Archive - Feb 2012

Consider that when we include the rest of the PIIGS countries, Deutsche Bank’s “actual” exposure (as downplayed as it might be) is still 35 BILLION Euros, an amount equal to 60% of the banks’ total equity.

As the Greek 'deal' is being finalized and we anxiously await next week's LTRO, it would appear that the market is now pricing in a very different way forward. EURUSD is soaring and decoupling (the other way) from risk assets as market participants begin to anticipate potential rate hikes in Europe to combat soaring energy prices, and furthermore that following the second LTRO, any and all easing expectations (and the pump to keep global asset prices afloat) will be squarely on the shoulders of the somewhat ambivalent Fed as the rest of the world already pumped about $2 trillion of cash into the market.

As the banks in Europe report out earnings; or the lack thereof in most cases, it becomes clear that the LTRO is helping with liquidity but not with solvency past some very short term point. This is always the case of course but it is beginning to hit home. The balance sheets for many European banks have now swelled on the liability side with more and more debt piling up courtesy of the ECB while their assets decrease due to the Basel III mandates so that the financials of these banks begin to deteriorate. It is not just the losses from their Greek debt holdings that are coming into play but also their potential future losses from sovereign debt write downs markedly for Portugal soon I think but also perhaps for Spain and Italy in the near term as the recession in Europe brings new problems to the fore which will further reduce the value of sovereign and bank credits in Europe.

We announced previously that as a result of the second "bailout" Greece would not see one penny, as it itself would be required to fund the creditor escrow package, in essence meaning that the flow of funds would from Greece to Europe. Yet somehow, a little money must have made its way to the Greek government. We now have a first look at just what it is that Greece is spending this newly panhandled cash on, courtesy of the WSJ...

The last six months' market behavior is somewhat breath-takingly similar to the same period a year ago. With global central banks pumping (RoW replacing Fed for now), energy prices soaring, and since the market is the economy - hope is rising that we are doing better; the drivers of the asset price reflation are similar too. While Treasury yields appear to be bucking this sentiment-euphoria, perhaps it is the because the US is the hottest market and all the world's money comes here that we are 'decoupling'. It seems the stakes are higher and scale of known unknowns even larger this time as the can that we are kicking is gathering a lot of trash as it rolls down the road.

We have been saying it for weeks, and today even the WSJ jumped on the bandwagon: the sole reason why crude prices are surging (RIP European profit margins: with EUR Brent at a record, we can only assume the ECB will pull a 2011 and hike rates in 3-4 months even as it pumps trillions in PIIGS, banks bailout liquidity) - is because global liquidity has risen by $2 trillion in a few short months, on the most epic shadow liquidity tsunami launched in history in lieu of QE3 (discussed extensively here in our words, but here are JPM's). Luckily, the market is finally waking up to this, and just as world central banks were preparing to offset deflation, they will instead have to deal with spiking inflation, because the market may have a short memory, it can remember what happened just about this time in 2011. And the problem is that when it comes to the inflation trade, the market, unlike in most other instances, can be fast - blazing fast, at anticipating what the central planning collective's next step will be, after all there is only one. And if Bank of America is correct, that next step could well lead to the same unprecedented economic catastrophe that we saw back in 2008, only worse: $200 oil. Note - this is completely independent of what happens in Iran, and is 100% dependent on what happens in the 3rd subbasement of the Marriner Eccles building. Throw in an Iran war and all bets are off. Needless to say, an epic deflationary shock will need to follow immediately, just as in 2008, which means that, in keeping with the tradition of being 6-9 months ahead of the market, our question today is - which bank will be 2012's sacrificial Lehman to set off the latest and greatest deflationary collapse and send crude plunging to $30 just after it hits $200.

A funny thing happened while we all waited for the Fed to announce QE3. The rest of the world did it for them. Courtesy of Bloomberg's excellent Economics Brief, and the n'th time, here is what a multi-trillion dollar liquidity expansion looks like even with the Fed running silent. And this is also what $10 trillion in 2 years pumped into the markets looks like. Wonder where the market gets its "spring step" from? Now you know. Thank you Economist PhD's!

Enough is enough, its already too much.

The better tone in risk markets is largely being driven by encouraging economic data from the US and Europe, which as a result saw Bunds trade in negative territory. Of note, ECB’s Liikanen has said that inflation is not a particular concern in Europe, adding that the ECB has never said that there is an interest rate floor. On the other hand, Gilts are being supported by comments from BoE’s Fisher, as well as less than impressive GDP report. Nevertheless, EUR/USD took out touted barrier at the 1.3400 level earlier in the session, while USD/JPY is trading in close proximity to an intraday option expiry at 80.60.

Bunch of irrelevant and reflexive (stock market is up so confidence - in what? manipulated markets? - is higher, so stock market is up so confidence is higher etc) stuff today, as the world central banks prepare to pump another $600-$1000 billion into the consolidated balance sheet and send input costs into the stratosphere. Somehow this is bullish for stocks. Luckily, it will finally break the EURUSD - ES linkage.

Currency debasement of all major currencies is happening today on a scale never before seen in history. Yet there continues to be a complete lack of awareness amongst the majority in the western world as to the risks posed by our currency monetary and financial system. There continues to be a lack of knowledge and indeed often wilful ignorance regarding gold. Indeed, some comments on gold are so ignorant of the historical and academic record that they have all the hallmarks of crude anti-gold propaganda – and will be seen as such in time. Gold is a proven safe haven asset and currency. Despite much recent academic evidence and the historical record showing this and despite voluminous articles, research and evidence, (evidence succinctly summarised in the video 'Gold Bullion or Cash'), there continue to be frequent anti gold outbursts by some of the most respected and trusted people in the western financial and economic world. Such attacks on gold have come from men such as Paul Krugman, Nouriel Roubini and more recently Warren Buffett. Alan Greenspan correctly wrote in 1966 that "an almost hysterical antagonism toward the gold standard is one issue which unites statists of all persuasions”. Today, an almost hysterical antagonism towards gold bullion as a diversification and as a store of wealth alternative to fiat currencies unites beneficiaries of the current status quo – both intellectual beneficiaries and material beneficiaries. That status quo is a massively leveraged and insolvent monetary, financial and economic system. 

• U.S. Postal Service to Cut 35,000 Jobs as Plants Are Shut (BBG) -Expect one whopper of a seasonal adjustment to compensate
• European Banks May Tap ECB for $629 Billion Cash (Bloomberg) - EURUSD surging as all ECB easing now priced in; Fed is next
• Madrid presses EU to ease deficit targets (FT)
• Greek Parliament Approves Debt Write-Down (WSJ)
• Mentor of Central Bankers Fischer Rues Complacency as Economy Accelerates (Bloomberg)
• Draghi Takes Tough Line on Austerity (WSJ)
• European Banks Hit by Losses (WSJ)
• Moody's: won't take ratings action on Japan on Friday (Reuters)
• Athens told to change spending and taxes (FT)

In a must-watch follow-up to his original Punk Economics Lesson, David McWilliams describes how the new bankocracy in Europe will lead to a massive injection of liquidity; blowing bubbles in financial assets while the citizenry is bled dry (ring any recent bells?). The banks again get all the money they need while the average citizen shoulders the burden. Specifically in the case of the Greeks, they are left with the uncertainty of a return to the Drachma or the certainty of decades of indentured servitude. Enter the ECB with their cash-for-trash deal. This is a scam, he proclaims correctly, insolvent banks lending to insolvent governments and we are calling it success? The banks can turn a tidy profit, but the straight-talking Irishmen asks the question every Greek citizen should be asking: "where does the profit come from?" The answer: the average tax-paying European citizen, and it is this that provides the comfort for the Germans to allow the Greeks to default without bringing down every bank in Europe in a contagious cascade of margin calls, un-hypothecation and deleveraging. Critically, the question is not if or when Greece will default but will they be allowed to default enough? The lesson for all is that to stay in the Euro, all European nations have to become more like Germany - which is very different from the community of equal nations that the Europeans signed up for 20 years ago at Maastricht. Don't be fooled that the European debt story is over, it is not. In fact, he finishes - rather ominously, the interesting bit hasn't even started yet.

Having spent much of the day attempting to explain the difference between nominal and real wealth creation and that asset price movements are different to the economy, we turn back to Michael Cembalest of JP Morgan to set the story straight on one of the most frequently cited reasons for the rally: "It's the economy, stupid".  It is hard to disagree that there are positive signs, but as the JPM CIO opines, let's be realistic: US growth is projected to be ~2.5% for 2012. Some argue that profits are the driver, and they are doing well, but their apparent strength is masked by a sad truth that gets little exposure. Looking at where those profits come from shows that if labor compensation grew at trends comparable to prior recoveries, a big chunk of current-cycle profits would disappear (quicker than a rehypothecated 2Y BTP under Corzine's watch). Cembalest summarizes that while this doesn't mean these profits are entirely illusory; it does mean that they come with related costs: such as weak household income and bloated government budget deficits - which have a cost as well (don't they?).