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Daily Archives: May 10, 2022

Chart: Spread Between U.S. Fed Funds Rate and CPI Is Largest Ever

Source : Bloomberg

Chart: U.S. Energy Spending as a Percentage of Personal Expenditure Is at Historically Low

The current ~3% is a far cry from the ~6% in the late 1970’s peak.

Source : Bloomberg

Japan’s ‘Accidental Governor’ on Why Ultra-low Is Not the Way to Go

Michael Smith wrote . . . . . . . . .

When I arrive early for lunch with Masaaki Shirakawa, the restaurant staff are clearly on edge. This is nothing to do with the former Bank of Japan (BoJ) governor himself who is polite and engaging throughout our two-hour lunch, but a heightened sense of caution around COVID-19.

The photographer and I are quickly ushered into a large private room with glass walls sealed off from the main dining room. It feels like a transparent cage with all the charm of an office conference room.

My request to move to another table, perhaps one with the sprawling views of the Imperial Palace grounds, is denied. When I ask if some dishes can be brought to the table early for the photoshoot, I am told not until the photographer leaves. No is a rare response in Japan, but these are not normal times.

I am surprised Shirakawa, 72, has accepted my invite to lunch at all given many in Tokyo half his age are nervous about venturing out in a pandemic. However, I suspect his years managing unexpected financial crises and political upheaval mean not even a global pandemic would rattle him.

Unfazed by the setting, he poses for the photographer in a manner that suggests he has done this many times before. When we sit down, he opens by talking about why he has written a book about his tumultuous years as central bank governor of the world’s No. 3 economy.

“The traditional implicit understanding among Japanese who hold public office was they should not write a memoir and everything should be kept private until he or she dies,” the former governor says in his clear English.

“But several close friends advised me to write a book because my time as governor was so turbulent, and they said you have a responsibility,” he says shortly after we sit down.

“My final decision to write a book is heavily influenced by my frustration with the way the Japanese economy is analysed by foreign economists. I have a strong frustration over the interpretation of the Japanese economy and Bank of Japan’s monetary policy by mainstream macroeconomists in the US.”

Indeed, his book has been described as a rare insider’s account of the workings of the Japanese economic and monetary system.

The career central banker was the BoJ governor from 2008 to 2013. His book describes that period as “like driving with an opaque windshield” as he was hit with crisis after crisis, including Lehman Brother’s collapse in 2008, Europe’s debt crisis and Japan’s 2011 devastating earthquake and tsunami.

His 530-page memoir, Tumultuous Times: Central Banking in an Era of Crisis, was published in Japanese in 2018, almost six years after he abruptly departed the central bank three weeks before his tenure officially expired. The English version, which Shirakawa translated himself, came out last year.

Like many in Japan, Shirakawa dislikes rocking the boat. Bespectacled and trim, his modest demeanour and considered answers to questions mask a toughness that had him standing up to immense political pressure during his tenure.

In the lead-up to Shinzō Abe’s election as prime minister in December 2012, the BoJ was increasingly blamed for Japan’s economic woes. Shirakawa resisted Abe’s call for more aggressive monetary easing and called his 3 per cent inflation target “unrealistic”.

He has long argued that instability does not take the form of inflation alone and Japan needs structural reform, productivity improvements and social change rather than quick fix solutions to ramp up spending.

“Monetary easing is essentially policies that bring about a shift in the timing of expenditure. The central bank lowers interest rates and this is essentially bringing forward future demand to the present. Tomorrow becomes today, so then we have to rely on demand for the day after tomorrow,” he says.

“But we cannot continue to do this indefinitely.

“If the Japanese economy is faced with a temporary demand shortfall that is OK but what Japan was faced with was not a cyclical upturn, or downturn, but rather a steady decline in the growth rate due to demographic changes and the decline in productivity.”

His comments are pertinent in a week when Australia joined the global retreat from near zero interest rates in a world where that ultra-dovish experiment now looks unsustainable without generating financial instability. Much like the Reserve Bank of Australia governor, Philip Lowe, Shirakawa says he had to put politics aside when he was pressured to stem the yen’s appreciation with more aggressive monetary policy.

“Central banks are faced with political pressure. But it is not accurate to describe this just as pressure from politics. It is more of a reflection of society. There are no easy solutions. People recognise that while the central bank is not the solution, they tend to ask the central bank to do something.”

Shirakawa has chosen ARGO, a French restaurant named after a mythological Greek ship, in central Tokyo. His old office at the central bank is a short drive away on the other side of the sprawling palace grounds.

These days he is busy lecturing on macroeconomics at Aoyama Gakuin University and sits on the board of several companies, including insurer Swiss Re Group. He also works with a non-profit advocating for more women in senior leadership roles, an area where Japan lags the rest of the developed world.

When the photographer leaves, the masked waiters are comfortable coming into the room with the first of seven courses on the degustation menu. It appears I have accidentally ordered the matching teas with each course so by the end of our meal we are both flanked by a comical row of spectacular glassware still partly full of an array of different brews.

Shirakawa has a Chinese banquet that evening to celebrate his granddaughter passing her university entrance exam so says he is going to take it easy on the food. The meal starts with marinated sayori with yuzu and ends with kuroge wagyu, one of Japan’s most coveted beef brands.

He goes on to talk about the book, keen to emphasise he set to write a memoir to attack his critics, which is why he waited six years. He is clearly not a fan of Abe’s economic blueprint known as Abenomics, which failed to pull Japan out of decades of stagnation after the end of the boom in the ’90s.

“If we compare growth during this cyclical recovery period from the fourth quarter of 2012 among other G7 countries, Japan’s growth rate is among the lowest next to Italy. Inflation didn’t rise despite the fact that the central bank balance sheet increased massively,” he says.

“More importantly, the potential growth rate as well as total factor productivity growth has declined. So, I don’t think Abenomics succeeded, although the narrative we often hear is different. Japan needs to address fundamental issues in order to raise potential growth rate.”

Economic bubble

Shirakawa joined the Bank of Japan in 1973, having abandoned his original aspiration to be a lawyer after becoming mesmerised by the teachings of economist Paul Williams while at the University of Tokyo.

He has lived in the US, where he studied at the University of Chicago, and is attuned to the thinking of Western bank chiefs he admires such as Mervyn King, former governor at the Bank of England. (Shirakawa also praises Lowe and his predecessor at the RBA, Glenn Stevens, as “extremely intelligent”.) However, his main perspective is Japan’s recent economic experience which is hugely different to that of the US, Europe, or Australia.

Japan’s economy functions in the shadow of its late 1980s bubble and the disastrous years that followed when it burst.

He was in his late 30s when the bubble peaked in Japan but was still dealing with the aftershocks when he became governor in early 2008. He is said to have played a key role even before he became governor in the bank’s departure from earlier policies of flooding the banking system with cash. In his book, he jokingly refers to himself as an “accidental governor” born out of the unusual political landscape at the time.

Shirakawa’s first big test was the global financial crisis. When he joined a call in September 2008 with G7 finance ministers and governors, he did not believe Lehman Brother’s would be allowed to go under.

“While it is not the only cause, if it was not for such the big increase in unemployment due to the global financial crisis, especially for low-income people, we might not have seen the kind of divisiveness in [US] society that we have now,” he says, alluding to widespread social division that helped sweep Donald Trump into the Oval Office.

Another period of upheaval began in March 2011 when Japan’s earthquake, tsunami and nuclear meltdown killed thousands and triggered sell-offs in Japanese shares and sent the yen surging to a fresh post-war high.

The BoJ raced to provide enough liquidity to calm the market and consumer sentiment, expanding a program to buy government bonds. Minutes of policy meetings directly after the crisis show Shirakawa was worried about underwriting Japanese government bonds to support construction, saying it would risk a rise in inflation and undermine fiscal discipline, the Japan Times reported last year.

“There was broad pressure from society. Corporate CEOs were always demanding prevention of the yen’s appreciation. Financial market participants were always expecting the Bank of Japan to adopt accommodative monetary policy against the background of deflation,” he recalls as a delicate plate of steamed sea bream arrives.

“Some were saying the constant pressure for monetary easing was described as fiscal dominance. But I often said the pressure we have is not necessarily described as fiscal dominance but is better described as financial dominance or more generally social dominance.

”How did I cope with this situation? First of all, I did aggressive monetary policy of my version, though critics said it was not aggressive enough. We not only expanded the balance-sheet but also purchased risk assets such as corporate bonds, ETF and REIT. These were quite unusual measures.

“Secondly, even when we were doing aggressive monetary policy we always explained both potential benefit and side effect. For me, this is about accountability of independent central bank in a democratic society and personal integrity as a professional.

In 2011, Japan’s government debt was more than double the size of its economy and that remains the case today. In this context, Shirakawa points to the fundamental structural problems facing the world’s third-largest economy.

“In the old days of high growth in the ’60s and early ’70s and still relatively high growth in 1980s, the Japanese system worked well. But the Japanese social system was gradually becoming not well suited to globalisation and the IT revolution,” he says.

“For example, Japan’s lifetime employment system, a core element of the Japanese system, means even in the face of a severe financial shock they had to prioritise employment over anything else. This kind of system is rational if a shock to the economy is temporary, but the ongoing changes such as globalisation, IT revolution and rapid ageing were not temporary shocks.”

‘An awkward period’

“It was in the best interests of everyone for me to depart a bit early,” says Shirakawa. Christopher Jue

When Abe won office in 2012 on the promise of bringing Japan’s economy out of its prolonged slump, he appointed Haruhiko Kuroda who was a supporter of monetary stimulus to boost growth as Shirakawa’s successor.

Shirakawa stepped down three weeks before his term as governor was due to expire on April 9, 2013. He says he did not want his early departure to be seen as a protest but was done to avoid putting his colleagues in a difficult position.

“It was an awkward period. Already the government was adamant that they adopt aggressive monetary easing as such and my successor and the new deputy governor were regarded as people close to this policy,” he says.

“If I had stayed as governor, I would have to lead a monetary policy committee, based on my philosophy, but two deputy governors were against my ideas and the other six board members were in a difficult position,” he says.

“I realised I had to avoid this awkward this situation. It was in the best interests of everyone for me to depart a bit early. Some people interpreted my decision as a protest, but it was not.”

As lunch draws to a close with a selection of tiny desserts, Shirakawa asks me questions about China and Australia. He fears China faces the same demographic challenges Japan does now and will face social unrest if its leaders cannot deliver on growth.

He is positive about Australia’s economic management and seems to understand the country following his numerous visits over the year. He sits on the Group of Thirty alongside former Westpac chief executive Gail Kelly.

Over coffee, we discuss how the world has changed dramatically since Shirakawa wrote his book. The war in Ukraine, the COVID-19 pandemic and the end of what he calls a “monetary policy experiment” which did not deliver what it promised.

While Tumultuous Times makes some dire predictions, including financial crises and growing social discontent due to wealth inequality, Shirakawa keeps faith in human nature.

“On the one hand, I tend to become more pessimistic [since writing the book], but on the other hand, I find myself wanting to believe in the will of human beings. The economy is not a natural phenomenon; it is a result of corrected human actions.”

“Many people are arguing how we should analyse the economy, and for that matter, how we could improve the economy. My book is only a tiny contribution to this process, but I hope societal recognitions will change in a good direction. I am a believer in human beings’ ultimate ability to comprehend the economy and society correctly, although in the short term, I am pessimistic.”


Source : Financial Review

Sorry, But for You, Oil Trades at $250 a Barrel

Javier Blas wrote . . . . . . . . .

The culprit is the refinery margin and the consequences are huge for global inflation.

If you are the owner of an oil refinery, then crude is trading happily just a little above $110 a barrel — expensive, but not extortionate. If you aren’t an oil baron, I have bad news: it’s as if oil is trading somewhere between $150 and $275 a barrel.

The oil market is projecting a false sense of stability when it comes to energy inflation. Instead, the real economy is suffering a much stronger price shock than it appears, because fuel prices are rising much faster than crude, and that matters for monetary policy.

Petroleum Shock

Refined oil products have risen between 30% and nearly 140% since Russia invaded Ukraine in late February, compared to less than 15% for crude.

To understand why, let’s examine the guts of the oil market: the refining industry.

Wall Street closely monitors the price of crude, particularly a grade called West Texas Intermediate traded in New York. It’s a benchmark followed by everyone, from bond investors to central bankers. But only oil refiners buy crude — and therefore, are exposed to its price. The rest of us — the real economy — purchase refined petroleum products like gasoline, diesel and jet-fuel that we can use to run cars, trucks and airplanes. It’s those post-refinery prices that matter to us.

Typically, the price of crude and the price of refined products go up and down in tandem, almost symmetrically. What’s in between is a refining margin. In normal times, WTI is a handy price shorthand for the entirety of the petroleum market. So when, say, U.S. Federal Reserve Chairman Jerome Powell looks at WTI, he gets a neat picture of the whole energy market.

But we aren’t in normal times. Right now, the traditional relationship between crude and refined products is broken. WTI is anchored around $100-$110 a barrel, suggesting that — in barrel terms — gasoline, diesel and jet-fuel prices shouldn’t be much higher, once you add the average refining margin.

In reality, they are a lot more expensive. Take jet-fuel: in New York harbor, a key hub, it’s changing hands at the equivalent to $275 per barrel. Diesel isn’t far away, at about $175 a barrel. And gasoline is at about $155 a barrel. Those are wholesale prices, before you add taxes and marketing margins.

What’s changed? Refining margins have exploded. And that means energy inflation is far stronger than it appears.

Oil refineries are complex machines, capable of processing multiple streams of crude into dozens of different petroleum products. For simplicity’s sake, the industry measures refining margins using a rough calculation called the “3-2-1 crack spread”: for every three barrels of WTI crude oil the refinery processes, it makes two barrels of gasoline and one barrel of distillate fuel like diesel and jet-fuel.

Cracking Profits

Oil refiners are enjoying the best ever processing margins, lifting the cost of fuels such as gasoline, diesel and jet-fuel well above that of crude

From 1985 to 2021, the crack spread averaged about $10.50 a barrel. Even between 2004 and 2008, during the so-called golden age of refining, the crack spread never surpassed $30. It rarely spent more than a few weeks above $20. Last week, however, the margin jumped to a record high of nearly $55. Crack margins for diesel and other petroleum products surged much higher.

There are four main reasons behind the explosion in refining margins.

First, demand — particularly for diesel — has rebounded strongly, depleting global inventories. In some markets, like the U.S. East Coast, diesel stocks have fallen to a 30-year low. Despite rising prices and fears of an economic slowdown later this year, oil executive say they see strong consumption for now. “Demand is not that easily destroyed,” Shell Plc Chief Executive Officer Ben van Beurden told investors last week.

Second, the U.S. and its allies have tapped their strategic petroleum reserves to cap the rally in oil prices. That has provided extra crude, which has put a lid on WTI prices, but it hasn’t addressed the tightness in refined products. Only a small fraction of the emergency release is in the form of refined products, and only in Europe.

Third, and perhaps most importantly, refining capacity has declined where it matters for the market now, and the plants that are operating are struggling to process enough crude to satisfy the demand for fuel. Martijn Rats, an oil analyst at Morgan Stanley, estimates that outside China and the Middle East, oil distillation capacity fell by 1.9 million barrels a day from the end of 2019 to today — that’s the largest decline in 30 years.

The downward trend started well before the pandemic hit, as old Western refineries struggled to compete, environmental regulations increased costs and the unfounded fear of peak oil demand amid the energy transition prompted some companies to close plants. The fuel-demand collapse triggered by Covid-19 only turbo-charged the trend, resulting in dozens of refinery operations shutting down for good in Europe and the U.S. in 2020 and 2021. New capacity has emerged in China. However, Beijing tightly controls how much fuel its refiners can export so that capacity is effectively out of reach of the global market.

“Has the oil market hit the refinery wall?,” Rats asked in a note to clients last week. “Unusually, the answer appears to be yes.”

Fourth, are the sanctions and unilateral embargos — also known as self-sanctions — on Russian oil. Before the invasion of Ukraine, Russia was a major exporter not just of crude, but also of diesel and semi-processed oil that Western refiners turned into fuel. Europe, in particular, relied on Russian refineries for a significant chunk of its diesel imports. The flow has now dried.

Europe not only needs to find extra crude to produce the diesel and other fuels it’s not buying from Russia, but, crucially, it needs the refining capacity to do so, too. It’s a double blow. Oil traders estimate that Russia has shut down 1.3 million to 1.5 million barrels a day of refining capacity as result of the self-sanctions.

Who’s benefiting? The pure-play oil refiners, which are quietly enjoying record-high profit margins. While OPEC and Big Oil get the blame, independent refiners are cashing-in. The sky-high crack margins explains why the share prices of U.S. refining giants Marathon Petroleum Corp. and Valero Energy Corp. have surged to all-time highs. The longer the refiners make super-profits, the harder the energy shock will hit the economy. The only solution is to lower demand. For that, however, a recession will be necessary.


Source : Bloomberg

Infographic: Historical Oil Prices (1968-2022)

See large image . . . . . .

Source : Visual Capitalist

Chart: How Much Living Space Does $1,500/month Get You in the U.S?

Source : Statista