Central Banks

All you need to read.

We have not been shy to point out the potential (and now proven) flaws in the Euro experiment (here, here, and here for example) over the past year or so but UBS reminds us that while most people remain fixated on the absence of a fiscal transfer union in so large a monetary union (to offset incidents of inappropriate monetary policy) as Eurobonds and Federalism come back to the fore; it is the second flaw - the absence of an integrated banking system (backed implicitly by a credible lender of last resort) - that should be getting front-page headlines. As Niall Ferguson noted at Zeitgeist this morning, "Structural reforms will work but will not work this week" and in the meantime, TARGET2 balances grow out of control and the longer the 'problem' remains, the worse it becomes leaving an implicit infinitely supported firewall as the only interim solution. While most who foresaw the Euro as implicitly leading to federalism were right, it seems the link to a German dominance (of ECB rulings and general fiscal and monetary decisions) has been the ultimate outcome. While an integrated banking system would do nothing to change the relative competitiveness or growth issues that plague Europe, the 'essential' internal capital flows would be sustained. Is this sort of integration a realistic prospect? The politics is not especially propitious.

Back on March 21, Goldman's Peter Oppenheimer released the "Long Good Buy, The Case For Equities", which was Goldman's subversive attempt to rally equity into buying all the stocks that Goldman had to offload, as well as buy all TSYs that GS clients had to sell. Needless to say, Goldman top ticked the market and stocks have tumbled ever since, even as the 10 Year soared from 2.5% to the current ~1.75%. So what? Well, this morning the same analyst, precisely two months on the anniversary of his "once in in a lifetime" stock buying opportunity, has released a new report with the paradoxical header: "Near-term risks are to the downside." But, but... Anyway, that's all the market needed to grasp that Goldman's prop desk is now buying every piece of risk not nailed down hand over fist as the June FOMC meeting is now the D-Day. Futures have soared ever since.

Adam Fleming, Chairman of Wits Gold and Fleming Family & Partners (yes, related to Ian Fleming of James Bond game), discusses the gold bull market with GoldMoney's Chairman James Turk. Topics include metal price action, the eurozone's debt crisis, and mining in South Africa. Both men think that we are the "in the foothills" of a long precious metals bull market, and that the gold price is in some ways cheaper than it was back when they spoke at GATA's Dawson City conference in 2005, owing to all the quantitative easing – or more bluntly, money printing – that central banks have engaged in since the financial crisis of 2008.

What is a black swan event, or tail event, in the stock market?

- It depends on who’s asking.

- To those familiar with Austrian capital theory, the impending U.S. stock market plunge (of even well over 40%)—like pretty much all that came before in the past century—will certainly  not be a Black Swan, nor even a tail event.
- Nonetheless, the black swan notion is paramount—in perception: Market participants’ failure to expect a perfectly expected event—that is, they price in only Anglo swans despite the  Viennese bird lurking conspicuously in the weeds—much like what is happening today, brings tremendous opportunity.

"So lets "run" through the mechanics of a Greek bank run. ... The end is of course ECB printing, Eurobonds and every developed market central bank dumping massive liquidity into the global financial markets as systemic risks rise - QE, LTROs, Currency swaps, and every funding facility under the sun come into play. The path to this end game will be bumpy, but make no mistake, the developed market central banks will dump so much fiat on the system to cover the losses, that risk free real rates will plummet to levels so negative that anyone left holding cash or cash equivalents will see massive destruction of real wealth. We may have to push risk assets a bit lower from here, but the global central banks will be firing howitzers and tomahawks very shortly, not bazookas!"

The standard Keynesian narrative that "Households and countries are not spending because they can’t borrow the funds to do so, and the best way to revive growth, the argument goes, is to find ways to get the money flowing again." is not working. In fact, former IMF Director Raghuram Rajan points out, today’s economic troubles are not simply the result of inadequate demand but the result, equally, of a distorted supply side as technology and foreign competition means that "advanced economies were losing their ability to grow by making useful things." Detailing his view of the mistakes of the Keynesian dream, Rajan notes "The growth that these countries engineered, with its dependence on borrowing, proved unsustainable.", and critically his conclusion that the industrial countries have a choice. They can act as if all is well except that their consumers are in a funk and so what John Maynard Keynes called “animal spirits” must be revived through stimulus measures. Or they can treat the crisis as a wake-up call and move to fix all that has been papered over in the last few decades and thus put themselves in a better position to take advantage of coming opportunities.

The two biggest market props of the last two years: the Fed and the ECB have found their hands tied. What will follow will make 2008 look like a joke. On that note, if you have not taken steps to prepare for the end of the EU (and its impact on the US and global banking system), you NEED TO DO SO NOW!

Based on a swap-spread-based model, EURUSD should trade around 1.30, but based on GDP-weighted sovereign credit risk EURUSD should trade around 1.00; so who is right and what are the factors that supporting the Euro at higher levels than many would assume (given the rising probability of a Euro-zone #fail and the 0.82 lows from 2000). UBS addresses four key reasons for the apparent paradox based on the difference between ECB and Fed 'monetization', the EZ's balanced current account (independent of foreign capital flows), and the high-oil-price induced petro-dollar circulation diversifying into Euros (or out of USD). The final and most telling of factors though is bank deleveraging as European financial entities, who remain under pressure to shrink their balance sheets and re-build capital, have been selling foreign assets. They remain EUR dismalists with a year-end target of 1.15 but expect the slide to these levels to be cushioned (absent an imminent break-up) by banks' 'shrinkage'.

The policy responses and hints of policy responses are starting to come out.  What will they be, how big will they be, and what will they accomplish remains to be seen, but the market is due to rally on almost anything. We expect some announcements out of Europe.  A policy shift towards “growth” and some new ECB plans. We don’t think they will work well, especially if they don’t address the root of depositor fear in Spain, Ireland, Portugal, and Italy, but with so many indicators pointing to oversold conditions, the markets could snap back, and that is the way Peter Tchir of TF Market Advisors is leaning.

Gold Has Fallen Due To:

• Gold’s recent weakness is in large part due to a period of recent dollar strength. While gold in dollar terms has fallen by 25% ($1,920 to $1,540), gold in euro terms is only down by 14% (from €1,374/oz to €1,210/oz). 
• Oil weakness – since the end of February, oil has fallen from $111 a barrel to below $95 a barrel (NYMEX) today. Gold and oil are often correlated and many buy gold to hedge inflation that comes from higher oil prices.
• Gold’s weakness may also have been due to wholesale liquidation in all risk markets due another bout of "risk off" which has seen global equities and commodities all come under pressure.
• Physical demand from retail investors in the western world has slowed down as did demand from India in recent weeks due to the increase in taxes on bullion (since removed).
• Much of the selling has been technical in nature – whereby more speculative elements on the COMEX who trade gold on a proprietary basis have been selling gold due to the recent price weakness and the short term trend clearly being down. This has led to speculative longs now having their smallest positions since December 2008.

Taxation is theft. There is no denying this.  If I and a few brutes appeared at the door of an unsuspecting individual and demanded monetary compensation less we drag him off to jail, this would be a clear cut case of robbery.  It is a common tactic used by mobs or street gangs to offer protection with the barrel of a gun.  The only difference between shakedowns by private thugs and those employed by the state is the badge.  The badge legalizes extortion and imprisonment. With that being said, it has been three years since the financial crisis and governments around the world are still reeling in the lesser Depression.  Tax collections are down while public expenditures have skyrocketed in a vain effort to stabilize the economy.  Much of this mass orgy in spending has been financed by central banks printing money and the suppression of interest rates down to artificially low levels.  This is the Keynesian remedy to recession.  Spend what you don’t have via the printing press.  Have central bankers create paradise on Earth through counterfeiting.

So far it hasn’t worked.

This week we bring back Alasdair Macleod, publisher of Finance and economics.org, because, as he puts it "every horror that we discussed last time we spoke is coming about". Especially scary since our previous conversation with him was less than three weeks ago... Today's interview continues building on his excellent synopsis from last month that detailed the origins of the Eurozone crisis. The fundamental shortcomings warned of at the Euro's creation in 1997, combined with the excessive sovereign debts run up since then, have finally expressed themselves at a scale too large to be contained any longer. Today, Alasdair details in-depth the huge and serious challenges facing Greece and the major Eurozone countries, and the likely impacts of the fast-dwindling options left remaining.  He sees no happy ending to this story, no outcome in which serious pain and permanent behavior change can be avoided. And for those looking for shelter from the unfolding economic storm, he sees few options besides the precious metals (which he believes are severely under priced at the moment):

The big banks are getting restless. Nowhere is this more evident than in the latest just released letter from Citi's European Credit Strategy, literally a letter to Europe's trio of leading politicians, which follows hot on the heels of yet another recent Citigroup missive from Willem Buiter, which was largely ignored in the noise, yet which made it all too clear that when all else fails, it is the Chairman's sworn duty to paradrop money. Because if anyone, it is the banks that know that if things aren't fixed (they aren't), it is up to the central banks to do something to prevent the vigilantes from forcing the politicians hands, as they did in the summer and fall of 2011 (which will not provide a long-term fix, but at least allow bankers to hope that the next collapse won't take place before bonus season). As Citi says, "Until the gravity of the situation is made clear, until the self-reinforcing mechanisms that already seem to be in motion are understood, we don't see how the solutions, the answers, and the certainty that market craves can be brought to the table." Which simply means that things are about to get much, much worse as it will be up to the markets to bring the world to the edge of collapse once again, just so Europe, with the help of the Fed of course, once again is forced to get over the political bickering and prop up risk assets, in yet another iteration of "this time it's different", even though it isn't. Sure enough: "Our impression is that markets will need to act as the proverbial 'attack dog', forcing the issue on the political agenda. We can't escape the sense that it is probably politically easier to let the markets run loose for the time being to make it apparent that further intervention is needed. But 1000bp on Crossover is much closer than you imagine." In other words, Citi just gave the green light for the bottom to fall from the market just so Europe's increasingly impotent political elite does something, anything. Look for many more banks to sign off on the same letter.

The problem with self-reported economic data by various countries, especially those which are supposed to be at the forefront of economic growth, now that the "developed" world is groaning under consolidated debt/GDP ratios which will soon be the 4 digits, is just that - that they are self-reported: a main reason for the development of such governmental offshoot programs as the "Ministry of Truth." Which means that when the investing public hears of an updated Chinese GDP, or Brazilian inflation, or Russian industrial production, most roll their eyes but go with it, as this is the data that the greater fool down the street will also be using for investment decisions. Luckily, there are secondary indicators which present a much more realistic picture of what is truly happening in this fringe growth markets. A few days ago, we presented the "stock" view of the world's two biggest housing bubbles: China and Saudi Arabia, when demonstrating the epic outlier nature of these two countries in the context of cement consumption relative to GDP per capita: a snapshot which showed just how unsustainable the regional construction bubble in these two countries is. But since this is a snapshot in time, and hence "stock", how about the "flow", or the perspective of the economy from a continuous basis. For that we once again go to Goldman, which has conveniently compiled two alternative yet very critical data sets which go to the core of the BRIC economies: Chinese electricity consumption, as well as Brazilian toll road traffic. The picture(s) is (are) not pretty.