble etc. Then the game becomes bubble-hopping.

        But isn’t that what markets already are? People jumping on and off bubbles before they burst? What fun. By that logic Las Vegas is the sanest place on earth.

        See what Mondays do to me! I love them.

  7. Thriftcriminal

    Biflation eh? Interesting. Sounds like just the job for retiring boomers, inflating equities based pensions pot with general cost of living held low. Perhaps it is not just about the 1%, but more about the much larger percentage of the population who are expecting to maintain their standard of living well into their retirement, whatever the cost to younger generations?

  8. StephenKenny

    “There will be no shortage of credit in Europe, and this will apply to Ireland too.”. So what does this mean? Surely, this is the core of economics, not a book keeping exercise that just balances trillions of new borrowing against trillions of old debt.
    What will this ‘no shortage of credit’ do? Property prices, stock market prices, anything else?

  9. cooldude

    “Yet again , an event which was thought to be massively significant, has passed without incident.”

    QE has barely ended for a wet week and yet it is now deemed to be a major success. Lets have a look in six months time and see if it is still such a great success.

    I predict a major pullback in the markets after the mid term elections which will be followed by even more monetary debasement. Its QE to infinity because the fiat king is stark naked.

  10. Japan announced more QE. Is it any wonder that inequality is rising when rising inequality isn’t just the by-product of policy, but its aim ?

    The previous commentary asked the question and here you supply the answer.

    Yes monetary policy lines the pockets of the financial asset classes and pauperizes the rest. We on an ever faster spinning treadmill and sooner rather than later we will not be able to keep up with the pace and fall off.

    Better a country uses its own currency. closes the central banking system and reverts to treasury money debt free and interest free. Then fixes to amount in circulation and bases it on a hard money substance. The solidity of the currency will add stability. Stability leads to sound decision making which in turn leads to a sound economy.

    Let us hope that the Swiss make the right decision in the referendum vote on 30th Nov. I doubt it will happen but if it does the Swiss franc will once again be backed by gold and regain its position as the strongest currency in the world.

    The central bankers will use every dirty trick in the book including assassination to prevent this occurring.

  11. Last week two major events – both bank related – which had been billed as hugely important, almost cataclysmic, passed off without as much as a whimper.

    The first was the much-awaited ECB bank stress tests and the second was the ending of Quantitative Easing (QE) in America.

    Perhaps replaced with Unprecedented QE from Japan.

  12. The Elephant

    Sometimes our senses are blind to the obvious .We can speak in volumes about what we perceive and each of us just add to the chorus more of the same hymn sheet .Without thinking the heard instinct prevails and collective amnesia prevails and at the same time all of us feel ok with this .We should know that we cannot score with this passive mindset and are we afraid to admit to this .

    The direction of the ‘Ball’ will be written ‘in English’ and that country that remains a member of the EU will become a future Leader and castigate the old coat once worn inside the EU of a different member who held that mantle .Ireland will replace the old guard and Dublin will become anointed with new royalty and London will be a suburban of Baghdad .

  13. Deco

    There will be no shortage of credit in Europe, and this will apply to Ireland too.

    There was no shortage of credit in the Eurozone when Trichet dropped interest rates. It provided a boom in the aftermath of the eastward EU expansion.

    But in the end it bankrupted several countries.

    Credit is not the answer. You cannot make money out of nothing, on a sustainable basis. The easier the credit policy, the more bankrupt the banks becoming from playing in it.

    The ECB is going to be responsible for the banks.

    Not a great idea. Look at the mess they made of the entire system, from being in charge of interest rate policy. The ECB’s competence is not great. They produce disasters like the Spanish and Irish housing boom-bust messes. Like the government debt problems in Italy and Greece.

    And they will contribute to the eventual bankruptcy of Belgium, and perhaps France.

    • Pat Flannery

      Deco, I am beginning to think that blaming everything on the central banks is leading us astray. They have a limited role. They are not governments.

      It seems to me that we are losing site of government policies as the real focus of failure. That would lead us to focusing on HOW governments use credit rather than seeing credit as the cause of our many failures.

      It really all comes down to regulation, which is the primary role of all governments. Every game has to have rules and a referee. The Reagan/Thatcherites thought we could dispense with both. That was the seed of our present problems.

      We need to get back to thinking about the role of governments, not just central banks.

      • You are correct Pat. Governments spend what the bankers provide.
        The central banking system needs to be removed to prevent government spending money it does not have and cannot raise in taxes. The money system needs constitutionally fixing as will be the case in Switzerland if the referendum succeeds.Not that I am not suggesting the Swiss will have fixed their money system but they will have taken a giant step toward that.

        That is why referendum , initiative and recall are an essential part of a countries constitution. We have a pale version in BC but the modus operandi is too difficult to achieve any change.

        The Swiss require 100,000 signatures and you are on the ballot.

        The first step is to remove the central bank fiat money issued as debt and at interest.
        Replace it with treasury money where it is not debt and carries no interest.
        Then back it with a commodity and fix the amount of currency issued so inflation is eliminated
        Pass a resolution that no government can spend more than is covered by taxes. That is no bonds issued as debt to the people, operate with your means.
        That applies to all aspects of government.
        We then have eliminated all government debt, all interest payable from the national budget, and freed up the taxes to be spent on services to the people as decided by the people.

        Ireland needs to embrace the principles of direct democracy.

        • Pat Flannery

          In California we have stringent Constitutional debt limit laws the most important being “Section 18” that prevents all levels of government from borrowing in excess of what it can service by the revenue of that year without the assent of two-thirds of the voters.

          Ireland has no such restriction.

          • Is that to finance longer term capital projects or can they borrow to cover a budget deficit?

          • Pat Flannery

            Yes Tony I should have said capital projects. But there is also a constitutional requirement to balance their budgets each year at state and local level. Deficit spending is therefore constitutionally barred in California. Many of the political and legal battles we have in CA are with the pols’ sometimes bizarre schemes to get around our Constitution.

            As you know efforts to achieve a constitution requirement to balance the Federal budget have been dismal failures.

            So we have the political tools just not the political will to contain the madness of unbridled Federal borrowing.

            To crudely paraphrase Shakespeare: the fault dear Tony is not in our Fed but in ourselves that we are debt slaves.

          • Yes Pat, we the people must change and become self reliant. We must take responsibility for our actions.
            It starts with education, knowledge leads to awareness, and hopefully awareness to action.

            In the meantime look after yourself and family as best as one can.

            enjoy the day Pat.

  14. staying ahead of the curve economically speaking requires extensive study and knowledge. where will the game put the ball next, what will my position be?

    A man who has made the call before and does so again id Jim Sinclair.

  15. Mike Lucey

    Jim Sinclair speaks with confidence based on facts from what I see. He is well worth listening to in order to get a picture of how things could well play out with the ‘Great Leveling’ (currently happening) and the ‘The Great Reset’ probably initiated by the BRICS. It looks like its going to be a Currency World War on the cards rather than nukes flying around the place. At least we can be thankful for that.

    Gold is being hammered at the moment, now at $1,151 oz and some forecasters are saying it could go down to $850 oz! I wonder if the upcoming Swiss Referendum has anything to do with this obvious manipulation? Could it be that the manipulators want to make the ‘Barbaric Relic’ look less attractive to the Swiss?

    The current price is nearly at production cost in many parts of the World. Here are some good visual stats on the situation, Gold miners will simply stop production rather than work at a loss. If this happens I think the game will be up.

    After the PayPal account stunt / dirty trick, I imagine we will see more stunts to come. The question is, will the Swiss citizens see through these dirty tricks. We will know very shortly.

  16. Mike Lucey

    Tony, I agree with “…. the takers want more…” but at the same time the ‘takers’ settle for the ‘basics’ in most cases with little opportunity of betterment for themselves or their offspring. This looks to be the case in the US with annual university fees running on average at $40K. Its not too bad in Europe yet but if the EU bosses have their way with behind the door deals, education could shortly become seriously commercialized by multinationals.

    As far as the ‘free meal takers’ go, was this all part of the globalists master plan that has got out of control? After all ‘cannon fodder’ is not required these days like it was in WW I and II.

    I think the only way forward is for more true direct democracy down to local community levels with co-operation at national levels and upward to even federation levels . The ‘Big Brother’ system has not worked for some time!

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