Archive - Jul 10, 2011 - Story

Technically the title of this post is wrong: the truth is that nobody could possibly know or predict what a bank run would looks like in details suffice to say that it would have terminal and devastating results on the global economy. One needs only remember what happened when the Reserve Fund broke the buck and the $3 billion money market industry was at risk of unwinding (for those who do not, Paul Kanjorski does a good summary here). What we do, however, wish to demonstrate is the tenuous balance between physical money - yes, just like precious metals, there is actual "physical money", better known as currency in circulation - and more abstract, confidence-based, "electronic money." Now when it comes to talking about systemic instability, pundits often enjoy bringing up the case of the $600+ trillion (recently discussed here in a different capacity) in synthetic derivatives, whose implosion would "wipe out the world." While that may indeed be the case (the memory of the CDS-precipitated AIG implosion is still all too fresh), since nobody really can comprehend the side effects of the collapse of global derivative system, which by some estimates is over $1 quadrillion when combining exchange and OTC based derivatives, it is largely based on pure conjecture. And, as we demonstrate below, one doesn't even need to do get that high up in the pyramid of credit money. The truth is that should there be an American bank run, what would happen is the conversion of all electronic dollars into physical dollars, as retail Americans rush to empty their checking and savings accounts, exit their money markets, while institutional America converts all "shadow" liabilities into hard dollar assets (Zero Hedge has a specific methodology of defining what liabilities make up the shadow banking system). The truth is that should there be a D-Day in the American banking system and there is a global scramble for physical paper (ignore gold) the conversion ratio for binary dollars into hard ones could be as high as 30 to 1. Which begs the question: should one apply a 90% discount when evaluating their electronic dollar exposure? That, and many other questions too...

Remember when the dollar reigned supreme, and nobody cared about that joke of a currency, the Chinese Renminbi? Neither do we. And neither does the CME, which just announced it is launching USD/CNY futures, which will be available in standard and E-micro sizes beginning August 22. Put otherwise, with one fell swoop the CME will now allow one to transform liability risk, credit and maturity of underlying assets from one currency to another, while on margin (granted, exposed to the same margin shenanigans that make silver bulls scream blood murder every time the CME's name is mentioned). And the CME is just the beginning of what soon will allow everyone to denominate their liability exposure into the Chinese currency. In the process, the dollar lost yet another battle, as it continues to lose the war.

In 1938 the citizens of the major European powers, Germany, France and the UK, along with isolationist America, having suffered grievously during WW1 were willing to believe almost any lie that supported the prevailing sentiment. Sentiment exemplified by the aforementioned timeless speech from Neville Chamberlain. Today I see a European political and economic elite clinging desperately to the notion that any action that calls into question the current construct of pan-European “unity” must be quashed to preserve the peace. The reality from the available evidence suggests that what these elites are more fearful of is broad realization that this current construct is as fatally flawed as the one in existence in 1938.

After meeting for exactly 75 minutes, the president and members of congress achieved absolutely nothing except for what ZH readers already knew: that a debt deal has to be reached by July 22 or else. "President Barack Obama said Sunday that "we need to" work out a debt deal within the next 10 days as he convened a meeting with congressional leaders, aiming to fashion a deficit reduction package for the next 10 years. As the meeting opened, Obama and the leaders sat around the table in Sunday casual dress. Asked whether the White House and Congress could "work it out in 10 days," Obama replied, "We need to." Despite Boehner's preference for a smaller, $2 trillion plan for deficit reduction, White House aides said Sunday that Obama would press the lawmakers to accept the larger deal. Republicans object to its substantial tax increases and Democrats dislike its cuts to programs for seniors and the poor. The aides, however, left room for negotiations on a more modest approach." And just like on Friday when the president's appearance was heralded as a harbinger of a massive NFP beat only to be the biggest let down since Geithner's TV appearances in February which sent the market down by 10 S&P points each time, so the president will address the nation tomorrow. From Reuters: "U.S. President Barack Obama will hold a news conference at 11 a.m. EDT (1500 GMT) on Monday about the status of negotiations to cut the deficit and raise the debt ceiling, the White House said on Sunday. Obama met with congressional leaders for about 75 minutes Sunday evening and will meet again with them on Monday "to discuss the ongoing efforts to find a balanced approach to deficit reduction," the White House said, without giving a time for that session."

Something curious happened with outstanding Treasury debt over the past few years: after plunging in average maturity to just 49 months during the Lehman crisis, when everyone scrambled to safety of Bills and the Treasury was forced to issue gobs of it, since then average maturity has been a one way street, and as of the end of Q1 as per the most recent quarterly refunding statement, is at 60 months. This is the "oldest" average Treasury age since 2003, and a substantial shift from the recent average of about 55 months. Incidentally, 60 months is what Stone McCarthy calculates is the average maturity of Fed SOMA holdings (as in debt purchased as part of the various QE programs). Keep in mind this chart is as of March 31: in the past three months due to the debt ceiling breach, Geithner has aggressively reduced Bill rollovers, which means the average Treasury age is likely about 65 months if not more. And while we have discussed the imminent surge of Bill issuance as soon as the debt ceiling is raised, this will be nowhere near enough to get the Treasury comfortable with average bond aging. Since Geithner will certainly do all in his power to reduce the average duration on marketable bonds to recent historic lows, the only way we can think of this happening on a "voluntary" basis is for a recreation of the same Lehman conditions that forced a 6 month change in maturity in the span of 60 days back in October 2008.

The European financial system, like the others, is efficient but is not robust. It makes the most of what it has and runs on a razor edge between efficiency gains for individual agents and horrendous systemic losses. It depends crucially on the performance of its sovereign assets. System survival depends on one hand whether or not counterparties can absorb the necessary haircuts and on the other, whether fundamentals of debtor nations are strong enough to stand on their own. Spain and Italy will have to stand on their own, because when Greece goes, Ireland will most likely go, which will in turn set off a critical mass such that the nation who dictates monetary policy (Germany) will be taking care of its own self.

China activity data: Following the June CPI print, which saw inflation rise to 6.4% yoy, in line with our above-consensus forecast, we will be looking for above-consensus activity readings for Q2 GDP and June industrial production. Eurogroup meeting and bank stress tests: This will be an important policy week for Europe. On Friday, the IMF approved its disbursement to Greece under the old EU/IMF program of EUR110 bn agreed in 2010. Discussions at the Eurogroup meeting will center on the financing of a new program, which is supposed to close the financing gap for Greece for 2012 and 2013. The role of private sector involvement remains a key issue. The week also brings a bond auction for Italy on Thursday, for an estimated EUR7 bn. The week ends with the publication of the EU-wide bank stress tests on Friday. Summary results will be published at 6 pm CEST, with bank-by-bank results following thereafter. Bernanke testimony: In his semiannual monetary policy testimony, Fed Chairman Bernanke is likely to repeat the basic message from his recent press conference—namely that labor market performance has been disappointing but that inflation remains too high to combat the weakness with additional monetary easing.

The earlier news that Italy's regulator may forbid naked short selling in a desperate attempt to preempt the bond vigilantes from taking down the country's financial system (how shorting stocks prevent evil speculators from selling bonds is somewhat confusing) has been confirmed. But that's just the beginning. The latest twist is that the Consob has also requiring shorts to immediately disclose their short positions "in an effort to increase market transparency." Odd how shorts are never required to be exposed when the markets are surging (or how silver margins have yet to be reduced despite the near 40% price drop in the metal from recent peaks). It gets worse: from Bloomberg: "The European Securities and Markets Authority, which co- ordinates the work of national regulators in the 27-nation EU, should be given emergency powers to temporarily ban short selling or trades in CDS on sovereign debt in the EU, the Parliament said. The Italian regulator said short sellers must disclose their net positions when they reach 0.2 percent or more of a company’s capital and then make additional filings for each additional 0.1 percent."

Once again the great diversionary scapegoating of speculators begins, after as Il Sole 24 Ora reported that the Consob, or Italy's regulator, may enact a naked short selling ban as early as tonight. The premise is that it is the shorters who are responsible for the ruinous state of the global ponzi. Not the fact that it is a, well, global ponzi. Distraction 101. And yes, it did not work back in 2010 when banning naked shorting was implemented in other European countries, it will not work this time either. But it won't stop bankrupt governments from trying. To wit: "Commissioners will assess the situation before markets open Monday, said a Consob spokesman, who declined to be named in line with the regulator's policy. Commissioners may decide to restrict "naked" short-selling in line with similar decisions taken in other European countries, he said.... The Consob meeting occurs after shares of Italy’s biggest banks fell to the lowest in more than two years on July 8, and government bonds dropped, driving 10-year yields to a nine-year high." 24 Ore adds: "Consob intervened several times in the past on short selling after the collapse of Lehman Brothers to protect stock markets."

So much for China converting from an export-led economy to a consumer-driven society. In June, the Chinese trade balance soared to $22.3 billion, nearly double the consistently clueless economist consensus of $14.2 billion. The surplus was $13.1 billion the previous month and $20 billion a year earlier. This was a result of an all time record in gross exports which hit $162 billion in June, driven by all time high exports to both the US and the EU, at $28 billion and $30.3 billion, respectively. Also, the surge in Chinese exports to the US in June to a near record $19.1 billion (lower than just the $19.4 billion in July 2010), means that the official read of the US trade deficit which will be reported on Tuesday, will almost certainly spike, pushing GDP expectations lower yet again. This is precisely the last news China needed as the surge in new money entering the economy will merely hasten an already overheating economy, and following yesterday's announcement of June CPI coming in at 6.4%, it likely means that the PBoC's statement that inflation is now under control is full of hot air. It also likely means many more attempts at tightening are imminent: expect another RRR hike within a few weeks. Per Bloomberg: "The surplus adds to the cash flooding the economy and complicates Premier Wen Jiabao’s efforts to cool the fastest inflation in three years. Policy makers are seeking to rein in price gains that are stoking social discontent without choking off growth that’s already showing signs of slowing. “We don’t think the PBOC will halt monetary tightening soon,” said Liu Li-Gang, head of Greater China economic research at Australia & New Zealand Banking Corp. in Hong Kong. The central bank will increase bill sales to soak up the extra liquidity from the trade surplus and prevent it from boosting money supply, he said." It also likely means that repo rates and SHIBOR will continue their inexorable trek higher as the Chinese central bank is the latest to find itself between the rock of short-end liquidity constraints, and the hard place of long-term "anchored" inflation expectations.

The latest italy contingency stunner comes from Die Welt which has just reported that the European rescue fund will be insufficient to bail out the latest biggest loser in the game of musical ponzi chairs, Italy. As Reuters translates: "The existing rescue fund in Europe is not sufficient to provide a credible defensive wall for Italy," the central bank source was quoted telling the newspaper in an advance text of an article to appear on Monday. "It was never designed for that," the source added." The newspaper said that the rescue fund might have to be doubled to up to 1.5 trillion euros. But it was not clear if it was the central bank source calling for the increase." Doubling the bailout fund is not a new idea and was previously proposed by Nout Wellink of the Dutch Central Bank, although as Die Welt explains, the decision will ultimately be not that of the ECB but of the separate governments. Germany, as a reminder, is already the biggest backstopper of Europe, and is on the hook for €211 billion euros as the primary funder of the EFSF: which just happens to be the CDO at the heart of the eurozone. Should Germany have to add another 200 billion euros to its rescue commitment, Merkel can forget any and all reelection chances, which is funny since just today it was announced that "Chancellor Angela Merkel has stated publicly that she wishes to run again in 2013. This comes as polls show she would face strong challengers from the opposition Social Democrats." Her chances would be roughly zero if German taxpayers learn that the fate of a failed monetary experiment is increasingly more reliant on their direct labor even as the populations of "austere" countries refuse to work and merely subsist on existing entitlements.

Bill Buckler presents an amusing compendium of facts, let us call them inconvenient truths, in the latest edition of his newsletter, some of which would make for very entertaining anecdotes if presented at the Biden "deficit cutting" talks, which also, and very paradoxically, aim to cut US debt by increasing it.

As was reported last week, Europe has suddenly found itself shocked, shocked, that the bond vigilantes decided to not pass go and go directly to the purgatory of the European core, in the form of the country that, at €1.5 trillion euros, has more debt than even Germany, but far more importantly, has a debt/GDP ratio of over 100%, and has the biggest amount of net notional CDS outstanding (not to mention that it has dominated Sigma X trading for the past several weeks). Italy. On Friday we explained why things are about to get really ugly for the boot as a flurry of bond auctions is now imminent. Which is why it was not surprising to read that tomorrow morning the European Council has called an emergency meeting "of top officials dealing with the euro zone debt crisis for Monday morning, reelecting [sic; we assume Reuters means reflecting] concern that the crisis could spread to Italy, the region's third largest economy." Newsflash: the crisis has spread to Italy. And it will only get worse at this point as Spain is largely ignored for now (until its own mortgage crisis starts making daily headlines like this one, however, where courtesy of the insolvent Cajas which are simply a GSE waiting to be nationalized, the can will be kicked down the road for at least 6-9 months ) and the vigilantes start dumping Italian debt and buying up every CDS available and related to Italy. "We can't go on for many more days like Friday," a senior ECB official said. "We're very worried about Italy." But, but, didn't Draghi just say Italy's banks will pass the second, "far more credible" stress test en masse? Welcome to the second, and final, part of the European insolvent dominoes contagion, the one which culminates with everyone bailing each other out... and the death of the euro currency of course.