Central Banks

While at a glance this may seem like a straightforward question with a simple and obvious answer, troubled Italian bank UniCredit has released a ponderous article comparing and contrasting the two heavily indebted, politically challenged, and growth-retarded nations. Comparing debt-to-GDP ratios and trajectories, GDP growth, and unemployment (as well as funding needs), the answer actually becomes a little less obvious and boils down to the central bank (as does every trading decision in the world currently). Furthermore, their (admittedly biased) perspective leaves one wondering whether to invest in a country that hopes things will miraculously improve on its own, or in a country that has realized that reforms are needed and that has shown the willingness to take the painful steps in the right direction? Or c) none of the above.

Austria's central bank, Oesterreichische Nationalbank (OeNB) delivers headlines ranging from opaque to criminal these days.
Market observers scratch their heads about a secretive agreement between the OeNB and the People's Bank of China (PBoC) that makes Austria the first non-Asian country permitted to engage in Renminbi investments with its Chinese counterpart as the intermediary. Further media inquiries were stonewalled.

Spreads across Europe are tighter today, and stocks higher, as investors hope that a power shuffle at the top in Greece and Italy, where the placement of two Fed and ECB puppet rulers, would change decades of flawed fiscal planning and destructive habits. Of note, the catalysts inducing a substantial rise in French, Italian, Belgian and Irish bonds, is the expectation of a new Greek government as well as the Italian Senate voting on approving the 2012 budget and passing austerity measures (which it has already done before, and nothing happened) such as increasing the retirement age by 2 years in 15 years. The vote itself is a symbolic ouster to Berlusconi who has previously said he would retire the second the budget is passed. The question remains what happens after Berlusconi falls: elections or a new technocratic consensus government, headed by Mario Monti, and whether the ECB will support whatever course Italy takes. So needless to say prepare for vicious 50-100 pip moves in the EURUSD, and with every pip amounting to 1-3 DJIA point, the volatility in the market today will be significant. Buckle in. In other news, the one fundamental question that needs some answer before all this is over, namely how Italy will fund €300 billion in debt maturities and interest payments over the next year, with the EFSF now a formal dud, remains unanswered, and will, as there is no answer.

To print or not to print: the choice of whether to open the European Pandora's box, which as we suggested two months ago is an interesting but ultimately moot thought experiment, has suddenly become the only talking point for TV pundits desperate for eyeballs and suckers to buy their books, who are now experts not only on monetary policy but European monetary policy. And while 99% of these empty chatterboxes should be promptly muted, one person whose opinion we value in any regard is that of Jim Grant. Earlier today, with Bloomberg TV's Deirdre Bolton, he discussed not only the expected ECB response to the ever worsening contagion (while the ECB bought Italian bonds in the open market, and potentially primary against its charter, it is prohibited from buying French bonds which is why the OAT-Bund spread closed at record wides), but all the other developments in the insolvent continent. Here are some of the key sounbdbites, and, of course, the full clip.

You can't handle it. 

Minutes ago the Treasury auctioned off yet another block of $16 billion in 30 Year bonds. The auction was pretty horrible: the When Issued was trading at 3.155% when the press release hit that the bond cleared at only 3.199%, a huge 4+ bps tail for the longest duration paper. Internals were not pretty either: the Bid to Cover dropped from 2.94 to 2.40 and Dealers had to buy well over half again or 55.7% with Indirects taking a meager 28.4%, and the remaining 15.8% going to Directs, nearly half of the 29.5% from October. Obviously this is the inverse of what happened in Italy today, when the tail was a negative 150 bps and the 1 year Bill closed at just over 6% with the WI trading in the mid-7%'s. Perhaps the global banks, in an attempt to preserve the Ponzi one more time, pushed all their freely allocatable and repoable capital into Italy and had far less left for long US paper. Nonetheless, the yield at 3.199% was just the second lowest. We salute anyone who believes that as central banks are about to set off on a record printing episode to bail out Europe, that inflation will not rise. Needless to say, the weak auction pushed the entire treasury complex lower, as senn by the second chart of the 30 Year following the auction. With this auction, the refunding trio of issuance for the week is over and when all is settled on Monday, total US debt will be just shy of $15.1 trillion. We are so lucky that the Supercommittee is working up to snuff even as the next debt ceiling hike is rapidly approaching.

Ben Bernanke is speaking in Texas to some soldiers and ther families in what is mostly a boilerplate presentation: he mourns the bubble economy, protects his policies and tries to deflect focus away from the Fed, just like the ECB, to the legislative. To wit: "it doesn't feel like the recession ever ended. The unemployment rate remains painfully high, and more than two-fifths of the unemployed have been out of work for longer than six months, by far the highest ratio since World War II. These problems are very serious, and we at the Federal Reserve have been focusing intently on supporting job creation. Supporting job creation is half of our marching orders, so to speak; the other half is controlling inflation." On Congress: "the Federal Reserve was never intended to shoulder the entire burden of promoting economic prosperity. Fostering healthy growth and job creation is a shared responsibility of all economic policymakers, in close cooperation with the private sector." Most interesting is Bernanke's attempt to get quite cozy with men and women in uniform: "soldiers who had taken the course were more likely to make smart financial choices, such as comparison shopping for major purchases, saving for retirement, and educating themselves about money management. They were less likely to make questionable financial decisions, like paying overdraft fees, taking out car title loans, and continually running credit card balances. Making good, well-thought-out financial decisions can make all the difference to your financial future." Like saving, yes? But with 0.001% deposit rates, just why should these brave men and women do anything "smart" choices: can't they simply do what the banks do every day and make dumb choices, instead knowing full well that you will bail them out. Will you bail out the soldiers of this country who follow in the banks' footsteps? Or do they need more weapons before they become too big to fail?

As far back as May 2011, Bernanke admitted the benefits of QE were less attractive. Now he’s not only admitting that asset bubbles exist (something Greenspan never admitted) but that Central Banks may even need to “burst” them!?!? In plain terms, the Fed will NOT be launching another round of QE or major policy changes until the next round of the Great Crisis hits in full force. And by that time it will be pointless anyway as once the defaults begin, the leverage in the global banking system will implode rapidly.

For anyone who thinks that the ECB is some pristine virgin which has barely been touched in that special monetary printing place, we, or rather JP Morgan's Michael Cembalest, has some news for you: "To-date, that’s what the ECB has done: of the 1.1 trillion Euros extended to European banks and governments (through sovereign/covered bond purchases and repo), 970 billion has been given by the ECB." So anyone demanding that the ECB print even more outright (which incidentally we are certain will eventually happen - our thoughts are identical to those of Dylan Grice from two months ago: "ECBCTRL+P: The Next Steps In The European Implosion") should probably keep this in mind. It will also explain why German members of the ECB are dropping like flies, and why Germany, which better than anyone else, most certainly proponents of modern reincarnations of failed Keynesianism, knows what happens when central banks have gone wild, is certain that the ECB proceeding to move from €1 to many, many more trillions of explicit monetary support, will mean nothing short of hyperinflation.

For years I have warned of the impending European collapse. Now, as it is happening, we still have banks getting away with nonsensical 60% writedowns on essentially worthless debt. LGD > 100+% - You ain't seen the worst of it, not by a long shot!

Eric Sprott, Chairman of Sprott Asset Management, and James Turk, Director of the GoldMoney Foundation, meet in Munich and talk about the Munich Precious metals conference (Edelmetallmesse). They comment on Eric Sprott’s speech at the conference and how increasing interventions by central banks, from zero interest rates to money printing and bond buying have completely distorted the financial markets. Other discussion topics include the choices between austerity and increasing stimulus and how both will bring on a meltdown, whether bankruptcy or hyperinflation brought on by money printing. They talk about the huge leverage in the banking system and the risk inherent in the system. People are only now starting to understand counterparty risk. They explain that 20-to-1 and even higher leverage is common in the banking system. Lastly, the two talk about the short-term focus of political decisions and the bad omens for the dollar as a world reserve currency. Kicking the can down the road is increasingly not an option for bankrupt governments, as even the bond markets are increasingly uncooperative with new stimulus efforts. As an example the recent failed attempt by the EFSF to raise 3 billion. They talk about the IMF creating $280 Billion SDRs out of thin air and ask whether that will keep the party going a bit longer.

Like a full-blown alcoholic, the people and governments of the U.S. and Europe stagger from debt source to debt source, weaving drunkenly between "stashes" of new debt in the Fed, Treasury and private sector markets. Despite the abject failure of the magical-thinking "fix" of becoming solvent by exponentially expanding debt, we see the same pathetic pattern repeating in Europe, where the apologists for the alcoholic debt-binge continue to claim the risk of systemic failure and collapse of asset values is low. While everyone is focused on the drunk being pulled from the pool--Europe's sovereign debt--another drunk is teetering on the edge: public and private pension plans. Here's the reality in a nutshell: pension plans only work if they earn average returns of around 8% per year, basically forever. Gripped by the mono-maniacal desperation of an addict who sees no other path but another hit, central banks have lowered interest rates to near-zero to "spark growth." Unfortunately the only thing being goosed is the future cost of servicing the additional debt. How do you earn 8% on money which yields at best 3%? You can't. How do you reap a gain on bonds when interest rates have already hit bottom and can't fall any lower? You can't.

Gold has retraced over 60% of its September swing high to low - rallying almost 12% off late September lows. Whether by cause or effect, it seems our stimulus-driven, vendor-financing, USD-heavy, mercantilist neighbors across the Pacific have decided the time is right to BTFDs in gold and gold miners as today's South China Morning Post notes "China Gold to buy Central Asia mine". Jery Xie Quan, VP of China Gold, further noted that was also negotiating potential mine acquisitions in Canada and Mongolia, which are either in advanced development or close to starting production. Are the Chinese using their excess USD to purchase gold-producing assets? Who knows but it may help explain the relatively strong performance of the EUR against the USD as the former region deteriorate fast.

Remember how virtually all "experts" speculated that the drop in the price of gold would set off a liquidation cascade in China, where everyone was "loaded to the gills" and at the first hint of deflation would dump all holdings (not to mention that economic Ph.D. proclaimed the gold "bubble" popped two months and $200 lower)? It seems that as so often happens when all experts agree on something, it is precisely the opposite that happens. The FT reports that "Chinese gold imports from Hong Kong, a proxy for the country’s overall overseas buying, leapt to a record high in September, when monthly purchases matched almost half that for the whole of 2010....After hitting a nominal all-time high of $1,920.30 a troy ounce in early September, the yellow metal fell to a three-month low of $1,534 an ounce later in the month. Chinese investors snapped up the metal as prices fell." Fair enough: this means the natural bid under gold will pretty much always be there, especially since the SHCOMP plunged at the same time, and if there was truly cross asset liquidation, imports would hardly rise. Which begs the question: if not China, then who sold? Was the move purely a function of fears that Paulson was liquidating? Or were rumors that various central banks are liquidating gold, actually true? We will likely find out when the next WGC report is filed. WE will also know that the Chinese number for total gold holdings is grossly underreported.

As the following update from the World Gold Council reminds us, at the end of October, Italy had 2,451.8 tonnes of gold, or roughly $140 billion dollars at today's price. We doubt we are the only ones keeping track of all this gold (most of it almost certainly 'safe and sound' about 150 feet deep under the infamous LIberty 33 location). We also doubt we are the only ones curious about its future, which we see as have five distinct possible outcomes: i) nothing; ii) it is currently being shipped quietly from The New York Fed to Italy for "general corporate purposes); iii) it has already been shipped and is currently being loaded up in Silvio's private jet; iv) the G-20 is already preparing to launch a formal demand that in order to remain in the Eurozone and to find the EFSF, which will be used to buy Italian bonds, Italy will have to do its patriotic duty and remit it to the ECB, an extortion attempt which was tried with Germany last week and which failed spectacularly; or v) it is being lent out to other countries who have long since sold their gold and continue to pretend they have some hard asset backing to the currencies issued by their own central banks. We hope to get an answer shortly.