Global Economy

The World Gold Council have just published their commentary on gold’s price performance in various currencies, its volatility statistics and correlation to other assets in the quarter - Gold Q2, 2012 - Investment Statistics and Commentary. It provides macroeconomic context to the investment statistics published at the end of each quarter and highlights emerging themes relevant to gold’s future development. One of their key findings is that gold will act as hedge against possible coming dollar weakness and gold will act as a "currency hedge in the international monetary system." The key findings of the World Gold Council’s report are presented inside.

With Corn hitting its highs again, we are reminded that global food production has been hitting constraints as rising populations and changing diets hit against flattening productivity, water and fertility constraints, and the likely early effects of climate change. As was described in the recent all-encompassing theory of global-collapse, there is general agreement that one of the contributing factors to the rolling revolutions beginning at the end of 2010 was increasing food prices eating into already strained incomes. It is unclear how much impact easing has had on food prices this time, weather has very much made its presence felt (as we noted here). From one omnipotent force (central bankers) to another (hand of god), the fear is that more broadly, food is likely to be a more persistent problem than oil supply. This is because we require almost continual replenishment of food to stay alive and avoid severe social and behavioral stress - food is the most inelastic part of consumption. This says nothing of the pernicious inflationary impact that will likely quell the kind of free-flowing printing so many hope to see from China et al.

By now it should be more than clear that the entire hope-based, short-squeeze driven, algo-mediated rally is the result of the last traces of hope: with the US economy openly in free-fall mode, housing supported only by once again increasing shadow inventory (and even that myth is starting to falter following today's existing home sales update), corporate profits just barely holding in as a result of the last possible cuts into the bone via personnel terminations now that YoY revenue numbers have once again sloped lower and the corporate growth cycle has turned, there is little sustaining the market aside from the mysterious seller of endless vol, which could be well, anyone, and some quiet prayer that China may step in and once again, like back in 2009, be the marginal economic dynamo that restarts the global economy one more time. It would do that in the conventional way, of course: by easing as much as it possibly can. There is, however, one problem with this: food prices. As everyone knows the product the PBOC pays more attention to than anything else is food: pork, soy, corn, etc., and particularly food prices. Because if there is one thing that can cause social upheavals in the world's most populous country, it is a rerun of the spring of 2011 when as a result of global easing, we saw not only the Arab Spring, but violent flare ups throughout China. Which brings us to today's topic: black swans. Deep fried black swans.  As UBS explains the record drought that has gripped America may well have far-reaching implications beyond just the price of corn in the US. If, indeed, adverse US climatic conditions spread, and it appears they already have as "the monsoon season, which is critical for that country’s agricultural production, is 22% below normal conditions for the year" it means that Asian food prices will broadly be the next commodity sector to go sky high, and with that kill any hope of either an RRR cut, or an outright reduction in the PBOC's Interest Rate.

There is a strange delayed reaction between the initial exposure of weakness in the financial system and the public’s realization of the truth, sort of like Wile E. Coyote dashing off a cliff in the cartoons only to continue running in mid-air above the abyss below.  It is a testament to the fact that beyond the math, there is an undeniable power of psychology in our economy.  The investment world naively believes it can fly, even with the weight of endless debt around its ankles, and for a very short time, that pure delirious oblivious belief sustains the markets.  Eventually, though, gravity always triumphs over fantasy…

• Who Needs the Euro When You Can Pay With Deutsche Marks? (WSJ)
• Now it's personal and ad hominem: Is German Economist Exacerbating Euro Crisis? (Spiegel)
• Bernanke Outlines Range Of Options For Additional Easing (Bloomberg)
• Italy's Monti says serious worry Sicily region may default (Reuters)
• Libor ‘structurally flawed’, says Fed (FT)
• Some Firms Opt to Bring Manufacturing Back to U.S. (WSJ)
• ECB Signals Support for Easing Irish Debt Terms (WSJ)
• China’s Wen Warns Of Severe Job Outlook As Growth Yet To Return (Bloomberg)
• Hollande scraps tax breaks on overtime (WSJ)
• China’s June Home Prices Rebound As Sentiment Improves (Bloomberg)

The IMF just took a bucket of bath-salts to world economies as it slashes growth expectations for every major global economy (and emerging nations suffer too). Noting that Q1's upward surprise was "partly due to temporary factors", they reduce 2012's overall global growth to 3.5% adding that developments during the second quarter have been worse. Job creation has been hampered - with unemployment high in many advanced economies, especially among the young in the euro area periphery; but incoming data from the US also suggests less robust growth than forecast previously. While distortions to seasonal adjustment and payback from the unusually mild winter explain some of the softening, there also seems to be an underlying loss of momentum. Growth momentum has also slowed in various emerging market economies, notably Brazil, China, and India. This partly reflects a weaker external environment, but domestic demand has also decelerated sharply in response to capacity constraints. The baseline projections in this WEO Update incorporate weaker growth through much of the second half of 2012 in both advanced and key emerging market economies, reflecting the setbacks to the global recovery. Downside risks to this weaker global outlook continue to loom large. The most immediate risk is still that delayed or insufficient policy action will further escalate the euro area crisis. How long before those Q4 hockey-stick earnings forecasts get reduced?

In the US and Europe we have slowly come to the realization that traditional accommodative economic policies leave, and have left, the real economy limp.  Wildly divided governments don't help, but beyond the fact that western decision making bodies are polarized, it is abundantly clear that the panacea for the global economy is not even on the table right now.  The western world has been thrown into a bout of sovereign game theory, and by the constructs of game theory itself, one country will "win," while everyone else will lose to varying degrees.  But that we are such a highly integrated global economy--the reason the whole world is heading towards recession right now--means that a solution must incorporate every economy around the world.  The current game Europe is playing is bound to fail because if one country gets their way, others lose by definition.

Greece's Eurozone exit is almost done.

The Fed is promising once again to pound nails with the only tools in its toolbox, a saw and a chisel. The "nails" the Fed is trying to pound down are unemployment and deflation. Needless to say, whacking these big nails with a handsaw and a chisel is completely useless: they can't get the job done. The Fed claims all sorts of supernatural powers to sink nails at will--"unconventional monetary policy," quantitative easing, money dropped from helicopters and so on. But all it really has are two tools which have no positive effect on unemployment or the real economy.

1. The Fed can manipulate interest rates to near-zero
2. The Fed can shove "free money" to the banks

That's it. That's all the tools the Fed has in its toolbox. Let's consider what these tools accomplish in the real world.

European equities are seen softer at the North American crossover as continued concerns regarding global demand remain stubborn ahead of tonight’s Chinese GDP release. Adding to the risk-aversion is continued caution surrounding the periphery, evident in the Spanish and Italian bourses underperforming today. A key catalyst for trade today has been the ECB’s daily liquidity update, wherein deposits, unsurprisingly, fell dramatically to EUR 324.9bln following the central bank’s cut to zero-deposit rates. The move by the ECB to boost credit flows and lending has slipped at the first hurdle, as the fall in deposits is matched almost exactly by an uptick in the ECB’s current account. As such, it is evident that the banks are still sitting on their cash reserves, reluctant to lend, as the real economy is yet to see a boost from the zero-deposit rate. As expected, the European banks’ share prices are showing the disappointment, with financials one of the worst performing sectors, and CDS’ on bank bonds seen markedly higher. A brief stint of risk appetite was observed following the release of positive money supply figures from China, particularly the new CNY loans number, however the effect was shortlived, as participants continue to eye the upcoming growth release as the next sign of health, or lack thereof, from the world’s second largest economy.

Something is different this morning. Whether it is the aftermath of yesterday's inexplicable 10 Year auction demand spike, or more explicable plunge in the ECB's deposit facility usage, or, the fresh record low yield in the supreme risk indicator, Swiss 2 Year bonds, now at under 0.5%, market participants are realizing that the status quo is changing, leading to fresh 2 year lows in the EURUSD which was at 1.2175 at last check, sliding equity futures (those are largely irrelevant, and purely a function of what Simon "Harry" Potter does today when the clockworkesque ramp at 3:30pm has the FRBNY start selling Vol like a drunken sailor), and negative yields also for German, French, and Finland, with Austria and Belgium expected to follow suit as the herd scrambles into the "safety" of the core (which incidentally is carrying the periphery on its shoulders but who cares about details). Either way, Europe's ZIRP is finally being felt, only not in a way that many had expected and hoped and instead of the money being used to ramp risk, it is further accelerating the divide between risky and safe assets. Look for the Direct take down in today's 30 Year auction: it could be a doozy.

If anyone still actually cares, or trades, we just saw the third California muni bankruptcy in two weeks, German bonds priced at record low yields, and Spanish 2 year nominal yields just hit all time lows of -0.37%. Abroad Spain promised to crush its middle class even more by impairing retail held sub debt and hybrids, while forcing them to pay more taxes, a move which will lead to some spectacular Syntagma Square riotcam moments, yet which has sent Spanish bonds slightly higher. As for US equity futures, they continue the headless chicken dance higher even as company after company now rushes to preannounce horrifying Q2 earnings. And that's it in a nutshell.

Josh Barro of Bloomberg has an interesting theory.  According to him, conservatives in modern day America have become so infatuated with the school of Austrian economics that they no longer listen to reason.  It is because of this diehard obsession that they reject all empirical evidence and refuse to change their favorable views of laissez faire capitalism following the financial crisis.  Basically, because the conservative movement is so smitten with the works of Ludwig von Mises and F.A. Hayek, they see no need to pose any intellectual challenge to the idea that the economy desperately needs to be guided along by an “always knows best” government; much like a parent to a child.  CNN and Newsweek contributor David Frum has jumped on board with Barro and levels the same critique of conservatives while complaining that not enough of them follow Milton Friedman anymore.

To put this as nicely as possible, Barro and Frum aren’t just incorrect; they have put their embarrassingly ignorant understandings of Austrian economics on full display for all to see.

If we look at the global economy with unclouded eyes, we reach this conclusion: "This whole thing is about leverage." If leverage doesn't increase, the system implodes. But since collateral is disappearing from the global economy like sand castles in a rising tide, and disposable income has stagnated, there is no foundation for more leverage. As a result, the State/finance cartel has only one choice: increase leverage by whatever means are left. There are only two:

1. Allow banks to claim phantom assets as capital/reserves
2. Lower interest rates so stagnant income can leverage ever greater quantities of debt

The State/finance Empire and its army of academic toadies (economists) must cloak this reliance on leverage from the citizenry, lest they grasp the precariousness of the entire financial system. As the economic Establishment is discredited by reality (that their sputtering reflation policies have come at an unbearable cost is now undeniable), their attempts to discredit their critics become increasingly comic: only PhD economists in the employ of the Empire are qualified to comment on the Empire's policies, etc.

The global economy is an entangled affair, make no mistake in your calculation here, and the numbers from around the globe are telling and will affect both the U.S. bond and equity markets. Much of the financing for the Emerging Markets was provided by the European banks and as they pull back and reorganize based not just on Basel III but based upon problems of the sovereign where they are domiciled the situation exacerbates. Two of the world’s financial axises are slowing and troubled and to not think that this will not affect America will lead you to conclusions causing you to play the Great Game badly. What did the meeting of the European Finance Ministers accomplish; not much. They nodded to the Spanish banks and agreed to inject $30 billion by the way of the sovereign, increasing the debt of Spain, with veiled promises of a new ESM fund which would lend money directly to the banks at some point in the future and this point is highly subjective depending upon to whom you listen. The Spanish claim within days or weeks while the Germans indicate it may be sometime next year. There is now a “maybe-maybe” timeline in Europe for almost anything as the weaker nations prod the stronger nations for more money.