Friday, August 26, 2016

Today's links

1---It is clear that Washington’s support for the Turkish invasion is aimed at creating the conditions for a broader intervention to topple the Assad regime.

It is clear that Washington’s support for the Turkish invasion is aimed at creating the conditions for a broader intervention to topple the Assad regime. Turkey intends to establish a zone under its control in northern Syria along the Turkish border so as to block the emergence of a Kurdish-controlled area. But the seizing of Syrian territory in violation of international law prepares the ground for a direct clash or fabricated attack involving Assad’s forces that would serve as a justification for a wider NATO intervention. This would increase the likelihood of a war with nuclear-armed Russia, which intervened in Syria last year to defend its sole military base outside of the former Soviet Union and prop up its main ally in the region.

Just days before the Turkish intervention, the US accused the Assad regime of carrying out bombing raids close to an area where US special forces were operating in support of the YPG militia fighting ISIS in the town of Hasakeh. General Stephen Townsend, the US Army’s military commanding officer in Iraq and Syria, subsequently warned that US forces would defend themselves if they felt threatened–a tacit threat that Syrian government forces, or their Russian allies, would be fired upon.

Townsend also unveiled plans to step up US airstrikes in Syria and Iraq to assist its local proxy forces in the capture of Mosul and Raqqa from ISIS

2--Air of crisis overhangs central bankers’ meeting

overshadowing the conjecture about short-term decisions on monetary policy is a growing sense in ruling circles that the quantitative easing (QE) program of pumping trillions of dollars into the financial system has completely failed. What’s worse, it is creating the conditions for a new crisis.

In an article on the upcoming meeting, the right-wing British Daily Telegraph said there were three tough questions central bankers needed to ask themselves: is quantitative easing actually working, has the banking system been broken by the spread of negative interest rates, and is it time to update an economic model that “no longer tells us much about the real world.”

The rationale for QE, which bailed out the banks and financial institutions responsible for the 2008 crisis and fostered further speculation, was that lower rates would stimulate finance capital to invest in the real economy. This has not happened.

Eight years on, investment worldwide is well below where it was before 2008 with no sign of any uplift. This has been coupled with a downturn in the rate of productivity growth because of the reduction in capital spending, as funds accumulated by major corporations are channelled into speculative activities such as share buy-backs and mergers. So sharp has been the decline that productivity in the US could well be in negative territory.

The chief effect of quantitative easing has been to increase financial asset prices. Share values in the US are at or near record highs under conditions where economic recovery is taking place at the slowest rate for any period since World War II. In major cities around the world, cheap money has fuelled a property boom.....

When the US Federal Reserve began its QE program, its then-chairman, Ben Bernanke, predicted its actions would turn the situation around, lifting inflation and returning the capitalist economy to its previous growth path. “We have a technology called the printing press,” he said in a major speech on deflation in 2002.
The contradictions of the capitalist system, however, have proven to be more powerful than even the most powerful of central bankers.

Despite QE, inflation is running at below historical norms in the US and the UK and close to zero in Japan and the eurozone. Far from overcoming the crisis, QE has exacerbated it.
Ultra-low and even negative interest rates have directly impacted on one of the pillars of the global financial system. Pension funds and insurance companies are now facing a situation where their returns on secure assets, principally government bonds, are so low that their entire funding model is under threat.....

There is a growing fear this rate has fallen so low, largely because of a slowdown in US economic growth, that interest rates cannot be raised much further. This is of concern because without an increase in rates, the Fed has no room to manoeuvre downwards in the event of another recession.

(The conundrum)

On top of this there are concerns that the bond markets have been inflated to such a degree that any increase in real growth rates will put upward pressure on interest rates, bringing a fall in inflated bond prices. This will result in significant losses for investors and speculators who have bought into the market at already high levels, expecting that prices will rise even further. The Fitch ratings agency has calculated that even a return to the market conditions of 2011, when interest rates were already at very low levels, would bring losses totalling some $3.8 trillion. In other words, even a small “success” in moving back to more “normal” conditions could have the effect of triggering a financial crisis.

3--Stock Buybacks Are Driving Companies Into Debt, Barrons (Today's "must read")

Corporate debt is now near record levels, due in part to borrowing to buy back stock. It isn’t a situation that can last

The bond market should be concerned about stock buybacks, but not because of their bullish effect on share prices. Instead, bondholders should be anxious about where the cash to pay for them comes from. It isn’t widely appreciated that the money has been borrowed in the credit markets, and that the borrowers have taken on a large amount of debt to support the buybacks. That’s cause for worry on several fronts.

The first is simply that outstanding corporate debt is now at a record high. Many pooh-pooh this, arguing that the debt was issued when rates were low and corporate borrowing was cheaper than usual relative to government borrowing, which carries less credit risk. That’s fair.

But what happens in a recession or a recession for earnings? Those tight spreads between corporate and government rates will widen and, given the level of corporate indebtedness, could cause credit downgrades. That will put further pressure on the debtors. According to the Federal Reserve’s flow of funds data, outstanding nonfinancial corporate debt is 45.3% of GDP. That nearly matches the level seen in the first quarter of 2009 (45.4%) and exceeds the prior peak of 44.9% achieved in the third quarter of 2001 (see chart below.)

The result of the buybacks is that net equity issuance has been negative for the last several years and bears a striking resemblance to the period leading up to the 2008 financial crisis. The sheer level of buybacks is staggering. A Deutsche Bank report notes that Standard & Poor’s 500 companies pay out two-thirds of their earnings through buybacks and dividends. FactSet further notes that those same companies spent $166.3 billion on share buybacks in the first quarter, a post-recession high and one only surpassed by $178.5 billion in the third quarter of 2007. Keep the latter date in mind.

Buyback activity correlates well with the performance of the S&P 500, which shouldn’t be surprising; we’ve seen it in the run-up to the last two recessions. But what has been overlooked is that this activity was financed and shows a strong inverse correlation with nonfinancial corporate borrowing. In other words, companies are issuing massive amounts of debt to buy stocks in a market whose outstanding supply of shares is shrinking. This can’t last.

In the first quarter, nonfinancial corporate borrowing hit $724 billion. That’s the second-highest on record and is surpassed only by, again, the third quarter of 2007 with $807 billion. The similarities should give pause.

Managers of big bond portfolios have taken on added credit risk in the last few years to gain incremental yield. Now these investors are overweight corporate bonds and concerned about performance. As long as the rate differential between creditworthy and less-creditworthy borrowers remains tight, all is well. But if the Fed tightens, or if a slowdown in earnings or the economy unfolds, a lot of investors will rush to rebalance. (This is why the fed can't raise rates)

Closely related to our worry about borrowing to buy back stock is concern about what it isn’t being used for, with rates so low. The latest report on gross domestic product provides insight. There we see that total private domestic investment fell for the third quarter in a row, and it was soft in the preceding three quarters. Contrast that with the low unemployment and recent acceleration in the Employment Cost Index, and you have a recipe for softening productivity gains.

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