Bill Gross: State of the Monopoly

[don]

Games People Play



My mother taught me how to play Monopoly – the game – and the markets over 40 years past have taught me how to play Monopoly – the financial economy. Financial markets and our finance-based economy are actually quite similar to the game in terms of the rules and strategies it takes to win. Monopoly’s real-time bank (the Fed) distributes money to players at the beginning and then continues to create more and more credit as the economy passes go. The cash in Monopoly isn’t credit and the player can’t borrow, so in this respect the game and the reality are quite different, but the addition of cash liquifies the player in a similar way that the Fed creates money out of thin air to liquify today’s finance-based system and create growth in the real economy.

Good players know that it is critical to move quickly around the board, make acquisitions and then develop the properties by creating hotels. Three hotels on each property are desirable and of course as every Monopoly pro knows, it’s not Boardwalk or Park Place that are the key holdings but the Oranges and the Reds. Same thing in reality’s markets, I would suggest. Which companies and which investments to overweight and how much leverage to use usually point to the eventual winners. But an ample amount of cash is important as well as you land on other owners’ properties. You need liquidity to pay rent or service debt – otherwise you sell assets at a discounted price and are swiftly out of the game. That reminds me of Lehman Brothers and its aftermath. Early in Monopoly, property is king but later in the game, cash becomes king and those without cash and the ability to get it go bankrupt.

It appears however, that since 2008 the rules of the finance-based economy have been substantially changed. Perhaps Parker Brothers will have to come with a new version of its own which incorporates the modern day methodology of central banks using Quantitative Easing and the outright purchase and occasional guarantee of private securities and public stocks to keep the game going. It’s as if Monopoly’s bank, which has a limited amount of 1, 5, 10 … dollar bills in each game box had “virtually” added trillions of dollars more in order to keep players solvent, in the hopes that some of it would trickle out to the real economy. With interest rates near zero and banks and other financial intermediaries sitting on trillions of Dollars, Euros, and Yen, why wouldn’t they lend it out to the private economy in hopes that they could obtain a higher return on their money? Sounds commonsensical, doesn’t it? Not in reality.

Well to be fair, in some cases and some countries they have. Bank loans in the U.S., for instance, are currently growing at 8% year over year and our economy appears to be growing at a 3% real and nominal growth rate with inflation at 0%. Still, even with the U.S. growing at an acceptable rate for now, its recovery over the past 5 years has been anemic compared to historic norms, and other developed economies are faring much worse. Many appear to be facing new recessions even with interest rates at 0% or – incredibly – negative rates. German and Swiss 5 year yields cost the lender money. Surreal to say the least. Before 2008, economists and historians would not have believed such a condition could exist, but here it is with individual sovereign countries and their respective central banks pushing each other out of the way in a race to the bottom of interest rates – wherever that is – and a race to the bottom in terms of currency valuations. Central bankers claim that they are doing no such thing, but that bravado should be dismissed out of hand. You can’t accuse them of lying but you can accuse them of distorting reality.

If all of them collectively could be labeled “Parker Brothers,” like the creator of the board game, players would be justified in saying that competitive devaluations and the purchase of bonds at near zero interest rates is indeed a significant distortion of the markets and – more importantly – capitalism’s rules which have been the foundation of growth for centuries, long before Parker Brothers central bankers came into existence in the early part of the 20th century. Even as the financial system morphed from the gold standard, to the Bretton Woods Dollar standard in 1944, and then the abandonment of any standard in 1971, capitalism seemed to be on firm ground. Incentives to lend, borrow, and invest for a profit were never challenged on a secular basis prior to 2008, except in Japan. There may have been recessions where such an appeal was eliminated at the margin, but no – capitalism was king. It was, as Francis Fukuyama proclaimed, “The End of History” – game, set, match – as Communism and other similar economic systems headed for the trash bin.

But the distortions created by post 2008 Parker Brothers have called Fukuyama’s forecast into question. There can be no doubt that negative or even zero percent interest rates cannot be a permanent rule on Monopoly’s new board. Investors and game players do not logically give money away; a mattress ultimately becomes a more attractive haven. And most importantly – because the markets and the financial sector are ultimately the servants of the real economy – growth is challenged and stunted.

In a new world, returns on real investment – ROI’s and ROE’s – become so low that the risk of a new project or the purchase of green hotels offer too little return for too much risk. Like the endgame in Monopoly where cash becomes king at the game’s conclusion, cash accumulates in corporate coffers or is used to repurchase stock in the financial economy. Investment in plant and equipment is deferred. Structural headwinds such as aging demographics and abnormally high debt/GDP ratios do not offer the player a “get out of jail free” card, in fact they help keep the cell door closed. Hope is challenged.

In the final analysis, while there is no better system than capitalism, it is incumbent upon it and its policymakers to promote a future condition which offers hope as opposed to despair. Capitalism depends on hope – rational hope that an investor gets his or her money back with an attractive return. Without it, capitalism morphs and breaks down at the margin. The global economy in January of 2015 is at just that point with its zero percent interest rates.


Officials at the Federal Reserve – the most powerful and strongest of Parker Brothers – seem to now appreciate the hole that they have dug by allowing interest rates to go too low for too long. Despite reasonable growth, some of them recognize the system’s distortion if only because inflation is going down, not up, in the process. Other Parker Brothers countries face deflation in the midst of negative interest rates. But the Fed, uniquely in my opinion, will move up the Monopoly board’s interest rates in late 2015, hoping to avoid landing on the figurative Park Place and Boardwalk in the process. It won’t however, move quickly – capitalism has been damaged by the change in rules since 2008. Caution, therefore will prevail in the U.S. and elsewhere for a long time. Bonds despite their ridiculous yields will not easily be threatened with a new bear market. Investors should expect as well, that because of the slow unwinding of zero percent rates in the U.S., that U.S. and global stocks will be supported. Their heyday is over however. In effect, equity holders now own the Greens, the Blues and the railroads on Monopoly’s board while the Reds and the Oranges belong to another era. Returns in the real economy are too low partially because of the misguided efforts of Parker Brothers bankers. There is no doubt that structural secular stagnation factors such as demographics, high debt, and technology have contributed significantly as well. Fiscal policy has been anemic since 2010.

In the final analysis, an investor – a player – must be cognizant of future low and in some cases negative total returns in 2015 and beyond. Capitalism’s distortion, with its near term deflation, poses a small but not insignificant risk to what my mother warned was the final destination for all games – entertainment or real. “In the end,” she said, “all of the tokens, all of the hotels, all of the properties – they all go back in the box.” The strong odds are that 2015’s distorted capitalism continues with anemic growth, but the box rests on the family room coffee table, waiting, waiting, for its turn.

[don]

Stephen Roach's 3 Ts

Stephen Roach via Project Syndicate

Predictably, the European Central Bank has joined the world’s other major monetary authorities in the greatest experiment in the history of central banking. By now, the pattern is all too familiar. First, central banks take the conventional policy rate down to the dreaded “zero bound.” Facing continued economic weakness, but having run out of conventional tools, they then embrace the unconventional approach of quantitative easing (QE).

The theory behind this strategy is simple: Unable to cut the price of credit further, central banks shift their focus to expanding its quantity. The implicit argument is that this move from price to quantity adjustments is the functional equivalent of additional monetary-policy easing. Thus, even at the zero bound of nominal interest rates, it is argued, central banks still have weapons in their arsenal.

But are those weapons up to the task? For the ECB and the Bank of Japan (BOJ), both of which are facing formidable downside risks to their economies and aggregate price levels, this is hardly an idle question. For the United States, where the ultimate consequences of QE remain to be seen, the answer is just as consequential.

QE’s impact hinges on the “three Ts” of monetary policy:transmission (the channels by which monetary policy affects the real economy); traction (the responsiveness of economies to policy actions); and time consistency (the unwavering credibility of the authorities’ promise to reach specified targets like full employment and price stability). Notwithstanding financial markets’ celebration of QE, not to mention the US Federal Reserve’s hearty self-congratulation, an analysis based on the three Ts should give the ECB pause.

In terms of transmission, the Fed has focused on the so-called wealth effect. First, the balance-sheet expansion of some $3.6 trillion since late 2008 – which far exceeded the $2.5 trillion in nominal GDP growth over the QE period – boosted asset markets. It was assumed that the improvement in investors’ portfolio performance – reflected in a more than threefold rise in the S&P 500 from its crisis-induced low in March 2009 – would spur a burst of spending by increasingly wealthy consumers. The BOJ has used a similar justification for its own policy of quantitative and qualitative easing (QQE).

The ECB, however, will have a harder time making the case for wealth effects, largely because equity ownership by individuals (either direct or through their pension accounts) is far lower in Europe than in the US or Japan. For Europe, monetary policy seems more likely to be transmitted through banks, as well as through the currency channel, as a weaker euro – it has fallen some 15% against the dollar over the last year – boosts exports.

The real sticking point for QE relates to traction. The US, where consumption accounts for the bulk of the shortfall in the post-crisis recovery, is a case in point. In an environment of excess debt and inadequate savings, wealth effects have done very little to ameliorate the balance-sheet recession that clobbered US households when the property and credit bubbles burst. Indeed, annualized real consumption growth has averaged just 1.3% since early 2008. With the current recovery in real GDP on a trajectory of 2.3% annual growth – two percentage points below the norm of past cycles – it is tough to justify the widespread praise of QE.

Japan’s massive QQE campaign has faced similar traction problems. After expanding its balance sheet to nearly 60% of GDP – double the size of the Fed’s – the BOJ is finding that its campaign to end deflation is increasingly ineffective. Japan has lapsed back into recession, and the BOJ has just cut the inflation target for this year from 1.7% to 1%.

Finally, QE also disappoints in terms of time consistency. The Fed has long qualified its post-QE normalization strategy with a host of data-dependent conditions pertaining to the state of the economy and/or inflation risks. Moreover, it is now relying on ambiguous adjectives to provide guidance to financial markets, having recently shifted from stating that it would maintain low rates for a “considerable” time to pledging to be “patient" in determining when to raise rates.

But it is the Swiss National Bank, which printed money to prevent excessive appreciation after pegging its currency to the euro in 2011, that has thrust the sharpest dagger into QE’s heart. By unexpectedly abandoning the euro peg on January 15 – just a month after reiterating a commitment to it – the once-disciplined SNB has run roughshod over the credibility requirements of time consistency.

With the SNB’s assets amounting to nearly 90% of Switzerland’s GDP, the reversal raises serious questions about both the limits and repercussions of open-ended QE. And it serves as a chilling reminder of the fundamental fragility of promises like that of ECB President Mario Draghi to do “whatever it takes” to save the euro.

In the QE era, monetary policy has lost any semblance of discipline and coherence. As Draghi attempts to deliver on his nearly two-and-a-half-year-old commitment, the limits of his promise – like comparable assurances by the Fed and the BOJ – could become glaringly apparent. Like lemmings at the cliff’s edge, central banks seem steeped in denial of the risks they face.

[don]

forget "currency wars"

guess that depends on how far you are from the battlefield . . .

WARSAW — Piotr Szczepaniak, an apartment manager here, had just finished work, checking faucets and making sure rents were paid. After making himself a coffee, he logged on to a Polish social network and noticed that someone had posted the current exchange rate of the Swiss franc.

“I was frozen,” he said, seeing that the franc’s value had soared that day. Like hundreds of thousands of other Eastern Europeans, Mr. Szczepaniak, 46, is paying off a mortgage he took out in francs, instead of his local currency, the zloty.

In an instant, his monthly payment rose by more than 20 percent when Switzerland’s central bank unexpectedly removed a cap on its currency.

Central bankers are increasingly viewed as wizards capable of rescuing countries from the doldrums by printing money to manage interest rates and control currencies. But the monetary magic is unleashing unintended consequences on the global economy, financial markets and ordinary people.

The action by the Swiss central bank, which came in mid-January, was one of the biggest surprises. The Swiss National Bank decided it would be hard-pressed to keep the franc tied to the euro when the European Central Bankbegan a major round of stimulus.

The move set off shock waves in financial markets and a one-day 23 percent spike in the franc’s value against the euro.

The fallout has been far-reaching. Some hedge funds, like one run by the Fortress Investment Group, took steep losses; the IG Group, a publicly traded British brokerage firm and financial trading company, issued a profit warning. Swiss exporters howled, and the chief executive of the watchmaker Swatch Group called it a “tsunami.”

Many of the worst hit are average Europeans who took out loans in Swiss francs, often from foreign-owned banks, to take advantage of the far lower interest rates being offered.

Poland has nearly $40 billion in loans denominated in francs, according to European Central Bank data. The borrowing, which accounts for nearly 8 percent of the country’s gross domestic product, has left Poland weighing its options. On Wednesday, the Polish government urged banks to convert franc loans to zloty at market rates.

Poland is hardly the only country in this predicament. Austria has about $41 billion worth of such loans, close to 10 percent of its economic output. Other ordinary borrowers, from France to Croatia, have also felt the sting.

“With hindsight, it’s easy to say the foreign banks are guilty of pushing these mortgages and not informing customers of the risks,” said Nicholas Spiro, managing director of Spiro Sovereign Strategy in London, who also blamed “insufficient regulation.” Poland’s troubles, which come during an election year, are “political dynamite,” he added.

Before the financial crisis gripped Europe, banks heavily marketed loans in Swiss francs, which were available at interest rates a third as high as for loans in Polish zlotys, or even lower. In Poland, there were 562,487 home loans in francs in 2013, representing almost a third of the total number of mortgages, according to the Polish Financial Supervision Authority.

Poland is a country that is still getting used to the idea of mortgages. Many Poles who took out loans were the first in their family to do so.

“It was quite a shock for my parents,” said Rafal Jackowski, 39, a marketing executive who took out a loan in francs for an apartment in Krakow in 2004.

“They said, ‘My God, you can pay that much?'” he said, adding, “We were not used to spending money that we don’t have.”

Photo

Katarzyna Szczerbowska, a 43-year-old writer, said she was advised by a financial consultant when she bought a two-story apartment in 2008.

“The adviser said Swiss francs were the best option because the interest rates were lower and the currency rates were stable,” she said.
“Everybody around me advised me to take a mortgage in Swiss francs,” she added. “Everybody else was doing the same thing.”

She says she is now so far behind on her payments, and feels so trapped by her accumulating debts, that she has contemplated suicide.
She learned on Facebook of the Swiss central bank’s action the morning it happened. She immediately began calling her bank and kept calling all day, but could not get through.

Over the last five years, her payments have doubled to about $2,000 a month. A few months ago, her boyfriend — the father of her 20-year-old daughter — went abroad to help cover the added costs by getting a job in a factory.
When she first took out her loan, the United States was already in the grip of a financial crisis, but its impact on Europe was still not clear.

“Everybody kept saying that the crisis in the States was very local — nobody knew why — but it was the U.S. that had problems,” Ms. Szczerbowska said. “People had to be idiots to think the crisis wouldn’t spread. Unfortunately, I was the idiot.”

[gwynedd1]

Re: forget "currency wars"

guess that depends on how far you are from the battlefield . . .

WARSAW — Piotr Szczepaniak, an apartment manager here, had just finished work, checking faucets and making sure rents were paid. After making himself a coffee, he logged on to a Polish social network and noticed that someone had posted the current exchange rate of the Swiss franc.

“I was frozen,” he said, seeing that the franc’s value had soared that day. Like hundreds of thousands of other Eastern Europeans, Mr. Szczepaniak, 46, is paying off a mortgage he took out in francs, instead of his local currency, the zloty.

In an instant, his monthly payment rose by more than 20 percent when Switzerland’s central bank unexpectedly removed a cap on its currency.

Central bankers are increasingly viewed as wizards capable of rescuing countries from the doldrums by printing money to manage interest rates and control currencies. But the monetary magic is unleashing unintended consequences on the global economy, financial markets and ordinary people.

The action by the Swiss central bank, which came in mid-January, was one of the biggest surprises. The Swiss National Bank decided it would be hard-pressed to keep the franc tied to the euro when the European Central Bankbegan a major round of stimulus.

The move set off shock waves in financial markets and a one-day 23 percent spike in the franc’s value against the euro.

The fallout has been far-reaching. Some hedge funds, like one run by the Fortress Investment Group, took steep losses; the IG Group, a publicly traded British brokerage firm and financial trading company, issued a profit warning. Swiss exporters howled, and the chief executive of the watchmaker Swatch Group called it a “tsunami.”

Many of the worst hit are average Europeans who took out loans in Swiss francs, often from foreign-owned banks, to take advantage of the far lower interest rates being offered.

Poland has nearly $40 billion in loans denominated in francs, according to European Central Bank data. The borrowing, which accounts for nearly 8 percent of the country’s gross domestic product, has left Poland weighing its options. On Wednesday, the Polish government urged banks to convert franc loans to zloty at market rates.

Poland is hardly the only country in this predicament. Austria has about $41 billion worth of such loans, close to 10 percent of its economic output. Other ordinary borrowers, from France to Croatia, have also felt the sting.

“With hindsight, it’s easy to say the foreign banks are guilty of pushing these mortgages and not informing customers of the risks,” said Nicholas Spiro, managing director of Spiro Sovereign Strategy in London, who also blamed “insufficient regulation.” Poland’s troubles, which come during an election year, are “political dynamite,” he added.

Before the financial crisis gripped Europe, banks heavily marketed loans in Swiss francs, which were available at interest rates a third as high as for loans in Polish zlotys, or even lower. In Poland, there were 562,487 home loans in francs in 2013, representing almost a third of the total number of mortgages, according to the Polish Financial Supervision Authority.

Poland is a country that is still getting used to the idea of mortgages. Many Poles who took out loans were the first in their family to do so.

“It was quite a shock for my parents,” said Rafal Jackowski, 39, a marketing executive who took out a loan in francs for an apartment in Krakow in 2004.

“They said, ‘My God, you can pay that much?'” he said, adding, “We were not used to spending money that we don’t have.”

Photo

Katarzyna Szczerbowska, a 43-year-old writer, said she was advised by a financial consultant when she bought a two-story apartment in 2008.

“The adviser said Swiss francs were the best option because the interest rates were lower and the currency rates were stable,” she said.
“Everybody around me advised me to take a mortgage in Swiss francs,” she added. “Everybody else was doing the same thing.”

She says she is now so far behind on her payments, and feels so trapped by her accumulating debts, that she has contemplated suicide.
She learned on Facebook of the Swiss central bank’s action the morning it happened. She immediately began calling her bank and kept calling all day, but could not get through.

Over the last five years, her payments have doubled to about $2,000 a month. A few months ago, her boyfriend — the father of her 20-year-old daughter — went abroad to help cover the added costs by getting a job in a factory.
When she first took out her loan, the United States was already in the grip of a financial crisis, but its impact on Europe was still not clear.

“Everybody kept saying that the crisis in the States was very local — nobody knew why — but it was the U.S. that had problems,” Ms. Szczerbowska said. “People had to be idiots to think the crisis wouldn’t spread. Unfortunately, I was the idiot.”

Borrow in a foreign currency? Then I hope one never makes any disparaging remarks about ARMS. Most ARMS that I know of cannot even reset beyond a fixed rate every year. If a 3/1 ARM is considered risky, borrowing in a foreign currency under the floating rate regime is criminally insane in the act of victimizing one's self. Its and ARM and a LEG. How are they not catching on to this?

[dcarrigg]

Re: forget "currency wars"

Borrow in a foreign currency? Then I hope one never makes any disparaging remarks about ARMS. Most ARMS that I know of cannot even reset beyond a fixed rate every year. If a 3/1 ARM is considered risky, borrowing in a foreign currency under the floating rate regime is criminally insane in the act of victimizing one's self. Its and ARM and a LEG. How are they not catching on to this?

Is there a country on earth where the majority of the population didn't get robbed within a couple decades of first allowing capitalization of land? Take the unsuspecting peasants, indenture them for 30 years, put a fence around what was previously free, and charge them interest to boot. Wait until the farms fail. That's usually when the real tragedy begins. And is there anyone in the world easier to take advantage of with fancy contracts than a tenant farmer with dreams of becoming a yeoman?

I knew when the Economist started publishing articles about "The Golden Age in Polish Farming," that it was probably about time to short it. Didn't see clearly where the knife would fall from until now. If they've got loans in CHF, combined with sanctions on Russia hurting ag export prospects, and relatively low commodity prices, I imagine they're going to be in a damn tough spot coming up with the scratch for planting season...

[don]

Re: forget "currency wars"

How are they not catching on to this?

This may have something to do with it:

Poland is a country that is still getting used to the idea of mortgages. Many Poles who took out loans were the first in their family to do so.

Can they play catchup?

(fool me once, you SOB; fool me twice . . .)