13 Economic Tales To Take You Into 2013
"Are the key governments and their leaders able to maintain confidence in this fragile system?" "Are 'they' going to do the 'right' things?"
It may not be apparent immediately, but in the aftermath of last night's epic collapse in fiscal cliff negotiations, which incidentally was perfectly obvious to anyone with half a brain and who experienced last summer's debt ceiling fiasco, which sadly excludes all paid political and financial - including sellside - commentators, all of whom expected a prompt resolution to this polarized issue as recently as a week ago, there is major behind the scenes panic. Because while banks would write profuse, long-winded essays to explain the logic and rationality of the "deal", now that they are all faced with adjusting their narrative the best they can come up with are two sentence fragments such as this one from Citi's Steven Englander "Problem is that it is the right wing of the Republican Party that wouldn’t give Boehner their support, making it less likely that he could win broad support among Republicans for a compromise with the White House. Also he will have to spend next couple of days negotiating with both his own party and the Democrats without knowing how much he can deliver." The answer: nothing at all. In fact as Scott Rigell said “I’m not sure the people who have been up here 20 or 30 years really understand what the next iteration of this process is”. He is speaking for pretty much everyone else who has now been made a total fool by the Black Swan that is Congress. As a reminder a 3 month delay resolution assures a US recession, and a ~20% or so minimum correction in the stock market, which has been priced for absolute perfection for months, and which will once again have to be used by Wall Street as a means to get a consensus out of DC. Just as we predicted over a month ago. Finally while we may have avoided the Mayan apocalypse, we do have a quad witching and a NASDAQ rebalance to look forward to. Enjoy!
One of the best bond traders on Wall Street said this recently: “Get ready for The Great Bond Shortage in North America. If it has a cusip and it is rated, it is going higher/tighter.” The compression in bond spreads since the Fed started all of their “made-up/newly printed money for free” antics is the root of all of this and we do not expect a change anytime soon. There are various estimations for the 2013 net new issue supply in all sectors of Fixed Income but I peg it around $400 billion. Around $800 billion will be paid to bond holders during the year in coupon payments and, if reinvested, will cause a supply deficit of about $400 billion for the year. Exacerbating all of this is the Fed, who will buy around $500 billion in MBS this year and perhaps the same amount in Treasuries which could take $1 trillion out of the market all by itself. Consequently we face a lack of bonds denominated somewhere between $900 billion and $1.4 trillion, depending upon the Fed, which will increase the rolling train of compression, lower interest rates further in all likelihood and cause great angst for investors who will find very little of value left in the Fixed Income markets. Safety; yes but yield; no. Inflation and Deflation, it should be noted, only work in operative systems; but it is not Inflation or Deflation that are going to matter in the short run, though it will later; it will be the lack of bonds of any sort to purchase and a stock market that may be dangerously out of sync with the fundamentals opening the possibility of a crash. If so much money is printed and so little regard is placed upon fundamental economic principles then the Real Estate crash of several years ago will look like child’s play by comparison. “Systemic Breakdown” would be the functioning words.
With only three days to the big unveiling, the candidates are essentially tied for the Presidential election. The Reuters/Ipsos daily tracking poll released this morning has (of likely voters) 47% backing Obama and 46% backing Romney. The two statistics fall within the realm of statistical noise implying there is no difference and that is why so much time is now being spent in the battleground states; especially since the same poll has Obama leading on electoral college votes and such a huge swathe of 'undecideds' who remain very balanced. The closeness of the race does raise the concern about Bush-Gore-like hanging-chad discord and as we have discussed in the past (the 70-percent, the 3.5 class society, and the Political Black Swan). The chances of social unrest at a close decision are non-negligible in the current environment and should not be dismissed; though we are not sure that Bill Maher's 'comedic' sentiment is really helping: "If you're thinking about voting for Mitt Romney, I would like to make this one plea: black people know who you are and they will come after you."
What if the fiscal cliff collides with a replay of the Bush vs Gore 2000 election fiasco...
The ECB has $15 trillion in loans outstanding to Europe. They claim a $4 trillion balance sheet based upon not counting guaranteed loans by various nations and by not counting contingent liabilities. This is the same scheme that is used for calculating the debt to GDP ratios of the countries in Europe. If a loan, a debt, is guaranteed by a nation or if the liability is “contingent;” it is not counted. This, of course, does not mean that possibility of having to fund or write-off something is not there; it just means it is not counted. Do not disregard or minimize the recent announcement by Germany, Finland and the Netherlands that was joined twenty-four hours later by Austria. The funding nations in Europe placed a line in the concrete when they rejected assisting legacy issues and loans. This group of nations vacated, in this one statement, all of the pleas and demands of the periphery countries that had lined up for aid and ever-more aid relying upon the pledges of the solidarity of Europe and they got an answer, a very Germanic answer which is not, I am quite sure, what they wanted to hear.
What Do Economic Indicators Show? What Do Economists Say?
Meet the man, who many say (most of whom correctly) has been running pretty much everything from deep behind the scenes.
It would appear the concerns regarding rising rates in the Treasury Bond market are overblown - no matter how much the inflation break-evens spike. Implied volatility for the Interest Rate market is practically at all-time record lows currently as the Fed continues to remove duration and high convexity assets from the market. One thing concerns us though - the velocity of spikes in volatility once it gets down to these levels has empirically been tremendous - though we are sure this time it's different. In fact this time is different, since this time it is the Fed (as majority owner) that faces the pain from the now-marginal Minsky-like seller of Treasuries running away from inflation-flares (or China/Japan tensions) - and what would Treasury do without that pass-through ponzi revenue from the Fed's winnings? Or as Taleb wrote: "There is no freedom without noise - and no stability without volatility."
Since 2007 our analysis has suggested the likelihood of economic outcomes that most have considered unlikely: significant and ongoing monetary inflation, policy-administered currency devaluation, substantial global price inflation, and an eventual change in how the forty year old global monetary system is structured. Most observers have viewed such outlooks as tail events – highly unlikely, unworthy of serious consideration or a long way off. We remain resolute, and believe last week’s movements in Frankfurt and Washington towards perpetual quantitative easing confirmed and accelerated the validity of our outlook. With QBAMCO's view that $15,000 - $19,000 Gold is possible, timing of the catch-up phase is impossible - though they suspect last week's events may be the catalyst that begins to raise public awareness of the link between monetary inflation and price inflation.
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.
"If you’re rich you get a bailout. If you’re poor you get a handout. And if you’re middle class you get left out." That's not a sustainable way to run the system, exclaims investment strategist Keith Fitz-Gerald. A cancer at the core of our current economy is the magical thinking, "no pain, all gain" philosophy, pursued by those running it. They are doing all they can to remove the consequences of failure from the system -- blind to failure's essential 'waste-clearing' function in a healthy free market. Without the discipline of Darwinism, the individual actors in the system make all sorts of malinvestments that would never make sense in an efficient marketplace. But since the losses from these inane pursuits are socialized, there's no incentive to stop making them. At least, up until the point where the class whose back is burdened with paying for the socialized messes finally breaks.
The US is clearly heading into another recession in the context of a larger depression. And it’s doing this while in the worst economic shape in its post-WWII history. We’ve never once entered a recession when the average duration of unemployment is at an all time high, industrial production has failed to break above its previous peak, and food stamp usage is at a record high. We’ve never done this.