Capital Markets

With declining crude revenues clashing head on with the cost of simultaneously financing the state while intervening militarily in Yemen, the Saudis are looking to tap the bond market (a move which could increase debt-to-GDP by a factor of 10 by the end of next year) and some are speculating that the riyal’s dollar peg could ultimately prove unsustainable. Now, as Bloomberg reports, "Saudi Arabia is seeking to cut billions of dollars from next year’s budget because of the slump in crude prices."

Every Federal Reserve Chair since 1979 has faced a notable challenge in the first 12-20 months of their tenure – something akin to capital markets “Bullies” hazing the new kid at school. Paul Volcker had the 1979-1980 Iranian oil shock/recession, Alan Greenspan the 1987 Stock Market Crash, and Ben Bernanke the 2007 Financial Crisis. Their responses shaped market perceptions about Federal Reserve priorities and set the stage for the remainder of their tenures, from Inflation-Fighting Volcker to Save-the-World Bernanke. Now, it is Chair Yellen’s turn...

"... others took us to task a great deal more disconcertingly, calling upon us to close our business; to take up another vocation; to stop making “calls” and as one “pundit” rather comically suggested we should go have sexual relations with our self."

My advice to my generation if they would like to buy various assets is to just literally say to yourself, "Don't think about the price or what other people are paying. Just ask: 'What would I pay for 1 share of XYZ, knowing it has an artificial edifice around it?'" Then take a swing while flying blind and pray you hit it.

But until that is no longer the case, count me out. Me and my entire generation.

"The hedge fund guys didn't build this country. These are guys that shift paper around and they get lucky. They are energetic. They are very smart. But a lot of them - they are paper-pushers. They make a fortune. They pay no tax. It's ridiculous, ok?"

So now comes the era of gluts, shrinking profits and a drastic deflation of the giant financial bubble that the world’s central banks have so foolishly generated. And this time they will be powerless to stop the carnage. Yet the beleaguered central bankers will launch desperate verbal and market manipulation ploys to brake the current sell-off and thereby preserve the bloodied remnants of their handiwork.  When in response the gamblers make their eighth run at buying a dip that is now rapidly turning into a crater, it will be an excellent time to sell anything in the casino that isn’t nailed down.

On the heels of China's "failure" to send the PBoC to the rescue with an RRR cut over the weekend, battered EM assets were hit hard again on Monday as stocks, bonds, and currencies all went into panic mode as the global meltdown gathers pace.

"We should all be in “survival mode” today; there is no reason to take action of any sort other than to raise liquidity where  necessary in order to survive the present chaotic situation. Survival is all that matters. All else is secondary, even if that means surviving with far less liquidity than one had only mid-week last week. This is time for retaining what liquidity we can muster; this is not a time for courage. Get smaller; get liquid and get safe. This is getting ugly and we can only hope it does not get worse."

"It is an old saying in commodities that the best cure for low prices is low prices. Market participants are now asking how much further prices need to fall and how long they need to stay there to bring supply and demand back in to balance and halt the price declines across a broad swathe of different raw materials markets. The fear is that just as the upside of the supercycle brought an unprecedented and long period of historical price highs, the plunge to the downside is shaping up to be equally dramatic and may yet have a way to run."

As the capital markets from Shanghai to New York were melting down in ways hearkening back to the early days of the prior financial crisis - a period of time many would like to forget (or act) as if it never happened - the Nobel Laureate economist Paul Krugman decided it was time once again to weigh in with what will surely be viewed by the so-called “smart crowd” as a brilliant perspective on what ails the world: Not enough debt. He came out blazing with what seems the only bullet in his arsenal as a cure-all for what ever the ailment might be (e.g., debt.) as he argues this view in his latest: Debt Is Good.

Over the weeks, months, and years ahead we’ll begin to understand more about the fallout from the death of the petrodollar and nowhere is it likely to be more apparent than in Saudi Arabia where widening fiscal and current account deficits have forced the Saudis to tap the bond market to mitigate the FX drawdown that's fueling speculation about the viability of the dollar peg. As Bloomberg reports, the current situation mirrors a "very scary moment" in Saudi Arabia’s history.

Last week, in the global currency war’s latest escalation, Kazakhstan instituted a free float for the tenge causing the currency to immediately plunge by some 25%. The rationale behind the move was clear enough. What might not be as clear is how recent events in developing economy FX markets stem from a seismic shift we began discussing late last year - namely, the death of the petrodollar system which has served to underwrite decades of dollar dominance and was, until recently, a fixture of the post-war global economic order.

In the aftermath of China's worst manufacturing PMI since the financial crisis, which in turn sent the Shanghai Composite crashing to the "hard floor" level of 3500, below which the PBOC and Beijing officially are seen as having lost control, virtually every China expert and strategist rushed to defend China's policymakers (and its stock market) with predictions that an RRR cut as large as 100 bps is imminent, and would take place as soon as this weekend, a much-needed move to calm nerves that China is in control. it did not.

The only question, now that stocks are back to their fair excess-liquidity implied value, is what happens next?

China believes, with good reason, that she is more politically and economically robust, and has a better grasp over the actions of her own citizens, than the welfare economies of the west in the event of an economic downturn. Therefore, she is pursuing her foreign exchange policy from a position of strength. And the increments that will now be added to gold reserves month by month are a signal that China believes she can destabilise the dollar through her control of the physical gold market, because it gently reminds us of an unanswered question always ducked by the US Treasury: what evidence is there of the state of the US's gold reserves?