All posts by Daniel Lacalle

About Daniel Lacalle

Daniel Lacalle (Madrid, 1967). PhD Economist and Fund Manager. Author of bestsellers "Life In The Financial Markets" and "The Energy World Is Flat" as well as "Escape From the Central Bank Trap". Daniel Lacalle (Madrid, 1967). PhD Economist and Fund Manager. Frequent collaborator with CNBC, Bloomberg, CNN, Hedgeye, Epoch Times, Mises Institute, BBN Times, Wall Street Journal, El Español, A3 Media and 13TV. Holds the CIIA (Certified International Investment Analyst) and masters in Economic Investigation and IESE.

Lessons from Popular, the latest banking crisis

Global Economy, On the cover, Sin categoría, Spain

The end of Banco Popular, a bail-in under the EU’s resolution mechanism, shows that:

. Belief that EU banks are fine is an exaggeration.

. Euro banks still have €900bn of Non-performing loans and weak margins.

. The Eurozone QE has been disastrous for banks, as margins have collapsed and core capital remains weak.

. Betting on the recovery through hybrids is dangerous. When bail-ins are enforced, CoCos and shares rarely cover capital gaps.

. CoCos, hybrids and DTAs are no solution for poorly capitalized banks. They become accelerators of demise when capital erodes.

. Since the ECB declared that Euro banks are strong, we have had banking crises in Italy, Portugal, Deutsche Bank and, now, Popular.

. The vast majority of failed banks since 2008 had passed the stress tests with good results, showing how little these exercises matter.

Santander does not buy “cheap” for “one euro”. Santander assumes €7bn of debt and needs to make a capital increase of the same amount.

There was not a single competitor offering any or higher price, and not for lack of attempts. The new management team, which inherited a bank that was already in distress, has not stopped looking for any purchase option, but the equity gap far outweighed the attractive assets still held by the bank (as confirmed by the Single Resolution Mechanism itself).

The purchase is not a bargain, but a favour made by Santander to manage and restructure the sunken ship, given the risk that depositors and senior debt would also suffer.

Banco Santander itself explains that the operation, including 7 billion euro capital increase, will not increase its core capital at all . This shows us that, at least, the additional equity gap that Popular estimates is much larger than its market cap, its subordinated bonds and also an additional amount.

Daniel Lacalle has a PhD in Economics and is author of “Escape from the Central Bank Trap”, “Life In The Financial Markets” and “The Energy World Is Flat” (Wiley)

@dlacalle_IA

Picture courtesy of Google

The central-bank trap: the real price of cheap money (World Economic Forum)

Global Economy, On the cover, Sin categoría

This article was published in The World Economic Forum here.

At the time of writing, the pace of expansion of the main central banks in the world exceeds $200 billion per month. In fact, in the first four months of 2017, central-bank asset purchases have surpassed the $1 trillion mark, according to Bank of America Merrill Lynch. All this, without a crisis or a recession.

The unprecedented monetary expansion we have witnessed in the past eight years is on track to put the balance sheet of some of these central banks at 20% to 100% of the GDP of their countries by 2018. Massive monetary stimulus and more than 600 interest-rate cuts have been drivers to support a global recovery. But the risks cannot be underestimated.

Extreme easing has the objective of combating the risk of deflation and supporting growth, but excessive liquidity has unintended consequences: weak growth, poor productivity, and low inflation.

Cheap and abundant money perpetuates overcapacity, which exceeds 25% in the main economies of the OECD, by keeping highly indebted, low-productivity sectors “zombified” through perennial refinancing of non-performing loans. Money is cheap, and many sectors that generate returns well below cost of capital simply survive thanks to cheap debt, but fundamentals remain poor. Additionally, weak growth comes from the combination of excess debt, which has soared to 225% of global GDP according to the IMF; while consumption, commerce, and internal demand remain disappointing because the tax burden has risen to all-time highs, according to the OECD.

Funding low productivity

The first unintended consequence of excess liquidity and cheap money is an indirect subsidy for low-productivity and high-debt economic agents. That is why money velocity collapses and productivity growth is extremely poor in almost every developed economy. It has never been so cheap to borrow, and at the same time, real productive annual investment is at the lowest level in a decade.

The second unintended consequence is that the failed policy of creating inflation in the real economy has in fact generated a worryingly high inflation in financial assets.

As low rates and high liquidity perpetuate overcapacity and financial repression burdens potential growth, the extreme liquidity is directed to liquid financial assets. Bond yields are at the lowest seen in history, with the so-called higher risk “high-yield” bonds issued at the lowest rate in 40 years. In the meantime, stock market valuations have reached bubble-type multiples, surpassing fundamental levels using any metric, including Shiller’s price-to-earnings ratio.

Central banks pay very little attention to stock market risks, but at the same time are too worried about short-term market reactions, which leads them to unwillingly fuel speculative bubbles. An overly optimistic assessment of the risks of monetary policy and perception that monetary policy can be normalized without abrupt changes in prices of financial assets may increase the chances of a financial crisis generated by excess risk-taking. At the end of the day, the consequences of inflating financial asset prices way beyond fundamentals is the same if it comes from accumulation, from private risk or from massive intervention from central banks.

The idea that imbalances created by central-bank policy are not an issue because they can be covered by even more extreme policies is simply incorrect. The diminishing returns of unconventional policies and weaker impact of new measures is very evident, as we have seen with the subsequent rate cuts and zero-interest-rate policies. Financial repression does not force economic agents to invest and consume more in the real economy, and long-term it makes them more cautious, focusing on short-term liquid assets.

Cheap money becomes very expensive because perpetuating overcapacity, low-productivity sectors and incentivizing higher risk in financial assets for lower returns generates imbalances that are unlikely to be solved by the same traditional tools used before: lowering interest rates and increasing liquidity.

No return to deficit spending

However, there is an escape from this central-bank trap, as I explain in my latest book. The key is to normalize monetary policy while at the same time promoting a growth-oriented fiscal policy. When I mention growth-oriented fiscal policy, this by no means entails deficit spending and even more white elephants under the disguise of “infrastructure”. An effective fiscal policy has to focus on rebuilding the middle class, increasing disposable income by lowering the tax burden, and for companies, supporting the development of high-productivity and technology industries.

Central banks and policymakers cannot ignore the risk built in financial assets, particularly in bond markets. It is neither small nor manageable. Moody’s has warned that while yields in government and corporate bonds have collapsed due to monetary policy, debt-servicing capabilities have not improved, and in cases have markedly deteriorated. Policymakers cannot ignore the perverse incentive of misallocating capital to over-indebted and low-productivity sectors. Overcapacity is not just a problem for today; it creates a long-term burden that limits potential growth and weakens the economy when cycles change.

The next financial crisis will not be solved with more liquidity and lower rates because, after five decades of using the same tools, policymakers have come to the end of the so-called unconventional measures that have actually become the most conventional of them all. The focus of governments and central banks must be to prevent the next crisis by returning to sound money and fiscal policies that support the middle class as well as small and medium enterprises. Promoting more large-scale infrastructure plans financed by debt that inevitably disappoint in their growth and jobs objectives of is not the solution. Increasing the tax burden is not solving the fiscal problem, and will not do so if policymakers persist in penalizing the productive to finance the indebted sectors.

A reserve of credibility

Central banks find themselves in a difficult position. Perpetuate the extreme monetary policy and fuel a risky bubble, or stop it and maybe create a market scare. There is a third option, and it entails a fiscal policy that, cutting taxes, incentivizes real productive growth, thus gradually justifying financial market multiples while moving capital from liquid assets to the real economy.

Central banks do not have unlimited tools. The main asset they have is credibility. This credibility would immediately disappear if the policy of sterilization – that is, selling the assets they buy when economic conditions improve – is abandoned to become an ever-expanding money-printing machine. If that credibility disappears, either we face a massive financial bust or a humanitarian crisis in the form of hyperinflation. Both extremes can be prevented with simple but effective tools like following a Taylor rule on monetary policy and changing fiscal expansion from deficit spending to tax cuts to the productive sectors. When the economy is out of recession, like today, these measures help reduce the chances of another financial crisis.

Policymakers can support growth and productivity. The solution to the liquidity trap is to let productive economic agents breathe. There is an escape from the central-bank trap.

Daniel Lacalle has a PhD in Economics and is author of “Escape from the Central Bank Trap”, “Life In The Financial Markets” and “The Energy World Is Flat” (Wiley)

@dlacalle_IA

Picture, graph, and text courtesy of The World Economic Forum

 

Climate Agreement, Hypocrisy and Summits

Energy, Global Economy, On the cover, Sin categoría

Trump’s decision to withdraw from the Paris “climate agreement” with the aim of negotiating a better one can be debated, but the whole summit and agreement smell of bureaucracy and hypocrisy. What no one should do is deny reality.

If governments were truly concerned about “climate change”, they would make fewer summits and act more.

These summits are photo opportunities that mask a very different truth. Bureaucrats care about the process, not the results, that’s why they love summits and multilateral vague agreements. Those same bureaucrats justify the atrocious results by organizing another summit.

Keep calm. Do not worry about those who make catastrophic predictions. The history of blunders of the end-of-the-world doomsayers is so vast that only a politician could ignore them. Let us remember that, according to “scientific analysis” of a few decades ago, we would have run out of oil and water already seventeen years ago. Ignoring efficiency, technology and substitution is the favorite hobby of subsidy collectors.

The problem of “combating climate change by a committee decision” is that it neither does so, neither helps consumers.

These summits and agreements perpetuate the perverse incentives of subsidized and crony polluters while penalizing consumers via taxes.

But there is good news. Decarbonization is unstoppable . Not thanks to a summit or due to politicians, quite the opposite. Thanks to competition, technology and research. Thanks to human ingenuity. Coal has been disappearing from the global energy mix for decades, despite – not to thanks to – governments. And the same is happening with oil.

In fact, my reader will not be surprised to know that climate summits always hide agreements to perpetuate the polluting rent-seeking sectors of each member country by setting targets to 2030 that no one will monitor and someone else will come to explain .

The reality is that, summit after summit, with a smile and a handshake, leaders return with their state-owned polluting sectors intact.

– Of the 147 countries that have ratified the agreement, in the overwhelming majority (more than 90%) the most polluting companies and sectors are 100% public (producers in petro-states, coal producers, refineries, steel mills, etc …). Even seeing the Climate Accountability Institute analysis, 63% of emissions come from 90 companies, of which 31 are state-owned, 9 are government-run and 50 develop government-owned resources through royalty-providing concessions.

If these countries were so concerned about climate change, they would not need to meet in exotic places at expensive hotels. Closing down their state-owned polluters would solve “the problem”. In fact, no need to close them.  If those countries that signed the “climate” agreement implemented the measures of efficiency, environmental control and best practices of US companies, there would be no need for a summit.

The reality is that the US and its companies do more in terms of R &D, technology, efficiency and corporate responsibility than the vast majority of countries that signed this agreement.

  • The US energy intensity has plummeted and needs much less energy consumption to grow, even though it has increased its energy independence until it is almost self-sufficient. The energy intensity of the US is 60% lower than that of 1956 and the country grows in a more sustainable way.
  • China is the biggest polluter in the world. It accounts for 15% of the global economy but is almost 30% of total emissions. If China is concerned about climate change, all its government needs to do is to look at the sky in Beijing and see that it is black, not blue, then close its coal companies. They are mostly all state-owned.
  • India is almost 7% of global emissions and the vast majority comes from state-run and subsidized coal and high-energy intensity sectors.
  • China consumes much more coal than their official figures say. Both The Guardian and The New York Times have reported that China emits up to 1 billion tonnes of CO2 more than it officially recognizes each year. But it appears before the world as the leader of the fight against climate change. Well, in 2030 60% of its energy mix will still be coal.
  • To say that China and India emit more CO2 because they produce goods for the West is simply untrue. Governments decide what energy mix they want through central planning in four out of five of the top CO2 emitters in the world.
  • The so-called “green” European Union spends $ 6.9 billion annually on coal subsidies. Since the 2015 “Paris agreement”, these subsidies have actually increased by $875 million per annum. In other words, coal subsidies (as well as refineries and subsidies to the car industry) have increased, while consumer bills have skyrocketed with the excuse of being “green”. In addition, the European super-green Union is about 10% of the world’s CO2 emissions but its citizens bear 100% of the costs in their tariffs.
  • Of the subsidies to fossil fuels, the largest by far is Iran – which has also signed the “Paris agreement” – and spends more than Saudi Arabia, Russia and India together in fossil fuel subsidies.

As I explained before, decarbonisation is unstoppable . But it would be even faster without the pitfalls of those who today present themselves as saviors of the Earth while in reality they just tax citizens to perpetuate their polluting “national champions”.

No Hollywood star in a private jet denounces these hypocrisies. The hundreds of thousands of pages of legislation that this summit will produce are not going to eliminate progress, but delay it, they do .

Trump is not an anti-environment monster, and Macron is no green giant. The US has reduced its CO2 emissions more than the vast majority of countries thanks to competition. The success of the US in its energy policy has been precisely not having one, Dick Cheney told me years ago. If it had been up to the administration in 2007, today the US would not be self-sufficient in natural gas, one of the largest oil producers in the world, and a leader in competitive wind and solar without subsidies.

The gradual decarbonization of the US has not only come from healthy competition, but a cheaper transition helped fthe consumer. The US has cut more emissions in the past ten years thanks to fracking and competition than the European Union’s subsidy -driven interventionist nightmare (read).

The US has achieved this reduction by lowering gas and electricity prices to its citizens, while in the EU they have skyrocketed .

Trump is not going to stop a winning formula. Neither will he join a summit of perverse incentive decisions with little practical use. Obama could not stop the energy revolution that he initially rejected and now considers natural gas and almost energy independence a personal achievement.

Would it have been better for the US to accept the agreement? I’m not sure. It may negotiate something less cosmetic and more realistic. An agreement that does not harm competitiveness and employment.

Therefore, let us be calm.

If you think that Trump’s decision is bad, breathe easy. The Paris agreement is non-binding and completely unenforceable anyway. And the US will take at least three and a half years to fully implement the withdrawal. And if you really think that the climate savers are going to be the Chinese, take a trip to Beijing and Shanghai, look at the sky, and tell me what you see (if you can see anything).

Regardless of what you believe, technology and efficiency will continue to generate more progress, cleaner and more abundant energy. 

The whole Paris climate agreement is non-binding, not enforced and with no guidelines other than “annual contribution reports” -ie, papers. Whether or not the agreement was accepted by Trump, nothing in it is enforceable, so efficiency and technology change will happen whether there was an agreement or not.

Daniel Lacalle has a PhD in Economics and is author of “Escape from the Central Bank Trap”, “Life In The Financial Markets” and “The Energy World Is Flat” (Wiley)

@dlacalle_IA

Picture courtesy of Google