Radio Show Notes: Central Bank Fog, Bank Stress Tests and HK 20 years on

Thursday, June 29, 2017 // Written by Enzio von Pfeil
    1. Central bank fears.  Quite correctly, Central Banks fear the return of inflation.  Given my  German background, I can vouch for the seriousness of this concern. But today, as we shall show now, inflation keeps falling, not rising. So, what gives?


  1. Anachronistic paradigms.  The Fed and the ECB are driving by looking at a rear view mirror.  That rear view mirror is outdated  frameworks that no longer apply today. These frameworks are akin to repairing a car by working with a manual on how to repair a horse buggy.  Here are the anachronistic paradigms, the horse buggy repair manuals:

                                         i.     Money drives inflation.  This thinking is based on the simple idea that the larger the amount of money swilling about, the more that this money will chase too few goods. This feeds through into “demand-pull” inflation. This framework – this  horse buggy repair manual is about 100 years old!  BUT TODAY, we have massive amounts of money supply yet LOW demand-pull inflation.

                                       ii.     Wages drive inflation.  This thinking is based on the Philips Curve, which states that tight labour markets produce wage inflation.   This feeds through into “wage push” inflation. This framework – this horse buggy repair manual  - is over 70 years old! BUT TODAY, despite falling unemployment, despite tight labour markets, wages are not rising.

                                     iii.     Weak exchange rates drive inflation.  This thinking is based on the idea that when, for instance, the dollar weakens, you have to pay more dollars per unit of foreign currency.  This feeds through to “imported inflation”.  This framework – this horse buggy repair manual – is as at least 300 years old!   BUT TODAY, despite a falling dollar since 1973, US inflation is weaker, not stronger!


  1. Confusion at the ECB

                                         i.     Joke. The old joke is that the world wanted Germans to run Italian monetary policy – but instead, an Italian is running Germany monetary policy!

                                       ii.     Horse buggy repair manuals. A great deal of the ECB’s confusion stems from the fact that these three 100-year old frameworks, these horse buggy repair manuals, simply are not working anymore!

                                     iii.     Frozen cheese. But most people don’t like to move their cheese – they don’t like having to think differently about something. So there is huge policy dissent within the ranks of the ECB – and the Fed and the Bank of Japan.  Nobody quite knows what to do.


  1. The Fed’s policy mistake.  By trying to solve today’s problem – massive unemployment – with a 100-year old horse buggy repair manual, the Fed risks overshooting. It risks raising rates far too much relative to tepid inflationary pressures. That overshoot will choke America’s economic recovery, will worsen her Economic Time®. Market players will begin sniffing this danger of overshoot during the fourth quarter of this year, meaning and the punters  and algorithmic traders will head for the exits simultaneously.  So I am talking about a stock market crash  come the fourth quarter of this year – courtesy of the Fed using a horse buggy repair manual to fight the chimera of inflation.


    1. Looming bank crises.  I see these bank crises surfacing towards the first half of next year – by the time the Fed has choked off economic growth by overshooting in the interest rate dept.  That slowdown will beget crises in the bundled markets of

                                         i.     Student loans

                                       ii.     Automobile loans, and

                                     iii.     Home loans, i.e. mortgages.


  1. Horse buggy repair manual (II)?  I not a banking expert, but if you believe that people generally don’t like to move their cheese – don’t like to change the frameworks within which they think – then why should they think differently when it comes to bank stress tests? No, I am afraid that yet again, horse buggy repair manuals are being consulted to solve today’s modern problems.


  1. Anachronistic stress tests.  These have been conducted by using a rear view mirror:


                                         i.     Comparison with 2007/8 crises valid?  Whilst there are similarities between what could go wrongly now and what went wrongly a decade ago (!), one should be wary of concocting too many similarities.

  1. Bungled loans far greater. As we pointed out above, the coming crises will be much deeper and more far-flung than a decade ago. That‘s because we not only are dealing with bundled mortgages, but also with bundled student as well as bundled automobile loans.
  2. What about the unknowns?  Listeners know that we prefer dealing with our circumference of ignorance – as opposed to our circle of knowledge.  This circumference of ignorance consists of two parts
    1. Known unknowns, and
    2. Unknown unknowns


Known unknown.  One “known unknown” is the extent to which local US banks are exposed to foreign influences, ones which could explode and thus endanger US banks in their wake…


No more qualitative stress tests. Ominously, the Fed has dropped the qualitative stress tests, but esp. these would go some way to identifyiung those “ unknowns” that we are so worried about.


                                       ii.     Sensible to reduce capital? Thus, is REDUCING capital the way to go?  Surely with more unknowns trigger  banking crises, the worse and more pervasive these banking crises will become. So banks should salt away MORE, not less money – in order to save the tax payer from having to bail our overpaid bankers out again.  




    1. No numerical razzle dazzle.  I am not going to dazzle you with statistics.
    2. No glowing report card. Nor am I going to give you a glowing, government-friendly report card. Just read CY Leung’s self-praises that he recently lectured us serfs with about his glorious five years in office
    3. Instead, a sobre assessment.  Instead, what I will sketch are key areas  where we have improved and where we have worsened over the past 20 years
    4. On the plus side of the ledger

                                         i.     Dollar peg. We have maintained that all-important dollar peg. It’s vital because every time that HK has gone off the peg, it has gone off course…

                                       ii.     Low inflation.  That maintenance of the dollar peg has kept panic purchases away, so we have enjoyed low inflation – in line with America’s, and

                                     iii.     Low, simple taxes. We have managed to keep the tax form very simple – and the tax rate very low. Working makes sense in HK – contrary to working in that welfare museum, Europe….

  1. On the minus side of the ledger

                                         i.     Landlord taxes. Our government taxes remain enviably low – but not so our landlord taxes.  High rents will keep eroding our global competitiveness, making firms think twice about whether they wish to move to HK – or to less expensive parts of China and non-HK Asia.

                                       ii.     Strangulation by cartel.  The grip of the cartels on HK only can have strengthened over the past 20 years.  We are not referring just to the overt ones that limit consumer choice – e.g. two grocery store chains. We also are referring to more insidious ones like the closed shop of the doctors and nurses, who refuse to facilitate the entry of more foreign medical specialists.

                                     iii.     Rotting standard of English.  We all know how our standard of English has been rotting esp. since 1997.  This was a public policy choice initiated by CH Tung’s government. Tough to know how one can be an international financial centre without speaking proper English at all levels….One result is that our youth speak neither fluent English nor fluent Mandarin. So how do we keep up with the ever-evolving global financial as well as Chinese economies?

                                    iv.     Crucially, NONE of these “negatives”are the fault of Beijing.  They are the result of local avarice, local greed along with lacking local vision,  ruling the roost.


[1] Peter. I assume that you will paint a market picture for your listeners, so I wanted to go backstage and explain to them whence this confusion…

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