Former PBOC Member: "The Situation Is Unsustainable. The Longer It Continues, The More Violent And Destructive The Final Adjustment Will Be."Submitted by Tyler Durden on 08/07/2011 12:07 -0500
Yesterday it was an editorial piece in the main Chinese media outlet Xinhua. Today, China brings its message of helpless (for now) fury to the FT, where Yu Yongding, a former member of the Monetary Policy committee of the Chinese Central Bank has just said what everyone who realizes that mean reversions after 30 years worth of a "great moderation" can and will be a nasty, nasty thing, thinks. Namely: "the situation is ultimately unsustainable. The longer it continues, the more violent and destructive the final adjustment will be. " He is referring to the relentless recycling of Chinese trade surplus in the form of US paper which is increasingly looking like it will never get repaid. His chief rhetorical question is key: "The question is: what losses is China willing to bear in its foreign exchange reserves in order to slow the pace of the renminbi appreciation?" And that's the ballgame. Just like in Europe the question is what amount of gross economic loss is Germany willing to sustain in order to backstop Europe's insolvent countries (and with an imminent French downgrade looming, it will be the only country doing so in the form of sole EFSF funding) simply to keep the euro up and running, and its export sector humming courtesy of no return to a DEM, so in China the question now is how much risk is the country willing to take with its US-based paper holdings in order to keep its own export sector moving along courtesy of a weak CNY. Ironically, the longer Germany and China pretend all is good, the greater the impairment of their natural import partners. And in a globalized economy, even having the cheapest (no matter how artificially contrived) currency does nothing if the global economy tanks and import level implode. Alas, it will be too late for Germany and China to do anything about their flawed mercantilist policies at that point, as the third and final depression will be here. And what is the right move? The former PBOC member spells it out: "The danger for China is that it does not learn the right lesson – namely, that now is the time to end its dependency on the US dollar." And therein lies the rub.
Around the world, starting Monday, all eyes are on the markets. The tension is palpable. The uncertainty is ample. And anger is heavy in the air. As predicted, the debt ceiling deal was not only NOT enough to assuage economic fears, it actually exacerbated them, triggering a flight from the Dow, and creating a decisive opportunity for ratings agency S&P to cut the once perfect U.S. credit rating from AAA to AA+. At Alt-Market, we often talk about points of balance, and how certain moments in history become highly visible indicators of balance lost. If we pay close attention, and know what we are looking for, these moments can be recognized, allowing us time to shield ourselves from the explosion and the resulting financial shrapnel. The past two weeks have culminated into one of these defining events that tell us the tide has fully turned, and something new and dangerous is just over the horizon. The question now is; what should we expect? The nature of the credit downgrade situation is not necessarily “unprecedented” in history, but it is surely unprecedented on the scale we see currently in the U.S. It is difficult to predict how exactly the investment world will react. Some consequences, though, are probable, if not inevitable. Let’s examine the events we are likely to see in the coming weeks as well as the coming months, as nations attempt to adjust to America’s final plunge…
Citi's head FX guy Steven Englander is barely back to the US, and already is pouring the daily dose of fire and brimstone (much deserved) into a market that after nearly 2.5 years of unprecedented complicity, is about to realize that every escalator action has an equal and opposite express elevator reaction (oh, and those same HFTs that make money in an upward momentum environment, are just as effective at putting a minus sign in front of all their signals, wink wink). Some key soundbites from his just released note on what to expect (spoiler alert: nothing good): "The accelerated timing is a surprise and comes at a point at which global market sentiment is extremely weak, so it seems more likely that the reaction in markets will be negative than positive" ..."there may be concern in FX markets that the EUR AAAs are not solid, given the political and economic issues facing the euro zone and how conditions have worsened since the agencies last commented on ratings"..."a downward shock to markets is likely to be USD positive in the near term. This is hardly USD positive once things settle down, but before they settle down, the short term will likely dominate the long-term"..."The odds are that the week will start with FX investors challenging the SNB and MoF to intervene in size"... most importantly, why Europe is sweating bullets after the last bailout attempt announced from Friday has now gone up in flames and the EFSF is seen as being on edge of functionality: "In terms of FX market impact, the biggest would come from a downgrade of one of the AAA eurozone countries who back the EFSF’s AAA rating. This would mean either dropping the EFSF AAA or increasing the contributions of the remaining AAA."and on the topic of everyone's most favorite Federal Reserve: "A Fed response is likely to emerge only if there is turmoil in markets." And here we were warning anyone who cared to listen that the Fed needs a 25% correction before QE3 comes. Well, you may just get it very soon.
The market has taken a nasty hit this past week, and as expected, investors have turned bearish.
“Equities in Dallas” was the worst job a trainee at Salomon brothers could get. I have to believe that the G-20 sovereign debt rating group was the equivalent at the rating agencies. It wasn’t volatile and sexy like Emerging Markets. It had nothing to do with the core business of rating corporate debt. It had even less to do with the fast growing structured product business. It must have been a pretty dull place to work. I think that is important because it means, certainly at this stage that all the decisions on sovereign debt are being made at a very high level within the rating agencies. Someone isn’t running some numbers and coming up with a rating proposal. Some people are sitting around in a room, trying to figure out what rating they want to give, or need to give, or can get away with giving. Knowing that these decisions are being made at the highest levels of the firm and have nothing to do with what any analyst in the area says or does is important in trying to figure out where the ratings go next.
Speaking Of "Credibility", Here Is The CBO's 2001 Forecast Which Predicted Negative $2.5 Trillion Net Debt In 2011Submitted by Tyler Durden on 08/06/2011 21:02 -0500
While we reserve judgment for S&P's effectiveness at being accurate in anything they do (they are, after all a rating agency and as such they goal seek results to comply with what their paying groupthink seeking customers demand), we would like to redirect to the modest topic of CBO predictive efficiency (the organization that is at the basis of the current credibility spat between Treasury and S&P, and which, incidentally has created the baseline forecast against which the debt ceiling compromise plan is supposed to cut $2.1 trillion over the next decade), by pointing out according to the same CBO in 2001, net US indebtedness in 2011 would be negative $2.436 trillion, the ratio of debt held by the public to GDP would be 4.8%, total budget surplus would be $889 billion, and GDP would be $16.9 trillion. We won't comment on the error interval in CBO forecasts when compared to actual 2011 results, and we most certainly won't comment on the idiocy of the Treasury chastising someone, anyone, for erring, or disputing, forecasts.
Today at about 4 pm, the Treasury's John Bellows issued a hastily written statement, in which he explained why in his view, a day after a historic downgrade of its debt, the $2 trillion mistake that S&P made "raises fundamental questions about the credibility and integrity of S&P’s ratings action." What is ironic is that in the explanation, it is the Treasury's own credibility that is put at stake. Supposedly the reason for the mix up is as follows: "S&P incorrectly added that same $2.1 trillion in deficit reduction to an entirely different “baseline” where discretionary funding levels grow with nominal GDP over the next 10 years. Relative to this alternative “baseline,” the Budget Control Act will save more than $4 trillion over ten years – or over $2 trillion more than S&P calculated. (The baseline in which discretionary spending grows with nominal GDP is substantially higher because CBO assumes that nominal GDP grows by just under 5 percent a year on average, while inflation is around 2.5 percent a year on average." So let's get this straight: the Treasury department is kicking and screaming at S&P for daring to downgrade the US, when it is using as its baseline a forecast prepared by the same CBO which back in 2001 predicted a net negative debt balance by 2008 (!), and which in the same year expected 2011 US GDP to be $16.9 trillion, and a budget surplus of about $1 trillion, putting any S&P forecast from the peak of the credit bubble, to shame, but far more importantly, Bellows, and his plethora of bosses, is pissed that the S&P did not use a baseline that assumes a 5% GDP annual growth, when current annualized GDP, 2 years after the end of the recession, is under 2%? And this is what is supposed to make S&P less than credible? This is like the pot and the kettle having commenced global thermonuclear warfare.
We told you the downgrade was coming, too.
Time for deeply introspective Op-Eds galore. Not too surprisingly, the first one comes from blogging powerhouse Pimco, and its chief literary superstar, Mo El-Erian, titled "U.S. Downgrade Heralds a New Financial Era." While Mohamed's outlook is mostly politically correct fluff, he does bring up the absolutely spot on point that FrAAAnce is about to become FrAAnce, which also means that Germany's worst nightmare: that of backstopping the EFSF entirely on its own, is about to become reality.
What to make of this? My thoughts.
Volatility and mispriced risk for years to haunt investors after S&P Downgrade
Well, so much for the conspiracies. S&P has just released a scathing critique of the total chaos that this country's government has become. "The political brinksmanship of recent months highlights what we see as America's governance and policymaking becoming less stable, less effective, and less predictable than what we previously believed. The statutory debt ceiling and the threat of default have become political bargaining chips in the debate over fiscal policy. Despite this year's wide-ranging debate, in our view, the differences between political parties have proven to be extraordinarily difficult to bridge, and, as we see it, the resulting agreement fell well short of the comprehensive fiscal consolidation program that some proponents had envisaged until quite recently. Republicans and Democrats have only been able to agree to relatively modest savings on discretionary spending while delegating to the Select Committee decisions on more comprehensive measures. It appears that for now, new revenues have dropped down on the menu of policy options. In addition, the plan envisions only minor policy changes on Medicare and little change in other entitlements, the containment of which we and most other independent observers regard as key to long-term fiscal sustainability." What to expect on Monday: " it is possible that interest rates could rise if investors re-price relative risks. As a result, our alternate scenario factors in a 50 basis point (bp)-75 bp rise in 10-year bond yields relative to the base and upside cases from 2013 onwards. In this scenario, we project the net public debt burden would rise from 74% of GDP in 2011 to 90% in 2015 and to 101% by 2021." And why all those who have said the downgrade will have no impact on markets will be tested as soon as Monday: "On Monday, we will issue separate releases concerning affected ratings in the funds, government-related entities, financial institutions, insurance, public finance, and structured finance sectors." Translation: unpredictable consequences: you are welcome!
McGraw-Hill: meet Chicago-style negotiations. And there, in one sentence, is all that is broken with this country. The reason for the beyond ridiculous horse trade, according to CNN: S&P analysis of U.S. revenue, deficit picture was questioned. Presumably S&P ignored to add the $10 quintillion dollars that were saved by America not declaring war on Tatooine and its most infamous Hutt resident: Larry Summers. Indeed, again according to CNN, S&P acknowledged some errors in its analysis. Isn't it amazing what being threatened with having your NRSRO license can do for motivation to double check your work, eh you pathetic sellouts? Who would have thought that last week's farce debt ceiling would continue and develop into a national pastime. Below, for the sake of S&P's non-existent conscience and incompetence, are their own guidelines for what constitutes an AAA-rated credit. Readers can decide if the US is one. In other news, in USSAAA, government downgrade rating agency.
Your one stop summary of all the bullish and bearish events of the past week.
Juvenal makes reference to the Roman practice of providing free wheat to Roman citizens as well as costly circus games and other forms of entertainment as a means of gaining political power through populism. Roman politicians devised a plan in 140 B.C. to win the votes of the poor: giving out cheap food and entertainment, “bread and circuses”. The Roman politicians realized this would be the most effective way to rise to power and stay in power. With the revolting display of political theater in the last few weeks, I couldn’t help but consider the parallels between the Roman Empire and the American Empire. The entire debt ceiling farce was a circus on an epic scale – The Greatest Show on Earth. The American public was treated to high wire acts of near debt experiences, Senators putting their heads into the mouths of lions, and hundreds of clowns riding tiny bikes with squeaking horns. In the end, American politicians did what they do best - pretended to solve a spending problem without cutting spending. Only in America could politicians put the country on course to increase its national debt from $14.5 trillion to $23 trillion by 2021 and declare they are cutting spending. For those that need to visualize the lies of politicians, take a gander at this chart and try to find the cuts in spending.