From Capital & Conflict (Great Britain)-
If I’d told you just three months ago that today we’d be talking about the potential collapse of Germany’s largest bank, you would have heaved a pint of warm lager in my face. Or laughed. Lager is valuable, and expensive. It costs real money.
Yet here we are, 98 days since Britain voted to leave the European Union. And we’re not talking about anarchy in the UK. We’re talking about entropy in Europe.
What a world!
Let’s begin with the good news. There’s not much of it so it won’t take long. But fortunately most of it is right here in Britain. It begins and ends with confidence. A survey of 2,000 Britons by GfK revealed that consumer confidence levels about the economy and household and personal finances are right back where they were before the Brexit vote.
The September rise was larger than economists expected. For their part, economists seem locked into the expectation that Brexit will be a disaster at some point. And strictly speaking, they could still be right.
No one knows what will happen if and when the government triggers Article 50 of the Lisbon Treaty early next year. If that’s when the government intends to do it. And if legal challenges to the government’s authority to trigger Article 50 without a vote in Parliament are shot down.
In the meantime, Britons, being first and foremost human beings, are getting on with the business of living life, as we all must do whether we like it or not. And since the promised catastrophe has failed to materialise, they’re evidently feeling as good about the future as they have at any time in the last 98 days.
Joe Staton from GfK explained the confidence numbers, saying that “Wages continue to grow faster than prices, rising employment boosts income and low interest rates encourage people to spend rather than save.” Ah, yes. Somebody had to mention low interest rates. That brings us to Berlin.
You could argue that no national banking system has been hit harder than Germany’s by the negative rates imposed on Europe by the European Central Bank (ECB). The ECB, along with the Bank of Japan and the US Federal Reserve, has made banking a lousy business with low rates. They are killing banking as we know it. Today’s question: have they made it fatal for Deutsche Bank?
Hedge fund flight begins
Concerns continue to swirl around Germany’s largest lender. Part of the problem is just what I’ve mentioned above: confidence. Once confidence wanes, it can be completely lost in an accelerating feedback loop. The fear of something worse actually makes things worse. What do I mean?
Let’s take liquidity. The lack of it – and the Federal Reserve’s willingness to let Lehman Brothers go it alone – is what caused so much of the selling in 2008. Banks needed cash. They had to sell assets. Selling begat selling. And the sight of so much selling scared depositors and investors. Selling begat selling.
Hedge funds and derivatives traders began moving money out of Deutsche Bank (DB) yesterday, according to Bloomberg. Millennium Partners moved $34 billion out. Rokos Capital Management moved $4 billion. Capula Investment $14 billion. All up, the first steps to the exit were taken by just ten hedge funds.
I say “just” ten because it’s important to keep the move in context. DB has 800 hedge fund clients. It has 200 clients who use the bank for derivatives clearing. It has $600 billion in customer deposits. And it has $246 billion in liquid reserves.
All of that suggests that liquidity is not the issue at DB. A small number of firms have exercised an abundance of caution. DB spokesman Michael Goldman was at pains to point out that it’s a small move in the scheme of things. Goldman said:
Our trading clients are amongst the world’s most sophisticated investors. We are confident that the vast majority of them have a full understanding of our stable financial position, the current macroeconomic environment, the litigation process in the U.S. and the progress we are making with our strategy.
He has a point. In addition to $246 billion in liquid reserves, the bank would have access to huge sums of liquidity from the ECB, should they be required. It’s likely the German government would step in if it had to. And in a pinch, if it needs to sell assets, DB proved it could do so. On Wednesday the bank sold Abbey Life Insurance for $1.2 billion.
All of that ought to reassure investors that there’s nothing to see here. So why were the shares down yesterday? Why are they down again this morning? And why are they down 57% year-to-date? Why is DB’s price-to-book value ratio of 0.233, from Simon Ballard at Bloomberg, the third-lowest of the 26 stocks in the Euro Stoxx Bank Index?
If it’s not a liquidity problem (yet) then it’s a confidence/solvency issue. That sounds like a dodge. But a stock doesn’t trade at such a small price-to-book ratio unless there are some serious concerns about the quality of the assets on the books. In DB’s case, it may be that the bank is so large, so interconnected, and so vital in the derivatives market, that people simply don’t know or don’t trust that assets are safe.
Trust, then, is the real issue. As my friend Jim Rickards has said when talking about money, confidence comes from trust. All forms of money are backed by confidence at some level, Jim says. Trust can be lost quickly. And confidence is inherently psychological. It’s hard to measure. But you know when it’s gone.
It’s going right now for DB. And even though the bank is based in Frankfurt, I’ve chosen the subject line “Berlin has fallen” because I think the same confidence dynamic at play with DB is in play for global central bankers and the European Union. Confidence in the ability of big, centralised institutions to solve complex problems is being lost.
The loss of confidence is related to competence. We’re eight years into the era of quantitative easing (QE) and low rates, and very little seems to have changed. Debts are larger. Financial repression has put the borrowing interests of indebted governments ahead of savers and pensioners. And now the authorities are talking about banning cash.
At a basic level, QE simply hasn’t worked. That’s why we’re nearing the monetary endgame. It’s what we’ll be talking about Monday at the MoneyWeek Conference,When banking dies: how to invest during the monetary endgame . What’s the next move by central banks? How do you prepare?
Banks may be the next victim of central bank incompetence simply because their business models have been crushed by low interest rates. How does a bank survive in an era of low rates and negative rates? When there are persistent worries about whether a bank has enough capital? And when the government is running the economy for its own benefit?
Are we actually on the verge of even more centralisation? I’m talking about a financial system where the government is the largest borrower; the central bank is the largest buyer of asset prices; and credit creation is no longer done via commercial banks with bank money, but by central banks with fiat money, digital money, or stamp money. Quasi-nationalisation of the banking system is the logical end of the centralising trend.
All of that is a massive drag if you’re the sort of person who believes in individual liberty, small government, free markets, free trade, low taxes, sound money, and the rule of law. We’re not getting closer to those classical liberal values. We’re getting further away day by day.
My claim here is that you can’t really live a free and happy life if you’re a debt slave in a financial system controlled by people who believe in the morally coercive power of big government. Our job is to help free you from the clutches of those people and survive the catastrophe they have cooked up (either by design or through sheer incompetence).
The markets reflect the psychological anxiety people have that something is wrong with our financial system. And yet again, the problems in the financial system threaten to spill over into the real economy, into national politics, and into geopolitical relations. If there was ever a time for a cheap beer, it’s now. It looks like we’re going to need it.