Deutsche Bank

Welcome to the Fed’s Weekend at Bernie’s ...

The answer, of course, is yes: they are after all, economists (who somehow, with no real world experience, determine the daily fate of billions of productive and capital-allocation decisions every day). But it is one thing for everyone to discuss the obvious anecdotally by the water cooler. It is something else for this verbal heresy to be printed in a "serious" publication. Such as Reuters, which today asks if "the Federal Reserve has watched the U.S. recession and painfully slow recovery through rose-colored glasses?" And answers: "A look at the U.S. central bank's economic forecasts over the past five years suggest it has." It then explains: "Since October 2007, when the Fed's policy committee began giving quarterly predictions for GDP growth and the jobless rate, the central bank has downgraded its nearer-term forecasts almost two-and-a-half times as often as it upgraded them. The gap between Wall Street's expectations for 2012 growth and the Fed's own current view points to yet another downgrade on Thursday, when policymakers wrap up a two-day meeting that has world financial markets rapt." It concludes: "The trend of back-pedaling shows how poorly the central bank has fared at reading the economic tea leaves, with the Fed's optimism a likely factor in policy decisions through the Great Recession and its fallout, economists say." In summary: the world's most ebullient and permabullish forecasters, who incidentally happen to constantly be wrong in their desperate attempts to affect the only thing that matters: consumer and investor sentiment and confidence via the increasingly irrelevant myth that are asset prices, happen to run the monetary world and "determine" just what the future looks like. Needless to say, if the Fed's presidents were actually employed in the private sector, they would have been fired ages ago. Only in a fiat world do they not only keep their jobs, but keep on running the world.

• Germany Can Ratify ESM Fund With Conditions, Court Rules (Bloomberg)
• Obama Discusses Iran Nuclear Threat With Netanyahu (Bloomberg)
• Stocks, Euro Gain as Court Allows ESM; Irish Bonds Climb (Bloomberg)
• U.S. cautions Japan, China over escalating islands row (Reuters)
• Draghi alone cannot save the euro (FT)
• 'New York Post' Runs Boldest Anti-Obama Ad Yet (Bloomberg)
• Another urban legend: Fish Oil Pills Don’t Fix Heart Ills in 24-Year Data Review (Bloomberg)
• Troika Says Portugal’s Program is ‘On Track’ (Bloomberg)
• Russia Wants to Steer Clear of 'Gas War' (WSJ)
• U.S. Said Set to Target First Non-Bank Firms for Scrutiny (Bloomberg)
• Wen Says China’s Policy Strength Will Secure Growth Targets (Bloomberg)
• UK faces clash with Brussels on City (FT)

The conundra continue to mount up around the world as central planning efforts dislocate asset-values from reality wherever one looks. Nowhere is the juxtaposition of hope-and-fear more evident than in the industrial metals. We have discussed the reality of Iron Ore, and the unreality of China stimulus (funded or unfunded) bringing the excess inventory back from the edge ad nauseum but, as the WSJ notes, the stacks of copper slabs inside the warehouses of Shanghai last month grew by 20% since July. In fact, so much copper has been sent into storage that it is being lined up outside some buildings as "there's much more metal than we'd expected," and some would see this huge inventory growth as a signal of "people's uneasiness about Chinese growth." However, sure enough, copper prices are soaring - on the back of expectations that inventories are so high that the PBoC will step in with some stimulus and all will be well in the world again. While Deutsche Bank opines "any rally in copper prices based on expectations will likely not be sustainable," the alternate perspective, based on hope and dreams is that "just a couple of months of better demand - it will quickly change the perception of surplus to tightness." Meanwhile, the effervescence of central-bank-driven exuberance in prices has driven the 'value' of a good-old-US-Nickel up to 5.2 cents (its highest in four months).

• Germany says U.S. debt levels "much too high" (Reuters)
• Netanyahu ramps up Iran attack threat (Reuters)
• Burberry plummets by most ever, slashes guidance, rattles Luxury-Goods Industry as Revenue Growth (Bloomberg)
• FoxConn Again Faces Labor Issue on iPhones (NYT)
• Southern whites troubled by Romney's wealth, religion (Reuters)
• China's Xi not seen in public because of ailment (Reuters)
• Another California muni default: Oakdale, Calif., Restructuring Debt, Planning Rate Raise After Default (Bond Buyer)
• Spain's PM expects "reasonable" terms for any new aid (Reuters)
• Bernanke Proves Like No Other Fed Chairman on Joblessness (Bloomberg) - Ineffective like no other?
• John Lennon’s Island Goes on Sale as Irish Unpick Property Boom (Bloomberg)

The chart below shows 2050 years of relative global GDP, during which there was a surprisingly flat distribution of the major economic powers: China, India, and the "West", at least until the mid-1800s, when the "Western" Golden Age began primarily courtesy of the industrial revolution, followed by the arrival of the Fed and virtually endless leverage (i.e., borrowing from the future until such time as no more debt capacity remains at either the public or private sectors), only to end in the late 1900s when the marginal balance of power shifted back to Asia, which became the next nexus of debt accumulation (see our earlier post on The Great Recoupling for some additional perspectives). And while the chart, from Deutsche Bank and PWC, attempts to predict the next 40 years of relative GDP distribution by eventually regressing back to the the long-term trendline, we feel that this is quite an optimistic assumption for a world in which virtually every "developed" country is insolvent, begs for China to ease whenever western inflation sends gas prices soaring making reelection of the incumbent impossible, and is reliant on the indefinite continuation of the USD's reserve status to preserve the last traces of western superiority (not to mention cheap funding of $-trillion deficits as far as the eye can see).

Even in the face of worsening odds of re-election (no sitting government has been returned to power in EU elections since the start of the crisis) one would expect national governments to do what is necessary to maintain current stability. The ultimate arbiter of burden sharing capacity, or whether the Euro will continue on the steady incremental path to integration, is whether regular voters vote for it. Hence the importance of elections, like the Dutch election this week. The anti-austerity Socialist Party (SP) has gained significant ground on the incumbent VVD party - focusing the market's attention on the willingness of the Dutch to meet the 3% of GDP deficit targets in 2013. The two 'extreme' parties look set to gain considerably more seats, and either a very broad coalition would be required, including a tail of small parties, or all four mainstream parties will have to participate in the new government: either way, government stability might be questionable. The scenario troubling markets is the potential for a long government formation process coinciding with the euro area’s need to fight the crisis and progress communal policies - though in the last week or two, support for the SP has declined. With the 2013 budget an immediate test, a 'new' Dutch government faces decisions over Greece, Cyprus, EFSF bond buying, and a common-bank supervisory body - none of which have anything like majority support across the coalitions.

A world of ongoing global integration leads to rising global trade and to rising competition between companies from different countries and to some degree also between the countries themselves. Some countries have benefited from rising global trade and strengthened their positions, expressed by rising trade surplus; other countries have come under pressure, expressed by rising trade deficit. These global trade imbalances are a consequence of competitive differences. Deutsche Bank note that investors invest in companies and the countries are the platform of the companies. Therefore, an understanding of global competiveness of countries is key for investors. It is most helpful to look at the combination of competiveness and hourly wages. The more competitive a country is, the higher its wages can be justified. There is a clear relation between the two variables. Countries below the regression curve have a strong competiveness rank relative to their labour costs while countries above the curve have a lower competiveness rank relative to their labour costs. Greece is one of the most extreme outliers, but Italy, Spain, and Argentina are also above the curve. They have a long way to go to get close to competitive - but then again - why would they care?

There is only one event on pundits and traders minds today: the ECB's press conference, during which Draghi will announce nothing material, as the substance of the bank's message has been leaked, telegraphed and distributed extensively over the past three weeks before just to gauge and test the market's response as every part of this latest "plan", which is nothing but SMP-meets-Operation "Tsiwt" was being made up on the fly. And not even a weaker than expected Spanish short-term auction in which €3.5 billion in 2014-2016 bonds were sold at plunging Bids to Cover, sending yields paradoxically spiking just ahead of what the ECB should otherwise announce will be the buying sweet spot, can dent the market's hope that Draghi will pull some final detail out of his hat. Or any detail for that matter, because while the leaks have been rich in broad strokes, there has been no information on the Spanish bailout conditions, on how one can use "unlimited" and "sterilized" in the same sentence, and how the ECB can strip its seniority with impairing its current holdings of tens of billions in Greek bonds without suddenly finding itself with negative capital. Elsewhere, the Swedish central bank cut rates by 25 bps unexpectedly: after all nobody wants to be last in the global currency devaluation race. Ironically, just before this happened, the BOJ's Shirakawa said that he won't buy bonds to finance sovereign debt: but why? Everyone is doing it. Finally, in news that really matters, and not in the "how to extend a ponzi by simply diluting the purchasing power of money" category, Greek unemployment soared to 24.4% on expectations of a rise to "just" 23.5%. This means there was an increase of 1.3% in Greek unemployment in one month.

There are three key factors to modeling trade flows - or relevance - in a post-globalization world. While competitiveness is important, countries gain from being generally 'Technology-rich', 'Labor-rich', and/or 'Resource-rich'. The following chart, from Deutsche Bank, shows where the world's countries fit into the Venn diagram of give-and-take in a post-globalization market. The red oval highlights where Italy, Greece, Portugal, and Spain (and Argentina sadly enough) do not fit into this picture. Two words - Euro-sustainability?

That the SEC is the most incompetent, corrupt, irrelevant and captured organization "serving" the US public is known by everyone. And while the details of the SEC's glaring lack of capacity to do anything to restore investor confidence in the capital markets, which has become a casino used exclusively by Wall Street to defraud any retail investor still stupid enough to play (which lately a moot point as there have been no material retail inflows into mutual funds in over three years), are scattered, courtesy of Bloomberg we now have the best summary of just how the utterly clueless SEC is a muppet plaything of Wall Street, and together with it, the "grand regulation" that was supposed to keep Wall Street in check, is nothing but what Wall Street demand it to be, and forced the SEC, way over its head on regulation, to accept every change, that the very banks that are supposed to be regulated, demands as part of Dodd-Frank reforms. In short: everything we know about Wall Street 'regulation' has been a farce, and a lie, exclusively thanks to corruption rampant at the now documentedly incompetent Securities And Exchange Commission.

• The bankers are coming: Banker Plan Would Fund Super-PACs to Sway U.S. Senate Elections (Bloomberg)
• Risk Increases of Prolonged World Slowdown, BOJ’s Miyao Says (Bloomberg)
• Spain Seeks to Stem Its Banking Crisis (WSJ)
• Deadly shooting mars new Quebec premier's victory rally (NBC)
• Democrats Keep Tax-Raising Focus On Top 2% Of Households (Bloomberg)
• Merkel Swings Into 2013 Election Mode Evoking Crisis, China (Bloomberg)
• Europe’s money market funds future in focus (FT)
• Pressure Mounts on ECB to Bring Down Bond Yields (Reuters)
• Swiss bank vows to hold franc down (FT)
• Australia economy still solid in Q2 despite GDP miss, but threats mount (Reuters)
• Clinton Brings to Beijing Plea for Maritime Solution (Bloomberg)
• The End of a 1,400-Year-Old Business (BusinessWeek)

"Recessions are a natural economic feature and their regular occurrence is healthy and indeed essential," is how Deutsche's Jim Reid introduces his investigation into post-Fed un-natural business cycles. Without them there is a serious danger of bubbles and the misallocation of resources as the further market participants detach themselves from the last downturn the more they tend to under-estimate risk. We, like Jim, would argue that the reason the Great Financial Crisis was so deep was due to the authorities continued refusal to let the business cycle take its natural course. The three 'super-cycles' between 1982 and 2007 were the exception rather than the norm, one where Central Banks and Governments had almost total flexibility over policy. Not only are we battling with the huge structural problems that the post-credit crisis world brings, we are fighting it without much policy flexibility and are indeed being forced into a reversal of stimulus at arguably exactly the wrong time. So it all adds up to a return to more normal length business cycles in our opinion - or perhaps even shorter.

Some hours ago Spain finally bit the bullet, and after months of waffling had no choice but to hand over €4.5 billion (the first of many such cash rescues) in the form of a bridge loan to insolvent Bankia, which last week reported staggering losses (translation: huge deposit outflows which have made the fudging of its balance sheet impossible). As a reminder, in June Spain formally announced it would request up to €100 billion in bailout cash for its insolvent banking system, which subsequently was determined would come from the bank rescue fund, the Frob, which in turn would be funded with ESM debt which subordinates regular Spanish bonds, promises to the contrary by all politicians (whose job is to lie when it becomes serious) notwithstanding. And while Rajoy has promised that the whole €100 billion will not be used, the truth is that considering the soaring level of nonperforming loans in Spain - the biggest drain of both bank capital and liquidity - it is guaranteed that the final funding need for Spain's banks will be far greater. As a further reminder, Deutsche Bank calculated that when (not if) the recap amount hits €120 billion, Spanish total debt/GDP would soar to 97% in 2014 from an official number of 68.5% in 2011 (luckily the endspiel will come far sooner than that). But all of that is well-known, and what we wanted to focus on instead was the fact that bank bailout notwithstanding, Spain will have no choice but to demand a full blown rescue within a few short month for one simple reason: its cash will run out.

Upcoming calls from Ben and Mario to the governments?

Get your act together, there’s just so much that can be done.

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