The Economist

The odds of some instability erupting globally in 2013-14 seem high, but what the trigger might be remains unknown. The fragility and vulnerability of systems pushed to extremes are like sandpiles: it doesn't really matter which grains finally trigger the cascade; the system's rising instability is the causal factor. Where does this put us? If the ultimate crisis is another decade away, we might as well enjoy what we can in the meantime and assemble the pieces of a semi-sustainable life: income streams that we own/control, a very low cost of living, and property in areas that are universally desirable, i.e. they have decent weather, surface supplies of water, concentrations of intellectual and financial capital, and ideally, a functioning local government that isn’t hopelessly corrupted by vested interests. Any disadvantages in these resources can be offset by a solid network of friends, family, associates, business contacts, etc., i.e. social capital. I think it is safe to assume the promises of Social Security, Medicare and pensions will be chipped away by one force or another (inflation, taxation, “austerity,” etc.) and so those who have written these out of their own personal expectations will be psychologically primed for self-reliance embedded in local support networks.

Who knows? not me.

To use the analogy offered by Senor Cervantes we would say that Rodrigo, as representing Spain, is about to be devoured by the snakes. The central bank of Spain just released the net capital outflow numbers and they are disastrous. During the month of June alone $70.90 billion left the Spanish banks and in July it was worse at $92.88 billion which is 4.7% of total bank deposits in Spain. For the first seven months of the year the outflow adds up to $368.80 billion or 17.7% of the total bank deposits of Spain and the trajectory of the outflow is increasing dramatically. Reality is reality and Spain is experiencing a full-fledged run on its banks whether anyone in Europe wants to admit it or not. We are now at the virtual epicenter of the European Crisis where decisions will have to be made; avoidance is no longer possible. We have reached the end of the road where there is no more path left for can kicking.

Many have talked about it. More have eschewed it. But Minsky's hugely important insight in asking the question "Can 'It' Happen Again?" regarding the Depression remains critical reading for any- and every-one who opines day-in and day-out on how much we need or do not need Central Bank money-printing. As Bill Gross put it: "Minsky, originator of the commonsensical “stability leads to instability” thesis; the economist with naming rights for 2008’s “Minsky Moment”; the exposer of the financial fragility of modern capitalism; probably couldn’t imagine the liquidity trap qualities of zero-based money, because who could have conceived 30 or 40 years ago that interest rates could ever approach zero per cent for an extended period of time? Probably no one. Nor, more importantly I suppose, can Ben Bernanke, Mario Draghi or Mervyn King. In their historical models, credit is as credit does, expanding perpetually after brief periods of recessionary contraction, showering economic activity with liquid fertiliser for productive investment and inevitable growth." For a long-weekend, we present the full 30-year-old must-read paper.

In the past 50 years, the way health care is financed has changed, with private payers and public insurance paying for more care. The California Healthcare Foundation has created this excellent interactive graphic shows who paid for the nation's health care and how much it's costs have shifted since 1960. The tree-map provides an intriguing exposition of the 'relative costs' but as The Economist adds, with regard the 'absolute costs': American healthcare costs increased by roughly 100 times, from $27 billion in 1960 to $2.6 trillion in 2010.

Two years in and they are only starting now? What took them so long. Also, absolutely nothing new here, but merely the latest attempt to shift public opinion and EUR viability perceptions ever so slightly by one of Germany's most respect magazines. Those whose agenda it is to spook Germany with images of fire, brimstone, and 3-page mutual assured destruction termsheets if the Euro implodes, are now free to take the podium. One wonders: if it wasn't for the inevitable collapse of the EUR.... the inevitable collapse of the EUR.... the inevitable collapse of the EUR.... the inevitable collapse of the EUR, and of course Paul Ryan, would there be absolutely no news today?

Will Germany leave the Euro? I believe so. The country is already  bordering on insolvency due to nearly €1 trillion in backdoor EU bailouts (pushing Germany’s Debt to GDP to 90%). Over 69% of Germans are worried about inflation. Angela Merkel is up for re-election next year (and has gained political points anytime she played hardball with Europe) and Germany has implemented steps to place a firewall around its financial system and passed legislation allowing it to leave the Euro if need be.

Otherwise… No titbits…

Nada. Rien. Nichts. Nothing.

Gluskin Sheff's David Rosenberg details the four major downside risks for US growth over the next four quarters:

1. More Adverse News Out Of Europe
2. The Sharp Run-Up In Food Prices
3. Negative Export Shock
4. The Proverbial Fiscal Cliff

Whether it is central bank policy leaked as a strawman or as Stephen Roach notes, Jon Hilsenrath is the new Fed head (as what he writes - prompted by 'friends' - must be adhered to for fear of disappointing markets), UBS' Art Cashin notes a strange coincidence this week. While WSJ's Hilsenrath is the unofficial floater-of-ideas-and-saver-of-markets in the US, it appears The Economist's Greg Ip is the ECB's unofficial suggester-in-chief. As the avuncular Art notes "Mario Draghi's comments stunned the markets. What prompted the timing of the move? We'd like to present a possibility"

This is looking more and more like a modem-day depression. After all, last month alone, 85,000 Americans signed on for Social Security disability cheques, which exceeded the 80,000 net new jobs that were created: and a record 46 million Americans or 14.8% of the population (also a record) are in the Food Stamp program (participation averaged 7.9% from 1970 to 2000, by way of contrast) — enrollment has risen an average of over 400,000 per month over the past four years. A record share of 41% pay zero national incomes tax as well (58 million), a share that has doubled over the past two decades. Increasingly, the U.S. is following in the footsteps of Europe of becoming a nation of dependants. Meanwhile, policy stimulus, whether traditional or non-conventional, are still falling well short of generating self-sustaining economic growth.

Duration mismatch is when a bank (or anyone else) borrows short to lend long.  It is fraud, it is unfair to depositors (much less shareholders) and it is certain to collapse sooner or later. This discussion is of paramount importance if we are to move to a monetary system that actually works. By taking demand deposits and buying long bonds, the banks distort the cost of money.  They send a false signal to entrepreneurs that higher-order projects are viable, while in reality they are not.  The capital is not really there to complete the project, though it is temporarily there to begin it. Capital is not fungible; one cannot repurpose a partially completed desalination plant that isn’t needed into a car manufacturing plant that is.  The bond on the plant cannot be repaid.  The plant construction project was aborted prior to the plant producing anything of value.  The bond will be defaulted.  Real wealth was destroyed, and this is experienced by those who malinvested their gold as total losses. Note that this is not a matter of probability.  Non-viable ventures will default, as unsupported projects will collapse. Unfortunately, someone must take the losses as real capital is consumed and destroyed - and these losses are caused by government’s attempts at central planning, and also by duration mismatch.

European equities are seen softer at the North American crossover as continued concerns regarding global demand remain stubborn ahead of tonight’s Chinese GDP release. Adding to the risk-aversion is continued caution surrounding the periphery, evident in the Spanish and Italian bourses underperforming today. A key catalyst for trade today has been the ECB’s daily liquidity update, wherein deposits, unsurprisingly, fell dramatically to EUR 324.9bln following the central bank’s cut to zero-deposit rates. The move by the ECB to boost credit flows and lending has slipped at the first hurdle, as the fall in deposits is matched almost exactly by an uptick in the ECB’s current account. As such, it is evident that the banks are still sitting on their cash reserves, reluctant to lend, as the real economy is yet to see a boost from the zero-deposit rate. As expected, the European banks’ share prices are showing the disappointment, with financials one of the worst performing sectors, and CDS’ on bank bonds seen markedly higher. A brief stint of risk appetite was observed following the release of positive money supply figures from China, particularly the new CNY loans number, however the effect was shortlived, as participants continue to eye the upcoming growth release as the next sign of health, or lack thereof, from the world’s second largest economy.

With AAPL and several other strange-attracting hedge fund hotels dominating the holdings of the 2-and-20'ers, we thought it timely that Bloomberg TV would point out today that their aggregate hedge fund index is now significantly underperforming the S&P 500 (from both the top in 2007 and the lows in 2009 - in order to be fair). While the assumption is that 'sophisticated' investors are paying for alpha - and as always the focus is absolute return on the way up no matter what the mandate - it seems the extreme correlations both across asset-class and within-and-across individual equities (as we have discussed in depth - most recently here) have indeed eaten into any 'value' that has empirically been added. As The Economist notes, in June "funds suffered the largest withdrawals in assets since October 2009." Furthermore, as Citi's recent study on risk drivers shows, the high-beta momentum trade has become by far the most crowded trade around - so even sales of DB9s and NYC apartments are now entirely dependent on NEW QE coming before year-end.

Josh Barro of Bloomberg has an interesting theory.  According to him, conservatives in modern day America have become so infatuated with the school of Austrian economics that they no longer listen to reason.  It is because of this diehard obsession that they reject all empirical evidence and refuse to change their favorable views of laissez faire capitalism following the financial crisis.  Basically, because the conservative movement is so smitten with the works of Ludwig von Mises and F.A. Hayek, they see no need to pose any intellectual challenge to the idea that the economy desperately needs to be guided along by an “always knows best” government; much like a parent to a child.  CNN and Newsweek contributor David Frum has jumped on board with Barro and levels the same critique of conservatives while complaining that not enough of them follow Milton Friedman anymore.

To put this as nicely as possible, Barro and Frum aren’t just incorrect; they have put their embarrassingly ignorant understandings of Austrian economics on full display for all to see.