Guest post by Bill Luby of Vix and more.
When the VIX recently slid below 20.00 for an extended period, I sensed a noticeable unease about the state of the market in many traders and investors. Clearly a sub-20 VIX was underestimating the risks in the current and future market environment, they thought. When the VIX dipped below 18.00 that unease intensified and now with the VIX hovering around the 15.00 range and I can sense that quite a few are ready to grab the nearest pitchfork and riot about the inhumanity of the wayward VIX.
I will be the first to admit that there are a number of perplexing geopolitical, macroeconomic and other factors that pose real threats to the economy and to stocks, but I also believe that investors have become so fixated on some of the past problems thatavailability bias and disaster imprinting has clouded their judgment to the extent that they cannot separate the current market environment from the ghosts of markets past.
When Dalio writes, you should read. Dalio on the deleveraging process.
The purpose of this paper is to show the compositions of past deleveragings and, through this process, to convey in-depth, how the deleveraging process works. The deleveraging process reduces debt/income ratios. When debt burdens become too large, deleveragings must happen. These deleveragings can be well managed or badly managed. Some have been very ugly (causing great economic pain, social upheaval and sometimes wars, while failing to bring down the debt/income ratio), while others have been quite beautiful (causing orderly adjustments to healthy production-consumption balances in debt/income ratios). In this study, we are going to review the mechanics of deleveragings by showing how a number of past deleveragings transpired in order to convey that some are ugly and some are beautiful. What you will see is that beautiful deleveragings are well balanced and ugly ones are badly imbalanced. The differences between how deleveragings are resolved depend on the amounts and paces of 1) debt reduction, 2) austerity, 3) transferring wealth from the haves to the have-nots and 4) debt monetization. What we are saying is that beautiful ones balance these well and ugly ones don’t and what we will show below is how. Before we examine these, we will review the typical deleveraging process. (Full reading here).
Sweden dealt with a very hard economic reality in the early 90′s. Bad banks were created, hard measures adopted, but out of that mess, was born a very successful economy. What lessons can be taught by the Sweden. By Lars Calmfors via Voxeu.
Several Eurozone countries are currently struggling with acute fiscal crises (eg Corsetti and Müller 2012). At the same time, the new fiscal compact is an attempt to beef up fiscal frameworks for the future. In order to judge both the fiscal consolidation efforts and the reforms, comparisons with economies that have in the past carried through such processes successfully are helpful.
A prominent example is Sweden, which stands out among the EU countries for its strong public finances. At the trough of the recession in 2009, Sweden had a fiscal deficit of only 0.9% of GDP. In 2011, it even showed a small surplus. This is a stark contrast to the fiscal crisis that Sweden experienced in the 1990s. The lessons from Sweden are diverse. They show that a determined policy can indeed turn around the fiscal situation. But they also highlight that fiscal consolidation will be very painful in the Eurozone crisis countries and that the fiscal reforms underway may not be the optimal ones. Full article here.
Some charts on Money supply. Courtesy Jessie.
As a reminder, in a purely fiat monetary system, inflation and deflation are the result of policy decisions, and not any endogenous factors in the economy. Extreme outcomes such as a protracted deflation or hyperinflation are almost always the result of some policy decision which may be in error, unless they are caused by some exogenous shock or force.
This is a fundamental fact of how a fiat money system works, and what makes it different from a system in which the money is tied to some external control or standard, or some other relatively inflexible metric from the perspective of the system.
Please see Money Supply: A Primer if you wish for an explanation of some of these money supply measures.
And for all the Austrian econommists, I have included True Money Supply as the second graph.
European governments are prodding Spain to make deeper budget cuts in a first test of stiffer fiscal rules. Ten days after Prime Minister Mariano Rajoy unilaterally raised the 2012 Spanish deficit target, European finance chiefs called on Spain to cut an extra 0.5 percent of gross domestic product out of the 2012 budget.
Junker’s body language speaks for itself. Video below from Bloomberg.