The second half of 2011 will mark the point in time when all the world’s financial operators will finally understand that the West will not repay in full a significant portion of the loans advanced over the last two decades. For LEAP/E2020 it is, in effect, around October 2011, due to the plunge of a large number of US cities and states into an inextricable financial situation following the end of the federal funding of their deficits, whilst Europe will face a very significant debt refinancing requirement (1), that this explosive situation will be fully revealed. Media escalation of the European crisis regarding sovereign debt of Euroland’s peripheral countries will have created the favourable context for such an explosion, of which the US “Muni” (2) market incidentally has just given a foretaste in November 2010 (as our team anticipated last June in GEAB No. 46 ) with a mini-crash that saw all the year’s gains go up in smoke in a few days. This time this crash (including the failure of the monoline reinsurer Ambac (3)) took place discreetly (4) since the Anglo-Saxon media machine (5) succeeded in focusing world attention on a further episode of the fantasy sitcom "The end of the Euro, or the financial remake of Swine fever" (6). Yet the contemporaneous shocks in the United States and Europe make for a very disturbing set-up comparable, according to our team, to the "Bear Stearn " crash which preceded Lehman Brothers’ bankruptcy and the collapse of Wall Street in September 2008 by eight months. But the GEAB readers know very well that major crashes rarely make headlines in the media several months in advance, so false alarms are customary (7)!
Net cash outflows from Mutual Funds investing in « Munis » (2007-11/2010) (in USD billions) - Withdrawals were higher than in October 2008 - Source: New York Times, 11/2010
In this GEAB issue, we therefore anticipate the progression of the terminal crash of Western public debt (in particular US and European debt) as well as ways to protect oneself. Furthermore, we analyze the very important structural consequences of the Wikileaks revelations on the United States’ international influence as well as their interaction with the global consequences of the US Federal Reserve’s QE II programme. This GEAB December issue is, of course, the opportunity to assess the validity of our anticipations for 2010, with a of 78% success rate for the year. We also develop strategic advice for Euroland (8) and the United States. And we publish the GEAB-$ index that will now allow us to synthetically follow the progress of US Dollar against major world currencies every month (9).
In this issue, we have chosen to present an excerpt of the forecast on the explosion of the Western public debt bubble.
Thus, the Western public debt crisis is growing very rapidly under the pressure of four increasingly strong limitations:
. the absence of economic recovery in the United States which strangles all public bodies (including the federal state (10)) accustomed to an easy flow of debt and significant tax revenues in recent decades (11)
. the accelerated structural weakening of the United States in monetary, financial as well as diplomatic (12) affairs which reduces their ability to attract world savings (13)
. the global drying up of sources of cheap finance, which precipitates the crisis of excessive debt in Europe’s peripheral countries (in Euroland like Greece, Ireland, Portugal, Spain, ... and the United Kingdom as well (14)) and is starting to touch key countries (USA, Germany, Japan) (15) in a context of very large European debt refinancing in 2011
. the transformation of Euroland into a new "sovereign" that gradually develops new rules for the continent’s public debts.
These four constraints generate varying phenomena and reactions in different regions / countries.
The European context: the price of the path from laxity to austerity will be partly paid for by investors
From the European side, we have thus witnessed the difficult, but ultimately incredibly fast, transformation of the Eurozone into a sort of semi-state entity, Euroland. The delays in the process weren’t only due to the poor quality of the political individuals concerned (16) as the interviews of the "forerunners" such as Helmut Schmidt, Valéry Giscard d'Estaing or Jacques Delors hammered on at length. They themselves never having had to face a historic crisis of this magnitude, a little modesty would have done them good.
These delays are equally due to the fact that current developments in the Eurozone are on a huge political scale (17) and conducted without any democratic political mandate: this situation paralyzes the European leaders who consequently spend their time denying that they are really doing what they do, i.e. namely, building a kind of political entity with its own economic, social and fiscal constituent parts, .... (18) Elected before the crisis erupted, they do not know that their voters (and the economic and financial players at the same time) would be largely satisfied with an explanation about the decisions being planned (19). Because most of major decisions to come are already identifiable, as we analyze in this issue.
Finally, it is a fact that the actions of these same leaders are dissected and manipulated by the main media specializing in economic and financial issues, none of which belong to the Eurozone, and all of which are, on the contrary, entrenched in the $ / £ zone where the strengthening of the euro is considered a disaster. This same media very directly contributes to blur the process underway in Euroland (20) even more.
However, we can see that this adverse effect decreases because between the "Greek crisis" and the "Irish crisis", the resulting Euro exchange rate volatility has weakened. For our team, in spring 2011, it will become an insignificant event. This only leaves, therefore, the issue of the quality of Euroland’s political personnel which will be profoundly changed beginning in 2012 (21) and, more fundamentally, the significant problem of the democratic legitimacy of the tremendous advances in European integration (22). But in a certain fashion, we can say that by 2012/2013, Euroland will have really established mechanisms which will have allowed it to withstand the shock of the crisis, even if it’s necessary to legitimize their existence retrospectively (23).
Comparison of yields on Euroland 10 year government bonds - Source: Thomson Reuters Datastream, 11/16/2010
In this regard, what will help accelerate the bursting of the Western public debt bubble, and what will occur concomitantly for its US catalyst, is the understanding by financial operators of what lies behind the "Eurobligations” (or E-Bonds) (24) debate which has begun to be talked about in recent weeks (25). It is from late 2011 (at the latest) that the merits of this debate will begin to be unveiled within the framework of the preparation for the permanent European Financial Stabilisation Fund (26). Although, what will suddenly appear for the majority of investors who currently speculate on the exorbitant rates of Greek, Irish,... debt is that Euroland solidarity will not extend to them, especially when the case of Spain, Italy or Belgium will start being posed, whatever European leaders say today (27).
In short, according to LEAP/E2020, we should expect a huge operation of sovereign debt transactions (amid a government debt global crisis) which will offer Euroland guaranteed Eurobligations at very low rates in exchange of national securities at high interest rates with a 30% to 50% discount since, in the meantime, the situation of the entire Western public debt market will have deteriorated. Democratically speaking, the newly elected Euroland leaders (28) (after 2012) will be fully authorized to effect such an operation, of which the major banks (including European ones (29)) will be the first victims. It is highly likely that some privileged sovereign creditors like China, Russia, the oil producing countries,... will be offered preferential treatment. They will not complain since the undertaking will result in their sizeable assets in Euros being guaranteed.
Charts at link
21 December 2010
11 December 2010
GEAB N°49 is available! Warning Global systemic crisis – First quarter 2011: Breach of the critical threshold of global geopolitical dislocation
As the LEAP/E2020 team anticipated in its open letter to the G20 leaders published in the international edition of the Financial Times of 24 March 2009, on the eve of the London Summit, the question of a fundamental reform of the international monetary system is central to any attempt to solve the current crisis. But sadly, as was demonstrated again at the failure of the G20 summit in Seoul, the window of opportunity for achieving such a reform peaceably closed at the end of summer 2009 and will not open again before 2012/2013 (1). The world is indeed in the throes of the global geopolitical dislocation that we had announced as beginning at the end of 2009 and which can be seen, less than a year later, in the proliferation of movements, the economic woes, the fiscal deficits, the monetary disagreements, all setting the scene for major geopolitical shocks. With the G20 summit in Seoul, which signalled to the planet in its entirety the end of US domination of the international agenda and its replacement by a generalised mood of “every man for himself”, a new phase of the crisis has begun, prompting the LEAP/E2020 team to issue a new warning. The world is about to breach a critical threshold in this phase of global geopolitical dislocation. And as with every breach of threshold in a complex system, this will generate, as from the first quarter of 2011, a suite of non-linear phenomena: developments that do not conform to the usual rules and the traditional projections, be they economic, monetary, financial, social or political.
In this GEAB N°49, in addition to the analysis of the six main steps marking the breach of this critical threshold of the global geopolitical, our team presents numerous recommendations to help cope with the consequences of this new phase of the crisis. They address, for example the currency/interest rates/gold and precious metals group; wealth preservation and the replacement of the US dollar by another measure of net worth; the bubbles in asset classes denominated in US dollars; and the stock markets and the most vulnerable corporate categories in this phase of the crisis. The LEAP/E2020 team also presents the “three simple reflexes” to adopt to understand and anticipate better the new world taking shape. Also in this issue, our team describes the double Franco-German electoral shock in store for 2012/2013. And we also present an excerpt from the Manual of Political Anticipation, written by the president of LEAP, Marie-Hélène Caillol, and published by Anticipolis in French, English, German and Spanish.
Trade balances of the G20 countries (forecast for 2010) - Source: Spiegel, 11/2010
In this press release for the GEAB N°49, our team chose to present three of the six steps that characterise the critical threshold that the world is about to breach.
The crisis that we are experiencing is characterised by developments on a planetary scale, taking place at two levels that, while correlated, are different in nature. On the one hand, the crisis is symptomatic of the profound changes to our world’s economic, financial and geopolitical reality. It accelerates and amplifies the underlying trends that have been at work for several decades, trends that we have described regularly in the GEAB since its launch at the beginning of 2006. On the other hand it reflects the steadily increasing collective awareness of those changes. This growing awareness is in itself a phenomenon of collective psychology on a global level and it influences the way the crisis develops and triggers sharp bursts of speed in its evolution. Several times in recent years, we have anticipated “inflexion points” in the crisis, corresponding to “sudden leaps” in this collective awareness of the changes under way. And we consider that all the pre-requisites for “rupture” crystallised around the G20 summit in Seoul, enabling a crucial advance in collective awareness of the global geopolitical dislocation. It is that phenomenon that led LEAP/E2020 to identify the breach of a critical threshold and to issue a warning about the consequences of that breach as from the first quarter of 2011.
Around the date of the G20 summit in Seoul, LEAP/E2020 identified a build-up of events likely to lead to “rupture”. Let us examine the main events concerned (2) and their chaotic consequences.
Concluding the quantitative easing: the Fed placed under “house arrest”
The Federal Reserve’s decision to launch “QE2” (by purchasing USD 600 billion of US Treasuries from now to 2011), triggered an outcry, for the first time since 1945, amongst almost all the other global powers: Japan, Brazil, China (3), India, Germany, the ASEAN countries (4), …(5) It is not the Fed’s decision that marks a rupture: it is the fact that for the first time, America’s central bank had its ears boxed by the rest of the world (6), and in a very public and determined manner (7). This is certainly not the cosy atmosphere of Jackson Hole and the central bankers’ meetings. It seems that Ben Bernanke’s threats to his colleagues, conveyed to our readers in GEAB No. 47, did not have the effect that the Fed’s chairman had hoped. The rest of the world made it clear in November 2010 that it had no intention of letting the US central bank continue printing US dollars at will in an attempt to solve America’s problems at the expense of every other country on the globe (8). The dollar is now getting back to being what every national currency is supposed to be: the currency and thus the problem of the country that prints it. In fact, in these last weeks of 2010, we have witnessed the end of an era where the dollar was the currency of the US and the problem of the rest of the world, as John Connally put it so neatly in 1971, when the US unilaterally terminated the convertibility of the dollar into gold. Why? Simply because from now on the Fed must take into account the opinion of the outside world (9). It is not yet under guardianship, but it is under “house arrest” (10). According to LEAP/E2020, we can already anticipate that there will be no QE3 (11) regardless of the US leaders’ opinions on the subject (12); or it will take place at the end of 2011 to the tune of major geopolitical conflict and the collapse of the US dollar (13).
U.S. Federal Reserve’s Assets (2008-2010) – Sources: Federal Reserve of Cleveland / New York Times, 10/2010
European austerity: spread of social resistance movements; mounting populism; risk of fostering radicalism in rising generations; higher taxes
From Paris to Berlin (14), Lisbon to Dublin, Vilnius to Bucharest, London to Rome,… the protest marches and strikes are spreading. The social dimension of the global geopolitical dislocation is clearly visible in the Europe of end-2010. While these events have not yet managed to disrupt the austerity programmes planned by the European governments, they point to a significant collective development: public opinions are emerging from their torpor at the beginning of the crisis, suddenly aware of its duration and cost (social and financial) (15). So the next elections should prove costly for all the current political teams who have forgotten that without fair treatment, austerity will never win popular support (16). In the meantime, the teams in office are still applying the recipes of the pre-crisis period (i.e. neo-liberal solutions based on tax cuts for the richest households and an assortment of higher indirect taxes). But the rise in social disputes (inevitable according to LEAP/E2020) and the policy changes that will emerge in the next national elections, country by country, will lead to a questioning of those solutions; and a dramatic strengthening of the populist and extremist parties (17): Europe is going to get politically “tougher”. In parallel, in view of what looks increasingly like an unconscious desire on the part of the baby-boomers to have younger citizens shoulder their costs, we can expect to see an increase in violent reactions from the rising generations (18). According to our team, they will probably become more radical if they feel that the situation is hopeless, unless a compromise can be reached. But without an improvement in tax receipts, the only compromise credible in their eyes would be cuts in existing pensions, rather than higher education costs. Today is always a compromise between yesterday and tomorrow, particularly when it comes to taxes. And the most likely fiscal consequences of these developments are higher taxes on high earnings and capital gains, a new bank tax and a new, community-wide drive to protect the borders (19). The EU’s trade partners should take rapid note (20).
Selected governments’ borrowing needs (2010-2011) - Sources: FMI / Wall Street Journal, 10/2010
Japan: the latest efforts to resist China’s power
For several weeks now Tokyo and Beijing have been locked in a diplomatic dispute of rare intensity. Under various pretexts (a Chinese trawler about to enter Japanese territorial waters (21), massive Chinese purchases of Japanese assets, causing the yen to appreciate) the two powers exchanged harsh words, suspended their high-level talks and appealed to international public opinion. To the countries in the region, the international visibility of this Sino-Japanese spat is especially revealing because of a glaring absence –that of the US. While these quarrels clearly illustrate Beijing’s growing determination to be recognised as the dominant power in East and South-East Asia and Japan’s bid to oppose that regional Chinese hegemony, there is no denying that the power supposed to dominate in this region of the world since 1945, namely the US, is strangely absent from table. We can therefore assume that what we are witnessing is a real-life test on China’s part to measure its new influence on Japan; and on Japan’s part to evaluate how much scope for action the US still has in Asia, faced with China. The events of recent weeks have shown that, hampered by political paralysis and its economic and financial dependence regarding China, Washington prefers not to get involved. No doubt throughout Asia this spectacle serves to accelerate the awareness that a new milestone has been passed in terms of regional order (22); and that in Japan, mired in an endless recession (23) the economic interests linked to the Chinese market have not been strengthened by the experience.
Global changes under way – massive growth in world port traffic, benefiting Asia (1994-2009) - Sources : Transport Trackers / Clusterstock, 10/2010
In conclusion, this accumulation of events, centred round a G20 summit that was patently incapable of resolving the sources of economic, financial and monetary tension between its principal members, contributed to a decisive advance in the world’s collective awareness of the process of global geographic dislocation under way. And in its turn, this increased awareness will, as from the beginning of 2011, accelerate and amplify the changes affecting the international system and our various societies, generating non-linear, chaotic phenomena such as those described in this issue of GEAB and previous issues. As we emphasised in September 2010, we focus on the fact that chief among those phenomena will be the entry of the US into an austerity phase, beginning in spring 2011. But we also bear in mind that one of the surprises of the next eighteen months could simply be the announcement that the Chinese economy had overtaken the US economy as from 2012 as the Wall Street Journal of 10/11/2010 indicates in its report of the Conference Board’s analysis.
http://www.leap2020.eu/GEAB-N-49-is-available-Warning-Global-systemic-crisis-First-quarter-2011-Breach-of-the-critical-threshold-of-global_a5458.html
- Public announcement GEAB N°49 (November 16, 2010) -
In this GEAB N°49, in addition to the analysis of the six main steps marking the breach of this critical threshold of the global geopolitical, our team presents numerous recommendations to help cope with the consequences of this new phase of the crisis. They address, for example the currency/interest rates/gold and precious metals group; wealth preservation and the replacement of the US dollar by another measure of net worth; the bubbles in asset classes denominated in US dollars; and the stock markets and the most vulnerable corporate categories in this phase of the crisis. The LEAP/E2020 team also presents the “three simple reflexes” to adopt to understand and anticipate better the new world taking shape. Also in this issue, our team describes the double Franco-German electoral shock in store for 2012/2013. And we also present an excerpt from the Manual of Political Anticipation, written by the president of LEAP, Marie-Hélène Caillol, and published by Anticipolis in French, English, German and Spanish.
Trade balances of the G20 countries (forecast for 2010) - Source: Spiegel, 11/2010
In this press release for the GEAB N°49, our team chose to present three of the six steps that characterise the critical threshold that the world is about to breach.
The crisis that we are experiencing is characterised by developments on a planetary scale, taking place at two levels that, while correlated, are different in nature. On the one hand, the crisis is symptomatic of the profound changes to our world’s economic, financial and geopolitical reality. It accelerates and amplifies the underlying trends that have been at work for several decades, trends that we have described regularly in the GEAB since its launch at the beginning of 2006. On the other hand it reflects the steadily increasing collective awareness of those changes. This growing awareness is in itself a phenomenon of collective psychology on a global level and it influences the way the crisis develops and triggers sharp bursts of speed in its evolution. Several times in recent years, we have anticipated “inflexion points” in the crisis, corresponding to “sudden leaps” in this collective awareness of the changes under way. And we consider that all the pre-requisites for “rupture” crystallised around the G20 summit in Seoul, enabling a crucial advance in collective awareness of the global geopolitical dislocation. It is that phenomenon that led LEAP/E2020 to identify the breach of a critical threshold and to issue a warning about the consequences of that breach as from the first quarter of 2011.
Around the date of the G20 summit in Seoul, LEAP/E2020 identified a build-up of events likely to lead to “rupture”. Let us examine the main events concerned (2) and their chaotic consequences.
Concluding the quantitative easing: the Fed placed under “house arrest”
The Federal Reserve’s decision to launch “QE2” (by purchasing USD 600 billion of US Treasuries from now to 2011), triggered an outcry, for the first time since 1945, amongst almost all the other global powers: Japan, Brazil, China (3), India, Germany, the ASEAN countries (4), …(5) It is not the Fed’s decision that marks a rupture: it is the fact that for the first time, America’s central bank had its ears boxed by the rest of the world (6), and in a very public and determined manner (7). This is certainly not the cosy atmosphere of Jackson Hole and the central bankers’ meetings. It seems that Ben Bernanke’s threats to his colleagues, conveyed to our readers in GEAB No. 47, did not have the effect that the Fed’s chairman had hoped. The rest of the world made it clear in November 2010 that it had no intention of letting the US central bank continue printing US dollars at will in an attempt to solve America’s problems at the expense of every other country on the globe (8). The dollar is now getting back to being what every national currency is supposed to be: the currency and thus the problem of the country that prints it. In fact, in these last weeks of 2010, we have witnessed the end of an era where the dollar was the currency of the US and the problem of the rest of the world, as John Connally put it so neatly in 1971, when the US unilaterally terminated the convertibility of the dollar into gold. Why? Simply because from now on the Fed must take into account the opinion of the outside world (9). It is not yet under guardianship, but it is under “house arrest” (10). According to LEAP/E2020, we can already anticipate that there will be no QE3 (11) regardless of the US leaders’ opinions on the subject (12); or it will take place at the end of 2011 to the tune of major geopolitical conflict and the collapse of the US dollar (13).
U.S. Federal Reserve’s Assets (2008-2010) – Sources: Federal Reserve of Cleveland / New York Times, 10/2010
European austerity: spread of social resistance movements; mounting populism; risk of fostering radicalism in rising generations; higher taxes
From Paris to Berlin (14), Lisbon to Dublin, Vilnius to Bucharest, London to Rome,… the protest marches and strikes are spreading. The social dimension of the global geopolitical dislocation is clearly visible in the Europe of end-2010. While these events have not yet managed to disrupt the austerity programmes planned by the European governments, they point to a significant collective development: public opinions are emerging from their torpor at the beginning of the crisis, suddenly aware of its duration and cost (social and financial) (15). So the next elections should prove costly for all the current political teams who have forgotten that without fair treatment, austerity will never win popular support (16). In the meantime, the teams in office are still applying the recipes of the pre-crisis period (i.e. neo-liberal solutions based on tax cuts for the richest households and an assortment of higher indirect taxes). But the rise in social disputes (inevitable according to LEAP/E2020) and the policy changes that will emerge in the next national elections, country by country, will lead to a questioning of those solutions; and a dramatic strengthening of the populist and extremist parties (17): Europe is going to get politically “tougher”. In parallel, in view of what looks increasingly like an unconscious desire on the part of the baby-boomers to have younger citizens shoulder their costs, we can expect to see an increase in violent reactions from the rising generations (18). According to our team, they will probably become more radical if they feel that the situation is hopeless, unless a compromise can be reached. But without an improvement in tax receipts, the only compromise credible in their eyes would be cuts in existing pensions, rather than higher education costs. Today is always a compromise between yesterday and tomorrow, particularly when it comes to taxes. And the most likely fiscal consequences of these developments are higher taxes on high earnings and capital gains, a new bank tax and a new, community-wide drive to protect the borders (19). The EU’s trade partners should take rapid note (20).
Selected governments’ borrowing needs (2010-2011) - Sources: FMI / Wall Street Journal, 10/2010
Japan: the latest efforts to resist China’s power
For several weeks now Tokyo and Beijing have been locked in a diplomatic dispute of rare intensity. Under various pretexts (a Chinese trawler about to enter Japanese territorial waters (21), massive Chinese purchases of Japanese assets, causing the yen to appreciate) the two powers exchanged harsh words, suspended their high-level talks and appealed to international public opinion. To the countries in the region, the international visibility of this Sino-Japanese spat is especially revealing because of a glaring absence –that of the US. While these quarrels clearly illustrate Beijing’s growing determination to be recognised as the dominant power in East and South-East Asia and Japan’s bid to oppose that regional Chinese hegemony, there is no denying that the power supposed to dominate in this region of the world since 1945, namely the US, is strangely absent from table. We can therefore assume that what we are witnessing is a real-life test on China’s part to measure its new influence on Japan; and on Japan’s part to evaluate how much scope for action the US still has in Asia, faced with China. The events of recent weeks have shown that, hampered by political paralysis and its economic and financial dependence regarding China, Washington prefers not to get involved. No doubt throughout Asia this spectacle serves to accelerate the awareness that a new milestone has been passed in terms of regional order (22); and that in Japan, mired in an endless recession (23) the economic interests linked to the Chinese market have not been strengthened by the experience.
Global changes under way – massive growth in world port traffic, benefiting Asia (1994-2009) - Sources : Transport Trackers / Clusterstock, 10/2010
In conclusion, this accumulation of events, centred round a G20 summit that was patently incapable of resolving the sources of economic, financial and monetary tension between its principal members, contributed to a decisive advance in the world’s collective awareness of the process of global geographic dislocation under way. And in its turn, this increased awareness will, as from the beginning of 2011, accelerate and amplify the changes affecting the international system and our various societies, generating non-linear, chaotic phenomena such as those described in this issue of GEAB and previous issues. As we emphasised in September 2010, we focus on the fact that chief among those phenomena will be the entry of the US into an austerity phase, beginning in spring 2011. But we also bear in mind that one of the surprises of the next eighteen months could simply be the announcement that the Chinese economy had overtaken the US economy as from 2012 as the Wall Street Journal of 10/11/2010 indicates in its report of the Conference Board’s analysis.
http://www.leap2020.eu/GEAB-N-49-is-available-Warning-Global-systemic-crisis-First-quarter-2011-Breach-of-the-critical-threshold-of-global_a5458.html
- Public announcement GEAB N°49 (November 16, 2010) -
19 October 2010
GEAB N°48 is available! Global systemic crisis - LEAP/E2020’s analysis of 39 countries’ risks 2010-2014: A collective but contrasting dive into the ph
No wonder Gold and everything else is going up.
- Public announcement GEAB N°48 (October 16, 2010) -
http://www.leap2020.eu/geab-n-48-is-available-global-systemic-crisis-leap-e2020-s-analysis-of-39-countries-risks-2010-2014-a-collective-but_a5295.html
In this issue, our team introduces the annual "country risk" update in the light of the crisis. Based on an analysis incorporating eleven criteria this year, this decision-making tool has already demonstrated its relevance in faithfully anticipating developments over these past twelve months. The identification, at the beginning of 2009, of a new phase of the crisis (the phase of global geopolitical dislocation) forced us to take new parameters into account (nine indicators were selected in 2009) to effectively incorporate trends that are reshaping the global system (1). As 2010 draws to a close, LEAP/E2020 now estimates that the world’s various countries are heading for a collective dive at the core of this phase of socio-economic and strategic geopolitical dislocation (2). Thus our studies enabled us to continue presenting the LEAP/E2020 anticipation of "country risk" for the 2010-2014 period (3), by adapting the categories to the crisis’ development, via four groups of countries (4) characterized by the contrasting impacts of this dive in the geopolitical dislocation phase of the global systemic crisis (5).
On the other hand, in this GEAB issue, we give our anticipations for the progress of Euro-Russian relations between now and 2014. In our recommendations, we pay particular attention to helping our readers deal with a currency market in global conflict, a fallout anticipated over 18 months ago by our team, as a result of geopolitical dislocation. Moreover, on the occasion of the publication of his book "The Global Crisis: The Path to the World After - France, Europe and the World in the 2010-2020 decade ", Franck Biancheri, Director of LEAP/E2020, and Anticipolis editions, have given us permission to publish his analysis of the process of the ongoing global geopolitical dislocation.
Documented instances of social unrest 2009-2010 - Source: IILS, 09/2010
The G20’s (or IMF’s) now patent failure to secure effective international cooperation to try and remedy the structural weaknesses of the current international monetary system perfectly illustrates LEAP/E2020’s anticipation which in March 2009, before the London G20 meeting, explained that the summit was the only window of opportunity to fundamentally rethink the global monetary system at the heart of the current crisis. In failing to seize this opportunity, we reported that the world would begin to enter the global geopolitical dislocation phase from late 2009. At that time, by way of an introduction to this new phase of the crisis, the world has seen the mid-flight explosion, during the Copenhagen summit, of the whole international process on global warming. Since then, every month brings a stream of public finance crises in one state or another, drastic austerity measures causing increase in social unrest (6), international meetings leading to reports of disagreement, the proliferation of threats between States over trade imbalances, etc., all against a background of a downward spiral into hell of the global system’s central power, namely the United States (7).
Change in labour force participation between the first quarters of 2009 and 2010 (Indonesia, Mexico, Brazil, Germany, France, South Korea, Argentina, Italy, Canada, United Kingdom, Japan and the United States) - Source: IILS, 09/2010
For several months now we have been witnessing the onset of a massive currency world war just like LEAP/E2020 anticipated nearly two years ago and reiterated in its time-frame of the crisis (8). Several weeks hence, the inevitable failure (9) of the FMI/G20 duo to resolve these currency-trade (10) tensions will provide both new evidence while marking a new tipping point of global geopolitical dislocation: every man for himself becoming the rule (11).
Two weeks from now, with the announcement of the actual details of a comprehensive plan to reduce spending, the United Kingdom will eventually have to face an unprecedented (12) socio-economic crisis that it has desperately tried to hide for months (13), and it will have to do it alone (since the United States are unable to help it, and it has put itself outside the European financial rescue system).
And in three weeks, the United States will concurrently expose an unprecedented political paralysis following the mid-term election (14), whilst the US Federal Reserve will launch a new attempt to rescue the US economy by monetizing a stimulus plan that the federal government is no longer able to launch (15). This attempt - whose size will be less than financial markets expect (because the Fed is now forced, in this case by the holders of US Dollar denominated assets: China, Japan, Europe, oil-producing countries (16)...) but more than enough to lead to a further fall in the dollar and plunge the world monetary system into an even worse conflict - will fail anyway because US society has, de facto, entered a phase of austerity that US leaders, in 2011, will have to recognize must also constrain the country’s fiscal and monetary policy (17).
From the world leaders’ side (18), the next four years’ global sequence can be summarized quite simply: last US attempts to "return to the world before the crisis" (stimulating consumption, maintaining deficits, debt monetization) that will all fail (19), last Western attempts to deal with the crisis using "Washington consensus" methods (limiting deficits by reducing social spending, no tax increases on high incomes, privatization of public services, ...) which will generate growing socio-political chaos, acceleration of the BRIC countries’ exit from the majority of Western financial and monetary markets (especially the two financial pillars of Wall Street and London) which will increase monetary instability, rising intensity of trade wars (coextensive with currency wars (20)), the coming to power from 2012 of groups of leaders who have decided to try new solutions (21) to exit the social, economic and political consequences of the crisis, taking note of the fact that the “Washington consensus” is dead ... because there is no consensus anymore and because Washington is a moribund world power.
As for the rest, the keeping the US debt’s Triple-A rating belongs to the same virtual world as the recent declaration by US economic authorities (22) of the end of recession: the growing disconnect between the words of a collapsing system’s key players and the reality perceived by the majority of citizens and socio-economic players is an infallible indication of systemic decline (23). But the financial markets are not mistaken because with the soaring cost of insuring US debt hot on the heels of Ireland and Portugal with a 28% third quarter increase in cost, the United States has become the third country for which the debt markets fear some very unpleasant surprises (24).
Comparative progression of the United States’ deficit (in trillions USD) and the amount of known global reserves held in U.S. Dollars (1999-2009) - Sources: Reuters/IMF/White House OMB, 10/2010
---------
Notes:
(1) From the beginning of 2006, in the GEAB No. 5, LEAP/E2020 indicated that the global systemic crisis would evolve in 4 major phases. "A global systemic crisis develops in a complex process that can be cut into four phases which may overlap:
. a first "trigger" phase that suddenly sees a whole series of factors, hitherto disconnected, start to converge and interact, and which mainly remain noticeable to alert watchers and the main players
. a second phase called "acceleration" which is characterized by the sudden realization by the vast majority of players and observers that the crisis is here because it starts affecting a rapidly growing number of the system’s elements
. a third "impact" phase which is formed by the radical transformation of the system itself (implosion and/or explosion) under the effect of accumulated factors and which simultaneously affects the entire system
. and finally, a fourth phase called "decanting" that sees the release of the new system’s characteristics resulting from the crisis. Source GEAB No. 5, 15/05/2006
. early 2009, in the GEAB No. 32, LEAP/E2020 identified a fifth phase of the crisis, called global geopolitical dislocation, which begins at the end of 2009, following the G20 failure to launch a credible process of establishing a new international system, particularly in the monetary field. This new phase has been, of course, integrated into the time-frame presented last year in GEAB No. 38.
(2) The ability of states to cope with social unrest that will multiply in the coming quarters and years is closely linked to their ability to contain the most traumatic social effects of the crisis; therefore, our team has introduced a tenth indicator correlated to the tax burden of the past twenty years, whilst an eleventh indicator has been added to assess the resilience to a global monetary war.
(3) Our team has analyzed indicators for 39 countries in addition to Euroland.
(4) These country- risk analyses may be particularly useful for those planning an investment in a given country, intending to settle there or wishing to make an investment in assets linked to that country.
(5) We chose to keep 2014 as an overview because we believe that the changes in political leadership occurring in many important countries (China, USA, Russia, France, ...) in 2012, and which are the principal potential positive factor looking at the next four years, will have no appreciable impact on these country-risks before 2014, the time that new policies are starting to yield results.
(6) France gives a striking example with the growing unpopularity of an executive which fails to prevent social unrest against its reforms and which risks turning into a general strike (France 24, 14/10/2010). Meanwhile, throughout Europe, there is a marked increase of extremist political forces. Source: Le Point, 20/09/2010
(7) All the lights are turning red. The road transport volume has started to decline again (Los Angeles Times, 13/10/2010). Foreclosures continued to grow last month, whilst the whole legal system on which they rest has now broken down (for the legal reasons mentioned in the GEAB a year ago) upsetting a real estate market on Fed and Federal Government life support even more (CNBC, 14/10/2010; USAToday, 14/10/2010; USAToday, 11/10/2010). Cities are sinking into vey deep deficits (such as their employee retirement funds estimated at over 500 billion USD, CNBC/FT, 12/10/2010) and are obliged to turn to the states to try and extricate themselves (CNBC/NYT, 05/10/2010), while the latter can no longer balance their budgets and are obliged to pay interest rates higher than developing countries (thus, Illinois must now pay more than Mexico to borrow, Bloomberg, 05/10/2010).
(8) See the GEAB N°43 particularly.
(9) History doesn’t repeat itself. If we pushed so hard (including at the cost of a full page advertisement in the global edition of the Financial Times) for world leaders to seize the opportunity at the G20 in Spring 2009, it was because we were aware that such a set-up would not happen again. Now the US is too weak to continue to steer the global game, no other player is able to take affairs in hand ... and therefore, the global financial system looks more and more like the "drunken boat; in Rimbaud's poem describing the drift towards unexplored beaches, a perfect description of the world’s course today.
(10) As for the negotiations on climate change, a "West" already clearly divided (here between the Dollar, Pound, Yen and Euro), tries to make the emerging countries (the Yuan in particular) pay the cost of adapting a system they invented and which no longer works. And it's not by ending the game as shown by US efforts to prevent any new Chinese rating agency from operating in the United States that will dissipate this feeling in the BRIC countries. One remembers the performance in Copenhagen. It will pale in comparison to what awaits us at the G20 meeting in Seoul. Besides, the soaring gold price is a very reliable indicator: even the European central banks have stopped their sales. Sources: New York Times, 21/09/2010; Vigile, 29/09/2010; PrisonPlanet/FT, 27/09/2010, Bloomberg, 10/10/2010; ChinaDaily, 27/09/2010
(11) The Telegraph summarized it admirably on 11/10/2010 in "Jobless America threatens to sweep us all away." Sign of the times, Bloomberg on 08/09/2010 announces the opening of a Ruble-Yuan currency exchange in Shanghai to finance Sino-Russian trade.
(12) There is a growing fear in the United Kingdom over the country’s social and political situation in the context of "super-austerity" planned by the government due to financial and budget crisis: the loss of nearly a million jobs, social crisis, unrest.... Sources: Independent, 02/10/2010; Telegraph, 13/10/2010; Guardian, 11/09/2010; MarketWatch, 21/09/2010.
(13) This was, moreover, the main reason for the “Greek crisis becoming the Euro crisis” in Spring 2010, in particular fed daily by articles in the Financial Times to divert attention from London and the Pound Sterling. See GEAB in the first half of 2010.
(14) Recent statements by Steve Schwarzman, head of the financial giant Blackstone, comparing Barack Obama's willingness to tax financial companies more heavily to Hitler’s invasion of Poland, illustrates the explosive atmosphere that rules at the core of the US elite. Source: NewYorkPost, 14/10/2010
(15) Because of the magnitude of existing deficits and political deadlock in Washington.
(16) In this regard, our team gives a timely reminder that there is no mystery about the simultaneous rise of different asset classes, like stocks or gold for example: operators are leaving the stock exchanges (as we showed in the last GEAB issue) and selling their financial and monetary assets for gold (or other less dangerous assets) and the Fed (and its partners) are injecting liquidity into the financial markets to prevent a widespread collapse. The only problem, when the music stops: it will be a tragedy for the stock exchanges. Source: CNBC, 08/10/2010
(17) The situation is so bad that a reading of the New York Times of 13/10/2010 started to look like a cut and paste of the GEAB a year or two ago ... that’s saying something! The article by Michael Powell and Motoko Rich, which describes the "recovery" as merely a continuation of this recession shows the plight of the middle classes across the country in a harsh light, while the very same day Paul Reyes unveils a remarkable collection of photographs showing the ravages of the "Very Great US Depression" as LEAP/E2020 has called it since late 2006.
(18) Franck Biancheri offers a detailed presentation, with the two likely main scenarios for 2010-2020, in his book "The Global Crisis: The Path to the World after;
(19) Source: SeekingAlpha, 24/09/2010
(20) Singapore’s recent announcement that from now on its currency’s trading band against the U.S. dollar will be wider, is the latest example (each day brings a new one) of increasingly defensive positions taken by individual states. Each one tries to increase its room for maneuver to cope with the unexpected. Incidentally, it is interesting to note that Singapore suffered a 19% third quarter fall in GDP, evidence that the mood in Asia is becoming gloomy. Source: YahooFinances, 14/10/2010; MarketWatch, 13/10/2010
(21) For China, one solution will most probably be to inject the country's huge US Dollar reserves into the economy as already suggested by the new generation of Chinese bankers. This will not help the US Dollar. Source: Dallasnews, 19/09/2010
(22) The National Bureau of Economic Research (NBER is in charge of "holding a Mass" on this subject.
(23) As MSNBC aptly described on 06/10/2010, it’s once a month at midnight that America’s great depression is revealed in the supermarkets, when tens of millions of food voucher recipients go and do their shopping. According to the study by the Center for Economic and Policy Research published on 16/09/2010, in effect now one in three Americans can no longer make ends meet (one hundred million people ).
(24) Source: CNNMoney, 12/10/2010
Samedi 16 Octobre 2010
- Public announcement GEAB N°48 (October 16, 2010) -
http://www.leap2020.eu/geab-n-48-is-available-global-systemic-crisis-leap-e2020-s-analysis-of-39-countries-risks-2010-2014-a-collective-but_a5295.html
In this issue, our team introduces the annual "country risk" update in the light of the crisis. Based on an analysis incorporating eleven criteria this year, this decision-making tool has already demonstrated its relevance in faithfully anticipating developments over these past twelve months. The identification, at the beginning of 2009, of a new phase of the crisis (the phase of global geopolitical dislocation) forced us to take new parameters into account (nine indicators were selected in 2009) to effectively incorporate trends that are reshaping the global system (1). As 2010 draws to a close, LEAP/E2020 now estimates that the world’s various countries are heading for a collective dive at the core of this phase of socio-economic and strategic geopolitical dislocation (2). Thus our studies enabled us to continue presenting the LEAP/E2020 anticipation of "country risk" for the 2010-2014 period (3), by adapting the categories to the crisis’ development, via four groups of countries (4) characterized by the contrasting impacts of this dive in the geopolitical dislocation phase of the global systemic crisis (5).
On the other hand, in this GEAB issue, we give our anticipations for the progress of Euro-Russian relations between now and 2014. In our recommendations, we pay particular attention to helping our readers deal with a currency market in global conflict, a fallout anticipated over 18 months ago by our team, as a result of geopolitical dislocation. Moreover, on the occasion of the publication of his book "The Global Crisis: The Path to the World After - France, Europe and the World in the 2010-2020 decade ", Franck Biancheri, Director of LEAP/E2020, and Anticipolis editions, have given us permission to publish his analysis of the process of the ongoing global geopolitical dislocation.
Documented instances of social unrest 2009-2010 - Source: IILS, 09/2010
The G20’s (or IMF’s) now patent failure to secure effective international cooperation to try and remedy the structural weaknesses of the current international monetary system perfectly illustrates LEAP/E2020’s anticipation which in March 2009, before the London G20 meeting, explained that the summit was the only window of opportunity to fundamentally rethink the global monetary system at the heart of the current crisis. In failing to seize this opportunity, we reported that the world would begin to enter the global geopolitical dislocation phase from late 2009. At that time, by way of an introduction to this new phase of the crisis, the world has seen the mid-flight explosion, during the Copenhagen summit, of the whole international process on global warming. Since then, every month brings a stream of public finance crises in one state or another, drastic austerity measures causing increase in social unrest (6), international meetings leading to reports of disagreement, the proliferation of threats between States over trade imbalances, etc., all against a background of a downward spiral into hell of the global system’s central power, namely the United States (7).
Change in labour force participation between the first quarters of 2009 and 2010 (Indonesia, Mexico, Brazil, Germany, France, South Korea, Argentina, Italy, Canada, United Kingdom, Japan and the United States) - Source: IILS, 09/2010
For several months now we have been witnessing the onset of a massive currency world war just like LEAP/E2020 anticipated nearly two years ago and reiterated in its time-frame of the crisis (8). Several weeks hence, the inevitable failure (9) of the FMI/G20 duo to resolve these currency-trade (10) tensions will provide both new evidence while marking a new tipping point of global geopolitical dislocation: every man for himself becoming the rule (11).
Two weeks from now, with the announcement of the actual details of a comprehensive plan to reduce spending, the United Kingdom will eventually have to face an unprecedented (12) socio-economic crisis that it has desperately tried to hide for months (13), and it will have to do it alone (since the United States are unable to help it, and it has put itself outside the European financial rescue system).
And in three weeks, the United States will concurrently expose an unprecedented political paralysis following the mid-term election (14), whilst the US Federal Reserve will launch a new attempt to rescue the US economy by monetizing a stimulus plan that the federal government is no longer able to launch (15). This attempt - whose size will be less than financial markets expect (because the Fed is now forced, in this case by the holders of US Dollar denominated assets: China, Japan, Europe, oil-producing countries (16)...) but more than enough to lead to a further fall in the dollar and plunge the world monetary system into an even worse conflict - will fail anyway because US society has, de facto, entered a phase of austerity that US leaders, in 2011, will have to recognize must also constrain the country’s fiscal and monetary policy (17).
From the world leaders’ side (18), the next four years’ global sequence can be summarized quite simply: last US attempts to "return to the world before the crisis" (stimulating consumption, maintaining deficits, debt monetization) that will all fail (19), last Western attempts to deal with the crisis using "Washington consensus" methods (limiting deficits by reducing social spending, no tax increases on high incomes, privatization of public services, ...) which will generate growing socio-political chaos, acceleration of the BRIC countries’ exit from the majority of Western financial and monetary markets (especially the two financial pillars of Wall Street and London) which will increase monetary instability, rising intensity of trade wars (coextensive with currency wars (20)), the coming to power from 2012 of groups of leaders who have decided to try new solutions (21) to exit the social, economic and political consequences of the crisis, taking note of the fact that the “Washington consensus” is dead ... because there is no consensus anymore and because Washington is a moribund world power.
As for the rest, the keeping the US debt’s Triple-A rating belongs to the same virtual world as the recent declaration by US economic authorities (22) of the end of recession: the growing disconnect between the words of a collapsing system’s key players and the reality perceived by the majority of citizens and socio-economic players is an infallible indication of systemic decline (23). But the financial markets are not mistaken because with the soaring cost of insuring US debt hot on the heels of Ireland and Portugal with a 28% third quarter increase in cost, the United States has become the third country for which the debt markets fear some very unpleasant surprises (24).
Comparative progression of the United States’ deficit (in trillions USD) and the amount of known global reserves held in U.S. Dollars (1999-2009) - Sources: Reuters/IMF/White House OMB, 10/2010
---------
Notes:
(1) From the beginning of 2006, in the GEAB No. 5, LEAP/E2020 indicated that the global systemic crisis would evolve in 4 major phases. "A global systemic crisis develops in a complex process that can be cut into four phases which may overlap:
. a first "trigger" phase that suddenly sees a whole series of factors, hitherto disconnected, start to converge and interact, and which mainly remain noticeable to alert watchers and the main players
. a second phase called "acceleration" which is characterized by the sudden realization by the vast majority of players and observers that the crisis is here because it starts affecting a rapidly growing number of the system’s elements
. a third "impact" phase which is formed by the radical transformation of the system itself (implosion and/or explosion) under the effect of accumulated factors and which simultaneously affects the entire system
. and finally, a fourth phase called "decanting" that sees the release of the new system’s characteristics resulting from the crisis. Source GEAB No. 5, 15/05/2006
. early 2009, in the GEAB No. 32, LEAP/E2020 identified a fifth phase of the crisis, called global geopolitical dislocation, which begins at the end of 2009, following the G20 failure to launch a credible process of establishing a new international system, particularly in the monetary field. This new phase has been, of course, integrated into the time-frame presented last year in GEAB No. 38.
(2) The ability of states to cope with social unrest that will multiply in the coming quarters and years is closely linked to their ability to contain the most traumatic social effects of the crisis; therefore, our team has introduced a tenth indicator correlated to the tax burden of the past twenty years, whilst an eleventh indicator has been added to assess the resilience to a global monetary war.
(3) Our team has analyzed indicators for 39 countries in addition to Euroland.
(4) These country- risk analyses may be particularly useful for those planning an investment in a given country, intending to settle there or wishing to make an investment in assets linked to that country.
(5) We chose to keep 2014 as an overview because we believe that the changes in political leadership occurring in many important countries (China, USA, Russia, France, ...) in 2012, and which are the principal potential positive factor looking at the next four years, will have no appreciable impact on these country-risks before 2014, the time that new policies are starting to yield results.
(6) France gives a striking example with the growing unpopularity of an executive which fails to prevent social unrest against its reforms and which risks turning into a general strike (France 24, 14/10/2010). Meanwhile, throughout Europe, there is a marked increase of extremist political forces. Source: Le Point, 20/09/2010
(7) All the lights are turning red. The road transport volume has started to decline again (Los Angeles Times, 13/10/2010). Foreclosures continued to grow last month, whilst the whole legal system on which they rest has now broken down (for the legal reasons mentioned in the GEAB a year ago) upsetting a real estate market on Fed and Federal Government life support even more (CNBC, 14/10/2010; USAToday, 14/10/2010; USAToday, 11/10/2010). Cities are sinking into vey deep deficits (such as their employee retirement funds estimated at over 500 billion USD, CNBC/FT, 12/10/2010) and are obliged to turn to the states to try and extricate themselves (CNBC/NYT, 05/10/2010), while the latter can no longer balance their budgets and are obliged to pay interest rates higher than developing countries (thus, Illinois must now pay more than Mexico to borrow, Bloomberg, 05/10/2010).
(8) See the GEAB N°43 particularly.
(9) History doesn’t repeat itself. If we pushed so hard (including at the cost of a full page advertisement in the global edition of the Financial Times) for world leaders to seize the opportunity at the G20 in Spring 2009, it was because we were aware that such a set-up would not happen again. Now the US is too weak to continue to steer the global game, no other player is able to take affairs in hand ... and therefore, the global financial system looks more and more like the "drunken boat; in Rimbaud's poem describing the drift towards unexplored beaches, a perfect description of the world’s course today.
(10) As for the negotiations on climate change, a "West" already clearly divided (here between the Dollar, Pound, Yen and Euro), tries to make the emerging countries (the Yuan in particular) pay the cost of adapting a system they invented and which no longer works. And it's not by ending the game as shown by US efforts to prevent any new Chinese rating agency from operating in the United States that will dissipate this feeling in the BRIC countries. One remembers the performance in Copenhagen. It will pale in comparison to what awaits us at the G20 meeting in Seoul. Besides, the soaring gold price is a very reliable indicator: even the European central banks have stopped their sales. Sources: New York Times, 21/09/2010; Vigile, 29/09/2010; PrisonPlanet/FT, 27/09/2010, Bloomberg, 10/10/2010; ChinaDaily, 27/09/2010
(11) The Telegraph summarized it admirably on 11/10/2010 in "Jobless America threatens to sweep us all away." Sign of the times, Bloomberg on 08/09/2010 announces the opening of a Ruble-Yuan currency exchange in Shanghai to finance Sino-Russian trade.
(12) There is a growing fear in the United Kingdom over the country’s social and political situation in the context of "super-austerity" planned by the government due to financial and budget crisis: the loss of nearly a million jobs, social crisis, unrest.... Sources: Independent, 02/10/2010; Telegraph, 13/10/2010; Guardian, 11/09/2010; MarketWatch, 21/09/2010.
(13) This was, moreover, the main reason for the “Greek crisis becoming the Euro crisis” in Spring 2010, in particular fed daily by articles in the Financial Times to divert attention from London and the Pound Sterling. See GEAB in the first half of 2010.
(14) Recent statements by Steve Schwarzman, head of the financial giant Blackstone, comparing Barack Obama's willingness to tax financial companies more heavily to Hitler’s invasion of Poland, illustrates the explosive atmosphere that rules at the core of the US elite. Source: NewYorkPost, 14/10/2010
(15) Because of the magnitude of existing deficits and political deadlock in Washington.
(16) In this regard, our team gives a timely reminder that there is no mystery about the simultaneous rise of different asset classes, like stocks or gold for example: operators are leaving the stock exchanges (as we showed in the last GEAB issue) and selling their financial and monetary assets for gold (or other less dangerous assets) and the Fed (and its partners) are injecting liquidity into the financial markets to prevent a widespread collapse. The only problem, when the music stops: it will be a tragedy for the stock exchanges. Source: CNBC, 08/10/2010
(17) The situation is so bad that a reading of the New York Times of 13/10/2010 started to look like a cut and paste of the GEAB a year or two ago ... that’s saying something! The article by Michael Powell and Motoko Rich, which describes the "recovery" as merely a continuation of this recession shows the plight of the middle classes across the country in a harsh light, while the very same day Paul Reyes unveils a remarkable collection of photographs showing the ravages of the "Very Great US Depression" as LEAP/E2020 has called it since late 2006.
(18) Franck Biancheri offers a detailed presentation, with the two likely main scenarios for 2010-2020, in his book "The Global Crisis: The Path to the World after;
(19) Source: SeekingAlpha, 24/09/2010
(20) Singapore’s recent announcement that from now on its currency’s trading band against the U.S. dollar will be wider, is the latest example (each day brings a new one) of increasingly defensive positions taken by individual states. Each one tries to increase its room for maneuver to cope with the unexpected. Incidentally, it is interesting to note that Singapore suffered a 19% third quarter fall in GDP, evidence that the mood in Asia is becoming gloomy. Source: YahooFinances, 14/10/2010; MarketWatch, 13/10/2010
(21) For China, one solution will most probably be to inject the country's huge US Dollar reserves into the economy as already suggested by the new generation of Chinese bankers. This will not help the US Dollar. Source: Dallasnews, 19/09/2010
(22) The National Bureau of Economic Research (NBER is in charge of "holding a Mass" on this subject.
(23) As MSNBC aptly described on 06/10/2010, it’s once a month at midnight that America’s great depression is revealed in the supermarkets, when tens of millions of food voucher recipients go and do their shopping. According to the study by the Center for Economic and Policy Research published on 16/09/2010, in effect now one in three Americans can no longer make ends meet (one hundred million people ).
(24) Source: CNNMoney, 12/10/2010
Samedi 16 Octobre 2010
18 October 2010
Why the U.S. has Launched a New Financial World War -- And How the the Rest of the World Will Fight Back
By MICHAEL HUDSON
“Coming events cast their shadows forward.”
– Goethe
What is to stop U.S. banks and their customers from creating $1 trillion, $10 trillion or even $50 trillion on their computer keyboards to buy up all the bonds and stocks in the world, along with all the land and other assets for sale in the hope of making capital gains and pocketing the arbitrage spreads by debt leveraging at less than 1 per cent interest cost? This is the game that is being played today.
Finance is the new form of warfare – without the expense of a military overhead and an occupation against unwilling hosts. It is a competition in credit creation to buy foreign resources, real estate, public and privatized infrastructure, bonds and corporate stock ownership. Who needs an army when you can obtain the usual objective (monetary wealth and asset appropriation) simply by financial means? All that is required is for central banks to accept dollar credit of depreciating international value in payment for local assets. Victory promises to go to whatever economy’s banking system can create the most credit, using an army of computer keyboards to appropriate the world’s resources. The key is to persuade foreign central banks to accept this electronic credit.
U.S. officials demonize foreign countries as aggressive “currency manipulators” keeping their currencies weak. But they simply are trying to protect their currencies from being pushed up against the dollar by arbitrageurs and speculators flooding their financial markets with dollars. Foreign central banks find them obliged to choose between passively letting dollar inflows push up their exchange rates – thereby pricing their exports out of global markets – or recycling these dollar inflows into U.S. Treasury bills yielding only 1% and whose exchange value is declining. (Longer-term bonds risk a domestic dollar-price decline if U.S interest rates should rise.)
“Quantitative easing” is a euphemism for flooding economies with credit, that is, debt on the other side of the balance sheet. The Fed is pumping liquidity and reserves into the domestic financial system to reduce interest rates, ostensibly to enable banks to “earn their way” out of negative equity resulting from the bad loans made during the real estate bubble. But why would banks lend more under conditions where a third of U.S. homes already are in negative equity and the economy is shrinking as a result of debt deflation?
The problem is that U.S. quantitative easing is driving the dollar downward and other currencies up, much to the applause of currency speculators enjoying a quick and easy free lunch. Yet it is to defend this system that U.S. diplomats are threatening to plunge the world economy into financial anarchy if other countries do not agree to a replay of the 1985 Plaza Accord “as a possible framework for engineering an orderly decline in the dollar and avoiding potentially destabilizing trade fights.” The run-up to this weekend’s IMF meetings saw the United States threaten to derail the international financial system, bringing monetary chaos if it does not get its way. This threat has succeeded for the past few generations.
The world is seeing a competition in credit creation to buy foreign resources, real estate, public and privatized infrastructure, bonds and corporate stock ownership. This financial grab is occurring without an army to seize the land or take over the government. Finance is the new form of warfare – without the expense of a military overhead and an occupation against unwilling hosts. Indeed, this “currency war” so far has been voluntary among individual buyers and the sellers who receive surplus dollars for their assets. It is foreign economies that lose, as their central banks recycle this tidal wave of dollar “keyboard credit” back into low-yielding U.S. Treasury securities of declining international value.
For thousands of years tribute was extracted by conquering land and looting silver and gold, as in the sacking of Constantinople in 1204, or Incan Peru and Aztec Mexico three centuries later. But who needs a military war when the same objective can be won financially? Today’s preferred mode of warfare is financial. Victory in today’s monetary warfare promises to go to whatever economy’s banking system can create the most credit. Computer keyboards are today’s army appropriating the world’s resources.
The key to victory is to persuade foreign central banks to accept this electronic credit, bringing pressure to bear via the International Monetary Fund, meeting this last weekend. The aim is nothing as blatant as extracting overt tribute by military occupation. Who needs an army when you can obtain the usual objective (monetary wealth and asset appropriation) simply by financial means? All that is required is for central banks to accept dollar credit of depreciating international value in payment for local assets.
But the world has seen the Plaza Accord derail Japan’s economy by obliging its currency to appreciate while lowering interest rates by flooding its economy with enough credit to inflate a real estate bubble. The alternative to a new currency war “getting completely out of control,” the bank lobbyist suggested, is “to try and reach some broad understandings about where currencies should move.” However, IMF managing director Dominique Strauss-Kahn, was more realistic. “I'm not sure the mood is to have a new Plaza or Louvre accord,” he said at a press briefing. “We are in a different time today.” On the eve of the Washington IMF meetings he added: “The idea that there is an absolute need in a globalised world to work together may lose some steam.” (Alan Beattie Chris Giles and Michiyo Nakamoto, “Currency war fears dominate IMF talks,” Financial Times, October 9, 2010, and Alex Frangos, “Easy Money Churns Emerging Markets,” Wall Street Journal, October 8, 2010.)
Quite the contrary, he added: “We can understand that some element of capital controls [need to] be put in place.”
The great question in global finance today is thus how long other nations will continue to succumb as the cumulative costs rise into the financial stratosphere? The world is being forced to choose between financial anarchy and subordination to a new U.S. economic nationalism. This is what is prompting nations to create an alternative financial system altogether.
The global financial system already has seen one long and unsuccessful experiment in quantitative easing in Japan’s carry trade that sprouted in the wake of Japan’s financial bubble bursting after 1990. Bank of Japan liquidity enabled the banks to lend yen credit to arbitrageurs at a low interest rate to buy higher-yielding securities. Iceland, for example, was paying 15 per cent. So Japanese yen were converted into foreign currencies, pushing down its exchange rate.
It was Japan that refined the “carry trade” in its present-day form. After its financial and property bubble burst in 1990, the Bank of Japan sought to enable its banks to “earn their way out of negative equity” by supplying them with low-interest credit for them to lend out. Japan’s recession left little demand at home, so its banks developed the carry trade: lending at a low interest rate to arbitrageurs at home and abroad, to lend to countries offering the highest returns. Yen were borrowed to convert into dollars, euros, Icelandic kroner and Chinese renminbi to buy government bonds, private-sector bonds, stocks, currency options and other financial intermediation. This “carry trade” was capped by foreign arbitrage in bonds of countries such as Iceland, paying 15 per cent. Not much of this funding was used to finance new capital formation. It was purely financial in character – extractive, not productive.
By 2006 the United States and Europe were experiencing a Japan-style financial and real estate bubble. After it burst in 2008, they did what Japan’s banks did after 1990. Seeking to help U.S. banks work their way out of negative equity, the Federal Reserve flooded the economy with credit. The aim was to provide banks with more liquidity, in the hope that they would lend more to domestic borrowers. The economy would “borrow its way out of debt,” re-inflating asset prices real estate, stocks and bonds so as to deter home foreclosures and the ensuing wipeout of the collateral on bank balance sheets.
This is occurring today as U.S. liquidity spills over to foreign economies, increasing their exchange rates. Joseph Stiglitz recently explained that instead of helping the global recovery, the “flood of liquidity” from the Federal Reserve and the European Central Bank is causing “chaos” in foreign exchange markets. “The irony is that the Fed is creating all this liquidity with the hope that it will revive the American economy. ... It’s doing nothing for the American economy, but it’s causing chaos over the rest of the world.” (Walter Brandimarte, “Fed, ECB throwing world into chaos: Stiglitz,” Reuters, Oct. 5, 2010, reporting on a talk by Prof. Stiglitz at Colombia University. )
Dirk Bezemer and Geoffrey Gardiner, in their paper “Quantitative Easing is Pushing on a String” , prepared for the Boeckler Conference, Berlin, October 29-30, 2010, make clear that “QE provides bank customers, not banks, with loanable funds. Central Banks can supply commercial banks with liquidity that facilitates interbank payments and payments by customers and banks to the government, but what banks lend is their own debt, not that of the central bank. Whether the funds are lent for useful purposes will depend, not on the adequacy of the supply of fund, but on whether the environment is encouraging to real investment.”
Quantitative easing subsidizes U.S. capital flight, pushing up non-dollar currency exchange rates
Federal Reserve Chairman Ben Bernanke’s quantitative easing may not have set out to disrupt the global trade and financial system or start a round of currency speculation that is forcing other countries to defend their economies by rejecting the dollar as a pariah currency. But that is the result of the Fed’s decision in 2008 to keep unpayably high debts from defaulting by re-inflating U.S. real estate and financial markets. The aim is to pull home ownership out of negative equity, rescuing the banking system’s balance sheets and thus saving the government from having to indulge in a Tarp II, which looks politically impossible given the mood of most Americans.
The announced objective is not materializing. The Fed’s new credit creation is not increasing bank loans to real estate, consumers or businesses. Banks are not lending – at home, that is. They are collecting on past loans. This is why the U.S. savings rate is jumping. The “saving” that is reported (up from zero to 3 per cent of GDP) is taking the form of paying down debt, not building up liquid funds on which to draw. Just as hoarding diverts revenue away from being spent on goods and services, so debt repayment shrinks spendable income.
So Bernanke created $2 trillion in new Federal Reserve credit. And now (October 2010) the Fed is proposing to increase the Fed’s money creation by another $1 trillion over the coming year. This is what has led gold prices to surge and investors to move out of weakening “paper currencies” since early September – and prompted other nations to protect their own economies accordingly.
It is hardly surprising that banks are not lending to an economy being shrunk by debt deflation. The entire quantitative easing has been sent abroad, mainly to the BRIC countries: Brazil, Russia, India and China. “Recent research at the International Monetary Fund has shown conclusively that G4 monetary easing has in the past transferred itself almost completely to the emerging economies … since 1995, the stance of monetary policy in Asia has been almost entirely determined by the monetary stance of the G4 – the US, eurozone, Japan and China – led by the Fed.” According to the IMF, “equity prices in Asia and Latin America generally rise when excess liquidity is transferred from the G4 to the emerging economies.”
Borrowing unprecedented amounts from U.S., Japanese and British banks to buy bonds, stocks and currencies in the BRIC and Third World countries is a self-feeding expansion. Speculative inflows into these countries are pushing up their currencies as well as their asset prices, but. Their central banks settle these transactions in dollars, whose value falls as measured in their own local currencies.
U.S. officials say that this is all part of the free market. “It is not good for the world for the burden of solving this broader problem … to rest on the shoulders of the United States,” insisted Treasury Secretary Tim Geithner on Wednesday.
So other countries are solving the problem on their own. Japan is trying to hold down its exchange rate by selling yen and buying U.S. Treasury bonds in the face of its carry trade being unwound as arbitrageurs are paying back the yen that they earlier borrowed to buy higher-yielding but increasingly risky sovereign debt from countries such as Greece. Paying back these arbitrage loans has pushed up the yen’s exchange rate by 12 per cent against the dollar so far during 2010. On Tuesday, October 5, Bank of Japan governor Masaaki Shirakawa announced that Japan had “no choice” but to “spend 5 trillion yen ($60 billion) to buy government bonds, corporate IOUs, real-estate investment trust funds and exchange-traded funds – the latter two a departure from past practice.”
This “sterilization” of unwanted financial speculation is precisely what the United States has criticized China for doing. China has tried more “normal” ways to recycle its trade surplus, by seeking out U.S. companies to buy. But Congress would not let CNOOC buy into U.S. oil refinery capacity a few years ago, and the Canadian government is now being urged to block China’s attempt to purchase its potash resources. This leaves little option for China and other countries but to hold their currencies stable by purchasing U.S. and European government bonds.
This has become the problem for all countries today. As presently structured, the international financial system rewards speculation and makes it difficult for central banks to maintain stability without forced loans to the U.S. Government that has long enjoyed a near monopoly in providing central bank reserves. As noted earlier, arbitrageurs obtain a twofold gain: the arbitrage margin between Brazil’s nearly 12 per cent yield on its long-term government bonds and the cost of U.S. credit (1 per cent), plus the foreign-exchange gain resulting from the fact that the outflow from dollars into reals has pushed up the real’s exchange rate some 30 per cent – from R$2.50 at the start of 2009 to $1.75 last week. Taking into account the ability to leverage $1 million of one’s own equity investment to buy $100 million of foreign securities, the rate of return is 3000 per cent since January 2009.
Brazil has been more a victim than a beneficiary of what is euphemized as a “capital inflow.” The inflow of foreign money has pushed up the real by 4 per cent in just over a month (from September 1 through early October). The past year’s run-up has eroded the competitiveness of Brazilian exports, prompting the government to impose 4 per cent tax on foreign purchases of its bonds on October 4 to deter the currency’s rise. “It’s not only a currency war,” Finance Minister Guido Mantega said on Monday. “It tends to become a trade war and this is our concern.” And Thailand’s central bank director Wongwatoo Potirat warned that his country was considering similar taxes and currency trade restrictions to stem the baht’s rise, and Subir Gokarn, deputy governor of the Reserve Bank of India announced that his country also was reviewing defenses against the “potential threat” of inward capital flows.”
Such inflows do not provide capital for tangible investment. They are predatory, and cause currency fluctuation that disrupts trade patterns while creating enormous trading profits for large financial institutions and their customers. Yet most discussions of exchange rate treat the balance of payments and exchange rates as if they were determined purely by commodity trade and “purchasing power parity,” not by the financial flows and military spending that actually dominate the balance of payments. The reality is that today’s financial interregnum – anarchic “free” markets prior to countries hurriedly putting up their own monetary defenses – provides the arbitrage opportunity of the century. This is what bank lobbyists have been pressing for. It has little to do with the welfare of workers.
The potentially largest speculative prize of all promises to be an upward revaluation of China’s renminbi. The House Ways and Means Committee is backing this gamble, by demanding that China raise its exchange rate by the 20 per cent that the Treasury and Federal Reserve are suggesting. A revaluation of this magnitude would enable speculators to put down 1 per cent equity – say, $1 million to borrow $99 million and buy Chinese renminbi forward. The revaluation being demanded would produce a 2000 per cent profit of $20 million by turning the $100 million bet (and just $1 million “serious money”) into $120 million. Banks can trade on much larger, nearly infinitely leveraged margins, much like drawing up CDO swaps and other derivative plays.
This kind of money already has been made by speculating on Brazilian, Indian and Chinese securities and those of other countries whose exchange rates have been forced up by credit-flight out of the dollar, which has fallen by 7 per cent against a basket of currencies since early September when the Federal Reserve floated the prospect of quantitative easing. During the week leading up to the IMF meetings in Washington, the Thai baht and Indian rupee soared in anticipation that the United States and Britain would block any attempts by foreign countries to change the financial system and curb disruptive currency gambling.
This capital outflow from the United States has indeed helped domestic banks rebuild their balance sheets, as the Fed intended. But in the process the international financial system has been victimized as collateral damage. This prompted Chinese officials to counter U.S. attempts to blame it for running a trade surplus by retorting that U.S. financial aggression “risked bringing mutual destruction upon the great economic powers.
From the gold-exchange standard to the Treasury-bill standard to “free credit” anarchy
Indeed, the standoff between the United States and other countries at the IMF meetings in Washington this weekend threatens to cause the most serious rupture since the breakdown of the London Monetary Conference in 1933. The global financial system threatens once again to break apart, deranging the world’s trade and investment relationships – or to take a new form that will leave the United States isolated in the face of its structural long-term balance-of-payments deficit.
This crisis provides an opportunity – indeed, a need – to step back and review the longue durée of international financial evolution to see where past trends are leading and what paths need to be re-tracked. For many centuries prior to 1971, nations settled their balance of payments in gold or silver. This “money of the world,” as Sir James Steuart called gold in 1767, formed the basis of domestic currency as well. Until 1971 each U.S. Federal Reserve note was backed 25 per cent by gold, valued at $35 an ounce. Countries had to obtain gold by running trade and payments surpluses in order to increase their money supply to facilitate general economic expansion. And when they ran trade deficits or undertook military campaigns, central banks restricted the supply of domestic credit to raise interest rates and attract foreign financial inflows.
As long as this behavioral condition remained in place, the international financial system operated fairly smoothly under checks and balances, albeit under “stop-go” policies when business expansions led to trade and payments deficits. Countries running such deficits raised their interest rates to attract foreign capital, while slashing government spending, raising taxes on consumers and slowing the domestic economy so as to reduce the purchase of imports.
What destabilized this system was war spending. War-related transactions spanning World Wars I and II enabled the United States to accumulate some 80 per cent of the world’s monetary gold by 1950. This made the dollar a virtual proxy for gold. But after the Korean War broke out, U.S. overseas military spending accounted for the entire payments deficit during the 1950s and ‘60s and early ‘70s. Private-sector trade and investment was exactly in balance.
By August 1971, war spending in Vietnam and other foreign countries forced the United States to suspend gold convertibility of the dollar through sales via the London Gold Pool. But largely by inertia, central banks continued to settle their payments balances in U.S. Treasury securities. After all, there was no other asset in sufficient supply to form the basis for central bank monetary reserves. But replacing gold – a pure asset – with dollar-denominated U.S. Treasury debt transformed the global financial system. It became debt-based, not asset-based. And geopolitically, the Treasury-bill standard made the United States immune from the traditional balance-of-payments and financial constraints, enabling its capital markets to become more highly debt-leveraged and “innovative.” It also enabled the U.S. Government to wage foreign policy and military campaigns without much regard for the balance of payments.
The problem is that the supply of dollar credit has become potentially infinite. The “dollar glut” has grown in proportion to the U.S. payments deficit. Growth in central bank reserves and sovereign-country funds has taken the form of recycling of dollar inflows into new purchases of U.S. Treasury securities – thereby making foreign central banks (and taxpayers) responsible for financing most of the U.S. federal budget deficit. The fact that this deficit is largely military in nature – for purposes that many foreign voters oppose – makes this lock-in particularly galling. So it hardly is surprising that foreign countries are seeking an alternative.
Contrary to most public media posturing, the U.S. payments deficit – and hence, other countries’ payments surpluses – is not primarily a trade deficit. Foreign military spending has accelerated despite the Cold War ending with dissolution of the Soviet Union in 1991. Even more important has been rising capital outflows from the United States. Banks lent to foreign governments from Third World countries, to other deficit countries to cover their national payments deficits, to private borrowers to buy the foreign infrastructure being privatized, foreign stocks and bonds, and to arbitrageurs to borrow at a low interest rate to buy higher-yielding securities abroad.
The corollary is that other countries’ balance-of-payments surpluses do not stem primarily from trade relations, but from financial speculation and a spillover of U.S. global military spending. Under these conditions the maneuvering for quick returns by banks and their arbitrage customers is distorting exchange rates for international trade. U.S. “quantitative easing” is coming to be perceived as a euphemism for a predatory financial attack on the rest of the world. Trade and currency stability are part of the “collateral damage” being caused by the Federal Reserve and Treasury flooding the economy with liquidity in their attempt to re-inflate U.S. asset prices. Faced with U.S. quantitative easing flooding the economy with reserves to “save the banks” from negative equity, all countries are obliged to act as “currency manipulators.” So much money is made by purely financial speculation that “real” economies are being destroyed.
The coming capital controls
The global financial system is being broken up as U.S. monetary officials change the rules they laid down nearly half a century ago. Prior to the United States going off gold in 1971, nobody dreamed that an economy – especially the United States – would create unlimited credit on computer keyboards and not see its currency plunge. But that is what happens under the Treasury-bill standard of international finance. Under this condition, foreign countries can prevent their currencies from rising against the dollar (thereby pricing their labor and exports out of foreign markets) only by (1) recycling dollar inflows into U.S. Treasury securities, (2) by imposing capital controls, or (3) by avoiding use of the dollar or other currencies used by financial speculators in economies promoting “quantitative easing.”
Malaysia successfully used capital controls during the 1997 Asian Crisis to prevent short-sellers from covering their bets. This confronted speculators with a short squeeze that George Soros says made him lose money on the attempted raid. Other countries are now reviewing how to impose capital controls to protect themselves from the tsunami of credit from flowing into their currencies and buying up their assets – along with gold and other commodities that are turning into vehicles for speculation rather than actual use in production. Brazil took a modest step along this path by using tax policy rather than outright capital controls when it taxed foreign buyers of its bonds last week.
If other nations take this route, it will reverse the policy of open and unprotected capital markets adopted after World War II. This trend threatens to lead to the kind of international monetary practice found from the 1930s into the ‘50s: dual exchange rates, one for financial movements and another for trade. It probably would mean replacing the IMF, World Bank and WTO with a new set of institutions, isolating U.S., British and Eurozone representation.
To defend itself, the IMF is proposing to act as a “central bank” creating what was called “paper gold” in the late 1960s – artificial credit in the form of Special Drawing Rights (SDRs). However, other countries already have complained that voting control remains dominated by the major promoters of arbitrage speculation – the United States, Britain and Eurozone. And the IMF’s Articles of Agreement prevent countries from protecting themselves, characterizing this as “interfering” with “open capital markets.” So the impasse reached this weekend appears to be permanent. As one report summarized matters: “‘There is only one obstacle, which is the agreement of the members,’ said a frustrated Kahn .”
Paul Martin, the former Canadian prime minister who helped create the G20 after the 1997-1998 Asian financial crisis, said “said the big powers were largely immune to being named andshamed.” And in a Financial Times interview Mohamed El Erian, a former senior IMF official and now chief executive of Pimco said, “You have a burst pipe behind the wall and the water is coming out. You have to fix the pipe, not just patch the wall.”
The BRIC countries are simply creating their own parallel system. In September, China supported a Russian proposal to start direct trading between the yuan and the ruble. It has brokered a similar deal with Brazil. And on the eve of the IMF meetings in Washington on Friday, October 8, Chinese Premier Wen stopped off in Istanbul to reach agreement with Turkish Prime Minister Erdogan to use their own currencies in tripling Turkish-Chinese trade to $50 billion over the next five years, effectively excluding the U.S. dollar. “We are forming an economic strategic partnership … In all of our relations, we have agreed to use the lira and yuan,” Mr. Erdogan said.
On the deepest economic lane, the present global financial breakdown is part of the price to be paid for the Federal Reserve and U.S. Treasury refusing to accept a prime axiom of banking: Debts that cannot be paid, won’t be. They tried to “save” the banking system from debt write-downs in 2008 by keeping the debt overhead in place. The resulting repayment burden continues to shrink the U.S. economy, while the Fed’s way to help the banks “earn their way out of negative equity” has been to fuel a flood of international financial speculation. Faced with normalizing world trade or providing opportunities for predatory finance, the U.S. and Britain have thrown their weigh behind the latter. Targeted economies understandably seeking alternative arrangements.
Michael Hudson is a former Wall Street economist. A Distinguished Research Professor at University of Missouri, Kansas City (UMKC), he is the author of many books, including Super Imperialism: The Economic Strategy of American Empire (new ed., Pluto Press, 2002) and Trade, Development and Foreign Debt: A History of Theories of Polarization v. Convergence in the World Economy. He can be reached via his website, mh@michael-hudson.com
“Coming events cast their shadows forward.”
– Goethe
What is to stop U.S. banks and their customers from creating $1 trillion, $10 trillion or even $50 trillion on their computer keyboards to buy up all the bonds and stocks in the world, along with all the land and other assets for sale in the hope of making capital gains and pocketing the arbitrage spreads by debt leveraging at less than 1 per cent interest cost? This is the game that is being played today.
Finance is the new form of warfare – without the expense of a military overhead and an occupation against unwilling hosts. It is a competition in credit creation to buy foreign resources, real estate, public and privatized infrastructure, bonds and corporate stock ownership. Who needs an army when you can obtain the usual objective (monetary wealth and asset appropriation) simply by financial means? All that is required is for central banks to accept dollar credit of depreciating international value in payment for local assets. Victory promises to go to whatever economy’s banking system can create the most credit, using an army of computer keyboards to appropriate the world’s resources. The key is to persuade foreign central banks to accept this electronic credit.
U.S. officials demonize foreign countries as aggressive “currency manipulators” keeping their currencies weak. But they simply are trying to protect their currencies from being pushed up against the dollar by arbitrageurs and speculators flooding their financial markets with dollars. Foreign central banks find them obliged to choose between passively letting dollar inflows push up their exchange rates – thereby pricing their exports out of global markets – or recycling these dollar inflows into U.S. Treasury bills yielding only 1% and whose exchange value is declining. (Longer-term bonds risk a domestic dollar-price decline if U.S interest rates should rise.)
“Quantitative easing” is a euphemism for flooding economies with credit, that is, debt on the other side of the balance sheet. The Fed is pumping liquidity and reserves into the domestic financial system to reduce interest rates, ostensibly to enable banks to “earn their way” out of negative equity resulting from the bad loans made during the real estate bubble. But why would banks lend more under conditions where a third of U.S. homes already are in negative equity and the economy is shrinking as a result of debt deflation?
The problem is that U.S. quantitative easing is driving the dollar downward and other currencies up, much to the applause of currency speculators enjoying a quick and easy free lunch. Yet it is to defend this system that U.S. diplomats are threatening to plunge the world economy into financial anarchy if other countries do not agree to a replay of the 1985 Plaza Accord “as a possible framework for engineering an orderly decline in the dollar and avoiding potentially destabilizing trade fights.” The run-up to this weekend’s IMF meetings saw the United States threaten to derail the international financial system, bringing monetary chaos if it does not get its way. This threat has succeeded for the past few generations.
The world is seeing a competition in credit creation to buy foreign resources, real estate, public and privatized infrastructure, bonds and corporate stock ownership. This financial grab is occurring without an army to seize the land or take over the government. Finance is the new form of warfare – without the expense of a military overhead and an occupation against unwilling hosts. Indeed, this “currency war” so far has been voluntary among individual buyers and the sellers who receive surplus dollars for their assets. It is foreign economies that lose, as their central banks recycle this tidal wave of dollar “keyboard credit” back into low-yielding U.S. Treasury securities of declining international value.
For thousands of years tribute was extracted by conquering land and looting silver and gold, as in the sacking of Constantinople in 1204, or Incan Peru and Aztec Mexico three centuries later. But who needs a military war when the same objective can be won financially? Today’s preferred mode of warfare is financial. Victory in today’s monetary warfare promises to go to whatever economy’s banking system can create the most credit. Computer keyboards are today’s army appropriating the world’s resources.
The key to victory is to persuade foreign central banks to accept this electronic credit, bringing pressure to bear via the International Monetary Fund, meeting this last weekend. The aim is nothing as blatant as extracting overt tribute by military occupation. Who needs an army when you can obtain the usual objective (monetary wealth and asset appropriation) simply by financial means? All that is required is for central banks to accept dollar credit of depreciating international value in payment for local assets.
But the world has seen the Plaza Accord derail Japan’s economy by obliging its currency to appreciate while lowering interest rates by flooding its economy with enough credit to inflate a real estate bubble. The alternative to a new currency war “getting completely out of control,” the bank lobbyist suggested, is “to try and reach some broad understandings about where currencies should move.” However, IMF managing director Dominique Strauss-Kahn, was more realistic. “I'm not sure the mood is to have a new Plaza or Louvre accord,” he said at a press briefing. “We are in a different time today.” On the eve of the Washington IMF meetings he added: “The idea that there is an absolute need in a globalised world to work together may lose some steam.” (Alan Beattie Chris Giles and Michiyo Nakamoto, “Currency war fears dominate IMF talks,” Financial Times, October 9, 2010, and Alex Frangos, “Easy Money Churns Emerging Markets,” Wall Street Journal, October 8, 2010.)
Quite the contrary, he added: “We can understand that some element of capital controls [need to] be put in place.”
The great question in global finance today is thus how long other nations will continue to succumb as the cumulative costs rise into the financial stratosphere? The world is being forced to choose between financial anarchy and subordination to a new U.S. economic nationalism. This is what is prompting nations to create an alternative financial system altogether.
The global financial system already has seen one long and unsuccessful experiment in quantitative easing in Japan’s carry trade that sprouted in the wake of Japan’s financial bubble bursting after 1990. Bank of Japan liquidity enabled the banks to lend yen credit to arbitrageurs at a low interest rate to buy higher-yielding securities. Iceland, for example, was paying 15 per cent. So Japanese yen were converted into foreign currencies, pushing down its exchange rate.
It was Japan that refined the “carry trade” in its present-day form. After its financial and property bubble burst in 1990, the Bank of Japan sought to enable its banks to “earn their way out of negative equity” by supplying them with low-interest credit for them to lend out. Japan’s recession left little demand at home, so its banks developed the carry trade: lending at a low interest rate to arbitrageurs at home and abroad, to lend to countries offering the highest returns. Yen were borrowed to convert into dollars, euros, Icelandic kroner and Chinese renminbi to buy government bonds, private-sector bonds, stocks, currency options and other financial intermediation. This “carry trade” was capped by foreign arbitrage in bonds of countries such as Iceland, paying 15 per cent. Not much of this funding was used to finance new capital formation. It was purely financial in character – extractive, not productive.
By 2006 the United States and Europe were experiencing a Japan-style financial and real estate bubble. After it burst in 2008, they did what Japan’s banks did after 1990. Seeking to help U.S. banks work their way out of negative equity, the Federal Reserve flooded the economy with credit. The aim was to provide banks with more liquidity, in the hope that they would lend more to domestic borrowers. The economy would “borrow its way out of debt,” re-inflating asset prices real estate, stocks and bonds so as to deter home foreclosures and the ensuing wipeout of the collateral on bank balance sheets.
This is occurring today as U.S. liquidity spills over to foreign economies, increasing their exchange rates. Joseph Stiglitz recently explained that instead of helping the global recovery, the “flood of liquidity” from the Federal Reserve and the European Central Bank is causing “chaos” in foreign exchange markets. “The irony is that the Fed is creating all this liquidity with the hope that it will revive the American economy. ... It’s doing nothing for the American economy, but it’s causing chaos over the rest of the world.” (Walter Brandimarte, “Fed, ECB throwing world into chaos: Stiglitz,” Reuters, Oct. 5, 2010, reporting on a talk by Prof. Stiglitz at Colombia University. )
Dirk Bezemer and Geoffrey Gardiner, in their paper “Quantitative Easing is Pushing on a String” , prepared for the Boeckler Conference, Berlin, October 29-30, 2010, make clear that “QE provides bank customers, not banks, with loanable funds. Central Banks can supply commercial banks with liquidity that facilitates interbank payments and payments by customers and banks to the government, but what banks lend is their own debt, not that of the central bank. Whether the funds are lent for useful purposes will depend, not on the adequacy of the supply of fund, but on whether the environment is encouraging to real investment.”
Quantitative easing subsidizes U.S. capital flight, pushing up non-dollar currency exchange rates
Federal Reserve Chairman Ben Bernanke’s quantitative easing may not have set out to disrupt the global trade and financial system or start a round of currency speculation that is forcing other countries to defend their economies by rejecting the dollar as a pariah currency. But that is the result of the Fed’s decision in 2008 to keep unpayably high debts from defaulting by re-inflating U.S. real estate and financial markets. The aim is to pull home ownership out of negative equity, rescuing the banking system’s balance sheets and thus saving the government from having to indulge in a Tarp II, which looks politically impossible given the mood of most Americans.
The announced objective is not materializing. The Fed’s new credit creation is not increasing bank loans to real estate, consumers or businesses. Banks are not lending – at home, that is. They are collecting on past loans. This is why the U.S. savings rate is jumping. The “saving” that is reported (up from zero to 3 per cent of GDP) is taking the form of paying down debt, not building up liquid funds on which to draw. Just as hoarding diverts revenue away from being spent on goods and services, so debt repayment shrinks spendable income.
So Bernanke created $2 trillion in new Federal Reserve credit. And now (October 2010) the Fed is proposing to increase the Fed’s money creation by another $1 trillion over the coming year. This is what has led gold prices to surge and investors to move out of weakening “paper currencies” since early September – and prompted other nations to protect their own economies accordingly.
It is hardly surprising that banks are not lending to an economy being shrunk by debt deflation. The entire quantitative easing has been sent abroad, mainly to the BRIC countries: Brazil, Russia, India and China. “Recent research at the International Monetary Fund has shown conclusively that G4 monetary easing has in the past transferred itself almost completely to the emerging economies … since 1995, the stance of monetary policy in Asia has been almost entirely determined by the monetary stance of the G4 – the US, eurozone, Japan and China – led by the Fed.” According to the IMF, “equity prices in Asia and Latin America generally rise when excess liquidity is transferred from the G4 to the emerging economies.”
Borrowing unprecedented amounts from U.S., Japanese and British banks to buy bonds, stocks and currencies in the BRIC and Third World countries is a self-feeding expansion. Speculative inflows into these countries are pushing up their currencies as well as their asset prices, but. Their central banks settle these transactions in dollars, whose value falls as measured in their own local currencies.
U.S. officials say that this is all part of the free market. “It is not good for the world for the burden of solving this broader problem … to rest on the shoulders of the United States,” insisted Treasury Secretary Tim Geithner on Wednesday.
So other countries are solving the problem on their own. Japan is trying to hold down its exchange rate by selling yen and buying U.S. Treasury bonds in the face of its carry trade being unwound as arbitrageurs are paying back the yen that they earlier borrowed to buy higher-yielding but increasingly risky sovereign debt from countries such as Greece. Paying back these arbitrage loans has pushed up the yen’s exchange rate by 12 per cent against the dollar so far during 2010. On Tuesday, October 5, Bank of Japan governor Masaaki Shirakawa announced that Japan had “no choice” but to “spend 5 trillion yen ($60 billion) to buy government bonds, corporate IOUs, real-estate investment trust funds and exchange-traded funds – the latter two a departure from past practice.”
This “sterilization” of unwanted financial speculation is precisely what the United States has criticized China for doing. China has tried more “normal” ways to recycle its trade surplus, by seeking out U.S. companies to buy. But Congress would not let CNOOC buy into U.S. oil refinery capacity a few years ago, and the Canadian government is now being urged to block China’s attempt to purchase its potash resources. This leaves little option for China and other countries but to hold their currencies stable by purchasing U.S. and European government bonds.
This has become the problem for all countries today. As presently structured, the international financial system rewards speculation and makes it difficult for central banks to maintain stability without forced loans to the U.S. Government that has long enjoyed a near monopoly in providing central bank reserves. As noted earlier, arbitrageurs obtain a twofold gain: the arbitrage margin between Brazil’s nearly 12 per cent yield on its long-term government bonds and the cost of U.S. credit (1 per cent), plus the foreign-exchange gain resulting from the fact that the outflow from dollars into reals has pushed up the real’s exchange rate some 30 per cent – from R$2.50 at the start of 2009 to $1.75 last week. Taking into account the ability to leverage $1 million of one’s own equity investment to buy $100 million of foreign securities, the rate of return is 3000 per cent since January 2009.
Brazil has been more a victim than a beneficiary of what is euphemized as a “capital inflow.” The inflow of foreign money has pushed up the real by 4 per cent in just over a month (from September 1 through early October). The past year’s run-up has eroded the competitiveness of Brazilian exports, prompting the government to impose 4 per cent tax on foreign purchases of its bonds on October 4 to deter the currency’s rise. “It’s not only a currency war,” Finance Minister Guido Mantega said on Monday. “It tends to become a trade war and this is our concern.” And Thailand’s central bank director Wongwatoo Potirat warned that his country was considering similar taxes and currency trade restrictions to stem the baht’s rise, and Subir Gokarn, deputy governor of the Reserve Bank of India announced that his country also was reviewing defenses against the “potential threat” of inward capital flows.”
Such inflows do not provide capital for tangible investment. They are predatory, and cause currency fluctuation that disrupts trade patterns while creating enormous trading profits for large financial institutions and their customers. Yet most discussions of exchange rate treat the balance of payments and exchange rates as if they were determined purely by commodity trade and “purchasing power parity,” not by the financial flows and military spending that actually dominate the balance of payments. The reality is that today’s financial interregnum – anarchic “free” markets prior to countries hurriedly putting up their own monetary defenses – provides the arbitrage opportunity of the century. This is what bank lobbyists have been pressing for. It has little to do with the welfare of workers.
The potentially largest speculative prize of all promises to be an upward revaluation of China’s renminbi. The House Ways and Means Committee is backing this gamble, by demanding that China raise its exchange rate by the 20 per cent that the Treasury and Federal Reserve are suggesting. A revaluation of this magnitude would enable speculators to put down 1 per cent equity – say, $1 million to borrow $99 million and buy Chinese renminbi forward. The revaluation being demanded would produce a 2000 per cent profit of $20 million by turning the $100 million bet (and just $1 million “serious money”) into $120 million. Banks can trade on much larger, nearly infinitely leveraged margins, much like drawing up CDO swaps and other derivative plays.
This kind of money already has been made by speculating on Brazilian, Indian and Chinese securities and those of other countries whose exchange rates have been forced up by credit-flight out of the dollar, which has fallen by 7 per cent against a basket of currencies since early September when the Federal Reserve floated the prospect of quantitative easing. During the week leading up to the IMF meetings in Washington, the Thai baht and Indian rupee soared in anticipation that the United States and Britain would block any attempts by foreign countries to change the financial system and curb disruptive currency gambling.
This capital outflow from the United States has indeed helped domestic banks rebuild their balance sheets, as the Fed intended. But in the process the international financial system has been victimized as collateral damage. This prompted Chinese officials to counter U.S. attempts to blame it for running a trade surplus by retorting that U.S. financial aggression “risked bringing mutual destruction upon the great economic powers.
From the gold-exchange standard to the Treasury-bill standard to “free credit” anarchy
Indeed, the standoff between the United States and other countries at the IMF meetings in Washington this weekend threatens to cause the most serious rupture since the breakdown of the London Monetary Conference in 1933. The global financial system threatens once again to break apart, deranging the world’s trade and investment relationships – or to take a new form that will leave the United States isolated in the face of its structural long-term balance-of-payments deficit.
This crisis provides an opportunity – indeed, a need – to step back and review the longue durée of international financial evolution to see where past trends are leading and what paths need to be re-tracked. For many centuries prior to 1971, nations settled their balance of payments in gold or silver. This “money of the world,” as Sir James Steuart called gold in 1767, formed the basis of domestic currency as well. Until 1971 each U.S. Federal Reserve note was backed 25 per cent by gold, valued at $35 an ounce. Countries had to obtain gold by running trade and payments surpluses in order to increase their money supply to facilitate general economic expansion. And when they ran trade deficits or undertook military campaigns, central banks restricted the supply of domestic credit to raise interest rates and attract foreign financial inflows.
As long as this behavioral condition remained in place, the international financial system operated fairly smoothly under checks and balances, albeit under “stop-go” policies when business expansions led to trade and payments deficits. Countries running such deficits raised their interest rates to attract foreign capital, while slashing government spending, raising taxes on consumers and slowing the domestic economy so as to reduce the purchase of imports.
What destabilized this system was war spending. War-related transactions spanning World Wars I and II enabled the United States to accumulate some 80 per cent of the world’s monetary gold by 1950. This made the dollar a virtual proxy for gold. But after the Korean War broke out, U.S. overseas military spending accounted for the entire payments deficit during the 1950s and ‘60s and early ‘70s. Private-sector trade and investment was exactly in balance.
By August 1971, war spending in Vietnam and other foreign countries forced the United States to suspend gold convertibility of the dollar through sales via the London Gold Pool. But largely by inertia, central banks continued to settle their payments balances in U.S. Treasury securities. After all, there was no other asset in sufficient supply to form the basis for central bank monetary reserves. But replacing gold – a pure asset – with dollar-denominated U.S. Treasury debt transformed the global financial system. It became debt-based, not asset-based. And geopolitically, the Treasury-bill standard made the United States immune from the traditional balance-of-payments and financial constraints, enabling its capital markets to become more highly debt-leveraged and “innovative.” It also enabled the U.S. Government to wage foreign policy and military campaigns without much regard for the balance of payments.
The problem is that the supply of dollar credit has become potentially infinite. The “dollar glut” has grown in proportion to the U.S. payments deficit. Growth in central bank reserves and sovereign-country funds has taken the form of recycling of dollar inflows into new purchases of U.S. Treasury securities – thereby making foreign central banks (and taxpayers) responsible for financing most of the U.S. federal budget deficit. The fact that this deficit is largely military in nature – for purposes that many foreign voters oppose – makes this lock-in particularly galling. So it hardly is surprising that foreign countries are seeking an alternative.
Contrary to most public media posturing, the U.S. payments deficit – and hence, other countries’ payments surpluses – is not primarily a trade deficit. Foreign military spending has accelerated despite the Cold War ending with dissolution of the Soviet Union in 1991. Even more important has been rising capital outflows from the United States. Banks lent to foreign governments from Third World countries, to other deficit countries to cover their national payments deficits, to private borrowers to buy the foreign infrastructure being privatized, foreign stocks and bonds, and to arbitrageurs to borrow at a low interest rate to buy higher-yielding securities abroad.
The corollary is that other countries’ balance-of-payments surpluses do not stem primarily from trade relations, but from financial speculation and a spillover of U.S. global military spending. Under these conditions the maneuvering for quick returns by banks and their arbitrage customers is distorting exchange rates for international trade. U.S. “quantitative easing” is coming to be perceived as a euphemism for a predatory financial attack on the rest of the world. Trade and currency stability are part of the “collateral damage” being caused by the Federal Reserve and Treasury flooding the economy with liquidity in their attempt to re-inflate U.S. asset prices. Faced with U.S. quantitative easing flooding the economy with reserves to “save the banks” from negative equity, all countries are obliged to act as “currency manipulators.” So much money is made by purely financial speculation that “real” economies are being destroyed.
The coming capital controls
The global financial system is being broken up as U.S. monetary officials change the rules they laid down nearly half a century ago. Prior to the United States going off gold in 1971, nobody dreamed that an economy – especially the United States – would create unlimited credit on computer keyboards and not see its currency plunge. But that is what happens under the Treasury-bill standard of international finance. Under this condition, foreign countries can prevent their currencies from rising against the dollar (thereby pricing their labor and exports out of foreign markets) only by (1) recycling dollar inflows into U.S. Treasury securities, (2) by imposing capital controls, or (3) by avoiding use of the dollar or other currencies used by financial speculators in economies promoting “quantitative easing.”
Malaysia successfully used capital controls during the 1997 Asian Crisis to prevent short-sellers from covering their bets. This confronted speculators with a short squeeze that George Soros says made him lose money on the attempted raid. Other countries are now reviewing how to impose capital controls to protect themselves from the tsunami of credit from flowing into their currencies and buying up their assets – along with gold and other commodities that are turning into vehicles for speculation rather than actual use in production. Brazil took a modest step along this path by using tax policy rather than outright capital controls when it taxed foreign buyers of its bonds last week.
If other nations take this route, it will reverse the policy of open and unprotected capital markets adopted after World War II. This trend threatens to lead to the kind of international monetary practice found from the 1930s into the ‘50s: dual exchange rates, one for financial movements and another for trade. It probably would mean replacing the IMF, World Bank and WTO with a new set of institutions, isolating U.S., British and Eurozone representation.
To defend itself, the IMF is proposing to act as a “central bank” creating what was called “paper gold” in the late 1960s – artificial credit in the form of Special Drawing Rights (SDRs). However, other countries already have complained that voting control remains dominated by the major promoters of arbitrage speculation – the United States, Britain and Eurozone. And the IMF’s Articles of Agreement prevent countries from protecting themselves, characterizing this as “interfering” with “open capital markets.” So the impasse reached this weekend appears to be permanent. As one report summarized matters: “‘There is only one obstacle, which is the agreement of the members,’ said a frustrated Kahn .”
Paul Martin, the former Canadian prime minister who helped create the G20 after the 1997-1998 Asian financial crisis, said “said the big powers were largely immune to being named andshamed.” And in a Financial Times interview Mohamed El Erian, a former senior IMF official and now chief executive of Pimco said, “You have a burst pipe behind the wall and the water is coming out. You have to fix the pipe, not just patch the wall.”
The BRIC countries are simply creating their own parallel system. In September, China supported a Russian proposal to start direct trading between the yuan and the ruble. It has brokered a similar deal with Brazil. And on the eve of the IMF meetings in Washington on Friday, October 8, Chinese Premier Wen stopped off in Istanbul to reach agreement with Turkish Prime Minister Erdogan to use their own currencies in tripling Turkish-Chinese trade to $50 billion over the next five years, effectively excluding the U.S. dollar. “We are forming an economic strategic partnership … In all of our relations, we have agreed to use the lira and yuan,” Mr. Erdogan said.
On the deepest economic lane, the present global financial breakdown is part of the price to be paid for the Federal Reserve and U.S. Treasury refusing to accept a prime axiom of banking: Debts that cannot be paid, won’t be. They tried to “save” the banking system from debt write-downs in 2008 by keeping the debt overhead in place. The resulting repayment burden continues to shrink the U.S. economy, while the Fed’s way to help the banks “earn their way out of negative equity” has been to fuel a flood of international financial speculation. Faced with normalizing world trade or providing opportunities for predatory finance, the U.S. and Britain have thrown their weigh behind the latter. Targeted economies understandably seeking alternative arrangements.
Michael Hudson is a former Wall Street economist. A Distinguished Research Professor at University of Missouri, Kansas City (UMKC), he is the author of many books, including Super Imperialism: The Economic Strategy of American Empire (new ed., Pluto Press, 2002) and Trade, Development and Foreign Debt: A History of Theories of Polarization v. Convergence in the World Economy. He can be reached via his website, mh@michael-hudson.com
17 May 2010
Global systemic crisis – From « Eurozone coup d’Etat » to the tragic solitude of the United Kingdom, global geopolitical dislocation quickens
Just as anticipated by LEAP/E2020 in issues N°40 (December 2009) and N°42 (February 2010), spring 2010 really marks a tipping point of the global systemic crisis, characterized by a sudden expansion due to the intolerable size of public deficits (see issue N° 39, November 2009) and the inexistence of the recovery, so often announced (see issue N°37, September 2009). Besides, the dramatic social and political consequences of this development clearly reflect the beginning of the process of global geopolitical dislocation as anticipated in issue N°32 (February 2009). Finally, the Eurozone leaders’ recent decisions confirm LEAP/E2020’s anticipations, contrary to the dominant chatter of these last few months, of the fact that not only will the Euro not « explode » because of the Greek problem but, on the contrary, a strengthened Eurozone will emerge from this stage of the crisis (1). One could even consider that, since the Eurozone decision, a kind of « Eurozone coup d’Etat » supported by Sweden and Poland, to create a huge apparatus to protect the interests of the 26 EU member states (2), the geopolitical deal in Europe has changed radically. Because it runs contrary to the prejudices which fashion their vision of the world, several months will be needed by the majority of the media and players to accept that, behind the appearance of a purely European budgetary-financial decision, lies a geopolitical split with worldwide impact.
Current increases in national debt for the USA, United Kingdom, Euroland and Japan (in green: % of debt to GDP / in red: forecast debt increase for 2009 and 2010 / in yellow: comparative figures for Germany) - Source: European Commission, 2010
Eurozone coup d’Etat in Brussels: The EU founding states regain control
In this issue N°45, we analyse in detail the numerous consequences for Europeans and for the world from what could be called the Eurozone « coup d’Etat » within the EU. In the face of the worsening crisis, the sixteen have indeed taken control of the EU reins of power, creating new tools and instruments which leave no other choice for the other members but to follow or find themselves isolated. Ten out of the eleven other member states have decided to follow, such as the two most important of them, Sweden and Poland, who have chosen to actively participate in the apparatus put into place by the Eurozone (the other eight are currently either in the course of negotiating their Eurozone entry, like Estonia from 2011 (3), or receiving direct help from the Eurozone, like Lithuania, Hungary, Romania, for example…). It is a (r)evolution that our team has clearly anticipated for over three years and we had even stated recently that events would rapidly unfold in the Eurozone once the German regional elections and the British general election had taken place. However, we would never have thought that it would happen in just a few hours, neither with such boldness as to the amount (750 billion Euros, or one trillion USD) and the character (EU control taken by the Eurozone (4) and a leap ahead in terms of economic and financial integration).
The fact remains that without knowing it, and without having asked their opinion, 440 million Europeans have just joined a new country, Euroland, of which some already share the currency, the Euro, and of which all now share the indebtedness and the joint means to solve the serious problems posed in the context of the global systemic crisis. The budgetary and financial decisions taken during the Summit of the weekend of the 8th May in terms of a response to the European public debt crisis can be evaluated differently according to one’s analysis of the crisis and its causes. LEAP/E2020 will roll out its own analyses on the subject in this issue N°45 but, without doubt, a radical unraveling of European governance has just taken place: a collective continental governance has just brutally emerged, ironically 65 years after the end of the Second World War, moreover celebrated with a big display in Moscow the same day (5) as the holiday celebrating the creation of the European Coal and Steel Community, the common ancestor of the EU and Euroland. This simultaneity isn’t a coincidence (6) and marks an important step forward in global geopolitical dislocation and the reconstitution of new global balances. Under the pressure of events set off by the crisis, the Eurozone has thus undertaken to grasp its independence with regard to the Anglo-Saxon world still expressed via the financial markets. This 750 billion Euros and this new European governance (of the 26) constitutes, at the one and the same time, the putting in place of the fortifications against the next storms caused by draconian Western indebtedness, and which will affect the United Kingdom and then the United States (cf. issue N°44 causing disturbances of which the « Greek crisis » has only given a small preview.
The EMF will, in the long run, deprive the IMF of 50% of its major contributions: those of the Europeans
Concerning this, LEAP/E2020 reminds readers of a fact that the majority of the media has been oblivious of for many weeks. Contrary to the prevailing discussion, the IMF is first and foremost European money. In effect one out of three IMF Dollars is contributed by Europeans, compared to only one in six by the USA (their share has been cut in half in 50 years) and one of the consequences of the European decisions of these last few days is that it will not be the case for very much longer. Our team is convinced that, within three years at the latest, when it is time to formalize the integration of the intervention fund created on the 8th and 9th May 2010 into the European Monetary Fund, the EU will reduce its contribution to the IMF by a similar proportion. One could guess already that this reduction in the European contribution (UK excluded) will be in the order of 50% at least. That will allow the IMF to become more globally representative by automatically rebalancing the BRIC share and, in the same breath, requiring the USA to abandon its right of veto (7). But that will equally contribute to it becoming heavily marginalized since Asia has already created its own emergency intervention fund. It is an example which illustrates just how many of the European decisions of the beginning of May 2010 are full of wide sweeping geopolitical changes which will scale out in all of the coming years. In fact, it is unlikely that the majority of the decision makers involved in the « Eurozone coup d’Etat » have clearly understood the implications of their decisions. But no-one has ever said that history was largely made by those people who knew what they were doing.
Countries’ and markets’ IMF contributions (1948-2001) - Source: IMF / Danmarks National Bank - 2001
The United Kingdom: isolated in the face of an historic crisis
One of the simultaneous causes and consequences of this development is the complete marginalization of the United Kingdom. Its increasing weakness since the beginning of the crisis, along with that of its US sponsor, has created the possibility of a complete takeover, without concessions, of the march forward of the European project by the continental countries. This loss of influence reinforces, in return, Great Britain’s marginalization because British leaders are trapped in a denial of reality which they have made their people share as well. None of the British political parties, not even at this point the Liberal Democrats, even though showing greater clarity than the other political parties of the country, could consider reconsidering the decades of diatribe accusing Europe for all the ills and dressing-up the Euro for all the losses. Indeed, even if their leaders were aware of the folly of a strategy consisting of isolating Great Britain a little more day-by-day, even when the world crisis has moved up a gear, they will collide with this public Euroscepticism which they have fostered over the course of the past years. The irony of history was, once again, clearly shown during this historic weekend of the 8th/9th May 2010: in refusing to participate in the Eurozone’s joint defensive and protective measures, the British leaders have, de facto, refused to catch the last lifeline within their grasp (8). The European continent will now content itself with watching them try to find the 200 billion Euros which their country needs to balance this year’s budget (9). And if the leaders in London think that City speculators will have any qualms breaking the Pound sterling and selling Gilts, it is because they haven’t understood the basics of global finance (10), nor checked the nationalities of these same players (11). Between Wall Street, which will do anything to attract the world’s capital (one only needs to ask the Swiss market what it thinks of the war that world markets are currently delivering one another), Washington, which is knocking itself out to hover up all the world’s available savings, and a European continent which has, from now on, placed itself under the protection of a common currency and debt, the dice have been cast. At this stage, we are still in the drama, because the major English players have not yet realised that they are caught in a trap; a few weeks from now, we will move on to the British tragedy because, this summer, the whole country will have discovered the historic trap into which the country, on its own, has fallen.
So, at the moment when Euroland emerges in Brussels, the United Kingdom struggles with a hung parliament, compelling it to move on to the first coalition government since 1945 and which will take the country to a further election between now and the end of the year.
The British and their leaders in trouble, who are going to have to « think the unthinkable »
Whatever the supporters of the coalition now running the country may tell, LEAP/E2020 thinks it highly unlikely that this alliance will last more than a few months. The very different structure of the two parties involved (Conservatives and Liberal Democrats are divided on a number of issues), combined with unpopular decisions, is leading this team straight to internal crises for each party and, then, to a government collapse. The Conservatives will play this card because, unlike the Liberal Democrats, they have sufficient funds to « finance » a new electoral campaign between now and the end of the year (12). But the most dangerous underlying stumbling-block is intellectual: to avoid the tragedy which portends, the United Kingdom is going to have to « think the unthinkable », i.e. reconsider its basic beliefs on its insular outlook, its transatlantic « relationship », its relationship with a continent now on the road to complete integration, while, for centuries, it has thought of the continent as a disunion. However the problem set is simple: if the United Kingdom has always thought that its power depended on a divided European continent, then logically, considering current events, it must now admit that it is heading to a state of impotence... and draw the necessary conclusions, i.e. that it too should make a « quantum leap ». If Nick Clegg seems intellectually equipped to make such a leap, neither David Cameron’s Conservatives, nor the British leaders altogether, seem mature enough yet. In such a case, Great Britain, sadly, must take the « tragic » path (13).
In any case, this weekend of the 8th/9th May 2010 in Europe dips a number of its roots directly into the Second World War and its consequences (14). It is, besides, one of the features of the global systemic crisis as foretold by LEAP/E2020 in February 2006 in issue N°2: it brings to « an end the West as one has known it since 1945 ».
Another of these features is the take-off in the gold price (compared to the US Dollar especially), in the face of the growing distrust in all fiat currencies (see issue N°41, January 2010 (15)). Indeed, whilst all the world speak of the Euro/US Dollar exchange rate, the Dollar remains at its historically lowest levels compared to its major trade partners (see chart below), a sign of the US currency’s structural weakness. In the coming months, as GEAB anticipated, the Euro will climb back to its medium-term equilibrium level of above 1.45/€.
In this issue, before giving our recommendations on currencies, the stock exchange and gold, LEAP/E2020 will analyse in greater detail the US pseudo-recovery which internally is basically a vast focused news operation aimed at re-starting household spending (an impossible task now) and externally at avoiding panicking foreign investors (at best, several quarters can be gained). Thus the United States maintains that it will be able to escape brutal austerity treatment, like the other Western countries, whilst, in fact, the recovery is an « unrecovery » as Michael Panzner, with a touch of humour, called his excellent article of 04/27/2010, published in Seeking Alpha.investors (at best, several quarters can be gained). Thus the United States maintains that it will be able to escape brutal austerity treatment, like the other Western countries, whilst, in fact, the recovery is an « unrecovery » as Michael Panzner, with a touch of humour, called his excellent article of 04/27/2010, published in Seeking Alpha.
Charts and Data
Current increases in national debt for the USA, United Kingdom, Euroland and Japan (in green: % of debt to GDP / in red: forecast debt increase for 2009 and 2010 / in yellow: comparative figures for Germany) - Source: European Commission, 2010
Eurozone coup d’Etat in Brussels: The EU founding states regain control
In this issue N°45, we analyse in detail the numerous consequences for Europeans and for the world from what could be called the Eurozone « coup d’Etat » within the EU. In the face of the worsening crisis, the sixteen have indeed taken control of the EU reins of power, creating new tools and instruments which leave no other choice for the other members but to follow or find themselves isolated. Ten out of the eleven other member states have decided to follow, such as the two most important of them, Sweden and Poland, who have chosen to actively participate in the apparatus put into place by the Eurozone (the other eight are currently either in the course of negotiating their Eurozone entry, like Estonia from 2011 (3), or receiving direct help from the Eurozone, like Lithuania, Hungary, Romania, for example…). It is a (r)evolution that our team has clearly anticipated for over three years and we had even stated recently that events would rapidly unfold in the Eurozone once the German regional elections and the British general election had taken place. However, we would never have thought that it would happen in just a few hours, neither with such boldness as to the amount (750 billion Euros, or one trillion USD) and the character (EU control taken by the Eurozone (4) and a leap ahead in terms of economic and financial integration).
The fact remains that without knowing it, and without having asked their opinion, 440 million Europeans have just joined a new country, Euroland, of which some already share the currency, the Euro, and of which all now share the indebtedness and the joint means to solve the serious problems posed in the context of the global systemic crisis. The budgetary and financial decisions taken during the Summit of the weekend of the 8th May in terms of a response to the European public debt crisis can be evaluated differently according to one’s analysis of the crisis and its causes. LEAP/E2020 will roll out its own analyses on the subject in this issue N°45 but, without doubt, a radical unraveling of European governance has just taken place: a collective continental governance has just brutally emerged, ironically 65 years after the end of the Second World War, moreover celebrated with a big display in Moscow the same day (5) as the holiday celebrating the creation of the European Coal and Steel Community, the common ancestor of the EU and Euroland. This simultaneity isn’t a coincidence (6) and marks an important step forward in global geopolitical dislocation and the reconstitution of new global balances. Under the pressure of events set off by the crisis, the Eurozone has thus undertaken to grasp its independence with regard to the Anglo-Saxon world still expressed via the financial markets. This 750 billion Euros and this new European governance (of the 26) constitutes, at the one and the same time, the putting in place of the fortifications against the next storms caused by draconian Western indebtedness, and which will affect the United Kingdom and then the United States (cf. issue N°44 causing disturbances of which the « Greek crisis » has only given a small preview.
The EMF will, in the long run, deprive the IMF of 50% of its major contributions: those of the Europeans
Concerning this, LEAP/E2020 reminds readers of a fact that the majority of the media has been oblivious of for many weeks. Contrary to the prevailing discussion, the IMF is first and foremost European money. In effect one out of three IMF Dollars is contributed by Europeans, compared to only one in six by the USA (their share has been cut in half in 50 years) and one of the consequences of the European decisions of these last few days is that it will not be the case for very much longer. Our team is convinced that, within three years at the latest, when it is time to formalize the integration of the intervention fund created on the 8th and 9th May 2010 into the European Monetary Fund, the EU will reduce its contribution to the IMF by a similar proportion. One could guess already that this reduction in the European contribution (UK excluded) will be in the order of 50% at least. That will allow the IMF to become more globally representative by automatically rebalancing the BRIC share and, in the same breath, requiring the USA to abandon its right of veto (7). But that will equally contribute to it becoming heavily marginalized since Asia has already created its own emergency intervention fund. It is an example which illustrates just how many of the European decisions of the beginning of May 2010 are full of wide sweeping geopolitical changes which will scale out in all of the coming years. In fact, it is unlikely that the majority of the decision makers involved in the « Eurozone coup d’Etat » have clearly understood the implications of their decisions. But no-one has ever said that history was largely made by those people who knew what they were doing.
Countries’ and markets’ IMF contributions (1948-2001) - Source: IMF / Danmarks National Bank - 2001
The United Kingdom: isolated in the face of an historic crisis
One of the simultaneous causes and consequences of this development is the complete marginalization of the United Kingdom. Its increasing weakness since the beginning of the crisis, along with that of its US sponsor, has created the possibility of a complete takeover, without concessions, of the march forward of the European project by the continental countries. This loss of influence reinforces, in return, Great Britain’s marginalization because British leaders are trapped in a denial of reality which they have made their people share as well. None of the British political parties, not even at this point the Liberal Democrats, even though showing greater clarity than the other political parties of the country, could consider reconsidering the decades of diatribe accusing Europe for all the ills and dressing-up the Euro for all the losses. Indeed, even if their leaders were aware of the folly of a strategy consisting of isolating Great Britain a little more day-by-day, even when the world crisis has moved up a gear, they will collide with this public Euroscepticism which they have fostered over the course of the past years. The irony of history was, once again, clearly shown during this historic weekend of the 8th/9th May 2010: in refusing to participate in the Eurozone’s joint defensive and protective measures, the British leaders have, de facto, refused to catch the last lifeline within their grasp (8). The European continent will now content itself with watching them try to find the 200 billion Euros which their country needs to balance this year’s budget (9). And if the leaders in London think that City speculators will have any qualms breaking the Pound sterling and selling Gilts, it is because they haven’t understood the basics of global finance (10), nor checked the nationalities of these same players (11). Between Wall Street, which will do anything to attract the world’s capital (one only needs to ask the Swiss market what it thinks of the war that world markets are currently delivering one another), Washington, which is knocking itself out to hover up all the world’s available savings, and a European continent which has, from now on, placed itself under the protection of a common currency and debt, the dice have been cast. At this stage, we are still in the drama, because the major English players have not yet realised that they are caught in a trap; a few weeks from now, we will move on to the British tragedy because, this summer, the whole country will have discovered the historic trap into which the country, on its own, has fallen.
So, at the moment when Euroland emerges in Brussels, the United Kingdom struggles with a hung parliament, compelling it to move on to the first coalition government since 1945 and which will take the country to a further election between now and the end of the year.
The British and their leaders in trouble, who are going to have to « think the unthinkable »
Whatever the supporters of the coalition now running the country may tell, LEAP/E2020 thinks it highly unlikely that this alliance will last more than a few months. The very different structure of the two parties involved (Conservatives and Liberal Democrats are divided on a number of issues), combined with unpopular decisions, is leading this team straight to internal crises for each party and, then, to a government collapse. The Conservatives will play this card because, unlike the Liberal Democrats, they have sufficient funds to « finance » a new electoral campaign between now and the end of the year (12). But the most dangerous underlying stumbling-block is intellectual: to avoid the tragedy which portends, the United Kingdom is going to have to « think the unthinkable », i.e. reconsider its basic beliefs on its insular outlook, its transatlantic « relationship », its relationship with a continent now on the road to complete integration, while, for centuries, it has thought of the continent as a disunion. However the problem set is simple: if the United Kingdom has always thought that its power depended on a divided European continent, then logically, considering current events, it must now admit that it is heading to a state of impotence... and draw the necessary conclusions, i.e. that it too should make a « quantum leap ». If Nick Clegg seems intellectually equipped to make such a leap, neither David Cameron’s Conservatives, nor the British leaders altogether, seem mature enough yet. In such a case, Great Britain, sadly, must take the « tragic » path (13).
In any case, this weekend of the 8th/9th May 2010 in Europe dips a number of its roots directly into the Second World War and its consequences (14). It is, besides, one of the features of the global systemic crisis as foretold by LEAP/E2020 in February 2006 in issue N°2: it brings to « an end the West as one has known it since 1945 ».
Another of these features is the take-off in the gold price (compared to the US Dollar especially), in the face of the growing distrust in all fiat currencies (see issue N°41, January 2010 (15)). Indeed, whilst all the world speak of the Euro/US Dollar exchange rate, the Dollar remains at its historically lowest levels compared to its major trade partners (see chart below), a sign of the US currency’s structural weakness. In the coming months, as GEAB anticipated, the Euro will climb back to its medium-term equilibrium level of above 1.45/€.
In this issue, before giving our recommendations on currencies, the stock exchange and gold, LEAP/E2020 will analyse in greater detail the US pseudo-recovery which internally is basically a vast focused news operation aimed at re-starting household spending (an impossible task now) and externally at avoiding panicking foreign investors (at best, several quarters can be gained). Thus the United States maintains that it will be able to escape brutal austerity treatment, like the other Western countries, whilst, in fact, the recovery is an « unrecovery » as Michael Panzner, with a touch of humour, called his excellent article of 04/27/2010, published in Seeking Alpha.investors (at best, several quarters can be gained). Thus the United States maintains that it will be able to escape brutal austerity treatment, like the other Western countries, whilst, in fact, the recovery is an « unrecovery » as Michael Panzner, with a touch of humour, called his excellent article of 04/27/2010, published in Seeking Alpha.
Charts and Data
Dysfunctional Markets
Dysfunctional Markets
by Doug Noland May 14, 2010
For the week, the S&P500 rallied 2.2% (up 1.8% y-t-d), and the Dow gained 2.3% (up 1.8%). The S&P 400 Mid-Caps jumped 4.3% (up 8.6%), and the small cap Russell 2000 recovered 6.3% (up 11.0%). The Morgan Stanley Cyclicals jumped 4.4% (up 7.0%), and the Transports gained 4.4% (up 9.5%). The Morgan Stanley Consumer index rose 1.8% (up 3.4%), and the Utilities gained 2.4% (down 3.9%). The Banks jumped 3.1% (up 24.7%), and the Broker/Dealers increased 1.5% (down 1.8%). The Nasdaq100 increased 3.1% (up 2.5%), and the Morgan Stanley High Tech index gained 2.1% (down 2.1%). The Semiconductors rose 2.1% (down 1.7%). The InteractiveWeek Internet index jumped 4.5% (up 4.1%). The Biotechs rallied 3.7%, increasing 2010 gains to 15.3%. With bullion jumping $22, the HUI gold index surged 7.9% (up 13.4%).
One-month Treasury bill rates ended the week at 14 bps and three-month bills closed at 14 bps. Two-year government yields declined 3 bps to 0.72%. Five-year T-note yields fell 3 bps to 2.10%. Ten-year yields increased 3 bps to 3.46%. Long bond yields rose 6 bps to 4.34%. Benchmark Fannie MBS yields declined 7 bps to 4.20%. The spread between 10-year Treasury and benchmark MBS yields narrowed 10 bps to 74 bps. Agency 10-yr debt spreads declined 3 bps to 44 bps. The implied yield on December 2010 eurodollar futures declined 4 bps to 0.855%. The 10-year dollar swap spread declined 1.25 to 3.5. The 30-year swap spread increased 2.25 to negative 18.5. Corporate bond spreads were mixed. An index of investment grade bond spreads narrowed 15 to 103 bps. An index of junk bond spreads widened 27 to 516 bps.
Debt issuance remained slow. Investment grade issuers included Enterprise Products $2.0bn, Morgan Stanley $1.75bn, Citigroup $1.5bn, CVS Caremark $1.0bn, Kinder Morgan $1.0bn, Burlington Northern $750 million, XCEL Energy $550 million, PNC Funding $500 million, Pearson Funding $350 million, Cigna $300 million, FPL Group $250 million, and San Diego G&E $250 million.
May 14 – Bloomberg (Shiyin Chen): “High-yield bond funds posted the largest outflows in five years and emerging-market equity funds had a second straight week of redemptions as Europe’s sovereign- debt crisis dented demand for riskier assets, EPFR Global said.”
Junk issuers included Mylan $1.25bn, MCE Finance $600 million, Omnicare $400 million, Wireco Worldgroup $275 million and Kratos $225 million.
I saw no converts issued.
International dollar debt sales included Inter-American Development Bank $1.0bn, Metinvest $500 million, Kazatomprom $500 million, and Renhe Commercial $300 million.
U.K. 10-year gilt yields declined 6 bps to 3.75%, while German bund yields rose 6 bps to 2.86%. Greek bond yields collapsed 470 bps to 7.70%, and 10-year Portuguese yields dropped 163 bps to 4.63%. The German DAX equities index rallied 6.0% (up 1.7% y-t-d). Japanese 10-year "JGB" yields rose 3 bps to 1.30%. The Nikkei 225 recovered 0.9% (down 0.8%). Emerging markets recovered some of last week's decline. For the week, Brazil's Bovespa equities index gained 0.9% (down 7.5%), and Mexico's Bolsa rose 1.0% (down 1.0%). Russia’s RTS equities index gained 4.8% (down 0.6%). India’s Sensex equities index gained 1.3% (down 2.7%). China’s Shanghai Exchange added 0.3% (down 17.7%). Brazil’s benchmark dollar bond yields dropped 17 bps to 4.83%, and Mexico's benchmark bond yields sank 43 bps to 4.78%.
Freddie Mac 30-year fixed mortgage rates dropped 7 bps last week to 4.93% (up 7bps y-o-y). Fifteen-year fixed rates fell 6 bps to 4.30% (down 22bps y-o-y). One-year ARMs declined 5 bps to 4.02% (down 69bps y-o-y). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed jumbo rates down 15 bps to 5.63% (down 64bps y-o-y).
Federal Reserve Credit dipped $1.2bn last week to $2.310 TN. Fed Credit was up $90.3bn y-t-d (11.1% annualized) and $193.7bn, or 9.2%, from a year ago. Elsewhere, Fed Foreign Holdings of Treasury, Agency Debt this past week (ended 5/12) declined $11.8bn to $3.064 TN. "Custody holdings" have increased $108bn y-t-d (10.0% annualized), with a one-year rise of $380bn, or 14.2%.
M2 (narrow) "money" supply was up $34.3bn to $8.504 TN (week of 5/3). Narrow "money" has declined $8.1bn y-t-d. Over the past year, M2 grew 1.4%. For the week, Currency added $0.8bn, and Demand & Checkable Deposits surged $40.7bn. Savings Deposits declined $4.0bn, and Small Denominated Deposits fell $5.0bn. Retail Money Fund assets added $1.9bn.
Total Money Market Fund assets (from Invest Co Inst) jumped $24.2bn to $2.878 TN, the first rise since February. In the first 19 weeks of the year, money fund assets have dropped $416bn, with a one-year decline of $912bn, or 24.1%.
Total Commercial Paper outstanding added $0.9bn last week to $1.103 TN. CP has declined 67$bn, or 15.7% annualized, year-to-date, and was down $195bn from a year ago (15%).
International reserve assets (excluding gold) - as tallied by Bloomberg’s Alex Tanzi – were up $1.297 TN y-o-y, or 19.4%, to a record $7.986 TN.
Global Credit Market Watch:
May 12 – Bloomberg (Tim Catts and Pierre Paulden): “Europe’s sovereign debt crisis is punishing corporate borrowers, with bond issuance tumbling as investors doubt a $1 trillion bailout plan will be enough to bolster confidence in government finances for the region. Borrowers worldwide have sold $15 billion of corporate debt this month, a 62% decline from the same period in April and 83% less than the average for the past year… The extra yield investors demand to own corporate debt instead of government bonds soared last week to the highest in more than four months… ‘This is a fix and not a resolution,’ said Jason Brady, a managing director at Thornburg Investment Management… ‘Investors have seen volatility and that makes it harder to get excited about longer-dated assets paying a fixed return.’”
May 11 – International Herald Tribune (Andrew E. Kramer): “As the financial markets try to absorb news of a rescue package for Greece and other teetering euro-zone countries, some bankers and economists see parallels to Russia’s meltdown in 1998. A decade ago Russia was walking in the same shoes as Greece is today, striving to restore confidence in government bonds by seeking a huge loan from the International Monetary Fund and other lenders. Then, as now, the debt crisis was roiling global financial markets. And big hopes were pinned on a bailout — one that in Russia’s case did not work. ‘Greece creates a remarkable sense of déjà vu,’ Roland Nash, the head of research for Renaissance Capital, an investment bank in Moscow, wrote…”
May 11 – Finanacial Times (David Oakley and Ralph Atkins): “Investors on Tuesday warned that the European Central Bank would have to introduce quantitative easing to stave off the worst crisis in the eurozone since it was launched 11 years ago. The ECB has resisted following the Bank of England and the US Federal Reserve in expanding the money supply by buying government bonds because it fears that it could stoke inflation. Although eurozone central banks bought eurozone government bonds this week for the first time as part of the international rescue plan, this is not QE as the ECB is funding this by selling German bunds or using commercial bank deposits.”
May 11- New York Times (Landon Thomas Jr. and Jack Ewing): “Like the giant financial bailout announced by the United States in 2008, the sweeping rescue package announced by Europe eased fears of a market collapse but left a big question: will it work long term? Stung by criticism that it was slow and weak, the European Union surpassed expectations in arranging a nearly $1 trillion financial commitment for its ailing members over the weekend and paved the way for the European Central Bank to begin purchases of European debt on Monday... The premium that investors had been demanding to buy Greek bonds plunged… And as details crystallized of the package’s main component — a promise by the European Union’s member states to back 440 billion euros, or $560 billion, in new loans to bail out European economies — the wisdom of solving a debt crisis by taking on more debt was challenged by some analysts. ‘Lending more money to already overborrowed governments does not solve their problems,’ Carl Weinberg, chief economist of High Frequency Economics…said…"
May 12 – Bloomberg (Tim Catts and Pierre Paulden): “Europe’s sovereign debt crisis is punishing corporate borrowers, with bond issuance tumbling as investors doubt a $1 trillion bailout plan will be enough to bolster confidence in government finances for the region. Borrowers worldwide have sold $15 billion of corporate debt this month, a 62% decline from the same period in April and 83% less than the average for the past year…”
May 14 – Wall Street Journal (Ianthe Jeanne Dugan): “Federal regulators and state officials are examining Wall Street's role in trading derivatives that essentially bet the municipal bonds they sold would go bust. The Securities and Exchange Commission has launched a preliminary inquiry into banks' trades of municipal credit-default swaps that allow investors to short-sell, or bet against, municipal bonds… The probe is exploring potential conflicts of interest by banks that sell municipal bonds and then poise themselves to profit if those bonds fail, these people said. A main thrust of their investigation is whether firms use their own money to bet against the bonds they sell and, if so, whether that activity is properly disclosed to bond buyers.”
May 14 – Bloomberg (Christine Harper): “Goldman Sachs… is ceasing proprietary trading in one type of structured debt… A group of traders who were focused on making bets on collateralized loan obligations with the New York-based firm’s own money are now handling trades for clients…”
May 12 – Bloomberg (Takahiko Hyuga and Finbarr Flynn): “Morgan Stanley Chief Executive Officer James Gorman denied allegations the U.S. bank misled investors about mortgage derivatives it sold them. The firm is being probed by U.S. prosecutors over whether the bank misled clients when it sold them collateralized debt obligations as its own traders bet that the value of the securities would drop… Wall Street firms are facing unprecedented scrutiny from lawmakers and prosecutors over whether they missold CDOs linked to the subprime mortgages that caused the credit crisis.”
Global Government Finance Bubble Watch:
May 12 – Bloomberg (Abigail Moses and John Glover): “The cost of saving the world from financial meltdown has been bloated by ‘hyperinflation’ since Long Term Capital Management LP’s rescue in 1998… rising price of bailouts since the $3.5 billion pledged to hedge fund LTCM after it was crushed by Russia’s default, and the almost $1 trillion committed to halt the European Union’s sovereign debt crisis this week. It cost just $29 billion to sooth markets in March 2008 when Bear Stearns Cos. was taken over, and $700 billion for the Federal Reserve to save the banking system with the Troubled Asset Relief Program in October that year. ‘We haven’t had any kind of normal inflation in the last decade, but we’ve had hyperinflation in writedowns and the magnitude of bailouts,’ said Jim Reid, head of fundamental strategy at Deutsche Bank… ‘You have to do more to get a similar effect every time.’”
May 12 – Bloomberg (David Mildenberg and Dawn Kopecki): “Four of the largest U.S. banks, including Citigroup Inc., racked up perfect quarters in their trading businesses between January and March, underscoring how government support and less competition is fueling Wall Street’s revival. Bank of America Corp., JPMorgan Chase & Co. and Goldman Sachs Group Inc., the first, second and fifth-biggest U.S. banks by assets, all said in regulatory filings that they had zero days of trading losses in the first quarter… ‘The trading profits of the Street is just another way of measuring the subsidy the Fed is giving to the banks,’ said Christopher Whalen, managing director… Institutional Risk Analytics. ‘It’s a transfer from savers to banks.’
Currency Watch:
The dollar index jumped 2.1% this week to 86.249 (up 10.8% y-t-d). For the week on the upside, the South Korean won increased 2.2%, the Mexican peso 2.1%, the Brazilian real 2.0%, the South African rand 1.3%, the Canadian dollar 1.1%, and the Singapore dollar 0.6%. For the week on the downside, the euro declined 3.1%, the Danish krone 3.0%, the Swiss franc 2.2%, the British pound 1.8%, the Swedish krona 1.35, the New Zealand dollar 1.1%, the Japanese yen 0.9%, the Norwegian krone 0.3%, and the Australian dollar 0.2%.
Commodities Watch:
May 12 – Bloomberg (Stuart Wallace): “There has been a ‘significant’ surge in sales of gold coins and bars, particularly in Germany, Ross Norman, one of the founders of TheBullionDesk.com, said… ‘The last time we saw this level of grass-roots activity was in October 2008 when the economy was on the brink and the retail gold buying community effectively drained gold from the market,” the former bullion dealer said in the report.”
May 10 – Financial Times (Jack Farchy): “Silk ties and handkerchiefs are forecast to rise in price after the cost of silk jumped to its highest level in at least 15 years as rapid industrialisation in China, the world’s largest supplier, robs the sector of valuable farmland. The price of silk cocoons… has doubled since the start of 2009…”
The CRB index declined another 1.1% (down 8.8% y-t-d). The Goldman Sachs Commodities Index (GSCI) slipped 0.4% (down 4.4% y-t-d). Spot Gold jumped 1.8% to $1,230 (up 12.1% y-t-d). Silver surged 4.6% to $19.30 (up 14.6% y-t-d). June Crude sank $3.18 to $71.93 (down 9.4% y-t-d). June Gasoline 0.6% (up 4% y-t-d), and June Natural Gas jumped 7.7% (down 22% y-t-d). July Copper declined 0.8% (down 7% y-t-d). May Wheat sank 7.3% (down 14% y-t-d), and May Corn declined 2.2% (down 14% y-t-d).
China Bubble Watch:
May 11 – Wall Street Journal Asia: “The direction of China’s economy is set. The question troubling investors is whether policy makers have set their course, too. With consumer-price inflation rising to 2.8% in April, real interest rates have moved farther into negative territory… More inflation is in the pipeline. The producer-price index rose 6.8% year-to-year in April, up from 5.9% in March. Higher manufacturing costs should eventually feed through to consumers. The latest housing-market data adds to fears of overheating, with prices up 12.8% year-to-year across 70 of China's larger cities. New bank lending was up, too, with $113.3 billion more loans pumped into the economy in April -- back to around the average monthly level during 2009's credit bonanza. Against this backdrop, Beijing's tightening measures to date are inadequate.”
May 13 – Bloomberg (Peter Woodifield): “China is set to overtake Japan as the largest Asia-Pacific commercial real estate market next year following a surge in values, according to property adviser DTZ Holdings Plc.”
India Watch:
May 13 – Bloomberg (Unni Krishnan): “India’s food inflation rate climbed… An index measuring wholesale prices of agriculture products… rose 16.44% in the week ended May 1 from a year earlier…”
May 12 – Bloomberg (Kartik Goyal): “India’s industrial production grew more than 10% for a sixth straight month, adding to inflation pressures even as Europe’s debt crisis threatens to undermine the global economic recovery.
Asia Bubble Watch:
May 12 – Bloomberg (David Yong): “Asian interest-rate swaps show traders are betting central banks will be less aggressive in raising borrowing costs because of the European Union’s sovereign-debt crisis. ‘The euro crisis has hurt market confidence and liquidity,’ Matthew Huang, an interest-rate strategist… at Barclays Capital Plc, said… ‘If liquidity freezes up, Asian policy makers will likely choose to leave monetary conditions looser for longer.’”
May 10 – Wall Street Journal Asia (Alex Frangos): “The European bailout plan could be too much medicine for an overheating Asia. Before the Greece crisis intensified last week, policy makers in China and elsewhere in Asia said too much growth and an abundance of capital inflows were pushing real-estate and other asset prices dangerously high. While Asian markets welcomed the 750 billion euro ($955 billion) bailout plan, economists and analysts warned that the rescue package could end up bringing even more capital to Asian markets… Loose monetary policy in Europe and the U.S. has already helped to inflate assets prices in Asia, especially for emerging-market bonds and real estate.”
May 12 – Bloomberg (Eunkyung Seo): “South Korea’s unemployment rate declined in April for a third straight month… The jobless rate fell to 3.7% from 3.8% in March… ‘Jobs market conditions are improving on the economic recovery,’ Lee Sang Jae, an economist at Hyundai Securities... said… ‘But there remains some weakness, supporting policy makers’ views that the economy isn’t strong enough to endure higher borrowing costs.’”
May 13 – Bloomberg (Shamim Adam and Manirajan Ramasamy): “Malaysia’s economy grew at the fastest pace in at least 10 years last quarter… Gross domestic product increased 10.1% in the three months ended March 31 from a year earlier…”
Latin America Bubble Watch:
May 12 – Bloomberg (Jens Erik Gould): “Mexico’s industrial production rose the most in almost four years in March on surging demand for exports to the U.S. Output climbed 7.6% from a year earlier…”
May 12 – Bloomberg (Fabiola Moura and Drew Benson): “Argentine Economy Minister Amado Boudou said last week’s jump in bond yields may prompt the government to shelve plans to sell as much as $1 billion of bonds, its first international offer since defaulting in 2001.”
Unbalanced Global Economy Watch:
May 10 – Bloomberg (Bob Willis and Thomas R. Keene): “The fallout from the European debt crisis raises the risk of a ‘double dip’ recession for the global economy, said Stephen Roach, chairman of Morgan Stanley Asia Ltd. ‘When you have a vulnerable post-crisis economic recovery and crises reverberating in the aftermath of that, you have some very serious risks to the global business cycle,’ Roach said… ‘This concept of the global double dip which no one wants to talk about… is alive and well.’”
May 12 – Bloomberg (Svenja O’Donnell): “U.K. unemployment climbed to a 16- year high in the first quarter, underlining the fragility of the recovery as Conservative David Cameron begins his premiership.”
May 12 – Bloomberg (Simone Meier): “Europe’s economy expanded at a faster pace than economists forecast in the first quarter as a global recovery boosted exports… Gross domestic product in the 16 euro nations rose 0.2% from the fourth quarter…”
May 12 – Bloomberg (Christian Vits): “Germany’s economy unexpectedly grew in the first three months of the year as rising exports and company investment outweighed the effects of the cold winter. Gross domestic product… rose 0.2%..."
May 12 – Bloomberg (Maria Levitov): “Russia faces a ‘massive’ capital influx as investors look for alternatives to Europe’s crisis- ridden debt markets, said Mikhail Dmitriev, president of the Center for Strategic Development. That’s putting pressure on Russian policy makers to implement capital controls soon to stem the flows and avoid ruble volatility, Dmitriev, whose think tank conducts research for the government, said in an interview… ‘The government is unarmed against the distortions that may result from massive capital inflows,’ said Dmitriev, who is also a former First Deputy Economy Minister. ‘Russia’s balance of payments and internal macroeconomic stability would undoubtedly be at risk.’”
May 14 – Bloomberg (Paul Abelsky): “Russia’s economy expanded for the first time since 2008… Gross domestic product rose an annual 2.9% in the first quarter after contracting 3.8% in the last three months of 2009…”
May 13 – Bloomberg (Jacob Greber): “Australia’s job growth accelerated in April, propelled by full-time employment… The unemployment rate held at 5.4%.”
May 13 – Bloomberg (Tracy Withers): “New Zealand’s manufacturing industry expanded at the fastest pace in more than five years in April amid rising production and orders.”
U.S. Bubble Economy Watch:
May 12 – Bloomberg (Shobhana Chandra): “The trade deficit in the U.S. widened in March to the highest level in more than a year as imports climbed faster than exports, adding to evidence of the global recovery from the worst recession in the post-World War II era. The gap grew 2.5% to $40.4 billion…”
May 13 – Bloomberg (Ryan J. Donmoyer): “White House budget director Peter Orszag predicted Congress would approve higher taxes on managers of private equity firms, real estate funds and other investment partnerships in the coming weeks. Orszag, speaking yesterday…”
May 10 – Bloomberg (Terrence Dopp): “New Jersey’s Democratic lawmakers plan to introduce legislation to resurrect an income-tax surcharge on residents who earn $1 million a year or more…”
Derivatives Watch:
May 11 – Bloomberg (Phil Mattingly): “The Federal Deposit Insurance Corp. advanced a proposal aimed at overhauling part of the $4 trillion asset-backed securities market and introduced a rule that would require the biggest U.S. banks to submit ‘funeral plans’ to handle their possible collapse… ‘Now is the time to put some prudent controls in place to make sure we don’t get into some of the problems we saw in the past,’ Bair said…
Real Estate Watch:
May 13 – Bloomberg Dan Levy): “U.S. home repossessions rose to a record level in April while foreclosure filings dropped in a sign mortgage lenders are working off a backlog of seized properties, according to RealtyTrac… ‘Right now it appears that the banks are focusing on processing the loans already in foreclosure, and slowing down the initiation of new foreclosure proceedings as a way of managing inventory levels,’ Rick Sharga, RealtyTrac’s executive vice president, said… A record 92,432 bank repossessions were reported in April, up 45% from a year earlier…”
Central Bank Watch:
May 13 – DPA: “The European Central Bank (ECB) on Thursday defended its decision to intervene in European bond markets, rejecting claims that this threatened the bank’s independence. ‘These measures are designed not to affect the monetary policy stance,’ the ECB wrote in its monthly report of its decision to buy debt from troubled eurozone members. ECB chief economist Juergen Stark said this was a ‘temporary emergency measure,’ to which there was no alternative after the euro currency had come under attack. Stark said the bank was not responding to political pressures… ‘The credibility of the ECB does not just hinge on the question whether or not we buy government securities, but whether we fulfill our central task, which is ensuring price stability,’ Stark said. The economist said there was no doubt that ‘an attack’ on individual eurozone countries was being carried out by "anonymous market sources.’”
May 10 – Bloomberg (Mayumi Otsuma): “Central banks from the U.S., Japan and Europe will participate in temporary U.S. dollar swap agreements amid heightened tension in global financial markets, the Bank of Japan said. ‘In response to the re-emergence of strains in U.S. dollar short-term funding markets in Europe’ the central banks of Canada, England and Switzerland will also participate in the re- establishment of currency swaps that were implemented during the financial crisis, the BOJ said… ‘These facilities are designed to help improve liquidity conditions in U.S. dollar funding markets and to prevent the spread of strains to other markets and financial centers.’ Central banks ‘will continue to work together closely as needed to address pressures in funding markets’ the BOJ said.”
May 10 – Bloomberg (Saburo Funabiki): “The Bank of Japan said it would pump 2 trillion yen ($21.7bn) into the financial system for a second day to help reassure markets after the Greek fiscal crisis set off a slump in stocks worldwide.”
GSE Watch:
May 10 – Bloomberg (Nick Timiraos): “Fannie Mae asked the U.S. government for an additional $8.4 billion in aid after posting an $11.5 billion net loss for the first quarter, the latest sign that the bailout of the mortgage investor and its main rival, Freddie Mac, is likely to be the most expensive legacy of the U.S. housing-market bust… The company has now racked up losses of nearly $145 billion, or nearly double its profits for the previous 35 years.”
Fiscal Watch:
May 13 – Bloomberg (Vincent Del Giudice): “The U.S. posted its largest April budget deficit on record as receipts declined in a month that typically sees an increase in individual income tax payments. The excess of spending over revenue rose to $82.7 billion last month compared with a $20.9 billion gap in April 2009… April marked a record 19th straight monthly shortfall… Deterioration in the government’s balance sheet in coming years raises the risk of higher interest rates even as an improving economy helps lift tax receipts. ‘With the recovery in place, we should be seeing higher revenue and lower outlays, not the other way around,’ said Win Thin, senior currency strategist at Brown Brothers Harriman… The government’s April budget deficit compares with a median forecast of $57.9 billion… The last time the U.S. had back-to-back April deficits was 1963-1964… For the fiscal year that began in October, the budget deficit totaled $799.7 billion compared with $802.3 billion during the same period last year.”
May 12 – Associated Press: “President Obama’s new health-care law could potentially add at least $115 billion more to government health care spending over the next 10 years, if Congress approves all the additional spending called for in the legislation, congressional budget referees said… That would push the 10-year cost of the overhaul above $1 trillion…”
California Watch:
May 11 – Bloomberg (Michael B. Marois and William Selway): “California Governor Arnold Schwarzenegger will seek ‘terrible cuts’ to eliminate an $18.6 billion budget deficit facing the most-populous U.S. state through June 2011… California’s revenue in April, when income-tax payments are due, trailed the governor’s estimates by $3.6 billion, or 26%.”
May 14 – Bloomberg (Michael B. Marois and William Selway): “California Governor Arnold Schwarzenegger proposed a new round of budget cuts, including eliminating the state’s main welfare program for families, to close a $19.1 billion budget deficit for the year starting July 1. The $83.4 billion plan calls for $12.4 billion in spending reductions, $3.4 billion in additional federal aid and $3.4 billion in fund shifts, fees and assessments…”
Speculator Watch:
May 14 – Bloomberg (Jody Shenn and Michael J. Moore): “In June 2006, a year before the subprime mortgage market collapsed, Morgan Stanley created a cluster of investments doomed to fail even if default rates stayed low -- then bet against its concoction. Known as the Baldwin deals, the $167 million of synthetic collateralized debt obligations had an unusual feature… Rather than curtailing their bets on mortgage bonds as the underlying home loans paid down, the CDOs kept wagering as if the risk hadn’t changed. That left Baldwin investors facing losses on a modest rise in U.S. housing foreclosures, while Morgan Stanley was positioned to gain. ‘I can’t imagine anybody would take that bet knowingly,’ said Thomas Adams, a former executive at bond insurers Ambac Financial Group Inc. and FGIC Corp… ‘You’re overriding the natural process of risk-mitigation.’”
May 12 – Bloomberg (Tomoko Yamazaki and Komaki Ito): “Japanese hedge funds, the world’s worst performers last year, returned 6.7% in the first four months of 2010, the best year-to-April return in six years, according to Eurekahedge Pte.”
Dysfunctional Markets:
It scrolled by quickly Wednesday afternoon on my Bloomberg screen: a one-line headline quoting ECB Executive Board member Jose Manuel Gonzalez-Paramo: “Central Banks Can’t Work if Markets Dysfunctional.” My efforts to located Mr. Gonzalez-Paramo’s full comments on the issue were unsuccessful; we’ll have to assume the context. I do believe strongly that many things these days can’t work because global markets are hopelessly dysfunctional.
I was never a big fan of the simplistic analytical fixation on the so-called “shadow banking system.” Key components of this “system” – i.e. the Wall Street securities firms, ABS, CDOs, SIVs, private-label MBS, etc. – have been reined in. This would imply a more stable financial backdrop, which is nowhere to been seen. I am similarly not a subscriber to a “new normal” thesis. Again, the focus seems to detract from today’s key issues. I have posited a “Newest Abnormal” thesis – that the long process of market distortions and economic imbalances has actually accelerated. Things go from bad to only worse. Things may look somewhat different, but there’s nothing new.
From my analytical perspective, the heart of the problem lies with this dysfunctional dynamic between global marketable debt and derivatives, policy-induced distortions, and unfettered speculative finance. Unique in history, we continue to operate with a global financial “system” functioning without limits to either the quantity or quality of new Credit created. There’s way too much Credit backed by little more than government assurances or perceptions of government insurance. And never before has an enormous global “leveraged speculating community” so dominated the markets for debt instruments and, in the process, so relied on faith in the efficacy of government market interventions. It’s global wildcat banking in its purest ever form.
These days, entities all over the world issue enormous quantities of tradable debt instruments. This debt, in large part, is purchased by sophisticated market operators earning unimaginable compensation for achieving “above market” returns. When market psychology is bullish, there is essentially unlimited demand for marketable debt – a significant portion acquired through the use of leverage. And as long as demand for new marketable securities remains robust, underlying positive fundamentals appear to support a high market valuation for this debt (irrespective of the quantity issued) - and the party lives on. But Katy bar the door whenever the crowd moves to cut exposure – either through liquidating positions or acquiring market “insurance.”
Eurozone policymakers look foolish these days for not having reined in profligate Greek borrowing and spending. To many, the ECB looks foolish for Sunday’s decision to purchase in the open market debt issued by Greece, Portugal, Spain and other troubled European countries. Others believe the ECB was foolish for not having had initiated a Federal Reserve-style monetization plan long before the debt crisis spiraled out of control. I sympathize with the ECB. Dysfunctional global markets placed them in a winless situation. Greek 10-year bond yields were below 5% for much of 2009. The market was happy to accommodate profligacy - until it wasn’t. If only well-functioning global markets disciplined borrowers rather than emboldening them.
The sea change in global finance gained unstoppable momentum in the early nineties. The Greenspan Federal Reserve nurtured marketable debt as a mechanism to help overcome severe banking system impairment. There was no stopping the historic boom in market-based Credit once unleashed. The problem was clear by the time of the 1994 bond and mortgage securities dislocation. But it was politically and monetarily expedient to allow GSE Credit (with its implicit government guarantee) to evolve into a mechanism for stabilizing the Credit system and spurring economic expansion.
The rapidly escalating scope of the problem was illuminated with the collapse of LTCM. Yet, the Greenspan Fed supported this new financial infrastructure with only more powerful words and deeds. Pegging short term interest rates and aggressively intervening to rectify market tumult incited unprecedented leveraged speculation throughout the Credit system. Dr. Bernanke’s 2002 “helicopter money” and “government printing press” speeches sealed the fate of runaway Bubbles in both marketable debt and leveraged speculation.
Especially during the Bubble years 2004 through 2007, massive U.S. current account deficits worked to unleash U.S. Credit Bubble dynamics upon the entire world. The more Bubbles became ingrained in the financial architecture the deeper market perceptions became that policymakers wouldn’t tolerate a bust. Worse yet, policymakers resorted to using the debt markets and the market’s propensity for leveraged speculation as mechanisms for increasingly aggressive monetary reflation.
Global policymakers and Credit markets have been fueling Bubbles and accommodating profligacy for years now. It would have taken a concerted effort by global central bankers to rein things in. The Greenspan/Bernanke Federal Reserve would have had no part of it. Quite the contrary. It was fundamental to Greenspan/Bernanke doctrine to deal with market and economic fragility through the aggressive reflation of system Credit. This doctrine of inflationism was instrumental in nurturing Credit and speculation excesses that worked over time to increasingly distort the pricing of finance, the quantity of Credit created, and the allocation of real and financial resources. The ECB’s big mistake was not to have forcefully fought the Fed.
We’re now two years into the greatest expansion of global government debt in the history of mankind. Manic-depressive debt markets have now pulled the rug out from under Greece and periphery Europe, but in the process have further accommodated profligate government borrowings here at home. It is frightening to think of how distorted the Treasury market has become - and how things might play out down the road.
My bearish thesis on our markets and economy is based upon the view that the financial fuel for our recovery has been unsound, unstable and unsustainable. This “Monetary Process” is now in jeopardy. The Global Government Finance Bubble, which lunged into its terminal phase of excess with the collapse of the Wall Street/mortgage finance Bubble, has been pierced. Greece’s debt crisis marks a momentous inflection point. And, yes, some government markets – certainly including Treasuries – are benefiting from Greek and periphery European debt woes. Yet key Bubble dynamics percolate under the surface.
I have argued that the Global Government Finance Bubble has been the biggest and most precarious Bubble yet. The incredible scope of global sovereign debt expansion over the past couple years has been rather obvious. Less apparent are related distortions - to the pricing and allocation of finance throughout international markets - based specifically upon the market's perception that politicians and central bankers would act aggressively and successfully to forestall future crises. This policy-induced market distortion fostered an incredible bout of risk-taking – especially considering the fundamental backdrop – and a resulting massive flood of finance out to the risk markets. This perception has been blown to smithereens in Europe and has quickly become vulnerable everywhere.
Global markets in sovereign Credit default swap (CDS) protection have flourished on the assumption that policymakers would thwart any debt crisis. In the post-Greek debacle era, writing insurance against a government default is no longer free money. New realities have profoundly changed the risk and reward profiles of operating in this key market - and I’ll assume some profoundly less attractive marketplace liquidity dynamics going forward. And a faltering market for sovereign debt insurance significantly changes the risk profile of owning the underlying sovereign debt. To be sure, changing perceptions in the market for government debt work to corrode market confidence in the capacity of policymakers to stem financial and economic crises generally. This implies a major adjustment in the markets’ perception of risk in various markets, including corporate, municipal and mortgage instruments.
But I’m getting somewhat ahead of myself. Thus far, dislocation in Greek debt has fed powerful contagion effects throughout European debt and CDS. This has forced a major market reassessment of the relative stability of the euro currency, which has unleashed bloody havoc throughout the currency and “carry trade” arena. Currency and “carry trade” tumult has forced market reassessment as to near-term prospects for both the dollar (upward) and global growth (downward). This has caused trading liquidation and de-leveraging havoc in the enormous global “reflation trade” and in risk markets more generally. And there’s nothing like liquidation and forced de-leveraging to really bring out the animal spirits for those seeking to make nice speculative profits from others’ misfortune.
The dollar and Treasuries have benefited. This has supported the bullish view that the unfolding crisis is largely a European issue. It has also helped dampen the impact to our markets from changing global perceptions with respect to the capacity of policymakers to stem crises. Here in the U.S., Credit spreads and risk premiums (corporates, MBS, municipals, etc.) have widened some. Yet faith still runs deep that Washington won’t allow a crisis. This confidence must hold for sufficiently loose U.S. finance to continue to support our fragile recovery.
The confluence of global financial crisis and intense financial sector scrutiny here at home will at some point prove confidence in Washington overly optimistic. For now, when it comes to pricing risk and disciplining profligate borrowers, our debt markets remain dysfunctional.
This has caused liquidation and de-leveraging havoc in the enormous global “reflation trade” and in risk markets more generally. And there’s nothing like liquidation and forced de-leveraging to really bring out the animal spirits for those seeking to make nice speculative profits from others’ misfortune.
The dollar and Treasuries have benefited. This has supported the bullish view that the unfolding crisis is largely a European issue. It has also helped dampen the impact to our markets from changing global perceptions with respect to the capacity of policymakers to stem crises. Here in the U.S., Credit spreads and risk premiums (corporates, MBS, municipals, etc.) have widened some. Yet faith still runs deep that Washington won’t allow a crisis. This confidence must hold for sufficiently loose U.S. finance to continue to support our fragile recovery.
The confluence of global financial crisis and intense financial sector scrutiny here at home will at some point prove confidence in Washington overly optimistic. For now, when it comes to pricing risk and disciplining profligate borrowers, our debt markets remain dysfunctional.
http://prudentbear.com/index.php/creditbubblebulletinview?art_id=10376
by Doug Noland May 14, 2010
For the week, the S&P500 rallied 2.2% (up 1.8% y-t-d), and the Dow gained 2.3% (up 1.8%). The S&P 400 Mid-Caps jumped 4.3% (up 8.6%), and the small cap Russell 2000 recovered 6.3% (up 11.0%). The Morgan Stanley Cyclicals jumped 4.4% (up 7.0%), and the Transports gained 4.4% (up 9.5%). The Morgan Stanley Consumer index rose 1.8% (up 3.4%), and the Utilities gained 2.4% (down 3.9%). The Banks jumped 3.1% (up 24.7%), and the Broker/Dealers increased 1.5% (down 1.8%). The Nasdaq100 increased 3.1% (up 2.5%), and the Morgan Stanley High Tech index gained 2.1% (down 2.1%). The Semiconductors rose 2.1% (down 1.7%). The InteractiveWeek Internet index jumped 4.5% (up 4.1%). The Biotechs rallied 3.7%, increasing 2010 gains to 15.3%. With bullion jumping $22, the HUI gold index surged 7.9% (up 13.4%).
One-month Treasury bill rates ended the week at 14 bps and three-month bills closed at 14 bps. Two-year government yields declined 3 bps to 0.72%. Five-year T-note yields fell 3 bps to 2.10%. Ten-year yields increased 3 bps to 3.46%. Long bond yields rose 6 bps to 4.34%. Benchmark Fannie MBS yields declined 7 bps to 4.20%. The spread between 10-year Treasury and benchmark MBS yields narrowed 10 bps to 74 bps. Agency 10-yr debt spreads declined 3 bps to 44 bps. The implied yield on December 2010 eurodollar futures declined 4 bps to 0.855%. The 10-year dollar swap spread declined 1.25 to 3.5. The 30-year swap spread increased 2.25 to negative 18.5. Corporate bond spreads were mixed. An index of investment grade bond spreads narrowed 15 to 103 bps. An index of junk bond spreads widened 27 to 516 bps.
Debt issuance remained slow. Investment grade issuers included Enterprise Products $2.0bn, Morgan Stanley $1.75bn, Citigroup $1.5bn, CVS Caremark $1.0bn, Kinder Morgan $1.0bn, Burlington Northern $750 million, XCEL Energy $550 million, PNC Funding $500 million, Pearson Funding $350 million, Cigna $300 million, FPL Group $250 million, and San Diego G&E $250 million.
May 14 – Bloomberg (Shiyin Chen): “High-yield bond funds posted the largest outflows in five years and emerging-market equity funds had a second straight week of redemptions as Europe’s sovereign- debt crisis dented demand for riskier assets, EPFR Global said.”
Junk issuers included Mylan $1.25bn, MCE Finance $600 million, Omnicare $400 million, Wireco Worldgroup $275 million and Kratos $225 million.
I saw no converts issued.
International dollar debt sales included Inter-American Development Bank $1.0bn, Metinvest $500 million, Kazatomprom $500 million, and Renhe Commercial $300 million.
U.K. 10-year gilt yields declined 6 bps to 3.75%, while German bund yields rose 6 bps to 2.86%. Greek bond yields collapsed 470 bps to 7.70%, and 10-year Portuguese yields dropped 163 bps to 4.63%. The German DAX equities index rallied 6.0% (up 1.7% y-t-d). Japanese 10-year "JGB" yields rose 3 bps to 1.30%. The Nikkei 225 recovered 0.9% (down 0.8%). Emerging markets recovered some of last week's decline. For the week, Brazil's Bovespa equities index gained 0.9% (down 7.5%), and Mexico's Bolsa rose 1.0% (down 1.0%). Russia’s RTS equities index gained 4.8% (down 0.6%). India’s Sensex equities index gained 1.3% (down 2.7%). China’s Shanghai Exchange added 0.3% (down 17.7%). Brazil’s benchmark dollar bond yields dropped 17 bps to 4.83%, and Mexico's benchmark bond yields sank 43 bps to 4.78%.
Freddie Mac 30-year fixed mortgage rates dropped 7 bps last week to 4.93% (up 7bps y-o-y). Fifteen-year fixed rates fell 6 bps to 4.30% (down 22bps y-o-y). One-year ARMs declined 5 bps to 4.02% (down 69bps y-o-y). Bankrate's survey of jumbo mortgage borrowing costs had 30-yr fixed jumbo rates down 15 bps to 5.63% (down 64bps y-o-y).
Federal Reserve Credit dipped $1.2bn last week to $2.310 TN. Fed Credit was up $90.3bn y-t-d (11.1% annualized) and $193.7bn, or 9.2%, from a year ago. Elsewhere, Fed Foreign Holdings of Treasury, Agency Debt this past week (ended 5/12) declined $11.8bn to $3.064 TN. "Custody holdings" have increased $108bn y-t-d (10.0% annualized), with a one-year rise of $380bn, or 14.2%.
M2 (narrow) "money" supply was up $34.3bn to $8.504 TN (week of 5/3). Narrow "money" has declined $8.1bn y-t-d. Over the past year, M2 grew 1.4%. For the week, Currency added $0.8bn, and Demand & Checkable Deposits surged $40.7bn. Savings Deposits declined $4.0bn, and Small Denominated Deposits fell $5.0bn. Retail Money Fund assets added $1.9bn.
Total Money Market Fund assets (from Invest Co Inst) jumped $24.2bn to $2.878 TN, the first rise since February. In the first 19 weeks of the year, money fund assets have dropped $416bn, with a one-year decline of $912bn, or 24.1%.
Total Commercial Paper outstanding added $0.9bn last week to $1.103 TN. CP has declined 67$bn, or 15.7% annualized, year-to-date, and was down $195bn from a year ago (15%).
International reserve assets (excluding gold) - as tallied by Bloomberg’s Alex Tanzi – were up $1.297 TN y-o-y, or 19.4%, to a record $7.986 TN.
Global Credit Market Watch:
May 12 – Bloomberg (Tim Catts and Pierre Paulden): “Europe’s sovereign debt crisis is punishing corporate borrowers, with bond issuance tumbling as investors doubt a $1 trillion bailout plan will be enough to bolster confidence in government finances for the region. Borrowers worldwide have sold $15 billion of corporate debt this month, a 62% decline from the same period in April and 83% less than the average for the past year… The extra yield investors demand to own corporate debt instead of government bonds soared last week to the highest in more than four months… ‘This is a fix and not a resolution,’ said Jason Brady, a managing director at Thornburg Investment Management… ‘Investors have seen volatility and that makes it harder to get excited about longer-dated assets paying a fixed return.’”
May 11 – International Herald Tribune (Andrew E. Kramer): “As the financial markets try to absorb news of a rescue package for Greece and other teetering euro-zone countries, some bankers and economists see parallels to Russia’s meltdown in 1998. A decade ago Russia was walking in the same shoes as Greece is today, striving to restore confidence in government bonds by seeking a huge loan from the International Monetary Fund and other lenders. Then, as now, the debt crisis was roiling global financial markets. And big hopes were pinned on a bailout — one that in Russia’s case did not work. ‘Greece creates a remarkable sense of déjà vu,’ Roland Nash, the head of research for Renaissance Capital, an investment bank in Moscow, wrote…”
May 11 – Finanacial Times (David Oakley and Ralph Atkins): “Investors on Tuesday warned that the European Central Bank would have to introduce quantitative easing to stave off the worst crisis in the eurozone since it was launched 11 years ago. The ECB has resisted following the Bank of England and the US Federal Reserve in expanding the money supply by buying government bonds because it fears that it could stoke inflation. Although eurozone central banks bought eurozone government bonds this week for the first time as part of the international rescue plan, this is not QE as the ECB is funding this by selling German bunds or using commercial bank deposits.”
May 11- New York Times (Landon Thomas Jr. and Jack Ewing): “Like the giant financial bailout announced by the United States in 2008, the sweeping rescue package announced by Europe eased fears of a market collapse but left a big question: will it work long term? Stung by criticism that it was slow and weak, the European Union surpassed expectations in arranging a nearly $1 trillion financial commitment for its ailing members over the weekend and paved the way for the European Central Bank to begin purchases of European debt on Monday... The premium that investors had been demanding to buy Greek bonds plunged… And as details crystallized of the package’s main component — a promise by the European Union’s member states to back 440 billion euros, or $560 billion, in new loans to bail out European economies — the wisdom of solving a debt crisis by taking on more debt was challenged by some analysts. ‘Lending more money to already overborrowed governments does not solve their problems,’ Carl Weinberg, chief economist of High Frequency Economics…said…"
May 12 – Bloomberg (Tim Catts and Pierre Paulden): “Europe’s sovereign debt crisis is punishing corporate borrowers, with bond issuance tumbling as investors doubt a $1 trillion bailout plan will be enough to bolster confidence in government finances for the region. Borrowers worldwide have sold $15 billion of corporate debt this month, a 62% decline from the same period in April and 83% less than the average for the past year…”
May 14 – Wall Street Journal (Ianthe Jeanne Dugan): “Federal regulators and state officials are examining Wall Street's role in trading derivatives that essentially bet the municipal bonds they sold would go bust. The Securities and Exchange Commission has launched a preliminary inquiry into banks' trades of municipal credit-default swaps that allow investors to short-sell, or bet against, municipal bonds… The probe is exploring potential conflicts of interest by banks that sell municipal bonds and then poise themselves to profit if those bonds fail, these people said. A main thrust of their investigation is whether firms use their own money to bet against the bonds they sell and, if so, whether that activity is properly disclosed to bond buyers.”
May 14 – Bloomberg (Christine Harper): “Goldman Sachs… is ceasing proprietary trading in one type of structured debt… A group of traders who were focused on making bets on collateralized loan obligations with the New York-based firm’s own money are now handling trades for clients…”
May 12 – Bloomberg (Takahiko Hyuga and Finbarr Flynn): “Morgan Stanley Chief Executive Officer James Gorman denied allegations the U.S. bank misled investors about mortgage derivatives it sold them. The firm is being probed by U.S. prosecutors over whether the bank misled clients when it sold them collateralized debt obligations as its own traders bet that the value of the securities would drop… Wall Street firms are facing unprecedented scrutiny from lawmakers and prosecutors over whether they missold CDOs linked to the subprime mortgages that caused the credit crisis.”
Global Government Finance Bubble Watch:
May 12 – Bloomberg (Abigail Moses and John Glover): “The cost of saving the world from financial meltdown has been bloated by ‘hyperinflation’ since Long Term Capital Management LP’s rescue in 1998… rising price of bailouts since the $3.5 billion pledged to hedge fund LTCM after it was crushed by Russia’s default, and the almost $1 trillion committed to halt the European Union’s sovereign debt crisis this week. It cost just $29 billion to sooth markets in March 2008 when Bear Stearns Cos. was taken over, and $700 billion for the Federal Reserve to save the banking system with the Troubled Asset Relief Program in October that year. ‘We haven’t had any kind of normal inflation in the last decade, but we’ve had hyperinflation in writedowns and the magnitude of bailouts,’ said Jim Reid, head of fundamental strategy at Deutsche Bank… ‘You have to do more to get a similar effect every time.’”
May 12 – Bloomberg (David Mildenberg and Dawn Kopecki): “Four of the largest U.S. banks, including Citigroup Inc., racked up perfect quarters in their trading businesses between January and March, underscoring how government support and less competition is fueling Wall Street’s revival. Bank of America Corp., JPMorgan Chase & Co. and Goldman Sachs Group Inc., the first, second and fifth-biggest U.S. banks by assets, all said in regulatory filings that they had zero days of trading losses in the first quarter… ‘The trading profits of the Street is just another way of measuring the subsidy the Fed is giving to the banks,’ said Christopher Whalen, managing director… Institutional Risk Analytics. ‘It’s a transfer from savers to banks.’
Currency Watch:
The dollar index jumped 2.1% this week to 86.249 (up 10.8% y-t-d). For the week on the upside, the South Korean won increased 2.2%, the Mexican peso 2.1%, the Brazilian real 2.0%, the South African rand 1.3%, the Canadian dollar 1.1%, and the Singapore dollar 0.6%. For the week on the downside, the euro declined 3.1%, the Danish krone 3.0%, the Swiss franc 2.2%, the British pound 1.8%, the Swedish krona 1.35, the New Zealand dollar 1.1%, the Japanese yen 0.9%, the Norwegian krone 0.3%, and the Australian dollar 0.2%.
Commodities Watch:
May 12 – Bloomberg (Stuart Wallace): “There has been a ‘significant’ surge in sales of gold coins and bars, particularly in Germany, Ross Norman, one of the founders of TheBullionDesk.com, said… ‘The last time we saw this level of grass-roots activity was in October 2008 when the economy was on the brink and the retail gold buying community effectively drained gold from the market,” the former bullion dealer said in the report.”
May 10 – Financial Times (Jack Farchy): “Silk ties and handkerchiefs are forecast to rise in price after the cost of silk jumped to its highest level in at least 15 years as rapid industrialisation in China, the world’s largest supplier, robs the sector of valuable farmland. The price of silk cocoons… has doubled since the start of 2009…”
The CRB index declined another 1.1% (down 8.8% y-t-d). The Goldman Sachs Commodities Index (GSCI) slipped 0.4% (down 4.4% y-t-d). Spot Gold jumped 1.8% to $1,230 (up 12.1% y-t-d). Silver surged 4.6% to $19.30 (up 14.6% y-t-d). June Crude sank $3.18 to $71.93 (down 9.4% y-t-d). June Gasoline 0.6% (up 4% y-t-d), and June Natural Gas jumped 7.7% (down 22% y-t-d). July Copper declined 0.8% (down 7% y-t-d). May Wheat sank 7.3% (down 14% y-t-d), and May Corn declined 2.2% (down 14% y-t-d).
China Bubble Watch:
May 11 – Wall Street Journal Asia: “The direction of China’s economy is set. The question troubling investors is whether policy makers have set their course, too. With consumer-price inflation rising to 2.8% in April, real interest rates have moved farther into negative territory… More inflation is in the pipeline. The producer-price index rose 6.8% year-to-year in April, up from 5.9% in March. Higher manufacturing costs should eventually feed through to consumers. The latest housing-market data adds to fears of overheating, with prices up 12.8% year-to-year across 70 of China's larger cities. New bank lending was up, too, with $113.3 billion more loans pumped into the economy in April -- back to around the average monthly level during 2009's credit bonanza. Against this backdrop, Beijing's tightening measures to date are inadequate.”
May 13 – Bloomberg (Peter Woodifield): “China is set to overtake Japan as the largest Asia-Pacific commercial real estate market next year following a surge in values, according to property adviser DTZ Holdings Plc.”
India Watch:
May 13 – Bloomberg (Unni Krishnan): “India’s food inflation rate climbed… An index measuring wholesale prices of agriculture products… rose 16.44% in the week ended May 1 from a year earlier…”
May 12 – Bloomberg (Kartik Goyal): “India’s industrial production grew more than 10% for a sixth straight month, adding to inflation pressures even as Europe’s debt crisis threatens to undermine the global economic recovery.
Asia Bubble Watch:
May 12 – Bloomberg (David Yong): “Asian interest-rate swaps show traders are betting central banks will be less aggressive in raising borrowing costs because of the European Union’s sovereign-debt crisis. ‘The euro crisis has hurt market confidence and liquidity,’ Matthew Huang, an interest-rate strategist… at Barclays Capital Plc, said… ‘If liquidity freezes up, Asian policy makers will likely choose to leave monetary conditions looser for longer.’”
May 10 – Wall Street Journal Asia (Alex Frangos): “The European bailout plan could be too much medicine for an overheating Asia. Before the Greece crisis intensified last week, policy makers in China and elsewhere in Asia said too much growth and an abundance of capital inflows were pushing real-estate and other asset prices dangerously high. While Asian markets welcomed the 750 billion euro ($955 billion) bailout plan, economists and analysts warned that the rescue package could end up bringing even more capital to Asian markets… Loose monetary policy in Europe and the U.S. has already helped to inflate assets prices in Asia, especially for emerging-market bonds and real estate.”
May 12 – Bloomberg (Eunkyung Seo): “South Korea’s unemployment rate declined in April for a third straight month… The jobless rate fell to 3.7% from 3.8% in March… ‘Jobs market conditions are improving on the economic recovery,’ Lee Sang Jae, an economist at Hyundai Securities... said… ‘But there remains some weakness, supporting policy makers’ views that the economy isn’t strong enough to endure higher borrowing costs.’”
May 13 – Bloomberg (Shamim Adam and Manirajan Ramasamy): “Malaysia’s economy grew at the fastest pace in at least 10 years last quarter… Gross domestic product increased 10.1% in the three months ended March 31 from a year earlier…”
Latin America Bubble Watch:
May 12 – Bloomberg (Jens Erik Gould): “Mexico’s industrial production rose the most in almost four years in March on surging demand for exports to the U.S. Output climbed 7.6% from a year earlier…”
May 12 – Bloomberg (Fabiola Moura and Drew Benson): “Argentine Economy Minister Amado Boudou said last week’s jump in bond yields may prompt the government to shelve plans to sell as much as $1 billion of bonds, its first international offer since defaulting in 2001.”
Unbalanced Global Economy Watch:
May 10 – Bloomberg (Bob Willis and Thomas R. Keene): “The fallout from the European debt crisis raises the risk of a ‘double dip’ recession for the global economy, said Stephen Roach, chairman of Morgan Stanley Asia Ltd. ‘When you have a vulnerable post-crisis economic recovery and crises reverberating in the aftermath of that, you have some very serious risks to the global business cycle,’ Roach said… ‘This concept of the global double dip which no one wants to talk about… is alive and well.’”
May 12 – Bloomberg (Svenja O’Donnell): “U.K. unemployment climbed to a 16- year high in the first quarter, underlining the fragility of the recovery as Conservative David Cameron begins his premiership.”
May 12 – Bloomberg (Simone Meier): “Europe’s economy expanded at a faster pace than economists forecast in the first quarter as a global recovery boosted exports… Gross domestic product in the 16 euro nations rose 0.2% from the fourth quarter…”
May 12 – Bloomberg (Christian Vits): “Germany’s economy unexpectedly grew in the first three months of the year as rising exports and company investment outweighed the effects of the cold winter. Gross domestic product… rose 0.2%..."
May 12 – Bloomberg (Maria Levitov): “Russia faces a ‘massive’ capital influx as investors look for alternatives to Europe’s crisis- ridden debt markets, said Mikhail Dmitriev, president of the Center for Strategic Development. That’s putting pressure on Russian policy makers to implement capital controls soon to stem the flows and avoid ruble volatility, Dmitriev, whose think tank conducts research for the government, said in an interview… ‘The government is unarmed against the distortions that may result from massive capital inflows,’ said Dmitriev, who is also a former First Deputy Economy Minister. ‘Russia’s balance of payments and internal macroeconomic stability would undoubtedly be at risk.’”
May 14 – Bloomberg (Paul Abelsky): “Russia’s economy expanded for the first time since 2008… Gross domestic product rose an annual 2.9% in the first quarter after contracting 3.8% in the last three months of 2009…”
May 13 – Bloomberg (Jacob Greber): “Australia’s job growth accelerated in April, propelled by full-time employment… The unemployment rate held at 5.4%.”
May 13 – Bloomberg (Tracy Withers): “New Zealand’s manufacturing industry expanded at the fastest pace in more than five years in April amid rising production and orders.”
U.S. Bubble Economy Watch:
May 12 – Bloomberg (Shobhana Chandra): “The trade deficit in the U.S. widened in March to the highest level in more than a year as imports climbed faster than exports, adding to evidence of the global recovery from the worst recession in the post-World War II era. The gap grew 2.5% to $40.4 billion…”
May 13 – Bloomberg (Ryan J. Donmoyer): “White House budget director Peter Orszag predicted Congress would approve higher taxes on managers of private equity firms, real estate funds and other investment partnerships in the coming weeks. Orszag, speaking yesterday…”
May 10 – Bloomberg (Terrence Dopp): “New Jersey’s Democratic lawmakers plan to introduce legislation to resurrect an income-tax surcharge on residents who earn $1 million a year or more…”
Derivatives Watch:
May 11 – Bloomberg (Phil Mattingly): “The Federal Deposit Insurance Corp. advanced a proposal aimed at overhauling part of the $4 trillion asset-backed securities market and introduced a rule that would require the biggest U.S. banks to submit ‘funeral plans’ to handle their possible collapse… ‘Now is the time to put some prudent controls in place to make sure we don’t get into some of the problems we saw in the past,’ Bair said…
Real Estate Watch:
May 13 – Bloomberg Dan Levy): “U.S. home repossessions rose to a record level in April while foreclosure filings dropped in a sign mortgage lenders are working off a backlog of seized properties, according to RealtyTrac… ‘Right now it appears that the banks are focusing on processing the loans already in foreclosure, and slowing down the initiation of new foreclosure proceedings as a way of managing inventory levels,’ Rick Sharga, RealtyTrac’s executive vice president, said… A record 92,432 bank repossessions were reported in April, up 45% from a year earlier…”
Central Bank Watch:
May 13 – DPA: “The European Central Bank (ECB) on Thursday defended its decision to intervene in European bond markets, rejecting claims that this threatened the bank’s independence. ‘These measures are designed not to affect the monetary policy stance,’ the ECB wrote in its monthly report of its decision to buy debt from troubled eurozone members. ECB chief economist Juergen Stark said this was a ‘temporary emergency measure,’ to which there was no alternative after the euro currency had come under attack. Stark said the bank was not responding to political pressures… ‘The credibility of the ECB does not just hinge on the question whether or not we buy government securities, but whether we fulfill our central task, which is ensuring price stability,’ Stark said. The economist said there was no doubt that ‘an attack’ on individual eurozone countries was being carried out by "anonymous market sources.’”
May 10 – Bloomberg (Mayumi Otsuma): “Central banks from the U.S., Japan and Europe will participate in temporary U.S. dollar swap agreements amid heightened tension in global financial markets, the Bank of Japan said. ‘In response to the re-emergence of strains in U.S. dollar short-term funding markets in Europe’ the central banks of Canada, England and Switzerland will also participate in the re- establishment of currency swaps that were implemented during the financial crisis, the BOJ said… ‘These facilities are designed to help improve liquidity conditions in U.S. dollar funding markets and to prevent the spread of strains to other markets and financial centers.’ Central banks ‘will continue to work together closely as needed to address pressures in funding markets’ the BOJ said.”
May 10 – Bloomberg (Saburo Funabiki): “The Bank of Japan said it would pump 2 trillion yen ($21.7bn) into the financial system for a second day to help reassure markets after the Greek fiscal crisis set off a slump in stocks worldwide.”
GSE Watch:
May 10 – Bloomberg (Nick Timiraos): “Fannie Mae asked the U.S. government for an additional $8.4 billion in aid after posting an $11.5 billion net loss for the first quarter, the latest sign that the bailout of the mortgage investor and its main rival, Freddie Mac, is likely to be the most expensive legacy of the U.S. housing-market bust… The company has now racked up losses of nearly $145 billion, or nearly double its profits for the previous 35 years.”
Fiscal Watch:
May 13 – Bloomberg (Vincent Del Giudice): “The U.S. posted its largest April budget deficit on record as receipts declined in a month that typically sees an increase in individual income tax payments. The excess of spending over revenue rose to $82.7 billion last month compared with a $20.9 billion gap in April 2009… April marked a record 19th straight monthly shortfall… Deterioration in the government’s balance sheet in coming years raises the risk of higher interest rates even as an improving economy helps lift tax receipts. ‘With the recovery in place, we should be seeing higher revenue and lower outlays, not the other way around,’ said Win Thin, senior currency strategist at Brown Brothers Harriman… The government’s April budget deficit compares with a median forecast of $57.9 billion… The last time the U.S. had back-to-back April deficits was 1963-1964… For the fiscal year that began in October, the budget deficit totaled $799.7 billion compared with $802.3 billion during the same period last year.”
May 12 – Associated Press: “President Obama’s new health-care law could potentially add at least $115 billion more to government health care spending over the next 10 years, if Congress approves all the additional spending called for in the legislation, congressional budget referees said… That would push the 10-year cost of the overhaul above $1 trillion…”
California Watch:
May 11 – Bloomberg (Michael B. Marois and William Selway): “California Governor Arnold Schwarzenegger will seek ‘terrible cuts’ to eliminate an $18.6 billion budget deficit facing the most-populous U.S. state through June 2011… California’s revenue in April, when income-tax payments are due, trailed the governor’s estimates by $3.6 billion, or 26%.”
May 14 – Bloomberg (Michael B. Marois and William Selway): “California Governor Arnold Schwarzenegger proposed a new round of budget cuts, including eliminating the state’s main welfare program for families, to close a $19.1 billion budget deficit for the year starting July 1. The $83.4 billion plan calls for $12.4 billion in spending reductions, $3.4 billion in additional federal aid and $3.4 billion in fund shifts, fees and assessments…”
Speculator Watch:
May 14 – Bloomberg (Jody Shenn and Michael J. Moore): “In June 2006, a year before the subprime mortgage market collapsed, Morgan Stanley created a cluster of investments doomed to fail even if default rates stayed low -- then bet against its concoction. Known as the Baldwin deals, the $167 million of synthetic collateralized debt obligations had an unusual feature… Rather than curtailing their bets on mortgage bonds as the underlying home loans paid down, the CDOs kept wagering as if the risk hadn’t changed. That left Baldwin investors facing losses on a modest rise in U.S. housing foreclosures, while Morgan Stanley was positioned to gain. ‘I can’t imagine anybody would take that bet knowingly,’ said Thomas Adams, a former executive at bond insurers Ambac Financial Group Inc. and FGIC Corp… ‘You’re overriding the natural process of risk-mitigation.’”
May 12 – Bloomberg (Tomoko Yamazaki and Komaki Ito): “Japanese hedge funds, the world’s worst performers last year, returned 6.7% in the first four months of 2010, the best year-to-April return in six years, according to Eurekahedge Pte.”
Dysfunctional Markets:
It scrolled by quickly Wednesday afternoon on my Bloomberg screen: a one-line headline quoting ECB Executive Board member Jose Manuel Gonzalez-Paramo: “Central Banks Can’t Work if Markets Dysfunctional.” My efforts to located Mr. Gonzalez-Paramo’s full comments on the issue were unsuccessful; we’ll have to assume the context. I do believe strongly that many things these days can’t work because global markets are hopelessly dysfunctional.
I was never a big fan of the simplistic analytical fixation on the so-called “shadow banking system.” Key components of this “system” – i.e. the Wall Street securities firms, ABS, CDOs, SIVs, private-label MBS, etc. – have been reined in. This would imply a more stable financial backdrop, which is nowhere to been seen. I am similarly not a subscriber to a “new normal” thesis. Again, the focus seems to detract from today’s key issues. I have posited a “Newest Abnormal” thesis – that the long process of market distortions and economic imbalances has actually accelerated. Things go from bad to only worse. Things may look somewhat different, but there’s nothing new.
From my analytical perspective, the heart of the problem lies with this dysfunctional dynamic between global marketable debt and derivatives, policy-induced distortions, and unfettered speculative finance. Unique in history, we continue to operate with a global financial “system” functioning without limits to either the quantity or quality of new Credit created. There’s way too much Credit backed by little more than government assurances or perceptions of government insurance. And never before has an enormous global “leveraged speculating community” so dominated the markets for debt instruments and, in the process, so relied on faith in the efficacy of government market interventions. It’s global wildcat banking in its purest ever form.
These days, entities all over the world issue enormous quantities of tradable debt instruments. This debt, in large part, is purchased by sophisticated market operators earning unimaginable compensation for achieving “above market” returns. When market psychology is bullish, there is essentially unlimited demand for marketable debt – a significant portion acquired through the use of leverage. And as long as demand for new marketable securities remains robust, underlying positive fundamentals appear to support a high market valuation for this debt (irrespective of the quantity issued) - and the party lives on. But Katy bar the door whenever the crowd moves to cut exposure – either through liquidating positions or acquiring market “insurance.”
Eurozone policymakers look foolish these days for not having reined in profligate Greek borrowing and spending. To many, the ECB looks foolish for Sunday’s decision to purchase in the open market debt issued by Greece, Portugal, Spain and other troubled European countries. Others believe the ECB was foolish for not having had initiated a Federal Reserve-style monetization plan long before the debt crisis spiraled out of control. I sympathize with the ECB. Dysfunctional global markets placed them in a winless situation. Greek 10-year bond yields were below 5% for much of 2009. The market was happy to accommodate profligacy - until it wasn’t. If only well-functioning global markets disciplined borrowers rather than emboldening them.
The sea change in global finance gained unstoppable momentum in the early nineties. The Greenspan Federal Reserve nurtured marketable debt as a mechanism to help overcome severe banking system impairment. There was no stopping the historic boom in market-based Credit once unleashed. The problem was clear by the time of the 1994 bond and mortgage securities dislocation. But it was politically and monetarily expedient to allow GSE Credit (with its implicit government guarantee) to evolve into a mechanism for stabilizing the Credit system and spurring economic expansion.
The rapidly escalating scope of the problem was illuminated with the collapse of LTCM. Yet, the Greenspan Fed supported this new financial infrastructure with only more powerful words and deeds. Pegging short term interest rates and aggressively intervening to rectify market tumult incited unprecedented leveraged speculation throughout the Credit system. Dr. Bernanke’s 2002 “helicopter money” and “government printing press” speeches sealed the fate of runaway Bubbles in both marketable debt and leveraged speculation.
Especially during the Bubble years 2004 through 2007, massive U.S. current account deficits worked to unleash U.S. Credit Bubble dynamics upon the entire world. The more Bubbles became ingrained in the financial architecture the deeper market perceptions became that policymakers wouldn’t tolerate a bust. Worse yet, policymakers resorted to using the debt markets and the market’s propensity for leveraged speculation as mechanisms for increasingly aggressive monetary reflation.
Global policymakers and Credit markets have been fueling Bubbles and accommodating profligacy for years now. It would have taken a concerted effort by global central bankers to rein things in. The Greenspan/Bernanke Federal Reserve would have had no part of it. Quite the contrary. It was fundamental to Greenspan/Bernanke doctrine to deal with market and economic fragility through the aggressive reflation of system Credit. This doctrine of inflationism was instrumental in nurturing Credit and speculation excesses that worked over time to increasingly distort the pricing of finance, the quantity of Credit created, and the allocation of real and financial resources. The ECB’s big mistake was not to have forcefully fought the Fed.
We’re now two years into the greatest expansion of global government debt in the history of mankind. Manic-depressive debt markets have now pulled the rug out from under Greece and periphery Europe, but in the process have further accommodated profligate government borrowings here at home. It is frightening to think of how distorted the Treasury market has become - and how things might play out down the road.
My bearish thesis on our markets and economy is based upon the view that the financial fuel for our recovery has been unsound, unstable and unsustainable. This “Monetary Process” is now in jeopardy. The Global Government Finance Bubble, which lunged into its terminal phase of excess with the collapse of the Wall Street/mortgage finance Bubble, has been pierced. Greece’s debt crisis marks a momentous inflection point. And, yes, some government markets – certainly including Treasuries – are benefiting from Greek and periphery European debt woes. Yet key Bubble dynamics percolate under the surface.
I have argued that the Global Government Finance Bubble has been the biggest and most precarious Bubble yet. The incredible scope of global sovereign debt expansion over the past couple years has been rather obvious. Less apparent are related distortions - to the pricing and allocation of finance throughout international markets - based specifically upon the market's perception that politicians and central bankers would act aggressively and successfully to forestall future crises. This policy-induced market distortion fostered an incredible bout of risk-taking – especially considering the fundamental backdrop – and a resulting massive flood of finance out to the risk markets. This perception has been blown to smithereens in Europe and has quickly become vulnerable everywhere.
Global markets in sovereign Credit default swap (CDS) protection have flourished on the assumption that policymakers would thwart any debt crisis. In the post-Greek debacle era, writing insurance against a government default is no longer free money. New realities have profoundly changed the risk and reward profiles of operating in this key market - and I’ll assume some profoundly less attractive marketplace liquidity dynamics going forward. And a faltering market for sovereign debt insurance significantly changes the risk profile of owning the underlying sovereign debt. To be sure, changing perceptions in the market for government debt work to corrode market confidence in the capacity of policymakers to stem financial and economic crises generally. This implies a major adjustment in the markets’ perception of risk in various markets, including corporate, municipal and mortgage instruments.
But I’m getting somewhat ahead of myself. Thus far, dislocation in Greek debt has fed powerful contagion effects throughout European debt and CDS. This has forced a major market reassessment of the relative stability of the euro currency, which has unleashed bloody havoc throughout the currency and “carry trade” arena. Currency and “carry trade” tumult has forced market reassessment as to near-term prospects for both the dollar (upward) and global growth (downward). This has caused trading liquidation and de-leveraging havoc in the enormous global “reflation trade” and in risk markets more generally. And there’s nothing like liquidation and forced de-leveraging to really bring out the animal spirits for those seeking to make nice speculative profits from others’ misfortune.
The dollar and Treasuries have benefited. This has supported the bullish view that the unfolding crisis is largely a European issue. It has also helped dampen the impact to our markets from changing global perceptions with respect to the capacity of policymakers to stem crises. Here in the U.S., Credit spreads and risk premiums (corporates, MBS, municipals, etc.) have widened some. Yet faith still runs deep that Washington won’t allow a crisis. This confidence must hold for sufficiently loose U.S. finance to continue to support our fragile recovery.
The confluence of global financial crisis and intense financial sector scrutiny here at home will at some point prove confidence in Washington overly optimistic. For now, when it comes to pricing risk and disciplining profligate borrowers, our debt markets remain dysfunctional.
This has caused liquidation and de-leveraging havoc in the enormous global “reflation trade” and in risk markets more generally. And there’s nothing like liquidation and forced de-leveraging to really bring out the animal spirits for those seeking to make nice speculative profits from others’ misfortune.
The dollar and Treasuries have benefited. This has supported the bullish view that the unfolding crisis is largely a European issue. It has also helped dampen the impact to our markets from changing global perceptions with respect to the capacity of policymakers to stem crises. Here in the U.S., Credit spreads and risk premiums (corporates, MBS, municipals, etc.) have widened some. Yet faith still runs deep that Washington won’t allow a crisis. This confidence must hold for sufficiently loose U.S. finance to continue to support our fragile recovery.
The confluence of global financial crisis and intense financial sector scrutiny here at home will at some point prove confidence in Washington overly optimistic. For now, when it comes to pricing risk and disciplining profligate borrowers, our debt markets remain dysfunctional.
http://prudentbear.com/index.php/creditbubblebulletinview?art_id=10376
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