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Low Interest Rates Subsidize Wealthy Households

October 22, 2017 Tyler Durden 0

Authored by Hal Snarr via The Mises Institute,

When the economy begins to sink into recession, politicians, mainstream economists, policy wonks, and the Federal Reserve begin beating the economic stimulus drum.

Politicians, however, disagree over the…

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Here Is The IMF’s Global Financial Crash Scenario

October 22, 2017 Tyler Durden 0

Hidden almost all the way in the end of the first chapter of the IMF’s latest Financial Stability Report, is a surprisingly candid discussion on the topic of whether “Rising Medium-Term Vulnerabilities Could Derail the Global Recovery”, which is a politically correct way of saying is the financial system on the verge of crashing.

In the section also called “Global Financial Dislocation Scenario” because “crash” sounds just a little too pedestrian, the IMF uses a DSGE model to project the current global financial sitution, and ominously admits that “concerns about a continuing buildup in debt loads and overstretched asset valuations could have global economic repercussions” and – in modeling out the next crash, pardon “dislocation” – the IMF conducts a “scenario analysis” to illustrate how a repricing of risks could “lead to a rise in credit spreads and a fall in capital market and housing prices, derailing the economic recovery and undermining financial stability.”

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From the IMF’s Financial Statbility Report:

Could Rising Medium-Term Vulnerabilities Derail the Global Recovery?”

This section illustrates how shocks to individual credit and financial markets well within historical norms can propagate and lead to larger global impacts because of knock-on effects, a dearth of policy buffers, and extreme starting points in debt levels and asset valuations. A sudden uncoiling of compressed risk premiums, declines in asset prices, and rises in volatility would lead to a global financial downturn. With monetary policy in several advanced economies at or close to the effective lower bound, the economic consequences would be magnified by the limited scope for monetary stimulus. Indeed, monetary policy normalization would be stalled in its tracks and reversed in some cases.

The Global Macrofinancial Model documented in Vitek 2017 is used to assess the consequences of a continued buildup in debt and an extended rise in risky asset prices, from already elevated levels in some cases. This dynamic stochastic general equilibrium model covers 40 economies and features extensive macro-financial linkages—with both bank- and capital-market-based financial intermediation—as well as diverse spillover channels.

This scenario has two phases. The first phase features a continuation of low volatility and compressed spreads. Equity and housing prices continue to climb in overheated markets. As collateral values rise, bank lending conditions adjust to maintain steady loan-to-value ratios, facilitating favorable bank lending rates and more credit growth. As discussed, leverage in the nonfinancial private sector has already increased over the past decade across major advanced and emerging market economies. In the scenario, a further loosening in lending conditions, combined with low default rates and low volatility, leads investors to drift beyond their traditional risk limits as the search for yield intensifies despite increases in policy rates.

As presented earlier, market and credit risk premiums are close to decade-low levels—leaving markets exposed to a decompression of risk premiums. Thus, the second phase begins with a rapid decompression of credit spreads and declines of up to 15 and 9 percent in equity and house prices, respectively, starting at the beginning of 2020. This shift reflects debt levels breaching critical thresholds, prompting markets to grow concerned about debt sustainability, while risk premiums jump, aggravating deleveraging pressures.

As risk premiums rise, debt servicing pressures are revealed as high debt-to-income ratios make borrowers more vulnerable to shocks. The asset repricing is moderate in magnitude, but is broad-based across jurisdictions and leads to a tightening of financial conditions. Flight to quality flows reduce long-term bond yields in safe havens and raise them in the rest of the world. Segments with higher leverage and extended valuations are hit particularly hard, leading to higher funding costs and debt servicing strains.

Underlying vulnerabilities are exposed, and the global recovery is interrupted. Figure 1.30 summarizes the main impacts and spillovers:

  • The global economic impact of this scenario is broad-based and significant, about one-third as severe as the global financial crisis. The level of global output falls by 1.7 percent by 2022 relative to the WEO baseline, with varying cross-country impacts.
  • The severity of the economic impact on the United States is cushioned by stronger bank buffers, milder house price declines, and more monetary policy space compared with other advanced economies, despite relatively high equity valuations. The Federal Reserve reverses interest rate hikes during the second phase of the scenario, cutting the policy rate by 150 basis points to 1.75 percent by 2022.
  • The euro area suffers a larger output loss because the policy rate is at the effective lower bound and—as a result of renewed financial fragmentation—term premiums rise in high-spread euro area economies. Government debt ratios climb because nominal output is lower and debt service costs are higher for these economies.
  • Emerging market economies are disproportionately affected by the correction in global risk assets. The flight to quality prompts outflows from their equity and bond markets, putting pressure on currencies and challenging countries with large external financing needs.
  • Corporate and household defaults rise on the back of higher interest costs, lower earnings, and weaker growth. Default rates do not breach global financial crisis levels but return to levels consistent with prior cyclical peaks. Firms in some euro area countries and China with excessive debt overhangs are more sensitive to the increase in credit costs. Household leverage and high house prices in Australia and Canada make these economies more  susceptible to risk premium shocks.
  • Higher credit and trading losses, in turn, reduce bank capital ratios to varying degrees worldwide. Banking systems in advanced economies are healthier compared with the precrisis period, while leverage is less of a potential amplifier. Chinese banks suffer outsize declines in capital, but strong policy buffers could be used to mitigate the financial and economic impacts.

Emerging Markets Would Suffer a Retrenchment in Foreign Capital Inflows

Drawing on the above scenario, the potential for emerging market stress due to pressures on portfolio inflows is examined in more detail, including by taking into account the likely reduction in these flows from Federal Reserve balance sheet normalization (as discussed earlier).

  • During the first phase of the scenario, portfolio flows to emerging market economies are supported by rising investor risk appetite. This partially offsets the drag on portfolio inflows from US monetary policy normalization observed during 2017–19. As a result, there is a (net) reduction in portfolio inflows to emerging market economies of about $25 billion a year, compared with $35 billion under the baseline (Figure 1.31, panel 1).
  • During the second phase of the scenario, the asset market correction triggers a more rapid retrenchment in capital inflows to emerging market economies of about $65 billion over the first four quarters, in addition to the projected reduction of $35 billion in inflows associated with continued Federal Reserve balance sheet normalization. The combined effect results in a reduction of portfolio inflows of some $100 billion during the first four quarters of the correction (and about $65 billion during the subsequent four quarters).
  • At the country level, the associated portfolio inflow reduction during the first two years of the shock to global risk premiums ranges from 1.6 to 2.3 percent of GDP for the most affected countries (Figure 1.31, panel 2). Such a reduction is likely to lead to an outright reversal of portfolio flows, at least during some quarters, considering that the decompression of risk premiums is likely to be more rapid in some periods than in others (rather than unfolding at a steady pace as depicted in this exercise).

The buildup in external financing pressures could be particularly challenging for countries with large and rising projected current account deficits. For example, Colombia, South Africa, and Turkey have projected current account deficits in the range of 3 to 4½ percent of GDP in 2019 (Figure 1.31, panel 3). Moreover, emerging market currencies would come under pressure, limiting space for monetary policy to ease. In turn, higher domestic interest rates would affect firms’ debt servicing capacity, hitting those with still high levels of corporate leverage and increasing risks to weaker banking systems.

Emerging Market Policies In emerging market economies, policymakers should take advantage of current favorable external conditions to further enhance their resilience, including by continuing to strengthen external positions where needed and reduce corporate leverage where it is high. Deploying policy buffers and exchange rate flexibility would help buffer external shocks, while improving corporate debt-restructuring mechanisms and monitoring firms’ foreign exchange exposures would lower corporate vulnerabilities. Advances in these areas would leave these economies better placed to cushion any reduction in capital inflows that may occur from monetary policy normalization in advanced economies.

However, capital outflow pressures could become more significant if there is a severe retrenchment in global risk appetite, as in the scenario described earlier. Such pressures should usually be handled primarily with macroeconomic, structural, and financial policies, although the appropriate response will differ across countries depending on available policy space (see IMF 2012, 2015, 2016a). Where appropriate, exchange rate flexibility should be a key shock absorber, but in countries with sufficient international reserves, foreign exchange intervention can be useful to prevent disorderly market conditions. In periods of stress, liquidity provision may also be needed to support the orderly functioning of financial markets. Capital flow management measures should be implemented only in crisis situations, or when a crisis is considered imminent, and should not substitute for any  needed macroeconomic adjustment. When circumstances warrant the use of such measures on outflows, they should be transparent, temporary, and nondiscriminatory and should be lifted once crisis conditions abate.

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Economic data due from Asia today

October 22, 2017 Eamonn Sheridan 0

A sparse calendar here today
China property prices due at 0130 GMT
Japan Leading and Coincident indexes,  August (final) due at 0500 GMT
That’s pretty much it!
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93-Year-Old President Carter: Russians Didn’t Alter Election, Obama Didn’t Deliver, We Didn’t Vote For Hillary

October 22, 2017 Tyler Durden 0

Spot the odd one out…

Only one of these six people admits that Russians did not alter the election outcome and did not vote for Hillary…

In a lengthy interview with The New York Times recently, 93-year-old former President Jimmy Carter cut loose on some painful establishment ‘facts’.

As DailyWire.com’s Joseph Curl reports, The Times decided to play up the fact that Carter would love to go over to North Korea as an envoy. But the Times is steadily proving how out of touch it is — and how it no longer seems to actually “get” what real news is.

Here are some major highlights from the interview:

1. The Russians didn’t steal the 2016 election.

Carter was asked “Did the Russians purloin the election from Hillary?”

 

“I don’t think there’s any evidence that what the Russians did changed enough votes — or any votes,” Carter said.

 

So the hard-left former president doesn’t think the Russians stole the election? Take note, Capitol Hill Democrats.

2. We didn’t vote for Hillary.

Carter and his wife, Roselyn, disagreed on the Russia question. In the interview, she “looked over archly [and said] ‘They obviously did'” purloin the election.

 

“Rosie and I have a difference of opinion on that,” Carter said.

 

Rosalynn then said, “The drip-drip-drip about Hillary.”

 

Which prompted Carter to note that during the primary, they didn’t vote for Hillary Clinton. “We voted for Sanders.”

3. Obama fell far short of his promises.

Barack Obama whooshed into office on pledges of delivering “hope and change” to the country, spilt by partisan politics.

 

He didn’t. In fact, he made it worse.

 

“He made some very wonderful statements, in my opinion, when he first got in office, and then he reneged on that,” he said about Obama’s action on the Middle East.

4. Media “harder on Trump than any president.”

A recent Harvard study showed that 93% of new coverage about President Trump is negative.

 

But here’s another shocker: Carter defended Trump.

 

“I think the media have been harder on Trump than any other president certainly that I’ve known about,” Carter said. “I think they feel free to claim that Trump is mentally deranged and everything else without hesitation.”

5. NFL players should “stand during the American anthem.”

Carter, who joined the other four living ex-presidents on Saturday for a hurricane fundraiser, put his hand on his heart when the national anthem played — and he has a strong opinion about what NFL players should do, too.

 

“I think they ought to find a different way to object, to demonstrate,” he said. ” I would rather see all the players stand during the American anthem.”

*  *  *
Not exactly the narrative The Times was painting…

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