Guest Post: The Cantillon Effect

Expansionary monetary policy constitutes a transfer of purchasing power away from those who hold old money to whoever gets new money. This is known as the Cantillon Effect, after 18th Century economist Richard Cantillon who first proposed it. In the immediate term, as more dollars are created, each one translates to a smaller slice of all goods and services produced. How we measure this phenomenon and its size depends how we define money....  What is clear is that the dramatic expansion of the monetary base that we saw after 2008 is merely catching up with the more gradual growth of debt that took place in the 90s and 00s. While it is my hunch that overblown credit bubbles are better liquidated than reflated (not least because the reflation of a corrupt and dysfunctional financial sector entails huge moral hazard), it is true the Fed’s efforts to inflate the money supply have so far prevented a default cascade. We should expect that such initiatives will continue, not least because Bernanke has a deep intellectual investment in reflationism.

European Stocks End Green; Sovereigns And Credit Not So Much

It's happening again. The euphoria is fading in the critical fulcrum security markets but stocks remain oblivious in their momentum-heavy liquidity-less way. Spanish and Italian sovereign bonds ended weaker - quite notably weaker in the case of Spain with the curve flattening significantly as the much-heralded front-end started to give some back and 10Y spain leaked back up towards 7% yields. Compared to post Draghi-'believe' (and post-Draghi 'reality') the Spanish and Italian stock markets are cock-a-hoop - massively outperforming. European equity markets in general are now the Usain Bolt compared with the Derek Redmond of European credit markets as once again stock holders are either last to get the joke or first to be ignorant enough to play the ECB's game of chicken. Spain's IBEX is now +13% from Thursday's close, followed by Italy +10% - but Italy and Spain 10Y bonds are still wide of the pre-Draghi 'reality' trough in spreads. German and Swiss rates increased modestly today but the latter remains negative out to 6Y.

Desperately Seeking: Subprime Collateral

UPDATE: Added Santelli carefully negotiating LeBeau's awesome optimism.

Like everywhere else, quality collateral is increasingly being soaked away and nowhere is this more evident than in the auto industry. We recently noted the significance of the auto industry and its self-fulfilling (and destroying) channel-stuffing 'mandates' around the world but today we get confirmation of the depths the car industry will stoop to. Via Subprime News, we see that Preferred Automobile Credit Co. (PACCO) is 'expanding' both the age and mileage limits of vehicles eligible for collateral, as "the pool of quality used cars has been shrinking, making it more challenging for dealers to find quality inventory". Of course, any 'knock' on the risk management or honesty or sustainability of an auto industry so much a part of the US recovery would not be complete without CNBC's Phil LeBeau's rebuff that the entire industry sees things as golden (in all its rear-view mirror glory) - we wonder what subprime lenders were saying about the environment for loans in 2006? And of course they can carry that 20% interest-rate, car prices never go down right?

Short Squeezeability Of Two Main Market ETFs Slides To Multi Year Lows

Exactly one year ago, the short-interest in SPY (the S&P 500 ETF) reached epic heights at over 536mm shares. At the same time, short-interest in QQQ (the Nasdaq ETF) also short-term peaked at over 116mm shares short. While QQQ has seen a gentle drift lower in general (somewhat reflective of trading volumes in the last few years), since July of last year SPY has seen a 62% drop in short-interest and QQQ 59%. QQQ short-interest is now its lowest since October 2000 and SPY short-interest its equal lowest since October 2007 and so ammunition for charging this market higher seems to be running out. This is even more highlighted by the 45% and 30% plunge in QQQ and SPY short-interest in the last six weeks alone.

Geithner Sacrificed Pensions Of Non-Union Delphi Retirees

Back in 2009 when the government sacrificed GM and Chrysler bondholders just so labor unions (read voters) can be made whole, the media, for various reasons, decided not to pursue the decision-making process that left some workers with their pensions wiped out, while others were made whole and suffered no losses (with a comparable lack of investigation being conducted as to the decisions that shuttered some Chrysler dealers, but left others operating, a topic Zero Hedge had some say over). In fact, as the Daily Caller reminds us "The White House and Treasury Department have consistently maintained that the Pension Benefit Guaranty Corporation (PBGC) independently made the decision to terminate the 20,000 non-union Delphi workers’ pension plan...Former Treasury official Matthew Feldman and former White House auto czar Ron Bloom, both key members of the Presidential Task Force on the Auto Industry during the GM bailout, have testified under oath that the PBGC, not the administration, led the effort to terminate the non-union Delphi workers’ pension plan." Turns out they lied... Under oath.

Putting A Face To Einstein's Definition Of Insanity

If ever there was a name and a face synonymous with Einstein's famous definition of repeating the same action and expecting a different unicorn-full world of happiness, it is Boston Fed's Eric Rosengren. Thankfully far from consensus among the Fed heads - though worrying fanatical - the hyperinflationary head used the propaganda channel this morning to pump hope into an increasingly skeptical market. In an effort to pre-empt a possible slowing global economy, his prescription is "open-ended quantitative easing triggered on economic outcomes". Fearful of the US merely treading water, Rosengren sounds like he admits that it's all about the flow when he shuns pegging interest rates as a 'trigger' since this removes control of the Fed's balance sheet to market forces (in other words - we need to keep printing and expanding the balance sheet no matter what rates or stocks are doing). Stunningly, the only limiting factor he sees to this open-ended print-fest is the size of the asset markets they are buying in - which he would like to see in MBS (and suggests his disappointment at the limited scope of assets available to the Fed). Just under nine minutes sums up the extremely dangerous experimental mind of an eternal optimist "if at first (or second, or third) you don't succeed..." as he shuns the impact on (transitory) energy price rises by pointing at the lack of inflationary pressures.

S&P Above 1400 As Fed Conducts Second $600 Million Repo Following Nearly 4 Year Hiatus

Last week we explained why while endless promises of Fed intervention may be enough to confuse the market and force endless rounds of short covering as weak hands are flushed out of positions under threat (but never action) of central planning, banks are no longer in a position to delay indefinitely the moment they have all been waiting for: a $500+ billion reserve injection which will allow them to go hog wild in investing in risk assets or plug capital shortfalls (off the books of course), and otherwise continue their lives in a ZIRP environment which makes net interest margin existence impossible. We also showed that for the first time after nearly 4 years, the Fed conducted a regular (not reverse) repo last Friday. As we explained, regular repos are liquidity injecting, and while the Fed may promise these are merely test runs, everyone knows they are anything but, and are merely a telegraphing to the banks of what is in store. Today, the day after the last repo expired, we just got a new 3 day repo, only not for $210 million this time, but one for $600 million, including not only Treasury, but also Agency and MBS securities. The result: S&P above 1400 for the first time in months.

Guest Post: Has The Perfect Moment To Kill The Dollar Arrived?

The idea of “collapse”, social and financial, comes with an incredible array of hypothetical consequences ranging from public dissent and martial law, to the complete disintegration of infrastructure and the devolution of mankind into a swarm of mindless arm chewing cannibals.  In an age of television nirvana and cinema overload, I have found that the collective unconscious of our culture has now defined what collapse is based only on the most narrow of extremes.  If they aren’t being hunted down by machete wielding looters or swastika wearing jackboots, then the average American dupe figures that the country is not in much danger.  Hollywood fantasy has blinded us to the tangible crises at our doorstep. In 2012, we still await that trigger event, which I believe will be the announcement of QE3 (or any unlimited stimulus program regardless of title), and the final debasement of the dollar.  At the beginning of this year, I pointed out that we were likely to see such an announcement before 2012 was out, and it would seem that the private Federal Reserve is right on track. Last month, the Fed announced that it was formulating a plan to “expand its tool kit”.

Art Cashin On Obama's Reelection Tactic: Pleading For A Spanish Bailout

"Who knew that the 24th electoral district in Chicago actually sits in Northwest Madrid?" That is how Art Cashin concludes his tangent into the president's pre-election tactics, which now apparently involve begging heads of sovereigns to accept bailouts from other sovereigns (coughgermanycough) just to boost one's reelection chances. Why? Because the one thing that could send the S&P ripping higher, however briefly, is what we have been discussing for the past week: namely the market finally getting the paradoxical catalyst that the market has already priced in - Spain admitting it is broke. And why would Obama be focused on a rising S&P, fiscal cliff after the election notwithstanding? The chart below should explain it.

Robert Shiller Has A Chiller For Housing Recovery Hopes

Recent research by Robert Shiller indicates sounding the all-clear for a housing recovery is premature since the home-price rebound, if that's what it is, doesn't yet have momentum - which is the most powerful driver of home prices. As he notes in today's WSJ, momentum is a modestly weak force in the stock market but the most important driver of the 'feedback loop' in home-price increases (followed by unemployment). "It could be a bottom, I just don't know", he adds pointing to the large overhang of homes that are either in foreclosure of near it - which would push prices down further if they were ever released to the market (wanting to see momentum carry into the Spring to be convinced). Critically, he sees bubbles once again forming in some areas, commenting that investors have been "primed to think speculatively" adding that "There was a change in our mindset. Now we start thinking about the housing market as like the stock market." Our question is, if the increasingly speculative housing market is part of the CPI basket, why then is the stock market not also part of it?

Japan's Demographic Death Rattle In 3 Charts And 333 Words

Courtesy of Bloomberg's Michael McDonough, here is how the end game for demographically defunct, deflationary debt holes such as Japan looks like extrapolated into the future. And for the time-strapped it is condensed into 333 words and 3 charts. "Fewer workers and less labor will reduce the potential output of the Japanese economy, which will increase the country’s reliance on imports as retirees continue to spend, inhibiting GDP growth. The rising number of retirees will strain the government’s welfare programs and the country’s pension funds, which have been major buyers of government bonds. Japan already maintains the world’s second-largest debt load in nominal terms at more than $13.7 trillion and growing."

Italy And Spain 'Steady' At Pre-Draghi Sell-Off Levels As Front-End Softens

In spite of all the exuberance of front-running the ebullient print/buy response of a dysphoric request for help (that may never come - just like QE3 if market levels remains elevated), Spanish and Italian 10Y bond spreads are only now just making it back to pre-Draghi 'let-down' press-conference levels - and holding steady. The basis (the spread between CDS and bond spreads) has compressed dramatically as bonds have outperformed with the 'hope' of a substantial SMP enabling an illiquid bond market to remove whatever event risk (PSI/haircut/subordination) premium was priced in cash and not CDS. The front-end of the Spanish and Italian curves is softening modestly 7-10bps (though admittedly off compressed levels) but with Spain and Italy stock markets up 12 and 9% from Thursday close respectively - and well above pre-Draghi levels (even as German and Swiss rates stumble along the bottom on a safety bid) it seems whatever volume there is (which is tepid at best) is marginally lifting the unshortable irrepressible equity market (which is outperforming credit markets notably now).

In The Merry Old Land Of Oz!

The tin man is now living at the bank in Frankfurt and he has received the Wall Street certificate for his brain which promises much and is short on delivery but that is what he learned. The Munchkins are all out on the yellow brick road and off to see someone or another and are presently mired in the poppy fields where they are having flower induced dreams of unlimited money, no responsibility and the Wizard, now living in Florida with Toto’s cousins Princess and Mr. Trooper, is finding great amusement with the antics of it all and reminds everyone that a horse of a different color will be a staring figure in the next act of the play as the poppy fields are left behind and the gates of the not quite so Emerald City come into view.

Daily US Opening News And Market Re-Cap: August 7

European equities are seen in decent positive territory heading into the Wall Street bell, though a clear lack of direction has been observed as well a thin summer volumes . The FTSE-100 is the day's underperformer following last night's allegations made by the State of New York against UK bank Standard Chartered that the company violated US sanctions by making secret transactions to the tune of USD 250bln with Iran. The Spanish 10-year yield has held below the key 7.00% level, though higher than yesterday's close at 6.76 with the spread over the benchmark Bund is slightly wider by 1.2bps. Steepening seen in the Spanish 2-year over the last couple of days as ECB's Draghi commented that any periphery bond-buying programme would be in the short end has halted and is now wider by 13bps. The Italian 10-year yield briefly traded above the 6.00% level though has since pulled back to lows printed earlier, currently standing at 5.91%, its spread tighter by 10.4bps on the session.

Market Optimistic On Central Bank Intervention

Market players are watching for any details on the ECB’s bond purchasing plans, after bank chief Mario Draghi said last week that the ECB would target short-term debt, fuelling optimism in the bond markets. A Reuter’s poll of economists on Friday highlighted that they expect the Fed to start QE3 in September, but a top Fed official said that a stimulus package so close to a presidential election would not be prudent. Since the ECB conditioned it would buy more government debt from Spain & Italy if they agreed to strict austerity packages, this has decreased pressure on either country to act quickly. The Financial Times interviewed Ken Wattret, a BNP Paribas economist who said: “If people think this will all be sorted in a matter of days, or weeks, then they will be disappointed. We could be in limbo for months.”

77.9% Of Spanish Voters Polled Have Little Or No Confidence In Rajoy

According to the latest Centro de Investigaciones Sociológicas (CIS) poll, Spanish Prime Minister Mariano Rajoy’s popularity has sunk to the point where 77.9% of the country’s electorate has little or no confidence in him. The survey still shows Rajoy’s conservative Popular Party (PP) ahead of the Socialist Party, however, by 6.7 per cent – eight percentage points down from the PP’s historic election win eight months ago. Ironically, during his entire his political campaign, and during his time as leader of the opposition, Rajoy’s fundamental message was that the country needed “a shot of confidence” to overcome its economic woes. Rajoy’s promises to implement swift and credible policies that would restore confidence in Spain were pivotal to his landslide electoral victory last November. However, the complete U-turn his Administration begun only days after taking office has left many feeling betrayed. Broken promises aside, his distant and elusive manners have only added to the detriment of his public image.

Frontrunning: August 7

  • Standard Chartered Falls Most in 24 Years on U.S. Iran Probe (Bloomberg)
  • Iran accusations wipe $15 billion off StanChart shares (Reuters)
  • Hilsenrath tells us that Fed Official Calls for Open-Ended Bond Buying (WSJ) - shocking indeed
  • German opposition backs fiscal union, demands constitutional change and referendum (FT)
  • Gary Gensler speaks: Libor, Naked and Exposed (NYT)
  • IMF Pushes Europe to Ease Greek Burden (WSJ)
  • Second TSE System Error in Seven Months Halts Derivatives (Bloomberg)
  • Rice Hoard Offers World Respite as Food Costs Surge (Bloomberg)
  • UK coalition in crisis over parliamentary reform (Reuters)
  • Ethics probe could deal losing hand to Nevada Democrat (Reuters)

Europe's Economic Contraction Continues As Core Succumbs To Peripheral Weakness

This morning there was a round of European economic data which showed that regardless of whether Italian and Spanish bonds trade up or down by 100 bps on any given day, the continent remains deeply mired in recession. First we got Dutch June Industrial Production (a AAA country), which slid from -0.3% to -0.6%, on expectations of an increase, then this was repeated with Italian June Industrial Production which also missed estimates printing at at -1.4% in June, a drop from +1.0%, and below the estimate of -1.05%, followed by UK Industrial production which collapsed, IP sliding from 1.0% to -2.5%, the biggest one month drop since November 2008, but modestly better than expectation which is what apparently drove the GBP higher - the market: always the optimist. And then the cherry on top was German factory orders which plunged from 0.7% to -1.7%, missing expectations of a -0.8% print. Completing the sad economic picture was Italian Q2 3GDP which which was essentially unchanged at -0.7% compared to Q1's -0.8%. Goldman was certainly not happy with Italian data: "The recessionary dynamic is likely to mechanically weaken tax revenues this year, creating hurdles for the fiscal consolidation that is otherwise well underway... We believe that the domestic economy - in particular private sector consumption and investment - currently faces strong headwinds (fiscal adjustment, financing conditions) that may end up harming sequential growth dynamics by more than we currently foresee."