Warning: Not for the faint of heart.
A riddle, wrapped in a mystery, inside an enema.
One of the dirty little secrets of the stock market rally is that the rising corporate profits that powered it are largely phantom profits. Why are they phantom? Because they are artifacts of currency devaluation, not an increase in efficiency or production of goods and services. Though few domestic observers make mention of it, the large, global U.S.-based corporations are now dependent on non-U.S. sales for about 40% of their revenues (50% and up for many companies) and virtually all their profit growth. Overseas sales are made in the local currency: the euro, yen, renminbi, Australian dollar, Canadian dollar and so on, and the profits are stated in U.S. dollars on corporate profit and loss statements. In 2002, 1 euro of profit earned by a U.S. global corporation equaled $1 in profit when converted to U.S. dollars. That same 1 euro profit swelled to $1.60 in 2008 as the U.S. dollar depreciated against the euro. That $ .60 of profit was phantom, an artifact of the depreciating dollar; it did not result from a higher production of goods and services or greater efficiencies.
Aspirin at the door
The European Central Bank, in a very misguided attempt to protect itself, has now opened Pandora’s Box. I doubt if they even realize what they have done; but they will, most assuredly they will. The consequences of their horrendous mistake will soon be upon them as institutions not coerced or forced into buying European sovereign debt will be leaving the playing field en masse as the realization dawns upon investors of just what has taken place. You cannot fool all of the people all of the time and the people that manage money for a living are not a forgiving group when governments try to supersede their lawful rights.
All the pseudo-scientific yada-yada on economic theory are just hollow bones thrown to journalists and pundits to have something to “chew” on and write about. The only thing that matters is the monetization of more and more government debt, and how to sell it to the public. Paul Krugman would argue that despite all the “quantitative easing” inflation has not really picked up. At zero percent interest rates, money has no preference – there is no opportunity cost of just “lying around” without interest. Investing money for 4 years for 0.15% return is not “riskless return” – it’s “return-less risk”. Perversely, the Fed has created a situation where raising interest rates would probably lead to inflation. It is boxed into ZIRP (zero interest rate policy) for infinity. Things will get serious once the Fed adopts a policy called N-GDP targeting. Instead of inflation, the Fed will try to “target” nominal GDP. If real GDP growth is zero, the nominal GDP growth will be made up entirely of inflation. Debt is a nominal unit, and it is supported by nominal GDP. In order to keep the ratio between GDP and debt halfway bearable, GDP must be inflated. It is a tax on everybody holding dollars, since the value of those will decline. Meanwhile, the Japanese are resorting to stealth interventions to break the Yen’s strength. Currency wars have gone from “cold” to “hot”. The Fed’s printing of dollars is forcing other central banks to purchase them and selling their own currency in the hope of stemming their own currency’s rise. This makes them involuntary buyers of Treasury bills and bonds, making it easier for the US government to finance its deficit.
One thing is for certain, the litigation is beginning to shift from minor players to major players at the core of the Financial Crisis. Investors take note, this is a major shift and needs to be monitored as it will have major implications for market dynamics going forward.
While there is precious little in terms of detail coming out of the latest and literally greatest "fake" bond story in history, the BBC has been kind enough to release the pictures of the boxes that the supposedly fake bonds were contained in. While we reserve judgment on the authenticity of the bonds, what we wonder is whether the boxes were also fake. Because while we can understand why someone would counterfeit the Treasury paper itself, what we don't get is why someone would go the extra effort to also create a "fake" compartment in which to store it. In this case a compartment that is property of the "CHICAGO FEDERAL RESERVE SYSTEM." Perhaps Fed uberdove and Chicago Fed President Charles Evans will be kind enough to explain why Versailles Treaty Chicago Fed crates are floating around in Europe (and filled with $6 trillion in supposedly fake bearer bonds)?
Today, Rand’s fictional world has seemingly become a reality – endless bailouts and economic stimulus for the unproductive at the expense of the most productive, and calls for additional taxation on capital investment. The shrug of Rand’s heroic entrepreneurs is to be found today within the tangled ciphers of corporate and government balance sheets. The US Federal Reserve has added more than $2 trillion to the base money supply since 2008 – an incredible and unprecedented number that is basically a gift to banks intended to cover their deep losses and spur lending and investment. Instead, as banks continue their enormous deleveraging, almost all of their new money remains at the Fed in the form of excess reserves. Corporations, moreover, are holding the largest amounts of cash, relative to assets and net worth, ever recorded. And yet, despite what pundits claim about strong balance sheets, firms’ debt levels, relative to assets and net worth, also remain near record-high levels. Hoarded cash is king. The velocity of money (the frequency at which money is spent, or GDP relative to base money) continues to plunge to historic lows. No wonder monetary policy has had so little impact. Capital, the engine of economic growth, sits idle – shrugging everywhere.
Sprott strategist John Embry has never been a fan of the existing financial system. Today, he makes that once again quite clear in this interview with Egon von Grayerz' Matterhorn Asset Management in which he says: "I think that the current financial system, as we know it, will be totally destroyed, probably sooner rather than later. The next system will require gold backing to have any legitimacy. This has happened many times in history." Needless to say, he proceeds to explain why a monetary system based on gold, one in which one, gasp, lives according to one's means, is better. Logically, he also explains why the status quo, whose insolvent welfare world has nearly a third of a quadrillion in the form of unfunded future liabilities, will never let this happen. Much more inside.
The task of the financial/political/media Status Quo is to convince Americans to overlook the abundant evidence of economic deterioration and focus on heavily juiced "evidence" of robust "growth." The game plan is this: if the Status Quo can convince you that the economy has righted itself and from here on in everything will get better and better, every day and in every way, then we will abandon financial rationality and start buying homes we can't afford on credit, cars we can't afford on credit and boatloads of stuff from China that we don't need on credit (of course looking cool is a "need," i.e. having an iPad to carry around). In other words, believing it is so will make it so. That is the essence of the campaign to stimulate "animal spirits" confidence: though the economy is actually tanking, if they can only convince us the Dow is moving to 15,000 and then on to 20,000, jobs are being created left and right and things are looking up everywhere, then the resulting piranha-like shopping-feeding-frenzy will create the expansion that is currently chimerical.
Now everybody's bank bashing, of course the reason to bash the banks is 4 years old, despite Bove-like analysis to the contrary. I will discuss this on CNBC for a FULL HOUR tomorrow from 12 pm to 1pm.
Busy day in the economic headlines arena, with Housing Start, Claims PPI and Philly Fed all on deck. Goldman summarizes the expectations and the upwardly biased consensus.
- Europe Demands More Greek Budget Controls in Bid to Forge Rescue (Bloomberg)
- Moody's Warns May Downgrade 17 Global Banks, Securities Firms (Reuters)
- Officials at Fed Split on More Bond Buys (Hilsenrath)
- Greek deal delays pressure periphery (Reuters)
- Talk, but No Action, to Break US Grip on World Bank Job (Reuters)
- Greek Rhetoric Turns Into Battle of Wills (FT)
- Greece Seeks Monday Bailout Deal, EU Questions Remain (Reuters)
- US Lawmakers Announce Payroll Tax-Cut Deal (Reuters)
- China Leader-In-Waiting Xi Woos and Warns US (Reuters)
- China's FDI falls 0.3% in Jan (Reuters)
Make no mistake, inflation is creeping into the system in a big way. And the Fed will not raise interest rates to fight it until it’s far too late. Debt levels are simply too high for the Federal Government and US corporations, particularly the large banks which the Fed has been doing everything it can to prop up.