Archive - Sep 2012 - Story

Going back to the FOMC's own archives reveals some truly stunning disclosures arising from none other than the Federal Reserve on the topics of inflation, currency "debauching", money creation, and what it would take for the Communists and Stalin to win. "I agree with you entirely that the Soviet dictators would like to bring about our economic collapse and, as you know, inflation is perhaps the greatest force for arraying the various sectors of a capitalistic economy against each other. John Maynard Keynes stated in his 'Economic Consequences of the Peace' (1919): 'Lenin is said to have declared that the best way to destroy the Capitalist System was to debauch the currency...Lenin was certainly right. There is no subtler, no surer means of overturning the existing basis of Society than to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose.'"

The Grand Plan, as we have espoused for years, is to force all 'safe' assets to a point where they appear 'rich' to 'risk' assets - and inflate another bubble to take our eyes off the debt being inflated away in the other hand. In the Fed's mind, they tried this before with QE1 and it worked magnificently - lifting stocks phoenix-like from the ashes of a credit-crunch reality. However, this time is different. The last time the Fed forced MBS CurCpn yields down to 'match' the S&P 500's dividend yield was March 2009 - and investors 'rotated' back to risk (to many people's surprise). Yields were at 4% then and the S&P's P/E multiple was 10x; this time yields are just above 2% and the S&P 500's P/E multiple is a staggering 14.9x. We suspect that rather than re-enacting the post-March 2009 eruption, valuations this time will force that liquidity to flood into non-equity asset classes (and with HY call-constrained, it leaves little but the energy and precious metals complex to soak up the Fed's exuberance).

As the US Presidential and Congressional election campaigns move into their frenetic final stages ahead of the November 6th polling date, we thought it would be good to see what the futures markets think about the outcome. As UBS notes, the Iowa Electronic Markets (IEM) are futures markets allow traders to take positions, with real money, on a variety of economic and political events, the best known of which are US elections. Since inception, the IEM has had an impressive track record of forecasting elections, consistently better than conventional polls months in advance. The current data, however, highly contradictory - or Schrodinger-like - as the gap in the popular vote has narrowed significantly, yet the gap in the winner-take-all election result market has widened dramatically in favor of Obama. Furthermore, there is a 70% chance the Republicans wrest control of the Senate and the probability of the democrats gaining a House of Representatives majority is a mere 10%. It would seem gridlock will persist with a divided government - not good news for the fiscal cliff.

If the Federal Reserve’s nightmare comes true and deflation occurs, something else happens that the banks fear and loathe: marginal borrowers default on all their debts. Rather than being easier to pay, the debts become more difficult to pay as money gains value. Marginal borrowers no longer get the “boost” of inflation, so they increasingly default on their loans. How is it bad for hopelessly over-indebted, overleveraged households to default on all their debt and get a fresh start? Exactly why is that bad? What is the over-indebted household losing other than a lifetime of debt-serfdom, stress and poverty? The banks have to absorb the losses, and since they are so highly leveraged, the losses drive the banks into insolvency. They are bankrupt and must close their doors. Note that 99.9% of the people benefit when bad banks absorb losses and close their doors. Only the bank managers, owners and bond holders lose, and everyone else gains as an unproductive, poorly managed bank no longer burdens the economy with its malinvestments and risky bets. The Federal Reserve’s policy of protecting the wealth and power of the banks while stealing from wage earners via inflation is a catastrophe for the nation and the 99.9% who are not financiers, politicians and lobbyists.

If you want to do something for the poor and middle class, encourage deflation.

Nigeria gets it. So why not our distinguished Princeton/MIT/Harvard edumacated PeeEichDees?

• NIGERIA'S SANUSI: ECB, US QUANTITATIVE EASING DRIVING OIL PRICE
• NIGERIA'S SANUSI: THREAT OF HOT MONEY FROM QUANTITATIVE EASING

We give our own Politburo intelligentisa at least 3-4 years before they grasp what is now painfully obvious even in Africa.

As we have been discussing for a few weeks, the European markets need a risk flare for any of the oh-so-conditional firewalls, that have been heralded as cutting risk's tail, to become relevant. What is stunning is the level of disappointment that Rajoy has not requested a bailout yet (noted this morning on CNBC as the reason Europe is red today). It seems, as we pointed out Friday and yesterday, Operation Adios Rajoy is underway in the markets... Spanish bonds have pushed notably higher in yield (with the front-end leaking rather considerably), Spanish 5Y CDS are 21bps wider today, but it is the Portuguese market that we suspect is where the leverage is being applied. The Portuguese market was used as evidence of Draghi's awesomeness and while its illiquidity helped on the way down in yields, it is also hindering now - as Portugal's 10Y is now 70bps higher in yield in the last two days - notably back above an unsustainable 8% (at the same time as government revenues missed expectations - shocker). Risk flare-on.

The spread between Chinese and Japanese US Treasury holdings has declined to a tiny $33 billion, from $430 billion one short year ago (we know that China is now actively buying gold with its current account cash instead of US paper but that is irrelevant for the time being). What is more importantly is which of its top US Treasury holders (the Fed being naturally the largest) will the US end up disappointing: China or Japan, because as much as it wants, it won't be able to support both. What happens if and when the snubbed party decides to dispose of its $1.1 trillion in US securities?

The market rally has assuredly been more powerful than Morgan Stanley had anticipated, defying the weak fundamentals. Many have said they don’t think fundamentals will matter for the rest of this year. We don’t do heroin. We are sure the period of being high on heroin is “enjoyable.” We had thought that most investors would decide this “heroin” wasn’t worth it. We forgot about what it means to be an addict. Will equities continue to go higher simply because the specter of unlimited liquidity is there or will investors see through to the other side of the “high”? People can’t envision a catalyst to make fundamentals matter, they can’t envision a catalyst for earnings to come down, and they still think the “tradable rally” from positioning and policy will last. It well may last for a while more, but the disconnect from fundamentals can’t last forever. We all know that the current “bad is good, good is good” mentality can’t persist.

Curious why the mere prospect of a gold, or gold-linked "standard" (or any other hard-asset backing for that matter) - a monetary system in which the creation of money units, i.e., literally the creation of money out of thin air, is constrained by some real-world limitation is the scariest thing to the status quo, the following chart courtesy of Grant Williams should explain it all. It shows the expansion of the world's monetary bases coupled with the expansion in the world's gold supply over a comparable period. Needless to say, expanding the money supply at 8% in several years will hardly lead to the massive inflation needed to "inflate away" the roughly $35 trillion in debt overhang by now (vs $21 billion through 2009) that is crushing the entire developed world.

Global gold production remains at its level of the late '90s, even though prices have risen to over $1,700 per ounce from $252 per ounce in 1999 or roughly 16% per annum in dollar terms. Only Rio Tinto and Ivanhoe's Oyu Tolgoi mine in Mongolia stand out as a major new gold mines expected to begin production in the near future. Bulls note that global production has remained impervious to the price of gold. This may continue to be the case due to the increasingly obvious geological constraints being seen in the gold mining sector. Resource nationalism is beginning to become an important factor again. This will also almost certainly affect supply at a time when demand is increasing from people throughout the world and many hedge funds, pension funds and central banks’ due to geopolitical, systemic and monetary risks. The lesson of QE is that fiat currencies increasingly grow on trees. Gold does not.  This is the primary reason that gold will continue to protect investors in the coming months.

The world is awash in liquidity. If you listen closely you can hear the giant slurping sound of it rushing the shores at home and continents away. The Fed is providing it and the ECB is providing it while China doesn’t need it but it is sloshing around anyway. The world’s problems, the financial mess in Europe, the global slowdown that is resplendent from sea to not-so-shining sea is all being addressed with liquidity. Liquidity provided must be paid back and if the banks and nations that receive it do not provide structural changes, reduce their deficits, decrease their borrowings then, ultimately, the gods of chaos are unleashed. The applause of today may become the tears of tomorrow if the current course continues.

Stocks fell in Europe today, that’s in spite of the fact that German investor confidence rose the first time in 5 months (ZEW), as market participants focused on somewhat unfavourable auction schedule for Spain, which may force the Treasury to raise its T-bill issuance in order to meet its zero-net funding target. As a result, Bunds traded higher throughout the session, with the shorter-dated Spanish and Italian bonds underperforming (Italian and Spanish 2s up by c.3bps). Of note, Spanish 10y bond yield has risen back above 6% and given the upcoming supply, there is a risk that yields will continue to rise and flatten the curve. On that note, the Spanish Treasury is set to sell a new 3y benchmark and a 10y re-opening this Thursday, which proved notoriously difficult to sell in the past. Spain is also planning to issue EUR 8bln in private placements with EUR 3bln on Sep-21st and EUR 5bln in mid-October.

"The bottom line is simple: The Fed and the ECB are directing and attempting to orchestrate the grossest misallocation and mispricing of capital in the history of mankind. Their problem is that their actions have enormous unintended and even (eventually) intended consequences which serve to negate their actions in the shorter run, and which could create even bigger problems than we currently face in the near future. Kicking the can is not a viable policy for us now. The private sector knows all this, consciously and/or sub-consciously, which is why I feel these current policy settings are doomed to fail. Having said all that, the one area which for some reason still holds onto hope that Draghi and Bernanke can still perform feats of "magic" is the financial market, which central bankers assume, rely on and are happy to encourage Pavlovian responses. The reality here though is that even financial markets are, collectively, either sensing or assigning a half-life to the "positives" of central bank debasement policies, which to me means that even markets are only suggesting a short-term benefit from the latest policy actions. This is not what Draghi and Bernanke are hoping for, but in order for them to see the half-life outcome averted they know that we need to see major political and structural real economy reforms which somehow make Western workers competitive and hopeful again. The track record of the last four to five years inspires very little confidence that we will see such great necessary reformist strides taken anytime soon."

• Nothing has changed and things have just gotten worse: Europe Banks Fail to Cut as Draghi Loans Defer Deleverage (Bloomberg)
• Mitt Romney secret video reveals views on Obama voters (BBC)
• Romney Stands by Government-Dependent ‘Victims’ Remark (Bloomberg)
• Video shows Libyans helping rescue U.S. ambassador after attack (Reuters)
• Fannie Mae paid BofA premium to transfer soured loans-regulator (Reuters)
• Northrop to shed nearly 600 jobs (LA Times)
• LOLmarkets: Retail Currency Traders Turn to Algorithms (WSJ)
• U.K. Royal Family Wins French Ruling on Kate Photos (Bloomberg)
• Nevada recluse dies with $200 in bank, $7 million in gold at home (LA Times)
• Gap Between Rich and Poor Grows in Germany (Spiegel)
• Chicago teachers meet Tuesday to decide whether to end strike (Reuters)
• Australia's Fortescue wins debt breather, shares soar (Reuters) ... a deal which ultimately will prime equity and unsecureds by $4.5 billion in secured debt
• Ford car sales fall 29% in Europe (FT)

Anyone who thought that anti-Japan protests would quietly go away on the 81st anniversary of the Japanese invasion of Manchuria may have to reevaluate. First, overnight the HKEJ said that China is preparing economic sanctions against Japan, and as the situation again escalates, Reuters reports that at least two of 11 Chinese ocean surveillance and fishery patrol ships sailing near East China Sea islets claimed by both Tokyo and Beijing have entered what Japan considers its territory, public broadcast NHK said on Tuesday, quoting Japan's Coast Guard. Subsequently, NHK reported that "a Chinese fisheries patrol ship has departed after approaching Japan's territorial waters off the Senkaku Islands in the East China Sea. The Japan Coast Guard remains on the alert, saying the Chinese vessel may enter the area again. The Coast Guard spotted the boat some 43 kilometers north-northwest of the largest island, Uotsuri, early Tuesday morning. The Coast Guard confirmed the boat had left the area before 10:30 AM. It said at around 11:10 AM, the vessel again approached Japan's territorial waters off another island and left soon afterward. In response to warnings from Japan's Coast Guard, the Chinese vessel replied the islands are inherent Chinese territory and that its mission is legitimate." Watch this space carefully, especially once the Chinese armada of 1000 fishing boats, which is already en route to Senkaku, engages in a stand off with Japanese battleships: "China's state-run radio has reported 1,000 fishing boats have left the provinces of Zhejiang and Fujian for waters near the Senkaku Islands. But Japan's Coast Guard says it has not yet spotted a large fleet in the area." It will quite soon. Elsewhere, sentiment across mainland China is getting the opposite of better, fast.